# 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 June 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 July 27, 2001 was 8,930,849

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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)    June 30, 2001 and December 31, 2000                                                                  | 3-4 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------- | ----
| |                                                                                                                                                           |     
| | Condensed Consolidated Statements of Operations (Unaudited)
    For the Three Months and Six Months Ended
    June 30, 2001 and 2000                      | 5   
| |                                                                                                                                                           |     
| | Condensed Consolidated Statements of Cash Flows (Unaudited)
    For the Six Months Ended June 30, 2001 and 2000                                           | 6   
| |                                                                                                                                                           |     
| | Condensed Consolidated Statements of Stockholders Equity
    (Unaudited) For the Year Ended December 31, 2000
    and the Six Months Ended June 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 4.    Submission of Matters to a Vote
of Security Holders | 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)June 30,
2001 and December 31, 2000

`June 30,    December 31,
Assets                                                    2001          2000
------                                               ------------- -------------
Current assets:
   Cash and cash equivalents                         $  9,049,706  $  9,528,721
   Certificates of deposit with maturities
      over 90 days at purchase                             93,000     1,040,000
   Marketable securities                                1,384,556     1,038,317

   Receivables:
    Trade accounts, less allowance for doubtful
      accounts of $178,216 in 2001
      and $213,249 in 2000                              5,760,328     5,164,231
   Interest and other                                     121,189       734,550
                                                     ------------- -------------
         Total receivables                              5,881,517     5,898,781
                                                     ------------- -------------

   Inventories:
    Raw materials                                       4,486,539     3,432,335
    Work-in-process                                     1,558,019     1,075,111
    Finished goods                                      2,985,710     2,580,193
                                                     ------------- -------------
         Total inventories                              9,030,268     7,087,639
                                                     ------------- -------------

   Deferred income taxes                                1,375,441     1,282,072
   Refundable income taxes                                    ---       359,953
   Prepaid expenses and other current assets              753,339     1,064,850
                                                     ------------- -------------
         Total current assets                          27,567,827    27,300,333
                                                     ------------- -------------

Equipment and fixtures:
   Furniture and fixtures                               3,054,168     2,900,149
   Machinery and equipment                              7,477,833     6,585,774
   Leasehold improvements                               1,545,691     1,525,542
                                                     ------------- -------------
                                                       12,077,692    11,011,465
   Less accumulated depreciation and amortization       5,356,940     4,390,113
                                                     ------------- -------------
         Net property, plant and equipment              6,720,752     6,621,352
                                                     ------------- -------------

Cost in excess of net assets acquired, net of
   accumulated amortization of $3,126,125 in 2001
   and $2,847,824 in 2000                               7,685,539     7,963,840
Patents, net of accumulated amortization of
   $823,220 in 2001 and $674,220 in 2000                5,579,346     3,104,254
Purchased technology from acquisitions, net of
   accumulated amortization of $1,666,667 in 2001
   and $1,533,334 in 2000                               2,333,333     2,466,666
Tradenames, net of accumulated amortization of
   $781,241 in 2001 and $718,745 in 2000                1,718,759     1,781,255
Other assets, net of accumulated amortization
   of $292,593 in 2001 and $221,320 in 2000               517,795       326,866
                                                     ------------- -------------
                                                     $ 52,123,351  $ 49,564,566
                                                     ============= =============`

Page 3

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

`June 30,    December 31,
Liabilities and Stockholders' Equity                      2001          2000
------------------------------------                 ------------- -------------
Current liabilities:
   Accounts payable                                  $  1,619,660  $  1,144,103
   Customer deposits                                    1,486,928       543,885
   Accrued salary and employee benefit costs            1,027,863     1,293,065
   Accrued tax abatement liability                        969,204       969,204
   Warranty reserve                                       594,557       422,182
   Short-term obligations                                     ---       131,500
   Current maturities of long-term notes payable           50,281        29,601
   Income taxes payable                                       ---        67,240
   Obligations under capital leases                        40,090        69,918
   Other accrued expenses                                 376,681       410,811
                                                     ------------- -------------
         Total current liabilities                      6,165,264     5,081,509
                                                     ------------- -------------

Deferred income taxes                                   2,287,586     2,354,170
Long-term notes payable                                   163,815       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 8,929,349 shares
    in 2001 and 8,883,059 in 2000                         446,468       444,153
   Additional capital                                  36,531,812    34,469,471
   Retained earnings                                    6,553,797     6,539,223
   Cost of common shares in treasury;
    119,100 shares in 2000                                    ---      (927,793)
   Accumulated other comprehensive income (loss),
    net of tax benefit of $13,082 in 2001
    and $42,883 in 2000                                   (25,391)      (83,241)
                                                     ------------- -------------

         Total stockholders' equity                    43,506,686    40,441,813



                                                     ------------- -------------
                                                     $ 52,123,351  $ 49,564,566
                                                     ============= =============

See accompanying notes to condensed consolidated financial statements.`

Page 4



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Advanced Neuromodulation Systems, Inc. and
SubsidiariesCondensed Consolidated Statement of Operations (Unaudited)
For the Three Months and Six Months Ended June 30, 2001 and 2000

`Three Months Ended        Six Months Ended
                                       June 30,                 June 30,
                                ----------------------- ------------------------
                                    2001       2000        2001         2000
                                ----------- ----------- ----------- ------------
Net revenue                     $ 9,204,721 $ 8,357,988 $17,545,531 $15,785,612
Cost of revenue                   3,934,655   3,727,959   7,507,444   7,172,484
                                ----------- ----------- ----------- ------------
         Gross profit             5,270,066   4,630,029  10,038,087   8,613,128
                                ----------- ----------- ----------- ------------

Operating expenses:
   Research and development       1,233,282     943,905   2,380,812   1,924,573
   Marketing                      2,079,851   1,695,805   4,136,829   3,325,636
   Amortization of intangibles      382,083     307,409     694,403     614,280
   General and administrative     1,043,914   1,112,550   1,962,343   2,053,227
                                ----------- ----------- ----------- ------------
                                  4,739,130   4,059,669   9,174,387   7,917,716
                                ----------- ----------- ----------- ------------
         Earnings from
          operations                530,936     570,360     863,700     695,412
                                ----------- ----------- ----------- ------------

Other income (expenses):
   Acquisition related costs            ---         ---    (483,766)        ---
   Interest expense                  (6,212)    (21,241)    (16,672)    (32,714)
   Interest and other income        153,979     138,432     302,281     303,460
                                ----------- ----------- ----------- ------------
                                    147,767     117,191    (198,157)    270,746
                                ----------- ----------- ----------- ------------

         Earnings before
          income taxes              678,703     687,551     665,543     966,158
Income taxes                        310,189     303,671     303,290     426,723
                                ----------- ----------- ----------- ------------
         Net earnings           $   368,514 $   383,880 $   362,253 $   539,435
                                =========== =========== =========== ============

Net earnings per share:
                                =========== =========== ========================
         Basic                  $      .04  $      .05  $      .04  $      .06
                                =========== =========== =========== ============
         Diluted                $      .04  $      .04  $      .04  $      .06
                                =========== =========== =========== ============

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 Six Months Ended June 30, 2001 and 2000

`Six Months Ended June 30,
                                                     ---------------------------
                                                          2001          2000
                                                     ------------- -------------
Cash flows from operating activities:
   Net earnings                                      $    362,253  $    539,435
   Adjustments to reconcile net earnings to
    net cash provided by (used in)
    operating activities:
      Depreciation and amortization                     1,629,877     1,385,542
      Loss (gain) on sale of  marketable securities           ---       (36,727)
      Deferred income taxes                              (131,006)     (131,780)
      Changes in operating assets and liabilities:
        Receivables                                      (179,199)      518,359
        Inventories                                    (1,846,149)      (86,725)
        Refundable income taxes                           359,953           ---
        Prepaid expenses and other assets                 496,696       422,218
        Customer deposits                                (262,679)     (760,012)
        Income taxes payable                              201,423      (259,339)
        Accounts payable                                  395,883    (1,044,001)
        Accrued expenses                                  (70,853)     (401,501)
                                                     ------------- -------------
           Total adjustments                              593,946      (393,966)
                                                     ------------- -------------
           Net cash provided by operating activities      956,199       145,469
                                                     ------------- -------------

Cash flows from investing activities:
   Purchase of certificates of deposit with
    maturities over 90 days                                   ---    (1,139,000)
   Proceeds from certificates of deposits with
    maturities over 90 days                               947,000           ---
   Purchases of marketable securities                  (1,686,557)          ---
   Proceeds from sales of marketable securities         1,427,970       142,899
   Additions to patents and intangible assets            (459,632)      (52,756)
   Additions to equipment and fixtures                 (1,051,711)     (613,664)
                                                     -------------- ------------
           Net cash used in investing activities         (822,930)   (1,662,521)
                                                     ------------- -------------

Cash flows from financing activities:
   Proceeds from long-term obligations                        ---       270,000
   Payment of obligations under capital leases            (25,031)      (39,159)
   Payment of short-term obligations                     (129,333)      (19,677)
   Payment of long-term obligations                       (23,433)          ---
   Exercise of stock options                              237,957       402,601
                                                     ------------- -------------
           Net cash provided by financing activities       60,160       613,765
                                                     ------------- -------------

Net increase (decrease) in cash and cash equivalents      193,429      (903,287)
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 June 30                 $  9,049,706  $  8,301,594
                                                     ============= =============

Supplemental cash flow information is presented
  below:
Income taxes paid                                    $    290,000  $    791,304
                                                     ============= =============
Interest paid                                        $     13,531  $     30,514
                                                     ============= =============

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 earnings                  ---           ---           ---        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 exercises            ---           ---       (832,999)         ---
   Tax benefit from
     employee stock
     option exercise             ---           ---        604,358          ---
                         ------------- ------------- ------------- -------------
Balance at
December 31, 2000           8,883,059       444,153    34,469,471     6,539,223
   Net earnings                  ---           ---           ---        362,253
   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
     December 2000               ---           ---         37,029          ---
   Issuance of
     119,100 from
     treasury for
     acquisition                 ---           ---      1,498,869          ---
   Tax benefit from
     employee stock
     option exercise             ---           ---        290,801          ---
   Issuance of
     shares  for
     stock option
     exercises                 46,290         2,315       235,642          ---
                         ------------- ------------- ------------- -------------
Balance at
June 30, 2001               8,929,349  $    446,468  $ 36,531,812  $  6,553,797
                         ============= ============= ============= =============`

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 earnings                  ---           ---        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 exercise             ---           ---        604,358
                         ------------- ------------- -------------
Balance at
December 31, 2000             (83,241)     (927,793)   40,441,813
   Net earnings                  ---           ---        362,253
   Net loss of
     Hi-tronics
     for December 2000
     (see Note 1)                ---           ---       (347,679)
   Adjustment to
     unrealized
     losses on
     marketable
     securities                57,850         ---          57,850
   Comprehensive                                     -------------
     Income                                                72,424
   Compensation                                      -------------
     expense
     resulting from
     changes to
     Hi-tronics stock
     options in December 2000    ---           ---         37,029
   Issuance of
     119,100 from
     treasury for
     acquisition                 ---        927,793     2,426,662
   Tax benefit from
     employee stock
     option exercise             ---           ---        290,801
   Issuance of 30,300
     shares  for
     stock option
     exercises                   ---           ---        237,957
                         ------------- ------------- -------------
Balance at
June 30, 2001            $    (25,391) $       ---   $ 43,506,686
                         ============= ============= =============

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 June 30, 2001 and are not reflected in the Condensed
Consolidated Statements of Operations. 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 June 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 aquired
responsibility for a note payable with a principal balance of $214,096 at
June 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: $24,383 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 June 30,
2001:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

`Gross       Gross
                                             Unrealized  Unrealized   Estimated
                                    Cost       Gains      Losses     Fair Value
                                ----------- ----------- ----------- ------------
     Investment grade
       preferred security       $  250,000  $     ---   $   25,500  $   224,500
     Investment grade
       municipal bonds           1,075,347       5,378       2,344    1,078,381
     Real estate investment
       trust                        97,682        ---       16,007       81,675
                                ----------- ----------- ----------- ------------
                                $1,423,029  $    5,378  $   43,851  $ 1,384,556
                                =========== =========== =========== ============`

| | Estimated fair value for the investment grade preferred security
and 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 June 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 June 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 first right of
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 June 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    | The Company is a party to product liability claims 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 three months ended June 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.                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

Page 11

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

|(6) | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | The Company recorded income tax expense during the three months ended June
30, 2001 and 2000, of $310,189 and $303,671, an overall effective tax rate of
45.7 percent and 44.2 percent, respectively. For the six months ended June 30,
2001 and 2000, the Company recorded income tax expense of $303,290 and $426,723,
an overall effective tax rate of 45.6 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 six month periods ended June 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 six month period
ended June 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) | Earnings Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|    | Basic earnings per share is computed based only on the weighted average
number of common shares outstanding during the period. Diluted earnings 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        Six Months Ended
                                        June 30,                June 30,
                                ----------------------- ------------------------
                                    2001        2000        2001         2000
                                ----------- ----------- ----------- ------------
    Weighted-average shares
     outstanding (basic shares)  8,919,235   8,470,494   8,907,010    8,453,032
    Effect of dilutive
     instruments
           Stock options           917,595     789,841     905,878      802,477
           Warrants                    ---      56,434         ---       57,427
                                ----------- ----------- ----------- ------------
           Dilutive potential
            common shares          917,595     846,275     905,878      859,904
                                ----------- ----------- ----------- ------------
           Diluted shares        9,836,830   9,316,769   9,812,888    9,312,936
                                =========== =========== =========== ============`

| | For the three months and six months ended June 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. Options to purchase 51,900 shares at
an average price of $15.38 were outstanding at June 30, 2000 but were not
included in the computation of diluted earnings per share for the three months
ended June 30, 2000 because the options' exercise prices were greater than the
average market price of the common shares and, therefore, the effect would be
antidilutive. For the three months ended June 30, 2001, options to purchase
76,000 shares at an average price of $19.61 were outstanding at June 30, 2001
but were not included in the computation of diluted earnings per share for the
three months ended June 30, 2001 because the options' exercise prices were
greater than the average price of the common stock and, therefore, the effect
would be antidilutive.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 six months ended June 30,
2001 is reported in the Condensed Consolidated Statements of Stockholders'
Equity. Comprehensive income for the three months and six months ended June 30,
2001 and 2000 is as follows:

`Three Months Ended        Six Months Ended
                                        June 30,                June 30,
                                ----------------------- ------------------------
                                    2001        2000        2001         2000
                                ----------- ----------- ----------- ------------
  Net earnings                  $  368,514  $  383,880  $  362,253  $   539,435
  Other comprehensive Income        31,032      95,598      57,850       94,617
  Net loss of Hi-tronics for
    December 2000 (see Note 1)         ---         ---    (347,679)         ---
                                ----------- ----------- ----------- ------------
  Comprehensive income          $  399,546  $  479,478  $   72,424  $   634,052
                                ----------- ----------- ----------- ------------`

|(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 June 30, 2001 is as follows:                                                                                                                                                                                                                                                                                                                                                                                    

`Inter-
                             Neuro          HDI         company    Consolidated
                           Products        O.E.M.    Eliminations      Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $  6,577,624  $  2,627,097  $        ---  $  9,204,721
  Intersegment revenues  $        ---  $    604,555  $   (604,555) $        ---
  Segment earnings from
    operations           $    138,990  $    391,946  $        ---  $    530,936`

Page 13

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

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

`Inter-
                             Neuro          HDI         company    Consolidated
                           Products        O.E.M.    Eliminations      Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $  5,707,692  $  2,650,296  $        ---  $  8,357,988
  Intersegment revenues  $        ---  $    502,043  $   (502,043) $        ---
  Segment earnings from
    operations           $    316,944  $    253,416  $        ---  $    570,360`

| | Segment  data for the six months ended June 30, 2001 is as
follows:
| | -------------------------------------------------------------------

`Inter-
                             Neuro          HDI         company    Consolidated
                           Products        O.E.M.    Eliminations      Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $ 12,915,927  $  4,629,604  $       ---   $ 17,545,531
  Intersegment revenues  $        ---  $  1,002,547  $ (1,002,547) $        ---
  Segment earnings from
    operations           $    343,357  $    520,343  $       ---   $    863,700
  Segment assets         $ 47,515,925  $  6,766,794  $ (2,159,368) $ 52,123,351`

| | Segment  data for the six months ended June 30, 2000 is as
follows:
| | -------------------------------------------------------------------

`Inter-
                             Neuro          HDI         company    Consolidated
                           Products        O.E.M.    Eliminations      Total
                         ------------- ------------- ------------- -------------
  Revenue from external
    customers            $ 11,306,556  $  4,479,056  $        ---  $ 15,785,612
  Intersegment revenues  $        ---  $    990,424  $   (990,424) $        ---
  Segment earnings from
    operations           $    510,773  $    184,639  $        ---  $    695,412
  Segment assets         $ 43,063,327  $  5,010,488  $   (950,510) $ 47,123,305`

Page 14

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|Item 2. | Management's Discussion and Analysis ofFinancial
Condition and Results of Operations
|------- | ------------------------------------------------------------------------------------

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

Overview

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 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 during late 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.

Also 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.

Page 15

---

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 Stockholders' Equity for the period
ended June 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 has been resolved with the vendor and shipments of
products using the component commenced in late January 2001.

On February 26, 2001, the FDA notified us that it had denied our petition to
reclassify Totally Implanted Spinal Cord Stimulators for treatment of pain of
the trunk and/or limbs from a Class III device to a Class II device. The FDA's
denial was surprising and disappointing principally because at a presubmission
meeting with the FDA, the agency itself had recommended that ANS submit a
reclassification petition as the "least burdensome path to market" instead of
pursuing the PMA process. A FDA Advisory Panel also had recommended the
reclassification and the agency itself had supported the panel recommendation as
late as September 6, 2000. We are currently appealing the reclassification
decision, while simultaneously pursuing the PMA process to gain approval to
market the IPG in the United States. 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. Our next milestone will be a meeting with the FDA in
mid-September 2001 to discuss in detail the status of the application. By law,
the FDA has up until the end of November to review and respond to our PMA
filing. Also, during the second quarter of 2001, we completed training of our
international distribution organization on the IPG and commenced sales and
implants in key international markets during the second quarter of 2001.
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 in the United
States, Medtronic, Inc. is the sole provider of IPGs.

Results of Operations

Comparison of the Three Months and Six Months Ended June 30, 2001 and
2000

We reported net earnings of $369,000 or $.04 per diluted share for the three
months ended June 30, 2001, compared to net earnings of $384,000 or $.04 per
diluted share in the same 2000 period. For the six months ended June 30, 2001,
we reported net earnings of $362,000 or $.04 per diluted share compared to
$539,000 or $.06 per diluted share in the same 2000 period. Results for the
six-month period ended June 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 earnings were $673,000 or $.07 per diluted share for the
six-month period ended June 30, 2001.

Page 16

---

Net revenue was $9.20 million for the three months ended June 30,
2001 compared to $8.36 million in the comparable 2000 period. This 10% growth in
net revenue for our second quarter of fiscal 2001 was 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 for the three months ended June 30, 2001 was $2.6 million, the
same as was recorded during the same period in 2000. For the six months ended
June 30, 2001, net revenue increased 11% to $17.55 million from $15.79 million
for the six 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 slightly to
$4.63 million for the six-months ended June 30, 2001 from $4.48 million during
the same six-month period in 2000.

Because neuromodulation devices have gained 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 plan to continue 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 expect further approvals
in international countries during the third quarter of 2001.

Gross profit increased to $5.27 million during the three months ended June
30, 2001 from $4.63 million in 2000, due to the increase in net revenue
discussed above and an improvement in gross profit margins. Gross profit margin
increased to 57.3% in 2001 compared to 55.4% in 2000, due to higher sales of the
Renew radio-frequency spinal cord stimulation system, which contributes higher
margins than the HDI business. For the six months ended June 30, 2001, gross
profit increased to $10.04 million from $8.61 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 57.2% in
2001 compared to 54.6% in 2000 due again to higher sales of the Renew
radio-frequency spinal cord stimulation system.

Total operating expenses (the aggregate of research and development,
marketing, amortization of intangibles and administrative expenses) increased to
$4.74 million, or 51.5% of net revenue for the three months ended June 30, 2001
from $4.06 million, or 48.6% of net revenue in the same period during 2000. For
the six months ended June 30, 2001, total operating expenses increased to $9.17
million, or 52.3% of net revenue from $7.92 million, or 50.2% of net revenue for
the six-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.

Page 17

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Research and development expense increased to $1.23 million during
the three months ended June 30, 2001, or 13.4 percent of net revenue during the
period, from $944,000 during the same period in 2000, or 11.3 percent of net
revenue during the prior year period. For the six months ended June 30, 2001,
research and development expense increased to $2.38 million, or 13.6% of net
revenue from $1.92 million, or 12.2% of net revenue for the same six 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 half 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.

Marketing expense, as a percentage of net revenue, increased to 22.6% during
the three months ended June 30, 2001 from 20.3% in the same 2000 period, and the
absolute dollar amount increased from $1.70 million during 2000 to $2.08 million
in 2001. For the six months ended June 30, 2001, marketing expense as a
percentage of net revenue increased to 23.6% from 21.1% in the same period in
2000 and the absolute dollar amount increased from $3.33 million during the 2000
period to $4.14 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 $1.11 million during the
three months ended June 30, 2000 to $1.04 million during the same period in
2001, and as a percentage of net revenue, decreased to 11.3% in 2001 from 13.3%
during 2000. For the six months ended June 30, 2001, general and administrative
expense decreased to $1.96 million from $2.05 million during the same period in
2000 and as a percentage of net revenue, decreased to 11.2% in 2001 from 13.0%
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 intangibles increased to $382,000 during the three months
ended June 30, 2001 from $307,000 during the same period in 2000. For the six
months ended June 30, 2001, amortization of intangibles increased to $694,000
from $614,000 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 increased to $148,000 for the three months ended June 30, 2001
from $117,000 in the same period in 2000 due to slightly higher interest income
combined with slightly lower interest expense. Other income decreased to an
expense of $198,000 for the six months ended June 30, 2001 from income of
$271,000 during the same period in 2000 primarily due to an expense of $484,000
in 2001 for costs associated with the acquisition of HDI.

Page 18

---

We recorded income tax expense during the three months ended June
30, 2001 and 2000, of $310,000 and $304,000, an overall effective tax rate of
45.7 % and 44.2%, respectively. For the six months ended June 30, 2001 and 2000,
we recorded income tax expense of $303,000 and $427,000, an overall effective
tax rate of 45.6% 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 six month periods ended June 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 six month period ended June 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.

Liquidity and Capital Resources

At June 30, 2001 our working capital decreased to $21.40 million from $22.22
million at year-end 2000. The ratio of current assets to current liabilities was
4.47:1 at June 30, 2001, compared to 5.37:1 at December 31, 2000. Cash, cash
equivalents and marketable securities totaled $10.53 million at June 30, 2001
compared to $11.61 million at December 31, 2000.

We increased our investment in inventories to $9.03 million at June 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 half of 2001. Finally, we
increased our investment in inventories at HDI in anticipation of increased
O.E.M. orders.

We spent $1.05 million during the six months ended June 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 $450,000. We also spent $460,000 during the first
half 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 $956,000 for the six months
ended June 30, 2001 from $145,000 during the same period in 2000 despite a
decrease in net earnings from $539,000 in 2000 to $362,000 in 2001. 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 $1.6 million in 2000 to $905,000 in
2001.

Page 19

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Net cash used in investing activities decreased to $823,000 for
the six months ended June 30, 2001 from $1.66 million during the same period in
2000, a decrease of $840,000. 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.

Net cash provided by financing activities decreased to $60,000 during the
six months ended June 30, 2001 from $614,000 during the same period in 2000.
During the first half of 2001, we used $178,000 to reduce certain debt
obligations while we received $238,000 from the exercise of stock options.
During the first half of 2000, we received $403,000 from the exercise of stock
options and $270,000 from the proceeds of a loan obligation while we used
$59,000 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

Page 20

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- 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

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 June 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.

Page 21

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PART II

OTHER INFORMATION

|Item 4. | Submission of Matters to a Vote of Security
Holders
|------- | ---------------------------------------------------

The Company held its 2001 Annual Meeting of Shareholders
("Annual Meeting") on May 23, 2001 at the Company's corporate
office in Plano, Texas. At the Annual Meeting, the following matter was voted on
and approved:

`Votes       Votes        Votes Abstained
                                      For       Against            And
         Proposal                   Nominee     Nominee      Broker Non-Votes
         --------                   -------     -------      ----------------

1)  Election of seven
     directors for a
     one-year term

    Christopher G. Chavez          7,398,337       --             429,818
    Robert C. Eberhart, Ph.D.      7,825,522       --               2,633
    Joseph E. Laptewicz            7,825,222       --               2,933
    A. Ronald Lerner               7,825,322       --               2,833
    Hugh M. Morrison               7,825,197       --               2,958
    Richard D. Nikolaev            7,825,422       --               2,733
    Michael J. Torma, M.D.         7,825,097       --               3,058`

There were present at the Annual Meeting in person or by proxy, shareholders
holding 7,828,155 shares, or approximately 87.8% of the eligible voting shares.

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

| | (a) | Exhibit 3.1- Articles of Incorporation, as amended and
restated (1)                                                                             
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                 
| |     | Exhibit 3.2- ByLaws (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 June 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: August 13, 2001 | By: /s/ F. Robert Merrill III                                                               
|                      | F. Robert Merrill IIIExecutive Vice President, Finance
Chief Financial Officer and Treasurer

Page 23

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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.