# SECURITIES AND EXCHANGE COMMISSION

# Washington, D.C. 20549

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# FORM 10-Q

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# [X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THESECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30,
2001

OR

# [  ] TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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Commission file number 0-10521

# ADVANCED NEUROMODULATION SYSTEMS, INC.

Incorporated pursuant to the Laws of the State of
Texas

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Internal Revenue Service  Employer
Identification No. 75-1646002

6501 Windcrest Drive, Plano, Texas 75024

(972) 309-8000

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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X]     No [  ]

The total number of shares of the registrants Common
Stock, $.05 par value, outstanding on November 2, 2001 was 8,936,637

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Advanced Neuromodulation Systems, Inc. and
Subsidiaries

Table of Contents

|PART I.    FINANCIAL
INFORMATION | 2
|-------------------------------- | -
|                                 |  

| | Item 1. | Financial Statements | 
| | ------- | -------------------- | 
| |         |                      | 

| | Condensed Consolidated Balance Sheets
(Unaudited)    September 30, 2001 and December 31, 2000                                                                   | 3-4 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----
| |                                                                                                                                                                 |     
| | Condensed Consolidated Statements of Income (Unaudited)
    For the Three Months and Nine Months Ended
    September 30, 2001 and 2000                          | 5   
| |                                                                                                                                                                 |     
| | Condensed Consolidated Statements of Cash Flows (Unaudited)
    For the Nine Months Ended September 30, 2001 and 2000                                           | 6   
| |                                                                                                                                                                 |     
| | Condensed Consolidated Statements of Stockholders Equity
    (Unaudited) For the Year Ended December 31, 2000
    and the Nine Months Ended September 30, 2001 | 7   
| |                                                                                                                                                                 |     
| | Notes to Condensed Consolidated Financial Statements                                                                                                            | 8-14
| |                                                                                                                                                                 |     

| | Item 2. | Management's Discussion and Analysis of Financial Condition
     and Results of Operations | 15-21
| | ------- | ------------------------------------------------------------------------------------------ | -----
| |         |                                                                                            |      
| | Item 3. | Quantitative and Qualitative Disclosures About Market Risk                                 | 21   
| |         |                                                                                            |      

|Part II.   Other
Information | 22
|---------------------------- | --
|                             |   

| | Item 6.    Exhibits and Reports on Form 8-K | 22
| | ------------------------------------------- | --
| |                                            

|Signatures | 23
|---------- | --

Page 1

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PART I

FINANCIAL INFORMATION

Page 2

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|Item 1. | Financial Statements
|------- | --------------------

Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Balance Sheets (Unaudited)September
30, 2001 and December 31, 2000

`September 30,  December 31,
Assets                                                    2001          2000
------                                               ------------- -------------
Current assets:
   Cash and cash equivalents                         $  8,815,772  $  9,528,721
   Certificates of deposit with maturities
     over 90 days at purchase                                 ---     1,040,000
   Marketable securities                                1,652,221     1,038,317

   Receivables:
     Trade accounts, less allowance for doubtful
       accounts of $153,192 in 2001
       and $213,249 in 2000                             5,720,240     5,164,231
     Interest and other                                   231,240       734,550
                                                     ------------ -------------
         Total receivables                              5,951,480     5,898,781
                                                     ------------- -------------
   Inventories:
     Raw materials                                      4,636,769     3,432,335
     Work-in-process                                    1,345,927     1,075,111
     Finished goods                                     3,313,097     2,580,193
                                                     ------------- -------------
         Total inventories                              9,295,793     7,087,639
                                                     ------------- -------------

   Deferred income taxes                                1,376,794     1,282,072
   Refundable income taxes                                    ---       359,953
   Prepaid expenses and other current assets              915,793     1,064,850
                                                     ------------- -------------
         Total current assets                          28,007,853    27,300,333
                                                     ------------- -------------

Equipment and fixtures:
   Furniture and fixtures                               3,224,068     2,900,149
   Machinery and equipment                              7,920,584     6,585,774
   Leasehold improvements                               1,581,623     1,525,542
                                                     ------------- -------------
                                                       12,726,275    11,011,465
   Less accumulated depreciation and amortization       5,833,451     4,390,113
                                                     ------------- -------------
         Net property, plant and equipment              6,892,824     6,621,352
                                                     ------------- -------------

Cost in excess of net assets acquired, net of
   accumulated amortization of $3,265,276 in 2001
   and $2,847,824 in 2000                               7,546,388     7,963,840
Patents, net of accumulated amortization of
   $919,566 in 2001 and $674,220 in 2000                5,483,424     3,104,254
Purchased technology from acquisitions, net of
   accumulated amortization of $1,733,334 in 2001
   and $1,533,334 in 2000                               2,266,666     2,466,666
Tradenames, net of accumulated amortization of
   $812,489 in 2001 and $718,745 in 2000                1,687,511     1,781,255
Other assets, net of accumulated amortization of
   $341,944 in 2001 and $221,320 in 2000                  525,366       326,866
                                                     ------------- -------------
                                                     $ 52,410,032  $ 49,564,566
                                                     ============= =============`

Page 3

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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Balance Sheets (Unaudited)September
30, 2001 and December 31, 2000

`September 30,  December 31,
Liabilities and Stockholders' Equity                      2001          2000
------------------------------------                 ------------- -------------
Current liabilities:
   Accounts payable                                  $  1,410,729  $  1,144,103
   Customer deposits                                    1,017,271       543,885
   Accrued salary and employee benefit costs            1,424,853     1,293,065
   Accrued tax abatement liability                        969,204       969,204
   Warranty reserve                                       471,557       422,182
   Short-term obligations                                     ---       131,500
   Current maturities of long-term notes payable           51,199        29,601
   Income taxes payable                                       ---        67,240
   Obligations under capital leases                        27,603        69,918
   Other accrued expenses                                 438,465       410,811
                                                     ------------- -------------
         Total current liabilities                      5,810,881     5,081,509
                                                     ------------- -------------

Deferred income taxes                                   2,254,294     2,354,170
Long-term notes payable                                   150,888       211,681
Non-current customer deposits                                 ---     1,475,393

Commitments and contingencies

Stockholders' equity:
   Common stock of $.05 par value. Authorized
     25,000,000 shares; issued 8,935,766 shares
     in 2001 and 8,883,059 in 2000                        446,788       444,153
   Additional capital                                  36,723,185    34,469,471
   Retained earnings                                    7,029,041     6,539,223
   Accumulated other comprehensive income (loss),
     net of tax benefit of $2,602 in 2001
     and $42,883 in 2000                                   (5,045)      (83,241)
   Cost of common shares in treasury;
     119,100 shares in 2000                                   ---      (927,793)
                                                     ------------- -------------
         Total stockholders' equity                    44,193,969    40,441,813


                                                     ------------- -------------
                                                     $ 52,410,032  $ 49,564,566
                                                     ============= =============

See accompanying notes to condensed consolidated financial statements.`

Page 4



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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2001 and 2000

`Three Months Ended     Nine Months Ended
                                     September 30,         September 30,
                                ----------------------- ------------------------
                                    2001        2000        2001        2000
                                ----------- ----------- ----------- ------------
Net revenue                     $ 9,899,973 $ 8,176,084 $27,445,504 $23,961,696
Cost of revenue                   4,069,017   3,869,060  11,576,461  11,041,544
                                ----------- ----------- ----------- ------------
         Gross profit             5,830,956   4,307,024  15,869,043  12,920,152
                                ----------- ----------- ----------- ------------
Operating expenses:
   Research and development       1,268,681     908,232   3,649,493   2,832,805
   Marketing                      2,409,820   1,738,141   6,546,649   5,063,777
   Amortization of goodwill         139,151     139,151     417,452     417,452
   Amortization of
    other intangibles               243,612     169,217     659,714     505,016
   General and administrative       986,371   1,121,746   2,948,714   3,174,973
                                ----------- ----------- ----------- ------------
                                  5,047,635   4,076,487  14,222,022  11,994,203
                                ----------- ----------- ----------- ------------
         Income from
          operations                783,321     230,537   1,647,021     925,949
                                ----------- ----------- ----------- ------------
Other income (expenses):
   Acquisition related costs            ---         ---    (483,766)        ---
   Interest expense                  (5,739)    (12,474)    (22,411)    (45,188)
   Interest and other income         85,797     136,368     388,078     439,828
                                ----------- ----------- ----------- ------------
                                     80,058     123,894    (118,099)    394,640
                                ----------- ----------- ----------- ------------
         Income before
          income taxes              863,379     354,431   1,528,922   1,320,589
Income taxes                        388,135     156,541     691,425     583,264
                                ----------- ----------- ----------- ------------
         Net income             $   475,244 $   197,890 $   837,497 $   737,325
                                =========== =========== =========== ============

Net income per share:
                                =========== =========== =========== ============
         Basic                  $      .05  $      .02  $      .09  $      .09
                                =========== =========== =========== ============
         Diluted                $      .05  $      .02  $      .08  $      .08
                                =========== =========== =========== ============

See accompanying notes to condensed consolidated financial statements.`

Page 5

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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2001 and 2000

`Nine Months Ended
                                                          September 30,
                                                     ---------------------------
                                                          2001          2000
                                                     ------------- -------------
Cash flows from operating activities:
   Net income                                        $    837,497  $    737,325
   Adjustments to reconcile net income to
    net cash provided by operating activities:
      Depreciation and amortization                     2,489,150     2,146,631
      Gain on sale of  marketable securities                  ---       (36,727)
      Deferred income taxes                              (176,131)     (182,730)
      Changes in operating assets and liabilities:
        Receivables                                      (249,162)     (500,012)
        Inventories                                    (2,111,674)      417,720
        Refundable income taxes                           359,953           ---
        Prepaid expenses and other assets                 334,242       417,208
        Customer deposits                                (732,335)     (968,735)
        Income taxes payable                              359,632       (50,641)
        Accounts payable                                  186,952    (1,169,250)
        Accrued expenses                                  264,920      (535,579)
                                                     ------------- -------------
           Total adjustments                              725,547      (462,115)
                                                     ------------- -------------
           Net cash provided by operating activities    1,563,044       275,210
                                                     ------------- -------------

Cash flows from investing activities:
   Purchase of certificates of deposit with
    maturities over 90 days                                   ---    (1,425,000)
   Proceeds from certificates of deposits with
    maturities over 90 days                             1,139,000           ---
   Purchases of marketable securities                  (2,497,518)          ---
   Proceeds from sales of marketable securities         1,903,092       142,899
   Additions to patents and intangible assets            (459,632)     (101,079)
   Additions to equipment and fixtures                 (1,757,640)     (915,114)
                                                     ------------- -------------
           Net cash used in investing activities       (1,672,698)   (2,298,294)
                                                     ------------- -------------

Cash flows from financing activities:
   Proceeds from long-term obligations                        ---       270,000
   Payment of obligations under capital leases            (37,517)      (59,382)
   Payment of short-term obligations                     (129,333)      (26,177)
   Payment of long-term obligations                       (35,442)      (23,831)
   Exercise of stock options                              271,441       559,009
                                                     ------------- -------------
           Net cash provided by financing activities       69,149       719,619
                                                     ------------- -------------

Net decrease in cash and cash equivalents                 (40,505)   (1,303,465)
Net cash used by Hi-tronics in December 2000
   (see Note 1)                                          (672,444)          ---
Cash and cash equivalents at beginning of year          9,528,721     9,204,881
                                                     ------------- -------------
Cash and cash equivalents at September 30            $  8,815,772  $  7,901,416
                                                     ============= =============

Supplemental cash flow information is presented
   below:
Income taxes paid                                    $    690,000  $    836,304
                                                     ============= =============
Interest paid                                        $     19,270  $     55,037
                                                     ============= =============

Non-cash activity:
Stock issued for patents and intangible assets       $  2,426,662  $        ---
                                                     ============= =============

See accompanying notes to condensed consolidated financial statements.`

Page 6

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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Statements of Stockholders Equity
(Unaudited)

`(Wide table - columns continue on following page)

                                Common Stock           Additional     Retained
                             Shares        Amount       Capital       Earnings
                         ------------- ------------- ------------- -------------
Balance at
December 31, 1999           8,883,059  $    444,153  $ 34,598,112  $  5,706,765
   Net income                     ---           ---           ---       832,458
   Adjustment to
     unrealized
     losses on
     marketable                   ---           ---           ---           ---
     securities

   Comprehensive
     Income

   Issuance of 32,900
     shares from
     treasury for
     private placement            ---           ---       100,000           ---
   Issuance of
     337,941 shares
     from treasury
     for stock option             ---           ---      (832,999)          ---
     exercises
   Tax benefit from
     employee stock
     option exercises             ---           ---       604,358           ---
                         ------------- ------------- ------------- -------------
Balance at
December 31, 2000           8,883,059       444,153    34,469,471     6,539,223
   Net income                     ---           ---           ---       837,497
   Net loss of
     Hi-tronics for
     December 2000
     (see Note 1)                 ---           ---           ---      (347,679)
   Adjustment to
     unrealized
     losses on
     marketable                   ---           ---           ---           ---
     securities

   Comprehensive
     Income

   Compensation
     expense
     resulting from
     changes to
     Hi-tronics stock
     options in                   ---           ---        37,029           ---
     December 2000
   Issuance of
     119,100 shares from
     treasury for                 ---           ---     1,498,869           ---
     acquisition
   Issuance of
     shares  for
     stock option              52,707         2,635       268,806           ---
     exercises
   Tax benefit from
     employee stock
     option exercise              ---           ---       449,010           ---

                         ------------- ------------- ------------- -------------
Balance at
September 30, 2001          8,935,766  $    446,788  $ 36,723,185  $  7,029,041
                         ============= ============= ============= =============`

Page 7

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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Statements of Stockholders Equity
(Unaudited)

`(Table Continued)            Other                       Total
                         Comprehensive   Treasury    Stockholders'
                         Income (Loss)     Stock        Equity
                         ------------- ------------- -------------
Balance at
December 31, 1999        $   (222,581) $ (3,990,242) $ 36,536,207
   Net income                     ---           ---       832,458
   Adjustment to
     unrealized
     losses on
     marketable
     securities               139,340           ---       139,340
                                                     -------------
   Comprehensive
     Income                                               971,798
                                                     -------------
   Issuance of 32,900
     shares from
     treasury for
     private placement            ---       300,000       400,000
   Issuance of
     337,941 shares
     from treasury
     for stock option
     exercises                    ---     2,762,449     1,929,450
   Tax benefit from
     employee stock
     option exercises             ---           ---       604,358
                         ------------- ------------- -------------
Balance at
December 31, 2000             (83,241)     (927,793)   40,441,813
   Net income                     ---           ---       837,497
   Net loss of
     Hi-tronics for
     December 2000
     (see Note 1)                 ---           ---      (347,679)
   Adjustment to
     unrealized
     losses on
     marketable
     securities                78,196           ---        78,196
                                                     -------------
   Comprehensive
     Income                                               568,014
                                                     -------------
   Compensation
     expense
     resulting from
     changes to
     Hi-tronics stock
     options in                   ---           ---        37,029
     December 2000
   Issuance of
     119,100 shares from
     treasury for
     acquisition                  ---       927,793     2,426,662
   Issuance of
     shares  for
     stock option
     exercises                    ---           ---       271,441
   Tax benefit from
     employee stock
     option exercise              ---           ---       449,010

                         ------------- ------------- -------------
Balance at
September 30, 2001       $     (5,045) $        ---  $ 44,193,969
                         ============= ============= =============

See accompanying notes to condensed consolidated financial statements.`

Page 7

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

|(1) | Business/New Accounting Standards                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS") designs,
develops, manufactures and markets implantable medical device systems used to
manage chronic intractable pain and other disorders of the central nervous
system. ANS revenues are derived primarily from sales throughout the United
States, Europe and Australia.                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | On January 2, 2001, the Company acquired the assets (primarily intellectual
property consisting of patents) of Implantable Devices Limited Partnership (IDP)
and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota
companies, for 119,100 shares of common stock valued at $2.43 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | On January 2, 2001, the Company completed the acquisition of Hi-tronics
Designs, Inc. (HDI), a privately-held contract developer and original equipment
manufacturer (O.E.M.) of electro-mechanical devices with headquarters in Budd
Lake, New Jersey. The Company acquired all of HDI's outstanding stock through a
merger in exchange for 1,104,725 shares of ANS common stock. The transaction was
accounted for on a pooling of interests basis and accordingly prior periods have
been restated. HDI developed and is the manufacturer of the Company's totally
implantable pulse generator (IPG) and is also the manufacturer of the
transmitter used with the Company's Renew® radio-frequency spinal cord
stimulation system.                                                  
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | Prior to the Company's acquisition of HDI, HDI's fiscal year ended on
November 30. The Condensed Consolidated Balance Sheet at December 31, 2000
combines the Balance Sheet of HDI at November 30, 2000 with the Balance Sheet of
the Company at December 31, 2000. Beginning in 2001, the fiscal year-ends have
been conformed to December 31. As a result, the results of operations of HDI for
the one-month period ending December 31, 2000 have been recorded directly to
retained earnings in the Condensed Consolidated Statement of Stockholders'
Equity for the period ended September 30, 2001 and are not reflected in the
Condensed Consolidated Statements of Income. Summary operating results of
HDI for this one-month period ending December 31, 2000, were as follows:

`Net revenue                                  $  119,481
                  Loss before income tax benefit               $ (591,600)
                  Net loss                                     $ (347,679)

        For the one-month period ended December 31, 2000, cash flows
           for HDI were as follows:

                  Net cash used by operating activities        $ (647,210)
                  Net cash used by investing activities        $  (14,516)
                  Net cash used by financing activities        $  (10,718)
                                                               -----------
                           Net decrease in cash                $ (672,444)
                                                               -----------`

Page 8

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

|    | 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 and other
users who then bill various third party payers including Medicare, Medicaid,
private insurance companies and managed care organizations. These third party
payers reimburse fixed amounts for services based on a specific diagnosis. The
impact of changes in third party payer 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 June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS 133, as amended by SFAS 138, is effective
for fiscal years beginning after June 15, 2000. The adoption of SFAS 133 as of
January 1, 2001 did not have a material impact on the financial position or
results of operations of the Company because the Company has no derivatives or
hedges.                                  
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|    | In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations" and
Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and
Other Intangible Assets." SFAS 141 and SFAS 142 are effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill and intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests in accordance with the statements. Other
intangible assets will continue to be amortized over their useful lives. The
Company is currently reviewing the impact of SFAS 141 and SFAS 142 and will be
performing a fair-value analysis at a later date in connection with the adoption
of SFAS 142 on January 1, 2002.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(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.                                                                                                                          

Page 9

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Advanced Neuromodulation Systems, Inc. and
SubsidiariesNotes 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, 2000 Annual Report on Form 10-K. The results of
operations for the period ended September 30, 2001 are not necessarily
indicative of operations for the full year.                                                                                                                     
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    | The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.                                                                                                                                                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(3) | Notes Payable                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    | In connection with the acquisition of HDI (see Note 1), the Company acquired
responsibility for a note payable with a principal balance of $202,087 at
September 30, 2001. The note was entered into during March 2000, has a five-year
term, and bears interest at a fixed rate of 9 percent per annum. The monthly
installments for principal and interest are $5,623. The loan is collateralized
by the equipment purchased from the proceeds of the note and accounts receivable
of HDI. Maturities of the note payable are as follows: $12,374 in 2001, $52,373
in 2002, $57,357 in 2003, $62,797 in 2004 and $17,186 in 2005.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(4) | Marketable Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|    | The following is a summary of available-for-sale securities at September 30,
2001:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

`Gross       Gross
                                            Unrealized  Unrealized    Estimated
                                    Cost       Gains       Losses    Fair Value
                                ----------- ----------- ----------- ------------
     Real estate
       investment trust         $   97,682  $      ---  $   16,682  $    81,000
     Investment grade
       municipal bonds           1,562,186       9,518         483    1,571,221
                                ----------- ----------- ----------- ------------
                                $1,659,868  $    9,518  $   17,165  $ 1,652,221
                                =========== =========== =========== ============`

| | Estimated fair value for the real estate investment trust are
determined by the closing prices as reported on the New York Stock Exchange at
each financial reporting period. In the case of the investment grade municipal
bonds, the brokerage firms holding such bonds provide the values at each
reporting period by utilizing a standard pricing service.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                               
| | At September 30, 2001, no individual security represented more than 25
percent of the total portfolio or 1 percent of total assets. The Company did not
have any investments in derivative financial instruments at September 30, 2001.                                                                                                                       

Page 10

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

|(5) | Commitments and Contingencies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    | In February 1999, the Company entered into a sixty-three month lease
agreement on 40,000 square feet of space located in the North Dallas area. Under
the terms of the lease agreement the monthly rental rate for the remaining term
of the lease is $48,308. The monthly rental rate includes certain operating
expenses such as property taxes on the facility, insurance, landscape and
maintenance and janitorial services. The Company also has a right of
first refusal to acquire the facility.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    | 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 8,800 square feet of office space that is used for administration, design
engineering, drafting, documentation and regulatory affairs. The lease is on a
month-to-month basis at a monthly rental rate of $10,891. The Company also
leases 15,000 square feet of space in Hackettstown, New Jersey used for the
O.E.M. manufacturing operations. The Hackettstown lease, which expires on
December 31, 2001, has a monthly rental rate of $9,636 and is renewable for
three additional one-year periods. In addition, during January 2001, the Company
leased 2,200 square feet of additional space in the Hackettstown facility
adjacent to the 15,000 square feet of manufacturing space. The lease on the
2,200 square feet expires on June 30, 2002 and has a monthly rental rate of
$2,269. All of the New Jersey monthly lease rates include certain operating
expenses such as property taxes, insurance, utilities, landscape, and
maintenance and janitorial services.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    | Other than the facility leases discussed above, the Company has no material
commitments under noncancelable operating leases at September 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    | The Company is a defendant to product liability litigation related to ANS
implantable stimulation devices. Product liability insurers have assumed
responsibility for defending the Company against these claims. While
historically product liability claims for ANS stimulation devices have not
resulted in significant monetary liability for 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 or that the
Company's stimulation business and future ANS product lines will not be
adversely affected by these product liability claims.                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    | In June 2001, HDI settled a contractual dispute with a former customer,
Cyberonics Inc., related to the development and manufacture of components for
the Cyberonics NCP System. Under the settlement agreement, HDI received a cash
payment of $300,000 and title to certain equipment valued at approximately
$100,000 to settle accounts receivable, development and inventory claims. Of the
$400,000 settlement, $133,000 was applied to accounts receivable on the HDI
balance sheet. The remaining $267,000 was for the sale of inventory on hand and
was recorded as net revenue on the Condensed Consolidated Statements of
Operations for the nine months ended September 30, 2001 and resulted in a
$215,000 pretax profit after expensing the cost of the inventory and reversing
inventory reserves previously provided. In addition, HDI and Cyberonics entered
a License Agreement under which each party's continuing rights to intellectual
property were defined.                                                                                                                                                            

Page 11

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

|    | Except for the product liability claims 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(6) | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    | The Company recorded income tax expense during the three months ended
September 30, 2001 and 2000, of $388,135 and $156,541, an overall effective tax
rate of 45.0 percent and 44.2 percent, respectively. For the nine months ended
September 30, 2001 and 2000, the Company recorded income tax expense of $691,425
and $583,264, an overall effective tax rate of 45.2 percent in the 2001 period
and 44.2 percent in the 2000 period. The Company's expense for amortization of
costs in excess of net assets acquired (goodwill) is not deductible for tax
purposes, and, when combined with a provision for state taxes, results in the
higher effective tax rate for both the three month and nine month periods ended
September 30, 2001 and 2000 compared to the U.S. statutory rate for corporations
of 34 percent. In addition, approximately $234,000 of the $484,000 of costs
incurred in the acquisition of HDI recorded in the nine month period ended
September 30, 2001 are not deductible for tax purposes, which also contributed
to the higher effective tax rate during 2001 compared to the U.S. statutory rate
of 34 percent.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(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        Nine Months Ended
                                     September 30,             September 30,
                                ----------------------- ------------------------
                                   2001        2000        2001         2000
                                ----------- ----------- ----------- ------------
    Weighted-average shares
     outstanding (basic shares)  8,932,417   8,497,674   8,915,479    8,467,913
    Effect of dilutive
     instruments
           Stock options         1,064,141     877,927     958,632      827,626
           Warrants                    ---      63,298         ---       59,384
                                ----------- ----------- ----------- ------------
           Dilutive potential
            Common shares        1,064,141     941,225     958,632      887,010
                                ----------- ----------- ----------- ------------
           Diluted shares        9,996,558   9,438,899   9,874,111    9,354,923
                                =========== =========== =========== ============`

| | For the three months and nine months ended September 30, 2001 and
2000, the incremental shares used for dilutive earnings per share relate to
stock options and warrants whose exercise price was less than the average market
price in the underlying quarterly computations. For the three months ended
September 30, 2001 and 2000, all outstanding options and warrants were included
in the computation of diluted net income per share since all the exercise prices
were less than the average market price of the common shares for the respective
three month periods.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Page 12

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

|(8) | Comprehensive Income                                                                                                                                                                                                                                                         
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                              
|    | Total comprehensive income for 2000 and for the nine months ended
September 30, 2001 is reported in the Condensed Consolidated Statements of
Stockholders' Equity. Comprehensive income for the three months and nine months
ended September 30, 2001 and 2000 is as follows:

`Three Months Ended       Nine Months Ended
                                     September 30,           September 30,
                                ----------------------- ------------------------
                                    2001        2000        2001         2000
                                ----------- ----------- ----------- ------------
  Net income                    $  475,244  $  197,890  $  837,497  $   737,325
  Other comprehensive income        20,346      21,286      78,196      115,903
  Net loss of Hi-tronics for
    December 2000 (see Note 1)         ---         ---    (347,679)         ---
                                ----------- ----------- ----------- ------------
  Comprehensive income          $  495,590  $  219,176  $  568,014  $   853,228
                                ----------- ----------- ----------- ------------`

|(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 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.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|    | Segment data for the three months ended September 30, 2001 is as follows:                                                                                                                                                                                                                                                                                                                                                                               

`Neuro         HDI       Intercompany  Consolidated
                           Products       O.E.M.     Eliminations     Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $  7,047,020  $  2,852,953  $        ---  $  9,899,973
  Intersegment revenues  $        ---  $    797,670  $   (797,670) $        ---
  Segment income from
    operations           $    299,606  $    483,715  $        ---  $    783,321`

Page 13

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

| | Segment  data for the three months ended September 30, 2000 is as
follows:
| | --------------------------------------------------------------------------

`Neuro         HDI       Intercompany  Consolidated
                           Products       O.E.M.     Eliminations     Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $  5,762,546  $  2,413,538  $        ---  $  8,176,084
  Intersegment revenues  $        ---  $    256,311  $   (256,311) $        ---
  Segment income
    (loss)from
    operations           $    309,751  $    (79,214) $        ---  $    230,537`

| | Segment data for the nine months ended September 30, 2001 is as
follows:
| | ------------------------------------------------------------------------

`Neuro          HDI      Intercompany   Consolidated
                           Products        O.E.M.    Eliminations      Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $ 19,962,947  $  7,482,557  $        ---  $ 27,445,504
  Intersegment revenues  $        ---  $  1,800,217  $ (1,800,217) $        ---
  Segment income from
    operations           $    642,963  $  1,004,058  $        ---  $  1,647,021
  Segment assets         $ 47,922,799  $  6,833,753  $ (2,346,520) $ 52,410,032`

| | Segment  data for the nine months ended September 30, 2000 is as
follows:
| | -------------------------------------------------------------------------

`Neuro          HDI      Intercompany  Consolidated
                           Products        O.E.M.    Eliminations     Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $ 17,069,102  $  6,892,594  $        ---  $ 23,961,696
  Intersegment revenues  $        ---  $  1,246,735  $ (1,246,735) $        ---
  Segment income from
    operations           $    820,524  $    105,425  $        ---  $    925,949
  Segment assets         $ 43,713,172  $  6,282,900  $ (2,840,380) $ 47,155,692`

Page 14

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|Item 2. | Management's Discussion and Analysis of Financial
Conditionand 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.

Overview

On January 2, 2001, we completed the acquisition of Hi-tronics Designs,
Inc. (HDI or Hi-tronics), a privately-held contract developer and original
equipment manufacturer (O.E.M.) of electro-mechanical devices with headquarters
in Budd Lake, New Jersey. We acquired HDI through a stock-for-stock merger in
which we issued 1,104,725 shares of ANS common stock. The transaction is
accounted for on a pooling of interests basis and accordingly, prior year
results have been restated. HDI developed and is the manufacturer of our
Genesis totally implantable pulse generator (IPG) used in the treatment of
chronic intractable pain and is also the O.E.M. manufacturer of the transmitter
used with our Renew® radio-frequency spinal cord stimulation system. HDI was
founded in 1987 and has developed more than thirty medical devices for some of
the leading medical device companies. The core strength of HDI is in developing
highly sophisticated electronic circuits with very low power requirements,
utilizing both discrete and highly integrated technology. We believe this
competency, when combined with our own strengths in lead design and packaging,
will allow us to develop more sophisticated products in compressed,
development-cycle timetables. In addition, the merger should result in vertical
integration benefits in manufacturing that should in turn enhance margins on our
current and future products. HDI's revenues for its fiscal 2000, which ended
November 30, 2000, were approximately $10.4 million, including approximately
$1.6 million of revenue associated with sales to ANS.

As a result of HDI's fiscal year ending on a different date than the
Company's, for the one-month period ended December 31, 2000 the results of
operations of HDI have been charged directly to retained earnings in the
Condensed Consolidated Statement of Stockholder' Equity for the period ended
September 30, 2001. During the month of December 2000, HDI recorded net revenue
of $119,481 and a loss before income tax benefit of $591,600. The net loss for
the one-month period ended December 31, 2000 was $347,679. Results of HDI for
this one-month period were negatively impacted by a problem with a component
supplied by a vendor. This resulted in substantially lower than normal revenue
since the products using the component could not be manufactured and delivered.
The component problem was quickly resolved with the vendor and shipments of
products using the component commenced in late January 2001.

Also on January 2, 2001, we acquired the assets (primarily intellectual
property consisting of patents and know-how) of Implantable Devices Limited
Partnership (IDP) and ESOX Technology Holdings, LLC (ESOX), two privately held
Minnesota companies, for 119,100 shares of ANS common stock. Based on the
closing price of ANS common stock on December 29, 2000, the value of the stock
issued to acquire the assets was $2.43 million. IDP was formed in 1986 to
commercialize certain implantable infusion technologies developed at the
University of Minnesota. We entered a license agreement with IDP in 1995 to
license rights to implantable infusion pump technologies developed by IDP and
ESOX for applications in pain and cancer therapy. Under the license agreement,
we were obligated to pay IDP royalties on worldwide sales of implantable

Page 15

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infusion pumps using IDP technology. The January 2, 2001 acquisition canceled
the license agreement, thereby eliminating our future royalty obligations, and
expanded our rights to use the pump technologies in all applications through our
acquisition of the intellectual property. We completed development of our
AccuRx fully implantable constant rate infusion pump in late 2000 using
technology we licensed from IDP. We received CE mark approval to distribute the
pump internationally and commenced sales in international markets late in the
second quarter of fiscal 2001. We also received an Investigational Device
Exemption (IDE) from the FDA to initiate clinical trials in the United States.
The clinical trials will include 109 patients and will be conducted in twelve
sites. The trials commenced in the first quarter of 2001 and are progressing
according to plan. The data gathered during the trials will be used to support a
Pre-Market Approval (PMA) application.

On July 9, 2001, we announced that the FDA had accepted for review our PMA
filing for the IPG. The acceptance signaled that major sub-sections of our PMA
application met the initial filing requirements for a detailed PMA review. On
September 14, 2001, we met with the FDA to discuss in detail the status of the
PMA application. The meeting was positive and constructive and no major issues
were identified. Since the September 14 meeting, we have maintained an
active dialogue with the FDA to address and resolve questions regarding our
PMA application. By law, the FDA has until the end of November to review and
respond to our PMA filing. We are hopeful that the FDA completes the review and
approval of our PMA application within the November 2001 time frame; however, we
cannot assure you that the FDA will approve our PMA application by such date.
Industry analysts estimate that the IPG market for spinal cord stimulation to
treat pain of the trunk and/or limbs will approach $175 million in 2001, and
that the market is growing at a 25% to 30% annual rate. Currently, Medtronic,
Inc. is the sole provider of IPGs in the United States.

Results of Operations

Comparison of the Three Months and Nine Months Ended September 30, 2001
and 2000

We reported net income of $475,000 or $.05 per diluted share for the three
months ended September 30, 2001, compared to net income of $198,000 or $.02
per diluted share in the same 2000 period. For the nine months ended September
30, 2001, we reported net income of $837,000 or $.08 per diluted share
compared to $737,000 or $.08 per diluted share in the same 2000 period. Results
for the nine-month period ended September 30, 2001 reflect an expense of
$484,000 for costs associated with our acquisition of HDI on January 2, 2001.
These costs were expensed instead of capitalized because the acquisition is
accounted for under the pooling of interests method. Excluding such acquisition
related costs, on a pro forma basis, net income was $1,181,000 or $.12 per
diluted share for the nine-month period ended September 30, 2001.

Net revenue was $9.90 million for the three months ended September 30, 2001
compared to $8.18 million in the comparable 2000 period. This growth of 21% in
net revenue for our third quarter of fiscal 2001 was primarily attributable to
continued strong sales of our advanced Renew radio-frequency spinal cord
stimulation system for the treatment of chronic intractable pain. Revenue from
the HDI business also contributed to the growth during the third quarter of 2001
as revenue increased to $2.85 million in 2001 from $2.41 during the same three
month period a year earlier. For the nine months ended September 30, 2001, net
revenue increased 15% to $27.45 million from $23.96 million for the nine month
period in 2000 primarily due to strong sales of our advanced Renew
radio-frequency spinal cord stimulation system for the treatment of chronic
intractable pain. Revenue from the HDI business increased 9% to $7.48 million
for the nine-months ended September 30, 2001 from $6.89 million during the same
nine-month period in 2000.

Page 16

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Because neuromodulation devices are gaining increasing acceptance as a
viable, efficacious and cost-effective treatment alternative for relieving
chronic intractable pain and improving neurological function, we are continuing
our efforts to expand our product offerings in the high growth market of
neuromodulation. Today, we are a market share and technology leader in the
radio-frequency stimulation segment of the neuromodulation market, which is
expected by industry analysts to approach $50 million in 2001. During the past
several years, to position ourselves to participate in the other larger and more
rapidly growing segments of the neuromodulation market, we have aggressively
invested in product development projects, including our IPG for spinal cord
stimulation, IPG for deep brain stimulation and our proprietary AccuRx constant
flow implantable infusion pump. We have continued these efforts in 2001. Some of
the fruits of our development efforts were realized during the second quarter of
2001 when we commenced commercialization of our Genesis IPG and AccuRx constant
flow implantable infusion pump in certain international countries where the
appropriate regulatory approvals were obtained. We received further approvals in
international countries during the third quarter of 2001.

Gross profit increased to $5.83 million during the three months ended
September 30, 2001 from $4.31 million in 2000, due to the increase in net
revenue discussed above and an improvement in gross profit margins. Gross profit
margin increased to 58.9% in 2001 compared to 52.7% in 2000, due to higher sales
of the Renew radio-frequency spinal cord stimulation system and operational
efficiencies from higher manufacturing volumes. For the nine months ended
September 30, 2001, gross profit increased to $15.87 million from $12.92 million
in the comparable period in 2000, again due to the increase in net revenue
discussed above and an improvement in gross profit margins. Gross profit margin
increased to 57.8% in 2001 compared to 53.9% in 2000 due again to higher sales
of the Renew radio-frequency spinal cord stimulation system and operational
efficiencies from higher manufacturing volumes.

Total operating expenses (the aggregate of research and development,
marketing, amortization of intangibles and administrative expenses) increased to
$5.05 million, or 51.0% of net revenue for the three months ended September 30,
2001 from $4.08 million, or 49.9% of net revenue in the same period during 2000.
For the nine months ended September 30, 2001, total operating expenses increased
to $14.22 million, or 51.8% of net revenue from $11.99 million, or 50.1% of net
revenue for the nine-month period in 2000. The increase in both periods in 2001,
compared to the same periods a year ago, reflect increased investments in
research and development to expand our product development pipeline and
increased investments in marketing to strengthen our selling and distribution
capabilities.

Research and development expense increased to $1.27 million during the three
months ended September 30, 2001, or 12.8 percent of net revenue during the
period, from $908,000 during the same period in 2000, or 11.1 percent of net
revenue during the prior year period. For the nine months ended September 30,
2001, research and development expense increased to $3.65 million, or 13.3% of
net revenue from $2.83 million, or 11.8% of net revenue for the same nine month
period in 2000. The increase in the absolute dollar amounts during both periods
in 2001 compared to the same periods in 2000 was the result of higher consulting
expense and test material expense. Expenditures for research and development
during the first nine months of 2001 continued to be directed toward development
of our next generation radio-frequency stimulation system platform, our IPG
stimulation system platforms for both spinal cord stimulation and deep brain
stimulation and our implantable infusion pump platforms.

Page 17

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Marketing expense, as a percentage of net revenue, increased to 24.3% during
the three months ended September 30, 2001 from 21.3% in the same 2000 period,
and the absolute dollar amount increased from $1.74 million during 2000 to $2.41
million in 2001. For the nine months ended September 30, 2001, marketing expense
as a percentage of net revenue increased to 23.9% from 21.1% in the same period
in 2000 and the absolute dollar amount increased from $5.06 million during the
2000 period to $6.55 million during the 2001 period. The increase in the
absolute dollar amounts during both periods in 2001 compared to the same periods
a year earlier was attributable to higher commission expense from increased
product sales and a change from distributors to commissioned sales agents in
certain territories, higher expense for education and training of new implanters
and expense for new product introductions in international markets.

General and administrative expense decreased from $1.12 million during the
three months ended September 30, 2000 to $986,000 during the same period in
2001, and as a percentage of net revenue, decreased to 10.0% in 2001 from 13.7%
during 2000. For the nine months ended September 30, 2001, general and
administrative expense decreased to $2.95 million from $3.17 million during the
same period in 2000 and as a percentage of net revenue, decreased to 10.7% in
2001 from 13.3% during 2000. The decrease in expense for both periods in 2001
compared to the same periods in 2000 was principally the result of lower salary
expense from a reduction in certain salaries of the former owners of HDI
effective on January 2, 2001 when we acquired HDI.

Amortization of goodwill and other intangibles increased to $383,000 during
the three months ended September 30, 2001 from $308,000 during the same period
in 2000. For the nine months ended September 30, 2001, amortization of
goodwill and other intangibles increased to $1.08 million from $923,000 during
the same period in 2000. This increase in expense during both periods in 2001
compared to the same periods in 2000 was primarily the result of additional
amortization expense from patents we acquired from ESOX on January 2, 2001.

Other income decreased to $80,000 for the three months ended September 30,
2001 from $124,000 in the same period in 2000 due to a $51,000 decrease in
interest income due to lower yields on invested funds. Other income decreased to
an expense of $118,000 for the nine months ended September 30, 2001 from income
of $395,000 during the same period in 2000 primarily due to an expense of
$484,000 in 2001 for costs associated with the acquisition of HDI.

We recorded income tax expense during the three months ended September 30,
2001 and 2000, of $388,000 and $157,000, an overall effective tax rate of 45.0 %
and 44.2%, respectively. For the nine months ended September 30, 2001 and 2000,
we recorded income tax expense of $691,000 and $583,000, an overall effective
tax rate of 45.2% in the 2001 period and 44.2% in the 2000 period. The Company's
expense for amortization of costs in excess of net assets acquired (goodwill) is
not deductible for tax purposes, and, when combined with a provision for state
taxes, results in the higher effective tax rate for both the three month and
nine month periods ended September 30, 2001 and 2000 compared to the U.S.
statutory rate for corporations of 34 percent. In addition, approximately
$234,000 of the $484,000 of costs incurred in the acquisition of Hi-tronics
recorded in the nine month period ended September 30, 2001 are not deductible
for tax purposes, which also contributed to the higher effective tax rate during
2001 compared to the U.S. statutory rate of 34 percent.

Page 18

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Liquidity and Capital Resources

At September 30, 2001 our working capital was $22.20 million, approximately
the same as the $22.22 million at year-end 2000. The ratio of current assets to
current liabilities was 4.82:1 at September 30, 2001, compared to 5.37:1 at
December 31, 2000. Cash, cash equivalents and marketable securities totaled
$10.47 million at September 30, 2001 compared to $11.61 million at December 31,
2000.

We increased our investment in inventories to $9.30 million at September 30,
2001, from $7.09 million at December 31, 2000. This increase from year-end 2000
was primarily the result of three factors. First, we purchased raw materials and
manufactured finished goods for our Genesis IPG and AccuRx implantable infusion
pump products for our international market launch during the second quarter of
2001 and in anticipation of a domestic launch of the Genesis IPG later this year
or early in fiscal 2002 if the FDA approves our PMA application. Second, we
increased our investment in consignment inventories as a result of adding
fifteen commissioned sales agents during the first nine-months of 2001. Finally,
we increased our investment in inventories at HDI in anticipation of increased
O.E.M. orders.

We spent $1.76 million during the nine months ended September 30, 2001 for
capital expenditures for additional equipment and fixtures. These expenditures
consisted primarily of additional tooling, machinery and equipment used in our
manufacturing processes. We expect capital expenditures for the remainder of
fiscal 2001 to approximate $250,000. We also spent $460,000 during the first
nine months of 2001 for patents and non-compete agreements.

We believe our current cash, cash equivalents and marketable securities and
cash generated from operations will be sufficient to fund all of our operating
needs and capital expenditures for the foreseeable future.

Cash Flows

Net cash provided by operations increased to $1.56 million for the nine
months ended September 30, 2001 from $275,000 during the same period in 2000.
This increase in cash provided by operations during 2001 compared to 2000 was
primarily the result of a reduction in the amount of cash used for changes in
working capital components from $2.4 million in 2000 to $1.6 million in 2001.

Net cash used in investing activities decreased to $1.67 million for the nine
months ended September 30, 2001 from $2.30 million during the same period in
2000, a decrease of $626,000. This reduction in the amount of cash used in
investing activities during 2001 compared to 2000 was primarily due to higher
proceeds received from the sale of marketable securities and maturing
certificates of deposit in the 2001 period.

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Net cash provided by financing activities decreased to $69,000 during the
nine months ended September 30, 2001 from $720,000 during the same period in
2000. During the first nine months of 2001, we used $202,000 to reduce certain
debt obligations while we received $271,000 from the exercise of stock options.
During the first nine months of 2000, we received $559,000 from the exercise of
stock options and $270,000 from the proceeds of a loan obligation while we used
$109,000 to reduce our obligations under certain debt agreements.

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

Forward-Looking Statements

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 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:

- completion of research and development projects in an efficient and timely
manner
- obtaining regulatory approvals on a timely and cost efficient basis to
permit the introduction of new products, including our IPG stimulation system
for treatment of pain of the trunk and/or limbs
- domination of the market for stimulation systems and implantable infusion
pumps by Medtronic, Inc.
- entering into suitable strategic alliances that enable us to leverage our
technology into other markets
- the satisfactory completion of clinical trials and/or market tests prior to
the introduction of new products
- the adequacy, acceptability and timeliness of component supply
- the approval of new products by reimbursement agencies like insurance
companies, HMOs, Medicare and Medicaid
- retention of major customers
- the efficacy of our products for new applications
- general economic risks
- other risks detailed from time to time in our SEC public filings

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Consequently, 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 September 30, 2001, 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, 2000.

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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 QuestMedical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent (2)
| |     |                                                                                                                                                 
| | (b) | No reports on Form 8-K have been filed
during the quarter ended September 30, 2001                                                              
| |     |                                                                                                                                                 
| |    

_______________________________

|(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.              

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Signatures

In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

|                        | ADVANCED NEUROMODULATION SYSTEMS, INC.                                                      
|----------------------- | --------------------------------------------------------------------------------------------
|                        |                                                                                             
|                        |                                                                                             
|Date: November 13, 2001 | By: /s/ F. Robert Merrill III                                                               
|                        | F. Robert Merrill IIIExecutive Vice President, Finance
Chief Financial Officer and Treasurer

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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)

_______________________________

|(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.              

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