<TABLE>
<CAPTION>
                         Selected Financial Highlights

(In thousands, except per share data)
<S>                                        <C>         <C>        <C>        <C>         <C>
Fiscal Year Ended December 31,                 1996        1995      1994        1993       1992
Statement of Operations Data:
Revenues:

         Product sales and research

                  testing services         $  2,860    $  1,830   $  1,152   $    417    $     -
         Research and development fees        1,087       1,495        630        585        675
         Licensing fees                           -           -          -        900        900
                                           --------    --------   --------   --------    -------
                  Total revenues              3,947       3,325      1,782      1,902      1,575

Operating expenses:

         Costs of products sold                 926         603        517        226          -
         Research and development             3,163       3,200      3,308      1,940      1,279
         Selling, general and              --------    --------   --------   --------    -------
                  administrative              9,201       6,583      2,222      1,754      1,160

                  Total operating expenses   13,290      10,386      6,047      3,920      2,439

Loss from operations                         (9,343)     (7,061)    (4,265)    (2,018)      (864)
Other income (expense):
Interest income                               1,317       1,684        194        128         75
Interest expense                                (44)          -          -          -          -
                                           --------    --------   --------   --------    -------
Net loss                                   $ (8,070)   $ (5,377)  $ (4,071)  $ (1,890)   $  (789)
                                           ========    ========   ========   ========    =======

Net loss per common and

         common equivalent share           $   (.65)   $   (.45)  $   (.47)         -          -
                                           --------    --------   --------   --------    -------
Weighted average number of
         common and common

         equivalent shares outstanding       12,441      11,929      8,737          -          -
                                           --------    --------   --------   --------    -------

(In thousands)

December 31,                                   1996        1995       1994       1993        1992

Balance Sheet Data:
Cash, cash equivalents and

    short-term investments                 $ 21,229    $ 27,794    $ 3,668    $ 7,916     $ 2,688
Working capital                              20,901      28,361      3,172      7,890       2,988
Total assets                                 25,691      32,841      5,590      8,807       3,495
Accumulated deficit                         (21,864)    (13,794)    (8,417)    (4,346)     (2,456)
Total shareholders' equity                   23,526      31,518      4,698      8,460       3,348

</TABLE>
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

Ostex  International,   Inc.  (the  "Company")  is  engaged  in  the  discovery,
development and  commercialization  of diagnostics and therapeutics for diseases
of the skeleton and connective  tissues.  The Company believes its lead product,
the Osteomark(R) assay, incorporates breakthrough technology in the area of bone
resorption  measurement.  Ostex has formed  collaborative  relationships  with a
number  of  leading  diagnostic  and  pharmaceutical  companies  to  aid  in the
commercialization of the Osteomark test.

This Management's  Discussion and Analysis of Financial Condition and Results of
Operations  includes a number of  forward-looking  statements  which reflect the
Company's current views with respect to future events and financial performance.
These forward-looking statements are subject to certain risks and uncertainties,
including  those  discussed  below,  that could cause  actual  results to differ
materially from historical results or those anticipated.  Words used herein such
as "believes,"  "anticipates," "expects," "intends," and similar expressions are
intended to identify forward-looking  statements but are not the exclusive means
of identifying  such statements.  In addition,  the disclosures on page 12 under
the  caption  "Other  Factors  that  May  Affect  Operating   Results,"  consist
principally  of a brief  discussion of risks which may affect future results and
are thus, in their  entirety,  forward-looking  in nature.  Readers are urged to
carefully  review and  consider the various  disclosures  made by the Company in
this report and in the Company's  other reports  filed with the  Securities  and
Exchange  Commission,  including  the  Company's  Annual Report on Form 10-K for
fiscal year ended December 31, 1996, that attempt to advise  interested  parties
of the risks and factors that may affect the company's business.

On May 8, 1995,  the Osteomark test first became  commercially  available in the
United  States as a urinary assay that  provides a  quantitative  measure of the
excretion  of  cross-linked  N-telopeptides  of type I  collagen  ("NTx")  as an
indicator of human bone resorption.  Prior to becoming  commercially  available,
the Osteomark test was available domestically only for research purposes.

To date, the Company's  revenues have  consisted  primarily of product sales and
fees  for  research  testing  services,  as  well  as  licensing,  research  and
development fees from Mochida Pharmaceutical,  Co., Ltd. ("Mochida"),  Johnson &
Johnson Clinical Diagnostics, Inc. ("Johnson & Johnson") and Boehringer Mannheim
Diagnostics  ("Boehringer  Mannheim").  Mochida  has  agreed  to pay Ostex up to
approximately  $6,600,000  in a combination  of licensing  fees and research and
development  milestone  payments,  of which  $5,350,000 has been earned to date.
Pursuant to the research  and  development  agreement,  Mochida has an option to
license  the  NTx  serum  assay  under  development.  Future  payments  totaling
$1,250,000  are  contingent  upon  Mochida's  decision to exercise its option to
license the NTx serum assay and achievement of certain milestones.

Expenses incurred have been primarily for selling, administrative,  research and
development  activities  and have  exceeded  revenues  in each  year  since  the
Company's  inception.  As of December 31, 1996,  the Company had an  accumulated
deficit of $21,864,000.  Successful  future operations depend upon the Company's
ability to effectively  commercialize and market its products.  The Company will
require a substantial  amount of additional funds to develop new products and to
fund the level of selling,  general and administrative expenses that the Company
expects to incur in connection with its product commercialization efforts in the
next several years.

RESULTS OF OPERATIONS

     Years Ended  December 31, 1996,  1995 and 1994. The Company had revenues of
$3,947,000  for the year ended  December 31, 1996,  compared to  $3,325,000  and
$1,782,000in the years ended December 31, 1995 and 1994, respectively.  Research
and development  fees received during 1996 totaled  $1,087,000,  almost all from
Mochida.  Research  and  development  fees in 1995  amounted to  $1,495,000  and
consisted of $1,000,000  from Johnson & Johnson and $495,000 from Mochida.  This
is compared to $630,000 in 1994, consisting of $450,000 from Boehringer Mannheim
and $180,000 from Mochida.

Revenue from  product  sales and  research  testing  services for the year ended
December 31, 1996 was  $2,860,000,  compared to $1,830,000 and $1,152,000 in the
years ended December 31, 1995 and 1994, respectively. The increase of $1,030,000
in 1996 revenue is  attributable  to higher  volumes of  Osteomark  kits sold to
laboratories  and  distributors  worldwide  during  the year.  The  increase  of
$678,000  in 1995 is  attributable  to  higher  billings  for  research  testing
services sold to companies conducting drug development trials and higher volumes
of kits sold in the U.S. for  investigation and research use. The Company's cost
of products sold totaled $926,000 for the year ended December 31, 1996, compared
to $603,000 and  $517,000  for the same periods in 1995 and 1994,  respectively.
The gross profit rate on product sales for the year ended 1996 was 68%, compared
to 67% for 1995 and 55% for 1994.  The change in gross  profit rate from 1994 to
1995 was a function of  increased  volume and overall  efficiency  gains made in
part by improvements in the production process.

The  Company's  research  and  development   expenditures   totaled  $3,163,000,
$3,200,000, and $3,308,000, in 1996, 1995, and 1994, respectively.  Research and
development  expenditures  have  remained  steady  from  1995 to 1996  due to an
increase in research and development grants and royalties paid to the Washington
Research  Foundation ("WRF") offset by decreased clinical trial expenditures due
to the completion of one of its clinical trial in November 1995. The decrease in
1995 compared to 1994 is due primarily to the completion of the Company's  first
clinical trial.

<PAGE>

Selling, general and administrative expenses totaled $9,201,000, $6,583,000, and
$2,222,000, in 1996, 1995 and 1994, respectively.  The 40% increase from 1995 to
1996 is due primarily to the implementation of marketing programs to support the
Osteomark assay in the United States, the addition of sales personnel to support
these  efforts,  increased  legal costs  involved with the  Boehringer  Mannheim
arbitration and patent  litigation costs. The 196% increase from 1994 to 1995 is
due to the  implementation of marketing  programs,  including national newspaper
and magazine advertising campaigns, test market initiatives and other efforts to
support the launch of the  Osteomark  test  domestically.  The addition of sales
personnel  to support  the field  selling  effort,  legal fees  associated  with
pursuing patent  infringement cases and increased costs associated with becoming
a public company at the beginning of 1995 also contributed to the  significantly
higher levels of selling, general and administrative expenses in 1995.

Interest income totaled $1,317,000, $1,684,000, and $194,000 for the years ended
December  31,  1996,  1995,  and 1994,  respectively.  The  decrease in 1996 was
primarily due to lower average  invested  balances  resulting from financing the
Company's operations.  The increase from 1994 to 1995 was due to higher invested
balances  resulting from  investment of the proceeds from the public offering of
Company common stock in February 1995.

At December 31, 1996,  the Company had tax net operating loss  carryforwards  of
$26,994,000,  which will begin to expire in 2004.  Income  taxes are provided in
the  Statements of  Operations as required by Statement of Financial  Accounting
Standards No. 109,  "Accounting  For Income Taxes" ("SFAS No. 109").  Under SFAS
No. 109,  deferred taxes are determined  using an asset and liability  approach.
The Company has  determined  that the tax assets do not satisfy the  recognition
criteria set forth in SFAS No. 109. Accordingly, a valuation adjustment has been
recorded  against the  applicable  deferred  tax assets,  and  therefore  no tax
benefit has been recorded.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations from inception  primarily  through three
private  placements of preferred stock that provided  approximately  $12,800,000
aggregate  proceeds,  and its initial  public  offering of  3,645,642  shares of
common stock that provided net proceeds of approximately $32,000,000. Additional
funds  of  approximately  $12,500,000  have  been  generated  through  sales  of
Osteomark assay kits and fees for research testing  services,  and collaborative
research and  licensing  agreements.  As of December  31, 1996,  the Company had
$21,229,000 in cash and cash  equivalents  and short-term  investments,  working
capital of $20,901,000 and total  shareholders'  equity of  $23,526,000.  During
1996, cash, cash equivalents and short-term investments decreased by $6,565,000,
working capital  decreased by $7,460,000 and  shareholders'  equity decreased by
$7,992,000.

During 1996,  the Company used  $6,787,000 of cash for operating  activities and
approximately $495,000 for the purchase of laboratory,  manufacturing and office
equipment.  The  Company  entered  into a note  agreement  that  provides  up to
$1,500,000 for expansion of manufacturing and administrative  facilities and has
borrowed  $746,000  against the note.  The note is repayable in 48 equal monthly
installments  of  principal  and  interest of $19,784.  As of December 31, 1996,
outstanding borrowings under this agreement amounted to $672,000. The Company is
committed to spend  approximately  $1,000,000  during 1997 for  relocation  (and
expansion) of its laboratory facilities, $500,000 of which will be financed with
proceeds from the note agreement.

The Company's future capital  requirements  depend upon many factors,  including
effectiveness of Osteomark assay commercialization  activities and arrangements;
continued scientific progress in its research and development programs; progress
toward  development of the O-CSF  technology,  which potentially has therapeutic
uses; the costs involved in filing, prosecuting and enforcing patent claims; the
costs  involved  in legal  efforts to  enforce  patent  rights and  distribution
contracts;  and the time and costs involved in obtaining  regulatory  approvals.
Additional funds from equity or debt financing may be required.  There can be no
assurance that such additional funds will be available on favorable terms, if at
all. Because of the Company's  significant  long-term cash requirements,  it may
seek to raise additional  capital if conditions in the public equity markets are
favorable,  even if the Company does not have an immediate  need for  additional
cash at that  time.  If  additional  financing  is not  available,  the  Company
anticipates  that its existing  available  cash, its future license and research
revenues  from  existing  collaboration  agreements,  product sales and interest
income  from  short-term  investments  will be  adequate  to satisfy its capital
requirements  and to fund  operations  through at least 1998.  In addition,  the
Company was awarded  $6,400,000 as a result of the arbitration of a dispute with
Boehringer  Mannheim.  Boehringer  Mannheim has  indicated  in  post-arbitration
motions that it plans to appeal the award.

OTHER FACTORS THAT MAY AFFECT OPERATING RESULTS

The  Company's  operating  results  may  fluctuate  due to a number  of  factors
including,  but not limited  to,  volume and timing of product  sales,  pricing,
market acceptance of the Company's products, changing economic conditions in the
healthcare  industry,  delays  and  increased  costs of product  and  technology
development,  the  Company's  ability  to  develop  and  maintain  collaborative
arrangements,  the  outcome  of  litigation,  and the  effect  of the  Company's
accounting  policies and other risk factors  detailed in the Company's 1996 Form
10-K and other SEC filings.  All of the foregoing  factors are difficult for the
Company to predict and can materially  adversely  affect the Company's  business
and operating results.

<PAGE>

                                 BALANCE SHEETS
<TABLE>
<CAPTION>

(In thousands, except share amounts)

December 31,                                                        1996            1995
<S>                                                            <C>             <C>
ASSETS
Current Assets:

         Cash and cash equivalents                             $   1,289       $   6,241
         Short-term investments                                   19,940          21,553
         Trade receivables, net of allowance
           of $25 in 1996                                            640           1,077
         Interest receivable                                         365             482
         Inventory, at cost                                          153             236
         Other                                                       156              95
                                                               ---------       ---------
                  Total current assets                            22,543          29,684
                                                               ---------       ---------

Property, Plant and Equipment, at cost                             3,573           3,078
         Less-- accumulated depreciation and amortization         (1,099)           (597)
                                                               ---------       ---------

                  Property, plant and equipment, net               2,474           2,481
                                                               ---------       ---------
Other Assets, net                                                    674             676
                                                               ---------       ---------
                  Total assets                                 $  25,691       $  32,841
                                                               =========       =========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities:

         Accounts payable                                      $   1,259       $   1,155
         Accrued expenses                                            234             168
         Note payable                                                149               -
                                                               ---------       ---------
                  Total current liabilities                        1,642           1,323
                                                               ---------       ---------
Non-Current Liabilities:
         Note payable, net of current portion                        523               -
                                                               ---------       ---------

Commitments and Contingencies

Shareholders' Equity:

         Common stock, $.01 par value, 50,000,000
           shares authorized; 12,441,617 and 12,432,667

           issued and outstanding, respectively                      125             125
         Additional paid-in capital                               45,195          45,121
         Unrealized gain on short-term investments                    70              66
         Accumulated deficit                                     (21,864)        (13,794)
                                                               ---------       ---------
                  Total shareholders' equity                      23,526          31,518
                                                               ---------       ---------
                  Total liabilities and shareholders' equity   $  25,691       $  32,841
                                                               =========       =========
</TABLE>

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

<PAGE>

                            STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>

(In thousands, except per share amounts)

Year Ended December 31,                                           1996          1995         1994
<S>                                                           <C>           <C>          <C>
Revenue:
         Product sales and research testing services          $  2,860      $  1,830     $  1,152
         Research and development fees                           1,087         1,495          630
                                                              -----------------------------------
                  Total revenues                                 3,947         3,325        1,782
                                                              -----------------------------------
Operating Expenses:
         Costs of products sold                                    926           603          517
         Research and development                                3,163         3,200        3,308
         Selling, general and administrative                     9,201         6,583        2,222
                                                              -----------------------------------
                  Total operating expenses                      13,290        10,386        6,047
                                                              -----------------------------------
                  Loss from operations                          (9,343)       (7,061)      (4,265)
Other Income (Expense):

         Interest income                                         1,317         1,684          194
         Interest expense                                          (44)            -            -
                                                              -----------------------------------
                  Net loss                                    $ (8,070)     $ (5,377)    $ (4,071)
                                                              ===================================

Net loss per common and common equivalent share               $   (.65)     $   (.45)    $   (.47)
                                                              -----------------------------------
Weighted average number of common and common
         equivalent shares outstanding                          12,441        11,929        8,737
                                                              -----------------------------------
</TABLE>

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

<PAGE>

                            STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

(In thousands)

Year Ended December 31,                                                                      1996         1995         1994
<S>                                                                                    <C>          <C>          <C>
Cash Flows from Operating Activities:
         Net loss                                                                      $   (8,070)  $   (5,377)  $   (4,071)
         Adjustments to reconcile net loss to net cash used in
                  operating activities

                           Depreciation and amortization                                      504          295          153
                           Compensation expense from stock awards and grants                   33           40           84
                           Decrease (increase) in receivables                                 554       (1,318)         (37)
                           Decrease (increase) in inventory                                    83         (161)          19
                           Increase in other current assets                                   (61)         (15)         (45)
                           Increase in accounts payable and accrued expenses                  170          511          465
                           Loss on disposal of property, plant and equipment                    -            -            5
                                                                                       ------------------------------------
                                    Net cash used in operating activities                  (6,787)      (6,025)      (3,427)
                                                                                       ------------------------------------
Cash Flows from Investing Activities:

         Purchases of short-term investments                                              (22,958)     (52,521)      (7,249)
         Proceeds from sales and maturities of short-term investments                      24,575       32,996       10,288
         Purchases of property, plant and equipment                                          (495)      (1,746)        (574)
         Long-term investments                                                                  -         (500)        (232)
                                                                                       ------------------------------------
                                    Net cash provided by (used in) investing activities     1,122      (21,771)       2,233
                                                                                       ------------------------------------
Cash Flows from Financing Activities:
         Net proceeds from issuance of common stock

                  and exercise of stock options                                                41       32,166          225
         Deferred offering costs                                                                -            -         (240)
         Proceeds from borrowings on note payable                                             746            -            -
         Payments on note payable                                                             (74)           -            -
         Proceeds from stock subscription payment                                               -          165            -
                                                                                       ------------------------------------
                                    Net cash provided by (used in) financing activities       713       32,331          (15)
                                                                                       ------------------------------------
                                    Net (Decrease) Increase in Cash and Cash Equivalents   (4,952)       4,535       (1,209)
                                    Cash and Cash Equivalents, beginning of period          6,241        1,706        2,915
                                                                                       ------------------------------------
                                    Cash and Cash Equivalents, end of period           $   1,289    $   6,241    $   1,706
                                                                                       ====================================
</TABLE>

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

<PAGE>

                       STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands, except per share amounts)
<TABLE>
<CAPTION>

                                                                        Unrealized

                           Preferred Stock   Common Stock   Additional   Gain on          Stock                            Total
                                                              Paid-In   Short-term    Subscriptions  Accumulated    Shareholders'
                           Shares   Amount  Shares   Amount   Capital  Investments      Receivable       Deficit          Equity
                           -----------------------------------------------------------------------------------------------------
<S>                        <C>       <C>    <C>       <C>    <C>        <C>               <C>        <C>               <C>

Balance, December 31, 1993 $1,059     $ 10  $2,720    $ 27   $ 12,934   $  -              $(165)     $   (4,346)       $  8,460
  Issuance of common stock
   in exchange for license
   granted - February 10,
   1994 ($5.00 per share)       -        -       5       -        25       -                  -               -              25
  Compensation expense
   for stock option grants      -        -       -       -        59       -                  -               -              59
  Stock options and
   warrants exercised           -        -     286       3       222       -                  -               -             225
  Net loss                      -        -       -       -         -       -                  -          (4,071)         (4,071)
                           ----------------------------------------------------------------------------------------------------
Balance, December 31, 1994  1,059       10   3,011      30     13,240      -               (165)         (8,417)          4,698
  Sale of common stock
   in initial public
   offering and conversion
   of preferred stock      (1,059)     (10)  9,153      92     31,468      -                  -               -          31,550
  Compensation expense
   for stock option
   grants                       -        -       -       -        40       -                  -               -              40
  Stock options and
   warrants exercised           -        -     269       3       373       -                  -               -             376
  Payment for subscription
   receivable                   -        -       -       -         -       -                165               -             165
  Unrealized gain on
   short-term investments       -        -       -       -         -      66                  -               -              66
  Net loss                      -        -       -       -         -       -                  -          (5,377)         (5,377)
                           ----------------------------------------------------------------------------------------------------
Balance, December 31, 1995      -        -   12,433    125     45,121     66                  -         (13,794)         31,518
  Compensation expense
   for stock option grants      -        -       -       -        33       -                  -               -              33
  Stock options exercised       -        -       9       -        41       -                  -               -              41
  Unrealized gain on
   short-term investments       -        -       -       -         -       4                  -               -               4
  Net loss                      -        -       -       -         -       -                  -          (8,070)         (8,070)
                           ----------------------------------------------------------------------------------------------------
Balance, December 31, 1996      -    $   -  $12,442   $125   $ 45,195   $ 70              $   -      $  (21,864)       $ 23,526
                           ====================================================================================================
</TABLE>

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


<PAGE>

                         NOTES TO FINANCIAL STATEMENTS

NOTE 1.  ORGANIZATION AND SUMMARY OF
         SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

Ostex  International,   Inc.  (the  "Company")  is  engaged  in  the  discovery,
development and  commercialization  of diagnostics and therapeutics for diseases
of the skeleton and connective  tissues.  The Company believes its lead product,
the Osteomark assay,  incorporates  breakthrough  technology in the area of bone
resorption  measurement.  Ostex has formed  collaborative  relationships  with a
number  of  leading  diagnostic  and  pharmaceutical  companies  to  aid  in the
commercialization of the Osteomark test.

The Company markets the Osteomark assay through  distributors  and its own sales
force.  While the United  States has been the  Company's  principal  market,  an
increasing percentage of the Company's sales are overseas, primarily in Europe.

The  Company was  incorporated  in the state of  Washington  on May 11, 1989 and
completed its initial public offering  ("IPO") of common stock in February 1995.
Prior to the year ended  December 31, 1995,  the Company was considered to be in
the development stage for financial reporting purposes.

ESTIMATES AND UNCERTAINTIES

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

REVENUE RECOGNITION

License  and  research  and  development  fees are  recognized  when the related
contract is signed and upon attainment of the agreed-upon  milestones.  Research
testing  fees are  recognized  when the  services  are  substantially  complete.
Product sales are recognized upon shipment.


<PAGE>



PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost and

depreciated on the  straight-line  method over the estimated  useful life of the
asset. Estimated lives range from five to 10 years. Depreciation expense charged
to operations  during 1996,  1995 and 1994 was $502,000,  $294,000 and $153,000,
respectively.

SHORT-TERM INVESTMENTS

The Company considers all of its investments as "available

for sale,"  reporting them at fair market value with unrealized gains and losses
included in  Shareholders'  Equity.  Realized  gains and losses and  declines in
value of securities judged to be other-than-temporary are included in income.

INVENTORY

Inventory consists principally of raw materials and finished goods.  Inventories
are stated at the lower of cost (first-in, first-out) or market.

STATEMENTS OF CASH FLOWS

For the purpose of the  statements  of cash flows,  the  Company  considers  all
highly  liquid debt  instruments  with a maturity  of three  months or less when
purchased to be cash  equivalents.  The carrying amount  approximates fair value
due to the short maturity of these instruments.

NET LOSS PER COMMON AND COMMON
EQUIVALENT SHARE

For the years ended  December 31, 1996 and 1995,  net loss per common and common
equivalent  share  was based on the  weighted  average  number of common  shares
outstanding during each period. The 1994 net loss per share computation  assumes
all series of convertible  preferred stock  outstanding at December 31, 1994 had
been  converted  to common  stock as of January 1, 1994.  The actual  conversion
occurred in 1995 in connection  with the completion of the Company's IPO. Common
stock  equivalents  in  1994  include  shares  issuable  upon  the  exercise  of
outstanding stock options or warrants granted within one year of the IPO.

ADVERTISING

The production costs of advertising are expensed as incurred.


<PAGE>



NOTE 2.  PROPERTY, PLANT AND EQUIPMENT

Property,  plant and  equipment at December 31, 1996 and 1995,  consisted of the
following (in thousands):

                                        1996      1995

Leasehold improvements               $ 1,463   $ 1,346
Laboratory and manufacturing
         equipment                     1,198     1,045
Computers and office equipment           912       687
                                     -----------------
                                       3,573     3,078

Accumulated depreciation              (1,099)     (597)
                                     -----------------
Net property, plant and equipment    $ 2,474   $ 2,481
                                     =================

NOTE 3.  SHORT-TERM INVESTMENTS

The Company's short-term investments at December 31, 1996 and 1995, consisted of
the following (in thousands):

                                        1996      1995

United States treasury obligations   $ 8,807  $ 15,082
Federal agency obligations and
         discount notes                7,636     2,626
Corporate and municipal bonds          3,427     1,815
Commercial paper                           -     1,964
Unrealized gain on short-term
         investments                      70        66
                                    ------------------
                                    $ 19,940  $ 21,553
                                    ==================

The maturity of all classes of the  Company's  short-term  investments  was less
than two years at December 31, 1996 and 1995.

NOTE 4.  OTHER ASSETS

Other assets include investments totaling $637,000 in preferred stock of Metrika
Laboratories,  Inc., a privately held medical device company in the  development
stage. The investment  represents an ownership  interest of less than 10% and is
recorded in the accompanying financial statements at cost.


<PAGE>



NOTE 5.  ACCRUED EXPENSES

Accrued  expenses at December 31, 1996 and 1995,  consisted of the following (in
thousands):

                                        1996      1995

Business taxes payable                 $ 127      $ 19
Accrued wages, benefits
         and payroll taxes               107       149
                                       ---------------
                                       $ 234     $ 168
                                       ===============


NOTE 6.  NOTE PAYABLE

In July 1996,  the Company  borrowed  $746,000 under a secured  promissory  note
agreement.  The note agreement allows the Company to make additional  borrowings
up to a maximum of $1,500,000 for future  capital needs.  The note is secured by
real  property and equipment  and is payable in equal  monthly  installments  of
principal  and  interest of  $19,784.  The  interest  rate is fixed at 12.5% for
amounts owed as of December 31, 1996.  Interest on any future borrowings will be
based on the  three-year  U.S.  Treasury  Note at the time of securing the loan,
plus a margin of 5.80%.  During  1996,  the Company made $44,000 in payments for
interest.

Minimum principal payments are as follows (in thousands):

     1997                              $ 149
     1998                                183
     1999                                207
     2000                                133
                                       -----
                                       $ 672
                                       =====

NOTE 7.  SHAREHOLDERS' EQUITY

INITIAL PUBLIC OFFERING

On January 25,  1995,  the Company  completed  its  initial  public  offering of
3,645,642 shares of common stock at

$9.50  per  share for  proceeds  of  $34,634,000  less  underwriting  discounts,
commissions  and other  offering  costs  approximating  $3,085,000.  Convertible
preferred stock outstanding  immediately prior to the closing was converted into
5,506,464 shares of common stock.


<PAGE>



NOTE 7.  SHAREHOLDERS' EQUITY (continued)

STOCK OPTION PLANS

The Company has an Amended and Restated Stock Option Plan,  which was originally
adopted in 1989 (the "Old  Plan"),  under which a total of  1,653,000  shares of
common stock are reserved for issuance.  As of December 31, 1996, 479,000 shares
have been exercised,  and 1,174,000 shares are subject to outstanding options at
exercise  prices  ranging  from  $.08  to  $5.00  per  share  with  a  remaining
weighted-average  contractual  life of six  years.  No  further  options  may be
granted  by the  Company  under  the Old  Plan,  which  is  administered  by the
Compensation  Committee  of the  Board of  Directors.  These  options  vest over
periods of three to four years.  Total  options  vested  under the Old Plan were
856,000, 603,000 and 707,500 shares, respectively, as of December 31, 1996, 1995
and 1994. The weighted-average  exercise price of these vested options was $3.68
as of December 31, 1996. All options granted under the Old Plan expire either 90
days  after  termination  of  employment  or 10 years  from  the date of  grant,
whichever occurs first.

Prior to the  Company's  IPO, the Company  granted  nonqualified  options  whose
exercise price was below the estimated fair market value of the Company's common
stock on the dates of grant.  The  difference  between  the grant  price and the
estimated fair market value on the dates of grant was recognized as compensation
expense  over the  vesting  period of the  option.  Total  compensation  expense
recognized  was  approximately  $33,000,  $40,000 and $59,000 in 1996,  1995 and
1994,  respectively.  Compensation  expense to be recognized  in future  periods
related to these grants was approximately $6,000 as of December 31, 1996.

In June 1994,  the Company  adopted its 1994 Stock Option Plan (the "1994 Plan")
and its Directors'  Nonqualified  Stock Option Plan (the "Directors'  Plan"). An
aggregate of 1,000,000  shares of common  stock were  collectively  reserved for
issuance  under these plans.  As of December 31, 1996,  options for 1,000 shares
had been  exercised,  and 654,000 shares are subject to  outstanding  options at
exercise  prices  ranging  from  $8.75 to  $17.13  per  share  with a  remaining
weighted-average contractual life of nine years.

All options  granted  under the 1994 Plan and  Directors'  Plan expire either 90
days  after  termination  of  employment  or 10 years  from  the date of  grant,
whichever occurs first. All options have been granted at the market value of the
common  stock on the date of grant  and vest  over  three to four  years.  Total
options vested under the 1994 Plan and  Directors'  Plan were 58,000 at December
31, 1996 and none in prior years. The weighted-average  exercise price of vested
options was $9.23 as of December 31, 1996.

Information  relating to activity  under the Company's  stock option plans is as
follows:

                                                     Weighted
                                        Shares        Average
                                    Subject to       Exercise
                                        Option          Price

Balance, December 31, 1993             973,750         $ 1.26
         Granted                       776,750           5.00
         Exercised                    (192,185)           .80
         Canceled                      (13,125)          4.33
                                     ------------------------
Balance, December 31, 1994           1,545,190           3.19
         Granted                       245,500           9.09
         Exercised                    (268,786)          1.38
         Canceled                      (90,625)          3.56
                                     ------------------------
Balance, December 31, 1995           1,431,279           4.51
         Granted                       446,000          12.30
         Exercised                      (8,950)          4.56
         Canceled                      (40,703)          9.64
                                     ------------------------
Balance, December 31, 1996           1,827,626         $ 6.61
                                     ========================

The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123,  "Accounting for Stock-Based  Compensation" ("SFAS
No. 123").  Accordingly,  no  compensation  cost has been  recognized  for stock
options issued at market value on the date of grant. Had  compensation  cost for
the Company's stock option plans been determined  based on the fair value of the
options  at the  grant  date for  awards  in 1996 and 1995  consistent  with the
provisions  of SFAS No.  123,  the  Company's  net loss and net loss per  common
equivalent  share would have been  increased to the pro forma amounts  indicated
below (in thousands):

                                        1996        1995

Net loss - as reported              $ (8,070)   $ (5,377)
Net loss - pro forma                $ (8,729)   $ (5,528)
Net loss per common and common
  equivalent share - as reported      $ (.65)     $ (.45)
Net loss per common and common
  equivalent share - pro forma        $ (.70)     $ (.46)

The fair value of each option  grant is  established  on the date of grant using
the  Black-Scholes  option-pricing  model  with the  following  weighted-average
assumptions  used for grants in 1996 and 1995:  zero  dividend  yield;  expected
volatility of 59%;  risk-free  interest rates varying by grant date between 5.8%
and 6.5%; and expected  lives of five years.  Because the SFAS No. 123 method of
accounting has not been applied to options granted prior to January 1, 1995, the
resulting pro forma  compensation  cost may not be  representative of that to be
expected in future years. The weighted-average  grant date fair value of options
granted during 1996 and 1995 according to the Black-Scholes option pricing model
was $7.00 and $5.11.

<PAGE>

NOTE 8.  LICENSING AGREEMENTS

Under the Company's  worldwide  exclusive license agreements with the Washington
Research  Foundation ("WRF") for the Urinary Assay for Measuring Bone Resorption
and Osteoclast Colony Stimulating Factor ("O-CSF") technologies, the Company has
the right to manufacture  and market these  technologies  developed from certain
research by the  Univer-sity  of Washington  ("UW").  As  consideration  for the
licenses acquired and for the attainment of certain milestones, the Company paid
WRF certain  nonrefundable  fees and issued  common  stock to the WRF and UW. In
addition,  future  cash  payments  and  common  stock  grants  may be  due  upon
attainment  of certain  other  milestones.  Under the O-CSF  license,  both cash
consideration  paid and the  market  value of shares  issued  shall  not  exceed
$500,000 for each therapeutic  licensed product and $150,000 for each diagnostic
licensed product. All legal costs incurred by WRF in connection with the filing,
prosecution and  maintenance of certain  defined patent rights,  will be paid by
the Company.  During 1996,  1995 and 1994,  the Company  incurred  approximately
$154,000,  $379,000 and $220,000 of license  fees,  including the value of stock
grants,  and patent legal expenses.  All license and legal fees and stock grants
have been expensed as research and development  costs.  The Company is obligated
to pay WRF royalties on net sales of any licensed products.

NOTE 9.  REVENUES

The Company has a license  agreement  and a research and  development  agreement
with  Mochida.  Under the  license  agreement,  the  Company  granted  exclusive
manufacturing,  marketing  and  distribution  rights to certain of the Company's
products  in Japan,  and through  December  31,  1996 had earned  $2,000,000  in
connection  with this agreement.  Under the research and development  agreement,
the Company earned fees of $1,080,000,  $550,000 and $200,000  during 1996, 1995
and 1994,  respectively.  As of December 31, 1996,  the Company had received all
milestone  payments  contemplated  by the  research and  development  agreement.
Mochida  has  an  option  to  license  the   Company's  NTx  serum  assay  under
development.

During 1995, the Company entered into research, development,  license and supply
agreements  with Johnson & Johnson  under which Ostex earned  $1,000,000  during
1995. These  agreements  grant Johnson & Johnson a license to manufacture,  sell
and distribute  certain products  utilizing Ostex's bone resorption  technology.
Ostex  will also  receive  royalties  on  Johnson &  Johnson  sales of  products
incorporating the Ostex technology.

NOTE 10. RELATED PARTY TRANSACTIONS

LEGAL AND CONSULTING SERVICES

The Company's  chairman and chief executive officer is a nonpracticing  director
and  shareholder  in a law firm that  provides  legal  services to the  Company.
During 1996, 1995 and 1994, the Company paid  approximately  $215,000,  $386,000
and  $516,000,  respectively,  for  these  services.  The 1995 and 1994  amounts
include cost of services rendered in connection with raising equity capital and,
accordingly, have been recorded as a charge to shareholders' equity.

RESEARCH AGREEMENTS

The Company has entered  into two research  agreements  with the  University  of
Washington  which extend  through  March 31, 1999.  Total  expense was $304,000,
$185,000 and $316,000 during 1996, 1995 and 1994,  respectively.  Future minimum
payments  under  these  agreements  as of  December  31, 1996 are as follows (in
thousands):

     1997                              $   535
     1998                                  469
     1999                                  200
                                       -------
                                       $ 1,204
                                       =======

NOTE 11. COMMITMENTS AND CONTINGENCIES

LEASES

The Company has entered into certain  noncancelable  operating leases for office
space and equipment. Future minimum payments as of December 31, 1996 under these
leases are as follows (in thousands):

     1997                                 $   564
     1998                                     490
     1999                                     490
     2000                                     484
     2001                                     491
                                          -------
                                          $ 2,519
                                          =======

Total rent expense was  approximately  $538,000,  $374,000 and $251,000 in 1996,
1995 and 1994, respectively.

<PAGE>

NOTE 11. COMMITMENTS AND CONTINGENCIES (continued)

LITIGATION

On August 25, 1995,  the Company  commenced an  arbitration  proceeding  against
Boehringer  Mannheim for breach of contract.  The hearing  before a panel of the
American Arbitration  Association (the "Panel") was held in Seattle on September
3-11,  1996. On January 28, 1997,  Ostex  received a final award from the Panel.
The Panel's  award  instructs  Boehringer  Mannheim to pay Ostex  $5,720,000  in
damages  for lost  profits,  and  $700,000  to  reimburse  Ostex for part of its
attorneys'  fees and expenses.  The award provides that interest will be paid on
such  amounts,  at the rate of 8% per  annum,  to the extent  that such  amounts
remain  unpaid 30 days from the January  28,  1997 date of the award.  The Panel
determined that Boehringer  Mannheim  breached a license agreement by failing to
use its best efforts to effectively  promote the Osteomark MTP kits.  Boehringer
Mannheim's  counterclaims  against  Ostex were  denied by the Panel.  Boehringer
Mannheim has indicated in  post-arbitration  motions that it plans to appeal the
award. Accordingly,  the award has not been reflected in the Company's financial
statements as of December 31, 1996.

In June 1996,  the Company filed an action in the United States  District  Court
for the  Western  District  of  Washington  against  Osteometer  Biotech  A/S, a
biotechnology  company based in Denmark,  and Diagnostic  Systems  Laboratories,
Inc., for patent infringement. The Company believes Osteometer's bone resorption
immunoassay   incorporates   technology   which   infringes  on  patented  Ostex
technology.   In  September  1996,  the  defendants  filed  a  response  denying
infringement   and   counterclaimed   that   Ostex's   patent  is  invalid   and
unenforceable.  The lawsuit is scheduled for trial commencing  December 2, 1997.
At the present time management  cannot estimate the outcome of the  infringement
action.

NOTE 12. FEDERAL INCOME TAXES

Deferred taxes are determined using an asset and liability approach. The Company
has incurred  operating  losses |since  inception and accordingly has determined
that the net deferred tax assets do not satisfy recognition criteria. Therefore,
a valuation  allowance has been recorded against the net deferred tax assets and
no tax benefit has been recorded in the  accompanying  statements of operations.
The change in the valuation  allowance  during 1996 and 1995 was  $2,755,000 and
$3,475,000,  respectively.  The Company's  deferred tax assets  (liabilities) at
December 31, 1996 and 1995 are as follows (in thousands):

                                        1996        1995

Net operating loss carryforward     $  9,448     $ 6,576
Research and experimentation
         credits                          62         135
Excess of market value over the
         exercise price of common
         stock options                    77          65
Section 195 start-up expenses             52         151
Amortization and depreciation            (44)        (64)
Other                                     68          45
                                    --------------------
Gross deferred tax asset               9,663       6,908
Valuation allowance                   (9,663)     (6,908)
                                    --------------------
Net deferred tax asset              $      -     $     -
                                    ====================

At December 31, 1996,  the Company had tax net operating loss  carryforwards  of
$26,994,000, which will begin to expire in 2004.

<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders of Ostex International, Inc.:

We have audited the accompanying balance sheets of Ostex International,  Inc. (a
Washington  corporation)  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 Ostex International, Inc. as of
December 31, 1996 and 1995 and the results of its  operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.

                                             /S/  Athur Andersen L.L.P.

Seattle, Washington,
February 12, 1997

<PAGE>

                              CORPORATE DIRECTORY

EXECUTIVE OFFICERS AND DIRECTORS

H. RAYMOND CAIRNCROSS

Chairman of the Board of Directors, Co-Founder, and Chief Executive Officer

ROBERT J. GLASER

Director, President, and Chief Operating Officer

ROBERT M. LITTAUER

Senior Vice President, Finance and Administration

JEFFREY J. MILLER, PH.D., J.D.

Senior Vice President, Corporate Development,Secretary

THOMAS F. BRODERICK

Vice President, Intellectual Property

NANCY J.S. MALLINAK

Vice President, Regulatory and Clinical Affairs

WILLIAM K. STRELKE

Vice President, Sales and Marketing

JOHN WYNNE

Vice President, European Operation

THOMAS J. CABLE
Director;

Partner and Co-Founder,
Cable & Howse Ventures, Inc.

DAVID R. EYRE, PH.D.
Director and Co-Founder;
Burgess Chair of Orthopedic Research,
University of Washington

GILBERT S. OMENN, M.D., PH.D.
Director;
Dean, School of Public Health, University of Washington

GREGORY D. PHELPS
Director;
Senior Vice President,
Genzyme Corporation

SCIENTIFIC ADVISORY BOARD

CHARLES H. CHESNUT III, M.D.
Chair, Ostex Scientific Advisory Board;
Professor of Medicine and Radiology,
Professor of Nutritional Sciences,
Adjunct Professor of Orthopedics,
University of Washington

ELIZABETH BARRETT-CONNOR, M.D.
Professor and Chair,
Family and Preventive Medicine,
Director, Division of Epidemiology,
University of California, San Diego

DAVID R. EYRE, PH.D.
Burgess Chair of Orthopedic Research, Adjunct Professor of Biochemistry and
Oral  Biology,  Director,  Osteoporosis  Research  Laboratories,  University  of
Washington

HERBERT A. FLEISCH, PH.D.
Professor and Chairman, Department of Pathophysiology, University of Berne,
Berne, Switzerland

C. CONRAD JOHNSTON, JR. M.D.
Professor of Medicine,  Indiana School of Medicine,  Director,  Division of
Endocrinology and Metabolism, Indiana University Medical Center

HOWARD JUDD, M.D.
Chairman,  Department of Obstetrics and Gynecology, Olive View/UCLA Medical
Center; Professor,  Department of Obstetrics and Gynecology,  Chief, Division of
Reproductive Endocrinology, UCLA Clinical Center for Women's Health Initiative

ROBERT LINDSAY, M.D., PH.D.
Chief of Internal  Medicine,  Helen Hayes  Hospital,  New York;  President,
National Osteoporosis Foundation

ALLAN LIPTON
Professor, Departments of Medicine; Chief, Division of Oncology, The Milton
S. Hershey Medical Center, The Pennsylvania State University

SOCRATES PAPAPOULOS, M.D.
Associate  Professor  of Medicine,  Director of Bone and Mineral  Research,
Department of Endocrinology and Metabolism, University of Leiden Medical School,
Leiden, The Netherlands

VERONICA RAVNIKAR, M.D.
Professor  of  Obstetrics   and   Gynecology,   Director  of   Reproductive
Endocrinology and Infertility, University of Massachusetts Medical Center

FREDERICK R. SINGER, M.D.
Medical Director,  Osteoporosis/Metabolic  Bone Disease Program,  St. Johns
Hospital and Health Center; Professor of Medicine in Residence, UCLA

<PAGE>

CORPORATE HEADQUARTERS

OSTEX INTERNATIONAL, INC.
2203 Airport Way South, Suite 400
Seattle, WA  98134-9967
Tel:     (206) 292-8082
Fax:     (206) 292-8625

INDEPENDENT ACCOUNTANTS

ARTHUR ANDERSEN LLP
801 Second Avenue, Suite 800
Seattle, WA  98104

LEGAL COUNSEL

CAIRNCROSS & HEMPELMANN
701 Fifth Avenue, 70th Floor
Seattle, WA  98104

TRANSFER AGENT AND REGISTRAR

CHASEMELLON SHAREHOLDER SERVICES L.L.C.
520 Pike Street, Suite 1220
Seattle, WA  98101

INVESTOR RELATIONS

LIPPERT/HEILSHORN & ASSOCIATES 300 Montgomery Street,  Suite 1140 San Francisco,
CA 94104

SEC FORM 10-K

A copy of the Company's annual report to the Securities and Exchange  Commission
on Form 10-K is  available  without  charge  upon  written  request to  Investor
Relations at the Company's headquarters.

SHAREHOLDERS OF RECORD

As of December 31, 1996, the Company had 156 registered  shareholders  of record
of its common stock.

SHAREHOLDER INQUIRIES

Communications  concerning transfer requirements,  lost certificates and changes
of address  should be directed to the Transfer  Agent.  For general  information
about the Company and its activities,  contact the Investor Relations Department
at Company headquarters.

INFORMATION SERVICE

For timely information about Ostex, news releases are available via facsimile on
the Company's  News-on-Demand  service by calling (800) 356-8061 or on the World
Wide Web at http://www.hnt.com/bizwire/cnn/451.htm.

PRICE RANGE OF COMMON STOCK

The  following  table  lists the high and low trading  places for the  Company's
common stock as reported on the Nasdaq National Market System.

         1996                 High      Low
         1st quarter       $ 20.00  $ 12.25
         2nd quarter         16.25    9.125
         3rd quarter         11.50    6.625
         4th quarter          8.75     5.25
        ------------------------------------
         1995                 High      Low
         1st quarter       $ 10.88  $ 9.375
         (from January 25)
         2nd quarter         23.50     8.00
         3rd quarter         23.50    16.75
         4th quarter         25.00    16.00

The Company's  common stock is traded on the Nasdaq National Market System under
the symbol OSTX. No dividends have been paid on the common stock.

ANNUAL MEETING

The Annual Meeting of Shareholders will be held Monday,  June 2, 1997 at 9:00 am
at the Bellevue Athletic Club, Bellevue, WA.

OSTEX WEBSITE

The Ostex Website is currently under  development.  For more  information  about
Ostex, visit us at http://www.ostex.com.

Osteomark and Ostex are registered trademarks of Ostex International, Inc.