ARADIGM CORP, S-1/A, 1996-06-18

ARADIGM CORP
S-1/A, 1996-06-18
ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 17, 1996
REGISTRATION NO. 333-4236
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

AMENDMENT NO. 2
TO

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------

ARADIGM CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

------------------------

<TABLE>
<S> <C> <C>
CALIFORNIA 3845 94-3133088
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>

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26219 EDEN LANDING ROAD
HAYWARD, CA 94545
(510) 783-0100
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

------------------------

RICHARD P. THOMPSON
PRESIDENT AND CHIEF EXECUTIVE OFFICER
ARADIGM CORPORATION
26219 EDEN LANDING ROAD
HAYWARD, CA 94545
(510) 783-0100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

------------------------

COPIES TO:

<TABLE>
<S> <C>
JAMES C. KITCH SCOTT T. SMITH
JEFFREY S. ZIMMAN JOHN L. DONAHUE
JOHN W. VANDER VORT SALLY BRAMMELL
COOLEY GODWARD CASTRO HUDDLESON & TATUM PILLSBURY MADISON & SUTRO LLP
ONE MARITIME PLAZA, 20TH FLOOR 235 MONTGOMERY STREET
SAN FRANCISCO, CA 94111 SAN FRANCISCO, CA 94104
(415) 693-2000 (415) 983-1000
</TABLE>

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the Registration Statement becomes effective.
------------------------

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, please check the following box. / /

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement number for the same offering. / /

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /

------------------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.

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<PAGE> 2

ARADIGM CORPORATION

CROSS-REFERENCE SHEET SHOWING LOCATION IN PROSPECTUS
OF INFORMATION REQUIRED BY ITEMS IN PART I OF FORM S-1
(PURSUANT TO ITEM 501(B) OF REGULATION S-K)

<TABLE>
<CAPTION>
FORM S-1
ITEM NUMBER AND HEADING LOCATION IN PROSPECTUS
------------------------------------------ ------------------------------------------
<C> <S> <C>
1. Forepart of the Registration Statement and
Outside Front Cover Page of
Prospectus.............................. Forepart of the Registration Statement and
Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages
of Prospectus........................... Inside Front Cover Page and Outside Back
Cover Page
3. Summary Information, Risk Factors and
Ratio of Earnings to Fixed Charges...... Prospectus Summary; Risk Factors
4. Use of Proceeds........................... Use of Proceeds
5. Determination of Offering Price........... Outside Front Cover Page of Prospectus;
Underwriting
6. Dilution.................................. Dilution
7. Selling Security Holders.................. Not Applicable
8. Plan of Distribution...................... Outside Front Cover Page and Inside Front
Cover Page; Underwriting
9. Description of Securities to be
Registered.............................. Prospectus Summary; Capitalization;
Description of Capital Stock
10. Interests of Named Experts and Counsel.... Legal Matters; Experts
11. Information with Respect to the
Registrant.............................. Outside Front Cover Page; Inside Front
Cover Page; Prospectus Summary; Risk
Factors; Dividend Policy;
Capitalization; Selected Financial Data;
Management's Discussion and Analysis of
Financial Condition and Results of
Operations; Business; Management;
Certain Transactions; Principal
Shareholders; Description of Capital
Stock; Shares Eligible for Future Sale;
Financial Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................. Not Applicable
</TABLE>
<PAGE> 3

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.

PROSPECTUS (SUBJECT TO COMPLETION)
Dated June , 1996

2,500,000 Shares

LOGO

Common Stock
------------------------

All of the 2,500,000 shares of Common Stock (the "Common Stock"), offered
hereby are being sold by Aradigm Corporation ("Aradigm" or the "Company"). Prior
to this offering, there has been no public market for the Common Stock of the
Company. It is estimated that the initial public offering price will be between
$11.00 and $13.00 per share. See "Underwriting" for a discussion of the factors
to be considered in determining the initial public offering price. Application
has been made to have the Common Stock approved for quotation on the Nasdaq
National Market under the symbol "ARDM."

------------------------

THIS OFFERING INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6 OF THIS PROSPECTUS.

------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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<TABLE>
<S> <C> <C> <C>
Underwriting
Price to Discounts and Proceeds to
Public Commissions(1) Company(2)
- ------------------------------------------------------------------------------------------------
Per Share................................. $ $ $
Total(3).................................. $ $ $
</TABLE>

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(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses payable by the Company, estimated to be $900,000.
(3) The Company has granted the Underwriters an option, exercisable within 30
days of the date hereof, to purchase an aggregate of up to 375,000
additional shares at the Price to Public less Underwriting Discounts and
Commissions to cover over-allotments, if any. If all such additional shares
are purchased, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."

------------------------

The Common Stock is offered by the several Underwriters named herein when,
as and if received and accepted by them, subject to their right to reject orders
in whole or in part and subject to certain other conditions. It is expected that
delivery of certificates for the shares will be made at the offices of Cowen &
Company, New York, New York, on or about , 1996.

------------------------

COWEN & COMPANY

OPPENHEIMER & CO., INC.
INVEMED ASSOCIATES, INC.

, 1996
<PAGE> 4

[INSERT PICTURE]

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
------------------------

Aradigm(TM), AERx(TM) and SmartMist(TM) are trademarks of the Company.
Trade names and trademarks of other companies appearing in this Prospectus are
the property of their respective holders.

2
<PAGE> 5

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and financial statements and notes appearing elsewhere in this
Prospectus. Unless otherwise indicated, all information in this Prospectus (i)
assumes no exercise of the Underwriters' over-allotment option and (ii) reflects
a three for two split of the capital stock effected prior to the effectiveness
of this offering and (iii) reflects the conversion of all outstanding Preferred
Stock of the Company into Common Stock upon the closing of this offering.

THE COMPANY

Aradigm is engaged in the development of novel, hand-held pulmonary drug
delivery systems designed to enhance the delivery and effectiveness of a number
of existing and development stage drugs and reduce the need for injectable drug
therapy. Subject to applicable regulatory clearances and approvals, Aradigm
plans to commercialize its proprietary technologies on two product platforms:
(i) the SmartMist system, which is designed to improve the effectiveness of
metered dose inhalers, such as those used to deliver asthma medications, and
(ii) the AERx system, which creates aerosols from liquid drug formulations for
delivery locally to the lung or into the blood stream via the lung. The Company
believes that its systems, if successfully developed and approved or cleared for
marketing, can be used to deliver existing drugs for a variety of applications,
including the treatment of respiratory diseases, pain management and diabetes
management, as well as to deliver imaging agents for certain lung diagnostic
applications. In addition, Aradigm's potential products also may offer a
promising means of delivery for new drugs under development by pharmaceutical
and biotechnology companies.

To date, the pulmonary drug delivery market has been comprised primarily of
drugs for treatment of local diseases of the lung, such as asthma, cystic
fibrosis, emphysema and chronic obstructive pulmonary disease. Sales in the
United States of drugs used in pulmonary delivery products for the treatment of
lung diseases exceeded $1.7 billion in 1995. In recent years, pharmaceutical and
drug delivery companies, recognizing the potential benefits of utilizing the
lung for systemic drug administration, have increased efforts to develop
products and systems for pulmonary drug delivery. Industry sources estimate that
the potential worldwide market for pulmonary drug delivery products may exceed
$9 billion annually by the year 2000.

Although widely used, existing systems for pulmonary drug delivery
generally fail to achieve precise, reproducible delivery of the desired drug
dose, either locally or systemically. Aradigm has combined core competencies in
physics, electrical engineering, mechanical engineering and pharmaceutical
sciences to overcome the limitations of conventional pulmonary drug delivery
systems. Through this integrated approach, the Company has developed
technologies which address each of the four key elements it believes are
required for the development of effective pulmonary drug delivery products: ease
of drug formulation; efficient precision aerosol generation; automated
breath-controlled delivery and patient compliance monitoring.

The SmartMist system incorporates the Company's breath control and
compliance monitoring technologies for use with standard metered dose inhalers
to improve the treatment of asthma and other respiratory diseases. In May 1996,
the Company obtained 510(k) clearance from the FDA for the initial version of
the SmartMist Asthma Management System, its first application of the SmartMist
platform, and expects to complete development and commence marketing of the
commercial version of the SmartMist Asthma Management System in the next 12
months. There can be no assurance that the Company will be able to develop and
market successfully the commercial version of the SmartMist Asthma Management
System or that changes made during such development will not necessitate the
submission of a second 510(k) notice. Depending on manufacturing costs and other
factors, the Company believes that the price to consumers of the Company's
SmartMist Asthma Management System will be approximately $400 per unit.

The AERx system is based on a novel and proprietary aerosol generation
technology capable of producing low velocity, small particles suitable for
delivery to the deep lung. By also incorporating the Company's breath control
and compliance monitoring technologies, the AERx system is designed to optimize
pulmonary delivery. The Company's lead AERx product under development is the
AERx Pain Management System, which is designed to deliver morphine systemically
by inhalation for the treatment of pain. In February 1996,

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<PAGE> 6

the Company filed an Investigational New Drug ("IND") application for this
indication and intends to commence clinical trials in the United States in
mid-1996. The Company also is conducting clinical feasibility studies of its
AERx system for the delivery of insulin and a pulmonary diagnostic imaging
agent.

Aradigm's goal is to become a leader in the development and
commercialization of pulmonary drug delivery products. The Company's development
strategy is to focus initially on early product opportunities which can take
advantage of shorter regulatory cycles and to establish broad applicability of
its systems for a variety of drugs. Having obtained 510(k) clearance to market
its SmartMist Asthma Management System, Aradigm expects to continue pursuing
this strategy by developing the AERx system to deliver existing pharmaceuticals,
such as morphine, insulin and certain diagnostic imaging agents, that have known
efficacy and safety profiles. In addition, the Company will seek to enter into
multiple collaborative relationships for the development of new products and for
the marketing and sale of products utilizing its technology, but the Company has
not yet established any such relationship and there can be no assurance that it
will be able to do so.

The Company believes that its products under development may improve the
management of certain diseases by reducing the cost of therapy, enhancing
patient management and compliance and providing an improved means to administer
drugs outside of the hospital setting.

The Company was incorporated in California in January 1991. The Company's
principal executive offices are located at 26219 Eden Landing Road, Hayward, CA
94545, and its telephone number is (510) 783-0100.

RISK FACTORS

The Company's plans and intentions with respect to the development and
commercialization of its technologies are subject to a number of risks and
uncertainties. There can be no assurance that the Company can obtain required
regulatory clearances and approvals or that the Company will be able to develop
and commercialize successfully any of its potential products. These and other
risks of investing in the Common Stock include the following factors: Early
Stage of Development; History of Losses; Anticipated Future Losses; Uncertainty
of Successful Product Development; Uncertainty of Successful Product
Commercialization; Dependence Upon Entering Into Collaborations; Limited
Manufacturing Experience; Risk of Scale-up Failure; Future Capital Needs;
Uncertainty of Additional Funding; Dependence Upon Proprietary Technology;
Uncertainty of Patents and Proprietary Technology; Government Regulation;
Uncertainty with Preclinical and Clinical Testing; Highly Competitive Markets;
Risk of Alternative Therapies; Dependence on Key Personnel; Managing Growth;
Exposure to Product Liability; Uncertainty Related to Health Care Reform;
Uncertainty Related to Third-Party Reimbursement; Hazardous Materials; Control
by Officers, Directors and Principal Shareholders; Lack of Public Market and
Possible Volatility of Stock Price; Adverse Impact of Shares Eligible for Future
Sale; Absence of Dividends; Dilution; and Management's Board Discretion to
Allocate Proceeds. See "Risk Factors."

4
<PAGE> 7

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company.............. 2,500,000 shares
Common Stock to be outstanding after the
offering....................................... 10,068,410 shares(1)
Use of proceeds.................................. To fund research and development efforts,
manufacturing process development,
manufacturing capacity, working capital
and for other general corporate purposes.
See "Use of Proceeds."
Proposed Nasdaq National Market symbol........... ARDM
</TABLE>

SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------- ------------------
1993 1994 1995 1995 1996
------- ------- ------- -------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Contract revenues................................................ $ -- $ 125 $ 155 $ 125 $ 86
Loss from operations............................................. (1,667) (3,737) (5,619) (1,194) (1,744)
Net loss......................................................... (1,655) (3,733) (5,433) (1,120) (1,608)
======= ======= ======= ======== =======
Pro forma net loss per share(2).................................. $ (0.76) $ (0.21)
Shares used in computing pro forma net loss per share(2)......... 7,196 7,510
</TABLE>

<TABLE>
<CAPTION>
MARCH 31, 1996
--------------------------
ACTUAL AS ADJUSTED(3)
------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................................................................... $10,779 $ 37,779
Working capital................................................................................... 10,053 37,053
Total assets...................................................................................... 11,817 38,817
Deficit accumulated during the development stage.................................................. (13,676) (13,676)
Total shareholders' equity........................................................................ 10,599 37,599
</TABLE>

- ------------------------------
(1) Excludes 88,689 shares of Common Stock reserved for issuance upon exercise
of stock options, and 196,391 shares of Common Stock issuable upon exercise
of warrants, outstanding, respectively, as of March 31, 1996. See
"Management -- Benefit Plans" and "Description of Capital Stock."

(2) See Note 1 of Notes to Financial Statements for an explanation of shares
used in computing pro forma net loss per share.

(3) Adjusted to give effect to the sale of 2,500,000 shares of Common Stock
offered by the Company hereby at an assumed initial public offering price of
$12.00 per share and after deducting estimated underwriting discounts and
commissions and estimated offering expenses payable by the Company. See "Use
of Proceeds" and "Capitalization."

5
<PAGE> 8

The discussion in this Prospectus contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed here. Factors that could cause or contribute to
such differences include, but are not limited to, those discussed in the
sections entitled "Risk Factors," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business," as well as those
discussed elsewhere in this Prospectus.

RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a high
degree of risk. The following factors should be considered carefully in
evaluating the Company and its business before purchasing shares of Common Stock
offered hereby.

EARLY STAGE OF DEVELOPMENT HISTORY OF LOSSES

Aradigm, a development stage company incorporated in January 1991, has a
limited history of operations and has generated only limited revenues to date,
primarily from two short-term research and feasibility agreements and interest
income. No revenues have been generated by sales of products or product
royalties. The Company has no products other than the initial version of its
SmartMist Asthma Management System approved for commercial sale, and all of its
potential products are in various stages of research or development. There can
be no assurance that the Company's research and development efforts will be
successful or that regulatory clearance for the sale of any of its potential
products will be obtained or that its potential products can be manufactured at
an acceptable cost. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

HISTORY OF LOSSES; ANTICIPATED FUTURE LOSSES

The Company has not been profitable since inception and, through March 31,
1996, had incurred a cumulative deficit of approximately $13.7 million. The
Company expects to continue to incur substantial and increasing losses over at
least the next several years as the Company's research and development efforts,
pre-clinical and clinical testing activities and manufacturing scale-up efforts
expand and as the Company plans and builds its late stage clinical and early
commercial production capabilities. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

UNCERTAINTY OF SUCCESSFUL PRODUCT DEVELOPMENT

The Company's SmartMist and AERx systems are still in the prototype stage
and will require further development and regulatory approvals before they can be
commercialized. While the Company is developing a commercial version of the
SmartMist Asthma Management System that has received 510(k) clearance from the
United States Food and Drug Administration ("FDA"), there can be no assurance
that such commercial version of the device can be successfully developed or
marketed without further design modifications. There also can be no assurance
that any such modifications of the approved device will not necessitate the
submission of a second 510(k) notice. The Company's AERx platform is at an
earlier stage of development than the SmartMist device and is being tested using
a clinical bench prototype. The AERx system will require substantial additional
development, preclinical and clinical testing and investment. To further develop
its AERx system, the Company must address many engineering and design issues,
including ensuring that the device has the ability to deliver a consistent and
predictable amount of drug into the blood stream and can be manufactured
successfully as a hand-held system. No assurance can be made that the Company
will be successful in addressing these design, engineering and manufacturing
issues. Additionally, the Company may need to formulate and will need to package
drugs for delivery by its AERx system. There can be no assurance that the
Company will be able to successfully formulate and package such drugs. The
Company will need to demonstrate that drugs delivered by its AERx system remain
safe and efficacious and that over time and under differing storage conditions,
such drugs will not be subject to physical or chemical instability or other
problems that would prohibit the AERx system from being a commercially viable
product. While development efforts are at different stages for different
products, there can be no assurance that the Company will be successful in

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<PAGE> 9

any of its product development efforts, or that the Company will not abandon
some or all of its proposed products. Failure by the Company to successfully
develop its potential products in a timely manner could have a material adverse
effect on the Company. See "Business -- Aradigm Technology,"
"Business -- Strategy" and "Business -- Aradigm Product Applications."

UNCERTAINTY OF SUCCESSFUL PRODUCT COMMERCIALIZATION

Even if the Company successfully develops and obtains necessary regulatory
approvals for a product, the Company's success in commercializing such product
will be dependent upon many factors, including acceptance by health care
professionals and patients. Acceptance of the Company's products by health care
professionals and patients will largely depend on demonstrating that the
Company's products are competitive with alternate delivery systems with respect
to safety, efficacy and price. The Company believes that market acceptance of
its SmartMist system will depend largely upon health care professionals and
third party payors determining that the SmartMist system offers medical and
economic benefits over existing asthma therapies. In addition, the SmartMist
Asthma Management System, is specifically designed for the canisters currently
used by some of the leading manufacturers of MDIs. If, among other things, these
manufacturers exit from this business or decide to change the dimensions of
their canisters, the Company could be materially and adversely affected.
Moreover, MDIs use chlorofluorocarbons ("CFCs"), as a propellant for the
medication. The Company is aware of initiatives and international agreements to
ban CFCs, which if extended to MDIs, could have a material adverse effect on the
Company. No assurance can be made that the Company's products will prove
competitive or that the Company will be successful in taking products from their
current state of development to commercial introduction or success. Failure by
the Company to successfully commercialize its potential products in a timely
manner would have a material adverse effect on the Company. See
"Business -- Aradigm Technology," "Business -- Strategy" and
"Business -- Aradigm Product Applications."

DEPENDENCE UPON ENTERING INTO COLLABORATIONS

The Company currently lacks the marketing and sales experience, personnel,
distribution channels and other infrastructure needed to successfully
commercialize the SmartMist Asthma Management System and plans to rely, in part,
on a corporate partner possessing strong marketing and distribution resources.
The Company has no such partner and there can be no assurance that the Company
will obtain any such partner, or even if obtained, that such a partnering
arrangement will be successful. The Company's ability to successfully develop
and commercialize products based on its AERx system is largely dependent upon
the Company entering into collaborative arrangements with corporate partners
willing to make available to the Company resources to assist with such areas as
product development, preclinical and clinical trials, regulatory processes,
marketing, sales and distribution. In addition, the Company's ability to apply
the AERx system to any proprietary drugs, including new drugs, biotechnology
drugs or established drugs in proprietary formulations, will depend upon the
Company's ability to establish and maintain partnering or collaborative
arrangements with the holders of proprietary rights to such drugs. The Company
also has no collaborative agreements with corporate partners for products based
on its AERx system. There can be no assurance that the Company will enter into
such partnering or collaborative arrangements or, even if entered into, that
such arrangements will be successful. The failure of the Company to enter into
collaborative or partnering arrangements would have a material adverse effect on
the Company. See "Business -- Aradigm Technology," "Business -- Strategy" and
"Business -- Aradigm Product Applications."

LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP FAILURE

To date, the Company has manufactured components of its systems under
development only on the small scale needed for early stage trials. To achieve
the levels of production necessary to support late stage human clinical trials
and for commercialization of Aradigm's potential products, the Company will need
to scale up its current manufacturing capabilities. Significant additional work
must be completed prior to commercialization of the SmartMist Asthma Management
System. There can be no assurance such work will be completed successfully. In
addition, the Company is in the early stages of scaling-up the production of
clinical trial supplies of disposable drug packages for the AERx system. The
Company anticipates making significant

7
<PAGE> 10

expenditures to attempt to provide for the high volume manufacturing required
for multiple AERx system products, if such products are successfully developed.
There can be no assurance that manufacturing and quality control problems will
not arise as the Company attempts to scale up or that such scale up can be
achieved in a timely manner or at a commercially reasonable cost. Any failure to
surmount such problems could delay or prevent late stage clinical testing and
commercialization of the Company's products. The Company's manufacturing
facilities and those of its contract manufacturers will be subject to periodic
regulatory inspections by the FDA and other federal and state regulatory
agencies and such facilities will be subject to current Good Manufacturing
Practices ("cGMP") requirements of the FDA. There can be no assurance the
Company will satisfy such regulatory requirements and any failure to satisfy
cGMP and other requirements could have a material adverse effect on the Company.

The Company has engaged certain contract manufacturers in connection with
production of its prototype inhalation devices and the Company intends to use
one or more contract manufacturers to produce key components, assemblies and
subassemblies for its clinical trials and commercialization. There can be no
assurance that Aradigm will be able to enter into or maintain satisfactory
contract manufacturing arrangements. Certain components of Aradigm's potential
products are or will be available initially only from single sources. While the
Company has contingency plans for alternate suppliers, there can be no assurance
that the Company could find alternate suppliers for such components. Even if new
suppliers are secured, there can be no assurance that this would not
significantly reduce or eliminate the Company's ability to supply product during
any transition. A delay of or interruption in production could have a material
adverse effect on the Company. See "Business -- Manufacturing."

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING

The Company's operations to date have consumed substantial and increasing
amounts of cash. The negative cash flow from operations is expected to continue
and to accelerate in the foreseeable future. The development of the Company's
technology and proposed products will require a commitment of substantial funds
to conduct the costly and time-consuming research and preclinical and clinical
testing activities necessary to develop and refine such technology and proposed
products, to establish a late stage clinical and early commercial production
facility and to bring any such products to market. The Company's future capital
requirements will depend on many factors, including continued progress in the
research and development of the Company's technology and drug delivery systems,
the ability of the Company to establish and maintain favorable collaborative
arrangements with others, progress with preclinical and clinical trials, the
time and costs involved in obtaining regulatory approvals, the cost of
development and the rate of scale up of the Company's production technologies,
the timing and cost of its late stage clinical and early commercial production
facility, the cost involved in preparing, filing, prosecuting, maintaining and
enforcing patent claims and the need to acquire licenses or other rights to new
technology.

The Company will need to raise substantial additional capital to fund its
operations. There can be no assurance that additional financing will be
available on acceptable terms or at all. If additional funds are raised by
issuing equity securities, substantial dilution to shareholders may result. If
adequate funds are not available, the Company may be required to delay, reduce
the scope of, or eliminate one or more of its research or development programs
or obtain funds through arrangements with collaborative partners or others that
may require the Company to relinquish rights to certain of its technologies,
product candidates or products that the Company would not otherwise relinquish.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."

DEPENDENCE UPON PROPRIETARY TECHNOLOGY; UNCERTAINTY OF PATENTS AND PROPRIETARY
TECHNOLOGY

The field of aerosolized drug delivery is crowded and a substantial number
of patents have been issued in this field. Competitors and institutions may have
applied for other patents and may obtain additional patents and proprietary
rights relating to products or processes competitive with those of the Company.
Patents or other publications may hinder or prevent the Company from obtaining
patent protection being sought or draw into question the validity of patents
already issued to the Company. In addition, patents issued to others might
provide competitors with the ability to prevent the Company from making its
products or carrying out

8
<PAGE> 11

processes necessary for use of its products. The Company may not be able to
obtain a license under any such patent and may thereby be prevented from making
products or carrying out processes which are important or essential to the
business of the Company. Although issued patents are presumed valid under
federal law, none of the patents of the Company has been challenged in
litigation. There can be no assurance that any of such patents will be found
valid if challenged. There also can be no assurance that any of the applications
will issue or if issued will later be found valid if challenged. Further, there
can be no assurance that any issued patents or applications which might later
issue as patents will provide the Company with a degree of market exclusivity
sufficient for the Company to profitably compete against its competitors.
Pending United States applications are maintained in secret until they are
issued as patents and as such can not be searched by the Company. There may be
pending applications which will later issue as patents which will create
infringement issues for the Company. Further, patents already issued to the
Company or applications of the Company which are pending may become involved in
interferences and interferences could be resolved in favor of competitors of the
Company and involve the expenditure of substantial financial and human resources
of the Company.

The Company pursues a policy of having its officers, employees, consultants
and advisors execute proprietary information and invention agreements upon
commencement of their relationships with the Company as officers, employees or
consultants, which agreements provide that all confidential information
developed or made known to the individual during the course of the relationship
shall be kept confidential, except in specified circumstances. These agreements
also provide that all inventions developed by the individual on behalf of the
Company shall be assigned to the Company and that the individual will cooperate
with the Company in connection with securing patent protection on the invention
if the Company wishes to pursue such protection. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's inventions, trade secrets or other proprietary information in the
event of unauthorized use or disclosure of such information. Violation of such
agreements are difficult to police. See "Business -- Intellectual Property and
Other Proprietary Rights."

GOVERNMENT REGULATION; UNCERTAINTY WITH PRECLINICAL AND CLINICAL TESTING

All medical devices and new drugs, including the Company's products under
development, are subject to extensive and rigorous regulation by the federal
government, principally the FDA, and by state and local governments. Such
regulations govern the development, testing, manufacture, labeling, storage,
premarket clearance or approval, advertising, promotion, sale and distribution
of such products. If medical devices or drug products are marketed abroad, they
also are subject to regulation by foreign governments.

The regulatory process for obtaining FDA premarket clearances or approvals
for medical devices and drug products is generally lengthy, expensive and
uncertain. Securing FDA marketing clearances and approvals often requires the
submission of extensive clinical data and supporting information to the FDA.
Product clearances and approvals, if granted, can be withdrawn for failure to
comply with regulatory requirements or upon the occurrence of unforeseen
problems following initial marketing.

There can be no assurance that the Company will be able to obtain necessary
regulatory clearances or approvals on a timely basis, if at all, for any of its
products under development, and delays in receipt or failure to receive such
clearances or approvals or failure to comply with existing or future regulatory
requirements could have a material adverse effect on the Company. Moreover,
regulatory clearances or approvals for products such as medical devices and new
drugs, even if granted, may include significant limitations on the uses for
which such products may be marketed. Certain material changes to medical devices
and new drugs also are subject to FDA review and clearance or approval. There
can be no assurance that any clearances or approvals that are required, once
obtained, will not be withdrawn or that compliance with other regulatory
requirements can be maintained. Further, failure to comply with applicable FDA
and other regulatory requirements can result in sanctions being imposed on the
Company or the manufacturers of its products, including warning letters, fines,
product recalls or seizures, injunctions, refusals to permit products to be
imported into or exported out of the United States, refusals of FDA to grant
premarket clearance or premarket approval of medical devices and drugs or to
allow the Company to enter into government supply contracts, withdrawals of
previously approved marketing applications and criminal prosecutions.

9
<PAGE> 12

There can be no assurance that the Company will be able to develop or
manufacture a version of the SmartMist Asthma Management System suitable for
commercialization. Any changes made to the initial version of the SmartMist
Asthma Management System that has been cleared by the FDA will require the
Company to evaluate whether such changes could significantly affect the safety
or effectiveness of the device and, therefore, require the submission of a
second 510(k) notice. The Company has yet to determine whether changes it may
make to the SmartMist Asthma Management System will require the submission of a
second 510(k) notice. If the submission of a 510(k) notice is required, there
can be no assurance that clearance can be obtained in a timely manner or at all.

Before the Company can file for regulatory approvals for the commercial
sale of the Company's potential AERx products, the FDA will require extensive
preclinical and clinical testing to demonstrate the safety and efficacy of such
potential products. To date, the Company has only tested an early prototype
bench-mounted version of the AERx Pain Management System with morphine on a
limited number of healthy volunteers in Australia and only recently received FDA
approval to begin Phase I clinical trials. The clinical study will be conducted
pursuant to an effective investigational new drug ("IND") application. An early
design stage prototype of the AERx system will be utilized in the study and the
Company is manufacturing only limited quantities of the morphine-filled
disposable nozzle packages for the study. There can be no assurance that the
Phase I study results will support additional clinical trials of the AERx
system, that the Company will be able to manufacture sufficient quantities of
the disposable nozzle packages to support any future clinical trials of the AERx
system, or that the design requirements of the AERx system will make it amenable
to development beyond the early design stage prototype currently being used.
Failure of the Company to progress to Phase II clinical studies or otherwise to
advance beyond the current early design stage prototype of the AERx system would
have a material adverse effect on the Company.

The timing of completion of clinical trials is dependent upon, among other
factors, the enrollment of patients. Patient accrual is a function of many
factors, including the size of the patient population, the proximity of patients
to clinical sites, the eligibility criteria for the study and the existence of
competitive clinical trials. Delays in planned patient enrollment in the
Company's current trials or future clinical trials may result in increased
costs, program delays or both, which could have a material adverse effect on the
Company.

The Company also is developing applications of its AERx system for the
delivery of insulin and imaging agents via inhalation. These applications are in
an early stage of development and the regulatory requirements associated with
obtaining the necessary marketing approvals from the FDA and other regulatory
agencies are not known. Potentially, the FDA could regulate the lung imaging
product as a medical device, as a drug, or as a device/drug combination product.
There can be no assurance that these applications of the AERx system will prove
to be viable or that any necessary regulatory approvals will be obtained in a
timely manner, if at all. Although the Company believes the data regarding the
Company's potential products is encouraging, the results of initial preclinical
and clinical testing of the products under development by the Company are not
necessarily predictive of results that will be obtained from subsequent or more
extensive preclinical and clinical testing. Furthermore, there can be no
assurance that clinical trials of products under development will demonstrate
the safety and efficacy of such products at all or to the extent necessary to
obtain regulatory approvals. Companies in the medical device, pharmaceutical and
biotechnology industries have suffered significant setbacks in advanced clinical
trials, even after promising results in earlier trials. The failure to
demonstrate adequately the safety and efficacy of a therapeutic product under
development could delay or prevent regulatory approval of the product and would
have a material adverse effect on the Company.

In addition, due to limited experience with chronic administration of drugs
delivered via the lung for systemic effect, the FDA may require clinical data to
demonstrate that such chronic administration is safe. There can be no assurance
that the Company will be able to present such data in a timely manner, or at
all.

The FDA and other regulatory agency requirements for manufacturing, product
testing and marketing can vary depending upon whether the product is a medical
device or a drug. Manufacturers of medical devices and drugs also are required
to comply with the applicable FDA and cGMP regulations, which include
requirements relating to product testing and quality assurance as well as the
corresponding maintenance of records and documentation. There can be no
assurance that the Company will be able to comply with the

10
<PAGE> 13

applicable cGMP regulations and other FDA regulatory requirements as it scales
up its manufacturing operations. Such failure could have a material adverse
effect on the Company.

Because the Company's AERx Pain Management System Phase I study involves
morphine, the Company is registered with the United States Drug Enforcement
Agency ("DEA") and its facilities are subject to inspection and DEA export,
import, security and production quota requirements. See "Business -- Government
Regulation."

HIGHLY COMPETITIVE MARKETS; RISK OF ALTERNATIVE THERAPIES

The medical device, pharmaceutical and biotechnology industries are highly
competitive and rapidly evolving and significant developments are expected to
continue at a rapid pace. The Company's success will depend on its ability to
successfully develop products and technologies for pulmonary drug delivery. If a
competing company were to develop or acquire rights to a better pulmonary
delivery device, the Company could be materially and adversely affected.

The Company is in competition with pharmaceutical, biotechnology and drug
delivery companies and other entities engaged in the development of alternative
drug delivery systems or new drug research and testing, as well as with entities
producing and developing injectable drugs. The Company is aware of a number of
companies currently seeking to develop new products and non-invasive
alternatives to injectable drug delivery, including oral, intranasal and
transdermal delivery systems and colonic absorption systems. The Company also is
aware of other companies currently engaged in the development and
commercialization of pulmonary drug delivery systems and enhanced injectable
drug delivery systems. Competitors in this field include: Astra AB, Boehringer
Ingelheim, Dura Pharmaceuticals, Inc., Fluid Propulsion Technologies, Inc.,
Forest Labs, Glaxo Wellcome, Inc., Inhale Therapeutic Systems, Ivax (Norton),
Medeva Ltd., Rhone-Poulenc Rorer (Fisons Limited), Schering Plough and 3M. Many
of these companies and entities have greater research and development
capabilities, experience, manufacturing, marketing, sales, financial and
managerial resources than the Company and represent significant competition for
the Company. Acquisitions of competing drug delivery companies by large
pharmaceutical companies or partnering arrangements between such companies could
enhance competitors' financial, marketing and other resources. The Company's
competitors may succeed in developing competing technologies, obtaining FDA
approval for products more rapidly than the Company and gaining greater market
acceptance of their products than the Company's products. There can be no
assurance that developments by others will not render some or all of the
Company's proposed products or technologies uncompetitive or obsolete, which
could have a material adverse effect on the Company. See
"Business -- Competition."

DEPENDENCE ON KEY PERSONNEL; MANAGING GROWTH

The Company is dependent upon a limited number of key management and
technical personnel. The loss of the services of one or more of such key
employees could have a material adverse effect on the Company. In addition, the
Company's success will depend upon its ability to attract and retain additional
highly qualified sales, management, manufacturing and research and development
personnel. The Company faces intense competition in its recruiting activities,
and there can be no assurance that the Company will be able to attract or retain
qualified personnel. Over at least the next year, the Company expects to
experience rapid growth in employee headcount and operations. The Company's
expected growth and development and commercialization efforts will require the
implementation of improved or new systems for financial control and management.
The failure to properly implement such systems and to effectively manage growth
could have a material adverse effect on the Company. See "Management."

EXPOSURE TO PRODUCT LIABILITY

The research, development and commercialization of medical devices and
therapeutic products entails significant product liability risks. If the Company
succeeds in commercializing products using the SmartMist system or the AERx
system and if it succeeds in developing additional devices and new products, the
use of such products in clinical trials and the commercial sale of such products
may expose the Company to liability

11
<PAGE> 14

claims. These claims might be made directly by consumers or by pharmaceutical
companies or others selling such products. Companies often address the exposure
of such risk by obtaining product liability insurance. Although the Company
currently maintains limited product liability insurance, there can be no
assurance that the Company will be able to continue to obtain such insurance on
acceptable terms in amounts sufficient to protect the Company.

UNCERTAINTY RELATED TO HEALTH CARE REFORM

Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. Although Congress has
failed to pass comprehensive health care reform legislation to date, the Company
anticipates that Congress, state legislatures and the private sector will
continue to review and assess alternative health care delivery and payment
systems. Market forces are expected to demand reduced costs. Aradigm cannot
predict what impact the adoption of any federal or state health care reform
measures or future private sector reform may have on its business.

UNCERTAINTY RELATED TO THIRD-PARTY REIMBURSEMENT

In both domestic and foreign markets, sales of the Company's potential
products, if any, will depend in part on the availability of reimbursement from
third-party payors such as government health administration authorities, private
health insurers and other organizations. Third-party payors are increasingly
challenging the price and cost-effectiveness of medical products and services.
Significant uncertainty exists as to the reimbursement status of newly approved
health care products. There can be no assurance that any of the Company's
potential products will be reimbursable by third parties. In addition, there can
be no assurance that the Company's proposed products will be considered
cost-effective or that adequate third-party reimbursement will be available to
enable Aradigm to maintain price levels sufficient to realize a profit.
Legislation and regulations affecting the pricing of pharmaceuticals may change
before the Company's proposed products are approved for marketing and any such
changes could further limit reimbursement for medical products and services.

HAZARDOUS MATERIALS

The Company's research and development involves the controlled use of
hazardous materials, chemicals and various radioactive compounds. Although the
Company believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by state and federal regulations,
the risk of accidental contamination or injury from these materials cannot be
completely eliminated. In the event of such an accident, the Company could be
held liable for any damages that result and any such liability could exceed the
resources of the Company.

CONTROL BY OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS

Following completion of this offering, directors, executive officers and
principal shareholders of the Company, will beneficially own approximately 60.2%
of the outstanding shares of the Company's Common Stock. Accordingly, these
persons, individually and as a group, may be able to control effectively the
Company and direct its affairs and business, including any determination with
respect to a change in control of the Company, future issuances of Common Stock
or other securities by the Company and the election of directors. See
"Management" and "Principal Shareholders."

LACK OF PRIOR PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE

Prior to this offering, there has been no public market for the Common
Stock and there can be no assurance that an active trading market will develop
or be sustained. The initial public offering price for the Common Stock to be
sold in this offering will be determined by agreement between the Company and
the Underwriters and may bear no relationship to the price at which the Common
Stock will trade after completion of this offering. The market prices for
securities of many companies engaged in pharmaceutical

12
<PAGE> 15

development activities historically have been highly volatile. In addition,
announcements of technological innovations or new commercial products by the
Company or its competitors, delays in the development or approval of the
Company's product candidates, developments or disputes concerning patent or
proprietary rights, publicity regarding actual or potential developments
relating to products under development by the Company or its competitors,
regulatory developments in both the United States and foreign countries, public
concern as to the safety of drug technologies and economic and other external
factors, as well as period-to-period fluctuations in financial results, may have
a significant impact on the market price of the Common Stock. See
"Underwriting."

ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE

Sales of shares of Common Stock (including shares issued upon the exercise
of outstanding options) in the public market after this offering could adversely
affect the market price of the Common Stock. Such sales also might make it more
difficult for the Company to sell equity securities or equity-related securities
in the future at a time and price that the Company deems appropriate. Upon
completion of this offering and assuming no exercise of outstanding options and
warrants and no exercise of the Underwriter's over-allotment option, the Company
will have approximately 10,068,410 shares of Common Stock outstanding. The
2,500,000 shares offered hereby will be freely tradeable without restriction.
The remaining approximately 7,568,410 shares are restricted securities that may
be sold only if registered under the Securities Act or sold in accordance with
an applicable exemption from registration, such as Rule 144 promulgated under
the Securities Act. Holders of approximately 7,139,268 of such restricted shares
are subject to agreements not to sell or otherwise transfer their shares for a
period of 180 days following the date of this offering (the "Lock-up Shares").
Of such Lock-up Shares, approximately 3,311,559 will become eligible for sale in
the public market 180 days after the date of this offering, subject to the
provisions of Rule 144(k), Rule 144 or Rule 701 promulgated under the Securities
Act, upon the expiration of agreements not to sell such shares (the "Lock-up
Agreements"). See "Shares Eligible for Future Sale."

ABSENCE OF DIVIDENDS; DILUTION

The Company has never paid cash dividends and does not anticipate paying
cash dividends on the Common Stock in the foreseeable future. Purchasers of the
shares of Common Stock offered hereby will experience immediate dilution in net
tangible book value per share. Such investors will experience additional
dilution upon the exercise of outstanding options. See "Dividend Policy" and
"Dilution."

MANAGEMENT'S BROAD DISCRETION TO ALLOCATE PROCEEDS

The Company's management will retain broad discretion in the allocation of
a substantial portion of the net proceeds of this offering and there can be no
assurance that the net proceeds will be expended in accordance with the
Company's current plans. See "Use of Proceeds."

13
<PAGE> 16

USE OF PROCEEDS

The net proceeds to be received by the Company from the sale of the shares
of Common Stock offered by the Company hereby are estimated to be approximately
$27,000,000 ($31,185,000 if the Underwriters' over-allotment option is exercised
in full), at an assumed initial public offering price of $12.00 per share, and
after deducting underwriting discounts and commissions and estimated offering
expenses.

The Company anticipates that it will use approximately $8 to $10 million of
the net proceeds of this offering to fund the Company's research and development
efforts, including capital expenditures and funding preclinical and clinical
trials, and approximately $12 to $15 million for manufacturing process
development in connection with the commercialization of the SmartMist system and
to provide manufacturing capacity for preclinical, clinical and full scale
manufacturing requirements of the AERx system. The Company will use the
remaining proceeds (approximately $2 to $7 million) for working capital and
general corporate purposes. The Company's management will have broad discretion
in the application of the net proceeds, and the amounts actually expended for
each purpose may vary significantly depending upon numerous factors, including
the progress of the Company's preclinical and clinical trials and actions
relating to regulatory matters, the costs and timing of expansion of
manufacturing activities and facilities and the ability of the Company to
establish and maintain collaborative arrangements with others. Pending such
uses, the Company intends to invest the net proceeds of this offering in
interest-bearing, investment grade securities.

DIVIDEND POLICY

The Company has not declared or paid any cash dividends since its inception
and does not anticipate paying any cash dividends in the foreseeable future. The
Company currently intends to retain any future earnings for use in the operation
of its business.

14
<PAGE> 17

CAPITALIZATION

The following table sets forth the capitalization of the Company (i) as of
March 31, 1996 giving effect to the automatic conversion of all outstanding
shares of Preferred Stock into Common Stock upon the closing of this offering
and (ii) as adjusted as of March 31, 1996 to reflect the restatement of the
Company's Articles of Incorporation and the receipt of the net proceeds from the
sale of the 2,500,000 shares of Common Stock offered by the Company hereby at an
assumed initial public offering price of $12.00 per share (after deducting the
estimated underwriting discounts and commissions and estimated offering expenses
payable by the Company).

<TABLE>
<CAPTION>
MARCH 31, 1996
------------------------
PRO
FORMA AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Noncurrent portion of capital lease obligations....................... $ 411 $ 411
Shareholders' equity:
Preferred Stock, no par value, issuable in series; 10,000,000 shares
authorized pro forma; 5,000,000 shares authorized as adjusted;
no shares issued or outstanding, pro forma as adjusted.............. -- --
Common Stock: No par value, 20,000,000 shares authorized actual;
40,000,000 shares authorized as adjusted; 7,568,410 shares issued
and outstanding, pro forma; 10,068,410 issued and outstanding as
adjusted(1)......................................................... 24,932 51,932
Notes receivable from shareholders.................................... (401) (401)
Deferred compensation................................................. (256) (256)
Deficit accumulated during the development stage...................... (13,676) (13,676)
-------- -----------
Total shareholders' equity.......................................... 10,599 37,599
-------- -----------
Total capitalization............................................. $ 11,010 $ 38,010
======== =========
</TABLE>

- ------------------------------
(1) Excludes, as of March 31, 1996: (i) options outstanding to purchase a total
of 88,689 shares of Common Stock; (ii) warrants to purchase 196,391 shares
of Common Stock and (iii) 160,961 shares available for future issuance under
the Company's 1992 Stock Option Plan. In April 1996, the Company amended and
restated the 1992 Stock Option Plan and renamed it the 1996 Equity Incentive
Plan, pursuant to which 1,980,000 shares were reserved for issuance,
including the 1,230,000 shares previously reserved under the 1992 Stock
Option Plan. In addition, in April 1996 the Board of Directors adopted the
1996 Employee Stock Purchase Plan and the 1996 Non-Employee Director Stock
Option Plan, pursuant to which 150,000, and 225,000 shares, respectively,
were reserved for issuance and as of March 31, 1996, no options or shares
had been issued under these plans. Subsequent to March 31, 1996, the Board
of Directors granted options to purchase an additional 156,600 shares under
the 1992 Stock Option Plan. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations," "Management -- Benefit
Plans," "Description of Capital Stock" and Note 5 of Notes to Financial
Statements.

15
<PAGE> 18

DILUTION

The net tangible book value of the Company's Common Stock as of March 31,
1996 was approximately $10,599,000, or $1.40 per share after giving effect to
the conversion of all outstanding shares of Preferred Stock into Common Stock
upon completion of this offering. Net tangible book value per share represents
the amount of the Company's total tangible assets less total liabilities,
divided by the number of shares of Common Stock outstanding. After giving effect
to the sale of 2,500,000 shares of Common Stock offered hereby by the Company at
an assumed initial public offering price of $12.00 per share and after deducting
underwriting discounts and commissions and estimated offering expenses payable
by the Company, the Company's pro forma net tangible book value at March 31,
1996 would have been $37,599,000, or $3.73 per share. This represents an
immediate increase in net tangible book value of $2.33 per share to existing
shareholders and an immediate dilution of $8.27 per share to new investors
purchasing shares of Common Stock in this offering, as illustrated in the
following table:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................... $12.00
Net tangible book value per share at March 31, 1996.............. $ 1.40
Increase per share attributable to investors in the offering..... 2.33
-------
-
Pro forma net tangible book value per share after the offering..... 3.73
-----
Dilution per share to new investors................................ $ 8.27
=====
</TABLE>

The following table sets forth on a pro forma basis as of March 31, 1996,
the number of shares of Common Stock purchased from the Company, the total
consideration paid and the average price per share paid by existing shareholders
and by purchasers of shares offered by the Company hereby, based upon an assumed
initial public offering price of $12.00 (before deducting the underwriting
discounts and commissions and estimated expenses payable by the Company):

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders.............. 7,568,410 75.2% $25,000,000 45.5% $ 3.30
New investors...................... 2,500,000 24.8 30,000,000 54.5 12.00
-------- ----- -------- -----
Total.................... 10,068,410 100.0% $55,000,000 100.0%
======== ===== ======== =====
</TABLE>

The foregoing table assumes no exercise of the following outstanding stock
options and warrants as of March 31, 1996: (i) options outstanding to purchase a
total of 88,689 shares of Common Stock at a weighted average exercise price of
$0.59 per share; and (ii) warrants to purchase 196,391 shares of Preferred Stock
at a weighted average exercise price of $3.25. To the extent that any of these
options or warrants are exercised, there will be further dilution to new
investors in this offering. See "Management -- Benefit Plans" and Note 5 of
Notes to Financial Statements.

16
<PAGE> 19

SELECTED FINANCIAL DATA

The following selected financial data for the years ended December 31,
1993, 1994 and 1995 are derived from the audited financial statements of Aradigm
Corporation. The financial data for the period from January 30, 1991 (inception)
through December 31, 1991, for the year ended December 31, 1992, for the three
month periods ended March 31, 1995 and 1996 and for the period from January 30,
1991 (inception) through March 31, 1996, are derived from unaudited financial
statements. The unaudited financial statements include all adjustments,
consisting of normal recurring adjustments, which Aradigm Corporation considers
necessary for a fair presentation of the financial position and the results of
operations for these periods. Operating results for the three months ended March
31, 1996 are not necessarily indicative of the results to be expected for the
entire year ending December 31, 1996 or any future period. The data should be
read in conjunction with the financial statements, related notes, and other
financial information included herein.

SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PERIOD FROM THREE MONTHS PERIOD FROM
JANUARY 30, 1991 ENDED JANUARY 30, 1991
(INCEPTION) TO YEARS ENDED DECEMBER 31, MARCH 31, (INCEPTION) TO
DECEMBER 31, ----------------------------------- ----------------- MARCH 31,
1991 1992 1993 1994 1995 1995 1996 1996
---------------- ----- ------- ------- ------- ------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Contract revenues.................... $ -- $ -- $ -- $ 125 $ 155 $ 125 $ 86 $ 366
Expenses:
Research and development........... 303 435 926 2,198 3,440 735 1,239 8,541
General and administrative......... 108 385 741 1,664 2,334 584 591 5,823
----- ----- ------- ------- ------- ------- -------
Total expenses....................... 411 820 1,667 3,862 5,774 1,319 1,830 14,364
----- ----- ------- ------- ------- ------- -------
Loss from operations................. (411) (820) (1,667) (3,737) (5,619) (1,194) (1,744) (13,998)
Interest income...................... -- 8 13 38 206 74 147 412
Interest expense..................... (6) (18) (1) (34) (20) -- (11) (90)
----- ----- ------- ------- ------- ------- -------
Net loss............................. $ (417) $(831) $(1,655) $(3,733) $(5,433) $(1,120) $(1,608) $(13,676)
===== ===== ======= ======= ======= ======= =======
Pro forma net loss per share(1)...... $ (0.76) $ (0.21)
Shares used in computing pro forma
net loss per share(1).............. 7,196 7,510
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------- MARCH 31,
1991 1992 1993 1994 1995 1996
------- ------- ------- ------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................... $ 22 $ 1,283 $ 1,932 $ 6,087 $ 12,117 $ 10,779
Working capital (deficit)............................... (221) 1,168 1,781 5,739 11,594 10,053
Total assets............................................ 57 1,367 2,055 6,343 13,306 11,817
Deficit accumulated during the development stage........ (417) (1,248) (2,903) (6,636) (12,069) (13,676 )
Total shareholders' equity (net capital deficiency)..... (287) 1,241 1,888 5,960 12,121 10,599
</TABLE>

- ------------------------------
(1) See Note 1 of Notes to Financial Statements for an explanation of shares
used in computing net loss per share.

17
<PAGE> 20

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Financial
Statements and the related Notes thereto included elsewhere in this Prospectus.
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in "Risk Factors" and elsewhere
in this Prospectus.

OVERVIEW

Since its inception in 1991, Aradigm has been a development stage company
engaged in the advancement of pulmonary drug delivery systems. As of March 31,
1996 the Company had an accumulated deficit of $13.7 million. The Company has
been unprofitable each year and expects to incur further significant and
increasing operating losses over the next several years primarily due to the
expansion of research efforts and to the establishment of manufacturing
capabilities to support clinical trials and, if any of its products are
successfully developed and receive necessary regulatory approvals,
commercialization of such products. To date, Aradigm has not sold any products
and does not anticipate receiving any revenue from products or product royalties
in the current year. The Company has not declared or paid any cash dividends on
its capital stock and does not anticipate paying cash dividends in the
foreseeable future.

The Company anticipates that its results of operations may fluctuate for
the foreseeable future due to several factors, including, the timing of research
and development expenses (including clinical trial-related expenditures),
actions related to regulatory and third-party reimbursement matters, the
Company's ability to manufacture its products, if any, efficiently, the timing
of new product introductions, if any, and competition. In addition, the
Company's results of operations will be affected by its ability to enter into
corporate collaborations.

RESULTS OF OPERATIONS

Three Months Ended March 31, 1996 and 1995

Contract Revenue. Contract revenue decreased to $86,000 in the first
quarter of 1996 from $125,000 in the first quarter of 1995. The decrease was due
to the conclusion of a feasibility research contract in the first quarter of
1995. The first quarter 1996 revenue is from a new feasibility research contract
that was initiated in the fourth quarter of 1995 and, if carried through to
conclusion, will continue through the first half of 1996.

Research and Development Expenses. Research and development expenses
increased to $1.2 million in the three months ended March 31, 1996, from
$735,000 in 1995. The increase was primarily due to the expansion of the AERx
system research and development project, the initiation of additional clinical
testing of the AERx system and the expansion of the SmartMist system program.
The Company expects research and development spending to increase significantly
over the next few years as the Company expands its development efforts.

General and Administrative Expenses. General and administrative expenses
increased to $591,000 in the three months ended March 31, 1996 from $584,000 in
the first quarter of 1995. The increase was primarily due to compensation
expense associated with stock options recorded in the first quarter of 1996, and
an increase in headcount, partially offset by a decrease in legal expenses. The
Company expects to incur significantly greater general and administrative
expenses in the future as it expands its operations and meets its obligations as
a public company.

Years Ended December 31, 1995 and 1994

Contract Revenue. Contract revenue increased to $155,000 during the year
ended December 31, 1995 from $125,000 in 1994. The increase in revenues was
primarily due to the initiation of a feasibility research contract during the
fourth quarter of 1995.

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Research and Development Expenses. Research and development expenses
increased to $3.4 million during the year ended December 31, 1995 from $2.2
million in 1994. The increase was primarily due to the expansion of the AERx
system research and development project which began preliminary clinical testing
during the year.

General and Administrative Expenses. General and administrative expenses
increased to $2.3 million during the year ended December 31, 1995 from $1.7
million in 1994. The increase was primarily due to the expansion of business
development activities and the expansion of the Company's facilities.

As of December 31, 1995, the Company had federal net operating loss tax
carryforwards of approximately $11.5 million. These carryforwards will expire
beginning in the year 2006. Utilization of net operating loss carryforwards may
be subject to substantial annual limitation due to the ownership change
limitation provided for by the Internal Revenue Code of 1986. The annual
limitation may result in the expiration of net operating loss carryforwards
before utilization.

Years Ended December 31, 1994 and 1993

Contract Revenue. The Company's initial revenue of $125,000 was recorded
during the year ended December 31, 1994. The revenue was from a feasibility
research contract evaluating the effect of controlled delivery on the asthma
drug salmeterol.

Research and Development Expenses. Research and development expenses
increased to $2.2 million for the year ended December 31, 1994 from $926,000 for
the year ended December 31, 1993. The increase was primarily due to the
expansion of the SmartMist system development project and the initiation of
development of the AERx system technology.

General and Administrative Expenses. General and administrative expenses
increased to $1.7 million for the year ended December 31, 1994 from $741,000 for
the year ended December 31, 1993. The increase was primarily due to the
initiation of efforts to develop collaborative relationships with corporate
partners and the expansion of the Company's facilities.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations since inception primarily through
private placement of its capital stock, proceeds from financings of equipment
acquisitions, contract revenue and interest earned on investments. As of March
31, 1996, the Company had realized approximately $24.2 million in net proceeds
from sales of its capital stock and the Company also has a secured line of
credit of $1.8 million for equipment purchases, of which $1.0 million remained
available at March 31, 1996. The draw down period under the line of credit
terminates on October 1, 1996. At March 31, 1996, the Company had cash and cash
equivalents of approximately $10.8 million.

Net cash used in operating activities increased, as compared to the three
months ended March 31, 1995, during the three months ended March 31, 1996 by
$539,000. The increase results primarily from the increase in the net loss of
$488,000. Net cash used in operating activities increased, as compared to the
year ended December 31, 1994, during the year ended December 31, 1995 by $1.8
million. The increase results primarily from the increase in the net loss of
$1.7 million.

Net cash used in investing activities for both the three months ended March
31, 1996 and the year ended December 31, 1996 relates solely to capital
expenditures by the Company.

Net cash provided by financing activities for the three months ended March
31, 1996 of $21,000 was limited to common stock issuances partially offset by
payments on lease obligations. Net cash provided by financing activities for the
year ended December 31, 1996 was $11.7 million and primarily related to a $11.6
million in proceeds from the issuance of preferred stock and $390,000 in
proceeds from the sale of equipment in a sale-leaseback transaction. These items
were partially offset by $150,000 in loans made to certain officers and $90,000
in payments on lease obligations.

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From inception through March 31, 1996, the Company's cash utilized for
operating activities totaled approximately $12.6 million. The cash utilized was
approximately $1.5 million in 1993, $3.4 million in 1994, $5.2 million in 1995
and $1.3 million for the three months ended March 31, 1996, and differ from the
Company's net loss in these periods principally due to depreciation expense and
increases in accounts payable, accrued compensation and deferred revenue. The
Company expects that its cash requirements will increase due to expected
increases in expenses related to research and development activities, the scale
up of manufacturing processes and increases in general and administrative costs.
The Company's cash requirements will be affected by the extent and duration of
the foreign and domestic regulatory approval processes for its potential
products. Although there can be no assurance that the Company will receive
regulatory approval for any of its products, if the Company does so, its cash
requirements may increase due to the significant expenses associated with
initial commercial production and marketing efforts. These expenses include, but
are not limited to, increases in personnel and related costs, capital
expenditures, product prototype development expenses and the costs of facilities
expansion.

The Company expects that its existing capital resources, including existing
contract research and development revenue, and the proceeds from this offering,
will enable the Company to maintain current and planned operations through 1997.
The Company's cash requirements, however, may vary materially from those now
planned because of results of research and development efforts, including
capital expenditures and funding preclinical and clinical trials, and for
manufacturing process development in connection with the commercialization of
the SmartMist system and to provide manufacturing capacity for preclinical,
clinical and full scale manufacturing requirements of the AERx system. The
Company may need to raise substantial additional capital to fund its operations
before the end of 1997. The Company expects that it will seek such additional
funding through collaborations, or through public or private equity or debt
financings. The Company has not yet established any corporate development
collaborations and there can be no assurance that it will be able to do so on
reasonable terms, or at all. Nor can there be any assurance that additional
financing can be obtained on acceptable terms, or at all. If additional funds
are raised by issuing equity securities, dilution to shareholders may result. If
adequate funds are not available, the Company may be required to delay, to
reduce the scope of or to eliminate one or more of its research and development
programs or to obtain funds through arrangements with collaborative partners or
others that may require the Company to relinquish rights to certain of its
technologies or products that the Company would not otherwise relinquish.

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BUSINESS

OVERVIEW

Aradigm is engaged in the development of novel, hand-held pulmonary drug
delivery systems designed to enhance the delivery and effectiveness of a number
of existing and development stage drugs and reduce the need for injectable drug
therapy. Subject to applicable regulatory clearances and approvals, Aradigm
plans to commercialize its proprietary technologies on two product platforms:
(i) the SmartMist system, which is designed to improve the effectiveness of
metered dose inhalers, such as those used to deliver asthma medications, and
(ii) the AERx system, which creates aerosols from liquid drug formulations for
delivery locally to the lung or into the blood stream via the lung. The Company
believes that its systems, if successfully developed and approved or cleared for
marketing, can be used to deliver existing drugs for a variety of applications,
including the treatment of respiratory diseases, pain management and diabetes
management, as well as to deliver imaging agents for certain lung diagnostic
applications. In addition, Aradigm's potential products may offer a promising
means of delivery for new drugs under development by pharmaceutical and
biotechnology companies.

Aradigm's lead SmartMist product under development is the SmartMist Asthma
Management System. In May 1996, the Company obtained 510(k) clearance from the
FDA of the initial version of its SmartMist Asthma Management System and expects
to complete development and commence marketing of the commercial version of the
SmartMist Asthma Management System in the next 12 months. There can be no
assurance that the Company will be able to develop and market successfully the
commercial version of the SmartMist Asthma Management System or that changes
made during such development will not necessitate the submission of a second
510(k) notice. The Company's lead AERx product under development is the AERx
Pain Management System which is designed to deliver morphine systematically by
inhalation for the treatment of pain. The Company filed an Investigational New
Drug ("IND") application for acute pain management with the FDA in February 1996
and intends to commence clinical trials for inhalational delivery of morphine in
the United States in mid-1996. The Company also has commenced early clinical
studies of its AERx system for the delivery of insulin and a pulmonary
diagnostic imaging agent. The Company believes that its products under
development may improve the management of certain diseases by reducing the cost
of therapy, enhancing patient management and compliance and providing an
improved means to administer drugs outside of the hospital setting.

BACKGROUND

Pulmonary Drug Delivery

Pulmonary drug delivery is widely used to treat respiratory diseases by
delivering pharmaceuticals locally to the lung and may have utility in the
delivery of drugs for systemic application by using the lung's natural ability
to transfer molecules into the blood stream. Pulmonary delivery of drugs for the
treatment of respiratory diseases has proven desirable because topical
application to affected lung tissues promotes a rapid therapeutic effect and
minimizes the side effects of several important pulmonary drugs. The potential
for pulmonary delivery to the blood stream for systemic effect offers a
non-invasive alternative to injection that may achieve a more rapid speed of
onset and superior bioavailability than has been shown with other approaches,
such as oral, transdermal or nasal delivery. Speed of onset is an important
therapeutic element for drugs such as morphine for pain management and insulin
for diabetes.

The respiratory system starts with the branching of the trachea into two
mainstream bronchi, which are further branched into large conducting airways.
The airways continue to branch through approximately 23 generations until they
end in the deep lung with air sacs, known as the alveoli, which are the site of
gas exchange. The internal surface area of the lung is approximately 1,000
square feet, most of which is available

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<PAGE> 24

for the free exchange of oxygen, carbon dioxide and other molecules between
ambient air and the blood stream. Because of its physiology and natural
function, the lung represents an attractive pathway for the non-invasive
delivery of drugs.
LOGO

The conducting airways within the lung branch repeatedly (left image) until
ending to form alveoli (shown on the right) where gas exchange takes place.

To deliver pharmaceuticals to or through the lungs, drugs must be
transformed into a low velocity aerosol (a suspension of drug particles in air)
which can be inhaled by the patient. Large particles (i.e., greater than four
microns in diameter) typically get deposited in the large airways, where they
may be useful in treating diseases of the lung. Smaller particles (i.e., less
than four microns in diameter), however, are more likely to pass through the
lung's airways and be dispersed in the alveoli, where they may be absorbed by
the alveolar membrane to enter the blood stream for systemic effect.

To date, the pulmonary drug delivery market has consisted primarily of
drugs for the treatment of local diseases of the lung, such as asthma, cystic
fibrosis, emphysema and chronic obstructive pulmonary disease ("COPD"). Sales in
the United States of drugs used in pulmonary delivery products for the treatment
of lung diseases exceeded $1.7 billion in 1995. In recent years, pharmaceutical
and drug delivery companies, recognizing the potential benefits of utilizing the
lung for systemic drug administration, have increased efforts to develop
products and systems for pulmonary drug delivery. Industry sources estimate that
the potential worldwide market for pulmonary drug delivery products may exceed
$9 billion annually by the year 2000.

Existing Pulmonary Drug Delivery Technology

Three aerosol generating technologies currently are being used for
pulmonary drug delivery: nebulizers, metered dose inhalers ("MDIs"), and dry
powder inhalers ("DPIs"). Each of these systems was originally developed to
treat lung diseases and produces a local therapeutic effect by depositing
aerosolized medication on the large conducting airways of the lung. The
effectiveness of these devices depends upon proper inhalation technique to
produce a consistent, reproducible dose. In addition, the ability of these
technologies to improve the management of major pulmonary diseases has been
limited by their inability to compensate automatically for poor patient
technique or provide physicians with information on patient inhalation and
dosing patterns.

Nebulizers. Nebulizers are primarily used in hospitals for the treatment
of respiratory diseases, such as asthma. Liquid drug is loaded into the
nebulizer prior to each use, and the patient breathes through a mouthpiece or
mask as the continuous fog of drug particles is produced. Because nebulizers
require an external power source or compressed gas supply, they are not easily
portable. Although drugs in liquid form are easily converted to an aerosol,
nebulizers are inefficient and require several minutes to administer a single
dose of medication. Because nebulizers produce a wide range of particle sizes,
the majority of which are too large to reach the alveoli, these devices are
impractical for systemic delivery.

MDIs. Metered dose inhalers, the most widely used system for pulmonary
drug delivery, have been in existence for over 40 years and are used to deliver
asthma drugs. The drug is packaged in a portable canister as a suspension or
solution in a volatile propellant, typically chlorofluorocarbons ("CFCs"). To
self-administer a

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drug, the patient must depress the canister, releasing a high-velocity jet of
aerosolized drug, while inhaling slowly and evenly. Although widely used, there
are certain inherent problems with the use of MDIs. A patient must properly
coordinate inhalation and activation of the aerosol jet to optimize the
effectiveness of treatment. Several clinical studies have demonstrated that
patients routinely use MDIs improperly, resulting in ineffective therapy. Much
of the drug is deposited at the back of the throat and swallowed, rather than
reaching the desired location in the lung. Many leading asthma specialists,
however, believe that MDIs, when used properly, can effectively manage a
significant percentage of asthmatics. Although spacer devices have been
developed to address the problem of press-and-breathe coordination, these
devices do not fully address problems with inhalation technique and compliance
monitoring. Because MDIs produce a wide range of particles sizes, only a small
portion of which reach the alveoli, they are not optimal for the delivery of
systemic therapies.

DPIs. Dry powder inhalers, which are also used to deliver drugs locally to
the lung, have been and are being developed by pharmaceutical companies to
replace CFC-based MDI systems. DPI drugs are formulated in solid form and
packaged in portable containers. Patients self-administer the drug by inhaling
small, dry particles. Dry powder drug formulations present a considerable
challenge for pharmaceutical chemists because drugs must be prepared as solids,
must tolerate storage in a solid phase and must facilitate rapid and complete
dispersion as an aerosol at the point of delivery. Although DPIs have been used
for the delivery of some asthma drugs, several companies are exploring the
development of DPIs for the systemic delivery of other compounds, including
proteins and peptides.

ARADIGM TECHNOLOGY

Existing systems for pulmonary drug delivery generally fail to achieve
precise, reproducible delivery of the desired drug dose, either locally or
systemically. Aradigm believes that its two product platforms, the SmartMist
system and the AERx system, may be capable of improving or enabling a wide range
of pulmonary drug delivery applications. Aradigm has combined core competencies
in physics, electrical engineering, mechanical engineering and pharmaceutical
sciences to overcome the limitations of conventional pulmonary drug delivery
systems. Through this integrated approach, the Company has developed
technologies which address each of the four key elements which it believes are
required for the development of effective pulmonary drug delivery products:

- Ease of Drug Formulation: The Aradigm systems take advantage of existing
drug formulations, including standard MDI formats and liquid drug
formulations, thereby reducing formulation risks compared to other
pulmonary delivery technologies. In addition, liquid formulations
facilitate the generation of small particle aerosols necessary for
efficient delivery to the alveoli.

- Efficient Precision Aerosol Generation: Aradigm has developed a
proprietary aerosolization technology capable of producing low velocity,
small particle aerosols at the point of delivery for efficient deposition
of drug in the alveoli. Through this technology, the Company believes it
is able to overcome the limitations of conventional pulmonary drug
delivery systems in which particle size and velocity cannot be optimized
for systemic delivery.

- Automated Breath-Controlled Delivery: Since proper inhalation technique
is needed to achieve effective pulmonary drug delivery, Aradigm's systems
are designed to guide the patient to inhale slowly and evenly and to
automatically deliver a drug aerosol early in the breath.

- Patient Compliance Monitoring: Because patient adherence to prescribed
dosing regimens is an important determinant of therapeutic benefit,
Aradigm's systems are also being designed to record drug administration,
inhalation patterns and other relevant physiological information for use
by physicians to analyze and optimize patient treatment regimens and
improve patient outcomes.

Aradigm is seeking to exploit various combinations of these four elements to
develop pulmonary drug delivery systems which overcome the limitations of
existing systems or enable pulmonary delivery of drugs which are currently not
deliverable systemically via the lung.

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SmartMist System

The SmartMist system incorporates the Company's breath control and
compliance monitoring technologies for use with standard MDIs for the treatment
of asthma and other respiratory diseases. The initial SmartMist product, which
is currently in pre-production prototype form, is being developed as a
hand-held, battery-operated aerosol drug delivery system. The patient inserts a
standard MDI into the SmartMist device and inhales normally through the
mouthpiece. Indicator lights on the device switch from red to green to guide the
patient to inhale slowly and evenly within a predetermined range suitable for
drug delivery. When the desired flow rate is established early in the
inspiratory cycle, the MDI is automatically actuated by the SmartMist system.
The delivery of the medication is breath controlled, rather than manually
activated, eliminating the need for the patient to coordinate pressing and
breathing while using an MDI.

The microprocessor-controlled SmartMist system contains an electronic air
flow transducer and automatically calculates flow rate and volume. Additionally,
the SmartMist system incorporates an electronic peak flow meter, which
quantitatively measures the effect of therapy when the patient exhales though a
separate mouthpiece attached to the device. The peak flow rate is displayed to
the patient and recorded in the internal memory of the product. Each system can
store a 30-day record of drug administrations, inhalation patterns and pulmonary
function data that can be downloaded into a computer for review by the patient
and the health care professional to enhance patient management and compliance.

AERx System

The AERx system is a novel drug delivery system that is being developed to
enable pulmonary delivery of a wide range of liquid pharmaceuticals for local or
systemic effect. The AERx system is based on a proprietary aerosol generation
technology capable of producing low velocity, small particles suitable for
delivery to the alveoli. By also incorporating the Company's proprietary breath
control and compliance monitoring technologies, the AERx system is designed to
optimize the delivery of aerosolized medications to the lung. The AERx system,
which is currently being tested in a clinical bench prototype form, will
aerosolize liquid drug formulations that are pre-packaged into proprietary unit
dose packages for inhalation. As depicted below, each

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unit dose package is comprised of (i) a small blister package which stores a
liquid drug formulation and (ii) an aerosolization nozzle consisting of a porous
membrane made with an array of micromachined holes.

LOGO
The AERx disposable unit dose package is smaller than a postage stamp. The large
arrows show the piston action that compresses the unit dose package containing
the liquid drug. The small arrows show the path the drug product will take after
the package is compressed by the piston during patient inhalation. The drug is
separated from the nozzle outlet by a sealed channel which is forced open as the
piston compresses the package and the drug is extruded through the
aerosolization nozzle. The generated aerosol flows through the AERx device
mouthpiece and into the patient's lungs.

The AERx system creates a respirable aerosol by releasing a mechanical
piston that is activated automatically when the patient's inhalation is optimal
for drug delivery. The piston compresses the blister package, thereby forcing
open the sealed channel and extruding the liquid drug through the aerosolization
nozzle. The aerosolized drug produced by this process is then inhaled through
the mouthpiece of the AERx device. The extrusion of the liquid drug through the
disposable nozzle takes approximately one second and produces a low velocity,
fine particle aerosol for optimized deposition within the lung. The force
applied to drive the liquid through the nozzle and the diameter of the nozzle
holes influence the size of the droplets or particles that form the emitted
aerosol. The size of the micromachined holes within the single use nozzle can be
adjusted for each specific clinical application, including the creation of
larger particles for delivery of drug to the large conducting airways of the
lung for local effect or smaller particles for delivery of drug to the deep lung
for systemic effect.

Formulations developed for use in the AERx system are in liquid form,
typically using an aqueous-based solvent, similar to those employed with
nebulizers. No propellants, such as the CFCs used in MDIs, are required since
mechanical pressure is used to generate the aerosol. Moreover, since the drug is
stored in unit dose packages, preservatives may not be needed for some
applications, further simplifying the formulation process.

The AERx system employs the same patented technology used in the SmartMist
system to measure precisely the airflow through the device while the patient is
inhaling. Breath control ensures that the patient is breathing the same way each
time a dose of aerosolized drug is delivered. As a result, essentially the same
dose of medication is delivered each time the product is used.

Compliance monitoring technology similar to that used in the SmartMist
system has been designed for the AERx system. Information about each drug
administration, including dosage, breathing technique and other relevant
physiological parameters are recorded automatically for later review by the
patient and health care professional. The Company expects to customize the
software embedded in the AERx device for the

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<PAGE> 28

particular therapeutic application in order to collect and present the data most
relevant for managing each patient type. The Company believes that the combined
features of the AERx product will make the AERx system an effective disease
management tool in the outpatient setting.

STRATEGY

Aradigm's goal is to become a leader in the development and
commercialization of pulmonary drug delivery products. The Company's strategy
incorporates the following principal elements:

Focus on Early Product Opportunities: The Company is focusing its initial
commercial development efforts on product opportunities which have the potential
to reach the market quickly. The Company designed the SmartMist Asthma
Management System specifically to take advantage of the shorter regulatory cycle
for 510(k) approvable products. In addition, the Company is developing a
diagnostic application of its AERx technology which may have a shorter
regulatory approval process than therapeutic applications of the AERx system.
The Company's initial therapeutic development programs will target previously
approved and widely used drugs. For example, the first AERx therapeutic product
is expected to be the AERx Pain Management System for the delivery of morphine.
Because morphine is a well characterized drug with a demonstrated safety
profile, the Company believes the AERx Pain Management System carries less
development risk than new drug development projects and may require less time
for regulatory approval. Nevertheless, there can be no assurance that the
Company can secure regulatory approval for its potential products or that the
Company can successfully develop or market any such products.

Establish Broad Applicability: The Company believes that its AERx
technology can effectively deliver many pharmaceutical products. The Company is
conducting feasibility studies on a number of compounds to demonstrate the
applicability of the AERx system to a broad range of molecule sizes and types,
including proteins, peptides and small molecules. The Company plans to publish
results from these and other studies to promote the acceptance of the AERx
system as a viable pulmonary drug delivery technology for a wide variety of
compounds. The Company believes this strategy will maximize the number of
commercial product opportunities for Aradigm and will increase the interest of
potential partners to develop drugs for the AERx system, thereby reducing the
Company's dependence on any single product.

Establish Collaborative Relationships: In order to enhance its commercial
opportunities and effectively leverage its core scientific resources, Aradigm
intends to enter into multiple collaborative relationships for the development
of new products and for the marketing and sale of products utilizing its
technologies. Through product development collaborations, Aradigm will seek
access to proprietary pharmaceutical compounds as well as to the resources and
expertise necessary to conduct late stage clinical trials and obtain regulatory
approvals. In addition, the Company will pursue relationships with
pharmaceutical and device companies with established sales forces and
distribution channels in the Company's target markets. By establishing such
collaborative relationships, Aradigm intends to introduce multiple new products
while avoiding the need to establish drug discovery research and sales and
marketing capabilities for each target market. Nevertheless, the Company has not
established any corporate development collaborations and there can be no
assurance that it will be able to do so on reasonable terms, or at all.

Build Strong Proprietary Position: The Company believes that establishing
a strong proprietary position in pulmonary drug delivery could provide an
important competitive advantage in its target markets. The Company has
aggressively pursued patent protection of its technology and to date has
received 11 issued United States patents and has more than 20 United States
patent applications pending. When appropriate, the Company also seeks
international patent protection. While there can be no assurance that any of the
Company's patents will provide a significant commercial advantage, these patents
are intended to provide protection for important aspects of the Company's
technology, including aerosol generation, breath control, compliance monitoring
and unit dose formulation. In addition, the Company plans to develop in-house
manufacturing capability for the production of certain components of its
products, including the disposable unit dose package for the AERx system, to
further protect its core technologies.

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ARADIGM PRODUCT APPLICATIONS

The SmartMist System

The Company is initially developing the SmartMist technology to be applied
to asthma management with the SmartMist Asthma Management System. In the future,
the SmartMist platform may be utilized to develop products for other lung
diseases, such as cystic fibrosis, emphysema and COPD.

SmartMist Asthma Management System

The Company is developing the SmartMist Asthma Management System to ensure
proper breath control and compliance by MDI users. By improving the
self-administration of MDIs, the Company believes that these patients will be
better managed, have fewer symptoms and will make fewer visits to the emergency
room, resulting in improved patient care and reduced health care expenses.

Asthma is an inflammatory disease process characterized by abnormally high
responsiveness of the tracheobronchial tree to a multitude of stimuli, such as
dust, pollen and stress. The hallmark of the disease is reversible airway
obstruction, and the characteristic wheezing sounds are due to narrowing of the
airways.

Of the estimated 12 million asthmatics in the United States, approximately
one million severe asthmatics consume a majority of the nearly $3.6 billion
which is spent annually in the United States for direct health care costs
related to the treatment of asthma. Over half of those dollars is spent on
hospital care, including approximately 450,000 hospitalizations and 1.5 million
emergency room visits occurring annually in the United States for acute asthma
incidents. Asthma is a chronic disease which, if properly treated, should not
progress to crisis stage. It is believed that most hospitalizations for
treatment of asthma represent patient management and compliance failures. The
Company believes that there is a significant market opportunity to improve
patient management and compliance, thereby minimizing patient utilization of
costly acute care and overall reducing the cost of asthma management.

Studies have shown that up to 70% of patients use their MDIs incorrectly
and that nearly 50% of patients revert to incorrect technique following
retraining. Even patients who have good technique are inconsistent in applying
it, especially during an acute asthma attack. Proper technique is particularly
important for patients using topical steroids, drugs which treat the underlying
inflammation that causes asthma, but do not act immediately or provide
palliative benefits. Inhaled steroids can take six to eight weeks to effect
improvement noticeable to the patient. With no immediate relief of symptoms
providing feedback to the patient, there is no way for patients to know if they
have received the intended drug dose.

The management of asthma can also be improved by monitoring patient
compliance with the prescribed therapy and recording the effect of the therapy.
Peak flow, defined as peak velocity achieved during maximum forced exhalation,
is a direct indicator of airway obstruction. Routine peak flow measurement has
been generally recommended by pulmonary specialists, but many patients do not
diligently take and record these measurements.

The Company believes that its SmartMist system is capable of addressing MDI
limitations, such as improper inhalation, improperly timed release of the
aerosol, and the lack of information regarding patient usage and patient lung
function following usage. Without modifying the MDI or the drug itself, the
SmartMist device is designed to assist the patient in self-administering the
drug while inhaling in an optimal manner, guided by the breath indicator lights
on the device. The built-in peak flow meter is designed to allow patients to
track their own lung function so that patients can anticipate asthma
exacerbations in time to modify their therapy. In addition, the device is
designed to compile data on drug delivery events and lung function readings so
that a complete record can be reviewed by health care professionals.

Aradigm has completed a radiolabeled asthma drug study that demonstrates
the benefits of the breath control technology incorporated in the SmartMist
system. Recently published in the peer review journal, Thorax, the study showed
that use of the SmartMist breath control feature can significantly influence the
amount of drug delivered to the lung. The Company is also currently sponsoring
clinical trials to support market adoption of the SmartMist Asthma Management
System. The first study, which will involve

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<PAGE> 30

approximately 40 patients with asthma, is being conducted at the University of
California at San Francisco and at National Jewish Hospital in Denver to compare
the technique of patients using the SmartMist system with the technique of other
patients using MDIs equipped with the Technique Assessor, a research device
developed by Aradigm to measure how patients actuate and inhale through
conventional MDIs. The second study, being conducted at Northwest Asthma and
Allergy Inc. in Seattle, is evaluating the performance of the SmartMist system
when used by adolescent patients.

A prototype of the SmartMist Asthma Management System has been developed
for use in clinical testing. While this version of the device received 510(k)
clearance from the FDA in May, 1996, the Company expects to complete its final
design and manufacturing scale up in cooperation with a corporate partner. While
the Company is in discussions with potential partners for the commercialization
of this product, no assurance can be given that the Company will enter into a
partnering arrangement. Moreover, there can be no assurance that the Company
will be able to develop or manufacture a version of the SmartMist Asthma
Management System suitable for commercialization that can be marketed without
additional regulatory filings or approvals.

Depending on manufacturing costs and other factors, the Company believes
that the price to consumers of the Company's SmartMist Asthma Management System
will be approximately $400 per unit.

The AERx System

The Company is developing the AERx platform based on a comprehensive
approach to pulmonary drug delivery that includes drug formulation, aerosol
generation, patient breath control and compliance monitoring technologies. The
Company believes that the AERx system will be broadly applicable to drugs that
are intended for systemic delivery, for local delivery to the lung or for
pulmonary diagnostics. The Company currently is developing AERx products for
pain management, diabetes management and pulmonary diagnostics. In addition, the
Company is planning to develop the AERx system for the non-invasive delivery of
certain other drugs, including biotechnology drugs.

AERx Pain Management System

The Company is developing the AERx Pain Management System as a
non-invasive, patient-controlled pulmonary drug delivery product for treatment
of chronic and acute pain. In March 1996, the Company's IND application covering
the use of AERx to deliver morphine for the management of acute pain cleared the
FDA review period, and the Company intends to initiate Phase I clinical studies
in the United States in mid-1996.

The pain management market includes patients with cancer, post-operative,
migraine headache and chronic persistent pain. Pharmaceutical care is the
mainstay of pain treatment and dominates the pain management market. The United
States market for drugs and devices used in pain management is estimated to be
more than $15 billion annually. The Company believes that non-invasive rapid
treatment of breakthrough pain is a major unmet medical need.

Aradigm has targeted cancer pain as one of the first indications for the
AERx Pain Management System. There are approximately 3,000,000 patients with
active cancer in the United States. Based on published reports, the Company
believes that approximately 45% of such patients report suffering from pain,
with nearly half of those cancer patients reporting that their pain was not
alleviated by their pain management therapy.

Conventional drug delivery methods for pain management include oral,
transdermal patch, intravenous, intramuscular and subcutaneous delivery. Patient
controlled analgesia ("PCA") products allow patients to self-administer pain
medication on demand from a microprocessor controlled intravenous infusion pump.
PCA systems have proven to be a cost-effective means of intravenous delivery in
the hospital setting. Widespread adoption of PCA outside of the hospital,
however, has been limited by the requirement for an intravenous delivery site
that requires regular and expensive maintenance. Home PCA can cost as much as
$4,000 per month, due partially to the home nursing required to maintain the
needle site.

The Company believes that a patient controlled, non-invasive drug delivery
system that provides for rapid uptake of medication, could significantly expand
the outpatient market for pain management. Features of the Company's AERx Pain
Management System are expected to be similar to those of PCA products, but will
not

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be limited by the necessity of intravenous or subcutaneous access. The AERx
product is being designed to be programmed to allow for patient-activated
delivery in accordance with a physician-directed dosing program. Lock-out
mechanisms being designed for the product should eliminate the risk of
inappropriate dosing, and a patented electronic patient identification feature
should prevent unauthorized use of the device. An automatically maintained
dosing event diary to be embedded within the AERx device is designed to allow
the physician to closely monitor patient use. The Company believes that these
features of the AERx platform combined with the inherent speed of onset of
pulmonary delivery should provide a significant advance in ambulatory pain
management.

Aradigm has demonstrated in early clinical testing with six healthy
volunteers that the AERx system can deliver morphine into the blood stream with
efficiency comparable to intravenous delivery. The following graph summarizes
certain data from the study conducted by Dr. Michael Cousins at the Royal North
Shore Hospital in Sydney, Australia. The graph illustrates two key factors of
the AERx Pain Management System. First, morphine administered in the lung
resulted in almost immediate uptake of the drug into the blood stream. Second,
there was direct correlation between the dose provided and the concentration of
drug in the blood. Both of these results are key objectives in providing therapy
for breakthrough pain. Data from this study also showed that in excess of 80% of
the aerosolized morphine emitted from the AERx device appeared in the subject's
blood. In addition, the intra and inter subject variability was essentially
indistinguishable from that seen following intravenous administration of
morphine in the same subjects.
This pharmacokinetic profile summarizes a dose ranging study performed using a
bench prototype of the AERx Pain Management System by Dr. Michael Cousins at the
Royal North Shore Hospital in Sydney, Australia. A healthy volunteer was given
2.2 mg at 0 minutes, 4.4 mg at 40 minutes and 8.8 mg at 80 minutes of morphine
sulfate. Blood samples were taken from a radial arterial line.

The Company plans to commence Phase I clinical trials in mid-1996 using the
AERx Pain Management System to deliver morphine via the lung. The first study,
to be conducted at Harris Laboratories in Lincoln, Nebraska, involves 16 healthy
volunteers and will test the bioavailability of morphine delivered via the AERx
system. The second study, which will evaluate the time to peak effect when
morphine is delivered via a prototype of the AERx Pain Management System versus
intravenous administration, will involve 12 healthy volunteers and will be
conducted at Massachusetts General Hospital.

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<PAGE> 32

AERx Diabetes Management System

The Company is developing the AERx Diabetes Management System to permit
diabetes patients to non-invasively self-administer insulin. The Company
believes that when provided with a non-invasive delivery alternative to
injection, patients are more likely to self-administer insulin as often as
needed to keep tight control of their blood glucose levels. The Company has
begun early formulation development of insulin for the AERx Diabetes Management
System. Preliminary in vitro analysis of these formulations is complete, and
early clinical testing is underway and is expected to continue throughout 1996.

In healthy individuals, the pancreas secretes insulin, which helps the body
to regulate blood glucose levels. Patients with Type I diabetes do not have the
ability to produce their own insulin and must self-inject insulin regularly to
control their disease. Patients with Type II diabetes are unable to use
efficiently the insulin that their body produces. While they may have some
impairment in their ability to produce insulin as well, it is the defect in
their ability to use insulin efficiently that leads to the addition of insulin
to their treatment program. By increasing the circulating insulin concentration,
the inefficiency can be partially overcome. The Diabetes Control and
Complications Trial ("DCCT") study sponsored by National Institutes of Health
from 1983 to 1993 indicated that insulin should be given throughout the day in
response to frequently measured blood glucose levels. The DCCT study showed that
keeping blood glucose levels as close to normal as possible slows the onset and
progression of eye, kidney and nerve diseases often caused by diabetes. In fact,
the DCCT study demonstrated that any sustained lowering of blood glucose levels
is beneficial, even if the person has a history of poor blood glucose control.

The Company believes that approximately 700,000 Americans suffer from Type
I diabetes. Virtually all of them are on daily insulin injection therapy, and
most are currently monitoring their own blood glucose level. It is believed that
more than 13 million Americans suffer from Type II diabetes, of which
approximately 50% are not yet diagnosed. Although most of this Type II
population does not currently use insulin as part of their therapy, in aggregate
they consume the majority of insulin used in the United States, due to their
larger numbers. The insulin market in the United States was $680 million in
1994. The direct costs associated with diabetes are estimated to be greater than
$45 billion annually.

Patients with diabetes often avoid or limit the amount of insulin therapy
because of the pain and inconvenience of administering the drug by injection.
The Company believes that its AERx Diabetes Management System can provide a
non-invasive method for delivery of insulin that would be efficacious and
reproducible. Such a system should support diabetics in complying with their
insulin therapy, thereby lessening the risk of long-term complications.

AERx Diagnostic System

The Company believes that the same technologies that may make the AERx
system a precision pulmonary drug delivery system can be applied to more safely
deliver radiolabeled imaging agents to diagnose certain lung conditions than
currently available methods. In an early clinical study, the Company
demonstrated that the AERx Diagnostic System was effective in delivering
technetium DTPA ("(99m)Tc-DTPA"), a commonly used agent for lung imaging.

Radiolabeled imaging agents ("radiopharmaceuticals") are widely used for
the diagnosis of a variety of cardiopulmonary conditions, such as pulmonary
embolism. The radiopharmaceutical is imaged by a gamma camera in a process
called ventilation lung scanning. Ventilation lung scans require that patients
inhale either radioactive gas or radiolabeled aqueous solution of aerosol
delivered to the lung via conventional nebulizers. Because nebulizers are
inefficient and result in inconsistent deposition of particles in the lung, they
often require a relatively higher amount of radiopharmaceutical to produce an
adequate scan. Additionally, the nebulization process can take several minutes,
which increases the risk of undesirable radiation exposure for the patient and
attending staff.

The Company estimates that approximately 800,000 ventilation lung scans are
performed in the United States each year at a cost of about $200 million. The
radioactive materials used in ventilation lung scans in the

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<PAGE> 33

United States are prepared at radiopharmacies located throughout the country
which supply these materials to hospitals and clinics.

The Company believes that its AERx technology can provide an effective and
safe alternative to nebulizers for supplying radiopharmaceuticals for
ventilation lung scans. The Company intends to supply its unit dose packaging
equipment to radiopharmacies to allow the pharmacies to fill and seal single-use
doses of 99m)Tc-DTPA to be used with the AERx Diagnostic System for ventilation
lung scans. The Company believes that the AERx Diagnostic System will use less
radioactive material and will provide better image quality for diagnosis.
Moreover, because the radiopharmaceutical is self-contained and does not need to
be nebulized, the amount of ambient radiation can be substantially reduced,
thereby minimizing staff exposure to radiation.

AERx has been shown in a clinical feasibility study to deliver efficiently
and reproducibly the same radiolabeled aqueous solution to the lungs of ten
healthy volunteers as is currently used with nebulizers for ventilation lung
imaging, and the images produced were of the same high quality as those
generated using krypton gas, the "gold standard" for nuclear imaging. A second
study is scheduled to be conducted to evaluate the quality of lung images
produced with the AERx system in patients known to have COPD. The Company is
currently investigating the regulatory path for approval of the AERx Diagnostic
System for sale in the United States and abroad and is exploring development
partnerships with contract research and development organizations.

Additional Potential AERx Applications

The Company is evaluating the use of the AERx system to deliver other
pharmaceutical compounds. The Company has successfully evaluated a number of
compounds in in vitro and in vivo feasibility studies. The Company has approved
protocols with the Royal North Shore Hospital in Sydney, Australia for the
clinical evaluation of additional drugs often used for pain management. Aradigm
is considering further feasibility studies with anti-infectives, peptides,
proteins and gene vectors for the treatment of asthma, and severe chronic
diseases of the respiratory tract, such as lung cancer, emphysema and cystic
fibrosis.

The Company believes that the AERx system may have applicability for a
range of compounds developed by biotechnology companies that cannot be delivered
orally. Due to their large size and poor oral bioavailability, macromolecules
developed by the biotechnology industry are typically developed in liquid
formulation and delivered by injection. The Company believes that the AERx
platform can potentially provide for improved delivery and broader applications
of these therapies or potential therapies. The Company is currently conducting a
feasibility study, under the sponsorship of a pharmaceutical company, for a
protein for systemic delivery.

The Company believes that its technology can be applied to many new or
approved pharmaceutical and biological compounds. A partial list of compounds
that have been evaluated or may be evaluated appears below (asterisks indicate
compounds which the Company has successfully aerosolized in preliminary in vitro
tests).

<TABLE>
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------
PHARMACEUTICALS BIOLOGICALS
- ------------------------------------------------------------------------------------------------
Albuterol* Midazolam* Alpha Interferon Gamma Interferon
Beclomethasone* NSAIDs Calcitonin Growth Hormone
Cromolyn* Pentamidine DNAse* IGF-1
Fentanyl* Sumatriptan Erythropoietin*
Levorphanol Triamcinolone
- ------------------------------------------------------------------------------------------------
</TABLE>

The Company has not acquired rights to develop applications for any of the
proprietary compounds listed above and may not pursue or be successful in
acquiring such rights.

MANUFACTURING

The Company plans to build manufacturing facilities for the production of
certain components of its drug delivery systems that it considers to be key to
its core technologies. These may include the production of the disposable
aerosol generating nozzles, the assembly of the disposable unit dose packages
and the sterile filling

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<PAGE> 34

of drug into the unit dose packages. The Company also may complete the final
calibration, assembly and packaging of the AERx and SmartMist systems to control
both quality and cost.

The Company may seek to have many key components, assemblies and
subassemblies completed by contract manufacturers. These are expected to include
the assembly of printed circuit boards, the production of application specific
integrated circuits ("ASICs"), the production of mechanical assemblies and the
production of specific plastics and laminates for the disposable unit dose
packages. In some cases, the Company may choose to license commercial partners
to produce some of the disposable unit dose packages in the partner's own
facilities.

The Company is in the process of scaling up the production of the SmartMist
Asthma Management System with the assistance of contract manufacturers.
Significant additional work must be completed prior to commercialization. In
addition, the Company is in the early stages of scaling up to clinical levels
the production of disposable unit dose packages for clinical trials of the AERx
system. The Company plans to build a sterile pharmaceutical packaging production
line sufficient to meet the capacity requirements for clinical trials and
initial product sales, if any. The Company anticipates making significant
expenditures to provide for the high volume manufacturing required for multiple
AERx products, if such products are successfully developed. Although the Company
is working with contract manufacturers that are experienced in medical device
manufacturing, there can be no assurance that the Company will be able to
complete the scale-up process in a timely manner or that significant problems
will not be discovered during the scale-up process.

Although the majority of the materials to be used in Aradigm's potential
products are readily available from multiple sources, certain materials,
including the ASICs, microprocessors, plastics and plastic laminates, are or
will be available initially only from single sources. While the Company has
contingency plans for alternate suppliers, there can be no assurance that the
Company could find alternate manufacturers for such components. Even if new
suppliers are secured, there can be no assurance that this would not
significantly reduce the Company's ability to supply product during any
transition.

COMPETITION

The Company faces intense competition. Several companies are developing and
marketing nebulizer, MDI and DPI devices as well as other drug delivery
approaches. Aradigm is aware that a number of pharmaceutical and biotechnology
companies and research institutions are working on processing peptide and
protein respirable dry powders. There can be no assurance that competitors will
not introduce products or processes competitive with, or superior to, those
under development by the Company. The Company faces intense competition to
develop a solution to non-invasive delivery from a number of drug delivery and
pharmaceutical companies, including: Astra AB, Boehringer Ingelheim, Dura
Pharmaceuticals, Inc., Fluid Propulsion Technologies, Inc., Forest Labs, Glaxo
Wellcome, Inc., Inhale Therapeutic Systems, Ivax (Norton), Medeva Ltd.,
Rhone-Poulenc Rorer (Fisons Limited), Schering Plough and 3M. Many of these
companies are much larger and have far greater resources than Aradigm. These
include companies working on developing systems for other non-invasive routes of
delivery, such as oral, transdermal and intranasal administration, as well as
companies working on pulmonary delivery systems. New drugs or further
developments in alternative drug delivery methods may provide greater
therapeutic benefits for a specific drug or indication or may offer comparable
performance at lower cost, than the Company's pulmonary drug delivery systems
under development.

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

The Company's business and competitive position is dependent upon its
ability to protect its proprietary technology and avoid infringing the
proprietary rights of others.

The Company relies on patents, patent applications and trade secret law to
protect its proprietary technology. To date the Company has been issued 11
United States patents and presently has more than 20 United States patent
applications pending. There can be no assurance that any of the Company's patent
applications will issue or, if issued, will later be found valid if challenged.
Further, there can be no assurance

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<PAGE> 35

that any issued patents, or applications which might later issue as patents,
will provide the Company with a degree of market exclusivity sufficient for the
Company to compete profitably against its competitors. Patents can not prevent
others from developing alternative technologies which are used for aerosolized
drug delivery and patent applications do not provide any exclusivity until and
if they are issued as a patent. Because the general idea of aerosolized drug
delivery is well established, no entity may obtain patent protection covering
all forms of aerosolized delivery of all types of drugs. There can be no
assurance that others have not independently developed or will not develop
devices, components and methods of aerosolized drug delivery and obtained or
will obtain patents on such which patents could be used to prevent the Company
from making, using or selling its patented technology.

The Company's success will depend on its ability to obtain patents,
maintain trade secrets and operate without infringing upon the proprietary
rights of others. A substantial number of patents have been issued to
competitors in the field of aerosolized drug delivery. These and other
competitors and institutions may have applied for other patents and may obtain
additional patents and proprietary rights relating to products or processes
similar to those of the Company. The Company may not be able to obtain a license
under any such patent and therefore could be prevented from making products or
carrying out processes that may be important to the business of the Company.

The Company has carried out and continues to carry out searches of
publications including patents and scientific papers relating to the business of
the Company. These searches are supplemented by searches done by examiners in
the United States Patent Office and other patent offices reviewing patent
applications of the Company. Many entities are obtaining patents and publishing
papers in the field of aerosolized delivery and there can be no assurance that
the searches carried out by the Company have found the most relevant
publications. Thus, patents may exist which would provide competitors with the
ability to prevent the Company from making or selling its products. Further,
existing and future patents or other publications may hinder or prevent the
Company from obtaining patents or draw into question the validity of patents
already issued to the Company.

The Company's current policy is to file patent applications on what it
deems to be important technological developments which might relate to products
of the Company or methods of using such products. To date all inventions have
originated in the United States and all patent applications were originally
filed in the United States. The Company also seeks to protect these inventions
through foreign counterpart applications in selected other countries. The
Company currently has National Phase applications pending in patent offices
outside of the United States. Statutory differences in patentable subject matter
may limit the protection the Company can obtain on some of its inventions
outside of the United States. For example, methods of treating humans are not
patentable in many countries outside of the United States. These and other
issues may prevent the Company from obtaining patent protection outside of the
United States. Further, competitors may have obtained or could later obtain
patent protection outside of the United States which would prevent the Company
from making, using or selling products or processes of its business in countries
other than the United States.

The Company pursues a policy of having its officers, employees, consultants
and advisors execute proprietary information and invention agreements upon
commencement of their relationships with the Company. These agreements provide
that all confidential information developed or made known to the individual
during the course of the relationship shall be kept confidential except in
specified circumstances. These agreements also provide that all inventions
developed by the individual on behalf of the Company shall be assigned to the
Company and that the individual will cooperate with the Company in connection
with securing patent protection on the invention if the Company wishes to pursue
such protection. There can be no assurance, however, that these agreements will
provide meaningful protection for the Company's inventions, trade secrets or
other proprietary information in the event of unauthorized use or disclosure of
such information.

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<PAGE> 36

GOVERNMENT REGULATION

All medical devices and drugs, including the Company's products under
development, are subject to extensive and rigorous regulation by the federal
government, principally the FDA, and by state and local governments. If these
products are marketed abroad, they also are subject to export requirements and
to regulation by foreign governments. The regulatory clearance process is
generally lengthy, expensive and uncertain. The Federal Food, Drug, and Cosmetic
Act (the "FDC Act"), and other federal statutes and regulations, govern or
influence the development, testing, manufacture, labeling, storage, approval,
advertising, promotion, sale and distribution of such products. Failure to
comply with applicable FDA and other regulatory requirements can result in
sanctions being imposed on the Company or the manufacturers of its products,
including warning letters, fines, product recalls or seizures, injunctions,
refusals to permit products to be imported into or exported out of the United
States, refusals of the FDA to grant premarket clearance or premarket approval
of medical devices and drugs or to allow the Company to enter into government
supply contracts, withdrawals of previously approved marketing applications and
criminal prosecutions.

The FDA and other regulatory agency requirements for manufacturing, product
testing and marketing can vary depending upon whether the product is a medical
device or a drug. Sales of the Company's products outside of the United States
are subject to foreign regulatory requirements that may vary from country to
country. The time required to obtain clearance from a foreign country may be
longer or shorter than that required by the FDA, and clearance or approval or
other product requirements may differ. There can be no assurance that the
Company will be able to obtain necessary regulatory clearances or approvals on a
timely basis, if at all, for any of its products under development, and delays
in receipt or failure to receive such clearances or approvals, the loss of
previously received clearances or approvals, or failure to comply with existing
or future regulatory requirements could have a material adverse effect on the
Company.

Regulation of Medical Devices

The Company is required to file a premarket notification ("510(k)
notification") submission or premarket approval ("PMA") application or
supplement with the FDA before it begins marketing a new medical device or
changes or modifies an existing device in a manner that could significantly
affect the device's safety or effectiveness or changes the device's intended
use.

The FDA categorizes medical devices into one of three regulatory
classifications -- Class I, II or III -- on the basis of controls deemed by the
FDA to be necessary reasonably to assure their safety and effectiveness.
Generally, Class I devices are subject to general controls (e.g., labeling,
premarket notification, and adherence to the current good manufacturing practice
("cGMP") regulations for medical devices). Class II devices are subject to
general and special controls (e.g., performance standards, post-market
surveillance, patient registries and FDA guidelines). Class III devices, which
typically are life-sustaining or life-supporting and implantable devices, or new
devices that have been found not to be substantially equivalent to a legally
marketed predicate device, are subject to general controls and also require
clinical testing to assure safety and effectiveness before FDA approval is
obtained. The FDA also has the authority to require clinical testing of Class I
and II devices.

If a company can establish that a new device is "substantially equivalent"
to a legally marketed Class I or II medical device, or to a preamendment Class
III medical device (i.e., a Class III device in commercial distribution prior to
enactment of the Medical Device Amendments of 1976) for which the FDA has not
called for PMA applications, the company may seek clearance to market the device
by filing a 510(k) notification. The 510(k) may need to be supported by
appropriate data, including clinical study data, establishing substantial
equivalence to the FDA's satisfaction. The FDA recently has been requiring a
more rigorous demonstration of substantial equivalence.

The Company may not place the device into commercial distribution until an
order of substantial equivalence is issued by the FDA. No law or regulation
specifies the time by which the FDA must respond to a 510(k) notification. At
this time, the FDA typically responds to a 510(k) notification within 90 to 180
days, although some submissions take considerably longer. An FDA order may
declare that the device is substantially equivalent and allow the proposed
device to be marketed in the United States. The FDA may

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<PAGE> 37

determine, however, that the proposed device is not substantially equivalent or
may require further information, such as additional test data, before it can
make a final determination.

If a company cannot establish that a proposed device is substantially
equivalent to a legally marketed predicate device, the company must seek
premarket approval from the FDA through the submission of a PMA application. A
PMA application must be supported by extensive data, including preclinical and
clinical trial data, to demonstrate the safety and effectiveness of the device.
If human clinical trials are required and the device presents a "significant
risk," the company must file an investigational device exemption ("IDE")
application prior to commencing clinical trials. The IDE application must be
supported by data, typically including the results of animal and mechanical
testing. If the IDE application is not disapproved by the FDA, human clinical
trials may begin at the specified investigational sites and with the specified
number of patients 30 days after the FDA receives the application. Sponsors of
clinical trials are permitted to sell study devices, provided compensation does
not exceed the cost of manufacture, research, development and handling. The
clinical trials must be conducted under the auspices of an independent
institutional review board ("IRB") established pursuant to FDA regulations. If
the device does not present a significant risk, the study may be conducted under
IRB authority as a nonsignificant risk study.

Following receipt of the PMA application, if the FDA determines that the
application is sufficiently complete to permit a substantive review, the agency
will "file" the application. Once the submission is filed, the FDA begins a
review of the PMA application. The FDA has 180 days to review a PMA application,
although reviews more often occur over a significantly protracted time period,
and the FDA generally takes two years or more from the date of filing to
complete its review.

The PMA process can be expensive, uncertain and lengthy. A number of
devices for which premarket approval has been sought by other companies have
never been approved. Review time is often significantly extended by the FDA,
which may require more information or clarification of information provided in
the submission. During the review period, an advisory committee likely will be
convened to review and evaluate the application and provide recommendations to
the FDA as to whether the device should be approved. In addition, the FDA will
inspect the manufacturing facility to ensure compliance with the cGMP
regulations for medical devices prior to approval of the PMA application. If
granted, the premarket approval may include significant limitations on the
indicated uses for which the product may be marketed, and the agency may require
post-marketing studies of the device.

There can be no assurance that any required FDA or other governmental
clearance or approval will be granted, or, if granted, will not be withdrawn.
Governmental regulation may prevent or substantially delay the marketing of the
Company's proposed products and cause the Company to undertake costly
procedures. In addition, the extent of potentially adverse government regulation
that might arise from future administrative regulations or policy or from
legislation cannot be predicted. Any failure to obtain or delay in obtaining
such clearances or approvals could materially and adversely affect the Company's
ability to market its proposed products.

The FDA's Medical Device Reporting regulation requires medical device
manufacturers, distributors, and user facilities to provide information to the
agency on deaths or serious injuries or illnesses alleged to have been
associated with the use of its devices, as well as product malfunctions that
would likely cause or contribute to death, serious injury or serious illness if
the malfunction were to recur. In addition, the FDA prohibits a company from
promoting a cleared or approved device for an indication for use not approved by
the FDA.

In May 1996, the Company obtained 510(k) clearance from the FDA for the
initial version of its SmartMist Asthma Management System to guide patient
self-administration of asthma medications and compile data on drug delivery
events and lung function, and the Company expects to complete development and
commence marketing of the commercial version of the SmartMist Asthma Management
System in the next 12 months. There can be no assurance that the Company will be
able to fully develop and market successfully the commercial version of the
SmartMist Asthma Management System. The Company has yet to determine whether
changes it may make to the commercial version of the SmartMist Asthma Management
System will necessitate the submission of a second 510(k) notice. If the
submission of a 510(k) notice is required, there can be no assurance that
clearance can be obtained in a timely manner or at all. Delays in receipt of
market clearance or restrictions on the types of asthma drugs with which the
SmartMist Asthma

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<PAGE> 38

Management System can be used or failure to comply with existing or future
regulatory requirements could have a material adverse effect on the Company.

Regulation of Drugs

Different types of FDA regulations apply to various drug products,
depending upon whether they are marketed only upon the order of a physician
(i.e., they are prescription drugs) or over-the-counter, are biological, insulin
or antibiotic drugs or are controlled drugs, such as narcotics. Product
development and approval within this regulatory framework takes a number of
years, involves the expenditure of substantial resources and is uncertain. Many
drug products ultimately do not reach the market because they are not found to
be safe or effective or cannot meet the FDA's other regulatory requirements. In
addition, there can be no assurance that the current regulatory framework will
not change or that additional regulation will not arise at any stage of the
Company's product development that may affect approval, delay the submission or
review of an application or require additional expenditures by the Company.

The activities required before a new drug product may be marketed in the
United States includes pre-clinical and clinical testing. Preclinical tests
include laboratory evaluation of product chemistry and other characteristics and
animal studies to assess the potential safety and efficacy of the product as
formulated. Many preclinical studies are regulated by the FDA under a series of
regulations called the current Good Laboratory Practice regulations. Violations
of these regulations can, in some cases, lead to invalidation of the studies,
requiring such studies to be replicated.

The preclinical work necessary to administer investigational drugs to human
subjects is summarized in an IND application to the FDA. FDA regulations provide
that human clinical trials may begin 30 days following submission of an IND
application, unless the FDA advises otherwise or requests additional
information. There is no assurance that the submission of an IND will eventually
allow a company to commence clinical trials. Once trials have commenced, the FDA
may stop the trials by placing them on "clinical hold" because of concerns
about, for example, the safety of the product being tested.

Clinical testing involves the administration of the drug to healthy human
volunteers or to patients under the supervision of a qualified principal
investigator, usually a physician, pursuant to an FDA reviewed protocol. Each
clinical study is conducted under the auspices of an IRB at each of the
institutions at which the study will be conducted. An IRB will consider, among
other things, ethical factors, the safety of human subjects, informed consent
requirements and the possible liability of the institution. Human clinical
trials typically are conducted in three sequential phases, but the phases may
overlap. Phase I trials consist of testing the product in a small number of
patients or normal volunteers, primarily for safety, at one or more dosage
levels, as well as characterization of a drug's pharmacokinetic and/or
pharmacodynamic profile. The Company is currently planning to conduct a Phase I
limited feasibility clinical study of its AERx Pain Management System for
delivery of morphine for acute pain management. The clinical study is being
conducted pursuant to an effective IND application. An early design stage
prototype of this AERx product is being utilized in the study, and the Company
is manufacturing only limited quantities of the morphine-filled disposable
nozzle packages for the study. There can be no assurance that the Phase I
limited feasibility study results will support additional clinical trials of the
AERx Pain Management System, that the Company will be able to manufacture
sufficient quantities of the disposable nozzle packages to support any future
clinical trials or marketing of the AERx Pain Management System, or that the
design requirements of the AERx Pain Management System will make it amenable to
development beyond the early design stage prototype currently being used.

In Phase II clinical trials, in addition to safety, the efficacy of the
product is usually evaluated in a patient population. Phase III trials typically
involve additional testing for safety and clinical efficacy in an expanded
population at geographically disperse sites. All of the phases of clinical
studies must be conducted in conformance with FDA's bioresearch monitoring
regulations.

A company seeking FDA approval to market a new drug, including insulin and
controlled substances, must file a new drug application ("NDA") with the FDA
pursuant to the FDC Act. In addition to reports of the preclinical and clinical
trials conducted under an effective IND application, the NDA includes
information pertaining to the preparation of the drug substance, analytical
methods, drug product formulation, details on the manufacture of finished
products and proposed product packaging and labeling. Submission of a

36
<PAGE> 39

NDA does not assure FDA approval for marketing. The application review process
generally takes several years to complete, although reviews of treatments for
cancer and other life-threatening diseases may be accelerated or expedited.
However, the process may take substantially longer if, among other things, the
FDA has questions or concerns about the safety or efficacy of a product. In
general, FDA requires at least two properly conducted, adequate and
well-controlled clinical studies demonstrating efficacy with sufficient levels
of statistical assurance.

Notwithstanding the submission of safety and efficacy data, the FDA
ultimately may decide that the application does not satisfy all of its
regulatory criteria for approval. The FDA also may require additional clinical
tests (i.e., Phase IV clinical trials) following NDA approval to confirm safety
and efficacy.

In addition, the FDA may in some circumstances impose restrictions on the
use of the drug that may be difficult and expensive to administer. Product
approvals may be withdrawn if compliance with regulatory requirements are not
maintained or if problems occur after the product reaches the market. The FDA
also requires reporting of certain safety and other information that becomes
known to a manufacturer of an approved drug. The product testing and approval
process is likely to take a substantial number of years and involves expenditure
of substantial resources. There can be no assurance that any approval will be
granted on a timely basis, or at all. Upon approval, a prescription drug may
only be marketed for the approved indications in the approved dosage forms and
at the approved dosage.

Among the other requirements for drug product approval is the requirement
that the prospective manufacturer conform to the FDA's and cGMP regulations for
drugs. In complying with the cGMP regulations, manufacturers must continue to
expend time, money and effort in product, record keeping and quality control to
assure that the product meets applicable specifications and other requirements.
The FDA periodically inspects manufacturing facilities in the United States to
assure compliance with applicable cGMP requirements. Failure of the Company to
comply with the cGMP regulations or other FDA regulatory requirements could have
a material adverse effect on the Company.

The Company also is developing applications of its AERx technology for the
delivery of insulin and lung imaging agents via inhalation. The Company believes
that the use of its AERx technology for insulin delivery inhalation will be
subject to the drug regulations, including conducting clinical studies pursuant
to an IND and the submission and approval of an NDA before marketing can occur.
If the Company obtains FDA approval to market the AERx Diabetes Management
System for the delivery of insulin, each batch of unit-dose insulin-containing
packages used in the AERx Diabetes Management System will be subject to the
insulin certification requirements.

The Company believes that use of the AERx Diagnostic Imaging System for
delivery of lung imaging agents is likely to be regulated by the FDA as either a
new drug or medical device, or a drug-device combination. Although the time to
obtain market clearance or approval of a medical device may be shorter than that
required to obtain FDA approval of a new drug, the FDA likely will require
substantial clinical data for market clearance or approval under the medical
device or drug regulatory framework or both. There can be no assurance that the
use of the AERx platform for insulin or lung imaging agent delivery will prove
to be viable or that any necessary regulatory clearance approvals will be
obtained in a timely manner, if at all.

The Company also will be subject to certain user fees that the FDA is
authorized to collect under the Prescription Drug User Fees Act of 1992 for
certain drugs, including insulin and morphine. User fees also pertain to the
establishments where the products are made and to the marketed prescription drug
products. In addition to these FDA requirements, the Company is subject to
foreign regulatory authorities governing clinical trials and drug sales.
Unapproved new drugs can be exported from the United States to certain countries
for commercialization only after FDA authorization is obtained.

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<PAGE> 40

Other Regulations

Products marketed outside the United States that are manufactured in the
United States are subject to certain FDA regulations, as well as regulation by
the country in which the products are to be sold. The Company also would be
subject to foreign regulatory requirements governing clinical trials and medical
device and drug product sales if products are marketed abroad. Whether or not
FDA approval has been obtained, approval of a product by the comparable
regulatory authorities of foreign countries usually must be obtained prior to
commencement of marketing of the product in those countries. The approval
process varies from country to country and the time required may be longer or
shorter than that required for FDA approval.

The Company is subject to numerous federal, state and local laws relating
to such matters as controlled drug substances, safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal or hazardous or potentially hazardous substances. For example, the Drug
Enforcement Agency ("DEA") regulates controlled drug substances, such as
morphine and other narcotics. Establishments handling controlled drug substances
such as morphine must, for example, be registered and inspected by the DEA, and
may be subject to export, import, security and production quota requirements. In
addition, advertising and promotional materials relating to medical devices and
drugs are, in certain instances, subject to regulation by the Federal Trade
Commission or the FDA. There can be no assurance that the Company will not be
required to incur significant costs to comply with such laws and regulations in
the future or that such laws or regulations will not have a materially adverse
effect upon the Company's business, financial condition or results of
operations.

SCIENTIFIC ADVISORY BOARD

The Company has assembled an International Scientific Advisory Board
comprised of scientific and development advisors that provide consulting
services expertise in the areas of pain management, allergy and immunology,
pharmaceutical development and drug delivery, but are employed elsewhere on a
full time basis. As a result, they can only spend a limited amount of time on
the Company's affairs. The International Scientific Advisory Board assists the
Company on issues related to potential product applications, product development
and clinical testing. Its members and their affiliations and areas of expertise
include:

<TABLE>
<CAPTION>
NAME AFFILIATION AREA OF EXPERTISE
- ---------------------------------------- -------------------------------- --------------------
<S> <C> <C>
Peter Byron, Ph.D. ..................... Medical College of Virginia, Aerosol Science/
Virginia Commonwealth University Pharmaceutics
Michael Cousins, M.D. .................. University of Sydney, Australia Pain Management
Peter Creticos, M.D. ................... The Johns Hopkins University Allergy/Immunology/
School of Medicine Asthma
Stanley S. Davis, Ph.D.................. Lord Trent Professor of Drug Delivery
Pharmacy, University of
Nottingham
Jeffrey Drazen, M.D. ................... Harvard University Medical Pulmonary Medicine
School
Lorne Eltherington, M.D., Ph.D. ........ Sequoia Hospital Pain Management
Richard Kitz, M.D. ..................... Harvard University Medical Anesthesiology
School, Massachusetts General
Hospital
Lawrence M. Lichtenstein, M.D., The Johns Hopkins University Allergy/Immunology
Ph.D. ................................ School of Medicine
Leigh Thompson, M.D., Ph.D. ............ CEO, Profound Quality Resources, Pharmaceutical
former Chief Scientific Officer, Product Development
Eli Lilly and Company
</TABLE>

EMPLOYEES

As of March 31, 1996, the Company had 38 employees, of whom 33 were in
product development and five are in administration. The Company believes that
its future success is dependent on attracting and

38
<PAGE> 41

retaining highly-skilled scientific, sales and marketing and senior management
personnel. Competition for such skills is intense, and there is no assurance
that the Company will continue to be able to attract and retain high-caliber
employees. The Company's employees are not represented by any collective
bargaining agreement. The Company considers its relations with its employees to
be good.

FACILITIES

The Company's principal administrative and product development facilities
occupy approximately 12,800 square feet in two buildings in an office park in
Hayward, California. The Company believes that its existing facilities are
adequate for its current requirements and that additional space can be obtained
to meet its future requirements.

LEGAL PROCEEDINGS

The Company is not currently a party to any legal proceedings.

39
<PAGE> 42

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The directors and executive officers of the Company and their ages as of
March 31, 1996 are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------ --- --------------------------------------------------------
<S> <C> <C>
Lester John Lloyd................... 59 Chairman of the Board of Directors
Richard P. Thompson................. 44 President, Chief Executive Officer, Chief Financial
Officer and Director
Reid M. Rubsamen, M.D. ............. 39 Vice President, Medical Affairs, Secretary and Director
R. Ray Cummings..................... 39 Vice President, Business Development
Max D. Fiore........................ 41 Vice President, Engineering
Igor Gonda, Ph.D. .................. 48 Vice President, Research & Development
Jared A. Anderson, Ph.D.(2)......... 58 Director
Ross A. Jaffe, M.D.(2).............. 37 Director
Burton J. McMurtry, Ph.D.(1)........ 61 Director
Gordon W. Russell(1)................ 62 Director
Fred E. Silverstein, M.D. .......... 53 Director
Virgil D. Thompson(2)............... 56 Director
</TABLE>

- ------------------------------
(1) Member of Audit Committee

(2) Member of Compensation Committee

LESTER JOHN LLOYD has been a director of the Company since 1991 and
Chairman of the Board of Directors since 1992. Mr. Lloyd also served as the
Company's President from 1992 to 1994 and Chief Financial Officer from 1992 to
April 1996. Mr. Lloyd was a founder of Nellcor Incorporated, a medical
electronic instruments company, and its Chief Executive Officer through 1990.
Mr. Lloyd is a director of Molecular Dynamics, Inc. Mr. Lloyd holds a B.S.M.E.
from the University of California, Berkeley.

RICHARD P. THOMPSON has been a director of the Company and has served as
the Company's President and Chief Executive Officer since 1994 and Chief
Financial Officer since April 1996. From 1991 to 1994, he was President of
LifeScan, Inc., a Johnson & Johnson Company, a medical device manufacturing and
development company. Mr. Thompson was a founder of LifeScan and between 1981 and
1991 he held the positions of Vice President, Operations, and later Vice
President, Sales and Marketing, at LifeScan. Mr. Thompson holds a B.S. in
biological sciences from the University of California at Irvine and an M.B.A.
from California Lutheran College.

REID M. RUBSAMEN, M.D., a founder of the Company, has been a director of
the Company and has served as the Company's Vice President of Medical Affairs
and Secretary since 1991. Dr. Rubsamen is a Board Certified anesthesiologist
having received his medical training at Pacific Medical Center, San Francisco
and Massachusetts General Hospital, where in 1989 he served as Chief Resident in
Anesthesia. He was also a doctoral candidate in the computer science department
at the Massachusetts Institute of Technology, leaving in 1990 to found the
Company. Dr. Rubsamen holds an A.B. in biochemistry and computer science from
the University of California, Berkeley, and an M.S. in computer science and an
M.D. from Stanford University.

R. RAY CUMMINGS has served as the Company's Vice President of Business
Development since 1995. From 1994 to 1995, he served as Vice President, Business
Development of Celtrix Pharmaceuticals. From 1992 to 1994, Mr. Cummings was
employed as Director, Corporate Licensing of G. D. Searle and Company, a
pharmaceutical company. From 1990 to 1992, he was the Director of New Business
Development and Licensing of Immunex Corporation, another pharmaceutical
company. Mr. Cummings holds a B.S. in biological sciences from Stanford
University, an M.S. in biochemistry and molecular biology from Harvard
University and an M.B.A. from University of California, Berkeley.

40
<PAGE> 43

MAX D. FIORE has served as the Company's Vice President of Engineering
since 1994. From 1991 to 1994, Mr. Fiore served as Director of Engineering at
Lifescan, Inc. From 1990 to 1991, Mr. Fiore was the IMX(TM) Business Unit
Research & Development Manager for Abbott Laboratories, a pharmaceuticals and
medical device company. Mr. Fiore holds a B.S.E.E. and a B.S. in engineering
from Northwestern University and an M.S.E.E. in bio-medical/microprocessor-based
instrument design from University of Wisconsin.

IGOR GONDA, PH.D. has served as the Company's Vice President of Research &
Development since 1995. From 1992 to 1995, Dr. Gonda was a Senior Scientist and
Group Leader at Genentech, Inc., a pharmaceutical company. Prior to joining
Genentech, Inc., Dr. Gonda was a Senior Lecturer in the Department of Pharmacy
at University of Sydney, Australia. Dr. Gonda holds a B.Sc. in chemistry and a
Ph.D. in physical chemistry from the University of Leeds, United Kingdom.

JARED A. ANDERSON, PH.D. has been a director of the Company since 1992. Dr.
Anderson manages a small portfolio of high technology investments and works
closely with members of the investment banking and venture capital industry.
Since 1980, Dr. Anderson has been an investment advisor to Electronic
Investments Ltd., a high technology investment company. From 1980 through 1987,
Dr. Anderson worked with Valid Logic Systems Incorporated as a founder, Chief
Executive Officer and Chairman of the Board. Dr. Anderson holds a B.S. in
physics from the University of Texas at Austin and a Ph.D. in physics from the
University of California, Berkeley.

ROSS A. JAFFE, M.D. has been a director of the Company since 1993. Since
April 1993, he has been a general partner of Brentwood Associates, a venture
capital investment firm, which he joined in August 1990. During the period of
1988 to 1995, Dr. Jaffe served part-time as a Clinical Instructor and Attending
Physician in various clinics of the University of California, San Francisco and
University of California, Irvine. Dr. Jaffe holds an A.B. in Policy Studies from
Dartmouth College, an M.D. from The Johns Hopkins University School of Medicine,
an M.B.A. from Stanford University and is Board Certified in internal medicine.
He is also a director of several privately-held companies.

BURTON J. MCMURTRY, PH.D. has been a director of the Company since 1992.
Since July 1980, he has been a general partner of various limited partnerships
that, in turn, are general partners of various Technology Venture Investors
venture capital partnerships. Dr. McMurtry holds a B.A. and a B.S. in electrical
engineering from Rice University and an M.S. and a Ph.D. in electrical
engineering from Stanford University. He is also a director of Intuit, Inc.,
Edify Corporation and SpectraLink Corp.

GORDON W. RUSSELL has been a director of the Company since 1992. He has
been a general partner of Sequoia Capital, a venture capital investment
partnership, since 1979. Mr. Russell holds an A.B. in history from Dartmouth
College. Mr. Russell is Chairman of the Board of Overseers of the Dartmouth
Medical School and is Chairman Emeritus of the Board of Trustees of the Palo
Alto Medical Foundation. Mr. Russell is also a director of SangStat Medical
Corp., ChemTrak Incorporated and several privately-held health care companies.

FRED E. SILVERSTEIN, M.D. has been a director of the Company since 1996.
Dr. Silverstein is a Clinical Professor of Medicine at the University of
Washington, Seattle. Since 1994, he has been a partner of Frazier Management,
L.L.C. He holds a B.S. from Alfred University and an M.D. from Columbia
University College of Physicians and Surgeons. He is Board Certified in internal
medicine and gastroenterology. Dr. Silverstein is also a director of two medical
device development companies, Vision Sciences Inc. and Diametrics Medical Inc.,
and several privately-held companies. He holds more than 20 United States
patents on a variety of medical devices.

VIRGIL D. THOMPSON has been a director of the Company since 1995. Since
January 1996, he has been the President and Chief Executive Officer and a
director of Cytel Corporation, a biopharmaceutical company. From 1994 to 1996,
he was President and Chief Executive Officer of Cibus Pharmaceuticals, Inc., a
pharmaceutical company. From 1991 to 1993 he was President of Syntex
Laboratories, Inc., a pharmaceutical company. Mr. Thompson holds a B.S. in
Pharmacy from Kansas University and a J.D. from The George Washington University
Law School. He is also a director of two pharmaceutical companies, Biotechnology
General Corporation and Cypros Pharmaceutical Corporation.

41
<PAGE> 44

BOARD COMMITTEES

The Company's Board of Directors established a Compensation Committee and
an Audit Committee in 1994. The Compensation Committee recommends to the Board
of Directors compensation levels for officers of the Company, establishes
compensation levels for non-officer employees of the Company, makes
recommendations to the Board of Directors regarding stock option grants under
the Company's 1992 Stock Option Plan, as amended (the "Plan"), and otherwise
administers the Plan. The Audit Committee monitors the corporate financial
reporting and the internal and external audits of the Company, provides the
Board of Directors the results of its examinations and recommendations, outlines
to the Board of Directors the improvements made, or to be made, in internal
accounting controls, and nominates independent auditors.

DIRECTOR COMPENSATION

Directors do not currently receive any cash compensation from the Company
for their service as members of the Board of Directors, although they are
reimbursed for certain expenses in connection with attendance at Board and
Committee meetings. Non-employee directors of the Company are eligible to
receive options under the Directors' Plan. See "Management -- Benefit Plans."

LIMITATION ON DIRECTORS' AND OFFICERS' LIABILITY

The Company's Bylaws provide that the Company will indemnify its directors,
and may indemnify its officers, employees and other agents, to the fullest
extent not prohibited by California law. The Company is also empowered under its
Bylaws to enter into indemnification agreements with its directors, officers,
employees and other agents and to purchase insurance on behalf of any person
whom it is required or permitted to indemnify. Pursuant to this provision, the
Company has entered into indemnity agreements with each of its directors and
executive officers.

In addition, the Company's Amended and Restated Articles of Incorporation
provide that, to the fullest extent permitted by California law, the Company's
directors will not be liable for monetary damages for breach of the directors'
fiduciary duty of care to the Company and its shareholders. This provision in
the Amended and Restated Articles of Incorporation does not eliminate the duty
of care, and in appropriate circumstances, equitable remedies such as an
injunction or other forms of non-monetary relief would remain available under
California law. Each director will continue to be subject to liability for
breach of the director's duty of loyalty to the Company for acts or omissions
not in good faith or involving intentional misconduct or knowing or culpable
violations of law that the director believes to be contrary to the best
interests of the Company or its shareholders, for acts or omissions involving a
reckless disregard for the director's duty to the Company or its shareholders
when the director was aware or should have been aware of a risk of serious
injury to the Company or its shareholders, or an unexcused pattern of
inattention that amounts to an abdication of the director's duty to the Company
or its shareholders, for improper transactions between the director and the
Company or for improper distributions to shareholders and loans to directors and
officers, or for acts or omissions by the director as an officer. This provision
also does not affect a director's responsibilities under any other laws, such as
the federal securities laws or state or federal environmental laws.

There is no pending litigation or proceeding involving a director, officer,
employee or other agent of the Company as to which indemnification is being
sought, nor is the Company aware of any pending or threatened litigation that
may result in claims for indemnification by any director, officer, employee or
other agent.

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<PAGE> 45

EXECUTIVE COMPENSATION

The following table sets forth the compensation earned by the Company's
Chief Executive Officer and the other executive officers whose combined salary
and bonus for the year ended December 31, 1995 were in excess of $100,000 (the
"Named Executive Officers"):

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
----------------------
NAME AND PRINCIPAL POSITION SALARY($) BONUS($)
- ------------------------------------------------------------------------ --------- --------
<S> <C> <C>
Richard P. Thompson..................................................... $ 150,000 $30,000
President, Chief Executive Officer, Chief Financial Officer and Director
Reid M. Rubsamen, M.D................................................... $ 120,000 --
Vice President, Medical Affairs, Secretary and Director
Max D. Fiore............................................................ $ 115,000 $15,000
Vice President, Engineering
</TABLE>

The compensation of R. Ray Cummings, the Company's Vice President of
Business Development, and Igor Gonda, Ph.D., the Company's Vice President of
Research and Development, who joined the Company after the commencement of
fiscal 1995, is currently in excess of $100,000 on an annual basis.

STOCK OPTION INFORMATION

The Company did not grant options to purchase shares of the Company's
Common Stock to any of the Named Executive Officers during fiscal year 1995.
Subsequent to December 31, 1995, the Named Executive Officers were granted stock
options exercisable for the following number of shares of Common Stock at an
exercise price of $0.57 per share: Richard P. Thompson, 106,596 shares; Reid M.
Rubsamen, M.D., 28,065 shares; and Max D. Fiore, 28,675 shares.

The following table sets forth certain information concerning the number
and value of unexercised stock options held as of December 31, 1995 for each of
the Named Executive Officers who hold stock options.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT AT FISCAL YEAR END
SHARES FISCAL YEAR END ($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------- ------------ ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Max D. Fiore............... -0- -0- 78,750 -0- 15,750 -0-
</TABLE>

- ------------------------------
(1) Based on the difference between the deemed fair market value of the
securities underlying the options at December 31, 1995 (which for purposes
of this table, is assumed to be $0.5667 per share) and the exercise price.

BENEFIT PLANS

1996 Equity Incentive Plan. The Company's 1996 Equity Incentive Plan (the
"Incentive Plan") was adopted by the Board of Directors in April 1996 as an
amendment and restatement of the Company's 1992 Stock Option Plan (the "1992
Plan"). There are currently 1,980,000 shares of Common Stock authorized for
issuance under the Incentive Plan.

The Incentive Plan provides for the grant of incentive stock options under
the Internal Revenue Code of 1986, as amended (the "Code"), to employees
(including officers and employee-directors) and nonstatutory stock options,
stock appreciation rights, restricted stock purchase awards and stock bonuses to
employees (including officers and employee-directors) and consultants of the
Company. The Incentive Plan is administered by the Board of Directors or a
Committee appointed by the Board that determines recipients and

43
<PAGE> 46

types of awards to be granted, including the exercise price, number of shares
subject to the award and the exercisability thereof.

The terms of stock options granted under the Incentive Plan generally may
not exceed 10 years. The exercise price of options granted under the Incentive
Plan is determined by the Board of Directors, provided that the exercise price
for a nonstatutory stock option cannot be less than 85% of the fair market value
of the Common Stock on the date of the option grant, and the exercise price for
an incentive stock option cannot be less than 100% of the fair market value of
the Common Stock on the date of the option grant. Options granted under the
Incentive Plan vest at the rate specified in the option agreement. No stock
option may be transferred by the optionee other than by will or the laws of
descent or distribution or, in certain limited instances, pursuant to a
qualified domestic relations order, provided that an optionee may designate a
beneficiary who may exercise the option following the optionee's death. An
optionee whose relationship with the Company or any related corporation ceases
for any reason (other than by death or permanent and total disability) may
exercise options in the three-month period following such cessation (unless such
options terminate or expire sooner by their terms) or in such longer period as
may be determined by the Board of Directors. Options may be exercised for up to
twelve months after an optionee's relationship with the Company and related
corporations ceases due death or disability.

No incentive stock option may be granted to any person who, at the time of
the grant, owns (or is deemed to own) stock possessing more than 10% of the
total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant and the term of the option
does not exceed five years from the date of grant. The aggregate fair market
value, determined at the time of grant, of the shares of Common Stock with
respect to which incentive stock options are exercisable for the first time by
an optionee during any calendar year (under all such plans of the Company and
its affiliates) may not exceed $100,000.

Shares subject to stock awards that have expired or otherwise terminated
without having been exercised in full again become available for the grant of
awards under the Incentive Plan. Shares subject to exercised stock appreciation
rights shall not again become available for the grant of new awards.

The Board of Directors has the authority to reprice outstanding options and
stock appreciation rights and to offer optionees and holders of stock
appreciation rights the opportunity to replace outstanding options and stock
appreciation rights with new options or stock appreciation rights for the same
or a different number of shares.

Restricted stock purchase awards granted under the Incentive Plan may be
granted pursuant to a repurchase option in favor of the Company in accordance
with a vesting schedule and at a price determined by the Board of Directors.
Restricted stock purchases must be at a price equal to at least 85% of the
stock's fair market value on the award date, but stock bonuses may be awarded in
consideration of past services without a purchase payment. Rights under a stock
bonus or restricted stock bonus agreement may not be transferred other than by
will, the laws of descent and distribution or a qualified domestic relations
order while the stock awarded pursuant to such an agreement remains subject to
the agreement. Stock appreciation rights granted under the Incentive Plan may be
tandem rights, concurrent rights or independent rights.

Upon certain changes in control of the Company, all outstanding awards
under the Incentive Plan shall either be assumed or substituted by the surviving
entity. If the surviving entity determines not to assume or substitute such
awards, and with respect to persons then performing services as employees,
directors or consultants, the time during which such awards may be exercised
shall be accelerated and the awards terminated if not exercised prior to such
change in control.

As of March 31, 1996, 980,350 shares of Common Stock had been issued upon
the exercise of options granted under the 1992 Plan and the Incentive Plan,
88,689 shares were subject to outstanding options and 160,961 shares remained
available for future grant. In April 1996, in connection with the amendment and
restatement of the 1992 Plan, the Board of Directors approved an increase of the
number of shares issuable upon conversion of the options granted under the
Incentive Plan from 1,230,000 shares to 1,980,000 shares.

44
<PAGE> 47

The Incentive Plan will terminate in April 2006 unless sooner terminated by the
Board of Directors. As of March 31, 1996, no stock bonuses or restricted stock
have been granted under the Incentive Plan.

Non-Employee Directors' Stock Option Plan. In April 1996, the Board
adopted the 1996 Non-Employee Directors' Stock Option Plan (the "Directors'
Plan") to provide for the automatic grant of options to purchase shares of
Common Stock to non-employee directors of the Company. Subject to shareholder
approval, the Directors' Plan will become effective upon effectiveness of this
offering. The Directors' Plan is administered by the Board, unless the Board
delegates administration to a committee of disinterested directors.

The maximum number of shares of Common Stock that may be issued pursuant to
options granted under the Directors' Plan is 225,000. Pursuant to the terms of
the Directors' Plan, each person serving as a director of the Company who is not
an employee of the Company ( a "Non-Employee Director") shall upon the date such
person first becomes a Non-Employee Director after the effectiveness of the
initial public offering of the Company's Common Stock automatically be granted
an option to purchase 7,500 shares of Common Stock. In addition, on each
anniversary of the effectiveness of the initial public offering each
Non-Employee Director will automatically be granted an option to purchase 7,500
shares of Common Stock (pro-rated for Non-Employee Directors with less than a
full year's tenure).

Options under the Directors' Plan will vest in four equal, quarterly
installments commencing on the date of the grant of the option. The exercise
price of the options granted under the Directors' Plan must equal or exceed the
fair market value of the Common Stock granted on the date of grant. No option
granted under the Directors' Plan may be exercised after the expiration of ten
years from the date it was granted. Options granted under the Directors' Plan
are generally non-transferable except pursuant to a qualified domestic relations
order in beneficiary descriptions. The Directors' Plan will terminate at the
direction of the Board.

In the event of certain changes of control, options outstanding under the
Plan will automatically become fully vested and will terminate if not exercised
prior to such change of control.

As of March 31, 1996, no options to purchase Common Stock have been granted
pursuant to the Directors' Plan.

1996 Employee Stock Purchase Plan. In April 1996, the Company's Board of
Directors approved the 1996 Employee Stock Purchase Plan (the "Purchase Plan")
covering an aggregate of 150,000 shares of Common Stock. The Purchase Plan is to
become effective after the effectiveness of this offering. The Purchase Plan is
intended to qualify as an employee stock purchase plan within the meaning of
Section 423 of the Code. Under the Purchase Plan, the Board of Directors may
authorize participation by eligible employees, including officers, in periodic
offerings following the adoption of the Purchase Plan. The offering period for
any offering will be no more than 27 months.

Employees are eligible to participate if they are employed by the Company
or an affiliate of the Company designated by the Board of Directors. Employees
who participate in an offering can have up to 15% of their earnings withheld
pursuant to the Purchase Plan and applied, on specified dates determined by the
Board of Directors, to the purchase of shares of Common Stock. The price of
Common Stock purchased under the Purchase Plan will be equal to 85% of the lower
of the fair market value of the Common Stock on the commencement date of each
offering period or the relevant purchase date. Employees may end their
participation in the offering at any time during the offering period, and
participation ends automatically on termination of employment with the Company.

In the event of certain changes of control, the Company and the Board of
Directors has discretion to provide that each right to purchase Common Stock
will be assumed or an equivalent right substituted by the successor corporation,
or the Board may shorten the offering period and provide for all sums collected
by payroll deductions to be applied to purchase stock immediately prior to the
change in control. The Purchase Plan will terminate at the Board's direction.

45
<PAGE> 48

CERTAIN TRANSACTIONS

Since the beginning of 1993, the Company has sold 645,831 shares of its
Series C Preferred Stock at a price of $3.60 per share, 1,854,594 shares of its
Series D Preferred Stock at a price of $4.2267 per share and 2,108,452 shares of
its Series E Preferred Stock at a price of $5.50 per share in a series of
private financings. The Company sold the above securities pursuant to preferred
stock purchase agreements on substantially similar terms (except for terms
relating to date and price), under which the Company made standard
representations, warranties and covenants, and which provided the purchasers
thereunder with registration rights, information rights and rights of first
refusal, among other provisions standard in venture capital financings. Each
share of Preferred Stock will convert into one share of Common Stock upon the
closing of this offering. The purchasers of the Preferred Stock included, among
others, the following of 5% shareholders, directors and entities associated with
directors:

<TABLE>
<CAPTION>
SHARES OF PREFERRED STOCK
PURCHASED
----------------------------------
INVESTOR SERIES C SERIES D SERIES E
------------------------------------------------------ -------- -------- --------
<S> <C> <C> <C>
Lester John Lloyd(1).................................. 13,888 -- --
Technology Venture Investors-IV, as nominee for
various TVI funds(2)................................ 208,333 358,137 282,727
Sprout Group entities(3).............................. -- 946,372 127,272
Sequoia Capital entities(4)........................... 208,332 199,891 45,454
Brentwood Associates VI, L.P.(5)...................... 208,333 296,964 90,909
Frazier Healthcare II, L.P.(6)........................ -- -- 636,363
Electronic Investments Ltd.(7)........................ -- -- 172,728
David S. Rubsamen, M.D.(8)............................ -- -- 3,000
</TABLE>

- ------------------------------
(1) Lester John Lloyd is the Chairman of the Company's Board of Directors. Mr.
Lloyd transferred all of such shares on October 21, 1995.

(2) Burton J. McMurtry, Ph.D., a director of the Company, is a general partner
of TVI Management-4, L.P., the General Partner of Technology Venture
Investors-IV.

(3) Represents 329,688 shares of Series D Preferred Stock and 44,437 shares of
Series E Preferred Stock held by Sprout Capital VI, L.P., 76,351 shares of
Series E Preferred Stock purchased by Sprout Capital VII, L.P. and 616,684
shares of Series D Preferred Stock and 6,484 shares of Series E Preferred
Stock purchased by DLJ Capital Corporation. DLJ Capital Corporation ("DLJ")
is the Managing General Partner of Sprout Capital VI, L.P. and Sprout
Capital VII, L.P. DLJ transferred 564,472 shares of the Series D Preferred
Stock to Sprout Capital VII, L.P. on August 15, 1995.

(4) Represents 193,750 shares of Series C Preferred Stock, 186,138 shares of
Series D Preferred Stock and 42,273 shares of Series E Preferred Stock
purchased by Sequoia Capital V, 8,332 shares of Series C Preferred Stock
purchased by Sequoia XXIII, 6,250 shares of Series C Preferred Stock, 5,757
shares of Series D Preferred Stock and 1,363 shares of Series E Preferred
Stock purchased by Sequoia Technology Partners V and 7,996 shares of Series
D Preferred Stock and 1,818 shares of Series E Preferred Stock purchased by
Sequoia XXIV. Gordon W. Russell, a director of the Company, is a general
partner of Sequoia Technology Partners V and Sequoia Partners F.R., the
General Partner of Sequoia Capital V, and an investment advisor of Sequoia
XXIII and Sequoia XXIV.

(5) Ross A. Jaffe, M.D., a director of the Company, is a general partner of
Brentwood VI Ventures, L.P., the General Partner of Brentwood Associates VI,
L.P.

(6) Fred E. Silverstein, M.D., a director of the Company, is a member of Frazier
Management L.L.C.

(7) Jared A. Anderson, Ph.D., a director of the Company, is an Attorney-in-Fact
for Electronic Investments Ltd.

(8) Reid M. Rubsamen, M.D., Vice President of Medical Affairs, Secretary and a
director of the Company, is the son of David S. Rubsamen, M.D.

46
<PAGE> 49

In July 1994, The Company issued certain warrants to purchase shares of the
Company's Preferred Stock to Brentwood Associates VI, L.P., Technology Venture
Investors-IV, as nominee for various TVI funds, Sequoia Capital V and Sequoia
XXIV pursuant to a note and warrant purchase agreement, which warrants are
exercisable for an aggregate of 88,719 shares of Series D Preferred Stock. See
"Description of Capital Stock." Pursuant to such note and warrant purchase
agreement, the Company also issued to Brentwood Associates VI, L.P., Technology
Venture Investors-IV, as nominee for various TVI funds, Sequoia Capital V and
Sequoia XXIV promissory notes in the aggregate principal amount of $1,499,999,
which notes accrued interest at the rate of 5.63% per annum and were convertible
into shares of the Company's Series D Preferred Stock. In December 1994, the
outstanding balance of each such note, representing an aggregate of $1,532,622,
was converted into an aggregate of 362,607 shares of the Company's Series D
Preferred Stock.

In May 1994, the Company issued and sold to Richard P. Thompson, President,
Chief Executive Officer, Chief Financial Officer and a director of the Company,
an aggregate of 225,000 shares of its Common Stock for an aggregate purchase
price of $82,500, payable pursuant to a secured promissory note bearing interest
at the rate of 7% per annum, with accrued but unpaid interest due and payable
annually and the principal and remaining interest due and payable on July 1,
1999. The largest aggregate amount of Mr. Thompson's indebtedness to the Company
during fiscal 1995 was $87,009. The outstanding balance of the loan to Mr.
Thompson was $85,886 as of March 31, 1996.

In May 1995, the Company issued and sold to R. Ray Cummings, Vice President
of Business Development of the Company, an aggregate of 67,500 shares of its
Common Stock for an aggregate purchase price of $29,250, payable pursuant to a
secured promissory note bearing interest at the rate of 7.12% per annum, with
accrued but unpaid interest due and payable annually and the principal and
remaining interest due and payable on July 1, 2000. In May 1995, the Company
loaned Mr. Cummings $53,235 pursuant to a Promissory Note Secured by Deed of
Trust, with the principal and 6% interest due and payable on February 7, 2001.
The largest aggregate amount of Mr. Cummings' indebtedness to the Company during
fiscal 1995 was $85,722. The aggregate outstanding balance of the loans to Mr.
Cummings was $88,749 as of March 31, 1996.

In September 1995, the Company granted an option to purchase 150,000 shares
of the Company's Common Stock with an exercise price of $0.4333 per share to
Igor Gonda, Ph.D., Vice President of Research and Development of the Company. In
December 1995, Dr. Gonda exercised such option for an aggregate exercise price
of $65,000, with $6,500 paid in cash and the remaining $58,500 payable pursuant
to a secured promissory note bearing interest at the rate of 5.73% per annum,
with the principal and accrued but unpaid interest due and payable on December
27, 2000. In October 1995, the Company loaned Dr. Gonda $90,000 pursuant to a
promissory note which is interest-free as long as Dr. Gonda is employed by the
Company. The principal amount of the note will be due and payable in October
1998. The largest aggregate amount of Dr. Gonda's indebtedness to the Company
during fiscal 1995 was $148,538. The aggregate outstanding balance of the loans
to Dr. Gonda was $149,390 as of March 31, 1996.

The Company believes that the foregoing transactions were in its best
interests. As a matter of policy these transactions were, and all future
transactions between the Company and any of its officers, directors or principal
shareholders will be, approved by a majority of the independent and
disinterested members of the Board of Directors, will be on terms no less
favorable to the Company than could be obtained from unaffiliated third parties
and will be in connection with bona fide business purposes of the Company.

47
<PAGE> 50

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information known to the Company
with respect to the beneficial ownership of its Common Stock as of March 31,
1996, assuming the conversion of all shares of Preferred Stock into shares of
Common Stock and as adjusted to reflect the sale of Common Stock offered by the
Company hereby for (i) each shareholder who is known by the Company to own
beneficially more than 5% of the Common Stock, (ii) each Named Executive Officer
of the Company and certain other executive officers; (iii) each director of the
Company; and (iv) all directors and executive officers of the Company as a
group.

<TABLE>
<CAPTION>
SHARES PERCENT BENEFICIALLY
BENEFICIALLY OWNED(1)
OWNED(1) ------------------------
------------ BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER OFFERING OFFERING(2)
---------------------------------------------------- ------------ -------- -----------
<S> <C> <C> <C>
Burton J. McMurtry, Ph.D.(3)........................ 1,231,354 16.2% 12.0%
Technology Venture Investors-IV
2480 Sand Hill Road, Suite 101
Menlo Park, CA 94025
Kathleen D. LaPorte(4).............................. 1,073,644 14.2% 10.7%
Sprout Group
3000 Sand Hill Road
Building 4, Suite 270
Menlo Park, CA 94025
Gordon W. Russell(5)................................ 835,833 11.0% 8.2%
Sequoia Capital
3000 Sand Hill Road
Building 4, Suite 280
Menlo Park, CA 94025
Fred E. Silverstein, M.D.(6)........................ 636,363 8.4% 6.2%
Frazier & Company
Two Union Square
601 Union Street, Suite 2110
Seattle, WA 98101
Ross A. Jaffe, M.D.(7).............................. 610,265 8.1% 6.0%
Brentwood Associates VI, L.P.
2730 Sand Hill Road, Suite 250
Menlo Park, CA 94025
Jared A. Anderson, Ph.D.(8)......................... 433,843 5.7% 4.2%
Electronic Investments Ltd.
140 Sunrise Drive
Woodside, CA 94062
Richard P. Thompson................................. 331,596 4.4% 3.3%
Reid M. Rubsamen, M.D............................... 328,065 4.3% 3.2%
Igor Gonda, Ph.D. .................................. 150,000 2.0% 1.5%
Lester John Lloyd(9)................................ 107,866 1.4% 1.1%
Max D. Fiore........................................ 106,825 1.4% 1.0%
R. Ray Cummings..................................... 71,857 * *
Virgil D. Thompson(10).............................. 12,000 * *
All directors and executive officers as a group
(12 persons)...................................... 4,855,807 62.9% 45.3%
</TABLE>

- ------------------------------
* Represents beneficial ownership of less than 1%.

(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Except as indicated by
footnote, and subject to community property laws where applicable, the
persons named in the table above have sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by them.
Percentage of beneficial ownership is based on 7,568,410 shares of

48
<PAGE> 51

Common Stock outstanding as of March 31, 1996 and 10,068,410 shares of
Common Stock outstanding after completion of this offering.

(2) Assumes no exercise of the Underwriters' over-allotment option to purchase
up to an aggregate of 375,000 shares of Common Stock from the Company.

(3) Represents 1,194,024 shares held by Technology Venture Investors-IV, as
nominee for various TVI funds, and a warrant to purchase 37,330 shares held
by Technology Venture Investors-IV. Mr. McMurtry, a director of the
Company, is a general partner of TVI Management-4, L.P., the General
Partner of Technology Venture Investors-IV, and, as such, may be deemed to
share voting and investment power with respect to such shares. Mr. McMurtry
disclaims beneficial ownership of such shares except to the extent of his
pecuniary interest in such shares arising from his interest in the entities
referred to herein.

(4) Represents 640,823 shares held by Sprout Capital VII, L.P. ("Sprout VII"),
374,125 shares held by Sprout Capital VI, L.P. ("Sprout VI") and 58,696
shares held by DLJ Capital Corporation ("DLJ"), the Managing General
Partner of both Sprout VII and Sprout VI. Ms. LaPorte is a general partner
of DLJ Associates VII, L.P. and DLJ Associates VI, L.P., the general
partners of Sprout VII and Sprout VI, respectively, and an Attorney-in-Fact
for DLJ, and, as such, may be deemed to have voting and investment power
with respect to such shares. Ms. LaPorte disclaims beneficial ownership of
such shares except to the extent of her pecuniary interest in such shares
arising from her interest in the entities referred to herein.

(5) Represents 732,506 shares held by Sequoia Capital V, 34,059 shares held by
Sequoia Technology Partners V, 13,792 shares held by Sequoia XXII, 9,814
shares held by Sequoia XXIV, 8,332 shares held by Sequoia XXIII and
warrants to purchase 35,838 shares held by Sequoia Capital V and 1,492
shares held by Sequoia XXIV. Mr. Russell, a director of the Company, is a
general partner of Sequoia Technology Partners V and Sequoia Partners F.R.,
the General Partner of Sequoia Capital V, and an investment advisor of
Sequoia XXII, Sequoia XXIII and Sequoia XXIV, and, as such, may be deemed
to share voting and investment power with respect to such shares. Mr.
Russell disclaims beneficial ownership of such shares except to the extent
of his pecuniary interest in such shares arising from his interest in the
entities referred to herein.

(6) Represents 636,363 shares held by Frazier Healthcare II, L.P. Dr.
Silverstein, a director of the Company, is a member of Frazier Management,
L.L.C., the Managing Member of FHM II, L.L.C., the General Partner of
Frazier Healthcare II, L.P., and, as such, may be deemed to share voting
and investment power with respect to such shares. Dr. Silverstein disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest in such shares arising from his interest in Frazier Healthcare II,
L.P.

(7) Represents 596,206 shares held by Brentwood Associates VI, L.P. and a
warrant to purchase 14,059 shares held by Brentwood Associates VI, L.P. Dr.
Jaffe, a director of the Company, is a general partner of Brentwood VI
Ventures, L.P., the General Partner of Brentwood Associates VI, L.P., and,
as such, may be deemed to share voting and investment power with respect to
such shares. Dr. Jaffe disclaims beneficial ownership of such shares except
to the extent of his pecuniary interest in such shares arising from his
interest in the entities referred to herein.

(8) Represents 406,257 shares held by Electronic Investments Ltd. and a warrant
to purchase 27,586 shares held by Electronic Investments Ltd. Dr. Anderson,
a director of the Company, is an Attorney-in-Fact for Electronic
Investments Ltd., and, as such, may be deemed to share voting and
investment power with respect to such shares. Dr. Anderson disclaims
beneficial ownership of such shares except to the extent of his pecuniary
interest arising from his interest in Electronic Investments Ltd.

(9) Represents 71,660 shares held by Mr. Lloyd, 8,620 shares held by The Lloyd
Trust and a warrant to purchase 27,586 shares held by Mr. Lloyd. Mr. Lloyd,
Chairman of the Board of Directors of the Company, is Trustee of The Lloyd
Trust and, as such, may be deemed to have shared voting and investment
power with respect to the shares held by The Lloyd Trust. Mr. Lloyd
disclaims beneficial ownership of such shares except to the extent of his
pecuniary interest arising from his interest in such entity. Mr. Lloyd is
an investment advisor of Farm Street Investments Ltd. and disclaims
beneficial ownership of the 293,822 shares held by Farm Street Investments
Ltd.

(10) Represents 12,000 shares subject to an option exercisable within 60 days of
March 31, 1996.

49
<PAGE> 52

DESCRIPTION OF CAPITAL STOCK

Following the closing of the sale of the shares offered hereby, the
authorized capital stock of the Company will consist of 40,000,000 shares of
Common Stock, without par value, and 5,000,000 shares of Preferred Stock,
without par value. The following summaries of certain provisions of the Common
Stock and Preferred Stock do not purport to be complete and are subject to, and
qualified by, the provisions of the Company's Amended and Restated Articles of
Incorporation, which are included as exhibits to the Registration Statement of
which this Prospectus is a part, and by applicable law.

COMMON STOCK

As of March 31, 1996, there were 7,568,410 shares of Common Stock
outstanding that were held of record by approximately 65 shareholders, after
giving effect to the conversion of the Company's Series A, Series B, Series C,
Series D and Series E Preferred Stock into Common Stock. The holders of Common
Stock are entitled to one vote for each share held of record on all matters
submitted to a vote of the shareholders, except that upon giving the legally
required notice, shareholders may cumulate their votes in the election of
directors. The Company's Amended and Restated Articles of Incorporation provide
that the ability of the shareholders to cumulate their votes in the election of
directors shall be eliminated on and after the Company becomes a "listed
corporation" as defined in Section 301.5 of the California Corporations Code.
Subject to preferences that may be applicable to any then outstanding Preferred
Stock, holders of Common Stock are entitled to receive ratably such dividends as
may be declared by the Board of Directors out of funds legally available
therefor. See "Dividend Policy." In the event of a liquidation, dissolution or
winding up of the Company, holders of the Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities and the liquidation
preference of any then outstanding Preferred Stock. Holders of Common Stock have
no preemptive rights and no right to convert their Common Stock into any other
securities. There are no redemption or sinking fund provisions applicable to the
Common Stock. All outstanding shares of Common Stock are, and all shares of
Common Stock to be outstanding upon completion of this offering will be, fully
paid and nonassessable.

PREFERRED STOCK

Effective following the closing of this offering, the Company will be
authorized to issue 5,000,000 shares of undesignated Preferred Stock. The Board
of Directors will have the authority to issue the undesignated Preferred Stock
in one or more series and to determine the powers, preferences and rights and
the qualifications, limitations or restrictions granted to or imposed upon any
wholly unissued series of undesignated Preferred Stock including dividend
rights, dividend rates, conversion rights, voting rights, terms of redemption
prices, liquidation preferences, and to fix the number of shares constituting
any series and the designation of such series, without any further vote or
action by the shareholders. The issuance of Preferred Stock may have the effect
of delaying, deferring or preventing a change in control of the Company without
further action by the shareholders and may adversely affect the voting and other
rights of the holders of Common Stock. The issuance of Preferred Stock with
voting and conversion rights may adversely affect the voting power of the
holders of Common Stock, including the loss of voting control to others. At
present, the Company has no plans to issue any shares of Preferred Stock.

WARRANTS

In March 1992 and July 1992, the Company issued warrants to purchase shares
of Preferred Stock of the Company to Electronic Investments, Ltd. and Lester
John Lloyd, the Chairman of the Company's Board of Directors, respectively, with
the exercise price of such warrant and number of shares of Preferred Stock
covered by such warrant to be based upon the price per share of Preferred Stock
subsequently issued by the Company. Currently, each such warrant is exercisable
for 27,586 shares of the Company's Series E Preferred Stock and becomes
exercisable for Common Stock immediately prior to the closing of this offering
at an exercise price of $1.45 per share. The warrants include a net exercise
provision and expire on June 30, 1997.

50
<PAGE> 53

In August 1992, the Company issued a warrant to purchase 15,000 shares of
Series A Preferred Stock at an exercise price of $1.6667 per share to
Professional Liability Newsletter Trust Fund, David S. Rubsamen, M.D., TTEE. The
warrant includes a net exercise provision and expires on the earlier to occur of
the closing of this offering of the Company's Common Stock or August 31, 1996.

In July 1994, pursuant to a note and warrant purchase agreement, the
Company issued warrants to purchase certain shares of Preferred Stock of the
Company to Brentwood Associates VI, L.P., Technology Venture Investors-IV,
Sequoia Capital V and Sequoia XXIV, with the exercise price of such warrants and
the number of shares covered by such warrants to be based upon the price per
share of Preferred Stock subsequently issued by the Company. Currently, the
warrants held by Brentwood Associates VI, L.P., Technology Venture Investors-IV,
as nominee for various TVI funds, Sequoia Capital V and Sequoia XXIV are
exercisable for 14,059 shares, 37,330 shares, 35,838 shares and 1,492 shares of
Series D Preferred Stock, respectively, at an exercise price of $4.2267 per
share. The warrants include a net exercise provision and expire on the earlier
to occur of the closing of this offering of the Company's Common Stock or June
30, 1999.

In June 1995, the Company issued a warrant to purchase 37,500 shares of the
Company's Series D Preferred Stock at an exercise price of $4.2267 per share to
Comdisco, Inc. The warrant includes a net exercise provision and expires on the
earlier to occur of two years from the effective date of this offering or June
9, 2005.

REGISTRATION RIGHTS

Pursuant to an agreement between the Company and the holders (or their
permitted transferees) of approximately 6,382,339 shares of Common Stock
("Holders"), the Holders are entitled to certain rights with respect to the
registration of such shares under the Securities Act of 1933, as amended (the
"Securities Act"). If the Company proposes to register its Common Stock, subject
to certain exceptions, under the Securities Act, the Holders are entitled to
notice of the registration and are entitled to include, at the Company's
expense, such shares therein, provided that the managing underwriters have the
right to limit the number of such shares included in the registration. The
Company has provided the Holders with notice of the registration and the Holders
have waived their registration right with respect to this offering. In addition,
certain of the Holders may require the Company, at its expense on no more than
two occasions, to file a registration statement under the Securities Act with
respect to their shares of Common Stock. Such rights may not be exercised until
180 days after the completion of this offering. Further, certain Holders may
require the Company at its expense to register their shares on no more than four
occasions on Form S-3 when such form becomes available to the Company, subject
to certain conditions and limitations. All such rights expire on the fifth
anniversary of completion of this offering.

CERTAIN ANTI-TAKEOVER CHARTER PROVISIONS

The Company's Bylaws (i) provide that only a majority of the members of the
Board of Directors in office, although less than a quorum, may elect directors
to fill vacancies created either by resignation, death, disqualification,
removal or by an increase in the size of the Board of Directors and (ii) require
advance notice by a shareholder of a proposal or director nomination that such
shareholder desires to present at the annual meeting. In addition, the Company's
Amended and Restated Articles of Incorporation (i) prohibit shareholder actions
by written consent, (ii) eliminate automatically on and after the Company
becomes a "listed corporation" as defined in Section 301.5 of the California
Corporations Code the ability of the shareholders to cumulate votes in the
election of directors and (iii) provide that the Bylaws of the Company may only
be amended by the Board of Directors or two-thirds of the Company's outstanding
voting stock. These provisions may have the effect of deterring hostile
takeovers or delaying changes in control or management of the Company.

TRANSFER AGENT AND REGISTRAR

The First National Bank of Boston has been appointed as the transfer agent
and registrar for the Company's Common Stock.

51
<PAGE> 54

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering and assuming no exercise of options and
warrants outstanding as of March 31, 1996 and no exercise of the Underwriters'
over-allotment option, the Company will have outstanding 10,068,410 shares of
Common Stock. Of these shares, the 2,500,000 shares sold in this offering will
be freely tradeable without restriction or further registration under the
Securities Act, except for any shares held by "affiliates" of the Company as
that term is defined in Rule 144 under the Securities Act ("Affiliates"), which
shares will be subject to the resale limitations of Rule 144. The remaining
7,568,410 shares of Common Stock held by existing shareholders (the "Restricted
Shares") were issued and sold by the Company in reliance on exemptions from the
registration requirements of the Securities Act. These shares may be sold in the
public market only if registered or pursuant to an exemption from registration
such as Rules 144, 144(k), or 701 under the Securities Act, which are summarized
below.

In the absence of the restrictions contained in the agreements not to sell
described below, approximately 234,759 of these Restricted Shares will be
eligible for sale in the public market upon the date of this offering pursuant
to Rule 144(k). In the absence of the restrictions contained in the agreements
not to sell described below, approximately 3,269,578 additional Restricted
Shares will be eligible for sale beginning 90 days after the date of this
offering pursuant to Rule 144 and Rule 701. Holders of approximately 7,139,268
of the Restricted Shares are subject to agreements not to sell or otherwise
transfer their shares for a period of 180 days following the date of this
offering (the "Lock-up Shares"). Of such Lock-up Shares, 3,311,559 will become
available for sale in the public market 180 days after the date of this
offering, although 1,810,083 of the Lock-up Shares will still be subject to
certain volume and other restrictions on resale under Rule 144 at the expiration
of such 180-day period. Cowen & Company may, in its sole discretion and at any
time without notice, release any or all of the holders of the Lock-up Shares
from any or all of their obligations under their respective agreements not to
sell.

As of March 31, 1996, there were 88,689 shares of Common Stock issuable
upon exercise of outstanding options. The Company intends to file a registration
statement under the Securities Act to register shares of Common Stock reserved
for issuance under the Option Plan, thus permitting the sale of such shares by
non-affiliates in the public market without restriction under the Securities
Act. Such registration statement will become effective immediately upon filing.
Upon effectiveness of such registration statement, holders of vested options to
purchase approximately 46,516 shares will be entitled to exercise such options
and immediately sell such shares. Holders of all of these option shares have
entered into agreements not to sell any shares of Common Stock received upon
exercise of such options for 180 days following the date of this offering. Cowen
& Company, in its sole discretion and at any time without notice, may release
any or all of such option holders from any or all of their obligations under
their respective agreements not to sell.

In addition, as of March 31, 1996, there were 196,391 shares of Common
Stock issuable upon the exercise of outstanding warrants. Of such shares, an
aggregate of 136,937 shares will be outstanding as of the completion of this
offering, assuming the net exercise of all such warrants based on a public
offering price of $12.00 per share. The holders of warrants covering 112,641
shares issuable upon net exercise of such warrants are subject to agreements not
to sell or otherwise dispose their shares for a period of 180 days following the
date of this offering. The shares issuable upon the exercise of such warrants
will become available for sale in the public market 180 days after the date of
this offering, although such shares will still be subject to certain volume and
other restrictions on resale under Rule 144 at the expiration of such 180-day
period. Cowen & Company may, in its sole discretion and at any time without
notice, release any or all of the holders of the Lock-up Shares from any or all
of their obligations under their respective agreements not to sell.

In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, an Affiliate of the Company, or person (or persons
whose shares are aggregated) who has beneficially owned Restricted Shares for at
least two years, will be entitled to sell in any three-month period a number of
shares that does not exceed the greater of (i) 1% of the then outstanding shares
of the Company's Common Stock (approximately 100,700 shares immediately after
this offering) or (ii) the average weekly trading volume of the Company's Common
Stock in the Nasdaq National Market during the four calendar weeks immediately
preceding the date on which notice of the sale is filed with the Securities and
Exchange Commission. Sales

52
<PAGE> 55

pursuant to Rule 144 are subject to certain requirements relating to manner of
sale, notice and availability of current public information about the Company. A
person (or person whose shares are aggregated) who is not deemed to have been an
Affiliate of the Company at any time during the 90 days immediately preceding
the sale and who has beneficially owned Restricted Shares for at least three
years is entitled to sell such shares pursuant to Rule 144(k) without regard to
the limitations described above.

An employee, officer or director of or consultant to the Company who
purchased or was awarded shares or options to purchase shares pursuant to a
written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701 under the Securities Act, which permits Affiliates and
non-Affiliates to sell their Rule 701 shares without having to comply with Rule
144's holding period restrictions, in each case commencing 90 days after the
date of this Prospectus. In addition, non-Affiliates may sell Rule 701 shares
without complying with the public information, volume and notice provisions of
Rule 144.

Prior to this offering, there has been no public market for the Common
Stock of the Company. Future sales of substantial amounts of Common Stock in the
public market could adversely affect market prices prevailing from time to time.
As described herein, only a limited number of shares will be available for sale
shortly after this offering because of certain contractual and legal
restrictions on resale. Sales of substantial amounts of Common Stock of the
Company in the public market after the restrictions lapse could adversely affect
the prevailing market price and the ability of the Company to raise equity
capital in the future.

53
<PAGE> 56

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters"), through their representatives,
Cowen & Company, Oppenheimer & Co., Inc. and Invemed Associates, Inc., have
severally agreed to purchase from the Company the following respective number of
shares at the initial public offering price less the underwriting discounts and
commissions set forth on the cover page of this Prospectus:

<TABLE>
<CAPTION>
NUMBER
OF
NAME SHARES
-------------------------------------------------------------------------- ---------
<S> <C>
Cowen & Company...........................................................
Oppenheimer & Co., Inc....................................................
Invemed Associates, Inc...................................................
---------
Total........................................................... 2,500,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company and its counsel and
independent auditors. The nature of the Underwriters' obligation is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.

The Underwriters propose to offer the shares of Common Stock directly to
the public at the initial public offering price set forth on the cover page of
this Prospectus and to certain dealers at such price less a concession not in
excess of $ per share. The Underwriters may allow and such dealers may
re-allow a concession not in excess of $ per share to certain other
dealers. The Underwriters have informed the Company that they do not intend to
confirm sales to any accounts over which they exercise discretionary authority.
After the initial public offering of the shares, the offering price and other
selling terms may from time to time be varied by the Underwriters.

The Company has granted to the Underwriters an option, exercisable no later
than 30 days after the date of this Prospectus, to purchase up to 375,000
additional shares of Common Stock at the initial public offering price, less the
underwriting discounts and commissions, set forth on the cover page of this
Prospectus, to cover over-allotments, if any. If the Underwriters exercise such
over-allotment option, the Underwriters have severally agreed, subject to
certain conditions, to purchase approximately the same percentage thereof that
the number of shares of Common Stock to be purchased by each of them shown in
the foregoing table bears to the total number of shares of Common Stock offered
hereby. The Underwriters may exercise such option only to cover over-allotments
made in connection with the sale of shares of Common Stock offered hereby.

The Company's officers and directors and certain other shareholders of the
Company holding in the aggregate approximately 7,139,268 shares of Common Stock
have agreed that they will not, without the prior written consent of Cowen &
Company, offer, sell or otherwise dispose of any shares of Common Stock,
options, rights or warrants to acquire shares of Common Stock, or securities
exchangeable for or convertible into shares of Common Stock owned by them during
the 180-day period commencing on the effective date of the Registration
Statement. In addition, the Company has agreed that it will not, without the
prior written consent of Cowen & Company, offer, sell or otherwise dispose of
any shares of Common Stock, options, rights or warrants to acquire shares of
Common Stock, or securities exchangeable for or convertible into shares of
Common Stock during such 180-day period except in certain limited circumstances.

The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, and to contribute
to payments the Underwriters may be required to make in respect thereof.

Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price for the Common Stock will be determined
by negotiation among the Company and the Representatives. The factors considered
in determining the initial public offering price will be prevailing market and
economic conditions, market valuations of other companies engaged in activities
similar to the Company, estimates of the business potential and prospects of the
Company, the present state of the Company's business operations,

54
<PAGE> 57

the Company's management. The estimated initial public offering price range set
forth on the cover of this Prospectus is subject to change as a result of market
conditions and other factors.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward Castro Huddleson & Tatum, San Francisco, California
("Cooley Godward"). As of the date of this Prospectus, members of Cooley Godward
held an aggregate of 36,570 shares of Common Stock. Pillsbury Madison & Sutro
LLP, San Francisco, California, is acting as counsel for the Underwriters in
connection with certain legal matters relating to the shares of Common Stock
offered hereby.

EXPERTS

The financial statements of the Company as of December 31, 1994 and 1995,
and for the years ended December 31, 1994 and 1995 and for the period from
January 30, 1991 (inception) through December 31, 1995 appearing in this
Prospectus and Registration Statement have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein and in the Registration Statement and are included in reliance upon such
report given on the authority of such firm as experts in accounting and
auditing. The financial statements for the period from January 30, 1991
(inception) through December 31, 1993 include total revenues and net loss of $0
and $2.9 million, respectively. The opinion of Ernst & Young LLP on the
statements of operations, shareholders' equity, and cash flows for the period
from January 30, 1991 (inception) through December 31, 1995, insofar as it
relates to amounts for periods ended through December 31, 1993, is based solely
on the report of other auditors.

The financial statements of the Company for the year ended December 31,
1993 appearing in this Prospectus and Registration Statement have been audited
by Bregante + Company LLP, independent auditors, as set forth in their report
thereon appearing elsewhere herein and in the Registration Statement and are
included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.

CHANGE IN ACCOUNTANTS

At a meeting held on March 14, 1995, the Board of Directors of the Company
approved the engagement of Ernst & Young LLP as its independent auditors for the
fiscal year ending December 31, 1994. Prior to the engagement of Ernst & Young
LLP, Bregante + Company LLP served as independent auditors of the Company. The
Audit Committee of the Board of Directors approved the change in auditors on
that date.

The report of Bregante + Company LLP on the Company's financial statements
for the year ended December 31, 1993 did not contain an adverse opinion or a
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope, or accounting principles.

In connection with the audit of the Company's financial statements for the
fiscal year ended December 31, 1993, there were no disagreements with Bregante +
Company LLP on any matters of accounting principles or practices, financial
statement disclosure, or auditing scope and procedures which, if not resolved to
the satisfaction of Bregante + Company LLP, would have caused Bregante + Company
LLP to make reference to the matter in their report.

ADDITIONAL INFORMATION

A Registration Statement on Form S-1, including amendments thereto,
relating to the Common Stock offered hereby has been filed by the Company with
the Securities and Exchange Commission, Washington, D.C. This Prospectus does
not contain all of the information set forth in the Registration Statement and
the exhibits and schedules thereto. Statements contained in this Prospectus as
to the contents of any contract or other document referred to are not
necessarily complete and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference; provided,
however, that each such statement includes all of the material elements of such
document or contract. For further information with respect to the Company and
the Common Stock offered hereby, reference is made to such Registration
Statement, exhibits and schedules. A copy of the Registration Statement may be
inspected by anyone without charge at the public reference facilities maintained
by the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C.
20549, and copies of all or any part thereof may be obtained from the Commission
upon the payment of certain fees prescribed by the Commission.

55
<PAGE> 58

ARADIGM CORPORATION

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................................... F-2
Report of Bregante + Company LLP, Independent Auditors................................ F-3
Financial Statements
Balance Sheets........................................................................ F-4
Statements of Operations.............................................................. F-5
Statement of Shareholders' Equity..................................................... F-6
Statements of Cash Flows.............................................................. F-7
Notes to Financial Statements......................................................... F-8
</TABLE>

F-1
<PAGE> 59

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Aradigm Corporation

We have audited the accompanying balance sheets of Aradigm Corporation (a
development stage company) as of December 31, 1994 and 1995, and the related
statements of operations, shareholders' equity, and cash flows for the years
then ended and for the period from January 30, 1991 (inception) through December
31, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The financial statements for the year ended
December 31, 1993 and for the period from January 30, 1991 (inception) through
December 31, 1993, were audited by other auditors whose report dated February
22, 1994 expressed an unqualified opinion on those statements. The financial
statements for the period from January 30, 1991 (inception) through December 31,
1993 include total revenues and net loss of $0 and $2.9 million, respectively.
Our opinion on the statements of operations, shareholders' equity, and cash
flows for the period from January 30, 1991 (inception) through December 31,
1995, insofar as it relates to amounts for periods ended through December 31,
1993, is based solely on the report of other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Aradigm Corporation (a development stage company) at
December 31, 1994 and 1995, and the results of its operations and its cash flows
for the years then ended and for the period from January 30, 1991 (inception)
through December 31, 1995, in conformity with generally accepted accounting
principles.

ERNST & YOUNG LLP

Palo Alto, California
February 23, 1996, except Note 8
as to which the date is June 11, 1996

F-2
<PAGE> 60

REPORT OF BREGANTE + COMPANY LLP, INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
Aradigm Corporation

We have audited the accompanying statements of operations, shareholders'
equity and cash flows of Aradigm Corporation (a Company in the development
stage) for the year ended December 31, 1993 and for the period from inception
(January 30, 1991) through December 31, 1993. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Aradigm
Corporation for the year ended December 31, 1993 and for the period from
inception (January 30, 1991) through December 31, 1993, in conformity with
generally accepted accounting principles.

Bregante + Company LLP

San Francisco, California
February 22, 1994

F-3
<PAGE> 61

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

BALANCE SHEETS

<TABLE>
<CAPTION>
(UNAUDITED)
DECEMBER 31, PRO FORMA
---------------------------- MARCH 31, SHAREHOLDERS'
1994 1995 1996 EQUITY AT
----------- ------------ ------------ MARCH 31,
1996
(UNAUDITED) ----------------
(NOTE 8)
<S> <C> <C> <C> <C>
ASSETS

Current assets:
Cash and cash equivalents............... $ 6,086,912 $ 12,117,355 $ 10,779,461
Contract receivable..................... -- 260,000 --
Other current assets.................... 35,793 74,127 80,361
----------- ------------ ------------
Total current assets............ 6,122,705 12,451,482 10,859,822
Property and equipment, net............... 212,472 636,351 720,371
Notes receivable from officers............ -- 150,444 162,147
Other assets.............................. 8,320 68,099 75,063
----------- ------------ ------------
Total assets.................... $ 6,343,497 $ 13,306,376 $ 11,817,403
=========== ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................ $ 215,999 $ 243,302 $ 246,820
Accrued compensation.................... 167,829 217,643 204,355
Deferred revenue........................ -- 230,000 143,750
Current portion of capital lease
obligations.......................... -- 167,003 212,247
----------- ------------ ------------
Total current liabilities....... 383,828 857,948 807,172
Noncurrent portion of capital lease
obligations............................. -- 327,407 411,237
Commitments
Shareholders' equity:
Preferred stock, no par value, issuable
in series; 10,000,000 shares
authorized (5,000,000 pro forma);
issued and outstanding shares, all of
which are convertible:
1994 -- 3,503,458; 1995 and
1996 -- 5,611,910; pro forma -- none;
aggregate liquidation preference of
$25,284,342 at December 31, 1995 and
March 31, 1996....................... 12,565,893 24,119,060 24,119,060 $ --
Common stock, no par value, 20,000,000
shares authorized (40,000,000 pro
forma); issued and outstanding
shares: 1994 -- 936,679;
1995 -- 1,327,025; 1996 -- 1,956,500;
pro forma -- 7,568,410............... 114,021 267,158 812,780 24,931,840
Notes receivable from shareholders...... (84,480) (196,664) (400,821) (400,821)
Deferred compensation................... -- -- (255,744) (255,744)
Deficit accumulated during the
development stage.................... (6,635,765) (12,068,533) (13,676,281) (13,676,281)
----------- ------------ ------------ ------------
Total shareholders' equity...... 5,959,669 12,121,021 10,598,994 $ 10,598,994
============
----------- ------------ ------------
Total liabilities and
shareholders' equity.......... $ 6,343,497 $ 13,306,376 $ 11,817,403
=========== ============ ============
</TABLE>

See accompanying notes.

F-4
<PAGE> 62

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
JANUARY 30, 1991 JANUARY 30, 1991
(INCEPTION) THREE MONTHS (INCEPTION)
YEARS ENDED DECEMBER 31, THROUGH ENDED MARCH 31, THROUGH
--------------------------------------- DECEMBER 31, ------------------------- MARCH 31,
1993 1994 1995 1995 1995 1996 1996
----------- ----------- ----------- ---------------- ----------- ----------- ----------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Contract revenues..... $ -- $ 125,000 $ 155,000 $ 280,000 $ 125,000 $ 86,250 $ 366,250
Expenses:
Research and
development....... 926,116 2,197,708 3,440,181 7,302,526 734,424 1,239,185 8,541,711
General and
administrative.... 741,358 1,664,596 2,333,372 5,231,673 584,181 591,143 5,822,816
----------- ----------- ----------- ------------ ----------- ----------- ------------
Total expenses........ 1,667,474 3,862,304 5,773,553 12,534,199 1,318,605 1,830,328 14,364,527
----------- ----------- ----------- ------------ ----------- ----------- ------------
Loss from
operations.......... (1,667,474) (3,737,304) (5,618,553) (12,254,199) (1,193,605) (1,744,078) (13,998,277)
Interest income....... 13,342 38,050 205,863 264,811 73,889 147,213 412,024
Interest expense...... (477) (33,423) (20,078) (79,145) -- (10,883) (90,028)
----------- ----------- ----------- ------------ ----------- ----------- ------------
Net loss.............. $(1,654,609) $(3,732,677) $(5,432,768) $(12,068,533) $(1,119,716) $(1,607,748) $(13,676,281)
=========== =========== =========== ============ =========== =========== ============
Pro forma net loss per
share............... $ (0.76) $ (0.21)
=========== ===========
Shares used in
computing pro forma
net loss per
share............... 7,195,556 7,509,576
=========== ===========
</TABLE>

See accompanying notes.

F-5
<PAGE> 63

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

STATEMENT OF SHAREHOLDERS' EQUITY
PERIOD FROM JANUARY 30, 1991 (INCEPTION) THROUGH MARCH 31, 1996

<TABLE>
<CAPTION>
DEFICIT
NOTES ACCUMULATED
PREFERRED STOCK COMMON STOCK RECEIVABLE DURING THE TOTAL
----------------------- -------------------- FROM DEFERRED DEVELOPMENT SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT SHAREHOLDERS COMPENSATION STAGE EQUITY
--------- ----------- --------- -------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at January
30, 1991
(inception)....... -- $ -- -- $ -- $ -- $ -- $ -- $ --
Issuance of common
stock in
exchange for
equipment and
cash at $0.03
and $0.05, per
share,
respectively.... -- -- 805,400 30,270 -- -- -- 30,270
Issuance of Series
A convertible
preferred stock
for cash at
$0.67 per
share........... 149,594 99,730 -- -- -- -- -- 99,730
Net loss.......... -- -- -- -- -- -- (416,551 ) (416,551 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at December
31, 1991.......... 149,594 99,730 805,400 30,270 -- -- (416,551 ) (286,551 )
Issuance of common
stock for cash
at $0.05 and
$0.10 per
share........... -- -- 97,500 5,625 -- -- -- 5,625
Issuance of Series
A convertible
preferred stock
for cash and in
exchange for
cancellation of
indebtedness at
$0.67 per
share........... 49,998 33,332 -- -- -- -- -- 33,332
Issuance of Series
B convertible
preferred stock
for cash and in
exchange for
cancellation of
indebtedness at
$2.90 per share,
net of issuance
costs of
$9,129.......... 803,441 2,320,862 -- -- -- -- -- 2,320,862
Net loss.......... -- -- -- -- -- (831,928 ) (831,928 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at December
31, 1992.......... 1,003,033 2,453,924 902,900 35,895 -- -- (1,248,479 ) 1,241,340
Issuance of Series
C convertible
preferred stock
for cash and in
exchange for
cancellation of
indebtedness at
$3.60 per share,
net of issuance
costs of
$16,673......... 645,831 2,308,331 -- -- -- -- -- 2,308,331
Repurchase of
common stock at
$0.03 per
share........... -- -- (197,221) (6,574) -- -- -- (6,574 )
Net loss.......... -- -- -- -- -- -- (1,654,609 ) (1,654,609 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at December
31, 1993.......... 1,648,864 4,762,255 705,679 29,321 -- -- (2,903,088 ) 1,888,488
Issuance of common
stock in
exchange for
notes receivable
at $0.37 per
share........... -- -- 231,000 84,700 (84,700) -- -- --
Repayment of notes
receivable...... -- -- -- -- 220 -- -- 220
Issuance of Series
D convertible
preferred stock
for cash and in
exchange for
cancellation of
indebtedness and
accrued interest
at $4.23 per
share, net of
issuance costs
of $35,195...... 1,854,594 7,803,638 -- -- -- -- -- 7,803,638
Net loss.......... -- -- -- -- -- -- (3,732,677 ) (3,732,677 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at December
31, 1994.......... 3,503,458 12,565,893 936,679 114,021 (84,480) -- (6,635,765 ) 5,959,669
Issuance of common
stock in
exchange for
cash and a note
receivable at
$0.33, $0.37 and
$0.43 per
share........... -- -- 397,375 155,714 (142,544) -- -- 13,170
Repurchase of
common stock at
$0.37 per
share........... -- -- (7,029) (2,577) 2,577 -- -- --
Repayments of
notes
receivable...... -- -- -- -- 27,783 -- -- 27,783
Issuance of Series
E convertible
preferred stock
for cash at
$5.50 per share,
net of issuance
costs of
$43,347......... 2,108,452 11,553,167 -- -- -- -- -- 11,553,167
Net loss.......... -- -- -- -- -- -- (5,432,768 ) (5,432,768 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at December
31, 1995.......... 5,611,910 24,119,060 1,327,025 267,158 (196,664) -- (12,068,533 ) 12,121,021
Issuance of common
stock in
exchange for
cash and notes
receivable at
$0.10 to $0.57
per share
(unaudited)..... -- -- 629,475 256,878 (204,157) -- -- 52,721
Deferred
compensation
(unaudited)..... -- -- -- 288,744 -- (288,744) -- --
Amortization of
deferred
compensation
(unaudited)..... -- -- -- -- -- 33,000 -- 33,000
Net loss
(unaudited)..... -- -- -- -- -- -- (1,607,748 ) (1,607,748 )
-- --
-------- ---------- ------- ------- ------------ -----------
Balances at March
31, 1996
(unaudited)....... 5,611,910 $24,119,060 1,956,500 $812,780 $ (400,821) $ (255,744) $(13,676,281) $ 10,598,994
======== ========== ======= ======= == == ============ ===========
</TABLE>

See accompanying notes.

F-6
<PAGE> 64

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
JANUARY 30, 1991 JANUARY 30, 1991
(INCEPTION) THREE MONTHS ENDED MARCH (INCEPTION)
YEARS ENDED DECEMBER 31, THROUGH 31, THROUGH
--------------------------------------- DECEMBER 31, ------------------------- MARCH 31,
1993 1994 1995 1995 1995 1996 1996
----------- ----------- ----------- ---------------- ----------- ----------- ----------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
CASH FLOWS USED IN
OPERATING ACTIVITIES
Net loss.............. $(1,654,609) $(3,732,677) $(5,432,768) $(12,068,533) $(1,119,716) $(1,607,748) $(13,676,281)
ADJUSTMENTS TO
RECONCILE NET LOSS
TO NET CASH USED IN
OPERATING
ACTIVITIES:
Depreciation and
amortization...... 31,470 87,678 192,495 329,756 52,215 81,598 411,354
Amortization of
deferred
compensation...... -- -- -- -- -- 33,000 33,000
Accrued interest on
note exchanged for
preferred stock... -- 32,622 -- 32,622 -- -- 32,622
Loss on disposal of
property and
equipment......... -- -- 18,467 37,666 -- -- 37,666
Loss on
sale-leaseback
transaction....... -- -- 95,294 95,294 -- -- 95,294
CHANGES IN
OPERATING ASSETS
AND LIABILITIES:
Contract
receivable.... -- -- (260,000) (260,000) (125,000) 260,000 --
Other current
assets........ (4,697) (20,237) (38,334) (74,127) 18,186 (6,234) (80,361)
Other assets.... 17,184 (5,520) (59,779) (68,099) -- (6,964) (75,063)
Accounts
payable....... 98,852 87,824 27,303 243,302 417,434 3,518 246,820
Accrued
compensation... (25,138) 129,103 49,814 217,643 (46,672) (13,288) 204,355
Deferred
revenue....... -- -- 230,000 230,000 -- (86,250) 143,750
----------- ----------- ----------- ------------ ----------- ------------ -------------
Net cash used in
operating
activities.......... (1,536,938) (3,421,207) (5,177,508) (11,284,476) (803,553) (1,342,368) (12,626,844)
----------- ----------- ----------- ------------ ----------- ------------ -------------
CASH FLOWS USED IN
INVESTING ACTIVITIES
Capital
expenditures........ (82,957) (195,077) (535,230) (884,161) (535,967) (16,324) (900,485)
----------- ----------- ----------- ------------ ----------- ------------ -------------
CASH FLOWS PROVIDED BY
FINANCING ACTIVITIES
Proceeds from issuance
of notes payable to
shareholders........ 50,000 1,500,000 -- 2,111,395 -- -- 2,111,395
Repayment of notes
payable to
shareholders........ (32,794) -- -- (298,972) -- -- (298,972)
Proceeds from issuance
of preferred
stock............... 2,258,331 6,271,016 11,553,167 22,274,014 -- -- 22,274,014
Proceeds from issuance
of common stock..... -- 220 40,953 57,068 -- 52,721 109,789
Repurchase of common
stock............... (6,574) -- -- (6,574) -- -- (6,574)
Proceeds from sale of
equipment in sale-
leaseback
transaction......... -- -- 389,621 389,621 -- -- 389,621
Notes receivable from
officers............ -- -- (150,444) (150,444) -- (11,703) (162,147)
Payments on lease
obligations......... -- -- (90,116) (90,116) -- (20,220) (110,336)
----------- ----------- ----------- ------------ ----------- ------------ -------------
Net cash provided by
financing
activities.......... 2,268,963 7,771,236 11,743,181 24,285,992 -- 20,798 24,306,790
----------- ----------- ----------- ------------ ----------- ------------ -------------
Net increase in cash
and cash
equivalents......... 649,068 4,154,952 6,030,443 12,117,355 (1,339,520) (1,337,894) 10,779,461
Cash and cash
equivalents at
beginning of
period.............. 1,282,892 1,931,960 6,086,912 -- 6,086,912 12,117,355 --
----------- ----------- ----------- ------------ ----------- ------------ -------------
Cash and cash
equivalents at end
of period........... $ 1,931,960 $ 6,086,912 $12,117,355 $ 12,117,355 $ 4,747,392 $10,779,461 $ 10,779,461
=========== =========== =========== ============ =========== ============ =============
SUPPLEMENTAL
DISCLOSURE OF CASH
FLOW INFORMATION
Common stock issued in
exchange for
equipment........... $ -- $ -- $ -- $ 20,000 $ -- $ -- $ 20,000
=========== =========== =========== ============ =========== ============ =============
Common stock issued in
exchange for notes
receivable.......... $ -- $ 84,700 $ 142,544 $ 227,244 $ -- $ 204,157 $ 431,401
=========== =========== =========== ============ =========== ============ =============
Preferred stock issued
in exchange for
debt................ $ 50,000 $ 1,500,000 $ -- $ 1,812,423 $ -- $ -- $ 1,812,423
=========== =========== =========== ============ =========== ============ =============
Acquisition of
equipment under
capital leases...... $ -- $ -- $ 584,526 $ 584,526 $ -- $ 149,294 $ 733,820
=========== =========== =========== ============ =========== ============ =============
</TABLE>

See accompanying notes.

F-7
<PAGE> 65

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Description of Business

Aradigm Corporation (the "Company") was incorporated in the State of
California on January 30, 1991. Since inception, the Company has been engaged in
the development of non-invasive pulmonary drug delivery products. The Company's
principal activities to date have been conducting research and development,
recruiting personnel, focusing on business development, raising capital and
acquiring assets. Accordingly, the Company is considered a development stage
company.

Basis of Presentation

The Company expects increasing losses over the next several years as
development efforts continue. The Company plans to meet its capital requirements
primarily through issuances of equity securities, research and development
contract revenue, capital lease financing, and in the longer term, revenue from
product sales. If the financing arrangements contemplated by management are not
consummated, the Company may have to seek other sources of capital or reevaluate
operating plans.

Interim Financial Information

The financial information at March 31, 1996 and for the three-month periods
ended March 31, 1995 and 1996 is unaudited but includes all adjustments
(consisting only of normal recurring adjustments) which the Company considers
necessary for a fair presentation of the financial position at such date and the
operating results and cash flows for those periods. Results for the interim
periods are not necessarily indicative of the results for the entire year.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. The Company
maintains its cash and cash equivalents in depository and money market accounts
with a single financial institution. The recorded amounts approximate fair
value.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful lives of the respective
assets (ranging from three to five years). Machinery and equipment acquired
under capital leases is amortized over the useful lives of the respective assets
or the lease period, whichever is shorter, using the straight-line method.

Stock-Based Compensation

In October 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") was issued and is
effective for the Company's fiscal year 1996. As permitted under SFAS 123, the
Company intends to continue to account for stock options in accordance with APB
Opinion No. 25 and will make the necessary pro forma disclosures mandated by
SFAS 123 beginning in 1996.

F-8
<PAGE> 66

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

Revenue Recognition

Contract revenues consists of revenue from a research agreement and a
feasibility study. Revenue is generally recognized in accordance with the terms
of the milestones set forth in the related agreements. Deferred revenue
represents the portion of research payments received which have not been earned.

Net Loss Per Share

Except as noted below, net income (loss) per share is computed using the
weighted average number of common and dilutive common equivalent shares
outstanding during the period. Common equivalent shares consist of the
incremental common shares issuable upon conversion of the convertible preferred
stock (using the if-converted method) and shares issuable upon the exercise of
stock options and warrants (using the treasury stock method) when their effect
is dilutive. In addition, pursuant to Securities and Exchange Commission Staff
Accounting Bulletins and Staff policy, such computations include the effect of
all dilutive and antidilutive common and common equivalent shares issued within
12 months of the proposed public offering date as if they were outstanding for
all periods presented determined using the treasury stock method and the
estimated per share public offering price.

Per share information calculated on the above basis is as follows (shares
in thousands):

<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------------------ ------------------
1993 1994 1995 1995 1996
------- ------- ------ ------- ------
<S> <C> <C> <C> <C> <C>
Net loss per share................. $ (0.48) $ (1.06) $(1.47) $ (0.31) $(0.40)
======= ======= ====== ======= ======
Shares used in computing net loss
per share........................ 3,468 3,537 3,692 3,625 4,006
======= ======= ====== ======= ======
</TABLE>

Pro Forma Net Loss Per Share

Pro forma net loss per share has been computed as described above and also
gives effect, even if antidilutive, to common equivalent shares from convertible
preferred stock that will automatically convert upon the closing of the
Company's initial public offering (using the if-converted method) (see Note 8).

2. RESEARCH AGREEMENTS

In January 1994, the Company entered into a research agreement with a
pharmaceutical company to develop a modified version of the Company's
breath-actuated, volatile propellant delivery device and to conduct certain
performance studies. The agreement provided for a payment of $125,000 upon
execution and $125,000 upon acceptance by the pharmaceutical company of certain
specified deliverables. Costs associated with research and development
activities attributable to this agreement approximated the revenues recognized
and are included in research and development expenses in the accompanying
financial statements. Under this agreement, revenues of $125,000 were recognized
both in 1994 and in 1995.

In December 1995, the Company entered into a feasibility agreement with a
pharmaceutical company to determine the feasibility of using the Company's AERx
Pulmonary Drug Delivery System for the delivery of specified drugs. The
agreement provides for a payment of $260,000 upon execution. Under this
agreement, revenues of $30,000 and $86,250 were recognized in 1995 and for the
three months ended March 31, 1996, respectively. Costs associated with research
and development activities attributable to this agreement are expected to
approximate the revenues recognized and are included in research and development
expenses in

F-9
<PAGE> 67

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

the accompanying financial statements. The agreement also provides the
pharmaceutical company with a six-month option to enter into a development and
commercialization agreement with the Company at the conclusion of the
feasibility study. This option expires six months after the completion of the
feasibility study.

3. PROPERTY AND EQUIPMENT

Property and equipment is comprised of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
--------- ---------
<S> <C> <C>
Machinery and equipment...................................... $ 191,178 $ 340,469
Furniture and fixtures....................................... 12,758 153,992
Lab equipment................................................ -- 222,845
Computer equipment and software.............................. 137,721 240,725
--------- ---------
341,657 958,031
Less accumulated depreciation and amortization............... (129,185) (321,680)
--------- ---------
$ 212,472 $ 636,351
========= =========
</TABLE>

Property and equipment at December 31, 1995 includes assets under
capitalized leases of approximately $585,000 (none in 1994). Accumulated
amortization related to leased assets was approximately $99,000 at December 31,
1995 (none in 1994).

4. LEASES AND COMMITMENTS

In June 1995, as part of a sale-leaseback transaction, the Company entered
into a $1,750,000 capital lease line of credit for financing of equipment. At
December 31, 1995 and March 31, 1996 approximately $1,200,000 and $1,000,000 was
available under the lease line of credit arrangement. The draw down period under
the lease line of credit expires October 1, 1996. Amounts borrowed under the
line of credit bear interest at 10.4% and are collateralized by the equipment
purchased. Under the terms of the master lease agreement, the Company will have
the option to purchase the leased equipment at a negotiated price at the end of
the 42-month lease term.

The Company occupies two facilities under operating leases. The first lease
commenced in November 1992 and expires in November 1997. The second lease
commenced in March 1995 and expires in February 1998.

F-10
<PAGE> 68

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

Future minimum lease payments under operating and capital leases at
December 31, 1995 are as follows:

<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
--------- ---------
<S> <C> <C>
Years ending December 31:
1996....................................................... $ 87,400 $ 198,431
1997....................................................... 91,160 198,431
1998....................................................... 8,640 185,879
1999....................................................... -- 11,671
2000....................................................... -- --
-------- --------
Total minimum lease payments................................. $ 187,200 594,412
========
Less amount representing interest............................ (100,002)
--------
Present value of future lease payments....................... 494,410
Current portion of capital lease obligations................. (167,003)
--------
Noncurrent portion of capital lease obligations due after one
year....................................................... $ 327,407
========
</TABLE>

Rent expense under operating leases totaled $48,559, $61,357 and $76,320
for the years ended December 31, 1993, 1994 and 1995, respectively, and $219,786
for the period from inception (January 30, 1991) through December 31, 1995.

In February 1996, the Company entered into a third operating lease for a
new facility. This lease expires in February 1999 and is cancelable after the
thirteenth month of the lease term if satisfactory expansion space is not made
available to the Company by the landlord. Future minimum payments for this
facility lease at March 31, 1996 total $91,653.

5. SHAREHOLDERS' EQUITY

Preferred Stock

The Company is authorized to issue 10,000,000 shares of preferred stock in
one or more series. The board of directors is authorized to determine the
rights, preferences, privileges and restrictions of any unissued series of
preferred stock and to fix the number of shares of any series and the
designation of any series.

Preferred stock designated and outstanding consists of the following:

<TABLE>
<CAPTION>
SHARES DESIGNATED SHARES ISSUED AND OUTSTANDING
------------------------------------- -------------------------------------
DECEMBER 31, DECEMBER 31,
----------------------- MARCH 31, ----------------------- MARCH 31,
1994 1995 1996 1994 1995 1996
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Series A............ 214,596 214,596 214,596 199,592 199,592 199,592
Series B............ 900,000 900,000 900,000 803,441 803,441 803,441
Series C............ 735,000 735,000 735,000 645,831 645,831 645,831
Series D............ 2,250,000 2,250,000 2,250,000 1,854,594 1,854,594 1,854,594
Series E............ -- 2,115,000 2,115,000 -- 2,108,452 2,108,452
---------- ---------- ---------- ---------- ---------- ----------
Total..... 4,099,596 6,214,596 6,214,596 3,503,458 5,611,910 5,611,910
========== ========== ========== ========== ========== ==========
</TABLE>

Each share of preferred stock is convertible at the option of the
shareholder into shares of common stock based on a "Conversion Rate," which is
defined as the respective original issue price of the Series A, Series B,

F-11
<PAGE> 69

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

Series C, Series D and Series E shares divided by the Conversion Price at the
time in effect for such shares. The initial Conversion Price is the respective
original issue price of the preferred stock and is subject to adjustment for the
issuance of additional common stock. The current Conversion Rate is one share of
common stock for one share of preferred stock.

Each share of preferred stock will automatically convert into common stock
upon the closing of a firm commitment underwritten public offering pursuant to
an effective registration statement under the Securities Act of 1933 covering
the offer and sale of common stock of the Company to the public at an aggregate
offering price of not less than $15,000,000.

In the event of any voluntary or involuntary liquidation, the holders of
preferred stock will be entitled to receive, prior and in preference to any
distributions of any assets or surplus funds of the Company to the holders of
common stock, an amount equal to $0.67, $2.90, $3.60, $4.23 and $6.00 per share
for each share of Series A, B, C, D and E convertible preferred stock,
respectively, plus all declared and unpaid dividends. If the assets and funds to
be distributed are insufficient to permit the payment of the full preferential
amounts to the preferred shareholders, the entire assets and funds of the
Company will be distributed ratably among the preferred shareholders in
proportion to the preferential amount each such shareholder is otherwise
entitled to receive.

In the event funds are sufficient to make a complete distribution to the
preferred shareholders as described above, the remaining assets of the Company
will be distributed to the holders of common stock pro rata based on the number
of shares of common stock held by each shareholder.

Holders of Series B, Series C, Series D and Series E preferred shares are
entitled to receive, prior and in preference to any declaration or payment of
any dividend on Series A preferred shares or common shares, if and when declared
by the board of directors, a noncumulative dividend of $0.24 per share for
Series B shares, $0.29 per share for Series C shares, $0.34 per share for Series
D and $0.44 per share for Series E shares per annum or, if greater, an amount
equal to that paid on common shares on an as-converted basis.

Holders of Series A preferred shares are entitled to receive, prior and in
preference to any declaration or payment of any dividend on common shares, if
and when declared by the board of directors, a noncumulative dividend at the
rate determined by the board of directors, which must be at least equal to that
paid on common shares on an as-converted basis.

Each share of preferred stock is entitled to the same number of votes as
the number of shares of common stock into which it is convertible. At December
31, 1995 and March 31, 1996, the Company has reserved 5,611,910 shares of its
common stock for issuance upon conversion of its preferred stock.

Stock Warrants

In March and July of 1992, in consideration of the cancellation of certain
indebtedness to shareholders the Company issued warrants that entitle the
holders to purchase convertible preferred stock. These warrants are presently
exercisable for the purchase of up to 55,172 shares of Series E convertible
preferred stock at $1.45 per share and are exercisable through June 30, 1997.

In August 1992, in conjunction with the issuance of a note to a
shareholder, the Company issued a warrant that entitles the holder to purchase
15,000 shares of Series A convertible preferred stock at an exercise price of
$1.67 per share. These warrants are exercisable through the earlier of an
initial public offering or August 31, 1996.

F-12
<PAGE> 70

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

In July 1994, in conjunction with the issuance of notes to shareholders,
the Company issued warrants that entitle the holder to purchase convertible
preferred stock. These warrants are presently exercisable into 88,719 shares of
Series D convertible preferred stock at an exercise price of $4.23 per share.
These warrants are exercisable through the earlier of an initial public offering
or June 30, 1999.

In June 1995, in conjunction with a master lease agreement, the Company
issued a warrant that entitles the holder to purchase 37,500 shares of Series D
convertible preferred stock at an exercise price of $4.23 per share. This
warrant is exercisable through June 9, 2005 or two years from the effective date
of the Company's initial public offering, whichever is earlier.

At March 31, 1996 and December 31, 1995, the Company has reserved 196,391
shares of its common stock for issuance upon conversion of its preferred stock
warrants.

No amounts have been recorded by the Company for the above warrant
issuances, as the amounts were determined to be immaterial at the time of
issuance.

1992 Stock Option Plan

In May 1992, the Company adopted a stock option plan (the "Plan"). Options
granted under this Plan may be either incentive stock options or nonstatutory
stock options. At December 31, 1995 and March 31, 1996, the Company had
authorized 975,000 and 1,230,000 shares, respectively, of common stock for
issuance under the Plan. Options granted under the Plan expire no later than ten
years from the date of grant. For incentive stock options and nonstatutory stock
option grants, the option price shall be at least 100% and 85%, respectively, of
the fair value on the date of grant, as determined by the board of directors.
If, at any time the Company grants an option, and the optionee directly or by
attribution owns stock possessing more than 10% of the total combined voting
power of all classes of stock of the Company, the option price shall be at least
110% of the fair value and shall not be exercisable more than five years after
the date of grant.

Options are exercisable upon grant and generally vest over a period of four
years from the date of grant. Stock issued to employees of the Company under
stock options is subject to stock repurchase agreements whereby the Company has
the option to repurchase the unvested shares upon termination of employment for
any reason with or without cause at the original issue price. In 1995, the
Company repurchased 7,029 shares (none in 1994), in accordance with these
agreements. As of December 31, 1995, 391,860 shares remained subject to
repurchase. Options may be granted with different vesting terms from time to
time.

F-13
<PAGE> 71

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

A summary of activity under the Plan is as follows:

<TABLE>
<CAPTION>
SHARES OPTIONS OUTSTANDING
AVAILABLE FOR -------------------------
GRANT OF NUMBER OF PRICE PER
OPTIONS SHARES SHARE
------------- --------- -----------
<S> <C> <C> <C>
Balance at December 31, 1992................... 463,200 121,800 $0.10-$0.33
Options granted.............................. (163,200) 163,200 $0.33
------- ------- -----------
Balance at December 31, 1993................... 300,000 285,000 $0.10-$0.33
Shares authorized............................ 225,000 -- $--
Options granted.............................. (254,175) 254,175 $0.33-$0.37
------- ------- -----------
Balance at December 31, 1994................... 270,825 539,175 $0.10-$0.37
Shares authorized............................ 150,000 -- $--
Options granted.............................. (290,550) 290,550 $0.33-$0.43
Options exercised............................ -- (335,876) $0.33-$0.43
Options canceled............................. 41,607 (41,607) $0.33-$0.43
------- ------- -----------
Balance at December 31, 1995................... 171,882 452,242 $0.10-$0.43
Shares authorized (unaudited)................ 255,000 -- $--
Options granted (unaudited).................. (265,921) 265,921 $0.57-$2.00
Options exercised (unaudited)................ -- (629,474) $0.10-$0.57
------- ------- -----------
Balance at March 31, 1996 (unaudited).......... 160,961 88,689 $0.10-$2.00
======= ======= ===========
</TABLE>

At December 31, 1995 and March 31, 1996, the Company has reserved 624,124
and 249,650 shares, respectively, of its common stock for issuance upon exercise
of options.

Deferred Compensation

The Company has recorded deferred compensation expense of $288,744 for the
difference between the grant price and the deemed fair value of certain of the
Company's common stock options granted in 1996. This amount is being amortized
over the vesting period of the individual options, generally a 48-month period.
Deferred compensation expense recognized in the period ended March 31, 1996
totaled $33,000.

6. RELATED PARTY TRANSACTIONS

In May 1994, the Company issued 225,000 shares of common stock at fair
value to an officer of the Company in exchange for an $82,500 full recourse
promissory note. Twenty-five percent (56,250) of the common shares vested on
June 30, 1995. The remaining shares vest at a rate of 6.25% at the end of each
calendar quarter for 12 quarters subsequent to June 30, 1995. Under certain
circumstances, unvested shares are subject to repurchase by the Company. The
promissory note bears interest at 7% per annum and is due and payable on July 1,
1999.

At December 31, 1995, the Company holds two additional notes receivable
totaling $150,444 from officers of the Company; the first of which is a $60,444
promissory note bearing interest at 6% per annum and is due and payable on
February 7, 2001. The note is collateralized by certain personal assets of the
officer. The second note is a $90,000 full recourse promissory note bearing no
interest and is due and payable on September 18, 1998.

F-14
<PAGE> 72

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

At December 31, 1995, the fair value of these notes is not materially
different from their carrying values. The fair values were estimated using
discounted cash flow analyses, using interest rates currently being offered for
loans with similar terms of borrowers of similar credit quality.

7. INCOME TAXES

The Company uses the liability method to account for income taxes as
required by Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes." Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using enacted tax rules and laws that
will be in effect when the differences are expected to reverse.

Significant components of the Company's deferred tax assets (in thousands)
are as follows at December 31, 1994 and 1995:

<TABLE>
<CAPTION>
1994 1995
------- -------
<S> <C> <C>
Net operating loss carryforward.................................. $ 2,470 $ 4,520
Research and development credit carryforward..................... 340 476
Other............................................................ 34 51
------- -------
Gross deferred tax assets........................................ 2,844 5,047
Valuation allowance.............................................. (2,844) (5,047)
------- -------
Net deferred tax assets.......................................... $ -- $ --
======= =======
</TABLE>

The valuation allowance increased by $691,000, $1,647,000 and $2,203,000 in
1993, 1994 and 1995, respectively.

At December 31, 1995, the Company had net operating loss carryforwards of
approximately $11,478,000 for federal income tax purposes expiring in the years
2006 through 2010 and net operating losses for state income tax purposes of
$10,296,000 expiring in the years 1997 through 2000. At December 31, 1995, the
Company had research and development credit carryforwards for federal income tax
purposes of approximately $379,000, which expire in the years 2006 through 2010.

Because of the "change in ownership" provisions of the Tax Reform Act of
1986, utilization of the Company's tax net operating loss carryforwards and tax
credit carryforwards may be subject to an annual limitation in future periods.
As a result of the annual limitation, a portion of these carryforwards may
expire before ultimately becoming available to reduce future income tax
liabilities.

8. SUBSEQUENT EVENTS

Proposed Public Offering and Related Matters

On April 16, 1996, the board of directors authorized management of the
Company to file a Registration Statement with the Securities and Exchange
Commission offering its common stock to the public. If the offering is
consummated under the terms presently anticipated, all of the preferred stock
outstanding will convert into 5,611,910 shares of common stock. Unaudited pro
forma shareholders' equity as adjusted for the assumed conversion of the
preferred stock is set forth on the accompanying balance sheet.

In conjunction with the registration, the board of directors approved,
subject to shareholders' approval, a three-for-two stock split of the common
stock. The stock split is expected to become effective prior to the

F-15
<PAGE> 73

ARADIGM CORPORATION
(A DEVELOPMENT STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AT MARCH 31, 1996 AND FOR THE THREE MONTH PERIODS ENDED
MARCH 31, 1995 AND 1996 IS UNAUDITED)

effective date of the offering. All the share and per share data in the
accompanying financial statements has been adjusted retroactively to give effect
to the stock split.

Upon completion of this offering the board of directors will have authority
to issue up to 5,000,000 shares of preferred stock and 40,000,000 shares of
common stock. The board of directors have the authority to fix the price,
rights, preferences, privileges and restrictions, including voting rights, of
the preferred shares without any further vote or action by the shareholders.

Stock Option and Stock Purchase Plans

In April 1996, the Company's board of directors adopted, subject to the
shareholders' approval, the 1996 Equity Incentive Plan, which amends and
restates the 1992 Stock Option Plan, and under which the Company is authorized
to grant up to 1,980,000 options for the Company's common stock with similar
terms to the 1992 Stock Option Plan.

In April 1996, the Company's board of directors adopted, subject to the
shareholders' approval, the 1996 Non-Employee Directors' Stock Option Plan (the
"Directors' Plan") which authorizes the issuance of 225,000 options for the
Company's common stock. Pursuant to the terms of the Directors' Plan, each
person serving as a director of the Company who is not an employee of the
Company (a "Non-Employee Director") shall upon the date such person first
becomes a Non-Employee Director after the effectiveness of the initial public
offering of the Company's Common Stock automatically be granted an option to
purchase 7,500 shares of Common Stock. In addition, on each anniversary of the
effectiveness of the initial public offering each Non-Employee Director will
automatically be granted an option to purchase 7,500 shares of Common Stock
(pro-rated for Non-Employee Directors with less than a full year's tenure).
Options under the Directors' Plan will vest in four equal, quarterly
installments commencing on the date of the grant of the option.

In April 1996, the Company's board of directors adopted, subject to the
shareholders' approval, the Employee Stock Purchase Plan (the "Purchase Plan")
which authorizes the issuance of 150,000 shares of common stock.

F-16
<PAGE> 74

- ------------------------------------------------------
- ------------------------------------------------------

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS OR BY ANY OTHER
PERSON. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY A SECURITY OTHER THAN THE SHARES OF COMMON STOCK OFFERED
HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY OF THE SECURITIES OFFERED HEREBY, TO ANY PERSON IN ANY JURISDICTION IN
WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION TO SUCH PERSON. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY
CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.

------------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 3
Risk Factors........................... 6
Use of Proceeds........................ 14
Dividend Policy........................ 14
Capitalization......................... 15
Dilution............................... 16
Selected Financial Data................ 17
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 18
Business............................... 21
Management............................. 40
Certain Transactions................... 46
Principal Shareholders................. 48
Description of Capital Stock........... 50
Shares Eligible for Future Sale........ 52
Underwriting........................... 54
Legal Matters.......................... 55
Experts................................ 55
Change in Accountants.................. 55
Additional Information................. 55
Index to Financial Statements.......... F-1
</TABLE>

------------------------------
UNTIL , 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
2,500,000 SHARES

LOGO

COMMON STOCK
------------------------------
PROSPECTUS
------------------------------
COWEN & COMPANY

OPPENHEIMER & CO., INC.

INVEMED ASSOCIATES, INC.

, 1996
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 75

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the Registrant in connection with the sale
of the shares of Common Stock being registered. All the amounts shown are
estimates except for the registration fee, the NASD filing fee and the Nasdaq
National Market application fee.

<TABLE>
<S> <C>
Registration fee........................................................ $ 12,888.00
NASD filing fee......................................................... 4,237.50
Nasdaq National Market application fee.................................. 35,000.00
Blue sky qualification fee and expenses................................. 20,000.00
Printing and engraving expenses......................................... 150,000.00
Legal fees and expenses................................................. 300,000.00
Accounting fees and expenses............................................ 170,000.00
Transfer agent and registrar fees....................................... 10,000.00
Directors and officers liability insurance.............................. 150,000.00
Miscellaneous........................................................... 47,874.50
----------
Total......................................................... $900,000.00
==========
</TABLE>

ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.

The Company's Amended and Restated Articles of Incorporation and Bylaws
include provisions to (i) eliminate the personal liability of its directors for
monetary damages resulting from breaches of their fiduciary duty to the extent
permitted by California law and (ii) permit the Company to indemnify its
directors and officers, employees and other agents to the fullest extent
permitted by the California Corporations Code (the "Corporations Code").
Pursuant to Section 317 of the Corporations Code, a corporation generally has
the power to indemnify its present and former directors, officers, employees and
agents against any expenses incurred by them in connection with any suit to
which they are, or are threatened to be made, a party by reason of their serving
in such positions so long as they acted in good faith and in a manner they
reasonably believed to be in, or not opposed to, the best interests of a
corporation, and with respect to any criminal action, they had no reasonable
cause to believe their conduct was unlawful. The Company believes that these
provisions are necessary to attract and retain qualified persons as directors
and officers. These provisions do not eliminate liability for breach of the
director's duty of loyalty to the Company or its shareholders, for acts or
omissions not in good faith or involving intentional misconduct or knowing
violations of law, for any transaction from which the director derived an
improper personal benefit or for any willful or negligent payment of any
unlawful dividend.

The Company has entered into agreements with its directors and executive
officers that require the Company to indemnify such persons against expenses,
judgments, fines, settlements and other amounts that such person becomes legally
obligated to pay (including expenses of a derivative action) in connection with
any proceeding, whether actual or threatened, to which any such person may be
made a party by reason of the fact that such person is or was a director or
officer of the Company or any of its affiliated enterprises, provided such
person acted in good faith and in a manner such person reasonably believed to be
in or not opposed to the best interests of the Company. The indemnification
agreements also set forth certain procedures that will apply in the event of a
claim for indemnification thereunder.

The Underwriting Agreement filed as Exhibit 1.1 to this Registration
Statement provides for indemnification by the Underwriters of the Registrant and
its officers and directors for certain liabilities arising under the Securities
Act of 1933, as amended (the "Securities Act"), or otherwise.

II-1
<PAGE> 76

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

Since March 1993, the Registrant has sold and issued the following
unregistered securities:

(1) In December 1993, the Company sold an aggregate of 645,831 shares
of the Company's Series C Preferred Stock to certain employee and
non-employee investors for an aggregate purchase price of $2,325,004.

(2) In May 1994, the Company issued and sold to Richard P. Thompson,
President, Chief Executive Officer and a director of the Company, an
aggregate of 225,000 shares of its Common Stock for an aggregate purchase
price of $82,500, payable pursuant to a secured promissory note, with
interest due and payable annually and the principal amount due and payable
in July 1999.

(3) In July 1994, the Company issued certain warrants to purchase
shares of the Company's Preferred Stock to Brentwood Associates VI, L.P.,
Technology Venture Investors-IV, Sequoia Capital V and Sequoia XXIV, which
warrants are exercisable for an aggregate of 88,719 shares of Series D
Preferred Stock.

(4) In December 1994, the Company sold an aggregate of 1,854,594
shares of the Company's Series D Preferred Stock to certain employee and
non-employee investors for an aggregate purchase price of $7,838,833.

(5) In December 1995, the Company sold an aggregate of 2,108,452
shares of the Company's Series E Preferred Stock to certain employee and
non-employee investors for an aggregate purchase price of $11,596,511.

(6) In May 1995, the Company issued and sold to R. Ray Cummings, Vice
President of Business Development of the Company, an aggregate of 67,500
shares of its Common Stock for an aggregate purchase price of $29,250,
payable pursuant to a secured promissory note with interest due and payable
annually and the principal amount due and payable on July 1, 2000.

(7) In June 1995, the Company issued a warrant to purchase 37,500
shares of the Company's Series D Preferred Stock at an exercise price of
$4.226 per share to Comdisco, Inc. in connection with an equipment lease.

(8) From May 1992 to April 1996, the Company granted stock options to
employees, directors and consultants covering an aggregate of 1,110,649
shares of the Company's Common Stock, at an average exercise price varying
from $0.10 to $4.00. Of such shares, 980,352 shares have been issued and
sold pursuant to the exercise of such options. Options to purchase 41,607
shares of Common stock have been canceled or have lapsed without being
exercised or otherwise been cancelled.

The sale and issuance of securities in the transactions described in
paragraphs (1) and (3) through (5) and (7) above were deemed to be exempt from
registration under the Securities Act by virtue of Section 4(2) adopted
thereunder. The purchasers in each case represented their intention to acquire
the securities for investment only and not with a view to the distribution
thereof. Appropriate legends are affixed to the stock certificate issued in such
transactions. All recipients either received adequate information about the
Registrant or had access, through employment or other relationships, to such
information.

The sales and issuances of securities in the transactions described in
paragraphs (2), (6) and (8) above were deemed to be exempt from registration
under the Securities Act by virtue of Rule 701 promulgated thereunder, in that
they were issued either pursuant to written compensatory benefits plans or
pursuant to a written contract relating to compensation, as provided by Rule
701.

II-2
<PAGE> 77

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(A) EXHIBITS.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- ------------------------------------------------------------------------------------
<C> <S>
*1.1 Form of Underwriting Agreement among Cowen & Company, Oppenheimer & Co., Inc.,
Invemed Associates, Inc. and the Company.
*3.1 Amended and Restated Articles of Incorporation of the Company.
*3.2 Form of Amended and Restated Articles of Incorporation of the Company to be filed
prior to the effective date of this offering.
*3.3 Form of Amended and Restated Articles of Incorporation of the Company to be filed
immediately after the closing of the offering.
*3.4 Bylaws of the Company.
*3.5 Form of Bylaws adopted prior to the effective date.
*4.1 Reference is made to Exhibits 3.1 through 3.5.
*4.2 Specimen stock certificate.
*4.3 Amended and Restated Investor Rights Agreement, dated December 22, 1995, among the
Company and certain of its shareholders.
*5.1 Opinion of Cooley Godward Castro Huddleson & Tatum.
*10.1 Form of Indemnity Agreement between the Registrant and each of its directors and
officers.
*10.2 The Company's Equity Incentive Plan, as amended (the "Equity Incentive Plan").
*10.3 Form of the Company's Incentive Stock Option Agreement under the Equity Incentive
Plan.
*10.4 Form of the Company's Nonstatutory Stock Option Agreement under the Equity Incentive
Plan.
*10.5 Form of the Company's Non-Employee Directors' Stock Option Plan.
*10.6 Form of the Company's Nonstatutory Stock Option Agreement under the Non-Employee
Directors' Stock Option Plan.
*10.7 Form of the Company's Employee Stock Purchase Plan.
*10.8 Form of the Company's Employee Stock Purchase Plan Offering Document.
*10.9 Lease Agreement for the property located at 26219 Eden Landing Road, Hayward,
California, dated November 1992 and amended November 29, 1994, between the Company
and Hayward Point Eden I Limited Partnership.
*10.10 Lease Agreement for the property located at 26224 Executive Place, Hayward,
California, dated November 29, 1994, and amended January 30, 1995, between the
Company and Hayward Point Eden I Limited Partnership.
*10.11 Lease Agreement for the property located at 3930 Point Eden Way, Hayward,
California, dated February 21, 1996, between the Company and Hayward Point Eden I
Limited Partnership.
*10.12 Stock Purchase Agreement and related agreements, including Promissory Note, dated
May 19, 1994, between the Company and Richard P. Thompson.
*10.13 Stock Purchase Agreement and related agreements, including Promissory Note, dated
May 23, 1995, between the Company and R. Ray Cummings.
*10.14 Note Agreement and Promissory Note Secured by Deed of Trust, dated May 1, 1995,
between the Company and R. Ray Cummings.
*10.15 Promissory Note, dated October 26, 1995, between the Company and Igor Gonda.
*10.16 Promissory Note, dated December 27, 1995, between the Company and Igor Gonda.
*10.17 Warrant to Purchase Preferred Stock issued to Professional Liability Newsletter
Trust Fund, David S. Rubsamen, M.D., TTEE, dated August 13, 1992.
*10.18 Warrant to Purchase Preferred Stock issued to Lester John Lloyd, dated July 9, 1992.
*10.19 Warrant to Purchase Preferred Stock issued to Electronic Investments Ltd., dated
March 20, 1992.
*10.20 Note and Warrant Purchase Agreement, between the Company and Brentwood Associates
VI, L.P., Technology Venture Investors-IV, as nominee, Sequoia Capital XXIV and
Sequoia Capital V, dated July 25, 1994.
</TABLE>

II-3
<PAGE> 78

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- ------------------------------------------------------------------------------------
<C> <S>
*10.21 Master Lease Agreement and Warrant, between the Company and Comdisco, Inc., dated
June 9, 1995.
*11.1 Statement regarding computation of pro forma per share loss.
*16.1 Letter from Bregante + Company LLP regarding change in accountant.
23.1 Consent of Ernst & Young LLP, Independent Auditors. Reference is made to page II-6.
23.2 Consent of Bregante + Company LLP, Independent Auditors. Reference is made to page
II-7.
*23.3 Consent of Cooley Godward Castro Huddleson & Tatum. Reference is made to Exhibit
5.1.
24.1 Power of Attorney. Reference is made to page II-5.
</TABLE>

- ------------------------------
* Previously filed.

(B) FINANCIAL STATEMENT SCHEDULES.

All financial statement schedules are omitted because they are not
required, they are not applicable or the relevant information is already
included in the financial statements or notes thereto.

ITEM 17. UNDERTAKINGS.

The undersigned Registrant hereby undertakes to provide the Underwriters at
the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers, and controlling
persons of the Registrant pursuant to the provisions described in Item 14 or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a claim
for indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer, or controlling
person of the Registrant in the successful defense of any action, suit, or
proceeding) is asserted by such director, officer, or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.

The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Act, the information omitted from the form
of prospectus as filed as part of the registration statement in reliance upon
Rule 430A and contained in the form of prospectus filed by the Registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be deemed to be
part of the registration statement as of the time it was declared effective, and
(2) for the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
this offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.

II-4
<PAGE> 79

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS CAUSED THIS AMENDMENT NO. 2 TO THE REGISTRATION STATEMENT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
HAYWARD, COUNTY OF ALAMEDA, STATE OF CALIFORNIA, ON THE 17TH DAY OF JUNE, 1996.

ARADIGM CORPORATION

By: RICHARD P. THOMPSON
Richard P. Thompson
President, Chief Executive Officer
and
Chief Financial Officer
(Principal Executive Officer)

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 2 TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING
PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ---------------------------------------- ------------------------------------- ---------------
<C> <S> <C>
RICHARD P. THOMPSON President, Chief Executive Officer, June 17, 1996
- ---------------------------------------- Chief Financial Officer and Director
Richard P. Thompson (Principal Executive Officer,
Principal Financial Officer and
Principal Accounting Officer)
REID M. RUBSAMEN, M.D.* Vice President of Medical Affairs, June 17, 1996
- ---------------------------------------- Secretary and Director
Reid M. Rubsamen, M.D.
LESTER JOHN LLOYD* Chairman of the Board of Directors June 17, 1996
- ----------------------------------------
Lester John Lloyd
JARED A. ANDERSON, PH.D.* Director June 17, 1996
- ----------------------------------------
Jared A. Anderson, Ph.D.
ROSS A. JAFFE, M.D.* Director June 17, 1996
- ----------------------------------------
Ross A. Jaffe, M.D.
BURTON J. MCMURTRY, PH.D.* Director June 17, 1996
- ----------------------------------------
Burton J. McMurtry, Ph.D.
GORDON W. RUSSELL* Director June 17, 1996
- ----------------------------------------
Gordon W. Russell
FRED E. SILVERSTEIN, M.D.* Director June 17, 1996
- ----------------------------------------
Fred E. Silverstein, M.D.
VIRGIL D. THOMPSON* Director June 17, 1996
- ----------------------------------------
Virgil D. Thompson
*By: RICHARD P. THOMPSON
Richard P. Thompson,
Attorney-in-Fact
</TABLE>

II-5
<PAGE> 80

EXHIBIT 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the caption "Experts," and to the
use of our report dated February 23, 1996 (except Note 8, as to which the date
is June 11, 1996), in Amendment No. 2 to the Registration Statement (Form S-1)
and related Prospectus of Aradigm Corporation for the registration of 2,875,000
shares of its common stock.

ERNST & YOUNG LLP

Palo Alto, California
June 17, 1996

II-6
<PAGE> 81

EXHIBIT 23.2

CONSENT OF BREGANTE + COMPANY LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the caption "Experts," and to
the use of our report dated February 22, 1994 in Amendment No. 2 of the
Registration Statement (Form S-1) and related Prospectus of Aradigm Corporation
for the registration of 2,875,000 shares of its common stock.

Bregante + Company LLP

San Francisco, California
June 17, 1996

II-7
<PAGE> 82

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE
- ------ ------------------------------------------------------------------------------ ----
<C> <S> <C>
*1.1 Form of Underwriting Agreement among Cowen & Company, Oppenheimer & Co., Inc.,
Invemed Associates, Inc. and the Company......................................
*3.1 Amended and Restated Articles of Incorporation of the Company.................
*3.2 Form of Amended and Restated Articles of Incorporation of the Company to be
filed prior to the effective date of this offering............................
*3.3 Form of Amended and Restated Articles of Incorporation of the Company to be
filed immediately after the closing of the offering...........................
*3.4 Bylaws of the Company.........................................................
*3.5 Form of Bylaws adopted prior to the effective date............................
*4.1 Reference is made to Exhibits 3.1 through 3.5.................................
*4.2 Specimen stock certificate....................................................
*4.3 Amended and Restated Investor Rights Agreement, dated December 22, 1995, among
the Company and certain of its shareholders...................................
*5.1 Opinion of Cooley Godward Castro Huddleson & Tatum............................
*10.1 Form of Indemnity Agreement between the Registrant and each of its directors
and officers..................................................................
*10.2 The Company's Equity Incentive Plan, as amended (the "Equity Incentive
Plan")........................................................................
*10.3 Form of the Company's Incentive Stock Option Agreement under the Equity
Incentive Plan................................................................
*10.4 Form of the Company's Nonstatutory Stock Option Agreement under the Equity
Incentive Plan................................................................
*10.5 Form of the Company's Non-Employee Directors' Stock Option Plan...............
*10.6 Form of the Company's Nonstatutory Stock Option Agreement under the
Non-Employee Directors' Stock Option Plan.....................................
*10.7 Form of the Company's Employee Stock Purchase Plan............................
*10.8 Form of the Company's Employee Stock Purchase Plan Offering Document..........
*10.9 Lease Agreement for the property located at 26219 Eden Landing Road, Hayward,
California, dated November 1992 and amended November 29, 1994, between the
Company and Hayward Point Eden I Limited Partnership..........................
*10.10 Lease Agreement for the property located at 26224 Executive Place, Hayward,
California, dated November 29, 1994, and amended January 30, 1995, between the
Company and Hayward Point Eden I Limited Partnership..........................
*10.11 Lease Agreement for the property located at 3930 Point Eden Way, Hayward,
California, dated February 21, 1996, between the Company and Hayward Point
Eden I Limited Partnership....................................................
*10.12 Stock Purchase Agreement and related agreements, including Promissory Note,
dated May 19, 1994, between the Company and Richard P. Thompson...............
*10.13 Stock Purchase Agreement and related agreements, including Promissory Note,
dated May 23, 1995, between the Company and R. Ray Cummings...................
*10.14 Note Agreement and Promissory Note Secured by Deed of Trust, dated May 1,
1995, between the Company and R. Ray Cummings.................................
*10.15 Promissory Note, dated October 26, 1995, between the Company and Igor Gonda...
*10.16 Promissory Note, dated December 27, 1995, between the Company and Igor
Gonda.........................................................................
*10.17 Warrant to Purchase Preferred Stock issued to Professional Liability
Newsletter Trust Fund, David S. Rubsamen, M.D., TTEE, dated August 13, 1992...
*10.18 Warrant to Purchase Preferred Stock issued to Lester John Lloyd, dated July 9,
1992..........................................................................
</TABLE>
<PAGE> 83

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE
- ------ ------------------------------------------------------------------------------ ----
<C> <S> <C>
*10.19 Warrant to Purchase Preferred Stock issued to Electronic Investments Ltd.,
dated March 20, 1992..........................................................
*10.20 Note and Warrant Purchase Agreement, between the Company and Brentwood
Associates VI, L.P., Technology Venture Investors-IV, as nominee, Sequoia
Capital XXIV and Sequoia Capital V, dated July 25, 1994.......................
*10.21 Master Lease Agreement and Warrant, between the Company and Comdisco, Inc.,
dated June 9, 1995............................................................
*11.1 Statement regarding computation of pro forma per share loss...................
*16.1 Letter from Bregante + Company LLP regarding change in accountant.............
23.1 Consent of Ernst & Young LLP, Independent Auditors. Reference is made to page
II-6..........................................................................
23.2 Consent of Bregante + Company LLP, Independent Auditors. Reference is made to
page II-7.....................................................................
*23.3 Consent of Cooley Godward Castro Huddleson & Tatum. Reference is made to
Exhibit 5.1...................................................................
24.1 Power of Attorney. Reference is made to page II-5.
</TABLE>

- ------------------------------
* Previously filed.