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

• Specialized implants, including our fixation products for fusion and CoRoent® suite of implants.

Our fusion fixation products include our SpheRx® pedicle screw systems, XLP™ lateral fixation plate, Halo™ anterior fixation plate, Helix™ cervical plate and Gradient Plus™ cervical plate. We also offer our Triad® and Extensure® lines of bone allograft, in our patented saline packaging, and a synthetic bone void filler, FormaGraft®, designed to aid in bone growth with fusion procedures. Osteocel®, the most recent addition to our comprehensive product portfolio, is part of our biologics offering that we expect to contribute to the growth of our biologics platform over the next several years.
We have an active product development pipeline focused on expanding our current fusion product platform as well as products designed to preserve spinal motion. We completed the enrollment of our pivotal clinical trial in August for NeoDisc, our cervical disc replacement device. The trial protocol requires a two-year follow up period on all patients before submitting to the FDA for potential approval.
Since inception, we have been unprofitable. As of September 30, 2008, we had an accumulated deficit of $199.2 million.
Revenues. The majority of our revenues are derived from the sale of implants and disposables and we expect this trend to continue in the near term. We loan our NeuroVision systems and surgical instrument sets at no cost to surgeons and hospitals that purchase disposables and implants for use in individual procedures; there are no minimum purchase requirements of disposables and implants related to these loaned surgical instruments. In addition, we place NeuroVision, MaXcess and other MAS or cervical 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. These extended loan transactions represent less than 20% of our total stock of loaner surgical assets. Our implants and disposables are currently sold and shipped from our San Diego and Memphis facilities. We recognize revenue for disposables or implants used upon receiving a purchase order from the hospital indicating product use or implantation. In

addition, we sell a small number of MAS instrument sets, MaXcess devices, and NeuroVision systems. To date, we have derived less than 5% of our total revenues from these sales.
Sales and Marketing. Through September 30, 2008, 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 exclusive sales agents and our own directly employed sales professionals. 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. Sales force 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. In the second quarter of 2006, we completed our efforts to transition our sales force to one that is exclusive to us with respect to the sale of spine products. Late in 2007, we began an expansion in international markets focusing initially on European markets. We expect our international sales force to be made up of a combination of distributors and direct sales personnel.
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). 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, income taxes, and stock-based compensation. 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) collectability is reasonably assured. Specifically, revenue from the sale of implants and disposables is recognized upon receipt of a purchase order from the hospital indicating product use or implantation or upon shipment to third party customers who immediately accept title. Revenue from the sale of our 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 sales, marketing and administrative 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 customer's future ability to pay outstanding receivables, significant additional allowances could be required.
Excess and Obsolete Inventory and Instruments. 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 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 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 dispose of existing inventory and related capital instruments and/or write off the value or accelerate the depreciation of these assets.
Long-Term Assets. Property and equipment is carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of three to seven years for machinery and equipment and three years for loaner instruments. We own land and a building in Memphis, Tennessee that we use as a warehouse and distribution facility. The building is depreciated over a period of 20 years. Maintenance and repairs are expensed as incurred. Intangible assets, consisting of purchased and licensed technology and a supply agreement, are amortized on a straight-line basis over their estimated useful lives ranging from ten to 20 years.
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 material impairment losses on long-term intangible assets through September 30, 2008.
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 September 30, 2008 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 shareowner (employee) and non-employee director services and requires us to expense the estimated fair value of these awards over the requisite service period. Option awards issued to non-employees are recorded at their fair value as determined in accordance with 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 expense, we estimate the fair value of all share-based awards to shareowners (employees) and directors at the date of grant using the Black-Scholes option-pricing model and the portion that is ultimately expected to vest is recognized as compensation expense over the requisite service period on an accelerated basis.
The determination of fair value using the Black-Scholes option-pricing model is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividend and expected term. Stock-based compensation expense is recognized only for those awards that are ultimately expected to vest, and we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. Stock-based compensation related to stock options 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, specifically with respect to anticipated forfeitures, we may change the input factors used in determining stock-based compensation costs. These changes, if any, 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 accounting principles generally accepted in the United States (GAAP). See our unaudited condensed consolidated financial statements and notes thereto included in this report, and our audited consolidated

financial statements and notes thereto for the year ended December 31, 2007 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, which contain accounting policies and other disclosures required by GAAP.
Osteocel® Biologics Business Acquisition On July 24, 2008, NuVasive completed the acquisition of certain assets of Osiris Therapeutics, Inc. (Osiris) (the Osteocel® Biologics Business Acquisition) for $35.0 million in cash paid at closing pursuant to the Asset Purchase Agreement, as amended. The completion date of this transaction is referred to as the Technology Closing Date. At the Technology Closing Date, the Company also entered into a Manufacturing Agreement, as amended, (collectively with the Asset Purchase Agreement, the Agreements) with Osiris.
Under the terms of the Agreements, NuVasive will make additional payments of up to $50 million, including milestone-based contingent payments not to exceed $37.5 million and a non-contingent $12.5 million payment for the transfer of the manufacturing facility Osiris currently utilizes to manufacture the Osteocel product. Both the contingent and non-contingent payments are payable in either cash or a combination of cash and stock, at the Company's election. The contingent payments are based on meeting a combination of specific product delivery milestones and a sales performance milestone and are not included in the preliminary estimate of the purchase price of the Osteocel Biologics Business.
Pursuant to the Agreements, Osiris will supply, and the Company will purchase, specified quantities of Osteocel product and Osiris will meet certain performance criteria for a period not to exceed 18 months. At the conclusion of this period, NuVasive will make the non-contingent payment for the manufacturing facility and will be assigned the lease agreement for the manufacturing facility. Title to the manufacturing related assets, leasehold improvements and all other tangible assets, as defined in the Agreements, will pass to NuVasive on this date. NuVasive will record the fair value of the assets acquired as of the Manufacturing Closing Date and estimates their value will be approximately $5 million to $10 million.
Pursuant to the Agreements, as amended, the sales price per cubic centimeter
(cc) of the Osteocel product transferred to NuVasive was reduced for the first approximate 40,000 cc's delivered after the Technology Closing Date. NuVasive has recorded a short-term asset of $2.5 million representing the value of the discounted purchase price contract. Management expects substantially all of the $2.5 million to be amortized by December 31, 2008. The transaction provides NuVasive with a comprehensive stem cell biologic platform with benefits similar to autograft, as well as rights to acquire the next generation cultured version of the product. Osteocel is the only viable bone matrix product on the market that provides the three beneficial properties similar to autograft: osteoconduction (provides a scaffold for bone growth), osteoinduction (bone formation stimulation) and osteogenesis (bone production). Osteocel allows surgeons to offer the benefits of these properties to patients without the discomfort and potential complications of autograft harvesting, in addition to eliminating the time spent on a secondary surgical procedure. Osteocel is produced for use in spinal applications through a proprietary processing method that preserves the native stem cell population that resides in marrow rich bone. The acquisition has been accounted for using the purchase method of accounting in accordance with Financial Accounting Standards Board Opinion No. 141, Business Combinations (FAS 141). Accordingly, NuVasive's cost to acquire the Osteocel Biologics Business has been allocated to the tangible assets, intangible assets and in-process research and development acquired, based upon their respective estimated fair values as of the date of the Technology Closing Date. The fair value estimates are preliminary and may change upon finalization of the purchase price allocation.

Results of Operations
Revenue

                                        September 30,
         (dollars in thousands)      2008          2007        $ Change     % Change
         Three months ended       $  66,915     $  38,522     $ 28,393          73.7 %
         Nine months ended        $ 175,501     $ 107,360     $ 68,141          63.5 %

Revenues have increased over time due primarily to continued market acceptance of our products within our MAS platform, including NeuroVision, MaXcess disposables, and our specialized implants such as our XLP™ lateral plate, SpheRx® pedicle screw systems, and CoRoent® suite of products. The continued adoption of minimally invasive procedures for spine has led to the continued expansion of our innovative lateral procedure known as eXtreme Lateral Interbody Fusion, or XLIF®, in which surgeons access the spine for a fusion procedure from the side of the patient's body, rather than from the front or back. The execution of our strategy of expanding our product offering for the lumbar region and addressing broader indications further up the spine in the thoracic and cervical regions through product introductions in 2008 and 2007 have contributed to revenue growth in both years. We expect revenue to continue to increase, which can be attributed to the continued adoption of our XLIF procedure and deeper penetration into existing accounts as our sales force executes on the strategy of selling the full mix of our products. In addition, the expansion of our biologics offering through the acquisition of the Osteocel Biologics Business, and our new product introductions and sales force initiatives are expected to lead to continued revenue growth. Included in revenues for the quarter ended September 30, 2008 is $4.4 million of Osteocel revenue. Excluding Osteocel revenue, revenues for the first three quarters of 2008 increased 62.3% compared to the same period in 2007.

Cost of Goods Sold

                                        September 30,
          (dollars in thousands)      2008         2007       $ Change     % Change
          Three months ended       $ 12,195     $  6,925     $  5,270          76.1 %
          % of revenue                 18.2 %       18.0 %
          Nine months ended        $ 30,845     $ 19,342     $ 11,503          59.5 %
          % of revenue                 17.6 %       18.0 %

Cost of goods sold consists of purchased goods and overhead costs, including depreciation expense for instruments.
The increase in cost of goods sold in total dollars in the three- and nine-month periods ended September 30, 2008 compared to the same periods in 2007 resulted primarily from (i) increased material costs of $4.9 million and $9.8 million, respectively, primarily to support revenue growth and new product launches; and (ii) increased depreciation expense of $0.3 million and $1.4 million, respectively, incurred on the increased amount of surgical instruments held for use in surgeries. We expect cost of goods sold, as a percentage of revenue, to increase slightly through the remainder of 2008. We expect our gross margin to range between 81% and 82% for the remainder of 2008. Operating Expenses
Sales, Marketing and Administrative.

                                        September 30,
          (dollars in thousands)      2008          2007       $ Change     % Change
          Three months ended       $  54,557     $ 29,480     $ 25,077          85.1 %
          % of revenue                  81.5 %       76.5 %
          Nine months ended        $ 135,975     $ 86,463     $ 49,512          57.3 %
          % of revenue                  77.5 %       80.5 %

Sales, marketing and administrative expenses consist primarily of compensation, commission and training costs for personnel engaged in sales, marketing and customer support functions, distributor commissions, surgeon training costs, shareowner (employee) related expenses for our administrative functions, third party professional service fees, amortization of acquired intangible assets, and facilities and insurance expenses.
The increases in sales, marketing and administrative expenses principally result from growth in our revenue and the overall growth in the Company, including expenses that fluctuate with sales and expenses associated with investments in our infrastructure and headcount growth. Increases in costs based on revenue, such as sales force compensation and shipping costs, were $ 3.8 million, and $13.4 million, for the three- and nine- month periods ended September 30, 2008, respectively, compared to the same periods in 2007. In addition, in the third quarter of 2008, $4.8 million and $2.6 million were included in sales, marketing and administrative expenses for a charge related to vacating the Company's previous corporate headquarters and incremental transition costs related to the Company's ERP system, respectively. These charges are described in further detail below. Increases in costs based on overall company growth and administrative support, such as compensation and other shareowner (employee) related costs, were $8.3 million and $13.9 million, respectively, for the three- and nine-month periods ended September 30, 2008, compared to the same periods in 2007. We also incurred an increase in equipment and facility costs of $2.5 million and $4.7 million for the three- and nine-month period ended September 30, 2008, respectively, compared to the same period in 2007, also a result of company growth and the relocation to our new facility.
Total costs related to our sales force, as a percent of revenue, decreased to 30.3% from 31.6% for the three months ended September 30, 2008 compared to the same period in 2007. The decrease in costs as a percentage of revenue was primarily attributable to the increased revenues and to certain costs associated with our transition to sales force exclusivity that were incurred in the 2007 period but not incurred in the 2008 period.
On a long-term basis, as a percentage of revenue, we expect sales, marketing and administrative costs to continue to decrease over time as we continue to see the synergies of investments we have made. However, we have incurred other significant expenses that are designed to increase the scalability of our business over time. For example, we purchased and began the implementation of a new enterprise resource planning, or ERP, software system, in 2007. We completed the implementation of our new ERP system during the third quarter of 2008. We capitalized the majority of the aggregate $10.9 million anticipated cost of the ERP project and are amortizing it over a 7-year period. During the quarter, we determined that additional consulting time was important for a successful transition and therefore incurred $2.6 million in Q3 2008 which was an incremental non-capitalizable expense related to the ongoing support costs for the implementation. We anticipate an additional charge of approximately $1.5 million in the fourth quarter of 2008. These third and fourth quarter investments minimize the potential for transitional risk of moving to a new SAP based system and will assist in driving expected efficiencies in 2009. We expect to move to a more traditional and leverage-able on-going support model in 2009, without significant incremental costs.
In addition, we entered into a lease of a two-building campus-style headquarters complex in November 2007 to accommodate our Company's growth. Relocation to the new facility was completed in August 2008, and, as a result, we began to incur increased facility costs beginning on the relocation dates. Specifically, we expect to incur approximately $1.9 million in incremental facility costs in 2008 plus a charge of $4.8 million related to vacating our previous corporate headquarters, as discussed below.
We expect to sublease our previous corporate headquarters through August 2012, the date on which the related lease agreement expires, however expect that the space will remain vacant for approximately 24 months with no associated sublease during that time. At the completion of moving the final phase of shareowners (employees) and operations from our previous facility to our new headquarters during August 2008, we recorded a loss equal to the present value of expected net future cash flows in the amount of $4.8 million. We assumed, in performing the calculation of the loss, that the facility will remain vacant for approximately 24 months given the current market conditions. As of the date of this filing, we have not yet entered into a sublease agreement and cannot be assured that a sublease, if any, will provide the anticipated sublease income used to estimate the charge recorded.

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