UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number 0-22570

Solexa, Inc.

(Exact name of registrant as specified in its charter)

25861 Industrial Blvd., Hayward, CA 94545

(Address of principal executive offices, including zip code)

(510) 670-9300

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value per share

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

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

      Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes o          No þ

      State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $17,041,928.(1)

      The number of shares of common stock of the Registrant outstanding as of March 10, 2005, was 17,597,581.

      (1) Based on a closing price of $4.60 per share on June 30, 2004 and 3,763,732 shares outstanding. Share price and number of shares reflect the Registrant’s 1 for 2 reverse stock split effected on March 2, 2005. Excludes 58,965 shares of the Registrant’s common stock held by executive officers, directors and stockholders whose ownership exceed 5% of the common stock outstanding at June 30, 2004. Exclusion of these shares should not be construed to indicate that such persons controls, is controlled by or is under common control with the Registrant. Determination of affiliate status for the purposes of this calculation is not necessarily a conclusive determination for any other purposes.

SOLEXA, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED

DECEMBER 31, 2004

Table of Contents

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

      Except for the historical information contained herein, this report contains certain information that is forward-looking in nature. Examples of forward-looking statements include statements regarding our future financial results, operating results, product successes, business strategies, projected costs, future products, competitive positions and plans and objectives of management for future operations. In some cases, you can identify forward-looking statements by terminology, such as “may,” “will,” “should,” “expects,” “plans,” “optimistic,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “envisions,” “hopes,” “intends,” “confident,” “could” or “continue” or the negative of such terms and other comparable terminology. In addition, statements that refer to expectations or other characterizations of future events or circumstances are forward-looking statements. These statements involve known and unknown risks and uncertainties that may cause our or our industry’s results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed under the captions “Item 1. Business — Business Risks” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These and many other factors could affect our future financial and operating results. We undertake no obligation to update any forward-looking statement to reflect events after the date of this report, except as required by law or applicable regulations.

PART I

Business Combination and Name Change

      On March 4, 2005, Lynx Therapeutics, Inc. or Lynx, completed a business combination with Solexa Limited. Solexa Limited is a privately held company registered in England and Wales that develops systems for the comprehensive and economical analysis of individual genomes. Solexa Limited has become a wholly-owned subsidiary of Lynx as a result of the transaction. However, because Solexa Limited’s shareholders own approximately 80% of the shares of Lynx common stock after the transaction, Solexa Limited’s designees to the combined company’s board of directors represent a majority of the combined company’s directors and Solexa Limited’s senior management represent a majority of the initial senior management of the combined company, Solexa Limited is deemed to be the acquiring company for accounting purposes. Accordingly, the assets and liabilities of Lynx will be recorded, as of the date of the business combination, at their respective fair values and added to those of Solexa Limited. Reported results of operations of the combined company issued for periods subsequent to the combination will reflect those of Solexa Limited, to which the operations of Lynx will be added from the date of the consummation of the business combination. The operating results of the combined company will reflect purchase accounting adjustments, including increased amortization and depreciation expense for acquired assets. Additionally, historical financial condition and results of operations shown for comparative purposes in periodic filings subsequent to the completion of the business combination will reflect those of Solexa Limited. Lynx issued approximately 14.75 million shares or options to purchase shares of its common stock in exchange for all of the outstanding share capital and outstanding share options of Solexa Limited.

      In connection with this transaction, Lynx changed its name to Solexa, Inc. or Solexa. Unless specifically noted otherwise, as used throughout this document, “Lynx Therapeutics” or “Lynx” refers to the business, operations and financial results of Lynx prior to the business combination on March 4, 2005, “Solexa Limited” refers to the business of Solexa Limited, “Solexa” refers to the business of the combined company after the business combination and “we” refers to either the business operations and financial results of Lynx prior to the business combination or the business of the combined company after the business combination, as the context requires.

Overview

      We are in the business of developing and commercializing genetic analysis technologies. We are currently developing and preparing to commercialize a novel instrumentation system for genetic analysis based on our Sequencing-by-Synthesis, or SBS, chemistry and the DNA “cluster” technology we acquired in 2004. This one platform is expected to support many types of genetic analysis, including DNA sequencing, gene expression, genotyping and micro-RNA analysis. We believe that this technology, which can potentially generate over a billion bases of DNA sequence from a single experiment with a single sample preparation, will dramatically reduce the cost, and improve the practicality, of human re-sequencing relative to conventional technologies. We anticipate launching our first generation whole-genome sequencing system by the end of 2005. Our longer-term goal is to further reduce the cost of human re-sequencing to a few thousand dollars for use in a wide range of applications from basic research through clinical diagnostics.

      We believe our new DNA sequencing system will enable us to implement a new business model based primarily on the sales of genomic sequencing equipment, reagents and services to end user customers. Historically, our business model has been based on providing genomics discovery services using our Massively Parallel Sequencing System, or MPSS, and supplying customers with DNA sequences and other information that result from experiments. We expect to continue to provide genomics discovery services for at least the next several years.

      In March 2005, we received stockholder approval for, and effected, a reverse stock split of our common stock at a ratio of 1-for-2. As a result of the reverse stock split, each outstanding share of common stock automatically converted into one-half of a share of common stock, with the par value of each share of common stock remaining at one cent ($.01) per share. Accordingly, common stock share and per share amounts for all periods presented have been adjusted to reflect the impact of the reverse stock split.

      We were incorporated in Delaware in February 1992. Please see a discussion of our plans under Item 1. “Business — Business Risks” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

Market Opportunity

      DNA sequencing is currently used in both research applications and in medical diagnostic tests. In research, some of the most common applications are as follows:

      As a diagnostic, DNA sequencing has been used several ways, including:

      The market for DNA sequencing in research is currently larger than in diagnostics. The market leader, Applied Biosystems, a business unit of Applera Corporation, has reported revenues in excess of $500 million for the year ended June 30, 2004 in their DNA sequencing segment. Revenue from clinical diagnostics based on DNA sequencing is smaller but has been growing rapidly. We expect to focus our efforts on the research market for at least the next few years.

Our Products under Development

      We are currently developing a DNA sequencing instrument system for commercial sale, focusing initially on the genomic resequencing market. This system includes the instrument itself, a set of biochemical reagents, a set of consumable devices used in the operation of the instrument (e.g. flow cells) and data analysis software. We anticipate offering successive generations of instrument designs to meet different customer needs, serve different price points and take advantage of improving technology. We similarly anticipate offering multiple reagent sets and corresponding software systems for different applications. We also expect to sell service contracts and spare parts for the instruments.

Our Service Business

      Our service business, which accounted for substantially all of our revenues in 2004, provides in-depth gene expression information to customers based on our MPSS technology.

      We anticipate that our new instrument system will be phased into our existing service business and that, over time, it may replace some or all of our current service offering based on the MPSS technology. While there are many unknowns because the design of this new system and its ultimate performance in real applications have not yet been determined, we are optimistic that it will provide the basis for a much more broadly cost competitive service than the MPSS technology, and may enable us to increase our service business revenues.

      Our existing service facility has not previously offered large scale re-sequencing as a service. If our system is developed as we expect, we may be able to add this capability as a new service. As this would tap into an additional market need, it might significantly expand our service business.

      Given that we plan to incorporate our new technologies into instrument systems that can be sold to customers, the extent to which customers of the service business may elect to purchase instrument systems and curtail or discontinue using our services is not clear. As a result, the revenue and profitability of our service business could decrease over time.

      In addition to its direct revenue role in our business, our service facility is also expected to serve as a strategic test facility. By operating a high-throughput in-house laboratory, we may be able to test new products and product improvements faster than we would be able to by working only with external customer test sites.

Collaborations, Customers and Licensees

      We have derived substantially all of our revenues from corporate collaborations, customer agreements and licensing arrangements related to Lynx’s gene expression services business. For the year ended December 31, 2004, revenues from E.I. DuPont de Nemours and Company, The National Human Genome Research Institute and Axaron Bioscience AG, an affiliate of Solexa, accounted for 35%, 30% and 11%, respectively, of our total revenues.

Competition

      Competition among entities developing or commercializing instruments, research tools or services to identify the genes associated with specific diseases and to develop products based on such discoveries is intense. We face, and will continue to face, competition primarily from biotechnology companies, such as Affymetrix, Inc., Celera Genomics Group, Gene Logic, Inc., and Agencourt Biosciences, academic and research institutions and government agencies, both in the United States and abroad. We are aware that certain entities are using a variety of gene expression analysis methodologies, including chip-based systems, to attempt to identify disease-related genes and to perform clinical diagnostic tests. A number of large companies offer DNA sequencing equipment including Applera Corporation, Beckman Coulter, Inc., and the Amersham Biosciences business of General Electric. A number of other smaller companies are also in the process of developing novel techniques for DNA sequencing. These companies include 454 Corporation, Helicos Biosciences, Nanofluidics, Visigen and Genovoxx. In order to successfully compete against existing and future technologies, we will need to demonstrate to potential customers that our technologies and capabilities are superior to those of our competitors.

      Many of our competitors have substantially greater capital resources, research and development staffs, facilities, manufacturing and marketing experience, distribution channels and human resources than we do. These competitors may develop or commercialize genetic analysis technologies in advance of us or that are more effective than those we have developed. Moreover, our competitors may obtain patent protection or other intellectual property rights that could limit our rights to offer genetic analysis products or services.

Intellectual Property

      We are pursuing a strategy designed to obtain United States and foreign patent protection for our core technologies. Our long-term commercial success will be dependent in part on our ability to obtain commercially valuable patent claims and to protect our intellectual property portfolio.

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

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

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

Employees

      As of December 31, 2004, Lynx employed 75 full-time employees, of which 65 were engaged in production and research and development activities.

      Following completion of the combination with Solexa Limited, as of March 4, 2005, we engaged 60 full-time employees, of which 54 were engaged in research and development.

      We believe we have been successful in attracting skilled and experienced scientific personnel; however, competition for such personnel is intense. None of our employees are covered by collective bargaining agreements, and management considers relations with our employees to be good.

Available Information

      We maintain sites on the World Wide Web at www.solexa.com and www.lynxgen.com; however, information found on our websites are not incorporated by reference into this report. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form  8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. This information may also be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

Business Risks

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

      We have incurred net losses each year since our inception in 1992 and we have an accumulated deficit of approximately $123.2 million as of December 31, 2004. Our net loss in 2004 was $15.5 million and we had cash and equivalents of $2.2 million at December 31, 2004. Ernst & Young LLP, independent registered public accounting firm for Lynx, has noted in its report on Lynx’s consolidated financial statements included in this Annual Report on Form 10-K for the year ended December 31, 2004 that our financial condition raises substantial doubt about our ability to continue as a going concern. In addition, Solexa Limited has incurred net losses each year since its inception in 1998. Net losses for the combined company may continue for the next several years as the combined company proceeds with the development and commercialization of its technologies. The presence and size of these potential net losses will depend, in part, on the rate of growth, if any, in revenues and on the level of expenses. Research and development expenditures and general and administrative costs have exceeded revenues to date, and these expenses may increase in the future. We will need to generate significant revenues to achieve profitability, and even if we are successful in achieving profitability, there is no assurance we will be able to sustain profitability.

      We will need to raise additional capital through public or private equity or debt financings in order to satisfy our projected capital needs. We estimate that we will require approximately $35 million in capital to meet our needs through 2006. The amount of additional capital we would need to raise would depend on many factors, including:

      We cannot be certain that additional capital will be available when needed or that our actual cash requirements will not be greater than anticipated. If we require additional capital at a time when investment in biotechnology companies or in the marketplace in general is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter. If we are unable to obtain financing on terms favorable to us, we may be unable to execute our business plan and may be required to cease or reduce development or commercialization of our products, to sell some of all of our technology or assets or to merge with another entity. In addition, if we are unable to obtain such financing, we may not have sufficient funds to repay our loan from Silicon Valley Bank. See the risk factor entitled “If we do not obtain additional funding, we may default under the loan and security agreement with Silicon Valley Bank.”

      If we raise additional capital by issuing equity securities or convertible debt securities, our existing stockholders may incur substantial dilution and any shares so issued will likely have rights, preferences and privileges superior to the rights, preferences and privileges of our outstanding common stock. If we raise additional funds through collaboration, licensing or other arrangements with third parties, we may be required to relinquish rights or grant licenses on unfavorable terms to certain of our technologies or products that we would otherwise seek to develop or commercialize on our own. These actions, while necessary for the continuance of operations during a time of cash constraints and a shortage of working capital, could make it difficult or impossible to implement our long-term business plans or could harm our business, financial condition and results of operations.

      The integration of Lynx and Solexa Limited will be complex, time consuming and expensive, and may disrupt our businesses. We will need to overcome significant challenges in order to realize any benefits or synergies from the combination of Lynx and Solexa Limited. These challenges include the timely, efficient and successful execution of a number of post-transaction events.

      We may not succeed in addressing these risks or any other problems encountered in connection with the combination. The inability to successfully integrate the operations, technology and personnel of Lynx and Solexa Limited, or any significant delay in achieving integration, could hurt our business and, as a result, the market price of our common stock.

      On March 4 2005, Solexa Limited’s 60 employees based outside of Cambridge, U.K. were added to Lynx’s existing 75 employees based in Hayward, California. As a result we will face challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, financial controls, policies, standards and benefits and compliance programs. The inability to successfully manage the substantially larger and internationally diverse organization, or any significant delay in achieving successful management, could hurt our business.

      Effective March 4, 2005, John West was named chief executive officer of Solexa. Mr. West has been the chief executive officer of Solexa Limited since August 2004. Effective March 10, 2005, Peter Lundberg was named vice president and chief technical officer of Solexa. Effective March 22, 2005, Linda Rubinstein was named vice president and, effective with the filing of this Form 10-K, chief financial officer of Solexa. In addition we anticipate hiring during 2005 to fill executive positions in marketing and manufacturing. While Mr. West has experience managing private genomics companies and large genomics teams within public

U.S. companies, he has not previously been chief executive of a public company in the U.S. Mr. West anticipates dividing his time between our operations in California and our operations in the U.K. for the foreseeable future. These executives are new to our company and may not be effective, individually or as a group, in executing our business plan, and our operating results may suffer as a result.

      As a result of the combination, current and prospective employees of the combined company could experience uncertainty about their future roles within the combined company. Any of our key personnel could terminate their employment, sometimes without notice, at any time. People key to the operation and management of the combined company are John West, our chief executive officer; Peter Lundberg, our chief technical officer, Mary Schramke, vice president and general manager of genomic services, Linda Rubinstein, vice president, and Tony Smith, our vice president and chief scientific officer. We are also highly dependent on the principal members of our scientific staff. The loss of any of these persons’ services might adversely impact the achievement of our objectives and the continuation of existing customer, collaborative and license agreements. In addition, recruiting and retaining qualified scientific personnel to perform future research and development work will be critical to our success. There is currently a shortage of skilled executives and employees with technical expertise, and this shortage is likely to continue. As a result, competition for skilled personnel is intense and turnover rates are high. Competition for experienced scientists from numerous companies, academic and other research institutions may limit our ability to attract and retain such personnel.

      Our executive officers, directors and entities affiliated with them, in the aggregate, beneficially own approximately 78% of our common stock. These stockholders, if acting together, will be able to influence significantly all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other changes in corporate control.

      Our new business model that we plan to implement is based primarily on sales of genomic sequencing equipment and future sales of reagents and services to support customers in their use of that equipment. Our historical business model was based primarily on providing genomics discovery services using MPSS and supplying customers with DNA sequences and other information that result from experiments. A change in emphasis from our former business model may cause our current customers to delay, defer or cancel any purchasing decisions with respect to new or existing agreements. To date, we have not been contacted by any current customer with respect to any such delay, deferral or cancellation of any existing agreement. There is no assurance that we will be successful in changing the emphasis of our business model from providing sequencing services to selling equipment, reagents and support services to new or existing customers.

      We have set out to develop new genomics sequencing technologies and we are now using those technologies to develop new equipment, reagents and services. If our strategy does not result in the development of products that we can commercialize, we will be unable to generate significant revenues. Although we have developed genomics sequencing machines and have provided gene expression services to customers with our machines, these were based on the MPSS technology that we previously developed rather than the new technologies under development. We cannot be certain that we can successfully develop any new products or that they will receive commercial acceptance, in which case we may not be able to recover our investment in the product development.

      If we are successful in achieving market acceptance for our new machines, we will need to either build internal manufacturing capacity or contract it to a manufacturing partner. There is no assurance that we will be able to build the capacity internally, or find a manufacturing partner, to meet both the volume and quality requirements necessary to be successful in the market. Any delay in establishing or inability to expand our manufacturing capacity could hurt our business.

      While some of our gene expression technology has been commercialized and is currently in use, we are developing additional technologies to generate information about gene sequences that may enable scientists to better understand complex biological processes. These technologies are still in development, and we may not be able to successfully commercialize them. Our success depends on many factors, including:

      You must evaluate us in light of the uncertainties and complexities affecting an early stage genetic analysis company. Our technologies are in too early a stage of development to determine whether they can be successfully implemented. Our technologies also depend on the successful integration of independent technologies, each of which has its own development risks. Furthermore, we are anticipating that, if our technology is able to successfully reduce the cost of genetic analysis relative to existing providers, our technology may be able to displace current technology as well as to expand the market for genetic analysis to include new applications that are not practical with current technology. There is no guarantee, even if our technology is able to successfully reduce the cost of genetic analysis relative to existing providers, that we will be able to induce customers with installed bases of conventional genetic analysis instruments to purchase our system or to expand the market for genetic analysis to include new applications. Furthermore, if we are able to successfully commercialize our genetic analysis systems only as a replacement for existing technology, we may face a much smaller market.

      Our strategy for the development and commercialization of our technologies and potential products includes entering into collaborations, customer agreements or licensing arrangements with pharmaceutical, biotechnology and agricultural companies and research institutes. We have derived substantially all of our revenues, to date, from corporate collaborations, customer agreements and licensing arrangements. Furthermore, our revenues from collaborations, customer agreements and licenses declined by 39% from 2003 to

2004. To date, we have received, and expect to continue to receive in the future, a significant portion of our revenues from a small number of collaborators, customers and licensees, as shown in the following table:

      Thus, until we are able to commercialize our new products under development, we will be dependent on a small number of customers to continue our current business, and the loss of one or more of those customers could harm our results of operations.

      The biotechnology industry is highly fragmented and is characterized by rapid technological change. In particular, the areas of genetic analysis platforms and genomics research are rapidly evolving fields. Competition among entities developing genetic analysis platform or using such platforms to attempt to identify genes and proteins associated with specific diseases and to develop products based on such discoveries is intense. Many of our competitors have substantially greater research and product development capabilities and financial, scientific and marketing resources than we do.

      In our genetic analysis platform business, we face, and will continue to face, competition primarily from biotechnology companies, such as Affymetrix, Inc., Celera Genomics Group, Gene Logic, Inc., and Agencourt Biosciences, academic and research institutions and government agencies, both in the United States and abroad. We are aware that certain entities are using a variety of gene expression analysis methodologies, including chip-based systems, to attempt to identify disease-related genes and to perform clinical diagnostic tests. A number of large companies offer DNA sequencing equipment including Applera Corporation, Beckman Coulter, Inc., and the Amersham Biosciences business of General Electric. A number of other smaller companies are also in the process of developing novel techniques for DNA sequencing. These companies include 454 Corporation, Helicos Biosciences, Nanofluidics, Visigen and Genovoxx. In order to successfully compete against existing and future technologies, we will need to demonstrate to potential customers that our technologies and capabilities are superior to those of our competitors. Some of our competitors may be:

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

      Any products developed through our technologies will compete in highly competitive markets. Our competitors may be more effective at using their technologies to develop commercial products. Moreover, our competitors may introduce novel genetic analysis platforms before we do, which, if adopted by customers,

could eliminate the market for our new genetic analysis systems. Further, our competitors may obtain intellectual property rights that would limit the use of our technologies or the commercialization of diagnostic or therapeutic products using our technologies. As a result, our competitors’ products or technologies may render our technologies and products, and those of our collaborators, obsolete or noncompetitive.

      Our ability to achieve profitability depends on attracting customers for our products and services. There are a limited number of pharmaceutical, biotechnology and agricultural companies and research institutes that are potential customers for our products and services. To market our technologies and products, we intend to develop a sales and marketing group with the appropriate technical expertise. We may not successfully build such a sales force. In addition, we may seek to enlist a third party to assist with sales and distribution globally or in certain regions of the world. There is no guarantee, if we do seek to enter into such an arrangement, that we will be successful in attracting a desirable sales and distribution partner, or that we will be able to enter into such an arrangement on favorable terms. If our sales and marketing efforts, or those of any third-party sales and distribution partner, are not successful, our technologies and products may not gain market acceptance.

      Our ability to obtain collaborators and customers for our technologies and products depends in significant part upon the perception that our technologies and products can help accelerate their drug discovery and genomics efforts. Our sales cycle for our service business is typically lengthy, up to approximately nine months, because we need to educate our potential collaborators and customers and sell the benefits of our products to a variety of constituencies within such companies. In addition, we may be required to negotiate agreements containing terms unique to each collaborator or customer. We may expend substantial funds and management effort without any assurance that we will successfully sell our technologies and products. Actual and proposed consolidations of pharmaceutical companies have negatively affected, and may in the future negatively affect, the timing and progress of our sales efforts.

      PacI is a restriction enzyme used to digest the PCR product that is loaded onto 5-micron beads prior to MPSS sequencing. We currently purchase PacI from New England BioLabs under a supply agreement, the term of which is scheduled to expire on August 15, 2005. Our reliance on a sole vendor involves several risks, including:

      We do not believe, however, that our business is dependent substantially on PacI or the intellectual property associated with PacI. We believe that we would be able to purchase alternative enzymes from other providers without incurring significant additional expenses or time delays should the need arise. In addition, if we are able to successfully implement new SBS sequencing technologies under development in our genetic services business, we will no longer require PacI or an alternative enzyme. We have not yet determined if we will seek to extend or renew our contract with New England BioLabs but we believe we could do so without unreasonable effort or expense.

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

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

      We also rely on trade secret protection for our confidential and proprietary information. However, trade secrets are difficult to protect. We protect our proprietary information and processes, in part, with confidentiality agreements with employees, collaborators and consultants. However, third parties may breach these agreements, we may not have adequate remedies for any such breach or our trade secrets may still otherwise become known by our competitors. In addition, our competitors may independently develop substantially equivalent proprietary information.

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

      Third parties may accuse us of employing their proprietary technology without authorization. In addition, third parties may obtain patents that relate to our technologies and claim that use of such technologies infringes these patents. Regardless of their merit, such claims could require us to incur substantial costs,

including the diversion of management and technical personnel, in defending ourselves against any such claims or enforcing our patents. In the event that a successful claim of infringement is brought against us, we may need to pay damages and obtain one or more licenses from third parties. We may not be able to obtain these licenses at a reasonable cost, or at all. Defense of any lawsuit or failure to obtain any of these licenses could adversely affect our ability to develop and commercialize our technologies and products and thus prevent us from achieving profitability.

      Our collaborators and customers may seek to develop diagnostic products based on genes or proteins. The prospect of broadly available gene-based diagnostic tests raises ethical, legal and social issues regarding the appropriate use of gene-based diagnostic testing and the resulting confidential information. It is possible that discrimination by third-party payors, based on the results of such testing, could lead to the increase of premiums by such payors to prohibitive levels, outright cancellation of insurance or unwillingness to provide coverage to individuals showing unfavorable gene or protein expression profiles. Similarly, employers could discriminate against employees with gene or protein expression profiles indicative of the potential for high disease-related costs and lost employment time. Finally, government authorities could, for social or other purposes, limit or prohibit the use of such tests under certain circumstances. These ethical, legal and social concerns about genetic testing and target identification may delay or prevent market acceptance of our technologies and products.

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

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

      We believe that the market price of our common stock will remain highly volatile and may fluctuate significantly due to a number of factors. The market prices for securities of many publicly-held, early-stage biotechnology companies have in the past been, and can in the future be expected to be, especially volatile. For example, during the two-year period from January 1, 2003 to December 31, 2004, the closing sales price of our common stock as quoted on the Nasdaq National Market and Nasdaq SmallCap Market fluctuated from a low of $2.96 to a high of $15.88 per share. In addition, the securities markets have from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. The following factors and events may have a significant and adverse impact on the market price of our common stock:

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

      Effective May 22, 2003, a Nasdaq Qualifications Panel terminated our Nasdaq National Market Listing and transferred our securities to the Nasdaq SmallCap Market. In order to maintain the listing of our securities on the Nasdaq SmallCap Market, we must be able to demonstrate compliance with all applicable listing maintenance requirements. In the event we are unable to do so, our securities will be delisted from the Nasdaq Stock Market.

      With our securities listed on the Nasdaq SmallCap Market, we face a variety of legal and other consequences that will likely negatively affect our business including, without limitation, the following:

      In addition, we are required to satisfy various listing maintenance standards for our common stock to be quoted on the Nasdaq SmallCap Market. If we fail to meet such standards, our common stock would likely be delisted from the Nasdaq SmallCap Market and trade on the over-the-counter bulletin board, commonly referred to as the “pink sheets.” This alternative is generally considered to be a less efficient market and would seriously impair the liquidity of our common stock and limit our potential to raise future capital through the sale of our common stock, which could materially harm our business.

      If we do not obtain additional funding, we may not have sufficient funds to repay the loan from Silicon Valley Bank when the loan is due and payable. The loan is due on the earlier to occur of fifteen days after the receipt by us of gross proceeds in the amount of $10 million for the issuance of equity in a private placement transaction, or July 31, 2005. If we default under the loan and security agreement and the default continues,

Silicon Valley Bank has the right to accelerate repayment of the loan and to realize on its security interest, including without limitation, to reclaim and sell the collateral under the loan and security agreement, including but not limited to all of our goods, equipment, inventory, contract rights, licenses and intellectual property rights.

      Under our certificate of incorporation, our board of directors has the authority, without further action by the holders of our common stock, to issue 2,000,000 additional shares of preferred stock from time to time in series and with preferences and rights as it may designate. These preferences and rights may be superior to those of the holders of our common stock. For example, the holders of preferred stock may be given a preference in payment upon our liquidation or for the payment or accumulation of dividends before any distributions are made to the holders of common stock.

      Any authorization or issuance of preferred stock, while providing desirable flexibility in connection with financings, possible acquisitions and other corporate purposes, could also have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock or making it more difficult to remove directors and effect a change in management. The preferred stock may have other rights, including economic rights senior to those of our common stock, and, as a result, an issuance of additional preferred stock could lower the market value of our common stock. Provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging with us.

      In February 1998, we entered into a noncancelable operating lease for facilities space of approximately 111,000 square-feet in two buildings in Hayward, California. In July 2000, we leased approximately 37,000 square feet of additional space in one of the buildings for further expansion purposes. Our corporate headquarters, principal research and development facilities and production facilities are currently located in one of the two buildings. The remaining space will be developed and occupied in phases, depending on our growth. The leases run through December 2008. We have an option to extend the lease for an additional five-year period, subject to certain conditions. In addition, we lease approximately 16,000 square feet in Little Chesterford, England which is occupied by Solexa Limited, our wholly-owned subsidiary. The lease expires in 2005 but we believe that the lease can be renewed on satisfactory terms or that alternative facilities can be found nearby on satisfactory terms.

      We are not a party to any material legal proceedings.

      No matters were submitted to a vote of security holders during the quarter ended December 31, 2004.

PART II

      Effective May 22, 2003, our common stock under the symbol LYNX was transferred from the Nasdaq National Market Listing to the Nasdaq SmallCap Market. Effective March 7, 2005, in connection with the change of our name from Lynx Therapeutics, Inc. to Solexa, Inc., we changed our symbol to SLXA. The following table sets forth, for the periods indicated, the high and low closing bid information for our common stock as reported by the Nasdaq Stock Market and Nasdaq SmallCap Market, as adjusted to reflect the effect of a 1-for-2 reverse split of our common stock effected on March 2, 2005:

      As of February 28, 2005, there were approximately 1,700 stockholders of record of our common stock. On February 28, 2005, the last reported sale price of our common stock was $9.90.

      We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings to support the development of our business and do not anticipate paying cash dividends for the foreseeable future. Our loan agreement with Silicon Valley Bank prohibits us from paying dividends until such time as the loan is repaid. Any future determination to pay dividends will be at the discretion of our board of directors.

Recent Sales and Purchases of Unregistered Securities

      In connection with the Loan Agreement, dated December 28, 2004, by and between Solexa and Silicon Valley Bank, or SVB, we issued SVB a warrant to purchase 47,770 shares of our common stock, $0.01 par value per share. The warrant is exercisable until December 27, 2007 at an exercise price of $6.28 per share. The number of shares for which the warrant is exercisable and the warrant price are subject to certain adjustments as set forth in the warrant. The warrant was issued to SVB in a private placement transaction exempt from registration in reliance upon Section 4(2) of the Securities Act of 1933, as amended, or the Securities Act, and/or Regulation D of the Securities Act.

      This section presents our selected consolidated historical financial data. You should read this information together with the consolidated financial statements and related notes included in this report and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      The consolidated statement of operations data for the years ended December 31, 2004, 2003 and 2002 and the consolidated balance sheet data as of December 31, 2004 and 2003 have been derived from our audited consolidated financial statements included elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 2001 and 2000 and the consolidated balance sheet data as of

December 31, 2002, 2001 and 2000 have been derived from our audited financial statements that are not included in this report. Historical results are not necessarily indicative of future results.

      Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. When used herein, the words “believe,” “anticipate,” “expect,” “estimate” and similar expressions are intended to identify such forward-looking statements. There can be no assurance that these statements will prove to be correct. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as in Item 1. “Business — Business Risks.” We undertake no obligation to update any of the forward-looking statements contained herein to reflect any future events or developments.

Overview

      On March 4, 2005, Lynx Therapeutics, Inc. or Lynx, completed a business combination with Solexa Limited. Solexa Limited is a privately held company registered in England and Wales that develops systems for the comprehensive and economical analysis of individual genomes. Solexa Limited has become a wholly-owned subsidiary of Lynx as a result of the transaction. However, because Solexa Limited’s shareholders own approximately 80% of the shares of Lynx common stock after the transaction, Solexa Limited’s designees to the combined company’s board of directors represent a majority of the combined company’s directors and Solexa Limited’s senior management represent a majority of the initial senior management of the combined company, Solexa Limited is deemed to be the acquiring company for accounting purposes. Accordingly, the assets and liabilities of Lynx will be recorded, as of the date of the business combination, at their respective fair values and added to those of Solexa Limited. Reported results of operations of the combined company issued for periods subsequent to the combination will reflect those of Solexa Limited, to which the operations of Lynx will be added from the date of the consummation of the business combination. The operating results of the combined company will reflect purchase accounting adjustments, including increased amortization and depreciation expense for acquired assets. Additionally, historical financial condition and results of operations shown for comparative purposes in periodic filings subsequent to the completion of the business combination will reflect those of Solexa Limited. Lynx issued approximately 14.75 million shares or options to purchase shares of its common stock in exchange for all of the outstanding share capital and outstanding share options of Solexa Limited.

      In connection with this transaction, Lynx changed its name to Solexa, Inc. or Solexa. Unless specifically noted otherwise, as used throughout this document, “Lynx Therapeutics” or “Lynx” refers to the business, operations and financial results of Lynx prior to the business combination on March 4, 2005, “Solexa Limited” refers to the business of Solexa Limited, “Solexa” refers to the business of the combined company after the business combination and “we” refers to either the business operations and financial results of Lynx prior to the business combination or the business of the combined company after the business combination, as the context requires.

      We are in the business of developing and commercializing genetic analysis technologies. We are currently developing and preparing to commercialize a novel instrumentation system for genetic analysis based on our Sequencing-by-Synthesis, or SBS, chemistry and the DNA “cluster” technology we acquired in 2004. This one platform is expected to support many types of genetic analysis, including DNA sequencing, gene expression, genotyping and micro-RNA analysis. We believe that this technology, which can potentially generate over a billion bases of DNA sequence from a single experiment with a single sample preparation, will dramatically reduce the cost, and improve the practicality, of human re-sequencing relative to conventional technologies. The company anticipates launching its first generation whole-genome sequencing system by the end of 2005. Our longer-term goal is to further reduce the cost of human re-sequencing to a few thousand dollars for use in a wide range of applications from basic research through clinical diagnostics.

      We believe our new DNA sequencing system will enable us to implement a new business model based primarily on sales of genomic sequencing equipment and reagents and services to end user customers. Historically, our business model has been based on providing genomics discovery services using our Massively Parallel Sequencing System, or MPSS, and supplying customers with DNA sequences and other information that result from experiments. We expect to continue to provide genomics discovery services for at least the next several years.

      We have experienced operating losses since inception totaling $123.2 million, including a net loss of $15.5 million for the year ended December 31, 2004. We expect to continue to incur net losses as we proceed with the commercialization and additional development of our technologies. The presence and size of these potential net losses will depend on the rate of growth, if any, in our revenues and on the level of our expenses. Our cash and cash equivalents have decreased from $5.6 million as of December 31, 2003, including restricted cash of $0.7 million, to $2.2 million as of December 31, 2004. On March 4, 2005, we closed a business combination transaction with Solexa Limited, a privately-held company registered in England and Wales. The combined company will require additional funding to continue its business activities through at least December 31, 2005. As a result, the report of our Independent Registered Public Accounting Firm regarding our consolidated financial statements included in this annual report includes an explanatory paragraph concerning our ability to continue as a going concern. We are considering various options, which include securing additional equity financing, obtaining new collaborators and customers and other strategic actions. If we raise additional capital by issuing equity or convertible debt securities, our existing stockholders may experience substantial dilution. If we require additional financing, there can be no assurance that it will be available on satisfactory terms, or at all. If we are unable to secure additional financing on reasonable terms, or are unable to generate sufficient new sources of revenue through arrangements with customers, collaborators and licensees, we will be forced to take substantial restructuring actions, which may include significantly reducing our anticipated level of expenditures, the sale of some or all of our assets, or obtaining funds by entering into financing or collaborative agreements on unattractive terms, or we will not be able to fund operations. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

      In April 2004, we acquired jointly with Solexa Limited the rights to proprietary technology assets for DNA colony generation from Manteia SA, a company established under the laws of Switzerland. The acquired technology assets feature a process to enable parallel amplification of millions of DNA fragments, each from a single DNA molecule, to create DNA colonies or “clusters.” The clusters are dense collections of DNA molecules on a surface, which should enable fast and simplified preparation of the biological sample for analysis and allow reduced reagent consumption as a result of the highly parallel nature of the analysis. We intend to incorporate the cluster technology assets into our genomic sequencing equipment.

Critical Accounting Policies and Estimates

      The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. The items in our financial statements requiring significant estimates and judgments include determining the useful lives of fixed assets for depreciation and amortization calculations, assumptions for valuing options and warrants and estimated lives of license and collaborative agreements related to deferred revenue. Actual results could differ materially from these estimates.

      Technology access fees have generally resulted from upfront payments from collaborators, customers and licensees who are provided access to our technologies for specified periods. We receive service fees from collaborators and customers for genomics discovery services that we perform on the biological samples they send to us. Collaborative research revenues are payments received under various agreements and include such items as milestone payments. Milestone payments are recognized as revenue pursuant to collaborative agreements upon the achievement of specified technology developments, representing the culmination of the earnings process. Other revenues include the proceeds from the sale of technology assets, the sale of proprietary instruments and reagents, and grant revenues.

      Technology access and license fees are deferred and recognized as revenue on a straight-line basis over the noncancelable term of the agreement to which they relate. Payments for services and/or materials we

provide are recognized as revenues when earned over the period in which the services are performed and/or materials are delivered, provided that no other consequential obligations, refunds or credits to be applied to future work exist. When consequential obligations, refunds or credits to be applied to future work exist, revenues are deferred until the obligation is fulfilled or the refund or credit is applied. Revenues from the sale of technology assets are recognized upon the transfer of the assets to the purchaser. Revenues from the sales of instruments and reagents are recognized upon shipment to the customer.

      Inventory is stated at the lower of cost (which approximates first-in, first-out cost) or market. The balances at December 31, 2004 and December 31, 2003 included raw materials and services in process.

      Raw materials consist primarily of reagents and other chemicals utilized while performing genomics discovery services. Services in process include direct material, direct service labor, overhead and other direct costs. Market is “net realizable value,” which, for services in process, is the estimated selling price, less costs to complete the service. For raw materials, it is replacement cost or the cost of acquiring similar products from our vendors, as adjusted for our assessment of excess or obsolete materials. While cost is readily determinable, estimates of market value involve significant estimates and judgments about the future.

      We initially record our inventory at cost and each quarter evaluate the difference, if any, between cost and market. The determination of the market value of inventories is primarily dependent on estimates of future demand for our services, which in turn is based on other market estimates such as technological change, competitor actions and estimates of future selling prices.

      We record write-downs for the amount that cost of inventory exceeds our estimated market value. No adjustment is required when market value exceeds cost.

      Inventory, including allocated services labor and overhead, used in providing genomics discovery services and for reagent sales is charged to cost of services fees and other as consumed. Reagents and chemicals purchased for internal development purposes are charged to research and development expense as incurred.

Results of Operations

      To date, we have received, and expect to continue to receive in the future, a significant portion of our revenues from a small number of collaborators, customers and licensees, as shown in the following table.

      Total revenues were $7.1 million in 2004, $18.1 million in 2003 and $17.4 million in 2002. Technology access and service fee revenues were $5.7 million in 2004, $15.8 million in 2003 and $13.0 million in 2002. Technology access fees are upfront payments from collaborators, customers and licensees who are provided access to our technologies for specified periods. These fees are deferred and recognized as revenue on a straight-line basis over the noncancelable term of the agreement to which they relate. All such fees were fully recognized by the end of 2003. Approximately half of the decrease in technology access and service fees from 2003 to 2004 resulted from the reduction of technology access fee revenues to zero in 2004. The remainder of the decrease was the result of a decrease in fees charged per MPSS experiment in 2004 compared to 2003,

offset by an increase in the number of experiments performed in 2004. The increase in 2003 compared to 2002 resulted primarily from a cash payment of approximately $2.0 million from Takara related to an amendment of our agreement with them. The license fees from related party relate to the recognition of revenues over the term of a licensing agreement with Axaron, a company in which we have a 42% investment. Collaborative research and other revenues were $608,000 in 2004, $1.5 million in 2003 and $3.6 million in 2002. The 2004 revenues included $476,000 related to an original equipment manufacturer development agreement with Solexa Limited. The 2003 revenues included $1.0 million related to the sale of MPSS instruments to Takara, and the 2002 revenues included the sale of certain of our technology assets to Geron and the sale of MPSS instruments to Takara.

      Our revenues have historically fluctuated from quarter to quarter and year to year and may continue to fluctuate in future periods due primarily to our service fees, which are impacted principally by the timing and number of biological samples received from existing customers and collaborators, as well as our performance of related services on these samples. Additionally, the number, type and timing of new collaborations and agreements and the related demand for, and delivery of, our services or products will impact the level of future revenues.

      Cost of service fees and other includes primarily the costs of direct labor, materials and supplies, outside expenses, equipment and overhead incurred by us in performing our genomics discovery services for, and the costs of reagents and instruments sold to, our collaborators, customers and licensees. Cost of services fees and other were $5.8 million in 2004, $4.4 million in 2003 and $3.5 million in 2002. These costs reflect primarily the costs of providing our genomics discovery services and, in 2003 and 2002, the cost of MPSS instruments sold to Takara. The increase in cost of service fees and other in 2004 reflects our organizational changes discussed below, which resulted in proportionately more overhead being allocated to the services group than in the past, and an increase in depreciation from the implementation of new production equipment.

      Research and development expenses include the costs of personnel, materials and supplies, outside expenses, equipment and overhead incurred by us in our technology and application development and process improvement efforts. Research and development expenses were $9.4 million 2004, $12.2 million in 2003 and $20.8 million in 2002. The year-to-year decreases in research and development expenses reflect decreases in materials consumed in research and development efforts and lower personnel expenses, primarily resulting from the workforce reductions that occurred in the second quarter of 2004, the first quarter of 2003 and the second quarter of 2002.

      In April 2004, we reorganized our staff to focus on the development of the cluster technology, its integration with our MPSS technology and creation of a plan for the commercial launch of the cluster technology. In 2004, we also focused our efforts related to MPSS primarily on cost reduction, including development of our third generation MPSS instrument technology, which is more efficient than earlier versions of our MPSS instrument technology, and work related to lowering bead loading costs and achieving lower reagent usage. In 2003 and 2002, substantially all of our research and development expense related to MPSS, except for the amounts discussed below related to the Protein ProFiler and Megatype projects.

      In January 2003, we discontinued our development work on our proteomics technology, Protein ProFiler, which was intended to provide high-resolution analysis of complex mixtures of proteins from cells or tissues. Proteomics is the study of the number of proteins and the extent to which they are expressed in cells or tissues. Expenses related to this project totaled $150,000 in 2003 and $1.6 million in 2002. In April 2002, we discontinued our development effort on Megatype, a technology that was being developed to permit the comparison of collected genomes of two populations and enable the detection and recovery of DNA fragments with the single nucleotide polymorphisms, or SNPs, that distinguish these two populations. Expenses related to this project totaled $1.4 million in 2002. The primary reason for discontinuing our development efforts on both Protein ProFiler and Megatype was to focus our financial and human resources on expanding the commercial use of MPSS.

      We anticipate that our research and development expenses will increase in 2005 due primarily to the business combination with Solexa Limited and activities directed toward the development and commercialization of new genome sequencing equipment, including the deployment of this equipment in Solexa’s genomics discovery services business. Solexa cannot predict when or whether we will successfully complete the development of Solexa’s first generation genome sequencing equipment or the ultimate costs of such efforts.

      General and administrative expenses include the costs of personnel, materials and supplies, outside expenses, equipment and overhead incurred by us primarily in our administrative, business development, legal and investor relations activities. General and administrative expenses were $7.4 million in 2004, $6.8 million in 2003 and $6.3 million in 2002. The increase in general and administrative expenses in 2004 is primarily due to costs associated with the business combination with Solexa Limited. In 2004, we incurred approximately $1.3 million in business combination related expenses. General and administrative expenses may increase in support of our continuing commercial, business development and research and development activities, planned headcount additions and the business combination with Solexa Limited.

      In March 2004, we implemented a reduction of approximately 15% of our workforce, or 14 people. The reduction included positions in all functions of our business. The workforce reduction was intended to further focus our financial and human resources on expanding the commercial use of our technology. We recorded a restructuring charge related to the workforce reduction of $118,000 in the second quarter of 2004 primarily for severance compensation amounts paid to former employees. In terms of compensation, benefits and employer taxes that would have been paid to, and on behalf of, such former employees had they remained employed by us, we realized cost savings of approximately $1.3 million during 2004.

      In January 2003, we implemented a reduction of approximately 25% of our workforce, or 32 people. The groups affected primarily by this action included research and development personnel based at Lynx Therapeutics GmbH in Germany and in our proteomics group in California. The workforce reduction was intended to further focus our financial and human resources on expanding the commercial use of MPSS. We recorded a restructuring charge for workforce reduction of $0.3 million in the first quarter of 2003 related primarily to severance compensation expense for our former employees. In terms of compensation, benefits and employer taxes that would have been paid to, and on behalf of, such former employees had they remained employed by us, we realized cost savings of approximately $2.0 million during 2003.

      The restructuring charge for workforce reduction of $0.5 million in the second quarter of 2002 was comprised primarily of severance charges for former Lynx employees who were part of Lynx’s workforce reduction of approximately 30% of our domestic workforce, or 45 people, in that period. The group affected primarily by this action was research and development personnel in California. The workforce reduction was intended to focus our financial and human resources on the expansion of the commercial applications of, and process improvements for, MPSS and our other genomics technologies, and the continued development of our proteomics technology. In terms of compensation, benefits and employer taxes that would have been paid to, and on behalf of, such former employees had they remained employed by us, we realized cost savings of approximately $3.0 million during 2003.

      Net interest expense was $104,000 in 2004, $158,000 in 2003 and $282,000 in 2002. The year-to-year decreases reflect lower interest expense incurred on equipment-related debt outstanding as the balances of this debt was paid down, partially offset in 2004 by interest on the notes payable to Solexa Limited and Silicon Valley Bank.

      Other income (expense) was income of $78,000 in the 2004, expense of $966,000 in 2003 and income of $882,000 in 2002. The income in 2004 consists of gains on asset sales partially offset by closure costs for Lynx Therapeutics GmbH, our German subsidiary. The expense in 2003 relates primarily to the loss recorded on the disposal of certain fixed assets no longer used in the operations of our German subsidiary. The 2002

income resulted primarily from the gain on the sale of our equity investment in Inex Pharmaceuticals Corporation.

      The income tax provision was $1,000 in 2004 and $202,000 in 2003, compared to an income tax benefit of $98,000 in 2002. The income tax provisions consisted primarily of minimum state taxes in 2004 and foreign withholding tax on payments received from our licensee, Takara, in 2003. The income tax benefit in 2002 related primarily to a refund received for federal alternative minimum taxes paid in prior periods, partially offset by foreign withholding tax due on payments received from Takara.

      As of December 31, 2004, we had federal net operating loss carryforwards of approximately $100.7 million, which will expire at various dates from 2010 through 2024, if not utilized. We had state net operating loss carryforwards of approximately $30.9 million, which will expire in the years 2012 through 2014. Deferred tax assets related to carryforwards at December 31, 2004 include approximately $3.9 million associated with stock option activity which, when utilized, will be credited directly to stockholders’ equity.

      As of December 31, 2004, we also had research and development and other tax credit carryforwards of $3.7 million for federal purposes and $3.5 million for state purposes. The federal research and development credits will expire at various dates from 2012 through 2024, if not utilized. The state research and development credits do not expire.

      Utilization of our net operating loss may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss before utilization.

      Through December 31, 2003, we accounted for our investment in Axaron Bioscience AG, a company owned primarily by BASF AG and us, using the equity method. Accordingly, we recorded our pro rata share of Axaron’s losses of $1.9 million in 2003 and $2.5 million in 2002. We discontinued applying the equity method as of December 31, 2003, as our investment in Axaron has been reduced to zero.

Liquidity and Capital Resources

      Cash and cash equivalents at December 31, 2004 were $2.2 million. Net cash used in operating activities was $11.6 million in 2004, $10.5 million in 2003 and $16.2 million in 2002. The year-to-year changes substantially mirror our net losses in each year. Net cash used in operating activities differs from our net loss primarily due to non-cash charges, including depreciation and amortization and, in 2003 and 2002, our pro rata share of the net loss of Axaron, and fluctuations in amounts of deferred revenue.

      Investing activities provided net cash of $81,000 in 2004 and $1.4 million in 2002 and used net cash of $174,000 in 2003. Proceeds in 2004 resulted primarily from sales of fixed assets partially offset by increases in other assets. Use of cash in 2003 resulted from purchases of fixed assets partially offset by proceeds from the sale of fixed assets. Net cash provided by investing activities in 2002 was due primarily to proceeds from the sale of equity investments and repayment of notes receivable from employees, partially offset by expenditures for capital equipment.

      Net cash provided by financing activities was $8.2 million in 2004, $4.5 million in 2003 and $23.3 million in 2002. The issuance of common stock in private placements generated cash of $3.8 million in 2004, $6.7 million in 2003 and $23.2 million in 2002. In 2004, we also raised cash from loans from Solexa Limited of $2.5 million and from Silicon Valley Bank, or SVB, of $3.0 million, and in 2002, we raised cash of $1.6 million from equipment loans. In each year, cash raised through these activities was partially offset by the repayment of equipment loans.

      On December 28, 2004, we entered into a loan and security agreement, or the Loan Agreement, with SVB under which SVB advanced a loan to us in the aggregate principal amount of $3,000,000. The loan bears

interest at 10% per annum and is due on the earlier to occur of fifteen days after our receipt of gross proceeds in the amount of $10 million for the issuance of equity in a private placement transaction or July 31, 2005. Under the Loan Agreement, we granted to SVB a security interest in substantially all of our assets, including but not limited to all of our goods, equipment, inventory, contract rights, licenses and intellectual property rights. The Loan Agreement includes negative covenants that, among other things, restrict us from acquiring all or substantially all of the capital stock of another person, or having a material change in our ownership or management, without the prior written consent of SVB, which consent shall not be unreasonably withheld. The business combination with Solexa Limited received the consent of SVB. We also received a consent and waiver for the name change from Lynx Therapeutics, Inc. to Solexa, Inc.

      In connection with the Loan Agreement, we issued to SVB a warrant to purchase 47,770 shares of our common stock at an exercise price of $6.28 per share. The warrant is exercisable until December 27, 2007. We recorded the fair value of the warrant of $253,000 as a discount on the loan. The discount will be amortized as additional interest expense over the term of the loan.

      On August 12, 2004, we entered into a loan agreement with Solexa Limited under which we issued Solexa Limited four promissory notes each bearing interest at 10% per annum in the aggregate principal amount of $2,500,000. The loans are due on December 31, 2005.

      In October 2002, we entered into a loan and security agreement with a financial institution, Comerica Bank-California, for an equipment line of credit of up to $2.0 million with a draw-down period of one year. Under the initial advance, we drew down $1.6 million in November 2002 related to purchases of equipment in previous periods. We granted Comerica Bank-California a security interest in all items that we financed under this agreement. The initial advance under the loan had a term of 24 months from the date of advance and bore interest at a rate of 7.25%. In May 2003, we renegotiated the terms of the agreement to require that we maintain a minimum cash balance of restricted cash and cash equivalents in an account at Comerica Bank-California of at least 110% of the principal balance under loans outstanding under this agreement until Comerica Bank-California received payment in full of all outstanding obligations. The loan was paid in full in October 2004.

      In 1998, we entered into a financing agreement with a financial institution, TransAmerica Business Credit Corporation, or TransAmerica, under which we drew down $4.8 million during 1999 for the purchase of equipment and certain other capital expenditures. We granted TransAmerica a security interest in all items that we financed under this agreement. Each draw down under the loan had a term of 48 months from the date of the draw down and bore interest at rates ranging from 10.9% to 11.8%. The original draw-down period under the agreement expired on March 31, 2000. In September 2000, we obtained additional financing of $950,000 under an amendment to the original financing agreement. The loan was paid in full in October 2004.

      Our contractual obligations for the next five years and thereafter are as follows:

      We plan to use available funds for ongoing commercial and research and development activities, working capital and other general corporate purposes and capital expenditures. We expect capital investments during

2005 for us to be approximately $1.0 million and will be comprised primarily of expenditures for capital equipment required in the normal course of business. We intend to invest our excess cash in investment-grade, interest-bearing securities.

      We have obtained funding for our operations primarily through sales of common stock, payments received under contractual arrangements with customers, collaborators and licensees and interest income. Consequently, investors in our equity securities and our customers, collaborators and licensees are significant sources of liquidity for us. Therefore, our ability to maintain liquidity is dependent upon a number of uncertain factors, including but not limited to the following: our ability to advance and commercialize further our technologies; our ability to generate revenues through expanding existing collaborations, customer and licensee arrangements and obtaining significant new customers, collaborators and licensees; and the receptivity of capital markets toward our equity or debt securities. The cost, timing and amount of funds required for specific uses by us cannot be precisely determined at this time and will be based upon the progress and the scope of our commercial and research and development activities; payments received under customer, collaborative and license agreements; our ability to establish and maintain customer, collaborative and license agreements; costs of protecting intellectual property rights; legal and administrative costs; additional facilities capacity needs, and the availability of alternate methods of financing.

      We have experienced operating losses since inception totaling $123.2 million, including a net loss of $15.5 million for the year ended December 31, 2004. We expect to continue to incur net losses as we proceed with the commercialization and additional development of our technologies. The presence and size of these potential net losses will depend on the rate of growth, if any, in our revenues and on the level of our expenses. Our cash and cash equivalents have decreased from $5.6 million, including restricted cash of $0.7 million, as of December 31, 2003 to $2.2 million as of December 31, 2004. On March 4, 2005, we closed a business combination transaction with Solexa Limited, a privately-held company registered in England and Wales that develops systems for the comprehensive and economical analysis of individual genomes, under which, for accounting purposes, Solexa Limited acquired Lynx. We will require additional funding to continue our business activities through at least December 31, 2005. As a result, the report of our Independent Registered Public Accounting Firm regarding our consolidated financial statements included in this annual report includes an explanatory paragraph concerning our ability to continue as a going concern. We are considering various options, which include securing additional equity financing, obtaining new collaborators and customers and other strategic actions. If we raise additional capital by issuing equity or convertible debt securities, our existing stockholders may experience substantial dilution. There can be no assurance that additional financing will be available on satisfactory terms, or at all. If we are unable to secure additional financing on reasonable terms, or are unable to generate sufficient new sources of revenue through arrangements with customers, collaborators and licensees, Solexa will be forced to take substantial restructuring actions, which may include significantly reducing ours anticipated level of expenditures, the sale of some or all of our assets, or obtaining funds by entering into financing or collaborative agreements on unattractive terms, or we will not be able to fund operations. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

Recent Accounting Pronouncements

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. SFAS No. 123R is effective for fiscal periods beginning after June 15, 2005 and, thus, will be effective for us beginning with the third quarter of 2005. Early adoption is encouraged and retroactive application of the provisions of SFAS No. 123R to the beginning of the fiscal year that includes the effective date is permitted, but not required. We are currently evaluating the impact of SFAS No. 123R on our financial position and results of operations. See “Stock-Based Compensation” in Note 1 of Notes to Consolidated Financial Statements for information

related to the pro forma effects on our reported net loss and net loss per share when applying the fair value recognition provisions of the previous SFAS No. 123 to stock-based employee compensation.

      In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS No. 151 to have a significant impact on our consolidated financial position, results of operations or cash flows.

      In October 2004, the FASB issued Emerging Issues Task Force (“EITF”) Consensus No. 04-1, “Accounting for Preexisting Relationships between the Parties to a Business Combination,” which provides new guidance for the accounting for preexisting relationships between the parties to a business combination. Additionally, EITF 04-1 includes additional disclosure requirements for business combinations between parties with a preexisting relationship. EITF 04-1 is effective for fiscal periods beginning after October 13, 2004. We do not expect the adoption of EITF 04-1 to have a material impact on our consolidated financial position, results of operations or cash flows.

      In March 2004, the FASB issued EITF Consensus No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. The adoption of the disclosure provisions of EITF 03-1 did not have a material impact on our consolidated financial statements. We do not expect the accounting provisions of EITF 03-1 to have a material impact on our consolidated financial position, results of operations or cash flows.

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

      On March 4, 2005, we completed the business combination with Solexa Limited, a privately-held company registered in England and Wales. Solexa Limited has become our wholly-owned subsidiary as a result of the transaction. The functional currency for Solexa Limited is the British Pound. Its accounts will be translated from the British Pound to the U.S. dollar using the current exchange rate in effect at the balance sheet date, for balance sheet accounts, and using the average exchange rate during the period, for revenues and expense accounts. The effects of translation will be recorded as a separate component of stockholders’ equity. Exchange gains and losses arising from these transactions will be recorded using the actual exchange differences on the date of the transaction. We have not yet determined if we will take any action to reduce our exposure to changes in foreign currency exchange rates, such as options or futures contracts, with respect to transactions with Solexa Limited.

      The functional currency for our German subsidiary (the operations of which substantially ceased at the end of 2003) was the Euro. Our German subsidiary’s accounts are translated from the Euro to the U.S. dollar using the current exchange rate in effect at the balance sheet date, for balance sheet accounts, and using the average exchange rate during the period, for revenues and expense accounts. The effects of translation are recorded as a separate component of stockholders’ equity. Exchange gains and losses arising from these transactions are recorded using the actual exchange differences on the date of the transaction. We did not take any action to reduce our exposure to changes in foreign currency exchange rates, such as options or futures contracts, with respect to transactions with our German subsidiary. Transactions with our European collaborators and customers are denominated in US dollars.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Solexa, Inc.

      We have audited the accompanying consolidated balance sheets of Solexa, Inc. (formerly Lynx Therapeutics, Inc.) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Solexa, Inc. (formerly Lynx Therapeutics, Inc.) at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

      The accompanying consolidated financial statements have been prepared assuming that Solexa, Inc. (formerly Lynx Therapeutics, Inc.) will continue as a going concern. As more fully described in the second paragraph of Note 1, the Company has incurred losses since inception and expects that such losses will continue for the foreseeable future. Additionally, the Company anticipates requiring additional financial resources to fund its operations at least through December 31, 2005. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans as to these matters are also described in the second paragraph of Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Palo Alto, California

February 18, 2005, except for Note 17,

as to which the date is March 4, 2005

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

CONSOLIDATED BALANCE SHEETS

See accompanying notes.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

See accompanying notes.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     Business and Basis of Presentation

      Lynx Therapeutics, Inc. (“Lynx” the “Company” or “we”) believes that it is a leader in the development and application of novel genomics analysis solutions. Our Massively Parallel Signature Sequencing (“MPSS”) instruments analyze millions of DNA molecules in parallel, enabling genome structure characterization at what we believe to be an unprecedented level of resolution. As applied to gene expression analysis, MPSS provides comprehensive and quantitative digital gene expression information important to modern systems biology research in the pharmaceutical, biotechnology and agricultural industries. Gene expression refers to the number of genes and the extent a cell or tissue expresses those genes, and represents a way to move beyond DNA sequence data to understand the function of genes, the proteins that they encode and the role they play in health and disease. Systems biology is an approach in which researchers seek to gain a complete molecular understanding of biological systems in health and disease.

      We have experienced operating losses since inception totaling $123.2 million, including a net loss of $15.5 million for the year ended December 31, 2004. We expect to continue to incur net losses as we proceed with the commercialization and additional development of our technologies. The presence and size of these potential net losses will depend on the rate of growth, if any, in our revenues and on the level of our expenses. Our cash and cash equivalents have decreased from $5.6 million, including restricted cash of $0.7 million, as of December 31, 2003 to $2.2 million as of December 31, 2004. On March 4, 2005, we closed a business combination transaction with Solexa Limited, a privately-held company registered in England and Wales (see Note 17). The combined company will require additional funding to continue its business activities through at least December 31, 2005. We are considering various options, which include securing additional equity financing, obtaining new collaborators and customers and other strategic actions. If we raise additional capital by issuing equity or convertible debt securities, our existing stockholders may experience substantial dilution. There can be no assurance that additional financing will be available on satisfactory terms, or at all. If we are unable to secure additional financing on reasonable terms, or are unable to generate sufficient new sources of revenue through arrangements with customers, collaborators and licensees, we will be forced to take substantial restructuring actions, which may include significantly reducing our anticipated level of expenditures, the sale of some or all of our assets, or obtaining funds by entering into financing or collaborative agreements on unattractive terms, or we will not be able to fund operations. The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

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

      On March 4, 2005, we closed a business combination with Solexa Limited, a privately-held company registered in England and Wales that develops systems for the comprehensive and economical analysis of individual genomes (see Note 17). In connection with this transaction, we changed our name from Lynx Therapeutics, Inc. to Solexa, Inc. Unless specifically noted otherwise, as used throughout these Consolidated Financial Statements, “Lynx Therapeutics,” “Lynx” or “we” refers to the business, operations and financial results of Lynx Therapeutics, Inc. prior to the business combination on March 4, 2005, “Solexa Limited”

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

refers to the business of Solexa Limited, a privately-held United Kingdom company, prior to the business combination and “Solexa” refers to the business of the combined company after the business combination.

      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.

      Assets and liabilities of our wholly-owned foreign subsidiary are translated from its local currency at exchange rates in effect at the balance sheet date, and revenues and expenses are translated at average exchange rates prevailing during the year. The resulting translation adjustments are reflected as a separate component of stockholders’ equity.

      Financial instruments that potentially subject us to concentration of credit risk consist principally of cash equivalents and trade receivables. We invest our excess cash in deposits with major banks and in money market and short-term debt securities of companies with strong credit ratings from a variety of industries. These securities generally mature within 365 days and, therefore, bear minimal interest-rate risk. Our investment policy limits the amount of credit exposure to any one issuer and to any one type of investment.

      Pharmaceutical companies and other research institutions account for a substantial portion of our trade receivables. Accounts receivable are stated as amounts billed to customers. We provide credit in the normal course of business to our customers and collateral for these receivables is generally not required. We monitor the creditworthiness of our customers to which we grant credit terms in the normal course of business. We have not experienced significant credit losses to date.

      Substantially all of our revenues are derived from sales of our MPSS services. We depend on a single supplier to manufacture flow cells used in our MPSS technology. We currently purchase the flow cells from a single supplier, although the flow cells are potentially available from multiple suppliers. While we believe that alternative suppliers for flow cells exist, identifying and qualifying new suppliers could be an expensive and time-consuming process. Our reliance on outside vendors involves several risks, including the inability to obtain an adequate supply of required components due to manufacturing capacity constraints, a discontinuance of a product by a third-party manufacturer or other supply constraints, reduced control over quality and pricing of components and delays and long lead times in receiving materials from vendors.

      We currently utilize a single supplier to purchase PacI, a restriction enzyme used with our MegaClone bead technology to digest the PCR product that is loaded onto 5-micron beads prior to MPSS sequencing. We currently purchase PacI from New England BioLabs under a supply agreement, the term of which is scheduled to expire on August 15, 2005. Our reliance on a sole vendor involves several risks, including: the inability to obtain an adequate supply due to manufacturing capacity constraints, a discontinuance of a product by a third-party manufacturer or other supply constraints, the potential lack of leverage in contract negotiations with the sole vendor reduced control over quality and pricing of components, and delays and long lead times in receiving materials from the vendor.

      The carrying value of our cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates their fair value because of the short-term nature of these financial instruments. The

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

fair value of other short-term and long-term obligations is estimated based on current interest rates available to us for debt instruments with similar terms, degrees of risk and remaining maturities. The carrying values of these obligations approximate their fair values, with the exception of the obligation to Silicon Valley Bank (see Note 7), the estimated fair value of which is $3 million.

      We consider all investments in money market mutual funds, commercial paper and corporate bonds and notes with maturities at the date of purchase of 90 days or less to be cash equivalents. Investments in debt securities with maturities beyond 90 days, but less than one year, and investments in publicly traded equity securities are considered to be short-term investments. Our investment policy stipulates that our investment portfolio be maintained with the objectives of preserving principal, maintaining liquidity and maximizing return.

      We classify our investments in money market mutual funds, commercial paper, equity securities and corporate bonds and notes as available-for-sale. Available-for-sale securities are carried at fair value based on quoted market prices, with the unrealized gains and losses reported as a component of accumulated other comprehensive income. If a decline in the fair value of a short-term investment is below its cost for two consecutive quarters or if the decline is due to a significant adverse event, it is considered to be an other-than-temporary decline. In such circumstances, the investment would be written down to its estimated fair value. Other-than-temporary declines in fair value on short-term investments are charged against interest income.

      The cost of investments in commercial paper and corporate bonds and notes is adjusted for the amortization of premiums and accretion of discounts to maturity, which is included in interest income. The cost of securities sold, if any, is based on the specific identification method. Realized gains and losses, if any, are included in interest income.

      Inventory is stated at the lower of cost (which approximates first-in, first out cost) or market. Inventory used in providing genomics discovery services and for reagent sales is charged to cost of service fees and other as consumed. Reagents and chemicals purchased for internal development purposes are charged to research and development expense as incurred.

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

      In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we identify and record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. No such impairments have been identified with respect to our long-lived assets, which consist primarily of property and equipment and intangible assets.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Technology access fees have generally resulted from upfront payments from collaborators, customers and licensees who are provided access to our technologies for specified periods. We receive service fees from collaborators and customers for genomics discovery services that we perform on the biological samples that our collaborators and customers send to us. Collaborative research revenues are payments received under various agreements and include such items as milestone payments. Milestone payments pursuant to collaborative agreements are recognized as revenue upon the achievement of specified technology developments, representing the culmination of the earnings process. Other revenues include the proceeds from sales of technology assets, proprietary instruments and reagents, and grant revenues.

      Technology access and license fees are deferred and recognized as revenues on a straight-line basis over the noncancelable term of the agreement to which they relate. Payments for services and/or materials we provide are recognized as revenues when earned over the period in which the services are performed and/or materials are delivered, provided that no other consequential obligations, refunds or credits to be applied to future work exist. When consequential obligations, refunds or credits to be applied to future work exist, revenues are deferred until the obligation is fulfilled or the refund or credit is applied. Revenues from the sale of technology assets are recognized upon the transfer of the assets to the purchaser. Revenues from the sales of instruments and reagents are recognized upon shipment to the customer.

      Revenue from significant collaborators, customers and licensees represented the following percentages of total revenues:

      Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Basic and diluted net loss per share amounts are the same for each period in which we have incurred a net loss.

      The following table sets forth the computation of basic and diluted net loss per share:

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Options and warrants to purchase common stock were excluded from the calculation of diluted loss per share for all periods because the effect of inclusion would be antidilutive. The total number of shares excluded related to options and warrants was approximately 820,242 at December 31, 2004, 944,000 at December 31, 2003 and 669,000 at December 31, 2002. The options and warrants will be included in the calculation at such time as the effect is no longer antidilutive, as calculated using the treasury stock method.

      We grant stock options for a fixed number of shares to employees with an exercise price equal to the fair market value of the shares at the date of grant. We account for stock option grants in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations. Under APB 25, when the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

      All stock option awards to non-employees are accounted for at the fair value of the consideration received or the fair value of the equity instrument issued, as calculated using the Black-Scholes model, in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” and Emerging Issues Task Force (“EITF”) Consensus No. 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” The option arrangements are subject to periodic remeasurement over their vesting terms. We recorded compensation expense related to option grants to non-employees of $4,000 in 2004. We recorded no compensation expense related to option grants to non-employees in 2003 and 2002.

      Pro forma information regarding net loss and net loss per share required by SFAS No. 123 is presented below and has been determined as if we had accounted for awards under our stock option and employee stock purchase plans using the fair value method:

      SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the way that public business enterprises report information about operating segments in financial statements. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. Our business activities include the development and commercialization of technologies aimed at handling and/or analyzing the DNA molecules or fragments in biological

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

samples. Accordingly, we operate in only one business segment. All of our assets and revenues are derived from this activity.

      Substantially all of our long-lived assets are located in the United States. To date, revenues have been derived primarily from contracts with companies located in the United States and other countries as follows (revenues are attributed to geographic areas based on the location of the customer):

      Under SFAS No. 109, “Accounting for Income Taxes,” deferred tax assets and liabilities are determined based on the difference between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. SFAS No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses for the prior three years, we have provided a full valuation allowance against our net deferred tax assets as of December 31, 2004 and 2003. We intend to evaluate the realizability of the deferred tax assets on a quarterly basis. See Note 12.

      Accumulated other comprehensive income consists of translation adjustments related to our German subsidiary during the years ended December 31, 2004 and 2003 and an unrealized loss on available-for-sale investments during the year ended December 31, 2002.

      We hold an equity investment in Axaron Bioscience AG (“Axaron”), a company owned primarily by BASF AG and us. As of December 31, 2004, we held approximately a 42% ownership interest in Axaron and had the ability to exercise significant influence over Axaron’s operating and accounting policies. We initially accounted for our investment in Axaron using the equity method in accordance with APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” Under the equity method, we recorded our pro-rata share of the income or losses of Axaron. We discontinued applying the equity method as of December 31, 2003, as our investment in Axaron had been reduced to zero.

      In connection with the March 1998 sale of our portfolio of phosphorothioate antisense patents and licenses and our therapeutic oligonucleotide manufacturing facility to Inex Pharmaceuticals Corporation (“Inex”), we received 1.2 million shares of Inex common stock as partial consideration in the transaction. In the first quarter of 2002, we sold all of our remaining shares of Inex common stock and recognized a gain of approximately $1.0 million.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. SFAS No. 123R is effective for fiscal periods beginning after June 15, 2005 and, thus, will be effective for us beginning with the third quarter of 2005. Early adoption is encouraged and retroactive application of the provisions of SFAS No. 123R to the beginning of the fiscal year that includes the effective date is permitted, but not required. We are currently evaluating the impact of SFAS No. 123R on our financial position and results of operations. See “Stock-Based Compensation” above for information related to the pro forma effects on our reported net loss and net loss per share when applying the fair value recognition provisions of the previous SFAS No. 123 to stock-based employee compensation.

      In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current period charges. In addition, SFAS No. 151 requires that allocation of fixed production overhead to the cost of conversion be based on the normal capacity of the production facilities. The provisions of SFAS No. 151 are effective fiscal years beginning after June 15, 2005. We do not expect the adoption of SFAS No. 151 to have a significant impact on our consolidated financial position, results of operations or cash flows.

      In October 2004, the FASB issued EITF Consensus No. 04-1, “Accounting for Preexisting Relationships between the Parties to a Business Combination,” which provides new guidance for the accounting for preexisting relationships between the parties to a business combination. Additionally, EITF 04-1 includes additional disclosure requirements for business combinations between parties with a preexisting relationship. EITF 04-1 is effective for fiscal periods beginning after October 13, 2004. We do not expect the adoption of EITF 04-1 to have a material impact on our consolidated financial position, results of operations or cash flows.

      In March 2004, the FASB issued EITF Consensus No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which provides new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however, the disclosure requirements remain effective for annual periods ending after June 15, 2004. The adoption of the disclosure provisions of EITF 03-1 did not have a material impact on our consolidated financial statements. We do not expect the accounting provisions of EITF 03-1 to have a material impact on our consolidated financial position, results of operations or cash flows.

      In April 2004, Lynx and Solexa Limited jointly acquired from Manteia SA (“Manteia”), a company established under the laws of Switzerland, the rights to proprietary technology assets for DNA colony generation. The acquired technology assets feature a process to enable parallel amplification of millions of DNA fragments, each from a single DNA molecule, to create DNA colonies or “clusters.” The clusters are dense collections of DNA molecules on a surface, which should enable fast and simplified preparation of the biological sample for analysis and allow reduced reagent consumption as a result of the highly parallel nature of the analysis. We intend to incorporate the cluster technology assets into our MPSS process, with the goal of streamlining our sequencing service operations and developing commercial sequencing instrumentation for widespread laboratory use. The cluster technology is expected to improve our current bead-based sequencing process by delivering higher density, thus greater information content. This improvement targets a significant reduction in the cost of DNA sequencing and is expected to create multiple market opportunities in basic and applied research. We have entered into a technology sharing agreement with Solexa Limited for the purpose of managing the ownership and development of the asset acquired from Manteia.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      We issued and delivered to Manteia 270,029 shares of our common stock for a value representing fifty percent of the purchase price. The shares were valued at $2.55 million and the purchase price was allocated to intellectual property in the amount of $2.45 million and equipment and supplies valued at $100,000. The acquired intellectual property is being amortized over 8 years.

      In October 2004, pursuant to the terms of a loan agreement dated August 12, 2004, Lynx and Solexa Limited entered into a deed to amend the technology sharing agreement. Under the terms of the deed, in the event that the first closing of the proposed combination with Solexa Limited did not take place and the transaction was, therefore, not completed, we had agreed to transfer our right, title and interest in the cluster technology to Solexa Limited in consideration for the grant of a worldwide, perpetual and non-exclusive license of the cluster technology.

      On August 12, 2004, Lynx and Solexa Limited entered into a loan agreement pursuant to which we issued Solexa Limited four promissory notes each bearing interest at 10% per annum in the aggregate principal amount of $2,500,000. Under the loan agreement and as a result of the issuance of the promissory notes, certain royalty rates contained in the technology sharing agreement were reduced and we were obligated to make certain instruments available to Solexa Limited. The loans are due on December 31, 2005.

      On September 28, 2004, we entered into a definitive acquisition agreement with Solexa Limited pursuant to which we made an offer to acquire all of the outstanding share capital of Solexa Limited and an option offer for each outstanding Solexa Limited stock option. In connection with the acquisition agreement, the directors and the executive officers and major shareholders of Solexa Limited who are registered holders of approximately 90% of the outstanding shares of Solexa Limited’s share capital entered into support agreements with Lynx, pursuant to which they agreed to exchange their shares of Solexa Limited capital stock for Lynx common stock in connection with the transaction. In addition, certain directors and executive officers of Lynx entered into support agreements with Solexa Limited, pursuant to which they agreed to approve the transaction and the issuance of shares of Lynx common stock to the Solexa Limited shareholders in connection with the combination. This business combination closed on March 4, 2005 (see Note 17).

      In October 2004, we signed a development agreement with Solexa Limited whereby Solexa Limited will provide us with additional funding to accelerate development of the next generation DNA sequencing instruments. We recognized revenues of $476,000 in 2004 under this agreement.

      The following are summary descriptions of certain key collaborators, customers and licensees:

      In October 1998, we entered into a research collaboration agreement with E.I. DuPont de Nemours and Company (“DuPont”) to apply our technologies on an exclusive basis to the study of certain crops and their protection. Under the terms of the agreement, we received payments over a five-year period that ended in the fourth quarter of 2003 for genomics discovery services, the achievement of specific technology milestones and the delivery of genomic maps of specified crops. We received an initial payment of $10.0 million for technology access at the execution of the agreement, and service fees of $12.0 million were received by Lynx over a three-year period, which commenced in January 1999. The agreement was extended with Lynx for a two-year period during which we received additional service fees of $8.0 million through the fourth quarter of 2003. In the fourth quarter of 1999, we achieved a technology milestone under the agreement that resulted in a $5.0 million payment from DuPont.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In late November 2003, Lynx entered into a new five year services agreement with DuPont. Through this agreement, we will continue to provide MPSS services to enhance DuPont’s discovery and development of new agricultural traits and products. We received services fees of $2.5 million in 2004 under this agreement.

      Through December 31, 2004, Lynx received aggregate payments of $37.5 million from DuPont under the 1998 and 2003 agreements.

      In 1996, Lynx and BASF established Axaron Bioscience AG (“Axaron”), a joint venture company in Heidelberg, Germany. Axaron began operations in 1997 and is employing Lynx’s technologies in its neuroscience, toxicology and microbiology research programs. Upon the establishment of Axaron, we contributed access to our technologies to Axaron in exchange for an initial 49% equity ownership in Axaron. BASF, by committing to provide research funding to Axaron of DM50 million (or approximately $32.0 million based on a December 2003 exchange rate) over a five-year period beginning in 1997, received an initial 51% equity ownership in Axaron. In 1998, BASF agreed to provide an additional $10.0 million in research funding to Axaron, of which $4.3 million was paid to us for technology assets related to a central nervous system program. In the period since the joint venture was established, management and employees increased their equity ownership in Axaron to 15%, thereby reducing the ownership of Lynx and BASF to 41.6% and 43.4%, respectively.

      In June 2001, we extended our technology licensing agreement with Axaron. The license extends Axaron’s right to use our proprietary MPSS and Megasort technologies nonexclusively in Axaron’s neuroscience, toxicology and microbiology programs until December 31, 2007. The agreement also positions Axaron to apply our technologies to specific disorders in the neuroscience field. Under the terms of the agreement, we received a $5.0 million technology license fee from Axaron. We intend to furnish to Axaron, initially without charge and later for a fee, proprietary reagents and additional MPSS instruments for use in Axaron’s research programs.

      In 2001, Lynx and BASF agreed to continue their support of Axaron’s growth, including an increase in the capital of Axaron. We made an additional investment of $4.5 million in Axaron, which maintained our ownership interest in Axaron at approximately 42%. Given our ownership share of Axaron and our ability to exercise significant influence over Axaron’s operating and accounting policies, we initially accounted for our investment in Axaron using the equity method in accordance with APB Opinion No. 18. We discontinued applying the equity method as of December 31, 2003, as our investment in Axaron has been reduced to zero.

SOLEXA, INC.

(formerly Lynx Therapeutics, Inc.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Summarized unaudited financial information of Axaron is as follows: