Kyphon Annual Report 03

Kyphon’s vision: Improve patient quality of life through revolutionizing the practice of medicine. [

ANNUAL

REPORT

2003

]

>> Kyphon is driven by our mission: To be the recognized global leader in restoring spinal function through minimally invasive therapies.

[

TO

OUR

Richard W. Mott President and Chief Executive Officer

SHAREHOLDERS,

CUSTOMERS

AND

EMPLOYEES

]

I am pleased to report the progress of Kyphon during 2003. This was a significant and important year in the development, growth and financial performance of our Company. During the year, we successfully broadened focus from our initial market opportunity in enabling the treatment of osteoporosis - related vertebral fractures and have now built a broader foundation to become a leading innovator in minimally invasive spinal fracture therapies.

Our strategic expansion was supported by strong financial and operational achievements throughout 2003. For the year, net sales increased 74% to $131 million and we leveraged this growth into pro forma net income of $8.7 million, or $0.21 per share. After years of significant investment in our business, fiscal 2003 was our first profitable year. Our organization is very proud of this achievement. >>

I N N O VAT I O N C R E AT E S O P P O R T U N I T Y Kyphon was founded upon a truly innovative technology. Our kyphoplasty and fracture reduction products enable spine specialists to provide therapies to a significant patient community that they did not treat previously. This community represents our core market of patients with spinal fractures caused by osteoporosis.

This technological advance—balloon-based, minimally invasive spinal fracture treatment—creates a significant market opportunity for Kyphon. We believe that 550,000 patients are diagnosed with 700,000 vertebral compression fractures due to osteoporosis each year in the United States and Europe. During 2003, we believe that our products were used in over 33,000 procedures, which represents only six percent of our $2.2 billion core market opportunity.

With innovation as our guiding principle, we are developing additional therapies to provide spine specialists with alternatives for patients with a variety of spinal fractures.

In the near term, we are concentrating on developing minimally invasive procedural solutions for spinal fractures caused by cancer and trauma.

With the addition of these incremental market opportunities, we will address the three most common causes of spinal fractures and a potential market of over 900,000 fractures, valued at $3 billion, annually.

> > R o n L u p e r i ne , r etir ed banker Diagnosis:

Age: 62

Steroid-induced fracture

Location: Castr o Valley, Calif. USA

A lung ailment slowed Mr. Luperine down for four years, causing doctors to prescribe a corticosteroid. Unfortunately, the drugs caused him to lose bone mass—a common side-effect of steroid regimens—and he developed osteoporosis. His resulting spinal fracture was so debilitating that a pain pump was implanted to manage the pain. Following a Balloon Kyphoplasty procedure to treat his fracture, the pump was removed, and Mr. Luperine is now happy to “be living and getting around again.”

I N N O V A T I O

Recent advances in surgical imaging technology are enabling minimally invasive, image-guided surgery in the spine.

131

76

36

2001

2002

2003

Revenue (in millions)

2 0 0 3 WA S A Y E A R O F G R O W T H A N D E V O L U T I O N F O R K Y P H O N

12

This past year included a series of important milestones in Kyphon’s evolution as a leading medical device company.

During the year, we established a strong foundation for continued growth by focusing on enhancing our organizational infrastructure. Specifically, we expanded our senior leadership team, grew our employee base to over 440 individuals, and implemented the Six Sigma methodology for identifying areas of operational improvement and employing successful solutions.

To support this growth, we recently moved into new corporate headquarters in Sunnyvale, California, more than doubling our facility space. This new facility will allow for significant growth in our technology research, development and manufacturing capacity, while supporting the implementation of our marketing and sales strategies.

B U I L D I N G A P O W E R F U L C H A N N E L T O T H E M A R K E T Our direct

sales organization plays a vital role in working with the 3,900 spine specialists we had trained worldwide by the end of this past year. We expanded our surgical sales organization during 2003 as we continued to support significant interest from the spine specialist community. As a complement to this effort, we deployed a second, independently managed Spine Education Specialist (SES) sales organization in 2003. This group is focused on educating the broader medical community about treatment options for patients with spinal fractures.

2

1

2001

2002

2003

New Products

Far left: KyphX® Latitude™ Curette enables uniform scraping and scoring of bone in the spine.

Left: KyphX® Bone Biopsy Device cuts cleanly through cancellous bone for easy specimen collection.

E V O L U T I O N

> > C h r i s t i ne S i eg e l , teacher Diagnosis:

Age: 57

Myeloma-induced fractures

Location: Gr eenbrae, Calif. USA

Fighting a blood cancer like multiple myeloma is frightening enough; add the consequences of related spinal fractures and life can be more difficult. Ms. Siegel lost 6 inches of height from five fractures in her back due to myeloma and was “bed ridden for over a year while taking (strong opoids) for pain.” After a Balloon Kyphoplasty procedure to repair four spinal fractures, she threw away all of the pain killers. “The cancer caused me to fall apart, this procedure put me back together again.”

KyphX® Exact™ Inflatable Bone Tamp with rigid stainless steel shaft allows for fine-tuning of unidirectional balloon inflation for focused fracture reduction.

KyphX® Elevate™ Inflatable Bone Tamp with advanced balloon design results in preferential inferior/superior inflation profile.

> > Ja n Va n M o l cr eative agency owner Diagnosis:

Age: 36

Traumatic fracture

Location: Louvain, Belgium

While vacationing in France, Mr. Van Mol was flying his hang glider when something went terribly wrong.

The sail collapsed, causing him to slam his back into a high tree and suffer a spinal fracture and a broken arm. After a painful nine-hour car ride back to Belgium, he was treated with a Balloon Kyphoplasty procedure using a biomaterial. “I immediately started walking. In two weeks, I was able to ride on my motorcycle again.�

R E V O L U T I O

I believe that we are unique in the medical device industry in employing two separate but complementary sales organizations that work with the surgical and primary care physician communities.

F O C U S O N N E W P R O D U C T D E V E L O P M E N T Our powerful channel to

the market enables Kyphon to monitor the evolving dynamics and needs of the spine community so we can provide our customers with new products that will enhance their practices. Specifically, we launched 12 new products during 2003, which is a significant achievement for our organization.

Looking ahead to 2004 and beyond, I am very excited about our April 1, 2004 510(k) clearance by the U.S. Food & Drug Administration (FDA) of our proprietary KyphXŽ HV-R™ PMMA Bone Cement for use in kyphoplasty. We now will be able to provide and promote a complete procedural solution for spine specialists who treat patients with these spinal fractures. Perhaps more importantly, we believe clearance to promote the cleared clinical outcomes of kyphoplasty to the referring physician community and among patients and caregivers will continue to enhance our ability to penetrate our core market over the long term.

This clearance is a seminal milestone in the history of our Company and has clearly established Kyphon as a world class innovator in minimally invasive spinal fracture therapies.

A R E V O L U T I O N I N M I N I M A L LY I N VA S I V E S P I N E S U R G E R Y

We believe that kyphoplasty is the first example of what will become a significant trend in spine surgery: minimally invasive, restorative therapies that enable spine specialists to provide patients with significant clinical outcomes and short hospital stays. The strategic goal of Kyphon is to be the recognized leader in this ongoing movement and we are actively investigating next generation technologies.

3900

2700

1500

2001

2002

2003

Spine Specialists Trained Worldwide

E S TA B L I S H I N G A G L O B A L F R A N C H I S E With the success we have had generating operating leverage

in our core business in the U.S. and primary countries in Europe, this is the right time for Kyphon to invest in geographic expansion. International sales contributed 10 percent of our corporate revenue in 2003, which reflects the significant but nascent opportunity for kyphoplasty outside of the U.S. During the year, we set the stage for expanding our operations further into Europe as well as into Canada, and parts of Central and South America. In addition, we completed an important planning process preparing for our entrance into Japan, the world’s third largest medical device market. Progress in all of these geographies is important to our business, and we will continue to invest in establishing kyphoplasty with our products as a treatment alternative throughout the world.

P R E PA R E D F O R C O N T I N U E D S U C C E S S As I contemplate all of the advances we made in 2003, and

the momentum we carry into 2004, I couldn’t be more excited. I believe that the foundation we have established is a testament to the talent and dedication of the Kyphon employees throughout the world. The entire Kyphon team appreciates and thanks all of our shareholders for their continued support and the recognition of our growing family of customers.

Sincerely,

Richard W. Mott President and Chief Executive Officer

Sales Today Near Term Expansion Key Longer Term Goals

215 19 17

130 85

2001

10

2002

2003

Global Sales Force

2001

2002

2003

Countries Served

> > E l l e n S i m p s o n , M.D., r etir ed pediatric car diologist C h r i s Ke rn , for mer x-ray technician

Age: 86 (left)

Age: 84 (right)

A nd y, canine companion (far right) Diagnosis:

Osteoporotic fractures

Locations: San Francisco and Fair fax, Calif. USA

Dr. Simpson (four fractures from osteoporosis repaired in August 2003) and Ms. Kern (two fractures repaired in January 2003) met at a holiday party and found out that they had much in common—retired healthcare professionals who love gardening and living active lives in Northern California. They are also two of the hundreds of thousands of people who suffer spinal fractures due to osteoporosis each year in the United States. What brought these two women together for this photograph is a procedure called Balloon Kyphoplasty. They underwent the procedure to treat the pain, deformity and diminished quality of life they were suffering due to their fractures. Both are excited now about living pain free lives and getting back to their respective gardens.

MANAGEMENT TEAM

BOARD OF DIRECTORS

ANNUAL MEETING

Richard W. Mott President, Chief Executive Officer and Director

James T. Treace Chairman of the Board of Directors J & A Group, LLC

Karen D. Talmadge, Ph.D. Executive Vice President, Chief Science Officer, Co-Founder and Director

Stephen M. Campe Investor Growth Capital, Inc.

Kyphon’s annual meeting will be held at 2:00 p.m., June 16, 2004 at Kyphon’s corporate offices, 1221 Crossman Avenue Sunnyvale, California 94089

Jeffrey L. Kaiser Vice President, Finance and Administration and Chief Financial Officer Cindy M. Domecus Vice President, Clinical Research and Regulatory Affairs Avram A. Edidin, Ph.D. Vice President, Research and Development Mary K. Hailey Vice President, Reimbursement Stephen C. Hams Vice President, Human Resources Anthony J. Recupero Vice President, Sales Elizabeth A. Rothwell Vice President, Quality and Operations David M. Shaw Vice President, Legal Affairs and General Counsel Julie D. Tracy Vice President, Marketing Bert Vandervelde Vice President and General Manager, Kyphon Europe

Douglas W. Kohrs American Medical Systems, Inc. Jack W. Lasersohn The Vertical Group

A D D I T I O N A L I N F O R M AT I O N

Elizabeth H. Weatherman Warburg Pincus, LLC

Corporate Counsel Wilson Sonsini Goodrich & Rosati Palo Alto, California

Richard W. Mott President and Chief Executive Officer, Kyphon Inc.

Public Accounting Firm PricewaterhouseCoopers San Jose, California

Karen D. Talmadge, Ph.D. Executive Vice President, Chief Science Officer, and Co-Founder, Kyphon Inc.

Stock Transfer Agent U.S. Stock Transfer Corporation 1745 Gardena Avenue Glendale, California 91204 Phone: 800.835.8778

Corporate Offices: Kyphon Inc. 1221 Crossman Avenue Sunnyvale, California 94089 USA Phone: 408.548.6500

w w w. k y p h o n . c o m Š 2004 Kyphon Inc. All rights reserved.