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<SEC-DOCUMENT>0000351721-01-000014.txt : 20010409
<SEC-HEADER>0000351721-01-000014.hdr.sgml : 20010409
ACCESSION NUMBER: 0000351721-01-000014
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 2
CONFORMED PERIOD OF REPORT: 20001231
FILED AS OF DATE: 20010402
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: ADVANCED NEUROMODULATION SYSTEMS INC
CENTRAL INDEX KEY: 0000351721
STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841]
IRS NUMBER: 751646002
STATE OF INCORPORATION: TX
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT:
SEC FILE NUMBER: 000-10521
FILM NUMBER: 1591768
BUSINESS ADDRESS:
STREET 1: 6501 WINDCREST DRIVE SUITE 100
CITY: PLANO
STATE: TX
ZIP: 75024
BUSINESS PHONE: 9723098000
MAIL ADDRESS:
STREET 1: 6501 WINDCREST DRIVE SUITE 100
CITY: PLANO
STATE: TX
ZIP: 75024
FORMER COMPANY:
FORMER CONFORMED NAME: QUEST MEDICAL INC
DATE OF NAME CHANGE: 19920703
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>0001.htm
<DESCRIPTION>FORM 10-K FOR YEAR ENDED DECEMBER 31, 2000
<TEXT>
<HTML>
<HEAD>
<TITLE>Form 10-K for Year Ended December 31, 2000</TITLE>
</HEAD>
<BODY>
<H1 ALIGN=CENTER><FONT SIZE=3>SECURITIES AND EXCHANGE COMMISSION</FONT></H1>
<H1 ALIGN=CENTER><FONT SIZE=3>Washington, D.C. 20549</FONT></H1>
<HR SIZE=1 WIDTH=15% ALIGN=CENTER>
<H1 ALIGN=CENTER><FONT SIZE=4>FORM 10-K</FONT></H1>
<HR SIZE=1 WIDTH=15% ALIGN=CENTER>
<H1 ALIGN=CENTER><FONT SIZE=3>[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE<BR>SECURITIES EXCHANGE ACT OF 1934</FONT></H1>
<P ALIGN=CENTER><FONT SIZE=3>For the Fiscal Year Ended December 31,
2000</FONT></P>
<P ALIGN=CENTER><FONT SIZE=3>OR</FONT></P>
<H1 ALIGN=CENTER><FONT SIZE=3>[ ] TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE<BR> SECURITIES EXCHANGE ACT OF 1934</FONT></H1>
<HR SIZE=1 WIDTH=15% ALIGN=CENTER>
<P ALIGN=CENTER><FONT SIZE=3>Commission file number 0-10521</FONT></P>
<H1 ALIGN=CENTER><FONT SIZE=4>ADVANCED NEUROMODULATION SYSTEMS, INC.</FONT></H1>
<P ALIGN=CENTER><FONT SIZE=3>Incorporated pursuant to the Laws of the State of
Texas</FONT></P>
<HR SIZE=1 WIDTH=15% ALIGN=CENTER>
<P ALIGN=CENTER><FONT SIZE=3>Internal Revenue Service — Employer
Identification No. 75-1646002</FONT></P>
<P ALIGN=CENTER><FONT SIZE=3>6501 Windcrest Drive, Plano, Texas 75024</FONT></P>
<P ALIGN=CENTER><FONT SIZE=3>(972) 309-8000</FONT></P>
<HR SIZE=1 WIDTH=15% ALIGN=CENTER>
<P><FONT SIZE=2>Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ] </FONT></P>
<P><FONT SIZE=2>Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of the S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]</FONT></P>
<P><FONT SIZE=2>Aggregate market value of the registrant’s Common
Stock held by non-affiliates of the registrant as of March 16, 2001:
$104,494,166</FONT></P>
<P><FONT SIZE=2>Number of shares outstanding of the registrant’s Common
Stock as of March 16, 2001: 8,913,359</FONT></P>
<P ALIGN=CENTER><FONT SIZE=2><B>DOCUMENTS INCORPORATED BY REFERENCE</B></FONT>
</P>
<P><FONT SIZE=2>Portions of the registrant’s definitive Proxy Statement
for the registrant's Annual Meeting of Stockholders to be held on May 23, 2001,
are incorporated by reference into Part III.</FONT></P>
<HR SIZE=5>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc.</B></P>
<P ALIGN=CENTER><B>Annual Report</B></P>
<P ALIGN=CENTER><B>Form 10-K</B></P>
<P ALIGN=CENTER><B>Year Ended December 31, 2000</B></P>
<P ALIGN=CENTER><B>PART I</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 1.</B></TD>
<TD WIDTH=85%><B>BUSINESS</B></TD></TR></TABLE>
<P ALIGN=CENTER><B><U>General</U></B></P>
<P>Advanced Neuromodulation Systems, Inc. designs, develops, manufactures and
markets advanced implantable neuromodulation devices that improve the quality of
life for people with disabling chronic pain or nervous system disorders.
Neuromodulation is the electrical or chemical modulation of the central nervous
system to significantly reduce chronic pain or improve neurological
function.</P>
<P>Because neuromodulation devices have gained acceptance as a viable,
efficacious and cost-effective treatment alternative for relieving chronic
intractable pain and improving neurological function, we are continuing efforts
to expand our product offerings in the high growth market of neuromodulation. In
2000, we were the market share and technology leader in the $45 million
radio-frequency stimulation segment of the neuromodulation market. In 2000, we
continued our aggressive investment in development projects to position us to
participate in the other larger and more rapidly growing segments of the
neuromodulation market. Excluding vagus nerve stimulation for treating epilepsy,
which we do not currently anticipate addressing, industry analysts expect the
neuromodulation market to grow from $425 million in 2000 to nearly $800 million
by 2003 solely on current FDA approved indications.</P>
<P ALIGN=CENTER><B><U>Recent Developments</U></B></P>
<P>On January 2, 2001, we acquired the assets (primarily intellectual property
consisting of patents and know-how) of Implantable Devices Limited Partnership
(IDP) and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota
companies, for 119,100 shares of ANS common stock. Based on the closing price of
ANS common stock on December 29, 2000, the value of the stock issued to acquire
the assets was $2.43 million. IDP was formed in 1986 to commercialize certain
implantable infusion technologies developed at the University of Minnesota. We
entered a license agreement with IDP in 1995 to license rights to implantable
infusion pump technologies developed by IDP and ESOX for applications in pain
and cancer therapy. Under the license agreement, we were obligated to pay IDP
royalties on worldwide sales of implantable infusion pumps using IDP technology.
The January 2, 2001 acquisition canceled the license agreement, thereby
eliminating our future royalty obligations, and expanded our rights to use the
pump technologies in all applications through our acquisition of the
intellectual property. We completed development of our AccuRx™ fully
implantable constant rate infusion pump in late 2000 using technology we
licensed from IDP. We received CE mark approval to distribute the pump
internationally, with international sales expected to commence in the second
quarter of fiscal 2001. We also received an Investigational Device Exemption
(IDE) from the FDA to initiate clinical trials in the United States. The
clinical trials will include 109 patients and will be conducted in twelve sites.
The trials commenced in the first quarter of 2001. The data gathered during the
trials will be used to support a Pre-Market Approval (PMA) application.</P>
<P ALIGN=CENTER>Page 1</P>
<HR>
<P>Also on January 2, 2001, we completed the acquisition of Hi-tronics Designs,
Inc. (HDI or Hi-tronics), a privately-held contract developer and original
equipment manufacturer (OEM) of electro-mechanical devices headquartered in Budd
Lake, New Jersey. We acquired HDI through a stock-for-stock merger in which we
issued 1,104,725 shares of ANS common stock. The transaction will be accounted
for on a pooling of interests basis. HDI developed and is the manufacturer of
our Genesis™ totally implantable pulse generator (IPG) used in the
treatment of chronic intractable pain and is also the OEM manufacturer of the
transmitter used with our Renew® radio-frequency spinal cord stimulation
system. HDI was founded in 1987 and has developed more than thirty medical
devices for some of the leading medical device companies. The core strength of
HDI is in developing highly sophisticated electronic circuits with very low
power requirements, utilizing both discreet and highly integrated technology. We
believe this competency, when combined with our own strengths in lead design and
packaging, will allow us to develop more sophisticated products in compressed,
development-cycle timetables. In addition, the merger will result in vertical
integration benefits in manufacturing that should enhance margins on our current
and future products. HDI’s revenues for its fiscal 2000, which ended
November 30, 2000, were approximately $10.4 million, including approximately
$1.6 million of revenue associated with sales to ANS.</P>
<P>In September 1999, the Neurological Devices Panel of the Medical Devices
Advisory Committee recommended that the FDA reclassify Totally Implanted Spinal
Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs from a
Class III device to a Class II device. Class III devices typically require a
PMA, supplemented with clinical trials to prove the safety and effectiveness of
the device. Class II devices typically require a Pre-Market Notification
(510(k)) to demonstrate substantial equivalence to an existing legally marketed
device prior to receiving market clearance by the FDA. According to the
FDA’s 2000 ODE Annual Report, the average time for a PMA clearance was 11.9
months (excluding the one-year typically required for clinical trials, or
approximately 24 months total), while the average elapsed time for a 510(k)
approval was 3.4 months in 2000.</P>
<P>On September 6, 2000, the FDA published a Notice of Panel Recommendation in
the Federal Register to tentatively accept the September 1999 Medical Devices
Neurological Advisory Panel recommendation to reclassify the IPG device and
established a 30-day public comment period regarding the reclassification. The
FDA extended the comment period by 28 days until November 3, 2000 at the request
of Medtronic, Inc. On February 26, 2001, the FDA notified ANS that the agency
had denied ANS' petition to reclassify Totally Implanted Spinal Cord Stimulators
(IPGs) for treatment of pain of the trunk and/or limbs from a Class III device
to a Class II device. The FDA’s denial was surprising and disappointing
principally because at a presubmission meeting with the FDA, the agency itself
had recommended that ANS submit a reclassification petition instead of the PMA
process as a "least burdensome path to market." Furthermore, the FDA Advisory
Panel recommended the reclassification and the agency itself had supported the
recommendation as late as September 6, 2000. We are currently requesting an
internal review of the administrative record to appeal the decision, while
simultaneously pursuing the PMA application to gain approval to market the IPG
in the United States. We are already marketing the IPG product in Europe.
Industry analysts estimate that the IPG market for spinal cord stimulation to
treat pain of the trunk and/or limbs will approach $175 million in 2001, and
that the market is growing at a 25% to 30% annual rate. Currently Medtronic,
Inc. is the sole provider of IPGs in the United States.<P>
<P ALIGN=CENTER><B><U>The Neuromodulation Market</U></B></P>
<P>The neuromodulation market is comprised of implantable electrical stimulation
systems and fully implantable infusion pumps that modulate the central nervous
system by delivering precise doses of either electricity or pharmaceuticals
directly to targeted nerve sites.</P>
<P ALIGN=CENTER>page 2</P>
<HR>
<P>Four product technology platforms address the chronic intractable pain
segment of the neuromodulation market. These platforms are: (1) radio-frequency
stimulation systems for spinal cord stimulation, (2) implantable pulse generator
stimulation systems for spinal cord and deep brain stimulation, (3) fully
implantable constant rate infusion pumps and (4) fully implantable programmable
rate infusion pumps. Industry analysts estimate the market for these
neuromodulation devices at $425 million in 2000 and growing to nearly $800
million by 2003 solely on current FDA approved indications. The growth in the
market for stimulation systems and fully implantable infusion pumps is being
driven by a number of factors, including:</P>
<UL>
<LI>New technology is increasing the capability of these devices
<LI>New clinical applications for stimulation systems and fully implantable
infusion pumps are being discovered and tested
<LI>Improved outcomes are being driven by technology, patient selection and
improved techniques
<LI>Stimulation and fully implantable infusion pump devices are generally low
risk and cost effective and the therapies are reversible
<LI>Patient awareness and advocacy is generally high
<LI>The base of pain specialists and centers of excellence is growing</UL>
<P>Listed below is the estimated revenue by market segment in 2000 and 2003 for
all manufacturers of such products. These estimates do not consider the use of
neuromodulation technology platforms for applications such as epilepsy,
depression, peripheral nerve stimulation, chronic intractable angina, chronic
headaches, functional stimulation, tens stimulation, peripheral vascular disease
and deep brain applications for disorders other than Parkinson's Disease
and Essential Tremor.</P>
<P><I>Estimated, for all product manufacturers, by market segment:</I></P>
<P></P>
<PRE>
2000 2003
----------- -----------
$(000's) $(000's)
----------- -----------
Radio-frequency stimulation systems for spinal
cord stimulation $ 45,000 $ 70,000
Implantable pulse generator stimulation systems
for spinal cord stimulation 142,000 275,000
Implantable pulse generator stimulation systems
for deep brain stimulation for Parkinson's Disease
and Essential Tremor 40,000 85,000
Implantable pulse generator stimulation systems
for sacral nerve stimulation for incontinence 15,000 55,000
Fully implantable constant rate infusion pumps 24,000 41,000
Fully implantable programmable rate infusion pumps 159,000 264,000
----------- -----------
Total $ 425,000 $ 790,000
----------- -----------
</PRE>
<P>According to industry analysts, there are millions of patients who could
benefit from the use of stimulation or fully implantable infusion pump devices.
Thus, we believe the market is under-served and under-penetrated. In 2000, only
approximately 60,000 patients benefited from neuromodulation devices.</P>
<P ALIGN=CENTER>Page 3</P>
<HR>
<P>Our growth strategy is to develop and license proprietary product platforms
to expand from our participation in only the radio-frequency stimulation segment
during 2000 into the other major market segments of the neuromodulation market.
Since most pain practitioners implant all four of the product platforms
(radio-frequency stimulation systems, implantable pulse generator stimulation
systems, fully implantable constant-rate infusion pumps and fully implantable
programmable infusion pumps), we believe we are in a unique position to leverage
our distribution capabilities.</P>
<P ALIGN=CENTER><B><U>Products</U></B></P>
<P><B>Stimulation Systems</B></P>
<P>Stimulation devices electrically stimulate nerve fibers along the spinal cord
to reduce chronic severe neuropathic pain by “masking” the pain
signals sent to the brain. Neuropathic pain usually arises from nerve damage.
Stimulation device implantation manages the pain associated with failed back
surgery syndrome (FBSS), peripheral neuropathy, phantom limb or stump pain,
ischemic pain and reflex sympathetic dystrophy (RSD), also known as complex
regional pain syndrome (CRPS). Stimulation device implantation in the brain is
being used to relieve the effects of various neurological disorders, such as
Parkinson’s Disease and Essential Tremor by delivering small electrical
impulses to targeted structures in the brain.</P>
<P>The market for stimulation systems is currently divided between
radio-frequency stimulation systems, which use an external power source, and
stimulation systems that utilize implantable battery driven systems known as
implantable pulse generators (IPGs). According to industry analysts, lPG devices
account for around 80 percent of the number of spinal cord stimulation
procedures performed, with radio-frequency devices accounting for the remainder.
We currently design, develop, manufacture and market radio-frequency stimulation
devices and in 2000 we completed the development of our first generation IPG
device. The primary advantage of the radio-frequency device revolves around the
benefits of the system’s external battery. An external battery system
allows the patient to recharge the device by simply changing a special nine-volt
battery. The IPG requires surgical intervention, revision and replacement after
two to four years. Due to its inexpensive power system, the radio-frequency
device can be programmed with a wide range of amplitude, frequency and pulse
width settings for a variety of programs controlled by the patient. These
features make the radio-frequency devices the most cost efficient for long-term
stimulation treatment. On the other hand, IPG devices provide the convenience of
a completely internalized system, although they involve added long-term cost
when repeat surgeries are required to replace the IPG power source. Both
radio-frequency systems and IPG systems are useful to the pain physician.
Radio-frequency systems are most often prescribed for patients who have complex
bilateral pain syndromes or widespread pain that require higher power levels.
IPGs are most often prescribed for patients with simple unilateral and single
extremity pain complaints or indications with lower power requirements.</P>
<P>Our radio-frequency stimulation systems consist of four primary components:
leads, a receiver, a transmitter and programmer. The leads are most commonly
placed percutaneously through the skin into the epidural space of the spinal
column. This procedure for lead placement is similar to that employed by
anesthesiologists in routine epidural procedures. Typically, one or two leads
are inserted, each of which has multiple electrodes that can be used to
stimulate the targeted nerve roots of the spinal cord. Laminotomy style (paddle)
leads are also available for neurosurgeons or orthopedic surgeons who prefer to
insert leads in an open surgical procedure approach. The leads are then
connected to a passive receiver, which is implanted under the skin on the side
of the abdomen. The receiver contains electronics that receive radio-frequency
energy and data from a source (the transmitter) outside the body, and delivers
the prescribed electrical pulses to the leads. The transmitter is approximately
the size of a pager, and is typically worn on a belt. Since it is external to
the body, the transmitter can be easily programmed and serviced as needed, and
its battery can be simply recharged or replaced.</P>
<P ALIGN=CENTER>Page 4</P>
<HR>
<P>Our CompuStim™ systems include four, seven, eight and sixteen electrodes
on one, two or more leads; simple and complex receivers; and an external
battery-powered transmitter. We believe that the CompuStim product line’s
multi-electrode leads and advanced multiprogrammable technology have changed the
manner in which neuromodulation is performed worldwide. For example, our
“Dual Octrode” device, a system of dual leads with eight electrodes on
each lead introduced in 1995, creates a targeted current density that appears to
be especially effective in relieving complex and multi-extremity pain patterns.
Previously, quadrapolar stimulation systems only relieved the leg pain
associated with FBSS. Many experts support the view that the Dual Octrode device
provides improved pain relief to both the legs and the back. Dual Octrode
systems are enjoying increasing acceptance from the physician community and, in
our judgment, are the technological leaders in the stimulation field. We believe
that the long-term results of stimulation in the treatment of pain have improved
as a result of the technological superiority of ANS products. Moreover, the ease
of use of the system has expanded the potential market for these products.</P>
<P>In early 1999, we completed the development of our enhanced radio-frequency
stimulation system, the Renew System, and introduced the products in the United
States during June 1999. These products include enhancements that simplify the
procedure for implanters while providing improved function. We introduced the
Renew System in international markets during 2000.</P>
<P>In 1998, we licensed the rights to method patents for sacral nerve root
stimulation aimed at relieving the effects of chronic pelvic pain, including
interstitial cystitis. Interstitial cystitis is an extremely painful bladder
disease that afflicts approximately 450,000 people in the United States alone.
We believe our advanced radio-frequency stimulation devices can be effective in
treating pelvic pain indications including interstitial cystitis. In February
1999, we received conditional approval from the FDA to initiate a pilot study to
evaluate the use of our advanced radio-frequency stimulation systems to treat
interstitial cystitis. The pilot study is continuing and if successful, we will
seek approval from the FDA to initiate further clinical studies in the process
to receive a PMA approval to begin marketing in the United States.</P>
<P>We believe our radio-frequency stimulation devices represent a strong base
for penetration of the broader neuromodulation market. During 2000, we completed
development of our first generation IPG, Genesis™, to better serve the
broad needs of the pain management market. The IPG stimulation system will allow
us to participate in the largest segment of the stimulation market for spinal
cord stimulation and leverage our sales and marketing capabilities. In late
2000, we received the CE mark approval for our Genesis IPG and commenced our
selling efforts in international markets during January 2001. In the United
States, we are seeking a PMA approval due to the February 26, 2001 decision by
the FDA denying our petition to reclassify the IPG device to a Class II device
from a Class III device. See Item 1. “Business-Recent Developments.”
</P>
<P>Our IPG platform also provides us with the opportunity to address a number
of new indications such as chronic intractable angina, occipital headaches,
urinary urge incontinence, peripheral nerve stimulation and Deep Brain
Stimulation (DBS) for Essential Tremor and tremor associated with
Parkinson’s Disease. During the fourth quarter of 2000, we received an
Investigational Device Exemption (IDE) approval from the FDA to initiate a pilot
clinical study to evaluate the efficacy of our Genesis IPG stimulation system
for the treatment of occipital headaches (chronic severe headaches). The pilot
clinical study of 10 patients at 2 sites in the U.S. began in January 2001. Data
from the pilot study will be used to determine the parameters for a larger
pivotal clinical study to support a PMA application for our Genesis IPG to treat
occipital headaches.</P>
<P ALIGN=CENTER>Page 5</P>
<HR>
<P><B>PainDoc®</B></P>
<P>In early 1997 we began marketing PainDoc, a pen-based computer system that is
designed to assist physicians and their patients in optimizing the performance
of our stimulation devices both pre- and post-operatively. PainDoc interfaces
with our CompuStim and Renew transmitters to optimize stimulation therapy and
document treatment outcomes. PainDoc allows the physician to interact with the
patient to map the location and intensity of the patient’s pain. The
resulting “pain map” is then used to assess and select the most
effective stimulation sets, or combination of multi-electrode stimulation
arrays, to treat the pain. The idea is to generate pain coverage that overlaps
the patient’s pain map. The selected arrays (programs) are uploaded into
the patient’s CompuStim or Renew transmitter. The physician can visually
compare the patient’s pain map against a stimulation map and optimize the
patient’s stimulator setting to address the patient’s needs and assess
whether desired levels of pain relief have been obtained and whether excess
stimulation has been delivered.</P>
<P>PainDoc enables the physician to program up to 24 different stimulation sets
delivering electrical stimulation every 50 milliseconds to expand pain area
coverage and relief. We believe that PainDoc should also allow physicians to
create a broad-based database tool that, by using a standardized methodology,
will enable physicians to share and compare outcome data, which can then be used
to deliver more efficacious pain relief to individual patients. We believe that
PainDoc and ANS transmitter devices used in tandem significantly enhance the
effectiveness, flexibility and precision of managing chronic neuropathic pain.
We expect PainDoc to promote the selection of our devices for stimulation
procedures, especially as stimulation devices become more sophisticated and the
pain management process becomes more refined.</P>
<P>We continue to make improvements to PainDoc and will continue to develop
systems that are easier to use and offer more capability.</P>
<P><B>Implantable Infusion Systems</B></P>
<P>Fully implantable infusion pumps are designed to deliver drugs directly to
targeted sites of action within the body. This contrasts to oral or intravenous
drug delivery, where a drug is distributed systemically throughout the entire
body. When the drug is being delivered directly to the site of action, a better
therapeutic effect often can be achieved with much lower quantities of drug,
with fewer side effects. Today, implantable infusion pumps are used for the
intraspinal delivery of morphine and baclofen for the treatment of pain and
spasticity, and for the intra-arterial delivery of various drugs for
chemotherapy.</P>
<P>Implantable infusion systems consist of an implantable pump and a delivery
catheter. The pump and the catheter work together as a system to deliver small,
precisely controlled doses of drug directly to the targeted delivery site. The
pump consists of a reservoir that holds a several-week supply of drug, a pumping
mechanism to push the drug along the catheter, and a port for refilling the pump
with drug as necessary. The pump is implanted under the skin generally in the
abdominal area and is connected to the delivery catheter. The delivery catheter
is a spaghetti-sized tube that runs between the pump and the targeted delivery
site. The pump is refilled as necessary using a needle inserted through the skin
into the pump’s refill port. The refill procedure is generally performed on
an outpatient basis by a physician or under the direct supervision of a
physician.</P>
<P>In 2000, industry analysts estimated the market for implantable infusion
systems was $183 million and they expect the market to grow to $305 million by
the year 2003. There are two types of implantable pumps: constant flow pumps and
programmable pumps. According to industry analysts, programmable pumps hold an
81 percent unit share of worldwide intraspinal pump procedures, with constant
flow pumps accounting for the balance. Currently, Medtronic, Inc. is the sole
worldwide provider of a programmable pump for intraspinal applications.</P>
<P ALIGN=CENTER>Page 6</P>
<HR>
<P>The programmable pump is the most versatile type of implantable pump since it
allows the fluid (drug) flow rate to be changed non-invasively to meet varying
patients’ needs. Medtronic’s programmable pump contains a battery,
control and telemetry circuitry, and motor. The battery delivers pulses of
energy to the motor, which pushes the drug from the pump into the delivery
catheter and to the targeted delivery site. The programmability feature allows
for time-modified delivery of the drug. For example, it can be non-invasively
programmed to deliver more medication at night and less during the day. Since
the pump is powered with a battery, the entire pump typically needs to be
replaced every five to seven years.</P>
<P>Constant flow pumps are designed to provide drug infusion at a constant
factory-set flow rate. Once implanted, the medication flow rates remain the
same. The physician adjusts dose by adjusting the concentration of the drug in
the pump reservoir. Constant flow pumps are smaller, lighter, less expensive,
and because they have no battery, typically have a significantly longer service
life than programmable pumps.</P>
<P>Management believes that the implantable infusion pump market offers
significant opportunity. In August 1998, we completed an agreement with Tricumed
Medizintechnik GmbH, a German corporation, granting ANS rights to distribute
Tricumed’s implantable pump products in various international markets.
During 2000, ANS and Tricumed mutually agreed to terminate this
relationship.</P>
<P>In 2000, we completed development of our proprietary constant flow
implantable infusion pump, AccuRx™, utilizing technology licensed from the
University of Minnesota. We received CE mark approval to distribute the pump
internationally, with international sales expected to commence in the second
quarter of fiscal 2001. We also received an Investigational Device Exemption
(IDE) from the FDA to initiate clinical trials in the United States. The
clinical trials will include 109 patients and will be conducted in twelve sites.
The trials commenced in the first quarter of 2001. The data gathered during the
trials will be used to support a PMA application.</P>
<P>On January 2, 2001, we acquired the intellectual property rights to our
AccuRx constant flow implantable infusion pump for 119,100 shares of our common
stock valued at $2.43 million. Prior to purchasing these rights, we licensed
rights from the University of Minnesota for pain and cancer therapy
applications. By purchasing the intellectual property rights, we eliminated
future royalty obligations to the University of Minnesota and expanded our
rights to use the AccuRx pump for any application.</P>
<P>Management believes that the market for constant flow implantable infusion
pumps will continue to expand, and that our proprietary pump products offer
unique features and benefits that will enable us to capture a meaningful share
of this market segment after the appropriate regulatory approvals are
secured.</P>
<P ALIGN=CENTER><B><U>Other Business Matters</U></B></P>
<P><B>Marketing and Major Customers</B></P>
<P>Domestically, we utilize independent specialty distributors and commissioned
sales agents who are focused on the chronic pain market to sell our stimulation
systems. Domestically, we have six distributor territories, which employ a total
of thirty-seven pain specialists who devote the majority of their selling
efforts to ANS products. In addition, we have seventeen sales agent territories
that employ thirty-three sales agents who are focused on the pain market and
depend upon ANS products as their flagship product line. We employ four regional
sales managers who personally interact with our customers and oversee the
distributors and sales agents. We also employ a Vice President of North American
Sales who coordinates the sales efforts of our distribution network in North
America.</P>
<P ALIGN=CENTER>Page 7</P>
<HR>
<P>Internationally, we sell ANS product to sixteen specialty pain distributors
who represent ANS in nineteen countries. Additionally, we employ one sales agent
and two direct sales representatives in two countries. All international
distribution reports to our Director of International Operations who is
headquartered in the United Kingdom.</P>
<P>The primary medical specialists we target in our marketing efforts are
anesthesiologists, neurosurgeons and orthopedic surgeons. Although neurosurgeons
were the first practitioners to use stimulation systems, anesthesiologists
(specializing in pain medicine) now account for a greater percentage of sales,
as the relative number of these practitioners has grown and as the understanding
and acceptance of stimulation treatment for chronic pain conditions has
increased. We derive 93 percent of net revenues from product sales of our
stimulation systems from domestic sales and approximately 7 percent from export
sales.</P>
<P>During 2000 and 1998, we had one major customer that accounted for 10 percent
or more of our net revenue from product sales. Sun Medical, Inc., a specialty
distributor of ANS products, accounted for $3.2 million, or 14 percent of our
net revenue from product sales for the year ended December 31, 2000 and $3.4
million, or 20 percent of our net revenue from product sales for the year ended
December 31, 1998. While we believe our relations with Sun Medical are good, the
loss of this customer could have a material adverse effect on our business,
financial condition and results of operations. During 1999, we had two major
customers that accounted for 10 percent or more of our net revenue from product
sales. Sun Medical, Inc. and Primesource Surgical, Inc., each a specialty
distributor of ANS products, accounted for $3.0 million and $2.3 million,
respectively, or 15 percent and 11 percent, respectively, of our net revenue
from product sales for the year ended December 31, 1999.</P>
<P><B>Research and Development</B></P>
<P>In 2000, we focused our research and development efforts on the continued
development of our enhanced radio-frequency stimulation systems and ongoing
research and development of new products for the neuromodulation market, such as
our Genesis IPG stimulation system for spinal cord stimulation, an implantable
pulse generator stimulation system for DBS and our proprietary AccuRx constant
rate infusion pump. We expended $3.56 million (15.4 percent of net revenue) on
our research and development activities in 2000, compared to $3.77 million (18.3
percent of net revenue from product sales) in 1999. We expect to increase our
investment in research and development and clinical trials during 2000 and
expect expenditures of approximately $5.0 million. These expenditures will be
directed toward next-generation infusion pumps, next-generation implantable
pulse generator stimulation systems for spinal cord stimulation, next generation
radio-frequency stimulation systems and our implantable pulse generator
stimulation system for DBS. These expenditures also include expenses for
clinical trials that we expect to initiate on several of our new products upon
approval from the FDA. The clinical trials are a necessary process to receive
approval from the FDA to begin marketing the products in the United States. As
of March 15, 2001, we had an in-house research and development staff of 38
personnel as compared to 29 in March 2000. The March 2001 total includes 12
development personnel employed by Hi-tronics Designs, Inc., which we acquired on
January 2, 2001.</P>
<P ALIGN=CENTER>Page 8</P>
<HR>
<P>We may seek strategic partners for DBS to replace our terminated agreement
with Sofamor Danek that could partially fund research and development
expenditures during 2001. In addition to DBS, we believe our implantable pulse
generator stimulation platform has market opportunities outside our focus of
chronic pain, including applications such as epilepsy, urinary incontinence,
angina, peripheral nerve stimulation and peripheral vascular disease. Any such
market expansion, however, would require PMA approvals from the FDA. We may also
seek strategic partners with established distribution systems to develop these
market opportunities outside the chronic pain market area, although there is no
assurance that we will be successful in negotiating and consummating agreements
with strategic partners.</P>
<P><B>Manufacturing</B></P>
<P>We manufacture and package our stimulation systems at our manufacturing
facility in Plano, Texas. This facility was re-certified to ISO 9001/EN 46001/
iso 13485 in January 2001. Hi-tronics Designs, Inc. is also ISO 9001 certified
and was re-certified in May 2000. See Item 1. "Business-Other Business
Matters-Government Regulations."</P>
<P>Our manufacturing processes consist of the assembly of standard and custom
component parts and the testing of completed products. We subcontract with
various suppliers to provide us with the quantity of component parts necessary
to assemble our products. Almost all of these components are available from a
number of different suppliers, although certain components are purchased from
single sources. For example, we currently rely on a single supplier for a
computer chip used in the receiver of our stimulation systems. The supplier of
this computer chip has indicated its desire to cease manufacturing and supplying
the computer chip in the future, but to date has not determined when this will
occur. The supplier has agreed to notify us once a date has been determined and
allow us to place a final one-time purchase order for the computer chip. In the
interim, we are maintaining a higher than normal inventory of the computer chip.
In addition, we are developing a new receiver design at Hi-tronics that does not
use any custom computer chips. A sudden disruption in supply from the computer
chip supplier or another single-source supplier could adversely affect our
ability to deliver finished products on time.</P>
<P>We devote significant attention to quality assurance. Our quality assurance
measures begin at the manufacturing level where components are assembled in a
“clean room” environment designed and maintained to reduce product
exposure to particulate matter. Products are tested throughout the manufacturing
process for adherence to specifications. Finished components are shipped to
outside processors for ethylene oxide gas sterilization.</P>
<P>Skills of assembly workers required for the manufacture of medical products
are similar to those required in typical assembly operations. We believe that
workers with these skills are readily available in the Dallas and New Jersey
geographical areas.</P>
<P><B>Competition</B></P>
<P>In marketing our stimulation systems, we compete with one other significant
supplier, Medtronic, Inc. Medtronic has substantially greater financial
resources and engages in substantially greater research and development and
marketing efforts. Medtronic holds a substantial majority share of the
stimulation market and sells both radio-frequency stimulation systems and
implantable pulse generator stimulation systems. Medtronic is the sole provider
of implantable pulse generators in the United States. Medtronic also holds the
substantial majority share of the market for fully implantable infusion pumps
and is the sole marketer worldwide of fully implantable programmable infusion
pumps.</P>
<P ALIGN=CENTER>Page 9</P>
<HR>
<P>We believe that the principal competitive factors in the neuromodulation
market are cost-effectiveness, impact on patient outcomes, product performance,
quality, ease of use, technical innovation and customer service. We intend to
continue to compete on the basis of our high-performance products, innovative
technologies, manufacturing capabilities, close customer relations and support,
and our strategy to increase our offerings of products within the
neuromodulation market.</P>
<P><B>Patents, Trademarks and Proprietary Information</B></P>
<P>We currently own twenty-two United States patents and three foreign patents.
In management’s view, these patents offer reasonable coverage of our
stimulation devices’ electrode, receiver, transmitter and programmer
technology, our advanced PainDoc computer system technology, and our fully
implantable infusion pump technology. These patents, in part, cover both
radio-frequency stimulation systems and implantable pulse generator stimulation
systems for a wide range of current and future applications. We currently have
seven pending U.S patent applications and four foreign patent applications.
Among other things, these pending patent applications cover new stimulation
lead technology, implant accessories, improved connector mechanisms and
implantable drug delivery technology.</P>
<P>Additionally, we are exclusively licensing a patent directed to advanced
placement techniques and a patent directed to methods to facilitate relieving
the effects of chronic pelvic pain such as interstitial cystitis.</P>
<P>The validity of any patents issued to us may be challenged by others and we
could encounter legal and financial difficulties in enforcing our patent rights
against infringers. In addition, there can be no assurance that other
technologies cannot or will not be developed or that patents will not be
obtained by others which would render our patents obsolete. The loss of any one
patent would not have a material adverse effect on our current revenue base.
Although we do not believe that patents are the sole determinant of the
commercial success of our products, the loss of a significant percentage of our
patents could have a material adverse effect on our business, financial
condition and results of operations.</P>
<P>We have developed technical knowledge which, although non-patentable, we
consider as significant in enabling us to compete. However, the proprietary
nature of such knowledge may be difficult to protect. We have entered into an
agreement with each key employee prohibiting such employee from disclosing any
confidential information or trade secrets of the Company and prohibiting that
employee from engaging in any competitive business while the employee is working
for the Company and for a period of one year thereafter. In addition, these
agreements also provide that any inventions or discoveries by these individuals
relating to the business of the Company will be assigned to the Company and
become the Company’s sole property.</P>
<P>Claims by competitors and other third parties that our products allegedly
infringe the patent rights of others could have a material adverse effect on the
Company. The interventional pain management market is characterized by extensive
patent and other intellectual property claims, which can create greater
potential than in less developed markets for possible allegations of
infringement, particularly with respect to newly developed technology.
Intellectual property litigation is complex and expensive and its outcome is
difficult to predict. Any future litigation, regardless of outcome, could result
in substantial expense to the Company and significant diversion of the efforts
of the Company’s technical and management personnel. An adverse
determination in any such proceeding could subject the Company to significant
liabilities to third parties, or require the Company to seek licenses from third
parties or pay royalties that may be substantial. Furthermore, there can be no
assurance that necessary licenses would be available to the Company on
satisfactory terms or at all. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses
could prevent the Company from manufacturing or selling certain of its products,
which could have a material adverse effect on the Company’s business,
financial condition and results of operations.</P>
<P ALIGN=CENTER>Page 10</P>
<HR>
<P>Renew®, Multistim®, Paindoc®, Octrode®, ANS® and Advanced
Neuromodulation Systems® are among our registered trademarks. Registration
applications are pending for various trademarks, which we believe, have value in
the marketplace, including Compustim™, Genesis™ and AccuRx™.</P>
<P><B>Government Regulation</B></P>
<P>The manufacture and sale of our products are subject to regulation by
numerous governmental authorities, principally the FDA and corresponding foreign
agencies. The research and development, manufacturing, promotion, marketing and
distribution of our products in the United States are governed by the Federal
Food, Drug and Cosmetic Act and the regulations promulgated thereunder (the
“FDC Act and Regulations”). We are subject to inspection by the FDA
for compliance with such regulations and procedures.</P>
<P>The FDA has traditionally pursued a rigorous enforcement program to ensure
that regulated entities such as the Company comply with the FDC Act and
Regulations. A company not in compliance may face a variety of regulatory
actions, including warning letters, product detentions, device alerts, mandatory
recalls or field corrections, product seizures, recession of marketing permits,
injunctive actions or civil penalties and criminal prosecutions of the Company
or responsible employees, officers and directors. Our Texas facility was last
inspected in the summer of 1996, and no major non-conformance was found. In
September 2000, the FDA inspected Hi-tronics' New Jersey facility, and no major
non-conformance was found.</P>
<P>Under the FDA’s requirements, a new medical device cannot be released
for commercial use until a pre-market approval application (a “PMA”)
has been filed with the FDA and the FDA has approved the device’s release.
If a manufacturer can establish that a newly developed device is
“substantially equivalent” to a legally marketed device, the
manufacturer may seek marketing clearance from the FDA to market the device by
filing a 510(k) premarket notification with the FDA, which usually takes less
time than a PMA. The process of obtaining FDA clearance can be lengthy,
expensive and uncertain. Both a 510(k) and a PMA, if granted, may include
significant limitations on the indicated uses for which a product may be
marketed. FDA enforcement policy strictly prohibits the promotion of approved
medical devices for unapproved uses. In addition, product approvals can be
withdrawn for failure to comply with regulatory requirements or the occurrence
of unforeseen problems following initial marketing. Although all of our
currently marketed products have been the subject of successful 510(k)
submissions, we believe that because the products we are currently developing
are more innovative, some of these products will require the PMA submission
process, which is lengthier and more costly than the 510(k) process.</P>
<P>We are also subject to regulation in each of the foreign countries in which
we sell our products with regard to product standards, packaging requirements,
labeling requirements, import restrictions, tariff regulations, duties and tax
requirements. Many of the regulations applicable to our products in such
countries are similar to those of the FDA. The national health or social
security organizations of certain countries require our products to be qualified
before they can be marketed in those countries. To date, we have not experienced
significant difficulty in complying with these regulations.</P>
<P>To position ourselves for access to European and other international markets,
we have maintained certification under the ISO 9000 Series of Standards. ISO
9000 is a set of integrated requirements, which when implemented, form the
foundation and framework for an effective quality management system. These
standards were developed and published by the ISO, a worldwide federation of
national standard bodies, founded in Geneva, Switzerland in 1946. ISO has over
92 member countries. ISO certification is essential to enter European Community
markets.</P>
<P ALIGN=CENTER>Page 11</P>
<HR>
<P>In January 2001, our quality system was re-certified to ISO 9001/EN 46001/ISO
13485 certification. The ISO 9001 registration is the most stringent standard in
the ISO series. The German notified body TUV Product Services issued the
re-certification certificates. The ISO 9001 standard covers design, production,
installation and servicing of products. EN 46001 and ISO 13485 cover the same
elements as the ISO 9001 standard; however, the focus is on quality systems for
medical device manufacturing. In addition, we are certified to the Active
Implantable Medical Device Directive allowing us to market devices throughout
the European Community. We are subject to an annual audit by the notified body
to maintain our registrations.</P>
<P>The financial arrangements through which we market, sell and distribute our
products may be subject to certain federal and state laws and regulations in the
United States with respect to the provision of services or products to patients
who are Medicare or Medicaid beneficiaries. The “fraud and abuse” laws
and regulations prohibit the knowing and willful offer, payment or receipt of
anything of value to induce the referral of Medicare or Medicaid patients for
services or goods. In addition, the physician anti-referral laws prohibit the
referral of Medicare or Medicaid patients for certain “Designated Health
Services” to entities in which the referring physician has an ownership or
compensation interest. Violations of these laws and regulations may result in
civil and criminal penalties, including substantial fines and imprisonment. In a
number of states, the scope of fraud and abuse or physician anti-referral laws
and regulations, or both, have been extended to include the provision of
services or products to all patients, regardless of the source of payment,
although there is variation from state to state as to the exact provisions of
such laws or regulations. In other states, and on a national level, several
health care reform initiatives have been proposed which would have a similar
impact. We believe that our operations and our marketing, sales and distribution
practices currently comply in all respects with all current fraud and abuse and
physician anti-referral laws and regulations, to the extent they are applicable.
Although we do not believe that we will need to undertake any significant
expense or modification to our operations or our marketing, sales and
distribution practices to comply with federal and state fraud and abuse and
physician anti-referral regulations currently in effect or proposed, financial
arrangements between manufacturers of medical devices and other health care
providers may be subject to increasing regulation in the future. Compliance with
such regulation could adversely affect our marketing, sales and distribution
practices, and may affect us in other respects not presently foreseeable, but
which could have an adverse impact on our business, financial condition and
results of operations.</P>
<P><B>Third-Party Reimbursement and Cost Containment</B></P>
<P>Our products are purchased primarily by hospitals and ambulatory surgery
centers, which then bill various third-party payors for the services provided to
the patients. These payors, which include Medicare, Medicaid, private insurance
companies, managed care and worker’s compensation organizations, reimburse
part or all of the costs and fees associated with the procedures performed with
these devices.</P>
<P>Medicare and Medicaid reimbursement for hospitals is based on a fixed amount
for admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique, and as a result hospitals are generally willing to
implement new cost-saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of further changes in the resource-based relative value scale method of
payment calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using our products or the eligibility (or the extent or amount of
coverage) of our products could have an adverse impact on our business,
financial condition and results of operations. Third-party payors are
increasingly challenging the prices charged for medical products and services
and may deny reimbursement if they determine that a device was not used in
accordance with cost-effective treatment methods as determined by the payor, was
experimental or was used for an unapproved application.</P>
<P ALIGN=CENTER>Page 12</P>
<HR>
<P>Our stimulation systems, while cost-effective compared to repeat back
surgeries, have encountered some resistance to third party reimbursement.
Although Medicare, Medicaid and many private insurers reimburse for the
stimulation systems and procedure, especially after repeat back surgeries have
failed to relieve chronic pain, some managed care and private payors
occasionally refuse to reimburse for stimulation systems or restrict
reimbursement. There can be no assurance that in the future, third-party payors
will continue to reimburse for our products, or that their reimbursement levels
will not adversely affect the profitability of our products. In addition, health
care costs have risen significantly over the past decade, and there have been
and will continue to be proposals by legislators and regulators to curb these
costs. Legislative action limiting reimbursement for certain procedures could
have a material adverse effect on our business, financial condition and results
of operations.</P>
<P>In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge. In
addition to legislative and regulatory initiatives, there has also been a
significant increase in the number of Americans enrolling in some form of
managed care plan. It has become a typical practice for hospitals to affiliate
themselves with as many managed care plans as possible. Higher managed care
penetration typically drives down the prices of health care procedures, which in
turn places pressure on medical supply prices. This causes hospitals to
implement tighter vendor selection and certification processes, by reducing the
number of vendors used, purchasing more products from fewer vendors and trading
discounts on price for guaranteed higher volumes to vendors. Hospitals have also
sought to control and reduce costs over the last decade by joining group
purchasing organizations or purchasing alliances. We cannot predict what
continuing or future impact existing or proposed legislation, regulation or such
third-party payor measures may have on our future business, financial condition
or results of operations.</P>
<P>Changes in reimbursement policies and practices of third-party payors could
have a substantial and material impact on sales of our products. The development
or increased use of more cost-effective treatments could cause such payors to
decrease or deny reimbursement to favor these other treatments.</P>
<P><B>Employees</B></P>
<P>As of March 15, 2001, we employed 198 full-time employees, 38 in research and
development, 27 in sales and marketing, 116 in manufacturing and related
operations, and the remainder in executive and administrative positions. This
total includes 93 full-time employees at Hi-tronics Designs, Inc., which we
acquired on January 2, 2001. None of our employees is represented by a labor
union and we consider our employee relations to be good.</P>
<P ALIGN=CENTER>Page 13</P>
<HR>
<P><B>Advisory Board</B></P>
<P>We have established the Advanced Neuromodulation Systems Advisory Board,
which is comprised of individuals with substantial expertise in neuromodulation
and pain management. Members of our management and scientific and technical
staff consult closely with members of the Advisory Board to identify specific
areas where techniques are changing and where existing products do not
adequately fulfill the needs of the pain physician. The Advisory Board helps
management evaluate new product ideas and concepts and once a product is
approved for development, its subsequent design and development. The Advisory
Board may also participate in the clinical testing of products developed.</P>
<P>Certain members of the Advisory Board are employed by academic institutions
and may have commitments to or consulting or advisory agreements with other
entities that may limit their availability to us. The members of the Advisory
Board may also serve as consultants to other medical device companies. No
members of the Advisory Board are expected to devote more than a small portion
of their time to the Company.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 2.</B></TD>
<TD WIDTH=85%><B>PROPERTIES</B></TD></TR></TABLE>
<P>In connection with the January 1998 sale of our cardiovascular products
division, we granted Atrion a nine-month option to acquire our principal office
and manufacturing facility in Allen, Texas for $6.5 million. Atrion exercised
the option to acquire the facility during October 1998 and the transaction
closed on February 1, 1999. We repaid the outstanding mortgage debt on the
facility of $3.6 million at closing and received net proceeds of $2.7 million
after paying expenses related to the transaction. See Note 9- “Sale of CVS
Operations/Discontinued Operations” of the Notes to Consolidated Financial
Statements. No material gain or loss was realized on the sale of the facility.
We leased space, furniture and equipment from Atrion until May 1999 at the
monthly rate of $48,125 and paid Atrion fifty percent of certain operating
expenses including utilities, janitorial services, landscaping services,
insurance and property taxes. At that time we moved our operations to a 40,000
square foot leased facility in Plano, Texas, a northeast suburb of Dallas.</P>
<P>We entered a sixty-three month lease agreement in February 1999 for the Plano
facility. Under the terms of the lease agreement, which became effective on June
1, 1999, we received three months of free rent and the monthly rental rate for
the remaining term of the lease is $48,308. The monthly rental rate includes
certain operating expenses such as property taxes on the facility, insurance,
landscape and maintenance and janitorial services. We also have a right of first
refusal to acquire the facility.</P>
<P>We also lease facilities in New Jersey as a result of our acquisition of
Hi-tronics Designs, Inc. on January 2, 2001. One of the facilities, located in
Budd Lake, New Jersey, is 8,800 square feet of office space that is used for
administration, design engineering, drafting, documentation and regulatory
affairs. The lease is on a month-to month basis at a monthly rental rate of
$10,891. We have agreed to provide the landlord with six months notice in the
event that we wish to relocate. We also lease 15,000 square feet of space in
Hackettstown, New Jersey used for our OEM manufacturing operations. The
Hackettstown lease, which expires on December 31, 2001, has a monthly rental
rate of $9,636 and is renewable for three additional one-year periods. In
addition, on January 1, 2001, Hi-tronics entered an agreement to lease an
additional 2,200 square feet of additional space in the Hackettstown facility
adjacent to the 15,000 square feet of manufacturing space. The lease expires on
June 30, 2002 and has a monthly rental rate of $2,269. All of the monthly rental
rates include certain operating expenses such as property taxes, insurance,
utilities, landscape and maintenance and janitorial services.</P>
<P ALIGN=CENTER>Page 14</P>
<HR>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 3.</B></TD>
<TD WIDTH=85%><B>LEGAL PROCEEDINGS</B></TD></TR></TABLE>
<P>We are a party to product liability claims related to ANS’ stimulation
systems. Product liability insurers have assumed responsibility for defending us
against these claims, subject to reservation of rights in certain cases. While
historically product liability claims for our stimulation systems have not
resulted in significant monetary liability beyond our insurance coverage, there
can be no assurances that we will not incur significant monetary liability to
the claimants if such insurance is unavailable or inadequate for any reason, or
that our current stimulation business and future neuromodulation products will
not be adversely affected by these product liability claims. While we seek to
maintain appropriate levels of product liability insurance with coverage that we
believe is comparable to that maintained by companies similar in size and
serving similar markets, there can be no assurance that we will avoid
significant future product liability claims relating to our stimulation systems.
</P>
<P>We are involved in a contractual dispute with a former customer of
Hi-tronics, Cyberonics, Inc. (“Cyberonics”), relating to the
development and manufacture of components for the Cyberonics NCP System.
Hi-tronics and Cyberonics agree that the contractual relationship has been
terminated, but the companies dispute who was first to terminate and the
ramifications of termination. Pursuant to the terms of the contract, the dispute
has been submitted for binding arbitration and is now pending before the
American Arbitration Association. We have asserted a claim for breach of
contract by Cyberonics and we seek as our remedy the contractual termination fee
of approximately $800,000 plus the payment of outstanding accounts receivable
and purchase of inventory related to the model 101 NCP stimulator. We also seek
a declaration of our rights that survive termination of the contract, such as
our access to intellectual property under the contract. The loss of our right to
maintain the existing intellectual property sublicenses could have an adverse
impact on our business.</P>
<P>In response, Cyberonics has asserted a counterclaim of breach against us and
is seeking monetary remedies in excess of the contractual provisions. We believe
we have valid claims against Cyberonics and valid defenses to their
counterclaims. We intend to vigorously prosecute our claims and to vigorously
contest Cyberonics’ claims in the arbitration.</P>
<P>In light of the preliminary state of the dispute and the inherent
uncertainties involved in the arbitration with Cyberonics, we are not able to
assess at this time the likelihood of a favorable or unfavorable outcome or
range of any possible gain or loss.</P>
<P>Except for the product liability claims and the arbitration with Cyberonics,
we are not currently a party to any other pending legal proceeding. We maintain
general liability insurance against risks arising out of the normal course of
business.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 4.</B></TD>
<TD WIDTH=85%><B>SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS</B></TD>
</TR></TABLE>
<P>Inapplicable.</P>
<P ALIGN=CENTER>Page 15</P>
<HR>
<P ALIGN=CENTER><B>PART II</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 5.</B></TD>
<TD WIDTH=85%><B>MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS</B></TD></TR></TABLE>
<P>Our common stock is currently quoted on the Nasdaq National Market under the
symbol "ANSI." On March 16, 2001, there were approximately 640 holders
of record of our common stock. The following table sets forth the quarterly high
and low closing sales prices for our common stock. These prices do not include
adjustments for retail mark-ups, markdowns or commissions.</P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%> </TD>
<TD WIDTH=30%><U>1999:</U></TD>
<TD WIDTH=15%><U> High </U></TD>
<TD WIDTH=15%><U> Low </U></TD>
<TD WIDTH=25%> </TD></TR>
<TR>
<TD> </TD>
<TD>First Quarter</TD>
<TD>$ 8.19</TD>
<TD>$ 6.19</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Second Quarter</TD>
<TD>$ 9.56</TD>
<TD>$ 6.50</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Third Quarter</TD>
<TD>$11.44</TD>
<TD>$ 7.69</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Fourth Quarter</TD>
<TD>$ 9.38</TD>
<TD>$ 7.00</TD>
<TD></TD></TR>
</TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%> </TD>
<TD WIDTH=30%><U>2000:</U></TD>
<TD WIDTH=15%><U> High </U></TD>
<TD WIDTH=15%><U> Low </U></TD>
<TD WIDTH=25%> </TD></TR>
<TR>
<TD> </TD>
<TD>First Quarter</TD>
<TD>$19.38</TD>
<TD>$ 9.94</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Second Quarter</TD>
<TD>$18.38</TD>
<TD>$12.25</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Third Quarter</TD>
<TD>$21.50</TD>
<TD>$14.25</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>Fourth Quarter</TD>
<TD>$23.19</TD>
<TD>$19.25</TD>
<TD></TD></TR>
</TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%> </TD>
<TD WIDTH=30%><U>2001:</U></TD>
<TD WIDTH=15%><U> High </U></TD>
<TD WIDTH=15%><U> Low </U></TD>
<TD WIDTH=25%> </TD></TR>
<TR>
<TD> </TD>
<TD>First Quarter</TD>
<TD>$26.88</TD>
<TD>$12.63</TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>(through March 16, 2001)</TD>
<TD></TD>
<TD></TD>
<TD></TD></TR>
</TABLE>
<P>To date, we have not declared or paid any cash dividends on our common stock
and the Board of Directors does not anticipate paying cash dividends on our
common stock in the foreseeable future.</P>
<P>On various occasions in 1998 and 1999, the Board of Directors approved stock
repurchases of up to an aggregate of 1,750,000 shares of our common stock.
During the year ended December 31, 1998, we repurchased 1,258,625 shares of our
common stock at an aggregate cost of $9,411,055, or an average of $7.48 per
share. During the year ended December 31, 1999, we repurchased 404,875 shares
of our common stock at an aggregate cost of $2,952,311, or an average of $7.29
per share. We made no repurchases during the year ended December 31, 2000. In
the aggregate, we purchased 1,663,500 shares under the authorized repurchase
programs. In November 2000 in connection with our signing an agreement to
acquire Hi-tronics designs, Inc., the Board of Directors rescinded the share
repurchase program under which 86,500 shares of common stock remained authorized
for repurchase. During the years ended December 31, 2000, 1999 and 1998, we
issued 267,425, 162,068 and 184,874 shares respectively, from the treasury upon
the exercise of stock options and a warrant.</P>
<P>At December 31, 2000, 1,049,133 shares remained in the treasury. We issued
119,100 of these treasury shares on January 2, 2001 in connection with our
acquisition of the assets of Implantable Devices Limited Partnership and ESOX
Technology Holdings, LLC. On January 2, 2001, we also issued the remaining
930,033 treasury shares (plus an additional 174,692 newly issued shares) in
connection with our acquisition of Hi-tronics Designs, Inc. Both issuances of
common stock were exempt under Rule 506 of Regulation D under the Securities
Act of 1933, as amended.</P>
<P ALIGN=CENTER>Page 16</P>
<HR>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 6.</B></TD>
<TD WIDTH=85%><B>SELECTED FINANCIAL DATA</B></TD></TR></TABLE>
<PRE>
--------------------------------------------------------------------------
Years Ended December 31,
--------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------- -------------- -------------- -------------- --------------
(in thousands, except per share data)
Statement of Operations Data:(1)
Net revenue-product sales $ 23,082 $ 20,578 $ 17,006 $ 14,718 $ 11,403
Total net revenue 23,082 29,478 20,106 14,718 11,403
Gross profit-product sales 15,593 13,949 12,021 9,878 8,088
Research and development
expense 3,562 3,773 2,801 977 1,316
Marketing, general and
administrative and
amortization expenses 10,922 10,235 8,486 6,815 6,257
Earnings from operations 1,109 8,842 3,833 2,086 515
Net earnings from continuing
operations 954 6,003 2,586 818 115
Loss from discontinued
operations -- -- (212) (93) (527)
Gain on the sale of assets of
discontinued operations -- -- 4,585 -- --
Net earnings (loss) from
discontinued operations -- -- 4,373 (93) (527)
Net earnings (loss) $ 954 $ 6,003 $ 6,959 $ 724 $ (412)
Diluted earnings (loss) per
share:
Continuing operations $ .11 $ .75 $ .30 $ .09 $ .01
Discontinued operations $ -- $ -- $ .51 $ (.01) $ (.06)
Net earnings (loss) $ .11 $ .75 $ .81 $ .08 $ (.05)
- --------------------------
(1) On January 30, 1998, the Company sold its cardiovascular and intravenous
fluid delivery product lines (CVS Operations). The CVS Operations have been
accounted for as discontinued operations. See Note 9 of the Notes to
Consolidated Financial Statements.
</PRE>
<PRE>
--------------------------------------------------------------------------
Years Ended December 31,
--------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------- -------------- -------------- -------------- --------------
(in thousands)
Balance Sheet Data:
Cash, cash equivalents,
certificates of deposit and
marketable securities $ 9,576 $ 8,752 $ 12,263 $ 2,204 $ 2,206
Working capital 19,088 16,178 16,426 14,128 11,088
Total assets 45,372 43,555 45,485 48,982 47,188
Short-term notes payable and
current maturities of
long-term notes payable -- -- 3,633 8,257 2,084
Notes payable, excluding
current maturities -- -- -- 3,635 11,912
Stockholders' equity $ 40,160 $ 37,038 $ 33,304 $ 33,906 $ 30,993
</PRE>
<P ALIGN=CENTER>Page 17</P>
<HR>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 7.</B></TD>
<TD WIDTH=85%><B>MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS</B></TD></TR></TABLE>
<P>The following discussion of the financial condition and results of operations
of the Company should be read in conjunction with the Consolidated Financial
Statements of the Company and the related Notes.</P>
<P><B>Overview</B></P>
<P>In June 1998, we completed an agreement under which we would develop and
manufacture products and systems for use in Deep Brain Stimulation ("DBS") for
Sofamor Danek. See Note 10 – "Product Development Agreement" of the Notes to
Consolidated Financial Statements. We received a payment of $4 million upon
execution of the agreement that was being recognized into income as revenue
based upon the estimated completion of the development project. During the year
ended December 31, 1998, we recognized $3.1 million into income as revenue. The
remaining $900,000 was recognized into income as revenue during January 1999 due
to the termination of the agreement with Sofamor Danek as a result of the merger
of Sofamor Danek and Medtronic, Inc. In connection with the termination, we also
received an additional payment of $8 million from Sofamor Danek, which was
recognized into income as revenue during January 1999.</P>
<P>The former agreement with Sofamor Danek fit with our strategy to strengthen
and broaden our neuromodulation technology platforms and to ally ourselves with
strategic partners who can help us leverage ANS' core technology into other
significant market segments beyond our focus on the chronic pain segment of the
neuromodulation market. We cannot assure you, however, that we will be
successful in negotiating and consummating research and development agreements
with other strategic partners.</P>
<P>Subsequent to the end of the fiscal year, on January 2, 2001, we completed
the acquisition of the assets of Implantable Devices Limited Partnership and
ESOX Technology Holdings, LLC and the acquisition by merger of Hi-tronics
Designs, Inc. See Note 11 of the Notes to Consolidated Financial Statements.
Because these acquisitions were completed subsequent to the 2000 fiscal year,
their results of operations and balance sheet data are not included in the
Company's 2000 financial information but will be reflected in the results of the
Company for the three months ended March 31, 2001.</P>
<P>Also subsequent to the end of the fiscal year, on February 26, 2001, the FDA
notified us that it had denied our petition to reclassify Totally Implanted
Spinal Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs
from a Class III device to a Class II device. The FDA’s denial was
surprising and disappointing principally because at a presubmission meeting with
the FDA, the agency itself had recommended that ANS submit a reclassification
petition instead of the Pre-Market Approval (PMA) process as a "least burdensome
path to market". An FDA Advisory Panel also recommended the reclassification and
the agency itself had supported the panel recommendation as late as September 6,
2000. We are currently requesting an appeal of the decision, while
simultaneously pursuing the PMA process to gain approval to market the IPG in
the United States. We are marketing the IPG product in Europe. Industry analysts
estimate that the IPG market for spinal cord stimulation to treat pain of the
trunk and/or limbs will approach $175 million in 2001, and that the market is
growing at a 25% to 30% annual rate. Currently in the United States, Medtronic,
Inc. is the sole provider of IPGs.</P>
<P ALIGN=CENTER>Page 18</P>
<HR>
<P><B>Results of Operations</B></P>
<P><I>Comparison of the Years Ended December 31, 2000 and 1999</I></P>
<P>We reported net earnings of $954,000 or $.11 per diluted share in 2000
compared to $6.00 million or $.75 per diluted share in 1999. Net earnings for
the 1999 period benefited from $8.9 million of revenue recorded in connection
with our former development agreement with Sofamor Danek.</P>
<P>Total net revenue of $23.08 million for the year ended December 31, 2000, was
$6.40 million below the comparable 1999 level of $29.48 million due to $8.9
million of net revenue in the 1999 period associated with our former development
agreement with Sofamor Danek. Excluding the development agreement revenue, net
revenue from ANS product sales increased 12.2 percent to $23.08 million during
2000 compared to $20.58 million in 1999. This increase in net revenue from
product sales was the result of higher unit sales volume, primarily in the
United States, of ANS' radio-frequency stimulation systems used to treat complex
pain patterns.</P>
<P>Because neuromodulation devices have gained acceptance as a viable,
efficacious and cost-effective treatment alternative for relieving chronic
intractable pain and improving neurological function, we are continuing our
efforts to expand our product offerings in the high-growth market of
neuromodulation. Today, ANS is a market share and technology leader in the $45
million radio-frequency stimulation segment of the neuromodulation market.
During 1999 and 2000, to position ourselves to participate in the other larger
and more rapidly growing segments of the neuromodulation market, we continued to
aggressively invest in development projects, including our IPG for spinal cord
stimulation, IPG for deep brain stimulation and a fully implantable
constant-rate infusion pump. We plan to continue these efforts in 2001.</P>
<P>Gross profit from product sales increased to $15.59 million in 2000 from
$13.95 million in 1999 due to the increase in net revenue from product sales
discussed above. Gross profit margin from product sales remained approximately
the same at 67.6 percent in the 2000 period compared to 67.8 percent in the 1999
period.<P>
<P>Total operating expenses (the aggregate of research and development,
marketing, amortization of intangibles and administrative expenses) increased to
$14.48 million in 2000 compared to $14.01 million in 1999, while as a percentage
of net revenue from product sales, decreased to 62.8 percent in 2000 from 68.1
percent in 1999.</P>
<P>Research and development expense decreased to $3.56 million in 2000, or 15.4
percent of 2000 net revenue from product sales, from $3.77 million during 1999,
or 18.3 percent of 1999 net revenue from product sales. This decrease in the
absolute dollar amount in 2000 compared to1999 was the result of lower
consulting expense. During 2000, these expenditures were directed toward
development of our IPG stimulation system for spinal cord stimulation, our next
generation radio-frequency stimulation systems, our proprietary fully
implantable constant-rate infusion pump and an IPG stimulation system for Deep
Brain Stimulation.</P>
<P>We received CE mark approval for our IPG stimulation system and began our
market launch into the European markets in the first quarter of 2001. We also
received CE mark approval on our proprietary fully implantable constant-rate
infusion pump and expect to launch it in the European market during the second
quarter of 2001. In the United States, we have received the necessary clearance
from the FDA to initiate clinical trials for our fully implantable constant-rate
infusion pump and initiated the trials during the first quarter of 2001. We are
currently preparing our PMA submission for the FDA following the February 26,
2001 denial of our petition for reclassification of this IPG.</P>
<P ALIGN=CENTER>Page 19</P>
<HR>
<P>Marketing expense, as a percentage of net revenue from product sales,
decreased from 30.6 percent in 1999 to 29.7 percent in 2000, while the absolute
dollar amount increased from $6.29 million during 1999 to $6.85 million in 2000.
This dollar increase during 2000 was attributable to higher commission expense
from increased product sales and a change from distributors to commissioned
sales agents in certain United States territories, higher expense for education
and training of new implanters and higher convention expense.</P>
<P>General and administrative expense increased to $2.84 million during 2000
from $2.76 million in 1999 while as a percentage of net revenue from product
sales, decreased to 12.3 percent in 2000 from 13.4 percent during 1999. The
increase of $81,000 in absolute dollar expense during 2000 was principally the
result of higher property tax and investor relation expenses.</P>
<P>Amortization of ANS intangibles increased slightly to $1.23 million in 2000
from $1.19 million during 1999 due to expense for additional patents we have
licensed.</P>
<P>Other income decreased to $579,000 in 2000 compared to $706,000 in 1999
primarily as a result of a lower interest income due to lower funds available
for investment.</P>
<P>Income tax expense from continuing operations decreased to $734,000 in 2000
from $3.55 million in 1999 due to lower earnings from ANS operations as the 1999
period included the $8.0 million termination payment from our former development
agreement with Sofamor Danek. This represents effective tax rates of 43.5
percent in 2000 and 37.1 percent in 1999. Our expense for amortization of costs
in excess of net assets acquired (goodwill) is not deductible for tax purposes,
and, when combined with a provision for state taxes, results in the higher
effective tax rate during both 2000 and 1999 compared to the U.S. statutory rate
for corporations of 34 percent.</P>
<P><I>Comparison of the Years Ended December 31, 1999 and 1998</I></P>
<P>We reported net earnings of $6 million or $.75 per diluted share in 1999
compared to $6.96 million or $.81 per diluted share in 1998. The 1998 results
included net earnings of $4.4 million from the discontinued CVS Operations or
$.51 per diluted share primarily due to an after-tax gain of $4.6 million on the
sale of the discontinued operations. Net earnings from continuing operations
increased to $6 million or $.75 per diluted share in 1999 compared to $2.59
million or $.30 per diluted share in 1998. Net earnings from continuing
operations in 1999 and 1998 benefited from $8.9 million and $3.1 million,
respectively, of revenue recorded in connection with our former development
agreement with Sofamor Danek.</P>
<P>Total net revenue from continuing ANS operations of $29.48 million for the
year ended December 31, 1999, was $9.37 million, or 46.6 percent, above the
comparable 1998 level of $20.11 million. The 1999 period included $8.9 million
of net revenue and the 1998 period included $3.1 million of net revenue
associated with our former development agreement with Sofamor Danek. Net revenue
from ANS product sales increased 21 percent to $20.58 million during 1999
compared to $17.01 million in 1998. This increase in net revenue from product
sales was the result of higher unit sales volume of ANS' radio-frequency
stimulation systems used to treat complex pain patterns. All of the $3.57
million increase in 1999 was the result of higher sales in the United States.
During June 1999, we launched our enhanced radio-frequency stimulation system,
the Renew® System, in the United States.</P>
<P>Gross profit from product sales increased to $13.95 million in 1999 from
$12.02 million in 1998 due to the increase in net revenue from product sales
discussed above. Gross profit margin from product sales decreased to 67.8
percent in 1999 compared to 70.7 percent in 1998 due to (1) approximately
$350,000 of additional costs we incurred from product transition and unexpected
lower manufacturing yields related to the Renew System during the third quarter
of 1999, (2) higher component costs for the Renew System, and (3) production
downtime associated with our move to our new leased facility in May 1999.</P>
<P ALIGN=CENTER>Page 20</P>
<HR>
<P>Total operating expenses (the aggregate of research and development,
marketing, amortization of intangibles and administrative expenses) increased to
$14.01 million in 1999 compared to $11.29 million in 1998 and as a percentage of
net revenue from product sales increased to 68.1 percent in 1999 from 66.4
percent in 1998.</P>
<P>Research and development expense increased to $3.77 million in 1999, or 18.3
percent of 1999 net revenue from product sales, from $2.80 million during 1998,
or 16.5 percent of 1998 net revenue from product sales, reflecting our
stepped-up commitment to develop products that will expand our presence into
other rapidly growing segments of the neuromodulation market. This increase
during 1999 compared to 1998 was the result of higher salary and benefit expense
from staffing additions, increased consulting expense, and higher test material
expense. These expenditures during 1999 were directed toward development of our
Renew System, which we launched in the United States during June 1999, a
fully implantable constant–rate infusion pump, an IPG stimulation system
for spinal cord stimulation and an IPG stimulation system for Deep Brain
Stimulation.</P>
<P>Marketing expense, as a percentage of net revenue from product sales,
increased to 30.6 percent in 1999 from 27.5 percent in 1998, and the absolute
dollar amount increased from $4.68 million during 1998 to $6.29 million in 1999.
This dollar increase during 1999 was attributable to higher commission expense
from increased product sales and a change from distributors to commissioned
sales agents in certain United States territories, higher salary and benefit
expense from staffing additions, higher expense for education and training of
new implanters and expense related to the launch of our Renew System.</P>
<P>General and administrative expense increased from $2.63 million during 1998
to $2.76 million in 1999 while as a percentage of net revenue from product
sales, decreased to 13.4 percent in 1999 from 15.5 percent during 1998. The
increase of $124,000 in absolute dollar expense during 1999 was principally the
result of higher salary and benefit expense from staffing additions, higher
expense related to investor relations and higher patent legal expense.</P>
<P>Amortization of ANS intangibles increased from $1.17 million in 1998 to $1.19
million during 1999 due to expense for additional patents we have licensed.</P>
<P>Other income increased to $706,000 in 1999 compared to $499,000 in 1998
primarily as a result of a $287,000 reduction in interest expense due to the
repayment of our mortgage debt in February 1999 when we sold our facility to
Atrion Corporation.</P>
<P>Income tax expense from continuing operations increased to $3.55 million in
1999 from $1.75 million in 1998 due to higher earnings from ANS operations. This
represents effective tax rates of 37.1 percent in 1999 and 40.3 percent in 1998.
Our expense for amortization of costs in excess of net assets acquired
(goodwill) was not deductible for tax purposes, and, when combined with a
provision for state taxes, resulted in the higher effective tax rate during both
1999 and 1998 compared to the U.S. statutory rate for corporations of 34
percent.</P>
<P><B>Liquidity and Capital Resources</B></P>
<P>At December 31, 2000 our working capital increased to $19.09 million from
$16.18 million at year-end 1999. The ratio of current assets to current
liabilities was 7.56:1 at December 31, 2000, compared to 4.86:1 at December 31,
1999. Cash, cash equivalents, certificates of deposit and marketable securities
totaled $9.58 million at December 31, 2000 compared to $8.75 million at December
31, 1999.</P>
<P ALIGN=CENTER>Page 21</P>
<HR>
<P>In 1998 and 1999, the Board of Directors authorized stock repurchases of up
to 1,750,000 shares. During 1998 and 1999, we repurchased 1,663,500 shares under
the authorized repurchase programs at an aggregate cost of $12.36 million. We
made no repurchases during 2000. In November 2000, in connection with signing
the agreement to acquire Hi-tronics Designs, Inc. in a stock-for-stock merger,
the Board of Directors rescinded the share repurchase program under which 86,500
shares of common stock remained authorized for repurchase. During the three
years ended December 31, 2000, we issued 267,425; 162,068 and 184,874 shares
respectively, from our treasury upon the exercise of stock options and a
warrant. At December 31, 2000, 1,049,133 shares remained in the treasury. On
January 2, 2001, we issued 119,100 shares from the treasury for the purchase of
the assets of ESOX Corporation and issued the remaining 930,033 shares from the
treasury as part of the 1,104,725 shares we issued to acquire Hi-tronics
Designs, Inc.</P>
<P>We decreased our investment in inventories to $5.65 million at December 31,
2000, from $6 million at December 31, 1999. We estimate that our investment
in inventory will also decrease by year-end 2001 by approximately $500,000 to a
level of $5.15 million.</P>
<P>We spent $1.24 million during 2000 for capital expenditures and license fees
for additional patents and intellectual property we are licensing. Of such
expenditures, approximately $805,000 was spent for manufacturing tooling and
equipment primarily for the new products we developed including our IPG system
for spinal cord stimulation and our fully implantable constant-rate infusion
pump. We also spent $435,000 during 2000 to license additional patents and
intellectual property.</P>
<P>We believe our current cash, cash equivalents, certificates of deposit and
marketable securities and cash generated from operations will be sufficient to
fund all of our operating needs and capital expenditures for the foreseeable
future.</P>
<P><B>Cash Flows</B></P>
<P>Net cash provided by continuing operations was $1.92 million in 2000, $2.22
million in 1999 and $6.93 million in 1998. This decrease of approximately
$300,000 in 2000 compared to 1999 related to the decrease in net earnings from
$6 million in 1999 to $954,000 in 2000 due to including the $8 million
termination payment from our former development agreement with Sofamor Danek in
the 1999 results. In 2000, we used $2.05 million of cash to increase our
investment in assets such as accounts receivable and prepaid expenses and to
reduce our accounts payable and income taxes payable. Although net earnings from
continuing operations increased to $6 million in 1999 from $2.59 million in
1998, net cash provided from continuing operations decreased by $4.71 million
primarily due to changes in components of working capital. During 1999, we used
cash to increase our investment in assets such as inventories, account
receivable and prepaid expenses and other assets and to reduce our income taxes
payable.</P>
<P>Net cash used in investing activities was $2.67 million in 2000 while
investing activities provided cash of $447,000 in 1999 and $20.81 million in
1998. During 2000, we used $1.24 million for capital expenditures related to
additional manufacturing tooling and equipment for new products we developed and
licensing fees for patents. We also used in the 2000 period a net of $1.44
million for the purchase of investments in certificates of deposit with
maturities over 90 days and investment-grade municipal bonds with maturities
less than one year from the date we purchased them. The 1999 period reflects
$6.35 million of net proceeds we received when we sold our facility to Atrion
Corporation. We utilized $5.91 million in 1999 for capital expenditures for
leasehold improvements, furnishings and equipment for our new leased facility,
manufacturing tooling and equipment for our Renew System and new products we are
developing, and licensing fees for patents. The 1998 period reflects net
proceeds of $21.8 million from the sale of discontinued operations. We utilized
$1.68 million in 1998 for capital expenditures, primarily for manufacturing
tooling and equipment for the new products we are developing, and license fees
for patents we licensed.</P>
<P ALIGN=CENTER>Page 22</P>
<HR>
<P>Net cash used in financing activities was $94,600 in 2000, $6.01 million in
1999 and $16.85 million in 1998. During 2000, we received net cash of $1.41
million from the exercise of stock options and a warrant, while $1.50 million
was used for a loan to a third party. During 1999, we received net cash of
$573,000 from the exercise of stock options while $2.95 million was used for
share repurchases and $3.63 million was used for the repayment of our mortgage
debt. During 1998, we received net cash of $818,000 from the exercise of stock
options while $9.41 million was used for share repurchases and $8.26 million was
used to reduce debt.</P>
<P><B>Outlook and Uncertainties</B></P>
<P><I>The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: The matters discussed in this Annual Report on
Form 10-K contain statements that constitute forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
The words "expect," "estimate," "anticipate," "predict," "believe," "plan,"
"will," "should," "intend" and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this Annual Report on Form 10-K and include statements
regarding our intent, belief or current expectations with respect to, among
other things: (i) trends affecting our financial condition or results of
operations; (ii) our financing plans; and (iii) our business growth strategies.
We caution our readers that any forward-looking statements are not guarantees of
future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in the forward-looking statements as a
result of various factors. These risks and uncertainties include the
following:</I></P>
<P><I>Product Development and Market Acceptance.</I> Our growth depends in part
on our ability to develop and gain market acceptance of new products, including
next-generation ANS products. We cannot assure you that we will continue to
develop successful products, that we will not experience delays in product
introduction, or that once such products are introduced, the market will accept
them.</P>
<P><I>Government Regulation.</I> Our business is subject to extensive government
regulation, principally by the FDA. The regulatory process, especially as it
relates to product approvals, can be lengthy, expensive and uncertain and may
involve the satisfactory completion of clinical trials and market tests prior to
the introduction of new products. Failure to obtain government approval of our
products on a timely and cost-efficient basis, including the approval of our IPG
stimulation system for spinal cord stimulation, could have a material adverse
effect on our business, financial condition and results of operations. See Item
1-"Business-Government Regulation".</P>
<P><I>Component Supply.</I> We depend on various suppliers for certain
components used to manufacture our products, and our business depends in part on
the adequacy, acceptability and timeliness of component supply. In addition, we
rely on a single supplier for the computer chip used in the receiver of our
stimulation systems. The supplier of this computer chip has indicated its desire
to cease manufacturing and supplying the computer chip in the future, but to
date has not determined when this will occur. The supplier has agreed to notify
us when a date has been determined and allow us to place a final one-time
purchase order for the computer chip. In the interim, we are maintaining a
higher than normal inventory of the computer chip and are developing a new
receiver design that does not use a custom computer chip. A sudden disruption in
supply from the computer chip supplier or another single-source supplier could
adversely affect our ability to deliver finished products on time.</P>
<P ALIGN=CENTER>Page 23</P>
<HR>
<P><I>Competition and Technological Change.</I> The medical device market is
highly competitive. We compete with larger companies that have access to greater
capital, research and development, marketing, distribution and other resources
than we do. In addition, our market is characterized by extensive research
efforts and rapid product development and technological change, which could
render our products obsolete or noncompetitive. One large supplier, Medtronic,
Inc, dominates the market for electrical stimulation systems and fully
implantable infusion pumps.</P>
<P><I>Intellectual Property Rights.</I> We rely in part on patents, trade
secrets and proprietary technology to remain competitive. It may be necessary to
defend these rights or to defend against claims that we are infringing on the
rights of others. Intellectual property litigation and controversies are
disruptive and expensive.</P>
<P><I>Cost Pressures on Medical Technology.</I> The overall escalating cost of
medical products and healthcare results in significant cost pressure.
Third-party payors, such as insurance companies and HMO's, are under intense
pressure to challenge the prices charged for medical products and services. We
rely heavily on Medicare and Medicaid reimbursement. Any amendments to existing
reimbursement rules and regulations that restrict or terminate the reimbursement
eligibility (or the extent or amount of coverage) of medical procedures using
our products or the eligibility (or the extent or amount of coverage) of our
products could adversely impact our business, financial condition and results of
operations.</P>
<P><I>Potential Product Liability.</I> The testing, manufacturing, marketing and
sale of medical devices entail substantial risks of liability claims or product
recalls.</P>
<P><I>Reliance on Major Customer/Distributor.</I> During 2000, we had one major
customer that accounted for 10 percent or more of our net revenue. Sun Medical,
Inc., a specialty distributor of ANS products, accounted for $3.2 million, or 14
percent of ANS' net revenue from product sales for the year ended December 31,
2000. While we believe our relations with Sun Medical are good, the loss of this
customer could have a material adverse effect on our business, financial
condition and results of operations.</P>
<P><I>Year 2000 Compliance.</I> Although our Year 2000 readiness efforts were
successful and we have not experienced any Year 2000 issues to date, we cannot
assure you that Year 2000 issues will not occur at a later date that would have
a material adverse impact on our results of operations, financial condition and
cash flows.</P>
<P><I>Other Uncertainties.</I> We discuss other operating, financial or legal
risks or uncertainties in this Form 10-K in specific contexts and in the
Company's other periodic SEC filings. The Company is, of course, also subject to
general economic risks, the risk of interruption in the source of supply,
dependence on key personnel and other risks and uncertainties.</P>
<P><B>Currency Fluctuations</B></P>
<P>Substantially all of our international sales are denominated in U.S. dollars.
Fluctuations in currency exchange rates in other countries could reduce the
demand for our products by increasing the price of our products in the currency
of the countries in which the products are sold, although we do not believe
currency fluctuations have had a material effect on the Company's results of
operations to date.</P>
<P ALIGN=CENTER>Page 24</p>
<HR>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 7A.</B></TD>
<TD WIDTH=85%><B>QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK</B>
</TD></TR></TABLE>
<P>We do not use derivative financial instruments to manage the impact of
interest rate changes on our investments or debt instruments.</P>
<P>We invest our cash reserves in high quality short-term liquid money market
instruments with major financial institutions and in certificates of deposit. At
December 31, 2000, we had $5,790,323 invested in money market funds, $1,069,575
in certificates of deposit with maturities less than 90 days from the purchase
date and $1,040,000 in certificates of deposit with maturity dates of greater
than 90 days from the purchase date. The rate of interest earned on these
investments will vary with overall market rates. A hypothetical 100-basis point
change in the interest rate earned on these investments would not have a
material effect on our income or cash flows.</P>
<P>We also have certain investments in available-for-sale securities. These
investments primarily consist of investment grade municipal bonds with
maturities less than one year from the date of purchase, a real estate
investment trust traded on the New York Stock Exchange and an investment grade
corporate preferred security also traded on the New York Stock Exchange. The
cost of these investments is $1,156,442 and the fair value at December 31, 2000
was $1,030,318. The investments are subject to overall stock market and interest
rate risk. A hypothetical 20 percent decrease in the value of these investments
from the prices at December 31, 2000 would decrease the fair value by
$206,064.</P>
<P>At December 31, 2000, we had no debt instruments.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 8.</B></TD>
<TD WIDTH=85%><B>FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA</B></TD></TR>
</TABLE>
<P>The information required by this item is set forth in Appendices A, B and C.
</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 9.</B></TD>
<TD WIDTH=85%><B>CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE</B></TD></TR></TABLE>
<P>None.</P>
<P ALIGN=CENTER><B>PART III</B></P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15%><B>ITEM 10.</B></TD>
<TD WIDTH=85%><B>DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT</B></TD>
</TR></TABLE>
<P>The information required by this item is contained under the captions
"Election of Directors" and "Executive Officers" in our definitive proxy
material which will be filed in connection with our 2001 annual meeting of
stockholders, which information is incorporated herein by reference.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 11.</B></TD>
<TD WIDTH=85%><B>EXECUTIVE COMPENSATION</B></TD></TR></TABLE>
<P>The information required by this item is contained under the captions
"Compensation and Committees of the Board of Directors" and "Compensation of
Executive Officers" in our definitive proxy material which will be filed in
connection with our 2001 annual meeting of stockholders, which information is
incorporated herein by reference. Information in the section entitled
"Compensation Committee Report" and in the subsection entitled " Performance
Graph" are not incorporated herein by reference.</P>
<P ALIGN=CENTER>Page 25</P>
<HR>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 12.</B></TD>
<TD WIDTH=85%><B>SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
</B></TD></TR></TABLE>
<P>The information required by this item is contained under the caption
"Security Ownership of Management and Principal Shareholders" in our definitive
proxy material which will be filed in connection with our 2001 annual meeting of
stockholders, which information is incorporated herein by reference.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 13.</B></TD>
<TD WIDTH=85%><B>CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS OWNERS AND
MANAGEMENT</B></TD></TR></TABLE>
<P>Inapplicable.</P>
<P ALIGN=CENTER><B>PART IV</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=15% VALIGN=TOP><B>ITEM 14.</B></TD>
<TD WIDTH=85%><B>EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K</B></TD></TR></TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%>(a)</TD>
<TD WIDTH=90%>Documents filed as part of this report.</TD></TR></TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%> </TD>
<TD WIDTH=10%>1.</TD>
<TD WIDTH=90%>Financial Statements:<BR>See Index to Financial Statements on the
second page of Appendix A.</TD></TR>
<TR>
<TD> </TD>
<TD></TD>
<TD></TD></TR>
<TR>
<TD> </TD>
<TD>2.</TD>
<TD>Financial Statement Schedules:*<BR>Schedule II - Valuation and Qualifying
Accounts.<BR>See Appendix B.</TD></TR>
</TABLE>
<P></P>
<P>*Those schedules not listed above are omitted as not applicable or not
required.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%> </TD>
<TD WIDTH=10%>3.</TD>
<TD WIDTH=90%>Exhibits: See (c) below.</TD></TR></TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%>(b)</TD>
<TD WIDTH=90%>Reports on Form 8-K.</TD></TR></TABLE>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%> </TD>
<TD WIDTH=90%>The Company filed a report on Form 8-K on December 1, 2000 to
report the definitive agreement on November 30, 2000 to acquire Hi-tronics
Designs, Inc.<BR><BR>The Company filed a report on Form 8-K on January 9, 2001,
to report the consummation of the acquisition of Hi-tronics Designs, Inc. on
January 2, 2001.<BR><BR>The Company filed a report on Form 8-K on January 18,
2001 reporting certain information under Regulation FD Disclosure which the
Company intended to disclose in a series of analyst/investor conferences
commencing on January 18, 2001.</TD></TR>
</TABLE>
<P ALIGN=CENTER>Page 26</P>
<HR>
<P></P><TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10%>(c)</TD>
<TD WIDTH=90%>Exhibits:</TD></TR>
</TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>
<TD WIDTH=5%></TD>
<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>
</TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>
<TD WIDTH=5%> </TD>
<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by
and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and
Hi-tronics Designs, Inc.(10)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>
<TD></TD>
<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>
<TD></TD>
<TD>Bylaws(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>
<TD></TD>
<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.
and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option
Plan(2)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.2 </TD>
<TD></TD>
<TD>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>
<TD></TD>
<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>
<TD></TD>
<TD>Form of Directors Stock Option Agreement(1)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.5 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1987 Stock Option Plan(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>
<TD></TD>
<TD>Form of 1987 Employee Stock Option Agreement(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1995 Stock Option Plan(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>
<TD></TD>
<TD>Form of 1995 Employee Stock Option Agreement(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1998 Stock Option Plan(7)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>
<TD></TD>
<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between Christopher G. Chavez and
Quest Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest
Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill III and
Quest Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>
<TD></TD>
<TD>Form of Employment Agreement and Covenant Not to Compete, between the
Company and key employees(1)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>
<TD></TD>
<TD>Lease Agreement dated as of February 4, 1999, between Advanced
Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>11.1 </TD>
<TD></TD>
<TD>Computation of Earnings Per Share(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>
<TD></TD>
<TD>Subsidiaries(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>
<TD></TD>
<TD>Consent of Independent Auditors(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>27.1 </TD>
<TD></TD>
<TD>Financial Data Schedule - December 31, 2000(11)</TD></TR>
</TABLE>
<P>__________________________________</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5% VALIGN=TOP>(1) </TD>
<TD WIDTH=2%></TD>
<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on
Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.
</TD></TR>
<TR>
<TD>(2) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year
ended December 31, 1987, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(3) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration No. 2-78186, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(4) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,
Registration No. 33-62991, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(5) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September
3, 1996, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(6) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the
quarterly period ended March 31, 1998, and incorporated herein by reference.
</TD></TR>
<TR>
<TD>(7) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated
April 27, 1998, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(8) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the
year ended December 31, 1998, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(9) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated
April 17, 2000, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(10)</TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January
9, 2001, and incorporated herein by reference. Upon request, the Company will
furnish a copy of any omitted schedule to the Commission.</TD></TR>
<TR>
<TD>(11)</TD>
<TD></TD>
<TD>Filed herewith.</TD></TR>
</TABLE>
<P ALIGN=CENTER>Page 27</P>
<HR>
<P ALIGN=CENTER><U><B>Signatures</B></U></P>
<P>Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.</P>
<P>Date: March 29, 2001</P>
<P>ADVANCED NEUROMODULATION SYSTEMS, INC.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=40%></TD>
<TD WIDTH=5%>By:</TD>
<TD WIDTH=55%><U>/s/Christopher G. Chavez</U></TD></TR>
<TR>
<TD></TD>
<TD></TD>
<TD>Christopher G. Chavez</TD></TR>
<TR>
<TD></TD>
<TD></TD>
<TD>President and Chief Executive Officer</TD></TR></TABLE>
<P></P>
<P>Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Company and in
the capacities and on the dates indicated:</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=25% ALIGN=CENTER><U>Signature</U></TD>
<TD WIDTH=5%></TD>
<TD WIDTH=45% ALIGN=CENTER><U>Title</U></TD>
<TD WIDTH=5%></TD>
<TD WIDTH=20% ALIGN=CENTER><U>Date</U></TD></TR>
<TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Christopher G. Chavez</U><BR>Christopher G.
Chavez</TD>
<TD></TD>
<TD ALIGN=LEFT>Chief Executive Officer, President and Director of Advanced
Neuromodulation Systems, Inc. (Principal Executive Officer)</TD>
<TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/F. Robert Merrill III</U><BR>F. Robert Merrill
III</TD><TD></TD>
<TD ALIGN=LEFT>Executive Vice President-Finance, Treasurer and Secretary of
Advanced Neuromodulation Systems, Inc. (Principal Financial and Accounting
Officer)</TD>
<TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Hugh M. Morrison</U><BR>Hugh M. Morrison</TD>
<TD></TD>
<TD ALIGN=LEFT>Chairman of the Board and Director of Advanced Neuromodulation
Systems, Inc.</TD>
<TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Robert C. Eberhart</U><BR>Robert C. Eberhart
</TD><TD></TD>
<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.
</TD><TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Joseph E. Laptewicz</U><BR>Joseph E. Laptewicz
</TD><TD></TD>
<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.
</TD><TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/A. Ronald Lerner</U><BR>A. Ronald Lerner
</TD><TD></TD>
<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.
</TD><TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Richard D. Nikolaev</U><BR>Richard D. Nikolaev
</TD><TD></TD>
<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.
</TD><TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR><TR>
<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>
<TD ALIGN=LEFT VALIGN=TOP><U>/s/Michael J. Torma</U><BR>Michael J. Torma
</TD><TD></TD>
<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.
</TD><TD></TD>
<TD ALIGN=CENTER VALIGN=TOP>March 29, 2001</TD></TR>
</TABLE>
<P ALIGN=CENTER>Page 28</P>
<HR>
<P ALIGN=RIGHT><B><U>Appendix A</U></B></P>
<P></P><P></P>
<P ALIGN=CENTER><B>Consolidated Financial Statements<BR>Independent
Auditors’ Report<BR><BR>Three Years Ended December 31, 2000<BR><BR>
Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>Item 8<BR><BR><BR>
of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of issuer)<BR><BR><BR>
<BR>Filed with the<BR><BR>Securities and Exchange Commission<BR><BR>Washington,
D.C. 20549<BR><BR><BR>under<BR><BR>The Securities and Exchange Act of 1934</B>
</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
<BR>Table of Contents<BR>to<BR>Consolidated Financial Statements<BR><BR>
Form 10-K - Item 8</B></P>
<P></P><P></P><P></P><P></P>
<P><B>Independent Auditors’ Report</B></P>
<P></P><P></P>
<P><B>Consolidated Financial Statements:</B></P>
<P>Consolidated Balance Sheets - December 31, 2000 and 1999<BR> Consolidated
Statements of Operations - Years ended December 31, 2000, 1999 and 1998<BR>
Consolidated Statements of Stockholders' Equity - Years ended December 31, 2000,
1999 and 1998<BR> Consolidated Statements of Cash Flows - Years ended December
31, 2000, 1999 and 1998<BR> Notes to Consolidated Financial Statements</P>
<HR>
<P ALIGN=CENTER>Report of Independent Auditors</P>
<P>The Board of Directors<BR>Advanced Neuromodulation Systems, Inc.</P>
<P>We have audited the accompanying consolidated balance sheets of Advanced
Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31,
2000 and 1999, and the related consolidated statements of operations,
stockholders’ equity and cash flows for each of the three years in the
period ended December 31, 2000. Our audits also included the financial statement
schedule listed in the Index at Item 14A. These consolidated financial
statements and schedule are the responsibility of the Company’s management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.</P>
<P>We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.</P>
<P>In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Advanced
Neuromodulation Systems, Inc. and subsidiaries at December 31, 2000 and 1999,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.</P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=40%> </TD>
<TD WIDTH=60%><U>/s/Ernst and Young LLP</U><BR>Ernst and Young LLP</TD></TR>
</TABLE>
<P></P>
<P></P>
<P>Dallas, Texas<BR>March 2, 2001</P>
<HR>
<P></P>
<PRE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2000 and 1999
Assets 2000 1999
------ ------------ ------------
Current assets:
Cash and cash equivalents $ 7,505,578 $ 8,353,658
Certificates of deposit with maturities over
90 days at purchase 1,040,000 --
Marketable securities 1,030,318 398,208
Receivables:
Trade accounts, less allowance for doubtful
accounts of $130,255 in 2000 and $140,824 in 1999 3,850,605 3,785,719
Note receivable-current portion 100,000 --
Interest and other 282,567 70,965
------------ ------------
Total receivables 4,233,172 3,856,684
------------ ------------
Inventories:
Raw materials 2,187,500 3,014,908
Work-in-process 880,097 626,402
Finished goods 2,580,193 2,357,907
------------ ------------
Total inventories 5,647,790 5,999,217
------------ ------------
Deferred income taxes 546,671 654,086
Refundable income taxes 359,953 --
Prepaid expenses and other current assets 1,634,677 1,107,380
------------ ------------
Total current assets 21,998,159 20,369,233
------------ ------------
Equipment and fixtures:
Furniture and fixtures 3,185,477 3,240,322
Machinery and equipment 4,203,401 3,599,338
Leasehold improvements 716,189 711,271
------------ ------------
8,105,067 7,550,931
Less accumulated depreciation and amortization 2,830,420 1,862,361
------------ ------------
Net equipment and fixtures 5,274,647 5,688,570
------------ ------------
Note receivable, excluding current portion 1,400,000 --
Cost in excess of net assets acquired, net of accumulated
amortization of $2,847,824 in 2000 and $2,291,220 in 1999 7,963,840 8,520,444
Patents and licenses, net of accumulated amortization
of $674,220 in 2000 and $472,708 in 1999 4,160,253 4,071,196
Purchased technology from acquisitions, net of accumulated
amortization of $1,533,334 in 2000 and $1,266,667 in 1999 2,466,666 2,733,333
Tradenames, net of accumulated amortization of
$718,745 in 2000 and $593,750 in 1999 1,781,255 1,906,250
Other assets, net of accumulated amortization of
$221,320 in 2000 and $137,985 in 1999 326,866 265,748
------------ ------------
$ 45,371,686 $ 43,554,774
============ ============
See accompanying notes to consolidated financial statements.
</PRE>
<HR>
<PRE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2000 and 1999
Liabilities and Stockholders' Equity 2000 1999
------------------------------------ ------------ ------------
Current liabilities:
Accounts payable $ 783,761 $1,765,377
Accrued salary and employee benefit costs 1,015,643 793,275
Accrued tax abatement liability 969,204 969,204
Income taxes payable -- 511,848
Other accrued expenses 141,416 151,372
------------ ------------
Total current liabilities 2,910,024 4,191,076
------------ ------------
Deferred income taxes 2,301,670 2,325,403
Commitments and contingencies
Stockholders' equity:
Common stock, $.05 par value
Authorized-25,000,000 shares;
Issued-8,708,367 shares 435,418 435,418
Additional capital 40,313,751 40,423,457
Retained earnings 6,648,066 5,694,422
Accumulated other comprehensive income (loss), net of
tax benefit of $42,883 in 2000 and $124,437 in 1999 (83,241) (241,550)
Cost of common shares in treasury; 1,049,133 shares
in 2000 and 1,316,558 shares in 1999 (7,154,002) (9,273,452)
------------ ------------
Total stockholders' equity 40,159,992 37,038,295
------------ ------------
$45,371,686 $43,554,774
============ ============
See accompanying notes to consolidated financial statements.
</PRE>
<HR>
<PRE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31
2000 1999 1998
------------ ------------ ------------
Net revenue-product sales $23,081,624 $20,578,384 $17,006,407
Net revenue-contract research and development --- 8,900,000 3,100,000
------------ ------------ ------------
Total net revenue 23,081,624 29,478,384 20,106,407
------------ ------------ ------------
Operating expenses:
Cost of product sales 7,488,321 6,628,983 4,985,887
General and administrative 2,838,319 2,756,931 2,633,250
Research and development 3,561,956 3,772,579 2,801,175
Amortization of intangibles 1,233,112 1,187,689 1,170,585
Marketing 6,851,022 6,290,004 4,682,423
------------ ------------ ------------
21,972,730 20,636,186 16,273,320
------------ ------------ ------------
Earnings from operations 1,108,894 8,842,198 3,833,087
Other income (expense):
Loss on sale of marketable securities (3,218) -- (4,381)
Interest expense -- (44,861) (331,468)
Investment and other income, net 582,181 751,238 834,772
------------ ------------ ------------
578,963 706,377 498,923
------------ ------------ ------------
Earnings from continuing operations
before income taxes 1,687,857 9,548,575 4,332,010
Income taxes 734,213 3,545,294 1,746,304
------------ ------------ ------------
Net earnings from continuing operations 953,644 6,003,281 2,585,706
------------ ------------ ------------
Loss from discontinued operations, net of income
tax benefits of $129,711 -- -- (211,634)
Gain on sale of assets of discontinued operations, net of
income tax expense of $2,473,293 -- -- 4,585,130
------------ ------------ ------------
Net earnings from discontinued operations -- -- 4,373,496
------------ ------------ ------------
Net earnings $ 953,644 $ 6,003,281 $ 6,959,202
============ ============ ============
Basic earnings per share:
Continuing operations $ .13 $ .79 $ .31
Discontinued operations -- -- .53
------------ ------------ ------------
Net earnings $ .13 $ .79 $ .84
============ ============ ============
Diluted earnings per share:
Continuing operations $ .11 $ .75 $ .30
Discontinued operations -- -- .51
------------ ------------ ------------
Net earnings $ .11 $ .75 $ .81
============ ============ ============
See accompanying notes to consolidated financial statements.
</PRE>
<HR>
<PRE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31
2000 1999 1998
------------ ------------ ------------
Cash flows from operating activities:
Net earnings from continuing operations $ 953,644 $ 6,003,281 $ 2,585,706
Adjustments to reconcile earnings from continuing
operations to net cash provided by operating
activities:
Depreciation 1,217,331 816,125 615,388
Amortization 1,233,112 1,187,689 1,170,585
Deferred income taxes 2,129 225,525 103,267
Non-operating loss included in net earnings 3,218 -- 4,381
Increase in inventory reserve 5,133 -- 52,818
Changes in operating assets and liabilities
Receivables (276,488) (596,558) (748,442)
Inventories 346,294 (3,355,955) 200,834
Prepaid expenses and other current assets (527,297) (254,427) (383,940)
Income taxes payable (267,443) (1,543,713) 1,605,319
Accounts payable (981,616) 860,478 649,802
Accrued expenses 212,412 (220,897) 177,904
Deferred revenue -- (900,000) 900,000
------------ ------------ ------------
Net cash provided by continuing operations 1,920,429 2,221,548 6,933,622
Net cash provided by discontinued operations -- -- 59,049
------------ ------------ ------------
Net cash provided by operating activities 1,920,429 2,221,548 6,992,671
------------ ------------ ------------
Cash flows from investing activities:
Purchases of certificates of deposit with maturities
over 90 days (1,425,000) -- --
Proceeds from certificates of deposits with maturities
over 90 days 385,000 -- --
Purchases of marketable securities (808,760) -- (106,001)
Net proceeds from sales of marketable securities 413,290 -- 851,621
Additions to equipment, fixtures and patent
licenses - continuing operations (1,239,025) (5,907,550) (1,678,842)
Additions to property, plant and equipment-
discontinued operations -- -- (12,060)
Net proceeds from sale of assets in 2000 and
discontinued operations in 1999 and 1998 600 6,354,965 21,754,181
------------ ------------ ------------
Net cash provided by (used in) investing
activities (2,673,895) 447,415 20,808,899
------------ ------------ ------------
Cash flows from financing activities:
Loan to third party (1,500,000) -- --
Decrease in short-term obligations -- (3,633,475) (8,081,763)
Payment of long-term notes -- -- (177,137)
Exercise of stock options and warrants 1,405,386 573,272 817,766
Purchase of treasury stock -- (2,952,311) (9,411,055)
------------ ------------ ------------
Net cash used in financing activities (94,614) (6,012,514) (16,852,189)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (848,080) (3,343,551) 10,949,381
Cash and cash equivalents at beginning of year 8,353,658 11,697,209 747,828
------------ ------------ ------------
Cash and cash equivalents at end of year $ 7,505,578 $ 8,353,658 $11,697,209
============ ============ ============
Supplemental cash flow information is presented below:
Income taxes paid $ 958,585 $ 4,863,482 $ 37,715
============ ============ ============
Interest paid $ -- $ 44,861 $ 370,304
============ ============ ============
See accompanying notes to consolidated financial statements.
</PRE>
<HR>
<PRE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Three Years Ended December 31, 2000
Other
Retained Comprehensive Total
Common Stock Additional Earnings Income Treasury Stockholders'
Shares Amount Capital (Deficit) (Loss) Stock Equity
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
December 31, 1997 8,635,509 $ 431,775 $ 40,780,717 $ (7,268,061) $ (38,494) $ -- $ 33,905,937
Net earnings -- -- -- 6,959,202 -- -- 6,959,202
Adjustment to
unrealized losses
on marketable
securities -- -- -- -- (92,266) -- (92,266)
-------------
Comprehensive income 6,866,936
-------------
Shares issued upon
exercise of stock
options 72,858 3,643 160,554 -- -- -- 164,197
Compensation expense
resulting from
changes to stock
options -- -- 1,004,654 -- -- -- 1,004,654
Issuance of 184,874
shares from
treasury for
stock option
exercises -- -- (908,852) -- -- 1,562,421 653,569
Purchase of
1,258,625 treasury
shares, at cost -- -- -- -- -- (9,411,055) (9,411,055)
Tax benefit from
employee stock
option exercises -- -- 119,509 -- -- -- 119,509
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
December 31, 1998 8,708,367 435,418 41,156,582 (308,859) (130,760) (7,848,634) 33,303,747
Net earnings -- -- -- 6,003,281 -- -- 6,003,281
Adjustment to
unrealized losses
on marketable
securities -- -- -- -- (110,790) -- (110,790)
-------------
Comprehensive income 5,892,491
-------------
Tax benefit from
employee stock
option exercises -- -- 221,096 -- -- -- 221,096
Issuance of 162,068
shares from
treasury for
stock option
exercises -- -- (954,221) -- -- 1,527,493 573,272
Purchase of 404,875
treasury shares,
at cost -- -- -- -- -- (2,952,311) (2,952,311)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
December 31, 1999 8,708,367 435,418 40,423,457 5,694,422 (241,550) (9,273,452) 37,038,295
Net earnings -- -- -- 953,644 -- -- 953,644
Adjustment to
unrealized losses
on marketable
securities -- -- -- -- 158,309 -- 158,309
-------------
Comprehensive income 1,111,953
-------------
Tax benefit from
employee stock
option exercises -- -- 604,358 -- -- -- 604,358
Issuance of 267,425
shares from
treasury for
stock option
exercises and
warrant exercise -- -- (714,064) -- -- 2,119,450 1,405,386
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
December 31, 2000 8,708,367 $ 435,418 $ 40,313,751 $ 6,648,066 $ (83,241) $ (7,154,002) $ 40,159,992
============= ============= ============= ============= ============= ============= =============
See accompanying notes to consolidated financial statements.
</PRE>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(1)</B></TD>
<TD WIDTH=95%><B>Business</B></TD></TR></TABLE>
<P><B>Continuing Operations</B></P>
<P>Advanced Neuromodulation Systems, Inc. (the “Company” or
“ANS”) designs, develops, manufactures and markets implantable
neuromodulation devices. ANS devices are used primarily to manage chronic severe
pain. ANS revenues are derived primarily from sales throughout the United
States, Europe and Australia.</P>
<P>The neuromodulation 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.</P>
<P>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.</P>
<P>In addition, ANS products are purchased primarily by hospitals and other
users who then bill various third-party payors including Medicare, Medicaid,
private insurance companies and managed care organizations. These third-party
payors reimburse fixed amounts for services based on a specific diagnosis. The
impact of changes in third-party payor reimbursement policies and any amendments
to existing reimbursement rules and regulations that restrict or terminate the
eligibility of ANS products could have an adverse impact on the Company’s
financial condition and results of operations.</P>
<P><B>Discontinued Operations</B></P>
<P>On January 30, 1998, the Company sold its cardiovascular and intravenous
fluid product lines (“CVS Operations”), including its MPS®
myocardial protection system product line, to Atrion Corporation (see Note 9 -
“Sale of CVS Operations/Discontinued Operations”). The CVS Operations
have been accounted for as discontinued operations in the Consolidated
Statements of Operations for the year ended December 31, 1998. During October
1998, Atrion also exercised an option to acquire the Company’s land, office
and manufacturing facility for $6.5 million. The transaction was closed on
February 1, 1999.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(2)</B></TD>
<TD WIDTH=95%><B>Summary of Significant Accounting Policies</B></TD></TR>
</TABLE>
<P><B>Principles of Consolidation</B></P>
<P>The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and all of its subsidiaries. All significant
inter-company transactions and accounts have been eliminated in
consolidation.</P>
<P><B>Use of Estimates</B></P>
<P>The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.</P>
<P ALIGN=CENTER>Page 1</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P><B>Cash Equivalents</B></P>
<P>The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents.</P>
<P><B>Revenue Recognition</B></P>
<P>The Company recognizes revenue from product sales when the goods are shipped
to its customers. The Company recognizes revenue from research and development
contracts based upon the estimated percentage of completion of the development
project which is determined by hours completed as a percentage of the total
estimated hours under the product development plan.</P>
<P><B>Marketable Securities</B></P>
<P>The Company’s marketable securities and debt securities are classified
as available-for-sale and are carried at fair value with the unrealized gains
and losses reported in a separate component of stockholders’ equity
entitled “Other comprehensive income”. The amortized cost of debt
securities in this category is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is included in investment
income. Realized gains and losses and declines in value judged to be other than
temporary are included in other income. The cost of securities sold is based on
the specific identification method. Interest and dividends are included in
investment income.</P>
<P><B>Inventories</B></P>
<P>Inventories are recorded at the lower of standard cost or market. Standard
cost approximates actual cost determined on the first-in, first-out
(“FIFO”) basis. Cost includes the acquisition cost of raw materials
and components, direct labor and overhead.</P>
<P><B>Equipment and Fixtures</B></P>
<P>Equipment and fixtures are stated at cost. Additions and improvements
extending asset lives are capitalized while maintenance and repairs are expensed
as incurred. The cost and accumulated depreciation of assets sold or retired are
removed from the accounts and any gain or loss is reflected in the Statement of
Operations.</P>
<P>Depreciation is provided using the straight-line method over the estimated
useful lives of the various assets as follows:</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=35%>Leasehold improvements</TD>
<TD WIDTH=25% ALIGN=RIGHT>5 years</TD>
<TD WIDTH=40%></TD></TR>
<TR>
<TD>Furniture and fixtures</TD>
<TD ALIGN=RIGHT>2 to 10 years</TD>
<TD></TD></TR>
<TR>
<TD>Machinery and equipment</TD>
<TD ALIGN=RIGHT>3 to 10 years</TD>
<TD></TD></TR></TABLE>
<P><B>Intangible Assets</B></P>
<P>The excess of cost over the net assets of acquired businesses
(“goodwill”) is amortized on a straight-line basis over the estimated
useful life of 20 years.</P>
<P>The cost of purchased technology related to acquisitions is based on
appraised values at the date of acquisition and is amortized on a straight-line
basis over the estimated useful life (15 years) of such technology.</P>
<P ALIGN=CENTER>Page 2</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>The cost of purchased tradenames is based on appraised values at the date of
acquisition and is amortized on a straight-line basis over the estimated useful
life (20 years) of such tradenames.</P>
<P>The cost of purchased patents is amortized on a straight-line basis over the
estimated useful life (17 years) of such patents. The cost of certain licensed
patents is amortized on a straight-line basis over the estimated useful life (20
years) of such patents while the cost of certain other licensed patents is
amortized on a units of production method. Costs of patents that are the result
of internal development are charged to current operations.</P>
<P>The Company assesses the recoverability of all its intangible assets
primarily based on its current and anticipated future undiscounted cash flows.
At December 31, 2000, the Company does not believe there has been any impairment
of its intangible assets.</P>
<P><B>Research and Development</B></P>
<P>Product development costs including start-up and research and development are
charged to operations in the year in which such costs are incurred.</P>
<P><B>Advertising</B></P>
<P>Advertising expense is charged to operations in the year in which such costs
are incurred. Total advertising expense included in marketing expense from
continuing operations was $24,716, $40,440 and $21,843 at December 31, 2000,
1999 and 1998, respectively.</P>
<P><B>Deferred Taxes</B></P>
<P>Deferred income taxes are recorded based on the liability method and
represent the tax effect of the differences between the financial and tax basis
of assets and liabilities other than costs in excess of the net assets of
businesses acquired.</P>
<P><B>Stock-Based Compensation</B></P>
<P>The Company has adopted the disclosure-only provisions of SFAS No. 123,
“Accounting for Stock-Based Compensation”, which disclosures are
presented in Note 5, “Stockholders’ Equity”. Because of this
election, the Company continues to account for its stock-based compensation
plans under APB No. 25, “Accounting for Stock Issued to Employees”.
All of the Company’s stock option grants are at exercise prices equal to
the fair market value of the Company’s stock on the date of grant, and
therefore, no compensation expense is recorded.</P>
<P><B>Earnings Per Share</B></P>
<P>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 per share for 2000, 1999 and 1998
are based upon 7,484,572, 7,583,159, and 8,314,290 shares, respectively. Diluted
earnings per share for 2000, 1999, and 1998 are based upon 8,328,169, 8,003,087,
and 8,544,040 shares, respectively. The following table presents the
reconciliation of basic and diluted shares:</P>
<P ALIGN=CENTER>Page 3</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<PRE>
2000 1999 1998
--------- --------- ---------
Weighted-average shares outstanding
(basic shares) 7,484,572 7,583,159 8,314,290
Effect of dilutive instruments(1)
Stock options 799,060 401,292 214,806
Warrants 44,537 18,636 14,944
--------- --------- ---------
Dilutive potential common shares 843,597 419,928 229,750
--------- --------- ---------
Diluted shares 8,328,169 8,003,087 8,544,040
========= ========= =========
</PRE>
<P>(1) See Note 5 for a description of these instruments.</P>
<P></P>
<P>For 2000, 1999 and 1998 the incremental shares used for dilutive earnings per
share relate to stock options and warrants whose exercise price was less than
the average market price in the underlying quarterly computations. Options to
purchase 12,975 shares at an average price of $15.38 per share were outstanding
in 2000, 250 shares at an average price of $8.94 per share were outstanding in
1999, and options to purchase 215,981 shares at an average price of $9.02 per
share were outstanding in 1998 but were not included in the computation of
diluted earnings per share because the options’ exercise prices were
greater than the average market price of the common shares and, therefore, the
effect would be antidilutive.</P>
<P><B>Comprehensive Income</B></P>
<P>Statement of Financial Accounting Standards No. 130 – “Reporting
Comprehensive Income” – requires unrealized gains or losses on the
Company’s available for sale securities to be included in “Other
comprehensive income” and be reported in the Consolidated Statements of
Stockholders’ Equity.</P>
<P><B>New Accounting Standards</B></P>
<P>In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (“SFAS 133”), “Accounting
for Derivative Instruments and Hedging Activities.” SFAS 133 requires
companies to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. SFAS 133, as amended by SFAS 138,
is effective for fiscal years beginning after June 15, 2000. The adoption of
SFAS 133 as of January 1, 2001 is not expected to have a material impact on the
financial position or results of operations of the Company because we have no
derivatives or hedges.</P>
<P><B>Reclassification</B></P>
<P>Certain prior period amounts have been reclassified to conform to
current-year presentation.</P>
<P ALIGN=CENTER>Page 4</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(3)</B></TD>
<TD WIDTH=95%><B>Marketable Securities</B></TD></TR>
</TABLE>
<P>The following is a summary of available-for-sale securities at December 31,
2000:</P>
<PRE>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
Investment grade preferred security $ 250,000 -- $ 89,380 $ 160,620
Investment grade municipal bonds 808,760 -- -- 808,760
Real estate investment trust 97,682 -- 36,744 60,938
---------- ---------- ---------- ----------
$1,156,442 -- $ 126,124 $1,030,318
========== ========== ========== ==========
</PRE>
<P>Estimated fair value for the investment grade preferred security and real
estate investment trust are determined by the closing prices as reported on the
New York Stock Exchange at each financial reporting period. In the case of the
investment grade municipal bonds, the brokerage firms holding such bonds provide
the values at each reporting period by utilizing a standard pricing service.</P>
<P>At December 31, 2000, no individual security represented more than 45 percent
of the total portfolio or 1.1 percent of total assets. The Company did not have
any investments in derivative financial instruments at December 31, 2000.</P>
<P>The following is a summary of available-for-sale securities at December 31,
1999:</P>
<PRE>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
Investment grade preferred securities $ 554,596 -- $ 275,107 $ 279,489
Publicly traded limited partnerships 51,875 -- 27,815 24,060
Real estate investment trusts 141,590 -- 47,143 94,447
Other 16,134 -- 15,922 212
---------- ---------- ---------- ----------
$ 764,195 -- $ 365,987 $ 398,208
========== ========== ========== ==========
</PRE>
<P>At December 31, 1999, 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 December 31, 1999.</P>
<P ALIGN=CENTER>Page 5</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(4)</B></TD>
<TD WIDTH=95%><B>Federal Income Taxes</B></TD></TR>
</TABLE>
<P>The significant components of the net deferred tax liability at December 31,
were as follows:</P>
<PRE>
Deferred tax assets: 2000 1999
------------ ------------
Tax credit and net operating loss carry forwards $ -- $ 36,649
Accrued expenses and reserves 519,593 496,213
Unrealized loss on marketable securities 42,883 124,437
------------ ------------
Total deferred tax asset 562,476 657,299
Deferred tax liabilities:
Purchased intangible assets (1,529,252) (1,670,250)
Excess of tax over book depreciation (678,262) (597,425)
Other (109,961) (60,941)
------------ ------------
Total deferred tax liabilities (2,317,475) (2,328,616)
------------ ------------
Net deferred tax liabilities $(1,754,999) $(1,671,317)
============ ============
</PRE>
<P>The provision for income taxes on earnings from continuing operations for the
years ended December 31 consists of the following:</P>
<PRE>
2000 1999 1998
----------- ----------- -----------
Current $ 741,382 $3,682,727 $2,005,713
Deferred (7,169) (137,433) (259,409)
----------- ----------- -----------
$ 734,213 $3,545,294 $1,746,304
=========== =========== ===========
</PRE>
<P>A reconciliation of the provision for income taxes on earnings from
continuing operations to the expense calculated at the U.S. statutory rate
follows:</P>
<PRE>
2000 1999 1998
----------- ----------- -----------
Income tax expense at statutory rate $ 573,871 $3,246,515 $1,472,883
Tax effect of:
State taxes 4,581 183,625 117,900
Nondeductible amortization of goodwill 189,279 189,211 189,245
Other (33,518) (74,057) (33,724)
----------- ----------- -----------
Income tax expense $ 734,213 $3,545,294 $1,746,304
=========== =========== ===========
</PRE>
<P>In 1998, the Company utilized net operating loss carry forwards of $4,277,540
and general business credits and alternative minimum tax credits of $1,038,669
to reduce its tax liabilities.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(5)</B></TD>
<TD WIDTH=95%><B>Stockholders' Equity</B></TD></TR>
</TABLE>
<P>The Company has a Shareholder’s Rights Plan, adopted in 1996, which
permits shareholders to purchase shares of the Company’s common stock at
significant discounts in the event a person or group acquires more than 15
percent of the Company’s common stock or announces a tender or exchange
offer for more than 20 percent of the Company’s common stock.</P>
<P ALIGN=CENTER>Page 6</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>During the year ended December 31, 1998, the Company repurchased 1,258,625
shares of its common stock at an aggregate cost of $9,411,055 and during the
year ended December 31, 1999, the Company repurchased 404,875 shares of its
common stock at an aggregate cost of $2,952,311. No repurchases were made during
the year ended December 31, 2000. During the years ended December 31, 2000, 1999
and 1998, the Company issued 267,425, 162,068 and 184,874 shares respectively,
from its treasury upon the exercise of stock options and a warrant. At December
31, 2000, 1,049,133 shares remained in the treasury. These shares were reissued
in connection with two acquisitions in January 2001. See Note 11.</P>
<P>In 1998, the Company issued a five-year warrant to purchase 100,000 shares of
common stock at an exercise price of $6.50 per share in connection with a
$2,000,000 loan from a nonaffiliate shareholder. The warrant was exercised by
the nonaffiliate shareholder in December 2000.</P>
<P>The Company has various stock option plans pursuant to which stock options
may be granted to key employees, officers, directors and advisory directors of
the Company. The most recent of the plans, approved by the shareholders during
2000 (the “2000 Plan”), reserved 500,000 shares of common stock for
options under the plan; provided, however, that on January 1 of each year
(commencing in 2001), the aggregate number of shares of common stock reserved
for options under the 2000 Plan shall be increased by the same percentage that
the total number of issued and outstanding shares of common stock increased from
the preceding January 1 to the following December 31 (if such percentage is
positive). On January 1, 2001, 18,100 options were added to the 2000 Plan.</P>
<P>Several of the plans allow for the grant of incentive stock options to key
employees and officers intended to qualify for preferential tax treatment under
Section 422 of the Internal Revenue Code of 1986. Under all of the
Company’s plans, the exercise price of options granted must equal or exceed
the fair market value of the common stock at the time of the grant. Options
granted to employees and officers expire ten years from the date of grant and
for the most part are exercisable one-fourth each year over a four-year period
of continuous service. Options granted to directors and advisory directors
expire six years from the date of grant and for the most part are exercisable
one-fourth each year over a four-year period of continuous service. Certain
options, however, have a two-year vesting schedule.</P>
<P>At December 31, 2000, under all of the Company’s stock option plans,
1,422,196 shares had been granted and were outstanding, 1,975,672 shares of
common stock had been issued upon exercise, and 225,894 shares were reserved for
future grants.</P>
<P ALIGN=CENTER>Page 7</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>Data with respect to stock option plans of the Company are as follows:</P>
<PRE>
------------------------------------------------- -----------------------------
Options Outstanding Exercisable Options
------------------------------------------------- -----------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
----------------- ------------ -------------- ------------ --------------
January 1, 1998 833,272 $ 5.68 568,285 $ 4.66
Granted 1,352,800 $ 6.12
Exercised (257,732) $ 3.49
Forfeited (860,125) $ 8.10
----------------- ------------ -------------- ------------ --------------
January 1, 1999 1,068,215 $ 4.82 465,340 $ 4.58
Granted 332,500 $ 6.73
Exercised (162,068) $ 3.99
Forfeited (18,000) $ 8.14
----------------- ------------ -------------- ------------ --------------
January 1, 2000 1,220,647 $ 5.40 499,397 $ 4.83
Granted 422,332 $ 14.21
Exercised (167,158) $ 4.67
Forfeited (53,625) $ 6.82
----------------- ------------ -------------- ------------ --------------
December 31, 2000 1,422,196 $ 8.05 601,989 $ 5.19
----------------- ============ ============== ============ ==============
</PRE>
<PRE>
Exercisable Options
Options Outstanding at December 31, 2000 at December 31, 2000
- -------------------------------------------------------- ------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Price Shares Life (Years) Exercise Price Shares Exercise Price
- -------------- --------- ------------ -------------- -------- --------------
$ 3.50 - 5.25 728,864 7.83 $ 5.00 532,614 $ 5.00
$ 5.25 - 8.00 278,000 8.30 $ 6.69 69,125 $ 6.68
$ 8.00 - 12.00 39,500 9.00 $ 9.36 250 $ 8.94
$12.00 - 16.00 324,332 9.49 $ 14.13 -- $ --
$16.00 - 20.00 51,500 9.96 $ 19.25 -- $ --
- -------------- --- ----- ------------ -------------- -------- --------------
1,422,196 8.41 $ 8.05 601,989 $ 5.19
========= ============ ============== ======== ==============
</PRE>
<P>Exercisable options at January 1, 1999 and 1998 included options for 134,904
and 306,297 shares, respectively, with a weighted average exercise price of
$4.53 per share at January 1, 1999 and $4.22 per share at January 1, 1998, which
were held by employees who terminated employment with the Company on January 30,
1998 in connection with the sale of the CVS Operations (see Note 9 - “Sale
of CVS Operations/Discontinued Operations”). The Company accelerated the
vesting of the unvested portion of these terminated employee options as a result
of the sale. The Company also extended the normal 90-day exercise period
subsequent to termination to January 30, 1999 for these options.</P>
<P>In November 1998, the Board of Directors authorized the repricing of options
for certain employees, advisory directors and directors under several of the
Plans. Stock options were rescinded for these participants and a new option was
granted at the then fair market value of the common stock of $5.00 per share.
Data with respect to the option repricing during November 1998 is as
follows:</P>
<P ALIGN=CENTER>Page 8</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<PRE>
1998 Option Repricing Data
------------------------------------------------------
Range of Exercise Weighted Average
Price Before Exercise Price
Repricing Shares Before Repricing
-------------------- ----------- -------------------
$ 5.75 - 7.75 293,000 $ 6.28
$ 7.75 - 9.75 408,500 $ 8.58
$ 9.75 - 11.75 77,000 $ 10.25
$ 11.75 - 12.25 15,000 $ 12.13
----------- -------------------
793,500 $ 7.96
=========== ===================
</PRE>
<P>In accordance with APB No. 25, the Company has not recorded compensation
expense for its stock option awards. As required by SFAS No. 123, the Company
provides the following disclosure of hypothetical values for these awards. The
weighted-average fair value of an option granted in 2000, 1999 and 1998 was
$5.76, $2.73 and $2.30, respectively. For purposes of fair market value
disclosures, the fair market value of an option grant was estimated using the
Black-Scholes option pricing model with the following assumptions:</P>
<PRE>
2000 1999 1998
-------- -------- --------
Risk-free interest rate 5.9% 5.5% 4.6%
Average life of options (years) 3.0 3.0 3.0
Volatility 52.4% 49.1% 49.2%
Dividend Yield -- -- --
</PRE>
<P>Had the compensation expense been recorded based on these hypothetical
values, pro forma net earnings (loss) for 2000, 1999 and 1998 would have been
$(187,653), $5,047,706 and $6,457,825, respectively, and pro forma diluted net
earnings per common share for 2000, 1999 and 1998 would have been $(0.02), $.63
and $.76, respectively.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(6)</B></TD>
<TD WIDTH=95%><B>Commitments and Contingencies</B></TD></TR>
</TABLE>
<P>On February 1, 1999, the Company sold its principal office and manufacturing
facility in Allen, Texas to Atrion Corporation. Atrion leased space to the
Company at the rate of $48,125 per month from February 1, 1999 through May 31,
1999. The Company entered into a sixty-three month lease agreement on 40,000
square feet of space located in the North Dallas area during February 1999. The
Company relocated its operations to the leased facility in May 1999 and the
rental period under the lease commenced on June 1, 1999. Under the terms of the
lease agreement, the Company received three months free rent and the monthly
rental rate for the remaining term of the lease is $48,308. The monthly rental
rate includes certain operating expenses such as property taxes on the facility,
insurance, landscape and maintenance and janitorial services. The Company also
has the first right of refusal to acquire the facility. Future minimum rental
payments relating to the leased facility for the years ended December 31 are
$579,696 in 2001, 2002 and 2003 and $386,464 in 2004.</P>
<P>In addition, the Company leases transportation equipment under non-cancelable
operating leases. Future minimum rental payments under non-cancelable
transportation leases for the years ended December 31 are $17,667 in 2001 and
$5,104 in 2002.</P>
<P ALIGN=CENTER>Page 9</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>Total rent expense included in continuing operations for the years ended
December 31, 2000, 1999 and 1998 was $572,447, $533,600 and $8,782,
respectively.</P>
<P>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 neurostimulation business and future ANS product lines will not
be adversely affected by these product liability claims.</P>
<P>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.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(7)</B></TD>
<TD WIDTH=95%><B>Financial Instruments, Risk Concentration and Major Customers
</B></TD></TR>
</TABLE>
<P>In the United States, the Company’s accounts receivable are due
primarily from hospitals and distributors located throughout the country.
Internationally, the Company’s accounts receivable are due primarily from
distributors located in Europe and Australia. The Company generally does not
require collateral for trade receivables. The Company maintains an allowance for
doubtful accounts based upon expected collectibility. Any losses from bad debts
have historically been within management’s expectations.</P>
<P>Net sales of implantable neurostimulation systems to one major customer for
each of the years ended December 31, as a percentage of net revenue from product
sales from continuing operations, were as follows: 2000- 14 percent and 1998- 20
percent. Net sales of implantable neurostimulation systems to two major
customers for the year ended December 31, 1999, as a percentage of net revenue
from product sales from continuing operations, were 15 percent and 11 percent,
respectively.</P>
<P>Foreign sales, primarily Europe and Australia, for the years ended December
31, 2000, 1999 and 1998 were approximately 7 percent, 7 percent and 10 percent
of net revenue from product sales from continuing operations, respectively.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(8)</B></TD>
<TD WIDTH=95%><B>Employee Benefit Plans</B></TD></TR></TABLE>
<P>The Company has a defined contribution retirement savings plan (the
“Plan”) available to substantially all employees. The Plan permits
employees to elect salary deferral contributions of up to 15 percent of their
compensation and requires the Company to make matching contributions equal to 50
percent of the participants’ contributions to a maximum of 6 percent of the
participants’ compensation. The Board of Directors may change the
percentage of matching contribution at their discretion. The expense of the
Company’s contribution for continuing operations was $157,601 in 2000,
$158,842 in 1999 and $119,543 in 1998.</P>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(9)</B></TD>
<TD WIDTH=95%><B>Sale of CVS Operations/Discontinued Operations</B></TD></TR>
</TABLE>
<P>On January 30, 1998, the Company sold its cardiovascular and intravenous
fluid product lines, including its 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 Company reported a net gain (after
income tax expense) from the sale of $4.6 million. This gain is net of a pre-tax
expense of $969,204, discussed below, recorded in connection with the sale of
the corporate facility to Atrion in February 1999. The gain is also net of a
pre-tax compensation expense of $1,004,654 recorded as a result of changes made
to the options held by employees of the CVS Operations (see Note 5 –
“Stockholders’ Equity”). The Company also reported a net loss for
the CVS Operations of approximately $211,634 in January 1998 prior to the
sale.</P>
<P ALIGN=CENTER>Page 10</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>As part of the sale of the CVS Operations to Atrion, 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. During October 1998,
Atrion exercised its option to acquire the facility. When the facility was built
in 1993, the Company entered a ten-year agreement with the City of Allen
granting tax abatements to the Company if a minimum job base and personal
property base were maintained in the City of Allen. The agreement provided for
the repayment of abated taxes if the Company defaulted under the agreement. As
mentioned above, during 1998 the Company recorded a pretax expense of $969,204
in connection with the abated taxes. In April 1999, the Company was successful
in petitioning the City of Allen to assign the abatement agreement to Atrion. In
July 1999, the Company, Atrion and the City of Allen executed an assignment
agreement under which Atrion (as successor in interest to the Company) must
continue to meet the conditions of the original tax abatement agreement until
August 2003. The City preserved its rights to collect previously abated taxes if
Atrion fails to comply with its obligations any time prior to August 2003. The
Company retains monetary liability for the amount of abated taxes, even after
assignment, because pursuant to the purchase and sale agreement with Atrion, the
Company indemnified Atrion from any tax abatement liabilities that accrued to
the City of Allen prior to the sale of the CVS Operations in January 1998. If
Atrion meets the minimum requirements under the agreement until August 2003,
then no payment will be required. If no payment is required, the Company intends
to reverse the obligation of $969,204 in September 2003.</P>
<P>On February 1, 1999, the sale of the facility to Atrion was consummated. The
Company repaid the mortgage debt on the facility at the closing of the
transaction. After repayment of the mortgage debt and expenses related to the
transaction, the Company received $2.7 million of net proceeds. No material gain
or loss was recorded on the sale of the facility except related to the tax
abatement liability described above. The Company moved its operations to a
40,000 square foot leased facility in the North Dallas area during May 1999.
Until such time, the Company leased space from Atrion at a monthly expense of
$48,175 and paid Atrion fifty percent of certain operating expenses. The expense
of moving and transitioning into the new leased facility was immaterial.</P>
<P>Operating results of the CVS Operations have been reclassified and reported
as discontinued operations. Summary operating results for the year ended
December 31, 1998 for the CVS Operations were as follows (the 1998 period
includes results for one month until the sale on January 30, 1998):</P>
<PRE>
1998
--------------
Revenue $ 1,111,992
Gross profit 206,481
Loss from operations (307,120)
Interest expense (34,225)
--------------
Loss before income tax benefit (341,345)
Income tax benefit (129,711)
--------------
Net loss $ (211,634)
==============
</PRE>
<P ALIGN=CENTER>Page 11</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>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. General overhead of the Company includes charges for regulatory,
general corporate management, accounting and payroll services, human resources,
management information systems and facilities expenses. These expenses were
charged to the CVS Operations in amounts that approximate the discreet
identifiable costs of the CVS Operations that will not continue after the sale.
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.</P>
<P>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.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(10)</B></TD>
<TD WIDTH=95%><B>Product Development Agreement</B></TD></TR></TABLE>
<P>In June 1998, the Company entered an agreement with Sofamor Danek Group, Inc.
(“Sofamor Danek”) under which the Company agreed to 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 that was being recognized into income as revenue
based upon the estimated percentage of completion of the development project.
During the year ended December 31, 1998, the Company recognized $3.1 million
into income as revenue. Due to the termination of the agreement discussed below,
the remaining $900,000 was recognized into income as revenue during January 1999
and is included in the Statements of Operations for the year ended December 31,
1999. The agreement also called for ANS to receive four additional payments of
$2 million each, to be recognized into income upon the satisfactory completion
of certain domestic and international regulatory milestones over the next
several years.</P>
<P>In December 1998, the Company and Sofamor Danek agreed to terminate the June
1998 DBS agreement due to the impending merger of Sofamor Danek and Medtronic,
the Company’s sole competitor in the DBS market. Under the termination
agreement, Sofamor Danek agreed to accelerate payments due the Company in the
amount of $8 million and the Company agreed to release Sofamor Danek from
further contractual obligations. The Company received the $8 million payment
from Sofamor Danek in January 1999. The $8 million payment was recognized into
revenue during January 1999 and is included in the Statements of Operations for
the year ended December 31, 1999.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5%><B>(11)</B></TD>
<TD WIDTH=95%><B>Subsequent Events</B></TD></TR></TABLE>
<P>On January 2, 2001, the Company acquired the assets of Implantable Devices
Limited Partnership (IDP) and ESOX Technology Holdings, LLC (ESOX), two
privately held Minnesota companies, for 119,100 shares of the Company’s
common stock. Based on the closing price of ANS common stock on December 29,
2000, the value of the stock issued to acquire the assets was $2.43 million. The
assets purchased consisted primarily of intellectual property and technology for
the fully implantable constant-rate infusion pump that ANS has developed. Prior
to the acquisition, the Company had licensed rights to the technology only for
pain and cancer therapy applications.</P>
<P ALIGN=CENTER>Page 12</P>
<HR>
<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>
Notes to Consolidated Financial Statements</B></P>
<P>Also on January 2, 2001, the Company completed the acquisition of Hi-tronics
Designs, Inc. (HDI), a privately-held contract developer and original equipment
manufacturer (OEM) of electro-mechanical devices with headquarters in Budd Lake,
New Jersey. The Company acquired all of HDI’s outstanding stock through a
merger in exchange for 1,104,725 shares of ANS common stock. The transaction
will be accounted for on a pooling of interests basis. HDI developed and is the
manufacturer of the Company’s totally implantable pulse generator (IPG)
used in the treatment of chronic intractable pain and was also the OEM
manufacturer of the transmitter used with the Company’s Renew
radio-frequency spinal cord stimulation system. HDI’s revenues for its
fiscal 2000, which ended November 30, 2000, were approximately $10.4 million,
including approximately $1.6 million of revenue associated with sales to
ANS.</P>
<P>A summary of operations data as if the acquisition had taken place as of
January 1, 1999, excluding the charges related to the acquisition, follows:</P>
<PRE>
2000 1999 1998
------------- ------------- -------------
Revenues $ 31,826,998 $ 35,779,019 $ 26,516,870
Net income $ 832,458 $ 5,816,922 $ 6,700,231
Earnings per share $ .09 $ .64 $ .69
</PRE>
<P ALIGN=CENTER>Page 13</P>
<HR>
<P ALIGN=RIGHT><B><U>Appendix B</U></B></P>
<P></P><P></P><P></P>
<P ALIGN=CENTER><B>Schedule II - Valuation and Qualifying Accounts</B></P>
<P></P><P></P>
<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>
Item 14<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>
(Name of issuer)</B></P>
<P></P><P></P>
<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>
<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities and Exchange
Act of 1934</B></P>
<HR>
<PRE>
Schedule II - Valuation and Qualifying Accounts
Advanced Neuromodulation Systems, Inc. and Subsidiaries
December 31, 2000
Balance at Charged to
Beginning Charged to Other Balance at
Description of Year Expenses Accounts Deductions End of Year
- ----------------------------------- ----------- ----------- ----------- ----------- -----------
Year ended December 31, 2000:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 140,824 $ 19,990 $ -- $ 30,559 $ 130,255
Reserve for obsolete inventory 86,599 5,133 -- -- 91,732
----------- ----------- ----------- ----------- -----------
Total $ 227,423 $ 25,123 $ -- $ 30,559 $ 221,987
=========== =========== =========== =========== ===========
Year ended December 31, 1999:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 249,607 $ 35,756 $ -- $ 144,539 $ 140,824
Reserve for obsolete inventory 86,599 -- -- -- 86,599
----------- ----------- ----------- ----------- -----------
Total $ 336,206 $ 35,756 $ -- $ 144,539 $ 227,423
=========== =========== =========== =========== ===========
Year ended December 31, 1998:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 212,375 $ 25,000 $ -- $ (12,232)(1) $ 249,607(1)
Reserve for obsolete inventory 56,005 50,709 -- 20,115 86,599
----------- ----------- ----------- ----------- -----------
Total $ 268,380 $ 75,709 $ -- $ 7,883 $ 336,206
=========== =========== =========== =========== ===========
Discontinued Operations:
-----------------------
Allowance for doubtful accounts $ 30,610 $ 96,238 $ -- $ 126,848 $ --
Reserve for obsolete inventory 154,347 -- -- 154,347 --
----------- ----------- ----------- ----------- -----------
Total $ 184,957 $ 96,238 $ -- $ 281,195 $ --
=========== =========== =========== =========== ===========
(1) Includes $96,238 transferred from discontinued operations for accounts remaining with the Company.
</PRE>
<HR>
<P ALIGN=RIGHT><B><U>Appendix C</U></B></P>
<P></P><P></P><P></P>
<P ALIGN=CENTER><B>Quarterly Financial Data<BR>(unaudited)</B></P>
<P></P><P></P>
<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>
Item 8<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of
issuer)</B></P>
<P></P><P></P>
<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>
<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities and Exchange
Act of 1934</B></P>
<HR>
<PRE>
2000 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- --------------------------------------------- ------------- ------------- ------------- -------------
Net revenue- product sales $ 5,598,864 $ 5,707,692 $ 5,762,546 $ 6,012,522
Total net revenue 5,598,864 5,707,692 5,762,546 6,012,522
Gross profit- product sales 3,750,268 3,847,647 3,878,081 4,117,307
Earnings from operations 189,880 312,995 277,552 328,467
Earnings from operations before income taxes 317,937 449,975 425,617 494,328
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings $ 181,132 $ 256,781 $ 239,357 $ 276,374
- --------------------------------------------- ------------- ------------- ------------- -------------
- --------------------------------------------- ------------- ------------- ------------- -------------
Basic earnings per share $ 0.02 $ 0.03 $ 0.03 $ 0.04
- --------------------------------------------- ------------- ------------- ------------- -------------
- --------------------------------------------- ------------- ------------- ------------- -------------
Diluted earnings per share $ 0.02 $ 0.03 $ 0.03 $ 0.03
- --------------------------------------------- ------------- ------------- ------------- -------------
1999 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- --------------------------------------------- ------------- ------------- ------------- -------------
Net revenue- product sales $ 4,595,238 $ 5,169,614 $ 5,488,479 $ 5,325,053
Total net revenue 13,495,238 5,169,614 5,488,479 5,325,053
Gross profit- product sales 3,235,058 3,583,979 3,413,948 3,716,416
Earnings (loss) from operations 8,775,155 161,881 (70,851) (23,987)
Earnings from operations before income taxes 8,957,826 375,382 97,758 117,609
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings $ 5,446,358 $ 222,494 $ 216,135 $ 118,294
- --------------------------------------------- ------------- ------------- ------------- -------------
- --------------------------------------------- ------------- ------------- ------------- -------------
Basic earnings per share $ 0.70 $ 0.03 $ 0.03 $ 0.02
- --------------------------------------------- ------------- ------------- ------------- -------------
- --------------------------------------------- ------------- ------------- ------------- -------------
Diluted earnings per share $ 0.67 $ 0.03 $ 0.03 $ 0.02
- --------------------------------------------- ------------- ------------- ------------- -------------
</PRE>
<HR>
<P ALIGN=CENTER><B>INDEX TO EXHIBITS</B></P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>
<TD WIDTH=5%></TD>
<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>
</TABLE>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>
<TD WIDTH=5%> </TD>
<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by
and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and
Hi-tronics Designs, Inc.(10)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>
<TD></TD>
<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>
<TD></TD>
<TD>Bylaws(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>
<TD></TD>
<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.
and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option
Plan(2)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.2 </TD>
<TD></TD>
<TD>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>
<TD></TD>
<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>
<TD></TD>
<TD>Form of Directors Stock Option Agreement(1)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.5 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1987 Stock Option Plan(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>
<TD></TD>
<TD>Form of 1987 Employee Stock Option Agreement(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1995 Stock Option Plan(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>
<TD></TD>
<TD>Form of 1995 Employee Stock Option Agreement(4)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>
<TD></TD>
<TD>Quest Medical, Inc. 1998 Stock Option Plan(7)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>
<TD></TD>
<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between Christopher G. Chavez and
Quest Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest
Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>
<TD></TD>
<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill III and
Quest Medical, Inc.(6)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>
<TD></TD>
<TD>Form of Employment Agreement and Covenant Not to Compete, between the
Company and key employees(1)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>
<TD></TD>
<TD>Lease Agreement dated as of February 4, 1999, between Advanced
Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>11.1 </TD>
<TD></TD>
<TD>Computation of Earnings Per Share(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>
<TD></TD>
<TD>Subsidiaries(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>
<TD></TD>
<TD>Consent of Independent Auditors(11)</TD></TR>
<TR>
<TD ALIGN=RIGHT VALIGN=TOP>27.1 </TD>
<TD></TD>
<TD>Financial Data Schedule - December 31, 2000(11)</TD></TR>
</TABLE>
<P>__________________________________</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=5% VALIGN=TOP>(1) </TD>
<TD WIDTH=2%></TD>
<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on
Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.
</TD></TR>
<TR>
<TD>(2) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year
ended December 31, 1987, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(3) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration No. 2-78186, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(4) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,
Registration No. 33-62991, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(5) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September
3, 1996, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(6) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the
quarterly period ended March 31, 1998, and incorporated herein by reference.
</TD></TR>
<TR>
<TD>(7) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated
April 27, 1998, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(8) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the
year ended December 31, 1998, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(9) </TD>
<TD></TD>
<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated
April 17, 2000, and incorporated herein by reference.</TD></TR>
<TR>
<TD>(10)</TD>
<TD></TD>
<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January
9, 2001, and incorporated herein by reference. Upon request, the Company will
furnish a copy of any omitted schedule to the Commission.</TD></TR>
<TR>
<TD>(11)</TD>
<TD></TD>
<TD>Filed herewith.</TD></TR>
</TABLE>
<HR>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P ALIGN=CENTER><B>EXHIBIT 3.1</B></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<HR>
<P ALIGN=CENTER><B>ARTICLES OF INCORPORATION</B></P>
<P ALIGN=CENTER><B>OF</B></P>
<P ALIGN=CENTER><B>ADVANCED NEUROMODULATION SYSTEMS, INC.</B></P>
<P ALIGN=CENTER>(restated March 2001 for purposes of filing with the Securities
and Exchange Commission)</P>
<P ALIGN=CENTER><B>ARTICLE ONE</B></P>
<P>The name of the corporation is Advanced Neuromodulation Systems, Inc. (the
"Corporation")</P>
<P ALIGN=CENTER><B>ARTICLE TWO</B></P>
<P>The period of duration of the Corporation is perpetual.</P>
<P ALIGN=CENTER><B>ARTICLE THREE</B></P>
<P>The purpose for which the Corporation is organized is to engage in the
transaction of any and all lawful business for which Corporations may be
incorporated under the Texas Business Corporation Act.</P>
<P ALIGN=CENTER><B>ARTICLE FOUR</B></P>
<P>The Corporation shall have authority to issue 25,000,000 shares of common
stock, $.05 par value (“Common Stock”). Each share of Common Stock
shall have identical rights and privileges in every respect.</P>
<P ALIGN=CENTER><B>ARTICLE FIVE</B></P>
<P>No holder of any shares of Common Stock shall have any preemptive or
preferential right to receive, purchase, or subscribe to (a) any unissued or
treasury shares of any class of stock (whether now or hereafter authorized) of
the Corporation, (b) any obligations, evidences of indebtedness, or other
securities of the Corporation convertible into or exchangeable for, or carrying
or accompanied by any rights to receive, purchase, or subscribe to, any such
unissued or treasury shares, (c) any right of subscription to or right to
receive, or any warrant or option for the purchase of, any of the foregoing
securities, or (d) any other securities that may be issued or sold by the
Corporation.</P>
<P ALIGN=CENTER><B>ARTICLE SIX</B></P>
<P>The Corporation will not commence business until it has received for the
issuance of its shares consideration of the value of $1,000, consisting of
money, labor done, or property actually received.</P>
<P ALIGN=CENTER><B>ARTICLE SEVEN</B></P>
<P>Cumulative voting for the election of directors is expressly denied and
prohibited.</P>
<P ALIGN=CENTER><B>ARTICLE EIGHT</B></P>
<P>No contract or other transaction between the Corporation and any other person
(as used herein the term “person” means an individual, firm, trust,
partnership, joint venture, association, corporation, or other entity) shall be
affected or invalidated by the fact that any director of the Corporation is
interested in, or is a member, director, or an officer of, such other person,
and any director may be a party to or may be interested in any contract or
transaction of the Corporation or in which the Corporation is interested; and no
contract, act, or transaction of the Corporation with any person shall be
affected or invalidated by the fact that any director of the Corporation is a
party to, or interested in, such contract, act, or transaction, or in any way
connected with such person. Each and every person who may become a director of
the Corporation is hereby relieved from any liability that might otherwise exist
from contracting with the Corporation for the benefit of himself or any person
in which he may be in any way interested; provided that the fact of such
interest shall have been disclosed to or shall be known by the other directors
or the shareholders of the Corporation, as the case may be, acting upon or with
reference to such act, contract, or transaction, even though the presence at a
meeting or vote or votes of such interested director might have been necessary
to obligate the Corporation upon such act, contract, or transaction.</P>
<HR>
<P ALIGN=CENTER><B>ARTICLE NINE</B></P>
<P>To the extent permitted by applicable law, and by resolution or other proper
action of the board of directors of the Corporation, the Corporation may
indemnify (a) any present or former director or officer of the Corporation, (b)
any other employee or agent of the Corporation, and (c) any other person serving
at the request of the Corporation as a director, trustee, officer, employee, or
agent of another corporation, domestic or foreign, nonprofit or for profit,
partnership, joint venture, association, trust, or other enterprise, against
expenses, including attorneys’ fees, judgments, fines, and amounts paid in
settlement actually and reasonably incurred in connection with any threatened,
pending, or completed action, suit, or proceeding to which any such person is,
or is threatened to be made, a party and which may arise by reason of the fact
he is or was a person occupying any such office or position.</P>
<P ALIGN=CENTER><B>ARTICLE TEN</B></P>
<P>The Corporation shall have the authority to purchase, directly or indirectly,
its own shares to the extent of the aggregate of the unrestricted capital
surplus available therefore and unrestricted reduction surplus available
therefore, without submitting such purchase to a vote of the shareholders of the
Corporation.</P>
<P ALIGN=CENTER><B>ARTICLE ELEVEN</B></P>
<P>Any action of the Corporation which, under the provisions of the Texas
Business Corporation Act, is required to be authorized or approved by the
holders of two-thirds or any other specified fraction which is in excess of
one-half or any specified percentage which is in excess of 50%, of the
outstanding shares (or any class or series thereof) of the Corporation shall,
notwithstanding any such provisions of the Texas Business Corporation Act, be
deemed effectively and properly authorized or approved if authorized or approved
by the vote of the holders of more than 50% of the outstanding shares entitled
to vote thereon (or, if the holders of any class or series of the
Corporation’s shares shall be entitled by the Texas Business Corporation
Act to vote thereon separately as a class, by the vote of the holders of more
than 50% of the outstanding shares of each such class or series). Nothing
contained in this article is intended to require shareholder authorization or
approval of any action of the Corporation whatsoever unless such authorization
or approval is specifically required by the other provisions of these articles
of incorporation, the bylaws of the Corporation, or by the Texas Business
Corporation Act.</P>
<HR>
<P ALIGN=CENTER><B>ARTICLE TWELVE</B></P>
<P>The post office address of the registered office of the Corporation is 6501
Windcrest Dr., Suite 100, Plano, Texas 75024, and the name of its registered
agent at such address is Christopher G. Chavez.</P>
<P ALIGN=CENTER><B>ARTICLE THIRTEEN</B></P>
<P>The number of directors constituting the board of directors of the
Corporation is seven, and the names and addresses of the persons who are to
serve as directors until the next annual meeting of shareholders and until their
successors are elected and qualified are:</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=30%><U>Name</U></TD>
<TD WIDTH=70%><U>Address</U></TD></TR>
<TR>
<TD>Hugh M. Morrison</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>Christopher G. Chavez</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>Robert C. Eberhart</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>Joseph E. Laptewicz</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>A. Ronald Lerner</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>Richard D. Nikolaev</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
<TR>
<TD>Michael J. Torma</TD>
<TD>6501 Windcrest Dr., Suite 100, Plano, Texas 75024</TD></TR>
</TABLE>
<P ALIGN=CENTER><B>ARTICLE FOURTEEN</B></P>
<P>A director of the Corporation is not liable to the Corporation or its
shareholders for monetary damages for an act or omission in the director’s
capacity as a director, except that this article does not eliminate or limit the
liability of a director for:</P>
<OL>
<LI>a breach of a director's duty of loyalty to the
Corporation or its shareholders;
<LI>an act or omission not in good faith or that
involves intentional misconduct or a knowing violation of the law;
<LI>a transaction from which a director received an
improper benefit, whether or not the benefit resulted from an action taken
within the scope of the director's office;
<LI>an act or omission for which the liability of a director is expressly
provided for by statute; or
<LI>an act related to an unlawful stock repurchase or payment of a
dividend.</OL>
<HR>
<P>If the Texas Business Corporation Act, Texas Miscellaneous Corporation Laws
or related laws are amended after approval by the shareholders of this Article
to authorize corporation action further eliminating or limiting the personal
liability of directors, then the liability of a director of the Corporation
shall be eliminated or limited to the fullest extent permitted by applicable
Texas law, as so amended.</P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=40%></TD>
<TD WIDTH=60%>ADVANCED NEUROMODULATION SYSTEMS, INC.</TD></TR>
<TR>
<TD> </TD><TD></TD></TR><TR>
<TD> </TD>
<TD><U>/s/F. Robert Merrill III</U></TD></TR><TR>
<TD> </TD>
<TD>F. Robert Merrill III</TD></TR><TR>
<TD> </TD>
<TD>Executive Vice President - Finance,</TD></TR><TR>
<TD> </TD>
<TD>Treasurer and Secretary</TD></TR></TABLE>
<HR>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P ALIGN=CENTER><B>EXHIBIT 3.2</B></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<HR>
<P ALIGN=CENTER>AMENDED AND RESTATED BYLAWS<BR><BR>OF<BR><BR>ADVANCED
NEUROMODULATION SYSTEMS, INC., a Texas Corporation</P>
<P ALIGN=CENTER>(Restated in March 2001 for purposes of filing with the
Securities and Exchange Commission)</P>
<P></P>
<P ALIGN=CENTER>PREAMBLE</P>
<P></P>
<P>These bylaws are subject to, and governed by, the Texas Business Corporation
Act and the articles of incorporation of Advanced Neuromodulation Systems, Inc.
(the “Corporation”). In the event of a direct conflict between the
provisions of these bylaws and the mandatory provisions of the Texas Business
Corporation Act or the provisions of the articles of incorporation of the
Corporation, such provisions of the Texas Business Corporation Act or the
articles of incorporation of the Corporation, as the case may be, will be
controlling.</P>
<P></P>
<P ALIGN=CENTER>ARTICLE ONE: OFFICES</P>
<P></P>
<P>1.01 <U>Registered Office and Agent.</U> The
registered office and registered agent of the Corporation shall be as designated
from time to time by the appropriate filing by the Corporation in the office of
the Secretary of State of Texas.</P>
<P>1.02 <U>Other Offices</U>. The Corporation may also
have offices at such other places, both within and without the State of Texas,
as the board of directors may from time to time determine or the business of the
Corporation may require.</P>
<P></P>
<P ALIGN=CENTER>ARTICLE TWO: SHAREHOLDERS</P>
<P></P>
<P>2.01 <U>Annual Meetings.</U> An annual meeting of
shareholders of the Corporation shall be held during each calendar year on such
date and at such time as shall be designated from time to time by the board of
directors and stated in the notice of the meeting. At such meeting, the
shareholders shall elect directors and transact such other business as may
properly be brought before the meeting.</P>
<P>2.02 <U>Special Meetings</U>. A special meeting of the
shareholders may be called at any time by the chairman of the board, the
president, the board of directors, or the holders of not less than ten percent
of all shares entitled to vote at such meeting. Only such business shall be
transacted at a special meeting as may be stated or indicated in the notice of
such meeting.</P>
<P>2.03 <U>Place of Meetings</U>. The annual meeting of
shareholders may be held at any place within or without the State of Texas as
may be designated by the board of directors. Special meetings of shareholders
may be held at any place within or without the State of Texas as may be
designated by the person or persons calling such special meeting as provided in
Section 2.02. If no place for a meeting is designated, it shall be held at the
registered office of the Corporation.</P>
<P>2.04 <U>Notice</U>. Written or printed notice stating
the place, day, and hour of each meeting of shareholders, and, in case of a
special meeting, the purpose or purposes for which the meeting is called, shall
be delivered not less than ten nor more than 50 days before the date of the
meeting, either personally or by mail, by or at the direction of the chairman of
the board, the president, the secretary, or the person calling the meeting, to
each shareholder of record entitled to vote at such meeting.</P>
<HR>
<P>2.05 <U>Voting List</U>. At least ten days before each
meeting of shareholders, the secretary shall prepare a complete list of
shareholders entitled to vote at such meeting, arranged in alphabetical order,
including the address of each shareholder and the number of voting shares held
by each shareholder. For a period of ten days prior to such meeting, such list
shall be kept on file at the registered office of the Corporation and shall be
subject to inspection by any shareholder during usual business hours. Such list
shall be produced at such meeting, and at all times during such meeting shall be
subject to inspection by any shareholder. The original stock transfer books
shall be prima facie evidence as to who are the shareholders entitled to examine
such list or stock transfer books.</P>
<P>2.06 <U>Voting of Shares</U>. Treasury shares, shares
of the Corporation’s own stock owned by another corporation the majority of
the voting stock of which is owned or controlled by the Corporation, and shares
of the Corporation’s own stock held by another corporation in a fiduciary
capacity, shall not be shares entitled to vote or to be counted in determining
the total number of outstanding shares. Shares held by an administrator,
executor, guardian, or conservator may be voted by him, either in person or by
proxy, without transfer of such shares into his name so long as such shares form
a part of the estate and are in the possession of the estate being served by
him. Shares standing in the name of a trustee may be voted by him, either in
person or by proxy, only after the shares have been transferred into his name as
trustee. Shares standing in the name of a receiver may be voted by such
receiver, and shares held by or under the control of a receiver may be voted by
such receiver without transfer of such shares into his name if authority to do
so is contained in the court order by which such receiver was appointed. Shares
standing in the name of another domestic or foreign corporation of any type or
kind may be voted by such officer, agent, or proxy as the bylaws of such
corporation may provide or, in the absence of such provision, as the board of
directors of such corporation may determine. A shareholder whose shares are
pledged shall be entitled to vote such shares until they have been transferred
into the name of the pledgee, and thereafter, the pledgee shall be entitled to
vote such shares.</P>
<P>2.07 <U>Quorum</U>. The holders of a majority of the
outstanding shares entitled to vote, present in person or represented by proxy,
shall constitute a quorum at any meeting of shareholders, except as otherwise
provided by law, the articles of incorporation, or these bylaws. If a quorum
shall not be present or represented at any meeting of shareholders, a majority
of the shareholders entitled to vote at the meeting, who are present in person
or represented by proxy, may adjourn the meeting from time to time, without
notice other than announcement at the meeting, until a quorum shall be present
or represented. At any reconvening of an adjourned meeting at which a quorum
shall be present or represented any business may be transacted which could have
been transacted at the original meeting, if a quorum had been present or
represented.</P>
<P>2.08 <U>Majority Vote; Withdrawal of Quorum.</U> If a
quorum is present in person or represented by proxy at any meeting, the vote of
the holders of a majority of the outstanding shares entitled to vote, present in
person or represented by proxy, shall decide any question brought before such
meeting, unless the question is one on which, by express provision of law, the
articles of incorporation, or these bylaws, a different vote is required, in
which event such express provision shall govern and control the decision of such
question. The shareholders present at a duly convened meeting may continue to
transact business until adjournment, notwithstanding any withdrawal of
shareholders which may leave less than a quorum remaining.</P>
<HR>
<P>2.09 <U>Method of Voting; Proxies</U>. Every
shareholder of record shall be entitled at every meeting of shareholders to one
vote on each matter submitted to a vote, for every share standing in his name on
the original stock transfer books of the Corporation except to the extent that
the voting rights of the shares of any class or classes are limited or denied by
the articles of incorporation. Such books shall be prima facie evidence as to
the identity of shareholders entitled to vote. At any meeting of shareholders,
every shareholder having the right to vote may vote either in person or by a
proxy executed in writing by the shareholder or by his duly authorized
attorney-in-fact. Each such proxy shall be filed with the secretary of the
Corporation before or at the time of the meeting. No proxy shall be valid after
11 months from the date of its execution, unless otherwise provided in the
proxy. If no date is stated on a proxy, such proxy shall be presumed to have
been executed on the date of the meeting at which it is to be voted. Each proxy
shall be revocable, unless expressly provided therein to be irrevocable, or
unless otherwise made irrevocable by law.</P>
<P>2.10 <U>Closing of Transfer Books; Record Date.</U>
For the purpose of determining shareholders entitled to notice of or to vote at
any meeting of shareholders or any reconvening thereof or entitled to receive
payment of any dividend or in order to make a determination of shareholders for
any other proper purpose, the board of directors may provide that the stock
transfer books of the Corporation shall be closed for a stated period but not to
exceed in any event 50 days. If the stock transfer books are closed for the
purpose of determining shareholders entitled to notice of or to vote at a
meeting of shareholders, such books shall be closed for at least ten days
immediately preceding such meeting. In lieu of closing the stock transfer books,
the board of directors may fix in advance a date as the record date for any such
determination of shareholders, such date in any case to be not more than 50 days
and, in case of a meeting of shareholders, not less than ten days prior to the
date on which the particular action requiring such determination of shareholders
is to be taken. If the stock transfer books are not closed and if no record date
is fixed for the determination of shareholders entitled to notice of or to vote
at a meeting of shareholders or entitled to receive payment of a dividend, the
date on which the notice of the meeting is mailed or the date on which the
resolution of the board of directors declaring such dividend is adopted, as the
case may be, shall be the record date for such determination of shareholders.
</P>
<P>2.11 <U>Presiding Officials at Meetings</U>. Unless
some other person or persons are elected by a vote of a majority of the shares
then entitled to vote at a meeting of shareholders, the chairman of the board
shall preside at and the secretary shall prepare minutes of each meeting of
shareholders. </P>
<P></P>
<P ALIGN=CENTER>ARTICLE THREE: DIRECTORS</P>
<P></P>
<P>3.01 <U>Management</U>. The business and affairs of
the Corporation shall be managed by the board of directors, subject to the
restrictions imposed by law, the articles of incorporation, or these bylaws.
</P>
<P>3.02 <U>Number; Election; Term; Qualification</U>. The
first board of directors shall consist of the number of directors named in the
articles of incorporation. Thereafter, the number of directors which shall
constitute the entire board of directors shall be determined by resolution of
the board of directors at any meeting thereof or by the shareholders at any
meeting thereof, but shall never be less than one. At each annual meeting of
shareholders, directors shall be elected to hold office until the next annual
meeting of shareholders and until their successors are elected and qualified. No
director need be a shareholder, a resident of the State of Texas, or a citizen
of the United States.</P>
<P>3.03 <U>Decreases in Number</U>. No decrease in the
number of directors constituting the entire board of directors shall have the
effect of shortening the term of any incumbent director.</P>
<HR>
<P>3.04 <U>Removal</U>. At any meeting of shareholders
called expressly for that purpose, any director or the entire board of directors
may be removed, with or without cause, by a vote of the holders of a majority of
the shares then entitled to vote on the election of directors.</P>
<P>3.05 <U>Vacancies; Increases in Number</U>. Any
vacancy occurring in the board of directors (by death, resignation, removal, or
otherwise) may be filled by the affirmative vote of a majority of the remaining
directors though less than a quorum of the board of directors. A director
elected to fill a vacancy shall be elected to serve for the unexpired term of
his predecessor in office. In case of any increase in the number of directors
constituting the entire board of directors, the additional directors shall be
elected at a meeting of shareholders.</P>
<P>3.06 <U>First Meeting</U>. Each newly elected board of
directors may hold its first meeting for the purpose of organization and the
transaction of business, if a quorum is present, immediately after and at the
same place as the annual meeting of shareholders, and notice of such meeting
shall not be necessary.</P>
<P>3.07 <U>Regular Meetings</U>. Regular meetings of the
board of directors may be held without notice at such times and places as may be
designated from time to time by the chairman of the board, or by resolution of
the board of directors and communicated to all directors. </P>
<P>3.08 <U>Special Meetings</U>. A special meeting of the
board of directors shall be held whenever called by any director at such time
and place as such director shall designate in the notice of such special
meeting. The director calling any special meeting shall cause notice of such
special meeting to be given to each director at least 24 hours before such
special meeting. Neither the business to be transacted at, nor the purpose of,
any special meeting of the board of directors need be specified in the notice or
waiver of notice of any special meeting. </P>
<P>3.09 <U>Quorum; Majority Vote</U>. At all meetings of
the board of directors, a majority of the directors, fixed in the manner
provided in these bylaws, shall constitute a quorum for the transaction of
business. If a quorum is not present at a meeting, a majority of the directors
present may adjourn the meeting from time to time, without notice other than an
announcement at the meeting, until a quorum is present. The vote of a majority
of the directors present at a meeting at which a quorum is in attendance shall
be the act of the board of directors, unless the vote of a different number is
required by the articles of incorporation or these bylaws.</P>
<P>3.10 <U>Procedure; Minutes</U>. At meetings of the
board of directors, business shall be transacted in such order as the chairman
of the board or the board of directors may determine from time to time. If
present, the chairman of the board shall preside at the meeting. If not so
present, the board of directors shall appoint at the meeting another director to
preside at the meeting and a person to act as secretary of the meeting. The
secretary of the meeting shall prepare minutes of the meeting which shall be
delivered to the secretary of the Corporation for placement in the minute books
of the Corporation.</P>
<P>3.11 <U>Presumption of Assent</U>. A director of the
Corporation who is present at any meeting of the board of directors at which
action on any matter is taken shall be presumed to have assented to the action
unless his dissent shall be entered in the minutes of the meeting or unless he
shall file his written dissent to such action with the person acting as
secretary of the meeting before the adjournment thereof or shall forward any
dissent by certified or registered mail to the secretary of the Corporation
immediately after the adjournment of the meeting. Such right to dissent shall
not apply to a director who voted in favor of such action. </P>
<HR>
<P>3.12 <U>Compensation</U>. Directors, in their capacity
as directors, may receive, by resolution of the board of directors, a fixed sum
and expenses of attendance, if any, for attending meetings of the board of
directors or a stated salary. No director shall be precluded from serving the
Corporation in any other capacity or receiving compensation there for. </P>
<P></P>
<P ALIGN=CENTER>ARTICLE FOUR: COMMITTEES</P>
<P></P>
<P>4.01 <U>Designation.</U> The board of directors may,
by resolution adopted by a majority of the entire board of directors, designate
executive and other committees.</P>
<P>4.02 <U>Number; Qualification; Term</U>. Each
committee shall consist of one or more directors appointed by resolution adopted
by a majority of the entire board of directors. The number of committee members
may be increased or decreased from time to time by resolution adopted by a
majority of the entire board of directors. Each committee member shall serve as
such until the expiration of his term as a director or his earlier resignation,
unless sooner removed as a committee member or as a director. </P>
<P>4.03 <U>Authority</U>. The executive committee, unless
expressly restricted in the resolution adopted by a majority of the entire board
of directors establishing the executive committee, shall have and may exercise
all of the authority of the board of directors in the management of the business
and affairs of the Corporation. Each other committee, to the extent expressly
provided for in the resolution adopted by a majority of the entire board of
directors establishing such committee, shall have and may exercise all of the
authority of the board of directors in the management of the business and
affairs of the Corporation. However, no committee shall have the authority of
the board of directors in reference to: </P>
<OL TYPE=a>
<LI>amending the articles of incorporation;
<LI>approving a plan of merger or consolidation;
<LI>recommending to the shareholders the sale, lease, or exchange of all or
substantially all of the property and assets of the Corporation otherwise than
in the usual and regular course of its business;
<LI>recommending to the shareholders a voluntary dissolution of the Corporation
or a revocation thereof;
<LI>amending, altering, or repealing these bylaws or adopting new bylaws;
<LI>filling vacancies in or removing members of the board of directors or of any
committee;
<LI>electing or removing officers or committee members;
<LI>fixing the compensation of any committee member; and
<LI>altering or repealing any resolution of the board of directors which by its
terms provides that it shall not be amendable or repealable.</OL>
<P>In the resolution adopted by a majority of the entire board of directors
establishing an executive or other committee, the board of directors may
expressly authorize such committee to declare dividends or to authorize the
issuance of shares of the Corporation.</P>
<P>4.04 <U>Committee Changes.</U> The board of directors
shall have the power at any time to fill vacancies in, to change the membership
of, and to discharge any committee. However, a committee member may be removed
by the board of directors, only if, in the judgment of the board of directors,
the best interests of the Corporation will be served thereby, but such removal
shall be without prejudice to the contract rights, if any, of the person so
removed.</P>
<HR>
<P>4.05 <U>Regular Meetings.</U> Regular meetings of any
committee may be held without notice at such times and places as may be
designated from time to time by resolution of the committee and communicated to
all committee members.</P>
<P>4.06 <U>Special Meetings</U>. A special meeting of any
committee may be held whenever called by any committee member at such time and
place as such committee member shall designate in the notice of such special
meeting. The committee member calling any special meeting shall cause notice of
such special meeting to be given to each committee member at least 12 hours
before such special meeting. Neither the business to be transacted at, nor the
purpose of, any special meeting of any committee need be specified in the notice
or waiver of notice or any special meeting. </P>
<P>4.07 <U>Quorum; Majority Vote</U>. At all meetings of
any committee, a majority of the number of committee members designated by the
board of directors shall constitute a quorum for the transaction of business. If
a quorum is not present at a meeting of any committee, a majority of the
committee members present may adjourn the meeting from time to time, without
notice other than an announcement at the meeting, until a quorum is present. The
vote of a majority of the committee members present at any meeting at which a
quorum is in attendance shall be the act of a committee, unless the vote of a
different number is required by the articles of incorporation or these bylaws.
</P>
<P>4.08 <U>Minutes</U>. Each committee shall cause
minutes of its proceedings to be prepared and shall report the same to the board
of directors upon the request of the board of directors. The minutes of the
proceedings of each committee shall be delivered to the secretary of the
Corporation for placement in the minute books of the Corporation. </P>
<P>4.09 <U>Compensation</U>. Committee members may, by
resolution of the board of directors, be allowed a fixed sum and expenses of
attendance, if any, for attending any committee meetings or a stated salary.
</P>
<P>4.10 <U>Responsibility</U>. The designation of any
committee and the delegation of authority to it shall not operate to relieve the
board of directors or any director of any responsibility imposed upon it or such
director by law.</P>
<P></P>
<P ALIGN=CENTER>ARTICLE FIVE: GENERAL PROVISIONS RELATING TO MEETINGS</P>
<P></P>
<P>5.01 <U>Notice</U>. Whenever by law, the articles of
incorporation, or these bylaws, notice is required to be given to any
shareholder, director, or committee member and no provision is made as to how
such notice shall be given, it shall be construed to mean that notice may be
given either (a) in person, (b) in writing, by mail, (c) except in the case of a
shareholder, by telegram, telex, cable, telecopies, or similar means, or (d) by
any other method permitted by law. Any notice required or permitted to be given
hereunder (other than personal notice) shall be addressed to such shareholder,
director, or committee member at his address as it appears on the books of the
Corporation or, in the case of a shareholder, on the stock transfer records of
the Corporation or at such other place as such shareholder, director, or
committee member is known to be at the time notice is mailed or transmitted. Any
notice required or permitted to be given by mail shall be deemed to be delivered
and given at the time when the same is deposited in the United States mail,
postage prepaid. Any notice required or permitted to be given by telegram,
telex, cable, telecopier, or similar means shall be deemed to be delivered and
given at the time transmitted.</P>
<HR>
<P>5.02 <U>Waiver of Notice</U>. Whenever by law, the
articles of incorporation, or these bylaws, any notice is required to be given
to any shareholder, director, or committee member of the Corporation a waiver
thereof in writing signed by the person or persons entitled to such notice,
whether before or after the time notice should have been given, shall be
equivalent to the giving of such notice. Attendance of a director at a meeting
shall constitute a waiver of notice of such meeting, except where a director
attends a meeting for the express purpose of objecting to the transaction of any
business on the ground that the meeting is not lawfully called or convened. </P>
<P>5.03 <U>Telephone and Similar Meetings.</U>
Shareholders, directors, or committee members may participate in and hold a
meeting by means of a conference telephone or similar communications equipment
by means of which persons participating in the meeting can hear each other.
Participation in such a meeting shall constitute presence in person at such
meeting, except where a person participates in the meeting for the express
purpose of objecting to the transaction of any business on the ground that the
meeting is not lawfully called or convened.</P>
<P>5.04 <U>Action Without Meeting</U>. Any action which
may be taken, or is required by law, the articles of incorporation, or these
bylaws to be taken, at a meeting of shareholders, directors, or committee
members may be taken without a meeting if a consent in writing, setting forth
the action so taken, shall be signed by all of the shareholders, directors, or
committee members, as the case may be, entitled to vote with respect to the
subject matter thereof, and such consent shall have the same force and effect,
as of the date stated therein, as a unanimous vote of such shareholders,
directors, or committee members, as the case may be, and may be stated as such
in any document filed with the Secretary of State of Texas or in any certificate
or other document delivered to any person. The consent may be in one or more
counterparts so long as each shareholder, director, or committee member signs
one of the counterparts. The signed consent shall be placed in the minute books
of the Corporation.</P>
<P></P>
<P ALIGN=CENTER>ARTICLE SIX: OFFICERS AND OTHER AGENTS</P>
<P></P>
<P>6.01 <U>Number; Titles; Election; Term</U>. The
Corporation shall have a president and a secretary, and such other officers and
agents as the board of directors may deem desirable. The board of directors
shall elect a president and secretary at its first meeting at which a quorum
shall be present after the annual meeting of shareholders or whenever a vacancy
exists. The board of directors then, or from time to time, may also elect or
appoint one or more other officers or agents as it shall deem advisable. Each
officer and agent shall hold office until his successor has been elected or
appointed and qualified, or, if earlier, at his death, resignation, or removal.
Any two or more offices may be held by the same person. No officer or agent need
be a shareholder, a director, a resident of the State of Texas, or a citizen of
the United States.</P>
<P>6.02 <U>Removal</U>. Any officer or agent elected or
appointed by the board of directors may be removed by the board of directors,
whenever, in the judgment of the board of directors, the best interests of the
Corporation will be served thereby, but such removal shall be without prejudice
to the contract rights, if any, of the person so removed. Election or
appointment of an officer or agent shall not of itself create contract rights.
</P>
<P>6.03 <U>Vacancies.</U> Any vacancy occurring in any
office of the Corporation (by death, resignation, removal, or otherwise) may be
filled by the board of directors.</P>
<P>6.04 <U>Authority</U>. Officers shall have such
authority and perform such duties in the management of the Corporation as are
provided in these bylaws or as may be determined by resolution of the board of
directors not inconsistent with these bylaws.</P>
<HR>
<P>6.05 <U>Compensation.</U> The compensation, if any, of
the officers shall be fixed, increased, or decreased from time to time by the
board of directors.
<P>6.06 <U>Chairman of the Board</U>. The chairman of the
board, if a person is elected to such office by the board of directors, shall
perform the following duties and have the following responsibilities: schedule
regular meetings of the board of directors; work with the officers and other
directors of the Corporation to set the agenda for regular and special meetings
of the board of directors; preside at all meetings of the board of directors
that the chairman is able to attend; ensure that the directors are given
adequate information to render informed decisions at board meetings; work with
the president and the other officers of the Corporation to formulate public
announcements, press releases and shareholder and analyst communications and
oversee and coordinate their release; ensure the smooth operation of the
committees of the board of directors; see that all orders and resolutions of the
board are carried into effect; and perform such other duties and have such other
authority and powers as the board of directors may from time to time prescribe.
</P>
<P>6.07 <U>President and Chief Executive Officer</U>. The
president and chief executive officer shall be the chief executive officer of
the Corporation subject to the supervision of the board of directors. The
president and chief executive officer shall perform the following duties and
have the following responsibilities: generally manage the business and property
of the Corporation in the ordinary course of business with all such powers of
oversight, supervision and management with respect to such business and property
as may be reasonably incident to such responsibilities, including, but not
limited to, the power to employ, discharge, or suspend employees or agents of
the Corporation, to fix the compensation of employees and agents, and to
suspend, with or without cause, any officer of the Corporation pending final
action by the board of directors with respect to continued suspension, removal,
or reinstatement of such officer; perform such other duties and have such other
authority and powers as are typically possessed and exercised by corporate
presidents and chief executive officers, all subject to the board’s further
instructions on discharging the duties of managing the business and property of
the Corporation. If the board of directors has not elected a person to the
office of chairman of the board, the president shall exercise all of the powers
and discharge all of the duties of the chairman of the board. As between the
Corporation and third parties, any action taken by the president in the
performance of the duties of the chairman of the board shall be conclusive
evidence that there is no chairman of the board. </P>
<P>6.08 <U>Secretary</U>. The secretary shall maintain
minutes of all meetings of the board of directors, of any committee, and of the
shareholders or consents in lieu of such minutes in the Corporation’s
minute books, and shall cause notice of such meetings to be given when requested
by any person authorized to call such meetings. With respect to any contract,
deed, deed of trust, mortgage, or other instrument executed by the Corporation
through its duly authorized officer or officers, the attestation to such
execution by the secretary shall not be necessary to constitute such contract,
deed, deed of trust, mortgage, or other instrument a valid and binding
obligation against the Corporation unless the resolution, if any, of the board
of directors authorizing such execution expressly states that such attestation
is necessary. The secretary shall have charge of the certificate books, stock
transfer books, and stock papers as the board of directors may direct, all of
which shall at all reasonable times be open to inspection by any director. The
secretary shall perform such other duties as may be prescribed from time to time
by the board of directors or as may be delegated from time to time by the
president.</P>
<HR>
<P></P>
<P ALIGN=CENTER>ARTICLE SEVEN: CERTIFICATES AND SHAREHOLDERS</P>
<P></P>
<P>7.01 <U>Certificates for Shares</U>. The certificates
for shares of stock of the Corporation shall be in such form as shall be
approved by the board of directors in conformity with law. The certificates
shall be consecutively numbered, shall be entered as they are issued in the
books of the Corporation or in the records of the Corporation’s designated
transfer agent, if any, and shall state the shareholder’s name, the number
of shares, and such other matters as may be required by law. The certificates
shall be signed by the president or any vice president and also by the
secretary, an assistant secretary, or any other officer, and may be sealed with
the seal of the Corporation or a facsimile thereof. If any certificate is
countersigned by a transfer agent or registered by a registrar, either of which
is other than the Corporation itself or an employee of the Corporation, the
signatures of the foregoing officers may be a facsimile. </P>
<P>7.02 <U>Lost, Stolen, or Destroyed Certificates.</U>
The Corporation shall issue a new certificate in place of any certificate for
shares previously issued if the registered owner of the certificate:</P>
<OL TYPE=a>
<LI><U>Claim.</U> Makes proof by affidavit, in form and substance satisfactory
to the board of directors, that a previously issued certificate for shares has
been lost, destroyed, or stolen;
<LI><U>Timely Request.</U> Requests the issuance of a new certificate before the
Corporation has notice that the certificate has been acquired by a purchaser for
value in good faith and without notice of an adverse claim;
<LI><U>Bond</U>. If requested by the board of directors, delivers to the
Corporation a bond, in form and substance satisfactory to the board of
directors, with such surety or sureties and with fixed or open penalty, as the
board of directors may direct, in its discretion, to indemnify the Corporation
(and its transfer agent and registrar, if any) against any claim that may be
made on account of the alleged loss, destruction, or theft of the certificate;
and
<LI><U>Other Requirements.</U> Satisfies any other reasonable requirements
imposed by the board of directors.</OL>
<P>When a certificate has been lost, destroyed, or stolen, and the shareholder
of record fails to notify the Corporation within a reasonable time after he has
notice of it, and the Corporation registers a transfer of the shares represented
by the certificate before receiving such notification, the shareholder of record
is precluded from making any claim against the Corporation for the transfer or
for a new certificate.</P>
<P>7.03 <U>Transfer of Shares</U>. Shares of stock of the
Corporation shall be transferable only on the books of the Corporation by the
shareholders thereof in person or by their duly authorized attorneys or legal
representatives. Upon surrender to the Corporation or the transfer agent of the
Corporation of a certificate representing shares duly endorsed or accompanied by
proper evidence of succession, assignment, or authority to transfer, the
Corporation or its transfer agent shall issue a new certificate to the person
entitled thereto, cancel the old certificate, and record the transaction upon
its books. </P>
<P>7.04 <U>Registered Shareholders.</U> The Corporation
shall be entitled to treat the shareholder of record as the shareholder in fact
of any shares and, accordingly, shall not be bound to recognize any equitable or
other claim to or interest in such shares on the part of any other person,
whether or not it shall have actual or other notice thereof, except as otherwise
provided by law.</P>
<HR>
<P></P>
<P ALIGN=CENTER>ARTICLE EIGHT: MISCELLANEOUS PROVISIONS</P>
<P></P>
<P>8.01 <U>Fiscal Year.</U> The fiscal year of the
Corporation shall be fixed by the board of directors; provided, that if such
fiscal year is not fixed by the board of directors it shall be the calendar
year.</P>
<P>8.02 <U>Seal</U>. The seal, if any, of the Corporation
shall be in such form as may be approved from time to time by the board of
directors. If the board of directors approves a seal, the affixation of such
seal shall not be required to create a valid and binding obligation against the
Corporation. </P>
<P>8.03 <U>Resignation</U>. A director, committee member,
officer, or agent may resign by so stating at any meeting of the board of
directors or by giving written notice to the Corporation. The effective time of
such resignation shall be any time specified in the statement made at the board
of directors’ meeting or in the written notice given to the Corporation,
but in no event may the effective time of such resignation be prior to the time
such statement is made or such notice is given. If no effective time is
specified in the resignation, the resignation shall be effective immediately.
Unless a resignation specifies otherwise, it is effective without being
accepted. </P>
<P>8.04 <U>Securities of Other Corporations</U>. The
president or any vice president of the Corporation or any other person
authorized by resolution of the board of directors shall have the power and
authority to transfer, endorse for transfer, vote, consent, or take any other
action with respect to any securities of another issuer which may be held or
owned by the Corporation and to make, execute, and deliver any waiver, proxy, or
consent with respect to any such securities. </P>
<P>8.05 <U>Amendment</U>. The power to alter, amend, or
repeal these bylaws or to adopt new bylaws is vested in the board of directors,
subject to repeal or change by action of the shareholders. </P>
<P>8.06 <U>Invalid Provisions</U>. If any provision of
these bylaws is held to be illegal, invalid, or unenforceable under present or
future laws, such provision shall be fully severable; these bylaws shall be
construed and enforced as if such illegal, invalid, or unenforceable provision
had never comprised a part hereof; and the remaining provisions hereof shall
remain in full force and effect and shall not be affected by the illegal,
invalid, or unenforceable provision or by its severance herefrom. Furthermore,
in lieu of such illegal, invalid, or unenforceable provision there shall be
added automatically as a part of these bylaws a provision as similar in terms to
such illegal, invalid, or unenforceable provision as may be possible and be
legal, valid, and enforceable. </P>
<P>8.07 <U>Headings.</U> The headings used in these
bylaws are for reference purposes only and do not affect in any way the meaning
or interpretation of these bylaws.
<P></P>
<P ALIGN=CENTER><U>CERTIFICATE</U></P>
<P></P>
<P>These Amended and Restated Bylaws were adopted by the Board of Directors of
the Corporation on July 3, 1996. </P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=60%></TD>
<TD WIDTH=40%><U>/s/ F. Robert Merrill III</U><BR>F. Robert Merrill III<BR>
Secretary</TD></TR></TABLE>
<HR>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P ALIGN=CENTER><B>EXHIBIT 11.1</B></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<HR>
<PRE>
Advanced Neuromodulation Systems, Inc.
Computation of Earnings Per Share
Years Ended December 31
2000 1999 1998
------------ ------------ ------------
Basic earnings per share:
Weighted average common
shares outstanding 7,484,572 7,583,159 8,314,290
------------ ------------ ------------
Net earnings from continuing operations $ 953,644 $ 6,003,281 $ 2,585,706
Net earnings from discontinued operations -- -- 4,373,496
------------ ------------ ------------
Net earnings $ 953,644 $ 6,003,281 $ 6,959,202
------------ ------------ ------------
Net earnings from continuing operations
per share $ 0.13 $ 0.79 $ 0.31
Net earnings from discontinued operations
per share -- -- 0.53
------------ ------------ ------------
Net earnings per share $ 0.13 $ 0.79 $ 0.84
------------ ------------ ------------
Diluted earnings per share:
Weighted average common
shares outstanding 7,484,572 7,583,159 8,314,290
Stock options and warrants--based on the treasury
stock method using average market price 843,597 419,928 229,750
------------ ------------ ------------
Diluted common and common equivalent
shares outstanding 8,328,169 8,003,087 8,544,040
------------ ------------ ------------
Net earnings from continuing operations $ 953,644 $ 6,003,281 $ 2,585,706
Net earnings from discontinued operations -- -- 4,373,496
------------ ------------ ------------
Net earnings $ 953,644 $ 6,003,281 $ 6,959,202
------------ ------------ ------------
Net earnings from continuing operations
per share $ 0.11 $ 0.75 $ 0.30
Net earnings from discontinued operations
per share -- -- 0.51
------------ ------------ ------------
Net earnings per share $ 0.11 $ 0.75 $ 0.81
------------ ------------ ------------
</PRE>
<HR>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P ALIGN=CENTER><B>EXHIBIT 21.1</B></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<HR>
<PAGE>
<P ALIGN=CENTER><B><U>SUBSIDIARIES</U></B></P>
<P></P>
<P>The Company has no "significant subsidiaries" as defined in Rule 1-02 (w) of
Regulation S-X.</P>
<HR>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P ALIGN=CENTER><B>EXHIBIT 23.1</B></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<P></P>
<HR>
<P ALIGN=CENTER><U>Consent of Independent Auditors</U></P>
<P></P>
<P>We consent to the incorporation by reference in the Registration Statements
(Form S-8 - Nos. 2-82414, 2-91410, 33-235312, 33-00967 and 333-75879, and Form
S-3 - Nos. 333-40927 and 333-53440) pertaining to the Advanced Neuromodulation
Systems, Inc. 1979 Amended and Restated Employees’ Stock Option Plan; the
Advanced Neuromodulation Systems, Inc. Directors’ Stock Option Plan; the
Advanced Neuromodulation Systems, Inc. 1987 Employees’ Stock Option Plan;
the Advanced Neuromodulation Systems, Inc. 1995 Stock Option Plan; the Advanced
Neuromodulation Systems, Inc. Sales and Marketing Employees Stock Option Plan;
the Heaton Stock Option Plan; the Advanced Neuromodulation Systems, Inc. 1998
Stock Option Plan; the registration of 100,000 shares of Common Stock issued
pursuant to a Common Stock Purchase Warrant between Advanced Neuromodulation
Systems, Inc. and Robert L. Swisher, Jr., the registration of 1,223,825 shares
of Common Stock issued pursuant to an Agreement and Plan of Merger dated
November 30, 2000 between the Company and Hi-tronics Designs, Inc. and an Asset
Purchase Agreement dated as of January 2, 2001 between the Company and
Implantable Devices Limited Partnership, ESOX Technology Corporation and
Implantable Devices, Inc. and the related Prospectuses of our report dated March
2, 2001, with respect to the consolidated financial statements of Advanced
Neuromodulation Systems, Inc. and Subsidiaries, included in the Annual Report
(Form 10-K) for the year ended December 31, 2000.</P>
<P></P>
<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>
<TR>
<TD WIDTH=40%> </TD>
<TD WIDTH=60%><U>/s/Ernst and Young LLP</U><BR>Ernst and Young LLP</TD></TR>
</TABLE>
<P></P>
<P>Dallas, Texas<BR>March 27, 2001</P>
<H1 ALIGN=CENTER><FONT SIZE=3>EXHIBIT 27.1</FONT></H1>
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<TEXT>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
(Exhibit 27.1, Financial Data Sheet)
</LEGEND>
<CIK> 0000351721
<NAME> Advanced Neuromodulation Systems, Inc.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> DEC-31-2000
<CASH> 8,545,578
<SECURITIES> 1,030,318
<RECEIVABLES> 3,980,860
<ALLOWANCES> 130,255
<INVENTORY> 5,647,790
<CURRENT-ASSETS> 21,998,159
<PP&E> 8,105,067
<DEPRECIATION> 2,830,420
<TOTAL-ASSETS> 45,371,686
<CURRENT-LIABILITIES> 2,910,024
<BONDS> 0
<PREFERRED-MANDATORY> 0
<PREFERRED> 0
<COMMON> 435,418
<OTHER-SE> 39,724,574
<TOTAL-LIABILITY-AND-EQUITY> 45,371,686
<SALES> 23,081,624
<TOTAL-REVENUES> 23,081,624
<CGS> 7,488,321
<TOTAL-COSTS> 14,484,409
<OTHER-EXPENSES> (578,963)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,687,857
<INCOME-TAX> 734,213
<INCOME-CONTINUING> 953,644
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 953,644
<EPS-BASIC> .13
<EPS-DILUTED> .11
</TABLE>
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