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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934

For the year ended                       December 31, 1996
                    ------------------------------------------------------------

                                       or

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



                         Commission file number 0-22570

                             LYNX THERAPEUTICS, INC.
             (Exact name of Registrant as specified in its charter)

         Delaware                                        94-3161073
(State or other jurisdiction of               (IRS Employer Identification No.)
incorporation or organization)

                    3832 Bay Center Place, 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                  Common Stock, $.001 Par Value
Section 12(g) of the Act:       
                                                  


         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
                                              ---    ---

         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
                             ---

         The number of shares of Common Stock,  Series B Preferred Stock, Series
C Preferred  Stock and Series D Preferred  Stock  outstanding as of December 31,
1996, was 3,152,148,  332,288,  123,299 and 40,000, respectively.  The Series B,
Series C and Series D Preferred  Stock are  convertible  into Common  Stock on a
ten-for-one  basis.  Information  regarding  the  aggregate  market value of the
Registrant's  voting  stock  is not  included  because  there  is  currently  no
established public trading market for the Company's voting stock.


<PAGE>


                                     PART I


ITEM 1.           BUSINESS

         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  The Company's 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
the section entitled "Item 7. Management's  Discussion and Analysis of Financial
Condition and Results of Operations."

         Lynx  Therapeutics,  Inc.  ("Lynx" or the "Company") was formed in late
1992 to discover  and target  inappropriate  gene  expression  in  disease.  The
Company's early efforts relied on academic  collaborations for the discovery and
understanding of altered or inappropriate gene function and on its own expertise
in synthetic DNA ("oligodeoxynucleotide" or "ODN") chemistry for the development
of  compounds  aimed at  modulating  undesirable  gene  expression.  These early
collaborations  resulted  in  a  number  of  compounds.  One  compound  for  the
prevention of restenosis  following balloon  angioplasty is in Phase II clinical
trials  in  Europe  and is  the  object  of  development  and  commercialization
agreements with two  pharmaceutical  companies.  The other  compounds,  aimed at
certain leukemias and cancers,  are currently the objects of in-vivo preclinical
studies.

         As  successful as these  programs  have been, their  progress  has been
generally constrained by the inherent difficulties of elucidating gene functions
with current  technologies.  As a result,  the Company has undertaken to acquire
and develop novel gene  identification  technologies  that promise to accelerate
the discovery and validation of important new targets.

         In   addition,   the  Company  has   recently   initiated  an  internal
biology-based drug discovery program designed around in vitro and in vivo models
of acute  biological  stress or injury.  This  program is  currently  focused on
models relevant to diseases  resulting from brain and spinal cord injuries.  Its
aim is to better define and characterize  gene function and  inappropriate  gene
expression in the diseases of interest.


LYNX  TECHNOLOGIES

Target Discovery Technologies

Massively Parallel Signature Sequencing  ("MPSS")

         In 1994 the Company  established a group to focus on the development of
new and  proprietary  DNA  sequencing  technologies  that  would be  capable  of
accelerating  the  discovery  and  validation  of  targets  for drug  discovery.
Foremost among these are the Massively  Parallel Signature  Sequencing  ("MPSS")
and the Massively Parallel Genomic Sequencing ("MPGS")  technologies.  The first
is designed to enable  researchers to identify a majority of all genes expressed
by a cell  (or  tissue)  from the  simultaneous  sequencing  of up to a  million
molecules  representing  that cell's (or  tissue's)  full gene  expression.  The
second is  designed  to enable the  simultaneous  sequencing  of up to a million
genomic fragments in order to arrive rapidly at genomic  sequences.  The Company
is currently refining various aspects of the biochemistries and  instrumentation
needed to  implement  these  technologies.  Barring  unforeseen  obstacles,  the
Company expects to deploy MPSS in its internal  research  programs as well as in
the programs of its customers and research  partners  during 1997,  and MPGS for
its own programs shortly thereafter.


                                       2.
<PAGE>


Biology-based Target Discovery Programs

         In  1995  the  Company   established  a  target   discovery  and  early
development program designed to capitalize  eventually on the power of MPSS, but
which could develop  nevertheless  with expertise and intermediate  technologies
currently  resident  within  Lynx.  The  initial  projects  are  centered on the
medically important field of neurovascular  diseases, in areas for which good in
vitro and in vivo models  exist,  and that are well suited to eventual  analyses
with the Company's gene sequencing and target discovery MPSS technologies.

         Various  forms of  sub-lethal  stress or challenge  that will not cause
cellular  or tissue  injury are known to lead to states  wherein  certain  cells
become protected from subsequent  injury.  It is as if the cells have protective
reserves which are quiescent under normal resting  conditions,  but which become
activated upon sub-lethal challenges.  Examples include ischemic conditioning of
myocardial  muscle  cells,  liver  cells,  neurons,  and  depolarization-induced
conditioning  of  neurons.  Therefore,  analyzing  the  genes  induced  by  such
challenges could reveal endogenous  protective mechanisms which could then serve
as targets for drug development.

         Animal models of hypoxic  ischemic  nervous  system  injuries  (stroke,
global   ischemias)   reproduce   similar  human  conditions   reasonably  well.
Experiments in these models can be planned and timed  conveniently.  Stroke, for
example, can be modeled by blocking flow in a specific cerebral artery.  Tissues
can then be collected  from various  brain  regions,  and at desired time points
following the original insult. Thus,  progression of post-ischemic events can be
monitored  in affected  and  unaffected  hemispheres  to gain  insight  into the
molecular  pathologies  of the  modeled  disease.  Similar  models  exist  which
reproduce  certain  psychiatric  disorders  such as  depression.  Lynx is in the
process of studying such models of neurological  and psychiatric  diseases using
differential  molecular analysis  techniques.  These models include, but are not
limited to, those of hypoxic  ischemic brain injury,  epilepsy,  central nervous
system trauma,  depression,  and age-related memory deficits. By deciphering the
mechanisms  involved,  Lynx  expects  to  identify  potential  targets  for drug
developments.

Oligodeoxynucleotide Chemistries

         Oligodeoxynucleotides  or ODNs are short,  synthetic  DNA or DNA analog
fragments. Interest in their use stems from their ability, when synthesized with
the appropriate sequence, to bind to target mRNA molecules (the antisense mode),
or, in special cases, to double  stranded DNA (the antigene  mode),  and thereby
block or interfere with gene expression.

         ODN analogs are usually preferred over "natural" ODNs as the latter are
readily degraded by cellular  enzymes.  Lynx has expertise with two types of ODN
analogs, phosphorothioates, a class of compounds licensed from the United States
National  Institute of Health,  and  phosphoramidates,  a  proprietary  class of
compounds developed by the Company.

         ODNs can be used  both as  therapeutic  compounds  or as tools in model
experiments  to  block  expression  of a  given  gene in  order  to  validate  a
hypothesized   function.   Lynx  expects  its  ODN  expertise  and   proprietary
technologies to play a significant role in the discovery of gene function and in
the early and specific validation of potential drug targets.


CLINICAL AND PRE-CLINICAL PROGRAMS

Oligodeoxynucleotide Therapeutic Programs

         Lynx's ODN drug clinical  development  program is currently  focused on
evaluating  in humans the  efficacy  observed  earlier in porcine  models,  of a
proprietary phosphorothioate ODN antisense compound, LR-3280, in coronary artery
restenosis following balloon angioplasty.


                                       3.
<PAGE>

         The target of LR-3280 is the c-myc  oncogene  whose dynamic  expression
suggests  that it plays a causal  role in the  pathologic  process  of  arterial
restenosis.  Lynx's  restenosis  program is an early example of intervening in a
specific disease process by targeting  inappropriate  gene expression.  Lynx has
completed a Phase I safety study of LR-3280 in humans and has  commenced a Phase
II  efficacy  study in Europe.  The  Company has also  completed  two  corporate
development and marketing  partnerships to fully support clinical development of
this compound in North America, Europe, Japan and certain Asian countries.

         The Company and its  collaborators  are now  conducting in vitro and in
vivo  pre-clinical  studies  of a  number  of  phosphoramidate  drug  candidates
targeting   proliferative   diseases  and  viruses.  The  potential  utility  of
phosphoramidate  ODNs as direct antigene drugs is especially promising since the
number of copies of a target  gene in a cell is usually  two,  not  hundreds  or
thousands as with many target mRNA  molecules and viruses.  Thus,  the effective
intracellular  concentration  required  of an  "antigene"  ODN may be many times
lower than that of an "antisense" ODN drug.  Antigene ODNs also have interesting
implications   for  treating  viral  diseases  that  involve  the  viral  genome
integrating itself into the host genome once or a few times--as does HIV.

Process Development and Manufacturing

         The  development  of  ODN-based  drugs  requires the ability to produce
amounts of  synthetic  DNA far  larger  than those  which can be  obtained  from
research-oriented DNA synthesizers. Few other sources can match the quantity and
quality  of  phosphorothioate   compounds  that  Lynx's  process  chemistry  and
synthetic  technology  have made available for in vitro, in vivo, and now human,
testing.  This  manufacturing  technology traces its origins to the beginning of
Lynx as a division of Applied Biosystems Inc., ("ABI"), now a division of Perkin
Elmer  Corporation.  Lynx retains  royalty-free  licenses to ABI's DNA synthesis
technologies and holds exclusive positions in the therapeutics field for some of
them.

         The development of phosphoramidate  analogs has necessitated  extensive
process  development  research to enable their  manufacture  as their  synthesis
requires different chemistries than those developed previously for DNA and other
analogs.  Progress  to date  has  resulted  in  making  the  phosphoramidates  a
practical alternative in addition to being a more potent and versatile one.

Business Risks

Technological Uncertainty; Government Regulation

         All of Lynx's  products are in a research  and  development  phase;  no
significant  revenues have been generated from services or product sales.  There
is no assurance that Lynx's  technologies will be successfully  developed or, if
they are, that they can be successfully  marketed.  Certain Lynx products depend
on the continuance of outside  collaborations and/or the development of in-house
expertise  to  complement  the  efforts of such  collaborators.  There can be no
assurance that Lynx will successfully  maintain these  collaborations or that it
will be able to develop such in-house  expertise.  Moreover,  Lynx's products in
research  or  development  may prove to have  undesirable  and  unintended  side
effects or other characteristics that may prevent or limit their commercial use.
Pharmaceutical or biotechnology  based products,  if any,  resulting from Lynx's
research and development programs are not expected to be commercially  available
for a number of years.

         The FDA and comparable agencies in foreign countries impose substantial
pre-market   approval   requirements   upon  the   introduction  of  therapeutic
pharmaceutical  products  through lengthy and detailed  preclinical and clinical
testing procedures and other costly and time-consuming procedures.  Satisfaction
of these requirements,  which includes  demonstrating to the satisfaction of the
FDA that the product is both safe and effective,  typically  takes several years
or more, depending on the type, complexity and novelty of the product. There can
be no  assurance  that  government  approval  will be obtained for any of Lynx's
products. Even if obtained,  regulatory approval of a product may not be granted
on a timely basis,  may impose  limitations  on the indicated uses for which the
product may be marketed or may impose costly compliance procedures, all of 


                                       4.

<PAGE>

which could diminish any competitive advantage that Lynx may obtain.  Further, a
marketed product, its manufacturer and its manufacturing  facilities are subject
to continual review and periodic inspections and discovery of previously unknown
problems with a product,  manufacturer or facility may result in restrictions on
such product manufacturer,  including withdrawal of the product from the market.
Also, additional government regulation, legislation or administrative action may
be established  which could also prevent or delay regulatory  approval of Lynx's
products.

Loss History; Uncertainty of Future Profitability; Need for Additional Funds

         Lynx had an accumulated  deficit of approximately $31.5 million through
December 31, 1996 and expects to incur substantial operating losses for at least
the next several years. There can be no assurance that Lynx will ever be able to
achieve or  sustain  profitability.  See "Item 7.  Management's  Discussion  and
Analysis of Financial Condition and Results of Operations."

         Lynx's  operations to date have consumed  substantial  amounts of cash.
Negative cash flow from  operations is expected to continue and to increase over
the foreseeable  future.  Lynx anticipates  that its existing capital  resources
will enable Lynx to maintain its current and planned  operations  through  1997.
Lynx intends to seek additional  funding through future equity or debt offerings
in the public or private markets or through collaborative  arrangements.  Lynx's
ability  to obtain  additional  financing  will  depend on the  progress  in its
research  and  development   efforts,   its  financial  condition  and  business
prospects, and conditions prevailing in the relevant capital markets at the time
financing is sought.  There can be no assurance  that any  additional  financing
required by Lynx will be available or, if available,  will be on terms favorable
to  Lynx.  See  "Item 7.  Management's  Discussion  and  Analysis  of  Financial
Condition and Results of  Operations--Liquidity  and Capital Resources." Failure
to obtain  such  additional  funds would have a material  adverse  effect on the
Company.

Competition

         Lynx  is  subject  to  competition   from  many  directions   including
complementary  DNA ("cDNA") cloning and sequencing  technologies,  ODN chemistry
and drug development,  and the discovery and development of  pharmaceutical  and
biotechnology drugs. Competition in the latter arena includes all of the world's
pharmaceutical and biotechnology  companies that have research programs pursuing
the same general targets as Lynx, including cardiovascular diseases, cancers and
leukemias and neurovascular  diseases.  There are several companies that are now
actively engaged in technology developments and discovery programs pertaining to
genomic  elucidation and gene function  determination.  Key to these efforts are
cDNA cloning and DNA sequencing  techniques.  However, there can be no assurance
that  combinations  of  novel  cloning  and  sequencing  techniques  will not be
discovered or developed elsewhere. See "Lynx Technologies."

Patents and Proprietary Rights

         Lynx's  success  will  depend in part on its  ability to obtain  patent
protection for its products both in the U.S. and other countries. Lynx has filed
and will continue to file  applications,  as appropriate,  for patents  covering
both its products and  processes and has licensed a number of patents and patent
applications covering certain of its compounds.  Some of the patent applications
owned by Lynx have already  issued,  but no assurance  can be given that patents
will issue from any of the pending  applications  or that,  if patents do issue,
the claims allowed will be sufficiently broad to protect Lynx's  technology.  In
addition,  no assurance  can be given that any patents  issued to or licensed by
Lynx will not be challenged, invalidated, infringed or circumvented, or that the
rights granted thereunder will provide competitive advantages to Lynx.

         The  commercial  success  of Lynx will also  depend in part on Lynx not
infringing  patents  issued to  competitors  and on  others  not  breaching  the
technology  licenses upon which Lynx's products might be based.  There can be no
assurance  that  Lynx  will be able to  obtain  a  license  to any  third  party
technology  that it may require to conduct its business or that, if  obtainable,
such technology can be licensed at a reasonable cost.  Failure 

                                       5.

<PAGE>


by  Lynx  to  obtain  a  license  to  any  technology  that  it may  require  to
commercialize its technologies or products may have a material adverse effect on
Lynx.

         Litigation,  which could result in substantial  costs to Lynx, may also
be necessary to enforce any patents issued to Lynx or to determine the scope and
validity  of other  parties'  proprietary  rights.  If the  outcome  of any such
litigation is adverse to Lynx, Lynx's business could be adversely affected. Lynx
may have to participate in interference  proceedings declared by the U.S. Patent
and  Trademark  Office,  which  could  result  in  substantial  cost  to Lynx to
determine the priority of inventions.  Furthermore, Lynx may have to participate
at substantial cost in International  Trade Commission  proceedings to abate the
importation of products which would compete unfairly with products of Lynx.

         Lynx also relies on trade secrets and proprietary  expertise,  which it
seeks to protect in part by  confidentiality  agreements with its collaborators,
employees and consultants.  There can be no assurance that these agreements will
not be breached,  that Lynx would have adequate remedies for any breach, or that
its trade secrets will not otherwise become known or be independently  developed
by competitors.

Need to Establish Collaborative Relationships; Dependence on Partners

         Lynx's business strategy includes entering into strategic  alliances or
licensing  arrangements with corporate  partners,  primarily  pharmaceutical and
biotechnology  companies,  relating to the development and  commercialization of
certain of its potential technologies,  databases and products.  There can be no
assurance  that  Lynx  will  be  able  to  negotiate  attractive   collaborative
arrangements or that such collaborations will be available to Lynx on acceptable
terms so that any such relationships,  once established,  will be scientifically
or  commercially  successful.  In addition,  there can be no assurance  that the
Company  will be able to  maintain  its  existing  collaborations,  or that  the
Company's partners will perform under such collaborations.

Attraction and Retention of Key Employees and Consultants

         Lynx is highly dependent on the principal members of its management and
scientific  staff,  the loss of whose  services  could have a  material  adverse
effect on Lynx.  Furthermore,  recruiting  and  retaining  qualified  scientific
personnel to perform  research and  development  work in the future will also be
critical to Lynx's  success.  Lynx  believes it will be successful in attracting
and retaining skilled and experienced  scientific personnel,  although there can
be no assurance  that Lynx will be able to attract and retain such  personnel on
acceptable terms, given the competition among numerous pharmaceutical and health
care  companies,   universities   and  non-profit   research   institutions  for
experienced scientists. See "Employees."

Manufacturing Capability

         The manufacture of Lynx's products will be a time consuming and complex
process and will be subject to good manufacturing practice ("GMP") prescribed by
the FDA or other standards  prescribed by the appropriate  regulatory  agency in
the  country  of  use.  There  can be no  assurance  that  Lynx  will be able to
manufacture  products in a timely fashion, at acceptable quality and cost and in
sufficient quantities.

Absence of Sales and Marketing Experience; Product Liability Exposure and 
Insurance; Hazardous Materials

         Lynx has no  experience  in the sales,  marketing  or  distribution  of
pharmaceutical  products  and does  not  expect  to  establish  a  direct  sales
capability for at least several years.  To market any of its products  directly,
Lynx must  develop  a  substantial  sales and  marketing  force  with  technical
expertise and with supporting distribution capability. There can be no assurance
that Lynx  will  desire  to or be able to build  such a sales  force or that its
direct sales and marketing efforts will be successful.

         The use of any of Lynx's  products in  clinical  trials and the sale of
any products may expose Lynx to liability  claims resulting from the use of such
products.  These  claims  might  be made  directly  by  consumers,  

                                       6.
<PAGE>

health care providers, pharmaceutical companies or others selling such products.
Lynx intends to obtain product liability insurance coverage. No assurance can be
given that Lynx will be able to obtain such  insurance or, if  obtainable,  that
such  insurance can be acquired at reasonable  cost or in sufficient  amounts to
protect Lynx against losses that could have a material adverse effect on Lynx.

         Lynx's  research  and  development  may involve the  controlled  use of
hazardous materials,  chemicals,  viruses and various radioactive compounds.  In
the event of such an  accident,  Lynx could be held liable for any damages  that
result, and any liability could exceed the resources of Lynx.

Non-Corporate Collaborations/Sponsored Research

         Lynx's  R&D  strategy  has  been to  leverage  its  know-how  with  the
expertise  of  extramural  experts  active in a variety of disease  areas.  When
appropriate,  the Company has provided  financial support for its collaborators'
work  and,  in most  cases,  has  secured  the full  commercial  rights  for any
resulting drugs and targets.  The resulting research has thus drawn on resources
and skills far greater than the Company could have assembled  alone in its short
history and with its limited finances.  This strategy has allowed the Company to
defer investing in expensive  skills and  technologies  until it could ascertain
their relevance to specific product developments.

         Lynx has entered into a number of collaborations aimed at enhancing and
extending its research and development  activities.  The following describes the
Company's current academic collaborations:

         o A Sponsored  Research  Agreement with the Department of Neurosciences
of the Johns  Hopkins  University  Medical  Center is directed at the  molecular
characterization of genes induced in the brain by neural activation.

         o A Sponsored  Research  Agreement with Thomas Jefferson  University is
directed at in vivo mouse  experiments in CML and acute leukemias  utilizing the
Company's phosphoramidate ODNs. Basic research is also aimed at identifying mRNA
targets  that are  products of nuclear  proto-oncogenes  and  oncogenes,  and at
characterizing  receptor-mediated mechanisms associated with signal transduction
pathways in cancer.

         o A Sponsored Research  Agreement with the Thomas Jefferson  University
is directed at understanding the role of the IGF-1 receptor in protecting cancer
cells from dying. Phosphoramidate ODN anti-mRNA compounds targeting the receptor
are being optimized in vitro and in vivo.

         o A Sponsored  Research  Agreement with the  Interventional  Cardiology
Group at the Thomas  Jefferson  University  Medical Center is focused on in vivo
experiments using pigs to continue the exploration of the mechanism of action of
LR-3280,  and its possible  applicability  to  prevention  of restenosis in vein
grafts and related clinical indications.

         o A Sponsored Research Agreement with the Polish Academy of Sciences is
aimed at developing chiral phosphorothioate synthesis technology.

         o A Sponsored Research Agreement with the Hungarian Academy of Sciences
is aimed at the  development  of an  informatics  system  compatible  with  MPSS
analyses as well as the detailed analysis of novel genes identified at Lynx.

         o A Sponsored Research  Agreement with the Applied Biosystems  Division
of  Perkin  Elmer  Corporation  is aimed at the  application  of new  nucleotide
sequencing techniques to novel genes identified at Lynx.

         o  A   Sponsored   Research   Agreement  with  The  Molecular  Sciences
Institute is aimed at  conducting  feasibility  research on  Massively  Parallel
Genomic Sequencing ("MPGS"). 

                                       7.
<PAGE>


Corporate Collaborations

         o In October 1996,  Lynx entered into two agreements with BASF AG aimed
at exploiting  Lynx's  proprietary MPSS technology.  The first agreement commits
the two  companies  to form a new  biotechnology  Joint  Venture  ("JV")  called
BASF-LYNX  Bioscience  AG in  Heidelberg,  Germany,  which will be governed by a
detailed  operating  agreement  developed  jointly between the Company and BASF.
Initial  ownership  of the JV  will be  split  51%-49%  between  BASF  and  Lynx
respectively.  Under  the  sponsorship  of BASF  and  Lynx  the JV will  seek to
identify novel drug targets in certain central nervous system diseases;  it will
attempt to determine whether the safety of chemicals can be correlated with, and
anticipated by, their effects on gene expression;  and, finally, it will seek to
optimize microorganisms used in the fermentation production of chemicals such as
vitamins or amino acids.  BASF will provide research funding of up to 50 million
DM (approximately  $33 million at current exchange rates) over the next 5 years,
as well as access to certain of its  technologies,  and Lynx will provide access
to its MPSS technology for use in the JV's research programs.

         The second  agreement  is a service  agreement  through  which BASF may
exploit the expected  power of Lynx's MPSS  technology  for its own internal and
proprietary  research,  independent of the JV's  objectives.  For access to this
service,  which  commits  Lynx to  provide  BASF with a  certain  number of MPSS
analyses  per year,  BASF  agreed to pay Lynx an access  fee of $5.5  million on
execution of the agreement, an additional fee of $5.5 million on the achievement
of a certain  milestone,  and a subscription fee of $8 million for the first two
years of the subscription agreement.

         o In September 1996,  Lynx entered into a collaboration  agreement with
Schwarz  Pharma AG to develop and market  Lynx's LR 3280 drug  candidate for the
European and North American  markets.  The agreement calls for Schwarz Pharma to
pay  Lynx  $4.0  million  and  $16.0  million  in  sign-up  and  milestone  fees
respectively,  and  for  Schwarz  Pharma  to  bear  the  costs  of  development,
regulatory approval and sales in the specified territories.  Schwarz Pharma will
also purchase the drug from Lynx, which retains all manufacturing rights.

         o In July 1996, Lynx entered into a collaboration agreement with Tanabe
Seiyaku Co.,  Ltd. to develop and market  Lynx's LR 3280 drug  candidate for the
Japanese and certain other Asian markets.  The agreement calls for Tanabe to pay
Lynx $3.5 million and $8.0 million in sign-up and milestone  fees  respectively,
and for Tanabe to bear the costs of development,  regulatory  approval and sales
in specified  territories.  Tanabe will also purchase the drug from Lynx,  which
retains all manufacturing rights.

         o In October 1995,  Lynx entered into an agreement  with Hoechst AG and
Hoechst Marion Roussel  (collectively  referred to as "Hoechst")  which provides
Hoechst access to Lynx's MPSS technology. Under the terms of the agreement, Lynx
received funds to accelerate  the  development  of its MPSS  technology  plus an
equity investment.  In return,  Lynx will clone and sequence cDNA libraries from
samples of interest to Hoechst. The agreement also stipulates that not more than
two  additional  companies  may  similarly  access  the  MPSS  technology  for a
specified period.  The combined equity,  R&D support payments,  and subscription
fees could reach $35 million by the end of 1998,  depending upon the achievement
of certain milestones and the quantity of samples submitted for analyses.

Research and Development Expenditures

         Lynx has devoted its efforts  primarily  to research  and  development.
Research and development expenses were $12.3 million for the year ended December
31, 1996,  $11.0  million for the year ended  December 31, 1995 and $7.7 million
for the year ended December 31, 1994.

                                       8.

<PAGE>


Scientific Advisors

         The following are Lynx's principal scientific advisors:

         Sydney Brenner,  M.B., D. Phil. Director and President of The Molecular
Sciences  Institute,  a non-profit  research institute in La Jolla,  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 the genetic code and  information
transfer from genes to proteins, and for his pioneering research on the genetics
and  development  of the nematode.  Dr. Brenner is a Fellow of the Royal Society
(1955) and a Foreign  Associate of the U.S.  National Academy of Sciences (1977)
and has received  numerous  awards of  recognition,  including the Albert Lasker
Medical Research Award (1991), the Genetics Society of America Medal (1987), and
the Kyoto Prize (1990).

         Dennis Choi,  M.D.,  Ph.D.  Chairman of the Department of Neurology and
Director  of the  Center for the Study of Nervous  System  Injury at  Washington
University   School  of  Medicine,   St.  Louis,   Missouri.   Dr.  Choi  is  an
internationally  recognized  leader  in  the  area  of  cellular  and  molecular
neuroscience  with a specific focus on understanding the mechanisms of brain and
nervous system injury.

         Robert L. Letsinger,  Ph.D. holds joint appointments in the Departments
of Chemistry  and  Molecular  Biology and is also  Professor of Chemistry at the
Northwestern  University in Evanston,  Illinois.  Dr. Letsinger is known for his
pioneering  work in solid phase  synthesis of DNA and the  phosphite  method for
assembly of oligonucleotides.  Dr. Letsinger's  achievements in these areas laid
much of the conceptual groundwork for current automated  technologies to produce
synthetic DNA.

         Laszlo Patthy,  Ph.D.,  D.Sc.  Director of the Institute of Enzymology,
Hungarian  Academy  of  Sciences,  Budapest,  Hungary.  Dr.  Patthy,  a  leading
structural and evolutionary biologist,  has made seminal discoveries in the area
of modular protein evolution.  Dr. Patthy has developed a sophisticated  protein
sequence  informatics  technology  that is making  unique  contributions  to the
structural and functional aspects of proteins and their genes.

         Peter H. Seeburg,  Ph.D.,  D.Sc.  Professor,  University of Heidelberg,
Germany.  Dr.  Seeburg is an  internationally  recognized  pioneer in  molecular
biology who developed several essential molecular biological  techniques and was
the sixth most cited  scientific  author of the 1980's.  He was also a principal
scientist in the early phase of Genentech, Inc. In recent years, Dr. Seeburg has
made seminal  discoveries  in molecular  neuroscience.  In 1996,  he assumed the
directorship of the Max Planck Institute of Heidelberg.

         Wojciech  J.  Stec,  Ph.D.  Professor  and  Head of the  Department  of
Bioorganic  Chemistry,  Center of Molecular and Macromolecular  Studies,  Polish
Academy  of  Sciences,  in  Lodz,  Poland.  Professor  Stec  is  known  for  his
contributions to organophosphorus  chemistry and seminal work on stereochemistry
including  phosphorothioate  analogs  of DNA.  Prof.  Stec was  recognized  by a
Fogarty  Scholar-in-Residence  award  (1992-1993) at the National  Institutes of
Health in Bethesda, Maryland.

         Paul F. Worley,  M.D. Associate  Professor,  Department of Neuroscience
and  Neurology  at Johns  Hopkins  University  Medical  School.  Dr.  Worley,  a
neurologist  and  molecular  biologist,  is a pioneer in  applying  differential
cloning techniques to understand the molecular basis of neuronal plasticity.

Employees

         As of December 31, 1996, Lynx employed 63 full-time employees, of which
51 were engaged in research and development and manufacturing  activities and 12
in  finance  and  administrative  activities.  Lynx  believes  that it has  been
successful in attracting skilled and experienced scientific personnel;  however,
competition for such personnel is intense.  None of Lynx's employees are covered
by collective bargaining agreements, and management considers relations with its
employees to be good.

                                       9.
<PAGE>


ITEM 2.           PROPERTIES

         Lynx's corporate  headquarters  and principal  research and development
facilities  are  located  in  Hayward,   California,   in  a  building  totaling
approximately  43,000 square feet. The building is leased through July 2003, and
the Company has  options to renew the lease for two  additional  periods of five
years  each.  Lynx  believes  it is  positioned  to obtain  the space  needed to
accommodate its anticipated growth on commercially reasonable terms.


ITEM 3.           LEGAL PROCEEDINGS

         The Company is not a party to any material legal proceedings.


ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         On December 22, 1995, the Company commenced the solicitation of proxies
and written consents pursuant to Regulation 14 under the Securities Exchange Act
of 1934.  The  stockholders  of the  Company  voted by  written  consent  on the
following   proposal:   to  approve  an  amendment  to  the  Company's  Restated
Certificate  of  Incorporation  to effect a reverse stock split of the Company's
Common Stock and Preferred Stock, so that every ten shares of Common Stock would
be converted  into one share of Common Stock,  and every ten shares of Preferred
Stock would be converted into one share of the  appropriate  series of Preferred
Stock.  The  foregoing  proposal was  approved in January 1996 by the  Company's
stockholders.

         On October 7, 1996, the Company  commenced the  solicitation of proxies
and written consents pursuant to Regulation 14 under the Securities Exchange Act
of 1934. Only certain holders of record of Common Stock,  Series B, Series C and
Series  D  Preferred  Stock  of the  Company  voted by  written  consent  on the
following  proposal:  to approve  an  amendment  to the  Company's  Amended  and
Restated  Certificate of Incorporation  solely to decrease the authorized number
of shares of the Company's  Common Stock from  120,000,000  shares to 20,000,000
shares  and  the  authorized  number  of  the  Company's  Preferred  Stock  from
25,000,000 shares to 2,000,000 shares.  The decrease in the number of authorized
shares had no effect on the rights of existing security  holders.  The foregoing
proposal was approved in December 1996 by the Company's stockholders.

                                      10.

<PAGE>


                                     PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         Although the  Company's  Common Stock has been  registered  pursuant to
Section 12(g) of the Securities  Exchange Act of 1934, as amended (the "Exchange
Act"),  the  Company has not listed its Common  Stock on any  exchange or on the
Nasdaq National Market.  There is currently no established public trading market
for the Company's voting stock.

         The  Company  also has  outstanding  Series  B,  Series C and  Series D
Preferred  Stock,  the shares of which are  convertible  into Common  Stock on a
ten-for-one  basis (i.e., ten shares of Common Stock for each share of Preferred
Stock).  The Company's  Series B, Series C and Series D Preferred  Stock has not
been  registered  pursuant  to the  Exchange  Act and has not been listed on any
exchange or on the Nasdaq  National  Market.  There is currently no  established
trading market for the Company's Preferred Stock.

         As of February 28, 1997, there were 3,005 stockholders of record of the
Company's  Common Stock,  26  stockholders  of record of the Company's  Series B
Preferred  Stock, 28 stockholders of record of the Company's  Series C Preferred
Stock and 1 stockholder of record of the Company's Series D Preferred Stock.

         The Company has not paid any dividends on its Common Stock or Preferred
Stock and does not  anticipate  the  payment  of  dividends  in the  foreseeable
future.  The Company  expects  that any future  earnings  will be  retained  and
applied toward the development of the Company's business.


                                      11.
<PAGE>

<TABLE>

ITEM 6.           SELECTED FINANCIAL DATA

<CAPTION>
                                                                                                          Fiscal Year Ended June 30,
                                                                                                           -------------------------
                                                                                                 Six-Month               Predecessor
                                                                Year Ended December 31,        Period Ended              Division(1)
                                                          ----------------------------------    December 31,             -----------
                                                             1996        1995          1994       1993(2)        1993        1992
                                                             ----        ----          ----       ------         ----        ----
<S>                                                       <C>          <C>          <C>          <C>          <C>          <C>     
Consolidated Statements of Operations
(in thousands, except net loss per share data)

Revenues                                                  $  9,749     $    680     $  4,699     $    183     $  1,238     $    998

Operating costs and expenses:

     Costs of product sales and other revenues                 291          265          742          110            2          644

     Research and development                               12,254       11,036        7,715        3,321        6,194        2,004

     Selling, general and administrative                     3,170        1,591        1,768          650        1,102          470
                                                          --------     --------     --------     --------     --------     --------

Total operating costs and expenses                          15,715       12,892       10,225        4,081        7,298        3,118
                                                          --------     --------     --------     --------     --------     --------

Loss from operations                                        (5,966)     (12,212)      (5,526)      (3,898)      (6,060)      (2,120)

Interest income                                                585          744          506           75          243         --

Provision for income taxes                                      10         --           --           --           --           --
                                                          --------     --------     --------     --------     --------     --------

Net loss                                                  $ (5,391)    $(11,468)    $ (5,020)    $ (3,823)    $ (5,817)    $  2,120)
                                                          ========     ========     ========     ========     ========     ========

Net loss per share (3)                                    $  (2.19)    $  (5.00)    $  (4.83)    $  (5.60)    $  (8.23)
                                                          ========     ========     ========     ========     ========

Shares used in per share computation (3)                     2,467        2,294        1,039          683          707

</TABLE>

<TABLE>
<CAPTION>

                                                                                                          June 30,
                                                                                                   ----------------------
                                                                                                              Predecessor
                                                                     December 31,                             Division(1)
                                                    ------------------------------------------     ----------------------
                                                      1996       1995       1994       1993(2)          1993      1992
                                                    ---------------------------------------------------------------------
<S>                                                 <C>         <C>        <C>          <C>           <C>       <C>    
Consolidated Balance Sheets
(in thousands)
Cash, cash equivalents and short-term investments   $14,082     $13,779    $12,246      $2,383        $7,014    $     5
Working capital                                      12,993      12,730     11,702         891         6,408        133
Total assets                                         18,412      17,685     15,142       4,857         7,396        452
Stockholders' equity                                 10,732      13,742     14,044       2,930         6,744        342

<FN>

(1)    Consolidated  Balance  Sheet data as of June 30, 1992,  and  Consolidated
       Statements of Operations data for the period ended June 30, 1992, are for
       the  Company's   predecessor,   the  Therapeutics   Division  of  Applied
       Biosystems,  Inc., (ABI is now a wholly-owned  subsidiary of Perkin Elmer
       Corporation). Share and per share data for 1992 are not presented for the
       predecessor  because the predecessor was a division and such  information
       is not meaningful.



                                      12.
<PAGE>

(2)    In July 1993, the Company  changed its fiscal year end from a year ending
       June 30 to a calendar year.

(3)    In February  1996,  the Company filed an amendment to its  Certificate of
       Incorporation   effecting  a  one-for-ten  reverse  stock  split  of  all
       outstanding Common and Preferred Stock,  warrants and options to purchase
       Common and Preferred  Stock.  The reverse stock split was approved by the
       majority  of its  stockholders  in January  1996.  The net loss per share
       computations  and number of shares have been  adjusted  retroactively  to
       reflect the stock split for all periods presented.

</FN>
</TABLE>

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.  The Company's 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
the section entitled "Item 1 Business--Business Risks."

Overview

         Since its inception in July 1989 (as a division of Applied  Biosystems,
Inc. "ABI"),  Lynx  Therapeutics,  Inc.  ("Lynx") has devoted its efforts toward
research,  drug discovery and development  programs.  Lynx has been unprofitable
since its inception and expects to incur substantial losses for the next several
years, due primarily to the expansion of its research and development  programs,
including  development of its Massively Parallel Signature  Sequencing  ("MPSS")
and Massively Parallel Genomic Sequencing ("MPGS") technologies, phosphoramidate
chemistry and preclinical  studies and clinical trials. As of December 31, 1996,
Lynx's  accumulated  deficit was  approximately  $31.5 million (the  accumulated
deficit including Lynx's operations as a division of ABI as of December 31, 1996
was  approximately  $35.7  million).  Lynx may  generate  revenues  based on its
agreements  with  collaborative  partners  as a  result  of  achievement  of the
milestones  defined in the agreements.  However,  there is no guarantee that the
milestones will be achieved or that the technologies will be proven  successful.
Lynx does not anticipate that it will generate significant revenues and profits,
if any, from the commercial  sale of its products and services for several years
if not more. There can be no assurance that Lynx will ever successfully  develop
and market any of its proposed  products or that it will ever be able to achieve
or sustain profitability.

         Lynx's  business is subject to significant  risks,  including the risks
inherent in its research and development efforts,  uncertainties associated with
obtaining and enforcing patents,  the lengthy and expensive  regulatory approval
process,  and  possible  competition  from other  products.  The MPSS program is
dependent upon the successful integration of independent  technologies,  each of
which has its own development  risks. In addition,  Lynx's MPSS technology could
face  competition  from the  development  of  similarly  efficient,  or  better,
combinations of novel cloning and sequencing techniques. Further, even if Lynx's
products appear  promising at an early stage of development,  they may not reach
the market for a number of reasons.  Such reasons  include,  but are not limited
to, the  possibilities  that the  Company's  compounds  are found to be toxic or
ineffective during clinical trials, the failure to receive necessary  regulatory
approvals,  the  difficulty to  manufacture on a large scale or the inability to
market a compound due to proprietary rights of third parties.

                                      13.

<PAGE>


Results of Operations

Years Ended December 31, 1996 and 1995

Revenue

         Lynx had total  revenues  of $9.7  million and  $680,000  for the years
ended December 31, 1996 and 1995, respectively.  The 1996 revenue  included $7.5
million  in  sign-up  fees  under the  Tanabe  and  Schwarz  Pharma  agreements;
approximately  $2.0  million  earned  under the  collaborative  agreements  with
Hoechst and BASF; and  approximately  $291,000 from a government grant. The 1995
revenue included  $375,000 of revenue earned under the  collaborative  agreement
with Hoechst and approximately  $305,000 generated from compound sales and grant
revenue.

Operating Expenses

         Costs of product  sales and other  revenues  were $291,000 for the year
ended  December 31, 1996,  compared to $265,000 for the year ended  December 31,
1995. The 1996 cost is related to activity under the government grant, while the
1995 cost is related both to grant activity and cost of compounds sold.

         Research and development expenses were $12.3 million for the year ended
December  31, 1996  compared to $11.0  million for the year ended  December  31,
1995.  The  increase  was due to expenses  associated  with the issuance of Lynx
Common Stock and stock options to certain employees and one consultant  pursuant
to the  Agreement  of Merger  between  Lynx and its  majority-owned  subsidiary,
Spectragen Inc.,  increased spending in support of clinical trials and increased
depreciation  on lab equipment used in research.  A portion of this increase was
offset by reduced funding to various  laboratories under collaborative  research
agreements and lower patent and related legal expense.  Lynx expects to continue
to incur substantial  research and development  expenses due to planned spending
for ongoing research activities and new research applications.

         General  and  administrative  expenses  were $3.2  million for the year
ended  December 31, 1996,  compared to $1.6 million for the year ended  December
31, 1995.  The increase was due  primarily to increased  legal fees,  investment
banking  fees,  and travel  expenses  incurred in  conjunction  with the Tanabe,
Schwarz-Pharma  and BASF  agreements  and to higher salary  expense  relating to
increased headcount and the settlement agreement associated with the termination
of a corporate  officer.  Lynx expects to continue to incur substantial  general
and administrative expenses in support of its research and corporate development
efforts.

Other

         Interest  income was  $585,000  for the year ended  December  31,  1996
compared to $744,000 for the year ended  December 31, 1995. The decrease was due
primarily to somewhat lower interest rates despite  slightly higher average cash
balances during the year ended December 31, 1996 as compared to the prior fiscal
year.

Income Taxes

         The provision for income taxes for the year ended  December 31, 1996 of
$10,000  consisted  entirely  of  alternative  minimum  tax.  There  was  no tax
provision for the year ended December 31, 1995.


                                      14.
<PAGE>


Years Ended December 31, 1995 and 1994

Revenue

         Lynx had total  revenues of $680,000  for the year ended  December  31,
1995,  including  $375,000 of revenue earned under the  collaborative  agreement
with Hoechst.  In addition,  approximately  $305,000 was generated from compound
sales and grant revenue. This compared to total revenues of $4.7 million for the
year ended  December  31, 1994 which  consisted  of a $4.0  million  license fee
received  in  connection  with Lynx's  collaborative  research  and  development
agreement  with The  Wellcome  Foundation  Limited  ("Wellcome"),  approximately
$600,000  in  sales  of  compound   relating  to  the  Wellcome   agreement  and
approximately  $100,000 in grant  revenue.  During the year ended  December  31,
1995,  Wellcome and its parent company,  the Burroughs Wellcome Co., merged with
Glaxo plc and formed Glaxo Wellcome plc. Lynx was subsequently notified by Glaxo
Wellcome of its intention to terminate  Wellcome's agreement with Lynx effective
in March 1996.

Operating Expenses

         Costs of product  sales and other  revenue  were  $265,000 for the year
ended  December 31, 1995,  compared to $742,000 for the year ended  December 31,
1994. The decrease is due primarily to lower costs  associated  with lower sales
of compounds and grant revenue.

         Research and development expenses were $11.0 million for the year ended
December 31, 1995 compared to $7.7 million for the year ended December 31, 1994.
The increase was due primarily to higher  spending for  chemicals,  supplies and
prototype  materials,  increases  in  personnel,  expanded  funding  to  various
laboratories  under  collaborative  research  agreements  and higher  patent and
licensing expenses.

         General  and  administrative  expenses  were $1.6  million for the year
ended  December 31, 1995,  compared to $1.8 million for the year ended  December
31,  1994.  The  decrease in expenses  was due  primarily to a decrease in legal
services for corporate  general matters offset in part by increases in personnel
and increases in corporate development activities.

Other

         Interest  income was  $744,000  for the year ended  December  31, 1995,
compared to $506,000 for the year ended  December 31, 1994. The increase was due
primarily to higher  interest  rates during the year ended December 31, 1995, as
compared to the prior fiscal year.

Liquidity and Capital Resources

         Since inception,  Lynx has funded its operations  through advances from
ABI,  sales of  Preferred  and Common  Stock to venture  capital  investors  and
collaborative  partners,  revenues from  collaborative  research and development
arrangements,  interest income,  product sales and government  grants.  Lynx may
receive  additional  collaborative  research payments from BASF, Schwarz Pharma,
Tanabe  and  Hoechst,  and  equity  investments  from  Hoechst,  subject to Lynx
achieving the milestones as specified in the various agreements.

         Net cash provided in operating  activities of $1.3 million for the year
ended  December  31,  1996  differs  from the net loss for the same  period  for
several  reasons:  receipt of an access fee  related to the  collaboration  with
BASF,  the non-cash  expense  related to stock  issuance in the  Lynx/Spectragen
merger,  depreciation and amortization  expenses and changes in working capital.
Net cash  used in  investing  activities  of $3.1  million  for the  year  ended
December 31, 1996, was primarily due to the purchase of short-term  investments,
the expansion of facilities and capital equipment  purchases.  Net cash provided
by financing  activities  in 1996  consisted  primarily of the exercise of stock
options for cash by employees.  Cash and cash  equivalents were $12.1 million at
December 31, 1996.


                                      15.
<PAGE>


         Lynx  is  currently   utilizing  its  available  funds  for  supporting
development of its MPSS technology,  funding  preclinical  research and clinical
trials and the planned growth in Lynx's internal efforts toward  research,  drug
discovery and development  programs.  Pending such uses as described above, Lynx
intends  to  invest   its  excess   cash  in   short-term,   investment   grade,
interest-bearing securities or certificates of deposit.

         The cost, timing and amount of funds required for specific uses by Lynx
cannot  be  precisely  determined  at this  time and will be based  upon  Lynx's
progress in its research and  development,  the scope and results of preclinical
research  and  clinical  trials,  the cost and timing of  regulatory  approvals,
administrative and legal costs, the establishment of corporate  partnerships and
the  availability  of alternate  methods of  financing.  Lynx  believes that its
current capital resources and interest income thereon will enable it to maintain
its  current  and planned  operations  through the end of 1997.  There can be no
assurance that any additional  financing  required by Lynx will be available or,
if available, will be on terms favorable to Lynx.


                                      16.


<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                             Lynx Therapeutics, Inc.

                   Index to Consolidated Financial Statements




Report of Ernst & Young LLP, Independent Auditors.......................     18

Audited Consolidated Financial Statements:

Consolidated Balance Sheets.............................................     19
Consolidated Statements of Operations...................................     20
Consolidated Statement of Stockholders' Equity..........................     21
Consolidated Statements of Cash Flows...................................     22
Notes to Consolidated Financial Statements..............................     23


                                      17.
<PAGE>


               Report of Ernst & Young, LLP, Independent Auditors



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, 1996 and 1995 and the related consolidated
statements of  operations,  stockholders'  equity and cash flows for each of the
years in the  three  year  period  ended  December  31,  1996.  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 generally accepted auditing standards
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 financial  statements  referred to above present fairly, in
all material respects, the consolidated financial position of Lynx Therapeutics,
Inc.  at  December  31,  1996  and  1995  and the  consolidated  results  of its
operations  and its cash  flows for each of the years in the three  year  period
ended  December 31, 1996,  in  conformity  with  generally  accepted  accounting
principles.





Palo Alto, California
February 4, 1997


                                      18.
<PAGE>

<TABLE>


                                                  Lynx Therapeutics, Inc.

                                                Consolidated Balance Sheets
                                     (In thousands, except share and per share amounts)
<CAPTION>

                                                                                                                  December 31,
Assets                                                                                                       1996            1995
                                                                                                           ------------------------
<S>                                                                                                        <C>             <C>     
Current assets:
   Cash and cash equivalents                                                                               $ 12,109        $ 13,779
   Short-term investments                                                                                     1,973            --
   Accounts receivable                                                                                          118              88
   Other current assets                                                                                         158              79
                                                                                                           ------------------------
Total current assets                                                                                         14,358          13,946

Property and equipment:
   Leasehold improvements                                                                                     3,193           2,501
   Laboratory and other equipment                                                                             2,976           2,157
                                                                                                           ------------------------
                                                                                                              6,169           4,658
   Less accumulated depreciation                                                                             (2,290)         (1,461)
                                                                                                           ------------------------
Net property and equipment                                                                                    3,879           3,197

Notes receivable from officers and employees                                                                    175             542
                                                                                                           ------------------------
                                                                                                           $ 18,412        $ 17,685
                                                                                                           ========================

Liabilities and stockholders' equity
 Current liabilities:
   Accounts payable                                                                                        $    429        $    693
   Accrued compensation                                                                                         394             206
   Accrued professional fees                                                                                    169             187
   Other accrued liabilities                                                                                    373             130
                                                                                                           ------------------------
Total current liabilities                                                                                     1,365           1,216

Deferred revenue from related party                                                                           6,167           2,625
Other noncurrent liabilities                                                                                    148             102

Stockholders' equity:
   Preferred  Stock,  issuable  in  series,  $.001 par value; 2,000,000 shares
     authorized, all shares designated represent convertible Preferred Stock:
   Series B, 400,000 shares designated; 332,288 shares issued and outstanding at
     December 31, 1996 and 1995; aggregate liquidation value of $16,614 at
     December 31, 1996 and 1995;                                                                             16,091          16,091
   Series C, 145,000 shares designated; 123,299  shares issued and outstanding
     at December 31, 1996 and 1995; aggregate liquidation value of $6,165 at
     December 31, 1996 and 1995;                                                                              6,109           6,109
   Series D, 40,000 shares designated; 40,000 shares issued and outstanding
     at December 31, 1996 and 1995; aggregate liquidation value of $5,000 at
     December  31, 1996 and 1995;                                                                             4,989           4,989
   Common Stock, $.001 par value; 20,000,000 shares authorized, 3,152,148 and 2,334,524
     shares issued and outstanding at December 31, 1996 and 1995, respectively;                              17,361          13,394
   Notes receivable from stockholders                                                                          (210)           (660)
   Deferred compensation                                                                                     (2,092)            (51)
   Unrealized gain/(loss) on marketable securities                                                                3              (2)
   Accumulated deficit                                                                                      (31,519)        (26,128)
                                                                                                           ------------------------
Total stockholders' equity                                                                                   10,732          13,742
                                                                                                           ------------------------
                                                                                                           $ 18,412        $ 17,685
                                                                                                           ========================
<FN>



                                                  See accompanying notes.

</FN>
</TABLE>
                                      19.
<PAGE>

<TABLE>

                                                  Lynx Therapeutics, Inc.
                                           Consolidated Statements of Operations
                                     (In thousands, except share and per share amounts)


<CAPTION>

                                                                         Year Ended December 31,
                                                            ----------------------------------------------
                                                                   1996             1995              1994
                                                            ----------------------------------------------
<S>                                                            <C>              <C>             <C>
Net revenues:
   License fees                                                $  7,500         $     --         $   4,000
   Revenues from collaborative arrangements
     with related parties                                         1,958              375                --
   Product sales and other revenues                                 291              305               699
                                                            ----------------------------------------------
Total revenues                                                    9,749              680             4,699

Operating costs and expenses:
   Costs of product and other revenues                              291              265               742
   Research and development                                      12,254           11,036             7,715
   Selling, general and administrative                            3,170            1,591             1,768
                                                            ----------------------------------------------
Total operating costs and expenses                               15,715           12,892            10,225
                                                            ----------------------------------------------

Loss from operations                                            (5,966)         (12,212)           (5,526)

Interest income                                                     585              744               506
Provision for income taxes                                           10               --                --
                                                            ----------------------------------------------
Net loss                                                       $(5,391)        $(11,468)          $(5,020)
                                                            ==============================================

Net loss per share                                            $  (2.19)      $    (5.00)         $  (4.83)
                                                            ==============================================

Shares used in per share computation                          2,466,891        2,293,975         1,039,105
                                                            ==============================================

<FN>


                                                  See accompanying notes.
</FN>
</TABLE>

                                                           20.
<PAGE>


<TABLE>

                                                       Lynx Therapeutics, Inc.
                                           Consolidated Statement of Stockholders' Equity
                                        For the Years Ended December 31, 1994, 1995 and 1996
                                                (In thousands, except share numbers)

<CAPTION>

                                                                                                                                    
                                                                                                                                    
                                                              Preferred Stock                  Common Stock                 Notes   
                                                              ---------------                  ------------             Receivable 
                                                           Shares         Amount           Shares        Amount        From Officers
                                                           ----------------------          --------------------        -------------
<S>                                                       <C>            <C>                <C>          <C>             <C>        
Balance at December 31, 1993                              1,135,865      $   11,358         703,513      $    1,332      $     --   
Issuance of Series B Preferred Stock for
   cash, net of issuance costs of $524                      332,288          16,091            --              --              --   
Conversion of Series A Preferred Stock to
   Common Stock in September 1994                        (1,135,865)        (11,358)      1,135,865          11,358            --   
Exercise of Chiron option for cash                             --              --           150,000              15            --   
Exercise of employee stock options for cash                    --              --            18,513              16            --   
Issuance of Common Stock for services                          --              --             2,438               2            --   
Amortization of deferred compensation                          --              --              --              --              --   
Net unrealized loss on securities available
   for sale                                                    --              --              --              --              --   
Net loss                                                       --              --              --              --              --   
                                                          --------------------------------------------------------------------------
Balance at December 31, 1994                                332,288          16,091       2,010,329          12,723               0
Issuance of Series C Preferred Stock for
   cash, net of issuance costs of $56                       123,299           6,109            --              --              --   
Issuance of Series D Preferred Stock for
   cash, net of issuance costs of $11                        40,000           4,989            --              --              --   
Exercise of employee stock options for cash
   and note receivable                                         --              --           324,410             675            (660)
Issuance of Common Stock for services                          --              --               812               1            --   
Cash paid in lieu of fractional shares
   for reverse stock split                                     --              --            (1,027)             (5)           --   
Amortization of deferred compensation                          --              --              --              --              --   
Net unrealized gain on securities available
   for sale                                                    --              --              --              --              --   
Net loss                                                       --              --              --              --              --   
                                                          --------------------------------------------------------------------------
Balance at December 31, 1995                                495,587          27,189       2,334,524          13,394            (660)
Exercise of employee stock options for cash                    --              --             9,663              12            --   
Repurchase of Common Stock                                     --              --          (157,500)           (297)            450
Issuance of Common Stock in connection
    with Lynx/Spectragen merger                                --              --           959,182           4,221            --   
Issuance of Common Stock for services                          --              --             6,279              31            --   
Amortization of deferred compensation                          --              --              --              --              --   
Net unrealized gain on securities                              --              --              --              --              --   
Net loss                                                       --              --              --              --              --   
                                                          --------------------------------------------------------------------------
Balance at December 31, 1996                                495,587      $   27,189       3,152,148      $   17,361      $     (210)
                                                          ==========================================================================

<FN>

                                                      See accompanying notes.
</FN>
</TABLE>

<TABLE>
<CAPTION>

                                                                                      Unrealized
                                                                                     Gain/(Loss) on                         Total  
                                                                     Deferred         Marketable       Accumulated     Stockholders'
                                                                    Compensation      Securities          Deficit          Equity
                                                                     --------          --------          --------          --------
<S>                                                                  <C>               <C>               <C>               <C>     
Balance at December 31, 1993                                         $   (120)         $   --            $ (9,640)         $  2,930
Issuance of Series B Preferred Stock for
   cash, net of issuance costs of $524                                   --                --                --              16,091
Conversion of Series A Preferred Stock to
   Common Stock in September 1994                                        --                --                --                --
Exercise of Chiron option for cash                                       --                --                --                  15
Exercise of employee stock options for cash                              --                --                --                  16
Issuance of Common Stock for services                                    --                --                --                   2
Amortization of deferred compensation                                      34              --                --                  34
Net unrealized loss on securities available
   for sale                                                              --                 (24)             --                 (24)
Net loss                                                                 --                --              (5,020)           (5,020)
                                                                     ---------------------------------------------------------------
Balance at December 31, 1994                                              (86)              (24)          (14,660)           14,044
Issuance of Series C Preferred Stock for
   cash, net of issuance costs of $56                                    --                --                --               6,109
Issuance of Series D Preferred Stock for
   cash, net of issuance costs of $11                                    --                --                --               4,989
Exercise of employee stock options for cash
   and note receivable                                                   --                --                --                  15
Issuance of Common Stock for services                                    --                --                --                   1
Cash paid in lieu of fractional shares
   for reverse stock split                                               --                --                --                  (5)
Amortization of deferred compensation                                      35              --                --                  35
Net unrealized gain on securities available
   for sale                                                              --                  22              --                  22
Net loss                                                                 --                --             (11,468)          (11,468)
                                                                     ---------------------------------------------------------------
Balance at December 31, 1995                                              (51)               (2)          (26,128)           13,742
Exercise of employee stock options for cash                              --                --                --                  12
Repurchase of Common Stock                                               --                --                --                 153
Issuance of Common Stock in connection
    with Lynx/Spectragen merger                                        (2,076)             --                --               2,145
Issuance of Common Stock for services                                    --                --                --                  31
Amortization of deferred compensation                                      35              --                --                  35
Net unrealized gain on securities                                        --                   5              --                   5
Net loss                                                                 --                --              (5,391)           (5,391)
                                                                     ---------------------------------------------------------------
Balance at December 31, 1996                                         $ (2,092)         $      3          $(31,519)         $ 10,732
                                                                     ===============================================================
<FN>

                                                      See accompanying notes.
</FN>
</TABLE>



<PAGE>

<TABLE>

                                                       Lynx Therapeutics, Inc.

                                                Consolidated Statements of Cash Flows
                                        Net increase (decrease) in cash and cash equivalents
                                                           (In thousands)

<CAPTION>

                                                                                                   Year Ended December 31,
                                                                                       ---------------------------------------------
                                                                                          1996             1995              1994
                                                                                       ---------------------------------------------
<S>                                                                                    <C>               <C>               <C>      
Cash flows from operating activities
Net loss                                                                               $ (5,391)         $(11,468)         $ (5,020)
Adjustments to reconcile net loss to net cash used in
     operating activities:
   Depreciation and amortization                                                            829               608               404
   Loss on disposal of fixed assets                                                        --                   6              --
   Deferred compensation                                                                     35                34                34
   Issuance of Common Stock expensed in connection with
     the Lynx/Spectragen merger                                                           2,145              --                --
   Issuance of Common Stock for services                                                     31                 1                 2
   Changes in operating assets and liabilities:
     Accounts receivable                                                                    (30)              174               (95)
     Other current assets                                                                   (79)              157                 4
     Accounts payable                                                                      (264)              334               189
     Accrued liabilities                                                                    413              (160)             (292)
     Deferred revenue from related parties                                                3,542             2,625              --
     Other noncurrent liabilities                                                            46                46                28
                                                                                       ---------------------------------------------
Net cash provided by (used in) in operating activities                                    1,277            (7,643)           (4,746)

Cash flows from investing activities
Purchases of short-term investments                                                      (6,903)             --             (12,024)
Maturities of short-term investments                                                      4,935             8,022             4,000
Purchases of property and equipment, net of retirements                                  (1,511)           (1,430)           (1,489)
Notes receivable from officers                                                              367              (524)             --
                                                                                       ---------------------------------------------
Net cash provided by (used in) investing activities                                      (3,112)            6,068            (9,513)

Cash flows from financing activities
Issuance of Preferred Stock, net of repurchases                                            --              11,098            16,091
Issuance of Common Stock, net of repurchases                                                165                10                31
                                                                                       ---------------------------------------------
Net cash provided by investing activities                                                   165            11,108            16,122
                                                                                       ---------------------------------------------

Net increase (decrease) in cash and cash equivalents                                     (1,670)            9,533             1,863
Cash and cash equivalents at beginning of period                                         13,779             4,246             2,383
                                                                                       ---------------------------------------------
Cash and cash equivalents at end of period                                             $ 12,109          $ 13,779          $  4,246
                                                                                       =============================================

Supplemental schedule of non-cash financing activities
Accounts payable for construction-in-progress                                          $   --            $   --            $   (754)
                                                                                       =============================================


<FN>

                                                       See accompanying notes.
</FN>
</TABLE>

                                                                 24.
<PAGE>


                             Lynx Therapeutics, Inc.
                   Notes to Consolidated Financial Statements

                                December 31, 1996


1.       Summary of Significant Accounting Policies and Basis of Presentation

Ownership and Basis of Presentation

         Lynx Therapeutics,  Inc. ("Lynx" or the "Company"), was incorporated in
February 1992 under the laws of the State of Delaware.  Lynx was  capitalized in
June 1992 and, effective July 1, 1992, commenced operations.

         Lynx  is  focused  on  exploiting   novel,   proprietary  DNA  cloning,
sequencing and synthesis  technologies  to identify  targets for drug discovery.
Foremost among the Company's  proprietary  assets is a set of novel cDNA cloning
and sequencing  technologies,  collectively dubbed "massively parallel signature
sequencing"  ("MPSS")  which  is  being  developed  to be used to  identify  and
quantify,  in a single analysis, a complete  representative  sampling of all the
mRNA molecules present in a tissue sample. The rapidity (days, instead of months
or years) of this new analytical approach,  if successful,  should allow for the
first time the analysis of the changes in gene  expression that occur during the
progression of a disease.  Lynx's second set of proprietary  technologies  is an
outgrowth of the expertise on which Lynx was originally founded.  This expertise
relates to synthetic  DNA  ("oligodeoxynucleotide"  or "ODN")  chemistry and the
manufacture  and use of  synthetic  ODN  analogues  for  the  pursuit  of  their
therapeutic  applications.  Diseases that have been targeted for the application
of these potential therapeutic agents include cardiovascular  diseases,  cancers
and leukemias, and neurovascular diseases.

         In November 1996, Lynx and its majority owned  subsidiary,  Spectragen,
Inc.  ("Spectragen"),  a Delaware  corporation,  entered  into an  Agreement  of
Merger,   whereby  Lynx  acquired  the  outstanding  17%  minority  interest  in
Spectragen  and  Spectragen  was  merged  with  and into  Lynx and the  separate
corporate  existence  of  Spectragen  ceased  (the  "Merger").   Each  share  of
Spectragen Common Stock outstanding at the time of Merger was converted into 1.3
shares of Lynx  Common  Stock and all vested and  unvested  options to  purchase
shares of  Spectragen  Common  Stock  were  assumed by Lynx and  converted  into
options to purchase Lynx Common Stock at the same ratio.

         In February 1996, the Company filed an amendment to its  Certificate of
Incorporation  effecting a one-for-ten  reverse  stock split of all  outstanding
Common and Preferred  Stock,  warrants and options to purchase Common Stock. The
reverse stock split was approved by the majority of its  stockholders in January
1996.  All references to the number of shares and share prices  throughout  this
document reflect post-split activity.

         The  consolidated  financial  statements  include  the  accounts of the
Company  and  its  wholly  owned  subsidiary,   LYNXNebraska.   All  significant
intercompany balances and transactions have been eliminated.

         The Company has sustained  continuing operating losses and expects such
losses to continue for at least the next  several  years.  The Company  plans to
finance  operations  through equity  offerings to existing and new investors and
through  arrangements  with  corporate  partners.  Should  the  financing  plans
contemplated  by  management  not be  consummated,  the Company may have to seek
alternative sources of capital or reevaluate its operating plans.

                                      23.

<PAGE>


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.

Cash, Cash Equivalents and Short-Term Investments

         The Company considers all investments with a remaining  maturity at the
date of  purchase  of 90 days or  less  as cash  equivalents.  Investments  with
remaining  maturities beyond 90 days but less than one year 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   determines  the  appropriate   classification   of  debt
securities at the time of purchase and reevaluates  such  designation as of each
balance sheet date. As of December 31, 1996 and 1995, the Company has classified
its  entire  investment  portfolio  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 separate  component of  stockholders'
equity.  The amortized cost of debt  securities in this category is adjusted for
amortization  of premiums and  accretion  of  discounts  to maturity,  which are
included in interest  income.  Realized  gains and losses and  declines in value
judged to be other-than-temporary on available-for-sale  securities are included
in  interest  income or  expense.  The cost of  securities  sold is based on the
specific identification method.

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 is generally three years.  Leasehold  improvements  are amortized over the
lessor of the useful  life of the asset or the  remaining  term of the  facility
lease.

Revenue Recognition

         Payments  under  collaborative  arrangements  are recognized as revenue
when earned as defined under the terms of the  respective  agreements.  Payments
received  which are related to future  performance  are deferred  until  earned.
Non-refundable  license fees are generally recorded as revenue upon execution of
the agreement. Revenues from the sales of products are recognized upon shipment.

         During 1996, revenue from three collaborative  partners represented 92%
of total revenue.  During 1995 and 1994, revenue from one collaborative  partner
represented 55% and 85% of total revenue, respectively.

Net Loss per Share

         Net loss per share is calculated  based on the weighted  average number
of common shares  outstanding  during the period.  Common equivalent shares from
stock options,  warrants and  convertible  Preferred Stock are excluded from the
computation as their effect is antidilutive.

Stock-Based Compensation

         As permitted by Statements of Financial  Accounting  Standards No. 123,
"Accounting for Stock-Based  Compensation" ("SFAS 123"), the Company has elected
to account for stock  options  granted to employees  using the  intrinsic  value
method and,  accordingly,  does not recognize  compensation  expense for options
granted to employees with exercise  prices equal to the fair market value of the
Company's Common Stock.

                                      24.
<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)

<TABLE>

2.       Investments

         The following is a summary of available-for-sale securities:
<CAPTION>

                                                                   Available-for-Sale Securities
                                                  ------------------------------------------------------------
                                                                     Gross            Gross          Estimated
                                                   Amortized      Unrealized       Unrealized          Fair
                                                     Cost            Gains           Losses            Value
                                                  ------------------------------------------------------------
                                                                           (In thousands)
<S>                                              <C>            <C>             <C>            <C>
         December 31, 1996
         Money market mutual funds               $     979      $     -         $      -       $        979
         Commercial paper                           12,964            3               -              12,967
                                                  ------------------------------------------------------------
                                                    13,943            3               -              13,946

         December 31, 1995
         Money market mutual funds                   4,362            -                -              4,362
         Commercial paper                            9,478            -              (2)              9,476
                                                  ------------------------------------------------------------
                                                   $13,840      $     -         $    (2)            $13,838

</TABLE>


         During the years ended  December 31, 1996 and 1995, the Company did not
sell any  securities.  As of December 31, 1996,  $11.9 million of the marketable
securities were classified as cash equivalents,  and the balance of $2.0 million
was  classified  as  short-term  investments.  As  of  December  31,  1995,  all
marketable  securities were classified as cash equivalents.  Expected maturities
may differ from contractual maturities because the issuers of the securities may
have the right to prepay obligations without prepayment penalties.

3.       Collaborative Arrangements

         In October 1996, Lynx entered into two agreements with BASF AG aimed at
exploiting Lynx's  proprietary MPSS technology.  The first agreement commits the
two companies to form a new biotechnology  Joint Venture ("JV") called BASF-LYNX
Bioscience AG in Heidelberg,  Germany. Initial ownership of the JV will be split
51%-49%  between BASF and Lynx  respectively.  Under the sponsorship of BASF and
Lynx the JV will seek to identify novel drug targets in certain  central nervous
system  diseases;  it will attempt to determine  whether the safety of chemicals
can be correlated  with, and  anticipated  by, their effects on gene  expression
and, finally,  it will seek to optimize  microorganisms used in the fermentation
production  of  chemicals  such as vitamins or amino  acids.  BASF will  provide
research  funding of up to 50 Million DM  (approximately  $33 million at current
exchange  rates) over the next five  years,  as well as access to certain of its
technologies, and Lynx will provide access to its MPSS technology for use in the
JV's research programs.

         The second  agreement  is a service  agreement  through  which BASF may
exploit the expected  power of Lynx's MPSS for its own internal and  proprietary
research,  independently  of the JV's  objectives.  For access to this  service,
which  commits Lynx to provide BASF with a certain  number of MPSS  analyses per
year,  BASF agreed to pay Lynx an access fee of $5.5 million  upon  execution of
the  agreement,  of which  $458,000 was  recognized as revenue in the year ended
December 31, 1996. BASF will pay an additional access fee of $5.5 million on the
achievement of a certain  milestone and a subscription fee of $8 million for the
first two years of the subscription agreement.

                                      25.
<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


3.       Collaborative Arrangements  (continued)

         In September  1996,  Lynx entered into a  collaboration  agreement with
Schwarz  Pharma AG to develop and market  Lynx's LR 3280 drug  candidate for the
European and North American  markets.  The agreement calls for Schwarz Pharma to
pay Lynx certain  sign-up and milestone fees, and for Schwarz Pharma to bear the
costs  of   development,   regulatory   approval  and  sales  in  the  specified
territories. Schwarz Pharma will also purchase the drug from Lynx, which retains
all manufacturing rights.

         In July 1996, Lynx entered into a  collaboration  agreement with Tanabe
Seiyaku Co.,  Ltd. to develop and market  Lynx's LR 3280 drug  candidate for the
Japanese and certain other Asian markets. The agreements calls for Tanabe to pay
Lynx  certain  sign-up  and  milestone  fees and for Tanabe to bear the costs of
development,  regulatory approval and sales in the specified territories. Tanabe
will also purchase the drug from Lynx, which retains all manufacturing rights.

         In July and October  1996,  Lynx  received the sign-up fees of $3.5 and
$4.0 million from the agreements with Tanabe and Schwarz  Pharma,  respectively.
These  payments  were  recorded as revenue in the period  received.  The Company
could  receive an  additional  $24.0  million in the form of milestone  payments
under the agreements.

         In October  1995,  Lynx entered  into an agreement  with Hoechst AG and
Hoechst Marion Roussel (collectively  referred to as "Hoechst"),  which provides
Hoechst with access to Lynx's MPSS technology. Under the terms of the agreement,
Lynx will receive funding to accelerate the development of its MPSS  technology,
and in  return,  it will  clone and  sequence  cDNA  libraries  from  samples of
interest  to Hoechst as soon as the  technology  is  reduced to  practice.  This
agreement  allows  for no more than two  additional  companies  to  access  this
technology for a specified period.

         In October 1995,  Lynx received  $3.0 million in  development  payments
from Hoechst,  of which $1.5 million and $375,000 were recognized as revenue for
the years ended  December  31, 1996 and 1995,  respectively.  In  addition,  the
Company  received  $5.0  million in November  1995  relating to the closing of a
private  placement  offering to Hoechst  40,000 shares of its Series D Preferred
Stock at $125.00 per share.  The Company could receive up to an additional $27.0
million through the end of 1998 in the form of milestone payments,  subscription
fees and additional equity investments.

4.       License Agreements

University of Nebraska

         In June 1992,  Lynx entered into an agreement  with the  University  of
Nebraska  under  which the  University  agreed to fund most  aspects  of certain
clinical  trials and grant licenses to certain  technology to Lynx. In exchange,
Lynx issued 10,000 shares of its Common  Stock,  and an additional  5,000 shares
upon  achievement of a clinical  trial  milestone by the  University.  The costs
associated  with the issuance of the Common Stock were  included in research and
development expense and are recorded at its deemed fair market value at the date
of issuance. In January 1996, this agreement was terminated.

                                      26.
<PAGE>



                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)

4.       License Agreements (continued)

Other

         Lynx or its  predecessor,  ABI, has entered into various  other license
agreements  with other  companies  and academic  institutions.  Such  agreements
generally  require  Lynx  to pay  annual  or  semiannual  license  fees  and are
generally cancelable upon 60 to 120 days' notice.

5.      Transaction with Related Parties

        Hoechst  AG  and  Hoechst  Marion  Roussel.  See  Note  3. Collaborative
        Arrangements

Notes Receivable from Officers

         In May and June 1995,  the Company  entered  into three  separate  loan
agreements  with an officer of the  Company.  The first loan of  $450,000  was a
promissory note secured by a second mortgage on real property. The principal and
interest  on this  loan  were  repaid  according  to the  terms  of the  note in
September  1996,  upon sale of the  property.  The second loan of  $450,000  was
issued under a stock  purchase  agreement for the purchase of 250,000  shares of
Common Stock whereby all the shares  issued under the agreement  were pledged as
collateral.  Of the 250,000 shares, 225,000 shares were subject to the Company's
right of repurchase  which lapsed  ratably over five years.  The loan  agreement
specified  that upon  termination,  after the Company's  right of repurchase was
exercised,  the  remaining  principal  and  interest  on the  loan  were due and
payable.  In November  1996, the officer left the Company and the stock purchase
loan was repaid in full. The third loan was a line of credit  agreement  whereby
the officer  could  borrow from the Company up to $25,000 per  calendar  quarter
during the first two years of employment.  The line was secured by shares of the
Company's stock owned by the officer.  The principal and accrued interest due on
the line of credit,  an aggregate of $157,862,  was forgiven  upon the officer's
separation from the Company.

         In October 1995, the Company entered into a loan agreement with another
officer of the Company. The note receivable of $210,000 was issued under a stock
purchase agreement for the purchase of 60,000 shares of Common Stock whereby all
the shares issued under the agreement are pledged as collateral. The outstanding
principal  amount is due and  payable in full on October 1, 2000,  subject to an
obligation to prepay under specified circumstances. Interest is payable upon the
expiration  or  termination  of the note and  accrues  at the rate of 6.38%  per
annum.

6.       Stockholders' Equity

Preferred Stock

         Each  share of  Series  B,  Series C and  Series D  Preferred  Stock is
convertible into ten shares of Common Stock at the option of the holder (subject
to adjustment for certain changes in the effective conversion price). The Series
B, Series C and Series D preferred shares have voting rights equal to the voting
rights of the common shares  issuable upon  conversion.  Conversion is automatic
upon the earlier of (i) the closing of an underwritten public offering of Common
Stock under the  Securities  Act of 1933 in which the Company  receives at least
$15,000,000 in gross proceeds and a price per share of at least $15.00 per share
(subject to adjustment for stock splits or similar events),  or (ii) the vote or
written consent of the holders of a majority of the outstanding Series B, Series
C and Series D  convertible  Preferred  Stock.  Series B,  Series C and Series D
stockholders  are  entitled to receive  noncumulative  dividends,  amounts to be
determined  if and when  declared by the Board of  Directors.  In  addition,  no
dividend  other than a stock  dividend  shall be paid on Common  Stock  unless a
dividend  in an equal  amount per share  (based on the  then-current  conversion
rate) is  first  declared  and  paid on the  Series  B,  Series  C and  Series D
Preferred  Stock. In the event of liquidation,  holders of Series B and Series C
Preferred  Stock  shall be  entitled  to receive  an amount  equal to $50.00 per
share, and Series D Preferred Stock, $125.00 per share (all of which are subject
to adjustment),  plus all declared but unpaid  dividends before any payments are
made to holders of Common Stock.

                                      27.
<PAGE>

                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


6.       Stockholders' Equity  (continued)

Common Stock

         In 1992,  Lynx issued  approximately  140,000 shares of Common Stock to
certain employees of and consultants to the Company. These shares are subject to
repurchase  rights which expire ratably over a five-year period from the date of
issuance.  Lynx has recorded  deferred  compensation  expense for the difference
between the  purchase  price and the deemed value of certain of these shares for
financial statement purposes.  At December 31, 1996,  approximately 5,083 shares
were subject to repurchase at $0.10 per share.

         In November  1996,  Lynx issued  959,182 shares of Lynx Common Stock to
certain officers, employees and one consultant in exchange for 737,832 shares of
Spectragen,  Inc.  Common Stock  pursuant to Merger  between Lynx and Spectragen
(See  "Note 1 of Notes to  Financial  Statements").  A portion of the shares are
subject to repurchase  rights which expire ratably  through 2006.  Lynx recorded
compensation  and consultant  expense of $2.0 million and deferred  compensation
expense of $1.4 million for the difference  between the fair market value of the
Lynx stock and the deemed fair market value of the  Spectragen  stock on the day
of acquisition.

         At December 31, 1996,  Lynx has  reserved  10,652,862  shares of Common
Stock for  issuance  upon  conversion  of the  Series B,  Series C and  Series D
Preferred  Stock,  upon the achievement of certain  established  milestones by a
research  collaborator  and  upon  the  exercise  of  outstanding  employee  and
nonemployee stock options.

1992 Stock Option Plan

         In July 1992,  Lynx  adopted the 1992 Stock  Option  Plan ("the  Plan")
under which incentive or nonqualified stock options to purchase shares of Common
Stock may be granted to  employees  and  officers  of, and  consultants  to, the
Company.  In January 1995 and May 1996, the stockholders  approved amendments to
the 1992 Plan to  increase  the  number  of  shares  reserved  for  issuance  to
1,400,000 and 2,100,000, respectively. The number of shares available for option
grants has been reduced by the 140,000  shares of Common Stock which were issued
to certain employees and consultants, as discussed above.

         Under the Plan, the exercise price of incentive 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  Common  Stock  at the  date of  grant.
Nonqualified options may be granted at not less than 85% of fair market value 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).

         In November 1996,  Lynx issued 524,355  options to purchase Lynx Common
Stock in  exchange  for  403,350  options to purchase  Spectragen  Common  Stock
pursuant to the  Agreement  of Merger  between the  Company and  Spectragen.  In
accordance  with  APB  25,  Accounting  for  Stock  Issued  to  Employees,  Lynx
recognized  compensation  costs  and  deferred  compensation   representing  the
difference  between the exercise  price of the options and the fair market value
of the  Company's  Common Stock on the day of the grants.  The Company  recorded
approximately  $29,000 as  compensation  expense for the year ended December 31,
1996,  for the portion of the options that had vested  during  fiscal year 1996,
and  deferred  compensation  of  approximately  $683,000  for the portion of the
grants  that will vest in future  periods.  The  deferred  compensation  will be
charged to expense over the vesting period of the grants.

                                      28.
<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


6.       Stockholders' Equity  (continued)

<TABLE>

         The stock option activity under the Plan was as follows:
<CAPTION>

                                                                              Options Outstanding
                                                -----------------------------------------------------------------------
                                                                     Number of                              Weighted
                                                 Available        Shares Subject        Option Price         Average
                                                 for Grant          to Options            per Share      Exercise Price
                                                 ---------        --------------        ------------     --------------
<S>                                             <C>                <C>                   <C>                   <C>  
         Balance at December 31, 1993              141,498            102,871            $0.10-$2.00           $1.11
         Options authorized                      1,000,000                 --                     --
         Options granted                         (369,500)            369,500            $1.00-$2.00            1.01
         Options exercised                              --           (18,513)            $0.10-$2.00             .98
         Options canceled                            9,157            (9,157)            $0.10-$2.00            1.36
                                                ----------         ----------                                        
         Balance at December 31, 1994              781,155            444,701            $0.10-$2.00            1.03
         Options granted                         (678,436)            678,436            $1.00-$5.00            2.55
         Options exercised                              --          (324,410)            $1.00-$5.00            2.08
         Options canceled                           66,316           (66,316)            $1.00-$2.00            1.06
                                                ----------         ----------            
         Balance at December 31, 1995              169,035            732,411            $0.10-$5.00            1.97
         Options authorized                      1,224,355                 --                     --
         Options granted                         (859,858)            859,858            $0.15-$6.00            2.75
         Options exercised                              --            (9,663)            $0.10-$6.00            1.23
         Options canceled                           64,954           (65,004)            $0.10-$6.00            2.76
                                                ----------         ----------                                       
         Balance at December 31, 1996              598,486         1,517,602             $0.10-$6.00            2.39
                                                ==========         =========

</TABLE>

         To date, all options granted under the Plan are  nonqualified  options.
Options to purchase a total of 682,254 shares were exercisable under the Plan at
December 31, 1996.  Certain  officers and  employees of the Company were granted
the right to exercise  their options prior to vesting,  subject to the Company's
right of repurchase at the original issue price,  which lapses ratably over five
years. As of December 31, 1996, 438,384 shares were subject to repurchase.

                                      29.

<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


6.       Stockholders' Equity  (continued)

<TABLE>

         The options  outstanding at December 31, 1996 have been segregated into
ranges for  additional  disclosure  as follows  (option  amounts are recorded in
thousands):

<CAPTION>

                                          Options Outstanding                                   Options Exercisable
                       --------------------------------------------------------      -------------------------------------
                                             Weighted-
                                              average                                     Options
                            Options          remaining                                   currently
                        outstanding at      contractual            Weighted-          exercisable at           Weighted-
     Range of`           December 31,          life                 average            December 31,             average
exercises prices             1996           (in years)          exercise price             1996             exercise price
----------------        ---------------   -------------         --------------       ---------------        --------------
<S>                            <C>              <C>                  <C>                    <C>                   <C>  
$0.10 - 0.15                     101            4.8                  $0.13                   99                   $0.13
$0.38 - 0.77                      94            9.5                   0.39                    7                    0.39
$1.00 - 2.00                     832            8.5                   1.28                  402                    1.07
$3.50 - 6.00                     491            9.2                   5.10                  174                    4.82
                              ------                                                        ---
                               1,518            8.7                  $2.39                  682                   $1.88
                               =====                                                        ===
</TABLE>

Pro Forma Information

         The Company has elected to follow APB 25 and related interpretations in
accounting for its stock options  because,  as discussed  below, the alternative
fair  value  accounting  provided  for  under  SFAS 123  requires  use of option
valuation models that were not developed for use in valuing stock options. Under
APB 25, when the exercise price of the Company's stock options equals the market
price of the underlying stock on the date of the grant, no compensation  expense
is recognized.

         Pro  forma  information  regarding  net loss and net loss per  share is
required by SFAS 123, 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 fair value for these  options was estimated at the
date of grant using a Black-Scholes option pricing model for the multiple option
approach with the following  weighted-average  assumptions: a risk-free interest
rate of 6.26%  and  6.36%  for 1995 and 1996  respectively,  a  weighted-average
expected  life of 4.4 years for 1995  grants and 4.1 years for 1996  grants;  an
expected dividend yield of zero for both years. The Company believes that due to
the low  trading  volume of Lynx stock,  particularly  in 1995,  the  calculated
volatility of the expected  market price of the Company's  Common Stock does not
provide a representative picture of future volatility. Consequently, an industry
average volatility of 73% was used in the calculations.

         The  Black-Scholes  option  valuation  model was  developed  for use in
estimating the fair value of traded  options which 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 estimate,  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.

                                      30.

<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


6.       Stockholders' Equity  (continued)


         For purposes of pro forma disclosures,  the estimated fair value of the
options is amortized to pro forma net loss over the options' vesting period. The
Company's historical and pro forma information follows (in thousands, except for
net loss per share information):


                                                  Years Ended
                                                 December 31,
                                            1996              1995
                                            ----------------------
                                                 (in thousands)
Net loss
         Historical                         $5,391          $11,468
         Pro forma                          $5,940          $11,665

Net loss per share
         Historical                          $2.19            $5.00
         Pro Forma                           $2.41            $5.09

         Because SFAS 123 is applicable  only to options  granted  subsequent to
December  31,  1994,  future pro forma net income and  earnings/loss,  per share
results may be materially different from actual amounts presented.

Warrants

         As of December  31, 1996,  warrants to purchase  6,300 shares of Common
Stock were  outstanding at an exercise  price of $12.50 per share.  The warrants
expired on February 14, 1997.

7.       Income Taxes

         The Company  accounts  for income taxes under the  Statement  Financial
Accounting  Standards  No. 109,  "Accounting  for Income  Taxes."  Lynx's losses
through November 20, 1992 were included in the  consolidated  income tax returns
of ABI or ABI's  parent  (Perkin  Elmer  Corporation).  As a result,  Lynx's net
operating loss  carryforwards  available to offset future taxable income consist
only of losses incurred after November 20, 1992.

         The  provision  for  income  taxes for 1996 in the  amount  of  $10,000
consists entirely of alternative minimum tax.

         As of  December  31,  1996,  the  Company  has  federal  and state loss
carryforwards of approximately $20.3 million and $1.2 million, respectively. The
Company  also  has  federal  and  state  research  and  development  tax  credit
carryforwards of approximately $634,000 and $297,000,  respectively. The federal
net  operating  loss and federal and state credit  carryforwards  will expire at
various dates  beginning in the years 2007 through  2010,  if not utilized.  The
state net operating loss will expire in 2000, if not utilized.

         Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change  limitations  provided
by the Internal  Revenue Code of 1986 and similar state  provisions.  The annual
limitation  may result in the  expiration  of net  operating  losses and credits
before utilization.

         The  federal  net  operating   loss   carryforwards   differ  from  the
accumulated  deficit  principally due to losses incurred while the Company was a
division of ABI, and timing  differences in the  recognition of certain  expense
items for financial and federal tax reporting purposes,  consisting primarily of
certain  accrued  expenses  that are not  currently  deductible  for  income tax
purposes.


                                      31.
<PAGE>

                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)

7.       Income Taxes (continued)

         Deferred income taxes reflect the tax effects of net operating loss and
credit  carryforwards and of temporary  differences between the carrying amounts
of assets and liabilities for financial reporting and the amount used for income
tax purposes.

<TABLE>

         Significant components of the Company's deferred tax assets for federal
and state income taxes as of December 31 are as follows:

<CAPTION>

                                                                      1996                 1995
                                                                    ---------------------------
                                                                            (In thousands)
<S>                                                                 <C>                <C>     
    Deferred tax assets:
    Net operating losses                                            $  6,980           $  6,837
    Research and development credit carryforwards                        830                669
    Capitalized research and development expenditures                  1,031              1,197
    Deferred revenue                                                   2,475                 --
    Other                                                                241                 81
    Valuation allowance                                              (11,557)            (8,784)
                                                                  ------------------------------
                                                                    $      -            $  --
                                                                  ==============================
</TABLE>

         The change in  valuation  allowance  was a net increase of $2.8 million
and $3.2 million in 1996 and 1995, respectively.

                                      32.

<PAGE>


                             Lynx Therapeutics, Inc.
             Notes to Consolidated Financial Statements (continued)


8.       Obligations under Operating Leases

         The Company entered into a noncancelable operating lease for facilities
which commenced on August 1, 1993 and expires on July 31, 2003.  Under the terms
of the lease,  rental  payments  commenced  in the third  month of the lease and
increase on a graduated scale beginning with the second year of the lease as the
Company occupies  additional space. The Company is recognizing rent expense on a
straight-line method over the lease period. The Company has the option to extend
the lease for two  additional  periods of five years each,  with  payments to be
determined when the option is exercised. The Company also leases equipment under
various operating lease agreements subject to minimum annual lease payments.

         Minimum  annual  rental  commitments  under  operating  leases  are  as
follows:

                                                               (in thousands)
                 Years ending December 31:
                 1997                                            $    578
                 1998                                                 539
                 1999                                                 560
                 2000                                                 560
                 2001                                                 561
                 Thereafter                                           783
                                                                 --------
                                                                 $  3,581
                                                                 ========

         Rent expense for facilities and equipment  under  operating  leases was
$676,000  $637,000 and $424,000 for the years ended December 31, 1996,  1995 and
1994, respectively.

9.       401(k) Plan

         In  October  1992,  Lynx  adopted  a 401(k)  Plan  covering  all of its
employees.  The 401(k) Plan is intended to qualify under Section 401 of the Code
so that contributions by employees or by Lynx to the 401(k) Plan are not taxable
to employees until withdrawn from the 401(k) Plan, and so that  contributions by
Lynx, if any, will be deductible by Lynx when made. Pursuant to the 401(k) Plan,
employees may elect to reduce their current  compensation  by up to 15% (subject
to an annual  limit  prescribed  by the Code as  described  below)  and have the
amount of such  reduction  contributed  to the 401(k)  Plan.  Under  limitations
imposed by the Code, the maximum amount of compensation  reduction a participant
could elect to have  contributed  to the 401(k) Plan for the 1996  calendar year
was $9,500.  This amount is subject to annual  adjustments  for increases in the
cost of living,  as determined under Internal Revenue Service  regulations.  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.



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

         Not applicable.

                                      33.
<PAGE>


                                    PART III

<TABLE>

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The Company's executive officers,  directors and certain employees, and
their ages as of December 31, 1996 are as follows:

<CAPTION>

                NAME                         AGE                             POSITION
      ------------------------------        ----       ---------------------------------------------------
<S>                                          <C>       <C>                                                   
      Sam Eletr, Ph.D.                       57        Chief Executive Officer and Chairman of the Board
      Timothy G. Geiser, Ph.D.               54        Vice President, Business Development
      Stephen C. Macevicz, Ph.D.             47        Vice President, Intellectual Property
      Karoly Nikolich, Ph.D.                 48        Vice President, Research
      Gerald Zon, Ph.D.                      51        Vice President, Medicinal Chemistry
      William K. Bowes, Jr.(2)               70        Director
      Sydney Brenner, M.B., D. Phil.         69        Director
      James C. Kitch(2)                      49        Director
      Kathleen D. La Porte(1)                35        Director
      Craig C. Taylor(1)                     46        Director and Acting Chief Financial Officer
<FN>
---------------------
(1)      Member of Compensation Committee
(2)      Member of Audit Committee
</FN>
</TABLE>

         Dr.  Eletr has served as  Chairman  of the Board of the  Company  since
February 1992 and resumed the position of Chief Executive Officer of the Company
in November 1996, a position he held from February 1992 through January 1996. In
1981, Dr. Eletr founded Applied  Biosystems,  Inc.,  ("ABI"),  a manufacturer of
instruments and consumables for life science research and related  applications,
now a  wholly-owned  subsidiary  of  Perkin  Elmer  Corporation,  and  served as
Chairman of the Board of  Directors  and in various  executive  positions at ABI
from its inception until March 1987. Dr. Eletr acted as a consultant to ABI from
September  1990 until July 1992,  during  which time he  undertook to assume the
leadership of the Company.

         Dr. Geiser has served as Vice President,  Business  Development of Lynx
since May 1996 and Vice President,  Manufacturing  and Operations from July 1992
to May 1996.  Prior to that time, he was a Senior Scientist of ABI from May 1981
to July 1992 where he had earlier  directed DNA chemistry and peptide  chemistry
R&D  activities  and  later  joined  with  Dr.  Zon in  1987  to  co-direct  the
establishment of the DNA  Therapeutics  Group which led to the formation of Lynx
Therapeutics,  Inc. He received  his Ph.D.  in Organic  Chemistry  from  Cornell
University.

         Dr.  Macevicz  joined the Company in September 1995, as Vice President,
Intellectual Property. He was Senior Patent Attorney and chief patent counsel of
ABI from  1992 to  August  1995 and,  prior to that,  from 1986 to 1992,  Patent
Counsel of DNAX Research Institute of Molecular and Cellular Biology, a research
subsidiary  of  Schering-Plough  Corporation.  He  received  his law degree from
University  of  California,  Berkeley  (Boalt  Hall)  in 1984 and his  Ph.D.  in
Biophysics from the University of California, Berkeley in 1979.

         Dr.  Nikolich  has served as Vice  President,  Research  of the Company
since  November 1996 and was Vice  President,  Biological  Research from October
1995 to November 1996.  Prior to that time he was a Senior Scientist and Head of
the Neuroscience  Research  Program at Genentech,  Inc. from 1989 to 1995, and a
scientist from 1985 to 1989. Dr. Nikolich  established the neuroscience  program
at Genentech and is a widely  published  and  recognized  expert in  neurotropic
factor  research.  After  receiving  his  doctorate  from Eotvos  University  of
Budapest,  he was a  postdoctoral  fellow at Tulane  University  and a  visiting
scientist at the Hormone  Research  Laboratory,  University of  California,  San
Francisco.

                                      34.
<PAGE>


         Dr. Zon has served as Vice President,  Medicinal  Chemistry and Head of
Quality  Control and  Regulatory  Affairs of Lynx since  January  1993.  Dr. Zon
joined Lynx in July 1992.  Prior to that time, he served as Senior  Scientist at
ABI  from  November  1986  to  July  1992,   and  directed  the  Food  and  Drug
Administration's Pharmacology Laboratory from 1981 to 1986. Dr. Zon received his
Ph.D.  in  Organic  Chemistry  from  Princeton  University,  and  has  over  200
publications in the areas of organic, medicinal and oligonucleotide chemistry.

         Mr. Bowes has served as a director of the Company  since March 1994. He
has  been a  general  partner  of  U.S.  Venture  Partners,  a  venture  capital
partnership,  since 1981. He currently serves as a director of Amgen, Inc., XOMA
Corporation  and a number of U.S.  Venture  Partners'  privately owned portfolio
companies.

         Dr. Brenner has served as a director of the Company since October 1993.
In July 1996 he was  appointed  the  Director  and  President  of the  Molecular
Sciences Institute, a non-profit research institute in La Jolla, California.  In
September  1996 he retired  from his  position of Honorary  Professor of Genetic
Medicine,  University of Cambridge Clinical School.  From 1986 to his retirement
in 1991, Dr.  Brenner  directed the Medical  Research  Council Unit of Molecular
Genetics.  He was a  member  of the  Scripps  Research  Institute  in La  Jolla,
California until December 1994.

         Mr. Kitch has served as a director of the Company  since  February 1993
and  Secretary of Lynx since  February  1992.  He was a director of ABI,  Lynx's
predecessor,  from  August  1986 to  February  1993.  He is a partner  at Cooley
Godward LLP, a law firm which has provided legal services to the Company.

         Ms. La Porte has served as a director of the Company  since March 1994.
She is a general partner of the Sprout Group,  the venture capital  affiliate of
Donaldson,  Lufkin and Jenrette. From 1987 to 1993, Ms. La Porte was a principal
at  Asset  Management  Company.  She  currently  serves  as a  director  of Onyx
Pharmaceuticals, Inc., Fem Rx, Inc. and several private companies.

         Mr. Taylor has served as a director of the Company since March 1994 and
Acting Chief  Financial  Officer  since July 1994. He has been active in venture
capital  since 1977 when he joined  Asset  Management  Company.  He is a general
partner of AMC Partners 89 L.P.,  which  serves as the general  partner of Asset
Management  Associates  1989 L.P., a private  venture  capital  partnership.  He
currently serves as a director of Metra BioSystems,  Inc.,  Pharmacyclics,  Inc.
and several private companies.

         Pursuant to the terms of the  Shareholders  Agreement  between Lynx and
Applied Biosystems,  Applied Biosystems has the right to nominate one member for
election to the Board of Directors of Lynx as long as it holds at least  200,000
shares of Lynx Common Stock. No nominee of Applied  Biosystems  currently serves
on the Board of Directors.

Compliance with the Reporting Requirements  of Section 16(a)

         Section 16(a) of the Exchange Act requires the Company's  directors and
executive  officers,  and  persons  who own  more  than ten  percent  (10%) of a
registered class of the Company's equity  securities,  to file with the Security
and Exchange  Commission  ("SEC")  initial  reports of ownership  and reports of
changes in ownership of Common Stock and other equity securities of the Company.
Officers, directors and greater than ten percent (10%) stockholders are required
by SEC  regulation to furnish the Company with copies of all Section 16(a) forms
they file.

         To the Company's  knowledge,  based solely on a review of the copies of
such reports  furnished to the Company,  during the calendar year ended December
31, 1996,  all Section  16(a) filing  requirements  applicable  to its officers,
directors  and greater than ten percent  (10%)  beneficial  owners were complied
with, except for Mr. Taylor's  acquisition of 239 shares through the exercise of
a stock option which was reported late.

                                      35.

<PAGE>

<TABLE>

ITEM 11. EXECUTIVE COMPENSATION

         The following table sets forth certain compensation paid by the Company
during the calendar  year ended  December 31, 1996,  1995 and 1994, to its Chief
Executive Officer and each of the four other most highly  compensated  executive
officers whose compensation exceeded $100,000 (the "Named Executive Officers"):

<CAPTION>

                           Summary Compensation Table

                                                                                  Long Term
                                                                                Compensation
                                                                                   Awards
                                                                                -------------
                                                                                 Securities
                                                                Annual           Underlying               All Other
Name and Principal Position                      Year         Salary($)(1)       Options (#)           Compensation($)
----------------------------                     ----         ------------      -------------          ---------------
<S>                                              <C>          <C>                     <C>                 <C>       
Sam Eletr, Ph.D.                                 1996         176,121                  32,500                    0
   Chief Executive Officer and                   1995         170,484                 105,000                    0
   Chairman of the Board                         1994         160,990                  80,000                    0

David W. Martin, Jr., M.D.(2)                    1996         206,229                  32,500             158,612(3)
   President and Chief                           1995         133,713(4)              250,000                 750(5)
   Executive Officer                             1994               0                       0                    0

Timothy G. Geiser, Ph.D.                         1996         153,818                       0                 750(5)
   Vice President, Business                      1995         142,674                  60,000                 750(5)
   Development                                   1994         132,176                  60,000                 750(5)

Karoly Nikolich, Ph.D.                           1996         150,210                  30,000                 750(5)
   Vice President, Research                      1995          37,085(6)               70,000                    0
                                                 1994               0                       0                    0

Gerald Zon, Ph.D.                                1996         154,168                       0                 750(5)
   Vice President, Medicinal Chemistry           1995         143,130                  60,000                 750(5)
                                                 1994         132,468                  60,000                 750(5)

<FN>

(1)      Includes amounts earned but deferred at the election of the Named Executive Officer pursuant to the Company's 401(k) Plan.

(2)      Dr. Martin terminated  his  relationship  with the Company in November 1996.  The Company will continue to pay Dr. Martin's
         annual base salary for a period of time not to exceed (12) months pursuant to the terms of the Separation Agreement between
         the Company and Dr. Martin.

(3)      Includes  $157,862 in principal and accrued interest due on the line of credit that was forgiven as part of the Separation 
         Agreement. Also includes $750 in contributions made by the Company to the Company's 401(k) Plan on behalf of such employee.

(4)      Dr. Martin joined the Company in May 1995.  The 1995 annual salary represents a partial year and is not comparable to 1996.

(5)      Contributions made by the Company to the Company's 401(k) Plan on behalf of such employee.

(6)      Dr. Nikolich joined the Company in October 1995.  The 1995 annual salary represents a partial year and is not comparable to
         1996.
</FN>
</TABLE>
                                      36.

<PAGE>

         Except as disclosed  above, no compensation  characterized as long-term
compensation,  including  restricted  stock awards  issued at a price below fair
market  value or  long-term  incentive  plan  payouts,  were paid by the Company
during the year ended December 31, 1996, to any of the Named Executive Officers.

1992 Stock Option Plan

         In June  1992,  Lynx  adopted  the 1992  Stock  Option  Plan (the "1992
Plan"),  under which  400,000  shares,  less any shares of Lynx's  Common  Stock
remaining outstanding which were originally issued to employees, officers of, or
consultants  to Lynx pursuant to Stock  Purchase  Agreements  approved by Lynx's
Board of  Directors,  were  initially  reserved  for issuance  upon  exercise of
options  granted to employees  and  consultants  of Lynx or its  affiliates.  In
January 1995 and May 1996, the stockholders approved amendments to the 1992 Plan
to  increase  the  number of shares  reserved  for  issuance  to  1,400,000  and
2,100,000, respectively In May 1996, the stockholders also approved an amendment
to the 1992 Plan to  extend  the term of the Plan to March  2006.  The 1992 Plan
provides for the grant of both  incentive  stock options  intended to qualify as
such under  Section 422 of the  Internal  Revenue  Code of 1986 (the "Code") and
nonstatutory  stock options,  which are options that do not qualify as incentive
stock options.

         In November  1996,  pursuant  to the  Agreement  of Merger  between the
Company and Spectragen,  options to purchase 403,350 shares of Spectragen Common
Stock were assumed by the Company and converted into options to purchase 524,355
shares of Lynx Common Stock.

         The 1992 Plan is administered by the Board of Directors. Subject to the
provision of the 1992 Plan, the Board has the authority to select the persons to
whom grants are to be made,  to designate  the number of shares to be covered by
each option,  to determine  whether an option is an incentive  stock option or a
nonstatutory stock option, to establish vesting  schedules,  to specify the type
of  consideration  to be paid to Lynx upon exercise or purchase and,  subject to
certain restrictions, to specify other terms.

         The maximum term of options  granted  under the 1992 Plan is ten years.
The  aggregate  fair market value of the stock with  respect to which  incentive
stock  options  are  first  exercisable  in any  calendar  year  may not  exceed
$100,000. Options granted under the 1992 Plan generally are non-transferable and
expire  three  months  after  the  termination  of  any  optionee's  employment,
directorship or consulting  relationship with Lynx. However, in general, if such
termination  of  employment  is  due  to  the  optionee's  permanent  and  total
disability,  such person's option may be exercised up to one year following such
disability,  and if such  termination  of  employment  is due to the  optionee's
death,  such  person's  option  may be  exercised  up to  eighteen  (18)  months
following death.

         The exercise price of incentive stock options must be at least the fair
market  value of the Common Stock on the date of grant.  The  exercise  price of
nonstatutory  stock options must be at least 85% of the fair market value of the
Common Stock on the date of grant.  The exercise price of options granted to any
person who at the time of grant owns stock possessing more than 10% of the total
combined  voting power of all classes of stock must be at least 110% of the fair
market value of such stock on the date of grant,  and the term of these  options
cannot exceed five years. Shares covered by currently  outstanding options under
the 1992 Plan  typically  vest over a  five-year  period  following  the date of
grant.

                                      37.
<PAGE>


Stock Option Grants and Exercises

<TABLE>

Option Grants in the Year Ended December 31, 1996

         The  following  table  sets  forth,  for  each of the  Named  Executive
Officers  in the  Summary  Compensation  Table,  certain  information  regarding
options granted during the year.

<CAPTION>

                        OPTION GRANTS IN LAST FISCAL YEAR

                                                                                                    Potential Realizable
                                                                                                      Value at Assumed
                                                                                                    Annual Rates of Stock
                                                                                                   Price Appreciation
                                                      Individual Grants                              for Option Term(4)
                                   ------------------------------------------------------------    ------------------------
                                                     % of Total
                                     Number of         Options
                                    Securities       Granted to
                                    Underlying        Employees   Exercise or
                                      Options         in Fiscal   Base Price     Expiration    
         Name                        Granted (1)      Year (2)     ($/sh)(3)        Date              5%($)        10%($)
----------------------               -----------      --------     ---------    -------------      -----------     ------
<S>                                    <C>               <C>         <C>          <C>               <C>           <C>
Sam Eletr, Ph.D.                         32,500          3.78%       $1.54        08/06/2006        $373,463      $624,323
                                                                                                                
David W. Martin, Jr., M.D.               32,500(5)                                                               
                                                                                                                
Timothy G. Geiser, Ph.D.                     --                                                                 
                                                                                                                
Karoly Nikolich, Ph.D.                   30,000          3.49%       $4.00        11/18/2006         $75,467      $191,249
                                                                                                              
Gerald Zon, Ph.D.                            --

<FN>

(1)      Officers of the Company were granted the right to exercise their options prior to vesting,  subject to the Company's right
         of repurchase at the original issue price,  which lapses ratably over five years.  Options granted generally vest over a
         five-year period.  The term of the options is ten years.

(2)      Based on an aggregate of 859,858 options granted to employees of and consultants to the Company during the year ended 
         December 31, 1996, including the Named Executive Officers.

(3)      The exercise price per share of each option is equal to the fair market value as determined by the Board of Directors, 
         except for the grants pursuant to the Merger,  the exercise price is the original Spectragen grant price, as adjusted 
         pursuant to the terms of the Agreement of Merger.

(4)      The potential  realizable  value is calculated based on the term of the option at its time of grant (ten years).  It is
         calculated by assuming that the fair market value of the stock as determined by the Board of Directors on the date of grant
         appreciated  at the  indicated  annual rate  compounded  annually  for the entire term of the option and that the option is
         exercised and sold on the last day of its term for the appreciated  stock price.  These amounts  represent  certain assumed
         rates of  appreciation  only,  in  accordance  with the rules of the SEC,  and do not  reflect  the  Company's  estimate or
         projection of future stock price  performance.  Actual gains, if any, are dependent on the actual future performance of the
         Company's Common Stock and no gain to the optionee is possible unless the stock price increases over the option term, which
         will benefit all stockholders.

(5)      Dr. Martin's shares were canceled in November 1996 due to the termination of his relationship with the Company.
</FN>
</TABLE>

                                       38.
<PAGE>

<TABLE>

                  AGGREGATED OPTION EXERCISES IN THE YEAR ENDED
                       DECEMBER 31, 1996 AND OPTION VALUES

         The  following  table  sets  forth,  for  each of the  Named  Executive
Officers in the Summary  Compensation  Table,  the shares acquired and the value
realized  on each  exercise  of stock  options  during  the year and  number  of
unexercised options:

<CAPTION>
                                                                                                            Value of     
                                                                                    Number of              Unexercised   
                                                                                   Unexercised            In-the-Money   
                                                                                     Options               Options at    
                                                                                   at Year-End           Year-End ($)(1) 
                                     Shares                                     -----------------        ----------------
                                   Acquired on              Value                 (Exercisable/           (Exercisable/
         Name                      Exercise(#)         Realized($)(1)           Unexercisable)(2)        Unexercisable)
---------------------------        ------------        --------------           -----------------        ----------------
<S>                                 <C>                   <C>                         <C>                      <C>         
Sam Eletr, Ph.D.                    130,000(3)             630,500                    217,500/0                489,950/0

David W. Martin, Jr., M.D.             --                     --                           --                       --

Timothy G. Geiser, Ph.D.               --                     --                      123,500/0                288,150/0

Karoly Nikolich, Ph.D.                 --                     --                       40,000/0                  5,000/0

Gerald Zon, Ph.D.                      --                     --                      130,750/0                311,925/0
<FN>
------------------
(1)      Represents  the fair market value of the  Company's  Common Stock on the date of exercise,  as  determined  by the Board of
         Directors, minus the exercise price of the option, multiplied by the number of shares underlying the option.

(2)      Includes unvested shares from grants which allow exercises of unvested shares.

(3)      Shares exercised are subject to a Stock Purchase Agreement between the optionee and the Company.  The shares are subject to
         repurchase by the Company at the original  purchase price in the event of  termination  of  employment.  The shares will be
         released from the Company's repurchase option ratably over a five year period.
</FN>
</TABLE>

Compensation of Directors

         Directors are not compensated by the Company for service as directors.

Compensation Committee Interlocks and Insider Participation

         The Company's  Compensation  Committee was  established  in March 1994.
There  were  no  officers  or  employees  of the  Company  who  participated  in
deliberations  of the  Company's  Compensation  Committee  concerning  executive
officer compensation during the year ended December 31, 1996.

Limitations of Liability and Indemnification

         The  Company's  Bylaws  provide  that the Company  will  indemnify  its
directors and executive officers and may indemnify its other officers, employees
and other agents to the fullest extent permitted by Delaware law. The Company is
also empowered  under its Bylaws to enter into  indemnification  agreements with
its  directors  and officers  and to purchase  insurance on behalf of any person
whom it is required or permitted to 


                                       39.
<PAGE>

indemnify.  Pursuant to this  provision,  the Company has entered into indemnity
agreements with each of its directors and executive officers.

         In addition,  the Company's Certificate of Incorporation provides that,
to the fullest  extent  permitted by Delaware law, the Company's  directors will
not be liable for monetary  damages for breach of the directors'  fiduciary duty
of care to the Company and its  stockholders.  This provision in the Certificate
of  Incorporation  does  not  eliminate  the duty of  care,  and in  appropriate
circumstances,  equitable  remedies  such as an  injunction  or  other  forms of
nonmonetary relief would remain available under Delaware law. Each director will
continue to be subject to liability for breach of the director's duty of loyalty
to the Company, for acts or omissions not in good faith or involving intentional
misconduct or knowing violations of law, for acts or omissions that the director
believes  to  be  contrary  to  the  best   interests  of  the  Company  or  its
stockholders,  for any transaction  from which the director  derived an improper
personal benefit,  for acts or omissions  involving a reckless disregard for the
director's duty to the Company or its  stockholders  when the director was aware
or should  have been  aware of a risk of  serious  injury to the  Company or its
stockholders,  for acts or omissions  that  constitute  an unexcused  pattern of
inattention  that amounts to an abdication of the director's duty to the Company
or its  stockholders,  for  improper  transactions  between the director and the
Company and for improper  distributions  to stockholders  and loans to directors
and officers. This provision also does not affect a director's  responsibilities
under any other  laws such as the  federal  securities  laws or state or federal
environmental laws.

         No pending  material  litigation  or  proceeding  involving a director,
officer,  employee or other agent of the Company as to which  indemnification is
being sought  exists,  and the Company is not aware of any pending or threatened
material  litigation  that may  result  in  claims  for  indemnification  by any
director, officer, employee or other agent.


                                      40.

<PAGE>

<TABLE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth certain information regarding beneficial
ownership of each class of the  Company's  voting stock as of February 28, 1997,
by (i) each  stockholder  who is known by the Company to own  beneficially  more
than 5% of the Common Stock;  Series B Preferred Stock; Series C Preferred Stock
and Series D Preferred Stock;  (ii) each Named Executive Officer of the Company;
(iii)  each  director  of the  Company;  and (iv) all  directors  and  executive
officers  of the  Company as a group.  All Series D  Preferred  Stock is held by
Hoechst  Marion  Roussel as  reflected in the Common Stock table and as noted in
footnote (5).
<CAPTION>

                                                                            Series B                    Series C
                                           Common Stock(1)             Preferred Stock(1)         Preferred Stock(1)
Name and Address                      ----------------------        ----------------------      -----------------------
of Beneficial Owners                   Number      Percent(2)        Number      Percent(2)      Number      Percent(2)
--------------------                   ------      ----------        ------      ----------      ------      ----------
<S>                                       <C>          <C>             <C>          <C>             <C>         <C>  
Entities affiliated with the
     Sprout Group(3)                      729,980      18.9%           49,999       15.0%           22,999      18.7%
     3000 Sand Hill Road
     Building 4, Suite 270
     Menlo Park, CA  94025


Entities affiliated with
     U.S. Venture Partners IV, L.P.(4)    730,000      18.9%           50,000       15.0%           23,000       18.7%
     2180 Sand Hill Road
     Suite 300
     Menlo Park, CA  94025

Cannon Street Fund Ltd.                   565,000      15.3%           40,000       12.0%           16,500       13.4%
     c/o Meridian Venture Group
     R.R. Box 272
     Charlottesville, VA  22314

Biotechnology Investments Limited         545,000      14.8%           40,000       12.0%           14,500       11.8%
     c/o Old Court Limited
     P.O. Box 58
     St. Julian's Court
     St. Peter Port
     Guernsey, Channel Islands

Singapore Bio-Innovations Pte, Ltd.       420,000      11.8%           42,000       12.6%                0          **
     250 North Bridge Road
     24-00 Raffles City Tower
     Singapore  0617

Hoechst Marion Roussel(5)                 400,000      11.3%                0          **                0          **
     9300 Ward Parkway
     Kansas City, MO  64114

Asset Management Associates               360,000      10.3%           36,000       10.8%                0          **
  1989 L.P.(6)
     2275 East Bayshore Rd., #150
     Palo Alto, CA  94303

Applied Biosystems a Division of          353,800      10.7%                0          **                0          **
  Perkin Elmer Corporation(7)
     850 Lincoln Centre Drive
     Foster City, CA  94404

Chiron Corporation                        300,000       9.6%                0          **                0          **
     4360 Horton Street
     Emeryville, CA  94608
</TABLE>

                                      41.
<PAGE>

<TABLE>
<CAPTION>

                                                                            Series B                    Series C
                                           Common Stock(1)             Preferred Stock(1)           Preferred Stock(1)
Name and Address                          -----------------          -------------------           -------------------
of Beneficial Owners                       Number Percent(2)           Number  Percent(2)           Number  Percent(2)
----------------------------------         ------ ---------           -------- -----------         -------- ----------
<S>                                       <C>           <C>            <C>           <C>            <C>          <C>  
Entities affiliated with
     Partech International(8)             300,000       8.7%           15,000        4.5%           15,000       12.2%
     101 California Ave., Suite 3150
     San Francisco, CA  94111

New York Life Insurance Company           270,000       7.9%           20,000        6.0%            7,000        5.7%
     51 Madison Avenue, Room 203
     New York, NY  10010

Becton Dickinson & Company                233,689       7.4%                0          **                0          **
     One Becton Drive
     Franklin Lakes,  NJ  07417

Sam Eletr, Ph.D.(9)                       413,759      12.3%                0          **                0          **

William K. Bowes, Jr.(10)                 747,721      19.3%           50,000       15.0%           23,000       18.7%

Sydney Brenner, M.D., D. Phil.(11)        275,375       8.7%                0          **                0          **

Timothy G. Geiser(12)                     160,327       4.9%                0          **                0          **

James C. Kitch(13)                         15,818         **              700          **              300          **

Kathleen D. La Porte(3)                   729,980      18.9%           49,999       15.0%           22,999       18.7%

David W. Martin, Jr., M.D.                 92,500       2.9%                0          **                0          **

Karoly Nikolich, Ph.D.(14)                100,000       3.1%                0          **                0          **

Craig C. Taylor(15)                       371,499      10.6%           36,000       10.8%                0          **

Gerald Zon, Ph.D.(16)                     160,806       4.9%                0          **                0          **

All directors and officers              3,175,303      57.0%          136,699       41.1%           46,299       37.6%
     as a group (11 persons)(17)

<FN>

**Less than one percent.

(1)      Except as otherwise noted, and subject to community property laws where
         applicable,  each  person or entity  named in the table has sole voting
         and investment  power with respect to all shares shown as  beneficially
         owned by him, her or it. Beneficial  ownership of Common Stock reflects
         beneficial  ownership of Series B Preferred  Stock,  Series C Preferred
         Stock and Series D  Preferred  Stock as set forth in the table or, with
         respect to Hoechst Marion Roussel, as set forth in footnote (5).

 (2)     Percentage of beneficial  ownership is based on 3,140,672 shares of the
         Company's  Common  Stock,  332,288  shares  of the  Company's  Series B
         Preferred  Stock,  123,299  shares of the Company's  Series C Preferred
         Stock and  40,000  shares of the  Company's  Series D  Preferred  Stock
         outstanding as of February 28, 1997,  except as otherwise  noted in the
         footnotes.  The  Series B,  Series C and  Series D  Preferred  Stock is
         convertible into Common Stock on a ten-for-one basis.

 (3)     Includes 49,999 shares of Series B Preferred Stock and 22,999 shares of
         Series C Preferred Stock held by entities affiliated with Sprout Group.
         Ms. La Porte,  a director of the Company,  is a general  partner of the
         Sprout  Group,  an entity  affiliated  with Sprout  Capital VI,  Sprout
         Capital VII and DLJ Capital.  Ms. La Porte shares the power to vote and
         control the  disposition  of shares held by Sprout  Capital VI,  Sprout
         Capital  VII and DLJ  Capital  and  therefore  may be  deemed to be the
         beneficial  owner of such  shares.  Ms. La Porte  disclaims  beneficial
         ownership of such shares,  except to the extent of her prorata interest
         therein.

                                      42.
<PAGE>


(4)      Includes 50,000 shares of Series B Preferred Stock and 23,000 shares of
         Series C Preferred Stock held by entities  affiliated with U.S. Venture
         Partners IV, L.P. ("U.S.V.P. IV") Mr. Bowes, a director of the Company,
         is a general  partner of  Presidio  Management  Group IV,  the  general
         partner of U.S.V.P.  IV. Mr. Bowes shares the power to vote and control
         the  disposition  of shares held by U.S.V.P.  IV and  therefore  may be
         deemed to be the beneficial  owner of such shares.  Mr. Bowes disclaims
         beneficial  ownership  of such  shares,  except  to the  extent  of his
         prorata interest therein.

(5)      Consists  solely of 40,000  shares of Series D Preferred  Stock,  which
         constitutes 100% of the shares of Series D Preferred Stock outstanding.

(6)      Includes  36,000  shares  of  Series B  Preferred  Stock  held by Asset
         Management  Associates  1989 L.P.  ("Asset 1989 L.P.").  Mr. Taylor,  a
         director of the Company, is a general partner of AMC Partners 89, which
         is the general  partner of Asset 1989 L.P. Mr.  Taylor shares the power
         to vote and control the  disposition  of shares held by Asset 1989 L.P.
         and therefore may be deemed to be the beneficial  owner of such shares.
         Mr. Taylor disclaims beneficial ownership of such shares, except to the
         extent of his prorata interest therein.

(7)      Includes  152,400 shares of Common Stock issuable upon exercise of Lynx
         option held by Applied Biosystems that is exercisable immediately.

(8)      Includes  15,000  shares of Series B Preferred  Stock and 15,000 shares
         Series C  Preferred  Stock held by  entities  affiliated  with  Partech
         International.

(9)      Includes  217,500 shares of Common Stock issuable upon exercise of Lynx
         stock options held by Dr. Eletr that are exercisable within 60 days.

(10)     See Note 4 above.  Common  Stock  amount  also  includes  608 shares of
         Common Stock  issuable upon exercise of Perkin Elmer Option held by Mr.
         Bowes that are fully vested and exercisable.

(11)     Includes  15,375 shares of Common Stock  issuable upon exercise of Lynx
         stock  options held by Sydney  Brenner that are  exercisable  within 60
         days.

(12)     Includes  123,500 shares of Common Stock issuable upon exercise of Lynx
         stock options held by Dr. Geiser that are  exercisable  within 60 days.
         Also  includes 4 shares of Common Stock held of record by Dr.  Geiser's
         wife, to which shares Dr. Geiser disclaims beneficial ownership.

(13)     Includes  700  shares of  Series B  Preferred  Stock and 300  shares of
         Series  C  Preferred  Stock  held by GC&H  Investments,  an  investment
         partnership  of which Mr.  Kitch is a general  partner.  Also  includes
         3,833 shares of Common Stock  issuable  upon the exercise of Lynx stock
         option  held by Mr.  Kitch on behalf  of GC&H  Investments.  Mr.  Kitch
         shares the power to vote and control the disposition of such shares and
         therefore may be deemed to be the beneficial owner of such shares.  Mr.
         Kitch  disclaims  beneficial  ownership of such  shares,  except to the
         extent of his prorata interest therein.

(14)     Includes  40,000 shares of Common Stock  issuable upon exercise of Lynx
         stock options held by Dr. Nikolich that are exercisable within 60 days.

(15)     See Note 6 above.  Common  Stock amount also  includes  1,000 shares of
         Series C  Preferred  Stock held by Mr.  Taylor and 369 shares of Common
         Stock  issuable  upon  exercise of Perkin  Elmer  Option that are fully
         vested and exercisable.

(16)     Includes  130,750 shares of Common Stock issuable upon exercise of Lynx
         stock options held by Dr. Zon that are exercisable within 60 days. Also
         includes  105 shares of Common  Stock held of record by Dr.  Zon's wife
         and 64 shares of Common Stock  issuable  upon  exercise of Perkin Elmer
         Options held by Dr.  


                                      43.
<PAGE>

         Zon's wife that are fully  vested and  exercisable,  as to which shares
         Dr. Zon disclaims beneficial ownership.

(17)     Common Stock amount includes  1,839,980 shares of Series B and Series C
         Preferred Stock (common  equivalent)  held by entities  affiliated with
         certain  directors  and 585,999  shares of Common Stock  issuable  upon
         exercise of the  Company's  stock options and Perkin Elmer Options held
         by directors  and officers  that are  exercisable  within 60 days.  See
         Notes 9 through 16 above.
</FN>
</TABLE>


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Corporate  Collaborations

         See Item 1. Business and Note 3. of the Notes to Consolidated Financial
Statements.

         In 1992, ABI  distributed all but an aggregate of 299,800 shares of the
Lynx  Common  Stock  it  held  to  its  shareholders  (the  "Distribution").  In
connection with this  transaction,  Lynx granted ABI an option to purchase up to
215,900  shares of Lynx Common Stock at $0.10 per share which,  prior to October
1996, may only be exercised by ABI in connection with the distribution by ABI of
Lynx  stock  to its  option  holders  upon the  exercise  of ABI  stock  options
outstanding  as of  the  date  of  the  Distribution.  Thereafter,  through  the
termination  of the option in  September  1997,  ABI may  exercise  such  option
provided  that it promptly  sells or otherwise  disposes of any shares  received
upon such exercise.  At December 31, 1996,  there were 152,400 shares  available
for exercise.

Transactions with Directors and Executive Officers

         In November 1996, Lynx and its majority owned  subsidiary,  Spectragen,
Inc. ("Spectragen"), a Delaware corporation, entered into an Agreement of Merger
pursuant  to which  Spectragen  was merged  with and into Lynx and the  separate
corporate  existence  of  Spectragen  ceased  (the  "Merger").   Each  share  of
Spectragen Common Stock outstanding at the time of Merger was converted into 1.3
shares of Lynx  Common  Stock and all vested and  unvested  options to  purchase
shares of  Spectragen  Common  Stock  were  assumed by Lynx and  converted  into
options to purchase  Lynx Common Stock at the same ratio.  Dr.  Eletr,  a former
stockholder  and  optionholder  of Spectragen,  received  130,000 shares of Lynx
Common Stock and an option to purchase  32,500  shares of Lynx Common Stock as a
result of the merger.  Dr. Brenner,  a former  stockholder  and  optionholder of
Spectragen,  received  260,000  shares  of Lynx  Common  Stock  and an option to
purchase 65,000 shares of Lynx Common Stock as a result of the merger.

         In May and June 1995,  the Company  entered  into three  separate  loan
agreements  with  David  W.  Martin,  Jr.,  M.D.,  who was  then  the  Company's
President.  The first loan of $450,000 was a promissory note secured by a second
mortgage on real  property.  The principal and interest on this loan were repaid
according to the terms of the note in September 1996, upon sale of the property.
The second loan of $450,000 was issued under a Stock Purchase  Agreement for the
purchase of 250,000  shares of Common Stock  whereby all the shares issued under
the agreement were pledged as collateral.  Of the 250,000 shares, 225,000 shares
were subject to the Company's right of repurchase which lapsed ratably over five
years. The loan agreement  specified that upon termination,  after the Company's
right of repurchase was exercised,  the remaining  principal and interest on the
loan were due and payable.  In November  1996,  the officer left the Company and
the stock  purchase loan was repaid in full. The third loan was a line of credit
agreement  whereby Dr.  Martin  could  borrow from the Company up to $25,000 per
calendar quarter during the first two years of employment.  The line was secured
by shares of the Company's  Common Stock owned by Dr. Martin.  The principal and
accrued  interest  due on the line of credit,  an  aggregate  of  $157,862,  was
forgiven upon Dr. Martin's separation from the Company.

         In October 1995, the Company entered into a loan agreement with another
officer of the Company. The note receivable of $210,000 was issued under a Stock
Purchase Agreement for the purchase of 60,000 shares of Common Stock whereby all
the shares issued under the agreement are pledged as collateral. The outstanding
principal  amount is due and  payable in full on October 1, 2000,  subject to an
obligation to prepay under specified circumstances. Interest is payable upon the
expiration  or  termination  of the note and  accrues  at the rate of 

                                      44.
<PAGE>

6.38% per annum. As of February 28, 1997, the outstanding  principal and accrued
interest under the note was $228,906.

         The Company currently has no other employment  contracts with any Named
Executive  Officers,   and  the  Company  has  no  other  compensatory  plan  or
arrangement  with Named  Executive  Officers where the amounts to be paid exceed
$100,000 and which are activated upon resignation,  termination or retirement of
any such executive officer or upon a change in control of the Company.

         For legal services rendered during the calendar year ended December 31,
1996,  the Company  paid  approximately  $468,937  to Cooley  Godward  LLP,  the
Company's counsel, of which Mr. Kitch, a director of the Company, is a partner.

                                      45.

<PAGE>


ITEM 14.         EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 (a) (1) The following index, Report of Ernst & Young LLP,  Independent Auditors
         and financial  statements  are set forth on pages 18 through 22 of this
         report:

         (i)    Report of Ernst & Young LLP, Independent Auditors.

         (ii)   Consolidated Balance Sheets as of December 31, 1996 and 1995.

         (iii)  Consolidated  Statements  of  Operations  for  the  years  ended
                December 31, 1996, 1995 and 1994.

         (iv)   Consolidated  Statement  of  Stockholders'  Equity for the years
                ended December 31, 1996, 1995 and 1994.

         (v)    Consolidated  Statements  of  Cash  Flows  for the  years  ended
                December 31, 1996, 1995 and 1994.

         (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 filed as Exhibits to this report:

EXHIBIT
NUMBER                               DESCRIPTION OF DOCUMENT
--------                             -----------------------

3.1.1     Certificate  of Amendment of  Certificate  of the Amended and Restated
          Certificate of Incorporation of the Company.

3.2       Bylaws of the Company,  as amended,  incorporated  by reference to the
          indicated  exhibit  of the  Registrant's  Statement  Form 10 (File No.
          0-22570), as amended.

3.3       Certificate  of  Designation  of  Preferences  of Series B Convertible
          Preferred  Stock of the  Company,  incorporated  by  reference  to the
          indicated  exhibit of the  Registrant's  Form 10-K for the  transition
          period ended December 31, 1993.

3.4       Certificate  of Amendment of Certificate of Designation of Preferences
          of Series B Convertible  Preferred Stock of the Company,  incorporated
          by reference to the indicated  exhibit of the  Registrant's  Form 10-Q
          for the period ended March 31, 1995.

3.4.1     Certificate  of Amendment to Certificate of Designation of Preferences
          of Series B Convertible Preferred Stock of the Company.

3.5       Certificate  of  Designation  of  Preferences  of Series C Convertible
          Preferred Stock, incorporated by reference to the indicated exhibit of
          the Registrant's Form 10-Q for the period ended March 31, 1995.

3.5.1     Certificate  of Amendment to Certificate of Designation of Preferences
          of Series C Convertible Preferred Stock of the Company.

3.6       Certificate  of Amendment to Certificate of Designation of Preferences
          of Series D Convertible Preferred Stock of the Company.

4.1       Shareholders Agreement,  dated as of October 1, 1992, by and among the
          Company,  Applied  Biosystems,  Inc.  ("ABI")  and Chiron  Corporation
          ("Chiron"),  incorporated by reference to the indicated exhibit of the
          Registrant's Statement Form 10 (File No. 0-22570), as amended.

4.2       Form of Common  Stock  Certificate,  incorporated  by reference to the
          indicated  exhibit  of the  Registrant's  Statement  Form 10 (File No.
          0-22570), as amended.

4.3       Form  of  Series  B  Preferred  Stock  Certificate,   incorporated  by
          reference  to  Exhibit  4.4 of the  Registrant's  Form  10-K  for  the
          transition period ended December 31, 1993.

4.4       Form  of  Series  C  Preferred  Stock  Certificate,   incorporated  by
          reference to Exhibit 4.5 of the Registrant's  Form 10-K for the period
          ended December 31, 1995.


                                      46.
<PAGE>

4.5       Form  of  Series  D  Preferred  Stock  Certificate,   incorporated  by
          reference to Exhibit 4.6 of the Registrant's  Form 10-K for the period
          ended December 31, 1995.

10.1      Preferred  Stock  Purchase  Agreement,  dated as of  October  1, 1992,
          between  the  Company  and  ABI,  incorporated  by  reference  to  the
          indicated  exhibit  of the  Registrant's  Statement  Form 10 (File No.
          0-22570), as amended.

10.2      Stock  Purchase  Agreement,  dated as of June 30,  1992,  between  the
          Company and Timothy Geiser, incorporated by reference to the indicated
          exhibit of the Registrant's  Statement Form 10 (File No. 0-22570),  as
          amended.

10.3      Stock  Purchase  Agreement,  dated as of June 30,  1992,  between  the
          Company and Gerald Zon,  incorporated  by reference  to the  indicated
          exhibit of the Registrant's  Statement Form 10 (File No. 0-22570),  as
          amended.

10.4      Stock  Purchase  Agreement,  dated as of August 25, 1992,  between the
          Company and Sam Eletr,  incorporated  by  reference to Exhibit 10.6 of
          the Registrant's Statement Form 10 (File No. 0-22570), as amended.

10.5      Form of Indemnity  Agreement  entered into between the Company and its
          directors and officers,  incorporated  by reference to Exhibit 10.7 of
          the Registrant's Statement Form 10 (File No. 0-22570), as amended.

10.6+     The  Company's  1992 Stock  Option  Plan (the  "Stock  Option  Plan"),
          incorporated  by  reference  to  Exhibit  10.8  of  the   Registrant's
          Statement Form 10 (File No. 0-22570), as amended.

10.7+     Form of  Incentive  Stock  Option  Grant under the Stock  Option Plan,
          incorporated  by  reference  to  Exhibit  10.9  of  the   Registrant's
          Statement Form 10 (File No. 0-22570), as amended.

10.8+     Form of  Nonstatutory  Stock Option Grant under the Stock Option Plan,
          incorporated  by  reference  to  Exhibit  10.10  of  the  Registrant's
          Statement Form 10 (File No. 0-22570), as amended.

10.9      Agreement of Assignment and License of Intellectual  Property  Rights,
          dated June 30,  1992,  between the Company  and ABI,  incorporated  by
          reference to Exhibit 10.11 of the Registrant's Statement Form 10 (File
          No. 0-22570), as amended.

10.10     Lease,  dated as of June 28,  1993,  by and  between  the  Company and
          Spieker-Singleton #87, Limited Partnership,  incorporated by reference
          to  Exhibit  10.14 of the  Registrant's  Statement  Form 10 (File  No.
          0-22570), as amended.

10.11     Series B Convertible  Preferred Stock Purchase Agreement,  dated as of
          February   15,   1994,   between  the  Company  and  the   Purchasers,
          incorporated  by  reference to the Exhibit  10.16 of the  Registrant's
          Form 10-K for the transition period ended December 31, 1993.

10.12     Investor Rights Agreement,  dated as of February 15, 1994, between the
          Company and the  Purchasers,  incorporated by reference to the Exhibit
          10.17 of the  Registrant's  Form 10-K for the transition  period ended
          December 31, 1993.

10.13     Series C Convertible  Preferred Stock Purchase Agreement,  dated as of
          March 24, 1995,  incorporated  by  reference  to Exhibit  10.19 of the
          Registrant's Form 10-K for the period ended December 31, 1995.

10.14     Investors Rights Agreement,  dated as of March 24, 1995,  incorporated
          by reference to Exhibit  10.20 of the  Registrant's  Form 10-K for the
          period ended December 31, 1995.

10.15     Spectragen   Formation   Agreement,   dated  as  of  March  24,  1995,
          incorporated  by reference to Exhibit 10.21 of the  Registrant's  Form
          10-Q for the period ended March 31, 1996.
          
10.16+    Spectragen  Stockholder's  Agreement,  dated as of  August  21,  1995,
          incorporated  by reference to Exhibit 10.22 of the  Registrant's  Form
          10-Q for the period ended March 31, 1996.

10.17+    Employment Agreement,  dated as of May 1, 1995 between the Company and
          David W. Martin, Jr., M.D., incorporated by reference to Exhibit 10.23
          of the Registrant's Form 10-K for the period ended December 31, 1995.

10.18+    Stock Purchase  Agreement dated as of May 1, 1995, between the Company
          and David W. Martin,  Jr. M.D.,  incorporated  by reference to Exhibit
          10.24 of the Registrant's  Form 10-K for the period ended December 31,
          1995.

10.19+    Loan Agreement, dated as of May 1, 1995, between the Company and David
          W. Martin, Jr., M.D. incorporated by reference to Exhibit 10.25 of the
          Registrant's Form 10-K for the period ended December 31, 1995.

                                      47.
<PAGE>

10.20+    Promissory Note Secured by Mortgage, dated as of June 12, 1995, to the
          Company  by  David  W.  and  Kathleen  M.  Martin   Revocable   Trust,
          incorporated  by reference to Exhibit 10.26 of the  Registrant's  Form
          10-K for the period ended December 31, 1995.

10.21+    Stock  Purchase  Agreement  dated as of October 2, 1995,  between  the
          Company and Karoly  Nikolich,  incorporated  by  reference  to Exhibit
          10.27 of the Registrant's  Form 10-K for the period ended December 31,
          1995.

10.22     Technology Development and Services Agreement,  dated as of October 2,
          1995,  between  the Company  and  Hoechst  Aktiengesellschaft  and its
          subsidiary,  Hoechst  Marion  Roussel,  incorporated  by  reference to
          Exhibit  10.28 of the  Registrant's  Form  10-K for the  period  ended
          December 31, 1995.

10.23     Series D. Convertible Preferred Stock Purchase Agreement,  dated as of
          October 2, 1995,  incorporated  by reference  to Exhibit  10.29 of the
          Registrant's Form 10-K for the period ended December 31, 1995.

10.24     Amended and Restated Investor Rights  Agreement,  dated as of November
          1,  1995,   incorporated   by  reference  to  Exhibit   10.30  of  the
          Registrant's Form 10-K for the period ended December 31, 1995.

10.25+    Stock  Purchase  Agreement,   dated  as  of  June  13,  1996,  between
          Spectragen,  Inc. and Sam Eletr.  (The Stock  Purchase  Agreement  was
          assumed by the Company pursuant to the Agreement of Merger between the
          Company and Spectragen, Inc.

10.26     Collaboration  Agreement  ,  dated  as of July 9,  1996,  between  the
          Company and Tanabe  Seiyaku Co.,  Ltd.,  incorporated  by reference to
          Exhibit 10.31 of the Registrant's  Form 10-Q for the period ended June
          30, 1996.

10.27     Collaboration  Agreement , dated as of September 30, 1996, between the
          Company and Schwarz Pharma AG.,  incorporated  by reference to Exhibit
          10.32 of the Registrant's Form 10-Q for the period ended September 20,
          1996.

10.28     Technology  Services  Agreement,  dated October 23, 1996,  between the
          Company and BASF Aktiengesellschaft.**  

10.29     Joint  Venture  Agreement,  dated as of October 23, 1996,  between the
          Company and BASF Aktiengesellschaft.**

10.30     Agreement of Merger, dated as of October 23, 1996, between the Company
          and Spectragen, Inc.


10.31+    Separation  Agreement,  dated as of  November  1,  1996,  between  the
          Company and David W. Martin, Jr., M.D.

21.1       Subsidiaries of the Company.

23.1       Consent of Ernst & Young LLP, Independent Auditors.

24.1       Power of Attorney.  Reference is made to page 49.

------------------
(+)        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
           N/A


                                      48.
<PAGE>


                                   SIGNATURES

         Pursuant to the  requirements of Section 13 or 15(d)  Securities Act of
1934,  the  Registrant  has duly caused this report on Form 10-K to be signed on
its behalf by the  undersigned,  thereunto duly  authorized,  on the 24th day of
March 1997.

                             LYNX THERAPEUTICS, INC.


                                     By:  /s/  Sam Eletr
                                         ------------------------------
                                                Sam Eletr, Ph.D.
                                              Chairman of the Board

<TABLE>

                                POWER OF ATTORNEY

         Each person whose signature  appears below constitutes and appoints Sam
Eletr and James C. Kitch his true and lawful  attorneys-in-fact and agents, each
acting alone, with full power of substitution and resubstitution, for him and in
his  name,  place  and  stead,  in any and all  capacities,  to sign  any or all
amendments (including  post-effective  amendments) to the Registration Statement
on Form 10-K, and to file the same, with all exhibits thereto, and all documents
in connection therewith,  with the Securities and Exchange Commission,  granting
unto said  attorneys-in-fact  and  agents,  full power and  authority  to do and
perform each and every act and thing  requisite  and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could do
in person,  hereby ratifying and confirming all that said  attorneys-in-fact and
agents, each acting alone, or his substitute or substitutes,  may lawfully do or
cause to be done by virtue hereof.

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

<CAPTION>

              Signature                                              Title                                   Date
              ---------                                              -----                                   ----
<S>                                              <C>                                                       <C>
         /s/  Sam Eletr                                   Chief Executive Officer and                      March 24, 1997   
------------------------------------------                   Chairman of the Board                                          
         Sam Eletr                                       (Principal Executive Officer)                     
                                                         

         /s/  William K. Bowes, Jr.                                Director                                March 24, 1997
------------------------------------------
         William K. Bowes, Jr.

         /s/  Sydney Brenner                                       Director                                March 24, 1997
------------------------------------------
         Sydney Brenner

         /s/  James C. Kitch                                       Director                                March 24, 1997
------------------------------------------
         James C. Kitch

         /s/  Kathleen D. La Porte                                 Director                                March 24, 1997
------------------------------------------
         Kathleen D. La Porte

                                                 
         /s/  Craig C. Taylor                     Director and Acting Chief Financial Officer              March 24, 1997
------------------------------------------       (Principal Financial and Accounting Officer)                                 
         Craig C. Taylor                                            Officer

</TABLE>

                                      49.