<PAGE>

                                ABOUT THE COMPANY


     Spine-Tech, Inc. designs, manufactures and markets an innovative series of
spinal implants, instruments and procedures based on the company's BAK-TM-
technology for the treatment of degenerative conditions of the human spine. The
company's BAK systems are designed for the lumbar (BAK) and cervical
(BAK/C-Registered Trademark-) regions of the spine.

     Spine-Tech intends to become an internationally recognized leader in this
market by:

     -    Expanding technological leadership;

     -    Enhancing minimally invasive surgical treatments for degenerative
          spinal conditions;

     -    Establishing the clinical utility and cost-effectiveness of its
          products;

     -    Providing superior clinical, engineering and educational support to
          patients and customers; and

     -    Developing focused worldwide marketing and sales capabilities.






1996 MILESTONES
      |
      |
      |     U.S. PATENT OFFICE ISSUES TWO
      |     PATENTS FOR BAK IMPLANTS, SURGICAL          SURGICAL TRAINING CENTER
      |     PROCEDURES AND INSTRUMENTS.                 OPENS AT HEADQUARTERS.
      |           |                                            |
      --------FEBRUARY-------------MAY----------------------AUGUST--------------
                                    |
                          U.S. FDA ORTHOPAEDIC AND
                   REHABILITATION DEVICES PANEL RECOMMENDS
                   APPROVAL OF SPINE-TECH'S BAK TECHNOLOGY.

                         ISO 9001 QUALITY SYSTEMS AND
                       CE MARK CERTIFICATIONS RECEIVED.

<PAGE>

                             LETTER TO SHAREHOLDERS


ON SEPTEMBER 23, 1996, the U.S. Food and Drug Administration (FDA) approved the
     Spine-Tech BAK-TM- system, designed to treat chronic low back pain caused
     by degenerative disc disease in the lumbar spine, for marketing in the
     United States. This first FDA approval of a Spine-Tech product is a pivotal
     event for our company - establishing the opportunity to launch the BAK
     system in the United States and laying the foundation for future approvals
     of other BAK-based products. Now, we are transforming Spine-Tech from a
     development-stage entity to a company with full-fledged marketing and
     manufacturing operations.
          Our innovative series of proprietary implantable devices, instruments
     and surgical methods has been evaluated in clinical trials at more than 20
     medical centers over five years. More than 1,900 patients have received BAK
     implants in clinical trials; an additional 900 patients have received BAK
     implants since commercial launch. The BAK system has produced outstanding
     results in comparison to traditional fusion techniques, and patient
     outcomes after commercial introduction have been consistent with data
     collected in clinical trials. The surgical procedure is less traumatic,
     operating times are short, pain relief is fast and patients recover
     quickly, reducing lost worker productivity.

FINANCIAL RESULTS  Revenues for the year ended December 31, 1996, reached $10.2
     million, a 36 percent increase over revenues of $7.5 million in 1995. For
     the year ended December 31, 1996, we reported a loss of $247,000, or $.02
     per share, compared to earnings of $268,000, or $.03 per share, in 1995.
          In the 1996 fourth quarter, which includes our first commercial sales
     of the BAK system in the United States, we recorded revenues of $5.7
     million, a 159 percent increase over fourth quarter 1995 revenues, and
     earned $2.1 million, or $.19 per share. We believe this quarter begins to
     reflect Spine-Tech's potential. The commercial launch of the BAK system is
     well under way. We also continue to generate revenues from the sale of
     other BAK products in clinical trials, including trials using laparoscopic
     surgical procedures.

                       SURGICAL TRAINING SEMINARS HELD AT
                      NORTH AMERICAN SPINE SOCIETY MEETING.
                                      |
                                      |
-SEPTEMBER ------------------------ OCTOBER ---------------- DECEMBER
   |                                                           |
FDA APPROVAL RECEIVED FOR THE BAK                              |
SYSTEM FOR USE IN THE LUMBAR SPINE.                            |
                                                               |
                                       AGREEMENT SIGNED WITH ORQUEST CORPORATION
                                       TO EVALUATE AND COMMERCIALIZE SYNTHETIC
                                               BONE GRAFT WITH BAK IMPLANTS.
                                                               |
                                                               |
                                          SUPPLEMENTAL PRE-MARKET APPROVAL (PMA)
                                 APPLICATION SUBMITTED TO FDA FOR A LAPAROSCOPIC
                                                PROCEDURE FOR THE BAK SYSTEM.

                                                                               1
<PAGE>

                          LETTER TO SHAREHOLDERS CONT'D

          Three significant factors affected 1996 results. First, we received
     FDA approval for the commercial launch of our principal product, which
     positively affected our revenue growth and established a foundation for
     future revenue growth in our major market.  Second, we ended our
     distribution agreement outside the United States with Smith & Nephew, an
     orthopaedic products company based in the United Kingdom, and started to
     develop our own independent distributor network. This had a negative
     short-term effect on revenue. We believe that the overseas market offers
     strong potential and that we will be better served by developing our own
     network of independent distributors. Third, we decided to build a direct
     sales force in the United States to assure consistency in how the
     innovative BAK system is presented. Consequently, sales and marketing
     expenses were higher than originally projected.

EXECUTING OUR PLAN  In 1996, we established our surgeon education program and
     developed our marketing and sales organization - both essential to our
     commercial launch. As 1997 unfolds, we are focused on executing our plan
     for the commercial launch of the BAK system while continuing clinical
     trials for other BAK systems and conducting research and development to
     refine and develop complementary products.
          We have confidence in the design of the BAK system and recognize that
     surgeon training is critical to consistent, strong patient outcomes. In
     August, we opened our surgeon education center at our headquarters. By the
     end of 1996, more than 600 surgeons had attended our BAK surgical seminars.
     We plan to train more than 100 surgeons monthly during 1997 and expect to
     have trained most of the 1,800 spine surgeons who regularly perform lumbar
     fusion surgery in the United States by the end of 1997. Our seminar faculty
     includes 30 surgeons involved in our clinical trials, most of whom have
     three to five years of experience with the BAK system. In addition, we have
     developed a network of more than 100 sales and support specialists who are
     available to assist BAK-trained surgeons in operating rooms across the
     United States.
          Spine-Tech has become a familiar and exciting participant in major
     medical conferences. In 1996, we exhibited at the annual meetings of the
     North American Spine Society, American Association of Neurological
     Surgeons, Congress of Neurological Surgeons, American Academy of
     Orthopaedic Surgeons and the European Spine Society. At each of these
     meetings, several papers on the BAK system were presented, which
     consistently showed strong findings.
          To date, the feedback about the BAK system from surgeons, patients and
     payors has been consistently positive. Physicians appreciate the
     thoroughness of our clinical research, quality of our training and
     continuing technical support. Patients have been pleased with surgical
     outcomes. And payors note the low cost of the procedure itself and
     patients' faster return to work.

1996 REVENUES
(IN MILLIONS)
Q1    $1.4
Q2    $1.5
Q3    $1.5
Q4    $5.7


1996 NET INCOME
   (LOSS)
Q1       $(355)
Q2       $(585)
Q3     $(1,449)
Q4      $2,144


2

<PAGE>

     [PHOTO]

                                   (LEFT TO RIGHT)
     STEPHEN D. KUSLICH, M.D., ORTHOPAEDIC SURGEON
     AND MEDICAL DIRECTOR; DAVID W. STASSEN, CHIEF
     EXECUTIVE OFFICER AND PRESIDENT; DOUGLAS W. KOHRS,
     VICE PRESIDENT OF RESEARCH AND PRODUCT DEVELOPMENT.

          As in the United States, patients and surgeons in other nations
     have been awaiting the results of clinical trials and FDA approval
     before adopting BAK technology. We believe that the strength of our
     clinical trial results and FDA approval in the United States will
     support increasing international acceptance of the BAK system.

BUILDING THE MOMENTUM  The commercial launch of the BAK system will accelerate
     the growth of Spine-Tech's sales in 1997. Nearly half of our 96 employees
     are devoted to sales, education and clinical support. This reflects our
     commitment to the successful commercial launch of the BAK system. We now
     have 25 direct sales representatives, all with successful experience
     selling medical/surgical specialty devices, four regional sales managers
     and a network of seven agent groups.
          In December, we submitted a Pre-Market Approval (PMA) supplemental
     application to the FDA for a laparoscopic procedure to implant BAK devices.
     This is a less invasive procedure that significantly reduces surgical
     trauma and further shortens recovery times. We are optimistic that we will
     receive FDA clearance for this procedure during 1997.
          Clinical trials for the BAK/C-Registered Trademark- system, implants
     and procedures for the cervical spine (neck) are progressing. Patient
     enrollment continues in these clinical trials.
          Our commitment to research and development continues, with more than
     17 percent of revenues devoted to this effort in 1996. Our focus is on
     refining our current implants, instruments and procedures, and developing
     new products related to treatment of spinal diseases. In December, we
     signed an agreement with Orquest Corporation, a medical manufacturer based
     in Mountain View, California, to evaluate and commercialize
     Healos-Registered Trademark-, a synthetic bone graft material. Healos has
     the potential to fill the BAK device and eliminate the need for a second
     surgery to harvest bone graft from the patient's hip.
          In closing, we are appreciative of our surgeon customers who have
     embraced the BAK technology and are adopting it in their practices. I am
     proud of the contributions of our employees. Through their hard work and
     commitment, we are moving forward with full-scale manufacturing and
     marketing of our BAK system.


          Sincerely,

                    /s/ David W. Stassen           DAVID W. STASSEN
                                                   CHIEF EXECUTIVE OFFICER
                                                   AND PRESIDENT


                                                                               3
                          SPINE-TECH 1996 ANNUAL REPORT

<PAGE>

                              REVIEW OF OPERATIONS


BACK PAIN CAUSED BY DEGENERATIVE DISC DISEASE  disables millions annually and
     absorbs a large portion of health care resources in the United States and
     around the world. In the United States alone, back pain leads to an
     estimated $25 billion annually in medical treatment costs and $60 billion
     in lost worker productivity.
          The treatment of last resort for many back pain patients is spinal
     fusion surgery, in which adjacent vertebrae are joined to stabilize the
     joint and reduce pressure on nerves. Each year, more than 200,000 spinal
     fusion surgical procedures are performed in the United States and 400,000
     such procedures are performed worldwide.
          The BAK system of implants, surgical procedures and instruments offers
     physicians and their patients an innovative approach to spinal fusion in
     the lumbar area of the spine, offering less invasive surgery, lower
     treatment costs and superior patient outcomes.
          Between 1992 and 1996, 1,900 patients were enrolled in BAK clinical
     trials conducted by 42 surgeons at 23 medical centers. On September 23,
     1996, Spine-Tech received FDA approval to begin marketing the BAK system
     for spinal fusion in the lumbar area, the most common region for
     degenerative disc disease. Since then, Spine-Tech's sales and marketing
     efforts have focused on the U.S. introduction of the BAK system. By year-
     end 1996, more than 2,800 patients had received BAK implants.
          The adoption of a new technology is a process of creating awareness,
     building credibility and gaining acceptance. We offer comprehensive
     training programs to assist surgeons in understanding BAK procedures and to
     ensure their appropriate use. To assure physicians and patients of the
     efficacy of the BAK technology, Spine-Tech conducted extensive FDA-approved
     clinical trials. We continue to follow up with patients and collect long-
     term outcomes data.

AVERAGE PATIENT PAIN SCORES
 AT FOLLOW-UP

[CHART]

[PHOTO]

DIRECTOR OF PROFESSIONAL EDUCTION,
DUANE LINENKUGEL, IN SPINE-TECH'S TRAINING LAB.

                          SPINE-TECH 1996 ANNUAL REPORT

4

<PAGE>

TRAINING FOR SUCCESSFUL OUTCOMES Spine-Tech is committed to preparing surgeons
     to use the BAK system by providing a comprehensive training program and
     follow-up technical support. As soon as we received FDA approval for the
     BAK system in late September, we launched the first seminars at our
     headquarters training facility. By year-end 1996, we had trained more
     than 600 surgeons.
          Currently, we provide training programs for four groups:
          ORTHOPAEDIC OR NEUROLOGICAL SURGEONS, whose practices are dedicated to
     spinal surgery. Surgeons invited to attend training seminars have the
     appropriate patient volume, referral patterns, surgical judgment and
     experience. Our goal is to only have surgeons who have completed training
     use the BAK system.
          CLINICAL PROFESSIONALS, such as physician's assistants and surgical
     technicians, who assist with BAK procedures and patients.
          CLINICAL SUPPORT NURSES, who are available for support in the
     operating room during BAK surgery.
          SPINE-TECH DIRECT AND INDIRECT SALES REPRESENTATIVES, who are
     technically oriented and have previous experience with medical and surgical
     products.
          The training seminar encompasses lectures on the bioscience and design
     of the BAK implant, patient indications and evaluation for BAK surgery. A
     review of clinical results helps surgeons determine which patients will
     benefit the most from BAK implants.


TRAINING IS ESSENTIAL

"BAK implants are re-engineering the management of degenerative disc
disease. At Spine-Tech, we believe education is essential to the adoption
of new technology and to preserving our consistently outstanding clinical
results. We invite appropriate surgeons to attend our training seminars and
require that surgeons complete training before performing BAK procedures."

                         -    Duane Linenkugel
                              Director of
                              Professional Education

                                                                               5
<PAGE>

                           REVIEW OF OPERATIONS CONT'D

          Anterior (from the front) and posterior (from the back) surgical
     procedures are reviewed in detail, as well as unusual situations. The
     anterior approach is new to many surgeons, but gaining acceptance as
     they see reduced operating times and less patient discomfort with this
     procedure. The traditional posterior approach involves dissecting back
     muscles to expose the spine; this additional surgical trauma can
     lengthen patient recovery time compared to our anterior approach.
          Our 30 faculty members performed BAK procedures under our U.S.
     clinical trials. Each has an average of three years of experience with
     the BAK system. Surgeons attending our seminars appreciate the
     opportunity to learn from their peers.
          In 1997, our training program will continue its focus on
     introducing BAK technology to U.S. spinal surgeons. In addition, we
     anticipate offering training in laparoscopic procedures, pending FDA
     approval for this less invasive surgical technique. As the BAK system
     gains acceptance overseas, we expect to train more surgeons in other
     nations.

PREDICTABLE PATIENT OUTCOMES

          Traditional spinal fusion methods have met with mixed success,
     often leading to the need for second surgeries. In extensive clinical
     trials and early U.S. commercialization, the Spine-Tech BAK system has
     provided exceptional spinal stability and predictable patient outcomes.
     BAK instruments and procedures provide accuracy, precision and safety -
     for consistent results. BAK implants differ from previous spinal fusion
     devices by

                                    [GRAPHIC]
                                 A SUCCESS STORY

"In 1992, I was in constant pain and needed to get back to living. My doctor
said I needed spinal fusion surgery and recommended a traditional technique. He
also said it would be six to 12 months before I could work, and I would have
life-long limitations. The BAK implants made more sense to me. I was discharged
three days after BAK surgery and, in five weeks, returned to work full-time in
my position as a disability manager. Less than six months later, I could garden,
go grocery shopping and do everything I couldn't do before surgery."

                    -    Vicki Carlson
                         BAK patient

                          SPINE-TECH 1996 ANNUAL REPORT

6
<PAGE>

[PHOTO]
VICKI CARLSON, BAK PATIENT, IS BACK TO ENJOYING THE THINGS
SHE COULDN'T DO BEFORE SURGERY.


     directly addressing the pain source - the instability in the vertebral
     joint caused by a degenerative disc. The traditional instrumented spinal
     fusion involves attaching a device to the side of the spine. The BAK
     implants - two titanium alloy cylinders - are inserted between the
     vertebrae. The ribbed structure of the BAK implants enables them to
     withstand the enormous loading forces of the spine. In testing, BAK
     implants tolerated forces many times greater than those experienced in
     the lumbar spine. Further, the large hole design encourages bone growth
     through the implant for long-term stability.
          The BAK system offers improvements beginning with the surgical
     procedure and extending through recovery. The BAK fusion procedure is a
     less invasive surgical technique, reducing operating times and blood
     loss. The anterior approach, discussed above, results in even less
     surgical trauma. The average hospital stay experienced during clinical
     trials has been 4.1 days, compared to 6-7 days for traditional
     instrumented spinal fusion surgery.
          In clinical trials, BAK patients consistently reported improvements
     in pain relief. After one year, 83.3 percent of patients reported less
     pain, and after three years, 90.3 percent of patients reported less
     pain. Moreover, major complications have been minimal.
          Fast recovery and rehabilitation lead to exceptional return-to-work
     times. Of the patients who were not working prior to surgery due to
     disability, 38 percent were working within one year of surgery and 90
     percent were working three years later.

          As we enter 1997, Spine-Tech is committed to providing physicians
     and their patients with innovative, effective solutions to degenerative
     disc disease, supported by thorough research, an exceptional training
     program and continuing technical support.

  BAK FUSION RESULTS
  (% OF PATIENTS WITH
  SUCCESSFUL FUSION)
YEAR
1                86.2%
2                92.0%
3                98.3%

                                                                               7
<PAGE>

                        SPINAL FUSION AND THE BAK SYSTEM


IN THE UNITED STATE  back pain is the leading cause of workers' compensation
     expense, the second leading reason for physician office visits and a
     leading reason for surgical procedures. A commonly performed surgical
     treatment for back pain is spinal fusion, in which the disc between two
     adjacent vertebrae is removed and the two vertebrae are fused together
     using bone graft. Worldwide, an estimated 400,000 spinal fusion surgical
     procedures are performed each year, with approximately half of these
     occurring in the United States.

[GRAPHIC]
          The Spine-Tech BAK system is a patented series of spinal implants,
     surgical instruments and procedures that aid the positioning of the
     implants between the vertebrae to stabilize the spine and facilitate the
     fusion of the vertebrae. The BAK implants are hollow, threaded titanium
     alloy cylinders that are implanted between two or more vertebrae. The
     implants are packed with bone graft and fusion is achieved when adjoining
     vertebrae grow together through the implant, resulting in stabilization and
     pain relief.
          In the United States, more than 2,800 patients have received BAK
     implants and have shown that the BAK system offers significant improvements
     over traditional fusion techniques, including:

[GRAPHIC]
          -    A high fusion success rate;
          -    Quick functional recovery and rehabilitation, leading to
               exceptional return-to-work outcomes;
          -    A low re-operation rate resulting from a predictable, definitive
               surgical procedure; and
          -    Less invasive surgical techniques that can reduce operating
               times, hospitalization and blood loss, resulting in minimized
               patient stress and lower health care costs.

Spine-Tech-Registered Trademark-, BAK/C-Registered Trademark- and Cervi-Lok-
Registered Trademark- are registered trademarks of Spine-Tech, Inc.
BAKTM  is a trademark of Spine-Tech, Inc.
Healos-Registered Trademark- is a registered trademark of Orquest Corporation.

<PAGE>

             SPINE-TECH, INC.  MANAGEMENT'S DISCUSSION AND ANALYSIS


     The following table sets forth selected financial data for the Company and
should be read in conjunction with the financial statements and related notes
included in this document and with the balance of the management's discussion
and analysis.


STATEMENT OF OPERATIONS DATA

<TABLE>
<CAPTION>

                                                                           YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)             1996           1995           1994           1993           1992
--------------------------------------------------------------------------------------------------------------------
<S>                                            <C>             <C>            <C>           <C>          <C>
Net sales                                       $10,153         $7,517         $4,398         $2,001       $    321
Cost of goods sold                                2,849          2,488          1,330            391             38
                                              ---------------------------------------------------------------------
    Gross profit                                  7,304          5,029          3,068          1,610            283
Operating expenses:
    Sales and marketing                           5,387          1,563            962             --             --
    General and administrative                    3,294          2,487          1,491          1,638            879
    Research and development                      1,777          1,597          1,202            675            807
                                              ----------------------------------------------------------------------
       Total operating expenses                  10,458          5,647          3,655          2,313          1,686
                                              ----------------------------------------------------------------------
Operating loss                                   (3,154)          (618)          (587)          (703)        (1,403)
Exclusive distribution agreement                                    --             40            677             --
Interest income                                   1,223            896            168             38             25
                                              ----------------------------------------------------------------------
Net pretax income (loss)                         (1,931)           278           (379)            12         (1,378)
Provision (benefit) for income taxes             (1,684)            10             --             --             --
Net income (loss)                                  (247)           268           (379)            12         (1,378)
Net income (loss) per weighted
    average common share                      $    (.02)      $    .03       $   (.06)      $     --      $    (.30)


<CAPTION>

BALANCE SHEET DATA

                                                                           DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)             1996           1995          1994           1993            1992
---------------------------------------------------------------------------------------------------------------------
<S>                                           <C>            <C>             <C>            <C>            <C>
Current assets                                  $24,053        $27,652        $ 4,337        $ 5,809        $ 1,345
Current liabilities                               1,412            862            566            665            111
                                              ----------------------------------------------------------------------
Working capital                                 $22,641        $26,790        $ 3,771        $ 5,144        $ 1,234
Total assets                                    $34,058        $32,667        $ 5,549        $ 5,955        $ 1,429
Accumulated deficit                            $ (2,562)      $ (2,315)       $(2,378)       $(1,999)       $(2,011)
Shareholders' equity                            $32,646        $31,805        $ 4,983        $ 5,290        $ 1,317

</TABLE>

     All international sales are conducted in U.S. dollars. International
revenues were $1.9 million, $5.2 million, $2.0 million and $607,000 for 1996,
1995, 1994 and 1993, respectively. No assets other than accounts receivable are
specifically attributable to international sales. International accounts
receivable at the end of the year were $800,000, $1.6 million, $467,000 and
$173,000 for 1996, 1995, 1994 and 1993, respectively.

1996 COMPARED TO 1995
YEARS ENDED DECEMBER 31, 1996, AND
DECEMBER 31, 1995
     Net sales increased to $10.2 million for 1996 compared to $7.5 million for
1995 primarily as a result of increased sales of the BAK Interbody Fusion System
in the United States. Domestic sales of the BAK Interbody Fusion System in the
United States increased to $7.7 million for 1996 from $2.0 million for 1995.
Sales of the BAK Interbody Fusion System to Smith & Nephew Richards, Inc. (Smith
& Nephew) for international distribution decreased to $350,000 for 1996 compared
to $4.7 million for 1995, decreasing to 3 percent of sales in 1996 from 61
percent for 1995. In February 1996, the Company ended its exclusive distribution
agreement with Smith & Nephew and has been establishing a network of independent
distributors for international

                          SPINE-TECH 1996 ANNUAL REPORT
8
<PAGE>

markets. As a result, international sales of the BAK/C-Registered Trademark- and
Cervi-Lok-Registered Trademark- products exceeded $800,000 for 1996, compared to
approximately $500,000 for 1995. Domestically, BAK/C and Cervi-Lok sales
increased to $500,000 for 1996 from approximately $300,000 for 1995.
     Gross profit increased to $7.3 million for 1996 from $5.0 million for 1995.
This increase is directly related to the increase in sales in 1996 versus 1995.
As a percentage of net sales, gross profit increased to 71.9 percent in 1996 as
compared to 66.9 percent in 1995, due primarily to the stabilization in prices
paid to outside vendors for the manufacture of implants and instruments and
increased utilization of the Company's manufacturing operations.
     Total operating expenses increased to $10.5 million for 1996 compared to
$5.6 million for 1995. Sales and marketing expenses increased to $5.4 million
for 1996 from $1.6 million for 1995, increasing as a percentage of net sales to
53.1 percent in 1996 compared to 20.8 percent in 1995. This increase occurred as
the result of the Company's expansion of its capabilities to support both
international and domestic sales activity. In June 1996, the Company began
establishing a network of direct sales persons to complement the seven
independent agency groups which service customers in certain geographic areas in
the United States. This decision to establish a direct sales force across most
of the United States resulted in higher than anticipated sales and marketing
expenses for the last half of 1996. General and administrative expenses
increased to $3.3 million for 1996 from $2.5 million for 1995, but decreased as
a percentage of net sales to 32.4 percent in 1996 from 33.1 percent in 1995. The
increase in these expenses was primarily the result of increased corporate
activities required to support the expanded sales and marketing activities.
Research and development expenses increased to $1.8 million for 1996 compared to
$1.6 million for 1995, but decreased as a percentage of net sales to 17.5
percent in 1996 from 21.2 percent in 1995. The increase in these expenses
reflects the hiring of additional development engineers and payments to outside
contractors for prototype development projects.
     The Company's operating loss increased to $3.2 million in 1996 from
$600,000 in 1995. The pre-tax loss for 1996 was $1.9 million, which included an
increase in interest income to $1.2 million, compared to pre-tax income of
$278,000 for 1995, which included interest income of $896,000. In 1996, a one-
time income tax benefit of $1.7 million was recognized. Until the fourth quarter
of 1996, there was substantial doubt whether the Company would be able to
realize the benefits of its loss carry-forward. In recognition of this doubt,
the Company had provided a full valuation allowance for the net deferred tax
assets. With the Company receiving approval from the FDA in September 1996 to
market the BAK Interbody Fusion System in the United States, the Company
determined that the realization of the net deferred tax assets would be more
likely than not. As a result, in the fourth quarter of 1996 the Company reversed
the valuation allowance and recognized an income tax benefit of $1.7 million, or
$.17 per share. This one-time event resulted in the Company recording a net loss
of $247,000 for 1996 compared to net income of $268,000 in 1995. The 1996 loss
before recognition of the $1.7 million income tax benefit was $1.9 million.

1995 COMPARED TO 1994
YEARS ENDED DECEMBER 31, 1995, AND
DECEMBER 31, 1994
     Net sales increased to $7.5 million for 1995 compared to $4.4 million for
1994
                                                                               9


<PAGE>
                   MANAGEMENT'S DISCUSSION AND ANALYSIS CONT'D

reflecting primarily increased sales of the BAK Interbody Fusion System to Smith
& Nephew for international distribution and sales of the BAK/C and Cervi-Lok
implants (which were introduced in 1995). Sales of BAK devices to Smith & Nephew
accounted for 61 percent of the Company's net sales in 1995. Domestic sales of
BAK implants remained relatively constant between 1994 and 1995, reflecting the
continuation of clinical trials. International sales of the BAK/C and Cervi-Lok
products were approximately $500,000 for 1995. Domestically, BAK/C and Cervi-Lok
sales increased to approximately $300,000.
     Gross profit increased to $5.0 million for 1995 from $3.1 million in 1994.
This increase is directly related to the increase in net sales in 1995 versus
1994. As a percentage of net sales, gross profit decreased to 66.9 percent in
1995 from 69.8 percent in 1994, due primarily to variations in prices paid by
the Company to outside vendors for the manufacture of implants and instruments
and because of the costs associated with the introduction of new products.
     Total operating expenses increased to $5.6 million for 1995 compared to
$3.7 million for 1994. Sales and marketing expenses increased to $1.6 million
for 1995 from $1.0 million for 1994, but decreased as a percentage of net sales
to 20.8 percent in 1995 compared to 21.9 percent in 1995. Increased expenses
related primarily to the addition of personnel to support increased domestic and
international sales activities. General and administrative expenses increased to
$2.5 million for 1995 from $1.5 million for 1994, but decreased as a percentage
of net sales to 33.1 percent in 1995 from 33.9 percent in 1994. Increased
expenses resulted primarily from the Company's preparation for FDA approval of
the BAK and the addition of personnel to support the increased levels of sales
and corporate activities. Research and development expenses increased to $1.6
million in 1995 from $1.2 million in 1994. Research and development expenses
declined as a percentage of net sales to 21.2 percent in 1995 from 27.3 percent
in 1994. The increase in the amount of these expenses reflects the hiring of
additional development engineers and payment to outside contractors for
prototype development projects and the increase in clinical study activity.
     The Company's operating loss remained relatively constant at $600,000;
however, the Company had net income of $268,000 in 1995 compared to a loss of
$379,000 in 1994, due primarily to an increase in interest income to $896,000 in
1995 from $168,000 in 1994, due to a higher level of  cash available for short-
term investments resulting from the Company's initial public offering which was
completed in June 1995.

LIQUIDITY AND CAPITAL RESOURCES
     In June 1995, the Company successfully completed its initial public
offering of 3,225,000 shares of newly issued Common Stock. After selling
expenses, the Company received proceeds of just over $26 million from the
offering. The Company expects to use these proceeds for working capital
requirements, funding of clinical trials, expansion of research and development
and sales and marketing activities, and other general corporate purposes. In
November 1995, the Company used a portion of these proceeds to acquire and
relocate to a new facility, and to renovate such new facility. During 1996, the
Company used approximately $12.2 million for operating activities and for
capital asset acquisitions. Of this amount, $5.2 million was used to increase
inventory, $1.2 million was due to an increase in accounts receivable, and


                          SPINE-TECH 1996 ANNUAL REPORT
10
<PAGE>

$4.7 million was used to renovate the new facility and purchase equipment. Also
during 1996 approximately $600,000 was provided by proceeds from the exercise of
stock options and the purchase of Common Stock pursuant to the Employee Stock
Purchase Plan.
     Cash and cash equivalents are invested in U.S. government obligations and
corporate debt securities. Securities totaling $9.6 million and $3.5 million
will mature during 1997 and 1998, respectively. During the first half of 1997,
the Company expects to continue to use cash and cash equivalents to fund working
capital needs associated with continued building of inventory and financing of
accounts receivable associated with product sales. The Company may also use a
portion of its available capital resources to acquire or license technology,
products or businesses related to the Company's current business, although no
such acquisitions or licenses are currently being negotiated or planned. During
the second half of 1997, the Company expects, based upon existing operations, to
begin generating cash resources from operations. The Company believes that its
currently available cash and cash equivalents, combined with additional cash
flow from operations, will be adequate to finance ongoing operations for the
foreseeable future.
     The Company's future liquidity and capital requirements will depend on
numerous factors, including FDA regulatory actions and continued domestic and
international sales of its entire product line.

FORWARD-LOOKING STATEMENTS
     Certain statements made above in Management's Discussion and Analysis and
elsewhere in the Annual Report, which are summarized below, are forward-looking
statements that inherently involve risks and uncertainties. Actual results may
be materially different. Factors that could cause actual results to differ
include the following:
     INCREASE IN REVENUES AND EARNINGS - General market conditions and
competitive conditions within the market for the Company's products; acceptance
by spine surgeons and other medical professionals; absence of adverse patient
outcomes; continued intellectual property protection; development of direct
internal sales force; development, acceptance and regulatory approval of the
Company's new products and procedures; the entrance of additional competitors
into the market.
     INCREASED TRAINING OF MEDICAL PROFESSIONALS - Continued acceptance of the
BAK system by spine surgeons and other medical professionals; absence of adverse
patient outcomes; continued acceptance by patients and payors; marketing efforts
by competitors.
     INCREASED INTERNATIONAL SALES - Establishment of a network of independent
distributors for the international market; obtaining necessary foreign
regulatory approvals and acceptance by foreign spine surgeons and other medical
professionals; absence of adverse patient outcomes; continued acceptance by
patients and payors; continued intellectual property protection in foreign
markets.
     FDA APPROVAL OF LAPAROSCOPIC PROCEDURES - Approval by the FDA of these
procedures in line with the Company's projected timetable.
     ADEQUATE FUNDING - Unanticipated events or circumstances may alter the
Company's capital requirements, including demand for the Company's products;
general market and competitive conditions within the market for the Company's
products; potential adverse patient outcomes; potential litigation relating to
protection of the Company's intellectual property; development, acceptance and
regulatory approval of the Company's new products and procedures.

                                                                              11

<PAGE>

                         SPINE-TECH, INC. BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                     DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)                         1996            1995
------------------------------------------------------------------------------------------
ASSETS
<S>                                                          <C>                <C>
Current assets:
     Cash and cash equivalents                                $  1,724           $  1,171
     Short-term investments                                      9,674             22,416
     Accounts receivable, less allowances
          of $187--1996; $158--1995                              3,151              1,957
     Inventories                                                 6,982              1,822
     Deferred tax asset                                          2,155                 --
     Interest receivable                                           221                228
     Prepaid expenses                                              146                 58
                                                             -----------------------------
          Total current assets                                  24,053             27,652

Property, plant and equipment:
     Land                                                          438                438
     Building, furniture and fixtures                            5,317              1,429
     Equipment                                                   1,087                388
                                                             -----------------------------
                                                                 6,842              2,255
     Accumulated depreciation                                     (373)              (196)
                                                             -----------------------------
                                                                 6,469              2,059
Investments                                                      3,536              2,956
                                                             -----------------------------
          Total assets                                         $34,058            $32,667
                                                             -----------------------------
                                                             -----------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
     Accounts payable                                         $    567           $    233
     Accrued clinical payments                                      42                330
     Accrued royalties                                             365                199
     Accrued commissions                                           337                 16
     Other accrued expenses                                        101                 84
                                                             -----------------------------
          Total current liabilities                              1,412                862

Shareholders' equity:
     Preferred Stock, par value $.01 per share:
          Authorized shares--300,000
          Issued and outstanding shares:
             1996--none; 1995--none                                 --                 --
     Common Stock, par value $.01 per share:
          Authorized shares--15,000,000
          Issued and outstanding shares:
             1996--9,939,055; 1995--9,653,252                       99                 96
     Additional paid-in capital                                 35,109             34,024
     Accumulated deficit                                        (2,562)            (2,315)
                                                             -----------------------------
          Total shareholders' equity                            32,646             31,805
                                                             -----------------------------
            Total liabilities and shareholders' equity         $34,058            $32,667
                                                             -----------------------------
                                                             -----------------------------
</TABLE>

See accompanying notes.

                          SPINE-TECH 1996 ANNUAL REPORT
12
<PAGE>

                    STATEMENTS OF OPERATIONS SPINE-TECH, INC

<TABLE>
<CAPTION>


                                                                        YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)                         1996               1995            1994
-----------------------------------------------------------------------------------------------------------
<S>                                                        <C>                   <C>              <C>
Net sales                                                   $   10,153           $  7,517         $ 4,398
Cost of goods sold                                               2,849              2,488           1,330
                                                             ----------------------------------------------
     Gross profit                                                7,304              5,029           3,068

Operating expenses:
     Sales and marketing                                         5,387              1,563             962
     General and administrative                                  3,294              2,487           1,491
     Research and development                                    1,777              1,597           1,202
                                                             ----------------------------------------------
          Total operating expenses                              10,458              5,647           3,655

Other operating income:
     Exclusive distribution agreement fee                           --                 --              40
                                                             ----------------------------------------------
Operating loss                                                  (3,154)              (618)           (547)

Interest income                                                  1,223                896             168
                                                             ----------------------------------------------
(Loss) income before income taxes                               (1,931)               278            (379)
Income tax (benefit) expense                                     1,684)                10              --
                                                             ----------------------------------------------
Net (loss) income                                           $     (247)          $    268         $  (379)
                                                             ----------------------------------------------
                                                             ----------------------------------------------
Net (loss) income per share:
     Primary                                                $     (.02)          $    .04         $  (.18)
     Fully diluted                                          $     (.02)          $    .03         $  (.06)

Weighted average number of shares outstanding:
     Primary                                                 9,831,733          7,261,466       2,465,398
     Fully diluted                                           9,831,733          9,641,751       6,600,630
</TABLE>

SEE ACCOMPANYING NOTES.
                                                                              13
<PAGE>

                SPINE-TECH, INC STATEMENT OF SHAREHOLDERS' EQUITY


<TABLE>
<CAPTION>

                                                  CONVERTIBLE                                   ADDITIONAL   ACCUM-
                                                PREFERRED STOCK              COMMON STOCK       PAID-IN     ULATED
 (IN THOUSANDS)                                SHARES       AMOUNT        SHARES     AMOUNT     CAPITAL     DEFICIT        TOTAL
------------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>           <C>          <C>         <C>        <C>          <C>          <C>
Balance at December 31, 1993                   2,757         $27          2,070       $21        $ 7,241     $(1,999)      $  5,290
  Exercise of stock option in
     April 1994                                   --          --             30        --             30          --             30
Value of stock options issued for
     research and development in
     process                                      --          --             --        --             42          --             42
  Net loss                                        --          --             --        --             --        (379)          (379)
                                              --------------------------------------------------------------------------------------
Balance at December 31, 1994                   2,757          27          2,100        21          7,313      (2,378)         4,983
  Issuance of Common Stock for
     consulting services in January
     1995                                         --          --              8        --             27          --             27
  Value of stock options issued for
     consulting services in March 1995            --          --             --        --             24          --             24
  Exercise of stock options                       --          --             91         1            109          --            110
  Issuance of Common Stock, net of
     offering expense                             --          --          3,225        32         26,361          --         26,393
  Conversion of Preferred Stock in
     July 1995                                (2,757)        (27)         4,135        41            (14)         --             --
  Exercise of warrants in
     October 1995                                 --          --             94         1            204        (205)            --
  Net income                                      --          --             --        --             --         268            268
                                              --------------------------------------------------------------------------------------
Balance at December 31, 1995                      --          --          9,653        96         34,024      (2,315)        31,805
  Shares purchased for Employee
     Stock Purchase Plan                          --          --              1        --             22          --             22
  Tax benefit of stock options                    --          --             --        --            471          --            471
  Exercise of stock options                       --          --            285         3            592          --            595
  Net loss                                        --          --             --        --             --        (247)          (247)
                                              --------------------------------------------------------------------------------------
Balance at December 31, 1996                      --         $--          9,939       $99        $35,109     $(2,562)       $32,646
                                              --------------------------------------------------------------------------------------
                                              --------------------------------------------------------------------------------------

</TABLE>

See accompanying notes.

                          SPINE-TECH 1996 ANNUAL REPORT
14
<PAGE>

                    STATEMENTS OF CASH FLOWS SPINE-TECH, INC

<TABLE>
<CAPTION>

                                                                      YEAR ENDED DECEMBER 31,
(IN THOUSANDS)                                                   1996               1995             1994
----------------------------------------------------------------------------------------------------------
<S>                                                         <C>               <C>                <C>
Operating activities:
   Net income (loss)                                         $    (247)        $      268        $   (379)
   Adjustments to reconcile net income (loss) to net cash
     used in operating activities:
     Depreciation                                                  215                103              72
     Common Stock and stock options issued for
         services provided                                          --                 51              42
     Deferred tax benefit                                       (1,684)                --              --
     Loss on sale of equipment                                      31                 --              --
     Changes in operating assets and liabilities:
       Accounts receivable                                      (1,194)            (1,254)           (292)
       Inventories                                              (5,160)              (906)           (567)
       Interest receivable                                           7               (228)             --
       Prepaid expenses                                            (88)                (4)            (51)
       Accounts payable and accrued expenses                       550                296             (99)
                                                               --------------------------------------------
         Net cash used in operating activities                  (7,570)            (1,674)         (1,274)

Investing activities:
   Purchases of property, plant and equipment                   (4,656)            (1,866)           (225)
   Purchase of investments                                     (41,320)           (22,211)         (3,161)
   Proceeds from sales and maturities of investments            53,482                 --              --
                                                               --------------------------------------------
         Net cash provided by (used in) investing activities     7,506            (24,077)         (3,386)

Financing activities:
   Proceeds from sale of Common Stock                               22             26,393              30
   Proceeds from exercise of stock options                         595                110              --
                                                               --------------------------------------------
         Net cash provided by financing activities                 617             26,503              30
                                                               --------------------------------------------
   Increase (decrease) in cash and cash equivalents                553                752          (4,630)
   Cash and cash equivalents at beginning of year                1,171                419           5,049
                                                               --------------------------------------------
   Cash and cash equivalents at end of year                  $   1,724          $   1,171        $    419
                                                               --------------------------------------------
                                                               --------------------------------------------
</TABLE>

See accompanying notes.

                                                                              15
<PAGE>

                 SPINE-TECH, INC. NOTES TO FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS
     The Company designs, develops, manufactures and sells spinal implant
devices and instruments which facilitate the minimally invasive surgical
treatment of degenerative diseases. The Company's primary products, the BAK-
Lumbar, BAK-Cervical and BAK-Thoracic Interbody Fusion Systems and the Cervi-Lok
System are designed to surgically treat spinal instability which can cause
chronic, disabling back pain. The Company has, or has licensed, several patents
and is currently developing additional instruments and techniques for use in
spinal surgery.   In the United States and internationally, customers consist of
hospitals and medical centers.

2. SUMMARY OF ACCOUNTING POLICIES
REVENUE RECOGNITION
     Revenue is recognized for domestic sales when implants or instruments are
shipped to a hospital or medical center based upon a purchase order number
generated by the hospital or medical center.

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

CASH EQUIVALENTS
     The Company considers all highly liquid investments which are available
immediately or upon a one-day notice to be cash equivalents. This includes all
demand deposits, savings and money market accounts.

MARKETABLE SECURITIES
     Short-term investments include all purchased U.S. government obligations
and corporate debt securities with maturities of less than one year. Investments
with a remaining maturity of more than one year are classified as long-term
investments. Management determines the appropriate classification of debt and
equity securities at the time of purchase and reevaluates such designation as of
each balance sheet date. Debt securities are classified as held-to-maturity
because the Company has the positive intent and ability to hold such securities
to maturity. Investments are stated at amortized cost, which approximates market
value. Interest on securities is included in interest income.

INVENTORIES
     Inventories are valued at the lower of cost, first-in, first-out (FIFO)
method, or market. As a medical device company, inventories are maintained and
costed by lot. Inventory cost elements consist of:
     RAW MATERIALS - primarily packaging and labeling materials for implants
     WORK-IN-PROCESS - outside manufacturing costs for implants and instruments
which have not been released into finished goods
     FINISHED GOODS-IMPLANTS - outside manufacturing costs, packaging materials
and sterilization costs
FINISHED GOODS-INSTRUMENTS - outside manufacturing costs

PROPERTY AND EQUIPMENT
     Property and equipment is stated at cost. Depreciation and amortization
expense is recognized on the straight-line basis over lives ranging from 5-20
years.

                          SPINE-TECH 1996 ANNUAL REPORT
16

<PAGE>

INCOME TAXES
     The Company accounts for income taxes using the liability method. Deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities.

NET INCOME (LOSS) PER COMMON SHARE
     Income (loss) per common share for the years ended December 31, 1996, 1995
and 1994 is computed using the weighted average number of shares of Common Stock
and Common Stock equivalents, if dilutive, outstanding during the periods
presented. Additionally, for 1994 and for the first quarter of 1995, pursuant to
the rules of the Securities and Exchange Commission, Common Stock issued by the
Company at prices less than the initial public offering price during the 12
months immediately preceding the initial public offering, plus stock options
granted at exercise prices less than the initial public offering price during
the same period, have been included in the calculation of shares used in the
calculation of net income (loss) per share as if they were outstanding for all
periods prior to the initial public offering. The fully diluted loss per share
is presented using the "if converted" method and reflects the impact of the
conversion of the Preferred Stock to Common Stock at the beginning of the
earliest period  presented or at the date of issuance, if later.

STOCK-BASED COMPENSATION
     The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," but applies Accounting Principles Board Opinion No. 25 (APB 25)
and related interpretations in accounting for its plans. Under APB 25, when the
exercise price of employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.

IMPAIRMENT OF LONG-LIVED ASSETS
     The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.

RECLASSIFICATION
     Certain prior year items have been reclassified to conform with the 1996
presentation.

3. INVESTMENTS
     The amortized cost and estimated market value of investments are as
follows:

<TABLE>
<CAPTION>

                                                                GROSS          GROSS         ESTIMATED
                                        AMORTIZED             UNREALIZED    UNREALIZED       MARKET
                                           COST                 GAINS          LOSSES        VALUE
----------------------------------------------------------------------------------------------------
<S>                                  <C>                   <C>              <C>         <C>
As of December 31, 1996:
  U.S. government obligations         $  3,525,974           $   7,691        $    --   $  3,533,665
  Corporate debt securities              6,022,928                  --         66,288      5,956,640
  Commercial paper                       3,660,794              15,059             --      3,675,853
                                     ----------------------------------------------------------------
                                       $13,209,696           $  22,750        $66,288    $13,166,158
                                     ----------------------------------------------------------------
                                     ----------------------------------------------------------------
As of December 31, 1995:
  U.S. government obligations         $  4,000,110           $      --        $   149   $  3,999,961
  Corporate debt securities              6,102,249                  --         22,163      6,080,086
  Commercial paper                      15,269,432             142,661             --     15,412,093
                                     ---------------------------------------------------------------
                                       $25,371,791            $142,661        $22,312    $25,492,140
                                     ---------------------------------------------------------------
                                     ---------------------------------------------------------------
</TABLE>

                                                                              17
<PAGE>
                      NOTES TO FINANCIAL STATEMENTS CONT'D

     The amortized cost and estimated fair market value of investments at
December 31st by contractual maturity are shown below.

<TABLE>
<CAPTION>

                                                    1996                               1995
                                     ----------------------------------------------------------------------
                                                             ESTIMATED                           ESTIMATED
                                       AMORTIZED              MARKET        AMORTIZED            MARKET
                                           COST                VALUE          COST                VALUE
----------------------------------------------------------------------------------------------------------
<S>                                   <C>                <C>             <C>                 <C>
Due in one year or less               $  9,674,222        $  9,645,727    $22,416,043         $22,545,909
Due after one year through two years     3,535,474           3,520,431      2,955,748           2,946,231
                                      --------------------------------------------------------------------
                                       $13,209,696         $13,166,158    $25,371,791         $25,492,140
                                      --------------------------------------------------------------------
                                      --------------------------------------------------------------------
</TABLE>

4. INVENTORIES
     Inventories consist of the following:

                                                      DECEMBER 31,
                                                 1996                1995
---------------------------------------------------------------------------
Raw materials                               $    38,653         $    18,423
Work-in-process                               1,285,133             213,202
Finished goods                                5,657,986           1,589,934
                                           ---------------------------------
                                             $6,981,772          $1,821,559
                                           ---------------------------------

     At December 31, 1996, finished goods were comprised of $4,184,117 of final
product implants and instruments, $1,233,117 of consigned implants and
instruments, and $240,752 of instruments used in the training facility.

5. LINE OF CREDIT
     The Company has a line of credit arrangement that allows it to borrow up to
$500,000. Any borrowings under this agreement bear interest at the prime rate
plus 1 1/2 percent. Borrowings under the facility are limited to 75 percent of
eligible domestic accounts receivable. The agreement contains certain financial
and operational covenants. At December 31, 1996, the Company had no
outstanding balance on the line of credit.

6. SHAREHOLDERS' EQUITY
     On April 7, 1995, the Board of Directors increased the authorized shares of
Common Stock from 10,000,000 to 15,000,000 and approved a 3-for-2 stock split of
the Common Stock to be effected in the form of a stock dividend, payable to
shareholders of record as of April 21, 1995. Accordingly, all share, per share,
weighted average share, and stock option information has been restated to
reflect the split.
     The Company completed an initial public offering of Common Stock in 1995 in
which it sold 3,225,000 shares of Common Stock, resulting in net proceeds to the
Company of $26,391,000.
     At the time of the initial public offering, all outstanding Convertible
Preferred Stock was converted into 4,135,232 shares of Common Stock on a one-
for-one and one-half share basis.
     In connection with the sale of series of Convertible Preferred Stock in
1992, the Company issued warrants to purchase 71,067 shares of Series B
Convertible Preferred Stock at $3.25 per share. The warrants were exercised in a
cashless transaction in October 1995.

SHAREHOLDER RIGHTS PLAN
     In 1996, the Company's Board of Directors adopted a Shareholder Rights Plan
by declaring a dividend of one preferred share purchase right (the "Right") for
each outstanding share of Common Stock. Under certain circumstances, a Right may
be exercised to purchase one one-hundredth of a share of Series A Junior
Preferred Stock for $150. The rights become exercisable if a person or group
acquires 20 percent or more of the


                       SPINE-TECH 1996 ANNUAL REPORT

18
<PAGE>

Company's outstanding Common Stock, subject to certain exceptions, or announces
an offer which would result in such person or group acquiring 20 percent or more
of the Company's outstanding Common Stock. If a person or group acquires 20
percent or more of the Company's outstanding Common Stock, subject to certain
exceptions, each right will entitle its holder to buy Common Stock of the
Company having a market value of twice the exercise price of the Right. The
Rights expire in 2006 and may be redeemed by the Company for $.01 per Right at
any timebefore, or, in certain circumstances, within 20 days (subject to
extension) following, the announcement that a person has acquired 20 percent or
more of the Company's outstanding Common Stock. Until a Right is exercised, the
holder of a Right, as such, has no rights as a shareholder of the Company.
     In connection with the adoption of the Shareholder Rights Plan, the Company
authorized 300,000 shares of Series A Junior Participating Preferred Stock (the
"Preferred Stock"). Holders of the Preferred Stock are entitled to quarterly
dividends in the amount of $1.00 or one hundred times the aggregate per share
amount of dividends paid to Common Stock shareholders, whichever is greater.
Each Preferred Stock share is entitled to one hundred votes on all matters
submitted to a vote of the shareholders of the Company. The Preferred Stock has
liquidation preference over the Company's Common Stock. The liquidation rate on
the Preferred Stock is the greater of $100 per share or an amount one hundred
times greater than the amount distributed to the Common Stock shareholders.


7. STOCK PURCHASE AND OPTION PLANS
STOCK PURCHASE PLAN
     The Company has an employee stock purchase plan under which the sale of
500,000 shares of its Common Stock has been authorized. The purchase price of
the shares under the plan is the lesser of 85 percent of the fair market value
on the first or last day of the offering period. Offering periods are three
months each. Employees may designate up to 10 percent of their compensation for
the purchase of stock.

STOCK OPTION PLANS
     Under the Company's stock option plans, the Company may grant employees,
Directors and consultants options to purchase Common Stock of the Company. Such
options are generally granted at the fair market value on date of grant and vest
over four years.
     The Company also has options outstanding to Smith & Nephew Richards Inc.
("Smith & Nephew"), pursuant to certain preemptive rights, to purchase an
aggregate of 51,788 shares of Common Stock at exercise prices of $3.27 to $9.00
per share. These options were valued at the fair market value of the stock on
the date of grant and generally vest over a four-year period.
     The following table summarizes the options to purchase shares of the
Company's stock option plans:


                                                                              19
<PAGE>
                      NOTES TO FINANCIAL STATEMENTS CONT'D
<TABLE>
<CAPTION>

                                                                                                   WEIGHTED
                                          SHARES                                NON-PLAN             AVERAGE
                                         AVAILABLE         OPTIONS              OPTIONS          EXERCISE PRICE
                                         FOR GRANT       OUTSTANDING           OUTSTANDING         PER SHARE
---------------------------------------------------------------------------------------------------------------
<S>                                    <C>              <C>                   <C>               <C>
Balance at December 31, 1993                89,250        1,253,250                     --           $  1.20
    Shares reserved                        645,000               --                     --                --
    Granted                               (601,950)         601,950                 38,981              3.28
    Became exercisable                          --               --                     --                --
    Exercised                                   --          (30,000)                    --              1.00
    Canceled                                45,000          (45,000)                    --              1.00
                                       ----------------------------------------------------
Balance at December 31, 1994               177,300        1,780,200                 38,981              1.90
    Granted                               (173,950)         173,950                 12,807             10.42
    Became exercisable                          --               --                     --
    Exercised                                   --          (91,000)                    --              1.21
    Canceled                                55,750          (55,750)                    --              5.00
                                       ---------------------------------------------------
Balance at December 31, 1995                59,100        1,807,400                51,7880              2.65
    Shares reserved                        500,000               --                     --                --
    Granted                               (558,200)         558,200                     --             24.08
    Became exercisable                          --               --                     --                --
    Exercised                                   --         (284,875)                    --              2.09
    Canceled                                30,400          (30,400)                    --             12.50
                                        --------------------------------------------------
Balance at December 31, 1996                31,300        2,050,325                 51,788           $  8.41
                                        --------------------------------------------------
                                        --------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>

                                       OPTIONS OUTSTANDING                                       OPTIONS EXERCISABLE
                           ----------------------------------------------------------------------------------------------------
      RANGE OF                  NUMBER            WEIGHTED AVERAGE        WEIGHTED           NUMBER                WEIGHTED
      EXERCISE               OUTSTANDING AT          REMAINING           AVERAGE          EXERCISABLE AT             AVERAGE
       PRICES               DECEMBER 31, 1996     CONTRACTUAL LIFE        PRICE           DECEMBER 31, 1996      EXERCISE PRICE
-------------------------------------------------------------------------------------------------------------------------------
<S>                        <C>                    <C>                   <C>               <C>                   <C>
$   .34   to   1.67              738,250              5 years            $  0.96                738,250           $    .96
   2.17   to   3.67              672,425              7 years               3.10                401,750               3.01
   9.00   to  15.00               52,250              9 years             11.42                  17,750              10.78
  15.25   to  22.50              230,450            9.5 years              20.94                 23,337              18.93
  22.75   to  30.00              356,950             10 years              25.38                  2,084              26.50
                              -----------                                -----------------------------------------------------
                               2,050,325                                 $  8.41              1,183,171            $  2.20
                              -----------                                ------------------------------------------------------
                              -----------                                ------------------------------------------------------
</TABLE>

     The weighted-average fair value of options granted during the years ended
December 31, 1996 and 1995 were $13.33 and $5.20, respectively.

PRO FORMA DISCLOSURES
     Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
the Statement. The fair value for these options was estimated at the date of the
grant using a Black-Scholes option pricing model with the following weighted
average assumptions for 1996 and 1995, respectively:  risk free interest rates
of 5 1/2 percent; dividend yield of 0 percent; volatility factors of the
expected market price of the Company's stock of .582 and .517; and a
weighted-average expected life of the option of five years.
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models

                          SPINE-TECH 1996 ANNUAL REPORT

20
<PAGE>

require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's employee stock options have
characteristics significantly different than those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:

                                                        DECEMBER 31,
                                                    1996           1995
------------------------------------------------------------------------
Pro forma net (loss) income
     (in thousands)                               $(866)           $204
Pro forma (loss) income per share:
     Primary                                       (.09)            .03
     Fully diluted                                 (.09)            .02


     NOTE: THE PRO FORMA EFFECT ON NET INCOME FOR 1996 AND 1995 IS NOT
REPRESENTATIVE OF THE PRO FORMA EFFECT ON NET INCOME IN FUTURE YEARS BECAUSE
IT DOES NOT TAKE INTO CONSIDERATION PRO FORMA COMPENSATION EXPENSE RELATED TO
GRANTS MADE PRIOR TO 1995.

8. LEASES
     The Company leased its administrative facilities under an operating lease
through December 1995 and furniture and fixtures under operating leases through
June 1996. Total rent expense was $46,143, $80,006 and $80,791 in 1996, 1995 and
1994, respectively.

9. INCOME TAXES
     The Company has operating loss carryforwards for income tax purposes
expiring at various times through 2011 of approximately $2,872,000 at December
31, 1996, which can be used to offset future earnings.
     Until the fourth quarter of 1996, there was substantial doubt that the
Company would be able to realize the benefits of its net deferred tax assets. In
recognition of this doubt, the Company had provided a full valuation allowance
for the net deferred tax assets. In September 1996, the Company obtained FDA
approval of its BAK Interbody Fusion System, which caused the Company to
consider the realization of the net deferred tax assets to be more likely than
not. As a result, in the fourth quarter of 1996, the Company reversed the
valuation allowance and recorded an income tax benefit of $1,684,000 or $.17 per
share.
     Components of deferred tax assets and
liabilities are as follows:

<TABLE>
<CAPTION>

                                                                   DECEMBER 31,
                                                           1996                     1995
--------------------------------------------------------------------------------------------
<S>                                                 <C>                       <C>
Deferred tax assets:
    Net operating loss
      carryforwards                                    $1,106,000               $  608,000
    Tax benefit of stock options                          471,000                       --
    Inventory capitalization
      and reserves                                        387,000                  224,000
    Research and development
      credits                                             194,000                  159,000
    Other                                                  36,000                   10,000
--------------------------------------------------------------------------------------------
      Total deferred tax assets                         2,194,000                1,001,000

Deferred tax liabilities:
    Depreciation and amortization                         (39,000)                 (29,000)
-------------------------------------------------------------------------------------------
Net deferred tax assets                                 2,155,000                  972,000
Valuation allowance                                            --                 (972,000)
-------------------------------------------------------------------------------------------
    Total deferred tax assets                          $2,155,000           $           --
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------

</TABLE>
    Income tax expense consists of:

<TABLE>
<CAPTION>

                                                           1996                      1995                1994
------------------------------------------------------------------------------------------------------------------
<S>                                               <C>                       <C>                      <C>
Current:
    Federal                                       $            --            $          --           $       --
    State                                                      --                       --                   --
    Alternative
      minimum tax                                              --                   10,000                   --

Deferred:
    Federal                                              (629,000)                      --                   --
    State                                                 (83,000)                      --                   --
    Change in valu-
       ation allowance                                   (972,000)                      --                   --
                                                 ---------------------------------------------------------------
                                                      $(1,684,000)                 $10,000            $      --
                                                  --------------------------------------------------------------
</TABLE>
                                       21

<PAGE>
                     NOTES TO FINANCIAL STATEMENTS CONT'D


     Reconciliation of the statutory federal income tax rate to the Company's
effective tax rate follows:
                                        1996            1995           1994
----------------------------------------------------------------------------
Tax at statutory rate                    34.0%          34.0%          34.0%
State income taxes                        4.5            6.5            6.5
Alternative minimum tax                    --            1.0             --
Impact of net operating
   loss carryforward                    (38.5)         (39.5)         (40.5)
Change in valuation
   allowance                            (87.2)            --             --
                                   ------------------------------------------
                                        (87.2)%          2.0%            --
                                   ------------------------------------------
                                   ------------------------------------------

10. DISTRIBUTION AGREEMENT
   In September 1993, the Company entered into an exclusive distribution
agreement for the Spine-Tech BAK Lumbar Interbody Fusion System with Smith &
Nephew for which the Company received a non-refundable fee of $1,000,000. The
agreement grants Smith & Nephew sales exclusivity for the BAK-Lumbar product
in all countries in the world other than the United States. Included in
accounts receivable at December 31, 1996 and 1995 is $26,560 and $1,314,700,
respectively, reflecting purchases of BAK Systems by Smith & Nephew. The
agreement was terminated in February 1996 as certain minimum annual purchase
requirements were not met.

11. LICENSE AGREEMENTS
   During 1992, the Company entered into a license agreement with Dr. Gary
Michelson and an affiliated company, Karlin Technology, Inc. ("Karlin"), as the
owners of certain patents and patent applications relating to threaded
cylindrical spinal implants (the "Karlin Technology"), the technology which is
the basis of the Company's BAK system. Pursuant to the license agreement, the
Company has a co-exclusive worldwide license during the life of the patent to
make, use or sell products covered by the Karlin Technology.
   During 1994, the Company entered into license agreements relating to the
development of the BAK/C system, the Cervi-Lok System, and a set of minimally
invasive hand-held dissectomy techniques and instruments. In connection with
these license agreements, the Company granted options to purchase 90,000 shares
of the Company's Common Stock at prices of $2.67 to $3.27 per share. In
addition, the Company will pay royalties under some of these agreements based
upon a percentage of net sales under these agreements. The Company determined
the value of the technology associated with these license agreements to be
$42,500 and expensed the entire amount as research and development in-process
during 1994.

12. SIGNIFICANT CUSTOMERS
   Sales to Smith & Nephew, consisting entirely of export sales, accounted for
$354,302, $4,670,595 and $1,813,000 or 3 percent, 61 percent and 41 percent of
net sales for the years ended December 31, 1996, 1995 and 1994, respectively. In
1994, the Company had sales to a domestic customer which accounted for $474,000,
or 11 percent of net sales.

13. LEGAL PROCEEDINGS
   In 1994, the Company was served with a lawsuit related to its license of the
Karlin Technology. The suit alleged various causes of action concerning Dr.
Michelson's and Karlin's (the plaintiffs) right to co-license the Karlin
Technology to a third party, including tortious interference with prospective
and contractual business relationships, unfair competition and breach of
contract, and requested various types of relief, including money damages,
injunctive relief and declaratory judgment. In February 1996, a final judgment
was entered in favor of the Company regarding the lawsuit related to this
license. The plaintiffs have appealed the decision.

                          SPINE-TECH 1996 ANNUAL REPORT

22
<PAGE>

   In June 1995, the Company received a purported notice of termination of the
license agreement with respect to the Karlin Technology. The Company has
commenced non-binding arbitration against the plaintiffs concerning the
termination of the license agreement. The plaintiffs have taken the position in
the arbitration that they do not intend to seek to enforce the purported
termination; however, they have also contended that they may in the future
terminate the license agreement if the royalty reports are determined to have
been inadequate.
   In February 1996, the Company filed a lawsuit which seeks a declaratory
judgment concerning the respective rights of the Company and the plaintiffs on a
patent issued to the Company in 1996. Procedural hearings and discovery continue
in this case.
   In August 1996, the plaintiffs commenced non-binding arbitration to seek
purported unpaid royalties and damages for failure to give Dr. Michelson
credit as the inventor for certain surgical methods used or claimed to be
invented by the Company.
Arbitration is pending and no hearing date has been set.
   In December 1996, the plaintiffs served the Company with an additional
lawsuit related to the 1996 patent and license agreement referred to above. The
suit alleges that Dr. Michelson is the inventor of the Company patent and
requests various types of relief including money damages, punitive damages and
declaratory judgment. The Company has not yet responded to the Complaint and
expects to vigorously contest the action both on procedural and substantive
grounds.
   It is not possible at this time to estimate the loss, if any, the Company
will incur with regards to the legal proceedings, and thus the Company has not
established a reserve for the outcome of the proceedings.


AUDITOR'S REPORT

REPORT OF INDEPENDENT AUDITORS
To the Shareholders
Spine-Tech, Inc.

   We have audited the accompanying balance sheets of Spine-Tech, Inc. as of
December 31, 1996 and 1995, and the related statements of operations,
shareholders' 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 Spine-Tech, Inc. at December
31, 1996 and 1995, and the results of its operations and cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.



                                                           /s/ Ernst & Young LLP
Minneapolis, Minnesota
February 7, 1997
                                                                              23
<PAGE>

CORPORATE INFORMATION

EXECUTIVE OFFICERS
DAVID W. STASSEN
Chief Executive Officer and President

KEITH M. EASTMAN
Chief Financial Officer and Secretary

RICHARD C. JANSEN
Vice President, Regulatory and Clinical Affairs

DOUGLAS W. KOHRS
Vice President, Research and Product
Development

TED K. SCHWARZROCK
Vice President, Sales and Marketing

DAVID L. SHAW
Vice President, Manufacturing Operations

DIRECTORS
KENNETH W. ANSTEY
President and Chief Executive Officer
Bio-field Corporation
(medical technology company)

ROBERT J. DEPASQUA(1, 2)
Private Investor

STEPHEN D. KUSLICH, M.D.
Orthopaedic Surgeon
Medical Director of the Company

JAMES F. LYONS(1, 2)
Chairman of the Board of Directors
Biovascular, Inc.
(medical technology company)

DAVID W. Stassen
Chief Executive Officer and President

1 Member of the Compensation Committee
2 Member of the Audit Committee


SHAREHOLDER INFORMATION

STOCK LISTING
The  Company's Common Stock trades on the Nasdaq National Market tier of the
Nasdaq Stock Market under the symbol: SPYN.

TRANSFER AGENT AND REGISTRAR
Norwest Bank Minnesota, N.A.
Stock Transfer Department
161 North Concord Exchange
P.O. Box 738
South St. Paul, Minnesota 55075-0738

FORM 10-K
A copy of the Company's annual report on Form 10-K as filed with the Securities
and Exchange Commission is available free of charge by writing to Keith M.
Eastman at the Company (see Investor Inquiries).

ANNUAL MEETING
The annual meeting of Spine-Tech shareholders will
be held May 8, 1997, at 3:30 p.m. at Minneapolis
Marriot Southwest, 5801 Opus Parkway, Minnetonka, Minnesota 55343. All
shareholders and other
interested parties are invited to attend.

INVESTOR INQUIRIES
Please direct all inquiries to: Keith M. Eastman,
Chief Financial Officer, Spine-Tech, Inc., 7375 Bush Lake Road, Minneapolis,
Minnesota 55439-2029.
Phone: (612) 832-5600

STOCK INFORMATION
High and low quarterly closing prices for
Spine-Tech, Inc., Common Stock as quoted on
the Nasdaq Stock Market were:

                                        1996                      1995
                                 High          Low         High           Low
------------------------------------------------------------------------------
First Quarter                    $27 3/8      $21   1/4    $--       $ --
Second Quarter                   $34          $23   3/4    $11       $  9
Third Quarter                    $28 3/8      $18 11/16    $16 7/8   $  9 7/8
Fourth Quarter                   $28 3/4      $23          $23 1/4   $ 15

   Public trading of the Company's Common Stock commenced June 23, 1995, the
effective date of the initial public offering.
   There were 238 common shareholders of record as of December 31, 1996. The
Company has not paid any stock dividends on its Common Stock since its
inception, and management does not anticipate paying cash dividends in the
foreseeable future.

                          SPINE-TECH 1996 ANNUAL REPORT

24