<PAGE>
                       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 OF 1934
                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998


            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-------                 SECURITIES EXCHANGE ACT OF 1934
            FOR THE TRANSITION PERIOD FROM ____________ TO _________

                         Commission file number 0-10521

                     ADVANCED NEUROMODULATION SYSTEMS, INC.
             ------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)

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

                    One Allentown Parkway, Allen, Texas 75002
               ---------------------------------------------------
               (Address of Principal Executive Offices) (Zip Code)

                                 (972) 390-9800
              ----------------------------------------------------
              (Registrant's Telephone Number, Including Area Code)

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

Indicate the number of shares  outstanding  of each of the  issuer's  classes of
common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
                                              Number of Shares Outstanding at
            Title of Each Class                       October 30, 1998
         ------------------------             ---------------------------------
         <S>                                             <C>
         Common stock, $.05 Par Value                    7,654,316
</TABLE>

<PAGE>

             ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES


                                TABLE OF CONTENTS


<TABLE>
<S>                                                                         <C>
PART I.     Financial Information                                             2

     Item 1.     Financial Statements

                      Condensed Consolidated Balance Sheets
                           September 30, 1998 and December 31, 1997         3-4


                      Condensed Consolidated Statements of Operations
                           For the Three Months and Nine Months Ended
                           September 30, 1998 and 1997                        5


                      Condensed Consolidated Statements of Cash Flows
                           For the Nine Months Ended
                           September 30, 1998 and 1997                        6


                      Condensed Consolidated Statements of Stockholders'
                           Equity For the Year Ended December 31, 1997
                           and the Nine Months Ended September 30, 1998       7


                      Notes to Condensed Consolidated
                           Financial Statements                            8-14

     Item 2.     Management's Discussion and Analysis of Financial
                      Condition and Results of Operations                 15-22

PART II.    Other Information                                                23

     Item 6.     Exhibits and Reports on Form 8-K                            23

SIGNATURES                                                                   24
</TABLE>

                                       1
<PAGE>








                                     PART I


                              FINANCIAL INFORMATION





                                       2
<PAGE>
                                        
             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
                      Condensed Consolidated Balance Sheets
                    September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
                                                     September 30,
                                                         1998       December 31,
Assets                                                (Unaudited)      1997
                                                     ------------- -------------
<S>                                                  <C>           <C>
Current assets:
  Cash and cash equivalents                          $  15,701,501 $    747,828
  Marketable securities                                    547,817    1,455,864
  Receivables:
   Trade accounts, less allowance for
      doubtful accounts of $224,250 in 1998              2,854,155    2,398,327
      and $212,375 in 1997
   Interest and other                                       94,940      209,595
                                                     ------------- -------------
      Total receivables                                  2,949,095    2,607,922
                                                     ------------- -------------
  Inventories:
   Raw materials                                         1,164,262    1,056,718
   Work-in-process                                         467,753      323,929
   Finished goods                                        1,363,511    1,597,840
                                                     ------------- ------------
      Total inventories                                  2,995,526    2,978,487
                                                     ------------- ------------

  Net assets of discontinued operations sold in 1998           --    12,831,318
  Deferred income taxes                                  1,201,932    2,288,192
  Prepaid expenses and other current assets                469,490      476,716
                                                     ------------- ------------
      Total current assets                              23,865,361   23,386,327
                                                     ------------- -------------

Property, plant and equipment:
  Land                                                   1,927,900    1,927,900
  Building and improvements                              5,254,945    5,254,945
  Furniture and fixtures                                   832,955      624,753
  Machinery and equipment                                1,519,899      920,879
                                                     ------------- ------------
                                                         9,535,699    8,728,477
  Less accumulated depreciation and amortization         1,770,559    1,317,362
                                                     ------------- ------------
      Net property, plant and equipment                  7,765,140    7,411,115
                                                     ------------- ------------

Cost in excess of net assets acquired, net
  of accumulated amortization of $1,595,466              9,216,198    9,633,650
  in 1998 and $1,178,014 in 1997
Patents, net of accumulated amortization of
  $261,562 in 1998 and $148,958 in 1997                  2,988,438    2,851,042
Purchased technology from acquisitions, net
  of accumulated amortization of $933,334                3,066,666    3,266,666
  in 1998 and $733,334 in 1997
Tradenames, net of accumulated amortization
  of $437,500 in 1998 and $343,750 in 1997               2,062,500    2,156,250
Other assets, net of accumulated
  amortization of $51,744 in 1998                          234,156      277,270
                                                     ============= ============
                                                     $  49,198,459 $ 48,982,320
                                                     ============= ============
</TABLE>

                                       3
<PAGE>

             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
                      Condensed Consolidated Balance Sheets
                    September 30, 1998 and December 31, 1997

<TABLE>
<CAPTION>
                                                     September 30,
                                                         1998       December 31,
                                                      (Unaudited)      1997
                                                     ------------- -------------
<S>                                                  <C>           <C>
Liabilities and Stockholders' Equity
 
Current liabilities:
   Accounts payable                                  $     510,293 $    240,249
   Short-term notes payable and current maturities
      of long-term notes payable                           186,581    8,257,348
   Deferred revenue- R&D contract                        2,100,000           --
   Accrued salary and employee benefit costs               731,287      381,735
   Income taxes payable                                  3,199,703           --
   Other accrued expenses                                  674,717      379,444
                                                     ------------- ------------
         Total current liabilities                       7,402,581    9,258,776
                                                     ------------- ------------

Notes payable                                            3,492,532    3,635,027
Deferred income taxes                                    2,082,704    2,182,580

Commitments and contingencies

Stockholders' equity:
   Common stock of $.05 par value. Authorized 
      25,000,000 shares; issued 8,872,941 shares
      in 1998 and 8,635,509 in 1997                        443,647      431,775
   Additional paid-in capital                           42,593,241   40,780,717
   Retained earnings (deficit)                            (242,651)  (7,268,061)
   Cost of common shares in treasury;
      806,000 shares in 1998                            (6,430,790)         --
   Accumulated other comprehensive income                 (142,805)     (38,494)
                                                     ------------- ------------
         Total stockholders' equity                     36,220,642   33,905,937
                                                     ------------- ------------

                                                     $ 49,198,459  $ 48,982,320
                                                     ============= ============
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                       4
<PAGE>

             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
           Condensed Consolidated Statements of Operations (Unaudited)
     For the Three Months and Nine Months Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
                                   Three Months Ended      Nine Months Ended
                                      September 30,           September 30,
                                ----------------------- -----------------------
                                   1998        1997        1998        1997
                                ----------- ----------- ----------- -----------
<S>                             <C>         <C>         <C>         <C>
Net revenue-product sales       $ 3,706,402 $ 4,220,002 $12,860,529 $10,821,336
Net revenue-contract
  research and development        1,300,000         --    1,900,000         --
                                ----------- ----------- ----------- -----------
     Total net revenue            5,006,402   4,220,002  14,760,529  10,821,336

Costs and expenses:
  Cost of product sales           1,049,089   1,154,591   3,544,290   3,732,764
  Research and development          869,647     207,031   1,940,129     682,808
  Marketing                       1,223,392     989,495   3,461,254   2,923,907
  Amortization of intangibles       292,544     274,256     875,550     811,616
  General and administrative        706,726     469,545   1,946,339   1,332,527
                                ----------- ----------- ----------- -----------
                                  4,141,398   3,094,918  11,767,562   9,483,622
                                ----------- ----------- ----------- -----------
     Earnings from operations       865,004   1,125,084   2,992,967   1,337,714
                                ----------- ----------- ----------- -----------
Other income (expenses):
  Interest expense                  (78,395)   (156,349)   (254,133)   (456,575)
  Interest and other income         250,466      29,194     665,882      74,156
  Gain (loss) on sale of assets
   and marketable securities         (4,300)      9,497      (4,381)    (14,982)
                                ----------- ----------- ----------- -----------
                                    167,771    (117,658)    407,368    (397,401)
                                ----------- ----------- ----------- -----------
     Earnings from continuing
       operations before
       income taxes               1,032,775   1,007,426   3,400,335     940,313
Income taxes                        419,138     358,326   1,363,866     375,335
                                ----------- ----------- ----------- -----------
     Net earnings from
       continuing operations        613,637     649,100   2,036,469     564,978
                                ----------- ----------- ----------- -----------

Discontinued Operations:
  Loss from discontinued
   operations, net of income
   tax benefits of $129,711 in 
   1998 and income tax benefits
   of $33,989 and $9,529 in 1997        --     (199,738)   (211,634)    (55,998)

  Gain on sale of assets of
   discontinued operations, net
   of income tax expense of
   $3,037,968                           --           --   5,200,575         --
                                ----------- ----------- ----------- -----------
     Net earnings (loss)
       from discontinued
       operations                       --     (199,738)  4,988,941     (55,998)
                                ----------- ----------- ----------- -----------
     Net earnings               $   613,637 $   449,362 $ 7,025,410 $   508,980
                                =========== =========== =========== ===========

Basic earnings (loss) per share:
     Continuing operations      $      .07  $      .08  $      .24  $      .07
                                =========== =========== =========== ===========
     Discontinued operations    $       --  $     (.03) $      .58  $     (.01)
                                =========== =========== =========== ===========
     Net earnings               $      .07  $      .05  $      .82  $      .06
                                =========== =========== =========== ===========

Diluted earnings (loss) per share:
  Continuing operations         $      .07  $      .07  $      .23  $      .06
                                =========== =========== =========== ===========
  Discontinued operations       $       --  $     (.02) $      .57  $       --
                                =========== =========== =========== ===========
  Net earnings                  $      .07  $      .05  $      .80  $      .06
                                =========== =========== =========== ===========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>

             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
           Condensed Consolidated Statements of Cash Flows (Unaudited)
              For the Nine Months Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
                                                          Nine Months Ended
                                                            September 30,
                                                     --------------------------
                                                          1998         1997
                                                     ------------- ------------
<S>                                                  <C>           <C>
Cash flows from operating activities:
   Net earnings from continuing operations           $   2,036,469 $    564,978
                                                     ------------- ------------
   Adjustments to reconcile net earnings from
      continuing operations to net cash provided
      by operating activities
        Depreciation and amortization                    1,328,747    1,117,069
        Loss on sale of assets and marketable
          securities                                         4,381       14,982
        Increase in inventory reserve                          --       478,619
        Deferred income taxes                             (866,377)     365,806
        Changes in assets and liabilities:
          Receivables                                     (341,173)    (318,791)
          Inventories                                      (17,039)    (320,913)
          Prepaid expenses and other assets                 (1,404)     104,053
          Accounts payable                                 270,044     (478,154)
          Deferred revenue                               2,100,000          --
          Income taxes payable                           2,197,942          --
          Accrued expenses                                 576,825     (158,777)
                                                     ------------- ------------
           Total adjustments                             5,251,946      803,894
                                                     ------------- ------------
            Net cash provided by
             continuing operations                      7,288,415     1,368,872
            Net cash provided by
             discontinued operations                       59,049       673,708
                                                     ------------- ------------
             Net cash provided by operating
               activities                                7,347,464    2,042,580
                                                     ------------- ------------
Cash flows from investing activities:
  Purchases of marketable securities                      (106,001)  (1,181,383)
  Proceeds from sales of marketable securities             851,623    1,403,607
  Additions to property, plant and equipment
      - continuing operations                             (807,222)    (438,874)
  Additions to property, plant and equipment
      - discontinued operations                            (12,060)    (734,280)
  Acquisition of patent rights                            (250,000)         --
  Final payments for 1995 acquisition of Neuromed              --    (4,472,197)
  Net proceeds from sale of discontinued operations
      and assets                                        21,754,179        7,690
                                                     ------------- ------------
             Net cash provided by (used in)
               investing activities                     21,430,519   (5,415,437)
                                                     ------------- ------------
Cash flows from financing activities:
  Exercise of stock options                                819,742      695,248
  Purchase of treasury stock                            (6,430,790)         --
  Proceeds from short-term obligations                         --     3,911,221
  Payment of short-term obligations                     (8,081,763)  (1,161,221)
  Payment of long-term debt                               (131,499)    (121,263)
                                                     ------------- ------------
             Net cash provided by (used in)
               financing activities                    (13,824,310)   3,323,985
                                                     ------------- ------------
  Net increase (decrease) in cash and cash
    equivalents                                         14,953,673      (48,872)

Cash and cash equivalents at beginning of year             747,828      696,196
                                                     ============= ============
Cash and cash equivalents at September 30            $  15,701,501 $    647,324
                                                     ============= ============

Supplemental cash flow information is presented
  below:
Income taxes paid                                    $      32,300 $        --
                                                     ============= ============
Interest paid                                        $     292,977 $    707,098
                                                     ============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.

                                       6
<PAGE>

             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
            Condensed Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
                                                       Additional    Retained        Other                      Total
                                Common Stock            Paid-in      Earnings    Comprehensive   Treasury    Stockholders'
                             Share         Amount       Capital      (Deficit)   Income (Loss)     Stock        Equity
                         ------------- ------------- ------------- ------------- ------------- ------------- -------------
<S>                      <C>           <C>           <C>           <C>           <C>           <C>           <C>
Balance at
December 31, 1996           8,338,510  $    416,926  $ 38,699,517  $ (7,992,082) $   (130,878)          --   $  30,993,483

   Net earnings                   --             --            --       724,021           --            --         724,021
   Adjustment to
     unrealized losses
     on marketable
     securities                   --             --            --            --        92,384           --          92,384
                                                                                                             -------------
   Comprehensive Income                                                                                            816,405
                                                                                                             -------------
   Shares issued upon
     exercise of
     stock options            296,999        14,849       907,537            --            --           --         922,386
   Tax benefit from
     employee stock
     option exercise              --             --     1,173,663            --            --           --       1,173,663
                         ------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at December
31, 1997                    8,635,509       431,775    40,780,717    (7,268,061)      (38,494)          --      33,905,937

   Net earnings                   --             --           --      7,025,410           --            --       7,025,410
   Adjustment to
     unrealized
     losses on
     marketable
     securities                   --             --           --            --       (104,311)          --        (104,311)
                                                                                                             -------------
   Comprehensive Income                                                                                          6,921,099
                                                                                                             -------------
   Shares issued upon
     exercise of
     stock options            237,432        11,872       807,870           --            --            --         819,742
   Compensation
     expense
     resulting from
     changes to stock
     options                      --             --     1,004,654           --            --            --       1,004,654
   Purchase of
     806,000 common
     shares, at cost              --             --           --            --            --     (6,430,790)    (6,430,790)
                         ------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
September 30, 1998          8,872,941  $    443,647  $ 42,593,241  $   (242,651) $   (142,805) $ (6,430,790) $  36,220,642
                         ============= ============= ============= ============= ============= ============= =============
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                                                          7
<PAGE>
                                                                 
             ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
              Notes to Condensed Consolidated Financial Statements

(1)      Business

         Continuing Operations

         Advanced  Neuromodulation  Systems,  Inc.  (the  "Company"  or  "ANS"),
         formerly Quest  Medical,  Inc.,  designs,  develops,  manufactures  and
         markets  implantable  neurostimulation  systems.  ANS  devices are used
         primarily  to manage  chronic  severe  pain.  ANS  revenues are derived
         primarily  from  sales   throughout  the  United  States,   Europe  and
         Australia.

         The neurostimulation systems business, described above, was acquired in
         March 1995.  All other  businesses  of the Company were sold in January
         1998 as described below under Discontinued Operations.

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

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

         The  Company  changed  its  name  from Quest  Medical, Inc. to Advanced
         Neuromodulation  Systems,  Inc.  during June 1998. The Company's NASDAQ
         stock symbol was changed from "QMED" to "ANSI" on July 1, 1998.

         Discontinued Operations

         On  January  30,  1998,  the  Company  sold  its   cardiovascular   and
         intravenous  fluid  product  lines ("CVS  Operations"),  including  its
         MPS(R)   myocardial   protection   system   product   line,  to  Atrion
         Corporation. The CVS Operations have been accounted for as discontinued
         operations in the Condensed  Consolidated  Financial Statements for the
         three  months and nine  months  ended  September  30, 1997 and the nine
         months ended  September 30, 1998. Net assets of the CVS Operations have
         been  presented on the  Condensed  Consolidated  Balance  Sheet for the
         period  ending   December  31,  1997  as  net  assets  of  discontinued
         operations.

(2)      Condensed Financial Statements

         The  unaudited  consolidated  financial  information  contained in this
         report  reflects  all  adjustments   (consisting  of  normal  recurring
         accruals)  considered  necessary,  in the opinion of management,  for a
         fair  presentation  of results for the interim periods  presented.  The
         preparation  of  financial  statements  in  conformity  with  generally
         accepted  accounting  principles  requires management to make estimates
         
                                       8
<PAGE>

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

         Certain  information  and  footnote  disclosures  normally  included in
         financial  statements  prepared in accordance  with generally  accepted
         accounting  principles have been condensed or omitted.  These financial
         statements should be read in conjunction with the financial  statements
         and notes thereto  included in the  Company's  December 31, 1997 Annual
         Report on Form  10-K.  The  results of  operations  for  periods  ended
         September 30, 1998 are not necessarily indicative of operations for the
         full year.

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

(3)      Marketable Securities

         The  following  is  a  summary  of  available-for-sale   securities  at
         September 30, 1998:

<TABLE>
<CAPTION>
                                               Gross       Gross
                                             Unrealized  Unrealized  Estimated
                                   Cost        Gains       Losses   Fair Value
                                ----------- ----------- ----------- -----------
<S>                             <C>         <C>         <C>         <C>
Investment grade preferred
  securities                    $  557,596  $       --  $  141,556  $   416,040
Publicly traded limited
  partnerships                      51,875          --      35,000       16,875
Real estate investment trusts      141,590          --      27,496      114,094
Other                               13,128          --      12,320          808
                                =========== =========== =========== ===========
                                $  764,189  $       --  $  216,372  $   547,817
                                =========== =========== =========== ===========
</TABLE>

         At September 30, 1998, no individual security  represented more than 40
         percent  of the total  portfolio  or 1  percent  of total  assets.  The
         Company  did  not  have  any   investments   in  derivative   financial
         instruments at September 30, 1998.

         Accumulated  unrealized  losses at September  30, 1998 and December 31,
         1997 are  included as  "Accumulated  other  comprehensive  income" as a
         component of Stockholders' Equity in the Condensed Consolidated Balance
         Sheets.  Such  amounts are net of tax  benefits of $73,567 and $19,831,
         respectively.
     
 (4)     Notes Payable

         Notes  payable at  September  30,  1998 and  December  31, 1997 were as
         follows:
<TABLE>
<CAPTION>
                                                     September 30,  December 31,
                                                          1998         1997
                                                     ------------- ------------
<S>                                                  <C>           <C>
         Notes payable to banks                      $         --  $  5,000,000
         Notes payable to shareholder                          --     2,000,000
         Acquisition notes payable                             --     1,000,000
         
                                       9
<PAGE>

         Mortgage notes                                  3,679,113    3,810,612
         Other                                                 --        81,763
                                                     ------------- ------------
                                                         3,679,113   11,892,375
         Less current maturities                          (186,581)  (8,257,348)
                                                     ============= ============
         Long-term notes payable                     $   3,492,532 $  3,635,027
                                                     ============= ============
</TABLE>

         At December 31, 1997, the Company's notes payable to banks were under a
         $5,650,000  working  capital  line of credit and a  $350,000  term loan
         facility (the "Facilities").  The Facilities were collateralized by all
         of the  Company's  assets  with the  exception  of the  real  property,
         building and equipment that  collateralize the mortgage notes described
         below.  On January 30, 1998, the Company repaid all notes payable under
         the  Facilities  with  proceeds  from the sale of the assets of its CVS
         Operations   (see  Note  8  -  "Sale  of  CVS   Operations/Discontinued
         Operations") and the Facilities expired.

         In February 1997, the Company  borrowed  $2,000,000 from a nonaffiliate
         shareholder  pursuant  to a  promissory  note.  Under  the terms of the
         promissory  note, the Company was required to make  quarterly  interest
         payments with a principal  payment of $2,000,000 due and payable at the
         maturity  of  the  note  in  February  1998.  The  Company  issued  the
         shareholder  five-year  warrants to purchase  100,000  shares of common
         stock at an exercise price of $6.50 per share,  the closing sales price
         on the date the indebtedness was incurred. Under the warrant agreement,
         the shareholder had the right to one demand registration in addition to
         piggyback registration rights. During November 1997, upon demand of the
         shareholder, the Company filed a registration statement on Form S-3. At
         September 30, 1998, the warrants remain unexercised. The Company repaid
         the note on January 30, 1998 with  proceeds from the sale of the assets
         of its CVS Operations.

         In February 1997, the Company issued the former owner of Neuromed, Inc.
         a  promissory  note in the  amount of  $1,000,000.  Under  terms of the
         promissory  note,  the Company was  required to make  monthly  interest
         payments  with a  principal  payment of  $1,000,000  due and payable at
         maturity of the note in February  1998.  The Company repaid the note on
         January 30, 1998 with  proceeds  from the sale of the assets of its CVS
         Operations.

         In 1993,  the Company  entered into two mortgage  notes relating to its
         principal  office and  manufacturing  facility.  The first note, in the
         amount of  $2,838,509  at September  30, 1998,  bears  interest at 8.59
         percent and has a twenty-five  year  amortization.  The Company has the
         option of  prepaying  this note during years six through ten subject to
         certain  provisions.  The loan is  collateralized by the Allen facility
         and land.  The second note,  in the amount of $840,604 at September 30,
         1998, is related to equipment  and  furnishings  and bears  interest at
         7.94   percent.   The  note  has  a   ten-year   amortization   and  is
         collateralized by the equipment and furnishings.

(5)      Commitments and Contingencies

         The Company has no material  commitments under noncancelable  operating
         leases at September 30, 1998.

         The  Company  is a party to  product  liability  claims  related to ANS
         neurostimulation  devices.  Product  liability  insurers  have  assumed

                                       10
<PAGE>

         responsibility  for defending the Company  against these claims.  While
         historically product liability claims for ANS neurostimulation  devices
         have not resulted in  significant  monetary  liability  for the Company
         beyond its  insurance  coverage,  there can be no  assurances  that the
         Company will not incur significant  monetary liability to the claimants
         if such insurance is inadequate or that the Company's  neurostimulation
         business and future ANS product lines will not be adversely affected by
         these product liability claims.

         Except for such product  liability  claims and other  ordinary  routine
         litigation incidental or immaterial to its business, the Company is not
         currently a party to any other  pending legal  proceeding.  The Company
         maintains general liability  insurance against risks arising out of the
         normal course of business.

(6)      Income Taxes

         The Company  recorded  income tax expense  from  continuing  operations
         during the three months and nine months ended  September  30, 1998,  of
         $419,138 and $1,363,866,  an overall effective tax rate of 40.6 percent
         and 40.1 percent,  respectively. The Company's expense for amortization
         of costs in excess of net assets acquired  (goodwill) is not deductible
         for tax  purposes,  thus  explaining  the  higher  effective  tax  rate
         compared to the U.S. statutory rate for corporations of 34 percent. The
         Company also recorded income tax expense from  discontinued  operations
         of  $2,908,257  during the nine months ended  September  30,  1998,  an
         effective tax rate of 36.8 percent.  The tax expense from  discontinued
         operations  during the nine months ended  September  30, 1998  resulted
         from the gain on the sale of the CVS Operations  (see Note 8 - "Sale of
         CVS Operations/Discontinued Operations"). During the three months ended
         September 30, 1997, the Company recorded income tax expense of $358,326
         from  continuing  operations  and an income tax benefit of $33,989 from
         discontinued operations, an overall effective tax rate of 41.9 percent.
         During the nine months ended  September 30, 1997, the Company  recorded
         income tax expense of $375,335 from continuing operations and an income
         tax  benefit  of  $9,529  from  discontinued  operations,   an  overall
         effective  tax  rate  of  41.8  percent.   The  Company's  expense  for
         amortization  of  goodwill is not  deductible  for tax  purposes,  thus
         explaining  the higher  effective  tax rate during the three months and
         nine months ended  September 30, 1997,  compared to the U.S.  statutory
         rate for corporations of 34 percent.
          
(7)      Earnings Per Share

         Basic earnings per share is computed based only on the weighted average
         number of common shares outstanding during the period, and the dilutive
         effect of stock options and warrants is excluded.  Diluted earnings per
         share is computed  using the  additional  dilutive  effect,  if any, of
         stock options and warrants using the treasury stock method based on the
         average  market  price of the stock during the period.  Basic  earnings
         (loss) per share for the three months ended September 30, 1998 and 1997
         are based upon  8,327,546 and  8,457,354  shares,  respectively.  Basic
         earnings  (loss) per share for the nine months ended September 30, 1998
         and 1997 are based upon 8,528,789 and 8,390,748  shares,  respectively.
         Diluted  earnings (loss) per share for the three months ended September
         30,  1998 and 1997 are  based  upon  8,526,627  and  8,935,670  shares,
         respectively.  Diluted  earnings  (loss) per share for the nine  months
         ended  September  30,  1998 and  1997  are  based  upon  8,767,131  and
         8,816,297 shares, respectively.

                                       11
<PAGE>

 (8)     Sale of CVS Operations/Discontinued Operations

         On  January  30,  1998,  the  Company  sold  its   cardiovascular   and
         intravenous  fluid  product  lines,  including  its  MPS(R)  myocardial
         protection  system  product  line, to Atrion  Corporation.  The Company
         received  approximately  $23 million  from the sale and  utilized  $8.0
         million of the proceeds to retire debt and $1.2 million to pay expenses
         related to the  transaction.  The  remaining  proceeds will be used for
         working capital for the expanding ANS business and stock repurchases as
         deemed  appropriate by the Board of Directors.  The Company  reported a
         pretax gain from the sale of $8.2 million  during the nine months ended
         September  30,  1998.  This gain is net of $1 million  of  compensation
         expense  recorded as a result of changes made to the stock options held
         by employees of the CVS Operations.  These changes included accelerated
         vesting of the unvested portion of these terminated employee options as
         a result of the sale and extension of the normal 90-day exercise period
         subsequent to termination to one year for these options.

         As part of the sale of the CVS  Operations  to Atrion in January  1998,
         the Company granted Atrion a nine-month option to acquire the Company's
         principal office and  manufacturing  facility in Allen,  Texas for $6.5
         million. On October 29, 1998, Atrion notified the Company of its intent
         to  exercise  the  option  to  acquire  the  facility.  Closing  of the
         transaction  will occur on February 1, 1999. The Company will repay the
         mortgage  debt on the  facility at closing  (see Note 4 of the Notes to
         Condensed Consolidated  Financial  Statements).  After repayment of the
         mortgage  debt and  expenses  related to the  transaction,  the Company
         expects to receive  net  proceeds of  approximately  $2.7  million.  No
         material  gain or loss is  expected on the sale of the facility. During
         the second  quarter of 1999, the Company intends to lease a facility in
         the  North Dallas area and  relocate  its operations there. The expense
         of  moving  and transitioning  into the new facility  is expected to be
         immaterial.

         Operating  results of the CVS  Operations  have been  reclassified  and
         reported as discontinued operations.  Summary operating results for the
         one month ended  January 30, 1998 and the three  months and nine months
         ended  September 30, 1997 for the CVS  Operations  were as follows (the
         1998 period included results until the sale on January 30, 1998):
<TABLE>
<CAPTION>
                                      One Month    Three Months    Nine Months
                                        Ended          Ended          Ended
                                     January 30,   September 30,  September 30,
                                        1998           1997           1997
                                    ------------- -------------- --------------
<S>                                 <C>           <C>            <C>
Net revenue - product sales         $  1,111,992  $   3,606,976  $   10,816,494
Gross profit from product sales          206,481      1,351,025       4,948,138
Earnings (loss) from operations         (307,120)      (123,231)        260,754
Interest expense                         (34,225)      (110,496)       (326,281)
                                    ------------- -------------- --------------
Earnings (loss) before income tax       (341,345)      (233,727)        (65,527)
Income tax expense (benefit)            (129,711)       (33,989)         (9,529)
                                    ------------- -------------- --------------
Net earnings (loss)                 $   (211,634) $    (199,738) $      (55,998)
                                    ============= ============== ==============
</TABLE>

                                       12
<PAGE>

         The above operating results of the CVS Operations  reflect the revenues
         and  expenses  of the CVS  Operations  including  direct  and  indirect
         expenses of the CVS Operations that are paid by the Company and charged
         directly to the CVS Operations. Allocation of general overhead from the
         Company includes charges for regulatory,  general corporate management,
         accounting   and  payroll   services,   human   resources,   management
         information  systems and  facilities  expenses based on revenues of the
         CVS  Operations to total revenues of the Company.  Management  believes
         that the expenses  charged to the CVS  Operations on this basis are not
         materially  different  from the costs that would have been incurred had
         the CVS Operations borne such expenses on a direct basis.

         Interest expense on the Company's corporate facility has been allocated
         to the CVS Operations based on space  utilization.  Interest expense on
         the  Company's  general  credit  facilities  was  allocated  to the CVS
         Operations  based on the ratio of the net assets of the CVS  Operations
         to the total net assets of the Company.

         Assets and liabilities of  discontinued  CVS Operations at December 31,
         1997 were as follows:
<TABLE>
<S>                                                              <C>
Current assets:
  Accounts receivable                                            $    2,481,278
  Inventories                                                         5,208,676
  Prepaid expenses                                                      131,735
                                                                 --------------
                                                                      7,821,689
                                                                 --------------
Noncurrent assets:
  Net property, plant, and equipment                                  3,633,855
  Net intangible assets consisting of patents, purchased
    technology and costs in excess of net assets acquired             2,043,107

Other assets                                                              8,631
                                                                 --------------
                                                                      5,685,593
                                                                 --------------
Total assets                                                         13,507,282
                                                                 --------------
Current liabilities:
  Accounts payable                                                      410,483
  Accrued liabilities                                                   265,481
                                                                 --------------
                                                                        675,964
                                                                 --------------

                                                                 --------------
Net assets of CVS Operations                                     $   12,831,318
                                                                 ==============
</TABLE>

(9)      Product Development Agreement

         On June 22,  1998,  the Company  announced  that it had entered into an
         agreement with Sofamor Danek Group, Inc.  ("Sofamor Danek") under which
         the Company will develop and  manufacture  for Sofamor Danek,  products
         and systems for use in Deep Brain  Stimulation  ("DBS").  DBS  products
         provide  electrical  stimulation  to certain areas of the brain and are
         intended to relieve the effects of various neurological disorders, such
         as  Parkinson's  Disease  and  Essential  Tremor.  Under  terms  of the
         agreement, the Company granted Sofamor Danek exclusive worldwide rights
         to use, market and sell the DBS products  developed and manufactured by
         ANS. The Company  received a cash payment of $4 million upon  execution

                                       13
<PAGE>

         of the agreement which is being recognized into income as revenue based
         upon the estimated percentage of completion of the development project.
         During the three months and nine months ended  September 30, 1998,  the
         Company  recognized $1.3 million and $1.9 million,  respectively,  into
         income as revenue. ANS will also receive four additional payments of $2
         million  each,   which  will  be   recognized   into  income  upon  the
         satisfactory   completion   of  certain   domestic  and   international
         regulatory  milestones  over the next several years,  which  management
         believes  will  commence in fiscal 1999.  In order for Sofamor Danek to
         market the DBS products in the United  States,  FDA  clearance  will be
         necessary,  which  will  require  clinical  trials.  Sofamor  Danek has
         accepted  the   responsibility   and  expense  for  seeking  regulatory
         approvals.  Sofamor  Danek has also agreed to purchase the DBS products
         exclusively  from ANS and has  agreed to pay ANS a royalty  on  Sofamor
         Danek sales of the DBS products.

(10)     Comprehensive Income

         Statement  of  Financial  Accounting  Standards  No.  130 -  "Reporting
         Comprehensive  Income" - was  adopted  by the  Company as of January 1,
         1998. The new rules require the reporting and display of  comprehensive
         income and its components;  however, the adoption of this statement had
         no impact on the Company's net earnings or stockholders'  equity.  SFAS
         No. 130 requires  unrealized gains or losses on the Company's available
         for sale securities,  which prior to adoption were reported  separately
         in  shareholders'  equity,  to  be  included  in  "Other  comprehensive
         income".  Prior period financial  statements have been  reclassified to
         conform to the requirements of SFAS No. 130. Total comprehensive income
         for 1997 and for the nine months ended  September  30, 1998 is reported
         in the  Condensed  Consolidated  Statements  of  Stockholders'  Equity.
         Comprehensive  income  for the  three  months  and  nine  months  ended
         September 30, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>
                                   Three Months Ended       Nine Months Ended
                                      September 30,            September 30,
                                ----------------------- ------------------------
                                     1998        1997        1998        1997
                                ----------- ----------- ----------- ------------
<S>                             <C>         <C>         <C>         <C>
Net earnings                    $   613,637 $   449,362 $ 7,025,410 $   508,980
Other comprehensive income          (18,557)     28,161    (104,311)     84,355
                                ----------- ----------- ----------- -----------
Comprehensive income            $   595,080 $   477,523 $ 6,921,099 $   593,335
                                ----------- ----------- ----------- -----------
</TABLE>

                                       14
<PAGE>
                                       
                      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 thereto.

Overview

On  January  30,  1998,  the  Company  sold the  assets  of its CVS  Operations,
including  its MPS(R)  myocardial  protection  system  product  line,  to Atrion
Corporation (see Note 8 - "Sale of CVS Operations/Discontinued Operations"). The
Company received cash proceeds of approximately $23 million,  after post-closing
adjustments  as defined in the  purchase  agreement.  The Company  also  granted
Atrion a  nine-month  option to  acquire  the  Company's  principal  office  and
manufacturing  facility in Allen,  Texas for $6.5 million.  On October 29, 1998,
Atrion  notified the Company of its intent to exercise the option to acquire the
facility. Closing of the transaction will occur on February 1, 1999. The Company
will repay its outstanding  mortgage debt on the facility at closing and expects
to receive net proceeds of $2.7 million after repayment of the mortgage debt and
expenses related to the transaction. No material gain or loss is expected on the
sale of the facility.  Until  January 31, 1999,  the Company is leasing space to
Atrion for the CVS  Operations  for $24,606 per month.  In turn,  the Company is
leasing certain office and computer equipment from Atrion for $13,175 per month.
The Company  will lease space and certain  office and  computer  equipment  from
Atrion for $48,000 per month from  February 1 through  April 30, 1999,  at which
time the Company currently  intends to lease a facility in the North Dallas area
and relocate its operations there.  The expense of moving and transitioning into
the new facility is expected to be immaterial.

Assets of the CVS  Operations  sold to Atrion  primarily  consisted  of accounts
receivable,  inventories,  furniture  and  fixtures,  manufacturing  tooling and
equipment,  and intangible  assets including  patents,  trademarks and purchased
technology.  The  intangible  assets also  included the rights to the name Quest
Medical,  Inc.  The Company  reported a pretax gain on the  transaction  of $8.2
million ($5.2 million  after-tax) which is included in the Company's results for
the nine months ended  September 30, 1998.  The pretax gain is net of $1 million
compensation  expense  recorded  as a result of  certain  changes  made to stock
options  held by  employees  of the CVS  Operations  (see  Note 8 - "Sale of CVS
Operations/Discontinued  Operations").  The Company utilized $9.2 million of the
proceeds  from  the  sale  to  retire  debt  and  pay  expenses  related  to the
transaction.

The CVS  Operations  have been accounted for as  discontinued  operations in the
Condensed  Consolidated  Statements of Operations  for the three months and nine
months ended September 30, 1997 and the nine months ended September 30, 1998.

At its Annual Meeting of Shareholders on May 28, 1998, the shareholders approved
a  proposal  to change  the name of the  Company  from Quest  Medical,  Inc.  to
Advanced Neuromodulation Systems, Inc. ("ANS"). The name change became effective
upon the filing and recording of the Certificate of Amendment to the Articles of
Incorporation on June 17, 1998. The Company's trading symbol on the Nasdaq Stock
Market was changed to "ANSI" on July 1, 1998.

During June 1998,  the Company  completed an agreement with Sofamor Danek Group,
Inc.  ("Sofamor Danek") under which the Company will develop and manufacture for
Sofamor Danek,  products and systems for use in Deep Brain Stimulation  ("DBS").

                                       15
<PAGE>

DBS products  provide  electrical  stimulation to certain areas of the brain and
are intended to relieve the effects of various neurological  disorders,  such as
Parkinson's  Disease and Essential  Tremor.  Under terms of the  agreement,  the
Company granted Sofamor Danek exclusive worldwide rights to use, market and sell
the DBS products  developed and manufactured by ANS. The Company received a cash
payment of $4 million upon execution of the agreement which is being  recognized
into income as revenue based upon the estimated  percentage of completion of the
development project. During the three months and nine months ended September 30,
1998, the Company recognized $1.3 million and $1.9 million,  respectively,  into
income as revenue.  ANS will also receive four additional payments of $2 million
each, which will be recognized into income upon the  satisfactory  completion of
certain domestic and international  regulatory  milestones over the next several
years,  which  management  believes  will  commence in fiscal 1999. In order for
Sofamor  Danek to market the DBS products in the United  States,  FDA  clearance
will be  necessary,  which  will  require  clinical  trials.  Sofamor  Danek has
accepted  the  responsibility  and  expense for  seeking  regulatory  approvals.
Sofamor Danek has also agreed to purchase the DBS products  exclusively from ANS
and has agreed to pay ANS a royalty on Sofamor Danek sales of the DBS products.

The agreement with Sofamor Danek fits with the Company's  strategy to strengthen
and broaden  its  neuromodulation  technology  platforms  and to find  strategic
partners to leverage ANS' core technology into other significant market segments
beyond the Company's focus on the pain management market.

During  August  1998,   the  Company   completed  an  agreement   with  Tricumed
Medizintechnik  GmbH, a German  corporation,  granting ANS  exclusive  rights to
distribute Tricumed's CE mark approved constant rate intraspinal drug pump and a
future  programmable  rate  intraspinal  drug pump,  which Tricumed is currently
developing,  in international  markets including the United States,  Canada, the
United Kingdom, France, Spain, Switzerland,  South America,  Australia and other
world markets.  The Company expects to begin marketing the constant rate pump in
international markets during the first quarter of 1999.

Also in August 1998,  the Company  completed  an agreement to license  exclusive
worldwide  rights to method patents for sacral nerve root  stimulation  aimed at
relieving  the effects of chronic  pelvic pain  including  such  indications  as
interstitial  cystitis, an extremely painful bladder disease that affects around
450,000 people  worldwide,  and vulvodynia,  an extremely painful disease of the
vulva which also affects around 450,000 women  worldwide.  The Company  believes
its dual octrode radio frequency  electrical  stimulation ("RF") systems and its
advanced  laminotomy  RF  systems  can be  effective  in  treating  pelvic  pain
indications such as interstitial cystitis and vulvodynia. The Company expects to
apply for  approval  from the FDA during the fourth  quarter of 1998 to initiate
pilot clinical  studies,  a necessary step in the process of receiving  approval
from the FDA to market the products domestically.

Results of Operations

Comparison of the Three Months and Nine Months Ended September 30, 1998 and 1997

Revenues.  Net revenue from  continuing  ANS operations of $5.01 million for the
three  months  ended  September  30, 1998 was  $786,000  above the level for the
comparable  1997 period of $4.22 million.  The 1998 period includes $1.3 million
of net revenue  associated  with the  Company's  development  agreement  for DBS
products with Sofamor Danek.  Net revenue from ANS product sales  decreased 12.2
percent to $3.71 million  during the three months ended  September 30, 1998 from
$4.22 million during the  comparable  1997 period due to lower unit sales volume

                                       16
<PAGE>

resulting from a lower number of implants.  For the nine months ended  September
30, 1998,  net revenue  increased to $14.76  million from $10.82  million during
1997,  an increase of $3.94  million.  The 1998 nine month period  includes $1.9
million of net revenue associated with the Sofamor Danek development  agreement.
Excluding such revenue,  ANS net revenue from product sales  increased to $12.86
million  during 1998 from $10.82  million in 1997, an increase of $2.04 million,
or 18.9 percent. This increase in net revenue from product sales during the nine
month 1998 period compared to 1997 was primarily the result of higher unit sales
volume of ANS' RF spinal cord stimulation ("SCS") systems used to manage chronic
intractable pain,  principally in the United States.  Management  expects fourth
quarter 1998 revenue from  product  sales to be flat or grow  modestly  from the
1997 fourth quarter level of $3.9 million.  However,  management expects revenue
growth from product  sales to resume in fiscal 1999  resulting  from new product
introductions  from its research and development  investments and  international
sales of the  constant  rate  implantable  drug pump from the  Company's  recent
distribution  agreement  with  Tricumed.  In addition,  management  continues to
explore ways to improve the Company's market position through new  technologies,
additional product offerings,  enhanced distribution channels and addressing new
indications.

Gross Profit from Product  Sales.  Gross  profit from  product  sales  decreased
during the three months ended  September 30, 1998 to $2.66  million  compared to
$3.07  million in 1997 and as a percentage  of net revenue  from product  sales,
gross profit decreased slightly during the three months ended September 30, 1998
to 71.7 percent compared to 72.6 percent during the comparable 1997 period. This
decrease in gross profit from product  sales was primarily  attributable  to the
decrease in revenue and to a lesser  extent the decrease in gross profit  margin
from product sales. The decrease in gross profit margin resulted from lower unit
sales volume of the Company's dual octrode  systems for the treatment of complex
pain patterns which  contribute  somewhat  higher margins than other ANS systems
marketed by the Company.  For the nine months ended  September  30, 1998,  gross
profit from product sales  increased to $9.32 million from $7.09 million in 1997
due to the  increased  revenue  generated by ANS and an increase in gross profit
margin from product sales which  increased to 72.4 percent during the nine month
period in 1998  compared to 65.5  percent in 1997 as a result of three  factors.
First,  the 1997 nine month  period  includes a write-off  of  $479,000  for ANS
inventories of previous  designs which resulted in a reduction of the 1997 gross
profit margin by 4.4  percentage  points (the gross margin without the inventory
write-off was 69.9 percent).  Second, the 1998 nine month period included higher
unit  sales  volume of the  Company's  dual  octrode  systems  which  contribute
somewhat higher margins than other ANS systems  marketed by the Company.  Third,
the Company  implemented  certain  manufacturing  cost improvements  during 1998
which reduced manufacturing costs on certain of the Company's products.

Operating  Expenses.  Total  operating  expenses of $3.09  million for the three
months ended  September 30, 1998  increased  from $1.94 million  during the same
period in 1997 and as a percentage  of net  revenue,  total  operating  expenses
increased from 46.0 percent in 1997 to 61.8 percent in 1998. For the nine months
ended September 30, 1998,  total operating  expenses  increased to $8.22 million
from $5.75 million in 1997 and as a percentage of net revenue,  total  operating
expenses increased from 53.1 percent in 1997 to 55.7 percent in 1998.

Research and development  expense  increased to $870,000 during the three months
ended  September 30, 1998,  compared to $207,000 for the same period a year ago,
and  increased as a  percentage  of net revenue from 4.9 percent in 1997 to 17.4
percent in 1998,  reflecting  the  Company's  investment  in future  products to
enhance revenue growth.  For the nine months ended September 30, 1998,  research
and development  expense  increased to $1.94 million compared to $683,000 during
the  comparable  1997 period,  and increased as a percentage of net revenue from

                                       17
<PAGE>

6.3 percent in 1997 to 13.1  percent in 1998.  This  increase in expense  during
both  1998  periods  compared  to the same  periods  in 1997 was the  result  of
additional  salary  and  benefit  expense  from  staffing  increases,  increased
consulting  and contract  labor expense and higher  expense for test  materials.
Management expects research and development expenditures to approximate $800,000
for the remainder of 1998.  These  expenditures  during the first nine months of
1998 and for the final quarter of 1998 are being directed toward  development of
improved RF SCS systems which are expected to be introduced in the United States
in the first  quarter of fiscal 1999,  an  implantable  constant rate drug pump,
development of an implantable  pulse generator  ("IPG") system and DBS products.
The Company has entered  into a  development  and  manufacturing  contract  with
Hi-tronics Design,  Inc.,  a contract  engineering  and  manufacturing  firm, to
develop an  IPG. IPG systems currently  account for 80  percent of the SCS units
sold worldwide.  Management expects to seek FDA approval in the first quarter of
1999 to begin  clinical  studies of the IPG systems during the second quarter of
1999, a necessary step toward regulatory approval to commercially market the IPG
domestically.  In addition, ANS will seek CE mark approval during the first half
of 1999, which is needed for  commercialization  of the IPG system in Europe and
other markets worldwide. If successfully developed,  the IPG system should allow
ANS to  compete  in the  largest  segment  of  the  SCS  market  as  well  as to
manufacture and supply products for DBS pursuant to the Company's agreement with
Sofamor Danek. Additionally,  the IPG system potentially expands the markets for
ANS products for use in new applications such as urge incontinence,  intractable
angina, peripheral vascular disease and peripheral nerve stimulation.

Marketing expense, as a percentage of net revenue, increased to 24.4 percent for
the three months  ended  September  30,  1998,  compared to 23.4 percent for the
comparable  period during 1997,  while the dollar amount increased from $989,000
during 1997 to $1.22 million in 1998. This increase in marketing  expense during
the 1998 period compared to 1997 was attributable to higher training expense for
new users of ANS products and higher convention and promotional expense. For the
nine months ended September 30, 1998,  marketing  expense as a percentage of net
revenue  decreased  to 23.4 percent  from 27.0  percent in the  comparable  1997
period,  while the dollar  amount  increased to $3.46 million in 1998 from $2.92
million during 1997.  This dollar  increase during the nine month period in 1998
compared to the same period in 1997 was  attributable to higher  commissions due
to increased revenue,  higher training expense for new users of ANS products and
higher convention and promotional expense.

Amortization  expense for  intangibles  increased from $274,000 during the three
months ended  September 30, 1997 to $293,000  during the comparable 1998 period.
For the nine months ended September 30, 1998,  amortization expense increased to
$876,000  from  $812,000 in 1997.  This  increase  during  both  periods of 1998
compared  to 1997 was due,  for the most  part,  to  expense  associated  with a
non-compete agreement with the former president and chief executive officer.

General and  administrative  expense as a percentage of net revenue increased to
14.1 percent  during the three months ended  September 30, 1998 compared to 11.1
percent for the same period  during  1997,  and the dollar  amount  increased by
$237,000.  This  increase in expense  during 1998 compared to 1997 was primarily
the result of expense  relating  to the  Tricumed  distribution  agreement,  the
sacral nerve root patent license agreement and other  agreements,  and increased
costs for recruiting  and  relocation.  For the nine months ended  September 30,
1998,  general  and  administrative  expense  as a  percentage  of  net  revenue
increased to 13.2 percent from 12.3 percent in the same period during 1997,  and
the dollar amount  increased by $614,000.  This increase in expense  during 1998
compared  to 1997 was  primarily  the result of expense  relating to the Sofamor
Danek agreement,  Tricumed distribution agreement,  the sacral nerve root patent

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<PAGE>

license  agreement and other  agreements,  increased  costs for  recruiting  and
relocation, and increased costs of existing employee benefit plans.

Earnings From Operations.  Earnings from operations decreased to $865,000 during
the three  months ended  September  30, 1998  compared to $1.13  million for the
comparable  1997 period  primarily  as a result of  decreased  gross profit from
product  sales due to lower sales of ANS products and higher  overall  operating
expenses.  Earnings from  operations  increased to $2.99 million during the nine
months ended  September 30, 1998  compared to $1.34  million for the  comparable
1997 period primarily as a result of increased gross profit which was due to (i)
higher sales of ANS products,  (ii) revenue  recognized  from the agreement with
Sofamor Danek, (iii) the expense in 1997 related to the write-off of inventories
of previous design and (iv) manufacturing  cost improvements  implemented during
1998.

Other Income/Expense. Other income increased to $168,000 during the three months
ended  September 30, 1998 compared to an expense of $118,000 for the  comparable
1997  period.  For the nine  months  ended  September  30,  1998,  other  income
increased to $407,000 compared to an expense of $397,000 for the comparable 1997
period.  This increase  during both periods in 1998 compared to the same periods
in 1997 was primarily a result of two factors. First, interest expense decreased
during  both  1998  periods  compared  to 1997 as a result of the  repayment  of
short-term  notes payable  during  January 1998  utilizing the proceeds from the
sale  of the  CVS  Operations  (see  Notes  4 and 8 of the  Notes  to  Condensed
Consolidated  Financial  Statements).  Second,  interest income increased during
both 1998 periods  compared to 1997 due to higher funds available for investment
as a  result  of the  net  proceeds  from  the  January  1998  sale  of the  CVS
Operations.

Income  Taxes.  The  Company's  income tax  expense  for  continuing  operations
increased to $419,000 for the three months ended  September 30, 1998 compared to
$358,000 during the same period in 1997. For the nine months ended September 30,
1998,  income tax expense for continuing  operations  increased to $1.36 million
from $375,000  during the  comparable  1997 period due to the improved  earnings
from continuing ANS operations in 1998. The effective tax rates during the three
months and nine  months  ended  September  30,  1998 were 40.6  percent and 40.1
percent,  respectively,  as the Company's  expense for  amortization of costs in
excess of net assets  acquired  (goodwill) is not  deductible  for tax purposes,
thus explaining the higher effective tax rate compared to the U.S.
statutory rate for corporations of 34 percent.

Net Earnings From Continuing Operations. Net earnings from continuing operations
decreased  slightly to $614,000 during the three months ended September 30, 1998
compared to $649,000 during the same period a year earlier.  For the nine months
ended September 30, 1998, net earnings from continuing  operations  increased to
$2.04 million  compared to $565,000  during the same 1997 period.  This increase
during the nine month  period in 1998  compared  to the same  period in 1997 was
primarily  the result of the higher  earnings from  operations  due to increased
gross profit from (i) higher sales of ANS products, (ii) revenue recognized from
the Sofamor Danek  agreement,  (iii) the 1997 expense  related to a write-off of
inventories and (iv) manufacturing cost improvements implemented during 1998 and
the increase in other income due to lower interest  expense and higher  interest
income.

Discontinued  Operations.  The net loss from discontinued  operations during the
three months ended  September  30, 1997 was  $200,000.  No results were recorded
during the similar  three months during 1998 since the  discontinued  operations
were sold  during  January  1998.  Net  earnings  from  discontinued  operations
increased  to $4.99  million  during the nine months  ended  September  30, 1998
compared  to a net loss of  $56,000  during  the  comparable  1997  period.  Net

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<PAGE>

earnings from discontinued  operations during 1998 included an after-tax gain of
$5.2 million on the sale of the assets of the  discontinued  CVS  Operations  to
Atrion  on  January  30,  1998.  This gain was  partially  offset by a loss from
discontinued  operations  of  $212,000  from  January  1, 1998 until the sale on
January 30, 1998.

Net Earnings.  Net earnings  increased to $614,000 during the three months ended
September 30, 1998 compared to $449,000 during the comparable 1997 period due to
the loss from  discontinued  CVS Operations of $200,000 in the 1997 period.  For
the nine months  ended  September  30,  1998,  net  earnings  increased to $7.03
million  compared to $509,000  during the comparable 1997 period due to the gain
on the sale of the assets of the discontinued CVS Operations and the increase in
net earnings from continuing operations discussed above.

Liquidity and Financial Position

In the sale of assets of the CVS Operations to Atrion, the Company received cash
proceeds,  after post-closing  adjustments as defined in the purchase agreement,
of  approximately  $23  million  which  significantly   enhanced  the  Company's
financial  position.  The Company  utilized  approximately  $9.2  million of the
proceeds  to  retire  short-term  notes  payable  and  related  expenses  of the
transaction.  After such repayment, the Company has no debt other than its Allen
facility mortgage of $3.7 million.  The Company also granted Atrion a nine-month
option to purchase the Allen  facility for $6.5 million and is leasing  space in
the Allen  facility to Atrion under a lease  agreement  which expires on January
30,  1999.  On October 29,  1998,  Atrion  notified the Company of its intent to
exercise the option to acquire the  facility.  Closing of the  transaction  will
occur on February 1, 1999, and after repayment of the mortgage debt and expenses
of the transaction, the Company expects to receive net proceeds of approximately
$2.7  million.  The Company  will lease space and  certain  office and  computer
equipment  from Atrion for $48,000 per month from  February 1 through  April 30,
1999,  at which time the  Company  currently  intends to lease a facility in the
North Dallas area and relocate its operations  there.  The expense of moving and
transitioning into the new facility is expected to be immaterial.  

The Company's  working capital  increased from $14.1 million at year-end 1997 to
$16.5  million at  September  30, 1998.  The ratio of current  assets to current
liabilities  was 3.2:1 at September 30, 1998,  compared to 2.5:1 at December 31,
1997. Cash, cash equivalents and marketable  securities totaled $16.2 million at
September 30, 1998 compared to $2.2 million at December 31, 1997.

During January 1998, the Board of Directors  approved a stock repurchase program
of up to 500,000  shares of the  Company's  common stock and during  August 1998
approved an additional 1,000,000 shares.  During the nine months ended September
30,  1998,  the Company  repurchased  806,000  shares of its common  stock at an
aggregate cost of $6,430,790,  or an average of $7.98 per share. The Company has
continued to  repurchase  shares  subsequent  to September  30, 1998 and through
October 30, 1998,  has  repurchased a total of 1,218,625  shares at an aggregate
cost of $9,186,095, or an average of $7.54 per share.

During the nine months ended September 30, 1998,  capital  expenditures  totaled
$807,000,   primarily  for  additional   manufacturing  tooling  and  equipment.
Management  expects  capital  expenditures  for the  remainder of fiscal 1998 of
$700,000  primarily  related to manufacturing  tooling and equipment for the new
products the Company is developing,  including  improved RF SCS systems,  an IPG
system and a constant rate  implantable  drug pump.  During the third quarter of
1998,  the Company  licensed  exclusive  worldwide  rights to method patents for
sacral nerve root  stimulation  aimed at relieving the effects of chronic pelvic

                                       20
<PAGE>

pain. The Company made an initial  licensing  payment of $250,000 upon executing
the licensing  agreement and will pay up to an additional  $750,000 in licensing
payments upon certain  regulatory  approvals which the Company  anticipates will
occur  during  1999 and 2000.  The  Company  will  also pay a royalty  on future
product  sales used in sacral root  stimulation.  If the Company  relocates  its
operations to a leased  facility  during the second quarter of 1999, the Company
expects to spend  approximately  $1 million for the purchase of office furniture
and  equipment,  a computer  system and cleanroom  system for its  manufacturing
operations.

During June 1998,  the Company  received $4 million cash from Sofamor Danek upon
execution of the  agreement  in which the Company  will develop and  manufacture
products and systems for Sofamor  Danek for use in Deep Brain  Stimulation.  The
Company  will also  receive  four  additional  payments of $2 million  each from
Sofamor  Danek  upon  the  satisfactory   completion  of  certain  domestic  and
international  regulatory  milestones  over the next several  years.  Management
believes the Company should earn the next $2 million payment in fiscal 1999.

Management  believes  that its current cash,  cash  equivalents  and  marketable
securities  and funds  generated from  operations  will be sufficient to satisfy
normal cash operating  requirements,  capital expenditures and stock repurchases
for the foreseeable future.

Cash Flows

Net cash provided by continuing operations increased to $7.29 million during the
nine months ended  September 30, 1998,  from $1.37 million for the same period a
year ago  primarily  due to the  improved  operating  results  of ANS,  deferred
revenue  associated  with the Company's  agreement with Sofamor Danek and income
taxes  payable  which  are  not  due  until  1999.  The  primary  use of cash in
continuing  operations  during the nine months ended  September  30, 1998 was an
increase in the level of accounts  receivable of $341,000.  Net cash provided by
discontinued  operations  decreased  to  $59,000  during the nine  months  ended
September  30, 1998 compared to $674,000 for the  comparable  1997 period as the
1998  period  included  only  one  month of  results  until  the sale to  Atrion
Corporation on January 30, 1998.

Net cash provided by investing  activities increased to $21.4 million during the
nine months ended September 30, 1998,  compared to a net use of cash during 1997
of $5.4 million.  This increase resulted primarily from two factors.  First, the
Company  received $21.8 million of net proceeds  during the 1998 period from the
sale of its CVS Operations on January 30, 1998.  Second,  during the 1997 period
the  Company  used $4.5  million of cash for  payments  to the  former  owner of
Neuromed, Inc. for the purchase of certain patents and the settlement of certain
purchase price issues.

Net cash used in financing  activities  for the nine months ended  September 30,
1998 was $13.8 million while financing activities during the same period in 1997
provided net cash of $3.3 million. This decrease was primarily due to the use of
$8.1  million in 1998 to reduce  debt under  short-term  notes  payable and $6.4
million  used in 1998 for the  repurchase  of  806,000  shares of the  Company's
common stock while the 1997 period  included  additional  net  borrowings  under
short-term notes of $2.8 million.

Year 2000

The Year 2000 issue  results from  computer  programs  being  written  using two
digits rather than four to identify an applicable year.  Computer  programs that
have  time-sensitive  software may  recognize a date using "00" as the year 1900
rather than the year 2000.

                                       21
<PAGE>

Based on recent  assessments of its computer  systems and programs,  the Company
believes that its core  manufacturing  system  software is Year 2000  compliant.
Lesser internal  applications may require minor  modifications or replacement to
attain  full  Year 2000  compliance  and the  Company  intends  to make  certain
investments  in its  software  systems  and  applications  to ensure  that these
systems and applications are Year 2000 compliant.  Management believes, however,
that the Year 2000 issue does not pose significant  operational problems for the
Company's  computer  systems and that the financial  impact of the issue has not
been and should not be material to the Company's  financial  position or results
of operations in any given year.

Forward-Looking Statements

The  following  is a  "safe  harbor"  statement  under  the  Private  Securities
Litigation  Reform Act of 1995:  Statements  contained in this document that are
not based on historical facts are  "forward-looking  statements".  Terms such as
"plan",  "should",  "anticipate",  "believe",  "intend",  "estimate",  "expect",
"predict",  "new market",  "potential",  "potential new market applications" and
similar expressions are intended to identify  forward-looking  statements.  Such
statements are by nature subject to uncertainties  and risks,  including but not
limited  to: the  resumption  of growth in ANS  revenues  in 1999 and  continued
market  acceptance  of ANS products  consistent  with  management  expectations;
completion of research and  development and capital  expenditure  projects in an
efficient and timely manner; obtaining regulatory approvals on a timely and cost
efficient  basis to permit the  introduction of new products;  the  satisfactory
completion of clinical  trials and/or market tests prior to the  introduction of
new products;  the adequacy,  acceptability  and timeliness of component supply;
continued  reimbursement  for medical  procedures  using the Company's  existing
products by medical  reimbursement  agencies  like  insurance  companies,  HMOs,
Medicare and Medicaid without material adverse changes in reimbursement amounts,
qualifications  or  requirements;  the approval of new products by reimbursement
agencies;  retention of major customers;  the efficacy of the Company's products
for  proposed or  potential  new  applications;  competition  and  technological
changes  that may render the  Company's  products  obsolete  or  noncompetitive;
general domestic and international economic conditions; and other risks detailed
from time to time in the Company's  SEC public  filings.  Consequently,  if such
management  assumptions  prove to be  incorrect  or such risks or  uncertainties
materialize,  anticipated results could differ materially from those forecast in
forward-looking statements.

Currency Fluctuations

Substantially all of the Company's  international  sales are denominated in U.S.
dollars. Fluctuations in currency exchange rates in other countries could reduce
the demand for the Company's  products by increasing  the price of the Company's
products  in the  currency  of the  countries  in which the  products  are sold,
although  management does not believe currency  fluctuations have had a material
effect on the Company's results of operations.

                                       22
<PAGE>





                                     PART II

                                OTHER INFORMATION



ITEM 6.           EXHIBITS AND REPORTS ON FORM 8-K

          (a)     Exhibit 27.1 --  Financial Data Schedule
                  Exhibit 27.2 --  Restated Financial Data Schedule

          (b) No reports on Form 8-K have been filed  during the  quarter  ended
              September 30, 1998.

                                       23
<PAGE>



                                   SIGNATURES



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







                                       ADVANCED NEUROMODULATION SYSTEMS, INC.



Date:  November 12, 1998                By: /s/ F. Robert Merrill III
                                       ----------------------------------
                                       F. Robert Merrill III
                                       Executive Vice President, Finance
                                       Chief Financial Officer and Treasurer



                                       24