MEDICINOVA INC - Quarter Report: 2010 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

FOR THE TRANSITION PERIOD FROM            TO            

Commission file number: 001-33185

MEDICINOVA, INC.

(Exact name of registrant as specified in its charter)

(858) 373-1500

(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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 8, 2010, the registrant had 12,436,381 shares of Common Stock ($0.001 par value) outstanding.

Table of Contents

MEDICINOVA, INC.

(a development stage company)

TABLE OF CONTENTS

2

Table of Contents

PART I. FINANCIAL INFORMATION

MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

3

Table of Contents

MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes.

4

Table of Contents

MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes.

5

Table of Contents

MEDICINOVA, INC.

(a development stage company)

Notes to Consolidated Financial Statements

(Unaudited)

1. Interim Financial Information

The Company

We were incorporated in the state of Delaware in September 2000. We are a development stage biopharmaceutical company focused on acquiring and developing novel, small molecule therapeutics for the treatment of diseases with unmet need with a specific focus on the U.S. market. Through strategic alliances primarily with Japanese pharmaceutical companies, we hold rights to a diversified portfolio of clinical and preclinical product candidates, each of which we believe has a well-characterized and differentiated therapeutic profile, attractive commercial potential and patent assets having claims of commercially adequate scope.

Basis of Presentation

We have prepared the accompanying unaudited consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations and cash flow for the interim period presented have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010 or for any other period. For further information, see the financial statements and disclosures thereto for the year ended December 31, 2009 in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 24, 2010.

Principles of Consolidation

The consolidated financial statements include the accounts of MediciNova, Inc. and its wholly-owned subsidiaries. MediciNova, Inc. and its subsidiaries are collectively referred to herein as “we,” “our” or “us.”

On December 13, 2006, MediciNova (Europe) Limited, a wholly-owned subsidiary of MediciNova, Inc., was incorporated under the laws of England and Wales and established for the purpose of facilitating the clinical development of the Company’s compounds for the European marketplace. MediciNova (Europe) Limited’s functional currency is the U.S. dollar, the reporting currency of its parent.

On January 4, 2007, MediciNova Japan, Inc., a wholly-owned subsidiary of MediciNova, Inc., was incorporated under the laws of Japan and established to strengthen business development and investor and public relations activities in Japan and other Asian countries. MediciNova Japan, Inc.’s functional currency is the Japanese yen.

On August 17, 2009, Absolute Merger, Inc., a wholly-owned subsidiary of MediciNova, Inc. was incorporated under the General Corporation Law of the State of Delaware for the purpose of facilitating the Merger (the “Merger”) with Avigen, Inc. (“Avigen”). On December 18, 2009, Absolute Merger, Inc. merged with and into Avigen, with Avigen continuing as the surviving entity and wholly-owned subsidiary of ours.

All intercompany transactions and investments in our subsidiaries have been eliminated in consolidation.

6

Table of Contents

Use of Estimates

We prepared the accompanying unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.

Concentrations and Uncertainties

We maintain cash balances at various financial institutions and such balances commonly exceed the $250,000 insured amount by the Federal Deposit Insurance Corporation. We also maintain money market funds at various financial institutions which are not federally insured. We have not experienced any losses in such accounts and management believes that we are not exposed to any significant credit risk with respect to such cash and cash equivalents.

On May 10, 2010, we entered into a loan and security agreement, or Loan Agreement, with Oxford Finance Corporation or, the Lender, under which we borrowed $15.0 million. We are required to pay interest on borrowings on a monthly basis through and including February 1, 2011. Beginning March 1, 2011 through maturity of the loan on August 1, 2013, we will be required to make payments of outstanding principal and interest in 30 equal monthly installments. The stated interest rate on the loan is 12.87 percent. See Note 4, Long-term Debt, for further information on the loan.

We have sustained operating losses since inception and expect such losses to continue over the next several years. Management plans to continue financing the operations with equity issuances, debt arrangements or a combination thereof. We expect current working capital to be sufficient to fund our operations inclusive of planned research and development activities, inclusive of debt repayment in the event of default, through at least September 30, 2011. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research or development programs or implement a reduction in workforce.

Reclassifications

Certain amounts in the consolidated statements of operations for the three and nine month periods ended September 30, 2009 and the consolidated statement of cash flows for the nine months ended September 30, 2009 and the period from September 26, 2000 (inception) to September 30, 2010 have been reclassified to conform the presentation of interest expense, other expense and other income.

New Accounting Pronouncements

In April 2010, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2010-12, which indicates that the Securities and Exchange Commission (“SEC”) staff would not object to incorporating the effects of the Health Care and Education Reconciliation Act of 2010 (which was enacted on March 30, 2010) when accounting for the Patient Protection and Affordable Care Act (which was enacted on March 23, 2010). This view is based partly on the SEC’s understanding that the two aforementioned acts, when taken together, represent the current health care reforms as passed by Congress and signed by the President. We have performed an initial review of the two acts, and we do not believe that either will have a material impact on our consolidated results of operations or financial condition. Our belief is based on the fact that: we are a development stage biopharmaceutical whose lead drug candidates are in Phase II of development and we have no other revenue generating products; therefore the pharmaceutical industry fee should not be applicable to us, nor would we be impacted by the drug subsidy changes; we have less than 25 employees so the fee for health plans will have minimal impact to our operating expenses; we do not have “high-cost” coverage health plans, nor do we offer retiree medical benefits; thus, the fees and the changes related to these would not

7

Table of Contents

impact our operating expenses, and, with regard to the limit on tax-deductible employee compensation this should not impact our tax position as we are currently a net loss company and will continue to be a net loss company in the foreseeable future. The health care reforms also provide for a “new investment tax credit for qualified therapeutic discovery,” for which we submitted an application on July 16, 2010. In October 2010, we were notified that our application for a grant payment under the investment tax credit for qualified therapeutic discovery was not approved by the Department of Health and Human Services.

In April 2010, the FASB issued ASU No. 2010-17, which codifies the consensus reached in EITF No. 08-9, which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. The amendments in this ASU are effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. Adoption of this standard did not have a material effect on our consolidated results of operations or financial condition.

2. Avigen Transaction

On December 18, 2009 we acquired 100% of the outstanding shares of Avigen, a biopharmaceutical company that had focused on identifying and developing differentiated products to treat patients with serious disorders, whose potential product candidate is AV411, a glial attenuator and ibudilast small molecule therapeutic, for CNS disorders. Under the terms of the Merger, Avigen shareholders, at their election, received an amount per share either in cash, convertible notes issued by us or a combination thereof, upon closing. Of the 29,852,115 shares of Avigen common stock outstanding, approximately 17% of Avigen shareholders elected to receive cash at closing in the amount of approximately $1.19 per share with an additional $0.04 per share expected to be paid in two increments on or about June 30, 2010 and after November 30, 2010 subject to certain adjustments, and rights under contingent payment rights issued as part of the merger consideration, while the remaining 83% elected to receive convertible notes issued by us. The amount to be paid in the two installments was adjusted to approximately $0.044 per share at June 30, 2010, based on a reconciliation of expenses. The primary reasons for the Avigen acquisition were to combine the ibudilast development programs each company was respectively pursuing, to utilize the preclinical and clinical data for AV411 as support for the development pathway of MN-166 resulting in cost savings for us, and to capture a potential financing opportunity given Avigen’s cash balance prior to the Merger.

8

Table of Contents

The following table reconciles the December 31, 2009 acquisition related balances with their respective balances at September 30, 2010:

9

Table of Contents

See Notes to Consolidated Financial Statements—Note 2, Avigen Transaction, in our Annual Report on Form 10-K for further information on the Merger.

3. Fair Value Measurements—Other Than Intangibles and Goodwill

As defined in the authoritative guidance for fair value measurements and disclosures under ASC 820 (formerly SFAS No. 157), fair value is based on the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability and consistency of fair value measurements, ASC 820 prescribes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels which are described below:

At September 30, 2010, cash and cash equivalents (instruments with maturities of three months or less at the date of purchase) were $31.2 million and primarily invested in money market accounts. At September 30, 2010, restricted cash, restricted investments and restricted letter of credit were $29.5 million and primarily invested in money market funds. We measure our cash equivalents, restricted letter of credit, restricted cash and restricted investments (each current assets) on a recurring basis and the fair value of these assets is based on Level 1 criteria in which their carrying amount is a reasonable estimate of their fair value based on daily quoted market prices.

In August 2008, UBS, the brokerage firm through which we purchased the majority of our investment securities, all of which were auction rate securities, or ARS, entered into a settlement with the SEC, the New York Attorney General and other state agencies, or UBS ARS Rights Offer. Under the settlement, we received the right to sell to UBS the ARS held in accounts with UBS at par value at any time during the period beginning June 30, 2010 and ending July 2, 2012. The right to sell the ARS back to UBS is considered an ARS Put. As part of the settlement, UBS also offered to us a no net cost loan program, or ARS Loan, whereby we would be able to borrow up to 75 percent of the market value, as determined by UBS at its sole discretion, of our ARS that have been pledged as collateral at an interest cost that would not exceed the interest being paid on the underlying ARS

10

Table of Contents

investments. At September 30, 2010, we no longer held any investment securities originally purchased by UBS and we no longer held the ARS Put. In July 2010, the UBS ARS and the ARS Put were redeemed at par value by UBS and the associated ARS Loan was repaid.

At September 30, 2010, we reclassified our long-term investments which consisted of ARS that principally represented interests in insurance notes and portfolios of securities (primarily commercial paper) to current investments because we no longer had the intent to hold these securities for more than a year. In addition, the fair market value of these investment securities were no longer determined on a Level 3 basis, but rather on a Level 2 basis based on indicative liquidation quotes in an inactive market.

At September 30, 2010, our total ARS portfolio of $0.8 million at fair value ($2.2 million at par value) consisted entirely of private placement investment securities. None of the underlying collateral of these securities consisted of subprime mortgages or collateralized debt obligations. These securities had been designated as trading investment securities at December 31, 2008; therefore, any additional increase or decrease in the fair value of our investment securities is recorded as either a gain or an impairment charge, respectively, in our consolidated statement of operations. For the three and nine months ended September 30, 2010, we recorded a net impairment charge on our investment securities of approximately $0.9 million and $0.8 million, respectively, to reduce the carrying value of our investment securities portfolio. The table below reconciles fair value of our ARS trading investment securities and the ARS Put at December 31, 2009 with fair value at September 30, 2010:

11

Table of Contents

The following table presents our financial instruments measured at fair value on a non-recurring basis classified by the fair value measurements and disclosures valuation hierarchy:

4. Long-term Debt

On May 10, 2010, we entered the Loan Agreement with Lender, under which we borrowed $15.0 million.

Our obligations under the Loan Agreement are secured by a first priority security interest in substantially all of our assets, other than our intellectual property. We also have agreed not to pledge or otherwise encumber our intellectual property assets. Our obligations under the Loan Agreement are guaranteed on a senior secured basis by Avigen.

In addition, the Loan Agreement contains covenants that restrict our ability to:

12

Table of Contents

The Loan Agreement also requires that on or before March 31, 2011 we must have either (i) entered into a collaboration, joint venture or partnership with a non-affiliate providing for up-front cash proceeds to us (with such proceeds received on or before March 31, 2011) of not less than $15.0 million from either or a combination of an upfront payment(s) or proceeds from the sale or conversion of our securities issued in connection therewith or (ii) received positive Phase IIB data on MN-221, as defined in a completed partnership or joint venture agreement relating to MN-221, or had a positive end-of-phase II meeting with the FDA and obtained the approval of the board of directors to proceed to Phase III with MN-221. A failure to meet the Loan Agreement requirements by March 31, 2011, would result in an immediate requirement for Loan repayment (as well as an increase in interest rate). As of September 30, 2010, we were in compliance with the Loan Agreement covenants.

We are required to pay interest on borrowings on a monthly basis through and including February 1, 2011. Beginning March 1, 2011 through maturity of the loan on August 1, 2013, we will be required to make payments of outstanding principal and interest in 30 equal monthly installments. The stated interest rate on the loan is 12.87 percent. The effective interest rate on the debt financing is calculated to be 18.14 percent and for the three and nine month period ended September 30, 2010, we recorded total interest expense on this loan of approximately $659,000 and $1.0 million, respectively.

We paid the Lender a facility fee of $150,000 and we have paid outside third parties approximately $180,000 in connection with procuring the loan. We also will pay the Lender a deferred interest payment equal to $450,000, payable on September 30, 2011, provided that a pro rata portion of such deferred interest payment shall be paid upon any prepayment of the loan. In addition, if we prepay all or a portion of the loan prior to maturity, we will pay the Lender a prepayment penalty of three percent of the total amount prepaid if the prepayment occurs prior to May 10, 2011, two percent of the total amount prepaid if the prepayment occurs between May 11, 2011 and May 10, 2012 and one percent of the total amount prepaid if the prepayment occurs on or after May 10, 2012.

In connection with the Loan Agreement, we issued to the Lender a warrant to purchase up to 198,020 shares of our common stock. This warrant is exercisable, in whole or in part, immediately, has a per share exercise price of $6.06 and may be exercised on a cashless basis. The warrant will terminate on the earlier of May 10, 2017 or the closing date of a merger or consolidation transaction in which we are not the surviving entity. In addition, the warrant and debt instrument are immediately separable and were issued separately; thus, we accounted for the warrant as a component of stockholders’ equity as the agreement requires settlement in shares and under no provision of the agreement are we required to settle the warrant in cash.

13

Table of Contents

We accounted for the interest on the long-term debt using the effective interest method wherein we treated the debt issuance costs paid directly to the lender (financing fees) and the relative fair value of the warrants issued to the lender as a discount on the debt (or a contra liability) and we treated the debt issuance costs paid to third parties (primarily legal fees) as an other asset in our consolidated balance sheet. The amortization of the debt discount is recorded as interest expense and the amortization of the debt issuance costs paid to third parties is recorded as other expense in our consolidated statement of operations. The table below summarizes the long-term debt activity recorded during the nine months ended September 30, 2010:

5. Net Loss Per Share

Net loss per share is presented as basic and diluted net loss per share. Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted average number of common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, convertible preferred stock, stock options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive. For the nine months ended September 30, 2010 and September 30, 2009, respectively, 309,100 and 387,000 of potentially dilutive securities were excluded from determining diluted earnings per share because of their anti-dilutive effect.

14

Table of Contents

6. Comprehensive Income (Loss)

Our comprehensive loss includes unrealized losses on marketable securities and currency translation. The table below sets forth the components of our accumulated other comprehensive loss at:

For the nine months ended of September 30, 2010 and 2009, our comprehensive loss was $15,187,419 and $14,483,528, respectively.

7. Share-Based Payments

For the three months ended September 30, 2010 and 2009, share-based compensation expense related to stock options of approximately $0.4 million and $0.5 million, respectively, was recorded as a component of general and administrative expense, and approximately $0.1 million and $0.1 million, respectively, was recorded as research and development expense. For the nine months ended September 30, 2010 and 2009, share-based compensation expense related to stock options of approximately $1.3 million and $1.4 million, respectively, was recorded as a component of general and administrative expense, and approximately $0.3 million and $0.5 million, respectively, was recorded as research and development expense.

During the three months ended September 30, 2010, stock options to purchase 19,420 shares of common stock were exercised for approximately $62,000. During the nine months ended September 30, 2010, stock options to purchase 38,049 shares of common stock were exercised for approximately $135,000. As of September 30, 2010, there was $2.5 million of unamortized compensation cost related to unvested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 1.2 years.

The exercise price of stock options to purchase 525,000 shares of common stock granted during the nine months ended September 30, 2010 was equal to market value on the date of grant and the share-based compensation expense for such stock options is reflected in operating results for the three months and nine months ended September 30, 2010. The estimated fair value of each stock option award was determined on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for stock option grants:

The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of our outstanding stock options. The expected volatility of our common stock is based on the historical volatility of our stock since listing on the Nasdaq Global Market in December 2006. We have not paid any dividends on our common stock since our inception, and we do not anticipate paying any dividends on our common stock in the foreseeable future. The expected term of employee stock options is based on the simplified method for “plain

15

Table of Contents

vanilla options” as provided by the authoritative guidance on stock compensation, as we concluded that our historical stock option exercise experience does not provide a reasonable basis for us to estimate the expected term.

As share-based compensation expense recognized in the accompanying consolidated statement of operations for the three and nine month periods ended September 30, 2010 was based on stock option awards ultimately expected to vest, such expense should be reduced for estimated forfeitures. The authoritative guidance for compensation under ASC 718 (formerly SFAS No. 123R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We have very few employees and our stock options vest monthly; therefore, we did not estimate any forfeitures during the nine months ended September 30, 2010, and we will adjust our stock-based compensation expense should any forfeitures occur. The weighted-average fair value of each stock option granted during the nine month period ended September 30, 2010, estimated as of the grant date using the Black-Scholes option valuation model, was $4.02 per stock option, whereas the weighted-average fair value of each stock option granted during the three and nine month periods ended September 30, 2009 was $2.68, per stock option.

8. Income Taxes

In accordance with the authoritative guidance for income taxes under ASC 740 (formerly SFAS No. 109), a deferred liability is determined based on the difference between the financial statement and the tax basis of assets and liabilities as measured by the enacted tax rates, which will be in effect when these differences reverse. We provide a valuation allowance against net deferred assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized.

Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrued interest or penalties at September 30, 2010 and we have not recorded any uncertain income tax benefits at September 30, 2010.

9. Commitments and Contingencies

Legal Proceedings

On August 24, 2009, The Pennsylvania Avenue Funds, an Avigen stockholder, filed a complaint in Alameda County Superior Court alleging that Avigen’s directors breached their fiduciary duties in connection with the proposed transaction with us. On October 15, 2009, The Pennsylvania Avenue Funds filed an amended complaint adding us as a defendant. In the amended complaint, The Pennsylvania Avenue funds alleged, among other things, that we aided and abetted the alleged breach of fiduciary duties by the Avigen directors. On June 24, 2010, a final order and judgment approving final settlement of $140,000 was received. The final settlement was paid by Avigen’s insurance carrier on July 2, 2010.

10. Stockholders’ Equity

Stock Options

We currently grant stock options to our employees, officers, directors and consultants under the 2004 Plan, the successor to the 2000 Plan. No additional stock options have been or will be issued under the 2000 Plan subsequent to our initial public offering. However, the stock options previously granted under the 2000 Plan will remain outstanding until the earlier of expiration or exercise.

16

Table of Contents

A summary of the changes in stock options outstanding under the 2000 Plan and 2004 Plan during the nine months ended September 30, 2010 is as follows:

The aggregate intrinsic value of stock options exercised during the nine months ended September 30, 2010 was approximately $39,000. The aggregate intrinsic value of stock options outstanding at September 30, 2010 and exercisable at September 30, 2010 was approximately $1,118,000 and approximately $498,000, respectively. Of the total stock options outstanding as of September 30, 2010, options to purchase 1,538,804 shares of common stock are exercisable, with a weighted average exercise price of $9.78 per share and a weighted average contractual life of 6.4 years.

Employee Stock Purchase Plan (“ESPP”)

The following assumptions were used to value the September 30, 2010 employee stock purchases: a risk-free interest rate of 1.38%, expected volatility of 76%, expected term of six months and a dividend rate of 0%. For the three months ended and nine months ended September 30, 2010, 2,072 shares of common stock and 6,558 shares of common stock, respectively, were issued under the ESPP and 259,127 shares of common stock are available for future issuance.

Convertible Notes

Holders of the convertible notes may submit conversion notices, which are irrevocable, instructing the trustee to convert such convertible notes into shares of our common stock at an initial conversion price of $6.80 per share. Following each conversion date, which date generally is the final business day of each calendar month, we will issue the number of whole shares of common stock issuable upon conversion as promptly as practicable (and in any event within 10 business days). The trustee will in turn release to us the respective amount of restricted cash to cover the stock issuance. We will then invest the unrestricted cash into either a money market fund or a money market account. Any fractional shares (after aggregating all convertible notes being converted by a holder on such date) will be rounded down and we will deliver cash for the current market value of the fractional share. For the three months and nine months ended September 30, 2010, approximately $9,000 and $1.8 million, respectively, of convertible notes were converted into our common stock.

11. Subsequent Events

Investment Securities

In October 2010, we sold all of our remaining investment securities- current assets and received total proceeds of approximately $868,000 which were invested in cash equivalents. We also recorded a gain on the sale of approximately $28,000 associated with the sale of these investment securities.

17

Table of Contents

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended December 31, 2009 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 24, 2010. Past operating results are not necessarily indicative of results that may occur in future periods.

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties, many of which are beyond our control. Our actual results may differ from those anticipated in these forward-looking statements as a result of various factors, including those set forth in Part II of this Quarterly Report on Form 10-Q under the caption “Item 1A. Risk Factors” and under the caption “Item 1A. Risk Factors” in our Annual Report on Form 10-K, and the differences may be material. Forward-looking statements discuss matters that are not historical facts. Forward-looking statements include statements regarding our plans, strategies, objectives, development programs, clinical trials, industry, financial condition, liquidity and capital resources, future performance and other statements that are not historical facts. Such forward-looking statements include statements preceded by, followed by or that otherwise include the words “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “anticipate,” “predict,” “potential,” “plan” or similar words. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You should not rely unduly on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

Overview and Recent Developments

We are a biopharmaceutical company focused on acquiring and developing novel, small molecule therapeutics for the treatment of diseases with unmet medical need with a specific focus on the U.S. market. Through strategic alliances, primarily with Japanese pharmaceutical companies, we hold rights to a diversified portfolio of clinical and preclinical product candidates, each of which we believe has a well-characterized and differentiated therapeutic profile, attractive commercial potential and patent assets having claims of commercially adequate scope. We were incorporated in Delaware in September 2000.

We are a development stage company. We have incurred significant net losses since our inception. At September 30, 2010, from inception, our accumulated deficit was approximately $262.5 million, including $47.9 million of non-cash stock-based compensation charges related to employee stock-based compensation and founders’ warrants. We expect to continue to incur losses as we continue to develop MN-221 for the treatment of acute exacerbations of asthma and Chronic Obstructive Pulmonary Disease, or COPD, exacerbations. We expect current working capital to be sufficient to fund our operations and planned research and development activities through the next fiscal year. We are actively pursuing potential partners to facilitate the advancement of our clinical development programs to potential commercialization.

We have acquired licenses to eight compounds for the development of ten product candidates. Our development pipeline consists of eight product development programs which have been in clinical development for the treatment of acute exacerbations of asthma, MS, bronchial asthma, interstitial cystitis, solid tumor cancers, Generalized Anxiety Disorders/insomnia, preterm labor and urinary incontinence, and two product development programs which have been in preclinical development for the treatment of thrombotic disorders.

In December 2009 we acquired Avigen Inc., or Avigen, a biopharmaceutical company that focused on identifying and developing differentiated products to treat patients with serious disorders, whose potential

18

Table of Contents

product candidate was AV411, a macrophage migration inhibitory factor and a glial attenuator, for CNS disorders, such as neuropathic pain, opioid withdrawal and methamphetamine addiction. Avigen’s AV411 and our MN-166 are both ibudilast, an orally available, small molecule therapeutic. With the acquisition of AV411, through the third quarter of 2010, we continue to integrate the two ibudilast-based product development programs into a combined development program.

At present, we are focusing our resources on the following prioritized product development programs:

Upon completion of proof-of-concept Phase II clinical trials, we intend to make a determination as to whether we will continue to pursue development independently in select markets, or establish a strategic collaboration to support further clinical development, as we currently intend with MN-221 and MN-166/AV411. In addition, we continue to limit development activities for the balance of our existing product candidates. For each of these remaining product candidates, we plan to conduct development activities only to the extent deemed necessary to maintain our license rights or maximize its value while pursuing a variety of initiatives to monetize such product candidate on appropriate terms. See “Research and Development” below.

Our eight non-prioritized product development programs consist of the following:

19

Table of Contents

Avigen Transaction

On December 18, 2009, Absolute Merger, Inc., a wholly-owned subsidiary of ours, merged with and into Avigen, with Avigen continuing as the surviving entity and wholly-owned subsidiary of ours. Under the terms of the merger, we issued $29.4 million in secured convertible notes that mature on June 18, 2011, the 18-month anniversary of the closing of the merger. Holders of these convertible notes may convert their notes into our common stock at an initial conversion price of $6.80 per share. At the maturity of the convertible notes, the remaining holders would be paid out the same per share amount as the Avigen shareholders that elected to receive cash at the merger closing, plus accrued interest. As part of the merger consideration, the former Avigen shareholders also are entitled to receive approximately $0.04 per share expected to be paid in two increments on or about June 30, 2010 and after November 30, 2010, subject to certain adjustments, and rights under contingent payment rights issued as part of the merger consideration. The amount to be paid in the two installments was adjusted to approximately $0.044 per share at June 30, 2010, based on a reconciliation of expenses. Under the first installment paid out in the third quarter of 2010, we paid a total of $140,119 to Avigen shareholders who elected payment in cash and we issued an additional principal amount of $685,917 in convertible notes to Avigen shareholders who elected payment in convertible notes in lieu of a cash payment.

As a result of the Avigen transaction, our consolidated financial statements include Avigen’s operations after the completion of the acquisition. We accounted for the Avigen merger using the acquisition method of accounting. The acquisition method of accounting for acquired businesses requires, among other things, that most assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date and that the fair value of acquired in-process research and development (IPR&D) be recorded on the balance sheet. Also, transaction costs are expensed as incurred. As a result of the Avigen transaction we recorded $4.8 million of IPR&D related to Avigen’s AV411 asset and we originally recorded $9.1 million of goodwill related to the excess purchase price over the assigned values of the net assets acquired. At June 30, 2010, with the reconciliation of expenses performed with regard to the two payments discussed above, goodwill was adjusted by $0.2 million to $9.4 million to reflect the increase in liabilities assumed. The goodwill was primarily a result of the conversion feature related to the convertible notes issued pursuant to the merger agreement. Our annual test date for IPR&D and goodwill impairment is December 31. We operate as one reporting segment and during the nine months ended September 30, 2010 through the date of this report, there were no triggering events, market conditions (such as a drop in our stock price by more than 50%) or other factors (such as adverse clinical trial results) that would indicate possible or actual impairment of IPR&D or goodwill.

Long-term Debt

On May 10, 2010, we entered into a loan and security agreement, or the Loan Agreement, with Oxford Finance Corporation, or Lender under which we borrowed $15.0 million. The financing will be used to satisfy working capital needs, including the continued clinical development of MN-221.

We are required to pay interest on borrowings on a monthly basis through and including February 1, 2011. Beginning March 1, 2011 through maturity of the loan on August 1, 2013, we will be required to make payments of outstanding principal and interest in 30 equal monthly installments. The stated interest rate on the loan is 12.87

20

Table of Contents

percent. The effective interest rate on the loan was 18.14% when taking into consideration the deferred interest payment, the relative fair value of the warrants issued in connection with the loan and the fees associated with procuring the loan. Pursuant to the Loan Agreement, we also issued to Lender a warrant to acquire up to 198,020 shares of our common stock, par value $0.001 per share, at an exercise price of $6.06 per share. Based on a Black Scholes model, the relative fair value of the warrant was approximately $859,000. In addition, the warrant and debt instrument are immediately separable and were issued separately; thus, we accounted for the warrant as a component of stockholders’ equity as the agreement requires settlement in shares and under no provision of the agreement are we required to settle the warrant in cash.

We paid Lender a facility fee of $150,000 and we paid outside third parties fees of approximately $180,000. We also will pay Lender a deferred interest payment equal to $450,000, payable on September 30, 2011, provided that a pro rata portion of such deferred interest payment shall be paid upon any prepayment of the loan. In addition, if we prepay all or a portion of the loan prior to maturity, we will pay Lender a prepayment penalty of three percent of the total amount prepaid if the prepayment occurs prior to May 10, 2011, two percent of the total amount prepaid if the prepayment occurs between May 11, 2011 and May 10, 2012 and one percent of the total amount prepaid if the prepayment occurs on or after May 10, 2012.

We accounted for the interest on the long-term debt under the effective interest method wherein we treated the debt issuance costs paid directly to Lender and the fair value of the warrants issued to Lender as a discount on the debt (or a contra liability) and we treated the debt issuance costs paid to third parties as an asset. The related amortization of the debt discount is recorded as interest expense and the amortization of the debt issuance costs paid to third parties is recorded as other expense in our consolidated statement of operations.

In addition, the Loan Agreement contains covenants that restrict our ability to:

The Loan Agreement also requires that on or before March 31, 2011 we must have either (i) entered into a collaboration, joint venture or partnership with a non-affiliate providing for up-front cash proceeds to us (with such proceeds received on or before March 31, 2011) of not less than $15.0 million from either or a combination of an upfront payment(s) or proceeds from the sale or conversion of our securities issued in connection therewith or (ii) received positive Phase IIB data on MN-221, as defined in a completed partnership or joint venture agreement relating to MN-221, or had a positive end-of-phase II meeting with the FDA and obtained the approval of the board of directors to proceed to Phase III with MN-221. A failure to meet the Loan Agreement requirements by March 31, 2011, would result in an immediate requirement for Loan repayment (as well as an increase in interest rate). As of September 30, 2010, we were in compliance with the Loan Agreement covenants.

Internal Control-Material Weakness

As required by SEC rules, we carried out the required quarterly evaluation, under the supervision and with the participation of our management, including our principal executive officer and our principal financial and accounting officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2010, the end of the period covered by this Report. Based on this evaluation and due to the material weakness described below, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of September 30, 2010.

21

Table of Contents

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting that creates a reasonable possibility that a material misstatement of our interim or annual financial statements will not be prevented or detected on a timely basis. In the course of preparing the financial statements as of September 30, 2010, that are included in this Report, management identified control overrides and policy deviations by one of our senior executive officers. These actions, collectively, represent a material weakness in our internal control over financial reporting. This material weakness was reported by management to our Audit Committee and remedial actions have taken place subsequent to September 30, 2010.

(See ITEM 4, CONTROLS AND PROCEDURES for further information on the identified material weakness and the remedial actions implemented.)

Revenues and Cost of Revenues

We have not generated any revenues from licensing, milestones or product sales to date, and we do not expect to generate any revenues from the commercialization of our product candidates within the next several years, if at all. Our revenues to date have been generated from providing development management services under master service agreements with Asahi Kasei Pharma Corporation and Argenes, Inc., pursuant to which we billed consulting fees and our pass-through clinical contract costs. The primary costs associated with our revenue were the clinical contract costs we incurred and passed-through to our customer. Our agreement with Asahi Kasei Pharma Corporation has been completed, and we terminated our agreement with Argenes, Inc. Therefore, we will not generate any further revenue from these agreements.

Research and Development

Our research and development expenses consist primarily of the license fees related to our product candidates, salaries and related employee benefits, costs associated with the preclinical and clinical development of our product candidates, costs associated with non-clinical activities, such as intellection property expenses, regulatory expenses, and pre-commercialization manufacturing development activities. We use external service providers to manufacture our product candidates to be used in clinical trials and for the majority of the services performed in connection with the preclinical and clinical development of our product candidates; therefore, these research and development expenses consist substantially of external costs, such as fees paid to consultants, contract research organizations, contract manufacturers and other external service providers, including professional fees and costs associated with legal services, patents and patent applications for our intellectual property. Internal research and development expenses consist of costs of compensation and other expenses for research and development personnel, supplies, materials, facility costs and depreciation. Research and development costs are expensed as incurred or accrued based on certain contractual factors such as for estimates of work performed, milestones achieved, patient enrollment and experience with similar contracts. As actual costs become known, accruals are adjusted. To date, our estimates have not differed significantly from the actual costs incurred.

22

Table of Contents

The following table summarizes our research and development expenses for the periods indicated for each of our product candidates. To the extent that costs, including personnel costs, are not tracked to a specific product development program, such costs are included in the “Unallocated” category (in thousands):