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. On August 15, 2007 (the "Redemption Date"), we split-off from Acacia and all 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 (symbol: "CBMX"). 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.

Liquidity

At December 31, 2008, we had cash, cash equivalents and available-for-sale investments of $9.1 million, 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 approximately $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 7 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 and six months ended June 30, 2009, our operating activities included the recognition of $1.2 million and $2.8 million in revenues, respectively, including $291,000 and $816,000 in government contract revenues, respectively, $339,000 and $627,000 in CustomArray product and service revenues, respectively, and $606,000 and $1.3 million in diagnostic lab revenues, respectively. Research and development expenses, excluding government contract costs and non-cash stock based compensation, increased in the three and six months ended June 30, 2009 due primarily to the increased activities on our comprehensive cancer array test currently under development. Marketing, general and administrative expenses, excluding non-cash stock compensation, also increased over the same periods 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 second quarter ended June 30, 2009 were:

† In April 2009, Dr. Karine Hovanes joined 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.

† Also in April 2009, we announced an update to our Influenza-Detection Microarray to include sequence information of the latest strain of Swine Flu. The previous version of the Influenza-Detection Microarray already detected several strains of Swine Flu as well as the pathogenic Bird Flu. Within one day of receiving sequence information of the new strain, we were able to update the array to definitively identify the Swine Flu strain.

† In May 2009, we closed a registered direct offering of our common stock and warrants for gross proceeds of $8.25 million.

† In June 2009, we announced that the validation study performed by CMDX, in collaboration with the Department of Pathology at the University of Texas Health Science Center in San Antonio, TX of our HerScanTM breast cancer test, was available as an advance online publication in the official journal of the United States and Canadian Academy of Pathology, Modern Pathology.

† Also in June 2009, we announced that all of the appellate briefs associated with our ongoing litigation against National Union Fire Insurance Co. of Pittsburg, PA had been filed with the U.S. Ninth Circuit Court of Appeals (the "Appeals Court"), and that the next step in the appellate process is for the Appeals Court to schedule oral hearings.

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 and Six months Ended June 30, 2009 and 2008

Revenues and Cost of Revenues (In thousands)



                              Three Months Ended                           Six Months Ended
                                   June 30,              Change                June 30,               Change
                              2009         2008        $        %          2009         2008        $         %

Government contracts        $     291    $     968   $ (677 ) (70 )%     $     816    $  2,037   $ (1,221 ) (60 )%
Cost of government                                                )%
contract revenues                (242 )       (955 )    713   (75             (737 )    (1,969 )    1,232   (63 )%
Products                          300          623     (323 ) (52 )%           557       1,198       (641 ) (54 )%
Services                          582          414      168    41 %          1,278         697        581    83 %
Cost of products and                                              %
services                         (521 )       (484 )    (37 )   8           (1,178 )      (888 )     (290 )  33 %
Collaboration agreements           63           62        1     2 %            125         124          1     1 %

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 and six months ended June 30, 2009 versus the comparable periods 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 and six months ended June 30, 2009 versus the comparable periods 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, ElectraSense® microarray readers and related hardware. Product revenues decreased in the three and six months ended June 30, 2009 versus the comparable periods 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 lab 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 $565,000 and $1.3 million for the three and six months ended June 30, 2009, versus $369,000 and $622,000 in the comparable periods 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 $606,000 and $1.3 million for the three and six months ended June 30, 2009 versus $395,000 and $668,000 in the comparable periods in 2008.

Operating Expenses (In thousands)





                                 Three Months Ended                            Six Months Ended
                                      June 30,               Change                June 30,              Change
                                  2009          2008       $        %           2009       2008        $        %

Research and development
expenses                      $      1,282    $    913   $  369    40 %      $    2,413   $ 2,259   $   154     7 %
Marketing, general and
admin. expenses                      2,861       2,397      464    19 %           5,630     4,480     1,150    26 %
Patent amortization and
royalties                              333         361      (28 )  (8 )%            679       722       (43 )  (6 )%
Equity in loss of of
investees                              261         241       20     8 %             511       490        21     4 %

Research and Development Expenses. The increases in internal research and development expenses for the periods presented were due primarily to the increased development efforts underway on our comprehensive cancer array test. In addition, for the three and six months ended June 30, 2009 and 2008, research and development expenses included $152,000, $289,000, $71,000 and $140,000, respectively, of non-cash stock compensation expense recognized under SFAS No. 123R. These increases were due primarily to increases in the overall 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 increases in marketing, general and administrative expenses for the periods presented were 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 and six months ended June 30, 2009 and 2008, marketing, general and administrative expenses included $655,000, $1.3 million, $331,000 and $618,000, respectively, of non-cash stock compensation expense recognized under SFAS No. 123R. These increases were due primarily to increases in the overall 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

Interest expense $ (509 ) $ (4 ) $ (505 ) 12625 % $ (1,022 ) $ (5 ) $ (1,017 ) 20340 % Derivative credits (charges) 137 - 137 - (1,384 ) - (1,384 ) -

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 $8.4 million as of June 30, 2009. 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 for the three and six months ended June 30, 2009.

Derivative Credits (Charges). These amounts represent the net credits or charges recognized during the periods from mark-to-model adjustments to the embedded derivatives associated with the Debenture that were outstanding as of June 30, 2009. There were no such debenture or embedded derivatives outstanding during the periods ended June 30, 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 June 30, 2009, cash, cash equivalents and available-for-sale investments totaled $11.0 million versus to $9.1 million at December 31, 2008. Working capital at June 30, 2009 was 9.8 million, compared to $7.6 million at December 31, 2008. The change in working capital was due primarily to the impact of our registered direct offering executed May 1, 2009 as well as our 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):

                                                     Six Months Ended
                                                         June 30,
                                                     2009        2008
Net cash provided by (used in) operations:
Operating activities                               $  (5,034 ) $ (5,191 )
Investing activities                                   1,511      3,988
Financing activities                                   6,929        905
Increase (decrease) in cash and cash equivalents   $   3,406   $   (298 )

Operating Activities. The overall net decrease in cash used in operating activities for the six months ended June 30, 2009 versus the comparable period in 2008 was due primarily to a decrease in operating cash outflows, which totaled $7.5 million for the six months ended June 30, 2009 versus $8.2 million in the comparable period in 2008. This decrease was due primarily from reduced litigation expenses in 2009 versus 2008 as well as 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 $2.5 million for the six months ended June 30, 2009 versus $3.0 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 six months ended June 30, 2009 and 2008, we incurred $15,000 and $42,000, respectively, of capital expenditures.

Financing Activities. The overall net increase in financing activities was due to the execution of a registered direct offering (the "Offering") of our common stock and warrants for gross proceeds of $8.25 million, which we closed on May 1, 2009. Under the terms of the Offering, we sold 1.1 million units for $7.50 per unit to certain 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. Net proceeds from the Offering, net of placement agent fees and expenses, were approximately $7.6 million. This increase in net cash flows from financing activities was partially offset by the repayment of credit line borrowings totaling $820,000 during the period ended June 30, 2009 versus our draw on the same credit line of $808,000 in the comparable period in 2008. Also, proceeds from the exercise of common stock options and warrants were $89,000 during the period ended June 30, 2009 versus $111,000 in the comparable period in 2008.

Future Liquidity. We believe that the additional capital from the Offering will allow us to meet our operating cash requirements through June of 2010. In order for us to continue to meet our cash requirements beyond this point, 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;

. . .