As filed pursuant to Rule 424(b)(4)
Registration Nos. 333-138169 and 333-

33,000,000 Shares

ARADIGM CORPORATION

Common Stock

We are offering 33,000,000 shares of our common stock. We have granted the underwriters a 30-day option to purchase up to an additional 4,950,000 shares to cover over-allotments.

Our common stock is quoted on the OTC Bulletin Board under the symbol “ARDM.” The last reported sale price of our common stock on the OTC Bulletin Board on January 24, 2007 was $0.95 per share.

Investing in our common stock involves risks. See “Risk Factors” beginning on page 7.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares to purchasers on January 30, 2007.

The date of this prospectus is January 25, 2007.

TABLE OF CONTENTS

     You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with information that is different. This prospectus is not an offer to sell, nor is it seeking an offer to buy, these securities in any jurisdiction where the offer or sale of these securities is not permitted. You should assume that the information contained in this prospectus is accurate as of the date on the front of this prospectus only. Our business, financial condition, results of operations and prospects may have changed since that date.

     Aradigm^®, AERx^® and the Aradigm^® logo are registered trademarks of Aradigm Corporation. This prospectus also includes other trademarks of Aradigm Corporation and trademarks of other persons.

     This prospectus also contains statistical data that we obtained from industry publications and reports generated by Business Insights, Wolters Kluwer PHAST, the Cystic Fibrosis Foundation, the American Lung Association, the American Diabetes Association, Datamonitor and Decision Resources. These industry publications and reports generally indicate that the information contained therein was obtained from sources believed to be reliable, but do not guarantee the accuracy and completeness of such information. Although we believe that the publications and reports are reliable, we have not independently verified the data.

	•	We intend to develop a proprietary portfolio of respiratory disease therapies, where we apply our delivery and formulation technologies to existing drugs to provide a superior therapeutic profile or other valuable benefits to the patient when compared with existing treatment options.
	•	We will seek to use regulatory pathways that will allow us to reduce the time, risks and costs associated with product development.
	•	As we approach commercialization of our own products, we intend to establish a specialty sales and marketing force addressing pulmonologists and subspecialists in the United States.
	•	We will continue to explore and exploit the potentially broad applicability of our validated delivery technologies for systemic applications in collaborations with companies that will fund development and commercialization.
	•	We plan to outsource the late stage clinical and commercial scale manufacturing of our products to conserve our capital for product development.

Product Candidate		Indication		Stage of Development
Proprietary Programs Under Development
ARD-3100 (Liposomal ciprofloxacin)		Cystic Fibrosis (CF)			Preclinical
ARD-1100 (Liposomal ciprofloxacin)		Inhalation Anthrax			Preclinical
Collaborative Programs Under Development
AERx iDMS (Insulin)		Type 1 and Type 2 Diabetes			Phase 3
ARD-1300 (Hydroxychloroquine)		Asthma			Phase 2 (1	)
ARD-1500 (Liposomal treprostinil)		Pulmonary Arterial Hypertension			Preclinical

(1)	A Phase 2a clinical study did not meet pre-specified clinical endpoints. The program is currently under review.

	•	None of our product candidates has been approved or commercialized, and we may never successfully develop any products.
	•	We recently changed our product development strategy, and if we do not successfully implement this new strategy our business and reputation will be damaged.
	•	We will need additional capital, and we may not be able to obtain it.
	•	We have a history of losses, we expect to incur losses for at least the foreseeable future, and we may never attain or maintain profitability.
	•	Our dependence on collaborators may delay or prevent the progress of certain of our programs.

	•	The results of later stage clinical trials of our product candidates may not be as favorable as earlier trials and that could result in additional costs and delay or prevent commercialization of our products.
	•	If our clinical trials are delayed because of patient enrollment or other problems, we would incur additional cost and postpone the potential receipt of revenues.
	•	We are subject to extensive regulation, including the requirement of approval before any of our product candidates can be marketed. We may not obtain regulatory approval for our product candidates on a timely basis, or at all.
	•	In order to market our proprietary products, we are likely to establish our own sales, marketing and distribution capabilities. We have no experience in these areas, and if we have problems establishing these capabilities, the commercialization of our products would be impaired.
	•	If any products that we or our collaborators may develop do not attain adequate market acceptance by healthcare professionals and patients, our business prospects and results of operations will suffer.
	•	We depend upon our proprietary technologies, and we may not be able to protect our potential competitive proprietary advantage.
	•	Our common stock was delisted from the Nasdaq Capital Market; this delisting may reduce the liquidity of our common stock and the price may decline.

Common stock offered by us		33,000,000 shares
Common stock to be outstanding after this offering		49,012,113 shares
Use of proceeds		We estimate that our net proceeds from this offering will be approximately $28.9 million. We intend to use approximately $20 million of the net proceeds of this offering for the further development of our ARD-3100 product for the treatment of cystic fibrosis, $2 million for the completion of development of our next-generation AERx pulmonary drug delivery device and the remaining net proceeds for general corporate purposes, including the continued development and advancement of our other programs. We may also use a portion of the net proceeds to acquire complementary technologies or businesses. See “Use of Proceeds.”
OTC Bulletin Board symbol		ARDM

	•	3,253,894 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $9.29 per share;
	•	2,119,766 shares of common stock issuable upon exercise of outstanding warrants with a weighted average exercise price of $11.11 per share; and
	•	1,633,998 shares of common stock reserved for future issuance under our 2005 Equity Incentive Plan and our Employee Stock Purchase Plan.

	•	Reflects a one-for-five reverse split of our common stock effected in January 2006;
	•	Assumes the automatic conversion of all outstanding shares of Series A Convertible Preferred Stock into 1,235,701 shares of common stock upon the completion of this offering; and
	•	Assumes no exercise of the underwriters’ over-allotment option.

															Nine Months Ended
			Year Ended December 31,												September 30,
			2003				2004				2005				2005				2006
															(Unaudited)
			(In thousands, except per share data)
Statements of operations data:
Contract and license revenues			$	33,857			$	28,045			$	10,507			$	9,645			$	4,006
Operating expenses:
	Research and development			49,636				46,477				30,174				20,858				17,645
	General and administrative			10,391				11,934				10,895				8,274				9,051
	Restructuring and asset impairment			—				—				—				—				5,717
	Total operating expenses			60,027				58,411				41,069				29,132				32,413
Loss from operations				(26,170	)			(30,366	)			(30,562	)			(19,487	)			(28,407	)
Gain on sale of patent and royalty interest (to related party)				—				—				—				—				20,000
Interest income				338				194				1,317				980				839
Interest expense				(138	)			(16	)			(6	)			—				(101	)
Other income (expense)				—				(1	)			36				(37	)			26
Net loss			$	(25,970	)		$	(30,189	)		$	(29,215	)		$	(18,544	)		$	(7,643	)
	Basic and diluted net loss per share		$	(2.59	)		$	(2.37	)		$	(2.01	)		$	(1.28	)		$	(0.52	)
	Shares used in computing basic and diluted net loss per share			10,039				12,741				14,513				14,497				14,625

		As of September 30, 2006
		Actual				As Adjusted (1)
		(Unaudited, in thousands)
Balance sheet data:
Cash, cash equivalents and short term investments		$	32,784			$	61,643
Working capital			30,216				59,075
Total assets			37,270				66,129
Convertible preferred stock			23,669				—
Accumulated deficit			(282,481	)			(282,481	)
Total shareholders’ equity			1,100				53,628

(1)

The as adjusted balance sheet data as of September 30, 2006 gives effect to the automatic conversion of all outstanding shares of our Series A Convertible Preferred Stock into 1,235,701 shares of our common stock upon the completion of this offering, resulting in an increase in shareholders’ equity of approximately $23.7 million, and the receipt of net proceeds of approximately $28.9 million from the sale of 33,000,000 shares of common stock offered by us at the public offering price of $0.95 per share, after deducting the underwriting discount and estimated offering expenses payable by us. The Series A Convertible Preferred Stock converts automatically into common stock upon the completion of an underwritten public offering of common stock with gross proceeds of at least $25 million.

RISK FACTORS

     Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus and the information incorporated by reference in this prospectus, before deciding whether to invest in shares of our common stock. The occurrence of any of the following risks, or other risks that are currently unknown or unforeseen by us, could harm our business, financial condition, results of operations or growth prospects. If any of these events occur, the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Related to Our Business

None of our product candidates has been approved or commercialized, and we may never successfully develop any products.

     Most of our product candidates are in an early stage of development. Development of our products will require extensive additional time, effort and cost in preclinical testing and clinical trials. Our products also require lengthy regulatory reviews before they can be marketed. None of our products has yet received FDA approval, and our development efforts may never result in a commercialized product. We have spent more than 10 years developing AERx iDMS for the treatment of diabetes and it is still not on the market. We may abandon the development of some or all of our product candidates at any time and without prior notice. We must incur substantial up-front expenses to develop and commercialize products and failure to achieve commercial feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory approval or successfully manufacture and market products will significantly hurt our results of operations.

We recently changed our product development strategy, and if we do not successfully implement this new strategy our business and reputation will be damaged.

     Since our inception in 1991 we have focused on developing drug delivery technologies. We have recently transitioned our business focus from the development of delivery technologies to the application of our pulmonary drug delivery technologies and expertise to the development of novel drug products to treat respiratory diseases. As part of this transition we have implemented workforce reductions in an effort to reduce our expenses and improve our cash flows. We have not yet implemented or are only in the early stages of implementing various aspects of our new strategy, and we may not be successful in implementing our new strategy. Even if we are able to implement the various aspects of our new strategy, it may not be successful.

We will need additional capital, and we may not be able to obtain it.

     Our operations to date have consumed substantial amounts of cash and have generated no product revenues. While our refocused development strategy will reduce capital expenditures, we expect negative operating cash flows to continue for at least the foreseeable future. Even though we do not plan to engage in drug discovery, we will nevertheless need to commit substantial funds to develop our product candidates and we may not be able to obtain sufficient funds on acceptable terms or at all. Our future capital requirements will depend on many factors, including:

     Since inception, we have financed our operations primarily through private placements and public offerings of our capital stock, proceeds from equipment lease financings, contract research funding and interest earned on investments. We believe that our existing cash and cash equivalent balances at September 30, 2006, together with funding commitments from collaborators, interest earned on our investments and the estimated net proceeds from this offering, should be sufficient to meet our needs for at least the next 18 months. We will need to obtain substantial additional funds before we would be able to bring any of our product candidates to market. Our estimates of future capital use are uncertain, and changing circumstances, including those related to implementation of our new development strategy or further changes to our development strategy, could cause us to consume capital significantly faster than currently expected, and our expected sources of funding may not be sufficient. If adequate funds are not available, we will be required to delay, reduce the scope of, or eliminate one or more of our product development programs and reduce personnel-related costs, or to obtain funds through arrangements with collaborators or other sources that may require us to relinquish rights to certain of our technologies or products that we would not otherwise relinquish. If we are able to obtain funds through the issuance of debt securities or borrowing, the terms may restrict our operations. If we are able to obtain funds through the issuance of equity securities, your interest will be diluted and our stock price may drop as a result.

We have a history of losses, we expect to incur losses for at least the foreseeable future, and we may never attain or maintain profitability.

     We have never been profitable and have incurred significant losses in each year since our inception. Through September 30, 2006, we have incurred a cumulative deficit of $282.5 million. We have not had any product sales and do not anticipate receiving any revenues from product sales for at least the next few years, if ever. While our recent shift in development strategy may result in reduced capital expenditures, we expect to continue to incur substantial losses over at least the next several years as we:

     To achieve and sustain profitability, we must, alone or with others, successfully develop, obtain regulatory approval for, manufacture, market and sell our products. We will incur substantial expenses in our efforts to develop and commercialize products and we may never generate sufficient product or contract research revenues to become profitable or to sustain profitability.

Our dependence on collaborators may delay or prevent the progress of certain of our programs.

     Our commercialization strategy for certain of our product candidates depends on our ability to enter into agreements with collaborators to obtain assistance and funding for the development and potential commercialization of our product candidates. Collaborations may involve greater uncertainty for us, as we have less control over certain aspects of our collaborative programs than we do over our proprietary development and commercialization programs. We may determine that continuing a collaboration under the terms provided is not in our best interest, and we may terminate the collaboration. Our existing collaborators could delay or terminate their agreements, and our products subject to collaborative arrangements may never

be successfully commercialized. For example, Novo Nordisk has control over and responsibility for development and commercialization of AERx iDMS. The development and commercialization of AERx iDMS could be delayed further or terminated if Novo Nordisk fails to conduct these activities in a timely manner or at all. In 2004, Novo Nordisk amended the protocols of a Phase 3 clinical program, which resulted in a significant delay of the development of the product. If, due to delays or otherwise, we do not receive development funds or achieve milestones set forth in the agreements governing our collaborations, or if any of our collaborators breach or terminate their collaborative agreements or do not devote sufficient resources or priority to our programs, our business prospects and potential to receive revenues would be hurt.

     Further, our existing or future collaborators may pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, and the priorities or focus of our collaborators may shift such that our programs receive less attention or resources than we would like. Any such actions by our collaborators may adversely affect our business prospects and ability to earn revenues. In addition, we could have disputes with our existing or future collaborators regarding, for example, the interpretation of terms in our agreements. Any such disagreements could lead to delays in the development or commercialization of any potential products or could result in time-consuming and expensive litigation or arbitration, which may not be resolved in our favor.

     Even with respect to certain other programs that we intend to commercialize ourselves, we may enter into agreements with collaborators to share in the burden of conducting clinical trials, manufacturing and marketing our product candidates or products. In addition, our ability to apply our proprietary technologies to develop proprietary drugs will depend on our ability to establish and maintain licensing arrangements or other collaborative arrangements with the holders of proprietary rights to such drugs. We may not be able to establish such arrangements on favorable terms or at all, and our existing or future collaborative arrangements may not be successful.

The results of later stage clinical trials of our product candidates may not be as favorable as earlier trials and that could result in additional costs and delay or prevent commercialization of our products.

     Although we believe the limited and preliminary data we have regarding our potential products is encouraging, the results of initial preclinical testing and clinical trials do not necessarily predict the results that we will get from subsequent or more extensive preclinical testing and clinical trials. Clinical trials of our product candidates may not demonstrate that they are safe and effective to the extent necessary to obtain regulatory approvals. Many companies in the biopharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after receiving promising results in earlier trials. If we cannot adequately demonstrate through the clinical trial process that a therapeutic product we are developing is safe and effective, regulatory approval of that product would be delayed or prevented, which would impair our reputation, increase our costs and prevent us from earning revenues.

If our clinical trials are delayed because of patient enrollment or other problems, we would incur additional cost and postpone the potential receipt of revenues.

     Before we or our collaborators can file for regulatory approval for the commercial sale of our potential products, the FDA will require extensive preclinical safety testing and clinical trials to demonstrate their safety and efficacy. Completing clinical trials in a timely manner depends on, among other factors, the timely enrollment of patients. Our collaborators’ and our ability to recruit patients depends on a number of 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 competing clinical trials. Delays in planned patient enrollment in our current or future clinical trials may result in increased costs, program delays or both, and the loss of potential revenues.

We are subject to extensive regulation, including the requirement of approval before any of our product candidates can be marketed. We may not obtain regulatory approval for our product candidates on a timely basis, or at all.

     We, our collaborators and our products are subject to extensive and rigorous regulation by the federal government, principally the FDA, and by state and local government agencies. Both before and after regulatory approval, the development, testing, manufacture, quality control, labeling, storage, approval, advertising, promotion, sale, distribution and export of our potential products are subject to regulation. Pharmaceutical products that are marketed abroad are also subject to regulation by foreign governments. Our products cannot be marketed in the United States without FDA approval. The process for obtaining FDA approval for drug products is generally lengthy, expensive and uncertain. To date, we have not sought or received approval from the FDA or any corresponding foreign authority for any of our product candidates.

     Even though we intend to apply for approval of most of our products in the United States under Section 505(b)(2) of the United States Food, Drug and Cosmetic Act, which applies to reformulations of approved drugs and that may require smaller and shorter safety and efficacy testing than that for entirely new drugs, the approval process will still be costly, time-consuming and uncertain. We or our collaborators may not be able to obtain necessary regulatory approvals on a timely basis, if at all, for any of our potential products. Even if granted, regulatory approvals may include significant limitations on the uses for which products may be marketed. Failure to comply with applicable regulatory requirements can, among other things, result in warning letters, imposition of civil penalties or other monetary payments, delay in approving or refusal to approve a product candidate, suspension or withdrawal of regulatory approval, product recall or seizure, operating restrictions, interruption of clinical trials or manufacturing, injunctions and criminal prosecution.

Regulatory authorities may not approve our product candidates even if the product candidates meet safety and efficacy endpoints in clinical trials or the approvals may be too limited for us to earn sufficient revenues.

     The FDA and other foreign regulatory agencies can delay approval of or refuse to approve our product candidates for a variety of reasons, including failure to meet safety and efficacy endpoints in our clinical trials. Our product candidates may not be approved even if they achieve their endpoints in clinical trials. Regulatory agencies, including the FDA, may disagree with our trial design and our interpretations of data from preclinical studies and clinical trials. Even if a product candidate is approved, it may be approved for fewer or more limited indications than requested or the approval may be subject to the performance of significant post-marketing studies. In addition, regulatory agencies may not approve the labeling claims that are necessary or desirable for the successful commercialization of our product candidates. Any limitation, condition or denial of approval would have an adverse affect on our business, reputation and results of operations.

Even if we are granted initial FDA approval for any of our product candidates, we may not be able to maintain such approval, which would reduce our revenues.

     Even if we are granted initial regulatory approval for a product candidate, the FDA and similar foreign regulatory agencies can limit or withdraw product approvals for a variety of reasons, including failure to comply with regulatory requirements, changes in regulatory requirements, problems with manufacturing facilities or processes or the occurrence of unforeseen problems, such as the discovery of previously undiscovered side effects. If we are able to obtain any product approvals, they may be limited or withdrawn or we may be unable to remain in compliance with regulatory requirements. Both before and after approval we, our collaborators and our products are subject to a number of additional requirements. For example, certain changes to the approved product, such as adding new indications, certain manufacturing changes and additional labeling claims are subject to additional FDA review and approval. Advertising and other promotional material must comply with FDA requirements and established requirements applicable to drug samples. We, our collaborators and our manufacturers will be subject to continuing review and periodic inspections by the FDA and other authorities where applicable and must comply with ongoing requirements, including the FDA’s Good Manufacturing Practices, or GMP, requirements. Once the FDA approves a

product, a manufacturer must provide certain updated safety and efficacy information, submit copies of promotional materials to the FDA and make certain other required reports. Product approvals may be withdrawn if regulatory requirements are not complied with or if problems concerning safety or efficacy of the product occur following approval. Any limitation or withdrawal of approval of any of our products could delay or prevent sales of our products, which would adversely affect our revenues. Further continuing regulatory requirements involve expensive ongoing monitoring and testing requirements.

Since one of our key proprietary programs, the ARD-3100 liposomal ciprofloxacin program, relies on the FDA’s granting of orphan drug designation for potential market exclusivity, the product may not be able to obtain market exclusivity and could be barred from the market for up to seven years.

     The FDA has granted orphan drug designation for our proprietary liposomal ciprofloxacin for the management of cystic fibrosis. Orphan drug designation is intended to encourage research and development of new therapies for diseases that affect fewer than 200,000 patients in the United States. The designation provides the opportunity to obtain market exclusivity for seven years from the date of the FDA’s approval of a new drug application, or NDA. However, the market exclusivity is granted only to the first chemical entity to be approved by the FDA for a given indication. Therefore, if another inhaled ciprofloxacin product were to be approved by the FDA for a cystic fibrosis indication before our product, then we may be blocked from launching our product in the United States for seven years, unless we are able to demonstrate to the FDA clinical superiority of our product on the basis of safety or efficacy. We may seek to develop additional products that incorporate drugs that have received orphan drug designations for specific indications. In each case, if our product is not the first to be approved by the FDA for a given indication, we will be unable to access the target market in the United States, which would adversely affect our ability to earn revenues.

We have limited manufacturing capacity and will have to depend on contract manufacturers and collaborators; if they do not perform as expected, our revenues and customer relations will suffer.

     We have limited capacity to manufacture our requirements for the development and commercialization of our product candidates. We intend to use contract manufacturers to produce key components, assemblies and subassemblies in the clinical and commercial manufacturing of our products. We may not be able to enter into or maintain satisfactory contract manufacturing arrangements. Specifically, an affiliate of Novo Nordisk has agreed to supply devices and dosage forms to us for use in the development of our products that incorporate our proprietary AERx technology through January 27, 2008. We may not be able to extend this agreement at satisfactory terms, if at all, and we may not be able to find a replacement contract manufacturer at satisfactory terms.

     We may decide to invest in additional clinical manufacturing facilities in order to internally produce critical components of our product candidates and to handle critical aspects of the production process, such as assembly of the disposable unit-dose packets and filling of the unit-dose packets. If we decide to produce components of any of our product candidates in-house, rather than use contract manufacturers, it will be costly and we may not be able to do so in a timely or cost-effective manner or in compliance with regulatory requirements.

     With respect to some of our product development programs targeted at large markets, either our collaborators or we will have to invest significant amounts to attempt to provide for the high-volume manufacturing required to take advantage of these product markets, and much of this spending may occur before a product is approved by the FDA for commercialization. Any such effort will entail many significant risks. For example, the design requirements of our products may make it too costly or otherwise infeasible for us to develop them at a commercial scale, or manufacturing and quality control problems may arise as we attempt to expand production. Failure to address these issues could delay or prevent late-stage clinical testing and commercialization of any products that may receive FDA approval.

     Further, we, our contract manufacturers and our collaborators are required to comply with the FDA’s GMP requirements that relate to product testing, quality assurance, manufacturing and maintaining records and documentation. We, our contract manufacturers or our collaborators may not be able to comply with the

applicable GMP and other FDA regulatory requirements for manufacturing, which could result in an enforcement or other action, prevent commercialization of our product candidates and impair our reputation and results of operations.

We rely on a small number of vendors and contract manufacturers to supply us with specialized equipment, tools and components; if they do not perform as we need them to, we will not be able to develop or commercialize products.

     We rely on a small number of vendors and contract manufacturers to supply us and our collaborators with specialized equipment, tools and components for use in development and manufacturing processes. These vendors may not continue to supply such specialized equipment, tools and components, and we may not be able to find alternative sources for such specialized equipment and tools. Any inability to acquire or any delay in our ability to acquire necessary equipment, tools and components would increase our expenses and could delay or prevent our development of products.

In order to market our proprietary products, we are likely to establish our own sales, marketing and distribution capabilities. We have no experience in these areas, and if we have problems establishing these capabilities, the commercialization of our products would be impaired.

     We intend to establish our own sales, marketing and distribution capabilities to market products to concentrated, easily addressable prescriber markets. We have no experience in these areas, and developing these capabilities will require significant expenditures on personnel and infrastructure. While we intend to market products that are aimed at a small patient population, we may not be able to create an effective sales force around even a niche market. In addition, some of our product development programs will require a large sales force to call on, educate and support physicians and patients. While we intend to enter into collaborations with one or more pharmaceutical companies to sell, market and distribute such products, we may not be able to enter into any such arrangement on acceptable terms, if at all. Any collaborations we do enter into may not be effective in generating meaningful product royalties or other revenues for us.

If any products that we or our collaborators may develop do not attain adequate market acceptance by healthcare professionals and patients, our business prospects and results of operations will suffer.

     Even if we or our collaborators successfully develop one or more products, such products may not be commercially acceptable to healthcare professionals and patients, who will have to choose our products over alternative products for the same disease indications, and many of these alternative products will be more established than ours. For our products to be commercially viable, we will need to demonstrate to healthcare professionals and patients that our products afford benefits to the patient that are cost-effective as compared to the benefits of alternative therapies. Our ability to demonstrate this depends on a variety of factors, including:

     Our product revenues will be adversely affected if, due to these or other factors, the products we or our collaborators are able to commercialize do not gain significant market acceptance.

We depend upon our proprietary technologies, and we may not be able to protect our potential competitive proprietary advantage.

     Our business and competitive position is dependent upon our and our collaborators’ ability to protect our proprietary technologies related to various aspects of pulmonary drug delivery and drug formulation. While our intellectual property rights may not provide a significant commercial advantage for us, our patents and know-how are intended to provide protection for important aspects of our technology, including methods for aerosol generation, devices used to generate aerosols, breath control, compliance monitoring, certain pharmaceutical formulations, design of dosage forms and their manufacturing and testing methods. In addition, we are maintaining as non-patented trade secrets some of the key elements of our manufacturing technologies, for example, those associated with production of disposable unit-dose packets for our AERx delivery system.

     Our ability to compete effectively will also depend to a significant extent on our and our collaborators’ ability to obtain and enforce patents and maintain trade secret protection over our proprietary technologies. The coverage claimed in a patent application typically is significantly reduced before a patent is issued, either in the United States or abroad. Consequently, any of our pending or future patent applications may not result in the issuance of patents and any patents issued may be subjected to further proceedings limiting their scope and may in any event not contain claims broad enough to provide meaningful protection. Any patents that are issued to us or our collaborators may not provide significant proprietary protection or competitive advantage, and may be circumvented or invalidated. In addition, unpatented proprietary rights, including trade secrets and know-how, can be difficult to protect and may lose their value if they are independently developed by a third party or if their secrecy is lost. Further, because development and commercialization of pharmaceutical products can be subject to substantial delays, patents may expire early and provide only a short period of protection, if any, following commercialization of products.

     In July 2006, we assigned 23 issued United States patents to Novo Nordisk along with corresponding non-United States counterparts and certain related pending applications. In August 2006, Novo Nordisk brought suit against Pfizer, Inc. claiming infringement of certain claims in one of the assigned United States patents. In December 2006, Novo Nordisk’s motion for a preliminary injunction in this case was denied. That patent is placed at risk in connection with this infringement lawsuit. Other patents assigned to Novo Nordisk may become the subject of future litigation. If all or any of the patents assigned to Novo Nordisk are invalidated, it may reduce Novo Nordisk’s commitment to move forward with AERx iDMS and would adversely affect any royalties or other compensation which we might potentially otherwise receive based directly on such patents. Further, the patents assigned to Novo Nordisk encompass, in some instances, technology beyond inhaled insulin and, if all or any of these patents are invalidated, it could harm our ability to obtain market exclusivity with respect to other product candidates.

We may infringe on the intellectual property rights of others, and any litigation could force us to stop developing or selling potential products and could be costly, divert management attention and harm our business.

     We must be able to develop products without infringing the proprietary rights of other parties. Because the markets in which we operate involve established competitors with significant patent portfolios, including patents relating to compositions of matter, methods of use and methods of drug delivery, it could be difficult for us to use our technologies or develop products without infringing the proprietary rights of others. We may not be able to design around the patented technologies or inventions of others and we may not be able to obtain licenses to use patented technologies on acceptable terms, or at all. If we cannot operate without infringing the proprietary rights of others, we will not earn product revenues.

     If we are required to defend ourselves in a lawsuit, we could incur substantial costs and the lawsuit could divert management attention, regardless of the lawsuit’s merit or outcome. These legal actions could seek

damages and seek to enjoin testing, manufacturing and marketing of the accused product or process. In addition to potential liability for significant damages, we could be required to obtain a license to continue to manufacture or market the accused product or process and any license required under any such patent may not be made available to us on acceptable terms, if at all.

     Periodically, we review publicly available information regarding the development efforts of others in order to determine whether these efforts may violate our proprietary rights. We may determine that litigation is necessary to enforce our proprietary rights against others. Such litigation could result in substantial expense, regardless of its outcome, and may not be resolved in our favor.

     Furthermore, patents already issued to us or our pending patent applications may become subject to dispute, and any disputes could be resolved against us. For example, Eli Lilly and Company brought an action against us seeking to have one or more employees of Eli Lilly named as co-inventors on one of our patents. This case was determined in our favor in 2004, but we may face other similar claims in the future and we may lose or settle cases at significant loss to us. In addition, because patent applications in the United States are currently maintained in secrecy for a period of time prior to issuance, and patent applications in certain other countries generally are not published until more than 18 months after they are first filed, and because publication of discoveries in scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first creator of inventions covered by our pending patent applications or that we were the first to file patent applications on such inventions.

We are in a highly competitive market, and our competitors have developed or may develop alternative therapies for our target indications, which would limit the revenue potential of any product we may develop.

     We are in competition with pharmaceutical, biotechnology and drug delivery companies, hospitals, research organizations, individual scientists and nonprofit organizations engaged in the development of drugs and therapies for the disease indications we are targeting. Our competitors may succeed before we can, and many already have succeeded, in developing competing technologies for the same disease indications, obtaining FDA approval for products or gaining acceptance for the same markets that we are targeting. If we are not “first to market,” it may be more difficult for us and our collaborators to enter markets as second or subsequent competitors and become commercially successful. We are aware of a number of companies that are developing or have developed therapies to address indications we are targeting, including major pharmaceutical companies such as Bayer, Eli Lilly, Genentech, Gilead Sciences, Merck & Co., Novartis and Pfizer. Certain of these companies are addressing these target markets with pulmonary products that are similar to ours. These companies and many other potential competitors have greater research and development, manufacturing, marketing, sales, distribution, financial and managerial resources and experience than we have and many of these companies may have products and product candidates that are on the market or in a more advanced stage of development than our product candidates. Our ability to earn product revenues and our market share would be substantially harmed if any existing or potential competitors brought a product to market before we or our collaborators were able to, or if a competitor introduced at any time a product superior to or more cost-effective than ours.

If we do not continue to attract and retain key employees, our product development efforts will be delayed and impaired.

     We depend on a small number of key management and technical personnel. Our success also depends on our ability to attract and retain additional highly qualified marketing, management, manufacturing, engineering and development personnel. There is a shortage of skilled personnel in our industry, we face intense competition in our recruiting activities, and we may not be able to attract or retain qualified personnel. Losing any of our key employees, particularly our new President and Chief Executive Officer, Dr. Igor Gonda, who plays a central role in our strategy shift to a specialty pharmaceutical company, could impair our product development efforts and otherwise harm our business. Any of our employees may terminate their employment with us at will.

Acquisition of complementary businesses or technologies could result in operating difficulties and harm our results of operations.

     While we have not identified any definitive targets, we may use a portion of the proceeds from this offering to acquire products, businesses or technologies that we believe are complementary to our business strategy. The process of investigating, acquiring and integrating any business or technology into our business and operations is risky and we may not be able to accurately predict or derive the benefits of any such acquisition. The process of acquiring and integrating any business or technology may create operating difficulties and unexpected expenditures, such as:

     In addition to the factors set forth above, we may encounter other unforeseen problems with acquisitions that we may not be able to overcome. Any future acquisitions may require us to issue shares of our stock or other securities that dilute the ownership interests of our other shareholders, expend cash, incur debt, assume liabilities, including contingent or unknown liabilities, or incur additional expenses related to write-offs or amortization of intangible assets, any of which could materially adversely affect our operating results.

If we market our products in other countries, we will be subject to different laws and we may not be able to adapt to those laws, which could increase our costs while reducing our revenues.

     If we market any approved products in foreign countries, we will be subject to different laws, particularly with respect to intellectual property rights and regulatory approval. To maintain a proprietary market position in foreign countries, we may seek to protect some of our proprietary inventions through foreign counterpart patent applications. Statutory differences in patentable subject matter may limit the protection we can obtain on some of our inventions outside of the United States. The diversity of patent laws may make our expenses associated with the development and maintenance of intellectual property in foreign jurisdictions more expensive than we anticipate. We probably will not obtain the same patent protection in every market in which we may otherwise be able to potentially generate revenues. In addition, in order to market our products in foreign jurisdictions, we and our collaborators must obtain required regulatory approvals from foreign regulatory agencies and comply with extensive regulations regarding safety and quality. We may not be able to obtain regulatory approvals in such jurisdictions and we may have to incur significant costs in obtaining or maintaining any foreign regulatory approvals. If approvals to market our products are delayed, if we fail to receive these approvals, or if we lose previously received approvals, our business would be impaired as we could not earn revenues from sales in those countries.

We may be exposed to product liability claims, which would hurt our reputation, market position and operating results.

     We face an inherent risk of product liability as a result of the clinical testing of our product candidates in humans and will face an even greater risk upon commercialization of any products. These claims may be made directly by consumers or by pharmaceutical companies or others selling such products. We may be held liable if any product we develop causes injury or is found otherwise unsuitable during product testing, manufacturing or sale. Regardless of merit or eventual outcome, liability claims would likely result in negative publicity, decreased demand for any products that we may develop, injury to our reputation and suspension or withdrawal of clinical trials. Any such claim will be very costly to defend and also may result in substantial monetary awards to clinical trial participants or customers, loss of revenues and the inability to commercialize products that we develop. Although we currently have product liability insurance, we may not be able to maintain such insurance or obtain additional insurance on acceptable terms, in amounts sufficient to protect our business, or at all. A successful claim brought against us in excess of our insurance coverage would have a material adverse effect on our results of operations.

If we cannot arrange for adequate third-party reimbursement for our products, our revenues will suffer.

     In both domestic and foreign markets, sales of our potential products will depend in substantial part on the availability of adequate reimbursement from third-party payors such as government health administration authorities, private health insurers and other organizations. Third-party payors often challenge the price and cost-effectiveness of medical products and services. Significant uncertainty exists as to the adequate reimbursement status of newly approved health care products. Any products we are able to successfully develop may not be reimbursable by third-party payors. In addition, our products may not be considered cost-effective and adequate third-party reimbursement may not be available to enable us to maintain price levels sufficient to realize a profit. Legislation and regulations affecting the pricing of pharmaceuticals may change before our products are approved for marketing and any such changes could further limit reimbursement. If any products we develop do not receive adequate reimbursement, our revenues will be severely limited.

Our use of hazardous materials could subject us to liabilities, fines and sanctions.

     Our laboratory and clinical testing sometimes involve use of hazardous and toxic materials. We are subject to federal, state and local laws and regulations governing how we use, manufacture, handle, store and dispose of these materials. Although we believe that our safety procedures for handling and disposing of such materials comply in all material respects with all federal, state and local regulations and standards, there is always the risk of accidental contamination or injury from these materials. In the event of an accident, we could be held liable for any damages that result and such liability could exceed our financial resources. Compliance with environmental and other laws may be expensive and current or future regulations may impair our development or commercialization efforts.

If we are unable to effectively implement or maintain a system of internal controls over financial reporting, we may not be able to accurately or timely report our financial results and our stock price could be adversely affected.

     Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm, beginning with our fiscal year ending December 31, 2007, to attest to, and report on, management’s assessment of our internal controls over financial reporting. Our ability to comply with the annual internal control report requirements will depend on the effectiveness of our financial reporting and data systems and controls across our company. We expect these systems and controls to involve significant expenditures and to become increasingly complex as our business grows and to the extent that we make and integrate acquisitions. To effectively manage this complexity, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. Any failure to implement required new or improved controls, or difficulties encountered in the implementation or operation of these controls, could harm our operating results and cause us to fail to meet our financial reporting obligations, which could adversely affect our business and reduce our stock price.

Risks Related to This Offering

Our stock price is likely to remain volatile.

     The market prices for securities of many companies in the drug delivery and pharmaceutical industries, including ours, have historically been highly volatile, and the market from time to time has experienced significant price and volume fluctuations unrelated to the operating performance of particular companies. Prices for our common stock may be influenced by many factors, including:

     In the past, class action securities litigation has often been instituted against companies promptly following volatility in the market price of their securities. Any such litigation instigated against us would, regardless of its merit, result in substantial costs and a diversion of management’s attention and resources.

Our common stock was delisted from the Nasdaq Capital Market; this delisting may reduce the liquidity of our common stock and the price may decline.

     On November 10, 2006, our common stock was delisted from the Nasdaq Capital Market due to non-compliance with Nasdaq’s continued listing standards. Our common stock is currently quoted on the OTC Bulletin Board. This delisting may reduce the liquidity of our common stock, may cause investors not to trade in our stock and may result in a lower stock price. In addition, investors may find it more difficult to obtain accurate quotations of the share price of our common stock.

We have implemented certain anti-takeover provisions, which make it less likely that we would be acquired and you would receive a premium price for your shares.

     Certain provisions of our articles of incorporation and the California Corporations Code could discourage a party from acquiring, or make it more difficult for a party to acquire, control of our company without approval of our board of directors. These provisions could also limit the price that certain investors might be willing to pay in the future for shares of our common stock. Certain provisions allow our board of directors to authorize the issuance, without shareholder approval, of preferred stock with rights superior to those of the common stock. We are also subject to the provisions of Section 1203 of the California Corporations Code, which requires us to provide a fairness opinion to our shareholders in connection with their consideration of any proposed “interested party” reorganization transaction.

     We have adopted a shareholder rights plan, commonly known as a “poison pill.” We have also adopted an Executive Officer Severance Plan and a Form of Change of Control Agreement, both of which may provide for the payment of benefits to our officers in connection with an acquisition. The provisions of our articles of incorporation, our poison pill, our severance plan and our change of control agreements, and provisions of the California Corporations Code may discourage, delay or prevent another party from acquiring us or reduce the price that a buyer is willing to pay for our common stock.

Because management has broad discretion as to the use of the net proceeds from this offering, you may not agree with how we use them, and such proceeds may not be applied successfully.

     Our management will have broad discretion with respect to the use of the net proceeds from this offering. We currently intend to use the net proceeds from the offering to fund the further development of ARD-3100, as well as other development programs and for working capital and general corporate purposes. You will be relying on the judgment of our management concerning these uses and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately. The failure of our management to apply these funds effectively could result in unfavorable returns and uncertainty about our prospects, each of which would cause the price of our common stock to decline.

We have never paid dividends on our capital stock, and we do not anticipate paying cash dividends for at least the foreseeable future.

     We have never declared or paid cash dividends on our capital stock. We do not anticipate paying any cash dividends on our common stock for at least the foreseeable future. We currently intend to retain all available funds and future earnings, if any, to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for at least the foreseeable future.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     This prospectus contains forward-looking statements. When used in this prospectus the words “anticipate,” “objective,” “may,” “might,” “should,” “could,” “can,” “intend,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan” or the negative of these and similar expressions identify forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

     These statements reflect our current views with respect to uncertain future events and are based on imprecise estimates and assumptions and subject to risk and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. While we believe our plans, intentions and expectations reflected in those forward-looking statements are reasonable, these plans, intentions or expectations may not be achieved. Our actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this prospectus for a variety of reasons, including those under the heading “Risk Factors.”

     All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the risk factors and other cautionary statements set forth in this prospectus. Other than as required by applicable securities laws, we are under no obligation, and we do not intend, to update any forward-looking statement, whether as result of new information, future events or otherwise.

USE OF PROCEEDS

     We estimate that our net proceeds from the sale of our common stock in this offering will be approximately $28.9 million, or approximately $33.3 million if the underwriters exercise their over-allotment option in full, based upon the public offering price of $0.95 per share and after deducting the underwriting discount and estimated offering expenses payable by us.

     We currently expect to use the net proceeds from this offering as follows:

     We may also use a portion of the proceeds for the potential acquisition of, or investment in, product candidates, technologies, formulations or companies that complement our business, although we have no current understandings, commitments or agreements to do so.

     As of September 30, 2006 we had $32.8 million in cash, cash equivalents and short-term investments. We believe that our existing capital resources, together with funding commitments from collaborators, interest earned on our investments and the estimated net proceeds from this offering, will be sufficient to enable us to maintain currently planned operations through at least the next 18 months. We do not expect our existing capital resources and the estimated net proceeds from this offering to be sufficient to enable us to fund to completion the development of any of our product candidates. During the next 18 months we expect to:

     We will need additional funds to develop our product candidates and to continue our operations. Such funds may not be available when needed on acceptable terms or at all. In order to reach commercialization of ARD-3100, we estimate we will need to spend an additional $15 million to $20 million. If we cannot raise sufficient funds when needed, we may have to delay, scale back or abandon clinical trials or other product development activities, or we may be forced to license or sell rights to our product candidates that we would have preferred to retain. If we are able to raise additional capital through the issuance of equity securities, your equity interest will be diluted. If we are able to raise additional capital through the issuance of debt securities, the terms of the debt securities may restrict our operations, including our ability to pay dividends on our common stock.

     The actual costs and timing of clinical trials are highly uncertain, subject to risk and may change depending upon the clinical indication targeted, the development strategy pursued and the results of preclinical testing and early stage clinical trials. The amounts and timing of other expenditures will depend on numerous factors, including the status of our product development and commercialization efforts, the amount of proceeds actually raised in this offering, competition, manufacturing activities and any collaborative arrangements we may enter into. As a result, our management will have broad discretion to allocate the net proceeds from this offering.

PRICE RANGE OF COMMON STOCK

     Since December 21, 2006, our common stock has been quoted on the OTC Bulletin Board, an electronic quotation service for securities traded over-the-counter. Between June 20, 1996 and May 1, 2006 our common stock was listed on the Nasdaq Global Market (formerly the Nasdaq National Market); between May 2, 2006 and November 9, 2006 our common stock was listed on the Nasdaq Capital Market (formerly the Nasdaq SmallCap Market); and between November 10, 2006 and December 20, 2006 our common stock was quoted on the Pink Sheets.

     The following table sets forth the high and low closing sale prices of our common stock for the periods indicated.

     On January 24, 2007, the last reported sale price of our common stock on the OTC Bulletin Board was $0.95. As of January 24, 2007, there were 14,760,599 shares of our common stock outstanding, held by 124 holders of record.

DIVIDEND POLICY

     We have never declared or paid any cash dividends on our capital stock and we do not currently intend to pay any cash dividends on our capital stock for at least the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our capital stock will be, subject to applicable law, at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions in loan agreements or other agreements.

CAPITALIZATION

     The following table sets forth our unaudited capitalization as of September 30, 2006:

     You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited and unaudited financial statements and the related notes, each appearing elsewhere in this prospectus.

     The outstanding share information in the table above excludes as of September 30, 2006:

SELECTED FINANCIAL DATA

     We present below our selected financial data. The statement of operations data for the years ended December 31, 2003, 2004 and 2005 and the balance sheet data as of December 31, 2004 and 2005 have been derived from our audited financial statements included elsewhere in this prospectus. The statement of operations data for the years ended December 31, 2001 and 2002 and the balance sheet data as of December 31, 2001, 2002 and 2003 have been derived from our audited financial statements not included in this prospectus. The statement of operations data for the nine months ended September 30, 2005 and 2006 and the balance sheet data as of September 30, 2006 have been derived from our unaudited financial statements included elsewhere in this prospectus. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited and unaudited financial statements and related notes, each included elsewhere in this prospectus. Our interim results are not necessarily indicative of results for the full fiscal year and our historical results are not necessarily indicative of the results to be expected in any future period.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and our financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

     We are an emerging specialty pharmaceutical company focused on the development and commercialization of a portfolio of drugs delivered by inhalation for the treatment of severe respiratory diseases by pulmonologists. Over the last decade, we have invested a large amount of capital to develop drug delivery technologies, and in doing so we have developed a significant amount of expertise in pulmonary drug delivery. We have also invested considerable effort into the generation of a large volume of laboratory and clinical data demonstrating the performance of our AERx pulmonary drug delivery platform. We have not been profitable since inception and expect to incur additional operating losses over at least the next several years as we expand product development efforts, preclinical testing and clinical trial activities and possible sales and marketing efforts and as we secure production capabilities from outside contract manufacturers. To date, we have not had any significant product sales, and we do not anticipate receiving any revenues from the sale of products for at least the next several years. As of September 30, 2006, we had an accumulated deficit of $282.5 million. Historically we have funded our operations primarily through private placements and public offerings of our capital stock, proceeds from equipment lease financings, license fees and milestone payments from collaborators, proceeds from our restructuring transaction with Novo Nordisk and interest earned on investment.

     We have performed initial feasibility work and conducted early stage clinical work on a number of potential products and have been compensated for expenses incurred while performing this work in several cases pursuant to feasibility study agreements and other collaborative arrangements. We will seek to develop certain potential products ourselves, including those that can benefit from our experience in pulmonary delivery, and that have markets we can address with a targeted sales and marketing force and that we believe are likely to provide a superior therapeutic profile or other valuable benefits to patients when compared to existing products. For other potential products with larger or less concentrated markets we may seek to enter into development and commercialization agreements with collaborators.

     In 2004, we executed a development agreement with Defence Research and Development Canada, a division of the Canadian Department of National Defence, for the development of liposomal ciprofloxacin for the treatment of biological terrorism-related inhalation anthrax. We are also exploring the use of liposomal ciprofloxacin to treat other indications. We have received orphan drug designation for this formulation from the United States Food and Drug Administration, or the FDA, for the management of cystic fibrosis, or CF. We initiated preclinical studies for our ARD-3100 product candidate in 2006 and expect to initiate human clinical studies for the CF indication in the first half of 2007. We anticipate using safety data from these studies to support our expected application for approval of the ARD-1100 product candidate for the prevention and treatment of inhalation anthrax and possibly other inhaled life-threatening bioterrorism infections as well.

     The AERx insulin Diabetes Management System, or AERx iDMS, which we initially developed and is now licensed to Novo Nordisk, is being developed to control blood glucose levels in patients with diabetes. Following the restructuring of our collaborative arrangement in January 2005, all responsibility for funding and conducting the remaining development and commercialization of this product, including manufacturing, clinical trials, regulatory filings, marketing and sales, has been transferred to Novo Nordisk. We have the right to receive royalties on any sales of AERx iDMS. AERx iDMS is currently undergoing testing in a Phase 3 clinical program, which began in May 2006. This program follows significant prior clinical work

which provided preliminary evidence that AERx iDMS is comparable to regular injectable insulin in the overall management of Type 1 and Type 2 diabetes. The Phase 3 clinical program is expected to include a total of approximately 3,400 Type 1 and Type 2 diabetes patients and is taking place worldwide with primary focus on Europe and the United States. The program includes treatment comparisons with other antidiabetics. The longest of these trials is expected to last 27 months. Novo Nordisk announced in October 2006 that it expects commercial launch of the product in 2010. As with any clinical program, there are many factors that could delay the launch or could result in AERx iDMS not receiving or maintaining regulatory approval.

     We have other ongoing collaborator-funded and proprietary programs under development. In 2006, we expect self-initiated research and development expenses to decrease from 2005; however, the extent of and costs associated with future research and development efforts are uncertain and difficult to predict due to the early stage of development of our programs.

Restructured Relationship with Novo Nordisk

     During 2005, our collaborative agreement with Novo Nordisk and its subsidiary, Novo Nordisk Delivery Technologies, or NNDT, contributed approximately 76% of our total contract revenues. From the inception of our collaboration in June 1998 through December 31, 2005, we have received from Novo Nordisk $137.1 million in product development payments, $13.0 million in milestone payments and $35.0 million from the purchase of our common stock by Novo Nordisk and its affiliates. All product development and milestone payments received to date have been recognized as revenue.

     As of January 26, 2005, we restructured the AERx iDMS program, pursuant to a restructuring agreement entered into with Novo Nordisk and NNDT in September 2004. Under the terms of the restructuring agreement, we sold certain equipment, leasehold improvements and other tangible assets used in the AERx iDMS program to NNDT, for a cash payment of $55.3 million (before refund of cost advances made by Novo Nordisk). Our expenses related to this transaction for legal and other consulting costs were $1.1 million. In connection with the restructuring transaction, we entered into various related agreements with Novo Nordisk and NNDT, including the following:

     As a result of this transaction, we recorded our final project development revenues from Novo Nordisk in the first quarter of 2005, and, as we were no longer obligated to continue work related to the non-refundable milestone payment from Novo Nordisk in connection with the commercialization of AERx, we recognized the remaining balance of the deferred revenue associated with the milestone of $5.2 million as revenue in the first quarter of 2005. In 2005 we recorded revenues of approximately $727,000 from NNDT related to transition and support agreements. As a result of this transaction, we were released from our contractual obligations relating to future operating lease payments for two buildings assigned to NNDT and accordingly reversed the deferred rent liability related to the two buildings of $1.4 million, resulting in a reduction of

operating expenses in 2005. In addition, pursuant to the restructuring agreement, we terminated a manufacturing and supply agreement and a patent cooperation agreement, each previously in place with Novo Nordisk and dated October 22, 2001.

     On July 3, 2006, we further restructured our relationship with Novo Nordisk through an intellectual property assignment, a royalty prepayment and an eight-year promissory note with Novo Nordisk. The promissory note was secured by the royalty payments on any AERx iDMS sales by Novo Nordisk under the license with us. The key features of this restructuring included:

     We and Novo Nordisk continue to cooperate and share in technology development, as well as intellectual property development and defense. Both we and Novo Nordisk have access to any developments or improvements the other might make to the AERx delivery system, within their respective fields of use. Novo Nordisk also remains a substantial holder of our common stock and is restricted from disposing of any of our common stock until January 1, 2009 or the earlier occurrence of certain specified events.

     In August 2006, Novo Nordisk announced that it had filed a lawsuit against Pfizer claiming that Exubera, an inhaled insulin product that Pfizer has been developing with Nektar Therapeutics, infringes a patent originally owned by us and now owned by Novo Nordisk with rights retained by us outside the field of glucose control. In December 2006, Novo Nordisk’s motion for a preliminary injunction in this case was denied. While the outcome of this lawsuit is highly uncertain, we are entitled to a portion of any proceeds, net of litigation costs, that may be received by Novo Nordisk from a favorable outcome.

Purchase and Sale of Intraject Technology

     In May 2003, we acquired select assets from the Weston Medical Group, a company based in the United Kingdom, including the Intraject needle-free delivery technology, related manufacturing equipment and intellectual property and associated transfer costs, for a total of $2.9 million. The purchase price and additional costs were allocated to the major pieces of purchased commercial equipment for the production of Intraject and were recorded in property and equipment as construction in progress. No costs or expenses were allocated to intellectual property or in-process research and development on a pro-rata basis, because of the lack of market information, the early stage of development and the immateriality of any allocation to intellectual property or in-process research and development based on the substantial value of the tangible assets acquired.

     In October 2004, we announced positive results from the clinical performance verification trial of the Intraject needle-free delivery system. Following the results from the configuration trial, we initiated a pilot pharmacokinetic study comparing Intraject with sumatriptan, a treatment for migraines, to the currently marketed needle-injected product. In June 2005, we announced results from this study, which showed that Intraject sumatriptan was bioequivalent to the marketed injectable product and that patients were able to self-administer using Intraject.

     In August 2006, we sold all of our assets related to the Intraject technology platform and products, including 12 United States patents along with any foreign counterparts corresponding to those United States patents, to Zogenix, Inc., a newly created private company that has some officers who were former officers of our company. Zogenix is responsible for further development and commercialization efforts of Intraject. We received a $4.0 million initial payment and we will be entitled to a milestone payment upon initial commercialization and royalty payments upon any commercialization of products that may be developed and sold using the Intraject technology. Our potential royalty payments will be affected by the ability of Zogenix to maintain and, if necessary, enforce the patents we assigned to it.

Nasdaq Listing

     On May 18, 2006, we received a notice indicating that we had failed to comply with Marketplace Rule 4310(c)(2)(B) of the Nasdaq Stock Market (Nasdaq), requiring us to either maintain a minimum market value or shareholders’ equity or meet certain net income levels. Upon subsequently receiving a staff determination letter from Nasdaq stating that our common stock was subject to delisting from the Nasdaq Capital Market for not meeting specific listing criteria, we requested and were granted a hearing before the Nasdaq Listing Qualifications Panel. On August 22, 2006, the panel granted our request for continued listing, pending receipt of third quarter financial statements demonstrating continued compliance. On October 24, 2006, we notified Nasdaq that our third quarter financial statements were not expected to demonstrate continued compliance and requested a hearing to show our plan to regain and maintain compliance. On November 9, 2006, we announced that the Nasdaq Listing Qualifications Panel had determined to delist our common stock from the Nasdaq Capital Market, effective with the commencement of trading on Friday, November 10, 2006. Our common stock is currently quoted on the OTC Bulletin Board, an electronic quotation service for securities traded over-the-counter.

Critical Accounting Policies and Estimates

     We consider certain accounting policies related to revenue recognition, stock-based compensation and impairment of long-lived assets to be critical accounting policies that require the use of significant judgments and estimates relating to matters that are inherently uncertain and may result in materially different results under different assumptions and conditions. The preparation of financial statements in conformity with United States generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. These estimates include useful lives for property and equipment and related depreciation calculations, estimated amortization periods for payments received from product development and license agreements as they relate to the revenue recognition of deferred revenue and assumptions for valuing options, warrants and other stock-based compensation. Our actual results could differ from these estimates.

Revenue Recognition

     Contract revenues consist of revenues from collaboration agreements and feasibility studies. We recognize revenues under the provisions of the Securities and Exchange Commission issued Staff Accounting Bulletin, or SAB, No. 104, “Revenue Recognition.” Under collaboration agreements, revenues are recognized as costs are incurred. Deferred revenue represents the portion of all refundable and nonrefundable research payments received that have not been earned. In accordance with contract terms, milestone payments from collaborative research agreements are considered reimbursements for costs incurred under the agreements and, accordingly, are generally recognized as revenues either upon the completion of the milestone effort when payments are contingent upon completion of the effort or are based on actual efforts expended over the remaining term of the agreements when payments precede the required efforts. Costs of contract revenues are approximate to or are greater than such revenues and are included in research and development expenses when incurred. Refundable development and license fee payments are deferred until the specified performance criteria are achieved. Refundable development and license fee payments are generally not refundable once the specific performance criteria are achieved and accepted.

Impairment of Long-Lived Assets

     We review for impairment whenever events or changes in circumstances indicate that the carrying amount of property and equipment may not be recoverable in accordance with Statement of Financial Accounting Standard, or SFAS, No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Future cash flows that are contingent in nature are generally not recognized. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written down to their estimated fair values and the loss is recognized in the statements of operations. We recorded a non-cash impairment charge of $4.0 million during the nine months ended September 30, 2006 related to our estimate of the net realizable value of the Intraject-related assets, based on the expected sale of those assets.

Stock-Based Compensation Expense

     Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123R, using the modified prospective transition method and, therefore, have not restated prior periods’ results. Under this method, we recognize compensation expense, net of estimated forfeitures, for all stock-based payments granted after January 1, 2006 and all stock-based payments granted prior to but not vested as of January 1, 2006.

     Under the provisions of SFAS No. 123R, stock-based compensation cost is estimated at the grant date based on the award’s fair value and is recognized as expense, net of estimated forfeitures, ratably over the requisite vesting period. We have elected to calculate an award’s fair value based on the Black-Scholes option-pricing model. The Black-Scholes model requires various assumptions including expected option life and expected stock price volatility. If any of the assumptions used in the Black-Scholes model or the estimated forfeiture rate change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

     Under SFAS No. 123R, we recognized compensation expense for stock-based compensation of $1.3 million for the nine months ended September 30, 2006.

Comparison of Nine Months Ended September 30, 2006 and 2005

     Total revenues consist of contract and milestone revenues. Total revenues decreased $5.6 million for the nine months ended September 30, 2006 over the comparable period in 2005 due to decreases in both contract and milestone revenues. The decreases were primarily due to the restructuring of the AERx iDMS program in January 2005, which resulted in a decrease in revenues associated with that program. In the nine months ended September 30, 2006, we recorded revenues from a transition agreement with Zogenix of $360,000 and increased contract revenues of $1.8 million from our AERx programs, including increases from the ARD-3100, ARD-1500, ARD-1300 and AERx Smoking Cessation programs of $545,000, $378,000, $679,000 and $166,000, respectively. This increase was primarily offset by a net decrease in contract revenues of $2.1 million due to the January 2005 restructuring with Novo Nordisk and a decrease of $566,000 due to the conclusion of a transition service agreement with Novo Nordisk on January 27, 2006. Milestone revenues for the nine months ended September 30, 2006 decreased by approximately $5.0 million due primarily to the

consummation of the restructuring with Novo Nordisk on January 26, 2005, which resulted in a decrease of $5.2 million, offset by an increase of $210,000 for the ARD-1300 development program. We expect contract revenues to decrease as we decrease collaborative activities in favor of self-initiated development activities.

     Research and development expenses include salaries, payments to contract manufacturers and contract research organizations, contractor and consultant fees, stock-based compensation expense, and other support costs including facilities, depreciation and travel costs. Stock-based compensation expense charged to research and development for the nine months ended September 30, 2006 was $665,000 due to the adoption of SFAS No. 123R effective January 1, 2006.

     The decrease in collaborative program expenses in the nine months ended September 30, 2006 was due primarily to the conclusion of the January 2005 restructuring agreement with Novo Nordisk. Similarly, the decrease in research and development expense for self-initiated projects was due primarily to a decrease in our Intraject clinical batch registration lot activities that were substantially completed at year-end 2005 and finalized in early 2006. In August 2006, we sold all of our assets related to the Intraject technology platform to Zogenix, a newly created private company that is responsible for further development and commercialization efforts of Intraject. We expect that our research and development expenses will remain relatively constant over the next few quarters as we redirect our focus from Intraject programs to our AERx programs.

     General and administrative expenses are comprised of salaries, legal fees, insurance, marketing research, contractor and consultant fees, stock-based compensation expense and other support costs including facilities, depreciation and travel costs. Stock-based compensation expense charged to general and administrative expenses for the nine months ended September 30, 2006 was $614,000 due to the adoption of SFAS 123R effective January 1, 2006.

     General and administrative expenses for the nine months ended September 30, 2006 increased over the comparable period in 2005 primarily as a result of legal expenses incurred related to the restructuring transaction entered into with Novo Nordisk in July 2006 and an increase in stock-based compensation. We expect that our general and administrative expenses will remain relatively constant over the next few quarters; however, there may be increased expenses associated with additional financings.

     Restructuring and asset impairment expenses are comprised of severance-related expenses including payroll, health insurance payments, outplacement expenses and Intraject-related asset impairment expenses. Severance-related expenses for the nine months ended September 30, 2006 were $1.7 million, primarily due to the reduction in workforce announced on May 15, 2006. In addition, we recorded $566,000 in severance expense related to the resignation of V. Bryan Lawlis, our former President and Chief Executive Officer, and Bobba Venkatadri, our former Senior Vice President of Operations, in August 2006, which was offset by a reduction in previously recorded severance expense of $233,000 related to the departure of employees in connection with the sale of Intraject-related assets to Zogenix. We expect to pay the severance-related balance in full by the end of 2007. In addition, we recorded a non-cash asset impairment charge of $4.0 million during the nine months ended September 30, 2006 related to our estimate of the net realizable value of the Intraject-related assets, based on the expected sale of those assets.

     The gain on sale of patent and royalty interest reflects two transactions we entered into with Novo Nordisk, a related party: (i) our transfer of certain intellectual property, including all right, title and interest to our patents that contain claims that pertain generally to breath control or specifically to the pulmonary delivery of monomeric insulin and monomeric insulin analogs, together with interrelated patents, which are linked via terminal disclaimers, as well as certain of our pending patent applications and continuations thereof for a cash payment of $12.0 million, with us retaining exclusive, royalty-free control of these patents outside the field of glucose control; and (ii) a reduction by 100 basis points of each royalty rate payable by Novo Nordisk to us for a cash payment of $8.0 million.

     Interest income primarily represents interest earned on our investments. Interest income for the nine months ended September 30, 2006 decreased $141,000 over the comparable period in 2005 due to a lower average invested balance. Interest expense primarily reflects interest on the $7.5 million note payable issued to Novo Nordisk in July 2006 with an interest rate of 5%. Interest expense was $101,000 for the nine months ended September 30, 2006 as opposed to no interest expense for the comparable period in 2005. Other income (expense) primarily represents realized gains from exchange rate transactions and loss on the disposition of assets.

Comparison of Years Ended December 31, 2005, 2004 and 2003

Revenues

     The 63% decrease in total revenues in 2005 compared to 2004 is due primarily to decreases in contract revenues as a result of the January 2005 restructuring of the AERx iDMS program. A decrease in contract revenues of $23.6 million in 2005 from the AERx iDMS program was offset by an increase of $727,000 in AERx iDMS consulting revenues and an increase of $1.3 million as a result of initiating four new feasibility projects. Milestone revenues increased by $3.9 million due to the recognition of deferred revenue from a non refundable milestone balance of $5.2 million and by $162,000 from the initiation of a new feasibility project.

     The 17% decrease in total revenues in 2004 compared to 2003 is due primarily to decreases in contract revenues and milestone revenues as a result of the maturation of the collaboration agreement with Novo Nordisk. This decrease of $6.1 million was offset by a $734,000 increase in other collaborator-funded programs. Milestone revenues from Novo Nordisk decreased in 2004 by $455,000.

Research and Development

     The decrease in research and development expenses in 2005 compared to 2004 is primarily due to a reduction in headcount and facility costs associated with the restructuring transaction with Novo Nordisk and cost reduction programs. This was offset by a $5.9 million increase in self-initiated development efforts primarily relating to Intraject. The decrease in research and development expenses in 2004 compared to 2003 is primarily due to cost reduction programs, including a reduction in force implemented in July 2003 in order to align our costs with the reduced revenues from collaborators. These decreases were offset by a net increase of $2.2 million in self-initiated program costs. A reduction in pulmonary delivery development efforts was offset by increased spending on the Intraject program. The reduced head count affected six months of 2003 and all of 2004.

General and Administrative

     The decrease in general and administrative expenses in 2005 as compared to 2004 resulted primarily from legal and consulting costs incurred in 2004 associated with the January 2005 restructuring transaction with Novo Nordisk. Other than the restructuring transaction, there were no significant corporate transactions in 2005, 2004 and 2003.

Interest Income, Interest Expense and Other Income (Expense)

     The increase in interest income in 2005 compared to 2004 is due to an increase in interest rates earned and higher average invested balances in 2005. The average cash and investment balances were higher in 2005 primarily due to receipt of net proceeds of $11.7 million from a private placement of common stock in December 2004 and net proceeds of $51.3 million from the closing of the January 2005 restructuring transaction with Novo Nordisk. The decrease in interest income in 2004 compared to 2003 was primarily due to lower average cash and investment balances in 2004 and, to a lesser extent, a decrease in interest rates earned on invested cash balances.

     The decrease in interest expense in 2005 and 2004 compared to 2003 is primarily due to lower outstanding capital lease and equipment loan balances under various equipment and lease lines of credit which were completely paid off during 2004. The increase in other income (expense) in 2005 compared to 2004 is due primarily to the $49,000 net gain on the sale of assets and $10,000 reduction in interest expense, offset by $12,000 loss on foreign exchange translation.

Selected Quarterly Financial Information

     The following table sets forth our unaudited quarterly statements of operations for each of the eleven quarters in the period ended September 30, 2006. You should read the following table in conjunction with our financial statements and related notes contained elsewhere in this prospectus. We have prepared the unaudited information on the same basis as our audited financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for the full fiscal year or any other future period.

Liquidity and Capital Resources

     Since inception, we have financed our operations primarily through private placements and public offerings of our capital stock, proceeds from equipment lease financings, contract research funding, proceeds from our restructuring transactions with Novo Nordisk and interest earned on investments. As of

September 30, 2006, we had cash, cash equivalents and short-term investments of $32.8 million and total working capital of $30.2 million. During the three months ended September 30, 2006, we received proceeds of $20.0 million from the sale of patents and royalty interest to Novo Nordisk, proceeds from a $7.5 million promissory note we issued to Novo Nordisk and proceeds of $4.0 million from the sale of Intraject-related assets to Zogenix. Our principal requirements for cash are to fund working capital needs and, to a lesser extent, capital expenditures for equipment purchases.

     For the nine months ended September 30, 2006, our operating activities used net cash of $25.4 million and reflect our net loss of $7.6 million offset by non-cash charges, including stock-based compensation expense under SFAS No. 123R, an asset impairment charge on property and equipment and depreciation expense, and our use of operating cash to fund changes in operating assets and liabilities. Cash was used to pay for an increase in invoices outstanding for the Intraject program, to pay for severance-related expenses accrued for the reduction in workforce and to fund accounts receivable, primarily related to our partnered programs. This compares to the net cash used in our operating activities for the nine months ended September 30, 2005 of $26.8 million reflecting our net loss of $18.5 million offset by non-cash charges, including depreciation expense and our use of cash to fund changes in operating assets and liabilities. The primary changes in operating assets and liabilities were the recognition of deferred revenues of $7.2 million and reduction in deferred rent of $1.3 million, recognized in the statement of operations in the nine months ended September 30, 2005 in conjunction with the January 2005 Novo Nordisk restructuring.

     For the nine months ended September 30, 2006, net cash provided by investing activities was $22.2 million, which consisted primarily of $20.0 million in proceeds from the sale of patents and royalty interest and $4.0 million in proceeds from the sale of Intraject-related assets. This was partly offset by $1.3 million for purchases of equipment primarily for the Intraject commercialization program and $507,000 used to purchase short-term investments. This compares to net cash provided by investing activities for the nine months ended September 30, 2005 of $45.4 million, which consisted primarily of $50.3 million in net proceeds from Novo Nordisk in connection with the January 2005 restructuring and $4.5 million in proceeds from sale of investments, offset by our purchase of $4.0 million of fixed assets relating to our Intraject platform and our purchases of $5.3 million in securities classified as short-term investments with funds received in connection with the restructuring.

     Net cash provided by financing activities was $7.8 million for the nine months ended September 30, 2006, primarily representing proceeds from the $7.5 million promissory note issued to Novo Nordisk and net cash provided by purchases under our employee stock plans, compared to $557,000 for the comparable period in 2005.

     As of September 30, 2006, we had an accumulated deficit of $282.5 million, working capital of $30.2 million and shareholders’ equity of $1.1 million. Management believes that cash and cash equivalents on hand at September 30, 2006, together with funding commitments from collaborators, interest earned on our investments and the estimated net proceeds from this offering, will be sufficient to enable us to meet our obligations through at least the next 18 months.

     We will likely need to raise additional capital to fund our operations and to develop our product candidates. Such funds may not be available when needed on acceptable terms or at all. If we cannot raise sufficient funds when needed, we may have to delay, scale back or abandon clinical trials or other product development activities, or we may be forced to license or sell rights to our product candidates that we would have preferred to retain. If we are able to raise additional capital through the issuance of equity securities, your equity interest will be diluted. If we are able to raise additional capital through the issuance of debt securities, the terms of the debt securities may restrict our operations, including our ability to pay dividends on our common stock.

     Our development efforts have and will continue to require a commitment of substantial funds to conduct the preclinical safety testing and clinical testing activities necessary to develop and refine such technology and proposed products and to bring any such products to market. Our future capital requirements will depend on many factors, including continued progress with product development, our ability to establish and maintain favorable collaborative arrangements with others, progress with preclinical studies and clinical trials and the

results thereof, the time and costs involved in seeking regulatory approvals, the cost to us of scale-up of our technologies, mainly through contract manufacturers, the cost involved in preparing, filing, prosecuting, maintaining and enforcing patent claims, and the need to acquire licenses or other rights to new technology.

     We continue to review our planned operations through the end of 2006 and beyond. We particularly focus on capital spending requirements to ensure that capital outlays are not expended sooner than necessary. If we make good progress in our development programs, we would expect our cash requirements for capital spending and operations to increase in future periods. Our capital expenditure budget through the end of 2007 is for a total of $3.0 million, primarily for investment in manufacturing processes and equipment.

Contractual Obligations

     Our contractual obligations and future minimum lease payments that are non-cancelable at December 31, 2005 are disclosed in the following table.

Off-Balance Sheet Financings and Liabilities

     Other than contractual obligations incurred in the normal course of business, we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries.

Quantitative and Qualitative Disclosure About Market Risk

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

     As of September 30, 2006, we had cash, cash equivalents and short-term investments of $32.8 million, consisting of cash, cash equivalents and highly liquid short-term investments. Our short-term investments will likely decline by an immaterial amount if market interest rates increase and, therefore, we believe our exposure to interest rate changes is immaterial. Declines of interest rates over time will, however, reduce our interest income from short-term investments.

BUSINESS

     We are an emerging specialty pharmaceutical company focused on the development and commercialization of a portfolio of drugs delivered by inhalation for the treatment of severe respiratory diseases by pulmonologists. Historically we have focused on the development of our drug delivery technologies, including our AERx pulmonary drug delivery platform for both respiratory and systemic diseases. Today, our core business focus is to utilize our expertise and our pulmonary delivery and formulation technologies to develop treatments for patients with respiratory diseases that we believe could be better than the therapies that are currently available. We select for development those inhaled drugs for respiratory disease indications that, due to expected development costs, market size and other factors, we believe we can successfully develop and market with our own sales force.

     Where we determine it would not be desirable or feasible for us to develop or commercialize product candidates on our own, we enter into co-development and co-marketing arrangements in order to benefit from cost and risk reduction during development and increased sales from collaborators’ marketing activities.

     Additionally, multiple opportunities exist for the use of our pulmonary delivery technology for the treatment of systemic diseases, both for the delivery of biologics, including proteins, antibodies and peptides, that today must be delivered by injection, and for small molecule drugs, where rapid absorption is desirable. We have demonstrated with a variety of drugs and biologics that pulmonary delivery of drugs using our proprietary technologies enhances their absorption profiles. We believe that our technologies can provide advantages in terms of convenience, efficiency, safety and reproducibility over other methods of administration. Where appropriate, we will out-license aspects of our technology and intellectual property assets for these products that lie outside our strategic interests and core expertise.

Our Strategy

     We are transitioning our business model toward a specialty pharmaceutical company focused on development and commercialization of a portfolio of drugs delivered by inhalation for the treatment of respiratory diseases. We have chosen to focus on respiratory diseases based on the expertise of our management team and the history of our company. We have significant experience in the treatment of respiratory diseases and specifically in the development of inhalation products that are uniquely suited for their treatment. We have a portfolio of proprietary technologies that may potentially address significant unmet medical needs for better products in the global respiratory market, which showed 10.3% growth overall in 2005 with higher growth rates in the areas of innovative products. There are five key elements of our strategy:

Product Candidates

     Products in development include both our own proprietary products and products under development with collaborators. They consist of approved drugs combined with our controlled inhalation delivery and/or

formulation technologies. The following table shows the disease indication and stage of development for each product candidate in our portfolio.

In addition to these programs, we are continually evaluating opportunities for product development where we can apply our expertise and intellectual property to produce better therapies and where we believe the investment could provide significant value to our shareholders.

     Ciprofloxacin is approved by the FDA as an anti-infective agent and is widely used for the treatment of a variety of bacterial infections. Today ciprofloxacin is delivered by oral or intravenous administration. We believe that delivering this potent antibiotic directly to the lung may improve its safety and efficacy in the treatment of pulmonary infections. We believe that our novel sustained release formulation of ciprofloxacin may be able to maintain therapeutic concentrations of the antibiotic within infected lung tissues, while reducing systemic exposure and the resulting side effects seen with currently marketed ciprofloxacin products. To achieve this sustained release, we employ liposomes, which are lipid-based nanoparticles dispersed in water that encapsulate the drug during storage and release the drug slowly upon contact with fluid covering the airways and the lung. In an animal experiment, ciprofloxacin delivered to the lung of mice appeared to be rapidly absorbed into the bloodstream, with no drug detectable four hours after administration. In contrast, the liposomal formulation of ciprofloxacin produced significantly higher levels of ciprofloxacin in the lung at all time points and was still detectable at 12 hours. We also believe that for certain respiratory disease indications it may be possible that a liposomal formulation enables better interaction of the drug with the disease target, leading to improved effectiveness over other therapies. We have at present two target indications with distinct delivery systems for this formulation that share much of the laboratory and production development efforts, as well as a common safety data base.

     One of our liposomal ciprofloxacin programs is a proprietary program using our liposomal formulation of ciprofloxacin for the treatment and control of respiratory infections common to patients with cystic fibrosis, or CF. CF is a genetic disease that causes thick, sticky mucus to form in the lungs, pancreas and other organs. In the lungs, the mucus tends to block the airways, causing lung damage and making these patients highly susceptible to lung infections. According to the Cystic Fibrosis Foundation, CF affects roughly 30,000 children and adults in the United States and roughly 70,000 children and adults worldwide. According to the American Lung Association, the direct medical care costs for an individual with CF are currently estimated to be in excess of $40,000 per year.

     The inhalation route affords direct administration of the drug to the infected part of the lung, maximizing the dose to the affected site and minimizing the wasteful exposure to the rest of the body where it could cause side effects. Therefore, treatment of CF-related lung infections by direct administration of antibiotics to the lung may improve both the safety and efficacy of treatment compared to systemic administration by other routes, as well as improving patient convenience as compared to injections. Oral and injectable forms of ciprofloxacin are approved for the treatment of Pseudomonas aeruginosa, a lung infection to which CF patients are vulnerable. Currently, there is only one inhalation antibiotic approved for the treatment of this

infection. We believe that local lung delivery via inhalation of ciprofloxacin in a sustained release formulation could provide a convenient, effective and safe treatment of the debilitating and often life-threatening lung infections that afflict patients with CF.

     Our liposomal ciprofloxacin CF program represents the first program in which we intend to retain full ownership and development rights. We believe we have the preclinical development, clinical and regulatory knowledge to advance this product through development in the most efficient manner. We intend to commercialize this program on our own.

     We have received orphan drug designation from the FDA for this product for the management of CF. As a designated orphan drug, liposomal ciprofloxacin is eligible for tax credits based upon its clinical development costs, as well as assistance from the FDA to coordinate study design. The designation also provides the opportunity to obtain market exclusivity for seven years from the date of New Drug Application, or NDA, approval.

     We initiated preclinical studies for liposomal ciprofloxacin in 2006 and expect to initiate human clinical studies in the first half of 2007. We expect to use approximately $20 million of the net proceeds from this offering to complete preclinical studies and fund early stage clinical trials and related manufacturing requirements for ARD-3100. In order to reach commercialization of ARD-3100, we estimate we will need to spend an additional $15 million to $20 million. In order to expedite anticipated time to market and increase market acceptance, we have elected to deliver ciprofloxacin via nebulizer, as most CF patients already own a nebulizer and are familiar with this method of drug delivery. We intend to examine the potential for delivery of ciprofloxacin via our AERx delivery system. We share the formulation and manufacturing development as well as the safety data developed for our inhalation anthrax program discussed below in the development of this CF opportunity. We also intend to explore the utility of liposomal ciprofloxacin for the treatment of serious infections associated with other respiratory diseases, such as chronic obstructive pulmonary disease and bronchiectasis.

     The second of our liposomal ciprofloxacin programs is for the prevention and treatment of pulmonary anthrax infections. Anthrax spores are naturally occurring in soil throughout the world. Anthrax infections are most commonly acquired through skin contact with infected animals and animal products or, less frequently, by inhalation or ingestion of spores. With inhalation anthrax, once symptoms appear, fatality rates are high even with the initiation of antibiotic and supportive therapy. Further, a portion of the anthrax spores, once inhaled, may remain dormant in the lung for several months and germinate. Anthrax has been identified by the Centers for Disease Control as a likely potential agent of bioterrorism. In the fall of 2001, when anthrax-contaminated mail was deliberately sent through the United States Postal Service to government officials and members of the media, five people died and many more became sick. These attacks highlighted the concern that inhalation anthrax as a bioterror agent represents a real and current threat.

     Ciprofloxacin has been approved orally and via injection for the treatment of inhalation anthrax (post-exposure) since 2000. This ARD-1100 research and development program has been funded by Defence Research and Development Canada, or DRDC, a division of the Canadian Department of National Defence. We believe that this product candidate may potentially be able to deliver a long acting formulation of ciprofloxacin directly into the lung and could have fewer side effects and be more effective to prevent and treat inhalation anthrax than currently available therapies.

     We began our research into liposomal ciprofloxacin under a technology demonstration program funded by DRDC as part of their interest to develop products to counter bioterrorism. DRDC had already demonstrated the feasibility of inhaled liposomal ciprofloxacin for post-exposure prophylaxis of Francisella tularensis, a potential bioterrorism agent similar to anthrax. Mice were exposed to a lethal dose of F. tularensis and then

24 hours later were exposed via inhalation to a single dose of free ciprofloxacin, liposomal ciprofloxacin or saline. All the mice in the control group and the free ciprofloxacin group were dead within 11 days post-infection; in contrast, all the mice in the liposomal ciprofloxacin group were alive 14 days post-infection. The same results were obtained when the mice received the single inhaled treatment as late as 48 or 72 hours post-infection. The DRDC has funded our development efforts to date and additional development of this program is dependent on negotiating for and obtaining continued funding from DRDC or on identifying other collaborators or sources of funding. We plan to use our preclinical and clinical safety data from our CF program to supplement the data needed to have this product candidate considered for approval for use in treating inhalation anthrax and possibly other inhaled life-threatening bioterrorism infections.

     If we can obtain sufficient additional funding, we would anticipate developing this drug for approval under FDA regulations relating to the approval of new drugs or biologics for potentially fatal diseases where human studies cannot be conducted ethically or practically. Unlike most drugs, which require large, well controlled Phase 3 clinical trials in patients with the disease or condition being targeted, these regulations allow for a drug to be evaluated and approved by the FDA on the basis of demonstrated safety in humans combined with studies in animal models to show effectiveness.

     AERx iDMS is being developed to control blood glucose levels in patients with diabetes. This product is currently in Phase 3 clinical trials, and our licensee, Novo Nordisk, is responsible for all remaining development, manufacturing and commercialization. We will receive royalties from any sales of this product as well as from future enhancements or generations of this technology. According to 2005 statistics from the American Diabetes Association, approximately 20.8 million Americans suffer from either Type 1 or Type 2 diabetes. Over 90% of these Americans have Type 2 diabetes, the prevalence of which is increasing dramatically due to lifestyle factors such as inappropriate diet and lack of physical activity. Patients with Type 1 diabetes do not have the ability to produce their own insulin and must administer insulin injections to survive. Patients with Type 2 diabetes are insulin resistant and unable to efficiently use the insulin that their bodies produce. While many Type 2 patients can initially maintain adequate control over blood glucose through diet, exercise and oral medications, most Type 2 patients progress within three years to where they cannot maintain adequate control over their glucose levels and insulin therapy is needed. However, given the less acute nature of Type 2 diabetes, many of these patients are reluctant to take insulin by injection despite the risks. Inadequate regulation of glucose levels in diabetes patients is associated with a variety of short and long-term effects, including blindness, kidney disease, heart disease, amputation resulting from chronic or extended periods of reduced blood circulation to body tissue and other circulatory disorders. The global market for diabetes therapies in 2005 was in excess of $18 billion, according to Business Insights. The majority of this amount was from sales of oral antidiabetics, while insulin and insulin analogues accounted for $7.3 billion, a 17% increase over the prior year. Sales of insulin and insulin analogues are forecast to grow to $9.8 billion in 2011. Type 2 patients consume the majority of insulin used in the United States. We believe that when patients are provided a non-invasive delivery alternative to injection, they will be more likely to self-administer insulin as often as needed to keep tight control over their blood-glucose levels.

     We believe that AERx iDMS possesses features that will benefit diabetes patients and will provide an advantage over competitive pulmonary insulin products or can be used as a replacement for or adjunct to currently available therapies. Our patented breath control methods and technologies guide patients into the optimal breathing pattern for effective insulin deposition in and absorption from the lung. An optimal breathing pattern for insulin delivery depends on several elements: actuation of drug delivery at the early part of inspiration, control of inspiratory flow rate, and the state of inflation of the lung after the insulin is deposited, with the fully inflated lung providing the most desirable absorption profile. We believe a patient’s ability to breathe reproducibly will be required to assure adequate safety and efficacy of inhaled insulin for the treatment of Type 1 and Type 2 diabetes. Our system also allows patients to adjust dosage in single unit increments, which is key to proper glucose control in diabetes. AERx iDMS offers the ability for patients and physicians to monitor and review a patient’s dosing regimen. We believe the combination of breath control,

high efficiency of delivery to the lung and single unit adjustable dosing in an inhalation device will make AERx iDMS a competitively attractive product.