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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (MARK ONE) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934
 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
 o
    
    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. 
  Texas
    
    75-1646002(State or Other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 6901 Preston Road, Plano, Texas 75024 
  (972) 309-8000 
  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 o Indicate by check ü whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES ü NO o 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 atTitle of Each Class
    
    July 30, 2004Common stock, $.05 Par Value
    
    
    20,182,319




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ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES Table of Contents  
 PART I.Financial Information
    
    
    2Item 1. Financial StatementsCondensed Consolidated Balance Sheets
June 30, 2004 (Unaudited) and December 31, 2003
    
    
    3-4Condensed Consolidated Statements of Income (Unaudited)
For the Three Months and Six Months Ended June 30, 2004 and 2003
    
    
    5Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 2004 and 2003
    
    
    6Condensed Consolidated Statements of Stockholders Equity
For the Year Ended December 31, 2003 and the
Six Months Ended June 30, 2004 (Unaudited)
    
    
    7Notes to Condensed Consolidated Financial Statements
    
    
    8-15Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    16-26Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    26PART II.Other Information
    
    
    27Item 1. Legal Proceedings
    
    
    27Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    27-28Item 6. Exhibits and Reports on Form 8-K
    
    
    28-29Signatures
    
    
    30Certification of the CEO Pursuant to Section 302Certification of the CFO Pursuant to Section 302Certification of the CEO Pursuant to Section 906Certification of the CFO Pursuant to Section 906
  -1-




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PART I FINANCIAL INFORMATION -2-




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ITEM 1. FINANCIAL STATEMENTS Advanced Neuromodulation Systems, Inc. and Subsidiaries 
 Condensed Consolidated Balance Sheets
June 30, 2004 (Unaudited) and December 31, 2003
 June 30,
    
    December 31,2004
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    4,396,581
    
    
    $
    8,588,281Marketable securities
    
    
    85,161,894
    
    
    
    86,213,841Receivables:Trade accounts, less allowances of
$449,513 in 2004 and $447,457 in 2003
    
    
    23,043,458
    
    
    
    17,892,416Interest and other
    
    
    798,363
    
    
    
    259,687Total receivables
    
    
    23,841,821
    
    
    
    18,152,103Inventories:Raw materials
    
    
    8,933,921
    
    
    
    10,766,127Work-in-process
    
    
    5,718,683
    
    
    
    3,569,111Finished goods
    
    
    8,326,412
    
    
    
    7,777,921Total inventories
    
    
    22,979,016
    
    
    
    22,113,159Deferred income taxes
    
    
    1,427,072
    
    
    
    1,423,228Income taxes receivable
    
    
    392,926
    
    
    
    1,324,001Prepaid expenses and other current assets
    
    
    2,036,420
    
    
    
    1,007,244Total current assets
    
    
    140,235,730
    
    
    
    138,821,857Property, equipment and fixtures:Land
    
    
    3,191,427
    
    
    
    3,191,427New facility construction in progress
    
    
    14,144,993
    
    
    
    8,825,730Furniture and fixtures
    
    
    5,736,493
    
    
    
    4,429,672Machinery and equipment
    
    
    18,373,480
    
    
    
    13,944,120Leasehold improvements
    
    
    1,826,184
    
    
    
    1,822,15243,272,577
    
    
    
    32,213,101Less accumulated depreciation and amortization
    
    
    13,129,380
    
    
    
    11,063,091Net property, equipment and fixtures
    
    
    30,143,197
    
    
    
    21,150,010Minority equity investments in preferred stock
    
    
    1,104,000
    
    
    
    1,104,000Goodwill
    
    
    12,078,668
    
    
    
    12,078,668Patents and licenses, net of accumulated
amortization of $2,070,839 in 2004 and
$1,848,354 in 2003
    
    
    5,922,917
    
    
    
    5,814,974Purchased technology, net of accumulated
amortization of $3,399,992 in 2004 and
$2,910,895 in 2003
    
    
    11,932,184
    
    
    
    10,319,679Tradenames, net of accumulated amortization of
$1,187,858 in 2004 and $1,110,458 in 2003
    
    
    1,815,352
    
    
    
    1,800,572Customer and supplier relations, net of
accumulated amortization of $409,206 in 2004 and
$194,303 in 2003
    
    
    2,618,019
    
    
    
    2,373,558Other assets, net of accumulated amortization of
$992,694 in 2004 and $803,797 in 2003
    
    
    1,394,034
    
    
    
    1,342,969$
    207,244,101
    
    
    $
    194,806,287
 See accompanying notes to condensed consolidated financial statements. -3-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
June 30, 2004 (Unaudited) and December 31, 2003 June 30,
    
    December 31,2004
    
    2003Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    3,090,554
    
    
    $
    5,717,222Accrued salary and employee benefit costs
    
    
    2,385,160
    
    
    
    4,045,361Accrued commissions
    
    
    1,708,647
    
    
    
    1,424,471Deferred revenue
    
    
    166,136
    
    
    
    503,093Warranty reserve
    
    
    179,788
    
    
    
    294,290Other accrued expenses
    
    
    275,053
    
    
    
    400,159Total current liabilities
    
    
    7,805,338
    
    
    
    12,384,596Deferred income taxes
    
    
    3,728,536
    
    
    
    3,389,255Non-current deferred revenue
    
    
    832,431
    
    
    
    907,513Commitments and contingenciesStockholders equity:Common stock
$.05 par value
Authorized 100,000,000 shares;
Issued  20,173,697 shares in 2004 and 19,712,938 in 2003
    
    
    1,008,685
    
    
    
    985,647Additional capital
    
    
    158,181,888
    
    
    
    149,644,033Retained earnings
    
    
    35,807,004
    
    
    
    27,515,001Accumulated other comprehensive income (loss), net of tax
benefit of $8,550 in 2004 and $10,181 in 2003
    
    
    (119,781
    )
    
    
    (19,758
    )Total stockholders equity
    
    
    194,877,796
    
    
    
    178,124,923$
    207,244,101
    
    
    $
    194,806,287
 See accompanying notes to condensed consolidated financial statements. -4-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries 
 Condensed Consolidated
Statements of Income (Unaudited)
For the Three Months and Six Months Ended June 30, 2004 and 2003
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenue
    
    $
    30,487,851
    
    
    $
    22,324,461
    
    
    $
    57,120,714
    
    
    $
    41,995,052Cost of revenue
    
    
    8,371,311
    
    
    
    7,051,279
    
    
    
    15,336,843
    
    
    
    13,932,970Gross profit
    
    
    22,116,540
    
    
    
    15,273,182
    
    
    
    41,783,871
    
    
    
    28,062,082Operating expenses:Sales and marketing
    
    
    9,454,727
    
    
    
    6,330,144
    
    
    
    18,018,773
    
    
    
    11,490,052Research and development
    
    
    2,869,660
    
    
    
    2,352,468
    
    
    
    5,184,610
    
    
    
    4,044,899General and administrative
    
    
    2,706,956
    
    
    
    1,866,333
    
    
    
    5,023,696
    
    
    
    3,632,251Amortization of other intangibles
    
    
    623,773
    
    
    
    450,338
    
    
    
    1,198,647
    
    
    
    805,27215,655,116
    
    
    
    10,999,283
    
    
    
    29,425,726
    
    
    
    19,972,474Income from operations
    
    
    6,461,424
    
    
    
    4,273,899
    
    
    
    12,358,145
    
    
    
    8,089,608Other income (expense):Foreign currency transaction loss
    
    
    (25,506
    )
    
    
    
    
    
    
    (54,853
    )
    
    
    Investment and other income
    
    
    229,842
    
    
    
    294,472
    
    
    
    481,171
    
    
    
    576,127204,336
    
    
    
    294,472
    
    
    
    426,318
    
    
    
    576,127Income before income taxes
    
    
    6,665,760
    
    
    
    4,568,371
    
    
    
    12,784,463
    
    
    
    8,665,735Income taxes
    
    
    2,342,348
    
    
    
    1,645,256
    
    
    
    4,492,460
    
    
    
    3,122,806Net income
    
    $
    4,323,412
    
    
    $
    2,923,115
    
    
    $
    8,292,003
    
    
    $
    5,542,929Net income per share:Basic
    
    $
    .22
    
    
    $
    .15
    
    
    $
    .41
    
    
    $
    .29Diluted
    
    $
    .21
    
    
    $
    .14
    
    
    $
    .39
    
    
    $
    .27
 See accompanying notes to condensed consolidated financial statements. -5-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries 
 Condensed Consolidated Statements of Cash Flows (Unaudited)
 For the Six Months Ended June 30, 2004 and 2003
 Six Months Ended June 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    8,292,003
    
    
    $
    5,542,929Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    3,221,292
    
    
    
    2,085,171Deferred income taxes
    
    
    (72,059
    )
    
    
    (1,719,914
    )Stock-based compensation
    
    
    (1,150
    )
    
    
    240,485Changes in operating assets and liabilities, net of acquisitions:Receivables
    
    
    (5,637,013
    )
    
    
    (4,837,303
    )Inventories
    
    
    (204,256
    )
    
    
    (3,086,920
    )Income taxes receivable
    
    
    931,075
    
    
    
    Prepaid expenses and other current assets
    
    
    (1,029,176
    )
    
    
    174,498Income taxes payable
    
    
    
    
    
    
    (822,228
    )Tax benefit from stock option exercises
    
    
    3,429,444
    
    
    
    4,756,798Accounts payable
    
    
    (2,708,241
    )
    
    
    639,640Accrued expenses
    
    
    (1,665,633
    )
    
    
    (437,854
    )Deferred revenue
    
    
    (412,039
    )
    
    
    969,159Total adjustments
    
    
    (4,147,756
    )
    
    
    (2,038,468
    )Net cash provided by operating activities
    
    
    4,144,247
    
    
    
    3,504,461Cash flows from investing activities:Purchases of marketable securities
    
    
    (100,101,123
    )
    
    
    (234,133,936
    )Proceeds from sales of marketable securities
    
    
    101,157,866
    
    
    
    231,419,854New facility construction in progress
    
    
    (5,319,263
    )
    
    
    (1,167,516
    )Acquisition of certain assets of microHelix, Inc.
    
    
    (2,046,105
    )
    
    
    Acquisition of certain operations of distributors
    
    
    (1,086,558
    )
    
    
    (4,857,192
    )Minority equity investments in preferred stock
    
    
    
    
    
    
    (1,104,000
    )Additions to property, equipment, fixtures and intangible assets
    
    
    (5,202,664
    )
    
    
    (2,390,676
    )Net cash used in investing activities
    
    
    (12,597,847
    )
    
    
    (12,233,466
    )Cash flows from financing activities:Exercise of stock options
    
    
    4,365,088
    
    
    
    3,611,405Net cash provided by financing activities
    
    
    4,365,088
    
    
    
    3,611,405Net decrease in cash and cash equivalents
    
    
    (4,088,512
    )
    
    
    (5,117,600
    )Effect of exchange rates on cash and cash equivalents
    
    
    (103,188
    )
    
    
    Cash and cash equivalents at beginning of year
    
    
    8,588,281
    
    
    
    10,972,974Cash and cash equivalents at June 30
    
    $
    4,396,581
    
    
    $
    5,855,374Supplemental cash flow information is presented below:Income taxes paid (net of refunds)
    
    $
    198,524
    
    
    $
    950,090Non-cash activity:Assumed acquisition liabilities
    
    $
    131,574
    
    
    $
    Stock issued for intangible assets
    
    $
    767,511
    
    
    $
    1,020,059
 See accompanying notes to condensed consolidated financial statements. -6-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries 
 Condensed Consolidated Statements of Stockholders Equity
 Year Ended December 31, 2003 and the Six Months Ended June 30, 2004 (Unaudited)
 Common Stock
    
    
    
    
    
    
    
    
    
    AccumulatedOther
    
    TotalAdditional
    
    Retained
    
    Comprehensive
    
    Stockholders'Shares
    
    Amount
    
    Capital
    
    Earnings
    
    Income (Loss)
    
    EquityBalance at
December 31, 2002
(restated for 3
for 2 stock split)
    
    
    18,526,014
    
    
    $
    926,301
    
    
    $
    129,738,644
    
    
    $
    14,393,748
    
    
    $
    (13,885
    )
    
    $
    145,044,808Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,217,254
    
    
    
    
    
    
    
    13,217,254Adjustment to
unrealized
losses on
marketable
securities, net
of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,873
    )
    
    
    (5,873
    )Comprehensive
income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,211,381Issuance of
shares for stock
option exercises
    
    
    1,124,372
    
    
    
    56,219
    
    
    
    7,460,722
    
    
    
    
    
    
    
    
    
    
    
    7,516,941Stock-based
compensation
    
    
    
    
    
    
    
    
    
    
    845,480
    
    
    
    
    
    
    
    
    
    
    
    845,480Shares issued
for fractional
share round-up
in 3 for 2 stock
split
    
    
    2,571
    
    
    
    128
    
    
    
    95,873
    
    
    
    (96,001
    )
    
    
    
    
    
    
    Issuance of
earn-out shares
for acquisition
    
    
    59,981
    
    
    
    2,999
    
    
    
    1,717,242
    
    
    
    
    
    
    
    
    
    
    
    1,720,241Tax benefit from
stock option
exercises
    
    
    
    
    
    
    
    
    
    
    9,786,072
    
    
    
    
    
    
    
    
    
    
    
    9,786,072Balance at December
31, 2003
    
    
    19,712,938
    
    
    
    985,647
    
    
    
    149,644,033
    
    
    
    27,515,001
    
    
    
    (19,758
    )
    
    
    178,124,923Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,292,003
    
    
    
    
    
    
    
    8,292,003Adjustment to
unrealized
losses on
marketable
securities, net
of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,165
    
    
    
    3,165Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (103,188
    )
    
    
    (103,188
    )Comprehensive
income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,191,980Issuance of
shares for stock
option exercises
    
    
    444,054
    
    
    
    22,203
    
    
    
    4,342,885
    
    
    
    
    
    
    
    
    
    
    
    4,365,088Issuance of
earn-out shares
for acquisition
    
    
    16,705
    
    
    
    835
    
    
    
    766,676
    
    
    
    
    
    
    
    
    
    
    
    767,511Stock-based
compensation
    
    
    
    
    
    
    
    
    
    
    (1,150
    )
    
    
    
    
    
    
    
    
    
    
    (1,150
    )Tax benefit from
stock option
exercises
    
    
    
    
    
    
    
    
    
    
    3,429,444
    
    
    
    
    
    
    
    
    
    
    
    3,429,444Balance at
June 30, 2004
    
    
    20,173,697
    
    
    $
    1,008,685
    
    
    $
    158,181,888
    
    
    $
    35,807,004
    
    
    $
    (119,781
    )
    
    $
    194,877,796
 See accompanying notes to condensed consolidated financial statements. -7-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries 
 Notes to Condensed Consolidated Financial Statements
  (1)
    
    BusinessAdvanced Neuromodulation Systems, Inc. (the Company or ANS) designs,
develops, manufactures and markets implantable neuromodulation devices.
ANS devices are used primarily to manage chronic severe pain. The Company
also provides contract development and custom manufacturing for other
medical device companies through the Hi-tronics Designs, Inc. (HDI)
subsidiary and through the ANS Portland division (formerly the Cable and
Wire Division of microHelix, Inc., which was acquired in April 2004). ANS
neuromodulation revenues are derived primarily from sales throughout the
United States, Europe and Australia while HDI and ANS Portland revenues
are derived within the United States.The research and development, manufacture, sale and distribution of
medical devices is 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 neuromodulation products are purchased primarily by
hospitals and other users who then bill various third party payors
including Medicare, Medicaid, private insurance companies and managed
care organizations. These third party payors reimburse fixed amounts for
products and 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.In January 2004, the Company began operations in Germany to sell its
neuromodulation devices through its wholly-owned subsidiary, ANS GmbH.
Previously, the Company utilized a distributor in Germany, and this
relationship was terminated in January 2004 at no cost to the Company. On
April 1, 2004, the Company began operations in Australia to sell its
neuromodulation devices though its wholly-owned subsidiary, ANS
Australia. Previously, the Company utilized a distributor in Australia,
MedTel Pty Limited (formerly Getz Brothers Australia) based in Sydney,
Australia (MedTel). The Company acquired certain assets of MedTel on
April 1, 2004 for approximately $1.1 million. The foreign subsidiaries
financial position and results of operations are measured using the local
currency as the functional currency. Transaction gains and losses are
recorded in the Condensed Consolidated Statement of Income for
transactions denominated in a currency other than the functional
currency. Assets and liabilities are translated at the exchange rate in
effect at the balance sheet date, and income and expense accounts at
average exchange rates during the period. Resulting translation
adjustments are recorded directly to accumulated other comprehensive
income (loss). -8-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements  (2)
    
    Condensed Financial StatementsThe unaudited condensed 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.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 our December 31, 2003 Annual Report on Form
10-K. The results of operations for the period ended June 30, 2004 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)
    
    AcquisitionsOn November 26, 2002, the Company completed the acquisition of MicroNet
Medical, Inc. (MicroNet), a privately-held developer of medical devices
based on proprietary micro-lead technology. MicroNet developed a line of
very thin and steerable spinal cord stimulation leads called Axxess
leads. In addition to the initial purchase price paid at closing, the
Company agreed to pay the former MicroNet shareholders additional shares
of ANS common stock if certain product, regulatory approvals, and sales
milestones are met. Certain product milestones were met in March and
October 2003, and the Company paid the related milestone payments at that
time.In January 2004, MicroNet satisfied another product milestone relating to
the development of a four-electrode lead, and the Company issued 16,705
shares of ANS common stock to the former MicroNet shareholders (of which
11,202 were released from escrow) with a value at the time of issuance
and release from escrow of $767,511. The value of ANS common stock issued
and released from escrow was allocated to certain identifiable intangible
assets in accordance with the original purchase price, and resulted in
the following additions to identifiable intangible assets: Amount
    Amortization PeriodPurchased technology
    
    $
    736,043
    
    
    15 yearsTradenames
    
    
    17,653
    
    
    15 yearsNon-compete agreements (included
in other assets)
    
    
    13,815
    
    
    5 yearsTotal
    
    $
    767,511
 As the MicroNet acquisition was effected through a stock-for-stock
exchange, and therefore not tax deductible beyond MicroNets existing tax
basis, the Company -9-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements recorded a deferred tax liability of $405,865 for the identified
intangible assets related to the January 2004 earn-out consideration. The
recording of the deferred tax liability resulted in additional basis in
purchased technology of $396,359 and in additional tradenames of $9,506. In May 2004, the Company and the former MicroNet shareholders agreed that
no further product milestone payments will be payable under the agreement
because no further product milestones will be met. Consequently, 89,609
shares of ANS common stock held in escrow will be returned to the
Company. However, the former MicroNet shareholders may still earn
additional ANS common stock with an aggregate value of $3 million if the
Company generates $5 million in cumulative net sales of MicroNet lead
products by November 2006. As a result of the May 2004 agreement with
MicroNet, the Company reviewed the previously recorded identifiable
intangible assets associated with the MicroNet acquisition and has
concluded there is no impairment of these intangible assets. On April 1, 2004, the Company acquired certain assets of its exclusive
distributor of neuromodulation devices for Australia, MedTel Pty Limited
(formerly Getz Brothers Australia) based in Sydney, Australia for
$1,086,558 cash. Two sales professionals from MedTel joined the Companys
sales force and additional direct sales personnel will be hired as
needed. The assets and operations acquired are part of the Neuro Products
segment and the Company began operations in Australia to sell its
neuromodulation devices through its wholly owned subsidiary, ANS
Australia. The purchase price allocation is as follows: Amount
    Amortization PeriodCustomer and supplier relations
    
    $
    400,000
    
    
    7 yearsNon-compete agreements (included in other
assets)
    
    
    100,000
    
    
    1.75 yearsProduct registrations (included in other assets)
    
    
    43,537
    
    
    3.5 yearsInventory
    
    
    490,316
    
    
    
    n/aReceivables
    
    
    52,705
    
    
    
    n/aTotal
    
    $
    1,086,558
 On April 21, 2004, the Company acquired the assets of the Cable and Wire
Division from microHelix, Inc. (microHelix), which operates out of
Portland, Oregon. The purchase price was $2,177,679 consisting of
$2,006,551 in cash, assumed liabilities of $131,574 and acquisition costs
of $39,554. microHelix previously supplied coated fine wire, antennas,
and certain other products to ANS and HDI. The acquisition represents a
vertical integration of a component supplier and provides the Company
with additional engineering resources and intellectual property for the
design and development of new products, notably leads, extensions, trial
cables and related products. Thirty-three personnel from microHelix
joined the Company upon consummation of the transaction. The assets and
operations acquired (now known as ANS Portland Division) are part of the
O.E.M. segment. The purchase price allocation is as follows: -10-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements Amount
    Amortization PeriodPurchased technology
    
    $
    969,200
    
    
    15 yearsMachinery and equipment
    
    
    1,008,394
    
    
    1-15 yearsInventory
    
    
    171,285
    
    
    
    n/aNon-compete agreements
(included in other assets)
    
    
    28,800
    
    
    1 yearTotal
    
    $
    2,177,679
 The results of operations for the acquisitions above have been included
in the Companys Condensed Consolidated Statements of Income after the
date of the acquisition.  (4)
    
    Stock Based CompensationThe 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. Stock-based
compensation to non-employees is measured at fair market value over the
service period and recorded as compensation expense in the Condensed
Consolidated Statement of Income. The Company recorded $18,248 and
$198,113 of stock-based compensation expense to non-employees in the
three months ended June 30, 2004 and 2003, respectively. The Company
recorded $(1,150) and $240,485 of stock-based compensation expense
(benefit) to non-employees in the six months ended June 30, 2004 and
2003, respectively. The Company has adopted the pro forma disclosure-only
provisions 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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income as reported
    
    $
    4,323,412
    
    
    $
    2,923,115
    
    
    $
    8,292,003
    
    
    $
    5,542,929Stock-based
compensation
    
    
    1,259,896
    
    
    
    1,045,865
    
    
    
    2,426,203
    
    
    
    1,992,842Pro forma net income
    
    $
    3,063,516
    
    
    $
    1,877,250
    
    
    $
    5,865,800
    
    
    $
    3,550,087Basic shares
    
    
    20,107,481
    
    
    
    19,118,414
    
    
    
    20,018,213
    
    
    
    18,868,663Diluted shares
    
    
    21,047,875
    
    
    
    20,471,865
    
    
    
    21,158,756
    
    
    
    20,232,006Pro forma Basic EPS
    
    $
    .15
    
    
    $
    .10
    
    
    $
    .29
    
    
    $
    .19Pro forma Diluted EPS
    
    $
    .15
    
    
    $
    .09
    
    
    $
    .28
    
    
    $
    .18
 -11-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements  (5)
    
    Commitments and ContingenciesOn April 21, 2004, the Company filed a lawsuit in the U.S. District Court
for the Eastern District of Texas, Sherman Division (Docket No.
4:404-CV-00131-PNB-DDB) against Advanced Bionics Corporation, asserting
claims of patent infringement, misappropriation of trade secrets,
tortious interference with contract, misappropriation of time, labor,
skill, and money, violation of the Texas Theft Liability Act, conversion
and constructive trust. The lawsuit alleges, among other things, that
Advanced Bionics is infringing United States Patent No. 4,793,353
entitled Non-Invasive Multiprogrammable Tissue Stimulator And Method.
In addition, the lawsuit alleges that Advanced Bionics hired a former ANS
employee to aid in the design, development and manufacture of its
implantable stimulation lead, that Advanced Bionics misappropriated the
former employees knowledge of ANS confidential, proprietary, and trade
secret information with respect to ANS implantable stimulation leads,
and that this enabled Advanced Bionics to unfairly compete with ANS. The
lawsuit seeks injunctive relief, compensatory and punitive damages,
attorneys fees and costs. On June 7, 2004, Advanced Bionics filed a
lawsuit with the United States District Court, Central District of
California, Case No. CV04-4054ABC, seeking a declaratory judgment that it
is not infringing ANS patent No. 4,793,353 (the subject of ANS current
patent infringement claim against Advanced Bionics) and that such patent
is invalid and unenforceable. ANS has not been served in the declaratory
judgment matter, however.The Company is a party to certain product liability claims related to ANS
neurostimulation devices. Product liability insurers have assumed
responsibility for defending the Company against these claims. The
Company seeks to maintain appropriate levels of product liability
insurance with coverage comparable to that maintained by companies
similar in size and serving similar markets. While historically, product
liability claims for ANS neurostimulation devices have not resulted in
significant monetary liability to the Company beyond its insurance
coverage, there can be no assurances that the Company will not incur
significant monetary liability to the claimants if such insurance is
inadequate, and there can be no assurance that the Companys
neurostimulation business and future ANS product lines will not be
adversely affected by these product liability claims.Except for the matters described above, and other ordinary routine
litigation incidental or immaterial to its business, the Company is not
currently a party to any other pending legal proceeding. The Company
maintains general liability insurance against risks arising out of the
normal course of business.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 -12-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements potential exposure under these indemnities cannot reasonably be estimated
or determined.  (6)
    
    Income TaxesThe Company recorded income tax expense during the three months and six
months ended June 30, 2004 of $2,342,348 and $4,492,460, respectively,
representing an overall effective tax rate in both periods of 35.14%. For
the three months and six months ended June 30, 2003, the Company recorded
income tax expense of $1,645,256 and $3,122,806, respectively,
representing overall effective tax rates of 36.01% and 36.04%. The
decreased effective tax rate in 2004 is primarily due to a research and
development tax credit. The effective tax rates in 2004 and 2003 reflect
a provision for federal income taxes at the statutory rate of 35% and a
provision for state taxes, offset by tax-exempt investment income earned
on our cash, cash equivalents, and marketable securities and, in 2004,
the research and development tax credit.(7)
    
    Net Income Per ShareBasic 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 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
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Weighted-average shares
outstanding (basic shares)
    
    
    20,107,481
    
    
    
    19,118,414
    
    
    
    20,018,213
    
    
    
    18,868,663Effect of dilutive stock options
    
    
    940,394
    
    
    
    1,353,451
    
    
    
    1,140,543
    
    
    
    1,363,343Diluted shares
    
    
    21,047,875
    
    
    
    20,471,865
    
    
    
    21,158,756
    
    
    
    20,232,006
 For the three months and six months ended June 30, 2004 and 2003, the
incremental shares used for dilutive earnings per share relate to stock
options whose exercise price was less than the average market price in
the underlying quarterly computations. For the three months ended June
30, 2004 and 2003, options to purchase 745,158 and 19,059 shares,
respectively, were outstanding, and for the six months ended June 30,
2004 and 2003, options to purchase 434,142 and 10,600 shares,
respectively, were outstanding, but were not included in the computation
of diluted earnings per share because the options exercise price was
greater than the average market price of the common shares and,
therefore, the effect would be antidilutive.  (8)
    
    Comprehensive IncomeComprehensive income is the total of net income and all other non-owner
changes in equity, and consists of net income, unrealized gains or losses
on the Companys available for sale securities, and foreign currency
translation adjustments. Comprehensive income for 2003 and for the six
months ended June 30, 2004 is reported in the Condensed Consolidated
Statements of Stockholders Equity. -13-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements Comprehensive income (loss) for the three months and six months ended
June 30, 2004 and 2003 is as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    4,323,412
    
    
    $
    2,923,115
    
    
    $
    8,292,003
    
    
    $
    5,542,929Other comprehensive
income (loss)
    
    
    (111,299
    )
    
    
    5,960
    
    
    
    (100,023
    )
    
    
    (5,389
    )Comprehensive income
    
    $
    4,212,113
    
    
    $
    2,929,075
    
    
    $
    8,191,980
    
    
    $
    5,537,540
  (9)
    
    Segment InformationThe 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 system through the delivery of electrical current or
drugs directly to targeted nerve fibers. The O.E.M. segment provides
contract development and O.E.M. manufacturing of electro-mechanical
devices. Intersegment revenue is billed at cost with no intercompany
mark-up.Segment data for the three months ended June 30, 2004 is as follows: Neuro
    
    
    
    
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    27,633,459
    
    
    $
    2,854,392
    
    
    $
    
    
    
    $
    30,487,851Intersegment revenues
    
    $
    
    
    
    $
    1,598,442
    
    
    $
    (1,598,442
    )
    
    $
    Segment income
(loss) from
operations
    
    $
    6,726,894
    
    
    $
    (265,470
    )
    
    $
    
    
    
    $
    6,461,424
 Segment data for the three months ended June 30, 2003 is as follows: Neuro
    
    
    
    
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    19,347,907
    
    
    $
    2,976,554
    
    
    $
    
    
    
    $
    22,324,461Intersegment revenues
    
    $
    
    
    
    $
    2,049,514
    
    
    $
    (2,049,514
    )
    
    $
    Segment income from
operations
    
    $
    3,732,812
    
    
    $
    541,087
    
    
    $
    
    
    
    $
    4,273,899
 Segment data for the six months ended June 30, 2004 is as follows: Neuro
    
    
    
    
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    51,861,143
    
    
    $
    5,259,571
    
    
    $
    
    
    
    $
    57,120,714Intersegment revenues
    
    $
    
    
    
    $
    3,281,020
    
    
    $
    (3,281,020
    )
    
    $
    Segment income from
operations
    
    $
    12,204,707
    
    
    $
    153,438
    
    
    $
    
    
    
    $
    12,358,145
 -14-




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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements Segment data for the six months ended June 30, 2003 follows: Neuro
    
    
    
    
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    35,975,353
    
    
    $
    6,019,699
    
    
    $
    
    
    
    $
    41,995,052Intersegment revenues
    
    $
    
    
    
    $
    3,481,246
    
    
    $
    (3,481,246
    )
    
    $
    Segment income from
operations
    
    $
    7,184,060
    
    
    $
    905,548
    
    
    $
    
    
    
    $
    8,089,608
 -15-




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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. Recent Developments On November 26, 2002, we completed the acquisition of MicroNet Medical, Inc.
(MicroNet), a privately-held developer of medical devices based on proprietary
micro-lead technology. MicroNet developed a line of very thin and steerable
spinal cord stimulation leads called Axxessleads. In addition to the initial
purchase price paid at closing, we agreed to pay the former MicroNet
shareholders additional shares of ANS common stock if certain product,
regulatory approvals, and sales milestones are met. Certain product milestones
were met in March and October 2003, and we paid the related milestone payments
at that time. In January 2004, MicroNet satisfied another product milestone and we issued
16,705 shares of our common stock to the former MicroNet shareholders (of which
11,202 were released from escrow) with a value at the time of issuance and
release from escrow of $767,511. The value of ANS common stock issued and
released from escrow was allocated to certain identifiable intangible assets in
accordance with the original purchase price, and resulted in the following
additions to identifiable intangible assets: purchased technology-$736,043;
tradenames-$17,653; and non-compete agreements-$13,815. In May 2004, the Company and the former MicroNet shareholders agreed that no
further product milestone payments will be payable under the agreement because
no further product milestones will be met. Consequently, 89,609 shares of ANS
common stock held in escrow will be returned to the Company. However, the
former MicroNet shareholders may still earn additional shares of ANS common
stock with an aggregate value of $3 million if the Company generates $5 million
in cumulative net sales of MicroNet lead products by November 2006. In January 2004, we began operations in Germany to sell our neuromodulation
devices through our wholly owned subsidiary, ANS GmbH. Previously, we utilized
a distributor in Germany and this relationship was terminated in January 2004
at no cost to us. On April 1, 2004, we acquired certain assets of our exclusive
distributor of Neuro Products for Australia, MedTel Pty Limited
(formerly Getz Brothers Australia) based in Sydney, Australia (MedTel). Two
sales professionals from MedTel joined our sales force and additional direct
sales personnel will be hired as needed. The purchase price of the assets was
$1,086,558. The assets and operations acquired are part of the Neuro Products
segment and we began operations in Australia to sell our neuromodulation
devices through our wholly owned subsidiary, ANS Australia in April 2004. On April 21, 2004, we acquired the assets of the Cable and Wire Division from
microHelix, Inc. (microHelix), which operates out of Portland, Oregon, for
approximately $2 million in cash and assumed liabilities of approximately
$132,000. microHelix previously supplied coated fine wire, antennas, and
certain other products to us and our wholly-owned subsidiary, Hi-Tronics
Designs, Inc (HDI). The acquisition represents a vertical integration of a
component supplier and provides us with additional engineering resources and
intellectual property for the design and development of new products, notably
leads, extensions, trial cables and related products. -16-




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Thirty-three personnel from microHelix joined us upon consummation of the
transaction. The assets and operations acquired are part of the O.E.M. segment. On April 21, 2004, we filed a lawsuit in the U.S. District Court for the
Eastern District of Texas, Sherman Division, asserting, among other things,
that Advanced Bionics Corporation is infringing a patent we own and has
misappropriated certain of our trade secrets. Critical Accounting Policies and Estimates General Our discussion and analysis of our financial condition and results of
operations are based upon our condensed 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
third-party reimbursement rates, bad debts, inventories, intangible assets, 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 condensed
consolidated financial statements. Revenue Recognition We generate revenues from product sales to end customers, product sales to
international 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.
Certain of our customers are third-party payors who reimburse fixed amounts for
services based on a specific diagnosis. Revenue is recognized on these
third-party payor sales based on the sales price less a contractual adjustment,
which is based on our history of reimbursement with the third-party payor,
provided all other revenue recognition criteria are met. We do not have any
continuing obligation to our customers for installation or training, and there
are no acceptance clauses in our customer arrangements. 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 -17-




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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. Under the Companys shipping terms, title transfers to the end customer or
distributor at the point of shipment. Shipping and handling costs are included
in cost of revenue. Payments 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 Intangible assets consist of goodwill, patents, purchased technology,
trademarks, customer and supplier relations and covenants not to compete, and
are amortized using the straight-line method over their respective 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 assets. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for these assets. Contingencies and Litigation We are subject to proceedings, lawsuits and other claims related to our
products and business. We are 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 careful 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. While historically our product liability claims have not resulted in
significant monetary liability beyond our insurance coverage, an adverse
judgment beyond our insurance coverage could have a material adverse impact on
our results of operations and financial condition. -18-




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Stock Compensation See Note 4 to the Condensed Consolidated Financial Statements for a discussion
of the application of Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock-Based Compensation and SFAS 148, Accounting for
Stock-Based Compensation  Transition and Disclosure to our stock compensation
programs. Results of Operations Comparison of the Three Months and Six Months Ended June 30, 2004 and 2003 Results for the second quarter and first half of 2004 continue to reflect the
positive impact of revenue growth from increased unit sales of our Genesisand
GenesisXPIPG systems, which we launched in the United States in January 2002
and December 2002, respectively. We believe these systems will generate most of
our revenue growth during the remainder of 2004. References below to the second
quarter are comparisons of the three months ended June 30, 2004 and 2003 and
references below to the first half are comparisons of the six months ended June
30, 2004 and 2003, unless otherwise specified. Net revenue.Net revenue for the second quarter increased $8.16 million, or
36.6%, and for the first half increased $15.13 million, or 36.0%, due to
increased sales of our neuro products during both 2004 periods. Neuro product
revenue increased 42.8% to a record $27.63 million in the second quarter of
2004 from $19.35 million in 2003, and for the first half neuro product revenue
increased 44.2% to a record $51.86 million in 2004 from $35.98 million in 2003,
primarily due to increased sales of our Genesisfamily of IPG systems. Revenue
from our Renew RF system grew modestly during both the second quarter and first
half of 2004 compared to 2003. Net revenue of our O.E.M. business for the
second quarter decreased slightly to $2.85 million in 2004 from $2.98 million
in 2003 and for the first half, decreased to $5.26 million in 2004 from $6.02
million in 2003 primarily due to lower volume of O.E.M. product sales. We
continue to use more of our O.E.M. manufacturing and development capabilities
for our own increasing needs, and accordingly, O.E.M. revenues may flatten or
decline during fiscal 2004 compared to fiscal 2003. Gross profit.Gross profit for the second quarter increased $6.84 million, or
44.8%, and for the first half increased $13.72 million, or 48.9%, due to the
increase in net revenue discussed above and an improvement in gross profit
margins. Gross profit margins for the second quarter increased to 72.5% in
2004, compared to 68.4% in 2003, and for the first half increased to 73.2% in
2004, compared to 66.8% in 2003 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. In March, September and November
2003, we completed three separate acquisitions of certain operations of our
remaining U.S. distributors and transitioned to a direct sales model in those
associated territories and in April 2004, we completed the acquisition of
certain assets of our Australian distributor and transitioned to a direct sales
model in that territory. This had the effect of improving gross margins in 2004
due to direct sales of product versus sales to distributors at reduced pricing.
Correspondingly, sales and marketing expense increased as we added direct
salespeople. -19-




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Operating expenses.Total operating expenses for the second quarter increased
$4.66 million, or 42.3%, and increased as a percentage of revenue to 51.3% in
2004 from 49.3% in 2003. For the first half, total operating expenses increased
$9.45 million, or 47.3%, and increased as a percentage of revenue to 51.5% in
2004 from 47.6% in 2003. These increased operating expenses during both periods
in 2004 compared to 2003 were primarily due to increased investments in our
sales and marketing capabilities. During late 2003 and early 2004, we added a
total of 41 personnel in our sales organization including sales reps, regional
sales managers and clinical specialists. We expect to leverage this investment
in the next few quarters as our new sales personnel ramp up productivity this
year. Sales and marketing.Sales and marketing expense for the second quarter, as a
percentage of net revenue, increased to 31.0% in 2004 from 28.4% in 2003, and
the expense increased in absolute dollars by $3.1 million. Sales and marketing
expense for the first half, as a percentage of net revenue, increased to 31.5%
in 2004 from 27.4% in 2003, and the expense increased in absolute dollars by
$6.5 million. Increases during both periods in 2004 compared to 2003 were
principally due to higher salary and benefit expense from annual salary
increases and staffing additions in reimbursement, direct sales, clinical
specialists and regional sales managers, higher commission expense from
increased neuro product sales, and higher travel expense due to increased
direct sales activities. As noted above, part of the increase in sales and
marketing expense is attributable to the addition of direct salespeople as a
result of the three acquisitions of certain operations of our remaining U.S.
distributors completed in 2003 and our Australian distributor in April 2004. Research and development.Research and development expense for the second
quarter, as a percentage of net revenue, decreased to 9.4% in 2004 from 10.5%
in 2003, while the expense increased in absolute dollars by $517,000. Research
and development expense for the first half, as a percentage of net revenue,
decreased to 9.1% in 2004 from 9.6% in 2003, while the expense increased in
absolute dollars by $1.1 million. The increase in expense in terms of absolute
dollars during both periods in 2004 compared to 2003 was principally due to
higher salary and benefit expense from staffing additions and annual salary
increases. Our development efforts continue to focus on next-generation IPG
stimulation systems, next-generation RF stimulation systems, an IPG stimulation
system for deep brain stimulation and next generation drug pumps. We have
budgeted $12 million in research and development expense in fiscal 2004 and
expect spending to increase during the second half of 2004 to $6.8 million
compared to $5.2 million in the first half as we begin clinical trials on deep
brain stimulation and migraine headaches. General and administrative.General and administrative expense for the second
quarter, as a percentage of net revenue, increased to 8.9% in 2004 from 8.4% in
2003, and the expense increased in absolute dollars by $841,000. General and
administrative expense for the first half, as a percentage of net revenue,
increased to 8.8% in 2004 from 8.6% in 2003, and the expense increased in
absolute dollars by $1.4 million. The increase in expense during both periods
in 2004 compared to 2003 was principally due to higher salary and benefit
expense from annual salary increases and staffing additions, higher legal
expense including expense associated with our lawsuit against Advanced Bionics,
expense related to compliance with the Sarbanes-Oxley Act of 2002 and higher
depreciation expense. Amortization of intangibles.Amortization expense of intangibles for the second
quarter, as a percentage of net revenue, remained flat in 2004 from in 2003,
and the expense increased in absolute dollars by $173,000. Amortization expense
for the first half, as a percentage of net -20-




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revenue, increased to 2.10% in 2004 from 1.92% in 2003, and the expense
increased in absolute dollars by $393,000. The increase in expense during both
periods in 2004 compared to 2003 was due to additional expense for intangible
assets we acquired in the April 2004 acquisitions of MedTel and microHelix,
additional intangible assets from earn-out consideration as milestones were met
pursuant to the MicroNet acquisition agreement in 2004 and additional
intangible assets we acquired in certain distributor acquisitions during the
second half of 2003. Other income.Other income for the second quarter decreased by $90,000 during
2004 from 2003 principally due to lower yields on invested funds and an expense
in 2004 of $25,500 associated with foreign currency transactions from our
German subsidiary, ANS GmbH and our Australian subsidiary, ANS Australia. For
the first half, other income decreased $150,000 during 2004 from 2003
principally due to lower yields on invested funds and an expense in 2004 of
$54,900 associated with foreign currency transactions from our foreign
subsidiaries in Germany and Australia, which began operations in 2004. Income tax expense.Income tax expense for the second quarter increased
$697,000 in 2004 from 2003 as a result of increased income before taxes. Our
tax rate in the second quarter of 2004 was 35.14% compared to 36.01% in 2003.
For the first half, income tax expense increased $1.37 million in 2004 from
2003 as a result of increased income before taxes. Our tax rate for the first
half of 2004 was 35.14% compared to 36.04% in 2003. Our decreased effective tax
rate during both periods in 2004 compared to 2003 is primarily due to a
research and development tax credit. The effective tax rates reflect a
provision for state taxes, offset by tax-exempt interest income earned on our
cash and cash equivalents, and marketable securities and, in 2004, a research
and development tax credit. Net income.Net income for the second quarter increased $1.40 million, or
47.9%, in 2004 from 2003 primarily due to the positive impact of revenue growth
from increased unit sales of our Genesisand GenesisXPIPG systems and
increased gross margin. Net income per diluted share during the second quarter
increased to $.21 in 2004 from $.14 in 2003. For the six-month period, net
income increased $2.75 million, or 49.6%, in 2004 from 2003 again due to
increased unit sales of IPG systems and increased gross margin. Net income per
diluted share for the six-month period increased to $.39 in 2004 from $.27 in
2003. Liquidity and Capital Resources At June 30, 2004, our working capital increased to $132.43 million from $126.44
million at year-end 2003. The ratio of current assets to current liabilities
was 17.97:1 at June 30, 2004, compared to 11.21:1 at December 31, 2003. Cash,
cash equivalents, and marketable securities totaled $89.56 million at June 30,
2004 compared to $94.80 million at December 31, 2003, a decrease of $5.24
million principally due to $4.29 million used to reduce accounts payable and
accrued salary and benefit costs, $5.32 million used to finance interim
construction costs of our new corporate headquarters facility, $1.09 million
used in the MedTel acquisition and $2.05 million used in the micoHelix
acquisition. We increased our investment in inventories from year-end 2003 by $866,000. Of
such increase, approximately $204,000 was inventory we built in anticipation of
our move to our new corporate headquarters facility because regulatory process
validation is required before product could be manufactured in and shipped from
the new facility. The new facility has been validated and we have initiated
manufacturing and shipping from that facility. The remainder of the increase of
$662,000 was inventory in the amount of $171,000 we acquired in the microHelix
acquisition -21-




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and inventory totaling $491,000 from the MedTel acquisition. We anticipate
inventory investments will decrease during the second half of fiscal 2004. Our investment in trade accounts receivable increased from year-end 2003 by
$5.15 million due to the increase in sales of our neuromodulation products and
an increase in our days sales outstanding. Days sales outstanding increased to
67 days at June 30, 2004 from 64 days at December 31, 2003 due to higher sales
to third party payors, receivables from going direct in Australia and
receivables generated from microHelix O.E.M. sales after we acquired microHelix
in late April 2004. Excluding expenditures discussed below relating to the construction of our new
facility, we spent $5.2 million during the six months ended June 30, 2004 for
capital expenditures, which includes $1.9 million for new office furniture and
equipment for our new facility discussed below. The remainder of the capital
expenditures during the six months ended June 30, 2004, primarily related to
tooling and equipment for current products as well as new products being
developed. We completed our relocation to our new corporate headquarters facility in
Plano, Texas in July 2004, prior to the expiration of our current lease in
August 2004. The new facility consists of 143,000 square feet and was designed
to accommodate planned growth within a five-year horizon. The construction cost
of the facility is approximately $15 million. We have funded the interim
construction costs from our cash reserves. For the six months ended June 30,
2004, we spent $5.32 million on interim construction costs for the new
facility, and through June 30, 2004, we have spent in total $14.14 million.
While we have not yet determined the method by which we will permanently
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 $4.37 million of cash during the six months ended June 30, 2004,
from the exercise of employee and director stock options to purchase 444,054
shares of our common stock. On June 1, 2004, we issued a press release announcing that our Board of
Directors approved the repurchase of up to 1,000,000 shares of our common
stock. These repurchases will be made from time to time in open market
purchases or privately negotiated transactions, subject to price and
availability, and financed out of working capital. We did not repurchase any
shares of our common stock during the quarter ended June 30, 2004. Liquidity may also be enhanced based on our ability to utilize all or part of a
net operating loss carryforward of $4.3 million to offset future taxable
income. We acquired $3.4 million of the net operating loss carryforward in
connection with the MicroNet 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 acquisition to reduce its federal taxable income is subject to these
rules. Provided the Company 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 immediately use the net operating
loss carryforwards to reduce taxable income in future periods. The total amount
of -22-




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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. Based on current estimates and assumptions,
we expect to utilize at least approximately $700,000 in net operating loss
carryforwards per twelve-month 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 stock option exercises. Exercises of nonqualified stock options, and
exercises of incentive stock options followed by disqualifying dispositions
of the underlying common stock within one year following exercise generate
compensation expense for tax purposes in the year of exercise or disposition,
as the case may be. During the six months ended June 30, 2004, we generated a
$3.43 million tax benefit related to nonqualified stock option exercises and
disqualifying dispositions of common stock acquired on exercise of incentive
stock options, which will be utilized along with the prior year income tax
receivable to offset current year taxes payable. On April 1, 2004, we acquired certain assets of our exclusive distributor of
our neuromodulation devices for Australia, MedTel. With this acquisition, we
are now selling direct in the Australian marketplace. Two sales professionals
from MedTel joined our sales force and we plan to hire additional direct sales
personnel as needed. We paid cash of $1.09 million to acquire the assets. On April 21, 2004, we acquired the assets of microHelixs Cable and Wire
Division, which is operated out of Portland, Oregon. Excluding related
acquisition costs, we paid approximately $2 million in cash and assumed
liabilities of approximately $132,000. microHelix previously supplied coated
fine wire, antennas, and certain other products to us and our HDI subsidiary.
The acquisition represents a vertical integration of an important component
supplier and provides us with additional engineering resources and intellectual
property for the design and development of new products, notably leads,
extensions, trial cables and related products. Thirty-three personnel from
microHelix joined us upon consummation of the transaction. On April 21, 2004, we filed a lawsuit in U.S. District Court for the Eastern
District of Texas, Sherman Division, asserting that Advanced Bionics
Corporation infringes a patent we own and has misappropriated certain of our
trade secrets. We estimate that the pre-tax costs associated with the lawsuit
will be approximately $400,000 per quarter. 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 provided by operations was $4.14 million in 2004 compared to $3.50
million in 2003, an increase of $640,000. While net income increased by $2.75
million for the six-month period in 2004 compared to 2003, net cash provided by
operations increased by only $640,000 as we used more cash in 2004 for
increases in accounts receivable and prepaid expenses and for the reduction of
accounts payable and accrued expenses. -23-




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Net cash used by investing activities was $12.60 million in 2004 compared to
$12.23 million in 2003, an increase of $364,000. During 2004, we used an
additional $4.15 million for construction of our new corporate headquarters
facility. Net cash provided by financing activities was $4.37 million in 2004 compared to
$3.61 in 2003, an increase of $754,000 due to higher cash received from the
exercise of stock options. Currency Fluctuations Our international sales are denominated in U.S. dollars with the exception of
Germany and Australia, where we began selling direct on January 1, 2004 and
April 1, 2004, respectively. Sales are denominated in Euros in Germany and
Australian dollars in Australia. 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 sold, although we do not believe currency fluctuations have had a material
effect on the Companys results of operations to date. Off-Balance Sheet Arrangements The Company does not have any obligations which meet the definition of an
off-balance sheet arrangement and which have or are reasonably likely to have a
material adverse effect on the Companys financial statements. 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 27A of the Securities Act of 1933 and 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, although not all forward-looking statements contain
such identifying words. 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:  
    
    on April 28, 2004, Advanced Bionics Corporation announced that it had received FDA approval of its rechargeable implantable
SCS system for the treatment of chronic pain. In June 2004, Advanced Bionics was acquired by Boston Scientific Corporation.
Advanced Bionics and Boston Scientific have announced that they plan to commercially launch their SCS system for the
treatment of chronic pain in the third quarter of 2004. The entrance into the neuromodulation market of new competitors,
including Advanced Bionics/Boston Scientific, may make it more difficult to compete in this market -24-




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
    
    the launch of new competitive products by Advanced Bionics, Medtronic, Inc. or others, as well as other market factors,
could impede growth in or reduce sales of our IPG and RF systems, which would adversely affect our revenues and
profitability
    
    failure of our Genesisand GenesisXPIPG systems to gain and maintain market acceptance would adversely affect our revenue
growth and profitability
    
    because our main competitor, Medtronic, Inc., has significantly greater resources than we do 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
    
    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
    
    the cost, uncertainty and other risks inherent in our intellectual property litigation against Advanced Bionics Corporation
    
    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
    
    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, Medtronic, Inc., 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, including a competitive rechargeable IPG, 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 businesses, 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 -25-




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
    
    our manufacturing operations are conducted at three locations, and a disaster at any of these facilities could result in a
prolonged interruption of our business
    
    general economic risks
    
    other risks detailed from time to time in our SEC public filings Certain of the foregoing risks are described in more detail in our Annual
Report on Form 10-K for the year ended December 31, 2003. 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 June 30, 2004, 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 for the year
ended December 31, 2003. 
 ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, an evaluation was carried
out by our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934). Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and procedures were
effective. There were no changes in the Companys internal control over financial
reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of
1934) that occurred during the Companys most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. -26-




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PART II OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS On April 21, 2004, the Company filed a lawsuit in the U.S. District Court for
the Eastern District of Texas, Sherman Division (Docket No.
4:404-CV-00131-PNB-DDB) against Advanced Bionics Corporation, asserting claims
of patent infringement, misappropriation of trade secrets, tortious
interference with contract, misappropriation of time, labor, skill, and money,
violation of the Texas Theft Liability Act, conversion and constructive trust.
The lawsuit alleges, among other things, that Advanced Bionics is infringing
United States Patent No. 4,793,353 entitled Non-Invasive Multiprogrammable
Tissue Stimulator And Method. In addition, the lawsuit alleges that Advanced
Bionics hired a former ANS employee to aid in the design, development and
manufacture of its implantable stimulation lead, that Advanced Bionics
misappropriated the former employees knowledge of ANS confidential,
proprietary, and trade secret information with respect to ANS implantable
stimulation leads, and that this enabled Advanced Bionics to unfairly compete
with ANS. The lawsuit seeks injunctive relief, compensatory and punitive
damages, attorneys fees and costs. On June 7, 2004, Advanced Bionics filed a
lawsuit with the United States District Court, Central District of California,
Case No. CV04-4054ABC, seeking a declaratory judgment that it is not infringing
ANS patent No. 4,793,353 (the subject of ANS current patent infringement
claim against Advanced Bionics) and that such patent is invalid and
unenforceable. ANS has not been served in the declaratory judgment matter,
however. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES Share Repurchase Program On June 1, 2004, the Company issued a press release announcing that our Board
of Directors approved the repurchase of up to 1,000,000 shares of our common
stock. These repurchases will be made from time to time in open market
purchases or privately negotiated transactions, subject to price and
availability, and financed out of working capital. A copy of this press release
was filed as an exhibit to the Companys Form 8-K filed on June 2, 2004. The
Company did not repurchase any shares of its common stock during the quarter
ended June 30, 2004. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its 2004 Annual Meeting of Shareholders on May 26, 2004 at the
Companys corporate office in Plano, Texas. At the Annual Meeting, the
following matters as proposed in the Proxy Statement dated as of April 16,
2004, were voted on and approved: -27-




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Votes For
    
    Votes Against
    
    Votes WithheldProposal
    
    Nominee
    
    Nominee
    
    From Nominee1)
    
    Election of sevendirectors for aone-year termChristopher G. Chavez
    
    
    17,433,312
    
    
    
    
    
    
    
    1,061,856Robert C. Eberhart, Ph.D.
    
    
    17,565,140
    
    
    
    
    
    
    
    930,028Joseph E. Laptewicz
    
    
    17,471,442
    
    
    
    
    
    
    
    1,023,726J. Philip McCormick
    
    
    17,302,123
    
    
    
    
    
    
    
    1,193,045Hugh M. Morrison
    
    
    17,134,748
    
    
    
    
    
    
    
    1,360,420Richard D. Nikolaev
    
    
    17,468,456
    
    
    
    
    
    
    
    1,026,712Michael J. Torma, M.D.
    
    
    17,557,220
    
    
    
    
    
    
    
    937,948
 Votes For
    
    Votes AgainstProposal
    
    Proposal
    
    Proposal
    
    Votes Abstained2)
    
    Approval of an amendmentto the Articles of Incorporationto increase the authorizedshares of common stock from25,000,000 to 100,000,000
    
    
    
    12,029,756
    
    
    
    6,459,588
    
    
    
    5,824
 Votes For
    
    Votes Against
    
    VotesProposal
    
    Proposal
    
    Proposal
    
    Abstained
    
    Non-Vote3)
    
    Approval of the AdvancedNeuromodulation Systems, Inc.2004 Stock Incentive Plan
    
    
    11,531,227
    
    
    
    3,700,345
    
    
    
    34,731
    
    
    
    3,228,865
 There were present at the Annual Meeting in person or by proxy, shareholders
holding 18,495,168 shares, or approximately 92.35% of the eligible voting
shares. 
 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, as amended and restated (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)
 -28-




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Exhibit 10.30  Advanced Neuromodulation Systems, Inc. 2004 Stock
Incentive Plan (4)Exhibit 31.1  Certification of the Chief Executive Officer
Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(5)Exhibit 31.2  Certification of the Chief Financial Officer
Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(5)Exhibit 32.1  Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (6)Exhibit 32.2  Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (6)(b)
    
    The Company furnished a report on Form 8-K on April 22, 2004,
providing under Item 5. Other Events, a press release issued by the
Company on April 22, 2004 announcing the completion of the
acquisition of microHelix Inc., for approximately $2 million in cash
and assumed liabilities and under Item 9. Regulation FD Disclosure
and Item 12. Results of Operations and Financial Condition, a press
release issued by the Company on April 22, 2004 disclosing
information regarding our results of operations and financial
condition for the first quarter ended March 31, 2004 and our outlook
for the remainder of 2004.The Company furnished a report on Form 8-K on June 2, 2004,
providing under Item 9. Regulation FD Disclosure, a press release
issued by the Company on June 1, 2004, announcing that our Board of
Directors approved the repurchase of up to 1,000,000 shares of our
common stock. The release stated that repurchases will be made from
time to time in open market purchases or privately negotiated
transactions, subject to price and availability, and financed out
of working capital.The Company furnished a report on Form 8-K on June 8, 2004,
providing under Item 9. Regulation FD Disclosure, a press release
issued by the Company on June 7, 2004, that contained the comments
of our President and Chief Executive Officer, Christopher G.
Chavez, on Boston Scientific Corporations announcement that it is
acquiring Advanced Bionics Corporation.
   (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 as an Exhibit to the Definitive Proxy Statement on Schedule 14A
dated April 16, 2004, and incorporated herein by reference.(5)
    
    Filed herewith.(6)
    
    Furnished herewith. -29-




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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: August 9, 2004
    By:
    /s/ F. Robert Merrill IIIF. Robert Merrill III
Executive Vice President, Finance

Chief Financial Officer and Treasurer -30-




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EXHIBIT INDEX Exhibit 3.1
    
    Articles of Incorporation, as amended and restated (1)Exhibit 3.2
    
    Bylaws, as amended and restated (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 10.30
    
    Advanced Neuromodulation Systems, Inc. 2004 Stock Incentive Plan (4)Exhibit 31.1
    
    Certification of the Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (5)Exhibit 31.2
    
    Certification of the Chief Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (5)Exhibit 32.1
    
    Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (6)Exhibit 32.2
    
    Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (6)
   (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 as an Exhibit to the Definitive Proxy Statement on Schedule 14A
dated April 16, 2004, and incorporated herein by reference.(5)
    
    Filed herewith.(6)
    
    Furnished herewith.