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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
    FORM 10-K/A Amendment No. 3
  x
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2003 OR  o
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-22570 LYNX THERAPEUTICS, INC.  Delaware
    
    94-3161073(State or other jurisdiction of
    
    (I.R.S. Employer Identificationincorporation or organization)
    
    No.)
 25861 Industrial Blvd., Hayward, CA 94545
(Address of principal executive offices, including zip code) (510) 670-9300
(Registrants telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value per share 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 and 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 o Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. x Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes o No x State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the Registrant computed by reference to the
price at which the common equity was last sold, or the average bid and asked
price of such common equity, as of the last business day of the registrants
most recently completed second fiscal quarter: $10,920,824.1 The number of shares of common stock of the Registrant outstanding as of
March 9, 2004, was 6,199,245. The aggregate market value of the common stock of
the Registrant held by non-affiliates of the Registrant, based upon the closing
price of the common stock reported on the Nasdaq National Market on March 9,
2004, was $30,264,929.2      1
    
    Based on a closing price of $3.79 per share on June 30, 2003 and
4,654,245 shares outstanding (as adjusted to reflect the Registrants
reverse stock split effected in January 2003). Excludes 1,772,761 shares
of the Registrants common stock held by executive officers, directors and
stockholders whose ownership exceed 5% of the common stock outstanding at
June 30, 2003.2
    
    Based on a closing price of $6.30 per share on March 9, 2004 and
6,199,245 shares outstanding. Excludes 1,395,288 shares of the
Registrants common stock held by executive officers, directors and
stockholders whose ownership exceed 5% of the common stock outstanding at
March 9, 2004.




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DOCUMENTS INCORPORATED BY REFERENCE EXPLANATORY NOTE Lynx Therapeutics, Inc. is filing this Amendment No. 3 on Form 10-K/A to our
Annual Report on Form 10-K, originally filed with the Securities and Exchange
Commission on March 30, 2004, solely for the purpose of amending and restating
certain portions of such Annual Report on Form 10-K. Each of the following
sections of the Annual Report is amended and restated in its entirely, and
current as of October 22, 2004: Part I, Item 1. Business  Business Risks  We will need additional funds
in the future, which may not be available to us; Part II, Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital Reserves; Part II, Item 8. Consolidated Financial Statements and Supplementary Data
 Report of Ernst & Young LLP; Part II, Item 8. Consolidated Financial Statements and Supplementary Data
 Notes to Consolidated Financial Statements  Note 1. Summary of Significant
Accounting Policies and Basis of Presentation  Business and Basis of
Presentation; and Part II, Item 8. Consolidated Financial Statements and Supplementary Data
 Notes to Consolidated Financial Statements  Note 18. Liquidity. In addition, we have filed the following exhibits herewith:  23.3
    
    Consent of Ernst & Young LLP, Independent Registered
Public Accounting Firm.31.7
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.31.8
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.32.3
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section
1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350). Except as specifically indicated herein, no other information included in the
Annual Report on Form 10-K is amended by this Amendment No. 3 on Form 10-K/A.




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LYNX THERAPEUTICS, INC. FORM 10-K/A ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2003 Table of Contents PART I
    
    
    1Item 1. Business
    
    
    1PART II
    
    
    19Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 8. Consolidated Financial Statements and Supplementary Data
    
    
    29PART IVItem 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K
    
    
    58SIGNATURES
    
    
    63EXHIBIT 23.3EXHIBIT 31.7EXHIBIT 31.8EXHIBIT 32.3




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PART I 
 Item 1. Business Except for the historical information contained herein, this report
contains certain information that is forward-looking in nature. Examples of
forward-looking statements include statements regarding Lynxs future financial
results, operating results, product successes, business strategies, projected
costs, future products, competitive positions and plans and objectives of
management for future operations. In some cases, you can identify
forward-looking statements by terminology, such as may, will, should,
expects, plans, anticipates, believes, estimates, predicts,
potential or continue or the negative of such terms and other comparable
terminology. In addition, statements that refer to expectations or other
characterizations of future events or circumstances are forward-looking
statements. These statements involve known and unknown risks and uncertainties
that may cause Lynxs or its industrys results, levels of activity,
performance or achievements to be materially different from those expressed or
implied by the forward-looking statements. Factors that may cause or
contribute to such differences include, among others, those discussed under the
captions Item 1. Business  Business Risks and Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations.
These and many other factors could affect the future financial and operating
results of Lynx. Lynx undertakes no obligation to update any forward-looking
statement to reflect events after the date of this report. Lynx, MPSS, Megaclone, Megasort, Megatype, Protein ProFiler and the
Lynx logo are some of Lynx Therapeutics, Inc.s trademarks and service marks. In January 2003, we received stockholder approval for, and effected, a
reverse stock split of our common stock at a ratio of 1-for-7 (the reverse
stock split). As a result of the reverse stock split, each outstanding share
of common stock automatically converted into one-seventh of a share of common
stock, with the par value of each share of common stock remaining at one cent
($.01) per share. Accordingly, common stock share and per share amounts for
all periods presented have been adjusted to reflect the impact of the reverse
stock split. Overview We believe that Lynx Therapeutics, Inc. is a leader in the development and
application of novel genomics analysis solutions. Our Massively Parallel
Signature Sequencing, or MPSS, instruments analyze millions of DNA molecules in
parallel, enabling genome structure characterization at what we believe to be
an unprecedented level of resolution. As applied to gene expression analysis,
MPSS provides comprehensive and quantitative digital information important to
modern systems biology research in the pharmaceutical, biotechnology and
agricultural industries. Gene expression refers to the number of genes and the
extent a cell or tissue expresses those genes, and represents a way to move
beyond DNA sequence data to understand the function of genes, the proteins that
they encode and the role they play in health and disease. Systems biology is an
approach in which researchers seek to gain a complete molecular understanding
of biological systems in health and disease. We believe that our MPSS generates a complete, accurate and quantitative
analysis of the Transcriptome, which is the full complement of activated genes,
messenger RNAs or transcripts in a particular tissue at a particular time, to
enable systems biology. Transcriptome analysis provides information about all
of the genes that are expressed in a biological sample. MPSS generates
simultaneously, from a million or more Megaclone, our unique and proprietary
cloning procedure, micro-beads, gene sequence information that uniquely
identifies a samples DNA molecules without the need for individual
conventional sequencing reactions and produces a comprehensive quantitative
profile of gene expression in cells or tissues. MPSS is capable of finding and
identifying genes that are expressed at low levels in the cell, beyond the
normal sensitivity levels of microarrays, which are small glass or silicon
wafers with tens of thousands of DNA molecules arrayed on the surface for
subsequent analysis and are the current leading tool for gene expression
analysis on the market. As a result, Lynx believes that MPSS provides a highly
reproducible, quantitative digital readout for the activity of virtually every
gene in a biological sample. Additionally, unlike microarrays, which are
limited to the genes represented on them, MPSS does not require advance
knowledge of genes or sequences and, therefore, has broad potential commercial
applicability to humans, animals, plants and other commercially important
organisms. 1




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Our current business model is primarily focused on providing genomics
discovery services, such as gene expression analysis and genomic sequencing
using MPSS. Our commercialization strategies, tactics and target customers for
MPSS generally involve expanding our work with scientific thought leaders and
genomics researchers and gaining additional customers in the pharmaceutical,
biotechnology and agricultural industries. Megaclone, our unique and proprietary cloning procedure, is the DNA
cloning technology that underlies MPSS. Megaclone transforms a biological
sample containing millions of DNA molecules into one made up of millions of
micro-beads, which are microscopic beads of latex, each of which carries
approximately 100,000 copies of one of the DNA molecules in the sample. We were
incorporated in Delaware in February 1992. Please see a discussion of our plans
under Item 1. Business  Business Risks and Item 7. Managements Discussion
and Analysis of Financial Condition and Results of Operations  Liquidity and
Capital Resources. Industry Background The publication of the human genome was a milestone in the history of
genetics and genomics. Genetic differences between people and populations can
have a significant biological impact, including a major influence on health.
However, the remaining challenge for researchers in industry and academia alike
is to explore the multitude of genomic variations and to discover, from the
analysis of these differences, the functions of genes and their roles in health
and disease. Researchers in industry and academia alike are exploring the
multitude of genomic sequence and epigenetic variations of individuals and
populations for a better understanding of the role of genes and gene expression
in the human body, suggesting new ways to tackle disease and ultimately to the
discovery of new diagnostics and therapies. It is this work, post
genome-sequencing, that is expected to lead to commercial opportunities and
ultimately to the discovery of new therapies and diagnostics for unmet medical
needs and to provide the basis for the emerging fields of pharmacogenomics (the
identification and assessment of genes that are predictive of the efficacy
and/or toxicity of drug compounds or that may correlate drug responses to the
genotype, or genetic makeup, of an individual), and individualized patient
therapy (personalized medicine). Many diseases result from a malfunction of the genetically programmed
protective response to insults, such as trauma, infection, stress and/or
inherited mutant genes and/or deleterious combinations of common variants of a
number of genes. That malfunction may result in inadequate, misguided or
exaggerated gene expression, unfolding a complex pathogenic process that may
resolve itself, linger chronically or evolve with increasingly destructive
effects in a manner quite removed from, and even independent of, the original
insult. Complex traits often play a significant role in disease; these are
due to interactions between the environment and common variants of many
genetic factors sometimes including defective, mutant genes. By analyzing
which genes are expressed in a cell or tissue, the level of expression can
illustrate which physiological pathways are active in the cell and to what
degree. By understanding when and where abnormal gene expression occurs and the
changes in expression that a drug can cause, the physiological pathways
implicated in disease and drug action can be pinpointed. This knowledge could
be used to help discover drug targets, screen drug leads, predict a compounds
toxic effects, anticipate pharmacological responses to drug leads and tailor
clinical trials to the specific needs of subgroups within a population. By
recognizing gene expression patterns, researchers, and ultimately physicians,
may also be able to determine which treatments are likely to be effective for a
specific condition and which may be ineffective or harmful. Genomics approaches to therapeutics discovery seek to identify genes
connected to the origin of a disease. Searches to identify such genes generally
are laborious and involve a very large amount of conventional DNA sequencing to
identify genes or gene fragments. This knowledge of genes is only a first step.
While it may pave the way for the development of better diagnostics, it may not
necessarily lead to a successful therapy. For example, while a particular gene,
or absence of a gene, may predispose a person to a cancer, an entirely
different set of genes is likely to govern the tumor and its metastases. Hence,
in addition to understanding the cause of disease, it is important to
understand entire networks of genes and their functions in both healthy and
diseased states in order to identify the optimal targets for therapy. One current approach to genomics research is based on the study of gene
expression and regulation of gene expression in cells in differing states or
conditions. Gene expression in a cell consists of transcription, the process
that converts the genetic information encoded in the double-stranded DNA of a
gene into mRNA or transcripts, and translation, the process that converts the
genetic information encoded in mRNA transcripts into a specific protein
molecule. At any one time, any particular human cell expresses thousands of
genes. A different number of 2




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copies of each mRNA transcript will be present in each biological sample
depending upon the particular cell, its function and its environmental
conditions at the time. Thus, a cell will contain, at any one time, tens of
thousands of different transcripts, in various quantities, for a total on the
order of one million or more transcripts. Elucidating gene function involves not only determining which genes are
expressed in a healthy or diseased tissue, but also requires determining which
of the altered transcripts or transcript levels cause a disease rather than
result from the disease. In general, only the most abundant transcripts are
currently accessible using conventional methods. In addition, conventional
methods are dependent on separating and cloning double-stranded DNA copies
(cDNA) of each individual mRNA transcript, or cDNA, prior to analysis. Thus, by
conventional methods, it is impractical to obtain a comprehensive,
high-resolution analysis of gene expression across one million or more
transcripts in cells of interest to the researcher. Epigenomics is the genome-wide study of epigenetic effects that are
distinct from changes to the primary DNA sequence (mutations). Cells are
impacted by epigenetic structural changes that can lead to changes in control
of gene expression, either gene silencing or gene activation. Epigenomics and
genome structure play a major role in the regulation of gene expression and
disease. Indeed, most cancers involve the epigenetic silencing of genes that
normally control cell proliferation. Chemical modifications, such as
methylation, and the patterns of protein binding are interdependent and
ultimately determine in any given cell which genes will be expressed when and
to what degree. For example, cancer cells often contain a variety of genome
structure alterations, some subtle, some dramatic, that contribute to the onset
and progression of disease through their influence on gene expression. The
major forms of epigenetic modification occurring in human tumors are DNA
methylation and histone deacetylation. Comprehensive knowledge of the structure
and state of the genome, and quantifying the activity level of all genes offers
great promise to the understanding of disease, as well as to the prospect for
early detection through diagnostics and treatment through novel, precisely
targeted therapeutics and personalized medicine. Our Solution We have developed a powerful genome analysis system, a high throughput DNA
sequencing process, Massively Parallel Signature Sequencing (MPSS) technology,
which permits the characterization of up to two million targeted DNA molecules
in a single assay. Each of our MPSS machines has 10,000 times the capacity of
any other commercially available DNA sequencing process at less than 1/100th
the cost per DNA molecule analyzed. This capacity and the resulting economy
enable a variety of biological analyses at previously unachievable levels of
precision and completeness. Furthermore, our MPSS technology provides digital
data based on actual DNA sequence information for many biological processes
where imprecise analogue fluorescent readouts are the current standard such as
expression profiling with DNA microarrays. We believe that MPSS expression profiling generates a complete, accurate
and quantitative analysis of the transcriptome to enable systems biology.
Transcriptome analysis provides information about all the genes that are
expressed in a biological sample. MPSS expression analysis generates
simultaneously, from millions of Megaclone micro-beads, DNA sequence
information that uniquely identifies a samples transcripts without the need
for individual conventional sequencing reactions and produces a comprehensive
quantitative profile of gene expression in cells or tissues. MPSS analysis is
capable of finding and identifying genes using a process involving the targeted
capture of short DNA fragments derived from each message expressed in a cell,
all within a single sample. This allows for detection and quantitation of
virtually all genes that are expressed, particularly those at low levels in the
cell that are beyond the normal sensitivity levels of microarrays. As a result,
we believe that MPSS analysis provides a highly reproducible, quantitative
digital readout for the activity of virtually every gene in a biological
sample. Additionally, unlike microarrays, MPSS gene expression analysis does
not require advance knowledge of genes or sequences and, therefore, has broad
potential commercial applicability to humans, animals, plants and other
commercially important organisms. Our Commercialization Strategies, Tactics and Target Customers Our commercialization strategies, tactics and target customers for MPSS
gene expression analysis generally involve expanding our work with scientific
thought leaders and genomics researchers and gaining additional customers in
the pharmaceutical, biotechnology and agricultural industries. Additionally,
our business development 3




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efforts include collaborating with IT and other companies that we believe
can help design the software and other tools necessary to understand the large,
complex MPSS-based data sets required to enable systems biology. Expanding Our Genomics Discovery Services Business Our current business model is primarily focused on providing MPSS genomics
discovery services such as gene expression analysis and genomic sequencing to
research institutions and pharmaceutical, biotechnology and agricultural
companies. Research Institutes We believe that scientific thought leaders affiliated with research
institutes can provide an immediate, significant and enduring source of
revenue, both directly from their institutes and from access to labs doing
genomics research in the larger scientific research community. More broadly,
we believe that we will benefit by having MPSS data placed in the public
domain by these researchers. The scientific thought leaders should provide
public and very visible exposure and validation of MPSS through their
commentary and publications in scientific journals. Pharmaceutical, Biotechnology and Agricultural Companies Pharmaceutical, biotechnology and agricultural customers are an integral
component of our business development focus and commercialization efforts.
With the assumed accessibility to data sets containing gene expression
information for cells or tissues and sequence information for genomes for
comparative purposes stemming from our work with scientific thought leaders
and IT companies, we expect that pharmaceutical, biotechnology and
agricultural companies will engage us to produce a comprehensive quantitative
profile of gene expression in cells or tissues and genomic sequencing for
their specific interests, such as in diseased, abnormal or induced states or
conditions. In these arrangements, we could provide information content for
each companys specific internal programs. We believe that MPSS gene expression analysis can become the technology
of choice to: (1) accelerate drug discovery by identifying and validating drug
targets and identifying pathways and mode of action; (2) accelerate drug
development through lead (which is a representative of a compound series with
sufficient potential to progress to a drug development program) qualification
and optimization (which is the synthetic modification of a biologically active
compound to fulfill all of the necessary properties required for clinical
usefulness) by improving the success rate of getting products into clinical
testing and to the market by patient group stratification (which is the
division or arrangement of patients into representative subject populations
within the clinical trial) and toxicology; and (3) enable discovery of
biomarkers (which is a biochemical feature that can be used to measure the
progress of disease or the effects of treatment) for diagnostics and
pharmacogenomics. We believe that most of the important drug targets cannot be
reliably monitored by gene expression methods other than MPSS. The revenue sources from genomics discovery service arrangements may
include technology access and services fees from performing MPSS analyses and
providing MPSS data. Additionally, Takara Bio Inc. has licensed from us the
right to use our technologies to provide genomics discovery services and to
manufacture and sell microarrays containing content identified by our
technologies in specific geographic territories. In December 2002 and September
2003, Lynx sold to Takara two and three MPSS instruments, respectively, for
Takaras use in providing genomics discovery services in their licensed
territories. Our Technologies and Applications Massively Parallel Signature Sequencing Technology Our MPSS technology addresses the need to generate sequence information
from millions of DNA fragments. At this extremely large scale, our MPSS
approach eliminates the need for individual sequencing reactions and the
physical separation of DNA fragments required by conventional sequencing
methods. MPSS uses proprietary instruments and reagents developed by us. 4




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MPSS enables the simultaneous identification of all the DNA molecules in a
sample. MPSS uses flow cells, which are glass plates that are micromachined, or
fabricated, to very precise, small dimensions, to create a grooved chamber for
immobilizing microbeads in a planar microarray, which is a two-dimensional,
dense ordered array of DNA samples. With MPSS, one million or more Megaclone
micro-beads are fixed in a single layer array in a flow cell, so solvents and
reagents can be washed over the micro-beads in each cycle of the process. Our
proprietary protocols elicit from the Megaclone micro-beads sequence-dependent
fluorescent responses, which are recorded by a charged coupled device, or CCD,
camera after each cycle. The process produces short signature, or identifying,
sequences, 20 or more nucleotides long, without requiring fragment separation
and separate sequencing reactions as in conventional DNA sequencing approaches.
We have developed proprietary instrumentation and software to automate the
delivery of reagents and solutions used in our sequencing process and to
compile, from the images obtained at each cycle, the signature sequences that
result from each experiment. We believe MPSS has the following advantages over conventional DNA sequencing methods:  
    
    it sequences DNA molecules on as many as one million or more Megaclone beads simultaneously;
    
    it eliminates the need for individual sequencing reactions and gels;
    
    it identifies each of the DNA molecules by a unique signature sequence;
    
    it produces a comprehensive quantitative profile of gene expression in cells or tissues of interest; and
    
    it identifies even the rarest expressed genes. Lynx currently has 25 operational proprietary MPSS instruments. Megaclone Technology Megaclone, our unique and proprietary cloning procedure, underlies our
MPSS technology. Megaclone transforms a biological sample containing millions
of DNA molecules into one made up of millions of micro-beads, which are
microscopic beads of latex, each of which carries approximately 100,000 copies
of one of the DNA molecules in the sample. In contrast to conventional cloning,
in which an individual DNA molecule is selected from a sample and amplified
into many copies for analysis or identification, we can capture on one set of
micro-beads clones of nearly all the DNA sequences that characterize a sample.
Once attached to the micro-beads, these clones can be handled and subjected to
experiments and analyses all at the same time. Megaclone thereby enables many
analyses or characterizations to be conducted that would otherwise be too
cumbersome or onerous to conduct using conventional procedures where each clone
must be addressed individually. Megaclone is a process that uses a proprietary library of approximately
16.7 million short synthetic DNA sequences, called tags, and their
complementary anti-tags, to uniquely mark and process each DNA molecule in a
sample. Each unique tag is a permanent identifier of the DNA molecule it is
attached to, and all of the tagged molecules in a sample are amplified together
to create multiple copies of the tagged molecules. We use another proprietary
process to generate five-micron diameter micro-beads, each of which carries
multiple copies of a short anti-tag DNA sequence complementary to one of the
16.7 million tags. Then, we collect the amplified tagged DNA molecules onto the
micro-beads through hybridization of the tags to the complementary anti-tags.
Each micro-bead carries on its surface enough complementary anti-tags to
collect approximately 100,000 identical copies of the corresponding tagged DNA
molecule. By this process, each tagged target DNA molecule in the original sample is
converted into a micro-bead carrying about 100,000 copies of the same sequence.
Therefore, in a few steps, our Megaclone technology can transform a complex
mixture of more than a million individual DNA molecules into a usable format
that provides the following benefits:  
    
    substantially all the different DNA molecules present in a sample
(typically more than one million) are represented in the final
micro-bead collection; 5




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
    
    these million or more DNA molecules can be analyzed simultaneously in various applications; and
    
    the need for storing and handling millions of individual DNA clones is eliminated. Megaclone is the foundation for our genome-wide analytical applications,
principally MPSS gene expression analysis and other MPSS genome functional
assays under development. Collaborations, Customers and Licensees We have derived substantially all of our revenues from corporate
collaborations, customer agreements and licensing arrangements. For the year
ended December 31, 2003, revenues from Takara, DuPont, BASF, and Bayer
CropScience accounted for 39%, 28%, 14% and 4%, respectively, of our total
revenues. The following are summary descriptions of certain key collaborators,
customers and licensees: E.I. DuPont de Nemours and Company In October 1998, Lynx entered into a research collaboration agreement with
E.I. DuPont de Nemours and Company to apply our technologies on an exclusive
basis to the study of certain crops and their protection. Under the terms of
the agreement, we received payments over a five-year period that ended in the
fourth quarter of 2003 for genomics discovery services, the achievement of
specific technology milestones and the delivery of genomic maps of specified
crops. We received an initial payment of $10.0 million for technology access at
the execution of the agreement, and service fees of $12.0 million were received
by us over a three-year period, which commenced in January 1999. The agreement
was extended with us for a two-year period during which we received additional
service fees of $8.0 million through the fourth quarter of 2003. In the fourth
quarter of 1999, we achieved a technology milestone under the agreement that
resulted in a $5.0 million payment from DuPont. Through December 31, 2003, we received aggregate payments of $35.0 million
from DuPont under the 1998 agreement. In November 2003, we entered into a new five year services agreement with
DuPont. Through this agreement, we will continue to provide MPSS services to
enhance DuPonts discovery and development of new agricultural traits and
products. BASF AG In October 1996, we entered into an agreement with BASF AG, as amended in
October 1998, to provide BASF with nonexclusive access to certain of our
genomics discovery services. In connection with certain technology development
accomplishments, BASF paid us a technology access fee of $4.5 million in the
fourth quarter of 1999. BASFs access to our genomics discovery services is for
a minimum of two years and requires BASF to purchase services at a minimum rate
of $4.0 million per year. At the end of the initial two-year service period in
the fourth quarter of 2001, BASF exercised its right to carryover for an
additional two-year period through the fourth quarter of 2003, a certain level
of previously unrequested genomics discovery services. The agreement expired in
September 2003. Through December 31, 2003, we received aggregate payments of $19.0 million
from BASF under the agreement. Bayer CropScience (formerly Aventis CropScience GmbH) In March 1999, Aventis Pharmaceuticals, formerly Hoechst Marion Roussel,
Inc., obtained nonexclusive access to certain of our genomics discovery
services for the benefit of its affiliate, Aventis CropScience, which is now
Bayer CropScience. We received an initial payment for genomics discovery
services to be performed by us for Bayer CropScience. The service period was
renewed in March 2000, extended in March 2002 for an additional five-year
period, and amended in September 2002. Related to the five-year extension and
subsequent amendment, Bayer CropScience and Lynx plan to jointly develop and
commercialize a novel assay based on Lynxs proprietary bead- 6




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based technologies. Lynx and Bayer CropScience will own the assay
technology jointly. We will manufacture and sell the services or products based
on the assay technology and will pay related royalties to Bayer CropScience.
Additionally, we will derive revenues from performing genomics discovery
services for Bayer CropScience during the development and commercialization
phase of the agreement. Lynx and Bayer CropScience currently collaborate to
apply our technology for the purpose of identifying sequences that might be
inserted in genetically modified plants. This is an evaluation project for
understanding the possible Bayer CropScience product applicability and our
commercial viability of this limited application. Through December 31, 2003, we have received aggregate payments of $6.0
million from Bayer CropScience under these agreements. Takara Bio Inc. (formerly Takara Shuzo Co., Ltd.) In November 2000, we entered into a collaboration and license agreement
with Takara Bio Inc. of Japan. The license, as amended in December 2002 and in
July 2003, provided Takara with the right in Japan, Korea and China, including
Taiwan, to use our proprietary Megaclone, Megasort and MPSS technologies
exclusively until the expiration of the relevant Lynx patents to provide
genomics discovery services and to manufacture and sell microarrays containing
content identified by our technologies. Under the terms of the original license
agreement, Takara has a nonexclusive license right to manufacture and sell such
microarrays elsewhere throughout the world. In connection with the 2002
amendment to the collaboration, Takara was also granted a royalty-bearing,
nonexclusive right to provide genomics discovery services to customers in
France and Italy. Under the terms of the collaboration agreement, as amended, we received
payments from Takara for technology access fees, royalties on sales of
microarrays and revenues from genomics discovery services, the sale to Takara
of proprietary instruments and reagents used in applying our technologies and
purchases of our common stock. In the event of improvements made by Takara that
increase the efficiency of our technologies by a defined amount, we agreed with
Takara to negotiate in good faith a limited reduction to the royalty rate
applicable to the above royalties. In December 2002, we sold two MPSS
instruments to Takara for Takaras use in providing genomics discovery services
in licensed territories. As part of the 2002 amendment to the collaboration,
Takara accelerated its technology access fee payments to us. In both September and December 2002, in connection with the collaboration
agreement, we issued and sold 291,545 shares of common stock, at a purchase
price of $3.43 per share, to Takara in private placements pursuant to the terms
and conditions of common stock purchase agreements. In October 2001, in
connection with the collaboration agreement, we issued and sold 45,787 shares
of common stock, at a purchase price of $21.84 per share, to Takara in a
private placement pursuant to the terms and conditions of a common stock
purchase agreement. As part of the August 2003 amendment to the collaboration and license
agreement with Takara, Takara made a payment of approximately $3.0 million
dollars to us in exchange for which Takara was relieved of its obligation to
make technology access fee payments to us totaling approximately $2.0 million
dollars during 2003 and 2004 and royalties in respect of Takaras sales, and
acquired three additional MPSS instruments for Takaras use in providing
genomics discovery services in Takaras licensed territories. In addition,
Takara will no longer be required to make future equity investments in us. Through December 31, 2003, we have received aggregate payments of $14.7
million, net of foreign withholding taxes, from Takara under the collaboration
agreement. The remaining commitment under this agreement is limited to
providing a minimum level of reagents to Takara, at agreed prices, in order for
Takara to perform MPSS in their licensed territories. 7




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Axaron Bioscience AG, formerly BASF-LYNX Bioscience AG In 1996, Lynx and BASF established Axaron Bioscience AG, a joint venture
company in Heidelberg, Germany. Axaron began operations in 1997 and is
employing our technologies in its neuroscience, toxicology and microbiology
research programs. Upon the establishment of Axaron, we contributed access to
our technologies to Axaron in exchange for an initial 49% equity ownership in
Axaron. BASF, by committing to provide research funding to Axaron of DM50
million (or approximately $32 million based on a December 2003 exchange rate)
over a five-year period beginning in 1997, received an initial 51% equity
ownership in Axaron. In 1998, BASF agreed to provide an additional $10.0
million in research funding to Axaron, of which $4.3 million was paid to us for
technology assets related to a central nervous system program. In the period
since the joint venture was established, management and employees increased
their equity ownership in Axaron to 15%, thereby reducing the ownership of Lynx
and BASF to 41.6% and 43.4%, respectively. In June 2001, we extended our technology licensing agreement with Axaron.
The license extends Axarons right to use our proprietary MPSS and Megasort
technologies nonexclusively in Axarons neuroscience, toxicology and
microbiology programs until December 31, 2007. The agreement also positions
Axaron to apply our technologies to specific disorders in the neuroscience
field. Under the terms of the agreement, we received a $5.0 million technology
license fee from Axaron. We intend to furnish to Axaron, initially without
charge and later for a fee, proprietary reagents and additional MPSS
instruments for use in Axarons research programs. In 2001, Lynx and BASF agreed to continue their support of Axarons
growth, including an increase in the capital of Axaron. We made an additional
investment of $4.5 million in Axaron, which maintained our ownership interest
in Axaron at approximately 40%. Given our ownership share of Axaron and our
ability to exercise significant influence over Axarons operating and
accounting policies, we have accounted for the investment under the equity
method in accordance with Accounting Principles Board Opinion No. 18, The
Equity Method of Accounting for Investments in Common Stock. Through December 31, 2003, we have received aggregate payments of $9.3
million from Axaron under all related agreements. We recorded revenue of $0.8
million in 2003, $0.8 million in 2002, and $0.4 million in 2001 from Axaron, as
the technology license fee from Axaron is being recognized as revenue on a
straight-line basis over the noncancelable term of the technology licensing
agreement. We may receive additional payments from Axaron over the remaining
term of the technology licensing agreement from the sale to Axaron of
proprietary reagents and additional MPSS instruments for use in Axarons
research programs. We have no on-going financial commitment to Axaron. Competition Competition among entities attempting to identify the genes associated
with specific diseases and to develop products based on such discoveries is
intense. We face, and will continue to face, competition from pharmaceutical,
biotechnology and agricultural companies, such as Affymetrix, Inc., Celera
Genomics Group, Gene Logic, Inc., and Genome Therapeutics Corporation, academic
and research institutions and government agencies, both in the United States
and abroad. Several entities are attempting to identify and patent randomly
sequenced genes and gene fragments, while others are pursuing a gene
identification, characterization and product development strategy based on
positional cloning. We are aware that certain entities are using a variety of
gene expression analysis methodologies, including chip-based systems, to
attempt to identify disease-related genes. In addition, numerous pharmaceutical
companies are developing genomic research programs, either alone or in
partnership with our competitors. Competition among such entities is intense
and is expected to increase. In order to successfully compete against existing
and future technologies, we will need to demonstrate to potential customers
that our technologies and capabilities are superior to those of our
competitors. Many of our competitors have substantially greater capital resources,
research and development staffs, facilities, manufacturing and marketing
experience, distribution channels and human resources than we do. These
competitors may discover, characterize or develop important genes, drug targets
or drug leads, drug discovery technologies or drugs in advance of our customers
or us or that are more effective than those developed by our collaborators and
customers or us. They may also obtain regulatory approvals for their drugs more
rapidly than our collaborators or customers will, any of which could have a
material adverse effect on our business. Moreover, our competitors may 8




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obtain patent protection or other intellectual property rights that could
limit our rights or our collaborators and customers abilities to use our
technologies or commercialize therapeutic, diagnostic or agricultural products.
We also face competition from these and other entities in gaining access to
cells, tissues and nucleic acid samples for use in our discovery programs. Intellectual Property We are pursuing a strategy designed to obtain United States and foreign
patent protection for our core technologies. Our long-term commercial success
will be dependent in part on our ability to obtain commercially valuable patent
claims and to protect our intellectual property portfolio. As of December 31,
2003, we owned or controlled 84 issued patents and 98 pending patent
applications in the United States and foreign countries relating to our
genomics and proteomics technologies. In addition to acquiring patent protection for our core analysis
technologies, as part of our business strategy, we may file for patent
protection on sets of genes, both known and newly discovered, that have
diagnostic or prognostic applications, novel genes that may serve as drug
development targets, genetic maps and sets of genetic markers, such as SNPs,
that are associated with traits or conditions of medical or economic
importance. However, there is substantial uncertainty regarding the
availability of such patent protection. Patent law relating to the scope of claims in the technology field in
which we operate is still evolving. The degree to which we will be able to
protect our technology with patents, therefore, is uncertain. Others may
independently develop similar or alternative technologies, duplicate any of our
technologies and, if patents are licensed or issued to us, design around the
patented technologies licensed to or developed by us. In addition, we could
incur substantial costs in litigation if we are required to defend ourselves in
patent suits brought by third parties or if we initiate such suits. With respect to proprietary know-how that is not patentable and for
processes for which patents are difficult to enforce, we rely on trade secret
protection and confidentiality agreements to protect our interests. We intend
to maintain several important aspects of our technology platform as trade
secrets. While we require all employees, consultants, collaborators, customers
and licensees to enter into confidentiality agreements, we cannot be certain
that proprietary information will not be disclosed or that others will not
independently develop substantially equivalent proprietary information. Research and Development Expenditures We have devoted our efforts primarily to research and development.
Research and development expenses were $12.2 million for the year ended
December 31, 2003, $20.8 million for the year ended December 31, 2002 and $24.7
million for the year ended December 31, 2001. Scientific Advisor Sydney Brenner, M.B., D.Phil.,our principal scientific advisor,is a
distinguished Professor at the Salk Institute of Biological Studies in La
Jolla, California. From July 1996 to January 2001, Dr. Brenner served as
Director and President of The Molecular Sciences Institute, a non-profit
research institute in Berkeley, California. Until his retirement in 1996, Dr.
Brenner was Honorary Professor of Genetic Medicine, University of Cambridge
School of Clinical Medicine, Cambridge, England. Dr. Brenner is known for his
work on genetic code and the information transfer from genes to proteins and
for his pioneering research on the genetics and development of the nematode.
Dr. Brenner is the principal inventor of Lynxs bead-based technologies. Dr.
Brenner is a Fellow of the Royal Society (1995) and a Foreign Associate of the
U.S. National Academy of Sciences (1977) and has received numerous awards of
recognition, including the Nobel Prize in Physiology or Medicine for 2002, the
Albert Lasker Medical Research Award (2000 and 1991), the Genetics Society of
America Medal (1987) and the Kyoto Prize (1990). 9




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Employees As of December 31, 2003, we employed 90 full-time employees, of which 75
were engaged in production and research and development activities. We believe we have been successful in attracting skilled and experienced
scientific personnel; however, competition for such personnel is intense. None
of our employees are covered by collective bargaining agreements, and
management considers relations with our employees to be good. Available Information We maintain a site on the World Wide Web at www.lynxgen.com; however,
information found on our website is not incorporated by reference into this
report. We make available free of charge on or through our website our annual
report of Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC. We have not adopted a code of ethics because adoption of such a code is
not yet required, however, we intend to adopt a code of ethics prior to our
annual meeting for 2004 that applies to our principal executive officer,
principal financial officer, principal accounting officer or controller, or
persons performing similar functions. We intend to post the text of our code of
ethics on our website at www.lynxgen.com in connection with Investor
Resources material and will include a copy of such code of ethics as an
exhibit to our definitive proxy statement with respect to our annual meeting of
stockholders. In addition, we intend to promptly disclose (1) the nature of any
amendment to our code of ethics that applies to our principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions and (2) the nature of any
waiver, including an implicit waiver, from a provision of our code of ethics
that is granted to one of these specified officers, the name of such person who
is granted the waiver and the date of the waiver on our website in the future. Business Risks Our business faces significant risks. These risks include those described
below and may include additional risks of which we are not currently aware or
which we currently do not believe are material. If any of the events or
circumstances described in the following risks actually occurs, our business,
financial condition or results of operations could be materially adversely
affected. These risks should be read in conjunction with the other information
set forth in this report. We have a history of net losses. We expect to continue to incur net losses, and
we may not achieve or maintain profitability. We have incurred net losses each year since our inception in 1992,
including net losses of approximately $8.8 million for the year ended December
31, 2003, $15.5 million in 2002 and $16.7 million in 2001. As of December 31,
2003, we had an accumulated deficit of approximately $107.7 million. Net
losses may continue for at least the next several years as we proceed with the
commercialization and additional development of our technologies. The presence
and size of these potential net losses will depend, in part, on the rate of
growth, if any, in our revenues and on the level of our expenses. Our research
and development expenditures and general and administrative costs have exceeded
our revenues to date. Research and development expenses may increase due to
spending for ongoing technology development and implementation, as well as new
applications. We will need to generate significant additional revenues to
achieve profitability. Even if we do increase our revenues and achieve
profitability, we may not be able to sustain profitability. Our ability to generate revenues and achieve profitability depends on many
factors, including:  
    
    our ability to continue existing customer relationships and enter
into additional corporate collaborations and agreements; 10




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
    
    our ability to expand the scope of our products and services into
new areas of pharmaceutical, biotechnology and agricultural research;
    
    our customers and collaborators abilities to develop diagnostic,
therapeutic and other commercial products from the application of our
technologies; and
    
    the successful clinical testing, regulatory approval and
commercialization of such products by our customers and collaborators. The time required to reach profitability is highly uncertain. We may not
achieve profitability on a sustained basis, if at all. We will need additional funds in the future, which may not be available to us. We have invested significant capital in our scientific and business
development activities. Our future capital requirements will be substantial as
we conduct our operations, and will depend on many factors including:  
    
    the progress and scope of our research and development projects;
    
    payments received under our customer, license and collaborative agreements;
    
    our ability to establish and maintain customer, license and collaborative arrangements;
    
    the progress of the development and commercialization efforts under
our customer, license and collaborative agreements;
    
    the costs associated with obtaining access to biological samples
and related information; and
    
    the costs involved in preparing, filing, prosecuting, maintaining
and enforcing patent claims and other intellectual property rights. We have experienced losses since our inception, including a net loss for
the six months ended June 30, 2004. We expect to continue to incur net losses
as we proceed with the commercialization and additional development of our
technologies. The size of these losses will depend on the rate of growth, if
any, in our revenues and on the level of our expenses. Our cash and cash
equivalents have decreased from the $5.6 million, including $0.7 million of
restricted cash, as of December 31, 2003. As of June 30, 2004, our cash and
cash equivalents consisted of $2.0 million in unrestricted cash and investments
and restricted cash of $0.3 million. We will require additional funding to
continue our business activities through at least December 31, 2005. We are
considering various options, which include securing additional equity
financing, obtaining new collaborators and customers and other strategic
actions. If we raise additional capital by issuing equity or convertible debt
securities, our existing stockholders may experience substantial dilution. If
we require additional financing, there can be no assurance that it will be
available on satisfactory terms, or at all. If we are unable to secure
additional financing on reasonable terms, or are unable to generate sufficient
new sources of revenue through arrangements with customers, collaborators and
licensees, we will be forced to take substantial restructuring actions, which
may include significantly reducing our anticipated level of expenditures, the
sale of some or all of our assets, or obtaining funds by entering into
financing or collaborative agreements on unattractive terms, or we will not be
able to fund operations. Our technologies are new and unproven and may not allow our customers,
collaborators or us to identify genes, proteins or targets for drug discovery. You must evaluate us in light of the uncertainties and complexities
affecting an early stage genomics company. Our technologies are new and
unproven. The application of these technologies is in too early a stage to
determine whether it can be successfully implemented. These technologies
assume that information about gene expression and gene sequences may enable
scientists to better understand complex biological processes and, therefore,
provide us with increased commercial opportunities for our products. Our
technologies also depend on the successful 11




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integration of independent technologies, each of which has its own
development risks. Relatively few therapeutic products based on gene
discoveries have been successfully developed and commercialized. Our
technologies may not enable our customers, collaborators or us to identify
genes, proteins or targets for drug discovery. To date, neither our customers
nor we have identified any targets for drug discovery based on our
technologies. We are dependent on our customers and collaborators and will need to find
additional customers and collaborators in the future to develop and
commercialize diagnostic or therapeutic products. Our strategy for the development and commercialization of our technologies
and potential products includes entering into collaborations, customer
agreements or licensing arrangements with pharmaceutical, biotechnology and
agricultural companies and research institutes. We do not have the resources
to develop or commercialize diagnostic or therapeutic products on our own. If
we cannot negotiate additional collaborative arrangements or contracts on
acceptable terms, or at all, or if such collaborations or relationships are not
successful, we may never become profitable. We have derived substantially all of our revenues from corporate
collaborations, customer agreements and licensing arrangements. Revenues from
such agreements depend upon continuation of the related relationships, our
performance of genomics discovery services, the achievement of milestones and
royalties derived from future products developed from our research and
technologies. To date, we have received, and expect to continue to receive in
the future, a significant portion of our revenues from a small number of
collaborators, customers and licensees, as shown on the following table: Year Ended December 31,2003
    
    2002
    
    2001Takara Bio Inc.
    
    
    39
    %
    
    
    16
    %
    
    
    12
    %E.I. DuPont de Nemours and Company
    
    
    28
    %
    
    
    32
    %
    
    
    37
    %BASF AG
    
    
    14
    %
    
    
    11
    %
    
    
    24
    %Bayer CropScience
    
    
    4
    %
    
    
    14
    %
    
    
    4
    %Geron Corporation
    
    
    
    
    
    
    15
    %
    
    
    Institute of Molecular and Cell Biology
    
    
    
    
    
    
    
    
    
    
    12
    %
 If we fail to perform genomics discovery services or successfully achieve
milestones or our collaborators fail to develop successful products, we will
not earn the revenues contemplated under such agreements. If our
collaborators, customers or licensees do not renew existing agreements, we lose
one of these collaborators, customers or licensees, we do not attract new
collaborators, customers or licensees or we are unable to enter into new
collaborative, customer or license agreements on commercially acceptable terms,
our revenues may decrease, and our activities may fail to lead to
commercialized products. Our dependence on collaborations, agreements or licenses with third
parties subjects us to a number of risks. We have limited or no control over
the resources that such third parties may choose to devote to our joint
efforts. Our collaborators, customers or licensees may breach or terminate
their agreements with us or fail to perform their obligations thereunder.
Further, our collaborators, customer or licensees may elect not to develop
products arising out of our agreements or may fail to devote sufficient
resources to the development, manufacture, marketing or sale of such products.
While we do not currently compete directly with any of our customers and
collaborators, some of our customers and collaborators could become our
competitors in the future if they internally develop DNA analysis technologies
or if they acquire other genomics companies and move into the genomics
industry. We will not earn the revenues contemplated under our customer and
collaborative arrangements, if our customers and collaborators:  
    
    do not develop commercially successful products using our technologies;
    
    develop competing products;
    
    preclude us from entering into collaborations with their competitors;
    
    fail to obtain necessary regulatory approvals; or
    
    terminate their agreements with us. 12




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We depend on a single supplier to manufacture flow cells used in our MPSS
technology. Flow cells are glass plates that are micromachined, or fabricated to very
precise, small dimensions, to create a grooved chamber for immobilizing
micro-beads in a planar microarray, which is a two-dimensional, dense ordered
array of DNA samples. We use flow cells in our MPSS technology. We currently
purchase the flow cells used in our MPSS technology from a single supplier,
although the flow cells are potentially available from multiple suppliers.
While we believe that alternative suppliers for flow cells exist, identifying
and qualifying new suppliers could be an expensive and time-consuming process.
Our reliance on outside vendors involves several risks, including:  
    
    the inability to obtain an adequate supply of required components
due to manufacturing capacity constraints, a discontinuance of a
product by a third-party manufacturer or other supply constraints;
    
    reduced control over quality and pricing of components; and
    
    delays and long lead times in receiving materials from vendors. We operate in an intensely competitive industry with rapidly evolving
technologies, and our competitors may develop products and technologies that
make ours obsolete. The biotechnology industry is highly fragmented and is characterized by
rapid technological change. In particular, the area of genomics research is a
rapidly evolving field. Competition among entities attempting to identify
genes and proteins associated with specific diseases and to develop products
based on such discoveries is intense. Many of our competitors have
substantially greater research and product development capabilities and
financial, scientific and marketing resources than we do. We face, and will continue to face, competition from pharmaceutical,
biotechnology and agricultural companies, as well as academic research
institutions, clinical reference laboratories and government agencies. Some of
our competitors, such as Affymetrix, Inc., Celera Genomics Group, Gene Logic,
Inc., and Genome Therapeutics Corporation may be:  
    
    attempting to identify and patent randomly sequenced genes and gene
fragments and proteins;
    
    pursuing a gene identification, characterization and product
development strategy based on positional cloning, which uses disease
inheritance patterns to isolate the genes that are linked to the
transmission of disease from one generation to the next; and
    
    using a variety of different gene and protein expression analysis
methodologies, including the use of chip-based systems, to attempt to
identify disease-related genes and proteins. In addition, numerous pharmaceutical, biotechnology and agricultural
companies are developing genomics research programs, either alone or in
partnership with our competitors. Our future success will depend on our
ability to maintain a competitive position with respect to technological
advances. Rapid technological development by others may make our technologies
and future products obsolete. Any products developed through our technologies will compete in highly
competitive markets. Our competitors may be more effective at using their
technologies to develop commercial products. Further, our competitors may
obtain intellectual property rights that would limit the use of our
technologies or the commercialization of diagnostic or therapeutic products
using our technologies. As a result, our competitors products or technologies
may render our technologies and products, and those of our collaborators,
obsolete or noncompetitive. If we fail to adequately protect our proprietary technologies, third parties
may be able to use our technologies, which could prevent us from competing in
the market. Our success depends in part on our ability to obtain patents and maintain
adequate protection of the intellectual property related to our technologies
and products. The patent positions of biotechnology companies, including our
patent position, are generally uncertain and involve complex legal and factual
questions. We will be able to protect 13




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our proprietary rights from unauthorized use by third parties only to the
extent that our proprietary technologies are covered by valid and enforceable
patents or are effectively maintained as trade secrets. The laws of some
foreign countries do not protect proprietary rights to the same extent as the
laws of the U.S., and many companies have encountered significant problems in
protecting and defending their proprietary rights in foreign jurisdictions. We
have applied and will continue to apply for patents covering our technologies,
processes and products, as and when we deem appropriate. However, third
parties may challenge these applications, or these applications may fail to
result in issued patents. Our existing patents and any future patents we
obtain may not be sufficiently broad to prevent others from practicing our
technologies or from developing competing products. Furthermore, others may
independently develop similar or alternative technologies or design around our
patents. In addition, our patents may be challenged or invalidated or fail to
provide us with any competitive advantage. We also rely on trade secret protection for our confidential and
proprietary information. However, trade secrets are difficult to protect. We
protect our proprietary information and processes, in part, with
confidentiality agreements with employees, collaborators and consultants.
However, third parties may breach these agreements, we may not have adequate
remedies for any such breach or our trade secrets may still otherwise become
known by our competitors. In addition, our competitors may independently
develop substantially equivalent proprietary information. Litigation or third-party claims of intellectual property infringement could
require us to spend substantial time and money and adversely affect our ability
to develop and commercialize our technologies and products. Our commercial success depends in part on our ability to avoid infringing
patents and proprietary rights of third parties and not breaching any licenses
that we have entered into with regard to our technologies. Other parties have
filed, and in the future are likely to file, patent applications covering
genes, gene fragments, proteins, the analysis of gene expression and protein
expression and the manufacture and use of DNA chips or microarrays, which are
tiny glass or silicon wafers on which tens of thousands of DNA molecules can be
arrayed on the surface for subsequent analysis. We intend to continue to apply
for patent protection for methods relating to gene expression and protein
expression and for the individual disease genes and proteins and drug discovery
targets we discover. If patents covering technologies required by our
operations are issued to others, we may have to rely on licenses from third
parties, which may not be available on commercially reasonable terms, or at
all. Third parties may accuse us of employing their proprietary technology
without authorization. In addition, third parties may obtain patents that
relate to our technologies and claim that use of such technologies infringes
these patents. Regardless of their merit, such claims could require us to
incur substantial costs, including the diversion of management and technical
personnel, in defending ourselves against any such claims or enforcing our
patents. In the event that a successful claim of infringement is brought
against us, we may need to pay damages and obtain one or more licenses from
third parties. We may not be able to obtain these licenses at a reasonable
cost, or at all. Defense of any lawsuit or failure to obtain any of these
licenses could adversely affect our ability to develop and commercialize our
technologies and products and thus prevent us from achieving profitability. We have limited experience in sales and marketing and thus may be unable to
further commercialize our technologies and products. Our ability to achieve profitability depends on attracting collaborators
and customers for our technologies and products. There are a limited number of
pharmaceutical, biotechnology and agricultural companies and research
institutes that are potential collaborators and customers for our technologies
and products. To market our technologies and products, we must develop a sales
and marketing group with the appropriate technical expertise. We may not
successfully build such a sales force. If our sales and marketing efforts fail
to be successful, our technologies and products may fail to gain market
acceptance. Our sales cycle is lengthy, and we may spend considerable resources on
unsuccessful sales efforts or may not be able to enter into agreements on the
schedule we anticipate. Our ability to obtain collaborators and customers for our technologies and
products depends in significant part upon the perception that our technologies
and products can help accelerate their drug discovery and genomics efforts.
Our sales cycle is typically lengthy because we need to educate our potential
collaborators and customers and sell 14




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the benefits of our products to a variety of constituencies within such
companies. In addition, we may be required to negotiate agreements containing
terms unique to each collaborator or customer. We may expend substantial funds
and management effort without any assurance that we will successfully sell our
technologies and products. Actual and proposed consolidations of
pharmaceutical companies have negatively affected, and may in the future
negatively affect, the timing and progress of our sales efforts. The loss of key personnel or the inability to attract and retain additional
personnel could impair the growth of our business. We are highly dependent on the principal members of our management and
scientific staff. The loss of any of these persons services might adversely
impact the achievement of our objectives and the continuation of existing
customer, collaborative and license agreements. In addition, recruiting and
retaining qualified scientific personnel to perform future research and
development work will be critical to our success. There is currently a
shortage of skilled executives and employees with technical expertise, and this
shortage is likely to continue. As a result, competition for skilled personnel
is intense and turnover rates are high. Competition for experienced scientists
from numerous companies, academic and other research institutions may limit our
ability to attract and retain such personnel. We depend on our President and
Chief Executive Officer, Kevin P. Corcoran, the loss of whose services could
have a material adverse effect on our business. Although we have an employment
agreement with Mr. Corcoran in place, currently we do not maintain key person
insurance for him or any other key personnel. We use hazardous chemicals and radioactive and biological materials in our
business. Any claims relating to improper handling, storage or disposal of
these materials could be time consuming and costly. Our research and development processes involve the controlled use of
hazardous materials, including chemicals and radioactive and biological
materials. Our operations produce hazardous waste products. We cannot
eliminate the risk of accidental contamination or discharge and any resultant
injury from these materials. We may be sued for any injury or contamination
that results from our use or the use by third parties of these materials, and
our liability may exceed our insurance coverage and our total assets. Federal,
state and local laws and regulations govern the use, manufacture, storage,
handling and disposal of hazardous materials. Compliance with environmental
laws and regulations may be expensive, and current or future environmental
regulations may impair our research, development and production efforts. Ethical, legal and social issues may limit the public acceptance of, and demand
for, our technologies and products. Our collaborators and customers may seek to develop diagnostic products
based on genes or proteins. The prospect of broadly available gene-based
diagnostic tests raises ethical, legal and social issues regarding the
appropriate use of gene-based diagnostic testing and the resulting confidential
information. It is possible that discrimination by third-party payors, based
on the results of such testing, could lead to the increase of premiums by such
payors to prohibitive levels, outright cancellation of insurance or
unwillingness to provide coverage to individuals showing unfavorable gene or
protein expression profiles. Similarly, employers could discriminate against
employees with gene or protein expression profiles indicative of the potential
for high disease-related costs and lost employment time. Finally, government
authorities could, for social or other purposes, limit or prohibit the use of
such tests under certain circumstances. These ethical, legal and social
concerns about genetic testing and target identification may delay or prevent
market acceptance of our technologies and products. Although our technology does not depend on genetic engineering, genetic
engineering plays a prominent role in our approach to product development. The
subject of genetically modified food has received negative publicity, which has
aroused public debate. Adverse publicity has resulted in greater regulation
internationally and trade restrictions on imports of genetically altered
agricultural products. Claims that genetically engineered products are unsafe
for consumption or pose a danger to the environment may influence public
attitudes and prevent genetically engineered products from gaining public
acceptance. The commercial success of our future products may depend, in part,
on public acceptance of the use of genetically engineered products, including
drugs and plant and animal products. 15




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If we develop products with our collaborators, and if product liability
lawsuits are successfully brought against us, we could face substantial
liabilities that exceed our resources. We may be held liable, if any product we develop with our collaborators
causes injury or is otherwise found unsuitable during product testing,
manufacturing, marketing or sale. Although we have general liability and
product liability insurance, this insurance may become prohibitively expensive
or may not fully cover our potential liabilities. Inability to obtain
sufficient insurance coverage at an acceptable cost or to otherwise protect us
against potential product liability claims could prevent or inhibit our ability
to commercialize products developed with our collaborators. Healthcare reform and restrictions on reimbursements may limit our returns on
diagnostic or therapeutic products that we may develop with our collaborators. If we successfully validate targets for drug discovery, products that we
develop with our collaborators based on those targets may include diagnostic or
therapeutic products. The ability of our collaborators to commercialize such
products may depend, in part, on the extent to which reimbursement for the cost
of these products will be available from government health administration
authorities, private health insurers and other organizations. In the U.S.,
third-party payors are increasingly challenging the price of medical products
and services. The trend towards managed healthcare in the U.S., legislative
healthcare reforms and the growth of organizations such as health maintenance
organizations that may control or significantly influence the purchase of
healthcare products and services, may result in lower prices for any products
our collaborators may develop. Significant uncertainty exists as to the
reimbursement status of newly approved healthcare products. If adequate
third-party coverage is not available in the future, our collaborators may fail
to maintain price levels sufficient to realize an appropriate return on their
investment in research and product development. Our facilities are located near known earthquake fault zones, and the
occurrence of an earthquake or other catastrophic disaster could cause damage
to our facilities and equipment, which could require us to cease or curtail
operations. Our facilities are located near known earthquake fault zones and are
vulnerable to damage from earthquakes. We are also vulnerable to damage from
other types of disasters, including fire, floods, power loss, communications
failures and similar events. If any disaster were to occur, our ability to
operate our business at our facilities would be seriously, or potentially
completely, impaired. In addition, the unique nature of our research
activities could cause significant delays in our programs and make it difficult
for us to recover from a disaster. The insurance we maintain may not be
adequate to cover our losses resulting from disasters or other business
interruptions. Accordingly, an earthquake or other disaster could materially
and adversely harm our ability to conduct business. Our stock price may be extremely volatile. We believe that the market price of our common stock will remain highly
volatile and may fluctuate significantly due to a number of factors. The
market prices for securities of many publicly-held, early-stage biotechnology
companies have in the past been, and can in the future be expected to be,
especially volatile. For example, during the two-year period from January 1,
2002 to December 31, 2003, the closing sales price of our common stock as
quoted on the Nasdaq National Market and Nasdaq SmallCap Market fluctuated from
a low of $1.61 to a high of $32.89 per share. In addition, the securities
markets have from time to time experienced significant price and volume
fluctuations that may be unrelated to the operating performance of particular
companies. The following factors and events may have a significant and adverse
impact on the market price of our common stock:  
    
    fluctuations in our operating results;
    
    announcements of technological innovations or new commercial products by us or our competitors;
    
    release of reports by securities analysts;
    
    developments or disputes concerning patent or proprietary rights;
    
    developments in our relationships with current or future collaborators, customers or licensees; and 16




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
    
    general market conditions. Many of these factors are beyond our control. These factors may cause a
decrease in the market price of our common stock, regardless of our operating
performance. Our securities have been transferred from the Nasdaq National Market to the
Nasdaq SmallCap Market, which has subjected us to various statutory
requirements and may have adversely affected the liquidity of our common stock,
and a failure by us to meet the listing maintenance standards of the Nasdaq
SmallCap Market could result in delisting from the Nasdaq SmallCap Market. Effective May 22, 2003, a Nasdaq Qualifications Panel terminated our
Nasdaq National Market Listing and transferred our securities to the Nasdaq
SmallCap Market. In order to maintain the listing of our securities on the
Nasdaq SmallCap Market, we must be able to demonstrate compliance with all
applicable listing maintenance requirements. In the event we are unable to do
so, our securities will be delisted from the Nasdaq Stock Market. With our securities listed on the Nasdaq SmallCap Market, we face a
variety of legal and other consequences that will likely negatively affect our
business including, without limitation, the following:  
    
    we may have lost our exemption from the provisions of Section 2115
of the California Corporations Code, which imposes aspects of
California corporate law on certain non-California corporations
operating within California. As a result, (i) our stockholders may be
entitled to cumulative voting and (ii) we may be subject to more
stringent stockholder approval requirements and more
stockholder-favorable dissenters rights in connection with certain
strategic transactions;
    
    the state securities law exemptions available to us are more
limited, and, as a result, future issuances of our securities may
require time-consuming and costly registration statements and
qualifications;
    
    due to the application of different securities law exemptions and
provisions, we have been required to amend our stock option plan,
suspend our stock purchase plan and must comply with time-consuming and
costly administrative procedures;
    
    the coverage of Lynx by securities analysts may decrease or cease entirely; and
    
    we may lose current or potential investors. In addition, we are required to satisfy various listing maintenance
standards for our common stock to be quoted on the Nasdaq SmallCap Market. If
we fail to meet such standards, our common stock would likely be delisted from
the Nasdaq SmallCap Market and trade on the over-the-counter bulletin board,
commonly referred to as the pink sheets. This alternative is generally
considered to be a less efficient market and would seriously impair the
liquidity of our common stock and limit our potential to raise future capital
through the sale of our common stock, which could materially harm our business. Anti-takeover provisions in our charter documents and under Delaware law may
make it more difficult to acquire us or to effect a change in our management,
even though an acquisition or management change may be beneficial to our
stockholders. Under our certificate of incorporation, our board of directors has the
authority, without further action by the holders of our common stock, to issue
2,000,000 additional shares of preferred stock from time to time in series and
with preferences and rights as it may designate. These preferences and rights
may be superior to those of the holders of our common stock. For example, the
holders of preferred stock may be given a preference in payment upon our
liquidation or for the payment or accumulation of dividends before any
distributions are made to the holders of common stock. Any authorization or issuance of preferred stock, while providing
desirable flexibility in connection with financings, possible acquisitions and
other corporate purposes, could also have the effect of making it more
difficult for a third party to acquire a majority of our outstanding voting
stock or making it more difficult to remove directors and effect a change in
management. The preferred stock may have other rights, including economic
rights senior to those of our common stock, and, as a result, an issuance of
additional preferred stock could lower the market value 17




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of our common stock. Provisions of Delaware law may also discourage, delay
or prevent someone from acquiring or merging with us. 18




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PART II 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results
of Operations Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. When used herein, the words believe, anticipate, expect,
estimate and similar expressions are intended to identify such
forward-looking statements. There can be no assurance that these statements
will prove to be correct. Our actual results could differ materially from
those discussed here. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in this section,
as well as in Item 1. Business-Business Risks. We undertake no obligation
to update any of the forward-looking statements contained herein to reflect any
future events or developments. Overview We believe that Lynx Therapeutics, Inc. (Lynx or the Company) is a
leader in the development and application of novel genomics analysis solutions.
Our Massively Parallel Signature Sequencing, or MPSS, instruments analyze
millions of DNA molecules in parallel, enabling genome structure
characterization at what we believe to be an unprecedented level of resolution.
As applied to gene expression analysis, MPSS provides comprehensive and
quantitative digital gene expression information important to modern systems
biology research in the pharmaceutical, biotechnology and agricultural
industries. Gene expression refers to the number of genes and the extent a
cell or tissue expresses those genes, and represents a way to move beyond DNA
sequence data to understand the function of genes, the proteins that they
encode and the role they play in health and disease. Systems biology is an
approach in which researchers seek to gain a complete molecular understanding
of biological systems in health and disease. We have incurred net losses each year since our inception in 1992. As of
December 31, 2003, we had an accumulated deficit of approximately $107.7
million, including a net loss of $8.8 million in 2003. Net losses may continue
for at least the next several years as we proceed with the commercialization
and additional development of our technologies. The presence and size of these
potential net losses will depend, in part, on the rate of growth, if any, in
our revenues and on the level of our expenses. Our cash and cash equivalents
have decreased from $11.7 million as of December 31, 2002 to $5.6 million as of
December 31, 2003, which includes restricted cash of $0.7 million. In March
2004, we raised an additional $4 million through the sale of common stock. We
believe that with the funds raised in March 2004, we will have sufficient
funding to meet our projected operating and capital requirements through at
least December 31, 2004. In addition, we are considering various options to
raise additional funds, which will be required to allow us to continue our
business activities beyond 2004. These options include securing additional
equity financing and obtaining new collaborators and customers. If we raise
additional capital by issuing equity or convertible debt securities, our
existing stockholders may experience substantial dilution. There can be no
assurance that additional financing will be available on satisfactory terms, or
at all. If we are unable to secure additional financing on reasonable terms, or
are unable to generate sufficient new sources of revenue through arrangements
with customers, collaborators and licensees, we will be forced to take
substantial restructuring actions, which may include significantly reducing our
anticipated level of expenditures, the sale of some or all of our assets, or
obtaining funds by entering into financing or collaborative agreements on
unattractive terms, or we will not be able to fund operations. 19




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To date, we have received, and expect to continue to receive in the
future, a significant portion of our revenues from a small number of
collaborators, customers and licensees, as shown on the following table. Year Ended December 31,2003
    
    2002
    
    2001Takara Bio Inc.
    
    
    39
    %
    
    
    16
    %
    
    
    12
    %E.I. DuPont de Nemours and Company
    
    
    28
    %
    
    
    32
    %
    
    
    37
    %BASF AG
    
    
    14
    %
    
    
    11
    %
    
    
    24
    %Bayer CropScience
    
    
    4
    %
    
    
    14
    %
    
    
    4
    %Geron Corporation
    
    
    
    
    
    
    15
    %
    
    
    Institute of Molecular and Cell Biology
    
    
    
    
    
    
    
    
    
    
    12
    %
 Revenues in each quarterly and annual period have in the past, and could
in the future, fluctuate due to: the timing and amount of any technology access
fees and the period over which the revenue is recognized; the level of service
fees, which is tied to the number and timing of biological samples received
from our collaborators and customers, as well as our performance of the related
genomics discovery services on the samples; the timing of achievement of
milestones and the amount of related payments to us; and the number, type and
timing of new, and the termination of existing, agreements with collaborators,
customers and licensees. Our operating costs and expenses include cost of service fees and other,
research and development expenses and general and administrative expenses.
Cost of services fees and other includes primarily the costs of direct labor,
materials and supplies, outside expenses, equipment and overhead incurred by us
in performing our genomics discovery services for, and the costs of reagents
and instruments sold to, our collaborators, customers and licensees. Research
and development expenses include the costs of personnel, materials and
supplies, outside expenses, equipment and overhead incurred by us in our
technology and application development and process improvement efforts.
Research and development expenses may increase due to spending for ongoing
technology development and implementation, as well as new applications,
primarily for MPSS. General and administrative expenses include the costs of
personnel, materials and supplies, outside expenses, equipment and overhead
incurred by us primarily in our administrative, business development, legal and
investor relations activities. General and administrative expenses may
increase in support of our research and development, commercial and business
development efforts. We account for our investment in Axaron Bioscience AG, a company owned
primarily by BASF AG and us, using the equity method. For the years ended
December 31, 2003 and 2002, our pro-rata share of Axarons losses was
approximately $1.9 million and $2.5 million, respectively. As of December 31, 2003, we employed 90 full-time employees, of which 75
were engaged in production and research and development activities. In January
2003, we implemented a reduction of approximately 25% of our total workforce,
or 32 people. The groups affected primarily by this action included research
and development personnel based at Lynx Therapeutics GmbH in Germany and our
proteomics group in California. In March 2004, we implemented another
reduction of approximately 15% of our total workforce, or 14 people which
included positions in all functions of the Companys business. The workforce
reductions were intended to further focus our financial and human resources on
expanding the commercial use of MPSS. Critical Accounting Estimates The preparation of our consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported
in our financial statements and accompanying notes. The items in our financial
statements requiring significant estimates and judgments include determining
the useful lives of fixed assets for depreciation and amortization
calculations, assumptions for valuing options and warrants and estimated lives
of license and collaborative agreements related to deferred revenue. Actual
results could differ materially from these estimates. Revenue Recognition Technology access fees have generally resulted from upfront payments from
collaborators, customers and licensees who are provided access to Lynxs
technologies for specified periods. We receive service fees from 20




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collaborators and customers for genomics discovery services performed by
us on the biological samples they send to Lynx. Collaborative research
revenues are payments received under various agreements and include such items
as milestone payments. Milestone payments are recognized as revenue pursuant
to collaborative agreements upon the achievement of specified technology
developments, representing the culmination of the earnings process. Other
revenues include the proceeds from the sale of technology assets, the sale of
proprietary instruments and reagents, and grant revenue. Technology access and license fees are deferred and recognized as revenue
on a straight-line basis over the noncancelable term of the agreement to which
they relate. Payments for services and/or materials provided by Lynx are
recognized as revenues when earned over the period in which the services are
performed and/or materials are delivered, provided that no other consequential
obligations, refunds or credits to be applied to future work exist. Revenues
from the sale of technology assets are recognized upon the transfer of the
assets to the purchaser. Revenues from the sales of instruments and reagents
are recognized upon shipment to the customer. Inventory Inventory is stated at the lower of cost (which approximates first-in,
first-out cost) or market. The balances at December 31, 2003 and December 31,
2002 were classified as raw materials and consisted primarily of reagents and
other chemicals to be utilized while performing genomics discovery services,
plus services in process. Services in process include direct material, direct service labor,
overhead and other direct costs. Market is net realizable value, which, for
services in process, is the estimated selling price, less costs to complete the
service. For raw materials, it is replacement cost or the cost of acquiring
similar products from our vendors, as adjusted for our assessment of excess or
obsolete materials. While cost is readily determinable, estimates of market
value involve significant estimates and judgments about the future. We initially record our inventory at cost and each quarter evaluate the
difference, if any, between cost and market. The determination of the market
value of inventories is primarily dependent on estimates of future demand for
our services, which in turn is based on other market estimates such as
technological change, competitor actions and estimates of future selling
prices. We record write-downs for the amount that cost of inventory exceeds our
estimated market value. No adjustment is required when market value exceeds
cost. Inventory, including allocated services labor and overhead, used in
providing genomics discovery services and for reagent sales is charged to cost
of services fees and other as consumed. Reagents and chemicals purchased for
internal development purposes are charged to research and development expense
as incurred. Investments in Equity Securities As of December 31, 2003, we held an approximate 42% equity interest in
Axaron Bioscience AG. In 2001, we made a capital investment in Axaron of
approximately $4.5 million. We account for our equity investment in Axaron
using the equity method in accordance with Accounting Principles Board No.
Opinion 18, The Equity Method of Accounting for Investments in Common Stock
because our ownership is greater than 20% and we have the ability to exercise
significant influence over the operating, investing and financing decisions of
Axaron. Under the equity method, we record our pro-rata share of Axarons
income or losses and adjust the basis of our investment accordingly. Although we have the ability to exercise significant influence over the
operations of Axaron, we may choose not to exercise such influence or may not
have influence over certain operating matters. Consequently, Axarons
operating results could differ significantly from our expectations and our
pro-rata share of Axarons income or losses that we record in the future could
be material. 21




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Results of Operations Year Ended December 31, 2003 and 2002 Revenues Revenues for the year ended December 31, 2003 were $18.1 million, compared
to revenues of $17.4 million for the year ended December 31, 2002. Revenues
for 2003 included technology access fees and service fees of $15.8 million,
license fees from Axaron, a related party, of $0.8 million and collaborative
research and other revenues of $1.5 million, including $1.0 million related to
the sale of three MPSS instruments to Takara. In addition to the $1.0 million
related to the sale of the instruments, we received a cash payment of
approximately $2.0 million from Takara related to an amendment of our existing
collaboration with them. In the third quarter of 2003, we met the research and
development obligations under the collaboration agreement, as amended, related
to amounts that we have been paid by Takara, including those amounts that we
had recorded previously as deferred revenue. Accordingly, we recognized such
amounts, aggregating approximately $2.5 million, as revenue in the third
quarter of 2003. Revenues for 2002 included technology access fees and
services fees of $13.0 million, license fees of $0.8 million from Axaron, a
related party, and $3.6 million of collaborative research and other revenue,
primarily from the sale of certain of Lynxs technology assets to Geron
Corporation and the sale of MPSS instruments to Takara. Our revenues have historically fluctuated from quarter to quarter and year
to year and may continue to fluctuate in future periods due primarily to our
service fees, which are impacted principally by the timing and number of
biological samples received from existing customers and collaborators, as well
as our performance of related services on these samples. Additionally, the
number, type and timing of new collaborations and agreements and the related
demand for, and delivery of, our services or products will impact the level of
future revenues. Operating Costs and Expenses Our total operating costs and expenses were $23.6 million for the year
ended December 31, 2003, compared to $31.1 million for the year ended December
31, 2002. Cost of services fees and other were $4.4 million for the year ended
December 31, 2003, compared to $3.5 million for the year ended December 31,
2002, and reflect primarily the costs of providing our genomics discovery
services and the cost of MPSS instruments sold to Takara. Research and development expenses were $12.2 million 2003, compared to
$20.8 million in 2002. The decrease in research and development expenses in
2003 reflects a decrease in materials consumed in research and development
efforts and lower personnel expenses, primarily resulting from the workforce
reductions that occurred in the first quarter of 2003 and the second quarter of
2002. Our research and development efforts in 2003 were directed primarily
toward the expansion of the commercial applications of, and process
improvements for, MPSS. In January 2003, we discontinued our development work on our proteomics
technology, Protein ProFiler, which was intended to provide high-resolution
analysis of complex mixtures of proteins from cells or tissues. Proteomics is
the study of the number of proteins and the extent to which they are expressed
in cells or tissues. In April 2002, we discontinued our development effort on
Megatype, a technology that was being developed to permit the comparison of
collected genomes of two populations and enable the detection and recovery of
DNA fragments with the single nucleotide polymorphisms, or SNPs, that
distinguish these two populations. SNPs are single nucleotide variations, or
differences occurring in a single subunit of DNA or RNA, in the genetic code
that occur on average at every 1,000 bases along the three billion nucleotides
in the human genome. The primary reason for discontinuing our development
efforts on both Protein ProFiler and Megatype was to focus our financial and
human resources on expanding the commercial use of MPSS, which we believe will
have the greatest commercial value to us. We anticipate that our research and development expenses may increase due
primarily to efforts directed toward the expansion of the commercial
applications of, and process improvements for, MPSS. These research and
development efforts assume that information about gene expression and gene
sequences may enable scientists to 22




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better understand complex biological processes and, therefore, provide us with
increased commercial opportunities for our MPSS. Relatively few therapeutic
products based on gene discoveries have been successfully developed or
commercialized. Because of these risks and uncertainties, we cannot predict
when or whether we will successfully complete the development of MPSS and
related technologies or the ultimate costs of such efforts. General and administrative expenses were $6.8 million and $6.3 million for
the years ended December 31, 2003 and 2002, respectively, and reflect primarily
expenses for outside services in support of our commercial and business
development efforts. General and administrative expenses may increase in
support of our continuing commercial, business development and research and
development activities. In January 2003, we implemented a reduction of approximately 25% of our
workforce, or 32 people. The groups affected primarily by this action included
research and development personnel based at Lynx Therapeutics GmbH in Germany
and in our proteomics group in California. The workforce reduction was
intended to further focus our financial and human resources on expanding the
commercial use of MPSS. We recorded a restructuring charge for workforce
reduction of $0.3 million in the first quarter of 2003 related primarily to
severance compensation expense for our former employees. In terms of
compensation, benefits and employer taxes that would have been paid to, and on
behalf of, such former employees had they remained employed by Lynx, we
realized cost savings of approximately $2.0 million during 2003. The restructuring charge for workforce reduction of $0.5 million in the
second quarter of 2002 was comprised primarily of severance charges for former
Lynx employees who were part of Lynxs workforce reduction of approximately 30%
of our domestic workforce, or 45 people, in that period. The group affected
primarily by this action was research and development personnel in California.
The workforce reduction was intended to focus our financial and human resources
on the expansion of the commercial applications of, and process improvements
for, MPSS and our other genomics technologies, and the continued development of
our proteomics technology. In terms of compensation, benefits and employer
taxes that would have been paid to, and on behalf of, such former employees had
they remained employed by Lynx, we realized cost savings of approximately $3.0
million during 2003. Equity Share of Net Loss of Related Party The equity share of the net loss of related party of $1.9 million and $2.5
million for the years ended December 31, 2003 and 2002, respectively, reflects
Lynxs pro-rata share of the net loss of Axaron, a joint venture investee, for
the same periods. Interest Expense, Net Net interest expense was $0.2 million for the year ended December 31,
2003, compared to $0.3 million for the year ended December 31, 2002. The
decrease in net interest expense from 2002 to 2003 reflects primarily lower
interest expense in 2003 incurred on equipment-related debt outstanding during
both the 2003 and 2002 periods. Other Income (Expense), Net Other expense was $1.0 million in the year ended December 31, 2003,
compared to other income of $0.9 million for the year ended December 31, 2002.
The other expense amount for the 2003 period relates primarily to the loss
recorded on the disposal of certain fixed assets no longer used in the
operations of Lynx Therapeutics GmbH in Germany. The 2002 other income amount
was related primarily to the gain on the sale of our equity investment in Inex
Pharmaceuticals Corporation. Income Tax Provision (Benefit) The income tax provision was $0.2 million for the year ended December 31, 2003,
compared to the income taxes benefit of $98,000 for the year ended December 31,
2002. The 2003 provision consisted primarily of foreign withholding tax on
payments received from our licensee, Takara. The 2002 income tax benefit
related primarily to a 23




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refund received for federal alternative minimum taxes paid in prior periods,
offset by foreign withholding tax due on payments received from our licensee,
Takara. As of December 31, 2003, we had a federal net operating loss carryforward
of approximately $85.5 million, which will expire at various dates from 2010
through 2023, if not utilized. We had a state net operating loss carryforward
of approximately $10.7 million, which will expire in the years 2004 through
2013. Deferred tax assets related to carryforwards at December 31, 2003
include approximately $3.9 million associated with stock option activity for
which any subsequently recognized tax benefits will be credited directly to
stockholders equity. As of December 31, 2003, we also had federal and California research and
development and other tax credit carryforwards of approximately $3.4 million
and $3.3 million, respectively. The federal research and development credit
will expire at various dates from 2018 through 2023, if not utilized. The
California research and development credits do not expire. Utilization of our net operating loss may be subject to substantial annual
limitation due to the ownership change limitations provided by the Internal
Revenue Code and similar state provisions. Such an annual limitation could
result in the expiration of the net operating loss before utilization. Years Ended December 31, 2002 and 2001 Revenues We had total revenues of $17.4 million for the year ended December 31,
2002, compared to $19.3 million for the year ended December 31, 2001. Revenues
for 2002 included technology access fees and service fees of $13.0 million,
license fees of $0.8 million from Axaron, a related party, and $3.6 million of
collaborative research and other revenue, primarily from the sale of certain of
our technology assets to Geron Corporation and the sale of MPSS instruments to
Takara. Revenues for 2001 included technology access fees and service fees of
$18.4 million, license fees of $0.5 million from Axaron, a related party, and
$0.4 million of collaborative research and other revenue. Operating Costs and Expenses Our total operating costs and expenses were $31.1 million for the year
ended December 31, 2002, compared to $36.3 million for the year ended December
31, 2001. Cost of services fees and other were $3.5 million for the year ended
December 31, 2002, compared to $4.1 million for the year ended December 31,
2001, and reflect the costs of providing our genomics discovery services and,
in 2002, the cost of the MPSS instruments sold to Takara. Research and development expenses were $20.8 million in 2002 and $24.7
million in 2001. The decrease in research and development expenses in 2002
reflects a decrease in materials consumed in research and development efforts
and lower personnel expenses, primarily resulting from the workforce reduction
that occurred in the second quarter of 2002. Our efforts in 2002 were directed
primarily toward the expansion of the commercial applications of, and process
improvements for, our genomics technologies and the continued development of
our proteomics technology. Our research and development expenses of $20.8 million for 2002 were
comprised of $4.4 million in research expenses related primarily to internal
discovery projects and $16.4 million in development expenses, including $0.9
million for the Megatype technology and $1.6 million for the Protein ProFiler
technology. In April 2002, we discontinued our development effort on Megatype, a
technology that was being developed to permit the comparison of collected
genomes of two populations and enable the detection and recovery of DNA
fragments with the single nucleotide polymorphisms, or SNPs, that distinguish
these two populations. SNPs are single nucleotide variations, or differences
occurring in a single subunit of DNA or RNA, in the genetic code that occur on
average at every 1,000 bases along the three billion nucleotides in the human
genome. 24




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General and administrative expenses were $6.3 million for the year ended
December 31, 2002, compared to $7.5 million for the year ended December 31,
2001. The decrease in general and administrative expenses from the 2001 period
to the 2002 period reflects lower personnel expenses and lower outside service
costs. The restructuring charge of $0.5 million in the year ended December 31,
2002, was comprised primarily of severance charges for former Lynx employees
who were part of Lynxs workforce reduction of approximately 30% of our
domestic workforce, or 45 people, in the second quarter of 2002. Equity Share of Net Loss of Related Party The equity share of loss of related party of $2.5 million for the year
ended December 31, 2002 reflects Lynxs pro-rata share of the net loss of
Axaron, a joint venture investee, for the same period. Lynxs pro-rata share of
Axarons losses was immaterial for 2001. Interest Expense, Net Net interest expense was $0.3 million in the year ended December 31, 2002,
compared to $0.1 million for the year ended December 31, 2001. The 2002 net
interest expense reflects primarily increased expense incurred on
equipment-related debt outstanding in 2002 and a decrease in interest income
due to the decline in interest rates during 2002 as compared to the 2001
period. Other Income (Expense), Net Other income was $0.9 million for the year ended December 31, 2002,
compared to $0.5 million for the year ended December 31, 2001. The 2002 other
income was related primarily to the gain on the sale of our equity investment
in Inex Pharmaceuticals Corporation. In 2001, other income was due primarily
to a gain of $1.1 million from the receipt of shares of common stock from Inex,
as part of the proceeds related to the March 1998 sale of our former antisense
program, and a realized gain of $1.1 million from the sale of previously held
Inex shares, partially offset by an other-than-temporary write down in the
value of previously held Inex shares of $1.6 million. Income Tax Provision (Benefit) The income tax benefit was $98,000 in the year ended December 31, 2002,
compared to the provision for income taxes of $81,000 for the year ended
December 31, 2001. The 2002 income tax benefit related primarily to a refund
received for federal alternative minimum taxes paid in prior periods, offset by
foreign withholding tax due on payments received from our licensee, Takara.
The 2001 income tax provision consisted entirely of foreign withholding tax on
a payment received from our licensee, Takara. Liquidity and Capital Resources Cash and cash equivalents at December 31, 2003 consisted of $5.6 million,
including restricted cash of $0.7 million. Net cash used in operating
activities was $10.5 million for the year ended December 31, 2003, as compared
to $16.2 million for the same period in 2002. The change was due primarily to
a lower net loss and the greater increase in accounts payable in 2003 than in
2002, partially offset by a greater decrease in deferred revenues and the
impact of the difference between non-cash expenses, losses and gains in the
2003 period as compared to the 2002 period. The amount of net cash used in
operating activities differed from the 2003 net loss due primarily to the
decrease in deferred revenues, partially offset by the adjustment for non-cash
items, primarily depreciation and amortization expenses and the impact of our
pro rata share of the net loss of Axaron. For 2002, the amount of net cash
used in operating activities differed from the net loss due primarily to
decreases in deferred revenue and accounts payable, offset partially by the net
adjustment for non-cash items, primarily depreciation and amortization expenses
and the impact of our pro rata share of the net loss of Axaron, and a decrease
in inventory. Net cash used in operating activities was $16.2 million for the year ended
December 31, 2002, as compared to $15.4 million for fiscal year 2001. The
change between 2002 and 2001 was due primarily to a higher decrease in deferred
revenues and a decrease, rather than an increase, in accounts payable and other
liabilities during 2002 as compared 25




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to 2001, partially offset by a lower net loss, excluding the impact of
depreciation and amortization expenses and non-cash gains and losses. The
amount of net cash used in operating activities differed from the 2001 net loss
due primarily to the depreciation and amortization expenses, the amortization
of deferred compensation and the write down of an equity investment, partially
offset by a decrease in deferred revenue and a gain on the sale of the
antisense business. Net cash used in investing activities of $0.2 million for the year ended
December 31, 2003 was due primarily to expenditures for capital equipment. Net
cash provided by investing activities of $1.4 million for year ended December
31, 2002 was due primarily to proceeds from the sale of equity investments and
repayment of notes receivable from employees, partially offset by expenditures
for capital equipment. Net cash used in investing activities of $0.4 million
for the year ended December 31, 2001, was due primarily to expenditures for
capital equipment and leasehold improvements and our investment in Axaron,
partially offset by proceeds from the sale of Inex securities and net
maturities of short-term investments. Net cash provided by financing activities of $4.5 million in 2003 related
primarily to the issuance of common stock pursuant to a common stock purchase
agreement between Lynx and certain investors in two private placements,
partially offset by the repayment of principal under equipment-related debt.
Net cash provided by financing activities in 2002 of $23.3 million was due
primarily to the issuance of Lynx common stock in three private placements.
Net cash provided by financing activities in 2001 of $11.1 million was due
primarily to the issuance of Lynx common stock in two private placements,
partially offset by the repayment of principal under equipment-related debt. In March 2004, we completed a $4.0 million private placement of common
stock and warrants to purchase common stock (the financing) resulting in
proceeds of $3.9 million, net of commissions and expenses. The financing
included the sale of 788,235 shares of newly issued shares of common stock at
$5.10 per share and the issuance of warrants to purchase 181,295 shares of
common stock at an exercise price of $6.25 per share. In December 2003, we completed a private financing of common stock and
warrants to purchase common stock. The financing included the sale of 800,000
newly issued shares of common stock, at a purchase price of $5.00 per share,
resulting in gross proceeds of $4 million, pursuant to a common stock purchase
agreement between Lynx and certain investors. In connection with this
transaction, Lynx issued warrants to purchase up to 200,000 shares of common
stock at an exercise price of $6.25 per share. In September 2003, we completed a private financing of common stock and
warrants to purchase common stock. The financing included the sale of 744,000
newly issued shares of common stock, at a purchase price of $4.03 per share,
resulting in gross proceeds of $3 million, pursuant to a common stock purchase
agreement between Lynx and certain investors. In connection with this
transaction, Lynx issued warrants to purchase 186,000 shares of common stock at
an exercise price of $9.91 per share. In both September and December 2002, in connection with our collaboration
agreement with Takara, we issued and sold 291,545 shares of common stock, at a
purchase price of $3.43 per share, to Takara in private placements pursuant to
the terms and conditions of common stock purchase agreements. In April 2002, we completed a private placement of common stock and
warrants to purchase common stock. The financing included the sale of 2.1
million newly issued shares of common stock, at a purchase price of $10.85 per
share, resulting in gross proceeds of $22.6 million, pursuant to a common stock
purchase agreement between Lynx and certain investors. In connection with this
transaction, Lynx issued warrants to purchase up to 0.8 million shares of
common stock at an exercise price of $13.58 per share. Additionally, Lynx
issued a warrant to purchase up to an aggregate of 41,714 shares of common
stock at an exercise price of $10.85 per share to Friedman, Billings, Ramsey &
Co., Inc. (FBR), as partial consideration, in addition to other customary fees,
for services rendered by FBR as sole manager for the private equity financing. In October 2001, in connection with our collaboration agreement with
Takara, we issued and sold 45,787 shares of common stock, at a purchase price
of $21.84 per share, to Takara in a private placement pursuant to the terms and
conditions of a common stock purchase agreement. 26




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##### Table of Contents



In May 2001, we completed a private placement of common stock and warrants
to purchase common stock. The financing included the sale of 249,605 newly
issued shares of common stock, at a purchase price of $44.59 per share,
resulting in net proceeds of $10.5 million, pursuant to a common stock purchase
agreement between Lynx and certain investors. In connection with this
transaction, we issued warrants to purchase up to 62,399 shares of common stock
at an exercise price of $ 64.41 per share. In October 2002, we entered into a loan and security agreement with a
financial institution, Comerica Bank-California, for an equipment line of
credit of up to $2.0 million with a draw-down period of one year. Under the
initial advance, we drew down $1.6 million in November 2002 related to the
purchase of equipment made in previous periods. We granted Comerica
Bank-California a security interest in all items we financed under this
agreement. The initial advance under the loan to finance the purchase of
equipment made in previous periods has a term of 24 months from the date of
advance and bears interest at a rate of 7.25%. In May 2003, we renegotiated
the terms of the agreement, which now require that we maintain a minimum cash
balance of restricted cash and cash equivalents in an account at Comerica
Bank-California of at least 110% of the principal balance under loans
outstanding under this agreement until Comerica Bank-California receives
payment in full of all outstanding obligations. As of December 31, 2003, the
balance of restricted cash was approximately $0.7 million. As of December 31,
2003, the principal balance under loans outstanding under this agreement was
approximately $0.7 million. We believe that we are in compliance with all
terms of the loan agreement. In late 1998, we entered into a financing agreement with a financial
institution, Transamerica Business Credit Corporation, under which we drew down
$4.8 million during 1999 for the purchase of equipment and certain other
capital expenditures. In September 2000, Lynx obtained additional financing of
approximately $1.0 million under an amendment to the original financing
agreement. We granted the lender a security interest in all items financed by
it under this agreement. Each draw down under the loan has a term of 48 months
from the date of the draw down. As of December 31, 2003, the principal balance
under loans outstanding under this agreement was $0.4 million. The draw down
period under the agreement expired on March 31, 2000. Our contractual obligations for the next five years and thereafter are as
follows: Payments Due by PeriodLess than 1Contractual Obligations
    
    year
    
    1-3 Years
    
    4-5 Years
    
    After 5 Years
    
    Total(in thousands)Operating leases
    
    $
    2,742
    
    
    $
    5,676
    
    
    $
    5,848
    
    
    $
    
    
    
    $
    14,266Equipment loans
    
    
    1,093
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,093Total contractual cash obligations
    
    $
    3,835
    
    
    $
    5,676
    
    
    $
    5,848
    
    
    $
    
    
    
    $
    15,359
 We plan to use available funds for ongoing commercial and research and
development activities, working capital and other general corporate purposes
and capital expenditures. We expect capital investments during 2004 will be
less than $2.0 million and will be comprised primarily of expenditures for
capital equipment required in the normal course of business. We intend to
invest our excess cash in investment-grade, interest-bearing securities. We have obtained funding for our operations primarily through sales of
preferred and common stock, payments received under contractual arrangements
with customers, collaborators and licensees and interest income. Consequently,
investors in our equity securities and our customers, collaborators and
licensees are significant sources of liquidity for us. Therefore, our ability
to maintain liquidity is dependent upon a number of uncertain factors,
including but not limited to the following: our ability to advance and
commercialize further our technologies; our ability to generate revenues
through expanding existing collaborations, customer and licensee arrangements
and obtaining significant new customers, collaborators and licensees; and the
receptivity of capital markets toward our equity or debt securities. The cost,
timing and amount of funds required for specific uses by us cannot be precisely
determined at this time and will be based upon the progress and the scope of
our commercial and research and development activities; payments received under
customer, collaborative and license agreements; our ability to establish and
maintain customer, collaborative and license agreements; costs of protecting
intellectual property rights; legal and administrative costs; additional
facilities capacity needs, and the availability of alternate methods of
financing. 27




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We have incurred net losses each year since our inception in 1992. As of
December 31, 2003, we had an accumulated deficit of $107.7 million, including a
net loss of $8.8 million in 2003. Net losses may continue for at least the
next several years as we proceed with the commercialization and additional
development of our technologies. The presence and size of these potential net
losses will depend, in part, on the rate of growth, if any, in our revenues and
on the level of our expenses. We have experienced losses since our inception, including a net loss for
the six months ended June 30, 2004. We expect to continue to incur net losses
as we proceed with the commercialization and additional development of our
technologies. The size of these losses will depend on the rate of growth, if
any, in our revenues and on the level of our expenses. Our cash and cash
equivalents have decreased from the $5.6 million, including $0.7 million of
restricted cash, as of December 31, 2003. As of June 30, 2004, our cash and
cash equivalents consisted of $2.0 million in unrestricted cash and investments
and restricted cash of $0.3 million. We will require additional funding to
continue our business activities through at least December 31, 2005. As a
result, the report of Ernst & Young LLP regarding our consolidated financial
statements included in this annual report includes an explanatory paragraph
concerning our ability to continue as a going concern. We are considering
various options, which include securing additional equity financing, obtaining
new collaborators and customers and other strategic actions. If we raise
additional capital by issuing equity or convertible debt securities, our
existing stockholders may experience substantial dilution. If we require
additional financing, there can be no assurance that it will be available on
satisfactory terms, or at all. If we are unable to secure additional financing
on reasonable terms, or are unable to generate sufficient new sources of
revenue through arrangements with customers, collaborators and licensees, we
will be forced to take substantial restructuring actions, which may include
significantly reducing our anticipated level of expenditures, the sale of some
or all of our assets, or obtaining funds by entering into financing or
collaborative agreements on unattractive terms, or we will not be able to fund
operations. Recent Accounting Pronouncements In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). The SFAS 150 establishes standards for classifying and measuring
as liabilities certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. The SFAS 150
is effective for all financial instruments created or modified after May 31,
2003, and to other instruments for periods beginning after June 15, 2003. The
adoption of SFAS 150 did not have a material effect on our results of
operations or financial position. In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN 46 requires
a variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or entitled to receive a majority of the entitys residual returns
or both. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim period
ending after March 15, 2004. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. We do not believe the adoption of
FIN 46 will have a material impact on our financial position or results of
operations. In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus regarding EITF Issue 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables. The consensus addresses not only when and how an
arrangement involving multiple deliverables should be divided into separate
units of accounting, but also how the arrangements consideration should be
allocated among separate units. The pronouncement is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF Issue 00-21 did not have a material effect on our results of
operations or financial position. 28




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Item 8. Consolidated Financial Statements and Supplementary Data Index to Consolidated Financial Statements PageReport of Ernst & Young LLP, Independent Registered Public Accounting Firm
    
    
    30Consolidated Balance Sheets as of December 31, 2003 and 2002
    
    
    31Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001
    
    
    32Consolidated Statements of Stockholders Equity for the years ended December 31, 2003,
2002 and 2001
    
    
    33Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
    
    
    34Notes to Consolidated Financial Statements
    
    
    35
 29




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##### Table of Contents



Report of Ernst & Young LLP, Independent Registered Public Accounting Firm The Board of Directors and Stockholders
Lynx Therapeutics, Inc. We have audited the accompanying consolidated balance sheets of Lynx
Therapeutics, Inc. as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders equity and cash flows for
each of the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Lynx
Therapeutics, Inc. at December 31, 2003 and 2002, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2003, in conformity with U.S. generally accepted accounting
principles. The accompanying consolidated financial statements have been prepared assuming
that Lynx Therapeutics, Inc. will continue as a going concern. As more fully
described in Note 18, the Company has incurred losses since inception and
expects that such losses will continue for the foreseeable future.
Additionally, the Company anticipates requiring additional financial resources
to fund its operations at least through December 31, 2005. These conditions
raise substantial doubt about the Companys ability to continue as a going
concern. Managements plans as to these matters are also described in Note 18.
The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the
amounts and classification of liabilities that may result from the outcome of
this uncertainty. /s/ Ernst & Young LLP Palo Alto, California
February 20, 2004, except for
paragraph 2 of Business and
Basis of Presentation in Note 1,
as to which the date is March 10, 2004
and Note 18, as to which the date
is October 18, 2004 30




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LYNX THERAPEUTICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts) December 31,2003
    
    2002AssetsCurrent assets:Cash and cash equivalents
    
    $
    4,881
    
    
    $
    11,735Restricted cash
    
    
    728
    
    
    
    Accounts receivable
    
    
    402
    
    
    
    836Inventory
    
    
    904
    
    
    
    1,030Other current assets
    
    
    722
    
    
    
    714Total current assets
    
    
    7,637
    
    
    
    14,315Property and equipment:Leasehold improvements
    
    
    11,510
    
    
    
    12,238Laboratory and other equipment
    
    
    21,667
    
    
    
    22,97233,177
    
    
    
    35,210Less accumulated depreciation and amortization
    
    
    (22,190
    )
    
    
    (19,640
    )Net property and equipment
    
    
    10,987
    
    
    
    15,570Investment in related party
    
    
    
    
    
    
    1,930Other non-current assets
    
    
    172
    
    
    
    172$
    18,796
    
    
    $
    31,987Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    1,070
    
    
    $
    962Accrued compensation
    
    
    284
    
    
    
    516Deferred revenues
    
    
    759
    
    
    
    2,926Equipment loans  current portion
    
    
    1,128
    
    
    
    2,250Other accrued liabilities
    
    
    344
    
    
    
    604Total current liabilities
    
    
    3,585
    
    
    
    7,258Deferred revenues
    
    
    4,213
    
    
    
    10,634Equipment loans, less current portion
    
    
    
    
    
    
    1,093Other non-current liabilities
    
    
    932
    
    
    
    946CommitmentsStockholders equity:Preferred stock, $0.01 par value; 2,000,000 shares authorized; no shares
issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value; 60,000,000 shares authorized; 6,199,245 and
4,646,784 shares issued and outstanding at December 31, 2003 and 2002,
respectively
    
    
    117,722
    
    
    
    110,978Deferred compensation
    
    
    
    
    
    
    (9
    )Accumulated other comprehensive income(loss)
    
    
    17
    
    
    
    Accumulated deficit
    
    
    (107,673
    )
    
    
    (98,913
    )Total stockholders equity
    
    
    10,066
    
    
    
    12,056$
    18,796
    
    
    $
    31,987
 See accompanying notes. 31




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##### Table of Contents



LYNX THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts) Year Ended December 31,2003
    
    2002
    
    2001Revenues:Technology access and services fees
    
    $
    15,840
    
    
    $
    13,026
    
    
    $
    18,372License fee from related party
    
    
    760
    
    
    
    759
    
    
    
    453Collaborative research and other
    
    
    1,501
    
    
    
    3,621
    
    
    
    429Total revenues
    
    
    18,101
    
    
    
    17,406
    
    
    
    19,254Operating costs and expenses:Cost of services fees and other
    
    
    4,362
    
    
    
    3,499
    
    
    
    4,118Research and development
    
    
    12,178
    
    
    
    20,813
    
    
    
    24,660General and administrative
    
    
    6,773
    
    
    
    6,271
    
    
    
    7,503Restructuring charge for workforce reduction
    
    
    292
    
    
    
    530
    
    
    
    Total operating costs and expenses
    
    
    23,605
    
    
    
    31,113
    
    
    
    36,281Loss from operations
    
    
    (5,504
    )
    
    
    (13,707
    )
    
    
    (17,027
    )Equity share of net loss of related party
    
    
    (1,930
    )
    
    
    (2,522
    )
    
    
    Interest income (expense), net
    
    
    (158
    )
    
    
    (282
    )
    
    
    (86
    )Other income (expense), net
    
    
    (966
    )
    
    
    882
    
    
    
    464Loss before income taxes
    
    
    (8,558
    )
    
    
    (15,629
    )
    
    
    (16,649
    )Income tax provision (benefit)
    
    
    202
    
    
    
    (98
    )
    
    
    81Net loss
    
    $
    (8,760
    )
    
    $
    (15,531
    )
    
    $
    (16,730
    )Basic and diluted net loss per share
    
    $
    (1.80
    )
    
    $
    (4.50
    )
    
    $
    (9.18
    )Shares used in per share computation
    
    
    4,854
    
    
    
    3,455
    
    
    
    1,822
 See accompanying notes. 32




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LYNX THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands, except share amounts) Common Stock
    
    NotesReceivablefrom
    
    Deferred
    
    AccumulatedOtherComprehensive
    
    Accumulated
    
    TotalStockholdersShares
    
    Amount
    
    Stockholders
    
    Compensation
    
    Income (Loss)
    
    Deficit
    
    EquityBalance at January 1, 2001
    
    
    1,634,317
    
    
    
    75,851
    
    
    
    (263
    )
    
    
    (1,557
    )
    
    
    (1,157
    )
    
    
    (66,652
    )
    
    
    6,222Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,730
    )
    
    
    (16,730
    )Net unrealized gain on securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,296
    
    
    
    
    
    
    
    2,296Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,434
    )Employee stock purchase plan issuance
    
    
    5,665
    
    
    
    314
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    314Exercise of stock options for cash and repayment of
note receivable
    
    
    31,122
    
    
    
    458
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    471Issuance of common stock in connection with private
placements, net of issuance costs of $619
    
    
    295,392
    
    
    
    11,511
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,511Amortization of deferred compensation, including
forfeitures
    
    
    
    
    
    
    (183
    )
    
    
    
    
    
    
    813
    
    
    
    
    
    
    
    
    
    
    
    630Balance at December 31, 2001
    
    
    1,966,496
    
    
    
    87,951
    
    
    
    (250
    )
    
    
    (744
    )
    
    
    1,139
    
    
    
    (83,382
    )
    
    
    4,714Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,531
    )
    
    
    (15,531
    )Net unrealized loss on securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,139
    )
    
    
    
    
    
    
    (1,139
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,670
    )Employee stock purchase plan issuance
    
    
    10,489
    
    
    
    143
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    143Exercise of stock options for cash and repayment of
note receivable
    
    
    1,011
    
    
    
    3
    
    
    
    250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    253Issuance of common stock in connection with private
placements, net of issuance costs of $1,700
    
    
    2,668,788
    
    
    
    23,075
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,075Amortization of deferred compensation, including
forfeitures
    
    
    
    
    
    
    (194
    )
    
    
    
    
    
    
    735
    
    
    
    
    
    
    
    
    
    
    
    541Balance at December 31, 2002
    
    
    4,646,784
    
    
    $
    110,978
    
    
    $
    
    
    
    $
    (9
    )
    
    $
    
    
    
    $
    (98,913
    )
    
    $
    12,056Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,760
    )
    
    
    (8,760
    )Foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    17Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,743
    )Employee stock purchase plan issuance
    
    
    7,461
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13Exercise of stock options for cash
    
    
    1,000
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Issuance of common stock in connection with private
placements, net of issuance costs of $272,000
    
    
    1,544,000
    
    
    
    6,729
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,729Amortization of deferred compensation, including
forfeitures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    9Balance at December 31, 2003
    
    
    6,199,245
    
    
    $
    117,722
    
    
    $
    
    
    
    $
    
    
    
    $
    17
    
    
    $
    (107,673
    )
    
    $
    10,066
 See accompanying notes. 33




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LYNX THERAPEUTICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Year Ended December 31,2003
    
    2002
    
    2001Cash flows from operating activitiesNet loss
    
    $
    (8,760
    )
    
    $
    (15,531
    )
    
    $
    (16,730
    )Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization of fixed assets and leasehold improvements
    
    
    3,328
    
    
    
    5,357
    
    
    
    5,020Amortization of deferred compensation
    
    
    9
    
    
    
    541
    
    
    
    630Forgiveness of principal and interest on loans
    
    
    
    
    
    
    181
    
    
    
    224Equity share of net loss of related party
    
    
    1,930
    
    
    
    2,522
    
    
    
    Gain on sale of antisense business
    
    
    
    
    
    
    (1,009
    )
    
    
    (2,113
    )Non-cash portion of gain from sale of technology assets
    
    
    
    
    
    
    (1,586
    )
    
    
    Loss on sale of equity investment
    
    
    
    
    
    
    64
    
    
    
    Loss on write down of equity investment
    
    
    
    
    
    
    
    
    
    
    1,605Loss on disposal of fixed assets
    
    
    689Changes in operating assets and liabilitiesAccounts receivable
    
    
    434
    
    
    
    316
    
    
    
    387Inventory
    
    
    866
    
    
    
    688
    
    
    
    150Other current assets
    
    
    (8
    )
    
    
    183
    
    
    
    (495
    )Accounts payable
    
    
    108
    
    
    
    (1,075
    )
    
    
    397Accrued liabilities
    
    
    (492
    )
    
    
    97
    
    
    
    (519
    )Deferred revenues
    
    
    (8,588
    )
    
    
    (6,814
    )
    
    
    (4,312
    )Other non-current liabilities
    
    
    (14
    )
    
    
    (157
    )
    
    
    374Currency translation adjustment
    
    
    17Net cash provided by (used in) operating activities
    
    
    (10,481
    )
    
    
    (16,223
    )
    
    
    (15,382
    )Cash flows from investing activitiesPurchases of short-term investments
    
    
    
    
    
    
    (3,261
    )
    
    
    (3,808
    )Maturities of short-term investments
    
    
    
    
    
    
    3,261
    
    
    
    12,153Proceeds from sale of equity securities
    
    
    
    
    
    
    3,702
    
    
    
    3,072Leasehold improvements and equipment purchases, net of retirements and sale to licensee
    
    
    (435
    )
    
    
    (2,701
    )
    
    
    (7,427
    )Proceeds from disposal of fixed assets
    
    
    261
    
    
    
    
    
    
    
    Payments received on notes receivable from officers and employees
    
    
    
    
    
    
    456
    
    
    
    70Investment in related party
    
    
    
    
    
    
    
    
    
    
    (4,452
    )Other assets
    
    
    
    
    
    
    (11
    )
    
    
    (40
    )Net cash provided by (used in ) investing activities
    
    
    (174
    )
    
    
    1,446
    
    
    
    (432
    )Cash flows from financing activitiesIssuance of common stock, net of repurchases
    
    
    6,744
    
    
    
    23,221
    
    
    
    12,283Proceeds from equipment loan
    
    
    
    
    
    
    1,588
    
    
    
    Repayment of equipment loan
    
    
    (2,215
    )
    
    
    (1,496
    )
    
    
    (1,145
    )Net cash provided by financing activities
    
    
    4,529
    
    
    
    23,313
    
    
    
    11,138Net increase (decrease) in cash and cash equivalents
    
    
    (6,126
    )
    
    
    8,536
    
    
    
    (4,676
    )Cash and cash equivalents at beginning of year
    
    
    11,735
    
    
    
    3,199
    
    
    
    7,875Cash and cash equivalents at end of year
    
    $
    5,609
    
    
    $
    11,735
    
    
    $
    3,199Supplemental disclosures of cash flow informationIncome taxes paid
    
    $
    202
    
    
    $
    
    
    
    $
    Interest paid
    
    $
    208
    
    
    $
    308
    
    
    $
    399Inex stock received
    
    $
    
    
    
    $
    
    
    
    $
    1,060Geron stock received
    
    $
    
    
    
    $
    1,586
    
    
    $
    Transfer of instruments into inventory
    
    $
    740
    
    
    $
    
    
    
    $
    
 See accompanying notes 34




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies and Basis of Presentation Business and Basis of Presentation Lynx Therapeutics, Inc. (Lynx the Company or we) believes that it is
a leader in the development and application of novel genomics analysis
solutions. The Companys Massively Parallel Signature Sequencing, or MPSS,
instruments analyze millions of DNA molecules in parallel, enabling genome
structure characterization at what we believe to be an unprecedented level of
resolution. As applied to gene expression analysis, MPSS provides
comprehensive and quantitative digital gene expression information important to
modern systems biology research in the pharmaceutical, biotechnology and
agricultural industries. Gene expression refers to the number of genes and the
extent a cell or tissue expresses those genes, and represents a way to move
beyond DNA sequence data to understand the function of genes, the proteins that
they encode and the role they play in health and disease. Systems biology is
an approach in which researchers seek to gain a complete molecular
understanding of biological systems in health and disease. The Companys consolidated financial statements have been presented on a
basis that contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has experienced
operating losses since its inception of $107.7 million, including a net loss of
$8.8 million for the year ended December 31, 2003. Net losses may continue for
at least the next several years as we proceed with the commercialization and
additional development of the Companys technologies. The presence and size of
these potential net losses will depend, in part, on the rate of growth, if any,
in the Companys revenues and on the level of its expenses. The Companys cash
and cash equivalents have decreased from $11.7 million as of December 31, 2002.
As of December 31, 2003, the Companys cash and cash equivalents were $5.6
million, which includes restricted cash of $0.7 million. On March 10, 2004,
Lynx completed a $4.0 million private placement of common stock and warrants to
purchase common stock (the financing) resulting in proceeds of $3.9 million,
net of commissions and expenses. The financing included the sale of 788,235
shares of newly issued shares of common stock at $5.10 per share and the
issuance of warrants to purchase 181,295 shares of common stock at an exercise
price of $6.25 per share. Management believes that with the funds raised in
March 2004, its current cash, cash equivalents and restricted cash, along with
cash flows to be generated from customers, collaborators and licensees will be
sufficient to enable the Company to meet its projected operating and capital
requirements through at least December 31, 2004. The Company may seek
additional financing, as needed through arrangements with customers,
collaborators and licensees, and equity or debt offerings. There can be no
assurance that additional financing, if required, will be available on
satisfactory terms, or at all. If the Company is unable to secure additional
financing on reasonable terms, or is unable to generate sufficient new sources
of revenue through arrangements with customers, collaborators and licensees,
the Company will be forced to take substantial restructuring actions, which may
include significantly reducing its anticipated level of expenditures, the sale
of some or all of its assets, or obtaining funds by entering into financing or
collaborative agreements on unattractive terms, or the Company will not be able
to fund operations. See Note 18 for an updated discussion regarding the
Companys liquidity. The consolidated financial statements of the Company include the accounts
of the Company and its wholly-owned subsidiary, Lynx Therapeutics GmbH, formed
under the laws of the Federal Republic of Germany. All significant
intercompany balances and transactions have been eliminated. Certain amounts
in prior periods have been reclassified to conform to the current year
presentation. Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. 35




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Foreign Currency Translation Assets and liabilities of the Companys wholly-owned foreign subsidiary
are translated from its local currency at exchange rates in effect at the
balance sheet date, and revenues and expenses are translated at average
exchange rates prevailing during the year. Any material resulting translation
adjustments are reflected as a separate component of stockholders equity. Concentration of Credit Risk and Other Concentrations Financial instruments that potentially subject Lynx to concentration of
credit risk consist principally of cash equivalents, short-term investments and
trade receivables. The Company invests its excess cash in deposits with major
banks and in money market and short-term debt securities of companies with
strong credit ratings from a variety of industries. These securities generally
mature within 365 days and, therefore, bear minimal interest-rate risk. The
Company, by corporate policy, limits the amount of credit exposure to any one
issuer and to any one type of investment. Pharmaceutical companies and other research institutions account for a
substantial portion of the Companys trade receivables. Accounts receivable
are stated as amount billed to customers. The Company provides credit in the
normal course of business to its customers and collateral for these receivables
is generally not required. The Company monitors the creditworthiness of its
customers to which it grants credit terms in the normal course of business.
The Company has not experienced significant credit losses to date. Lynx depends on a single supplier to manufacture flow cells used in its
MPSS technology. Lynx currently purchases the flow cells from a single
supplier, although the flow cells are potentially available from multiple
suppliers. While Lynx believes that alternative suppliers for flow cells
exist, identifying and qualifying new suppliers could be an expensive and
time-consuming process. Lynxs reliance on outside vendors involves several
risks, including the inability to obtain an adequate supply of required
components due to manufacturing capacity constraints, a discontinuance of a
product by a third-party manufacturer or other supply constraints, reduced
control over quality and pricing of components and delays and long lead times
in receiving materials from vendors. Fair Value of Debt Obligations The fair value of short-term and long-term obligations is estimated based
on current interest rates available to Lynx for debt instruments with similar
terms, degrees of risk and remaining maturities. The carrying values of these
obligations approximate their fair values. Cash, Cash Equivalents and Short-term Investments The Company considers all investments in money market mutual funds,
commercial paper and corporate bonds and notes with maturities at the date of
purchase of 90 days or less as cash equivalents. Investments in debt
securities with maturities beyond 90 days, but less than one year, and
investments in publicly traded equity securities are considered to be
short-term investments. The Companys investment policy stipulates that the
investment portfolio be maintained with the objectives of preserving principal,
maintaining liquidity and maximizing return. The Company classifies its investments in money market mutual funds,
commercial paper, equity securities and corporate bonds and notes as
available-for-sale. Available-for-sale securities are carried at fair value
based on quoted market prices, with the unrealized gains and losses reported as
a component of accumulated other comprehensive income. If a decline in the
fair value of a short-term investment is below its cost for two consecutive
quarters or if the decline is due to a significant adverse event, it is
considered to be an other-than-temporary decline. Accordingly, the investment
is written down to its estimated fair value. Other-than-temporary declines in
fair value on short-term investments are charged against interest income. 36




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Cash, Cash Equivalents and Short-term Investments(continued) The cost of investments in commercial paper and corporate bonds and notes
is adjusted for the amortization of premiums and accretion of discounts to
maturity, which is included in interest income. The cost of securities sold,
if any, is based on the specific identification method. Inventory Inventory is stated at the lower of cost (which approximates first-in,
first out cost) or market. The balances at December 31, 2003 and December 31,
2002 were classified as raw materials and consisted primarily of reagents and
other chemicals utilized while performing genomics discovery services.
Inventory used in providing genomics discovery services and for reagent sales
is charged to cost of services fees and other as consumed. Reagents and
chemicals purchased for internal development purposes are charged to research
and development expense as incurred. Property and Equipment Property and equipment are stated at original cost and are depreciated
using the straight-line method over the estimated useful lives of the assets,
which are generally three years. Leasehold improvements are amortized over the
lesser of the useful life of the asset or the remaining term of the facility
lease. Amortization of assets recorded under capital leases is included with
depreciation expense. Long-lived Assets In accordance with Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), the
Company identifies and records impairment losses, as circumstances dictate, on
long-lived assets used in operations when events and circumstances indicate
that the assets might be impaired and the discounted cash flows estimated to be
generated by those assets are less than the carrying amounts of those assets.
No such impairments have been identified with respect to the Companys
long-lived assets, which consist primarily of property and equipment. Revenue Recognition Technology access fees have generally resulted from upfront payments from
collaborators, customers and licensees who are provided access to Lynxs
technologies for specified periods. Lynx receives service fees from
collaborators and customers for genomics discovery services performed by the
Company on the biological samples they send to Lynx. Collaborative research
revenues are payments received under various agreements and include such items
as milestone payments. Milestone payments are recognized as revenue pursuant
to collaborative agreements upon the achievement of specified technology
developments, representing the culmination of the earnings process. Other
revenues include the proceeds from the sale of technology assets, the sale of
proprietary instruments and reagents and grant revenue. Technology access and license fees are deferred and recognized as revenue
on a straight-line basis over the noncancelable term of the agreement to which
they relate. Payments for services and/or materials provided by Lynx are
recognized as revenues when earned over the period in which the services are
performed and/or materials are delivered, provided that no other consequential
obligations, refunds or credits to be applied to future work exist. Revenues
from the sale of technology assets are recognized upon the transfer of the
assets to the purchaser. Revenues from the sales of instruments and reagents
are recognized upon shipment to the customer. 37




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Revenue Recognition(continued) Revenue from significant collaborators, customers and licensees
represented the following percentages of total revenue: Year Ended December 31,2003
    
    2002
    
    2001Takara Bio Inc.
    
    
    39
    %
    
    
    16
    %
    
    
    12
    %E.I. DuPont de Nemours and Company
    
    
    28
    %
    
    
    32
    %
    
    
    37
    %BASF AG
    
    
    14
    %
    
    
    11
    %
    
    
    24
    %Bayer CropScience
    
    
    4
    %
    
    
    14
    %
    
    
    4
    %Geron Corporation
    
    
    
    
    
    
    15
    %
    
    
    Institute of Molecular and Cell Biology
    
    
    
    
    
    
    
    
    
    
    12
    %
 Net Loss Per Share Basic and diluted net loss per share have been computed using the
weighted-average number of shares of common stock outstanding during the
period, less shares subject to repurchase. Basic and diluted net loss per
share amounts are the same in each year as the Company incurred a net loss for
all periods presented. The following table sets forth the computation of basic and diluted net
loss per share (in thousands, except per share amounts): Year Ended December 31,2003
    
    2002
    
    2001Net loss
    
    $
    (8,760
    )
    
    $
    (15,531
    )
    
    $
    (16,730
    )Basic and diluted:Weighted-average shares of common stock
outstanding
    
    
    4,854
    
    
    
    3,455
    
    
    
    1,823Less weighted-average shares subject to repurchase
    
    
    
    
    
    
    
    
    
    
    (1
    )Shares used in computing basic and diluted net
loss per share
    
    
    4,854
    
    
    
    3,455
    
    
    
    1,822Basic and diluted net loss per share
    
    $
    (1.80
    )
    
    $
    (4.50
    )
    
    $
    (9.18
    )
 Had Lynx been in a net income position, diluted earnings per share would
have included the impact of outstanding shares subject to repurchase and the
impact of dilutive outstanding options and warrants to purchase common stock.
Excluded from the computation of basic and diluted net loss per share are
approximately 1,887,000, 1,338,000 and 443,000 shares related to options and
warrants to purchase common stock at December 31, 2003, 2002 and 2001,
respectively, prior to the application of the treasury stock method. Such
shares have been excluded because they are anti-dilutive for all periods
presented. Stock-Based Compensation The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the shares at the date of
grant. The Company accounts for stock option grants in accordance with APB
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related
Interpretations. Under APB 25, because the exercise price of the Companys
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized. 38




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Stock-Based Compensation(continued) All stock option awards to non-employees are accounted for at the fair
value of the consideration received or the fair value of the equity instrument
issued, as calculated using the Black-Scholes model, in accordance with SFAS
123 and Emerging Issues Task Force Consensus No. 96-18, Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. The option arrangements are
subject to periodic remeasurement over their vesting terms. The Company
recorded no compensation expense related to option grants to non-employees for
the years ended December 31, 2003, 2002 and 2001. Pro forma information regarding net loss and net loss per share required
by Statement of Financial Accounting Standard No. 123, Accounting for
Stock-based Compensation (SFAS 123), as amended by SFAS 148, is presented below
and has been determined as if the Company had accounted for awards under its
stock option and employee stock purchase plans using the fair value method: Year Ended December 31,2003
    
    2002
    
    2001(in thousands, except per share amounts)Net loss, as reported
    
    $
    (8,760
    )
    
    $
    (15,531
    )
    
    $
    (16,730
    )Add: Stock-based employee compensation, as
reported
    
    
    9
    
    
    
    541
    
    
    
    630Deduct: Stock based employee compensation, as if
fair value method applied to all awards
    
    
    (2,457
    )
    
    
    (4,765
    )
    
    
    (5,976
    )Net loss, pro forma as if fair value method
applied to all awards
    
    $
    (11,208
    )
    
    $
    (19,755
    )
    
    $
    (22,076
    )Basic and diluted net loss per share, as reported
    
    $
    (1.80
    )
    
    $
    (4.50
    )
    
    $
    (9.18
    )Basic and diluted net loss per share, pro forma
as if fair value method applied to all awards
    
    $
    (2.31
    )
    
    $
    (5.72
    )
    
    $
    (12.12
    )
 Segment Reporting Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131), establishes
standards for the way that public business enterprises report information about
operating segments in financial statements. SFAS 131 also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Companys business activities include the development
and commercialization of technologies aimed at handling and/or analyzing the
DNA molecules or fragments in biological samples. Accordingly, the Company
operates in only one business segment. All of the Companys assets and
revenues are derived from this activity. Substantially all of the Companys
long-lived assets are located in the United States. To date, revenues have
been derived primarily from contracts with companies located in North America,
Europe and Asia, as follows (revenue is attributed to geographic areas based on
the location of the customers): 39




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Segment Reporting(continued) Year Ended December 31,2003
    
    2002
    
    2001(in thousands)United States
    
    $
    6,692
    
    
    $
    8,906
    
    
    $
    7,520EuropeGermany
    
    
    4,058
    
    
    
    5,570
    
    
    
    6,346France
    
    
    
    
    
    
    35
    
    
    
    696United Kingdom
    
    
    63
    
    
    
    
    
    
    
    100Norway
    
    
    
    
    
    
    30
    
    
    
    AsiaJapan
    
    
    7,098
    
    
    
    2,865
    
    
    
    2,322Singapore
    
    
    150
    
    
    
    
    
    
    
    2,270Africa
    
    
    40$
    18,101
    
    
    $
    17,406
    
    
    $
    19,254
 Income Taxes Under Statement of Financial Accounting Standards No. 109, Accounting for
Income Taxes (SFAS 109), deferred tax assets and liabilities are determined
based on the difference between financial reporting and tax bases of assets and
liabilities, and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. SFAS 109 provides for
the recognition of deferred tax assets if realization of such assets is more
likely than not. Based upon the weight of available evidence, which includes
the Companys historical operating performance and the reported cumulative net
losses for the prior three years, the Company has provided a full valuation
against its net deferred tax assets as of December 31, 2003 and 2002. The
Company intends to evaluate the realizability of the deferred tax assets on a
quarterly basis. See Note 10 to the Consolidated Financial Statements. Investments in Equity Securities As of December 31, 2003, Lynx held an approximate 42% equity interest in
Axaron Bioscience AG. In 2001, Lynx made a capital investment in Axaron of
approximately $4.5 million. Lynx accounts for its equity investment in Axaron
using the equity method in accordance with Accounting Principles Board No. 18,
The Equity Method of Accounting for Investments in Common Stock (APB 18),
because Lynxs ownership is greater than 20% and Lynx has the ability to
exercise significant influence over the operating, investing and financing
decisions of Axaron. Under the equity method, Lynx records its pro-rata share
of Axarons income or losses and adjusts the basis of its investment
accordingly. As of December 31, 2003, the Companys investment in Axaron was
reduced to zero. Recent Accounting Pronouncements In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). SFAS 150 establishes standards for classifying and measuring as
liabilities certain financial instruments that embody obligations of the issuer
and have characteristics of both liabilities and equity. SFAS 150 is effective
for all financial instruments created or modified after May 31, 2003, and to
other instruments for periods beginning after June 15, 2003. The adoption of
SFAS 150 did not have a material effect on the Companys results of operations
or financial position. 40




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) Recent Accounting Pronouncements(continued) In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN 46 requires
a variable interest entity to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable interest entitys
activities or entitled to receive a majority of the entitys residual returns
or both. The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim period
ending after March 15, 2004. Certain of the disclosure requirements apply in
all financial statements issued after January 31, 2003, regardless of when the
variable interest entity was established. The Company does not believe the
adoption of FIN 46 will have a material impact on its financial position or
results of operations. In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus regarding EITF Issue 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables. The consensus addresses not only when and how an
arrangement involving multiple deliverables should be divided into separate
units of accounting, but also how the arrangements consideration should be
allocated among separate units. The pronouncement is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF Issue 00-21 did not have a material effect on our results of
operations or financial position. 2. Cash Equivalents and Short-term Investments The following is a summary of available-for-sale securities: Available-for-Sale SecuritiesGross
    
    GrossUnrealized
    
    Unrealized
    
    EstimatedAmortized Cost
    
    Gains
    
    Losses
    
    Fair Value(in thousands)December 31, 2003Money market mutual funds
    
    $
    1,508
    
    
    $
    
    
    
    $
    
    
    
    $
    1,508December 31, 2002Money market mutual funds
    
    $
    9,179
    
    
    $
    
    
    
    $
    
    
    
    $
    9,179
 As of December 31, 2003 and 2002, no securities were classified as
short-term investments. 3. Investment in and Transactions with Related Parties Axaron Bioscience AG The Company holds an equity investment in Axaron Bioscience AG (Axaron)
(See Note 4). As of December 31, 2003, Lynx held approximately a 42% ownership
interest in Axaron and had the ability to exercise significant influence over
Axarons operating and accounting policies. Lynx has accounted for the
investment under the equity method in accordance with APB Opinion No. 108.
Under the equity method, the Company records its pro-rata share of the income
or losses of Axaron. Axaron is engaged in employing Lynxs technologies in its
neuroscience, toxicology and microbiology research programs. See Note 4 for
further discussion of the joint venture. 41




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 3. Investment in and Transactions with Related Parties (continued) Summarized unaudited financial information of Axaron is as follows (in
thousands): December 31,2003
    
    2002
    
    2001Condensed Balance Sheet Data:Current assets
    
    $
    4,574
    
    
    $
    7,459
    
    
    $
    11,502Noncurrent assets
    
    
    5,198
    
    
    
    5,727
    
    
    
    5,665Current liabilities
    
    
    1,247
    
    
    
    1,872
    
    
    
    3,269Stockholders equity
    
    
    8,525
    
    
    
    11,314
    
    
    
    13,898Condensed Statements of Operations Data:Net sales
    
    
    4,226
    
    
    
    2,539
    
    
    
    9,486Operating costs and expenses
    
    
    8,987
    
    
    
    8,911
    
    
    
    9,525Income or (loss) from continuing operations
    
    
    (4,759
    )
    
    
    (6,372
    )
    
    
    (39
    )Net income (loss)
    
    
    (4,644
    )
    
    
    (6,131
    )
    
    
    65
 In 2001, Lynx extended its technology licensing agreement with Axaron.
The license extends Axarons right to use Lynxs proprietary MPSS and Megasort
technologies non-exclusively in Axarons neuroscience, toxicology and
microbiology programs until December 31, 2007. Lynx received from Axaron a
$5.0 million technology license fee, which was recorded as deferred revenue and
is being recognized on a straight-line basis over the noncancelable term of the
agreement. The recorded revenue for year ended December 31, 2003, 2002 and
2001 was $760,000, $759,000 and $443,000, respectively. The Company performed
genomics discovery services for Axaron in 2001, and recorded service revenue of
$10,000. In 2001, Lynx made a capital investment in Axaron of approximately
$4.5 million. For the year ended December 31, 2003 and 2002, Lynxs pro-rata
share of Axarons losses was approximately $1.9 million and $2.5 million,
respectively. Lynxs pro-rata share of Axarons earnings was immaterial for
2001. The Company has also subleased certain offices in Germany to Axaron.
During 2003, 2002 and 2001, the Company received an immaterial amount of
sublease income from Axaron. Other Transactions with Related Parties For legal services and expenses during the calendar year ended December
31, 2003, Lynx paid approximately $322,000 to Cooley Godward LLP, Lynxs
counsel, of which a director of Lynx, is a partner. At December 31, 2003 Lynx
had an outstanding liability to Cooley Godward LLP of approximately $55,000. For business development consulting services and expenses during the
calendar year ended December 31, 2003, Lynx paid approximately $222,000 to
L.E.K. Consulting LLC, of which a director of Lynx is President of its North
American practice. At December 31, 2003 Lynx had an outstanding liability to
L.E.K. of approximately $1,200. For genomics discovery services performed during the calendar year ended
December 31, 2003, Lynx received approximately $248,000 from the Institute for
Systems Biology, of which a director of Lynx is President and Director. In June 2001, Dr. Sydney Brenner, a director of the Company, entered into
a consulting agreement with us. Pursuant to the agreement, Dr. Brenner
performs consulting services of at least eight to 16 hours per month in
consideration of his standard consulting fee. In 2003, Dr. Brenner received no
consulting fees under this agreement. 42




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 4. Collaborators, Customers and Licensees The following are summary descriptions of certain key collaborators,
customers and licensees: E.I. DuPont de Nemours and Company In October 1998, Lynx entered into a research collaboration agreement with
E.I. DuPont de Nemours and Company to apply Lynxs technologies on an exclusive
basis to the study of certain crops and their protection. Under the terms of
the agreement, Lynx received payments over a five-year period that ended in the
fourth quarter of 2003 for genomics discovery services, the achievement of
specific technology milestones and the delivery of genomic maps of specified
crops. Lynx received an initial payment of $10.0 million for technology access
at the execution of the agreement, and service fees of $12.0 million were
received by Lynx over a three-year period, which commenced in January 1999.
The agreement was extended with Lynx for a two-year period during which the
Company received additional service fees of $8.0 million through the fourth
quarter of 2003. Through December 31, 2003, Lynx received aggregate payments of $35.0
million from DuPont under the 1998 agreement. In late November 2003, Lynx entered into a new five year services
agreement with DuPont. Through this agreement, we will continue to provide
MPSS services to enhance DuPonts discovery and development of new agricultural
traits and products. BASF AG In October 1996, Lynx entered into an agreement with BASF AG, as amended
in October 1998, to provide BASF with nonexclusive access to certain of Lynxs
genomics discovery services. In connection with certain technology development
accomplishments, BASF paid Lynx a technology access fee of $4.5 million in the
fourth quarter of 1999. BASFs access to Lynxs genomics discovery services is
for a minimum of two years and requires BASF to purchase services at a minimum
rate of $4.0 million per year. At the end of the initial two-year service
period in the fourth quarter of 2001, BASF exercised its right to carryover for
an additional two-year period through the fourth quarter of 2003, a certain
level of previously unrequested genomics discovery services. The agreement
expired in September 2003. Through December 31, 2003, Lynx received aggregate payments of $19.0
million from BASF under the agreement. Bayer CropScience (formerly Aventis CropScience GmbH) In March 1999, Aventis Pharmaceuticals, formerly Hoechst Marion Roussel,
Inc., obtained nonexclusive access to certain of Lynxs genomics discovery
services for the benefit of its affiliate, Aventis CropScience, which is now
Bayer CropScience. Lynx received an initial payment for genomics discovery
services to be performed by Lynx for Bayer CropScience. The service period was
renewed in March 2000, extended in March 2002 for an additional five-year
period, and amended in September 2002. Related to the five-year extension and
subsequent amendment, Bayer CropScience and Lynx plan to jointly develop and
commercialize a novel assay based on Lynxs proprietary bead-based
technologies. Lynx and Bayer CropScience will own the assay technology
jointly. Lynx will manufacture and sell the services or products based on the
assay technology and will pay related royalties to Bayer CropScience.
Additionally, Lynx will derive revenues from performing genomics discovery
services for Bayer CropScience during the development and commercialization
phase of the agreement. Lynx and Bayer CropScience currently collaborate to
apply our technology for the purpose of identifying sequences that might be
inserted in genetically modified plants. This is an evaluation project for
understanding the possible Bayer CropScience product applicability and our
commercial viability of this limited application. 43




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 4. Collaborators, Customers and Licensees(continued) Takara Bio Inc. (formerly Takara Shuzo Co., Ltd.) In November 2000, Lynx entered into a collaboration and license agreement
with Takara Bio Inc. of Japan. The license, as amended in December 2002 and in
July 2003, provided Takara with the right in Japan, Korea and China, including
Taiwan, to use Lynxs proprietary Megaclone, Megasort and MPSS technologies
exclusively until the expiration of the relevant Lynx patents to provide
genomics discovery services and to manufacture and sell microarrays containing
content identified by Lynxs technologies. Under the terms of the original
license agreement, Takara has a nonexclusive license right to manufacture and
sell such microarrays elsewhere throughout the world. In connection with the
2002 amendment to the collaboration, Takara was also granted a royalty-bearing,
nonexclusive right to provide genomics discovery services to customers in
France and Italy. Under the terms of the collaboration agreement, as amended, Lynx received
payments from Takara for technology access fees, royalties on sales of
microarrays and revenues from genomics discovery services, the sale to Takara
of proprietary instruments and reagents used in applying Lynxs technologies
and purchases of Lynx common stock. In the event of improvements made by Takara
that increase the efficiency of Lynxs technologies by a defined amount, Lynx
and Takara have agreed to negotiate in good faith a limited reduction to the
royalty rate applicable to the above royalties. In December 2002, Lynx sold
two MPSS instruments to Takara for Takaras use in providing genomics discovery
services in licensed territories. As part of the 2002 amendment to the
collaboration, Takara accelerated its technology access fee payments to Lynx. In both September and December 2002, in connection with the collaboration
agreement, Lynx issued and sold 291,545 shares of common stock, at a purchase
price of $3.43 per share, to Takara in private placements pursuant to the terms
and conditions of common stock purchase agreements. In October 2001, in
connection with the collaboration agreement, Lynx issued and sold 45,787 shares
of common stock, at a purchase price of $21.84 per share, to Takara in a
private placement pursuant to the terms and conditions of a common stock
purchase agreement. As part of a 2003 amendment to the collaboration and license agreement
with Takara, Takara made a payment of approximately $3.0 million dollars to
Lynx in exchange for which Takara was relieved of its obligation to make
technology access fee payments to Lynx totaling approximately $2.0 million
dollars during 2003 and 2004 and royalties in respect of Takaras sales, and
acquired three additional MPSS instruments for Takaras use in providing
genomics discovery services in Takaras licensed territories. In addition,
Takara will no longer be required to make future equity investments in Lynx. Through December 31, 2003, Lynx received aggregate payments of $14.7
million, net of foreign withholding taxes, from Takara under the collaboration
agreement. The remaining commitment under this agreement is limited to
providing a minimum level of reagents to Takara, at agreed prices, in order for
Takara to perform MPSS in their licensed territories. Axaron Bioscience AG, formerly BASF-LYNX Bioscience AG In 1996, Lynx and BASF established Axaron Bioscience AG, a joint venture
company in Heidelberg, Germany. Axaron began operations in 1997 and is
employing Lynxs technologies in its neuroscience, toxicology and microbiology
research programs. Upon the establishment of Axaron, Lynx contributed access
to Lynxs technologies to Axaron in exchange for an initial 49% equity
ownership in Axaron. BASF, by committing to provide research funding to Axaron
of DM50 million (or approximately $32.0 million based on a December 2003
exchange rate) over a five-year period beginning in 1997, received an initial
51% equity ownership in Axaron. In 1998, BASF agreed to provide an additional
$10.0 million in research funding to Axaron, of which $4.3 million was paid to
us for technology assets related to a central nervous system program. In the
period since the joint venture was established, management and employees
increased their equity ownership in Axaron to 15%, thereby reducing the
ownership of Lynx and BASF to 41.6% and 43.4%, respectively. 44




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 4. Collaborators, Customers and Licensees(continued) In June 2001, Lynx extended its technology licensing agreement with
Axaron. The license extends Axarons right to use Lynxs proprietary MPSS and
Megasort technologies nonexclusively in Axarons neuroscience, toxicology and
microbiology programs until December 31, 2007. The agreement also positions
Axaron to apply Lynxs technologies to specific disorders in the neuroscience
field. Under the terms of the agreement, Lynx received a $5.0 million
technology license fee from Axaron. Lynx intends to furnish to Axaron,
initially without charge and later for a fee, proprietary reagents and
additional MPSS instruments for use in Axarons research programs. In 2001, Lynx and BASF agreed to continue their support of Axarons
growth, including an increase in the capital of Axaron. Lynx made an
additional investment of $4.5 million in Axaron, which maintained its ownership
interest in Axaron at approximately 42%. Given Lynxs ownership share of
Axaron and its ability to exercise significant influence over Axarons
operating and accounting policies, Lynx has accounted for the investment under
the equity method in accordance with Accounting Principles Board No. 18, The
Equity Method of Accounting for Investments in Common Stock. Through December 31, 2003, Lynx received aggregate payments of $9.3
million from Axaron under all related agreements. Lynx recorded revenue of
$0.8 million in 2003, $0.8 million in 2002, and $0.4 million in 2001 from
Axaron, as the technology license fee from Axaron is being recognized as
revenue on a straight-line basis over the noncancelable term of the technology
licensing agreement. Lynx may receive additional payments from Axaron over the
remaining term of the technology licensing agreement from the sale to Axaron of
proprietary reagents and additional MPSS instruments for use in Axarons
research programs. 5. Sale of the Antisense Business In March 1998, Lynx sold its portfolio of phosphorothioate antisense
patents and licenses and its therapeutic oligonucleotide manufacturing facility
(collectively, the Antisense Business) to Inex Pharmaceuticals Corporation
(Inex), a Canadian company. As partial consideration in this transaction,
Lynx received $3.0 million in cash and 1.2 million shares of Inex common stock,
in three equal installments of 400,000 shares in each of March 1998, March 2000
and March 2001. Lynx recorded the installments of the Inex common stock received on March
31, 2001 and 2000, at fair value, in other income when received. The Company
recognized other income of $1.1 million in 2001 and $3.1 million in 2000
related to the receipt of shares. During fiscal year 2001, the Company sold
763,000 shares of Inex common stock and recognized a gain of $1.0 million. The
2001 gains were offset by a loss of $1.6 million recorded in 2001 as a result
of charges related to other-than-temporary declines in the fair value of Inex
shares. In the first quarter of 2002, the Company sold its remaining 437,000
shares of Inex common stock and recognized a gain of approximately $1.0
million. 6. Sale of Technology Assets In March 2002, Lynx sold its intellectual property rights under the
N3-P5 phosphoramidate patent estate to Geron Corporation (Geron) in
exchange for $1.0 million in cash and 210,000 shares of Geron common stock.
The agreement with Geron involves the sale of a family of patents covering
process and compositional matter claims related to oligonucleotides containing
phosphoramidate backbone linkages. The Company recognized proceeds of
approximately $2.6 million from the sale of this technology to Geron, reflected
in the statement of operations as collaborative research and other revenue.
The Company sold all of the Geron stock in April 2002, realizing a loss upon
sale of approximately $64,000. 45




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 7. Restructuring Charges In January 2003, Lynx implemented a reduction of approximately 25% of its
workforce, or 32 people. The Company recorded a workforce reduction charge of
$0.3 million related primarily to severance compensation expense for former
Lynx employees in the first quarter of 2003, which amounts had been paid
entirely as of April 30, 2003. In April 2002, Lynx implemented a reduction of approximately 30% of its
domestic workforce, or 45 people. The Company recorded a workforce reduction
charge of $0.5 million related primarily to severance compensation expense for
former Lynx employees in the second quarter of 2002. The entire $0.5 million
charge was paid during 2002. 8. License Agreements Lynx has entered into various license agreements with companies and
academic institutions. Such agreements generally require Lynx to pay annual or
semiannual license fees and are generally cancelable upon 30 to 90 days
notice. The expenses associated with licenses were approximately $139,000,
$60,000 and $75,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. 9. Notes Receivable from Officers In 1999, the Company entered into loan agreements with certain officers of
the Company. The aggregate loans totaled $360,000, were secured by second
mortgages on real property, had interest accruable at rates of 4.83% to 6.02%
per annum and were subject to early repayment under specified circumstances.
The principal and interest on the loans were to be forgiven, based on the
officers continuous employment over a four-year period, on the anniversary
dates of employment. The loans were either paid in full or forgiven in 2002
under the terms of the agreements. In August 1998, Lynx entered into two loan agreements with an officer of
the Company. Each loan was in the amount of $100,000, secured by a second
mortgage on real property, with interest accruable at the rate of 5.57% per
annum, and subject to early repayment under specified circumstances. The
principal and interest on one loan were to be forgiven, based on the officers
continuous employment over a four-year period, in the following amounts: 50% on
the second anniversary date of employment; and 25% on each of the third and
fourth anniversary dates of employment. The second loan was to be repaid by
the officer according to the following schedule: 50% of the principal on the
third anniversary date of employment; and the remainder of the principal plus
accrued interest on the fourth anniversary date of employment. The first loan
was forgiven under the terms of the agreement, and the second loan was paid in
full in 2002. In April 1997, Lynx entered into a full-recourse loan agreement with an
officer of the Company. A note receivable of $250,000 was issued under a stock
purchase agreement for the purchase of 50,000 shares of common stock whereby
all the shares issued under the agreement were pledged as collateral. The
outstanding principal amount was due and payable in full in April 2002, subject
to an obligation to repay under specified circumstances. Interest was payable
upon the expiration or termination of the note and accrued at the rate of 6.49%
per annum, and $81,125 in interest was forgiven in 2002. The loans principal
was paid in full in 2002. 46




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 10. Stockholders Equity Common Stock At December 31, 2003, Lynx had reserved shares of common stock for
issuance upon the exercise of outstanding employee and non-employee stock
options, upon the issuance of shares to be purchased pursuant to the employee
stock purchase plan and upon the exercise of outstanding warrants as noted
below: Stock option grants outstanding
    
    
    524,103Shares available for future option grants
    
    
    208,156Employee stock purchase plan shares
    
    
    75,010Warrants
    
    
    1,363,0682,170,337
 In December 2003, we completed a private financing of common stock and
warrants to purchase common stock. The financing included the sale of 800,000
newly issued shares of common stock, at a purchase price of $5.00 per share,
resulting in gross proceeds of $4 million, pursuant to a common stock purchase
agreement between Lynx and certain investors. In connection with this
transaction, Lynx issued warrants to purchase up to 200,000 shares of common
stock at an exercise price of $6.25 per share. In September 2003, we completed a private financing of common stock and
warrants to purchase common stock. The financing included the sale of 744,000
newly issued shares of common stock, at a purchase price of $4.03 per share,
resulting in gross proceeds of $3 million, pursuant to a common stock purchase
agreement between Lynx and certain investors. In connection with this
transaction, Lynx issued warrants to purchase 186,000 shares of common stock at
an exercise price of $9.91 per share. In both September and December 2002, in connection with the collaboration
agreement, Lynx issued and sold 291,545 shares of common stock, at a purchase
price of $3.43 per share, to Takara in private placements pursuant to the terms
and conditions of common stock purchase agreements. In April 2002, Lynx completed a $22.6 million private placement of common
stock and warrants to purchase common stock (the financing) resulting in
proceeds of $20.9 million, net of commissions and expenses. The financing
included the sale of 2.1 million newly issued shares of common stock at $10.85
per share and the issuance of warrants to purchase approximately 0.8 million
shares of common stock at an exercise price of $13.58 per share. In connection
with the financing, the Company issued a warrant to purchase up to an aggregate
of 41,714 shares of the Companys common stock at an exercise price of $10.85
per share to Friedman, Billings, Ramsey & Co., Inc. (FBR), as partial
consideration, in addition to other customary fees, for services rendered by
FBR as sole manager for the private equity financing. In October 2001, in connection with the collaboration agreement, Lynx
issued and sold 45,787 shares of common stock, at a purchase price of $21.84
per share, to Takara in a private placement pursuant to the terms and
conditions of a common stock purchase agreement. In May 2001, Lynx completed a private placement of common stock and
warrants to purchase common stock. The financing included the sale of 249,605
newly issued shares of common stock at a purchase price of $44.59 per share,
resulting in net proceeds of approximately $10.5 million, pursuant to a common
stock purchase agreement between Lynx and certain investors. In connection
with this transaction, Lynx issued warrants to purchase up to 101,082 shares of
common stock at an exercise price of $39.76 per share. 47




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 10. Stockholders Equity(continued) In November 1996, Lynx issued common stock and options in exchange for
shares of Spectragen, Inc. common stock and options held by certain officers,
employees and one consultant of Spectragen, pursuant to an agreement of merger
between Lynx and Spectragen, and charged deferred compensation of approximately
$1.4 million ratably to expense as the repurchase rights expired over the
period of 1997 through 2002. At the same time, Lynx issued options to purchase
shares of Lynx common stock in exchange for options to purchase shares of
Spectragen common stock pursuant to the agreement of merger between the Company
and Spectragen and charged deferred compensation of approximately $712,000 to
expense over the respective vesting periods of the grants from 1997 through
2002. In December 1997, Lynxs board of directors (the Board) approved the
commencement of vesting of certain performance-based stock options that had
been granted to certain employees prior to the merger between Spectragen and
Lynx. In connection with this action, Lynx recognized deferred compensation of
$4.1 million, which has been charged to expense over the five-year vesting
period from December 1997 through November 2002. 1992 Stock Option Plan In July 1992, the Board adopted, and the stockholders subsequently
approved, the Companys 1992 Stock Option Plan (the 1992 Plan). In May 1996,
the stockholders approved an amendment to the 1992 Plan extending the term of
the 1992 Plan until March 2006. In May 2003, the stockholders approved an
amendment to the 1992 Plan, authorizing the increase in the number of shares
authorized for issuance under the 1992 Plan from a total of 871,052 shares to
1,071,052 shares. Under the 1992 Plan, the exercise price of incentive stock options granted
may not be less than 100% (110% in the case of options granted to a person who
owns more than 10% of the total combined voting power of all classes of stock
of the Company) of the fair market value of Lynxs common stock at the date of
grant. Nonqualified options may be granted at not less than 85% of the fair
market value of Lynxs common stock at the date of grant. Options generally
vest over a five-year period from the date of grant and have a term of ten
years (five years in the case of options granted to a person who owns more than
10% of the total combined voting power of all classes of stock of the Company). 48




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 10. Stockholders Equity(continued) The stock option activity under the 1992 Plan was as follows: Options OutstandingAvailable for
    
    Number of Shares
    
    Weighted AverageGrant
    
    Subject to Options
    
    Exercise PriceBalance at January 1, 2000
    
    
    41,904
    
    
    
    348,498
    
    
    $
    92.61Shares authorized
    
    
    100,000
    
    
    
    
    
    
    
    Options granted
    
    
    (97,115
    )
    
    
    97,115
    
    
    $
    54.90Options exercised
    
    
    
    
    
    
    (31,122
    )
    
    $
    14.71Options canceled
    
    
    34,187
    
    
    
    (34,248
    )
    
    $
    77.48Balance at December 31, 2001
    
    
    78,976
    
    
    
    380,243
    
    
    $
    90.72Shares authorized
    
    
    85,714
    
    
    
    
    
    
    
    Options granted
    
    
    (129,120
    )
    
    
    129,120
    
    
    $
    9.29Options exercised
    
    
    
    
    
    
    (1,011
    )
    
    $
    2.50Options canceled
    
    
    139,986
    
    
    
    (147,765
    )
    
    $
    64.60Balance at December 31, 2002
    
    
    175,556
    
    
    
    360,587
    
    
    $
    72.51Shares authorized
    
    
    200,000
    
    
    
    
    
    
    
    Options granted
    
    
    (242,750
    )
    
    
    242,750
    
    
    $
    2.17Options exercised
    
    
    
    
    
    
    (1,000
    )
    
    $
    2.09Options canceled
    
    
    75,350
    
    
    
    (78,234
    )
    
    $
    77.10Balance at December 31, 2003
    
    
    208,156
    
    
    
    524,103
    
    
    $
    39.38
 As of December 31, 2003, all options granted under the 1992 Plan were
nonqualified options. There were 223,929, 180,384 and 167,786 options
exercisable under the 1992 Plan at December 31, 2003, 2002 and 2001,
respectively. 49




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 10. Stockholders Equity(continued) The options outstanding at December 31, 2003 have been segregated into
ranges for additional disclosure as follows: Options Outstanding
    
    Options ExercisableOptions
    
    Weighted-average
    
    Weighted-
    
    Options currently
    
    Weighted-outstanding at
    
    remaining
    
    average
    
    exercisable at
    
    averageRange of
    
    December 31,
    
    contractual life
    
    exercise
    
    December 31,
    
    exerciseexercise prices
    
    2003
    
    (in years)
    
    price
    
    2003
    
    price$2.09 - $2.09
    
    
    231,000
    
    
    
    9.22
    
    
    $
    2.09
    
    
    
    28,250
    
    
    $
    2.09$2.66 - $10.01
    
    
    101,717
    
    
    
    8.30
    
    
    $
    8.26
    
    
    
    37,190
    
    
    $
    7.86$10.78 - $56.98
    
    
    60,298
    
    
    
    4.16
    
    
    $
    30.27
    
    
    
    50,634
    
    
    $
    27.27$58.63 - $80.50
    
    
    62,626
    
    
    
    5.70
    
    
    $
    71.36
    
    
    
    51,944
    
    
    $
    70.59$80.92 - $243.25
    
    
    53,805
    
    
    
    5.75
    
    
    $
    118.20
    
    
    
    45,090
    
    
    $
    114.39$245.00 - $332.92
    
    
    2,803
    
    
    
    6.56
    
    
    $
    276.37
    
    
    
    1,913
    
    
    $
    277.04$339.50- $339.50
    
    
    1,142
    
    
    
    6.53
    
    
    $
    339.50
    
    
    
    780
    
    
    $
    339.50$341.25 - $341.25
    
    
    856
    
    
    
    6.51
    
    
    $
    341.25
    
    
    
    583
    
    
    $
    341.25$386.75 - $386.75
    
    
    571
    
    
    
    6.11
    
    
    $
    386.75
    
    
    
    428
    
    
    $
    386.75$537.25 - $537.25
    
    
    9,285
    
    
    
    6.15
    
    
    $
    537.25
    
    
    
    7,117
    
    
    $
    537.25$2.09 - $537.25
    
    
    524,103
    
    
    
    7.60
    
    
    $
    39.38
    
    
    
    223,929
    
    
    $
    69.39
 1998 Employee Stock Purchase Plan In May 1998, the stockholders approved the adoption of the Companys 1998
Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan
authorized the issuance of 103,369 shares of common stock pursuant to purchase
rights granted to employees of the Company and is intended to be an employee
stock purchase plan as defined in Section 423 of the Internal Revenue Code.
As of December 31, 2003, a total of 28,359 shares of common stock had been
issued to employees at an aggregate purchase price of $922,556 and a
weighted-average purchase price of $32.53 per share pursuant to offerings under
the Purchase Plan, and 75,010 shares remained available for future issuance.
Pursuant to our transfer from the Nasdaq National Market to the Nasdaq SmallCap
Market, we have suspended our Purchase Plan. Pro Forma Information Pro forma information regarding net loss and net loss per share is
required by Statement of Financial Accounting Standard No. 123, Accounting for
Stock-based Compensation (SFAS 123), as amended by SFAS 148, and has been
determined as if the Company had accounted for its stock options granted
subsequent to December 31, 1994 under the fair value method of SFAS 123. The
weighted-average fair value of options granted in 2003, 2002 and 2001 was
$1.53, $6.99 and $41.68 per share, respectively. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model for the single option approach with the following weighted-average
assumptions: a risk-free interest rate of 2.84%, 2.98% and 4.35% for 2003, 2002
and 2001, respectively; a weighted-average expected life of five years for
2003, 2002 and 2001 grants; an expected dividend yield of zero for all three
years; and a volatility factor of the expected market price of the Companys
common stock of 88% for 2003, 106% for 2002 and 109% for 2001. 50




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 10. Stockholders Equity(continued) Under SFAS 123, the fair value for the Purchase Plan purchase rights was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions for 2003, 2002 and 2001,
respectively: risk-free interest rate of 2.93%, 2.98% and 2.2%; no dividend
yields; volatility factor of the expected market price of the Companys common
stock of 86%, 106% and 109%; and a weighted-average expected life of 0.50, 0.50
and 0.47 years. The weighted-average fair value of those purchase rights
granted in 2003, 2002 and 2001, respectively, was $2.07, $17.74 and $58.00. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because the Companys stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimates, in managements opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of the Companys stock
options. Preferred Stock Under Lynxs certificate of incorporation, the Board has the authority,
without further action by the holders of Lynxs common stock, to issue
2,000,000 additional shares of preferred stock from time to time in series and
with preferences and rights as it may designate. These preferences and rights
may be superior to those of the holders of Lynxs common stock. For example,
the holders of preferred stock may be given a preference in payment upon Lynxs
liquidation or for the payment or accumulation of dividends before any
distributions are made to the holders of common stock. Any authorization or issuance of preferred stock, while providing
desirable flexibility in connection with financings, possible acquisitions and
other corporate purposes, could also have the effect of making it more
difficult for a third party to acquire a majority of Lynxs outstanding voting
stock or making it more difficult to remove directors and effect a change in
management. The preferred stock may have other rights, including economic
rights senior to those of Lynxs common stock, and, as a result, an issuance of
additional preferred stock could lower the market value of Lynxs common stock.
Provisions of Delaware law may also discourage, delay or prevent someone from
acquiring or merging with Lynx. 11. Closure of German Operations In 2003 the Company decided to cease operations at its subsidiary, Lynx
GmbH, located in Heidelberg Germany since the Company determined that this
operation was no longer critical to the Companys core strategic focus. In
January 2003, Lynx implemented a workforce reduction of approximately 92% or 23
people based at Lynx Therapeutics, GmbH, and in December 2003, the GmbH
facility was closed. The Company incurred a loss of $689,000 due to the
closure consisting entirely of losses on the disposal of fixed assets. The net
book value of the assets sold was $0.9 million. This was recorded in other
income (expense), net in the statement of operations. Lynx may be required to
pay up to EURO 50,000, or approximately $63,000, based on a December 31, 2003
exchange rate, for costs necessary to alter the facilities space to permit or
enable another party to lease such space. Lynx is obliged to pay the remaining
unamortized balance for tenant improvements financed by the landlord over the
term of the lease of EURO 25,705 or approximately $32,300. The Company has
recognized the expected payment amounts as of December 31, 2003. 51




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 12. Income Taxes The income tax provision of $202,000 for 2003 consisted primarily of
foreign withholding tax on payments received from our licensee, Takara. The
income tax benefit of $98,000 for 2002 related primarily to a refund received
for federal alternative minimum taxes paid in prior periods, offset by foreign
withholding tax due on payments received from Lynxs licensee. The provision
for income taxes of $81,000 for 2001 relates entirely to foreign taxes. In the accompanying statements of operations, Loss before provision for
income taxes includes the following components for the years ended December
31, 2003, 2002 and 2001 (in thousands): Year Ended December 31,2003
    
    2002
    
    2001Domestic
    
    $
    (6,394
    )
    
    $
    (14,426
    )
    
    $
    (15,705
    )Foreign
    
    
    (2,164
    )
    
    
    (1,203
    )
    
    
    (944
    )$
    (8,558
    )
    
    $
    (15,629
    )
    
    $
    (16,649
    )
 The provision (benefit) for income taxes consists of the following: Year Ended December 31,2003
    
    2002
    
    2001Current:Federal
    
    $
    
    
    
    
    
    
    
    
    State
    
    
    1
    
    
    
    (38
    )
    
    
    Alternative
Minimum Taxes
    
    
    
    
    
    
    (270
    )
    
    
    Foreign
    
    
    201
    
    
    
    210
    
    
    
    81Total Current
    
    $
    202
    
    
    $
    (98
    )
    
    $
    81Deferred:Federal
    
    
    
    
    
    
    
    
    
    
    State
    
    
    
    
    
    
    
    
    
    
    Total Deferred
    
    
    
    
    
    
    
    
    
    
    Total provision (benefit)
    
    $
    202
    
    
    $
    (98
    )
    
    $
    81
 52




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 12. Income Taxes(continued) The reconciliation of income tax expense (benefit) attributed to
continuing operations computed at the U.S. federal statutory rates to income
tax expense (benefit) for the fiscal years ended December 31, 2003, 2002 and
2001 is as follows (in thousands): Year Ended December 31,2003
    
    2002
    
    2001Tax provision (benefit) at U.S. statutory rate
    
    $
    (2,910
    )
    
    $
    (5,314
    )
    
    $
    (5,675
    )Alternative minimum tax
    
    
    1
    
    
    
    (308
    )
    
    
    Foreign taxes
    
    
    201
    
    
    
    210
    
    
    
    81Loss for which no tax benefit is currently
recognizable
    
    
    2,910
    
    
    
    5,314
    
    
    
    5,675$
    202
    
    
    $
    (98
    )
    
    $
    81
 Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Companys deferred tax assets are as follows (in thousands): 2003
    
    2002Deferred tax assets:Net operating loss carryforwards
    
    $
    29,714
    
    
    $
    21,400Research and development tax
credit carryforwards
    
    
    5,559
    
    
    
    4,540Alternative minimum tax credit
carryforwards
    
    
    
    
    
    
    Capitalized research and
development expenditures
    
    
    3,701
    
    
    
    3,110Deferred revenues
    
    
    1,989
    
    
    
    5,424Reserves and accruals
    
    
    497
    
    
    
    570Valuation allowance
    
    
    (41,460
    )
    
    
    (35,044
    )Net deferred tax assets
    
    $
    
    
    
    $
    
 Realization of deferred tax assets is dependent on future earnings, if
any, the timing and amount of which are uncertain. Accordingly, a valuation
allowance, in an amount equal to the net deferred tax assets as of December 31,
2003 and 2002 has been established to reflect these uncertainties. The change
in the valuation allowance was a net increase of $6.4 million for the year
ended December 31, 2003, a net decrease of $1.5 million and a net increase of
$5.9 million for the years ended December 31, 2002 and 2001, respectively.
Deferred tax assets related to carryforwards at December 31, 2003 include
approximately $3.9 million associated with stock option activity for which any
subsequently recognized tax benefits will be credited directly to stockholders
equity. As of December 31, 2003, the Company had a federal net operating loss
carryforward of approximately $85.5 million, which will expire at various dates
from 2010 through 2023, if not utilized. The Company had a state net operating
loss carryforward of approximately $10.7 million, which will expire in the
years 2004 through 2013. 53




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 12. Income Taxes(continued) As of December 31, 2003, the Company also had federal and California
research and development and other tax credit carryforwards of approximately
$3.4 million and $3.3 million, respectively. The federal research and
development credits will expire at various dates from 2018 through 2023, if not
utilized. The California research and development credits do not expire. Utilization of the Companys net operating loss and credit carryforwards
may be subject to substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code and similar state provisions.
Such an annual limitation could result in the expiration of the net operating
loss and credits before utilization. 13. Obligations Under Operating Leases In February 1998, the Company entered into a noncancelable operating lease
for facilities space of approximately 111,000 square-feet in two buildings in
Hayward, California. Currently, Lynxs corporate headquarters, principal
research and development facilities and production facilities are located in
one of the two buildings. The remaining space will be developed and occupied
in phases, depending on the Companys growth. The term of the lease commenced
on December 15, 1998 and expires on December 14, 2008. Under the terms of the
lease, the monthly rental payments were fixed for the first 24 months.
Thereafter, the monthly rental payments increase and are subject to annual
Consumer Price Index-based adjustments, with minimum and maximum limits. The
Company is recognizing rent expense on a straight-line basis over the lease
period. The Company leased approximately 37,000 square feet of additional
space in one of the buildings for further expansion purposes. The Company has
the option to extend the lease for an additional five-year period, subject to
certain conditions, with payments to be determined at the time of the exercise
of the option. In June 1998, Lynx GmbH entered into a noncancelable operating lease for
facilities space of approximately 6,300 square-feet in Heidelberg, Germany, to
house its operations. The lease was terminated as of December 31, 2003. Upon
termination, Lynx is obliged to pay the remaining unamortized balance of tenant
improvements financed by the landlord over the term of the lease.
Additionally, Lynx may be required to pay up to approximately EURO 50,000 (or
approximately $63,000 based on a December 31, 2003 exchange rate) for the costs
necessary to alter the facilities space to permit or enable another party to
lease such space. Now that the lease is terminated, Lynx estimates that the
total payments, including possible alteration costs, will be approximately
$97,600. The Company has also leased equipment under various operating lease
agreements subject to minimum annual lease payments. Minimum annual rental
commitments and sublease income under non-cancelable operating leases are as
follows (in thousands): LeaseYears Ending December 31,
    
    Commitments2004
    
    $
    2,7422005
    
    
    2,8032006
    
    
    2,8732007
    
    
    2,945Thereafter
    
    
    2,903$
    14,266
 Rent expense for facilities and equipment under operating leases was
$3,034,000, $2,752,000 and $2,854,000 for the years ended December 31, 2003,
2002 and 2001, respectively. Rental income for the facilities under sublease 54




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued) 13. Obligations Under Operating Leases(continued) was approximately $760,000, $1,266,000 and $1,227,000 for the years ended
December 31, 2003, 2002 and 2001, respectively. 14. 401(k) Plan In October 1992, Lynx adopted a 401(k) Plan covering all of its employees.
Pursuant to the 401(k) Plan, employees may elect to reduce their current
compensation by up to 25% (subject to an annual limit prescribed by the
Internal Revenue Code) and have the amount of such reduction contributed to the
401(k) Plan. The 401(k) Plan permits, but does not require, additional
contributions to the 401(k) Plan by Lynx on behalf of all participants in the
401(k) Plan. In the years ended December 31, 2003, 2002 and 2001, the Company
contributed $64,400, $98,900 and $99,500, respectively. 15. Equipment Financing In October 2002, Lynx entered into a loan and security agreement with a
financial institution, Comerica Bank-California, for an equipment line of
credit of up to $2.0 million with a draw-down period of one year. Under the
initial advance, Lynx drew down $1.6 million in November 2002 related to the
purchase of equipment made in previous periods. Lynx granted Comerica
Bank-California a security interest in all items Lynx financed under this
agreement. The initial advance under the loan to finance the purchase of
equipment made in previous periods has a term of 24 months from the date of
advance and bears interest at a rate of 7.25%. In May 2003, the Company
renegotiated the terms of the agreement, which now require that the Company
maintain a minimum cash balance of restricted cash and cash equivalents in an
account at Comerica Bank-California of at least 110% of the principal balance
under loans outstanding under this agreement until Comerica Bank-California
receives payment in full of all outstanding obligations. As of December 31,
2003, the principal balance under loans outstanding under this agreement was
$0.7 million. Accumulated depreciation relating to these assets as of December
31, 2003 and 2002, amounted to $0.3 million and $0.1 million, respectively. In 1998, the Company entered into a financing agreement with a financial
institution, TransAmerica Business Credit Corporation (TransAmerica), under
which Lynx drew down $4.8 million during 1999 for the purchase of equipment and
certain other capital expenditures. Lynx granted TransAmerica a security
interest in all items financed by the Company under this agreement. Each draw
down under the loan has a term of 48 months from the date of the draw down and
bears interest at rates ranging from 10.9% to 11.8%. The original draw-down
period under the agreement expired on March 31, 2000. In September 2000, Lynx
obtained additional financing of $950,000 under an amendment to the original
financing agreement. As of December 31, 2003, the principal balance under
loans outstanding under this agreement was approximately $0.4 million.
Accumulated depreciation relating to these assets amounted to $5.5 million and
$5.5 million as of December 31, 2003 and 2002, respectively. The carrying amounts of the Companys borrowings under its equipment
financings approximate their fair values. The fair values are estimated using
a discounted cash flow analysis based on the Companys current incremental
borrowing rates for similar types of borrowing arrangements. Equipment loans outstanding at December 31, 2003 will be fully repaid
during 2004. 55




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LYNX THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) 16. Quarterly Results (Unaudited) Fiscal Year 2003 Quarter EndedMar. 31
    
    June 30
    
    Sept. 30
    
    Dec. 31(in thousands, except per share data)Statement of Operations Data:Revenues
    
    $
    3,264
    
    
    $
    4,585
    
    
    $
    8,272
    
    
    $
    1,980Income (loss) from operations
    
    
    (3,102
    )
    
    
    (1,881
    )
    
    
    2,441
    
    
    
    (2,962
    )Net income (loss)
    
    
    (3,972
    )
    
    
    (2,857
    )
    
    
    1,813
    
    
    
    (3,744
    )Basic net income (loss) per share
    
    $
    (0.85
    )
    
    $
    (0.61
    )
    
    $
    0.39
    
    
    $
    (0.80
    )Diluted net income (loss) per
share
    
    $
    (0.85
    )
    
    $
    (0.61
    )
    
    $
    0.38
    
    
    $
    (0.80
    )
 Fiscal Year 2002 Quarter EndedMar. 31
    
    June 30
    
    Sept. 30
    
    Dec. 31(in thousands, except per share data)Statement of Operations Data:Revenues
    
    $
    5,022
    
    
    $
    2,853
    
    
    $
    4,833
    
    
    $
    4,698Loss from operations
    
    
    (3,898
    )
    
    
    (4,927
    )
    
    
    (2,086
    )
    
    
    (2,796
    )Net loss
    
    
    (3,759
    )
    
    
    (5,476
    )
    
    
    (3,274
    )
    
    
    (3,022
    )Basic and diluted net loss per
share
    
    $
    (1.91
    )
    
    $
    (1.61
    )
    
    $
    (0.80
    )
    
    $
    (0.69
    )
 Net loss per share amounts have been restated to reflect the effect of a
1-for-7 reverse split of Lynxs common stock effected on January 15, 2003.
Basic and diluted net loss per share is computed independently for each of the
quarters presented. Therefore, the sum of the quarters may not be equal to the
full year net loss per share amounts. 17. Subsequent Events (Unaudited) In March 2004, we announced a reduction of approximately 15% of our total
workforce, or 14 people. The reduction included positions in all functions of
the Companys business. The workforce reduction was intended to further focus
our financial and human resources on expanding the commercial use of MPSS. On March 24, 2004 Lynx and Solexa Ltd. jointly acquired from Manteia SA
the rights to proprietary technology assets for DNA colony generation. 18. Liquidity We have experienced losses since our inception, including a net loss for the
six months ended June 30, 2004. We expect to continue to incur net losses as we
proceed with the commercialization and additional development of our
technologies. The size of these losses will depend on the rate of growth, if
any, in our revenues and on the level of our expenses. Our cash and cash
equivalents have decreased from the $5.6 million, including $0.7 million of
restricted cash, as of December 31, 2003. As of June 30, 2004, our cash and
cash equivalents consisted of $2.0 million in unrestricted cash and investments
and restricted cash of $0.3 million. We will require additional funding to
continue our business activities through at least December 31, 2005. We are
considering various options, which include securing additional equity
financing, obtaining new collaborators and customers and other strategic
actions. If we raise additional capital by issuing equity or convertible debt
securities, our existing stockholders may experience substantial dilution. If
we require additional financing, there can be no assurance that it will be
available 56




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##### Table of Contents



on satisfactory terms, or at all. If we are unable to secure additional
financing on reasonable terms, or are unable to generate sufficient new sources
of revenue through arrangements with customers, collaborators and licensees, we
will be forced to take substantial restructuring actions, which may include
significantly reducing our anticipated level of expenditures, the sale of some
or all of our assets, or obtaining funds by entering into financing or
collaborative agreements on unattractive terms, or we will not be able to fund
operations. The accompanying consolidated financial statements have been
prepared assuming that we will continue as a going concern. The financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the matters discussed above. 57




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PART IV 
 Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K  (a)
    
    Financial Statements, Schedules and Exhibits  (1)
    
    The following index, Report of Ernst & Young LLP, Independent
Registered Public Accounting Firm, and financial statements set forth
on pages 30 through 57 of this report are being filed as part of this
report:  (i)
    
    Report of Ernst & Young LLP, Independent Registered Public
Accounting Firm.(ii)
    
    Consolidated Balance Sheets as of December 31, 2003 and 2002.(iii)
    
    Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001.(iv)
    
    Consolidated Statements of Stockholders Equity for the years
ended December 31, 2003, 2002 and 2001.(v)
    
    Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001.(vi)
    
    Notes to Consolidated Financial Statements.  (2)
    
    All schedules are omitted because they are not required, are not
applicable or the information is included in the consolidated financial
statement or notes thereto.(3)
    
    The following documents are being filed as part of this report: Exhibit No.
    
    Description of Document2.1
    
    Acquisition Agreement, dated as of February 4, 1998, by and between
the Company and Inex Pharmaceuticals Corporation, incorporated by
reference to the indicated exhibit of the Companys Current Report on
Form 8-K filed on March 24, 1998.3.1
    
    Amended and Restated Certificate of Incorporation of the Company,
incorporated by reference to the indicated exhibit of the Companys
Form 10-Q for the period ended June 30, 2000.3.1.1
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of the Company, incorporated by reference to the
indicated exhibit of the Companys Form 10-K for the period ended
December 31, 2002.3.2
    
    Bylaws of the Company, as amended, incorporated by reference to the
indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2000.4.1
    
    Form of Common Stock Certificate, incorporated by reference to
Exhibit 4.2 of the Companys Statement Form 10 (File No. 0-22570), as
amended (see the Statement Form 10).10.1
    
    Form of Indemnity Agreement entered into between the Company and its
directors and officers, incorporated by reference to Exhibit 10.7 of
the Companys Statement Form 10.10.2**
    
    The Companys 1992 Stock Option Plan (the Stock Option Plan),
incorporated by reference to Exhibit 10.8 of the Companys Statement
Form 10.10.3**
    
    Form of Incentive Stock Option Grant under the Stock Option Plan,
incorporated by reference to Exhibit 10.9 of the Companys Statement
Form 10.10.4**
    
    Form of Nonstatutory Stock Option Grant under the Stock Option Plan,
incorporated by reference to Exhibit 10.10 of the Companys Statement
Form 10.
 58




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##### Table of Contents



Exhibit No.
    
    Description of Document10.5
    
    Agreement of Assignment and License of Intellectual Property Rights,
dated June 30, 1992, by and between the Company and ABI, incorporated
by reference to Exhibit 10.11 of the Companys Statement Form 10.10.6
    
    Amended and Restated Investor Rights Agreement, dated as of November
1, 1995, incorporated by reference to Exhibit 10.30 of the Companys
Form 10-K for the period ended December 31, 1995.10.7+
    
    Technology Development and Services Agreement, dated as of October 2,
1995, by and among the Company, Hoechst Aktiengesellschaft and its
subsidiary, Hoechst Marion Roussel, Inc., incorporated by reference
to Exhibit 10.28 of the Companys Form 10-K for the period ended
December 31, 1995.10.7.1+
    
    Amended and Restated First Amendment to Technology Development and
Services Agreement, dated May 1, 1998, by and between the Company and
Hoechst Marion Roussel, Inc., incorporated by reference to Exhibit
10.36 of the Companys Form 10-Q for the period ended June 30, 1998.10.7.2+
    
    Second Amendment to Technology Development and Services Agreement,
dated March 1, 1999, by and among the Company, Hoechst Marion
Roussel, Inc. and its affiliate Hoechst Schering AgrEvo GmbH,
incorporated by reference to the indicated exhibit of the Companys
Form 10-K/A filed on August 24, 2001 for the period ended December
31, 2001.10.7.3+
    
    Third Amendment to Technology Development and Services Agreement,
dated December 20, 1999, by and among the Company, Aventis
Pharmaceutical Inc. and its affiliate Aventis CropScience GmbH,
incorporated by reference to the indicated exhibit of the Companys
Form 10-K/A filed on August 24, 2001 for the period ended December
31, 2001.10.7.4+
    
    Fourth Amendment to Technology Development and Services Agreement,
dated March 31, 2002, by and between the Company and Aventis
CropScience GmbH, incorporated by reference to the indicated exhibit
of the Companys Form 10-Q for the period ended March 31, 2002.10.7.5+
    
    Fifth Amendment to Technology Development and Services Agreement,
dated as of September 30, 2002, by and between the Company and Bayer
CropScience GmbH, incorporated by reference to the indicated exhibit
of the Companys Form 10-Q for the period ended September 30, 2002.10.10
    
    Lease, dated as of February 27, 1998, by and between the Company and
SimFirst, L.P., Limited Partnership, incorporated by reference to
Exhibit 10.35 of the Companys Form 10-Q for the period ended March
31, 1998.10.11**
    
    The Companys 1998 Employee Stock Purchase Plan (the Purchase
Plan), incorporated by reference to Exhibit 99.1 of the Companys
Form S-8 (File No. 333-59163).10.12+
    
    Research Collaboration Agreement, dated as of October 29, 1998, by
and between the Company and E.I. Dupont de Nemours and Co.,
incorporated by reference to Exhibit 10.13 of the Companys Form
10-K/A filed on August 24, 2001 for the period ended December 31,
2001.10.12.1+
    
    Letter Amendment, dated March 1, 2002, to Research Collaboration
Agreement by and between the Company and E.I. DuPont De Nemours and
Co., incorporated by reference to the indicated exhibit of the
Companys Form 10-Q for the period ended March 31, 2002.10.13
    
    Master Loan and Security Agreement, dated as of October 26, 1998, by
and between the Company and Transamerica Business Credit Corporation,
incorporated by reference to Exhibit 10.14 of the Companys Form
10-K/A filed on August 24, 2001 for the period ended December 31,
2001.10.14
    
    Promissory Note No. 7, dated as of September 29, 2000, issued by the
Company to Transamerica Business Credit Corporation, incorporated by
reference to Exhibit 10.15 of the Companys Form 10-K/A filed on
August 24, 2001 for the period ended December 31, 2001.
 59




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##### Table of Contents



Exhibit No.
    
    Description of Document10.15+
    
    Collaboration Agreement, dated as of September 30, 1999, by and
between the Company and Hoechst Schering AgrEvo GmbH, incorporated by
reference to Exhibit 10.1610.16**
    
    Employment Agreement, dated as of October 18, 1999, by and between
the Company and Norman John Wilkie Russell, Ph.D., incorporated by
reference to Exhibit 10.13 of the Companys Form 10-Q for the period
ended September 30, 1999.10.17+
    
    Collaboration Agreement, dated as of October 1, 2000, by and between
the Company and Takara Shuzo Co., Ltd. incorporated by reference to
Exhibit 10.18 of the Companys Form 10-K/A filed on August 24, 2001
for the period ended December 31, 2001.10.17.1+
    
    Amendment No. 1 to Collaboration Agreement, dated December 19, 2002,
by and between the Company and Takara Bio Inc., incorporated by
reference to the indicated exhibit of the Companys Form 10-K for the
period ended December 31, 2002.10.17.2+
    
    Amendment No. 2 to Collaboration Agreement, dated June 30, 2003, by
and between the Company and Takara Bio Inc., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended September 30, 2003.10.18
    
    Securities Purchase Agreement, dated as of May 24, 2001, by and among
the Company and the investors listed therein, incorporated by
reference to Exhibit 10.1 of the Companys Current Report on Form
8-K, filed on June 4, 2001.10.19
    
    Registration Rights Agreement, dated as of May 24, 2001, by and among
the Company and the investors listed therein, incorporated by
reference to Exhibit 10.2 of the Companys Current Report on Form
8-K, filed on June 4, 2001.10.20
    
    Form of Warrant issued by the Company in favor of each investor
thereto, incorporated by reference to Exhibit 10.3 of the Companys
Current Report on Form 8-K, filed on June 4, 2001.10.21+
    
    Joint Venture Agreement, dated as of June 29, 2001, by and between
the Company and BASF Aktiengesellschaft, incorporated by reference to
Exhibit 10.18 of the Companys Form 10-Q for the period ended June
30, 2001.10.22+
    
    First Amendment to Joint Venture Agreement, by and between the
Company and BASF Aktiengesellschaft, dated as of August 14, 2001,
incorporated by reference to Exhibit 10.22.2 of the Companys Form
10-Q for the period ended September 30, 2001.10.23+
    
    Technology License Agreement, dated as of June 1, 2001, by and
between the Company and BASF-LYNX Bioscience AG, incorporated by
reference to Exhibit 10.19 of the Companys Form 10-Q for the period
ended June 30, 2001.10.24
    
    Common Stock Purchase Agreement, by and between the Company and
Takara Shuzo Co., Ltd., dated as of October 1, 2001, incorporated by
reference to Exhibit 10.24 of the Companys Form 10-Q for the period
ended September 30, 2001.10.25+
    
    Purchase Agreement, dated as of March 5, 2002, by and between Geron
Corporation and Lynx Therapeutics, Inc., incorporated by reference to
the indicated exhibit of the Companys Current Report on Form 8-K
filed on March 18, 2002.10.26+
    
    Common Stock Purchase Agreement, dated as of March 5, 2002, by and
between Geron Corporation and Lynx Therapeutics, Inc., incorporated
by reference to the indicated exhibit of the Companys Current Report
on From 8-K filed on March 18, 2002.10.27
    
    Form of Securities Purchase Agreement by and among the Company and
the investors listed therein, incorporated by reference to the
indicated exhibit of the Companys Current Report on Form 8-K, as
amended, filed on April 30, 2002.
 60




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##### Table of Contents



Exhibit No.
    
    Description of Document10.28
    
    Form of Registration Rights Agreement by and among the Company and
the investors listed therein, incorporated by reference to the
indicated exhibit of the Companys Current Report on Form 8-K, as
amended, filed on April 30, 2002.10.29
    
    Form of Warrant issued by the Company in favor or each investor party
to the Securities Purchase Agreement and Friedman, Billings, Ramsey &
Co., Inc., incorporated by reference to the indicated exhibit of the
Companys Current Report on Form 8-K, as amended, filed on April 30,
2002.10.30**
    
    Employment Agreement, dated as of June 3, 2002, by and between the
Company and Kevin P. Corcoran, incorporated by reference to the
indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2002.10.31**
    
    Employment Agreement, dated as of June 10, 2002, by and between the
Company and Thomas J. Vasicek, Ph.D., incorporated by reference to
the indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2002.10.32**
    
    Letter Agreement, dated as of July 9, 2002, by and between the
Company and Norman John Wilkie Russell, Ph.D., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended June 30, 2002.10.33
    
    Common Stock Purchase Agreement, dated as of September 25, 2002, by
and between the Company and Takara Shuzo Co., Ltd., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended September 30, 2002.10.34
    
    Loan and Security Agreement, dated October 23, 2002, by and between
the Company and Comerica Bank-California, incorporated by reference
to the indicated exhibit of the Companys Form 10-Q for the period
ended September 30, 2002.10.35
    
    Common Stock Purchase Agreement, dated as of December 26, 2002, by
and between the Company and Takara Shuzo Co., Ltd., incorporated by
reference to the indicated exhibit of the Companys Form 10-K for the
period ended December 31, 2002.10.39
    
    Securities Purchase Agreement by and among the Company and the
investors listed therein, incorporated by reference to the indicated
exhibit of the Companys Form 8-K filed on September 25, 2003.10.40
    
    Form of Warrant issued by the Company in favor of each investor,
incorporated by reference to the indicated exhibit of the Companys
Form 8-K filed on September 25, 2003.10.41+
    
    Services Agreement, by and between E.I. DuPont de Nemours and Company.10.42
    
    Securities Purchase Agreement by and among the Company and the
investors listed therein, incorporated by reference to the indicated
exhibit of the Companys Form 8-K filed on January 2, 2004.10.43
    
    Form of Warrant issued by the Company in favor of each investor,
incorporated by reference to the indicated exhibit of the Companys
Form 8-K filed on January 2, 2004.21.1
    
    Subsidiaries of the Company.23.1
    
    Consent of Ernst & Young LLP,
Independent Registered Public Accounting Firm.23.2
    
    Consent of Ernst & Young AG, Independent Auditors.23.3*
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.24.1
    
    Power of Attorney. Reference is made to the signature page.31.1
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.
 61




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##### Table of Contents



Exhibit No.
    
    Description of Document31.2
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.3
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.4
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.5
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.6
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.7*
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.8*
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.32.1++
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).32.2++
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).32.3++*
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).++
    
    This certification accompanies the Annual Report on Form 10-K to
which it relates, pursuant to Section 906 of the Sarbanes Oxley Act
of 2002, and is not deemed filed with the Securities and Exchange
Commission and is not to be incorporated by reference into any filing
of Lynx Therapeutics, Inc. under the Securities Act or the Exchange
Act (whether made before or after the date of the Annual Report on
Form 10-K), irrespective of any general incorporation language
contained in such filing.
   *
    
    Being filed herewith; all other exhibits previously filed.**
    
    Management contract or compensatory plan or arrangement.(+)
    
    Portions of this agreement have been deleted pursuant to our request for confidential treatment.  (b)
    
    Reports on Form 8-K A current report on Form 8-K was filed on November 13, 2003 in connection
with the issuance of a press release dated November 13, 2003 announcing our
financial results for the third quarter of 2003. The press release was
furnished under Item 9. 62




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) Securities Exchange
Act of 1934, the Registrant has duly caused this report on Form 10-K/A to be
signed on its behalf by the undersigned, thereunto duly authorized, on October
22, 2004. LYNX THERAPEUTICS, INC.By:
    
    /s/ Kevin P. CorcoranKevin P. CorcoranPresident and Chief Executive Officer
 Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ Kevin P. Corcoran
    
    President, Chief Executive Officer and Director
    
    October 22, 2004(Principal Executive Officer)Kevin P. Corcoran*
    
    Chairman of the Board
    
    October 22, 2004Craig C. Taylor/s/ Kathy A. San Roman
    
    Vice President Human Resources & Administration and
    
    October 22, 2004Acting Chief Financial OfficerKathy A. San Roman
    
    (Principal Financial and Accounting Officer)*
    
    Director
    
    October 22, 2004Sydney Brenner*
    
    Director
    
    October 22, 2004Leroy Hood*
    
    Director
    
    October 22, 2004James C. Kitch*
    
    Director
    
    October 22, 2004Marc D. Kozin*
    
    Director
    
    October 22, 2004James V. Mitchell*
    
    Director
    
    October 22, 2004David C. UPrichard*
    
    Director
    
    October 22, 2004Richard P. Woychik
  *By:
    /s/ Kevin P. Corcoran

KEVIN P. CORCORAN
ATTORNEY-IN-FACT 63




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description of Document2.1
    
    Acquisition Agreement, dated as of February 4, 1998, by and between
the Company and Inex Pharmaceuticals Corporation, incorporated by
reference to the indicated exhibit of the Companys Current Report on
Form 8-K filed on March 24, 1998.3.1
    
    Amended and Restated Certificate of Incorporation of the Company,
incorporated by reference to the indicated exhibit of the Companys
Form 10-Q for the period ended June 30, 2000.3.1.1
    
    Certificate of Amendment to Amended and Restated Certificate of
Incorporation of the Company, incorporated by reference to the
indicated exhibit of the Companys Form 10-K for the period ended
December 31, 2002.3.2
    
    Bylaws of the Company, as amended, incorporated by reference to the
indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2000.4.1
    
    Form of Common Stock Certificate, incorporated by reference to
Exhibit 4.2 of the Companys Statement Form 10 (File No. 0-22570), as
amended (see the Statement Form 10).10.1
    
    Form of Indemnity Agreement entered into between the Company and its
directors and officers, incorporated by reference to Exhibit 10.7 of
the Companys Statement Form 10.10.2**
    
    The Companys 1992 Stock Option Plan (the Stock Option Plan),
incorporated by reference to Exhibit 10.8 of the Companys Statement
Form 10.10.3**
    
    Form of Incentive Stock Option Grant under the Stock Option Plan,
incorporated by reference to Exhibit 10.9 of the Companys Statement
Form 10.10.4**
    
    Form of Nonstatutory Stock Option Grant under the Stock Option Plan,
incorporated by reference to Exhibit 10.10 of the Companys Statement
Form 10.




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##### Table of Contents



Exhibit No.
    
    Description of Document10.5
    
    Agreement of Assignment and License of Intellectual Property Rights,
dated June 30, 1992, by and between the Company and ABI, incorporated
by reference to Exhibit 10.11 of the Companys Statement Form 10.10.6
    
    Amended and Restated Investor Rights Agreement, dated as of November
1, 1995, incorporated by reference to Exhibit 10.30 of the Companys
Form 10-K for the period ended December 31, 1995.10.7+
    
    Technology Development and Services Agreement, dated as of October 2,
1995, by and among the Company, Hoechst Aktiengesellschaft and its
subsidiary, Hoechst Marion Roussel, Inc., incorporated by reference
to Exhibit 10.28 of the Companys Form 10-K for the period ended
December 31, 1995.10.7.1+
    
    Amended and Restated First Amendment to Technology Development and
Services Agreement, dated May 1, 1998, by and between the Company and
Hoechst Marion Roussel, Inc., incorporated by reference to Exhibit
10.36 of the Companys Form 10-Q for the period ended June 30, 1998.10.7.2+
    
    Second Amendment to Technology Development and Services Agreement,
dated March 1, 1999, by and among the Company, Hoechst Marion
Roussel, Inc. and its affiliate Hoechst Schering AgrEvo GmbH,
incorporated by reference to the indicated exhibit of the Companys
Form 10-K/A filed on August 24, 2001 for the period ended December
31, 2001.10.7.3+
    
    Third Amendment to Technology Development and Services Agreement,
dated December 20, 1999, by and among the Company, Aventis
Pharmaceutical Inc. and its affiliate Aventis CropScience GmbH,
incorporated by reference to the indicated exhibit of the Companys
Form 10-K/A filed on August 24, 2001 for the period ended December
31, 2001.10.7.4+
    
    Fourth Amendment to Technology Development and Services Agreement,
dated March 31, 2002, by and between the Company and Aventis
CropScience GmbH, incorporated by reference to the indicated exhibit
of the Companys Form 10-Q for the period ended March 31, 2002.10.7.5+
    
    Fifth Amendment to Technology Development and Services Agreement,
dated as of September 30, 2002, by and between the Company and Bayer
CropScience GmbH, incorporated by reference to the indicated exhibit
of the Companys Form 10-Q for the period ended September 30, 2002.10.10
    
    Lease, dated as of February 27, 1998, by and between the Company and
SimFirst, L.P., Limited Partnership, incorporated by reference to
Exhibit 10.35 of the Companys Form 10-Q for the period ended March
31, 1998.10.11**
    
    The Companys 1998 Employee Stock Purchase Plan (the Purchase
Plan), incorporated by reference to Exhibit 99.1 of the Companys
Form S-8 (File No. 333-59163).10.12+
    
    Research Collaboration Agreement, dated as of October 29, 1998, by
and between the Company and E.I. Dupont de Nemours and Co.,
incorporated by reference to Exhibit 10.13 of the Companys Form
10-K/A filed on August 24, 2001 for the period ended December 31,
2001.10.12.1+
    
    Letter Amendment, dated March 1, 2002, to Research Collaboration
Agreement by and between the Company and E.I. DuPont De Nemours and
Co., incorporated by reference to the indicated exhibit of the
Companys Form 10-Q for the period ended March 31, 2002.10.13
    
    Master Loan and Security Agreement, dated as of October 26, 1998, by
and between the Company and Transamerica Business Credit Corporation,
incorporated by reference to Exhibit 10.14 of the Companys Form
10-K/A filed on August 24, 2001 for the period ended December 31,
2001.10.14
    
    Promissory Note No. 7, dated as of September 29, 2000, issued by the
Company to Transamerica Business Credit Corporation, incorporated by
reference to Exhibit 10.15 of the Companys Form 10-K/A filed on
August 24, 2001 for the period ended December 31, 2001.




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##### Table of Contents



Exhibit No.
    
    Description of Document10.15+
    
    Collaboration Agreement, dated as of September 30, 1999, by and
between the Company and Hoechst Schering AgrEvo GmbH, incorporated by
reference to Exhibit 10.1610.16**
    
    Employment Agreement, dated as of October 18, 1999, by and between
the Company and Norman John Wilkie Russell, Ph.D., incorporated by
reference to Exhibit 10.13 of the Companys Form 10-Q for the period
ended September 30, 1999.10.17+
    
    Collaboration Agreement, dated as of October 1, 2000, by and between
the Company and Takara Shuzo Co., Ltd. incorporated by reference to
Exhibit 10.18 of the Companys Form 10-K/A filed on August 24, 2001
for the period ended December 31, 2001.10.17.1+
    
    Amendment No. 1 to Collaboration Agreement, dated December 19, 2002,
by and between the Company and Takara Bio Inc., incorporated by
reference to the indicated exhibit of the Companys Form 10-K for the
period ended December 31, 2002.10.17.2+
    
    Amendment No. 2 to Collaboration Agreement, dated June 30, 2003, by
and between the Company and Takara Bio Inc., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended September 30, 2003.10.18
    
    Securities Purchase Agreement, dated as of May 24, 2001, by and among
the Company and the investors listed therein, incorporated by
reference to Exhibit 10.1 of the Companys Current Report on Form
8-K, filed on June 4, 2001.10.19
    
    Registration Rights Agreement, dated as of May 24, 2001, by and among
the Company and the investors listed therein, incorporated by
reference to Exhibit 10.2 of the Companys Current Report on Form
8-K, filed on June 4, 2001.10.20
    
    Form of Warrant issued by the Company in favor of each investor
thereto, incorporated by reference to Exhibit 10.3 of the Companys
Current Report on Form 8-K, filed on June 4, 2001.10.21+
    
    Joint Venture Agreement, dated as of June 29, 2001, by and between
the Company and BASF Aktiengesellschaft, incorporated by reference to
Exhibit 10.18 of the Companys Form 10-Q for the period ended June
30, 2001.10.22+
    
    First Amendment to Joint Venture Agreement, by and between the
Company and BASF Aktiengesellschaft, dated as of August 14, 2001,
incorporated by reference to Exhibit 10.22.2 of the Companys Form
10-Q for the period ended September 30, 2001.10.23+
    
    Technology License Agreement, dated as of June 1, 2001, by and
between the Company and BASF-LYNX Bioscience AG, incorporated by
reference to Exhibit 10.19 of the Companys Form 10-Q for the period
ended June 30, 2001.10.24
    
    Common Stock Purchase Agreement, by and between the Company and
Takara Shuzo Co., Ltd., dated as of October 1, 2001, incorporated by
reference to Exhibit 10.24 of the Companys Form 10-Q for the period
ended September 30, 2001.10.25+
    
    Purchase Agreement, dated as of March 5, 2002, by and between Geron
Corporation and Lynx Therapeutics, Inc., incorporated by reference to
the indicated exhibit of the Companys Current Report on Form 8-K
filed on March 18, 2002.10.26+
    
    Common Stock Purchase Agreement, dated as of March 5, 2002, by and
between Geron Corporation and Lynx Therapeutics, Inc., incorporated
by reference to the indicated exhibit of the Companys Current Report
on From 8-K filed on March 18, 2002.10.27
    
    Form of Securities Purchase Agreement by and among the Company and
the investors listed therein, incorporated by reference to the
indicated exhibit of the Companys Current Report on Form 8-K, as
amended, filed on April 30, 2002.




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##### Table of Contents



Exhibit No.
    
    Description of Document10.28
    
    Form of Registration Rights Agreement by and among the Company and
the investors listed therein, incorporated by reference to the
indicated exhibit of the Companys Current Report on Form 8-K, as
amended, filed on April 30, 2002.10.29
    
    Form of Warrant issued by the Company in favor or each investor party
to the Securities Purchase Agreement and Friedman, Billings, Ramsey &
Co., Inc., incorporated by reference to the indicated exhibit of the
Companys Current Report on Form 8-K, as amended, filed on April 30,
2002.10.30**
    
    Employment Agreement, dated as of June 3, 2002, by and between the
Company and Kevin P. Corcoran, incorporated by reference to the
indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2002.10.31**
    
    Employment Agreement, dated as of June 10, 2002, by and between the
Company and Thomas J. Vasicek, Ph.D., incorporated by reference to
the indicated exhibit of the Companys Form 10-Q for the period ended
June 30, 2002.10.32**
    
    Letter Agreement, dated as of July 9, 2002, by and between the
Company and Norman John Wilkie Russell, Ph.D., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended June 30, 2002.10.33
    
    Common Stock Purchase Agreement, dated as of September 25, 2002, by
and between the Company and Takara Shuzo Co., Ltd., incorporated by
reference to the indicated exhibit of the Companys Form 10-Q for the
period ended September 30, 2002.10.34
    
    Loan and Security Agreement, dated October 23, 2002, by and between
the Company and Comerica Bank-California, incorporated by reference
to the indicated exhibit of the Companys Form 10-Q for the period
ended September 30, 2002.10.35
    
    Common Stock Purchase Agreement, dated as of December 26, 2002, by
and between the Company and Takara Shuzo Co., Ltd., incorporated by
reference to the indicated exhibit of the Companys Form 10-K for the
period ended December 31, 2002.10.39
    
    Securities Purchase Agreement by and among the Company and the
investors listed therein, incorporated by reference to the indicated
exhibit of the Companys Form 8-K filed on September 25, 2003.10.40
    
    Form of Warrant issued by the Company in favor of each investor,
incorporated by reference to the indicated exhibit of the Companys
Form 8-K filed on September 25, 2003.10.41+
    
    Services Agreement, by and between E.I. DuPont de Nemours and Company.10.42
    
    Securities Purchase Agreement by and among the Company and the
investors listed therein, incorporated by reference to the indicated
exhibit of the Companys Form 8-K filed on January 2, 2004.10.43
    
    Form of Warrant issued by the Company in favor of each investor,
incorporated by reference to the indicated exhibit of the Companys
Form 8-K filed on January 2, 2004.21.1
    
    Subsidiaries of the Company.23.1
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.23.2
    
    Consent of Ernst & Young AG, Independent Auditors.23.3*
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.24.1
    
    Power of Attorney. Reference is made to the signature page.31.1
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.




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##### Table of Contents



Exhibit No.
    
    Description of Document31.2
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.3
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.4
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.5
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.6
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.7*
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.31.8*
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.32.1++
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).32.2++
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).32.3++*
    
    Certification required by Rule 13a-14(b) or Rule 15d-14(b) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350).++
    
    This certification accompanies the Annual Report on Form 10-K to
which it relates, pursuant to Section 906 of the Sarbanes Oxley Act
of 2002, and is not deemed filed with the Securities and Exchange
Commission and is not to be incorporated by reference into any filing
of Lynx Therapeutics, Inc. under the Securities Act or the Exchange
Act (whether made before or after the date of the Annual Report on
Form 10-K), irrespective of any general incorporation language
contained in such filing.
   *
    
    Being filed herewith; all other exhibits previously filed.**
    
    Management contract or compensatory plan or arrangement.(+)
    
    Portions of this agreement have been deleted pursuant to our request for confidential treatment.