Cautionary Statement

You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained in Part I, Item 1 of this report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our businesses or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the U.S. Securities and Exchange Commission, or "SEC," including our Annual Report on Form 10-K, filed on March 27, 2009.

This report contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives, and other forward-looking statements included in this report. Such statements may be identified by the use of forward-looking terminology such as "may," "will," "expect," "believe," "estimate," "anticipate," "intend," "continue," or similar terms, variations of such terms or the negative of such terms. Such statements are based on management's current expectations and are subject to a number of factors and uncertainties, which could cause actual results to differ materially from those described in the forward-looking statements. Such statements address future events and conditions concerning product development, capital expenditures, earnings, litigation, regulatory matters, markets for products and services, liquidity and capital resources and accounting matters. Actual results in each case could differ materially from those anticipated in such statements by reason of factors such as future economic conditions, changes in consumer demand, legislative, regulatory and competitive developments in markets in which we and our subsidiaries operate, results of litigation and other circumstances affecting anticipated revenues and costs. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements and in the "Risk Factors" described in our Annual Report on Form 10-K filed on March 27, 2009.

General

We are a diversified biotechnology business that develops proprietary technologies, including products and services in the areas of drug development, genetic analysis, molecular diagnostics, nanotechnology and defense and homeland security markets, as well as in other potential markets where our products and services could be utilized. The technologies we have developed include a platform technology to rapidly produce user-defined, in-situ synthesized, oligonucleotide arrays for use in identifying and determining the roles of genes, gene mutations and proteins. This technology has a wide range of potential applications in the areas of genomics, proteomics, biosensors, drug discovery, drug development, diagnostics, combinatorial chemistry, material sciences and nanotechnology. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs. We currently recognize revenues from selling these products and services and providing research and development services for organizations including the U.S. Department of Defense, or "DoD" and other strategic partners.

CombiMatrix Molecular Diagnostics, Inc., or "CMDX," our wholly owned subsidiary located in Irvine, California, has developed capabilities of producing arrays that utilize bacterial artificial chromosomes, or "BACs," which also enable genetic analysis. CMDX functions primarily as a diagnostics reference laboratory.

Leuchemix Inc. ("Leuchemix"), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases.

Relationship With Acacia Research Corporation

We were originally incorporated in October 1995 as a California corporation and later reincorporated 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 whereby Acacia created two classes of registered common stock called Acacia Research-CombiMatrix common stock ("AR-CombiMatrix stock") and Acacia Research-Acacia Technologies common stock ("AR-Acacia Technologies stock") and divided its existing Acacia common stock into shares of the two new classes of common stock.

In late 2006, Acacia announced its intent to split off the Company as an independent public company. On August 15, 2007 (the "Redemption Date"), all currently issued and outstanding shares of AR-CombiMatrix stock were redeemed and exchanged for shares of CombiMatrix common stock at a redemption ratio of ten shares of AR-CombiMatrix stock for one share of CombiMatrix common stock (the "Redemption Ratio"), which is publicly traded on the Nasdaq Global Market. Also, warrants to purchase AR-CombiMatrix stock became exercisable to purchase CombiMatrix common stock, adjusted for the Redemption Ratio. As of the Redemption Date, we ceased to be a subsidiary of, or affiliated with, Acacia. Our common stock currently trades on the Nasdaq Global Market under the symbol "CBMX."

Liquidity

At December 31, 2008 and March 31, 2009, we had cash, cash equivalents and available-for-sale investments of $9.1 million and $5.9 million, respectively, which we believed would be sufficient to meet our cash requirements to September 2009. On May 1, 2009, we closed a registered direct offering of our common stock and warrants which, after placement agent fees and other costs, netted $7.6 million to us, and thereby extending our ability to continue operating as a going concern into 2010 (see Liquidity and Capital Resources below as well as Note 9 to the consolidated interim financial statements included elsewhere herein for further discussion).

In order for our company to continue as a going concern beyond 2010 and ultimately to achieve profitability, we will be required to increase revenues, reduce operating costs and possibly to obtain capital from external sources. However, there can be no assurance that such capital will be available at times and at terms acceptable to us, or that higher levels of product and service revenues will be achieved. The issuance of additional equity securities, should that occur, will cause dilution to our shareholders. If external financing sources are not available or are inadequate to fund our operations, we will be required to reduce operating costs including research projects and personnel, which could jeopardize our future strategic initiatives and business plans. See Note 1 to the consolidated financial statements included elsewhere in this report for additional discussion of these matters.

Basis Of Presentation Of Financial Statements

The consolidated financial statements included in this Form 10-Q are consistent with our historical financial statements included in our Form 10-K for our fiscal year ended December 31, 2008.

Overview Of Recent Business Activities

For the three months ended March 31, 2009, our operating activities included the recognition of $1.5 million in revenues, including $525,000 in government contract revenues, $288,000 in CustomArray product and service revenues and $727,000 in diagnostic lab revenues. Research and development expenses, excluding government contract costs and non-cash stock based compensation, decreased in the first quarter of 2009 due primarily to the increased focus on commercialization of our existing suite of products and diagnostic test offerings, rather than on the development of new products and services. Marketing, general and administrative expenses increased due primarily to increased sales and marketing efforts at CMDX and also due to increased investor and public relations costs.

Significant business developments that occurred during and subsequent to the first quarter ended March 31, 2009 were:

† In January 2009, CMDX entered into a new partnership with Lenetix, a New York-based diagnostics laboratory, to co-market CMDX's suite of CGH array-based tests. These include the industry leading BAC HD ScanTM test, which is used for characterizing genomic causes of childhood developmental disorders. The BAC HD Scan test can identify over 290 genomic causes of developmental disorders and is routinely used in postnatal genetic diagnostics.

† In January 2009, Leuchemix, Inc., provided additional information regarding the initial clinical trial of its novel anticancer drug LC-1. The initial trial is being performed at Cardiff University in the United Kingdom under the supervision of Professor Alan Burnett. Work from Professor Burnett's laboratory has also demonstrated that LC-1 may be valuable for in-patients that respond poorly to conventional therapy.

† In January 2009, former U.S. Food and Drug Administration Deputy Commissioner Scott Gottlieb, M.D., joined our board of directors.

† In February 2009, we announced preliminary data on our investigational Comprehensive Cancer Array test, showing that it can non-invasively screen for the early detection of prostate, colon, ovarian, breast and lung cancers simultaneously. The results were presented at Cambridge Healthtech Institute's 16th International Molecular Medicine Tri-Conference held in San Francisco.

† In March 2009, we executed a four-year contract with NASA's Ames Research Center to design and test a microfluidic system that incorporates our semiconductor microarray as part of an integrated genetic analysis platform that can be deployed in satellites. Funding to us for the first year of this program will be $214,000 with three option years at similar funding levels.

† In March 2009, we announced that the Agency for Health Protection and Promotion in Ontario, Canada had independently verified the function of our Influenza-Detection system during the 2007-2008 influenza season.

† In April 2009, Dr. Karine Hovanes joined our wholly owned subsidiary, Combimatrix Molecular Diagnostics, Inc. (CMDX), as its Laboratory Director. Dr. Hovanes is a Diplomat of the American Board of Medical Genetics in Clinical Molecular Genetics and Clinical Cytogenetics and is also licensed in New York and California in both cytogenetics and molecular genetics. Dr. Hovanes joins CMDX from the Laboratory Corporation of America, otherwise known as LabCorp.

Critical Accounting Estimates

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

Comparison of the Results of Operations for the Three months Ended March 31, 2009 and 2008

Revenues and Cost of Revenues (In thousands)



                                          Three Months Ended
                                              March 31,              Change
                                         2009          2008         $       %

Government contracts                   $    525    $      1,069   $ (544 ) (51 )%
Cost of government contract revenues       (495 )        (1,014 )    519   (51 )%
Products                                    257             575     (318 ) (55 )%
Services                                    696             283      413   146 %
Cost of products and services              (657 )          (405 )   (252 )  62 %
Collaboration agreements                     62              62        -     -

Government Contracts and Cost of Government Contracts. Under the terms of our contracts with the DoD, we are reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee. Under the terms of our contract with NASA, we are reimbursed on a periodic basis based on scheduled, contractual fixed amounts. Revenues are recognized under the percentage-of-completion method of accounting, using the cost-to-cost approach to measure completeness at the end of the each reporting period. Cost of government contracts reflect research and development expenses incurred in connection with our commitments under our current contracts with the DoD.

The decrease in government contract revenues for the three months ended March 31, 2009 versus the comparable period in 2008 was due primarily to fewer active contracts during 2009 versus 2008. The recent completion of our multipathogen and electrochemical detection contracts resulted in a decrease in government contract activity and thus lower government contract revenues recognized during the three months ended March 31, 2009 versus the comparable period in 2008.

See Note 8 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts, completion rates and estimated costs to complete of our government contracts that are ongoing as well as prior contracts that were completed during the periods presented. As these contracts near completion, future contract revenues could be volatile in the short-term and decrease in the longer term if new government contracts are not awarded or executed.

Products and Cost of Products. Product revenues and costs of products relate to domestic and international sales of our array products, which include DNA synthesizer instruments, CustomArray 12K, 4X2K, 2X40K and 90K DNA expression arrays, ElectraSenseฎ microarray readers and related hardware. Product revenues decreased in the three months ended March 31, 2009 versus the comparable period in 2008 due primarily to lower instrument sales in 2009 than 2008. As we expand our business focus from exclusively selling array-based research and development products to providing array-based diagnostic services, we have reduced internal sales staff, marketing and production efforts regarding sales of CustomArray products and instead have executed product distribution and manufacturing agreements with various third-party distributors for the sales of our suite of CustomArray products into the research and development markets. Also, declining global economic conditions have negatively impacted the sales of our instruments. As a result, CustomArray product revenues will likely be volatile and could decrease in future periods, depending largely on the sales efforts of our distributors.

Services. Services revenues are comprised primarily of diagnostic services provided by CMDX as well as the amortization of one-year equipment maintenance and service contracts executed with certain customers of our DNA synthesizers. Diagnostic services revenue from CMDX was $688,000 for the three months ended March 31, 2009, versus $253,000 in the comparable period in 2008. These revenues have increased due to an increased number of diagnostic test offerings as well as increased customer demand for our suite of diagnostic lab services provided by CMDX, which is due primarily to increased sales and marketing efforts. Including BAC array product sales, total diagnostic lab revenues at CMDX were $727,000 for the three months ended March 31, 2009 versus $273,000 in the comparable period in 2008.

Operating Expenses (In thousands)

Research and development expenses $ 1,131 $ 1,345 $ (214 ) (16 )% Marketing, general and administrative expenses 2,769 2,083 686 33 %

Research and Development Expenses. The decrease in internal research and development expenses for the periods presented was due primarily to the impact of cost reduction efforts in the area of full-time staff and ongoing research and development projects for the CustomArray platform as well as reduced development efforts for new diagnostic tests. In addition, for the three months ended March 31, 2009 and 2008, research and development expenses included $137,000 and $46,000, respectively, of non-cash stock compensation expense recognized under SFAS No. 123R. This increase was due primarily to increases in the number of stock option awards granted to our employees during the past twelve months. See Note 2 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts recognized for the periods presented.

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

Marketing, General and Administrative Expenses. The increase in marketing, general and administrative expenses for the three months ended March 31, 2009 versus the comparable period in 2008 was due primarily to increases in sales and marketing expenses at CMDX, as well as increased investor and public relations expenses. In addition, for the three months ended March 31, 2009 and 2008, marketing, general and administrative expenses included $654,000 and $287,000, respectively, of non-cash stock compensation expense recognized under SFAS No. 123R. This increase was due primarily to increases in the number of stock option awards granted to our employees during the past twelve months.

See Note 2 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts recognized for the periods presented.

Other Non-Operating Items



                       Three Months Ended
                           March 31,            Change
                        2009         2008        $      %

Interest expense     $      (513 )  $    (1 ) $  (512 ) -
Derivative charges        (1,521 )        -    (1,521 ) -

Interest Expense. Since July 2008, interest expense is recognized from the issuance of a secured convertible debenture (the "Debenture"), which accrues interest at an annual rate of 10% and with a current principal amount of $8.5 million. Interest expense also includes amortization of the $2.9 million of debt discount recognized from issuance of the Debenture and warrants using the effective interest method.

Derivative Charges. These charges represent the net expense recognized during the period from mark-to-model adjustments to the embedded derivatives associated with the Debenture that were outstanding as of March 31, 2009. There were no such debenture or embedded derivatives outstanding during the period ended March 31, 2008. In accordance with SFAS 133, Derivative Implementation Group Statement 133 Implementation Issue No. B16, "Embedded Derivatives: Calls and Puts in Debt Instruments" and related guidance as well as the early adoption of EITF 07-5, the conversion feature, cash redemption option, potential acceleration of maturity of the Debenture and potential adjustments to the fixed conversion price all represent embedded derivatives of the Debenture that are recorded separately at fair value as other liabilities, with the corresponding fair value adjustments reflected as non-operating charges or credits, depending upon the results of mark-to-model valuation adjustments. The fair value of the embedded derivatives was determined using the convertible bond model, discounted cash flows and binomial lattice models.

Inflation

Inflation has not had a significant impact on our Company.

Liquidity and Capital Resources

At March 31, 2009, cash, cash equivalents and available-for-sale investments totaled $5.9 million versus to $9.1 million at December 31, 2008. Working capital at March 31, 2009 was $5.0 million, compared to $7.6 million at December 31, 2008. The change in working capital was due primarily to the impact of net cash flow activities as discussed below. The net change in cash and cash equivalents for the periods presented was comprised of the following (in thousands):

                                                     Three Months Ended
                                                         March 31,
                                                      2009         2008
Net cash provided by (used in) operations:
Operating activities                               $    (2,397 ) $ (2,664 )
Investing activities                                     1,513      4,012
Financing activities                                      (747 )       24
(Decrease) increase in cash and cash equivalents   $    (1,631 ) $  1,372

Operating Activities. The overall net decrease in cash used in operating activities for the three months ended March 31, 2009 versus the comparable period in 2008 was due primarily to a decrease in operating cash outflows, which totaled $3.6 million for the three months ended March 31, 2009 versus $4.1 million in the comparable period in 2008. This decrease was due primarily from the variances in timing of vendor payments. The improvement in net cash used in operating activities from this activity was partially offset by a decrease in cash inflows from customers, which were $1.2 million for the three months ended March 31, 2009 versus $1.5 million in the comparable period in 2008. Cash inflows from customers decreased for the periods presented primarily due to a decrease in billable DoD activity and reduced product sales as discussed above.

Investing Activities. The change in net cash flows from investing activities was due primarily to net sales of available-for-sale investments in connection with ongoing cash management activities during the periods presented. Also, for the three months ended March 31, 2009 and 2008, we incurred $13,000 and $18,000, respectively, of capital expenditures.

Financing Activities. The decrease in net cash flows from financing activities was due primarily to the repayment of credit line borrowings totaling $820,000 during the period ended March 31, 2009 versus no such activity in the comparable period in 2008. Also, proceeds from the exercise of common stock options and warrants were $81,000 during the period ended March 31, 2009 versus $31,000 in the comparable period in 2008.

Future Liquidity. On May 1, 2009, we closed a registered direct offering (the "Offering") of our common stock and warrants for gross proceeds of $8.3 million. Under the terms of the Offering, we sold 1.1 million units for $7.50 per unit to investors. Each unit consisted of one share of our common stock and one warrant, each warrant to purchase one share of our common stock at an exercise price of $9.00 per share. The warrants may not be exercised until six months after the Offering and have a term of five years. The warrants are also callable if our common stock trades at or above $22.50 per share during any 20 trading days during a period of 30 consecutive trading days, with a minimum daily trading volume of 50,000 shares each day during that 30 trading day period. Net proceeds from the Offering, net of placement agent fees and expenses, were approximately $7.6 million. We believe that the addition of this capital will allow us to meet our operating cash requirements into the later half of 2010. In order for us to continue to meet our cash requirements beyond 2010, we will be required to increase revenues, reduce operating costs and possibly to obtain capital from external sources. However, there can be no assurances that we will be able to secure additional sources of financing at times and at terms acceptable to management. The issuance of additional equity securities, should that occur, will cause dilution to our shareholders. If external financing sources are not available or are inadequate to fund our operations, management will be required to reduce our operating costs including research projects and personnel, which could jeopardize our future strategic initiatives and business plans. For example, reductions in research and development activities and/or personnel at our Mukilteo, Washington facility could result in the inability to invest the resources necessary to continue to develop next-generation products and improve existing product lines in order to remain competitive in the marketplace, resulting in reduced revenues and cash flows from the sales of our CustomArray products and services. Also, reductions in operating costs at CMDX, should they occur, could jeopardize our ability to launch, market and sell additional products and services necessary to grow and sustain our operations and eventually achieve profitability.

Capital Requirements. We may also encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated. Any efforts to seek additional funding could be made through equity, debt or other external financing, and there can be no assurance that additional funding will be available on favorable terms, if at all. Our long-term capital requirements will be substantial and the adequacy of available funds will depend upon many factors, including:

† the costs of commercialization activities, including sales and marketing, manufacturing and capital equipment;

† our continued progress in research and development programs;

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

† the costs involved in defending our Judgment against the appeal brought by National Union;

† our ability to license technology;

† competing technological developments;

† the creation and formation of strategic partnerships; and

† the costs associated with leasing and improving our Irvine, California facility.

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