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                                  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 year ended                      December 31, 1997
                    ------------------------------------------------------------

                                       or

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

                         Commission file number 0-22570

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

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

                    3832 Bay Center Place, Hayward, CA 94545
          (Address of principal executive offices, including zip code)

                                 (510) 670-9300
              (Registrant's telephone number, including area code)

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

Securities registered pursuant to Section 12(g) of the Act:
                                                   Common Stock, $.001 Par Value


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

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

         The number of shares of common stock,  Series B preferred stock, Series
C preferred stock and Series D preferred stock of the Registrant  outstanding as
of February 28, 1998, was 5,940,269,  332,288, 123,299 and 40,000, respectively.
The Series B, Series C and Series D preferred stock are convertible  into common
stock on a ten-for-one  basis. The aggregate market value of the common stock of
the Registrant held by non-affiliates as of February 28, 1998 was $49,777,060.

                                       1.
<PAGE>

                                     PART I

ITEM 1.           BUSINESS

         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  The Company's actual results could differ  materially from those
discussed  here.  Factors  that could cause or  contribute  to such  differences
include,  but are not limited to, those discussed in this section, as well as in
the section entitled "Item 7. Management's  Discussion and Analysis of Financial
Condition and Results of Operations."

         Lynx has spent the last several years  developing  unique,  proprietary
massively parallel cloning,  arraying,  and sequencing  technologies designed to
enable the simultaneous  identification  and analysis of all (or nearly all) the
DNA  molecules  or fragments in a single  biological  sample.  Lynx has recently
demonstrated  that these  technologies can be reduced to practice,  which should
enable the  Company to derive  revenue  from their uses.  At the same time,  the
Company's business model continues to evolve as Lynx identifies new applications
for its  technologies  and evaluates  alternative  approaches to their potential
commercialization.

         Lynx initially proposed to exploit its technologies in two ways. First,
in the short term,  by selling  access to its  technologies,  i.e., by analyzing
biological  samples,  and  then,  later,  by  selling  access  to  databases  to
pharmaceutical  and biotechnology  companies.  The Company now believes that the
range of genetic and genomic  information its technologies can access may be too
broad  to be  addressed  simultaneously  by the  Company  alone,  even  if it is
successful  in funding  these  efforts with the expected  revenue from  contract
analyses.  Consequently,  the Company is currently  evaluating whether it should
seek alliances with other genomic,  pharmaceutical,  and biotechnology companies
whose   complementary   expertises   may  enable   earlier  and  more  efficient
exploitation of Lynx's technologies.

         Pharmaceutical  companies  recognized  early  the  potential  of Lynx's
technologies.  As a  result,  the  Company  was  able to enter  into  agreements
involving access to its technologies  with Hoechst AG and Hoechst Marion Roussel
(collectively referred to as "Hoechst") and BASF AG ("BASF").

INDUSTRY BACKGROUND

Genomics

         A human consists of many  trillions of cells.  The nucleus of each cell
contains  the same DNA  material  comprising  the same set of  genes.  This full
complement of genes that is present in each cell is referred to as the "genome."
The many different  types of cells in a single human differ not in their genomes
but in which genes of the genome are active or expressed (i.e., transcribed into
messenger  RNA molecules  which are in turn  translated  into  specific  protein
molecules) in order to meet the  requirements  of that  particular  cell and its
function.  Proteins  play a  central  role  in  nearly  every  aspect  of  human
metabolism and  physiology.  Most human diseases  result from the  inappropriate
performance of specific protein molecules or their production.  Most drugs today
are either  compounds  designed  to  interact  with  proteins,  or are  proteins
themselves (such as insulin).  Proteins are difficult to purify and analyze, but
it is possible to access their  composition  (amino acid sequences) by analyzing
the genetic code (base  sequence) of the genes that  specify  them.  Advances in
techniques  for  analyzing  gene  sequences  to discover  new gene  products and
understand  gene  function,  have  generated  expectations  that more  effective
therapies could result from finding the genes or the messenger RNAs  responsible
for disease.

                                       2.

<PAGE>


DNA Composition (Sequence)

         The  DNA  material  that  makes  up  the  genome  contains  within  its
composition the coded  information for life's  functions.  DNA molecules (or DNA
fragments)  are double  stranded  long chains  made up of very large  numbers of
building blocks, called nucleotides,  strung together.  There are only four such
nucleotides  commonly  referred to as the four  bases,  adenine  ("A"),  guanine
("G"),  cytosine ("C"), or thymine ("T"). The single most important  determinant
of a  particular  DNA molecule or fragment is the sequence of bases that make up
the chains.  Analyzing such a molecule or fragment for the specific  sequence of
As, Gs, Cs and Ts that make it up, is called sequencing.

Gene Expression

         The  process  of  converting  the  genetic  information  encoded in the
double-stranded  DNA  of a gene  into  messenger  or  mRNA  (transcription)  and
subsequently  into a specific protein  molecule  (translation) is referred to as
"gene  expression." At any one time, the transcribing and translating  machinery
of any  particular  human cell expresses some tens of thousands of genes (out of
some 100,000 total genes in the human genome). Each mRNA type will be present at
different copy numbers  (abundances)  depending  upon the  particular  cell, its
function,  and its  environmental  conditions  at the  time.  A cell  will  thus
contain,  at any one time, perhaps as many as one million mRNA molecules of tens
of thousands of different types.

Regulation of Gene Expression

         The regulation of gene expression is highly complex, differing not only
between the various cell types within the organism,  but also  differing  within
each cell during growth, development and aging, as well as during the organism's
response to various  stimuli from the  environment.  Higher  organisms,  such as
humans,  include in their makeup genetically  programmed responses (to intrinsic
and  extrinsic  stimulations  or insults) that have evolved to protect them from
injury. These protective  responses require, in turn,  biochemical sensors (such
as  receptors)  that are coupled to the  cellular  mechanisms  controlling  gene
expression  through changes in the amounts of specific mRNA molecules within the
cell.

Disease

         Many  diseases  spring  from  a  failure  of  the  host's   genetically
programmed,  protective response to an insult such as trauma, infection, stress,
or an inherited  mutant gene.  That failure may mean that the insult is followed
by inadequate, misguided, or exaggerated gene expression(s). These then unfold 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.

The Genome and the Search for Therapeutics

         Genomic  approaches  to  therapeutics  begin  with a search  for  genes
connected to the origin of disease, or for genes whose expression differentiates
diseased  cells from healthy ones. In either case the searches are laborious and
involve  a very  large  amount  of DNA  sequencing  to  identify  genes  or gene
fragments.  Still,  laborious as it is to obtain,  this  knowledge of genes is a
first  step  only.  While it does set the stage  for  understanding  either  the
predispositions to a disease or its eventual characteristics, and thus paves the
way for the development of better diagnostics,  it doesn't necessarily lead to a
therapy.  For  example,  while a  particular  gene,  or absence  of a gene,  may
predispose  to a cancer,  the  full-blown  tumor and its  metastases  are likely
governed by entirely different genes. Hence, the more recent realization is that
in addition to understanding  disease causes,  it is equally  important,  if not
more so, to  understand  gene  function  in both  health and disease in order to
identify the optimal target for therapy.

                                       3.

<PAGE>


Gene Function and Gene Expression

         Elucidation of gene function is not simply a matter of looking up which
genes are  expressed in a healthy or diseased  tissue.  One needs to  understand
which of the altered gene expressions are causative and which are  consequences.
Ideally,  one would want to follow the full gene  expression of a cell or tissue
all along the  evolution of a disease,  from the healthy state to the point when
therapy would begin.  One would then also want to apply  specific and successive
biological and/or chemical  modulations of specific gene expressions in order to
gain insight into cause and effect.  This is obviously  not  practical,  or even
possible,  in human disease.  And, while  theoretically  possible in in-vitro or
in-vivo model systems,  it is not practical,  or cost effective,  because of the
limitations  of current  technologies.  At this time,  only the most  abundantly
expressed genes (the top 3% to 5% amongst the 10,000 to 30,000  expressed in any
one sample) are accessible using current gene identification technologies. Also,
because the latter are all dependent on separating and cloning  double  stranded
copies of each  individual  mRNA (cDNA) prior to analysis,  the process is quite
cumbersome and onerous.

LYNX'S MASSIVELY PARALLEL TECHNOLOGIES

         Lynx's  novel,   proprietary  technologies  are  designed  to  identify
hundreds  of  thousands,  perhaps  even a  million  or  more,  fragments  of DNA
simultaneously  from a single  sample  preparation.  The  Company  is  presently
testing three prototype  instruments,  each potentially capable of analyzing one
such  sample per week.  Second  generation  instruments,  of which two have been
built and eight are under construction,  are designed eventually to analyze each
up to eight  samples  simultaneously  in less than three  days.  This  contrasts
dramatically with instruments based on current  technology that can only analyze
several dozen individually prepared fragments in an instrument run.

         Massively  Parallel Solid Phase Cloning.  Central to Lynx's proprietary
technologies  is the ability to amplify,  simultaneously,  a million or more DNA
molecules or fragments  present in a given  sample,  and then to direct and bind
the amplified  copies of each fragment to one of a million or more beads.  These
bead libraries enable a number of previously  unavailable analyses.  They can be
probed to count the number of beads that carry a  particular  sequence,  thereby
determining  the  number of copies of that  sequence  that were  present  in the
original   sample.   They  can  be  compared  to  one  another  in   competitive
hybridization  experiments  and then  sorted to isolate  those  beads that carry
genes equally,  or differentially,  expressed in both samples.  They can also be
arrayed  and  immobilized  in a  reaction  cell  where  they  are all  subjected
simultaneously to biochemical  processes designed to probe for various pieces of
information.

         Massively Parallel  Hybridization  Arrays or "Chips." Unlike arrays, or
gene chips,  constructed with other  technologies,  arrays constructed with Lynx
beads can include any gene, from any species, whether already known or not. With
Lynx  technologies,  it is possible to construct an array or chip that  includes
any identifiable  subset, or all, of the genes involved in a particular  disease
or disease model. Genes arrayed in a Lynx device are identified after isolation,
cloning, and arraying, using a biochemical process proprietary to Lynx.

         Massively Parallel  Sequencing.  In this proprietary  process,  the DNA
fragments  bound to each bead are probed to determine the bases at the free ends
of the  fragments.  The process is then applied  repetitively  to determine  the
sequence carried by each bead.  Because DNA is made up of four types of bases, a
sequence of 24 is sufficiently  long to uniquely identify the fragments and thus
to provide unique  "signatures" for the fragments,  thereby  characterizing  the
genes or sequences that make up the array.

         Utilizing  these   massively   parallel   technologies,   Lynx  expects
eventually to probe for genetic and genomic information in a much more efficient
manner than allowed by current sequencing technology. Lynx eventually expects to
be able to obtain over a million  signatures  with only one sample  preparation,
and one machine run (a few days).  In contrast,  one  commercial  DNA sequencing
instrument  from the current  market  leader will yield at best a thousand or so
signatures from several runs in the same time interval,  provided, however, that
the thousand samples are prepared individually beforehand. The savings in sample
preparation,  the lower  number of runs,  and the savings

                                       4.

<PAGE>

in the use of reagents  due to the massive  parallelism  should  translate  into
significant economic advantages.  The cost of sequencing a base utilizing Lynx's
technology  is  expected  to be  significantly  lower  than  using  conventional
technology.

TECHNICAL APPLICATIONS OF LYNX'S MASSIVELY PARALLEL TECHNOLOGIES

         Lynx technologies have a number of major applications and each of these
can be applied to the  genomes of man,  pathogenic  organisms  and  commercially
important plants and animals.

         Gene Expression Analysis.  Cells in the human body contain the same set
of  100,000  or so  genes.  However,  in  any  given  cell,  only  an  estimated
10,000-30,000  may be active,  or expressed,  at any given time. Gene expression
varies,  not only as a function of different cell types, but also as a result of
disease.  Thus, by examining the levels and changes of gene expression  during a
disease  process,  or as a result  of  experimental  treatments,  pharmaceutical
companies can better identify new targets for drug screening.  In addition, gene
expression analysis can be applied to pathogenic organisms to help determine the
genes that cause virulence or antibiotic  resistance.  Lynx's  technologies  are
expected to enable more rapid,  and deeper,  analyses of gene expression than is
currently possible,  capturing in these analyses genes that are rarely expressed
and hence are missed when  conventional  technologies  are used. This is because
with conventional  technology one must, after amplifying the genetic messages in
a sample, sort them out and separate them to sequence them. Since the separation
procedures  favor the most abundant  messages,  i.e.  those present in high copy
numbers,  it is very difficult to detect the less abundant messages.  This means
that  conventional  technology  will miss  detecting  genes  expressed  at lower
levels.  But such genes are  believed  responsible  for many  important  control
functions in a cell and, as a  consequence,  they may represent  important  drug
targets. Since Lynx's technologies associate each copy of an expressed gene to a
particular bead, only very rarely  expressed genes may, on occasion,  be missed.
Since  each  copy  of a gene  is  associated  with a bead,  the  levels  of gene
expression are readily  quantified:  the more  abundantly  expressed  genes will
occupy proportionately more beads than genes expressed at lower levels.

         High   Resolution   Genomic  Maps.   Another   application   of  Lynx's
technologies is the  construction of high resolution maps of the human and other
genomes.  Genomic  maps are used by  researchers  in academic  institutions  and
companies  undertaking  positional  cloning  studies  to find  genes  that cause
specific  diseases.  Currently  available maps have  resolutions on the order of
hundreds of thousands of bases (i.e.,  identifiable markers, spaced with 100,000
or more DNA bases between  them).  Newer maps are under  development in industry
and academia that will have resolutions of 50,000.

         Lynx's  technologies can, in principle,  efficiently analyze any genome
for a particular subset of signatures and also construct a physical map of these
at the same time. For example,  a 1 kilobase  resolution map (1 signature  every
1,000  bases) of the entire  human  genome  could be derived by  determining  12
million  signatures and mapping them. Lynx believes that its technologies can be
used to  make  maps  with a  resolution  of  about  500 to  1,000  bases  with a
manageable  number of runs once such runs are able to routinely  process 500,000
signatures.

         Such  high-resolution  maps should have wide utility.  First, all human
DNA sequence  databases could be examined for the presence of these  signatures,
and any fragment containing a known signature sequence could instantly be placed
on the map. This should also apply to the gene expression  signatures  described
earlier, and should allow the production of expression maps for the entire human
genome well in advance of  determining  the entire genome  sequence or, for that
matter, the sequences of all cDNAs.

         The  possession  of such  maps,  together  with  the  capacity  for the
technology  to handle large  numbers of DNA  fragments in parallel,  should have
profound  implications for human genetics.  First,  positional  cloning of genes
located by genetic  mapping  techniques  in family  studies could be carried out
very easily  without the need to perform large amounts of sequencing to identify
candidate  genes.  For  example,  there may  already  be cDNAs  located by their
signatures in the region. In addition,  the signatures themselves can be used as
Polymerase Chain Reaction ("PCR") primer pairs to amplify selected regions, thus
bypassing the laborious screening of libraries of cloned DNA fragments.

                                       5.
<PAGE>


         Maps could be constructed for the mouse or rat in the same way, and the
signature data bases could be cross-referenced  simply through the known genetic
concordance of the human with rodent  genomes.  The  cross-referencing  could be
extended to the genomes of other mammals of economic  importance such as the pig
or the cow.

         Maps could also be constructed for economically important crops such as
wheat,  corn, and rice, thus  allowing  plant  geneticists  much more  efficient
studies and manipulations of these very large genomes.

OTHER LYNX PROGRAMS

Biology-based Target Discovery Programs

         In 1995,  the Company  launched a program to  establish  the  concepts,
strategies and techniques necessary for the identification of drug targets based
on the analysis of differential  gene  expression.  This program was designed to
capitalize   eventually  on  the  power  of  the  Company's  massively  parallel
technologies  but, in its early phase,  was built on know-how  and  intermediate
technologies currently resident within Lynx. These include existing differential
molecular techniques, as well as hybridization-based techniques for the analysis
of  specific  disease  paradigms.  The  initial  projects  were  centered on the
medically important field of neurovascular  diseases, in areas for which good in
vitro  and in vivo  models  exist,  and that are  particularly  well  suited  to
analyses with the Company's technologies.

         Early  results  from  these  programs  formed  one of the bases for the
biotechnology  joint venture company formed in partnership with BASF, and called
BASF-LYNX Bioscience AG.

Therapeutic Program

         Lynx  was  originally  formed  in 1992  to  target  inappropriate  gene
expression  in disease with  synthetic  DNA  fragments  designed to bind to, and
functionally  block,  genes whose  inappropriate  expression could be correlated
with  disease.  Lynx's  early  efforts in this area  formed the  foundation  and
understanding for the development of its massively  parallel  technologies.  The
research  efforts have resulted in a compound  ("LR-3280") for the prevention of
coronary  artery  restenosis.  The acute safety segment of its Phase II study on
LR-3280 has recently been completed. Certain follow-up measurements and analyses
from the clinical  trial are expected to be completed  during the next  quarter.
Two pharmaceutical  companies,  Schwarz Pharma AG ("Schwarz") and Tanabe Seiyaku
Co., Ltd. ("Tanabe"),  have purchased the rights to market the compound and have
also committed to bear the costs of its continued clinical development.

         In March 1998,  Lynx sold its portfolio of  phosphorothioate  antisense
patents  and   licenses   (which   includes   LR-3280),   and  its   therapeutic
oligonucleotide  manufacturing  facility,  to Inex  Pharmaceuticals  Corporation
("Inex") of Vancouver, Canada. Lynx received $3 million in cash and will receive
1.2  million  shares of Inex  common  stock  and  royalties  on future  sales of
phosphorothioate   antisense  products.  In  addition,  Lynx  has  agreed  to  a
royalty-bearing  license to Inex for its phosphoroamidate  chemistry for certain
therapeutic  applications in the fields of cancer and inflammation  that will be
defined later.

         Under the agreement,  Inex will assume  responsibility of manufacturing
LR-3280 for Schwarz and Tanabe.  Lynx retains the right to collect,  if and when
earned, the next milestone payments,  totaling $7 million, under the Schwarz and
Tanabe  agreements,  as well as 50% of all future  milestone  payments and gross
profits associated with the success in the development and sale of the compound.

Corporate Collaborations

     o   In October 1996, Lynx entered into two agreements with BASF AG aimed at
         exploiting Lynx's  proprietary  massively  parallel  technologies.  The
         first agreement  commits the two companies to form a new  biotechnology
         Joint Venture  ("JV")  called  BASF-LYNX  Bioscience AG in  Heidelberg,
         Germany,  which

                                       6.
<PAGE>

         will be governed by a detailed  operating  agreement  developed jointly
         between the Company and BASF. Initial ownership of the JV will be split
         51%-49% between BASF and Lynx,  respectively.  Under the sponsorship of
         BASF and Lynx the JV will be focused primarily on the identification of
         novel drug targets in certain  central  nervous system  diseases.  BASF
         will provide research funding of up to 50 million DM (approximately $27
         million at current exchange rates) over a five year period,  as well as
         access to certain of its technologies,  and Lynx will provide access to
         its  massively  parallel  technologies  for  use in the  JV's  research
         programs.

         The second agreement is a service  agreement which provides BASF access
         to Lynx's  massively  parallel  technologies  for its own  internal and
         proprietary research, independent of the JV's objectives. For access to
         this service,  which commits Lynx to provide BASF with a certain number
         of analyses  per year,  BASF paid Lynx an access fee of $5.5 million on
         execution of the  agreement.  Also,  upon the  achievement of a certain
         milestone,  BASF agreed to pay an additional  fee of $5.5 million and a
         subscription fee of $4 million for each year of a two-year subscription
         period for the analyses.

         o In October 1995,  Lynx entered into an agreement with Hoechst,  which
         provides Hoechst with access to Lynx's massively parallel technologies.
         Under the terms of the agreement, Hoechst paid Lynx an access fee of $3
         million on execution of the  agreement,  and upon the  achievement of a
         certain milestone,  agreed to pay an additional fee of $8 million and a
         subscription  fee of $4 million for a one year  subscription  under the
         agreement.  In return,  Lynx will provide Hoechst with a certain number
         of  analyses  per  year.  This  agreement  allows  for no more than two
         additional  companies to access this technology for a specified period.
         In addition, the Company received $5 million in November 1995, relating
         to the  closing of a private  placement  offering  to Hoechst of 40,000
         shares of its Series D preferred stock at $125.00 per share.

         In September 1997, the agreement  between Hoechst and Lynx was amended.
         The  amendment  modified  the  technology  milestone  included  in  the
         original  agreement and extended the date by which such  milestone must
         be achieved under the contract.  If the subject milestone is not met by
         such date,  then Hoechst may either  terminate  the agreement or extend
         the technology milestone date.

Research and Development Expenditures

         Lynx has devoted its efforts  primarily  to research  and  development.
Research and development expenses were $14.2 million for the year ended December
31, 1997,  $12.5 million for the year ended  December 31, 1996 and $11.3 million
for the year ended December 31, 1995.

Scientific Advisors

         The following are Lynx's principal scientific advisors:

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

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

                                       7.
<PAGE>


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

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

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

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

Employees

         As of December 31, 1997, Lynx employed 73 full-time employees, of which
59 were engaged in research  and  development  activities  and 14 in finance and
administrative  activities.  Lynx  believes  that  it  has  been  successful  in
attracting skilled and experienced  scientific personnel;  however,  competition
for  such  personnel  is  intense.  None of  Lynx's  employees  are  covered  by
collective  bargaining  agreements,  and management considers relations with its
employees to be good.

Business Risks

         Technology  Uncertainty  and Product  Development  Risk.  The Company's
strategy of using its massively  parallel  technologies  for gene sequencing for
the purpose of rapidly  identifying  genes,  defining  and  characterizing  gene
function,  and  enabling  high-resolution  genomic  mapping is  unproven.  While
certain  other  companies  have  similar  technology  or have  adopted a similar
strategy, the application of these technologies and strategies is in too early a
stage  to  determine   whether  it  can  be  successfully   implemented.   These
technologies  are new and unproven  approaches  and are based on the  assumption
that information  about gene expression and gene sequences may enable scientists
to understand  better complex  disease  processes.  Generally,  there is limited
understanding  of the  roles  of genes in these  diseases,  and  relatively  few
therapeutic   products  based  on  gene  discoveries  have  been  developed  and
commercialized.  There can be no assurance that the Company's  technologies will
enable it or its  strategic  partners to identify  genes,  drug targets and drug
leads useful for the discovery and  development  of  therapeutic  and diagnostic
products.  To date, no drug targets or drug leads have been identified  based on
the  Company's  technologies,   and  the  Company  has  not  commercialized  any
therapeutic  or  diagnostic  products  either alone or in  conjunction  with its
strategic partners.

         The Company's genomic database subscription business and the use of its
products  to  assist in and  improve  the  efficiency  of the  traditional  drug
discovery  process  is in too  early  a stage  to  determine  whether  it can be
successful.  There can be no assurance that companies will accept the usefulness
of the Company's  products and related  services.  In addition,  the Company has
limited  experience in providing  software-based  database products or services.
The Company's ability to achieve  profitability  depends on attracting customers
for its  database  and  sequencing  products  and  services.  The  nature of the
Company's products and services are such that there is a limited number of large
pharmaceutical  companies  that are  potential  customers  for such products and
services,  two of which

                                       8.

<PAGE>

have signed  agreements with the Company to date. There can be no assurance that
any of the Company's product development efforts will be successfully  completed
or that the Company's products will gain market acceptance.

         Early Stage of Development;  Limited Operating  History;  Profitability
Uncertainty.  Lynx is at an early stage of development  and must be evaluated in
light of the uncertainties and complications  present in an early stage genomics
company. All of Lynx's products and services are in research or development, and
have not generated significant revenues. The massively parallel technologies are
in the  development  stage and are dependent upon the successful  integration of
independent  technologies,  each of which  has its own  development  risks.  The
development of the Company's technologies and their application to the discovery
of genes, genomic mapping,  drug targets and drug leads will require significant
additional research and development and investment, including testing to further
validate  performance  and  demonstrate  cost  effectiveness.  There  can  be no
assurance  that the  Company's  technologies  will  continue to be  successfully
developed,  or  that  any  therapeutic  or  diagnostic  products  discovered  or
developed through their utilization will prove to be commercially  useful,  meet
applicable regulatory standards in a timely manner or at all, compete with other
technologies and products, avoid infringing the proprietary rights of others, be
manufactured  in sufficient  quantities  or at  reasonable  costs or be marketed
successfully. The Company may that it will be a number of years, if ever, before
the Company will recognize revenue from therapeutic or diagnostic  product sales
or  royalties.  There  can be no  assurance  that  these  technologies  will  be
successfully   developed   or,  if  they  are,   that  they  can  be  integrated
successfully.

         The Company has a limited  history of  operations  and has  experienced
significant  operating losses since its inception in 1992,  including net losses
of  approximately  $10.8 million  during the year ended  December 31, 1997.  The
Company  had an  accumulated  deficit of  approximately  $42.3  million  through
December 31, 1997. The Company expects to incur  additional  losses for at least
the next several years and that such losses may increase as the Company  expands
its research  and  development  activities.  The  Company's  losses to date have
resulted  principally  from costs incurred in research and  development and from
general and administrative  costs associated with the Company's  operations.  To
date,  substantially  all of the  Company's  revenues  have  been  derived  from
payments from strategic  alliances and licensing  arrangements,  and the Company
expects that  substantially all of its revenues for the foreseeable  future will
result from payments from  strategic  alliances and licensing  arrangements  and
interest  income.  There  can be no  assurance  that the  Company  will  receive
additional  revenues under existing strategic alliances or that the Company will
be  successful  in entering  into any new  strategic  alliance  that  results in
revenues.  The Company's ability to generate revenues and achieve  profitability
is dependent  in large part on the  Company's  ability to enter into  additional
strategic  alliances,  and on the  ability  of the  Company  and  its  strategic
partners to discover genes and drug targets associated with particular  diseases
and,  thereafter,  utilize  such  discoveries  to identify  drug leads,  develop
therapeutic and diagnostic  products,  conduct  preclinical studies and clinical
trials,  obtain  required  regulatory  approvals and  successfully  manufacture,
introduce and market such products.  In addition, to the extent that the Company
relies  upon  others  for  these  research,  development  and  commercialization
activities,  the Company's ability to achieve profitability will be dependent in
part upon the  success  of such  outside  parties.  The time  required  to reach
profitability is highly uncertain and there can be no assurance that the Company
will be able to achieve  profitability  on a sustained basis, if at all. Failure
to achieve  significant  revenue or profitability  would have a material adverse
effect on the Company's business, financial condition and results of operations.

         Intense  Competition;  Rapid Technological  Change.  There are a finite
number  of genes  in the  human  genome.  The race  amongst  competitors  in the
genomics field is not just to identify these genes by their sequences,  but also
to determine gene function,  particularly gene function in disease.  Competition
among entities  attempting to identify genes  associated with specific  diseases
and to develop  products  based on such  discoveries  is intense.  Even when all
genes  are  known,  and  their  sequences  determined,  the hunt for  functional
information  in the  wide  variety  of  diseases  and  disease  conditions  will
continue,  and characterization of genes (by their sequences) in various samples
will  still be  needed.  While  Lynx  believes  that it  contributes  a uniquely
efficient  gene  analysis   technique  to  that  hunt,   other   companies  have
substantially   greater  research  and  product  development   capabilities  and
financial, scientific, and marketing resources than the Company.

         The  Company  faces,  and  will  continue  to  face,  competition  from
pharmaceutical,  biotechnology and diagnostic  companies,  academic and research
institutions  and  government  agencies,  both in the United  States and

                                       9.
<PAGE>

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.  The Company is aware that certain entities are utilizing 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  companies are developing  genomic  research
programs,  either  alone  or in  partnership  with  the  Company's  competitors.
Competition among such entities is intense and is expected to increase. In order
to compete against  existing and future  technologies,  the Company will need to
demonstrate to potential  customers that its  technologies  and capabilities are
superior to competing technologies.

         Many of the Company's  competitors have  substantially  greater capital
resources,  research  and  development  staffs,  facilities,  manufacturing  and
marketing  experience,  distribution  channels  and  human  resources  than  the
Company.  These  competitors  may discover,  characterize  or develop  important
genes, drug targets or drug leads in advance of Lynx which could have a material
adverse effect on any similar Lynx program.  Moreover, there can be no assurance
that the  Company's  competitors  will not  obtain  patent  protection  or other
intellectual  property  rights that would limit the  Company's or its  strategic
partners'  ability  to  use  the  Company's  high  resolution   genomic  mapping
technologies  or drug discovery  technologies  or  commercialize  therapeutic or
diagnostic products, which could have a material adverse effect on the Company's
business,  financial condition and results of operations. The Company also faces
competition  from these and other entities in gaining access to relevant samples
used in its discovery programs.

         While Lynx,  at this time, is not aware of  technologies  equivalent or
superior to its massively parallel technologies,  there are other companies that
provide  data or access to data  similar to that  which  Lynx  intends to offer.
There can be no assurance that research and  development  efforts by others will
not render any of the Company's potential products and services noncompetitive.

         Future competition will come from existing competitors as well as other
companies  seeking to develop new  technologies for drug discovery based on gene
sequencing,  gene expression analysis,  bioinformatics and related technologies.
In addition, certain pharmaceutical and biotechnology companies have significant
needs for  genomic  information  and may choose to develop or acquire  competing
technologies  to meet such needs.  Genomic  technologies  have undergone and are
expected to continue to undergo  rapid and  significant  change.  The  Company's
future  success  will  depend in large  part on its  maintaining  a  competitive
position in the genomics field. Rapid  technological  development by the Company
or others may result in products or  technologies  becoming  obsolete before the
Company  recovers the expenses it incurs in connection  with their  development.
Products offered by the Company could be made obsolete by less expensive or more
effective drug target and drug lead technologies,  including  technologies which
may be unrelated to genomics. There can be no assurance that the Company will be
able  to  make  the  enhancements  to  its  technologies  necessary  to  compete
successfully with newly emerging technologies.

         Patents and Proprietary Rights; Third Party Rights. Lynx's success will
depend on its  ability to obtain  patents  for its  technologies  and  products,
maintain trade secrets and operate without  infringing on the proprietary rights
of others,  both in the United States and in other countries.  Patent matters in
biotechnology  are  highly  uncertain  and  involve  complex  legal and  factual
questions.  Accordingly,  the  availability  of and breadth of claims allowed in
biotechnology and pharmaceutical patents cannot be predicted. Lynx has filed and
will continue to file  applications,  as appropriate,  for patents covering both
its  products  and  processes  and has  licensed a number of patents  and patent
applications covering certain of its technologies,  processes and compounds.  No
assurance  can be  given  that  patents  will  issue  from  any  of the  pending
applications  or  that,  if  patents  do  issue,  the  claims  allowed  will  be
sufficiently  broad to protect  Lynx's  technologies.  In  addition,  patent law
relating  to the scope of claims in the  technology  field in which the  Company
operates is still  evolving.  The degree of future  protection for the Company's
proprietary  rights,  therefore,  is  uncertain.  Furthermore,  there  can be no
assurance  that others will not  independently  develop  similar or  alternative
technologies,  duplicate any of the Company's  technologies,  or, if patents are
licensed  or issued to the  Company,  design  around the  patented  technologies
licensed to or developed by the Company.  In addition,  the Company  could incur
substantial  costs in  litigation  if it is required to defend  itself in patent
suits brought by third parties or if it initiates such suits.

                                      10.
<PAGE>

         The  Company is aware of a number of United  States  patents and patent
applications and corresponding  foreign patents and patent applications owned by
third parties relating to the analysis of gene expression or the manufacture and
use of DNA chips.  There can be no  assurance  that these or other  technologies
will not provide third parties with competitive  advantages over the Company and
will not have a material  adverse  effect on the Company's  business,  financial
condition  and results of  operations.  In addition,  certain third party patent
applications  contain broad claims,  and it is not possible to determine whether
or not such claims will be narrowed  during  prosecution  and/or will be allowed
and issued as patents, even if such claims appear to cover the prior art or have
other  defects.  There can be no assurance that an owner or licensee of a patent
in the  field  will not  threaten  or file an  infringement  action  or that the
Company  would  prevail in any such action.  There can be no assurance  that the
cost of defending an infringement  action would not be substantial and would not
have a material adverse effect on the Company's  business,  financial  condition
and  results of  operations.  Furthermore,  there can be no  assurance  that any
required  licenses would be made available on  commercially  viable terms, if at
all.  Failure to obtain any  required  license  could  prevent the Company  from
utilizing or  commercializing  one or more of its  technologies and could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

         In  general,  the  Company  intends  to  continue  to apply for  patent
protection  for  methods  relating  to gene  expression  and to apply for patent
protection for the individual disease genes and drug targets it discovers.  Such
patents may include  claims  relating to novel genes and gene  fragments  and to
novel uses for known genes or gene  fragments  identified  through its discovery
programs.  There can be no  assurance  that the  Company  will be able to obtain
meaningful  patent  protection for its discoveries;  even if patents are issued,
the scope of the coverage or protection  afforded thereby is uncertain.  Failure
to secure such meaningful patent protection could have a material adverse effect
on the Company's business, financial condition and results of operations.

         Several groups are attempting to identify and patent gene fragments and
full-length genes, the functions of which have not been  characterized,  as well
as fully  characterized  genes. There is substantial  uncertainty  regarding the
possible patent protection for gene fragments or genes without known function or
correlation  with  specific  diseases.  To the extent any patents issue to other
parties on such  partial  or  full-length  genes,  the risk  increases  that the
potential  products and processes of the Company or its  strategic  partners may
give rise to claims of patent  infringement.  The public availability of partial
or full sequence  information  or the existence of patent  applications  related
thereto,  even if not accompanied by relevant  function or disease  association,
prior to the time the Company  applies for patent  protection on a corresponding
gene could adversely  affect the Company's  ability to obtain patent  protection
with respect to such gene or related expression  patterns.  Furthermore,  others
may have  filed,  and in the  future  are  likely to file,  patent  applications
covering  genes or gene  products that are similar or identical to any for which
the Company may seek patent protection.  No assurance can be given that any such
patent application will not have priority over patent  applications filed by the
Company. Any legal action against the Company or its strategic partners claiming
damages and seeking to enjoin  commercial  activities  relating to the  affected
products and processes could, in addition to subjecting the Company to potential
liability for damages, require the Company or its strategic partners to obtain a
license in order to continue to manufacture or market the affected  products and
processes.  There can be no assurance that the Company or its strategic partners
would  prevail in any such  action or that any license  required  under any such
patent would be made available on commercially  acceptable terms, if at all. The
Company  believes  that  there is likely  to be  significant  litigation  in the
industry regarding patent and other intellectual property rights. If the Company
becomes involved in such litigation,  it could consume a substantial  portion of
the Company's  managerial  and financial  resources and have a material  adverse
effect on the Company's business, financial condition and results of operations.

         Enactment of legislation  implementing the General Agreement on Tariffs
and Trade has  resulted  in certain  changes to United  States  patent laws that
became  effective on June 8, 1995. Most notably,  the term of patent  protection
for patent  applications filed on or after June 8, 1995 is no longer a period of
17 years  from the date of grant.  The new term of United  States  patents  will
commence  on the date of  issuance  and  terminate  20 years  from the  earliest
effective  filing  date of the  application.  Because  the time  from  filing to
issuance of biotechnology  patent applications is often more than three years, a
20-year  term from the  effective  date of filing may result in a  substantially
shortened  period of patent  protection which may adversely affect the Company's
patent position.  If this change results in a shorter period of patent coverage,
the  Company's  business  could be  adversely  affected  to the

                                      11.
<PAGE>

extent that the  duration  and level of the  royalties it is entitled to receive
from its  strategic  partners  are  based  on the  existence  of a valid  patent
covering the product subject to the royalty obligation.

         Lynx also relies on trade secrets and  proprietary  know-how,  which it
seeks to protect in part by  confidentiality  agreements with its collaborators,
employees and consultants.  There can be no assurance that these agreements will
not be breached,  that Lynx would have adequate  remedies for any breach or that
its trade secrets will not otherwise become known or be independently  developed
by  competitors.  To the extent that the Company or its  consultants or research
collaborators  use  intellectual  property owned by others in their work for the
Company,  disputes  may also  arise as to the  rights in  related  or  resulting
know-how and inventions.

         Need to Establish Collaborative Relationships;  Dependence on Partners.
Lynx's  business  strategy  includes  entering into  subscription  arrangements,
strategic alliances or licensing arrangements with corporate partners, primarily
pharmaceutical, biotechnology and genomic companies, relating to the development
and  commercialization of certain of its potential  technologies,  databases and
products.  There  can be no  assurance  that  Lynx  will be  able  to  negotiate
attractive  collaborative  arrangements  or  that  such  collaborations  will be
available  to Lynx on  acceptable  terms so that any  such  relationships,  once
established,  will be scientifically or commercially successful.  Lynx currently
has two  corporate  agreements  for  its  massively  parallel  DNA  cloning  and
sequencing technologies, with Hoechst and BASF.

         There can be no  assurance  that  Hoechst  or BASF or any other  future
collaborator  will not pursue  their  existing or  alternative  technologies  in
preference  to  those  being  developed  in  collaboration   with  the  Company.
Furthermore,  there  can be no  assurance  that  the  Company  will  be  able to
negotiate additional collaborative  arrangements on acceptable terms, if at all,
or that such collaborations  will be successful.  To the extent that the Company
chooses not to or is unable to establish  such  arrangements,  it would  require
substantially  greater capital to undertake  research and development of certain
of its potential technologies, data bases and products at its own expense.

         Absence of Sales and  Marketing  Experience.  Lynx has no experience in
the sales, marketing or distribution of pharmaceutical  products or services. To
market the products or services of its  massively  parallel  technologies,  Lynx
must define the particular  products and services that it will offer and develop
a sales and marketing group with the appropriate technical expertise.  Lynx does
not plan to market any future pharmaceutical products directly.  There can be no
assurance  that Lynx will be able to build such a sales force or that its direct
sales and marketing efforts will be successful.

         Use of Hazardous Materials. Lynx's research and development may involve
the  controlled  use of  hazardous  materials,  chemicals,  viruses  and various
radioactive  compounds.  Although Lynx believes that its safety  procedures  for
handling  and  disposing  of such  materials  will  comply  with  the  standards
prescribed  by state,  federal  and local  regulations,  the risk of  accidental
contamination or injury from these materials cannot be completely eliminated. In
the event of such an  accident,  Lynx could be held liable for any damages  that
result, and any such liability could exceed the resources of Lynx.

         Dependence  Upon  Key  Personnel.  Lynx  is  highly  dependent  on  the
principal  members of its  management and  scientific  staff,  the loss of whose
services  could  significantly  delay or prevent the  achievement  of  research,
development and business  objectives,  thus having a material  adverse effect on
Lynx.  Furthermore,  recruiting and retaining qualified  scientific personnel to
perform  research and development  work in the future will be critical to Lynx's
success.  Although  Lynx  believes  it  will be  successful  in  attracting  and
retaining  skilled  and  experienced  scientific  personnel,  there  can  be  no
assurance  that  Lynx will be able to  attract  and  retain  such  personnel  on
acceptable terms, given the competition among numerous pharmaceutical and health
care  companies,   universities   and  non-profit   research   institutions  for
experienced  scientists.  The Company is  dependent  on its  Chairman  and Chief
Executive  Officer,  Sam Eletr,  Ph.D.,  the loss of whose services would have a
material  adverse  effect on the Company.  The Company has recently  applied for
key-man  life  insurance  on Dr.  Eletr.  The Company  has not  entered  into an
employment agreement with him.

                                      12.
<PAGE>

         Potential  Volatility  of Stock Price;  Limited  Market for Stock.  The
Company  qualified  its  common  stock  to  trade  on The  Nasdaq  Stock  Market
("Nasdaq")  on December  30, 1997.  There can be no assurance  that a sufficient
trading market will develop. 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 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.  Factors such as fluctuations  in the Company's  operating
results,  announcements of technological  innovations or new commercial products
by the Company or its  competitors,  release of reports by securities  analysts,
developments or disputes concerning patent or proprietary  rights,  developments
in the Company's relationships with current or future collaborative partners, if
any, and general market  conditions may have a significant and adverse impact on
the market price of the common stock.

         Future  Capital  Requirements;  Uncertainty  Of  Access  To  Additional
Funding.  The Company has invested significant capital in its infrastructure and
in its scientific and business  development  activities and expects  capital and
operating expenditures to increase over the next several years as it expands its
operations. The Company's actual future capital requirements and the adequacy of
its available funds will depend on many factors,  including the number,  breadth
and  progress  of its  programs,  the ability of the  Company to  establish  and
maintain strategic  alliance and licensing  arrangements and the progress of the
development and  commercialization  efforts of the Company's strategic partners.
These  factors also include the level of the  Company's  activities  relating to
competing  technological  and market  developments,  the costs  associated  with
obtaining  access  to  tissue  samples  and  related  information  and the costs
involved in preparing,  filing,  prosecuting,  maintaining and enforcing  patent
claims and other intellectual property rights.

         The Company expects that it will require significant additional funding
in the future,  which it may seek through  public or private  equity  offerings,
debt financings or additional strategic alliance and licensing arrangements.  No
assurance  can be given that  additional  financing  or  strategic  alliance and
licensing  arrangements  will be available  when needed,  or that, if available,
such  financing  will be  obtained  on terms  favorable  to the  Company  or its
stockholders.  To the extent the Company  raises  additional  capital by issuing
equity or convertible debt securities,  ownership  dilution to stockholders will
result.  If adequate  funds are not  available  when needed,  the Company may be
required to curtail operations significantly or to obtain funds by entering into
strategic alliances and licensing arrangements, in which case the Company may be
required to relinquish  rights to certain of its  technologies,  discoveries  or
potential products,  or to grant licenses on terms that are not favorable to the
Company,  any of which  could have a material  adverse  effect on the  Company's
business,  financial  condition  and  results of  operations.  In the event that
adequate  funds are not  available,  the Company's  business  would be adversely
affected.

         Ethical, Legal And Social Implications Of Gene-Based  Diagnostics.  The
Company and its partners may seek to develop diagnostic  products based on genes
it discovers.  The prospect of broadly  available  gene-based  diagnostic  tests
raises issues regarding their appropriate utilization and the confidentiality of
the information  provided by such testing. 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.  There can be no  assurance  that such
ethical  and  social  factors  or  concerns  about  genetic  testing  and target
identification  will not have a material adverse effect on market  acceptance of
the Company's technologies and products.


                                      13.

<PAGE>


ITEM 2.           PROPERTIES

         Lynx's corporate  headquarters  and principal  research and development
facilities  are  located  in  Hayward,   California,   in  a  building  totaling
approximately  44,000 square feet. The building is leased through July 2003, and
the Company has  options to renew the lease for two  additional  periods of five
years each.

         In February  1998,  the  Company  entered  into a lease for  additional
facilities  space of  approximately  111,000  square  feet in two  buildings  in
Hayward,  California.  The  term of the  lease is ten  years  and  commences  on
December 15,  1998.  Lynx intends to relocate  its  corporate  headquarters  and
research  and  development  facilities  to,  and  to  construct  its  production
facilities  in, this space.  The space will be developed and occupied in phases,
depending on the growth of the Company.  Lynx has the option to extend the lease
for an additional five year period,  subject to certain conditions.  The Company
has an option to lease additional space, as needed, for expansion purposes. Lynx
believes  it is  positioned  to obtain  the  space  needed  to  accommodate  its
anticipated growth on commercially reasonable terms.

         In  connection  with the  aforementioned  transaction  with  Inex,  the
Company has entered into an agreement  to sublease to Inex  approximately  6,300
square feet of its existing  facilities under lease. The term of the sublease to
Inex is twenty-four months, commencing on March 10, 1998. Inex has the option to
extend the term of sublease  through July 2003,  subject to certain  conditions.
The Company intends to seek additional  sublessees for the remaining  portion of
its existing facilities.


ITEM 3.           LEGAL PROCEEDINGS

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


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

         No matters were submitted to a vote of security  holders in the quarter
ended December 31, 1997.


                                      14.

<PAGE>


                                     PART II


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

         On December 30, 1997, the Company listed its common stock on The Nasdaq
Stock  Market.  Prior to December  30,  1997,  there was no  established  public
trading market for the Company's voting stock.

         The  Company  also has  outstanding  Series  B,  Series C and  Series D
preferred  stock,  the  shares of which  will  convert  into  common  stock on a
ten-for-one  basis (i.e., ten shares of common stock for each share of preferred
stock)  on March  31,  1998.  The  Company's  Series  B,  Series C and  Series D
preferred stock has not been registered  pursuant to the Securities and Exchange
Act of 1934,  as  amended,  and has not been  listed on any  exchange  or on The
Nasdaq Stock Market.  There is currently no  established  trading market for the
Company's preferred stock.

         As of February 28, 1998, there were approximately 2,900 stockholders of
record of the Company's common stock, 26 stockholders of record of the Company's
Series B preferred  stock, 28  stockholders of record of the Company's  Series C
preferred stock and 1 stockholder of record of the Company's  Series D preferred
stock.  On March 23,  1998,  the last sale price  reported  on The Nasdaq  Stock
Market for the Company's common stock was $12.50.

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


                                      15.
<PAGE>

<TABLE>

ITEM 6.           SELECTED FINANCIAL DATA

<CAPTION>

                                                                                                             Six-Month   Fiscal Year
                                                                                                           Period Ended     Ended
                                                                          Year Ended December 31,           December 31,   June 30,
                                                          -----------------------------------------------     --------     --------
                                                            1997          1996        1995         1994        1993(1)       1993
                                                          --------     --------     --------     --------     --------     --------
<S>                                                       <C>          <C>          <C>          <C>          <C>          <C>
Consolidated Statements of Operations
(in thousands, except per share data)

Revenues                                                  $  4,582     $  9,749     $    680     $  4,699     $    183     $  1,238

Operating costs and expenses:

     Research and development                               14,226       12,545       11,301        8,457        3,431        6,196

     Selling, general and administrative                     1,930        3,170        1,591        1,768          650        1,102
                                                          --------     --------     --------     --------     --------     --------

Total operating costs and expenses                          16,156       15,715       12,892       10,225        4,081        7,298
                                                          --------     --------     --------     --------     --------     --------

Interest income                                                753          585          744          506           75          243

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

Net loss                                                  $(10,821)    $ (5,391)    $(11,468)    $ (5,020)    $ (3,823)    $ (5,817)
                                                          ========     ========     ========     ========     ========     ========

Basic and diluted net loss per share (2)                  $  (3.09)    $  (2.45)    $  (5.66)    $  (4.87)    $  (5.69)    $  (8.40)
                                                          ========     ========     ========     ========     ========     ========

Shares used in per share computation                         3,501        2,197        2,026        1,031          672          692

</TABLE>


<TABLE>

                                                                              December 31,
                                                     ------------------------------------------------------------
                                                          1997         1996       1995         1994       1993(1)
                                                     ------------------------------------------------------------
<S>                                                      <C>         <C>         <C>          <C>         <C>
Consolidated Balance Sheet Data
(in thousands)

Cash, cash equivalents and short-term investments        $24,930     $14,082     $13,779      $12,246     $2,383

Working capital                                           21,875       9,118      12,730       11,702        891

Total assets                                              29,267      18,412      17,685       15,142      4,857

Stockholders' equity                                      25,590      10,732      13,742       14,044      2,930

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

(2)    The net loss per  share  amounts  prior to 1997  have  been  restated  as
       required to comply with Statement of Financial  Accounting  Standards No.
       128, Earnings Per Share. For further discussion of net loss per share and
       the impact of Statement No. 128, see the Notes to Financial Statements.
</FN>
</TABLE>

                                      16.
<PAGE>


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


         Except for the historical  information  contained herein, the following
discussion   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  The Company's actual results could differ  materially from those
discussed  here.  Factors  that could cause or  contribute  to such  differences
include,  but are not limited to, those discussed in this section, as well as in
the section entitled "Item 1. Business--Business Risks."

Overview

         Lynx has spent the last several years  developing  unique,  proprietary
technologies designed to enable the simultaneous  identification and analysis of
all (or  nearly  all) the DNA  molecules  or  fragments  in a single  biological
sample. Utilizing its massively parallel solid phase cloning, massively parallel
hybridization  arrays,  and massively  parallel  sequencing  technologies,  Lynx
expects  eventually to probe for genetic and genomic  information in a much more
efficient manner than current technologies.  The proposed applications of Lynx's
massively parallel  technologies include gene discovery,  gene expression,  high
resolution  genome mapping and the  identification of genetic  variations.  Lynx
expects its  technologies  will be applicable to the genomes of man,  pathogenic
organisms, and commercially important plants and animals. Lynx believes that its
technologies   will  open  new  avenues  to   understanding   genetics  and  the
relationships  between  gene  function  and the  various  states  from health to
disease.

         In 1995, Lynx launched an internal biology-based drug discovery program
to  establish  the  concepts,   strategies  and  techniques  necessary  for  the
identification  of drug  targets  based on the  analysis  of  differential  gene
expression.  This program is  ultimately  designed to capitalize on the power of
Lynx's  massively  parallel  technologies,  but in its early phase is  utilizing
know-how and  intermediate  technologies  currently  resident  within Lynx.  The
projects are centered on the medically important field of neurovascular diseases
that are particularly well suited to analyses with the Company's technologies.

         Lynx  was  originally  formed  in 1992  to  target  inappropriate  gene
expression  in disease with  synthetic  DNA  fragments  designed to bind to, and
functionally  block,  genes whose  inappropriate  expression could be correlated
with  disease.  Lynx's  early  efforts in this area  formed the  foundation  and
understanding for the development of its massively  parallel  technologies.  The
research  efforts have resulted in a compound  ("LR-3280") for the prevention of
coronary  artery  restenosis.  The acute safety segment of its Phase II study on
LR-3280 has recently been completed. Certain follow-up measurements and analyses
from the clinical  trial are expected to be completed  during the next  quarter.
Two pharmaceutical  companies,  Schwarz Pharma AG ("Schwarz") and Tanabe Seiyaku
Co., Ltd. ("Tanabe"),  have purchased the rights to market the compound and have
also committed to bear the costs of its continued clinical development.

         In March 1998,  Lynx sold its portfolio of  phosphorothioate  antisense
patents  and   licenses   (which   includes   LR-3280),   and  its   therapeutic
oligonucleotide  manufacturing  facility,  to Inex  Pharmaceuticals  Corporation
("Inex") of Vancouver, Canada. Lynx received $3 million in cash and will receive
1.2  million  shares of Inex  common  stock  and  royalties  on future  sales of
phosphorothioate   antisense  products.  In  addition,  Lynx  has  agreed  to  a
royalty-bearing  license to Inex for its phosphoroamidate  chemistry for certain
therapeutic  applications in the fields of cancer and inflammation  that will be
defined later.

         Under the agreement,  Inex will assume  responsibility of manufacturing
LR-3280 for Schwarz and Tanabe.  Lynx retains the right to collect,  if and when
earned, the next milestone payments,  totaling $7 million, under the Schwarz and
Tanabe  agreements,  as well as 50% of all future  milestone  payments and gross
profits associated with the continued success in the development and sale of the
compound.

         Lynx  has  been   unprofitable   since  its  inception  and  may  incur
substantial losses for the next several years, due primarily to the expansion of
its research and development programs,  including additional  development of its
massively  parallel  technologies.  Lynx  may  generate  revenues  based  on its
agreements  with  collaborative  partners  as

                                      17.
<PAGE>

a result of achievement of the milestones  defined in the  agreements.  However,
there  is no  guarantee  that  the  milestones  will be  achieved  or  that  the
technologies will be proven  commercially  successful.  Lynx does not anticipate
that it will  generate  significant  revenues  and  profits,  if any,  from  the
commercial  sale of its products and services for several years,  if not longer.
There can be no assurance  that Lynx will ever  successfully  develop and market
any of its proposed  products or that it will ever be able to achieve or sustain
profitability.

         Lynx's  business is subject to significant  risks,  including the risks
inherent in its research and development efforts,  uncertainties associated with
obtaining and enforcing patents,  and possible  competition from other products.
Lynx's  massively   parallel   technologies  could  face  competition  from  the
development  of  similarly  efficient,  or better,  combinations  of cloning and
sequencing techniques.

         On March 31, 1998, the Series B, Series C and Series D preferred  stock
will  convert to common stock on a  ten-for-one  basis.  The  inclusion of these
shares in both the basic and diluted earnings per share, will have a significant
impact on the earnings per share amounts in 1998 and subsequent years.

Results of Operations

Years Ended December 31, 1997 and 1996

Revenue

         Lynx had total  revenues of $4.6 million and $9.7 million for the years
ended December 31, 1997 and 1996, respectively.  Revenues for 1997 included $3.9
million  earned  under  agreements  with  Hoechst  and BASF for  access  to gene
expression  analysis  services to be  performed  by Lynx.  The 1997 revenue also
included  approximately $400,000 in sales of LR-3280 for use in clinical trials,
and  approximately  $162,000 in grant revenue and other product sales.  The 1996
revenue  included $7.5 million in up-front fees under the agreements  related to
LR-3280 with  Schwarz and Tanabe,  approximately  $1.9 million  earned under the
agreements  with  Hoechst and BASF,  and  approximately  $291,000  earned from a
government grant.

Operating Expenses

         Research and development  expenses were $14.2 million and $12.5 million
in the years ended  December 31, 1997 and 1996,  respectively.  The increase was
primarily  due to  costs  associated  with  increased  levels  of  research  and
development personnel, and increased patent and licensing activity. Lynx expects
to  continue to incur  substantial  research  and  development  expenses  due to
planned spending for ongoing technology development and implementation,  and new
research applications.

         General  and  administrative  expenses  were $1.9  million for the year
ended December 31, 1997 compared to $3.2 million for the year ended December 31,
1996. The decrease is primarily  attributable to lower corporate development and
legal expenses in 1997 than in 1996,  which reflected the costs  associated with
the signing of several  corporate  collaborative  agreements.  Headcount related
expenses were also slightly  lower in 1997 than in 1996 due to the expiration of
the settlement  agreement associated with the termination of a corporate officer
in  1996.   Lynx   expects  to  continue  to  incur   substantial   general  and
administrative expenses in support of its research and development and corporate
development efforts.

Other

         Interest  income was $753,000 and $585,000 in the years ended  December
31, 1997 and 1996,  respectively.  The increase  was due to higher  average cash
balances in 1997 than in 1996, particularly in the fourth quarter.

Income Taxes

         Due to  operating  losses and the  inability to recognize an income tax
benefit  therefrom,  there is no  provision  for  income  taxes  for  1997.  The
provision for income taxes of approximately  $10,000 for 1996 consists  entirely
of alternative minimum tax.

                                      18.
<PAGE>


Years Ended December 31, 1996 and 1995

Revenue

         Lynx had total  revenues  of $9.7  million and  $680,000  for the years
ended December 31, 1996 and 1995,  respectively.  The 1996 revenue included $7.5
million  in  sign-up  fees  under the  Tanabe  and  Schwarz  Pharma  agreements,
approximately  $1.9 million earned under the  agreements  with Hoechst and BASF,
and  approximately  $291,000 from a government  grant. The 1995 revenue included
$375,000 of revenue  earned under the agreement  with Hoechst and  approximately
$305,000 generated from product sales and grant revenue.

Operating Expenses

         Research and development expenses were $12.5 million for the year ended
December  31, 1996  compared to $11.3  million for the year ended  December  31,
1995.  The  increase  was due to expenses  associated  with the issuance of Lynx
common stock and stock options to certain employees and one consultant  pursuant
to the  Agreement  of Merger  between  Lynx and its  majority-owned  subsidiary,
Spectragen Inc.,  increased  spending in support of clinical trials for LR-3280,
and higher depreciation on lab equipment.  A portion of this increase was offset
by  reduced  funding  to  various  laboratories  under  collaborative   research
agreements and lower patent and related legal expense.

         General  and  administrative  expenses  were $3.2  million for the year
ended  December 31, 1996,  compared to $1.6 million for the year ended  December
31, 1995. The increase is primarily attributable to higher corporate development
and legal  expenses  in 1996,  which  reflected  the costs  associated  with the
signing of several  corporate  collaborative  agreements,  higher salary expense
related to increased headcount and the settlement  agreement associated with the
termination of a corporate officer.

Other

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

Income Taxes

         The  provision  for  income  taxes of  approximately  $10,000  for 1996
consists  entirely of alternative  minimum tax. Due to operating  losses and the
inability to recognize  an income tax benefit  therefrom,  there is no provision
for income taxes for 1995.

Liquidity and Capital Resources

         Net cash used in  operating  activities  of $13.1  million for the year
ended December 31, 1997 differs from the net loss for the same period due to the
current  year  recognition  of  a  portion  of  previously   deferred   revenue,
depreciation  and  amortization  of fixed  assets  and  leasehold  improvements,
amortization of deferred compensation,  and changes in working capital. Net cash
used in investing  activities of $15.3  million for the year ended  December 31,
1997,  was primarily due to the purchase of short-term  investments  and capital
equipment purchases. Net cash provided by financing activities in 1997 consisted
primarily of $25.1  million  raised in the private  placement of common stock at
$10 per share, net of financing costs of $1.7 million. Cash and cash equivalents
were $8.8 million at December 31, 1997.

         Lynx   plans  to  use   available   funds  for  the   development   and
implementation of its massively parallel  technologies and to build capacity for
their early commercial uses.  Pending such uses as described above, Lynx intends
to invest its excess  cash in  short-term,  investment  grade,  interest-bearing
securities or certificates of deposit.

                                      19.
<PAGE>


         Since  commencing  operations  as  an  independent  company,  Lynx  has
obtained funding for its operations  through sales of preferred and common stock
to  venture  capital  investors,   institutional  investors,  and  collaborative
partners;  revenue from  collaborative  research and  development  arrangements;
interest income;  product sales; and government  grants.  The cost,  timing, and
amount  of  funds  required  for  specific  uses by  Lynx  cannot  be  precisely
determined  at this time and will be based upon Lynx's  progress in its research
and development,  administrative and legal costs, the establishment of corporate
collaborations and other arrangements, and the availability of alternate methods
of financing.

         Lynx  expects  to  incur   substantial  and  increasing   research  and
development  expenses  and  intends  to seek  additional  financing,  as needed,
through  contractual  arrangements  with  corporate  partners and equity or debt
offerings.  There can be no assurance that any additional  financing required by
Lynx will be available or, if available, will be on terms favorable to Lynx. The
Company  believes  that,  at  current  spending  levels,  its  existing  capital
resources and interest income thereon will enable it to maintain its current and
planned operations at least through 1998.

Impact of Year 2000

         The Company has  completed  an  assessment  of its  computer  operating
systems and related  software and, with only a few minor  exceptions,  has found
them to be Year 2000  compliant.  The  Company's  exposure is limited due to the
fact that most of its computers and software were acquired  within the past five
years and were Year 2000 compliant at purchase. The Company plans to replace the
operating  systems on the few  non-compliant  computers  before 2000 and expects
that the  cost  will be  immaterial.  The  Company  believes  that  even if such
modifications  are not made,  there  will be no  adverse  impact on  operations.
However,  Year 2000  problems may affect the computer  systems of the  Company's
business partners,  vendors, customers, and financial service organizations with
which the Company interacts.  The Compnay is in the process of developing a plan
to determine the impact that third parties which are not Year 2000 compliant may
have on the operations of the Company.  There can be no assurance that such plan
will be able to address fully, or at all, the "Year 2000 issue" which could have
a material adverse effect upon the Company's  business  financial  condition and
results of operations.

                                      20.
<PAGE>


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                             Lynx Therapeutics, Inc.

                   Index to Consolidated Financial Statements


Report of Ernst & Young LLP, Independent Auditors..........................   22

Audited Consolidated Financial Statements:

Consolidated Balance Sheets................................................   23
Consolidated Statements of Operations......................................   24
Consolidated Statements of Stockholders' Equity............................   25
Consolidated Statements of Cash Flows......................................   26
Notes to Consolidated Financial Statements.................................   27

                                       21
<PAGE>


                Report of Ernst & Young LLP, Independent Auditors



The Board of Directors and Stockholders
Lynx Therapeutics, Inc.

We  have  audited  the   accompanying   consolidated   balance  sheets  of  Lynx
Therapeutics, Inc. as of December 31, 1997 and 1996 and the related consolidated
statements of  operations,  stockholders'  equity and cash flows for each of the
three years in the period ended December 31, 1997.  These  financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects, the consolidated financial position of Lynx Therapeutics,
Inc.  at  December  31,  1997  and  1996  and the  consolidated  results  of its
operations  and its cash flows for each of the three  years in the period  ended
December 31, 1997, in conformity with generally accepted accounting principles.




                                             /s/ ERNST & YOUNG LLP

Palo Alto, California
January 30, 1998


                                      22.
<PAGE>

<TABLE>

                                              Lynx Therapeutics, Inc.

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

                                                                                                                December 31,
                                                                                                          1997             1996
                                                                                                       -----------      -----------
<S>                                                                                                    <C>              <C>
Assets
Current assets:
   Cash and cash equivalents                                                                           $     8,798      $    12,109
   Short-term investments                                                                                   16,132            1,973
   Accounts receivable                                                                                         244              118
   Other current assets                                                                                        199              158
                                                                                                       -----------      -----------
Total current assets                                                                                        25,373           14,358

Property and equipment:
   Leasehold improvements                                                                                    3,795            3,193
   Laboratory and other equipment                                                                            3,562            2,976
                                                                                                       -----------      -----------
                                                                                                             7,357            6,169
   Less accumulated depreciation                                                                            (3,588)          (2,290)
                                                                                                       -----------      -----------
Net property and equipment                                                                                   3,769            3,879

Notes receivable from officers and employees                                                                   125              175
                                                                                                       -----------      -----------
                                                                                                       $    29,267      $    18,412
                                                                                                       ===========      ===========
Liabilities and stockholders' equity
Current liabilities:
   Accounts payable                                                                                    $       210      $       429
   Accrued compensation                                                                                        289              394
   Accrued professional fees                                                                                   179              169
   Deferred revenue from related parties                                                                     2,292            3,875
   Other accrued liabilities                                                                                   528              373
                                                                                                       -----------      -----------
Total current liabilities                                                                                    3,498            5,240

Deferred revenue from related parties                                                                         --              2,292
Other noncurrent liabilities                                                                                   179              148

Stockholders' equity:
   Preferred  stock,  issuable  in  series,  $.001 par value; 2,000,000 shares
     authorized, all shares designated represent convertible preferred stock:
   Series B, 332,288 shares designated, issued, and outstanding at December 31, 1997
     and 1996; aggregate liquidation value of $16,614 at December 31, 1997                                  16,091           16,091
   Series C, 123,299 shares designated, issued, and outstanding at December 31, 1997
     and 1996; aggregate liquidation value of $6,165 at December 31, 1997                                    6,109            6,109
   Series D, 40,000 shares designated, issued, and outstanding at December 31, 1997
     and 1996; aggregate liquidation value of $5,000 at December 31, 1997                                    4,989            4,989
   Common stock, $.001 par value; 20,000,000 shares authorized, 5,892,353 and
     3,152,148 shares issued and outstanding at December 31, 1997 and 1996, respectively                    46,640           17,361
   Notes receivable from stockholders                                                                         (460)            (210)
   Deferred compensation                                                                                    (5,394)          (2,092)
   Unrealized gain/(loss) on marketable securities                                                             (45)               3
   Accumulated deficit                                                                                     (42,340)         (31,519)
                                                                                                       -----------      -----------
Total stockholders' equity                                                                                  25,590           10,732
                                                                                                       -----------      -----------
                                                                                                       $    29,267      $    18,412
                                                                                                       ===========      ===========
<FN>

                                              See accompanying notes.
</FN>
</TABLE>
                                                       23.

<PAGE>

<TABLE>

                                           Lynx Therapeutics, Inc.

                                    Consolidated Statements of Operations
                                   (In thousands, except per share amounts)

<CAPTION>

                                                                                                  Year Ended December 31,
                                                                                     ----------------------------------------------
                                                                                       1997               1996               1995
                                                                                     --------           --------           --------
<S>                                                                                  <C>                <C>                <C>
Net revenues:
   License fees                                                                      $   --             $  7,500           $   --
   Revenues from collaborative arrangements
     with related parties                                                               4,420              1,958                375
   Product sales and other revenues                                                       162                291                305
                                                                                     --------           --------           --------
Total revenues                                                                          4,582              9,749                680

Operating costs and expenses:
   Research and development                                                            14,226             12,545             11,301
   Selling, general and administrative                                                  1,930              3,170              1,591
                                                                                     --------           --------           --------
Total operating costs and expenses                                                     16,156             15,715             12,892
                                                                                     --------           --------           --------

Loss from operations                                                                  (11,574)            (5,966)           (12,212)

Interest income                                                                           753                585                744
Provision for income taxes                                                               --                   10               --
                                                                                     --------           --------           --------
Net loss                                                                             $(10,821)          $ (5,391)          $(11,468)
                                                                                     ========           ========           ========

Basic and diluted net loss per share (Note 1)                                        $  (3.09)          $  (2.45)          $  (5.66)
                                                                                     ========           ========           ========

Shares used in basic and diluted per share computation                                  3,501              2,197              2,026
                                                                                     ========           ========           ========

<FN>

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

                                                      24.

<PAGE>

<TABLE>



                                                                                 Lynx Therapeutics, Inc.
                                                                     Consolidated Statements of Stockholders' Equity
                                                                  For the Years Ended December 31, 1995, 1996 and 1997
                                                                          (In thousands, except share numbers)
<CAPTION>


                                                         Preferred Stock            Common Stock              Notes
                                                         ---------------            ------------            Receivable    Deferred
                                                         Shares       Amount    Shares       Amount       From Officers Compensation
                                                       --------------------     -------------------       ------------- ------------
<S>                                                     <C>       <C>           <C>          <C>           <C>           <C>
Balance at December 31, 1994                            332,288   $   16,091    2,010,329    $   12,723    $        0    $      (86)
Issuance of Series C preferred stock for
   cash, net of issuance costs of $56                   123,299        6,109         --            --            --            --
Issuance of Series D preferred stock for
   cash, net of issuance costs of $11                    40,000        4,989         --            --            --            --
Exercise of employee stock options for cash
   and note receivable                                     --           --        324,410           675          (660)         --
Issuance of common stock for services                      --           --            812             1          --            --
Cash paid in lieu of fractional shares
   for reverse stock split                                 --           --         (1,027)           (5)         --            --
Amortization of deferred compensation                      --           --           --            --            --              35
Net unrealized gain on securities available
   for sale                                                --           --           --            --            --            --
Net loss                                                   --           --           --            --            --            --
                                                       ----------------------------------------------------------------------------
Balance at December 31, 1995                            495,587       27,189    2,334,524        13,394          (660)          (51)
Exercise of employee stock options for cash                --           --          9,663            12          --            --
Repurchase of common stock                                 --           --       (157,500)         (297)          450          --
Issuance of common stock in connection
   with Lynx/Spectragen merger                             --           --        959,182         4,221          --          (2,076)
Issuance of common stock for services                      --           --          6,279            31          --            --
Amortization of deferred compensation                      --           --           --            --            --              35
Net unrealized gain on securities                          --           --           --            --            --            --
Net loss                                                   --           --           --            --            --            --
                                                       ----------------------------------------------------------------------------
Balance at December 31, 1996                            495,587       27,189    3,152,148        17,361          (210)       (2,092)
Exercise of employee stock options for cash
  and note receivable                                      --           --         76,181           287          (250)         --
Repurchase of common stock                                 --           --        (11,476)         (198)         --             197
Issuance of common stock for cash, net of
   issuance costs of $1,685                                --           --      2,675,500        25,070          --            --
Amortization of deferred compensation                      --           --           --            --            --             621
Recognition of deferred compensation on
   employee stock options                                  --           --           --           4,120          --          (4,120)
Net unrealized loss on securities                          --           --           --            --            --            --
Net loss                                                   --           --           --            --            --            --
                                                       ----------------------------------------------------------------------------
Balance at December 31, 1997                            495,587   $   27,189    5,892,353    $   46,640    $     (460)   $   (5,394)
                                                       ----------------------------------------------------------------------------

<FN>

                                                      See accompanying notes.

</FN>
</TABLE>

<TABLE>
<CAPTION>

                                                Unrealized
                                             Gain/(Loss) on                              Total
                                               Marketable          Accumulated        Stockholders'
                                               Securities           Deficit            Equity
                                               ------------       ----------         ---------
<S>                                            <C>                <C>                <C>
Balance at December 31, 1994                   $    (24)          $(14,660)          $ 14,044
Issuance of Series C preferred stock for
   cash, net of issuance costs of $56              --                 --                6,109
Issuance of Series D preferred stock for
   cash, net of issuance costs of $11              --                 --                4,989
Exercise of employee stock options for cash
   and note receivable                             --                 --                   15
Issuance of common stock for services              --                 --                    1
Cash paid in lieu of fractional shares
   for reverse stock split                         --                 --                   (5)
Amortization of deferred compensation              --                 --                   35
Net unrealized gain on securities available
   for sale                                          22                                    22
Net loss                                           --              (11,468)           (11,468)
                                               ------------       ----------         ---------
Balance at December 31, 1995                         (2)           (26,128)            13,742
Exercise of employee stock options for cash        --                 --                   12
Repurchase of common stock                         --                 --                  153
Issuance of common stock in connection
   with Lynx/Spectragen merger                     --                 --                2,145
Issuance of common stock for services              --                 --                   31
Amortization of deferred compensation              --                 --                   35
Net unrealized gain on securities                     5               --                    5
Net loss                                           --               (5,391)            (5,391)
                                               ------------       ----------         ---------
Balance at December 31, 1996                          3            (31,519)            10,732
Exercise of employee stock options for cash
  and note receivable                              --                 --                   37
Repurchase of common stock                         --                 --                   (1)
Issuance of common stock for cash, net of
   issuance costs of $1,685                        --                 --               25,070
Amortization of deferred compensation              --                 --                  621
Recognition of deferred compensation on
   employee stock options                          --                 --                 --
Net unrealized loss on securities                   (48)              --                  (48)
Net loss                                           --              (10,821)           (10,821)
                                               ------------       ----------         ---------
Balance at December 31, 1997                   $    (45)          $(42,340)          $ 25,590
                                               ------------       ----------         ---------

</TABLE>
                                                      25.
<PAGE>

<TABLE>

                                       Lynx Therapeutics, Inc.

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

<CAPTION>

                                                                                   Year Ended December 31,
                                                                       -----------------------------------------
                                                                          1997              1996           1995
                                                                       -----------------------------------------
<S>                                                                     <C>              <C>            <C>
Cash flows from operating activities
Net loss                                                                $(10,821)        $ (5,391)      $(11,468)
Adjustments to reconcile net loss to net cash provided by
     (used in) operating activities:
   Depreciation and amortization of fixed assets and
     leasehold improvements                                                1,298              829            608
   Issuance of common stock expensed in connection
     with the Lynx/Spectragen merger                                          --            2,145             --
   Amortization of deferred compensation                                     621               35             35
   Other                                                                      --               31              7
Changes in operating assets and liabilities:
   Accounts receivable                                                      (126)             (30)           174
   Other current assets                                                      (41)             (79)           157
   Accounts payable                                                         (219)            (264)           334
   Accrued liabilities                                                        60              413           (160)
   Deferred revenue from related parties                                  (3,875)           3,542          2,625
   Other noncurrent liabilities                                               31               46             45
                                                                       -----------------------------------------
Net cash provided by (used in) in operating activities                   (13,072)           1,277         (7,643)

Cash flows from investing activities
Purchases of short-term investments                                      (16,180)          (6,903)            --
Maturities of short-term investments                                       1,973            4,935          8,022
Purchases of property and equipment, net of retirements                   (1,188)          (1,511)        (1,430)
Notes receivable from officers and employees                                  50              367           (524)
                                                                       ------------------------------------------
Net cash provided by (used in) investing activities                      (15,345)          (3,112)         6,068

Cash flows from financing activities
Issuance of preferred stock, net of repurchases                               --               --         11,098
Issuance of common stock, net of repurchases                              25,106              165             10
                                                                       -----------------------------------------
Net cash provided by financing activities                                 25,106              165         11,108
                                                                       -----------------------------------------

Net increase (decrease) in cash and cash equivalents                      (3,311)          (1,670)         9,533
Cash and cash equivalents at beginning of year                            12,109           13,779          4,246
                                                                       -----------------------------------------
Cash and cash equivalents at end of year                               $   8,798          $12,109        $13,779
                                                                       =========================================

 Supplemental disclosures of cash flow information:
   Income tax paid                                                     $   --            $     10        $    --
                                                                       =========================================
<FN>

                                                 See accompanying notes.
</FN>
</TABLE>
                                                  26.

<PAGE>


                             Lynx Therapeutics, Inc.
                   Notes to Consolidated Financial Statements

                                December 31, 1997

1.       Summary of Significant Accounting Policies and Basis of Presentation

Ownership and Basis of Presentation

         Lynx Therapeutics,  Inc. ("Lynx" or the "Company"), was incorporated in
February  1992 under the laws of the State of Delaware.  Lynx has spent the last
several years developing unique, proprietary technologies designed to enable the
simultaneous  identification  and  analysis  of all  (or  nearly  all)  the  DNA
molecules or fragments in a single  biological  sample.  Utilizing its massively
parallel solid phase  cloning,  massively  parallel  hybridization  arrays,  and
massively parallel sequencing technologies, Lynx expects eventually to probe for
genetic and genomic  information  in a much more  efficient  manner than current
technologies.   The  proposed   applications   of  Lynx's   massively   parallel
technologies  include gene discovery,  gene expression,  high resolution  genome
mapping  and  the  identification  of  genetic  variations.   Lynx  expects  its
technologies will be applicable to the genomes of man, pathogenic organisms, and
commercially  important plants and animals.  Lynx believes that its technologies
will open new avenues to understanding  genetics and the  relationships  between
gene function and the various states from health to disease.

         In October 1997,  Lynx completed a $26.8 million  private  placement of
common  stock.  The  net  proceeds  of the  financing  are  being  used  for the
development and implementation of the Company's novel technologies, and to build
production  capacity for early  commercial uses. Lynx common stock began trading
on The Nasdaq Stock Market on December 30, 1997.

         The  consolidated  financial  statements  of the  Company  include  the
accounts of the Company and its wholly owned subsidiary, Lynx GmbH, formed under
the laws of the  Federal  Republic of Germany.  In November  1996,  Lynx and its
majority  owned  subsidiary,   Spectragen,   Inc.  ("Spectragen"),   a  Delaware
corporation,  entered  into an Agreement  of Merger,  whereby Lynx  acquired the
outstanding minority interest in Spectragen,  and Spectragen was merged with and
into  Lynx  and  the  separate   corporate   existence  of  Spectragen   ceased.
Additionally,   the  Company  has   dissolved   its  wholly  owned   subsidiary,
LYNXNebraska,  Inc.,  with no consequent  impact on the  consolidated  financial
statements.  All significant  intercompany  balances and transactions  have been
eliminated.

         The Company has sustained  continuing operating losses and expects such
losses to continue for at least the next  several  years.  The Company  plans to
finance operations through contractual  arrangements with corporate partners and
through equity or debt offerings.

Use of Estimates

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

Cash, Cash Equivalents and Short-Term Investments

         The Company  considers all investments with an original maturity at the
date of  purchase  of 90 days or  less  as cash  equivalents.  Investments  with
original  maturities  beyond 90 days but less than one year are considered to be
short-term  investments.  The Company's  investment  policy  stipulates that the
investment portfolio be maintained with the objectives of preserving  principal,
maintaining liquidity and maximizing return.

                                      27.
<PAGE>


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


1. Summary of Significant Accounting Policies and Basis of Presentation
   (continued)

Cash, Cash Equivalents and Short-Term Investments  (continued)

         The  Company   determines  the  appropriate   classification   of  debt
securities at the time of purchase and reevaluates  such  designation as of each
balance sheet date. As of December 31, 1997 and 1996, 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  debt  securities  in  this  category  is  adjusted  for
amortization  of premiums and  accretion  of  discounts  to maturity,  which are
included in interest  income.  Realized  gains and losses and  declines in value
judged to be other-than-temporary,  if any, on available-for-sale securities, if
any, are included in interest income or expense.  The cost of securities sold is
based on the specific identification method.

Property and Equipment

         Property and equipment are stated at original cost and are  depreciated
using the  straight-line  method over the estimated  useful lives of the assets,
which is generally three years.  Leasehold  improvements  are amortized over the
lesser of the useful  life of the asset or the  remaining  term of the  facility
lease.

Revenue Recognition

         Payments under collaborative  arrangements are recognized as revenue as
research  services  are  performed  pursuant  to the  terms  of  the  respective
agreements.  Payments  received  which are  related  to future  performance  are
deferred  until earned.  Non-refundable  license fees are generally  recorded as
revenue upon  execution of the agreement.  Milestone  payments are recognized as
revenue upon the achievement of the related  milestone.  Revenues from the sales
of products are recognized upon shipment.

         During  1997  and  1996,  revenue  from  three  collaborative  partners
represented   60%,  25%  and  11%, and  15%,  36%  and  30%  of  total  revenue,
respectively.  During 1995, revenue from one collaborative  partner  represented
55% of total revenue.

Net Loss per Share

         In 1997  the  Financial  Accounting  Standards  Board  ("FASB")  issued
Statement of Financial Accounting Standards No. 128 ("SFAS 128"),  "Earnings Per
Share"  ("EPS"),  effective for periods ending after December 15, 1997. SFAS 128
requires that  companies  present two measures of earnings per share,  basic and
diluted.  Basic  earnings  per  share is  computed  by  dividing  income or loss
applicable  to  common  shareholders  by the  weighted-average  number of common
shares  outstanding  for the period,  while  diluted EPS reflects the  potential
dilution of securities  that could share in the earnings of the company,  to the
extent such securities are dilutive.

         The  Company  has  adopted  SFAS 128 for annual and  interim  financial
statements  issued after  December 15, 1997, and has calculated and restated EPS
in accordance  with SFAS 128 for each prior period in which an income  statement
is reported.  Basic loss per share is calculated  based on the weighted  average
number of common shares  outstanding,  net of certain common shares  outstanding
which are subject to continued  vesting and the Company's  right of  repurchase.
Basic and diluted loss per share are equivalent for all periods presented herein
due to the  Company's  net  loss.  The  following  have been  excluded  from the
calculation  of loss  per  share  because  the  effect  of  inclusion  would  be
antidilutive:  approximately 300,000 common shares which are outstanding but are
subject to the  Company's  right of repurchase  which expires  ratably over five
years;  approximately 500,000 shares of Series B, C, and D preferred stock which
will be converted on March 31, 1998,  into common stock on a ten-for-one  basis;
and  options to purchase  approximately  1,600,000  shares of common  stock at a
weighted average price of $3.22 per

                                      28.
<PAGE>


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


1. Summary of Significant Accounting Policies and Basis of Presentation
   (continued)

Net Loss per Share  (continued)

share.  The preferred stock will be included in the loss per share  calculations
for all periods subsequent to conversion.  The repurchasable  shares and options
will be  included  in the  calculation  at such time as the  effect is no longer
antidilutive, as calculated using the treasury stock method.

         For additional  disclosure  regarding the preferred stock, common stock
and stock option plan, refer to Note 6.

Stock-Based Compensation

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

Recent Accounting Pronouncements

         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
Standard No. 130 (SFAS 130), "Reporting Comprehensive Income," and No. 131 (SFAS
131), "Disclosures About Segments of an Enterprise and Related Information." The
Company will be required to comply with the  provisions  of these  statements in
fiscal 1998. The Company believes that the adoption of these statements will not
have a material effect on its results of operations or financial  position,  but
may require additional disclosure.

<TABLE>
2.       Investments

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

                                                                                          Available-for-Sale Securities
                                                              ----------------------------------------------------------------------
                                                                                   Gross                Gross             Estimated
                                                               Amortized         Unrealized          Unrealized             Fair
                                                                 Cost              Gains               Losses               Value
                                                              ----------------------------------------------------------------------
                                                                                        (In thousands)
<S>                                                           <C>                 <C>                  <C>               <C>
December 31, 1997
Money market mutual funds                                     $  3,280            $   --               $   --            $  3,280
Commercial paper                                                 7,904                --                     (6)            7,898
Government notes                                                 6,902                --                    (35)            6,867
Mutual funds                                                     1,000                --                   --               1,000
Corporate bonds and notes                                        5,809                --                     (4)            5,805
                                                              -------------------------------------------------------------------
                                                              $ 24,895            $   --               $    (45)         $ 24,850
                                                              ===================================================================

December 31, 1996
Money market mutual funds                                     $    979            $   --               $   --            $    979
Commercial paper                                                12,964                   3                 --              12,967
                                                              -------------------------------------------------------------------
                                                              $ 13,943            $      3             $   --            $ 13,946
                                                              ===================================================================

</TABLE>

                                                  29.
<PAGE>


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


2.       Investments  (continued)

         During the years ended  December 31, 1997,  1996 and 1995,  the Company
did not sell any  securities.  As of  December  31,  1997,  $8.8  million of the
marketable  securities were classified as cash  equivalents,  and the balance of
$16.1 million was classified as short-term investments. As of December 31, 1996,
$11.9 million of the marketable  securities were classified as cash equivalents,
with the  remaining  $2.0 million  classified  as  short-term  investments.  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

         In October 1996, Lynx entered into two agreements with BASF AG aimed at
exploiting  Lynx's  proprietary  massively  parallel  technologies.   The  first
agreement  commits the two companies to form a new  biotechnology  Joint Venture
("JV") called  BASF-LYNX  Bioscience AG in  Heidelberg,  Germany,  which will be
governed by a detailed  operating  agreement to be developed jointly between the
Company and BASF. Initial ownership of the JV will be split 51%-49% between BASF
and Lynx,  respectively.  Under the  sponsorship of BASF and Lynx the JV will be
focused primarily on the identification of novel drug targets in certain central
nervous system diseases.  BASF will provide research funding of up to 50 million
DM  (approximately  $27  million at  current  exchange  rates)  over a five year
period, as well as access to certain of its technologies,  and Lynx will provide
access  to its  massively  parallel  technologies  for use in the JV's  research
programs.  The Company is accounting for its interest in the JV under the equity
method.

         The second agreement is a service  agreement which provides BASF access
to Lynx's massively  parallel  technologies for its own internal and proprietary
research,  independent of the JV's objectives. For access to this service, which
commits  Lynx to provide BASF with a certain  number of analyses per year,  BASF
paid Lynx an access fee of $5.5  million on execution  of the  agreement.  Also,
upon the  achievement  of a certain  milestone,  BASF agreed to make a milestone
payment of $5.5  million  and to pay a  subscription  fee of $4 million for each
year of a two year subscription period for the analyses.  The access fee of $5.5
million paid by BASF to Lynx is being recognized  ratably over a two year period
from the  commencement  of the  agreement.  Approximately  $2.8 million and $0.5
million was recognized as revenue in the years ended December 31, 1997 and 1996,
respectively.

         In October  1995,  Lynx entered  into an agreement  with Hoechst AG and
Hoechst Marion Roussel (collectively  referred to as "Hoechst"),  which provides
Hoechst with access to Lynx's massively parallel  technologies.  Under the terms
of the agreement,  Hoechst paid Lynx an access fee of $3 million on execution of
the agreement. Also, upon the achievement of a certain milestone, Hoechst agreed
to make a milestone  payment of $8 million and to pay a  subscription  fee of $4
million for a one year subscription  under the agreement.  In return,  Lynx will
provide  Hoechst  with a certain  number of  analyses  per year.  The $3 million
access fee Lynx  received  from Hoechst was  recognized  ratably over a two year
period from the  commencement  of the agreement,  in amounts of $1.125  million,
$1.5 million and $375,000 in the years ended  December 31, 1997,  1996 and 1995,
respectively. This agreement allows for no more than two additional companies to
access this technology for a specified period. In addition, the Company received
$5 million in November  1995,  relating  to the  closing of a private  placement
offering to Hoechst of 40,000 shares of its Series D preferred  stock at $125.00
per share.

         In September 1997, the agreement  between Hoechst and Lynx was amended.
The  amendment  modified  the  technology  milestone  included  in the  original
agreement and extended the date by which such  milestone  must be achieved under
the contract. If the subject milestone is not met by such date, then Hoechst may
either terminate the agreement or extend the technology milestone date.

                                      30.

<PAGE>


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


4.       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 such licenses were approximately  $314,000,
$242,000,  and $138,000 for the years ended  December 31, 1997,  1996, and 1995,
respectively.

5.       Notes Receivable from Officers

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

         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.

6.       Stockholders' Equity

Preferred Stock

         Each  share of  Series  B,  Series C and  Series D  preferred  stock is
convertible  into ten shares of common stock and has voting  rights equal to the
voting rights of the common shares issuable upon conversion. In the event of any
liquidation,  dissolution  or winding up of the  Company,  whether  voluntary or
involuntary,  the  holders  of each  share of  Series B,  Series C and  Series D
preferred stock then outstanding  shall be entitled to be paid out of the assets
of the Company legally  available for distribution to its  stockholders,  before
any  payment to be made in respect of the common  stock,  until such time as the
holders  of  Series B and  Series C  preferred  stock  shall  have  received  an
aggregate of $50.00 per share and the holders of Series D preferred  stock shall
have received an aggregate of $125.00 per share,  adjusted for any combinations,
consolidations,  or stock  distributions or stock dividends with respect to such
shares (a  "Recapitalization  Event"),  plus all declared  but unpaid  dividends
thereon,  if any, to the date fixed for  distribution.  If upon any liquidation,
dissolution  or winding up of the Company,  the assets of the Company  available
for distribution to its stockholders shall be insufficient to pay the holders of
shares of Series B, Series C, and Series D preferred  stockholders in full, then
such holders shall share ratably in any  distribution of assets in proportion to
the full amount to which they would otherwise be respectively entitled.

         Pursuant to the Amended and Restated Certificate of Designation,  dated
September  30,  1997,  the Series B, Series C and Series D preferred  stock will
convert to common stock on a ten-for-one basis on March 31, 1998.


                                      31.

<PAGE>


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


6.       Stockholders' Equity  (continued)

Common Stock

         In November  1996,  Lynx issued  959,182 shares of Lynx 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.  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 recorded compensation and consultant expense of $2.1 million and recognized
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.

         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.  The shares were registered
for resale on Form S-3 Registration  Statement that became effective on December
31, 1997.  In  connection  with this  transaction,  warrants to purchase  50,000
shares of common  stock at an exercise  price of $14.00 per share were issued to
the  underwriters  of the  transaction,  pursuant to the Common  Stock  Purchase
Agreement  dated  September 28, 1997 between the Company and certain  investors,
and will expire on October 1, 2000.

         At December 31,  1997,  Lynx has  reserved  7,392,932  shares of common
stock for  issuance  upon  conversion  of the  Series B,  Series C and  Series D
preferred stock, upon the exercise of outstanding employee and nonemployee stock
options, and upon the exercise of certain warrants, as noted below:

         Conversion of Series B preferred stock                    3,322,880
         Conversion of Series C preferred stock                    1,232,990
         Conversion of Series D preferred stock                      400,000
         Stock option grants outstanding                           1,626,254
         Shares available for grant                                  360,808
         Warrants outstanding                                         50,000
         Other                                                       400,000
                                                                  ----------
                                                                   7,392,932
                                                                  ==========

1992 Stock Option Plan

         In July 1992,  Lynx  adopted the 1992 Stock  Option  Plan ("the  Plan")
under which incentive or nonqualified stock options to purchase shares of common
stock may be granted to  employees  and  officers  of, and  consultants  to, the
Company. As a result of a series of amendments, an aggregate of 3,400,000 shares
of the Company's  common stock have been  authorized for issuance under the 1992
Plan. In February 1998, the Board of Directors approved an amendment to the 1992
Plan, subject to stockholder  approval,  to enhance the flexibility of the Board
and  the  Compensation  Committee  in  granting  stock  options.  The  amendment
increases the number of shares  authorized for issuance under the 1992 Plan from
a total of 3,400,000 to 4,000,000 shares.

         Under the Plan, the exercise price of incentive options granted may not
be less than 100% (110% in the case of options granted to a person who owns more
than 10% of the  total  combined  voting  power of all  classes  of stock of the
Company)  of the fair  market  value  of  common  stock  at the  date of  grant.
Nonqualified options may be granted at not less than 85% of fair market value at
the date of grant.  Options generally vest over a five-year period from the date
of grant and have a term of ten years (five years in the case of options granted
to a person  who owns more than 10% of the total  combined  voting  power of all
classes of stock of the Company).

                                      32.
<PAGE>


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


6.       Stockholders' Equity  (continued)

         In November 1996,  Lynx issued 524,355  options to purchase Lynx common
stock in  exchange  for  403,350  options to purchase  Spectragen  common  stock
pursuant to the  Agreement  of Merger  between the  Company and  Spectragen.  In
accordance  with  APB  25,  Accounting  for  Stock  Issued  to  Employees,  Lynx
recognized 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 grants. The deferred compensation will be charged
to expense over the five year vesting period of the grants.

         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.

<TABLE>

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

                                                                             Options Outstanding
                                                    ---------------------------------------------------------------
                                                                                                          Weighted
                                                                       Number of         Exercise          Average
                                                      Available     Shares Subject         Price          Exercise
                                                      for Grant       to Options         per Share          Price
                                                      ---------       ----------         ---------          -----
<S>                                                  <C>              <C>             <C>                   <C>
         Balance at December 31, 1994                  781,155           444,701      $0.10 - 2.00          $1.03
         Options granted                              (678,436)          678,436       1.00 - 5.00           2.55
         Options exercised                                  --          (324,410)      1.00 - 5.00           2.08
         Options canceled                               66,316           (66,316)      1.00 - 2.00           1.06
                                                     ---------         ---------
         Balance at December 31, 1995                  169,035           732,411       0.10 - 5.00           1.97
         Options authorized                          1,224,355                --               --             --
         Options granted                              (859,858)          859,858       0.15 - 6.00           2.75
         Options exercised                                  --            (9,663)      0.10 - 6.00           1.23
         Options canceled                               64,954           (65,004)      0.10 - 6.00           2.76
                                                     ---------         ---------
         Balance at December 31, 1996                  598,486         1,517,602       0.10 - 6.00           2.39
         Options granted                              (266,841)          266,841       4.00- 14.38           7.56
         Options retired                               (52,845)               --               --
         Options exercised                                  --           (76,181)      0.10 - 6.00           3.78
         Options canceled                               82,008           (82,008)      0.15- 14.10           1.68
                                                     ---------         ---------
         Balance at December 31, 1997                  360,808         1,626,254       0.10- 14.38           3.22
                                                     =========         =========
</TABLE>

         To date, all options granted under the Plan are  nonqualified  options.
Options to purchase a total of 767,037 shares were exercisable under the Plan at
December 31, 1997.  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, 1997,  333,066  shares  outstanding  were subject to
repurchase.

                                      33.
<PAGE>


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


6.       Stockholders' Equity  (continued)

<TABLE>
         The options  outstanding at December 31, 1997 have been segregated into
ranges for additional disclosure as follows:

<CAPTION>
                                   Options Outstanding                         Options Exercisable
                     ------------------------------------------------    ----------------------------------
                                        Weighted-
                                         average                             Options
                        Options         remaining                           currently
                    outstanding at     contractual        Weighted-      exercisable at        Weighted-
    Range of         December 31,         life             average        December 31,          average
exercises prices         1997          (in years)      exercise price         1997          exercise price
----------------    -------------     -------------    --------------    -------------      --------------
<S>                   <C>                   <C>           <C>              <C>                     <C>
$0.10 - 0.15             65,080             6.4            $0.13            65,080                 $0.13
$0.38 - 0.39             78,820             8.0             0.38            25,887                  0.38
$0.77 - 1.00            409,674             6.6             1.00           383,704                  1.00
$1.54 - 2.00            386,595             8.2             1.58            34,279                  2.00
$3.50 - 5.00            405,744             8.3             4.56           197,775                  4.66
$6.00 - 6.00            185,500             8.4             6.00            60,312                  6.00
$6.95 - 14.38            94,841             9.8            12.82                --                    --
                     ----------                                            -------
                      1,626,254             7.8           $ 3.22           767,037                 $2.29
                     ==========                                            =======
</TABLE>

Pro Forma Information

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

         Pro  forma  information  regarding  net loss and net loss per  share is
required by SFAS 123, and has been  determined  as if the Company had  accounted
for its stock  options  granted  subsequent  to December 31, 1994 under the fair
value method of SFAS 123. The weighted  average fair value of options granted in
1995,  1996 and 1997 was  $0.91,  $2.61 and $4.11 per share,  respectively.  The
weighted  average  fair value of options  granted in 1996 at a weighted  average
exercise price of $1.40 per share, which was less than the market price on grant
date,  was $6.79.  The fair value for these options was estimated at the date of
grant  using a  Black-Scholes  option  pricing  model  for the  multiple  option
approach with the following  weighted-average  assumptions: a risk-free interest
rate of  6.33%,  6.34%  and 6.26% for  1997,  1996,  and 1995,  respectively,  a
weighted-average  expected life of 4.2 years for 1997 grants, 4.3 years for 1996
grants,  and 4.4 years for 1995 grants,  and an expected  dividend yield of zero
for all three years.  The Company believes that due to the low trading volume of
Lynx stock in 1995 and 1996, the calculated  volatility of the Company's  common
stock  does  not  provide  a  representative   picture  of  future   volatility.
Consequently,  an  industry-based  proxy  volatility  of  73%  was  used  in the
calculations for 1995 and 1996. In 1997,  trading increased to a volume that was
sufficient to generate an average  volatility of 56%, which the Company believes
is representative of future volatility.

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

                                      34.

<PAGE>


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


6.       Stockholders' Equity  (continued)

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:

                                                 Year Ended December 31,
                                          1997           1996           1995
                                        ---------------------------------------
                                                   (in thousands)
          Net loss
                Historical               $10,821         $5,391       $11,468
                Pro forma                $11,498         $5,853       $11,661

          Net loss per share
                Historical                 $3.09          $2.45         $5.66
                Pro Forma                  $3.28          $2.66         $5.76

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

7.       Income Taxes

         The provision for income taxes is based on pre-tax financial accounting
income.  Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary  differences  between the tax and book basis of assets
and liabilities.

         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, 1997, 1996 and 1995 is
as follows (in thousands):
                                                         Fiscal Year Ended
                                              ----------------------------------
                                                1997         1996         1995
                                              -------      -------      -------

Tax provision (benefit) at U.S.               $(3,679)     $(1,830)     $(3,899)
   statutory rate

Alternative minimum tax                          --             10         --

Loss for which no tax benefit is
   currently recognizable                       3,679        1,830        3,899
                                              -------      -------      -------
                                              $  --        $    10      $  --
                                              =======      =======      =======


<PAGE>


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


7.       Income Taxes  (continued)

<TABLE>

         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):

<CAPTION>

                                                                                  1997                1996
                                                                            ----------------    ---------------
<S>                                                                          <C>                 <C>
      Deferred tax assets:
         Net operating loss carryforwards                                    $      10,800       $       6,980
         Research & development tax credit carryforwards                             1,172                 830
         Capitalized research and development expenditures                             616               1,031
         Deferred revenue                                                              912               2,475
         Other, net                                                                    718                 241
         Valuation allowance                                                       (14,218)            (11,557)
                                                                            ----------------    --------------
      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 asset as of December 31,
1997 and 1996 has been established to reflect these uncertainties. The change in
the  valuation  allowance  was  a  net  increase  of  approximately  $2,661,000,
$2,773,000 and 3,234,000 for the fiscal years ended December 31, 1997,  1996 and
1995, respectively.

         As of December 31,  1997,  the Company had federal and  California  net
operating  loss  carryforwards  of  approximately  $30,400,000  and  $9,300,000,
respectively,  which will expire from 2000 through 2012, if not utilized.  As of
December 31,  1997,  the Company  also had federal and  California  research and
development tax credit  carryforwards  of  approximately  $867,000 and $305,000,
respectively,  which will expire at various dates from 2007 through 2012, if not
utilized.

         The Company's  losses through  November 20, 1992,  were included in the
consolidated  income tax  returns of Applied  Biosystems,  a division  of Perkin
Elmer  Corporation.  As a result, the Company's net operating loss carryforwards
available to offset future taxable income consist only of losses  incurred after
November 20, 1992, and, therefore, differ from the book accumulated deficit.

         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.

                                      36.
<PAGE>


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


8.       Obligations under Operating Leases

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

         Minimum  annual  rental  commitments  under  operating  leases  are  as
follows:

                  Years ending December 31:                    (in thousands)
                          1998                                      $   606
                          1999                                          564
                          2000                                          546
                          2001                                          528
                          2002                                          553
                          Thereafter                                    322
                                                                     ------
                                                                     $3,119
                                                                     ======

         Rent expense for facilities and equipment  under  operating  leases was
$649,000, $722,000 and $684,000 for the years ended December 31, 1997, 1996, and
1995, respectively.

9.       401(k) Plan

         In  October  1992,  Lynx  adopted  a 401(k)  Plan  covering  all of its
employees.  The 401(k) Plan is intended to qualify under Section 401 of the Code
so that contributions by employees or by Lynx to the 401(k) Plan are not taxable
to employees until withdrawn from the 401(k) Plan, and so that  contributions by
Lynx, if any, will be deductible by Lynx when made. Pursuant to the 401(k) Plan,
employees may elect to reduce their current  compensation  by up to 15% (subject
to an annual  limit  prescribed  by the Code as  described  below)  and have the
amount of such  reduction  contributed  to the 401(k)  Plan.  Under  limitations
imposed by the Code, the maximum amount of compensation  reduction a participant
could elect to have  contributed  to the 401(k) Plan for the 1997  calendar year
was $9,500.  This amount is subject to annual  adjustments  for increases in the
cost of living,  as determined under Internal Revenue Service  regulations.  The
401(k) Plan  permits,  but does not  require,  additional  contributions  to the
401(k) Plan by Lynx on behalf of all  participants  in the 401(k)  Plan.  In the
years ended 1997, 1996 and 1995, the Company  contributed  $42,088,  $37,073 and
$22,825, respectively.

10.      Subsequent Events (unaudited)

         In March 1998,  Lynx sold its portfolio of  phosphorothioate  antisense
patents  and  licenses,  and  its  therapeutic   oligonucleotide   manufacturing
facility,  to Inex  Pharmaceuticals  Corporation ("Inex") a Canadian company. As
partial consideration in this transaction,  Lynx received $3 million in cash and
1.2 million shares of Inex common stock, in three equal  installments,  with the
first  400,000  shares  received  on the above  date,  and the  second and third
installments  of  stock  to be  received  no later  then  two and  three  years,
respectively,  from the closing date of the  transaction.  The Inex common stock
received  by Lynx is subject to certain  restrictions  on trading  for  specific
periods of time  following  receipt by Lynx.  Lynx is also  entitled  to receive
royalties on future sales of phosphorothioate  antisense products.  In addition,
Lynx has agreed to a  royalty-bearing  license to Inex for its  phosphoroamidate
chemistry  for  certain  therapeutic  applications  in the  fields of cancer and
inflammation that will be defined later.

                                      37.
<PAGE>


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


10.      Subsequent Events (unaudited)  (continued)

         The agreement requires that Inex will assume the responsibility,  going
forward,   of   manufacturing   LR-3280,   a  compound  for  the  prevention  of
cardiovascular  restenosis, for Schwarz Pharma AG ("Schwarz") and Tanabe Seiyaku
Co., Ltd.  ("Tanabe").  Under agreements  signed with Lynx in 1986,  Schwarz and
Tanabe purchased the rights to market LR-3280 and committed to bear the costs of
its continued clinical  development.  Lynx retains the right to collect,  if and
when earned, the next milestone payments, totaling $7 million, under the Schwarz
and Tanabe agreements, as well as 50% of all future milestone payments and gross
profits  associated  with the continued  success in the development and sales of
the compound.

         In  connection  with the  aforementioned  transaction  with  Inex,  the
Company  has  entered  into an  agreement  to  sublease to Inex a portion of its
existing facilities under lease. The term of the sublease to Inex is twenty-four
months,  commencing  March 10,  1998.  Inex has the option to extend the term of
sublease  through  July 31,  2003,  subject to certain  conditions.  The Company
expects to receive aggregate rental payments from Inex of approximately $462,000
over the term of the lease.  The Company intends to seek  additional  sublessees
for the remaining portion of its existing facilities not under sublease to Inex.

         On February 27, 1998, the Company  entered into a  noncancelable  lease
for additional facilities space. The term of the lease commences 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  twenty-four  months.  Thereafter,  the
monthly  rental  payments  increase,  and are subject to annual  Consumer  Price
Index-based  adjustments,  with  minimum and maximum  limits.  The Company  will
record rent expense on a straight-line method over the initial 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 such option. Additionally, the Company has an option (the "Expansion
Option"),  exercisable  on or prior to  January  1,  2000,  to lease  additional
building space for expansion  purposes.  In return for the Expansion Option, the
Company  may be  subject to a nominal  carrying  cost on the  additional  space,
depending on the timing of the exercise of such option, if ever.

         Minimum annual rental  commitments  under the above operating lease are
as follow:

              Years ending December 31:                        (in thousands)
                      1998                                        $      31
                      1999                                              848
                      2000                                            1,145
                      2001                                            1,465
                      2002                                            1,509
                      Thereafter                                      9,980
                                                                  ---------
                                                                  $  14,978
                                                                  =========


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

         Not applicable.

                                       38.
<PAGE>


                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
         The Company's executive officers,  directors and certain employees, and
their ages as of December 31, 1997 are as follows:

<CAPTION>
         Name                                        Age               Company Positions
         ----                                        ---               -----------------
<S>                                                  <C>               <C>
         Sam Eletr, Ph.D.                            58                Chief Executive Officer and
                                                                         Chairman of the Board
         Edward C. Albini                            40                Chief Financial Officer and Secretary
         Timothy G. Geiser, Ph.D.                    55                Vice President, Manufacturing
         Stephen C. Macevicz, Ph.D.                  48                Vice President, Intellectual Property
         Karoly Nikolich, Ph.D.                      49                Vice President, Research
         Gerald Zon, Ph.D.                           52                Vice President, Medicinal Chemistry
         William K. Bowes, Jr.(1)                    71                Director
         Sydney Brenner, M.B., D. Phil.              70                Director
         James C. Kitch(1)                           50                Director
         Kathleen D. La Porte(2)                     36                Director
         Craig C. Taylor(2)                          47                Director
         -----------
         (1)  Member of the Audit Committee
         (2)  Member of the Compensation Committee

</TABLE>

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

         Edward C. Albini,  has served as Chief Financial Officer of the Company
since April 1997. He was elected Secretary of the Company in February 1998. From
January 1983 to April 1997,  Mr. Albini served in various  financial  management
positions with Genentech, Inc., a biotechnology company ("Genentech").  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  Walter  A. Haas  School  of  Business  at the  University  of
California at Berkeley. Mr. Albini is also a certified public accountant.

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

         Stephen C. Macevicz,  Ph.D.,  joined the Company in September  1995, as
Vice President,  Intellectual  Property. He was Senior Patent Attorney and chief
patent counsel at ABI from 1992 to August 1995 and, prior to that,  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 University of California,  Berkeley (Boalt Hall) in 1984 and his
Ph.D. in Biophysics from the University of California, Berkeley in 1979.

                                       39.

<PAGE>

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

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

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

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

         Mr. Kitch has served as a director of the Company  since  February 1993
and Secretary of Lynx from February 1992 to December  1997. He was a director of
ABI, Lynx's  predecessor,  from August 1986 to February 1993. He is a partner at
Cooley Godward LLP, a law firm which has provided legal services to the Company.

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

         Mr. Taylor has served as a director of the Company since March 1994 and
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. He
is a general  partner  of AMC  Partners  89 L.P.,  which  serves as the  general
partner of Asset  Management  Associates  1989 L.P., a private  venture  capital
partnership.  He  currently  serves as a director of Metra  BioSystems,  Inc., a
biotechnology company, Pharmacyclics, Inc., a biotechnology company, and several
private companies.

Compliance with the Reporting Requirements of Section 16(a)

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

         To the Company's  knowledge,  based solely on a review of the copies of
such reports  furnished to the Company,  during the calendar year ended December
31, 1997,  all Section  16(a) filing  requirements  applicable  to its officers,
directors  and greater than ten percent  (10%)  beneficial  owners were complied
with.

                                      40.
<PAGE>

<TABLE>
ITEM 11. EXECUTIVE COMPENSATION

         The following table sets forth certain compensation paid by the Company
during the calendar years ended  December 31, 1997,  1996 and 1995, to its Chief
Executive Officer and each of the four other most highly  compensated  executive
officers whose compensation exceeded $100,000 (the "Named Executive Officers"):
<CAPTION>

                                         Summary Compensation Table

                                                                                  Long Term
                                                              Annual             Compensation                All Other
Name and Principal Position                    Year          Salary(1)            Options(#)              Compensation(2)
---------------------------                    ----          ---------            ----------              ---------------
<S>                                            <C>           <C>                    <C>                         <C>
Sam Eletr, Ph.D.                               1997          $196,131                    --                     $--
   Chief Executive Officer and                 1996           176,121                32,500                      --
   Chairman of the Board                       1995           170,484               105,000                      --

Timothy G. Geiser, Ph.D.                       1997           156,634(3)                  --                    750
   Vice President, Manufacturing               1996           153,818                    --                     750
                                               1995           142,674                60,000                     750

Stephen C. Macevicz, Ph.D.                     1997           155,886                    --                     750
   Vice President, Intellectual Property       1996           144,505                    --                     750
                                               1995           53,632(4)             106,000                      --

Karoly Nikolich, Ph.D.                         1997           155,889                    --                     750
   Vice President, Research                    1996           150,210                30,000                     750
                                               1995            37,085(5)             70,000                      --

Gerald Zon, Ph.D.                              1997           156,610(6)                 --                     750
   Vice President, Medicinal Chemistry         1996           154,168                    --                     750
                                               1995           143,130                60,000                     750

<FN>

(1)  Includes amounts earned but deferred at the election of the Named Executive
     Officer pursuant to the Company's 401(k) Plan.
(2)  Contributions made by the Company to the Company's 401(k) Plan on behalf of
     such employee.
(3)  Dr. Geiser  resigned  from the Company in January 1998, in connection  with
     the sale of the  phosphorothioate  antisense assets to Inex Pharmaceuticals
     Corporation.
(4)  Dr.  Macevicz  joined the Company in September 1995. The 1995 annual salary
     represents a partial year.
(5)  Dr.  Nikolich  joined the Company in October  1995.  The 1995 annual salary
     represents a partial year.
(6)  Dr. Zon resigned from the Company in January  1998, in connection  with the
     sale of the  phosphorothioate  antisense  assets  to  Inex  Pharmaceuticals
     Corporation.
</FN>
</TABLE>

         Except as disclosed  above, no compensation  characterized as long-term
compensation,  including  restricted  stock awards  issued at a price below fair
market  value or  long-term  incentive  plan  payouts,  were paid by the Company
during the year ended December 31, 1997, to any of the Named Executive Officers.

Stock Option Grants and Exercises

         There  were no grants of stock  options  to any of the Named  Executive
Officers in the Summary  Compensation  Table during the year ended  December 31,
1997.

                                      41.

<PAGE>

<TABLE>

         The  following  table sets forth  certain  information  concerning  the
number of options exercised by the Named Officers during the year ended December
31, 1997, and the number of shares covered by both exercisable and unexercisable
stock  options  held  by the  Named  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 31, 1997 ($16.25 per share).

          Aggregated Option Exercises in the Year Ended December 31, 1997 and Option Values

<CAPTION>

                                                                 Number of               Value of Unexercised
                                                            Unexercised Options         In-the-Money Options at
                        Shares                                  at Year-End                  Year-End (1)
                      Acquired on       Value          ---------------------------   ----------------------------
       Name            Exercise      Realized(1)       Exercisable   Unexercisable   Exercisable    Unexercisable
       ----            --------      -----------       -----------   -------------   -----------    -------------
<S>                                  <C>               <C>              <C>         <C>               <C>
Sam Eletr                --          $  --             185,000          32,500      $2,621,250        $478,075
Timothy G. Geiser        --             --             123,500              --       1,771,025              --
Stephen C. Macevicz      --             --              54,000              --         856,650              --
Karoly Nikolich          --             --              40,000              --         495,000              --
Gerald Zon               --             --             130,750              --       1,883,613              --

<FN>
(1)      Based on the fair market value of the Company's common stock at December 31, 1997 ($16.25),  minus the
         exercise price of the option,  multiplied by the number of shares  underlying the options.
</FN>
</TABLE>

Compensation of Directors

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

Compensation Committee Interlocks and Insider Participation

         The Company's  Compensation  Committee was  established  in March 1994.
There  were  no  officers  or  employees  of the  Company  who  participated  in
deliberations  of the  Company's  Compensation  Committee  concerning  executive
officer compensation during the year ended December 31, 1997.

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.

         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

                                      42.
<PAGE>

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.

<TABLE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth certain information regarding beneficial
ownership of the Common Stock (on an as-if  converted  basis) as of February 28,
1998, by (i) each  stockholder  who is known by the Company to own  beneficially
more than 5% of the Common Stock (on an as-if converted basis);  (ii) each Named
Executive Officer of the Company listed on the Summary Compensation Table below;
(iii)  each  director  of the  Company;  and (iv) all  directors  and  executive
officers  of the  Company as a group.  All Series D  preferred  stock is held by
Hoechst  Marion  Roussel as  reflected in the Common Stock table and as noted in
footnote (9).
<CAPTION>

                                                                          Series B                  Series C
                                            Common Stock(1)          Preferred Stock(1)        Preferred Stock(1)
Name and Address                        ---------------------        ------------------      ---------------------
of Beneficial Owners                    Number     Percent(2)        Number   Percent(2)     Number     Percent(2)
--------------------                    ------     ----------        ------   ----------     ------     ----------
<S>                                       <C>          <C>             <C>         <C>         <C>           <C>
Entities affiliated with
     U.S. Venture Partners IV, L.P.(3)    730,000      10.9%           50,000      15.0%       23,000        18.7%
     2180 Sand Hill Road
     Suite 300
     Menlo Park, CA  94025

Entities affiliated with the
     Sprout Group(4)                      729,980      10.9%           49,999      15.0%       22,999        18.7%
     3000 Sand Hill Road
     Building 4, Suite 270
     Menlo Park, CA  94025

Cannon Street Fund Ltd.                   565,000       8.7%           40,000      12.0%       16,500        13.4%
     c/o Meridian Venture Group
     R.R. Box 272
     Charlottesville, VA  22314

Biotechnology Investments Limited         545,000       8.4%           40,000      12.0%       14,500        11.8%
     c/o Old Court Limited
     P.O. Box 58
     St. Julian's Court
     St. Peter Port
     Guernsey, Channel Islands

Entities affiliated with
     WPG-Farber-Weber Fund(5)             500,000       8.4%               --        N/A           --          N/A
     590 Madison Avenue
     New York, NY  10022


                                                       43.

<PAGE>


                                                                          Series B                  Series C
                                            Common Stock(1)          Preferred Stock(1)        Preferred Stock(1)
Name and Address                        ---------------------        ------------------      ---------------------
of Beneficial Owners                    Number     Percent(2)        Number   Percent(2)     Number     Percent(2)
--------------------                    ------     ----------        ------   ----------     ------     ----------
     Lombard Odier & Cie(6)               490,000       8.2%               --        N/A           --          N/A
     11 Rue de la Corraterie
     1204 Geneva, Switzerland

Entities affiliated with
     Mehta and Isaly(7)                   450,000       7.6%               --        N/A           --          N/A
     41 Madison Avenue
     New York, NY  10010

Singapore Bio-Innovations Pte, Ltd.       420,000       6.6%           42,000      12.6%           --          N/A
     250 North Bridge Road
     24-00 Raffles City Tower
     Singapore  0617

Entities affiliated with
     Partech International(8)             415,000       6.7%           15,000       4.5%       15,000        12.2%
     101 California Ave., Suite 3150
     San Francisco, CA  94111

Hoechst Marion Roussel(9)                 400,000       6.3%               --        N/A           --          N/A
     10236 Marion Park Drive
     Kansas City, MO  64137-1405

Entities affiliated with
     The Tisch Family(10)                 400,000       6.7%               --        N/A           --          N/A
     667 Madison Avenue
     New York, NY  10021

Asset Management Associates               360,000       5.7%           36,000      10.8%           --          N/A
  1989 L.P.(11)
     2275 East Bayshore Rd., #150
     Palo Alto, CA  94303

Chiron Corporation                        300,000       5.1%               --        N/A           --          N/A
     4360 Horton Street
     Emeryville, CA  94608

Sam Eletr, Ph.D.(12)                      463,759       7.5%               --        N/A           --          N/A
     Lynx Therapeutics, Inc.
     3832 Bay Center Place
     Hayward, CA  94545

William K. Bowes, Jr.(13)                 747,721      11.2%           50,000      15.0%       23,000        18.7%
     U.S. Venture Partners IV, L.P.
     2180 Sand Hill Road
     Suite 300
     Menlo Park, CA  94025

                                                        44.
<PAGE>


                                                                          Series B                  Series C
                                            Common Stock(1)          Preferred Stock(1)        Preferred Stock(1)
Name and Address                        ---------------------        ------------------      ---------------------
of Beneficial Owners                    Number     Percent(2)        Number   Percent(2)     Number     Percent(2)
--------------------                    ------     ----------        ------   ----------     ------     ----------
Sydney Brenner, M.D., D. Phil.(14)        287,375       4.3%               --        N/A           --          N/A

Timothy G. Geiser(15)                     160,327       2.6%               --        N/A           --          N/A

James C. Kitch(16)                         17,818         **              700         **          300           **

Kathleen D. La Porte(4)                   729,980      10.9%           49,999      15.0%       22,999        18.7%
     Sprout Group
     3000 Sand Hill Road
     Building 4, Suite 270
     Menlo Park, CA  94025

Stephen C. Macevicz, Ph.D.(17)            106,151       1.8%               --        N/A           --          N/A

Karoly Nikolich, Ph.D.(18)                100,000       1.7%               --        N/A           --          N/A

Craig C. Taylor(19)                       371,497       5.9%           36,000      10.8%        1,000           **
     Asset Management Associates
       1989 L.P.
     2275 East Bayshore Rd., #150
     Palo Alto, CA  94303

Gerald Zon, Ph.D.(20)                     160,806       2.6%               --        N/A           --          N/A

All directors and officers              3,195,434      38.1%          136,699      41.1%       47,299        38.4%
     as a group (11 persons)(21)

<FN>
**Less than one percent.

 (1)     Except as otherwise noted, and subject to community property laws where
         applicable,  each  person or entity  named in the table has sole voting
         and investment  power with respect to all shares shown as  beneficially
         owned by him, her or it. Beneficial  ownership of common stock reflects
         beneficial ownership of Series B preferred stock and Series C preferred
         stock as set forth in the  table,  and  Series D  preferred  stock with
         respect to Hoechst Marion Roussel, as set forth in footnote (9).

 (2)     Percentage  of  beneficial  ownership is based on  5,940,269  shares of
         common stock, 332,288 shares of the Company's Series B preferred stock,
         123,299  shares of the  Company's  Series C preferred  stock and 40,000
         shares of the  Company's  Series D preferred  stock  outstanding  as of
         February 28,  1998,  except as otherwise  noted in the  footnotes.  The
         Series B,  Series C and  Series D  preferred  stock will  convert  into
         common  stock on a  ten-for-one  basis on March  31,  1998.  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
         28, 1998,  are deemed  outstanding  for computing the percentage of the
         person holding such option but are not deemed outstanding for computing
         the percentage of any other person.

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

                                      45.

<PAGE>

         shares,  except  to the  extent  of his pro-rata interest therein.

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

 (5)     Includes  500,000  shares of common  stock held by entities  affiliated
         with WPG-Farber-Weber Fund.

 (6)     Includes  490,000 shares of common stock held by Lombard Odier & Cie as
         custodian.  Lombard Odier & Cie disclaim  beneficial  ownership of such
         shares.

 (7)     Includes  450,000  shares of common  stock held by entities  affiliated
         with the Mehta and Isaly.

 (8)     Includes  115,000  shares of common stock,  150,000  shares of Series B
         preferred  stock and 150,000 shares of Series C preferred stock held by
         entities affiliated with Partech International.

 (9)     Consists  solely of 40,000  shares of Series D preferred  stock,  which
         constitutes 100% of the shares of Series D preferred stock outstanding.

(10)     Includes  400,000  shares of common  stock held by entities  affiliated
         with the Tisch Family Interests.

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

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

(13)     See Note 3 above.  Common stock amount also includes 17,721 shares held
         by Mr. Bowes.

(14)     Includes  27,375 shares of common stock  issuable upon exercise of Lynx
         stock  options held by Sydney  Brenner that are  exercisable  within 60
         days.

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

(16)     Includes  700  shares of  Series B  preferred  stock and 300  shares of
         Series  C  preferred  stock  held by GC&H  Investments,  an  investment
         partnership  of which Mr.  Kitch is a general  partner.  Also  includes
         1,985 shares of common stock and 5,833 shares of common stock  issuable
         upon the  exercise of Lynx stock  option held by Mr. Kitch on behalf of
         GC&H  Investments.  Mr.  Kitch shares the power to vote and control the
         disposition  of such  shares  and  therefore  may be  deemed  to be the
         beneficial  owner  of  such  shares.  Mr.  Kitch  disclaims  beneficial
         ownership of such shares, except to the extent of his pro-rata interest
         therein.

(17)     Includes  54,000 shares of common stock  issuable upon exercise of Lynx
         stock options held by Dr. Macevicz that are exercisable within 60 days.

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

                                      46.

<PAGE>

(19)     See Note 11 above.  Includes  1,497  shares  of common  stock and 1,000
         shares of Series C preferred stock held by Mr. Taylor.

(20)     Includes  130,750 shares of common stock issuable upon exercise of Lynx
         stock options held by Dr. Zon that are exercisable within 60 days. Also
         includes  105 shares of common  stock held of record by Dr.  Zon's wife
         and 64 shares of common stock  issuable  upon  exercise of Perkin Elmer
         Options held by Dr.  Zon's wife that are fully vested and  exercisable,
         as to which shares Dr. Zon disclaims beneficial ownership.

(21)     Common stock amount includes  1,839,980 shares of Series B and Series C
         preferred stock (common  equivalent)  held by entities  affiliated with
         certain  directors  and 599,022  shares of common stock  issuable  upon
         exercise of the Company's  stock options and Perkin Elmer stock options
         held by directors and officers that are exercisable within 60 days. See
         Notes 12 through 20 above.
</FN>
</TABLE>


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Corporate Collaborations

See  "ITEM 1.  BUSINESS"  and "Note 3. of the  Notes to  Consolidated  Financial
Statements"

         In 1992, ABI  distributed all but an aggregate of 299,800 shares of the
Lynx  common  stock  it  held  to  its  shareholders  (the  "Distribution").  In
connection with this  transaction,  Lynx granted ABI an option to purchase up to
215,900  shares of Lynx common stock at $0.10 per share which,  prior to October
1996,  could only be exercised by ABI in connection with the distribution by ABI
of Lynx stock to its  option  holders  upon the  exercise  of ABI stock  options
outstanding as of the date of the  Distribution.  In September  1997, the option
expired and the remaining shares were canceled.

Transactions with Directors and Executive Officers

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

         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.

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

         For legal services rendered during the calendar year ended December 31,
1997,  the Company  paid  approximately  $228,449  to Cooley  Godward  LLP,  the
Company's counsel, of which Mr. Kitch, a director of the Company, is a partner.


                                      47.

<PAGE>


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

 (a) (1) The following index, Report of Ernst & Young LLP,  Independent Auditors
and financial statements are set forth on pages 22 through 27 of this report:

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

         (ii)     Consolidated Balance Sheets as of December 31, 1997 and 1996.

         (iii)    Consolidated  Statements  of  Operations  for the years  ended
                  December 31, 1997, 1996 and 1995.

         (iv)     Consolidated  Statements of Stockholders' Equity for the years
                  ended December 31, 1997, 1996 and 1995.

         (v)      Consolidated  Statements  of Cash  Flows for the  years  ended
                  December 31, 1997, 1996 and 1995 .

         (vi)     Notes to Consolidated Financial Statements.

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

     (3) The following documents are filed as Exhibits to this report:




                                      48.

<PAGE>

EXHIBIT
NUMBER                        DESCRIPTION OF DOCUMENT
------                        -----------------------
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.
3.1.1      Certificate  of Amendment of  Certificate of the Amended and Restated
           Certificate of Incorporation of the Company.
3.2        Bylaws of the Company,  as amended,  incorporated by reference to the
           indicated  exhibit of the  Registrant's  Statement  Form 10 (File No.
           0-22570), as amended.
3.3        Certificate  of  Designation  of  Preferences of Series B Convertible
           Preferred  Stock of the  Company,  incorporated  by  reference to the
           indicated  exhibit of the  Registrant's  Form 10-K for the transition
           period ended December 31, 1993.
3.4        Certificate of Amendment of Certificate of Designation of Preferences
           of Series B Convertible Preferred Stock of the Company,  incorporated
           by reference to the indicated  exhibit of the Registrant's  Form 10-Q
           for the period ended March 31, 1995.
3.4.1      Certificate of Amendment to Certificate of Designation of Preferences
           of Series B Convertible Preferred Stock of the Company.
3.4.2      Certificate of Amendment to Certificate of Designation of Preferences
           of  Series  B  Convertible  Preferred  Stock  of  the  Company  dated
           September 30, 1997.
3.5        Certificate  of  Designation  of  Preferences of Series C Convertible
           Preferred Stock,  incorporated by reference to the indicated  exhibit
           of the Registrant's Form 10-Q for the period ended March 31, 1995.
3.5.1      Certificate of Amendment to Certificate of Designation of Preferences
           of  Series  C  Convertible  Preferred  Stock  of  the  Company  dated
           September 30, 1997.
3.5.2      Certificate of Amendment to Certificate of Designation of Preferences
           of Series C Convertible Preferred Stock of the Company.
3.6        Certificate of Amendment to Certificate of Designation of Preferences
           of Series D Convertible Preferred Stock of the Company.
4.1        Shareholders Agreement, dated as of October 1, 1992, by and among the
           Company,  Applied  Biosystems,  Inc.  ("ABI") and Chiron  Corporation
           ("Chiron"), incorporated by reference to the indicated exhibit of the
           Registrant's Statement Form 10 (File No. 0-22570), as amended.
4.2        Form of Common Stock  Certificate,  incorporated  by reference to the
           indicated  exhibit of the  Registrant's  Statement  Form 10 (File No.
           0-22570), as amended.
4.3        Form  of  Series  B  Preferred  Stock  Certificate,  incorporated  by
           reference  to  Exhibit  4.4 of the  Registrant's  Form  10-K  for the
           transition period ended December 31, 1993.
4.4        Form  of  Series  C  Preferred  Stock  Certificate,  incorporated  by
           reference to Exhibit 4.5 of the Registrant's Form 10-K for the period
           ended December 31, 1995.
4.5        Form  of  Series  D  Preferred  Stock  Certificate,  incorporated  by
           reference to Exhibit 4.6 of the Registrant's Form 10-K for the period
           ended December 31, 1995.
10.1       Preferred  Stock  Purchase  Agreement,  dated as of  October 1, 1992,
           between  the  Company  and  ABI,  incorporated  by  reference  to the
           indicated exhibit of the Registrant's Statement Form 10 (File No.
           0-22570), as amended.
10.2       Stock  Purchase  Agreement,  dated as of June 30,  1992,  between the
           Company  and  Timothy  Geiser,   incorporated  by  reference  to  the
           indicated exhibit of the Registrant's Statement Form 10 (File No.
           0-22570), as amended.
10.3       Stock  Purchase  Agreement,  dated as of June 30,  1992,  between the
           Company and Gerald Zon,  incorporated  by reference to the  indicated
           exhibit of the Registrant's  Statement Form 10 (File No. 0-22570), as
           amended.
10.4       Stock Purchase  Agreement,  dated as of August 25, 1992,  between the
           Company and Sam Eletr,  incorporated  by reference to Exhibit 10.6 of
           the Registrant's Statement Form 10 (File No. 0-22570), as amended.

                                      49.
<PAGE>

10.5       Form of Indemnity  Agreement entered into between the Company and its
           directors and officers,  incorporated by reference to Exhibit 10.7 of
           the Registrant's Statement Form 10 (File No. 0-22570), as amended.
10.6+      The  Company's  1992 Stock  Option  Plan (the "Stock  Option  Plan"),
           incorporated  by  reference  to  Exhibit  10.8  of  the  Registrant's
           Statement Form 10 (File No. 0-22570), as amended.
10.7+      Form of  Incentive  Stock  Option  Grant under the Stock Option Plan,
           incorporated  by  reference  to  Exhibit  10.9  of  the  Registrant's
           Statement Form 10 (File No. 0-22570), as amended.
10.8+      Form of Nonstatutory  Stock Option Grant under the Stock Option Plan,
           incorporated  by  reference  to  Exhibit  10.10  of the  Registrant's
           Statement Form 10 (File No. 0-22570), as amended.
10.9       Agreement of Assignment and License of Intellectual  Property Rights,
           dated June 30,  1992,  between the Company and ABI,  incorporated  by
           reference  to Exhibit  10.11 of the  Registrant's  Statement  Form 10
           (File No. 0-22570), as amended.
10.10      Lease,  dated as of June 28,  1993,  by and  between  the Company and
           Spieker-Singleton #87, Limited Partnership, incorporated by reference
           to  Exhibit  10.14 of the  Registrant's  Statement  Form 10 (File No.
           0-22570), as amended.
10.11      Series B Convertible Preferred Stock Purchase Agreement,  dated as of
           February   15,  1994,   between  the  Company  and  the   Purchasers,
           incorporated  by reference to the Exhibit  10.16 of the  Registrant's
           Form 10-K for the transition period ended December 31, 1993.
10.12      Investor Rights Agreement, dated as of February 15, 1994, between the
           Company and the Purchasers,  incorporated by reference to the Exhibit
           10.17 of the Registrant's  Form 10-K for the transition  period ended
           December 31, 1993.
10.13      Series C Convertible Preferred Stock Purchase Agreement,  dated as of
           March 24, 1995,  incorporated  by  reference to Exhibit  10.19 of the
           Registrant's Form 10-K for the period ended December 31, 1995.
10.14      Investors Rights Agreement,  dated as of March 24, 1995, incorporated
           by reference to Exhibit 10.20 of the  Registrant's  Form 10-K for the
           period ended December 31, 1995.
10.15      Spectragen  Formation   Agreement,   dated  as  of  March  24,  1995,
           incorporated by reference to Exhibit 10.21 of the  Registrant's  Form
           10-Q for the period ended March 31, 1996.
10.16+     Spectragen  Stockholder's  Agreement,  dated as of August  21,  1995,
           incorporated by reference to Exhibit 10.22 of the  Registrant's  Form
           10-Q for the period ended March 31, 1996.
10.17+     Employment Agreement, dated as of May 1, 1995 between the Company and
           David W.  Martin,  Jr.,  M.D.,  incorporated  by reference to Exhibit
           10.23 of the Registrant's Form 10-K for the period ended December 31,
           1995.
10.18+     Stock Purchase Agreement dated as of May 1, 1995, between the Company
           and David W. Martin,  Jr. M.D.,  incorporated by reference to Exhibit
           10.24 of the Registrant's Form 10-K for the period ended December 31,
           1995.
10.19+     Loan  Agreement,  dated as of May 1, 1995,  between  the  Company and
           David W. Martin, Jr., M.D. incorporated by reference to Exhibit 10.25
           of the Registrant's Form 10-K for the period ended December 31, 1995.
10.20+     Promissory  Note Secured by Mortgage,  dated as of June 12, 1995,  to
           the  Company by David W. and  Kathleen  M.  Martin  Revocable  Trust,
           incorporated by reference to Exhibit 10.26 of the  Registrant's  Form
           10-K for the period ended December 31, 1995.
10.21+     Stock  Purchase  Agreement  dated as of October 2, 1995,  between the
           Company and Karoly  Nikolich,  incorporated  by  reference to Exhibit
           10.27 of the Registrant's Form 10-K for the period ended December 31,
           1995.
10.22      Technology Development and Services Agreement, dated as of October 2,
           1995,  between the Company  and  Hoechst  Aktiengesellschaft  and its
           subsidiary,  Hoechst  Marion  Roussel,  incorporated  by reference to
           Exhibit  10.28 of the  Registrant's  Form 10-K for the  period  ended
           December 31, 1995.
10.23      Series D. Convertible Preferred Stock Purchase Agreement, dated as of
           October 2, 1995,  incorporated  by reference to Exhibit  10.29 of the
           Registrant's Form 10-K for the period ended December 31, 1995.
10.24      Amended and Restated Investor Rights Agreement,  dated as of November
           1,  1995,   incorporated   by  reference  to  Exhibit  10.30  of  the
           Registrant's Form 10-K for the period ended December 31, 1995.
10.25+     Stock  Purchase  Agreement,  dated  as  of  June  13,  1996,  between
           Spectragen,  Inc. and Sam Eletr.  (The Stock  Purchase  Agreement was
           assumed by the Company  pursuant to the  Agreement of Merger  between
           the Company and Spectragen, Inc.

                                      50.
<PAGE>

10.26      Collaboration  Agreement  , dated  as of July 9,  1996,  between  the
           Company and Tanabe  Seiyaku Co., Ltd.,  incorporated  by reference to
           Exhibit 10.31 of the Registrant's Form 10-Q for the period ended June
           30, 1996.
10.27      Collaboration Agreement , dated as of September 30, 1996, between the
           Company and Schwarz Pharma AG.,  incorporated by reference to Exhibit
           10.32 of the  Registrant's  Form 10-Q for the period ended  September
           20, 1996.
10.28**    Technology  Services  Agreement,  dated October 23, 1996, between the
           Company and BASF Aktiengesellschaft.
10.29      Joint Venture  Agreement,  dated as of October 23, 1996,  between the
           Company and BASF Aktiengesellschaft.**
10.30      Agreement  of  Merger,  dated as of October  23,  1996,  between  the
           Company and Spectragen, Inc.
10.31+     Separation  Agreement,  dated as of  November  1, 1996,  between  the
           Company and David W. Martin, Jr., M.D.
10.32+     Stock  Purchase  Agreement  dated as of April 14,  1997,  between the
           Company and Edward C. Albini.
10.33      First  Amemdment to Technology  Development  and Services  Agreement,
           dated   September   1,  1997,   between   the   Company  and  Hoechst
           Aktiengesellschaft  and  its  Subsidiary,   Hoechst  Marion  Roussel,
           incorporated by reference to Exhibit 10.32 of the  Registrant's  Form
           10-Q for the period ended September 30, 1997.
10.34      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 the Exhibit  4.1 of the  Registrant's
           Registration  Statement on Form S-3,  filed on October 31, 1997 (File
           No. 333-39171).
21.1       Subsidiaries of the Company.
23.1       Consent of Ernst & Young LLP, Independent Auditors.
24.1       Power of Attorney.  Reference is made to page 52.
27.0       Financial Data Table for the period ended December 31, 1997.
27.1       Financial Data Table for the period ended December 31, 1996.

------------------------------
(+)        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>


                                   SIGNATURES

         Pursuant to the  requirements of Section 13 or 15(d)  Securities Act of
1934,  the  Registrant  has duly caused this report on Form 10-K to be signed on
its behalf by the  undersigned,  thereunto duly  authorized,  on the 27th day of
March 1998.

                                             LYNX THERAPEUTICS, INC.


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

                                POWER OF ATTORNEY

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

         Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following  persons on behalf of the Registrant and of the
capacities and on the dates indicated.
<CAPTION>
              Signature                                         Title                                   Date
              ---------                                         -----                                   ----


<S>                                          <C>                                                  <C>
         /s/  Sam Eletr                              Chief Executive Officer and
--------------------------------------                  Chairman of the Board
         Sam Eletr                                  (Principal Executive Officer)                 March 27, 1998

         /s/  Edward C. Ablini                  Chief Financial Officer and Secretary
--------------------------------------      (Principal Financial and Accounting Officer)          March 27, 1998
         Edward C. Albini

         /s/  William K. Bowes, Jr.                           Director                            March 27, 1998
--------------------------------------
         William K. Bowes, Jr.

         /s/  Sydney Brenner                                  Director                            March 27, 1998
--------------------------------------
         Sydney Brenner

         /s/  James C. Kitch                                  Director                            March 27, 1998
--------------------------------------
         James C. Kitch

         /s/  Kathleen D. La Porte                            Director                            March 27, 1998
--------------------------------------
         Kathleen D. La Porte

         /s/  Craig C. Taylor                                 Director                            March 27, 1998
--------------------------------------
         Craig C. Taylor

</TABLE>
                                      52.