Nuvasive (NUVA) 10-Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ 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

o 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 000-50744

NUVASIVE, INC.

(Exact name of registrant as specified in its charter)

Delaware	33-0768598
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

4545 Towne Centre Court
San Diego, CA 92121
(Address of principal executive offices, including zip code)

(858) 909-1800
(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero Accelerated filerþ Non-accelerated filero

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

     Yeso Noþ

     As of April 30, 2006, there were 33,108,821 shares of the registrant’s common stock outstanding.

NUVASIVE, INC.

QUARTERLY REPORT ON FORM 10-Q

March 31, 2006

TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION		3
Item 1.	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005	4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005	5
	Notes to Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4.	Controls and Procedures	17
PART II—OTHER INFORMATION		18
Item 1.	Legal Proceedings	18
Item 1A.	Risk Factors	18
Item 6.	Exhibits	19
SIGNATURES
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NUVASIVE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited and in thousands, except per share data)

	March 31,			December 31,
	2006			2005
Assets
Current assets:
Cash and cash equivalents	$	107,759		$	12,545
Short-term investments		47,545			6,945
Accounts receivable, net		12,228			11,662
Inventory, net		13,960			11,870
Prepaid expenses and other current assets		1,118			1,496
Total current assets		182,610			44,518
Property and equipment, net of accumulated depreciation		18,432			17,974
Intangible assets, net of accumulated amortization		8,759			8,894
Other assets		192			104
Total assets	$	209,993		$	71,490
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued liabilities	$	8,145		$	6,102
Accrued payroll and related expenses		3,987			5,587
Total current liabilities		12,132			11,689
Long-term liabilities		1,676			1,665
Commitments and contingencies
Stockholders’ equity:
Common stock, $.001 par value; 70,000 shares authorized, 33,062 and 25,106 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively		33			25
Additional paid-in capital		313,075			168,143
Deferred compensation		—			(1,195	)
Accumulated other comprehensive loss		(12	)		(32	)
Accumulated deficit		(116,911	)		(108,805	)
Total stockholders’ equity		196,185			58,136
Total liabilities and stockholders’ equity	$	209,993		$	71,490

See accompanying notes to unaudited condensed consolidated financial statements.

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NUVASIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited and in thousands, except per share data)

	Three Months Ended
	March 31,
	2006			2005
Revenues	$	19,685		$	13,272
Cost of goods sold		3,880			2,627
Gross profit		15,805			10,645
Operating expenses:
Sales, marketing and administrative		21,132			11,981
Research and development		3,877			2,559
Total operating expenses		25,009			14,540
Interest and other income, net		1,098			340
Net loss	$	(8,106	)	$	(3,555	)
Net loss per share:
Basic and diluted	$	(0.27	)	$	(0.15	)
Weighted average shares—basic and diluted		29,649			23,881
Stock-based compensation is included in operating expenses in the following categories: (1)
Sales, marketing and administrative	$	2,789		$	539
Research and development		812			400
	$	3,601		$	939

(1) As a result of the adoption of Statement of Financial Accounting Standards (SFAS) 123 (revised 2004),Share-Based Payment, stock-based compensation for the 2006 period is not comparable to stock based compensation for the 2005 period. See Note 6 for a discussion of the impact of the adoption of this Statement of Financial Accounting Standards.

See accompanying notes to unaudited condensed consolidated financial statements.

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NUVASIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)

	Three Months Ended
	March 31,
	2006			2005
Operating activities:
Net loss	$	(8,106	)	$	(3,555	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,611			681
Stock-based compensation		3,601			939
Other non-cash adjustments		(110	)		198
Changes in operating assets and liabilities:
Accounts receivable		(471	)		(1,251	)
Inventory		(2,050	)		(971	)
Prepaid expenses and other current assets		378			109
Accounts payable and accrued liabilities		2,031			2,215
Accrued payroll and related expenses		(1,600	)		(670	)
Net cash used in operating activities		(4,716	)		(2,305	)
Investing activities:
Purchases of property and equipment		(1,934	)		(4,252	)
Sales of short-term investments		3,050			33,612
Purchases of short-term investments		(43,632	)		(19,223	)
Other assets		(88	)		(118	)
Net cash provided by (used in) investing activities		(42,604	)		10,019
Financing activities:
Payment of capital leases		—			(1	)
Issuance of common stock in secondary offering		142,534			98
Net cash provided by financing activities		142,534			97
Increase in cash and cash equivalents		95,214			7,811
Cash and cash equivalents at beginning of period		12,545			8,560
Cash and cash equivalents at end of period	$	107,759		$	16,371

See accompanying notes to unaudited condensed consolidated financial statements.

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NuVasive, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Description of Business

     NuVasive, Inc. (the Company or NuVasive) was incorporated in Delaware on July 21, 1997. The Company designs, develops and markets products for the surgical treatment of spine disorders and operates in one business segment. The Company began commercializing its products in 2001. Its current product portfolio is focused on applications for lumbar and cervical spine fusion. The principal product offering includes a minimally disruptive surgical platform called Maximum Access Surgery, or MAS™, as well as classic fusion implants. The Company’s products are used predominantly in spine fusion surgeries, both to enable access to the spine and to perform restorative and fusion procedures. MAS combines NeuroVision®, a nerve avoidance system, MaXcess®, a minimally invasive surgical system, and specialized implants.

     The Company loans its NeuroVision systems to surgeons and hospitals who purchase disposables and implants for use in individual procedures and places NeuroVision, MaXcess and surgical instrument sets with hospitals for an extended period at no up-front cost to them provided they commit to minimum monthly purchases of disposables and implants. The Company also sells a small quantity of MAS instrument sets, MaXcess, and NeuroVision systems to hospitals for use in surgery. The classic fusion portfolio includes a range of bone allografts in our patented saline packaging and spine implants such as rods, plates and screws. Implants and disposables are sold and shipped from the Company’s facility or from limited disposable inventories stored at distributors’ sites.

     The Company also focuses significant efforts on a research and development pipeline emphasizing both MAS and motion preservation products such as total disc replacement and nucleus-like cervical disc replacement.

2. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP). In management’s opinion, the financial statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented.

     These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2005 included in NuVasive, Inc.’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2006. The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

     Certain reclassifications to prior period information have been made for consistent presentation. In the first quarter of 2006, we reclassified the revenue related to freight charges, net of reserves on such revenue, from sales, marketing and administrative expense to the revenue line on the statement of operations in accordance with Emerging Issues Task Force Issue No. 00-10,Accounting for Shipping and Handling Fees and Costs. Freight revenue in the three-month periods ended March 31, 2006 and 2005 was $192,000 and $208,000, respectively. Prior year revenue and expenses have been reclassified to conform to this presentation change.

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3. Allowances

     The balances of the allowances for doubtful accounts and excess and obsolete inventory are as follows (in thousands):

	March 31, 2006		December 31, 2005
Allowance for doubtful accounts	$	708	$	613
Allowance for excess and obsolete inventory		1,372		1,332
	$	2,080	$	1,945

4. Net Loss Per Share

     NuVasive computes net loss per share using a weighted average number of common shares outstanding during the period and excluding the weighted average common shares subject to repurchase. Since NuVasive has experienced losses for all periods presented, net loss per share excludes the effect of approximately 4.2 million and 3.1 million stock options outstanding at March 31, 2006 and 2005, respectively, because such options are anti-dilutive. Therefore the number of shares calculated for basic net loss per share is also used for the diluted net loss per share calculation.

	Three Months Ended March 31,
	2006			2005
Historical:
Numerator:
Net loss attributable to common stockholders	$	(8,106	)	$	(3,555	)
Denominator:
Weighted average common shares		29,677			24,015
Weighted average unvested common shares subject to repurchase		(28	)		(134	)
Denominator for basic and diluted net loss per share		29,649			23,881
Basic and diluted net loss per share	$	(0.27	)	$	(0.15	)

5. Comprehensive Loss

     Comprehensive loss as defined by SFAS No. 130,Reporting Comprehensive Income, consists primarily of unrealized losses on cash equivalents and short-term investments and are immaterial to the results of operations for the periods presented.

6. Stock Based Compensation

     On January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) 123 (revised 2004),Share-Based Payment(SFAS 123(R)), which establishes accounting for share-based awards exchanged for employee and director services and requires the Company to expense the estimated fair value of these awards over the requisite employee service period. The Company has no awards with market or performance conditions. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 107, which provided supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R). Prior to January 1, 2006, the Company accounted for its share-based awards to employees and directors using the intrinsic value method under the recognition and measurement provisions of Accounting Principles Board Opinion (APB) 25,Accounting for Stock Issued to Employees,and related guidance.

     Through December 31, 2005, the Company had recorded deferred stock-based compensation for certain options granted during 2003 and 2004, of $771,000 and $7,791,000, respectively, for the incremental difference at the grant date between the fair value per share determined by the board of directors and the deemed fair value per share determined solely for financial reporting purposes in conjunction with the Company’s initial public offering. Deferred stock-based compensation was recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other

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Variable Stock Option Award Plans(FIN 28), over the vesting period of the related options, generally four years. Amortization of deferred stock-based compensation through December 31, 2005, net of terminations, was $7.2 million. Upon adoption of SFAS 123(R), the unamortized balance of deferred compensation of $1.2 million at December 31, 2005 was reclassified to additional paid in capital in the Company’s consolidated balance sheet. Future compensation expense related to these options will be included as a component of stock-based compensation included in the Company’s statement of operations.

     The Company has elected to adopt the modified prospective transition method permitted by SFAS 123(R) and accordingly prior periods have not been restated to reflect the impact of SFAS 123(R). The modified prospective transition method requires that stock-based compensation expense be recorded for (i) any share-based awards granted to employees and directors through, but not yet vested as of December 31, 2005 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123,Accounting for Stock-Based Compensation(SFAS 123), and (ii) any share-based awards granted to employees and directors subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R).

     Option or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123,Accounting for Stock-Based Compensation,and Emerging Issues Task Force (EITF) 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,and are periodically revalued as the options vest and are recognized as expense over the related service period.

     For purposes of calculating the stock-based compensation under SFAS 123(R), the Company estimates the fair value of stock options using a Black-Scholes option-pricing model which is consistent with the model used for pro forma disclosures under SFAS 123 prior to the adoption of SFAS 123(R). The Black-Scholes option-pricing model was developed for use in estimating the fair value of short lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model incorporates various and highly sensitive assumptions including expected volatility, expected term and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected term of the Company’s stock options. The expected term of the Company’s stock options is based on historical experience. In addition, in accordance with SFAS 123(R) share-based compensation expense recognized in the statement of operations for the first quarter of 2006 is based on awards ultimately expected to vest and is reduced for estimated forfeitures. In the Company’s pro forma information required under SFAS 123 for the periods prior to 2006, the Company accounted for forfeitures as they occurred.

     The assumptions used to estimate the fair value of stock options granted for the three-month periods ended March 31, 2006 and 2005 are as follows:

	Three Months Ended March 31,
	2006			2005
	Actual			Pro Forma
Volatility		65	%		60	%
Expected term (years)		4.0 to 4.5			5.0
Risk free interest rate		4.47 to 4.82	%		3.89	%
Expected dividend yield		0	%		0	%

     The compensation cost that has been included in the statement of operations for all share-based compensation arrangements was as follows for the first three months of 2006 and 2005:

	Three Months Ended March 31,
(in thousands, except per share amounts)	2006		2005
Sales, marketing and administrative expense	$	2,789	$	539
Research and development expense		812		400
Stock-based compensation expense	$	3,601	$	939
Effect on basic and diluted net loss per share	$	0.12	$	0.04

     Stock-based compensation is recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option Award Plans(FIN 28). As of March 31, 2006, there was $14.4 million of unrecognized stock-based

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compensation expense. This cost is expected to be recognized over a weighted-average period of approximately two years. The total intrinsic value of options exercised in the first three months of 2006 and 2005 was $2.0 million and $869,000, respectively.

     The following table illustrates the effect on net losses as if the Company had applied the fair value recognition provisions of SFAS 123 to determine stock-based compensation for the three months ending March 31, 2005:

	Three Months Ended
(in thousands, except per share amounts)	March 31, 2005
Net loss as reported	$	(3,555	)
Add: Stock-based compensation included in net loss		939
Deduct: Stock-based employee and director compensation expense determined under fair value method for all awards		(1,045	)
Pro forma net loss	$	(3,661	)
Basic and diluted net loss per share as reported	$	(0.15	)
Basic and diluted pro forma net loss per share	$	(0.15	)

Employee Stock Benefit Plans

     Stock Options.In October 1998, the Company adopted the 1998 Stock Incentive Plan (the 1998 Plan) to grant options to purchase common stock to eligible employees, non-employee members of the board of directors, consultants and other independent advisors who provide services to the Company. Under the 1998 Plan, 3,922,800 shares of common stock, as amended, were reserved for issuance upon exercise of options granted by the Company. The board of directors determines the terms of the stock option agreements, including vesting requirements. Options under the 1998 Plan have a 10-year term and generally vest over a period not to exceed four years from the date of grant. All options granted under the 1998 Plan allow for early exercise prior to the option becoming fully vested. Unvested common shares obtained upon early exercise of options are subject to repurchase by the Company at the original issue price.

     In April 2004, the board of directors replaced the 1998 Plan with the 2004 Equity Incentive Plan (the 2004 Plan) under which 800,000 shares (plus the remaining shares available for grant under the 1998 Plan) of the Company’s common stock are authorized for future issuance, and reserved for purchase upon exercise of options granted. In addition, the 2004 Plan provides for automatic annual increases in the number of shares reserved for issuance thereunder equal to the lesser of (i) 4% of the Company’s outstanding shares on the last business day in December of the calendar year immediately preceding; (ii) 4,000,000 shares; or (iii) a number of shares determined by the board of directors.

     The 2004 Plan provides for the grant of options to the Company’s directors, officers, employees and consultants. The 2004 Plan provides for the grant of incentive and nonstatutory stock options and rights to purchase stock to employees, directors or consultants of the Company. The 2004 Plan provides that incentive stock options will be granted only to employees and are subject to certain limitations as to fair value during a calendar year. Under the 2004 Plan, the exercise price of incentive stock options must equal at least the fair value on the date of grant and the exercise price of non-statutory stock options and the issuance price of common stock under the stock issuance program may be no less than 85% of the fair value on the date of grant or issuance. The options are exercisable for a period of up to ten years after the date of grant and generally vest 25% one year from date of grant and ratably each month thereafter for a period of 36 months.

     Also in April 2004, the board of directors approved the Employee Stock Purchase Plan (ESPP). The ESPP initially allowed for the issuance of up to 100,000 shares of NuVasive common stock, increasing annually on December 31 by the lesser of (i) 600,000 shares; (ii) 1% of the outstanding shares of NuVasive common stock; or (iii) a lesser amount determined by the board of directors. Under the terms of the ESPP, employees can elect to have up to 15% of their annual compensation withheld to purchase shares of NuVasive common stock. The purchase price of the common stock is equal to 85% of the lower of the fair market value per share of the common stock on the commencement date of the two-year offering period or the end of each semi-annual purchase period. As of March 31, 2005, 657,509 shares are available for issuance under the ESPP.

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     Following is a summary of stock option activity for the first quarter of 2006 under all stock options plans:

				Weighted
				Average
	Underlying			Exercise
(in thousands, except per share data)	Shares			Price
Outstanding at December 31, 2005		3,270		$	8.27
Granted		1,132		$	18.39
Exercised		(127	)	$	3.42
Canceled		(29	)	$	15.43
Outstanding at March 31, 2006		4,246		$	11.05
Aggregate Intrinsic Value	$	33,262
Options Exercisable as of March 31, 2006		2,101		$	5.50
Aggregate Intrinsic Value of Options Exercisable as of March 31, 2006	$	28,050

     The weighted-average fair value of options granted in the three months ended March 31, 2006, was $9.68. The aggregate intrinsic value of options exercisable at March 31, 2006 is based on the Company’s closing stock price on March 31, 2006. The Company received $435,000 in proceeds from the exercise of stock options during the three-month period ended March 31, 2006.

     The following table summarizes information about stock options outstanding and exercisable at March 31, 2006:

(shares in thousands)	Options Outstanding						Options Exercisable
			Weighted-
			Average
			Remaining		Weighted				Weighted
Range of Exercise	Number		Contractual		Average		Number		Average
Prices	of Shares		Life (in years)		Exercise Price		of Shares		Exercise Price
$0.25 to $0.63		500		6.42	$	0.60		500	$	0.60
$3.75 to $3.75		874		7.73	$	3.60		874	$	3.60
$9.41 to $10.75		910		8.05	$	9.82		591	$	9.88
$10.90 to $17.96		884		9.26	$	16.36		66	$	14.18
$17.99 to $21.40		1078		9.73	$	18.60		70	$	18.99
$0.25 to $21.40		4,246		8.47	$	11.05		2,101	$	5.50

     Common Stock Reserved for Future Issuance.The following table summarizes common shares reserved for issuance at March 31, 2006 on exercise or conversion of(in thousands):

Convertible preferred stock warrants	9
Common stock options:
Issued and outstanding	4,246
Available for future grant	316
Available for issuance under Employee Stock Purchase Plan	508
Total shares reserved for future issuance	5,079

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

Forward-Looking Statements May Prove Inaccurate

     You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes to those statements included in this report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth under heading “Risk Factors,” and elsewhere in this report, and in our Annual Report onForm 10-K for the year ending December 31, 2005. We undertake no responsibility to revise these forward looking statements to reflect future events or circumstances.

Overview

     Background.We are a medical device company focused on the design, development and marketing of products for the surgical treatment of spine disorders. Our product portfolio is focused on applications for lumbar and cervical spine fusion, as well as dynamic stabilization. Our principal product offering includes a minimally disruptive surgical platform called Maximum Access Surgery, or MAS™, as well as classic fusion implants comprised of bone allografts in our patented saline packaging and internal fixation products. Our products are used predominantly in spine fusion surgeries, both to enable access to the spine and to perform restorative and fusion procedures. As of March 31, 2006 we have trained over 850 surgeons in the use of our products.

     Since inception, we have been unprofitable. We incurred net losses of approximately $10.1 million in 2003, $14.2 million in 2004 and $30.3 million in 2005. As of March 31, 2006, we had an accumulated deficit of $116.9 million.

     Revenues.From inception to March 31, 2006, we have recognized $158.2 million in revenue from sales of our products. Our revenues are derived from the sale of medical products in two principal product categories:

     MAS.Our MAS platform combines three categories of our product offerings:

     • NeuroVision — a proprietary software-driven nerve avoidance system;

     • MaXcess — a unique split-blade design retraction system providing enhanced surgical access to the spine; and

     • Specialized implants, like our SpheRx pedicle screw system, CoRoent suite of products and new ExtenSure dynamic stabilization and fusion system.

     Classic Fusion.Our classic fusion revenues primarily consist of the sales of bone allograft, metal cage implants and fusion plates.

     Although we have historically presented revenues between these two product categories, beginning with fiscal year 2006 we now report revenues in a single aggregate line. With the growth of our business, particularly with respect to our MAS products, we believe this single line presentation is more meaningful in understanding trends and developments in our operations.

     The majority of our revenues are derived from the sale of disposables and implants and we expect this trend to continue in the near term. To date, we have derived less than 5% of our total revenues from the sale of MAS instrument sets, MaXcess devices, and NeuroVision systems. We do not expect these sales to contribute significantly to our revenues in the future because we intend to continue to (i) loan NeuroVision, MaXcess and surgical instrument sets to hospitals and surgeons who purchase our disposables and implants for use in individual procedures or (ii) place NeuroVision, MaXcess and surgical instrument sets with hospitals for an extended period at no up-front cost to them provided they commit to minimum monthly purchases of our disposables and implants. In the event a hospital or surgeon does not meet its minimum monthly purchase commitments, our sole remedy is to remove our products.

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     Our implants and disposables are sold and shipped from our facility or from limited disposable inventories stored at our distributors’ sites. We invoice hospitals a fee for using certain instruments and for any disposables or implants upon receiving notice of product use or implantation. For NeuroVision, we generally place the system in hospitals free of charge and allow it to remain on-site provided the hospital orders a minimum monthly quantity of our nerve avoidance disposable products. In addition, we have a program pursuant to which we loan, from a pool of fixed assets, NeuroVision, MaXcess and surgical instrument sets to hospitals without charge to support individual surgical procedures.

     Sales and Marketing.Substantially all of our operations are located in the United States and substantially all of our sales to date have been generated in the United States. We distribute our products through a sales force comprised of independent agencies and our own sales personnel. Our sales force provides a delivery and consultative service to our surgeon and hospital customers and is compensated based on sales and product placements in their territories. The commissions are reflected in our statement of operations in the sales, marketing and administrative expense line. We expect to continue to expand our distribution channel. Since the second quarter of 2005, we have been engaged in a process to create a sales force of independent distributors and our own employees that is exclusive to us with respect to the sale of spine products. These efforts are ongoing and we expect to incur increased sales and marketing expenses as we hire additional sales personnel and incentivize new and existing representatives to exclusively sell our products.

Critical Accounting Policies

     Our discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and regulations of the Securities and Exchange Commission. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates including those related to bad debts, inventories, long-term assets and income taxes. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities not readily apparent from other sources. Actual results may differ from these estimates.

     We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.

     Revenue Recognition.We follow the provisions of the Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104,Revenue Recognition,which sets forth guidelines for the timing of revenue recognition based upon factors such as passage of title, installation, payment and customer acceptance. We recognize revenue when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured. Specifically, revenue from the sale of implants and disposables is recognized upon receipt of written acknowledgement that the product has been used in a surgical procedure or upon shipment to third party customers who immediately accept title. Revenue from the sale of our NeuroVision units and instrument sets is recognized upon receipt of a purchase order and the subsequent shipment to customers who immediately accept title.

     Allowance for Doubtful Accounts.We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is reviewed quarterly and is estimated based on the aging of account balances, collection history and known trends with current customers. As a result of this review, the allowance is adjusted on a specific identification basis. Increases to the allowance for doubtful accounts result in a corresponding expense. We maintain a relatively large customer base that mitigates the risk of concentration with one customer. However, if the overall condition of the healthcare industry were to deteriorate, or if the historical data used to calculate the allowance provided for doubtful accounts does not reflect our future ability to collect outstanding receivables, resulting in an impairment of our customers’ ability to make payments, significant additional allowances could be required.

     Excess and Obsolete Inventory.We calculate an inventory reserve for estimated obsolescence and excess inventory based upon historical turnover and assumptions about future demand for our products and market conditions. Our allograft implants have a four-year shelf life and are subject to demand fluctuations based on the availability and demand for alternative implant products. Our MAS inventory, which consists primarily of instruments, disposables and specialized implants, is at risk of obsolescence following the introduction and development of new or enhanced products. Our estimates and assumptions for excess and obsolete inventory are

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reviewed and updated on a quarterly basis. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. Increases in the reserve for excess and obsolete inventory result in a corresponding expense to cost of goods sold.

     A stated goal of our business is to focus on continual product innovation and to obsolete our own products. While we believe this provides a competitive edge, it also results in the risk that our products and related capital instruments will become obsolete prior to the end of their anticipated useful lives. If we introduce new products or next-generation products prior to the end of the useful life of a prior generation, we may be required to sell off existing inventory and related capital instruments and/or write off the value of the these assets. In 2006, we expect to introduce new instruments for use with our next-generation MaXcess and SpheRx products which will result in a charge to cost of goods sold to write-off or impair existing instruments. The associated charge cannot be estimated at this time however it may be significant.

     Long Term Assets.Property, plant and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of two to seven years for machinery and equipment and three years for loaner equipment. Maintenance and repairs are expensed as incurred. Intangible assets consist of purchased technology and are amortized on a straight-line basis over their estimated useful lives of 17 years, the life of related patents. We evaluate our long-term assets for indications of impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If this evaluation indicates that the value of the long-term asset may be impaired, we make an assessment of the recoverability of the net carrying value of the asset over its remaining useful life. If this assessment indicates that the long-term asset is not recoverable, we reduce the net carrying value of the related asset to fair value and may adjust the remaining depreciation or amortization period. We have not recognized any impairment losses on long-term assets through March 31, 2006.

     Accounting for Income Taxes.Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of March 31, 2006 due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future.

     Valuation of Stock-Based Compensation.On January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) 123 (revised 2004),Share-Based Payment(SFAS 123(R)), which establishes accounting for share-based awards exchanged for employee and director services and requires us to expense the estimated fair value of these awards over the requisite employee service period. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 107, which provided supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R). Prior to January 1, 2006, we accounted for our share-based employee compensation plans using the intrinsic value method under the recognition and measurement provisions of Accounting Principles Board Opinion (APB) 25,Accounting for Stock Issued to Employees,and related guidance. Option or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123,Accounting for Stock-Based Compensation,and Emerging Issues Task Force (EITF) 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,and are periodically revalued as the options vest and are recognized as expense over the related service period.

     For purposes of calculating the stock-based compensation, we estimate the fair value of stock options using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model incorporates various and highly sensitive assumptions including expected volatility, expected term and interest rates. Stock-based compensation is recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option Award Plans(FIN 28). If there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation costs. These changes may materially impact our results of operations in the period such changes are made.

     The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles (GAAP). See our consolidated financial statements and notes thereto included in this report, which contain accounting policies and other disclosures required by GAAP.

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Results of Operations

Revenues

     Total revenues.Total revenues for the three months ended March 31, 2006, are summarized below.

	March 31,
	2006		2005		$ Change		% Change
Three months ended	$	19,685	$	13,272	$	6,413		48	%

     The increase in revenue in 2006 over 2005 is due primarily to the continued market acceptance of our products, including the products added to our product portfolio in 2005.

Cost of Goods Sold

	March 31,
	2006			2005			$ Change		% Change
Three months ended	$	3,880		$	2,627		$	1,253		48	%
% of revenue		20	%		20	%

     Cost of goods sold consists of purchased goods and overhead costs. The increase in cost of goods sold in total dollars in 2006 is due primarily to increased product sales, specifically the related material costs.

     Cost of goods sold as a percentage of total revenues has remained consistent over the periods presented. In general, MAS products have a higher margin than our classic fusion products. Our overall cost of goods sold and gross profit are subject to fluctuation based on the mix between MAS and classic fusion products.

Operating Expenses

     Sales, Marketing and Administrative.

	March 31,
	2006			2005			$ Change		% Change
Three months ended	$	21,132		$	11,981		$	9,151		76	%
% of revenue		107	%		90	%

     Sales, marketing and administrative expenses consist primarily of compensation and commission costs for personnel engaged in sales, marketing and customer support functions, distributor commissions, employee related expenses for our administrative functions, third party professional service fees, and facilities and insurance expenses. The increase in sales, marketing and administrative expenses in the periods presented resulted primarily from (i) an increase in compensation, commission and other employee-related costs for our sales force, including distributors, of $4.2 million, from $5.7 million in the first three months of 2005 to $9.9 million for the first three months of 2006, as a result of increased revenue; (ii) an increase in compensation and other employee-related costs for administrative personnel and consulting of $828,000, from $1.6 million in the first three months of 2005 to $2.4 million in the first three months of 2006 to support company growth; (iii) an increase in stock-based compensation expense of $2.2 million, from $539,000 in the first three months of 2005 to $2.8 million for the first three months of 2006 as a result of the adoption of SFAS 123(R); (iv) an increase in royalty expenses of $360,000 as a result of increased revenue; (v) increase of company meetings costs of $384,000 related primarily to our annual sales conference held in the first quarter of 2006; (vi) an increase in surgeon-related costs of $206,000, from $477,000 in the first three months of 2005 to $683,000 in the first three months of 2006 related to additional surgeons trained; and (vii) an increase in depreciation expense of $251,000, from $160,000 in the first three months of 2005 to $410,000 in the first three months of 2006 related to our increased base of depreciable assets.

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     We expect to increase the amounts we spend on sales, marketing and administrative activities for the foreseeable future. These increased amounts will be directed towards hiring direct sales agents and additional sales management training personnel, expanding and training our distribution channels, promoting awareness of our products and providing training to surgeons. These amounts will also be used to compensate our sales force, including both independent and direct sales agents, related to sales of our products and to provide incentive for our independent sales agents to exclusively sell our spine surgery products. As a percentage of revenue, we expect these costs to decrease over time. As we complete the transition to an exclusive sales force over the next quarter, we expect the incremental costs we incur to incentivize new and existing representatives to exclusively sell our products to decrease. Beginning in the fourth quarter of 2006, we expect sales force compensation to be relatively constant as a percentage of revenue. In addition, we expect to incur increased expense related to hiring additional administrative and support personnel and systems to support the planned growth of the Company.

     Research and Development.

	March 31,
	2006			2005			$ Change		% Change
Three months ended	$	3,877		$	2,559		$	1,318		52	%
% of revenue		20	%		19	%

     Research and development expenses consist primarily of product research and development, regulatory and clinical functions, and employee related expenses. The increases in research and development costs are primarily due to (i) an increase in compensation and other employee related expenses and consulting of $552,000, from $1.5 million in the first three months of 2005 to $2.0 million for the first three months of 2006 due primarily to increased headcount; (ii) an increase in lab supplies and equipment expenses of $268,000, from $575,000 in the first three months of 2005 to $843,000 for the first three months of 2006, both to support the development of new products in all product lines; and (iii) an increase in stock-based compensation expense of $412,000, from $400,000 in the first three months of 2005 to $812,000 for the first three months of 2006 as a result of the adoption of SFAS 123(R).

     We expect to increase the amounts we spend on research and development activities for the remainder of 2006. These increased amounts will be directed towards hiring additional personnel and increased costs in support of the development of next generation and new products.

Interest and Other Income, Net

	March 31,
	2006			2005			$ Change		% Change
Three months ended	$	1,098		$	340		$	758		223	%
% of revenue		6	%		3	%

     Interest and other income, net consists primarily of interest income. The increase in net interest income for the three months ended March 31, 2006 compared to the comparable period in 2005 is primarily due to interest earned on the investment of proceeds of $142.1 million received from our public offering completed in February 2006.

Stock-Based Compensation

     On January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) 123 (revised 2004),Share-Based Payment(SFAS 123(R)), which establishes accounting for share-based awards exchanged for employee and director services and requires us to expense the estimated fair value of these awards over the requisite employee service period. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 107, which provided supplemental implementation guidance for SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R). Prior to January 1, 2006, we accounted for our share-based awards to employees and directors using the intrinsic value method under the recognition and measurement provisions of Accounting Principles Board Opinion (APB) 25,Accounting for Stock Issued to Employees,and related guidance.

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     Through December 31, 2005, we recorded deferred stock-based compensation for certain options granted during 2003 and 2004, of $771,000 and $7,791,000, respectively, for the incremental difference at the grant date between the fair value per share determined by the board of directors and the deemed fair value per share determined solely for financial reporting purposes in conjunction with our initial public offering. Amortization of deferred stock-based compensation through December 31, 2005, net of terminations, was $7.2 million. Upon adoption of SFAS 123(R), the unamortized balance of deferred compensation of $1.2 million at December 31, 2005 was been reclassified to additional paid in capital in our consolidated balance sheet. Future compensation expense related to these options will be included as a component of stock-based compensation included in our statement of operations.

     We have elected to adopt the modified prospective transition method permitted by SFAS 123(R) and accordingly prior periods have not been restated to reflect the impact of SFAS 123(R). The modified prospective transition method requires that stock-based compensation expense be recorded for (i) any share-based awards granted to employees and directors through, but not yet vested as of December 31, 2005 based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123,Accounting for Stock-Based Compensation(SFAS 123), and (ii) any share-based awards granted to employees and directors subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R).

     The compensation cost that has been included in the statement of operations for all share-based compensation arrangements was as follows for the first three months of 2006:

	Three Months
	Ended March 31,
(in thousands, except per share amounts)	2006
Sales, marketing and administrative expense	$	2,789
Research and development expense		812
Stock-based compensation expense	$	3,601
Effect on basic and diluted net loss per share	$	0.12

     Stock-based compensation is recognized and amortized on an accelerated basis in accordance with Financial Accounting Standards Board Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option Award Plans(FIN 28). As of March 31, 2006, there was $ 14.4 million of unrecognized stock-based compensation expense which is expected to be recognized over a weighted-average period of approximately two years.

Liquidity and Capital Resources

     Since our inception in 1997, we have incurred significant losses and as of March 31, 2006, we had an accumulated deficit of approximately $116.9 million. We have not yet achieved profitability, and anticipate we will continue to incur net losses for the foreseeable future. We expect our, sales, marketing and administrative and research and development expenses will continue to grow and, as a result, we will need to generate significant net sales to achieve profitability. To date, our operations have been funded primarily with proceeds from the sale of our equity securities. Gross proceeds from our preferred stock sales, which occurred from inception through 2003, total $74.4 million. In May 2004, we closed our initial public offering, resulting in proceeds to us, net of underwriting fees and offering costs, of approximately $68.1 million. On February 7, 2006, we completed the sale of 7,829,120 shares of our common stock resulting in net proceeds of approximately $142.1 million.

     Cash, cash equivalents and short-term investments was $155.3 million at March 31, 2006 and $19.5 million at December 31, 2005. The increase was due primarily to the net proceeds from our sale of common stock in February 2006 of $142.1 million, offset by cash used to fund our operations of $4.7 million. The net proceeds from the secondary offering were invested primarily in short-term debt instruments of the U.S. government and its agencies and in high quality corporate issuers.

     Net cash used in operating activities was $4.7 million in the first three months of 2006 compared to $2.3 million in the first three months of 2005. The increase of net cash used in operating activities of $2.4 million was primarily due to increased inventory and other purchases as a result of, and to support, company growth.

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     Net cash used by investing activities was $42.6 million in the first three months of 2006 compared to $10.0 million provided by investing activities in the first three months of 2005. The increase in net cash used in investing activities is primarily due the investment $43.6 million of the net proceeds from our sale of common stock in February 2006 in instruments with initial maturities in excess of 90 days, offset by a decrease in purchases of property and equipment of $2.3 million in the first quarter of 2006 compared to the first quarter of 2005.

     Net cash provided by financing activities was $142.5 million in the first three months of 2006 compared to $97,000 in the first three months of 2005. The increase in 2006 is primarily due to the net proceeds from the sale of common stock in February 2006.

     We believe our current cash and cash equivalents together with our short-term investments will be sufficient to meet our projected operating requirements for at least the next 12 months.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio. Our risk associated with fluctuating interest income is limited to our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage this exposure to interest rate changes. We seek to ensure the safety and preservation of our invested principal by limiting default risk, market risk, and reinvestment risk. We mitigate default risk by investing in short-term investment grade securities. While changes in our interest rates may affect the fair value of our investment portfolio, any gains or losses are not recognized in our statement of income until the investment is sold or if a reduction in fair value is determined to be a permanent impairment.

     We have operated mainly in the United States of America, and the majority of our sales since inception have been made in U.S. dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations.

Item 4. Controls and Procedures.

     Disclosure Controls and Procedures.We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (Exchange Act) is recorded, processed, summarized and reported within the timelines specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

     Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in SEC Rules 13a — 15(e) and 15d — 15(e)) as of March 31, 2006. Based on such evaluation, our management has concluded as of March 31, 2006, the Company’s disclosure controls and procedures are effective.

     Changes in Internal Control over Financial Reporting.There has been no change to our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

     As described in our Annual Report on Form 10-K for the year ended December 31, 2005, we are involved in a series of related lawsuits involving families of decedents who donated their bodies through UCLA’s willed body program. This litigation is still ongoing. The complaint alleges that the head of UCLA’s willed body program, Henry G. Reid, and a third party, Ernest V. Nelson, improperly sold some of the donated cadavers to the defendants (including NuVasive). Plaintiffs allege the following causes of action: (i) negligence, (ii) fraud by Intentional Misrepresentation, (iii) negligent misrepresentation, and (iv) Fraud by Concealment.

     Although the outcome of this lawsuit cannot be determined with certainty, we believe that we acted within the relevant law in procuring the cadavers for our clinical research and intend to vigorously defend ourselves against the claims contained in the complaint.

     In addition, we are subject to a legal action that has arisen in connection with our transition to an exclusive sales force. One former independent distributor of our products, Synergy Orthopedic Products, LLC, has filed a claim for damages with respect to our termination of our business relationship with it. This case was filed on December 20, 2005, in the Superior Court of California, County of Orange, and alleges breach of contract. We intend to vigorously defend ourselves against the claims contained in this complaint and we believe that we acted within the relevant law in terminating our relationship with the plaintiff. Although the outcomes of this lawsuit cannot be determined with certainty, we believe that the ultimate outcome will not have a significant adverse effect on our business, financial condition or results of operations.

     We recently settled our litigation with nuSpine Medical Technologies, Inc., which had been pending in the Franklin County Common Pleas Court, Columbus, Ohio. The settlement was not material to our business. The case has been dismissed with prejudice.

Item 1A. Risk Factors

     An investment in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described under Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2005 together with all other information contained or incorporated by reference in this report before you decide to invest in our common stock. If any of the risks described in this report or in our annual report actually occurs, our business, financial condition, results of operations and our future growth prospects could be materially and adversely affected. Under these circumstances, the trading price of our common stock could decline, and you may lose all or part of your investment.

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Item 6. Exhibits.

EXHIBIT INDEX

Exhibit No.	Description
3.1(1)	Restated Certificate of Incorporation
3.2(1)	Restated Bylaws
31.1	Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
32 *	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 to our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 13, 2004.
*	These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of NuVasive, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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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.

	Nuvasive, Inc.
Date: May 10, 2006	By:	/s/Alexis V. Lukianov
		Alexis V. Lukianov
		Chairman and Chief Executive Officer
Date: May 10, 2006	By:	/s/Kevin C.O’ Boyle
		Kevin C. O’Boyle
		Executive Vice President and Chief Financial Officer

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EXHIBIT INDEX

Exhibit No.	Description
3.1(1)	Restated Certificate of Incorporation
3.2(1)	Restated Bylaws
31.1	Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
32 *	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 to our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 13, 2004.
*	These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of NuVasive, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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