Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **x** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**For The Quarterly Period Ended September 30, 2009**

 

**OR**

 
| **o** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|----------------------------------------------------------------------------------------------------------|

** **

**FOR THE TRANSITION PERIOD FROM                      TO            **

 

**Commission File Number****001-33523**

 

**COMBIMATRIX CORPORATION**

(Exact Name of Registrant as Specified inIts Charter)

 

| **Delaware**                                    | ** ** | **47-0899439**      |
|-------------------------------------------------|------------|---------------------|
| (State or Other Jurisdiction of                 |       | (I.R.S. Employer    |
| Incorporation or Organization)                  |       | Identification No.) |
|                                            |       |                |
| **6500 Harbour Heights Pkwy., Suite 303,** |       |                |
| **Mukilteo, WA**                                | ** ** | **98275**           |
| (Address of  Principal Executive Offices)       |       | (Zip Code)          |

 

Registrant’s telephone number, includingarea code: ** (425) 493-2000**

 

 

(Former name, former address and formerfiscal year, if changed since last report.)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to filing requirements for thepast 90 days. Yes xNo o

 

Indicate by check mark whether the registranthas submitted electronically and posted on its corporate Website, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).Yes oNo o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large accelerated filer o                                              |   | Accelerated filer o         |
|-----------------------------------------------------------------------------|--------|----------------------------------|
|                                                                        |   |                             |
| Non-accelerated filer o

(Do not check if a smaller reporting company) |   | Smaller reporting company x |

 

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

 

As ofNovember 9, 2009, 7,571,886 shares of CombiMatrixCorporation common stock were issued and outstanding.

 

 

** **

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**COMBIMATRIX**CORPORATION

**Table of Contents**

 
| ** Part I. Financial Information** | ** **                                                                                                               |
|----------------------------------------------|--------------------------------------------------------------------------------------------------------------------------|
|                                         |                                                                                                                     |   |
| Item 1.                                      | Financial  Statements                                                                                                    |   |
|                                         |                                                                                                                     |   |
|                                         | Consolidated  Balance Sheets as of September 30, 2009 (Unaudited) and December 31, 2008                        | 3 |
|                                         |                                                                                                                     |   |
|                                         | Consolidated Statements of Operations for the Three  and Nine Months Ended September 30, 2009 and 2008  (Unaudited) | 4 |
|                                         |                                                                                                                     |   |
|                                         | Consolidated Statements of Cash Flows for the Nine  Months Ended September 30, 2009 and 2008 (Unaudited)            | 5 |
|                                         |                                                                                                                     |   |
|                                         | Notes to Consolidated Financial Statements (Unaudited)                                                                   | 6 |
|                                         |                                                                                                                     |   |
| Item 2.                                      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                              | 17 |
|                                         |                                                                                                                     |   |
| Item 3.                                      | Quantitative  and Qualitative Disclosures about Market Risk                                                              | 24 |
|                                         |                                                                                                                     |   |
| Item 4T.                                     | Controls and  Procedures                                                                                                 | 24 |
|                                         |                                                                                                                     |   |
| **Part II.  Other Information**         | ** **                                                                                                               |
|                                         |                                                                                                                     |   |
| Item 1.                                      | Legal Proceedings                                                                                                        | 25 |
|                                         |                                                                                                                     |   |
| Item 2.                                      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                             | 25 |
|                                         |                                                                                                                     |   |
| Item 5.                                      | Other Information                                                                                                        | 25 |
|                                         |                                                                                                                     |   |
| Item  6.                                     | Exhibits                                                                                                                 | 26 |
|                                         |                                                                                                                     |   |
| **Signatures**                               |                                                                                                                     | 27 |
|                                         |                                                                                                                     |   |
| **Exhibit Index**                       |                                                                                                                     | 28 |

 

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** **

**COMBIMATRIXCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

** **
| ** **                                                                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                            | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                            | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                            |       |                   |       |                  |       |
|                                                                                                                  |       |                   |       |                  |       |
| Current assets:                                                                                                       |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                            |       | $                      | 7,905      |                  | $          | 7,579 |   |
| Available-for-sale  investments                                                                                       |       | —                 |       | 1,526                 |       |
| Accounts receivable,  net of allowance for doubtful accounts of $655 and $378                                         |       | 681                    |       | 916                   |       |
| Inventory                                                                                                             |       | 773                    |       | 725                   |       |
| Prepaid expenses and  other assets                                                                                    |       | 346                    |       | 219                   |       |
| Total current assets                                                                                                  |       | 9,705                  |       | 10,965                |       |
|                                                                                                                  |       |                   |       |                  |       |
| Property and equipment,  net                                                                                          |       | 516                    |       | 743                   |       |
| Investments in  unconsolidated subsidiaries                                                                           |       | 299                    |       | 938                   |       |
| Patents and licenses,  net                                                                                            |       | 4,099                  |       | 4,970                 |       |
| Goodwill                                                                                                              |       | 16,918                 |       | 16,918                |       |
| Total assets                                                                                                          |       | $                      | 31,537     |                  | $          | 34,534 |   |
|                                                                                                                  |       |                   |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                        |       |                   |       |                  |       |
|                                                                                                                  |       |                   |       |                  |       |
| Current liabilities:                                                                                                  |       |                   |       |                  |       |
| Accounts payable,  accrued expenses and other                                                                         |       | $                      | 1,992      |                  | $          | 2,130 |   |
| Credit line borrowings                                                                                                |       | —                 |       | 820                   |       |
| Current portion of  deferred revenues                                                                                 |       | 306                    |       | 418                   |       |
| Total current  liabilities                                                                                            |       | 2,298                  |       | 3,368                 |       |
|                                                                                                                  |       |                   |       |                  |       |
| Deferred revenues, net  of current portion                                                                            |       | 25                     |       | 125                   |       |
| Capital lease  obligation, net of current portion                                                                     |       | 33                     |       | 43                    |       |
| Secured convertible  debenture                                                                                        |       | 7,271                  |       | 6,483                 |       |
| Other liabilities                                                                                                     |       | 848                    |       | 469                   |       |
| Total liabilities                                                                                                     |       | 10,475                 |       | 10,488                |       |
|                                                                                                                  |       |                   |       |                  |       |
| Commitments and  contingencies (Note 8)                                                                               |       |                   |       |                  |       |
|                                                                                                                  |       |                   |       |                  |       |
| Shareholders’ equity:                                                                                            |       |                   |       |                  |       |
| Preferred stock; $0.001  par value; 5,000,000 shares authorized; none issued and outstanding                          |       | —                 |       | —                |       |
| Common stock; $0.001  par value; 25,000,000 shares authorized; 7,539,313 and 6,288,033 shares  issued and outstanding |       | 8                      |       | 6                     |       |
| Additional paid-in  capital                                                                                           |       | 54,728                 |       | 43,650                |       |
| Accumulated net losses                                                                                                |       | (33,674                | )          | (19,610               | )          |
| Total shareholders’  equity                                                                                      |       | 21,062                 |       | 24,046                |       |
| Total liabilities and  shareholders’ equity                                                                      |       | $                      | 31,537     |                  | $          | 34,534 |   |

** **

***The accompanyingnotes are an integral part of these consolidated financial statements.***

 

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**COMBIMATRIXCORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except share and per share information)**

**(Unaudited)**

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                    | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Revenues:                                                     |       |                   |       |                   |       |   |   |   |   |
| Government contracts                                          |       | $                      | 133        |                   | $          | 343 |   | $ | 949 |   | $ | 2,380 |   |
| Products                                                      |       | 250                    |       | 158                    |       | 807 |   | 1,356 |   |
| Services                                                      |       | 524                    |       | 448                    |       | 1,802 |   | 1,145 |   |
| Collaboration  agreements                                     |       | 63                     |       | 62                     |       | 188 |   | 186 |   |
| Total revenues                                                |       | 970                    |       | 1,011                  |       | 3,746 |   | 5,067 |   |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Operating expenses:                                           |       |                   |       |                   |       |   |   |   |   |
| Cost of government  contract revenues                         |       | 125                    |       | 336                    |       | 862 |   | 2,305 |   |
| Cost of products and  services                                |       | 409                    |       | 370                    |       | 1,587 |   | 1,258 |   |
| Research and  development expenses                            |       | 1,401                  |       | 1,336                  |       | 3,814 |   | 3,595 |   |
| Marketing, general and  administrative expenses               |       | 2,340                  |       | 2,301                  |       | 7,970 |   | 6,781 |   |
| Patent amortization and  royalties                            |       | 337                    |       | 341                    |       | 1,016 |   | 1,063 |   |
| Equity in loss of  investee                                   |       | 107                    |       | 247                    |       | 618 |   | 737 |   |
| Total operating  expenses                                     |       | 4,719                  |       | 4,931                  |       | 15,867 |   | 15,739 |   |
| Operating loss                                                |       | (3,749                 | )          | (3,920                 | )          | (12,121 | ) | (10,672 | ) |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Other income (expense):                                       |       |                   |       |                   |       |   |   |   |   |
| Interest income                                               |       | 2                      |       | 58                     |       | 17 |   | 183 |   |
| Interest expense                                              |       | (531                   | )          | (403                   | )          | (1,553 | ) | (408 | ) |
| Derivatives credits  (charges)                                |       | 977                    |       | 16                     |       | (407 | ) | 16 |   |
| Total other income  (expense)                                 |       | 448                    |       | (329                   | )          | (1,943 | ) | (209 | ) |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Net loss                                                      |       | $                      | (3,301     | )                      | $          | (4,249 | ) | $ | (14,064 | ) | $ | (10,881 | ) |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Basic and diluted net  loss per share                         |       | $                      | (0.44      | )                      | $          | (0.70 | ) | $ | (2.01 | ) | $ | (1.80 | ) |
|                                                          |       |                   |       |                   |       |   |   |   |   |
| Basic and diluted  weighted average common shares outstanding |       | 7,512,401              |       | 6,097,086              |       | 6,983,157 |   | 6,040,214 |   |

** **

***The accompanyingnotes are an integral part of these consolidated financial statements.***

** **

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**COMBIMATRIXCORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                      | ** ** | **September 30,** | ** ** |
| ** **                                                                      | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                                            |       |                   |       |   |   |
| Operating activities:                                                           |       |                   |       |   |   |
| Net loss                                                                        |       | $                      | (14,064    | ) | $ | (10,881 | ) |
| Adjustments to  reconcile net loss to net cash flows from operating activities: |       |                   |       |   |   |
| Depreciation and  amortization                                                  |       | 1,157                  |       | 1,352 |   |
| Non-cash stock  compensation                                                    |       | 2,535                  |       | 1,556 |   |
| Derivatives charges  (credits)                                                  |       | 407                    |       | (16 | ) |
| Equity in loss of  investees                                                    |       | 618                    |       | 737 |   |
| Warrants issued to  consultants                                                 |       | 135                    |       | — |   |
| Allowance for bad debt                                                          |       | 278                    |       | 248 |   |
| Amortization of debt  discount and issuance costs                               |       | 890                    |       | 181 |   |
| Changes in assets and  liabilities:                                             |       |                   |       |   |   |
| Accounts receivable                                                             |       | (43                    | )          | (561 | ) |
| Inventory, prepaid  expenses and other assets                                   |       | (175                   | )          | (284 | ) |
| Accounts payable,  accrued expenses and other                                   |       | 322                    |       | (310 | ) |
| Deferred revenues                                                               |       | (212                   | )          | (136 | ) |
| Net cash flows from  operating activities                                       |       | (8,152                 | )          | (8,114 | ) |
| Investing activities:                                                           |       |                   |       |   |   |
| Purchase of property  and equipment                                             |       | (59                    | )          | (55 | ) |
| Sale of  available-for-sale investments                                         |       | 1,526                  |       | 4,030 |   |
| Net cash flows from  investing activities                                       |       | 1,467                  |       | 3,975 |   |
| Financing activities:                                                           |       |                   |       |   |   |
| Proceeds from issuance  of secured convertible debenture                        |       | —                 |       | 10,000 |   |
| Payment of debt  issuance costs                                                 |       | —                 |       | (248 | ) |
| Net proceeds from  issuance of common stock                                     |       | 7,846                  |       | 711 |   |
| (Repayment) draw on  credit line                                                |       | (820                   | )          | 808 |   |
| Repayment of capital  lease obligations                                         |       | (15                    | )          | (21 | ) |
| Net cash flows from  financing activities                                       |       | 7,011                  |       | 11,250 |   |
|                                                                            |       |                   |       |   |   |
| Increase in cash and  cash equivalents                                          |       | 326                    |       | 7,111 |   |
| Cash and cash  equivalents, beginning                                           |       | 7,579                  |       | 2,314 |   |
| Cash and cash  equivalents, ending                                              |       | $                      | 7,905      |   | $ | 9,425 |   |
|                                                                            |       |                   |       |   |   |
| Non-cash financing  activities:                                                 |       |                   |       |   |   |
| Reclassification of  warrant liabilities to paid-in capital                     |       | $                      | —     |   | $ | 1,780 |   |
|                                                                            |       |                   |       |   |   |
| Accrued interest paid  in common stock                                          |       | $                      | 634        |   | $ | — |   |
|                                                                            |       |                   |       |   |   |
| Conversion of secured  convertible debenture to common stock                    |       | $                      | 100        |   | $ | 1,300 |   |

** **

***The accompanyingnotes are an integral part of these consolidated financial statements.***

 

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**COMBIMATRIX CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

****1.    OVERVIEW AND BACKGROUND****

 

CombiMatrixCorporation (the “Company” “we” “us” and “our”) was originally incorporated in October 1995as a California corporation and later reincorporated as a Delaware corporationin September 2000.  On December 13,2002 (the “Merger Date”), we merged with and became a wholly owned subsidiaryof Acacia Research Corporation (“Acacia”). Also on the Merger Date, Acacia entered into a recapitalizationtransaction whereby Acacia created two classes of registered common stockcalled Acacia Research-CombiMatrix common stock (“AR-CombiMatrix stock”) andAcacia Research-Acacia Technologies common stock (“AR-Acacia Technologies stock”)and divided its existing Acacia common stock into shares of the two new classesof common stock.  On August 15,2007, we split-off from Acacia (the “Redemption Date”), and all currentlyissued and outstanding shares of AR-CombiMatrix stock were redeemed andexchanged for shares of CombiMatrix common stock at a redemption ratio of tenshares of AR-CombiMatrix stock for one share of CombiMatrix common stock (the “RedemptionRatio”), which is currently traded on the Nasdaq Global Market.  Also, warrants to purchase AR-CombiMatrixstock became exercisable to purchase CombiMatrix common stock, adjusted for theRedemption Ratio.  As of the RedemptionDate, we ceased to be a subsidiary of, or affiliated with, Acacia.

 

*****Description ofthe Company*****

 

****Weare a diversified biotechnology business that develops proprietarytechnologies, including products and services in the areas of drug development,genetic analysis, molecular diagnostics, nanotechnology and defense andhomeland security markets, as well as in other potential markets where ourproducts and services could be utilized. The technologies we have developedinclude a platform technology to rapidly produce user-defined, in-situsynthesized, oligonucleotide arrays for use in identifying and determining theroles of genes, gene mutations and proteins. This technology has a wide rangeof potential applications in the areas of genomics, proteomics, biosensors,drug discovery, drug development, diagnostics, combinatorial chemistry,material sciences and nanotechnology. Other technologies include proprietary molecularsynthesis and screening methods for the discovery of potential new drugs****.  We currently recognize revenues from sellingthese products and services and providing research and development services fororganizations including the U.S. Department of Defense (“DoD”) and otherstrategic partners.

 

CombiMatrixMolecular Diagnostics, Inc. (“CMDX”), our wholly owned subsidiary locatedin Irvine, California, has developed capabilities of producing arrays thatutilize bacterial artificial chromosomes, or “BACs,” which also enable geneticanalysis.  CMDX functions primarily as adiagnostics reference laboratory.

 

LeuchemixInc. (“Leuchemix”), a minority owned subsidiary, is developing a series ofcompounds to address a number of oncology-related diseases.

 

*****Basis ofPresentation*****

 

The accompanyingconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andwith the instructions to Form 10-Q and Rule 10-01 of RegulationS-X.  Accordingly, certain informationand footnotes required by generally accepted accounting principles in annualfinancial statements have been omitted or condensed in accordance withquarterly reporting requirements of the SEC. These interim consolidated financial statements should be read inconjunction with the consolidated financial statements and notes thereto forthe year ended December 31, 2008, as reported by us in our Annual Reporton Form 10-K filed on March 27, 2009. The year-end consolidated balance sheet data was derived from auditedfinancial statements but does not include all disclosures required byaccounting principles generally accepted in the United States of America.  The consolidated financial statements includeall adjustments of a normal recurring nature which, in the opinion ofmanagement, are necessary for a fair statement of our financial position as of September 30,2009, and results of operations and cash flows for the interim periodspresented.  The results of operations forthe three and nine months ended September 30, 2009 are not necessarilyindicative of the results to be expected for the entire year.

 

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**COMBIMATRIX CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**(Unaudited)**

 

*****Liquidity andRisks*****

 

Wehave a history of incurring net losses and net operating cash flowdeficits.  We are also deploying new andunproven technologies and continue to develop commercial products. We haveseveral ongoing long-term development projects that involve experimentaltechnology and may require several years and substantial expenditures tocomplete.  Based on our cash andinvestment balances as of December 31, 2008, we believed that our cash andcash equivalent balances, anticipated cash flows from operations and otherexternal sources of available credit would be sufficient to meet our cashrequirements to September 2009, which raised substantial doubt about ourability to continue as a going concern beyond this point.  On May 1, 2009, we closed a registereddirect offering of our common stock and warrants which, after placement agentfees and other costs, netted approximately $7.6 million to us (see Note 7),which management believes extends our going concern to June 2010.

 

Inorder for us to continue operating as a going concern beyond June 2010, wewill be required to increase revenues, reduce operating costs and possibly toobtain capital from external sources. However, there can be no assurances that additional sources offinancing, including the issuance of debt and/or equity securities will beavailable at times and at terms acceptable to us.  The issuance of equity securities, should thatoccur, will cause dilution to our shareholders. If external sources of financing are not available or are inadequate tofund our operations, we will be required to reduce operating costs includingresearch projects and personnel, which could jeopardize the future strategicinitiatives and business plans of the Company. For example, reductions in research and development activities and/orpersonnel at our Mukilteo, Washington facility could result in the inability toinvest the resources necessary to continue to develop next-generation productsand improve existing product lines in order to remain competitive in themarketplace, resulting in reduced revenues and cash flows from the sales of ourCustomArrayTM products and services.  Also, reduction in operating costs at CMDX,should they occur, could jeopardize its ability to launch, market and selladditional products and services necessary in order to grow and sustain itsoperations and eventually achieve profitability.

 

Our businessoperations are also subject to certain risks and uncertainties, including:

 

·                  market acceptance of products andservices;

 

·                  technological advances that may make ourproducts and services obsolete or less competitive;

 

·                  increases in operating costs, includingcosts for supplies, personnel and equipment;

 

·                  the availability and cost of capital;

 

·                  the financial crisis affecting the globalbanking system and financial markets; and

 

·                  governmental regulation that may restrictour business.

 

Oursuccess also depends on our ability to protect our intellectual property, theloss thereof or our failure to secure the issuance of additional patentscovering elements of our business processes could materially harm our businessand financial condition.  The patentscovering our core technology begin to expire in 2018.

 

Ourproducts and services are concentrated in a highly competitive market that ischaracterized by rapid technological advances, frequent changes in customerrequirements and evolving regulatory requirements and industry standards.  Failure to anticipate or respond adequatelyto technological advances, changes in customer requirements, changes inregulatory requirements or industry standards, or any significant delays in thedevelopment or introduction of planned products or services, could have amaterial adverse effect on our business and operating results.  The accompanying consolidated financialstatements have been prepared assuming that the Company continues as a goingconcern.  The financial statements do notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that may result from the matters discussed herein.

 

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**COMBIMATRIX CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (CONTINUED)**

**(Unaudited)**

 

****2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES****

 

*****Recent Accounting Pronouncements.********* ****In June 2009, the Financial Accounting StandardsBoard (“FASB”) issued the Accounting Standards Codification (“ASC”) as thesingle source of authoritative U.S. GAAP recognized by the FASB to be appliedby nongovernmental entities in preparation of financial statements inconformity with U.S. GAAP, except for additional authoritative rules andinterpretative releases issued by the SEC. While the adoption of the ASC as of September 30, 2009 changes howaccounting standards are referenced, the adoption did not have an impact on ourconsolidated financial statements.

 

In October 2009, theFASB ratified new authoritative accounting guidance to require companies toallocate revenue in multiple-element arrangements based on an element’sestimated selling price if vendor-specific or other third-party evidence ofvalue is not available. The new guidance is effective for revenue transactionsentered into during fiscal years beginning on or after June 15, 2010, withearlier application permitted.  We arecurrently evaluating both the timing and the impact of the pending adoption ofthe guidance on our consolidated financial statements.

 

In June 2009,the FASB issued new authoritative guidance to eliminate the quantitativeapproach previously required for determining the primary beneficiary of avariable interest entity and requires ongoing qualitative reassessments ofwhether an enterprise is the primary beneficiary of a variable interestentity.  We will adopt this guidance forinterim and annual reporting periods beginning on November 15, 2009.  We do not expect the adoption of thisguidance to have any material impact on our consolidated financial statements.

 

In April 2009, theFASB issued additional authoritative guidance on the fair value of financialinstruments, which provides: (i) further provisions on estimating fairvalue when the markets become inactive and quoted prices reflect distressedtransactions; (ii) extended disclosure requirements for interim financialstatements regarding the fair value of financial instruments; and (iii) newcriteria for recording impairment charges on investments in debtinstruments.  We adopted the guidance ona prospective basis in the interim period ended June 30, 2009 withoutmaterial impact to our consolidated financial statements.

 

In June 2008, the FASB ratified newauthoritative guidance addressingthe accounting for certain instruments (or embedded features) determined to beindexed to an entity’s own stock.   This guidance provides that an entity shoulduse a two-step approach to evaluate whether an equity-linked financialinstrument (or embedded feature) is indexed to its own stock, includingevaluating the instrument’s contingent exercise and settlement provisions.  We chose to early-adopt this guidance in2008.  See Note 6 below for furtherdiscussion of the impact of this guidance to our consolidated financialstatements.

 

*Use of Estimates. *The preparation of financial statements in conformity withgenerally accepted accounting principles in the United States of Americarequires management to make estimates and assumptions that affect the reportedamount of assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting period. Actualresults could differ from these estimates.

 

**RevenueRecognition**. We recognize revenue when (i) persuasiveevidence of an arrangement exists, (ii) delivery has occurred or serviceshave been performed, (iii) amounts are fixed or determinable and (iv) collectibilityof amounts is reasonably assured.

 

Revenuefrom the sale of products and services, including shipping and handling feesbut excluding statutory taxes collected from customers, as applicable, arerecognized when delivery has occurred or services have been rendered.  We sell our products and services directly tocustomers and also through distributors, and our right to collection is notdependent upon installation or a subsequent sale of our products to end-users.  Our standard agreements do not provide forcredits, returns or exchanges with our customers or distributors.  Our distribution agreements include fixedpricing arrangements for our products and after customer acceptance, there isno written or implied right to return or exchange the products.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS****(CONTINUED)**

**(Unaudited)**

 

Revenuesfrom government contracts are recognized using the partial performance methodof accounting, whereby performance to date is established based on costsincurred to the total amount of estimated costs at each reporting period.  Under the partial performance method ofaccounting, contract revenues and costs are recognized in the period that workis performed based on the percentage of actual incurred costs to total contractcosts.  The partial performance method isused to recognize revenue because management considers actual costs incurred tobe the best available measure of progress towards the completion of governmentcontracts, the total profit can be reasonably computed, and collection isreasonably assured.  Actual contractcosts include direct charges for labor and materials and indirect charges forlabor, overhead and certain general and administrative charges.  Contract change orders and claims areincluded when they can be reliably estimated and are considered probable.  For contracts that extend over a one-yearperiod, revisions in contract cost estimates, if they occur, have the effect ofadjusting current period earnings applicable to performance in priorperiods.  Should current contractestimates indicate an overall future loss to be incurred, a provision is madefor the total anticipated loss in the current period.  Historically, contract revenue recognizedapproximates the amounts invoiced, resulting in no estimated costs and earningsin excess of billings or billings in excess of estimated costs and earnings.

 

Revenuesfrom multiple-element arrangements involving license fees, up-front payments,milestone payments, products and/or services, which are received and/orbillable by us in connection with other rights and services that representcontinuing obligations of ours, are deferred until all of the elements havebeen delivered or until we have established objective and verifiable evidenceof the fair value of the undelivered elements.

 

Deferredrevenues arise from payments received in advance of the culmination of theearnings process.  Deferred revenuesexpected to be recognized within the next twelve months are classified withincurrent liabilities.  Deferred revenues willbe recognized as revenue in future periods when the applicable revenue recognitioncriteria as described above are met.

 

**Stock-BasedCompensation**.  The compensation cost for allstock-based awards is measured at the grant date, based on the fair value ofthe award, and is recognized as an expense, on a straight-line basis, over theemployee’s requisite service period (generally the vesting period of the equityaward) which is generally three years. The fair value of each option award is estimated on the date of grantusing a Black-Scholes option valuation model. Stock-based compensation expense is recognized only for those awardsthat are expected to vest using an estimated forfeiture rate.  We estimate pre-vesting option forfeitures atthe time of grant and reflect the impact of estimated pre-vesting optionforfeitures in compensation expense recognized. Stock-based compensation expense for all periods presented attributableto our functional expense categories were as follows (in thousands; unaudited):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                             | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of products and  services         |       | $                      | 13         |                   | $          | 12 |   | $ | 61 |   | $ | 23 |   |
| Research and  development              |       | 172                    |       | 121                    |       | 461 |   | 261 |   |
| Marketing, general and  administrative |       | 704                    |       | 654                    |       | 2,013 |   | 1,272 |   |
| Total non-cash stock  compensation     |       | $                      | 889        |                   | $          | 787 |   | $ | 2,535 |   | $ | 1,556 |   |

 

**NetLoss Per Share**. Basic and diluted net loss per share has been computed by dividing thenet loss by the weighted average number of common shares issued and outstandingduring the periods presented.  Optionsand warrants to purchase CombiMatrix stock are anti-dilutive and therefore arenot included in the determination of the diluted net loss per share.  The following table presents a reconciliationof basic and diluted loss per share for all periods presented (in thousands,except share and per-share data; unaudited):

 
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | **Nine  Months Ended** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2009**                | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Numerator:                                  |       |                    |       |                   |       |   |   |   |   |
| Loss applicable to  common shareholders     |       | $                       | (3,301     | )                      | $          | (4,249 | ) | $ | (14,064 | ) | $ | (10,881 | ) |
| Denominator:                                |       |                    |       |                   |       |   |   |   |   |
| Weighted-average common  shares outstanding |       | 7,512,401               |       | 6,097,086              |       | 6,983,157 |   | 6,040,214 |   |
| Basic and diluted loss  per share           |       | $                       | (0.44      | )                      | $          | (0.70 | ) | $ | (2.01 | ) | $ | (1.80 | ) |
|                                        |       |                    |       |                   |       |   |   |   |   |
| Common stock options                        |       | 1,980,577               |       | 1,579,490              |       | 1,980,577 |   | 1,579,490 |   |
| Common stock warrants                       |       | 3,813,646               |       | 2,593,958              |       | 3,813,646 |   | 2,593,958 |   |
| Convertible debenture                       |       | 1,120,000               |       | 732,940                |       | 1,120,000 |   | 732,940 |   |
| Excluded potentially  dilutive securities   |       | 6,914,223               |       | 4,906,388              |       | 6,914,223 |   | 4,906,388 |   |

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

**Available-For-SaleInvestments**. Investments in marketable securities with original maturities of lessthan three months are included in cash and cash equivalents, and investmentswith original maturities of greater than three months and less than one yearare classified as short-term. Investments in marketable securities are typically classified asavailable-for-sale, which are reported at fair value with related unrealizedgains and losses in the value of such securities recorded as a component ofaccumulated other comprehensive income until realized.  We monitor our investments for impairment,which are deemed to be other-than-temporary based on a variety of factorsincluding:  (a) the duration andseverity of the impairment; (b) the ability and intent to hold aninvestment for a period of time sufficient for recovery of its carrying amount;and (c) the financial condition of the issuer.  All available evidence, both positive andnegative, is considered to determine whether the carrying amount of theinvestment is recoverable within a reasonable period of time.  In general, management does not consider aninvestment impairment to be other-than-temporary if the duration and amount ofthe impairment is less than twelve months and five percent of the historicalcost of the investment, respectively.

 

*****Fair Value Measurements. *****Wemeasure fair value as an exit price, representing the amount that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants. As such, fair value is a market-based measurement that is determinedbased on assumptions that market participants would use in pricing an asset orliability.  We utilize a three-tier fairvalue hierarchy, which prioritizes the inputs used in measuring fair value asfollows:

 
| · | Level 1: | Observable market inputs  such as quoted prices in active markets;                                                                 |
|--------|----------|------------------------------------------------------------------------------------------------------------------------------------|
|   |     |                                                                                                                               |
| · | Level 2: | Observable  market inputs, other than the quoted prices in active markets, that are  observable either directly or indirectly; and |
|   |     |                                                                                                                               |
| · | Level 3: | Unobservable  inputs where there is little or no market data, which require the reporting  entity to develop its own assumptions.  |

 

*Derivatives Embedded in Certain Debt Securities. *We evaluate financial instruments forfreestanding or embedded derivatives. Derivative instruments that have been separated from the host contractand do not qualify for hedge accounting are recorded at fair value with changesin value recognized in as other income (expense) in the consolidated statementsof operations in the period of change.

 

*****Subsequent Events.********* ****Wehave evaluated subsequent events and transactions for potential recognition ordisclosure in the consolidated financial statements through November 13,2009, the day the financial statements were issued.

 

# **3.     FAIR VALUEMEASUREMENTS**

 

The following table summarizes, for each majorcategory of financial assets or liabilities measured on a recurring basis, therespective fair value at September 30, 2009 and the classification bylevel of input within the fair value hierarchy defined above (in thousands;unaudited):

 
| ** **                          | ** ** | **September 30,** | ** ** | **Fair Value Measurements at** | ** ** |
|-------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2009**               | ** ** | **Level 1**                    | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Assets:                             |       |                   |       |                           |       |   |   |   |   |
| Cash equivalents                    |       | $                      | 7,569      |                           | $          | 7,569 |   | $ | — |   | $ | — |   |
| Available-for-sale  investments (1) |       | —                 |       | —                         |       | — |   | — |   |
| Total                               |       | $                      | 7,569      |                           | $          | 7,569 |   | $ | — |   | $ | — |   |
|                                |       |                   |       |                           |       |   |   |   |   |
| Liabilities:                        |       |                   |       |                           |       |   |   |   |   |
| Embedded derivatives  (2)           |       | $                      | (848       | )                              | $          | — |   | $ | — |   | $ | (848 | ) |

 

----

(1)          Allavailable-for-sale investments previously categorized as Level 3 assets wereredeemed in January 2009.

(2)          Includedin “other liabilities” in the accompanying September 30, 2009 consolidatedbalance sheet.  See Note 6 below fordiscussion of fair value measurements relating to embedded derivatives.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

The following table is a reconciliation of financialassets and liabilities measured at fair value on a recurring basis usingsignificant unobservable inputs (Level 3) during the nine months ended September 30,2009 (in thousands; unaudited):

 
| ** **                         | ** ** | **Available-**  | ** ** | ** **      | ** ** |
|------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                         | ** ** | **For-Sale**    | ** ** | **Embedded**    | ** ** |
| ** **                         | ** ** | **Investments** | ** ** | **Derivatives** | ** ** |
|                               |       |            |       |            |       |
| Balances,  December 31, 2008  |       | $               | 1,526      |            | $          | (469 | ) |
| Redemption of ARS                  |       | (1,526          | )          | —          |       |
| Conversions                        |       | —          |       | 28              |       |
| Derivative charges                 |       | —          |       | (407            | )          |
| Balances,  September 30, 2009 |       | $               | —     |            | $          | (848 | ) |

 

At December 31, 2008,our available-for-sale investments included $1.5 million of auction ratesecurities (“ARS”) at par value. Historically, the carrying value of our ARS approximated fair value dueto active, liquid markets for these securities as well as the frequentresetting of the interest rates at auction, which typically occurred every 7 to30 days.  However, in mid-February 2008,the market for ARS collapsed and as a result, our ARS experienced multiplefailed auctions during 2008.  During thefourth quarter of 2008, one of the issuers of our holdings in ARS redeemed$350,000 at par value, bringing the total amount of ARS held by us as of December 31,2008 to $1.5 million.  On January 2,2009, all of our remaining ARS were liquidated at par value.

 

From mid-February 2008 through the third quarterof 2008, the fair values of our holdings in ARS were estimated using discountedcash flow models.  These models consider,among other things, the timing of expected future successful auctions,estimated future cash flows, collateralization and credit worthiness ofunderlying security investments and discount rates applied to the estimatedfuture cash flows.  Since these inputswere not observable, they were classified as Level 3 inputs.  As a result of the lack of liquidity in theARS market and not as a result of the quality of the underlying collateral, werecorded unrealized losses on our ARS of $31,000 and $166,000 for the three andnine months ended September 30, 2008, respectively.  However, due to liquidations of our ARS atpar value prior to and subsequent to December 31, 2008, we reversed ourpreviously recognized unrealized losses and classified our ARS as currentassets at par value in our December 31, 2008 consolidated balancesheet.

 

# **4.     COMPREHENSIVE LOSS**

# ** **

The following table shows ourcomprehensive net loss for all periods presented (in thousands; unaudited):

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                             | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net unrealized loss on  available-for-sale investments |       | $                      | —     |                   | $          | (31 | ) | $ | — |   | $ | (166 | ) |
| Net loss                                               |       | (3,301                 | )          | (4,249                 | )          | (14,064 | ) | (10,881 | ) |
| Comprehensive loss                                     |       | $                      | (3,301     | )                      | $          | (4,280 | ) | $ | (14,064 | ) | $ | (11,047 | ) |

 

# **5.  CREDIT LINE BORROWINGS**

# ** **

On May 9, 2008 and pursuant to a LoanManagement Account agreement (the “LMA”) with a financial institution (the “Lender”),we borrowed $808,000 from the Lender, secured by investments held in aninvestment account with the Lender.  TheLMA is similar to a revolving line of credit borrowing facility.  The LMA provided that we accrue monthlyinterest charges at an annual, variable rate of 1% plus the 30-day LIBORrate.  The total amount available underthe LMA ranged from 50% to 92% of investments pledged as collateral, based uponthe amount and security type in our investment portfolio, up to a maximumamount of $2.8 million.  The LMA had nostated maturity for the principal and interest amounts borrowed by us.  However, because the Lender had the abilityunder the terms of the LMA to call in the principal amount of the borrowings atany time, we classified the liability as a component of current liabilities inthe accompanying December 31, 2008 consolidated balance sheet.  The LMA balance of $820,000 as of December 31,2008 was repaid by us during the first quarter of 2009, however the LMA remainsavailable for future borrowings at similar terms if so chosen by management.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

**6.  SECURED CONVERTIBLE DEBENTURE**

 

On July 10, 2008 (the “Closing Date”), weissued to YA Global Investments, L.P. (“YA”): (i) a secured convertibledebenture (the “Debenture”) with an aggregate principal amount of $10 million,which was convertible into shares of our common stock at a fixedconversion price of $11.87 per share (and was recently reduced to $7.50 pershare - see Note 7); and (ii) warrants (the “YA Warrants”) topurchase up to 336,984 shares of our common stock.  The Debenture is due on theearlier of July 10, 2010 (the “Term”) or within four months after receiptof payment of judgment or settlement proceeds from National Union Fire Ins. Co.of Pittsburgh, PA (“National Union”) in accordance with the $35.7million judgment (the “Judgment”) issued by the U.S. District Court for theCentral District of California (the “District Court”).  The Debenture bears interest at an annualrate of 10%, with interest payments due quarterly in either cash or our commonstock, beginning October 2008.  Wehave the right to force conversion of the Debenture into our common stock ifthe volume-weighted average price (“VWAP”) of our stock exceeds between 125%and 135% of the fixed conversion price for a period of thirty consecutivetrading days, among other conditions and restrictions.  We also have a cash redemption option wherebywe have the right to pre-pay the Debenture during the Term, but only if ourcommon stock is trading below the fixed conversion price, among otherconditions.  Prepayment penalties rangebetween 5% and 10% during the first fifteen months of the Term and are 0%thereafter until maturity.  The number ofshares issuable to YA upon conversion of the Debenture may increase due tocertain anti-dilution adjustments, including if we issue common stock at aprice lower than the $7.50 fixed conversion price while the outstandingprincipal amount of the Debenture is at least $5 million.  As a result of our registered direct offeringthat closed on May 1, 2009, the fixed conversion price of the Debenturewas reduced from $11.87 per share to $7.50 per share pursuant to ananti-dilution adjustment (see Note 7).  The Debenture issecured by the Judgment as well as our intellectual property.  The YA Warrants have a five-year term andallow YA to purchase: (i) 168,492 shares of common stock at an exerciseprice of $11.87; and (ii) 168,492 shares of common stock at an exerciseprice of $13.65.  We have the right tocall the YA Warrants, but only if the VWAP of our common stock is at or greaterthan 130% of the YA Warrants’ exercise price for at least twenty consecutivetrading days, among other conditions.  Wehave registered shares of our common stock that are issuable to YA uponconversion of the Debenture and exercise of the YA Warrants on Form S-3,which was declared effective by the SEC during the third quarter of 2008.

 

*Recognition on the Closing Date*

 

On the Closing Date, we recognized the Debenture andYA Warrants based on their relative fair values of $8.2 million and $1.8million, respectively.  The fair value ofthe Debenture was determined using the convertible bond model, assuming a 15%yield.  The relative fair value of the YAWarrants was classified as a component of additional paid-in capital with thecorresponding amount reflected as a contra-liability to the Debenture.  The fair value of the warrants was determinedusing the Black-Scholes model, assuming a term of five years, volatility of75%, no dividends, and a risk-free interest rate of 3.1%.

 

The conversion feature, cash redemption option,potential acceleration of maturity of the Debenture upon payment of theJudgment proceeds and potential adjustments to the fixed conversion price allrepresent embedded derivatives that, as of the Closing Date, were valued inaggregate at $927,000 and recorded separately from the Debenture as otherliabilities, with a corresponding amount reflected as an additionalcontra-liability to the Debenture.  Thefair value of the embedded derivatives was determined using the convertiblebond model, discounted cash flows and binomial lattice models.

 

As a result of separating the YA Warrants andembedded derivatives from the Debenture, the aggregate contra-liabilitytotaling $2.9 million was recognized as of the Closing Date and was nettedagainst the Debenture, which will accrete to the face amount due YA over theTerm using the effective interest method, with the corresponding chargesrecorded as interest expense.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

*Recognition Subsequent to the Closing Date*

 

Since the Closing Date through September 30,2009, YA has converted $1.6 million of the Debenture into common stock, $1.5million of which was converted in 2008 and $100,000 of which was convertedduring the second quarter of 2009.  As ofSeptember 30, 2009 and December 31, 2008, the remaining amount of theDebenture, net of the aggregate contra-liability, was $7.3 million and $6.5million, respectively.  The embeddedderivative liabilities were marked to fair value of $848,000 and $768,000 as ofSeptember 30, 2009 and 2008, respectively, resulting in net non-operatingderivative credits (charges) of $977,000 and $(407,000) for the three and ninemonths ended September 30, 2009, respectively, and credits of $16,000 forthe three and nine months ended September 30, 2008, respectively.  As of September 30, 2009, the remainingprincipal amount of the Debenture was $8.4 million, with an estimated fairvalue of $8.1 million (excluding the embedded derivative features).

 

Since the issuance of the Debenture through September 30,2009, accrued interest to YA in the amount of $846,000 has been paid by issuing103,679 shares of our common stock. Subsequent to September 30, 2009 but prior to the issuance of thisreport, accrued interest to YA as of September 30, 2009 in the amount of$212,000 was paid by issuing 32,573 shares of our common stock.

 

# **7.  SHAREHOLDERS’ EQUITY**

# ** **

*Common Stock*

 

**On May 1, 2009, we closed aregistered direct offering (the “Offering”) of our common stock and warrantsfor gross proceeds of $8.25 million. Under the terms of the Offering, we sold 1.1 million units for $7.50 perunit to certain investors.  Each unitconsisted of one share of our common stock and one warrant, each warrant topurchase one share of our common stock at an exercise price of $9.00 per share.  The warrants may not be exercised until sixmonths after the Offering and have a term of five years.  The warrants are also callable if our commonstock trades at or above $22.50 per share during any 20 trading days during aperiod of 30 consecutive trading days, with a minimum daily trading volume of50,000 shares each day during that 30 trading day period.  Subsequent to the date of the Offering, welisted the warrants on the Nasdaq Global Market under the symbol “CBMXW”.  Net proceeds from the Offering, net ofplacement agent fees and expenses, were approximately $7.6 million.  As a result of executing the Offering, thefixed conversion price of the Debenture has been reduced to $7.50 per share,effective May 1, 2009.**

** **

*Warrants*

 

Prior to theRedemption Date, Acacia had issued warrants to purchase approximately 23.8million shares of AR-CombiMatrix stock in connection with various financingtransactions.  As of the Redemption Date,all previously outstanding AR-CombiMatrix common stock warrants becameexercisable for CombiMatrix common stock, adjusted for the Redemption Ratiodiscussed above.

 

Outstanding warrants to purchaseCombiMatrix common stock are as follows (unaudited):

 
| ** **          | ** ** | **Shares of Common Stock** | ** ** | ** **            | ** ** | ** **      | ** ** |
|---------------------|------------|----------------------------|------------|-----------------------|------------|-----------------|------------|
| ** **          | ** ** | **Issuable from Warrants** | ** ** | ** **            | ** ** | ** **      | ** ** |
| ** **          | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** | **Exercise**    | ** ** | ** ** | ** ** |
| **Date of Issue**   | ** ** | **2009**                   | ** ** | **2008**              | ** ** | **Price**       | ** ** | **Expiration** | ** ** |
|                | ** ** | ** **                 | ** ** |                  |       |            |       |   |   |
| June 2009      |       | 129,688                    |       | —                |       | $7.50 - $9.00   |       | May 2014 -  June 2014 |   |
| May 2009       |       | 1,100,000                  |       | —                |       | $9.00           |       | May 2014 |   |
| July 2008      |       | 336,984                    |       | 336,984               |       | $11.87 - $13.65 |       | July 2013 |   |
| May 2007       |       | 959,390                    |       | 959,390               |       | $5.50           |       | May 2012 |   |
| December 2006  |       | 1,127,936                  |       | 1,127,936             |       | $8.70 - $10.88  |       | December 2011 |   |
| September 2005 |       | 159,648                    |       | 159,648               |       | $24.00          |       | September 2010 |   |
| Total               |       | 3,813,646                  |       | 2,583,958             |       |            |       |   |   |

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

On May 19,2009 (the “Grant Date”), we issued three warrants (the “Consultant Warrants”)to a consultant to purchase a total of 125,000 shares of our common stock withan exercise price of $9.00 per share and a term of five years.  The first warrant is for 25,000 shares andbecomes fully vested six months after the Grant Date.  The second and third warrants (the “ContingentWarrants”) are for 50,000 shares each of common stock, and become fully vestedonly if our underlying stock price achieves or exceeds $12.00 and $14.00 pershare, respectively, for five consecutive trading days as quoted on Nasdaq,over a period of twenty-four months from the Grant Date.  If these terms are not achieved during thistwenty-four month period, the Contingent warrants will expire on May 19,2011.  Otherwise, if the vestingconditions are achieved within twenty-four months from the Grant Date, theContingent warrants will become fully exercisable for the remainder of thefive-year term.

 

The fair value of theConsultant Warrants is classified as a component of additional paid-in capital with thecorresponding amount reflected as a component of marketing, general andadministrative expenses in our consolidated statements of operations.  We recognized mark-to-model credits (charges)of $55,000 and $(116,000) for the three and nine months ended September 30,2009, respectively, using the Black-Scholes model, assuming a remaining term of4.6 years, volatility of 70%, no dividends, and a risk-free interest rate of2.3%.  In addition, the fair value of theContingent Warrants was determined using a Monte Carlo binomial stocksimulation model to determine the probability that the vesting conditions willbe achieved.  We will continue torecognize mark-to-model adjustments to the Consultant Warrants during theirrespective vesting periods.

 

**8.   COMMITMENTS AND CONTINGENCIES**

** **

**Collaborationand Research Agreements**

 

On September 11,2009, we executed a fifteen-month, $1.5 million contract with the U.S. AirForce Research Laboratory for the development of automated instrumentation thatuses our semiconductor microarray technologies for detecting chemical,biological and environmental hazards that can impact the health of deployedmilitary personnel.  Under the terms ofthis contract, we will perform research and development activities, asdescribed under the contract, and will be reimbursed on a periodic basis foractual costs incurred to perform these obligations, plus a fixed fee, of up to$1.5 million.  As of September 30,2009, we had incurred $54,000 in actual costs under this contract, which wasapproximately 5% complete.

 

On March 10, 2009, we executed a four-year,$858,000 contract with the NASA Ames Research Center (“NASA”)for further development of our microarray technologies.  The primary objective of the contract is todesign and test a microfluidics system that incorporates oursemiconductor-based microarray platform as part of an integrated geneticanalysis system that can be deployed in space. Under the terms of this contract, we will perform research anddevelopment activities during the first year (“Phase I”) for a fixed fee of$214,000.  If NASA chooses to continuedevelopment for each of the subsequent years two through four of the contract,we will continue development at similar funding levels to the first year, notto exceed a maximum fee of $858,000 for the entire contract period.  As of September 30, 2009, we hadincurred $66,000 in actual costs for Phase I of this contract, which wasapproximately 42% complete.

 

On July 31, 2008, we executed a $250,000contract with the DoD for the development of label-free detection techniquesusing our microarray technology.  These detection techniques involve thesynthesis of molecules known as “aptamers,” which are molecules with uniquebiological properties.  Wesubstantially completed this contract during the first quarter of 2009 and donot expect to incur additional costs or revenues from this contract beyond2009.

 

On July 11, 2008, we executed a fifteen-month,$923,000 contract with the DoD to further development of our microarraytechnologies for a multipathogen detection system.  The primary objectives of the contract are tocontinue development of an automated biothreat agent detection system basedupon our complementary metal oxide semiconductor microarray and electrochemicaldetection techniques, to continue the integration of serological and genomic assaysfor orthogonal testing and to explore new methods of detection that expandtarget identification, reduce reagent burden, and improve assay time.  Under the terms of this contract, we willperform research and development activities, as described under the contract,and will be reimbursed on a periodic basis for actual costs incurred to performthese obligations, plus a fixed fee, of up to $923,000.  We substantially completed this contractduring the second quarter of 2009 and do not expect to incur additional costsor revenues from this contract beyond 2009.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

On July 26,2007, we executed a one-year, $2.2 million contract with the DoD to furtherdevelopment of our microarray technologies. The primary objectives of the contract were to continue development of amultipathogen and chemical detection system. Under the terms of this contract, we performed research and development activities, as described under thecontract, and were reimbursed on a periodic basis for actual costs incurred toperform these obligations, plus a fixed fee, of up to $2.2 million.  We substantially completedthis contract during the third quarter of 2008 and do not expect to incuradditional costs or revenues from this contract beyond 2008.

 

On March 13,2007, we executed a one-year, $869,000 contract with the DoD, focusing on thedevelopment of a field-deployable influenza genotyping system based on ourelectrochemical detection technology to be used for military and homelandsecurity applications.  Under the termsof this contract, we performed research and development activities, asdescribed under the contract, and were reimbursed on a periodic basis foractual costs incurred to perform our obligations, plus a fixed fee, of up to$869,000.  We substantially completedthis contract during the second quarter of 2008 and do not expect to incursignificant costs or revenues from this contract beyond 2008.

 

On August 9,2006, we executed a two-year, $1.9 million contract with the DoD, focusing onthe integration of our electrochemical detection technology currently underdevelopment with our microfluidics “lab-on-a-chip” technology to be used formilitary and homeland security applications. Under the terms of this contract,we performed research and development activities, as described under thecontract, and were reimbursed on a periodic basis for actual costs incurred toperform our obligations, plus a fixed fee, of up to $1.9 million.  We substantially completed this contractduring the fourth quarter of 2008 and do not expect to incur significant costsor revenues from this contract beyond 2008.

 

**HumanResources**

 

Weprovide certain severance benefits such that if an executive of CombiMatrix whois a vice president or higher is terminated for other than cause, death ordisability, the executive will receive payments equal to three months’ basesalary plus medical and dental benefits. If termination occurs as a result of a change in control transaction,these benefits will be extended by three months.  Also, if our chief executive officer isterminated for other than cause, or for death or disability, he will receivepayments equal to one year’s base salary plus medical and dental benefits.

 

**Litigation**

 

On September 30,2002, we entered into a settlement agreement with Nanogen, Inc. (“Nanogen”)to settle all pending litigation between the parties.  Pursuant to the terms of the settlementagreement, we agreed to make quarterly payments to Nanogen equal to 12.5% oftotal sales of products developed by us and our affiliates based on the patentsthat had been in dispute in the litigation, up to an annual maximum amount of$1.5 million.  The minimum quarterlypayments under the settlement agreement are $25,000 per quarter until thepatents expire in 2018.  Royalty expensesrecognized under the agreement for the three and nine months ended September 30,2009 and 2008 were $25,000, $75,000, 25,000 and $116,000, respectively, and areincluded in patent amortization and royalties in the accompanying consolidatedstatements of operations.

 

In April 2005,Acacia and CombiMatrix filed a complaint against our insurance carrier,National Union, seeking reimbursement of litigation and settlement costs for alawsuit, pursuant to our directors’ and officers’ insurance policy withNational Union.  A trial was held andconcluded during the fourth quarter of 2007. In March 2008, the District Court issued its Judgment in favor ofAcacia and us, and awarded approximately $32.1 million in monetary damages tobe paid by National Union.  In accordancewith the distribution agreement entered into between Acacia and us prior to ourseparation, all proceeds from the lawsuit will be paid to us.  In May 2008, the District Court awardedus an additional $3.6 million in attorneys’ fees and litigation costs, therebyincreasing the overall award to $35.7 million. This award was entered as a final Judgment in May 2008 and willcontinue to earn interest until paid. In September 2008, the DistrictCourt required National Union to post an appellate bond in the amount of $39.2million to cover the Judgment as well as accrued interest charges.  The appellate bond will remain in place untilthe appeal process is concluded. National Union has appealed the Judgment to the U.S. Ninth CircuitCourt of Appeals (the “Appellate Court”), and we intend to vigorouslydefend against the appeal.  All appellatebriefs by us and National Union were filed during the second quarter of2009.  Recently, the Appellate Court seta date for an oral hearing whereby each party will have 15 minutes to presentarguments supplementing those in the briefs. The date of the hearing was originally November 2, 2009.  National Union has subsequently requested andwas granted a continuance of the oral hearing due to a conflict with itsattorneys’ schedules.  As of the date ofthis filing, the Appellate Court had not determined the revised date of thehearing.

 

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**COMBIMATRIXCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

**(Unaudited)**

 

We aresubject to other claims and legal actions that arise in the ordinary course ofbusiness.  We believe that the ultimateliability with respect to these claims and legal actions, if any, will not havea material effect on our financial position, results of operations or cashflows.  Based on a distribution agreementexecuted between us and Acacia, it is expected that such claims, legal actions,etc. attributable to CombiMatrix Corporation prior to the Redemption Date willremain with the Company subsequent to the Redemption Date, however.  As of the date of this report and for allperiods presented, we are not aware of the existence of any such claims or legalactions.

 

**9.    SUBSEQUENTEVENT**

** **

**On November 10, 2009, our Board of Directorsapproved an Executive Change of Control Severance Plan (the “Severance Plan”)that affects certain of our senior management-level employees.  Pursuantto the Severance Plan, if a participating employee is involuntarily terminated(other than for death, disability or for cause) or resigns for “good reason”(as defined in the Severance Plan) during the two-year period following a “changeof control” (as defined in the Severance Plan) of the Company, then, subject toexecution of a release of claims against the Company, the employee will beentitled to receive: (i) a cash severance payment equal to one timesannual base salary, in the case of our Chief Executive Officer; or one-halftimes annual base salary, in the case of other participating employees; (ii) immediatevesting of outstanding compensatory equity awards; and (iii) payment ofCOBRA premiums for the participating employee and eligible dependants for apre-determined period of time.  Payment of benefits under the SeverancePlan will be limited by provisions contained in Section 409A ofthe U.S. Internal Revenue Code.  The Severance Plan is administered by aplan administrator, which initially is the Compensation Committee of the Boardof Directors.  In order to participate in the Severance Plan, an eligibleemployee must waive any prior retention or severance agreements.**

 

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**Item2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

** **

**Cautionary Statement**

 

You shouldread the following discussion and analysis in conjunction with the consolidatedfinancial statements and related notes thereto contained in Part I, Item 1of this report.  The informationcontained in this Quarterly Report on Form 10-Q is not a completedescription of our businesses or the risks associated with an investment in ourcommon stock.  We urge you to carefullyreview and consider the various disclosures made by us in this report and inour other reports filed with the U.S. Securities and Exchange Commission, or “SEC,”including our Annual Report on Form 10-K, filed on March 27, 2009.

 

This reportcontains forward-looking statements within the meaning of the “safe harbor”provisions of the Private Securities Litigation Reform Act of 1995. Referenceis made in particular to the description of our plans and objectives for futureoperations, assumptions underlying such plans and objectives, and otherforward-looking statements included in this report. Such statements may beidentified by the use of forward-looking terminology such as “may,” “will,” “expect,”“believe,” “estimate,” “anticipate,” “intend,” “continue,” or similar terms,variations of such terms or the negative of such terms.  Such statements are based on management’scurrent expectations and are subject to a number of factors and uncertainties,which could cause actual results to differ materially from those described inthe forward-looking statements.  Suchstatements address future events and conditions concerning product development,capital expenditures, earnings, litigation, regulatory matters, markets forproducts and services, liquidity and capital resources and accountingmatters.  Actual results in each casecould differ materially from those anticipated in such statements by reason offactors such as future economic conditions, changes in consumer demand, legislative,regulatory and competitive developments in markets in which we and oursubsidiaries operate, results of litigation and other circumstances affectinganticipated revenues and costs.  Weexpressly disclaim any obligation or undertaking to release publicly anyupdates or revisions to any forward-looking statements contained herein toreflect any change in our expectations with regard thereto or any change inevents, conditions or circumstances on which any such statement is based.  Additional factors that could cause suchresults to differ materially from those described in the forward-lookingstatements are set forth in connection with the forward-looking statements andin the “Risk Factors” described in our Annual Report on Form 10-K filed onMarch 27, 2009.

 

## **General**

## ** **

****Weare a diversified biotechnology business that develops proprietarytechnologies, including products and services in the areas of drug development,genetic analysis, molecular diagnostics, nanotechnology and defense andhomeland security markets, as well as in other potential markets where ourproducts and services could be utilized. The technologies we have developedinclude a platform technology to rapidly produce user-defined, in-situsynthesized, oligonucleotide arrays for use in identifying and determining theroles of genes, gene mutations and proteins. This technology has a wide rangeof potential applications in the areas of genomics, proteomics, biosensors,drug discovery, drug development, diagnostics, combinatorial chemistry,material sciences and nanotechnology. Other technologies include proprietarymolecular synthesis and screening methods for the discovery of potential newdrugs.****  Wecurrently recognize revenues from selling these products and services andproviding research and development services for organizations including theU.S. Department of Defense, or “DoD” and other strategic partners.

 

CombiMatrixMolecular Diagnostics, Inc., or “**CMDX,**”our wholly owned subsidiary located in Irvine, California, has developedcapabilities of producing arrays that utilize bacterial artificial chromosomes,or “BACs,” which also enable genetic analysis. CMDX functions primarily as a diagnostics reference laboratory.

 

LeuchemixInc. (“Leuchemix”), a minority owned subsidiary, is developing a series ofcompounds to address a number of oncology-related diseases.

 

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## **RelationshipWith Acacia Research Corporation**

## ** **

Wewere originally incorporated in October 1995 as a California corporationand later reincorporated as a Delaware corporation in September 2000. On December 13,2002, we merged with and became a wholly owned subsidiary of Acacia ResearchCorporation, or “**Acacia**.”On the same date, Acacia entered into a recapitalization transaction wherebyAcacia created two classes of registered common stock called AcaciaResearch-CombiMatrix common stock (“**AR-CombiMatrix stock**”) andAcacia Research-Acacia Technologies common stock (“**AR-Acacia Technologies stock**”)and divided its existing Acacia common stock into shares of the two new classesof common stock.  On August 15, 2007(the “Redemption Date”), we split-off from Acacia and all issued andoutstanding shares of AR-CombiMatrix stock were redeemed and exchanged forshares of CombiMatrix common stock at a redemption ratio of ten shares ofAR-CombiMatrix stock for one share of CombiMatrix common stock (the “RedemptionRatio”), which is publicly traded on the Nasdaq Global Market (symbol: “CBMX”). Also, warrants to purchaseAR-CombiMatrix stock became exercisable to purchase CombiMatrix common stock,adjusted for the Redemption Ratio.  As ofthe Redemption Date, we ceased to be a subsidiary of, or affiliated with,Acacia.

 

## **Liquidity**

## ** **

At December 31,2008, we had cash, cash equivalents and available-for-sale investments of $9.1million, which we believed would be sufficient to meet our cash requirements toSeptember 2009.  On May 1,2009, we closed a registered direct offering of our common stock and warrantswhich, after placement agent fees and other costs, netted approximately $7.6million to us, which we believe extends our ability to continue operating as agoing concern to June 2010 (see Liquidity and Capital Resources below aswell as Note 7 to the consolidated interim financial statements includedelsewhere herein for further discussion).

 

Inorder for our company to continue as a going concern beyond 2010 and ultimatelyto achieve profitability, we will be required to increase revenues, reduceoperating costs and possibly to obtain capital from external sources.  However, there can be no assurance that suchcapital will be available at times and at terms acceptable to us, or thathigher levels of product and service revenues will be achieved.  The issuance of additional equity securities,should that occur, will cause dilution to our shareholders.  If external financing sources are notavailable or are inadequate to fund our operations, we will be required toreduce operating costs including research projects and personnel, which couldjeopardize our future strategic initiatives and business plans.  See Note 1 to the consolidated financialstatements included elsewhere in this report for additional discussion of thesematters.

 

## **Basisof Presentation of Financial Statements**

## ** **

Theconsolidated financial statements included in this Form 10-Q areconsistent with our historical financial statements included in our Form 10-Kfor our fiscal year ended December 31, 2008.

 

## **Overviewof Recent Business Activities**

## ** **

Forthe three and nine months ended September 30, 2009, our operatingactivities included the recognition of $970,000 and $3.7 million in revenues,respectively, including $133,000 and $949,000 in government contract revenues,respectively, $233,000 and $860,000 in CustomArray product and servicerevenues, respectively, and $603,000 and $1.9 million in diagnostic labrevenues, respectively.  Research anddevelopment expenses, excluding government contract costs and non-cash stockbased compensation, increased slightly in the three and nine months ended September 30,2009 due primarily to the ongoing activities related to our comprehensivecancer array test currently under development. Marketing, general and administrative expenses, excluding non-cash stockcompensation, increased for the nine months ended September 30, 2009versus the comparable 2008 period due primarily to increased sales andmarketing expenses at CMDX as well as increased investor and public relationscosts.

 

Significantbusiness developments that occurred during and subsequent to the third quarterended September 30, 2009 were:

 

·                 In October 2009, Mr. Chris Emery and Dr. LonyLim joined our wholly owned subsidiary, CMDX, as Chief Operating Officer andVice President of Operations, respectively. Mr. Emery earned his B.S.degree from the University of California, San Diego, and his Master in BusinessAdministration from Pepperdine University. He started his career in healthcareas a Sales Manager with Johnson & Johnson’s pharmaceutical divisionand has since spent more than 10 years in the cancer-focused diagnosticslaboratory industry.  Mr. Emery wasa Marketing Manager with US LABS, Inc. (a division of LaboratoryCorporation of America Holdings) and was then promoted to National Sales Managerof the Oncology sales division.  Mr. Emerywas Vice President of Sales & Marketing at Response Genetics, Inc.,where he helped launch the company’s portfolio of molecular diagnostic,personalized medicine testing.  Herecently consulted for Agendia, a global leader in microarray genomicprofiling, as Director of Clinical Trials. Dr. Lim received both his B.S. and his Ph.D. from the University ofWisconsin-Madison and completed the William McLendon Clinical ImmunologyFellowship at the University of North Carolina Hospitals, Chapel Hill. Heserved as Director of Scientific Affairs, Director of Flow Cytometry andDirector of Anatomic Pathology at US LABS and Scientific Director — Division ofImmunology at AmeriPath Specialty Laboratories. He was one of the pioneers inthe genesis of Luminex Corporation’s Multi-Analyte Profiling technology (xMAP®)and was instrumental in delivering the initial clinical acceptance of xMAP®technology, which is now widely used in both protein and molecular profilingapplications across numerous clinical laboratories.

 

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·                 In October 2009, we announced that the BrookeArmy Medical Center (or “BAMC”) was using our influenza-detection system toanalyze influenza cases including those involving H1N1 Swine flu.  BAMC is a military hospital that isinvestigating the feasibility of screening all patients presenting in itsemergency room with symptoms of respiratory distress and consenting to nasalswabs, by both electrochemical array-based diagnostics and bead-based multiplexfluorescent methods.

 

·                 InSeptember 2009, we announced that we had received a contract from the U.S.Air Force Research Laboratory for $1.5 million to develop automatedinstrumentation that uses semiconductor microarray technologies for detectingchemical, biological and environmental hazards that can impact the health ofdeployed military personnel.

 

·                 InSeptember 2009, we announced the hiring of Robert W. Baird & Co.(or “Baird”) to serve as a financial and strategic advisor in developing andreviewing certain strategies aimed at unlocking shareholder value and creatingsynergistic relationships for our company.

 

·                 InSeptember 2009, we announced that the U.S. Ninth Circuit Court of Appeals(the “Appellate Court”) had set a date for an oral hearing regarding our $35.7million judgment (the “Judgment”) against National Union and their subsequentappeal, whereby each party will have 15 minutes to present argumentssupplementing those previously provided in the form of briefs to the AppellateCourt earlier in 2009.  The date of thehearing set by the Appellate Court was originally November 2, 2009.  National Union has subsequently requested andwas granted a continuance of the oral hearing due to a conflict with itsattorneys’ schedules.  As of the date ofthis filing, the Appellate Court had not determined the revised date of thehearing.

 

·                 InJuly 2009, we announced that a validation study of our HerScanTM breast cancer test performed by CMDX, incollaboration with the Department of Pathology at the University of TexasHealth Science Center in San Antonio, Texas was now available as an advanceonline publication in the official journal of the United States and CanadianAcademy of Pathology, Modern Pathology.

 

## **CriticalAccounting Estimates**

## ** **

Our unaudited interim financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America. Preparation of these statements requires management to make judgmentsand estimates.  Some accounting policieshave a significant impact on amounts reported in these financialstatements.  A summary of significantaccounting policies and a description of accounting policies that areconsidered critical may be found in our Annual Report on Form 10-K, filedon March 27, 2009, in the Notes to the Consolidated Financial Statementsand the Critical Accounting Estimates section. In addition, refer to Note 2 to the consolidated interim financialstatements included inPart I, Item 1 of this report.

 

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** **

**Comparison of the Results of Operations for the Threeand Nine Months Ended September 30, 2009 and 2008**

** **

Revenues and Cost of Revenues (Inthousands)

** **
| ** **                            | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|------------|------------|
| ** **                            | ** ** | **September 30,** | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change** | ** ** |
| ** **                            | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**      | ** ** | **2009** | ** ** | **2008** | ** ** | **$** | ** ** | **%** | ** ** |
|                                  |       |                   |       |       |       |                   |       |       |       |   |   |   |   |   |   |   |   |
| Government contracts                  |       | $                      | 133        |       | $          | 343                    |       | $          | (210       | ) | (61)% |   | $ | 949 |   | $ | 2,380 |   | $ | (1,431 | ) | (60)% |   |
| Cost of government  contract revenues |       | (125                   | )          | (336       | )          | 211                    |       | (63)%      |       | (862 | ) | (2,305 | ) | 1,443 |   | (63)% |   |
| Products                              |       | 250                    |       | 158        |       | 92                     |       | 58%        |       | 807 |   | 1,356 |   | (549 | ) | (40)% |   |
| Services                              |       | 524                    |       | 448        |       | 76                     |       | 17%        |       | 1,802 |   | 1,145 |   | 657 |   | 57% |   |
| Cost of products and  services        |       | (409                   | )          | (370       | )          | (39                    | )          | 11%        |       | (1,587 | ) | (1,258 | ) | (329 | ) | 26% |   |
| Collaboration  agreements             |       | 63                     |       | 62         |       | 1                      |       | 2%         |       | 188 |   | 186 |   | 2 |   | 1% |   |
|                                       |            |                        |            |            |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**GovernmentContracts and Cost of Government Contracts. **Under the terms of our contracts with the DoD, weare reimbursed on a periodic basis for actual costs incurred to perform ourobligations, plus a fixed fee.  Under theterms of our contract with NASA, we are reimbursed on a periodic basis, basedon scheduled, contractual fixed amounts. Revenues are recognized using the partial performance method ofaccounting, using the cost-to-cost approach to measure completeness at the endof the each reporting period.  Cost ofgovernment contracts reflect research and development expenses incurred inconnection with our commitments under our current contracts with the DoD andNASA.

 

Thedecrease in government contract revenues for the three and nine months ended September 30,2009 versus the comparable periods in 2008 was due primarily to fewer activecontracts during 2009 than in 2008.  SeeNote 8 to our consolidated interim financial statements included elsewhere inthis report for a detailed description of the amounts, completion rates andestimated costs to complete of our government contracts that are ongoing aswell as prior contracts that were completed during the periods presented.  Due to the recent execution of a contractwith the U.S. Air Force, we expect our government contract revenues to increasein the short-term.  As these contractsnear completion, future contract revenues could be volatile and could decreasein the longer term if new government contracts are not awarded or executed.

 

**Productsand Cost of Products**. Product revenues and costs of products relate to domestic andinternational sales of our array products, which include DNA synthesizerinstruments, CustomArray 12K, 4X2K, 2X40K and 90K DNA expression arrays,ElectraSense® microarray readers and related hardware, aswell as the sale of CGH arrays sold by our wholly owned subsidiary, CMDX.  Product revenues increased in the threemonths ended September 30, 2009 versus the comparable period in 2008 dueprimarily to higher CGH array sales, while our CustomArray-related productssold in similar volumes to the comparable period in 2008.  For the nine-months ended September 30,2009 versus 2008, product revenues decreased primarily due to lower CustomArrayinstrument sales.  As we expand ourbusiness focus from exclusively selling array-based research and developmentproducts to providing array-based diagnostic services, we have reduced internalsales staff, marketing and production efforts regarding sales of CustomArrayproducts and instead have executed product distribution and manufacturingagreements with various third-party distributors for the sales of our suite ofCustomArray products into the research and development markets.  Also, declining global economic conditionshave negatively impacted the sales of our instruments.  As a result, CustomArray product revenueswill likely be volatile and could decrease in future periods, depending largelyon the sales efforts of our distributors.

 

*Services.* Services revenues are comprised primarily of diagnostic lab servicesprovided by CMDX as well as the amortization of one-year equipment maintenanceand service contracts executed with certain customers of our DNAsynthesizers.  Diagnostic servicesrevenue from CMDX was $507,000 and $1.8 million for the three and nine monthsended September 30, 2009, respectively, versus $445,000 and $1.1 millionin the comparable periods in 2008, respectively.  These revenues have increased due to anincreased number of diagnostic test offerings as well as increased customerdemand for our suite of diagnostic lab services provided by CMDX, which is dueprimarily to increased sales and marketing efforts.  Including BAC array product sales, totaldiagnostic lab revenues at CMDX were $603,000 and $1.9 million for the three andnine months ended September 30, 2009, respectively versus $463,000 and$1.1 million in the comparable periods in 2008, respectively.

 

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Operating Expenses (In thousands)

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|------------|------------|
| ** **                              | ** ** | **September 30,** | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change** | ** ** |
| ** **                              | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**      | ** ** | **2009** | ** ** | **2008** | ** ** | **$** | ** ** | **%** | ** ** |
|                                    |       |                   |       |       |       |                   |       |       |       |   |   |   |   |   |   |   |   |
| Research and  development expenses      |       | $                      | 1,401      |       | $          | 1,336                  |       | $          | 65         |   | 5% |   | $ | 3,814 |   | $ | 3,595 |   | $ | 219 |   | 6% |   |
| Marketing, general and  admin. expenses |       | 2,340                  |       | 2,301      |       | 39                     |       | 2%         |       | 7,970 |   | 6,781 |   | 1,189 |   | 18% |   |
| Patent amortization and  royalties      |       | 337                    |       | 341        |       | (4                     | )          | (1)%       |       | 1,016 |   | 1,063 |   | (47 | ) | (4)% |   |
| Equity in loss of of  investees         |       | 107                    |       | 247        |       | (140                   | )          | (57)%      |       | 618 |   | 737 |   | (119 | ) | (16)% |   |
|                                         |            |                        |            |            |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Research and Development Expenses*.  The increases in internal research anddevelopment expenses for the periods presented were due primarily to theongoing development efforts underway relating to our comprehensive cancer arraytest.  In addition, for the three andnine months ended September 30, 2009 and 2008, research and developmentexpenses included $172,000, $461,000, $121,000 and $261,000, respectively, ofnon-cash stock compensation expense. These increases were due primarily to increases in the overall number ofstock option awards granted to our employees during the past twelve months.  See Note 2 to our consolidated interimfinancial statements included elsewhere in this report for a detaileddescription of the amounts recognized for the periods presented.

 

Futureresearch and development expenses will continue to be incurred in connectionwith our ongoing internal research and development efforts in the areas ofgenomics, diagnostics, drug discovery and product development.   We expect our research and developmentexpenses to continue to fluctuate and such expenses could increase in futureperiods as additional internal research and development agreements areundertaken and/or as new research and development collaborations are executedwith strategic partners.

 

**Marketing,General and Administrative Expenses.**  The increases in marketing, general andadministrative expenses for the periods presented were due primarily toincreases in sales and marketing expenses at CMDX, as well as increasedinvestor and public relations expenses. In addition, for the three and nine months ended September 30, 2009and 2008, marketing, general and administrative expenses included $704,000,$2.0 million, $654,000 and $1.3 million, respectively, of non-cash stockcompensation expense.  These increaseswere due primarily to increases in the overall number of stock option awardsgranted to our employees during the past twelve months.  See Note 2 to our consolidated interimfinancial statements included elsewhere in this report for a detaileddescription of the amounts recognized for the periods presented.

 

*Equity inLoss of Investees. *Forall periods presented, this expense represents our recognition under the equitymethod of accounting of our minority interests in the operations of Leuchemix,in which we own a one-third minority interest. During the quarter ended September 30, 2009, our equity investmentin Leuchemix reached $0 and as a result, we ceased recognizing additionalexpense from their operations.  This hascaused a decrease in this expense for the three and nine months ended September 30,2009 versus the comparable periods in 2008.

 

### *****Other Non-Operating Items (In thousands)*****

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|------------|------------|
| ** **                    | ** ** | **September 30,** | ** ** | **Change** | ** ** | **September 30,** | ** ** | **Change** | ** ** |
| ** **                    | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$**                  | ** ** | **%**      | ** ** | **2009** | ** ** | **2008** | ** ** | **$** | ** ** | **%** | ** ** |
|                          |       |                   |       |       |       |                   |       |       |       |   |   |   |   |   |   |   |   |
| Interest expense              |       | $                      | (531       | )          | $          | (403                   | )          | $          | (128       | ) | 32% |   | $ | (1,553 | ) | $ | (408 | ) | $ | (1,145 | ) | 281% |   |
| Derivative credits  (charges) |       | 977                    |       | 16         |       | 961                    |       | 6006%      |       | (407 | ) | 16 |   | (423 | ) | (2644)% |   |
|                               |            |                        |            |            |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**InterestExpense.****  Since July 2008,interest expense is recognized from the issuance of a secured convertibledebenture (the “Debenture”), which accrues interest at an annual rate of 10%and with a current principal amount of $8.4 million as of September 30,2009.  Interest expense also includesamortization of the $2.9 million of debt discount recognized from issuance ofthe Debenture and warrants using the effective interest method.**

 

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**DerivativeCredits (Charges).****  These amountsrepresent the net credits or charges recognized during the periods presentedfrom mark-to-model adjustments to the embedded derivatives associated with theDebenture that were outstanding as of September 30, 2009 and 2008.  T**he conversion feature, cash redemption option,potential acceleration ofmaturity of the Debenture and potential adjustments to the fixed conversionprice all represent embedded derivatives of the Debenture that are recordedseparately at fair value as other liabilities, with the corresponding fairvalue adjustments reflected as non-operating charges or credits, depending uponthe results of mark-to-model valuation adjustments.  The fair value of the embedded derivativeswas determined using the convertible bond model, discounted cash flows andbinomial lattice models.

 

**Inflation**

 

Inflation has not had a significant impacton our Company.

 

**Liquidity and CapitalResources**

 

At September 30,2009, cash, cash equivalents and available-for-sale investments totaled $7.9million versus to $9.1 million at December 31, 2008.  Working capital at September 30, 2009was $7.4 million, compared to $7.6 million at December 31, 2008.  The net change in cash and cash equivalentsfor the periods presented was comprised of the following (in thousands):

** **
| ** **                             | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **September 30,** | ** ** |
| ** **                             | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Net cash flows from  operations:       |       |                   |       |   |   |
| Operating activities                   |       | $                      | (8,152     | ) | $ | (8,114 | ) |
| Investing activities                   |       | 1,467                  |       | 3,975 |   |
| Financing activities                   |       | 7,011                  |       | 11,250 |   |
| Increase in cash and  cash equivalents |       | $                      | 326        |   | $ | 7,111 |   |

 

*Operating Activities.*  The overall net increase in cash used inoperating activities for the nine months ended September 30, 2009 versusthe comparable period in 2008 was due primarily to a decrease in cash receiptsfrom customers, which totaled $3.6 million in 2009 versus $4.4 million in2008.  This decrease was due primarily tolower DoD contract activity and thus lower billings and collections from DoDcontracts in 2009 versus 2008.  Thisdecrease was mostly offset by a decrease in operating cash outflows, whichtotaled $11.8 million in 2009 versus $12.6 million in 2008.  This decrease was due primarily to the netimpact of the timing of the payments to certain vendors.

 

*Investing Activities.*  The change in net cash flows from investingactivities was due primarily to net sales of available-for-sale investments inconnection with ongoing cash management activities during the periodspresented.  Also, for the nine monthsended September 30, 2009 and 2008, we incurred $59,000 and $55,000,respectively, of capital expenditures.

 

*Financing Activities.*  The change in cash flows from financingactivities was driven by certain financing transactions that were executedduring the nine months ended September 30, 2009 and 2008 as follows:

 

·      Forthe nine months ended September 30, 2009, our financing activities weredriven primarily by the execution of a registered direct offering (the “Offering”)of our common stock and warrants for gross proceeds of $8.25 million, which weclosed on May 1, 2009.  Under theterms of the Offering, we sold 1.1 million units for $7.50 per unit to certaininvestors.  Each unit consisted of oneshare of our common stock and one warrant, each warrant to purchase one shareof our common stock at an exercise price of $9.00 per share.  The warrants may not be exercised until sixmonths after the Offering and have a term of five years.  Net proceeds from the Offering, lessplacement agent fees and expenses, were approximately $7.6 million.  Also impacting our net cash flows fromfinancing activities was the repayment of credit line borrowings during thefirst quarter of 2009 totaling $820,000. Finally, proceeds from the exercise of common stock options were$225,000 during the nine months ended September 30, 2009.

 

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·                  For the nine months ended September 30,2008, our financing activities were driven primarily by the issuance to YAGlobal Investments, L.P. of: (i) the Debenture with an aggregate principalamount of $10 million, which was originally convertible into shares of ourcommon stock at a fixed conversion priceof $11.87 per share (and subsequently adjusted to $7.50 per share due toexecution of the Offering described above); and (ii) warrants topurchase up to 336,984 shares of our common stock.  TheDebenture is due on the earlier of July 10, 2010 or within four monthsafter receipt of payment of the settlement proceeds from National Union inaccordance with the Judgment.  TheDebenture bears interest at an annual rate of 10%, with interest payments duequarterly in either cash or our common stock. Also impacting our net cash flows from financing activities was adraw on our credit line totaling $808,000 during the second quarter of2008.  Finally, proceeds from theexercise of common stock options were $711,000 during the nine months ended September 30,2008.

 

*Future Liquidity.*  We believe that the additional capital fromthe Offering will allow us to meet our operating cash requirements to June 2010.  In order for us to continue to meet our cashrequirements beyond this point, we will be required to increase revenues,reduce operating costs and possibly to obtain capital from externalsources.  However, there can be noassurances that we will be able to secure additional sources of financing attimes and at terms acceptable to management. The issuance of additional equity securities, should that occur, willcause dilution to our shareholders.  Ifexternal financing sources are not available or are inadequate to fund ouroperations, management will be required to reduce our operating costs includingresearch projects and personnel, which could jeopardize our future strategicinitiatives and business plans.  Forexample, reductions in research and development activities and/or personnel atour Mukilteo, Washington facility could result in the inability to invest theresources necessary to continue to develop next-generation products and improveexisting product lines in order to remain competitive in the marketplace,resulting in reduced revenues and cash flows from the sales of our CustomArrayproducts and services.  Also, reductionsin operating costs at CMDX, should they occur, could jeopardize our ability tolaunch, market and sell additional products and services necessary to grow andsustain our operations and eventually achieve profitability.

 

*Capital Requirements.*  We may also encounter unforeseen difficultiesthat may deplete our capital resources more rapidly than anticipated.  Any efforts to seek additional funding couldbe made through equity, debt or other external financing, and there can be noassurance that additional funding will be available on favorable terms, if atall.  Our long-term capital requirementswill be substantial and the adequacy of available funds will depend upon manyfactors, including:

 

·                  the costs of commercializationactivities, including sales and marketing, manufacturing and capital equipment;

 

·                  our continued progress in research anddevelopment programs;

 

·                  the costs involved in filing,prosecuting, enforcing and defending any patents claims, should they arise;

 

·                  the costs involved in defending ourJudgment against the appeal brought by National Union;

 

·                  our ability to license technology;

 

·                  competing technological developments;

 

·                  the creation and formation of strategicpartnerships; and

 

·                  the costs associated with leasing andimproving our Irvine, California facility.

 

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#### **Off-Balance Sheet Arrangements**

#### ** **

We have not entered intooff-balance sheet financing arrangements, other than operating leases for ouroffice and laboratory premises.  We haveno significant commitments for capital expenditures in 2009 or beyond.  We have executed two capital leases totaling$109,000 for certain laboratory equipment. The following table lists our material known future cash commitments asof September 30, 2009:

 
| ** **                         | ** ** | **Payments Due by Period (in thousands)** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|
| ** **                         | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2013 and** | ** ** |
| ** **                         | ** ** | **2009**                                  | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
| ** **                         | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating leases                   |       | $                                         | 145        |   | $ | 367 |   | $ | — |   | $ | — |   | $ | — |   |
| Capital leases                     |       | 3                                         |       | 13 |   | 14 |   | 15 |   | 1 |   |
| Minimum royalty  payments          |       | 25                                        |       | 100 |   | 100 |   | 100 |   | 575 |   |
| Secured convertible  debenture (1) |       | —                                    |       | 8,400 |   | — |   | — |   | — |   |
| Total contractual  obligations     |       | $                                         | 173        |   | $ | 8,880 |   | $ | 114 |   | $ | 115 |   | $ | 576 |   |

 

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(1)          Theprincipal amount of the Debenture as of September 30, 2009, which is duethe earlier of July 10, 2010 or four months after receiving the settlementpayment from National Union, is reflected as being due in July, 2010 (the maturitydate of the Debenture), assuming no additional conversions or early prepaymentsoccur.

 

**Recent AccountingPronouncements**

 

Referto Note 2 to our consolidated interim financial statements included in Part I,Item 1 of this report.

 

**Item 3.****                      ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Not required for smallerreporting companies.

 

**Item 4T.     CONTROLSAND PROCEDURES**

 

*Evaluation of DisclosureControls and Procedures*

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”) isrecorded, processed, summarized and reported within the time periods specifiedin SEC rules and forms.  Ourdisclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed in ourreports filed under the Exchange Act is accumulated and communicated tomanagement as appropriate to allow timely decisions regarding requireddisclosures.  There are inherentlimitations to the effectiveness of any system of disclosure controls andprocedures, including the possibility of human error and the circumvention oroverriding of the controls and procedures. Accordingly, even effectivedisclosure controls and procedures can only provide reasonable assurance ofachieving their control objectives, and management necessarily is required touse its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  Our management,with the participation of our Chief Executive Officer and Chief FinancialOfficer, conducted an evaluation required by Rules 13a-15 and 15d-15 underthe Exchange Act of the effectiveness of our disclosure controls and proceduresas defined in Rules 13a-15 and 15d-15 under the Exchange Act as of September 30,2009.  Based on this evaluation, ourChief Executive Officer and Chief Financial Officer concluded that as of September 30,2009, the design and operation of our disclosure controls and procedures wereeffective.

 

*Changes in InternalControls*

 

There wereno changes in our internal control over financial reporting that occurredduring our last fiscal quarter (the quarter ended September 30, 2009) thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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** **

**PART II—OTHER INFORMATION**

** **

**Item 1.  LEGAL PROCEEDINGS**

 

In April 2005, Acacia and we filed a complaint inU.S. District Court for the Central District of California (the “District Court”) against ourinsurance carrier, National Union Fire Ins. Co. of Pittsburgh, PA (“NationalUnion”), seeking reimbursement of litigation and settlement costs for alawsuit, pursuant to our directors’ and officers’ insurance policy withNational Union.  A trial was held andconcluded during the fourth quarter of 2007. In March 2008, the District Court issued the Judgment in favor ofAcacia and us, and awarded approximately $32.1 million in monetary damages tobe paid by National Union.  In accordancewith the distribution agreement entered into between Acacia and us prior to ourseparation, all proceeds from the lawsuit will be paid to us.  In May 2008, the District Court awardedus an additional $3.6 million in attorneys’ fees and litigation costs, therebyincreasing the overall award to $35.7 million. This award was entered as a final Judgment in May 2008 and willcontinue to earn interest until paid.  In September 2008, the DistrictCourt required National Union to post an appellate bond in the amount of $39.2million to cover the Judgment as well as accrued interest charges.  The appellate bond will remain in place untilthe appeal process is concluded. National Union has appealed the Judgment to the U.S. Ninth CircuitCourt of Appeals (the “Appellate Court”), and we intend to vigorouslydefend against the appeal.  All appellatebriefs by us and National Union were filed during the second quarter of2009.  Recently, the Appellate Court seta date for an oral hearing whereby each party will have 15 minutes to presentarguments supplementing those in the briefs. The date of the hearing set by the Appellate Court was originally November 2,2009.  National Union has subsequentlyrequested and was granted a continuance of the oral hearing due to a conflictwith its attorneys’ schedules.  As of thedate of this filing, the Appellate Court had not determined the revised date ofthe hearing.

 

**Item 2.  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

For the nine monthsended September 30, 2009, we issued 89,274 shares of our common stock toYA in consideration of quarterly interest charges accrued during the fourthquarter of 2008 through the second quarter of 2009 under the terms of theDebenture.  The issuance of common stockto YA was made pursuant to an exemption under Rule 506 of Regulation Dand/or Section 4(2) of the Securities Act of 1933.

 

On May 19, 2009 (the “Grant Date”), we issued three warrants(the “Consultant Warrants”) to a consultant to purchase a total of 125,000unregistered shares of our common stock with an exercise price of $9.00 per shareand a term of five years.  The firstwarrant is for 25,000 shares and becomes fully vested six months after theGrant Date.  The second and thirdwarrants (the “Contingent Warrants”) are for 50,000 shares each of commonstock, and become fully vested only if our underlying stock price achieves orexceeds $12.00 and $14.00 per share, respectively, for five consecutive tradingdays as quoted on Nasdaq, over a period of twenty-four months from the GrantDate.  If these terms are not achievedduring this twenty-four month period, the Contingent warrants will expire on May 19,2011.  Otherwise, if the vestingconditions are achieved within twenty-four months from the Grant Date, theContingent warrants will become fully exercisable for the remainder of the five-yearterm. The warrants were issued pursuant to an exemption under Rule 506and/or Section 4(2) of the Securities Act of 1933.

 

**Item 5.  OTHERINFORMATION**

 

On November 10,2009, our Board of Directors approved an Executive Change of Control Severance Plan(the “Severance Plan”) that affects certain of our senior management-levelemployees.  Pursuant to the Severance Plan, if a participating employee isinvoluntarily terminated (other than for death, disability or for cause)or resigns for “good reason” (as defined in the Severance Plan) during thetwo-year period following a “change of control” (as defined in the SeverancePlan) of the Company, then, subject to execution of a release of claims againstthe Company, the employee will be entitled to receive: (i) a cashseverance payment equal to one times annual base salary, in the case of ourChief Executive Officer; or one-half times annual base salary, in the case ofother participating employees; (ii) immediate vesting of outstandingcompensatory equity awards; and (iii) payment of COBRA premiums for theparticipating employee and eligible dependants for a pre-determined period oftime.  Payment of benefits under the Severance Plan willbe limited by provisions contained in Section 409A of the U.S. InternalRevenue Code.  The Severance Plan is administered by a plan administrator,which initially is the Compensation Committee of the Board of Directors. In order to participate in the Severance Plan, an eligible employee must waiveany prior retention or severance agreements.

 

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**Item 6. EXHIBITS**

** **
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                            |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                       |
| 3.1                 |       | Amended and Restated  Certificate of Incorporation (1)                                                                                                                                     |
| 3.1a                |       | Certificate of  Amendment to Amended and Restated Certificate of Incorporation (2)                                                                                                         |
| 3.2                 |       | Amended and Restated  Bylaws (3)                                                                                                                                                           |
| 10.1                |       | Research and  Development Contract with U.S. Air Force Research Laboratory for the  Development and Use of a Semiconductor Microarray For Detecting Exposure to  Environmental Hazards (4) |
| 10.2                |       | Supply Agreement with  Illumina, Inc. (5)                                                                                                                                             |
| 10.3                |       | Executive Change in  Control Severance Plan                                                                                                                                                |
| 31.1                |       | Certification of Chief  Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002                                                                                        |
| 31.2                |       | Certification  of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act  of 2002                                                                                       |
| 32.1                |       | Certification  of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act  of 2002                                                                                       |
| 32.2                |       | Certification  of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act  of 2002                                                                                       |

 

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| (1) | Incorporated  by reference to Exhibit 3.1 to CombiMatrix Corporation’s Registration  Statement on Form S-1 (SEC File No. 333-139679), which became  effective June 8, 2007. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Incorporated by  reference to Exhibit 3.1A to CombiMatrix Corporation’s Quarterly Report  on Form 10-Q filed August 14, 2008.                                                    |
| (3) | Incorporated by  reference to Exhibit 3.2 to CombiMatrix Corporation’s Registration  Statement on Form S-1 (SEC File No. 333-139679), which became  effective June 8, 2007. |
| (4) | Incorporated by  reference to Exhibit 10.1 to CombiMatrix Corporation’s Current Report on  Form 8-K filed September 14, 2009.                                                    |
| (5) | Portions of this  exhibit have been omitted pursuant to a request for confidential treatment.                                                                                                        |

 

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**SIGNATURES**

** **

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 

 
|   | COMBIMATRIX CORPORATION |
|--------|-------------------------|
|   |                    |
|   |                    |   |
|   | By:                     | /s/ AMIT KUMAR, PH.D. |
|   |                    | Amit Kumar, Ph.D. |
|   |                    | Chief Executive Officer |
|   |                    | *(Authorized Signatory  and Principal Executive Officer)* |
|   |                    | * * |
|   |                    |   |
|   | By:                     | /s/ SCOTT R. BURELL |
|   |                    | Scott R. Burell |
|   |                    | Chief Financial Officer |
|   |                    | *(Principal Financial and Accounting Officer)* |

 

Date:  November 13,2009

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                            |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                       |
| 3.1                 |       | Amended and Restated  Certificate of Incorporation (1)                                                                                                                                     |
| 3.1a                |       | Certificate of  Amendment to Amended and Restated Certificate of Incorporation (2)                                                                                                         |
| 3.2                 |       | Amended and Restated  Bylaws (3)                                                                                                                                                           |
| 10.1                |       | Research and  Development Contract with U.S. Air Force Research Laboratory for the  Development and Use of a Semiconductor Microarray For Detecting Exposure to  Environmental Hazards (4) |
| 10.2                |       | Supply Agreement with  Illumina, Inc. (5)                                                                                                                                             |
| 10.3                |       | Executive Change in  Control Severance Plan                                                                                                                                                |
| 31.1                |       | Certification of Chief  Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002                                                                                        |
| 31.2                |       | Certification  of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act  of 2002                                                                                       |
| 32.1                |       | Certification  of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act  of 2002                                                                                       |
| 32.2                |       | Certification  of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act  of 2002                                                                                       |

 

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| (1) | Incorporated  by reference to Exhibit 3.1 to CombiMatrix Corporation’s Registration  Statement on Form S-1 (SEC File No. 333-139679), which became  effective June 8, 2007. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Incorporated by  reference to Exhibit 3.1A to CombiMatrix Corporation’s Quarterly Report  on Form 10-Q filed August 14, 2008.                                                    |
| (3) | Incorporated by  reference to Exhibit 3.2 to CombiMatrix Corporation’s Registration  Statement on Form S-1 (SEC File No. 333-139679), which became  effective June 8, 2007. |
| (4) | Incorporated by  reference to Exhibit 10.1 to CombiMatrix Corporation’s Current Report on  Form 8-K filed September 14, 2009.                                                    |
| (5) | Portions of this  exhibit have been omitted pursuant to a request for confidential treatment.                                                                                                        |

 

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