Aradigm Corporation Form 10-Q 3/31/02

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Aradigm Corporation (the “Company”) is a California corporation. Since inception, the Company has been engaged in the development and commercialization of non-invasive pulmonary drug delivery systems. The Company does not anticipate receiving any revenue from the sale of products in the upcoming year. Principal activities to date have included obtaining financing, recruiting management and technical personnel, securing operating facilities, conducting research and development, and expanding commercial production capabilities. The Company’s ability to continue its research, development and commercialization activities is dependent upon the ability of management to obtain additional financing as required.

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the financial statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair presentation. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with the Company’s Annual Report on Form 10-K. The results of the Company’s operations for the interim periods presented are not necessarily indicative of operating results for the full fiscal year or any future interim period.

The Balance Sheet at December 31, 2001 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain amounts have been reclassified to conform with the current period’s presentation.

Historical net loss per share has been calculated under Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic net loss per share has been computed using the weighted average number of shares of common stock outstanding less the weighted average number of shares subject to repurchase during the period. No diluted loss per share information has been presented in the accompanying statements of operations since potential common shares from stock options and warrants are antidilutive.

Company as to Lilly’s claims relating to an alleged license agreement, for misappropriation of trade secrets, breach of fiduciary duty, conversion, estoppel and breach of contract (in part), dismissing those claims from the case. The remaining claims were tried before a jury during the week of April 22, 2002. The jury returned verdicts in favor of the Company and against Lilly on three of four of Lilly’s asserted claims of co-inventorship and on Lilly’s unjust enrichment claim. The jury returned verdicts in favor of Lilly on one of Lilly’s claims of co-inventorship and on two breach of contract claims, awarding Lilly damages of $1 for each breach of contract claim. These verdicts will be subject to various post-trial motions and possible appeals by both parties. Although there can be no assurance that the Company will ultimately prevail in this matter, management believes that the ultimate outcome of this litigation will not in any event have a material adverse effect on the Company’s financial position or results of operations.

Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., are considered a related party and currently own approximately 22.5% of the Company’s total outstanding common stock.

In July 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”. The new rules require business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and goodwill acquired after this date will no longer be amortized, but will be subject to annual impairment tests. All other intangible assets will continue to be amortized over their estimated useful lives. The Company adopted the standard effective January 1, 2002. The Company has not completed any business combinations and as a result the adoption of these standards did not have a material impact on its financial position or operating results.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. SFAS No. 144 supercedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 also amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation of a subsidiary for which control is likely to be temporary. Companies are required to adopt SFAS No. 144 for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, but early adoption is encouraged. The Company adopted the standard effective January 1, 2002, and the adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

The discussion below contains forward-looking statements that are based on the beliefs of management, as well as assumptions made by, and information currently available to, management. Our future results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements as a result of certain factors, including, but not limited to, those discussed in this section as well as in the section entitled “Risk Factors” and elsewhere in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 29, 2002.

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

Since our inception in 1991, we have been engaged in the development of pulmonary drug delivery systems. As of March 31, 2002, we had an accumulated deficit of $162.1 million. We have not been profitable since inception and expect to incur additional operating losses over the next several years as research and development efforts, preclinical and clinical testing activities and manufacturing scale-up efforts expand and as we plan and build our late-stage clinical and early commercial production capabilities. To date, we have not had any material product sales and do not anticipate receiving any revenue from the sale of products during 2002. Our sources of working capital have been equity financings, equipment lease financings, contract revenues and interest earned on investments.

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

The collaborative agreement with Novo Nordisk a related party provides for reimbursement of research and development expenses as well as additional payments to us as we achieve certain significant milestones. We also expect to receive royalties from this development partner based on revenues from product sales and to receive revenue from the manufacturing of unit dose packets and hand-held devices. We recognize revenues under the terms of our collaborative agreement as the research and development expenses are incurred, to the extent they are reimbursable. For the three months ended March 31, 2002, this partner-funded program has contributed approximately 94% of our total contract revenues. Novo Nordisk and its affiliate, Novo Nordisk Pharmaceuticals, Inc., currently own approximately 22.5% of our total outstanding common stock.

During December 2000, GlaxoSmithKline and we amended the product development and commercialization agreement whereby we assumed full control and responsibility for conducting and financing the remainder of all development activities. Under the amendment, unless we have terminated the agreement, GlaxoSmithKline can restore its rights to participate in the development and commercialization of the product under the amended agreement upon payment of a restoration fee to us. We anticipate that GlaxoSmithKline will review its restoration election upon the delivery of Phase 2b trial results, which will be made available to

them in the first half of 2002, but there can be no assurance that GlaxoSmithKline will elect to restore its rights. If we elect to terminate the agreement and continue or intend to continue any development activities, either alone or in collaboration with a third party, we will be obligated to pay an exit fee to GlaxoSmithKline. If we elect to pay the exit fee, it will not have a material impact on our financial position or operating results. This development program is currently being funded through existing working capital.

In February 2001, we announced that Genentech had discontinued the development of dornase alfa using our proprietary AERx Respiratory Management System. We also entered into a new agreement allowing Genentech to evaluate the feasibility of using the AERx Pulmonary Drug Delivery System for pulmonary delivery of other Genentech compounds. Under the terms of the agreement, Genentech did not require us to repay the loan of funds required to conduct product development under the discontinued program. Forgiveness of the loan and accrued interest resulted in an extraordinary gain during the first quarter of 2001 of approximately $6.7 million. During 2001, we reimbursed Genentech $773,000 for unspent project prepayments.

In addition to the diabetes and pain management programs, we have three additional partner-funded programs and a gene therapy effort, which is funded through the National Institutes of Health. It is our policy not to disclose the identity of the partner or the drug until we have entered into long-term development agreements with a partner.

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

Contract revenues consist of revenue from collaboration agreements and feasibility studies. We recognize revenue under the agreements as costs are incurred. Deferred revenue represents the portion of all refundable and nonrefundable research payments received that have not been earned. In accordance with contract terms, milestone payments from collaborative research agreements are considered reimbursements for costs incurred under the agreements and, accordingly, are generally recognized as revenue either upon the completion of the milestone effort when payments are contingent upon completion of the effort or are based on actual efforts expended over the remaining term of the agreements when payments precede the required efforts. Costs of contract revenues approximate such revenue and are included in research and development expenses. Refundable development and license fee payments are deferred until the specified performance criteria are achieved. Refundable development and license fee payments are generally not refundable once the specific performance criteria are achieved.

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

Contract Revenues: Contract revenues for the three months ended March 31, 2002 increased to $8.1 million from $6.7 million for the same period in 2001. The revenue increase results primarily from an

increase in partner-funded project development revenue from Novo Nordisk, which was $7.6 million for the three months ended March 31, 2002 and $5.8 million for the same period in 2001. Costs associated with collaborative agreements approximate contract revenue as these expenses are incurred under the program agreements. These costs are included in research and development expenses.

Research and Development Expenses: Research and development expenses for the three months ended March 31, 2002 increased to $14.3 million from $14.2 million for the same period in 2001. The increase relates primarily to the hiring of additional scientific personnel and the expansion of other development efforts to support the ongoing program with Novo Nordisk. Expenses for other funded and unfunded development areas including manufacturing scale-up efforts decreased modestly from the same period in 2001. Research and development expenses associated with collaborative agreements approximate contract revenue as these expenses are incurred under the program agreements.

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

Currently, our lead development program is developing pulmonary delivery systems to manage diabetes using insulin and other blood glucose regulating compounds with our partner Novo Nordisk. Since Novo Nordisk and we successfully completed during 2001 a Phase 2b clinical trial using the AERx insulin Diabetes Management System, we are now focused on preparing for Phase 3 clinical trials, which Novo Nordisk intends to commence during the summer of 2002.

Our next major program is with our partner GlaxoSmithKline pursuant to our development agreement, as amended, which covers the use of the AERx Pain Management System for the delivery of narcotic analgesics. During December 2001, we successfully completed Phase 2b clinical trials for the AERx morphine Pain Management System. We will be working with GlaxoSmithKline to determine the next steps for the AERx morphine program. Future progress for this program is contingent on either GlaxoSmithKline recommitting to this program or our entering into another development agreement with a new partner. We continue to move forward with this program for a Phase 3 start, which could occur in early 2003.

We have three other partner-funded programs and a gene therapy effort, which is funded through the National Institutes of Health, that are all in early Phase 1 clinical trials. Though Phase 1 clinical trials are expected to be completed in 2002, future research and development efforts for these partner-funded programs are difficult to predict at this time due to their early stage of development.

General and Administrative Expenses: General and administrative expenses for the three months ended March 31, 2002 increased to $2.5 million from $2.3 million for the same period in 2001. The increase is primarily due to the hiring of additional personnel and higher facility costs.

Interest Income: Interest income for the three months ended March 31, 2002 decreased to $291,000 from $668,000 for the same period in 2001. The decrease is due to an overall decrease in interest rates earned on invested cash balances.

Interest Expense and Other: Interest expense for the three months ended March 31, 2002 decreased to $166,000 from $262,000 for the same period in 2001. The decrease is primarily due to lower outstanding capital lease and equipment loan balances under various equipment and lease lines of credit.

Extraordinary Gain: No extraordinary gain was reported for the three months ended March 31, 2002. For the same period in 2001, we reported an extraordinary gain of approximately $6.7 million. The extraordinary gain resulted from the cancellation of outstanding loans and accrued interest required for product development under a program that had been funded by Genentech.

Net Loss: Net loss for the three months ended March 31, 2002 increased to $8.5 million from $2.7 million for the same period in 2001. The increase in net loss for the three months ended March 31, 2002 is primarily due to the same prior year period including an extraordinary gain of approximately $6.7 million that resulted from the cancellation of outstanding loans and accrued interest required for product development under the program that had been funded by Genentech.

The Company has financed its operations since inception primarily through private placements and public offerings of capital stock, proceeds from equipment lease financing, contract revenues and interest earned on investments. As of March 31, 2002, we had cash, cash equivalents and total investments of approximately $54.5 million.

Net cash used in operating activities for the three months ended March 31, 2002 decreased to $14.2 million from $15.6 million for the same period in 2001. The decrease in net cash used resulted primarily from a decrease in net loss before extraordinary gain combined with a decrease in accounts receivable and an increase in accrued compensation offset by a decrease in accounts payable, other accrued liabilities and deferred revenue. The decrease in net loss before extraordinary gain is primarily due to an increase in revenue from partner-funded programs and a decrease in operating expenses for other development activities. The decrease in receivables is due to the receipt of payments from our partners for billings associated with our development activities. The increase in accrued compensation is due primarily to an increase in estimated accruals for employee compensation and other employee benefits. The increase in the net loss was primarily due to the prior year period including the forgiveness of outstanding loans and accrued interest under the cancellation of a development agreement with Genentech. The decrease in accounts payable and other accrued liabilities results primarily from increased payments for expenses associated with our development programs and capital expenditures, while the decrease in deferred revenue is due primarily to our partners funding future development at a lower level.

Net cash used in investing activities for the three months ended March 31, 2002 was $6.4 million compared to $66,000 for the same period in 2001. The increase in net cash used in investing activities resulted primarily from a reduction in proceeds from maturing investments offset by a decrease in capital expenditures. Capital expenditures from the prior year related primarily to the construction of our large-scale commercial manufacturing facility and the acquisition of related production equipment.

Net cash used in financing activities for the three months ended March 31, 2002 was $413,000 compared to net cash provided by financing activities of $9.5 million for the same period in 2001. The change results primarily from a significant reduction in proceeds from the issuance of equity funding during the current year and an increase in principal payments on lease obligations and equipment loans.

The development of our technology and proposed products will require a commitment of substantial funds to conduct the costly and time-consuming research, preclinical studies and clinical trial activities necessary to develop and refine the technology and proposed products and bring such products to market. Our future capital requirements will depend on many factors, including continued progress and results from research and development for the technology and drug delivery systems, the ability to establish and maintain favorable collaborative arrangements with others, progress with preclinical studies and clinical trials and the results thereof, the time and costs involved in obtaining regulatory approvals, the cost of development and the rate of scale-up for the required production technologies, the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and the need to acquire licenses or other rights to new technology.

We continue to review our planned operations through the end of 2002, and beyond. We particularly focus on capital spending requirements to ensure that capital outlays are not expended sooner than necessary. We expect our total annual capital outlays for 2002 will be approximately $25 million. Since December 31, 2001, there have been no material changes in our contractual obligations or commitments. We believe that our existing cash balances at March 31, 2002, together with the $25 million unused common stock purchase commitment from Novo Nordisk, funding commitments from corporate development partners and interest earned on our investments should be sufficient to meet our needs for at least the next twelve months. The sale

of additional common stock to Novo Nordisk is subject to certain conditions. In addition, there can be no assurance that our funding commitments from corporate development partners will not be amended or terminated. If we cannot exercise our option to sell additional shares of common stock to Novo Nordisk or if our current funding commitments from corporate development partners are amended or terminated, we will need to obtain additional sources of capital sooner than would otherwise be the case.

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

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

As of March 31, 2002, we had cash and cash equivalents and total investments of $54.5 million consisting of cash and highly liquid short-term and long-term investments. Our investments will decline by an immaterial amount if market interest rates increase, and therefore, our exposure to interest rate changes has been immaterial. Declines of interest rates over time will, however, reduce our interest income from our short-term and long-term investments. Our outstanding capital lease obligations are all at fixed interest rates and, therefore, have minimal exposure to changes in interest rates.

In June 1998, Eli Lilly and Company (“Lilly”) filed a complaint against the Company in the United States District Court for the Southern District of Indiana. The complaint made various allegations against the Company, arising from the Company’s decision to enter into an exclusive collaboration with Novo Nordisk with respect to the development and commercialization of a pulmonary delivery system for insulin and insulin analogs. The Company has sponsored various studies of the pulmonary delivery of insulin and insulin analogs using materials supplied by Lilly under a series of agreements dating from January 1996. The Company and Lilly had also conducted negotiations concerning a long-term supply agreement under which Lilly would supply bulk insulin to the Company for commercialization in the Company’s AERx insulin Diabetes Management System, and a separate agreement under which the Company would license certain intellectual property to Lilly. These negotiations were terminated after the Company proceeded with its agreement with Novo Nordisk. The complaint sought a declaration that Lilly scientists were co-inventors of a patent application filed by the Company relating to pulmonary delivery of an insulin analog or, in the alternative, enforcement of an alleged agreement to grant Lilly a nonexclusive license under such patent application. The complaint also contained allegations of misappropriation of trade secrets, breach of fiduciary duty, conversion and unjust enrichment and seeks unspecified damages and injunctive relief. The Company filed an answer denying all material allegations of the complaint. The Court has granted summary judgment in favor of the Company as to Lilly’s claims relating to an alleged license agreement, for misappropriation of trade secrets, breach of fiduciary duty, conversion, estoppel and breach of contract (in part), dismissing those claims from the case. The remaining claims were tried before a jury during the week of April 22, 2002. The jury returned verdicts in favor of the Company and against Lilly on three of four of Lilly’s asserted claims of co-inventorship and on Lilly’s unjust enrichment claim. The jury returned verdicts in favor of Lilly on one of Lilly’s claims of co-inventorship and on two breach of contract claims, awarding Lilly damages of $1 for each breach of contract claim. These verdicts will be subject to various post-trial motions and possible appeals by both parties. Although there can be no assurance that the Company will ultimately prevail in this matter, management believes that the ultimate outcome of this litigation will not in any event have a material adverse effect on the Company’s financial position or results of operations.

In February 2002, Aradigm Corporation (the “Company”) filed a Certificate of Amendment to the Company’s Amended and Restated Articles of Incorporation with the Secretary of State of the State of California to increase the Company’s authorized number of shares of Common Stock from 40,000,000 to 100,000,000 shares. The additional shares of Common Stock authorized by the amendment have rights identical to the Common Stock of the Company outstanding immediately before the filing of the amendment. Issuances of Common Stock from the additional authorized shares do not affect the rights of the holders of the Company’s Common Stock and Preferred Stock outstanding immediately before the filing of the amendment, except for effects that may be incidental to increasing the number of shares of the Company’s Common Stock outstanding, such as dilution of the earnings per share and voting rights of holders of other Common Stock.

(a) A Special Meeting of Shareholders of Aradigm Corporation was held on February 8, 2002.


	(b)	The matters voted upon at the meeting and the voting of the shareholders with respect thereto were as follows:


	(1)	To approve an amendment of the Company’s Articles of Incorporation to increase the authorized number of shares of Common Stock from 40,000,000 to 100,000,000 shares. The amendment was approved by a vote of 18,581,207 in favor, 511,808 against and 390,927 abstentions.

	(2)	Approval of an amendment to the Employee Stock Purchase Plan increasing the total number of shares of common stock authorized for issuance by 500,000 shares. The amendment was approved by a vote of 25,071,946 in favor, 223,089 against and 394,755 abstentions.


*	Filed as an exhibit to the Company’s Form S-3 (No. 333-76584).

**	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 29, 2002 and incorporated herein by reference.

***	Filed as an exhibit to the Company’s definitive proxy statement filed on January 4, 2002 and incorporated herein by reference.

The Company did not file any reports on Form 8-K during the quarter ended March 31, 2002.

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


	ARADIGM CORPORATION
	(Registrant)

	/s/ RICHARD P. THOMPSON
	Richard P. Thompson
	President and Chief Executive Officer

	/s/ MICHAEL MOLKENTIN
	Michael Molkentin
	Acting Chief Financial Officer


*	Filed as an exhibit to the Company’s Form S-3 (No. 333-76584).

**	Filed as an exhibit to the Company’s Annual Report on Form 10-K filed on March 29, 2002 and incorporated herein by reference.

***	Filed as an exhibit to the Company’s definitive proxy statement filed on January 4, 2002 and incorporated herein by reference.


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended March 31, 2002

or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to .


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


Common Stock, no par value		29,723,219
(Class)		(Outstanding at April 30, 2002)


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		STATEMENTS OF OPERATIONS
		BALANCE SHEETS
		STATEMENTS OF CASH FLOWS
		NOTES TO THE UNAUDITED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits
SIGNATURE
INDEX TO EXHIBITS


		Page
		No.

PART I. FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Statements of Operations (Unaudited) Three months ended March 31, 2002 and 2001		2
	Balance Sheets March 31, 2002 (Unaudited) and December 31, 2001		3
	Statements of Cash Flows (Unaudited) Three months ended March 31, 2002 and 2001		4
	Notes to Unaudited Financial Statements		5
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		7
ITEM 3.	Quantitative and Qualitative Disclosure About Market Risk		12
PART II. OTHER INFORMATION
ITEM 1.	Legal Proceedings		13
ITEM 2.	Changes in Securities and Use of Proceeds		13
ITEM 4.	Submission of Matters to a Vote of Security Holders		14
ITEM 6.	Exhibits and Reports on Form 8-K		14
Signature			15
Exhibits			16

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			Three Months Ended
			March 31,

			2002			2001


			(Unaudited)
Contract revenues (Including amounts from related parties: 2002 — $7,599; 2001 — $5,849)			$	8,118		$	6,687

Operating expenses:
	Research and development			14,313			14,160
	General and administrative			2,458			2,328

		Total operating expenses		16,771			16,488

Loss from operations				(8,653	)		(9,801	)
Interest income				291			668
Interest expense and other				(166	)		(262	)

Loss before extraordinary gain				(8,528	)		(9,395	)
Extraordinary gain				—			6,675

Net loss			$	(8,528	)	$	(2,720	)

Basic and diluted net loss per share:
Loss before extraordinary gain			$	(0.29	)	$	(0.50	)
Extraordinary gain				—			0.36

Net loss per share			$	(0.29	)	$	(0.14	)

Shares used in computing basic and diluted net loss per share				29,544			18,838


				March 31,			December 31,
				2002			2001

				(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents			$	48,944		$	69,965
	Short-term investments				3,516			1,199
	Receivables				69			1,349
	Prepaid expenses and other current assets				1,459			957

		Total current assets			53,988			73,470
Property and equipment, net					58,696			57,940
Long-term investments					2,031			—
Notes receivable from officers and employees					218			160
Other assets					511			530

		Total assets		$	115,444		$	132,100

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Accounts payable			$	1,549		$	5,297
	Accrued clinical and cost of other studies				341			703
	Accrued compensation				2,885			1,761
	Deferred revenue				8,076			11,115
	Current portion of capital lease obligations				3,114			3,526
	Other accrued liabilities				1,217			2,760

		Total current liabilities			17,182			25,162
Noncurrent portion of deferred revenue					2,036			2,327
Noncurrent portion of capital lease obligations					1,799			2,427
Noncurrent portion of deferred rent					375			300
Commitments and contingencies
Redeemable convertible preferred stock, no par value; 5,000,000 shares authorized; issued and outstanding shares: 2,001,236 at March 31, 2002 and December 31, 2001; liquidation preference of $48,430 at March 31, 2002 and December 31, 2001					30,679			30,735
Shareholders’ equity:
Common stock, no par value; 100,000,000 shares authorized; issued and outstanding shares: 29,723,219 at March 31, 2002 and 29,536,383 at December 31, 2001					225,462			224,738
Deferred compensation					(14	)		(54	)
Accumulated deficit					(162,075	)		(153,535	)

		Total shareholders’ equity			63,373			71,149

			Total liabilities, redeemable convertible preferred stock and shareholders’ equity	$	115,444		$	132,100


Item 2.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*


3.4	*	Amended and Restated Certificate of Determination and Preferences of Series A Convertible Preferred Stock.
3.5	**	Certificate of Amendment of Amended and Restated Articles of Incorporation of Aradigm Corporation.
3.6	**	Certificate of Amendment of Certificate of Determination of Series A Junior Participating Preferred Stock.
10.7	***	Employee Stock Purchase Plan, as amended.


Exhibit
Number			Description

	3.4	*	Amended and Restated Certificate of Determination and Preferences of Series A Convertible Preferred Stock.
	3.5	**	Certificate of Amendment of Amended and Restated Articles of Incorporation of Aradigm Corporation.
	3.6	**	Certificate of Amendment of Certificate of Determination of Series A Junior Participating Preferred Stock.
	10.7	***	Employee Stock Purchase Plan, as amended.


	*Revenue Recognition*


	*Use of Estimates*