.                                UNITED STATES
                     SECURITIES AND EXCHANGE COMMISSION
                           WASHINGTON, D.C.  20549

                                FORM 10-K
(Mark One)

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

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 (NO FEE REQUIRED)

For the transition period from             to

                  Commission file number      33-69286

                    WRIGHT MEDICAL TECHNOLOGY, INC.
        (Exact name of registrant as specified in its charter)

                Delaware                               62-1532765
    (State or other jurisdiction                   (I.R.S. employer
     of incorporation or organization)              identification no.)

 5677 Airline Road, Arlington, Tennessee              38002
(Address of principal executive offices)           (Zip Code)

Registrant's telephone number, including area code       (901) 867-9971

Securities registered pursuant to Section 12(b) of the Securities Exchange
Act of 1934:  None

Securities registered pursuant to Section 12(g) of the Securities Exchange
Act of 1934:  None

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

         The  registrant  has no publicly  traded equity  securities,  no market
quotations  are  available  and  accordingly,  information  is not provided with
respect to the aggregate market value of voting stock held by  non-affiliates of
the registrant.

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

         As of March 18, 1997 the registrant had 9,199,025 shares outstanding of
Class A Common Stock, $0.001 par value per share.

              DOCUMENTS INCORPORATED BY REFERENCE.  None

                                                      Page 1 of 105

<PAGE>




                                                     TABLE OF CONTENTS
                                                                           Page

PART I
         Item 1.           Business
                                    Overview..................................3
                                    Market Overview...........................4
                                    Principal Products........................6
                                    Biologic Product Opportunities...........10
                                    Marketing and Distribution...............12
                                    Competition..............................13
                                    Manufacturing and Quality Control........14
                                    Government Regulations...................14
                                    Research and Product Development.........16
                                    Principal Customers......................17
                                    Raw Materials............................18
                                    Environmental............................18
                                    Insurance................................18
                                    Patents and Trademarks...................19
                                    Royalty and Other Payments...............19
                                    Seasonality..............................19
                                    Employees................................19
         Item 2.           Properties........................................19
         Item 3.           Legal Proceedings.................................20
         Item 4.           Submission of Matters to a Vote of Security
                           Holders...........................................21

PART II
         Item 5.           Market for Registrant's Common Equity and Related
                           Stockholder Matters...............................22
         Item 6.           Selected Financial Data...........................23
         Item 7.           Management's Discussion and Analysis of Financial
                           Condition and Results of Operations...............24
         Item 8.           Financial Statements and Supplementary Data.......31
         Item 9.           Changes in and Disagreements with Accountants on
                           Accounting and Financial Disclosure...............31
PART III
         Item 10.          Directors and Executive Officers of the
                           Registrant........................................32
         Item 11.          Executive Compensation............................35
         Item 12.          Security Ownership of Certain Beneficial Owners
                           and Management ...................................41
         Item 13.          Certain Relationships and Related Transactions....44

PART IV
         Item 14.          Exhibits, Financial Statement Schedules and
                           Reports on Form 8-K...............................48


                                                      Page 2 of 105

<PAGE>



                                                         PART I.


ITEM 1.           BUSINESS.

Overview

         Wright Medical Technology,  Inc., a Delaware corporation  (collectively
with its subsidiaries, the "Company") is a designer,  manufacturer and worldwide
distributor   of   orthopaedic   implant   devices   and   instrumentation   for
reconstruction and fixation.  Reconstructive  devices are for joint arthroplasty
that involve the replacement  with mechanical  substitutes of impaired  skeletal
joints such as knees, hips, shoulders,  and the small joints of the elbow, hands
and feet. The Company also offers devices for 1) fracture fixation due to trauma
2) arthroscopic surgery of the knee, shoulder and extremities,  and 3) the spine
to aid in correction of deformity and instability.  In addition,  the Company is
developing a wide range of new  biological  products  that are designed to solve
orthopaedic  problems  by, in some  cases,  delaying or  obviating  the need for
traditional orthopaedic solutions.  The Company's business strategy is to design
and  develop  unique  and  innovative  products  to solve  clinical  orthopaedic
problems.  The Company was founded to acquire,  in July 1993,  substantially all
the assets of the large joint orthopaedic implant business of Dow Corning Wright
Corporation,  a subsidiary of Dow Corning Corporation  (collectively  "DCW")(the
"Acquisition").

         In  furtherance  of its  commitment  to find  innovative  solutions  to
orthopaedic  problems,  the Company 1) entered into a joint venture agreement in
mid 1996 with  Tissue  Engineering,  Inc.  ("TE  Inc.") a Boston,  Massachusetts
company  that  develops   collagen-based   scaffolds  for  ligament  and  tendon
reconstruction   and  other  orthopaedic   applications  and  2)  purchased  the
biomaterials business of the Industrial Division of United States Gypsum Company
("USG"), a subsidiary of USG Corporation, which had manufactured and licensed to
the Company  its  OSTEOSET(TM)  medical  grade  calcium  sulfate  product.  With
OSTEOSET(TM)  bone  void  filler  now  approved  by  the U.  S.  Food  and  Drug
Administration  ("FDA"), the Company can offer the medical community a specially
formulated medical grade calcium sulfate, that surgeons may use to treat defects
in  long  bones  caused  by  surgery,  tumors,  trauma,  implant  revisions  and
infections  without  questions of  biological  transfer of viruses and diseases.
Biological  skeletal  repair  is a new  area of  orthopaedics  that  offers  the
possibility of novel treatments for  musculoskeletal  injuries and defects using
the body's own healing responses.

         The Company's  headquarters,  manufacturing and distribution facilities
are located in Arlington,  Tennessee.  Products are  distributed  throughout the
world  through a  combination  of  distributors  and wholly owned  subsidiaries.
Principal  markets  include  the  United  States,  Canada,  Japan,  France,  and
Australia.

         Unless the  context  otherwise  requires,  the term  "Company"  as used
herein refers to Wright Medical Technology, Inc. and its subsidiaries.

         Throughout  this  document,  products are discussed  that are currently
under  development  or, for which  clearance by the FDA (or  applicable  foreign
regulatory clearance) has not been received. The Company can give no

                                                      Page 3 of 105

<PAGE>



assurance  that any of these  products will in fact be  successfully  developed,
that the  necessary  FDA or  foreign  approvals  will be  received  or that,  if
developed and approved, a market for these products will exist.

         This  document  contains  forecasts and  projections  that are forward-
looking  statements and are based on  management's  current  expectations of the
Company's near term results,  based on current information  available pertaining
to the Company. Actual future results and trends may differ materially depending
on a variety of factors,  including competition in the marketplace,  demographic
trends,  product  research  and  development,  and  other  factors.  Results  of
operations  in the  industry  generally  show a seasonal  pattern,  as customers
reduce shipments during the warm weather months.


Market Overview

         Demographic  Trends.  The United States population over 65 years of age
continues  to grow as a  percentage  of the total  population.  The aging of the
population is  significant in that  approximately  70% of all joint implants are
for patients over 65 years of age.  Osteoarthritis  (degenerative joint disease)
affects  over  15  million  people  in the  United  States  and  is the  primary
indication for orthopaedic implants.  Management believes that as the population
ages, the incidence of osteoarthritis and other ailments will increase and, as a
consequence,  the demand for orthopaedic  implants and new solutions for medical
problems  requiring  orthopaedic  applications  should  rise.  The  incidence of
rheumatoid  arthritis,  another major  disease  leading to the need for implants
that currently affects over two million people, may also increase with the aging
of the population.  Management  believes that another factor affecting growth of
implant use is the increasingly active lifestyle of many older Americans. A more
active lifestyle not only accelerates the joint degeneration  process,  but also
increases the expectations that people have of their bodies.  Joint degeneration
leads to pain and decreased mobility, while active lifestyles also may result in
more sports-related  traumatic injuries.  As a result, the Company believes that
the need for new and innovative orthopaedic solutions will continue to grow.

         Large Joint Orthopaedic  Implant Market.  Since its introduction in the
early  1960's,  total  large  joint  replacement  (knees,  hips  and  shoulders)
utilizing  orthopaedic  implants has grown rapidly to become the largest segment
of the global orthopaedic implant market. Over the last ten years, the number of
total joint  procedures  performed to replace  arthritic  or damaged  joints has
increased  steadily.  As a result of managed care, the industry has  experienced
pricing  pressures  over the past few years which has  stabilized or reduced the
average price of an implant per procedure.  Nevertheless,  the Company  believes
that the number of knee and hip replacement  procedures  performed in the United
States will continue to increase.  Management expects that revision  procedures,
in which new implants replace existing knee and hip implants, will contribute to
future industry growth.  Management believes that the Company is well positioned
in the  expanding  primary and revision knee markets with its  ADVANTIM(R)  Knee
System,  AXIOM(R)  Knee System and its new  ADVANCE(TM)  Knee System.  While the
market for hip procedures is growing at a smaller rate,  management believes the
Company is positioned to increase  market share in that segment  especially with
its  PERFECTA(R)  Hip System  acquired  in the  acquisition  of  Orthomet,  Inc.
("Orthomet") and with its new product offerings for surface

                                                      Page 4 of 105

<PAGE>



replacement and alternative bearing surfaces such as metal-on-metal and
ceramic-on-ceramic.

         Small Joint  Orthopaedic  Implant Market.  The small joint  orthopaedic
implant market includes implants for hands, feet, elbow, and wrists. The Company
believes that the annual number of finger and toe joints implanted in the United
States dropped  significantly  in 1993 (at the height of market concerns related
to silicone products),  but has subsequently  rebounded.  Sales and marketing of
small joint implants involves targeted efforts to specific groups of physicians.
Approximately 1,000 orthopaedic hand specialists and 600 plastic surgeons employ
hand and wrist implants and  approximately  500 orthopaedic foot specialists and
7,000 podiatric surgeons perform foot procedures.  The Company  anticipates that
the market for small joint  orthopaedic  implants  will grow in the near term as
the elderly population continues to grow.

         Trauma. Devices for trauma applications are one of the largest segments
of the orthopaedic  market.  Current market estimates place domestic revenue for
1996 in  excess  of $711  million.  Management  believes  that a  number  of its
fracture  fixation  products,  such as the  CONCISE(TM)  Compression  Hip  Screw
System,  the Medoff Sliding Plate,  the TYLOK(TM) High Tension  Cerclage Cabling
System and the CANNULATED  PLUS(TM) Screw System, are innovative and will enable
the Company to gain market share in one of orthopaedics' most stable markets. In
addition, the Company has plans to introduce in 1997 its innovative and patented
Magellan(TM)  Intramedullary  Nailing  System which will  provide  access to the
lucrative long bone trauma fixation market, and an external fixation system.

         Arthroscopy.  The desire for less  invasive  surgical  procedures  that
results in shortened  hospital stays,  quicker  recovery times, and less patient
discomfort  has also  resulted in  arthroscopic  procedures  becoming one of the
fastest growing  segments of the  orthopaedic  market.  The current  arthroscopy
market in the United  States is estimated to be in excess of $131 million with a
growth rate of  approximately  8% over prior year.  Today's typical  arthroscopy
procedure requires minimal operating room time and little or no hospitalization,
with approximately 65 percent of such procedures  occurring outside the hospital
setting.  As a result,  third party payors,  patients and their  physicians have
embraced  the use of  minimally  invasive  procedures  with  significant  growth
expected to continue.  The Company's  introduction into this market came in 1995
with the sale of the QUESTUS(TM)  LEADING  EDGE(TM)  Sheathed Knives and Grasper
Cutter,  and its patented  ANCHORLOK(TM)  soft tissue anchor.  In addition,  the
Company is developing what it believes will be a novel system of instrumentation
for repair of the  anterior  cruciate  ligament,  the  injury  which is the most
common orthopaedic injury in younger patients.

         Spine.  Current estimates are that  approximately 80% of the population
will experience  back pain at some point in their adult lives.  Back pain is the
second most frequent reason that people visit their physician and is the leading
cause of missed work days.  Although a majority of patients  are treated  with a
combination of non-surgical  treatments,  over 700,000  surgical back procedures
are performed in the U.S. each year. In 1996, this market grew approximately 20%
over prior  year.  Historically,  the spinal  implant  market has  increased  at
approximately 15% since the late 1980's making it

                                                      Page 5 of 105

<PAGE>



one of the highest growth areas in  orthopaedics.  With the introduction in late
1995 of the  WRIGHTLOCK(TM)  posterior  fixation system and  introduction of the
VERSALOK(TM) low back system,  currently underway, the Company believes it has a
superior   system  for   correcting   scoliosis  and  certain  types  of  spinal
instability.  The Company expects to introduce an innovative  anterior  cervical
plating system later in 1997.

Principal Products

         The  Company's   revenues  are  derived  primarily  from  the  sale  of
orthopaedic implant devices for reconstruction and fixation.

Reconstructive Knee Products

         The Company  currently  markets  several  reconstructive  knee  systems
including the AXIOM(TM)  Total Knee System (the "Axiom Knee"),  the  ADVANTIM(R)
Total Knee System (the "Advantim  Knee"),  and the ADVANCE(TM) Total Knee System
(the  "ADVANCE  Knee").  Each of these  systems is  designed  to  duplicate  the
anatomical function of the patient's knee, thereby improving its range of motion
and  stability.  In a typical  knee  replacement,  the  surgeon  may replace the
articulating surfaces of the knee: the knee cap (patella),  top of the shin bone
(tibia) and bottom of the thigh bone (femur).  In a total knee  replacement  the
surgeon   can  choose  to  leave  the   posterior   cruciate   ligament   intact
(necessitating   a  PCL  sparing  knee   component)   or  remove  that  ligament
(necessitating a posterior stabilized knee component).

         In early 1995, the Company entered into a product  licensing  agreement
with the  Hospital  for Special  Surgery  ("HSS") to develop a new  standard for
primary  posterior  stabilized  total  knee  arthroplasty.  With  over 20  years
experience in designing  total knee  replacements,  the HSS team of surgeons and
engineers  working  with the  Company  developed  the ADVANCE  Knee.  The design
reduces  stress  and  enhances  implant  survivorship  while  still  maintaining
rotational freedom.  Further,  the biomechanics of the ADVANCE Knee design allow
for a greater range of motion than traditional posterior stabilized knees. There
are many key design  advantages.  The Company  believes that the ADVANCE Knee is
one of the most advanced  posterior  stabilized knee systems on the market.  The
Company  anticipates  introducing the PCL sparing components of the ADVANCE Knee
in late 1997.

         Since its  formation,  the  Company  has been  committed  to  ultrahigh
molecular weight polyethylene research and development. As a result, the Company
developed DURAMER(TM) EtO Sterilized polyethylene which eliminates the incidence
of  gamma-induced  oxidation and  associated  poly wear in the joint.  There are
essentially no levels of EtO left in the Company's products after sterilization.
Products are aerated until the EtO is dissipated  and any amounts  remaining are
at least ten times lower than what is considered safe by the FDA.

         The Company's  primary knee product is the Advantim  Knee,  designed to
address the needs of the high demand patient. It has almost 15 years of clinical
success.





                                                      Page 6 of 105

<PAGE>



Reconstructive Hip Products

         The Company currently  markets a wide choice of hip products  including
those with brand names of  PERFECTA(R),  EXTEND(TM),  INFINITY(R),  NEXUS(R) II,
BRIDGE(R),  and the INTERSEAL(R)  Acetabular System. These systems are designed
to replace the natural hip joint. The Company's hip implants consist of the same
basic parts as the natural hip, including a femoral stem inserted into the femur
(thigh bone) with a spherical femoral head (ball) and an acetabular cup (socket)
on which the femoral head articulates. The Company's hip systems include several
different femoral stem designs and several  acetabular cup designs.  Each design
is  produced  in a  variety  of sizes for  either  low-  demand  or  high-demand
patients.  Surgeons have the option of  interchanging  stem, head and acetabular
cup designs to meet their own preferences and individual  patient  requirements.
The Company  also has  products  to address  hemi-arthroplasties  where only the
femoral component of the hip is replaced.  The femoral stems currently  marketed
by the Company are made of a titanium or cobalt  chrome alloy.  Acetabular  cups
are comprised of ultra high  molecular  weight  polyethylene  available  with or
without a metal backed shell with different  surfaces to enhance fixation to the
pelvis.

         The  Company's  femoral  stems are  offered in a variety  of  geometric
designs  and  in  smooth,   porous-coated   and  textured   surfaces   including
hydroxylapatite.  These  products  allow  for bone  on-growth,  bone  in-growth,
press-fit or cemented applications.

         The INTERSEAL(R)  Acetabular Cup is a system of titanium porous-coated
metal  shells  and  modular   liners   providing  the  surgeon  with   extensive
intraoperative flexibility. This product was introduced in 1995 and continues to
do well.  The  hemispherical  design  provides  rigid fixation at the rim with a
secure lock at the shell/liner interface. An apical hole in the shell allows the
surgeon to confirm  that the shell is  bottomed  out in the  pelvis,  and a plug
seals the hole from the  invasion of  particulate.  The system  also  features a
quadrant style shell featuring  optional screw fixation and  lateralized  liners
for revision cases. In 1996 a multiple hole cup for difficult revision cases and
liners with additional  inner-diameter choices were commercialized.  The Company
believes that the superior characteristics of the INTERSEAL(R) System will also
benefit the sales of its existing and newly released hip stems.

         The S.O.S.(TM),  or Segmented  Orthopaedic System, was created to offer
limb  salvage to the  patient  who  suffers  bone loss due to cancer,  trauma or
failed implants. The Company believes that the present system, which consists of
the Proximal  Femur System and the Distal Femur System,  is the only FDA cleared
product of its kind on the market.  The  Company is in the process of  expanding
this system to include a proximal tibia, total femur and total humerus.

         The Company has also  developed  three new innovative hip designs which
it plans to commercialize in 1997 under various FDA approval  processes.  First,
the CONSERVE(TM)  Hip System is a product  developed to replace only the surface
of  the  femoral  head  thereby  obviating  the  need  for a full  femoral  stem
prosthesis  which requires the removal of a great deal of the patient's  healthy
bone.  Second,  the Company has developed the TRANSCEND(TM)  metal-on- metal and
ceramic-on-ceramic  articulating surface systems (both products are awaiting FDA
approvals which may require clinical studies). The Company

                                                      Page 7 of 105

<PAGE>



believes that these systems,  which eliminate the use of a polyethylene  bearing
surface in the acetabular  component,  will provide advantages over conventional
hip systems due to anticipated reductions in wear debris.

         These product  lines should place the Company in an excellent  position
to sustain  rapid growth in primary and  revision  hip surgery,  as well as limb
salvage  cases.  The  products  allow the  orthopaedic  surgeon a wide  range of
material and design choices to solve the varied  medical  problems of individual
patients.

         Small  Joint and Upper  Extremity  Products.  Small  joint  orthopaedic
implants  have a long  clinical  history and over one million  devices have been
implanted  during  their  25-year  history.  Many of the  Company's  small joint
orthopaedic  implants were developed initially and patented by surgeon- inventor
Dr. Alfred  Swanson.  The Company has the exclusive  rights to use the surgeon's
name and patents.

         Most of the small joint  orthopaedic  implants being distributed by the
Company  are  manufactured  using  solid  silicone  elastomers  (known for their
fatigue strength,  tear-resistance and  biocompatibility),  and titanium that is
used to manufacture  protective  sleeves  (grommets) for some of these implants.
The balance of such small joint orthopaedic implants are manufactured  primarily
from  titanium and are commonly  used in more active  patients.  Key small joint
products include:

         Hand Implants.  Flexible one-piece hand implants are designed to
         help restore function to damaged or diseased small joints within
         the hand.  Key hand implants include the Swanson Flexible Hinge
         Finger Joint with grommets, the Swanson Titanium Basal Thumb
         Implant and the Swanson Trapezium Implant.

         Wrist Implants.  Wrist implants are designed to restore the
         anatomical relationship of the joint connecting the wrist and the
         hand.  Wrist implants include the Swanson Wrist Joint Implant
         with grommets, the Titanium Lunate Implant and the Titanium
         Scaphoid Implant.

         Foot Implants.  Foot implants are designed to replace damaged or
         diseased small joints found within the foot.  Principal products
         include the Swanson Titanium Great Toe Implant, the Hammertoe
         Implant, the Swanson Flexible Hinge Toe Implant with grommets and
         the Smith STA-Peg.

         Elbow Implants.  The Company recently introduced the Sorbie- Questor(R)
         Total  Elbow  System.   The  elbow's  design  promotes  accurate  joint
         tracking,   proportionate  distribution  of  load  forces  between  the
         humerus,  ulna and radius and the  replication  of the elbow's  natural
         anatomic structure.  The unique instrumentation  enhances results. This
         device was  developed  in  cooperation  with  Charles  Sorbie,  M.D., a
         well-known Canadian orthopaedic surgeon and inventor.

         The Company also  introduced the Swanson  Titanium Radial Head implant,
         an alternative to its silicone elastomer radial head implant.  The
         implant is manufactured from commercially pure titanium that features

                                                      Page 8 of 105

<PAGE>



         nitrogen ion implantation for increased surface  hardness.  The overall
         profile of the implant head is unchanged from the silicone  radial head
         implant design.

         Shoulder  Implants.  Shoulder  implants  are  designed  to replace  the
articulating  surfaces of the shoulder joint damaged  principally as a result of
osteoarthritis  and  trauma.  The  Company  distributes  the Neer II and Modular
shoulder prostheses manufactured by the 3M Corporation.

         Trauma.  Trauma  implants  encompass a wide variety of screws,  plates,
rods,  wires,  cables and pins all utilized to fix or support bone that has been
fractured due to accidental or surgically induced trauma. These devices serve to
orient and stabilize bone until healing can occur.  The CONCISE(TM)  Compression
Hip Screw System and the companion  Medoff Sliding Plate enable the  orthopaedic
surgeon to treat most types of proximal and supracondylar femoral fractures. The
TYLOK(TM)  High  Tension  Cerclage  Cabling  System  is used  for  fixation  and
stabilization  of long bone fractures and offers  distinct  advantages  over the
competitive  devices.  The stainless steel  CANNULATED  PLUS(TM) Screw System is
used for stabilization of fracture fragments.  The Company  expects to introduce
in the  third  quarter  of 1997, the first  components  (a femoral nail)  of its
Magellan(TM) Intramedullary  Nailing  System, a unique  modular  nailing  system
which allows  for  significant  inventory  reduction  compared  to other nailing
systems and a  unique  targeting  device  for  placement of  distal screws which
obviates the need for extended  x-ray  exposure for both  physician  and patient
in locating the distal screw holes in the nail.

         Arthroscopy.  Arthroscopic  products are a combination of both implants
and  instrumentation  that are utilized  through small  incisions in conjunction
with  visualization  (miniature  cameras) to repair  damaged  muscles,  tendons,
ligaments or other  connective or joint tissues.  The Company does not offer and
has no plans to offer the cameras and  visualization  systems that are routinely
used in arthroscopic  procedures.  Rather, it has determined to concentrate on a
limited line of innovative  instrumentation  to address problems in arthroscopy.
The Company  entered  the  arthroscopy  market in 1995 and has since  introduced
several new products. The QUESTUS(TM) LEADING EDGE(TM) Sheathed Knives including
the unique Grasper Cutter Knife, are a system of disposable sheathed knives that
allow precise resection of damaged tissues while greatly reducing the chance for
injury to normal structures.

         The  ANCHORLOK(TM)  Soft Tissue Anchors are used in a variety of joints
for  reattaching  ligaments  and  tendons  (or other soft  tissue) to bone where
tearing or  separation  has  occurred.  The  Company's  anchors  have a patented
self-tapping thread,  superior holding strength and can be removed easily giving
the surgeon more  surgical  options.  The Company plans to introduce in 1997 the
ANCHORLOK(TM) RL Soft Tissue Anchor, a lower cost version of the device which is
not prethreaded with sutures.

         The Company will also commence clinical  evaluation in 1997 of a unique
instrumentation  system for repair of the anterior  cruciate ligament damage for
which is the most common orthopaedic injury to younger patients.

         Spine.  The Company entered the spine instrumentation market in 1995
with the domestic and international introduction of the WRIGHTLOCK(TM)

                                                      Page 9 of 105

<PAGE>



posterior fixation system. The patented system, under license from Zimmer, Inc.,
is  indicated  for  scoliosis  and  spinal  instability,  and is based on a high
strength,  stainless steel rod technology with  Morse-taper  locking  mechanisms
that provide a low-profile  system. The profile (i.e. the height of the implant)
can be important in the scoliosis market that  principally  affects teenaged and
preteenaged girls.

         The Company has also received FDA clearance  for its  VERSALOK(TM)  low
back fixation system and began marketing the product on a limited basis. Working
with a select  group of spine  surgeons,  including  innovators  such as John R.
Johnson, M.D. and David Selby, M.D., the Company developed this surgeon friendly
low back fixation  system that features a  revolutionary  polyaxial screw with a
locking  design with no set screws and no locking nuts. The Company plans a full
introduction of its VERSALOK(TM) low back fixation system in 1997.

         In late 1996 the Company entered into an exclusive  agreement with Gary
K. Michelson, M.D. to develop an anterior cervical plating system. Michelson, an
innovative  spinal  surgeon and  inventor,  is well known as a developer of many
successful spine products.  Michelson's  plates,  used to help fuse the cervical
vertebrae,  are designed to be more  anatomically  correct  than  current  plate
options.  The system will utilize self tapping screws,  eliminating the need for
drilling or tapping.  The Company plans to commercially  introduce the Michelson
plating  system,  pending FDA clearance,  in 1997 - entering the Company into an
$87 million dollar worldwide cervical spine plate market.


Biologic Product Opportunities

         Because the  Company's  business  strategy  is to identify  and develop
unique  solutions  to  orthopaedic  problems,  the  Company  continues  to spend
substantial resources in the development of biologic products.

         Calcium Sulfate Bone Void Filler. In late 1996 the Company acquired the
biomaterials  business of USG. The business includes  patents,  technologies and
proprietary  processes  related  to the use of  medical  grade  calcium  sulfate
(gypsum) in the human body. Prior to the acquisition, the Company worked closely
with  USG  as  a  licensee  and  exclusive  orthopaedic   distributor  of  their
bioresorbable calcium sulfate materials. Under the terms of the acquisition, the
Company will continue to purchase the medical grade calcium sulfate raw material
from USG, but will now own the proprietary  process and technology  necessary to
create calcium sulfate  products for biomedical  applications.  USG spent twelve
years researching and developing gypsum  opportunities in the biomedical market.
While they are a world leader in the gypsum  industry,  the Company  believes it
has better  capabilities  to fully  commercialize  this  unique  technology  for
biomedical  applications.  The Company recently  received FDA clearance to begin
selling OSTEOSET(TM) bone void filler, its first calcium sulfate-based product.

         OSTEOSET(TM)  is the Company's  first entry into the bone graft market,
which is approaching  one-half  billion dollars  annually.  The Company plans to
offer other biological skeletal repair products in the near future. OSTEOSET(TM)
is currently offered in an "off the shelf" sterile pellet form.

                                                      Page 10 of 105

<PAGE>



Other  configurations  are  currently  under  development  and  should  soon  be
available to the market.

         Bone is the second most  implanted  material  in the body (after  blood
transfusions) and more than 300,000 bone graft procedures are completed annually
in the United  States.  Bone  grafts are used to repair bone  defects  caused by
surgery,  tumors, trauma,  implant revisions and infections,  and also for joint
fusion.

         The  preferred  method of treating  bone voids  involves the use of any
autologous  graft, in which bone is taken directly from the patient.  This graft
usually  achieves  good  results,  yet often  requires a second  surgery site to
retrieve  the graft.  This  second  harvesting  site is not only costly and time
consuming,  but  can  also be more  painful  to the  patient  than  the  primary
procedure.

         Currently,  the  second  most  common  bone  graft  alternative  is  an
allograft from a human bone bank which  generally  achieves  favorable  results.
This tissue has limited  applications  because of availability and, unless it is
demineralized,  it does little to induce new bone  growth.  The  possibility  of
viral  disease  transmission  is also a concern  even  though  the risk has been
reduced by sophisticated testing.

         The  third  alternative  for a  bone  graft  procedure  is  the  use of
artificial  substitutes.  The two  types of  substitutes  currently  on the U.S.
market are a  coral-based  product and a bovine  collagen-based  product.  These
substitutes provide a matrix in which bone can grow, but these types of implants
may remain  unchanged  within the patient's body for an extended  period of time
and in some cases may result in tissue irritation.

         Compared to the current alternatives,  OSTEOSET(TM) products provide an
ideal  bone void  filler  for many bone  grafting  procedures  because  they are
biocompatible  and  bioresorbable.  As a bioresorbable  material,  the body will
resorb  this  natural  substance  and  will  do so at a rate  comparable  to the
patient's  new bone  growth,  which  takes an  average  of four to eight  weeks.
OSTEOSET(TM)  material has also been shown to have  osteoconductive  properties.
This means that this material allows or encourages cells to generate bone in and
on its surfaces,  thus furthering the  effectiveness  of this material as a bone
void  filler.  Another  benefit is that the pellets can be seen on the x-ray and
become  their own  radiographic  marker to follow the course of  resorption  and
replacement of the graft by new bone.

         The properties of OSTEOSET(TM)  bone void filler make it attractive for
use in children and for  infected  sites.  Because  children do not have as much
available  bone stock as adults,  the surgeon may not be able to harvest  enough
bone from the  child and may need to add a  substitute.  Medical  grade  calcium
sulfate  pellets are ideal for this purpose.  Patients who have bone  infections
will also benefit from OSTEOSET(TM)'s  ability to be resorbed by the body. Other
bone graft substitutes which remain in the body for an extended period may serve
as agents or hosts to prolong the infection.  Since OSTEOSET(TM) pellets totally
resorb in four to eight  weeks  post-operation,  there is  nothing  on which the
infectious agents may reside or bind.

         The Company is also developing additional applications for its
OSTEOSET(TM) products.  Pending longer-term FDA approvals and approval in

                                                      Page 11 of 105

<PAGE>



foreign countries, OSTEOSET(TM) products may be mixed prior to implantation with
the  appropriate  drugs (which  would then be  delivered  locally as the product
resorbs)  such  as  antibiotics  to  be  used  to  treat  deep  bone  infections
(osteomyelitis), anti-neoplastic drugs to treat bone tumors or simply to deliver
medication to control pain.  Presently,  bone  infections  are treated by mixing
antibiotics  with  beads of  polymethylmethacrylate  bone  cement  that are then
implanted  inside  the bone at the site of the  bone  infection.  This is not an
ideal  treatment  method,  both  because  the  bone  cement  ceases  to  release
antibiotics in  therapeutic  doses within 72 hours after  implantation  (whereas
treatment of a bone  infection  often  requires six or more weeks of  antibiotic
treatment),  and because the bone cement  must  eventually  be removed  from the
infection site. The Company's research has shown that the calcium sulfate beads,
impregnated with antibiotics,  release the antibiotics over a multi-week period,
in steady therapeutic doses, while the calcium sulfate is resorbed.

         OsteoBiologics  Implants.  OsteoBiologics,  Inc., a San Antonio,  Texas
based  company  in  which  the  Company  has an  ownership  interest  as well as
distribution rights to certain orthopaedic  products,  is developing a series of
bioabsorbable,  polylactate  and  polyglycolic  acid implants that,  pending FDA
approvals,  may be  effective in a variety of uses  including:  as a bone growth
stimulant to aid spinal fusion; as a bone void filler; as a method to induce the
repair of articular  cartilage  defects (both focal defects and for resurfacing)
by growing  articular  cartilage in vivo; as a treatment for delayed  unions and
non-unions in fractures;  and the repair of bone voids  resulting from tumor and
cyst removal and from thinning bone.  OsteoBiologics  intends to seek regulatory
approval for its first  commercial  products,  the bone void  fillers,  in 1997.
OsteoBiologics  also has a unique patented  electronic  instrument for measuring
the physical  characteristics of soft tissue such as cartilage which employees a
reusable, sterilizable electronic hand piece and disposable probes. This product
is expected to be available for commercial  distribution  by the Company late in
1997.

         Collagen  based Tissue  Engineering.  The Company  entered into a joint
venture  agreement  in mid 1996 with  Tissue  Engineering,  Inc.  ("TE  Inc.") a
Boston,  Massachusetts company that develops  collagen-based  scaffolds used for
ligament and tendon reconstruction and for cartilage  regeneration.  The Company
is also  developing  a calcium  phosphate  based bone cement  which offers great
strength for fracture fixation and anchoring certain implants. The joint venture
company,  Orthopaedic  Tissue  Technology,  L.L.C., a Delaware limited liability
company,  will develop and distribute  biological  products for  musculoskeletal
applications.  The initial  technology  is designed to  reproduce  the events of
tissue formation.  Applications will include the treatment of medical conditions
involving disease, injury or deterioration of ligaments,  tendons,  cartilage or
bone and  sports  related  injuries.  Bioskeletal  repair  is a new  segment  of
orthopaedics that offers less invasive treatments for  musculoskeletal  injuries
and defects.  Orthopaedic Tissue Technology expects to begin trials of its first
products,  a biologically  engineered  ligament and a resorbable bone cement, in
1997.

Marketing and Distribution

         Overview and U.S. Marketing and Distribution.  The Company markets its
products in the United States through a network of 188 sales personnel,
including 47 distributors (the "Distributors") and 141 commissioned sales

                                                      Page 12 of 105

<PAGE>



representatives (collectively, the "Sales Organization"), serving every state in
the country. The Distributors,  who are mostly independent contractors,  and the
sales  representatives  sell the  Company's  orthopaedic  implants at commission
rates  that the  Company  believes  are  competitive  with  those  paid by other
orthopaedic manufacturers.

         In  early  1997,  the  Company  purchased  the  assets  of  one  of its
distributors,  Outcome Medical,  Inc., and its related companies ("OMI").  Those
related companies included two of the largest distributors of spinal devices for
one of the Company's competitors in the spinal device market, Sofamor-Danek. The
Company agreed to pay OMI for its assets over a three year period based in part,
and contingent upon, the achievement of certain sales goals in the territory. In
addition,  the Company contracted with all of OMI's salespeople and has provided
them with guaranteed  commissions  based upon sales goals.  The Company believes
that this transaction will give further support to the Company's expected growth
in sales of its spinal devices.

         Management   believes   that  the   Distributors   and  their   surgeon
relationships  are  a  critical   component  of  the  Company's   success.   For
distribution  purposes,  the Company divides the domestic market  geographically
into  46  territories,   each  of  which  is  controlled  by  a  Distributor  or
Distributors authorized to sell the Company's products.

         The  success  of  these  sales  professionals  depends  primarily  upon
high-quality   service   levels,   technical   proficiency  and  strong  surgeon
relationships.  As such, the Company's Sales Organization  undergoes significant
product and sales training with courses conducted throughout the year.

         The  Company  historically  has focused  its  marketing  efforts in the
United  States,   with  approximately  75%  of  the  Company's  revenue  derived
domestically over the past three years.

         International  Marketing and Distribution.  The Company's international
sales revenue  represented  approximately 25% of the Company's overall sales for
1996.  Management  intends to continue to expand its international  distribution
and  marketing   capabilities.   The  Company's   international   marketing  and
distribution is accomplished primarily through independent  distributors engaged
in distribution in Japan, South and Central America, Australia, Europe and Asia,
with the Company distributing products in France and Canada through wholly owned
subsidiaries.   Depending  on  the  market  size  and  conditions,  the  foreign
independent distributors are granted either exclusive or non-exclusive rights to
distribute the Company's products, with a majority being exclusive distributors.

Competition

         The orthopaedic implant industry is highly competitive and dominated by
a number of large  companies with more  resources than the Company.  Competitive
factors include service,  product design,  depth of product offering,  physician
recognition and price.  The Company believes its future success will depend upon
its ability to be  responsive  to the needs of its  customers  and on  continued
improvement and development of novel products designed not only to create better
solutions to orthopaedic problems, but

                                                      Page 13 of 105

<PAGE>



also to solve previously unaddressed orthopaedic problems.  The Company
believes the majority of the market share for the Company's products are
held by Biomet, Inc., Zimmer, Inc. (a subsidiary of Bristol-Myers Squibb
Company), Johnson & Johnson Professional, Inc. (a subsidiary of Johnson &
Johnson), Howmedica, Inc. (a subsidiary of Pfizer Inc.), DePuy (a subsidiary
of Corange), Smith & Nephew Orthopaedics, Inc. (a subsidiary of Smith &
Nephew Ltd.), Osteonics, Inc. (a subsidiary of Stryker Corporation), Sofamor
Danek Group, Inc. and Sulzer Orthopaedics, Inc. (a subsidiary of
Sulzermedica).

         With respect to large joint implants  (hips and knees) the  competitors
listed above  represent  approximately  94% of the hip implant market and 92% of
the knee implant  market.  In  addition,  there are several  manufacturers  that
compete only in the global small joint orthopaedic implant market. The Company's
most significant competitor in this market has less than a 10% market share.

Manufacturing and Quality Control

         Almost all of the Company's  orthopaedic  implants and  instruments are
manufactured at its headquarters in Arlington,  Tennessee,  and through a select
group  of  qualified  contract   manufacturers.   The  Company's   manufacturing
operations  are  subject  to Good  Manufacturing  Practices  ("GMP")  and  other
regulations  stipulated by the FDA and other relevant regulatory  organizations,
such as the Environmental  Protection Agency ("EPA") and Occupational Safety and
Health Agency ("OSHA"),  and similar state and foreign agencies and authorities.
In early 1997,  the  Company's  facilities  were  inspected  and cleared for GMP
compliance by the FDA.

         In  December  of  1995,   the  Company's   research  and   development,
manufacturing,  and  distribution  operations  became certified to the standards
established by the International Standards Organization ("ISO"). This "ISO 9000"
certification  and process  assures a level of product quality by regulating the
processes of product  development and manufacturing.  Approximately 80 countries
have currently adopted ISO 9000 for medical products,  thereby enabling ISO 9000
registered  companies  to sell their  products  in these  countries  without the
additional burden of individual country  regulation.  Manufacturers so certified
are recognized by the European Economic  Community as maintaining high levels of
quality in products and service and their products are granted the CE mark which
permits their importation into and sale within the European Economic  Community.
The renewal of ISO certification occurs annually via an on-site inspection by an
authority  of  the  European  Economic  Community.  The  Company  retained  ISO
certification  after  the  1996  audit  and has applied CE marks to many key
products.

         The   Company   utilizes   comprehensive,    integrated   systems   for
manufacturing,   planning,   scheduling,   in-process  testing,  inspection  and
measuring of all implants and components.  The Company's current facilities have
sufficient  capacity to meet its projected,  near-term growth of its orthopaedic
implant and instrument business.

Government Regulations

         The Company and  substantially  all of its  products are subject to the
provisions of the Federal Food, Drug and Cosmetic Act of 1976, as amended by

                                                      Page 14 of 105

<PAGE>



the Medical  Device  Amendments of 1976 and the Safe Medical Device Act of 1990,
as amended in 1992 (the "Safe Medical Device Act").  The Company also is subject
to various foreign laws governing medical devices.  All of these regulations are
designed to ensure the safety and effectiveness of medical devices. In addition,
certain of these  regulations  require the Company to maintain certain standards
and procedures with respect to the manufacturing  and labeling of products.  All
of the Company's records and manufacturing  facilities are subject to inspection
on a regular basis by the FDA. The Company's  facilities  were  inspected by the
FDA in early 1997.  The different  levels of FDA  compliance  include:  Official
Action  Indicated  (OAI),  Voluntary  Action  Indicated  (VAI),  and  No  Action
Indicated  (NAI).  Companies that receive an OAI may have official  action taken
against them including  product approval delays,  products taken off the market,
seizing of their products,  heavy fines or imprisonment.  Companies that receive
VAI have  voluntarily  agreed to correct  any  problems  the FDA has found.  The
Company  fit into the NAI  category  which  means  that the FDA  inspectors  had
confidence that the Company is manufacturing  its products within GMP guidelines
and saw complete regulatory compliance within the Company.

         The FDA  classifies  medical  devices  as Class  I, II or III.  Class I
devices generally do not require pre-marketing  approval.  In general,  Class II
and III devices  require  pre-market  FDA  approval  unless they are found to be
"substantially equivalent" to products already in the market. For "substantially
equivalent" products, the provisions of Section 510(k) of the Federal Food, Drug
and Cosmetic Act provide for an exemption to the pre- market  approval  process.
The Company's  orthopaedic  implants are generally Class II devices.  All of the
Company's  Class II devices being  marketed are cleared for marketing  under the
provisions of Section  510(k).  The Company  currently  manufactures no approved
Class III devices,  which require more extensive FDA approvals.  However, as the
Company  designs and develops more novel medical  devices,  the Company may have
difficulty in  establishing  that such device is  "substantially  equivalent" to
another  legally  marketed  device and  thereby  may be unable to obtain  510(k)
clearance to market a new product. The Company intends to pursue the manufacture
of Class III devices,  which would  require  extensive FDA  pre-market  approval
before commercial distribution. There can be no assurance that the Company would
be successful in obtaining regulatory approval of such Class III devices.

         At any given time, the Company has a number of medical devices that are
in various  stages of  development,  and  therefore,  subject  to FDA  clearance
procedures that may cause delays in the  commercialization of these devices. Any
future  devices  developed  by the  Company  are  likely  to be  subject  to FDA
registration,  notification, pre-market approval, performance standards or other
FDA controls that could have an adverse effect on the  commercialization of such
products.  Additionally, any changes in FDA or foreign medical device laws could
impose new regulatory burdens on medical device sales.

         During 1996 the Company  received 510(k)  clearance on 14 new products.
In addition,  the Company  received  regulatory  approval  (SHONINS) in Japan to
distribute key products.  The Company also enhanced its quality  control process
by  establishing  a  pre-production   quality  assurance  program.  The  Company
converted  to  the new GMP standards and to  the  new  Medical  Device Reposring
regulations.  No product recalls were experienced during 1996.


                                                      Page 15 of 105

<PAGE>



         The Safe  Medical  Device Act grants the FDA the  authority  to require
manufacturers to conduct post-market surveillance on most permanent implants and
devices that potentially present a serious risk to human health. The FDA is also
given the authority to require  manufacturers of certain devices to adopt device
tracking methods to enable patients to receive  required  notices  pertaining to
the devices they receive.  Such tracking requirements may increase the Company's
administrative procedures relating to the sale of many of the Company's implants
should the FDA  require  post-market  surveillance  of the  Company's  products.
Despite  the fact that the FDA has not yet  promulgated  all of the  regulations
needed to fully  implement  the Safe  Medical  Device Act,  the Company does not
believe  compliance  with that act will have a  material  adverse  affect on the
Company or its operations.

Research and Product Development

         The Company's research and development  activities and capabilities are
located primarily in Arlington, Tennessee. There is a small development activity
for  arthroscopy   products  at  Questus   Technologies,   Inc.  in  Marblehead,
Massachusetts  and a small  development  activity for the medical  grade calcium
sulfate products in Libertyville,  Illinois.  Both are in leased space.  Over 78
employees   are  active  in  the  areas  of  Applied   Research,   Biomechanical
Engineering,  Materials Testing and Analysis, Advanced Manufacturing Technology,
Implants and Instrument Development  Techniques,  Research,  Product Development
and New Technology Exploration. The Company's applied technology group maintains
laboratories capable of performing materials  characterization,  product testing
and  evaluation  in  simulated  clinical  use  environments,  including  fatigue
testing, wear testing and materials analysis.

         In  addition  to  classic  laboratory  testing  and  evaluation  of new
products and technologies, the Company conducts pre-clinical studies at a number
of university  and medical  center  locations,  as well as clinical  research to
evaluate the success and outcome of new products and  technologies.  The Company
maintains  consulting  relationships  with over 40  individuals  and has  active
testing or evaluation programs at 10 research institutions.

         The Company believes that custom implants built to prescription  from a
surgeon,  serve as a specific treatment for a patient,  but also help to explore
new and innovative products for general use. For example,  initially designed as
a  custom  implant  for  limb  salvage,   the  Company's  S.O.S.(R)   (Segmented
Orthopaedic  System) now has wide spread  application for oncology  patients and
severe  revision  cases.  During  1996 the  Company  shipped  approximately  250
individual patient devices,  with an average time of manufacture of less than 20
days. In addition to custom implants,  the Company  provided  surgeons with many
options for custom instrumentation to facilitate their surgical techniques.

         In 1996 the Company  created a biological  products  development  group
within its research and development area to focus on biological products.

         Major  products  that the Company  believes  will be introduced in 1997
are:

              The MAGELLAN(TM) Femoral Nail which has both an innovative product

                                                      Page 16 of 105

<PAGE>



         design,  including proximal  modularity,  and a breakthrough  targeting
         device  for the distal  interlocking  screws  that does not  require an
         x-ray or C-arm fluoroscope procedure.  Tibial and Humeral nails for the
         system are expected to be launched late in 1997.

                  The Orthomatrix(TM) External Fixator for the distal radius and
         hand area, with a fracture  alignment table to facilitate  reduction of
         the fractures and assist in alignment of the bones.

                  A   tri-modular   shoulder   that  will  allow  broader  based
         indications  in trauma and revision  shoulders and greater  flexibility
         for the surgeon to match the implant to the patients needs.

                  The TRANSCEND(TM) Hip System incorporating alternative bearing
         surfaces in the total hip area including metal-on-metal and ceramic-on-
         ceramic combinations. An IDE study on ceramic-on-ceramic is anticipated
         to  commence  in 1997.  Clinical  study of the metal-on-metal total hip
         product is also expected.

                  The CONSERVE(R) Hip System for resurfacing the femoral head of
         patients  thereby  delaying the time when a total hip  arthroplasty  is
         required.

                  A new PCL Sparing ADVANCE(TM) Knee, a Medial Pivot ADVANCE(TM)
         Knee and the development for evaluation of a Mobile Bearing Knee.

                An Anterior Cervical Plate System and the Intervertebral Spacer.

                The Actalon(R) Probe soft tissue measuring device.

                Osteoset T(R) bone void filler pre-mixed with tobramycin.

         The Company's  commitment to research and  development  is evidenced by
the  expenditures  it makes each year.  Research and  development  expenses were
approximately  $15.1 million in 1994,  approximately  $12.7 million in 1995, and
approximately  $13.2 million in 1996,  which the Company  believes  represents a
commitment  which is  significantly  higher as a percentage of sales than all of
its major competitors.

Principal Customers

         The Company currently markets its products to health care professionals
and  hospitals in the United States and in many major  countries  outside of the
United States. Key customers include orthopaedic surgeons  specializing in total
joint replacement, sports medicine, spinal surgery and traumatology. The Company
has approximately 4,800 active hospital and physician customers,  with no single
customer  representing  more  than two and  one-half  percent  of the  Company's
consolidated sales. The Company currently does not conduct any business directly
with  foreign  governments,  with such sales being made  through  the  Company's
established distribution network of independent contractors.




                                                      Page 17 of 105

<PAGE>



Raw Materials

         The majority of the Company's  raw material  purchases are comprised of
four principal materials that are generally available,  in implant grade, from a
variety of sources with various lead times.  Cobalt chrome is purchased in ingot
form and cast into implants and trials.  Titanium,  both  commercially  pure and
alloy  grade,  is purchased  in bar stock form and  machined  into  implants and
instruments.  Ultra high molecular  weight  polyethylene,  also purchased in bar
stock form,  is  machined  into  implants  for weight  bearing and  articulating
surfaces. Stainless Steel 17-4 precipitation hardened is purchased in both ingot
and bar form and is cast or  machined  into  instruments,  and  stainless  steel
22-13-5,  22-13-10,  and 316L is  purchased in wrought bar form that is machined
into implants. In addition,  the Company's small joint implants require silicone
that is purchased as processed extruded elastomer blocks.

         The Company has not  experienced  a shortage of raw  materials and does
not  anticipate  a  shortage  in the  future.  In  light  of  certain  business'
increasing  reluctance  to offer raw  materials  intended  for  medical  devices
because of product  liability  concerns,  there can be no assurance of continued
supply or that  finding  an  alternative  source  would not cause a delay in the
Company's manufacturing process.

Environmental

         The  Company  believes it is  operating  in  material  compliance  with
applicable  regulations  required  by the State of  Tennessee  and the EPA.  The
Company's objective is to operate in a clean and safe environment,  minimize the
generation  of hazardous  and  non-hazardous  waste and promote  environmentally
sound  recycling,  reuse  and  reclamation  of waste.  As part of the  Company's
recognition of resource  protection,  its level of recycling has been increased.
The Company does not expect to incur a material  amount of capital  expenditures
in order to maintain  its  environmental  compliance.  Furthermore,  the Company
believes that  compliance  with these  regulations  will not  materially  impact
either the Company's earnings or competitive position.

Insurance

         The Company maintains  comprehensive  and general liability  insurance,
including product liability,  with coverage up to $100,000,000 in the aggregate.
The Company  maintains a $250,000  per  incident  and  $750,000  aggregate  self
insured  retention.  Although the Company has not  experienced  any  significant
claims to date,  there can be no assurance that the Company's  insurance will be
adequate to cover any claims that may be  asserted in the future.  Although  Dow
Corning  Corporation has  contractually  agreed to indemnify the Company for all
products  manufactured  by Dow  Corning  prior to the  Acquisition  (other  than
certain  small  joint  implants  purchased  by the  Company  and sold  after the
Acquisition),  there can be no guarantee  that such  indemnity  will continue in
light  of Dow  Corning's  bankruptcy  filing;  the  Company  does  not  maintain
insurance for those claims.

         The Company also maintains  liability  insurance covering directors and
officers with coverage up to  $5,000,000.  There is no deductible per officer or
director per event and a $100,000 deductible for the Company per event.

                                                      Page 18 of 105

<PAGE>



The Company also carries  insurance  coverage for all real and personal property
including business interruption, and  coverage for workers' compensation,  crime
and fiduciary liability in amounts that management believes to be adequate.

Patents and Trademarks

         As of March 10, 1997, the Company owned or held licenses for 151 issued
patents and had  applications  pending in the United States and major  countries
throughout the world for eight additional inventions. The Company has purchased,
licensed or has distribution rights for the design, manufacture and distribution
of certain products. See  "Business--Principal  Products." The Company currently
has 29 registered  trademarks and applications  pending on 18 other marks in the
United States and major  countries  throughout  the world.  The Company uses its
patents and  trademarks  throughout  the world in  connection  with its business
operations.  As  necessary,  the  Company  vigorously  protects  its patents and
trademarks both domestically and internationally.

Royalty and Other Payments

         The Company has  various  agreements  with  unaffiliated  entities  and
persons that provide the Company with certain rights to  manufacture  and market
certain orthopaedic products developed independently by such entities or persons
or jointly with the Company. The agreements provide for royalty payments ranging
from  less  than  1% to 10%  of the  net  selling  price  (as  defined  in  such
agreements) of those certain orthopaedic products. In addition,  the Company has
a number of  consulting  agreements  pursuant  to which  distinguished  surgeons
evaluate the  Company's  new and existing  products in exchange for a consulting
fee.

Seasonality

         The  Company's  revenues  are  subject to some  seasonality.  Since the
majority of implant surgery is elective,  the warm weather months  traditionally
yield lower sales volumes than do the late fall and winter months.

Employees

         As of  March  10,  1997,  the  Company  had  609  full-time  employees,
including  571 at its  Arlington  operations,  8 in regional  operations  and 30
outside  the United  States.  The  Company's  employees  are not  covered by any
collective  bargaining  agreements.  The Company  believes that its relationship
with its employees is good.



ITEM 2.           PROPERTIES.

         The Company's headquarters and manufacturing  operations are located in
leased facilities in Arlington,  Tennessee,  which is located near Memphis.  The
Company's  facilities  consist of an aggregate of  approximately  168,000 square
feet, approximately 53,000 of which are utilized for manufacturing

                                                      Page 19 of 105

<PAGE>



and approximately 45,000 of which are utilized as a distribution center with the
balance being utilized for office space.

         The  acquisition  and  construction  by the  lessor  of  the  Company's
manufacturing  facilities  were  financed  through the issuance by the lessor of
industrial  development  bonds,  which  have  been  paid in full.  The base rent
payable under the lease for the initial term was the amount required to meet the
debt service  requirements  of the bonds.  Accordingly,  no further base rent is
payable  during the initial  term of the lease.  The  initial  term of the lease
expires  in 1999.  The  Company  has the  option  to renew  the  lease  for five
additional ten year terms at a base rental of $6,000 per year. In addition,  the
Company has the option to purchase the facilities at a price of $100 at any time
prior to the expiration of the lease in 1999.

         The lease for the Company's office facilities  provides for the payment
of annual  rent of $5,000,  plus the  lessor's  expenses.  The term of the lease
expires in 2005.  The  Company has the option to purchase  the  facilities  at a
price of $101,000 at any time prior to the expiration of the lease in 2005.

         The  acquisition  and  construction  by the  lessor  of  the  Company's
distribution  center was also  financed  through  the  issuance by the lessor of
industrial development bonds, which have also been paid in full. The base rental
under the lease was the amount required to meet the debt service requirements on
the bond.  Accordingly,  no further base rent is payable  during the term of the
lease. The term of the lease expired on the original maturity date of the bonds.
The Company has the option to purchase  the  facilities  at a price of $1,000 at
any time.  The Company  added 5,000  square feet as an extension to the original
distribution center structure during 1995.

         The Company  leases  approximately  4,000  square  feet in  Marblehead,
Massachusetts  for its  Questus  facility  that  provides  for  monthly  rent of
$10,860.  The initial term of the lease  expires in October 1997 and the Company
expects to be able to renew said lease on favorable  terms. The facility is used
for research and development and office space.



ITEM 3.           LEGAL PROCEEDINGS

         DCW,  pursuant to the  Acquisition  agreements,  retains  liability for
matters arising from certain  conduct of DCW prior to the Company's  acquisition
on June 30, 1993, of substantially all the assets of the large joint orthopaedic
implant  business  of DCW.  As such,  DCW has agreed to  indemnify  the  Company
against all liability  for all products  manufactured  prior to the  Acquisition
except  for  products  provided  under the  Company's  1993  agreement  with DCW
pursuant to which the Company purchased certain small joint orthopaedic implants
for worldwide  distribution.  However, the Company was notified in May 1995 that
DCW,  which filed for  reorganization  under  Chapter 11 of the U.S.  Bankruptcy
Code,  would no longer  defend the  Company in such  matters  until it  received
further  direction  from the bankruptcy  court.  On December 2, 1996 DCW filed a
proposed plan of reorganization that provides that all commercial creditors will
be paid 100% of their claims,  plus interest.  The plan did not however indicate
whether  DCW would  affirm or reject the  Acquisition  agreements.  Accordingly,
there

                                                      Page 20 of 105

<PAGE>



can be no assurance that Dow Corning will indemnify the Company on any claims in
the future.  Although the Company does not maintain insurance for claims arising
on products sold by DCW, management does not believe the outcome of any of these
matters will have a material adverse effect on the Company's  financial position
or results of operations.

         On October 25, 1996,  the Company was notified that it had been sued by
Mitek Surgical Products,  Inc., a subsidiary of Johnson & Johnson, in the United
States  District Court for the Northern  District of California  seeking damages
for the alleged  infringement of its patent by the Company's  ANCHORLOK(TM) soft
tissue  anchor.  The Company has denied the  allegations  and is  defending  the
action.

         On April 3, 1995,  the Company  (and  Orthomet,  Inc.,  a wholly  owned
subsidiary  at the time  that has  subsequently  been  merged  with and into the
Company)  was  notified  that  it  had  been  sued  by  Joint  Medical  Products
Corporation  (which was purchased by Johnson & Johnson  Professional,  Inc.), in
the United States District Court for the District of Connecticut seeking damages
for the alleged  infringement of its patent (U.S. Pat. No. 4,678,472,  the "'472
Patent") by certain of the  Company's  acetabular  cups and liners.  Pending the
resolution of an interference proceeding in the U.S. Patent and Trademark Office
regarding  the '472  Patent by  British  Technology  Group  Ltd.  ("BTG"),  such
complaint was dismissed without  prejudice.  In early November 1996, the Company
was notified  that the  interference  proceeding  was  resolved,  and that,  the
complaint  has been  refiled  (but not  served).  BTG has  offered the Company a
license of the '472  Patent and a  corresponding  reissue  patent.  The  Company
believes that it has valid defenses to claims of infringement of the '472 Patent
and to the reissue patent.

         The  Company  is not  involved  in any other  pending  litigation  of a
material  nature  that  would have a material  adverse  effect on the  Company's
financial position or results of operations.



ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.


         NONE

                                                      Page 21 of 105

<PAGE>



                                                         PART II.


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

         The Company's  Class A Common Stock  currently is not publicly  traded,
and, as such, market value quotations are unavailable. There were 400 registered
holders of Class A Common Stock as of March 19, 1997. The Company has never paid
dividends  on its  Class A Common  Stock  and does  not  expect  to pay any cash
dividends in the foreseeable future. The Company currently intends to retain its
earnings,  if any, for future  operations  and  expansion of its  business.  Any
decisions  as to the  payments  of  dividends  in the future  will depend on the
earnings  and  financial  position of the Company and such other  factors as the
Board of Directors deems  relevant.  In addition,  the Company's  indenture with
State Street Bank and Trust  Company,  as successor  to First  National  Bank of
Boston,  on providing  for the issuance of the Company's 10 3/4% Series B Senior
Secured  Notes,  due  July  2000  (the  "Indenture"),   the  Company's  Restated
Certificate of  Incorporation,  the Company's  Series B Preferred Stock Purchase
Agreement and Class A Common Stock Warrant  Agreement  dated as of July 29, 1994
with the California Public Employees Retirement System ("CalPERS"),  as amended,
and the Class A Common Stock  Warrant  Agreement  dated as of September 25, 1995
with CalPERS  (collectively,  the "CalPERS  Agreement") and its Credit Agreement
dated  September 13, 1996, by and between the Company and Sanwa Business  Credit
Corporation (the "Credit  Agreement"),  substantially  limit the payment of cash
dividends on the Company's capital stock.

                                                      Page 22 of 105

<PAGE>


<TABLE>
ITEM 6.           SELECTED FINANCIAL DATA.

         The following  selected  financial data of DCW medical device  business
(the  "Predecessor")  and the Company  and its  subsidiaries  (the  "Successor")
should  be read in  conjunction  with the  financial  statements  and the  notes
thereto included in Item 8.


                                              (in thousands, except per share data and ratio)
<CAPTION>
                                           Predecessor                          Successor
                                         Year       JAN 1,      JUN 30,       Year       Year         Year
                                        Ended      through      through       Ended      Ended        Ended
                                       DEC 31,     JUN 30,      DEC 31,      DEC 31,    DEC 31,      DEC 31,
                                         1992        1993         1993        1994       1995         1996
<S>                                     <C>         <C>        <C>         <C>        <C>          <C>
Operating Data:
  Net sales                             $71,598     $35,033    $ 43,027    $ 95,763   $123,196     $121,868
  Net income (loss)                       5,101         437      (2,572)    (49,380)    (6,492)     (14,589)
  Loss per common share                      --          --        (.41)      (6.10)     (2.24)       (3.90)

Balance Sheet Data:
  Total assets                          $71,747     $72,691    $113,497    $154,551   $174,371     $166,326
  Long term debt                            243         108      84,605      84,983     84,462       84,668
  Mandatorily redeemable
    Series B Preferred                       --          --          --      47,658     46,757       59,959

  Redeemable Convertible
    Series C Preferred                       --          --          --          --     20,548       24,995
  Parent company
    investment                           64,543      68,029          --          --         --
  Stockholders' equity                       --          --      11,602    (25,502)    (25,177)     (58,506)

Ratio of earnings to
 fixed charges and
 preferred dividends                         --          --         (A)       (A)         (A)            (A)



(A)      Earnings were  inadequate to cover fixed charges,  preferred  dividends
         and accretion of preferred stock by approximately  $3.6 million,  $61.7
         million, $26.3 million, and $35.3 million, respectively, for the period
         from June 30, 1993  through  December  31, 1993 and for the years ended
         December 31, 1994, December 31, 1995, and December 31, 1996.





                                                      Page 23 of 105
</TABLE>

<PAGE>



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

Overview

         Although  sales  declined  slightly,  1996  was  a  year  of  promising
successes as the Company  continued to introduce and develop new and  innovative
products,   upgrade  its  domestic   distribution,   improve  its  international
distribution,  reduce administrative  expenses,  hold inventories steady despite
large  inventory  builds for new products,  and generate cash from operations in
the last five months of the year.

         The Company's  largest  disappointment  was that the expected growth in
sales  failed to  materialize  and the sales ended the year down $1.3 million or
(1.1%) to $121.9 million.  International sales were up 8.6% while domestic sales
were down 3.9%. The Company  believes that this overall  decline led by the U.S.
market was not inconsistent with the orthopaedic device industry in general, and
the large joint  business (the sales of knee and hip  prostheses) in particular.
Throughout  the industry,  pricing  pressures  from buying  groups  reduced unit
prices despite continued increases in unit sales growth. In addition, the trends
created by managed care initiatives, which demand lower priced implants that are
affixed with cement rather than higher priced  porous coated  implants,  further
reduced average unit pricing. The Company suffered  particularly from this trend
because the more expensive porous coated implants  historically have comprised a
high  proportion of its knee implant sales (76% in 1994,  70% in 1995 and 64% in
1996).  Demonstrating  these overall  trends,  the sales of the  Company's  knee
prostheses were down $2.0 million from the prior year despite a 2.7% increase in
unit sales.

         The Company  was  encouraged  however by its  quarter to quarter  sales
trends as the sales  declines  were  experienced  in the first  half of the year
while third and fourth quarter sales increased over the prior year's periods. In
addition,  since September,  1995 through the third quarter of 1996, the Company
added  or  replaced  10 of its 47  domestic  distributors.  While  a  change  in
distributors  often  results  in a short  term  loss of  business,  the  Company
believes that upgrading to new distributors will positively affect the Company's
sales in the longer term. Finally, the Company believes that the changes to both
the tenor and substance of its relationship with its domestic  distributors will
also positively affect sales in the longer term.

         The  Company  was  pleased  with  its  new  product  development  as it
continues to seek penetration into segments of the orthopaedic  marketplace that
are not yet governed by the pricing and managed care  pressures  experienced  in
the large joint markets. The Company's sales of spinal, trauma,  arthroscopy and
biologics  products were $3.7 million, a growth of approximately 300% over prior
year.  Late in the  third  quarter  of 1996,  the  Company  received  regulatory
approval for, and began marketing its OSTEOSET(TM) Bone Void Filler. The product
is the  Company's  first  commercial  product  from  its  biologics  development
program, and is the industry's first FDA cleared bioresorbable bone void filler.
Other  products  launched in 1996  included the  VERSALOCK(TM)  Spinal  Fixation
System for lumbar spine fusions, and a posterior stabilizing version ADVANCE(TM)
Knee System,  developed in  cooperation  with the renowned  Hospital for Special
Surgery in New York City. The Company expects to generate significant sales from
these three products

                                                      Page 24 of 105

<PAGE>



in 1997.  The Company also expects to introduce in 1997  additional  products in
its OSTEOSET and ADVANCE product lines, the MAGELLAN(TM)  Intramedullary Nail to
address complex femoral  fractures,  and a novel plating system for the cervical
spine to compliment its spinal device product line.

         International  sales were also encouraging,  increasing $2.4 million to
$30.4 million.  This gain comes despite a slight decrease in sales to Japan, the
Company's largest  international  market. In 1996, the Company  consolidated its
Japanese  distribution  with a single  distributor,  Century Medical,  Inc., and
expects sales to that market to increase  significantly  in 1997.  International
sales excluding Japan were up 13.3% over prior year as the Company  continues to
devote  significant  resources  and  personnel in an effort to  penetrate  those
markets faster. The Company also added distributors in Italy and Korea in 1996.


RESULTS OF OPERATIONS

Year Ended December 31, 1996 Compared With Year Ended December 31, 1995

         Sales. In 1996, the Company posted sales of $121.9 million representing
a net sales  decrease of  approximately  1.1%, or $1.3 million,  compared to its
1995 sales of $123.2  million.  Although  sales were lower than prior year,  the
trend of the  Company's  sales  quarter-by-quarter  during 1996 compared to 1995
reflects an encouraging trend. Sales in 1996 were approximately 7.2% below prior
year in the first  quarter,  approximately  0.3% below  prior year in the second
quarter,  approximately  0.4%  above  prior  year  in  the  third  quarter,  and
approximately 3.7% above prior year in the fourth quarter.

         Domestic  sales for the year were $3.7  million or  approximately  3.9%
below 1995 while the Company's international sales grew by approximately 8.6% or
$2.4 million over prior year. Sales in Europe,  Latin America,  Canada, and Asia
grew by $1.6 million  (approximately  13.0%),$1.0 million (approximately 56.3%),
$0.5  million  (approximately  17.2%),  and $0.2 million  (approximately  10.1%)
respectively,  offset  primarily by lower than prior years' sales in Japan which
were due to prolonged transition in the change of distribution channels that was
initiated  by the  Company in order to better  serve this  market  over the long
term.

         Although  total  sales for 1996  decreased  as  compared  to 1995,  new
product  line  sales  increased  compared  to prior year sales for the period in
ADVANCE(TM) Knee ($2.6 million),  trauma ($0.7) million),  spine ($0.5 million),
arthroscopy  products ($1.0 million) and biologics ($0.3  million).  Those gains
were offset by decreased sales for the period in knees,  other than  ADVANCE(TM)
($4.7 million),  hips ($0.9  million),  and small joint products ($0.9 million).
Despite the decrease in sales dollars  during 1996,  unit sales of the Company's
large  joint  products  increased  during 1996 when  compared to 1995.  In large
joints,  particularly  hips and knees, the Company (and management  believes the
entire  orthopaedic  industry)  experienced  a shift from higher  priced  porous
coated  products  to  lower  priced  cemented  products.  While  selling  prices
increased  slightly  in  both  cemented  and porous  products,  the mix of sales
towards cemented designs resulted in a lower average selling price per 
procedure.

                                                      Page 25 of 105

<PAGE>




         Cost of Goods Sold.  Cost of goods sold increased from $33.7 million in
1995 to $44.4  million in 1996,  or  approximately  32%.  The $10.7  million net
increase is due to additional instrument reserving ($3.6 million) because of the
reclassification  of surgical  instruments to inventory as part of the Company's
revised   instrument   program  designed  to  give  the  Company's   independent
distributors better access to these instruments,  increased variances charged to
cost of goods sold ($2.8 million), a reduction of the sales return reserve ($0.8
million),  a higher level of sales of fully reserved  products in 1995 resulting
in the  reversal  of  inventory  reserves  during that year ($1.1  million),
additional product reserving in 1996 ($0.4 million) and increased  manufacturing
costs ($1.8 million).

         Selling.  Selling expenses  increased  slightly in 1996 by $0.3 million
when compared to 1995.  Although sales in 1996 were lower than 1995,  commission
expenses, primarily  guarantees,  increased  by  $0.7  million  in 1996 to $21.7
million.  Royalties increased in 1996 to $2.0 million compared to 1995 royalties
of $1.4  million  due  largely  to an  increase  on  royalties being paid on the
Company's  small  joint  orthopaedic   products.   Domestic  marketing  expenses
decreased  in 1996  ($0.2 million) due  primarily to lower literature,  supplies
and  advertising  ($0.6 million) because of fewer new product  launches  in 1996
and lower  travel  and  entertainment expense ($0.7 million) offset by increased
payments  ($0.6 million)  due  to  distributor   replacements  and  territory 
realignments  and  increased salaries  and  benefits   ($0.8  million)  due  to
critical   headcount  adds.  International marketing expenses decreased by $1.7 
million in 1996 when  compared  to the same period in 1995. The reduced spending
in 1996 resulted primarily from shutdowns in Brazil ($0.5 million) and Australia
($0.2 million) along with lower salaries  and  benefits  in  France  due  to the
transition to a  non-employee  sales force ($0.5 million),  and decreases in the
headquarters'  expenses in salaries, benefits,  and travel ($0.3 million) which
contributed to this favorable variance year over year.

         The Managed  Care  division of the Company  spent $1.3  million in 1996
which  was  $1.0  million  more  than  was  spent in  1995.  This  spending  was
non-recurring as this division was closed in December, 1996.

         General and Administrative.  General and administrative costs decreased
from $23.4  million  in 1995 to $19.4  million  in 1996,  or a decrease  of $4.0
million  (approximately  17%).  This decrease was  attributable in large part to
lower intangible  amortization ($1.2 million),  reduced travel and entertainment
expenses due to the sale of the corporate jet and reduced  overall  travel ($2.1
million),  lower  insurance  costs ($0.4  million),  decreased  legal fees ($0.4
million) and lower outside services ($0.4 million) offset by higher salaries and
benefits  due  to  payment  of  the  1996   management   bonus  ($1.0  million).
Additionally  lower  professional  fees in 1996 ($0.2 million) and international
favorable  variances  for the  period  due to lower  spending  in  France  ($0.2
million) contributed to the favorable year-over-year variance.

         Research & Development.  Research and  development  expenses  increased
$0.5 million from $12.7 million in 1995 to $13.2 million in 1996, or an increase
of approximately  4.0%. This increase  reflects  management's  continuing belief
that these strategic expenditures are necessary to

                                                      Page 26 of 105

<PAGE>



continue the flow of new and diverse products from the Company into the
marketplace.

         Other.  Equity in loss of  investment  ($0.5  million)  represents  the
Company's 50% share of the expenses  incurred  related to the joint venture with
Tissue  Engineering,  Inc.  discussed  further  in  Note 2 to  the  Consolidated
Financial  Statements.  Amortization of a certain license  arrangement  obtained
from Tissue Engineering,  Inc. ($0.3 million) was the primary contributor to the
joint venture loss.

         Other  income for the year  ended  December  31,  1996  increased  $0.3
million  as  compared  to the same  period in 1995 due  primarily  to  favorable
currency conversion.  Interest expense,  net of interest income,  increased from
$11.3 million in 1995 to $11.9 million in 1996, an increase of $0.6 million,  or
approximately  5%.  This  increase  in interest  expense  was  primarily  due to
financing costs associated with the private  placement of the Company's Series C
Preferred Stock late in 1995.

         For the year ended December 31, 1996 earnings before  interest,  taxes,
depreciation, and amortization ("EBITDA") is detailed in the table below. EBITDA
totals both before and after certain adjustments are shown:


                                                               December
                                                               31, 1996
                                                            ---------------
Operating Income                                                  $(3,055)
Depreciation and Instrument Amortization                           11,272
Amortization of Intangibles                                         3,266
Amortization of Other Assets                                          266
                                                            ---------------
EBITDA before Certain Adjustments                                 $11,749
Inventory Reserves and other Related
  Inventory Adjustments                                             4,852
Orthomet Inventory Step-Up*                                           992
                                                            ---------------
EBITDA after Certain Adjustments                                  $17,593
                                                            ===============

      *    Amount represents the flow through of the purchase
           accounting adjustment in 1996 as it related to
           acquired Orthomet inventory.


Year Ended December 31, 1995 Compared With Year Ended December 31, 1994

         Sales. In 1995, the Company posted sales of $123.2 million representing
a net sales increase of  approximately  28.6%,  or $27.4 million,  over its 1994
sales of $95.8  million.  Of this growth,  $25.8  million came from the Orthomet
product lines, either acquired or expanded by the Company over the course of the
year.


                                                      Page 27 of 105

<PAGE>



         Domestic sales increased $22.6 million,  while international sales grew
$4.8 million.  The Company experienced  declines in the sales of its products in
Australia,  Japan,  and  Asia as each of  these  regions  experienced  prolonged
transition in the change of  distribution  channels  that were  initiated by the
Company in order to better serve those  markets  over the long term.  Outside of
those regions, the Company's international sales were up greatly.

         The  total  sales  increase  of  $27.4  million  can be  attributed  to
increases  in hip products of $13.7  million,  knee  products of $12.1  million,
shoulder  products of $1.0 million,  and the new trauma,  spine, and arthroscopy
products of $1.2 million. Those gains were slightly offset by non-recurring 1994
sales of discontinued DCW products. While management believes that unit sales of
its large joint products have increased  (using estimates for the full-year 1994
Orthomet  performance),  a clear shift to lower  priced  cemented  products  was
experienced in both its hip and knee business. While selling prices increased in
both cemented  and  porous  coated  products, the mix of sales  towards cemented
designs resulted in a lower average selling  price per  procedure  when compared
to prior year.

         Cost of Sales.  Cost of sales  decreased  from $43.6 million in 1994 to
$33.7 million in 1995, or approximately  22.7%. The $9.9 million net decrease is
a net result of a $7.8 million increase due to volume increases,  1994 inventory
reserve  adjustments  which  increased 1994 Cost of Sales by $12.1 million which
did not occur in 1995, a $3.4 million decrease  principally  related to the 1995
sale  of  previously  reserved  inventory  as  well as  $2.2  million  of  other
decreases.  In 1994,  reserves were  established  for certain  products that the
Company did not expect to remain viable in 1995,  because of the  acquisition of
the Orthomet  products and the decision to cease gamma  radiation of implants in
favor of ethylene  oxide gas  technology.  However,  some of these products have
continued to be sold in 1995 resulting in the reversal of previously established
inventory reserves and thus favorable reserve adjustments.

         Selling. Selling expenses increased $13.9 million from $33.2 million in
1994 to $47.1 million in 1995, or approximately 41.7%. Selling expense increases
associated with 1995 sales volume increases were estimated at $5.3 million, with
the  Company  spending  approximately  an  additional  $1.0  million  in selling
expenses  related  to  Orthomet-to-Wright   transition  costs  and  sales  force
consolidation     costs.    In    addition    to    these    volume-driven    or
transition/consolidation  costs, selling expenses also increased domestically by
approximately  $3.1 million due to staffing and other  increases  related to the
Company's  initiatives  into the new markets of trauma,  spine, and arthroscopy.
International  selling expense increased $2.7 million (excluding $0.6 million of
instrument  amortization)  led by increases at headquarters and in Europe as the
Company began to invest in infrastructure  additions to service European markets
outside of France.  Selling  expenses are expected to decrease  dramatically  in
Australia  in  1996,  where  early  in the  fourth  quarter  the  Company  began
distributing  its  products  through a single  third party  distributor  (Device
Technologies, Australia) and subsequently closed its sales office, and in Brazil
where the Company  plans to similarly  transition  its  distribution.  Operating
expense  savings  from these  actions  will be  realized in 1996.  Also,  global
instrument amortization expenses increased  year-over-year by $1.8 million ($1.2
million domestic and $0.6 million international).


                                                      Page 28 of 105

<PAGE>



         General and Administrative.  General and administrative costs increased
from  $23.3  million  in 1994 to  $23.4  million  in  1995,  or an  increase  of
approximately  0.4%.  Increases in 1995 occurred  primarily in  amortization  of
intangibles  (largely  assets  acquired  from  Orthomet) of $2.3  million,  $0.5
million of Orthomet-to-Wright transition costs, and depreciation expense of $0.6
million.  These were offset by non-recurring  1994 product liability costs ($0.7
million),  no  management  bonus  expense in 1995  (savings of $1.5  million)and
savings from 1995 downsizing moves in Australia and Brazil ($0.9 million).

         Research & Development. Research and development expenses (exclusive of
1994  non-recurring  adjustments of $7.1 million described below) increased $4.7
million  from $8.0 million in 1994 to $12.7  million in 1995,  or an increase of
approximately  59.4% reflecting  managements view of these expenses as strategic
investments necessary to continue the flow of new and diverse ideas and products
into the  Company.  This increase was primarily  due to an increased  number of
development  consulting  agreements  initiated  by the Company  with a number of
distinguished orthopaedic surgeons and scientists to develop a new generation of
knee  and hip  prostheses,  spinal  systems,  upper  extremity  prostheses,  and
arthroscopy products.

         In 1994,  the  acquisitions  of  Orthomet  and  Questus  resulted  in a
one-time write off of $27.7 million for in-process research and development. The
in-process  research and development  was written off immediately  following the
1994  acquisition  because,  in the  opinion of  management,  the  technological
feasibility of the in-process  technology had not yet been  established  and the
technology  had no  alternative  future use.  Of the  research  and  development
projects  underway  at  Orthomet  at the  point of  acquisition,  two have  been
completed  and work on three  continues,  which  management  expects  to  become
commercially  viable over the course of the next three  years.  Five  additional
acquired projects or technologies either have been divested, canceled, or merged
into similar technology efforts underway at the Company.

         An additional $7.1 million of contractually  obligated costs associated
with product  development  efforts and  contracts  with ABI,  U.S.  Gypsum,  and
OsteoBiologics were also recognized in research and development expense in 1994.
These costs did not recur in 1995.

         Other.  Non-operating expenses decreased $1.0 million from $0.9 million
in 1994 to $0.1 million  (income) in 1995 due primarily to the write off in 1994
of certain non-operating receivables.  Interest expense, net of interest income,
increased  from $9.2  million in 1994 to $11.3  million in 1995,  an increase of
$2.1 million,  or  approximately  23%. This increase in interest expense was due
primarily  to  interest   charges   associated  with  the  Company's   increased
utilization of its revolving line of credit as well as  amortization of deferred
financing costs associated with the private  placement of the Company's Series C
Preferred Stock.


LIQUIDITY AND CAPITAL RESOURCES

         Since  the  Acquisition,  the  Company's  growth  strategy  has been to
position  itself  for  the  future  through  new  product  development  and  the
acquisition of new technologies through license agreements, joint ventures

                                                      Page 29 of 105

<PAGE>



and  purchases of other  companies in the  orthopaedic  field (see Note 2 to the
Financial Statements).  The Company's needs for capital have been funded through
the sale of $85  million  of senior  debt  securities  and the  contribution  of
approximately $15 million of equity at the time of the Acquisition. Further, the
Company  has  obtained  additional  capital  through  the  issuance  of Series B
Preferred  Stock in July 1994 to CalPERS ($60 million),  through the issuance of
Series C Preferred  Stock to Princes Gate  Investors,  L.P. and  affiliates,  in
September  1995 ($35  million)  (see Note 8 to the  Financial  Statements),  and
through  the use of  revolving  lines of  credit  (see  Note 7 to the  Financial
Statements).

         The Company had available to it a $30 million  revolving line of credit
under the Heller  Agreement  that  expired in  September,  1996.  The  Company's
projected  cash  flow   requirements  for  1996  due  to  continued  growth  and
development of new products, indicated that a similar revolving credit agreement
was needed to fund the  working  capital  needs of the  Company  going  forward.
Management  negotiated with several financial  institutions and on September 13,
1996  finalized and closed an agreement for a loan and security  agreement  with
Sanwa Business  Credit  Corporation  for a $25 million  revolving line of credit
(which can increase to $30 million with the  occurrence of certain  events) that
expires in September,  1999. As of December 31, 1996 this agreement  provided an
eligible  borrowing base of $19.4  million.  As of March 17, 1997 this agreement
provided an eligible  borrowing  base of $21.5 million and the Company had drawn
$16.3 million under this agreement.  During 1996 borrowings under the Heller and
Sanwa Agreements  averaged $12.5 million with a maximum amount borrowed of $16.1
million, as compared to 1995 when borrowing averaged $15.1 million and reached a
high of $29.0  million.  The Company  believes that the Sanwa  Agreement will be
sufficient to meet its working capital needs for 1997.

         The Company's  capitalization  includes senior debt securities of $84.4
million and Series A, B, and C of preferred stock with an aggregate  liquidation
value of $140.6 million including accrued dividends of $18.0 million at December
31, 1996.  These  securities  currently  bear interest or dividend rates ranging
from 10.8% to 16.9% and, in certain  circumstances,  these rates can increase to
21.4%. As a result of the Company's  obligations to establish a sinking fund for
its senior debt  securities  beginning  in July,  1998 ($28.3  million)  and its
obligation  to issue  additional  warrants to acquire  common stock in the event
that the Series C Preferred  Stock is not  redeemed  or there has not  otherwise
been a qualified  initial public offering on or before March,  1999,  management
believes that the Company will be required to effect a recapitalization  plan to
satisfy  these  future  obligations.  In this  regard,  the  Company  has  begun
discussions  with a limited  number of  investment  banks to discuss the various
alternatives available to the Company, including without limitation, refinancing
the  Senior  Secured  Notes.  Management  believes  that a  successful  plan  of
recapitalization  will be completed  prior to the sinking fund payment  becoming
due in July, 1998, however, there can be no assurance that such a refinancing or
recapitalization plan can be consummated.

         At year end  1996,  the  Company  had  approximately  $1.6  million  in
outstanding capital commitments, and has budgeted approximately $4.3 million for
1997 expenditures for the purchase of machinery and related capital equipment.


                                                      Page 30 of 105

<PAGE>



         As of December  31,  1996 the Company had net working  capital of $50.5
million,  compared  with $45.2  million as of December  31,  1995.  Of this $5.3
million growth, $4.3 million was attributed to growth in inventory due primarily
to the reclass of surgical  instruments to inventory  from  property,  plant and
equipment,  $3.6  million was due to the net change in deferred  income taxes in
1996 and $1.7 million was due to decreases in accounts payable. Offsetting these
charges were increases to accrued expenses and other current  liabilities  ($0.9
million) primarily due to U.S. Gypsum (see Note 11 of Financial  Statements) and
Orthopaedic  Tissue  Technology,  L.L.C.  obligations  (see Note 2 of  Financial
Statements) and increased  short-term  borrowings  against the revolving line of
credit ($4.5 million).



ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         Information  called  for by this  item is set  forth  in the  financial
statements  contained in this report on Form 10-K and is incorporated  herein by
this reference.  An index to the financial statements is set forth on page 53 of
this Form 10-K.



ITEM 9.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                  ON ACCOUNTING AND FINANCIAL DISCLOSURE.

         None.





                                                      Page 31 of 105

<PAGE>



                                                         PART III


ITEM 10.          DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Executive Officers and Directors

         Directors of the Company are elected annually and hold office until the
next annual meeting of stockholders  or until their  successors are duly elected
and  qualified.  All  officers of the Company are  appointed by and serve at the
discretion  of the Board of Directors  of the Company.  Election of directors is
governed in part by a Letter  Agreement  dated June 30, 1993, as amended on July
29, 1994 and as amended on November 21, 1995 between Mr.  Korthoff and Kidd Kamm
Equity Partners,  L.P. (the "Letter Agreement").  The following table sets forth
the executive officers and directors of the Company as of March 15, 1997.


      NAME                AGE          POSITION WITH COMPANY
Richard D. Nikolaev        58         Director, President and
                                      Chief Executive Officer
Lewis H. Ferguson, III     52         Director, Senior Vice President
                                      and Secretary
George G. Griffin, CPA     49         Executive Vice President and
                                      Chief Financial Officer
Jack E. Parr, Ph.D.        57         Executive Vice President,
                                      Research and Development
Allen H. DeSatnick         56         President of Questus Division
Richard H. Mazza           50         Executive Vice President,
                                      Operations
Herbert W. Korthoff        53         Chairman of the Board of
                                      Directors
William J. Kidd            55         Director
Kurt L. Kamm               54         Director
Walter S. Henning          54         Director
Eric R. Hamburg            34         Director

         Richard D. Nikolaev has been the President and Chief Executive  Officer
of the Company  since  November  1995 and a Director of the Company  since July,
1995.  Prior to joining the Company,  Mr.  Nikolaev  served as a  consultant  to
various  medical device  companies  since December 1994. From January 1992 until
December 1994, Mr. Nikolaev was Chairman,  President and Chief Executive Officer
of Orthomet,  Inc., a NASDAQ  company  acquired by the Company in December 1994.
Prior to joining Orthomet, Inc., Mr. Nikolaev served as President of Orthopaedic
Synergy,  an  orthopaedic  consulting  company  and as an  executive  officer of
various orthopaedic companies.

                                                      Page 32 of 105

<PAGE>



         Lewis H. Ferguson III  has been a Director of the Company since August
1993.  Mr. Ferguson became Senior Vice President in January 1994.  Prior to
joining the Company, Mr. Ferguson had been a partner in the Washington, D.C.
law firm of Williams & Connolly since 1979.  Mr. Ferguson is on an extended
leave of absence from Williams & Connolly.  Mr. Ferguson is elected to serve
as a Director pursuant to the Letter Agreement.  Mr. Ferguson is also a
director of OsteoBiologics, Inc., Orthopaedic Tissue Technology, LLC and
Tissue Engineering, Inc.

         George G. Griffin,  CPA has been Chief Financial Officer of the Company
since August 1993. He was elected  Executive  Vice President as of January 1994.
From 1979 until he joined the  Company,  Mr.  Griffin  was  employed  by Smith &
Nephew Richards Inc., a medical device manufacturer,  and since January 1989 had
served as the Vice President of Finance of its orthopaedic business.

         Jack E. Parr, Ph.D. was Vice President of Research and Development from
September  1993 until  February  1994,  when he was  elected to  Executive  Vice
President  of Research and  Development.  Prior to joining the Company and since
1980, Dr. Parr was employed by Zimmer, Inc., a medical device manufacturer where
he served as Vice  President of Research from January 1991 through  October 1993
and as Director of Advanced Technology from June 1980 to December 1990.

         Allen H. DeSatnick has been President of Questus Division since October
1994.  Prior to joining the Company and since 1989, Mr.  DeSatnick was President
and part owner of Questus Technologies, Inc.

         Richard H. Mazza was Vice  President of  Manufacturing  from April 1994
until March 1996 when he was elected to Executive  Vice President of Operations.
Prior to joining the Company,  Mr. Mazza was employed by United States  Surgical
Corporation as Senior Director of Operations.

         Herbert W. Korthoff has been a Director of the Company since May, 1993,
serving  as  Chairman  since  July 1,  1993.  Mr.  Korthoff  served as the Chief
Executive  Officer of the  Company  from July 1993 to  November  1995.  Prior to
joining  the  Company,   Mr.  Korthoff  was  the  Executive  Vice  President  of
Operations,  a member of the  Executive  Management  Committee and a Director of
United States Surgical Corporation.

         William J. Kidd has been a Director of the Company since July 1993. Mr.
Kidd has been an officer and principal  shareholder of Kidd,  Kamm & Company,  a
privately  owned  investment  firm (formerly a  partnership),  from 1987 when he
co-founded  the firm until  present.  As of January 1, 1997,  Mr. Kidd became an
officer,  controlling  shareholder  and founder of Kidd & Company,  LLC and is a
director of a number of other companies.

         Kurt L. Kamm has been a Director  of the Company  since July 1993.  Mr.
Kamm has been an officer and principal  shareholder of Kidd,  Kamm & Company,  a
privately  owned  investment  firm (formerly a  partnership),  from 1987 when he
co-founded  the firm until  present.  As of January 1, 1997,  Mr. Kamm became an
officer,  director and co-founder of Kamm Theodore and is a director of a number
of other companies.


                                                      Page 33 of 105

<PAGE>



         Walter S. Hennig has been a Director  of the Company  since April 1994.
Mr.  Hennig  had been Vice  President  of  Quality  Functions  at United  States
Surgical Corporation since 1976 prior to his retirement in March 1992.

         Eric R. Hamburg has been a Director of the Company since January 1996.
Mr. Hamburg was a partner with Kidd, Kamm & Company until late 1996.
Presently he is a principal shareholder of Industrial Renaissance.  Prior to
joining Kidd, Kamm & Company, Mr. Hamburg was a Senior Manager with Andersen
Consulting from 1985 to 1993, where he led the design and implementation of
numerous business turnarounds and profit improvement initiatives across a
wide variety of industries.  Mr. Hamburg is a director of a number of other
companies.


                                                      Page 34 of 105

<PAGE>


<TABLE>
ITEM 11.          EXECUTIVE COMPENSATION

         The  following  table sets forth  certain  information  with respect to
compensation  paid by the Company during the period from January 1, 1994 through
December 31, 1996, to the Company's Chief Executive Officer and to the four most
highly compensated  executive  officers whose compensation  exceeded $100,000 in
1996 (the "Named Executive Officers").


                                                       SUMMARY COMPENSATION TABLE
<CAPTION>
                                                                                        Long Term Compensation
                                                                                   -------------------------------
                                             Annual Compensation                                 Awards
                          -------------------------------------------------------------------------------------------------------
       (a)                  (b)           (c)               (d)             (e)                   (g)                        (i)
     Name and                                                           Other Annual       Securities Underlying          All Other
 Principal Position         Year         Salary           Bonus (1)     Compensation           Options (2)             Compensation
-----------------------------------------------------------------------------------------------------------------------------------
<S>                        <C>          <C>             <C>             <C>            <C>    <C>                      <C>
Richard D. Nikolaev        1994               $0              $0             $0        c.      20,000common                 $0
President and              1995          $51,754 (3)          $0             $0        a.     110,000common             $1,891 (4)
Chief Executive Officer    1996         $525,500              $0        $44,091 (5)                                     $9,270 (6)

Lewis H. Ferguson, III     1994         $500,000              $0         $9,796 (7)(8)              0                  $42,589 (9)
Senior Vice President      1995         $525,773              $0        $23,388 (10)                0                   $7,936 (9)
                           1996         $525,498              $0        $65,681 (11)                0                   $9,038 (12)

George G. Griffin, III,    1994         $165,000         $82,500         $3,064 (7)(8)              0                  $16,123 (13)
Executive Vice President,  1995         $171,783              $0             $0                     0                   $8,489 (13)
Chief Financial Officer    1996         $176,200         $44,050             $0 (8)                 0                   $8,921 (14)

Jack E. Parr, Ph.D.        1994         $165,000         $82,500              - (8)    b.      15,000common            $63,293 (15)
Executive Vice President,                                                                       1,500preferred
Research and Development   1995         $171,783              $0             $0                                         $8,458 (15)
                           1996         $176,200         $44,050             $0 (8)                 0                  $10,122 (16)

Richard H. Mazza,          1994         $102,039         $45,917             $0        a.      25,000common            $91,009 (17)
Executive Vice President,  1995         $150,700              $0             $0        a.      10,000common            $21,057 (17)
Operations                 1996         $173,317         $43,329             $0 (8)    a.      30,000common             $8,322 (17)


                                                      Page 35 of 105
</TABLE>

<PAGE>


(1)      Bonus payments for 1994 were calculated on 1994 performance, but paid
         in the first quarter of 1995.  Bonus payments for 1996 were calculated
         on 1996 performance, but paid in the first quarter of 1997.

(2)      Indicates  the  number  of shares  that may be purchased  pursuant to
         options  granted.  Options were granted under three  separate plans and
         are  identified  as "a" for  options to purchase  Class A Common  Stock
         granted  pursuant  to the 1993 Stock  Option  Plan;  "b" for options to
         purchase  Class A Common  Stock and Series A  Preferred  Stock  granted
         pursuant to the 1993  Special  Stock  Option  Plan;  "c" for options to
         purchase Class A Common Stock granted pursuant to the 1994 Non-Employee
         Stock Option Plan.

(3)      Mr. Nikolaev joined the Company on November 28, 1995 as Chief Executive
         Officer and President.  His annualized salary in 1995 was $525,000.

(4)      Represents $338 premium for group term life insurance and $1,553 of 
         401(k)employer matching contributions.

(5)      Represents a housing stipend in the amount of $10,186, personal travel
         expenses of $14,384, personal use of Company vehicle of $6,536, and 
         $12,985 to cover expected tax payments on all other annual
         compensation.

(6)      Represents $664 of club dues, $4,106 of group term life insurance, and
         $4,500 of 401(k) employer matching contributions.

(7)      Represents funds to cover expected tax payments on all other annual
         compensation.

(8)      Other perquisites and personal benefits were less than the lesser of
         $50,000 or 10% of the total of annual salary and bonus.

(9)      Includes  $36,893 for relocation  expenses,  $2,376 for group term life
         insurance  and $3,320 of 401(k)  employer  matching  contributions  for
         1994,  and  includes  $844 for club  dues,  $2,592  for group term life
         insurance  and $4,500 of 401(k)  employer  matching  contributions  for
         1995.

(10)     Mr. Ferguson received a housing stipend of $23,388 in 1995.

(11)     Includes a housing stipend of $18,000, personal travel expenses of
         $16,202, personal use of Company vehicle of $12,000, and $19,479 to
         cover expected tax payments on all other annual compensation.

(12)     Includes $1,238 for club dues, $672 for vehicle expenses, $2,628 for
         group term life insurance, and $4,500 for 401(k) employer matching
         contributions.

(13)     Includes $15,690 for relocation expenses and $433 for group term life
         insurance in 1994.  For 1995, includes $3,565 for club dues, $424 for
         group term life insurance and $4,500 of 401(k) employer matching
         contributions.

(14)     Represents $3,982 of club dues, $439 of group term life insurance, and
         $4,500 of 401(k) employer matching contributions.

(15)     Includes  $60,860 for relocation  expenses,  $1,121 for group term life
         insurance and $1,312 of 401(k) employer matching contributions in 1994.
         For 1995,  includes  $2,556 for club  dues,  $1,096 for group term life
         insurance,  $306 for  travel  and  $4,500 of 401(k)  employer  matching
         contributions.


                                                      Page 36 of 105

<PAGE>


(16)     Represents $4,486 of club dues, $1,136 of group term life insurance,
         and $4,500 of 401(k) employer matching contributions.

(17)     Represents relocation expenses of $89,666 and $1,097 of 401(k) employer
         matching  contributions in 1994 and $16,207 of relocation and $4,500 of
         401(k) employer  matching  contributions in 1995. Also represents group
         term  life  insurance  of $246 in 1994  and  $350 in  1995.  For  1996,
         represents $3,112 of club dues, $710 for group term life, and $4,500 of
         401(k) employer matching contributions.


                                                      Page 37 of 105

<PAGE>


<TABLE>

         The  following  table sets forth  certain  information  with respect to
stock options granted to the Named Executive Officers during 1996.
<CAPTION>

                                       Option Grants in Last Fiscal Year

                                                                                                         Potential Realizable Value
                                                                                                         at Assumed Annual rates of
                                                                                                       Stock Price Appreciation for
                                                                                                                 Option Term
                                               Individual Grants
      (a)                        (b)                  (c)                 (d)           (e)            (f)                 (g)
                              Number of           % of Total
                              Securities            Options            Exercise
                              Underlying          Granted to            or Base
                               Options           Employees in            Price      Expiration
      Name                    Granted (#)          Fiscal Year           ($/Sh)         Date            5%                 10%
      ----                    -----------          -----------           ------         ----            --                 --- 
<S>                             <C>                <C>                   <C>       <C>            <C>                  <C>         
Richard D.  Nikolaev             -0-                  N/A                 N/A           N/A            N/A                 N/A

Lewis H. Ferguson, III           -0-                  N/A                 N/A           N/A            N/A                 N/A
George G. Griffin, III           -0-                  N/A                 N/A           N/A            N/A                 N/A
Jack E. Parr, Ph.D.              -0-                  N/A                 N/A           N/A            N/A                 N/A
Richard H. Mazza                30,000              25.34%               21.00      10/1/06 (1)    347,337 (2)         855,507 (2)

<FN>

(1)    Options were granted under the Company's 1993 Stock Option Plan.  Options under that Plan entitle holders to purchase shares
       of Class A Common Stock  and are  conditional  on  employment.  These  options  vest over a four-year  period (in successive
       yearly  increments of 20%, 20%, 25% and 35% of the  total grant) on the  anniversary  date of  October 1, 1996, but  can be
       accelerated at the Board's discretion.

(2)    Based upon the Company's internal risk adjusted valuation model, the options were granted to Mr. Mazza at the then current
       market value of $21.00.
</FN>

                                                  Page 38 of 105
</TABLE>

<PAGE>


<TABLE>

       The following table sets forth certain  information with respect to stock
options held at December 31, 1996 by the Named Executive Officers.

<CAPTION>

                               Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values

              (a)                       (b)               (c)                        (d)                              (e)
                                                                                                               Value of Unexercised
                                                                                                                In-the-Money(1)
                                                                       Number of Securities                      Options at
                                       Shares                         Underlying Unexercised                     FY-end ($)
                                      Acquired           Value         Options at FY-end (#)                     Exercisable/
             Name                   on Exercise        Realized     Exercisable/ Unexercisable(2)               Unexercisable(3)
             ----                   -----------        --------    -----------------------------               --------------------
<S>                                    <C>              <C>         <C>                                         <C>            
Richard D. Nikolaev                     -0-               -0-       a. 22,000 / 88,000 common                       -0- / -0-
                                        -0-               -0-       c. 15,000 /  5,000 common                   108,450 /36,150
Lewis H. Ferguson, III                  -0-               -0-       a.    -0- / 96,500 common                       -0- / 2,012,797
George G. Griffin, III                  -0-               -0-       a. 12,500 / 17,500 common                   260,725 / 365,015
                                                                    b.  1,500 / -0- preferred                       -0- / -0-
Jack E. Parr, Ph.D.                    12,500           260,725     a.    -0- / 17,500 common                       -0- / 365,015
                                                                    b.  1,500 / -0- preferred                       -0- / -0-
Richard H. Mazza                        -0-               -0-       a. 16,250 /  8,750 common                   338,943 / 182,508
                                        -0-               -0-       d.  8,000 / 32,000 common                       -0- / -0-
</TABLE>

(1)    Given  the lack of a  public  trading  market  for the  Company's  equity
       securities at December 31, 1996, the fair market value of the unexercised
       options is necessarily subjective, subject to change and for the purposes
       of this  table  has been  established  by the Board of  Directors  of the
       Company at $21.00 per share of Class A Common Stock.  Shares of preferred
       stock were valued at their cost and,  accordingly,  were not in-the-money
       at December 31, 1996.

(2)    Options  under Plan "a" are  conditional  on  employment  and vest over a
       four-year  period (in successive  yearly  increments of 20%, 20%, 25% and
       35% of the total grant) for these  officers on the first  through  fourth
       anniversary  of June  30,  1993  but can be  accelerated  at the  Board's
       discretion.  Options  under  Plan "b" are sold in units of 10  shares  of
       Class A Common  Stock  and 1 share of  Series A  Preferred  Stock and are
       conditioned  only on employment as of March 31, 1995.  Options under Plan
       "c" were issued under the Company's 1994  Non-Employee  Stock Option Plan
       and vest equally over four years from the date of grant.  Options held by
       Mr. Ferguson under Plan "a" are subject to vesting  criteria set forth in
       the  Letter  Agreement.   Options  under  Plan  "d"  are  conditional  on
       employment  and  vest  over a  four-year  period  (in  successive  yearly
       increments  of 20%,  20%,  25%  and 35% of the  total  grant)  for  these
       officers on the first through fourth anniversary.

(3)    Values do not consider any tax payments related to the exercise of the
       options or sale of the underlying securities.

                                                  Page 39 of 105

<PAGE>



Director Compensation

         Directors  of the Company  are not  compensated  for their  services as
directors with the exception of (a) Mr. Walter Hennig,  who receives  $1,000 per
day of service as a director and, in  consideration  of his role as a consultant
to the Company,  has been granted options to 5,000 shares of common stock of the
Company and (b) Mr.  Herbert  Korthoff,  who  pursuant  to the Letter  Agreement
receives  an annual  salary of $100,000  for his service as the  Chairman of the
Company's Board of Directors.  Mr. Hennig's options vest over a four year period
at the rate of 20%, 20%, 25% and 35% on the first through fourth  anniversary of
January 1, 1994.  All  non-employee  directors of the Company are reimbursed for
ordinary  and  necessary  expenses  incurred  in  attending  board or  committee
meetings.

Employment Contracts

         Mr. Nikolaev's 1997 salary and Mr. Ferguson's 1997 salary remain
unchanged from prior year.  Pursuant to the Letter Agreement, Mr.
Korthoff is paid an annual salary of $100,000, and is eligible to
receive a bonus as the Board of Directors may determine.

         The Letter  Agreement  provides that the  Company's  Board of Directors
will consist of seven  directors or as otherwise  provided  under the  Company's
Restated  Certificate  of  Incorporation.  KKEP has the right to nominate  three
directors,  Mr.  Korthoff has the right to nominate three directors (one of whom
is subject to KKEP's  approval)  and the  holders of the Notes have the right to
nominate one director to the Company's Board.

Board Compensation Committee Interlocks and Insider Participation

         The directors functionally acting as the Company's compensation
committee are Mr. Korthoff and Mr. Kidd.  Mr. Nikolaev and Mr. Kidd
comprise the Option Committee.  Mr. Kidd and Mr. Ferguson functionally
act as the Company's Audit Committee.  There are no other committees of
the Board of Directors.

                                                  Page 40 of 105

<PAGE>


<TABLE>
ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following  tables set forth,  as of December 31, 1996,  information
with  respect to the  beneficial  ownership of shares of the  Company's  Class A
Common Stock and Series A Preferred Stock by (i) each  stockholder  known by the
Company  to be the  beneficial  owner of more  than 5% of  either  class of such
shares, (ii) each director of the Company, the Company's Chief Executive Officer
and each of the other Named Executive Officers (as defined in Item 11, Executive
Compensation),  and (iii) all directors and executive officers of the Company as
a group. Unless otherwise  indicated,  the persons named in this table have sole
voting power and investment power with respect to all shares  beneficially owned
by them.
<CAPTION>
                                                                                              Amount and Nature of       Percentage
  Title of Class                       Name and Address of Beneficial Owners                  Beneficial Ownership         of Class
  --------------                       -------------------------------------                  --------------------       ----------
<S>                              <C>                                                                 <C>                     <C>  
Class A Common Stock             Kidd Kamm Equity Partners, L.P.                                     5,353,820               44.3%
                                 Three Pickwick Plaza
                                 Greenwich, Connecticut  06830
                                 Herbert W. Korthoff                                                 1,797,150 (1)           14.88%
                                 444 August Drive
                                 Riverton, Wyoming 82501
                                 Barbara Korthoff                                                    1,797,150 (2)           14.88%
                                 Riverton, Wyoming 82501
                                 California Public Employee Retirement System                        1,143,737 (3)            9.47%
                                 1200 Prospect Street
                                 La Jolla, California  92037
                                 Princes Gate Investors, L.P.                                          741,110 (3)            6.14%
                                 1585 Broadway
                                 New York, New York  10036
                                 William J. Kidd                                                     5,353,820 (4)            44.3%
                                 c/o Kidd, Kamm & Company
                                 Three Pickwick Plaza
                                 Greenwich, Connecticut   06830
                                 Kurt L. Kamm                                                        5,353,820 (4)            44.3%
                                 c/o Kidd, Kamm & Company
                                 9454 Wilshire Boulevard, Suite 920
                                 Beverly Hills, California  90212
                                 Richard D. Nikolaev                                                    37,000 (5)              (7)
                                 Lewis H. Ferguson, III                                                479,920 (6)             4.0%
                                 George G. Griffin                                                      47,500                  (7)
                                 Jack E. Parr, Ph.D.                                                    47,500                  (7)
                                 Richard H. Mazza                                                       24,250                  (7)
                                 Walter S. Hennig                                                        3,250                  (7)
                                 Eric R. Hamburg                                                            -0-                 -0-
                                 All directors and officers as a group (10                           7,890,678               65.32%
                                 persons)




                                                               Page 41 of 105
</TABLE>

<PAGE>



(1)      Includes 96,500 shares of Class A Common Stock held by Mr. Korthoff's
         wife, Barbara Korthoff, of which Mr. Korthoff disclaims beneficial
         ownership.

(2)      Includes 1,700,650 shares of Class A Common Stock held by
         Mrs. Korthoff's husband, Herbert Korthoff, of which Mrs. Korthoff
         disclaims beneficial ownership.

(3)      Shares subject to warrants currently exercisable.

(4)      Deemed to be the beneficial owners of the Class A Common Stock
         beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm control KKEP.

(5)      Represents shares subject to options that are exercisable currently.

(6)      Includes  96,500  shares  subject to  repurchase  by KKEP under certain
         conditions pursuant to the Letter Agreement, and includes 96,500 shares
         of Class A Common  Stock  issuable  pursuant to options  granted to Mr.
         Ferguson,  which options may be exercisable  within the next 60 days as
         determined by formula contained in the Letter Agreement.

(7)      Less than one percent (1%).

                                                  Page 42 of 105

<PAGE>

<TABLE>


<CAPTION>

                                                                                      Amount and Nature of         Percentage
       Title of Class                Name and Address of 5% Beneficial Owner          Beneficial Ownership          of Class
       --------------                ---------------------------------------          --------------------          --------
<S>                               <C>                                                          <C>                      <C>  
Series A Preferred Stock          Kidd Kamm Equity Partners, L.P.                              535,382                  63.6%
                                  Three Pickwick Plaza
                                  Greenwich, Connecticut   06830
                                  Herbert W. Korthoff                                          179,715 (1)              21.3%
                                  444 August Drive
                                  Riverton, Wyoming 82501
                                  Barbara W. Korthoff                                          179,715 (2)              21.3%
                                  444 Augusta Drive
                                  Riverton, Wyoming 82501
                                  William J. Kidd                                              535,382 (3)              63.6%
                                  c/o Kidd, Kamm & Company
                                  Three Pickwick Plaza
                                  Greenwich, Connecticut   06830
                                  Kurt L. Kamm                                                 535,382 (3)              63.6%
                                  c/o Kidd, Kamm & Company
                                  9454 Wilshire Boulevard; Suite 920
                                  Beverly Hills, California  90212
                                  Richard D. Nikolaev                                              -0-                    -0-
                                  Lewis H. Ferguson, III                                        38,342 (4)               4.6%
                                  George G. Griffin                                              1,500 (5)                (6)
                                  Jack E. Parr, Ph.D.                                            1,500 (5)                (6)
                                  Richard H. Mazza                                                 -0-                    -0-
                                  Walter S. Hennig                                                 -0-                    -0-
                                  Eric R. Hamburg                                                  -0-                    -0-
                                  All directors and officers as a group (10
                                  persons)                                                     756,439                  89.8%

<FN>

(1)      Includes 9,650 share of Series A Preferred Stock held by Mr. Korthoff's wife Barbara Korthoff, of which Mr. Korthoff
         disclaims beneficial ownership.
(2)      Includes 170,065 shares of Series A Preferred Stock held by Mrs. Korthoff's husband, Herbert Korthoff, of which
         Mrs. Korthoff disclaims beneficial ownership.
(3)      Deemed to be the beneficial owners of the Series A Preferred Stock beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm
         control KKEP.
(4)      Includes 9,650 shares subject to repurchase by KKEP under certain conditions pursuant to the Letter Agreement.
(5)      Represents shares subject to options which are currently exercisable.
(6)      Less than one percent (1%).
</FN>

                                                  Page 43 of 105
</TABLE>

<PAGE>



ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS


Management Agreement with Kidd Kamm & Company and its Affiliates

         Kidd Kamm & Company,  an affiliate of KKEP,  has a management  services
agreement with the Company pursuant to which it renders  management,  consulting
and related  services to the Company for an annual  management  fee of $360,000,
subject to  increases  as  determined  by the Board of Directors of the Company,
plus out-of-pocket expenses.

Tissue Engineering, Inc.

         In February, 1997, William J. Kidd and the other principals of Kidd and
Company, LLC purchased common stock and warrants to acquire additional common 
stock options in Tissue Engineering Inc. (a company with which the Company 
entered into a joint venture agreement in 1996), Kidd and Company, LLC is 
providing financial advisory services to Tissue Engineering, Inc.

Transactions with Investors

         Stock  Transactions.  At  the  Acquisition  closing  date,  Herbert  W.
Korthoff,  the Company's Chairman,  purchased 1,254,500 shares of Class A Common
Stock and 125,450 shares of Series A Preferred Stock plus 96,500 shares of Class
A Common  Stock and 9,650  shares of Series A Preferred  Stock  purchased in his
wife's name, by delivering to the Company two recourse  promissory  notes in his
name,  the H. Korthoff Group 1 Note in the principal  amount of $1,232,877  with
respect to the purchase of the H. Korthoff Group 1 Shares, consisting of 579,000
shares of Class A Common  Stock and 57,900  shares of Series A Preferred  Stock,
and the H.  Korthoff  Group 2 Note in the principal  amount of  $1,438,356  with
respect to the purchase of the H. Korthoff Group 2 Shares, consisting of 675,500
shares of Class A Common Stock and 67,550 shares of Series A Preferred Stock and
by delivering to the Company two  promissory  notes in his wife's name, the Mrs.
Korthoff  Group 1 Note in the  principal  amount of $102,739 with respect to the
purchase of the Mrs.  Korthoff  Group 1 Shares,  consisting  of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred  Stock, and the Mrs.
Korthoff  Group 2 Note in the  principal  amount of $102,739 with respect to the
purchase of the Mrs.  Korthoff  Group 2 Shares,  consisting  of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred Stock.

         On June 1, 1994,  the Company  requested  that the holders of the Notes
waive  certain  provisions  of the  Indenture to allow the Company to repurchase
from Mr.  Korthoff  798,380  shares of Class A Common Stock and 79,838 shares of
Series A Preferred Stock for use in employee incentive programs. The Company was
notified on July 22, 1994 of the approval of the holders of the Notes for such a
transaction and accordingly repurchased such shares for $1,700,549 through a pro
rata credit of that sum against the principal balance of the H. Korthoff Group 1
Note and the H. Korthoff Group 2 Note. On December 27, 1995, Herbert W. Korthoff
and  Barbara  Korthoff  paid the  Company  $1,176,162  representing  the  entire
principal of the Korthoff Group 1 Note and Korthoff Group 2 Notes. The

                                                  Page 44 of 105

<PAGE>



balance of the Group 1 Notes and Group 2 Notes,  representing  the  accrued  but
unpaid interest on such notes, is evidenced by the Amended Note.

         Lewis H. Ferguson III, a director and officer of the Company, purchased
at the  Acquisition  closing  date  289,500  shares of Class A Common  Stock and
28,950  shares of Series A  Preferred  Stock by  delivering  to the  Company two
recourse  promissory notes, the Ferguson Group 1 Note in the principal amount of
$410,959 with respect to the purchase of the Ferguson Group 1 Shares  consisting
of  193,000  shares  of Class A Common  Stock  and  19,300  shares  of  Series A
Preferred  Stock and the Ferguson Group 2 Note (together with the Ferguson Group
1 Note, the "Ferguson  Notes") in the principal  amount of $205,480 with respect
to the purchase of the Ferguson  Group 2 Shares  consisting  of 96,500 shares of
Class A Common Stock and 9,650 shares of Series A Preferred Stock.

         The Amended Note is full recourse and (i) will mature on June 30, 1998,
subject to acceleration upon a sale of all or substantially all of the business,
assets or issued and outstanding  capital stock of the Company or the successful
completion of an initial  public  offering  by the  Company of any of its equity
securities  pursuant to the Securities  Act, and (ii) is secured by a pledge of,
and the  Company is entitled to offset,  all  dividends  payable on the Series A
Preferred Stock held by Herbert W. Korthoff and Barbara  Korthoff.  The Ferguson
Notes are full recourse and (i) bear interest,  payable semi-annually (but which
interest  may be, and to date has been,  deferred  and added to principal at the
option of the maker), at the rate of 10% per annum, (ii) will mature on June 30,
1998,  subject to acceleration  upon a sale of all or  substantially  all of the
business,  assets or issued and outstanding  capital stock of the Company or the
successful completion of an initial public offering by the Company of any of its
equity securities pursuant to a registration statement under the Securities Act,
and (iii) are secured by the pledge of the Ferguson Group 1 and Ferguson Group 2
Shares to the Company.

         Pursuant to the Letter  Agreement  among KKEP,  the Company and each of
Mr.  Korthoff,  his wife and Mr.  Ferguson,  each dated June 30, 1993,  upon the
occurrence  of an Event of Default  (defined as including (a) any default in the
payment of principal or interest which has continued for ten (10) business days,
or (b) certain  bankruptcy,  insolvency or similar  proceedings  not  dismissed,
vacated or stayed within sixty (60) days) under the Ferguson Notes,  the Company
has the right to foreclose upon the Ferguson  Shares,  and KKEP has the right to
elect to succeed to all the rights of the Company under said Ferguson  Notes and
related  stock  pledge  agreements.  In the event KKEP  elects to succeed to all
rights of the Company under said Ferguson Notes,  KKEP must make full payment to
the Company of the  outstanding  balance of the Ferguson  Notes, as the case may
be, and allow each of the other  initial  cash equity  investors  in the Company
(except the defaulting noteholder) to participate in such purchase in proportion
to their respective ownership of the capital stock of the Company.

         Mr.  Ferguson  also owns 9,650  shares of Series A Preferred  Stock and
96,500  shares  of Class A Common  Stock of the  Company  which are  subject  to
repurchase  by KKEP or the  Company  in the event  that KKEP has not  achieved a
certain target rate of return on its equity investment in

                                                  Page 45 of 105

<PAGE>



the Company in  accordance  with a formula that is set forth in an attachment to
the Letter Agreement. In addition, Mr. Ferguson holds options to purchase 96,500
shares of the  Company's  Class A Common  Stock that vest only in the event that
KKEP  achieves the target rates of return  described  in the  attachment  to the
Letter Agreement.

         Payments to Outside Counsel.  Mr. Ferguson is a partner (on an
extended leave of absence) in the law firm of Williams & Connolly, which
the Company retained during fiscal years 1994, 1995 and 1996 and
proposes to retain during fiscal year 1997.

         Officer and Director Arrangements. Mr. Korthoff's, Mr. Ferguson's
and Mr. Nikolaev's salaries will remain unchanged for 1997.

         The Letter  Agreement  provides that the  Company's  Board of Directors
will consist of seven  directors or as otherwise  provided  under the  Company's
Restated  Certificate  of  Incorporation.  KKEP has the right to nominate  three
directors,  Mr. Korthoff has the right to nominate three directors (one of which
is subject to KKEP's  approval)  and the  holders of the Notes have the right to
nominate one director to the Company's Board. Messrs. Kidd, Kamm and Hamburg are
of KKEP's nominees and Messrs. Korthoff, Ferguson, and Hennig are Mr. Korthoff's
nominees.  Neither KKEP nor the noteholders has nominated any other directors as
of the date hereof.

         Principal  Stockholders'  Agreement.  Pursuant  to  the  terms  of  the
Principal  Stockholders'  Agreement,  except  for  certain  permitted  transfers
including the  repurchase by KKEP and such of the other parties to the agreement
of a defaulting  person's  shares  subject to pledge to the  Company,  no person
subject  thereto may sell any of his, her or its shares of capital  stock of the
Company.

         The  Principal  Stockholders'  Agreement  also provides that if, at any
time prior to the third anniversary of the Principal Stockholders' Agreement and
provided no Event of Default (as defined in the  Indenture)  has occurred and is
continuing under the terms of the Indenture,  the holders of more than 662/3% of
the issued and outstanding shares (the "Requisite Percentage") determine to sell
all of their shares in an  arm's-length  transaction  to an  unaffiliated  third
person,  then all holders  will sell all of their  shares under the terms of the
sale, subject to certain conditions, but not to any restrictions as to price. At
any time after the third anniversary of the Principal  Stockholders'  Agreement,
or at any time an Event of Default under the terms of the Indenture has occurred
and is continuing at the time a contract of sale is entered into,  the Requisite
Percentage  necessary to cause the other  stockholders to sell their shares in a
qualified  transaction  will  be  a  majority-in-interest   of  the  issued  and
outstanding shares of capital stock.

         The Principal  Stockholders'  Agreement  also grants holders tag- along
rights making any transfers subject to the right of other holders to participate
in such  transfer in  proportion  to their  ownership of shares of the Company's
capital  stock at the same price per share  being  offered  to the  transferring
holder. The Principal  Stockholders'  Agreement  terminates on the closing of an
underwritten public offering

                                                  Page 46 of 105

<PAGE>



of the Company's shares of Common and Preferred Stock pursuant to a registration
statement  under the  Securities  Act declared  effective by the  Securities and
Exchange Commission.

         Other Related Party Transactions.  In 1995, Mr. Nikolaev was paid
a consulting fee of $135,000 for consulting services performed for the
Company.  At the election of Mr. Nikolaev, such amount was paid to the
company through which the services were rendered and which is owned by
one of the members of his family.

         On June 30, 1994 Mr.  Ferguson  received a loan from the Company in the
amount of $75,000 for the purchase of a residence.  That loan bears  interest at
7.25%,  the prime rate as of June 30, 1994. The original note was due January 1,
1996,  and has  been  extended  until  June  30,  1997,  and is  secured  by Mr.
Ferguson's stock in the Company.

                                                  Page 47 of 105

<PAGE>



                                                      PART IV


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

                  (a)     The following documents are filed or incorporated by
                          reference as part of this Form 10-K:

                  1.      Financial Statements and Financial Statement
                          Schedules:

                          The "Index to Financial Statements" set forth on page
                          53 of  this  Form  10-K  is  incorporated  herein  by
                          reference.

                          Schedules  have been omitted  because either they are
                          not required or the information is included elsewhere
                          in the financial statements and notes thereto.

                  2.      Exhibits (Exhibits listed below without asterisks are
                          filed herewith.)


EXHIBIT                   DESCRIPTION OF EXHIBIT
2.1*                      Purchase and Sale Agreement, dated May
                          14, 1993, among the Company, Dow Corning
                          and Dow Corning Wright Corporation.
3.1******                 Restated Certificate of Incorporation of
                          the Company dated September 25, 1995.
3.2*                      By-Laws of the Company.
4.1*                      Indenture dated as of June 30, 1993,
                          between the Company and the First
                          National Bank of Boston, as trustee.
4.1(a)*                   First Supplemental Indenture, dated as
                          of November 1, 1993, between the Company
                          and The First National Bank of Boston.
4.2*                      Security Agreement dated as of June 30,
                          1993, between the Company and BancBoston
                          Trust Company of New York, as collateral
                          agent acting on behalf of the First
                          National Bank of Boston.
4.3*                      Pledge Agreement, dated as of June 30,
                          1993, between the Company and BancBoston
                          Trust Company of New York, as collateral
                          agent acting on behalf of The First
                          National Bank of Boston.
4.4*                      Form of Purchase Agreement, dated June
                          30, 1993, between the Company and the
                          purchasers of the Notes.


                                                  Page 48 of 105

<PAGE>




4.5*                      Registration Rights Agreement, dated as
                          of June 30, 1993, between the Company
                          and the purchasers of the Notes.
4.6*****                  Series B Preferred Stock Purchase and
                          Class A Common Stock Warrant Agreement,
                          dated July 29, 1994, between the Company
                          and CalPERS.
4.6(a)*******             Amendment No. 1 dated September 25, 1995
                          to Series B Preferred Stock Purchase and
                          Class A Common Stock Warrant Agreement,
                          dated July 29, 1994 between the Company
                          and CalPERS.
10.1*                     Product Manufacturing Agreement, dated
                          June 30, 1993, between the Company and
                          Dow Corning Corporation.
10.2*                     Revolving Credit Agreement, dated
                          September 30, 1993, between the Company
                          and Heller Financial, Inc.
10.3*                     Principal Stockholders' Agreement, dated
                          June 30, 1993, among the Company and
                          certain of its stockholders.
10.4*                     Omnibus Stockholders' Agreement, among
                          the Company and certain of its
                          stockholders.
10.5*                     License Agreement, dated June 25, 1993,
                          between the Company and Dr. Alfred B.
                          Swanson.
10.6****                  1993 Stock Option Plan
10.7****                  1993 Special Stock Option Plan
10.8****                  Employee Common Stock Grant Plan
10.9****                  Distributor Stock Purchase Plan
10.10*                    Industrial Development Lease Agreement
                          date  as  of  July  9,  1985  between  The  Industrial
                          Development Board of The City of Arlington,  Tennessee
                          (the "Arlington IDB") and Dow Corning Wright, Inc.
10.11*                    Lease and Security Agreement dated as of
                          April 1, 1974 between the Arlington IDB
                          and Wright Manufacturing Company
                          together with First Supplement to Lease
                          dated as of December 1, 1981.


                                                  Page 49 of 105

<PAGE>




10.12*                    Industrial Development Lease Agreement
                          dated as of June 29, 1984 between
                          Langston Associates and the Arlington
                          IDB.
10.13*                    Letter Agreements dated June 30, 1993
                          among the Company and certain of its
                          Stockholders with Promissory Notes and
                          Stock Pledge and Security Agreements
                          attached.
10.14***                  Letter Agreement dated June 30, 1993
                          between KKEP and Herbert W. Korthoff,
                          Lewis Ferguson, and Barbara Korthoff.
10.14(a)*****             Amendment dated July 29, 1994 to Letter
                          Agreement dated June 30, 1993 between
                          KKEP and Herbert W. Korthoff, Lewis
                          Ferguson, and Barbara Korthoff.
10.15*                    Agreement dated January 24, 1983,
                          between Leo A.  Whiteside, M.D. and the
                          Company.
10.16**                   Acquisition Agreement dated February 5,
                          1994, between the Company and
                          OrthoTechnique.
10.17*****                Distribution Agreement dated December
                          20, 1993, between the Company and Kaneka
                          Medix Corporation.
10.18*****                Research and Development Agreement dated
                          October 7, 1994, between the Company and
                          OsteoBiologics, Inc.
10.19***                  Acquisition Agreement dated December 8,
                          1994, between the Company and Orthomet.
10.20*****                1994 Distributor Stock Option Plan.
10.21*****                Non-qualified Stock Option Agreement for
                          Non-Employees.
10.22*******              Securityholders Agreement, dated
                          September 25, 1995, between the Company,
                          the purchasers named therein and PG
                          Investors, Inc., as agent.
10.23*******              Distribution Agreement dated February
                          22, 1996, between the Company and
                          Century Medical, Inc.

10.24********             Revolving Credit Agreement, dated
                          September 13, 1996 between the Company
                          and Sanwa Business Credit Corporation.



                                                  Page 50 of 105

<PAGE>




10.25                     Joint Venture Agreement, dated July 12,
                          1996 between the Company and Tissue
                          Engineering, Inc.
11.1                      Statement re:  Computation of earnings
                          per share.
12.1                      Statement re: Computation of ratios of
                          earnings to fixed charges and preferred
                          dividends.
21.1                      Subsidiaries of the Company.
23.2                      Consent of Arthur Andersen LLP
*                         Document incorporated by reference from
                          Registration Statement on Form S-4 No.
                          33-69286 filed by the Company on
                          November 10, 1993.
**                        Document incorporated by reference to
                          Current Report on Form 8-K dated as of
                          February 5, 1994.
***                       Document incorporated by reference to
                          Current Report on Form 8-K dates as of
                          December 8, 1994.
****                      Document incorporated by reference to
                          Annual Report on Form 10-K filed March 25, 1994.
*****                     Document incorporated by reference to
                          Annual Report on Form 10-K filed March 31, 1995.
******                    Document incorporated by reference to
                          Quarterly Report on Form 10-Q filed November 14, 1995.
*******                   Document incorporated by reference to
                          Annual Report on Form 10-K Filed March
                          31, 1996.
********                  Document incorporated by reference to
                          current report on Form 8-K dated as of
                          September 13, 1996.

                  (b)      Reports on Form 8-K

                           The registrant  filed a current report on Form 8-K on
                           September 13, 1996  regarding  the  Revolving  Credit
                           Agreement  between  the  Company  and Sanwa  Business
                           Credit
                           Corporation.

                                                  Page 51 of 105

<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, thereunto duly authorized.

                                    WRIGHT MEDICAL TECHNOLOGY, INC.
                                    (Registrant)

                                    BY: /s/Richard D. Nikolaev
                                        Richard D. Nikolaev
                                        President and Chief Executive Officer

                                    DATE: March 25, 1997

           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 (CAPACITY)                      DATE
                           President, Chief Executive
                           Officer, and Director
/s/Richard D. Nikolaev     (Principal Executive
Richard D. Nikolaev        Officer)                           March 25, 1997

                           Chief Financial Officer
                           and Executive Vice
/s/George G. Griffin,III   President (Principal
George G. Griffin, III     Financial Officer)                 February 25, 1997

/s/Lewis H. Ferguson,III   Senior Vice President
Lewis H. Ferguson, III     Secretary, and Direct              March 18, 1997

/s/Herbert W. Korthoff     Chairman of the Board of
Herbert W. Korthoff        Directors                          March 18, 1997

/s/William J. Kidd
William J. Kidd            Director                           February 25, 1997

/s/Kurt L. Kamm
Kurt L. Kamm               Director                           March 18, 1997

/s/Walter S. Hennig
Walter S. Hennig           Director                           March 18, 1997

/s/Gregory K. Butler       Vice President, Controller
Gregory K. Butler          and Assistant Secretary            March 18, 1997

/s/Eric R. Hamburg
Eric R. Hamburg            Director                           March 18, 1997

                                                  Page 52 of 105

<PAGE>



                                           INDEX TO FINANCIAL STATEMENTS


Wright Medical Technology, Inc.

     Report of Independent Public Accountants...............................54
     Consolidated Financial Statements:
         Consolidated Balance Sheets as of December 31, 1996
           and 1995 ........................................................55
         Consolidated Statements of Operations for the Year Ended
           December 31, 1996, 1995 and 1994.................................56
         Consolidated Statements of Cash Flows for the Year Ended
           December 31, 1996, 1995 and 1994.................................57
         Consolidated Statements of Changes in Stockholders'
           Investment for the Year Ended December 31, 1996, 1995
           and 1994.........................................................58
         Notes to Consolidated Financial Statements.........................59





                                                  Page 53 of 105

<PAGE>



                                     REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



          To the Stockholders of Wright Medical Technology, Inc.:

          We have audited the accompanying consolidated balance sheets of Wright
     Medical  Technology,  Inc. (a Delaware  corporation) and subsidiaries as of
     December  31, 1996 and 1995,  and the related  consolidated  statements  of
     operations,  changes  in  stockholders'  investment  and cash flows for the
     years ended December 31, 1996, 1995 and 1994.  These  financial  statements
     are the responsibility of the Company's  management.  Our responsibility is
     to express an opinion on these financial statements based on our audits.

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

          In our opinion,  the  financial  statements  referred to above present
     fairly, in all material respects,  the financial position of Wright Medical
     Technology, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
     results  of their  operations  and their  cash  flows  for the years  ended
     December 31, 1996, 1995 and 1994, in conformity  with  generally  accepted
     accounting principles.





                                                           ARTHUR ANDERSEN LLP
     Memphis, Tennessee,
     March 14, 1997.

                                                  Page 54 of 105

<PAGE>
<TABLE>
                                 WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
                                                CONSOLIDATED BALANCE SHEETS
<CAPTION>
                                                                                    December 31,              December 31,
                                                                                        1996                      1995
                                                                                  ------------------        -----------------
ASSETS                                                                             (in thousands)            (in thousands)

Current Assets:
<S>                                                                                <C>                       <C>            
    Cash and cash equivalents                                                      $            910          $         1,126
    Trade receivables, net                                                                   18,289                   18,269
    Inventories, net                                                                         59,107                   54,815
    Prepaid expenses                                                                          1,692                    1,353
    Deferred income taxes                                                                       978                        -
    Other                                                                                     2,540                    1,948
                                                                                  ------------------        -----------------
       Total Current Assets                                                                  83,516                   77,511
                                                                                  ------------------        -----------------

Property, Plant and Equipment, net                                                           33,659                   39,141
Deferred Income Taxes                                                                             -                    2,608
Investment in Joint Venture                                                                   3,597                        -
Other Assets                                                                                 45,554                   55,111
                                                                                  ------------------        -----------------
                                                                                   $        166,326          $       174,371
                                                                                  ==================        =================

LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current Liabilities:
    Current portion of long-term debt                                              $            138          $           446
    Short-term borrowing                                                                      8,390                    3,900
    Accounts payable                                                                          6,063                    7,769
    Accrued expenses and other current liabilities                                           18,453                   17,550
    Deferred income taxes                                                                         -                    2,608
                                                                                  ------------------        -----------------
       Total Current Liabilities                                                             33,044                   32,273
                                                                                  ------------------        -----------------

Long-Term Debt                                                                               84,668                   84,462
Preferred Stock Dividends                                                                    17,999                   14,938
Other Liabilities                                                                             3,189                      570
Deferred Income Taxes                                                                           978                        -
                                                                                  ------------------        -----------------
       Total Liabilities                                                                    139,878                  132,243
                                                                                  ------------------        -----------------

Commitments and Contingencies (Notes 1, 3, 5 & 11)

Mandatorily  Redeemable  Series B Preferred  Stock,  $.01 par value,  (aggregate
    liquidation  value of $75.3 million,  including accrued and unpaid dividends
    of $4.1 million, 800,000 shares authorized, 600,000 shares
    issued and outstanding)                                                                  59,959                   46,757
Redeemable Convertible Series C Preferred Stock, $.01 par value,  (aggregate
    liquidation value of $40.3 million, including accrued and unpaid dividends
    of $5.3 million, 350,000 shares authorized, issued and outstanding)                      24,995                   20,548

Stockholders' Investment:
    Series A preferred stock,  $.01 par value,  (aggregate  liquidation value of
       $25.0 million,  including  accrued and unpaid dividends of $8.6 million),
       1,200,000 shares authorized,
       915,325 shares issued                                                                      9                        9
    Undesignated preferred stock, $.01 par value,
       650,000 shares authorized, no shares issued                                                -                        -
    Class A common stock, $.001 par value, 46,000,000 shares authorized,
       10,023,421 and 9,791,040 shares issued                                                    10                       10
    Class B common stock, $.01 par value, 1,000,000 shares authorized,
       no shares issued                                                                           -                        -
    Additional capital                                                                       53,853                   51,470
    Accumulated deficit                                                                    (111,855)                 (76,557)
    Other                                                                                       516                      930
                                                                                  ------------------        -----------------
                                                                                            (57,467)                 (24,138)

    Less - Notes receivable from stockholders                                                (1,037)                  (1,037)
         Series A preferred treasury stock, 86,688 shares                                        (1)                      (1)
         Class A common treasury stock, 878,130 shares                                           (1)                      (1)
                                                                                  ------------------        -----------------
       Total Stockholders' Investment                                                       (58,506)                 (25,177)
                                                                                  ------------------        -----------------

                                                                                   $        166,326          $        174,371
                                                                                  ==================        =================

                     The accompanying notes are an integral part of these consolidated balance sheets.
                                                  Page 55 of 105
</TABLE>
<PAGE>
<TABLE>




                              WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES

                                    CONSOLIDATED STATEMENTS OF OPERATIONS


                                  (in thousands, except earnings per share)

<CAPTION>

                                                                       Year Ended December 31,
                                                        ------------------------------------------------------
                                                             1996               1995                1994
                                                        ---------------    ---------------     -------------- 
<S>                                                      <C>                <C>                 <C>
Net sales                                                $      121,868     $      123,196      $      95,763

Cost of goods sold                                               44,433             33,722             43,610
                                                        ----------------   ----------------    ---------------

Gross profit                                                     77,435             89,474             52,153
                                                        ----------------   ----------------    ---------------

Operating expenses:
      Selling                                                    47,437             47,085             33,227
      General and administrative                                 19,357             23,358             23,274
      Research and development                                   13,196             12,728             15,083
      Purchased in-process research and development                   -                  -             27,700
      Equity in loss of joint venture                               500                  -                  -
                                                        ----------------   ----------------    ---------------
                                                                 80,490             83,171             99,284
                                                        ----------------   ----------------    ---------------

Operating income (loss)                                          (3,055)             6,303            (47,131)
Interest expense                                                (12,079)           (11,935)           (10,140)
Interest income                                                     132                613                931
Other income (expense), net                                         413                146               (921)
                                                        ----------------   ----------------    ---------------

Loss before income taxes                                        (14,589)            (4,873)           (57,261)

Income tax provision (benefit)                                        -              1,619             (7,881)
                                                        ----------------   ----------------    ---------------


Net loss                                                 $      (14,589)    $       (6,492)     $     (49,380)
                                                        ================   ================    ===============

Loss applicable to common stock                          $      (35,298)    $      (19,783)     $     (53,166)
                                                        ================   ================    ===============

Loss per share of common stock                           $       (3.90)     $        (2.24)     $       (6.10)
                                                        ================   ================    ===============

Weighted average common shares outstanding                       9,059               8,825              8,717
                                                        ================   ================    ===============





                      The accompanying notes are an integral part of these statements.




                                                  Page 56 of 105
</TABLE>
<PAGE>
<TABLE>



                                 WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES

                                         CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                    (in thousands)

<CAPTION>
                                                                                 Year Ended December 31,
                                                                   -----------------------------------------------------
                                                                        1996               1995               1994
                                                                   ---------------    ----------------   ---------------
      Cash Flows From Operating Activities: 
      <S>                                                           <C>                <C>                <C>           
           Net loss                                                 $     (14,589)     $       (6,492)    $     (49,380)
           Adjustments to reconcile net loss to
             net cash used in operating activities:
                Depreciation                                                7,007               7,272             7,246
                Instrument amortization                                     4,265               4,337                 -
                Provision for instrument reserves                           3,647                   -                 -
                Provision for excess/obsolete inventory                      (453)             (2,369)           12,114
                Provision for sales returns                                  (247)                290              (497)
                Deferred income tax provision (benefit)                         -               1,270            (8,455)
                Deferred income                                             1,502                   -                 -
                Amortization of intangible assets                           3,266               3,747             1,351
                Amortization of deferred financing costs                    1,361               1,036               829
                Loss on disposal/abandonment of equipment                     485                  97               138
                Equity in loss of joint venture                               500                   -                 -
                Purchased in-process research and development                   -                   -            27,700
                Other                                                         614                (178)             (126)
                Changes in assets and liabilities, net of effect of
                  purchases of businesses
                      Trade receivables                                       442                (522)             (769)
                      Inventories                                          (3,335)            (18,101)           (2,606)
                      Other current assets                                 (1,104)                (77)             (166)
                      Accounts payable                                     (1,706)              2,741            (3,282)
                      Accrued expenses and other liabilities               (1,380)            (16,848)           11,095
                      Other assets                                           (840)             (1,869)           (2,903)
                                                                   ---------------    ----------------   ---------------
                Net cash used in operating activities                        (565)            (25,666)           (7,711)
                                                                   ---------------    ----------------   ---------------

      Cash Flows From Investing Activities:
           Capital expenditures                                            (3,778)            (12,525)          (10,550)
           Purchases of businesses, net of cash acquired                        -                   -           (60,688)
           Other                                                             (884)             (1,139)             (497)
                                                                   ---------------    ----------------   ---------------
                Net cash used in investing activities                      (4,662)            (13,664)          (71,735)
                                                                   ---------------    ----------------   ---------------

      Cash Flows From Financing Activities:
           Net proceeds from short-term borrowings                          4,490               3,900                 -
           Proceeds from issuance of stock and stock warrants               1,278              33,409            59,493
           Payments of debt issuance costs                                   (387)                  -                 -
           Payments of debt                                                  (446)               (641)              (63)
           Proceeds from stockholders on notes receivable                       -               1,225               855
           Other                                                               76                (509)               44
                                                                   ---------------    ----------------   ---------------
                Net cash provided by financing activities                   5,011              37,384            60,329
                                                                   ---------------    ----------------   ---------------


      Net decrease in cash and cash equivalents                              (216)             (1,946)          (19,117)
      Cash and cash equivalents, beginning of period                        1,126               3,072            22,189
                                                                   ---------------    ----------------   ---------------
      Cash and cash equivalents, end of period                      $         910      $        1,126     $       3,072
                                                                   ===============    ================   ===============

      Supplemental Disclosure of Cash Flow Information:
           Cash paid for interest                                   $      10,474      $       11,885     $       9,336
                                                                   ===============    ================   ===============
           Cash paid for income taxes                               $          33      $          234     $         786
                                                                   ===============    ================   ===============

                                   The accompanying notes are an integral part of these statements.


                                                  Page 57 of 105
</TABLE>
<PAGE>
<TABLE>


                                 WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
                          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT
                                                  (in thousands)
<CAPTION>
                            Number of Shares                                                              Notes
                         Series A     Class A    Series A   Class A                                    Receivable
                        Preferred     Common     Preferred  Common    Additional  Accumulated              From     Treasury
                          Stock        Stock       Stock     Stock      Capital    Deficit      Other  Stockholders   Stock    Total
<S>                          <C>      <C>           <C>      <C>      <C>       <C>           <C>        <C>         <C>   <C>     
  BALANCE, 12/31/93          920       9,290        $9        $9      $19,589     ($3,608)       $-      ($4,397)     $-    $11,602
Purchase of treasury stock     -           -         -         -       (1,740)          -         -        1,573      (2)      (169)
Issuance of common stock
 warrants                      -           -         -         -       12,681           -         -            -       -     12,681
Acquisition of business        -         170         -         -        2,336           -         -            -       -      2,336
Preferred stock dividend       -           -         -         -            -      (3,447)        -            -       -     (3,447)
Payments on stockholder
 notes receivable              -           -         -         -            -           -         -          855       -       855
Accretion of preferred
 stock discount                -           -         -         -            -        (339)        -            -       -       (339)
Net loss                       -           -         -         -            -     (49,380)        -            -       -    (49,380)
Other                         (4)        (19)        -         -          (80)          -       439            -       -        359
                         ----------- ----------- ---------- --------- --------- -----------  ---------  ----------   ----- ---------
  BALANCE, 12/31/94          916       9,441         9         9       32,786     (56,774)      439       (1,969)     (2)   (25,502)
Issuance of common stock       -         350         -         1          497           -         -            -       -        498
Issuance of common stock
  warrants                     -           -         -         -       18,187           -         -            -       -     18,187
Preferred stock dividend       -           -         -         -            -     (10,455)        -            -       -    (10,455)
Payments on stockholder
  notes receivable             -           -         -         -            -           -         -        1,225       -      1,225
Accretion of preferred
 stock discount                -           -         -         -            -      (2,836)        -            -       -     (2,836)
Net loss                       -           -         -         -            -      (6,492)        -            -       -     (6,492)
Other                         (1)          -         -         -            -           -       491         (293)      -        198
                         ----------- ----------- ---------- --------- --------- -----------  ---------  ----------   ----- ---------
  BALANCE, 12/31/95          915       9,791         9        10       51,470     (76,557)      930       (1,037)     (2)   (25,177)
Issuance of common stock       -         232         -         -        2,383           -         -            -       -      2,383
Preferred stock dividend       -           -         -         -            -     (14,251)        -            -       -    (14,251)
Accretion of preferred
  stock discount               -           -         -         -            -      (6,458)        -            -       -     (6,458)
Net loss                       -           -         -         -            -     (14,589)        -            -       -    (14,589)
Other                          -           -         -         -            -           -      (414)           -       -       (414)
                         ----------- ----------- ---------- --------- --------- -----------  ---------  ----------  ------ ---------
  BALANCE, 12/31/96          915      10,023        $9       $10      $53,853   ($111,855)     $516      ($1,037)    ($2)  ($58,506)
                         =========== =========== ========== ========= ========= ===========  =========  ==========  ====== =========

               The accompanying notes are an integral part of these statements.

                                                  Page 58 of 105
</TABLE>
<PAGE>



                              WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES

                                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Description of Business -

        Wright Medical  Technology,  Inc. and its  subsidiaries  (the "Company")
engage in the  business of  developing,  manufacturing  and selling  orthopaedic
products, principally knee and hip implants. The Company's products are designed
to restore  mobility  and relieve  pain  through the  replacement  of damaged or
diseased   joints.   The  Company   distributes  its  products  through  various
distributors  with  approximately 75% of its products sold in the United States.
The Company  purchased  substantially  all of the assets of Dow  Corning  Wright
Corporation ("DCW") on June 30, 1993 (the "DCW Acquisition").

Liquidity and Capital Resources -

        Since the DCW Acquisition,  the Company's  strategy has been to position
itself for aggressive growth through new product development and the acquisition
of new technologies  through license agreements,  joint venture arrangements and
the purchase of other  companies in the  orthopaedic  industry (see Note 2). The
Company has funded this strategy  through the sale of $85 million of senior debt
securities and the  contribution of  approximately  $15 million of equity at the
time of the DCW  Acquisition.  Further,  the  Company  has  obtained  additional
capital  through the issuance of $60,000,000 of Series B Preferred Stock in 1994
and  $35,000,000  of Series C Preferred  Stock in 1995 (see Note 8). The Company
has also funded its growth and working capital  requirements  through the use of
revolving lines of credit (see Note 7).

        The Company has  incurred  significant  losses since its  inception  and
anticipates incurring a loss during 1997. Additionally,  the Company's projected
working  capital  requirements  for 1997  indicate a  continued  reliance on its
revolving credit facility. Accordingly,  management continues to closely monitor
the Company's  working  capital  needs and believes  that the Company's  current
revolving  line  of  credit  will be  sufficient  to meet  its  working  capital
requirements throughout 1997.

        In July 1998,  the Company's  first annual sinking fund payment of $28.3
million is due on its senior  debt  securities.  Prior to that time,  management
believes that it will need to effect a recapitalization plan for the Company. In
this  regard,  management  has  begun  discussions  with  a  limited  number  of
investment  banks to assess the various  alternatives  available  to the Company
including,  without  limitation,  refinancing  its senior debt securities and an
initial  public  offering  of  equity  securities.  Management  believes  that a
successful  plan of  recapitalization  will be  completed  prior to July,  1998;
however,  there can be no  assurance  that such a  recapitalization  plan can be
consummated.


                                                  Page 59 of 105

<PAGE>



Significant Risks and Uncertainties -

        Inherent in the accompanying  financial statements are certain risks and
uncertainties.  These risks and uncertainties  include,  but are not limited to,
timely  development  and  acceptances  of new  products,  impact of  competitive
products,  regulatory approval of new products,  regulation of current products,
disposition  of  certain  litigation  matters  (see  Note 11) and the  Company's
ability to accurately forecast and manage its working capital requirements.


Significant Accounting Policies -

Principles of Consolidation

        The accompanying  consolidated financial statements include the accounts
of the Company and its  wholly-owned  domestic  and  foreign  subsidiaries.  All
significant  intercompany  accounts and transactions  have been eliminated.  The
Company accounts for its investment in the Orthopaedic  Tissue Technology L.L.C.
joint venture under the equity method of accounting.

Use of Estimates

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

Cash and Cash Equivalents

        Cash and cash  equivalents  include  all cash  balances  and  short-term
investments with original maturities of three months or less.

Allowance for Returns

        An allowance is maintained  for  anticipated  future returns of products
sold by the Company.  An allowance for returns of approximately $0.6 million and
$1.2  million is included as a reduction  of trade  receivables  at December 31,
1996 and December 31, 1995, respectively.

Inventories

        Inventories  are stated at the lower of cost or market,  with cost being
determined using the first-in, first-out ("FIFO") method. Inventory reserves are
established  to reduce the carrying  amount of obsolete and excess  inventory to
its net realizable value. The Company  principally  follows an inventory reserve
formula that reserves  inventory  balances  based on historical  and  forecasted
sales.




                                                  Page 60 of 105

<PAGE>



        Statement  of  Position  94-6  ("SOP  94-6"),  issued  by  the  American
Institute of Certified Public Accountants, requires, among other things, certain
disclosures  regarding  the use of  estimates  in the  preparation  of financial
statements.  SOP 94-6 was required to be adopted by the Company in 1995. In that
regard,  management has made its best estimate in determining the required level
of the  inventory  reserves  discussed  above and does not expect  any  material
changes  thereto;  however,  given the  subjective  nature of the reserves,  the
Company's estimate of the required reserves could change in the future.

Property and Depreciation

        Property,  plant and  equipment  are  carried at cost.  Depreciation  is
provided on a straight-line  basis over estimated useful lives of 15 to 20 years
for land improvements, 15 to 45 years for buildings, 3 to 10 years for machinery
and  equipment,  and  5 to 15  years  for  furniture,  fixtures  and  equipment.
Expenditures  for major renewals and betterments  that extend the useful life of
the assets are capitalized.  Maintenance and repair costs are charged to expense
as incurred.  Upon sale or  retirement,  the asset cost and related  accumulated
depreciation are eliminated from the respective accounts, and any resulting gain
or loss is included in income.

        Instruments  loaned to and used by surgeons in the  implantation  of the
Company's products are included in property, plant and equipment and depreciated
on a straight-line  basis over periods not to exceed five years with adjustments
made as necessary for identified impairments in carrying value.

Impairment of Long-Lived Assets

        In March 1995, the Financial  Accounting Standards Board ("FASB") issued
Statement  of  Financial  Accounting  Standards  No.  121,  "Accounting  for the
Impairment of  Long-Lived  Assets and for  Long-Lived  Assets to Be Disposed Of"
("SFAS No. 121"), which requires  impairment losses to be recorded on long-lived
assets used in operations  when  indicators of  impairment  are present.  During
1996, the Company  adopted SFAS No. 121 which did not have a material  effect on
its consolidated financial position or operating results.

Goodwill and Other Intangible Assets

        The cost of intangible  assets is amortized  over the estimated  periods
benefited,  but not exceeding 40 years. The  realizability of goodwill and other
intangibles  is evaluated  periodically  as events or  circumstances  indicate a
possible inability to recover their carrying amount. Such evaluation is based on
various  analyses,  including  cash flow and  profitability  projections.  These
analyses necessarily involve significant  management judgement.  At December 31,
1996,  management  believes  that the  carrying  value of its goodwill and other
intangibles is realizable.





                                                  Page 61 of 105

<PAGE>



Stock-Based Compensation

        In October 1995, the FASB issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.
123").  This new standard encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options, and
other equity instruments based on a fair-value method of accounting.
Companies that do not choose to adopt the new expense recognition rules
of SFAS No. 123 will continue to apply the existing accounting rules
contained in Accounting Principles Board Opinion No. 25 ("APB No. 25")
and related Interpretations, but will be required to provide pro forma
disclosures of the compensation expenses determined under the fair-value
provisions of SFAS No. 123, if material.  The Company adopted the
disclosure provisions only of SFAS No. 123 during 1996.

Income Taxes

        Income taxes are accounted  for pursuant to the  provisions of Statement
of Financial  Accounting  Standards No. 109, "Accounting for Income Taxes." This
statement  requires the use of the liability  method of accounting  for deferred
income taxes.  The provision for income taxes  includes  federal,  foreign,  and
state income taxes  currently  payable and those  deferred  because of temporary
differences  between  the  financial  statement  and tax  bases  of  assets  and
liabilities.   Provisions   for  federal  income  taxes  are  not  made  on  the
undistributed  earnings of foreign  subsidiaries  where the  subsidiaries do not
have the  capability  to  remit  earnings  in the  foreseeable  future  and when
earnings are considered permanently invested.  Undistributed earnings of foreign
subsidiaries at December 31, 1996 are insignificant.

Research and Development Costs

        Research  and  development  costs are  charged to expense as incurred or
when expenditures for such costs are  contractually  obligated and the amount is
determinable.

Foreign Currency Translation

        Revenues and expenses for foreign  activities  are translated at average
exchange rates during the period. Assets (primarily inventories and receivables)
located  outside the U.S. are translated into U.S.  dollars using  end-of-period
exchange  rates.  The  cumulative  foreign  currency  translation  adjustment at
December 31, 1996 and 1995 is not significant.

Earnings Per Share

        Net loss per  common  share is  computed  by  dividing  net  loss,  plus
preferred stock dividends and accretion,  by the weighted  average common shares
outstanding  during the  period.  Because of the net loss  applicable  to common
stock, the assumed exercise of common stock equivalents has not been included in
the  computation  of weighted  average shares  outstanding  because their effect
would be anti-dilutive.



                                                  Page 62 of 105

<PAGE>



Fair Value of Financial Instruments

        The  following  methods and  assumptions  were used to estimate the fair
value of each class of  financial  instruments  for which it is  practicable  to
estimate that value:

        -   Cash and cash  equivalents - The carrying amount  approximates  fair
            value because of the short maturities of the cash equivalents.

        -   Long-term  debt - At December  31, 1996 and 1995,  the fair value of
            the  Series  B Notes  was  approximately  $85.9  million  and  $86.7
            million,  respectively,  based upon  market  quotes  provided  by an
            investment   banker.   The  carrying   amount  of  these  notes  was
            approximately  $84.4  million and $84.3 million at December 31, 1996
            and 1995, respectively.

        -   Series B and C preferred stock - These are  specialized  instruments
            with  various  terms  and  preferential  treatment  which  render it
            impracticable to determine their current fair value.

        -   Noncurrent  distributor  receivables  - The fair value is based upon
            the anticipated cash flows discounted at rates currently established
            by  management.  The  fair  value of these  receivable  balances  at
            December 31, 1996 and 1995 approximates book value.

Reclassifications

        Certain prior year amounts have been reclassified to conform to the 1996
presentation.


2.      ACQUISITIONS OF BUSINESSES

Orthopaedic Tissue Technology, L.L.C.

        On July 12, 1996 the Company and Tissue Engineering, Inc. entered into a
joint  venture  agreement to create a joint  venture  named  Orthopaedic  Tissue
Technology,   L.L.C.  ("OTT").  The  Company  executed  a  promissory  note  for
$1,500,000  of which  $630,000  was drawn in 1996.  The  Company  will also make
additional funding contributions of $1,500,000 to OTT on July 12, 1997 and 1998.
Tissue  Engineering,   Inc.  contributed  the  license  to  certain  proprietary
technology to OTT. The Company has a 49% equity interest in OTT and will receive
50% of OTT's annual profit/ losses.  OTT will develop and distribute  biological
products for  musculoskeletal  applications.  Products are designed to reproduce
the events of tissue  formation  including the  treatment of medical  conditions
involving disease, injury or deterioration of ligaments,  tendons,  cartilage or
bone and sports related injuries. The Company accounts for its investment in OTT
under the equity method of accounting and has reflected the present value of its
future  funding  commitments  as a liability  in the  accompanying  consolidated
financial statements.





                                                  Page 63 of 105

<PAGE>



U.S. Gypsum

        On  September  30,  1996,  the Company  entered  into an Asset  Purchase
Agreement  to  purchase  the  biomaterials  business  of the  Industrial  Gypsum
Division of United States Gypsum Company ("USG").  The Company will pay $750,000
for this business in four quarterly installments beginning on December 31, 1996.
The purchase  price was  principally  allocated to existing  patents and will be
amortized  over 5  years.  The  Company  also  receives  the  right  to sell and
distribute the OSTEOSET(TM)  medical grade calcium sulfate pellets for a 25 year
period.  The Company will pay USG a royalty of 6% of sales,  net of commissions,
on this product.

Orthomet

        On  December  8,  1994,  the  Company  acquired  Orthomet,  Incorporated
("Orthomet"),  a Minnesota corporation,  for a cash price of approximately $64.6
million,  including related fees and expenses.  Orthomet designed,  manufactured
and marketed selected orthopaedic  reconstructive  implants and related surgical
instrumentation.   The   acquisition  was  accounted  for  as  a  purchase  and,
accordingly,  the  consolidated  financial  statements  include  the  results of
operations of Orthomet from December 8, 1994.

        The accompanying  financial  statements include the estimated fair value
of assets  acquired and  liabilities  assumed by the  Company.  A summary of the
purchase  transaction  and the  final  allocation  of the  purchase  price is as
follows (in thousands):

Purchase price:
    Cash purchase price                                           $     62,906
    Transaction fees and expenses                                        1,678
                                                                 --------------
        Total purchase price                                      $     64,584
                                                                 ==============
Allocated to assets and liabilities as follows:
  Current assets, including cash of $8,816                        $     21,130
  Property, plant and equipment                                          3,496
    In-process research and development                                 20,700
    Other identifiable intangible assets                                 5,992
    Excess of cost over net assets acquired                             29,302
    Current liabilities                                                (10,787)
    Other noncurrent items, net                                         (5,249)
                                                                 --------------
                                                                  $     64,584
                                                                 ==============

        The amount allocated to in-process research and development was expensed
immediately following the acquisition because, in the opinion of management, the
technological  feasibility  of  the  in-process  technology  had  not  yet  been
established  and the technology has no  alternative  future use.  Excess of cost
over net assets  acquired is being  amortized  over 20 years on a  straight-line
basis.


                                                  Page 64 of 105

<PAGE>



Questus

        On  October  13,  1994,  the  Company   acquired   Questus   Corporation
("Questus"), a Massachusetts  corporation,  following the spin-off by Questus of
certain of its lines of business. The portion of Questus acquired by the Company
is in the business of medical device and arthroscopic research and development.

        In exchange for the Questus shares,  the Company paid $2 million in cash
and issued 169,630 shares of Class A Common Stock.  An additional  84,818 shares
of  Class A  Common  Stock  are  held  in  escrow  until  certain  research  and
development  milestones are achieved; in connection  therewith,  the Company has
committed to the former  Questus  shareholders  to spend $5 million  towards the
achievement of these milestones.  Additionally,  the Company will pay the former
Questus shareholders a royalty equal to 5% of net sales of certain products.

        The  acquisition was accounted for as a purchase and,  accordingly,  the
consolidated  financial  statements include the results of operations of Questus
from October 13, 1994. A summary of the purchase  transaction and the allocation
of the purchase price is as follows (in thousands):

Purchase price:
  Cash paid                                                         $    2,000
  Value of Company shares issued                                         2,336
  Transaction fees and expenses                                             62
                                                                    -----------
     Total purchase price                                           $    4,398
                                                                    ===========
Allocated to assets and liabilities as follows:
  In-process research and development                               $    7,000
  Deferred income taxes                                                 (2,660)
  Other                                                                     58
                                                                    -----------
                                                                    $    4,398
                                                                    ===========

        The amount allocated to in-process research and development was expensed
immediately following the acquisition because, in the opinion of management, the
technological  feasibility  of  the  in-process  technology  had  not  yet  been
established and the technology has no alternative future use.

OrthoTechnique

        On  February  5, 1994,  the  Company  acquired  100% of the  outstanding
capital stock of OrthoTechnique S.A.  ("OrthoTechnique")  which is headquartered
in France.  The purchase price,  including  acquisition  costs, was 28.9 million
French francs  (approximately  U.S. $4.9 million) plus additional  consideration
contingent upon OrthoTechnique's future operating results.  OrthoTechnique is in
the business of  distributing  medical  implants  throughout  France,  including
products manufactured by the Company.


                                                  Page 65 of 105

<PAGE>



        The  acquisition was accounted for as a purchase and,  accordingly,  the
consolidated   financial   statements  include  the  results  of  operations  of
OrthoTechnique   from  the  acquisition   date.  The  acquisition   resulted  in
approximately  $3.1  million  of excess of cost  over fair  value of net  assets
acquired, which is being amortized on a straight-line basis over 40 years.

        An allocation of the purchase price is as follows(in thousands):

Current assets, including cash of $888                              $   3,591
Excess of cost over net assets acquired                                 3,093
Current liabilities                                                    (2,084)
Other                                                                     288
                                                                    ----------
                                                                    $   4,888
                                                                    ==========

Pro Forma Financial Information

        Unaudited pro forma financial  information  relating to the Orthomet and
OrthoTechnique  acquisitions  is as  follows  (in  thousands,  except  per share
amounts):

                                                                        1994
                                                                   ------------
Net sales                                                          $   121,799
Net loss                                                               (25,620)
Net loss per share of common stock                                 $     (3.93)


        The pro forma results are not necessarily  indicative of what would have
occurred had the acquisitions  actually been consummated at the beginning of the
period presented, or of future results of the combined companies.

<TABLE>
3.      INVENTORIES

        The  components  of  inventories,  net of  reserves,  are as follows (in
thousands):
<CAPTION>
                                                               December 31,
                                                       ------------------------
                                                          1996           1995
                                                       ---------       --------
<S>                                                    <C>             <C>     
Raw materials                                          $   2,214       $  3,146
Work in process                                           10,186         10,971
Finished goods                                            36,388         35,650
Surgical instruments                                      10,319          5,048
                                                       ---------       --------
                                                       $  59,107       $ 54,815
                                                       =========       ========
</TABLE>
        In April 1996, the Company instituted a new surgical  instrument program
with its domestic distributor network. The program makes more

                                                  Page 66 of 105

<PAGE>



of the Company's  surgical  instruments  available for sale to its  distributors
and,  thus,  reduces  the demand for loaner  instruments.  Concurrent  with this
program  adoption,  the  Company  reclassified  approximately  $8.5  million  of
surgical  instruments  from property,  plant and equipment to inventory at their
net book value.

        Generally,  the Company's products are subject to regulation by the Food
and Drug Administration ("FDA"). Currently, management believes that the 
Company's products comply with applicable FDA regulations and that the Company 
has no significant inventory levels of products awaiting FDA approval that, if 
such approvals  were  denied,  would  have a  material  effect  on  the  
consolidated financial position or operating results of the Company.

<TABLE>

4.      PROPERTY, PLANT AND EQUIPMENT

        Property, plant and equipment consists of the following (in thousands):
<CAPTION>
                                                              December 31,
                                                        ------------------------
                                                            1996         1995
                                                        -----------   ----------
<S>                                                      <C>           <C>    
Land and land improvements                               $     844     $   859
Buildings                                                    5,696       5,619
Machinery and equipment                                     25,036      22,824
Furniture, fixtures and equipment                           13,033      12,672
Loaner instruments                                          14,174      17,633
                                                        -----------   ----------
                                                            58,783      59,607
Less:  Accumulated depreciation                            (25,124)    (20,466)
                                                        -----------   ----------
                                                         $  33,659     $39,141
                                                        ===========   -=========
</TABLE>
<TABLE>
5.      INTANGIBLE ASSETS

        Other  assets  include   certain   intangible   assets  as  follows  (in
thousands):
<CAPTION>
                                                              December 31,
                                                        ------------------------
                                                             1996         1995
                                                        -----------  -----------
<S>                                                      <C>          <C>      
Excess of cost over net assets acquired                  $  35,461    $  35,629
Distribution network                                         4,800        4,800
Patents, licenses and trademarks                             3,137        2,439
Other                                                        3,004        2,962
                                                        -----------  -----------
                                                            46,402       45,830
Less:  Accumulated amortization                             (8,528)      (5,656)
                                                        -----------  -----------
                                                         $  37,874    $  40,174
                                                        ===========  ===========

                                                  Page 67 of 105
</TABLE>
<PAGE>



        Excess of cost over net assets  acquired is being amortized over periods
ranging from 10 to 40 years on a  straight-line  basis.  Other  intangibles  are
being   amortized  over  periods  ranging  from  2  to  25  years  on  either  a
straight-line or double declining balance basis.

<TABLE>
6.      ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

        A detail of accrued expenses and other current liabilities is as follows
(in thousands):
<CAPTION>
                                                             December 31,
                                                       -------------------------
                                                           1996          1995
                                                       ------------  -----------
<S>                                                      <C>          <C>      
Interest                                                 $   4,668    $   4,619
Employee benefits                                            3,489        2,350
Joint venture                                                2,105            -
Research and development                                         -        2,600
Commissions                                                  1,358        1,385
Taxes                                                          761        1,194
Distributor product reserve                                    161          618
Professional fees                                            1,088        1,020
Other                                                        4,823        3,764
                                                        -----------  -----------
                                                         $  18,453    $  17,550
                                                       ============  ===========
</TABLE>
<TABLE>
7.      LONG-TERM DEBT

        Long-term debt consists of the following (in thousands):
<CAPTION>
                                                              December 31,
                                                        ------------------------
                                                            1996        1995
                                                        ------------ -----------
<S>                                                       <C>         <C>       
10-3/4% Series B Senior Secured
  Notes, net of unamortized
  discount of $572 and $735                               $ 84,428    $  84,265
Capital lease obligations                                      378          643
                                                         ----------  -----------
                                                            84,806       84,908
Less current portion                                          (138)        (446)
                                                         ----------  ----------
                                                          $ 84,668    $  84,462
                                                         ==========  ==========
</TABLE>

        On June 30, 1993,  the Company  issued  10-3/4%  Series A Senior Secured
Notes (the "Series A Notes") with an aggregate  principal amount of $85 million.
Attached to the Series A Notes were 350,000 common

                                                  Page 68 of 105

<PAGE>



stock purchase warrants which were sold for $.02 per warrant. The Series A Notes
were  issued at  99.389%  of par  resulting  in an  effective  interest  rate of
approximately 10-7/8%.

        The  Series  A Notes  were  issued  pursuant  to a  Registration  Rights
Agreement  whereby  the  Company  agreed  to use its best  efforts  to  effect a
registration  statement  for a new issue of senior  secured notes of the Company
identical  in all  respects  to the Series A Notes.  On  December  8,  1993,  an
exchange offer was consummated whereby the Company issued $85 million of 10-3/4%
Series B Senior  Secured Notes (the "Series B Notes") in exchange for the Series
A Notes.  In  connection  with the  issuance  of the Series A Notes and Series B
Notes, the Company incurred costs aggregating  approximately  $3.9 million which
have been deferred and are being  amortized over the 7-year term of the Series B
Notes.

        The  Series B Notes  mature on July 1, 2000 and are  subject  to certain
optional and  mandatory  redemption  provisions.  On or after July 1, 1996,  the
Company has the option to redeem the Series B Notes, in whole or in part, at the
following redemption price (expressed as a percentage of principal amount):

           Date                                Percentage
           ----                                ----------

      July 1, 1996 - June 30, 1997                106%
      July 1, 1997 - June 30, 1998                103%
      July 1, 1998 and thereafter                 100%

        The  mandatory  redemption  provision  of the  Series  B Notes  requires
sinking fund payments of  approximately  $28.3 million on July 1, 1998 and 1999.
If a change in control, as defined, of the Company occurs, the note holders have
the right to require the Company to repurchase,  in whole or in part, the Series
B Notes at 101% of the aggregate principal amount of the Series B Notes.

        Certain  restrictions  apply to the Series B Notes  which  limit,  among
other  things,  (a) the  issuance of  additional  debt or preferred  stock,  (b)
payment of cash dividends on, and  redemption  of, the Company's  capital stock,
(c) consolidations,  mergers,  transfers or sales of all or substantially all of
the Company's assets and (d) transactions  with  affiliates.  Additionally,  the
Company is required to maintain  specified  levels of consolidated net worth, as
defined,  throughout  the term of the Series B Notes.  At December 31, 1996, the
Company is in compliance with the Series B Notes  covenants.  Based upon current
operating   projections,   management   believes   the  Company  will  meet  its
consolidated net worth  requirements as of December 31, 1997, its next scheduled
compliance  date.  However,  to meet the consolidated net worth test at December
31, 1997, the Company will be required to pay dividends  "in-kind" on the Series
B Preferred Stock (see Note 8) during 1997. Also, there can be no assurance that
the Company will achieve its operating plan for 1997.

        The Series B Notes are secured by a first priority  security interest in
certain of the fixed assets,  intellectual  property rights and other intangible
assets of the  Company,  now in existence or  hereinafter  acquired,  other than
cash, cash equivalents, accounts

                                                  Page 69 of 105

<PAGE>



receivable  and  inventory,  and by a first  priority  pledge of all the capital
stock of all current and future subsidiaries of the Company.

        At  December  31,  1996,  the  fair  value  of the  Series  B Notes  was
approximately  $85.9 million based upon a market quote provided by an investment
banker.

        The Company had available to it a $30 million  revolving  line of credit
with Heller Financial,  Inc. (the "Heller Agreement") that expired in September,
1996. The Company's  projected cash flow  requirements  indicated that a similar
revolving credit agreement was needed to fund the on going working capital needs
of the Company. Management negotiated with several financial institutions and on
September 13, 1996,  finalized  and closed a Loan  and  Security  Agreement with
Sanwa Business Credit Corporation (the "Sanwa Agreement") for a $25 million 
(which can increase to $30 million upon the occurrence of certain events)
revolving line of credit which expires in September, 1999. As of December 31,
1996, this agreement provided an eligible  borrowing  base of $19.4 million and
the Company had drawn $8.4  million  pursuant to this  agreement.  During 1996,
borrowings under the Heller and Sanwa Agreements averaged $12.5 million  with a
maximum  amount borrowed of $16.1 million,  as compared to 1995 when  borrowings
averaged $15.1 million and reached a high of $29.0 million. Borrowings under
this agreement are collateralized  by the Company's accounts receivable and
inventories and bear interest at prime plus 1.5%.  A guaranty  fee of 3% per
annum is required on any letter of credit guaranties.

        The agreement  places various  restrictions  on the Company which limit,
among  other  things,  (a)  additional  indebtedness,   (b)  acquisitions,   (c)
consolidations,  mergers,  sales of all or  substantially  all of the  Company's
assets and (d) transactions with affiliates. Additionally, the Company must meet
a specified cash flow coverage ratio.


8.      CAPITAL STOCK

Common Stock

        Two classes of common  stock of the  Company  have been  authorized  for
issuance:  Class A Common Stock and Class B Common Stock. The holders of Class A
Common  Stock are  entitled to one vote for each share of Class A Common  Stock.
There are  currently no shares of Class B Common Stock  outstanding.  Subject to
any preferential  rights of any outstanding series of preferred stock designated
by the Board of  Directors,  the holders of Class A Common Stock are entitled to
receive,  ratably, with the holders of any Class B Common Stock, such dividends,
if any, as may be declared from time to time by the Board of Directors.

        Pursuant to a restated  certificate of incorporation dated September 25,
1995 (the "Restated Certificate"),  the Company has 47,000,000 authorized shares
of common  stock  consisting  of  46,000,000  shares of Class A Common Stock and
1,000,000 shares of Class B Common Stock.



                                                  Page 70 of 105

<PAGE>



Preferred Stock

        Pursuant  to  the  Restated  Certificate,   the  Company  has  3,000,000
authorized  shares of preferred stock consisting of 1,200,000 shares of Series A
Preferred Stock,  800,000 shares of Series B Preferred Stock,  350,000 shares of
Series C Preferred  Stock,  and 650,000 shares of undesignated  preferred stock.
The  Series C  Preferred  Stock is senior to the  Series A  Preferred  Stock and
junior to the Company's  Series B Preferred  Stock with respect to dividends and
rights upon liquidation.

        The Series A Preferred  Stock is voting stock and, upon  liquidation  or
dissolution of the Company, entitles the holders to a preferential distribution,
subordinate  to the  Series B and  Series C  Preferred  Stock,  from the  assets
legally  available for  distribution  to  stockholders  after the payment of all
debts and  liabilities  of the  Company.  At December 31,  1996,  the  aggregate
preferential  distribution would amount to $25.0 million,  including accrued and
unpaid dividends ($8.6 million).

        Dividends on the Series A Preferred Stock  accumulate at the rate of 12%
per annum for a  five-year  period and at the rate of 15% per annum  thereafter,
subject  to  escalation  in the  event  of  delinquency  in the  payment  of the
dividends;  as of December 31, 1996,  the dividend  rate had escalated to 16.86%
per  share.  Dividends  can be paid  on the  Series  A  Preferred  Stock  at the
Company's  discretion and the Series A Preferred Stock is redeemable at any time
at the option of the Company;  such dividend and redemption rights are currently
restricted, however, by the indenture relating to the Series B Notes.

        On  July  29,  1994,  the  Company  and  California   Public  Employees'
Retirement System  ("CalPERS")  entered into a Series B Preferred Stock Purchase
and Class A Common Stock  Warrant  Agreement  whereby the Company would have the
option, for a period of 30 months after July 29, 1994, to sell up to $60 million
of Series B  Preferred  Stock to CalPERS.  On July 29,  1994,  the Company  sold
150,000 shares of the Series B Preferred Stock and 254,684  warrants to purchase
Class A Common  Stock to CalPERS  for $15  million.  On October  31,  1994,  the
Company sold 450,000 shares of Series B Preferred Stock and 764,053  warrants to
purchase Class A Common Stock to CalPERS for $45 million. Each warrant (exercise
price of $.001 per share)  entitles  CalPERS to  purchase  from the  Company one
share of Class A Common Stock at any time.  The Company may be required to issue
additional  warrants to CalPERS to allow CalPERS to achieve a certain  return on
its investment in the Company.

        The Series B Preferred  Stock is  non-voting  and, upon  liquidation  or
dissolution  of the  Company,  the holders of the Series B  Preferred  Stock are
entitled to a preferential  distribution  from the assets legally  available for
distribution to  stockholders  after the payment of all debts and liabilities of
the Company. As of December 31, 1996, such aggregate  preferential  distribution
would amount to $75.3  million,  including  accrued and unpaid  dividends  ($4.1
million).

        Dividends  on the Series B Preferred  Stock are payable on January 2 and
July 1 of each  year,  subject to the  dividend  restrictions  in the  indenture
relating to the Series B Notes. The dividend rate,  originally $10 per share, is
subject to escalation in the event of delinquency in

                                                  Page 71 of 105

<PAGE>




the payment of the  dividends;  as of December 31, 1996,  the dividend  rate had
escalated  to $12.10 per share.  The Company has the option to pay  dividends in
either cash or additional shares of Series B Preferred Stock.

        On February  25,  1997,  the  Company's  Board of  Directors  declared a
dividend "in-kind" of $11.2 million to the Series B Preferred Stock shareholders
by issuing  111,910 shares of Series B Preferred Stock to shareholders of record
as of December 31, 1996. Accordingly, this "in-kind" dividend has been reflected
in the carrying amount of the Mandatorily Redeemable Series B Preferred Stock in
the accompanying consolidated balance sheet. Subsequently,  the Company declared
an  additional  "in-kind"  dividend of $5.3 million by issuing  53,485 shares of
Series B Preferred  Stock to its Series B  Preferred  Stock  shareholders  as of
February 28, 1997.

        The Series B Preferred Stock is subject to an optional redemption by the
Company.  The  Company  must pay a premium of 6-1/2% if such  redemption  occurs
prior to July 29, 1997, and a 5% premium during the subsequent 24 months. Unless
earlier  redeemed,  the Company must redeem all Series B Preferred Stock on July
29, 2002. The Series B Preferred Stock also may be redeemed at the option of the
holder in  certain  circumstances.  The terms of the  Series B  Preferred  Stock
limit,  among other things,  (a) the issuance of additional  capital stock,  (b)
consolidations,  mergers,  transfers or sales of all or substantially all of the
Company's  assets,  (c) payment of dividends on and  redemption of the Company's
capital stock, and (d) additional indebtedness.

        On September 25, 1995, the Company and Princes Gate Investors,  L.P. and
affiliates, investment partnerships managed by Morgan Stanley & Co. Incorporated
(collectively,  the "Princes Gate Investors") entered into a Securities Purchase
Agreement,  pursuant  to which the  Princes  Gate  Investors  purchased,  for an
aggregate sum of $35 million ($33.8 million net of commissions),  350,000 shares
of preferred stock designated  Redeemable  Convertible Preferred Stock, Series C
(the "Series C Preferred Stock") and 741,110 warrants to purchase Class A Common
Stock (the "Series B Warrants").

        The Series C Preferred  Stock is senior to the Company's  Class A Common
Stock  and  Series A  Preferred  Stock  and  junior  to the  Company's  Series B
Preferred  Stock with  respect to  dividends  and rights upon  liquidation.  The
Series C Preferred Stock is non-voting and, upon liquidation of the Company, the
holders  of  the  Series  C  Preferred  Stock  are  entitled  to a  preferential
distribution  from the assets legally available for distribution to stockholders
after  the  payment  of all  debts  and  liabilities  of  the  Company  and  all
liquidation  payments to the holders of the Series B Preferred Stock,  including
all accrued and unpaid  dividends  (the  "Series C  Redemption  Amount").  As of
December 31, 1996, the Series C Redemption  Amount was $40.3 million,  including
accrued and unpaid dividends ($5.3 million).

        Dividends on the Series C Preferred Stock, which are payable on
January 1, April 1, July 1 and October 1 of each calendar year, cumulate
at the rate of $12 per share per annum through March 24, 1999.  The

                                                  Page 72 of 105

<PAGE>



dividend rate per share per annum increases according to the following
schedule:


       March 25, 1999 to September 24, 1999         $13.00
       September 25, 1999 to March 24, 2000          14.00
       March 25, 2000 to September 24, 2000          15.00
       September 25, 2000 to March 24, 2001          16.00
       March 25, 2001 and thereafter                 17.00

        Under the terms of the  Company's  indenture  relating  to the  Series B
Notes,  dividends  on the  Series C  Preferred  Stock may not be paid  until the
Series B Notes are paid in full and, under the Restated  Certificate,  dividends
on the Series C Preferred Stock are subject to the prior payment of dividends on
and, under certain circumstances, redemption of the Series B Preferred Stock.

        At any time after March 24, 1999,  the Princes Gate  Investors,  holding
not less than 66-2/3% of all Series C Preferred Stock, have the right to convert
the Series C Preferred  Stock into shares of Class A Common  Stock having a fair
market  value, as  defined, equal to 110% of  the  Series  C Redemption  Amount
on that date.  After any such  conversion,  no new shares of Series C  Preferred
Stock may be issued by the Company. Additionally, subject to certain limitations
imposed  by the  Restated  Certificate  and the  Series  B Notes,  the  Series C
Preferred  Stock is  redeemable at the option of the Company for an amount equal
to the Series C Redemption Amount on the date of any such redemption.

        The terms of the Series C Preferred  Stock,  contain  certain  covenants
that,  among other things,  limit the Company's  ability to (a) issue additional
shares  of  preferred  stock,   (b)  incur   additional   indebtedness  and  (c)
consolidate, merge or sell substantially all of the Company's assets.

        Each of the Series B Warrants  entitles  the holder  thereof to purchase
one share of Class A Common  Stock at an exercise  price of $.01 per share.  The
Company  will be  required  to  issue  additional  Series  B  Warrants  upon the
occurrence of certain events as follows:  If 1) the Company has not repurchased,
redeemed or  converted  all  outstanding  Series C Preferred  Stock on or before
March 25, 1999,  or 2) prior to March 25, 1999, an initial  public  offering has
occurred  and all of the  proceeds  from  such  offering  are not used to redeem
outstanding  shares of Series C Preferred  Stock,  then on the earlier of (1) or
(2) above,  additional  Series B Warrants shall be issued, if Series C Preferred
Stock is still outstanding;  provided,  however,  that at no time is the Company
required to issue more than an aggregate of 3,989,931 Series B Warrants.

        In  September  1995,  the  Company  also  issued an  additional  125,000
warrants (exercise price of $.001 per share) to purchase Class A Common Stock to
the holders of the  Company's  Series B Preferred  Stock.  These  warrants  were
issued in exchange for the consent of the holders of the

                                                  Page 73 of 105

<PAGE>



Series B Preferred Stock to the issuance of the Series C Preferred Stock.

Warrants

        In  addition  to  the  warrants  issued  to  CalPERS  and  Princes  Gate
Investors,  the Company issued  warrants to the purchasers of its senior secured
notes at the purchase price of $.02 per warrant. In the aggregate,  the warrants
entitle the holders to purchase  350,000 shares of the Company's  Class A Common
Stock at $.142 per share.  The exercise  price and the number of warrant  shares
are both subject to adjustment in certain cases. The warrants are exercisable at
any time and, unless exercised, the warrants will automatically expire ten years
from the date of issuance.

        The  holders of the  warrants  have no voting or  dividend  rights.  The
holders of the  warrants  are not entitled to share in the assets of the Company
in the event of liquidation  or  dissolution of the Company.  In case of certain
consolidations  or mergers of the Company,  or the sale of all or  substantially
all of the assets of the  Company to another  corporation,  each  warrant  shall
thereafter be exercisable for the right to receive the kind and amount of shares
of stock or other  securities  or property to which such holder  would have been
entitled as a result of such consolidation, merger or sale had the warrants been
exercised immediately prior thereto.

Stock Option Plans

        At December 31,  1996,  the Company has two fixed stock option plans for
employees,  two stock option plans for nonemployees  which principally  includes
the  distributors  of the Company's  products and a distributor  stock  purchase
plan. Generally,  the Company's stock option plans grant options to purchase the
Company's Class A Common Stock and, in certain instances, the Company's Series A
Preferred Stock.

        Under the 1993 Stock Option Plan,  the Company may grant  options to its
employees for up to 1.5 million  shares of Class A Common Stock.  Under the 1993
Special Stock Option Plan, the Company may grant options to its employees for up
to 200,000  shares of common stock and 20,000 shares of preferred  stock.  Under
these two fixed stock option plans,  options  generally  become  exercisable  in
installments  of 25% annually in each of the first through fourth  anniversaries
of the grant date and have a maximum  term of ten years.  Under both plans,  the
exercise  price  of  each  option  equals  the  market  price  of the  Company's
respective stock on the date of grant.

        The  Company's  non-employee  stock option  plans  include the 1994 Non-
employee Stock Option Plan ("NSOP") which  authorizes  up to  125,000  shares of
Class A  Common  Stock and the 1994 Distributor Stock Option Plan ("DSOP") which
authorizes  up to 500,000  shares of Class A Common  Stock.  Under both of those
plans,  the  exercise  price  of each  option  equals  the  market  price of the
Company's  Common  Stock on the date of grant  with  the  options  maximum  term
equaling ten years.  Under the NSOP,  options  generally  become  exercisable in
installments  of 25% annually in each of the first through fourth  anniversaries
of the grant date. Under the

                                                  Page 74 of 105

<PAGE>



DSOP,  options generally become  exercisable upon the achievement of a specified
performance target.

        A summary of the Company's fixed and non-employee  stock option plans as
of December  31,  1994,  1995 and 1996,  and changes  during the years ending on
those dates is as follows:


<TABLE>
<CAPTION>

                          1994                  1995                1996
                          ----                  ----                ----
                              Weighted              Weighted            Weighted
                               Average               Average             Average
Class A             Shares    Exercise    Shares    Exercise   Shares   Exercise
Common Stock        (000's)     Price     (000's)     Price    (000's)    Price
------------        ------    --------    -------   --------   -------  --------
<S>                <C>           <C>      <C>          <C>    <C>         <C>
Balance,
Beginning of year    971.5       $0.14    1,635.3      $3.09   1,822.2     $8.78
Granted              819.3        6.32      624.5      19.28     204.7     21.00
Exercised                -           -     (330.5)      0.14    (123.0)     0.14
Lapsed              (155.5)       0.85     (107.1)      9.66    (231.8)    11.57
                  ---------               --------             --------
Balance,
End of year        1,635.3        3.09    1,822.2       8.78   1,672.1     10.53
                  ==============================================================
</TABLE>




<TABLE>
<CAPTION>
                         1994                  1995                 1996
                         ----                  ----                 ----
                             Weighted              Weighted             Weighted
                              Average               Average              Average
Series A            Shares   Exercise    Shares    Exercise    Shares   Exercise
Preferred Stock     (000's)    Price     (000's)     Price     (000's)    Price
---------------     ------   --------   --------   --------    -------  --------
<S>                 <C>       <C>        <C>        <C>        <C>        <C>
Balance,
Beginning of year   14,750    $19.88     14,775     $19.88     17,000     $19.88
Granted              3,025     19.88      3,250      19.88          -         -
Exercised                -         -       (525)     19.88          -         -
Lapsed              (3,000)    19.88       (500)     19.88     (3,250)     19.88
                  ---------              -------              --------
Balance,
End of year         14,775     19.88     17,000      19.88     13,750      19.88
                  ==============================================================



                                                  Page 75 of 105
</TABLE>
<PAGE>


<TABLE>
        The following  table  summarizes  information  concerning  the Company's
stock option plan's at December 31, 1996:

<CAPTION>

                             Weighted
                              Average     Weighted                 Weighted
    Range of                 Remaining    Average                   Average
    Exercise     Number     Contractual   Exercise      Number     Exercise
     Prices   Outstanding   Life (years)   Price     Exercisable    Price
<S> <C>        <C>             <C>         <C>         <C>           <C>

     $0.14     1,026,875       6.79         $0.14      260,250        $0.14
     $7.50       132,880       7.44         $7.50      101,380        $7.50
     $8.48       153,560       7.71         $8.48       74,918        $8.48
    $13.77       119,800       7.90        $13.77       69,130       $13.77
    $16.57       166,980       8.16        $16.57       76,491       $16.57
    $20.13       108,200       8.41        $20.13       32,700       $20.13
    $21.00       417,275       9.11        $21.00       69,070       $21.00
</TABLE>

       The  Company  applies  APB  Opinion  25 and  related  Interpretations  in
accounting for its stock option plans.  Accordingly,  no  compensation  cost has
been recognized for its fixed stock option plans. Also, no compensation cost has
been recognized under the Company's  non-employee stock option plans during 1994
and 1995, however, approximately $126,000 of compensation cost was recognized in
the  accompanying  consolidated  statement  of  operations  for the  year  ended
December  31,  1996  related  to  the  non-employee   stock  option  plans.  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 SFAS No. 123,  the  Company's  net loss and earnings per
share  would  have  been  increased  to the  following  pro  forma  amounts  (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
                                             1996      1995
                                             ----      ----
     <S>                  <C>             <C>        <C>    
     Net loss             As reported     ($14,589)  ($6,492)
                          Pro forma       ($15,554)  ($7,356)
     Loss Per Share       As reported       ($3.90)   ($2.24)
                          Pro forma         ($4.00)   ($2.35)
</TABLE>


       The fair value of each option is estimated on the date of grant using the
minimum value methodology promulgated by SFAS No. 123. The weighted average fair
value  of  options   granted   during  1996  and  1995  were  $9.62  and  $9.03,
respectively.  This methodology is used as the Company's shares are not publicly
traded. In applying the minimum value  methodology,  the Company utilized a risk
free interest  rate that varied  between 5.63% and 7.50% for 1996 and 1995 grant
dates and expected lives of the options of 10 years for both 1996 and 1995.



                                                  Page 76 of 105

<PAGE>




Employees' Common Stock Grant Plan

       The Company has an  Employees'  Common Stock Grant Plan of which  122,500
shares are  reserved  for  issuance  under this plan.  No grants  have been made
during 1996, 1995 and 1994.

Distributor Stock Purchase Plan

       During  1993,  the  Company  established  a Stock  Purchase  Plan for its
distributors  pursuant  to which  shares of Class A Common  Stock  and  Series A
Preferred Stock were offered to the Company's  distributors for a purchase price
of $.142 and $19.88,  respectively,  per share. As of December 31, 1996, 417,000
shares of Class A Common  Stock and 39,450  shares of Series A  Preferred  Stock
purchased  under this plan were  outstanding.  Shares  purchased under this plan
vest on  December  31,  1999,  or  earlier if certain  criteria  are met.  As of
December 31, 1996,  342,040  shares of Class A Common Stock and 31,954 shares of
Series A Preferred Stock were vested.  These shares are subject to repurchase by
the Company in the event that a  distributor's  association  with the Company is
terminated or if the  distributor is no longer  operating as an exclusive  sales
representative for the Company.  The repurchase price shall be the distributor's
cost to purchase  the shares until the shares vest;  thereafter, the  repurchase
price shall be at fair market value.

<TABLE>
9.     INCOME TAXES

       Consolidated  income (loss) before income taxes consists of the following
(in thousands):

<CAPTION>
                                          1996           1995           1994
                                      -----------    ------------   -----------
     <S>                                <C>             <C>           <C>      
     United States                      $(10,525)       $ (4,403)     $(59,038)
     Foreign                              (4,064)           (470)        1,777
                                      -----------    ------------   -----------
                                        $(14,589)       $ (4,873)     $(57,261)
                                      ===========    ============   ===========
</TABLE>
<TABLE>

       The provision  (benefit)  for income taxes  consists of the following (in
thousands):

<CAPTION>
                                            1996          1995         1994
                                        -----------   -----------   ------------
     <S>                                  <C>           <C>           <C>      
     Current - Foreign                    $ (1,278)     $    351      $     574
     Deferred                               (1,603)        2,167        (17,550)
     Tax benefit of operating loss          (1,495)       (3,426)        (5,179)
       carryforward 
     Adjustment to valuation allowance       4,376         2,527         14,274
                                        -----------   -----------   ------------
                                          $      -      $  1,619      $  (7,881)
                                        ===========   ===========   ============


                                                  Page 77 of 105
</TABLE>
<PAGE>



<TABLE>
       The income tax provision  (benefit)  differs from the amount  computed by
applying the U.S.  statutory  federal  income tax rate due to the  following (in
thousands):
<CAPTION>
                                              1996          1995        1994
                                           ----------   ----------    ---------
   <S>                                      <C>          <C>          <C>      
   Income tax benefit at statutory rate     $ (4,911)    $ (1,657)    $(19,469)
   Adjustment to valuation allowance           4,376        2,527       14,274
   State income taxes                           (415)        (176)      (2,385)
   Foreign income taxes                          104          162         (388)
   Goodwill amortization                         560          584           32
   Other, net                                    286          179           55
                                           ----------   ----------   ----------
                                            $      -     $  1,619     $ (7,881)
                                           ==========   ==========   ==========
</TABLE>
<TABLE>

       The components of deferred taxes are as follows (in thousands):
<CAPTION>
                                                  1996           1995
                                              ------------   ------------
Deferred tax assets:
<S>                                             <C>           <C>     
     Operating loss carryforward                $  9,718      $   7,544
     Reserves and allowances                       9,398          9,088
     Intercompany profit on inventories              319            700
     Other                                         5,294          3,910
                                              -----------    -----------
                                                  24,729         21,242
  Valuation allowance                            (22,051)       (17,675)
                                              -----------    -----------
                                                $  2,678      $   3,567
                                              ===========    ===========
Deferred tax liabilities:
  Intangible assets                             $  1,700      $   1,873
  Depreciation                                       363            604
  Other                                              615          1,090
                                              -----------    -----------
                                                $  2,678      $   3,567
                                              ===========    ===========
</TABLE>
        The Company has provided a valuation  allowance against its net deferred
tax assets  because,  given the  Company's  history  of  operating  losses,  the
realizability of these assets is uncertain.  Management's assessment of the need
for a valuation  allowance  could  change in the future  based on the  Company's
future operating results.

        At December 31, 1996, the Company has a net operating loss  carryforward
for U.S.  federal  income tax  purposes of  approximately  $21.3  million  which
expires in 2008 through 2011. Additionally, the Company has credit carryforwards
of approximately $646,000 which expire through 2010.


                                                  Page 78 of 105

<PAGE>



10.     EMPLOYEE BENEFIT PLANS

        The Company sponsors a defined  contribution plan which covers employees
that are 21 years of age and over.  The  Company  has the  option to  contribute
annually  to the  plan  shares  of  Company  stock  determined  by the  Board of
Directors and will match employee's voluntary  contributions at rates of 100% of
the first 2% of an employee's annual compensation,  and 50% of the next 2% of an
employee's annual  compensation.  Employees vest in the Company's  contributions
after 5 years.  The Company's cost related to this plan was  approximately  $1.7
million,  $1.7  million  and $1.2  million,  respectively,  for the years  ended
December 31, 1996, 1995 and 1994.

<TABLE>
11.     COMMITMENTS AND CONTINGENCIES

Lease Commitments

        The  Company   leases  certain   equipment   under  capital  leases  and
noncancelable  operating leases. The future annual minimum rental payments under
these leases are as follows (in thousands):
<CAPTION>
                                                        Capital       Operating
     Year                                                Leases        Leases
     ----                                            -----------     -----------
     <S>                                                   <C>          <C>    
     1997                                                  $170         $   622
     1998                                                   108             360
     1999                                                    84             253
     2000                                                    42              73
     2001                                                    33               5
     Thereafter                                               8               -
                                                     -----------     -----------
     Total minimum lease payments                           445         $ 1,313
                                                                     ===========
     Less amount representing interest                      (67)
                                                     -----------
     Present value of future lease payments                $378
                                                     ===========
</TABLE>

        Rental  cost under  operating  leases for the years ended  December  31,
1996,  1995 and 1994 was  approximately  $1.2 million,  $1.3  million,  and $1.0
million, respectively.

Concentration of Credit Risk

        Substantially  all of the  Company's  sales  and trade  receivables  are
concentrated with hospitals and physicians.  The Company maintains  reserves for
potential  credit  losses  on  trade   receivables,   which  are  generally  not
collateralized.

Legal Proceedings

        Substantial patent litigation among competitors occurs regularly in
the medical device industry.  The Company assumed responsibility for

                                                  Page 79 of 105

<PAGE>



certain patent  litigation in which the Company  and/or Dow Corning  Corporation
and/or its former  subsidiary,  Dow Corning  Wright  Corporation  (collectively,
"DCW") was a party.  Those proceedings in which the Company was a defendant have
now been resolved.

        DCW,  pursuant to the  Acquisition  agreements,  retains  liability  for
matters  arising from conduct of DCW prior to the Company's  acquisition on June
30, 1993, of substantially all the assets of the large joint orthopaedic implant
business of DCW. As such,  DCW has agreed to indemnify  the Company  against all
liability for all products  manufactured prior to the DCW Acquisition except for
products  provided under the Company's 1993 agreement with DCW pursuant to which
the Company  purchased  certain small joint  orthopaedic  implants for worldwide
distribution.  However,  the  Company was  notified in May 1995 that DCW,  which
filed for reorganization  under Chapter 11 of the U.S. Bankruptcy Code, would no
longer  defend the Company in such matters until it received  further  direction
from the  bankruptcy  court.  On December 2, 1996, DCW filed a proposed  plan of
reorganization that provides that all commercial  creditors will be paid 100% of
their claims,  plus interest.  The plan did not,  however,  indicate whether DCW
would affirm or reject the Acquisition agreements.  Accordingly, there can be no
assurance  that Dow  Corning  will  indemnify  the  Company on any claims in the
future.  Although the Company does not maintain  insurance for claims arising on
products  sold by DCW,  management  does not  believe the outcome of this matter
will have a material  adverse  effect on the  Company's  financial  position  or
results of operations.

        On October 25, 1996,  the Company was notified  that it had been sued by
Mitek  Surgical  Products,  Inc.  in the United  States  District  Court for the
Northern District of California seeking damages for the alleged  infringement of
its patent by the Company's  ANCHORLOK(TM)  soft tissue anchor.  The Company has
denied the allegations and is defending the action.

        On April 3, 1995,  the  Company  (and  Orthomet,  Inc.,  a wholly  owned
subsidiary  at the time  that has  subsequently  been  merged  with and into the
Company)  was  notified  that  it  had  been  sued  by  Joint  Medical  Products
Corporation  (which was purchased by Johnson & Johnson  Professional,  Inc.), in
the United States District Court for the District of Connecticut seeking damages
for the alleged infringement of its patent (the "'472 Patent") by certain of the
Company's acetabular cups and liners.  Pending the resolution of an interference
proceeding in the U.S. Patent and Trademark  Office regarding the '472 Patent by
British  Technology  Group Ltd.  ("BTG"),  such complaint was dismissed  without
prejudice.   In  early   November  1996,  the  Company  was  notified  that  the
interference  proceeding was resolved,  and that, the complaint has been refiled
(but not served). BTG has offered the Company a license of the '472 Patent and a
corresponding reissue patent. The Company believes that it has valid defenses to
claims of infringement of the '472 Patent and to the reissue patent.

        The  Company  is not  involved  in any  other  pending  litigation  of a
material  nature or that would have a material  adverse  effect on the Company's
financial position or results of operations.


                                                  Page 80 of 105

<PAGE>



Other

        On October 7, 1994, the Company  entered into a research and development
funding agreement with OsteoBiologics, Inc. ("OBI") based in San Antonio, Texas.
In exchange for the Company's $6.5 million funding  commitment,  OBI has granted
the Company (a) exclusive  worldwide  distribution  rights for 15 years from the
date of  commercialization  of certain OBI orthopaedic products and (b) warrants
to purchase up to 1,252,848  shares of OBI common stock at $0.025 per share.  In
1994,  the  Company  expensed  the  $6.5  million  commitment  as  research  and
development  expense.  At  December  31,  1996,  the Company had paid all of its
funding obligations pursuant to this agreement.

        On February 22, 1996, the Company entered into a Distribution  Agreement
with a Japanese  corporation whereby the Company received $3 million in exchange
for 60,000 shares of the Company's Class A Common Stock and the exclusive rights
to  distribute  the  Company's  products in Japan for an initial  period of five
years,  with a possible  extension for an  additional  five years subject to the
achievement  of  certain  sales  goals.  In  connection  with this  Distribution
Agreement, the Company is amortizing $1,740,000 for the proceeds assigned to the
distribution  rights to income  ratably  over 5 years.  At  December  31,  1996,
deferred income in the accompanying consolidated financial statements related to
this distribution right was $1,502,000.

        During 1996, the Company  decided to  discontinue  operations of certain
subsidiaries  including Wright Medical  Technology of Hong Kong Limited,  Wright
Medical  Technology  do Brasil  Importadora  e Comercial  Ltda,  Wright  Medical
Technology  of  Australia  Pty  Limited  and Wright  Medical  Technology  France
S.A.R.L.  Discontinuance  of those  operations did not have a material effect on
the Company's consolidated operating results or financial position.

12.     RELATED PARTY TRANSACTIONS

Stockholder Notes Receivable

        As of December 31, 1996 and 1995, the Company has notes  receivable from
stockholders  aggregating  approximately  $1.0 and $1.0  million,  respectively,
relating to purchases of the Company's  common and preferred  stock. On December
27, 1995,  Herbert  Korthoff,  the Company's  Chairman and then Chief  Executive
Officer,  and  Barbara  Korthoff  repaid the  outstanding  principal  balance of
$1,176,164 on 552,690 shares of Class A Common Stock and 55,269 shares of Series
A Preferred Stock purchased  through a note on June 30, 1993. A new non-interest
bearing  note was issued for the unpaid  interest on the above note of $420,480.
Effective  April 1, 1994,  the  Company  repurchased  798,380  shares of Class A
Common  Stock and  79,838  shares  of  Series A  Preferred  Stock  from  Herbert
Korthoff.  The  Company  repurchased  the shares at the same price at which such
shares had originally  been sold to Mr.  Korthoff.  The repurchase of the shares
was  accomplished  through a $1.7 million  reduction of the stock  purchase note
receivable from Mr. Korthoff.

        The remaining stockholder notes receivable bear interest at the
rate of 10% per annum, payable semi-annually.  At the option of the

                                                  Page 81 of 105

<PAGE>



maker,  the interest may be deferred  and added to  principal,  and to date such
interest has been added to principal. The entire principal amount is due on June
30, 1998, subject to acceleration upon a sale of all or substantially all of the
business assets,  or issued and outstanding  capital stock of the Company or the
successful completion of an initial public offering by the Company of any of its
equity securities pursuant to a registration  statement under the Securities Act
of 1933.  The notes are secured by a pledge of the related  preferred and common
stock. Approximately $61,644,  $178,000, and $265,000 respectively,  of interest
income  relating to  stockholder  notes  receivable  was recorded by the Company
during the years ended December 31, 1996, 1995 and 1994.

Distributor Notes Receivable

        The  Company  has  notes  receivable  from  its  distributors   relating
primarily to the purchase of instruments used by surgeons in the implantation of
the Company's  products.  The notes bear interest at variable rates ranging from
approximately  6%  to  8%  and  generally  are  collateralized  by  the  related
instruments.  The  outstanding  balance on these  notes was  approximately  $0.4
million and $8.6 million at December 31, 1996 and 1995,  respectively,  of which
the current portion (included in "other current assets" in accompanying  balance
sheets) was $0.3 million and $1.5 million, respectively.

        During 1996, the Company repurchased certain surgical  instruments owned
by  distributors  at the lower of the instruments' fair  value  or  the  related
unpaid  note balance.  This repurchase was  done  to  implement  the  instrument
program discussed in Note 3 to the consolidated financial statements.

        The  accompanying  statements of operations for the years ended December
31, 1996, 1995 and 1994, include  approximately $0.8 million,  $2.4 million, and
$2.0  million,  respectively,  of net  sales  of  instruments  to  distributors.
Typically,  the Company has not reflected  any gross margin on these  instrument
sales.

Management Agreement

        The Company has a management  agreement  with an affiliate of one of its
principal  stockholders  pursuant  to which  management  fees of  $360,000  were
incurred for the years ended December 31, 1996, 1995 and 1994.

13.     SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
        FINANCING ACTIVITIES

        Following is a summary of the Company's  noncash investing and financing
activities for the year ended December 31:

                                                       1994

        -   Repurchased 798,380 shares of Class A Common Stock and 79,838 shares
            of Series A Preferred  Stock  through a $1.7  million  reduction  of
            stock purchase note receivable.

        -   Acquired Questus for approximately $4.4 million, of which

                                                  Page 82 of 105

<PAGE>



            approximately  $2.3  million  was funded by the  issuance of 169,630
            shares of the Company's Class A Common Stock.

        -   Acquired certain intellectual  property rights through incurrence of
            related indebtedness of approximately $3.6 million.

                                                       1995

        -   None

                                                       1996

        -   Issued 111,910 shares of Series B Preferred  Stock in the form of an
            "in-kind" dividend payment aggregating $11.2 million.

        -   Repurchased  surgical  instruments from  distributors  totaling $6.8
            million  through the forgiveness of accounts owed by distributors to
            the Company on such surgical instruments.
<TABLE>
14.     INDUSTRY SEGMENT AND FOREIGN OPERATIONS

        The Company's  operations are classified as a single  industry  segment.
Selected financial information by geographic area is as follows (in thousands):
<CAPTION>
                                   United                   Elimi-
Year Ended December 31, 1994       States     Foreign      nations      Total
-----------------------------    ----------  ---------   -----------  ----------
     Net sales
 <S>                             <C>         <C>         <C>          <C>      
       Unaffiliated customers    $   72,963  $  22,800   $       -    $  95,763
       Intercompany                   9,045          -      (9,045)           -
                                 ----------- ----------  -----------  ----------
         Total                   $   82,008  $  22,800   $  (9,045)   $  95,763
                                 ----------- ----------  -----------  ----------
     Operating loss              $  (34,673) $ (11,452)  $  (1,006)   $ (47,131)
                                 ----------- ----------  -----------  ----------
     Identifiable assets         $  137,597  $  18,621   $  (1,667)   $ 154,551
                                 ----------- ----------  -----------  ----------

Year Ended December 31, 1995
     Net sales
       Unaffiliated customers    $  109,046  $  14,150   $       -    $ 123,196
       Intercompany                   3,005          -      (3,005)           -
                                 ----------- ----------  ----------   ----------
         Total                   $  112,051  $  14,150   $  (3,005)   $ 123,196
                                 ----------- ----------  ----------   ----------

     Operating income (loss)     $    5,308  $   1,171   $    (176)   $   6,303
                                 ----------- ----------  ----------   ----------
     Identifiable assets         $  159,871  $  16,339   $  (1,839)   $ 174,371
                                 ----------- ----------  ----------   ----------

Year Ended December 31, 1996
     Net sales
       Unaffiliated customers    $  108,125  $  13,743   $       -    $ 121,868
       Intercompany                   5,375          -      (5,375)           -
                                 ----------- ----------  ----------   ----------
         Total                   $  113,500  $  13,743   $  (5,375)   $ 121,868
                                 ----------- ----------  ----------   ----------

     Operating income (loss)     $     (774) $  (3,289)  $   1,008    $  (3,055)
                                 ----------- ----------  ----------   ----------
     Identifiable assets         $  167,458  $   5,761   $  (6,893)   $ 166,326
                                 ----------- ----------  ----------   ----------

                                                  Page 83 of 105
</TABLE>
<PAGE>


        Operating  expenses  not  directly  related to a  particular  geographic
segment have been allocated between segments in proportion to net sales.


15.     SUBSEQUENT EVENT

        On January 3, 1997,  the Company  entered into an agreement with Gary K.
Michelson, M.D., to purchase rights to patents, ideas and designs related to the
"MultiLock"  design for an anterior cervical plating system.  The purchase price
includes a payment of  $120,000  due in four  installments  in 1997,  as well as
royalties  equal to 8% of the sales,  net of  commissions,  of the  locking  cam
products. The Company guaranteed minimum royalties as follows:


     04/01/98 - 03/31/99              $320,000
     04/01/99 - 03/31/00              $480,000
     04/01/00 - 03/31/01              $700,000
     04/01/01 - 03/31/02            $1,000,000

        For each of the annual periods commencing April 1, 2002 through March 31
of the  subsequent  year,  and continuing for the longer of the period for which
the  MultiLock  products  are being sold or 10 years from  January 3, 1997,  the
minimum royalty shall be $1.0 million.

        The  Company  also  entered  into an  agreement  with Dr.  Michelson  to
purchase rights to patents, ideas and designs related to the "SingleLock" design
for an anterior  cervical plating system.  The purchase price includes a payment
of $100,000 due in 1997,  as well as  royalties  equal to 8% of the net sales of
the SingleLock products. The Company guaranteed minimum royalties as follows:


     10/01/98 - 03/31/99               $80,000
     04/01/99 - 03/31/00              $200,000
     04/01/00 - 03/31/01              $295,000
     04/01/01 - 03/31/02              $425,000
     04/01/02 - 03/31/03              $500,000
     and years thereafter

        Dr.  Michelson  agreed to provide  exclusive  continuing  services  as a
developer,  product  lecturer  and  general  consultant  for  anterior  cervical
plating.  The  Company  is  acquiring  a  $5,000,000  ten year term key man life
insurance policy on Dr. Michelson with the Company as beneficiary.

                                                  Page 84 of 105

<PAGE>



                                                   EXHIBIT INDEX

        Does not include the documents  incorporated  by reference as delineated
by Item 14 of this Form 10-K.


10.25                    Joint Venture Agreement with Tissue
                         Engineering, Inc.
11.1                     Statements re: Computation of Earnings per
                         Share
12.1                     Statement re: Computation of Ratios of
                         Earnings to Fixed Charges and Preferred
                         Dividends
21.1                     Subsidiaries of the Company
23.2                     Consent of Arthur Andersen LLP


                                                  Page 85 of 105