**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**FORTHE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007**

 

**CommissionFile Number 0001383183**

 

**COMBIMATRIXCORPORATION**

(Exact Name ofRegistrant as Specified in Its 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 telephonenumber, including area code: ** (425) 493-2000**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to filing requirements for the past 90days.

Yes xNo o

 

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

 
|  Large accelerated  filer   o |    |             Accelerated filer  o |    |                     Non-accelerated filer  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 5, 2007, 5,990,515 shares of CombiMatrix Corporation common stock wereissued and outstanding.

 

 

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**COMBIMATRIX**CORPORATION

**Table of Contents**

 
| **Part I.   Financial  Information** | ** ** | ** **                                                                                                        |
|------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|
| ** **                                     | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 1.                                        |       | Financial  Statements                                                                                             |   |   |
|                                           |       |                                                                                                              |   |   |
|                                           |       | CombiMatrix  Corporation Consolidated Financial Statements                                                        |   |   |
|                                           |       |                                                                                                              |   |   |
|                                           |       | Consolidated  Balance Sheets as of September 30, 2007 (Unaudited) and  December 31, 2006                          |   |   |
|                                           |       |                                                                                                              |   |   |
|                                           |       | Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2006 (Unaudited) |   |   |
|                                           |       |                                                                                                              |   |   |
|                                           |       | Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2007 and 2006 (Unaudited)          |   |   |
|                                           |       |                                                                                                              |   |   |
|                                           |       | Notes to Consolidated Financial Statements  (Unaudited)                                                           |   |   |
|                                           |       |                                                                                                              |   |   |
| Item 2.                                        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |   |   |
|                                           |       |                                                                                                              |   |   |
| Item 3.                                        |       | Quantitative and Qualitative Disclosures  About Market Risk                                                       |   |   |
|                                           |       |                                                                                                              |   |   |
| Item 4T.                                       |       | Controls and  Procedures                                                                                          |   |   |
|                                           |       |                                                                                                              |   |   |
| **Part  II.   Other Information**    | ** ** | ** **                                                                                                        |
| ** **                                     | ** ** | ** **                                                                                                        | ** ** | ** ** |
| Item 1.                                        |       | Legal Proceedings                                                                                                 |   |   |
|                                           |       |                                                                                                              |   |   |
| Item 2.                                        |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                      |   |   |
|                                           |       |                                                                                                              |   |   |
| Item  6.                                       |       | Exhibits                                                                                                          |   |   |
|                                           |       |                                                                                                              |   |   |
| **Signatures**                                 |       |                                                                                                              |   |   |
| ** **                                     | ** ** | ** **                                                                                                        | ** ** | ** ** |
| **Exhibit  Index**                             |       |                                                                                                              |   |   |
|                                                |            |                                                                                                                   |  |  |  |

 

2

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**COMBIMATRIXCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

**(Unaudited)**

*** ***
| ** **                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                       | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| ** **                                                                                       | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                       |       |                   |       |                  |       |
|                                                                                             |       |                   |       |                  |       |
| Current assets:                                                                                  |       |                   |       |                  |       |
| Cash and cash equivalents                                                                        |       | $                      | 2,591      |                  | $          | 7,829 |   |
| Available-for-sale investments                                                                   |       | 7,917                  |       | 6,512                 |       |
| Accounts receivable                                                                              |       | 516                    |       | 605                   |       |
| Inventory                                                                                        |       | 501                    |       | 480                   |       |
| Prepaid expenses and other assets                                                                |       | 323                    |       | 125                   |       |
| Total current assets                                                                             |       | 11,848                 |       | 15,551                |       |
|                                                                                             |       |                   |       |                  |       |
| Property and equipment, net                                                                      |       | 1,356                  |       | 1,785                 |       |
| Patents and licenses, net                                                                        |       | 6,421                  |       | 7,292                 |       |
| Goodwill                                                                                         |       | 16,918                 |       | 16,918                |       |
| Investments in unconsolidated subsidiaries                                                       |       | 1,900                  |       | 2,667                 |       |
| Total assets                                                                                     |       | $                      | 38,443     |                  | $          | 44,213 |   |
|                                                                                             |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                             |       |                   |       |                  |       |
| Current liabilities:                                                                             |       |                   |       |                  |       |
| Accounts payable, accrued expenses and  other                                                    |       | $                      | 1,936      |                  | $          | 2,770 |   |
| Current portion of deferred revenues                                                             |       | 327                    |       | 365                   |       |
| Payable to Acacia Research Corporation                                                           |       | —                 |       | 456                   |       |
| Total current liabilities                                                                        |       | 2,263                  |       | 3,591                 |       |
|                                                                                             |       |                   |       |                  |       |
| Deferred revenues, net of current portion                                                        |       | 437                    |       | 1,076                 |       |
| Warrant liability                                                                                |       | —                 |       | 6,732                 |       |
| Total liabilities                                                                                |       | 2,700                  |       | 11,399                |       |
|                                                                                             |       |                   |       |                  |       |
| Commitments and contingencies (Note 5)                                                           |       |                   |       |                  |       |
|                                                                                             |       |                   |       |                  |       |
| Stockholders’ Equity:                                                                       |       |                   |       |                  |       |
| Preferred stock; $0.001 par value;  30,000,000 shares authorized; none issued and outstanding    |       | —                 |       | —                |       |
| Common stock; $0.001 par value; 180,000,000  shares authorized; 5,990,515 issued and outstanding |       | 6                      |       | —                |       |
| Additional paid-in capital                                                                       |       | 36,880                 |       | —                |       |
| Accumulated other comprehensive income                                                           |       | 4                      |       | —                |       |
| Net allocations from Acacia Research  Corporation                                                |       | —                 |       | 177,404               |       |
| Accumulated net losses (August 15, 2007)                                                         |       | (1,147                 | )          | (144,590              | )          |
| Total stockholders’ equity                                                                  |       | 35,743                 |       | 32,814                |       |
| Total liabilities and stockholders’ equity                                                  |       | $                      | 38,443     |                  | $          | 44,213 |   |

** **

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

** **

**3**

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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,**          | ** ** |
| ** **                                                    | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                     |       |                             |       |                            |       |   |   |   |   |
| Government contracts                                          |       | $                                | 627        |                            | $          | 725 |   | $ | 1,855 |   | $ | 1,563 |   |
| Products                                                      |       | 828                              |       | 968                             |       | 1,726 |   | 3,050 |   |
| Service contracts                                             |       | 164                              |       | 88                              |       | 386 |   | 205 |   |
| Collaboration agreements                                      |       | 62                               |       | 63                              |       | 187 |   | 63 |   |
| Total revenues                                                |       | 1,681                            |       | 1,844                           |       | 4,154 |   | 4,881 |   |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                           |       |                             |       |                            |       |   |   |   |   |
| Cost of government contracts                                  |       | 593                              |       | 684                             |       | 1,768 |   | 1,476 |   |
| Cost of products                                              |       | 307                              |       | 412                             |       | 858 |   | 973 |   |
| Research and development expenses                             |       | 1,924                            |       | 2,819                           |       | 4,874 |   | 7,380 |   |
| Marketing, general and administrative  expenses               |       | 2,167                            |       | 2,661                           |       | 6,956 |   | 9,691 |   |
| Patent amortization and royalties                             |       | 332                              |       | 366                             |       | 994 |   | 1,075 |   |
| Equity in loss of investees                                   |       | 248                              |       | 253                             |       | 770 |   | 786 |   |
| Total operating expenses                                      |       | 5,571                            |       | 7,195                           |       | 16,220 |   | 21,381 |   |
| Operating loss                                                |       | (3,890                           | )          | (5,351                          | )          | (12,066 | ) | (16,500 | ) |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Other income (expense):                                       |       |                             |       |                            |       |   |   |   |   |
| Interest income                                               |       | 167                              |       | 111                             |       | 448 |   | 429 |   |
| Loss on sale of interest in subsidiary                        |       | —                           |       | —                          |       | — |   | (84 | ) |
| Warrant gains                                                 |       | 290                              |       | 913                             |       | 2,523 |   | 663 |   |
| Total other income                                            |       | 457                              |       | 1,024                           |       | 2,971 |   | 1,008 |   |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Loss from operations before income taxes                      |       | (3,433                           | )          | (4,327                          | )          | (9,095 | ) | (15,492 | ) |
| Benefit for income taxes                                      |       | —                           |       | —                          |       | — |   | 34 |   |
| Net loss                                                      |       | $                                | (3,433     | )                               | $          | (4,327 | ) | $ | (9,095 | ) | $ | (15,458 | ) |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted net loss per share                          |       | $                                | (0.57      | )                               |       |   | $ | (1.52 | ) |   |   |
|                                                          |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted weighted average common  shares outstanding |       | 5,990,189                        |       |                            |       | 5,990,189 |   |   |   |

** **

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

** **

**4**

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** **

**COMBIMATRIXCORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

**(Unaudited)**

** **
| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                   | ** ** | **2007**                        | ** ** | **2006** | ** ** |
|                                                                         |       |                            |       |   |   |
| Operating activities:                                                        |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (9,095     | ) | $ | (15,458 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                            |       |   |   |
| Depreciation and amortization                                                |       | 1,420                           |       | 1,507 |   |
| Non-cash stock compensation                                                  |       | 2,163                           |       | 1,756 |   |
| Deferred taxes                                                               |       | —                          |       | (34 | ) |
| Warrant gains                                                                |       | (2,523                          | )          | (663 | ) |
| Equity in loss of investee                                                   |       | 770                             |       | 786 |   |
| Loss on sale of interest in subsidiary                                       |       | —                          |       | 84 |   |
| Allowance for bad debt                                                       |       | 241                             |       | — |   |
| Equity issued to consultant                                                  |       | 224                             |       | — |   |
| Other                                                                        |       | 27                              |       | 218 |   |
| Changes in assets and liabilities:                                           |       |                            |       |   |   |
| Accounts receivable                                                          |       | (152                            | )          | (393 | ) |
| Inventory, prepaid expenses and other  assets                                |       | (208                            | )          | 83 |   |
| Accounts payable, accrued expenses and  other                                |       | (1,326                          | )          | 265 |   |
| Deferred revenues                                                            |       | (677                            | )          | 1 |   |
| Net cash used in operating activities                                        |       | (9,136                          | )          | (11,848 | ) |
|                                                                         |       |                            |       |   |   |
| Investing activities:                                                        |       |                            |       |   |   |
| Purchase of property and equipment                                           |       | (122                            | )          | (495 | ) |
| Purchase of available-for-sale investments                                   |       | (4,980                          | )          | (1,021 | ) |
| Sale of available-for-sale investments                                       |       | 3,590                           |       | 9,551 |   |
| Purchase of additional interest in equity  method investee                   |       | —                          |       | (1,400 | ) |
| Sale of interest in subsidiary                                               |       | —                          |       | (369 | ) |
| Net cash provided by (used in) investing  activities                         |       | (1,512                          | )          | 6,266 |   |
|                                                                         |       |                            |       |   |   |
| Financing activities:                                                        |       |                            |       |   |   |
| Net proceeds from issuance of common stock                                   |       | 5,369                           |       | — |   |
| Imputed management fees from Acacia  Research Corporation                    |       | 41                              |       | — |   |
| Net cash flows transferred from Acacia  Research Corporation                 |       | —                          |       | 2,220 |   |
| Net cash provided by financing activities                                    |       | 5,410                           |       | 2,220 |   |
|                                                                         |       |                            |       |   |   |
| Decrease in cash and cash equivalents                                        |       | (5,238                          | )          | (3,362 | ) |
|                                                                         |       |                            |       |   |   |
| Cash and cash equivalents, beginning                                         |       | 7,829                           |       | 5,666 |   |
|                                                                         |       |                            |       |   |   |
| Cash and cash equivalents, ending                                            |       | $                               | 2,591      |   | $ | 2,304 |   |
|                                                                         |       |                            |       |   |   |
| Noncash investing and financing activites:                                   |       |                            |       |   |   |
| Reclassification of warrant liabilities to  additional paid-in capital       |       | $                               | 9,089      |   | $ | — |   |

** **

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

** **

**5**

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** **

****1.     OVERVIEWAND BACKGROUND****

 

CombiMatrixCorporation (the “Company” “we” “us” and “our”) was originally incorporated inOctober 1995 as a California corporation and later reincorporated as a Delawarecorporation in September 2000. On December 13, 2002 (the “Merger Date”), wemerged with and became a wholly owned subsidiary of 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. The AR-CombiMatrix stock was intended to reflect separatelythe performance of CombiMatrix Corporation and its subsidiaries, referred to as“the CombiMatrix group,” whereas the AR-Acacia Technologies stock was intendedto reflect separately the performance of Acacia’s technology business, referredto as “the Acacia Technologies group.” Immediately following the Merger Date,the Company had 1,000 shares of common stock authorized and 100 shares issuedand outstanding, all of which were owned by Acacia.

 

In 2006, Acaciaannounced its intent to split-off the Company from Acacia as an independentpublic company. On December 26, 2006, we filed a registration statement withthe U.S. Securities and Exchange Commission (“SEC”) in order to register ourcommon stock under the Securities Act of 1934 to be redeemed for AR-CombiMatrixstock. On June 8, 2007, the SEC declared our registration statement effective. OnAugust 15, 2007 (the “Redemption Date”), all currently issued and outstandingshares of AR-CombiMatrix were redeemed and exchanged for shares of CombiMatrixcommon stock at a redemption ratio of ten shares of AR-CombiMatrix common stockfor one share of CombiMatrix common stock (the Redemption Ratio), which ispublicly traded on the Nasdaq Capital Market exchange. As of the RedemptionDate, we are no longer a subsidiary of, nor are we affiliated with, AcaciaResearch Corporation.

 

*****Description of the Company*****

 

We are adiversified biotechnology business, through the development of proprietarytechnologies, products and services in the areas of drug development, geneticanalysis, molecular diagnostics, nanotechnology research, defense and homelandsecurity markets, as well as other potential markets where our products andservices could be utilized. The technologies we have developed include aplatform technology to rapidly produce customizable, in-situ synthesized,oligonucleotide arrays for use in identifying and determining the roles ofgenes, gene mutations and proteins. This technology has a wide range ofpotential applications in the areas of genomics, proteomics, biosensors, drugdiscovery, drug development, diagnostics, combinatorial chemistry, materialsciences and nanotechnology. Other technologies include proprietary molecularsynthesis and screening methods for the discovery of potential new drugs. CombiMatrixMolecular Diagnostics, Inc. (“CMDX”), a wholly owned subsidiary of the Companylocated in Irvine California, has developed capabilities of producing arraysthat utilize bacterial artificial chromosomes, which also enable geneticanalysis.

 

*****Basis of Presentation*****

 

Through the Redemption Date, the consolidated financial statementsincluded herein include the assets, liabilities, operating results and cashflows of the Company using Acacia’s historical bases in the assets andliabilities and the historical results of operations of the Company. Historicalallocated net worth represents the net allocations by Acacia to us for equitytransactions of Acacia that have been attributed to the Company as well as theaccumulation of our net losses. Subsequent to the Redemption Date, amountsreflected as allocated net worth were reclassified to additional paid-incapital, and retained deficits have been accumulating since the RedemptionDate.

 

Through theRedemption Date, the consolidated financial statements include allocations ofcertain Acacia corporate expenses, including governance, legal, accounting,insurance services, management of treasury and other Acacia corporate andinfrastructure costs. The expense allocations were determined on bases thatAcacia and the Company considered to be a reasonable reflection of theutilization of services provided or the benefit received by us. However, thefinancial information included herein may not reflect the consolidatedfinancial position, operating results, changes in stockholder’s equity and cashflows of the Company in the future or what they would have been had we been a separate,stand-alone entity during the periods presented. Direct salaries, payroll taxesand fringe benefits incurred by Acacia were allocated to Acacia’s reportinggroups based on the percentage of actual time incurred by specific employees tototal annual time available and direct costs including, postage, insurance,legal fees, accounting and tax and other expenses or costs were allocated tothe groups based on specific identification of costs incurred on behalf of eachgroup.

 

6

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Otherdirect costs, including direct depreciation expense, computer costs, generaloffice supplies and rent were allocated to the groups based on the ratio ofdirect salaries to total salaries. Indirect costs, including indirect salariesand benefits, investor relations, rent, general office supplies and indirectdepreciation were allocated to the groups based on the ratio of direct salariesfor each group to total direct salaries. For the three and nine months endedSeptember 30, 2007 and 2006, corporate expenses totaling $15,000, $102,000,$118,000 and $378,000, respectively, were allocated to us by Acacia. Acaciaceased allocating overhead charges to us following the Redemption Date.

 

Theaccompanying consolidated financial statements have been prepared in accordancewith generally accepted accounting principles for interim financial informationand with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,certain information and footnotes required by generally accepted accountingprinciples in annual financial statements have been omitted or condensed inaccordance with quarterly reporting requirements of the SEC. These interimconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto for the year ended December31, 2006, as reported by us in our Form S-1/A Registration Statement dated June8, 2007. 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. Theconsolidated financial statements include all adjustments of a normal recurringnature which, in the opinion of management, are necessary for a fair statementof our financial position as of September 30, 2007, and results of operationsand cash flows for the interim periods presented. The results of operations forthe three and nine months ended September 30, 2007, are not necessarilyindicative of the results to be expected for the entire year.

 

*****Liquidity and Risks*****

 

We have a history of incurring net losses and netoperating cash flow deficits. We are also deploying new and unproventechnologies and continue to develop commercial products. We have severalongoing long-term development projects that involve experimental technology andmay require several years and substantial expenditures to complete. Based onour cash and investment balances as of December 31, 2006, we believed that ourcash and cash equivalent balances, anticipated cash flows from operations andother external sources of available credit would be sufficient to meet our cashrequirements through December 31, 2007, which raised substantial doubt aboutour ability to continue as a going concern beyond this point. On May 4, 2007,Acacia executed a registered direct offering of $5.0 million, the proceeds ofwhich were allocated to us (see Note 6).

 

We will continue to require capital from externalsources, and there can be no assurances that additional sources of financing,including the issuance of debt and/or equity securities will be available attimes and at terms acceptable to us. The issuance of equity securities willalso cause dilution to our shareholders. If external sources of financing arenot available or are inadequate to fund our operations, we will be required toreduce operating costs including research projects and personnel, which couldjeopardize the future strategic initiatives and business plans of the Company. 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, reduction in operating costs at CMDX, should theyoccur, could jeopardize its ability to launch, market and sell additionalproducts and services necessary in order to grow and sustain its operations andeventually achieve profitability.

 

Our business operations are also subject to certainrisks and uncertainties, including:

 

•                  market acceptance of products and services;

 

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

 

•                  increases in operating costs, including costsfor supplies, personnel and equipment;

 

•                  the availability and cost of capital;

 

•                  general economic conditions; and

 

•                  governmental regulation that may restrict ourbusiness.

 

7

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Historically, wehave been substantially dependent on arrangements with strategic partners andhave relied upon payments by our partners for a significant component of ourworking capital. We intend to enter into additional strategic partnerships todevelop and commercialize future products. However, there can be no assurancethat we will be able to implement our future plans. Failure to achieve ourplans would have a material adverse effect on our ability to achieve ourintended business objectives. Our success also depends on our ability toprotect our intellectual property, the loss thereof or our failure to securethe issuance of additional patents covering elements of our business processescould materially harm our business and financial condition. The patentscovering our core technology begin to expire in 2018.

 

Our products andservices are concentrated in a highly competitive market that is characterizedby rapid technological advances, frequent changes in customer requirements andevolving regulatory requirements and industry standards. Failure to anticipateor respond adequately to technological advances, changes in customerrequirements, changes in regulatory requirements or industry standards, or anysignificant delays in the development or introduction of planned products orservices, could have a material adverse effect on our business and operatingresults. The accompanying consolidated financial statements have been preparedassuming that the Company continues as a going concern. The financialstatements do not include any adjustments to reflect the possible futureeffects on the recoverability and classification of assets or the amounts andclassification of liabilities that may result from the matters discussedherein.

 

In addition toseeking additional capital from outside sources, our plans in regard to thesematters include reductions in personnel and in our fixed overhead costs made inlate 2006 and early 2007. Also, we are focusing our sales and productdevelopment efforts on our core diagnostic array platform as well as our fundedresearch and development projects for the U.S. Department of Defense (“DoD”).

 

*Nasdaq Notification*

 

On April 23, 2007, Acacia received a Nasdaq StaffDeficiency Letter notifying Acacia that the AR-CombiMatrix stock (tradingsymbol: CBMX) was not in compliance with the minimum trading price of theNasdaq Global Market set forth in Marketplace Rule 4450(a)(5). As discussedabove, we completed the split-off of CombiMatrix from Acacia by redeeming theAR-CombiMatrix stock for common stock of CombiMatrix Corporation as of theRedemption Date. As a result, AR-CombiMatrix stock is no longer issued oroutstanding, nor does it trade on a national exchange. On August 15, 2007,CombiMatrix Corporation common stock began trading on the Nasdaq Capital Marketexchange and we are currently in compliance with Nasdaq Capital Market exchangelisting requirements.

 

****2.     SUMMARY OF SIGNIFICANTACCOUNTING POLICIES****

 

*Use of Estimates.*Thepreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions that affect the reported amount of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from theseestimates.

 

**Revenue Recognition**.We recognize revenue in accordance with Staff Accounting Bulletin No. 104, “RevenueRecognition” (“SAB No. 104”) and related authoritative pronouncements. Revenuesfrom multiple-element arrangements are accounted for in accordance withEmerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements withMultiple Deliverables.”  Revenue isrecognized when (i) persuasive evidence of an arrangement exists, (ii) allobligations have been performed pursuant to the terms of the agreement, (iii)amounts are fixed or determinable and (iv) collectibility of amounts isreasonably assured.

 

Revenues frommultiple-element arrangements involving license fees, up-front payments, milestonepayments, products and/or services, which are received and/or billable by us inconnection with other rights and services that represent continuing obligationsof ours, are deferred until all of the elements have been delivered or until wehave established objective and verifiable evidence of the fair value of theundelivered elements.

 

Revenues fromgovernment grants and contracts are recognized in accordance with AccountingResearch Bulletin (“ARB”) No. 43, “Government Contracts,” and related pronouncements,such as Statement of Position 81-1, “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts.”  

 

8

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Accordingly,revenues are recognized under the percentage-of-completion method ofaccounting, using the cost-to-cost approach to measure completeness at eachreporting period. Under the percentage-of-completion method of accounting,contract revenues and expenses are recognized in the period that work isperformed based on the percentage of actual incurred costs to total contractcosts. Actual contract costs include direct charges for labor and materials andindirect charges for labor, overhead and certain general and administrativecharges. Contract change orders and claims are included when they can bereliably estimated and are considered probable. For contracts that extend overa one-year period, revisions in contract cost estimates, if they occur, havethe effect of adjusting current period earnings applicable to performance inprior periods. Should current contract estimates indicate an overall futureloss to be incurred, a provision is made for the total anticipated loss in thecurrent period.

 

Revenue from thesale of products and services, including shipping and handling fees, arerecognized when delivery has occurred or services have been rendered. We sellour products and services directly to customers and also through distributors,and our right to collection is not dependent upon installation or a subsequentsale of our products to end-users. Our standard agreements do not provide forcredits, returns or exchanges with our customers or distributors. Ourdistribution agreements include fixed pricing arrangements for our products andafter customer acceptance, there is no written or implied right to return orexchange the products.

 

**Stock-basedCompensation**. Prior to the Redemption Date, employees ofCombiMatrix Corporation had been granted options to purchase AR-CombiMatrixcommon stock. As a result, the following disclosures prior to the RedemptionDate relate to AR-CombiMatrix stock option awards. Subsequent to the RedemptionDate, we began issuing stock option awards under the CombiMatrix Corporation2006 Stock Incentive Plan (the Plan), which provides for equity-based awards inCombiMatrix Corporation common stock.

 

In December 2006,the Acacia board of directors passed a clarifying amendment to the CombiMatrix2000 Stock Awards Plan and the 2002 CombiMatrix Stock Incentive Plan (the “PriorPlans”) to include the planned split-off of CombiMatrix Corporation as a changein control under the terms of the Prior Plans. This is due to the fact that theholders of stock in Acacia Research Corporation no longer own an interest inthe assets of CombiMatrix, and the Board of Directors of Acacia ResearchCorporation will no longer administer the Prior Plans. As a result and as ofthe Redemption Date, all but 346 outstanding options under the Prior Plansrelating to AR-CombiMatrix stock immediately vested on the Redemption Date asthe split-off of the Company from Acacia was deemed a change in control. As ofthe Redemption Date, we recognized a charge of approximately $1.3 million,representing previously unrecognized compensation expense related to nonvestedAR-CombiMatrix common stock option awards outstanding as of the Redemption Date.None of these options were exercised and all but 346 of the options issuedunder the Prior Plans were subsequently terminated. During the third quarter of2007, our board of directors approved grants of stock option awards to purchase1,006,120 shares of our common stock under the Plan. These options generallyvest over a three-year period from the date of grant.

 

EffectiveJanuary 1, 2006, we adopted the provisions of Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”),which sets forth the accounting requirements for “share-based” compensationpayments to employees and non-employee directors and requires that compensationcost relating to share-based payment transactions be recognized in thestatement of operations. The compensation cost for all stock-based awards ismeasured at the grant date, based on the fair value of the award, and isrecognized as an expense, on a straight-line basis, over the employee’srequisite service period (generally the vesting period of the equity award)which is generally two to four years. The fair value of each option award isestimated on the date of grant using a Black-Scholes option valuation model. SFASNo. 123R requires stock-based compensation expense to be recorded only forthose awards expected to vest using an estimated forfeiture rate. We estimatepre-vesting option forfeitures at the time of grant and reflect the impact ofestimated pre-vesting option forfeitures in compensation expense recognized.Stock-based compensation expense for all periods presented attributable to ourfunctional expense categories were as follows (in thousands; unaudited):

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                            | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of product sales                 |       | $                                | 5          |                            | $          | — |   | $ | 5 |   | $ | — |   |
| Research and development              |       | 793                              |       | 311                             |       | 1,195 |   | 797 |   |
| Marketing, general and administrative |       | 629                              |       | 277                             |       | 963 |   | 959 |   |
| Total non-cash stock compensation     |       | $                                | 1,427      |                            | $          | 588 |   | $ | 2,163 |   | $ | 1,756 |   |
|                                       |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |

 

9

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**Income Taxes**.Effective January 1, 2007, we adopted FASB Interpretation No. 48 (“FIN 48”), “Accountingfor Uncertainty in Income Taxes,” which clarifies the accounting foruncertainty in income taxes recognized in the financial statements inaccordance with FASB Statement No. 109, “Accounting for Income Taxes.”  FIN 48 provides guidance on the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosures, and transition. In accordance with FIN 48, a tax position is aposition in a previously filed tax return or a position expected to be taken ina future tax filing that is reflected in measuring current or deferred incometax assets and liabilities. Tax positions shall be recognized only when it ismore likely than not (likelihood of greater than 50%), based on technicalmerits, that the position would be sustained upon examination. Tax positionsthat meet the more likely than not threshold should be measured using aprobability-weighted approach as the largest amount of tax benefit that isgreater than 50% likely of being realized upon settlement. The adoption of FIN48 did not have a material impact on our consolidated financial position,results of operations or cash flows.

 

**Income (Loss) PerShare**. As discussed in Note 1, we were a wholly ownedsubsidiary of Acacia and had 100 shares of common stock outstanding for allperiods presented prior to the Redemption Date. Therefore, historical earnings(losses) per share have not been presented in the consolidated financialstatements, as this information is not considered meaningful.

 

Net loss per sharehas been presented for current financial periods only in order to reflect thecapital structure of the Company subsequent to the Redemption Date. Basic anddiluted net loss per share has been computed by dividing the net loss by theweighted average number of CombiMatrix shares issued and outstanding subsequentto the Redemption Date. Options and warrants to purchase CombiMatrix stock areanti-dilutive for all periods presented and therefore were not included in thedetermination of the diluted net loss per share for the current periodspresented.

 

*****Recent Accounting Pronouncements*****

 

In June 2007, the EITF issued EITF Issue No.07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services tobe Used in Future Research and Development Activities” (“EITF 07-3”), which iseffective for fiscal years beginning after December 15, 2007.  EITF 07-3requires that nonrefundable advance payments for future research anddevelopment activities be deferred and capitalized.  Such amounts will berecognized as an expense as the goods are delivered or the related services areperformed.  We do not expect the adoption of EITF 07-3 to have a materialimpact on our consolidated financial position, results of operations and cashflows.

 

In February2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities Including an Amendment of FASB Statement No. 115” (“SFASNo. 159”).  SFAS No. 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value, with unrealizedgains and losses related to these financial instruments reported in earnings ateach subsequent reporting date.  We are currently assessing the impact, ifany, of adopting SFAS No. 159 on our consolidated financial position, resultsof operations and cash flows.

 

# **3.     COMPREHENSIVE LOSS**

 

Prior tothe Redemption Date, comprehensive loss was included as a component of netallocations from Acacia and was not separately reported in our consolidatedgroup financial statements. The following table shows our comprehensive netloss in accordance with SFAS No. 130, “Reporting Comprehensive Income,”subsequent to the Redemption Date (unaudited):

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **September 30, 2007** | ** ** | **September 30, 2007** | ** ** |
| ** **                                           | ** ** | ** **                       | ** ** | ** **                       | ** ** |
| Net realized gain on available for sale  investments |       | $                                | 4          |                             | $          | 4 |   |
| Net loss                                             |       | (3,433                           | )          | (9,095                           | )          |
| Comprehensive loss                                   |       | $                                | (3,429     | )                                | $          | (9,091 | ) |

 

10

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# **4.     COMMON STOCK WARRANTLIABILITY**

# ** **

Prior to theRedemption Date, Acacia had issued approximately 23.8 million warrants topurchase AR-CombiMatrix stock in connection with various financing transactions.As of the Redemption Date, all previously outstanding AR-CombiMatrix commonstock warrants became exercisable in CombiMatrix Corporation common stock,adjusted for the Redemption Ratio discussed above.

 

Outstandingwarrants to purchase CombiMatrix stock (adjusted for the Redemption Ratio) areas follows:

 
| ** **                  | ** ** | **Number of Warrants Outstanding** | ** ** | ** **                  | ** ** | ** **              | ** **                                                 |
|-----------------------------|------------|---------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------------------------------------------------------|
| **Date of Issue** | ** ** | **September 30,  2007**                      | ** ** | **December 31,  2006** | ** ** | **Exercise Price** | ** **                                                 | **Expiration** | ** ** |
|                        |       |                                              |       |                        |       |                    |                                                       |   |   |
| May 2007                    |       | 1,017,140                                         |       | —                      |       | $                       |          5.50 |   | May 2017 |   |
| December 2006               |       | 1,178,736                                         |       | 1,221,039                   |       | $                       | 8.70 - $10.88                                              |   | December  2011 |   |
| September 2005              |       | 159,648                                           |       | 159,648                     |       | $                       |        24.00            |   | September  2010 |   |
| May 2003                    |       | 28,341                                            |       | 28,341                      |       | $                       |        27.50            |   | May 2008 |   |
|                        |       |                                              |       |                        |       |                    |                                                       |   |   |
| Total                       |       | 2,383,865                                         |       | 1,409,027                   |       |                    |                                                       |   |   |

 

Acacia’s classes of common stock were subject to certain redemptionprovisions in the event that Acacia Research Corporation were to sell,transfer, assign or otherwise dispose of, in one transaction or a series ofrelated transactions, all or substantially all of the properties and assetsattributed to the CombiMatrix group, in which case the shareholders ofAR-CombiMatrix common stock would have the right to receive a dividend or aredemption of the stock equal to the net proceeds generated from the sale ofassets. Pursuant to guidance set forth in FSP No. 150-5, EITF 00-19 and relatedguidance, we recorded a liability representing the fair value of common stockwarrants issued to investors and adjusted the warrant liability to its marketvalue at each balance sheet date. As of December 31, 2006, the warrant liabilitywas $6,732,000.

 

Our current capital structure does not include the redemptionprovisions that required liability classification of the warrants and as such,since the Redemption Date, we have classified all outstanding warrants topurchase CombiMatrix common stock as a component of permanent equity. On theRedemption Date, the warrants became exercisable in CombiMatrix Corporationcommon stock and were adjusted to their fair value of $9.1 million and werereclassified to additional paid-in capital on August 14, 2007, which was thelast day that the warrants were exercisable in AR-CombiMatrix stock. For thethree and nine months ended September 30, 2007, adjusting the warrantliabilities to their fair values resulted in net credits to our consolidated statementsof operations of $(290,000) and $(2,523,000), respectively. We do not expect to incur warrantcharges (credits) in the future from our existing warrants as a result ofachieving permanent equity classification as of the Redemption Date.

 

The fair value of AR-CombiMatrix stock purchase warrants at August 14,2007 and December 31, 2006 was determined using the Black-Scholesoption-pricing model, using weighted-average assumptions as follows:

 
| ** **                 | ** ** | **August 14,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|---------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2007**            | ** ** | **2006**              | ** ** |
|                       |       |                |       |                  |       |
| Risk free interest rate    |       | 4.5                 | %          | 4.7                   | %          |
| Volatility                 |       | 78                  | %          | 80                    | %          |
| Remaining contractual term |       | 6.5 years           |       | 4.7 years             |       |

 

In February2007, proceeds of $368,000 were received from the issuance of 42,300 (adjustedfor the Redemption Ratio) shares of AR-CombiMatrix stock related to theexercise of certain warrants issued in connection with previous equityfinancings. There have been no warrant exercises subsequent to February 2007.

 

11

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**5.     COMMITMENTS AND CONTINGENCIES**

** **

**Facilities Lease**

 

On February 1,2007, we executed an amendment to our operating lease for office and laboratoryspace in Mukilteo, Washington, which reduced our future annual lease commitmentby approximately 80%. The amended lease includes an extension of two yearsbeyond our original termination date of October 31, 2008 (Termination Date). However,we have the right to terminate the lease without penalty as of the TerminationDate if we provide notice to the landlord on or before July 31, 2008.

 

**Collaboration andResearch Agreements**

 

On July 26, 2007, we executed a one-year,$2.2 million contract with the DoD to further development of our microarraytechnologies. The primary objectives of the contract are to continuedevelopment of a multipathogen and chemical detection system. Under the termsof this contract, we will perform research and development activities, as described under thecontract, and will be reimbursed on a periodic basis for actual costs incurredto perform these obligations, plus a fixed fee, of up to $2.2 million. As ofSeptember 30, 2007, we had incurred $237,000 in actual contract costs for thechemical detection contract, which was 15% complete.

 

OnMarch 13, 2007, we executed a one-year, $869,000 contract with the DoD,focusing on the development of a field-deployable influenza genotyping systembased on our electrochemical detection technology to be used for military andhomeland security applications. 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 performour obligations, plus a fixed fee, of up to $869,000. As of September 30, 2007,we had incurred $400,000 in actual contract costs for the genotyping contract,which was 63% complete.

 

OnAugust 9, 2006, we executed a two-year, $1.9 million contract with the DoD,focusing on the integration of our electrochemical detection technologycurrently under development with our microfluidics “lab-on-a-chip” technologyto be used for military and homeland security applications. 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 our obligations, plus a fixed fee, of up to$1.9 million. As of September 30, 2007 and December 31, 2006, we had incurred$719,000 and $190,000 in actual costs for the microfluidics contract, which wasapproximately 50% and 13% complete, respectively.

 

OnFebruary 8, 2006, we executed a one-year, $2.1 million contract with the DoD tofurther the development of our array technology for the electrochemicaldetection of biological and chemical threat agents. Under the terms of thiscontract, we will perform research and development activities as describedunder the contract and will be reimbursed on a periodic basis for actual costsincurred to perform our obligations, plus a fixed fee, of up to $2.1 million.We substantially completed this contract during the first quarter of 2007 anddo not expect to incur significant costs or revenues from this contract beyondthe first quarter of 2007.

 

**Human Resources**

 

Weprovide certain severance benefits such that if an executive who is a vicepresident or higher is terminated for other than cause, death or disability,the executive will receive payments equal to three months’ base salary plusmedical and dental benefits. If termination occurs as a result of a change incontrol transaction, these benefits will be extended by three months.

 

**Litigation**

 

OnSeptember 30, 2002, we entered into a settlement agreement with Nanogen, Inc. (“Nanogen”)to settle all pending litigation between the parties. Pursuant to the terms ofthe settlement agreement, we agreed to make quarterly payments to Nanogen equalto 12.5% of total sales of products developed by us and our affiliates based onthe patents that had been in dispute in the litigation, up to an annual maximumof $1,500,000. The minimum quarterly payments under the settlement agreementare $25,000 per quarter until the patents expire in 2018. Royalty expensesrecognized under the agreement for the nine months ended September 30, 2007 and2006 were $95,000 and $253,000, respectively, and are included in patent amortizationand royalties in the accompanying consolidated statements of operations.

 

12

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**Other**

** **

We are subject to other claims and legal actionsthat arise in the ordinary course of business. 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 agreement recently executed between us andAcacia, it is expected that such claims, legal actions, etc. attributable toCombiMatrix Corporation prior to the Redemption Date will remain with theCompany subsequent to the Redemption Date.

 

**6.     EQUITY FINANCING**

** **

Thefollowing share and per share amounts have been adjusted to reflect theRedemption Ratio discussed above.

 

OnMay 4, 2007, Acacia executed a registered direct offering with certain directorsof CombiMatrix Corporation and other unaffiliated investors raising grossproceeds of $5,000,000 through the issuance of 678,093 units.  Each unit consisted of one share ofAR-CombiMatrix common stock and a 1.5 ten-year common stock warrant, for a totalof 678,093 shares and warrants to purchase 1,017,139 shares of AR-CombiMatrixcommon stock, respectively, issued to investors.  Each warrant entitled the holder to purchasea share of AR-CombiMatrix stock at a price of $5.50 per share.  These warrants as well as warrants fromprevious financings (see Note 4) were assumed by us as of the Redemption Dateand are currently exercisable for CombiMatrix common stock.  

 

Theproceeds from the May 2007 registered direct offering were attributed tous.  As a result of this financing, webelieve that we will have sufficient funds to operate without requiringadditional external funding through September of 2008.

 

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**Item2.    MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS 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 1 ofthis report. The information contained in this Quarterly Report on Form 10-Q isnot a complete description of our businesses or the risks associated with aninvestment in our common stock. We urge you to carefully review and considerthe various disclosures made by us in this report and in our other reportsfiled with the Securities and Exchange Commission, or SEC, including our FormS-1/A, which was declared effective on June 8, 2007.

 

This reportcontains forward-looking statements within the meaning of the “safe harbor” provisionsof the Private Securities Litigation Reform Act of 1995. Reference is made inparticular 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 arebased on management’s current expectations and are subject to a number offactors and uncertainties, which could cause actual results to differmaterially from those described in the 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 accounting matters.Actual results in each case could differ materially from those anticipated insuch statements by reason of factors such as future economic conditions,changes in consumer demand, legislative, regulatory and competitivedevelopments in markets in which we and our subsidiaries operate, results oflitigation and other circumstances affecting anticipated 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 such results to differ materially fromthose described in the forward-looking statements are set forth in connectionwith the forward-looking statements and in our “Risk Factors” incorporated byreference in Part II, Item 1A of this report. 

 

## **General**

## ** **

We are adiversified biotechnology business, through the development of proprietarytechnologies, products and services in the areas of drug development, geneticanalysis, molecular diagnostics, nanotechnology research, defense and homelandsecurity markets, as well as other potential markets where our products andservices could be utilized. The technologies we have developed include aplatform technology to rapidly produce customizable, in-situ synthesized,oligonucleotide arrays for use in identifying and determining the roles ofgenes, gene mutations and proteins. This technology has a wide range ofpotential applications in the areas of genomics, proteomics, biosensors, drugdiscovery, drug development, diagnostics, combinatorial chemistry, materialsciences and nanotechnology.  We havealso developed the capabilities of producing arrays that utilize bacterialartificial chromosomes on our arrays, also enabling genetic analysis.  Other technologies include proprietarymolecular synthesis and screening methods for the discovery of potential newdrugs.  We currently recognize revenuesfrom selling these products and services and providing research and developmentservices for organizations including the U.S. Department of Defense and otherstrategic partners.

 

CombiMatrixMolecular Diagnostics, Inc., or “**CMDX**”, our wholly ownedsubsidiary located in Irvine, California, is exploring opportunities for ourarrays in the field of molecular diagnostics. This subsidiary has historicallycurrently focusing on product development and has begun generating modestrevenues. 

 

## **RelationshipWith Acacia Research Corporation**

## ** **

We were originallyincorporated in October 1995 as a California corporation and laterreincorporated as a Delaware corporation in September 2000. On December 13,2002, we merged with and became a wholly owned subsidiary of Acacia Research Corporation,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. 

 

14

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TheAR-CombiMatrix stock was intended to reflect separately the performance of theCombiMatrix Corporation and its subsidiaries, referred to as the******“CombiMatrix group****,**” whereas theAR-Acacia Technologies stock was intended to reflect separately the performanceof Acacia’s technology business, referred to as “**Acacia Technologies group**.”  

 

In December 2006,we filed a registration statement on Form S-1 with the Securities and ExchangeCommission (or “SEC”) to register our common stock in order to affect asplit-off of our Company from Acacia by redeeming shares of existingAR-CombiMatrix common stock with our common stock.  The Form S-1 was declared effective by theSEC on June 8, 2007 and on August 15, 2007 (the “Redemption Date”), each one(1) share of our common stock was issued in exchange for every ten (10) sharesAR-CombiMatrix common issued and outstanding on August 15, 2007.  Since the Redemption Date, we are no longer asubsidiary or an affiliate of Acacia, and the holders of AR-CombiMatrix becamethe stockholders of our company.  Ourcommon stock began trading on the Nasdaq Capital Market under the symbol “CBMXD”as of the Redemption Date and was subsequently changed to “CBMX” on September13, 2007.

 

## **Liquidity**

## ** **

At December 31,2006, we had cash and cash equivalents of $14.3 million.  As a result, management anticipated that ourcash and cash equivalent balances, anticipated cash flows from operations andother sources of funding from the capital markets would be sufficient to meetour cash requirements through December 31, 2007.  On May 4, 2007, Acacia executed a registereddirect offering of $5.0 million of AR-CombiMatrix stock, the proceeds of whichwere allocated to us by Acacia.  As ofSeptember 30, 2007, we had cash and cash equivalent balances of $10.5 millionand we expect that our cash balances, anticipated cash flows from operationsand other sources of funding will allow us to meet our cash requirementsthrough September of 2008.  In order forour company to continue as a going concern beyond this point and ultimately toachieve profitability, we will be required to obtain capital from externalsources, increase revenues and reduce operating costs.  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 ofadditional equity securities will also cause dilution to our shareholders.  If external sources of financing are notavailable or are inadequate to fund our operations, we will be required toreduce operating costs including research projects and personnel, which couldjeopardize the future strategic initiatives and business plans of ourcompany.  See Note 1 the consolidatedfinancial statements included in Part I, Item I of this report.  

 

## **BasisOf Presentation Of Financial Statements**

## ** **

The consolidatedfinancial statements included in this Form 10-Q are consistent with ourhistorical financial statements included in our June 30, 2007 Form 10-Q, ourForm S-1/A as well as Acacia’s reports filed with the Securities and ExchangeCommission under the Securities Act of 1933 and the Securities Act of1934.  Through the Redemption Date, theconsolidated financial statements included the assets, liabilities, operatingresults and cash flows of CombiMatrix Corporation using Acacia’s historicalbases in the assets and liabilities and the historical results of operations ofCombiMatrix Corporation. Also through the Redemption Date, the consolidatedfinancial statements included allocations of certain Acacia corporate expenses,including governance, legal, accounting, insurance services, treasury and otherAcacia corporate and infrastructure costs. The expense allocations were determined on bases that we determined withAcacia to be a reasonable reflection of the utilization of services providedfor the benefit received by us and are discussed in more detail below.  Since the Redemption Date, Acacia is nolonger allocating operating expenses to us.

 

## **OverviewOf Recent Business Activities**

## ** **

On August 15,2007, we completed our split-off from Acacia Research Corporation and are nolonger affiliated with Acacia.

 

For the ninemonths ended September 30, 2007, our operating activities included therecognition of $4.2 million in revenues, including $1.9 million in government contractrevenues and $2.3 million in CustomArraysTM product and service revenues.  

 

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Researchand development expenses, excluding government contract costs and non-cashstock based compensation, decreased due primarily to the impact of our costreduction efforts, which began during the fourth quarter of 2006 and continuedduring the first and second quarter of 2007. Such efforts also contributed to the overall decrease in general andadministrative expenses, which were impacted primarily by the execution of anamendment to our facilities lease in Mukilteo that reduced the amount of spaceas well as the lease rate paid by us.  

 

Historically, wehave relied primarily upon investing and financing activities to fund operatingactivities. At December 31, 2006, our cash and cash equivalent balances,including anticipated cash flows from future operations and other existingsources of credit were not considered to be sufficient to meet our operatingcapital requirements beyond December 31, 2007. However, due to the May 4, 2007 registered direct offering discussedabove, we believe the proceeds from this offering will allow us to meet ourcash requirements through September 2008 (see Note 1 and 6 of our consolidatedfinancial statements included herein). We will continue to seek additional sources of capital including theissuance of debt and/or equity securities.

 

**Critical Accounting Estimates**

 

Our unauditedinterim financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America. Preparation ofthese statements requires management to make judgments and estimates. Someaccounting policies have a significant impact on amounts reported in these financialstatements. A summary of significant accounting policies and a description ofaccounting policies that are considered critical may be found in our FormS-1/A, which was declared effective on June 8, 2007, in the Notes to theConsolidated Financial Statements and the Critical Accounting Estimatessection.  In addition, refer to Note 2 tothe consolidated interim financial statements included in Part I, Item 1 of this report.

 

**Comparison of the Resultsof Operations for the Three and Nine months Ended September 30, 2007 and 2006**

** **

**Revenues and Cost ofRevenues (In thousands)**

** **
| ** **                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                   | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                         |       |                             |       |                            |       |   |   |   |   |
| Government contracts         |       | $                                | 627        |                            | $          | 725 |   | $ | 1,855 |   | $ | 1,563 |   |
| Cost of government contracts |       | (593                             | )          | (684                            | )          | (1,768 | ) | (1,476 | ) |
| Products                     |       | 828                              |       | 968                             |       | 1,726 |   | 3,050 |   |
| Cost of products             |       | (307                             | )          | (412                            | )          | (858 | ) | (973 | ) |
| Service contracts            |       | 164                              |       | 88                              |       | 386 |   | 205 |   |
| Collaboration agreements     |       | 62                               |       | 63                              |       | 187 |   | 63 |   |
|                              |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

** **

**GovernmentContracts and Cost of Government Contracts. **Under the terms of our contracts with theDepartment of Defense (or “DoD”), we are reimbursed on a periodic basis foractual costs incurred to perform our obligations, plus a fixed fee. Revenuesare recognized under the percentage-of-completion method of accounting, usingthe cost-to-cost approach to measure completeness at the end of the eachreporting period. Cost of government contracts reflect research and developmentexpenses incurred in connection with our commitments under our currentcontracts with the DoD.  

 

The changes ingovernment contract revenues for both the three- and nine-month periods endedSeptember 30, 2007 vs. 2006 reflects ongoing performance of our electrochemicaldetection, microfluidics and influenza genotyping contracts during the 2007 and2006 periods.  Changes in the number ofcontracts underway coupled with changes in the underlying contract activitycontributes to the overall increase or decrease in contract revenue from periodto period.  These changes in contractactivity also contribute to the change in government contract costs during thethree- and nine-month periods ended September 30, 2007 vs. 2006.  

 

**Product Revenuesand Cost of Products**. Product revenues and costs of products relate to domestic andinternational sales of our array products. Product revenues include the sale of CustomArray 12K DNA expressionarrays, ElectraSenseTM microarray readers and related hardwareduring the three- and nine month periods ended September 30, 2007, compared toDNA synthesizer instruments and 12K DNA expression arrays during the comparable2006 periods.  

 

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Thedecrease in product revenues was due primarily to the lack of DNA synthesizerinstrument sales in 2007 compared to 2006. As we shift our business focus from selling array-based research anddevelopment products to providing array-based diagnostic services, we havereduced internal sales staff, marketing and production efforts regarding salesof CustomArray products and instead have executed product distribution andmanufacturing agreements with various third party distributors for the sales ofour suite of CustomArray products into the research and development markets.  As a result, CustomArray product revenueswill likely be volatile in future periods depending on the sales efforts of ourdistributors.

 

**Operating Expenses (InThousands)**

** **
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                        | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                              |       |                             |       |                            |       |   |   |   |   |
| Research and development expenses |       | $                                | 1,924      |                            | $          | 2,819 |   | $ | 4,874 |   | $ | 7,380 |   |
|                                   |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

* *

*Researchand Development Expenses*. The decrease in internal research and development expenses was dueprimarily to the impact of cost reduction efforts in the area of full-timestaff and ongoing research and development projects for the CustomArrayplatform, while continuing to develop microarray-based diagnostics services atCMDX.  The overall decrease is partiallyoffset by an increase in non-cash stock compensation charges of $793,000 and$1.2 million recognized for the three- and nine-month periods ended September30, 2007, respectively, vs. $311,000 and $797,000 in the comparable 2006periods, respectively.  The increase wasprimarily due to a one-time charge of $781,000 incurred during the thirdquarter of 2007 from unvested AR-CombiMatrix stock options that became fullyvested on the Redemption Date as a result of the split-off of CombiMatrix fromAcacia. 

 

Future researchand development expenses will continue to be incurred in connection with ourongoing internal research and development efforts in the areas of genomics,diagnostics, drug discovery and development.  We expect our research and development expenses to continue to fluctuateand such expenses could increase in future periods as additional internalresearch and development agreements are undertaken and/or as new research anddevelopment collaborations are executed with strategic partners.

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                      | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                            |       |                             |       |                            |       |   |   |   |   |
| Marketing, general and administrative  expenses |       | $                                | 2,167      |                            | $          | 2,661 |   | $ | 6,956 |   | $ | 9,691 |   |
| Patent amortization and royalties               |       | 332                              |       | 366                             |       | 994 |   | 1,075 |   |
| Equity in loss of of investees                  |       | 248                              |       | 253                             |       | 770 |   | 786 |   |
|                                                 |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

**Marketing, Generaland Administrative Expenses.**  The decrease for both the three- andnine-month periods ended September 30, 2007 vs. 2006 was due primarily to adecrease in facilities-related costs from executing the February 1, 2007 leaseamendment that significantly reduced our office space and lease rates,reduction in sales and marketing staff and expenses at our Mukilteo operationsand overall reductions in general and administrative staff, which includedone-time bonuses and severance-related costs in the first quarter of 2006,which were not incurred in 2007.  Theoverall decrease is partially offset by an increase in non-cash stockcompensation charges of $629,000 and $963,000 recognized for the three- andnine-month periods ended September 30, 2007, respectively, vs. $277,000 and$959,000 in the comparable 2006 periods, respectively.  The increase was primarily due to a one-timecharge of $560,000 incurred during the third quarter of 2007 from unvested AR-CombiMatrixstock options that became fully vested on the Redemption Date as a result ofthe split-off of CombiMatrix from Acacia.

 

A summary of themain drivers of the changes in marketing, general and administrative expensesfor the periods presented is as follows (in thousands): 

 

17

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| ** **                                             | ** ** | **For the Three Months Ended**  | ** ** | **For the Nine Months Ended**   | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **September 30, 2007 vs. 2006** | ** ** | **September 30, 2007 vs. 2006** | ** ** |
|                                                   |       |                                                |       |                                                |       |
| Decrease in marketing and sales expenses               |       | $                                                   | (162       | )                                                   | $          | (704 | ) |
| Increase (decrease) in G&A expenses at  CMDX       |       | 74                                                  |       | (519                                                | )          |
| Decrease in salaries and benefits                      |       | (126                                                | )          | (423                                                | )          |
| Decrease in facilities lease and related  costs        |       | (488                                                | )          | (1,234                                              | )          |
| Increase in legal expenses                             |       | 55                                                  |       | 232                                                 |       |
| Increase in allowance for bad debt expense             |       | 16                                                  |       | 241                                                 |       |
| Decrease in consulting and professional  fees          |       | (146                                                | )          | (113                                                | )          |
| Increase in non-cash stock compensation                |       | 352                                                 |       | 4                                                   |       |
| Decrease in other general and  administrative expenses |       | (69                                                 | )          | (219                                                | )          |
|                                                        |            |                                                     |            |                                                     |            |  |  |

** **

### *****OtherNon-Operating Items*****

### ***** *****

**WarrantGains. ****Prior to the RedemptionDate and**in accordance with SFAS No. 150, “Accountingfor Certain Instruments with Characteristics of Both Liabilities and Equity,”and related interpretations, the outstanding AR-CombiMatrix stock purchasewarrants were classified as long-term liabilities due to certain redemptionprovisions associated with the underlying AR-CombiMatrix stock. Changes in thefair value of the stock purchase warrant liabilities are reflected in theconsolidated statement of operations.  Onthe Redemption Date, all outstanding warrants to purchase AR-CombiMatrix commonstock became exercisable in CombiMatrix common stock, which is not subject tothe redemption provisions that required liability classification of thewarrants prior to the Redemption Date. In accordance with EITF 00-19 and related guidance, the fair value ofthe warrants as of the close of trading on August 14, 2007 (the last day thatthe warrants were exercisable in AR-CombiMatrix common stock) of $9.1 millionwas classified to additional paid-in capital. We do not expect to incur additional warrant gains or charges in thefuture for our existing common stock purchase warrants.

 

**Inflation**

** **

Inflationhas not had a significant impact on our company.

 

**Liquidity and CapitalResources**

** **
| ** **                                             | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **September 30,**          | ** ** |
| ** **                                             | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| Net cash provided by (used in) continuing  operations: |       |                            |       |   |   |
| Operating activities                                   |       | $                               | (9,136     | ) | $ | (11,848 | ) |
| Investing activities                                   |       | (1,512                          | )          | 6,266 |   |
| Financing activities                                   |       | 5,410                           |       | 2,220 |   |
| Decrease in cash and cash equivalents                  |       | $                               | (5,238     | ) | $ | (3,362 | ) |

 

At September 30,2007, cash and cash equivalents and short-term investments totaled $10.5million compared to $14.3 million at December 31, 2006.  Working capital at September 30, 2007 was$9.6 million, compared $12.0 million at December 31, 2006.  The change in working capital was dueprimarily to the impact of net cash flow activities as discussed below.  The net change in cash and cash equivalentsfor the periods presented was comprised of the following (in thousands): 

 

Cash receipts fromcustomers for the nine months ended September 30, 2007, were $3.3 million,comprised of $1.5 million from the sale of array products and services and $1.8million in payments received from the DoD. Cash receipts in the comparable 2006 period totaled $4.5 million, comprisedof $2.6 million from the sale of array products and services and $1.9 millionin payments received from the DoD.  Cashoutflows from operations (excluding cash receipts from customers) for the ninemonths ended September 30, 2007 and 2006 were $12.4 million and $16.3 million,respectively.

 

The change in netcash flows provided by (used in) investing activities was due primarily to netpurchases and sales of available-for-sale investments in connection withongoing short-term cash management activities during the periodspresented.  For the nine months endedSeptember 30, 2007 and 2006, we incurred $122,000 and $495,000, respectively,of capital expenditures.  

 

18

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Ournet cash outflows from investing activities for the nine months ended September30, 2006, included additional contractual investments in Leuchemix totaling$1.4 million.  There were no suchinvestments for the nine-month period ending September 30, 2007.

 

The increase innet cash flows provided by financing activities was due primarily to thecompletion of a registered direct offering of AR-CombiMatrix common stock inMay of 2007 for $5.0 million as well as the exercise of AR-CombiMatrix commonstock warrants totaling $368,000 during February of 2007, compared to $2.1million in net proceeds received from the sales of AR-CombiMatrix common stockduring the comparable 2006 period.  SeeNotes 4 and 6 to our consolidated financial statements included in Part I, ItemI of this report.

 

Based on ourending cash balances as of September 30, 2007, we believe that our cash andcash equivalent balances, anticipated cash flows from operations and externalsources of funding from the capital markets will be sufficient to meet our cashrequirements through September 2008.  Inorder for us to continue to meet our cash requirements beyond this point, wewill be required to obtain capital from external sources.  However, there can be no assurances that wewill be able to secure additional sources of financing at times and at termsacceptable to management.  The issuanceof additional equity securities will also cause dilution to ourshareholders.  If external financingsources of financing 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.  As discussed in Note 1 to the consolidatedfinancial statements included herein, the anticipation that we would berequired to obtain additional financing in the foreseeable future raisedsubstantial doubt about our ability to continue as a going concern beyondDecember 31, 2007.  However, we believethat we have resources to remain a going concern through September of 2008based primarily on the May 4, 2007 financing discussed above and in Note 6 ofour consolidated financial statements, as well as our cost reductionefforts.  In addition to seeking capitalfrom outside sources, our plans in regard to these matters included reductionsin personnel and in fixed overhead costs (e.g., our lease commitment reductiondiscussed elsewhere herein) made in late 2006 and early 2007.  Also, we are focusing our sales and productdevelopment efforts on our core diagnostic array platform as well as our fundedresearch and development projects for the DoD.

 

We may alsoencounter unforeseen difficulties that may deplete our capital resources morerapidly than anticipated.  Any efforts toseek additional funding could be made through equity, debt or other externalfinancing, and there can be no assurance that additional funding will beavailable on favorable terms, if at all.

 

Our long-termcapital requirements will be substantial and the adequacy of available fundswill depend upon many factors, including:

 

•                  the costs of commercialization activities,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;

 

•                  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; and other factors that may not bewithin our control.

 

Pursuant to thetax allocation agreement executed between us and Acacia, we have agreed not totake certain actions for two years following the split-off, unless we obtain anIRS ruling or an opinion of counsel to the effect that these actions will notaffect the tax-free nature of the split-off. 

 

19

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Theseactions include certain issuances of our stock, a liquidation or merger of ourcompany, and dispositions of assets outside the ordinary course of ourbusiness.  If any of these transactionswere to occur, the split-off could be deemed to be a taxable distribution toAcacia.  In particular, we have agreed toindemnify Acacia for any tax resulting from an acquisition by one or morepersons of a 50% or greater interest in our company.

 

#### **Off-Balance SheetArrangements**

#### ** **

We have notentered into off-balance sheet financing arrangements, other than operatingleases. We have no significant commitments for capital expenditures in 2007 orbeyond. Other than as set forth below, we have no committed lines of credit orother committed funding or long-term debt. The following table lists ourmaterial known future cash commitments as of September 30, 2007: 

 
| ** **                         | ** ** | **Payments Due by Period (in thousands)** | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                         | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **2011 and** | ** ** |
| ** **                         | ** ** | **2007**                                                           | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
|                               |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating leases                   |       | $                                                                  | 136        |   | $ | 552 |   | $ | 495 |   | $ | 333 |   | $ | — |   |
| Minimum license payments           |       | 125                                                                |       | — |   | — |   | — |   | — |   |
| Minimum royalty payments           |       | 25                                                                 |       | 100 |   | 100 |   | 100 |   | 775 |   |
| Total contractual cash obligations |       | $                                                                  | 286        |   | $ | 652 |   | $ | 595 |   | $ | 433 |   | $ | 775 |   |
|                                    |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Recent AccountingPronouncements**

** **

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

 

**Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

** **

Our exposureto market risk is limited primarily to interest income sensitivity, which isaffected by changes in the general level of United States interest rates,particularly because a significant portion of our investments are in short-termdebt securities issued by the U.S. government, U.S. corporations, institutionalmoney market funds and other money market instruments. The primary objective ofour investment activities is to preserve principal while at the same timemaximizing the income received without significantly increasing risk. Tominimize risk, we maintain a portfolio of cash, cash equivalents and short-terminvestments in a variety of investment-grade securities and with a variety ofissuers, including corporate notes, commercial paper and money marketinstruments. Due to the nature of our short-term investments, we believe thatwe are not subject to any material market risk exposure. We do not have anyderivative financial instruments.

 

**Item 4T.  CONTROLS AND PROCEDURES**

** **

*Evaluation of DisclosureControls and Procedures*

* *

Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of our disclosure controls and procedures, as such term is definedunder Rule 13a-15(e) promulgated under the Securities Exchange Act of1934, as amended. Based on this evaluation, our principal executive officer andour principal financial officer concluded that, as of the end of the periodcovered by this quarterly report, our disclosure controls and procedures wereeffective to ensure that the information required to be disclosed by us in thereports that we file or submit under the Securities Exchange Act of 1934 isaccumulated and communicated to management, including our chief executiveofficer and chief financial officer, to allow timely decisions regardingrequired disclosure, and that such information is recorded, processed,summarized and reported within the time periods prescribed by the SEC.

 

20

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*Changes in InternalControls*

* *

There wereno changes in our internal control over financial reporting that occurredduring our last fiscal quarter (the quarter ended September 30, 2007) that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

21

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**PART II—OTHER INFORMATION**

** **

**Item 1.  LEGAL PROCEEDINGS**

** **

In connection withthe complaint Mr. Jeffrey Oster filed against CombiMatrix Corporation andothers on July 17, 2007, as previously disclosed in our Quarterly Report forthe period ended June 30, 2007, we have alleged counterclaims against Mr. Osterfor breach of employment contract, breach of common law duties of loyalty andconfidentiality, and misappropriation of trade secrets, with a demand forunspecified damages.  We continue tovigorously defend against Mr. Oster’s claims. A trial date has been scheduled for early in the first quarter of 2008.

 

On September 2,2005, Ms. Jennifer Dent and Mr. Michael Strathmann (a married couple), who areboth former employees of CombiMatrix Corporation, filed a complaint in theSuperior Court for King County, Washington (Cause No. 05-2-37874-3 SEA),asserting claims arising out of the resignation of their employment withCombiMatrix and seeking unpaid bonus compensation and other damages as well asother claims regarding certain intellectual property rights.  We believe these claims are without merit andintend to vigorously defend against them. We have asserted intellectual property counterclaims against Mr.Strathmann and have asked for certain injunctive relief and damages based onthose counterclaims.  A trial date hasbeen scheduled for early in the first quarter of 2008.

 

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

** **

On August 20, 2007, CombiMatrix Corporationissued 3,000 shares of unregistered CombiMatrix common stock pursuant to theterms of a consulting services agreement between CombiMatrix Corporation and athird-party consultant.  The consultingservices agreement is more fully described in Part II, Item 2 of the QuarterlyReport of CombiMatrix Corporation for the period ended June 30, 2007,incorporated by reference herein and included as Exhibit 99.1 of this report.

 

The issuance and sale of these securities wasexempt from the registration and prospectus delivery requirements of theSecurities Act of 1933 by virtue of Section 4(2) and Rule 506 of RegulationD.  The sale did not involve a publicoffering or general solicitation and was limited to a single accreditedinvestor.  No commissions were paid onthe issuance and sale of the shares.  Thestock certificates issued pursuant to the consulting agreement have contained arestrictive legend in accordance with Rule 144.

 

**Item 6.  EXHIBITS**

** **
| 10.1   |   | Amendment No. 1 to Lease (1)                                                                                                                                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                      |
| 10.2   |   | Research and development contract with the U.S. Department  of Defense for the development of a CMOS Microarray Platform for Bio and  Chemical Threat Agent Detection (2) |
|   |   |                                                                                                                                                                      |
| 31.1   |   | Rule 13a-14(a) Certification of Principal Executive Officer                                                                                                               |
|   |   |                                                                                                                                                                      |
| 31.2   |   | Rule 13a-14(a) Certification of Principal Financial Officer                                                                                                               |
|   |   |                                                                                                                                                                      |
| 32.1   |   | Section 1350 Certification of Principal Executive Officer                                                                                                                 |
|   |   |                                                                                                                                                                      |
| 32.2   |   | Section 1350 Certification of Principal Financial Officer                                                                                                                 |
|   |   |                                                                                                                                                                      |
| 99.1   |   | Part II, Item 2 of Quarterly Report of CombiMatrix  Corporation for Period Ended June 30, 2007                                                                            |

 

----

| (1) |   | Incorporated by reference to the Form 8-K of  CombiMatrix Corporation filed with the Commission on July 7, 2007, as File  No. 07975313   |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated  by reference to the Form 8-K of CombiMatrix Corporation filed with the  Commission on July 31, 2007, as File No. 071010714 |

 

22

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**SIGNATURES**

** **

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 

 
|   | COMBIMATRIX CORPORATION |
|--------|-------------------------|
|   |                    |   |
|   |                    |   |
|   | By:                     | /s/ Amit Kumar |
|   |                    | Amit Kumar |
|   |                    | Chief Executive Officer |
|   |                    | (Authorized Signatory) |
|   |                    |   |
|   |                    |   |
|   | By:                     | /s/ Scott R.  Burell |
|   |                    | Scott R. Burell |
|   |                    | Chief Financial Officer |
|   |                    | (Principal Financial Officer) |
|   |                    |   |
| Date:  | November  7, 2007       |   |   |
|        |                         |  |  |

 

23

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** **

**EXHIBITINDEX**

** **
| **EXHIBIT** | ** ** | ** **                                                                                                                                                                |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER**  | ** ** | **EXHIBIT**                                                                                                                                                               |
| ** **  | ** ** | ** **                                                                                                                                                                |
| 10.1        |       | Amendment No. 1 to Lease (1)                                                                                                                                              |
|        |       |                                                                                                                                                                      |
| 10.2        |       | Research and development contract with the U.S. Department  of Defense for the development of a CMOS Microarray Platform for Bio and  Chemical Threat Agent Detection (2) |
|        |       |                                                                                                                                                                      |
| 31.1        |       | Rule 13a-14(a) Certification of Principal Executive Officer                                                                                                               |
|        |       |                                                                                                                                                                      |
| 31.2        |       | Rule 13a-14(a) Certification of Principal Financial Officer                                                                                                               |
|        |       |                                                                                                                                                                      |
| 32.1        |       | Section 1350 Certification of Principal Executive Officer                                                                                                                 |
|        |       |                                                                                                                                                                      |
| 32.2        |       | Section 1350 Certification of Principal Financial  Officer                                                                                                                |
|        |       |                                                                                                                                                                      |
| 99.1        |       | Part II, Item 2 of Quarterly Report of CombiMatrix  Corporation for Period Ended June 30, 2007                                                                            |

 

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| (1) |   | Incorporated by reference to the Form 8-K of  CombiMatrix Corporation filed with the Commission on July 7, 2007, as File  No. 07975313   |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated  by reference to the Form 8-K of CombiMatrix Corporation filed with the  Commission on July 31, 2007, as File No. 071010714 |

 

24

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