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

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED JUNE 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 August 13, 2010, the registrant had 12,403,355 shares of Common Stock ($0.001 par value) outstanding.

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MEDICINOVA, INC.

(a development stage company)

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PART I. FINANCIAL INFORMATION

MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

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MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes.

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MEDICINOVA, INC.

(a development stage company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes.

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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 six months ended June 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.

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

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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 debt repayment in the event of default, through at least June 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 six month periods ended June 30, 2009, the three months ended March 31, 2010, and the consolidated statement of cash flows for the six months ended June 30, 2009 and the period from September 26, 2000 (inception) to March 31, 2010 have been reclassified to conform to the June 30, 2010 presentation of interest expense, other expense and other income.

New Accounting Standards Not Yet Adopted

In April 2010, the FASB issued 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. As of June 30, 2010, 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 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. Because we cannot be assured that our product candidate will be selected to receive a cash grant in lieu of a research and development tax credit, we are uncertain if our application will have a material impact on our consolidated results of operations or financial condition.

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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. We have not early adopted this accounting standard; however, we do not believe adoption of this standard will 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.

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

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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 June 30, 2010, cash and cash equivalents (instruments with maturities of three months or less at the date of purchase) were $25.4 million and primarily invested in money market accounts. At June 30, 2010, restricted cash, restricted investments and restricted letter of credit were $29.4 million and primarily invested in money market funds. We measure our cash equivalents and restricted letter of credit (each current assets) and restricted cash and restricted investments (each non-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.

At June 30, 2010, we held investment securities-current of $9.9 million consisting of Auction Rate Securities (“ARS”), all of which had AAA ratings at the time of purchase, that principally represent interests in government-guaranteed student loans and we held an ARS Put (as defined below) in the amount of $1.6 million. In August 2008, UBS AG and its affiliates (“UBS”), the brokerage firm through which we purchased the majority of our ARS, entered into a settlement with the SEC, the New York Attorney General and other state agencies. Pursuant to the settlement, UBS issued to us Auction Rate Security Rights, which would allow us to sell to UBS our ARS held in accounts with UBS (“ARS Rights Offer”). As part of the ARS Rights Offer, we received the right to sell to UBS our ARS held in accounts with UBS at par value any time during the period beginning June 30, 2010 and ending July 2, 2012 (“ARS Put”). As part of the settlement, UBS also offered to us a no net cost loan program, 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 investments (“ARS Loan”). Under the terms of

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the ARS Loan, UBS may demand full or partial payment of the ARS Loan, at its sole option and without cause, at any time. If at any time UBS exercises its right to terminate the credit line agreement governing the ARS Loan, then UBS is required to provide, as soon as reasonably possible, alternative financing on substantially the same terms and conditions as those under the credit line agreement and the agreement will remain in full force and effect until such time as such alternative financing has been established. In January 2009, we were approved for the ARS Loan in the amount of $15.9 million and drew down the entire preapproved amount. In addition, in February 2009, we borrowed an additional $2.2 million under the ARS Loan, bringing the total amount outstanding under the ARS Loan to $18.1 million, following UBS’ decision to increase our availability under the ARS Loan. All cash received under the ARS Loan was invested in money market accounts. At June 30, 2009, the ARS associated with the ARS Rights Offer and the ARS Put were reclassified out of long-term assets to current assets due to the time frame in which they can be readily converted to cash.

At June 30, 2010, the carrying cost of the ARS Loan, which approximates its fair value due to its short-term nature, was $2.0 million. For the three months and six months ended June 30, 2010, $12.3 million and $15.4 million, respectively, of our current investment securities were redeemed at par value, with the proceeds being used to pay down the outstanding balance of the ARS Loan. Although the ARS Loan is a “no net cost loan”, for the three and six months ended June 30, 2010, approximately $40,000 and $85,000, respectively, of interest (or 1.4%) was charged on the ARS Loan and approximately $181,000 and $287,000 of interest earned on the associated ARS for the three and six months ended June 30, 2010, respectively, was applied to the ARS Loan.

At June 30, 2010, we held long-term investments of $1.8 million which consisted of ARS that principally represent interests in insurance notes and portfolios of securities (primarily commercial paper). For the three months and six months ended June 30, 2010, $0.0 and $0.3 million, respectively, of our long-term investment securities, were redeemed at less than par value, with the proceeds being invested in money market funds.

At June 30, 2010, our total ARS portfolio (both current and long-term) totaled $11.7 million at fair value ($13.8 million at par value), of which $1.8 million at fair value ($2.2 million at par value) consisted of private placement securities. None of the underlying collateral of our ARS portfolio consisted of subprime mortgages or collateralized debt obligations. Our ARS were designated as trading investment securities at December 31, 2008. We measure all of our ARS and the ARS Put on a recurring basis based on Level 3 criteria because neither an active primary nor active secondary market exists for these securities. The table below reconciles fair value of our ARS trading investment securities and the ARS Put at December 31, 2009 with fair value at June 30, 2010, as determined by Level 3 (unobservable) inputs:

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The portion of trading gains and losses for the six months ended June 30, 2010 related to our investment securities classified as trading securities which were still held at June 30, 2010 is as follows:

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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 Oxford Finance Corporation or, the “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.

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

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percent. The effective interest rate on the debt financing is calculated to be 18.14 percent and for the three and six month period ended June 30, 2010, we recorded total interest expense on this loan of approximately $366,000.

We have 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 June 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.

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 six months ended June 30, 2010:

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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 six months ended June 30, 2010 and June 30, 2009, respectively, 236,064 and 217,800 of potentially dilutive securities, were excluded from determining diluted earnings per share because of their anti-dilutive effect.

6. Comprehensive Income (Loss)

The authoritative guidance for comprehensive income under ASC 820 (formerly SFAS No. 130) requires that all components of comprehensive income (loss), including net income (loss), be reported in the financial statements in the period in which they are recognized. Comprehensive income (loss) is defined as the change in equity (net assets) during a period from transactions and other events and circumstances from non-owner sources. Net income (loss) and other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments, are reported, net of their related tax effect, to arrive at 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 six months ended of June 30, 2010 and 2009, our comprehensive loss was $9,493,771 and $9,696,390, respectively.

7. Share-Based Payments

For the three months ended June 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 $0.2 million, respectively, was recorded as research and development expense. For the six months ended June 30, 2010 and 2009, share-based compensation expense related to stock options of approximately $0.9 million and $0.9 million, respectively, was recorded as a component of general and administrative expense, and approximately $0.2 million and $0.4 million, respectively, was recorded as research and development expense.

During the three months and six months ended June 30, 2010, stock options to purchase 18,629 shares of common stock were exercised for approximately $74,000. As of June 30, 2010, there was $3.1 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 1.4 years.

The exercise price of stock options to purchase 125,000 shares of common stock and 525,000 shares of common stock granted during the three months and six months ended June 30, 2010, was equal to market value

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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 six months ended June 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 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 six month periods ended June 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 first or second quarter of 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 three and six month periods ended June 30, 2010, estimated as of the grant date using the Black-Scholes option valuation model, was $3.01 and $4.02, respectively per stock option, whereas the weighted-average fair value of each stock option granted during the three and six month periods ended June 30, 2009 was $1.66 and $1.17, respectively, 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 June 30, 2010 and we have not recorded any uncertain income tax benefits at June 30, 2010.

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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. Avigen and Pennsylvania Avenue Funds have signed a stipulation of settlement agreement and moved the court for preliminary approval. The Court heard oral arguments on the Motion for Preliminary Approval of Settlement and held a case management conference on March 8, 2010, during which it raised a few issues regarding the settlement provisions. On April 6, 2010, the Superior Court for the State of California for the County of Alameda approved the preliminary settlement and set a final settlement hearing for June 24, 2010. Under the terms of the Stipulation of Settlement, Avigen has agreed not to oppose a fee motion by counsel to The Pennsylvania Avenue Funds for fees and expenses in the amount not to exceed $140,000 and a petition by The Pennsylvania Avenue Funds for an incentive award of up to $2,500. On June 24, 2010, the final order and judgment approving final settlement of $140,000 was received. As the final settlement is to be paid by Avigen’s insurance carrier, at June 30, 2010 we recorded the $140,000 liability and corresponding receivable in our consolidated balance sheet.

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.

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

The aggregate intrinsic value of stock options exercised during the six months ended June 30, 2010 was approximately $23,000. The aggregate intrinsic value of stock options outstanding at June 30, 2010 and exercisable at June 30, 2010 was approximately $809,000 and approximately $312,000, respectively. Of the total stock options outstanding as of June 30, 2010, options to purchase 1,502,353 shares of common stock are exercisable, with a weighted average exercise price of $9.97 per share and a weighted average contractual life of 6.6 years.

Employee Stock Purchase Plan (“ESPP”)

The following assumptions were used to value the March 31, 2010 employee stock purchases: a risk-free interest rate of 2.37%, expected volatility of 73%, expected term of six months and a dividend rate of 0%. There were no ESPP stock purchases for the three months ended June 30, 2010. For the six months ended June 30,

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2010, 4,486 shares of common stock were issued under the ESPP and 261,199 shares of common stock were 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 six months ended June 30, 2010, approximately $55,000 and $1.8 million, respectively, of convertible notes were converted into our common stock.

11. Subsequent Events

On July 1, 2010, we completed the sale of all of our Auction Rate Securities (“ARS”) held by UBS AG at par value and we recorded a gain of approximately $77,000. After repaying our ARS loan, we netted proceeds of $9.5 million, all of which was invested in money market funds. In addition, our ARS line of credit was cancelled upon our repayment of the ARS loan.

On July 2, 2010, the liability related to the approved $140,000 final settlement of The Pennsylvania Avenue Funds lawsuit was paid by Avigen’s insurance carrier directly to The Pennsylvania Avenue Funds.

On July 22, 2010, under the terms of the Merger, former Avigen stockholders were paid on a pro-rata basis $0.0277 per share of Avigen common stock outstanding at the time of the Merger, or a total of approximately $140,000, as part of the first release of the Second Payment Consideration. An aggregate of $500,000 from the Second Payment Consideration amount is deferred and will be paid to the former Avigen stockholders on a pro rata basis upon expiry of a letter of credit issued by Wells Fargo Bank, N.A. in connection with expenses under Avigen’s building lease, expected to expire November 30, 2010. The distributable amount will be offset by any amounts drawn by the beneficiary under the letter of credit and will be paid to former Avigen stockholders on the earlier of December 31, 2010 and the date on which the entire amount of restricted cash becomes unrestricted.

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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 June 30, 2010, from inception, our accumulated deficit was approximately $256.8 million, including $47.4 million of non-cash stock-based compensation charges related to employee stock-based compensation and founders’ warrants. We expect to incur substantial net losses for at least the next several years as we continue to develop certain of our existing product development programs, primarily MN-221 for the treatment of acute exacerbations of asthma and Chronic Obstructive Pulmonary Disease, or COPD, exacerbations, and over the long-term if we are successful in expanding our research and development programs and acquiring or in-licensing products, technologies or businesses that are complementary to our own.

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, IC, 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 addition, we have expanded our development program for MN-221 for the treatment of COPD exacerbations.

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

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product candidate was AV411, 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, we are in the process of integrating the two ibudilast-based product development programs and we are pursuing discussions with potential partners to secure a strategic collaboration to advance clinical development of the combined development programs.

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:

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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.

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 six months ended June 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 Oxford, 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 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 Oxford 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 Oxford a facility fee of $150,000 and we paid associated legal fees of approximately $180,000. We also will pay Oxford a deferred interest payment equal to $450,000, payable on June 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 Oxford 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

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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 the lender and the 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 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.

Subsequent Events

On July 1, 2010, we completed the sale of all of our Auction Rate Securities, or ARS, held by UBS AG at par value and we recorded a gain of approximately $77,000. After repaying our ARS loan, we netted proceeds of $9.5 million, all of which was invested in money market funds. In addition, our ARS line of credit was cancelled upon our repayment of the ARS loan.

On July 2, 2010, the liability related to the approved $140,000 final settlement of The Pennsylvania Avenue Funds lawsuit was paid by Avigen’s insurance carrier directly to The Pennsylvania Avenue Funds.

On July 22, 2010, under the terms of the Merger, former Avigen stockholders were paid on a pro-rata basis $0.0277 per share of Avigen common stock outstanding at the Merger, or a total of approximately $140,000, as part of the first release of the Second Payment Consideration. An aggregate of $500,000 from the Second Payment Consideration amount is deferred and will be paid to the former Avigen stockholders on a pro rata basis upon expiry of a letter of credit issued by Wells Fargo Bank, N.A. in connection with expenses under Avigen’s building lease, expected to expire November 30, 2010. The distributable amount will be offset by any amounts drawn by the beneficiary under the letter of credit and will be paid to former Avigen stockholders on the earlier of December 31, 2010 and the date on which the entire amount of restricted cash becomes unrestricted.

New Accounting Standards Not Yet Adopted

In April 2010, the FASB issued 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. As of June 30, 2010, 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 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. Because we cannot be assured that our product candidate will be selected to receive a cash grant in lieu of a research and development tax credit, we are uncertain if our application will have a material impact on our consolidated results of operations or financial condition.

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.

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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. We have not early adopted this accounting standard; however, we do not believe adoption of this standard will have a material effect on our consolidated results of operations or financial condition.

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 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.

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):

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As of the end of the second quarter of 2007, we determined to focus our resources on the development of our two prioritized product candidates, MN-221 for the treatment of acute exacerbations of asthma and MN-166 for the treatment of MS. However, following completion of the Phase II clinical trial of MN-166 ibudilast for the treatment of MS in the second quarter of 2008 and the December 2009 acquisition of AV411 ibudilast for the treatment of other CNS disorders, we are in the process of combining the two ibudilast-based development programs and we are pursuing discussions with potential partners to secure a strategic collaboration. As such, we do not plan to undertake any further significant clinical development of MN-166/AV411 until such time that we secure a strategic collaboration to advance the combined ibudilast-based development program. In addition, as of the third quarter of 2009, we determined to expand the product development program for MN-221 to evaluate MN-221 for the treatment of COPD exacerbations. We anticipate that our research and development expenses will increase with respect to MN-221 in future periods as we continue development and launch clinical trials in support of potential commercialization of this product candidate for the treatment of acute exacerbations of asthma and COPD exacerbations and decrease with respect to MN-166/AV411 in future periods as we will limit expenditures on this product candidate to those development activities deemed necessary, if any, to maximize its value for purposes of securing a partner for clinical development. However, at this time, due to the risks inherent in the clinical development process and given the early stage of our MN-221 product development programs, we are unable to estimate with any certainty the costs that we will incur in the continued development of such product candidate for potential commercialization.

Our current ongoing Phase II trial for MN-221 treating patients with acute exacerbations of asthma experienced slower than expected enrollment in the first half of 2010. We recently received approval for an amendment to the protocol that should facilitate enrollment in the emergency room, or ER, setting as it shortens the length of time the patient needs to stay in the ER, as well as gives the ER physician control over the standard-of-care that is given to the patient during the treatment period.

We will continue to limit our expenditures on the remainder of our existing product candidates to only those activities deemed necessary to maintain our license rights or maximize the value of such product candidates, if any, while pursuing a variety of initiatives to monetize such product candidates on appropriate terms. As a result, we expect that research and development expenses will decrease or otherwise remain low for the remainder of our existing product candidates in future periods.

General and Administrative

Our general and administrative expenses primarily consist of salaries, benefits and consulting and professional fees related to our administrative, finance, human resources, business development, legal and information systems support functions. In addition, general and administrative expenses include facilities and insurance costs. General and administrative costs are expensed as incurred or accrued based on monitoring the status of the specified project, contractual factors such as milestones or retainer fees, services provided and invoices received. As actual costs become known to us, we adjust our accruals. To date, general and administrative accruals have not differed significantly from the actual costs incurred.

We anticipate that our general and administrative expenses may increase in future periods if we are required to expand our infrastructure based on the success of our current prioritized product development programs and in raising capital to support those and other development programs or otherwise in connection with increased business development activities related to partnering, out-licensing or disposition of our product candidates.

Investment Securities and ARS Put

As of June 30, 2010, our investment securities consisted of ARS, all of which had AAA ratings at the time of original purchase. ARS are generally long-term debt instruments that historically have provided liquidity through a “Dutch” auction process that resets the applicable interest rate at predetermined calendar intervals, typically seven, 28, 35 or 49 days. All of our ARS principally represent interests in government-guaranteed

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student loans, insurance notes and portfolios of securities (primarily commercial paper). When our ARS were originally purchased, there was an active market for purchasing and selling ARS; therefore, we considered these investment securities to be available-for-sale.

Due to continued negative conditions in the global credit markets, our ARS have continued to fail at auction with few to no trades in either the primary or the secondary markets. As such, with the adoption of Accounting Standards Codification, or ASC, 820, authoritative guidance for fair value measurements and disclosures (formerly Statement of Financial Accounting Standards, or SFAS, No. 157), we determine the fair value of our ARS portfolio primarily on Level 3 criteria, which results in our reliance on a discounted cash flow valuation model with assumptions related to interest rates, maturities and liquidity determined by us based on the credit quality of the security, the credit quality of the associated insurer, if applicable, the respective prospectus and the credit market outlook. Given the lack of a primary and secondary market for our ARS investment securities, we designated all of our ARS investment securities as trading securities at December 31, 2008. As a result, any additional increase or decrease in the fair value of our ARS investment securities is recorded as either a gain or an impairment charge, respectively, in our consolidated statement of operations. For the six months ended June 30, 2010, we recorded a net impairment charge on our investment securities portfolio of approximately $564,000 to decrease the overall carrying value of our investment securities. In addition, for the six months ended June 30, 2010, we recorded a loss recapture (a gain in our consolidated statement of operations) of approximately $1.6 million on the UBS ARS that had previously been marked down due to a decline in fair value, but, were redeemed at par value during the quarter. We have classified our investment securities covered by the ARS Rights Offer (as described below) as current assets given that they can be converted into cash starting June 30, 2010. Our remaining investment securities are considered long-term assets, as they cannot be readily converted to cash within 12 months from June 30, 2010.

In August 2008, UBS, the brokerage firm through which we purchased the majority of our ARS, entered into a settlement with the SEC, the New York Attorney General and other state agencies. Under the settlement, UBS issued to us ARS, which would allow us to sell to UBS our ARS held in accounts with UBS, or the ARS Rights Offer. Pursuant to the ARS Rights Offer, 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, or the 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 investments. Under the terms of the ARS Loan, UBS may demand full or partial payment of the ARS Loan, at its sole option and without cause, at any time. If at any time UBS exercises its right to terminate the credit line agreement governing the ARS Loan, then UBS is required to provide, as soon as reasonably possible, alternative financing on substantially the same terms and conditions as those under the credit line agreement and the agreement will remain in full force and effect until such time as such alternative financing has been established. In January 2009, we were approved for the ARS Loan in the amount of $15.9 million and drew down the entire preapproved amount. In addition, in February 2009, we borrowed an additional $2.2 million under the ARS Loan, bringing the total amount outstanding under the ARS Loan to $18.1 million, following UBS’ decision to increase our availability under the ARS Loan. All cash received under the ARS Loan was invested in money market accounts. At June 30, 2010, the outstanding balance of the ARS Loan was $2.0 million. For the three and six month periods ended June 30, 2010, $12.3 million and $15.4 million, respectively, of our current investment securities were redeemed at par value, with the proceeds used to pay down the outstanding loan balance.

We determined the fair market value of the ARS without consideration of the ARS Put because they are deemed separate contractual agreements under ASC 820.

We elected to measure the ARS Put under the fair value option of ASC 825, authoritative guidance on financial instruments (formerly SFAS No. 159), to mitigate the volatility in reported earnings due to the linkage of certain of our ARS and the ARS Put. Under ASC 825, any subsequent increase or decrease in the fair value of the ARS Put would be recorded as either a gain or an impairment charge, respectively, in our consolidated

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statement of operations. The fair value of the ARS Put was also determined by a discounted cash flow valuation model with assumptions being made related to interest rate, maturity and liquidity. For the three and six month periods ended June 30, 2010, based on our discounted cash flow valuation, we recorded in our consolidated statement of operations an impairment charge of approximately $1.2 million and $1.0 million, respectively, due to the decrease in the carrying value of the ARS Put, which offset the net loss recapture (gain) we recorded of $1.3 million and $1.0 million for the three and six month periods ended June 30, 2010, respectively, in the consolidated statement of operations on the UBS ARS which were redeemed at par value and are linked with the ARS Put.

Foreign Exchange Loss/(Gain)

To date, we have conducted most of our clinical trials in the United States. However, the Phase II clinical trial for MN-166 for the treatment of MS that completed in 2008 was conducted in Eastern Europe and the on-going Phase II clinical trial in MN-221 for the treatment of acute exacerbations of asthma, has a small number of clinical sites located in Canada, Australia and New Zealand in which certain of the invoices are denominated in the Canadian dollar, the Australian dollar and the New Zealand dollar, respectively. In addition, we have certain investor relation invoices denominated in Japanese Yen and we have certain manufacturing invoices denominated in British Pounds. At this time, we have not established a hedging program to mitigate our foreign exchange exposure. Foreign exchange gain/loss is based on the difference between the exchange rate at the settlement date and the exchange rate at the balance sheet date for the respective foreign currency invoice.

Other Expense

Other expense consists of accretion related to the convertible notes and the amortization of debt issuance costs paid to third parties.

Interest Expense

Interest expense consists of interest charged on our ARS Loan, interest charged on our long-term debt based on the effective interest method and amortization of debt discount.

Other Income

Other income consists of interest earned on our cash, cash equivalents and ARS.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent liabilities. We review our estimates on an ongoing basis, including those related to our significant accruals. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are the same as those noted in our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the SEC on March 24, 2010.

Results of Operations

Comparison of the Three Months Ended June 30, 2010 and 2009

Revenues

There were no revenues for the three months ended June 30, 2010 or June 30, 2009.

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Research and Development

Research and development expenses for the three months ended June 30, 2010 were $2.3 million, a decrease of $0.4 million when compared to $2.7 million for the three months ended June 30, 2009. This decrease in research and development expenses was primarily due to a decrease of $0.7 million in spending on our prioritized asset MN-221 for the treatment of acute exacerbations of asthma due to slowed enrollment in our on-going MN-221-CL-007 clinical trial set in the emergency department. This decrease was offset by $0.3 million on increased spending on the MN-166 monkey toxicity preclinical study completed in the quarter and as well as expenditures related to the AV411 opioid withdrawal clinical trial.

General and Administrative

General and administrative expenses were $1.8 million for the three months ended June 30, 2010, a decrease of $0.4 million when compared to $2.2 million for the three months ended June 30, 2009. This decrease in general and administrative expenses was due primarily to a decrease in fees paid for legal and accounting services due to the completion of the Avigen transaction in 2009.

Impairment Charge/Gain, net, on Investment Securities

Net gain on investment securities for the three months ended June 30, 2010 was $64,000, as compared to a net gain on investment securities of $114,000 for the three months ended June 30, 2009. The net gain in the current quarter was a result of the recapture of loss related to UBS ARS previously written down to fair market value, but, redeemed in the quarter at par value, offset by the corresponding impairment charge on the linked ARS Put, whereas the net gain in the prior year quarter was a result of an increase in fair market value of our ARS based on our discounted cash flow model.

Foreign Exchange Loss/Gain

Foreign exchange gain for the three months ended June 30, 2010 was $2,000, as compared to a foreign exchange loss of $18,000 for the three months ended June 30, 2009. The foreign exchange gain in the current quarter was a result of the revaluation of Japanese yen-denominated liabilities, whereas in the second quarter of 2009, the revaluation of the euro-denominated liability resulted in a foreign exchange loss.

Other Expense

Other expense for the three months ended June 30, 2010 was $43,000, as compared to $0 for the three months ended June 30, 2009. Other expense relates to accretion on the convertible notes and amortization of debt issuance costs paid to third parties. We did not have the convertible notes or long-term debt in 2009.

Interest Expense

Interest expense for the three months ended June 30, 2010 was $406,000, as compared to $65,000 for the three months ended June 30, 2009. The increase in interest expense was due to the interest charged on the long-term debt using the effective interest method, offset by a slight decrease in the amount of interest charged on the ARS Loan. In 2009 interest expense was only comprised of interest charged on the ARS Loan.

Other Income

Other income for the three months ended June 30, 2010 was $201,000, as compared to $249,000 for the three months ended June 30, 2009. The decrease is due to a decrease in interest income due to less yield earned on invested balances.

Comparison of the Six Months Ended June 30, 2010 and 2009

Revenues

There were no revenues for the six months ended June 30, 2010 or June 30, 2009.

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Research and Development

Research and development expenses for the six months ended June 30, 2010 were $5.3 million, a decrease of $0.5 million when compared to $5.8 million for the six months ended June 30, 2009. This decrease in research and development expenses was due to a decrease of $0.2 million in spending on our prioritized asset MN-221 for the treatment of acute exacerbations of asthma due to slowed enrollment in our on-going MN-221-CL-007 clinical trial set in the emergency department and a decrease of $0.3 million primarily in unallocated research and development expenses due to a reduction in headcount.

General and Administrative

General and administrative expenses were $4.1 million for the six months ended June 30, 2010, a decrease of $0.3 million when compared to $4.4 million for the six months ended June 30, 2009. This decrease in general and administrative expenses was due primarily to a decrease in fees paid for legal and accounting services due to the completion of the Avigen transaction in 2009.

Impairment Charge/Gain, net, on Investment Securities

Net gain on investment securities for the six months ended June 30, 2010 was $57,000, as compared to a net gain on investment securities of $141,000 for the six months ended June 30, 2009. The net gain for the six months ended June 30, 2010, was a result of the recapture of loss related to UBS ARS previously written down to fair market value, but, redeemed at par value, offset by the corresponding impairment charge on the linked ARS Put, whereas the net gain in the prior year quarter was a result of an increase in fair market value of our ARS based on our discounted cash flow model.

Foreign Exchange Loss/Gain

Foreign exchange loss for the six months ended June 30, 2010 was $2,000, as compared to a foreign exchange gain of $9,000 for the six months ended June 30, 2009. The foreign exchange loss was a result of the revaluation of Japanese yen-denominated liabilities in which the U.S. dollar continued to weaken against the Japanese yen over the first six months of 2010, whereas in the first six months of 2009, the revaluation of the outstanding euro-denominated invoice resulted in the foreign exchange gain due to the strengthening of the U.S. dollar against the euro at March 31, 2009 being greater than the weakening of the U.S dollar against the euro at June 30, 2009.

Other Expense

Other expense for the six months ended June 30, 2010 was $75,000, as compared to $0 for the six months ended June 30, 2009. Other expense relates to accretion on the convertible notes and amortization of debt issuance costs paid to third parties. We did not have the convertible notes or long-term debt in 2009.

Interest Expense

Interest expense for the six months ended June 30, 2010 was $450,000, as compared to $108,000 for the six months ended June 30, 2009. The increase in interest expense was due to the interest charged on the long-term debt using the effective interest method, offset by a slight decrease in the amount of interest charged on the ARS Loan. In 2009 interest expense was only comprised of interest charged on the ARS Loan.

Other Income

Other income for the six months ended June 30, 2010 was $362,000, as compared to $509,000 for the six months ended June 30, 2009. The decrease is due to a decrease in interest income due to less yield earned on invested balances.

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Liquidity and Capital Resources

Since our inception, we have primarily financed our operations through the private placement of our equity securities, the public sale of our common stock, long-term debt, the conversion of convertible notes to our common stock and the exercise of founders’ warrants, net of treasury stock repurchases. Through June 30, 2010, we received estimated proceeds of $201.6 million from the sale of equity securities, the exercise of warrants and stock options and employee stock purchases and proceeds of $1.8 million from the conversion of convertible notes into our common stock. In addition through June 30, 2010 we procured long-term debt of $15.0 million in gross proceeds.

At June 30, 2010, we had $34.8 million in cash, cash equivalents, investment securities—current and an ARS put, net of ARS loan, as compared to $28.4 million as of December 31, 2009, which increase of $6.4 million was primarily a result of the long-term debt, offset by our net loss. At June 30, 2010, $9.9 million of our ARS consisted primarily of government-guaranteed student loan securities and $1.8 million of our ARS consisted of private placement securities. None of the underlying collateral for our ARS consisted of subprime mortgages or collateralized debt obligations. Based on our discounted cash flow model, our current investment securities consisting of ARS, which were designated as trading securities, decreased in fair value by $301,000, for the three months ended June 30, 2010, which net the recapture of loss (gain) of $1.6 million which we recorded in our consolidated statement of operations to account for previously written down UBS ARS redeemed at par value during the quarter. In addition, we also recorded a loss of $1.2 million, for the three months ended June 30, 2010, on the linked ARS Put to decrease its carrying value.

The fair value of our ARS and the ARS Put are based in part on management’s estimates and assumptions. In the event of actual market exchanges, if any, these assumptions may prove materially different from those assumed in our valuation models and amounts may be materially different than our estimates. For example, a reduction of the expected term to redemption by two years for our ARS portfolio yielded in our models an increase in valuation of our ARS of $0.7 million and an increase in expected term to redemption by two years for our ARS portfolio yielded in our models a decrease in valuation of our ARS of $0.7 million. Other factors that may impact the valuation of our ARS and the ARS Put include changes to the credit quality of the underlying assets, discount rates, counterparty risk and the condition of the overall credit market.

Based on our discounted cash flow model, our long-term investment securities, which were designated as trading securities, decreased in fair value and resulted in the recording of an impairment charge of approximately $27,000, for the three months ended June 30, 2010, in our consolidated statement of operations to decrease their carrying value.

In August 2008, UBS, the brokerage firm through which we purchased the majority of our ARS investments, entered into a settlement with the SEC, the New York Attorney General and other state agencies. Under the settlement, UBS issued to us the ARS Rights Offer. Pursuant to the ARS Rights Offer, we received the ARS Put. As part of the settlement, UBS also offered to us the 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 investments. Under the ARS Loan program, UBS may demand full or partial payment of the ARS Loan, at its sole option and without cause, at any time. In January 2009, we were approved for the ARS Loan in the amount of $15.9 million and drew down the entire preapproved amount. In addition, in February 2009, we borrowed an additional $2.2 million under the ARS Loan, bringing the total amount outstanding under the ARS Loan to $18.1 million, following UBS’ decision to increase our availability under the ARS Loan. All cash received under the ARS Loan was invested in money market accounts.

Our ARS Loan balance was $2.0 million at June 30, 2010. For the three months ended June 30, 2010, $12.3 million of our current investment securities were redeemed at par value, with the proceeds used to pay down the outstanding ARS Loan balance. On June 30, 2010, we exercised our ARS Put. The ARS Put was settled on

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July 1, 2010, in which we received net proceeds of $9.5 million after paying off our ARS Loan and we recorded a gain of approximately $77,000. We invested the net proceeds received in money market funds. The line of credit associated with the ARS Loan was cancelled on July 2, 2010.

Net cash used in operating activities increased to $10.3 million for the six months ended June 30, 2010 from $8.6 million for the six months ended June 30, 2009. The increase was primarily a result of the payment of legal and CRO invoices and accrued compensation expenses. Net cash provided by investing activities increased to $15.5 million for the six months ended June 30, 2010, as compared to $87,000 of net cash provided by investing activities for the six months ended June 30, 2009. The increase was primarily due to the par redemptions of current investment securities and the sale of one of our long-term investment securities at less than par. Net cash provided by financing activities was $0.9 million for the six months ended June 30, 2010, compared to net cash provided by financing activities of $17.9 million for the six months ended June 30, 2009. The decrease was primarily due to the partial repayment of the ARS Loan which was put into service in the first quarter of 2009, offset by proceeds received from the long-term debt and the conversation of convertible notes.

We have consumed substantial amounts of capital since our inception. We do not have any material commitments for capital expenditures and our current cash, cash equivalents and the ARS Loan are our principal sources of liquidity as we cannot be assured of future conversion of the convertible notes into our common stock. We believe that our existing cash, cash equivalents and current investment securities, net of the ARS Loan, as of June 30, 2010, will be sufficient to fund our anticipated operating requirements, including our currently on-going research and development activities, and debt repayment in the event of default, at a minimum, through June 30, 2011. We anticipate that we will require additional funding in the future to fund our operations and intended research and development activities.

Our future uses and capital requirements will depend on many factors, including following:

Until we can generate significant continuing revenues, we expect to satisfy our future cash needs through strategic collaborations, private or public sales of our securities, debt financings or licensing transactions, involving all or a portion of our product candidates, to the extent we are able to do so. We may not be successful in obtaining strategic collaboration agreements or in receiving milestone or royalty payments under such agreements. We cannot be certain that additional sources of capital will be available to us on acceptable terms, or at all. If sources of capital are not available, we may not be in a position to pursue present or future business opportunities that require financial commitments, and we may be required to delay, reduce the scope of or terminate one or more of our product development programs, curtail our efforts to acquire new product

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candidates or relinquish some or even all rights to product candidates. Failure to obtain adequate financing also may adversely affect our ability to operate as a going concern.

Our primary exposure to market risk due to changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive without significantly increasing risk. Our risk associated with fluctuating interest rates is limited to our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments due to their relatively short term nature. Declines in interest rates over time, however, will reduce our interest income, while increases in interest rates over time will increase our interest income.

Our investment securities are trading securities and consist solely of ARS, which are debt instruments with long-term maturities in which the interest rates reset in short intervals through “Dutch” auctions by matching buyers and sellers. All of our ARS had AAA ratings at the time of purchase and principally represent interests in government-guaranteed student loans, insurance notes and portfolios of securities (primarily commercial paper). None of the underlying collateral for our ARS consisted of subprime mortgages or collateralized debt obligations. At June 30, 2010, $9.9 million of our ARS consisted primarily of government-guaranteed student loan securities and $1.8 million of our ARS consisted of private placement securities.

The continued negative conditions in the global credit markets have prevented most investors, including ourselves, from liquidating certain holdings of ARS because the amount of securities submitted for sale has exceeded the amount of purchase orders for the securities. If there is insufficient demand for the securities at the time of the “Dutch” auction, the auction may not be completed and the interest rates may be reset to the maximum interest rate applicable to the specific securities being auctioned as per the official statement issued at the initial bond sale. When auctions for these securities fail, as they continue to in 2010, the investments may not be readily convertible to cash until a future auction of these investments is successful or they are redeemed or repurchased, sold through a secondary market or mature. For the three months ended June 30, 2010, $12.3 million of ARS were redeemed, all of which was utilized to pay down our ARS Loan.

In the fourth quarter of 2008, we received and accepted the ARS Rights Offer from UBS. Pursuant to the ARS Rights Offer, we received the ARS Put. In January 2009, we were approved by UBS for the ARS Loan in the amount of $15.9 million and drew down the entire preapproved amount. In addition, in February 2009, we borrowed an additional $2.2 million under the ARS Loan, bringing the total amount outstanding under the ARS Loan to $18.1 million, following UBS’ decision to increase our availability under the ARS Loan. Under the ARS Loan program, UBS may demand full or partial payment of the ARS Loan, at its sole option and without cause, at any time. All cash received under the UBS Loan was invested in money market accounts. At June 30, 2010, our outstanding ARS Loan balance was $2.0 million. Because the interest that we pay on the ARS Loan will not exceed the interest that we receive on the ARS pledged as security for the ARS Loan and which are held in the collateral account, we do not believe that this arrangement subjects us to additional interest rate risk. In addition, we repaid the ARS Loan and the associated line of credit was cancelled on July 2, 2010.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive

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Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) of the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

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. Avigen and The Pennsylvania Avenue Funds have signed a stipulation of settlement agreement and moved the court for preliminary approval. The Court heard oral arguments on the Motion for Preliminary Approval of Settlement and held a case management conference on March 8, 2010, during which it raised a few issues regarding the settlement provisions. On April 6, 2010, the Superior Court for the State of California for the County of Alameda approved the preliminary settlement and set a final settlement hearing for June 24, 2010. Under the terms of the Stipulation of Settlement, Avigen agreed not to oppose a fee motion by counsel to The Pennsylvania Avenue Funds for fees and expenses in the amount not to exceed $140,000 and a petition by The Pennsylvania Avenue Funds for an incentive award of up to $2,500. On June 24, 2010, the final order and judgment approving final settlement of $140,000 for fees and expenses was received. The petition for the $2,500 incentive award was denied. Avigen’s insurance carrier paid the $140,000 balance due to The Pennsylvania Avenue Funds on July 2, 2010.

We operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. Certain factors may have a material adverse effect on our business, financial condition and results of operations, and you should carefully consider them. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors, in its entirety, in addition to other information contained in this Quarterly Report on Form 10-Q and our other public filings with the SEC. Other events that we do not currently anticipate or that we currently deem immaterial may also affect our results of operations and financial condition.

Risks Related to Our Business and Industry

We have incurred significant operating losses since our inception and expect that we will incur continued losses for the foreseeable future.

We are a development stage biopharmaceutical company with a limited operating history. We have incurred significant net losses since our inception. For the three months and six months ended June 30, 2010, we had a net loss of $4.3 million and $9.5 million, respectively, and our accumulated deficit was approximately $256.8 million. If we are successful in raising additional capital to support the expansion of our business, our annual net losses may increase over the next several years as we expand our infrastructure and incur significant costs related to the development of our product candidates.

We expect our research and development expenses to increase in connection with ongoing and planned clinical trials for our prioritized product candidates, primarily related to MN-221 for the treatment of acute exacerbations of asthma and COPD exacerbations, and any other development activities that it may initiate. In addition, our general and administrative expenses may increase in future periods as a result of several factors, including our research and development activities, our business development activities and any expansions in our infrastructure related to such activities. Consequently, we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with developing drug products, we are unable to predict the extent of any future losses or when we will become profitable, if at all.

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We do not have any products that are approved for commercial sale and therefore do not expect to generate any revenues from product sales in the foreseeable future, if ever.

To date, we have funded our operations primarily from sales of our securities and, to a lesser extent, debt financing. We have not received, and do not expect to receive for at least the next several years, if at all, any revenues from the commercialization of our product candidates. Our only source of revenues since inception has been from development management services rendered to Asahi Kasei Pharma Corporation and Argenes, Inc., both Japanese pharmaceutical companies, in connection with their clinical development of pharmaceutical product candidates. We completed our agreement with Asahi Kasei Pharma Corporation and terminated our agreement with Argenes, Inc.; therefore, we will not generate any further revenues from these agreements. We anticipate that, prior to our commercialization of a product candidate, out-licensing upfront and milestone payments will be our primary source of revenue. To obtain revenues from sales of our product candidates, we must succeed, either alone or with third parties, in developing, obtaining regulatory approval for, manufacturing and marketing drugs with commercial potential. We may never succeed in these activities, and we may not generate sufficient revenues to continue our business operations or achieve profitability.

We are largely dependent on the success of our two prioritized product candidates, MN-221 and MN-166/AV411, and we cannot be certain that either of these product candidates will receive regulatory approval or be successfully commercialized.

We currently have no products for sale, and we cannot guarantee that we will ever have any drug products approved for sale. The research, testing, manufacturing, labeling, approval, selling, marketing and distribution of drug products are subject to extensive regulation by the U.S. Food and Drug Administration, or FDA, and comparable regulatory authorities in other countries. We are not permitted to market any of our product candidates in the United States until we submit and receive approval of a New Drug Application, or NDA, for a product candidate from the FDA or its foreign equivalent from a foreign regulatory authority. Obtaining FDA approval is a lengthy, expensive and uncertain process. We currently have two prioritized product candidates, MN-221 for the treatment of acute exacerbations of asthma and COPD exacerbations and MN-166/AV411, a combined ibudilast product development program covering MS and other CNS disorders and the success of our business currently depends on their successful development and commercialization. Neither of these product candidates has completed the clinical development process; therefore, we have not submitted an NDA or foreign equivalent or received marketing approval for either of these two prioritized product candidates. In addition, we are not currently planning to pursue any further significant clinical development of MN-166/AV411 until such time that we are able to secure a strategic collaboration to advance the combined development programs, which may delay or impede the process of completing clinical trials and seeking regulatory approval for this product candidate. We also cannot assure you that we will be able to secure such a strategic collaboration on attractive financial and other terms, or at all.

The clinical development programs for MN-221 and MN-166/AV411 may not lead to commercial products for a number of reasons, including if we fail to obtain necessary approvals from the FDA or similar foreign regulatory authorities because our clinical trials fail to demonstrate to their satisfaction that these product candidates are safe and effective. We may also fail to obtain the necessary approvals if we have inadequate financial or other resources to advance our product candidates through the clinical trial process or are unable to secure a strategic collaboration or partnership with a third party. Any failure or delay in completing clinical trials or obtaining regulatory approval for either MN-221 or MN-166/AV411 in a timely manner would have a material and adverse impact on our business and our stock price.

In order to commercialize a therapeutic drug successfully, a product candidate must receive regulatory approval after the successful completion of clinical trials, which are long, complex and costly, have a high risk of failure and can be delayed or terminated at any time.

Our product candidates are subject to extensive government regulations related to development, clinical trials, manufacturing and commercialization. The process of obtaining FDA and other regulatory approvals is

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costly, time-consuming, uncertain and subject to unanticipated delays. To receive regulatory approval for the commercial sale of any of our product candidates, we must conduct, at our own expense, adequate and well-controlled clinical trials in human patients to demonstrate the efficacy and safety of the product candidate. Clinical testing is expensive, takes many years and has an uncertain outcome. To date, we have obtained regulatory authorization to conduct clinical trials for eight of our product development programs. Investigational New Drug Applications, or INDs, were approved by the FDA and are active for seven of our product candidates. We also have obtained Clinical Trial Authorizations, or CTAs, for the ongoing Phase II clinical trial for MN-221 in Canada, Australia and New Zealand. Furthermore, through the acquisition of Avigen, we have assumed responsibility for AV411 clinical trials including one active IND for neuropathic pain and cross-reference and drug product support of the National Institute on Drug Abuse-funded opioid withdrawal investigator-initiated IND with Columbia University drug addiction clinical researchers.

It may take years to complete the clinical development necessary to commercialize a drug, and delays or failure can occur at any stage, which may result in our inability to market and sell any products derived from any of our product candidates that are ultimately approved by the FDA or foreign regulatory authorities. Our clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical and/or non-clinical testing. For example, in October 2007, we announced that our Phase II clinical trial of MN-305 for the treatment of insomnia failed to achieve statistical significance in its primary endpoint, and, as a result, we terminated development of MN-305 for the treatment of insomnia. Of the large number of drugs in development, only a small percentage result in the submission of an NDA to the FDA and even fewer are approved for commercialization. Interim results of clinical trials do not necessarily predict final results, and success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials even after promising results in earlier clinical trials. In addition, any delays in completing clinical trials or the rejection of data from a clinical trial by a regulatory authority will result in increased development costs and could have a material adverse effect on the development of the impacted product candidate.

In connection with the conduct of clinical trials for each of our product candidates, we face many risks, including the risks that: