##### Table of Contents



UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 (MARK ONE)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 FOR THE TRANSITION PERIOD FROM TO
 Commission file number 0-10521
 ADVANCED NEUROMODULATION SYSTEMS, INC.
  Texas
    
    75-1646002(State or Other Jurisdiction of
Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 6901 Preston Road, Plano, Texas 75024  (Address of Principal Executive Offices) (Zip Code)
 (972) 309-8000  (Registrants Telephone Number, Including Area Code)
 þ o
 þ  o
 o þ
  Title of Each Class
    
    Number of Shares Outstanding at
October 28, 2005Common stock, $.05 Par Value
    
    20,209,789




---



ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
  
 Table of Contents
 PART I. Financial Information
    
    
    2Item 1. Financial StatementsCondensed Consolidated Balance Sheets
September 30, 2005 (Unaudited) and December 31, 2004
    
    
    3-4Condensed Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2005 and 2004
    
    
    5Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2005 and 2004
    
    
    6Condensed Consolidated Statements of Stockholders Equity
For the Year Ended December 31, 2004 and the Nine Months Ended September 30, 2005 (Unaudited)
    
    
    7Notes to Condensed Consolidated Financial Statements
    
    
    8-17Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18-27Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    28PART II. Other Information
    
    
    29Item 1. Legal Proceedings
    
    
    29-31Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    31Item 6. Exhibits
    
    
    31-32Signatures
    
    
    33Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  -1-




---



##### Table of Contents



PART I
 FINANCIAL INFORMATION
 -2-




---



##### Table of Contents



ITEM 1. FINANCIAL STATEMENTS
 
 Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
September 30, 2005 (Unaudited) and December 31, 2004
 September 30,
    
    
    December 31,Assets
    
    2005
    
    
    2004Current assets:Cash and cash equivalents
    
    $
    6,616,404
    
    
    $
    6,654,712Marketable securities
    
    
    152,266,174
    
    
    
    117,361,352Receivables:Trade accounts, less allowances of
$499,532 in 2005 and $398,627 in 2004
    
    
    29,791,124
    
    
    
    25,322,813Interest and other
    
    
    1,722,025
    
    
    
    638,987Total receivables
    
    
    31,513,149
    
    
    
    25,961,800Inventories:Raw materials
    
    
    9,874,874
    
    
    
    10,067,802Work-in-process
    
    
    6,149,812
    
    
    
    4,435,746Finished goods
    
    
    9,337,697
    
    
    
    9,420,303Total inventories
    
    
    25,362,383
    
    
    
    23,923,851Deferred income taxes
    
    
    2,072,228
    
    
    
    2,029,091Prepaid expenses and other current assets
    
    
    1,967,525
    
    
    
    1,888,957Total current assets
    
    
    219,797,863
    
    
    
    177,819,763Property, equipment and fixtures:Land
    
    
    3,191,427
    
    
    
    3,191,427Building
    
    
    17,707,788
    
    
    
    17,523,181Furniture and fixtures
    
    
    9,285,691
    
    
    
    6,829,357Machinery and equipment
    
    
    22,111,100
    
    
    
    18,757,126Leasehold improvements
    
    
    652,804
    
    
    
    638,77852,948,810
    
    
    
    46,939,869Less accumulated depreciation and amortization
    
    
    17,799,588
    
    
    
    13,764,540Net property, equipment and fixtures
    
    
    35,149,222
    
    
    
    33,175,329Minority equity investments in preferred stock
    
    
    1,104,000
    
    
    
    1,104,000Goodwill
    
    
    12,078,668
    
    
    
    12,078,668Patents and licenses, net of accumulated
amortization of $2,690,411 in 2005 and
$2,301,780 in 2004
    
    
    6,881,151
    
    
    
    6,208,520Purchased technology, net of accumulated
amortization of $4,693,183 in 2005 and
$3,917,268 in 2004
    
    
    10,638,993
    
    
    
    11,414,908Tradenames, net of accumulated amortization of
$1,392,118 in 2005 and $1,266,929 in 2004
    
    
    1,871,046
    
    
    
    1,901,470Customer and supplier relations, net of
accumulated amortization of $995,161 in 2005 and
$645,336 in 2004
    
    
    2,071,395
    
    
    
    2,429,671Other assets, net of accumulated amortization of
$1,521,265 in 2005 and $1,202,605 in 2004
    
    
    1,168,135
    
    
    
    1,354,812$
    290,760,473
    
    
    $
    247,487,141
  -3-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
September 30, 2005 (Unaudited) and December 31, 2004
 September 30,
    
    
    December 31,Liabilities and Stockholders' Equity
    
    2005
    
    
    2004Current liabilities:Accounts payable
    
    $
    3,237,598
    
    
    $
    3,206,516Accrued salary and employee benefit costs
    
    
    3,732,694
    
    
    
    2,390,721Accrued commissions
    
    
    3,060,412
    
    
    
    2,656,112Income taxes payable
    
    
    8,299,711
    
    
    
    708,412Deferred revenue
    
    
    107,028
    
    
    
    165,861Other accrued expenses
    
    
    1,043,682
    
    
    
    342,075Total current liabilities
    
    
    19,481,125
    
    
    
    9,469,697Deferred income taxes
    
    
    6,055,263
    
    
    
    14,734,487Non-current deferred revenue
    
    
    616,849
    
    
    
    718,820Commitments and contingenciesStockholders equity:Common stock $.05 par valueAuthorized  100,000,000 shares;Issued  21,126,838 shares in 2005 and 20,337,501 in 2004
    
    
    1,056,341
    
    
    
    1,016,875Additional capital
    
    
    182,003,119
    
    
    
    161,625,018Retained earnings
    
    
    114,688,905
    
    
    
    45,681,864Accumulated other comprehensive income (loss), net of tax
(benefit) expense of $(122,292) in 2005 and $8,544,328 in 2004
    
    
    (203,986
    )
    
    
    14,240,380Deferred compensation
    
    
    (7,359,094
    )
    
    
    Treasury stock, at cost  923,674 shares in 2005
    
    
    (25,578,049
    )
    
    
    Total stockholders equity
    
    
    264,607,236
    
    
    
    222,564,137$
    290,760,473
    
    
    $
    247,487,141
  -4-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2005 and 2004
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenue
    
    $
    39,337,376
    
    
    $
    31,330,408
    
    
    $
    110,366,066
    
    
    $
    88,451,122Cost of revenue
    
    
    10,003,026
    
    
    
    8,414,174
    
    
    
    28,925,278
    
    
    
    23,751,017Gross profit
    
    
    29,334,350
    
    
    
    22,916,234
    
    
    
    81,440,788
    
    
    
    64,700,105Operating expenses:Sales and marketing
    
    
    12,411,385
    
    
    
    9,791,838
    
    
    
    34,553,480
    
    
    
    27,810,611Research and development
    
    
    4,524,520
    
    
    
    2,911,698
    
    
    
    12,314,218
    
    
    
    8,096,308General and administrative
    
    
    4,258,188
    
    
    
    2,974,620
    
    
    
    11,609,568
    
    
    
    7,998,316Amortization of other intangibles
    
    
    662,773
    
    
    
    626,191
    
    
    
    1,960,300
    
    
    
    1,824,83821,856,866
    
    
    
    16,304,347
    
    
    
    60,437,566
    
    
    
    45,730,073Income from operations
    
    
    7,477,484
    
    
    
    6,611,887
    
    
    
    21,003,222
    
    
    
    18,970,032Other income (expense):Gain on sale of investment in
common stock of Cyberonics,
Inc.
    
    
    
    
    
    
    
    
    
    
    85,244,301
    
    
    
    Foreign currency transaction
gain (loss)
    
    
    (5,793
    )
    
    
    81,009
    
    
    
    (170,608
    )
    
    
    26,156Investment income
    
    
    957,473
    
    
    
    482,850
    
    
    
    2,595,591
    
    
    
    964,021951,680
    
    
    
    563,859
    
    
    
    87,669,284
    
    
    
    990,177Income before income taxes
    
    
    8,429,164
    
    
    
    7,175,746
    
    
    
    108,672,506
    
    
    
    19,960,209Income taxes
    
    
    3,076,645
    
    
    
    2,433,791
    
    
    
    39,665,465
    
    
    
    6,926,251Net income
    
    $
    5,352,519
    
    
    $
    4,741,955
    
    
    $
    69,007,041
    
    
    $
    13,033,958Net income per share:Basic
    
    $
    .27
    
    
    $
    .23
    
    
    $
    3.46
    
    
    $
    .65Diluted
    
    $
    .26
    
    
    $
    .23
    
    
    $
    3.31
    
    
    $
    .62
  -5-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2005 and 2004
 Nine Months Ended September 30,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    69,007,041
    
    
    $
    13,033,958Adjustments to reconcile net income to net cash provided by (used
in) operating activities:Depreciation and amortization
    
    
    5,995,350
    
    
    
    5,050,411Deferred income taxes
    
    
    (37,420
    )
    
    
    1,753,671Stock-based compensation
    
    
    1,043,036
    
    
    
    9,885Increase (decrease) in inventory reserve
    
    
    (48,214
    )
    
    
    25,016Amortization of premiums on marketable securities
    
    
    833,130
    
    
    
    Gain on sale of marketable securities
    
    
    (85,074,894
    )
    
    
    168,857Changes in operating assets and liabilities, net of acquisitions:Receivables
    
    
    (5,551,349
    )
    
    
    (7,267,456
    )Inventories
    
    
    (1,390,318
    )
    
    
    (549,522
    )Income taxes receivable
    
    
    
    
    
    
    1,324,001Prepaid expenses and other current assets
    
    
    (427,938
    )
    
    
    (1,432,015
    )Income taxes payable
    
    
    7,591,299
    
    
    
    Tax benefit from stock option exercises
    
    
    4,421,889
    
    
    
    3,648,901Accounts payable
    
    
    31,082
    
    
    
    (1,352,476
    )Accrued expenses
    
    
    2,447,880
    
    
    
    (919,112
    )Deferred revenue
    
    
    (160,804
    )
    
    
    (402,077
    )Total adjustments
    
    
    (70,327,271
    )
    
    
    58,084Net cash provided by (used in) operating activities
    
    
    (1,320,230
    )
    
    
    13,092,042Cash flows from investing activities:Purchases of marketable securities
    
    
    (290,509,677
    )
    
    
    (290,303,534
    )Purchase of Cyberonics, Inc. common stock, net of short-term
obligation
    
    
    
    
    
    
    (44,658,911
    )Proceeds from sale of investment in common stock of Cyberonics, Inc.
    
    
    135,287,911
    
    
    
    Proceeds from sales of marketable securities
    
    
    181,751,874
    
    
    
    341,965,756New facility construction
    
    
    
    
    
    
    (8,582,765
    )Acquisition of certain assets of microHelix, Inc.
    
    
    
    
    
    
    (2,046,105
    )Acquisition of certain operations of distributors
    
    
    
    
    
    
    (1,086,558
    )Additions to property, equipment, fixtures and intangible assets
    
    
    (7,290,583
    )
    
    
    (5,845,969
    )Net cash provided by (used in) investing activities
    
    
    19,239,525
    
    
    
    (10,558,086
    )Cash flows from financing activities:Purchase of treasury stock
    
    
    (25,578,049
    )
    
    
    Exercise of stock options
    
    
    7,593,548
    
    
    
    4,684,022Net cash provided by (used in) financing activities
    
    
    (17,984,501
    )
    
    
    4,684,022Net increase (decrease) in cash and cash equivalents
    
    
    (65,206
    )
    
    
    7,217,978Effect of exchange rates on cash and cash equivalents
    
    
    26,898
    
    
    
    (75,121
    )Cash and cash equivalents at beginning of year
    
    
    6,654,712
    
    
    
    8,588,281Cash and cash equivalents at September 30
    
    $
    6,616,404
    
    
    $
    15,731,138Non-cash activity:Stock issued for intangible assets
    
    $
    
    
    
    $
    767,511Assumed acquisition liabilities
    
    $
    
    
    
    $
    131,574
  -6-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders Equity
For The Year Ended December 31, 2004 and the Nine Months Ended September 30, 2005 (Unaudited)
 AccumulatedCommon Stock
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    
    
    
    
    TotalAdditional
    
    
    Retained
    
    
    Comprehensive
    
    
    Deferred
    
    
    
    
    
    
    Stockholders'Shares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Compensation
    
    
    Treasury Stock
    
    
    EquityBalance at December 31, 2003
    
    
    19,712,938
    
    
    $
    985,647
    
    
    $
    149,644,033
    
    
    $
    27,515,001
    
    
    $
    (19,758
    )
    
    $
    
    
    
    $
    
    
    
    $
    178,124,923Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,166,863
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,166,863Adjustment to unrealized gains (losses) on
marketable securities, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,280,634
    
    
    
    
    
    
    
    
    
    
    
    14,280,634Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,496
    )
    
    
    
    
    
    
    
    
    
    
    (20,496
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,427,001Issuance of shares for stock option
exercises
    
    
    607,858
    
    
    
    30,393
    
    
    
    5,995,463
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,025,856Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    115,892
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115,892Issuance of earn-out shares for acquisition
    
    
    16,705
    
    
    
    835
    
    
    
    766,676
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    767,511Tax benefit from stock option exercises
    
    
    
    
    
    
    
    
    
    
    5,102,954
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,102,954Balance at December 31, 2004
    
    
    20,337,501
    
    
    
    1,016,875
    
    
    
    161,625,018
    
    
    
    45,681,864
    
    
    
    14,240,380
    
    
    
    
    
    
    
    
    
    
    
    222,564,137Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,007,041
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,007,041Adjustment to unrealized gains (losses) on
marketable securities, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,471,265
    )
    
    
    
    
    
    
    
    
    
    
    (14,471,265
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,899
    
    
    
    
    
    
    
    
    
    
    
    26,899Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,562,675Issuance of shares for stock option
exercises
    
    
    495,632
    
    
    
    24,781
    
    
    
    7,568,767
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,593,548Non-employee stock-based compensation
    
    
    
    
    
    
    
    
    
    
    188,205
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    188,205Tax benefit from stock option exercises
    
    
    
    
    
    
    
    
    
    
    4,421,889
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,421,889Issuance of restricted stock awards
    
    
    293,705
    
    
    
    14,685
    
    
    
    8,199,240
    
    
    
    
    
    
    
    
    
    
    
    (8,213,925
    )
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    854,831
    
    
    
    
    
    
    
    854,831Purchase of 923,674 treasury shares, at
cost
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25,578,049
    )
    
    
    (25,578,049
    )Balance at September 30, 2005
    
    
    21,126,838
    
    
    $
    1,056,341
    
    
    $
    182,003,119
    
    
    $
    114,688,905
    
    
    $
    (203,986
    )
    
    $
    (7,359,094
    )
    
    $
    (25,578,049
    )
    
    $
    264,607,236
  -7-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
 (1)
    
    BusinessAdvanced Neuromodulation Systems, Inc. (the Company or ANS) designs, develops, manufactures
and markets implantable neuromodulation devices. ANS devices are used primarily to manage
chronic severe pain. The Company also provides contract development and custom
manufacturing, also known as O.E.M. or original equipment manufacturing, for other medical
device companies through the Hi-tronics Designs, Inc. (HDI) subsidiary and through
operations in Portland, Oregon (formerly the Cable and Wire Division of microHelix, Inc.,
which was acquired in April 2004). ANS neuromodulation revenues are derived primarily from
sales throughout the United States, Europe and Australia while O.E.M. revenues are derived
within the United States.The research and development, manufacture, sale and distribution of medical devices is
subject to extensive regulation by various public agencies, principally the U.S. Food and
Drug Administration and corresponding state, local and foreign agencies. Product approvals
and clearances can be delayed or withdrawn for failure to comply with regulatory
requirements or the occurrence of unforeseen problems following initial marketing.In addition, ANS neuromodulation products are purchased by hospitals and other users who
then bill various third-party payors including Medicare, Medicaid, private insurance
companies and managed care organizations, and workers compensation programs. ANS also sells
and bills its neuromodulation products directly to third-party payors including Medicare,
Medicaid, private insurance companies and managed care organizations, and workers
compensation programs. These third-party payors reimburse fixed amounts for products and
services based on a specific diagnosis. The impact of changes in third-party payor
reimbursement policies and any amendments to existing reimbursement rules and regulations
that restrict or terminate the eligibility of ANS products could have an adverse impact on
the Companys financial condition and results of operations.(2)
    
    Condensed Financial StatementsThe unaudited condensed consolidated financial information contained in this report reflects
all adjustments (consisting of normal recurring accruals) considered necessary, in the
opinion of management, for a fair presentation of results for the interim periods presented.
The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.Certain information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been condensed or
omitted. These financial statements should be read in conjunction with the financial
statements and notes thereto included in our December 31, 2004 Annual Report on Form 10-K.
The results of operations for the period ended September 30, 2005 are not necessarily
indicative of results of operations for the full year.
 -8-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 The consolidated financial statements include the accounts of Advanced Neuromodulation
Systems, Inc. and its subsidiaries. All significant intercompany balances and transactions
have been eliminated in consolidation.(3)
    
    Marketable SecuritiesIn August 2004, the Company acquired 3,500,000 shares, or approximately 14.7%, of the
outstanding common stock of Cyberonics, Inc. in open market purchases. The aggregate
purchase price paid for the shares was $49.7 million. In February 2005, the Company sold
the 3,500,000 shares and received gross proceeds on the sale of $135.3 million, resulting in
a pre-tax gain of $85.2 million, net of acquisition costs.(4)
    
    Stock-Based CompensationThe Company accounts for its stock-based compensation plans in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and
related interpretations. Under APB 25, no compensation expense is recognized for stock
option grants if the exercise price of the Companys stock option grants is at or above fair
market value of the underlying stock on the date of grant. Stock-based compensation to
non-employees is measured at fair market value over the service period and recorded as
compensation expense in the Condensed Consolidated Statements of Income. The Company
recorded $113,045 and $11,035 of stock-based compensation expense to non-employees in the
three months ended September 30, 2005 and 2004, respectively. The Company recorded
$188,205 and $9,885 of stock-based compensation expense to non-employees in the nine months
ended September 30, 2005 and 2004, respectively. In 2005, the Company issued 293,705
restricted stock awards, net of cancellations, to employees and directors of the Company
pursuant to the terms of the Companys 2004 Stock Incentive Plan. The fair market value of
the awards, based on the price of the Companys common stock at issuance, has been recorded
to deferred compensation in the Condensed Consolidated Statements of Stockholders Equity
and is being amortized over the associated four-year vesting period.The Company has adopted the pro forma disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), as
amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. The following table illustrates the effect on net
income and net income per share amounts if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation:
 -9-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income as
reported
    
    $
    5,352,519
    
    
    $
    4,741,955
    
    
    $
    69,007,041
    
    
    $
    13,033,958Add: Stock-based
employee
compensation expense
included in reported
earnings, net of tax
    
    
    325,805
    
    
    
    
    
    
    
    542,818
    
    
    
    Deduct: Total
stock-based employee
compensation expense
determined under
fair value based
methods for all
awards, net of tax
    
    
    (1,733,261
    )
    
    
    (1,361,988
    )
    
    
    (4,700,725
    )
    
    
    (3,788,191
    )Pro forma net income
    
    $
    3,945,063
    
    
    $
    3,379,967
    
    
    $
    64,849,134
    
    
    $
    9,245,767Basic shares
    
    
    19,800,456
    
    
    
    20,189,242
    
    
    
    19,948,489
    
    
    
    20,075,233Diluted shares
    
    
    20,938,453
    
    
    
    21,032,695
    
    
    
    20,857,866
    
    
    
    21,116,735Pro forma Basic EPS
    
    $
    .20
    
    
    $
    .17
    
    
    $
    3.25
    
    
    $
    .46Pro forma Diluted EPS
    
    $
    .19
    
    
    $
    .16
    
    
    $
    3.11
    
    
    $
    .44
 (5)
    
    Commitments and ContingenciesThe Company is a party to product liability claims related to its neurostimulation devices
and other ordinary routine litigation claims arising in the ordinary course of business.Product liability insurers have assumed responsibility for defending the Company against
product liability claims, subject to reservation of rights in certain cases. Historically,
product liability claims related to the Companys neurostimulation devices have not resulted
in significant monetary liability beyond its insurance coverage. The Company seeks to
maintain appropriate levels of product liability insurance with coverage that it believes is
comparable to that maintained by companies similar in size and serving similar markets,
although there can be no assurances that the Company will not incur significant monetary
liability to the claimants if such insurance is inadequate, and there can be no assurance
that the Companys neurostimulation business and future ANS product lines will not be
adversely affected by these product liability claims.On September 19, 2005, the Company received a notification dated September 16, 2005 from
TrailBlazer Health Enterprises, LLC (TrailBlazer), a Centers for Medicare and Medicaid
Service (CMS) contracted intermediary and carrier, indicating that as of September 16, 2005,
TrailBlazer will no longer reimburse the Company directly for claims that ANS submitted to
TrailBlazer relating to ANS products implanted in the ambulatory service center (ASC)
environment. The notification indicated that such claims should be submitted by either the
ASC or the physician. Upon receipt of the notification, the Company ceased billing
TrailBlazer directly for such products and began billing directly either the ASC, physician,
or the healthcare facility where such implant procedure was required to be transitioned.
The Company has been in discussions with TrailBlazer and CMS regarding the legal basis for
this position, and is in the process of
 -10-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 responding in writing to TrailBlazer and CMS. The Company intends, among other things, to
request that Trailblazer reimburse the Companys unpaid claims of approximately $1.7
million, which were submitted prior to the notification date, consistent with previous
practice and consistent with previous advice and guidance from TrailBlazer with respect to
the billing and collection of such claims. Should TrailBlazer and CMS decide not to
reimburse the Company directly for such claims, the Company intends to bill and collect from
the associated ASC or physician, who ANS will ask to submit the claim for reimbursement to
CMS. Management believes that should this course of action ultimately be necessary, it will
not have a material impact on the financial results of the Company, but will result in a
delay in the collection of the Companys associated $1.7 million receivable and could result
in the noncollectibility of some portion of the billed amount, although it is impossible to
estimate whether and how much of such billed amount would be uncollectible.On April 21, 2004, the Company filed a lawsuit in the U.S. District Court for the Eastern
District of Texas, Sherman Division (Docket No. 4:404-CV-00131-PNB-DDB) (the Texas Action)
against Advanced Bionics Corporation, asserting claims of patent infringement,
misappropriation of trade secrets, tortious interference with contract, misappropriation of
time, labor, skill, and money, violation of the Texas Theft Act, conversion and constructive
trust. As initially filed, the lawsuit alleged, among other things, that Advanced Bionics is
infringing U.S. Patent No. 4,793,353 entitled Non-Invasive Multiprogrammable Tissue
Stimulator and Method. In addition, the lawsuit alleged that Advanced Bionics hired a
former ANS employee to aid in the design, development and manufacture of its implantable
stimulation lead, that Advanced Bionics misappropriated the former employees knowledge of
ANS confidential, proprietary, and trade secret information with respect to ANS implantable stimulation leads, and that this enabled
Advanced Bionics to unfairly compete with ANS. The lawsuit seeks injunctive relief,
compensatory and punitive damages, attorneys fees and costs.On October 15, 2004, the court in the Texas Action granted the Companys motion to amend its
lawsuit to add two additional patent infringement claims against Advanced Bionics. One claim
relates to the Companys patent covering the design and structure of its electrode lead
(U.S. Patent No. 6,216,045). The second claim relates to the Companys trial cable connector
patent (U.S. Patent No. 6,154,678). In addition, the court denied Advanced Bionics motion
to dismiss the Texas Action. The court also denied Advanced Bionics motion to transfer the
Texas Action to a California federal court. (Advanced Bionics had filed a California action
in federal court seeking to resolve the Companys patent claims, which was subsequently
dismissed.) The court in the Texas Action also granted Advanced Bionics motion to compel
alternative dispute resolution of the trade secrets misappropriation claims, although the
court retained jurisdiction over those claims.On March 11, 2005, Advanced Bionics filed its First Amended Answer and Counterclaims in the
Texas Action, asserting, among other things, that the Company is infringing Advanced
Bionics U.S. Patent Nos. 6,516,277 and 6,381,496. Advanced Bionics claims that the Company
is infringing these patents at least by marketing and selling GenesisRCä rechargeable
IPG systems, and Advanced Bionics may assert that
 -11-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 the Companys recently-approved Eonä system does as well. These patents relate to
changing operational parameters sets (6,381,496) and to a specific type of rechargeable
spinal cord stimulation system (6,516,277). The counterclaims seek temporary restraining
orders, permanent injunctions, compensatory damages, exemplary damages including treble
damages, pre- and post-judgment interest, attorneys fees and such other relief as the court
may grant. On May 18, 2005, the court granted the Companys motion to severe these
counterclaims from ANS claims against Advanced Bionics and ordered that the counterclaims
proceed separately. The Company intends to vigorously defend itself against these
counterclaims and has asserted that the patents are not infringed and are not valid. The
court has not set a schedule or trial date for Advanced Bionics counterclaims.The court in the Texas Action issued its Markman ruling on August 15, 2005, giving the
courts legal interpretation of the ANS patent claims at issue. On September 29, 2005, the
court issued an amended Markman ruling. The Company was generally pleased with the Markman ruling.Pursuant to the court's scheduling order, on October 10, 2005, Advanced Bionics filed four
motions for summary judgment, asking the court to dismiss the Companys patent claims and/or
the damages claims. The Company responded to each motion on October 31, 2005. The court has
yet to rule on these pending motions. The court has ordered that jury selection for the
Companys claims against Advanced Bionics will commence February 6, 2006, with trial to
proceed shortly thereafter.On July 12, 2005, the Company and the former ANS employee attempted to resolve ANS trade
secrets misappropriation claims through mediation. No resolution or settlement was effected
by the mediation.On October 19, 2005, the Company and Advanced Bionics attempted to resolve the ANS patent
infringement claims through court-ordered mediation. No resolution or settlement was
effected by the mediation.In late January 2005, the Company received a subpoena from the Office of the Inspector
General, Department of Health and Human Services (OIG), requesting documents related to
certain of its sales and marketing, reimbursement, Medicare and Medicaid billing, and
certain other business practices. The Company is cooperating fully with the OIGs request
for documents.In late May 2005, the United States District Court for the Eastern District of Texas granted
an order consolidating the three previously filed class action securities lawsuits against
the Company and certain of its officers and directors that were filed on behalf of
purchasers of the Companys securities between April 24, 2003 and February 16, 2005,
inclusive (the Class Period) into a single consolidated complaint styled as: PLA, LLC vs.
Advanced Neuromodulation Systems, Inc., et al. (Class Action Litigation). The court also
granted an order appointing lead and liaison counsel and appointing the lead plaintiff in
the lawsuit. The three previously filed suits each alleged the Company violated federal
securities laws by the issuance of false and misleading statements to the market regarding
the Companys financial performance throughout the Class Period, which statements allegedly
had the effect of artificially inflating the market price of the Companys securities. In
particular, the claims alleged that improper marketing and sales
 -12-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 practices accounted for the Companys revenue growth, citing, among other things, the
Companys public announcement made on February 17, 2005 that the Company had received a
subpoena from the Office of the Inspector General, Department of Health and Human Services,
requesting documents related to sales and marketing, reimbursement, Medicare and Medicaid
billing and other business practices. The plaintiffs are seeking unspecified compensatory
damages and costs and expenses of litigation. No class has been certified at this time. The
plaintiffs filed an amended consolidated complaint in September 2005. By agreement with the
plaintiffs, the Companys answer is due by January 16, 2006. The Company intends to
vigorously defend itself against the claims made in the Class Action Litigation and believes
the Class Action Litigation is without merit.On October 17, 2005, Arthur Ford derivatively and on behalf of Nominal Defendant Advanced
Neuromodulation Systems, Inc. filed an Original Petition in the 401st District
Court in Collin County, Texas, File No. 401-03524-05, against Christopher G. Chavez, Scott
F. Drees, and F. Robert Merrill, each of the Companys current directors, and the Company,
alleging that the named executive officers and directors breached their fiduciary duties by
allegedly engaging in the improper marketing and sales practices referred to in the Class
Action Litigation or allegedly approving the claimed violations of federal law and the
Companys Code of Conduct. The Original Petition purports to be a shareholders derivative
action brought pursuant to Texas Business Corporation Act Article 5.14 for the benefit of
nominal defendant Advanced Neuromodulation Systems, Inc. against the members of its Board of
Directors and certain executive officers seeking to remedy defendants breaches of fiduciary
duty. The Company has formed a Special Litigation Committee composed of three members of
the Board of Directors (Messrs. Morrison, Nikolaev and Laptewicz), who will evaluate Mr.
Fords claims. The Company intends to vigorously defend itself against the claims made in
the lawsuit and believes the lawsuit is without merit.Except for the litigation discussed above, and other ordinary routine litigation incidental
to its business, the Company is not currently a party to any other pending legal proceeding.
The Company maintains general liability insurance against risks arising out of the normal
course of business.Under the Companys sales agreements with its independent sales agents, the Company can
terminate those agreements without cause by paying an early termination fee equal to 100% of
the commissions that would otherwise be payable on sales in the territory for the 90 days
after termination and 50% of the commission that would otherwise be payable on sales in the
territory for the 90 day period after the first 90 day period.In addition, under its distributor agreements, sales agent agreements and certain other
ordinary course commercial contracts with third parties, the Company typically agrees to
indemnify the other contracting party from damages and costs that may arise from product
liability claims. The terms of the agreements and contracts vary and the potential exposure
under these indemnities cannot reasonably be estimated or determined. The Company currently
is not aware of any indemnification claims, nor has the Company had any indemnification
claims historically.
 -13-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 (6)
    
    Income TaxesThe Company recorded income tax expense during the three months and nine months ended
September 30, 2005 of $3,076,645 and $39,665,465, respectively, representing an overall
effective tax rate in both periods of 36.5%. For the three months and nine months ended
September 30, 2004, the Company recorded income tax expense of $2,433,791 and $6,926,251,
respectively, representing an overall effective tax rate of 33.9% and 34.7%, respectively.
The increased effective tax rate in 2005 is due to the $85.2 million pre-tax gain resulting
from the sale of the Companys investment in Cyberonics, Inc., which had the impact of
increasing federal and state taxable income without a significant corresponding increase in
other permanent exclusions from taxable income. The effective tax rates in 2005 and 2004
reflect a provision for federal income taxes at the statutory rate of 35% and a provision
for state taxes, offset by tax-exempt investment income, the research and development tax
credit, and benefits related to the extra-territorial income (ETI) exclusion.(7)
    
    Net Income Per ShareBasic net income per share is computed based only on the weighted average number of common
shares outstanding during the period. Diluted net income per share is computed using the
additional dilutive effect, if any, of stock options and restricted stock awards 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 EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Weighted-average shares
outstanding (basic
shares)
    
    
    19,800,456
    
    
    
    20,189,242
    
    
    
    19,948,489
    
    
    
    20,075,223Effect of dilutive
stock options and
restricted stock awards
    
    
    1,137,997
    
    
    
    843,453
    
    
    
    909,377
    
    
    
    1,041,512Diluted shares
    
    
    20,938,453
    
    
    
    21,032,695
    
    
    
    20,857,866
    
    
    
    21,116,735
 For the three months and nine months ended September 30, 2005 and 2004, the incremental
shares used for dilutive earnings per share relate to stock options whose exercise price was
less than the average market price in the underlying quarterly computations. For the three
months ended September 30, 2005 and 2004, options to purchase 9,353 and 1,083,475 shares,
respectively, and for the nine months ended September 30, 2005 and 2004, options to purchase
431,957 and 611,104 shares, respectively, were outstanding but were not included in the
computation of diluted earnings per share because the options exercise prices were greater than the average market
price of the common shares and, therefore, the effect would be antidilutive.
 -14-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 (8)
    
    Comprehensive IncomeComprehensive income is the total of net income and all other non-owner changes in equity
net of tax effects, and consists of net income, unrealized gains or losses on the Companys
available for sale marketable securities, and foreign currency translation adjustments.
Comprehensive income for the three months and nine months ended September 30, 2005 and
2004 is as follows:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
    
    $
    5,352,519
    
    
    $
    4,741,955
    
    
    $
    69,007,041
    
    
    $
    13,033,958Other comprehensive
income (loss)
    
    
    (211,031
    )
    
    
    14,544,817
    
    
    
    (14,444,366
    )
    
    
    14,444,794Comprehensive income
    
    $
    5,141,488
    
    
    $
    19,286,772
    
    
    $
    54,562,675
    
    
    $
    27,478,752
 Components of accumulated other comprehensive income are net of tax and are as follows:
 September 30,
    
    
    December 31,2005
    
    
    2004Unrealized gains (losses) on marketable securities
    
    $
    (210,388
    )
    
    $
    14,260,876Foreign currency translation adjustments
    
    
    6,402
    
    
    
    (20,496
    )Accumulated other comprehensive income (loss)
    
    $
    (203,986
    )
    
    $
    14,240,380
 The tax benefit (expense) on the unrealized gains (losses) on marketable securities was
$126,233 at September 30, 2005 and $(8,556,625) at December 31, 2004. The tax benefit
(expense) on foreign currency translation adjustment was $(3,841) at September 30, 2005 and
$12,297 at December 31, 2004.In connection with the realized gain resulting from the sale of the Companys investment in
Cyberonics, Inc. in February 2005 as discussed in Note 3, $14,275,238 of the December 31,
2004 unrealized gain on marketable securities was realized into other income, and the
associated tax expense of $8,565,143 was reclassified from deferred income taxes payable to
income taxes payable.(9)
    
    Treasury StockIn May 2004, the Companys board of directors approved the repurchase of up to 1,000,000
shares of the Companys common stock. In April 2005, the Companys board of directors
approved an increase in the amount of shares authorized to be repurchased by the Company up
to a total of 2,000,000 shares. The Company repurchased 923,674 shares of its common stock
at a cost of $25,578,049 during March and April 2005.
 -15-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 (10)
    
    Segment InformationThe Company operates in two business segments. The Neuro Products segment designs, develops,
manufactures and markets implantable medical devices that are used to manage chronic
intractable pain and other disorders of the central nervous system through the delivery of
electrical current or drugs directly to targeted nerve fibers. The O.E.M. segment provides
contract development and O.E.M. manufacturing primarily of electromechanical medical
devices. Intersegment revenue is billed at cost with no intercompany mark-up.Segment data for the three months ended September 30, 2005 is as follows:
 Neuro
    
    
    
    
    
    
    Intercompany
    
    
    ConsolidatedProducts
    
    
    O.E.M.
    
    
    Eliminations
    
    
    TotalRevenue from external customers
    
    $
    36,198,927
    
    
    $
    3,138,449
    
    
    $
    
    
    
    $
    39,337,376Intersegment revenues
    
    $
    
    
    
    $
    3,771,948
    
    
    $
    (3,771,948
    )
    
    $
    Segment income from
operations
    
    $
    7,562,737
    
    
    $
    (85,253
    )
    
    $
    
    
    
    $
    7,477,484
 Segment data for the three months ended September 30, 2004 is as follows:
 Neuro
    
    
    
    
    
    
    Intercompany
    
    
    ConsolidatedProducts
    
    
    O.E.M.
    
    
    Eliminations
    
    
    TotalRevenue from
external customers
    
    $
    28,222,826
    
    
    $
    3,107,582
    
    
    $
    
    
    
    $
    31,330,408Intersegment revenues
    
    $
    
    
    
    $
    1,759,443
    
    
    $
    (1,759,443
    )
    
    $
    Segment income from
operations
    
    $
    7,055,180
    
    
    $
    (443,293
    )
    
    $
    
    
    
    $
    6,611,887
 Segment data for the nine months ended September 30, 2005 is as follows:
 Neuro
    
    
    
    
    
    
    Intercompany
    
    
    ConsolidatedProducts
    
    
    O.E.M.
    
    
    Eliminations
    
    
    TotalRevenue from
external customers
    
    $
    99,771,402
    
    
    $
    10,594,664
    
    
    $
    
    
    
    $
    110,366,066Intersegment revenues
    
    $
    
    
    
    $
    9,048,536
    
    
    $
    (9,048,536
    )
    
    $
    Segment income from
operations
    
    $
    21,044,823
    
    
    $
    (41,601
    )
    
    $
    
    
    
    $
    21,003,222
 Segment data for the nine months ended September 30, 2004 is as follows:
 Neuro
    
    
    
    
    
    
    Intercompany
    
    
    ConsolidatedProducts
    
    
    O.E.M.
    
    
    Eliminations
    
    
    TotalRevenue from
external customers
    
    $
    80,083,969
    
    
    $
    8,367,153
    
    
    $
    
    
    
    $
    88,451,122Intersegment revenues
    
    $
    
    
    
    $
    5,040,463
    
    
    $
    (5,040,463
    )
    
    $
    Segment income from
operations
    
    $
    19,259,887
    
    
    $
    (289,855
    )
    
    $
    
    
    
    $
    18,970,032
 -16-




---



##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Continued)
 Foreign sales, primarily Europe and Australia, for the three months ended
September 30, 2005 and 2004 were approximately 8% and 10% of net revenue from the Neuro
Products segment, respectively. Foreign sales, primarily Europe and Australia, for the nine
months ended September 30, 2005 and 2004 were approximately 9% and 10% of net revenue from
the Neuro Products segment, respectively. The O.E.M. segment had no foreign sales for the
respective periods.(11)
    
    New Accounting StandardOn December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement
No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which is a revision of SFAS
123. SFAS 123(R) supersedes APB 25, and amends FASB Statement No. 95, Statement of Cash
Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS
123. However, SFAS 123(R) requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the income statement based on their fair
values. Pro forma disclosure is no longer an alternative.SFAS 123(R) required adoption no later than July 1, 2005; however, on April 14, 2005, the
Securities and Exchange Commission announced that it would require adoption of SFAS 123(R)
no later than the beginning of the first fiscal year beginning after June 15, 2005. Early
adoption will be permitted in periods in which financial statements have not yet been
issued. The Company will adopt SFAS 123(R) on January 1, 2006. The adoption of SFAS
123(R)s fair value method will have a significant impact on the Companys result of
operations which the Company is currently evaluating, although it will have no impact on the
Companys overall financial position. The Company is also currently assessing the method
(either the modified prospective or modified retrospective method, as defined) by which
SFAS 123(R) will be adopted.(12)
    
    Subsequent EventOn October 16, 2005, St. Jude Medical, Inc. (St. Jude Medical) and ANS announced that the
Boards of Directors of both companies unanimously approved a definitive agreement whereby
St. Jude Medical would acquire ANS for $61.25 per ANS share in cash, for a total of
approximately $1.3 billion. St. Jude Medical has commenced a tender offer for all of the
outstanding shares of ANS common stock. The transaction is subject to customary closing
conditions and regulatory approvals, as well as the valid tender of a majority of the
outstanding shares of ANS common stock, on a fully-diluted basis. The transaction is
expected to close by the end of the year.
 -17-




---



##### Table of Contents



ITEM
2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Recent Developments
  Eon Eon Eon Eon Eon Eon Eon Eon
 Libra Libra Libra Libra
   -18-




---



##### Table of Contents



-19-




---



##### Table of Contents



Critical Accounting Policies and Estimates
 General
  Revenue Recognition
  Bad Debt
 -20-




---



##### Table of Contents



Inventory Reserve
 Intangible Assets
  Contingencies and Litigation
 Income Taxes
 Stock Compensation
 Results of Operations
 Comparison of the Three Months and Nine Months Ended September 30, 2005 and 2004
 GenesisRC ä Eon
 -21-




---



##### Table of Contents



Net revenue. GenesisRC Eon Renew GenesisXP ä GenesisRC Eon
  Gross profit.
 Operating expenses.
 Sales and marketing.
 -22-




---



##### Table of Contents



Research and development.
 Libra Libra
  General and administrative.
 Amortization of intangibles.
 -23-




---



##### Table of Contents



Other income.
 Income tax expense.
 Net income.
 Liquidity and Capital Resources
   -24-




---



##### Table of Contents



Currency Fluctuations
  Off-Balance Sheet Arrangements
  -25-




---



##### Table of Contents



Guidance
 Eon
  Outlook and Uncertainties
 The following is a safe harbor statement under the Private Securities Litigation Reform Act of
1995: Certain matters discussed in this Quarterly Report on Form 10-Q contain statements that
constitute forward-looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. The words expect, estimate,
anticipate, predict, believe, plan, will, should, intend, would, scheduled,
potential, new market, potential market applications, and similar expressions and variations
thereof are intended to identify forward-looking statements, although not all forward-looking
statements contain such identifying words. Such statements appear in a number of places in this
Quarterly Report on Form 10-Q and include statements regarding our intent, belief or current
expectations with respect to, among other things: (i) trends affecting our financial condition or
results of operations; (ii) our financing plans; and (iii) our product development plans and other
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, but are not limited to, those discussed or identified from
time to time in our public filings, including the following:
 
    
    failure to gain market acceptance of our new rechargeable IPGs, to maintain continued market acceptance of our
conventional IPGs and radio-frequency (RF) powered spinal cord stimulation (SCS) systems, or failure to replace a
substantial portion of lost RF sales with sales of our new rechargeable IPGs could adversely affect our revenue growth
and profitability;
    
    competition from and the launch of new competitive products by Medtronic, Advanced Bionics/Boston Scientific or others,
as well as other market factors that could impede growth in or reduce sales of the Companys IPG and RF systems, which
could adversely affect revenues and profitability;
    
    patient or physician selection of less invasive or less expensive alternatives;
    
    adverse changes in coverage or reimbursement amounts by Medicare, Medicaid, private insurers, managed care
organizations or workers compensation programs could limit our ability to market and sell our products;
    
    intellectual property protection and potential infringement issues;
 -26-




---



##### Table of Contents




    
    the cost, uncertainty and other risks inherent in litigation generally, including without limitation, the intellectual
property and patent litigation against Advanced Bionics, the ongoing securities class action litigation filed in the
first quarter of 2005, and the pending shareholder derivative litigation filed in October 2005;
    
    successful patient enrollment in and timely implementation of the IDE clinical studies for migraine headache, essential
tremor and Parkinsons disease; physician and patient acceptance of the LibraDBS system for the essential tremor and
Parkinsons disease studies, for which already-approved products are already available on the market; the uncertainty
of clinical results that may ensue from these clinical studies; the risk that the FDA may not approve our PMA
applications for these applications following the completion of the clinical trials; and the satisfactory completion of
feasibility,pilot and pivotal studies and/or market tests prior to the introduction of new products generally;
    
    obtaining necessary government approvals for other new products or applications and maintaining compliance with FDA
product and manufacturing requirements;
    
    product liability;
    
    reliance on single suppliers for certain components;
    
    completion of research and development projects in an efficient and timely manner;
    
    successful integration of acquired businesses, products and technologies; and
    
    international trade risks.
   This Form 10-Q is neither an offer to purchase nor a solicitation of an offer to sell shares of the
Company. St. Jude Medical has filed a tender offer statement with the Securities and Exchange
Commission (SEC) and the Company has filed a solicitation/ recommendation statement with respect to
the tender offer. The Companys shareholders are advised to read the tender offer statement
regarding St. Jude Medicals acquisition of the Company referenced in this Form 10-Q , and the
related solicitation/recommendation statement. The tender offer statement and the
solicitation/recommendation statement contain important information that should be read carefully
before any decision is made with respect to the offer. These documents are available to all
shareholders of the Company at no expense to them. These documents are also available at no charge
on the SECs web site at www.sec.gov . Shareholders may also obtain copies of these
documents without charge by requesting them from the Company in writing at 6901 Preston Road,
Plano, Texas 75024, or by phone at 972-309-8000.
 -27-




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
   -28-




---



##### Table of Contents



PART II
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 Advanced Bionics Litigation
  GenesisRC Eon
  -29-




---



##### Table of Contents



Securities Class Action Litigation
 Derivative Action  st
 -30-




---



##### Table of Contents



Product Liability Litigation
 Other Litigation
 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Issuer Purchases of Equity SecuritiesTotal Number of
    
    Maximum Number ofShares Purchased as
    
    Shares that May YetTotal Number of
    
    Average Price Paid
    
    Part of Publicly
    
    Be Purchased UnderPeriod
    
    Shares Purchased
    
    Per Share
    
    Announced Plans
    
    the PlansMarch 1 through March 31, 2005
    
    
    381,894
    
    
    $
    27.96
    
    
    
    381,894
    
    
    
    1,618,106April 1 through April 30, 2005
    
    
    541,780
    
    
    $
    27.50
    
    
    
    923,674
    
    
    
    1,076,326
  
 ITEM 6. EXHIBITS
 (a)
    
    The following documents are filed as exhibits to this Quarterly Report on
Form 10-Q:
 Exhibit No.
    
    DescriptionExhibit 2.1
    
    Agreement and Plan of Merger, dated as of October 15, 2005, among St. Jude Medical, Inc., Apollo Merger Corp. and
Advanced Neuromodulation Systems, Inc. (1)
 -31-




---



##### Table of Contents



Exhibit No.
    
    DescriptionExhibit 3.1
    
    Articles of Incorporation, as amended and restated (2)Exhibit 3.2
    
    Bylaws, as amended and restated(1)Exhibit 4.1
    
    Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc.
as Rights Agent (3)Exhibit 4.2
    
    Amendment to Rights Agreement dated as of January 25, 2002, between Advanced Neuromodulation Systems, Inc and
Computershare Investor Services LLC (formerly KeyCorp Shareholder Services, Inc.) (4)Exhibit 4.3
    
    Second Amendment to Rights Agreement between Advanced Neuromodulation Systems, Inc. and Computershare Investor
Services LLC, dated as of October 14, 2005 (5)Exhibit 10.27
    
    Advanced Neuromodulation Systems, Inc. 2004 Stock Incentive Plan, as amended (6)Exhibit 31.1
    
    Certification of the Chief Executive Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (7)Exhibit 31.2
    
    Certification of the Chief Financial Officer Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (7)Exhibit 32.1
    
    Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (8)Exhibit 32.2
    
    Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (8)
 
 (1)
    
    Filed as an Exhibit to the report of the Company on Form 8-K filed October 17, 2005, and
incorporated herein by reference.(2)
    
    Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31,
2004, and incorporated herein by reference.(3)
    
    Filed as an Exhibit to the report of the Company on Form 8-K dated September 4, 1996, and
incorporated herein by reference.(4)
    
    Filed as an Exhibit to the report of the Company on Form 8-K dated January 30, 2002, and
incorporated herein by reference.(5)
    
    Filed as an Exhibit to the report of the Company on Form 14D-9 filed on October 19, 2005, and
incorporated herein by reference.(6)
    
    Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 15, 2005,
and incorporated herein by reference.(7)
    
    Filed herewith.(8)
    
    Furnished herewith.
 -32-




---



##### Table of Contents



Signatures
  ADVANCED NEUROMODULATION SYSTEMS, INC.Date:  November 2, 2005
    By:
    /s/ F. Robert Merrill IIIF. Robert Merrill IIIExecutive Vice President, Finance
Chief Financial Officer and Treasurer -33-




---



##### Table of Contents



EXHIBIT INDEX
 Exhibit No.
    
    DescriptionExhibit 2.1
    
    Agreement and Plan of Merger, dated as of October 15, 2005, among St. Jude Medical,
Inc., Apollo Merger Corp. and Advanced Neuromodulation Systems, Inc. (1)Exhibit 3.1
    
    Articles of Incorporation, as amended and restated (2)Exhibit 3.2
    
    Bylaws, as amended and restated(1)Exhibit 4.1
    
    Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and
KeyCorp Shareholder Services, Inc. as Rights Agent (3)Exhibit 4.2
    
    Amendment to Rights Agreement dated as of January 25, 2002, between Advanced
Neuromodulation Systems, Inc and Computershare Investor Services LLC (formerly KeyCorp
Shareholder Services, Inc.) (4)Exhibit 4.3
    
    Second Amendment to Rights Agreement between Advanced Neuromodulation Systems, Inc.
and Computershare Investor Services LLC, dated as of October 14, 2005 (5)Exhibit 10.27
    
    Advanced Neuromodulation Systems, Inc. 2004 Stock Incentive Plan, as amended
(6)Exhibit 31.1
    
    Certification of the Chief Executive Officer Pursuant to Rule 13a-14 of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (7)Exhibit 31.2
    
    Certification of the Chief Financial Officer Pursuant to Rule 13a-14 of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (7)Exhibit 32.1
    
    Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (8)Exhibit 32.2
    
    Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (8)
 
 (1)
    
    Filed as an Exhibit to the report of the Company on Form 8-K filed October 17, 2005, and
incorporated herein by reference.(2)
    
    Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31,
2004, and incorporated herein by reference.(3)
    
    Filed as an Exhibit to the report of the Company on Form 8-K dated September 4, 1996, and
incorporated herein by reference.(4)
    
    Filed as an Exhibit to the report of the Company on Form 8-K dated January 30, 2002, and
incorporated herein by reference.




---



##### Table of Contents



(5)
    
    Filed as an Exhibit to the report of the Company on Form 14D-9 filed on October 19, 2005, and
incorporated herein by reference.(6)
    
    Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 15, 2005,
and incorporated herein by reference.(7)
    
    Filed herewith.(8)
    
    Furnished herewith.