Kyphon Annual Report 04

WALK TO THE PARK EXERCISE AT THE GYM VISIT WITH GOOD FRIENDS PICK UP THE NEWSPAPER GO OUT TO BRUNCH SMILE GO DANCING PICK UP GRANDCHILD WORK IN THE GARDEN PLAY GOLF GO TO THE SUPERMARKET WALK ON THE BEACH WATER THE LAWN GO TO A MOVIE TRIM THE TREES GO TO A BALL GAME TRAVEL PLAY THE PIANO PICK UP THE MAIL LAUGH ATTEND A SYMPHONY CONCERT GO TO THE BANK ON A FRIDAY EXERCISE PLAY TENNIS WASH THE CAR RIDE A BIKE GO WINDOW SHOPPING GO ON A HIKE WALK THE DOG ATTEND A MUSIC RECITAL PLANT SOME FLOWERS TIE YOUR SHOELACES GO BOWLING PAINT A LANDSCAPE GO CAMPING TAKE OUT THE SAILBOAT GO TO A NICE RESTAURANT BREATH DEEPLY GET OUT OF BED BAKE SOME COOKIES

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TO OUR STOCKHOLDERS, CUSTOMERS AND EMPLOYEES

As the market leader in the minimally invasive surgical treatment of vertebral compression fractures, Kyphon delivered another strong year of financial performance, positioning the company for continued success in 2005.

For the year ended December 31, 2004, the Company achieved net sales of $213 million, a 63% increase over 2003 while operating margins expanded to 16% of revenues in 2004 from 9% in 2003. Our balance sheet continued to strengthen with cash and investments increasing to $116 million at year-end with no debt.

Our focus on establishing kyphoplasty as the treatment standard of choice for patients with spinal fractures due to osteoporosis or cancer has been instrumental to our success. In 2005, we have the opportunity to emerge as a true industry leader in the spine by expanding our franchise in minimally invasive spine therapies.

WALK TO THE PARK EXERCISE AT THE GYM VISIT WITH GOOD FRIENDS PICK UP THE NEWSPAPER GO OUT TO BRUNCH SMILE Minimally invasive technologies and products will revolutionize the spine marketplace in the years ahead. We believe our innovation heritage, unique knowledge and expertise in spine therapies coupled with our large and highly trained sales channel to the spine specialist community are strong platforms that will allow Kyphon to lead the introduction of new technologies and procedures that can bring substantial patient and practitioner benefits. >>

RICHARD W. MOTT, President and Chief Executive Officer

extraordinary Strengthening our Customer-Focused Global Organization Of all of Kyphon’s 2004 accomplishments, I am most proud of the growth and development of our organization. The Company’s worldwide family now totals more than 720 employees in 15 countries and we take great pride in the strong performance-oriented culture we have developed. We strive to remain a dynamic, vibrant, and progressive company, aligned around our corporate vision of improving patient quality of life by revolutionizing the practice of medicine.

Established, Growing Position in the Spine Industry Since introducing our products in 1999, the rapid growth and increasing acceptance by the orthopedic and neurosurgeon community has been extremely rewarding. Over 115,000 patients with spinal fractures have been treated to date with our products. Kyphon, kyphoplasty and our technologies are embraced by true innovators and forward thinkers in the industry, who help set the standard of care for the treatment of spinal fractures.

GO DANCING PICK UP MY GRANDCHILD WORK IN THE GARDEN PLAY GOLF GO TO THE SUPERMARKET WALK ON THE BEACH During 2004, we observed a transition in the way our products and technologies are viewed by spine specialists. Not only has kyphoplasty become a key procedure in orthopedic and neurosurgeon spine surgery practices, but our customers increasingly acknowledge that the minimally invasive products and techniques we pioneered are fundamental in the development of the future of spine surgery through image-guided, restorative technologies. We are encouraged by this perspective and believe we are well-positioned for bringing continued innovation leadership to the industry. >>

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TOM CALLAGHAN

I played golf today.

WATER THE LAWN GO TO A MOVIE TRIM THE TREES GO TO A BALL GAME TRAVEL PLAY THE PIANO PICK UP THE MAIL LAUGH

Personal photos shared by Tom: Recently I spent some quality time in Florida with my son, Brendan, who is currently a senior in high school. This coming fall he will be going off to Boston College, so these moments together are very special.

We also experienced clinical expansion during the year, as interventional radiologists and interventional neuroradiologists began taking significant interest in performing the kyphoplasty procedure. I view this development as further validation of the strong and positive position kyphoplasty has established with clinicians, and we look forward to working more closely with these specialists.

During the year we grew our substantial channel to the marketplace with over 5,600 spine specialists now trained worldwide on the use of our products. This large and growing base of trained spine surgery practitioners is an important driver for continued adoption of kyphoplasty as the leading therapy for patients with spinal compression fractures.

Kyphon Reaches the National Agenda I am gratified by the tremendous progress made in 2004 in working with the key governmental regulatory and reimbursement organizations that affect the medical device industry worldwide.

Specifically, the U.S. Food & Drug Administration (FDA) cleared our 510(k)s for KyphX ® HV-R ™ Bone Cement during 2004 for the treatment of spinal fractures caused by osteoporosis, cancer or benign

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lesions. Subsequent to the FDA’s clearances, we substantially broadened our efforts and related investments in sales and marketing, clinical research, and reimbursement in order to capitalize on this new ability to create awareness of the kyphoplasty procedure and the corresponding patient outcomes to the larger medical community. >>

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EXERCISE

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PLAY TENNIS WASH THE CAR RIDE A BIKE GO WINDOW SHOPPING GO ON A HIKE WALK THE DOG

Tom Callaghan, 58 yrs, Attorney Multiple fractures due to multiple myeloma.

T-10 treated May, 2001. T-5 and T-6 treated August, 2001. >> Most golfers would say that hitting a hole-in-one is cause for celebration. For

Tom Callaghan, the enjoyment he felt after making a hole-in-one on the 4th tee was short-lived. One hour later, he collapsed on the 9th tee in excruciating pain. The diagnosis Tom would later receive was dire—his pain was due to a severe spinal fracture caused by multiple myeloma. “The pain was constant ,” he states. “I couldn’t stand for more than a couple of minutes without severe pain.” His mobility improved after three Balloon Kyphoplasty procedures. “It was truly remarkable,” he says. “I was able to play golf the following summer. I could stand up straight and walk pain-free.” Tom’s cancer is in remission and he remains pain-free to this day.

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revenue (in millions)

There were also two favorable developments for kyphoplasty with respect to new national Medicare reimbursement policies. Specifically, the CPT Editorial Panel of the American Medical Association supported the establishment of a national current procedural terminology (CPT) code for physician reimbursement for performing kyphoplasty procedures, which should become effective in 2006.

In addition, the Centers for Medicare & Medicaid Services established a unique ICD-9 code for kyphoplasty, thereby creating for the first time a uniform nationwide system for hospital reimbursement for the procedure.

Focus on Patient Outcomes and Evidence-Based Medicine The advancements we made with the medical community, as well as in the regulatory and reimbursement environments, were founded on the clinical data supporting the patient outcomes that result from kyphoplasty procedures. Our customers’ ability to achieve and maintain spinal deformity correction and quality of life improvement with a low complication rate forms a fundamental driver of our business and enables us to bring significant value to the vast number of patients who suffer devastating long-term consequences from spinal fractures caused by osteoporosis or cancer.

The healthcare industry is increasingly focused on evidence-based medicine, and we are undertaking a variety of activities that further solidify the scientific and clinical foundation for our technologies.

By investing in science, we plan to further differentiate our technologies and create conclusive evidence supporting the use of our products to treat patients with a variety of spinal fractures.

Our Goal is to Become a Recognized Global Leader in Restoring Spinal Function Kyphon’s challenge during 2005 is to broaden our franchise towards the goal of becoming a recognized global leader in restoring spinal function through minimally invasive spine therapies. We have a healthy and growing core business, a scaleable global infrastructure, a highly focused sales organization,

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a solid financial foundation, scientific and technological expertise, and a clear strategy. >>

WALK TO

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Joan Schoengold, 82 yrs, Retired hospital administrator Fracture due to osteoporosis.

L-1 treated January, 2005; history of a fall from standing height. >> When you have osteoporosis, falling down can be disastrous. “I had the flu and

fainted walking into the bathroom,” the active retiree reports. “When I woke up, I was in agony and I was scared, because I didn’t know what was causing the pain.”

Joan managed to crawl to the phone to call for help, but the pain was so severe that paramedics gave her morphine before transporting her to the hospital. Following her Balloon Kyphoplasty procedure, Joan says, “I felt better right away. I’ve been able to keep my independence and go back to taking care of myself. It’s like a miracle.”

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spine specialists trained worldwide

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JOAN SCHOENGOLD

I am Joan again.

GO CAMPING TAKE OUT THE SAILBOAT GO TO A NICE RESTAURANT BREATH DEEPLY GET OUT OF BED BAKE SOME COOKIES

Personal photos shared by Joan: Half my family is an airplane ride away. I like to visit my great grandchildren for their birthdays and other special occasions.

GERRY RAGEN

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I had lunch at the clubhouse.

TAKE A TRIP GO SIGHTSEEING PLAY TENNIS TAKE SOME CLASSES WALK ALONG THE RIVER GO HORSEBACK RIDING BEND OVER

Personal photos shared by Gerry: Spending an afternoon at our local tennis resort, “The Colonel” and I enjoy an active life in Carmel Valley, California amidst the many golfers and egrets on our property.

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To enhance shareholder value and build upon our strong foundation to drive future growth, we are concentrating on the following objectives in 2005: •

Increase procedural penetration in the U.S. through expanding our direct sales force and training new clinicians to perform the kyphoplasty procedure,

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Increase our primary care physician activities coupled with select marketing activities targeted towards patients, both of which are intended to grow the diagnosis and referral of patients with spinal fractures,

•

Continue our expansion into international markets,

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Execute on eight clinical studies, including a pivotal registry trial in Japan and randomized controlled trials in osteoporosis, cancer and trauma,

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Drive minimally invasive spine therapy product and procedural innovation with highly focused R&D and business development programs centered around spinal deformity correction, treatment of disc disease, and therapies for patients who suffer cancer in the vertebral body,

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Achieve year-over-year improvement in operating leverage and efficiencies.

True to our commitment of continuous innovation, Kyphon is poised to lead the way in the evolving market for minimally invasive spine therapies. We are enthusiastic about the future potential of Kyphon and look forward to reporting on our progress throughout 2005.

On behalf of the board of directors and executive leadership team, we thank the Kyphon employees around the world whose dedication, talent and creativity are keys to our success. We also thank our hospital customers, clinicians, their patients and our stockholders for the support, confidence and trust they continue to place in all of us.

Sincerely,

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Richard W. Mott President and Chief Executive Officer

REACH UP

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Gerry Ragen, 80 yrs, Retired elementary school teacher and supervisor Fractures due to osteoporosis.

L-4 treated January, 2003; history of chronic back pain following normal activity. L-3 treated December, 2004; history of acute back pain following a minor incident.

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>> Patients with vertebral compression fracture due to osteoporosis are five times

more likely to sustain another fracture—that’s what happened to Gerry Ragen. She says that while making the bed one morning, “I heard my back crack. I sat down right away.” Gerry suffered for four months before having her first Balloon Kyphoplasty procedure. The second fracture occurred from performing her daily activities. Because her pain relief and recovery was so quick with her first Balloon Kyphoplasty procedure, she didn’t wait long to see her spine specialist for treatment.

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global sales force

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TENNIS TAKE SOME CLASSES PICK SOME FRUIT WALK ALONG THE RIVER GO HORSEBACK RIDING BEND OVER REACH UP RIDE THE TRAIN COOK A GOURMET MEAL LEARN TO SKI GO SWIMMING VOLUNTEER YOUR TIME LISTEN TO A LECTURE REPLACE BURNED OUT LIGHTBULBS BABYSIT YOUR GRANDCHILDREN MAKE THE BED ENJOY QUIET TIME HANG A PICTURE GO SNORKELING REARRANGE YOUR SHELVES RIDE A MOTORCYCLE TAKE THE STAIRS PLAY FETCH WITH THE DOG FLY ON A PLANE WALK DOWNTOWN GO ON A KyphX ® HV-R TM High-Viscosity Radiopaque

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specific needs of the Balloon Kyphoplasty

POST OFFICE RESTORE VINTAGE CAR GO for SHOPPING WALK AROUND THE LAKE GO FISHING PLAY POOL GO FOR A CAR RIDE CLEAN procedure by providing the controlled delivery of bone cement.

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transferring of bone cement.

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B OARD OF DIRECTORS

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James T. Treace

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J & A Group, LLC

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Jack W. Lasersohn

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Avram A. Edidin, Ph.D. Vice President, Emerging Technologies

Louis J. Lavigne, Jr. Former Executive Vice President and Chief Financial Officer, Genentech, Inc.

Mary K. Hailey

Elizabeth H. Weatherman

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President and Chief Executive Officer, Kyphon Inc.

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

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Bradley W. Paddock

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Kyphon’s annual meeting will be held at 2:00 p.m. PDT,

16, 2005 at Kyphon’s corporate offices, MUSEUM TAKE GRANDKIDS TO THE PARK TAKE THE ROAD LESSJune TRAVELED REARRANGE THE FURNITURE WALK TO THE POST OFFICE David M. Shaw

1221 Crossman Avenue, Sunnyvale, California 94089

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ADDITIONAL INFORMATIO N

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Bert Vandervelde

Menlo Park, California

International

Public Accounting Firm

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HORSEBACK RIDING BEND OVER REACH UP RIDE THE TRAIN COOK A GOURMET MEAL LEARN TO SKI GO SWIMMING VOLUNTEER YOUR TIME LISTEN TO A LECTURE REPLACE BURNED OUT LIGHTBULBS BABYSIT YOUR GRANDCHILDREN MAKE THE BED ENJOY QUIET TIME HANG A PICTURE GO SNORKELING REARRANGE YOUR SHELVES RIDE A MOTORCYCLE TAKE THE STAIRS PLAY FETCH WITH THE DOG FLY ON A PLANE WALK DOWNTOWN GO ON A CRUISE VISIT A MUSEUM TAKE GRANDKIDS TO THE PARK TAKE THE ROAD LESS TRAVELED AROUND THE LAKE

REARRANGE THE FURNITURE

GO FISHING

PLAY POOL

WALK TO THE POST OFFICE

GO FOR A CAR RIDE

RESTORE VINTAGE CAR

CLEAN OUT THE CLOSET

GO SHOPPING

VISIT WITH RELATIVES

WALK

WEED THE

GARDEN TOSS AROUND THE FOOTBALL PLANT A TREE GIVE YOUR PET A BATH WALK ON THE BEACH AT DAWN BUILD THAT HOME PROJECT GO TO AEROBICS CLASS COUNT YOUR BLESSINGS REFINISH THE CABINET DO PAPERWORK AT YOUR DESK SURF THE INTERNET STAND IN LINE AT THE THEATER GO

TO AN OPEN HOUSE LEARN TO PLAY BOCCE

BALL MEET YOUR FRIENDS FOR AN EVENING

OUT HANG NEW CURTAINS GO ON A GUIDED

TOUR RUN ON THE TREADMILL SEE THE CIRCUS GO ON A DAY HIKE GO BARGAIN SHOPPING PLANT SOME VEGETABLES BE A TOURIST BUILD A TOOLSHED GO TO A BIRTHDAY

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VISIT WITH GOOD FRIENDS PICK UP THE NEWSPAPER GO OUT TO BRUNCH SMILE GO DANCING PICK UP GRANDCHILD WORK IN THE GARDEN PLAY GOLF GO TO THE SUPERMARKET WALK ON THE BEACH WATER THE LAWN GO TO A MOVIE TRIM THE TREES GO TO A BALL GAME TRAVEL PLAY THE PIANO PICK UP THE MAIL LAUGH ATTEND A SYMPHONY CONCERT GO TO THE BANK ON A FRIDAY EXERCISE PLAY TENNIS WASH THE CAR RIDE A BIKE GO WINDOW SHOPPING GO ON A HIKE WALK THE DOG ATTEND A MUSIC RECITAL PLANT SOME FLOWERS TIE YOUR SHOELACES GO BOWLING PAINT A LANDSCAPE GO CAMPING TAKE OUT THE SAILBOAT GO TO A NICE RESTAURANT BREATH DEEPLY GET OUT OF BED BAKE SOME COOKIES TAKE A TRIP GO SIGHTSEEING PLAY TENNIS TAKE SOME CLASSES PICK SOME FRUIT WALK ALONG THE RIVER GO HORSEBACK RIDING BEND OVER REACH UP RIDE THE TRAIN COOK A GOURMET MEAL LEARN TO SKI GO SWIMMING VOLUNTEER YOUR TIME LISTEN TO A LECTURE REPLACE BURNED OUT LIGHTBULBS BABYSIT YOUR GRANDCHILDREN MAKE THE BED ENJOY QUIET TIME HANG A PICTURE GO SNORKELING REARRANGE YOUR SHELVES

RIDE A MOTORCYCLE

TAKE THE STAIRS

PLAY FETCH WITH THE DOG

FLY ON A PLANE

WALK

DOWNTOWN GO ON A CRUISE VISIT A MUSEUM TAKE GRANDKIDS TO THE PARK TAKE THE ROAD LESS TRAVELED REARRANGE THE FURNITURE WALK TO THE POST OFFICE RESTORE VINTAGE CAR GO SHOPPING WALK AROUND THE LAKE GO FISHING PLAY POOL GO FOR A CAR RIDE CLEAN OUT THE CLOSET VISIT WITH RELATIVES WEED THE GARDEN TOSS AROUND THE FOOTBALL PLANT A TREE

GIVE YOUR PET A BATH

BLESSINGS WALK

WALK ON THE BEACH AT DAWN

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DAWN REFINISH THE CABINET RESTORE VINTAGE

BUILD THAT PROJECT

GO TO AEROBICS CLASS

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COUNT YOUR

ON THE BEACH AT

CAR RUN ON THE TREADMILL DO PAPERWORK AT

YOUR DESK SURF THE INTERNET STAND IN LINE AT THE THEATER GO TO AN OPEN HOUSE LEARN TO PLAY BOCCE BALL ENJOY LIFE