<PAGE>   1
================================================================================


                                  UNITED STATES
                       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 FISCAL YEAR ENDED DECEMBER 31, 2000

                                       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)


<TABLE>
<S>                                        <C>
           DELAWARE                                   94-3161073
(STATE OR OTHER JURISDICTION OF            (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
</TABLE>


                    25861 Industrial Blvd., Hayward, CA 94545
          (Address of principal executive offices, including zip code)

                                 (510) 670-9300
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

           SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                     COMMON STOCK, $.01 PAR VALUE PER SHARE

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

        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 of the Registrant outstanding as of
February 15, 2001, was 11,459,521. The aggregate market value of the common
stock of the Registrant held by non-affiliates of the Registrant, based upon the
closing price of the Common Stock reported on the Nasdaq National Market on
February 15, 2001, was $108,953,607.

================================================================================


<PAGE>   2
                             LYNX THERAPEUTICS, INC.

                             FORM 10-K ANNUAL REPORT

                            FOR THE FISCAL YEAR ENDED
                                DECEMBER 31, 2000

                                TABLE OF CONTENTS


<TABLE>
<S>                                                                                                     <C>
PART I

Item 1.   Business ...................................................................................       1

Item 2.   Properties .................................................................................      17

Item 3.   Legal Proceedings ..........................................................................      17

Item 4.   Submission of Matters to a Vote of Security Holders ........................................      17

PART II

Item 5.   Market for Registrants Common Equity and Related Stockholder Matters .......................      18

Item 6.   Selected Financial Data ....................................................................      19

Item 7.   Management's Discussion and Analysis of Financial Condition and Results of
          Operations .................................................................................      20

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk .................................      24

Item 8.   Consolidated Financial Statements and Supplementary Data ...................................      25

Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .......      43

PART III

Item 10.  Directors and Executive Officers of the Registrant .........................................      44

Item 11.  Executive Compensation .....................................................................      46

Item 12.  Security Ownership of Certain Beneficial Owners and Management .............................      48

Item 13.  Certain Relationships and Related Transactions .............................................      49

PART IV

Item 14.  Exhibits, Financial Statement Schedule and Reports on Form 8-K .............................      50

Signatures ...........................................................................................      52
</TABLE>


<PAGE>   3
                                     PART I

ITEM 1. BUSINESS

        Except for the historical information contained herein, this report
contains certain information that is forward-looking in nature. Examples of
forward-looking statements include statements regarding Lynx's future financial
results, operating results, product successes, business strategies, projected
costs, future products, competitive positions and plans and objectives of
management for future operations. In some cases, you can identify
forward-looking statements by terminology, such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology. In addition, statements that refer to expectations or other
characterizations of future events or circumstances are forward-looking
statements. These statements involve known and unknown risks and uncertainties
that may cause Lynx's or its industry's results, levels of activity, performance
or achievements to be materially different from those expressed or implied by
the forward-looking statements. Factors that may cause or contribute to such
differences include, among others, those discussed under the captions
"Business," "Business -- Business Risks" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." These and many other
factors could affect the future financial and operating results of Lynx. Lynx
undertakes no obligation to update any forward-looking statement to reflect
events after the date of this report.

        Megaclone, MPSS, Megasort, Megatype and Protein ProFiler are trademarks
of Lynx Therapeutics, Inc.

OVERVIEW

        We are a leader in the development and application of novel technologies
for the discovery of gene expression patterns and genomic variations important
to the pharmaceutical, biotechnology and agricultural industries. These
technologies are based on Megaclone, our unique and proprietary cloning
procedure. Megaclone transforms a sample containing millions of DNA molecules
into one made up of millions of micro-beads, each of which carries approximately
100,000 copies of one of the DNA molecules in the sample. In contrast to
conventional cloning, in which an individual DNA molecule is selected from a
sample and amplified into many copies for analysis or identification, we can
capture on one set of micro-beads clones of nearly all the DNA sequences that
characterize a sample. Once attached to the micro-beads, these clones can be
handled and subjected to experiments and analyses all at the same time.
Megaclone thereby enables many analyses or characterizations to be conducted
that would otherwise be too cumbersome or onerous to conduct using conventional
procedures where each clone must be addressed individually. Based on Megaclone,
we have developed a suite of applications that have the potential to enhance the
pace, scale and quality of genomics and genetics research programs. Currently,
our principal collaborators and customers are BASF AG, E.I. DuPont de Nemours
and Company, Aventis CropScience GmbH, Oxagen Limited Hybrigenics S.A., Genomics
Collaborative Inc., Molecular Engines Laboratories SA, the Institute of
Molecular and Cell Biology, Phytera, Inc. and Celera Genomics. Additionally, we
have provided a license for the use of certain of our technologies to Takara
Shuzo Co. Ltd.

        Technologies we have developed that leverage the power of Megaclone are:

        -       Massively Parallel Signature Sequencing, or MPSS -- which
                generates simultaneously, from a million or more Megaclone
                micro-beads, sequence information that uniquely identifies a
                sample's DNA molecules without the need for individual
                conventional sequencing reactions, and produces a comprehensive
                quantitative profile of gene expression in cells or tissues; and

        -       Megasort -- which enables researchers to focus on potential
                target genes by permitting, from a single experiment, the direct
                physical isolation of nearly all the genes differentially
                expressed between samples.

        We are also developing the following application based on Megaclone:

        -       Megatype -- which, when fully developed, should enable a single
                experiment to yield directly, without individual genotyping,
                those disease- or trait-associated single nucleotide
                polymorphisms, or SNPs, that differentiate large populations of
                genomes.

        We are developing additional applications of these technologies, as well
as new technologies aimed at addressing the needs of the pharmaceutical,
biotechnology and agricultural industries. For example, we are working on a new
separation technology in the area of proteomics to provide high-resolution
analysis of complex mixtures of proteins from cells or tissues of interest.

        In addition to our and our licensee's work with collaborators and
customers, we intend to apply our suite of technologies in selected biological
areas to develop products internally to discover and then license or sell gene
targets, validated gene targets, genetic associations, genomic maps and other
products. For example, we are pursuing projects directed to gene discovery and
target validation in immunopathology and, through BASF-LYNX, our joint venture
with BASF, central nervous system disorders.


                                       1


<PAGE>   4
INDUSTRY BACKGROUND

        The publication of the first draft sequence of the human genome was a
milestone in the history of genetics and genomics. However, the remaining
challenge for researchers in industry and academia alike is to explore the
multitude of genomic variations and to discover, from the analysis of these
differences, the functions of genes and their roles in health and disease. It is
this work, post genome-sequencing, that is expected to lead to commercial
opportunities and ultimately to the discovery of new therapies for unmet medical
needs and to provide the basis for the emerging fields of pharmacogenetics and
individualized patient therapy.

        Many diseases result from a malfunction of the genetically programmed
protective response to insults, such as trauma, infection, stress or an
inherited mutant gene. That malfunction may result in inadequate, misguided or
exaggerated gene expression, unfolding a complex pathogenic process which may
resolve itself, linger chronically or evolve with increasingly destructive
effects in a manner quite removed from, and even independent of, the original
insult. Analyzing which genes are expressed in a cell or tissue, the level of
expression can illustrate which physiological pathways are active in the cell
and to what degree. By understanding when and where abnormal gene expression
occurs and the changes in expression that a drug can cause, the physiological
pathways implicated in disease and drug action can be pinpointed. This knowledge
could be used to help discover drug targets, screen drug leads, predict a
compound's toxic effects, anticipate pharmacological responses to drug leads and
tailor clinical trials to the specific needs of subgroups within a population.
By recognizing gene expression patterns, researchers, and ultimately physicians,
may also be able to determine which treatments are likely to be effective for a
specific condition and which may be ineffective or harmful.

        Genomic approaches to therapeutics seek to identify genes connected to
the origin of a disease. Searches to identify such genes generally are laborious
and involve a very large amount of conventional DNA sequencing to identify genes
or gene fragments. This knowledge of genes is a first step only. While it may
pave the way for the development of better diagnostics, it may not necessarily
lead to a successful therapy. For example, while a particular gene, or absence
of a gene, may predispose a person to a cancer, an entirely different set of
genes is likely to govern the tumor and its metastases. Hence, in addition to
understanding the cause of disease, it is important to understand entire
networks of genes and their functions in both healthy and diseased states in
order to identify the optimal targets for therapy.

        One approach to genomics research is based on the study of gene
expression and regulation of gene expression in cells in differing states or
conditions. Gene expression in a cell consists of transcription, the process
which converts the genetic information encoded in the double-stranded DNA of a
gene into mRNA, and translation, the process which converts the genetic
information encoded in mRNA into a specific protein molecule. At any one time,
any particular human cell expresses thousands of genes. A different number of
copies of each mRNA type will be present in each sample depending upon the
particular cell, its function and its environmental conditions at the time.
Thus, a cell will contain, at any one time, tens of thousands of different
mRNAs, in various quantities, for a total on the order of one million or more
mRNA molecules.

        Elucidating gene function involves not only determining which genes are
expressed in a healthy or diseased tissue, but also requires determining which
of the altered gene expressions cause a disease rather than result from the
disease. In general, only the most abundantly expressed genes are currently
accessible using conventional methods. In addition, conventional methods are
dependent on separating and cloning double-stranded copies of each individual
mRNA, or cDNA, prior to analysis. Thus, by conventional methods, it is
impractical to obtain a comprehensive, high-resolution analysis of gene
expression across one million or more mRNA molecules in cells of interest to the
researcher.

        Another approach to genomics research is based on the study of human
genetic variations. It is well known that the incidence of human diseases and
their severity differ in different groups and individuals. There are many common
diseases in which several genes play a role in the initiation and development of
the pathological process, as well as in the responses of the individual to a
therapy. This approach studies gene association with diseases by using a large
assembly of specific gene variants called polymorphisms. The most abundant of
these are single nucleotide polymorphisms, or SNPs, which are single-base
mutations in the genome. A SNP is found, on average, once in every 1,000 bases.
This means if any two individuals are compared, their genomes will be found to
differ at more than one million places. Genotyping refers to the process of
testing individual genomes for the presence or absence of a set of SNPs.

        If a SNP correlation to a disorder is proven, it would point to those
regions of the genome in which the sequences responsible for the disorder may be
located. However, to discover such regions, it is currently believed that one
would have to test several hundred individual genomes for the presence or
absence of tens of thousands, if not more, SNPs. Thus, there is a real need to
employ a technology that can quickly and efficiently determine which of these
thousands of SNPs are significantly associated with diseases in large
populations of patients and thereby provide a relevant set of SNPs for
downstream genotyping of individuals.


                                       2


<PAGE>   5
OUR SOLUTION

        We overcome many of the limitations of current technologies by capturing
essentially all of the different DNA molecules in a sample on micro-beads using
our Megaclone technology and applying our various analytical technologies to
conduct relevant comparisons and other analyses of the captured DNA molecules.
Thus, our patented Megaclone technology enables an automated, high-throughput
analysis of complex mixtures of DNA molecules.

        Megaclone is a process that uses a proprietary library of approximately
16.7 million short synthetic DNA sequences, called tags, and their complementary
anti-tags, to uniquely mark and process each DNA molecule in a sample. Each
unique tag is a permanent identifier of the DNA molecule it is attached to, and
all of the tagged molecules in a sample are amplified together to create
multiple copies of the tagged molecules. Another proprietary process is used to
generate five micron diameter micro-beads, each of which carries multiple copies
of a short anti-tag DNA sequence complementary to one of the 16.7 million tags.
The amplified tagged DNA molecules are then collected onto the micro-beads
through hybridization of the tags to the complementary anti-tags. Each
micro-bead carries on its surface enough complementary anti-tags to collect
approximately 100,000 identical copies of the corresponding tagged DNA molecule.

        By this process, each tagged DNA molecule in the original sample is
converted into a micro-bead carrying about 100,000 copies of the same sequence.
Therefore, in a few steps, our Megaclone technology can transform a complex
mixture of a million or more individual DNA molecules into a usable format that
provides the following benefits:

        -       substantially all the different DNA molecules present in a
                sample are represented in the final micro-bead collection;

        -       these million or more DNA molecules can be analyzed
                simultaneously in various applications; and

        -       the need for storing and handling millions of individual DNA
                clones is eliminated.

Megaclone is the foundation for our analytical applications, including MPSS,
which provides gene sequence information and high-resolution gene expression
information, Megasort, which provides focused sets of differentially expressed
genes and potential gene targets, and Megatype, which is expected to provide SNP
disease- or trait-association information.

OUR BUSINESS STRATEGY

        We intend to apply our technologies to maximize the value of human,
animal and plant genomic information for our licensee's, collaborators and
customers and ourselves through high-resolution gene expression analysis and in
the discovery and characterization of important genetic variations. Now that the
majority of our technologies have been reduced to practice, we intend to enlarge
our presence in the pharmaceutical, biotechnology, agricultural and other
commercially important markets. We believe many drug discovery and development
companies now recognize the need for significantly greater resolution and scope
in their genomics and genetics research.

        The primary elements of our business strategy are:

        -       Pursue selected internal programs to capture greater value

        We intend to use our technologies to discover and develop gene targets,
validated gene targets, genetic associations, genomic maps or other products in
selected fields. Through these internal programs, we will endeavor to create
valuable drug discovery information and related intellectual property that we
could license to third parties. If successful, we could realize revenues from
licensing our discoveries through licensing fees, milestone payments and
royalties or profit-sharing. For example, we have initiated a program directed
to the discovery and validation of targets in the field of immunopathology.

        -       Collaborate with others with whom we can create value

        We will seek to collaborate with companies and research institutions
under arrangements in which we provide access to our technologies, and our
collaborators provide access to well-defined clinical samples and/or biological
expertise. Through these programs, we will endeavor to create valuable drug
discovery information and related intellectual property that could be licensed
to third parties. If successful, we could realize revenues through a share in
any licensing or commercialization by us or our collaborators.


                                       3


<PAGE>   6
        -       Provide high-resolution gene expression information for use in
                databases

        We intend to use our technologies, particularly MPSS, to produce
high-resolution gene expression information from cells or tissues for inclusion
in databases. We believe the distinguishing feature of the information that Lynx
could produce is that it represents a comprehensive quantitative profile of gene
expression in cells or tissues. Our approach could be either to assemble this
information on our own or with a partner in a database format, accessible to
others for an access fee and/or continuing subscriptions, or to provide this
information to others for inclusion in their existing database products, in
return for services fees in producing the information and/or a share of the
revenues or profits from the commercialization of the database.

        -       Provide high-resolution gene expression information for the
                specific programs of others

        With the assumed accessibility to databases containing high-resolution
gene expression information on cells or tissues for comparative purposes, we
expect that pharmaceutical, biotechnology, agricultural and other companies will
engage us to produce a comprehensive quantitative profile of gene expression in
cells or tissues for their specific interests, such as in diseased, abnormal or
induced states or conditions. In these arrangements, we could provide
information content for each company's specific internal database or programs.
In return, we could earn services fees in producing the information and/or a
share of the revenues or profits from the commercialization of a product
stemming from the use the information by the company.

        -       Continue to grow our genomics discovery services

        We have generated revenues through agreements for genomics discovery
services. We plan to continue to provide such services to pharmaceutical,
biotechnology and agricultural companies for use in their discovery, development
and commercialization efforts. The revenue sources from these arrangements
typically include technology access and services fees. We have provided a
license for the use of certain of our technologies to Takara. The license
provides Takara with the right in Japan, Korea and China, including Taiwan, to
use our technologies exclusively for at least five years, and non-exclusively
thereafter, to provide genomics discovery services and to manufacture and sell
microarrays containing content identified by our technologies. Takara also
receives from us a non-exclusive license right to manufacture and sell such
microarrays elsewhere throughout the world.

        -       Develop new technologies and additional applications of our
                technologies

        We intend to continue to develop creative solutions to complex
biological problems. We are currently focused on reducing to commercial practice
our Megatype technology in order to extract from large populations those genomic
fragments exhibiting SNPs and associate these SNPs with traits or diseases. We
may further develop our technology to apply it to individual genotyping which
would determine the relevant SNPs present in an individual. We are also working
in the area of proteomics to provide a means of high-resolution analysis of
complex mixtures of proteins from cells or tissues.

OUR TECHNOLOGIES AND APPLICATIONS

        We have developed or are developing several important analytical
applications of our Megaclone technology to better address the need for
increased pace, scale and quality of genomics and genetics research programs.

Current Applications

        Massively Parallel Signature Sequencing Technology. Our MPSS technology
addresses the need to generate sequence information from millions of DNA
fragments. At this extremely large scale, our MPSS approach eliminates the need
for individual sequencing reactions and the physical separation of DNA fragments
required by conventional sequencing methods.

        MPSS enables the simultaneous identification of nearly all the DNA
molecules in a sample. With MPSS, one million or more Megaclone micro-beads are
fixed in a single layer array in a flow cell, so solvents and reagents can be
washed over the micro-beads in each cycle of the process. Our proprietary
protocol elicits from the Megaclone micro-beads sequence-dependent fluorescent
responses, which are recorded by a charged coupled device ("CCD") camera after
each cycle. The process produces short 16- to 20-base-pair signature, or
identifying, sequences, without requiring fragment separation and separate
sequencing reactions as in conventional DNA sequencing approaches. We have
developed proprietary instrumentation and software to automate the delivery of
reagents and solutions used in our sequencing process and to compile, from the
images obtained at each cycle, the signature sequences that result from each
experiment.


                                       4


<PAGE>   7
        We believe MPSS has the following advantages over conventional DNA
sequencing methods:

        -       it sequences DNA molecules on as many as one million or more
                Megaclone beads simultaneously;

        -       it eliminates the need for individual sequencing reactions and
                gels;

        -       it identifies each of the DNA molecules by a unique 16- to
                20-base signature sequence;

        -       it produces a comprehensive quantitative profile of gene
                expression in cells or tissues of interest; and

        -       it identifies even the rarest expressed genes.

        We currently have over 30 operational proprietary MPSS instruments. We
are utilizing MPSS to generate high-resolution expression data in several
biological systems for our collaborators and customers and for ourselves. These
data are being derived from tissues and samples that have been prioritized by
our collaborators and customers, in addition to those identified by our research
teams for our internal programs. We will also generate data that can be
delivered directly to our customers to identify new genes and otherwise enhance
their databases.

        MPSS delivers gene sequence information and high-resolution gene
expression information and could enable the construction of high-resolution gene
expression databases from cells or tissues of interest.

        Megasort Technology. Our Megasort technology provides a method to
identify and physically extract essentially all genes that differ in expression
level between two samples. The novelty of Megasort is that the identification
and extraction are performed in a single assay.

        Megasort compares two DNA samples, each containing millions of
molecules, and extracts those DNA molecules that are present in different
proportions in the samples. These could be differentially expressed genes or DNA
fragments that are found in one sample but not the other. Because the comparison
and sorting require no prior knowledge of the sequences of the genes in either
sample, Megasort can be used with samples isolated from tissues or organisms
that are not well characterized. Megasort involves hybridizing two probes
prepared separately, one from each of the samples to be compared, with a
population of Megaclone micro-beads, each of which carries many copies of a
single DNA fragment or gene derived from either of the samples. Because each
probe is labeled with a different fluorescent marker, genes or fragments that
are under- or over-represented in either sample are readily separated by a
fluorescence activated cell sorter, also referred to as a FACS. Genes or
fragments of interest can then be recovered from the sorted micro-beads for
further study.

        Megasort technology uses Megaclone micro-beads as a "fluid" microarray.
In a single experiment, Megasort can isolate nearly all the potential target
genes that are differentially expressed, and remove those that do not differ
between the samples. We believe Megasort has the following advantages over
conventional gene microarrays:

        -       it interrogates all the expressed genes, including rarely
                expressed genes, in the two samples being compared, whether
                known or not;

        -       it does not require advance knowledge about any of the genes in
                these samples; and

        -       it extracts, at the end of the experiment, physical DNA clones
                of those genes that are of interest attached to the micro-beads
                that were sorted.

Megasort delivers focused sets of differentially expressed genes and potential
gene targets.

Technologies, Applications and Products Under Development

        Megatype Technology. We believe our Megatype technology will permit the
comparison of collected genomes of two populations. It is designed to enable the
detection and recovery of DNA fragments with the SNPs that distinguish these two
populations. In contrast to other SNP validation methods that require thousands
or millions of assays, only a single Megatype experiment should be required for
SNP association with disease or other traits.


                                       5


<PAGE>   8
        Megatype is designed to identify SNPs that are differentially
represented in two populations of individuals. DNA fragments that exhibit a
specific class of SNPs in the combined populations are selected by a proprietary
method and loaded onto micro-beads with our Megaclone technology. Using
fluorescently labeled probes, prepared through the same proprietary method, from
the two separate populations, micro-beads bearing SNP-containing fragments that
are under- or over-represented in either of the two populations are easily
separated using the FACS. No prior knowledge of the SNP sequences or where they
are located in the genome is required to conduct this analysis.

        We believe the advantages of Megatype will include:

        -       enabling simultaneous discovery of disease- or trait-associated
                SNPs without prior knowledge of SNP sequences;

        -       identifying, in a single experiment, the genetic differences
                that distinguish large populations;

        -       extracting fragments containing over- or under-represented SNPs
                in different populations;

        -       eliminating the need for millions of individual genotyping
                assays to determine SNP disease association; and

        -       bypassing the prior need for a comprehensive SNP map.

We believe our Megatype technology will deliver information on the disease- or
trait-association of SNPs and should provide a cost-effective approach to drug
discovery and pharmacogenetics.

        Proteomics. Proteomics is the study of the entire protein complement in
cells. Our proteomics technology aims to provide high-resolution analysis of
complex mixtures of proteins from cells or tissues. Based on solution-phase
electrophoresis in proprietary micro-channel plates, the approach combines the
speed of capillary electrophoresis with the resolving power of conventional two-
dimensional gel-based techniques. Using this technology, we expect to complement
high-resolution gene expression measurements using our MPSS platform with
similar high-resolution analysis of a cell's translated proteins. The combined
data from these measurements should provide a much more accurate and
comprehensive picture of cell and tissue physiology than is available using
current techniques. Our goal is to use our proteomics technology to discover
drug targets, validate candidate targets and correlate gene expression with
protein expression in cells.

        Genotyping. As a natural extension of our Megatype technology, we may
further apply the technology to individual genotyping, which would determine the
relevant SNPs present in an individual. This application will attempt to derive
more of the downstream value from the scientifically relevant SNPs through the
additional enabling of trait selection in crops, and predictive or preventative
medicine in humans, thus moving closer to the notion of "personal genomics."
Furthermore, we may develop additional assays to help link associated SNPs
initially identified by Megatype technology to specific genes responsible for
the observed traits.

COLLABORATIONS AND CUSTOMERS

  BASF and BASF-LYNX

        In October 1996, we entered into an agreement with BASF to provide them
with nonexclusive access to certain of our genomics discovery services. In
connection with certain technology development accomplishments, BASF paid us a
technology access fee of $4.5 million in the fourth quarter of 1999. BASF's
access to our genomics discovery services is for a minimum of two years and
requires BASF to purchase services at a minimum rate of $4.0 million per year.
BASF paid us $4.0 million in each of the fourth quarters of 1999 and 2000 for
genomics discovery services to be performed by us.

        In 1996, we formed a joint venture company with BASF called BASF-LYNX
Bioscience AG. BASF-LYNX is located in Heidelberg, Germany. BASF-LYNX began
operations in 1997 and is employing our technologies to discover and validate
novel gene targets for central nervous system ("CNS") disorders. We have
contributed access to our technologies to BASF-LYNX in exchange for an initial
49% equity ownership. BASF, by committing to provide research funding to
BASF-LYNX of DM50 million (or approximately $23.3 million based on a March 2001
exchange rate) over a five-year period beginning in 1997, received an initial
51% equity ownership in BASF-LYNX. In 1998, BASF agreed to provide an additional
$10 million in research funding to BASF-LYNX, of which $4.3 million was paid to
us for technology assets related to a CNS program.


                                       6


<PAGE>   9
  DuPont

        In October 1998, we entered into a research collaboration agreement with
DuPont to apply our technologies on an exclusive basis to the study of certain
crops and their protection. Under the terms of the agreement, we could receive
payments over a five-year period for genomics discovery services, the
achievement of specific technology milestones and the delivery of genomic maps
of specified crops. An initial payment of $10 million for technology access was
received at the execution of the agreement, with additional minimum service fees
of $12 million to be received by us over a three-year period that commenced in
January 1999. In the fourth quarter of 1999, we achieved a technology milestone
under the agreement that resulted in a $5 million payment from DuPont.

  Aventis CropScience

        In March 1999, Aventis Pharmaceuticals, formerly Hoechst Marion Roussel,
Inc., obtained nonexclusive access to certain of our genomics discovery services
for the benefit of its affiliate, Aventis CropScience. We received an initial
payment for genomics discovery services to be performed by us for Aventis
CropScience. The service period, which was renewed in March 2000, ends on March
31, 2001, subject to renewal for up to two additional one-year periods.

        In September 1999, we signed a three-year research collaboration
agreement with Aventis CropScience. Aventis CropScience will receive exclusive
access to certain of our genomics discovery services for the study of certain
plants, which is aimed at developing new crop varieties and other agricultural
products. Under the terms of the agreement, Aventis CropScience paid us a
technology access fee upon execution of the agreement. We can earn additional
fees for the performance of genomics discovery services, the delivery of genomic
maps of certain plants and milestone payments and licensing fees related to the
discovery of trait-associated SNPs for the subject plants.

  Oxagen

        In May 1999, we entered into an agreement with Oxagen to collaborate on
a program to discover and validate disease-associated SNPs using our Megatype
technology. The program initially focuses on inflammatory bowel disease, but the
companies may extend it to other common human disorders. Under the terms of the
agreement, we could receive licensing fees and royalties or otherwise share in
the revenues, if any, from the licensing or sale and subsequent
commercialization of related products by Oxagen or third parties.

  Hybrigenics

        In May 2000, we entered into an agreement with Hybrigenics to
collaborate on a program to discover expressed genes and protein interactions
and pathways in human obesity, through applying our Megasort and MPSS
technologies and Hybrigenics' technologies. The goal is to use the findings to
create new diagnostics and treatments for this important disease area. Under the
terms of the agreement, we could share in the profits, if any, from the
licensing or sale of the scientific results of the collaboration to a third
party.

  Genomics Collaborative

        In August 2000, we entered into an agreement with Genomics Collaborative
to conduct a comprehensive genome-wide scan for single nucleotide polymorphisms,
or SNPs, that are associated with type 2 diabetes, also known a non-insulin
dependent diabetes mellitus, using our Megatype technology. Under the terms of
the agreement, we could share in the profits, if any, from the licensing or sale
of the scientific results of the collaboration to a third party.

  Molecular Engines Laboratories

        In October 2000, we entered into an agreement with Molecular Engines
Laboratories SA (MEL) to collaborate on a program to identify differentially
expressed genes associated with tumor reversion, through applying our Megasort
technology to cancer cell lines provided by MEL. MEL plans to incorporate the
findings into its overall research in the areas of tumor reversion, tumor
suppression, programmed cell death, cell growth arrest and other processes
involving cell death. Elucidation of the differentially expressed genes could
lead to the development of research, diagnostic and therapeutic products or
services in the cancer field. Under the terms of the agreement, we will receive
payments from MEL for genomic discovery services as well as royalty payments
from the commercialization of any products or services stemming from the
scientific results of the research program.


                                       7


<PAGE>   10
   Institute of Molecular and Cell Biology

        In October 2000, we entered into an agreement with the Institute of
Molecular and Cell Biology, or IMCB, an institute affiliated with the National
University of Singapore, to collaborate on a broad program designed to discover
genes and molecular mechanisms involved in cancer, infectious diseases and other
diseases prevalent in Asia Pacific. We will apply our Megasort and MPSS
technologies to samples provided by the IMCB to discover differentially
expressed genes. The IMCB will then use these discoveries to further
characterize the genes involved in the disease processes, using their
technologies and biological expertise. The data from the combined program are
expected to provide unique insights into diseases that could lead to research,
diagnostics and therapeutic products or services. Under the terms of the
agreement, we will receive from the IMCB payments for technology access fees and
for genomics discovery services to be performed by Lynx. Additionally, we could
share in the profits, if any, from the licensing or sale of the scientific
results of the collaboration to a third party.

  Takara

        In November 2000, we entered into a technology licensing agreement with
Takara Shuzo Co. Ltd. of Japan. The license provides Takara with the right in
Japan, Korea and China, including Taiwan, to use our proprietary Megaclone,
Megasort and MPSS technologies exclusively for at least five years, and
non-exclusively thereafter, to provide genomics discovery services and to
manufacture and sell microarrays containing content identified by our
technologies. Takara also receives a non-exclusive license right to manufacture
and sell such microarrays elsewhere throughout the world. Under the terms of the
agreement, we will receive from Takara payments for technology access fees,
royalties on sales of microarrays and revenues from genomics discovery services,
the sale to Takara of proprietary reagents used in applying our technologies and
purchases of Lynx common stock.

   Phytera

        In January 2001, we entered into a collaboration with Phytera, Inc. to
identify genes from plants involved in the biosynthesis of anti-oxidant
polyphenols, naturally occurring compounds with nutraceutical and pharmaceutical
activity. Phytera will select plant species from its culture libraries and apply
its proprietary ExPAND(R) manipulation technology to regulate the expression of
the metabolic pathways and genes responsible for the production of specific
anti-oxidant polyphenolic compounds. We will then use our proprietary Megasort
technology to identify genes activated after target compounds are induced. Lynx
and Phytera intend to validate gene targets and jointly commercialize the genes
with other partners in the nutraceutical and pharmaceutical sectors.

   Celera

        In March 2001, we entered into two agreements with Celera Genomics. The
first agreement involves the integration of sets of Lynx's high-resolution gene
expression data, derived from normal human tissues analyzed using Lynx's MPSS
technology, into Celera's database products for distribution to Celera's
customers through the Celera Discovery System (CDS). Under a second agreement,
Lynx will apply its MPSS technology to perform additional gene expression
analyses of various tissues for Celera and to help supplement the Lynx database
offering.

COMPETITION

        Competition among entities attempting to identify the genes associated
with specific diseases and to develop products based on such discoveries is
intense. We face, and will continue to face, competition from pharmaceutical,
biotechnology and agricultural companies, academic and research institutions and
government agencies, both in the United States and abroad. Several entities are
attempting to identify and patent randomly sequenced genes and gene fragments,
while others are pursuing a gene identification, characterization and product
development strategy based on positional cloning. We are aware that certain
entities are using a variety of gene expression analysis methodologies,
including chip-based systems, to attempt to identify disease-related genes. In
addition, numerous pharmaceutical companies are developing genomic research
programs, either alone or in partnership with our competitors. Competition among
such entities is intense and is expected to increase. In order to successfully
compete against existing and future technologies, we will need to demonstrate to
potential customers that our technologies and capabilities are superior to those
of competitors.

        Some of our competitors have substantially greater capital resources,
research and development staffs, facilities, manufacturing and marketing
experience, distribution channels and human resources than us. These competitors
may discover, characterize or develop important genes, drug targets or drug
leads, drug discovery technologies or drugs in advance of our customers or us or
which are more effective than those developed by our collaborators and customers
or us. They may also obtain regulatory approvals for their


                                       8


<PAGE>   11
drugs more rapidly than our collaborators or customers will, any of which could
have a material adverse effect on our business. Moreover, our competitors may
obtain patent protection or other intellectual property rights that could limit
our rights or our collaborators' and customers' abilities to use our
technologies or commercialize therapeutic, diagnostic or agricultural products.
We also face competition from these and other entities in gaining access to
cells, tissues and nucleic acid samples for use in our discovery programs.

INTELLECTUAL PROPERTY

        We are pursuing a strategy designed to obtain United States and foreign
patent protection for our core technologies. Our long-term commercial success
will be dependent in part on our ability to obtain commercially valuable patent
claims and to protect our intellectual property portfolio. As of December 31,
2000, we owned or controlled 63 issued patents and 117 pending patent
applications in the United States and foreign countries relating to our genomics
technologies.

        In addition to acquiring patent protection for our core analysis
technologies, as part of our business strategy, we intend to file for patent
protection on sets of genes, both known and newly discovered, that have
diagnostic or prognostic applications, novel genes that may serve as drug
development targets, genetic maps and sets of genetic markers, such as SNPs,
that are associated with traits or conditions of medical or economic importance.
However, there is substantial uncertainty regarding the availability of such
patent protection.

        Patent law relating to the scope of claims in the technology field in
which we operate is still evolving. The degree to which we will be able to
protect our technology with patents, therefore, is uncertain. Others may
independently develop similar or alternative technologies, duplicate any of our
technologies, and, if patents are licensed or issued to us, design around the
patented technologies licensed to or developed by us. In addition, we could
incur substantial costs in litigation if we are required to defend ourselves in
patent suits brought by third parties or if we initiate such suits.

        With respect to proprietary know-how that is not patentable and for
processes for which patents are difficult to enforce, we rely on trade secret
protection and confidentiality agreements to protect our interests. We intend to
maintain several important aspects of our technology platform as trade secrets.
While we require all employees, consultants, collaborators, customers and
licensees to enter into confidentiality agreements, we cannot be certain that
proprietary information will not be disclosed or that others will not
independently develop substantially equivalent proprietary information.

RESEARCH AND DEVELOPMENT EXPENDITURES

        We have devoted our efforts primarily to research and development.
Research and development expenses were $19.8 million for the year ended December
31, 2000, $15.5 million for the year ended December 31, 1999 and $13.2 million
for the year ended December 31, 1998.

SCIENTIFIC ADVISORS

        Our principal scientific advisor:

        Sydney Brenner, M.B., D.Phil., is a distinguished Professor at the Salk
Institute of Biological Studies in La Jolla, California. From July 1996 to
January 2001, Dr. Brenner served as Director and President of The Molecular
Sciences Institute, a non-profit research institute in Berkeley, California.
Until his retirement in 1996, Dr. Brenner was Honorary Professor of Genetic
Medicine, University of Cambridge School of Clinical Medicine, Cambridge,
England. Dr. Brenner is known for his work on genetic code and the information
transfer from genes to proteins, and for his pioneering research on the genetics
and development of the nematode. Dr. Brenner is a Fellow of the Royal Society
(1995) and a Foreign Associate of the U.S. National Academy of Sciences (1977)
and has received numerous awards of recognition, including the Albert Lasker
Medical Research Award (1991), the Genetics Society of America Medal (1987) and
the Kyoto Prize (1990). Dr. Brenner is the principal inventor of Lynx's
bead-based technologies.

EMPLOYEES

        As of December 31, 2000, we employed 156 full-time employees, of which
128 were engaged in research and development activities and 28 in finance and
administrative activities. We believe we have been successful in attracting
skilled and experienced scientific personnel; however, competition for such
personnel is intense. None of our employees are covered by collective bargaining
agreements, and management considers relations with our employees to be good.


                                       9


<PAGE>   12
                                 BUSINESS RISKS

        Lynx's business faces significant risks. These risks include those
described below and may include additional risks of which Lynx is not currently
aware or which Lynx currently does not believe are material. If any of the
events or circumstances described in the following risks actually occurs, our
business, financial condition or results of operations could be materially
adversely affected. These risks should be read in conjunction with the other
information set forth in this report.

OUR TECHNOLOGIES ARE NEW AND UNPROVEN AND MAY NOT ALLOW US OR OUR COLLABORATORS
TO IDENTIFY GENES OR TARGETS FOR DRUG DISCOVERY.

        Our technologies are new and unproven. The application of these
technologies is in too early a stage to determine whether they can be
successfully implemented. These technologies assume information about gene
expression and gene sequences that may enable scientists to better understand
complex biological processes. Relatively few therapeutic products based on gene
discoveries have been successfully developed and commercialized. Our
technologies may not enable us or our collaborators to identify genes or targets
for drug discovery. To date, no targets for drug discovery have been identified
based on our technologies.

WE ARE DEPENDENT ON OUR COLLABORATIONS AND WILL NEED TO FIND ADDITIONAL
COLLABORATORS IN THE FUTURE TO DEVELOP AND COMMERCIALIZE DIAGNOSTIC OR
THERAPEUTIC PRODUCTS.

        Our strategy for the development and commercialization of our
technologies and potential products includes entering into collaborations,
service agreements or licensing arrangements with pharmaceutical, biotechnology
and agricultural companies. We do not have the resources to develop or
commercialize diagnostic or therapeutic products on our own. We cannot assure
you that we will be able to negotiate additional collaborative and other
arrangements or contracts on acceptable terms, or at all, or that such
collaborations or relationships will be successful.

        Substantially all of our revenues have been derived from corporate
collaborations and agreements. Revenues from collaborations and related
agreements depend upon continuation of the collaborations, the achievement of
milestones and royalties derived from future products developed from our
research and technologies. If we are unable to successfully achieve milestones
or our collaborators fail to develop successful products, we will not earn the
revenues contemplated under such collaborative agreements. If existing
agreements are not renewed, or if we are unable to enter into new collaborative
and other agreements on commercially acceptable terms, our revenues may
decrease, and our activities may fail to lead to commercialized products.

        Our dependence on collaborative arrangements with third parties subjects
us to a number of risks. We have limited or no control over the resources that
our collaborators may choose to devote to our joint efforts. Our collaborators
may breach or terminate their agreements with us or fail to perform their
obligations thereunder. Further, our collaborators may elect not to develop
products arising out of our collaborative arrangements or may fail to devote
sufficient resources to the development, manufacture, market or sale of such
products. Some of our collaborators could also become our competitors in the
future. Our business could be harmed if our collaborators:

        -       do not develop commercially successful products using our
                technologies;

        -       develop competing products;

        -       preclude us from entering into collaborations with their
                competitors;

        -       fail to obtain necessary regulatory approvals; or

        -       terminate their agreements with us.

WE ARE AN EARLY STAGE COMPANY, SO OUR PROFITABILITY IS UNCERTAIN AND THERE IS A
HIGH RISK OF FAILURE.

        You must evaluate us in light of the uncertainties and complexities
affecting an early stage genomics company. Our products and services are still
in the early stages of commercialization. Our technologies depend on the
successful integration of independent technologies, each of which has its own
development risks. We cannot assure you that our technologies will continue to
be successfully developed, that our services will continue to be sought by
customers or that any products developed from our technologies will prove to be
commercially successful. Further, we cannot assure you that we will be
successful in expanding the


                                       10


<PAGE>   13
scope of our research into new areas of pharmaceutical, biotechnology or
agricultural research. Significant research and development, financial resources
and personnel will be required to capitalize on our technologies.
Commercialization of our technologies, whether through the sales of services,
royalties or other arrangements, may not generate sufficient or sustainable
revenues to enable us to be profitable.

WE HAVE A HISTORY OF NET LOSSES. WE EXPECT TO CONTINUE TO INCUR NET LOSSES, AND
WE MAY NOT ACHIEVE OR MAINTAIN PROFITABILITY.

        We have incurred net losses each year since our inception in 1992,
including net losses of approximately $4.3 million in 1998, $6.7 million in 1999
and $13.3 million in 2000. As of December 31, 2000, we had an accumulated
deficit of approximately $66.7 million. We expect these losses to continue for
at least the next several years. The size of these net losses will depend, in
part, on the rate of growth, if any, in our revenues and on the level of our
expenses. Our research and development expenditures and general and
administrative costs have exceeded our revenues to date, and we expect research
and development expenses to continue to increase due to planned spending for
ongoing technology development and implementation, as well as new applications.
As a result, we will need to generate significant additional revenues to achieve
profitability. Even if we do increase our revenues and achieve profitability, we
may not be able to sustain profitability.

        Our ability to generate revenues and achieve profitability is dependent
on many factors, including:

        -       our ability to enter into additional corporate collaborations
                and agreements;

        -       our ability to discover genes and targets for drug discovery;

        -       our collaborators' ability to develop diagnostic and therapeutic
                products from our drug discovery targets; and

        -       the successful clinical testing, regulatory approval and
                commercialization of such products.

The time required to reach profitability is highly uncertain, and we cannot
assure you that we will be able to achieve profitability on a sustained basis,
if at all.

WE MAY NEED TO RAISE ADDITIONAL FUNDS IN THE FUTURE, WHICH MAY NOT BE AVAILABLE
TO US.

        We have invested significant capital in our infrastructure and in our
scientific and business development activities. We expect our capital and
operating expenditures to increase over the next several years as we expand our
operations. Our future capital requirements will depend on many factors,
including:

        -       the progress and scope of our collaborative and independent
                research and development projects;

        -       payments received under collaborative and other agreements;

        -       our ability to establish and maintain collaborative and other
                arrangements;

        -       the progress of the development and commercialization efforts
                under our collaborations and corporate agreements;

        -       the costs associated with obtaining access to samples and
                related information; and

        -       the costs involved in preparing, filing, prosecuting,
                maintaining and enforcing patent claims and other intellectual
                property rights.

        Changes to our current operating plan may require us to consume
available capital resources significantly sooner than we expect. We may be
unable to raise sufficient additional capital when we need it, on favorable
terms, or at all. If our capital resources are insufficient to meet future
capital requirements, we will have to raise additional funds. The sale of equity
or convertible debt securities in the future would be dilutive to our
stockholders. If we are unable to obtain adequate funds on reasonable terms, we
may be required to curtail operations significantly or to obtain funds by
entering into financing or collaborative agreements on unattractive terms.


                                       11


<PAGE>   14
OUR REVENUES DEPEND ON A SMALL NUMBER OF COLLABORATORS AND CUSTOMERS.

        To date, we have received a significant portion of our revenues from a
small number of collaborators and customers. For the year ended December 31,
2000, revenues from 3 collaborators and customers accounted for 51%, 29% and 11%
of our total revenues. For the year ended December 31, 1999, revenues from 3
collaborators and customers accounted for 81%, 13% and 5% of our total revenues.
For the year ended December 31, 1998, revenues from three collaborators and
customers accounted for 61%, 33% and 5% of our total revenues. Our operating
results may be harmed, if we lose one of these collaborators or customers and we
are not able to attract new collaborators or customers.

WE DEPEND ON A SOLE SUPPLIER TO MANUFACTURE FLOW CELLS USED IN OUR MPSS
TECHNOLOGY.

        The flow cells used in our MPSS technology are obtained from a single
supplier. Our reliance on outside vendors generally, and this sole supplier in
particular, involves several risks, including:

        -       the inability to obtain an adequate supply of required
                components due to manufacturing capacity constraints, a
                discontinuance of a product by a third-party manufacturer or
                other supply constraints;

        -       reduced control over quality and pricing of components; and

        -       delays and long lead times in receiving materials from vendors.

THE GENOMICS INDUSTRY IS INTENSELY COMPETITIVE AND EVOLVING RAPIDLY, AND OUR
COMPETITORS MAY DEVELOP PRODUCTS AND TECHNOLOGIES THAT MAKE OURS OBSOLETE.

        The biotechnology industry is highly fragmented and is characterized by
rapid technological change. In particular, the area of genomics research is a
rapidly evolving field. Competition among entities attempting to identify genes
associated with specific diseases and to develop products based on such
discoveries is intense. Many of our competitors have substantially greater
research and product development capabilities and financial, scientific and
marketing resources than we do.

        We face, and will continue to face, competition from pharmaceutical,
biotechnology and agricultural companies, as well as academic research
institutions, clinical reference laboratories and government agencies. Some of
our competitors:

        -       are attempting to identify and patent randomly sequenced genes
                and gene fragments;

        -       are pursuing a gene identification, characterization and product
                development strategy based on positional cloning; and

        -       are using a variety of different gene expression analysis
                methodologies, including the use of chip-based systems, to
                attempt to identify disease-related genes.

        In addition, numerous pharmaceutical, biotechnology and agricultural
companies are developing genomic research programs, either alone or in
partnership with our competitors. Our future success will depend on our ability
to maintain a competitive position with respect to technological advances. Rapid
technological development by others may result in our technologies and future
products becoming obsolete.

        Any products that are developed through our technologies will compete in
highly competitive markets. Our competitors may be more effective at using their
technologies to develop commercial products. Further, we cannot assure you that
our competitors will not obtain intellectual property rights that would limit
the use of our technologies or the ability to commercialize diagnostic or
therapeutic products using our technologies. As a result, our competitors may be
able to more easily develop technologies and products that would render our
technologies and products, and those of our collaborators, obsolete and
noncompetitive.

IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGIES, THIRD
PARTIES MAY BE ABLE TO USE OUR TECHNOLOGY, WHICH COULD ADVERSELY AFFECT OUR
ABILITY TO COMPETE IN THE MARKET.

        Our success depends in part on our ability to obtain patents and
maintain adequate protection of the intellectual property related to our
technologies and products. The patent positions of biotechnology companies,
including our patent position, are generally uncertain


                                       12


<PAGE>   15
and involve complex legal and factual questions. We will be able to protect our
proprietary rights from unauthorized use by third parties only to the extent
that our proprietary technologies are covered by valid and enforceable patents
or are effectively maintained as trade secrets. The laws of some foreign
countries do not protect proprietary rights to the same extent as the laws of
the U.S., and many companies have encountered significant problems in protecting
and defending their proprietary rights in foreign jurisdictions. We have applied
and will continue to apply for patents covering our technologies, processes and
products as and when we deem appropriate. However, these applications may be
challenged or may fail to result in issued patents. Our existing patents and any
future patents we obtain may not be sufficiently broad to prevent others from
practicing our technologies or from developing competing products. Furthermore,
others may independently develop similar or alternative technologies or design
around our patents. In addition, our patents may be challenged or invalidated or
fail to provide us with any competitive advantage.

        We also rely on trade secret protection for our confidential and
proprietary information. We have taken security measures to protect our
proprietary information and trade secrets, but these measures may not provide
adequate protection. While we seek to protect our proprietary information by
entering into confidentiality agreements with employees, collaborators and
consultants, we cannot assure you that our proprietary information will not be
disclosed or that we can meaningfully protect our trade secrets. In addition,
our competitors may independently develop substantially equivalent proprietary
information or may otherwise gain access to our trade secrets, which could
adversely affect our ability to compete in the market.

LITIGATION OR THIRD-PARTY CLAIMS OF INTELLECTUAL PROPERTY INFRINGEMENT COULD
REQUIRE US TO SPEND SUBSTANTIAL TIME AND MONEY AND ADVERSELY AFFECT OUR ABILITY
TO DEVELOP AND COMMERCIALIZE OUR TECHNOLOGIES AND PRODUCTS.

        Our commercial success depends in part on our ability to avoid
infringing patents and proprietary rights of third parties and not breaching any
licenses that we have entered into with regard to our technologies. Other
parties have filed, and in the future are likely to file, patent applications
covering genes, gene fragments, the analysis of gene expression and the
manufacture and use of DNA chips. We intend to continue to apply for patent
protection for methods relating to gene expression and for the individual
disease genes and drug discovery targets we discover. If patents covering
technologies required by our operations are issued to others, we may have to
rely on licenses from third parties. We cannot assure you that such licenses
will be available on commercially reasonable terms, or at all.

        Third parties may accuse us of employing their proprietary technology
without authorization. In addition, third parties may obtain patents that relate
to our technologies and claim that use of such technologies infringes these
patents. Regardless of their merit, such claims could require us to incur
substantial costs, including the diversion of management and technical
personnel, in defending ourselves against any such claims or enforcing our
patents. In the event that a successful claim of infringement is brought against
us, we may be required to pay damages and obtain one or more licenses from third
parties. We may not be able to obtain these licenses at a reasonable cost, or at
all. Defense of any lawsuit or failure to obtain any of these licenses could
adversely affect our ability to develop and commercialize our technologies and
products.

WE HAVE LIMITED EXPERIENCE IN SALES AND MARKETING AND THUS MAY BE UNABLE TO
FURTHER COMMERCIALIZE OUR TECHNOLOGIES AND PRODUCTS.

        Our ability to achieve profitability depends on attracting collaborators
and customers for our technologies and products. There are a limited number of
pharmaceutical, biotechnology and agricultural companies that are potential
collaborators and customers for our technologies and products. To market our
technologies and products, we must develop a sales and marketing group with the
appropriate technical expertise. We may not be able to build such a sales force.
We cannot assure you that our sales and marketing efforts will be successful or
that our technologies and products will gain market acceptance.

OUR SALES CYCLE IS LENGTHY, AND WE MAY SPEND CONSIDERABLE RESOURCES ON
UNSUCCESSFUL SALES EFFORTS OR MAY NOT BE ABLE TO ENTER INTO AGREEMENTS ON THE
SCHEDULE WE ANTICIPATE.

        Our ability to obtain collaborators and customers for our technologies
and products depends in significant part upon the perception that our
technologies and products can help accelerate their drug discovery and genomics
efforts. Our sales cycle is typically lengthy, because we need to educate our
potential collaborators and customers and sell the benefits of our products to a
variety of constituencies within such companies. In addition, we may be required
to negotiate agreements containing terms unique to each collaborator or
customer. We may expend substantial funds and management effort with no
assurance that we will successfully sell our technologies and products. Actual
and proposed consolidations of pharmaceutical companies have negatively
affected, and may in the future negatively affect, the timing and progress of
our sales efforts.


                                       13


<PAGE>   16
WE MAY HAVE DIFFICULTY MANAGING OUR GROWTH.

        We expect to continue to experience significant growth in the number of
our employees and the scope of our operations. This growth may place a
significant strain on our management and operations. As our operations expand,
we expect that we will need to manage additional relationships with various
collaborators and customers, suppliers and other third parties. Our ability to
manage our operations and growth effectively requires us to continue to improve
our operational, financial and management controls, reporting systems and
procedures. If we are unable to manage this growth effectively, our business may
be harmed.

THE LOSS OF KEY PERSONNEL OR THE INABILITY TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL COULD IMPAIR THE GROWTH OF OUR BUSINESS.

        We are highly dependent on the principal members of our management and
scientific staff. The loss of any of these persons' services might adversely
impact the achievement of our objectives and the continuation of existing
collaborations. In addition, recruiting and retaining qualified scientific
personnel to perform future research and development work will be critical to
our success. There is currently a shortage of skilled executives and employees
with technical expertise, and this shortage is likely to continue. As a result,
competition for skilled personnel is intense and turnover rates are high.
Competition for experienced scientists from numerous companies and academic and
other research institutions may limit our ability to attract and retain such
personnel. We are dependent on our President and Chief Executive Officer, Norman
J.W. Russell, Ph.D., the loss of whose services could have a material adverse
effect on our business.

WE USE HAZARDOUS CHEMICALS AND RADIOACTIVE AND BIOLOGICAL MATERIALS IN OUR
BUSINESS. ANY CLAIMS RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE
MATERIALS COULD BE TIME CONSUMING AND COSTLY.

        Our research and development processes involve the controlled use of
hazardous materials, including chemicals and radioactive and biological
materials. Our operations produce hazardous waste products. We cannot eliminate
the risk of accidental contamination or discharge and any resultant injury from
these materials. Federal, state and local laws and regulations govern the use,
manufacture, storage, handling and disposal of hazardous materials. We may be
sued for any injury or contamination that results from our use or the use by
third parties of these materials, and our liability may exceed our insurance
coverage and our total assets. Compliance with environmental laws and
regulations may be expensive, and current or future environmental regulations
may impair our research, development and production efforts.

ETHICAL, LEGAL AND SOCIAL ISSUES MAY LIMIT THE PUBLIC ACCEPTANCE OF, AND DEMAND
FOR, OUR TECHNOLOGIES AND PRODUCTS.

        Our collaborators and customers may seek to develop diagnostic products
based on genes we discover. The prospect of broadly available gene-based
diagnostic tests raises ethical, legal and social issues regarding the
appropriate use of gene-based diagnostic testing and the resulting confidential
information. It is possible that discrimination by third-party payors, based on
the results of such testing, could lead to the increase of premiums by such
payors to prohibitive levels, outright cancellation of insurance or
unwillingness to provide coverage to individuals showing unfavorable gene
expression profiles. Similarly, employers could discriminate against employees
with gene expression profiles indicative of the potential for high
disease-related costs and lost employment time. Finally, government authorities
could, for social or other purposes, limit or prohibit the use of such tests
under certain circumstances. We cannot assure you that ethical, legal and social
concerns about genetic testing and target identification will not adversely
affect market acceptance of our technologies and products.

        Although our technology is not dependent on genetic engineering, genetic
engineering plays a prominent role in our approach to product development. The
subject of genetically modified food has received negative publicity, which has
aroused public debate. Adverse publicity has resulted in greater regulation
internationally and trade restrictions on imports of genetically altered
agricultural products. Public attitudes may be influenced by claims that
genetically engineered products are unsafe for consumption or pose a danger to
the environment. Such claims may prevent genetically engineered products from
gaining public acceptance. The commercial success of our future products may
depend, in part, on public acceptance of the use of genetically engineered
products, including drugs and plant and animal products.

IF WE DEVELOP PRODUCTS WITH OUR COLLABORATORS, AND IF PRODUCT LIABILITY LAWSUITS
ARE SUCCESSFULLY BROUGHT AGAINST US, WE COULD FACE SUBSTANTIAL LIABILITIES THAT
EXCEED OUR RESOURCES.

        We may be held liable if any product we develop with our collaborators
causes injury or is otherwise found unsuitable during product testing,
manufacturing, marketing or sale. Although we have general liability and product
liability insurance, this insurance may become prohibitively expensive or may
not fully cover our potential liabilities. Inability to obtain sufficient
insurance coverage at


                                       14


<PAGE>   17
an acceptable cost or to otherwise protect us against potential product
liability claims could prevent or inhibit the commercialization of products
developed with our collaborators.

HEALTHCARE REFORM AND RESTRICTIONS ON REIMBURSEMENTS MAY LIMIT OUR RETURNS ON
DIAGNOSTIC OR THERAPEUTIC PRODUCTS THAT WE MAY DEVELOP WITH OUR COLLABORATORS.

        If we are successful in validating targets for drug discovery, products
that we develop with our collaborators based on those targets may include
diagnostic or therapeutic products. The ability of our collaborators to
commercialize such products may depend, in part, on the extent to which
reimbursement for the cost of these products will be available from government
health administration authorities, private health insurers and other
organizations. In the U.S., third-party payors are increasingly challenging the
price of medical products and services. The trend towards managed healthcare in
the U.S., legislative healthcare reforms and the growth of organizations such as
health maintenance organizations that may control or significantly influence the
purchase of healthcare products and services, may result in lower prices for any
products our collaborators may develop. Significant uncertainty exists as to the
reimbursement status of newly approved healthcare products, and we cannot assure
you that adequate third-party coverage will be available to enable our
collaborators to maintain price levels sufficient to realize an appropriate
return on their investment in research and product development.

OUR FACILITIES ARE LOCATED NEAR KNOWN EARTHQUAKE FAULT ZONES, AND THE OCCURRENCE
OF AN EARTHQUAKE OR OTHER CATASTROPHIC DISASTER COULD CAUSE DAMAGE TO OUR
FACILITIES AND EQUIPMENT, WHICH COULD REQUIRE US TO CEASE OR CURTAIL OPERATION.

        Our facilities are located near known earthquake fault zones and are
vulnerable to damage from earthquakes. We are also vulnerable to damage from
other types of disasters, including fire, floods, power loss, communications
failures and similar events. If any disaster were to occur, our ability to
operate our business at our facilities would be seriously, or potentially
completely, impaired. In addition, the unique nature of our research activities
could cause significant delays in our programs and make it difficult for us to
recover from a disaster. The insurance we maintain may not be adequate to cover
our losses resulting from disasters or other business interruptions.
Accordingly, an earthquake or other disaster could materially and adversely harm
our ability to conduct business.

OUR STOCK PRICE MAY BE EXTREMELY VOLATILE.

        The trading price of our common stock is subject to significant
fluctuations. The market prices of the common stock of many publicly held, early
stage biotechnology companies have in the past been, and can in the future be
expected to be, especially volatile. In addition, the securities markets have
from time to time experienced significant price and volume fluctuations that may
be unrelated to the operating performance of particular companies. The following
factors and events may have a significant and adverse impact on the market price
of our common stock:

        -       fluctuations in our operating results;

        -       announcements of technological innovations or new commercial
                products by us or our competitors;

        -       release of reports by securities analysts;

        -       developments or disputes concerning patent or proprietary
                rights;

        -       developments in our relationships with current or future
                collaborators, customers or licensees; and

        -       general market conditions.

Many of these factors are beyond our control. These factors may cause a decrease
in the market price of our common stock, regardless of our operating
performance.

ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND UNDER DELAWARE LAW COULD
PREVENT OR DELAY A CHANGE IN CONTROL OF OUR COMPANY, EITHER OF WHICH COULD
ADVERSELY AFFECT OUR STOCK PRICE.

        Under our certificate of incorporation, our board of directors has the
authority, without further action by the holders of our common stock, to issue
2,000,000 additional shares of preferred stock from time to time in series and
with preferences and rights as it


                                       15


<PAGE>   18
may designate. These preferences and rights may be superior to those of the
holders of our common stock. For example, the holders of preferred stock may be
given a preference in payment upon our liquidation or for the payment or
accumulation of dividends before any distributions are made to the holders of
common stock.

        Although we have no present intention to authorize or issue any
additional series of preferred stock, any authorization or issuance, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could also have the effect of making it more difficult
for a third party to acquire a majority of our outstanding voting stock. The
preferred stock may have other rights, including economic rights senior to those
of our common stock, and, as a result, an issuance of additional preferred stock
could adversely affect the market value of our common stock. Provisions of
Delaware law may also discourage, delay or prevent someone from acquiring or
merging with us.

RECENT PRONOUNCEMENTS COULD IMPACT OUR FINANCIAL POSITION AND RESULTS OF
OPERATIONS.

        In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivative are either offset against the change in fair value of
assets, liabilities or firm commitments through earnings or recognized in the
other comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of the derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for our year ending December 31,
2001. We do not currently hold any derivatives and we do not expect this
pronouncement to materially impact results of operations.

        In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," which must be adopted in the
fourth quarter of 2000. SAB 101 summarizes certain areas of the Staff's views in
applying generally accepted accounting principles to revenue in financial
statements and specifically addresses revenue recognition for non-refundable
technology access fees. We believe that our revenue recognition policies prior
to adoption of SAB 101 complied with the requirements of SAB 101.

        In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation," which contains rules
designed to clarify the application of APB Opinion No. 25. FIN 44 was effective
on July 1, 2000 and adopted by us at that time. The adoption of FIN 44 did not
have a material impact on our operating results or financial position.


                                       16


<PAGE>   19
ITEM 2. PROPERTIES

        In February 1998, we entered into a noncancelable operating lease for
facilities space of approximately 111,000 square-feet in two buildings in
Hayward, California. Currently, our corporate headquarters, principal research
and development facilities and production facilities are located in one of the
two buildings. The remaining space will be developed and occupied in phases,
depending on our growth. The lease runs through December 2008. We have an option
to extend the lease for an additional five-year period, subject to certain
conditions. We have leased approximately 37,000 square feet of additional space
in one of the buildings for further expansion purposes.

        In June 1998, Lynx GmbH entered into a noncancelable operating lease for
facilities space of approximately 6,300 square-feet in Heidelberg, Germany, to
house its operations. The space will be developed and occupied in phases,
depending on the growth of the organization. The lease terminates in June 2005.
A portion of this space is currently being subleased by BASF-LYNX.

        In August 1993, we entered into a noncancelable operating lease for
another facility that expires on July 31, 2003. In 1998, we entered into an
agreement to sublease a portion of this space, and in 1999, through a subsequent
agreement, subleased the remaining portion of the facility. The term of the
sublease runs through July 2003. Rent from the sublease is sufficient to cover
the rent and other operating expenses incurred by Lynx under the terms of the
1993 lease.

ITEM 3. LEGAL PROCEEDINGS

        We are not a party to any material legal proceedings.

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

        No matters were submitted to a vote of security holders in the quarter
ended December 31, 2000.


                                       17


<PAGE>   20
                                     PART II

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

        On December 30, 1997, we listed our common stock on the Nasdaq National
Market. Prior to December 30, 1997, there was no established public trading
market for our voting stock. Our common stock trades on the Nasdaq National
Market under the symbol LYNX. The following table sets forth, for the periods
indicated, the high and low closing sale prices for our common stock as reported
by the Nasdaq National Market:


<TABLE>
<CAPTION>
                                         COMMON STOCK PRICE
                                         ------------------
                                          HIGH         LOW
                                         ------      ------
<S>                                      <C>         <C>
YEAR ENDED DECEMBER 31, 1999
  First Quarter ...................      $15.00      $ 8.88
  Second Quarter ..................       12.69        9.44
  Third Quarter ...................       15.75       10.63
  Fourth Quarter ..................       37.00        9.13
YEAR ENDED DECEMBER 31, 2000
  First Quarter ...................      $96.88      $24.06
  Second Quarter ..................       47.56       14.25
  Third Quarter ...................       48.75       24.00
  Fourth Quarter ..................       31.25        7.25
</TABLE>


        As of March 22, 2001, there were approximately 2,400 stockholders of
record of our common stock. On March 22, 2001, the last reported sale price of
our common stock was $7.50.

        We have never declared or paid any cash dividends on our common stock.
We currently intend to retain earnings to support the development of our
business and do not anticipate paying cash dividends for the foreseeable future.
Any future determination to pay dividends will be at the discretion of our board
of directors.


                                       18


<PAGE>   21
ITEM 6. SELECTED FINANCIAL DATA

        This section presents our selected consolidated historical financial
data. You should read carefully the consolidated financial statements and the
notes thereto included in this report and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."

        The Consolidated Statement of Operations Data for the years ended
December 31, 1998, 1999 and 2000 and the Consolidated Balance Sheet Data as of
December 31, 1999 and 2000 have been derived from our audited consolidated
financial statements included elsewhere in this report. The Consolidated
Statement of Operations Data for the years ended December 31, 1996 and 1997 and
the Consolidated Balance Sheet Data as of December 31, 1996, 1997 and 1998 have
been derived from our audited financial statements that are not included in this
report. Historical results are not necessarily indicative of future results. See
the Notes to Consolidated Financial Statements for an explanation of the method
used to determine the number of shares used in computing basic and diluted net
loss per share.


<TABLE>
<CAPTION>
                                                                            YEAR ENDED DECEMBER 31,
                                                     --------------------------------------------------------------------
                                                       1996           1997           1998           1999           2000
                                                     --------       --------       --------       --------       --------
                                                                    (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                  <C>            <C>            <C>            <C>            <C>
CONSOLIDATED STATEMENTS  OF  OPERATIONS DATA:
Revenues:
  Technology access and services fees .........      $  1,958       $  3,875       $  2,625       $  7,833       $ 12,389
  Collaborative research and other ............         7,791            707          4,380          5,042            235
                                                     --------       --------       --------       --------       --------
          Total revenues ......................         9,749          4,582          7,005         12,875         12,624
Operating costs and expenses:
  Cost of services fees .......................            --             --             --            828          3,652
  Research and development ....................        12,545         14,226         13,166         15,510         19,761
  General and administrative ..................         3,170          1,930          2,141          4,175          6,170
                                                     --------       --------       --------       --------       --------
          Total operating costs and expenses ..        15,715         16,156         15,307         20,513         29,583
                                                     --------       --------       --------       --------       --------
Loss from operations ..........................        (5,966)       (11,574)        (8,302)        (7,638)       (16,959)
Interest and other income, net ................           585            753          4,106          1,232          4,158
                                                     --------       --------       --------       --------       --------
Loss before provision for income taxes ........        (5,381)       (10,821)        (4,196)        (6,406)       (12,801)
Provision for income taxes ....................            10             --            151            258            500
                                                     --------       --------       --------       --------       --------
Net loss ......................................      $ (5,391)      $(10,821)      $ (4,347)      $ (6,664)      $(13,301)
                                                     ========       ========       ========       ========       ========
Basic and diluted net loss per share ..........      $  (2.45)      $  (3.09)      $  (0.45)      $  (0.60)      $  (1.17)
Shares used in per share computation ..........         2,197          3,501          9,642         11,128         11,388
</TABLE>


<TABLE>
<CAPTION>
                                                                                   DECEMBER 31,
                                                           -----------------------------------------------------------
                                                             1996         1997         1998         1999         2000
                                                           -------      -------      -------      -------      -------
                                                                                 (IN THOUSANDS)
<S>                                                        <C>          <C>          <C>          <C>          <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments ...      $14,082      $24,930      $23,862      $30,786      $18,798
Working capital .....................................        9,118       21,875       20,834       25,042       10,887
Total assets ........................................       18,412       29,267       40,334       51,638       39,215
Notes payable -- noncurrent portion .................           --           --           --        3,471        3,077
Stockholders' equity ................................      $10,732      $25,590      $23,457      $19,646      $ 6,222
</TABLE>


SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA


<TABLE>
<CAPTION>
                                                            FISCAL YEAR 2000 QUARTER ENDED
                                                 -----------------------------------------------------
                                                 MAR. 31        JUNE 30        SEPT. 30       DEC. 31
                                                 --------       --------       --------       --------
                                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                              <C>            <C>            <C>            <C>
STATEMENT OF OPERATIONS DATA:
Revenues ..................................      $  3,016       $  2,834       $  3,425       $  3,349
Loss from operations ......................        (3,918)        (3,421)        (5,177)        (4,443)
Net loss ..................................          (481)        (3,167)        (4,966)        (4,687)
Basic and diluted net loss per share ......      $  (0.04)      $  (0.28)      $  (0.44)      $  (0.41)
</TABLE>


<TABLE>
<CAPTION>
                                                                FISCAL YEAR 1999 QUARTER ENDED
                                                     -----------------------------------------------------
                                                     MAR. 31        JUNE 30        SEPT. 30       DEC. 31
                                                     --------       --------       --------       --------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                  <C>            <C>            <C>            <C>
STATEMENT OF OPERATIONS DATA:
Revenues ......................................      $    654       $    961       $  1,122       $ 10,138
Income (loss) from operations .................        (3,670)        (4,602)        (4,196)         4,830
Net income (loss) .............................        (3,200)        (4,557)        (3,950)         5,043
Basic and diluted net income (loss) per share .      $  (0.29)      $  (0.41)      $  (0.36)      $   0.46
</TABLE>


                                       19


<PAGE>   22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

        Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. When used herein, the words "believe," "anticipate," "expect,"
"estimate" and similar expressions are intended to identify such forward-looking
statements. There can be no assurance that these statements will prove to be
correct. The Lynx'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." Lynx undertakes no obligation to
update any of the forward-looking statements contained herein to reflect any
future events or developments.

OVERVIEW

        We are a leader in the development and application of novel technologies
for the discovery of gene expression patterns and genomic variations important
to the pharmaceutical, biotechnology and agricultural industries. These
technologies are based on Megaclone, our unique and proprietary cloning
procedure. Megaclone transforms a sample containing millions of DNA molecules
into one made up of millions of micro-beads, each of which carries approximately
100,000 copies of one of the DNA molecules in the sample. Based on Megaclone, we
have developed a suite of applications that have the potential to enhance the
pace, scale and quality of genomics and genetics research programs. Currently,
our principal collaborators and customers are BASF AG, E.I. DuPont de Nemours
and Company, Aventis CropScience GmbH, Oxagen Limited Hybrigenics S.A., Genomics
Collaborative Inc., Molecular Engines Laboratories SA, the Institute of
Molecular and Cell Biology, Phytera, Inc. and Celera Genomics. Additionally, we
have provided a license for the use of certain of our technologies to Takara
Shuzo Co. Ltd.

        We have incurred net losses each year since our inception in 1992. As of
December 31, 2000, we had an accumulated deficit of approximately $66.7 million.
We expect these losses to continue for at least the next several years. The size
of these losses will depend, in part, on the rate of growth, if any, in our
revenues and on the level of our expenses.

        Revenues from technology access fees are generally from upfront payments
from our collaborators, customers and licensees who are provided access to our
technologies for specified periods. We receive service fees from our
collaborators and customers for genomics discovery services performed by us on
the biological samples they send to us. Collaborative research revenues are
payments received under various agreements and include such items as milestone
payments. Other revenues include the proceeds from the sale of our technology
assets to BASF-LYNX and product sales under one of our former programs.

        Technology access fees are deferred and recognized as revenue on a
straight-line basis over the noncancelable term of the agreement to which they
relate. Payments for services and/or materials provided by us are recognized as
revenues when earned over the period in which the services are performed and/or
materials are delivered, provided no other obligations, refunds or credits to be
applied to future work exist. Milestone payments are recognized as revenues upon
the achievement of the related milestone and the satisfaction of any related
obligations. Revenues from the sales of products, which have been immaterial to
date, are recognized upon shipment to the customer.

        To date, we have received, and expect to continue to receive in the
future, a significant portion of our revenues from a small number of
collaborators and customers. During 2000, revenues from 3 collaborators and
customers accounted for 51%, 29% and 11% of total revenues. During 1999,
revenues from 3 collaborators and customers accounted for 81%, 13% and 5% of
total revenues. During 1998, revenues from 3 collaborators and customers
accounted for 61%, 33% and 5% of total revenues.

        Revenues in each quarterly and annual period have in the past, and could
in the future, fluctuate due to: the timing and amount of any technology access
fee and the period over which the revenue is recognized; the level of service
fees, which is tied to the number and timing of biological samples received from
our collaborators and customers, as well as our performance of the related
genomics discovery services on the samples; the timing of achievement of
milestones and the amount of related payments to us; and the number, type and
timing of new, and the termination of existing, agreements with collaborators
and customers.

        Cost of services fees includes the costs of direct labor, materials and
supplies, outside expenses, equipment and overhead incurred by us in performing
our genomics discovery services for our collaborators and customers. Research
and development expenses include the costs of personnel, materials and supplies,
outside expenses, equipment and overhead incurred by us in our technology and
application development efforts. We expect research and development expenses to
increase substantially due to planned spending for ongoing technology
development and implementation, as well as new applications. General and
administrative expenses include the costs of personnel, materials and supplies,
outside expenses, equipment and overhead incurred by us primarily in our
administrative,


                                       20


<PAGE>   23
business development, legal and investor relations activities. We expect general
and administrative expenses to increase in support of our research and
development, commercial and business development efforts.

        We account for our investment in BASF-LYNX on the equity method, however
such investment has a carrying value of zero in the financial statements. As we
have no obligation to fund the operations of BASF-LYNX, we have not recognized
our share of BASF-LYNX's losses in the accompanying statements of operations.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2000 AND 1999

Revenues

        We had total revenues of $12.6 million for the year ended December 31,
2000, compared to $12.9 million for the year ended December 31, 1999. Revenues
for 2000 included technology access fees and service fees of $12.4 million and
collaborative research and other revenue of $0.2 million. Revenues for 1999
included technology access and service fees of $7.8 million and collaborative
research revenue from a $5.0 million milestone fee.

Operating Costs and Expenses

        Our total operating costs and expenses were $29.6 million for the year
ended December 31, 2000, compared to $20.5 million for the year ended December
31, 1999. Cost of services fees were $3.7 million for the year ended December
31, 2000, compared to $0.8 million for the year ended December 31, 1999, and
reflect the costs of providing our genomics discovery services. Research and
development expenses were $19.8 million in 2000 and $15.5 million in 1999. The
increase in research and development expenses in 2000, as compared to 1999, is
due primarily to higher personnel-related and facilities expenses and an
increase in materials consumed in research and development efforts. Our efforts
in 2000 were directed toward the expansion of the commercial applications of our
genomics technologies. These activities included new collaborations and other
agreements, internal discovery projects and an internal investment in building a
store of human genomic information. We also continued our development work on
our Megatype and Protein ProFiler technologies. We expect research and
development expenses to continue to increase due to planned spending for ongoing
technology development and implementation, as well as new applications.

        General and administrative expenses were $6.2 million for the year ended
December 31, 2000, compared to $4.2 million for the year ended December 31,
1999. The increase was primarily due to higher personnel-related expenses and
increased costs for outside services. We expect general and administrative
expenses to increase in support of our research and development, commercial and
business development efforts.

Interest and Other Income

        Net interest income decreased to $0.9 million in the year ended December
31, 2000, from $1.1 million in the year ended December 31, 1999, primarily due
to lower average cash, cash equivalents and investment balances during 2000, as
compared to 1999, and increased interest expense incurred on equipment-related
debt outstanding in 2000. Other income was $3.3 million in the year ended
December 31, 2000, and $0.1 million in the year ended December 31, 1999. In
2000, other income was due primarily to a gain of approximately $3.1 million
from the receipt of shares of common stock from Inex Pharmaceuticals
Corporation, as part of the proceeds related to the March 1998 sale of our
former antisense program. In 1999, other income was attributable to a gain on
the sale of certain fixed assets no longer used in our operations.

Income Taxes

        The provision for income taxes of approximately $500,000 for 2000
consisted entirely of foreign withholding tax due on a payment received from one
of our customers, collaborators and licensees. The provision for income taxes of
approximately $258,000 for 1999 consisted entirely of alternative minimum tax.

        As of December 31, 2000, we had a federal net operating loss
carryforward of approximately $38.6 million, which will expire at various dates
from 2008 through 2020, if not utilized. We have a state net operating loss
carryforward of approximately $5.3 million, which will expire in 2010.


                                       21


<PAGE>   24
        As of December 31, 2000, we also had federal and California research and
development and other tax credit carryforwards of approximately $3.8 million and
$1.3 million, respectively. The federal research and development credit will
expire at various dates from 2008 through 2020, if not utilized.

        Utilization of net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended, and
similar state provisions. The annual limitation may result in expiration of net
operating loss and tax credit carryforwards before full utilization. Utilization
of federal and California net operating losses and credit carryforwards incurred
prior to February 1994 is limited on an annual basis under the Internal Revenue
Code of 1986, as amended, as a result of an ownership change in 1994.

YEARS ENDED DECEMBER 31, 1999 AND 1998

Revenues

        We had total revenues of $12.9 million for the year ended December 31,
1999, compared to $7.0 million for the year ended December 31, 1998. Revenues
for 1999 included technology access fees and service fees of $7.8 million and
collaborative research revenue from a $5.0 million milestone fee. Revenues for
1998 included technology access fees of $2.6 million and $4.3 million from the
sale of our technology assets for certain central nervous system, or CNS,
disorders.

Operating Costs and Expenses

        Our total operating costs and expenses were $20.5 million for the year
ended December 31, 1999, compared to $15.3 million for the year ended December
31, 1998. Cost of services fees were $0.8 million in 1999 and reflect the costs
of providing our genomics discovery services, which commenced in 1999. Research
and development expenses were $15.5 million in 1999 and $13.2 million in 1998.
The increase in research and development expenses in 1999, as compared to 1998,
is due primarily to a higher number of personnel, facilities expansion and
activities as we prepared to launch our commercial operations. Our efforts in
1999 focused on initiating production for the commercial application of our
genomics technologies and completing the scientific experimentation that led to
the successful achievement of technology milestones and achievements under
certain of our agreements. We expect research and development expenses to
continue to increase substantially due to planned spending for ongoing
technology development and implementation, as well as new applications.

        General and administrative expenses were $4.2 million for the year ended
December 31, 1999, compared to $2.1 million for the year ended December 31,
1998. The increase was primarily due to higher personnel-related expenses,
outside services costs and facilities expansion. We expect general and
administrative expenses to increase in support of our research and development,
commercial and business development efforts.

Interest and Other Income

        Net interest income decreased to $1.1 million in the year ended December
31, 1999, from $1.2 million in the year ended December 31, 1998, primarily due
to lower average cash, cash equivalents and investment balances during 1999, as
compared to 1998, and interest expense incurred on equipment-related debt
outstanding in 1999. Other income was $0.1 million in the year ended December
31, 1999, and $2.9 million in the year ended December 31, 1998. In 1998, other
income was due primarily to the gain from the sale of the assets associated with
our antisense program to Inex Pharmaceuticals Corporation.

Income Taxes

        The provision for income taxes of approximately $258,000 for 1999 and
$151,000 for 1998 consisted entirely of alternative minimum tax.

LIQUIDITY AND CAPITAL RESOURCES

        Net cash used in operating activities was $9.0 million for the year
ended December 31, 2000, as compared to net cash provided by operating
activities of $7.8 million for the same period in 1999. This change was
primarily due to the change in deferred revenue and a higher net loss in 2000,
offset partially by the change in accounts payable and accrued liabilities, the
difference in depreciation and amortization of fixed assets and leasehold
improvements and the change in accounts receivable. The amount of net cash used
in operating activities differed from the 2000 net loss due primarily to the
depreciation and amortization of fixed assets and leasehold


                                       22


<PAGE>   25
improvements and the collection of accounts receivable. The 1999 net cash
provided by operating activities differed from the 1999 net loss due primarily
to an increase in deferred revenue and collection of accounts receivable,
partially offset by a decrease in current liabilities. Net cash provided by
operating activities of $5.7 million for the year ended December 31, 1998, was
primarily due to increases in deferred revenue, accounts payable and accrued
liabilities, partially offset by an increase in accounts receivable.

        Net cash used in investing activities of $2.3 million for the year ended
December 31, 2000, was due primarily to expenditures for leasehold improvements
and purchases of equipment, partially offset by net maturities of short-term
investments. Net cash used in investing activities of $10.7 million for the year
ended December 31, 1999, was primarily due to net purchases of short-term
investments and leasehold improvements and equipment purchases. Net cash
provided by investing activities of $1.0 million for the year ended December 31,
1998, was primarily due to net maturities of short-term investments, offset in
part by expenditures for leasehold improvements and purchases of equipment.

        Net cash provided by financing activities in 2000 of $1.1 million was
due primarily to issuance of common stock from the exercise of employee stock
options. Net cash provided by financing activities in 1999 of $4.8 million
resulted primarily from borrowings under an equipment loan arrangement. Net cash
provided by financing activities of $0.6 million in the year ended December 31,
1998 resulted from the issuance of common stock. Cash and cash equivalents and
short-term investments were $18.8 million at December 31, 2000.

        In late 1998, we entered into a financing agreement with a financial
institution under which we drew down $4.8 million during 1999 for the purchase
of equipment and certain other capital expenditures. We granted the lender a
security interest in all items financed by us under this agreement. Each draw
down under the loan has a term of 48 months from the date of the draw down. The
original draw down period under the agreement expired on March 31, 2000. In
September 2000, we obtained additional financing of $950,000, under an amendment
to the original financing agreement. As of December 31, 2000, the principal
balance under loans outstanding under this agreement was approximately $4.4
million.

        We plan to use available funds for ongoing commercial and research and
development activities, working capital and other general corporate purposes and
capital expenditures. We expect capital investments during 2001 will be
comprised primarily of equipment purchases required in the normal course of
business and expenditures for leasehold improvements. We intend to invest our
excess cash in investment-grade, interest-bearing securities.

        We have obtained funding for our operations primarily through sales of
preferred and common stock to venture capital investors, institutional investors
and collaborators, payments under contractual arrangements with customers,
collaborators and licensees and interest income. The cost, timing and amount of
funds required for specific uses by us cannot be precisely determined at this
time and will be based upon the progress and the scope of our collaborative and
independent research and development projects; payments received under customer,
collaborative and license agreements; our ability to establish and maintain
customer, collaborative and license agreements; costs of protecting intellectual
property rights; legal and administrative costs; additional facilities capacity
needs and the availability of alternate methods of financing.

        We expect to incur substantial and increasing research and development
expenses and intend to seek additional financing, as needed, through
arrangements with customers, collaborators and licensees and equity or debt
offerings. We cannot assure you that any additional financing we require will be
available on favorable terms, or at all. We believe, at current spending levels,
our existing capital resources and interest income thereon, will enable us to
maintain our current and planned operations through at least the next 12 months.

RECENT ACCOUNTING PRONOUNCEMENTS

        In June 1998, the Financial Accounting Standards Board, or "FASB,"
issued Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 requires us to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivative are either offset against the change in fair value of
assets, liabilities or firm commitments through earnings or recognized in the
other comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of the derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for our year ending December 31,
2001. We do not currently hold any derivatives and we do not expect this
pronouncement to materially impact results of operations.


                                       23


<PAGE>   26
        In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," which must be adopted in the
fourth quarter of 2000. SAB 101 summarizes certain areas of the Staff's views in
applying generally accepted accounting principles to revenue in financial
statements and specifically addresses revenue recognition for non-refundable
technology access fees. We believe that our revenue recognition policies prior
to adoption of SAB 101 complied with the requirements of SAB 101.

        In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation", which contains rules
designed to clarify the application of APB Opinion No. 25. FIN 44 was effective
on July 1, 2000 and adopted by us at that time. The adoption of FIN 44 did not
have a material impact on our operating results or financial position.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Short-Term Investments

        The primary objective of our investment activities is to preserve
principal while, at the same time, maximizing yields without significantly
increasing risk. To achieve this objective, we invest in highly liquid and
high-quality debt securities. Our investments in debt securities are subject to
interest rate risk. To minimize the exposure due to adverse shifts in interest
rates, we invest in short-term securities and maintain an average maturity of
less than one year. As a result, we do not believe we are subject to significant
interest rate risk.

        The Company holds an investment in an equity security that is subject to
market volatility. The fair value of the equity security recorded at December
31, 2000 and 1999 was $2.6 million and $1.8 million, respectively.

Foreign Currency Rate Fluctuations

        The functional currency for our German subsidiary is the deutsche mark.
Our German subsidiary's accounts are translated from the German deutsche mark to
the U.S. dollar using the current exchange rate in effect at the balance sheet
date, for balance sheet accounts, and using the average exchange rate during the
period, for revenues and expense accounts. The effects of translation are
recorded as a separate component of stockholders' equity, and to date, have not
been material. Our German subsidiary conducts its business in local European
currencies. Exchange gains and losses arising from these transactions are
recorded using the actual exchange differences on the date of the transaction.
We have not taken any action to reduce our exposure to changes in foreign
currency exchange rates, such as options or futures contracts, with respect to
transactions with our German subsidiary or transactions with our European
collaborators and customers.


                                       24


<PAGE>   27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                                                         PAGE
                                                                                                         ----
<S>                                                                                                      <C>
Report of Ernst & Young LLP, Independent Auditors....................................................     26
Consolidated Balance Sheets as of December 31, 2000 and 1999.........................................     27
Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998...........     28
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998.     29
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998...........     30
Notes to Consolidated Financial Statements...........................................................     31
</TABLE>


                                       25


<PAGE>   28
                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Lynx Therapeutics

        We have audited the accompanying consolidated balance sheets of Lynx
Therapeutics, Inc. as of December 31, 2000 and 1999, and the related statements
of operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

        In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Lynx Therapeutics,
Inc. at December 31, 2000 and 1999, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States.


                                         /s/   ERNST & YOUNG LLP


Palo Alto, California
February 2, 2001


                                       26


<PAGE>   29
                             LYNX THERAPEUTICS, INC.

                           CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              -----------------------
                                                                2000           1999
                                                              --------       --------
<S>                                                           <C>            <C>
ASSETS
Current assets:
  Cash and cash equivalents ............................      $  7,875       $ 18,050
  Short-term investments ...............................        10,923         12,736
  Accounts receivable ..................................         1,539          4,045
  Other current assets .................................         2,270          1,379
                                                              --------       --------
          Total current assets .........................        22,607         36,210
Property and equipment:
  Leasehold improvements ...............................        11,527         10,347
  Laboratory and other equipment .......................        13,555          8,025
                                                              --------       --------
                                                                25,082         18,372
  Less accumulated depreciation and amortization .......        (9,263)        (5,494)
                                                              --------       --------
Net property and equipment .............................        15,819         12,878
Other non-current assets ...............................           789          2,550
                                                              --------       --------
                                                              $ 39,215       $ 51,638
                                                              ========       ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable .....................................      $  1,640       $    640
  Accrued compensation .................................           614            356
  Deferred revenues -- current portion .................         7,219          8,438
  Note payable -- current portion ......................         1,319            944
  Other accrued liabilities ............................           928            790
                                                              --------       --------
          Total current liabilities ....................        11,720         11,168
Deferred revenues ......................................        17,467         16,896
Note payable ...........................................         3,077          3,471
Other non-current liabilities ..........................           729            457
Commitments
Stockholders' equity:
  Preferred stock, $0.01 par value; 2,000,000 shares
     authorized; no shares issued and outstanding ......            --             --
  Common stock, $0.01 par value; 60,000,000 shares
     authorized, 11,443,702 and 11,219,188 shares
     issued and outstanding at December 31, 2000 and            75,851         74,606
      1999, respectively ...............................
  Notes receivable from stockholders ...................          (263)          (293)
  Deferred compensation ................................        (1,557)        (2,444)
  Accumulated other comprehensive income (loss) ........        (1,157)         1,128
  Accumulated deficit ..................................       (66,652)       (53,351)
                                                              --------       --------
          Total stockholders' equity ...................         6,222         19,646
                                                              --------       --------
                                                              $ 39,215       $ 51,638
                                                              ========       ========
</TABLE>


                             See accompanying notes.


                                       27


<PAGE>   30
                             LYNX THERAPEUTICS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                 --------------------------------------
                                                   2000           1999           1998
                                                 --------       --------       --------
<S>                                              <C>            <C>            <C>
Revenues:
  Technology access and services fees .....      $ 12,389       $  7,833       $  2,625
  Collaborative research and other ........           235          5,042          4,380
                                                 --------       --------       --------
          Total revenues ..................        12,624         12,875          7,005
Operating costs and expenses:
  Cost of services fees ...................         3,652            828             --
  Research and development ................        19,761         15,510         13,166
  General and administrative ..............         6,170          4,175          2,141
                                                 --------       --------       --------
          Total operating costs and
                    expenses...............        29,583         20,513         15,307
                                                 --------       --------       --------
Loss from operations ......................       (16,959)        (7,638)        (8,302)
Interest income, net ......................           900          1,125          1,241
Other income ..............................         3,258            107          2,865
                                                 --------       --------       --------
Loss before provision for income taxes ....       (12,801)        (6,406)        (4,196)
Provision for income taxes ................           500            258            151
                                                 --------       --------       --------
Net loss ..................................      $(13,301)      $ (6,664)      $ (4,347)
                                                 ========       ========       ========
Basic and diluted net loss per share ......      $  (1.17)      $  (0.60)      $  (0.45)
                                                 --------       --------       --------
Shares used in per share computation ......        11,388         11,128          9,642
                                                 ========       ========       ========
</TABLE>


                             See accompanying notes.


                                       28


<PAGE>   31
                             LYNX THERAPEUTICS, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)


<TABLE>
<CAPTION>

                                                          PREFERRED STOCK                      COMMON STOCK
                                                   -----------------------------       -----------------------------
                                                     SHARES             AMOUNT           SHARES            AMOUNT
                                                   -----------       -----------       -----------       -----------
<S>                                                <C>               <C>                 <C>             <C>
Balance at December 31, 1997 ................          495,587       $    27,189         5,892,353       $    46,640
 Comprehensive loss:
   Net loss .................................               --                --                --                --
   Other comprehensive income (loss) ........               --
     Net unrealized gain on
     securities .............................               --                --                --                --
 Comprehensive loss .........................               --                --                --                --
 Exercise of stock options for cash
   and note receivable ......................               --                --           334,309               744
 Repurchase of common stock .................               --                --           (49,717)             (108)
 Conversion of series B, C and D
   preferred stock to common stock ..........         (495,587)          (27,189)        4,955,870            27,189
 Amortization of deferred
   compensation, including forfeitures ......               --                --                --              (416)
 Consulting and service expense
   related to stock option grants ...........               --                --                --               280
                                                   -----------       -----------       -----------       -----------
Balance at December 31, 1998 ................               --                --        11,132,815            74,329
                                                   -----------       -----------       -----------       -----------
 Comprehensive loss:
   Net loss .................................               --                --                --                --
   Other comprehensive income (loss) ........

   Net unrealized gain on securities ........               --                --                --                --
 Comprehensive loss .........................               --                --                --                --
 Employee stock purchase plan issuance ......               --                --            17,379               182
 Exercise of stock options for
   cash and repayment of note receivable ....               --                --            68,994               196
 Amortization of deferred
   compensation, including forfeitures ......               --                --                --              (188)
 Consulting and service expense
   related to stock option grants ...........               --                --                --                87
                                                   -----------       -----------       -----------       -----------
Balance at December 31, 1999 ................               --                --        11,219,188            74,606
                                                   -----------       -----------       -----------       -----------
 Comprehensive loss:
   Net loss .................................               --                --                --                --
   Other comprehensive income (loss) ........
   Net unrealized loss on securities ........               --                --                --                --
 Comprehensive loss .........................               --                --                --                --
 Net exercise of warrants ...................               --                --            29,597                --
 Employee stock purchase plan
  issuance ..................................               --                --            16,532               288
 Exercise of stock options for
   cash and repayment of note receivable ....               --                --           178,385               843
 Amortization of deferred compensation,
   including forfeitures ....................               --                --                --                --
 Consulting and service expense
   related to stock option grants ...........               --                --                --               114
                                                   -----------       -----------       -----------       -----------
Balance at December 31, 2000 ................               --       $        --        11,443,702       $    75,851
                                                   ===========       ===========       ===========       ===========
</TABLE>


<TABLE>
<CAPTION>
                                                 NOTES                           ACCUMULATED
                                              RECEIVABLE                            OTHER                              TOTAL
                                                 FROM            DEFERRED       COMPREHENSIVE      ACCUMULATED      STOCKHOLDERS'
                                             STOCKHOLDERS      COMPENSATION     INCOME (LOSS)        DEFICIT           EQUITY
                                             ------------      ------------     -------------      -----------      -------------
<S>                                          <C>               <C>              <C>                <C>              <C>
Balance at December 31, 1997 .............   $      (460)      $    (5,394)      $       (45)      $   (42,340)      $    25,590
 Comprehensive loss:
   Net loss ..............................            --                --                --            (4,347)           (4,347)
   Other comprehensive income (loss) .....
     Net unrealized gain on
     securities ..........................            --                --                38                                  38
                                                                                                                     -----------
 Comprehensive loss ......................            --                --                --                --            (4,309)
 Exercise of stock options for cash
   and note receivable ...................           (81)               --                --                --               663
 Repurchase of common stock ..............           105                --                --                --                (3)
 Conversion of series B, C and D
   preferred stock to common stock .......            --                --                --                --                --
 Amortization of deferred
   compensation, including forfeitures ...            --             1,652                --                --             1,236
 Consulting and service expense
   related to stock option grants ........            --                --                --                --               280
                                             -----------       -----------       -----------       -----------       -----------
Balance at December 31, 1998 .............          (436)           (3,742)               (7)          (46,687)           23,457
                                             -----------       -----------       -----------       -----------       -----------
 Comprehensive loss:
   Net loss ..............................            --                --                --            (6,664)           (6,664)
   Other comprehensive income (loss) .....
   Net unrealized gain on securities .....            --                --             1,135                --             1,135
                                                                                                                     -----------
 Comprehensive loss ......................            --                --                --                --            (5,529)
 Employee stock purchase plan issuance ...            --                --                --                --               182
 Exercise of stock options for
   cash and repayment of note receivable .           143                --                --                --               339
 Amortization of deferred
   compensation, including forfeitures ...            --             1,298                --                --             1,110
 Consulting and service expense
   related to stock option grants ........            --                --                --                --                87
                                             -----------       -----------       -----------       -----------       -----------
Balance at December 31, 1999 .............          (293)           (2,444)            1,128           (53,351)           19,646
                                             -----------       -----------       -----------       -----------       -----------
 Comprehensive loss:
   Net loss ..............................            --                --                --           (13,301)          (13,301)
   Other comprehensive income (loss) .....
   Net unrealized loss on securities .....            --                --            (2,285)               --            (2,285)
                                                                                                                     -----------
 Comprehensive loss ......................            --                --                --                --           (15,586)
 Net exercise of warrants ................            --                --                --                --                --
 Employee stock purchase plan
  issuance ...............................            --                --                --                --               288
 Exercise of stock options for
   cash and repayment of note receivable .            30                --                --                --               873
 Amortization of deferred compensation,
   including forfeitures .................            --               887                --                --               887
 Consulting and service expense
   related to stock option grants ........            --                --                --                --               114
                                             -----------       -----------       -----------       -----------       -----------
Balance at December 31, 2000 .............   $      (263)      $    (1,557)      $    (1,157)      $   (66,652)      $     6,222
                                             ===========       ===========       ===========       ===========       ===========
</TABLE>


                             See accompanying notes.


                                       29


<PAGE>   32
                             LYNX THERAPEUTICS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                              --------------------------------------
                                                                2000           1999           1998
                                                              --------       --------       --------
<S>                                                           <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ...............................................      $(13,301)      $ (6,664)      $ (4,347)
Adjustments to reconcile net loss to net cash
     provided by (used in) operating activities:
  Depreciation and amortization of fixed assets and
     leasehold improvements ............................         3,769          1,964          1,176
  Issuance of stock options to non-employees in
     exchange for services .............................           114             87            111
  Amortization of deferred compensation ................           887          1,110          1,236
  Gain on sale of antisense business ...................        (3,119)            --             --
  Other ................................................            --             --           (138)
CHANGES IN OPERATING ASSETS AND LIABILITIES
  Accounts receivable ..................................         2,506          1,271         (5,072)
  Other current assets .................................          (891)          (701)          (479)
  Accounts payable .....................................         1,000         (1,130)         1,579
  Accrued liabilities ..................................           396         (3,106)         3,237
  Deferred revenues ....................................          (648)        14,667          8,375
  Other noncurrent liabilities .........................           272            269              9
                                                              --------       --------       --------
Net cash provided by (used in) operating activities ....        (9,015)         7,767          5,687
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments ....................        (8,097)       (22,121)       (21,767)
Maturities of short-term investments ...................        12,543         17,016         30,245
Leasehold improvements and equipment purchases, net of
  retirements ..........................................        (6,710)        (5,205)        (7,254)
Notes receivable from officers and employees ...........            30           (248)          (175)
Other assets ...........................................           (38)          (122)            --
                                                              --------       --------       --------
Net cash provided by (used in) investing activities ....        (2,272)       (10,680)         1,049
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock, net of repurchases ...........         1,131            378            636
Proceeds from equipment loan ...........................           950          4,838             --
Repayment of equipment loan ............................          (969)          (423)            --
                                                              --------       --------       --------
Net cash provided by financing activities ..............         1,112          4,793            636
                                                              --------       --------       --------
Net increase (decrease) in cash and cash equivalents ...       (10,175)         1,880          7,372
Cash and cash equivalents at beginning of year .........        18,050         16,170          8,798
                                                              --------       --------       --------
Cash and cash equivalents at end of year ...............      $  7,875       $ 18,050       $ 16,170
                                                              ========       ========       ========
SUPPLEMENTAL  DISCLOSURES OF  CASH FLOW INFORMATION
Income taxes paid ......................................      $    110       $    303             --
                                                              ========       ========       ========
Interest paid ..........................................      $    128       $    174             --
                                                              ========       ========       ========
Following are the effects of the non-cash
transactions relating to the sale of the antisense
business assets sold, net of depreciation ..............            --             --       $    210
                                                              ========       ========       ========
     Inex stock received ...............................            --             --       $    603
                                                              ========       ========       ========
</TABLE>


                             See accompanying notes.


                                       30


<PAGE>   33
                             LYNX THERAPEUTICS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION

BUSINESS AND BASIS OF PRESENTATION

        Lynx Therapeutics, Inc. ("Lynx" or the "Company") is a leader in the
development and application of novel technologies for the discovery of gene
expression patterns and genomic variations important to the pharmaceutical,
biotechnology and agricultural industries. These technologies are based on
Megaclone, Lynx's unique and proprietary cloning procedure. Megaclone transforms
a sample containing millions of DNA molecules into one made up of millions of
micro-beads, each of which carries approximately 100,000 copies of one of the
DNA molecules in the sample. Based on Megaclone, Lynx has developed a suite of
applications that have the potential to enhance the pace, scale and quality of
genomics and genetics research programs. Currently, Lynx's principal
collaborators and customers are BASF AG, E.I. DuPont de Nemours and Company,
Aventis CropScience GmbH, Oxagen Limited Hybrigenics S.A., Genomics
Collaborative Inc., Molecular Engines Laboratories SA, the Institute of
Molecular and Cell Biology, Phytera, Inc. and Celera Genomics. Additionally,
Lynx has provided a license for the use of certain of its technologies to Takara
Shuzo Co. Ltd.

        The Company's consolidated financial statements have been presented on a
basis that contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has experienced
operating losses since its inception of $66.7 million, including a net loss of
$13.3 million in the year ended December 31, 2000, and expects such losses to
continue as it proceeds with the development and commercialization of its
technology. The Company's cash, cash equivalents and short-term investments were
$18.8 million at December 31, 2000. Management believes that its current capital
resources along with cash to be generated from its existing collaboration
arrangements will be sufficient to enable the Company to meet its projected
operating and capital requirements through December 31, 2001. Additionally, Lynx
intends to seek additional financing, as needed, through arrangements with
customers, collaborators and licensees and equity or debt offerings. There can
be no assurance that additional financing, if required, will be available on
satisfactory terms or at all. If the Company is unable to secure additional
financing, management may need to reevaluate and revise its current operating
plans as well as reduce its anticipated level of expenditures.

        The consolidated financial statements of the Company include the
accounts of the Company and its wholly-owned subsidiary, Lynx Therapeutics GmbH,
formed under the laws of the Federal Republic of Germany. All significant
intercompany balances and transactions have been eliminated. Certain amounts in
prior periods have been reclassified to conform to the current year
presentation.

USE OF ESTIMATES

        The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

        The Company considers all investments in money market mutual funds,
commercial paper and corporate bonds and notes with original maturities from the
date of purchase of 90 days or less as cash equivalents. Investments with
original maturities beyond 90 days are considered to be short-term investments.
Equity securities are considered to be short-term investments. The Company's
investment policy stipulates that the investment portfolio be maintained with
the objectives of preserving principal, maintaining liquidity and maximizing
return.

        The Company determines the appropriate classification of money market
mutual funds, commercial paper and corporate bonds and notes at the time of
purchase and reevaluates such designation as of each balance sheet date. As of
December 31, 2000 and 1999, 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 cost of
investments 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, if any, are included in
interest income or expense. The cost of securities sold, if any, is based on the
specific identification method.


                                       31


<PAGE>   34
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION
(CONTINUED)

        The Company invests its excess cash in deposits with major banks and in
money market and short-term debt securities of companies with strong credit
ratings from a variety of industries. These securities generally mature within
365 days and, therefore, bear minimal interest-rate risk. The Company, by
corporate policy, limits the amount of credit exposure to any one issuer and to
any one type of investment.

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
lesser of the useful life of the asset or the remaining term of the facility
lease.

REVENUE RECOGNITION

        Revenues from technology access fees have generally resulted from
upfront payments from collaborators, customers and licensees who are provided
access to Lynx's technologies for specified periods. The Company receives
service fees from collaborators and customers for genomics discovery services
performed by Lynx on the biological samples they send to Lynx. Collaborative
research revenues are payments received under various agreements and include
such items as milestone payments. Milestone payments are recognized pursuant to
collaborative agreements upon the achievement of specified technology
developments, representing the culmination of the earnings process, for
financial accounting purposes. Other revenues include non-contract related
revenues, such as the proceeds from the sale of technology assets to BASF-LYNX
and product sales under one of Lynx's former programs.

        Technology access fees are deferred and recognized as revenue on a
straight-line basis over the noncancelable term of the agreement to which they
relate. Payments for services and/or materials provided by Lynx are recognized
as revenues when earned over the period in which the services are performed
and/or materials are delivered, provided no other obligations, refunds or
credits to be applied to future work exist. Milestone payments are recognized as
revenue upon the achievement of the related milestone and the satisfaction of
any related obligations. Revenues from the sales of products, which have been
immaterial to date, are recognized upon shipment to the customer.

        During 2000, revenue from 3 collaborators and customers represented 51%,
29% and 11% of total revenues. During 1999, revenue from 3 collaborators and
customers represented 81%, 13% and 5% of total revenues. During 1998, revenue
from three collaborators and customers represented 61%, 33% and 5% of total
revenues.

NET LOSS PER SHARE

        Basic earnings per share ("EPS") is computed by dividing income or loss
applicable to common stockholders by the weighted-average number of common
shares outstanding for the period, net of certain common shares outstanding
which are subject to continued vesting and the Company's right of repurchase.
Diluted EPS reflects the potential dilution of securities that could share in
the earnings of the Company, to the extent such securities are dilutive. Basic
and diluted net loss per share is equivalent for all periods presented herein
due to the Company's net loss in all periods. At December 31, 2000, options to
purchase approximately 2,457,000 shares of common stock at a weighted-average
price of $13.16 per share have been excluded from the calculation of diluted
loss per share for 2000 because the effect of inclusion would be antidilutive.
The options will be included in the calculation at such time as the effect is no
longer antidilutive, as calculated using the treasury stock method. The
weighted-average number of shares subject to repurchase for fiscal years 2000,
1999 and 1998 were 16,000, 55,000 and 152,000, respectively. The common shares
which are outstanding but are subject to the Company's right of repurchase,
which expires ratably over five years, have been excluded from the calculation
of basic loss per share. The repurchasable shares will be included in the
calculation of basic EPS at such time as the Company's right of repurchase
lapses.

        See Note 7 for additional disclosure regarding common stock and stock
options.


                                       32


<PAGE>   35
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION
(CONTINUED)

STOCK-BASED COMPENSATION

        The Company grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and
related Interpretations. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.

        All stock option awards to non-employees are accounted for at the fair
value of the consideration received or the fair value of the equity instrument
issued, as calculated using the Black-Scholes model, in accordance with FAS 123
and Emerging Issues Task Force Consensus No. 96-18, "Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." The option arrangements are
subject to periodic remeasurement over their vesting terms. The Company recorded
compensation expense related to option grants to non-employees of $114,000 for
the year ended December 31, 2000, $87,000 for the year ended December 31, 1999
and $111,000 for the year ended December 31, 1998.

SEGMENT REPORTING

        Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"), establishes
standards for the way that public business enterprises report information about
operating segments in financial statements. SFAS 131 also establishes standards
for related disclosures about products and services, geographic areas and major
customers. The Company's business activities include the development of
technologies aimed at handling and/or analyzing the DNA molecules or fragments
in biological samples. Accordingly, the Company operates in only one business
segment. All of the Company's assets and revenues are derived from this
activity. Substantially all of the Company's assets are located in the United
States. To date, revenues have been derived primarily from contracts with
companies located in North America, Europe and Asia, as follows (revenue is
attributed to geographic areas based on the location of the customers):


<TABLE>
<CAPTION>
                               YEAR ENDED DECEMBER 31,
                          ---------------------------------
                           2000         1999         1998
                          -------      -------      -------
                                   (IN THOUSANDS)
<S>                       <C>          <C>          <C>
North America ......      $ 6,480      $10,440      $   401
Europe .............        5,394        2,435        6,542
Asia ...............          750           --           62
                          -------      -------      -------
                          $12,624      $12,875      $ 7,005
                          =======      =======      =======
</TABLE>


INCOME TAXES

        Under Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" ("SFAS 109"), deferred tax assets and liabilities are
determined based on the difference between financial reporting and tax bases of
assets and liabilities, and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. SFAS 109
provides for the recognition of deferred tax assets if realization of such
assets is more likely than not. Based upon the weight of available evidence,
which includes the Company's historical operating performance and the reported
cumulative net losses for the prior three years, the Company has provided a full
valuation against its net deferred tax assets as of December 31, 2000 and 1999.
The Company intends to evaluate the realizability of the deferred tax assets on
a quarterly basis. See Note 8 to the Consolidated Financial Statements.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires Lynx to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivative are either offset against the change in fair value of
assets, liabilities or firm commitments through earnings or recognized in the
other comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of the derivative's change in fair value will be immediately
recognized in


                                       33


<PAGE>   36
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATION
(CONTINUED)

earnings. SFAS 133 is effective for Lynx's year ending December 31, 2001. Lynx
does not currently hold any derivatives and does not expect this pronouncement
to materially impact results of operations.

        In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," which must be adopted in the
fourth quarter of 2000. SAB 101 summarizes certain areas of the Staff's views in
applying generally accepted accounting principles to revenue in financial
statements and specifically addresses revenue recognition for non-refundable
technology access fees. Lynx believes that its revenue recognition policies
prior to adoption of SAB 101 complied with the requirements of SAB 101.

        In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation", which contains rules
designed to clarify the application of APB Opinion No. 25. FIN 44 was effective
on July 1, 2000 and adopted by Lynx at that time. The adoption of FIN 44 did not
have a material impact on Lynx's operating results or financial position.

2. INVESTMENTS

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


<TABLE>
<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, 2000
Equity securities ...........      $  3,791      $     --       $ (1,164)      $  2,627
Money market mutual funds ...         6,951            --             --          6,951
Corporate bonds and notes ...         8,298             6             --          8,304
                                   --------      --------       --------       --------
                                   $ 19,040      $      6       $ (1,164)      $ 17,882
                                   ========      ========       ========       ========
DECEMBER 31, 1999
Equity securities ...........      $    603      $  1,196       $     --       $  1,799
Money market mutual funds ...         9,624            --             --          9,624
Commercial paper ............        10,449            --            (45)        10,404
Corporate bonds and notes ...         8,781            --            (23)         8,758
                                   --------      --------       --------       --------
                                   $ 29,457      $  1,196       $    (68)      $ 30,585
                                   ========      ========       ========       ========
</TABLE>


        During the years ended December 31, 2000, 1999 and 1998, the Company did
not sell any equity securities. As of December 31, 2000, $7.0 million of the
marketable securities were classified as cash equivalents and $10.9 million were
classified as short-term investments. As of December 31, 1999, $16.1 million of
the marketable securities were classified as cash equivalents, $12.7 million
were classified as short-term investments and $1.8 million were classified as
other non-current assets. All short-term investments have maturities of less
than one year. 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

        BASF and BASF-LYNX

        In October 1996, the Company entered into an agreement with BASF to
provide them with nonexclusive access to certain of its genomics discovery
services. In connection with certain technology development accomplishments,
BASF paid Lynx a technology access fee of $4.5 million in the fourth quarter of
1999. BASF's access to our genomics discovery services is for a minimum of two
years and requires BASF to purchase services at a minimum rate of $4.0 million
per year. BASF paid Lynx $4.0 million in each of the fourth quarters of 1999 and
2000 for genomics discovery services to be performed by Lynx.


                                       34


<PAGE>   37
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. COLLABORATIVE ARRANGEMENTS (CONTINUED)

        In 1996, the Company formed a joint venture company with BASF called
BASF-LYNX Bioscience AG. BASF-LYNX is located in Heidelberg, Germany. BASF-LYNX
began operations in 1997 and is employing Lynx's technologies primarily to
discover and validate novel gene targets for CNS disorders. The Company has
contributed access to its technologies to BASF-LYNX in exchange for an initial
49% equity ownership. BASF, by committing to provide research funding to
BASF-LYNX of DM50 million (or approximately $23.3 million based on a March 2001
exchange rate) over a five-year period beginning in 1997, received an initial
51% equity ownership in BASF-LYNX. In 1998, BASF agreed to provide an additional
$10 million in research funding to BASF-LYNX, of which $4.3 million was paid to
Lynx for technology assets related to a CNS program.

        DuPont

        In October 1998, the Company entered into a research collaboration
agreement with DuPont to apply Lynx's technologies on an exclusive basis to the
study of certain crops and their protection. Under the terms of the agreement,
the Company could receive payments over a five-year period for genomics
discovery services, the achievement of specific technology milestones and the
delivery of genomic maps of specified crops. An initial payment of $10 million
for technology access was received at the execution of the agreement, with
additional minimum service fees of $12 million to be received by Lynx over a
three-year period which commenced in January 1999. In the fourth quarter of
1999, the Company achieved a technology milestone under the agreement that
resulted in a $5 million payment from DuPont.

        Aventis CropScience

        In March 1999, Aventis Pharmaceuticals, formerly Hoechst Marion Roussel,
Inc., obtained nonexclusive access to certain of Lynx's genomics discovery
services for the benefit of its affiliate, Aventis CropScience. The Company
received an initial payment for genomics discovery services to be performed by
Lynx for Aventis CropScience. The service period, which was renewed in March
2000, ends on March 31, 2001, subject to renewal for up to two additional
one-year periods.

        In September 1999, the Company signed a three-year research
collaboration agreement with Aventis CropScience. Aventis CropScience will
receive exclusive access to certain of Lynx's genomics discovery services for
the study of certain plants, which is aimed at developing new crop varieties and
other agricultural products. Under the terms of the agreement, Aventis
CropScience paid Lynx a technology access fee upon execution of the agreement.
The Company can earn additional fees for the performance of genomics discovery
services, the delivery of genomic maps of certain plants and milestone payments
and licensing fees related to the discovery of trait-associated SNPs for the
subject plants.

        Oxagen

        In May 1999, the Company entered into an agreement with Oxagen to
collaborate on a program to discover and validate disease-associated SNPs using
Lynx's Megatype technology. The program initially focuses on inflammatory bowel
disease, but the companies may extend it to other common human disorders. Under
the terms of the agreement, the Company could receive licensing fees and
royalties or otherwise share in the revenues, if any, from the licensing or sale
and subsequent commercialization of related products by Oxagen or third parties.

        Hybrigenics

        In May 2000, the Company entered into an agreement with Hybrigenics to
collaborate on a program to discover expressed genes and protein interactions
and pathways in human obesity, through applying Lynx's Megasort and MPSS
technologies and Hybrigenics' technologies. The goal is to use the findings to
create new diagnostics and treatments for this important disease area. Under the
terms of the agreement, the Company could share in the profits, if any, from the
licensing or sale of the scientific results of the collaboration to a third
party.


                                       35


<PAGE>   38
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. COLLABORATIVE ARRANGEMENTS (CONTINUED)

        Genomics Collaborative

        In August 2000, the Company entered into an agreement with Genomics
Collaborative to conduct a comprehensive genome-wide scan for single nucleotide
polymorphisms, or SNPs, that are associated with type 2 diabetes, also known a
non-insulin dependent diabetes mellitus, using Lynx's Megatype technology. Under
the terms of the agreement, the Company could share in the profits, if any, from
the licensing or sale of the scientific results of the collaboration to a third
party.

        Molecular Engines Laboratories

        In October 2000, the Company entered into an agreement with Molecular
Engines Laboratories SA (MEL) to collaborate on a program to identify
differentially expressed genes associated with tumor reversion, through applying
Lynx's Megasort technology to cancer cell lines provided by MEL. MEL plans to
incorporate the findings into its overall research in the areas of tumor
reversion, tumor suppression, programmed cell death, cell growth arrest and
other processes involving cell death. Elucidation of the differentially
expressed genes could lead to the development of research, diagnostic and
therapeutic products or services in the cancer field. Under the terms of the
agreement, the Company will receive payments from MEL for genomic discovery
services as well as royalty payments from the commercialization of any products
or services stemming from the scientific results of the research program.

        Institute of Molecular and Cell Biology

        In October 2000, the Company entered into an agreement with the
Institute of Molecular and Cell Biology, or IMCB, an institute affiliated with
the National University of Singapore, to collaborate on a broad program designed
to discover genes and molecular mechanisms involved in cancer, infectious
diseases, and other diseases prevalent in Asia Pacific. The Company will apply
its Megasort and MPSS technologies to samples provided by the IMCB to discover
differentially expressed genes. The IMCB will then use these discoveries to
further characterize the genes involved in the disease processes, using its
technologies and biological expertise. The data from the combined program are
expected to provide unique insights into diseases that could lead to research,
diagnostics and therapeutic products or services. Under the terms of the
agreement, the Company will receive from the IMCB payments for technology access
fees and for genomics discovery services to be performed by Lynx. Additionally,
the Company could share in the profits, if any, from the licensing or sale of
the scientific results of the collaboration to a third party.

        Takara

        In November 2000, the Company entered into a technology licensing
agreement with Takara Shuzo Co. Ltd. of Japan. The license provides Takara with
the right in Japan, Korea and China, including Taiwan, to use Lynx's proprietary
Megaclone, Megasort and MPSS technologies exclusively for at least five years,
and non-exclusively thereafter, to provide genomics discovery services and to
manufacture and sell microarrays containing content identified by Lynx's
technologies. Takara also receives from Lynx a non-exclusive license right to
manufacture and sell such microarrays elsewhere throughout the world. Under the
terms of the agreement, the Company will receive from Takara payments for
technology access fees, royalties on sales of microarrays and revenues from
genomics discovery services, the sale to Takara of proprietary reagents used in
applying Lynx's technologies and purchases of Lynx common stock.

4. SALE OF THE ANTISENSE BUSINESS

        In March 1998, Lynx sold its portfolio of phosphorothioate antisense
patents and licenses and its therapeutic oligonucleotide manufacturing facility
(collectively, the "Antisense Business") to Inex Pharmaceuticals Corporation
("Inex"), a Canadian company. As partial consideration in this transaction, Lynx
received $3 million in cash and will receive 1.2 million shares of Inex common
stock, in three equal installments, with the first 400,000 shares received in
March 1998, and the second 400,000 shares received in March 2000. The third
installment of stock is to be received in March 2001. The Inex common stock
received by Lynx is subject to certain restrictions on trading for specific
periods of time following receipt by Lynx, with the sale restriction on the
initial 400,000 shares and second installment of 400,000 shares having expired
on March 10, 2000, and March 10, 2001, respectively. Lynx is also entitled to
receive royalties on future sales of phosphorothioate antisense products. In
addition, Lynx is also entitled to receive royalties under a license to Inex for
phosphoroamidate chemistry for certain therapeutic applications in the fields of
cancer and inflammation.


                                       36


<PAGE>   39
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. SALE OF THE ANTISENSE BUSINESS (CONTINUED)

        The gain on the sale of the Antisense Business in 1998 is based on the
cash and the first installment of the Inex common stock received on the
transaction date, net of the book value of the assets transferred to Inex and
certain other costs associated with the transaction and incurred by Lynx.
Subsequent installments of Inex common stock are recorded at fair value by Lynx
in other income when received. As of December 31, 2000, Inex common stock was
classified as equity securities in short-term investments. As of December 31,
1999, Inex common stock was classified as equity securities in other non-current
assets.

5. LICENSE AGREEMENTS

        Lynx has entered into various license agreements with companies and
academic institutions. Such agreements generally require Lynx to pay annual or
semiannual license fees and are generally cancelable upon 60 to 120 days'
notice. The expenses associated with licenses were approximately $90,000 and
$86,000 for the years ended December 31, 2000 and 1999, respectively. Lynx
recorded a credit to expense of approximately $27,000 in the year ended December
31, 1998 for license fees which had been paid, then subsequently included in the
sale of the antisense business.


6. NOTES RECEIVABLE FROM OFFICERS

        In 1999, the Company entered into loan agreements with officers of the
Company. The aggregate loans total $360,000, are secured by second mortgages on
real property, have interest accruable at the rate of 4.83% to 6.02% per annum
and are subject to early repayment under specified circumstances. The principal
and interest on the loans will be forgiven, based on the officers' continuous
employment over a four-year period, in the following amounts: 50% on the second
anniversary dates of employment; and 25% on each of the third and fourth
anniversary dates of employment.

        In August 1998, the Company entered into two loan agreements with an
officer of the Company. Each loan is in the amount of $100,000, secured by a
second mortgage on real property, with interest accruable at the rate of 5.57%
per annum, and subject to early repayment under specified circumstances. The
principal and interest on one loan will be forgiven, based on the officer's
continuous employment over a four-year period, in the following amounts: 50% on
the second anniversary date of employment; and 25% on each of the third and
fourth anniversary dates of employment. The second loan is to be repaid by the
officer according to the following schedule: 50% of the principal on the third
anniversary date of employment; and the remainder of the principal plus accrued
interest on the fourth anniversary date of employment.

        In April 1997, the Company entered into a full-recourse loan agreement
with an officer of the Company. A note receivable of $250,000 was issued under a
stock purchase agreement for the purchase of 50,000 shares of common stock
whereby all the shares issued under the agreement are pledged as collateral. The
outstanding principal amount is due and payable in full in April 2002, 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 6.49%
per annum.

7. STOCKHOLDERS' EQUITY

PREFERRED STOCK

        On March 31, 1998, pursuant to the Amended and Restated Certificate of
Designation, dated September 30, 1997, 332,288 shares of Series B preferred
stock, 123,299 shares of Series C preferred stock and 40,000 shares of Series D
preferred stock converted into 4,955,870 shares of common stock.


                                       37


<PAGE>   40
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. STOCKHOLDERS' EQUITY (CONTINUED)

COMMON STOCK

        At December 31, 2000, Lynx has reserved 2,915,213 shares of common stock
for issuance upon the exercise of outstanding employee and nonemployee stock
options and upon the issuance of shares to be purchased pursuant to the employee
stock purchase plan as noted below:


<TABLE>
<S>                                           <C>
Stock option grants outstanding ........      2,456,533
Shares available for option grants .....        292,591
Employee stock purchase plan shares ....        166,089
                                              ---------
                                              2,915,213
                                              =========
</TABLE>


        In October 1997, Lynx issued 2,675,500 shares of common stock, resulting
in net proceeds of $25.1 million, pursuant to a common stock purchase agreement
between the Company and certain investors. In connection with this transaction,
warrants were issued by the Company to purchase 50,000 shares of common stock at
an exercise price of $14.00 per share. The warrants were exercised in January
2000.

        In November 1996, Lynx issued 959,182 shares of common stock in exchange
for 737,832 shares of Spectragen, Inc. common stock held by certain officers,
employees and one consultant of Spectragen, pursuant to an Agreement of Merger
between Lynx and Spectragen. Spectragen was a wholly-owned subsidiary of Lynx at
the time of the exchange. A portion of the shares are subject to repurchase
rights, which expire ratably over a five-year period. Pursuant to the merger,
and in accordance with APB 25, "Accounting for Stock Issued to Employees," Lynx
recognized compensation and consultant expense of $2.1 million and recorded
approximately $1.4 million in deferred compensation 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. The deferred compensation will be
charged ratably to expense as the repurchase rights expire.

        Also in November 1996, Lynx issued options to purchase 524,355 shares of
Lynx common stock in exchange for options to purchase 403,350 Spectragen common
stock pursuant to the Agreement of Merger between the Company and Spectragen. In
accordance with APB 25, Lynx recognized deferred compensation of $712,000
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 exchange. The
deferred compensation is being charged to expense over the respective vesting
period of the grants.

1992 STOCK OPTION PLAN

        In July 1992, the Board of Directors of the Company (the "Board")
adopted, and the stockholders subsequently approved, the Company's 1992 Stock
Option Plan (the "1992 Plan"). In May 2000, the stockholders approved an
amendment to the 1992 Plan, authorizing the increase in the number of shares
authorized for issuance under the 1992 Plan from a total of 4,200,000 shares to
4,800,000 shares and the inclusion of directors (including non-employee
directors) of the Company and its affiliates as eligible to participate in the
1992 Plan. In May 1996, the stockholders approved an amendment to the 1992 Plan
extending the term of the 1992 Plan until March 2006.

        Under the 1992 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 December 1997, the Board of Directors approved the commencement of
vesting of certain performance-based stock options that had been granted to
certain employees prior to the merger between Spectragen and Lynx. In connection
with this action, Lynx recognized deferred compensation of $4.1 million
representing the difference between the exercise price of the options and the
fair market value of the Company's common stock at the time of the December 1997
approval. The deferred compensation will be charged to expense over the period
beginning December 1997, through the end of the five-year vesting period.


                                       38


<PAGE>   41
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. STOCKHOLDERS' EQUITY (CONTINUED)

        The stock option activity under the 1992 Plan was as follows:


<TABLE>
<CAPTION>
                                                      OPTIONS OUTSTANDING
                                        ---------------------------------------------------
                                        AVAILABLE FOR   NUMBER OF SHARES   WEIGHTED AVERAGE
                                           GRANT       SUBJECT TO OPTIONS   EXERCISE PRICE
                                        -------------  ------------------  ----------------
<S>                                     <C>            <C>                    <C>
BALANCE AT DECEMBER 31, 1997 ......         360,808        1,626,254          $     3.22
  Shares authorized ...............         600,000               --                  --
  Options granted .................        (407,500)         407,500          $    11.27
  Options exercised ...............              --         (334,309)         $     2.27
  Options canceled ................         232,533         (269,723)         $     5.30
                                         ----------       ----------
BALANCE AT DECEMBER 31, 1998 ......         785,841        1,429,722          $     5.35
  Shares authorized ...............         200,000               --                  --
  Options granted .................        (639,000)         639,000          $    11.20
  Options exercised ...............              --          (68,994)         $     2.70
  Options canceled ................          40,246          (57,231)         $     7.10
                                         ----------       ----------
BALANCE AT DECEMBER 31, 1999 ......         387,087        1,942,497          $     7.32
  Shares authorized ...............         600,000               --                  --
  Options granted .................        (736,500)         736,500          $    26.42
  Options exercised ...............              --         (178,385)         $     4.72
  Options canceled ................          42,004          (44,079)         $    11.31
                                         ----------       ----------
BALANCE AT DECEMBER 31, 2000 ......         292,591        2,456,533          $    13.16
                                         ==========       ==========
</TABLE>


To date, all options granted under the 1992 Plan are nonqualified options.
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, 2000, 15,609 shares outstanding were subject to repurchase.

        The options outstanding at December 31, 2000, have been segregated into
ranges for additional disclosure as follows:


<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                      OPTIONS EXERCISABLE
                      -----------------------------------------------     ------------------------------
                          OPTIONS       WEIGHTED-AVERAGE    WEIGHTED-     OPTIONS CURRENTLY    WEIGHTED-
                      OUTSTANDING AT        REMAINING       AVERAGE       EXERCISABLE AT       AVERAGE
   RANGE OF             DECEMBER 31,     CONTRACTUAL LIFE   EXERCISE        DECEMBER 31,       EXERCISE
EXERCISE PRICES            2000            (IN YEARS)        PRICE             2000             PRICE
---------------       --------------    -----------------  ----------     -----------------    ---------
<S>                   <C>               <C>                <C>            <C>                  <C>
$ 0.10 - $ 1.00 ....        180,809           3.95         $    0.89           171,889         $    0.92
$ 1.54 - $ 1.54 ....        268,622           5.60         $    1.54           127,307         $    1.54
$ 2.00 - $ 6.00 ....        298,764           5.30         $    4.97           257,458         $    4.99
$ 7.13 - $ 9.38 ....        252,400           7.69         $    8.69           115,129         $    8.66
$ 9.44 - $11.13 ....        477,750           8.90         $   10.85            95,734         $   10.92
$11.50 - $13.13 ....        282,008           8.66         $   11.81            81,496         $   11.83
$13.25 - $15.75 ....        332,180           8.04         $   15.31           103,710         $   15.00
$16.00 - $40.50 ....        257,500           9.61         $   27.35             4,313         $   32.57
$40.88 - $55.25 ....         26,500           9.42         $   48.70                 0         $    0.00
$76.75 - $ 76.75 ...         80,000           9.15         $   76.75            10,832         $   76.75
                          ---------                                          ---------
$ 0.10 - $ 76.75 ...      2,456,533           7.56         $   13.16           967,868         $    7.41
                          =========                                          =========
</TABLE>

        As of December 31, 2000, 1999 and 1998, options to purchase 967,868,
709,433 and 505,522 shares were exercisable under the 1992 plan, respectively.

PRO FORMA INFORMATION

        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 weighted average fair value of options granted in
2000, 1999 and 1998 was $20.38, $7.87 and $6.74 per share, respectively. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model for the single option approach with the
following weighted-average assumptions: a risk-free interest rate of 6.0%, 4.97%
and 5.5% for 2000, 1999 and 1998, respectively; a weighted-average expected life
of five years for 2000 grants, five years for 1999 grants and 5.1 years for 1998
grants; an expected dividend yield of zero for all three years; and a volatility
factor of the expected market price of the Company's common stock of 100% for
2000, 86% for 1999 and 64% for 1998.


                                       39


<PAGE>   42
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. STOCKHOLDERS' EQUITY (CONTINUED)

        The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value 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.

        Had compensation cost for the Company's stock-based compensation plan
been determined based on the fair value at the grant date for awards under the
plan consistent with the method of SFAS 123, the Company's net loss and net loss
per share would have been increased to the pro forma amounts indicated below:


<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                              --------------------------------------------
                                                 2000             1999             1998
                                              ----------       ----------       ----------
                                                 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                           <C>              <C>              <C>
Net loss
  Historical ...........................      $  (13,301)      $   (6,664)      $   (4,347)
  Pro forma ............................      $  (16,839)      $   (7,874)      $   (5,610)
Net loss per share
  Historical ...........................      $    (1.17)      $    (0.60)      $    (0.45)
  Pro Forma ............................      $    (1.48)      $    (0.71)      $    (0.58)
</TABLE>


1998 EMPLOYEE STOCK PURCHASE PLAN

        In May 1998, the stockholders approved the adoption of the Company's
1998 Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan
authorized the issuance of 200,000 shares of common stock pursuant to purchase
rights granted to employees of the Company and is intended to be an "employee
stock purchase plan" as defined in Section 423 of the Internal Revenue Code.

        As of December 31, 2000, a total of 33,911 shares of common stock have
been issued to employees at an aggregate purchase price of $470,706 and a
weighted average purchase price of $13.88 per share pursuant to offerings under
the Purchase Plan, and 166,089 shares remain available for future issuance.

        Under SFAS 123, the fair value for these purchase options was estimated
at the date of grant using a Black-Scholes option pricing model with the
following weighted average assumptions for 2000 and 1999, respectively:
risk-free interest rate of 6.0% and 4.97%; no dividend yields; volatility factor
of the expected market price of the Company's common stock of 100% and 86%; and
a weighted average expected life of 0.55 and 0.49 years. The weighted average
fair value of those purchase rights granted in 2000 and 1999, respectively, was
$7.58 and $5.13.

8. INCOME TAXES

        The provision for income taxes of $500,000 for 2000 consists of foreign
withholding tax due on a payment received from one of Lynx's customers. The
provision for income taxes of approximately $258,000 for 1999 and $151,000 for
1998 consists entirely of alternative minimum tax.

        The reconciliation of income tax expense (benefit) attributable to
continuing operations computed at the U.S. federal statutory rates to income tax
expense (benefit) for the fiscal years ended December 31, 2000, 1999 and 1998 is
as follows (in thousands):


<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                        -----------------------------------
                                                         2000          1999          1998
                                                        -------       -------       -------
<S>                                                     <C>           <C>           <C>
Tax provision (benefit) at U.S statutory rate ....      $(4,352)      $(2,178)      $(1,427)
Alternative minimum tax ..........................           --           258           151
Foreign taxes ....................................          500            --            --
Loss for which no tax benefit is currently
recognizable .....................................        4,352         2,178         1,427
                                                        -------       -------       -------
                                                        $   500       $   258       $   151
                                                        =======       =======       =======
</TABLE>


                                       40


<PAGE>   43
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. INCOME TAXES (CONTINUED)

        Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets are as follows (in thousands):


<TABLE>
<CAPTION>
                                                          2000           1999
                                                        --------       --------
<S>                                                     <C>            <C>
Deferred tax assets:
  Net operating loss carryforwards ...............      $ 13,427       $  6,717
  Research and development tax credit
   carryforwards .................................         5,124          1,816
  Alternative minimum tax credit carryforwards ...           218            290
  Capitalized research and development
    expenditures .................................         1,422            859
  Deferred revenues ..............................         9,865         10,124
  Reserves and accruals ..........................           741            494
  Other, net .....................................            --            702
  Valuation allowance ............................       (30,623)       (21,002)
                                                        --------       --------
Net deferred tax assets ..........................           174             --
Deferred tax liabilities:
Other ............................................           174             --
                                                        --------       --------
Net deferred tax assets ..........................      $     --       $     --
                                                        ========       ========
</TABLE>


        Realization of deferred tax assets is dependent on future earnings, if
any, the timing and the amount of which are uncertain. Accordingly, a valuation
allowance, in an amount equal to the net deferred tax assets as of December 31,
2000 and 1999 has been established to reflect these uncertainties. The change in
the valuation allowance was a net increase of approximately $9.6 million and
$3.6 million for the fiscal years ended December 31, 2000 and 1999,
respectively. Approximately $2.0 million of the valuation allowance for deferred
tax assets relates to benefits of stock option deductions which, when recognized
will be allocated directly to contributed capital.

        As of December 31, 2000, the Company had a federal net operating loss
carryforward of approximately $38.6 million, which will expire at various dates
from 2008 through 2020, if not utilized. The Company has a state net operating
loss carryforward of approximately $5.3 million, which will expire in 2010.

        As of December 31, 2000, the Company also had federal and California
research and development and other tax credit carryforwards of approximately
$3.8 million and $1.3 million, respectively. The federal research and
development credit will expire at various dates from 2008 through 2020, if not
utilized.

        Utilization of net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended, and
similar state provisions. The annual limitation may result in expiration of net
operating loss and tax credit carryforwards before full utilization. Utilization
of federal and California net operating losses and credit carryforwards incurred
prior to February 1994 is limited on an annual basis under the Internal Revenue
Code of 1986, as amended, as a result of an ownership change in 1994.

9. OBLIGATIONS UNDER OPERATING LEASES

        In August 1993, the Company entered into a noncancelable operating lease
for facilities which expires on July 31, 2003. In 1998, the Company entered into
an agreement to sublease a portion of this space, and in 1999 through a
subsequent agreement, subleased the remaining portion of the facility. The term
of the sublease runs through July 2003. Rent from the sublease is sufficient to
cover the rent and other operating expenses incurred by Lynx under the terms of
the 1993 Lease.

        In February 1998, the Company entered into a noncancelable operating
lease for facilities. The term of the lease commenced on December 15, 1998 and
expires on December 14, 2008. Under the terms of the lease, the monthly rental
payments are fixed for the first 24 months. Thereafter, the monthly rental
payments increase and are subject to annual Consumer Price Index-based
adjustments, with minimum and maximum limits. The Company is recognizing rent
expense on a straight-line basis over the lease period. The Company has the
option to extend the lease for an additional five-year period, subject to
certain conditions, with payments to be determined at the time of the exercise
of the option.


                                       41


<PAGE>   44
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. OBLIGATIONS UNDER OPERATING LEASES (CONTINUED)

        In June 1998, Lynx GmbH entered into a noncancelable operating lease for
facilities space of approximately 6,300 square feet in Heidelberg, Germany, to
house its operations. The space will be developed and occupied in phases,
depending on the growth of the organization. The lease terminates in June 2005.
A portion of such space is currently being subleased by BASF-LYNX.

        The Company also leases equipment under various operating lease
agreements subject to minimum annual lease payments. Minimum annual rental
commitments and sublease income under non-cancelable operating leases are as
follows (in thousands):


<TABLE>
<CAPTION>
                                                  SUBLEASE
YEARS ENDING DECEMBER 31:      COMMITMENTS         INCOME
                               -----------        --------
<S>                               <C>              <C>
2001 ...............              $ 2,792          $ 1,117
2002 ...............                2,901            1,144
2003 ...............                2,691              682
2004 ...............                2,432               --
2005 ...............                2,498               --
Thereafter .........                7,524               --
                                  -------          -------
                                  $20,838          $ 2,943
                                  =======          =======
</TABLE>


        Rent expense for facilities and equipment under operating leases was
$2,055,000, $1,733,000 and $738,000 for the years ended December 31, 2000, 1999
and 1998, respectively. Rental income for the facility under sublease was
$1,127,000, $990,000 and $186,000 for the years ended December 31, 2000, 1999
and 1998, respectively.

10. 401(k) PLAN

        In October 1992, Lynx adopted a 401(k) Plan covering all of its
employees. Pursuant to the 401(k) Plan, employees may elect to reduce their
current compensation by up to 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. The 401(k) Plan permits, but does not require, additional
contributions to the 401(k) Plan by Lynx on behalf of all participants in the
401(k) Plan. In the years ended 2000, 1999 and 1998, the Company contributed
$74,000, $52,000 and $49,000, respectively.

11. EQUIPMENT FINANCING

        In 1998, the Company entered into a financing agreement with a financial
institution ("Lender") under which Lynx drew down $4.8 million during 1999 for
the purchase of equipment and certain other capital expenditures. Lynx granted
the lender a security interest in all items financed by the Company under this
agreement. Each draw down under the loan has a term of 48 months from the date
of the draw down at interest rates ranging from 10.9% to 11.8% The original draw
down period under the agreement expired on March 31, 2000. In September 2000,
Lynx obtained additional financing of $950,000, under an amendment to the
original financing agreement. As of December 31, 2000, the principal balance
under loans outstanding under this agreement was approximately $4.4 million.
Accumulated depreciation relating to these assets amounted to $2.5 million and
$0.7 million for the years ended December 31, 2000 and 1999, respectively. The
carrying amounts of the Company's borrowings under its equipment financing
approximate their fair values. The fair values are estimated using a discounted
cash flow analysis based on the Company's current incremental borrowing rates
for similar types of borrowing arrangements.

        Principal payments based on equipment loans outstanding at December 31,
2000 are (in thousands):


<TABLE>
<S>                                  <C>
2001..............................   $1,319
2002..............................    1,393
2003..............................    1,420
2004..............................      264
                                     ------
                                     $4,396
                                     ======
</TABLE>


                                       42


<PAGE>   45
                             LYNX THERAPEUTICS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)


12. SUBSEQUENT EVENTS (UNAUDITED)

        Phytera

        In January 2001, the Company entered into a collaboration with Phytera,
Inc. to identify genes from plants involved in the biosynthesis of anti-oxidant
polyphenols, naturally occurring compounds with nutraceutical and pharmaceutical
activity. Phytera will select plant species from its culture libraries and apply
its proprietary ExPAND(R) manipulation technology to regulate the expression of
the metabolic pathways and genes responsible for the production of specific
anti-oxidant polyphenolic compounds. Lynx will then use its proprietary Megasort
technology to identify genes activated after target compounds are induced. Lynx
and Phytera intend to validate gene targets and jointly commercialize the genes
with other partners in the nutraceutical and pharmaceutical sectors.

        Celera

        In March 2001, the Company entered into two agreements with Celera
Genomics. The first agreement involves the integration of sets of Lynx's
high-resolution gene expression data, derived from normal human tissues analyzed
using Lynx's MPSS technology, into Celera's database products for distribution
to Celera's customers through the Celera Discovery System (CDS). Under a second
agreement, Lynx will apply its MPSS technology to perform additional gene
expression analyses various tissues for Celera and to help supplement the Lynx
database offering.

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

        Not applicable.


                                       43


<PAGE>   46
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        The Company's executive officers, directors and certain employees, and
their ages as of February 15, 2001 are as follows:


<TABLE>
<CAPTION>
NAME                                     AGE                       POSITION
----                                     ---                       --------
<S>                                      <C>  <C>
Craig C. Taylor(1)(2).................   50   Chairman of the Board
Norman J. W. Russell, Ph.D............   48   President, Chief Executive Officer and Director
Edward C. Albini......................   43   Chief Financial Officer and Secretary
Stephen C. Macevicz, Ph.D.............   51   Vice President, Intellectual Property
William Wong, Ph.D....................   52   Vice President, Business Development
Richard C. Woychik, Ph.D..............   48   Chief Scientific Officer
Sydney Brenner, M.B., D. Phil.........   73   Director and Principal Scientific Advisor
William K. Bowes, Jr.(1)(2)...........   74   Director
Leroy Hood, M.D., Ph.D................   62   Director
James C. Kitch(1)(2)..................   53   Director
</TABLE>


------------

(1)     Member of the Audit Committee.

(2)     Member of the Compensation Committee.

        Craig C. Taylor was elected Chairman of the Board of Directors of Lynx
in December 2000 and has served as a director since March 1994, and served as
Acting Chief Financial Officer from July 1994 to April 1997. He has been active
in venture capital since 1977, when he joined Asset Management Company, a
venture capital firm. 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
Pharmacyclics, Inc., a biotechnology company, and several private companies.

        Norman J. W. Russell, Ph.D., joined Lynx in October 1999 as President
and Chief Executive Officer and was elected to the Board of Directors in
December 1999. Prior to joining Lynx, he was Head of Biological Science and
Technology at AstraZeneca Pharmaceuticals, a pharmaceutical company. His
previous positions in 20 years at Zeneca included Head of Target Discovery, Head
of International Genomics and Head of Biotechnology. Dr. Russell earned a Ph.D.
in Physiology from Glasgow University, Scotland.

        Edward C. Albini has served as Chief Financial Officer of Lynx since
April 1997. He was elected Secretary in February 1998. From January 1983 to
April 1997, Mr. Albini served in various financial management positions with
Genentech, Inc., a biotechnology company. His most recent role at Genentech was
as the Director of Financial Planning and Analysis. Mr. Albini holds a BS degree
in Accounting from Santa Clara University and an MBA degree from the Walter A.
Haas School of Business at the University of California, Berkeley. Mr. Albini is
also a certified public accountant.

        Stephen C. Macevicz, Ph.D., joined Lynx in September 1995 as Vice
President, Intellectual Property. He was Senior Patent Attorney and chief patent
counsel at Applied Biosystems, Inc. from 1992 to August 1995 and, from 1986 to
1992, Patent Counsel at DNAX Research Institute of Molecular and Cellular
Biology, a research subsidiary of Schering-Plough Corporation. He received his
law degree from the University of California, Berkeley, Boalt Hall, and his
Ph.D. in Biophysics from the University of California, Berkeley.

        William Wong, Ph.D., joined Lynx in January 2001 as Vice President,
Business Development. He was Executive Vice President, Business Development at
Nexell, a therapeutics company, from 1998 to 2000, Executive Director,
Technology and Business Development at Intracel Corp., a biotechnology company,
from 1995 to 1998, Sr. Vice President and General Manager at Zynaxis, Inc., a
drug delivery and diagnostics company, from 1994 to 1995, and he held various
positions at Zynaxis from 1990 to 1994. Dr. Wong received his Ph.D. from the
University of Rochester, School of Medicine, Rochester, New York.

        Richard C. Woychik, Ph.D., joined Lynx in January 2001 as Chief
Scientific Officer. Prior to joining Lynx, Dr. Woychik was Senior Director and
Head of the Global R&D Molecular Genetics Research Center at Pfizer, a
pharmaceutical company, from 1998 to 2000. From 1997 to 1998, Dr. Woychik was a
Professor in the Departments of Pediatrics, Genetics and Pharmacology and Vice
Chairman for Research in Pediatrics at Case Western Reserve University and from
1987 to 1997, he was a research scientist at the Oak Ridge National Laboratory.
Dr. Woychik earned his Ph.D. in Molecular Biology at Case Western Reserve
University.


                                       44


<PAGE>   47
        Sydney Brenner, M.B., D.Phil., has served as a director of Lynx since
October 1993. He is a distinguished Professor at the Salk Institute of
Biological Studies in La Jolla, California. He served as Director and President
of The Molecular Sciences Institute, a non-profit research institute in
Berkeley, California from July 1996 to January 2001, when he retired as Director
of Research. 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. Dr. Brenner is the
principal inventor of Lynx's bead-based technologies.

        William K. Bowes, Jr., has served as a director of Lynx 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., a
biotechnology company, AMCC, an integrated circuit company, XOMA Corporation, a
biotechnology company, and one U.S. Venture Partners privately owned portfolio
company.

        Leroy Hood, M.D., Ph.D., has served as a director of Lynx since May
2000. In December 1999, he founded the Institute of Systems Biology, a private
nonprofit research institute, and currently serves as the President and a
director. From 1992 to 1999, he was the Chair of the Molecular Biotechnology
Department at the University of Washington and the William Gates III Professor
of Biomedical Sciences. Dr. Hood received his M.D. from Johns Hopkins Medical
School and Ph.D. from the California Institute of Technology. He has been a
member of the National Academy of Sciences and the American Academy of Arts and
Sciences since 1982.

        James C. Kitch has served as a director of Lynx since February 1993 and
Secretary of Lynx from February 1992 to December 1997. Since 1979, he has been a
partner at Cooley Godward LLP, a law firm, which has provided legal services to
Lynx.

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 Securities
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, 2000, all Section 16(a) filing requirements applicable to its officers,
directors and greater than ten percent (10%) beneficial owners were complied
with.


                                       45


<PAGE>   48
ITEM 11. EXECUTIVE COMPENSATION

        The following table sets forth certain compensation paid by the Company
during the calendar years ended December 31, 2000, 1999 and 1998, to its Chief
Executive Officer and the two other most highly compensated executive officers
whose compensation exceeded $100,000 (the "Named Executive Officers"):

                           SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                                                                            LONG TERM
                                                                 ANNUAL    COMPENSATION      OTHER ANNUAL
NAME AND PRINCIPAL POSITION                           YEAR     SALARY (1)   OPTIONS (#)      COMPENSATION
---------------------------                           ----     ----------   -----------      ------------
<S>                                                   <C>      <C>          <C>              <C>
Norman J. W. Russell, Ph.D.(2) .............          2000      $262,571            --               --
  President & Chief Executive Officer ......          1999      $109,527       200,000         $ 33,212(2)

Edward C. Albini ...........................          2000      $196,405        70,000         $    750(3)
  Chief Financial Officer ..................          1999      $163,730            --         $    750(3)
                                                      1998      $147,336        50,000         $    750(3)
Stephen C. Macevicz, Ph.D ..................          2000      $191,538        20,000         $    750(3)
  Vice President, Intellectual Property ....          1999      $176,549        20,000         $    750(3)
                                                      1998      $167,611            --         $    750(3)
</TABLE>


------------

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

(2)     Dr. Russell joined the Company as President and Chief Executive Officer
        on October 18, 1999. Prior to this time, Dr. Russell was employed at
        Lynx Therapeutics GmbH, a wholly-owned subsidiary of the Company, from
        July 1, 1999. Dr. Russell's compensation received while employed at Lynx
        GmbH is reflected under Other Annual Compensation.

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

        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, was paid by the Company during
the year ended December 31, 2000, to any of the Named Executive Officers.

STOCK OPTION GRANTS AND EXERCISES

        The Company grants options to its executive officers under its 1992
Stock Option Plan, as amended. As of February 15, 2001, options to purchase a
total of 2,655,290 shares were outstanding under the 1992 Stock Option Plan, as
amended, and options to purchase 91,499 shares remained available for grant
thereunder.

        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 ended December 31, 2000.

                        OPTION GRANTS IN LAST FISCAL YEAR


<TABLE>
<CAPTION>
                                                                                                            POTENTIAL REALIZABLE
                                                                                                              VALUE AT ASSUMED
                                                      INDIVIDUAL GRANTS                                        ANNUAL RATES
                                ---------------------------------------------------------------------          OF STOCK PRICE
                                    NUMBER OF           % OF TOTAL                                              APPRECIATION
                                    SECURITIES         OPTIONS GRANTED     EXERCISE OR                      FOR OPTION TERM (2)
                                UNDERLYING OPTIONS      TO EMPLOYEES       BASE PRICE      EXPIRATION    --------------------------
NAME                                 GRANTED          IN FISCAL YEAR (1)      ($/SH)           DATE        5%($)            10%($)
                                ------------------    ------------------   -----------     ----------    ---------      -----------
<S>                             <C>                   <C>                  <C>             <C>           <C>            <C>
Edward C. Albini ...........         40,000                5.43%              76.75           02/22/10   1,930,706       4,892,789
                                     30,000                4.07%              15.75           05/26/10     297,153         753,043
Stephen C. Macevicz, Ph.D ..         20,000                2.72%              10.63           12/10/10     133,703         338,830
</TABLE>


------------


(1)     Based on options for an aggregate of 736,500 shares granted to employees
        of, and consultants to, the Company during the year ended December 31,
        2000, including the Named Executive Officer.


                                       46


<PAGE>   49
(2)     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 stock price on the date of grant appreciates at the indicated
        annual rate, compounded annually for the entire term of the option, and
        that option is exercised and sold on the last day of the term for the
        appreciated stock price.

        The following table sets forth certain information concerning the number
of options exercised by the Named Executive Officers during the year ended
December 31, 2000, and the number of shares covered by both exercisable and
unexercisable stock options held by the Named Executive Officers. Also reported
are values for "in-the-money" options that represent the positive spread between
the respective exercise prices of outstanding options and the fair market value
of the Company's common stock as of December 29, 2000 ($9.00 per share).

   AGGREGATED OPTION EXERCISES IN THE YEAR ENDED DECEMBER 31, 2000 AND OPTION
                                     VALUEs


<TABLE>
<CAPTION>
                                                                                                          VALUE OF UNEXERCISED
                                                                       NUMBER OF UNEXERCISED            IN-THE-MONEY OPTIONS AT
                                     SHARES                             OPTIONS AT YEAR-END                    YEAR-END (1)
                                  ACQUIRED ON        VALUE          -----------------------------     ----------------------------
NAME                                EXERCISE      REALIZED (1)      EXERCISABLE     UNEXERCISABLE     EXERCISABLE      EXERCISABLE
                                  -----------     ------------      -----------     -------------     -----------      -----------
<S>                               <C>             <C>               <C>             <C>               <C>              <C>
Norman J. W. Russell, Ph.D.             --               --           56,666          143,334                0                0
Edward C. Albini .........              --               --           28,333           21,667                0                0
                                        --               --            6,666           33,334                0                0
                                        --               --            3,500           26,500                0                0
Stephen C. Macevicz ......          14,000          238,840            1,000                0            8,000                0
                                    34,666          620,868            4,334                0           38,356                0
                                        --               --            4,000           16,000                0                0
                                        --               --                0           20,000                0                0
</TABLE>


-------

(1)     Based on the fair market value of the Company's common stock at December
        29, 2000 ($9.00), minus the exercise price of the options, multiplied by
        the number of shares underlying the options.

EMPLOYMENT SEVERANCE AND CHANGE OF CONTROL AGREEMENTS

        In October 1999, the Company entered into an employment agreement with
Dr. Norman J. W. Russell, President and Chief Executive Officer, providing for
an annual compensation of $255,000 per year and an option to purchase 200,000
shares of common stock at an exercise price of $11.31 per share, subject to a
five-year vesting schedule. If Dr. Russell is terminated due to a change in
control of the Company, Dr. Russell's shares covered by the option shall
accelerate so that fifty percent of the then unvested shares covered by the
option shall immediately vest and become exercisable upon the effective date of
the change in control. The Company also provided Dr. Russell with a loan in the
amount of $250,000 for the sole purpose of the purchase of a house, which loan
shall be secured by the property, and is forgivable over a four-year period.

COMPENSATION OF DIRECTORS

        Directors are not compensated by the Company for services as directors.
Non-employee directors are eligible to participate in the Company's 1992 Plan.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

        The Company's Compensation Committee was established in March 1994 and
is currently composed of three non-employee directors: Messrs. Bowes, Kitch and
Taylor. Mr. Taylor served as Acting Chief Financial Officer of the Company from
July 1994 to April 1997. 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, 2000.

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


                                       47


<PAGE>   50
        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.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The following table sets forth certain information regarding beneficial
ownership of the common stock as of February 15, 2001, by (i) each stockholder
who is known by the Company to own beneficially more than 5% of the common
stock; (ii) each Named Executive Officer of the Company listed on the Summary
Compensation Table; (iii) each director of the Company; and (iv) all directors
and executive officers of the Company as a group.


<TABLE>
<CAPTION>
                                                                         COMMON STOCK (1)
                                                                  -----------------------------
                                                                   NUMBER
NAME OF BENEFICIAL OWNER                                          OF SHARES            PERCENT
                                                                  ---------           ---------
<S>                                                               <C>                 <C>
Credit Suisse Asset Management, LLC ....................            723,296                6.3%
GEO Capital, LLC .......................................            654,990                5.7%
Norman J. W. Russell, Ph.D.(2) .........................             70,000                 **
Edward C. Albini(3) ....................................             95,219                 **
Stephen C. Macevicz, Ph.D.(4) ..........................             78,889                 **
William K. Bowes, Jr.(5) ...............................            183,496                1.6%
Sydney Brenner, M.B., D. Phil.(6) ......................            329,000                2.9%
Leroy Hood, M.D., Ph.D .................................              6,896                 **
James C. Kitch(7) ......................................             20,620                 **
Craig C. Taylor(8) .....................................            386,434                3.4%
All directors and officers as a group (10 persons)(9) ..          1,170,554               9.99%
</TABLE>


------------

**      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. Percentage of beneficial ownership is based on
        11,459,521 shares of common stock outstanding as of February 15, 2001,
        except as otherwise noted in the footnotes. Beneficial ownership is
        determined in accordance with the rules of the Securities and Exchange
        Commission and generally includes voting or investment power with
        respect to securities. Shares of common stock subject to options
        currently exercisable or exercisable within 60 days of February 15,
        2001, are deemed outstanding for computing the percentage of the person
        holding such options but are not deemed outstanding for computing the
        percentage of beneficial ownership of any other person.

(2)     Consists of 70,000 shares of common stock issuable upon exercise of
        stock options held by Dr. Russell that are exercisable within 60 days of
        February 15, 2001.

(3)     Includes 44,499 shares of common stock issuable upon exercise of stock
        options held by Mr. Albini that are exercisable within 60 days of
        February 15, 2001.


                                       48


<PAGE>   51
(4)     Includes 12,000 shares of common stock issuable upon exercise of stock
        options held by Dr. Macevicz that are exercisable within 60 days of
        February 15, 2001.

(5)     Includes 35,401 shares of common stock held by Mr. Bowes, 17,606 shares
        of common stock held by the William K. Bowes Charitable Remainder Trust,
        of which Mr. Bowes is Trustee, and 8,333 shares of common stock issuable
        upon exercise of stock options held by Mr. Bowes that are exercisable
        within 60 days of February 15, 2001. Also includes 122,156 shares of
        common stock held by entities affiliated with U.S. Venture Partners IV,
        L.P. or U.S.V.P. IV. Mr. Bowes, a director of Lynx, 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 pro-rata interest therein.

(6)     Includes 99,000 shares of common stock issuable upon exercise of stock
        options held by Dr. Brenner that are exercisable within 60 days of
        February 15, 2001.

(7)     Includes 2,287 shares of common stock, 8,333 shares of common stock
        issuable upon exercise of stock options held by Mr. Kitch and 10,000
        shares of common stock issuable upon the exercise of stock options also
        held by Mr. Kitch that are exercisable within 60 days of February 15,
        2001. Mr. Kitch holds these options for the benefit of Cooley Godward
        LLP. He 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 pro-rata interest therein.

(8)     Includes 13,997 shares of common stock held by Mr. Taylor and 8,333
        shares of common stock issuable upon exercise of stock options held by
        Mr. Taylor. Also includes 364,104 shares of common stock held by Asset
        Management Associates 1989 L.P. Mr. Taylor, the Chairman of the Board of
        Lynx, 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 pro-rata interest therein.

(9)     Includes 486,260 shares of common stock held by entities affiliated with
        certain directors and 423,796 shares of common stock issuable upon
        exercise of stock options held by directors and officers that are
        exercisable within 60 days of February 15, 2001. See Notes 2 through 8
        above.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        In November 1999, the Company entered into a loan agreement with Norman
J. W. Russell, Ph.D., President, Chief Executive Officer and a director of the
Company. The loan is in the amount of $250,000, secured by a second mortgage on
real property, with interest accruable at the rate of 6.02% per annum, and
subject to early repayment under specified circumstances. The principal and
interest on the loan will be forgiven, based on the officer's continuous
employment over a four-year period, in the following amounts: 50% on the second
anniversary date of employment; and 25% on each of the third and fourth
anniversary dates of employment. At February 15, 2001, the outstanding principal
and accrued interest on the loan was $267,224.

        In April 1997, the Company entered into a full-recourse loan agreement
with Edward C. Albini, an officer of the Company. A note receivable of $250,000
was issued under a stock purchase agreement for the purchase of 50,000 shares of
common stock whereby all the shares issued under the agreement are pledged as
collateral. The outstanding principal amount is due and payable in full in April
2002, 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 6.49% per annum. At February 15, 2001, the outstanding principal and
accrued interest on the loan was $293,988.

        For legal services rendered during the calendar year ended December 31,
2000, the Company paid approximately $307,500 to Cooley Godward LLP, the
Company's counsel, of which Mr. Kitch, a director of the Company, is a partner.

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


                                       49


<PAGE>   52
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K

        (a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS

                (1) The following index, Report of Ernst & Young LLP,
        Independent Auditors, and financial statements set forth on pages 26
        through 31 of this report are being filed as part of this report:

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

                (ii) Consolidated Balance Sheets as of December 31, 2000 and
        1999.

                (iii) Consolidated Statements of Operations for the years ended
        December 31, 2000, 1999 and 1998.

                (iv) Consolidated Statements of Stockholders' Equity for the
        years ended December 31, 2000, 1999 and 1998.

                (v) Consolidated Statements of Cash Flows for the years ended
        December 31, 2000, 1999 and 1998.

                (vi) Notes to Consolidated Financial Statements.

        (2) All schedules are omitted because they are not required, are not
applicable, or the information is included in the consolidated financial
statement or notes thereto.

        (3) The following documents are being filed as part of this report:


<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION OF DOCUMENT
-------                            -----------------------
<S>            <C>
2.1**          Acquisition Agreement, dated as of February 4, 1998, by and
               between the Company and Inex Pharmaceuticals Corporation,
               incorporated by reference to the indicated exhibit of the
               Registrant's current report on Form 8-K filed on March 24, 1998.

3.1            Amended and Restated Certificate of Incorporation of the Company,
               incorporated by reference to the indicated exhibit of the
               Registrant's Form 10-Q for the period ended June 30, 2000.

3.2            Bylaws of the Company, as amended, incorporated by reference to
               the indicated exhibit of the Registrant's Form 10-Q for the
               period ended June 30, 2000.

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

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

10.2+          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.

10.3+          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.

10.4+          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.

10.5           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.

10.6           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.

10.7+          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.), incorporated by
               reference to Exhibit 10.25 of the Registrant's Form 10-K for the
               period ended December 31, 1996.

10.8**         Joint Venture Agreement, dated as of October 23, 1996, between
               the Company and BASF Aktiengesellschaft, incorporated by
               reference to Exhibit 10.29 of the Registrant's Form 10-K for the
               period ended December 31,
</TABLE>


                                       50


<PAGE>   53
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                             DESCRIPTION OF DOCUMENT
-------                            -----------------------
<S>            <C>
               1997.

10.8.1**       First Amendment to Joint Venture Agreement dated as of October
               23, 1998, between the Company and BASF Aktiengesellschaft.

10.9+          Stock Purchase Agreement dated as of April 14, 1997, between the
               Company and Edward C. Albini, incorporated by reference to
               Exhibit 10.32 of the Registrant's Form 10-K for the period ended
               December 31, 1997.

10.10          Form of Common Stock Purchase Agreement, dated as of September
               28, 1997, by and between the Company and the investors listed
               therein, incorporated by reference to Exhibit 4.1 of the
               Registrant's Registration Statement on Form S-3, filed on October
               31, 1997 (File No. 333-39171).

10.11          Lease dated as of February 27, 1998, between the Company and
               SimFirst, L.P., Limited Partnership, incorporated by reference to
               Exhibit 10.35 of the Registrant's Form 10-Q for the period ended
               March 31, 1998.

10.12**        Technology License and Development Agreement dated as of January
               1, 1997, between the Company and BASF-LYNX Bioscience AG.

10.12.1**      First Amendment to Technology License and Development Agreement
               dated as of January 1, 1997, between the Company and BASF-LYNX
               Bioscience AG.

10.13          The Company's 1998 Employee Stock Purchase Plan (the "Purchase
               Plan"), incorporated by reference to Exhibit 99.1 of the
               Registrant's Form S-8 (File No. 333-59163).

10.14+         Employment Agreement dated as of October 18, 1999, between the
               Company and Norman John Wilkie Russell, Ph.D., incorporated by
               reference to Exhibit 10.13 of the Registrant's Form 10-Q for the
               period ended September 30, 1999.

21.1           Subsidiary of the Company.

23.1           Consent of Ernst & Young LLP, Independent Auditors.

24.1           Power of Attorney. Reference is made to the signature page.
</TABLE>


------------

(+)     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

               Not applicable.


                                       51


<PAGE>   54

                                   SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) Securities Exchange
Act of 1934, the Registrant has duly caused this report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, on the 30th
day of March 2001.

                                    LYNX THERAPEUTICS, INC.

                                    By:     /s/ NORMAN J.W. RUSSELL, PH.D.
                                       --------------------------------------
                                              Norman J.W. Russell, Ph.D.
                                        President and Chief Executive Officer

                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Edward C. Albini and James C. Kitch, and
each or any of them, as 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 to the Report 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 Exchange Act of 1934,
this report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
           SIGNATURE                                         TITLE                            DATE
           ---------                                         -----                            ----
<S>                                     <C>                                             <C>
   /s/   NORMAN J.W. RUSSELL                President, Chief Executive Officer and      March 30, 2001
-------------------------------             Director (Principal Executive Officer)
     Norman J.W. Russell

     /s/   CRAIG C. TAYLOR                          Chairman of the Board               March 30, 2001
-------------------------------
       Craig C. Taylor

     /s/   EDWARD C. ALBINI                 Chief Financial Officer and Secretary       March 30, 2001
-------------------------------         (Principal Financial and Accounting Officer)
       Edward C. Albini

  /s/   WILLIAM K. BOWES, Jr.                           Director                        March 30, 2001
-------------------------------
    William K. Bowes, Jr.

                                                        Director                        March __, 2001
-------------------------------
       Sydney Brenner

     /s/   JAMES C. KITCH                               Director                        March 30, 2001
-------------------------------
       James C. Kitch

                                                        Director                        March __, 2001
-------------------------------
        Leroy Hood

   /s/ DAVID C. U'PRICHARD                              Director                        March 30, 2001
-------------------------------
     David C. U'Prichard
</TABLE>


                                       52


<PAGE>   55
                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                        DESCRIPTION OF DOCUMENT
-------                        -----------------------
<S>            <C>
2.1**          Acquisition Agreement, dated as of February 4, 1998, by and
               between the Company and Inex Pharmaceuticals Corporation,
               incorporated by reference to the indicated exhibit of the
               Registrant's current report on Form 8-K filed on March 24, 1998.

3.1            Amended and Restated Certificate of Incorporation of the Company,
               incorporated by reference to the indicated exhibit of the
               Registrant's Form 10-Q for the period ended June 30, 2000.

3.2            Bylaws of the Company, as amended, incorporated by reference to
               the indicated exhibit of the Registrant's Form 10-Q for the
               period ended June 30, 2000.

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

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

10.2+          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.

10.3+          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.

10.4+          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.

10.5           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.

10.6           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.

10.7+          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.), incorporated by
               reference to Exhibit 10.25 of the Registrant's Form 10-K for the
               period ended December 31, 1996.

10.8**         Joint Venture Agreement, dated as of October 23, 1996, between
               the Company and BASF Aktiengesellschaft, incorporated by
               reference to Exhibit 10.29 of the Registrant's Form 10-K for the
               period ended December 31, 1997.

10.8.1**       First Amendment to Joint Venture Agreement dated as of October
               23, 1998, between the Company and BASF Aktiengesellschaft.

10.9+          Stock Purchase Agreement dated as of April 14, 1997, between the
               Company and Edward C. Albini, incorporated by reference to
               Exhibit 10.32 of the Registrant's Form 10-K for the period ended
               December 31, 1997.

10.10          Form of Common Stock Purchase Agreement, dated as of September
               28, 1997, by and between the Company and the investors listed
               therein, incorporated by reference to Exhibit 4.1 of the
               Registrant's Registration Statement on Form S-3, filed on October
               31, 1997 (File No. 333-39171).

10.11          Lease dated as of February 27, 1998, between the Company and
               SimFirst, L.P., Limited Partnership, incorporated by reference to
               Exhibit 10.35 of the Registrant's Form 10-Q for the period ended
               March 31, 1998.

10.12**        Technology License and Development Agreement dated as of January
               1, 1997, between the Company and BASF-LYNX Bioscience AG.

10.12.1**      First Amendment to Technology License and Development Agreement
               dated as of January 1, 1997, between the Company and BASF-LYNX
               Bioscience AG.

10.13          The Company's 1998 Employee Stock Purchase Plan (the "Purchase
               Plan"), incorporated by reference to Exhibit 99.1 of the
               Registrant's Form S-8 (File No. 333-59163).

10.14+         Employment Agreement dated as of October 18, 1999, between the
               Company and Norman John Wilkie Russell, Ph.D., incorporated by
               reference to Exhibit 10.13 of the Registrant's Form 10-Q for the
               period ended September
</TABLE>


                                       53


<PAGE>   56
<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                        DESCRIPTION OF DOCUMENT
-------                        -----------------------
<S>            <C>
               30, 1999.

21.1           Subsidiary of the Company.

23.1           Consent of Ernst & Young LLP, Independent Auditors.

24.1           Power of Attorney. Reference is made to the signature page.
</TABLE>


------------

(+)     Management contract or compensatory plan or arrangement.

**      Portions of this agreement have been deleted pursuant to our request for
        confidential treatment


                                       54