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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, DC 20549




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Form 10-Q



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|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(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           .                                     

Commission File Number 0-28402

Aradigm Corporation

(Exact name of registrant as specified in its
charter)


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

3929 Point Eden Way

Hayward, CA 94545


(Address of principal executive offices
including zip code)


(510) 265-9000

(Registrants telephone number, including
area code)


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.

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



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TABLE OF CONTENTS



|                              |                                                                                               |                                             |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------- |  |  |  |  |  | 
|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            



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ARADIGM CORPORATION

INDEX

|                                   |  |                                                                                               |    |      |    | 
|---------------------------------- |  | --------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                   |  |                                                                                               |    | 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 |     

1



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##### Table of Contents






PART I.     FINANCIAL
INFORMATION




Item 1.     Financial
Statements

ARADIGM CORPORATION






STATEMENTS OF OPERATIONS


(In thousands, except per share
data)


|                                                                                             |                            |                          |        |        |        |   |        |        |        | 
|-------------------------------------------------------------------------------------------- | -------------------------- | ------------------------ | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                                             |                            |                         
|                                                                                             |                            | 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 |       
|                                                                                             |                            |                          |        |        |        |   |        |       

See accompanying notes.

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ARADIGM CORPORATION






BALANCE SHEETS


(In thousands, except
shares data)


|                                                                                                                                                                                                                                                               |                                              |                            |                                                                                        |              |         |         |          |        |         |         | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------- | -------------------------------------------------------------------------------------- | ------------ | ------- | ------- | -------- | ------ | ------- | ------- | 
|                                                                                                                                                                                                                                                               |                                              | 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 | 
|                                                                                                                                                                                                                                                               |                                              |                            |                                                                                        |              |         |         |          |       

See accompanying notes.

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ARADIGM CORPORATION






STATEMENTS OF CASH FLOWS


(In thousands)


|                                                        |                                                                             |                                              |                                           |        |       |        |         |         |        |        |  
|------------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ------ | ----- | ------ | ------- | ------- | ------ | ------ | -
|                                                        |                                                                             |                                             
|                                                        |                                                                             | Three Months Ended                          
|                                                        |                                                                             | March 31,                                   
|                                                        |                                                                             |                                             
|                                                        |                                                                             | 2002                                         |                                           | 2001  
|                                                        |                                                                             |                                              |                                           |       
|                                                        |                                                                             |                                             
|                                                        |                                                                             | (Unaudited)                                 
|Cash flows from operating
    activities:               |                                                                             |                                              |                                           |        |       |        |         |        
|                                                        | Net loss                                                                    |                                              | $                                         | (8,528 | )     |        | $       | (2,720  | )     
|                                                        | Adjustments to reconcile net loss to cash used in
    operating activities: |                                              |                                           |        |       |        |         |         |       
|                                                        |                                                                             | Depreciation and amortization                |                                           |        | 1,325 |        |         |         | 992    |       
|                                                        |                                                                             | Extraordinary gain related to Genentech note |                                           |        |      |        |         |         | (6,675 | )     
|                                                        |                                                                             | Issuance of common stock for services        |                                           |        |      |        |         |         | 8      |       
|                                                        |                                                                             | Amortization of deferred compensation        |                                           |        | 40    |        |         |         | 41     |       
|                                                        |                                                                             | Changes in operating assets and liabilities: |                                           |        |       |        |         |         |        |       
|                                                        |                                                                             |                                              | Receivables                               |        |       | 1,280  |         |         |        | (3,164 | )
|                                                        |                                                                             |                                              | Prepaid expenses and other current assets |        |       | (519   | )       |         |        | (1,009 | )
|                                                        |                                                                             |                                              | Other assets                              |        |       | 19     |         |         |        | 60     |  
|                                                        |                                                                             |                                              | Accounts payable                          |        |       | (3,748 | )       |         |        | (1,266 | )
|                                                        |                                                                             |                                              | Accrued compensation                      |        |       | 1,124  |         |         |        | 1,042  |  
|                                                        |                                                                             |                                              | Other accrued liabilities                 |        |       | (1,830 | )       |         |        | (264   | )
|                                                        |                                                                             |                                              | Deferred revenue                          |        |       | (3,330 | )       |         |        | (2,616 | )
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Net cash used in operating activities                   |                                                                             |                                              | (14,167                                   | )      |       |        | (15,571 | )      
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Cash flows from investing
    activities:               |                                                                             |                                              |                                           |        |       |        |         |        
|                                                        | Capital expenditures                                                        |                                              |                                           | (2,081 | )     |        |         | (10,042 | )     
|                                                        | Purchase of available-for-sale investments                                  |                                              |                                           | (5,579 | )     |        |         | (5,733  | )     
|                                                        | Proceeds from maturities of available-for-sale
    investments              |                                              |                                           | 1,219  |       |        |         | 15,709  |       
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Net cash used in investing activities                   |                                                                             |                                              | (6,441                                    | )      |       |        | (66     | )      
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Cash flows from financing
    activities:               |                                                                             |                                              |                                           |        |       |        |         |        
|                                                        | Proceeds from issuance of common stock, net                                 |                                              |                                           | 724    |       |        |         | 10,182  |       
|                                                        | Cost from issuance of redeemable convertible
    preferred stock            |                                              |                                           | (56    | )     |        |         |        |       
|                                                        | Proceeds from repayments of shareholder notes                               |                                              |                                           |       |       |        |         | 37      |       
|                                                        | Notes receivable from officers                                              |                                              |                                           | (41    | )     |        |         | 11      |       
|                                                        | Payments on lease obligations and equipment loans                           |                                              |                                           | (1,040 | )     |        |         | (723    | )     
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Net cash provided by (used in) financing
    activities |                                                                             |                                              | (413                                      | )      |       |        | 9,507   |        
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Net decrease in cash and cash equivalents               |                                                                             |                                              | (21,021                                   | )      |       |        | (6,130  | )      
|Cash and cash equivalents at beginning of period        |                                                                             |                                              | 69,965                                    |        |       |        | 20,732  |        
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Cash and cash equivalents at end of period              |                                                                             | $                                            | 48,944                                    |        |       | $      | 14,602  |        
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Supplemental disclosure of cash flow
    information:   |                                                                             |                                              |                                           |        |       |        |         |        
|                                                        | Cash paid for interest                                                      |                                              | $                                         | 161    |       |        | $       | 248     |       
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        
|Non-cash investing and financing
    activities:        |                                                                             |                                              |                                           |        |       |        |         |        
|                                                        | Issuance of common stock for services                                       |                                              | $                                         |       |       |        | $       | 8       |       
|                                                        |                                                                             |                                              |                                           |        |       |        |         |        

See accompanying notes.

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ARADIGM CORPORATION






NOTES TO THE UNAUDITED FINANCIAL
STATEMENTS


March 31, 2002


1.     Summary of
Significant Accounting Policies

Organization
and Basis of Presentation

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.

Net Loss Per
Share

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.

2.     Contingencies

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

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ARADIGM CORPORATION


NOTES TO THE UNAUDITED FINANCIAL
STATEMENTS  (Continued)

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.

3.     Related
Party

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.

4.     Recent
Accounting Pronouncements

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.

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The discussion below contains forward-looking
statements that are based on the beliefs of management, as well
as assumptions made by, and information currently available to,
management. Our future results, performance or achievements
could differ materially from those expressed in, or implied by,
any such forward-looking statements as a result of certain
factors, including, but not limited to, those discussed in this
section as well as in the section entitled Risk
Factors and elsewhere in 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.

Overview

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

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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.

Critical Accounting Policies

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.



| |                    
| | -------------------
| | Revenue Recognition

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.



| |                 
| | ----------------
| | Use of Estimates

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.

Results of Operations



| |                                               
| | ----------------------------------------------
| | Three Months Ended March 31, 2002 and
    2001

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

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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.

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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.

Liquidity and Capital Resources

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

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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.

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Item 3.     Quantitative
and Qualitative Disclosures About Market Risk

Market Risk Disclosures

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.

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PART II.     OTHER
INFORMATION




Item 1.     Legal
Proceedings

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.




Item 2.     Changes
in Securities and Use of Proceeds

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.

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Item 4.     Submission
of Matters to a Vote of Security Holders

(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.        






Item 6.     Exhibits


(a) Exhibits

| |      |     |  |                                                                                                                   
| | ---- | --- |  | ------------------------------------------------------------------------------------------------------------------
| | 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.                                                                         



---



|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|*   | 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.

(b) Reports on Form 8-K

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

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SIGNATURE

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.

Dated: May 10, 2002



| |                                          
| | -----------------------------------------
| | ARADIGM CORPORATION                      
| | (Registrant)                             
|
| | /s/ RICHARD P. THOMPSON                  
| | Richard P. Thompson                      
| | President and Chief Executive
    Officer
|
| | /s/ MICHAEL MOLKENTIN                    
| | Michael Molkentin                        
| | Acting Chief Financial Officer           

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INDEX TO EXHIBITS

|        |      |             |  |                                                                                                                   
|------- | ---- | ----------- |  | ------------------------------------------------------------------------------------------------------------------
|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.                                                                         



---



|    |                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------
|*   | 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.

16