##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

(MARK ONE)

|  |  |                                                                                     
|- |  | ------------------------------------------------------------------------------------
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934
|  |  | FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003                                   

|  |  |                                                                                      
|- |  | -------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934

FOR THE TRANSITION PERIOD FROM  TO

Commission file number 0-10521

ADVANCED NEUROMODULATION SYSTEMS, INC.




(Exact Name of Registrant as Specified in Its Charter)


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


6501 Windcrest Drive, Plano, Texas 75024




(Address of Principal Executive Offices) (Zip Code)


(972) 309-8000




(Registrants Telephone Number, Including Area Code)


Indicate
by check þ 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 þ NO o

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

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

Number of Shares Outstanding atTitle of Each Class
    
    October 31, 2003Common stock, $.05 Par Value
    
    
    19,549,822






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TABLE OF CONTENTS



|                                           |                                                                                               |                                                                       |  |  |  |  |  | 
|------------------------------------------ | --------------------------------------------------------------------------------------------- | --------------------------------------------------------------------- |  |  |  |  |  | 
|PART I                                    
|FINANCIAL INFORMATION                     
|                                           | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                           |                                                                                               | Condensed Consolidated Balance Sheets                                
|                                           |                                                                                               | Condensed Consolidated Statements of Income (Unaudited)              
|                                           |                                                                                               | Condensed Consolidated Statements of Cash Flows (Unaudited)          
|                                           |                                                                                               | Condensed Consolidated Statements of Stockholders Equity (Unaudited)
|                                           |                                                                                               | Notes to Condensed Consoldiated Financial Statements                 
|                                           | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                           | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                                           | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II                                   
|OTHER INFORMATION                         
|                                           | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|Signatures                                
|EXHIBIT INDEX                             
|EX-31.1 Certification of CEO - Section 302
|EX-31.2 Certification of CFO - Section 302
|EX-32.1 Certification of CEO - Section 906
|EX-32.2 Certification of CFO - Section 906



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##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries

Table of Contents

PART I. Financial Information
    
    
    2Item 1. Financial StatementsCondensed Consolidated Balance Sheets
September 30, 2003 (Unaudited) and December 31, 2002
    
    
    3-4Condensed Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30,
2003 and 2002
    
    
    5Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2003 and 2002
    
    
    6Condensed Consolidated Statements of Stockholders Equity
For the Year Ended December 31, 2002 and the
Nine Months Ended September 30, 2003 (Unaudited)
    
    
    7Notes to Condensed Consolidated Financial Statements
    
    
    8-16Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    17-27Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    27PART II.Other Information
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    28Signatures
    
    
    29


1



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PART I







FINANCIAL INFORMATION

2



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##### Table of Contents









ITEM 1. FINANCIAL STATEMENTS







Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
September 30, 2003 (Unaudited) and December 31, 2002

September 30,
    
    December 31,Assets
    
    2003
    
    2002Current assets:Cash and cash equivalents
    
    $
    6,517,353
    
    
    $
    10,972,974Marketable securities
    
    
    90,092,003
    
    
    
    85,796,944Receivables:Trade accounts, less allowance for
doubtful accounts of $560,811 in 2003 and
$295,391 in 2002
    
    
    15,424,550
    
    
    
    10,847,237Interest and other
    
    
    146,758
    
    
    
    189,017Total receivables
    
    
    15,571,308
    
    
    
    11,036,254Inventories:Raw materials
    
    
    9,194,585
    
    
    
    7,141,338Work-in-process
    
    
    3,538,850
    
    
    
    2,364,386Finished goods
    
    
    7,111,405
    
    
    
    4,217,222Total inventories
    
    
    19,844,840
    
    
    
    13,722,946Deferred income taxes
    
    
    2,919,571
    
    
    
    1,122,617Income tax receivable
    
    
    321,378
    
    
    
    Prepaid expenses and other current assets
    
    
    1,142,111
    
    
    
    1,032,883Total current assets
    
    
    136,408,564
    
    
    
    123,684,618Equipment and fixtures:Land
    
    
    3,191,427
    
    
    
    3,191,427New facility construction in progress
    
    
    3,102,432
    
    
    
    Furniture and fixtures
    
    
    4,247,209
    
    
    
    4,022,901Machinery and equipment
    
    
    13,170,159
    
    
    
    10,343,953Leasehold improvements
    
    
    1,821,191
    
    
    
    1,702,96525,532,418
    
    
    
    19,261,246Less accumulated depreciation and amortization
    
    
    10,113,231
    
    
    
    8,653,255Net property, plant and equipment
    
    
    15,419,187
    
    
    
    10,607,991Minority equity investments in preferred stock
    
    
    1,104,000
    
    
    
    Goodwill, net
    
    
    9,553,168
    
    
    
    7,407,237Patents, net of accumulated amortization of
$1,739,813 in 2003 and $1,435,835 in 2002
    
    
    5,212,682
    
    
    
    5,323,417Purchased technology from acquisitions, net of
accumulated amortization of $2,688,319 in 2003
and $2,098,200 in 2002
    
    
    9,936,628
    
    
    
    9,033,472Trademarks, net of accumulated amortization of
$1,074,550 in 2003 and $969,952 in 2002
    
    
    1,715,013
    
    
    
    1,701,154Customer and supplier relations, net of
accumulated amortization of $107,951 in 2003
    
    
    1,559,910
    
    
    
    Other assets, net of accumulated amortization of
$700,547 in 2003 and $529,102 in 2002
    
    
    1,326,463
    
    
    
    586,238$
    182,235,615
    
    
    $
    158,344,127


3



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##### Table of Contents



Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (continued)
September 30, 2003 (Unaudited) and December 31, 2002

September 30,
    
    December 31,Liabilities and Stockholders' Equity
    
    2003
    
    2002Current liabilities:Accounts payable
    
    $
    2,175,187
    
    
    $
    2,392,579Accrued salary and employee benefit costs
    
    
    2,843,650
    
    
    
    3,077,603Deferred revenue
    
    
    561,066
    
    
    
    646,577Accrued commissions
    
    
    1,228,473
    
    
    
    794,521Accrued tax abatement liability
    
    
    
    
    
    
    969,204Income taxes payable
    
    
    
    
    
    
    822,228Warranty reserve
    
    
    354,029
    
    
    
    402,259Other accrued expenses
    
    
    520,264
    
    
    
    299,905Total current liabilities
    
    
    7,682,669
    
    
    
    9,404,876Deferred income taxes
    
    
    4,502,743
    
    
    
    3,731,939Non-current deferred revenue
    
    
    937,243
    
    
    
    162,504Commitments
and contingenciesStockholders equity:Common stock of $.05 par value
Authorized 25,000,000 shares; issued and
outstanding: 19,510,072 shares in 2003
and 18,526,014 in 2002
    
    
    975,503
    
    
    
    926,301Additional capital
    
    
    144,364,676
    
    
    
    129,738,644Retained earnings
    
    
    23,793,528
    
    
    
    14,393,748Accumulated other comprehensive income
(loss), net of tax benefit of $10,690 in
2003 and $7,155 in 2002
    
    
    (20,747
    )
    
    
    (13,885
    )Total stockholders equity
    
    
    169,112,960
    
    
    
    145,044,808$
    182,235,615
    
    
    $
    158,344,127


See accompanying notes to condensed consolidated financial statements.

4



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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
For the Three Months and Nine Months Ended September 30, 2003 and 2002

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net revenue
    
    $
    23,418,505
    
    
    $
    14,327,505
    
    
    $
    65,413,557
    
    
    $
    39,223,522Cost of revenue
    
    
    6,384,445
    
    
    
    4,853,409
    
    
    
    20,317,415
    
    
    
    14,430,996Gross profit
    
    
    17,034,060
    
    
    
    9,474,096
    
    
    
    45,096,142
    
    
    
    24,792,526Operating expenses:Research and development
    
    
    2,552,951
    
    
    
    1,518,610
    
    
    
    6,597,850
    
    
    
    4,186,833Sales and marketing
    
    
    6,970,941
    
    
    
    3,802,840
    
    
    
    18,460,993
    
    
    
    10,091,204Amortization of intangibles
    
    
    472,821
    
    
    
    229,464
    
    
    
    1,278,093
    
    
    
    686,094General and administrative
    
    
    1,871,833
    
    
    
    1,390,308
    
    
    
    5,504,084
    
    
    
    3,971,61711,868,546
    
    
    
    6,941,222
    
    
    
    31,841,020
    
    
    
    18,935,748Income from operations
    
    
    5,165,514
    
    
    
    2,532,874
    
    
    
    13,255,122
    
    
    
    5,856,778Other income (expense):Interest expense
    
    
    
    
    
    
    (2,514
    )
    
    
    
    
    
    
    (10,759
    )Other income
    
    
    969,204
    
    
    
    
    
    
    
    969,204
    
    
    
    Interest income
    
    
    200,243
    
    
    
    374,991
    
    
    
    776,370
    
    
    
    595,6851,169,447
    
    
    
    372,477
    
    
    
    1,745,574
    
    
    
    584,926Income before income taxes
    
    
    6,334,961
    
    
    
    2,905,351
    
    
    
    15,000,696
    
    
    
    6,441,704Income taxes
    
    
    2,382,109
    
    
    
    963,048
    
    
    
    5,504,915
    
    
    
    2,213,984Net income
    
    $
    3,952,852
    
    
    $
    1,942,303
    
    
    $
    9,495,781
    
    
    $
    4,227,720Net income per share:Basic
    
    $
    .20
    
    
    $
    .11
    
    
    $
    .50
    
    
    $
    .27Diluted
    
    $
    .19
    
    
    $
    .10
    
    
    $
    .46
    
    
    $
    .24


See accompanying notes to condensed consolidated financial statements.

5



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Advanced Neuromodulation Systems, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2003 and 2002

Nine Months Ended September 30,2003
    
    2002Cash flows from operating activities:Net income
    
    $
    9,495,781
    
    
    $
    4,227,720Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    3,379,235
    
    
    
    2,382,517Increase in inventory reserve
    
    
    20,559
    
    
    
    51,403Deferred income taxes
    
    
    (1,529,830
    )
    
    
    425,615Accrued tax abatement liability
    
    
    (969,204
    )
    
    
    Stock-based compensation
    
    
    505,430
    
    
    
    31,120Changes in operating assets and liabilities, net of acquisitions:Receivables
    
    
    (4,535,056
    )
    
    
    (2,602,695
    )Inventories
    
    
    (4,778,450
    )
    
    
    (2,660,865
    )Current income tax receivable
    
    
    (321,378
    )
    
    
    175,230Prepaid expenses and other assets
    
    
    (130,560
    )
    
    
    (231,573
    )Deferred revenue
    
    
    689,228
    
    
    
    (54,699
    )Income taxes payable
    
    
    (822,228
    )
    
    
    Tax benefit from stock option exercises
    
    
    7,240,918
    
    
    
    1,674,689Accounts payable
    
    
    (217,392
    )
    
    
    (201,155
    )Accrued expenses
    
    
    372,128
    
    
    
    647,475Total adjustments
    
    
    (1,096,600
    )
    
    
    (362,938
    )Net cash provided by operating activities
    
    
    8,399,181
    
    
    
    3,864,782Cash flows from investing activities:Purchases of marketable securities
    
    
    (307,383,482
    )
    
    
    (110,425,666
    )Proceeds from sales of marketable securities
    
    
    303,078,026
    
    
    
    19,793,545Acquisition of Sun Medical pain business
    
    
    (4,857,192
    )
    
    
    Minority equity investments in preferred stock
    
    
    (1,104,000
    )
    
    
    Acquisition of assets of Comedical, Inc.
    
    
    (1,134,079
    )
    
    
    New facility construction in progress
    
    
    (3,102,432
    )
    
    
    Additions to property, equipment, fixtures and intangible assets
    
    
    (4,164,469
    )
    
    
    (1,713,765
    )Net cash used in investing activities
    
    
    (18,667,628
    )
    
    
    (92,345,886
    )Cash flows from financing activities:Payment of long-term obligations
    
    
    
    
    
    
    (189,722
    )Net proceeds from public offering of common stock
    
    
    
    
    
    
    83,175,353Exercise of stock options
    
    
    5,812,826
    
    
    
    1,466,322Net cash provided by financing activities
    
    
    5,812,826
    
    
    
    84,451,953Net decrease in cash and cash equivalents
    
    
    (4,455,621
    )
    
    
    (4,029,151
    )Cash and cash equivalents at beginning of year
    
    
    10,972,974
    
    
    
    9,785,325Cash and cash equivalents at September 30
    
    $
    6,517,353
    
    
    $
    5,756,174Supplemental cash flow information is presented below:Income taxes paid
    
    $
    979,373
    
    
    $
    33,943Interest paid
    
    $
    
    
    
    $
    10,759Non-cash activity:Stock issued for intangible assets
    
    $
    1,020,059
    
    
    $
    


See accompanying notes to condensed consolidated financial statements.

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

Other
    
    TotalCommon Stock
    
    Additional
    
    Retained
    
    Comprehensive
    
    Stockholders'Shares
    
    Amount
    
    Capital
    
    Earnings
    
    Income (Loss)
    
    EquityBalance at
December 31, 2001
(restated for 3
for 2 stock
split)
    
    
    13,607,802
    
    
    $
    680,390
    
    
    $
    38,443,451
    
    
    $
    7,709,290
    
    
    $
    (21,250
    )
    
    $
    46,811,881Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,684,458
    
    
    
    
    
    
    
    6,684,458Adjustment to
unrealized
losses on
marketable
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,365
    
    
    
    7,365Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,691,823Sale of newly
issued common
stock in a
public offering,
net of offering
costs
    
    
    4,312,500
    
    
    
    215,625
    
    
    
    82,959,728
    
    
    
    
    
    
    
    
    
    
    
    83,175,353Issuance of
shares for stock
option exercises
    
    
    371,259
    
    
    
    18,563
    
    
    
    1,851,329
    
    
    
    
    
    
    
    
    
    
    
    1,869,892Issuance of
common stock for
acquisition
    
    
    234,453
    
    
    
    11,723
    
    
    
    4,636,698
    
    
    
    
    
    
    
    
    
    
    
    4,648,421Tax benefit from
stock option
exercises
    
    
    
    
    
    
    
    
    
    
    1,847,438
    
    
    
    
    
    
    
    
    
    
    
    1,847,438Balance at December
31, 2002
    
    
    18,526,014
    
    
    
    926,301
    
    
    
    129,738,644
    
    
    
    14,393,748
    
    
    
    (13,885
    )
    
    
    145,044,808Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,495,781
    
    
    
    
    
    
    
    9,495,781Adjustment to
unrealized
losses on
marketable
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,862
    )
    
    
    (6,862
    )Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,488,919Issuance of
shares for stock
option exercises
    
    
    938,968
    
    
    
    46,948
    
    
    
    5,765,878
    
    
    
    
    
    
    
    
    
    
    
    5,812,826Stock-based
compensation
    
    
    
    
    
    
    
    
    
    
    505,430
    
    
    
    
    
    
    
    
    
    
    
    505,430Issuance of
earn-out shares
for acquisition
    
    
    42,519
    
    
    
    2,126
    
    
    
    1,017,933
    
    
    
    
    
    
    
    
    
    
    
    1,020,059Shares issued
for fractional
share round-up
in 3 for 2 stock
split
    
    
    2,571
    
    
    
    128
    
    
    
    95,873
    
    
    
    (96,001
    )
    
    
    
    
    
    
    Tax benefit from
stock option
exercises
    
    
    
    
    
    
    
    
    
    
    7,240,918
    
    
    
    
    
    
    
    
    
    
    
    7,240,918Balance at
September 30, 2003
    
    
    19,510,072
    
    
    $
    975,503
    
    
    $
    144,364,676
    
    
    $
    23,793,528
    
    
    $
    (20,747
    )
    
    $
    169,112,960


See accompanying notes to condensed consolidated financial statements.

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



|(1) |  | Business
|--- |  | --------

Advanced Neuromodulation Systems, Inc. (we, the Company or ANS)
designs, develops, manufactures and markets implantable neuromodulation
devices used to manage chronic intractable pain and other disorders of
the central nervous system. We also provide contract development and
custom manufacturing for other medical device companies through our
Hi-tronics Designs, Inc. (HDI) subsidiary, which we acquired in January
2001. ANS neuromodulation revenues are derived primarily from sales
throughout the United States, Europe and Australia while HDI revenues are
derived within the United States.

On July 11, 2003, we effected a 3-for-2 stock split in the form of a 50%
stock dividend (one share of common stock paid for every two shares
held), paid to shareholders of record on June 20, 2003. All prior period
shares and income per share figures have been restated to reflect the
split.

In November 2002, the Company acquired MicroNet Medical, Inc., a
privately-held developer of medical devices based on proprietary
micro-lead technology based in St. Paul, Minnesota. See Note 3.

In March 2003, the Company acquired the pain management business of Sun
Medical, Inc., the Companys largest distributor of its Neuro Products.
See Note 3.

In September 2003, the Company acquired certain assets of Comedical, Inc,
a distributor of the Companys Neuro Products. See Note 3.

The research and development, manufacture, sale and distribution of
medical devices are subject to extensive regulation by various public
agencies, principally the Food and
Drug Administration and corresponding state, local and foreign agencies.
Product approvals and clearances can be delayed or withdrawn for failure
to comply with regulatory requirements or the occurrence of unforeseen
problems following initial marketing.

In addition, ANS products are purchased primarily by hospitals,
ambulatory surgery centers and other users who then bill various third
party payors including Medicare, Medicaid, Workmens Compensation,
private insurance companies and managed care organizations. These third
party payors reimburse fixed amounts for services based on a specific
diagnosis. The impact of changes in third party payor reimbursement
policies and any amendments to existing reimbursement rules and
regulations that restrict or terminate the eligibility of ANS products
could have an adverse impact on the Companys financial condition and
results of operations.



|(2) |  | Condensed Financial Statements
|--- |  | ------------------------------

The unaudited condensed consolidated financial information contained in
this report reflects all adjustments (consisting of normal recurring
accruals) considered necessary, in the opinion of management, for a fair
presentation of results for the interim periods presented. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and
assumptions that

8



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

affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from these estimates.

Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the financial statements
and notes thereto included in the Companys December 31, 2002
Annual Report on Form 10-K/A. The results of operations for the period
ended September 30, 2003 are not necessarily indicative of operations for
the full year.

The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and its subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.



|(3) |  | Acquisitions
|--- |  | ------------

On September 4, 2003, we completed the purchase of certain assets of
Comedical, Inc. for $1,134,079. The acquisition expanded our direct sales
force. Comedical was a distributor of our Neuro Products in the
Northwestern United States. As part of the acquisition, three of
Comedicals direct salespersons and three of its commissioned agents
joined the Companys direct sales force. Assets acquired consisted
primarily of customer lists, non-compete agreements, inventory, contracts
and equipment. The allocation of the purchase price is as follows:
inventory-$352,742, customer relations-$367,860, non-compete
agreements-$367,861 and equipment-$45,616. Amortization periods for the
identifiable intangible assets are as follows: customer relations-7 years
and non-compete agreements-4 years.

On March 27, 2003, we completed the acquisition of the pain management
business of Sun Medical, Inc. for $4,857,192 (including acquisition
related expenses of approximately $45,931). The acquisition expanded our
direct sales force. Sun Medical was the largest distributor of our Neuro
Products and accounted for $6.33 million, or 13.5% of revenue of the
Neuro Products segment during the twelve months ended December 31, 2002.
As part of the acquisition, we hired substantially all of the
salespersons and clinical support specialists who worked for Sun
Medicals pain management business. Assets acquired consisted primarily
of customer lists, non-compete agreements, inventory, contracts,
equipment and other tangible assets but excluded cash and accounts
receivable as of the closing date. The allocation of the purchase price
is as follows: goodwill-$2,145,931, customer relations-$1,100,000,
inventory-$1,011,261, other non-compete agreements-$300,000, supplier
relations-$200,000, and employee non-compete agreements- $100,000.
Amortization periods for the identifiable intangible assets are as
follows: customer relations-7 years, other non-compete agreements-5
years, supplier relations-4 years and employee non-compete agreements-1
year.

On November 25, 2002, we completed the acquisition of MicroNet Medical,
Inc., a privately-held developer of medical devices based on proprietary
micro-lead technology. MicroNet developed a line of very thin and
steerable spinal cord stimulation leads called Axxessleads. These leads
are the smallest diameter neurostimulation leads on the market, and
because of their size, we believe they offer advantages in certain

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

applications. Under the terms of the transaction, which we structured as
a merger, we acquired only MicroNets proprietary technology and certain
associated tangible assets. The MicroNet assets are a part of our Neuro
Products segment. MicroNets operations, other tangible assets, certain
liabilities and certain employees became part of a separate unaffiliated
company. We assumed no material debt, liabilities, or overhead in the
transaction. At closing, we paid the former MicroNet shareholders
$500,000 in cash and 234,453 shares of our common stock with a value at
the time of issuance of $4,648,421. In addition, we incurred expenses of
$859,460, including an investment-banking fee of $600,000. We also agreed
to pay the former MicroNet shareholders additional shares of our common
stock if certain product, regulatory approval and sales milestones are
met. These milestones consist of three principal product milestones and a
sales milestone. Each of the product milestones has four to six
sub-milestones that relate to the delivery of specific products,
including four 4-electrode leads (Milestone I), two 8-electrode leads
(Milestone II) and a 4-electrode lead and an 8-electrode lead designed
for use in specific applications (Milestone III). The product
sub-milestones are met if and when we are able to submit, and if and when
we receive, regulatory approvals for products that have been adapted for
use directly with our electrical stimulation devices. The sales milestone
will be met if and when we and our subsidiaries generate $5 million in
cumulative net sales of MicroNet lead products during the four years
following the closing of the MicroNet transaction.

The aggregate value of the additional potential milestone earnout
payments payable in shares of our common stock was $9 million as measured
at the time the transaction was completed. Of this $9 million in
additional shares, we issued a fixed number of shares totaling 134,409
with an aggregate value at closing of $3 million into an escrow account.
If and when the product and regulatory milestones are achieved, we will
release a specified and fixed number of shares of our common stock from
escrow to the former MicroNet shareholders (which for purchase price
accounting will be valued at the time of release from escrow). In
addition, if and when those same product and regulatory milestones are
achieved, we will also issue at that time a number of shares of our
common stock with an aggregate value of up to $3 million. Finally, if and
when we generate $5 million in cumulative net sales of MicroNet lead
products during the four years following the closing, we will issue at
that time a number of shares of our common stock with an aggregate value
of $3 million. In March 2003, two parts of the first major product
milestones were satisfied, and we issued the former MicroNet shareholders
an aggregate of 42,519 shares of our common stock (of which 22,401 shares
were from escrow) with a value at the time of issuance and release from
escrow of $1,020,059, which was allocated to certain identifiable
intangible assets in accordance with the original purchase price
allocation, resulting in additional purchased technology of $978,237,
tradenames of $23,461, and non-compete agreements of $18,361. In October
2003, an additional product milestone was satisfied, and we issued the
former MicroNet shareholders an aggregate of 17,463 shares of our common
stock (of which 11,197 shares were from escrow) with a value at the time
of issuance and release from escrow of $700,182, which will be allocated
to certain identifiable intangible assets in accordance with the original
purchase price allocation, which will result in additional purchased
technology of $671,475, tradenames of $16,104, and non-compete agreements
of $12,603. Important additional product milestone deadlines occur in
November 2003 and May 2004, while other milestones depend on the receipt
of regulatory approvals and meeting the aggregate sales milestone
referred to above. All

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

milestones must be met by November 2006 or November 2007, depending on
the milestone.



|(4) |  | Stock Based Compensation
|--- |  | ------------------------

The Company accounts for its stock-based compensation plans in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25) and related interpretations. Under APB 25,
no compensation expense is recognized for stock option grants if the
exercise price of the Companys stock option grants is at or above fair
market value of the underlying stock on the date of grant. The Company
has adopted the pro forma disclosure features of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation
(SFAS 123), as amended by Statement of Financial Accounting Standards No.
148, Accounting for Stock-Based Compensation-Transition and Disclosure.
The following table illustrates the effect on net income and net income
per share amounts if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation:

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net income as reported
    
    $
    3,952,852
    
    
    $
    1,942,303
    
    
    $
    9,495,781
    
    
    $
    4,227,720Stock-based
compensation expense
    
    
    1,026,105
    
    
    
    570,881
    
    
    
    3,018,947
    
    
    
    1,515,393Pro forma net income
    
    $
    2,926,747
    
    
    $
    1,371,422
    
    
    $
    6,476,834
    
    
    $
    2,712,327Basic shares
    
    
    19,382,991
    
    
    
    18,140,091
    
    
    
    19,040,105
    
    
    
    15,682,565Diluted shares
    
    
    20,860,041
    
    
    
    19,764,149
    
    
    
    20,441,351
    
    
    
    17,379,035Pro forma Basic EPS
    
    $
    .15
    
    
    $
    .08
    
    
    $
    .34
    
    
    $
    .17Pro forma Diluted EPS
    
    $
    .14
    
    
    $
    .07
    
    
    $
    .32
    
    
    $
    .16




|(5) |  | Commitments and Contingencies
|--- |  | -----------------------------

In January 1998, the Company sold its cardiovascular operations to Atrion
Corporation, and granted Atrion a nine-month option to acquire the
Companys principal office and manufacturing facility in Allen, Texas for
$6.5 million. During October 1998, Atrion exercised its option to acquire
the facility. When the facility was built in 1993, the Company entered a
ten-year agreement with the City of Allen granting tax abatements to the
Company if a minimum job base and personal property base were maintained
in the City of Allen. The agreement provided for the repayment of abated
taxes if the Company defaulted under the agreement. During 1998, the
Company recorded a pretax expense of $969,204 in connection with the
abated taxes. In April 1999, the Company was successful in petitioning
the City of Allen to assign the abatement agreement to Atrion. In July
1999, the Company, Atrion and the City of Allen executed an assignment
agreement under which Atrion (as successor in interest to the Company)
agreed to continue to meet the conditions of the original tax abatement
agreement until August 2003. The City preserved its rights to collect
previously abated taxes if Atrion failed to

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

comply with its obligations any time prior to August 2003. The Company
retained monetary liability for the amount of abated taxes, even after
assignment, because pursuant to the purchase and sale agreement with
Atrion, the Company indemnified Atrion from any tax abatement liabilities
that accrued to the City of Allen prior to the sale of the cardiovascular
operations in January 1998. Atrion met the conditions of the abatement
agreement through August 2003, and thus in September 2003, the Company
reversed the potential obligation to Atrion of $969,204, which is
reflected in other income in the Condensed Consolidated Statements of
Income.

The Company entered into a sixty-three month lease agreement on 40,000
square feet of space located in the North Dallas area during February
1999. The Company relocated its operations to the leased facility in May
1999 and the rental period under the lease commenced on June 1, 1999.
Under the terms of the lease agreement, the Company received three months
free rent, and the monthly rental rate for the remaining term of the
lease is $48,308, subject to certain annual adjustments for increases in
expenses for common area maintenance and property taxes. The monthly
rental rate was increased to $52,647 in January 2003. In September 2002,
the Company amended its lease agreement to add approximately 9,700 square
feet of office space located in the same complex as its 40,000 square
foot corporate headquarters. The lease on the additional space expires
during August 2004, the same as the corporate headquarters facility. The
monthly rental rate on the 9,700 square feet of office space is $11,485.
In July 2003, the Company entered into a sublease to add approximately
9,800 square feet of office space located in the same complex as its
40,000 square foot corporate headquarters. The sublease on the additional
space expires on July 31, 2004 and has a monthly rental rate of $10,655.

The Company also leases facilities in New Jersey as a result of the
January 2001 acquisition of HDI. One of the facilities, located in Budd
Lake, New Jersey, is 10,348 square feet of office space that is used for
administration, design engineering, drafting, documentation and
regulatory affairs. The lease expires on February 28, 2004 and has a
monthly rental rate of $9,615. The Company also leases 18,582 square feet
of space in Hackettstown, New Jersey used for the O.E.M. manufacturing
operations. The Hackettstown lease, which expires on December 31, 2005,
has a monthly rental rate of $9,517 and is renewable for one additional
three-year period.

The Company leases office equipment under non-cancelable operating leases
expiring through 2004. Monthly payments on the office equipment leases
are $2,412.

The Company is subject to proceedings, lawsuits and other claims related
to its products and business. The Company is required to assess the
likelihood of any adverse judgments or outcomes to these matters as well
as potential ranges of probable losses. A determination of the amount of
reserves required, if any, for these contingencies are made after
analysis of each individual issue. The required reserves may change in
the future due to new developments in each matter or changes in approach,
such as a change in settlement strategy, in dealing with these matters.

Currently, product liability claims and other ordinary routine litigation
incidental to the Companys business are the only litigation to which it
is a party. While historically the Companys product liability claims
have not resulted in significant monetary liability

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

beyond its insurance coverage, an adverse judgment beyond its insurance
coverage could have a material adverse impact on its results of
operations and financial condition.

Under the Companys sales agreements with its independent sales agents,
the Company can terminate those agreements without cause by paying an
early termination fee equal to 100% of the commissions that would
otherwise be payable on sales in the territory for the 90 days after
termination and 50% of the commission that would otherwise be payable on
sales in the territory for the 90 day period after the first 90 day
period.

In addition, under its distributor agreements, sales agent agreements and
certain other ordinary course commercial contracts with third parties,
the Company typically agrees to indemnify the other contracting party
from damages and costs that may arise from product liability claims. The
terms of the agreements and contracts vary, and the potential exposure
under these indemnities cannot reasonably be estimated or determined.
Historically, product liability claims for our neurostimulation devices
have not resulted in significant monetary liability beyond our insurance
coverage. We seek to maintain appropriate levels of product liability
insurance with coverage that we believe is comparable to that maintained
by companies similar in size and serving similar markets.

Financial Accounting Standards Board Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (Interpretation 45) requires
disclosures in interim and annual financial statements about obligations
under certain guarantees issued by the Company. Furthermore, it requires
recognition at the beginning of a guarantee of a liability for the fair
value of the obligation undertaken in issuing the guarantee, with limited
exceptions including: 1) a parents guarantee of a subsidiarys debt to a
third party, and 2) a subsidiarys guarantee of the debt owed to a third
party by either its parent or another subsidiary of that parent. The
initial recognition and initial measurement provisions are only
applicable on a prospective basis for guarantees issued or modified after
December 31, 2002. This interpretation has had no impact on the Companys
consolidated statement of operations or condensed consolidated balance
sheets.



|(6) |  | Income Taxes
|--- |  | ------------

The Company recorded income tax expense during the three months and nine
months ended September 30, 2003 of $2,382,109 and $5,504,915,
representing overall effective tax rates of 37.6% and 36.7%,
respectively. These effective tax rates during the 2003 periods are
higher than the U.S. statutory rate of 35% for corporations due to a
provision for state taxes, offset by tax-exempt interest income. During
the three months and nine months ended September 30, 2002, the Company
recorded income tax expense of $963,048 and $2,213,984, representing
overall effective tax rates of 33.2% and 34.4%, respectively. These
effective tax rates during the 2002 periods include a provision for state
taxes, offset by tax-exempt interest income.



|(7) |  | Stock Split and Net Income Per Share
|--- |  | ------------------------------------

On July 11, 2003, we effected a 3-for-2 stock split in the form of a 50%
stock dividend (one share of common stock paid for every two shares
held), paid to shareholders of

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

record on June 20, 2003. All prior period shares and income per share
figures have been restated to reflect the split.

Basic net income per share is computed based only on the weighted average
number of common shares outstanding during the period. Diluted net income
per share is computed to reflect the additional dilutive effect, if any,
of stock options and warrants using the treasury stock method based on
the average market price of the stock during the period. The following
table presents the reconciliation of basic and diluted shares:

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Weighted-average shares
outstanding (basic shares)
    
    
    19,382,991
    
    
    
    18,140,091
    
    
    
    19,040,105
    
    
    
    15,682,565Effect of dilutive stock options
    
    
    1,477,050
    
    
    
    1,624,058
    
    
    
    1,401,246
    
    
    
    1,696,470Diluted shares
    
    
    20,860,041
    
    
    
    19,764,149
    
    
    
    20,441,351
    
    
    
    17,379,035


For the three months and nine months ended September 30, 2003 and 2002,
the incremental shares used for dilutive income per share relate to stock
options whose exercise prices were less than the average market price in
the underlying quarterly computations. For the three months ended
September 30, 2003 and September 30, 2002, all stock options outstanding
were included in the computation of diluted income per share because the
options exercise prices were less than the average market price of the
common shares for that three month period. For the nine months ended
September 30, 2003, options to purchase 38,625 shares of common stock at
an average exercise price of $30.30 were outstanding but were not
included in the computation of diluted income per share because the
options exercise prices were greater than the average market price of
the common shares and, therefore, the effect would be antidilutive. For
the nine months ended September 30, 2002, all stock options outstanding
were included in the computation of diluted income per share because the
options exercise prices were less than the average market price of the
common shares.



|(8) |  | Comprehensive Income
|--- |  | --------------------

Total comprehensive income for 2002 and for the nine months ended
September 30, 2003 is reported in the Condensed Consolidated Statements
of Stockholders Equity. Other comprehensive income (loss) is due to
unrealized gains and losses on marketable securities. Comprehensive
income (loss) for the three months and nine months ended September 30,
2003 and 2002 is as follows:

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net income
    
    $
    3,952,852
    
    
    $
    1,942,303
    
    
    $
    9,495,781
    
    
    $
    4,227,720Other comprehensive
income (loss)
    
    
    (1,473
    )
    
    
    (6,822
    )
    
    
    (6,862
    )
    
    
    (71
    )Comprehensive income
    
    $
    3,951,379
    
    
    $
    1,935,481
    
    
    $
    9,488,919
    
    
    $
    4,227,649


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



|(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.

Intersegment revenue from HDI is billed at cost with no intercompany
mark-up.

Segment data for the three months ended September 30, 2003 is as follows:

Neuro
    
    HDI
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    20,612,131
    
    
    $
    2,806,374
    
    
    $
    
    
    
    $
    23,418,505Intersegment revenues
    
    $
    
    
    
    $
    2,300,033
    
    
    $
    (2,300,033
    )
    
    $
    Segment income from
operations
    
    $
    4,662,304
    
    
    $
    503,210
    
    
    $
    
    
    
    $
    5,165,514


Segment data for the three months ended September 30, 2002 is as follows:

Neuro
    
    HDI
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    11,604,437
    
    
    $
    2,723,068
    
    
    $
    
    
    
    $
    14,327,505Intersegment revenues
    
    $
    
    
    
    $
    1,483,118
    
    
    $
    (1,483,118
    )
    
    $
    Segment income from
operations
    
    $
    1,897,556
    
    
    $
    635,318
    
    
    $
    
    
    
    $
    2,532,874


Segment data for the nine months ended September 30, 2003 follows:

Neuro
    
    HDI
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    56,587,484
    
    
    $
    8,826,073
    
    
    $
    
    
    
    $
    65,413,557Intersegment revenues
    
    $
    
    
    
    $
    5,781,279
    
    
    $
    (5,781,279
    )
    
    $
    Segment income from
operations
    
    $
    11,846,364
    
    
    $
    1,408,758
    
    
    $
    
    
    
    $
    13,255,122Segment assets
    
    $
    178,677,543
    
    
    $
    10,856,888
    
    
    $
    (7,298,816
    )
    
    $
    182,235,615


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Segment data for the nine months ended September 30, 2002 follows:

Neuro
    
    HDI
    
    Intercompany
    
    ConsolidatedProducts
    
    O.E.M.
    
    Eliminations
    
    TotalRevenue from
external customers
    
    $
    31,422,384
    
    
    $
    7,801,138
    
    
    $
    
    
    
    $
    39,223,522Intersegment revenues
    
    $
    
    
    
    $
    3,953,856
    
    
    $
    (3,953,856
    )
    
    $
    Segment income from
operations
    
    $
    4,299,023
    
    
    
    1,557,755
    
    
    $
    
    
    
    $
    5,856,778Segment assets
    
    $
    142,400,508
    
    
    $
    8,151,841
    
    
    $
    (3,953,856
    )
    
    $
    146,588,542




|(10) |  | Minority Investment in Preferred Stock
|---- |  | --------------------------------------

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



|(11) |  | Subsequent Event
|---- |  | ----------------

On October 23, 2003, the Company announced that it had agreed to acquire
certain assets of its sole remaining distributor of its Neuro Products in
the United States, State of the Art Medical Products. As part of the
transaction, which became effective November 1, 2003, six of State of the
Art Medicals direct sales people joined the Companys direct sales
force. State of the Art Medical purchased $5.3 million of the Companys
Neuro Products during the year ended December 31, 2002, and purchased
$6.1 million for the nine months ended September 30, 2003. The purchase
price of the assets is $3.5 million plus the value of the inventory,
which we estimate at approximately $750,000.

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

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

On June 6, 2003, we announced that our Board of Directors had approved a
3-for-2 stock split to be effected in the form of a 50% stock dividend (one
share of common stock payable for every two shares held). The dividend was
paid on July 11, 2003 to shareholders of record on June 20, 2003. We have
restated all share data and net income per share data to reflect the split.

Recent Developments

On November 25, 2002, we completed the acquisition of MicroNet Medical, Inc., a
privately-held developer of medical devices based on proprietary micro-lead
technology. MicroNet developed a line of very thin and steerable spinal cord
stimulation leads called Axxessleads.These leads are the smallest diameter
neurostimulation leads on the market, and because of their size, we believe
they offer advantages in certain applications. Under the terms of the
transaction, which we structured as a merger, we acquired only MicroNets
proprietary technology and certain associated tangible assets. The MicroNet
assets are a part of our Neuro Products segment. MicroNets operations, other
tangible assets, certain liabilities and certain employees became part of a
separate unaffiliated company. We assumed no material debt, liabilities, or
overhead in the transaction. At closing, we paid the former MicroNet
shareholders $500,000 in cash and 234,453 shares of our common stock with a
value at the time of issuance of $4,648,421. In addition, we incurred expenses
of $859,460, including an investment-banking fee of $600,000. We also agreed to
pay the former MicroNet shareholders additional shares of our common stock if
certain product, regulatory approval and sales milestones are met. These
milestones consist of three principal product milestones and a sales milestone.
Each of the product milestones has four to six sub-milestones that relate to
the delivery of specific products, including four 4-electrode leads (Milestone
I), two 8-electrode leads (Milestone II) and a 4-electrode lead and an
8-electrode lead designed for use in specific applications (Milestone III). The
product sub-milestones are met if and when we are able to submit, and if and
when we receive, regulatory approvals for products that have been adapted for
use directly with our electrical stimulation devices. The sales milestone will
be met if and when we and our subsidiaries generate $5 million in cumulative
net sales of MicroNet lead products during the four years following the closing
of the MicroNet transaction.

The aggregate value of the additional potential milestone earnout payments
payable in shares of our common stock was $9 million as measured at the time
the transaction was completed. Of this $9 million in additional shares, we
issued a fixed number of shares totaling 134,409 with an aggregate value at
closing of $3 million into an escrow account. If and when the product and
regulatory milestones are achieved, we will release a specified and fixed
number of shares of our common stock from escrow to the former MicroNet
shareholders (which for purchase price accounting will be valued at the time of
release from escrow). In addition, if and when those same product and
regulatory milestones are achieved, we will also issue at that time a number of
shares of our common stock with an aggregate value of up to $3 million.
Finally, if and when we generate $5 million in cumulative net sales of MicroNet
lead products during the four years following the closing, we will issue at
that time a number of shares of our common stock with an

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aggregate value of $3 million. In March 2003, two parts of the first major
product milestone were satisfied, and we issued the former MicroNet
shareholders an aggregate of 42,519 shares of our common stock (of which 22,401
shares were from escrow) with a value at the time of issuance and release from
escrow of $1,020,059, which was allocated to certain identifiable intangible
assets in accordance with the original purchase price allocation, resulting in
additional purchased technology of $978,237, tradenames of $23,461, and
non-compete agreements of $18,361. In October 2003, an additional product
milestone was satisfied, and we issued the former MicroNet shareholders an
aggregate of 17,463 shares of our common stock (of which 11,197 shares were
from escrow) with a value at the time of issuance and release from escrow of
$700,182, which will be allocated to certain identifiable intangible assets in
accordance with the original purchase price allocation, which will result in
additional purchased technology of $671,475, tradenames of $16,104, and
non-compete agreements of $12,603. Important additional product milestone
deadlines occur in November 2003 and May 2004, while other milestones depend on
the receipt of regulatory approvals and meeting the aggregate sales milestone
referred to above. All milestones must be met by November 2006 or November
2007, depending on the milestone.

On March 27, 2003, we completed the acquisition of the pain management business
of Sun Medical, Inc. for $4,857,192 (including acquisition related expenses of
$45,931). Sun Medical was the largest distributor of our Neuro Products and
accounted for $6.33 million, or 13.5% of revenue of the Neuro Products segment
during the twelve months ended December 31, 2002 and $2.87 million, or 14.5% of
revenue of the Neuro Products segment during the six month period ended June
30, 2002. As part of the acquisition, we hired substantially all of the
salespersons and clinical support specialists who worked for Sun Medicals pain
management business. Assets acquired consisted primarily of customer lists,
non-competes, inventory, contracts, equipment and other tangible assets, but
excluded cash and accounts receivable as of the closing date. The allocation of
the purchase price as of March 31, 2003 is as follows: goodwill-$2,145,931,
customer relations-$1,100,000, inventory-$1,011,261, other non-compete
agreements-$300,000, supplier relations-$200,000, and employee non-compete
agreements- $100,000. Amortization periods for the identifiable intangible
assets are as follows: customer relations-7 years, other non-compete
agreements-5 years, supplier relations-4 years and employee non-compete
agreements-1 year.

On September 4, 2003, we completed the purchase of certain assets of Comedical,
Inc. for $1,134,079. The acquisition expands the Companys direct sales force.
Comedical was a distributor of the Companys Neuro Products in the Northwestern
United States. As part of the acquisition, three of Comedicals direct
salespersons and three of its commissioned agents joined the Companys sales
force. Assets acquired consisted primarily of customer lists, non-compete
agreements, inventory, contracts and equipment. The allocation of the purchase
price is as follows: inventory-$352,742, customer relations-$367,860,
non-compete agreements-$367,861 and equipment-$45,616. Amortization periods for
the identifiable intangible assets are as follows: customer relations-7 years
and non-compete agreements-4 years.

On October 23, 2003, we announced that we had agreed to acquire certain assets
of our sole remaining distributor of our Neuro Products in the United States,
State of the Art Medical Products. As part of the transaction, which closed on
November 1, 2003, six of State of the Art Medicals direct sales people joined
the Companys direct sales force. State of the Art Medical purchased $5.3
million of the Companys Neuro Products during the year ended December 31, 2002
and for the nine months ended September 30, 2003, purchased $6.1 million. The

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purchase price of the assets was $3.5 million plus the value of the inventory,
which we estimate at approximately $750,000.

Our current neuromodulation product line includes our Genesis®Implantable
Pulse Generator system, GenesisXPIPG system, Renew®Radio Frequency system
and AccuRx®constant rate drug pump. With the launch of our Genesisand
GenesisXPIPG systems,we now compete in 100% of the implantable
neurostimulation market to treat chronic pain of the trunk and limbs. The
launch of the GenesisIPG and GenesisXPIPG in 2002 slowed our growth rate in
sales of Renewsystems from an average annual percentage growth rate in the
mid-teens over the past several years to single-digit annual growth in 2002.
This trend has continued during the first nine-months of 2003 and we assume
that it will continue during the fourth quarter of 2003.

Critical Accounting Policies and Estimates

General

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

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

Revenue Recognition

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

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

End customers and distributors are granted rights of return for 60 days
following the point of sale. We record, as a reduction in revenue, a provision
for estimated sales returns and

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adjustments on these product sales in the same period as the related revenue is
recorded. These estimates are based on historical sales returns, analysis of
credit memo data, and other known factors. We typically sell our products to
distributors at a price equal to 75% to 78% of list price, and recognize the
net amount as revenue when all the revenue recognition criteria detailed above
are met. With the acquisition of State of the Art Medicals assets in November
2003, we no longer utilize distributors to sell our products in the United
States, although we continue to use distributors to sell our products in
certain markets internationally.

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

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

Bad Debt

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

Inventory Reserve

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

Intangible Assets

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

In assessing the recoverability of our intangible assets, we must make
assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for these assets.

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Contingencies

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

Results of Operations

Comparison of the Three Months and Nine Months Ended September 30, 2003 and
2002

Results for the third quarter and first nine months of 2003 continue to reflect
the positive impact of revenue growth from increased unit sales of our Genesis
and GenesisXP IPG systems, which we launched in the United States in January
2002 and December 2002, respectively. Based on our sales experience over the
last few quarters, we increased our earnings guidance for 2003 in a press
release dated October 23, 2003. We now expect net income per diluted share in a
range of $.63 to $.64 for the full year, up from our previous guidance of net
income per diluted share of $.59 to $.61.

Net revenue of our neuromodulation products increased 77.6% to $20.61 million
in 2003 from $11.60 million in 2002 primarily due to increased sales of our
Genesis and GenesisXP IPG systems. Revenue from our Renew RF system grew
modestly during the quarter compared to the prior year quarter. Net revenue
from our O.E.M. business increased 3.1% to $2.81 million in 2003 from $2.72
million in 2002 primarily due to higher volume of O.E.M. product sales. Net
revenue of our neuromodulation products increased 80.1% to $56.59 million in
2003 year-to-date from $31.42 million in the same nine-month period in 2002,
again primarily due to increased sales of our Genesis and GenesisXP IPG
systems. Net revenue from our O.E.M. business increased 13.1% to $8.83 million
in 2003 from $7.80 million in 2002 due to higher volume of O.E.M. product
sales. We now expect net revenue in a range of $88 to $89.5 million for the
full year, up from our previous guidance of $84 to $87 million.

Gross profit margins increased to 72.7% during the third quarter from 66.1% in
the prior year quarter, and to 68.9% during the nine months from 63.2% in the
prior year period, due to higher sales of our neuromodulation products, which
contribute higher margins than O.E.M. product sales, higher neuromodulation
product sales from direct sales and commissioned agents in part due to the
acquisition of two of our distributors during the current periods, which
contribute higher margins than distributor sales, and operational efficiencies
gained from higher manufacturing volumes.

Total operating expenses increased as a percentage of revenue during the third
quarter to 50.7% from 48.5% in the prior year quarter, and to 48.7% during the
nine months from 48.3% in the prior year period, primarily due to increased
investments in our sales and marketing capabilities, including the additional
sales personnel acquired in the March 2003 Sun Medical acquisition and the
September 2003 acquisition of Comedical, Inc.

Research and development expense increased in absolute dollar amounts during
both periods in 2003 compared to 2002 due to higher salary and benefit expense
from staffing additions and annual salary increases, higher stock based
compensation expense for certain consultants and higher prototype tooling and
test materials for new products under development. We also accelerated
certain research and development projects, although we expect annual
expenditures as a percentage of revenue to be consistent with budgeted amounts.
Our development efforts continue to focus on next-generation IPG stimulation
systems, next-

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generation RF stimulation systems, an IPG stimulation system for deep brain
stimulation and next generation drug pumps.

Sales and marketing expense increased during both the quarter and the
nine-month period in 2003 compared to 2002 principally due to higher commission
expense from increased Neuro Product sales, higher salary expense from annual
salary increases and staffing additions in reimbursement, direct sales and
clinical support specialists, higher employee benefit costs from staffing
additions, higher travel expense due to increased direct sales activities and
higher expense for education and training of new implanters of Neuro Products.

Amortization expense increased during both periods in 2003 compared to 2002 due
to amortization expense for intangible assets we acquired in the MicroNet
Medical, Inc. acquisition consummated in November 2002, the Sun Medical, Inc.
acquisition consummated on March 27, 2003 and the Comedical, Inc. acquisition
consummated on September 4, 2003.

General and administrative expense increased in absolute dollar amounts during
both 2003 periods compared to the same periods in 2002 principally as a result
of higher salary expense from annual salary increases and staffing additions,
higher employee benefit costs, higher recruiting fee expense and higher
depreciation expense.

Other income increased during both 2003 periods primarily due to the reversal
of an accrued tax-abatement liability of $969,204 as we were legally released
from our potential obligation to pay that amount during the third quarter of
2003. Interest income decreased during the third quarter of 2003 compared to
2002 due to lower yields on invested funds, but increased during the nine-month
period due to higher funds invested during the 2003 period compared to 2002.

Income tax expense increased during both 2003 periods compared to the same
periods in 2002 due to an increase in pretax income. The effective tax rate was
37.6% during the third quarter of 2003 compared to 33.2% during the 2002 third
quarter. The effective tax rate was 36.7% during the 2003 nine-month period
compared to 34.4% during the 2002 nine-month period. During both 2003 periods,
we used a 35% federal income tax rate due to higher projected income while
during 2002 we used a federal income tax rate of 34%. These effective tax rates
in both 2003 and 2002 are higher than the U.S. statutory rate for corporations
due to a provision for state taxes, offset by tax-exempt interest income.

Liquidity and Capital Resources

At September 30, 2003, our working capital increased to $128.7 million from
$114.3 million at December 31, 2002. The ratio of current assets to current
liabilities was 17.76:1 at September 30, 2003, compared to 13.15:1 at December
31, 2002. Cash, cash equivalents, certificates of deposit and marketable
securities totaled $96.61 million at September 30, 2003 compared to $96.77
million at December 31, 2002.

In 2003, we have acquired the assets of our three remaining domestic
distributors, at a cost of approximately $10.2 million in cash. On October 23,
2003, we announced that we had agreed to acquire certain assets of our sole
remaining distributor of our Neuro Products in the United States, State of the
Art Medical Products. As part of the transaction, which was effective November
1, 2003, six of State of the Art Medicals direct sales people joined the
Companys direct sales force. State of the Art Medical purchased $5.3 million
of our Neuro Products during the year ended December 31, 2002 and $6.1 million
during the nine months ended September

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30, 2003. The purchase price of the assets was $3.5 million, plus the value of
the inventory, which we estimate at approximately $750,000. In September 2003,
we acquired certain assets of our exclusive distributor of pain management
products for the Northwestern United States, Comedical, Inc. for approximately
$1,134,000 in cash. In March 2003, we acquired Sun Medicals pain management
business, which expanded our direct domestic salesforce, for approximately
$4,857,000 in cash, including approximately $46,000 in acquisition costs. See
Notes 3 and 11 to the Notes to Condensed Consolidated Financial Statements.

In January 2003, we invested $1 million in cash to purchase preferred stock for
a minority equity position in Innovative Spinal Technologies, Inc., a start-up
company that develops spine technologies, products and services through
intellectual property development and contract research.

We have increased our investment in inventories by approximately $4.8 million
during the year in anticipation of continuing sales growth.

Our investment in trade accounts receivable increased due to increased sales
and an increase in our days sales outstanding (DSOs) from 55 days at year-end
2002 to 61 days at September 30, 2003. Two factors accounted for the increase
in DSOs. First, we acquired the pain management business of Sun Medical on
March 27, 2003. Prior to our acquisition, Sun Medical would pay us within 10
days to take advantage of a payment discount. As such, our outstanding accounts
receivable from Sun Medical at any point in time was relatively small. After
this acquisition, we are now billing hospitals and insurance companies
directly, and these customers tend to pay on a slower cycle than did Sun.
Second, we experienced slower collections during the first nine months of 2003
from insurance companies because a larger portion of our neuro segment business
revenues were derived from direct billing to insurance companies compared to
the prior periods.

We spent $4.16 million during the nine months ended September 30, 2003 for
capital expenditures, primarily for new office furniture and equipment for
personnel we hired and additional manufacturing tooling and equipment to
provide increased capacity to support our current products and for tooling and
equipment for new products currently being developed. We have accelerated
capital expenditures compared to our original budgeted amount of $3.3 million
(excluding the facility discussed below) due to acceleration of development
projects and capacity.

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

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the second quarter of 2003 and through September 30, 2003, we have used $3.1
million to fund the interim construction.

We received $5.81 million of cash during the nine months ended September 30,
2003 from the exercise of employee and director stock options to purchase
938,968 shares of our common stock.

Liquidity may also be enhanced based on our ability to utilize all or part of a
net operating loss of $3.4 million to offset future taxable income. We acquired
the net operating loss in connection with the MicroNet Medical acquisition and
its utilization may be subject to a limitation under Section 382 of the
Internal Revenue Code. The rules of Section 382 of the Internal Revenue Code
generally apply to limit a corporations ability to utilize acquired net
operating loss carryforwards to reduce its federal taxable income in the
periods after an acquisition. The Companys ability to use the net operating
loss carryforwards acquired in the MicroNet Medical acquisition to reduce its
federal taxable income is subject to these rules. Provided the Company
generates sufficient taxable income in future years, the Section 382 limitation
will have the effect of deferring the utilization of the net operating loss
carryforwards over several years. Without this limitation, the Company would be
able to use all of the net operating loss carryforwards to reduce taxable
income in the tax periods immediately following the acquisition. The total
amount of net operating loss carryforwards that the Company may use to reduce
taxable income in any taxable year after the acquisition is determined with
reference to its purchase price of MicroNet Medical. Based on current estimates
and assumptions, we expect to utilize at least approximately $700,000 in net
operating loss carryforwards per full tax year over the next five years,
assuming we generate sufficient taxable income in any given year to utilize
such amount.

Additionally, liquidity may be enhanced to the extent we realize tax benefits
from employee stock option exercises. Exercises of nonqualified stock options,
and exercises of incentive stock options followed by disqualifying
dispositions of the underlying common stock within one year following exercise
generate compensation expense for tax purposes in the year of exercise or
disposition, as the case may be. During the nine months ended September 30,
2003, we generated a $7.24 million tax benefit related to nonqualified stock
option exercises and disqualifying dispositions of common stock acquired on
exercise of incentive stock options.

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

Cash Flows

Net cash provided by operations increased for the first nine months of 2003 due
to an increase in net income of $5.27 million. Major uses of cash for working
capital components during the 2003 period were for increased accounts
receivable from record sales levels and for increased investments in
inventories in anticipation of continued sales growth. We also received the
tax benefits from the exercise of stock options described above, and $1.2
million in cash from our distribution agreement with Boston Scientific
Corporation.

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Net cash used in investing activities decreased substantially during the
period, principally due to a decrease of $86.32 million in net purchases of
marketable securities because the prior period reflects the investing of the
$83.20 million raised in a public offering during the 2002 period. In the 2003
period, we used cash of $4.86 million in the acquisition of Sun Medicals pain
management business, $3.1 million used to fund interim construction on our new
facility, $1.1 million used to purchase minority investments in preferred
stock, mostly related to a $1.0 million investment in Innovative Spinal
Technologies, Inc., $1.13 million used in the acquisition of assets of
Comedical, Inc. and a $2.45 million increase in funds used for capital
expenditures.

Net cash provided by financing activities increased substantially in 2002,
reflecting the $83.20 million raised in a public offering in May 2002. Exercise
of stock options provided $5.81 million during the nine months ended September
30, 2003 compared to $1.47 million during the same period a year ago.

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.

Outlook and Uncertainties

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



| |  | failure of our Genesisand GenesisXPIPG systems to gain and maintain market acceptance would adversely affect our revenue
growth and profitability
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  | because our main competitor has significantly greater resources than we do and new competitors may enter the
neuromodulation market, it may be difficult for us to compete in this market
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | if pain management specialists do not recommend and endorse our products, our sales could be negatively impacted and we may
be unable to increase our revenues and profitability
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the launch of Genesisand GenesisXPand other market factors could impede growth in or reduce sales of Renew, which would
adversely affect our revenues and profitability
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | if patients choose less invasive or less expensive alternatives to our products, our sales could be negatively impacted
|- |  | -----------------------------------------------------------------------------------------------------------------------



| |  | any adverse changes in coverage or reimbursement amounts by Medicare and Medicaid, private insurance companies and managed
care organizations, or workers compensation programs could limit our ability to market and sell our products
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | if we fail to protect our intellectual property rights, our competitors may take advantage of our ideas and compete
directly against us
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | other parties may sue us for infringing their intellectual property rights, or we may have to sue them to protect our
intellectual property rights
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  | failure to obtain necessary government approvals for new products or for new applications for existing products would mean
we could not sell those new products, or sell our existing products for those new applications
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | modification of any marketed device could require a new 510(k) clearance or PMA or require us to cease marketing or recall
the modified device until we obtain this clearance or approval
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we will be unable to sell our products if we fail to comply with manufacturing regulations
|- |  | ------------------------------------------------------------------------------------------



| |  | our products are subject to product recalls even after receiving FDA clearance or approval, which would negatively affect
our financial performance and could harm our reputation
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we are subject to potential product liability and other claims and we may not have the insurance or other resources to
cover the cost of any successful claim
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we are subject to substantial government regulation and our failure to comply with all applicable government regulations
could subject us to numerous penalties, any of which could adversely affect our business
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our reliance on single suppliers for critical components used in our main products could adversely affect our ability to
deliver products on time
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our major competitor in the neuromodulation market currently accounts for a significant percentage of our revenue from our
O.E.M. segment
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | we are dependent upon the success of neuromodulation technology; our inability to continue to develop innovative
neuromodulation products, or the failure of the neuromodulation market to develop as we anticipate, would adversely affect
our business
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our success will depend on our ability to attract and retain key personnel and scientific staff
|- |  | -----------------------------------------------------------------------------------------------



| |  | if we choose to acquire complementary businesses, products or technologies instead of developing them ourselves, we may be
unable to complete these acquisitions or to successfully integrate an acquired business, product or technology in a
cost-effective and non-disruptive manner
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we are subject to additional risks associated with international operations
|- |  | ---------------------------------------------------------------------------



| |  | our operations are conducted at three locations, and a disaster at any of these facilities could result in a prolonged
interruption of our business
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our shareholders rights plan and Texas law may inhibit a takeover that our shareholders consider favorable
|- |  | -----------------------------------------------------------------------------------------------------------



| |  | we may be obligated to issue shares of our common stock in the future to the former shareholders of MicroNet Medical and
the number of shares could increase if our stock price decreases
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | general economic risks
|- |  | ----------------------



| |  | other risks detailed from time to time in our SEC public filings
|- |  | ----------------------------------------------------------------

The foregoing risks are described in more detail in our Form 10-K/A for the
year ended December 31, 2002. If our assumptions prove to be incorrect or such
risks or uncertainties

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materialize, anticipated results could differ materially from those forecasted
in forward-looking statements.







ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For the period ended September 30, 2003, the Company did not experience
material changes in market risk exposures that affect the quantitative and
qualitative disclosures presented in the Companys Annual Report on Form 10-K/A
for the year ended December 31, 2002.







ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, an evaluation was carried
out by our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934). Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and procedures were
effective.

There were no changes in the Companys internal control over financial
reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of
1934) that occurred during the Companys most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting.

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PART II







OTHER INFORMATION







ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibit 3.1- Articles of Incorporation, as amended and
restated (1)
| | --- |  | -------------------------------------------------------------------



| |  |  | Exhibit 3.2- Bylaws, as amended and restated (1)
| |  |  | ------------------------------------------------



| |  |  | Exhibit 4.1- Rights Agreement dated as of August 30, 1996, between
Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent (2)
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Exhibit 4.2- Amendment to Rights Agreement dated as of January 25,
2002, between Advanced Neuromodulation Systems, Inc and
Computershare Investor Services LLC (formerly KeyCorp Shareholder
Services, Inc.) (3)
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Exhibit 31.1  Certification of the Chief Executive Officer
Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(4)
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Exhibit 31.2  Certification of the Chief Financial Officer
Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(4)
| |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Exhibit 32.1  Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (5)
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Exhibit 32.2  Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (5)
| |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | The Company furnished a report on Form 8-K on July 28, 2003,
providing under Item 9. Regulation FD Disclosure, a press release
issued by the Company on July 28, 2003 disclosing information
regarding our results of operations and financial condition for the
second quarter of 2003 and our financial outlook for 2003.
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



---

|(1) |  | Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 2000, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.              
|   
|(3) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
January 30, 2002, and incorporated herein by reference.               
|   
|(4) |  | Filed herewith.                                                                                                                          
|   
|(5) |  | Furnished herewith.                                                                                                                      

28



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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

ADVANCED NEUROMODULATION SYSTEMS, INCDate: November 13, 2003
    
    By:
    
    /s/ F. Robert Merrill IIIF. Robert Merrill IIIExecutive Vice President, FinanceChief Financial Officer and Treasurer


29



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##### Table of Contents









EXHIBIT INDEX

Exhibit 3.1
    
    Articles of Incorporation, as amended and restated (1)Exhibit 3.2
    
    Bylaws, as amended and restated (1)Exhibit 4.1
    
    Rights Agreement dated as of August 30, 1996, between Quest
Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent (2)Exhibit 4.2
    
    Amendment to Rights Agreement dated as of January 25, 2002
between Advanced Neuromodulation Systems, Inc and
Computershare Investor Services LLC (formerly KeyCorp
Shareholder Services, Inc.) (3)Exhibit 31.1
    
    Certification of the Chief Executive Officer Pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (4)Exhibit 31.2
    
    Certification of the Chief Financial Officer Pursuant to Rule
13a-14 of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (4)Exhibit 32.1
    
    Certification of the Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (5)Exhibit 32.2
    
    Certification of the Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (5)




---

|(1) |  | Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 2000, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.              
|   
|(3) |  | Filed as an Exhibit to the report of the Company on Form 8-K dated
January 30, 2002, and incorporated herein by reference.               
|   
|(4) |  | Filed herewith.                                                                                                                          
|   
|(5) |  | Furnished herewith.