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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549


FORM 10-Q

(MARK ONE)

|    |  |                                                        
|--- |  | -------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
|    |  | SECURITIES EXCHANGE ACT 1934                           
|    |  | FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003          

|     |  |                                                         
|---- |  | --------------------------------------------------------
|[  ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
|     |  | SECURITIES EXCHANGE ACT 1934                            
|     |  | FOR THE TRANSITION PERIOD FROM         TO               

Commission file number 0-10521



|ADVANCED NEUROMODULATION SYSTEMS, INC.                
|------------------------------------------------------
|
|                                                      
|(Exact Name of Registrant as Specified in Its Charter)

|                             |  |                    
|---------------------------- |  | -------------------
|Texas                        |  | 75-1646002         
|                             |  |                    
|(State or Other Jurisdiction |  | (I.R.S. Employer   
|of Incorporation or          |  | Identification No.)
|Organization)                |  |                    

6501 Windcrest Drive, Plano, Texas 75024

(Address of Principal Executive Offices) (Zip Code)


(972) 309-8000

(Registrants Telephone Number, Including Area Code)


Indicate by check
[ü] 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.
YES
[ü]      NO [   ]

Indicate by check
[ü] whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES
[ü]      NO [   ]

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date.

|                             |  |                                
|---------------------------- |  | -------------------------------
|                             |  | Number of Shares Outstanding at
|Title of Each Class          |  | May 9, 2003                    
|                             |  |                                
|Common stock, $.05 Par Value |  | 12,746,878                     





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TABLE OF CONTENTS



|                                                  |                                                                                               |                                                           |  |  |  |  |  | 
|------------------------------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------- |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION                     
|                                                  | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                  |                                                                                               | Condensed Consolidated Balance Sheets                    
|                                                  |                                                                                               | Condensed Consolidated Statements of Income              
|                                                  |                                                                                               | Condensed Consolidated Statements of Cash Flows          
|                                                  |                                                                                               | Condensed Consolidated Statements of Stockholders Equity
|                                                  |                                                                                               | Notes to Condensed Consolidated Financial Statements     
|                                                  | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                  | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                                                  | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II OTHER INFORMATION                        
|                                                  | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|Signatures                                       
|§302 Certification of Chief Executive Officer    
|§302 Certification of Chief Financial Officer    
|EXHIBIT INDEX                                    
|EX-99.01 Certification of Chief Executive Officer
|EX-99.02 Certification of Chief Financial Officer



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##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries

Table of Contents

|                               |                                                                                               |                                                                                                                                                      |    |       |      | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------- | -- | ----- | ---- | 
|PART
I.  Financial Information |                                                                                               |                                                                                                                                                      | 2  |      
|                               | Item 1. Financial Statements                                                                  |                                                                                                                                                      |    |       |     
|                               |                                                                                               | Condensed Consolidated Balance Sheets
March 31, 2003 (Unaudited) and December 31, 2002                                                               |    |       | 3-4  | 
|                               |                                                                                               | Condensed Consolidated Statements of Income (Unaudited)
For the Three Months Ended March 31, 2003 and 2002                                           |    |       | 5    | 
|                               |                                                                                               | Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31, 2003 and 2002                                       |    |       | 6    | 
|                               |                                                                                               | Condensed Consolidated Statements of Stockholders Equity
For the Year Ended December 31, 2002 and the
Three Months Ended March 31, 2003 (Unaudited) |    |       | 7    | 
|                               |                                                                                               | Notes to Condensed Consolidated Financial Statements                                                                                                 |    |       | 8-14 | 
|                               | Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations |                                                                                                                                                      |    | 15-24 |     
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |                                                                                                                                                      |    | 24    |     
|                               | Item 4. Controls and Procedures                                                               |                                                                                                                                                      |    | 24-25 |     
|PART
II.  Other Information    |                                                                                               |                                                                                                                                                      | 26 |      
|                               | Item 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                                                      |    | 26    |     
|Signatures                     |                                                                                               |                                                                                                                                                      | 27 |      
|                               | §302 Certification of Chief Executive Officer                                                 |                                                                                                                                                      |    | 28    |     
|                               | §302 Certification of Chief Financial Officer                                                 |                                                                                                                                                      |    | 29    |     

1



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##### Table of Contents






PART I

FINANCIAL INFORMATION

2



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ITEM 1. FINANCIAL STATEMENTS

Advanced Neuromodulation Systems, Inc. and Subsidiaries




Condensed Consolidated Balance Sheets
March 31, 2003 (Unaudited) and December 31, 2002


|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |            |            |             | 
|-------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------- | ---------- | ---------- | ----------- | ------------ | ---------- | ---------- | ----------- | 
|                                                                                                                     |                                                |                                                                                               |                                   |            | March 31,  |             | December 31,
|Assets                                                                                                               |                                                | 2003                                                                                          |                                   | 2002      
|                                                                                                                     |                                                |                                                                                               |                                   |           
|Current assets:                                                                                                      |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     | Cash and cash equivalents                      |                                                                                               | $                                 | 4,960,705  |            |             | $            | 10,972,974 |           
|                                                                                                                     | Marketable securities                          |                                                                                               |                                   | 85,869,470 |            |             |              | 85,796,944 |           
|                                                                                                                     | Receivables:                                   |                                                                                               |                                   |            |            |             |              |            |           
|                                                                                                                     |                                                | Trade accounts, less allowance for
doubtful accounts of $281,131 in 2003 and
$295,391 in 2002 |                                   |            | 13,007,224 |             |              |            | 10,847,237 |            
|                                                                                                                     |                                                | Interest and other                                                                            |                                   |            | 163,839    |             |              |            | 189,017    |            
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                |                                                                                               | Total receivables                 |            |            | 13,171,063  |              |            |            | 11,036,254  | 
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     | Inventories:                                   |                                                                                               |                                   |            |            |             |              |            |           
|                                                                                                                     |                                                | Raw materials                                                                                 |                                   |            | 7,524,472  |             |              |            | 7,141,338  |            
|                                                                                                                     |                                                | Work-in-process                                                                               |                                   |            | 2,600,031  |             |              |            | 2,364,386  |            
|                                                                                                                     |                                                | Finished goods                                                                                |                                   |            | 5,849,356  |             |              |            | 4,217,222  |            
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                |                                                                                               | Total inventories                 |            |            | 15,973,859  |              |            |            | 13,722,946  | 
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     | Deferred income taxes                          |                                                                                               |                                   | 1,128,463  |            |             |              | 1,122,617  |           
|                                                                                                                     | Prepaid expenses and other current assets      |                                                                                               |                                   | 1,984,225  |            |             |              | 1,032,883  |           
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                |                                                                                               | Total current assets              |            |            | 123,087,785 |              |            |            | 123,684,618 | 
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|Equipment and fixtures:                                                                                              |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     | Land                                           |                                                                                               |                                   | 3,202,381  |            |             |              | 3,191,427  |           
|                                                                                                                     | Furniture and fixtures                         |                                                                                               |                                   | 4,190,895  |            |             |              | 4,022,901  |           
|                                                                                                                     | Machinery and equipment                        |                                                                                               |                                   | 10,942,071 |            |             |              | 10,343,953 |           
|                                                                                                                     | Leasehold improvements                         |                                                                                               |                                   | 1,720,655  |            |             |              | 1,702,965  |           
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                |                                                                                               | 20,056,002                        |            |            |             | 19,261,246   |           
|                                                                                                                     | Less accumulated depreciation and amortization |                                                                                               |                                   | 9,282,147  |            |             |              | 8,653,255  |           
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                |                                                                                               | Net property, plant and equipment |            |            | 10,773,855  |              |            |            | 10,607,991  | 
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|Minority equity investments in preferred stock                                                                       |                                                |                                                                                               | 1,132,000                         |            |            |             |             |           
|Goodwill, net                                                                                                        |                                                |                                                                                               | 9,607,237                         |            |            |             | 7,407,237    |           
|Patents, net of accumulated amortization of
$1,536,613 in 2003 and $1,435,835 in 2002                                |                                                |                                                                                               | 5,230,171                         |            |            |             | 5,323,417    |           
|Purchased technology from acquisitions, net of
accumulated amortization of $2,275,365 in 2003
and $2,098,200 in 2002 |                                                |                                                                                               | 9,855,001                         |            |            |             | 9,033,472    |           
|Trademarks, net of accumulated amortization of
$1,004,230 in 2003 and $969,952 in 2002                               |                                                |                                                                                               | 1,701,234                         |            |            |             | 1,701,154    |           
|Customer and supplier relations                                                                                      |                                                |                                                                                               | 1,300,000                         |            |            |             |             |           
|Other assets, net of accumulated amortization of
$571,816 in 2003 and $529,102 in 2002                               |                                                |                                                                                               | 988,193                           |            |            |             | 586,238      |           
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           
|                                                                                                                     |                                                | $                                                                                             | 163,675,476                       |            |            | $           | 158,344,127  |           
|                                                                                                                     |                                                |                                                                                               |                                   |            |            |             |              |           

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
March 31, 2003 (Unaudited) and December 31, 2002

|                                     |                                                                                                                                       |                            |             |             |             |              |             |             |             | 
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ----------- | ----------- | ----------- | ------------ | ----------- | ----------- | ----------- | 
|                                     |                                                                                                                                       |                            |             | March 31,   |             | December 31,
|Liabilities
and Stockholders Equity |                                                                                                                                       | 2003                       |             | 2002       
|                                     |                                                                                                                                       |                            |             |            
|Current liabilities:                 |                                                                                                                                       |                            |             |             |             |              |             |            
|                                     | Accounts payable                                                                                                                      |                            | $           | 3,643,888   |             |              | $           | 2,392,579   |            
|                                     | Accrued salary and employee benefit costs                                                                                             |                            |             | 1,155,140   |             |              |             | 3,077,603   |            
|                                     | Accrued tax abatement liability                                                                                                       |                            |             | 969,204     |             |              |             | 969,204     |            
|                                     | Accrued commissions                                                                                                                   |                            |             | 867,729     |             |              |             | 794,521     |            
|                                     | Income taxes payable                                                                                                                  |                            |             |            |             |              |             | 822,228     |            
|                                     | Deferred revenue                                                                                                                      |                            |             | 661,314     |             |              |             | 646,577     |            
|                                     | Warranty reserve                                                                                                                      |                            |             | 378,144     |             |              |             | 402,259     |            
|                                     | Other accrued expenses                                                                                                                |                            |             | 402,481     |             |              |             | 299,905     |            
|                                     |                                                                                                                                       |                            |             |             |             |              |             |            
|                                     |                                                                                                                                       | Total current liabilities  |             |             | 8,077,900   |              |             |             | 9,404,876   | 
|                                     |                                                                                                                                       |                            |             |             |             |              |             |            
|Deferred income taxes                |                                                                                                                                       |                            | 3,698,647   |             |             |              | 3,731,939   |            
|Non-current deferred revenue         |                                                                                                                                       |                            | 87,595      |             |             |              | 162,504     |            
|Commitments and contingencies        |                                                                                                                                       |                            |             |             |             |              |             |            
|Stockholders equity:                |                                                                                                                                       |                            |             |             |             |              |             |            
|                                     | Common stock of $.05 par value
Authorized 25,000,000 shares; issued and
outstanding: 12,585,517 shares in 2003
and 12,350,676 in 2002 |                            |             | 629,276     |             |              |             | 617,534     |            
|                                     | Additional capital                                                                                                                    |                            |             | 134,193,730 |             |              |             | 130,047,411 |            
|                                     | Retained earnings                                                                                                                     |                            |             | 17,013,562  |             |              |             | 14,393,748  |            
|                                     | Accumulated other comprehensive income
(loss), net of tax benefit of $13,001 in
2003 and $7,155 in 2002                               |                            |             | (25,234     | )           |              |             | (13,885     | )          
|                                     |                                                                                                                                       |                            |             |             |             |              |             |            
|                                     |                                                                                                                                       | Total stockholders equity |             |             | 151,811,334 |              |             |             | 145,044,808 | 
|                                     |                                                                                                                                       |                            |             |             |             |              |             |            
|                                     |                                                                                                                                       | $                          | 163,675,476 |             |             | $            | 158,344,127 |            
|                                     |                                                                                                                                       |                            |             |             |             |              |             |            

See accompanying notes to condensed consolidated financial statements.

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Advanced Neuromodulation Systems, Inc. and Subsidiaries




Condensed Consolidated Statements of Income (Unaudited)
For the Three Months Ended March 31, 2003 and 2002


|                              |                             |                            |            |                              |            |      |            |           |           | 
|----------------------------- | --------------------------- | -------------------------- | ---------- | ---------------------------- | ---------- | ---- | ---------- | --------- | --------- | 
|                              |                             |                            |            | Three Months Ended March 31,
|                              |                             |                            |            |                             
|                              |                             |                            |            | 2003                         |            | 2002
|                              |                             |                            |            |                              |            |     
|Net revenue                   |                             | $                          | 19,670,591 |                              |            | $    | 11,472,646 |          
|Cost of revenue               |                             |                            | 6,881,691  |                              |            |      | 4,514,160  |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             | Gross profit               |            |                              | 12,788,900 |      |            |           | 6,958,486 | 
|                              |                             |                            |            |                              |            |      |            |          
|Operating expenses:           |                             |                            |            |                              |            |      |            |          
|                              | Research and development    |                            |            | 1,692,431                    |            |      |            | 1,292,703 |          
|                              | Sales and marketing         |                            |            | 5,159,908                    |            |      |            | 2,895,890 |          
|                              | Amortization of intangibles |                            |            | 354,934                      |            |      |            | 227,796   |          
|                              | General and administrative  |                            |            | 1,765,918                    |            |      |            | 1,302,872 |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             |                            | 8,973,191  |                              |            |      | 5,719,261  |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             | Income from operations     |            |                              | 3,815,709  |      |            |           | 1,239,225 | 
|                              |                             |                            |            |                              |            |      |            |          
|Other income (expenses):      |                             |                            |            |                              |            |      |            |          
|                              | Interest expense            |                            |            |                             |            |      |            | (4,306    | )        
|                              | Interest and other income   |                            |            | 281,655                      |            |      |            | 73,506    |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             |                            | 281,655    |                              |            |      | 69,200     |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             | Income before income taxes |            |                              | 4,097,364  |      |            |           | 1,308,425 | 
|Income taxes                  |                             |                            | 1,477,550  |                              |            |      | 471,449    |          
|                              |                             |                            |            |                              |            |      |            |          
|                              |                             | Net income                 |            | $                            | 2,619,814  |      |            | $         | 836,976   | 
|                              |                             |                            |            |                              |            |      |            |          
|Basic net income per share:   |                             | $                          | .21        |                              |            | $    | .09        |          
|                              |                             |                            |            |                              |            |      |            |          
|Diluted net income per share: |                             | $                          | .20        |                              |            | $    | .08        |          
|                              |                             |                            |            |                              |            |      |            |          

See accompanying notes to condensed consolidated financial statements.

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Advanced Neuromodulation Systems, Inc. and Subsidiaries




Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31, 2003 and 2002


|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |          |         |         |            |  
|------------------------------------------------------ | ---------------------------------------------------------------- | ------------------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | --------- | ---------------------------- | ---------- | -------- | ------- | ------- | ---------- | -
|                                                       |                                                                  |                                                                                             |                                              |                                           |           | Three Months Ended March 31,
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                             
|                                                       |                                                                  |                                                                                             |                                              |                                           |           | 2003                         |            | 2002    
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Cash flows from operating activities:                  |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       |                                                                  | Net income                                                                                  |                                              | $                                         | 2,619,814 |                              |            | $        | 836,976 |        
|                                                       |                                                                  | Adjustments to reconcile net income to net cash provided by
(used in) operating activities: |                                              |                                           |           |                              |            |          |         |        
|                                                       |                                                                  |                                                                                             | Depreciation and amortization                |                                           |           | 983,827                      |            |          |         | 769,585 |           
|                                                       |                                                                  |                                                                                             | Deferred income taxes                        |                                           |           | (33,292                      | )          |          |         | 609,863 |           
|                                                       |                                                                  |                                                                                             | Changes in operating assets and liabilities: |                                           |           |                              |            |          |         |         |           
|                                                       |                                                                  |                                                                                             |                                              | Receivables                               |           |                              | (2,134,809 | )        |         |         | (1,004,003 | )
|                                                       |                                                                  |                                                                                             |                                              | Inventories                               |           |                              | (1,251,270 | )        |         |         | (705,402   | )
|                                                       |                                                                  |                                                                                             |                                              | Current income tax receivable             |           |                              |           |          |         |         | (675,491   | )
|                                                       |                                                                  |                                                                                             |                                              | Prepaid expenses and other assets         |           |                              | (972,674   | )        |         |         | 113,534    |  
|                                                       |                                                                  |                                                                                             |                                              | Deferred revenue                          |           |                              | (60,172    | )        |         |         | (235,250   | )
|                                                       |                                                                  |                                                                                             |                                              | Income taxes payable                      |           |                              | (822,228   | )        |         |         |           |  
|                                                       |                                                                  |                                                                                             |                                              | Tax benefit from stock option exercises   |           |                              | 2,102,907  |          |         |         | 535,655    |  
|                                                       |                                                                  |                                                                                             |                                              | Accounts payable                          |           |                              | 251,666    |          |         |         | (345,156   | )
|                                                       |                                                                  |                                                                                             |                                              | Accrued expenses                          |           |                              | (1,770,794 | )        |         |         | (960,141   | )
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       |                                                                  |                                                                                             |                                              | Total adjustments                         |           |                              | (3,706,839 | )        |         |         | (1,896,806 | )
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       |                                                                  |                                                                                             |                                              | Net cash used in operating activities     |           |                              | (1,087,025 | )        |         |         | (1,059,830 | )
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Cash flows from investing activities:                  |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       | Purchases of marketable securities                               |                                                                                             |                                              | (146,483,218                              | )         |                              |            | (830,964 | )      
|                                                       | Proceeds from sales of marketable securities                     |                                                                                             |                                              | 146,393,497                               |           |                              |            | 556,136  |        
|                                                       | Acquisition of Sun Medical pain business                         |                                                                                             |                                              | (3,900,000                                | )         |                              |            |         |        
|                                                       | Minority equity investments in preferred stock                   |                                                                                             |                                              | (1,132,000                                | )         |                              |            |         |        
|                                                       | Additions to property, equipment, fixtures and intangible assets |                                                                                             |                                              | (838,618                                  | )         |                              |            | (442,468 | )      
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       |                                                                  |                                                                                             |                                              | Net cash used in investing activities     |           |                              | (5,960,339 | )        |         |         | (717,296   | )
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Cash flows from financing activities:                  |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       | Payment of long-term obligations                                 |                                                                                             |                                              |                                          |           |                              |            | (12,694  | )      
|                                                       | Exercise of stock options                                        |                                                                                             |                                              | 1,035,095                                 |           |                              |            | 399,273  |        
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|                                                       |                                                                  |                                                                                             |                                              | Net cash provided by financing activities |           |                              | 1,035,095  |          |         |         | 386,579    |  
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Net decrease in cash and cash equivalents              |                                                                  |                                                                                             | (6,012,269                                   | )                                         |           |                              | (1,390,547 | )       
|Cash and cash equivalents at beginning of year         |                                                                  |                                                                                             | 10,972,974                                   |                                           |           |                              | 9,785,325  |         
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Cash and cash equivalents at March 31                  |                                                                  | $                                                                                           | 4,960,705                                    |                                           |           | $                            | 8,394,778  |         
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Supplemental cash flow information is presented below: |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Income taxes paid                                      |                                                                  | $                                                                                           | 1,073,709                                    |                                           |           | $                            |           |         
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Interest paid                                          |                                                                  | $                                                                                           |                                             |                                           |           | $                            | 4,306      |         
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Non-cash activity:                                     |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         
|Stock issued for intangible assets                     |                                                                  | $                                                                                           | 1,020,059                                    |                                           |           | $                            |           |         
|                                                       |                                                                  |                                                                                             |                                              |                                           |           |                              |            |         

See accompanying notes to condensed consolidated financial statements.

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##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries




Condensed Consolidated Statements of Stockholders Equity (Unaudited)


|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |            |  
|----------------------------- | ----------------------------------------------------------------------------- |  | ------------ | --------- | ---------- | - | -------- | ------- | ------------- | - | ------------- | ---------- | ------ | - | ---------- | --------- |  | - | ------- | ------- | ----- | - | ----------- | ---------- | -
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   | Other   |         | Total
|                              |                                                                               |  | Common Stock |           | Additional |   | Retained |         | Comprehensive |   | Stockholders
|                              |                                                                               |  | Shares       |           | Amount     |   | Capital  |         | Earnings      |   | Income (Loss) |            | Equity
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |       
|Balance
at
December 31, 2001  |                                                                               |  | 9,071,868    |           |            | $ | 453,593  |         |               | $ | 38,670,248    |            |        | $ | 7,709,290  |           |  | $ | (21,250 | )       |       | $ | 46,811,881  |           
|                              | Net income                                                                    |  |              |          |            |   |          |        |               |   |               |           |        |   |            | 6,684,458 |  |   |         |        |       |   |             | 6,684,458  |  
|                              | Adjustment to
unrealized
losses on
marketable
securities                      |  |              |          |            |   |          |        |               |   |               |           |        |   |            |          |  |   |         | 7,365   |       |   |             | 7,365      |  
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |            |  
|                              | Comprehensive
Income                                                          |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             | 6,691,823  |  
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |            |  
|                              | Sale of newly
issued common
stock in a
public offering,
net of offering
costs |  |              | 2,875,000 |            |   |          | 143,750 |               |   |               | 83,031,603 |        |   |            |          |  |   |         |        |       |   |             | 83,175,353 |  
|                              | Issuance of
shares for stock
option exercises                                 |  |              | 247,506   |            |   |          | 12,376  |               |   |               | 1,857,516  |        |   |            |          |  |   |         |        |       |   |             | 1,869,892  |  
|                              | Issuance of
common stock for
acquisition                                      |  |              | 156,302   |            |   |          | 7,815   |               |   |               | 4,640,606  |        |   |            |          |  |   |         |        |       |   |             | 4,648,421  |  
|                              | Tax benefit from
stock option
exercises                                       |  |              |          |            |   |          |        |               |   |               | 1,847,438  |        |   |            |          |  |   |         |        |       |   |             | 1,847,438  |  
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |           
|Balance
at
 December
31, 2002 |                                                                               |  | 12,350,676   |           |            |   | 617,534  |         |               |   | 130,047,411   |            |        |   | 14,393,748 |           |  |   | (13,885 | )       |       |   | 145,044,808 |           
|                              | Net income                                                                    |  |              |          |            |   |          |        |               |   |               |           |        |   |            | 2,619,814 |  |   |         |        |       |   |             | 2,619,814  |  
|                              | Adjustment to
unrealized
losses on
marketable
securities                      |  |              |          |            |   |          |        |               |   |               |           |        |   |            |          |  |   |         | (11,349 | )     |   |             | (11,349    | )
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |            |  
|                              | Comprehensive
Income                                                          |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             | 2,608,465  |  
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |            |  
|                              | Issuance of
shares for stock
option exercises                                 |  |              | 206,495   |            |   |          | 10,325  |               |   |               | 1,024,770  |        |   |            |          |  |   |         |        |       |   |             | 1,035,095  |  
|                              | Issuance of
earnout shares
for acquisition                                    |  |              | 28,346    |            |   |          | 1,417   |               |   |               | 1,018,642  |        |   |            |          |  |   |         |        |       |   |             | 1,020,059  |  
|                              | Tax benefit from
stock option
exercises                                       |  |              |          |            |   |          |        |               |   |               | 2,102,907  |        |   |            |          |  |   |         |        |       |   |             | 2,102,907  |  
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |           
|Balance
at

March 31, 2003    |                                                                               |  | 12,585,517   |           |            | $ | 629,276  |         |               | $ | 134,193,730   |            |        | $ | 17,013,562 |           |  | $ | (25,234 | )       |       | $ | 151,811,334 |           
|                              |                                                                               |  |              |           |            |   |          |         |               |   |               |            |        |   |            |           |  |   |         |         |       |   |             |           

See accompanying notes to condensed consolidated financial statements.

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##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries




Notes to Condensed Consolidated Financial Statements




|(1) |  | Business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | Advanced Neuromodulation Systems, Inc. (the Company or ANS) designs,
develops, manufactures and markets implantable neuromodulation devices
used to manage chronic intractable pain and other disorders of the
central nervous system. We also provide contract development and custom
manufacturing for other medical device companies through our Hi-tronics
Designs, Inc. (HDI) subsidiary, which we acquired in January 2001. ANS
neuromodulation revenues are derived primarily from sales throughout the
United States, Europe and Australia while HDI revenues are derived within
the United States.                                                                                                       
|   
|    |  | In November 2002, the Company acquired MicroNet Medical, Inc., a
privately-held developer of medical devices based on proprietary
micro-lead technology based in St. Paul, Minnesota. See Note 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|    |  | In March 2003, the Company acquired the pain management business of Sun
Medical, Inc., the Companys largest distributor of its Neuro Products.
See Note 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|    |  | The research and development, manufacture, sale and distribution of
medical devices are subject to extensive regulation by various public
agencies, principally the Food and
Drug Administration and corresponding state, local and foreign agencies.
Product approvals and clearances can be delayed or withdrawn for failure
to comply with regulatory requirements or the occurrence of unforeseen
problems following initial marketing.                                                                                                                                                                                                                                                                             
|   
|    |  | In addition, ANS products are purchased primarily by hospitals,
ambulatory surgery centers and other users who then bill various third
party payors including Medicare, Medicaid, Workmens Compensation,
private insurance companies and managed care organizations. These third
party payors reimburse fixed amounts for services based on a specific
diagnosis. The impact of changes in third party payor reimbursement
policies and any amendments to existing reimbursement rules and
regulations that restrict or terminate the eligibility of ANS products
could have an adverse impact on the Companys financial condition and
results of operations.                                                         
|   
|(2) |  | Condensed Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|    |  | The unaudited consolidated financial information contained in this report
reflects all adjustments (consisting of normal recurring accruals)
considered necessary, in the opinion of management, for a fair
presentation of results for the interim periods presented. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these
estimates.

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



|    |  | Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the financial statements
and notes thereto included in the Companys December 31, 2002
Annual Report on Form 10-K/A. The results of operations for the period
ended March 31, 2003 are not necessarily indicative of operations for the
full year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and its subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(3) |  | Acquisitions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|    |  | On March 27, 2003, the Company completed the acquisition of the pain
management business of Sun Medical, Inc. for approximately $4.9 million
(including acquisition related expenses of approximately $100,000), with
$3.9 million paid at the closing and the remainder to be paid during the
second quarter of 2003. The acquisition expands the Companys direct
sales force. Sun Medical was the largest distributor of the Companys
Neuro Products and accounted for $6.33 million, or 13.5% of revenue of
the Neuro Products segment during the twelve months ended December 31,
2002. As part of the acquisition, the Company hired substantially all of
the salespersons and clinical support specialists who worked for Sun
Medicals pain management business. Assets acquired consisted primarily
of customer lists, non-competes, inventory, contracts, equipment and
other tangible assets but excluded cash and accounts receivable as of the
closing date. The allocation of the purchase price as of March 31, 2003
is approximately as follows: goodwill-$2,200,000, customer
relations-$1,100,000, inventory-$1,000,000, other non-compete
agreements-$300,000, supplier relations-$200,000, and employee
non-compete agreements- $100,000. Amortization periods for the
identifiable intangible assets are as follows: customer relations-7
years, other non-compete agreements-5 years, supplier relations-4 years
and employee non-compete agreements-1 year.
|   
|    |  | On November 25, 2002, the Company completed the acquisition of MicroNet
Medical, Inc., a privately-held developer of medical devices based on
proprietary micro-lead technology based in St. Paul, Minnesota. The
acquired assets are part of the Companys Neuro Products segment. Under
the terms of the transaction, which was structured as a merger, the
Company acquired only MicroNets proprietary technology and certain
associated tangible assets. At closing, the Company paid the former
MicroNet shareholders $500,000 in cash and 156,302 shares of ANS common
stock valued at $4,648,421. The Company also paid acquisition related
costs of $859,460.The Company also agreed to pay the former MicroNet
shareholders additional shares of its common stock if certain product,
regulatory approval and sales milestones are met. These milestones
consist of three principal product milestones and a sales milestone. Each
of the product milestones has three to four sub-milestones that relate to
the delivery of specific products, including four quadrapolar leads
(Milestone I),
two octapolar leads (Milestone II) and a four channel lead and an eight
channel lead designed for use in deep brain stimulation (Milestone III).
The product sub-milestones are met if and when we are able to submit, and
if and when we receive, regulatory approvals for products that have been
adapted for use with our electrical stimulation                      

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



|    |  | devices. The sales milestone will be met if and when we and our
subsidiaries generate $5 million in cumulative net sales of MicroNet lead
products during the four years following the closing of the MicroNet
transaction. The aggregate value of the additional potential milestone
earnout payments payable in shares of the Companys common stock was $9
million as measured at the time the transaction was completed. In March
2003, the Company issued the former MicroNet shareholders an aggregate of
28,346 shares of common stock with a value at the time of issuance and
release from escrow of $1,020,059 upon the successful completion of half
of the first product milestone. All milestones must be met by November
2006 or November 2007, depending on the milestone. The earn-out shares
were allocated in accordance with the original purchase price allocation,
resulting in additional purchased technology of $978,237, tradenames of
$23,461, and non-compete agreements of $18,361.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(4) |  | Stock Based Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|    |  | The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25) and related interpretations. Under APB 25,
no compensation expense is recognized for stock option grants if the
exercise price of the Companys stock option grants is at or above fair
market value of the underlying stock on the date of grant. The Company
has adopted the pro forma disclosure features of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS 123), as amended by Statement of Financial Accounting Standards No.
148, Accounting for Stock-Based Compensation-Transition and Disclosure.
The following table illustrates the effect on net income and net income
per share amounts if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation:                                                 

|                         |  |                              |            |      |  |   |            | 
|------------------------ |  | ---------------------------- | ---------- | ---- |  | - | ---------- | 
|                         |  | Three Months Ended March 31,
|                         |  |                             
|                         |  | 2003                         |            | 2002
|                         |  |                              |            |     
|Net income as reported   |  | $                            | 2,619,814  |      |  | $ | 836,976    | 
|Stock-based compensation |  |                              | 946,977    |      |  |   | 431,363    | 
|                         |  |                              |            |      |  |   |            | 
|Pro forma net income     |  | $                            | 1,672,837  |      |  | $ | 405,613    | 
|                         |  |                              |            |      |  |   |            | 
|Basic shares             |  |                              | 12,412,607 |      |  |   | 9,107,985  | 
|Diluted shares           |  |                              | 13,328,098 |      |  |   | 10,292,947 | 
|                         |  |                              |            |      |  |   |            | 
|Pro forma Basic EPS      |  | $                            | .13        |      |  | $ | .05        | 
|                         |  |                              |            |      |  |   |            | 
|                         |  |                              |            |      |  |   |            | 
|Pro forma Diluted EPS    |  | $                            | .13        |      |  | $ | .04        | 
|                         |  |                              |            |      |  |   |            | 



|(5) |  | Commitments and Contingencies                                                                                                                                                                                                                                                                                                                          
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | In January 1998, the Company sold its cardiovascular operations to Atrion
Corporation, and granted Atrion a nine-month option to acquire the
Companys principal office and manufacturing facility in Allen, Texas for
$6.5 million. During October 1998, Atrion exercised its option to acquire
the facility. When the facility was built in 1993, the

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



| |  | Company entered a ten-year agreement with the City of Allen granting tax
abatements to the Company if a minimum job base and personal property
base were maintained in the City of Allen. The agreement provided for the
repayment of abated taxes if the Company defaulted under the agreement.
During 1998 the Company recorded a pretax expense of $969,204 in
connection with the abated taxes. In April 1999, the Company was
successful in petitioning the City of Allen to assign the abatement
agreement to Atrion. In July 1999, the Company, Atrion and the City of
Allen executed an assignment agreement under which Atrion (as successor
in interest to the Company) must continue to meet the conditions of the
original tax abatement agreement until August 2003. The City preserved
its rights to collect previously abated taxes if Atrion fails to comply
with its obligations any time prior to August 2003. The Company retains
monetary liability for the amount of abated taxes, even after assignment,
because pursuant to the purchase and sale agreement with Atrion, the
Company indemnified Atrion from any tax abatement liabilities that
accrued to the City of Allen prior to the sale of the cardiovascular
operations in January 1998. If Atrion meets the minimum requirements
under the agreement until August 2003, then no payment will be required.
If no payment is required, the Company intends to reverse the potential
obligation of $969,204 in September 2003, which would result in the
reporting of other income in this amount in the Consolidated Statement
of Income.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | The Company entered into a sixty-three month lease agreement on 40,000
square feet of space located in the North Dallas area during February
1999. The Company relocated its operations to the leased facility in May
1999 and the rental period under the lease commenced on June 1, 1999.
Under the terms of the lease agreement, the Company received three months
free rent and the monthly rental rate for the remaining term of the lease
is $48,308, subject to certain annual adjustments for increases in
expenses for common area maintenance and property taxes. The monthly
rental rate was increased to $52,647 in January 2003. In September 2002,
the Company amended its lease agreement to add approximately 9,700 square
feet of office space located in the same complex as its 40,000 square
foot corporate headquarters. The lease on the additional space expires
during August 2004, the same as the corporate headquarters facility. The
monthly rental rate on the 9,700 square feet of office space is $11,485.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | The Company also leases facilities in New Jersey as a result of the
January 2001 acquisition of HDI. One of the facilities, located in Budd
Lake, New Jersey, is 10,348 square feet of office space that is used for
administration, design engineering, drafting, documentation and
regulatory affairs. The lease expires on February 28, 2004 and has a
monthly rental rate of $9,615. The Company also leases 18,582 square feet
of space in Hackettstown, New Jersey used for the O.E.M. manufacturing
operations. The Hackettstown lease, which expires on December 31, 2005,
has a monthly rental rate of $9,517 and is renewable for one additional
three-year period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | The Company leases transportation equipment under non-cancelable
operating leases with expirations ranging from March 2005 until October
2006 at a monthly rate of $3,981.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | The Company leases office equipment under non-cancelable operating leases
expiring through 2004. Monthly payments on the office equipment leases
are $2,412.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



| |  | The Company is subject to proceedings, lawsuits and other claims related
to its products and business. The Company is required to assess the
likelihood of any adverse judgments or outcomes to these matters as well
as potential ranges of probable losses. A determination of the amount of
reserves required, if any, for these contingencies are made after
analysis of each individual issue. The required reserves may change in
the future due to new developments in each matter or changes in approach,
such as a change in settlement strategy, in dealing with these matters.                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Currently, product liability claims and other ordinary routine litigation
incidental to the Companys business are the only litigation to which it
is a party. While historically the Companys product liability claims
have not resulted in significant monetary liability beyond its insurance
coverage, an adverse judgment beyond its insurance coverage could have a
material adverse impact on its results of operations and financial
condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Certain of the Companys distributor sales agreements contain an early
termination provision that permits the Company to terminate the agreement
without cause by paying an early termination fee equal to 25% of the
prior years sales to the distributor. The termination fee for the
Companys two existing distributors would range from $392,000 to
$1,157,000. In addition, under the Companys sales agreements with its
independent sales agents, the Company can terminate those agreements
without cause by paying an early termination fee equal to 100% of the
commissions that would otherwise be payable on sales in the territory for
the 90 days after termination and 50% of the commission that would
otherwise be payable on sales in the territory for the 90 day period
after the first 90 day period.                                                                                                                                                                                                                        
|
| |  | In addition, under its distributor agreements, sales agent agreements and
certain other ordinary course commercial contracts with third parties,
the Company typically agrees to indemnify the other contracting party
from damages and costs that may arise from product liability claims. The
terms of the agreements and contracts vary and the
potential exposure under these indemnities cannot reasonably be estimated
or determined. Historically, product liability claims for our
neurostimulation devices have not resulted in significant monetary
liability beyond our insurance coverage. We seek to maintain appropriate
levels of product liability insurance with coverage that we believe is
comparable to that maintained by companies similar in size and serving
similar markets.                                                                                                                                                                                                                                               
|
| |  | Financial Accounting Standards Board Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (Interpretation 45) requires
disclosures in interim and annual financial statements about obligations
under certain guarantees issued by the Company. Furthermore, it requires
recognition at the beginning of a guarantee of a liability for the fair
value of the obligation undertaken in issuing the guarantee, with limited
exceptions including: 1) a parents guarantee of a subsidiarys debt to a
third party, and 2) a subsidiarys guarantee of the debt owed to a third
party by either its parent or another subsidiary of that parent. The
initial recognition and initial measurement provisions are only
applicable on a prospective basis for guarantees issued or modified after
December 31, 2002. This interpretation has had no impact on the Companys
consolidated statement of operations or condensed consolidated balance
sheets.

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



|(6) |  | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | The Company recorded income tax expense during the three months ended
March 31, 2003 of $1,477,550, an overall effective tax rate of 36.06%.
During the three months ended March 31, 2002, the Company recorded income
tax expense of $471,449, an overall effective tax rate of 36.03%. These
effective tax rates in both 2003 and 2002 are higher than the U.S.
statutory rate of 35% for corporations due to a provision for state
taxes, offset by tax-exempt interest income.
|   
|(7) |  | Net Income Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|    |  | Basic net income per share is computed based only on the weighted average
number of common shares outstanding during the period. Diluted net income
per share is computed using the additional dilutive effect, if any, of
stock options and warrants using the treasury stock method based on the
average market price of the stock during the period. The following table
presents the reconciliation of basic and diluted shares:                                              

|                                                   |                |  |                              |            |      |  |           |            | 
|-------------------------------------------------- | -------------- |  | ---------------------------- | ---------- | ---- |  | --------- | ---------- | 
|                                                   |                |  | Three Months Ended March 31,
|                                                   |                |  |                             
|                                                   |                |  | 2003                         |            | 2002
|                                                   |                |  |                              |            |     
|Weighted-average shares outstanding (basic shares) |                |  | 12,412,607                   |            |      |  | 9,107,985 |           
|Effect of dilutive stock options                   |                |  | 915,491                      |            |      |  | 1,184,962 |           
|                                                   |                |  |                              |            |      |  |           |           
|                                                   | Diluted shares |  |                              | 13,328,098 |      |  |           | 10,292,947 | 
|                                                   |                |  |                              |            |      |  |           |           



|    |  | For the three months ended March 31, 2003 and 2002, the incremental
shares used for dilutive income per share relate to stock options whose
exercise prices were less than the average market price in the underlying
quarterly computations. For the three months ended March 31, 2003,
options to purchase 28,000 shares at an average price of $40.82 per share
were outstanding but were not included in the computation of diluted
income per share because the options exercise prices were greater than
the average market price of the common shares for that three month period
and, therefore, the effect would be antidilutive. For the three months
ended March 31, 2002, all stock options were included in the computation
of diluted income per share since all exercise prices were less than the
average market price of the common shares for that three-month period.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(8) |  | Comprehensive Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|    |  | Total comprehensive income for 2002 and for the three months ended March
31, 2003 is reported in the Condensed Consolidated Statements of
Stockholders Equity. Comprehensive loss for the three months ended March
31, 2002 is as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

|                                  |  |                      |         |  
|--------------------------------- |  | -------------------- | ------- | -
|                                  |  | Three Months        
|                                  |  | Ended March 31, 2002
|                                  |  |                     
|Net income                        |  | $                    | 836,976 |  
|Other comprehensive income (loss) |  |                      | (1,453  | )
|                                  |  |                      |         |  
|Comprehensive income              |  | $                    | 835,523 |  
|                                  |  |                      |         |  



|(9) |  | Segment Information                                                                                                                                                                                                                          
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | The Company operates in two business segments. The Neuro Products segment
designs, develops, manufactures and markets implantable medical devices
that are used to manage chronic intractable pain and other disorders of
the central nervous

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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements



| |  | system through the delivery of electrical current or drugs directly to
targeted nerve fibers. The HDI O.E.M. segment provides contract
development and O.E.M. manufacturing of electro-mechanical devices.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Intersegment revenue from HDI is billed at cost with no intercompany
mark-up.                                                                                                                             
|
| |  | Segment data for the three months ended March 31, 2003 is as follows:                                                                                                                                     

|                                |  |          |             |        |  |              |           |              |  |   |            |   |  |   |             | 
|------------------------------- |  | -------- | ----------- | ------ |  | ------------ | --------- | ------------ |  | - | ---------- | - |  | - | ----------- | 
|                                |  | Neuro    |             | HDI    |  | Intercompany |           | Consolidated
|                                |  | Products |             | O.E.M. |  | Eliminations |           | Total       
|                                |  |          |             |        |  |              |           |             
|Revenue from external customers |  | $        | 16,627,446  |        |  | $            | 3,043,145 |              |  | $ |           |   |  | $ | 19,670,591  | 
|Intersegment revenues           |  | $        |            |        |  | $            | 1,431,732 |              |  | $ | (1,431,732 | ) |  | $ |            | 
|Segment income from operations  |  | $        | 3,451,248   |        |  | $            | 364,461   |              |  | $ |           |   |  | $ | 3,815,709   | 
|Segment assets                  |  | $        | 159,941,744 |        |  | $            | 9,008,052 |              |  | $ | (5,274,320 | ) |  | $ | 163,675,476 | 



| |  | Segment data for the three months ended March 31, 2002 is as follows:
| |  | ---------------------------------------------------------------------

|                                |  |          |            |        |  |              |           |              |  |   |            |   |  |   |            | 
|------------------------------- |  | -------- | ---------- | ------ |  | ------------ | --------- | ------------ |  | - | ---------- | - |  | - | ---------- | 
|                                |  | Neuro    |            | HDI    |  | Intercompany |           | Consolidated
|                                |  | Products |            | O.E.M. |  | Eliminations |           | Total       
|                                |  |          |            |        |  |              |           |             
|Revenue from external customers |  | $        | 8,988,419  |        |  | $            | 2,484,227 |              |  | $ |           |   |  | $ | 11,472,646 | 
|Intersegment revenues           |  | $        |           |        |  | $            | 1,135,360 |              |  | $ | (1,135,360 | ) |  | $ |           | 
|Segment income from operations  |  | $        | 757,717    |        |  | $            | 481,508   |              |  | $ |           |   |  | $ | 1,239,225  | 
|Segment assets                  |  | $        | 52,674,926 |        |  | $            | 6,887,338 |              |  | $ | (3,513,259 | ) |  | $ | 56,049,005 | 



|(10) |  | Minority Investment in Preferred Stock                                                                                                                                                                                                                                                                                                                                                                               
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|     |  | In January 2003, the Company invested $1 million in cash to purchase
preferred stock for a minority equity position in Innovative Spine
Technologies, Inc., a start-up company that develops spine technologies,
products and services through intellectual property development and
contract research. This investment is accounted for under the cost method
of accounting due to our minimal ownership percentage.

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

The following discussion of the financial condition and results of operations
of the Company should be read in conjunction with the Condensed Consolidated
Financial Statements of the Company and the related Notes.

Background

We entered the neuromodulation market in 1995 through the acquisition of a
company that had developed and marketed a radio-frequency (RF) neurostimulation
system. In 1998, we elected to reposition our business to focus exclusively on
the neuromodulation market. Implementation of this strategy involved selling
our cardiovascular and intravenous fluid product lines in January 1998. Through
our initiatives, we developed and launched our next generation neurostimulation
system, the Renew®RF spinal cord stimulation system, in 1999. We also recently
developed our Genesis®and GenesisXP totally implantable pulse generator (IPG)
spinal cord stimulation systems. We began selling Genesisin Europe in 2001 and
in the U.S. in 2002 subsequent to the FDAs approval of our PMA application in
November 2001, and our GenesisXPIPG system following FDA approval, in the
fourth quarter of 2002.

In 2000, we completed development of AccuRx,our constant rate implantable drug
pump, in part using proprietary technology we licensed from Implantable Devices
Limited Partnership (IDP). We initiated U.S. clinical trials of AccuRxunder an
Investigational Device Exemption (IDE) in the first quarter of 2001, and began
selling AccuRxin certain international markets in the second quarter of 2001.
On January 2, 2001, we strengthened our position in the neuromodulation market
by acquiring the assets of IDP and ESOX Technology Holdings, LLC (ESOX) for
119,100 shares of our common stock valued at approximately $2.43 million. This
acquisition provided us with intellectual property surrounding implantable drug
pump technologies in all applications, including pain and cancer therapy.

Also on January 2, 2001, we completed the acquisition of HDI, a privately-held
O.E.M. developer and manufacturer, for approximately 1.1 million shares of our
common stock. We accounted for this acquisition using the pooling of interests
method and, accordingly, the financial information for all periods prior to the
acquisition has been restated. Prior to the acquisition, HDI developed and
manufactured our GenesisIPG as well as the transmitter for our Renewsystem.
Acquiring HDI provided us with additional in-house expertise in the design and
manufacture of highly sophisticated electromechanical devices. Combined with
our capabilities in the design and manufacture of implantable leads, electronic
device control and communication systems and implantable drug pumps, we believe
HDIs expertise will allow us to develop more sophisticated products in less
time. Additionally, HDI continues to provide contract development and
manufacturing services to third parties, which we report as a separate segment
for financial reporting purposes (the O.E.M. segment). For the three months
ended March 31, 2003, our O.E. M. segment provided $3.04 million or 15.5% of
our total net revenue. In the future, we expect our O.E.M. segment revenue to
decrease as a percentage of our total revenue as we grow revenue from our
proprietary neurostimulation systems and drug pumps and increasingly utilize
HDIs research and development capabilities for internal product development.

In November 2002, we completed the acquisition of MicroNet Medical, Inc., a
privately-held developer of medical devices based on proprietary micro-lead
technology. MicroNet developed

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a line of very thin and steerable spinal cord
stimulation leads called Axxess.These leads are the smallest diameter
neurostimulation leads on the market, and because of their size, we believe
they offer advantages in certain applications. Under the terms of the
transaction, which we structured as a merger, we acquired only MicroNets
proprietary technology and certain associated tangible assets. The MicroNet
assets are a part of our Neuro Products segment. MicroNets operations, other
tangible assets, certain liabilities and certain employees became part of a
separate unaffiliated company. We assumed no material debt, liabilities, or
overhead in the transaction. At closing, we paid the former MicroNet
shareholders $500,000 in cash and 156,302 shares of our common stock with a
value at the time of issuance of $4,648,421. In addition, we incurred expenses
of $859,460, including an investment-banking fee of $600,000. We also agreed to
pay the former MicroNet shareholders additional shares of our common stock if
certain product, regulatory approval and sales milestones are met. These
milestones consist of three principal product milestones and a sales milestone.
Each of the product milestones has three to four sub-milestones that relate to
the delivery of specific products, including four quadrapolar leads (Milestone
I), two octapolar leads (Milestone II) and a four channel lead and an eight
channel lead designed for use in deep brain stimulation (Milestone III). The
product sub-milestones are met if and when we are able to submit, and if and
when we receive, regulatory approvals for products that have been adapted for
use with our electrical stimulation devices. The sales milestone will be met if
and when we and our subsidiaries generate $5 million in cumulative net sales of
MicroNet lead products during the four years following the closing of the
MicroNet transaction.

The aggregate value of the additional potential milestone earnout payments
payable in shares of our common stock was $9 million as measured at the time
the transaction was completed. Of this $9 million in additional shares, we
issued a fixed number of shares totaling 89,606 with an aggregate value at
closing of $3 million into an escrow account. If and when the product and
regulatory milestones are achieved, we will release a specified and fixed
number of shares of our common stock from escrow to the former MicroNet
shareholders (which for purchase price accounting will be valued at the time of
release from escrow). In addition, if and when those same product and
regulatory milestones are achieved, we will also issue at that time a number of
shares of our common stock with an aggregate value of up to $3 million.
Finally, if and when we generate $5 million in cumulative net sales of MicroNet
lead products during the four years following the closing, we will issue at
that time a number of shares of our common stock with an aggregate value of $3
million. In March 2003, two parts of the first major product milestones were
satisfied, and we issued the former MicroNet shareholders an aggregate of
28,346 shares of our common stock (of which 14,934 shares were from escrow)
with a value at the time of issuance and release from escrow of $1,020,059,
which was allocated to certain identifiable intangible assets in accordance
with the original purchase price allocation. Important additional product
milestone deadlines occur in November 2003 and May 2004, while other milestones
depend on the receipt of regulatory approvals and meeting the aggregate sales
milestone referred to above. All milestones must be met by November 2006 or
November 2007, depending on the milestone.

On March 27, 2003, we completed the acquisition of the pain management business
of Sun Medical, Inc. for approximately $4.9 million (including acquisition
related expenses of approximately $100,000), with $3.9 million paid at the
closing and the remainder to be paid during the second quarter of 2003. Sun
Medical was the largest distributor of our Neuro
Products and accounted for $6.33 million, or 13.5% of revenue of the Neuro
Products segment during the twelve months ended December 31, 2002. As part of
the acquisition, we hired substantially all of the salespersons and clinical
support specialists who worked for Sun

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Medicals pain management business.
Assets acquired consisted primarily of customer lists, non-competes, inventory,
contracts, equipment and other tangible assets, but excluded cash and accounts
receivable as of the closing date. The allocation of the purchase price as of
March 31, 2003 is as follows: goodwill-$2,200,000, customer
relations-$1,100,000, inventory-$1,000,000, other non-compete
agreements-$300,000, supplier relations-$200,000, and employee non-compete
agreements- $100,000. Amortization periods for the identifiable intangible
assets are as follows: customer relations-7 years, other non-compete
agreements-5 years, supplier relations-4 years and employee non-compete
agreements-1 year.

Our current neuromodulation product line includes our GenesisIPG system,
GenesisXPIPG system, RenewRF system and AccuRxconstant rate drug pump. With
the launch of our Genesisand GenesisXPIPG systems,we now compete in 100% of
the implantable neurostimulation market to treat chronic pain of the trunk and
limbs. The launch of the GenesisIPG and GenesisXPIPG in 2002 slowed our
growth rate in sales of Renewsystems from an average percentage growth rate in
the mid-teens over the past several years to single-digit growth in 2002.
Management believes this trend may continue in 2003 and has assumed similar
single-digit growth in Renewsales during 2003.

Critical Accounting Policies and Estimates

General

Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities and related disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. On an on-going basis, management
evaluates its estimates and judgments, including those related to product
returns, bad debts, inventories, intangible assets, warranty obligations and
contingencies and litigation. Management bases its estimates on historical
experience and on various other factors that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

Management believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements.

Revenue Recognition

We generate revenues from product sales to end customers, product sales to
distributors, and development contracts.

We recognize revenue on product sales to end customers and distributors upon
shipment, provided an arrangement with the customer or distributor exists, the
fee is fixed and
determinable, and collectibility is reasonably assured. Our shipping terms are
FOB shipping point. We do not have any continuing obligation to our customers
for installation or training, and there are no acceptance clauses in our
customer arrangements. The only continuing obligation is a standard warranty
that is offered to all customers. We accrue the estimated cost of

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providing
that warranty at the point of sale based on our historical experience in
fulfilling warranty obligations. We have not experienced warranty claims that
exceeded our expectations.

End customers and distributors are granted rights of return for 60 days
following the point of sale. We record, as a reduction in revenue, a provision
for estimated sales returns and adjustments on these product sales in the same
period as the related revenue is recorded. These estimates are based on
historical sales returns, analysis of credit memo data, and other known
factors. We typically sell our products to distributors at a price equal to 75%
to 78% of list price, and recognize the net amount as revenue when all the
revenue recognition criteria detailed above are met.

We recognize revenue on development contracts at HDI using either the
percentage of completion method for fixed price development contracts, or as
the services are performed for development contracts that are completed on a
time and materials basis. We recognize revenue using the percentage of
completion method for the fixed price development agreements as the contract
term can vary from 9 to 24 months, our right to receive payment depends on our
performance in accordance with the agreement, and we can reasonably estimate
the costs applicable to various stages of the development arrangement. Revenue
is recognized based on the ratio of costs incurred in relation to the estimated
costs for the total project. If we do not accurately estimate the resources
required or the scope of work to be performed under a fixed price development
agreement, then future profit margins and results of operations may be
negatively impacted.

Payment received in advance of revenue recognition requirements are recorded as
deferred revenue on the consolidated balance sheet.

Bad Debt

We are required to estimate the collectibility of our trade receivables. A
considerable amount of judgment is required in assessing the ultimate
realization of the receivables, including the current credit-worthiness of each
customer, the aging of receivables and our historical experience. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances or
write-offs may be required.

Inventory Reserve

Our reserve for excess and obsolete inventory is based upon forecasted demand
for our products. If the demand for our products is less favorable than those
projected by management, additional inventory write-downs or write-offs may be
required.

Intangible Assets

Identifiable definite-lived intangible assets, such as patents, purchased
technology, trademarks and covenants not to compete, are amortized using the
straight-line method over their useful lives.

In assessing the recoverability of our intangible assets, we must make
assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective

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assets. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for these assets.

Contingencies

See Note 5 to the Consolidated Financial Statements for a discussion of the
contingencies of proceedings, lawsuits and other claims related to our products
and business.

Results of Operations

Comparison of the Three Months Ended March 31, 2003 and 2002

We reported net income of $2.62 million, or $.20 per diluted share, for the
three months ended March 31, 2003, compared to $837,000, or $.08 per diluted
share in the same 2002 period. Results for the first quarter of 2003 continue
to reflect the positive impact of revenue growth from our Genesis and GenesisXP
IPG systems, which we launched in the United States in January 2002 and
December 2002, respectively.

Net revenue increased 71.5% to a record $19.67 million for the three months
ended March 31, 2003, compared to $11.47 million in the comparable 2002 period.
Net revenue of our neuromodulation products increased 85.0% to $16.63 million
in 2003 from $8.99 million in 2002 primarily due to increased sales of our
Genesis and GenesisXP IPG systems. Net revenue from our O.E.M. business
increased 22.5% to $3.04 million in 2003 from $2.48 million in 2002 primarily
due to higher volume of O.E.M. product sales.

Gross profit increased to $12.79 million during the three months ended March
31, 2003 from $6.96 million in 2002, principally due to the increase in net
revenue discussed above. Additionally, gross profit margins increased to 65.0%
in 2003, compared to 60.7% in 2002, due to higher sales of our neuromodulation
products, which contribute higher margins than O.E.M. product sales, higher
neuromodulation product sales from direct sales and commissioned agents, which
contribute higher margins than distributor sales, and operational efficiencies
gained from higher manufacturing volumes.

Total operating expenses increased to $8.97 million for the three months ended
March 31, 2003 from $5.72 million in the same period during 2002. However, as a
percentage of net revenue, these expenses decreased to 45.6% in 2002 from 49.9%
in 2002 due to leveraging of research and development and general and
administrative expenses.

Research and development expense, as a percentage of net revenue, decreased to
8.6% during the three months ended March 31, 2003 from 11.3% in the same 2002
period, while the absolute dollar amount increased to $1.69 million in 2003
from $1.29 million during 2002, an increase of approximately $400,000. This
increase in the absolute dollar amount in 2003
compared to 2002 was the result of higher salary and benefit expense from
staffing additions and annual salary increases, higher legal expense for patent
submissions and higher prototype tooling and test materials for new products
under development. Our development efforts continue to be focused on
next-generation IPG stimulation systems, next-generation RF stimulation
systems, an IPG stimulation system for deep brain stimulation, next generation
drug pumps, and clinical trials of our AccuRx.

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Sales and marketing expense, as a percentage of net revenue, increased to 26.2%
during the three months ended March 31, 2003 from 25.2% in the same 2002
period, and the absolute dollar amount increased to $5.16 million in 2003 from
$2.90 million during 2002. This increase in the absolute dollar amount during
2003 compared to 2002 was principally attributable to higher commission expense
from increased Neuro Product sales, higher salary expense from annual salary
increases and staffing additions in reimbursement, direct sales and clinical
support specialists, higher travel expense due to increased direct sales
activities and higher expense for education and training of new implanters of
Neuro Products.

Amortization of other intangibles increased to $355,000 during the three months
ended March 31, 2003 from $228,000 in the same period in 2002, due to
amortization expense for intangible assets we acquired in the MicroNet Medical,
Inc. acquisition consummated in November 2002.

General and administrative expense, as a percentage of net revenue, decreased
to 9.0% during the three months ended March 31, 2003 from 11.4% in the same
2002 period, while the absolute dollar amount increased to $1.77 million in
2003 from $1.30 million during 2002. This increase in the absolute dollar
amount of approximately $463,000 during 2003 compared to 2002 was principally
attributable to higher salary expense from annual salary increases and staffing
additions, higher employee benefit costs, higher recruiting fee expense and
higher depreciation expense.

Other income increased to $282,000 during the three months ended March 31, 2003
from $69,000 during the three months ended March 31, 2002 primarily as a result
of higher interest income due to higher funds available for investment from the
public offering of common stock completed during the second quarter of 2002.

Income tax expense increased to $1.48 million during the three months ended
March 31, 2003 from $471,000 in the same period in 2002, due to an increase in
pretax income to $4.10 million in 2003 from $1.31 million in 2002. The
effective tax rate was 36.06% during the 2003 period, similar to the 36.03%
during the 2002 period. These effective tax rates in both 2003 and 2002 are
higher than the U.S. statutory rate of 35% for corporations due to a provision
for state taxes, offset by tax-exempt interest income.

Liquidity and Capital Resources

At March 31, 2003, our working capital increased to $115.0 million from $114.3
million at December 31, 2002. The ratio of current assets to current
liabilities was 15.24:1 at March 31, 2003, compared to 13.15:1 at December 31,
2002. Cash, cash equivalents, certificates of deposit and marketable securities
totaled $90.83 million at March 31, 2003 compared to $96.77 million at December
31, 2002.

In March 2003, we acquired Sun Medicals pain management business, which will
expand our direct domestic salesforce, for approximately $4.9 million in cash,
including approximately $100,000 in acquisition costs. We paid $3.9 million at
closing and will pay the remaining $1.0 million of the purchase price in the
second quarter of 2003. See Note 3 to the Notes to Condensed Consolidated
Financial Statements.

In January 2003, we invested $1 million in cash to purchase preferred stock for
a minority equity position in Innovative Spinal Technologies, Inc., a start-up
company that develops spine

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technologies, products and services through
intellectual property development and contract research.

We increased our investment in inventories to $15.97 million at March 31, 2003,
from $13.72 million at December 31, 2002, an increase of $2.25 million. This
increase from year-end 2002 was primarily the result of two factors. First, in
our acquisition of the pain management business from Sun Medical, we acquired
approximately $1 million of inventory at Sun Medicals cost on March 27, 2003
when we completed the acquisition. Second, we increased our inventory of
stimulation products for Genesisand GenesisXPIPG systems in anticipation of
continuing sales growth.

Our investment in trade accounts receivable increased to $13.01 million at
March 31, 2003, from $10.85 million at December 31, 2002 due to increased sales
and an increase in our days sales outstanding (DSOs) from 55 days at year-end
2002 to 59 days at March 31, 2003. We experienced slower collections during the
first quarter of 2003 from insurance companies and hospitals resulting in the
increase in DSOs.

In November 2002, we completed the acquisition of MicroNet Medical, Inc. See
the discussion regarding this acquisition in Background above.

We spent $839,000 during the three months ended March 31, 2003, for capital
expenditures primarily for new office furniture and equipment for personnel we
hired and additional manufacturing tooling and equipment to provide increased
capacity to support our current products. We have budgeted $3.3 million in
capital expenditures (excluding the facility discussed below) in fiscal 2003.

Because we expect our business to continue to grow at rates that will demand
added office and facility space, we acquired approximately 10 acres of land in
December 2002 for approximately $3.19 million. The land is located in Plano,
Texas, near our current corporate headquarters. Our current lease on our 50,000
square foot corporate headquarters expires in August 2004. We intend to build a
new corporate headquarters facility on the land and relocate to the new
facility upon the expiration of our lease in August 2004. We are designing the
new facility to accommodate planned growth within a five-year horizon and
anticipate that the facility will contain 140,000 to 150,000 square feet and
cost between $16 million and $17 million. While we have not yet determined the
method by which we will finance the facility, we believe our cash position and
overall balance sheet position provides us with various financing alternatives,
including financing the facility from our current cash, financing through a
debt vehicle such as a mortgage or other form of note, or a sale-and-leaseback
transaction.

We received $1.04 million of cash during the three months ended March 31, 2003
from the exercise of 206,495 stock options.

Liquidity may also be enhanced based on our ability to utilize all or part of a
net operating loss of $3.4 million to offset future taxable income. We acquired
the net operating loss in connection with the MicroNet Medical acquisition and
its utilization may be subject to a limitation under Section 382 of the
Internal Revenue Code. The rules of Section 382 of the Internal Revenue Code
generally apply to limit a corporations ability to utilize acquired net
operating loss carryforwards to reduce its federal taxable income in the
periods after an acquisition. The Companys ability to use the net operating
loss carryforwards acquired in the MicroNet Medical acquisition to reduce its
federal taxable income is subject to these rules. Provided the Company

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generates sufficient taxable income in future years, the Section 382 limitation
will have the effect of deferring the utilization of the net operating loss
carryforwards over several years. Without this limitation, the Company would be
able to use all of the net operating loss carryforwards to reduce taxable
income in the tax periods immediately following the acquisition. The total
amount of net operating loss carryforwards that the Company may use to reduce
taxable income in any taxable year after the acquisition is determined with
reference to its purchase price of MicroNet Medical. Based on current estimates
and assumptions, we expect to utilize at least approximately $700,000 in net
operating loss carryforwards per full tax year, assuming we generate sufficient
taxable income in any given year to utilize such amount.

Additionally, liquidity may be enhanced to the extent we realize tax benefits
from employee stock option exercises. During the three months ended March 31,
2003, we generated a $2.1 million tax benefit related to disqualifying
dispositions of employee stock options.

We believe our current cash, cash equivalents, marketable securities and cash
generated from operations will be sufficient to fund our current levels of
operating needs and capital expenditures for the foreseeable future. We
currently have no credit facilities in place. If we decide to acquire
complementary businesses, product lines or technologies, or enter into joint
ventures or strategic alliances that require substantial capital, we intend to
finance those activities by the most attractive alternative available, which
could include utilizing our current cash, bank borrowings, or the issuance of
debt or equity securities.

Cash Flows

Net cash used by operations was $1.09 million for the three months ended March
31, 2003, as compared to $1.06 million in the same period in 2002. Although we
reported a $1.78 million increase in net income to $2.6 million during the 2003
period compared to $837,000 in the 2002 period, we used more cash in our
operating activities during the 2003 period for changes in working capital
primarily for increases in accounts receivable and inventories and reducing our
accrued liabilities.

Net cash used in investing activities was $5.96 million for the three months
ended March 31, 2003, as compared to $717,000 for the same period in 2002, an
increase of $5.24 million. This increase in the use of cash in investing
activities during the 2003 period compared to 2002 was principally due to $3.9
million used in the acquisition of the pain management business from Sun
Medical, Inc. and $1.1 million used to purchase minority
investments in preferred
stock, mostly related to a $1.0 million investment in Innovative Spinal
Technologies, Inc., a start-up company that develops spine technologies,
products and services through intellectual property development and contract
research.

Net cash provided by financing activities was $1.04 million for the three
months ended March 31, 2003, as compared to $387,000 for the same period in
2002, an increase of $636,000 principally due to an increase in proceeds from
stock option exercises.

Currency Fluctuations

Substantially all of our international sales are denominated in U.S. dollars.
Fluctuations in currency exchange rates in other countries could reduce the
demand for our products by increasing the price of our products in the currency
of the countries in which the products are

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sold, although we do not believe
currency fluctuations have had a material effect on the Companys results of
operations to date.

Outlook and Uncertainties

The following is a safe harbor statement under the Private Securities
Litigation Reform Act of 1995: The matters discussed in this Quarterly Report
on Form 10-Q contain statements that constitute forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. The words expect, estimate, anticipate, predict, believe,
plan, will, should, intend, potential, new market, potential
market applications and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this Quarterly Report on Form 10-Q and include statements
regarding our intent, belief or current expectations with respect to, among
other things: (i) trends affecting our financial condition or results of
operations; (ii) our financing plans; and (iii) our business growth strategies.
We caution our readers that any forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in the forward-looking statements as a
result of various factors. These risks and uncertainties include the following:



| |  | failure of our Genesisand GenesisXP IPG systems to gain and maintain market acceptance would adversely affect our revenue
growth and profitability                                                                                      
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | because our main competitor has significantly greater resources than we do and new competitors may enter the
neuromodulation market, it may be difficult for us to compete in this market                                               
| 
| |  | if pain management specialists do not recommend and endorse our products, our sales could be negatively impacted and we may
be unable to increase our revenues and profitability                                                        
| 
| |  | the launch of Genesisand GenesisXPand other market factors could impede growth in or reduce sales of Renew, which would
adversely affect our revenues and profitability                                                                 
| 
| |  | if patients choose less invasive or less expensive alternatives to our products, our sales could be negatively impacted                                                                                                                 
| 
| |  | any adverse changes in coverage or reimbursement amounts by Medicare and Medicaid, private insurance companies and managed
care organizations, or workers compensation programs could limit our ability to market and sell our products
| 
| |  | if we fail to protect our intellectual property rights, our competitors may take advantage of our ideas and compete
directly against us                                                                                                 
| 
| |  | other parties may sue us for infringing their intellectual property rights, or we may have to sue them to protect our
intellectual property rights                                                                                      
| 
| |  | failure to obtain necessary government approvals for new products or for new applications for existing products would mean
we could not sell those new products, or sell our existing products for those new applications               
| 
| |  | modification of any marketed device could require a new 510(k) clearance or PMA or require us to cease marketing or recall
the modified device until we obtain this clearance or approval                                               
| 
| |  | we will be unable to sell our products if we fail to comply with manufacturing regulations                                                                                                                                              
| 
| |  | our products are subject to product recalls even after receiving FDA clearance or approval, which would negatively affect
our financial performance and could harm our reputation                                                       
| 
| |  | we are subject to potential product liability and other claims and we may not have the insurance or other resources to
cover the cost of any successful claim                                                                           

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| |  | we are subject to substantial government regulation and our failure to comply with all applicable government regulations
could subject us to numerous penalties, any of which could adversely affect our business                                                                    
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | our reliance on single suppliers for critical components used in our main products could adversely affect our ability to
deliver products on time                                                                                                                                    
| 
| |  | our major competitor in the neuromodulation market currently accounts for a significant percentage of our revenue from our
O.E.M. segment                                                                                                                                            
| 
| |  | we are dependent upon the success of neuromodulation technology; our inability to continue to develop innovative
neuromodulation products, or the failure of the neuromodulation market to develop as we anticipate, would adversely affect
our business                             
| 
| |  | our success will depend on our ability to attract and retain key personnel and scientific staff                                                                                                                                                                                      
| 
| |  | if we choose to acquire complementary business, products or technologies instead of developing them ourselves, we may be
unable to complete these acquisitions or to successfully integrate an acquired business, product or technology in a
cost-effective and non-disruptive manner
| 
| |  | we are subject to additional risks associated with international operations                                                                                                                                                                                                          
| 
| |  | our operations are conducted at three locations, and a disaster at any of these facilities could result in a prolonged
interruption of our business                                                                                                                                  
| 
| |  | our shareholders rights plan and Texas law may inhibit a takeover that our shareholders consider favorable.                                                                                                                                                                         
| 
| |  | we may be obligated to issue shares of our common stock in the future to the former shareholders of MicroNet Medical and
the number of shares could increase if our stock price decreases                                                                                            
| 
| |  | general economic risks                                                                                                                                                                                                                                                               
| 
| |  | other risks detailed from time to time in our SEC public filings                                                                                                                                                                                                                     

The foregoing risks are described in more detail in our Form 10-K/A for the
year ended December 31, 2002. If our assumptions prove to be incorrect or such
risks or uncertainties materialize, anticipated results could differ materially
from those forecasted in forward-looking statements.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For the period ended March 31, 2003, the Company did not experience material
changes in market risk exposures that affect the quantitative and qualitative
disclosures presented in the Companys Annual Report on Form 10-K/A for the
year ended December 31, 2002.




ITEM 4. CONTROLS AND PROCEDURES



|(a) |  | Evaluation of disclosure controls and procedures.Based on their most
recent review, which was completed within 90 days of the filing of this
quarterly report, the Companys Chief Executive Officer, Christopher G.
Chavez and Chief Financial Officer, F. Robert Merrill III concluded that
the Companys disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in the reports
that it files or submits under the Securities Exchange Act of 1934, as
amended, is accumulated and communicated to such officers as is
appropriate to allow timely decisions regarding required disclosure, and
that these controls and procedures are effective to ensure that such
information is recorded, processed, summarized and reported within the
time periods specified in the SECs rules and forms.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|(b) |  | Changes in internal controls.Since the date of the evaluation
described above, there have not been any significant changes in the
Companys internal accounting controls or in other factors (including any
corrective actions with regard to significant deficiencies or material
weaknesses) that could significantly affect those controls.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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PART II

OTHER INFORMATION




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibit 3.1- Articles of Incorporation, as amended and
restated (1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | Exhibit 3.2- Bylaws (1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |     |  | Exhibit 4.1- Rights Agreement dated as of August 30, 1996, between
Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent (2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |     |  | Exhibit 4.2- Amendment to Rights Agreement dated as of January 25,
2002, between Advanced Neuromodulation Systems, Inc and
Computershare Investor Services LLC (formerly KeyCorp Shareholder
Services, Inc.) (3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |     |  | Exhibit 99.1- Certification of the Chief Executive Officer (4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |     |  | Exhibit 99.2- Certification of the Chief Financial Officer (4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | (b) |  | The Company furnished a report on Form 8-K on January 10,
2003 reporting that the Company increased its revenue and earnings
guidance for 2002 and 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |     |  | The Company filed a report on Form 8-K on March 17, 2003, as
amended on April 30, 2003, reporting that James P. Calhoun, Vice
President-Human Resources, Stuart Johnson, Vice
President-Manufacturing, John Erickson, Vice President-Research and
Development, Christopher G. Chavez, President and Chief Executive
Officer, Scott F. Drees, Executive Vice President-Sales and
Marketing and F. Robert Merrill III, Executive Vice
President-Finance, Chief Financial Officer and Treasurer, each
entered into a Preset Diversification Program (PDP), a stock
disposition plan intended to qualify for the safe harbor offered by
Rule 105-1 under the Securities Exchange Act of 1934, as amended.



---

|(1) |  | Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 2000, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.              
|   
|(3) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
January 30, 2002, and incorporated herein by reference.               
|   
|(4) |  | Filed herewith.                                                                                                                          

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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.

|                   |  |                                        |  |                          
|------------------ |  | -------------------------------------- |  | -------------------------
|                   |  | ADVANCED NEUROMODULATION SYSTEMS, INC.
|                   |  |                                        |  |                          
|Date: May 15, 2003 |  | By:                                    |  | /s/ F. Robert Merrill III
|                   |  | F. Robert Merrill III                 
|                   |  | Executive Vice President, Finance     
|                   |  | Chief Financial Officer and Treasurer 

27



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§302 Certification of Chief Executive Officer

I, Christopher G. Chavez, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Advanced
Neuromodulation Systems, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                   |  |                               
|------------------ |  | ------------------------------
|Date: May 15, 2003 |  |                               
|                   |  | /s/Christopher G. Chavez      
|                   |  | Name: Christopher G. Chavez   
|                   |  | Title: Chief Executive Officer

28



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##### Table of Contents






§302 Certification of Chief Financial Officer

I, F. Robert Merrill III, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Advanced
Neuromodulation Systems, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                   |  |                               
|------------------ |  | ------------------------------
|Date: May 15, 2003 |  |                               
|                   |  | /s/ F. Robert Merrill III     
|                   |  | Name: F. Robert Merrill III   
|                   |  | Title: Chief Financial Officer

29



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EXHIBIT INDEX

|             |  |                                                                                                                                                                                                   
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 3.1  |  | Articles of Incorporation, as amended and restated (1)                                                                                                                                            
|             |  |                                                                                                                                                                                                   
|Exhibit 3.2  |  | Bylaws (1)                                                                                                                                                                                        
|             |  |                                                                                                                                                                                                   
|Exhibit 4.1  |  | Rights Agreement dated as of August 30, 1996, between Quest
Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent (2)                                                              
|             |  |                                                                                                                                                                                                   
|Exhibit 4.2  |  | Amendment to Rights Agreement dated as of January 25, 2002
between Advanced Neuromodulation Systems, Inc and
Computershare Investor Services LLC (formerly KeyCorp
Shareholder Services, Inc.) (3)
|             |  |                                                                                                                                                                                                   
|Exhibit 99.1 |  | Certification of the Chief Executive Officer (4)                                                                                                                                                  
|             |  |                                                                                                                                                                                                   
|Exhibit 99.2 |  | Certification of the Chief Financial Officer (4)                                                                                                                                                  



---

|(1) |  | Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 2000, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.              
|   
|(3) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
January 30, 2002, and incorporated herein by reference.               
|   
|(4) |  | Filed herewith.