<PAGE>
 
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                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC 20549
 
                               ----------------
 
                                   FORM 10-K
 
                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
  OF 1934
 
 For the fiscal year ended December 31, 1996
 
                                      OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
  ACT OF 1934
 
 For the transition period from      to
 
                       Commission file number: 001-12229
 
                                  DEPUY, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
               DELAWARE                              35-1989795
    (STATE OR OTHER JURISDICTION OF               (I.R.S. EMPLOYER
    INCORPORATION OR ORGANIZATION)               IDENTIFICATION NO.)
 
700 ORTHOPAEDIC DRIVE, WARSAW, INDIANA               46581-0988
    (ADDRESS OF PRINCIPAL EXECUTIVE                  (ZIP CODE)
               OFFICES)
 
  Registrant's Telephone Number, Including Area Code: (219) 267-8143
 
  Securities registered pursuant to Section 12(b) of the Act:
 
<TABLE>
<CAPTION>
    TITLE OF EACH CLASS         NAME OF EACH EXCHANGE ON WHICH REGISTERED
    -------------------         -----------------------------------------
<S>                           <C>
Common Stock, par value $.01             New York Stock Exchange
</TABLE>
 
  Securities registered pursuant to Section 12(g) of the Act: None
 
  Indicate by check X whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  Yes  X   No
                                                      
  Indicate by check X if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. 
                ----    
  The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 17, 1997 was $357,726,383. Registrant's price as
reported on the New York Stock Exchange--Composite Transactions for March 17,
1997 was $23.00 per share.
 
  The number of shares of Common Stock, par value $.01 per share, outstanding
as of March 17, 1997 was 98,580,000.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Certain portions of the Company's Proxy Statement for its Annual Meeting of
Stockholders to be held on May 1, 1997 are incorporated by reference in Part
III of this Report.
 
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<PAGE>
 
                                    GENERAL
 
  This Report includes forward-looking statements concerning the Company's
operations, economic performance and financial condition. Such forward-looking
statements involve risks and uncertainties and are subject to change based on
various factors. Actual results could differ materially from those currently
anticipated. Readers are cautioned not to place undue reliance on forward-
looking statements, which only speak as of the date of this Report.
 
                               ----------------
 
  Certain of the information contained in "Item 1. Business" concerning the
definition, size and development of the various product markets in which the
Company participates and the Company's general expectations concerning the
development of such product markets, both domestically and internationally,
are based on estimates prepared by the Company using data from various sources
(primarily Wessels, Arnold & Henderson, Medifacts International, MDIS
Publications, Theta Corporation and Knowledge Enterprises, as well as data
from the Company's internal research), which data the Company has no reason to
believe are unreliable, and on assumptions made by the Company, based on such
data and its knowledge of the orthopaedic industry, which the Company believes
to be reasonable. While the Company is not aware of any misstatements in such
information, the Company's estimates, in particular as they relate to the
Company's general expectations concerning the product markets in which the
Company participates, involve risks and uncertainties and are subject to
change based on various factors. Sales and market share figures contained in
the narrative portions of Item 1. "Business" includes sales of the Company's
50% owned subsidiary, DePuy DuPont Orthopaedics.
 
                               ----------------
 
  DePuy(R), ACE(R), OrthoTech(R), LCS(R), AMK(R), Charnley(R), ENDURANCE(R),
Solution System(R), Duraloc(R), ELITE(TM), Coordinate(TM), Global(TM), STERILE
VIEW(R), STABILITY(R), POROCOAT(R), CMW(R), AML(R) and Cida(TM) are trademarks
of the Company, its subsidiaries or affiliates. Hylamer(R) is a registered
trademark of DePuy DuPont Orthopaedics. Kevlar(R) is a registered trademark of
E.I. DuPont de Nemours and Company. MOSS(R) is a registered trademark of
Biedermann Motech GmbH, the Company's joint venture partner in DePuy Motech.
 
                                    PART I
 
ITEM 1. BUSINESS.
 
INTRODUCTION
 
  DePuy, Inc. ("DePuy" or the "Company") is one of the world's leading
designers, manufacturers and distributors of orthopaedic devices and supplies.
The Company's products are used primarily by orthopaedic medical specialists
and, in the case of the Company's spinal implants, neurosurgeons in both
surgical and non-surgical therapy to treat patients with musculoskeletal
conditions resulting from degenerative diseases, deformities, trauma and
sports-related injuries. The Company's products cover a broad range of
orthopaedic needs and include primary and revision hip, primary and revision
knee and shoulder implants to reconstruct damaged joints; spinal implants to
facilitate fusion of elements of the spine and to correct deformities; trauma
products to reconstruct small and large bone fractures; and implants, knee
braces and other soft good supplies for the rehabilitation of sports-related
injuries. Additionally, the Company markets complementary products for the
operating room.
 
  Founded in 1895 by Revra DePuy, DePuy is the world's oldest manufacturer of
orthopaedic devices. In October 1996, the Company became a public company
through an initial public offering of its Common Stock (the "Initial Public
Offering"). Prior to the Initial Public Offering, the worldwide operations of
DePuy were consolidated under Corange U.S. Holdings, Inc., an Indiana
corporation ("CUSHI"), and an indirect wholly-owned subsidiary of Corange
Limited, a Bermuda company and the ultimate parent of the DePuy group. As part
of such reorganization, Boehringer Mannheim Corporation, the U.S. operating
subsidiary of the Boehringer Mannheim companies (which are under common
control with the DePuy subsidiaries) was transferred outside the CUSHI
consolidated group. Following such reorganization, for purposes of
reincorporating CUSHI in Delaware, CUSHI was merged downstream into the
Company, with the Company as the surviving company in such merger. The Company
had been organized in Delaware on July 26, 1996 as a wholly-owned subsidiary
of CUSHI for purposes of becoming the holding company for the DePuy group
after the Initial Public Offering.
 
                                       1
<PAGE>
 
 
  The Company's principal executive offices are located at 700 Orthopaedic
Drive, Warsaw, Indiana 46581-0988 and its telephone number is (219) 267-8143.
 
INDUSTRY OVERVIEW
 
  The orthopaedic product market is believed by the Company to have had
approximately $7.3 billion in 1996 sales worldwide, with U.S. sales
constituting approximately $4.1 billion of that total. The Company estimates
that reconstructive products accounted for approximately $3.2 billion of the
1996 worldwide orthopaedic market, with the U.S. and international markets
split equally with approximately $1.6 billion each. The Company believes that
it is one of the leading manufacturers of reconstructive products worldwide,
having a worldwide market share of approximately 15% in 1996, and the second
leading manufacturer in the U.S., having approximately a 17% market share in
1996. With respect to hip products, the Company believes that it is one of the
three leading manufacturers worldwide and one of the two leaders in the U.S.
Within the knee market, the Company believes it is the fourth leading
manufacturer worldwide and in the U.S. The Company believes it is the leading
manufacturer within the extremities market. The Company believes that it is
the fourth leading manufacturer within the worldwide spinal market, one of the
fastest growing segments in musculoskeletal surgery.
 
  DePuy has established a leading market position through the continued
introduction of high quality, clinically-proven products in major segments of
the orthopaedic industry. Geographically, the Company commenced the
development of international distribution channels in 1988 and now has
Company-owned distribution subsidiaries in all major markets outside the U.S.
International sales have increased to 46% of total sales in 1996, up from 11%
in 1988. The Company's acquisitions and alliances have also focused on the
entry into the high growth markets of spinal implants, trauma and sports
medicine. In 1993, the Company entered the expanding market of spinal implants
through a joint venture with Biedermann Motech GmbH of Germany. In 1994, the
Company expanded its position in the trauma device market through the
acquisition of ACE Medical Company, now called DePuy ACE Medical Company
("DePuy ACE"), a leading manufacturer of titanium alloy trauma products and
externally applied fixation devices for the treatment of fractures. Also in
1994, DePuy International Ltd. ("DePuy International"; formerly Charles F.
Thackray Limited, acquired by the Company in 1990) acquired CMW Laboratories,
("CMW"), the oldest orthopaedic bone cement manufacturer in the world. In
March 1996, the Company expanded its position in the fast-growing sports
medicine device market through its acquisition of Orthopedic Technology, Inc.,
now called DePuy Orthopaedic Technology, Inc. ("DePuy OrthoTech"), a
manufacturer and distributor of external braces used in the prevention and
rehabilitation of sports-induced injuries. On February 28, 1997, the Company
entered into an agreement with the stockholders of Landanger-Camus
("Landanger") to purchase the 1,939,452 shares (constituting 89.6% of the
outstanding shares) of such company's stock which are currently held by
members of the Landanger family and certain minority shareholders. The
purchase agreement is subject to a number of conditions. Upon satisfaction of
such conditions, and the closing of the purchase of such shares, it is
contemplated that the Company will make a tender offer to purchase the 10.4%
of the shares of Landanger owned by public shareholders. Landanger,
headquartered in Chaumont, France, is the leading French manufacturer of hip
implants and one of the leading French distributors of orthopaedic devices and
supplies. See Note 16 to the Consolidated Financial Statements contained
herein. DePuy believes that many of its target markets remain fragmented,
providing opportunities for continued consolidation. Technologically, DePuy
seeks to remain on the leading edge of innovation and has established programs
in the area of bone and tissue regeneration and biomaterials.
 
  In the United States, DePuy has been at the forefront of pursuing
opportunities in a managed care environment. As the pressure within the health
care industry to contain costs has increased, DePuy has actively pursued
contracts with national and regional hospital buying groups as well as
individual health care facilities, where the Company believes that the
increase in unit volume produced by high level product sales to such groups
and the opportunity for increased market share offsets the financial impact of
discounting products. The Company has also created and introduced software
packages to help surgeons and health care facilities document and collect
reliable data on costs, clinical results, outcomes and patient satisfaction.
By demonstrating the superiority of its products through careful tracking,
evaluation and promotion of clinical outcomes, the Company believes that it is
well positioned for its customers to receive patient referrals from third-
party payers and integrated health care delivery networks.
 
                                       2
<PAGE>
 
PRODUCTS
 
  The Company's core products are, and have traditionally been, reconstructive
implant devices for hips and knees. Having established itself as a market
leader in the United States in hip and knee replacements, the Company began,
in the late 1980s, to expand its product line to cover the full range of
orthopaedic products through strategic acquisitions and alliances. The
following chart traces the expansion of the Company's product lines during the
last five years. In the table below, reconstructive products include implants
for hips, knees and extremities.
 
                           YEARS ENDED DECEMBER 31,
                             (DOLLARS IN MILLIONS)
 
<TABLE>
<CAPTION>
                              1992           1993           1994           1995           1996
                         -------------- -------------- -------------- -------------- --------------
                                PERCENT        PERCENT        PERCENT        PERCENT        PERCENT
                          NET     OF     NET     OF     NET     OF     NET     OF     NET     OF
                         AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL
                         ------ ------- ------ ------- ------ ------- ------ ------- ------ -------
<S>                      <C>    <C>     <C>    <C>     <C>    <C>     <C>    <C>     <C>    <C>
Reconstructive
 Products............... $317.2    76%  $363.2    78%  $405.9    74%  $450.6    71%  $470.2    67%
Spinal Implants.........    --    --       3.2     1     12.5     2     30.6     5     45.5     7
Trauma Products.........    9.2     2      8.5     2     38.5     7     49.4     8     56.4     8
Sports Medicine(1)......    --    --       --    --      27.7     5     29.4     4     48.2     7
Other Products..........   93.5    22     91.8    19     67.2    12     76.6    12     77.0    11
                         ------   ---   ------   ---   ------   ---   ------   ---   ------   ---
  Total................. $419.9   100%  $466.7   100%  $551.8   100%  $636.6   100%  $697.3   100%
                         ======   ===   ======   ===   ======   ===   ======   ===   ======   ===
</TABLE>
--------
(1) Prior to 1994, sales of sports medicine products were included in other
    products.
 
  At the same time, recognizing that much of the future growth in its core
implant industry would come from international markets, the Company also began
focusing in the late 1980s on increasing its sales outside the United States
by developing distribution channels in countries outside the U.S. See
"Business--Marketing and Sales." From 1991 to 1996, non-U.S. revenue increased
from 33% to 46% of total revenues. The following table sets forth the
geographical sources of the Company's revenues for the past five years, based
on customer location during each such year.
 
                           YEARS ENDED DECEMBER 31,
                             (DOLLARS IN MILLIONS)
 
<TABLE>
<CAPTION>
                              1992           1993           1994           1995           1996
                         -------------- -------------- -------------- -------------- --------------
                                PERCENT        PERCENT        PERCENT        PERCENT        PERCENT
                          NET     OF     NET     OF     NET     OF     NET     OF     NET     OF
                         AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL  AMOUNT  TOTAL
                         ------ ------- ------ ------- ------ ------- ------ ------- ------ -------
<S>                      <C>    <C>     <C>    <C>     <C>    <C>     <C>    <C>     <C>    <C>
United States........... $266.3    64%  $296.7    64%  $333.3    61%  $349.9    55%  $373.8    54%
Europe..................  106.6    25    112.6    24    132.8    24    172.2    27    186.0    27
Asia/Pacific............   35.1     8     42.9     9     68.3    12     90.6    14    107.0    15
Other...................   11.9     3     14.5     3     17.4     3     23.9     4     30.5     4
                         ------   ---   ------   ---   ------   ---   ------   ---   ------   ---
  Total................. $419.9   100%  $466.7   100%  $551.8   100%  $636.6   100%  $697.3   100%
                         ======   ===   ======   ===   ======   ===   ======   ===   ======   ===
</TABLE>
 
 Reconstructive Implants
 
  Until the early 1960s the orthopaedic industry was primarily involved with
the manufacture and sale of products which were intended for treatment of
injuries, most often traumatic injuries. As a result of developments which
began in the late 1950s and the early 1960s, products and procedures were
developed for the treatment of joint disease, such as arthritis, as well.
Total joint replacement surgery replaces worn joints with components made of
stainless steel, titanium alloy or cobalt chromium alloy, depending on the
design, and ultra-high molecular weight polyethylene ("UHMWPE"), a medical
grade plastic. The first widely used products were various forms of hip
replacements, some of which, especially in the early years, involved the
replacement of the
 
                                       3
<PAGE>
 
femoral side only, but as the years progressed total joint replacement became
the norm. Development of total knee systems followed the development of total
hip replacements.
 
  The worldwide market for reconstructive implant devices in 1996 was
approximately $3.2 billion in sales. Of these sales, approximately 49% were in
the U.S. and 51% were in the rest of the world. The Company's worldwide sales
of reconstructive products in 1996 was $470.2 million.
 
  Reconstructive products may be further broken down by category into cemented
products, cementless products and revision products. Cemented products are
secured to the bone with a grout made of polymethylmethacrylate ("cement" or
"bone cement"). Cementless products are "biologically fixed," which means the
surrounding tissue grows into the implant's porous, beaded coating, or macro
texture features, securing it without the use of cement. A revision product,
which may be either cemented or cementless, is the implant used when a primary
implant wears out or becomes loose after years of use and revision surgery is
performed.
 
  The Company designs, manufactures and markets a full line of joint
reconstruction implants for the hip, knee, shoulder, elbow, wrist and ankle.
 
  Hip Systems. The Company believes the market for hip implant products in
1996 was approximately $1.7 billion in sales worldwide and approximately $700
million in sales in the U.S. The Company believes it is one of the three
leading manufacturers of hip implant products worldwide and is one of the two
leaders in the United States.
 
  In hip arthroplasty, the "ball and socket" of the hip joint are replaced
with several components, depending on the product design. The stem, made of
stainless steel, titanium alloy or cobalt chromium alloy, supports the head,
which is comprised of a "ball and neck." The acetabular component, which
usually consists of a polyethylene liner and metal cup or an all polyethylene
cup, replaces the socket. DePuy offers a full line of hip implants to meet
patient needs and surgeon preferences. Its two leading total hip systems are
the Charnley Hip and the AML Hip. The Charnley Hip is one of the leading
cemented hip implants in the world in terms of unit volume. The AML Hip, the
Solution System and the Duraloc Acetabular Cup System are, respectively, the
leading porous coated hip system, the leading revision hip system and the
leading acetabular cup in the U.S. in terms of unit volume.
 
    AML Total Hip System. The AML Hip is a cementless system that uses a
  proprietary porous implant coating (Porocoat) to secure the implant in
  place through biological fixation. Considered the Company's flagship
  product, the AML hip stem was the first implant to be cleared by the Food
  and Drug Administration (the "FDA") to be indicated for use without cement
  and has the longest clinical history of any cementless hip implant on the
  market today, with a 99% survivorship estimate at 10 years for the AML
  femoral hip stem. The AML Hip family of products is the most widely used
  family of cementless implants in the U.S.
 
    Charnley Hip System. Unlike the U.S., in the U.K. and much of Europe
  cemented hip systems, which are less expensive, continue to be preferred.
  The Charnley Hip is a specialized stainless steel alloy cemented hip
  implant. It was the world's first low friction total hip implant and has
  the longest clinical history of any implant on the market. The Charnley
  femoral hip stem has a 90% or better survivorship estimate at 20 years. The
  Charnley Hip is one of the leading cemented hip implants in the world in
  terms of unit volume. The new generation of the Charnley family, the Elite
  Plus Total Hip, was introduced in 1995, and can utilize a zirconian femoral
  bearing surface designed to further minimize wear of the surface and
  prolong the life of the arthroplasty. In the U.S., the ENDURANCE System has
  been designed using the principles of the Charnley Hip. Manufactured from a
  cobalt chromium alloy, the ENDURANCE System was introduced in 1994.
 
    Solution System. Revision hip surgery is performed when infection occurs
  or the supporting bone or primary implant wears out from years of use.
  Introduced in 1990, the Solution System was the first extensively coated
  revision system on the market. The Porocoat coating helps provide the
  additional stability required in revision hip surgery. The Solution System
  has a substantial share of the revision market in the U.S. DePuy also
  markets a cemented revision implant as part of the ENDURANCE System.
 
                                       4
<PAGE>
 
    Duraloc Acetabular Cup System. The Duraloc Acetabular Cup System uses a
  sensor-ring lock, uniform dome loading and optimal polyethylene thickness
  for the specific patient application. This combination permits mobility
  without sacrificing structural support. The patented Duraloc Acetabular Cup
  System is the leading cup system in the U.S.
 
  Knee Systems. The Company believes the worldwide and U.S. markets in 1996
for knee implants were $1.4 billion and $840 million, respectively, in sales.
The Company believes it is the fourth largest manufacturer in the knee market
in the U.S. and worldwide.
 
  Total knee arthroplasty consists of several components depending on the
product design: the femoral component or components, the tibial component or
components and the patellar component or components. The Company offers a full
range of implants, including the LCS Knee, the AMK Knee and the Coordinate
Revision Knee System.
 
    LCS Total Knee System. The LCS Total Knee System is a mobile-bearing Knee
  system. The mobile bearings incorporated into the design allowed the
  implant to more closely simulate the anatomic movement of a natural Knee
  while minimizing stresses on the implant components. The patented LCS Knee
  design, which was launched in 1985 after extensive clinical trials, has FDA
  Pre-Market Approval for both cemented and cementless indications for use.
  The LCS Knee design was the first, and continues to be the only, mobile-
  bearing knee commercially available for use in the U.S. The LCS Knee has 19
  years, including initial development and clinical trials, of clinical
  history with a 97% survival estimate at 7 years. The LCS Knee is the number
  one selling mobile-bearing knee implant worldwide and in the U.S. Within
  the U.S. sales have been increasing as the implant's success rate becomes
  more widely known and its clinical history is extended, providing more
  clinical data of its success.
 
    AMK Total Knee System. Introduced in 1987, the AMK Total Knee System is a
  fixed-bearing knee system which has left and right, rather than universal,
  femoral components. The AMK Knee may be used for primary and revision knee
  surgery needs and has nine years of clinical follow-up history. In 1990,
  the Company introduced the AMK PS (Posterior Stabilized) design, which is a
  complementary product intended to address another industry trend toward
  posterior stabilization of the knee joint, the fastest growing area in the
  knee implant market.
 
    Coordinate System. The Coordinate system is a revision knee system which
  uses the same instrumentation as the AMK Knee family of products.
 
  Extremities. The Company believes the worldwide and U.S. markets in 1996 for
extremities implants (shoulder, ankles, elbows and wrists) were nearly $90
million and nearly $60 million, respectively. Within the extremities market,
shoulder implants accounted for over 65% of 1996 sales worldwide and in the
U.S. DePuy believes it is the leading manufacturer of extremities implant
products in general and shoulder implants. The Global Total Shoulder System,
introduced in 1992, has in just four years become a market leader in the U.S.
shoulder market. Once considered a difficult surgery with questionable
outcomes, the improved technology embodied in the Global Shoulder has helped
the procedure gain acceptance, and shoulder surgery is now one of the fastest
growing segments in orthopaedics.
 
 Spinal Implants
 
  One of the fastest growing markets in musculoskeletal surgery, the spinal
implants market for 1996 was approximately $440 million in sales worldwide,
with approximately $200 million in sales in the U.S. In 1993, the Company
entered the spinal market through a joint venture with Biedermann Motech GmbH
of Germany. The resulting company, DePuy Motech, is 80% owned by DePuy. This
joint venture has resulted in the Company becoming fourth worldwide in the
sale of spinal implant devices in less than three years after its entry into
the market. The Company's 1996 worldwide sales were $45.5 million.
 
  The primary goals of spinal instrumentation systems are to correct for
spinal deformity or imbalance, to reestablish stability of the spine and to
eliminate pain. Hooks, rods, screws and anterior support devices (metallic,
ceramic and bone) acting as the equivalent of modular spinal anchoring
devices, are constructed by the surgeon
 
                                       5
<PAGE>
 
to create an internal bracing mechanism. Surgeons adapt these components to
the specific pathology of the individual patient, creating an implant
construct that is intended to reconstruct and restore normal spinal
biomechanics or facilitate bone fusion.
 
  DePuy Motech has differentiated itself from other manufacturers of spinal
implants by basing its implants on "load sharing", which advocates the support
of the spine both anteriorly (front) and posteriorly (back). This philosophy
has now become an important surgical trend in spinal surgery.
 
  Among the Company's products is the MOSS System, the first system to address
the concept of load sharing and recognize the importance of anterior column
support to restore and balance the natural forces in the spine. The MOSS Miami
System, introduced in 1995, set new design standards, while continuing to
adhere to the Company's basic design philosophies. These are complete systems
made of stainless steel and include anatomical hooks, monoaxial and polyaxial
screws and rods, and are designed for universal application in spinal surgery
for deformities, tumor, trauma and degenerative diseases of the spinal column.
These systems are marketed in the U.S. as spinal devices for fusion and for
bone repair under Section 510(k) Premarket Notification ("510(k)") clearances.
Within the U.S., DePuy markets the hooks and pedicle screws for use in certain
lumbar regions. Outside the U.S., marketing of pedicle screws for more general
use, and the labeling and marketing of the Company's surgical mesh product for
use between vertebrae, is allowed. The MOSS Miami System is also available in
titanium alloy which allows surgeons to use Magnetic Resonance Imaging and
Computer Aided Tomography evaluation following surgery and provides an implant
system for patients who may be sensitive to the nickel content of stainless
steel.
 
  Among DePuy Motech's other recent products is Titanium Surgical Mesh,
designed in Europe by Professor Jurgen Harms and Biedermann Motech to provide
a synthetic device to reinforce weak bony tissue. This product has gained
market acceptance outside the U.S. and is marketed in the U.S. pursuant to
510(k) clearance received by Biedermann Motech in 1990. DePuy Motech is
conducting an IDE study to further evaluate specific indications for use of
Titanium Surgical Mesh. In June 1996, the Company's Peak Anterior Cervical
Compression Plate and Peak Channeled Reconstruction Plate, part of the Peak
Fixation System, were offered for sale outside the U.S. The Peak Anterior
Cervical Compression Plate addresses degenerative diseases of the anterior
cervical spine and the Peak Channeled Reconstruction Plate is used in surgery
to stabilize bony structures. These products are expected to be marketed in
the near future in the U.S. following applicable 510(k) clearances.
 
 Trauma Devices
 
  The orthopaedic trauma field, which involves the management of fractures,
has as its objective the achievement of complete bone healing, or "union," and
restoration of alignment and full range of motion in patients who have
sustained fractures. The worldwide market for trauma products in 1996 was
approximately $1 billion in sales, of which approximately 45% were sales in
the U.S. The Company's fixation devices may be classified generally as
external fixation devices and internal fixation devices. The acquisition of
DePuy ACE in 1994 added critical mass to the Company's trauma product
offerings, specifically adding products in the growing market of external
fixation. Within the trauma market, the Company, through DePuy ACE, is a
leading manufacturer of titanium alloy trauma products and externally applied
fixation devices for the treatment of fractured bones. DePuy ACE was a pioneer
in the use of titanium alloy implants in the orthopaedic trauma market.
Titanium alloy more closely replicates the physical properties of bone than
stainless steel and is associated with a higher degree of biocompatibility
than stainless steel implants. The Company had sales of $56.4 million
worldwide in 1996 and $26 million in the U.S., representing 5% and 6%,
respectively, of the market. DePuy ACE is a market leader in Japan, the second
largest geographical market for trauma products.
 
 Sports Medicine Products
 
  The sports medicine market, which includes arthroscopy equipment, soft
tissue implants, casting, braces, cold therapy and supports, amounted to
approximately $810 million in sales worldwide in 1996, including approximately
$640 million in the U.S. The Company expanded its position in this area
through its acquisition of DePuy OrthoTech in March 1996, which added critical
mass and expanded product lines. The Company's aggregate sales of sports
medicine products in 1996 were $48.2 million worldwide.
 
                                       6
<PAGE>
 
  Among the Company's products are arthroscopy instruments, anterior cruciate
ligament reconstructive guide systems, tissue fixation devices, cold therapy
management systems, foot and ankle supports and orthopaedic knee braces.
Within its knee brace product line, the Company offers a complete line of
custom-made braces which are used by professional athletes in a number of
sports. The Company also offers a complete line of high-quality, off-the-shelf
knee braces.
 
 Cement
 
  To complement cemented reconstructive product lines, the Company entered the
bone cement market in 1994 through the acquisition of CMW. CMW manufactures
different types of bone cements used with reconstructive implants and had 1996
sales of approximately $15 million. Early in 1997, CMW received FDA clearance
to market directly in the U.S. one type of its bone cement. Additional
versions are awaiting clearance for marketing in the U.S.
 
 Operating Room Products
 
  To complement its reconstructive products, the Company developed a
comprehensive line of products designed to shield health care workers,
surgeons and patients from cross-contamination and contact with body fluids
which could contain potentially infectious bacteria and viruses during
surgery. Orthopaedic reconstructive surgery carries a higher risk of such
contamination or contacts than many other types of surgeries as a result of
the instrumentation required, which scatters microscopic particles, including
bone and blood.
 
  Among the Company's product offerings are a series of cut, stick and
puncture resistant glove liners, developed and marketed by DePuy DuPont
Orthopaedics, which incorporate Kevlar material, a lightweight fabric used in
military helmets and in flack jackets that is stronger than steel. Other
products include the Sterile View System ("space suits" that shield and filter
airborne particulates), and the Cida-system, a line of germicidal products
designed to ensure the cleanest possible surgical environment. In addition,
the Company markets power and manual instruments, wound drainage and
tourniquet systems, smoke evacuation systems and instrument repair services.
 
 Product Development
 
  The Company conducts its research and development programs to maintain its
proprietary position by making improvements to existing products and by
developing new generations of products focused on new materials, biologic
biomaterials, and new non-invasive or minimally-invasive forms of treatment
for afflictions and injuries currently requiring surgery.
 
  In-house, company-sponsored research and development programs at Warsaw,
Indiana and Leeds, United Kingdom focus on enhancements to the metallic and
polyethylene components of the implant and instrument devices manufactured by
the Company by increasing their strength, corrosion or oxidation resistance,
fatigue resistance, or focusing on bearing surface improvements to the
artificial joint being replaced in the human body. In addition, research is
being done on artificial joint simulators and enhancements to the bearing
interface.
 
  In 1990, as part of its long-range product development efforts, the Company
initiated programs in the biotechnology arena with an emphasis on
orthobiologics and biologic biomaterials. The Company is researching
technologies for the next century in the area of bone substitutes, cartilage
regeneration, ligament and tendon reconstruction and musculoskeletal tissue
engineering. These efforts, however, if successful, are not expected to
produce material product revenue until, at the earliest, the beginning of the
next decade.
 
  Bone and Tissue Regeneration. In the early 1990s, the demand for
musculoskeletal tissue to repair traumatic and sports related injuries
increased. At present, there are limited means of repairing injuries such as a
rotator cuff deficiency or a meniscus tear. For certain other types of injury
(particularly damage to ligaments and tendons), the treatment requires the use
of tissue from another site on the patient's body, thereby increasing chances
of morbidity and surgery costs. To address these problems, in March 1992,
DePuy moved into tissue engineering research by entering into an exclusive
license agreement with Purdue University to develop a tissue
 
                                       7
<PAGE>
 
engineering concept using Small Intestine Submucosa ("SIS"). SIS is a patented
xenographic biomaterial that may be used as a scaffold in tissue engineering
applications. SIS has been shown to facilitate the regeneration, repair and
re-growth of the patient's own tissues at various anatomical sites. The
Company is investigating SIS for ligament, tendon, bone, cartilage, meniscus
and rotator cuff applications. In late 1996, the Company filed an IDE
application for anterior cruciate ligament replacement using SIS and is
currently supplying the FDA with additional information as a follow-up to that
submission.
 
  With orthopaedic surgeons identifying cartilage repair and bone substitute
materials as significant needs, DePuy entered into an exclusive license
agreement with Genentech, Inc. in February 1992 which allows DePuy to evaluate
the use of Transforming Growth Factor Beta One ("TGFB-1") for orthopaedic
applications. TGFB-1 has been shown to aid in bone regeneration and remodeling
and to inhibit bone resorption, along with stimulating articular cartilage
repair and regeneration. Preclinical studies have demonstrated the efficacy of
TGFB-1 formulated with other biomaterials for bone substitute applications.
However, the preclinical studies also disclosed potential systemic effects of
TGFB-1 when delivered at a bony site which may preclude the use of TGFB-1
administered directly to bone. The Company is studying alternate methods of
utilizing TGFB-1 for bone regeneration through gene therapy and is
investigating the effects, both local and systemic, of direct applications of
TGFB-l to stimulate cartilage repair and regeneration.
 
  The Company is also involved in an orthobiologic program aimed at addressing
joint trauma and degeneration. The Company is researching articular cartilage
repair through collaborations with the Boehringer Mannheim group of companies
and others utilizing resorbable polymers, cell technology applications and
gene therapy delivery mechanisms. In addition, the Company is working with
Matrix Biotechnologies, Inc., in which the Company has a minority interest, to
research and develop cartilage repair products, including materials,
procedures and related instrumentation, without the need for prosthetics. One
focus of this collaboration is the development of technology for the repair
and/or regeneration of articular cartilage using a bioresorbable device which
can be placed at the defect site to promote the body's own ability to repair
cartilage damage.
 
  Biomaterials. In July 1987, DePuy signed an exclusive research agreement
with E.I. DuPont DeNemours and Company to investigate the use of advanced
biomaterials (polymers, composites and resorbables) in orthopaedic
applications and formed a partnership, DePuy DuPont Orthopaedics, in 1989 to
distribute new products developed by the joint venture. This venture has
already introduced a number of new products, including the Hylamer family of
orthopaedic bearing polymers consisting of UHMWPE bearing surfaces. The
polymers, available for use exclusively in the Company's hip, knee and
shoulder implants, are designed to resist wear, deformation and material
degradation, providing greater strength than traditional polymers. Current
research projects involve a newly-designed metacarpal phalangeal finger
spacer/implant, further improvements to UHMWPE, composite implant designs,
resorbable materials for screws, anchors and other fixation devices, as well
as continued research in the area of fibers, elastomers and other polymers at
various stages in the research and product development cycle.
 
MARKETING AND SALES
 
  The Company markets and distributes its products through a global
distribution network. Distribution within the U.S. is through a combination of
Company-owned sales offices that supervise independent commissioned sales
associates and a number of independent commissioned sales agents. Outside the
U.S., the majority of the Company's sales are conducted through Company-owned
distribution outlets, although the Company still distributes some products
through independent distributors in certain international markets. To promote
its key products, the Company collaborates with surgeons with national and, in
many cases, international reputations in the relevant area of orthopaedic
surgery and neurosurgery. These "surgeon champions" use and study the product
and participate in learning centers and other educational or professional
activities to educate other doctors on the use of the product.
 
 United States
 
  The Company markets its orthopaedic implant products in the United States
through a network of approximately 500 independent, commissioned sales
associates managed by 31 Company-employed territory
 
                                       8
<PAGE>
 
sales managers and 11 independent sales agents as of December 31, 1996. This
structure has been evolving since 1994. The salesforce was reorganized as
described below to create a structure where requisite investments in
personnel, training and instruments would be made in the Company's new product
areas such as spinal implants and trauma products. The reorganization also
allowed the Company to ensure that sales associates were receiving appropriate
incentives and compensation and to eliminate the involvement of those sales
agents who were unproductive.
 
  For many decades, as was typical in the industry, the Company distributed
its products in the U.S. exclusively through a network of independent
commissioned sales agents, each assigned a geographic territory in which the
agent had the exclusive right to solicit orders for the Company's products.
Sales agents established and maintained personal contact with customers and
provided services related to the products sold, such as attending surgeries to
ensure that the surgeon had the correct size of implant and the necessary
instrumentation. In exchange for soliciting orders, the sales agents were paid
a commission on the invoice price of all orders shipped to their respective
territory.
 
  As the Company's business expanded, in terms of both product offering and
share of market, in the 1980s and 1990s the sales agents were no longer able
to maintain personal customer contact with all of the customers in their
respective territories. As a result they began hiring independent sales
associates who they assigned to segments of their territories and who in time
took over customer and surgeon contact. The sales associates were compensated
by the sales agent in accordance with separate arrangements between the sales
agent and sales associates.
 
  In mid-1994, sales agents who were not managing their areas and sales
associates to the Company's satisfaction began to be replaced with territory
sales managers, who were charged with managing the territory and the sales
associates who work there. Sales associates continue to function as before but
are now compensated directly by the Company through commissions. The Company
provides the investment in training, support and general administrative
services.
 
  Trauma and sports medicine products are both marketed through a combination
of dedicated sales representatives and the Company's reconstructive implant
marketing system of sales associates, sales agents and territory sales
managers. In some areas, the Company has dedicated sales representatives for
each product line, while in others the sales agents and sales associates sell
all of the Company's product lines. In addition to the Company's sales agents,
sales associates and territory sales managers, DePuy ACE uses five independent
sales agents and one independent distributor who do not carry any other DePuy
products. DePuy OrthoTech's dedicated salesforce consists of its own 50-person
employee sales organization and one regional distributor. Spinal implant
products are marketed through a specialized sales force.
 
  To address the changing customer base in the U.S. orthopaedic market
resulting from health care reform and the emergence of managed care, the
Company has strengthened its national contracts department and added a managed
care area to its sales department. See "Business--Industry Overview".
 
 International
 
  The Company distributes its products outside the United States and Canada,
for the most part, through a number of distribution subsidiaries. Establishing
a separate distribution channel in each country has been a critical part of
the Company's strategy for marketing abroad. Knowledge of, and on site
compliance with, each country's regulatory scheme requires the presence and
unique knowledge of a local distributor. The ability to communicate with
physicians, nurses and other operating room personnel in their own language,
is also important. In addition, successful marketing requires an understanding
of each country's health care system and its purchasing and reimbursement
practices. Until 1988, all of the Company's sales outside the United States
and Canada were to distributors who purchased the products, sold on their own
account and established prices to their customers. Beginning in 1988 with the
acquisition of the former Chevalier A.G. (now De Puy A.G.) in Switzerland, and
continuing through the present time, the Company has followed a strategy of
establishing a separate Company-owned subsidiary with DePuy employed salesmen
in each major market or potential major
 
                                       9
<PAGE>
 
market. These subsidiaries establish the prices for the products sold in their
respective countries, first purchasing them from the Company and then
reselling them at retail. In major markets, this process has sometimes
involved the acquisition of the Company's previous distributor or entering
into a joint venture with such distributor. In other markets, new companies
have been created or are being formed at the present time. The Company now has
distribution subsidiaries in the United Kingdom, Canada, Germany, France,
Italy, Switzerland, Austria, Belgium, Portugal, Spain, Sweden, Japan, Korea,
Singapore, Mexico, Taiwan, Hungary, the Czech Republic, Australia, New
Zealand, Argentina and India.
 
  Japan represents a significant market for the Company's trauma products.
DePuy ACE has a longstanding exclusive arrangement with Japan Medical Dynamic
Marketing, an independent distributor, to sell DePuy ACE's products.
 
  In the sports medicine market, DePuy OrthoTech has an exclusive distribution
arrangement with Beiersdorf AG covering Germany, Austria, Belgium, Spain and
The Netherlands.
 
  For a breakdown of the Company's sales by geographical region and product,
see "Business--Products" and Note 15 to the Consolidated Financial Statements
contained elsewhere in this Report.
 
INTELLECTUAL PROPERTY
 
  The Company holds domestic and foreign patents covering certain of its
systems, components and instrumentation, has patent applications pending with
respect to certain implant components and certain surgical instrumentation and
anticipates that it will apply for additional patents it deems appropriate. In
addition, the Company holds licenses from third parties to utilize certain
patents, patent applications and technology utilized in the design of some of
its devices. See "Item 3. Legal Proceedings" for information concerning patent
infringement suits involving the Company.
 
  In addition, the Company relies on non-patented proprietary know-how, trade
secrets, processes and other proprietary information, which the Company
protects through a variety of methods, including confidentiality agreements
and proprietary information agreements.
 
  The Company markets its LCS Knee through an exclusive, worldwide license to
manufacture and sell the LCS Knee under patents owned by Biomedical
Engineering Trust ("BET").
 
  The Company and its subsidiaries market their products under a number of
trademarks.
 
MANUFACTURING
 
  The Company's manufacturing operations are carried out at a number of
facilities owned or leased by the Company or its subsidiaries. In 1995 and
1996, the Company obtained ISO 9001 series registration for its manufacturing
facilities in Warsaw, Indiana; Leeds, England; Blackpool, England; and Los
Angeles, California and ISO 9002 for its Albuquerque, New Mexico facilities.
The Company is in the process of obtaining appropriate ISO registration for
its other facilities. ISO 9001 and ISO 9002 are internationally recognized
quality standards for manufacturing. ISO certification assists the Company in
marketing its products in certain foreign markets. See "Business--Government
Regulation."
 
  The Company devotes significant attention to quality control in
manufacturing its products. At the main reconstructive products manufacturing
facilities, the quality control measures begin with an inspection of all raw
materials and castings to be used in implants. Each piece is inspected at each
step of the manufacturing process. As a final step, products pass through a
"clean room" environment designed and maintained to reduce product exposure to
particulate matter. In addition, the Company utilizes a new gas plasma
sterilization system for its implants. The Company cleared use of gas plasma
sterilization with the FDA through the 510(k) process, making the Company the
first and only company to receive such clearance for the industrial
application of gas plasma sterilization. This process reduces the possibility
of oxidation of polyethylene and is believed not to pose the environmental
threats of other methods of sterilization.
 
                                      10
<PAGE>
 
  Approximately 75% of the Company's products are manufactured in-house, with
the remaining 25% outsourced. Approximately 70% of DePuy ACE's trauma products
are presently outsourced. It is the Company's intention to bring all trauma
implant manufacturing in-house over time. The primary raw materials used by
the Company in the manufacture of its reconstructive products are cobalt
chromium alloy, stainless steel alloys, titanium alloy and UHMWP. Certain
components used by the Company, primarily castings and forgings which are the
major material components of most implants, are purchased from a limited
number of suppliers. However, the Company has back-up sources for all of its
materials and believes that adequate capacity exists at its suppliers to meet
all anticipated needs.
 
  As part of its business strategy, the Company has implemented certain
manufacturing procedures to reduce costs and improve efficiencies as well as
inventory management and control systems and is incorporating manufacturing
efficiencies into the design of instruments and is redesigning current
instruments to reduce manufacturing costs. Due in large measure to these
process improvements, manufacturing lead times have been considerably reduced,
from 25 days in 1994 to 7.2 days in 1996 in the U.S., and from 30 days in 1994
to 15 days in 1996 at DePuy International. Robotics is another means employed
to increase the manufacturing efficiency of its orthopaedic products. In
addition, in 1996, the Company purchased one of its major instrument suppliers
to further reduce costs and shorten the time required to get instruments to
market.
 
  In its trauma products, the Company uses commercial titanium and titanium
alloy in addition to stainless steel alloys. The Company competes with both
government and commercial aerospace requirements for titanium, as well as golf
equipment manufacturers. The aerospace industry controls both the price and
supply of titanium products and can dramatically affect both the cost and
availability of such materials. DePuy ACE has entered into a long-term
agreement with its primary supplier of titanium to address this concern.
 
  In its sports medicine products, the Company uses rolled cloth goods,
metals, plastics and foams, all of which are of standard stock and are readily
available from a number of sources.
 
COMPETITION
 
  The orthopaedic device industry is highly competitive and has been
characterized by innovation, technological change and advancement. Major
companies that compete in the total joint implant market, some of which also
market complementary non-implant lines that compete with the Company's other
products, include Biomet Inc.; Zimmer, Inc., a subsidiary of the Bristol-Myers
Squibb Company; Howmedica, Inc., a subsidiary of Pfizer, Inc.; Smith & Nephew
Orthopedics, a division of Smith & Nephew Ltd.; Osteonics, Inc., a subsidiary
of the Stryker Corporation; Johnson & Johnson Orthopaedics, Inc., a subsidiary
of Johnson & Johnson; and Protek, Allopro and Intermedics Orthopedics, all
divisions of Sulzer Limited. In the spinal instrumentation area, the Company's
main competitors are Sofamor Danek Group, Inc.; Synthes; Acromed, Corp.; Smith
& Nephew Ltd. and Spine-Tech, Inc. Competition within the orthopaedic implant
industry is primarily based on customer service, product design and
performance, ease of use, peer influence among surgeons and results of the
product over time. In recent years, price has become increasingly important as
the industry matures and health care providers become more concerned with
costs. At the present time, price is a factor in the sale of those devices
where differentiation of the product cannot be clearly proven and the decision
to buy is not significantly influenced by the surgeon. Additionally, as health
care providers become more cost-conscious, the use of higher-priced devices
has become increasingly limited to younger, more active patients, while
lesser-priced devices are used in patients with a lower demand (i.e., shorter
life expectancy and/or lower activity level). The Company believes that its
future success depends upon providing high quality service to all customers,
offering a wide range of quality products at different pricing points,
continuing to promote its key products and their already existing long-term
successful outcomes and clinical results, pursuing additional strategic
agreements with buying groups, offering a wide array of ancillary products
utilized by the orthopaedic community and continuing to pursue, through
research and development efforts, new products and services that can set the
Company apart from its competitors.
 
  The Company's trauma product lines compete with products of Biomet Inc.;
Zimmer, Inc.; Richards Manufacturing Co., Inc., a subsidiary of Smith & Nephew
Ltd; Synthes and Orthofix International N.V. Competition in this area is
primarily based on service, product design and performance, technological
advances, reputation and price.
 
                                      11
<PAGE>
 
  In the sports medicine product area, the Company competes with numerous
other companies, principally Don Joy, a division of Smith & Nephew Ltd.,
Innovation Sports, and Lenox Hill, a division of Hanger Orthopedic Group, Inc.
The Company believes that the principal competitive factors affecting the
sports medicine product field are customer service, product performance,
technology, reputation and price. It believes that its service and technology
distinguish it favorably from its competitors in the marketing and sale of its
products.
 
  In the cement market, the Company competes with numerous other companies,
primarily Howmedica, Inc., Schering-Plough Corp. and Zimmer, Inc.
 
EMPLOYEES
 
  As of December 31, 1996, the Company had approximately 2,930 employees
worldwide, including approximately 1,210 engaged in the Company's U.S.
reconstructive device business, approximately 40 employed by DePuy Motech,
approximately 180 employed by DePuy ACE, approximately 300 employed by DePuy
OrthoTech, and approximately 1,200 engaged in the Company's international
businesses.
 
  Approximately 320 employees in the Warsaw, Indiana facility are represented
by the United Paperworkers International Union, Local No. 7809, and are
subject to a five year collective bargaining agreement expiring in June 1997.
Approximately 230 employees in the Leeds, England facility are represented by
the Amalgamated Engineering and Electrical Union and are subject to a
collective bargaining agreement which expires in April 1997. In addition,
approximately 25 employees at the Leeds, England facility are represented by
the Manufacturing Scientific and Finance Union. Prior to July 31, 1996,
approximately 15 employees in the metals department at the Tracy, California
facility for sports medicine products were also represented by a union; the
union was decertified on that date.
 
  The Company believes that its employee relations are satisfactory, and that
its relationships with all unions representing its workers are non-adversarial
and cooperative.
 
GOVERNMENT REGULATION
 
  The Company's operations are subject to rigorous governmental agency
regulation in the United States and certain other countries.
 
  The FDA regulates the testing, labeling, manufacturing and marketing of
medical devices to ensure that medical products distributed in the United
States are safe and effective for their intended uses. Additionally, the FDA
regulates the export of medical devices manufactured in the United States to
international markets.
 
  Under the Food, Drug and Cosmetic Act, as amended, medical devices are
classified into one of three classes depending on the degree of risk imparted
to patients by the medical device. Class I devices are those for which safety
and effectiveness can be assured by adherence to General Controls, which
include compliance with Good Manufacturing Practices ("GMPs"), facility and
device registrations and listings, reporting of adverse medical events, and
appropriate truthful and non-misleading labeling, advertising and promotional
materials. Some Class I devices also require premarket review and clearance by
the FDA through the 510(k) process described below. Class II devices are those
which are subject to General Controls as well as premarket demonstration of
adherence to certain Performance Standards or other Special Controls as
specified by the FDA. Premarket review and clearance by the FDA for these
devices is accomplished through the 510(k) procedure. In the 510(k) procedure,
the manufacturer submits appropriate information to the FDA in a Premarket
Notification submission. If the FDA determines that the device is
"substantially equivalent" to a device that was legally marketed prior to May
28, 1976, the date upon which the Medical Device Amendments of 1976 were
enacted, or to another commercially available similar device subsequently
cleared through the 510(k) process, it will grant clearance to commercially
market the device. It generally takes from three to 12 months from the date of
submission to obtain clearance of a 510(k) submission, but may take longer. If
the FDA determines that the device, or its labeled intended use, is not
"substantially equivalent," the FDA will automatically place the device into
Class III.
 
                                      12
<PAGE>
 
  A Class III product is a product which has a wholly new intended use or is
based on advances in technology for which the device's safety and
effectiveness cannot be assured solely by the General Controls, Performance
Standards and Special Controls applied to Class I and II devices. These
devices often require formal clinical investigation studies to assess their
safety and effectiveness. A Premarket Approval (a "PMA") from the FDA is
required before marketing of a Class III product can proceed. The PMA process
is much more extensive than the 510(k) process. In order to obtain a PMA,
Class III devices, or a particular intended use of any such devices, usually
must undergo clinical trials pursuant to an application submitted by the
manufacturer for an IDE. An approved IDE exempts the manufacturer from the
otherwise applicable FDA regulations and grants approval for the conduct of
the human clinical investigation to generate the clinical data necessary to
scientifically evaluate the safety and efficacy of the Class III device or
intended use.
 
  When a manufacturer believes that sufficient pre-clinical and clinical data
has been generated to prove the safety and efficacy of the new device or new
intended use, it may submit a PMA application to the FDA. An FDA review of a
PMA application generally takes one to two years from the date the PMA
application is accepted for filing, but may take significantly longer.
 
  The Company's products include both pre-amendment and post-amendment Class
I, II and III medical devices. Most pre-amendment devices (those marketed
prior to the enactment of the Medical Device Amendment of 1976) are, in
general, exempt from such Premarket Approval requirements, as are Class I and
Class II devices. All currently marketed devices hold the relevant exemptions
or premarket clearances or approvals, as appropriate, required under federal
medical device law.
 
  In addition, the Company's manufacturing processes are required to comply
with GMP regulations which cover the methods and documentation of the design,
testing, production, control, quality assurance, labeling, packaging and
shipping of the Company's products. The Company's facilities, records and
manufacturing processes are subject to periodic unscheduled inspections by the
FDA or other agencies.
 
  The Company is also subject to regulations in many of the foreign countries
in which it sells its products in the areas of product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the
Company's devices and products in such countries are similar to those of the
FDA. The national health or social security organizations of certain such
countries require the Company's products to be qualified before they can be
marketed in those countries. To date, the Company has not experienced
difficulty in complying with these regulations.
 
  The Company is also implementing policies and procedures intended to allow
the Company to position itself for the changing international regulatory
environment. The ISO 9000 series of standards has been developed as an
internationally recognized set of guidelines that are aimed at ensuring the
design and manufacture of quality products. A company that passes an ISO audit
and obtains ISO registration becomes internationally recognized as being well
run and functioning under a competent quality system. In certain foreign
markets, it may be necessary or advantageous to obtain ISO 9000 series
certification, which, in some ways, is analogous to compliance with the FDA's
GMP requirements. The European Union has promulgated rules which require that
medical products receive a CE mark by mid-1998. A CE mark is an international
symbol of adherence to certain standards and compliance with applicable
European medical device requirements and certification. ISO 9000 series
certification is one of the prerequisites for CE marking of most of the
Company's products. Certain of the Company's facilities have received ISO
certification and ISO certification is being pursued at the others. See
"Business--Manufacturing."
 
  In addition, the Company must obtain export certificates from the FDA before
it can export some of its products.
 
  Certain provisions of the Social Security Act, commonly known as the
"Medicare Fraud and Abuse Statute," prohibit entities, such as the Company,
from offering, paying, soliciting or receiving any form of remuneration in
return for the referral of Medicare or state health program patients or
patient care opportunities,
 
                                      13
<PAGE>
 
or in return for the recommendation, arrangement, purchase, lease or order of
items or services that are covered by Medicare or state health programs. Many
states have adopted similar prohibitions against payments intended to induce
referrals of Medicaid and other third-party payer patients.
 
  Federal physician self-referral legislation prohibits, subject to certain
exemptions, a physician or a member of his immediate family from referring
Medicare or Medicaid patients to an entity providing "designated health
services" in which the physician has an ownership or investment interest, or
with which the physician has entered into a compensation arrangement.
 
ITEM 2. PROPERTIES.
 
  As of December 31, 1996, the Company owned or leased the following
facilities:
 
<TABLE>
<CAPTION>
                                                             APPROXIMATE   LEASED OR
    LOCATION                      TYPE OF FACILITY          SQUARE FOOTAGE   OWNED
    --------                      ----------------          -------------- ---------
<S>                      <C>                                <C>            <C>
Warsaw, Indiana(1)...... Executive Offices, Research and       242,200      Owned
                         Development, Manufacturing and
                         Distribution
El Segundo,              Executive Offices, Research and       114,000      Leased
 California(2).......... Development, Manufacturing and
                         Distribution
St. Louis, Missouri..... Warehousing and Distribution          100,900      Leased
Tracy, California(3).... Corporate Offices and                  80,000      Leased
                         Manufacturing
Jackson, Michigan....... Warehousing                            44,000      Leased
Jackson, Michigan....... Manufacturing                          24,000      Owned
Albuquerque, New         
 Mexico................. Manufacturing                          20,600      Leased
Westminster,             
 California............. Manufacturing and Repair Services      15,500      Leased
Ontario, California..... Manufacturing                          10,000      Leased
Dayton, Ohio............ Manufacturing                           7,700      Leased
Leeds, England(4)....... Corporate Offices, Research and       158,000      Owned
                         Development, Manufacturing and
                         Warehousing
Leeds, England.......... Manufacturing                          32,400      Owned
Barnet, England......... Manufacturing and Research and         30,000      Owned
                         Development
Blackpool, England...... Manufacturing                          28,500      Leased
Garforth, England....... Manufacturing                          23,000      Leased
</TABLE>
--------
(1) The Company's principal executive offices and primary U.S. manufacturing
    plant for reconstructive devices. The facility also currently serves as a
    distribution facility.
(2) Corporate offices of DePuy ACE and main manufacturing plant for trauma
    products.
(3) Corporate offices of DePuy OrthoTech and main manufacturing plant for
    sports medicine products.
(4) Corporate offices and primary manufacturing facility for DePuy
    International.
 
                                      14
<PAGE>
 
ITEM 3. LEGAL PROCEEDINGS.
 
  In 1990, the Company voluntarily recalled certain acetabular cups. Of all
such products sold and implemented, less than 2% have resulted in incidents of
product failure reported by the Company. Of those reported incidents, as of
March 14, 1997, 281 resulted in claims against the Company for product
failure, of which all but 55 have been settled. Of those settled incidents, 81
were in litigation. Forty-one claims remain in litigation. All such claims and
suits have been treated as one occurrence under the applicable insurance
policies. Any additional claims will be paid by the Company's insurers.
 
  On April 20, 1994, DePuy Motech was served with a class action complaint,
entitled Barbara Brown et al v. DePuy Motech et al, filed in the U.S. District
Court for the Eastern District of Louisiana on behalf of individuals who claim
to have been damaged through the use of various types of surgical screws
implanted in spinal pedicles. DePuy ACE was subsequently served with this
complaint as well. Numerous other manufacturers of spinal products, hospitals,
physicians, medical societies and other associations were also sued. The suits
allege tortious misconduct against all manufacturers engaged in spinal product
manufacture and sale, several surgeons, industry associations and professional
medical associations. Specific counts range from product liability and
negligence to various conspiracies allegedly involving efforts to mislead the
FDA into approving the use of the screws in spinal pedicles. DePuy Motech has
been named in approximately 600 lawsuits for damages filed on behalf of
individuals who claim to have been damaged through the use of various types of
surgical screws in spinal pedicles. On August 4, 1994, the Federal Judicial
Panel on multi-district litigation ordered that all federal court cases be
transferred to and consolidated for pretrial proceedings, including the
determination of class certification, in the Federal District Court for the
Eastern District of Pennsylvania. On February 22, 1995, Chief Judge Emeritus
Louis C. Bechtle denied class certification. Individual suits followed that
denial. A hearing ordered by the Court to determine if any factual basis
exists to support the conspiracy count was held July 23, 1996. On August 22,
1996, Judge Bechtle issued an order dismissing without prejudice claims based
on allegations of conspiracy and fraud and requiring that any amended
complaint be filed by September 30, 1996, which deadline was subsequently
extended to October 30, 1996. Amended or new complaints on behalf of
approximately 600 plaintiffs alleging liability of DePuy Motech based solely
on a theory of industry-wide conspiracy have been served after the August 22,
1996 dismissal order. Many, but not all, of these conspiracy complaints also
name DePuy ACE as a defendant. Motions to dismiss these amended complaints
have been filed on behalf of all defendants but no decision on the motions has
been issued. Seventeen plaintiffs in the multidistrict litigation allege
implantation of products which were sold by DePuy Motech or DePuy ACE. DePuy
Motech and DePuy ACE are responding to certain discovery initiated by the
Plaintiffs' Legal Committee. The Company believes that it has substantial
defenses to these claims and will continue to defend them vigorously, although
no assurance can be given of the eventual outcome of this litigation.
 
  On February 25, 1995, DePuy filed suit against BET, its licensor for
technology used in the LCS Knee in the U.S. District Court for the Northern
District of Indiana. The case was transferred to the U.S. District Court for
the District of New Jersey on April 25, 1996. DePuy is seeking a declaratory
judgment as to the proper construction of contract language relating to the
calculation of royalties on sales of various licensed products to purchasers
outside the United States. BET has counterclaimed seeking damages and a
declaration ordering DePuy to continue to pay royalties after the expiration
of the patents to which the royalties relate. DePuy has filed a motion for
partial summary judgment which has not been ruled on.
 
  Joint Medical Products Corporation ("Joint Medical") filed a complaint on
April 3, 1995 in the U.S. District Court of Connecticut against DePuy Inc. and
several other manufacturers of orthopaedic devices. The suit seeks injunctive
relief and treble damages for DePuy's alleged infringement of a patent owned
by Joint Medical. DePuy has filed a counterclaim seeking to have the patent
declared invalid and unenforceable. The Company believes it has substantial
defenses and is aggressively defending this action. The same patent was the
subject of an interference proceeding in the United States Patent and
Trademark Office between Joint Medical and a patentee from whom the Company
has a license. On October 3, 1996 Joint Medical, which has been acquired by
Johnson & Johnson, announced that, as a result of an agreement between Joint
Medical and the patentee from whom the Company has a license to arbitrate, it
has prevailed in the interference proceeding, and
 
                                      15
<PAGE>
 
established its right to ownership of the patent. The resolution of the
interference proceeding does not affect the defenses the Company has against
the claims of Joint Medical. Additionally, as a result of the purchase of
Joint Medical by Johnson & Johnson and the agreement between Joint Medical and
the patentee from whom the Company has a license and the terms under which the
interference proceedings were submitted to arbitration, the Company has filed
a Motion to Amend its pleadings in the suit to add both the patentee from whom
the Company has a license and Johnson & Johnson as defendants and to assert
additional claims against Joint Medical. The Court has not yet ruled on this
motion.
 
  On September 22, 1994, the Company filed a patent infringement suit against
Biomet, Inc. in the U.S. District Court for the Northern District of Indiana
seeking injunctive relief and damages. DePuy claimed Biomet infringed a DePuy
patent for a modular hip by making and selling infringing hip prostheses. On
April 17, 1995, the Company filed an amended complaint, adding claims for
infringement of a second modular hip patent and for misappropriation of trade
secrets, adding a prior DePuy employee who went to work for Biomet as a
defendant. DePuy subsequently added claims for inducing infringement and
contributory infringement as well as claims for infringement of a supertaper
patent. On May 29, 1996, Biomet filed a patent infringement suit against the
Company in the United States District Court for the Northern District of
Indiana seeking an injunction and damages for the alleged infringement by the
Company of a patent owned by Biomet relating to the manufacture of prostheses
from CAT Scan data and further alleging various tortious acts and unfair trade
practices relating to the Company's advertising. On May 31, 1996 Biomet filed
a patent infringement suit against the Company in the United States District
Court for the Northern District of Indiana seeking an injunction and damages
for the alleged infringement of a patent owned by Biomet relating to the
design of surgical instruments. On July 19, 1996 Biomet filed a patent
infringement suit against the Company in the United States District Court for
the Northern District of Indiana seeking damages for the alleged infringement
of a patent owned by Biomet relating to the design of other surgical
instruments. On May 31, 1996 Electro-Biology, Inc., a subsidiary of Biomet,
filed a patent infringement suit against DePuy ACE in the United States
District Court for the District of New Jersey seeking damages for the alleged
infringement by DePuy ACE of a patent owned by Electro-Biology, Inc. relating
to the design of an external bone fixator. On February 25, 1997 Biomet and the
Company agreed to settle all of the foregoing described litigation and
reported this agreement to the United States District Court for the Northern
District of Indiana. Pursuant to the terms of the settlement, Biomet and the
Company will cross-license each other, and each other's subsidiaries, to
permit the manufacture and sale of any product then being manufactured or sold
which would otherwise infringe any patent owned by either company or any
subsidiary of either company. The settlement and cross license will provide
royalty free licenses and each party, or a subsidiary thereof, will pay its
own costs and expenses. The litigation has been stayed to permit the parties
to prepare the necessary agreements and to file the necessary pleadings with
the respective courts to effect a dismissal of all of the foregoing
litigation.
 
  On February 8, 1994, Sofamor Danek filed a patent infringement suit against
DePuy Motech in the United States District Court for the Southern District of
Indiana, Indianapolis Division seeking injunctive relief and damages. DePuy
and Biedermann Motech GmbH were later added as additional parties. Sofamor
Danek claimed that DePuy Motech's MOSS Miami spinal system infringes three
patents owned by Sofamor Danek Group, Inc. On June 19, 1996 the Court entered
a summary judgment order in favor of DePuy Motech as to infringement of one
patent and on October 11, 1996, the Court entered summary judgment in favor of
DePuy Motech as to infringement of the other two patents. Also on October 11,
1996 the Court entered Judgment on these decisions and dismissed DePuy
Motech's counterclaim for a declaration that Sofamor Danek's patents were
invalid with prejudice. Sofamor Danek has appealed the Court's entry of
Judgment against Sofamor Danek to the United States Court of Appeals for the
Federal Circuit. DePuy Motech has cross-appealed the dismissal with prejudice
of its counterclaim. No decision has been rendered by the appellate court.
 
  In addition, the Company is party to certain other routine litigation
incidental to its business. The Company does not believe that any litigation
to which it is a party is likely, individually or in the aggregate, to have a
material adverse effect on the Company's business, financial condition or
results of operations.
 
  On June 26, 1996, the Supreme Court decided the case Medtronic, Inc. v.
Lohr, holding that the Medical Device Amendments to the Food, Drug, and
Cosmetics Act does not preempt state law tort actions when there
 
                                      16
<PAGE>
 
exists no specific counterpart federal products regulation. The Company does
not anticipate at this time that the decision will have a material adverse
effect on the Company. However, it is not possible to predict what impact, if
any, the decision may have.
 
ITEMS 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
  Not Applicable.
 
EXECUTIVE OFFICERS
 
  Set forth below are the names, ages, positions and a brief description of
the Company's executive officers:
 
<TABLE>
<CAPTION>
              NAME               AGE                  POSITION
              ----               ---                  --------
<S>                              <C> <C>
James A. Lent...................  54 Chairman of the Board and Chief Executive
                                     Officer
Michael J. Dormer...............  45 President and Chief Operating Officer
Robert E. Morel.................  59 President, DePuy ACE
James M. Taylor.................  40 President, DePuy International
William E. Tidmore, Jr..........  54 President, DePuy Motech
Steven L. Artusi................  52 Senior Vice President, General Counsel and
                                     Secretary
R. Michael McCaffrey............  54 President, DePuy Development, Inc.
Thomas J. Oberhausen............  44 Senior Vice President, Chief Financial
                                     Officer and Treasurer
G. Taylor Seward................  51 Senior Vice President, Personnel
</TABLE>
 
  James A. Lent has been Chairman and Chief Executive Officer of DePuy since
1991, having served as President from 1985 to 1991. Prior to joining DePuy,
Mr. Lent worked for Johnson & Johnson from 1967 to 1985, serving as President
of J&J Orthopaedics from 1982 to 1985. Mr. Lent is a member of the Board of
Directors of Corange and also serves on the Board of Directors of
Spectranetics Inc., a cardiovascular device company.
 
  Michael J. Dormer has been President and Chief Operating Officer of DePuy
since August 1996. Prior to that, he served as President of DePuy
International since 1993 and as Executive Vice President from 1992 until 1993.
Before joining DePuy International, he worked for Johnson & Johnson as
Managing Director, J&J Orthopaedics Europe and J&J Professional Products
Europe.
 
  Robert E. Morel has served as President and Chief Executive Officer of DePuy
ACE since May 1996. From 1993 until 1996, he served as Senior Vice President,
Operations for DePuy. From 1985, when he originally joined DePuy, until 1993,
he was Vice President, Operations.
 
  James M. Taylor has been President of DePuy International since August 1996.
He joined DePuy in July 1994 as Vice President, Operations. From June 1993
until April 1994, Mr. Taylor was the Chief Executive Officer of MSS Group in
the U.K. From 1989 to June 1993, Mr. Taylor was employed by Chloride
Industrial Batteries Ltd., as Operations Director.
 
  William E. Tidmore, Jr. has served as President of DePuy Motech since August
1996. Prior to that, he served as President of DePuy Orthopaedics, a division
of DePuy, from 1994 to 1996, as Executive Vice President of DePuy from 1993 to
1994, as President of DePuy International from 1992 to 1993 and as Vice
President, International of DePuy Inc. from 1988 until 1992. Mr. Tidmore
joined DePuy in 1986.
 
  Steven L. Artusi has served as the Company's Senior Vice President, General
Counsel and Secretary since 1992. Mr. Artusi served as Vice President, Legal
and Regulatory Affairs for DePuy, Division of BMC from 1987 to 1992 and as
Corporate Counsel of BMC from 1985 to 1987.
 
                                      17
<PAGE>
 
  R. Michael McCaffrey became President of DePuy Development, Inc., which is
engaged in business development for the DePuy worldwide group, in August 1996.
Prior to that, from 1994 until 1996, he was President of DePuy Motech, from
1990 until 1994 he was President of DePuy, and from 1985 until 1990 held
various positions at DePuy in management, marketing and sales.
 
  Thomas J. Oberhausen has served as Senior Vice President and Chief Financial
Officer of DePuy since 1992 and from 1993 to 1995, he also served as the
Finance Director for DePuy International. He joined Bio-Dynamics, Inc., a
subsidiary of BMC, in 1980.
 
  G. Taylor Seward has served as Senior Vice President, Personnel of DePuy
since 1990. Mr. Seward joined DePuy in 1978 and prior to 1990 held various
positions in DePuy's human resources department, including Personnel Manager,
Director of Personnel and Vice President, Personnel.
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
  The Company's common stock is listed on the New York Stock Exchange under
the ticker symbol "DPU". The daily trading activity and price quotation may be
found in most major newspapers under "Depuy".
 
  The range of high and low bid prices for the common stock from October 31,
1996 (the first trading date of the common stock) through December 31, 1996
was:
 
    High: 20 1/4
 
     Low: 16 1/2
 
  The Company has not paid dividends since its formation in July 1996. The
Company anticipates that it will pay an annual dividend, beginning in 1997.
 
  As of March 17, 1997, the Company had 896 stockholders of record.
 
ITEM 6. SELECTED FINANCIAL DATA.
 
  The following table summarizes the Company's operating results by quarter
for 1996 and 1995.
 
<TABLE>
<CAPTION>
                           DEC    SEPT   JUN    MAR    DEC    SEPT   JUN    MAR
                           1996   1996   1996   1996   1995   1995   1995   1995
                          ------ ------ ------ ------ ------ ------ ------ ------
                                     (IN MILLIONS, EXCEPT SHARE DATA)
<S>                       <C>    <C>    <C>    <C>    <C>    <C>    <C>    <C>
Net sales...............  $181.0 $167.3 $175.9 $173.1 $164.9 $148.4 $162.2 $161.1
Gross profit............   127.3  118.5  122.8  119.7  116.5  101.5  109.9  108.5
Net income..............    27.1   24.0   28.2   27.4   23.1   20.3   25.2   26.3
Pro forma net income per
 share (unaudited)......     .28    .27    .31    .31    .26    .22    .28    .29
</TABLE>
 
                                      18
<PAGE>
 
  Selected consolidated financial data for the Company and its subsidiaries
for each of the five years in the period ended December 31, 1996 is set forth
below. This data should be read in conjunction with the Consolidated Financial
Statements contained in Item 8 of this Form 10-K:
 
INCOME STATEMENT DATA
<TABLE>
<CAPTION>
                                        YEAR ENDED DECEMBER 31,
                              ----------------------------------------------
                               1996(1)      1995    1994(1)  1993      1992
                              ---------- ---------- ------- ------    ------
                                   (IN MILLIONS, EXCEPT SHARE DATA)
<S>                           <C>        <C>        <C>     <C>       <C>
Net sales...................  $    697.3 $    636.6 $551.8  $466.7    $419.9
Cost of sales...............       209.0      200.2  173.0   151.9     148.6
                              ---------- ---------- ------  ------    ------
  Gross profit..............       488.3      436.4  378.8   314.8     271.3
                              ---------- ---------- ------  ------    ------
Selling, general and admin-
 istration expenses.........       266.8      230.6  195.0   157.8     144.8
Research and development ex-
 penses.....................        21.7       21.3   18.6    17.4      13.8
Goodwill amortization.......        12.3       14.2   14.1    10.0      10.7
                              ---------- ---------- ------  ------    ------
  Operating income..........       187.5      170.3  151.1   129.6     102.0
                              ---------- ---------- ------  ------    ------
Interest expense and other,
 net........................         2.5        5.1     .9     2.7       4.6
Provisions for income tax-
 es.........................        78.7       72.7   65.8    57.0      40.5
Minority interest...........         1.6         .5     .7     -- (2)    -- (2)
Equity in earnings (loss) of
 unconsolidated affiliate...         2.0        2.9    3.1     2.3       1.0
Cumulative effect of ac-
 counting change(3).........         --         --     --      --        3.8
                              ---------- ---------- ------  ------    ------
  Net income................  $    106.7 $     94.9 $ 86.8  $ 72.2    $ 54.1
                              ========== ========== ======  ======    ======
Unaudited pro forma data:
  Net income per share......  $     1.17 $     1.05
                              ========== ==========
  Weighted average number of
   shares outstanding.......  91,430,000 90,000,000
                              ========== ==========
</TABLE>
--------
(1) Financial results include the effects of acquisitions as outlined in Note
    1 of the Notes to Consolidated Financial Statements.
(2) Prior to 1994, minority interest was immaterial and included in interest
    expense and other, net.
(3) Charge for adopting Financing Accounting Standard No. 106, "Employers'
    Accounting for Postretirement Benefits Other Than Pensions".
 
BALANCE SHEET DATA
<TABLE>
<CAPTION>
                                                    AT DECEMBER 31,
                                          ----------------------------------
                                           1996    1995    1994    1993
                                          ------- ------- ------- -------
                                           (IN MILLIONS, EXCEPT OTHER DATA)
<S>                                       <C>     <C>     <C>     <C>    <C>
Working capital.......................... $ 369.1 $ 176.8 $ 150.9 $ 99.3
Total assets.............................   908.4   623.3   567.5  386.0
Total noncurrent liabilities.............    56.6    73.5    68.4   22.7
Shareholders' equity.....................   670.6   378.1   357.1  247.8
 
OTHER DATA
 
Full-time employee equivalents...........   2,926   2,298   2,157  1,768
</TABLE>
 
                                      19
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS.
 
OVERVIEW
 
  Effective October 30, 1996, the Company issued 8,580,000 new shares, and its
primary shareholder sold 7,000,000 previously outstanding shares to the public
through an Initial Public Offering at an offering price of $17.50 per share.
The issuance of stock generated net proceeds after expenses, discounts and
commissions of approximately $139 million. The Company plans to use the net
proceeds from the sale of shares of its common stock primarily to finance the
expansion of the Company's business. The Company has signed an agreement to
purchase Landanger, as described in Note 16 of Notes to Consolidated Financial
Statements. The Company plans to fund this acquisition through debt and
available cash. Any remaining cash will be invested in highly liquid
investments.
 
  Prior to the public offering the Company was operated as the orthopaedic
division of Corange. This division comprised various legal entities that were
engaged, or partly engaged, in the orthopaedics business and were owned by a
number of different entities within Corange. As a result of a pre-offering
reorganization, (i) the non-U.S. entities (or in certain cases, the assets
thereof) that were involved in the DePuy business were transferred into the
Company's U.S. consolidated group, (ii) Boehringer Mannheim Corporation, the
U.S. operating subsidiary of the Boehringer Mannheim companies, which were
under common control with the DePuy companies, was transferred outside the
Company's U.S. consolidated group, and (iii) the Company was reincorporated in
Delaware. None of the transfers or exchanges made pursuant to the pre-offering
reorganization involved outside minority shareholders. Accordingly, all
transfers and exchanges were accounted for on a predecessor basis.
 
RESULTS OF OPERATIONS
 
  The following table summarizes selected financial information expressed as a
percentage of net sales and the change from year to year.
 
<TABLE>
<CAPTION>
                            PERCENTAGE OF NET SALES    PERCENTAGE CHANGE
                            -------------------------  ---------------------
                            YEAR ENDED DECEMBER 31
                            -------------------------    1996        1995
                             1996     1995     1994    VS 1995     VS 1994
                            -------  -------  -------  --------    ---------
<S>                         <C>      <C>      <C>      <C>         <C>
Net sales.................    100.0%   100.0%   100.0%         10%         15%
Cost of sales.............     30.0     31.4     31.3           4          16
                            -------  -------  -------    --------   ---------
  Gross profit............     70.0     68.6     68.7          12          15
                            -------  -------  -------    --------   ---------
Selling, general and ad-
 ministrative expenses....     38.2     36.2     35.4          16          18
Research and development
 expenses.................      3.1      3.4      3.4           2          15
Goodwill amortization.....      1.8      2.2      2.5         (13)          1
                            -------  -------  -------    --------   ---------
  Operating income........     26.9     26.8     27.4          10          13
                            -------  -------  -------    --------   ---------
Interest and other income
 (expense)................      (.4)     (.8)     (.2)         51        (486)
                            -------  -------  -------    --------   ---------
  Income before taxes,
   minority interest and
   equity in earnings of
   unconsolidated
   affiliate..............     26.5     26.0     27.2          12          10
                            -------  -------  -------    --------   ---------
Provisions for income tax-
 es.......................     11.3     11.4     11.9           8          11
Minority interest.........       .2       .1       .1         211         (33)
Equity in earnings of un-
 consolidated affiliate...       .3       .4       .5         (31)         (7)
                            -------  -------  -------    --------   ---------
  Net income..............     15.3%    14.9%    15.7%         12%          9%
                            =======  =======  =======    ========   =========
</TABLE>
 
                                      20
<PAGE>
 
  The following table summarizes sales by product line and geographical
location:
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                        -----------------------
                                                         1996    1995    1994
                                                        ------- ------- -------
                                                             (IN MILLIONS)
<S>                                                     <C>     <C>     <C>
Reconstructive products................................ $ 470.2 $ 450.6 $ 405.9
Spinal implants........................................    45.5    30.6    12.5
Trauma products........................................    56.4    49.4    38.5
Sports medicine........................................    48.2    29.4    27.7
Other products.........................................    77.0    76.6    67.2
                                                        ------- ------- -------
  Total sales.......................................... $ 697.3 $ 636.6 $ 551.8
                                                        ------- ------- -------
U.S. Sourced sales..................................... $ 408.9 $ 377.2 $ 358.8
International sourced sales............................   288.4   259.3   193.0
                                                        ------- ------- -------
  Total sales.......................................... $ 697.3 $ 636.6 $ 551.8
                                                        ------- ------- -------
Sales to customers located in the United States........ $ 373.8 $ 349.9 $ 333.3
Sales to customers located outside the United States...   323.5   286.7   218.5
                                                        ------- ------- -------
  Total sales.......................................... $ 697.3 $ 636.6 $ 551.8
                                                        ======= ======= =======
</TABLE>
 
 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
 
  Net sales were $697.3 million for the year ended December 31, 1996,
representing an increase of $60.7 million, or 10% over the prior year.
Continued penetration of the spinal implant market caused total sales to
increase by 2%. The acquisition of DePuy OrthoTech in March 1996 resulted in
additional sales growth of 3%. The effects of foreign exchange rates in 1996
compared with 1995 resulted in an unfavorable impact on sales of 1%. The
remaining 6% increase related primarily to sales growth in international
markets, partially offset by the negative impact of lower average prices in
the United States, predominantly resulting from the managed care environment.
 
  The components of the worldwide sales improvement were as follows:
 
<TABLE>
       <S>                                                                  <C>
       Acquisitions........................................................   3%
       Volume and product mix..............................................  10%
       Net pricing changes.................................................  (2)%
       Effect of foreign exchange rates....................................  (1)%
</TABLE>
 
  U.S. sourced sales to unaffiliated customers rose $31.6 million, or
approximately 8%. This growth was primarily attributable to the acquisition of
DePuy OrthoTech in March 1996 and to increased sales of spinal and shoulder
implants.
 
  International sourced sales to unaffiliated customers rose $29.1 million, or
11%. This increase in sales was related to continued expansion in the
European, Asia/Pacific and South American regions. Expansion in these areas
caused sales to grow by 12%, 11% and 7%, respectively, during the year ended
December 31, 1996.
 
  The Company's gross profit for the year ended December 31, 1996 was $488.3
million, or 70% of sales, as compared to 68.6% of sales for the prior year.
This margin improvement resulted from various manufacturing efficiencies
obtained through cost controls and higher unit sales, the consolidated impact
of which more than offset the negative impact of lower average prices realized
in the United States.
 
  Selling, general and administrative expenses totaled $266.8 million for the
current year, or 38.2% of sales, as compared to 36.2% in the preceding year.
The primary reason for this increase as a percent of sales was the cost
associated with converting approximately 75% of the Company's U.S.
distribution structure from independent sales agents to Company-managed
territories under the responsibility of territory sales managers. As part of
this conversion, the Company incurred additional (in certain cases, one time)
costs totaling $16.2
 
                                      21
<PAGE>
 
million, primarily related to new surgical instrumentation and additional
administration expenses incurred to set up the new territory offices. In
addition to these costs, the Company continued to invest in the development of
the U.S. sales infrastructure and in the expansion of its business in the
spinal and international markets.
 
  Research and development expense of $21.7 million represented a slight
increase over the $21.3 million expense reported in 1995.
 
  Goodwill amortization totaled $12.3 million during 1996, representing a $1.9
million decrease compared to the prior year. This decrease primarily related
to the fact that certain goodwill assets became fully amortized during 1995,
partially offset by additional goodwill recorded in the current year related
to the acquisition of DePuy OrthoTech in March 1996.
 
  The Company reported a 10% increase in operating income to $187.5 million,
or 26.9% of sales, for the year 1996, as compared to $170.3 million for 1995,
or 26.8% of sales. This increase was primarily attributable to improved gross
margins, offset by additional expenses incurred in selling, general and
administrative expenses.
 
  Interest expense was $6.8 million during 1996, representing a $.3 million
increase over the interest expense incurred in the prior year. This higher
expense primarily resulted from slightly higher interest rates.
 
  Other income, net, totaled $4.3 million for the year compared to $1.5
million reported in the prior year, representing an increase of $2.8 million.
This increase mainly resulted from higher interest income, primarily
attributable to income earned on the invested proceeds received from the
public offering.
 
  The effective income tax rate for the year was 42.5% as compared to 44.0%
recorded in the prior year. The 1.5% decrease in the rate is primarily
attributable to the reduction in non-deductible goodwill expense.
 
  Net income for the year ended December 31, 1996 was $106.7 million, or 15.3%
of sales, representing a 12% increase over the prior year. This increase was
primarily the result of a 10% increase in operating profit, higher interest
income and a lower effective income tax rate.
 
 Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
 
  Net sales were $636.6 million for the year ended December 31, 1995,
representing an increase of $84.8 million, or 15%, compared with the prior
year. Continued penetration of the spinal implant market caused total sales to
increase by 3%. The inclusion of a full year of sales of CMW (acquired in
November 1994) and DePuy ACE (acquired in March 1994) resulted in additional
sales of 3%. The remaining 9% increase in sales related to the effects of
favorable exchange rates and market growth in both the international and U.S.
markets.
 
  The components of the worldwide sales improvement were as follows:
 
<TABLE>
       <S>                                                                   <C>
       Acquisitions.........................................................   3%
       Volume and product mix...............................................   9%
       Net pricing changes..................................................   1%
       Effect of foreign exchange rates.....................................   2%
</TABLE>
 
  Sales to unaffiliated customers within the United States rose $18.4 million
or 5%. This growth was primarily attributable to increased sales of knee and
spinal implants and continued growth in the trauma market.
 
  International sales to unaffiliated customers rose $66.4 million or 34%. The
CMW acquisition contributed 6% of this international growth and the positive
effect of foreign currency rates contributed an additional 7% increase.
Expansion in the European, Asia/Pacific and other regions, excluding the
effects of foreign exchange, caused sales to grow by 11%, 6% and 4%,
respectively, during 1995.
 
                                      22
<PAGE>
 
  The Company's gross profit for 1995 was $436.4 million, or 68.6% of sales,
decreasing slightly compared to 68.7% of sales reported for the prior year.
Manufacturing efficiency improvements offset the negative impact of lower
average prices in the U.S. resulting from managed care contracts.
 
  Selling, general and administrative expense totalled $230.6 million for the
year or 36.2% of sales, as compared to 35.4% of sales in the prior year. This
increase was primarily the result of higher selling expense incurred as
efforts continued to strengthen the U.S. sales force infrastructure and
investments were made to grow the spinal implant business and to expand
international distribution. Increased investment in surgical instrumentation
sets provided to customers also produced higher selling expense during 1995.
 
  Research and development expense increased 14.6% for the year but remained
constant at 3.4% of sales. The Company continues to make investments in
technological advancements in order to remain competitive in the orthopaedic
market and to provide its customers with the latest technology available.
 
  Goodwill amortization totalled $14.2 million for the year representing a 1%
increase over the prior year. This increase related primarily to the goodwill
recorded in conjunction with the acquisition of CMW in November 1994 and the
full year amortization of goodwill relating to the acquisition of DePuy ACE in
March 1994, partially offset by certain goodwill assets becoming fully
amortized during 1995.
 
  Operating income for the year was $170.3 million, or 26.8% of sales, a 13%
increase as compared to operating income of $151.1 million, or 27.4% of sales,
in the prior year. The decrease in operating income as a percentage of sales
was primarily attributable to additional expenses incurred as the Company
continued to invest in the strengthening of the U.S. sales infrastructure, the
expansion of the international and spinal implant markets and the increased
cost of providing surgical instrument sets. The negative impact of managed
care cost restraints was also a contributing factor.
 
  Interest expense was $6.5 million, representing a $4.2 million increase over
the prior year. This higher expense primarily resulted from interest related
to additional indebtedness of approximately $35.0 million incurred to fund the
CMW acquisition.
 
  The effective income tax rate remained essentially constant at 44.0% in 1995
compared to 43.8% in 1994.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Prior to the reorganization previously described, the Company's cash flow in
the United States was pooled with that of Corange's other U.S. operations.
Effective with the Company becoming a public company, all cash generated is
now maintained in its own accounts and is available for use by the Company. In
addition to the net proceeds received from the Initial Public Offering
effective October 30, 1996, cash generated from operations is the principal
source of funding available and provides adequate liquidity to meet the
Company's operational needs. Cash and cash equivalents totaled $209.4 million
at December 31, 1996, compared to $46.9 million at December 31, 1995.
 
  Working capital at December 31, 1996, was $369.1 million, representing a
$192.3 million increase from December 31, 1995. The annualized inventory
turnover ratio for the year ended December 31, 1996 was 1.6, decreasing
slightly compared with the rate of 1.7 experienced during the prior year. The
annualized accounts receivable turnover rate was 5.8 for the current year
remaining constant with the prior year.
 
  Operating activities generated $99.0 million during 1996 as compared to
$90.3 million of cash provided in the prior year. The $8.7 million increase
resulted primarily from higher net income and the receipt of payment on an
affiliate receivable outstanding at December 31, 1995. This increase was
partially offset by investments made in surgical instrumentation sets,
investments in inventories in support of changes in the Company's method of
distribution and inventory buildup to support the faster-growing product lines
such as trauma and spinal.
 
                                      23
<PAGE>
 
  Cash flows used for investing activities totaled $84.4 million in the year
ended December 31, 1996, and was comprised of $54.9 million paid for various
acquisitions, capital expenditures of $24.9 million, and $4.6 million of
investments in short-term securities. The consideration paid for business
acquisitions (net of cash received) was comprised of $45.9 million paid for
the acquisition of DePuy OrthoTech and $9.0 million of payments related to
other various acquisitions, including deferred payments for DePuy ACE and CMW
Laboratories, both purchased in 1994.
 
  Cash flows provided by financing activities were $147.2 million during 1996
and included $138.6 million of net proceeds received from the issuance of
stock sold as part of the Initial Public Offering, $44.1 million of advances
received from Corange U.S. Holdings, Inc., an affiliate, as part of the
centralized cash management system previously described (funds used for the
DePuy OrthoTech acquisition) and $4.5 million of capital contributions
received from affiliates, partially offset by a net decrease in debt of $31.4
million and dividends of $8.6 million paid to affiliates.
 
  The Company anticipates that it will pay dividends annually, provided that
funds are available therefore and subject to the discretion of the Board of
Directors. Capital expenditures are expected to be approximately $27 million
in 1997, primarily consisting of purchases of machinery and equipment. In
addition to these funding requirements, the Company expects to continue to
evaluate potential acquisitions to expand its business.
 
  The Company has historically been able to fund its capital and operating
needs through its cash flow from operations and expects to be able to continue
to do so in the future. The Company believes that with its current cash
position and its ability to obtain additional cash, either through the
issuance of additional shares of common stock or utilization of credit lines,
it has the ability to fund its acquisition strategy.
 
FACTORS AFFECTING FUTURE PERFORMANCE
 
  The orthopaedic industry is experiencing a period of significant transition
as a result of healthcare reform. While cost containment issues have existed
for several years outside of the United States, these issues are relatively
recent phenomena in the U.S. orthopaedic market. Trends in the U.S. market,
which have had an impact on the Company, include the increased movement toward
the provision of healthcare through managed care and significant emphasis on
cost control.
 
  The advent of managed care in the orthopaedic products industry has meant
greater attention to tradeoffs of patient need and product cost, or demand
matching, where patients are evaluated as to their age, need for mobility, and
other parameters, and are then matched with a replacement product that is cost
effective in light of such evaluation. From about the middle of 1995 onward,
this has led to an increase in unit sales of lower-priced, cemented products,
sales of which constitute an increasing share of the Company's overall unit
growth. In addition, price discounting is becoming more prevalent in the
industry resulting in reduced margins for products sold to buying groups under
preferred supplier arrangements.
 
  The shift in product mix and trends toward industry discounting have had an
impact on the Company's sales with respect to hip replacement systems and, to
a lesser extent, knee replacement systems. Although it is uncertain how these
issues will affect future performance, the Company experienced a reduction in
the rate at which prices were declining during 1996.
 
                                      24
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31,
                                           -------------------------------------
                                              1996         1995        1994
                                           -----------  -----------  -----------
                                           (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                                        <C>          <C>          <C>
Net sales.................................    $697,273     $636,561  $ 551,773
Cost of sales.............................     208,976      200,139    172,939
                                           -----------  -----------  ---------
  Gross profit............................     488,297      436,422    378,834
                                           -----------  -----------  ---------
Selling, general and administrative ex-
 penses...................................     266,776      230,578    195,011
Research and development expenses.........      21,693       21,320     18,609
Goodwill amortization.....................      12,325       14,201     14,088
                                           -----------  -----------  ---------
  Operating income........................     187,503      170,323    151,126
                                           -----------  -----------  ---------
Interest expense, affiliate...............       4,869        4,479        909
Interest expense, other...................       1,942        2,061      1,358
Other income, net.........................      (4,330)      (1,493)    (1,406)
                                           -----------  -----------  ---------
  Income before taxes, minority interest
   and equity in earnings of unconsoli-
   dated affiliate........................     185,022      165,276    150,265
                                           -----------  -----------  ---------
Provisions for income taxes...............      78,689       72,707     65,758
Minority interest.........................       1,553          499        741
Equity in earnings of unconsolidated af-
 filiate..................................       1,968        2,859      3,070
                                           -----------  -----------  ---------
  Net income..............................    $106,748     $ 94,929  $  86,836
                                           ===========  ===========  =========
Unaudited pro forma data:
  Net income per share....................    $   1.17     $   1.05
  Weighted average number of shares out-
   standing...............................  91,430,000   90,000,000
                                           ===========  ===========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       25
<PAGE>
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           --------------------
                                                             1996       1995
                                                           ---------  ---------
                                                             (IN THOUSANDS,
                                                           EXCEPT SHARE DATA)
<S>                                                        <C>        <C>
                          ASSETS
Current Assets
  Cash and cash equivalents............................... $ 209,387  $  46,909
  Short-term investments..................................     4,640        --
  Accounts receivable, net of allowances of $8,534 (1996)
   and $6,628 (1995)......................................   126,465    115,452
  Receivable from affiliates, net.........................       --      24,265
  Inventories at lower of cost or market..................   151,406    116,566
  Deferred income taxes...................................    29,366     25,275
  Prepaid expenses and other current assets...............    25,455     18,023
                                                           ---------  ---------
    Total current assets..................................   546,719    346,490
                                                           ---------  ---------
Noncurrent Assets
  Goodwill, net of accumulated amortization of $78,373
   (1996) and $60,312 (1995)..............................   238,233    181,208
  Other intangible assets, net of accumulated amortization
   of $698 (1996) and $245 (1995).........................     1,894      1,278
  Deferred income taxes...................................    18,348      4,876
  Investment in affiliate.................................     2,648      2,081
  Other assets............................................    10,934     10,634
                                                           ---------  ---------
                                                             272,057    200,077
                                                           ---------  ---------
Property, plant and equipment, net........................    89,601     76,683
                                                           ---------  ---------
    Total assets.......................................... $ 908,377  $ 623,250
                                                           =========  =========
           LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
  Short-term debt payable to affiliates................... $  30,295  $  31,717
  Short-term debt.........................................    31,413     21,048
  Accounts payable........................................    30,515     26,090
  Accounts payable to affiliates, net.....................       709        --
  Income taxes payable....................................    17,384     23,088
  Income taxes payable to affiliate.......................       --      10,738
  Accrued royalties.......................................    18,580     16,596
  Accrued employee compensation...........................    18,237     16,121
  Other accrued expenses..................................    30,468     24,282
                                                           ---------  ---------
    Total current liabilities.............................   177,601    169,680
                                                           ---------  ---------
Noncurrent Liabilities
  Long-term debt payable to affiliates....................    15,413     42,591
  Long-term debt..........................................     4,754      5,342
  Long-term employee benefits.............................    17,141     17,756
  Noncurrent deferred income tax liability................    18,925      5,585
  Other noncurrent liabilities............................       401      2,236
                                                           ---------  ---------
    Total noncurrent liabilities..........................    56,634     73,510
                                                           ---------  ---------
Contingencies (Note 8)
Minority Interest.........................................     3,514      1,961
                                                           ---------  ---------
Shareholders' Equity
  Shareholder's net investment............................       --     378,099
  Common stock, $.01 par value, 130,000,000 shares autho-
   rized, shares outstanding of 98,580,000 (1996).........       986        --
  Additional paid-in capital..............................   675,144        --
  Retained earnings.......................................    17,108        --
  Net unrealized appreciation on securities...............       360        --
  Minimum pension liability adjustment....................      (236)       --
  Cumulative translation adjustment.......................   (22,734)       --
                                                           ---------  ---------
    Total shareholders' equity............................   670,628    378,099
                                                           ---------  ---------
      Total liabilities and shareholders' equity.......... $ 908,377  $ 623,250
                                                           =========  =========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       26
<PAGE>
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31,
                                                 -----------------------------
                                                   1996      1995      1994
                                                 --------  --------  ---------
                                                       (IN THOUSANDS)
<S>                                              <C>       <C>       <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.....................................  $106,748  $ 94,929  $  86,836
Adjustments to reconcile net income to net cash
 provided by operating activities:
  Depreciation and amortization................    28,378    26,635     25,718
  Deferred income taxes........................    (2,717)   (5,668)      (909)
  Other, net...................................    (2,123)      843        287
  Changes in operating assets and liabilities,
   net of effects of acquisitions:
    Accounts receivable........................    (8,510)  (11,474)   (15,448)
    Inventories................................   (32,037)    3,052    (17,878)
    Amounts payable to or receivable from af-
     filiates, net.............................    28,330   (28,215)       712
    Prepaid expenses and other current assets..    (7,291)   (2,090)   (10,661)
    Other noncurrent assets....................      (811)   (3,553)    (6,153)
    Accounts payable...........................     3,139        45        338
    Accrued employee compensation and other....     7,907     2,348      6,543
    Other current and noncurrent liabilities...    (3,805)    4,940      4,105
    Income taxes payable.......................   (18,237)    8,554      7,452
                                                 --------  --------  ---------
      Net cash provided by operating activi-
       ties....................................    98,971    90,346     80,942
                                                 --------  --------  ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures...........................   (24,882)  (15,598)   (14,015)
Business acquisitions, net of cash acquired....   (54,889)  (17,500)  (107,634)
Purchases of short-term investments............    (4,640)      --         --
                                                 --------  --------  ---------
      Net cash used for investing activities...   (84,411)  (33,098)  (121,649)
                                                 --------  --------  ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments of short-term debt....................   (33,232)   (6,550)   (15,631)
Proceeds from issuance of short-term debt......    31,140    38,378      4,747
Payments of long-term debt.....................   (29,860)   (1,027)    (2,876)
Proceeds from issuance of long-term debt.......       534       487     41,476
Advances from (to) affiliate...................    44,063   (76,558)    19,000
Net proceeds from issuance of stock............   138,563       --         --
Capital contributions from affiliates..........     4,564     4,000      1,625
Dividends paid to affiliate....................    (8,553)   (1,868)       --
                                                 --------  --------  ---------
      Net cash provided by (used for) financing
       activities..............................   147,219   (43,138)    48,341
                                                 --------  --------  ---------
Effect of exchange rate changes on cash........       699       668     (2,268)
                                                 --------  --------  ---------
      Increase in cash and cash equivalents....   162,478    14,778      5,366
                                                 --------  --------  ---------
Cash and cash equivalents at beginning of
 year..........................................    46,909    32,131     26,765
                                                 --------  --------  ---------
Cash and cash equivalents at end of year.......  $209,387  $ 46,909  $  32,131
                                                 ========  ========  =========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       27
<PAGE>
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                                                   NET       MINIMUM
                          SHAREHOLDER'S                   ADDITIONAL           UNREALIZED    PENSION   CUMULATIVE
                               NET        COMMON   COMMON  PAID-IN   RETAINED APPRECIATION  LIABILITY  TRANSLATION
                           INVESTMENT     SHARES   STOCK   CAPITAL   EARNINGS ON SECURITIES ADJUSTMENT ADJUSTMENT
                          ------------- ---------- ------ ---------- -------- ------------- ---------- -----------
                                                     (IN THOUSANDS, EXCEPT SHARE DATA)
<S>                       <C>           <C>        <C>    <C>        <C>      <C>           <C>        <C>
BALANCE AT DECEMBER 31,
 1993...................    $ 247,818          --   $--    $    --   $   --       $--         $ --      $    --
                            ---------   ----------  ----   --------  -------      ----        -----     --------
Net income for the
 year...................       86,836
Change in net transfers
 to affiliate...........       19,000
Foreign currency
 translation
 adjustments............        1,693
Minimum pension
 liability adjustment...           78
Capital contributions
 from affiliates........        1,625
                            ---------   ----------  ----   --------  -------      ----        -----     --------
BALANCE AT DECEMBER 31,
 1994...................      357,050          --    --         --       --        --           --           --
                            ---------   ----------  ----   --------  -------      ----        -----     --------
Net income for the
 year...................       94,929
Dividend to affiliate...       (1,868)
Change in net transfers
 to affiliate...........      (76,526)
Foreign currency
 translation
 adjustments............          333
Minimum pension
 liability adjustment...          181
Capital contributions
 from affiliate.........        4,000
                            ---------   ----------  ----   --------  -------      ----        -----     --------
BALANCE AT DECEMBER 31,
 1995...................      378,099          --    --         --       --        --           --           --
                            ---------   ----------  ----   --------  -------      ----        -----     --------
Net income for the
 period.................       89,640
Dividends to affiliate..       (8,553)
Change in net transfers
 to affiliate...........       44,063
Foreign currency
 translation
 adjustments............        4,727
Minimum pension
 liability adjustment...          --
Unrealized gain on
 securities.............           44
Capital contributions
 from affiliates........        4,564
Capitalization resulting
 from reorganization and
 initial public
 offering...............     (512,584)  98,580,000   986    675,144      --         44          (24)     (25,003)
                            ---------   ----------  ----   --------  -------      ----        -----     --------
BALANCE AT OCTOBER 30,
 1996, EFFECTIVE DATE OF
 INITIAL PUBLIC
 OFFERING...............          --    98,580,000   986    675,144      --         44          (24)     (25,003)
                            ---------   ----------  ----   --------  -------      ----        -----     --------
Net income for the
 period.................                                              17,108
Foreign currency
 translation
 adjustments............                                                                                   2,269
Minimum pension
 liability adjustment...                                                                       (212)
Unrealized gain on
 securities.............                                                           316
                            ---------   ----------  ----   --------  -------      ----        -----     --------
BALANCE AT DECEMBER 31,
 1996...................    $     --    98,580,000  $986   $675,144  $17,108      $360        $(236)    $(22,734)
                            =========   ==========  ====   ========  =======      ====        =====     ========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       28
<PAGE>
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
NOTE 1--ORGANIZATION/ACQUISITIONS
 
  DePuy, Inc. (the "Company") was formed as the result of a worldwide
reorganization completed by its parent, Corange Limited ("Parent"), to realign
its worldwide orthopaedic operations into a stand-alone entity in order to
sell shares of the realigned entity to the public through an Initial Public
Offering. Prior to the public offering, various actions were taken to form the
Company including (i) the consolidation of the worldwide operations of DePuy
under Corange U.S. Holdings, Inc., an Indiana corporation ("CUSHI"), (ii) the
transfer out of the CUSHI consolidated group Boehringer Mannheim Corporation
("BMC"), and (iii) the merging of CUSHI downstream into DePuy, Inc., which was
created on July 26, 1996 for purposes of becoming the holding company for the
DePuy worldwide operations, with DePuy, Inc. as the surviving company in the
merger, the effect of which was to reincorporate CUSHI in Delaware under the
name "DePuy, Inc." None of these actions involved outside minority
shareholders. Accordingly, the consolidation of the entities was accounted for
on a predecessor basis.
 
  Pursuant to a registration statement filed with the Securities and Exchange
Commission that became effective on October 30, 1996, the Company issued,
through an Initial Public Offering, 7,780,000 shares of its common stock at
$17.50 per share which generated net proceeds after expenses, discounts and
commissions of approximately $126,000. In November 1996, an additional 800,000
shares were sold pursuant to an underwriter's over allotment provision
generating net proceeds of approximately $13,000. The Company plans to use the
net proceeds from the sale of shares of its common stock primarily to finance
the expansion of the Company's business, provided suitable acquisitions can be
identified and negotiated.
 
  The Company's primary business is the development, manufacture and sale of
orthopaedic joint implants (primarily hips, knees and shoulders), spinal
implants, related surgical instruments, trauma products and sports medicine
soft goods.
 
  In 1993, the Company established a new entity, Argentina Joints S.A., funded
through a capital contribution of $1,000 from its parent. An additional $4,000
in capital was contributed during 1994.
 
  During 1996, various contributions of capital were made from affiliates
totaling $4,564 resulting primarily from the realignment previously described.
 
  On March 8, 1994, the Company acquired Ace Medical Company (ACE), a
developer and manufacturer of orthopaedic trauma products, for $70,500 in cash
and $10,000 in a note paid in January 1995. Under the terms of the purchase
agreement, contingent upon ACE achieving certain sales and profit levels, the
Company paid and recorded goodwill of $5,000 in 1995 and $5,000 in 1996. The
Company also recorded a liability and increased goodwill for $10,000 for an
additional contingent payment which will be paid in 1997. The purchase method
of accounting was applied to this acquisition, and $87,214 of goodwill has
been recorded.
 
  The operating results of ACE have been included in the consolidated
statements of income from the date of acquisition. Had the acquisition taken
place at the beginning of 1994, consolidated net sales would have been
$557,786 for the year ended December 31, 1994, and consolidated net income
would have been $86,925 for the fiscal year 1994. This unaudited pro forma
financial information is presented for informational purposes only and is not
necessarily indicative of the operating results that would have occurred had
the acquisition been consummated as of the above date, nor is it necessarily
indicative of future operating results.
 
  On November 22, 1994, the Company acquired certain assets and assumed
certain liabilities of CMW Laboratories ("CMW"), a division of Dentsply
Limited, for $35,000 in cash consideration. Under terms of the purchase
agreement, additional payments were made totaling $2,500 in 1995 and $1,000 in
1996, and recorded as goodwill, after certain milestones were achieved. The
Company may be required to make additional contingent payments of $5,000 over
the next five years based on the achievement of certain milestones. These
milestones
 
                                      29
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
relate to obtaining U.S. Food and Drug Administration clearance to market a
new product and achieving certain sales objectives for this product over the
next four years. The additional contingent payments will be recorded as
goodwill when earned. The purchase method of accounting was applied to this
acquisition, and $40,000 of goodwill has been recorded. CMW is a manufacturer
of bone cement for orthopaedic implant procedures. CMW net sales and net
income are not material to consolidated net sales or consolidated net income.
 
  On March 11, 1996, the Company acquired all of the outstanding shares of
common stock of Orthopedic Technology, Inc. ("DePuy OrthoTech"), a
manufacturer of orthopaedic products, primarily for the sports medicine
market, in consideration of $46,300 in cash. For the year ended September 30,
1995, DePuy OrthoTech reported net sales of $18,400 and net income of $600
(unaudited). The purchase method of accounting was applied to this acquisition
and a total of $41,551 was allocated to goodwill. The acquisition was funded
by available internal resources. The operating results of DePuy OrthoTech have
been included in the consolidated statements of income from the date of
acquisition and are not material to consolidated net sales or consolidated net
income.
 
NOTE 2--ACCOUNTING POLICIES
 
  PRINCIPLES OF CONSOLIDATION The consolidated financial statements include
the accounts of the Company and its subsidiaries as defined in Note 1. All
significant intercompany balances and transactions have been eliminated.
Investments in unconsolidated affiliates that are between 20% and 50% owned
are carried at cost plus equity in undistributed earnings since acquisition.
For periods prior to the reorganization as described in Note 1, the
consolidated financial statements have been prepared from the historical
accounting records of the consolidated affiliates.
 
  REVENUE RECOGNITION Revenues from product sales are recognized at the time
of shipment to the customer.
 
  TRANSLATION OF FOREIGN CURRENCY Assets and liabilities of foreign
subsidiaries are translated to U.S. dollars using exchange rates in effect as
of the balance sheet date. Revenues and expenses are translated using the
average exchange rates throughout the period. Translation gains and losses are
included in shareholders' equity. Foreign currency transaction gains and
losses are included in other income, net, and are not material to the results
of operations.
 
  CASH EQUIVALENTS The Company considers all highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents.
 
  INVENTORIES Inventories are stated at the lower of cost or market, with cost
being determined under the first-in, first-out method. At December 31,
inventories consisted of the following:
 
<TABLE>
<CAPTION>
                                                                 1996     1995
                                                               -------- --------
     <S>                                                       <C>      <C>
     Finished products........................................ $122,035 $ 98,887
     Work in process..........................................   10,392    7,656
     Raw materials............................................   18,979   10,023
                                                               -------- --------
                                                               $151,406 $116,566
                                                               ======== ========
</TABLE>
 
  GOODWILL AND OTHER INTANGIBLE ASSETS The Company's acquisitions have
generated goodwill. The Company determines the initial amortization period for
goodwill based upon an evaluation of criteria which would be indicators of
future success of the businesses acquired. Such criteria include, but are not
limited to, past and expected profitability and cash flows, customer base,
existing and new product offerings, and key contractual relationships. Based
upon the evaluations, the Company is amortizing goodwill on a straight-line
basis over the periods of expected benefit which range from 5 to 30 years, the
majority of which is over a period
 
                                      30
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
of 30 years. Other intangible assets are amortized over their estimated useful
lives ranging from one to three years. The Company assesses the recoverability
of long-lived assets including goodwill and other intangible assets whenever
adverse events or changes in circumstances or business climate indicate that
an impairment may have occurred. If the future cash flows (undiscounted and
without interest) expected to result from the use of the related assets are
less than the carrying value of such assets, an impairment has been incurred
and a loss is recognized to reduce the carrying value of the long-lived
assets, including goodwill, based on the expected discounted cash flows or
market prices. Expected cash flows are discounted at a rate commensurate with
the risk involved.
 
  PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are reported at
cost. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets which generally range from 10 to 40 years
for buildings and improvements and from 3 to 10 years for machinery and
equipment. Amounts expended for maintenance and repairs are charged to expense
as incurred. Upon disposition, any related gain or loss is credited or charged
to other income, net. Depreciation expense of $15,800, $12,400 and $11,600 was
recorded in 1996, 1995 and 1994, respectively. At December 31, property, plant
and equipment consisted of the following:
 
<TABLE>
<CAPTION>
                                                               1996      1995
                                                             --------  --------
     <S>                                                     <C>       <C>
     Land................................................... $  2,035  $  1,918
     Buildings and improvements.............................   43,729    37,037
     Machinery and equipment................................  130,582   108,507
                                                             --------  --------
                                                              176,346   147,462
     Less allowance for depreciation........................  (86,745)  (70,779)
                                                             --------  --------
                                                             $ 89,601  $ 76,683
                                                             ========  ========
</TABLE>
 
  The Company adopted Financial Accounting Standards Board Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of" (FAS 121) in 1996. The adoption of FAS 121 did not have a
material impact on the Company's consolidated financial condition, results of
operations or cash flows.
 
  FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK The Company uses
forward exchange contracts to manage its exposure to fluctuating foreign
currency exchange rates. All of the Company's forward exchange contracts are
with Corange International Limited ("CIL"), a related affiliate. Gains or
losses on these contracts are recognized in the basis of the transaction being
hedged.
 
  Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of trade accounts receivables.
The risk is limited due to the large number and types of entities comprising
the Company's customer base and their dispersion across many geographic
regions. At December 31, 1996, the Company had no significant concentrations
of credit risk.
 
  RISK 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 and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
 
  SHAREHOLDER'S NET INVESTMENT Prior to the reorganization, the Company
participated in a centralized cash management system for all of its U.S.
operations through an affiliate. Substantially all cash receipts and
disbursements were processed through CUSHI and the Company was charged or
credited for the net of cash
 
                                      31
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
receipts, cash disbursements, and other CUSHI allocated charges each month.
The net effect of this monthly activity was charged or credited to
shareholder's net investment.
 
  INCOME TAXES Income taxes are accounted for in accordance with Financial
Accounting Standards Board Statement No. 109, "Accounting for Income Taxes"
(FAS 109) and have been computed on the separate return method. The current
provision for income taxes is computed on the pretax income of the
consolidated entities located within each taxing country based upon the tax
law in effect during the respective period. Deferred income taxes result from
the future tax consequences associated with temporary differences between the
tax basis of assets and liabilities and the reported amounts of those assets
and liabilities for financial accounting purposes. Incremental U.S. income
taxes have not been provided on the cumulative undistributed earnings of the
foreign subsidiaries totaling $46,969 as of December 31, 1996. These earnings,
which reflect full provision for non-U.S. income taxes, are expected to be
reinvested indefinitely in non-U.S. operations or to be remitted substantially
free of additional tax due to the availability of foreign tax credits.
 
  STOCK-BASED COMPENSATION In October 1995, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (FAS 123). FAS 123 encourages, but does not
require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to account for stock-
based compensation using the intrinsic value method prescribed in Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock. Had the fair value based method proposed by FAS 123
been adopted, it would not have had a material effect on the Company's
financial position or results of operations.
 
  UNAUDITED PRO FORMA NET INCOME PER SHARE Prior to the reorganization
described in Note 1, the Company was not a legal entity and did not have a
separately identifiable pool of capital. Accordingly, historical per share
data has been omitted from the consolidated financial statements. Pro forma
net income per share for 1996 is based on historical net income and pro forma
weighted average shares outstanding giving effect to the shares outstanding
after the reorganization and the additional shares and common stock
equivalents issued through, or in connection with, the Initial Public
Offering. Pro forma net income per share for 1995 was based on historical net
income and the number of shares of common stock which were outstanding after
the reorganization.
 
  RECLASSIFICATIONS Certain reclassifications have been made for prior years
presented in the financial statements to conform to the classifications
adopted in 1996.
 
NOTE 3--INVESTMENT IN AFFILIATE
 
  The Company has a 50% investment interest in a joint venture with E.I.
DuPont de Nemours and Company for the purpose of sharing in the production and
sale of advanced technologies, primarily in North American countries. The
Company received pretax distributions of $3,538, $5,264 and $5,138 from this
venture in 1996, 1995 and 1994, respectively. This investment is reported
using the equity method as described in Note 2.
 
NOTE 4--RELATED PARTY TRANSACTIONS
 
  The Company recorded amounts (payable to) receivable from affiliates, net,
of $(709) and $24,265 at December 31, 1996 and 1995, respectively. The balance
at December 31, 1995, includes advances to an affiliate of $21,921, which was
repaid during the first quarter of 1996. The remaining balances represent
advances between affiliated companies for transactions incurred in the normal
course of business. In addition, the Company obtained financing from
affiliated entities as described in Note 6 and participated in a centralized
cash management system described in Note 2. Related party transactions are
also disclosed concerning forward exchange contracts, income taxes, and
employee benefit plans in Notes 2, 5, 11, 13 and 14.
 
                                      32
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  The consolidated financial statements reflect the results of operations,
financial condition and cash flows of the Company as a component of the Parent
and may not be indicative of actual results of the Company under other
ownership. Management believes that the consolidated statements of income
include a reasonable allocation of administrative expenses incurred by CUSHI
on behalf of the Company prior to its reorganization as described in Note 1.
The allocations of administrative expenses were based upon actual time and
expenses incurred totaling $674, $779 and $739 in 1996, 1995 and 1994,
respectively.
 
  Beginning in 1994, the Company is insured for product liability through an
affiliated captive insurance company, Bellago Insurance Limited of Hamilton
Bermuda ("Bellago"), for $2,000 per occurrence, $5,000 per group of related
claims and $10,000 in the aggregate. Excess claims are insured through
commercial carriers. Insurance premiums of $2,100, $1,900 and $556 were paid
to Bellago in 1996, 1995 and 1994, respectively.
 
  In 1992, the Company entered into an oral arrangement with BMC to fund
research in the area of orthobiologics. Total expenses incurred related to
this arrangement were $707, $638 and $506 for the years ended December 31,
1996, 1995 and 1994, respectively.
 
NOTE 5--INCOME TAXES
 
  The Company accounts for income taxes in accordance with the provisions of
FAS 109. This standard requires, among other things, recognition of future tax
expense or benefits, measured by enacted tax rates attributable to temporary
differences between financial reporting and income tax bases of assets and
liabilities, and net operating loss carryforwards, to the extent that
realization of such benefits is more likely than not.
 
  The Company's domestic operations have been members of a U.S. group filing a
consolidated federal corporation income tax return with other affiliated
companies. The group has had no tax sharing or allocation agreement and taxes
have been allocated on a separate company basis. The Company has entered into
a tax indemnity agreement with the Parent that limits the Company's liability
for taxes to those arising out of the Company's operations. Prior to the
reorganization, CUSHI had been responsible for remitting all federal and state
income tax payments for all members of the group. Therefore, while the Company
had not actually made payments of federal or state taxes prior to the
reorganization referred to in Note 1, it was assumed that the Company paid 90%
of its current federal and state provision during the year and the remaining
10% prior to the filing of its U.S. tax returns in the subsequent year. Total
income taxes paid, including actual and assumed payments, were $78,855,
$71,852 and $64,273 in 1996, 1995 and 1994, respectively.
 
  Earnings from operations before income taxes, minority interest and equity
in earnings of unconsolidated affiliate were as follows:
 
<TABLE>
<CAPTION>
                                                       1996     1995     1994
                                                     -------- -------- --------
     <S>                                             <C>      <C>      <C>
     United States.................................. $139,392 $124,443 $113,386
     International..................................   45,630   40,833   36,879
                                                     -------- -------- --------
       Total earnings before taxes.................. $185,022 $165,276 $150,265
                                                     ======== ======== ========
</TABLE>
 
                                      33
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  The provisions for income taxes are summarized as follows:
 
<TABLE>
<CAPTION>
                                                       1996     1995     1994
                                                      -------  -------  -------
     <S>                                              <C>      <C>      <C>
     Current:
       Federal....................................... $48,507  $48,303  $42,410
       International.................................  22,535   21,647   19,128
       State.........................................  10,364    8,425    8,758
                                                      -------  -------  -------
                                                       81,406   78,375   70,296
                                                      -------  -------  -------
     Deferred:
       Federal.......................................  (4,170)  (3,658)  (6,542)
       International.................................   1,644   (1,497)   2,922
       State.........................................    (191)    (513)    (918)
                                                      -------  -------  -------
                                                       (2,717)  (5,668)  (4,538)
                                                      -------  -------  -------
     Income tax expense.............................. $78,689  $72,707  $65,758
                                                      =======  =======  =======
</TABLE>
 
  A reconciliation of the effective income tax rate follows:
 
<TABLE>
<CAPTION>
                                                               1996  1995  1994
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     United States federal tax rate........................... 35.0% 35.0% 35.0%
     Add (deduct):
       Effect of international operations.....................  2.4   2.4   1.6
       State taxes, net of federal tax benefit................  3.6   3.1   3.4
       Impact of nondeductible goodwill.......................  1.7   2.8   3.0
       Other, net.............................................  (.2)   .7    .8
                                                               ----  ----  ----
     Effective income tax rate................................ 42.5% 44.0% 43.8%
                                                               ====  ====  ====
</TABLE>
 
  Significant components of the Company's deferred tax assets and liabilities
are comprised of the following at December 31:
 
<TABLE>
<CAPTION>
                                                              1996      1995
                                                            --------  --------
     <S>                                                    <C>       <C>
     Deferred tax assets:
       Inventory........................................... $  7,405  $  7,271
       Profit in inventory.................................   15,269    10,597
       Royalties...........................................    2,224     2,753
       Amortization other than goodwill....................   10,006     3,942
       Deferred compensation...............................    9,391     7,845
       Net operating losses................................    2,108       --
       Other...............................................    5,084     5,938
       Valuation allowances................................   (2,754)     (902)
                                                            --------  --------
         Net deferred tax assets........................... $ 48,733  $ 37,444
                                                            --------  --------
     Deferred tax liabilities:
       Depreciation........................................ $(18,601) $(12,497)
       Other...............................................   (1,343)     (381)
                                                            --------  --------
         Net deferred tax liabilities...................... $(19,944) $(12,878)
                                                            ========  ========
</TABLE>
 
                                       34
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
NOTE 6--LINES OF CREDIT AND LONG-TERM DEBT
 
  At December 31, 1996, the Company had lines of credit with affiliated
finance companies totaling $68,427, of which $45,708 has been used. The
Company also had a line of credit with an external bank amounting to $10,000
which has not been utilized. No compensating balances are required or
maintained.
 
  The Company has outstanding borrowings as follows:
 
<TABLE>
<CAPTION>
                                                                 1996    1995
                                                                ------- -------
<S>                                                             <C>     <C>
Short-term debt:
  Borrowings from affiliates, variable interest rates ranging
   from 4.0% to 11.1%, weighted average interest rate of 6.3%
   (1996) and 8.2% (1995), principal and interest due at
   various maturity dates...................................... $30,295 $31,717
  Short-term bank debt--
    7.00% interest rate, due 1/12/96...........................     --   17,263
    6.37% interest rate, due 6/18/97...........................  11,590     --
    Interest rate varies based upon MIBOR plus 15 basis points,
     due 12/20/97..............................................   2,506     --
    5.25% interest rate, due 3/27/97...........................   2,177     --
  Other bank debt, interest rates ranging from 7.5% to 7.66%,
   principal and interest due at various maturity dates........     729     --
  Acquisition related debt.....................................  10,000     --
  Other debt, variable interest rates ranging from 6.5% to
   8.25%, principal and interest due at various maturity
   dates.......................................................   4,411   3,785
                                                                ------- -------
    Total short-term debt...................................... $61,708 $52,765
                                                                ------- -------
Long-term debt:
  Note payable to affiliate, interest rate varies quarterly
   based upon LIBOR plus 37.5 basis points, due 11/22/99....... $15,413 $38,815
  Note payable, 7.66%, due 12/30/98............................     534     --
  Note payable, 8%, due 12/31/02...............................     --    1,287
  Note payable to affiliate, 3.25%, due 1/1/01.................     --    2,513
  Note payable to affiliate, 8.5%, due 1/1/01..................     --    1,263
  Other debt, variable interest rates ranging from 6.5% to
   8.25%, principal and interest due at various maturity
   dates.......................................................   4,220   4,055
                                                                ------- -------
    Total long-term debt....................................... $20,167 $47,933
                                                                ======= =======
</TABLE>
 
  At December 31, 1996, aggregate maturities of long-term debt are as follows:
 
<TABLE>
       <S>                                                               <C>
       1998............................................................. $ 4,127
       1999.............................................................  15,866
       2000.............................................................     119
       2001.............................................................      51
       2002.............................................................       4
</TABLE>
 
  Acquisition related debt comprises the $10,000 contingency recorded in
conjunction with the acquisition of ACE, described in Note 1.
 
  Interest paid was $5,116, $4,276 and $1,371 for 1996, 1995 and 1994,
respectively, including $4,553, $3,638 and $1,214 paid to affiliates in 1996,
1995 and 1994, respectively.
 
  During 1996, $28,465 of long-term notes payable were paid in advance of
their maturity dates to utilize excess cash and reduce future interest
expense.
 
                                      35
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
NOTE 7--LEASES
 
  The Company is a lessee under a number of cancelable and noncancelable
operating leases. Total rental expense was approximately $5,804, $4,153 and
$6,023 for the years ended December 31, 1996, 1995 and 1994, respectively.
Future minimum rental commitments under noncancelable operating leases are as
follows:
 
<TABLE>
<CAPTION>
                                                               OPERATING CAPITAL
                                                                LEASES   LEASES
                                                               --------- -------
     <S>                                                       <C>       <C>
     Year Ending December 31:
       1997...................................................  $ 5,108  $  678
       1998...................................................    4,187     200
       1999...................................................    2,607      90
       2000...................................................    1,941      65
       2001...................................................    1,730      19
       Thereafter.............................................    5,698     --
                                                                -------  ------
     Total minimum lease payments.............................  $21,271  $1,052
                                                                =======  ------
     Less amount representing interest........................               88
                                                                         ------
     Present value of net minimum lease payments..............              964
     Less current portion of capital leases...................              614
                                                                         ------
     Long-term portion of capital leases......................           $  350
                                                                         ======
</TABLE>
 
  Property, plant and equipment at December 31, 1996 and 1995 included $2,568
and $1,083, respectively, of equipment under leases that have been
capitalized. Accumulated depreciation for such equipment was $1,593 and $566
at December 31, 1996 and 1995, respectively.
 
NOTE 8--CONTINGENCIES
 
  The Company is subject to a number of investigations, lawsuits and claims
during the normal course of business. Management does not expect that
resulting liabilities beyond provisions already recorded will have a
materially adverse effect on the Company's consolidated financial position,
results of operations or cash flows. The loss provisions recorded have not
been reduced for any material amounts of anticipated insurance recoveries.
 
NOTE 9--STOCK COMPENSATION PLANS
 
  Effective October 30, 1996, the Company adopted the DePuy, Inc. 1996 Equity
Incentive Plan ("Incentive Plan"). Under the Incentive Plan, the Company may
grant nonqualified or incentive stock options, stock appreciation rights,
restricted stock or restricted stock units, performance awards, phantom stock
units or other stock-based awards for the benefit of selected executive
personnel, key employees, sales representatives, consultants of the Company
and its affiliates, and non-employee directors of the Company.
 
  The Incentive Plan provides that the aggregate number of shares of the
Company's stock which will be available for award to participants will be
9,485,069. The maximum number of shares available for restricted stock awards
under the Incentive Plan is 350,000. Subject to the provisions of the
Incentive Plan, the term of options awarded in 1996 is 10 years from the date
of grant.
 
  Effective with the Initial Public Offering, 1,249,250 stock options were
awarded with an exercise price of $17.50, the Initial Public Offering price.
One-third of the options granted in 1996 vest in each of the years 1997, 1998
and 1999. In addition, 85,069 phantom stock units were granted to key
personnel, which entitle the holder to one share of common stock for each
unit, in settlement of amounts payable under a long-term incentive
compensation plan which has been discontinued.
 
                                      36
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  A summary of the status of the Incentive Plan as of December 31, 1996 and
changes during the year is presented below:
 
<TABLE>
<CAPTION>
                                                FIXED OPTIONS    PHANTOM STOCK
                                              ------------------ -------------
                                                        WEIGHTED
                                                        AVERAGE
                                                        EXERCISE
                                               SHARES    PRICE      SHARES
                                              --------- -------- -------------
     <S>                                      <C>       <C>      <C>
     Outstanding at January 1, 1996..........       --   $  --         --
     Granted................................. 1,249,250   17.50     85,069
     Exercised...............................       --      --         --
     Forfeited...............................       --      --         --
     Expired.................................       --      --         --
                                              ---------  ------     ------
     Outstanding at December 31, 1996........ 1,249,250  $17.50     85,069
     Exercisable at December 31, 1996........       --      --         --
     Available for grant at December 31,
      1996................................... 8,150,750
                                              =========  ======     ======
</TABLE>
 
  The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1996: dividend yield of .75%, expected
volatility of 37.34%, risk-free interest rate of 6.18% and an expected life of
6 years. The weighted average remaining contractual life of the options is 9.8
years. The weighted average fair value of options and phantom stock units
granted during the year was $7.70 and $17.50, respectively.
 
  The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its plans and no compensation cost was recognized in connection
with the issuance of the stock options. Had compensation cost for the
Company's stock-based compensation plans been determined based on the fair
value at the grant dates for awards under those plans consistent with the
method of FAS 123, the Company's net income and earnings per share would have
been reduced to the pro forma amounts indicated as follows:
 
<TABLE>
<CAPTION>
                                                                          1996
                                                                        --------
       <S>                                                              <C>
       Net income
         As reported................................................... $106,748
         Pro forma..................................................... $106,447
                                                                        ========
       Earnings per share
         As reported................................................... $   1.17
         Pro forma..................................................... $   1.16
                                                                        ========
</TABLE>
 
  The effects of applying FAS 123 in this pro forma disclosure are not likely
to be representative of the effects on reported net income for future years.
 
NOTE 10--SHAREHOLDERS' EQUITY
 
  Prior to the reorganization and Initial Public Offering described in Note 1,
the total equity of the Company was recorded as shareholder's net investment.
As a result of the reorganization and Initial Public Offering, which was
effective October 30, 1996, the Company recorded the par value of the
98,580,000 shares outstanding as $986 of common stock. In addition, certain
identifiable components of equity including cumulative translation adjustment,
net unrealized appreciation on securities and minimum pension liability
adjustment, were capitalized separately as of the date of the offering. The
remaining equity of the Company totaling $675,144 was recorded as additional
paid-in capital resulting in the liquidation of the shareholder's net
investment balance.
 
                                      37
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  Retained earnings of $17,108 at December 31, 1996, represents the net income
of the Company subsequent to the effective date of the Initial Public
Offering.
 
NOTE 11--EMPLOYEE PENSION PLANS AND OTHER BENEFIT PLANS
 
  Eligible Company employees participate in a noncontributory defined
contribution plan, sponsored by CUSHI prior to the reorganization, which
covers substantially all non-union employees of the Company in the United
States. This plan provides for targeted benefits based on the employee's
average compensation in the years preceding retirement. In general, the
Company's policy is to contribute actuarially determined amounts that are
sufficient to meet projected benefit payment requirements. Pension expense for
this plan was $967, $898 and $693 for 1996, 1995 and 1994, respectively, and
was allocated based on the ratio of the target benefits for the Company's
participants relative to the total target benefits for all participants of the
plan.
 
  Employees of international subsidiaries are covered by various pension
benefit arrangements, some of which are considered to be defined benefit plans
for financial reporting purposes. Assets of the plans are comprised primarily
of equity securities. Benefits under these plans are primarily based on levels
of compensation. Funding policies are based on legal requirements, tax
considerations and local practices. Pension expense for the most significant
of these international plans was $1,312, $1,476 and $1,032 for 1996, 1995 and
1994, respectively.
 
  The following assumptions were made to develop net periodic benefit
obligations for the international defined benefit plan for 1996, 1995 and
1994:
 
<TABLE>
<CAPTION>
                                                               1996  1995  1994
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     Expected long-term rate of return........................ 9.0%  9.0%  9.0%
                                                               ===   ===   ===
     Weighted average discount rate........................... 9.0%  9.0%  9.0%
                                                               ===   ===   ===
     Rate of increase in compensation levels.................. 7.0%  7.0%  7.0%
                                                               ===   ===   ===
</TABLE>
 
  The U.S. operating division also has a noncontributory defined benefit
pension plan which covers substantially all of the Company's union employees
who meet eligibility requirements. This plan generally provides pension
benefits based on the employee's years of service with normal retirement at
age 65. Pension expense for this plan was $380, $381 and $405 for 1996, 1995
and 1994, respectively.
 
  The following table provides the assumptions used to develop net periodic
pension cost and the actuarial present value of projected benefit obligations
for the U.S. defined benefit plan:
 
<TABLE>
<CAPTION>
                                                               1996  1995  1994
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     Expected long-term rate of return on plan assets......... 7.5%  7.5%  7.75%
                                                               ===   ===   ====
     Weighted average discount rate........................... 7.0%  7.0%  7.00%
                                                               ===   ===   ====
</TABLE>
 
  The Company recorded a pension liability as required by Financial Accounting
Standards Board Statement No. 87, "Employers' Accounting for Pensions" (FAS
87), representing the amount by which the actuarial present value of the
accumulated benefit obligation exceeds the fair value of the plan's assets. A
corresponding amount is recognized as an intangible asset to the extent of the
unamortized prior service cost and transition obligation. The excess is
charged directly to shareholders' equity.
 
                                      38
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  The amounts recorded at December 31, 1996 and 1995 are as follows:
 
<TABLE>
<CAPTION>
                                   DECEMBER 31, 1996       DECEMBER 31, 1995
                                ----------------------- -----------------------
                                ACCUMULATED   ASSETS    ACCUMULATED   ASSETS
                                 BENEFITS     EXCEED     BENEFITS     EXCEED
                                  EXCEED    ACCUMULATED   EXCEED    ACCUMULATED
                                  ASSETS     BENEFITS     ASSETS     BENEFITS
                                ----------- ----------- ----------- -----------
<S>                             <C>         <C>         <C>         <C>
Actuarial present value of ac-
 cumulated benefit obligation:
  Vested......................    $(3,321)   $(19,798)    $(2,793)   $(15,617)
  Non-vested..................       (489)        --         (589)        --
                                  -------    --------     -------    --------
                                   (3,810)    (19,798)     (3,382)    (15,617)
Effect of projected future
 salary increases.............        --       (4,533)        --       (3,574)
                                  -------    --------     -------    --------
Projected benefit obligation..     (3,810)    (24,331)     (3,382)    (19,191)
Plan assets at fair value.....      2,809      30,411       2,475      25,044
                                  -------    --------     -------    --------
Projected benefit obligation
 (in excess of) or less than
 plan assets..................     (1,001)      6,080        (907)      5,853
Unamortized transition asset..        (13)     (4,658)        (15)     (4,488)
Unrecognized net actuarial
 losses (gains)...............        249        (168)         39        (752)
Unrecognized prior service
 costs........................        737         --          806         --
Adjustment to recognized mini-
 mum liability................       (973)        --         (830)        --
                                  -------    --------     -------    --------
Net (pension liability) pre-
 paid pension cost recognized
 in the consolidated balance
 sheets.......................    $(1,001)   $  1,254     $  (907)   $    613
                                  =======    ========     =======    ========
Amount reflected as an intan-
 gible asset..................    $  (737)   $    --      $  (806)   $    --
                                  =======    ========     =======    ========
Amount reflected as a minimum
 pension liability adjust-
 ment.........................    $  (236)   $    --      $   (24)   $    --
                                  =======    ========     =======    ========
</TABLE>
 
  The Company participates in a 401(k) plan for non-union employees of its
domestic operations. The Company made contributions under this plan of $1,511,
$1,250 and $1,017 in 1996, 1995 and 1994, respectively.
 
  The Company's senior management participates in a supplemental retirement
plan sponsored by the Company. The benefits under the plan are based on the
participants' salary at their retirement date adjusted by the total of
retirement income to be received by the participants from other sources.
Expense for this plan was $806, $763 and $515 for 1996, 1995 and 1994,
respectively.
 
NOTE 12--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
 
  Certain domestic subsidiaries of the Company sponsor unfunded postretirement
healthcare benefit plans that cover either salaried or union employees. In
general, the Company pays a defined portion of an eligible retiree's
healthcare premium. The plans are contributory based on years of service, with
contributions adjusted annually. Net periodic postretirement benefits cost
includes the following components:
 
<TABLE>
<CAPTION>
                                                                1996 1995 1994
                                                                ---- ---- ----
     <S>                                                        <C>  <C>  <C>
     Benefits cost for service during the year and other....... $505 $305 $426
     Interest cost on accumulated postretirement benefit obli-
      gation...................................................  490  409  403
                                                                ---- ---- ----
     Net periodic postretirement benefit cost.................. $995 $714 $829
                                                                ==== ==== ====
</TABLE>
 
                                      39
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  The accrued postretirement benefit obligation recorded at December 31, 1996
and 1995 is as follows:
 
<TABLE>
<CAPTION>
                                                                   1996   1995
                                                                  ------ ------
     <S>                                                          <C>    <C>
     Accumulated postretirement benefit obligation:
       Retirees.................................................. $1,751 $  782
       Fully eligible active plan participants...................    279    317
       Other active plan participants............................  6,703  6,194
                                                                  ------ ------
     Total accumulated postretirement benefit obligation.........  8,733  7,293
     Unrecognized net actuarial gains............................  1,157  1,313
                                                                  ------ ------
     Accrued postretirement benefit obligation................... $9,890 $8,606
                                                                  ====== ======
</TABLE>
 
  Expenditures for these benefits during 1996, 1995 and 1994 were immaterial.
 
  The assumed healthcare cost trend rates used to measure the expected cost of
benefits for 1996 ranged from 9.0% for a post-65 retiree to 12.0% for a pre-65
retiree and for 1995 ranged from 9.3% for a post-65 retiree to 12.7% for a
pre-65 retiree. The healthcare trend rates are assumed to decrease ratably
over a 10 year period down to 6.0%. An increase in this annual trend rate of
1.0% would increase the accumulated postretirement benefit obligation as of
December 31, 1996 by $1,781 and the aggregate of the service and interest cost
components of net periodic postretirement benefit cost for the year then ended
by approximately $320.
 
  The weighted average discount rate used to measure the accumulated
postretirement benefit obligation as of December 31, 1996 and 1995, was 7.0%
and 6.75%, respectively.
 
NOTE 13--DERIVATIVE FINANCIAL INSTRUMENTS
 
  Foreign Exchange Risk Management The Company uses forward exchange contracts
to manage its global foreign exchange exposure. The forward contracts serve
primarily to hedge nonfunctional currency denominated transactions and
commitments for the purchase of inventory within the Company and with
affiliates expected to occur within the year. Such contracts are with CIL, a
related affiliate. The Company does not hold or issue derivative financial
instruments for trading purposes or use leveraged derivatives in its financial
management program. The Company does not anticipate any material adverse
effect on its financial position resulting from its involvement in these
instruments, nor does it anticipate nonperformance by its counterparty. The
notional amounts of the Company's forward contracts at December 31, 1996 and
1995 were $136,636 and $134,734, respectively. The Company's domestic and
international operations are committed, under terms of the forward contracts,
to purchase the following currencies:
 
<TABLE>
<CAPTION>
                                                                   1996    1995
                                                                  ------- ------
       <S>                                                        <C>     <C>
       U.S. Dollars.............................................. 132,495 81,571
                                                                  ======= ======
       British Pounds............................................      88 29,690
                                                                  ======= ======
       French Francs.............................................  12,424  9,575
                                                                  ======= ======
       Deutsche Marks............................................   2,508  5,985
                                                                  ======= ======
       Swiss Francs..............................................     500  1,078
                                                                  ======= ======
</TABLE>
 
  Concentrations of Credit Risk Concentrations of credit risk may arise due to
financial instruments existing for groups of customers or counterparties
having similar economic characteristics that would cause their ability to meet
contractual obligations to be similarly affected by changes in economic or
other conditions. The Company anticipates, however, that counterparties will
be able to satisfy fully their obligations under the
 
                                      40
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
contracts. The Company does not obtain collateral or other security to support
financial instruments subject to credit risk, but monitors the credit standing
of the counterparty.
 
NOTE 14--FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1996 and 1995.
Financial Accounting Standards Board Statement No. 107, "Disclosures about
Fair Value of Financial Instruments" (FAS 107), defines the fair value of a
financial instrument as the amount at which the instrument could be exchanged
in a current transaction between willing parties:
 
<TABLE>
<CAPTION>
                                                     1996             1995
                                               ---------------- ----------------
                                               CARRYING  FAIR   CARRYING  FAIR
                                                AMOUNT   VALUE   AMOUNT   VALUE
                                               -------- ------- -------- -------
     <S>                                       <C>      <C>     <C>      <C>
     Nonderivatives:
       Long-term debt......................... $20,167  $20,227 $47,933  $47,638
                                               -------  ------- -------  -------
     Derivatives:
       Forward contracts...................... $   --   $ 2,986 $   --   $ 5,094
                                               =======  ======= =======  =======
</TABLE>
 
  The fair value of the long-term debt is estimated by discounting expected
cash flows at the rates likely to be offered to the Company for debt of the
same remaining maturities. The fair value of the forward contracts comprised
solely of contracts with CIL, a related affiliate, represents the amount of
hedging gain (or loss) deferred and generally reflects the estimated amounts
that the Company would receive or pay to terminate the contracts at the
reporting date based on dealer quotes. All other nonderivative financial
instruments approximate fair value.
 
NOTE 15--INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
 
  The Company operates in one dominant industry segment which includes the
manufacturing and marketing of joint and spinal implants, surgical
instruments, trauma products and sports medicine soft goods used primarily by
orthopaedic medical specialists in both surgical and nonsurgical therapies.
 
                                      41
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
 
  Net sales, operating income and identifiable assets by geographic area are
presented in the table following.
 
<TABLE>
<CAPTION>
                                                       1996
                         ------------------------------------------------------------------
                         UNITED STATES ASIA/PACIFIC  EUROPE   OTHER   ELIMINATIONS  TOTAL
                         ------------- ------------ -------- -------  ------------ --------
<S>                      <C>           <C>          <C>      <C>      <C>          <C>
Sales to unaffiliated
 customers..............  $  408,919     $79,093    $186,802 $22,459   $     --    $697,273
Sales to affiliated
 customers..............      72,753         629      56,588     --     (129,970)       --
                          ----------     -------    -------- -------   ---------   --------
  Total sales...........  $  481,672     $79,722    $243,390 $22,459   $(129,970)  $697,273
                          ----------     -------    -------- -------   ---------   --------
Operating income
 (loss).................  $  141,616     $18,389    $ 40,304 $(1,833)  $ (10,973)  $187,503
                          ----------     -------    -------- -------   ---------   --------
Identifiable assets.....  $1,071,153     $62,829    $362,732 $25,086   $(613,423)  $908,377
                          ==========     =======    ======== =======   =========   ========
<CAPTION>
                                                       1995
                         ------------------------------------------------------------------
                         UNITED STATES ASIA/PACIFIC  EUROPE   OTHER   ELIMINATIONS  TOTAL
                         ------------- ------------ -------- -------  ------------ --------
<S>                      <C>           <C>          <C>      <C>      <C>          <C>
Sales to unaffiliated
 customers..............  $  377,264     $71,549    $166,652 $21,096   $     --    $636,561
Sales to affiliated
 customers..............      54,695         982      40,416      26     (96,119)       --
                          ----------     -------    -------- -------   ---------   --------
  Total sales...........  $  431,959     $72,531    $207,068 $21,122   $ (96,119)  $636,561
                          ----------     -------    -------- -------   ---------   --------
Operating income
 (loss).................  $  132,737     $20,710    $ 25,972 $  (931)  $  (8,165)  $170,323
                          ----------     -------    -------- -------   ---------   --------
Identifiable assets.....  $  309,439     $54,940    $355,800 $18,410   $(115,339)  $623,250
                          ==========     =======    ======== =======   =========   ========
<CAPTION>
                                                       1994
                         ------------------------------------------------------------------
                         UNITED STATES ASIA/PACIFIC  EUROPE   OTHER   ELIMINATIONS  TOTAL
                         ------------- ------------ -------- -------  ------------ --------
<S>                      <C>           <C>          <C>      <C>      <C>          <C>
Sales to unaffiliated
 customers..............  $  358,840     $55,206    $125,068 $12,659   $     --    $551,773
Sales to affiliated
 customers..............      45,226         --       27,796     --      (73,022)       --
                          ----------     -------    -------- -------   ---------   --------
  Total sales...........  $  404,066     $55,206    $152,864 $12,659   $ (73,022)  $551,773
                          ----------     -------    -------- -------   ---------   --------
Operating income
 (loss).................  $  119,053     $16,816    $ 24,863 $   353   $  (9,959)  $151,126
                          ----------     -------    -------- -------   ---------   --------
Identifiable assets.....  $  298,854     $39,635    $314,426 $16,154   $(101,541)  $567,528
                          ==========     =======    ======== =======   =========   ========
</TABLE>
 
  Intercompany transfers are made at negotiated prices which include profit
margin.
 
  For the years ended December 31, 1996, 1995 and 1994, there were no
customers which accounted for 10% or more of the Company's sales.
 
  Sales to unaffiliated customers based on customer location were as follows:
 
<TABLE>
<CAPTION>
                                                       1996     1995     1994
                                                     -------- -------- --------
     <S>                                             <C>      <C>      <C>
     United States.................................. $373,771 $349,909 $333,310
     Europe.........................................  186,053  172,189  132,794
     Asia/Pacific...................................  106,971   90,595   68,297
     Other regions..................................   30,478   23,868   17,372
                                                     -------- -------- --------
       Total sales to unaffiliated customers........ $697,273 $636,561 $551,773
                                                     ======== ======== ========
</TABLE>
 
NOTE 16--SUBSEQUENT EVENTS
 
  The Company will adopt, effective January 1, 1997, subject to shareholder
approval, the DePuy, Inc. Employee Stock Option/Purchase Plan ("the Stock
Purchase Plan") for purposes of providing the employees of the Company with an
opportunity to participate in equity ownership of the Company by purchasing
stock of the Company at a discount. The maximum aggregate number of shares to
be issued under the Stock Purchase Plan
 
                                      42
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
will be 600,000. The committee administering the Stock Purchase Plan will
determine the maximum number of shares to be issued during each annual period,
except that the maximum number of shares to be issued during the 1997 annual
period will be 150,000. All employees who have completed 90 days of employment
with the Company are eligible to participate in offerings under the Stock
Purchase Plan. In order to participate, an eligible employee must authorize a
payroll deduction at a rate of 1% to 10% of base pay, which deductions are
credited to the participant's plan account. The option price of the stock
under the Stock Purchase Plan is 85% of the lower of the fair market value of
the stock on the offering commencement date or the termination date.
 
  UNAUDITED SUBSEQUENT EVENT On February 28, 1997, the Company entered into an
agreement to purchase 89.6% of the shares of Landanger-Camus ("Landanger") or
1,939,452 shares which are currently held by members of the Landanger family
and certain minority shareholders. The purchase price has not yet been
finalized but approximates $145 million (translated at the February 28, 1997
exchange rate of 5.7), subject to certain adjustments including changes
resulting from the audit of the net asset value of Landanger. The purchase
agreement is subject to a number of conditions, including receipt of necessary
regulatory approvals. Upon satisfaction of such conditions, the purchase will
be followed by a tender offer to purchase the remaining 10.4% shares owned by
minority shareholders. Landanger, headquartered in France, is a manufacturer
of hip implants and a distributor of orthopaedic devices and supplies. For the
year ended August 31, 1996, Landanger reported sales of $99.5 million and net
income of $8.0 million (unaudited and translated at the average exchange rate
of 5.0 for the fiscal year).
 
                                      43
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Shareholders of DePuy, Inc.
 
  In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 45 present fairly, in all
material respects, the financial position of DePuy, Inc. and its subsidiaries
at December 31, 1996 and 1995, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1996,
in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
 
/s/ Price Waterhouse LLP
 
Price Waterhouse LLP
 
Indianapolis, Indiana
February 21, 1997
 
                                      44
<PAGE>
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
  The information required to be provided under Item 10 with respect to the
Company's Executive Officers is included in Part I hereof under Item 4. The
material set forth under the headings "Election of Directors" and "Section
16(a) Beneficial Ownership Reporting Compliance" on pages 4 through 5 and page
13 of the Company's Proxy Statement for its Annual Meeting to be held on May
1, 1997 is incorporated herein by reference.
 
ITEM 11. EXECUTIVE COMPENSATION.
 
  The material set forth under the heading "Executive Compensation" on pages 6
through 15 of the Company's Proxy Statement for its Annual Meeting to be held
on May 1, 1997 is incorporated herein by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
  The material set forth under the heading "Security Ownership of Certain
Beneficial Owners and Management" on pages 2 through 3 of the Company's Proxy
Statement for its Annual Meeting to be held on May 1, 1997 is incorporated
herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
  The material set forth under the heading "Certain Relationships and Related
Transactions" on pages 32 through 33 of the Company's Proxy Statement for its
Annual Meeting to be held on May 1, 1997 is incorporated herein by reference.
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
 
  (a) The following documents are filed as part of this report:
 
   (1) Financial Statements:
 
       Consolidated Statements of Income for the three years ended December
       31, 1996
 
       Consolidated Balance Sheets as of December 31, 1996 and 1995
 
       Consolidated Statements of Cash Flows for the three years ended
       December 31, 1996
 
       Consolidated Statements of Shareholders' Equity for the three years
       ended December 31, 1996
 
       Notes to Consolidated Financial Statements
 
       Report of Independent Accountants
 
   (2) Financial Statement Schedules:
 
       II Valuation and Qualifying Accounts for the three years ended December
       31, 1996
 
  (b) Reports on Form 8-K.
 
    None.
 
  (c) Exhibits.
 
   3.1 Articles of Incorporation of the Company, incorporated by reference
       to Exhibit 3.1 of the Company's Registration Statement on Form S-1
       (Registration No. 333-09345).
 
   3.2 By-laws of the Company, incorporated by reference to Exhibit 3.2 of
       the Company's Registration Statement on Form S-1 (Registration No.
       333-09345).
 
  10.1 Employment Agreement, dated May 1, 1996, between Jim Lent and DePuy
       Inc., incorporated by reference to Exhibit 10.1 of the Company's
       Registration Statement on Form S-1 (Registration No. 333-09345).
 
                                      45
<PAGE>
 
  10.2  Employment Agreement, dated July 13, 1992, between Michael J. Dormer
        and DePuy Inc., incorporated by reference to Exhibit 10.2 of the    
        Company's Registration Statement on Form S-1 (Registration No. 333- 
        09345).                                                              
      
 
  10.3  Employment Agreement, dated May 1, 1996, between Michael J. Dormer
        and DePuy International Limited, incorporated by reference to Exhibit
        10.3 of the Company's Registration Statement on Form S-1
        (Registration No. 333-09345).
 
  10.4  Employment Agreement, dated May 1, 1996, between R. Michael McCaffrey
        and DePuy Inc., incorporated by reference to Exhibit 10.4 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.5  Employment Agreement, dated May 1, 1996, between William E. Tidmore
        and DePuy Inc., incorporated by reference to Exhibit 10.5 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.6  Employment Agreement, dated May 1, 1996, between Robert E. Morel and
        DePuy Inc., incorporated by reference to Exhibit 10.6 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.7  Employment Agreement, dated May 1, 1996, between Steve L. Artusi and
        DePuy Inc., incorporated by reference to Exhibit 10.7 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.8  Employment Agreement, dated May 1, 1996, between Thomas J. Oberhausen
        and DePuy Inc., incorporated by reference to Exhibit 10.8 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.9  Employment Agreement, dated May 1, 1996, between G. Taylor Seward and
        DePuy Inc., incorporated by reference to Exhibit 10.9 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.10 DePuy, Inc. 1996 Equity Incentive Plan. 
      
 
  10.11 DePuy, Inc. Employee Stock Option/Purchase Plan. 
      
 
  10.12 DePuy, Inc. Senior Executive Incentive Compensation Plan. 
      
 
  10.13 Corange Limited Incentive and Performance Plan--Executive          
        Remuneration, incorporated by reference to Exhibit 10.21 of the    
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).                                                             
      
 
  10.14 DePuy, Inc. and DePuy International Limited Orthopaedic Extra-       
        Compensation Opportunity, incorporated by reference to Exhibit 10.22 
        of the Company's Registration Statement on Form S-1 (Registration No.
        333-09345).                                                           
      
 
  10.15 DePuy, Inc. Supplemental Retirement Plan (Plan No. 1) (As Amended and 
        Restated Effective as of October 1, 1996).                             
      
 
  10.16 DePuy, Inc. Supplemental Retirement Plan (Plan No. 2) (As Amended and 
        Restated Effective as of October 1, 1996).                             
      
 
  10.17 Trust Deed, dated July 1, 1993, between DePuy International Limited
        and George Taylor Seward and Others, incorporated by reference to  
        Exhibit 10.25 of the Company's Registration Statement on Form S-1  
        (Registration No. 333-09345).                                       
      
 
  10.18 Deed of Appointment and Retirement for the DePuy Executive Retirement
        Benefits Scheme, dated January 23, 1996, between DePuy International 
        Limited and George Taylor Seward and Others, incorporated by         
        reference to Exhibit 10.26 of the Company's Registration Statement on
        Form S-1 (Registration No. 333-09345).                                
      
 
                                       46
<PAGE>
 
  10.19 DePuy, Inc. 1996 Incentive Planning and Special Recognition Program,
        incorporated by reference to Exhibit 10.27 of the Company's         
        Registration Statement on Form S-1 (Registration No. 333-09345).     
      
 
  10.20 DePuy, Inc. Excess Retirement Plan (As Amended and in Effect as of
        October 1, 1996).                                                  
      
 
  10.21 Tax Allocation and Indemnity Agreement, dated October 30, 1996, 
        between the Company, Boehringer Mannheim Corporation and Corange
        Limited.                                                         
      
 
  10.22 Registration Rights Agreement, dated October 30, 1996, between       
        Corange Limited, Corange International Limited, Corange International
        Holdings B.V., Pharminvest S.A., and the Company.                     
      
 
  10.23 Second License Agreement, dated July 24, 1979, by and between    
        Biomedical Engineering Corp. and DePuy Division of Bio-Dynamics, 
        Inc., incorporated by reference to Exhibit 10.14 of the Company's
        Registration Statement on Form S-1 (Registration No. 333-09345).* 
      
 
  10.24 Amendment to Second License Agreement, dated March 25, 1985, by and  
        between Biomedical Engineering Trust and DePuy, Division of          
        Boehringer Mannheim Corporation, incorporated by reference to Exhibit
        10.15 of the Company's Registration Statement on Form S-1            
        (Registration No. 333-09345).*                                        
      
 
  10.25 Purchase Agreement, dated June 1, 1995, by and between Columbia/HCA 
        Healthcare Corporation and DePuy Inc., incorporated by reference to 
        Exhibit 10.16 of the Company's Registration Statement on Form S-1   
        (Registration No. 333-09345).*                                       
      
 
  10.26 Letter Agreement, dated July 3, 1995, by and between Columbia/HCA  
        Healthcare Corporation and DePuy Inc., incorporated by reference to
        Exhibit 10.17 of the Company's Registration Statement on Form S-1  
        (Registration No. 333-09345).*                                      
      
 
  10.27 Purchase Agreement, dated August 15, 1995, by and between            
        Columbia/HCA Healthcare Corporation and DePuy Inc., incorporated by  
        reference to Exhibit 10.18 of the Company's Registration Statement on
        Form S-1 (Registration No. 333-09345).*                               
      
 
  10.28 Purchase Agreement, dated June 15, 1995, by and between Columbia/HCA
        Healthcare Corporation and DePuy Inc., incorporated by reference to 
        Exhibit 10.19 of the Company's Registration Statement on Form S-1   
        (Registration No. 333-09345).*                                       
      
 
  10.29 Joint Venture Agreement, dated February 4, 1993, by and among DePuy  
        Inc., Biedermann Motech GmbH and Lutz Biedermann, incorporated by    
        reference to Exhibit 10.20 of the Company's Registration Statement on
        Form S-1 (Registration No. 333-09345).*                               
      
 
  11.1  Statement re Computation of Per Share Earnings.
 
  21.1  Subsidiaries of the Registrant.
 
  23.1  Consent of Price Waterhouse LLP.
 
  27.1  Financial Data Schedule. 
      
--------
* Confidential portions omitted and filed separately with the Securities and
  Exchange Commission.
 
                                       47
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNDER DULY AUTHORIZED.
 
                                          DePuy, Inc.
 
March 28, 1997                            By:        /s/ James A. Lent
                                             ----------------------------------
                                                       JAMES A. LENT
                                               CHAIRMAN AND CHIEF EXECUTIVE
                                                          OFFICER
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
              SIGNATURE                        TITLE                 DATE
 
 
          /s/ James A. Lent            Chairman and Chief       March 28, 1997
_____________________________________   Executive Officer
            JAMES A. LENT
 
      /s/ Thomas J. Oberhausen         Senior Vice              March 28, 1997
_____________________________________   President and Chief
        THOMAS J. OBERHAUSEN            Financial and
                                        Accounting Officer
 
       /s/ Richard C. Bolesky          Director                 March 28, 1997
_____________________________________
         RICHARD C. BOLESKY
 
      /s/ Richard A. Gilleland         Director                 March 28, 1997
_____________________________________
        RICHARD A. GILLELAND
 
         /s/ Gerald C. Hanes           Director                 March 28, 1997
_____________________________________
           GERALD C. HANES
 
         /s/ M.L. Lowenkron            Director                 March 28, 1997
_____________________________________
           M.L. LOWENKRON
 
                                       Director                 March   , 1997
_____________________________________
          ROBERT VOLZ, M.D.
 
        /s/ Anthony Williams           Director                 March 28, 1997
_____________________________________
          ANTHONY WILLIAMS
 
                                      48
<PAGE>
 
                                                                     SCHEDULE II
 
                                  DEPUY, INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
DESCRIPTION                               ADDITIONS
-----------                         ----------------------                       
                                                           DEDUCTIONS            
                         BALANCE AT CHARGED TO CHARGED TO  BAD DEBTS  BALANCE AT 
                         BEGINNING  COSTS AND     OTHER     WRITTEN     END OF   
                         OF PERIOD   EXPENSES  ACCOUNTS(A)    OFF       PERIOD   
                         ---------- ---------- ----------- ---------- ---------- 
<S>                      <C>        <C>        <C>         <C>        <C>        
Allowance for doubtful
 accounts:
For the year ended
 December 31, 1996......   $6,628     $2,973      $466      $(1,533)    $8,534
For the year ended
 December 31, 1995......    5,677      1,863         9         (921)     6,628
For the year ended
 December 31, 1994......    4,004      1,927         9         (263)     5,677
Deferred tax valuation
 allowances:
For the year ended
 December 31, 1996......   $  902     $1,852      $--       $   --      $2,754
For the year ended
 December 31, 1995......      333        569       --           --         902
For the year ended
 December 31, 1994......      --         333       --           --         333
</TABLE>
--------
(a) Recovery of amounts previously written off.
 
                                      S-1
<PAGE>
 
                                 EXHIBIT INDEX
 
 EXHIBIT NO.                       DESCRIPTION
 
   3.1  Articles of Incorporation of the Company, incorporated by reference
        to Exhibit 3.1 of the Company's Registration Statement on Form S-1
        (Registration No. 333-09345).
 
   3.2  By-laws of the Company, incorporated by reference to Exhibit 3.2 of
        the Company's Registration Statement on Form S-1 (Registration No.
        333-09345).
 
  10.1  Employment Agreement, dated May 1, 1996, between Jim Lent and DePuy
        Inc., incorporated by reference to Exhibit 10.1 of the Company's
        Registration Statement on Form S-1 (Registration No. 333-09345).
 
  10.2  Employment Agreement, dated July 13, 1992, between Michael J. Dormer
        and DePuy Inc., incorporated by reference to Exhibit 10.2 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.3  Employment Agreement, dated May 1, 1996, between Michael J. Dormer
        and DePuy International Limited, incorporated by reference to Exhibit
        10.3 of the Company's Registration Statement on Form S-1
        (Registration No. 333-09345).
 
  10.4  Employment Agreement, dated May 1, 1996, between R. Michael McCaffrey
        and DePuy Inc., incorporated by reference to Exhibit 10.4 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.5  Employment Agreement, dated May 1, 1996, between William E. Tidmore
        and DePuy Inc., incorporated by reference to Exhibit 10.5 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.6  Employment Agreement, dated May 1, 1996, between Robert E. Morel and
        DePuy Inc., incorporated by reference to Exhibit 10.6 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.7  Employment Agreement, dated May 1, 1996, between Steve L. Artusi and
        DePuy Inc., incorporated by reference to Exhibit 10.7 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.8  Employment Agreement, dated May 1, 1996, between Thomas J. Oberhausen
        and DePuy Inc., incorporated by reference to Exhibit 10.8 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.9  Employment Agreement, dated May 1, 1996, between G. Taylor Seward and
        DePuy Inc., incorporated by reference to Exhibit 10.9 of the
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).
 
  10.10 DePuy, Inc. 1996 Equity Incentive Plan.
      
 
  10.11 DePuy, Inc. Employee Stock Option/Purchase Plan.
      
 
  10.12 DePuy, Inc. Senior Executive Incentive Compensation Plan.
      
 
  10.13 Corange Limited Incentive and Performance Plan--Executive          
        Remuneration, incorporated by reference to Exhibit 10.21 of the    
        Company's Registration Statement on Form S-1 (Registration No. 333-
        09345).                                                             
      
 
  10.14 DePuy, Inc. and DePuy International Limited Orthopaedic Extra-       
        Compensation Opportunity, incorporated by reference to Exhibit 10.22 
        of the Company's Registration Statement on Form S-1 (Registration No.
        333-09345).                                                           
      
 
  10.15 DePuy, Inc. Supplemental Retirement Plan (Plan No. 1) (As Amended and
        Restated Effective as of October 1, 1996).                            
      
<PAGE>
 
  10.16 DePuy, Inc. Supplemental Retirement Plan (Plan No. 2) (As Amended and
        Restated Effective as of October 1, 1996).                            
      
 
  10.17 Trust Deed, dated July 1, 1993, between DePuy International Limited
        and George Taylor Seward and Others, incorporated by reference to  
        Exhibit 10.25 of the Company's Registration Statement on Form S-1  
        (Registration No. 333-09345).                                       
      
 
  10.18 Deed of Appointment and Retirement for the DePuy Executive Retirement
        Benefits Scheme, dated January 23, 1996, between DePuy International 
        Limited and George Taylor Seward and Others, incorporated by         
        reference to Exhibit 10.26 of the Company's Registration Statement on
        Form S-1 (Registration No. 333-09345).                                
      
 
  10.19 DePuy, Inc. 1996 Incentive Planning and Special Recognition Program,
        incorporated by reference to Exhibit 10.27 of the Company's         
        Registration Statement on Form S-1 (Registration No. 333-09345).     
      
 
  10.20 DePuy, Inc. Excess Retirement Plan (As Amended and in Effect as of
        October 1, 1996).                                                  
      
 
  10.21 Tax Allocation and Indemnity Agreement, dated October 30, 1996,  
        between the Company, Boehringer Mannheim Corporation and Corange
        Limited.                                                         
      
  
  10.22 Registration Rights Agreement, dated October 30, 1996, between       
        Corange Limited, Corange International Limited, Corange International
        Holdings B.V., Pharminvest S.A., and the Company.                     
      
 
  10.23 Second License Agreement, dated July 24, 1979, by and between        
        Biomedical Engineering Corp. and DePuy Division of Bio-Dynamics, Inc,
        incorporated by reference to Exhibit 10.14 of the Company's          
        Registration Statement on Form S-1 (Registration No. 333-09345).*     
      
 
  10.24 Amendment to Second License Agreement, dated March 25, 1985, by and  
        between Biomedical Engineering Trust and DePuy, Division of          
        Boehringer Mannheim Corporation, incorporated by reference to Exhibit
        10.15 of the Company's Registration Statement on Form S-1            
        (Registration No. 333-09345).*                                        
      
 
  10.25 Purchase Agreement, dated June 1, 1995, by and between Columbia/HCA
        Healthcare Corporation and DePuy Inc., incorporated by reference to
        Exhibit 10.16 of the Company's Registration Statement on Form S-1  
        (Registration No. 333-09345).*                                      
      
 
  10.26 Letter Agreement, dated July 3, 1995, by and between Columbia/HCA  
        Healthcare Corporation and DePuy Inc., incorporated by reference to
        Exhibit 10.17 of the Company's Registration Statement on Form S-1  
        (Registration No. 333-09345).*                                      
      
 
  10.27 Purchase Agreement, dated August 15, 1995, by and between             
        Columbia/HCA Healthcare Corporation and DePuy Inc., incorporated by   
        reference to Exhibit 10.18 of the Company's Registration Statement on 
        Form S-1 (Registration No. 333-09345).*                                
      
 
  10.28 Purchase Agreement, dated June 15, 1995, by and between Columbia/HCA
        Healthcare Corporation and DePuy Inc., incorporated by reference to 
        Exhibit 10.19 of the Company's Registration Statement on Form S-1   
        (Registration No. 333-09345).*                                       
      
 
  10.29 Joint Venture Agreement, dated February 4, 1993, by and among DePuy  
        Inc., Biedermann Motech GmbH and Lutz Biedermann, incorporated by    
        reference to Exhibit 10.20 of the Company's Registration Statement on
        Form S-1 (Registration No. 333-09345).*                               
      
 
  11.1  Statement re Computation of Per Share Earnings.
 
  21.1  Subsidiaries of the Registrant.
 
  23.1  Consent of Price Waterhouse LLP.
 
  27.1  Financial Data Schedule.
--------
* Confidential portions omitted and filed separately with the Securities and
  Exchange Commission.