EPIRUS Biopharmaceuticals (EPRSQ) 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008.

Or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission File Number 000-51171

COMBINATORX, INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware	04-3514457
(State or other jurisdiction of Incorporation or organization)	(IRS Employer Identification Number)

245 First Street Sixteenth Floor Cambridge, Massachusetts	02142
(Address of Principal Executive Offices)	(Zip Code)

(617) 301-7000

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changes since last report)

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 such filing requirements for the past 90 days.    Yes  x    No  ¨

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 filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer:	¨	Accelerated Filer:	x
Non-Accelerated Filer:	¨	Smaller Reporting Company:	¨

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

Number of shares of the registrant’s Common Stock, $0.001 par value per share, outstanding as of November 5, 2008: 35,093,587 shares

COMBINATORX, INCORPORATED

QUARTERLY REPORT

ON FORM 10-Q

INDEX

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4.	Controls and Procedures	17
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	18
Item 1A.	Risk Factors	18
Item 6.	Exhibits	32
SIGNATURES		33

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PART I

FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of CombinatoRx to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any projections of financing needs, revenue, expenses, earnings or losses from operations, or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning product candidate research, development and commercialization plans and timelines; any statements regarding safety and efficacy of product candidates, any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. In addition, forward-looking statements may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” will continue,” “will result,” “seek,” “could,” “may,” “might,” or any variations of such words or other words with similar meanings.

The risks, uncertainties and assumptions referred to above include risks that are described in “Risk Factors” and elsewhere in this quarterly report and that are otherwise described from time to time in our annual report on Form 10-K and the other Securities and Exchange Commission reports filed after this report.

The forward-looking statements included in this quarterly report represent our estimates as of the date of this quarterly report. We specifically disclaim any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing our estimates or views as of any date subsequent to the date of this quarterly report.

Item 1. Financial Statements—Unaudited

The financial information set forth below should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Quarterly Report on Form 10-Q.

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CombinatoRx, Incorporated

Consolidated Balance Sheets

(in thousands except per share data)

(Unaudited)

	September 30, 2008			December 31, 2007
Assets
Current assets:
Cash and cash equivalents	$	12,552		$	11,585
Restricted cash		50			50
Short-term investments		52,882			96,999
Accounts receivable		279			397
Unbilled accounts receivable		664			746
Prepaid expenses and other current assets		1,570			2,526
Total current assets		67,997			112,303
Property and equipment, net		15,426			15,933
Restricted cash and other assets		4,118			4,007
Total assets	$	87,541		$	132,243
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	2,650		$	1,964
Accrued expenses		5,538			4,751
Deferred revenue		5,349			5,431
Current portion of notes payable, net of discount		3,245			3,099
Current portion of lease incentive obligation		649			649
Total current liabilities		17,431			15,894
Convertible notes payable of subsidiary		18,956			13,404
Notes payable, net of current portion and discount		3,081			5,415
Deferred revenue, net of current portion		8,192			12,068
Deferred rent		2,133			2,190
Lease incentive obligation, net of current portion		4,758			5,245
Total liabilities		54,551			54,216
Minority interest in subsidiary		2,885			2,792
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $0.001 par value: 60,000 shares authorized; 35,094 and 34,822 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively		35			35
Additional paid-in capital		266,245			261,187
Accumulated other comprehensive income		30			226
Accumulated deficit		(236,205	)		(186,213	)
Stockholders’ equity		30,105			75,235
Total liabilities and stockholders’ equity	$	87,541		$	132,243

4

CombinatoRx, Incorporated

Consolidated Statements of Operations

(in thousands, except share and per share amounts)

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Collaborations	$	2,987		$	2,513		$	8,873		$	9,529
Government contracts and grants		494			489			1,349			2,394
Total revenue		3,481			3,002			10,222			11,923
Operating expenses:
Research and development		15,273			15,874			49,764			41,350
General and administrative		3,790			4,116			11,429			12,706
Total operating expenses		19,063			19,990			61,193			54,056
Loss from operations		(15,582	)		(16,988	)		(50,971	)		(42,133	)
Investment income		451			1,207			2,216			3,955
Interest expense		(383	)		(375	)		(1,127	)		(928	)
Other (expense) income		(49	)		—			3			—
Loss before provision for income taxes		(15,563	)		(16,156	)		(49,879	)		(39,106	)
Provision for income taxes		—			—			(20	)		(21	)
Net loss	$	(15,563	)	$	(16,156	)	$	(49,899	)	$	(39,127	)
Net loss per share applicable to common stockholders— basic and diluted	$	(0.45	)	$	(0.56	)	$	(1.43	)	$	(1.36	)
Weighted average number of common shares used in net loss per share calculation – basic and diluted		34,926,731			28,971,559			34,802,763			28,816,073

5

CombinatoRx, Incorporated

Consolidated Statements of Cash Flow

(in thousands)

(Unaudited)

	Nine Months ended September 30,
	2008			2007
Operating activities
Net loss	$	(49,899	)	$	(39,127	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,748			2,245
Noncash interest expense		557			455
Noncash rent expense		(487	)		(487	)
Stock-based compensation expense		4,916			6,150
Decrease in deferred rent		(57	)		(24	)
Change in assets and liabilities:
Decrease (increase) in accounts receivable		118			(7,000	)
Decrease (increase) in unbilled accounts receivable		82			(430	)
Decrease (increase) in prepaid expenses and other assets		845			(591	)
Increase (decrease) in accounts payable		686			(2,352	)
Increase in accrued expenses		895			2,452
(Decrease) increase in deferred revenue		(3,958	)		1,049
Proceeds from landlord for tenant improvements		—			2,900
Net cash used in operating activities		(43,554	)		(34,760	)
Investing activities
Purchases of property and equipment		(2,241	)		(6,014	)
Purchases of short-term investments		(224,292	)		(337,502	)
Sales and maturities of short-term investments		268,213			374,727
Increase in restricted cash		—			(50	)
Net cash provided by investing activities		41,680			31,161
Financing activities
Proceeds from exercise of stock options		273			501
Repurchases of common stock		(131	)		—
Proceeds from convertible notes payable of subsidiary		5,000			3,500
Proceeds from notes payable		—			5,995
Repayment of notes payable		(2,301	)		(1,984	)
Net cash provided by financing activities		2,841			8,012
Net increase in cash and cash equivalents		967			4,413
Cash and cash equivalents at beginning of the period		11,585			9,194
Cash and cash equivalents at end of the period	$	12,552		$	13,607

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CombinatoRx, Incorporated

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and as required by Regulation S-X, Rule 10-01. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including those which are normal and recurring) considered necessary for a fair presentation of the interim financial information have been included. When preparing financial statements in conformity with GAAP, the Company must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements. Actual results could differ from those estimates. Additionally, operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2008. For further information, refer to the financial statements and footnotes included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (SEC) on March 13, 2008.

2. Recent Accounting Pronouncements

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”), which provides guidance for using fair value to measure assets and liabilities. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. SFAS 157 also requires expanded disclosure of the effect on earnings for items measured using unobservable data, establishes a fair value hierarchy that prioritizes the information used to develop those assumptions and requires separate disclosure by level within the fair value hierarchy.

The Company currently records short-term investments at fair value. SFAS 157 establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s own assumptions (unobservable inputs). The hierarchy consists of three levels:

• Level 1 – Quoted market prices in active markets for identical assets or liabilities. Assets utilizing Level 1 inputs include money market funds, U.S. government securities and bank deposits;

• Level 2 – Inputs other than Level 1 inputs that are either directly or indirectly observable, such as quoted market prices, interest rates and yield curves. Assets utilizing Level 2 inputs include U.S. agency securities, including direct issuance bonds and corporate bonds; and

• Level 3 – Unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use. We currently have no assets or liabilities valued with Level 3 inputs.

The following table summarizes the financial instruments measured at fair value on a recurring basis in the accompanying consolidated balance sheet as of September 30, 2008:

	Fair Value Measurement as of September 30, 2008
	Level 1		Level 2		Level 3		Total
Cash equivalents	$	9,550	$	—	$	—	$	9,550
Short-term investments		16,924		35,958		—		52,882
Total	$	26,474	$	35,958	$	—	$	62,432

Our Level 2 securities are valued using third-party pricing sources. These sources generally use interest rates and yield curves observable at commonly quoted intervals of similar assets as observable inputs for pricing.

On May 9, 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (the “FSP”). The FSP requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. In issuing the FSP, the FASB agreed with those that believe the current accounting for these instruments does not appropriately reflect the underlying economics as the value of the conversion options are not captured as borrowing costs (i.e., interest expense) and their potential dilutive effects are not fully reflected in earnings per share. The Company will be required to adopt the FSP on January 1, 2009. The transition guidance issued by FASB requires retrospective application to all periods presented. The Company believes that the FSP could have a material impact on its consolidated financial statements.

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3. Comprehensive Loss

The Company’s total comprehensive loss consists of the following:

	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Net loss	$	(15,563	)	$	(16,156	)	$	(49,899	)	$	(39,127	)
Other comprehensive income (loss):
Unrealized gain (loss) on investments		4			11			(196	)		25
Comprehensive loss	$	(15,559	)	$	(16,145	)	$	(50,095	)	$	(39,102	)

4. Stock-Based Compensation

Under Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), the Company recognized, for the three and nine months ended September 30, 2008 and 2007, stock-based compensation expense of approximately $1,567 and $4,860 and $1,844 and $5,955, respectively, in connection with its share-based payment awards.

Stock Plans

A summary of the status of the Company’s stock option plans at September 30, 2008 and changes during the nine months then ended is presented in the table and narrative below:

	Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at December 31, 2007	5,067,240		$	6.27
Granted	2,574,000		$	4.18
Exercised	(264,706	)	$	1.03
Cancelled	(883,468	)	$	7.12
Outstanding at September 30, 2008	6,493,066		$	5.48	7.96	$	2,356
Vested or expected to vest at September 30, 2008	5,785,193		$	5.49	7.82	$	2,352
Exercisable at September 30, 2008	2,611,052		$	5.37	6.53	$	2,264

The aggregate intrinsic value in the table above represents the value (the difference between the Company’s closing common stock price on the last trading day of the nine months ended September 30, 2008 and the exercise price of the options, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2008. As of September 30, 2008, there was $11,594 of total unrecognized stock-based compensation expense related to stock options granted under the plans. The expense is expected to be recognized over a weighted-average period of 2.7 years. The Company recorded the remaining stock-based compensation expense related to stock options granted below fair market value prior to January 1, 2005, in the nine months ended September 30, 2008.

During the three and nine months ended September 30, 2007, the Company modified certain stock option grants and restricted stock awards for employees to provide for acceleration of vesting in connection with termination agreements. In accordance with SFAS 123R, the Company recorded stock-based compensation expense of $0 and $412 for the three and nine months ended September 30, 2008, respectively, at the modification date as no additional service was required.

SFAS 123R requires share-based payments to employees to be measured at fair value. The Company uses the Black-Scholes pricing model in order to calculate the estimated fair value of its stock options. Since the Company completed its initial public offering in November 2005, it did not have sufficient history as a publicly traded company to evaluate its volatility factor and expected term. As such, the Company analyzes the volatilities and expected terms of several peer companies to support the assumptions used in its calculations.

8

During the three and nine months ended September 30, 2008 and 2007, respectively, the weighted-average assumptions used in the Black-Scholes pricing model were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Volatility factor	58.35	%	58.79	%	56.84	%	61.31	%
Risk-free interest rate	2.98	%	4.23	%	2.68	%	4.51	%
Dividend yield	—		—		—		—
Expected term (in years)	5.86		6.08		5.73		5.76

Restricted Stock

A summary of the status of non-vested restricted stock as of September 30, 2008 and changes during the nine months ended September 30, 2008 is as follows:

	Restricted Stock		Weighted- Average Grant Date Fair Value
Nonvested at December 31, 2007	165,938		$	10.18
Granted	45,000		$	4.84
Vested	(88,438	)	$	10.33
Canceled	(12,500	)	$	10.49
Nonvested at September 30, 2008	110,000		$	7.84

As of September 30, 2008, there was $704 of total unrecognized stock-based compensation expense related to non-vested restricted stock arrangements granted under the 2004 Equity Incentive Plan. The expense is expected to be recognized over a weighted-average period of 1.9 years. The total compensation expense recognized on restricted stock awards was $91 and $329 and $136 and $493 during the three and nine months ended September 30, 2008 and 2007, respectively.

5. Net Loss Per Share

The Company calculates net loss per share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic and diluted net loss per common share was determined by dividing net loss applicable to common stockholders by the weighted-average common shares outstanding during the period. The Company’s potentially dilutive shares, which include outstanding common stock options, unvested restricted stock, warrants and convertible notes have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive. The following common share equivalents, prior to the use of the treasury stock method, have been excluded from the computation of diluted weighted-average shares outstanding as of September 30, 2008 and 2007, as they would be anti-dilutive.

	Three and Nine Months Ended September 30,
	2008	2007
Options outstanding	6,493,066	5,079,370
Unvested restricted stock	110,000	168,750
Warrants outstanding	96,252	96,252
Convertible notes payable	2,159,349	1,195,733

6. CombinatoRx (Singapore) Pte Ltd

In August 2005, the Company formed a subsidiary in Singapore, CombinatoRx (Singapore) Pte. Ltd. (the “Subsidiary”), for the purpose of conducting discovery and development of product candidates to treat infectious diseases. The Company owns 51% of the Subsidiary capital stock. The Company has agreed to provide assay development and screening services for the subsidiary over a four year period. BioMedical Sciences Investment Fund Pte Ltd (“BioMedical Sciences”) invested $2,500 in 2,500,000 shares of redeemable, convertible preferred stock (the “Subsidiary Preferred Stock”) of the subsidiary and invested an additional $17,500 in the subsidiary through the purchase of a series of convertible promissory notes (“Notes”), $5,500 of which was purchased concurrently with its investment in the Subsidiary Preferred Stock (the “Series 1 Note”), and the remaining $12,000 in funding was provided through the purchase of additional series of Notes as the subsidiary achieved certain milestones related to the development of infectious disease product candidates. BioMedical Sciences invested an additional $3,500 in the Subsidiary for which it was issued a new $3,500 convertible promissory note (the “Series 2 Note”) on June 8, 2006, an additional $3,500 in the Subsidiary for which it was issued a new $3,500 convertible promissory note (the “Series 3 Note”) on May 30, 2007 and an additional $5,000 in the Subsidiary for which it was issued a new $5,000 convertible promissory note (the “Series 4 and 5 Notes”) on August 5, 2008.

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The Notes bear interest at an annual rate of 5% and are due and payable on December 31, 2009, unless the Company elects to prepay the Notes before that date through the Subsidiary. The Notes are secured by a security interest in the non-intellectual property assets of the Subsidiary and by a negative pledge by the Subsidiary with respect to its intellectual property rights. The Company has pledged its shares in the Subsidiary as additional collateral for the Subsidiary’s obligations under the Notes. The Notes are convertible into the Company’s common stock at the option of BioMedical Sciences only upon maturity, acceleration or default or any proposed prepayment. Upon maturity or any proposed prepayment, the Series 1 Note is convertible into a number of shares of the Company’s common stock obtained by dividing the aggregate principal balance of such Note by $10.803, the Series 2 Note is convertible at a price obtained by dividing the aggregate principal balance of such Notes by $11.572, the Series 3 Note is convertible at a price obtained by dividing the aggregate principal balance of such Notes by $9.11 and the Series 4 and 5 Notes are convertible at a price obtained by dividing the aggregate principal balance of such Notes by $5.19.

Upon a default by the Company or Subsidiary, the Notes and the Subsidiary Preferred Stock are convertible at the option of BioMedical Sciences as described with respect to a conversion upon maturity or prepayment except that (i) the conversion price of the Notes would include a 10% default interest rate accrued from the date of issuance and the Subsidiary Preferred Stock would also include a 10% dividend accrual accrued from the date of issuance and (ii) no conversion premium would apply.

7. Subsequent Events

Liverpool School of Tropical Medicine

On April 25, 2007, the Company and the Subsidiary entered into an Interim Consortium Agreement with the Liverpool School of Tropical Medicine (“LSTM”) and other parties (the “A-WOL Consortium”), under which the Company and its Subsidiary would act as subcontractors to perform assay development and screening services relating to a grant awarded to LSTM focusing on the development of treatment regimens against filariasis, or African river blindness. Under the terms of the interim agreement, and subject to certain conditions, the Subsidiary was eligible to receive up to $3,968 in research and development funding over a five-year period. The interim agreement expired by its terms on March 31, 2008, and the Company and the Subsidiary continued to perform services for LSTM as part of the A-WOL Consortium.

On October 8, 2008, the Company and the Subsidiary entered into a Consortium Agreement with the members of the A-WOL Consortium, as well as a Project Agreement and an Agreement Relating to Intellectual Property Rights with LSTM (the “Agreements”), all to allow the Subsidiary to continue to participate as a member of the A-WOL Consortium and perform assay development and screening services relating to the grant awarded to LSTM to develop treatment regimens against filariasis.

Under the terms of the Agreements, the Subsidiary will continue to be eligible to receive up to approximately $2,976 in remaining research and development funding, plus reimbursement of expenses relating to patent prosecution. The Agreement with respect to research and development terminates upon the expiration of the research and development project, which is currently planned to last until April 2012. The Agreements may be terminated by the A-WOL Consortium after thirty days’ notice of a persistent or material breach of the Agreements by the Company or the Subsidiary, the inability of the Company or the Subsidiary to continue the research project for reasons beyond its control, or the winding-up, liquidation, bankruptcy or similar action by the Company or the Subsidiary. The A-WOL Consortium may also terminate the Agreements if the grant is terminated or if LSTM and the grant provider agree that the number of remaining parties under the Agreements means that it is no longer viable to continue the research project under the terms of the original grant award to LSTM. The Company or the Subsidiary may terminate the Agreements with six months’ prior written notice.

Duchenne’s Muscular Dystrophy Collaboration

On October 20, 2008, the Company and DART Therapeutics, LLC (the “Sponsor”) amended their Sponsored Research Collaboration Agreement, dated as of November 7, 2007 (the “Amended Agreement”). Under the Amended Agreement, the Sponsor agreed to provide to the Company an additional $450 in research funding, which was provided to the Sponsor by GMT Charitable Research, LLC, an affiliate of a charitable organization focused on finding therapies for Duchenne’s Muscular Dystrophy, bringing the committed funding under the Amended Agreement to $3,450. The Company and the Sponsor will continue to seek to identify novel disease-modifying, multi-targeted treatments for Duchenne’s Muscular Dystrophy.

Restructuring

On October 29, 2008, the Company committed to a restructuring plan that will result in a reduction of approximately 45% of the Company’s United States workforce at its Cambridge, Massachusetts location. The restructuring is a result of a strategic realignment

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of the Company to focus efforts on near-term value drivers and to conserve capital. Employees received notification on October 30, 2008 and will be provided with severance payments and outplacement assistance. The Company expects to complete the restructuring by December 2008.

As a result of the restructuring plan, the Company estimates that it will record a restructuring charge of between approximately $1,600 and $2,000 in the fourth quarter of 2008, primarily representing cash payments for severance and other personnel-related expenses. The Company may also incur further restructuring charges that could be significant due to events that may occur as a result of, or associated with, the restructuring plan, including facilities-related costs. The majority of the severance payments will be paid out during the fourth quarter of 2008 and will continue into the first quarter of 2009.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and their notes appearing elsewhere in this quarterly report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those discussed below and elsewhere in this quarterly report or in our annual report on form 10-K, particularly under the heading “Risk Factors That May Affect Future Results.”

Overview

We are a biopharmaceutical company focused on developing synergistic combinations of approved drugs, with a portfolio of product candidates in Phase 2 clinical development. To date, we have devoted substantially all of our resources to the development of our drug discovery technology and the research and development of our drug candidates, including conducting preclinical and clinical trials and seeking protection for our technology and product candidates. Since our inception in March 2000, we have had no revenue from product sales, and have funded our operations principally through the sale of equity securities, debt financings and revenue from license, research and collaboration agreements as well as government contracts and grants. We expect to incur significant operating losses for the foreseeable future as we advance our product candidates from discovery through preclinical and clinical trials and seek regulatory approval and eventual commercialization. We will need to raise additional capital and generate significant revenues to achieve profitability and may never do so.

We have never been profitable and, as of September 30, 2008, we have an accumulated deficit of $236.2 million. We had net losses of $53.3 million for the year ended December 31, 2007 and $49.9 million for the nine months ended September 30, 2008.

We have been advancing four product candidates, Synavive^TM (CRx-102), CRx-401, CRx-197 and CRx-191, through clinical research and development. We have two other product candidates in our portfolio, CRx-139 for immuno-inflammatory diseases and CRx-170 for chronic pain, which have completed Phase 2a clinical trials, but are not currently being advanced into later-stage clinical trials, and we have a number of product candidates in preclinical development.

Our most advanced product candidate, Synavive, is a novel dissociated glucocorticoid product candidate being developed to treat immuno-inflammatory disorders. In July 2008, we discontinued enrollment in our ongoing Phase 2b clinical trial of Synavive in patients with rheumatoid arthritis, the MARS-1 study, which was targeted to enroll over 600 subjects. This decision was based on a number of factors that compromised the timing of results and therefore the strategic value of the MARS-1 study compared to both its significant cost and the results expected in October 2008 from an ongoing Phase 2b clinical trial of Synavive in 279 patients with knee osteoarthritis, the COMET-1 study. Given poor financial market conditions and that the MARS-1 data would not be available in a timeframe consistent with the expected timing of the COMET-1 study results, the MARS-1 Study was discontinued to preserve financial resources.

The COMET-1 study was completed in September 2008, and the preliminary analysis of the primary and certain secondary endpoints from the trial were disclosed on October 6, 2008. While there was a numerical trend in favor of Synavive and an observed dose-response relationship, Synavive did not demonstrate statistical significance compared to placebo for WOMAC question #1 measuring pain while walking on a flat surface (the primary endpoint), nor when compared to prednisolone alone, both analyzing the intent-to-treat (ITT) population from the study. We also conducted pre-specified analyses of the data from the COMET-1 study, using a modified ITT (mITT) analysis, which accounts for subjects who stopped taking their blinded study drug and commenced use of a prohibited medication (such as an NSAID or COX-2 inhibitor) prior to their end-of-study visit. For the mITT analysis, the last observation prior to this protocol violation was carried forward for all efficacy measures. In the mITT analysis, high-dose Synavive (2.7mg prednisolone/360mg dipyridamole) provided statistically significant treatment benefits as great as 19.5mm compared to placebo and 8mm compared to prednisolone, across a range of efficacy measures, including the WOMAC pain, stiffness and physical function subscales. These effects are comparable to current osteoarthritis therapies, including NSAIDs and COX-2 inhibitors, based on systematic reviews of published data. In addition, an effect was observed for those patients in the study who also experienced significant hand pain, a pre-specified analysis, thus corroborating activity observed in an earlier Phase 2 clinical study of Synavive in subjects with hand osteoarthritis.

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We are currently focused on finding a collaboration partner to license Synavive and fund its further development. As these efforts to enter into a potential collaboration surrounding Synavive continue, we are reducing our planned expenditures relating to Synavive. As described in further detail in the Liquidity and Capital Resources section below, we are implementing a significant restructuring plan in order to preserve capital to allow us to potentially outlicense Synavive and advance our other clinical and preclinical programs.

Our product candidate CRx-401 is a novel oral therapeutic that is currently being evaluated in a Phase 2a clinical trial for its anti-diabetic activity in subjects with Type 2 diabetes. CRx-401 is a synergistic combination drug candidate containing sustained-release bezafibrate, an anti-cholesterol agent approved outside the United States, and a low dose of diflunisal, a widely available analgesic. CRx-401 is thought to have a novel mechanism of action that reduces hyperglycemia and improves HDL and triglyceride levels without promoting weight gain. Our product candidate CRx-197 is a selective cytokine modulator containing low concentrations of the antihistamine loratadine, and the tricyclic anti-depressant nortriptyline, neither of which is approved for the treatment of topical dermatoses. This combination has been co-formulated as a topical cream for the treatment of atopic dermatitis and other inflammatory dermatoses. We have completed a healthy volunteers safety study for CRx-197 and plan to commence a Phase 2a plaque psoriasis clinical trial prior to the end of 2008. Our product candidate CRx-191 is a topical synergistic combination drug candidate thought to have a novel multi-target mechanism that inhibits TNF-a and interferon-gamma, key cell mediators of inflammation. CRx-191 contains the mid-potency glucocorticoid, mometasone, and a low dose of the tricyclic anti-depressant, nortriptyline, co-formulated as a topical cream for the treatment of psoriasis and other steroid-responsive dermatoses. We conducted a skin atrophy clinical study of CRx-191 during 2007 and conducted a Phase 2a clinical trial of CRx-191 in subjects with psoriasis during the first half of 2008.

Our management currently uses consolidated financial information in determining how to allocate resources and assess performance. We have determined that we conduct operations in one business segment. The majority of our revenues since inception have been generated in the United States, and the majority of our long-lived assets are located in the United States.

Critical Accounting Policies

We believe that several accounting policies are important to understanding our historical and future performance. We refer to these policies as “critical” because these specific areas generally require us to make judgments and estimates about matters that are uncertain at the time we make the estimate, and different estimates—which also would have been reasonable—could have been used, which would have resulted in different financial results.

The critical accounting policies we identified in our most recent Annual Report on Form 10-K for the fiscal year ended December 31, 2007 related to revenue recognition, stock-based compensation and accrued expenses. It is important that the discussion of our operating results that follows be read in conjunction with the critical accounting policies discussed below as well as those disclosed in our Annual Report on Form 10-K, as filed with the SEC on March 13, 2008.

Revenue Recognition

We have entered into collaborative research and development agreements with other pharmaceutical and biotechnology companies, government agencies and charitable foundations. These agreements are generally in the form of research and development and license agreements. The agreements are for early-stage compounds and are generally focused on specific disease areas. The agreements provide for nonrefundable up-front payments, milestone payments upon achieving significant milestone events and, in some cases, ongoing research funding. The agreements also contemplate royalty payments on sales if and when the product receives marketing approval by the FDA or other regulatory agency.

We recognize revenue in accordance with Emerging Issues Task Force, Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) and Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”). Revenue arrangements with multiple deliverables are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered elements. The consideration received is allocated among separate elements based on their respective fair values. Revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred, the price is fixed or determinable and collection is reasonably assured. License fees or other amounts received in advance of performance obligations, or in cases where we have a continuing obligation to perform services, are deferred and recognized over the performance period. Revenues from milestone payments that are deemed to be substantive and represent the culmination of a separate earnings process are recorded when the milestone is achieved. Contract revenues are recorded as the services are performed. The periods over which revenue should be recognized are subject to estimates by management and may change over the course of the collaborative agreement. Such a change could have a material impact on the amount of revenue we record in future periods.

Revenue under government grants or cost reimbursement contracts is recognized as we perform the underlying research and development activities.

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Stock-Based Compensation

We adopted SFAS 123R on January 1, 2006, using the prospective method for stock option grants prior to January 1, 2005 and the modified-prospective transition method for stock option grants and restricted stock issued after January 1, 2005. As a result, the fair value of unamortized compensation expense from stock options granted prior to January 1, 2005 is not included in the statement of operations. Stock options granted after January 1, 2005 are included due to the fact that once we were in registration for our initial public offering, we included a volatility factor in our Black-Scholes calculations for purposes of the proforma footnote disclosures under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation.” (“SFAS 123”).

Prior to January 1, 2006, we accounted for our stock-based compensation plans under the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (“APB 25”) and related interpretations as permitted by SFAS 123. Under APB 25, when the exercise price of stock options granted to employees equals the market price of the common stock on the date of grant, no compensation expense is recorded. When the exercise price of options granted to employees is less than the market price of the common stock on the date of grant, compensation expense is recognized over the vesting period.

SFAS 123R requires share-based payments to employees to be measured at fair value. However, the valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. We use the Black-Scholes pricing model in order to calculate the estimated fair value for our stock options. The input assumptions used in determining fair value are the expected life of the stock options, the expected volatility of our common stock, the risk-free interest rate over the expected life of the option and the expected forfeiture rate of the options granted. We recognize stock option compensation expense over the vesting period during which an employee provides service in exchange for the award.

Making estimates for the values required by Black-Scholes is more easily accomplished if a company has a substantial public market trading history. Since we have a limited history as a publicly traded entity, we rely on data from several peer companies similar to ours in generating our assumptions. Of the variables mentioned above, the estimates for expected term and stock price volatility are the most subjective. In accordance with the guidance provided in Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”), we generate our estimates by performing an analysis of these peer companies’ expected term and volatility data as reported in their filings with the SEC. Our peers had a similar amount of in-the-money stock options (options with exercise prices below the current market price of the underlying stock), a trading history of sufficient duration (at least as long as its expected term) and stock option life and vesting terms similar to ours (10 year options with approximately 4 year vesting).

The amount of stock-based compensation expense to be recorded in any future period cannot be accurately predicted due to the uncertainty of future grant levels and actual forfeitures to be recorded. Additionally, changes to the assumptions used in the Black-Scholes pricing model could cause a material change in the amount of stock-based compensation expense to be recorded in future reporting periods.

Accrued Expenses

As part of the process of preparing our consolidated financial statements, we are required to estimate certain accrued expenses. This process involves identifying services that third parties have performed on our behalf and estimating the amount of service performed and the associated cost incurred for these services as of the balance sheet date in our consolidated financial statements. Examples of estimated accrued expenses for our business are contract service fees, such as amounts due to clinical research organizations who are supporting clinical trials for our product candidates Synavive, CRx-401, CRx-197 and CRx-191, preclinical and toxicology research services providers and formulation development providers, professional service fees, such as attorneys and accountants, and investigators in conjunction with our clinical trials. In connection with these service fees, our estimates are most affected by our understanding of the status and timing of services provided relative to the actual level of services incurred by the service providers. In the event that we do not identify certain costs that have been incurred or we under- or over-estimate the level of services or the costs of such services, our reported expenses for a reporting period could be understated or overstated.

Results of Operations

Comparison of the Three Months ended September 30, 2008 and September 30, 2007

Revenue.For the three months ended September 30, 2008, we recorded $3.5 million of revenue from our research and development collaborations with Angiotech Pharmaceuticals, Inc., or Angiotech, Cystic Fibrosis Foundation Therapeutics, Inc., or CFFT, CHDI, Inc., Charley’s Fund and the Nash Avery Foundation, or the DMD Foundations and the Liverpool School of Tropical Medicine, or LSTM, and from government contracts and grants from the National Institutes of Allergy and Infectious Diseases, or NIAID, the U.S. Army Medical Research Institute for Infectious Diseases, or USAMRIID, and the Singapore Economic Development Board, or EDB. For the three months ended September 30, 2007 we recorded $3.0 million of revenue from our research and development collaborations with Angiotech, CFFT, CHDI, Inc., SAIC – National Institute of Neurological Disorders and Stroke, or SAIC (NINDS), LSTM, and from government contracts and grants from NIAID, and the Singapore EDB. The increase in revenue is primarily due to the revenue recognized under our research collaboration agreement with the DMD Foundations, which commenced in the fourth quarter of 2007.

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Research and Development. Research and development expense for the three months ended September 30, 2008 was $15.3 million compared to $15.9 million for the three months ended September 30, 2007. The $0.6 million decrease was primarily due to an increase of $1.7 million in external clinical trial program costs, primarily for Synavive, offset by a decrease of $1.1 million in pharmacology costs.

The table below summarizes our allocation of research and development expenses to our clinical programs Synavive, CRx-401, CRx-197 and CRx-191 for the three months ended September 30, 2008 and 2007. Our internal project costing methodology does not allocate all of the personnel and other indirect costs from all of our research and development departments to specific clinical and preclinical programs, and such unallocated costs are further summarized in the table below. Unallocated clinical program costs consist primarily of the personnel and other expenses for our clinical operations, medical affairs, biostatistics, data systems, medical writing and clinical program leadership departments, all of which support the development of our clinical product candidates Synavive, CRx-401, CRx-197 and CRx-191. Preclinical program costs consist of the personnel and other expenses allocated to our internally funded preclinical programs and the research activities of CombinatoRx Singapore, as well as the direct costs allocated to all of our research collaborations, including the personnel costs of our alliance management department. Unallocated clinical and preclinical program costs consist primarily of the personnel and other expenses for our formulations, pharmacology, regulatory, quality, new products and discovery departments, all of which supported the development of both our clinical product candidates Synavive, CRx-401, CRx-197 and CRx-191, as well as our preclinical product candidates. Infrastructure and support costs consist of facility costs, depreciation and amortization and costs for research and development support personnel such as our informatics and facilities departments.

	Three Months Ended September 30, (in thousands)
	2008		2007
Synavive	$	4,534	$	5,471
CRx-401		1,142		210
CRx-197		596		380
CRx-191		230		602
Other clinical program costs		363		758
Unallocated clinical program costs		499		725
Total clinical program costs		7,364		8,146
Preclinical program costs		3,371		3,484
Unallocated clinical and preclinical program costs		1,599		1,298
Infrastructure and support costs		2,272		2,147
Non-cash employee and non-employee stock-based compensation expense		667		799
Total research and development expenses	$	15,273	$	15,874

General and Administrative. General and administrative expense for the three months ended September 30, 2008 was $3.8 million compared to $4.1 million for the three months ended September 30, 2007. The $0.3 million decrease was primarily due to a $0.3 million decrease in stock-based compensation expense.

Investment Income. Investment income for the three months ended September 30, 2008 was $0.5 million compared to $1.2 million for the three months ended September 30, 2007. The $0.7 million decrease was primarily due to decreases in our average cash and short-term investments balances and lower average interest rates for the securities held in our investment portfolio.

Interest Expense. Interest expense for the three months ended September 30, 2008 and September 30, 2007 was $0.4 million.

Comparison of the Nine Months ended September 30, 2008 and September 30, 2007

Revenue.For the nine months ended September 30, 2008, we recorded $10.2 million of revenue from our research and development collaborations with Angiotech, CFFT, CHDI, Inc., the DMD Foundations and LSTM and from government contracts and grants from NIAID, USAMRIID and the EDB. For the nine months ended September 30, 2007 we recorded $11.9 million of revenue from our research and development collaborations with Angiotech, CFFT, CHDI, Inc., Fovea Pharmaceuticals SA, or Fovea, SAIC (NINDS), LSTM, and from government contracts and grants from NIAID, and the EDB. The decrease in revenue is primarily due to a decrease in the revenue recognized under our research and license agreement with Angiotech as a result of our extension of the research term in the third quarter of 2007.

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Research and Development. Research and development expense for the nine months ended September 30, 2008 was $49.8 million compared to $41.4 million for the nine months ended September 30, 2007. The $8.4 million increase was due primarily to an increase of $10.1 million in external clinical trial program costs, primarily for Synavive (CRx-102), offset by a $2.0 million decrease in pharmacology costs.

The table below summarizes our allocation of research and development expenses to our clinical programs Synavive, CRx-401, CRx-197 and CRx-191 for the nine months ended September 30, 2008 and 2007. Our internal project costing methodology does not allocate all of the personnel and other indirect costs from all of our research and development departments to specific clinical and preclinical programs, and such unallocated costs are further summarized in the table below. Unallocated clinical program costs consist primarily of the personnel and other expenses for our clinical operations, medical affairs, biostatistics, data systems, medical writing and clinical program leadership departments, all of which support the development of our clinical product candidates Synavive, CRx-401, CRx-197 and CRx-191. Preclinical program costs consist of the personnel and other expenses allocated to our internally funded preclinical programs and the research activities of CombinatoRx Singapore, as well as the direct costs allocated to all of our research collaborations, including the personnel costs of our alliance management department. Unallocated clinical and preclinical program costs consist primarily of the personnel and other expenses for our formulations, pharmacology, regulatory, quality, new products and discovery departments, all of which supported the development of both our clinical product candidates Synavive, CRx-401, CRx-197 and CRx-191, as well as our preclinical product candidates. Infrastructure and support costs consist of facility costs, depreciation and amortization and costs for research and development support personnel such as our informatics and facilities departments.

	Nine Months Ended September 30, (in thousands)
	2008		2007
Synavive	$	17,994	$	9,850
CRx-401		2,765		623
CRx-197		1,790		380
CRx-191		913		1,162
Other clinical program costs		779		1,930
Unallocated clinical program costs		1,580		3,518
Total clinical program costs		25,821		17,463
Preclinical program costs		9,812		8,854
Unallocated clinical and preclinical program costs		5,117		5,986
Infrastructure and support costs		6,980		6,138
Non-cash employee and non-employee stock-based compensation expense		2,034		2,909
Total research and development expenses	$	49,764	$	41,350

General and Administrative. General and administrative expense for the nine months ended September 30, 2008 was $11.4 million compared to $12.7 million for the nine months ended September 30, 2007. The $1.3 million decrease was primarily due to a $0.6 million decrease in general consulting costs, a $0.4 million decrease in stock-based compensation expense and a $0.3 million decrease in salary and bonus expenses.

Investment Income. Investment income for the nine months ended September 30, 2008 was $2.2 million compared to $4.0 million for the nine months ended September 30, 2007. The $1.8 million decrease was primarily due to decreases in our average cash and short-term investments balances and lower average interest rates for the securities held in our investment portfolio.

Interest Expense. Interest expense for the nine months ended September 30, 2008 was $1.1 million compared to $0.9 million for the nine months ended September 30, 2007. The $0.2 million increase was primarily due to higher average debt balances on our equipment lines of credit with General Electric Capital Corporation, or GECC, and the issuance of $5.0 million of additional convertible notes by CombinatoRx Singapore in both May 2007 and August 2008.

Liquidity and Capital Resources

Since our inception in March 2000 until our initial public offering on November 9, 2005, we have funded our operations principally through the private placement of equity securities, which provided net proceeds of approximately $104.9 million. Our initial public offering provided net proceeds of $43.8 million, a private placement of our common stock in March 2006 provided net proceeds of $45.4 million and a public offering of our common stock in October 2007 provided net proceeds of $33.0 million. We have also generated funds from debt financing and payments from our collaboration partners. As of September 30, 2008, we had cash, cash equivalents and short-term investments of approximately $69.5 million, which includes $4.1 million of restricted cash. Our funds are primarily invested in short-term, investment-grade securities, government agency securities and U. S. Treasury money market

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funds, and as such, we do not believe there is significant risk in our investment portfolio at September 30, 2008. Based upon our current operating plans, which include assumptions of cash proceeds from business development activities, we expect the resources of our United States operations to be sufficient to fund our planned United States operations into 2011.

Our operating activities used cash of $43.6 million for the nine months ended September 30, 2008 and used cash of $34.8 million for the nine months ended September 30, 2007. Our increase in the net use of cash in operating activities is primarily attributed to our $10.8 million increase in net loss which is a result of increased external clinical trial costs for our four major product candidates.

Our investing activities provided cash of $41.7 million for the nine months ended September 30, 2008 and provided cash of $31.2 million for the nine months ended September 30, 2007. The cash provided by investing activities for both periods was primarily due to sales and maturities of short-term investments. We incurred $2.2 million and $6.0 million in capital expenditures for the nine months ended September 30, 2008 and 2007, respectively, principally related to lab and computer equipment for our office and laboratory facility in Cambridge, Massachusetts. We do not expect to incur significant capital expenditures in the fourth quarter of 2008.

Our financing activities provided cash of $2.8 million for the nine months ended September 30, 2008 and provided cash of $8.0 million for the nine months ended September 30, 2007. The amount in the nine months ended September 30, 2008 is primarily due to the issuance of a $5.0 million convertible promissory note to Biomedical Sciences Investment Fund Pte. Ltd., or Biomedical Sciences, by CombinatoRx Singapore, offset by the repayment of our notes payable to GECC. The amount in the nine months ended September 30, 2007 is primarily due to increased borrowings under our equipment lines of credit of $6.0 million, partially offset by repayments of $2.0 million, and the issuance of a $3.5 million convertible promissory note to Biomedical Sciences by CombinatoRx Singapore. For the nine months ended September 30, 2008, we received $6.5 million in payments from our collaborations and research and development agreements with CFFT, CHDI, Inc., the DMD Foundations, LSTM, and government contracts and grants from the NIAID, USAMRIID and the EDB. We expect that our sources of funding for the next several years will continue to include, in addition to funds raised through the sale of equity, and subject to our satisfying conditions, additional research funding, license fees, potential milestone payments and royalties relating to our collaborative agreements with Angiotech, CFFT, CHDI, Inc., Fovea, LSTM, the DMD Foundations and government grants from the NIAID, USAMRIID and the EDB and any other collaborative agreements into which we might enter.

On October 29, 2008, we committed to a restructuring plan that will result in a reduction of approximately 45% of our United States workforce at our Cambridge, Massachusetts location. The restructuring is a result of a strategic realignment to focus efforts on near-term value drivers and to conserve capital. Employees received notification on October 30, 2008 and will be provided with severance payments and outplacement assistance. We expect to complete the restructuring by December 2008.

As a result of the restructuring plan, we plan to record a restructuring charge of between approximately $1.6 million and $2.0 million in the fourth quarter of 2008, representing cash payments for severance and other personnel-related expenses. We may also incur further restructuring charges that could be significant due to events that may occur as a result of, or associated with, the restructuring plan, including facilities-related costs. The majority of the severance payments will be paid out during the fourth quarter of 2008 and will continue into the first quarter of 2009.

Contractual Obligations

As described in the Liquidity and Capital Resources section, the following table summarizes our contractual obligations at September 30, 2008 and the effects such obligations are expected to have on our liquidity and cash flows in future periods. Other than as set forth in the table below, there have been no additional material contractual obligations incurred by us that materially changes the disclosure of our contractual obligations in our Form 10-K for the year ended December 31, 2007.

Contractual Obligations	Total		2008		2009 through 2010		2011 through 2012		After 2012
Short and long-term debt:
General Electric Capital(1)	$	6,946	$	954	$	5,414	$	578	$	—
Notes payable issued to BioMedical Sciences(2)		20,122		—		20,122		—		—
Operating lease obligations:
Cambridge facility(3)		24,266		679		5,430		5,777		12,380
Singapore facility(4)		249		40		209		—		—
Total contractual obligations	$	51,583	$	1,673	$	31,175	$	6,355	$	12,380

(1) This amount represents indebtedness incurred by us and CombinatoRx Singapore and includes approximately $0.7 million in interest payments. Our equipment lines of credit with General Electric Capital Corporation and its affiliates contain a subjective acceleration clause which provides the lender the ability to demand repayment of the loan upon a material adverse event.

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(2) Represents $17.5 million in principal amount of convertible promissory notes issued by CombinatoRx Singapore to BioMedical Sciences on August 30, 2005, June 8, 2006, May 30, 2007 and August 5, 2008 and interest of $2.6 million. The notes bear interest at an annual rate of 5% and are due and payable on December 31, 2009, unless we elect to prepay the notes before that date through CombinatoRx Singapore. The notes are secured by a security interest in the non-intellectual property assets of the subsidiary and by a negative pledge by the subsidiary with respect to its intellectual property rights. We have pledged our shares in CombinatoRx Singapore as additional collateral for the subsidiary’s obligations under the notes. The notes are convertible into our common stock at the option of BioMedical Sciences only upon maturity, acceleration or default of any proposed prepayment.

(3) On October 18, 2005, we entered into a lease agreement for approximately 40,000 square feet of office and laboratory space in Cambridge, Massachusetts. On March 9, 2006, we entered into an amendment to the lease agreement for an additional approximately 23,000 square feet of laboratory space. The lease term, as amended, extends through January 2017. Our obligations under the original lease and the March 2006 lease amendment are reflected as operating lease obligations in the table above. Our payment obligations under the amended lease are supported by standby letters of credit totaling $4.0 million.

(4) On February 16, 2006, we entered into a lease agreement for approximately 4,800 square feet of office and laboratory space in Singapore. The lease term extends until April 2010. Our obligations under the lease are reflected as operating lease obligations in the table above. Our payment obligations are supported by a security deposit equal to one month of rent.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements or relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

We are exposed to market risk related to changes in interest rates and changes in the exchange rate of the United States dollar to the Singapore dollar. As of September 30, 2008, we had unrestricted cash, cash equivalents and marketable securities of $65.4 million consisting of cash and highly liquid and short-term investments. Our cash is deposited in and invested through highly rated financial institutions in North America and Singapore. Our marketable securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 5% from levels at September 30, 2008, we estimate that the fair value of our investments would decline by an immaterial amount; and therefore, our exposure to interest rate changes is immaterial. Our outstanding notes payable are at fixed interest rates and, therefore, have minimal exposure to changes in interest rates.

Transactions by our subsidiary, CombinatoRx Singapore, may be denominated in a currency other than the entity’s functional currency, which is the United States dollar. Exchange gains or losses resulting from the translation between the currency in which a transaction is denominated and CombinatoRx Singapore’s functional currency are included in net loss for our consolidated financial statements and are immaterial. Fluctuations in exchange rates, primarily between the United States dollar and the Singapore dollar, may adversely affect our results of operations, financial position and cash flows.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a–15(b) of the Securities Exchange Act of 1934, as amended (the “1934 Act”), the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective at the reasonable assurance level in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control

As required by Rule 13a-15(d) of the 1934 Act, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the internal control over financial reporting to determine whether any changes occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded no such changes during the fiscal quarter covered by this Quarterly Report on Form 10-Q materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II

Item 1. Legal Proceedings

We are currently not a party to any material legal proceedings.

Item 1A. Risk Factors

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

Investment in our common stock involves a high degree of risk and uncertainty. You should carefully consider each of the risks and uncertainties described below before you decide to invest in our common stock. If any of the following risks and uncertainties actually occurs, our business, financial condition, and results of operations could be severely harmed. This could cause the trading price of our common stock to decline, and you could lose all or part of your investment.

Risks Related to Our Discovery, Development and Commercialization of Combination Drugs

Our approach to the discovery and development of combination drugs is unproven and may never lead to commercially viable products.

Our approach to drug discovery and development is complex and unproven and has not been successfully used or, to our knowledge, attempted by any company. Previously unrecognized or unexpected defects or limitations to our drug discovery technology or drug development strategy may emerge, which we may also be unable to overcome or mitigate. None of the product candidates identified or developed to date, through the application of our business model and drug discovery technology, has been approved by any regulatory agency for commercial sale or been commercialized.

While we have often advanced and continue to advance our product candidates into Phase 2a proof-of-concept and Phase 2 clinical trials on the basis of their approved drug components, these product candidates have and could fail in these or future clinical trials. In addition, in some cases we have been required to conduct additional preclinical and Phase 1 clinical studies for our product candidates prior to Phase 2a proof-of-concept clinical trials, and we may be required to conduct these studies in connection with the formulations of our product candidates we have developed or plan to develop. If the additional preclinical or Phase 1 clinical studies required for a product candidate or its new formulation are extensive, it could delay or prevent further development of the product candidate. Regulatory approval for a combination drug generally requires clinical trials to compare the activity of each component drug with the combination. As a result, it may be more difficult and costly to obtain regulatory approval of a combination drug than of a new drug containing only a single active pharmaceutical ingredient. In some instances, we may choose to advance product candidates where one or more of the compounds of the combination are not approved drugs, which may lead to longer clinical development timelines for these types of product candidates.

Our business model is dependent on the ability of our proprietary high throughput discovery technology to identify additional promising product candidates. High throughput screening involves testing large numbers of compounds in cell-based assays using automated systems that measure the biological activity of the compounds and provide detailed data regarding the results. Because our high throughput discovery technology is unproven in identifying drugs that can be approved, we cannot be certain that we will be able to discover additional drug combinations that show promising effects in our cell-based disease models and preclinical studies, which we can advance into clinical trials. As a result, we may not be able to identify additional product candidates. Many other companies with substantially greater resources than ours use high throughput screening for drug discovery. These or other companies may have developed or could in the future develop combination screening technology equal or superior to our technology.

For these and other reasons, our approach to drug discovery and development may not be successful and our business model may not generate viable products or revenue. Even if our approach is theoretically viable, we may not complete the significant research and development or obtain the financial resources and personnel required to further develop and apply our discovery technology, advance promising product candidates to and through clinical trials, and obtain required regulatory approvals.

Our results to date provide only a limited basis for predicting whether any of our product candidates will be safe or effective, or receive regulatory approval.

All of our product candidates are in an early stage of development and their risk of failure is high. The data supporting our drug discovery and development programs is derived from either laboratory and preclinical studies and limited early stage clinical trials that were not all designed to be statistically significant or proof-of-concept or Phase 2 clinical trials, some of which are exploratory in nature. We cannot predict when or if any one of our product candidates will prove effective or safe in humans or will receive regulatory approval. If we are unable to discover or successfully develop drugs that are effective and safe in humans, we will not have a viable business.

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The approved drugs included in our product candidates may have adverse or unacceptable side effects and we may not be able to achieve an acceptable level of side effect risks, compared to the potential therapeutic benefits, for our product candidates.

The approved drugs included in our combination product candidates have known adverse side effects. These side effects may be acceptable when an ingredient is used in its approved dosage to achieve a therapeutic benefit for its currently approved indications, but the side effect risk compared to the therapeutic benefit may not be acceptable when used for the intended indications for the product candidate. These side effects may also make it difficult for us to obtain regulatory or other approval to initiate clinical trials of our product candidates. In addition, the therapeutic effect of an approved drug in its currently approved indications may be inappropriate or undesirable in the intended indication for our product candidate. Also, the adverse side effects of an approved drug may be enhanced when it is combined with the other approved drug in the product candidate or other drugs patients are taking, or the combined drugs in a product candidate may produce additional side effects. Adverse side effects of the approved drugs could, in any of these situations, prevent successful development and commercialization of some or all of our product candidates, because the risks associated with the approved drug component may outweigh the therapeutic benefit of the combination.

The development of a product candidate could be adversely affected by safety or efficacy issues that subsequently arise or become the focus of increased attention or publicity regarding use of either of the approved drugs which comprise the product candidate or similar drugs. We could be forced to abandon a product candidate or an approved product due to adverse side effects from long-term or other use of one of the active pharmaceutical ingredients in the product candidate or product, even if such long-term or other use is not contemplated for such product candidate or product.

Several of our product candidates seek to increase the therapeutic effect of a reduced-dose oral glucocorticoid or mid-potency topical glucocorticoid by the combination of such glucocorticoid with a second pharmaceutical ingredient that serves as an enhancer agent. The adverse side effects of the steroids and the antidepressant or other enhancer agent included in these drug candidates are significant and generally increase as their dosage and/or duration of therapy increases. As a result, the success of these product candidates depends upon the ability of an acceptable dose of the candidate’s enhancer agent to selectively amplify the therapeutic effect of a reduced-dose glucocorticoid or mid-potency glucocorticoid, without causing unacceptable expected or unexpected adverse side effects. To achieve sufficient efficacy in humans, we may need to include higher doses of the glucocorticoid, or of the enhancer agent, than we expected to include based on our screening procedures, preclinical trials and limited clinical trials. As a result, our product candidates could have greater adverse side effects than anticipated and could fail to achieve risk-to-benefit profiles that would justify their continued development.

Certain antidepressants, including the antidepressants in our product candidates, CRx-139, CRx-170, CRx-191 and CRx-197, carry a black box warning and expanded warning statements that alert health care providers to an increased risk of suicidality in children and adolescents being treated with these drugs. Several scientific publications also suggest the possibility of an increased risk for suicidal behavior in adults, in addition to children and adolescents, who are being treated with antidepressant medications. In particular, studies and publications suggest that selective serotonin reuptake inhibitors, including the antidepressant included in CRx-139, may increase the risk of suicidal behavior in adults. In 2006, the FDA reviewed all available data and determined there is an increased risk of suicidality in adults being treated with antidepressant medications, particularly young adults. Additional product labeling or even suspension of the use of some or all of the anti-depressants included in our product candidates would delay or prevent the continuation of our clinical trials, development and eventual commercialization of these product candidates. The occurrence of the adverse side effects described in the black box warning during the development of the CRx-197 product candidate could lead to product liability claims.

Diflunisal, a component of our CRx-401 product candidate, is a member of the NSAID (non steroidal anti-inflammatory drug) class, which carries an FDA-required black box warning alerting physicians to the potential for increased thrombotic cardiovascular events (including heart attacks and stroke) which may increase with duration of use, an increased risk of serious gastrointestinal adverse events including bleeding, ulceration, and perforation of the stomach or intestines, which could be fatal and the fact that diflunisal is contraindicated for the treatment of peri-operative pain in the setting of coronary artery bypass graft (CABG) surgery. The occurrence of the adverse side effects described in the diflunisal black-box warning during the development of our CRx-401 product candidate could make it inadvisable to continue development of CRx-401 or lead to difficulty in obtaining regulatory approval or other approval for clinical trials, the termination of our clinical trials or could result in product liability claims.

Significant adverse side effects of the component drugs included in our clinical stage product candidates include: in the case of our product candidate Synavive, headache, nausea, dizziness, diarrhea, muscle and bone loss, diabetes, dyslipidemia, osteoporosis, fractures, weakness, adrenal suppression, infections, abdominal distress, peptic ulceration, arrhythmias, cataracts, glaucoma and myopathy; in the case of our product candidates CRx-191 and CRx-197 burning, skin atrophy, stinging, adrenal suppression, suicidality, headache, drowsiness, fatigue, nervousness, constipation, nausea, blurred vision, abdominal distress, tachycardia, and arrhythmias; in the case of our product candidate CRx-401 heart attack, stroke, hypertension, bleeding, ulceration, and perforation of the stomach or intestines, diarrhea, constipation, flatulence, liver effects, renal impairment, drowsiness, insomnia, dizziness, headache, fatigue, nausea, muscular pain, weakness or cramps and alopecia; and in the case of our product candidates CRx-139 and CRx-170, drowsiness, muscle and bone loss, fractures, adrenal suppression, cataracts, glaucoma, nausea, birth defects,

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suicidality, infections, constipation and abdominal distress. These side effects are not the only side effects of the components of our clinical stage product candidates, but are provided based on their severity and expected frequency of occurrence. The occurrence of these or other significant adverse side effects such as electrocardiogram changes, hepatic or renal dysfunction, infections, weight gain, immunosuppression, tachycardia and agranulocytosis could make it inadvisable to continue development of a product candidate or lead to difficulty in obtaining regulatory or other approval for clinical trials of our product candidates, the termination of our clinical trials or could result in product liability claims.

The active pharmaceutical ingredients in our product candidates may produce adverse side effects when delivered in combination.

While an active pharmaceutical ingredient in one of our product candidates may be safe, or have an acceptable risk-to-benefit profile when administered as a single agent for its approved indications, the same active pharmaceutical ingredient when delivered in combination with the other active pharmaceutical ingredient in the product candidate or other drugs being taken by patients we are seeking to treat may cause serious unexpected or unacceptable adverse side effects. Our discovery technology is not designed to and does not detect adverse side effects that may result from the combination of the two drugs, and these side effects may not be detected in any preclinical toxicology studies we conduct. Side effects resulting from the delivery in combination of our product candidates or the interaction with other drugs could be discovered in the course of performing clinical trials of our product candidates. In addition, the active pharmaceutical ingredients in a product candidate may not be approved for treatment of the product candidate’s targeted disease and may result in additional adverse side effects not typically associated with products for treatment of such a disease. The FDA or other regulators could require preclinical and Phase 1 studies testing for combination side effects before we advance product candidates to further clinical trials.

Our product candidates are generally combinations of approved drugs that are commercially available and marketed by other companies. As a result, our products may be subject to substitution and competition.

We anticipate that the approved drugs that are combined to produce our product candidates are likely to be commercially available at prices lower than the prices at which we would seek to market our product candidates. Even with new formulations, we cannot be sure that physicians will view our products as sufficiently superior to a treatment regimen of the individual active pharmaceutical ingredients as to justify the significantly higher cost we expect to seek for our combination products, and they may prescribe the individual drugs already approved and marketed by other companies instead of our combination products. Even if we are issued patents covering the composition of matter, method of use or formulations of our combination products, those patents may be ineffective as a practical matter to protect against physicians prescribing the individual drugs marketed by other companies instead of our combination products. To the extent that the price of our products is significantly higher than the prices of the individual components as marketed by other companies, physicians may have a greater incentive to write prescriptions for the individual components instead of for our combination products, and this may limit how we price our products. Similar concerns could also limit the reimbursement amounts private health insurers or government agencies in the United States are prepared to pay for our products, which could also limit market and patient acceptance of our products, and could negatively impact our revenues and net income, if any. Physicians might also prescribe the individual components of a product candidate prior to its approval, which could adversely affect our development of the product candidate due to our lack of control over the administration to patients of the combination of active pharmaceutical ingredients in our product candidate, the occurrence of adverse effects, and other reasons. Such pre-approval use could also adversely affect our ability to market and commercialize any such product candidate which we successfully develop.

In many countries where we plan to market our products, including Europe, Japan and Canada, the pricing of prescription drugs is controlled by the government or regulatory agencies. Regulatory agencies in these countries could determine that the pricing for our products should be based on prices for their active pharmaceutical ingredients when sold separately, rather than allowing us to market our products at a premium as new drugs.

We must create commercially viable pharmaceutical formulations for our product candidates.

The success of our product candidates will depend on our ability to develop a formulation of the product candidate that is superior to a treatment regimen of the two approved drugs included in the product candidate taken separately. In some instances, to be commercially successful, this formulation must have a different method of administration than the approved drugs. We have developed or are developing proprietary formulations for our most advanced product candidates. Developing such proprietary formulations is costly and difficult, and we have limited experience in developing formulations ourselves. We are relying on and expect to rely on third-party suppliers to develop the pharmaceutical formulations, delivery methods or packaging for our product candidates and they may not be successful in doing so or may experience delays in doing so that could delay our clinical trials, and ultimately our ability to obtain approval of our product candidates. Defects in the formulation, delivery method or packaging of any of our product candidates could delay our ability to conduct clinical trials or require us to repeat clinical trials using a revised formulation, delivery method or packaging. If we are unsuccessful in creating commercially viable formulations, delivery methods or packaging, we may never generate product revenue or be profitable.

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We are also undertaking some efforts to utilize medicinal chemistry to potentially develop new product candidates or to potentially create next-generation versions of our existing product candidates. We have only limited experience with medicinal chemistry and research and development regarding new chemical entities. We may be completely unsuccessful in finding new product candidates or in discovering potential next-generation product candidates. In addition, development and regulatory approval timelines for these product candidates will be longer in duration that the timelines for our combination product candidates.

We may not be able to initiate and complete clinical trials for our product candidates.

Conducting clinical studies for any of our drug candidates requires finding appropriate clinical sites and clinical investigators, securing approvals for such studies from the independent review board at each such site and local regulatory authorities and enrolling sufficient numbers of patients. We may not be able to arrange for appropriate clinical trials for our product candidates, secure the necessary approvals or enroll the necessary number of participants. We recently terminated enrollment in a Phase 2b clinical study of Synavive in rheumatoid arthritis due to delays in the enrollment associated with competing therapies otherwise available to the relevant patient population, enrollment criteria that required the discontinuance of glucocorticoid use by subjects and issues with third-party contract research organizations and third-party suppliers of clinical trial material. In addition, we cannot guarantee that outside clinical investigators conducting our clinical trials will conduct them in compliance with applicable United States or foreign regulations. Clinical sites may fail the FDA’s or other regulatory agencies’ inspections or reviews, and our trials could be halted for these or other reasons. We are conducting and planning to conduct additional proof-of-concept clinical trials as well as Phase 2b clinical trials for some of our product candidates. These clinical trials may be in indications where we do not have prior experience or may be of a size and scope greater than what we have undertaken before, and this lack of experience or size may lead to delays in enrollment and other aspects of the trials. We have contracted with third-party clinical research organizations to conduct some of our Phase 2b and other Phase 2 proof-of-concept clinical trials for our product candidates and plan to continue to do so. These organizations may not completely perform their contractual obligations regarding the trial, or may not diligently or completely perform their tasks with respect to clinical trials under their supervision. As a result of these risks, our clinical trials may be extended, delayed or terminated, which could delay the receipt of clinical results for our product candidates, which could delay, impede or stop the development, regulatory approval or successful commercialization of our product candidates.

We may be unable to find safe and effective doses and dose ratios for our product candidates without extensive clinical trials and substantial additional costs, if at all.

We must select the doses, including the amount, frequency and duration, of each of the two active pharmaceutical ingredients included in our product candidates, and the relative amounts, or dose ratios, of these doses. Our clinical trials in humans may show that the doses or dose ratios we select based on our high throughput screening, animal testing or early clinical trials do not achieve the desired therapeutic effect in humans, or achieve this effect only in a small part of the population. Even if the doses or dose ratios we select show efficacy in humans, the resulting doses or dose ratios of our active pharmaceutical ingredients may not have acceptable safety profiles for our targeted indications. Furthermore, even if we believe that our preclinical and clinical studies adequately demonstrate that the doses or dose ratios we select for our product candidates are safe and effective in humans, the FDA or other regulatory agencies in foreign jurisdictions may conclude that our clinical trials do not support our conclusion. We may be required to conduct additional long-term clinical studies and provide more evidence substantiating the safety and effectiveness of the doses or dose ratios we select in a significant patient population. If we need to adjust the doses or dose ratios, we may need to conduct new clinical trials. We may also be required to make different doses or dose ratios available for different types of patients. All of this may result in significant delays and additional costs or prevent commercialization of our product candidates.

We may fail to select or capitalize on the most scientifically, clinically or commercially promising or profitable product candidates.

We may make incorrect determinations as to which of our product candidates should proceed to initial clinical trials, later stage clinical development and potential commercialization. Our decisions to allocate our research, management and financial resources toward particular product candidates or therapeutic areas may not lead to the development of viable commercial products and may divert resources from better opportunities. Similarly, our decisions to delay or terminate drug development programs may also be incorrect and could cause us to miss valuable opportunities.

We have no sales or distribution capabilities and may not obtain the collaboration, development, commercialization, manufacturing or other third-party relationships that we will require to develop, commercialize and manufacture some or all of our product candidates.

We have no sales or distribution capabilities and lack the resources, capabilities, and experience necessary to clinically develop, formulate, test, market and sell pharmaceuticals. As a result, to succeed in our business plan, we will be dependent on the efforts of third parties. We depend on collaborators, licensees, clinical research organizations and other third parties to formulate product candidates and to conduct clinical trials for some or all of our product candidates. We also rely on obtaining sufficient quantities of the approved drugs in our product candidates from sources acceptable to the FDA and other regulators for early stage clinical trials.

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We expect to be able to develop and commercialize many of our product candidates only with the participation of pharmaceutical or biotechnology company collaborators or by out-licensing rights to the product candidates. Pharmaceutical and biotechnology companies and others may be reluctant to collaborate with us or to license rights to our product candidates due to the unproven nature of our drug discovery and development approach, the fact that the active pharmaceutical ingredients in our product candidates are approved drugs marketed by other companies, the risk that healthcare providers may substitute the component active pharmaceutical ingredients for our proposed combination products, concerns regarding the pricing of and reimbursement for our product candidates if they are successfully developed, or other factors.

We cannot guarantee that we will be able to successfully negotiate agreements for relationships with collaborators, partners, licensees, clinical investigators, manufacturers and other third parties on favorable terms, if at all. If we are unable to obtain these agreements, we may not be able to clinically develop, formulate, manufacture, test, obtain regulatory approvals for or commercialize our product candidates.

We expect to expend substantial funds and management time and effort to enter into relationships with these third parties and, if we successfully enter into such relationships, to manage these relationships. However, we cannot control the amount or timing of resources our contract partners will devote to our research and development programs, product candidates or potential product candidates, and we cannot guarantee that these parties will succeed in a timely fashion, if at all.

Because we have limited manufacturing experience, we depend on third-party manufacturers to manufacture product candidates for us. Failure of these manufacturers to perform could lead to delays in the clinical trials of our product candidates or costs and delays associated with contracting with new manufacturers.

We do not have any manufacturing experience, nor do we have any manufacturing facilities. We plan to rely upon third-party manufacturers to manufacture all clinical trial supplies of our product candidates. We depend on these third-party manufacturers to perform their obligations in a timely manner and in accordance with applicable governmental regulations. In most cases, we only have a single contract manufacturer making one of our product candidates, in which case there is a concentration of risk of non-performance with that single manufacturer that would be costly to mitigate or could lead to the delay, suspension or termination of one of our clinical trials if the manufacturer is unable to perform.

Our third-party manufacturers may encounter difficulties with meeting our requirements, including problems involving:

• inconsistent production yields;

• poor quality control and assurance or inadequate process controls; and

• lack of compliance with regulations set forth by the FDA or other foreign regulatory agencies.

These contract manufacturers may not be able to manufacture our product candidates at a cost or in quantities necessary to make them commercially viable. We also have no control over whether third-party manufacturers breach their agreements with us or whether they may terminate or decline to renew agreements with us. Changes in the manufacturing process or procedure, including a change in the location where the drug is manufactured or a change of a third-party manufacturer, require prior FDA review and approval in accordance with the FDA’s current Good Manufacturing Practices, or cGMPs or comparable foreign requirements. This review may be costly and time-consuming and could delay or prevent the use of the product candidate in clinical trials or the launch of a product. The FDA or similar foreign regulatory agencies at any time may also implement new standards, or change their interpretation and enforcement of existing standards for manufacture, packaging or testing of products. If we or our contract manufacturers are unable to comply, we or they may be subject to regulatory action, civil actions or penalties.

If we are unable to enter into agreements with additional manufacturers on commercially reasonable terms, or if there is poor manufacturing performance on the part of our third-party manufacturers, we may not be able to complete development of, or market, our product candidates.

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Financing arrangements for our subsidiary CombinatoRx (Singapore) Pte Ltd, which we refer to as CombinatoRx Singapore, may impact our liquidity, cause substantial dilution to our stockholders, limit our control over important development decisions, divert resources away from other projects, prevent us from entering into relationships with third parties for infectious disease indications and result in the loss of significant intellectual property rights.

Our Singapore subsidiary has issued convertible promissory notes with an aggregate principal amount of $17.5 million to BioMedical Sciences. These convertible notes will be due and repayable by our Singapore subsidiary on December 31, 2009, at which time, with accrued interest, there will be a $20.1 million debt obligation of our Singapore subsidiary. The convertible notes may be converted into shares of our common stock at the election of BioMedical Sciences upon maturity, but if they are not, our Singapore subsidiary may not have the financial resources to repay the convertible notes in full. We have not provided a guaranty of the convertible notes issued by our Singapore subsidiary, and there is no payment recourse to us, but if our subsidiary defaults on its payment obligations to BioMedical Sciences, we could lose our entire interest in the subsidiary and have no further ability to commercialize the intellectual property assigned to the subsidiary for the therapeutic treatment of infectious diseases.

Exercise by BioMedical Sciences of the rights granted to it to convert its shares of preferred stock in our Singapore subsidiary and convertible promissory notes issued by our Singapore subsidiary that they hold into shares of our common stock could result in substantial dilution to our stockholders. BioMedical Sciences may convert its shares of convertible preferred stock and convertible promissory notes in our Singapore subsidiary issued on August 30, 2005 into our common stock at a conversion price of $10.80 per share, in the case of the convertible promissory note issued by our Singapore subsidiary with a $3.5 million principal amount on June 8, 2006, the conversion price is $11.57 per share, in the case of the convertible promissory note issued by our Singapore subsidiary with a $3.5 million principal amount on May 30, 2007, the conversion price is $9.11 per share, and in the case of the convertible promissory notes issued by our Singapore subsidiary with a $5.0 million principal amount on August 5, 2008, the conversion price is $5.19 per share. These prices may be less than the market price of our shares at the time of conversion or the price per share paid by investors in our common stock.

As a condition of the financing provided to our subsidiary by BioMedical Sciences, we agreed to enter into a Services Agreement requiring us to provide substantial assay development and screening services to our subsidiary over the next three years and to assign to our subsidiary ownership of all intellectual property rights covering combination therapies for the treatment of infectious disease discovered by us through our work under the Services Agreement. We have also agreed to provide screening services in the field of the therapeutic treatment of infectious disease through combination therapies exclusively to the subsidiary and not to compete with the subsidiary, which will prevent us from doing work in infectious disease indications for third parties. We will commit substantial personnel resources to support operations of the subsidiary, both directly and under the Services Agreement, which could adversely affect our other operations. The performance of this work for the subsidiary may limit our ability to perform work on other disease indications. Assignment of the intellectual property rights to the subsidiary exposes us to the risk that the subsidiary may be unable to successfully develop promising therapies.

Our Singapore subsidiary will need substantially greater resources to commercialize any promising combination therapy than the resources provided by the BioMedical Sciences financing and may not be able to obtain such financing on terms acceptable to the subsidiary, us or BioMedical Sciences. BioMedical Sciences has extensive control over the operations of the subsidiary and we will not control development decisions regarding the combination therapies assigned to the subsidiary or other major decisions to be made in regard to the subsidiary.

Our equity interest in the subsidiary is illiquid and cannot be transferred or sold for at least four years from inception. In addition, our equity interest in the Singapore subsidiary is junior to the preferred stock and secured convertible promissory notes of the subsidiary held by Biomedical Sciences, and would likely be worthless in the event of any liquidation or forced sale of the subsidiary or its assets.

A material component of our business strategy is to establish and maintain collaborative relationships to fund research and possible development and commercialization of combination product candidates, by us or by collaborators. If we or any collaborator terminates or fails to perform any obligations under our collaboration agreements, the development and commercialization of product candidates under these agreements could be delayed or terminated.

A material component of our business strategy is to establish and maintain collaborative arrangements with pharmaceutical, biotechnology and medical device companies, research institutions and foundations, and to seek grants from agencies of the United States government, to fund research and possible development and commercialization of combination drug products for the treatment of diseases. We also intend to seek to establish collaborative relationships to obtain domestic or international sales, marketing and distribution capabilities if any of our combination product candidates receive regulatory approval.

The process of establishing collaborative relationships is difficult, time-consuming and involves significant uncertainty. Moreover, even if we do establish collaborative relationships, it may be difficult for us to maintain or perform under such

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collaboration arrangements, as our funding resources may be limited or our collaborators may seek to renegotiate or terminate their relationships with us due to unsatisfactory research or clinical results, a change in business strategy, a change of control or other reasons. If we or any collaborator fails to fulfill any responsibilities in a timely manner, or at all, our research, clinical development or commercialization efforts related to that collaboration could be delayed or terminated. Additionally it may become necessary for us to assume responsibility for activities that would otherwise have been the responsibility of our collaborator. Further, if we are unable to establish and maintain collaborative relationships on acceptable terms, we may have to delay or discontinue further development of one or more of our product candidates, undertake development and commercialization activities at our own expense or find alternative sources of funding.

Our collaborations are generally new, and we have only a short history of working together with Angiotech, Fovea, CFFT, CHDI, HenKan, the DMD Foundations or our other collaborators and cannot predict the success of any of our collaborations. Our collaborations typically involve a complex allocation of responsibilities, costs and benefits and provide for milestone payments to us upon the achievement of specified clinical and regulatory milestones. Our collaborations also may provide us with royalty-based revenue if product candidates are successfully commercialized. Under the Angiotech and other collaborations, we will rely on our collaborators to provide resources to develop new product candidates and to potentially achieve these milestones and commercialize any new products. We may not be able to achieve any of the milestones provided in our Angiotech or other collaboration agreements or derive any license or royalty revenue with respect to these collaborations.

Disputes under key agreements could delay or prevent development or commercialization of our product candidates.

Any agreements we have or may enter into with third parties, such as collaboration, license, formulation supplier, manufacturing, testing, clinical research organization or clinical trial agreements, may give rise to disputes regarding the rights and obligations of the parties. Disagreements could develop over rights to ownership or use of intellectual property, the scope and direction of research and development, the approach for regulatory approvals or commercialization strategy. We intend to conduct research programs in a range of therapeutic areas, but our pursuit of these opportunities could result in conflicts with the other parties to these agreements who may be developing or selling pharmaceuticals or conducting other activities in these same therapeutic areas. Any disputes or commercial conflicts could lead to the termination of our agreements, delay progress of our product development programs, compromise our ability to renew agreements or obtain future agreements, lead to the loss of intellectual property rights or result in costly litigation.

We may not be able to gain market acceptance of our product candidates, which would prevent us from becoming profitable.

We cannot be certain that any of our product candidates, if approved, will gain market acceptance among physicians, patients, healthcare payors, pharmaceutical companies or others. Demonstrating the safety and efficacy of our product candidates and obtaining regulatory approvals will not guarantee future revenue. Sales of medical products largely depend on the reimbursement of patients’ medical expenses by government healthcare programs and private health insurers. Governments and private insurers closely examine medical products to determine whether they should be covered by reimbursement and if so, the level of reimbursement that will apply. We cannot be certain that third-party payors will sufficiently reimburse sales of our products, or enable us to sell our products at profitable prices. Sales of medical products also depend on physicians’ willingness to prescribe the treatment, which is likely to be based on a determination by these physicians that the products are safe, therapeutically effective and cost-effective. We cannot predict whether physicians, other healthcare providers, government agencies or private insurers will determine that our products are safe, therapeutically effective and cost effective relative to competing treatments, including a treatment regimen of the individual approved drugs included in our combination products.

If we are not able to retain our current senior management team or attract and retain qualified scientific, technical and business personnel, our business will suffer.

We are dependent on the members of our management team for our business success. In addition, an important element of our strategy is to take advantage of the development, regulatory and commercialization expertise of our current management. Our employment agreements with our executive officers are terminable on short notice or no notice. The loss of any one of our executive officers could result in a significant loss in the knowledge and experience that we, as an organization, possess and could cause significant delays, or outright failure, in the development and further commercialization of our product candidates.

To execute on our business plan, we will need to hire and retain a significant number of qualified commercial, scientific and administrative personnel. However, there is intense competition for human resources, including management in the technical fields in which we operate, and we may not be able to attract and retain qualified personnel necessary for the successful development and commercialization of our product candidates. The inability to attract new employees when needed or to retain existing employees could limit our ability to execute on our business plan and may harm our business.

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We may need to further modify the size of our organization and reduce expenses, and we may experience difficulties in managing restructurings.

In October 2008, we undertook an organizational restructuring that reduced our United States workforce by approximately 45%. Effecting any restructuring places significant strains on management, our employees and our operational, financial and other resources. Furthermore, restructurings take time to fully implement and involve certain additional costs, including severance payments to terminated employees, and we may also incur liabilities from early termination or assignment of contracts, potential litigation or other effects from such restructuring. Such effects from our restructuring program could have a material adverse affect on our ability to execute on our business plan. There can be no assurance that we will be successful in implementing our restructuring program.

Future growth would impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Any future restructuring activities may involve significant changes to our drug development and business strategies and other operational capabilities as we may need to take additional measures such as curtailing discretionary spending or capital expenditures, as well as other steps to reduce expenses. Our future financial performance and our ability to develop our product candidates or our technology platform and to perform our obligations to collaboration partners effectively will depend, in part, on our ability to effectively manage any future growth or restructuring, as the case may be.

Risks Related to Our Financial Results and Need for Additional Financing

We have a history of operating losses, expect to incur significant and increasing operating losses and may never be profitable. Our stock is a highly speculative investment.

We commenced operations in March 2000 and have a limited operating history for you to evaluate our business. We have no approved products and have generated no product revenue. We have incurred operating losses since our inception in 2000. As of September 30, 2008, we had an accumulated deficit of $236.2 million. We have spent, and expect to continue to spend, significant resources to fund research and development of our product candidates and to enhance our drug discovery technology. We expect to incur substantial operating losses over the next several years due to our ongoing research, development, preclinical testing, and clinical trial activities increase. As a result, our accumulated deficit will also increase significantly.

Our product candidates are in the early stages of development and may never result in any revenue. We will not be able to generate product revenue unless and until one of our product candidates successfully completes clinical trials and receives regulatory approval. As our most advanced product candidates are in or recently emerged from Phase 2 clinical development, we do not expect to receive revenue from any product candidate for the next five years. We may seek to obtain revenue from collaboration or licensing agreements with third parties. Our current collaboration and license agreements may not provide us with material, sustainable ongoing future revenue, and we may not be able to enter into additional collaboration agreements. Even if we eventually generate product revenues, we may never be profitable, and if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

We may be unable to raise the substantial additional capital that we will need to sustain our operations.

We will need substantial additional funds to support our planned operations. Based on our current operating plans, which include assumptions of cash proceeds from business development activities, we expect the resources of our United States operation to be sufficient to fund our planned United States operations into 2011. We may, however, need to raise additional funds before that time if our research and development expenses exceed our current expectations or our collaboration funding is less than our current assumptions or expectations. This could occur for many reasons, including:

• some or all of our product candidates fail in clinical or preclinical studies or prove to be less commercially promising than we expect and we are forced to seek additional product candidates;

• our product candidates require more extensive clinical or preclinical testing or our clinical trials take longer to complete than we currently expect;

• we advance more of our product candidates than expected into costly later stage clinical trials;

• we advance more preclinical product candidates than expected into early stage clinical trials;

• we determine or are required to conduct more high throughput screening than expected against current or additional disease targets to develop additional product candidates;

• we are required, or consider it advisable, to acquire or license rights from one or more third parties; or

• we determine to acquire or license rights to additional product candidates or new technologies.

While we expect to seek additional funding through public or private financings, we may not be able to obtain financing on acceptable terms, or at all. In addition, the terms of our financings may be dilutive to, or otherwise adversely affect, holders of our

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common stock. We may also seek additional funds through arrangements with collaborators or others. These arrangements would generally require us to relinquish rights to some of our technologies, product candidates or products, and we may not be able to enter into such agreements, on acceptable terms, if at all. The arrangements also may include issuances of equity, which may also be dilutive to, or otherwise adversely affect, holders of our common stock. If we are unable to obtain additional funding on a timely basis, we may be required to curtail or terminate some or all of our research or development programs, including some or all of our product candidates.

Risks Related to Regulatory Approvals

The regulatory approval process is costly and lengthy and we may not be able to successfully obtain all required regulatory approvals.

The preclinical development, clinical trials, manufacturing, marketing, testing and labeling of pharmaceuticals and medical devices are all subject to extensive regulation by numerous governmental authorities and agencies in the United States and other countries. We or our collaborators must obtain regulatory approval for product candidates before marketing or selling any of them. The approval process is typically lengthy and expensive, and approval is never certain. It is not possible to predict how long the approval processes of the FDA or any other applicable federal or foreign regulatory authority or agency for any of our products will take or whether any such approvals ultimately will be granted. The FDA and foreign regulatory agencies have substantial discretion in the drug and medical device approval process, and positive results in preclinical testing or early phases of clinical studies offer no assurance of success in later phases of the approval process. Generally, preclinical and clinical testing of products and medical devices can take many years and require the expenditure of substantial resources, and the data obtained from these tests and trials can be susceptible to varying interpretations that could delay, limit or prevent regulatory approval. Any delay in obtaining, or failure to obtain, approvals could prevent or adversely affect the marketing of our products or our collaborator’s products and our ability to generate product revenue. The risks associated with the approval process include delays or rejections in the regulatory approval process based on the failure of clinical or other data to meet expectations, or the failure of the product or medical device to meet a regulatory agency’s requirements for safety, efficacy and quality. In addition, regulatory approval, if obtained, may significantly limit the indicated uses for which a product may be marketed.

We or our collaborators may delay, suspend or terminate clinical trials to obtain marketing authorization of any of our product candidates or their associated medical devices or products at any time for reasons including:

• ongoing discussions with the FDA or comparable foreign authorities regarding the scope or design of our clinical trials;

• delays or the inability to obtain required approvals from institutional review boards or other governing entities at clinical sites selected for participation in our clinical trials;

• delays in enrolling patients and volunteers into clinical trials;

• lower than anticipated retention rates of patients and volunteers in clinical trials;

• the need to repeat clinical trials as a result of inconclusive or negative results or poorly executed testing;

• lack of effectiveness of a product candidate in other clinical trials;

• lack of sufficient funds for further clinical development;

• insufficient supply or deficient quality of product candidate materials or other materials necessary to conduct our clinical trials;

• unfavorable regulatory inspection of a manufacturing, testing, labeling or packaging facility for drug substance or drug product;

• unfavorable regulatory inspection and review of a clinical or preclinical trial site or records of any clinical or preclinical investigation;

• serious and unexpected drug-related side effects or serious adverse safety events experienced by participants in our clinical trials or by patients following commercialization; or

• the placement of a clinical hold on a product candidate in an ongoing clinical trial.

Positive or timely results from preclinical studies and early clinical trials do not ensure positive or timely results in late stage clinical trials or product approval by the FDA or any other regulatory authority. Product candidates that show positive preclinical or early clinical results often fail in later stage clinical trials. Data obtained from preclinical and clinical activities is susceptible to varying interpretations, which could delay, limit, or prevent regulatory approvals.

We have limited experience in conducting the clinical trials required to obtain regulatory approval. We may not be able to conduct clinical trials at preferred sites, enlist clinical investigators, enroll sufficient numbers of patients, or begin or successfully complete clinical trials in a timely fashion, if at all. Any failure to perform may delay or terminate the trials. Our current clinical trials

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may be insufficient to demonstrate that our potential products are active, safe, or effective and as a result we may decide to abandon further development of such product candidates. Additional clinical trials may be required if clinical trial results are negative or inconclusive, which will require us to incur additional costs and significant delays. If we do not receive the necessary regulatory approvals, we will not be able to generate product revenues and will not become profitable. We may encounter significant delays in the regulatory process that could result in excessive costs that may prevent us from continuing to develop our product candidates. In addition, the failure to comply with applicable regulatory requirements may result in criminal prosecution, civil penalties, product recalls, withdrawal of product approval, mandatory restrictions or other actions that could impair our ability to conduct our business.

The FDA and other regulatory agencies may require additional preclinical and Phase 1 clinical data for our combination products.

Our proposed products are composed of drugs previously approved as single agents, and as a result, there is significant pre-existing information on the safety of those drugs as single agents for their approved indications in the form of animal studies, Phase 1 pharmacokinetic and other clinical studies and actual clinical experience. Nonetheless, new safety issues may arise when the previously approved drugs are used in combination in our products or when the proposed combination products are used in different treatment regimens for disease indications different than the disease indications for which the components are used as single agents. For example, the combination might be proposed for long-term use for a chronic condition, while the single agents are currently approved for short-term use in acute conditions. In addition, if a component has not been approved in all jurisdictions in which approval of the combination is sought, the regulatory agencies having authority over the combination in the jurisdictions that had not approved each component as a single agent may require us to submit data that would not otherwise be required. If any of these issues arises, we may be required to conduct additional nonclinical and Phase 1 clinical trials for our product candidates. If the additional nonclinical or Phase 1 clinical trials required for a product candidate or its formulation are extensive, it could delay or prevent further development of the product candidate.

The FDA and other regulatory agencies may require more extensive or expensive trials for our combination product candidates than may be required for single agent pharmaceuticals.

To obtain regulatory approval for our combination product candidates, we are typically required to show that each active pharmaceutical ingredient in the product candidate makes a contribution to the combined product candidate’s claimed effects and that the dosage of each component, including amount, frequency and duration, is such that the combination is safe and effective for a significant patient population requiring such concurrent therapy. As a result, we are typically required to conduct clinical trials comparing each component drug with the combination. This could require us to conduct more extensive and more expensive clinical trials than would be the case for many single agent pharmaceuticals. The need to conduct such trials could make it more difficult and costly to obtain regulatory approval of a combination drug than of a new drug containing only a single active pharmaceutical ingredient.

Even if we receive regulatory approvals for marketing our product candidates, if we fail to comply with continuing regulatory requirements, we could lose our regulatory approvals, and our business would be adversely affected.

The FDA and other regulatory authorities continue to review therapeutic products and medical devices even after they receive initial approval. If we receive approval to commercialize any product candidates, the manufacturing, testing, marketing, sale and distribution of these drugs and medical devices will be subject to continuing regulation, including compliance with quality systems regulations, good manufacturing practices, adverse event reporting requirements and prohibitions on promoting a product for unapproved uses. Furthermore, heightened Congressional scrutiny on the adequacy of the FDA’s drug approval process and the agency’s efforts to assure the safety of marketed drugs has resulted in the enactment of legislation, the FDA Amendments Act of 2007, addressing, among other things, drug safety issues. This law provides the FDA with expanded authority over drug products after approval, including the authority to require post-approval studies and clinical trials, labeling changes based on new safety information, and compliance with risk evaluation and mitigation strategies approved by the FDA. The FDA’s exercise of this authority could result in delays or increased costs during the period of product candidate development, clinical trials and regulatory review and approval, increased costs to assure compliance with new post-approval regulatory requirements, and potential restrictions on the sale of approved products, which could lead to lower product revenues to us or our collaborators. Enforcement actions resulting from failure to comply with government requirements could result in fines, suspension of approvals, withdrawal of approvals, recalls of products, product seizures, operating restrictions, and civil or criminal penalties. These enforcement actions could affect the manufacturing, testing, marketing, sale and distribution of our products.

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Healthcare reform measures could adversely affect our business.

The efforts of governmental and third-party payors to contain or reduce the costs of healthcare may adversely affect the business and financial condition of pharmaceutical, biotechnology and medical device companies. In the United States and in foreign jurisdictions there have been, and we expect that there will continue to be, a number of legislative and regulatory proposals aimed at changing the healthcare system. For example, in some countries other than the United States, pricing of prescription drugs and medical devices is subject to government control, and we expect proposals to implement similar controls in the United States to continue. The pendency or approval of such proposals could result in a decrease in our common stock price or limit our ability to raise capital or to enter into collaborations or license rights to our products.

Federal law may increase the pressure to reduce prices of pharmaceutical products paid for by Medicare, which could adversely affect our revenues, if any.

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or MMA, expanded Medicare coverage for drug purchases by the elderly and disabled beginning in 2006. Under the MMA, private insurance plans subsidized by the government offer prescription drug coverage to Medicare beneficiaries who elect to enroll in their plans. Although almost all prescription drugs are potentially available to plan enrollees, the plans are allowed to use formularies, preferred drug lists and similar mechanisms to favor selected drugs and limit access to other drugs except in certain circumstances. The price of a drug as negotiated between the manufacturer and a plan is a factor that the plan can consider in determining its availability to enrollees.

As a result, we expect that there will be increased pressure to reduce prices for drugs to obtain favorable status for them under the plans offering prescription drug coverage to Medicare beneficiaries. This pressure could decrease the coverage and price that we receive for our products in the future and could seriously harm our business. It is possible that our products, if successfully developed, could be particularly subject to price reduction initiatives because they are based on combinations of lower priced existing drugs.

In addition, some members of Congress advocate that the federal government should negotiate directly with manufacturers for lower prices for drugs in the Medicare program, rather than rely on private plans. If the law were changed to allow or require such direct negotiation, there could be additional reductions in the coverage of and prices that we receive for our products.

Federal laws or regulations on drug importation could make lower cost versions of our future products available, which could adversely affect our revenues, if any.

The prices of some drugs are lower in other countries than in the United States because of government regulation and market conditions. Under current law, importation of drugs into the United States is generally not permitted unless the drugs are approved in the United States and the entity that holds that approval consents to the importation. Various proposals have been advanced to permit the importation of drugs from other countries to provide lower cost alternatives to the products available in the United States. In addition, the MMA requires the Secretary of Health and Human Services to promulgate regulations for drug reimportation from Canada into the United States under some circumstances, including when the drugs are sold at a lower price than in the United States.

If the laws or regulations are changed to permit the importation of drugs into the United States in circumstances not now permitted, such a change could have an adverse effect on our business by making available lower priced alternatives to our future products.

Failure to obtain regulatory and pricing approvals in foreign jurisdictions could delay or prevent commercialization of our products abroad.

If we succeed in developing any products, we intend to market them in the European Union and other foreign jurisdictions. In order to do so, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval abroad may differ from that required to obtain FDA approval. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval and additional risks because there may be additional variations between how our combinations of approved drugs and single agent drugs are treated in foreign jurisdictions. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or by the FDA. We and our collaborators may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market outside the United States. The failure to obtain these approvals could materially adversely affect our business, financial condition and results of operations. Even if we are successful at obtaining these approvals, regulatory agencies in foreign countries where pricing of prescription drugs or medical devices is controlled by the government, could determine that pricing for our products should be based on prices for the existing drugs that comprise the active pharmaceutical ingredients in our combination products instead of allowing us to price our products at a premium as novel medicines.

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Risks Related to Our Intellectual Property

Our success depends upon our ability to obtain and maintain intellectual property protection for our products and technologies.

Our success will depend on our ability to obtain and maintain adequate protection of our intellectual property, including our proprietary drug discovery technology and any products or product candidates we plan to develop. We intend to apply for patents with claims covering our technologies, processes, products and product candidates when and where we deem it appropriate to do so and plan to take other steps to protect our intellectual property. We have applied for patent protection covering our clinical and preclinical product candidates and our drug discovery technologies in the United States, and some, but not all, foreign countries. In countries where we have not and do not seek patent protection, third parties may be able to manufacture and sell our products without our permission, and we may not be able to stop them from doing so.

Similar to other biotechnology companies, our patent position is generally uncertain and involves complex legal and factual questions. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the United States, and other biotechnology companies have encountered significant problems in protecting and defending their proprietary rights in foreign jurisdictions. Whether filed in the United States or abroad, our patent applications may be challenged or may fail to result in issued patents. In addition, our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing or commercializing competing products. Furthermore, others may independently develop or commercialize similar or alternative technologies or drugs, or design around our patents. Our patents may be challenged, invalidated or fail to provide us with any competitive advantages.

The United States Patent and Trademark Office and similar agencies in foreign jurisdictions may not agree with our view that our combination product candidates and our drug discovery technologies are patentable or novel and non-obvious, and on this basis may deny us patent protection. Even if we receive patent protection, others, including those who own patent or trade secret rights associated with the approved drugs that are active pharmaceutical ingredients of our product candidates, may attempt to invalidate our patent or trade secret rights. Even if our patent or trade secret rights are not directly challenged, disputes among third parties could lead to the weakening or invalidation of our intellectual property rights.

If we do not obtain or we are unable to maintain adequate patent or trade secret protection for our products in the United States, competitors could duplicate them without repeating the extensive testing that we will be required to undertake to obtain approval of the products by the FDA and other regulatory authorities. Regardless of any patent protection, under the current statutory framework the FDA is prohibited by law from approving any generic version of any of our combination products for three years after it has approved our product. Upon the expiration of that period, or if that time period is altered, the FDA could approve a generic version of our product unless we have patent protection sufficient for us to block that generic version. Without sufficient patent protection, the applicant for a generic version of our product would be required only to conduct a relatively inexpensive study to show that its product is bioequivalent to our product and would not have to repeat the studies that we conducted to demonstrate that the product is safe and effective. In the absence of adequate patent protection in other countries, competitors may similarly be able to obtain regulatory approval of products that duplicate our products.

We may not be able to develop or commercialize our product candidates due to intellectual property rights held by third parties.

If a third party holds a patent to a composition or method of use of an approved drug that is a component of one or more of our product candidates or a formulation technology related to our planned formulation of a product candidate, we may not be able to develop or commercialize such product candidates without first obtaining a license to such patent, or waiting for the patent to expire. In particular, for two of our product candidates, CRx-139 and CRx-170, some of the various formulations and methods of use of one drug in the combination are covered by third-party patents which could pose an impediment to our ability to develop and commercialize these products. We believe that other formulations and methods of use of these drugs, which are not covered by any third-party patents, are available. However, we cannot be sure that the unpatented formulations or methods of use of these drugs will be the optimal formulation, or that a feasible formulation for these product candidates will be available. Additionally, there are three United States patents that may cover therapeutic uses of CRx-401, our Type 2 diabetes product candidate. We may not be able to develop or commercialize our CRx-401 product candidate without first obtaining a license to these patents, or waiting for them to expire. Our business will be harmed if we are unable to use the optimal formulation or methods of use of the component drugs that comprise our product candidates. This may occur because the formulations or methods of use are covered by one or more third-party patents, and a license to such patents is unavailable or is available on terms that are unacceptable to us.

We may be unable to in-license intellectual property rights or technology necessary to develop and commercialize our products.

Depending on its ultimate formulation and method of use, before we can develop, make, use, or sell a particular product candidate, we may need to obtain a license from one or more third parties who have patent or other intellectual property rights

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covering components of our product candidate or its method of use. There can be no assurance that such licenses will be available on commercially reasonable terms, or at all. Because our product candidates are based on combinations of existing drugs, there may be a significant number of patents covering both the active pharmaceutical ingredients in our product candidates and their method of use. If a third party does not offer us a necessary license or offers a license only on terms that are unattractive or unacceptable to us, we might be unable to develop and commercialize one or more of our product candidates.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In our activities, we rely substantially upon proprietary materials, information, trade secrets and know-how to conduct our research and development activities, and to attract and retain collaborators, licensees and customers. We take steps to protect our proprietary rights and information, including the use of confidentiality and other agreements with our employees and consultants and in our academic and commercial relationships. However, these steps may be inadequate, agreements may be violated, or there may be no adequate remedy available for a violation of an agreement. Our proprietary information may be inadvertently disclosed or we may lose the protection of our trade secrets. Our competitors may independently develop substantially equivalent proprietary information or may otherwise gain access to our trade secrets, which could adversely affect our ability to compete in the market.

Litigation or third-party claims of intellectual property infringement could require substantial time and money to resolve. Unfavorable outcomes in these proceedings could limit our intellectual property rights and our activities.

We may need to resort to litigation to enforce or defend our intellectual property rights, including any patents issued to us. If a competitor or collaborator files a patent application claiming technology also invented by us, in order to protect our rights, we may have to participate in an expensive and time consuming interference proceeding before the United States Patent and Trademark Office. We cannot guarantee that our product candidates will be free of claims by third parties alleging that we have infringed their intellectual property rights. Third parties may assert that we are employing their proprietary technologies without authorization and they may resort to litigation to attempt to enforce their rights. Third parties may have or obtain patents in the future and claim that the use of our technology or any of our product candidates infringes their patents. We may not be able to develop or commercialize combination product candidates because of patent protection others have. Our business will be harmed if we cannot obtain a necessary or desirable license, can obtain such a license only on terms we consider to be unattractive or unacceptable, or if we are unable to redesign our product candidates or processes to avoid actual or potential patent or other intellectual property infringement.

Our efforts to obtain, protect and defend our patent and other intellectual property rights, whether we are successful or not, can be expensive and may require us to incur substantial costs, including the diversion of management and technical personnel. An unfavorable ruling in patent or intellectual property litigation could subject us to significant liabilities to third parties, require us to cease developing, manufacturing or selling the affected products or using the affected processes, require us to license the disputed rights from third parties, or result in awards of substantial damages against us. In addition, defending patent or other intellectual property litigation, whether we are successful or not, can be very expensive and may require us to incur substantial costs, including the diversion of management and technical personnel. During the course of any patent litigation, there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors regard these announcements as negative, the market price of our common stock may decline. General proclamations or statements by key public figures may also have a negative impact on the perceived value of our intellectual property.

There can be no assurance that we would prevail in any intellectual property infringement action, will be able to obtain a license to any third-party intellectual property on commercially reasonable terms, successfully develop non-infringing alternatives on a timely basis, or license non-infringing alternatives, if any exist, on commercially reasonable terms. Any significant intellectual property impediment to our ability to develop and commercialize our products could seriously harm our business and prospects.

Risks Related to Our Industry

Our competitors and potential competitors may develop products and technologies that make ours less attractive or obsolete.

Many companies, universities, and research organizations developing competing product candidates have greater resources and significantly greater experience in research and development, manufacturing, marketing, sales, distribution, financial and technical regulatory matters than we have. In addition, many competitors have greater name recognition and more extensive collaborative relationships. Our competitors could commence and complete clinical testing of their product candidates, obtain regulatory approvals, and begin commercial-scale manufacturing of their products faster than we are able to for our products. They could develop drug discovery technology or products that would render our drug discovery technology and product candidates, and those of our collaborators, obsolete and noncompetitive. They may also employ high throughput screening technologies to the discovery of combination drugs, which may render our technologies or our approach to drug discovery and development obsolete or noncompetitive. Our drug discovery technology will compete against well-established techniques to discover new drugs. If we are unable to compete effectively against these existing techniques and the companies that support them, then we may not be able to commercialize our product candidates or achieve a competitive position in the market. This would adversely affect our ability to generate revenues.

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We may have significant product liability exposure which may harm our business and our reputation.

We face exposure to product liability and other claims if our product candidates, products or processes are alleged to have caused harm. These risks are inherent in the testing, manufacturing, and marketing of human therapeutic products and medical devices. We maintain product liability insurance covering our clinical trials of our product candidates. We may not have sufficient insurance coverage, and we may not be able to obtain sufficient coverage at a reasonable cost, if at all. Our inability to obtain product liability insurance at an acceptable cost or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of any products or product candidates that we develop. If we are sued for any injury caused by our products, product candidates or processes, our liability could exceed our product liability insurance coverage and our total assets. Claims against us, regardless of their merit or potential outcome, may also generate negative publicity or hurt our ability to obtain physician endorsement of our products or expand our business.

We use and generate materials that may expose us to expensive and time-consuming legal claims.

Our development programs involve the use of hazardous materials, chemicals, and biological materials. We are subject to foreign, federal, state and local laws and regulations governing the use, manufacture, storage, and disposal of materials and waste products. We believe that our safety procedures for handling these materials comply with the standards prescribed by laws and regulations. However, we may incur significant costs to comply with current or future environmental laws and regulations. In addition, we cannot completely eliminate the risk of contamination or injury from hazardous materials. In the event of an accident, an injured party may seek to hold us liable for any damages that result. Any liability could exceed the limits or fall outside the coverage of our insurance, and we may not be able to maintain insurance on acceptable terms, if at all.

Risks Related to an Investment in Our Common Stock

Our common stock has a volatile public trading price.

The market price for our common stock has been volatile, and market prices for securities of companies comparable to us have been highly volatile. For example, the market price for our common stock declined sharply following our announcement of the results of our Phase 2b clinical trial for Synavive in patients with knee osteoarthritis. In addition, the stock market as a whole and biotechnology and other life science stocks in particular have experienced significant recent volatility. Like our common stock, these stocks have experienced significant price and volume fluctuations for reasons unrelated to the operating performance of the individual companies. In addition, due to our existing stock price, we may not continue to qualify for continued listing on the Nasdaq Global Market. To maintain listing, we are required, among other things, to maintain a minimum closing bid price of $1.00 per share. On October 16, 2008 Nasdaq suspended enforcement of its rules requiring a minimum $1.00 closing bid price until January 16, 2009. Factors giving rise to this volatility may include:

• disclosure of actual or potential clinical results with respect to product candidates we are developing or their components;

• regulatory developments in both the United States and abroad;

• developments concerning proprietary rights, including patents and litigation matters;

• public concern about the safety or efficacy of our product candidates or technology, their components, or related technology, or new technologies generally;

• public announcements by our competitors or others; and

• general market conditions and comments by securities analysts and investors.

Fluctuations in our operating losses could adversely affect the price of our common stock.

Our operating losses may fluctuate significantly on a quarterly basis. Some of the factors that may cause our operating losses to fluctuate on a period-to-period basis include the status of our preclinical and clinical development programs, level of expenses incurred in connection with our preclinical and clinical development programs, implementation or termination of collaboration, licensing, manufacturing or other material agreements with third parties, non-recurring revenue or expenses under any such agreement, and compliance with regulatory requirements. Period-to-period comparisons of our historical and future financial results may not be meaningful, and investors should not rely on them as an indication of future performance. Our fluctuating losses may fail to meet the expectations of securities analysts or investors. Our failure to meet these expectations may cause the price of our common stock to decline.

Our product development strategy may cause volatility in our stock price, and we may incur significant costs from class action litigation.

Our strategy of initiating proof-of-concept clinical trials for multiple product candidates and making development decisions based on the results of these trials may result in a greater number of public announcements regarding the progress of our development efforts than would be true for a company developing fewer products or advancing products less quickly into proof-of-concept clinical trials. These announcements, including announcements regarding decisions to terminate further development of one or more product candidates, may cause significant volatility in our stock price.

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Recently, when the market price of a stock has been volatile, as our stock price may be, holders of that stock have occasionally brought securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit of this type against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit. A stockholder lawsuit could also divert the time and attention of our management.

Anti-takeover provisions in our charter documents and provisions of Delaware law may make an acquisition more difficult and could result in the entrenchment of management.

We are incorporated in Delaware. Anti-takeover provisions of Delaware law and our charter documents may make a change in control or efforts to remove management more difficult. Also, under Delaware law, our board of directors may adopt additional anti-takeover measures.

Our charter authorizes our board of directors to issue up to 5,000,000 shares of preferred stock and to determine the terms of those shares of stock without any further action by our stockholders. If the board of directors exercises this power to issue preferred stock, it could be more difficult for a third party to acquire a majority of our outstanding voting stock and vote the stock they acquire to remove management or directors.

Our charter also provides staggered terms for the members of our board of directors. Under Section 141 of the Delaware General Corporation Law, our directors may be removed by stockholders only for cause and only by vote of the holders of a majority of voting shares then outstanding. These provisions may prevent stockholders from replacing the entire board in a single proxy contest, making it more difficult for a third party to acquire control of us without the consent of our board of directors. These provisions could also delay the removal of management by the board of directors with or without cause. In addition, our directors may only be removed for cause and our bylaws limit the ability our stockholders to call special meetings of stockholders.

Our equity incentive plans generally permit our board of directors to provide for acceleration of vesting of options granted under these plans in the event of certain transactions that result in a change of control. If our board of directors uses its authority to accelerate vesting of options, this action could make an acquisition more costly, and it could prevent an acquisition from going forward.

Under Section 203 of the Delaware General Corporation Law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock until the holder has held the stock for three years unless, among other possibilities, the board of directors approves the transaction. Our board of directors could use this provision to prevent changes in management. The existence of the foregoing provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

Under our research and license agreement with Angiotech, we have agreed that upon a change of control of us, as defined in the research and license agreement, the agreement would remain in effect, although Angiotech would have the right to terminate the agreement in the six months after a change of control if we were acquired by an entity operating primarily in Angiotech’s field.

Item 6. Exhibits.

(a) Exhibits.

The Exhibits listed in the Exhibit Index immediately preceding the Exhibits are filed as a part of this Quarterly Report on Form 10-Q.

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SIGNATURES

Pursuant to the requirements 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.

COMBINATORX, INCORPORATED
By:	/s/ Robert Forrester
	Robert Forrester
	Executive Vice President and Chief Financial Officer

Date: November 10, 2008

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EXHIBIT INDEX

		Incorporated by Reference to:
Exhibit No.	Description	Form or Schedule	Exhibit No.	Filing Date with SEC	SEC File Number
3.1	Sixth Amended and Restated Certificate of Incorporation.	S-1/A	3.2	11/4/2005	333-121173
3.2	Amended and Restated By-Laws.	8-K	3.1	06/04/2007	000-51171
4.1	Specimen Common Stock Certificate.	S-1/A	4.1	1/19/2005	333-121173
4.2	Warrant issued to General Electric Capital Corporation on September 15, 2004 to purchase up to 8,892 shares of the Registrant’s Common Stock.	S-1	10.7	12/10/2004	333-121173
4.3	Warrant issued to General Electric Capital Corporation on June 28, 2005 to purchase 471 shares of the Registrant’s Common Stock.	10-K	4.5	3/20/2006	000-51171
4.4	Warrant issued to Silicon Valley Bank on April 25, 2001 to purchase up to 10,019 of the Registrant’s Common Stock.	S-1	10.9	12/10/2004	333-121173
4.5	Registration Rights Agreement dated as of April 25, 2001 by and between Silicon Valley Bank and the Registrant.	S-1	10.10	12/10/2004	333-121173
4.6	Form of Warrant to purchase shares of the Registrant’s Stock, together with a schedule of warrant holders.	S-1	10.11	12/10/2004	333-121173
4.7	Form of Warrant issued to BioMedical Sciences Investment Fund Pte Ltd on August 19, 2005 to purchase up to 25,000 shares of the Registrant’s Common Stock.	S-1/A	10.45	8/19/2005	333-121173
4.8	Second Amended and Restated Investors’ Rights Agreement, dated as of February 18, 2004, by and between the Registrant and the investors named therein, as amended.	S-1	10.17	12/10/2004	333-121173
4.9	Amendment to the Second Amended and Restated Investors’ Rights Agreement by and between the Registrant and the investors named therein, dated as of December 8, 2004.	S-1	10.18	12/10/2004	333-121173
4.10	Omnibus Amendment Agreement to Second Amended and Restated Investors’ Right Agreement and by and between the Registrant and the investors named therein and the Registration Rights Agreement by and between Silicon Valley Bank and the Registrant.	8-K	10.1	12/6/2006	000-51171
#10.1	2000 Stock Option Plan, as amended.	S-1	10.1	12/10/2004	333-121173

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		Incorporated by Reference to:
Exhibit No.	Description	Form or Schedule	Exhibit No.	Filing Date with SEC	SEC File Number
#10.2	Amended and Restated 2004 Incentive Plan.	8-K	10.1	6/5/2006	000-51171
#10.3	Form Incentive Stock Option Agreement under the 2004 Incentive Plan.	10-K	10.3	3/20/2006	000-51171
#10.4	Form Non-Qualified Option Agreement under the 2004 Incentive Plan.	10-K	10.4	3/20/2006	000-51171
#10.5	Nonqualified Deferred Compensation Plan, effective December 1, 2007.	S-8	4.1	11/30/2007	333-147745
10.6	Master Security Agreement, dated as of July 20, 2004, by and between the Registrant and General Electric Capital Corporation.	S-1	10.12	12/10/2004	333-121173
10.7	Form of Promissory Note issued by the Registrant to General Electric Capital Corporation.	S-1	10.13	12/10/2004	333-121173
10.8	Revised Loan Proposal, dated as of May 3, 2005, between General Electric Capital Corporation and the Registrant.	10-K	10.8	3/20/2006	000-51171
10.9	Revised Loan Proposal dated as of April 19, 2006, between General Electric Capital Corporation and the Registrant.	8-K	10.2	6/30/2006	000-51171
10.10	Promissory Note, dated as of March 29, 2007, between General Electric Capital Corporation and the Registrant.	8-K	10.1	4/4/2007	000-51171
10.11	Loan Proposal, dated as of June 27, 2007, between General Electric Capital Corporation and the Registrant.	8-K	10.1	6/28/2007	000-51171
10.12	Promissory Note, dated as of December 21, 2007, between General Electric Capital Corporation and the Registrant.	8-K	10.1	12/21/2007	000-51171
10.13	Loan Proposal dated as of November 20, 2006, between CombinatoRx (Singapore) Pte. Ltd. and GE Capital Services Pte. Ltd.	8-K	10.1	2/21/2007	000-51171
10.14	Facility Letter, dated as of February 14, 2007, between CombinatoRx (Singapore) Pte. Ltd. and GE Capital Services Pte. Ltd.	8-K	10.1	2/21/2007	000-51171
10.15	Deed of Debenture, dated as of February 14, 2007, between CombinatoRx (Singapore) Pte. Ltd. and GE Capital Services Pte. Ltd.	8-K	10.1	2/21/2007	000-51171
10.16	Guaranty, dated as of February 14, 2007, between CombinatoRx (Singapore) Pte. Ltd. and GE Capital Services Pte. Ltd.	8-K	10.1	2/21/2007	000-51171

35

		Incorporated by Reference to:
Exhibit No.	Description	Form or Schedule	Exhibit No.	Filing Date with SEC	SEC File Number
#10.17	First Amended Employment, Confidentiality and Non-Competition Agreement with Alexis Borisy, dated as of July 1, 2004.	S-1	10.22	12/10/2004	333-121173
#10.18	Employment, Confidentiality and Non-Competition Agreement with Robert Forrester, dated as of February 23, 2004.	S-1	10.23	12/10/2004	333-121173
#10.19	Employment Letter Agreement with Jason F. Cole, dated as of January 23, 2006.	10-K	10.15	3/20/2006	000-51171
#10.20	Employment Letter Agreement with Lynn Baird, dated as of March 31, 2006	8-K	10.1	4/24/2006	000-51171
#10.21	Employment Letter Agreement with John Randle, dated as of July 24, 2007.	10-Q	10.22	3/8/2008	000-51171
#10.22	Amended and Restricted Stock Award Agreement, dated January 17, 2007, by and between Alexis Borisy and the Registrant.	8-K	10.1	1/22/2007	000-51171
#10.23	Amended and Restated Restricted Stock Award Agreement, dated January 17, 2007, by and between Robert Forrester and the Registrant.	8-K	10.2	1/23/2007	000-51171
#10.24	Amended and Restated Restricted Stock Award Agreement, dated January 17, 2007, by and between Lynn Baird and the Registrant.	10-K	10.23	3/15/2007	000-51171
*10.25	Amended and Restated Restricted Stock Award Agreement, dated September 5, 2008, by and between Jason Cole and the Registrant.
#10.26	Letter Agreement, dated February 7, 2008, between Curtis Keith and the Registrant regarding stock options.	10-Q	10.28	3/8/2008	000-51171
10.27	Form of Indemnification Agreement for directors.	S-1/A	10.32	1/19/2005	333-121173
10.28	License Agreement, dated as of May 4, 2005, by and between HenKan Pharmaceutical Company and the Registrant.	S-1/A	10.34	8/19/2005	333-121173
10.29	Amended and Restated Research Agreement, dated as of February 22, 2007, by and between the Registrant and CHDI, Inc.	10-K	10.29	3/15/2007	000-51171

36

		Incorporated by Reference to:
Exhibit No.	Description	Form or Schedule	Exhibit No.	Filing Date with SEC	SEC File Number
10.30	Research Project Cooperative Agreement, dated April 10, 2005, between the National Institutes of Health and the Registrant.	S-1/A	10.37	8/19/2005	333-121173
10.31	Form of Subscription and Shareholders Agreement, among CombinatoRx (Singapore) Pte Ltd, BioMedical Sciences Investment Fund Pte Ltd and the Registrant.	S-1/A	10.38	8/19/2005	333-121173
10.32	Form of Terms and Conditions of the Notes, of CombinatoRx (Singapore) Pte Ltd.	S-1/A	10.39	8/19/2005	333-121173
10.33	Form of Debenture between CombinatoRx (Singapore) Pte Ltd and BioMedical Sciences Investment Fund Pte Ltd.	S-1/A	10.40	8/19/2005	333-121173
10.34	Form of Services Agreement, by and between the Registrant and CombinatoRx (Singapore) Pte Ltd.	S-1/A	10.41	8/19/2005	333-121173
10.35	Form of Registration Rights Agreement, by and among the Registrant and BioMedical Sciences Investment Fund Pte Ltd.	S-1/A	10.42	8/19/2005	333-121173
10.36	Form of Swap-up Agreement, among CombinatoRx (Singapore) Pte Ltd, BioMedical Sciences Investment Fund Pte Ltd and the Registrant.	S-1/A	10.43	8/19/2005	333-121173
10.37	Form of Share Charge, between the Registrant and BioMedical Sciences Investment Fund Pte Ltd.	S-1/A	10.44	8/19/2005	333-121173
*10.38	Letter Agreement, dated as of August 5, 2008, between the Registrant and Biomedical Sciences Investment Fund Pte Ltd.
†10.39	Research and License Agreement, dated as of October 3, 2005, between Angiotech Pharmaceuticals, Inc. and the Registrant.	S-1/A	10.46	10/5/2005	333-121173
10.40	Stock Purchase Agreement, dated as of October 3, 2005, by and among the Registrant and Angiotech Pharmaceuticals, Inc.	S-1/A	10.47	10/3/2005	333-121173
10.41	Amended and Restated Research and License Agreement, dated June 12, 2007, between Fovea Pharmaceuticals SA and the Registrant	8-K	10.1	6/12/2007	000-51171
10.42	Office and Laboratory Lease Agreement, as of October 18, 2005, by and between MA-Riverview, 1245 First Street, L.L.C. and the Registrant.	S-1/A	10.48	10/24/2005	333-121173
10.43	First Amendment to Office and Laboratory Lease Agreement, as of March 9, 2006, by and between MA-Riverview, 245 First Street, L.L.C. and the Registrant.	10-K	10.44	3/20/2006	000-51171

37

		Incorporated by Reference to:
Exhibit No.	Description	Form or Schedule	Exhibit No.	Filing Date with SEC	SEC File Number
†10.44	Research, Development and Commercialization Agreement, dated May 31, 2006, between the Cystic Fibrosis Foundation Therapeutics, Inc. and the Registrant.	8-K	10.1	6/5/2006	000-51171
10.45	Sponsored Research Collaboration Agreement, dated November 7, 2007, between Dart Therapeutics, LLC and the Registrant.	8-K	10.1	11/8/2007	000-51171
10.46	First Amendment to Sponsored Research Collaboration Agreement, dated as of October 20, 2008, between the Registrant, DART Therapeutics, LLC and GMT Charitable Research, LLC.	8-K	10.1	10/22/2008	000-51171
21.1	List of subsidiaries.	10-K	21.1	3/13/2008	000-51171
*31.1	Certification of Chief Executive Officer pursuant to Exchange Act rules 13a-14 or 15d-14.
*31.2	Certification of Chief Financial Officer pursuant to Exchange Act rules 13a-14 or 15d-14.
*32.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Exchange Act rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350.

* Filed herewith.

† Confidential treatment requested as to certain portions, which portions are omitted and filed separately with the Securities and Exchange Commission.

# Management contract or compensatory plan or arrangement filed as an Exhibit to this report pursuant to Items 15(a) and 15(c) of Form 10-Q.

38