<PAGE>   1



                       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 JUNE 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 X 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                      JULY 31, 1998
        ----------------------------         -------------------------------
        <S>                                             <C>
        COMMON STOCK, $.05 PAR VALUE                    8,422,777
</TABLE>                                     
<PAGE>   2




            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
                           June 30, 1998 and December 31, 1997                                                        3-4


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


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


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


                      Notes to Condensed Consolidated
                           Financial Statements                                                                      8-13

      ITEM 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations             14-20

PART II.     OTHER INFORMATION                                                                                      21-22

      ITEM 4.     Submission of Matters to a Vote of Security Holders                                                  21

      ITEM 6.     Exhibits and Reports on Form 8-K                                                                  21-22

SIGNATURES                                                                                                             23
</TABLE>





                                       1
<PAGE>   3





                                    PART I


                            FINANCIAL INFORMATION





                                      2
<PAGE>   4





            ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                      JUNE 30, 1998 AND DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                                                               JUNE 30,      
                                                                                 1998        DECEMBER 31,
ASSETS                                                                        (UNAUDITED)        1997
                                                                              ------------   ------------
<S>                                                                           <C>            <C>         
Current assets:
   Cash and cash equivalents                                                  $ 18,202,797   $    747,828
   Marketable securities                                                           866,435      1,455,864
   Receivables:
    Trade accounts, less allowance for doubtful accounts of $225,240
       in 1998 and $212,375 in 1997                                              2,692,520      2,398,327
    Interest and other                                                             196,637        209,595
                                                                              ------------   ------------
         Total receivables                                                       2,889,157      2,607,922
                                                                              ------------   ------------

   Inventories:
    Raw materials                                                                  997,060      1,056,718
    Work-in-process                                                                466,545        323,929
    Finished goods                                                               1,325,234      1,597,840
                                                                              ------------   ------------
         Total inventories                                                       2,788,839      2,978,487
                                                                              ------------   ------------

   Net assets of discontinued operations sold in 1998                                   --     12,831,318
   Deferred income taxes                                                         1,666,872      2,288,192
   Prepaid expenses and other current assets                                       412,565        476,716
                                                                              ------------   ------------
         Total current assets                                                   26,826,665     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                                                          733,499        624,753
   Machinery and equipment                                                       1,509,129        920,879
                                                                              ------------   ------------
                                                                                 9,425,473      8,728,477
   Less accumulated depreciation and amortization                                1,611,289      1,317,362
                                                                              ------------   ------------
         Net property, plant and equipment                                       7,814,184      7,411,115
                                                                              ------------   ------------

Cost in excess of net assets acquired, net of accumulated amortization
    of $1,456,315 in 1998 and $1,178,014 in 1997                                 9,355,349      9,633,650
Patents, net of accumulated amortization of $223,333 in 1998 and
    $148,958 in 1997                                                             2,776,667      2,851,042
Purchased technology from acquisitions, net of accumulated amortization
    of $866,667 in 1998 and $733,334 in 1997                                     3,133,333      3,266,666
Tradenames, net of accumulated amortization of $406,250 in 1998 and
    $343,750 in 1997                                                             2,093,750      2,156,250
Other assets, net of accumulated amortization of $34,496 in 1998                   251,405        277,270
                                                                              ------------   ------------
                                                                              $ 52,251,353   $ 48,982,320
                                                                              ============   ============
</TABLE>





                                        3
<PAGE>   5



            ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                      JUNE 30, 1998 AND DECEMBER 31, 1997

<TABLE>
<CAPTION>
                                                                      JUNE 30, 
                                                                        1998        DECEMBER 31,
LIABILITIES AND STOCKHOLDERS' EQUITY                                (UNAUDITED)         1997
                                                                    ------------    ------------
<S>                                                                 <C>             <C>         
Current liabilities:
   Accounts payable                                                 $    516,610    $    240,249
   Short-term notes payable and current maturities
     of long-term notes payable                                          182,841       8,257,348
   Deferred revenue- R&D contract                                      3,400,000              --
   Accrued salary and employee benefit costs                             497,008         381,735
   Income taxes payable                                                3,226,272              --
   Other accrued expenses                                                415,116         379,444
                                                                    ------------    ------------
         Total current liabilities                                     8,237,847       9,258,776
                                                                    ------------    ------------

Notes payable                                                          3,540,996       3,635,027
Deferred income taxes                                                  2,115,996       2,182,580

Commitments and contingencies

Stockholders' equity:
   Common stock of $.05 par value. Authorized 25,000,000 shares;
      issued 8,780,572 shares in 1998 and 8,635,509 in 1997              439,028         431,775
   Additional paid-in capital                                         42,239,187      40,780,717
   Retained earnings (deficit)                                          (856,288)     (7,268,061)
   Cost of common shares in treasury; 373,600 shares in 1998          (3,341,165)             --
   Unrealized loss on marketable securities net of tax benefit of
      $64,006 in 1998 and $19,831 in 1997                               (124,248)        (38,494)
                                                                    ------------    ------------

         Total stockholders' equity                                   38,356,514      33,905,937
                                                                    ------------    ------------
                                                                    $ 52,251,353    $ 48,982,320
                                                                    ============    ============
</TABLE>

See accompanying notes to condensed consolidated financial statements


                                        4
<PAGE>   6



            ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
          CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
        FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                               THREE MONTHS ENDED JUNE 30,       SIX MONTHS ENDED JUNE 30,
                                                               ----------------------------    ----------------------------
                                                                    1998            1997            1998            1997
                                                               ------------    ------------    ------------    ------------
<S>                                                            <C>             <C>             <C>             <C>         
Net revenue-product sales                                      $  4,730,672    $  3,465,753    $  9,154,127    $  6,601,334
Net revenue-contract research and development                       600,000              --         600,000              --
                                                               ------------    ------------    ------------    ------------
         Total net revenue                                        5,330,672       3,465,753       9,754,127       6,601,334

Costs and expenses:
   Cost of product sales                                          1,237,569       1,660,595       2,495,201       2,578,173
   Research and development                                         606,534         210,759       1,070,482         475,777
   Marketing                                                      1,118,202       1,037,317       2,237,862       1,934,412
   Amortization of intangibles                                      291,504         274,253         583,006         537,360
   General and administrative                                       720,303         432,172       1,239,613         862,982
                                                               ------------    ------------    ------------    ------------
                                                                  3,974,112       3,615,096       7,626,164       6,388,704
                                                               ------------    ------------    ------------    ------------
         Earnings (loss) from operations                          1,356,560        (149,343)      2,127,963         212,630
                                                               ------------    ------------    ------------    ------------

Other income (expenses):
   Interest expense                                                 (79,346)       (163,601)       (175,738)       (300,226)
   Interest and other income                                        243,054          32,258         415,416          44,962
  Gain (loss) on sale of assets and marketable
    securities                                                          (81)         11,532             (81)        (24,479)
                                                               ------------    ------------    ------------    ------------
                                                                    163,627        (119,811)        239,597        (279,743)
                                                               ------------    ------------    ------------    ------------

         Earnings (loss) from continuing operations
             before income taxes                                  1,520,187        (269,154)      2,367,560         (67,113)
Income taxes (benefit)                                              598,999         (47,141)        944,728          17,009
                                                               ------------    ------------    ------------    ------------
         Net earnings (loss) from continuing
             operations                                             921,188        (222,013)      1,422,832         (84,122)
                                                               ------------    ------------    ------------    ------------

Discontinued Operations:
  Earnings (loss) from discontinued operations,
    net of income tax benefits of $129,711 in
    1998 and income tax expense of $31,867 and
    $24,460 in 1997                                                      --         187,265        (211,634)        143,740

  Gain (loss) 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                                                  --         187,265       4,988,941         143,740
                                                               ------------    ------------    ------------    ------------
         Net earnings (loss)                                   $    921,188    $    (34,748)   $  6,411,773    $     59,618
                                                               ============    ============    ============    ============

Basic earnings (loss) per share:
         Continuing operations                                 $        .11    $       (.03)   $        .16    $       (.01)
                                                               ============    ============    ============    ============
         Discontinued operations                               $         --    $        .03    $        .58    $        .02
                                                               ============    ============    ============    ============
         Net earnings                                          $        .11    $         --    $        .74    $        .01
                                                               ============    ============    ============    ============
Diluted earnings (loss) per share:
         Continuing operations                                 $        .10    $       (.03)   $        .16    $       (.01)
                                                               ============    ============    ============    ============
         Discontinued operations                               $         --    $        .03    $        .56    $        .02
                                                               ============    ============    ============    ============
         Net earnings                                          $        .10    $         --    $        .72    $        .01
                                                               ============    ============    ============    ============
</TABLE>

See accompanying notes to condensed consolidated financial statements.




                                        5
<PAGE>   7



            ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
          CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
                FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                          SIX MONTHS ENDED JUNE 30,
                                                                        ----------------------------
                                                                             1998            1997
                                                                        ------------    ------------
<S>                                                                     <C>             <C>          
Cash flows from operating activities:
   Net earnings (loss) from continuing operations                       $  1,422,832    $    (84,122)
                                                                        ------------    ------------
   Adjustments to reconcile net earnings (loss) from continuing
     operations to net cash provided by operating activities
       Depreciation and amortization                                         876,932         716,741
       Loss on sale of assets and marketable
        securities                                                                81          24,479
       Increase in inventory reserve                                              --         478,619
       Deferred income taxes                                              (1,307,584)        (66,583)
       Changes in assets and liabilities:
          Receivables                                                       (281,235)       (319,767)
          Inventories                                                        189,648         121,819
          Prepaid expenses and other assets                                   55,520         273,616
          Accounts payable                                                   276,361        (436,103)
          Deferred revenue                                                 3,400,000              --
          Income taxes payable                                             2,224,512              --
          Accrued expenses                                                    82,945        (178,009)
                                                                        ------------    ------------
            Total adjustments                                              5,517,180         614,812
                                                                        ------------    ------------
            Net cash provided by continuing operations                     6,940,012         530,690
            Net cash provided by discontinued operations                      59,049         971,622
                                                                        ------------    ------------
            Net cash provided by operating activities                      6,999,061       1,502,312
                                                                        ------------    ------------

Cash flows from investing activities:
  Purchases of marketable securities                                        (106,001)       (717,562)
  Proceeds from sales of marketable securities                               565,420         791,681
  Additions to property, plant and equipment - continuing operations        (696,996)       (333,257)
  Additions to property, plant and equipment - discontinued operations       (12,060)       (766,513)
  Final payments for 1995 acquisition of Neuromed                                 --      (4,472,197)
  Net proceeds from sale of discontinued operations and assets            21,754,179           4,348
                                                                        ------------    ------------
            Net cash provided by (used in) investing activities           21,504,542      (5,493,500)
                                                                        ------------    ------------

Cash flows from financing activities:
  Exercise of stock options                                                  461,069         320,479
  Purchase of treasury stock                                              (3,341,165)             --
  Proceeds from short-term obligations                                            --       3,911,221
  Payment of short-term obligations                                       (8,081,763)       (713,965)
  Payment of long-term debt                                                  (86,775)        (80,018)
                                                                        ------------    ------------
            Net cash provided by (used in) financing activities          (11,048,634)      3,437,717
                                                                        ------------    ------------
  Net increase (decrease) in cash and cash equivalents                    17,454,969        (553,471)

Cash and cash equivalents at beginning of year                               747,828         696,196
                                                                        ------------    ------------
Cash and cash equivalents at June 30                                    $ 18,202,797    $    142,725
                                                                        ============    ============

Supplemental cash flow information is presented below:
Income taxes paid                                                       $     27,800    $         --
                                                                        ============    ============
Interest paid                                                           $    214,582    $    470,314
                                                                        ============    ============
</TABLE>

See accompanying notes to condensed consolidated financial statements


                                        6
<PAGE>   8



            ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
           CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                                                     UNREALIZED
                                                       ADDITIONAL     RETAINED        LOSS ON                          TOTAL
                               COMMON STOCK             PAID-IN       EARNINGS       MARKETABLE       TREASURY      STOCKHOLDER'S
                          SHARE           AMOUNT        CAPITAL       (DEFICIT)      SECURITIES        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
   Shares issued
     upon exercise
     of stock
     options                296,999         14,849        907,537             --              --              --         922,386
   Adjustment to
     unrealized
     losses on
     marketable
     securities                  --             --             --             --          92,384              --          92,384
   Tax benefit from
     employee stock
     option
     exercises                   --             --      1,173,663             --              --              --       1,173,663
   Net earnings                  --             --             --        724,021              --              --         724,021
                       ------------   ------------   ------------   ------------    ------------    ------------    ------------

Balance at
December 31, 1997         8,635,509        431,775     40,780,717     (7,268,061)        (38,494)             --      33,905,937
   Shares issued
     upon exercise
     of stock
     options                145,063          7,253        453,816             --              --              --         461,069
   Compensation
     expense
     resulting from
     changes to
     stock options               --             --      1,004,654             --              --              --       1,004,654
   Purchase of
     373,600 common
     shares, at cost             --             --             --             --              --      (3,341,165)     (3,341,165)
   Adjustment to
     unrealized
     losses on
     marketable
     securities                  --             --             --             --         (85,754)             --         (85,754)
   Net earnings                  --             --             --      6,411,773              --              --       6,411,773
                       ------------   ------------   ------------   ------------    ------------    ------------    ------------

Balance at
June 30, 1998             8,780,572   $    439,028   $ 42,239,187   $   (856,288)   $   (124,248)   $ (3,341,165)   $ 38,356,514
                       ============   ============   ============   ============    ============    ============    ============
</TABLE>

See accompanying notes to condensed consolidated financial statements



                                        7
<PAGE>   9
            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 six months ended June 30, 1998 and
         1997. 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
         and assumptions that affect the





                                        8
<PAGE>   10
         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 June
         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 June 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   $       --   $  122,101   $  435,495
Publicly traded limited
  partnerships                      51,875           --       23,125       28,750
Real estate investment trusts      141,590           --       19,651      121,939
Other                              303,628           --       23,377      280,251
                                ----------   ----------   ----------   ----------
                                $1,054,689   $       --   $  188,254   $  866,435
                                ==========   ==========   ==========   ==========
</TABLE>

         At June 30, 1998, no individual security represented more than 29
         percent of the total portfolio or 1 percent of total assets. The
         Company did not have any investments in derivative financial
         instruments at June 30, 1998.

(4)      NOTES PAYABLE

         Notes payable at June 30, 1998 and December 31, 1997 were as follows:

<TABLE>
<CAPTION>
                                                  JUNE 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
Mortgage notes                                     3,723,837       3,810,612
Other                                                     --          81,763
                                                ------------    ------------
                                                   3,723,837      11,892,375
Less current maturities                             (182,841)     (8,257,348)
                                                ------------    ------------
Long-term notes payable                         $  3,540,996    $  3,635,027
                                                ============    ============
</TABLE>



                                        9
<PAGE>   11
         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 June 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 $2,851,408 at June 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 $872,429 at June 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.

         The carrying value of the Company's debt approximates its fair value.

(5)      COMMITMENTS AND CONTINGENCIES

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

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





                                       10
<PAGE>   12
         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 six months ended June 30, 1998, of $944,728 and income tax
         expense from discontinued operations of $2,908,257, an overall
         effective tax rate of 37.5 percent. The tax expense from discontinued
         operations during the six months ended June 30, 1998 resulted from the
         gain on the sale of the CVS Operations (see Note 8 - "Sale of CVS
         Operations/Discontinued Operations"). 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. During the six months ended June 30, 1997, the Company
         recorded income tax expense of $17,009 from continuing operations and
         income tax expense of $24,460 from discontinued operations, an overall
         effective tax rate of 41.0 percent. The Company's expense for
         amortization of 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.

(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 June 30,
         1998 and 1997 are based upon 8,637,750 and 8,371,000 shares,
         respectively. Basic earnings (loss) per share for the six months ended
         June 30, 1998 and 1997 are based upon 8,629,411 and 8,357,445 shares,
         respectively. Diluted earnings (loss) per share for the three months
         ended June 30, 1998 and 1997 are based upon 8,923,052 and 8,371,000
         shares, respectively. Diluted earnings (loss) per share for the six
         months ended June 30, 1998 and 1997 are based upon 8,887,383 and
         8,357,445 shares, respectively.

 (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 six months ended June 30, 1998. This gain is net of $1 million of
         compensation expense recorded as a result of





                                       11
<PAGE>   13
         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.

         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 six months
         ended June 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 Ended    Three Months Ended   Six Months Ended
                                                January 30, 1998     June 30, 1997       June 30, 1997
                                                ----------------   ------------------   ----------------
<S>                                             <C>                 <C>                 <C>             
Net revenue-product sales                       $      1,111,992    $      3,675,966    $      7,209,518
Gross profit from product sales                          206,481           1,952,786           3,597,113
Earnings (loss) from operations                         (307,120)            333,564             383,985
Interest expense                                         (34,225)           (114,432)           (215,785)
                                                ----------------    ----------------    ----------------
Earnings (loss) before income tax                       (341,345)            219,132             168,200
Income tax expense (benefit)                            (129,711)             31,867              24,460
                                                ----------------    ----------------    ----------------
Net earnings (loss)                             $       (211,634)   $        187,265    $        143,740
                                                ----------------    ----------------    ----------------
</TABLE>

         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.





                                       12
<PAGE>   14
         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 of the agreement which will be recognized into
         income as revenue over the next several quarters, beginning in the
         quarter ended June 30, 1998, based upon the estimated percentage of
         completion of the development project. 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.





                                       13
<PAGE>   15



                      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. During the option
period, 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.

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 six months ended June 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 six
months ended June 30, 1998 and 1997.

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.

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 of the
agreement which will be recognized into income as revenue over the next several
quarters,





                                       14
<PAGE>   16



beginning in the quarter ended June 30, 1998, based upon the estimated
percentage of completion of the development project. 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.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998 AND 1997

Revenues. Net revenue from continuing ANS operations of $5.33 million for the
three months ended June 30, 1998 was $1.86 million above the level for the
comparable 1997 period of $3.47 million. The 1998 period includes $600,000 of
net revenue associated with the Company's development agreement for DBS
products with Sofamor Danek. Net revenue from ANS product sales increased 36.5
percent to $4.73 million during the three months ended June 30, 1998 from $3.47
million during the comparable 1997 period. For the six months ended June 30,
1998, net revenue increased to $9.75 million from $6.60 million during 1997, an
increase of $3.15 million. Again, the 1998 six month period includes $600,000
of net revenue associated with the Sofamor Danek development agreement.
Excluding such revenue, ANS net revenue from product sales increased to $9.15
million during 1998 from $6.60 million in 1997, an increase of $2.55 million,
or 38.7 percent.  The increase in net revenue during both 1998 periods compared
to 1997 was primarily the result of higher unit sales volume of ANS' Radio
Frequency ("RF") spinal cord stimulation ("SCS") systems used to manage chronic
intractable pain, principally in the United States, and the revenue associated
with the development agreement with Sofamor Danek.  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 increased
during the three months ended June 30, 1998 to $3.49 million compared to $1.81
million in 1997 and as a percentage of net revenue from product sales, gross
profit increased during the three months ended June 30, 1998 to 73.8 percent
compared to 52.1 percent during the comparable 1997 period. This increase in
gross profit from product sales was attributable to the increased revenue
generated by ANS and an increase in gross profit margin from product sales
resulting from three factors. First, the 1997 period included a write-off of
$479,000 for ANS inventories of previous designs which resulted in a reduction
of the 1997 gross profit margin by 14 percentage points (the gross margin
without the inventory write-off was 66 percent). Second, the 1998 period
included higher unit sales 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. Third, the Company implemented
certain manufacturing cost





                                       15
<PAGE>   17



improvements during 1998 which have reduced manufacturing costs on certain of
the Company's products. For the six months ended June 30, 1998, gross profit
from product sales increased to $6.66 million from $4.02 million in 1997 due to
the increased revenue generated by ANS and an increase in gross profit margin
from product sales which increased to 72.7 percent during the six month period
in 1998 compared to 60.9 percent in 1997 as a result of the inventory write-off
during 1997, higher unit sales volume of the Company's dual octrode systems in
1998 and certain manufacturing cost improvements implemented during 1998 as
discussed above.

Operating Expenses. Total operating expenses of $2.74 million for the three
months ended June 30, 1998 increased from $1.95 million during the same period
in 1997, although as a percentage of net revenue, total operating expenses
decreased from 56.4 percent in 1997 to 51.3 percent in 1998. For the six months
ended June 30, 1998, total operating expenses increased to $5.13 million from
$3.81 million in 1997, although as a percentage of net revenue, total operating
expenses decreased from 57.7 percent in 1997 to 52.6 percent in 1998.

Research and development expense increased to $607,000 during the three months
ended June 30, 1998, compared to $211,000 for the same period a year ago, and
increased as a percentage of net revenue from 6.1 percent in 1997 to 11.4
percent in 1998. For the six months ended June 30, 1998, research and
development expense increased to $1.07 million compared to $476,000 during the
comparable 1997 period. 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 $1.6 million for the
remainder of 1998. These expenditures during the first half of 1998 and for the
remainder of 1998 are being directed toward development of next generation RF
SCS systems, 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 premier contract engineering and manufacturing firm, to develop an IPG.
IPG systems currently account for 80 percent of the SCS units sold worldwide.
Management expects the IPG system to be ready for clinical trials in the United
States and international market introduction in early 1999. 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 epilepsy, urinary incontinence, angina and peripheral vascular disease.

Marketing expense, as a percentage of net revenue, decreased to 21.0 percent
for the three months ended June 30, 1998, compared to 29.9 percent for the
comparable period during 1997, while the dollar amount increased from $1.04
million during 1997 to $1.12 million in 1998. For the six months ended June 30,
1998, marketing expense as a percentage of net revenue decreased to 22.9
percent from 29.3 percent in the comparable 1997 period, while the dollar
amount increased to $2.24 million in 1998 from $1.93 million during 1997. This
dollar increase during both periods in 1998 compared to the same periods in
1997 was attributable to higher commissions due to increased revenue and
training expense for new users of ANS products.

Amortization expense for intangibles increased from $274,000 during the three
months ended June 30, 1997 to $292,000 during the comparable 1998 period. For
the six months ended June





                                       16
<PAGE>   18



30, 1998, amortization expense increased to $583,000 from $537,000 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
13.5 percent during the three months ended June 30, 1998 compared to 12.5
percent for the same period during 1997, and the dollar amount increased by
$288,000. This increase in expense during 1998 compared to 1997 was primarily
the result of expense relating to the Sofamor Danek agreement and other
agreements, and increased costs of existing employee benefit plans. For the six
months ended June 30, 1998, general and administrative expense as a percentage
of net revenue decreased to 12.7 percent from 13.1 percent in the same period
during 1997, although the dollar amount increased by $377,000. This dollar
increase in expense during 1998 compared to 1997 was primarily the result of an
executive placement fee paid in connection with the hiring of a new president
and chief executive officer, expense relating to the Sofamor Danek agreement
and other agreements, and increased costs of existing employee benefit plans.

Earnings From Operations. Earnings from operations increased to $1.36 million
during the three months ended June 30, 1998 compared to a loss of $149,000 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. Earnings from operations increased to
$2.13 million during the six months ended June 30, 1998 compared to $213,000
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 $164,000 during the three
months ended June 30, 1998 compared to an expense of $120,000 for the
comparable 1997 period. For the six months ended June 30, 1998, other income
increased to $240,000 compared to an expense of $280,000 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 $599,000 for the three months ended June 30, 1998 compared to a
tax benefit of $47,000 during the same period in 1997 as a result of earnings
from continuing ANS operations in 1998 compared to a loss during the 1997
period. For the six months ended June 30, 1998, income tax expense for
continuing operations increased to $945,000 from $17,000 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 six months ended June
30, 1998 were 39.4 percent and 39.9 percent, respectively, as the Company's
expense for amortization of costs in





                                       17
<PAGE>   19



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 increased to $921,000 during the three months ended June 30, 1998
compared to a net loss of $222,000 during the same period a year earlier. For
the six months ended June 30, 1998, net earnings from continuing operations
increased to $1.42 million compared to a net loss during the same 1997 period
of $84,000. This increase during both 1998 periods compared to the same periods
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, to a lesser extent, the increase in other income due to lower
interest expense and higher interest income.

Discontinued Operations. Net earnings from discontinued operations during the
three months ended June 30, 1997 was $187,000. 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 six months ended June 30, 1998 compared to $144,000
during the comparable 1997 period. Net 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 $921,000 during the three months ended
June 30, 1998 compared to a net loss of $35,000 during the comparable 1997
period due to the increase in net earnings from continuing operations discussed
above. For the six months ended June 30, 1998, net earnings increased to $6.41
million compared to $60,000 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. If Atrion exercises the purchase option on the Allen facility, the
Company would receive another $2.8 million in net proceeds after paying off the
mortgage.

The Company's working capital increased from $14.1 million at year-end 1997 to
$18.6 million at June 30, 1998. The ratio of current assets to current
liabilities was 3.3:1 at June 30, 1998, compared to 2.5:1 at December 31, 1997.
Cash, cash equivalents and marketable securities totaled $19.1 million at June
30, 1998 compared to $2.2 million at December 31, 1997.





                                       18
<PAGE>   20




During January 1998, the Board of Directors approved a stock repurchase program
of up to 500,000 shares of the Company's common stock. During the six months
ended June 30, 1998, the Company repurchased 373,600 shares of its common stock
at an aggregate cost of $3,341,165, or $8.94 per share.

During the six months ended June 30, 1998, capital expenditures totaled
$697,000, primarily for additional manufacturing tooling and equipment.
Management expects capital expenditures for the remainder of fiscal 1998 of
$1.5 million primarily related to manufacturing tooling and equipment for the
new products the Company is developing, including next generation RF SCS
systems, an IPG system and a constant rate implantable drug pump.

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.

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 $6.94 million during
the six months ended June 30, 1998, from $531,000 for the same period a year
ago reflecting the improved operating results of ANS and the $4.0 million
payment received pursuant to the Company's agreement with Sofamor Danek. The
primary use of cash in continuing operations during the six months ended June
30, 1998 was an increase in the level of accounts receivable of $281,000. Net
cash provided by discontinued operations decreased to $59,000 during the six
months ended June 30, 1998 compared to $972,600 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 $21.5 million during the
six months ended June 30, 1998, compared to a net use of cash during 1997 of
$5.5 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 six months ended June 30, 1998
was $11.0 million while financing activities during the same period in 1997
provided net cash of $3.4 million. This decrease was primarily due to the use
of $8.1 million in 1998 to reduce debt under short-term notes payable and $3.3
million used in 1998 for the repurchase of 373,600 shares of the Company's
common stock while the 1997 period included additional net borrowings under
short-term notes of $3.2 million.





                                       19
<PAGE>   21



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.

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: continued growth in ANS revenues and 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.





                                       20
<PAGE>   22




                                    PART II

                               OTHER INFORMATION


ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its 1998 Annual Meeting of Shareholders ("Annual Meeting") on
May 28, 1998 at the Company's corporate office in Allen, Texas. At the Annual
Meeting, the following matters were voted on and approved:

<TABLE>
<CAPTION>
                                                                                          VOTES ABSTAINED
                                           VOTES FOR               VOTES AGAINST                AND
         PROPOSAL                     NOMINEE/PROPOSAL          NOMINEE/PROPOSAL          BROKER NON-VOTES
         --------                     ----------------          ----------------          ----------------
<S>                                        <C>                       <C>                    <C>      
1)   Election of six
     directors for a
     one-year term

     Christopher G. Chavez                 8,056,424                  77,742                       --
     Robert C. Eberhart, Ph.D.             8,035,970                  98,196                       --
     Joseph E. Laptewicz                   8,055,661                  78,505                       --
     Hugh M. Morrison                      8,056,321                  77,845                       --
     Richard D. Nikolaev                   8,056,424                  77,742                       --
     Michael J. Torma, M.D.                8,021,424                 112,742                       --

2)  Approval of an amendment
     to the Articles of Incorporation
     to change the Company's name
     to Advanced Neuromodulation
     Systems, Inc.                         8,037,290                  59,772                   37,104

3)  Approval of the Advanced
     Neuromodulation Systems, Inc.
     1998 Stock Option Plan                4,177,324                 971,911                2,984,931
</TABLE>

There were present at the Annual Meeting in person or by proxy, shareholders
holding 8,134,166 shares, or approximately 94.1% of the eligible voting shares.


ITEM 6.          EXHIBITS AND REPORTS ON FORM 8-K

          (a)    Exhibit 3.1   --  Articles of Amendment to the Articles of
                                   Incorporation

                 Exhibit 27.1  --  Financial Data Schedule

                 Exhibit 27.2  --  Restated Financial Data Schedule





                                       21
<PAGE>   23




         (b)     The Company filed a Form 8-K on December 31, 1997 to report
                 the press release announcing the Company's entering into a
                 definitive agreement on December 29, 1997 to sell the CVS
                 Operations to Atrion. On February 13, 1998 the Company filed a
                 Form 8-K to report the consummation of the sale of the CVS
                 Operations to Atrion on January 30, 1998. On April 9, 1998 the
                 Company filed Amendment No. 1 on a Form 8-K/A to its Form 8-K
                 filed on February 13, 1998 amending Item 7(b) to report pro
                 forma financial information.





                                       22
<PAGE>   24




                                   SIGNATURES



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





                                     ADVANCED NEUROMODULATION SYSTEMS, INC.



Date:  August 10, 1998               By: /s/ F. Robert Merrill III       
                                        ---------------------------------------
                                        F. Robert Merrill III
                                        Executive Vice President, Finance
                                        Chief Financial Officer and Treasurer




                                       23


<PAGE>   25




                                 EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER         DESCRIPTION
------         -----------
<S>            <C>
     3.1   --  Articles of Amendment to the Articles of Incorporation

     27.1  --  Financial Data Schedule

     27.2  --  Restated Financial Data Schedule
</TABLE>