MEDICINOVA INC - Quarter Report: 2011 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, 2011

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  x    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 10, 2011, the registrant had 15,285,706 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.

On June 29, 2011, we executed a joint venture agreement with Zhejiang Medicine Co., Ltd. and Beijing Make-Friend Medicine Technology Co., Ltd., which provides for the formation of a joint venture company to develop and commercialize MN-221 in China (China JV). Final approval from the Ministry of Commerce of the People’s Republic of China with respect to the joint venture has not yet been obtained.

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, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011 or for any other period. For further information, see the financial statements and disclosures thereto for the year ended December 31, 2010 in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 31, 2011.

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.

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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 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.

We have sustained operating losses since inception and expect such losses to continue over the next several years. We believe our existing cash and cash equivalents at June 30, 2011, will be sufficient through June 30, 2012, to fund our forecasted research and development expenses and our fixed contractual obligations; however, we will be required to implement another reduction-in-force unless we complete one or more additional financing transactions and/or corporate partnerships by the first quarter of 2012. Although there can be no assurances given, should we successfully raise cash, we would then re-assess the necessity to further down-size the company. On the other hand, if adequate funds are not available, we will be required to delay, reduce the scope of or terminate one or more of our product development programs and relinquish some or all rights to product candidates, all of which would raise substantial doubt as to our ability to continue as a going concern. As of June 30, 2011, the accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern.

2. 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 matured on June 18, 2011, the 18-month anniversary of the closing of the merger. Holders of these convertible notes could convert their notes into our common stock at an initial conversion price of $6.80 per share through May 31, 2011. At the maturity of the convertible notes, the remaining holders were paid out the same per share amount as the Avigen shareholders that elected to receive cash at the merger closing, plus accrued interest, approximately $1.19 per share. As part of the merger consideration, the former Avigen shareholders were also entitled to receive approximately $0.04 per share, which was paid in two increments in 2010, and rights under contingent payment rights issued as part of the merger consideration. The amount paid in the two installments was net of a reconciliation of Avigen expenses and a letter of credit after expiry. In fiscal year 2010, under the first and second installments, we paid $140,119 and $73,449, respectively, to Avigen shareholders who elected payment in cash and we issued an additional principal amount of $685,917 and $359,551, respectively, in convertible notes to Avigen shareholders who elected payment in convertible notes in lieu of a cash payment. 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.

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The following table reconciles the December 31, 2010 carrying value of the acquisition related assets and liabilities with their respective balances at June 30, 2011:

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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 Avigen merger.

3. Fair Value Measurements—Other Than Intangibles and Goodwill

As defined in the authoritative guidance for fair value measurements and disclosures, 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, 2011, cash and cash equivalents (instruments with maturities of three months or less at the date of purchase) were $11.9 million, which were invested in money market accounts and money market funds. At June 30, 2011, we no longer held any restricted cash. We measure our cash equivalents on a recurring basis and the fair value of these current 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, 2011, we no longer held any financial instruments measured at fair value on a non-recurring basis.

4. 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 stated interest rate on the loan was 12.87 percent. The effective interest rate on the debt financing was calculated to be 18.14 percent.

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

In connection with the Loan Agreement, we issued to Oxford a warrant to purchase up to 198,020 shares of our common stock. This warrant is exercisable, immediately, in whole or in part, 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.

On March 31, 2011, we executed a pay-off letter between us and Oxford, in which we negotiated the repayment of the loan in-full on April 1, 2011 and Oxford agreed to waive the early payment penalty of approximately $437,000.

We had accounted for the interest on the 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

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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 was recorded as interest expense and the amortization of the debt issuance costs paid to third parties was recorded as other expense in our consolidated statement of operations. On April 1, 2011, pursuant to a payoff agreement between us and Oxford, we paid Oxford approximately $15.2 million and paid the loan in-full, which resulted in the write-off of approximately $0.5 million, which was recorded in our consolidated statement of operations. The table below summarizes the early repayment of the debt:

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 three and six months ended June 30, 2011, 29,401 and 73,989, respectively, and for the three and six months ended June 30, 2010, 313,181 and 292,085, respectively, of potentially dilutive securities were excluded from determining diluted earnings per share because of their anti-dilutive effect.

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6. Comprehensive Income (Loss)

The authoritative guidance for comprehensive income 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:

As of June 30, 2011 and 2010, our comprehensive loss was $10,342,421 and $9,493,771, respectively.

7. Balance Sheet Detail

Accrued Expenses

A substantial portion of our ongoing research and development activities are performed under agreements we enter into with external service providers, including clinical research organizations, which conduct many of our research and development activities. A portion of our ongoing general and administrative activities relate to legal, accounting and consulting services. We accrue for costs incurred as the services are being provided by monitoring the status of clinical trials or specific projects or services rendered, contractual factors such as milestones or retainer fees and the invoices received from our external service providers. Accrued expenses consist of the following:

8. Share-Based Payments

For the three months ended June 30, 2011 and 2010, share-based compensation expense related to stock options of approximately $115,000 and $400,000, respectively, was recorded as a component of general and administrative expense, and approximately $43,000 and $100,000, respectively, was recorded as research and development expense. For the six months ended June 30, 2011 and 2010, share-based compensation expense related to stock options of approximately $ 245,000 and $900,000, respectively, was recorded as a component of general and administrative expense, and approximately $88,000 and $200,000, respectively, was recorded as research and development expense.

During the three and six months ended June 30, 2011, stock options to purchase 29,998 shares of common stock and 31,915 shares of common stock, respectively, were exercised for approximately $66,000 and $74,200, respectively. As of June 30, 2011, there was $1.5 million of unamortized compensation cost related to unvested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 2.3 years.

During the three and six months ended June 30, 2011, options to purchase 4,000 shares of common stock were granted. During the three and six months ended June 30, 2010, respectively, options to purchase 125,000

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shares and 525,000 shares of common stock were granted. The exercise price of the options granted was equal to market value on the date of grant and the share-based compensation expense for such stock options is reflected in operating results for the three and six months ended June 30, 2011. 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 months ended June 30, 2011 was based on stock option awards ultimately expected to vest, such expense should be reduced for estimated forfeitures. The authoritative guidance for compensation expense 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 half of 2011, 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 months ended June 30, 2011, estimated as of the grant date using the Black-Scholes option valuation model, was $1.34 per stock option, whereas 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.

9. Income Taxes

In accordance with the authoritative guidance for income taxes, 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, 2011 and we have not recorded any uncertain income tax benefits at June 30, 2011.

10. Commitments and Contingencies

Legal Proceedings

On March 3, 2011, we received a legal letter from a former employee who had been terminated in January 2011 pursuant to our planned reduction-in-force to save costs. The legal letter did not assert a claim outright;

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however, there were allegations made in the legal letter that could threaten litigation against us. We have engaged legal counsel in connection with the possibility of a lawsuit given this legal letter and the fact that this former employee’s separation agreement has expired. Given the inherent uncertainty and unpredictability of litigation and due to the status of this legal action, no range of loss or possible loss can be reasonably estimated. However, we do not expect the outcome of this matter to have a material adverse effect on our consolidated financial statements.

We may become involved in various disputes and legal proceedings which arise in the ordinary course of business. While it is not possible to accurately predict or determine the outcome of these matters, an adverse result in any of these matters may occur which could harm our business.

11. 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, 2011 is as follows:

The aggregate intrinsic value of stock options exercised during the six months ended June 30, 2011 was approximately $5,000. The aggregate intrinsic value of stock options outstanding at June 30, 2011 and exercisable at June 30, 2011 was approximately $87,000 and approximately $51,000, respectively. Of the total stock options outstanding as of June 30, 2011, options to purchase 1,282,984 shares of common stock are exercisable, with a weighted average exercise price of $ 8.94 per share and a weighted average contractual life of 6.0 years.

Employee Stock Purchase Plan (“ESPP”)

The following assumptions were used to value the March 31, 2011 employee stock purchases: a risk-free interest rate of 0.16 percent, expected volatility of 78 percent, expected term of six months and a dividend rate of 0 percent. There were no ESPP stock purchases for the three months ended June 30, 2011. For the six months ended June 30, 2011, 1,826 shares of common stock were issued under the ESPP and 272,301 shares of common stock were available for future issuance.

Convertible Notes

Prior to the maturity of the convertible notes on June 18, 2011, holders of the convertible notes could submit conversion notices, which were 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 was the final business day of each calendar month, we would issue the number of whole shares of

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common stock issuable upon conversion as promptly as practicable (and in any event within 10 business days). The trustee would in turn release to us the respective amount of restricted cash to cover the stock issuance. We would 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) would be rounded down and we would deliver cash for the current market value of the fractional share. For the three and six months ended June 30, 2011, approximately $40,000 and $76,000, respectively, of convertible notes was converted into 5,857 shares of our commons stock and 11,246 shares of our common stock, respectively. All remaining convertible notes expired on June 18, 2011.

Firm Commitment Underwritten Public Offering

On March 23, 2011, we announced a firm-commitment underwritten public offering of 2,750,000 units at a price to the public of $3.00 per unit for gross proceeds of $8.25 million. Each unit consists of one share of common stock, and a warrant to purchase one share of common stock. The shares of common stock and warrants are immediately separable and were issued separately. The warrants are exercisable immediately upon issuance, have a five-year term and an exercise price of $3.56 per share. On March 24, 2011, the underwriter exercised 50,666 units of its 412,500 unit overallotment. On March 29, 2011, we received net proceeds of approximately $7.9 million, after underwriter discount and underwriter expenses and no warrants exercised. In accordance with the authoritative guidance, we concluded that the warrants were indexed to our stock and do not permit net-cash settlement. Therefore, the warrants were classified as equity instruments and are not being marked to market prospectively as long as they continue to meet the conditions for equity classification.

At-The-Market Issuance Sales Agreement

On May 5, 2011, we entered into an at-the-market issuance sales agreement, or sales agreement, with McNicoll, Lewis & Vlak LLC, or MLV, pursuant to which we may issue and sell shares of our common stock having an aggregate offering price of up to $15.0 million from time to time through MLV as our sales agent. The issuance and sale of these shares by us under the sales agreement, if any, is subject to the effectiveness of our shelf registration statement on Form S-3 (File No. 333-163116), initially filed with the Securities and Exchange Commission on November 13, 2009.

Sales of our common stock through MLV, if any, will be made on The NASDAQ Global Market by means of ordinary brokers’ transactions at market prices, in block transactions or as otherwise agreed by us and MLV. Subject to the terms and conditions of the sales agreement, MLV will use commercially reasonable efforts to sell our common stock from time to time, based upon our instructions (including any price, time or size limits or other customary parameters or conditions we may impose). We are not obligated to make any sales of common stock under the sales agreement and may terminate the sales agreement at any time on 10 days notice. We will pay MLV an aggregate commission rate of 3.0% of the gross proceeds of the sales price per share of any common stock sold through MLV under the sales agreement. We have also provided MLV with customary indemnification rights. We have also engaged Ladenburg, Thalmann & Co., or Ladenburg, to act as a financial advisor in connection with the offering contemplated by the sales agreement and agreed to pay Ladenburg a fee of 0.5% of the gross proceeds of any “at-the-market” equity offering consummated in connection therewith payable upon the closing of each such “at-the-market” equity offering. For the three and six months ended June 30, 2011 we have not issued any shares of common stock under the sales agreement.

12. Subsequent Events

On July 6, 2011, we entered into a fifth amendment, the Lease Amendment, of our lease agreement, the Lease, with 4350 La Jolla Village LLC, the Landlord. The Lease Amendment amends the Lease of our headquarters located at 4350 La Jolla Village Drive, Suite 950, San Diego, California, 92122, and extends the Lease term for nine additional months with respect to 5,089 square feet, from August 31, 2011 to May 31, 2012. The Lease Amendment provides that we will pay the Landlord a monthly base rent of $12,468.00 for the premises during the nine-month extension period.

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On August 10, 2011, we announced a clinical trial collaboration with a headache and pain specialist in the Clinical Pharmacology department at the University of Adelaide, Australia who is initiating a Phase 2 trial of ibudilast (MN-166/AV411) as a potential new pharmacotherapy for medication overuse headache (MOH). This investigator-initiated and investigator-funded MOH trial has cleared necessary reviews and we will provide active drug and placebo product, as well as regulatory support for the trial. We do not expect that collaboration in the MOH trial will have a material effect on our financial condition.

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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, 2010 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 31, 2011. 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, but are not limited to, 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, 2011, from inception, our accumulated deficit was approximately $277.9 million, including $48.6 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. While there can be no assurances given, we will need to successfully complete one or more additional financing transactions and/or corporate partnerships in the near-term; otherwise, we will not have sufficient cash or other liquidity to fund our operations as currently conducted and staffed for the following 12 months, which raises substantial doubt as to our ability to continue as a going concern.

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.

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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 product candidate was AV411, a macrophage migration inhibitory factor and a glial attenuator for central nervous system, or CNS, disorders, such as neuropathic pain, progressive MS or drug (opioid and methamphetamine) addiction. We continue to integrate the two ibudilast-based product development programs and pursue 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 2 clinical trials, we intend to enter into strategic alliances with leading pharmaceutical or biotech companies to support further clinical development, and plan to keep certain commercialization rights in select markets. In addition, we continue to limit development activities for the balance of our existing product candidates in order to focus on our prioritized programs. 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.

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

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Avigen Transaction

In December 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 matured on June 18, 2011, the 18-month anniversary of the closing of the merger. Holders of these convertible notes could 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 were paid out the same per share amount as the Avigen shareholders that elected to receive cash at the merger closing, plus accrued interest, approximately $1.19 per share. As part of the merger consideration, the former Avigen shareholders received approximately $0.04 per share, which was paid in two increments in 2010, and rights under contingent payment rights issued as part of the merger consideration.

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. As a result, we recorded $4.8 million of IPR&D related to Avigen’s AV411 asset and we recorded $9.6 million of goodwill related to the excess purchase price over the assigned values of the net assets acquired. 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, 2011 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.

Debt

On May 10, 2010, we entered into a loan and security agreement, or the Loan Agreement, with Oxford, under which we borrowed $15.0 million. The financing was used to satisfy working capital needs, including the continued clinical development of MN-221. The stated interest rate on the loan was 12.87 percent. The effective interest rate on the loan was 18.14 percent 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 accounted for the interest on the debt under the effective interest method wherein we treated the debt issuance costs paid directly to Oxford and the fair value of the warrants issued to Oxford 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 was recorded as interest expense and the amortization of the debt issuance costs paid to third parties was recorded as other expense in our consolidated statement of operations.

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On March 31, 2011, we and Oxford executed a pay-off letter in which Oxford waived early payment penalties of approximately $437,000 and we repaid the loan in-full on April 1, 2011, which resulted in the write-off of the debt related costs.

Reduction-in-Force

In January 2011, we commenced a reduction-in-force, or RIF, wherein we down-sized the company to save costs. We believe that with this RIF, we are adequately staffed given our research and development focus and that we are a development stage company.

Chinese Joint Venture

On June 29, 2011, we executed a joint venture agreement with Zhejiang Medicine Co., Ltd. and Beijing Make-Friend Medicine Technology Co., Ltd., which provides for the formation of a joint venture company to develop and commercialize MN-221 in China (China JV). Final approval from the Ministry of Commerce of the People’s Republic of China with respect to the joint venture has not yet been obtained.

Underwritten Firm Commitment Public Offering

On March 23, 2011, we announced a firm-commitment underwritten public offering of 2,750,000 units at a price to the public of $3.00 per unit for gross proceeds of $8.25 million. Each unit consists of one share of common stock, and a warrant to purchase one share of common stock. The shares of common stock and warrants are immediately separable and were issued separately. The warrants are exercisable immediately upon issuance, have a five-year term and an exercise price of $3.56 per share. On March 24, 2011, the underwriter exercised 50,666 units of its 412,500 unit overallotment. On March 29, 2011, we received net proceeds of approximately $7.9 million, after underwriter discount and underwriter expenses and no warrants exercised. In accordance with the authoritative guidance, we concluded that the warrants were indexed to our stock and do not permit net-cash settlement. Therefore, the warrants were classified as equity instruments and are not being marked to market prospectively as long as they continue to meet the conditions for equity classification.

At-The-Market Issuance Sales Agreement

On May 5, 2011, we entered into an at-the-market issuance sales agreement, or sales agreement, with McNicoll, Lewis & Vlak LLC, or MLV, pursuant to which we may issue and sell shares of our common stock having an aggregate offering price of up to $15.0 million from time to time through MLV as our sales agent. The issuance and sale of these shares by us under the sales agreement, if any, is subject to the effectiveness of our shelf registration statement on Form S-3 (File No. 333-163116), initially filed with the Securities and Exchange Commission on November 13, 2009.

Sales of our common stock through MLV, if any, will be made on The NASDAQ Global Market by means of ordinary brokers’ transactions at market prices, in block transactions or as otherwise agreed by us and MLV. Subject to the terms and conditions of the sales agreement, MLV will use commercially reasonable efforts to sell our common stock from time to time, based upon our instructions (including any price, time or size limits or other customary parameters or conditions we may impose). We are not obligated to make any sales of common stock under the sales agreement and may terminate the sales agreement at any time on 10 days notice. We will pay MLV an aggregate commission rate of 3.0% of the gross proceeds of the sales price per share of any common stock sold through MLV under the sales agreement. We have also provided MLV with customary indemnification rights. We have also engaged Ladenburg, Thalmann & Co., or Ladenburg, to act as a financial advisor in connection with the offering contemplated by the sales agreement and agreed to pay Ladenburg a fee of 0.5% of the gross proceeds of any “at-the-market” equity offering consummated in connection therewith payable upon the closing of each such “at-the-market” equity offering. For the three and six months ended June 30, 2011 we have not issued any shares of common stock under the sales agreement.

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Subsequent Events

On July 6, 2011, we entered into a fifth amendment, the Lease Amendment, of our lease agreement, the Lease, with 4350 La Jolla Village LLC, the Landlord. The Lease Amendment amends the Lease of our headquarters located at 4350 La Jolla Village Drive, Suite 950, San Diego, California, 92122, and extends the Lease term for nine additional months with respect to 5,089 square feet, from August 31, 2011 to May 31, 2012. The Lease Amendment provides that we will pay the Landlord a monthly base rent of $12,468.00 for the premises during the nine-month extension period.

On August 10, 2011, we announced a clinical trial collaboration with a headache and pain specialist in the Clinical Pharmacology department at the University of Adelaide, Australia who is initiating a Phase 2 trial of ibudilast (MN-166/AV411) as a potential new pharmacotherapy for medication overuse headache (MOH). This investigator-initiated and investigator-funded MOH trial has cleared necessary reviews and we will provide active drug and placebo product, as well as regulatory support for the trial. We do not expect that collaboration in the MOH trial will have a material effect on our 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 customers. 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.

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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):

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. In 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. In the second quarter of 2008 we completed the Phase 2 clinical trial of MN-166 ibudilast for the treatment of MS and in December 2009, through the Avigen acquisition, we acquired AV411 ibudilast for the treatment of other CNS disorders. We continue to work on combing 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. We anticipate that our research and development expenses will increase with respect to MN-221 over the next two quarters as we strive to complete the current clinical trial, MN-221 CL-007, which is set in the ER. In addition, with respect to MN-166/AV411, in future periods, 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.

Following the last protocol amendment change to MN-221-CL-007 in 2010, we are experiencing a higher average enrollment rate for the quarter over last year’s average enrollment rate for the quarter. While we anticipate enrolling the last patient in this study by the end of 2011, due to the risks inherent in the clinical development process and given that this study is set in the ER, we are unable to estimate with certainty the costs that we will incur in the continued development of such product candidate and that we will complete this study as expected.

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

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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

Our investment securities had consisted of auction rate securities, or 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 insurance notes and portfolios of securities (primarily commercial paper).

Certain of our ARS were subject to a settlement in which we received the right to sell back certain of our ARS at par value at any time during the period beginning June 30, 2010 and ending July 2, 2012 and we were offered a no net cost loan program, or ARS Loan, whereby the interest cost would not exceed the interest being paid on the underlying ARS investments.

As of December 31, 2010, we no longer held any investment securities.

Write-off of Debt Related Costs

The Oxford loan had an original maturity of July 31, 2013, assuming certain affirmative covenants were met as of March 31, 2011. To preserve cash by saving on future interest payments, we negotiated with Oxford early repayment of the loan in-full on April 1, 2011, wherein the prepayment penalty of $437,000 was waived. In recording the loan repayment, we wrote off the unamortized debt discount and debt issuance costs related to the loan, which resulted in a total write-off of approximately $0.5 million being recorded in our statement of operations during the three and six months ended June 30, 2011.

Foreign Exchange Loss/(Gain)

To date, we have conducted most of our clinical trials in the United States. However, the Phase 2 clinical trial for MN-166 for the treatment of MS that completed in 2008 was conducted in Eastern Europe and the on-going Phase 2 clinical trial in MN-221 for the treatment of acute exacerbations of asthma, had a few clinical sites located in Australia and New Zealand in which certain of the invoices were denominated the Australian dollar and 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 Pound. 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 consisted of accretion related to the convertible notes and the amortization of debt issuance costs paid to third parties.

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Interest Expense

Interest expense consisted 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 investment securities.

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, 2010, as filed with the SEC on March 31, 2011.

Recently Issued Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board, or FASB, issued an accounting standard regarding comprehensive income. This recently issued accounting standard (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. This ASU is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011. We will adopt this standard in January 2012. As this accounting standard only requires enhanced disclosure, the adoption of this standard will not impact our financial position or results of operations.

In May 2011, the FASB issued clarification regarding fair value measurements. This recently issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. We will adopt this standard in January 2012. We do not expect that adoption of this standard will have a material impact on our financial position or results of operations.

In December 2010, the FASB issued updated guidance related goodwill impairment testing. This guidance requires an entity to use an equity premise when performing the first step of a goodwill impairment test and if a reporting unit has a zero or negative carrying amount, the entity must assess and consider qualitative factors and whether it is more likely than not that a goodwill impairment exists. The second step continues to compare the carrying amount of the reporting unit’s goodwill to its implied fair value. The guidance is effective for public entities, for impairment tests performed during entities’ fiscal years (and interim periods within those years) that begin after December 15, 2010. We adopted the updated guidance in January 2011 and using the transitional approach we determined not to perform an interim goodwill impairment test given that we operate as one reporting segment and did not have a zero or negative carrying amount. We will continue to monitor our stock price and equity and assess qualitative factors. However, should our stock price continue to decline, possible impairment of goodwill could have a material impact on our consolidated financial statements.

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Results of Operations

Comparison of the Three Months Ended June 30, 2011 and 2010

Revenues

There were no revenues for the three months ended June 30, 2011 or June 30, 2010.

Research and Development

Research and development expenses for the three months ended June 30, 2011 were $2.0 million, a decrease of $0.3 million when compared to $2.3 million for the three months ended June 30, 2010. This decrease in research and development expenses was primarily due to a decrease of $0.2 million in spending on our prioritized asset MN-221 for the treatment of acute exacerbations of asthma and COPD due primarily to the completion of the COPD and bioavailability clinical trials in 2010, offset by an increase MN-221 CL007 clinical trial expenses due to an increase in patient enrollment over prior year’s quarter and a decrease of $0.1 in unallocated personnel costs primarily due to a reduction in headcount.

General and Administrative

General and administrative expenses were $1.7 million for the three months ended June 30, 2011, a decrease of $0.1 million when compared to $1.8 million for the three months ended June 30, 2010. This decrease in general and administrative expenses was due primarily to a decrease of $0.3 million in stock based compensation expense due to employee terminations, offset by a $0.2 million increase in professional fees due primarily to the Chinese JV agreement.

Write-off of Debt Related Costs

Write-off of debt related costs for the three months ended June 30, 2011 was $494,000, as compared to no write-off of debt related costs for the three months ended June 30, 2010. In April 2011, pursuant to the early repayment of our debt with Oxford, we wrote-off the unamortized debt discount and debt issuance costs related to the debt.

Impairment Charge/Gain, net, on Investment Securities

There was no impairment charge or gain on investment securities for the three months ended June 30, 2011, as compared to a net gain on investment securities of $64,000 for the three months ended June 30, 2010. In 2011 we no longer held any investment securities.

Foreign Exchange Loss/Gain

Foreign exchange loss for the three months ended June 30, 2011 was $200, as compared to a foreign exchange gain of $2,000 for the three months ended June 30, 2010. The foreign exchange loss in the current quarter was a result of the revaluation of Japanese yen-denominated liabilities, whereas in the second quarter of 2010, the revaluation of the Japanese yen-denominated liabilities resulted in a foreign exchange gain.

Other Expense

Other expense for the three months ended June 30, 2011 was $31,000, as compared to $43,000 for the three months ended June 30, 2010. For the second quarter of 2011, other expense consists only of accretion related to the convertible notes as our debt with Oxford was repaid on April 1. In the second quarter of 2010, other expense related to both accretion on the convertible notes and amortization of debt issuance costs paid to third parties related to the long-term debt.

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Interest Expense

Interest expense for the three months ended June 30, 2011 was $450,000, as compared to $406,000 for the three months ended June 30, 2010. The increase in interest expense was due to the payment of the deferred interest upon repayment of our debt with Oxford. In 2010, interest expense was comprised of interest charged on the debt using the effective interest method and interest charged on the ARS Loan which was repaid in 2010.

Other Income

Other income for the three months ended June 30, 2011 was $16,000, as compared to $201,000 for the three months ended June 30, 2010. The decrease is due to a decrease in interest income due to a lower yield earned on invested balances as we converted higher yielding investment securities into cash and cash equivalents, which were invested in money market funds to preserve liquidity and principal.

Comparison of the Six Months Ended June 30, 2011 and 2010

Revenues

There were no revenues for the six months ended June 30, 2011 or June 30, 2010.

Research and Development

Research and development expenses for the six months ended June 30, 2011 were $4.7 million, a decrease of $0.6 million when compared to $5.3 million for the six months ended June 30, 2010. This decrease in research and development expenses was primarily due to a decrease of $0.6 million in spending on our prioritized asset MN-221 for the treatment of acute exacerbations of asthma and COPD due the completion of the COPD and bioavailability clinical trials and less drug manufacturing costs, offset by increased clinical trial costs in our on-going MN-221-CL-007 clinical trial due to higher enrollment in the study, as compared to the study’s enrollment in the prior year.

General and Administrative

General and administrative expenses were $4.0 million for the six months ended June 30, 2011, a decrease of $0.1 million when compared to $4.1 million for the six months ended June 30, 2010. This decrease in general and administrative expenses of $0.1 million was due primarily to a decrease in stock-based compensation expense due to a reduction in headcount, offset by an increase in professional fees related to the financing transactions and the China JV agreement.

Write-off of Debt Related Costs

Write-off of debt related costs for the six months ended June 30, 2011 was $494,000, as compared to no write-off of debt related costs for the six months ended June 30, 2010. In April 2011, pursuant to the early repayment of our debt with Oxford, we wrote-off the unamortized debt discount and debt issuance costs related to the debt.

Impairment Charge/Gain, net, on Investment Securities

There was no impairment charge or gain on investment securities for the six months ended June 30, 2011, as compared to a net gain on investment securities of $57,000 for the six months ended June 30, 2010. In 2011 we no longer held any investment securities.

Foreign Exchange Loss/Gain

Foreign exchange gain for the six months ended June 30, 2011 was $200, as compared to a foreign exchange loss of $2,000 for the six months ended June 30, 2010. The foreign exchange gain/loss for the six months ended June 30, 2011 and 2010 relate to the remeasurement of foreign payables.

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Other Expense

Other expense for the six months ended June 30, 2011 was $84,000, as compared to $75,000 for the six months ended June 30, 2010. Other expense relates to accretion on the convertible notes and amortization of debt issuance costs paid to third parties. The increase is due to a longer amortization period in 2011 as the debt was procured in May 2010.

Interest Expense

Interest expense for the six months ended June 30, 2011 was $1.1 million, as compared to $450,000 for the six months ended June 30, 2010. The increase in interest expense was due to the lump-sum payment of the deferred interest in April upon repayment of our debt with Oxford, whereas in 2010 interest expense was comprised on interest expense on the debt, derived under the effective interest method, and interest paid on our ARS Loan in which was repaid in the third quarter of 2010.

Other Income

Other income for the six months ended June 30, 2011 was $42,000, as compared to $362,000 for the six months ended June 30, 2010. The decrease is due to a decrease in interest income due to a lower yield earned on invested balances as we converted higher yielding investment securities into cash and cash equivalents, which were invested in money market funds to preserve liquidity and principal.

Liquidity and Capital Resources

We incurred losses of $4,681,348 and $10,337,078 for the three and six months ended June 30, 2011 and we have incurred losses of $20,187,308, $20,368,890 and $21,924,829 for the years ended December 31, 2010, 2009, and 2008 respectively. We have an accumulated deficit of $277,875,484 as of June 30, 2011. Additionally, we have used net cash of $9,384,326, $17,698,079, $17,014,162 and $21,118,380 to fund our operating activities for the six months ended June 30, 2011 and for the years ended December 31, 2010, 2009, and 2008, respectively. To date these operating losses have been funded primarily through the private placement of our equity securities, the public sale of our common stock, debt, the conversion of convertible notes to our common stock and the exercise of founders’ warrants, net of treasury stock repurchases.

As a development stage company, we have consumed substantial amounts of capital since our inception. We do not have any material commitments for capital expenditures; however, we have an on-going 200 patient Phase 2 clinical trial (MN-221-CL-007) for which we expect to complete enrollment by the end of 2011. Our clinical studies are administered by third-party CROs and there is a significant degree of estimation involved in quantifying the expense associated with clinical trial activity. We accrue costs for work performed by CROs based on the achievement of contracted milestone activities and on internal estimates of activities using patient enrollment and contractual or estimated rates during the period. If we do not receive complete and accurate information from the CRO or third parties on a timely basis or correctly estimate the outcome of contract negotiations, activity levels and the enrollment rate, this could potentially impact R&D expense and cash payments in subsequent periods.

We have had, and continue to have, an ongoing need to raise additional cash from outside sources to fund our operations. We have an established history of raising capital through equity and debt, and we are currently involved in discussions with multiple parties. In March 2011, we raised approximately $7.9 million in net proceeds from a firm underwritten public offering in which we offered 2,750,000 units, with each unit consisting of one share of common stock and a warrant to purchase one share of common stock. The purchase price for each unit was $3.00 and each warrant has an exercise price of $3.56 per share. In addition, in March 2011, the underwriter exercised 50,666 units of its 412,500 unit overallotment. Our current cash and cash equivalents, along with the proceeds from this offering, are our principal sources of liquidity as the convertible notes expired on June 18, 2011 and we have released all of our restricted assets to the respective noteholders. In May 2011, we

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entered into an at-the-market issuance sales agreement, with a sales agent, pursuant to which we may issue and sell shares of our common stock having an aggregate offering price of up to $15.0 million from time to time through the sales agent, subject to the effectiveness of our shelf registration statement on Form S-3, initially filed with the Securities and Exchange Commission on November 13, 2009. Our business will continue to require us to incur substantial research and development.

Although there can be no assurance given, we hope to successfully complete one or more additional financing transactions and/or corporate partnerships in the near-term; otherwise, we will not have sufficient cash or other liquidity to fund our operations as currently conducted and staffed for the following 12 months which raises substantial doubt as to our ability to continue as a going concern. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. If we are unsuccessful in our efforts to raise outside capital in the immediate near term through our effective S-3 shelf registration and/or our discussions with potential strategic partners, we will be required to delay, reduce the scope of or terminate one or more of our product development programs and relinquish some or even all rights to product candidates. In parallel, we would be required to implement another RIF, implement additional cost reduction measures related to compensation and employee benefits, and reduce our professional fees and our travel spending to minimize operating costs, to offset the lack of available funding.

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.

Cash and cash equivalents as of June 30, 2011 were $11.9 million and were primarily invested in money market interest bearing accounts and money market funds. A hypothetical 10% adverse change in the average interest rate on our money market cash investments and short-term investments would have had no material effect on net income for the year ended June 30, 2011.

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 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,

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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 March 3, 2011, we received a legal letter from a former employee who had been terminated in January 2011 pursuant to our planned reduction-in-force to save costs. The legal letter did not assert a claim outright; however, there were allegations made in the legal letter that could threaten litigation against us. We have engaged legal counsel in connection with the possibility of a lawsuit given this legal letter and the fact that this former employee’s separation agreement has expired. Given the inherent uncertainty and unpredictability of litigation and due to the status of this legal action, no range of loss or possible loss can be reasonably estimated. However, we do not expect the outcome of this matter to have a material adverse effect on our consolidated financial statements.

We may become involved in various disputes and legal proceedings which arise in the ordinary course of business. While it is not possible to accurately predict or determine the outcome of these matters, an adverse result in any of these matters may occur which could harm our business.

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 and six months ended June 30, 2011, we had a net loss of $4.7 million and $10.3 million, respectively, and our accumulated deficit was approximately $277.9 million. If we are successful in securing a strategic collaboration or 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.

If we have taxable income in the future, utilization of the net operating losses, or NOL, and tax credit carryforwards will be subject to a substantial annual limitation under Section 382 and 383 of the Internal Revenue Code of 1986, and similar state provisions due to ownership change limitations that have occurred. These ownership changes will limit the amount of NOL and tax credit carryforwards that can be utilized to offset future taxable income and tax, respectively.

We believe our existing cash and cash equivalents at June 30, 2011 will be sufficient to fund our forecasted research and development expenses and our fixed obligations over the next 12 months. However, we will need to successfully complete one or more additional financing transactions and/or corporate partnerships in the near-term; otherwise, we will not have sufficient cash or other liquidity to fund our operations as currently conducted and staffed for the following 12 months which raises doubt as to our ability to continue as a going concern.

These assumptions may prove to be wrong, and we could spend our available financial resources before we complete the clinical trial. Our future capital requirements will also depend on many factors, including:

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