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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

Commission File Number 000-1383183

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COMBIMATRIX CORPORATION
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (425) 493-2000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

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         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes ý    No o

         Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

         Indicate by check mark that disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated file," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

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

         As of June 30, 2009, the aggregate market value of the registrant's common stock held by non-affiliates was $50,423,000, based upon the last reported sale price of our Common Stock on that date as reported by Nasdaq. The number of shares of the registrant's Common Stock, $0.001 par value, outstanding on March 15, 2010, was 7,605,708.

DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the registrant's definitive proxy statement for its Annual Meeting of Shareholders to be filed with the Commission within 120 days after the close of its fiscal year are incorporated by reference into Part III.

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FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2009
COMBIMATRIX CORPORATION

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PART I

CAUTIONARY STATEMENT

        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, and other circumstances affecting anticipated revenues and costs, as more fully disclosed in our discussion of risk factors in Item 1A. of Part I of this report. 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.

        As used in this Form 10-K, "the Company," "we," "us" and "our" refer to CombiMatrix Corporation and its subsidiary companies.

Item 1.    BUSINESS

Overview

        CombiMatrix Corporation was originally incorporated in October 1995 as a California corporation and later reincorporated as a Delaware corporation in September 2000. In December 2002, we merged with and became a wholly owned subsidiary of Acacia Research Corporation ("Acacia"). In December 2006, we filed a registration statement with the U.S. Securities and Exchange Commission ("SEC") in order to independently register our common stock under the Securities Act of 1933 as part of a plan to split-off from Acacia (the "Split-Off"). On August 15, 2007 (the "Split-Off Date"), the Split-Off was effected and our common stock became publicly traded on the Nasdaq Global Market (symbol: CBMX). As of the Split-Off Date, we ceased to be a subsidiary of, or affiliated with, Acacia.

Description of the Company

        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. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs.

        Combimatrix Molecular Diagnostics, Inc. ("CMDX"), our wholly owned subsidiary located in Irvine, California, operates as a diagnostics reference laboratory that provides genetic diagnostics services to physicians, hospitals and clinics. CMDX provides its services through the use of arrays that utilize bacterial

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artificial chromosomes ("BACs") that enable genetic analysis. This type of technology is generally known as aCGH (or, array-Comparative Genomic Hybridization), and enables the analysis of gross genetic anomalies. CMDX also sells BAC array slides to labs outside the U.S. Throughout this document "CBMX" and "CMDX" may be used interchangeably. CMDX also utilizes other non-proprietary technologies and products to augment its laboratory services in aCGH as well as ancillary services.

        Leuchemix Inc. ("Leuchemix"), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases. Leuchemix's first compound has entered initial clinical trials in the United Kingdom.

Technologies

Semiconductor Based Array

        Our semiconductor based array technology enables rapid, parallel synthesis of molecules, as well as immobilization and detection of molecules and materials at discrete electrodes on a semiconductor chip. These chips, also known as microelectrode arrays, are used in multiple applications in the areas described above. Our technology integrates semiconductor micro-fabrication, proprietary software, chemistry and hardware into systems that we believe will enable us, our customers and our partners to design and fabricate arrays for biological, diagnostic, material sciences and nanotechnology applications, typically within a few days. Our system should enable researchers to conduct rapid, iterative experiments in each of these fields.

        The primary use of this technology is the fabrication of oligonucleotide arrays. Oligonucleotides are short sequences of deoxyribonucleic acid, or DNA, which, when synthesized in an array format, can be used to perform several types of genetic analyses. The most common types of analyses using these arrays are the evaluation of gene expression or the identification of mutations. Gene expression is the term used to describe the identification of cell genes that are expressed or not expressed or "active" or "inactive." By evaluating the expression patterns of normal cells versus suspected diseased cells, one may be able to diagnose a genetic disease and also provide information on how to address that disease. Abnormal expression patterns have been implicated for a number of diseases. Expression analysis can also be performed to analyze the activity of a newly discovered class of nucleic acid molecule known as miRNA (micro-Riborucleic Acid). Micro-RNA molecules were discovered in the last decade and have been identified as factors that modulate other nucleic acids, and as such have been utilized in drug discovery as well as diagnostics. The analysis of miRNAs in blood is the basis of a new product in development (vide infra).

        Mutation analysis is the identification of specific changes to the sequence of DNA, where the changes may be linked to particular diseases or drug responses. By identifying a specific mutation in an individual's genome, this identification may be used to identify a disease, pre-disposition to disease, or potential drug response.

        Utilizing this platform technology, we have designed and built DNA synthesizer instruments, which we use in our manufacturing facilities to fabricate our DNA arrays. We also sell these instruments to customers who desire to manufacture arrays in their own facilities utilizing semiconductor chips supplied by us. Additionally, we have built an array reader that utilizes the electronic nature of our array for the analysis of genetic experiments. The latest version of this array reader is about the size of a television remote control device. We believe that this reader is the most compact array reader available commercially.

Bacterial Artificial Chromosome Arrays ("BAC Arrays")

        Our BAC Arrays enable us to perform comparative genomic hybridization ("CGH") studies to evaluate gross genetic anomalies in genomes. These arrays incorporate BACs, which are fragments of

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DNA that have been cloned or manufactured in a bacterium. These fragments can be placed on a substrate; in our case, a chemically modified glass slide is used. These BACs are either developed by us or obtained through other sources. We utilize these arrays to perform CGH analysis in a diagnostic and research setting to identify genetic imbalances in the form of copy number differences. CGH analysis allows us to compare the genomic DNA of a normal individual with that of an individual who may have a disease. This type of analysis evaluates the genes rather than the expression of those genes. CGH analysis is useful in evaluating gross defects in an individual's genome, such as copy number differences. Copy number differences are situations where a gene or a large portion of a gene is missing or an extra copy exists. We also utilize our BAC understanding and capabilities to develop ancillary products, including oligonucleotide arrays, for certain diagnostic services.

        Utilizing these array technologies, we are engaged in three strategic business areas:

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The development of services and products in the field of molecular diagnostics, also known as personalized medicine;



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The development, manufacture and sale of research tools and services to life sciences researchers; and



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The development, manufacture and sale of biosensor systems and technology for national defense and homeland security.

Technologies and Compound Libraries for Oncological Drug Development

        Our minority owned subsidiary, Leuchemix, has access to proprietary compounds that have been shown to be cytotoxic towards certain cancers in vitro and in vivo. Many of these compounds were discovered through combinatorial chemistry, natural product chemistry and certain cellular screening assays. Leuchemix has access to state-of-the-art laboratories and equipment, which includes flow cytometry, molecular biology and cell culture facilities. In addition, Leuchemix has access to a bank of over 150 primary leukemia specimens and a panel of 15 leukemia and lymphoma cell lines as well as several xenogenic animal model systems. Leuchemix also has licensed proprietary compounds and compound libraries, which are being developed as drugs against a number of oncology indications including hematological disorders as well as solid tumors. Leuchemix's lead compound is a modified natural product that has demonstrated pre-clinical activity against several cancers including hematological disorders as well as solid tumors. This compound, referred to as LC-1, is currently undergoing human clinical trials in England. LC-1 is a modified natural compound, known as a parthenolide. The base compound has been modified to be more soluble and demonstrates superior pharmacokinetics. LC-1 was screened pre-clinically to demonstrate activity against a number of leukemia cells as well as leukemic stem cells. In addition, the compound has shown activity against certain solid tumors.

Market Overview

        The markets for our products and services include molecular diagnostics, also known as personalized medicine. We also sell products and services into pharmaceutical and biotechnology research markets, as well as the study of genes in other fields such as botany and agriculture (also referred to as life sciences), national defense and homeland security applications. In the future, if we are successful in developing approved drugs either internally or through our investments in companies such as Leuchemix, our market opportunities will expand to include pharmacies, physicians, hospitals, patients and other consumers of therapeutics. In addition, there may be opportunities for our products and services to address consumer-based genetic analysis as that market develops. At this time, the majority of our commercial efforts are focused on developing and marketing molecular diagnostics services and products.

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General Overview of Molecular Diagnostics, Life Sciences and Pharmaceutical Industries

        The molecular diagnostics market is a sub-segment of the overall diagnostics market. Molecular diagnostics, within the context of this discussion, refers to the use of genetic analysis of individuals to make medical decisions in the diagnosis of disease as well as the management of patients previously diagnosed. The sequencing of the human genome and associated research, as well as advances in technology, are enabling the growth of this market. Most experts believe that over the next few decades, the use of molecular diagnostics will grow rapidly and will have a revolutionary impact on the way medicine is practiced.

        This market is characterized by rapidly advancing technology, as well as uncertainty in regulatory oversight and reimbursement from third party payers. Due to rapid advances in technology, this industry is rife with many competitors and competing products and we expect continued entrance by new companies, both small and large. In addition, as regulatory agencies, such as the U.S. Food and Drug Administration ("FDA"), develop and implement new regulation, we anticipate that the operation of many tests will be affected in a manner that is difficult to predict. We have received a written opinion from the FDA indicating that our first launched test, and we believe our other tests operated in the same manner, are not subject to additional regulatory compliance. This does not guarantee that the FDA will not change its position in the future, and this opinion does not affect future tests that may be operated in a different manner.

        While there are multiple technologies being developed to address the noted molecular diagnostic applications, we feel that our technology and products are ideally suited to aid in many of these market segments. Additionally, the pharmaceutical and biotechnology industries continue to face increasing costs and risks in the drug discovery, development and commercialization process. Our products are typically used by researchers, as an aid in identifying or verifying biological markers that could be suitable targets for drugs or indicative of disease. Our products in the defense markets are utilized, by government and military agencies or private firms associated with such, in the detection of infectious agents.

Genes and Proteins

        The human body is composed of billions of cells, each containing DNA that encodes the basic instructions for cellular function. The complete set of an individual's DNA is called the genome and is organized into 23 pairs of chromosomes, which are further divided into smaller regions called genes. Each gene is composed of a strand of four types of nucleotide bases, referred to as A, C, G and T. The bases of one DNA strand bind to the bases of the other strand in a specific orientation to form base pairs: the base A always binds with the base T and the base G always binds with the base C.

        The human genome has approximately three billion nucleotides and their precise order is known as the DNA sequence. When a gene is turned on, or expressed, the genetic information encoded in the DNA is copied to a specific type of RNA, called messenger RNA, or mRNA. The mRNA provides instructions for the synthesis of proteins. Proteins direct cellular function and the development of individual traits and are involved in many diseases. Abnormal variations in the sequence of a gene, in the level of gene expression, or large anomalies (such as deletions, extra genes, etc.) can interfere with the normal physiology of particular cells and lead to a disease, a predisposition to a disease, or an adverse response to drugs.

        MicroRNAs are smaller than messenger-RNAs and are believed to modulate the function of mRNA, thus providing an additional level of control of gene function. miRNAs are being evaluated as external modulators of gene function and as drugs. They are also being evaluated as potential diagnostic biomarkers.

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Genes and Molecular Diagnostics

        There are a number of types of genetic analysis that can be useful in a diagnostic context. They include (i) gene expression profiling, (ii) comparative genomic hybridization, (iii) and mutation analysis. For many diagnostic applications using the above paradigms, it is only necessary to analyze either only one or a small number of genetic factors. For such situations, there are a number of ubiquitous techniques to perform the analysis. However, when a larger number of genetic factors need to be analyzed to make a medical decision, the most efficient method of analysis is a microarray. We feel that our microarrays provide advantages over other microarrays for molecular diagnostic applications.

Gene Expression Profiling

        Gene expression profiling is the process of determining which genes are active in a specific cell or group of cells and is accomplished by measuring mRNA, the intermediary between genes and proteins. By comparing gene expression patterns between cells from normal tissue and cells from diseased tissue, researchers may identify specific genes or groups of genes that play a role in the presence of disease. Studies of this type, used in drug discovery, require monitoring thousands, and preferably tens of thousands, of mRNAs in large numbers of samples. As the correlation between gene expression patterns and specific diseases is determined, we believe that gene expression profiling will have an increasingly important role as a diagnostic tool. Diagnostic use of expression profiling tools is anticipated to grow rapidly as the combination of the sequencing of various genomes and the availability of more cost-effective technologies further develops.

        While analysis of mRNA is the traditional application of gene expression profiling, recent studies have shown that analysis of expressed miRNA is also valuable in understanding gene function and disease correlations. Our oligonucleotide arrays can be utilized for gene expression studies of mRNA as well as miRNA.

Array Comparative Genomic Hybridization

        CGH is the study at the gene level of gross level anomalies such as copy number polymorphisms. Array CGH is the use of an array that multiplexes the analysis of a large portion of the genome. Unlike gene expression, which monitors the activity of genes, CGH analysis studies and identifies defects at the gene level that are characteristic of disease, predisposition to diseases, the clinical course of a disease, or response to drugs. Our CGH arrays utilize probes, cloned or manufactured in bacteria, which are referred to as bacterial artificial chromosomes or BACs. Recent studies have shown that copy number polymorphisms are the cause of many diseases, susceptibility to disease, and differing responses to therapy. Our BAC arrays, as well as complementary technologies and products from other companies, are utilized in our molecular diagnostics business.

Genetic Mutations

        The most common form of genetic variation occurs as a result of a difference in a single nucleotide in the DNA sequence, commonly referred to as a single nucleotide polymorphism, or SNP. The human genome is estimated to contain between three and six million SNPs. SNPs are believed to be associated with a large number of human diseases although most SNPs are believed to be benign and not to be associated with disease. It is believed that the genetic component of most major diseases is associated with a combination of SNPs.

Array-Based Analysis

        Traditional technologies for analyzing genetic or protein variation and function generally perform experiments individually, or serially, and often require relatively large sample volumes, adding significantly

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to the cost of conducting experiments. Arrays were developed to overcome the limitations of traditional technologies and enable the parallel evaluation of large numbers of genetic factors.

        An array is a collection of miniaturized test sites arranged in a manner that permits many tests to be performed simultaneously, or in parallel, in order to achieve higher throughput. The average size of test sites in an array and the spacing between them defines the array's density. Higher density increases parallel processing throughput. In addition to increasing the throughput, higher density reduces the required volume of the sample being tested and thereby lowers costs. Principal commercially available ways to produce arrays include mechanical deposition, bead immobilization, inkjet printing and photolithography.

        While current array technologies have revolutionized drug discovery and development and are poised to enter the molecular diagnostics markets, we believe that our advanced array technologies provide improved characteristics, including flexibility, superior cost metrics, and increased performance, all of which address certain needs not addressed by conventional arrays.

Diagnostics Market Segmentation

Clinical Market

        In general, our diagnostics services and test menus are focused around our highly specialized genome array technologies. Descriptions of these specific tests are summarized below. While there are risks associated with billing and reimbursement of these highly specialized tests, we believe that our unique market position and test portfolio gives us significant leverage in the rapidly growing personalized genomics/diagnostics space. Our test menu is further supplemented by what may be considered routine tests, which allow us access to a broader, yet synergistic market. We approach the clinical market by first dividing it into two basic genres, which are the diagnostic needs associated with: (i) childhood development testing, including both prenatal and postnatal development, collectively referred to as constitutional development with its concomitant constitutional diagnostic testing; and (ii) cancer testing, including both solid tumor and hematologic cancers. Within each of these broad genres, we then define our potential client base. Our market analysis indicates that regardless of which of these two genres we service, our potential customers can be divided into three general segments (listed below). Our services are tailor-made to meet the specific needs of each of the three segments. Moreover, all of our tests can be divided into two components, which in turn can be billed for independently or collectively. These components are the Technical Component ("TC"), and the Professional Component ("PC"). When performed collectively, a test is referred to and billed as, a "Global" test.

Constitutional Diagnostic Testing

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National reference laboratories, academic institutes with teaching hospitals and other large hospitals/multi-hospital systems:    This segment typically has comprehensive capabilities and performs most of the basic genetic testing, including, but not limited to, chromosome analyses, fluorescent in-situ hybridization ("FISH") and polymerase chain reaction ("PCR")-based tests in-house. Moreover, these facilities typically provide comprehensive genetic counseling to their patients, which is a key component in the clinical work-up and utilization of complex genomic assays in the constitutional arena. However, because of institutional budgetary restraints, a regulatory atmosphere that limits the use of third party manufactured kit components and, most importantly, limitations in the know-how to internalize specialized genomic testing platforms, this segment of the market typically out-sources the TC of their high complexity genomic test menu, while maintaining the PC interpretation in-house. Accordingly, we typically focus the marketing of our TC services to this segment of the market. From a billing perspective, many of these larger national reference laboratories have in-network relationships with third-party insurers or otherwise have allowances for esoteric tests such as ours. The latter is particularly true at academic teaching institutes with

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teaching hospitals. Therefore, we typically negotiate direct payment terms with this segment of the market for our TC services.

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Regional reference laboratories and community hospitals:    This segment of the market is characterized by labs with the professional competence and sophistication to internalize the PC portion of our tests. However, if appropriate licensed individuals are unavailable and/or resources are limited, particularly at smaller regional labs and community hospitals, we offer our Global test services. Notably, many of these smaller reference laboratories depend on us to provide the genetic counseling services where necessary. Furthermore, unlike the larger national laboratories, this segment of the market is characterized by a preponderance of clients requiring us to bill their patient's insurers directly as opposed to a direct-to-institute billing relationship.



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Physician groups:    In the developmental genetics market, physician groups, while individually constituting small market opportunities, collectively constitute a significant market opportunity. This segment of the market typically outsources all of their genetic testing services, requiring Global services and further requiring the testing laboratory (i.e., CMDX) to handle all aspects of patient billing.

Cancer Diagnostic Testing

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National reference laboratories, academic institutes with teaching hospitals and other large hospitals/multi-hospital systems:    This segment typically has comprehensive capabilities and performs most of the basic cancer genetic testing including, but not limited to, chromosome analyses, FISH and PCR-based tests, as well as routine pathology testing, in-house. However, because of institutional budgetary restraints, a regulatory atmosphere that limits the use of third party manufactured kit components and, most importantly, limitations in the know-how to internalize specialized genomic testing platforms, this segment of the market typically out-sources the TC of their high complexity genomic test menu, while maintaining the PC interpretation in-house. Accordingly, we typically focus marketing of our TC services to this segment of the market. From a billing perspective, many of these larger national reference laboratories have in-network relationships with third-party insurers or otherwise have allowances for esoteric tests such as ours. The latter is particularly true at academic teaching institutes with teaching hospitals. Therefore, we typically negotiate direct payment terms with this segment of the market for our TC services.



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Regional reference laboratories, large pathology groups and small community hospitals:    This segment of the market is characterized by labs with the professional competence and sophistication to internalize the PC portion of our tests. However, if appropriate licensed individuals are unavailable and/or resources are limited, particularly at smaller regional labs and community hospitals we offer our Global test services. Furthermore, unlike the larger national laboratories, this segment of the market is characterized by a preponderance of clients requiring us to bill their patient's insurers directly as opposed to a direct-to-institute billing relationship.



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Physician groups:    The physician groups in the cancer market differ substantially from those in the developmental market. They can be divided into oncology and pathology groups. Oncologists typically outsource all of their genetic testing and pathology services, requiring global services and further requiring the testing laboratory to handle all aspects of patient billing. Pathology groups on the other hand, typically perform routine pathology testing in-house, but out-source their high-complexity genome testing services. When the latter tests are outsourced, pathology groups typically require only TC services while maintaining the PC component in-house. Moreover, these groups typically prefer to internalize the billing for their PC services while requiring out-sourcing laboratories to bill their patient's insurers directly.

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Research Market

        While the primary use of our diagnostic test services is in the clinical arena, as a function of the ability to custom manufacture all of our assays in-house, coupled with our innovative and professional competence in this arena, we are also able to provide genome discovery platforms to the biopharmaceutical and biotechnology industries. We estimate that there are well over one thousand such organizations world-wide that could benefit from our laboratory expertise in the development of targeted therapeutics and companion diagnostics. We are in the very early stages of reaching out to this market since our primary commercial focus has been directed towards the clinical market.

Products and Services

CustomArray® Platform

        Our primary product for genetic studies in the life sciences market is marketed under the trademark CustomArray®, of which products include a highly flexible oligonucleotide array that addresses researchers' specific requirements for high-performance arrays that can interrogate small sets of target genes or whole genomes at a low cost. CustomArray microarrays currently come in two density formats: a medium-density 12K array and a high-density 90K array. The medium-density CustomArray 12K array is available as simply a 12K array or as a CustomArray 4X2K array. The CustomArray 12K array enables analysis of up to 12,000 genes in one experiment. In contrast, the 4X2K array enables the analysis of four separate experiments of up to 2,000 genes each. The CustomArray 90K array enables the analysis of approximately 90,000 genes in one experiment. This array enables analysis of the full human genome, or an analysis of other species with redundant probes for better performance and reliability. The CustomArray 90K array is also provided in a 2x40k array format, which enables two separate experiments to analyze up to 40,000 genes. These arrays are also designed to be re-usable if treated with our proprietary stripping reagents, thus enabling an even lower cost per sample for researchers.

        The CustomArray microarray is an advanced tool used to understand gene expression by measuring mRNA activity within a cell type or groups of cells, enabling users to understand and diagnose disease, predisposition to disease, drug response as well as provide information regarding drug development. The CustomArray microarray can also be used as a SNP genotyping tool by providing statistics on the effect of a SNP or groups of SNPs, giving rise to data that is important in diagnostic testing. The CustomArray microarray can also be used as an analysis tool for micro-RNA, or "miRNA," which is a recently discovered class of nucleic acid that has been shown to be important in the regulation of cells. Because of the product's flexibility, researchers have utilized and are evaluating the use of CustomArray microarrays for other applications such as gene assembly, sequencing, protein translation and others. CustomArray microarrays have been designed to be used on most commercially available scanners, thus enabling many researchers to perform assays without requiring additional capital expenditures for scanning equipment that several competing technologies require. These arrays can also be read electrochemically using our ElectraSense® Reader.

DNA Array Synthesizer

        Our DNA Array Synthesizer is a bench-top instrument that enables researchers to fabricate DNA arrays to their exact specifications with complete control over the content that is synthesized onto the array. The system consists of a synthesizer instrument that is operated using a personal computer. The synthesizer is connected to a cabinet that contains reagents necessary for array synthesis. The system is able to fabricate up to eight 12K arrays within a 24-hour period, or up to thirty-two 2K sectored arrays in the same period of time. The synthesizer's flexibility enables researchers to synthesize multiple designs or the same design in each synthesis run. To operate the synthesizers, researchers must purchase blank microarray slides (i.e., slides on which no DNA synthesis has been performed) from us and reagents from either us or other vendors.

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Stripping Reagents

        We have created the first commercially available array stripping kit. The kit allows researchers to re-use our microarrays up to four times. The ability to re-use microarrays reduces the cost per microarray to the researcher while eliminating problems associated with chip-to-chip reproducibility.

ElectraSense® Reader-Electrochemical Scanning Instrument

        The ElectraSense® Reader is a compact scanner for CombiMatrix arrays. The ElectraSense Reader was developed to provide the market with a compact, inexpensive and easy to use scanner for performing array experiments. Current arrays, including those manufactured by us, are designed to be analyzed using optical scanning instruments. While these scanners are quite functional, they are also relatively expensive, bulky and can be difficult to use. Due to the electrochemical nature of our arrays, it is possible to scan them using an electrochemical scanner as well as an optical scanner. The advantages of the electrochemical scanner arise out of the fact that the ElectraSense Reader does not have any optical components (such as lasers, lenses and optical detectors). By eliminating these components, we believe that the ElectraSense Reader is more compact, cost efficient and easier to use than most optical scanners. The ElectraSense Reader is designed to read only CombiMatrix arrays. Our most advanced version of the scanner is about the size of a television remote control. It is the most compact scanner for arrays that is commercially available.

Comparative Genomic Hybridization Arrays

        Our CGH arrays are fabricated using a traditional spotting instrument and are prepared on glass substrates. These arrays are used for research applications as well as molecular diagnostic applications.

Molecular Diagnostics Applications

        Our wholly owned subsidiary, CMDX, utilizes our DNA array technologies to develop molecular diagnostic services and products. The primary focus of CMDX's efforts is the ongoing development of diagnostic services for the diagnosis of diseases and the management of patients. CMDX is a fully functional molecular diagnostics laboratory and has received federal certification by the Clinical Laboratory Improvement Amendments ("CLIA"), as well as by other state and local regulatory agencies that are required for analysis of patient samples. As such, CMDX is currently operating as a service organization, providing testing services for patients. Although many of CMDX's initial services are designed to avoid pre-market approval by the FDA, many of the services CMDX will provide may require different levels of regulatory approval from the FDA. CMDX utilizes our proprietary technologies, as well as technologies and products purchased from outside vendors.

Constitutional Analysis (the CA 650, 850, 1000, 2500 and 2700 Suite of Tests)

        The focus of the constitutional analysis, or "CA" suite of array tests, is pre- and post-natal analysis for the diagnosis of developmental delays in early childhood, of which delays are often not easily diagnosed. An accurate diagnosis is essential to provide good guidance on the developmental expectations of the child.

        Additionally, pre-natal analysis is dominated by the use of the standard chromosomal analytical technique of karyotyping. Pre-natal analysis is utilized to determine if a fetus has a genetic defect that could lead to problems after birth.

        In the third quarter of 2006, we introduced our first constitutional genetic array test (the CA 650), which can identify over 50 different genetic disorders in one multiplexed analysis. In October of 2006, the FDA indicated that this test does not require approval under its guidance (IVDMIA-In Vitro Diagnostics Multivariate Index Analysis). Therefore, this test was launched under CLIA guidelines and became

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available for patients and physicians. In 2007 and 2008, we launched several upgrades of this test (the CA-850, CA-1000, CA-2500 and BAC HD SCAN™). The latest version of the BAC HD SCAN is capable of identifying up to 290 different genetic disorders, including Downs Syndrome (Trisomy 21), Trisomy 18, and Trisomy 13. This test is used for post-natal analysis, pre-natal analysis and the analysis of the products of conception (e.g., pregnancies that terminated spontaneously) to determine if the cause was a recognized genetic abnormality. In 2008, we launched a companion product to the BAC HD SCAN, called the Zoom-in™ array test, which enables a more detailed sequence analysis of a specific genetic aberration. While we have launched several upgraded version of CA arrays, we continue to make incremental improvements as new genetic information becomes available.

ATScan® for the Diagnosis of Autism Spectrum Disorder

        ATScan® array is designed to detect known genomic copy-number variations ("CNVs") associated with Autism Spectrum Disorder ("ASD"). While there is considerable debate as to all of the possible causes of ASD, numerous studies have reported that structural changes, in particular, CNVs of specific chromosomal regions, can be involved as predisposition factors. ATScan array, like many of our other diagnostic products, has been updated several times and incorporates the latest genomic information linked to pre-disposition to ASD.

HemeScan® Hematological Disorders

        Another area of focus for our diagnostic services is cancer. In the United States alone, the American Cancer Society indicates that 1.4 million individuals are diagnosed with cancer annually, and this rate is expected to grow rapidly as the overall population, including the "baby boomer" generation, ages. At any given time in the United States, there are several million living patients that either have cancer or are cancer survivors that are at high risk for recurrence. Patients who are newly diagnosed with cancer require significant levels of care, which includes surgery, hospital stays, examinations, drugs and diagnostics. CMDX has developed and continues to develop a series of products that, through the genetic analysis of blood, tissue or biopsy samples, will provide information to physicians in managing their patients.

        We have launched a family of diagnostic services known as HemeScan®. Our HemeScan suite of tests are designed to address several of the common hematological malignancies including Chronic Lymphocytic Leukemia ("CLL"), Acute Lymphoblastic Leukemia, and Myelodysplastic Syndrome. For each of these services, our array-based test is designed to evaluate the underlying genetic aberrations extant in these disorders in order to enable prognosis of the clinical course of the disease. Such information can be then utilized by physicians, in concert with other tests, to make better patient management decisions and recommendations. It is estimated that the combined diagnoses of CLL, ALL, and MDS annually in the US is roughly 60,000 patients.

        In 2008 and 2009, we published a number of papers, and made presentations at a number of conferences, that discussed studies comparing data from HemeScan array services with other techniques to evaluate CLL patients. These studies were conducted with collaborators including major cancer centers, such as the MD Anderson Cancer Center in Texas. These studies demonstrated the superiority of HemeScan array services over conventional diagnostic techniques in evaluating patients with CLL.

HerScan™

        Breast cancer is the most common malignancy in women in the United States. The American Cancer Society estimates that there were approximately 192,000 new cases of breast cancer in 2008 and about 40,000 women will die from this disease annually. Recent studies have shown that approximately 21 percent of newly diagnosed breast cancer cases have extra copies of the HER2 gene on chromosome 17 (called HER2-positive), and thus, these patients have a concomitant poor prognosis due to the aggressive disease characteristics conferred by the extra dosage of the HER2 gene product. HER2-positive tumors

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are likely to respond to the Herceptin drug because it is designed to target the product of the HER2 oncogene. Conversely, it is important to accurately identify patients with normal copy number or loss of the HER2 gene (HER2-negative) because, for these patients, the risks of side effects, including cardiotoxicity, are greater than any potential benefit of the drug.

        In 2008 and 2009, we launched two array services to address women with breast cancer. These were the first BAC CGH array based tests for breast cancer patients. The Her17Scan test is designed to detect amplification of the HER2 gene in breast cancer while simultaneously enumerating clinically relevant genomic changes across chromosome 17. In so doing, the Her17Scan test gives pathologists and oncologists an objective measure of the HER2 gene copy number and resolves cases that are equivocal by FISH and immuno-histochemistry ("IHC"), such as, polysomy of chromosome 17, as well as, non-concordance between FISH and IHC (estimated to account for as many as 30% of Her2-positive tumors). As a function of the enumeration of the HER2 gene through the Her17Scan test, patients are objectively assigned to one of four categories of HER2 gene status: amplification, gain, normal, or loss while simultaneously determining polysomy 17 status.

        The HerScan test provides the diagnostic insight of the Her17Scan while additionally analyzing the entire tumor genome. As part of the validation of the Her17Scan and HerScan tests, testing was completed on over 100 cases of invasive ductal and invasive lobular carcinomas. The Her17Scan test accurately and reproducibly determined HER2 status, and in addition, the HerScan test clearly revealed the genomic subtypes previously reported in the publication Cancer Research 64: 8541-8549; 2004. These subtypes include tumors showing gain of chromosome 1q; loss of chromosome 16q; amplification of the c-MYC oncogene on chromosome 8; and loss of the tumor suppressor gene P53 on chromosome 17. These additional markers, which are not simultaneously available by the conventional diagnostic techniques of IHC or FISH, provide additional relevant information, enabling the clinician to make better patient management decisions and recommendations.

Prostate Cancer Test

        In the United States, prostate cancer is currently the second leading cause of death in men and is the most frequently diagnosed cancer in men. The American Cancer Society estimates that there were approximately 192,000 new cases of prostate cancer in 2009 and about 27,000 men will die, annually, from this disease. There are estimated to be approximately two million survivors alive today.

        In 2008, we launched our prostate cancer test, which is designed to determine the aggressiveness of an individual's prostate cancer and provide a complete tumor genome analysis to enable better treatment decisions. This test is based on key peer-reviewed studies that identified several genetic tumor markers that enable a more precise stratification of the risk profile of cancer patients. Our prostate cancer test is comprised of probes for specific genomic loci of which copy number gains and losses have been shown to correlate with risk of recurrence and metastasis in patients post-prostatectomy. These additional probes are a further enhancement of the CMDX solid tumor array platform design, which enables whole-genome tumor profiling, or genomic grading, while also providing information about the copy-number status of specific disease-associated loci.

Comprehensive Cancer Array

        Our Comprehensive Cancer Array test, or "CCA", is a product under development that is being designed to provide an early indication of cancerous growths through the analysis of a blood sample. By not requiring an invasive procedure, we feel that this test could be utilized as a screening product with broad appeal and use. This test is an array-based approach to identify specific nucleic acids that are circulating in the blood and are linked to specific tissues that may have become cancerous.

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        Unlike our other oncology diagnostic products, which focus on situations where a cancer has been diagnosed, the CCA could be a screening test utilized at the time of each annual physical exam or even more frequently. The goal for this test is to identify a specific abnormal growth and possibly the organ location of the growth, so that further testing can confirm the cancer. The goal of the product is to enable the identification and diagnosis of many cancers, which would ordinarily go undetected until they had advanced to a mature stage, often making them difficult to treat. CCA is currently under development. While we hope to launch a version of the CCA in 2010, subject to acceptable clinical performance, we intend to continue to upgrade and update this test as well as perform additional clinical validations.

        We have presented preliminary data regarding the development of the CCA at a number of scientific conferences that suggests this test would be able to distinguish individuals that had cancer from those who are cancer-free. This preliminary data focused on prostate, colon, ovarian, breast, and lung cancers. We believe that the data also suggests that a methodology to identify the specific organ system where the tumor might reside might be possible upon additional development with larger patient numbers. The timely launch of this test will be dependant on a number of factors, such as partnerships, development and/or relationships with organizations with existing sales forces. An additional requirement for timely launch may be a positive regulatory opinion from the FDA.

Homeland Security and Defense Applications

        Through U.S. government funding, our array technology is being developed to simultaneously detect toxins, viruses, and bacteria using either genomic analysis or antigen-antibody experiments, or assays. The ability to conduct over 12,000 individual assays simultaneously means that our arrays can be configured to detect many biothreat agents of interest to the U.S. Department of Defense and Department of Homeland Security within hours and with a high degree of certainty that we feel surpasses current technologies. Our goal is that these systems will eventually be portable and ultimately be completely automated.

        Our technology can simultaneously identify hundreds of different microbes (including viruses), determine their ability to cause disease, and discover their characteristics, such as antibiotic resistance. Working with academia, industry, and government laboratories, we are developing assays, arrays and bioinformatics for quickly identifying human, animal, and plant pathogens in a single-assay format. This format and single test eliminates the need for a different test for each disease or threat and eliminates the time lost in developing a new test for each new disease or threat. For disease-control agencies, it should simplify the process, reduce costs, and allow more rapid identification and reaction, all in an environment where delayed diagnosis can equate to increased illness and loss of lives.

        This program is enabled by the electrical characteristics of our array technology, which allows the binding reactions to be measured through electrochemical means instead of optical methods. Though optical detection has been successful in many applications and our other products utilize these methods as well as electrochemical means, we feel that electrochemical detection techniques have the potential to be far superior. By eliminating the need for light sources, optical components and their corresponding mechanical requirements, as well as their power requirements, we believe that our ElectraSense® Reader detection system is less expensive, smaller, lighter and more portable than optical detection systems. In addition, certain technical characteristics of electrochemical detection on the arrays may enable higher sensitivity, better dynamic range and superior reproducibility in measurements.

        Though the focus of our government-funded development programs are products for military and homeland security markets, we believe that the core technology being developed by us will be applicable to products in the life sciences, molecular diagnostics, and other human healthcare markets as well. An example of a test that has been developed substantially with government funding is our Influenza A array. This array is designed to identify, specifically and objectively, which strain of Influenza A has infected an individual. This test can be used on animal samples as well as human samples. The array has been validated in collaboration with a World Health Organization laboratory and has been used in collaboration with the

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U.S. government in monitoring birds that may be infected by Influenza A, including the H5N1 strain that is known commonly as Eurasian Bird Flu.

Our Strategy

        Our strategic focus is to address the growing molecular diagnostics market as well as other life science markets.

Partnering to Expand Marketing and Sales Efforts

        We have established and will continue to pursue multiple relationships to facilitate the expansion of our array services. We hope to enter into relationships and collaborations to gain access to sales marketing and distribution channels. These relationships could include alliances with other laboratory service providers as well as larger corporations.

Expanding Our Offerings

        We also continue to utilize the flexibility of our array technologies to develop multiple diagnostic services. In addition to providing new sources of revenue, we believe these product lines will further our goal of establishing our company as a leader in the molecular diagnostic market.

Strengthening Technological Leadership

        We plan to continue advancing our proprietary technologies through our internal research efforts, collaborations with industry leaders and strategic licensing. We may also pursue acquisitions of complementary technologies and leverage our technologies into other value-added businesses.

Protecting and Strengthening Intellectual Property

        Currently, we have nine patents issued in the United States, 30 patents issued internationally, 21 patent applications pending in the United States and 54 patent applications pending internationally. Our patent portfolio, together with our trade secrets, is intended to protect our proprietary technologies in those markets where we operate and where a market for our products and services exists. We plan to build our intellectual property portfolio through internal research efforts, collaborations with industry leaders, strategic licensing, and possible acquisitions of complementary technologies. We also plan to pursue patent protection for downstream products created using our proprietary products.

Customer Billing

        Our CustomArray products and services are typically billed directly to our customers or distributors at prices that have been agreed to up-front between the customer and us.

        Customers of our diagnostics services typically fall into two broad payor categories: direct-bill and third-party payors. Direct-bill payors include healthcare institutions such as hospitals and clinics, physicians and individual patients. For the direct-bill category, our diagnostic services are billed at established contractual rates once the test results have been delivered to the referring physician. Third-party payors include organizations such as commercial insurance companies as well as government payors including Medicare and Medicaid. For the third-party payor category, our diagnostic services are billed at our list prices for the tests performed but are recognized for accounting and financial reporting purposes as service revenues based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected is recorded as a contractual allowance. For governmental payors, we bill our tests based upon published fee schedules established by the Centers for Medicare and Medicaid Services ("CMS") using individual billing codes known as Common Procedural Terminology (or "CPT") codes established for array-based laboratory diagnostic tests. The relevant CPT billing codes distinguish

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between TC services (i.e., the performance of a diagnostic test), PC services (i.e., the professional interpretation of a diagnostic test, typically performed by a licensed physician), and Global test services (i.e., the combination of Technical and Professional services). Medicare CPT codes and general billing and business factors allow us to provide either the Technical or Global services to our customers.

Regulatory Matters

        Our business is subject to extensive laws and regulations as described below.

Clinical Laboratory Improvement Amendments of 1988

        As a clinical reference laboratory, CMDX is required to hold certain federal, state and local licenses, certifications and permits to conduct our business. Under CLIA, we are required to hold a certificate applicable to the type of work we perform and to comply with standards covering personnel, facilities administration, quality systems and proficiency testing. We have a certificate of accreditation under CLIA to perform testing and are accredited by the College of American Pathologists ("CAP"). To renew our CLIA certificate, we are subject to periodic inspection and standards applicable to the testing that we perform. Should regulatory compliance requirements become substantially more complex, operational costs at our lab might increase in the future. If our laboratory is out of compliance with CLIA requirements, we may be subject to certain sanctions. We must maintain CLIA compliance and certification to be eligible to bill for services provided to Medicare beneficiaries. If we were to be found out of compliance with CLIA program requirements and subjected to sanction, our business could be harmed.

Health Insurance Portability and Accountability Act

        Under the federal Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), the U.S. Department of Health and Human Services has issued regulations to protect the privacy and security of protected health information used or disclosed by health care providers. HIPAA also regulates standardization of data content, codes and formats used in health care transactions and standardization of identifiers for health plans and providers. Penalties for violations of HIPAA regulations include civil and criminal penalties. Consequently, our policies and procedures are designed to comply with such regulations. The requirements under these regulations may change periodically and we will continue to monitor such changes. There are also a number of state laws governing confidentiality of health information that are applicable to our operations, and new laws governing privacy may be adopted in the future. While we feel that we comply with regulations currently, we can provide no assurance that we are or will remain in compliance with diverse privacy requirements as they develop.

Federal and State Insurance Regulations, Self-referral Prohibitions and Anti-kickback Laws

        Existing federal and state laws governing Medicare and Medicaid impose a variety of restrictions on financial relationships among healthcare providers, including clinical laboratories. These laws include the federal anti-kickback law. Numerous civil and criminal penalties exist for many of the federal and state anti-fraud statutes and regulations, including their application to joint ventures and collaborative agreements. These statutes and regulations are vague and have not yet been interpreted by the courts. There also exist federal and state self-referral prohibitions, which prohibit us from accepting referrals from physicians with whom we have a compensation relationship, and violations of such could result in civil and criminal penalties. There are also other rules addressing certain aspects of our business including billing and relationships with customer to which we are subject. These rules may evolve and change in the future.

State Laboratory Licensing

        In addition to federal certification requirements of laboratories under CLIA, licensure is required and maintained for our clinical reference laboratory under California law. If our clinical reference laboratory is

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out of compliance with California standards, our license may be suspended or revoked by the California Department of Health Services ("DHS") and may subject us to fines and penalties. However, we currently maintain a license in good standing with DHS.

        We must also satisfy various application and provisional requirements for other states in which we desire to do business, including New York, Florida, Maryland, Pennsylvania and Rhode Island. We are currently not licensed by the New York State Department of Health but are seeking such a license and have obtained licenses from the other noted states. We may become aware from time to time of additional states that require out-of-state laboratories to obtain licensure in order to accept patient specimens from those states, and it is possible that other states do have such requirements or will have such requirements in the future. If we identify any other state with such requirements or if we are contacted by any other states advising us of such requirements, we intend to strictly adhere to the instructions and guidelines from the state regulators as to how we should comply with such requirements.

FDA

        Regulations in the U.S. covering genetic testing are in a state of change and may dramatically affect the molecular diagnostics industry in the near future. Specific guidelines and regulations are being considered by the FDA. While we believe that all of our products meet with current regulatory guidelines, future regulations may affect our existing products and services as well as products that are in development. We also believe that several companies providing products and services to the diagnostics marketplace are not complying with appropriate regulations and perhaps are incurring liabilities as a result. Our philosophy is to meet with the FDA to gain a better understanding and appropriate interpretation of the regulatory framework as well to comply with such regulations. We have met and had discussions with the FDA on several occasions and will continue to do so as our products and the industry develop.

        In October of 2006, the FDA provided its opinion regarding the regulatory nature of our first test in a letter addressed to CMDX. The text of that letter, which can be found on our corporate website at www.combimatrix.com, indicated that the FDA did not believe that CMDX's device, as described to the FDA, met the definition of an In-Vitro Diagnostic Multivariate Index Assay ("IVDMIA") as defined in the Draft Guidance document on IVDMIAs.

Subsidiaries

        During the second quarter of 2005, we formed a wholly owned subsidiary, CMDX, in order to exploit our array technologies in the field of molecular diagnostics. As of December 31, 2009, CMDX had 34 employees located in Irvine, California.

        We also own one-third of Leuchemix, which is a private drug development company focused on the area of oncology, located in Woodside, California.

Marketing and Distribution

        We are currently selling our products and services directly, with partners and through distributors to customers in the United States, Europe and Asia. In some cases, our agreements allow for exclusive distribution of various CustomArray products in specific territories and for distribution of locally synthesized CustomArray microarrays, where the manufacturer purchases and uses CustomArray synthesizers and supplies from us for use in their manufacturing process. Current manufacturers and distributors include BioInsight Pty. Ltd., Prisma Biotech Corp., Macrogen, Inc., and BioTeltec. Where appropriate, we intend to continue to market and sell our products directly or through distribution arrangements and/or through other strategic alliances.

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        Our diagnostic services are being run by CMDX at our CLIA laboratory in Irvine, California. We market these services through web-based initiatives, trade-shows, direct sales and marketing. We also market our services through partnerships with other laboratories that enable us to leverage the commercial infrastructure of those companies. We hope to continue to expand the customer reach of our service offerings through new partnerships.

Manufacturing

        We have developed automated, computer-directed manufacturing processes for the synthesis of sequences electrochemically or spotting of DNA, RNA, BACs, peptides or small molecules on our arrays. Certain portions of our manufacturing are outsourced to subcontractors, while we conduct the steps involving synthesis or spotting of biological materials and quality control of our products.

        Substantially all of the components and raw materials used in the manufacture of our products, including semiconductors and reagents, are currently provided from a limited number of sources or, in some cases, from a single source. Although we believe that alternative sources for those components and raw materials are available, any supply interruption in a sole-sourced component or raw material might result in up to a several-month production delay and materially harm our ability to manufacture products until a new source of supply, if any, could be located and qualified. In addition, an uncorrected impurity or supplier's variation in a raw material, either unknown to us or incompatible with our manufacturing process, could have a materially adverse effect on our ability to manufacture products. We may be unable to find a sufficient alternative supply channel in a reasonable time period, or on commercially reasonable terms, if at all. We utilize non-standard semiconductor manufacturing processes to fabricate the electrode array, of which the electrodes provide a key aspect of the array structure. Although we have a supply agreement in place with the semiconductor wafer manufacturer to ensure availability of the raw materials, the agreement does not guarantee a permanent supply. These non-standard processes are not widely available, and it may be difficult or expensive to obtain sufficient quantities of semiconductor wafers if the current manufacturer changes or discontinues our manufacturing production capability.

Patents and Licenses

        We continue to build our intellectual property portfolio to protect our products in those markets where we operate and where a market for our products and services exists. In the United States, we have been issued nine United States patents. Three of these patents (U.S. Patent No. 6,093,302, 6,280,595 and 6,444,111 all of which expire on January 5, 2018) are first generation technology relating to methods for electrochemical synthesis of arrays of DNA and other biological materials as well as non-biological materials. These three patents have undergone ex parte reexamination in the United States Patent and Trademark Office, and all claims remain essentially the same as before the reexamination. The fourth United States Patent (U.S. Patent No. 6,456,942) describes and claims a network infrastructure for array synthesis and analysis. Ex parte reexamination of this patent is in progress. The fifth United States Patent (U.S. Patent No. 7,075,187) describes and claims a porous coating material that covers electrodes and is used as a three-dimensional support material for electrochemical synthesis on the individual electrodes of an array of electrodes. This patent has undergone ex parte reexamination in the United States Patent and Trademark Office, and all claims remain the same as before the reexamination. The sixth United States Patent (U.S. Patent No. 7,323,320) is licensed to Codon Devices. The seventh United States Patent (U.S. Patent No. 7,563,600) is also licensed to Codon Devices and is in the same family of applications as the sixth patent. The eighth United States Patent (U.S. Patent No. 7,507,837) describes and claims a process for performing an isolated palladium (II)-mediated oxidation reaction on our electrode for building libraries of organic compounds electrochemically and in parallel. The ninth United States Patent (U.S. Patent No. 7,541,314) describes and claims a microarray with a linker that is cleaved by a base for use in selective removal of oligonucleotides from the microarray. Corresponding patents describing and claiming methods for electrochemical synthesis of arrays have been issued to us in Europe (entire EU), Australia,

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and Taiwan and are pending in the remaining major industrialized markets. We have filed patent applications relating to new methods of, and materials for, electrochemical synthesis and for electrochemical detection, which eliminates the need for optical readers. In total, we have 75 patent applications pending in the United States, Europe, and elsewhere, and 21 of those applications are pending in the United States.

        We seek to protect our corporate identity, products, and services with trademarks and service marks. In addition, our trademark strategy includes protecting the identity and goodwill associated with our products and services. Currently, we have 11 registered trademarks (CUSTOMARRAY®, DESIGN-ON-DEMAND®, ELECTRASENSE®, HYB AND SEQ®, QUADROCAS®, COMBIMATRIX®, CMDX®, ATSCAN®, HEMESCAN®, UROSCAN®, and HERSCAN®) in the United States and 19 trademarks registered in numerous foreign jurisdictions. We also have seven pending trademarks in the United States and one pending trademark internationally.

        We try to obtain licenses to the patent rights of others when required to meet our business objective. For example, we purchase chemical reagents from suppliers who are licensed under appropriate patent rights. Further, our policy is to obtain licenses from patent holders for our products and services whenever such licenses are required. We evaluate if and when a license is needed and obtain opinions from outside counsel where required.

        Our success will depend, in part, upon our ability to obtain patents and maintain adequate protection of our intellectual property in the United States and other countries. If we do not protect our intellectual property adequately, competitors may be able to use our technologies and thereby erode any competitive advantage that we may have over our competition. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States; this lack of protection has resulted in many companies having significant problems in protecting their intellectual proprietary rights abroad. These problems can be caused by the absence of laws, rules, and/or procedures for protecting intellectual property rights. In addition, the laws of foreign jurisdictions, such as the European Union, provide an opportunity for parties to oppose the granting of patents when such patents have claims that may be construed as too broad or significantly beyond the scope of the initial teaching or disclosure in the patent application as filed. Moreover, the laws of the United States provide an opportunity for parties to file for reexamination of issued U.S. Patents; however, only prior art patents and publications can be used as the basis for a reexamination. Reexamination can result in narrowing of some claims and/or invalidation of some or all claims of a patent. With respect to European oppositions, we have been successful in European opposition proceedings against the patents of competitors. The basis for these proceedings has been that these patents have claims that extend beyond the scope of teachings provided in the respective disclosures of the patents. However, there is no assurance that we will continue to be successful in such oppositions.

        Generally, uncertainty and complexity of the regulatory, legal, and factual questions complicate the intellectual property position of companies developing tools and drugs for the biotechnology and pharmaceutical industries, including our company. With respect to such complexities and our products and services, we will be able to protect our intellectual property rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. As such, our existing patents and any further patents we obtain may not be sufficiently broad to prevent others from practicing our specific technologies or developing competing products. Moreover, there is a risk that others may independently develop similar or alternative technologies or design around our patented technologies. In addition, others may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantage. Finally, enforcing our intellectual property rights may be difficult, costly and time consuming, and ultimately may not be successful.

        We also rely upon trade secret protection for our confidential and proprietary information. Additionally, we seek to protect our proprietary information by entering into confidentiality and invention

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disclosure and transfer agreements with employees, collaborators, and consultants. These measures, however, may not provide adequate protection for our trade secrets or other proprietary information. Employees, collaborators, or consultants still may disclose our proprietary information by breaching such agreements. Moreover, we may not be able to meaningfully protect our trade secrets. Furthermore, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets. Finally, former employees may knowingly violate such agreements.

        We cannot assure you that any of our patent applications will (i) result in the issuance of any additional patents, (ii) have priority of invention or filing date over applications of others for the same or similar invention, or (iii) offer protection against our competitors. Furthermore, we cannot assure you that any patent issued to us will not be challenged, invalidated, narrowed in scope, or circumvented in the future or that our intellectual property will provide a competitive advantage. Finally, litigation and the resulting expenditures may be necessary to enforce our intellectual property rights or to determine the enforceability, scope of protection, or validity of the intellectual property rights of others.

Competition

        We expect to encounter competition for business opportunities from other entities having similar business objectives. Many of these potential competitors possess greater financial, technical, human and other resources than we do. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become available. Technological advances or entirely different approaches developed by one or more of our competitors could render our processes obsolete or uneconomical. The existing approaches of competitors or new approaches or technology developed by competitors may be more effective than those developed by us.

        We are aware of other companies or companies with divisions that have, or are developing, technologies for the molecular diagnostic markets. We believe that our primary competitors will be Affymetrix, Inc., Agilent Technologies, Inc., Applera Corporation, Baylor College of Medicine, Becton, Dickinson and Company, Genomic Health, Inc., Illumina, Inc., Johnson & Johnson, Roche Diagnostics GmbH, Sequenom, Inc. and Signature Genomics. However, our market is rapidly changing, and we expect to face additional competition from new market entrants, new product developments and consolidation of our existing competitors. Many of our competitors have existing strategic relationships with major pharmaceutical and biotechnology companies, greater commercial experience and substantially greater financial and personnel resources than we do. We expect new competitors to emerge and the intensity of competition to increase in the future. At times some of these competitors may be potential partners.

Research, Development and Engineering

        Our research and development expenses were $5.2 million and $4.9 million for the years ended December 31, 2009 and 2008, respectively. Of these amounts, research and development related non-cash stock compensation charges were $621,000 and $413,000 for the years ended December 31, 2009 and 2008, respectively. We intend to invest in our proprietary technologies through internal development and, to the extent available, licensing of third-party technologies to increase and improve other characteristics of our products. We also plan to continue to invest in improving the cost-effectiveness of our products through further automation and improved information technologies. Our future research and development efforts may involve research conducted by us, collaborations with other researchers and the acquisition of chemistries and other technologies developed by universities and other academic institutions.

        We are developing a variety of life sciences and non-life sciences products and services. Potential customers for these products operate in industries characterized by rapid technological development. We believe that our future success will depend in large part on our ability to continue to enhance our existing products and services and to develop other products and services that complement existing ones. In order

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to respond to rapidly changing competitive and technological conditions, we expect to continue to incur significant research and development expenses during the initial development phase of new products and services, as well as on an ongoing basis.

Government Grants and Contracts

        Government grants and contracts have allowed us to fund certain internal scientific programs and exploratory research. We retain ownership of all intellectual property and commercial rights generated during these projects. The United States government, however, retains a non-exclusive, non-transferable, paid-up license to practice the inventions made with federal funds pursuant to applicable statutes and regulations. We do not believe that the retained license will have any impact on our ability to market our products. We do not need government approval to enter into collaborations or other relationships with third parties.

        The following is a summary of our most recent contract awards from the U.S. federal government in connection with our biological and chemical array processor technology:

•

In September 2009, we executed a fifteen-month, $1.5 million contract with the U.S. Air Force Research Laboratory for the development of automated instrumentation that uses our semiconductor microarray technologies for detecting chemical, biological and environmental hazards that can impact the health of deployed military personnel. Under the terms of this contract, we will perform research and development activities, as described under the contract, and will be reimbursed on a periodic basis for actual costs incurred to perform these obligations, plus a fixed fee, of up to $1.5 million. This contract is currently ongoing.



•

In March 2009, we executed a four-year, $858,000 contract with the NASA Ames Research Center for further development of our microarray technologies. The primary objective of the contract is to design and test a microfluidics system that incorporates our semiconductor-based microarray platform as part of an integrated genetic analysis system that can be deployed in space. Under the terms of this contract, we will perform research and development activities during the first year ("Phase I") for a fixed fee of $214,000. If NASA chooses to continue development for each of the subsequent years two through four of the contract, we will continue development at similar funding levels to the first year, not to exceed a maximum fee of $858,000 for the entire contract period. This contract is currently ongoing.



•

In July 2008, we executed a six-month, $250,000 contract with the U.S. Department of Defense ("DoD") for the development of label-free detection techniques using our microarray technology. These detection techniques involve the synthesis of molecules known as "aptamers," which are molecules with unique biological properties. This contract was substantially completed during the first quarter of 2009.



•

Also in July 2008, we executed a fifteen-month, $923,000 contract with the DoD to further develop our microarray technologies for a multipathogen detection system. The primary objectives of the contract are to continue development of an automated biothreat agent detection system based upon our complementary metal oxide semiconductor microarray and electrochemical detection techniques, to continue the integration of serological and genomic assays for orthogonal testing and to explore new methods of detection that expand target identification, reduce reagent burden, and improve assay time. This contract was substantially completed during the second quarter of 2009.



•

In July 2007, we executed a one-year, $2.2 million contract with the DoD to further develop our microarray technologies. Under the terms of the contract, we are reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee, of up to $2.2 million. The primary objective of this contract is to continue development of a multipathogen and chemical detection

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system based on our microarray technologies. This contract was substantially completed during the third quarter of 2008.

•

In March 2007, we executed a one-year, $869,000 contract with the DoD to advance our Influenza Genotyping System. Under the terms of the contract, we are reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee, of up to $869,000. The field-deployable system is based on our CustomArray® microarray platform and ElectraSense® detection technologies. This contract was substantially completed during the second quarter of 2008.



•

In August 2006, we executed a two-year, $1.9 million contract with the DoD, focusing on the integration of our electrochemical detection technology currently under development with our microfluidics "lab-on-a-chip" technology to be used for military and homeland security applications. Under the terms of this contract, we performed research and development activities, as described under the contract, and were reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee, of up to $1.9 million. This contract was substantially completed during the fourth quarter of 2008.

        We intend to continue to pursue grants and contracts that complement our research and development efforts.

Employees

        As of December 31, 2009, we had 69 full-time employees, 13 of whom hold a Ph.D. or an M.D. degree and 22 of whom are engaged in either full-time production or research and development activities. We believe that we maintain good relationships with our employees.

Environmental Matters

        Our operations involve the use, transportation, storage and disposal of hazardous substances and as a result, we are subject to environmental and health and safety laws and regulations. The cost of complying with these and any future environmental regulations could be substantial. In addition, if we fail to comply with environmental laws and regulations, or release any hazardous substances into the environment, we could be exposed to substantial liability in the form of fines, penalties, remediation costs and other damages or could suffer a curtailment or shut down of our operations.

Available Information

        We are subject to the informational requirements of the Securities Exchange Act of 1934. Therefore, we file periodic reports, proxy statements and other information with the SEC. Such reports, proxy statements and other information may be obtained by visiting the Public Reference Room of the SEC at 100 F Street N.E., Washington, D.C. 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

        You can also access financial and other information at our Investor Relations website. Our website is located at www.combimatrix.com. We make available free of charge on our web site our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with or furnish them to the SEC. Information contained on our web site is not part of this Annual Report on Form 10-K or our other filings with the SEC.

        The charters of our Audit Committee, our Compensation Committee and our Nominating and Governance Committee are available on the Investor Relations section of our website under "Corporate Governance." Also available on that section of our website is our Code of Business Conduct and Ethics,

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which we expect every employee, officer and director to read, understand and abide by. This information is also available by writing to us at the address on the cover of this report.

Item 1A.    RISK FACTORS

        An investment in our securities involves a number of risks. Before making a decision to purchase our securities, you should carefully consider all of the risks described in this annual report. If any of the risks discussed in this annual report actually occur, our business, financial condition and results of operations could be materially adversely affected. If this were to occur, the trading price of our securities could decline significantly and you may lose all or part of your investment.

Risks Related To Our Business

We may not be able to meet our cash requirements beyond June 2011 without obtaining additional capital from external sources, and if we are unable to do so, we may not be able to continue as a going concern.

        As of December 31, 2009, we had $5.4 million in cash and cash equivalents which, along with litigation settlement proceeds received in February 2010, we anticipate will meet our cash requirements through approximately June 2011. However, in order for us to continue as a going concern beyond that point, we may be required to obtain capital from external sources. If external financing sources are not available or are inadequate to fund our operations, it could result in reduced revenues and cash flows from the sales of our CustomArray products and diagnostic services and/or could jeopardize our ability to launch, market and sell additional products and services necessary to grow and sustain our operations in order to eventually achieve profitability.

We may need to raise additional capital in the future, and if additional capital is not available on acceptable terms, we may have to curtail or cease operations.

        Our future capital requirements will be substantial and will depend on many factors, including how quickly we commercialize our products, the progress and scope of our collaborative and independent research and development projects, the filing, prosecution, enforcement and defense of patent claims and the need to obtain regulatory approval for certain products in the United States or elsewhere. Changes may occur that would cause our available capital resources to be consumed significantly sooner and more rapidly than we expect.

        We may be unable to raise sufficient additional capital on favorable terms or at all. If we fail to do so, we may have to curtail or cease operations or enter into agreements requiring us to relinquish rights to certain technologies, products, or markets because we will not have the capital necessary to exploit them.

We have a history of losses and expect to incur additional losses in the future.

        We have sustained substantial losses since our inception. We may never become profitable, or if we do, we may never be able to sustain profitability. We expect to incur significant research and development, marketing, general and administrative expenses. As a result, we expect to incur losses for the foreseeable future.

        To date, we have relied primarily upon selling equity and convertible securities, as well as payments from strategic partners, to generate the funds needed to finance the implementation of our business strategies. We cannot assure you that we will not encounter unforeseen difficulties, including the outside influences identified above that may deplete our capital resources more rapidly than anticipated. As a result, our subsidiary companies may be required to obtain additional financing through bank borrowings, debt or equity financings or otherwise, which would require us to make additional investments or face a dilution of our equity interests. Any efforts to seek additional funds could be made through equity, debt or other external financings. Nevertheless, we cannot be sure that additional funding will be available on

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favorable terms, if at all. If we fail to obtain additional funding when needed for our subsidiary companies and ourselves, we may not be able to execute our business plans or continue operations, and our business may suffer.

        We began commercialization of our CustomArray platform in 2004 and our molecular diagnostics services in 2006. Accordingly, we have a limited operating history of generating revenues from products and services. In addition, we are still developing our product and service offerings and you should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies with such limited operating histories. Since we have a limited operating history, we cannot assure you that our operations will be profitable or that we will generate sufficient revenues to meet our expenditures and support our activities.

If our stock price declines, this could result in a goodwill impairment.

        The market value of our company has been volatile and at times has approached our book value. Should our market value decline below our book value, our goodwill in the amount of $16.9 million as of December 31, 2009 could be impaired.

The recent financial crisis could negatively affect our business, results of operations and financial condition.

        The recent financial crisis affecting the banking system and financial markets and the going concern threats to investment banks and other financial institutions have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit and equity markets. There could be a number of follow-on effects from the credit crisis on our business, including insolvency of key suppliers resulting in product delays; inability of customers to obtain credit to finance purchases of our products and/or customer insolvencies; and increased expense or inability to obtain financing for our operations. We are unable to predict the length or severity that the economic downturn could have on our operations.

Because our business operations are subject to many uncontrollable outside influences, we may not succeed.

        Our business operations are subject to numerous risks from outside influences, including the following:

•

Technological advances may make our semiconductor based array technology obsolete or less competitive, and as a result, our revenue and the value of our assets could significantly decrease.

        Our products and services are dependent upon our semiconductor based array technology and our BAC array technology. These array-based technologies compete with conventional arrays that are used for the same purpose. Current array technologies have revolutionized drug discovery and development, and we believe that our array technology provides characteristics, including flexibility, superior cost metrics, and performance, all of which address certain needs of the life sciences market which are not addressed by conventional arrays and offers the latest in technological advances in this area. Our products and services are substantially dependent upon our ability to offer the latest in array technology in the SNP genotyping, gene expression profiling, CGH and proteomic markets. We believe technological advances of conventional arrays are currently being developed by our existing competition and potential new competitors in the market, including Affymetrix, Inc., Agilent Technologies, Inc., Applera Corporation, Baylor College of Medicine, Becton, Dickinson and Company, Ciphergen Biosystems, Inc., Gene Logic Inc., Genomic Health, Inc., Illumina, Inc., Johnson & Johnson, Nanogen, Inc., Orchid Biosciences, Inc., Roche Diagnostics GmbH, Sequenom, Inc and Signature Genomics. We also expect to face additional competition from new market entrants and consolidation of our existing competitors. Many of our competitors have existing strategic relationships with major pharmaceutical and biotechnology

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companies, greater commercial experience and substantially greater financial and personnel resources than we do. We expect new competitors to emerge and the intensity of competition to increase in the future. If these companies are able to offer technological advances, our products may become less valuable or even obsolete. While we continue to invest resources in research and development to enhance the technology of our products and services, we cannot provide any assurance that our competitors or new competitors will not enter the market with the same or similar technological advances before we are able to do so.

•

New environmental regulation may materially increase the net losses of our business.

        Our operations involve the use, transportation, storage and disposal of hazardous substances, and as a result, we are subject to environmental and health and safety laws and regulations. If we were to be found in violation of these laws and regulations, we may face fines or other penalties. Also, any changes in these laws and regulations could increase our compliance costs, and as a result, could materially increase our net losses.

•

Our technologies face uncertain market value.

        Our business includes many products, some of which were recently introduced into the market. These technologies and products have not gained widespread market acceptance, and we cannot provide any assurance that the increase, if any, in market acceptance of these technologies and products will meet or exceed our expectations.

        Further, we are developing products and services, some of which have not yet been introduced into the market. The level of market acceptance of these technologies, products and services will have a significant impact upon our results of operations, and we cannot provide any assurance that the increase, if any, in market acceptance of these technologies and products will meet or exceed our expectations.

•

We obtain components and raw materials from a limited number of sources, and the loss or interruption of our supply sources may adversely impact our ability to manufacture our products to meet our existing or future sales targets.

        Substantially all of the components and raw materials used in the manufacture of our products, including semiconductors and reagents, are currently provided from a limited number of sources or, in some cases, from a single source. Although we believe that alternative sources for those components and raw materials are available, any supply interruption in a sole-sourced component or raw material might result in significant production delays and materially harm our ability to manufacture products until a new source of supply, if any, could be located and qualified. In addition, an uncorrected impurity or supplier's variation in a raw material, either unknown to us or incompatible with our manufacturing process, could have a material adverse effect on our ability to manufacture products. We may be unable to find a sufficient alternative supply channel in a reasonable time period, or on commercially reasonable terms, if at all.

        Any one of the foregoing outside influences may cause our company to need additional financing to meet the challenges presented or to compensate for a loss in revenue, and we may not be able to obtain the needed financing on commercially reasonable terms or at all. Further, any one of the foregoing outside influences affecting our business could make it less likely that we will be able to gain acceptance of our array technology by researchers in the pharmaceutical, biotechnology and academic communities.

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Our revenues will be unpredictable, and this may harm our financial condition.

        The amount and timing of revenues that we may realize from our business will be unpredictable because whether our products and services are commercialized and generate revenues depends, in part, on the efforts and timing of our potential customers. Also, our sales cycles may be lengthy. As a result, our revenues may vary significantly from quarter to quarter, which could make our business difficult to manage and cause our quarterly results to be below market expectations. If this happens, the price of our common stock may decline significantly.

We are deploying new and unproven technologies, which makes evaluation of our business and prospects difficult, and we may be forced to cease operations if we do not develop commercially successful products.

        We have not proven our ability to commercialize products on a large scale. In order to successfully commercialize products on a large scale, we will have to make significant investments, including investments in research and development and testing, to demonstrate their technical benefits and cost-effectiveness. Problems frequently encountered in connection with the commercialization of products using new and unproven technologies might limit our ability to develop and commercialize our products. For example, our products may be found to be ineffective, unreliable or otherwise unsatisfactory to potential customers. We may experience unforeseen technical complications in the processes we use to develop, manufacture, or receive orders for our products. These complications could materially delay or limit the use of products we attempt to commercialize, substantially increase the anticipated cost of our products, or prevent us from implementing our processes at appropriate quality and scale levels, thereby causing our business to suffer.

The genetic diagnostic laboratory market is characterized by rapid technological change, frequent new product introductions, and evolving industry standards, and we may encounter difficulties keeping pace with changes in this market.

        The introduction of diagnostic tests embodying new technologies and the emergence of new industry standards can render existing tests obsolete and unmarketable in short periods of time. We expect our competitors to introduce new products and services and enhancements to their existing products and services. Our future success will depend upon our ability to enhance our current tests, and to develop new tests, in a manner that keeps pace with emerging industry standards and achieves market acceptance. Our inability to accomplish any of these endeavors will likely have a material adverse effect on our business, operating results, cash flows, and financial condition.

If we do not enter into successful partnerships and collaborations with other companies, we may not be able to fully develop our technologies or products, and our business would be harmed.

        Since we do not possess all of the resources necessary to develop and commercialize products that may result from our technologies on a mass scale, we will need either to grow our sales, marketing and support group or make appropriate arrangements with strategic partners to market, sell and support our products. We believe that we will have to enter into additional strategic partnerships to develop and commercialize future products. If we do not enter into adequate agreements, or if our existing arrangements or future agreements are not successful, our ability to develop and commercialize products will be impacted negatively, and our revenues will be adversely affected.

We have limited experience commercially manufacturing, marketing, or selling any of our potential products and services, and unless we develop these capabilities, we may not be successful.

        Even if we are able to develop our products and services for commercial release on a large scale, we have limited experience in manufacturing our products in the volumes that will be necessary for us to achieve commercial sales and in marketing or selling our products to potential customers. We cannot

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assure you that we will be able to commercially produce our products on a timely basis, in sufficient quantities, or on commercially reasonable terms.

We face intense competition, and we cannot assure you that we will be successful competing in the market.

        We expect to compete with companies that design, manufacture and market instruments for analysis of genetic variation and function and other applications using established sequential and parallel testing technologies. We are also aware of other biotechnology companies that have or are developing testing technologies for the SNP genotyping, gene expression profiling, CGH and proteomic markets. We anticipate that we will face increased competition in the future as new companies enter the market with new technologies and our competitors improve their current products or introduce new ones.

        The markets for our products are characterized by rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition and new product introductions. One or more of our competitors may offer technology superior to ours and render our technology obsolete or uneconomical. Many of our competitors have greater financial and personnel resources and more experience in marketing, sales and research and development than we have. Some of our competitors currently offer arrays with greater density than we do and have rights to intellectual property, such as genomic information or proprietary technology, which provides them with a competitive advantage. If we were not able to compete successfully, our business and financial condition would be materially harmed.

If our new and unproven technology is not used by researchers in the pharmaceutical, biotechnology and academic communities, or by physicians and laboratories in the diagnostics market, our business will suffer.

        Our products may not gain market acceptance. In that event, it is unlikely that our business will succeed. Biotechnology and pharmaceutical companies, academic research centers and reference laboratories have historically analyzed genetic variation and function using a variety of technologies, and many of them have made significant capital investments in existing technologies. Compared to existing technologies, our technologies are new and unproven. In order to be successful, our products must meet the commercial requirements of the biotechnology, pharmaceutical and academic communities as tools for the large-scale analysis of genetic variation and function. Market acceptance will depend on many factors, including:

•

the development of a market for our tools and diagnostic services for the analysis of genetic variation and function, including the study of proteins and other purposes;



•

the benefits and cost-effectiveness of our products relative to others available in the market;



•

our ability to manufacture products in sufficient quantities with acceptable quality and reliability and at an acceptable cost;



•

our ability to develop and market additional products and enhancements to existing products that are responsive to the changing needs of our customers;



•

the willingness and ability of customers to adopt new technologies requiring capital investments or the reluctance of customers to change technologies in which they have made a significant investment; and



•

the willingness of customers to transmit test data and permit us to transmit test results over the Internet, which will be a necessary component of our product and services packages unless customers purchase or license our equipment for use in their own facilities.

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A significant component of our revenue is dependent on successful insurance claims. Our revenue will be diminished if payors do not adequately cover or reimburse us for our services.

        Physicians and patients may decide not to order our high-complexity genomic microarray tests unless third-party payors, such as managed care organizations as well as government payors such as Medicare and Medicaid, pay a substantial portion of the test price. Reimbursement by a third-party payor may depend on a number of factors, including a payor's determination that tests using our technologies are:

•

not experimental or investigational;



•

medically necessary;



•

appropriate for the specific patient;



•

cost-effective;



•

supported by peer-reviewed publications; and



•

included in clinical practice guidelines.

        A substantial portion of the testing for which we bill our hospital and laboratory clients is ultimately paid by third-party payors. However, there is uncertainty concerning third-party payor reimbursement of any test, including our high-complexity genome microarray tests. Several entities conduct technology assessments of medical tests and devices and provide the results of their assessments for informational purposes to other parties. These assessments may be used by third-party payors and health care providers as grounds to deny coverage for a test or procedure. Although our tests have been determined to be a standard of care by several of the physician colleges and organizations in our arena, and we have received appropriate reimbursements from a number of insurers it is possible that federal, state and third party insurers may limit their coverage of our tests in the future.

        Increasing emphasis on managed care in the United States is likely to put pressure on the pricing of healthcare services. Uncertainty exists as to the coverage and reimbursement status of new applications or services. Governmental payors and private payors are scrutinizing new medical products and services. Such third-parties may not cover, or may limit coverage and resulting reimbursement for our services. Additionally, third-party insurance coverage may not be available to patients for any of our existing assays or assays we may discover and develop in the future. Any pricing pressure exerted by these third-party payors on our customers may, in turn, be exerted by our customers on us. If governmental payors, including their contracted administrators, and other third-party payors do not provide adequate coverage and/or timely reimbursement for our services, our operating results, cash flows, or financial condition may decline.

Our cash flows and financial condition may decline if payors do not reimburse us for our services in a timely manner.

        We depend on our payors to reimburse us for our services in timely manner. If our payors, particularly Medicare or Medicare's designated administrator, does not reimburse us in a timely manner, our cash flows and financial condition may decline.

Third party billing is extremely complicated and could result in us incurring significant additional costs.

        Billing for esoteric laboratory services is extremely complicated. The customer is the party that refers the tests and the payor is the party that pays for the tests, and the two are not always the same. Depending on the billing arrangement and/or applicable law, we need to bill various payors, such as patients, health insurance companies, Medicare, Medicaid, doctors and employer groups, all of which have different billing requirements. Health insurance companies and governmental payors also generally require complete and correct billing information within certain filing deadlines. Additionally, our billing relationships require us

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to undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. Health insurance companies also impose routine external audits to evaluate payments made. Additional factors complicating billing are:

•

pricing differences between our fee schedules and the reimbursement rates of the payors;



•

disputes with payors as to which party is responsible for payment; and



•

disparity in coverage and information requirements among various carriers.

        We incur significant additional costs as a result of our participation in the Medicare and Medicaid programs, as billing and reimbursement for laboratory testing are subject to considerable and complex federal and state regulations. The additional costs we expect to incur as a result of our participation in the Medicare and Medicaid programs include costs related to, among other factors: (1) complexity added to our billing processes; (2) training and education of our employees and customers; (3) implementing compliance procedures and oversight; (4) collections and legal costs; (5) challenging coverage and payment denials; and (6) providing patients with information regarding claims processing and services, such as advanced beneficiary notices.

Complying with numerous regulations pertaining to our business is an expensive and time-consuming process, failure of which could result in significant penalties and our suspension of one or more licenses.

        The clinical laboratory testing industry is highly regulated. We are subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. We have a current certificate of accreditation under CLIA to perform testing. To renew this certificate, we are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random inspections of our clinical reference laboratory.

        We are also required to maintain a license to conduct testing in California. California laws establish standards for day-to-day operation of our clinical reference laboratory, including the training and skills required of personnel and quality control. Moreover, several states require that we hold licenses to test specimens from patients in those states. Other states may have similar requirements or may adopt similar requirements in the future.

Loss of or adverse changes to our accreditations or licenses could materially and adversely affect our business, prospects and results of operations.

        We may be subject to regulation in foreign jurisdictions as we seek to expand international distribution of our test. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:

•

Federal and state laws applicable to billing and claims payment and/or regulatory agencies enforcing those laws and regulations;



•

Federal and state laboratory anti-mark-up laws;



•

Federal and state anti-kickback laws;



•

Federal and state false claims laws;



•

Federal and state self-referral and financial inducement laws, including the federal physician anti-self-referral law, or the Stark Law;

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•

Coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;



•

Restrictions on reimbursements for our services;



•

Federal and state laws governing laboratory testing, including CLIA;



•

Federal and state laws governing the development, use and distribution of diagnostic medical tests known as "home brews";



•

HIPAA;



•

Federal and state regulation of privacy, security and electronic transactions;



•

State laws regarding prohibitions on the corporate practice of medicine;



•

State laws regarding prohibitions on fee-splitting;



•

Federal, state and local laws governing the handling and disposal of medical and hazardous waste; and



•

Occupational Safety and Health Administration ("OSHA") rules and regulations.

        The above noted laws and regulations are extremely complex and in many instances, there are no significant regulatory or judicial interpretations of such laws and regulations. While we believe that we are currently in material compliance with applicable laws and regulations, a determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, would adversely affect our business, prospects, results of operations and financial condition. In addition, a significant change in any of these laws may require us to change our business model in order to maintain compliance with these laws, which could reduce our revenue or increase our costs and adversely affect our business, prospects, results of operations, and financial condition.

We are subject to significant environmental, health and safety regulation.

        We are subject to licensing and regulation under federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials, as well as to the safety and health of laboratory employees. In addition, the OSHA has established extensive requirements relating to workplace safety for health care employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis B virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations, and other measures designed to minimize exposure to, and transmission of, blood-borne pathogens. In addition, the federally-enacted Needlestick Safety and Prevention Act requires, among other things, that we include in our safety programs the evaluation and use of engineering controls such as safety needles if found to be effective at reducing the risk of needlestick injuries in the workplace. If we are found in violation of any of these regulations, we could be subject substantial penalties or discipline and our business, prospects and results of operations could be materially and adversely affected.

We are subject to federal and state laws governing the financial relationship among healthcare providers, including Medicare & Medicaid laws, and our failure to comply with these laws could result in significant penalties and other adverse consequences.

        As our business grows, particularly in the cancer arena, we anticipate that a significant component of our revenue will be dependent on reimbursement from Medicare and state Medicaid programs. The Medicare program is administered by CMS which, like the states that administer their respective state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers,

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including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims and how we provide our specialized diagnostic services. Our failure to comply with applicable Medicare, Medicaid and other governmental payor rules could result in our inability to participate in a governmental payor program, our returning of funds already paid to us, civil monetary penalties, criminal penalties and/or limitations on the operational function of our laboratory.

Our business is subject to stringent laws and regulations governing the privacy, security and transmission of medical information, and our failure to comply could subject us to criminal penalties and civil sanctions.

        Governmental laws and regulations affect the privacy, security and transmission of medical information. Such laws and regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations. The privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of PHI, including potential civil and criminal fines and penalties. Although the HIPAA statute and regulations do not expressly provide for a private right of damages, we also could incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information or other private personal information.

Our product development efforts may be hindered if we are unable to gain access to patients' tissue and blood samples.

        The development of our diagnostic products requires access to tissue and blood samples from patients who have the diseases we are addressing. Our clinical development relies on our ability to secure access to these samples, as well as information pertaining to their associated clinical outcomes. Access to samples can be difficult since it may involve multiple levels of approval, complex usage rights and privacy rights, among other issues.

If our current laboratory facility becomes inoperable or loses certification, we will be unable to perform our tests and our business will be harmed.

        Our diagnostic tests are operated out of our CLIA-certified laboratory in Irvine, California. Currently, we do not have a second certified laboratory. Should our only CLIA-certified laboratory be unable to perform tests, for any reason, we may be unable to perform needed diagnostic tests in connection with our product development and our business will be harmed.

Our future success depends on the continued service of our engineering, technical and key management personnel and our ability to identify, hire and retain additional engineering, technical and key management personnel.

        There is intense competition for qualified personnel in our industry, particularly for engineers and senior level management. Loss of the services of, or failure to recruit, engineers or other technical and key management personnel could be significantly detrimental to the group and could adversely affect our business and operating results. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our products and business or to replace engineers or other qualified personnel who may leave the group in the future. Our anticipated growth is expected to place increased demands on our resources and likely will require the addition of new management personnel. An inability to recruit and retain qualified management and employees on commercially reasonable terms would adversely and materially affect our business.

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The expansion of our product lines may subject us to regulation by the FDA and foreign regulatory authorities, of which regulation could prevent or delay our introduction of new products.

        If we manufacture, market, or sell any products for any regulated clinical or diagnostic applications, those products will be subject to extensive governmental regulation as medical devices in the United States by the FDA and in other countries by corresponding foreign regulatory authorities. The process of obtaining and maintaining required regulatory clearances and approvals is lengthy, expensive and uncertain. Products that we manufacture, market, or sell for research purposes only currently are not subject to governmental regulations as medical devices or as analyte specific reagents to aid in disease diagnosis. We believe that our success will depend upon commercial sales of improved versions of products, some of which cannot be marketed in the United States and other regulated markets unless and until we obtain clearance or approval from the FDA and our foreign counterparts, as the case may be. Delays or failures in receiving these approvals may limit our ability to benefit from our new products.

As our operations expand, our costs to comply with environmental laws and regulations will increase, and failure to comply with these laws and regulations could harm our financial results.

        Our operations involve the use, transportation, storage and disposal of hazardous substances and as a result we are subject to environmental and health and safety laws and regulations. As we expand our operations, our use of hazardous substances will increase and lead to additional and more stringent requirements. The cost to comply with these and any future environmental and health and safety regulations could be substantial. In addition, our failure to comply with laws and regulations, and any releases of hazardous substances into the environment or at our disposal sites, could expose our group to substantial liability in the form of fines, penalties, remediation costs and other damages, or could lead to a curtailment or shut down of our operations. These types of events, if they occur, would adversely impact our financial results.

Our business depends on issued and pending patents, and the loss of any patents or our failure to secure the issuance of patents covering elements of our business processes could materially harm our business and financial condition.

        Our success depends on our ability to protect and exploit our intellectual property. Currently, we have nine patents issued in the United States, 30 patents issued internationally, 21 patent applications pending in the United States and 54 patent applications pending internationally. The patents covering our core technology begin to expire January 5, 2018.

        The patent application process before the United States Patent and Trademark Office and similar agencies in other countries is initially confidential in nature. Patent applications that are filed outside the United States, however, are published approximately eighteen months after filing. Similarly, patent applications that are filed in the United States will be published approximately eighteen months after filing unless the applicant has opted out of publication and will not file any foreign applications on the same invention. Due to the confidential nature of the patent application process, we cannot determine in a timely manner whether patent applications covering technology that competes with our technology have been filed in the United States or foreign countries or which, if any, will ultimately issue or be granted as enforceable patents. Considering our patent applications and those of others, some of our patent applications may claim compositions, methods, or uses that may also be claimed in patent applications filed by others. In some or all of these applications, a determination of priority of inventorship may need to be decided in a proceeding before the United States Patent and Trademark Office or a court. In contrast, in foreign jurisdictions, the first to file on the invention will generally prevail on a priority contest. If we are unsuccessful in these invention ownership proceedings, we could be blocked from further developing, commercializing, or selling products and services that fall under the scope of the claims of the patents that are issued to others. Regardless of the ultimate outcome, this ownership determination process can be time-consuming and expensive.

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        If we do not protect our intellectual property adequately, competitors may be able to use our technologies and erode any competitive advantage that we may have. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting their proprietary rights abroad. These problems can be caused by the absence of laws, rules and/or methods for defending intellectual property rights.

        The patent position of companies developing tools for the biotechnology, pharmaceutical and academic communities, including our patent position, generally are uncertain and involve complex legal and factual questions. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. Our existing patents and any future issued or granted patents we obtain may not be sufficiently broad in scope to prevent others from practicing our technologies or from developing competing products. Also there is a risk that others may independently develop similar or alternative technologies or design around our patented technologies. In addition, others may cause reexamination of our patents in the United States or may oppose our patents in Europe, either of which may result in narrower patent claims or cancellation of some or all of the patent claims. Moreover, our patents may be invalidated during enforcement proceedings or may fail to provide us with any competitive advantage. Enforcing our intellectual property rights may be difficult, costly, and time-consuming and, ultimately, may not be successful.

        We also rely upon trade secret protection of our confidential and proprietary information. While we have taken security measures to protect our proprietary information, these measures may not provide adequate protection for our trade secrets or other proprietary information. We seek to protect our proprietary information by entering into confidentiality and invention disclosure and transfer agreements with employees, collaborators and consultants. Nevertheless, employees, collaborators, or consultants still may disclose our proprietary information in breach of such agreements, and we may not be able to meaningfully protect our trade secrets. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets.

Any litigation to protect our intellectual property, or any third-party claims of infringement, could divert substantial time and money from our business and could shut down some of our operations.

        Our commercial success depends, in part, on our non-infringement of the patents or proprietary rights of third parties. Many companies developing technology for the biotechnology and pharmaceutical industries use litigation aggressively as a strategy to protect and expand the scope of their intellectual property rights. Accordingly, third parties may assert that we are employing their proprietary technology without authorization. In addition, third parties may claim that use of our technologies infringes their current or future patents. We could incur substantial costs defending against such allegations regardless of their merit, and the attention of our management and technical personnel could be diverted while defending ourselves against any of these claims. We may incur the same liabilities in enforcing our patents against others. We have not made any provision in our financial plans for potential intellectual property related litigation, and we may not be able to pursue litigation as aggressively as competitors with substantially greater financial resources.

        If parties making infringement claims against us are successful, they may be able to obtain injunctive or other relief, which effectively could block our ability to further develop, commercialize, and sell products and/or services, and could result in the award of substantial damages against us. If we are unsuccessful in protecting and expanding the scope of our intellectual property rights, our competitors may be able to develop, commercialize, and sell products and/or services that compete against us using similar technologies or obtain patents that could effectively block our ability to further develop, commercialize, and sell our products and/or services. In the event of a successful claim of infringement against us, we may be required to pay substantial damages and either discontinue those aspects of our business involving the technology upon which we infringed or obtain one or more licenses from third parties. While we may

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license additional technology in the future, we may not be able to obtain these licenses at a reasonable cost, or at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products, and such attempts may not be successful. Defense of any lawsuit or failure to obtain any of these licenses could prevent us from commercializing available products and/or services.

        If parties making infringement claims against us are successful, they may be able to obtain injunctive or other relief, which effectively could block our ability to further develop, commercialize, and sell products and/or services, and could result in the award of substantial damages against us. If we are unsuccessful in protecting and expanding the scope of our intellectual property rights, our competitors may be able to develop, commercialize, and sell products and/or services that compete against us using similar technologies or obtain patents that could effectively block our ability to further develop, commercialize, and sell our products and/or services. In the event of a successful claim of infringement against us, we may be required to pay substantial damages and either discontinue those aspects of our business involving the technology upon which we infringed or obtain one or more licenses from third parties. While we may license additional technology in the future, we may not be able to obtain these licenses at a reasonable cost, or at all. In that event, we could encounter delays in product introductions while we attempt to develop alternative methods or products, and such attempts may not be successful. Defense of any lawsuit or failure to obtain any of these licenses could prevent us from commercializing available products and/or services.

We could face substantial liabilities if we are sued for product liability.

        Product liability claims could be filed by someone alleging that our product failed to perform as claimed. We may also be subject to liability for errors in the performance of our tests. Such product liability and related claims could be substantial. Though we believe we carry sufficient liability insurance, defense of such claims could be time consuming and expensive and could result in damages that are not covered by our insurance.

Failure to effectively manage our growth could place strains on our managerial, operational and financial resources and could adversely affect our business and operating results.

        Our growth has placed, and is expected to continue to place, a strain on our managerial, operational and financial resources. Further, as our subsidiary companies' businesses grow, we will be required to manage multiple relationships. Any further growth by us or our subsidiary companies or an increase in the number of our strategic relationships will increase this strain on our managerial, operational and financial resources. This strain may inhibit our ability to achieve the rapid execution necessary to successfully implement our business plan.

Our future success depends on our ability to expand our organization to match the growth of our subsidiaries.

        As our subsidiaries grow, the administrative demands upon our management will grow, and our success will depend upon our ability to meet those demands. These demands include increased accounting, management, legal services, staff support for our board of directors, and general office services. We may need to hire additional qualified personnel to meet these demands, the cost and quality of which is dependent in part upon market factors outside of our control. Further, we will need to effectively manage the training and growth of our staff to maintain an efficient and effective workforce, and our failure to do so could adversely affect our business and operating results.

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As a public company, we are subject to complex legal and accounting requirements that will require us to incur substantial expense and will expose us to risk of non-compliance.

        As a public company, we are subject to numerous legal and accounting requirements that do not apply to private companies. The cost of compliance with many of these requirements is substantial, not only in absolute terms but, more importantly, in relation to the overall scope of the operations of a small company. Our relative inexperience with these requirements may increase the cost of compliance and may also increase the risk that we will fail to comply. Failure to comply with these requirements can have numerous adverse consequences including, but not limited to, our inability to file required periodic reports on a timely basis, loss of market confidence, delisting of our securities and/or governmental or private actions against us. We cannot assure you that we will be able to comply with all of these requirements or that the cost of such compliance will not prove to be a substantial competitive disadvantage vis-à-vis our privately held and larger public competitors.

Ethical, legal and social concerns surrounding the use of genetic information could reduce demand for our products.

        Genetic testing has raised ethical issues regarding privacy and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, such concerns may lead individuals to refuse to use genetics tests even if permissible. Any of these scenarios could reduce the potential markets for our molecular diagnostic products, of which reduction could have a material adverse effect on our business.

Risks Related To Investment In Our Securities

Technology company stock prices are especially volatile, and this volatility may depress the price of our stock.

        The stock market has experienced significant price and volume fluctuations, and the market prices of technology companies, particularly biotechnology companies, has been highly volatile. In addition, our stock has historically experienced greater price fluctuations than the biotechnology index of other Nasdaq listed stock. We believe that various factors may cause the market price of our stock to fluctuate, perhaps substantially, including, among others, announcements of:

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our or our competitors' technological innovations;



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developments or disputes concerning patents or proprietary rights;



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supply, manufacturing, or distribution disruptions or other similar problems;



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proposed laws regulating participants in the biotechnology industry;



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developments in relationships with collaborative partners or customers;



•

our failure to meet or exceed securities analysts' expectations of our financial results; or



•

a change in financial estimates or securities analysts' recommendations.

        In the past, companies that have experienced volatility in the market price of their stock have been the objects of securities class action litigation. If our stock was the object of securities class action litigation, it could result in substantial costs and a diversion of management's attention and resources, all of which could materially harm the business and financial results of our business.

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While warrants to purchase our common stock are outstanding, it may be more difficult to raise additional equity capital.

        As of December 31, 2009, there were outstanding warrants to purchase approximately 3.9 million shares of our common stock. We may find it more difficult to raise additional equity capital while some or all of these warrants are outstanding. At any time during which these warrants are likely to be exercised, we may not be able to obtain financing on favorable terms, or at all. If we are unable to obtain financing, our business, results of operations, or financial condition could be materially and adversely affected, and we could be forced to curtail or cease operations.

Future sales or the potential for future sales of our securities may cause the trading price of our common stock to decline and could impair our ability to raise capital through subsequent equity offerings.

        Sales of a substantial number of shares of our common stock or other securities in the public markets, or the perception that these sales may occur, could cause the market price of our common stock or other securities to decline and could materially impair our ability to raise capital through the sale of additional securities.

We may fail to meet market expectations because of fluctuations in our quarterly operating results, all of which could cause our stock price to decline.

        Our revenues and operating results have fluctuated in the past and may continue to fluctuate significantly from quarter to quarter in the future. It is possible that, in future periods, our revenues could fall below the expectations of securities analysts or investors, all of which could cause the market price of our stock to decline. The following are among the factors that could cause our operating results to fluctuate significantly from period to period:

•

our unpredictable revenue sources, as described below;



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the nature, pricing and timing of our and our competitors' products;



•

changes in our and our competitors' research and development budgets;



•

expenses related to, and our ability to comply with, governmental regulations of our products and processes; and



•

expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights.

        We anticipate significant fixed expenses due in part to our need to continue to invest in product development. We may be unable to adjust our expenditures if revenues in a particular period fail to meet our expectations, all of which would harm our operating results for that period. As a result of these fluctuations, we believe that period-to-period comparisons of our financial results will not necessarily be meaningful, and you should not rely on these comparisons as an indication of our future performance.

Risks Related To Our Split-Off From Acacia Research Corporation

Our separation agreements with Acacia require us to assume the past, present and future liabilities related to our business and may be less favorable to us than if they had been negotiated with unaffiliated third parties.

        We have negotiated and entered into our separation agreements with Acacia at a time when we were a wholly owned subsidiary of Acacia and they were our only shareholder. Had these agreements been negotiated with unaffiliated third parties, they might have been more favorable to us. Pursuant to the terms of these agreements, we have agreed to indemnify Acacia for, among other matters, all past, present and future liabilities related to our business, and we have assumed these liabilities under the separation

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agreements. The past, present and future liabilities assumed by us are the same as those previously allocated to us prior to the Split-Off and reflected in our consolidated financial statements included in this report and disclosed by us in previous filings with the SEC as well as by Acacia. Nonetheless, the allocation of assets and liabilities between Acacia and us may not reflect the allocation that would have been reached between two unaffiliated parties.

Item 1B.    UNRESOLVED STAFF COMMENTS

        None.

Item 2.    PROPERTIES

        We currently lease office and laboratory space of approximately 31,000 square feet in Mukilteo, Washington, under a lease agreement that expires in October 2010. We also lease approximately 12,300 square feet in Irvine, California under a lease agreement that expires in January 2013. Management is currently reviewing a number of leasing options for its Mukilteo facilities.

Item 3.    LEGAL PROCEEDINGS

        In April 2005, Acacia and CombiMatrix filed a complaint against our insurance carrier, National Union Fire Ins. Co. of Pittsburgh, PA ("National Union") (collectively, the "Parties"), seeking reimbursement of litigation and settlement costs for a prior lawsuit, pursuant to our directors and officers insurance policy with National Union. A trial was held and concluded during the fourth quarter of 2007. In March 2008, the U.S. District Court for the Central District of California (the "District Court") issued its judgment in favor of Acacia and us, and awarded approximately $32.1 million in monetary damages to be paid by National Union (the "Judgment"). In accordance with the distribution agreement entered into between Acacia and us prior to the Split-Off, all proceeds from the lawsuit were to be paid to us. In May 2008, the District Court awarded us an additional $3.6 million in attorneys' fees and litigation costs, thereby increasing the overall award to $35.7 million. This award was entered as a final Judgment in May 2008 and would continue to earn interest until paid. National Union appealed the Judgment to the U.S. Ninth Circuit Court of Appeals, which we vigorously opposed. On January 27, 2010, the Parties entered into a settlement agreement whereby National Union agreed to pay $25.0 million to us in order to settle the dispute. These proceeds were paid on February 3, 2010 and a dismissal of the action was entered by the District Court on February 11, 2010.

Item 4.    RESERVED

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PART II

Item 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Recent Market Prices

        Our common stock is traded on the NASDAQ Global Market under the symbol of "CBMX." The following table sets forth, for the periods indicated, the high and low quarterly sales prices of our common stock as quoted on the NASDAQ stock market.

        As of March 15, 2010, there were 45 holders of record of our common stock, one of which is Cede & Co., a nominee for the Depository Trust Company ("DTC"). All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC and therefore are considered to be held of record by Cede & Co. as one shareholder.

        No dividends have been paid on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Equity Compensation Plan Information

        The following table provides information with respect to our common shares issuable under our equity compensation plans as of December 31, 2009:

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Recent Sales of Unregistered Securities

        For the three months ended December 31, 2009, we issued 32,573 shares of our common stock to YA Global Investments, L.P. ("YA"), in consideration of quarterly interest charges accrued during the third quarter of 2009 under the terms of a secured convertible debenture that we issued to YA in July 2008. The issuance of common stock to YA was made pursuant to an exemption under Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.

Item 6.    SELECTED FINANCIAL DATA

        Not required for smaller reporting companies.

Item 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion should be read in conjunction with our consolidated financial statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth under the heading "Risk Factors" elsewhere herein.

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. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs.

        Combimatrix Molecular Diagnostics, Inc. ("CMDX"), our wholly owned subsidiary located in Irvine, California, operates as a diagnostics reference laboratory that provides genetic diagnostics services to physicians, hospitals and clinics. CMDX provides its services through the use of arrays that utilize bacterial artificial chromosomes ("BACs") that enable genetic analysis. This type of technology is generally known as aCGH (or, array-Comparative Genomic Hybridization), and enables the analysis of gross genetic anomalies. CMDX also sells BAC array slides to labs outside the U.S. CMDX also utilizes other non-proprietary technologies and products to augment its laboratory services in aCGH as well as ancillary services.

        Leuchemix Inc. ("Leuchemix"), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases. Leuchemix's first compound has entered initial clinical trials in the United Kingdom.

Prior 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. In December 2002, we merged with and became a wholly owned subsidiary of Acacia Research Corporation ("Acacia"). In December 2006, we filed a registration statement with the U.S. Securities and Exchange Commission ("SEC") in order to register our common

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stock under the Securities Act of 1933 as part of a plan to split-off from Acacia (the "Split-Off"). On August 15, 2007 (the "Split-Off Date"), the Split-Off was effected and our common stock became publicly traded on the Nasdaq Global Market (symbol: CBMX). As of the Split-Off Date, we ceased to be a subsidiary of, or affiliated with, Acacia.

Liquidity

        At December 31, 2009, we had cash and cash equivalents of $5.4 million and in February 2010, we received $19.4 million in proceeds from our settlement with National Union Fire Ins. Co. of Pittsburgh, PA ("National Union"), net of attorneys' fees and costs. As a result, we anticipate that our cash and cash equivalent balances, anticipated cash flows from operations and other sources of funding from the capital markets will be sufficient to meet our cash requirements through approximately June 2011. In order for us to continue as a going concern beyond this point and ultimately to achieve profitability, we may be required to obtain capital from external sources, increase revenues and reduce operating costs. However, there can be no assurance that our operations will become profitable or that external sources of capital will be available at times and at terms acceptable to us. The issuance of additional equity securities may also 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, of which reduction could jeopardize the future strategic initiatives and business plans of our company. See the Liquidity and Capital Resources section below as well as Note 1 to the consolidated financial statements included elsewhere in this report for additional discussion of these matters.

Overview Of Recent Business Activities

        During 2009, our business activities were driven by activities in several strategic areas. First, we executed two new development contracts with the DoD and with NASA totaling $1.7 million to be recognized through 2010. Additional program funding of up to $644,000 is possible through 2013 should NASA choose to continue development. Late in 2009, we launched our next-generation ElectraSense® microarray reader that electrochemically measures up to 12,000 probes on an array in less than 25 seconds. Our diagnostics subsidiary, CMDX, launched new updates and improvements to several of its existing tests including its HemeScan™, ATScan™ and BAC HD Scan™ tests. During 2009, we continued the development of our cancer screen diagnostic test, which we expect to launch as a commercial test in late 2010 subject to U.S. FDA regulatory analysis. We strengthened our executive leadership team by adding Dr. Scott Gottlieb, the former Deputy Commissioner of the U.S. FDA, to our board of directors. In May 2009, we closed a registered direct offering of our common stock and warrants for net proceeds of $7.6 million. Finally, in September 2009, we hired Robert W. Baird & Co. to serve as a financial and strategic advisor to aid CombiMatrix in developing and reviewing certain strategies aimed at unlocking shareholder value and creating synergistic relationships for our company, and in early 2010, we added Inverness Advisors, LLC to augment the efforts of Robert W. Baird & Co. Historically, we have relied primarily upon investing and financing activities to fund operating activities. Our net proceeds from investing and financing activities in 2009 were consistent with prior years and at December 31, 2009, our cash and cash equivalent balances, including anticipated cash flows from future operations, proceeds from our settlement with National Union and other existing sources of credit are expected to be sufficient to meet our operating capital requirements through approximately June 2011. We may be required to seek additional sources of capital including the issuance of debt and/or equity securities.

        During 2008, our business activities were also driven by activities in several strategic areas. First, we executed two new development contracts with the DoD totaling $1.2 million to be recognized through 2009. Additional appropriations for CombiMatrix of up to $2.0 million were included in the 2009 U.S. Defense Appropriations Bill for the U.S. military, and contracts related to these appropriations are expected to be executed during 2009. Our diagnostics subsidiary, CMDX, launched several new diagnostic services using its Constitutional Genetic Array Test, or CGAT, during the year, including the HerScan™

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and ProScan™ tests for assessment of newly diagnosed breast cancer and prostate cancer, respectively, as well as launching updates and improvements to several of its existing tests including its HemeScan™, ATScan™ and BAC HD Scan™ tests. In October 2008, we announced the development of our cancer screen diagnostic test, which we expect to develop over the next eighteen to twenty-four months. In March 2008, the United States District Court for the Central District of California (the "District Court") issued a judgment in favor of CombiMatrix in the amount of $32.1 million (the "Judgment") to be paid by National Union, and later increased the award to $39.2 million for attorneys' fees, litigation costs and accrued interest. The Judgment was related to a lawsuit that we brought against National Union, our directors' and officers' insurance carrier, for failing to cover CombiMatrix for litigation and settlement costs incurred by us in defending a prior lawsuit that was settled in 2002. National Union appealed the Judgment, and we vigorously opposed its appeal until final settlement was reached in January 2010 (discussed above). Finally, in July 2008, we received $10 million in gross proceeds from selling a secured convertible debenture and warrants to a single institutional investor.

Critical Accounting Policies

        Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing these financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our financial statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis we evaluate our assumptions, judgments and estimates and make changes accordingly.

        We believe that, of the significant accounting policies discussed in Note 2 to our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:

•

revenue recognition;



•

accounting for stock-based compensation;



•

fair value measurements;



•

accounting for derivatives embedded in certain debt securities;



•

accounting for income taxes; and



•

valuation of long-lived and intangible assets and goodwill.

        We discuss below the critical accounting assumptions, judgments and estimates associated with these policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, refer to Note 2 to the consolidated financial statements included elsewhere herein.

Revenue Recognition

        As described below, significant management judgments must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized or deferred for any period if management made different judgments.

        In general, we recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been performed, (iii) amounts are fixed or determinable and (iv) collectibility of amounts is reasonably assured.

        Revenue from the sale of products, including shipping and handling fees but excluding statutory taxes collected from customers, as applicable, are recognized when delivery has occurred. We sell our products directly to customers and also through distributors, and our right to collection is not dependent upon

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installation or a subsequent sale of our products to end-users. Our standard agreements do not provide for credits, returns or exchanges with our customers or distributors. Our distribution agreements include fixed pricing arrangements for our products and after customer acceptance, there is no written or implied right to return or exchange the products.

        Service revenues from providing diagnostic tests are recognized when the testing process is complete and test results are reported to the ordering physician or clinic. These diagnostic services are billed to various payors, including commercial insurance companies, healthcare institutions, individuals and government payors including Medicare and Medicaid. We report revenues from contracted payors based on a contractual rate, or in the case of Medicare and Medicaid, published fee schedules for our tests. We report revenues from non-contracted payors based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected from non-contracted payors is recorded as a contractual allowance to arrive at net recognized revenues. The expected revenues from non-contracted payors are based on the historical collection experience of each payor or payor group, as appropriate. In each reporting period, we review our historical collection experience for non-contracted payors and adjust our expected revenues for current and subsequent periods accordingly. Because a substantial portion of our revenues is from non-contracted third party payors, it is likely that we will be required to make positive or negative adjustments to accounting estimates with respect to contractual allowances in the future, which may positively or adversely affect our results of operations. For all periods presented, such adjustments have not been significant.

        Revenues from government contracts are recognized using the partial performance method of accounting, whereby performance to date is established based on costs incurred to the total amount of estimated costs at each reporting period. Under the partial performance method of accounting, contract revenues and costs are recognized in the period that work is performed based on the percentage of actual incurred costs to total contract costs. The partial performance method is used to recognize revenue because management considers actual costs incurred to be the best available measure of progress towards the completion of government contracts, the total profit can be reasonably computed, and collection is reasonably assured. Actual contract costs include direct charges for labor and materials and indirect charges for labor, overhead and certain general and administrative charges. Contract change orders and claims are included when they can be reliably estimated and are considered probable. For contracts that extend over a one-year period, revisions in contract cost estimates, if they occur, have the effect of adjusting current period earnings applicable to performance in prior periods. Should current contract estimates indicate an overall future loss to be incurred, a provision is made for the total anticipated loss in the current period. Historically, contract revenue recognized approximates the amounts invoiced, resulting in no estimated costs and earnings in excess of billings or billings in excess of estimated costs and earnings.

        Revenues from multiple-element arrangements involving license fees, up-front payments, milestone payments, products and/or services, which are received and/or are billable by us in connection with other rights and services that represent continuing obligations of ours, are deferred until all of the elements have been delivered or until we have established objective and verifiable evidence of the fair value of the undelivered elements.

        Deferred revenues arise from payments received in advance of the culmination of the earnings process. Deferred revenues expected to be recognized within the next twelve months are classified within current liabilities. Deferred revenues will be recognized as revenue in future periods when the applicable revenue recognition criteria as described above are met.

Accounting for Stock-Based Compensation

        Compensation expense for all stock-based awards is measured at the grant date based on the fair value of the award and is recognized as an expense, on a straight-line basis, over the employee's requisite service period (generally the vesting period of the equity award), which is generally three years for awards

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to our employees. The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. Stock-based compensation expense is recognized only for those awards that are expected to vest using an estimated forfeiture rate. We estimate pre-vesting option forfeitures at the time of grant and reflect the impact of estimated pre-vesting option forfeitures in compensation expense recognized. We considered several factors in connection with our estimates of pre-vesting forfeitures including types of awards, employee class and historical pre-vesting forfeiture data. Estimates of pre-vesting forfeiture are periodically revised in subsequent periods if actual forfeitures differ from those estimates. To the extent that actual results differ from our estimates, such amounts will be recorded as cumulative adjustments in the period the estimates are revised.

Fair Value Measurements

        We measure fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. We utilize a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Derivatives Embedded in Certain Debt Securities

        We evaluate financial instruments for freestanding or embedded derivatives. Derivative instruments that have been separated from the host contract and do not qualify for hedge accounting are recorded at fair value with changes in value recognized in as other income (expense) in the consolidated statements of operations in the period of change.

Accounting for Income Taxes

        We recognize income taxes on an accrual basis based on tax position taken or expected to be taken in our tax returns. A tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions are recognized only when it is more likely than not (i.e., likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. A valuation allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more than likely not be realized. Should they occur, our policy is to classify interest and penalties related to tax positions as income tax expense. Since our inception, no such interest or penalties have been incurred, however.

Valuation of Long-Lived and Intangible Assets and Goodwill

        Long-lived assets and intangible assets are reviewed for potential impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In the event the sum of the expected undiscounted future cash flows resulting from the use of the asset is less than the carrying

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amount of the asset, an impairment loss equal to the excess of the asset's carrying value over its fair value is recorded. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows.

        Goodwill is evaluated annually for impairment at the reporting unit level, or earlier if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit can be an operating segment or a business if discrete financial information is prepared and reviewed by management. Under the impairment test, if a reporting unit's carrying amount exceeds its estimated fair value, goodwill impairment is recognized to the extent that the reporting unit's carrying amount of goodwill exceeds the implied fair value of the goodwill. We only have one reporting unit. The fair value of the CombiMatrix Corporation reporting unit for 2009 and 2008 was determined using quoted market prices for CombiMatrix Corporation common stock. There can be no assurance that future goodwill impairment tests will not result in impaired charges.

Results of Operations

Revenues and Cost of Revenues (In thousands)

        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 using the partial performance 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 and NASA. Changes in the number of contracts underway coupled with changes in the underlying contract activity contributes to the overall increase or decrease in government contracts revenue from year to year. The changes in contract activity also contribute to the change in government contract costs for the years presented. See Note 12 to our consolidated 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 years presented. As existing 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, as well as the sale of CGH arrays sold by our wholly owned subsidiary, CMDX. Product revenues decreased for the year ended December 31, 2009 compared to 2008 due primarily to lower DNA synthesizer instrument and microarray reader sales. As we expand our business focus from exclusively

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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. Product sales from CMDX were $238,000 and $127,000 for the years ended December 31, 2009 and 2008, respectively. Cost of products includes materials, labor and allocations for manufacturing overhead, as well as non-cash stock compensation expense charges, which were $18,000 and $11,000 for the years ended December 31, 2009 and 2008, respectively. The overall decrease in product cost of sales was commensurate with the decrease in overall product revenues.

        Services and Cost of 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 revenues from CMDX were $2.3 million and $1.6 million for the years ended December 31, 2009 and 2008, respectively. These revenues have increased due to an increased number of diagnostic test offerings as well as increased customer demand for our suite of diagnostic services provided by CMDX, which is due primarily to increased sales and marketing efforts at CMDX during 2009 and 2008. Cost of services includes materials, labor and allocations for manufacturing overhead, as well as non-cash stock compensation expense charges, which were $59,000 and $24,000 for the years ended December 31, 2009 and 2008, respectively. The increase in cost of services was commensurate with the increase in overall services revenues.

Operating Expenses (In thousands)

        Research and Development Expenses.    The increase in internal research and development expenses was due primarily to the ongoing development efforts underway relating to our comprehensive cancer array test. In addition, research and development expenses include $621,000 and $413,000 for the years ended December 31, 2009 and 2008, respectively, of non-cash stock compensation expense.

        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 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 was due primarily to increases in sales and marketing expenses at CMDX, as well as increased investor and public relations expenses. In addition, marketing, general and administrative expenses include non-cash stock compensation charges, which were $2.6 million and $2.0 million for the years ended December 31, 2009 and 2008, respectively. These increases were due primarily to increases in the overall number of stock option awards granted to our employees during the past twelve months.

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        Equity in Loss of Investee.    For all periods presented, this expense represents our recognition under the equity method of accounting of our minority interests in the operations of Leuchemix, in which we own a one-third minority interest. During 2009, our equity investment in Leuchemix reached $0 and as a result, we ceased recognizing additional expense from their underlying operations. This has caused a decrease in this expense for the year ended December 31, 2009 versus 2008.

Other Non-Operating Items (in thousands)

        Interest Income.    Interest income decreased due to lower average cash and investment balances coupled with lower market interest rates during 2009 compared to 2008.

        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% of the outstanding principal amount of the Debenture. Interest expense also includes amortization of the original $2.9 million of debt discount recognized from issuance of the Debenture and warrants in July 2008 using the effective interest method. Interest expense increased during 2009 compared to 2008 due to a full year's worth of interest and amortization charges incurred during 2009 versus only a partial year in 2008.

        Derivative (Charges) Gains.    These amounts represent the net charges or gains recognized during the periods presented from mark-to-model adjustments to the embedded derivatives associated with the Debenture that were outstanding as of December 31, 2009 and 2008. 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 gains, 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 in the current or prior periods.

Liquidity and Capital Resources

        At December 31, 2009, cash and cash equivalents totaled $5.4 million, compared to $9.1 million at December 31, 2008. Working capital was $(3.0 million) at December 31, 2009, compared to $7.6 million at December 31, 2008. Working capital decreased as of December 31, 2009 primarily due to the classification of the remaining $8.4 million Debenture due July 10, 2010 as a short-term liability as well as the overall decreases in cash, cash equivalents and available-for-sale investment balances compared to December 31, 2008. Cash balances decreased during 2009 due primarily to the operating and financing transactions discussed below that were executed in 2009 versus 2008.

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        The change in cash and cash equivalents for the years ended December 31, 2009 and 2008 was comprised of the following (in thousands):

        Operating Activities.    The overall decrease in net cash used in operations was due primarily to a decrease in cash receipts from customers, which totaled $4.7 million in 2009 compared to $5.6 million in 2008. The primary reason for the decrease in cash receipts from customers was due to decreased cash receipts from fewer active DoD contracts in 2009 compared to 2008. This decrease was partially offset by a decrease in cash outflows to vendors, which was $15.5 million in 2009 compared to $16.1 million in 2008. This decrease was caused primarily by lower litigation costs in 2009 compared to 2008 as well as timing of vendor payments.

        Investing Activities.    The decrease in net cash flows from investing activities was due primarily to our ongoing short-term cash management activities and changes in short-term investments in connection with certain financing activities discussed below. Fixed asset purchases were $104,000 and $62,000 in 2009 and 2008, respectively.

        Financing Activities.    The decrease in cash flows from financing activities was driven by certain financing transactions that were executed during the years ended December 31, 2009 and 2008 as follows:

•

During 2009, our financing activities were driven primarily by the completion 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 were not exercisable until six months after the Offering and have a term of five years. Net proceeds from the Offering, less placement agent fees and expenses, were approximately $7.6 million. Also impacting our net cash flows from financing activities was the repayment of credit line borrowings during the first quarter of 2009 totaling $820,000. Finally, proceeds from the exercise of common stock options were $224,000 during 2009.



•

During 2008, our financing activities were driven primarily by the issuance to YA Global Investments, L.P. ("YA") of: (i) the Debenture with an aggregate principal amount of $10 million, which was originally convertible into shares of our common stock at a fixed conversion price of $11.87 per share (and subsequently adjusted to $7.50 per share due to execution of the Offering in 2009); and (ii) warrants to purchase up to 336,984 shares of our common stock. The Debenture was due on the earlier of July 10, 2010 or within four months after receipt of payment of the settlement proceeds from National Union in accordance with the Judgment. The Debenture bore interest at an annual rate of 10%, with interest payments due quarterly in either cash or our common stock. We repaid the Debenture in full in 2010. Also impacting our net cash flows from financing activities was a draw on our credit line totaling $808,000 during the second quarter of 2008. Finally, proceeds from the exercise of common stock options were $808,000 during 2008.

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        Future Liquidity.    We have a history of incurring net losses and net operating cash flow deficits. We are also deploying new and unproven technologies and continue to develop commercial products. We have several ongoing long-term development projects that involve experimental technology and may require several years and substantial expenditures to complete. We believe that our cash and cash equivalent balances, proceeds from our settlement with National Union (received February 2010), anticipated cash flows from operations and other external sources of available credit will be sufficient to meet our cash requirements through approximately June 2011.

        In order for us to continue as a going concern beyond June 2011, we may be required to obtain capital from external sources. However, there can be no assurances that additional sources of financing, including the issuance of debt and/or equity securities will be available at times and at terms acceptable to us. The issuance of equity securities will also cause dilution to our shareholders. If external financing sources of financing 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 the future strategic initiatives and business plans of the Company. 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, reduction in operating costs at CMDX, should they occur, could jeopardize its ability to launch, market and sell additional diagnostics products and services necessary to grow and sustain its operations to 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;



•

our ability to license technology;



•

competing technological developments;



•

the creation and formation of strategic partnerships;



•

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



•

other factors that may not be within our control.

Off-Balance Sheet Arrangements

        We have not entered into off-balance sheet financing arrangements, other than operating leases for our premises. We have no significant commitments for capital expenditures in 2010 or beyond. We have

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executed three capital leases totaling $244,000 for certain laboratory equipment. The following table lists our material known future cash commitments as of December 31, 2009:

Recent Accounting Pronouncements

        Refer to Note 2 to the consolidated financial statements included elsewhere herein.

Quantitative and Qualitative Disclosures About Market Risk

        Our exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of United States interest rates, particularly because the majority of our investments are in short-term debt securities issued by the U.S. Treasury. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive without significantly increasing risk. To minimize risk, we maintain our portfolio of cash, cash equivalents and available-for-sale investments in a variety of investment-grade securities and with a variety of issuers, including government securities and money market funds.

Item 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Not required for smaller reporting companies.

Item 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The financial statements and related financial information required to be filed hereunder are indexed under Item 15 of this report and are incorporated herein by reference.

Item 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

Item 9A(T).    CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

        Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and

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procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that, as of the end of the period covered by this annual report, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized and reported within the time periods prescribed by the SEC.

Management's Report on Internal Controls Over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal controls over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal controls over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal controls over financial reporting were effective as of December 31, 2009.

        This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management's report in this annual report.

        There has been no change in our internal controls over financial reporting that occurred during the fiscal quarter ended December 31, 2009 that has materially affected, or is reasonably expected to materially affect, our internal controls over financial reporting.

Item 9B.    OTHER INFORMATION

        On March 16, 2010, the Board of Directors approved and adopted a Second Amended and Restated Bylaws, which, among other things, amended Sections 2.5(b) and 3.1 of the Company's bylaws. The text of the relevant provisions now read in their entirety as follows:

        Section 2.5(b):    Assuming that a quorum has been established, and unless otherwise provided by law or the Certificate of Incorporation: (1) action on a matter other than the election of directors will be approved if the number of votes cast in favor of the matter exceeds the number of votes cast against the matter; and (2) in connection with the election of directors, directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors. Where a separate vote by a class or series or classes or series is required, a majority of the outstanding shares of such class or series or classes or series, present in person or represented by proxy, shall constitute a quorum entitled to take action with respect to that vote on that matter and, in all matters other than the election of directors, the affirmative vote of the majority of shares of such class or series or classes or series present in person or represented by proxy at the meeting shall be the act of such class or series or classes or series.

        Section 3.1:    The number of directors of the corporation shall not be less than five (5) nor more than nine (9) until changed by amendment of the Certificate of Incorporation or by a Bylaw amending this Section 3.1 duly adopted in accordance with ARTICLE 11 hereof. The exact number of directors shall be fixed from time to time, within the limits specified in the Certificate of Incorporation or in this Section 3.1, by the Board of Directors or by a bylaw or amendment thereof duly adopted in accordance with ARTICLE 11 hereof. Subject to the foregoing provisions for changing the number of directors, the number of directors of the corporation has been fixed at seven (7).

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PART III

Item 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

        Except as provided below, the information required by this Item is incorporated by reference from the information under the captions entitled "Board of Directors," "Executive Officers and Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our definitive proxy statement to be filed with the SEC no later than 120 days after our most recent fiscal year end, which is December 31, 2009.

Code of Business Conduct and Ethics

        We have adopted a code of business conduct and ethics for directors, officers (including our Chief Executive Officer and Chief Financial Officer) and employees, known as the CombiMatrix Corporation Code of Business Conduct and Ethics (the "Code of Ethics"). The Code of Ethics is available on our website at http://www.combimatrix.com in the corporate governance section under the "Investors" link. Shareholders may request a free copy of the Code of Ethics by sending an email request to investors@combimatrix.com.

Item 11.    EXECUTIVE COMPENSATION

        The information required by this Item is incorporated by reference from the information under the caption entitled "Executive Compensation and Other Information" in our definitive proxy statement to be filed with the SEC no later than 120 days after our most recent fiscal year end, which is December 31, 2009.

Item 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        The information required by this Item is incorporated by reference from the information under the caption entitled "Security Ownership of Certain Beneficial Owners and Management" in our definitive proxy statement to be filed with the SEC no later than 120 days after our most recent fiscal year end, which is December 31, 2009.

Item 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

        The information required by this Item is incorporated by reference from the information under the caption entitled "Certain Transactions" in our definitive proxy statement to be filed with the SEC no later than 120 days after our most recent fiscal year end, which is December 31, 2009.

Item 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

        The information required by this Item is incorporated by reference from the information under the caption entitled "Principal Accountants" in our definitive proxy statement to be filed with the SEC no later than 120 days after our most recent fiscal year end, which is December 31, 2009.

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PART IV

Item 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)

(1) Financial Statements—See "Index to Consolidated Financial Statements" appearing on page F-1.

(2)

Financial Statement Schedules

Schedules have been omitted, as they are not required for smaller reporting companies, not applicable or the information is otherwise included.

(3)

Exhibits—Refer to Item 15(b) below.

(b)

Exhibits. The following exhibits are either filed herewith or incorporated herein by reference:

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

        Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and the capacities and on the dates indicated.

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COMBIMATRIX CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
CombiMatrix Corporation
Mukilteo, Washington

        We have audited the accompanying consolidated balance sheets of CombiMatrix Corporation and subsidiaries ("the Company") as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders' equity and comprehensive loss, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CombiMatrix Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.

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COMBIMATRIX CORPORATION

CONSOLIDATED BALANCE SHEETS

As of December 31, 2009 and 2008

(In thousands, except share and per share information)

The accompanying notes are an integral part of these consolidated financial statements.

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COMBIMATRIX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31, 2009 and 2008

(In thousands, except share and per share information)

The accompanying notes are an integral part of these consolidated financial statements.

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COMBIMATRIX CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE LOSS

For the Years Ended December 31, 2009 and 2008

(In thousands, except share information)

The accompanying notes are an integral part of these consolidated financial statements.

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COMBIMATRIX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2009 and 2008

(In thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     DESCRIPTION OF BUSINESS

        CombiMatrix Corporation (the "Company" "we" "us" and "our") was originally incorporated in October 1995 as a California corporation and later reincorporated as a Delaware corporation in September 2000. In December 2002, we merged with and became a wholly owned subsidiary of Acacia Research Corporation ("Acacia"). In December 2006, we filed a registration statement with the U.S. Securities and Exchange Commission ("SEC") in order to register our common stock under the Securities Act of 1933 as part of a plan to split-off from Acacia (the "Split-Off"). On August 15, 2007 (the "Split-Off Date"), the Split-Off was effected and our common stock became publicly traded on the Nasdaq Global Market (symbol: "CBMX"). As of the Split-Off Date, we ceased to be a subsidiary of, or affiliated with, Acacia.

Description of the Company

        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. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs.

        Combimatrix Molecular Diagnostics, Inc. ("CMDX"), our wholly owned subsidiary located in Irvine, California, operates as a diagnostics reference laboratory that provides genetic diagnostics services to physicians, hospitals and clinics. CMDX provides its services through the use of arrays that utilize bacterial artificial chromosomes ("BACs") that enable genetic analysis. This type of technology is generally known as aCGH (or, array-Comparative Genomic Hybridization), and enables the analysis of gross genetic anomalies. CMDX also sells BAC array slides to labs outside the U.S. CMDX also utilizes other non-proprietary technologies and products to augment its laboratory services in aCGH as well as ancillary services.

        Leuchemix Inc. ("Leuchemix"), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases. Leuchemix's first compound has entered initial clinical trials in the United Kingdom.

Liquidity and Risks

        We have a history of incurring net losses and net operating cash flow deficits. We are also deploying new and unproven technologies and continue to develop commercial products. We have several ongoing long-term development projects that involve experimental technology and may require several years and substantial expenditures to complete.

        At December 31, 2009, we had cash and cash equivalents of $5.4 million and in February 2010, we received $19.4 million in proceeds from our settlement with National Union Fire Ins. Co. of Pittsburgh, PA ("National Union"), net of attorneys' costs. As a result, we anticipate that our cash and cash equivalent balances, anticipated cash flows from operations and other sources of funding from the capital markets will be sufficient to meet our cash requirements through approximately June 2011 (see Notes 12 and 17). In order for us to continue as a going concern beyond this point we may be required to obtain capital from external sources. However, there can be no assurances that additional sources of financing, including the issuance of debt and/or equity securities will be available at times and at terms acceptable to us.

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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

•

market acceptance of products and services;



•

technological advances that may make our products and services obsolete or less competitive;



•

increases in operating costs, including costs for supplies, personnel and equipment;



•

the availability and cost of capital;



•

the financial crisis affecting the global banking system and financial markets; and



•

governmental regulation that may restrict our business.

        Our success also depends on our ability to protect our intellectual property, the loss thereof or our failure to secure the issuance of additional patents covering elements of our business processes could materially harm our business and financial condition. The patents covering our core technology begin to expire in 2018.

        Our products and services are concentrated in a highly competitive market that is characterized by rapid technological advances, frequent changes in customer requirements and evolving regulatory requirements and industry standards. Failure to anticipate or respond adequately to technological advances, changes in customer requirements, changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of planned products or services, could have a material adverse effect on our business and operating results. The accompanying consolidated financial statements have been prepared assuming that the Company continues as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed herein.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        References to Authoritative Accounting Literature.    In June 2009, the Financial Accounting Standards Board ("FASB") issued the Accounting Standards Codification ("ASC") as the single source of authoritative U.S. generally accepted accounting principles ("GAAP") recognized by the FASB to be applied by non-governmental entities in preparation of financial statements in conformity with U.S. GAAP, except for additional authoritative rules and interpretative releases issued by the SEC. While the adoption of the ASC changes how we reference accounting standards, the adoption did not have an impact on our consolidated financial statements.

        Accounting Principles and Fiscal Year End.    The consolidated financial statements and accompanying notes are prepared on the accrual basis of accounting in accordance with U.S. GAAP. We have a December 31 year-end.

        Use of Estimates.    The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

        Basis of Presentation and Principles of Consolidation.    The accompanying consolidated financial statements include the accounts of the Company and our wholly owned and majority-owned subsidiaries. Investments for which we possess the power to direct or cause the direction of the management and

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

policies, either through majority ownership or other means, are accounted for under the consolidation method. Material intercompany transactions and balances have been eliminated in consolidation. Investments in companies in which we maintain an ownership interest of 20% to 50% or exercise significant influence over operating and financial policies are accounted for under the equity method. The cost method is used where we maintain ownership interests of less than 20% and do not exercise significant influence over the investee. In addition, U.S. GAAP generally stipulates that an entity is a variable interest entity, or VIE, if it does not have sufficient equity investment at risk, or if the holders of the entity's equity instruments lack the essential characteristics of a controlling financial interest. Further, these standards require that the holder subject to a majority of the risk of loss from a VIE's activities must consolidate the VIE. However, if no holder has a majority of the risk of loss, then a holder entitled to receive a majority of the entity's residual returns would consolidate the entity.

        Revenue Recognition.    We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been performed, (iii) amounts are fixed or determinable and (iv) collectibility of amounts is reasonably assured.

        Revenue from the sale of products, including shipping and handling fees but excluding statutory taxes collected from customers, as applicable, are recognized when delivery has occurred. We sell our products directly to customers and also through distributors, and our right to collection is not dependent upon installation or a subsequent sale of our products to end-users. Our standard agreements do not provide for credits, returns or exchanges with our customers or distributors. Our distribution agreements include fixed pricing arrangements for our products and after customer acceptance, there is no written or implied right to return or exchange the products.

        Service revenues from providing diagnostic tests are recognized when the testing process is complete and test results are reported to the ordering physician or clinic. These diagnostic services are billed to various payors, including commercial insurance companies, healthcare institutions, individuals and government payors including Medicare and Medicaid. We report revenues from contracted payors based on a contractual rate, or in the case of Medicare and Medicaid, published fee schedules for our tests. We report revenues from non-contracted payors based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected from non-contracted payors is recorded as a contractual allowance to arrive at net recognized revenues. The expected revenues from non-contracted payors are based on the historical collection experience of each payor or payor group, as appropriate. In each reporting period, we review our historical collection experience for non-contracted payors and adjust our expected revenues for current and subsequent periods accordingly. Because a substantial portion of our revenues is from non-contracted third party payors, it is likely that we will be required to make positive or negative adjustments to accounting estimates with respect to contractual allowances in the future, which may positively or adversely affect our results of operations. For all periods presented, such adjustments have not been significant.

        Revenues from government contracts are recognized using the partial performance method of accounting, whereby performance to date is established based on costs incurred to the total amount of estimated costs at each reporting period. Under the partial performance method of accounting, contract revenues and costs are recognized in the period that work is performed based on the percentage of actual incurred costs to total contract costs. The partial performance method is used to recognize revenue because management considers actual costs incurred to be the best available measure of progress towards the completion of government contracts, the total profit can be reasonably computed, and collection is reasonably assured. Actual contract costs include direct charges for labor and materials and indirect charges for labor, overhead and certain general and administrative charges. Contract change orders and

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claims are included when they can be reliably estimated and are considered probable. For contracts that extend over a one-year period, revisions in contract cost estimates, if they occur, have the effect of adjusting current period earnings applicable to performance in prior periods. Should current contract estimates indicate an overall future loss to be incurred, a provision is made for the total anticipated loss in the current period. Historically, contract revenue recognized approximates the amounts invoiced, resulting in no estimated costs and earnings in excess of billings or billings in excess of estimated costs and earnings.

        Revenues from multiple-element arrangements involving license fees, up-front payments, milestone payments, products and/or services, which are received and/or are billable by us in connection with other rights and services that represent continuing obligations of ours, are deferred until all of the elements have been delivered or until we have established objective and verifiable evidence of the fair value of the undelivered elements.

        Deferred revenues arise from payments received in advance of the culmination of the earnings process. Deferred revenues expected to be recognized within the next twelve months are classified within current liabilities. Deferred revenues will be recognized as revenue in future periods when the applicable revenue recognition criteria as described above are met.

        Cash and Cash Equivalents.    We consider all highly liquid, short-term investments with original maturities of three months or less when purchased to be cash equivalents.

        Available-For-Sale Investments.    Investments in marketable securities with original maturities of less than three months are included in cash and cash equivalents, and investments with original maturities of greater than three months and less than one year are classified as short-term. Investments in marketable securities are typically classified as available-for-sale, which are reported at fair value with related unrealized gains and losses in the value of such securities recorded as a component of accumulated other comprehensive income until realized. We monitor our investments for impairment, which are deemed to be other-than-temporary based on a variety of factors including: (a) the duration and severity of the impairment; (b) the ability and intent to hold an investment for a period of time sufficient for recovery of its carrying amount; and (c) the financial condition of the issuer. All available evidence, both positive and negative, is considered to determine whether the carrying amount of the investment is recoverable within a reasonable period of time. In general, management does not consider an investment impairment to be other-than-temporary if the duration and amount of the impairment is less than twelve months and five percent of the historical cost of the investment, respectively.

        Fair Value Measurements.    We measure fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. We utilize a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

        Concentration of Credit Risks.    Financial instruments that potentially subject the Company to concentrations of credit risk are cash equivalents and available-for-sale investments. We position our cash

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equivalents and available-for-sale investments primarily in investment grade, short-term debt instruments. Cash equivalents are invested in deposits with certain financial institutions and may, at times, exceed federally insured limits. We have not experienced any significant losses on our deposits of cash and cash equivalents. As of December 31, 2008, available-for-sale investments include certain auction rate securities ("ARS"), the market for which became illiquid in mid-February of 2008 but were subsequently redeemed at par value. See Note 3 below for further disclosures regarding our investments in ARS.

        Government contract revenues recognized by us relate to our ongoing contracts with the DoD regarding our electrochemical and microfluidics technologies. At December 31, 2009 and 2008, accounts receivable due from the DoD were $128,000 and $199,000, respectively. Other than amounts due from the DoD, one and one customers represented approximately 18% and 22% of our accounts receivable at December 31, 2009 and 2008, respectively.

        Substantially all of the components and raw materials used in the manufacture of our products, including semiconductors and reagents, are currently provided to us from a limited number of sources or in some cases from a single source. Although we believe that alternative sources for those components and raw materials are available, any supply interruption in a sole-sourced component or raw material might result in up to a several-month production delay and materially harm our ability to manufacture products until a new source of supply, if any, could be located and qualified. We utilize non-standard semiconductor manufacturing processes to fabricate an electrode array that is a key aspect of the array structure. Although we have a supply agreement in place with a semiconductor wafer manufacturer to ensure availability of the raw materials, the agreement does not guarantee a permanent supply.

        Accounts Receivable and Allowances for Doubtful Accounts.    Accounts receivable are stated at principal amounts and are primarily comprised of amounts contractually due from customers for products and services and amounts due from contracts with the DoD. For billings to customers of our products, we provide an allowance for doubtful accounts based on an evaluation of specific customer account balances past due approximately 30 days from the date of invoicing. In determining whether to record an allowance for a specific customer, we consider a number of factors, including prior payment history and financial information for the customer.

        For billings to customers of our diagnostic services, an allowance for doubtful accounts is recorded for estimated uncollectible amounts due from various payor groups such as commercial insurance companies, healthcare institutions, government payors and individuals. The process for estimating the allowance for doubtful accounts associated with our diagnostic services involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically and is principally based upon specific identification of past due or disputed accounts. We also review the age of receivables by payor class to assess our allowance at each period end. The payment realization cycle for certain governmental and commercial insurance payors can be lengthy, involving denial, appeal and adjudication processes, and is subject to periodic adjustments that may be significant. Accounts receivable are periodically written off when identified as uncollectible and deducted from the allowance for doubtful accounts after appropriate collection efforts have been exhausted. Additions to the allowance for doubtful accounts are charged to bad debt expense as a component of marketing, general and administrative expenses in the consolidated statements of operations. Collection of governmental, private health insurer, and client receivables are generally a function of providing complete and correct billing information to the insurers and clients within the filing deadlines required by each payor. Collection of receivables due from patients and clients is generally subject to increased credit risk due to credit worthiness or inability to pay.

        Inventory.    Inventory, which consists primarily of raw materials to be used in the production of our array products, is stated at the lower of cost or market using the first-in, first-out method.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        Property and Equipment.    Property and equipment is recorded at cost. Additions and improvements that increase the value or extend the life of an asset are capitalized. Maintenance and repairs are expensed as incurred. Disposals are removed at cost less accumulated depreciation or amortization and any gain or loss from disposition is reflected in the consolidated statement of operations in the period of disposition. Depreciation is computed on a straight-line basis over the following estimated useful lives of the assets:

        Certain leasehold improvements, furniture and equipment held under capital leases are classified as property and equipment and are amortized over their useful lives using the straight-line method. Lease amortization is included in depreciation expense.

        Patents.    Patents, once issued or purchased, are amortized on the straight-line method over their economic remaining useful lives, ranging from seven to twenty years.

        Impairment of Long-Lived Assets and Goodwill.    Long-lived assets and intangible assets are reviewed for potential impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In the event the sum of the expected undiscounted future cash flows resulting from the use of the asset is less than the carrying amount of the asset, an impairment loss equal to the excess of the asset's carrying value over its fair value is recorded. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows.

        Goodwill is evaluated annually for impairment at the reporting unit level, or earlier if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit can be an operating segment or a business if discrete financial information is prepared and reviewed by management. Under the impairment test, if a reporting unit's carrying amount exceeds its estimated fair value, goodwill impairment is recognized to the extent that the reporting unit's carrying amount of goodwill exceeds the implied fair value of the goodwill. We only have one reporting unit. The fair value of the CombiMatrix Corporation reporting unit for 2009 and 2008 was determined using quoted market prices for CombiMatrix Corporation common stock. There can be no assurance that future goodwill impairment tests will not result in impairment.

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

        Stock-Based Compensation.    Compensation expense for all stock-based awards is measured at the grant date based on the fair value of the award and is recognized as an expense, on a straight-line basis, over the employee's requisite service period (generally the vesting period of the equity award), which is generally three years for awards to our employees. The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. Stock-based compensation expense is recognized only for those awards that are expected to vest using an estimated forfeiture rate. We estimate pre-vesting option forfeitures at the time of grant and reflect the impact of estimated pre-vesting option

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

forfeitures in compensation expense recognized. We considered several factors in connection with our estimates of pre-vesting forfeitures including types of awards, employee class and historical pre-vesting forfeiture data. Estimates of pre-vesting forfeiture are periodically revised in subsequent periods if actual forfeitures differ from those estimates. To the extent that actual results differ from our estimates, such amounts will be recorded as cumulative adjustments in the period the estimates are revised.

        The assumptions used to estimate the fair value of awards granted for the periods presented are noted in the table below. Expected volatility is based on the separate historical volatility of the market prices of our common stock. The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

        Stock-based compensation expense for 2009 and 2008 attributable to our functional expense categories were as follows (in thousands):

        Research and Development Expenses.    Research and development expenses consist of costs incurred for direct and overhead-related research expenses and are expensed as incurred. Costs to acquire technologies which are utilized in research and development and which have no alternative future use are expensed when incurred. Software developed for use in our products is expensed as incurred until both (i) technological feasibility for the software has been established and (ii) all research and development activities for the other components of the system have been completed. We believe these criteria are met after we have received evaluations from third-party test sites and completed any resulting modifications to the products. Expenditures to date have been classified as research and development expense.

        Advertising.    Costs associated with marketing and advertising of our products and services are expensed as incurred. For the years ended December 31, 2009 and 2008, we incurred marketing and advertising expenses of $357,000 and $199,000, respectively.

        Income Taxes.    We recognize income taxes on an accrual basis based on tax position taken or expected to be taken in our tax returns. A tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions are recognized only when it is more likely than not

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(i.e., likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. A valuation allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more than likely not be realized. Should they occur, our policy is to classify interest and penalties related to tax positions as income tax expense. Since our inception, no such interest or penalties have been incurred, however.

        Comprehensive Loss.    We display comprehensive loss and its components as a part of the statement of shareholders' equity. Components of comprehensive loss consist entirely of unrealized gains and losses on available-for-sale investments.

        Segments.    We have determined that we operate in one segment for financial reporting purposes.

        Loss Per Share.    Basic and diluted net loss per share has been computed by dividing the net loss by the weighted average number of common shares issued and outstanding. Options and warrants to purchase CombiMatrix common stock as well as securities convertible into common stock are anti-dilutive and therefore are not included in the determination of the diluted net loss per share for 2009 and 2008. The following table presents a reconciliation of basic and diluted loss per share for 2009 and 2008 (in thousands, except share and per-share data):

        Reclassifications.    Certain reclassifications have been made to prior period financial statements and footnotes in order to conform to the current period's presentation.

        Recent and Adopted Accounting Pronouncements.    In January 2010, the FASB issued new authoritative guidance regarding the disclosure of fair value measurements, which clarifies certain existing disclosure requirements as well as requiring new disclosures related to significant transfers between each fair value level as well as requiring additional information about Level 3 activity. This guidance begins phasing in during the first fiscal period after December 15, 2009. We do not expect the implementation of this guidance to have a material impact on our consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

        In October 2009, the FASB issued new authoritative guidance to require companies to allocate revenue in multiple-element arrangements based on an element's estimated selling price if vendor-specific or other third-party evidence of value is not available. The new guidance is effective for revenue transactions entered into during fiscal years beginning on or after June 15, 2010, with earlier application permitted. We are currently evaluating both the timing and the impact of the pending adoption of the guidance on our consolidated financial statements.

        In June 2009, the FASB issued new authoritative guidance to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. We adopted the guidance in 2009 without material impact on our consolidated financial statements.

        In May 2009, the FASB issued new authoritative guidance for the accounting for and disclosures of subsequent events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The guidance was effective for interim or annual financial periods ending after June 15, 2009. This guidance applies to both interim financial statements and annual financial statements. In February 2010, the FASB issued additional guidance that clarifies certain existing evaluation and disclosure requirements related to subsequent events. We adopted the initial and revised guidance without material impact on our consolidated financial statements.

        In April 2009, the FASB issued additional authoritative guidance on the fair value of financial instruments, which provides: (i) further provisions on estimating fair value when the markets become inactive and quoted prices reflect distressed transactions; (ii) extended disclosure requirements for interim financial statements regarding the fair value of financial instruments; and (iii) new criteria for recording impairment charges on investments in debt instruments. We adopted the guidance on a prospective basis in 2009 without material impact to our consolidated financial statements.

        In June 2008, the FASB issued new authoritative guidance addressing the accounting for certain instruments (or embedded features) determined to be indexed to an entity's own stock. This guidance provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. We chose to early-adopt this guidance in 2008. See Note 11 below for further discussion of the impact of this guidance to our consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3.     FAIR VALUE MEASUREMENTS

        The following table summarizes, for each major category of financial assets or liabilities measured on a recurring basis, the respective fair value at December 31, 2009 and the classification by level of input within the fair value hierarchy defined above (in thousands):

        The following table is a reconciliation of financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2009 (in thousands):

        At December 31, 2008, our available-for-sale investments included $1.5 million of ARS at par value. Historically, the carrying value of our ARS approximated fair value due to active, liquid markets for these securities as well as the frequent resetting of the interest rates at auction, which typically occurred every 7 to 30 days. However, in mid-February 2008, the market for ARS collapsed and as a result, our ARS experienced multiple failed auctions during 2008. During the fourth quarter of 2008, one of the issuers of our holdings in ARS redeemed $350,000 at par value, bringing the total amount of ARS held by us as of December 31, 2008 to $1.5 million. On January 2, 2009, all of our remaining ARS were liquidated at par value.

        During 2008, the fair values of our holdings in ARS were estimated using discounted cash flow models. These models considered, among other things, the timing of expected future successful auctions, estimated future cash flows, collateralization and credit worthiness of underlying security investments and discount rates applied to the estimated future cash flows. Since these inputs were not observable, they were classified as Level 3 inputs. As a result of the lack of liquidity in the ARS market and not as a result of the quality of the underlying collateral, we recorded unrealized losses on our ARS of $166,000 through the period ended September 30, 2008. However, due to liquidations of our ARS at par value prior to and subsequent to December 31, 2008, we reversed our previously recognized unrealized losses of $166,000

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

during the fourth quarter of 2008 and classified our ARS as current assets at par value in our December 31, 2008 consolidated balance sheet.

4.     AVAILABLE-FOR-SALE INVESTMENTS

        Available-for-sale investments consist solely of ARS with a fair value of $1.5 million as of December 31, 2008. Gross unrealized gains and losses related to these securities were not material for 2008. At December 31, 2008, none of our securities had contractual maturities of greater than one year, other than our ARS.

5.     PROPERTY AND EQUIPMENT

        Property and equipment consists of the following (in thousands):

        Depreciation and amortization expense was $373,000 and $549,000 for the years ended December 31, 2009 and 2008, respectfully. Fully depreciated assets of $1.0 million that were no longer in use were written off during 2008.

6.     BALANCE SHEET COMPONENTS

        Accounts payable and accrued expenses consist of the following (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)