Originally Posted by taupe
Yes. It's definitely epub, not PDF.
Just to make sure I wasn't doing something wrong, I just grabbed another epub book from Gutenberg and converted it to mobi, and the formatting turned out fine. So it appears to be an issue with the one file.
Is there anything in particular which would cause an epub file to not format correctly when converted?
Well, if someone had created it with a fixed line length - making each line a separate paragraph. Such as a hasty conversion from a PDF.
The answer to your questions lies inside the ePub. Unzip it and take a look at the xhtml files inside, and see what's going on.