Q1 2006 DOC

10-Q 1 form10q.htm FORM 10Q Q1 2006 DOC

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

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-49804

Kyphon Inc.
(Exact name of registrant as specified in its charter)

Delaware 77-0366069

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)

1221 Crossman Avenue
Sunnyvale, California 94089
(Address of principal executive offices including zip code)

(408) 548-6500
(Registrant's telephone number, including area code)

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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definistion of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act). Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). YES ¨ NO x


Class		Shares Outstanding at April 26, 2006
Common Stock, $0.001 par value		44,221,090

KYPHON INC.
FORM 10-Q
TABLE OF CONTENTS

Page No.

PART I. FINANCIAL INFORMATION



Item 1. Condensed Consolidated Financial Statements (unaudited):



           Condensed Consolidated Income Statements for the Three Months Ended March 31, 2006 and 2005 3



           Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005 4



           Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 5



           Notes to Condensed Consolidated Financial Statements 6



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13



Item 3. Quantitative and Qualitative Disclosures About Market Risk 20



Item 4. Controls and Procedures 21



PART II. OTHER INFORMATION



Item 1. Legal Proceedings 21



Item 1A. Risk Factors 22



Item 5. Other Information 23



Item 6. Exhibits 23



SIGNATURES

KYPHON INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in thousands, except per share amounts)
(unaudited)


                                                                      Three Months Ended
                                                                          March 31,
                                                                 --------------------------
                                                                     2006          2005
                                                                 ------------  ------------
Net sales                                                       $     91,428  $     66,234
Cost of goods sold (1)                                                10,965         7,925
                                                                 ------------  ------------
Gross profit                                                          80,463        58,309
                                                                 ------------  ------------
Operating expenses:
    Research and development (1)                                       8,589         5,460
    Sales and marketing (1)                                           45,386        34,985
    General and administrative (1)                                    13,568         7,698
                                                                 ------------  ------------
        Total operating expenses                                      67,543        48,143
                                                                 ------------  ------------
Income from operations                                                12,920        10,166
Interest income and other, net                                         2,123           525
                                                                 ------------  ------------
Income before income taxes                                            15,043        10,691
Provision for income taxes                                             6,550         4,270
                                                                 ------------  ------------
Net income                                                      $      8,493  $      6,421
                                                                 ============  ============
Net income per share:
    Basic                                                       $       0.19  $       0.15
                                                                 ============  ============
    Diluted                                                     $       0.19  $       0.15
                                                                 ============  ============
Weighted-average shares outstanding:
    Basic                                                             44,032        41,843
                                                                 ============  ============
    Diluted                                                           45,882        44,231
                                                                 ============  ============


(1) Includes employee stock-based compensation charges under FAS 123(R) for
    the current period and under APB 25 for the prior period as follows:
      Cost of goods sold                                        $        164  $         39
      Research and development                                           958           212
      Sales and marketing                                              2,603           291
      General and administrative                                       2,691            40
                                                                 ------------  ------------
                                                                $      6,416  $        582
                                                                 ============  ============

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

KYPHON INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts, unaudited)


                                                                                March 31,     December 31,
                                                                                  2006           2005
                                                                              -------------  -------------
Assets                                                                                                    
Current assets:
   Cash and cash equivalents                                                 $      92,084  $      76,149
   Investments                                                                     125,138        118,324
   Accounts receivable, net                                                         55,535         55,480
   Inventories                                                                       9,934          9,265
   Prepaid expenses and other current assets                                        20,306         16,387
                                                                              -------------  -------------
      Total current assets                                                         302,997        275,605
Property and equipment, net                                                         20,166         15,977
Goodwill and other intangible assets, net                                           15,204         15,377
Other assets                                                                         9,629          9,673
                                                                              -------------  -------------
      Total assets                                                           $     347,996  $     316,632
                                                                              =============  =============
                                                                                                          
Liabilities and Stockholders' Equity                                                                      
Current liabilities:
   Accounts payable                                                          $      10,551  $       9,308
   Accrued liabilities                                                              54,143         49,793
                                                                              -------------  -------------
      Total current liabilities                                                     64,694         59,101
Deferred rent and other                                                              5,324          4,051
Contingent purchase price                                                            3,556          3,424
                                                                              -------------  -------------
      Total liabilities                                                             73,574         66,576
                                                                              -------------  -------------
Commitments and contingencies (Note 7)

Stockholders' equity:
   Common stock, $0.001 par value per share                                             44             44
   Additional paid-in capital                                                      246,386        231,312
   Treasury stock, at cost                                                            (201)          (201)
   Deferred stock-based compensation, net                                               --           (116)
   Accumulated other comprehensive income                                              855            172
   Retained earnings                                                                27,338         18,845
                                                                              -------------  -------------
      Total stockholders' equity                                                   274,422        250,056
                                                                              -------------  -------------
      Total liabilities and stockholders' equity                             $     347,996  $     316,632
                                                                              =============  =============

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

KYPHON INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)


                                                                                     Three Months Ended
                                                                                          March 31,
                                                                                 ----------------------
                                                                                    2006        2005
                                                                                 ----------  ----------
Cash flows from operating activities:                                                                  
  Net income                                                                    $    8,493  $    6,421
  Adjustments to reconcile net income to net cash
  provided by operating activities:
    Provision for accounts receivable allowances                                       264          83
    Provision for excess and obsolete inventories                                      175          54
    Depreciation and amortization                                                    1,399       1,031
    Loss on disposal of property and equipment                                         117          37
    Tax benefits related to stock-based compensation plans                             303       4,327
    Excess tax benefit related to stock-based compensation plans                      (889)         --
    Stock-based compensation                                                         6,614         721
    Changes in operating assets and liabilities:
       Accounts receivable                                                              84      (1,604)
       Inventories                                                                    (523)        277
       Prepaid expenses and other current assets                                    (1,808)      1,162
       Other assets                                                                     62        (274)
       Accounts payable                                                              1,203       2,291
       Accrued liabilities                                                           4,060      (1,558)
       Deferred rent and other                                                       1,455         223
                                                                                 ----------  ----------
                   Net cash provided by operating activities                        21,009      13,191
                                                                                 ----------  ----------
Cash flows from investing activities:                                                                  
    Acquisition of property and equipment                                           (5,337)     (3,082)
    Maturities and sales of investments                                             22,325       8,750
    Purchase of investments                                                        (29,317)     (8,041)
                                                                                 ----------  ----------
                   Net cash used in investing activities                           (12,329)     (2,373)
                                                                                 ----------  ----------
Cash flows from financing activities:                                                                  
    Proceeds from issuance of common stock                                           2,982       2,456
    Proceeds from exercise of stock options                                          3,193       2,381
    Excess tax benefit related to stock-based compensation plans                       889          --
                                                                                 ----------  ----------
                   Net cash provided by financing activities                         7,064       4,837
                                                                                 ----------  ----------
Effect of foreign exchange rate changes on cash and cash equivalents                   191        (232)
                                                                                 ----------  ----------
Net increase in cash and cash equivalents                                           15,935      15,423
Cash and cash equivalents at beginning of period                                    76,149      87,236
                                                                                 ----------  ----------
Cash and cash equivalents at end of period                                      $   92,084  $  102,659
                                                                                 ==========  ==========

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

KYPHON INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1--Organization, Basis of Presentation, and Significant Accounting Policies:

Organization

Kyphon Inc. ("Kyphon" or the "Company") is a medical device company focused on the design, manufacture and marketing of instruments used in minimally invasive surgical therapies for the treatment and restoration of spinal anatomy. The Company is currently commercializing surgical tools that use its proprietary balloon technologies for the repair of spinal fractures. The Company markets its products through sales representatives in the United States, and through a combination of sales representatives, distributors and agents in its international markets. The Company is headquartered in Sunnyvale, California, and has subsidiaries in many of the major countries in Europe, as well as in Canada, Japan and Australia.

Basis of Presentation

The accompanying unaudited, condensed, consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. The results for the three-month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006, or for any future period. These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements included in the Company's Form 10-K for the fiscal year ended December 31, 2005, which was filed with the SEC on March 3, 2006.

Significant Accounting Policies

The Company's significant accounting policies are disclosed in the Company's Form 10-K for the year ended December 31, 2005. Except as noted below (see Note 2), the Company's significant accounting policies have not changed as of March 31, 2006.

NOTE 2--Stock-Based Compensation:

Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan ("ESPP"), under which eligible employees are permitted to purchase common stock at a discount through payroll deductions. The ESPP contains consecutive, overlapping twenty-four month offering periods. Each offering period includes four six-month purchase periods. The price of the common stock purchased shall be the lower of 85% of the fair market value of the common stock at the beginning of an offering period or at the end of a purchase period. The Company issued approximately 119,000 shares of common stock during the three months ended March 31, 2006. As of March 31, 2006, approximately 850,000 shares of common stock remained reserved for future issuance under the ESPP.

Stock Plans

The Company reserved shares of common stock for issuance under the 1996 Stock Incentive Plan (the "1996 Plan"). Under the 1996 Plan, the Board of Directors was authorized to issue incentive stock options to employees and nonqualified stock options to consultants or employees of the Company. The 1996 Plan is inactive, and no shares have been granted under the 1996 Plan since 2002. Upon adoption of the 2002 Stock Plan, all shares previously available for grant under the 1996 Plan were transferred to the 2002 Stock Plan. Any cancellations thereafter from the 1996 Plan are automatically added back to the 2002 Plan.

In April 2002, the Board of Directors adopted the 2002 Stock Plan. The 2002 Stock Plan, which will terminate no later than 2012, provides for the granting of incentive stock options to employees and nonqualified stock options and stock purchase rights to employees, directors and consultants.

In April 2002, the Board of Directors adopted the 2002 Director Option Plan. The 2002 Director Option Plan, which will terminate no later than 2012, provides for the granting of nonqualified stock options to non-employee directors.

For the 2002 Director Option Plan and the 2002 Stock Plan, the Board of Directors has the authority to determine to whom options will be granted, the number of shares, the term and exercise price (which cannot be less than the estimated fair market value at date of grant for incentive stock options or 85% of the estimated fair market value for nonqualified stock options). If an employee owns stock representing more than 10% of the outstanding shares, the exercise price of any incentive stock option shall be at least 110% of estimated fair market value, as determined by the Board of Directors. The options are exercisable at times and increments as specified by the Board of Directors, and generally expire ten years from date of grant.

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based Payment", which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options and employee stock purchases based on estimated fair values. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. Employee stock-based compensation expense recognized under SFAS No. 123(R) for the three months ended March 31, 2006 was $6,416,000. The Company previously used the intrinsic value method in accounting for its employee stock options, and presented disclosure of pro forma information as if the Company had accounted for stock-based compensation using the fair value method. The Company elected to adopt the modified prospective application method as provided by SFAS No. 123(R). Accordingly, previously reported amounts have not been restated. During the three months ended March 31, 2005, the Company recognized employee stock-based compensation expense of $582,000 under APB No. 25 related to stock options previously issued with exercise prices below the deemed fair market value of the Company's stock at the date of grant. Upon the adoption of SFAS No. 123(R) on January 1, 2006, the Company recorded a cumulative effect adjustment to eliminate the remaining deferred stock-based compensation relating to these equity awards. The deferred stock-based compensation balance of approximately $116,000 as of December 31, 2005 was eliminated against additional paid-in capital upon adoption. The Company did not record a cumulative effect adjustment to record estimated forfeitures for these stock-based awards upon the adoption of SFAS No. 123(R) as it was not significant.

Prior to the adoption of SFAS No. 123(R)

Prior to the adoption of SFAS No. 123(R), the Company provided a reconciliation of net income and net income per share to pro forma net income and pro forma net income per share had compensation cost for the Company's stock option grants to employees and employee stock purchases been determined based on the fair value of each option on the date of grant as follows (in thousands, except per share amounts):



                                                              Three Months Ended
                                                               March 31, 2005
                                                              ----------------
Net income, as reported                                         $      6,421
Add:  Stock-based employee compensation expense
    included in reported net income, net of related taxes                349
Deduct:  Total stock-based employee compensation
    expense, determined under fair value based
    method for all awards, net of related taxes                       (3,104)
                                                                 ------------
Pro forma net income                                            $      3,666
                                                                 ============
Net income per share
  Basic:
    As reported                                                 $       0.15
                                                                 ============
    Pro forma                                                   $       0.09
                                                                 ============
  Diluted:
    As reported                                                 $       0.15
                                                                 ============
    Pro forma                                                   $       0.08
                                                                 ============

Valuation and Expense Information under SFAS No. 123(R)

The Company estimates the value of employee stock options on the date of grant using a lattice-binomial model. The lattice-binomial model used by the Company to value employee stock options on the date of grant considers a range of assumptions related to volatility, risk-free interest rate and employee exercise behavior. Expected volatilities are based on a combination of implied market volatilities, historical volatility of the Company's stock price and other factors. The risk-free rate is derived from the U.S. Treasury zero-coupon yield curve in effect at the time of grant over the contractual term of the option. The lattice-binomial model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. The expected life of the stock option grants is derived from the output of the lattice-binomial model and represents the period of time that options granted are expected to be outstanding.

The Company recognized stock-based compensation expense related to employee options and employee stock purchases as follows (in thousands):


                                          Three Months Ended
                                           March 31, 2006
                                          ----------------
Stock-based compensation by type of award:
  Employee stock options                 $          5,854
  Employee stock purchase plan                        772
  Amount capitalized as inventory                    (210)
                                          ----------------
Total stock-based compensation expense   $          6,416
                                          ================

As of March 31, 2006, the Company had an unrecorded deferred stock-based compensation balance related to stock options of approximately $38,141,000 after estimated forfeitures, which will be recognized over an estimated weighted-average remaining requisite service period of 2.6 years. During the three months ended March 31, 2006, the Company granted 353,000 stock options with an estimated total grant-date fair value of approximately $3,986,000 after estimated forfeitures.

Valuation Assumptions

The weighted-average assumptions used are as follows:


                                   Three Months Ended March 31,
                                    ------------------------
                                       2006         2005
                                    -----------  -----------
Stock option plan:
   Risk-free interest rate                4.65%        3.75%
   Expected volatility                      44%          60%
   Expected life (in years)               4.42         4.00
   Dividend yield                           --           --
   Fair value per option granted        $13.50       $12.11

Stock purchase plan:
   Risk-free interest rate                4.59%        3.13%
   Expected volatility                      38%          60%
   Expected life (in years)               1.23         1.27
   Dividend yield                           --           --
   Fair value per share purchased       $13.42       $11.21

Activities under the 2002 Director Option Plan, the 2002 Stock Plan and the 1996 Plan, the ("Plans") for the three months ended March 31, 2006 are as follows:


                                               Options Outstanding
                                             ----------------------
                                                          Weighted
                                 Shares                   Average
                                Available    Number of    Exercise
                                for Grant      Shares      Price
                               -----------   ----------  ----------
Balances, January 1, 2006       2,574,358    7,078,412  $    21.78

Options granted                  (353,000)     353,000       38.78
Options exercised                      --     (261,991)      12.19
Options cancelled                 104,596     (104,596)      26.69
                               -----------   ----------  ----------

Balances, March 31, 2006        2,325,954    7,064,825  $    22.91
                               ===========   ==========  ==========

The options outstanding and exercisable at March 31, 2006 by exercise price ranges are as follows:


                                  Options Outstanding                             Options Exercisable
                   -------------------------------------------------------  -------------------------------------
                                    Weighted
                                    Average       Weighted     Aggregate                  Weighted     Aggregate
                                   Remaining      Average      Intrinsic                   Average     Intrinsic
    Range of         Number       Contractual     Exercise     Value (in      Options     Exercise     Value (in
Exercise Prices    Outstanding    Life in Years    Price       thousands)   Exercisable     Price      thousands)
----------------   -----------    ------------   ----------    -----------  -----------   ---------    ----------
 $0.05 - $3.00        657,128            4.71   $     1.18   $     23,670      656,971   $    1.18   $    23,664
 $6.95 - $9.98        375,462            6.84         8.70         10,701      165,969        8.60         4,747
 $10.50- $15.40     1,130,827            6.72        13.48         26,823      853,303       13.30        20,394
$19.40 - $27.66     3,146,471            8.27        24.04         41,408    1,132,859       23.77        15,214
$27.90 - $37.11       282,674            9.23        33.15          1,145       36,326       31.32           214
$37.30 - $45.34     1,472,263            9.44        39.07             --      163,474       38.28            --
                   -----------    ------------   ----------    -----------  -----------   ---------    ----------
                    7,064,825            7.90   $    22.91   $    103,747    3,008,902   $   15.91   $    64,233
                   ===========    ============   ==========    ===========  ===========   =========    ==========

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company's closing stock price of $37.20 per share as of March 31, 2006. The total number of in-the-money options exercisable as of March 31, 2006 was 2,845,000. As of December 31, 2005, there were 2,739,000 outstanding options exercisable, and the weighted-average exercise price was $14.40 per share.

The total intrinsic value of options exercised during the three months ended March 31, 2006 was approximately $6,781,000. The total cash received from employees as a result of employee stock option exercises during the three months ended March 31, 2006 was approximately $3,193,000. In connection with these employee stock option exercises, the tax benefits realized by the Company for the three months ended March 31, 2006 was approximately $2,116,000. As of March 31, 2006, as a result of the adoption of SFAS No. 123(R), the Company recorded a $1,888,000 deferred tax asset for the book expenses associated with nonqualified stock options.

The Company settles employee stock option exercises with newly issued common shares.

Non-Employee Stock-Based Compensation

The Company accounts for equity instruments issued to non-employees at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock options are earned. The options generally vest ratably over four years. The values attributable to these options have been amortized over the service period on a graded vesting method, and the vested portion of these options is remeasured at each vesting date. The Company believes that the fair value of the stock options is more reliably measurable than the fair value of the services received. The Company recognized stock-based compensation expense related to non-employee options as follows (in thousands):


                                 Three Months End
                                     March 31,
                              ---------------------
                                  2006        2005
                              ---------   ---------
Research and development     $      40   $      27
Sales and marketing                157          86
General and administrative          --          25
                              ---------   ---------
                             $     197   $     138
                              =========   =========

NOTE 3--Net Income Per Share:

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per share is computed by giving effect to all potentially dilutive common stock, including options. The dilutive effect of outstanding options is reflected in diluted net income per share by application of the treasury stock method, which includes consideration of stock-based compensation. For the three months ended March 31, 2006 and 2005, 1,491,000 and 804,000 options outstanding, respectively, were not included in the computation of diluted net income per share for the Company because the effect would have been antidilutive.

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):


                                                                   Three Months Ended
                                                                         March 31,
                                                                 --------------------------
                                                                     2006          2005
                                                                 ------------  ------------
Net income (1)                                                  $      8,493  $      6,421
                                                                 ============  ============

Basic weighted-average shares outstanding                             44,032        41,843
Dilutive effect of:
    Options to purchase common stock                                   1,850         2,388
                                                                 ------------  ------------
Diluted weighted-average shares outstanding                           45,882        44,231
                                                                 ============  ============

Net income per share:
    Basic (1)                                                   $       0.19  $       0.15
                                                                 ============  ============
    Diluted (1)                                                 $       0.19  $       0.15
                                                                 ============  ============

^{(1) Net income for the three months ended March 31, 2006 includes
$4,339,000 of stock-based compensation expense, net of taxes. The effect
of recording stock-based compensation expense on basic and diluted net income
per share was $0.10 and $0.09 per share, respectively.

NOTE 4--Comprehensive Income:

The changes in the components of other comprehensive income for the periods
presented are as follows (in thousands):

Three Months Ended
March 31,
--------------------------
2006 2005
------------ ------------
Net income $ 8,493 $ 6,421
Changes in unrealized gains (losses) on available-for-sale
investments, net of taxes -- (17)
Translation adjustments 683 (958)
------------ ------------
Total comprehensive income $ 9,176 $ 5,446
============ ============

The components of other comprehensive income are as follows (in
thousands):

March 31, December 31,
2006 2005
------------- -------------
Unrealized losses on available-for-sale investments, net of taxes $ (137) $ (137)
Translation adjustments 992 309
------------- -------------
$ 855 $ 172
============= =============

NOTE 5--Inventories:

Inventories consisted of the following (in thousands):

March 31, December 31,
2006 2005
------------ ------------
Raw materials $ 4,073 $ 4,331
Work-in-process 2,467 1,656
Finished goods 3,394 3,278
------------ ------------
$ 9,934 $ 9,265
============ ============

NOTE 6--Goodwill and Intangible Assets:

Changes in the carrying amount of goodwill during the three months ended
March 31, 2006 are as follows (in thousands):

Goodwill at January 1, 2006 $ 4,310
Foreign currency translation 108
------------
Total goodwill at March 31, 2006 $ 4,418
============

The components of the Company's intangible assets are as follows (in
thousands):

March 31, 2006
----------------------------------------------------------
Gross Foreign
Carrying Currency Accumulated Amortization
Amount Translation Amortization Net Period
------------ ------------ ------------ ------------ ------------
Developed technology $ 11,000 $ -- $ (275) $ 10,725 10 years
Patent 142 16 (97) 61 5 years
------------ ------------ ------------ ------------
Total intangibles $ 11,142 $ 16 $ (372) $ 10,786
============ ============ ============ ============

December 31, 2005
----------------------------------------------------------
Gross Foreign
Carrying Currency Accumulated Amortization
Amount Translation Amortization Net Period
------------ ------------ ------------ ------------ ------------
Developed technology $ 11,000 $ -- $ -- $ 11,000 10 years
Patent 142 13 (88) 67 5 years
------------ ------------ ------------ ------------
Total intangibles $ 11,142 $ 13 $ (88) $ 11,067
============ ============ ============ ============

Amortization expense related to the Company's other intangible assets was
approximately $283,000 and $8,000 for the three months ended March 31, 2006 and
2005, respectively. Based on the intangible assets balance at March 31, 2006,
the Company expects to recognize amortization expense of approximately $849,000
for the remaining nine months of fiscal 2006, approximately $1,132,000 in 2007,
approximately $1,105,000 in 2008, and approximately $1,100,000 for each year
from 2009 through 2015.

NOTE 7--Commitments and Contingencies:

In November 2005, Dr. Harvinder Sandhu, a well-respected orthopaedic surgeon
with whom the Company has an exclusive consulting relationship, and the Company
filed suit in federal district court in Memphis, Tennessee against Medtronic
Sofamor Danek ("MSD") and several other related corporate entities
seeking compensatory and punitive damages and injunctive relief for breach of
contract and related covenants, trade secret theft, fraud and correction of
inventorship of several patents and patent applications presently owned by MSD,
including U.S. Patent No. 6,676,665. The suit also requests, among other
relief, that MSD transfer to Dr. Sandhu ownership of the disputed patent and
patent applications. The dispute concerns inventions related to an expandable,
mechanical bone tamp for use in treating vertebral compression fractures that
Dr. Sandhu invented in the late 1990's and which he confidentially disclosed and
discussed with MSD. The complaint alleges that MSD later filed for several
patents encompassing and claiming Dr. Sandhu's inventions without naming him as
inventor of that technology, and that it also incorporated Dr. Sandhu's
inventions into its internal Equestra project without his permission.
The litigation is in its early stages; trial has been set for April 2007. The
Company intends to vigorously prosecute its and Dr. Sandhu's case against
MSD.
In April 2006, MSD and several other related corporate entities filed suit
against the Company in federal district court in the Northern District of
California, alleging that the Company's vertebral bone tamps and/or related
products infringe three angioplasty balloon dilatation catheter patents, numbers
4,820,349, 5,759,191 and 6,179,856, and a single claim of patent number
6,096,038, which generally concerns treatment of the disc space. The suit seeks
damages based upon the making, using, selling and offering for sale of the
Company's products, seeks enhanced damages for alleged willful infringement, and
seeks to enjoin the Company's continued activities relating to these products.
The Company believes the assertions of infringement are without merit. The suit
against the Company also seeks a declaratory judgment that five of the Company's
U.S. patents, numbers 4,969,888, 5,108,404, 6,235,043, 6,440,138, and 6,863,672,
are invalid and not infringed by an "osteotome," which the Company
believes is the Equestra product already at issue in the Memphis
litigation. The Company also believes the declaratory judgment is baseless.
Accordingly, the Company has already asked the federal court in Memphis to
enjoin and prevent MSD from proceeding with its declaratory judgment in
California. The Company has also filed an amended complaint in Memphis,
affirmatively asserting the same five U.S. patents against MSD and accusing MSD
of willfully infringing those patents through its development and
commercialization of the Equestra. Although the Company intends to
vigorously defend MSD's California lawsuit, MSD's action against the Company
subjects the Company to potential liability for damages, including treble
damages, and could require the Company to cease making, using or selling the
affected products, or to obtain a license in order to continue to manufacture,
use or sell the affected products. While the Company believes it has multiple
meritorious defenses to this action, the Company cannot assure you that it
ultimately will prevail on any issue in the litigation or that it will be able
to successfully defend MSD's charges, nor can the Company provide assurance that
any license required would be made available on commercially acceptable terms,
if at all. Failure to successfully defend against MSD's action could harm the
Company's business, financial condition and operating results. Due to the
inherent uncertainties of litigation, the Company cannot accurately predict the
ultimate outcome of this matter at this time and, therefore, cannot estimate the
range of possible loss. No provision for any liability that may result upon the
resolution of this matter has been made in the accompanying financial
statements.
In addition, the Company is subject to legal proceedings, claims, and
litigation arising in the ordinary course of business, including intellectual
property litigation. While the outcome of these matters is currently not
determinable, the Company does not expect that the ultimate costs to resolve
these matters will have a material adverse effect the Company's consolidated
financial position, results of operations, or cash flows.

In February 2006, the Company entered into a six year lease agreement for a
facility in London, England. The total commitment is approximately $266,000 to
be paid over the term of the lease.

NOTE 8--Provision for Income Taxes:

Provision for income taxes was $6,550,000 at an effective tax rate of
43.5% for the three months ended March 31, 2006 as compared to $4,270,000 at an
effective tax rate of 40.0% for the same period in 2005. The higher effective
tax rate for 2006 is primarily due to the impact of expensing certain non-tax
deductible stock-based compensation in accordance with SFAS No. 123(R), and the
expiration of research and development credits in 2005. As of March 31,
2006, the Company recorded a $1,888,000 deferred tax asset for the book expenses
associated with the nonqualified stock options.

NOTE 9--Recent Accounting
Pronouncements:

In November 2004, the Financial Accounting Standards Board
(FASB) issued SFAS No. 151, "Inventory Costs, an amendment of APB
No. 43, Chapter 4." SFAS No. 151 amends APB No. 43,
Chapter 4, to clarify that abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage) should be
recognized as current period charges. In addition, SFAS No. 151 requires that
allocation of fixed production overhead to the cost of conversion be based on
the normal capacity of the production facilities. The provisions of SFAS No.
151 are effective for fiscal years beginning after June 15, 2005. Accordingly,
the provisions of SFAS No. 151 were effective January 1, 2006 for the Company.
The adoption of SFAS No. 151 did not have a material impact on the Company's
consolidated financial statements.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the federal securities laws. These statements include,
but are not limited to, those concerning our intentions, beliefs and
expectations regarding our future growth, levels of expenses and operating
results; developments in Medicare and third-party payor coverage and
reimbursement of our products; the timing and success of our clinical trials and
regulatory submissions; our belief that our cash and cash equivalents will be
sufficient to satisfy our anticipated cash requirements; our expectations
regarding our revenues and customers; our distributors and territorial expansion
efforts; our beliefs regarding ongoing legal activities with the government and
third parties; and our plans to pursue research, development and
commercialization of additional spine products developed internally or arising
from acquisitions. These statements are subject to risks and uncertainties that
could cause actual results and events to differ materially from those expressed
or implied by such forward-looking statements. For a detailed discussion of
these risks and uncertainties, see the "Risk Factors" section in Item
1A of this Form 10-Q and in Item 1A of 2005 Form 10-K. We caution the reader not
to place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date of this Form 10-Q. We undertake no
obligation to update forward-looking statements to reflect events or
circumstances occurring after the date of this Form 10-Q.
Management's discussion and analysis of financial condition and results
of operations is organized as follows:

Executive summary. This section provides a general description and
history of our business, a brief discussion of our product lines and the
opportunities, trends, challenges and risks we focus on in the operation of our
business.

Results of operations. This section provides our analysis and outlook
for the significant line items on our condensed consolidated income
statements.
Stock-based compensation. This section describes the accounting
method and financial reporting of our stock options granted to employees and
non-employees.
Seasonality. This section describes the effects of seasonality on
our business.
Liquidity and capital resources. This section provides an analysis
of our liquidity and cash flows, as well as a discussion of our commitments that
existed as of March 31, 2006.
Recent accounting pronouncements. This section describes the
issuance and effects of recently issued accounting pronouncements.
Factors affecting future operating results. This section discusses
the most significant factors that could affect our future financial results.
The factors discussed in this section are in addition to factors that may be
described in the captions discussed above and elsewhere in this
report.

Executive Summary
Company Description. We are a global medical device company
specializing in the design, manufacture and marketing of medical devices used to
diagnose, treat and restore spinal anatomy using minimally invasive surgical
technologies. Our devices are presently used primarily by spine specialists,
including orthopaedic surgeons and neurosurgeons, interventional radiologists
and interventional neuroradiologists, who repair compression fractures of the
spine caused by osteoporosis, trauma, cancer or benign lesions through minimally
invasive spine surgeries known as balloon kyphoplasty procedures. Our
commercial products consist of our KyphX instruments, which are used to
treat spinal fractures during balloon kyphoplasty, including our proprietary
KyphX balloon technology, and our proprietary brands of bone filler
materials. Most alternative treatments for these types of spinal fractures are
either highly invasive or are only pain management therapies. In the third
quarter of 2006, we anticipate full market launch of the Functional Anaesthetic
Discography (FAD) product line acquired from the InnoSpine acquition in December
2005.

Our corporate headquarters and United States operations are located in
Sunnyvale, California, where we conduct our manufacturing, warehousing, research
and development, regulatory and administrative activities. Outside the United
States, we operate a sales, clinical, regulatory and administrative facility in
Brussels, Belgium, a research and biomaterials manufacturing facility in
Rosbach, Germany, a clinical, regulatory and administrative facility in Japan,
and we have direct selling operations in many of the major countries in Europe
and Canada. In November 2005, we leased a facility which serves as a temporary
facility in Neuchâtel, Switzerland for us to conduct administrative and
distribution activities for our international business while we build a larger
facility in that same location. We anticipate the larger facility should be
available in 2007, and are currently evaluating financing options for it. We
plan to conduct manufacturing, distribution, administrative and certain research
and development activities in this Swiss facility to support the growth of our
international business. Our global distribution network consists of a direct
sales organization of approximately 450 individuals who market our products in
the U.S., Europe and Canada. We also have distributors and sales agents in
other countries in which we do not have a direct sales force. In Japan, we are
presently focused primarily on procuring the appropriate governmental regulatory
clearances and approvals necessary to market and sell our KyphX products,
and we recently enrolled our sixth patient in our Japanese clinical trial.

Effective January 1, 2006, we
adopted the provisions of Statement of Financial Accounting Standards (SFAS) No.
123(R), "Share-Based Payment", which requires us to measure all
employee stock-based compensation awards using a fair value method and record
such expense in our consolidated financial statements. Prior to January 1,
2006, we used the intrinsic value method in accounting for our employee stock
options, and presented disclosure of pro forma information as if we had
accounted for stock based compensation using the fair value method. We have
chosen to implement SFAS No. 123(R) using the modified prospective method.
Under this method, periods prior to January 1, 2006 are not restated to reflect
stock-based compensation using a fair value method.

Products and Significant Business Trends. Our net sales consist of
the sales of our KyphX instruments, including our KyphX Inflatable
Bone Tamps, KyphX Inflation Syringe, KyphX Bone Access Systems,
KyphX Bone Filler Device, KyphX Curettes, KyphX Bone Biopsy
Device, KyphX HV-R Bone Cement, KyphX Mixer and our CE-Marked
KyphOs calcium phosphate from our acquisition of Sanatis GmbH (Sanatis).
In addition, we have commenced a limited initial launch of our FAD technology we
recently successfully acquired from InnoSpine, Inc.

During the first quarter of 2006, our business experienced significant
growth. Net sales in the first quarter of 2006 increased to $91.4 million,
compared to $66.2 million in the first quarter of 2005, representing growth
of 38%. We trained over 600 physicians during the first quarter of 2006,
primarily in the United States and in Europe. In the U.S., we added 66 new
hospitals to our customer base during the first quarter of 2006.

We have moved beyond our original sole focus of spinal deformity correction,
through treatment of vertebral compression fractures, to our second business
focus, disc repair and regeneration. We have a variety of internal resources
dedicated to supporting research and development in this area as well as
potential business development opportunities. Our third business focus, cancer
therapy aimed at addressing the actual cancerous conditions that affect the
spine rather than merely the effects of those cancerous conditions, such as
vertebral compression fractures, remains an area of interest for us and we
continue to investigate how and when best to enter that initiative. We believe
both additional business initiatives provide further opportunity to grow our
company in the area of minimally invasive spinal diagnosis and therapies.

Significant Industry Factors. Our industry is impacted by
numerous competitive, regulatory and other significant factors. The growth of
our business relies on our ability to continue to develop new products and
innovative technologies, obtain regulatory clearances and compliance for our
products, obtain adequate public and private payor reimbursements for our
products, protect the proprietary technology of our products and our
manufacturing processes, manufacture our products cost-effectively, and
successfully market and distribute our products in a profitable manner. We, and
the entire industry, are subject to extensive government regulation, including
but not limited to the United States Food and Drug Administration.
Failure to comply with all applicable regulatory and legal requirements could
adversely affect our business and our financial condition, which could cause our
stock price to decline. Additionally, our industry is highly competitive and
our success depends on our ability to compete successfully. A detailed
discussion of these and other factors is provided in Item 1A "Risk Factors
" below.

Results of Operations

Three Months Ended March 31, 2006 and March 31, 2005

The following table sets forth, for the periods indicated, our results of
operations expressed as dollar amounts (in thousands) and as percentages of net
sales:

Three Months Ended March 31,
------------------------------------------
2006 2005
-------------------- --------------------
% of % of
Amount Net sales Amount Net sales
--------- --------- --------- ---------
U.S. net sales $ 75,512 83% $ 57,866 87%
International net sales 15,916 17% 8,368 13%
--------- --------- --------- ---------
Net sales 91,428 100% 66,234 100%
Cost of goods sold 10,965 12% 7,925 12%
--------- --------- --------- ---------
Gross profit 80,463 88% 58,309 88%
--------- --------- --------- ---------
Operating expenses:
Research and development 8,589 9% 5,460 8%
Sales and marketing 45,386 50% 34,985 53%
General and administrative 13,568 15% 7,698 12%
--------- --------- --------- ---------
Total operating expenses 67,543 74% 48,143 73%
--------- --------- --------- ---------
Income from operations 12,920 14% 10,166 15%
Interest income and other, net 2,123 2% 525 1%
--------- --------- --------- ---------
Income before income taxes 15,043 16% 10,691 16%
Provision for income taxes 6,550 7% 4,270 6%
--------- --------- --------- ---------
Net income $ 8,493 9% $ 6,421 10%
========= ========= ========= =========

Net Sales. Net sales increased $25.2 million, or 38%, for the three
months ended March 31, 2006 as compared to the same period in 2005. The
increases in net sales primarily resulted from an increase in the number of
physicians trained in the use of our KyphX instruments as well as a 15%
increase in the number of procedures performed by trained physicians per month
compared to the same period in 2005. During the first quarter of 2006, over 600
physicians were trained in the use of our KyphX instruments. Domestic
sales increased $17.6 million, or 30% for the three months ended March 31, 2006
as compared to the same period in 2005. International sales increased $7.5
million, or 90% for the three months ended March 31, 2006 as compared to the
same period in 2005. International sales also reflected the unfavorable
currency impact of $1.4 million in 2006 based on the prior year's same quarter
average Euro rates. No customer accounted for more than 10% of total net sales
for the three months ended March 31, 2006 and 2005, respectively. As of March
31, 2006, we had trained approximately 5,300 spine specialists in the U.S. and
approximately 3,300 clinicians in other parts of the world, primarily in Europe.
We believe the total number of potential physicians who may perform balloon
kyphoplasty procedures using our products is approximately 11,000 in the U.S.
Internationally, the number of physicians who may perform balloon kyphoplasty is
not as well-defined, but we believe it to be more than 10,000. We have targeted
at least $398 million in net sales for 2006.

Cost of Goods Sold. Cost of goods sold consists of material,
labor, subcontract, and overhead costs. Cost of goods sold increased $3.0
million, or 38%, for the three months ended March 31, 2006 as compared to the
same period in 2005. The absolute increase in cost of goods sold resulted
primarily from increased material, labor, subcontract and overhead costs in
relation to the increased sales volume of our products in addition to a $164,000
increase in stock-based compensation expense recognized in accordance with SFAS
No. 123(R). Our cost of goods sold and corresponding gross profit percentages
can be expected to fluctuate in future periods depending upon changes in our
product sales mix and prices, distribution channels and geographies,
manufacturing yields, period expenses and levels of production volume. As a
percentage of net sales, we expect cost of goods sold to be in the range of 12%
to 13% for 2006.

Research and Development. Research and development expenses
consist of costs for product research, product development, clinical functions
and outside costs related to clinical trials and personnel. Research and
development expenses increased $3.1 million, or 57%, in the three months ended
March 31, 2006 as compared to the same period in 2005. The increase was
attributable to increased personnel costs of $808,000, a $760,000 increase in
stock-based compensation expense recognized in accordance with SFAS No. 123(R),
increased clinical studies expense of $542,000, increased consulting expenses of
$279,000, and increased product testing and development expenditures of
$243,000. We expect to continue to make substantial investments in research and
development and anticipate that research and development expenses in 2006 will
increase in absolute dollars as compared to 2005, excluding the license
acquisition charges of $21.0 million relating to Dr. Sandhu and to Dr. Berger in
the prior year period, due largely to the commencement of clinical studies. We
anticipate conducting significant additional clinical trial activity both in the
United States and abroad to collect further data that may support the use and
clinical efficacy of our products. As a percentage of net sales, we anticipate
our research and development expenses to be in the range of 10% to 11% for 2006.

Sales and Marketing. Sales and marketing expenses consist of
costs for personnel, physician training programs and marketing activities.
Sales and marketing expenses increased $10.4 million, or 30%, in the three
months ended March 31, 2006 as compared to the same period in 2005. The
increase was primarily attributable to a $6.4 million increase in the costs of
hiring, training and compensating additional direct selling representatives,
$2.4 million stock-based compensation expense recognized in accordance with SFAS
No. 123(R), and increased sales and marketing travel expenses of $1.2 million.
As we continue to commercialize our KyphX instruments on a global basis,
we expect to significantly increase our sales and marketing efforts and
expenditures in absolute dollars while maintaining our sales and marketing
expenses as a percentage of net sales at 47% to 48% for 2006.

General and Administrative. General and administrative expenses
consist of costs for personnel, professional service fees, expenses related to
legal issues and intellectual property rights, Sarbanes-Oxley compliance and
general corporate expenses. General and administrative expenses increased $5.9
million, or 76%, in the three months ended 2006 as compared to the same period
in 2005. The increase was primarily
attributable to a $2.5 million increase in stock-based compensation expense
recognized in accordance with SFAS No. 123(R), increased personnel costs
of $1.8 million, increased consulting and outside professional service fees of
$1.1 million, increased travel expenses of $394,000 and increased facility
expenses of $381,000. The increases were offset partially by decreased
litigation costs of $804,000. We expect general and administrative expenses to
increase in the future as we add personnel, continue to expand our patent
portfolio, incur additional public reporting, governmental compliance and
investor-related expenses as a public company, incur increased litigation
expenses prosecuting and defending various relevant legal claims, and incur
start-up costs for our new facility in Switzerland. Therefore, we anticipate
that our general and administrative expenses will increase in absolute dollars
as we expand our infrastructure. As a percentage of net sales, we expect that
our general and administrative expenses will be approximately 14% to 15% in
2006.

Interest Income and Other, Net. Interest income and other,
net, increased $1.6 million, or 304%, in the three months ended March 31, 2006
as compared to the same period in 2005. The increase resulted primarily from an
increase in interest income due to higher cash, cash equivalents and investment
balances, as well as higher interest rates. Our cash, cash equivalents and
investments balances were $217.2 million and $130.3 million as of March 31, 2006
and 2005, respectively.

Provision for Income
Taxes. Provision for income taxes was $6.6 million at an effective tax
rate of 43.5% for the three months ended March 31, 2006 as compared to $4.3
million at an effective tax rate of 40.0% for the same period in 2005. The
higher effective tax rate for 2006 is primarily due to the impact of expensing
certain non-tax deductible stock-based compensation in accordance with SFAS No.
123(R), and the expiration of research and development credits in 2005. We
recorded a $1.9 million deferred tax asset for the book expenses associated with
the nonqualified stock options as of March 31, 2006. We believe that in 2006
our effective tax rate will be approximately 43% of income before taxes, with
the actual amount of taxes paid reduced by the utilization of net operating loss
and research and development tax credit carryforwards as well as deductions due
to stock option activities.

Stock-Based Compensation

Effective January 1, 2006, we adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based
Payment", which requires the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors,
including employee stock options and employee stock purchases based on estimated
fair values. Accordingly, stock-based compensation cost is measured at grant
date, based on the fair value of the award, and is recognized as expense over
the employee requisite service period. Stock-based compensation expense
recognized under SFAS No. 123(R) for the three months ended March 31, 2006 was
$6,416,000. We previously used the intrinsic value method in accounting
for our employee stock options, and presented disclosure of pro forma
information as if we had accounted for stock based compensation using the fair
value method. During the three months ended March 31, 2005, we recognized
stock-based compensation expense of $582,000 related to employee stock options
issued prior to our initial public offering with exercise prices below the
deemed fair market value of our stock at the date of grant.

We estimate the value of employee stock options on the date of grant using a
lattice-binomial model. The determination of fair value of share-based payment
awards on the date of grant using an option-pricing model is affected by our
stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include, but are not limited to our
expected stock price volatility over the term of the awards, and actual and
projected employee stock option exercise behaviors.

During the three months ended March 31, 2006, we recognized stock-based
compensation charges related to our employee stock options and employee stock
purchase plan of $5.9 million, and $772,000, respectively. Of that total
charge approximately $210,000 of stock-based compensation was capitalized as
inventory as of March 31, 2006. As of March 31, 2006, the unrecorded
deferred stock-based compensation balance related to employee stock options was
$38.1 million after estimated forfeitures and will be recognized over an
estimated weighted-average remaining requisite service period of 2.6
years.

In our recent Proxy filing, we proposed that our shareholders approve a new
Employee Stock Purchase Plan that, if approved, would take effect on and after
the offering period ending February 1, 2007 under the current plan. Details of
the proposed ESPP plan are included in that filing.

Stock-based compensation expense for stock options granted to non-employees
is recognized as the stock options are earned. The stock-based compensation
expense will fluctuate as the fair market value of our common stock fluctuates.
In connection with the grant of stock options to non-employees, we recorded
stock-based compensation expense of approximately $197,000 and $138,000 for the
three months ended March 31, 2006 and 2005, respectively.

Seasonality
Our business is seasonal in nature. Historically, demand for our
products has been the highest in the first and second quarters in the U.S. and
in the second and fourth quarters in Europe. In the U.S., during the fourth
quarter, our net sales generally reflect the reduced number of selling days due
to the holiday season. In Europe, we traditionally experience somewhat lower
sales volumes in the third quarter months than throughout the rest of the year
as a result of the European summer holiday schedule. In addition, the fourth
quarter in Europe is typically favorably impacted by certain customers' budget
utilization patterns and our distributors' fulfillment of their annual purchase
commitments.

Liquidity and Capital Resources

As of March 31, 2006, we had $92.1 million of cash and cash equivalents,
$125.1 million of short-term investments, and working capital of $238.3 million.
Our cash and cash equivalents and investments increased by $22.7 million during
the first quarter of 2006.

Cash Provided by Operating Activities. Our operating cash flow
for the three months ended March 31, 2006 was primarily the result of our
operational profitability. Net cash provided by operations was $21.0 million,
attributable primarily to net income of $8.5 million adjusted for non-cash
charges related to stock-based compensation of $6.6 million and depreciation and
amortization expenses of $1.4 million. Net cash provided by operations for the
three months ended March 31, 2005 was $13.2 million, attributable primarily to
net income of $6.4 million adjusted for non-cash charges related to the tax
benefits from stock-based compensation plans of $4.3 million and depreciation
and amortization expenses of $1.0 million.

The increase in cash provided by operating activities for all periods was
adjusted by changes in our working capital. During the three months ended March
31, 2006, accounts receivable decreased by $84,000 as we increased collection
efforts; inventories increased by $523,000 in order to meet the increased demand
for our products; prepaid expenses and other current assets increased by $1.8
million due to the timing of certain deposits and annual license fee payments;
accounts payables increased by $1.2 million due to our increased operating
expenses; accrued liabilities increased by $4.1 million due to increased payroll
and income tax accruals; deferred rent and other increased $1.5 million due to
additional facilities being leased. During the three months ended March 31,
2005, accounts receivable increased $1.6 million due to increased net sales;
inventories decreased $277,000 due to improved inventory management; prepaid
expenses and other current assets decreased by $1.2 million due to the timing of
the prepaid expenses; accounts payables increased $2.3 million due to increased
operating expenses; accrued liabilities decreased $1.6 million mainly due to
decreased employee stock purchase and income tax accruals; deferred rent and
other increased $223,000 due to additional facilities being leased.

In the first quarter of 2006, we adopted SFAS No. 123(R), which requires that
the excess benefit of tax deductions over the recognized compensation cost for
nonqualified employee stock options be reported as cash flow from financing
activities rather than as cash flow from operations.

Cash Used in Investing Activities. Net cash used in investing
activities was $12.3 million for the three months ended March 31, 2006 and
resulted from the net investment purchases of $7.0 million, and purchases of
property and equipment of $5.3 million primarily due to the outfitting of our
Sunnyvale facility. Net cash used in investing activities was $2.4 million for
the three months ended March 31, 2005 and resulted primarily from the purchase
of information systems to improve our infrastructure and operating
efficiencies.

Cash Provided by Financing Activities. Net cash provided by
financing activities was $7.1 million during the three months ended March 31,
2006 and was attributable primarily to issuance of common stock under the
employee stock purchase plan of $3.0 million and proceeds from the exercise of
stock options of $3.2 million. Net cash provided by financing activities was
$4.8 million during the three months ended March 31, 2005 and was attributable
to proceeds from the issuance of common stock under the employee stock purchase
plan of $2.5 million and exercise of stock options of $2.4 million.

Contractual Cash Obligations. As of March 31, 2006 we had contractual
cash obligations as follows (in thousands):

Payment Due by Periods
-----------------------------------------------------------------------
Remainder of
Total 2006 2007 2008 2009 2010 After 2010
-------- -------- -------- -------- -------- -------- -----------
Operating leases $ 24,550 $ 2,576 $ 3,455 $ 2,999 $ 2,971 $ 2,996 $ 9,553
Consulting agreement 175 50 100 25 -- -- --
License agreement 15,000 5,000 10,000 -- -- -- --
Purchase commitments with contract
manufactures and suppliers 11,182 10,870 312
Purchase obligations 9,795 8,839 956
Asset retirement obligation 322 -- -- -- -- -- 322
-------- -------- -------- -------- -------- -------- -----------
Total commitments $ 61,024 $ 27,335 $ 14,823 $ 3,024 $ 2,971 $ 2,996 $ 9,875
======== ======== ======== ======== ======== ======== ===========

The amounts reflected in the table above for operating leases represent
aggregate future minimum lease payments under non-cancellable facility leases.
Portions of these payments and a portion of the asset retirement obligations are
denominated in foreign currencies and were translated in the tables above based
on their respective U.S. dollar exchange rates at March 31, 2006. These future
payments are subject to foreign currency exchange rate risk.

We are obligated to make a series of payments totaling up to $15.0 million
related to the license acquisition agreement with Dr. Sandhu. The payments of
these additional obligations, which shall be paid annually unless accelerated,
may be accelerated upon defined events and circumstances or may be forgiven upon
the occurrence of a third party event, outside the control of the Company.
Based on management judgment, ability and intent, this amount has been
classified as a current liability as of March 31, 2006.

On December 30, 2005, we entered into a definitive agreement to acquire
InnoSpine, Inc., a privately held company focused on developing and marketing
its proprietary technology platform for the diagnosis and potential treatment of
axial low back pain due to disc degeneration. The terms of the acquisition
called for an initial purchase price of $2.5 million in cash to the shareholders
of InnoSpine, plus the possibility of up to an additional $27.5 million in cash
or stock, based on achievement of clinical and other milestones as well as
royalties on future net sales. This contingent purchase price liability is not
included in the table above.

Purchase Commitments with Contract Manufacturers and
Suppliers.  We purchase components from a variety of
suppliers and use contract manufacturers to provide manufacturing services for
our products. During the normal course of business, in order to manage
manufacturing lead times and to help assure adequate component supply, we enter
into agreements with contract manufacturers and suppliers that either allow them
to procure inventory based upon criteria as defined by us or that establish the
parameters defining our requirements. In certain instances, these agreements
allow us the option to cancel, reschedule, and adjust our requirements based on
our business needs prior to firm orders being placed. Consequently, only a
portion of our reported purchase commitments arising from these agreements are
firm, noncancelable, and unconditional commitments. The purchase commitments
for inventory are expected to be fulfilled within one year.

Purchase Obligations.   Purchase
obligations represent an estimate of all open purchase orders and contractual
obligations in the ordinary course of business, other than commitments with
contract manufacturers and suppliers, for which we have not received the goods
or services. Although open purchase orders are considered enforceable and
legally binding, the terms generally allow us the option to cancel, reschedule,
and adjust our requirements based on our business needs prior to the delivery of
goods or performance of services.

Off-Balance Sheet Arrangements. We do not have any off-balance
sheet financing as of March 31, 2006. All of our subsidiaries are included in
the financial statements, and we do not have relationships with any special
purpose entities.

Stock Repurchase. Our Board of Directors approved a stock
repurchase program on November 7, 2002, pursuant to which we may purchase up to
2,000,000 shares of our outstanding common stock. The duration of the
repurchase program is open-ended. Under the program, we may purchase shares of
common stock through open market transactions at prices deemed appropriate by
management and the Board of Directors. The purchases will be funded from
available working capital. In 2002, we repurchased 30,000 shares pursuant to
this repurchase program. We have not repurchased any of our common stock since
2002.

Summary. We believe our current cash, cash equivalents,
investments and cash generated from operations will be sufficient to meet our
anticipated cash needs for working capital and capital expenditures for at least
the next 12 months. We anticipate conducting significant additional clinical
trial activity both in the United States and abroad to collect further data that
may support the use and clinical efficacy of our products. The costs of these
trials will be significant. If existing cash, cash equivalents, and cash
generated from operations are insufficient to satisfy our liquidity
requirements, whether as a result of investment in new markets or businesses
through both internal or external business development, expansion of product
lines, additional clinical trials, possible increased capital expenditures, or
for other reasons related to our business, we may seek to sell additional equity
securities or obtain a credit facility. The sale of additional equity or
convertible debt securities could result in dilution to our stockholders. If
additional funds are raised through the issuance of debt securities, these
securities could have rights senior to those associated with our common stock,
and could contain covenants that would restrict our operations. And additional
financing may not be available in amounts or on terms acceptable to us, or at
all. If we are unable to obtain adequate financing when needed, we may have to
delay, reduce the scope of, or eliminate certain of our business expansion
activities.

Recent Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 151, "Inventory Costs, an amendment of Accounting Principles Board
(APB) Opinion No. 43, Chapter 4." SFAS No. 151 amends APB
No. 43, Chapter 4, to clarify that abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage) should be
recognized as current period charges. In addition, SFAS No. 151 requires that
allocation of fixed production overhead to the cost of conversion be based on
the normal capacity of the production facilities. The provisions of SFAS No.
151 are effective for fiscal years beginning after June 15, 2005. Accordingly,
the provisions of SFAS No. 151 became effective January 1, 2006 for us. The
adoption of SFAS No. 151 did not have a material impact on our consolidated
financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk at March 31, 2006 is related primarily
to our investment portfolio. Our investment portfolio includes fixed rate debt
instruments of high quality corporate issuers and asset-backed securities. A
change in prevailing interest rates may cause the fair value of our investments
to fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing rate rises, the
fair value of the principal amount of our investment will probably decline. To
minimize this risk, investments are generally held to maturity and the weighted
average duration of our investments is 12 months or less. Due to the short-term
nature of these investments, we believe we have no material exposure to interest
rate risk arising from our investments. As of March 31, 2006, the carrying value of these investments
approximates fair market value. We do not believe any of our investments are
other than temporarily impaired at March 31, 2006.

We have operated mainly in the United States, and 83% and 87% of our sales
were made in U.S. dollars for the three months ended March 31, 2006 and 2005,
respectively. The majority of our non-U.S. sales are derived from European
Union countries and denominated in the Euro. Monthly income and expense from
our European operations are translated using average rates and balance sheets
are translated using month-end rates. Differences are recorded within
stockholders' equity as a component of accumulated other comprehensive income or
to the income statement, as applicable. As our revenues denominated in
currencies other than the dollar increase, we have an increased exposure to
foreign currency rate risk. Based on our overall exposure for foreign currency
at March 31, 2006, a hypothetical 10% change in foreign currency rates would not
have a material impact on our net sales and operating expenses. We may elect to
mitigate this rate risk, in part or in whole, through the purchase of forward
currency contracts.

ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and
procedures.    The Chief Executive Officer, Richard W.
Mott, and Chief Operating Officer and Chief Financial Officer, Arthur T. Taylor,
evaluated the effectiveness of Kyphon's disclosure controls and procedures as of
the end of the period covered by this report, and concluded that Kyphon's
disclosure controls and procedures were effective to ensure that the information
Kyphon is required to disclose in the reports that it files or submits with the
Securities and Exchange Commission under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the Commission's rules and forms, and to ensure that the information required
to be disclosed by Kyphon in the reports that it files or submits under the
Exchange Act is accumulated and communicated to Kyphon's management, including
its principal executive officer and principal financial officer, as appropriate
to allow timely decisions regarding required disclosure.
Changes in internal control over financial
reporting.    During the quarter ended March 31, 2006,
there were no changes in Kyphon's internal control over financial reporting (as
defined in Rule 13a-15(f) under the Exchange Act) that have materially
affected, or are reasonably likely to materially affect, Kyphon's internal
control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In November 2005, Dr. Harvinder Sandhu, a well-respected orthopaedic
surgeon with whom Kyphon has an exclusive consulting relationship, and Kyphon
filed suit in federal district court in Memphis, Tennessee against Medtronic
Sofamor Danek ("MSD") and several other related corporate entities
seeking compensatory and punitive damages and injunctive relief for breach of
contract and related covenants, trade secret theft, fraud and correction of
inventorship of several patents and patent applications presently owned by MSD,
including U.S. Patent No. 6,676,665. The suit also requests, among other
relief, that MSD transfer to Dr. Sandhu ownership of the disputed patent and
patent applications. The dispute concerns inventions related to an expandable,
mechanical bone tamp for use in treating vertebral compression fractures that
Dr. Sandhu invented in the late 1990's and which he confidentially disclosed and
discussed with MSD. The complaint alleges that MSD later filed for several
patents encompassing and claiming Dr. Sandhu's inventions without naming him as
inventor of that technology, and that it also incorporated Dr. Sandhu's
inventions into its internal Equestra project without his permission.
The litigation is in its early stages; trial has been set for April 2007. We
intend to vigorously prosecute our and Dr. Sandhu's case against MSD.

In April 2006, MSD and several other related corporate entities filed suit
against us in federal district court in the Northern District of California,
alleging that our vertebral bone tamps and/or related products infringe three
angioplasty balloon dilatation catheter patents, numbers 4,820,349, 5,759,191
and 6,179,856, and a single claim of patent number 6,096,038, which generally
concerns treatment of the disc space. The suit seeks damages based upon the
making, using, selling and offering for sale of our products, seeks enhanced
damages for alleged willful infringement, and seeks to enjoin our continued
activities relating to these products. We believe the assertions of infringement
are without merit. The suit against us also seeks a declaratory judgment that
five of our U.S. patents, numbers 4,969,888, 5,108,404, 6,235,043, 6,440,138,
and 6,863,672, are invalid and not infringed by an "osteotome," which
we believe is the Equestra product already at issue in the Memphis
litigation. We also believe the declaratory judgment is baseless. Accordingly,
we have already asked the federal court in Memphis to enjoin and prevent MSD
from proceeding with its declaratory judgment in California. We have also filed
an amended complaint in Memphis, affirmatively asserting the same five U.S.
patents against MSD and accusing MSD of willfully infringing those patents
through its development and commercialization of the Equestra. Although
we intend to vigorously defend MSD's California lawsuit, MSD's action against us
subjects us to potential liability for damages, including treble damages, and
could require us to cease making, using or selling the affected products, or to
obtain a license in order to continue to manufacture, use or sell the affected
products. While we believe we have multiple meritorious defenses to this action,
we cannot assure you that we ultimately will prevail on any issue in the
litigation or that we will be able to successfully defend MSD's charges, nor can
we provide assurance that any license required would be made available on
commercially acceptable terms, if at all. Failure to successfully defend
against MSD's action could harm our business, financial condition and operating
results. Due to the inherent uncertainties of litigation, we cannot accurately
predict the ultimate outcome of this matter at this time and, therefore, cannot
estimate the range of possible loss.

In addition, we are subject to legal proceedings, claims, and litigation
arising in the ordinary course of business, including intellectual property
litigation. While the outcome of these matters is currently not determinable, we
do not expect that the ultimate costs to resolve these matters will have a
material adverse effect on our consolidated financial position, results of
operations, or cash flows.

ITEM 1A. RISK FACTORS

The following are new or modified risk factors that should be read in
conjunction with the risk factors disclosed in our 2005 Annual Report on Form
10-K:

We are involved in patent infringement litigation with Medtronic Sofamor
Danek and related entities that may harm our competitive position, may be costly
to us and may prevent us from selling our products.

In April 2006, MSD and several other related corporate entities filed suit
against us in federal district court in the Northern District of California,
alleging that our vertebral bone tamps and/or related products infringe three
angioplasty balloon dilatation catheter patents, numbers 4,820,349, 5,759,191
and 6,179,856, and a single claim of patent number 6,096,038, which generally
concerns treatment of the disc space. The suit seeks damages based upon the
making, using, selling and offering for sale of our products, seeks enhanced
damages for alleged willful infringement, and seeks to enjoin our continued
activities relating to these products. The suit against us also seeks a
declaratory judgment that five of our U.S. patents, numbers 4,969,888,
5,108,404, 6,235,043, 6,440,138, and 6,863,672, are invalid and not infringed by
an "osteotome," which we believe is the Equestra product
already at issue in the Memphis litigation. While we
believe the assertions of infringement are without merit and the declaratory
judgment is baseless, we cannot assure you that the outcome of this litigation
will be favorable to us. If we lose the suit against us, it will hurt our
competitive position, may be costly to us and may prevent us from selling our
products. In addition, if we lose, we may need to obtain a license to the
patented technology, which could be expensive, or could require us to license to
MSD some of our own technology, which would result in a partial loss of our
competitive advantage in the marketplace, each of which could seriously harm our
business. If MSD is successful in its patent suit and is unwilling to grant us
a license, we may be required to stop selling our products that are found to
infringe any the asserted patents unless we can redesign them so they do not
infringe, which we may be unable to do. In addition, if we lose, we could be
required to pay damages, including treble damages, which could be substantial
and harm our financial position.
Defending this suit and prosecuting our related suit against MSD in federal
court in Memphis, Tennessee, will be expensive to litigate, the litigation may
be protracted and our confidential information may be compromised. Whether or
not we are successful in these lawsuits, this litigation could consume
substantial amounts of our financial and managerial resources. At any time, MSD
may file additional claims against us, or we may file further claims against
MSD, which could increase the risk, expense and duration of the litigations.
For more information on our litigation with MSD, see "Part II-Item 1: Legal
Proceedings."

Public announcements of litigation events may hurt our stock price.

During the course of our lawsuits with MSD and our other legal activities,
including the U.S. Attorney's Office (USAO) investigation of our sales and
marketing practices, there may be public announcements of various proceedings or
developments, including announcements concerning the results of hearings,
motions and other issues. If securities analysts or investors perceive such
information to be negative, it could have a substantial negative effect on the
trading price of our stock.

We are aware that a complaint, which we believe is a qui tam
complaint, is being evaluated by a U.S. Attorney's Office in connection with our
marketing and sales practices, including those relating to the Medicare
reimbursement available to our customer hospitals. If a subpoena or an
enforcement or other action ultimately results from this investigation, our
business and financial condition could be adversely affected which could cause
our stock price to decline.

We have learned that sometime in 2005, the USAO received a complaint that we
believe is a qui tam complaint that alleges impropriety in our business,
including regarding our reimbursement practices. Although no subpoena has been
issued to us, the USAO in connection with this complaint is investigating our
sales and marketing practices, including those relating to Medicare
reimbursement available to our customer hospitals, based on site-of-service, for
using Kyphon's products in surgery, and has asked to review some of our
documentation that may be relevant to the investigation. We believe we are in
substantial compliance with the healthcare laws relevant to our Company. Even
though we have not received a subpoena regarding the complaint or its
allegations, we continue to voluntarily cooperate with the USAO, to permit the
USAO to develop an informed opinion on whether or not to pursue any action in
connection with the complaint based in part on the information we provide,
although timing on that decision is uncertain. At this time, we do not
know whether the outcome of the investigation will have a material adverse
impact to our business, and cannot assure you regarding any future path USAO or
any related lawsuit may take. If an enforcement or other action results from
the ongoing investigation, our business and financial condition could be
adversely affected which could cause our stock price to decline.

Recent changes in the required accounting treatment for stock options will
have a material negative impact on our financial statements and may affect our
stock price.

In December 2004, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards SFAS No. 123(R),
pursuant to which we must measure all stock-based compensation awards, including
grants of employee stock options, using a fair value-based method and record
such expense in our consolidated financial statements. We were required to
expense employee stock-based compensation awards beginning January 1, 2006.
Previously, we disclosed such expenses on a pro forma basis in the notes to our
consolidated financial statements, but we did not record a charge for employee
stock option expense in the financial statements. As a result of our beginning
to comply with SFAS No. 123(R) as of January 1, 2006, our reported earnings
decreased and we expect this trend to continue for the foreseeable future, which
may affect our stock price. In addition, our reported earnings have increased
volatility due to the tax impact and timing of employee stock option exercises,
which could further negatively impact our financial statements and cause our
stock price to decline.

ITEM 5. OTHER INFORMATION

In accordance with Section 10A(i)(2) of the Securities Exchange Act of
1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002 (the
"Act"), we are required to disclose the non-audit services approved by
our Audit Committee to be performed by PricewaterhouseCoopers LLP, our
independent registered public accounting firm. Non-audit services are defined
in the Act as services other than those provided in connection with an audit or
a review of the financial statements of a company. The Audit Committee has
approved the engagement of PricewaterhouseCoopers LLP for the following non-
audit services: (1) various tax matter consultations concerning foreign, U.S.
federal and state taxes; and (2) the preparation of federal and state income tax
returns.

ITEM 6. EXHIBITS

Number



Description

  3.2
(7)



Amended and Restated Certificate of Incorporation of the
registrant.

  3.4  (7)



Amended and Restated Bylaws of the registrant.

  4.1  (1)



Specimen common stock certificate of the registrant.

10.1*  (1)



Form of Indemnification Agreement for directors and executive
officers.

10.2*  (1)



1996 Stock Option Plan, including form of option
agreement.

10.3*  (1)



2002 Stock Plan, including form of option agreement.

10.4*  (1)



2002 Employee Stock Purchase Plan, including form of employee
stock purchase plan subscription agreement.

10.5*  (1)



2002 Director Option Plan, including form of option
agreement.

10.8  (1)



Lease dated January 27, 2000 for office space located at 1350
Bordeaux Drive, Sunnyvale, CA 94089 and Second Amendment to Lease dated November
29, 2001.

10.8.1 (1)



Third Amendment to Lease dated March 29, 2002 for office space
located at 1350 Bordeaux Drive, Sunnyvale, CA 94089.

10.9*  (1)



Employment Agreement between the registrant and Gary L. Grenter
dated July 16, 2001.

10.10 (1)



Promissory Note Secured by Deed of Trust between the registrant
and Gary L. Grenter dated December 31, 2001.

10.11 (1)



Amended and Restated Stockholder Rights Agreement effective as
of December 14, 1999, among the registrant and certain stockholders of the
registrant.

10.12* (2)

Employment Agreement between the registrant and Richard W. Mott
dated September 3, 2002.

10.13+(2)



Sublicense Agreement effective as of August
19, 2002, between the registrant and Bonutti Research, Inc.

10.14 (3)

Stock Purchase Agreement by and between Kyphon and the
shareholders of Sanatis GmbH, dated February 15, 2003.

10.15 (4)

Lease dated September 18, 2003 for office spaces located at
1221 Crossman Avenue and 480 Java Drive, Sunnyvale,
California.

10.16* (5)

Form of Severance Agreement entered into by and between Kyphon Inc.
and its executive officers.

10.17* (5)

Severance Agreement, dated January 28, 2005, entered into by and between Kyphon Inc.
and Richard W. Mott.

10.18 (6)

First Amendment to Lease Agreement, made as of September 28, 2005, by and between
Moffett Office Park Investors LLC, a Delaware limited liability company, and Kyphon Inc.

31.1

Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.

31.2

Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.

32.1

Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference from
our Registration Statement on Form S-1 (Registration No. 333-83678), which was
declared effective on May 16, 2002.

(2) Incorporated by reference from
our Quarterly Report on Form 10-Q as filed with the Securities Exchange Commission on November 13, 2002.

(3) Incorporated by reference from
our Current Report on Form 8-K as filed with the Securities Exchange Commission on March 7, 2003.

(4) Incorporated by reference from
our Quarterly Report on Form 10-Q as filed with the Securities Exchange Commission on November 14, 2003.

(5) Incorporated by reference from
our Current Report on Form 8-K as filed with the Securities Exchange Commission on February 1, 2005.

(6) Incorporated by reference from
our Quarterly Report on Form 10-Q as filed with the Securities Exchange Commission on November 1, 2005.

(7) Incorporated by reference from
our Annual Report on Form 10-K as filed with the Securities Exchange Commission on March 3, 2006.

* Management compensatory plan or arrangement required to be filed as an
exhibit pursuant to Item 15(c) of Form 10-K.
+ Confidential treatment requested on
portions of this exhibit. Unredacted versions of this exhibit have been filed
separately with the Commission.

SIGNATURES
Pursuant to the requirements 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.

Kyphon Inc.

Date: May 10, 2006

By: /s/ Richard W. Mott

Richard W. Mott

President, Chief Executive Officer

and Director (Principal Executive Officer)

Date: May 10, 2006

By: /s/ Arthur T. Taylor

Arthur T. Taylor

Vice President, Chief Operating Officer and Chief Financial Officer

(Principal Accounting and Financial Officer)}

Delaware	77-0366069
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

	Page No.
PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (unaudited):

Condensed Consolidated Income Statements for the Three Months Ended March 31, 2006 and 2005	3

Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005	4

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005	5

Notes to Condensed Consolidated Financial Statements	6

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3. Quantitative and Qualitative Disclosures About Market Risk	20

Item 4. Controls and Procedures	21

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	21

Item 1A. Risk Factors	22

Item 5. Other Information	23

Item 6. Exhibits	23

SIGNATURES

Number		Description

3.2 (7)		Amended and Restated Certificate of Incorporation of the registrant.

3.4 (7)		Amended and Restated Bylaws of the registrant.

4.1 (1)		Specimen common stock certificate of the registrant.

10.1* (1)		Form of Indemnification Agreement for directors and executive officers.

10.2* (1)		1996 Stock Option Plan, including form of option agreement.

10.3* (1)		2002 Stock Plan, including form of option agreement.

10.4* (1)		2002 Employee Stock Purchase Plan, including form of employee stock purchase plan subscription agreement.

10.5* (1)		2002 Director Option Plan, including form of option agreement.

10.8 (1)		Lease dated January 27, 2000 for office space located at 1350 Bordeaux Drive, Sunnyvale, CA 94089 and Second Amendment to Lease dated November 29, 2001.

10.8.1 (1)		Third Amendment to Lease dated March 29, 2002 for office space located at 1350 Bordeaux Drive, Sunnyvale, CA 94089.

10.9* (1)		Employment Agreement between the registrant and Gary L. Grenter dated July 16, 2001.

10.10 (1)		Promissory Note Secured by Deed of Trust between the registrant and Gary L. Grenter dated December 31, 2001.

10.11 (1)		Amended and Restated Stockholder Rights Agreement effective as of December 14, 1999, among the registrant and certain stockholders of the registrant.
10.12* (2)		Employment Agreement between the registrant and Richard W. Mott dated September 3, 2002.
10.13+(2)		Sublicense Agreement effective as of August 19, 2002, between the registrant and Bonutti Research, Inc.
10.14 (3)		Stock Purchase Agreement by and between Kyphon and the shareholders of Sanatis GmbH, dated February 15, 2003.
10.15 (4)		Lease dated September 18, 2003 for office spaces located at 1221 Crossman Avenue and 480 Java Drive, Sunnyvale, California.
10.16* (5)		Form of Severance Agreement entered into by and between Kyphon Inc. and its executive officers.
10.17* (5)		Severance Agreement, dated January 28, 2005, entered into by and between Kyphon Inc. and Richard W. Mott.
10.18 (6)		First Amendment to Lease Agreement, made as of September 28, 2005, by and between Moffett Office Park Investors LLC, a Delaware limited liability company, and Kyphon Inc.
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	Kyphon Inc.
Date: May 10, 2006	By: /s/ Richard W. Mott Richard W. Mott President, Chief Executive Officer and Director (Principal Executive Officer)