SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 1996
Commission file number 000-19392

DIANON Systems, Inc.
--------------------
(Exact Name of Registrant as Specified in its Charter)

Delaware 06-1128081
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

200 Watson Boulevard, Stratford, Connecticut 06497
- -------------------------------------------- -----
Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code (203) 381-4000
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Securities registered pursuant to Section 12(b) of the Act:

Name of Each Exchange on
Title of Each Class Which Registered
------------------- ------------------------

None None

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

Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)

Number of shares of Common Stock outstanding as of March 14, 1997: 6,449,270

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 EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATIONS 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. [ ]

As of March 14, 1997, the aggregate market value of the voting Common Stock held
by non-affiliates of the registrant was $54,818,795.

Documents Incorporated By Reference
None

EXHIBIT INDEX ON PAGE 55 OF 133 PAGES

PART I
ITEM 1. BUSINESS

DIANON Systems, Inc. ("DIANON" or the "Company") is a provider of
anatomic pathology and clinical chemistry testing services to physicians,
patients and managed care organizations across the United States.

Historically, the Company has been a specialized laboratory with a
limited line of clinical chemistry and anatomic pathology testing services based
principally on new technology purchased or licensed from test developers. This
technology has been marketed directly to medical oncologists and urologists as
testing and information services rather than as products or test kits.

As a result of the Company's success in providing pathology services,
the mission of the Company has been expanded to include a full line of anatomic
pathology services and related information products to physicians, patients and
managed care organizations throughout the United States. The Company's principal
physician audience for these services includes approximately 50,000 clinicians
engaged in the fields of medical oncology, urology, dermatology, gynecology and
gastroenterology. The Company believes it can become one of the leading
specialized providers of anatomic pathology testing services in the United
States.

While the Company continues in its traditional role of assisting
developers of new technology and physicians evaluating such technology, it is
expected that this activity and the Company's clinical chemistry business will
represent a decreasing proportion of total revenue in future years as anatomic
pathology revenues grow.

The business of the Company is subject to a number of risks and
uncertainties that could adversely affect the Company's ability to achieve its
objectives. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition - Risk Factors: Forward Looking Statements" for a
description of various factors that could have an adverse effect on the
performance of the Company.

Medical Testing Markets

Medical laboratories offer a broad range of testing services to the
medical profession. These testing services are used by physicians in the
diagnosis, prognosis, monitoring and general management of diseases and other
clinical conditions. The tests they use generally detect medically significant
abnormalities and visual patterns in blood, tissue samples and other specimens.

Management divides the market for medical testing into anatomic
pathology testing and clinical chemistry testing and has set forth in very
general terms some of the major differences between them in the table below:

Anatomic Pathology Testing Clinical Chemistry Testing
-------------------------- --------------------------

Type of Specimen Tissue or cells - usually obtained by Blood or urine - usually collected by
a physician from a biopsy, Pap smear, a nurse (blood) or by the patient (urine)
urine specimen or surgery

Technology Employed Physician interpretation of tissue Highly automated blood chemistries and
slides supplemented by special antibody immunoassays
stains, DNA probes, genetic tests

1991 DIANON Net Revenues $ 9 million $18 million

1996 DIANON Net Revenues $37 million $19 million

The Company offers a complete line of anatomic pathology testing
services as well as selected clinical chemistry tests for cancer and
gynecological conditions. The Company performs all testing at its main facility
in Stratford, Connecticut and provides most test results to physicians within
forty-eight hours. In 1996 the Company opened a specimen processing facility at
the hub of its airfreight provider in Ohio in order to prepare certain specimens
for more rapid processing when they arrive in Stratford and to improve overall
turnaround time to the physicians. No test accounted for more than 20% of net
revenues in 1996.

Information Services

The Company's information services are used principally to assist the
physician in the analysis of test results and to help managed care organizations
better manage patient treatment. Patient specific reports aid the physician in
analyzing multiple prognostic tests and/or correlative trends in a patient's
test results, treatment, and clinical condition. Summary reports on all patients
in a physician's practice allow the physician to compare test results on
patients with similar conditions, review multiple patient histories, and compare
his or her experience with that of physicians across the country. Similar
reports help managed care organizations capture and compare utilization and
diagnostic trends within their own organization, with other managed care
organizations and with the Company's national database. The Company's current
information services are an important part of the Company's marketing program,
and while they do not specifically generate revenue they do provide important
value-added services which help the Company differentiate itself from
competitors.

Quality Assurance

The Company's quality assurance program includes adherence by employees
to the Standard Operating Procedures, continuing education and technical
training of technologists, statistical quality control of all analytical
processes, instrument maintenance, and regular inspection by governmental
agencies and the College of American Pathologists.

The Company utilizes a unique quality control program for anatomic
pathology which provides a reduced number of equivocal results reported to
clinicians. This program is applied to all anatomic pathology specimens. By
diminishing the number of equivocal diagnoses and providing the correct
diagnosis as soon as possible, the Company enables clinicians to treat patients
sooner and more effectively and to reduce overall health care costs.

European Operations

In recent years the Company has been engaged in a diagnostic testing
business in Europe, principally in Germany and Spain. In 1995, the Company
decided to sell or close its European operations and provided a reserve of
approximately $279,000 to cover the costs of doing so. Remaining reserves for
the discontinuance of operations at December 31, 1996 are approximately
$155,000. The Company is in the process of liquidating the European based
operations and plans to complete the liquidation process by the end of the 1997
fiscal year.

Reimbursement

In 1996, 1995, and 1994 approximately 40%, 41%, and 34%, respectively,
of the Company's net revenues were derived from testing performed for
beneficiaries under the Medicare and Medicaid programs, substantially all of
which was derived from the Medicare program. Revenues from testing performed for
other patients are derived principally from other third-party payors, including
commercial insurers, health maintenance and preferred provider organizations,
patients, physicians, hospitals, and other laboratories (who in turn usually
bill non-governmental third-party payors or patients). In each of 1996, 1995 and
1994, less than 10% of the Company's revenues were derived from health

maintenance organizations with whom the Company has contracts. For many of the
tests performed for Medicare or Medicaid beneficiaries (except clinical
diagnostic laboratory tests for those individuals being treated by a hospital),
laboratories are required to bill Medicare or Medicaid directly for covered
services and to accept Medicare or Medicaid reimbursement as payment in full for
such services. Management has elected, to date, to accept reimbursement rates
set by other third-party payors as payment in full (apart from any co-payment
which the payor has established) as well.

Reimbursement rates for some services of the type or similar to the
type performed by the Company have been established by Medicare, Medicaid and
other third-party payors, but have not been established for all services or by
all carriers with respect to any particular service. While most carriers,
including Medicare, do not cover services they determine to be investigational,
or otherwise not reasonable and necessary for diagnosis or treatment, a formal
coverage determination is made with respect to relatively few new procedures.
When such determinations do occur for Medicare purposes, they most commonly are
made by the local Medicare carrier which processes claims for reimbursement
within the carrier's geographic jurisdiction. The Company receives Medicare
reimbursement primarily through a single Medicare carrier. A positive coverage
determination, or reimbursement without such determination, by one or more
third-party payors, or clearance for market by the Food and Drug Administration
("FDA"), does not assure reimbursement by other third-party payors. A few
third-party payors have denied payment for services for which the Company
receives reimbursement from other payors. On occasion, Medicare or other
third-party payors have decided to cease payment for one or more of the
Company's services that historically have been reimbursed by them because such
services are performed using test kits or other products which have not received
FDA pre-market clearance or because such services may otherwise be deemed
investigational or for other reasons. Furthermore, Medicare and other
third-party payors have, on occasion, ceased reimbursement when certain tests
are ordered for patients with certain diagnoses while maintaining reimbursement
when such tests are ordered for other diagnoses deemed appropriate by the
carrier. This practice recently has become more prevalent with respect to
Medicare. Reimbursement disapprovals by the various carriers, reductions or
delays in the establishment of reimbursement rates, and crrier limitations on
the insurance coverage of the Company's services could have a material adverse
effect on the Company's future revenues.

Medicare Fee Schedule Payment for Clinical Chemistry Laboratory
Services. In 1984, Congress adopted legislation establishing a locality-specific
fee schedule reimbursement methodology with Consumer Price Index ("CPI")-related
updates for clinical diagnostic laboratory testing for non-hospital patients and
hospital out-patients under Medicare. (Payment for clinical chemistry laboratory
services performed for Medicare in-patients is included within the prospectively
determined Diagnosis Related Group rate paid to the hospital.) In addition,
state Medicaid programs are prohibited from paying more than the Medicare fee
schedule amount. Beginning with the consolidated Omnibus Budget Reconciliation
Act of 1985 ("OBRA '85"), Congress instituted a national cap on Medicare
clinical chemistry laboratory fee schedules. This national cap has been lowered
each year and now is 76% of the national median. In addition, the Omnibus Budget
Reconciliation Act of 1987 ("OBRA '87"), eliminated the CPI update for 1988 and,
in succeeding years, Congress has often either limited or eliminated the annual
CPI updates of the Medicare clinical chemistry laboratory fee schedules. Most
recently, the Omnibus Budget Reconciliation Act of 1993 ("OBRA '93") eliminated
the update for the years 1994 and 1995. In 1996, however, the fee schedule
update was 3.2%; the Health Care Financing Administration ("HCFA") has recently
announced that the fee schedule update for 1997 will be 2.7%. However, the
corresponding expected national cap increase of 2.7% may not be fully realized
due to a recalculation of national medians necessitated by conversion in some
carrier areas to a single statewide fee schedule. The update limitations and
changes in the national cap made to date have not had, and are not expected by
the Company to have, a material adverse effect on the Company's results of
operations. Any further significant decrease in such fee schedules, however,
could have a material adverse effect on the Company.

Any future changes in government and other third-party payor
reimbursement which may come about as a consequence of enactment of health care
reform or of deficit reduction legislation also likely will continue the
downward pressure on prices and make the market for clinical laboratory services
more competitive. The Medicare proposal contained in the President's fiscal year
1998 budget offers an indication of the direction future Medicare reform
legislation may take with respect to clinical laboratory services. The
President's proposed budget would not modify the national cap on Medicare
clinical chemistry laboratory fee schedules or eliminate annual updates;
however, it would establish competitive bidding for clinical chemistry
laboratory services. If the President's proposal failed to realize savings of at
least 20% for a given year through the competitive bidding process, the
Secretary of the Department of Health and Human Services ("HHS") would reduce
Medicare's fees for laboratory services to achieve this targeted savings.
Furthermore, the President's support for competitive bidding has rekindled
efforts in the HCFA to initiate a Medicare demonstration project to test the
savings potential of competitive bidding for Part B clinical laboratory
services, which include the type of services provided by the Company. If
ultimately adopted through legislation, these proposals likely would have an
adverse impact on the Company's revenues.

Moreover, the Congress has voiced concern that the President's budget
does not yield sufficient savings to balance the budget in 2002. As a result,
the Congress may propose additional savings measures, especially in the Medicare
program. H.R. 2491, the Balanced Budget Act of 1995, passed by Congress and
vetoed by President Clinton in December 1995, offers some indication of
additional savings measures that Congress may propose in the future. Although
H.R. 2491 would not have established competitive bidding for clinical chemistry
laboratory services, it instead proposed that a fail-safe budget mechanism be
used if projected savings were not realized in Medicare service expenditures.
This fail-safe mechanism might have further reduced reimbursement for Medicare
clinical chemistry laboratory services and physician services (including the
Company's anatomic pathology service). In addition, H.R. 2491 would have further
reduced the national cap on Medicare clinical chemistry laboratory fee schedules
to 65% of the national median in 1997. It also would have eliminated annual CPI
updates in the Medicare clinical chemistry laboratory fee schedules until fiscal
year 2002.

Both the Medicare proposal contained in the President's fiscal year
1998 budget and H.R. 2491 would revise the Medicare program substantially to
permit beneficiaries to choose between traditional fee-for-service Medicare and
several non-traditional Medicare options, including managed care plans and
provider-sponsored organization plans. These non-traditional Medicare plans
would have considerable discretion in determining whether and how to cover and
reimburse clinical laboratory services and to limit the number of labs with
which they deal. Although neither proposal would require Medicare beneficiaries
to pay 20% of the fee for each clinical laboratory service, nothing in the
proposals would prohibit non-traditional Medicare plans from implementing such a
requirement.

The Medicare proposal contained in the President's fiscal year 1998
budget also contains measures to establish market-oriented purchasing for
Medicare, including prospective payment systems for out-patient hospital
services, home health care, and nursing home care, and the use of global
payments and flexible purchasing. Although the details of these proposals are
yet to be developed, if implemented, they probably would increase pressure on
pricing in the clinical laboratory industry and may have an adverse impact on
the Company's revenues.

Medicare changes along the lines described above are possible this
year. Because of the uncertainties about the exact nature of any changes which
may ultimately be adopted, however, the Company currently is unable to predict
their ultimate impact on the clinical laboratory industry generally or on the
Company in particular. Even apart from federal legislative action, reforms may
occur at the state level and changes are occurring in the marketplace as a
result of market pressures, including the increasing number of patients covered
by some form of managed care. In general, these changes are likely to put a
downward pressure on price, and may also act to limit access by some
laboratories to some managed care patient groups. Because of the uncertainties
about the exact nature, extent, and timing of any such changes, however, the
Company currently is unable to predict their ultimate impact on the clinical
laboratory industry generally or on the Company in particular.

Medicare Payment for Anatomic Pathology Services. In addition to
furnishing clinical chemistry laboratory testing services, the Company furnishes
a number of services which are characterized for the purposes of the Medicare
program as anatomic pathology services. Medicare reimbursement for these
services constituted approximately 30%, 26%, and 18% of the Company's net
revenues in 1996, 1995, and 1994, respectively. As of January 1, 1992, all
physician services, including anatomic pathology services, have been reimbursed
by Medicare based on a methodology known as the resource-based relative value
scale ("RBRVS"), which was fully phased in by the end of 1996. Overall, anatomic
pathology reimbursement rates declined during the fee schedule phase-in period,
despite an increase in payment rates for certain pathology services performed by
the Company.

The Medicare RBRVS payment for each service is calculated by
multiplying the total relative value units ("RVUs") established for the service
by a conversion factor that is set by statute. The number of RVUs assigned to
each service is in turn calculated by adding three separate components,
including one representing the relative work values. In 1996, HCFA completed a
five-year review of the work value component and, as a result, revised the work
value amount assigned to many physician services. In addition, based on a
default formula established by statute, the 1997 conversion factor for
nonsurgical services dropped 0.8% from 1996 to $33.8454 per conversion factor.
The changes resulting from the five-year review, combined with the conversion
factor reductions, resulted in an overall decrease in payment rates for
pathology services of approximately 5.7% beginning January 1, 1997. Also, HCFA
reduced the number of physician fee schedule payment localities from 210 to 89,
effective January 1, 1997. Connecticut was one of the states that HCFA moved to
a single payment locality. This modification resulted in a 3.2% decrease in the
RBRVS geographic adjustment factor for physicians located in Western
Connecticut, where the Company's primary operations are located.

In the past, the Company has been able to offset a substantial portion
of the impact of the reduced Medicare reimbursement rates for anatomic pathology
services through the achievement of economies of scale and the introduction of
alternative technologies that will not depend on reimbursement through the RBRVS
system. Despite these offsets, the substantial modifications to the physician
fee schedule effective January 1, 1997, may have a negative effect on the
Company's average unit price.

Furthermore, as a result of the Social Security Act amendments of 1994,
Medicare is required to revise the formula for calculating the practice expense
component of the physicians' Medicare fee schedule from the current historical
basis to a resource basis beginning January 1, 1998. In order to complete this
task, HCFA hired a consultant to survey some 5,000 practices to collect
aggregate practice expense data. Although HCFA terminated the survey due to a
low response rate, the agency maintains that it still can meet its mandate to
implement a resource-based practice expense component by January 1, 1998, by
using existing data. Some concern has been expressed by physician specialty
groups that this data is not adequate and that the methodology being used could
result in specialty practice expenses being underestimated. At this point, HCFA
is considering a variety of options for calculating practice expense revisions.
It is possible that certain changes HCFA might make would have a significant
negative affect on reimbursement for anatomic pathology services, including
services furnished by the Company.

With respect to potential legislative changes, the Medicare proposals
contained in both the President's fiscal year 1998 budget and in H.R. 2491 would
implement a single conversion factor for physician services. In 1998, this
single conversion factor would likely be slightly higher than the current
conversion factor for pathologists. If enacted, this increase may favorably
affect or, more likely, offset to some degree the adverse impact of the other
developments described above on revenues from the Company's physician pathology
services. However, the Company is not able to predict the exact nature of any
legislative changes affecting anatomic pathology services reimbursement, and the
Company therefore currently is unable to predict the ultimate effect of any such
changes on the Company.

Other Developments Affecting Reimbursement. In 1996, approximately 16%
of the Company's net revenues were in the State of New York. In September 1996,
New York passed the New York Health Care Reform Act of 1996 ("NYHCRA"). The
NYHCRA requires payors to pay an 8.18% surcharge on services provided by a
variety of providers including independent laboratories for services rendered to
residents of the State of New York. If the payor neglects to pay the 8.18%
surcharge directly, providers are required to collect the surcharge plus an
additional assessment of 24% for a total surcharge of 32.18%. Under the NYHCRA,
it is possible that independent labs, such as the Company, will be placed at a
competitive disadvantage with physician office labs and other labs whose
services are not subject to the surcharge. In addition, independent labs
probably will be liable for the surcharge even if the payor fails to pay the
laboratory. Moreover, payors may reduce the fees they pay for laboratory
services in order to offset the surcharge. The New York State Clinical
Laboratory Association has brought suit against the New York State Department of
Health alleging that these provisions of NYHCRA are unconstitutional under the
United States and New York State Constitutions and should not be enforced.
Nonetheless, these changes currently are being implemented and could have a
negative impact on the portion of the Company's net revenues derived from the
State of New York.

Following a study of pricing practices in the clinical laboratory
industry, the Office of the Inspector General ("OIG") of HHS conducted a study
of, and in January 1990 issued a final report relating to, such practices. This
report addresses how these pricing practices relate to Medicare and Medicaid.
The OIG reviewed the industry's use of one fee schedule for physicians and other
professional accounts and another fee schedule for patients/third-party payors,
including Medicare, in billing for testing services.

The OIG also specifically reviewed the pricing differential when
profiles (or established groups of tests) are ordered. The OIG recommended that
HCFA seek legislation that would allow adjustments in the Medicare fee schedules
to bring the fee schedules into line with what the lower price laboratories
charge physicians. The OIG also recommended that when profiles are ordered for
Medicare beneficiaries that HCFA take necessary action specifically to ensure
that Medicare benefits from the pricing structure used by laboratories in
charging physicians for profiles. Similarly, in June 1991, the General
Accounting Office ("GAO") issued a report recommending a reduction in the
national cap on Medicare fee schedules for laboratory services to eliminate the
disparities in laboratory pricing practices. (This recommended reduction - to
76% of the national median - was in fact enacted as part of OBRA '93.) In
response to the GAO HCFA recommended that OIG initiate a legislative proposal to
enhance existing authority to penalize discriminatory pricing. Existing federal
law authorizes the Secretary of HHS to exclude providers from participation in
the Medicare and Medicaid programs if they charge state Medicaid programs or
Medicare fees "substantially in excess" of their "usual charges". On January 29,
1992, in the preamble to a Final Rule implementing program exclusion and civil
money penalty authorities established under the Medicare and Medicaid Patient
and Program Protection Act of 1987, the OIG considered but declined to provide
any standards as to when charges for a service are considered "substantially in
excess" of a provider's "usual charges". However, the OIG stated that it will
continue to evaluate the billing patterns of individuals and entities, including
clinical laboratories, on a case-by-case basis. The Medicaid laws in some states
also have prohibitions related to discriminatory pricing. The Company employs
practices similar to those examined in the 1990 OIG report discussed above in
billing for its services. Depending upon the nature of any regulatory or

enforcement action taken or the content of legislation, if any, which might be
adopted to address this issue, the Company could experience a significant
decreasein revenue which could have a material adverse effect on the Company.
The legislation also provides for civil or criminal penalties or exclusion from
participation in Medicare and Medicaid. The Company is unable to predict at this
time whether any further regulatory, enforcement, or legislative action will be
taken.

In December 1992, an unrelated clinical laboratory, National Health
Laboratories, Inc., ("NHL"), pleaded guilty to submitting false medical
reimbursement claims to the United States government, and entered into a
settlement which provides for payment of over $100 million. The United States
government alleged that NHL, by marketing to physicians diagnostic test panels
which bundled, together with a routine blood chemistry series, two other tests
(ferritin and HDL cholesterol), induced physicians to order these other tests
regardless of medical necessity. While NHL's additional charge to physicians for
these two tests ordered as part of the NHL panel was nominal, NHL billed this
Medicare program for them at full price. Since 1993, several other laboratories
have reached significant financial settlements with the government in cases
involving similar issues. While it is not possible to predict how broadly the
United States government may seek to expand the theory of liability it developed
in these cases, the Company believes its practices differ materially from those
at issue and has no reason to believe that its practices are the subject of any
investigation in this regard.

In February, 1997, the OIG released a model compliance plan for
laboratories that is based largely on the corporate integrity agreements
negotiated with the laboratories which settled the government's enforcement
actions. The Company is reviewing the model compliance plan and plans to adopt,
or modify for adoption, aspects of the model plan that the Company deems
appropriate to the conduct of its business. One key aspect of the corporate
integrity agreements and the model compliance plan is an emphasis on the
responsibilities of laboratories to notify physicians that Medicare covers only
medically necessary services. Although these requirements, and their likely
effect on physician test ordering habits, focus on chemistry tests, especially
routine tests, rather than on anatomic pathology services or the non-automated
tests which make up the bulk of the Company's business, they potentially could
affect physician test ordering habits more broadly. The Company is unable to
predict whether, or to what extent, these developments may have an impact on the
utilization of the Company's services.

Competition

The Company provides services in a segment of the healthcare industry
that is extremely competitive. The Company's actual or potential competitors
include large clinical laboratories, special purpose clinical laboratories and
product companies that manufacture test kits and other diagnostic tools.

The clinical laboratory business is characterized by intense
competition. The Company estimates that there are over 11,500 clinical
laboratories in the United States which might be deemed actual or potential
competitors for the testing business of a cancer-treating or cancer-diagnosing
physician. In the U.S., anatomic pathology and clinical chemistry laboratory
services are provided through physician-owned laboratories, commercial
laboratories and hospital laboratories. In the U.S., there are several large
clinical laboratory companies which market a "full line" of such services
nationally, and which have substantially greater financial, selling, logistical
and laboratory resources than the Company. These companies typically offer
hundreds of different tests and management believes that these companies compete
in general on quality, price and the time required to report results. The
Company estimates that the three largest national clinical laboratories in the
U.S. accounted for greater than 40% of the total non-hospital clinical
laboratory market in 1996.

In addition, the Company's management has identified a number of
specialized laboratories in the U.S. established since 1987. None of those
specialized laboratories have sales greater than 5% of the anatomic pathology
market.

The Company also processes specimens from a number of non-hospital
clinical laboratories. Sales to such laboratories amounted to approximately 3%
of the Company's net revenues in 1996 and 5% in 1995 and 1994.

In addition to competition for customers, there is increasing
competition for qualified personnel, particularly in the laboratory. To date,
such competition has not had an adverse impact on the Company's operations.

Significant factors that enhance the Company's ability to compete
effectively include a highly trained and knowledgeable sales force, high quality
laboratory operations, accurate and consistent test results, quality of service
to physicians, price and, to a lesser extent, speed of turnaround.

Patents and Proprietary Technology

To date, the Company has not relied heavily on patents or licensed
technology in its business. Tests or related diagnostic products purchased by
the Company may or may not be patented. There can be no assurance that such
tests or related products do not infringe patent rights of others, which could
give rise to claims against the Company. Typically the Company is not
indemnified against such risks. There can be no assurance that any issued patent
upon which the Company relies directly or indirectly will afford protection to
the Company in the face of challenges to the patent's validity.

Other private and public entities, including universities, have filed
applications for (or have been issued) patents in the Company's field and may
obtain additional patents and other proprietary rights to technology that may be
the same as or similar to that utilized by the Company. The scope and validity
of such patents, the extent to which the Company may wish or need to acquire
such rights, and the cost or availability of such rights are presently unknown.
There can be no assurance that others may not obtain access to the Company's
technology or independently develop the same or similar technology to that
utilized by the Company.

Employees

On December 31, 1996, the Company had 385 full-time and 35 part-time
employees worldwide.

Regulatory Matters

The Company's business is subject to governmental regulation at the
federal, state and local levels, some of which regulations are described under
"Laboratory", "Food and Drug Administration" and "Other" below.

Laboratory

The Company's laboratory is certified or licensed under the federal
Medicare program, the Connecticut Medicaid program and the Clinical Laboratories
Improvement Act of 1967, as amended by the Clinical Laboratory Improvement
Amendments of 1988 (collectively, "CLIA '88"). Licensure is maintained under the
clinical laboratory licensure laws of Connecticut, where the Company's clinical
laboratory is located and under the laws of several other jurisdictions. The
Company believes it has obtained all material laboratory licenses required for
its operations. In addition, the laboratory is licensed by the federal Nuclear
Regulatory Commission and is accredited by the College of American Pathology.

The federal and state certification and licensure programs establish
standards for the day-to-day operation of a medical laboratory, including, but
not limited to, personnel and quality control. Compliance with such standards is
verified by periodic inspections by inspectors employed by federal or state
regulatory agencies. In addition, federal regulatory authorities require
participation in a proficiency testing program approved by the HHS for each of
the specialties and subspecialties for which a laboratory seeks approval from
Medicare or Medicaid and licensure under CLIA '88. Proficiency testing programs
involve actual testing of specimens that have been prepared by an entity running
an approved program for testing by the laboratory.

The Final Rule implementing CLIA '88, published by HHS on February 28,
1992, became effective September 1, 1992. HHS currently has under review the
comments it received in response to the Final Rule, as well as those received in
response to revisions to such rule published on January 19, 1993 and April 24,
1995. This Final Rule covers all laboratories in the United States, including
the Company's laboratory. The Company has reviewed the Final Rule (and revisions
thereto), including, among other things, such rule's requirements regarding
laboratory administration, participation in proficiency testing, patient test
management (including patient preparation, proper specimen collection,
identification, preservation, transportation, processing and result reporting),
quality control, quality assurance and personnel for the types of testing
undertaken by the Company, and believes it to be in compliance with these
requirements. However, no assurances can be given that the Company's laboratory
will pass all future inspections conducted to ensure compliance with CLIA '88 or
with any other applicable licensure or certification laws.

Existing federal laws governing Medicare and Medicaid, as well as some
state laws, also regulate certain aspects of the relationship between healthcare
providers, including clinical laboratories, and their referral sources,
including physicians, hospitals and other laboratories. One provision of these
laws, known as the "anti-kickback law," contains extremely broad proscriptions,
and relatively little regulatory guidance or judicial precedent exists
concerning its application. Violation of this provision may result in exclusion
from Medicare and Medicaid or criminal penalties. Pronouncements from the OIG
have indicated that additional enforcement resources may be focused on financial
arrangements between laboratories and physicians and other purchasers of
laboratory services, including arrangements under which laboratories supply
physicians' offices with phlebotomists (blood-drawing technicians) who perform
additional tasks that normally are the responsibility of the physician office
staff. Under another provision, known as the "Stark" law or "self-referral
prohibition", physicians who have an investment or compensation relationship
with an entity furnishing clinical laboratory services (including clinical
chemistry and anatomic pathology services) may not, subject to certain
exceptions, refer clinical laboratory testing for Medicare patients to that
entity. Similarly, laboratories may not bill Medicare or Medicaid or any other
party for services furnished pursuant to a prohibited referral. Violation of
these provisions may result in disallowance of Medicare and Medicaid claims for
the affected testing services, as well as the imposition of civil monetary
penalties. On August 14, 1995, HHS published a Final Rule implementing this
prohibition on Medicare referrals. Both H.R. 2491 and the President's Medicare
proposal contained modifications to the anti-kickback law and the Stark law. The
provisions from H.R. 2491 have been introduced again in other bills in 1996.
While these provisions in some respects ould strengthen the anti-kickback and
Stark laws, in other respects they would moderate some of the current
restrictions. The Company does not expect that these changes, if they are
enacted, would have a major effect on the Company. The Company seeks to
structure its arrangements with physicians and other providers to be in
compliance with the anti-kickback, Stark and state laws, and to keep up-to-date
on developments concerning their application by various means including
consultation with legal counsel. However, the Company is unable to predict how
these laws will be applied in the future, and no assurances can be given that
its arrangements will not become subject to scrutiny under them.

Any exclusion or suspension from participation in the Medicare and
Medicaid programs, any loss of licensure or accreditation, or any inability to
obtain any required license or permit, whether arising from any action by HHS,
any state, or any other regulatory authority, would have a material adverse
effect on the Company's business. Any significant civil or criminal penalty
resulting from such proceedings could have a material adverse effect on the
Company's business.

Food and Drug Administration

The FDA regulates certain products purchased by the Company but does
not currently regulate laboratory testing services which is the Company's
principal business. However, the Company performs some testing services using
test kits purchased from manufacturers for which final FDA pre-market clearance
for sale in the United States has not been obtained by the manufacturers

("investigational test kits"). Under current FDA regulations and policies, such
investigational test kits may be sold by manufacturers for investigational use
if certain requirements are met. The manufacturers of these investigational test
kits are responsible for marketing them under conditions meeting applicable FDA
requirements. If the Company were to be substantially limited in or prevented
from purchasing investigational test kits by reason of the FDA taking a new
regulatory direction in this area, there could be adverse effects on the
Company's ability to access new technology, which could have a material adverse
effect on the Company's business.

The FDA is currently considering new guidelines with respect to the
sale of unapproved in vitro diagnostic test kits and other products that are
sold under "investigational use only" or "research use only" labeling. While it
is uncertain what the final substance of these guidelines will be, these
guidelines could place restrictions on the distribution and use of products used
by the Company to provide testing services. In addition, on March 14, 1996, the
FDA published a proposed rule regarding the classification and reclassification
of analyte specific reagents ("ASRs"). This proposal, if promulgated as
published, could also place restrictions on the sale, distribution, labeling,
and use of products used by the Company to provide testing services. The
ultimate scope of the proposed rule and how various ASRs will be classified is
still unclear, and thus the impact on the Company's testing services cannot be
determined at this time.

Other

Certain federal and state laws govern the handling and disposal of
medical specimens, infectious and hazardous wastes and radioactive materials.
Failure to comply with such laws could subject an entity covered by these laws
to fines, criminal penalties and/or other enforcement actions.

Pursuant to the Occupational Safety and Health Act, laboratories have a
general duty to provide a work place to their employees that is safe from
hazard. Over the past few years, the Occupational Safety and Health
Administration ("OSHA") has issued rules relevant to certain hazards that are
found in the laboratory. In addition, OSHA recently has promulgated final
regulations containing requirements healthcare providers must follow to protect
workers from bloodborne pathogens. Failure to comply with these regulations,
other applicable OSHA rules or with the general duty to provide a safe work
place could subject an employer, including a laboratory employer, to substantial
fines and penalties.

Recent Developments

On February 27, 1997, the Company announced that Kevin C. Johnson has
been named as the Chief Executive Officer of the Company in addition to duties
as President of the Company. In connection with this transition, the Company
also announced that Richard A. Sandberg, a co-founder of the Company, has
resigned as Chairman of the Company's Board of Directors while remaining as a
director and consultant to the Company and that John P. Davis was appointed as
non-executive Chairman of the Company's Board of Directors, for which Mr. Davis
previously acted as Vice Chairman. In addition, G.S. Beckwith Gilbert has been
elected as Chairman of the Executive Committee.

ITEM 2. PROPERTIES

The Company leases approximately 90,850 square feet of office and
laboratory space in Stratford, Connecticut and Wilmington, Ohio under leases
which will expire in December 1997 and May 2003 for the Stratford, Connecticut
facilities and March 2001 for the Wilmington, Ohio facility, each containing
renewal options (See Note 4 to the Company's consolidated financial statements
included herewith). The Company leases five regional sales offices located in
Florida, Maryland, North Carolina, Texas and Ohio. The terms of the leases range
from one to three years.

ITEM 3. LEGAL PROCEEDINGS

None.

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

On October 24, 1996, the Company held its 1996 Annual Meeting of
Shareholders at which the following actions were approved: directors were
elected; the Company's agreement with G.S. Beckwith Gilbert and certain of his
affiliates that Mr. Gilbert and such affiliates be permitted to vote shares of
the Company's Common Stock purchased by them from the Company in October 1995
representing up to 20% of the total voting power of the Company's voting
securities outstanding from time to time (the"Voting Rights Proposal") was
approved; the adoption of the Company's 1996 Stock Incentive Plan was approved;
and the appointment of Arthur Andersen, LLP ("Arthur Andersen") as the Company's
independent public accountants for the calendar year ended December 31, 1996 was
ratified. At the 1996 Annual Meeting of Shareholders, Messrs. Richard A.
Sandberg, Kevin C. Johnson, John P. Davis, Walter O. Fredericks, Jeffrey L.
Sklar, G.S. Beckwith Gilbert and Dr. James B. Amberson were elected as directors
of the Company. The vote for Messrs. Sandberg, Johnson, Davis, Fredericks, and
Gilbert and Dr. Amberson's election each consisted of 5,342,400 votes for and
42,479 votes against and the vote for Dr. Sklar consisted of 5,339,982 votes for
and 44,897 votes against.

The other actions taken at the Company's 1996 Annual Meeting of Shareholders
were approved pursuant to the following votes:

Broker
For Against Absentions Non-Votes
--- ------- ---------- ---------

1. Approve the Voting Rights Proposal 2,802,331 188,597 17,951 2,333,521

2. Adopt 1996 Stock Incentive Plan 2,403,912 555,980 49,158 2,333,521

3. Ratify appointment of Arthur Andersen
as the Company's independent public
accountant for the calendar year ended
December 31, 1996 5,622,438 6,403 3,408 289,849

PART II

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

DIANON's Common Stock trades on The Nasdaq Stock Market under the
symbol "DIAN". The following table shows the high and low sales prices of the
Company's Common Stock quoted on the Nasdaq Stock Market, for the periods
indicated below:

High Low
---- ---

1995:
First Quarter 6-1/8 3-3/4
Second Quarter 5-1/4 4-3/8
Third Quarter 5-3/4 4-7/16
Fourth Quarter 5 3-1/4

1996:
First Quarter 5-1/2 3-3/8
Second Quarter 8-5/8 4-1/8
Third Quarter 7-3/8 4-1/2
Fourth Quarter 9-5/16 6-3/8

As of March 14, 1997, the Company had approximately 2,511 shareholders
of record. No dividends have been paid by DIANON and it is not anticipated that
any will be paid in the foreseeable future.

ITEM 6. SELECTED FINANCIAL DATA

Statement of Operations: 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(in thousands, except per share data)

Net revenues(1) $ 56,000 $ 45,700 $ 41,017 $ 38,250 $ 34,456

Gross profit(1) 29,101 25,310 24,300 24,311 21,832

Expenses:
Selling(1) 10,618 9,709 9,008 9,783 7,885
Marketing 3,160 1,811 1,856 1,911 1,807
Research and development 3,157 5,255 4,512 4,342 3,369
General and administrative(1) 8,666 8,100 6,641 7,123 7,204
-------- -------- -------- -------- --------
Total expenses(2) 25,601 24,875 22,017 23,159 20,265

Income from operations 3,500 435 2,283 1,152 1,567

Net interest income (expense) 307 181 (90) (36) 223
Provision for income taxes(3) 1,637 509 832 270 776
-------- -------- -------- -------- --------
Net income $ 2,170 $ 107 $ 1,361 $ 846 $ 1,014
-------- -------- -------- -------- --------
Net income per share $ .34 $ .02 $ .26 $ .16 $ .19
Weighted average shares
outstanding 6,331 5,563 5,310 5,337 5,451
Dividend per share None None None None None

Balance Sheet Data:

Working capital $ 18,058 $ 16,974 $ 11,931 $ 11,110 $ 11,518
Total assets 34,536 30,455 25,206 24,614 21,103
Long-term obligations 272 750 1,674 2,519 194
Stockholders' equity 26,549 23,452 18,664 17,147 16,373

<FN>
- ----------
(1) Since implementing the restructuring of the international operations at the
end of the third quarter of 1992, international operating results have been
consolidated with domestic operating results in the consolidated statements
of operations. Applying the same accounting principles to prior periods,
the Company's revenue, cost of goods sold, selling, general and
administrative expenses for 1992 were higher by $327,000, $217,000,
$1,028,000, respectively.

(2) During 1996, 1995, 1994, 1993 and 1992, non-recurring charges relating to
severance, restructuring, accelerated amortization and other one-time costs
of $609,000, $2,668,000, $692,000, $2,542,000 and $1,674,000, respectively,
were incurred. (See Notes 2, 7, 10 and 13 to the Company's consolidated
financial statements included herewith).

(3) The Company's provision for income taxes in 1995, 1994, and 1993 includes
the benefit received from the utilization of tax credits. (See Note 3 to
the Company's consolidated financial statements included herewith).
</FN>

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

Results of Operations

o Net Revenues

Net revenues were $56 million in 1996, an increase of $10.3 million or
23% from 1995. Increased sales were attributable to increased market penetration
by the Company's anatomic pathology testing services. The increase in anatomic
pathology services in 1996 over 1995 was offset to some extent by a decrease in
clinical chemistry and hospital based tissue testing services.

Net revenues were $45.7 million in 1995, an increase of $4.7 million or
11% from 1994. Increased sales were attributable to increased market penetration
by the Company's anatomic pathology testing services. The increase in sales in
1995 and 1994 was offset to some extent by a decrease in clinical chemistry and
hospital based tissue testing services.

o Cost of Sales

Cost of sales, which consists primarily of payroll, laboratory
supplies, outside services, logistics (primarily shipping and handling), and
depreciation expense, was $27 million during 1996, an increase of $6.5 million
or 32% from 1995. Salaries and wages were approximately $8.7 million in 1996, an
increase of $2.6 million or 43% from 1995. This increase was principally due to
the average number of full time equivalent laboratory employees rising from 143
in 1995 to 193 in 1996. This increase in laboratory headcount was due in part to
the growth of the Company's anatomic pathology testing services in 1996.
Laboratory supplies were approximately $5.7 million in 1996, an increase of
$865,000 or 18% from 1995. This increase was the result of higher volume and
costs for reagents used for some of the Company's testing services. Logistics
were $4.6 million in 1996, an increase of $638,000 or 16% from 1995, primarily
due to higher sales volume. Overhead expenses (primarily building rent,
utilities and depreciation) were $7.9 million during 1996 an increase of $2.1
million or 36% over 1995. This increase was due primarily to the additional
facilities oriented expenses associated with the introduction of the Company's
new anatomic pathology testing service product line, specifically in the form of
additional depreciation and building expenses incurred from the continued
expansion and equipping of the Company's facilities. As a percentage of net
revenues, cost of sales increased to 48% during 1996 from 45% during 1995.

Cost of sales was $20.4 million during 1995, an increase of $3.7
million or 22% from 1994. Salaries and wages were approximately $6.1 million in
1995, an increase of $1.7 million or 39% from 1994. This increase was
principally due to the average number of full time equivalent laboratory
employees increasing from 112 in 1994 to 143 in 1995. This increase in
laboratory headcount was incurred in part to support new anatomic pathology
testing services and in part to prepare for anticipated growth in 1996.
Laboratory supplies were approximately $4.8 million in 1995, an increase of
$544,000 or 13% from 1994. This increase was the result of rising volume and
increased costs for reagents used for some of the Company's testing services.
Logistics were $4 million in 1995, an increase of $280,000 or 8% from 1994. This
increase was due to increased sales volume. Overhead expenses (primarily
building rent, utilities and depreciation) were $5.5 million during 1995, an
increase of $1.1 million or 26% over 1994. This increase was due primarily to
the additional facilities oriented expenses associated with the introduction of
the Company's new anatomic pathology product line, specifically in the form of
additional depreciation and building expenses incurred from the initial
expansion and equipping of the Company's facilities. As a percentage of net
revenues, cost of sales increased to 45% during 1995 from 41% during 1994.

o Gross Profit

As a result of the increase in sales volume in 1996, gross profit
increased $3.8 million from 1995. The Company's gross profit margin decreased to
52% in 1996 from 55% in 1995. The gross profit margin continued to decrease from
1995 to 1996 due to the erosion of the average price reimbursed for certain
clinical chemistry testing services and the higher costs associated with
providing anatomic pathology testing services.

Gross profit was $25.3 million in 1995, an increase of $1.0 million or
4% from 1994. As a percentage of net revenues, gross profit decreased to 55% in
1995 from 59% in 1994. The gross profit margin continued to decrease from 1994
to 1995 due to the erosion of the average price reimbursed for certain clinical
chemistry testing services and the higher costs associated with providing
anatomic pathology testing services.

The clinical laboratory industry, which includes both clinical
chemistry and anatomic pathology, has seen steady downward pressure on prices
exerted by both government and private third party payors. Also, payment for
services such as those provided by the Company is and likely will continue to be
affected by periodic reevaluations made by payors concerning which services to
reimburse and which to cease reimbursing. The reduction in reimbursement rates,
particularly by Medicare, has generally decreased the average unit price for
most of the Company's clinical chemistry services each year. In keeping with
this trend, as part of OBRA '93, Congress reduced over time the national cap on
Medicare laboratory fee schedules. This national cap has been lowered each year
and now is 76% of the national median. OBRA '93 also eliminated the annual
updates of Medicare laboratory fee schedules for the years 1994 and 1995. In
1996, however, the fee schedule update was 3.2%; the HCFA has recently announced
that the fee schedule update for 1997 will be 2.7%. However, the corresponding
expected national cap increase of 2.7% may not be fully realized due to a
recalculation of national medians necessitated by conversion in some carrier
areas to a single statewide fee schedule.

With respect to the Company's tissue testing services which are not
reimbursed under the Medicare laboratory fee schedules, the Medicare fees for
these services also generally declined with the implementation of the RBRVS
system which went into effect in 1992 and was fully phased in by the end of
1996. The Medicare RBRVS payment for each service is calculated by multiplying
the total RVU's established for the service by a conversion factor that is set
by law. The number of RVU's assigned to each service is in turn calculated by
adding three separate components, including one representing the relative work
values. In 1996, HCFA completed a five-year review of the work value component
and, as a result, revised the work value amount assigned to many physician
services. In addition, based on a default formula established in law, the 1997
conversion factor for nonsurgical services dropped 0.8% from 1996 to $33.8454
per conversion factor. The changes resulting from the five-year review, combined
with the conversion factor reductions, resulted in an overall decrease in
payments for pathology services of approximately 5.7% beginning January 1, 1997.
Also, HCFA reduced the number of physician fee schedule payment localities from
210 to 89, effective January 1, 1997. Connecticut was one of the states that
HCFA moved to a single payment locality. This modification created a 3.2%
decrease in the RBRVS geographic adjustment factor for physicians located in
Eastern Connecticut, where the Company's primary operations are located. In the
past, implementation of the RBRVS program has had the effect of reducing prices,
and thus the gross profit, of the Company. The recent substantial RBRVS
adjustments are likely to continue this trend.

Furthermore, as a result of the Social Security Act amendments of 1994,
Medicare is required to revise the formula for calculating the practice expense
component of the physicians' Medicare fee schedule from the current historical
basis to a resource basis beginning January 1, 1998. Some concern has been
expressed by physician specialty groups that this data HCFA plans to use for
these revisions is not adequate and that the agency's methodology could result
in specialty practice expenses being underestimated. At this point, HCFA is
considering a variety of options for calculating practice expense revisions. It
is possible that certain changes HCFA might make would have a significant
negative affect on reimbursement, and thus gross profit, for anatomic pathology
services. Practice expenses currently account for approximately 42% of the
physicians' Medicare fee schedule payment amount.

Any future changes in government and other third-party payor
reimbursement which may come about as a consequence of an enactment of health
care reform or of deficit reduction legislation also likely will continue the
downward pressure on prices and make the market for clinical laboratory services
more competitive. Changes in government reimbursed medicare, as previously
described in the reimbursement section are possible this year. Because of the
uncertainties about the exact nature of any changes which may ultimately be
adopted, however, the Company currently is unable to predict their ultimate
impact on the clinical laboratory industry generally or on the Company in
particular. Even apart from federal legislative action, reforms may occur at the
state level and changes are occurring in the marketplace as a result of market
pressures, including the increasing number of patients covered by some form of
managed care. In the past, the Company has offset a substantial portion of the
impact of price decreases and coverage changes through the achievement of
economies of scale and other strategies such as more favorable purchase
contracts and the introduction of alternative technologies. However, if price
decreases (for example arising from the proposed Medicare changes discussed
above) or coverage changes were to be rapidly and fully implemented, they would
be likely to have an adverse impact on gross profits from the Company's testing
services until management was able to mitigate such impact. Furthermore, in
recent years the Company's gross profit margin has trended down from over 60% to
about 52%, and there can be no assurances that such trends may not continue.

o Selling, General and Administrative Expenses

Selling, general and administrative expenses were $22 million during
1996, an increase of $4.9 million or 29% from 1995. General and administrative
expenses were $11.6 million in 1996, an increase of $3.0 million or 35% from
1995. These increases were primarily attributed to higher sales levels resulting
in increased selling, general and administrative activities of the Company. As a
percentage of net revenues, selling, general and administrative expenses
increased to 39% in 1996 from 37% in 1995.

Selling, general and administrative expenses were $17.1 million during
1995, an increase of $249,000 or 1% from 1994. General and administrative
expenses were $8.6 million in 1995, an increase of $234,000 or 3% from 1994.
These increases were primarily attributed to higher sales levels resulting in
increased selling, general and administrative activities of the Company. As a
percentage of net revenues, selling, general and administrative expenses
decreased to 37% in 1995 from 41% in 1994.

o Research and Development

Research and development expenses include the costs of building the
Company's database and the review, analysis and clinical evaluation of existing
as well as new technologies. Research and development expenses were $3.1 million
in 1996, a decrease of approximately $2.1 million or 40% from 1995. This
decrease in 1996 is primarily due to the completion in 1996 of the major portion
of expenditures for the development of the new anatomic pathology services. As a
percentage of net revenues, research and development expenses decreased to 6%
during 1996 compared to 12% in 1995. With the completion of such development
activities, it is expected that such expenditures will represent a smaller
percentage of sales in future years.

Research and development expenses were $5.3 million in 1995, an
increase of approximately $743,000 or 16% from 1994.

o Amortization Expense

Amortization expenses were $399,000 in 1996, a decrease of
approximately $866,000 or 68% from 1995. In the fourth quarter of 1996, the
Company recorded an extraordinary accelerated amortization charge of
approximately $44,000 based on management's estimate of future benefits
anticipated from a customer list (compared to a $765,000 accelerated
amortization charge in 1995).

Amortization expenses were $1.3 million in 1995, an increase of
approximately $723,000 or 133% from 1994. In the second quarter of 1995, the
Company recorded an extraordinary accelerated amortization charge of
approximately $765,000 based on management's estimate of future benefits
anticipated from a customer list (no such charge was recorded in 1994).

Amortization expense, severance costs, investment write-down and
restructuring costs have been included in general and administrative and
research and development expenses in the consolidated statements of operations
in the Company's consolidated financial statements included herewith.

o Severance Costs

During 1996, the Company recorded a reserve of approximately $148,000
for severance costs as a result of the resignation of certain officers of the
Company. Severance costs are expected to be paid by the end of the second
quarter of 1997.

During 1995, the Company recorded a reserve of approximately $595,000
for severance costs as a result of the streamlining its operating expenses and
the resignation of certain officers of the Company. Severance costs were paid by
the end of the second quarter of 1996.

o Investment Write-down

During 1996 and 1995, the Company recorded charges of $62,000 and
$530,000, respectively, to write down the investment in common stock of a
publicly traded company to market value as the loss in value was deemed other
than temporary in accordance with Statement of Financial Accounting Standard
115, "Accounting for Certain Investments in Debt and Equity Securities". The
Company plans to sell its remaining 24,386 shares of common stock of such
company in 1997.

o Restructuring Costs

In 1995, the Company provided a reserve of $279,000 due to management's
decision to discontinue European based operations. Remaining reserves for the
discontinuance of such operations at December 31, 1996 are approximately
$155,000. The Company is in the process of liquidating the European based
operations and plans to complete the liquidation process by the end of the 1997
fiscal year.

o Interest Income

Cash and cash equivalents as of December 31, 1996 was approximately
$7.5 million of which approximately $6 million was invested at year end. The
Company's interest income was approximately $384,000 for 1996, an increase of
approximately $67,000 or 21% from 1995.

Cash and cash equivalents as of December 31, 1995 was approximately $11
million. Approximately $4.6 million came from a private placement in October
1995. The Company's interest income was approximately $317,000 for 1995, a
increase of approximately $214,000 or 207% from 1994 which was caused both by
higher interest rates and by investing over $4.6 million from the private
placement completed in October 1995.

o Interest Expense

Interest expense was approximately $77,000 for 1996, a decrease of
$59,000 or 43% from 1995. The decrease in interest expense during 1996 was due
to the pay-down of a portion of the $3.5 million term loan obtained in July 1993
which bears interest at 6% per year.

Interest expense was approximately $136,000 for 1995, a decrease of
$58,000 or 30% from 1994. The decrease in interest expense during 1995 was due
to the pay-down of a portion of the $3.5 million term loan obtained in July
1993.

o Provision for Income Taxes

Provision for income tax expense was approximately $1,637,000 for 1996,
representing an increase of approximately $1.1 million or 222% from 1995 as a
result primarily of higher pretax income (pretax income increased 518%). The
effective tax rate was 43% during 1996 compared to 83% for 1995.

Provision for income tax expense was approximately $509,000 for 1995,
representing a decrease of approximately $323,000 from 1994 as a result of lower
pretax income. The effective tax rate was 83% during 1995 compared to 38% for
1994. The increase in the effective tax rate during 1995 was due to certain
expenses not being deductible for tax purposes including $530,000 arising from
the write-down of the investment in common stock of a publicly traded company.

o Net Income

As a result of the foregoing, 1996 net income was $2.2 million as
compared to $107,000 in 1995. Net income for 1995 decreased approximately $1.3
million or 92% from 1994. Net income for 1995 includes approximately $2.2
million in pretax extraordinary charges relating to severance, restructuring and
other extraordinary costs as compared to $254,000 for similar charges in 1996.

o Earnings Per Share

Earnings per share were $.34 in 1996, as compared to $.02 in 1995. The
extraordinary charges incurred in 1995 (described in the immediately succeeding
paragraph) represented approximately a $.23 reduction in 1995 earnings per share
(using an approximate pro forma 41% effective tax rate). Extraordinary charges
were substantially less in 1996, representing approximately a $.02 reduction in
1996 earnings per share (using an approximate pro forma 41% effective tax rate).

Earnings per share were $.02 in 1995, as compared to $.26 in 1994. The
non-recurring charges for the accelerated amortization of a customer list
recorded in the second quarter of 1995 for $765,000, the write-down of
investment for $530,000, the international restructuring reserve for $279,000
and the severance costs for $595,000 represented approximately a $.23 reduction
in 1995 earnings per share using a pro forma effective tax rate of approximately
41%.

o Liquidity and Capital Resources

As of December 31, 1996, the Company had total cash and cash
equivalents of $7.5 million which was invested in a fund holding U.S. Treasury
securities with maturities of less than three months.

As of December 31, 1996, the Company had working capital of $18.1
million compared to $17.0 million at December 31, 1995. The working capital
ratio as of December 31, 1996 was 3.4 to 1 compared to 3.7 to 1 at December 31,
1995.

Domestic trade receivables, net, were $15.2 million as of December 31,
1996, an increase of $5.7 million or 61% from December 31, 1995. During the
fourth quarter of 1996, the average number of days sales in domestic trade
receivables was approximately 79 days as compared to 65 days for the comparable
period of 1995. The increase in average number of days sales was a result of
increased volume in the growth of the Company's anatomic pathology services and
increased complexity of billing for anatomic pathology services.

Capital expenditures for 1996, 1995 and 1994 were $3.4 million, $2.3
million and $1.6 million, respectively. Capital expenditures for 1996 were
mainly for the expansion of the Company's laboratory facilities. Approximately
$1.9 million related to leasehold improvements to expand the Company's physical
plant in Stratford, CT and to develop the Company's new specimen processing
facility in Wilmington, OH.

In July 1993, the Company obtained a $3.5 million term loan from a bank
bearing interest at 6% per year and payable over a 47 month period. During 1995,

the loan agreement was modified to revise certain financial covenants, including
those with respect to tangible net worth and debt service coverage requirements
and limitation on certain expenditures. The principal outstanding under such
term loan is approximately $650,000 as of December 31, 1996 (See Note 11 to the
Company's consolidated financial statements included herewith).

On October 5, 1995, the Company completed a $5,612,000 private
placement with an investor for one million shares of Common Stock and a two-year
warrant for 800,000 shares exercisable at $6.00 per share of Common Stock
(except as otherwise described below). The Company received cash of $5,316,000
and a two-year promissory note for $296,000 bearing 7% interest. Some or all of
the warrants could be exercised at a price of $5.00 at any time on or before
October 31, 1996. Upon such election the Company would be required to extinguish
as an adjustment to the purchase price paid for such warrants, for each such
warrant for which such election has been made, $0.37 of the principal amount of
the note upon payment of the interest due on such extinguished amount for the
outstanding period. If the warrants for 800,000 shares were all exercised on or
before October 31, 1996, the two year promissory note for $296,000 would be
fully extinguished. On August 20, 1996, the Company's Board of Directors
approved an amendment to the terms of the warrants to extend from October 4,
1996 to October 31, 1996, the date through which the warrants could be exercised
at $5.00 per share. The amendment was approved in connection with the scheduling
of the Company's Annual Meeting for October 24, 1996 to enable voting at such
meeting on the Company's agreement to enable the investor to vote shares of the
Company's common stock owned by such investor and certain affiliates
representing up to 20% of the total voting power of the Company's voting
securities outstanding from time to time to be completed prior to the expiration
of the $5.00 per share exercise price. The Company's agreement was approved at
the Company's Annual Meeting on October 24, 1996. On October 29, 1996, the
investor exercised warrants for all 800,000 shares and in exchange for the
payment of approximately $4.0 million in cash representing the aggregate
exercise price of such warrants and interest on the principal amount of the
two-year promissory note for the outstandng period, the Company issued to the
investor 800,000 shares of its Common Stock and fully extinguished and cancelled
the promissory note.

As of December 31, 1996, the Company had purchased 117,196 shares of
Common Stock as required by its Employee Stock Purchase Plan ("ESPP"). The
Company's Board of Directors has authorized additional acquisitions for ESPP
requirements for further additional share repurchases costing up to $2,000,000.

The Company believes that cash flows from operations and available cash
and cash equivalents are adequate to fund the Company's operations for the
foreseeable future.

Risk Factors; Forward Looking Statements

The Management's Discussion and Analysis and the information provided
elsewhere in this 10K (including, without limitation, in the third and fourth
paragraphs of "Item 1. Business" and under "Gross Profit" and "Liquidity and
Capital Resources" above) contain forward looking statements regarding the
Company's future plans, objectives, and expected performance. These statements
are based on assumptions that the Company believes are reasonable, but are
subject to a wide range of risks and uncertainties, and a number of factors
could cause the Company's actual results to differ materially from those
expressed in the forward-looking statements referred to above. These factors
include, among others, the uncertainties in reimbursement rates and
reimbursement coverage of various tests sold by the Company to beneficiaries of
the Medicare program (see e.g. Item 1 - Business - "Reimbursement"); being
deemed to be not in compliance with Federal or state regulatory requirements
(see e.g. Item 1 - Business - "Regulatory"); the uncertainties relating to the
ability of the Company to convince physicians and/or managed care organizations
to use the Company as a provider of anatomic pathology testing services; the
ability of the Company to maintain superior quality relative to its competitors;
the ability of the Company to maintain its hospital-based business in light of
the competitive pressures and changes occurring in hospital healthcare delivery;
the uncertainties relating to states erecting barriers to the performance of
anatomic pathology testing by out-of-state laboratories; the ability of the
Company to find, attract and retain qualified management and technical
personnel; the uncertainties associated with competitive pressures from the
large national laboratories, small specialized laboratories and well established
local pathologists; and the uncertainties which would arise if integrated
delivery systems closed to outside providers emerged as the dominant form of
health care delivery.

PART III

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's consolidated financial statements and schedule and the
reports of independent public accountants thereon appear beginning on page F-2.
See index to such consolidated financial statements and schedules and reports on
page F-1.

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following information with respect to the principal occupation or
employment, other affiliations and business experience of each director and
executive officer during the last five years has been furnished to the Company
by such director or executive officer. Except as indicated, each of the
directors and executive officers has had the same principal occupation for the
last five years.

Information Regarding Directors

Set forth below is certain information concerning each director of
Dianon Systems, Inc.

Richard A. Sandberg, age 54, is a founder of the Company, and served as
either Chief Executive Officer or Co-Chief Executive Officer and as a director
from the Company's inception until May 1996. Mr. Sandberg also served as
Chairman of the Board from 1989 to February 1997. He currently serves the
Company as a Director and consultant. Mr. Sandberg also serves as a Director of
UroMed Corporation.

Kevin C. Johnson, age 42, a Director since May 1996, has served as
President since May 1996, when he joined the Company. In February 1997, he was
given the additional title of Chief Executive Officer. Formerly, Mr. Johnson was
with Corning Inc., a manufacturer of specialty materials and a provider of
laboratory services, for eighteen years, serving most recently as Vice President
and General Manager of Corning Clinical Laboratories' largest region in
Teterboro, New Jersey.

John P. Davis, age 55, a Director since 1984, is President and Chief
Executive Officer of Calypte Biomedical Corp., a diagnostic products company.
From 1984 to January 1995, Mr. Davis was an officer of the Company. Mr. Davis
joined the Company in January 1984 as President and Chief Operating Officer, and
subsequently became co-Chief Executive Officer in 1992 and Chief Executive
Officer in 1994. In January 1995, Mr. Davis resigned as Chief Executive Officer
of the Company and became Vice Chairman of the Board. As of February 1997, Mr.
Davis was elected non-executive Chairman of the Board. Mr. Davis also serves as
a Director of PepGen Corporation.

Walter O. Fredericks, age 57, a Director since 1989, is Chairman,
President and Chief Executive Officer of Lifecodes Corporation and Chairman of
Cellmark Diagnostics, Inc., both of which are in the human identity testing and
product supply field. Mr. Fredericks is also President and Chairman of
Electronic Instruments International Corporation, a manufacturer of electronic
instrumentation.

Jeffrey L. Sklar, age 49, a Director since 1994, is director, Division
of Diagnostic Molecular Biology, Department of Pathology, Brigham and Women's
Hospital. Dr. Sklar is Professor of Pathology, Harvard Medical School, and since
1992, Dr. Sklar has also served as Director, Molecular Diagnostic Laboratory,
Dana-Farber Cancer Institute. Dr. Sklar presently serves on the Editorial Boards
of the American Journal of Pathology and Genes, Chromosomes, and Cancer. In
addition, Dr. Sklar serves on the Scientific Advisory Committee for Clinical
Science, The Fred Hutchinson Cancer Center, Seattle, Washington; the Scientific
Advisory Committee, New England Primate Research Center, Harvard University; and
the Pathology B Study Section, National Institutes of Health. Dr. Sklar holds an
M.D. and Ph.D. from Yale University and a M.A. (honorary) from Harvard
University.

G. S. Beckwith Gilbert, age 55, a Director since October 1995, is
President, Chief Executive Officer and a Director of Field Point Capital
Management Company in Greenwich, Connecticut, a merchant banking firm. Mr.
Gilbert is also a partner of Wolsey & Co., a merchant banking firm. Mr. Gilbert
serves as a Director of Davidson Hubeny Brands, Inc. and TMS Technologics, Inc.
Mr. Gilbert is a graduate of Princeton University and has an M.B.A. from New
York University. In February 1997, Mr. Gilbert was elected Chairman of the
Executive Committee.

James B. Amberson, age 45, a Director since January 1995, is Senior
Vice President, Operations and Chief Medical Officer. Dr. Amberson joined DIANON
in 1989 as Director, Cytometry Business Unit, and has served as Vice President
of Pathology Services, Vice President of Medical Affairs and Senior Vice
President and General Manager of the Anatomic Pathology Unit before his present
position. Prior to joining the Company, he was Assistant Professor of Pathology,
Cornell University Medical College for six years. Dr. Amberson holds an M.D.
from Johns Hopkins University, and an M.B.A. from Columbia University School of
Business.

Compensation of Directors

Directors who are not employees of the Company are paid $1,500 for each
meeting of the Board of Directors attended in person and $500 for each meeting
attended by telephone. In addition, committee members are paid $500 for each
committee meeting attended which does not occur on the same day as a Board
meeting. Directors are also reimbursed for expenses to attend meetings of the
Board and its committees. In addition, the Company has made payments to Brigham
& Women's Hospital, Inc. for which Dr. Sklar is director, Division of Diagnostic
Molecular Biology, Department of Pathology. (See Note 6 to the Company's
consolidated financial statements included herewith.)

Pursuant to the Company's 1996 Stock Incentive Plan, Directors who are
not employees of the Company receive (i) automatic initial and quarterly grants
of stock options with tandem limited stock appreciation rights beginning July
1995, (ii) automatic quarterly grants of shares of Common Stock beginning
January 1997 and (iii) additional stock options or other equity awards to the
extent granted by the Board of Directors in its discretion.

Each initial and quarterly stock option which is automatically granted
under such plan is exercisable for that number of shares obtained by dividing
$5,000 by the closing price of the Common Stock on the date of grant and is
exercisable at that price. Each such option has a 10-year term and vests with
respect to 10% of the underlying shares on the date which is three months after
the date of grant, and an additional 10% at the end of each three-month period
thereafter. Each such option can be exercised for five years following a
director's termination of service to the extent it had vested prior to
termination. Each automatic quarterly stock grant is for the number of shares
obtained by dividing $2,000 by the closing price of the Common Stock on the date
of grant, and is fully vested at grant.

In November 1996, pursuant to authorization by the Board of Directors,
the Company granted to Dr. Sklar options to purchase 10,000 shares of Common
Stock at an exercise price of $6.375 to compensate him for his services as a
Director, which options vested 40% on grant with the remaining options vesting
20% on each of August 4, 1997, August 4, 1998 and August 4, 1999. Such grant is
a replacement of options to purchase 10,000 shares of Common Stock authorized
but not accepted by Dr. Skar in 1994 due to the conditions of his employment by
Brigham & Women's Hospital, Inc. In October 1996, pursuant to authorization by
the Board of Directors, the Company granted options to purchase 10,000 shares of
Common Stock at an exercise price of $7.125 per share to Mr. de Bruin in
replacement of options issued in June 1993 which were due to expire in June 2000
and were 60% vested as of October 1996 with the remaining options vesting 20% on
each of June 4, 1997 and June 4, 1998. These replacement options vested 100% in
October 1996 and expire ten years from the date of grant.

Messrs. Sandberg and Johnson and Dr. Amberson received no additional
compensation during 1996 for their services as directors of the Company.

Information Regarding Executive Officers

David R. Schreiber, age 37, has served as Senior Vice President,
Finance, Chief Financial Officer and Corporate Secretary since November 1996
when he joined the Company. Formerly, Mr. Schreiber was with Corning Clinical
Laboratories for 10 years, serving most recently as Vice President and General
Manager of the laboratory's Midwest region. Mr. Schreiber holds an M.B.A. from
Northern Illinois University.

Robert C. Verfurth, age 37, joined the Company in February 1989 as a
Sales Representative. He subsequently served as Southeast Regional Sales
Manager, National Accounts Manager, and Director of Sales. He has served as Vice
President, Sales since December 1996. Before joining the Company, Mr. Verfurth
was a captain in the U.S. Air Force. Mr. Verfurth holds an M.S. from the
University of Southern California.

James T. Barry, age 35, joined the Company in July 1989 as Corporate
Recruiter and subsequently served as Director of Managed Care. He has served as
Vice President of Marketing & Technology since December 1996. Before joining the
Company, Mr. Barry was a major in the U.S. Marine Corps. Mr. Barry holds a B.A.
from Rhode Island College.

Steven T. Clayton, age 30, has served as Vice President, Information
Services since he joined the Company in December 1996. Prior to joining the
Company, Mr. Clayton was with Corning Clinical Laboratories for nine years
serving most recently as the Midwest Regional Director of Information Systems.
Mr. Clayton holds an A.S.M. from Thomas Edison State College.

For information with respect to Mr. Johnson and Dr. Amberson, who are
also directors, see ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- - Information Regarding Directors.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than ten
percent of a registered class of the Company's equity securities, to file with
the Securities and Exchange Commission initial reports of ownership and reports
of changes in ownership of Common Stock and other equity securities of the
Company. Officers, directors and greater than ten percent shareholders are
required to furnish the Company with copies of all Section 16(a) forms they
file.

To the Company's knowledge, based solely on review of the copies of
such reports furnished to the Company and representations that no other reports
were required during the fiscal year ended December 31, 1996, all Section 16(a)
reporting requirements applicable to its officers, directors and greater than
ten percent beneficial shareholders were complied with except for the following:
Messrs. Johnson, Schreiber, Clayton, Verfurth and Barry each were late in filing
their initial Form 3 when becoming subject to the Section 16 reporting
requirements. Drs. Amberson and Sklar each filed a late report with respect to
one transaction. Mr. Gilbert filed a late report with respect to five outside
director option grants that became effective upon shareholder approval of the
1996 Stock Incentive Plan at the Company's Annual Meeting of Shareholders on
October 24, 1996.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth information with respect to the
following named executive officers: (i) the person who served as Chief Executive
Officer ("CEO") during 1996, (ii) the four executive officers other than the CEO
serving at December 31, 1996 whose total salary and bonus for 1996 exceeded
$100,000, and (iii) two additional executive officers who terminated employment
with the Company during 1996.

SUMMARY COMPENSATION TABLE
Long Term
Annual Compensation Compensation
----------------------------------- ------------
Long Term
Other Securities
Name and Annual Underlying All Other
Principal Position Year Salary Bonus Compensation Options (4) Compensation
------------------ ---- ------ ----- ------------ ----------- ------------

Richard A. Sandberg (1) 1996 $212,500 $20,000 $ -- -- $ 3,681 (2)
Chairman of the Board and 1995 212,500 36,975 -- -- 3,681
Chief Executive Officer 1994 203,280 47,902 -- 20,000 3,681

Kevin C. Johnson (3) 1996 174,520 50,000 (4) -- 200,000 1,507 (5)
President and Director

David R. Schreiber 1996 29,231 80,000 (6) -- 50,000 1,742 (7)
Sr. Vice President Finance,
Chief Financial Officer and
Corporate Secretary

James B. Amberson, M.D. 1996 200,013 47,869 -- 15,000 2,530 (8)
Senior Vice President, 1995 185,465 36,997 -- 25,000 2,104
Operations and Chief 1994 173,764 39,230 -- 31,500 12,889
Medical Officer and
Director

Albert A. Luderer, Ph.D. (9) 1996 171,191 29,206 -- -- 9,199 (11)
Vice President, Technology 1995 163,369 41,758 4,190 (10) 10,000 8,530
1994 155,048 27,110 2,214 (10) 26,000 22,639

Carl R. Iberger(12) 1996 88,587 13,212 -- -- 71,318 (13)
Vice President, Finance and 1995 108,952 27,788 -- -- 3,144
Administration and 1994 103,981 17,847 -- 26,800 3,465
Corporate Secretary

Daniel J. Cronin (14) 1996 89,048 13,564 -- -- 6,368 (15)
Vice President, Management 1995 91,038 18,995 -- 4,000 3,092
Information Systems 1994 79,615 15,904 -- 15,800 726

<FN>
- ----------
(1) Mr. Sandberg ceased serving as Chief Executive Officer of the Company in
May 1996, while continuing to serve as an employee holding the title
Chairman of the Board. As of February 1997, Mr. Sandberg resigned as
Chairman of the Board. He continues to serve as a Director and consultant
to the Company.

(2) The $3,681 indicated for Mr. Sandberg represents contributions paid by the
Company pursuant to the Company's 401(K) Retirement Plan and premiums paid
by the Company for term life insurance which for 1996 amounted to $1,500
and $2,181, respectively.

(3) Mr. Johnson joined the Company as President in May 1996 and was elected to
the position of Chief Executive Officer in February 1997.

(4) The $50,000 indicated for Mr. Johnson represents a sign-on bonus he
received when he joined the Company in May 1996.

(5) The $1,507 indicated for Mr. Johnson represents premiums paid by the
Company for term life insurance.

(6) The $80,000 indicated for Mr. Schreiber represents a sign-on bonus he
received when he joined the Company in November 1996.

(7) The $1,742 indicated for Mr. Schreiber represents relocation costs paid in
1996.

(8) The $2,530 indicated for Dr. Amberson represents contributions paid by the
Company pursuant to the Company's 401(K) Retirement Plan and premiums paid
by the Company for term life insurance which for 1996 amounted to $1,500
and $1,030, respectively.

(9) Dr. Luderer resigned as Vice President, Technology in January 1997.

(10) The amounts indicated for 1995 and 1994 for Dr. Luderer are relocation tax
gross-ups.

(11) The $9,199 indicated for Dr. Luderer includes deferred compensation under
the Company's vacation banking policy accrued for during 1996,
contributions paid by the Company pursuant to their 401(K) Retirement Plan,
and premiums paid by the Company for term life insurance which for 1996
amounted to $6,681, $1,300 and $1,218, respectively.

(12) Mr. Iberger resigned as Vice President, Finance and Administration and as
Corporate Secretary in September 1996.

(13) The $71,318 indicated for Mr. Iberger represents severance pay,
contributions paid by the Company pursuant to the Company's 401(K)
Retirement Plan and premiums paid by the Company for term life insurance
which for 1996 amounted to $69,339, $1,500 and $479, respectively.

(14) Mr. Cronin resigned as Vice President, Management Information Systems in
December 1996.

(15) The $6,368 indicated for Mr. Cronin represents severance pay, contributions
paid by the Company pursuant to the Company's 401(K) Retirement Plan and
premiums paid by the Company for term life insurance which for 1996
amounted to $5,452, $520 and $396, respectively.
</FN>

Employment and Severance Agreements

In January 1995, Mr. Davis resigned his full-time employment and
officer position with the Company. The Company paid approximately $257,000
during 1995 and $21,000 during 1996 for severance benefits to Mr. Davis. As part
of the severance agreement, during 1995 stock options to purchase 69,916 shares
of Common Stock at exercise prices ranging from $4.56 to $10.75 were cancelled
and stock options to purchase 116,084 shares of Common Stock with exercise
prices ranging from $8.00 to $10.75 were amended to set their exercise price at
$5.25. These amended options vested 25% in March 1995 and the remaining 75% in
January 1997.

The Company entered into an employment agreement with Mr. Johnson on
May 2, 1996 as President of the Company. The agreement provides for an initial
base salary of $275,000 per annum, the grant of options to purchase 200,000
shares of Common Stock with a 10-year term and an exercise price of $5.69, stock
grants of 15,000 shares of Common Stock on each of January 2, 1997 and January
2, 1998 provided Mr. Johnson continues to be employed by the Company, a signing
bonus of $50,000 and a loan of $150,000. The loan carries an interest rate of
5.9%, payable annually, and is repayable upon termination of Mr. Johnson's
employment by the Company. If Mr. Johnson continues to be employed by the
Company, the loan principal will be forgiven at the rate of $2,500 per complete
month of employment from January 31, 1998 through December 31, 2002. This
agreement provides that in the event of a termination of Mr. Johnson's
employment other than for "Cause", as defined in the agreement, he is entitled
to receive one year's salary and other benefits. Subject to the foregoing, this
agreement is subject to termination at will by either party.

The Company entered into executive employment agreements with Richard
A. Sandberg and Dr. James B. Amberson (the "Employees") on September 1, 1996.
Each such agreement provides that in the event of a "Change in Control of the
Company", as defined in the agreements, if the Employee's employment is
terminated other than for "Cause", as defined in the agreements, he is entitled
to receive one year's salary and bonus and all his stock options will vest
completely. The agreements expire in September 2001 and are subject to
successive automatic one-year renewals thereafter (unless certain notice is
given).

The Company also entered into an employment agreement with Dr. James B.
Amberson on September 1, 1996. Pursuant to such agreement, Dr. Amberson is
entitled to a salary as determined by the Company and other benefits of the
Company. This agreement provides that in the event of a termination of Dr.
Amberson's employment for other than "Stated Cause" (as defined in the
agreement), he is entitled to receive six months salary and other benefits.
Subject to the foregoing, this agreement is subject to termination at will by
either party.

During the third quarter 1996, the Company recorded a charge of
$133,933 for severance benefits relating to Messrs. Iberger and Cronin, two
officers of the Company who resigned their full-time employment and officer
positions in September 1996 and December 1996, respectively. The Company is
paying Mr. Cronin severance payments of $7,270 per month for the period of four
months after his termination and for the following two months if he has not
obtained other employment. Mr. Iberger received a lump sum payment of $60,000
and is receiving severance payments totaling approximately $27,000 for the
period of nine months after his termination.

The Company entered into an employment agreement with David R.
Schreiber on September 30, 1996 as the Chief Financial Officer and Senior Vice
President, Finance of the Company. The agreement provides for an initial base
salary of $190,000 per annum, the grant of options to purchase 50,000 shares of
Common Stock with a 10-year term and an exercise price of $6.625, a signing
bonus of $80,000 and stock grants of 7,500 shares of Common Stock on April 1,
1997 if Mr. Schreiber continues to be employed by the Company on such date. This
agreement provides that in the event of a termination of Mr. Schreiber's
employment other than for "Cause", as defined in the agreement, he is entitled
to receive one year's salary (and certain other benefits) if such termination
occurs within the first year of employment or six months after the Company is
acquired by another business entity or six month's salary (and certain other
benefits) if such termination occurs after the first year of employment. Subject
to the foregoing, this agreement is subject to termination at will by either
party.

The Company entered into an employment agreement with Steven T. Clayton
on November 18, 1996 as Vice President, Information Services of the Company. The
agreement provides for an initial base salary of $120,000 per annum, a signing
bonus of $14,000 and the grant of options to purchase 15,000 shares of Common
Stock with a 10-year term and an exercise price of $7.875.

Richard A. Sandberg resigned as Chairman of the Board and as an officer
of the Company effective February 27, 1997. In connection with his resignation,
the Company and Mr. Sandberg entered into an agreement pursuant to which the
Company agreed to employ Mr. Sandberg, and Mr. Sandberg agreed to be employed,
as a consultant to the President until February 28, 1998 or his earlier death,
disability, resignation, or termination for cause (as defined in the agreement).
Such agreement provides for Mr. Sandberg to receive annual base compensation of
$232,000 plus all benefits provided to management employees of the Company other
than participation in management incentive programs. In addition such agreement
provides that all options to purchase Common Stock held by Mr. Sandberg as of
February 27, 1997 became fully vested on such date to the extent not previously
vested. Mr. Sandberg also has the right to sell any or all of such options to
the Company at any time on or before May 28, 1997 for an amount per share
subject to the option equal to the difference between $10.875 and the per share
exercise price of the option. If such agreement is not otherwise renewed by
mutual agreement of the Company and Mr. Sandberg, it terminates by its terms on
February 28, 1998, in which event for six months after such termination, Mr.
Sandberg will be entitled to severance pay of $19,333 per month plus medical
insurance premiums and car allowance. Under these circumstances, 20,000 shares
of Mr. Sandberg's stock options will terminate in May 1998 and 156,000 shares
will terminate in February 2000. Mr. Sandberg has agreed that he will not
compete with the Company within the United States for a period of two years
after the termination of his employment as a consultant pursuant to this
agreement.

Stock Options

The following table shows, as to the named executive officers of the
Company, information about option grants in the last fiscal year. The Company,
as of December 31, 1996, has not granted any Stock Appreciation Rights to
officers.

OPTION GRANTS IN LAST FISCAL YEAR

Potential Realizable
Number of % of Total Value at Assumed
Securities Options Annual Rates of Stock Price
Underlying Granted to Exercise or Appreciation for Option Term
Options Employees Base Price Expiration --------------------------------
Name Granted(#)(1) in 1996 ($/Share) Date 5%($) 10%($)
---- ------------- ------- --------- ---- ------------- ------------

Richard A. Sandberg -- -- -- -- -- --
Kevin C. Johnson 200,000(2) 43% 5.6875 05/02/06 715,368 1,812,882
David R. Schreiber 50,000(3) 11% 6.6250 10/01/06 208,321 527,927
James B. Amberson, M.D. 15,000(4) 3% 6.3750 11/04/06 60,138 152,402
Albert A. Luderer, Ph.D. -- -- -- -- -- --
Carl R. Iberger -- -- -- -- -- --
Daniel J. Cronin -- -- -- -- -- --

<FN>
- ----------
(1) Does not include options granted under the Company's Employee Stock
Purchase Plan, which were made available to all employees of the Company on
a non-discriminatory basis.

(2) In May 1996, the Company granted Mr. Johnson options to purchase 200,000
shares of Common Stock at $5.6875 per share pursuant to his employment
agreement. These options vest 40% in May 1998 and 20% during each year
thereafter. Upon termination of employment, all unvested options are
cancelled and all vested options expire 90 days after termination of
employment.

(3) In October 1996, the Company granted Mr. Schreiber options to purchase
50,000 shares of Common Stock at $6.625 per share pursuant to his
employment agreement. These options vest 40% in October 1998 and 20% during
each year thereafter. Upon termination of employment, all unvested options
are cancelled and all vested options expire 90 days after termination of
employment.

(4) In November 1996, the Company granted certain employees and officers
options to purchase 203,000 shares of Common Stock at $6.375 per share.
These options vest 40% in November 1998 and 20% during each year
thereafter. Upon termination, all unvested options are cancelled and all
vested options expire 90 days after termination of employment.

</FN>

The following table shows aggregate option exercises in the last fiscal year and
fiscal year-end option values for the named executive officers. The Company, as
of December 31, 1996, has not granted any Stock Appreciation Rights.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES

Value
Realized Value of Unexercised
(Market Number of In-the-Money Options
Price at Securities Underlying at FY-End (based on
Exercise Unexercised FY-End Price of
Shares less Options at FY-End(#) $8.625/share)(1)
Acquired on Exercise ---------------------------- ----------------------------
Name Exercise(#) Price)($) Exercisable Unexercisable Exercisable Unexercisable
- --------------------- ----------- --------- ----------- ------------- ----------- -------------

Richard A. Sandberg -- $ -- 149,024 26,976 $101,160 $ 58,140
Kevin C. Johnson -- -- -- 200,000 -- 587,500
David R. Schreiber -- -- -- 50,000 -- 100,000
James B. Amberson, M.D -- -- 19,340 52,160 78,617 167,555
Albert A. Luderer, Ph.D. 12,800 41,632 -- -- -- --
Carl R. Iberger -- -- 15,440 -- 62,764 --
Daniel J. Cronin 7,920 26,326 -- -- -- --

<FN>
- ----------
(1) Computed based upon difference between aggregate fair market value and
aggregate exercise price.

</FN>

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Dr. Sklar served as a member of the Compensation Committee of the
Company's Board of Directors during the last completed fiscal year and is
continuing to serve as such in the 1997 fiscal year. In 1995 the Company entered
into a three-year research and development agreement with Brigham & Women's
Hospital, Inc., for which Dr. Sklar is director, Division of Diagnostic
Molecular Biology, Department of Pathology. The agreement requires the Company
to make quarterly payments of $30,000 totaling $360,000 in exchange for an
option to obtain rights in certain existing inventions as well as inventions
developed during the course of research in the areas of cancer detection and
diagnosis. The research is to be conducted by Dr. Sklar. The Company paid
$120,000 and $60,000 in 1996 and 1995, respectively. In addition, the Company
has made payments to Brigham & Women's Hospital, Inc. of $30,000 in each of 1996
and 1995 for consulting services by Dr. Sklar. As of December 31, 1996, the
Company has terminated this agreement effective June 30, 1997 and has accrued
$60,000 for future payments in 1997.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Ownership of Voting Stock by Management

The following table gives information concerning the beneficial
ownership of the Company's Common Stock as of March 14, 1997 by each director
and each of the executive officers named in the summary compensation table and
all current directors and executive officers (as of March 14, 1997) as a group.

Total Shares
Beneficially Direct Right to Percent of
Beneficial Owners Owned(1)(2) Ownership Acquire(3) Class(4)
- ----------------- ----------- --------- ---------- --------

Richard A. Sandberg 201,722 12,773 185,520 3%
Kevin C. Johnson 28,832 15,000 -- -- (5)
David R. Schreiber -- -- -- -- (5)
James B. Amberson, M.D. 58,344 15,652 28,860 -- (5)
Albert A. Luderer, Ph.D. -- -- -- -- (5)
Carl R. Iberger 17,390 17,390 -- -- (5)
Daniel J. Cronin -- -- -- -- (5)
John P. Davis 235,267 116,455 118,812 4%
Walter O. Fredericks 6,863 235 6,628 -- (5)
Jeffrey L. Sklar 6,963 235 6,728 -- (5)
G. S. Beckwith Gilbert 1,802,314 1,800,235 2,079 28%(6)

All current directors and
executive officers as a
group (11 persons) 2,316,067 1,961,637 351,001 34%

<FN>
- ----------
(1) The information as to beneficial ownership is based on statements furnished
to the Company by its executive officers and directors. Each executive
officer and director has sole voting and sole investment power with respect
to his respective shares listed above, except as follows: The shares
reported for Mr. Gilbert include 121,951 shares which are held by a trust
of which Mr. Gilbert is a trustee, as to which Mr. Gilbert shares voting
and investment powers. Amounts shown for Messrs. Sandberg and Johnson and
Dr. Amberson include 13,832 shares held in the Company's 401(K) Retirement
Plan, as to which such officers share voting power as trustees of such plan
and each individual plan participant has investment power, subject to the
terms of such plan, of the shares in his account; such amount includes
10,403 shares in Mr. Sandberg's account.

(2) Includes shares listed under the captions "Direct Ownership" and "Right to
Acquire", as well as shares held in the Company's 401(K) Retirement Plan
which are beneficially owned but as to which the named individual or group
has no economic interest.

(3) Individuals currently have the right to acquire these shares within 60 days
of March 14, 1997 by the exercise of stock options or through purchases
under the Company's Employee Stock Purchase Plan.

(4) For the purposes of this table, "Percent of Class" held by each individual
has been calculated based on a total class equal to the sum of (i)
6,449,270 shares of Common Stock issued and outstanding on March 14, 1997
plus (ii) for such individual the number of shares of Common Stock subject
to stock options or warrants presently exercisable, or exercisable within
60 days after March 14, 1997, held by that individual, and which percent is
rounded to the nearest whole number.

(5) Owns less than 1% of the outstanding Common Stock.

(6) As of March 14, 1997, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,289,854
votes as of March 14, 1997. As of March 14, 1997, any votes in excess of
1,289,854 represented by Common Stock or other voting securities of the
Company beneficially owned by Mr. Gilbert as of such date are required to
be voted in proportion to the votes cast by all other shareholders of the
Company.
</FN>

Ownership of Voting Stock by Certain Beneficial Owners

The following table sets forth information with respect to the only
persons who, to the best knowledge of the Company's management as derived from
schedules 13F, 13D and 13G filed by such persons, beneficially owned more than
five percent of the Common Stock of the Company as of March 14, 1997. Unless
otherwise indicated below, each person included in the table has sole voting and
investment power with respect to all shares included therein.

Amount
and Nature
Name and Address of of Beneficial Percent
Title of Class Beneficial Owner Ownership of Class(1)
-------------- ---------------- --------- -----------

DIANON Common Stock G.S. Beckwith Gilbert et al 1,802,314(2) 28%(3)
35 Vista Drive
Greenwich, CT 06830

DIANON Common Stock Oracle Management Partners, Inc. 461,328 7%
and Affiliates
712 E 5th Avenue - 45th Floor
New York, NY 10019

DIANON Common Stock John M. Bryan et al 356,412 6%
Bryan and Edwards
600 Montgomery Street - 35th Floor
San Francisco, CA 94111

<FN>
- ----------
(1) For the purposes of this table, "Percent of Class" held by each individual
has been calculated based on a total class equal to the sum of (i)
6,449,270 shares of Common Stock issued and outstanding on March 14, 1997
plus (ii) for such individual the number of shares of Common Stock subject
to stock options or warrants presently exercisable, or exercisable within
60 days after March 14, 1997, held by that individual, and which percent is
rounded to the nearest whole number.

(2) Mr. Gilbert has shared voting and investment power with respect to 121,951
shares included in the table above.

(3) As of March 14, 1997, Mr. Gilbert cannot vote, without restriction, any
Common Stock or other voting securities of the Company beneficially owned
by him representing greater than 20% of the total voting power of the
Company's voting securities outstanding from time to time, or 1,289,854
votes as of March 14, 1997. As of March 14, 1997, any votes in excess of
1,289,854 represented by Common Stock or other voting securities of the
Company beneficially owned by Mr. Gilbert as of such date are required to
be voted in proportion to the votes cast by all other shareholders of the
Company.
</FN>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See Item 11 - Executive Compensation - "Compensation Committee
Interlocks and Insider Participation" and Notes 6 and 14 of the Company's
consolidated financial statements included herewith.

As part of the process to recruit a new executive, the Company lent an
affiliate of Mr. Sandberg $75,000 in March 1995 at 8% interest. Such loan was
repaid in full with interest in March 1996.

For description of a loan from the Company to Mr. Johnson, see Item 11
- - Executive Compensation "Employment and Severance Agreements".

In January 1997, the Company purchased 89,000 shares of Common Stock
from Richard A. Sandberg at a price of $8.50 per share.

PART IV

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

(a) Financial Statements, Financial Statement Schedules Filed.

1) Financial Statements - See accompanying Consolidated Financial
Statements and Schedules, Pages F-1 through F-18.

2) Financial Statement Schedules - See accompanying Consolidated
Financial Statements and Schedules, Pages F-1 through F-18.

3) Exhibits - Refer to 14(c) below.

(b) The Company filed no reports on Form 8-K in the fourth quarter of 1996
with the Securities and Exchange Commission.

3.1 Restated Certificate of Incorporation of the Company, as amended
through June 12, 1991 (incorporated by reference to Exhibit 3.1 of
the Registrant's Registration Statement No. 33-41226).

3.2 Restated By-Laws of the Company, as amended through October 24,
1996 (incorporated by reference to Exhibit 4.2 of the Registrant's
Registration Statement No. 333-18817).

10.1 Consulting Agreement, dated August 4, 1989, between DIANON
Systems, Inc. and Nonda Katopodis (incorporated by reference to
Exhibit 10.7 of the Registrant's Registration Statement No.
33-41226).**

10.2 Executive Vesting Agreement, dated as of June 11, 1991, between
DIANON Systems, Inc. and James B. Amberson (incorporated by
reference to Exhibit 10.13 of the Registrant's Registration
Statement No. 33-41226).**

10.3 1991 Stock Incentive Plan (incorporated by reference to Exhibit
10.17 of the Registrant's Registration Statement No. 33-41226).**

10.4 Management Incentive Plan (incorporated by reference to Exhibit
10.18 of the Registrant's Registration Statement No. 33-41226).**

10.5 Stock Option Grant to Walter O. Fredericks, dated April 27, 1990
(incorporated by reference to Exhibit 10.23 of the Registrant's
Registration Statement No. 33-41226).**

10.6 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.24 of the Registrant's
Registration Statement No. 33-41226).**

10.7 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991
(incorporated by reference to Exhibit 10.25 of the Registrant's
Registration Statement No. 33-41226).**

10.8 Lease Agreement, made as of February 14, 1989, between Watson
Boulevard Development Limited Partnership, as lessor, and DIANON
Systems, Inc., as lessee, for premises located at 200 Watson
Boulevard (incorporated by reference to Exhibit 10.29 of the
Registrant's Registration Statement No. 33-41226).

10.9 License Agreement, dated June 9, 1983, between Sloan-Kettering
Institute for Cancer Research and N-K Laboratories Limited
Partnership (incorporated by reference to Exhibit 10.30 of the
Registrant's Registration Statement No. 33-41226).

10.10 License Agreement, dated July 29, 1987, between University of
Rochester and DIANON Systems, Inc. (incorporated by reference to
Exhibit 10.32 of the Registrant's Registration Statement No.
33-41226).

10.11 Development Agreement, effective September 25, 1987, between
Connecticut Product Development Corporation and DIANON Systems,
Inc. (incorporated by reference to Exhibit 10.33 of the
Registrant's Registration Statement No. 33-41226).

10.12 Stock Option Grant to James B. Amberson, dated April 23, 1991
(incorporated by reference to Exhibit 28.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1991).**

10.13 Stock Option Grant to Richard A. Sandberg, dated June 12, 1991, as
amended (incorporated by reference to Exhibit 10.37 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1991).**

10.14 Asset Purchase Agreement, dated April 30, 1993, by and among the
Registrant and Molecular Oncology, Inc., and Oncologix, Inc.
(incorporated by reference to Exhibit 1.1 to the Registrant's Form
8-K dated April 30, 1993, filed with the Securities and Exchange
Commission on May 14, 1993).

10.15 Asset Purchase Agreement, dated June 29, 1993, by and among the
Registrant and Collaborative Research, Inc. (incorporated by
reference to Exhibit 1.2 to the Registrant's Form 8-K dated June
29, 1993, filed with the Securities and Exchange Commission on
July 13, 1993).

10.16 Term Loan Agreement, dated July 14, 1993, by and among the
Registrant and the Union Trust Company (incorporated by reference
to Exhibit 10.34 to the Registrant's Annual Report on Form 10-K/A
Amendment 1 for the year ended December 31, 1993, filed with the
Securities and Exchange Commission on April 28, 1994).

10.17 Rights Agreement, dated April 29, 1994, by and among the
Registrant and American Stock and Trust Company, as Rights Agent
(incorporated by reference to Exhibit 1 to the Registrant's Form
8-K dated April 29, 1994, filed with the Securities and Exchange
Commission on May 9, 1994).

10.18 Severance Agreement, dated January 20, 1995, by and among the
Registrant and John P. Davis (incorporated by reference to Exhibit
10.36 to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the Securities and Exchange
Commission on March 29, 1996).**

10.19 Employment Agreement, dated May 3, 1996, by the Registrant and
Kevin C. Johnson (incorporated by reference to Exhibit 10.37 to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996).**

10.20 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Richard A. Sandberg (incorporated by reference to
Exhibit 10.38 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996).**

10.21 Employment Agreement, dated September 1, 1996, by the Registrant
and Dr. James B. Amberson (incorporated by reference to Exhibit
10.39 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996).**

10.22 Executive Employment Agreement, dated September 1, 1996, by the
Registrant and Dr. James B. Amberson (incorporated by reference to
Exhibit 10.40 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996).**

10.23 Severance Agreement, dated September 27, 1996, by the Registrant
and Carl R. Iberger (incorporated by reference to Exhibit 10.41 to
the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996).**

10.24 Employment Agreement, dated September 30,1996, by the Registrant
and David R. Schreiber (incorporated by reference to Exhibit 10.42
to the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996).**

10.25 Employment Agreement, dated November 18, 1996, by the Registrant
and Steven T. Clayton (filed herewith).**

10.26 Separation Agreement dated November 18, 1996, by the Registrant
and Daniel J. Cronin, III (filed herewith).**

10.27 Amendment dated as of October 4, 1995 to Rights Agreement dated as
of April 29, 1994 between the Registrant and American Stock
Transfer and Trust Company, as Rights Agent (incorporated by
reference to Exhibit No. 1 to the Registrant's Form 8-K dated
October 30, 1996 filed with the Securities and Exchange Commission
on November 8, 1995).

10.28 1996 Stock Incentive Plan (incorporated by reference to Appendix A
to the Registrant's Statement on Schedule 14A filed with the
Securities and Exchange Commission on September 23, 1996).**

10.29 Stock and Warrant Purchase Agreement, dated as of October 4, 1995,
among the Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A.
Contributory Account, G.S. Beckwith Gilbert and the Registrant
(filed herewith).

10.30 Registration Rights Agreement, dated as of October 4, 1995, among
the Gilbert Family Trust, the G.S. Beckwith Gilbert I.R.A.
Contributory Account, G.S. Beckwith Gilbert and the Registrant
(filed herewith).

10.31 Warrant No. 1, dated as of October 4, 1995, by the Registrant in
favor of G.S. Beckwith Gilbert (filed herewith).

10.32 Promissory Note, dated October 4, 1995, by G.S. Beckwith Gilbert
in favor of the Registrant (filed herewith).

10.33 Stock Option Grant dated October 24, 1996 by the Registrant to
Andre de Bruin (filed herewith).**

10.34 Stock Option Grant dated November 4, 1996 by the Registrant to
Jeffrey M. Sklar, M.D. (filed herewith).**

10.35 Loan Agreement dated December 3, 1996 by the Registrant to Kevin
C. Johnson (filed herewith).**

10.36 Form of standard Stock Option Grant for outside directors (filed
herewith).**

10.37 Amendment to Warrant Certificate No. W-1 dated as of October 2,
1996 between the Registrant and G.S. Beckwith Gilbert (filed
herewith).

10.38 Severance Agreement, dated February 27, 1997, by the Registrant
and Richard A. Sandberg (filed herewith).**

11.1 Statement re: computation of per share earnings. *

22.1 List of Subsidiaries of the Company (incorporated by reference to
Exhibit 22.1 of the Registrant's Registration Statement No.
33-41226).

23.1 1996 Consent of Arthur Andersen LLP (incorporated by reference to
Exhibit 23.1 of the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1995).

23.2 1997 Consent of Arthur Andersen LLP (filed herewith).

27.1 Financial Data Schedule.

- --------------
* Not applicable or contained elsewhere herein.

** A management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form pursuant to Item 14(c) of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

DATED: March 26, 1997

DIANON SYSTEMS, INC.

By: /s/ KEVIN C. JOHNSON
----------------------------------
Kevin C. Johnson,
President and Chief Executive Officer

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

Signature Capacity Date
--------- -------- ----

/s/ KEVIN C. JOHNSON President and Chief March 26, 1997
---------------------------- Executive Officer
Kevin C. Johnson and a Director
(Principal Executive
Officer)

/s/ DAVID R. SCHREIBER Senior Vice President, March 26, 1997
---------------------------- Finance and Chief
David R. Schreiber Financial Officer
(Principal Financial
and Accounting Officer)

/s/ JAMES B. AMBERSON, MD Director, Chief Medical March 26, 1997
---------------------------- Officer and Senior Vice
James B. Amberson, M.D. President, Operations

/s/ JOHN P. DAVIS Chairman of the Board March 26, 1997
----------------------------
John P. Davis

/s/ G. S. BECKWITH GILBERT Director and Chairman March 26, 1997
---------------------------- of the Executive Committee
G. S. Beckwith Gilbert

/s/ RICHARD A. SANDBERG Director March 26, 1997
----------------------------
Richard A. Sandberg

/s/ WALTER O. FREDERICKS Director March 26, 1997
----------------------------
Walter O. Fredericks

/s/ JEFFREY L. SKLAR, MD PhD Director March 26, 1997
----------------------------
Jeffrey L. Sklar, M.D., Ph.D.

DIANON SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

PAGE
----

Report of Independent Public Accountants F-2

Consolidated Balance Sheets as of
December 31, 1996 and 1995 F-3 & F-4

Consolidated Statements of Operations for
the Years Ended December 31, 1996,
1995 and 1994 F-5

Consolidated Statements of Stockholders'
Equity for the Years Ended December 31,
1996, 1995 and 1994 F-6

Consolidated Statements of Cash Flows for the
Years Ended December 31, 1996, 1995 and 1994 F-7 & F-8

Notes to Consolidated Financial Statements F-9 to F-17

Schedules:

Report of Independent Public Accountants F-18

Schedule II - Valuation and Qualifying Accounts F-19

All other schedules called for by Regulation S-X have been omitted
because they are not applicable or because the required information is included
in the financial statements or notes thereto.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To DIANON Systems, Inc.:

We have audited the accompanying consolidated balance sheets of DIANON
Systems, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1996
and 1995, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of DIANON Systems, Inc.
and subsidiaries as of December 31, 1996 and 1995 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Stamford, Connecticut,
February 27, 1997

F-2

DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1996 AND 1995

1996 1995
------------ ------------
ASSETS

CURRENT ASSETS:

Cash and cash equivalents $ 7,488,590 $ 10,990,231
Accounts receivable, net of allowances of
$1,056,920 and $786,920, respectively 15,426,221 9,653,971
Prepaid expenses and employee advances 1,189,139 1,071,963
Prepaid and refundable income taxes 329,371 168,420
Inventory 662,567 554,398
Deferred income tax asset (Note 3) 677,277 652,328
Investment in common stock (Note 10) -- 135,508
------------ ------------
Total current assets 25,773,165 23,226,819
------------ ------------

PROPERTY AND EQUIPMENT, at cost (Note 4)

Laboratory and office equipment 12,233,989 11,068,949
Leasehold improvements 3,612,198 1,717,606
Less - accumulated depreciation and amortization (8,606,176) (6,879,799)
------------ ------------
7,240,011 5,906,756
------------ ------------

INTANGIBLE ASSETS, net of accumulated
amortization of $2,991,286 and
$2,731,291, respectively 604,313 864,308

DEFERRED INCOME TAX ASSET (Note 3) 458,465 178,575

OTHER ASSETS 459,696 278,948
------------ -----------
TOTAL ASSETS $34,535,650 $30,455,406
============ ===========

The accompanying notes to consolidated financial statements are an
integral part of these balance sheets.

F-3

DIANON SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1996 AND 1995

1996 1995
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:

Accounts payable $ 1,903,448 $ 2,034,277
Accrued employee bonuses and commissions 1,351,616 1,442,826
Accrued employee stock purchase plan 549,540 48,914
Current portion of capitalized lease
obligations (Note 4) 26,107 38,466
Current portion of note payable (Note 11) 650,154 916,150
Other accrued expenses 3,234,295 1,772,216
------------ ------------
Total current liabilities 7,715,160 6,252,849
------------ ------------
LONG-TERM PORTION OF CAPITALIZED LEASE OBLIGATIONS
(Note 4) 69,611 34,413

LONG-TERM NOTE PAYABLE (Note 11) -- 650,154

DEFERRED INCOME TAX LIABILITY (Note 3) 201,951 65,651
------------ ------------
Total liabilities 7,986,722 7,003,067
------------ ------------

COMMITMENTS (Notes 4 and 8)

STOCKHOLDERS' EQUITY (Notes 5 and 7):

Common stock, par value $.01 per share,
20,000,000 shares authorized,6,712,774
and 6,311,451 shares issued and
outstanding at December 31, 1996
and 1995, respectively 67,128 63,115
Additional paid-in capital 27,965,560 26,609,657
Accumulated deficit (554,317) (2,724,433)
Common stock held in treasury, at cost -
117,196 and 50,000 shares at
December 31, 1996 and 1995, respectively (929,443) (200,000)
Shareholder note receivable -- (296,000)
------------ ------------
Total stockholders' equity 26,548,928 23,452,339
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 34,535,650 $ 30,455,406
============ ============

The accompanying notes to consolidated financial statements are an
integral part of these balance sheets.

F-4

DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

1996 1995 1994
----------- ----------- -----------

NET REVENUES $55,998,995 $45,700,321 $41,016,949

COST OF SALES 26,897,576 20,390,742 16,717,401
----------- ----------- -----------

GROSS PROFIT 29,101,419 25,309,579 24,299,548

SELLING, GENERAL, AND ADMINISTRATIVE
EXPENSES 22,443,192 19,619,773 17,504,722

RESEARCH AND DEVELOPMENT EXPENSES 3,157,846 5,255,032 4,511,708
----------- ----------- -----------
INCOME FROM OPERATIONS 3,500,381 434,774 2,283,118

INTEREST INCOME 384,306 317,353 103,531

INTEREST EXPENSE 77,466 136,113 193,759
----------- ----------- -----------
INCOME BEFORE PROVISION FOR INCOME TAXES 3,807,221 616,014 2,192,890

PROVISION FOR INCOME TAXES (Note 3) 1,637,105 508,918 831,796
----------- ----------- -----------
NET INCOME $ 2,170,116 $ 107,096 $ 1,361,094
=========== =========== ===========
PRIMARY AND FULLY DILUTED EARNINGS PER SHARE $ .34 $ .02 .26
=========== =========== ===========

The accompanying notes to consolidated financial statements are an
integral part of these statements.

F-5

DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994

Unrealized Foreign Common Stock
Additional Holdings Currency Held in Shareholder
Common Stock Paid-In Accumulated Gains/ Translation Treasury, Note
Shares Amount Capital Deficit (Losses) Adjustment at Cost Receivable Total
--------- ------- ---------- ----------- --------- ----------- ------------ ----------- ---------

BALANCE, December 31, 1993 5,246,448 $52,465 $21,529,478 ($4,192,623) ($242,281) $ -- $ -- $ -- $17,147,039
Stock options exercised 50,431 504 59,053 -- -- -- -- -- 59,557
Stock compensation
expense - stock options -- -- 3,411 -- -- -- -- -- 3,411
Unrealized holding gains -- -- -- -- 151,898 -- -- -- 151,898
Changes in foreign
currency translation
adjustment -- -- -- -- -- (58,938) -- -- (58,938)
Net Income -- -- -- 1,361,094 -- -- -- -- 1,361,094
--------- ------- ----------- ---------- --------- -------- -------- -------- -----------
BALANCE, December 31, 1994 5,296,879 52,969 21,591,942 (2,831,529) (90,383) (58,938) -- -- 18,664,061
Stock options exercised 14,572 146 59,286 -- -- -- -- -- 59,432
Issuance of common stock
and warrants net of
issuance costs 1,000,000 10,000 4,976,443 -- -- -- -- -- 4,986,443
Common stock held in
treasury -- -- -- -- -- -- (200,000) -- (200,000)
Shareholder note
receivable -- -- -- -- -- -- -- (296,000) (296,000)
Stock compensations
expense -stock
options -- -- (18,014) -- -- -- -- -- (18,014)
Write-off of unrealized
holding losses -- -- -- -- 90,383 -- -- -- 90,383
Write-off of foreign
currency translation
adjustment -- -- -- -- -- 58,938 -- -- 58,938
Net Income -- -- -- 107,096 -- -- -- -- 107,096
--------- ------- ----------- ---------- --------- -------- --------- ------------ -----------
BALANCE, December 31, 1995 6,311,451 63,115 26,609,657 (2,724,433) -- -- (200,000) (296,000) 23,452,339
Stock options exercised 23,621 236 107,476 -- -- -- -- -- 107,712
Exercise of warrants net
of exercise costs 800,000 3,777 1,536,540 -- -- -- 2,478,889 -- 4,019,206
Common stock held in
treasury -- -- -- -- -- -- (3,208,332) -- (3,208,332)
Extinguishment of
shareholder note
receivable -- -- (296,000) -- -- -- -- 296,000 --
Stock compensation
expense - stock
options -- -- 7,887 -- -- -- -- -- 7,887
Net Income -- -- -- 2,170,116 -- -- -- -- 2,170,116
--------- ------- ----------- ---------- --------- -------- --------- ------------ -----------
BALANCE, December 31, 1996 7,135,072 $67,128 $27,965,560 ($ 554,317) -- -- ($929,443) -- $26,548,928
========= ======= =========== ========== ========= ======== ============= ============ ===========

The accompanying notes to consolidated financial statements are an
integral part of these statements.

F-6

DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

1996 1995 1994
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:

Net income $ 2,170,116 $ 107,096 $ 1,361,094
Adjustments to reconcile net income
to net cash provided by (used
in) operations -
Non-cash charges
Depreciation and amortization 2,463,325 2,758,611 1,951,726
Stock compensation expense 7,887 (18,014) 3,411
Loss on disposal of fixed assets 27,240 56,266 111,969
Investment write-down 61,846 529,625 --
(Increase) decrease in deferred
tax asset (304,839) (108,425) 147,785
Increase in deferred tax liability 136,300 11,214 54,437
Changes in other current assets and liabilities
(Increase) decrease in accounts receivable (5,772,250) 1,345,427 (2,178,403)
(Increase) decrease in prepaid expenses and
employee advances (278,127) (147,728) 440,951
(Increase) decrease in inventory (108,169) 158,643 213,116
(Increase) in other assets (320,176) (29,075) (102,273)
Increase in accounts payable and other
accrued liabilities 1,751,788 1,358,348 464,849
(Decrease) increase in restructuring
reserves (11,123) 66,148 (624,309)
---------- ---------- ----------
Net cash (used in) provided by operating
activities (176,182) 6,088,136 1,844,353
---------- ---------- ----------

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures (3,431,895) (2,290,720) (1,557,160)
Proceeds from the sale of stock
held for investment 73,661 14,867 --
Proceeds from the sale of fixed
assets 7,500 10,040 8,000
---------- ---------- ----------
Net cash (used in) investing activities ($3,350,734) ($2,265,813) ($1,549,160)
---------- ---------- ----------

The accompanying notes to consolidated financial statements are an
integral part of these statements.

F-7

DIANON SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (CONTINUED)

1996 1995 1994
----------- ---------- ---------

CASH FLOWS FROM FINANCING ACTIVITIES:

Repayments of note payable (916,150) (862,446) (810,511)
Net borrowings (repayments)
of capitalized lease
obligations 22,839 (53,614) (67,809)
Net proceeds from issuance
of common stock and
warrants -- 4,690,443 --
Net proceeds from exercise
of warrants 4,019,206 -- --
Purchase of common stock
held in treasury (3,208,332) (200,000) --
Exercise of stock options 107,712 59,432 59,557
----------- ---------- ---------
Net cash provided by (used in)
financing activities 25,275 3,633,815 (818,763)
----------- ---------- ---------

Net (decrease) increase in
cash and cash equivalents (3,501,641) 7,456,138 (523,570)

CASH AND CASH EQUIVALENTS,
beginning of year 10,990,231 3,534,093 4,057,663

CASH AND CASH EQUIVALENTS,
end of year $ 7,488,590 $ 10,990,231 $ 3,534,093
============ ============ ===========

1996 1995 1994
----------- ---------- ---------
SUPPLEMENTAL CASH FLOWS DISCLOSURES:

Cash paid during the year:

Interest $ 77,782 $ 135,644 $ 191,879
Income taxes 1,712,200 588,149 311,689

During 1996, the Company received $4,000,000 in cash for the exercise of 800,000
warrants and extinguished a note receivable of $296,000. (See Note 14.)

The accompanying notes to consolidated financial statements are an
integral part of these statements.

F-8

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) The Company

DIANON Systems, Inc. (the "Company") is a provider of testing services
and diagnostic information primarily to physicians who treat and diagnose cancer
throughout the United States. The Company has established a national sales and
marketing organization to market a complete line of anatomic pathology testing
services as well as specialized clinical chemistry tests and information
services directly to physicians, payors and managed care organizations. A
significant portion of the services provided by the Company are paid for by
either the patients' Medicare or private medical insurance policies. The
remaining services are generally paid for by physicians or hospitals directly.

(2) Significant Accounting Policies

Principles of Consolidation -

The consolidated financial statements include the accounts of the
Company and all of its subsidiaries. All significant intercompany transactions
have been eliminated in consolidation.

Use of Estimates -

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents -

The Company considers all highly liquid instruments purchased with a
maturity of three months or less to be cash equivalents. At December 31, 1996
and 1995, the Company had approximately $6 million and $11 million,
respectively, invested in short-term U.S. treasury funds with maturities of less
than three months. The carrying amount of the cash equivalents approximates its
fair value due to the relatively short period to maturity of these instruments.
The Company is obligated to keep a compensating balance of $2 million in
accordance with its loan agreement. (See Note 11).

Inventory -

Inventory consists primarily of bulk reagents, specimen collection kits
and devices. Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method.

Intangible Assets -

Intangible assets are amortized on a straight line basis over the
respective economic life as follows:

YEARS
-----

Unamortized customer lists 7
Noncompete agreement 5

The Company periodically reviews the anticipated revenues related to
intangible assets to determine whether any adjustment to their carrying value is
necessary. During 1996 and 1995, the Company recorded accelerated amortization
charges of approximately $44,000 and $765,000, respectively, based on the
Company's revised estimate of future benefits from a customer list.

F-9

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenue Recognition -

Revenues are recognized in the period in which services are provided.
Revenues subject to Medicare, direct physician and hospital billing are based on
fixed reimbursement fee schedules. All remaining revenues subject to third-party
reimbursement are recorded at estimated reimbursable amounts based on Uniform
Customary Charges.

Depreciation and Amortization -

Laboratory and office equipment are depreciated using the straight-line
method on a useful life of two to seven years. Leasehold improvements are
amortized over the shorter of their economic useful life or the remaining life
of the lease.

Research and Development -

Research and development costs are charged to expense as incurred.

Income Taxes -

The Company utilizes the liability method of accounting for income
taxes as set forth in Statement of Financial Accounting Standard 109,
"Accounting for Income Taxes". Under this method, deferred income taxes are
determined based on the difference between the financial statements and tax
bases of assets and liabilities using presently enacted tax rates and
regulations.

Earnings Per Share -

Primary earnings per share has been computed based on the weighted
average number of common shares and common equivalent shares outstanding during
each year (6,330,553, 5,550,615 and 5,310,174 for the years ended December 31,
1996, 1995 and 1994, respectively). Common equivalent shares outstanding include
the common equivalent shares calculated for warrants and stock options under the
treasury stock method.

Foreign Currency Translation -

In 1995, the Company charged to income the Germany currency translation
adjustment of $160,567 due to management's decision to discontinue European
based operations. During prior periods, assets and liabilities of the Company's
foreign subsidiaries were translated into U.S. dollars using the exchange rate
in effect at the balance sheet date. Results of operations were translated using
the average exchange rate prevailing for the period. The effects of exchange
rate fluctuations on translating foreign currency assets and liabilities into
U.S. dollars were included in net income for all of the Company's European
subsidiaries except Germany. (See Note 7).

Reclassifications -

Certain reclassifications have been made to prior year amounts to
conform to the classifications used in the current year presentation.

F-10

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(3) Income Taxes

The income tax provisions for the years ended December 31, 1996, 1995,
and 1994 consist of the following:

Year Ended December 31
----------------------------------
1996 1995 1994
----------- --------- --------

Current
Federal $ 1,387,967 $ 461,361 $539,401
State 446,091 152,593 208,255
----------- --------- --------
Total Current 1,834,058 613,954 747,656
----------- --------- --------
Deferred
Federal (152,112) (33,532) 71,477
State (44,841) (71,504) 12,663
----------- --------- --------
Total Deferred (196,953) (105,036) 84,140
----------- --------- --------
Total provision for income
taxes $ 1,637,105 $ 508,918 $831,796
=========== ========= ========

The reasons for the differences between the statutory and effective
rates are as follows:

Year Ended December 31
----------------------------------
1996 1995 1994
----------- --------- --------

Statutory federal income
tax rate 34.0% 34.0% 34.0%
State taxes, net of federal
tax benefit 7.0 8.7 6.7
Utilization of research
& development credits -- (5.7) (7.4)
Utilization of foreign
net operating loss
carryforwards -- -- (1.8)
Utilization of AMT credit -- (4.6) --
Non-deductible expenses 2.9 9.6 2.7
Other (1.6) 3.1 3.7
Non-deductible write-down
of invest. in stock .7 37.5 --
==== ==== ====
43.0% 82.6% 37.9%
==== ==== ====

The net deferred tax asset is a result of the following temporary
differences:

Year Ended December 31
----------------------------------
1996 1995 1994
----------- --------- --------

Comp. not currently recognized
for tax reporting $180,126 $213,100 $208,797
Allowance for bad debts 428,761 316,090 319,834
Domestic restructuring reserve -- -- 29,922
International restructuring reserve 196,417 188,415 46,850
Tax credits benefited -- -- 98,500
Depreciation 95,067 (62,256) (54,437)
Accrued expense (4,395) 19,982 --
Inventory reserve -- 60,955 --
Amortization expense 37,264 22,441 --
Other 550 6,525 18,575
======== ======== ========
$933,790 $765,252 $668,041
======== ======== ========

During 1996 and 1995, the Company recorded a capital write-down of
$61,846 and $529,625, respectively, for which a tax benefit has not been
recognized.

F-11

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(4) Lease Obligations

Included in property and equipment at December 31, 1996 and 1995 is
laboratory and office equipment held under capitalized leases as follows: 1996
1995.

1996 1995
-------- --------

Property and equipment $752,240 $731,444
Less - accumulated depreciation 660,312 665,468
-------- --------
$ 91,928 $ 65,976
======== ========

The future minimum lease payments under non-cancelable operating leases
and the present value of future minimum capital lease payments at December 31,
1996 are:

Capital Operating
Leases Leases
------- ---------

1997 $29,672 $989,246
1998 33,796 800,823
1999 19,630 791,114
2000 15,768 790,455
2001 9,842 730,695
Thereafter -- 1,006,931
------- ----------
Minimum Lease Payments 108,708 $5,109,264
==========
Less - Amount representing interest 12,990
-------
Present value of total minimum lease payments $95,718
=======

Total rental expense relating to operating leases for the years ended
December 31, 1996, 1995, and 1994 was approximately $1,041,127, $864,549 and
$793,850, respectively.

The Company leases office and laboratory space at two facilities in
Stratford, Connecticut under a nine year lease commencing June 1994 with an
option to renew for up to three years and a ten month lease commencing March
1997 with an option to renew for an additional one-year period. The annual rent
on these leases will be increased by a pro rata portion of the increase in real
estate taxes and the increase in common area maintenance.

The Company also leases five regional sales offices located in Florida,
Maryland, North Carolina, Texas and Ohio. The terms of the leases range from one
to three years.

In March 1996, the Company executed a lease for a laboratory facility
in Wilmington, Ohio with a five year term commencing April 1, 1996 and a renewal
option for five additional terms of three years each.

(5) Stock-Based Compensation Plans

In June 1991, the Company adopted the 1991 Stock Incentive Plan which
provides for up to 400,000 shares of the Company's Common Stock, par value $.01
per share ("Common Stock"), to be reserved for potential future issuance for
stock options or awards. This plan is the successor to the Company's previous
plan which expired. As of December 31, 1996, 9,408 shares of Common Stock are
available under the 1991 Stock Incentive Plan for future issuance. The majority
of the options vest 40% on the second year and 20% each year thereafter and
expire ten years from the original grant date.

F-12

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In October 1996, the Company's shareholders approved the Company's
adoption of the 1996 Stock Incentive Plan, which provides for up to 700,000
shares of Common Stock to be reserved for potential future issuance for stock
options or awards. This plan is the successor to the 1991 Stock Incentive Plan
for which only a limited number of shares of Common Stock remain available for
grants. As of December 31, 1996, 463,647 shares of Common Stock are available
under the 1996 Stock Incentive Plan. The majority of options issued to officers
and key employees of the Company vest at a rate of 40% in the second year and
20% per year thereafter and expire ten years from the original date of grant.
The majority of options issued to directors vest at a rate of 10% per quarter
and expire ten years from the original date of grant.

The Company accounts for these plans under APB Opinion No. 25, under
which no compensation cost has been recognized. Had compensation cost for these
plans been determined consistent with FASB Statement No. 123, the Company's net
income and earnings per share would have been reduced to the following pro forma
amounts:

1996 1995
---- ----

Net Income: As Reported $2,170,116 $107,096
Pro Forma $1,586,169 $ 11,403
Primary and Fully Diluted EPS: As Reported $.34 $.02
Pro Forma $.25 $.00

Because the Statement 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
costs may not be representative of that to be expected in future years. A
summary of the status of the Company's two fixed stock option plans as of
December 31, 1996, 1995 and 1994, and changes during the years ending on those
dates is presented below:

1996 1995 1994
Weighted Weighted Weighted
Average Average Average
1996 Exercise 1995 Exercise 1994 Exercise
Fixed Options Shares Price Shares Price Shares Price
- ------------- ------ -------- ------ -------- ------ --------

Outstanding at beginning
of year 397,153 $5.42 298,736 $5.89 261,484 $7.49
Granted 296,550 6.43 197,409 5.26 253,908 4.56
Exercised (23,621) 4.56 (4,688) 4.08 (31,665) 1.28
Forfeited (72,406) 5.06 (94,304) 6.78 (184,991) 7.83
-------- ----- -------- --------
Outstanding at end of year 597,676 6.00 397,153 5.42 298,736 5.89
-------- ----- -------- --------
Options exercisable at year-end 120,512 6.35 93,440 6.73 45,080 7.87
Weighted-average fair value of
options granted $5.19 $4.25

279,063 of the 597,676 options outstanding at December 31, 1996 have
exercise prices between $4.13 and $6.00, with a weighted average exercise price
of $4.92 and a weighted average remaining contractual life of 8.2 years. 82,277
of these options are exercisable; their weighted average exercise price is
$4.58. 285,013 of the 597,676 options outstanding have exercise prices between
$6.01 and $8.00, with a weighted average exercise price of $6.50 and a weighted
average remaining contractual life of 9.8 years. 4,845 of the options are
exercisable; their weighted average exercise price is $6.52. The remaining
33,600 options have exercise prices between $8.01 and $10.75, with a weighted
average exercise price of $10.69 and a weighted average remaining contractual
life of 4.2 years. 33,390 of these options are exercisable; their weighted
average exercise price is $10.69.

F-13

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1996 and 1995, respectively,: risk-free interest
rates of 6.67 and 6.78 percent; expected lives of 8.1 years for 1996 and 1995;
expected volatility of 80 percent for 1996 and 1995.

In June 1994, the Company offered the officers and key employees
(except for the Chairman of the Board and Chief Executive Officer) of the
Company an opportunity to revise the terms of their original stock options
issued in 1991, 1992, and 1993.

In June 1994, employees who held 1991 unexercised vested non-incentive
stock options with an exercise price of $3.85 per share and termination date of
April 23, 1995 were offered the opportunity to exchange them on a one-for-one
basis for vested non-incentive stock options exercisable until April 30, 2000 at
the fair market value on June 9, 1994 of $4.56 per share. In addition, employees
who held 1991 unexercised unvested non-incentive stock options with an exercise
price of $3.85 per share were offered the opportunity to exchange them on a
one-for-one basis for incentive stock options exercisable until April 30, 2000
at the fair market value on June 9, 1994 of $4.56 per share with vesting terms
identical to the exchanged options.

In June 1994, employees who held 1991 and 1992 unexercised incentive
stock options with an exercise price of $9.88 and $9.94 respectively had two
options available. They were offered the opportunity to exchange them on a
five-for-four basis for incentive stock options exercisable until April 30, 2001
and 2002, respectively, at the fair market value on June 9, 1994 of $4.56 per
share or exchange them on a one-for-one basis for incentive stock options
exercisable until April 30, 2001 and 2002, respectively, at the original
exercise prices of $9.88 and $9.94, respectively.

In June 1994, employees who held 1993 unexercised incentive stock
options with an exercise price of $8.00 were offered the opportunity to exchange
them on a five-for-four basis for incentive stock options exercisable until
April 30, 2003 at the fair market value on June 9, 1994 of $4.56 per share.

In addition to the disclosures above related to options granted under
the Company's 1991 Stock Incentive Plan and 1996 Stock Incentive Plan, the
disclosure that follows relates to options granted pursuant to employment
agreements or otherwise not under such plans.

In June 1994, the Company granted options to purchase 20,000 and 30,000
shares of Common Stock at $4.56 per share to the Chairman of the Board and the
Chief Executive Officer of the Company, respectively. These options vest over a
five year period. In addition, the Chairman of the Board and the Chief Executive
Officer were offered the opportunity to amend certain non-qualified stock
options of 71,282 shares each for options with identical exercise prices and
vesting provisions and with expiration dates equal to ten years from the
original date of issue. The Chief Executive Officer was offered an additional
opportunity to exchange the 71,282 shares of non-qualified stock options for an
equal number of shares of incentive stock options.

In August 1994, the Company authorized and granted options to purchase
10,000 shares of Common Stock at $6.00 per share to one outside Director of the
Company, Dr. Katopodis, which option vests over a five-year period. Also in
August 1994, the Company authorized the award of options to purchase 10,000
shares of Common Stock at $6.00 per share to a second outside Director of the
Company, Dr. Sklar, but because of certain restrictions applicable to Dr. Sklar
at the time of such award he was not able to accept a grant of such options.

In January 1995, the Chief Executive Officer of the Company resigned
his employment with the Company. As part of the severance agreement, stock
options to purchase 69,916 shares of Common Stock at prices ranging from $4.56
to $10.75 were canceled and stock options to purchase 116,084 shares of Common
Stock were amended to set their exercise price at $5.25. These amended options
vested 25% in March, 1995. The remaining 75% vested in January 1997.

F-14

DIANON SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In July 1995, the Company adopted the DIANON Systems, Inc. Employee
Stock Purchase Plan (the "ESPP" or "Plan") as described in Section 423 of the
Code. The Plan provides for the sale of not more than 300,000 shares of Common
Stock, subject to adjustments in the event of stock splits and other changes in
capitalization. The Plan provides that all shares issued pursuant to the Plan be
treasury shares acquired by the Company in open market transactions and that no
shares issued will be authorized but unissued Common Stock. Commencing on August
15, 1995, the Company offered the ESPP to eligible employees as defined by the
Plan at a purchase price equal to the lesser of 85% of the market price at the
date of grant or 85% of the market price at the date of exercise or as otherwise
defined in the grant offering.

In May 1996, the Company granted an officer options to purchase 200,000
shares of Common Stock at $5.69 per share pursuant to the terms of an employee
agreement. These options vest 40% in May 1998 and 20% over each year thereafter.

In October 1996, the Company granted options to purchase 10,000 shares
of Common Stock at $7.13 per share to an outside director of the Company, Mr. de
Bruin, in replacement of options issued in June 1993. These options vest
immediately and expire ten years from the date of grant.

(6) Related Parties

The Company pays Dr. Katopodis, a stockholder who is also Chairman
Emeritus and who was a director until January 1995, a royalty of 6% of revenue
on sales of technology covered by a license agreement, which was revised in
January 1995 and has no minimums. Pursuant to a consulting agreement revised in
March 1990, on a month-to-month basis, the Company provides Dr. Katopodis with
certain insurance benefits, the use of an automobile and the reimbursement of
expenses incident to his performance as a consultant to the Company. The Company
paid licensing and royalty fees to this stockholder of approximately $79,000,
$122,000 and $110,000 during the years ended December 31, 1996, 1995 and 1994,
respectively.

In 1995, the Company entered into a three year research and development
agreement with Brigham & Women's Hospital, Inc. The agreement requires the
Company to make quarterly payments of $30,000 totaling $360,000 in exchange for
an option to obtain rights in certain existing inventions as well as inventions
developed during the course of the research in the areas of cancer detection and
diagnosis. The research is to be conducted by Dr. Sklar, M.D., a director of the
Company. The Company paid $120,000 and $60,000 under this agreement in 1996 and
1995, respectively. As of December 31, 1996, the Company has terminated this
agreement effective as of June 30, 1997 and has accrued $60,000 for future
payments in 1997. In addition, the Company has made payments to Brigham &
Women's Hospital, Inc. of $30,000 in each of 1995 and 1996 for consulting
services by Dr. Sklar.

For description of a loan from the Company to Mr. Johnson, see Item 11
- - Executive Compensation - "Employment and Severance Agreements".

In January 1997, the Company purchased 89,000 shares of Common Stock
from Richard A. Sandberg at a price of $8.50 per share.