10-K/A

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K/A

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2002

OR

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

For the transition period from                      to                     

Commission File Number: 0-10521

ADVANCED NEUROMODULATION SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Texas (State or other jurisdiction of incorporation or organization)	75-1646002 (I.R.S. Employer Identification No.)
6501 Windcrest Drive, Plano, Texas (Address of principal executive offices)	75024 (Zip Code)

Registrant’s telephone number, including area code: (972) 309-8000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT:

Title of Each Class	Name of Each Exchange on Which Registered
NONE	NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:

Title of Class

Common Stock, $.05 Par Value

     Indicate by checkmark 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 o

     Indicate by checkmark 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. o

     Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes x No o

     Aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant as of June 30, 2002: $349,090,251

     Number of shares outstanding of the registrant’s Common Stock as of March 17, 2003: 12,476,795

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the registrant’s Annual Meeting of Shareholders to be held on June 4, 2003, are incorporated by reference into Part III.

TABLE OF CONTENTS

PART I
	ITEM 1. BUSINESS
	ITEM 2. FACILITIES
	ITEM 3. LEGAL PROCEEDINGS
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
	ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
	ITEM 6. SELECTED FINANCIAL DATA
	ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
	ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
	ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
	ITEM 11. EXECUTIVE COMPENSATION
	ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
	ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
	ITEM 14. CONTROLS AND PROCEDURES
PART IV
	ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Signatures
§302 Certification of Chief Executive Officer
§302 Certification of Chief Financial Officer
Report of Ernst & Young LLP, Independent Auditors
		Consolidated Balance Sheets
		Consolidated Statements of Income
		Consolidated Statements of Cash Flows
		Consolidated Statements of Stockholders’ Equity
		Notes to Consolidated Financial Statements
INDEX TO EXHIBITS
EX-10.19 Escrow Agreement
EX-23.1 Consent of Independent Auditors
EX-99.1 Certification of Chief Executive Officer
EX-99.2 Certification of Chief Financial Officer

Advanced Neuromodulation Systems, Inc.

Annual Report

Form 10-K

Year Ended December 31, 2002

PART I

ITEM 1. BUSINESS

Overview

We design, develop, manufacture and market advanced implantable neuromodulation devices that improve the quality of life for people suffering from chronic pain. Neuromodulation devices include implantable neurostimulation devices, which deliver electric current directly to targeted nerves, and implantable drug pumps, which deliver small, precisely controlled doses of drugs directly to targeted sites within the body. Our products utilize innovative technologies that offer advanced programming features, user-friendly interfaces and smaller implanted devices, resulting in greater patient comfort. We are leveraging our neuromodulation product platforms to develop new pain management products and to expand into new applications.

We market our products to physicians who specialize in managing chronic pain. We define chronic pain as pain that persists or recurs for more than six months, is resistant to conservative therapies and significantly restricts a patient’s normal activities. There are approximately 3,000 pain management specialists in the U.S., approximately 80% of whom are anesthesiologists and approximately 20% of whom are neurosurgeons or orthopedic surgeons, and the number of pain management specialists is growing steadily.

We currently market three principal product lines: our Renew® radio frequency (RF) system, our Genesis® and GenesisXP™ implantable pulse generator (IPG) systems and our AccuRx® implantable drug pump. We have sold Renew in the U.S. since June 1999 for treatment of chronic pain of the trunk and limbs. Renew’s advanced features effectively manage complex and multi-extremity pain patterns and provide pain management specialists with significant programming flexibility. We began selling Genesis in Europe in the first quarter of 2001 and in the U.S. and Australia in January 2002 for treatment of chronic pain of the trunk and limbs. We believe that Genesis offers a superior size-to-function ratio, greater patient comfort, more flexibility in addressing different pain patterns and other technological advances, which provide us with a competitive advantage. Additionally, we recently received approval from the U.S. Food and Drug Administration (FDA) to market an enhanced version of Genesis, the GenesisXP IPG system for treatment of chronic pain of the trunk and limbs, which we launched in the U.S. in the fourth quarter of 2002. The GenesisXP offers substantially more battery capacity than Genesis resulting in enhanced longevity and/or additional power to treat more complex pain. We began selling AccuRx in certain international markets in the second quarter of 2001 and recently completed all implants in a 109 patient clinical trial we are conducting of AccuRx in the U.S. under an investigational device exemption (IDE) from the FDA. AccuRx is smaller than the other constant rate drug pumps currently on the market, and it incorporates a new polymeric diaphragm technology that makes it more precise under varying conditions than other constant rate drug pumps. We expect to file our pre-market approval (PMA) application for AccuRx with the FDA later in 2003.

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Our Hi-tronics Designs, Inc. (HDI) subsidiary, which we acquired in January 2001, designs and manufactures medical devices for us, and for other companies on an O.E.M. (original equipment manufacturer) basis. HDI’s core strength is in developing highly-sophisticated electromechanical devices featuring electronic circuits with very low power requirements. We acquired HDI to leverage its expertise in development and manufacturing and benefit from its technology platforms.

The Neuromodulation Market Opportunity

When treating patients suffering from chronic pain, pain management specialists can select from several therapy options, ranging from the least invasive and lowest-cost therapies to the most aggressive and expensive therapies. Initially, patients typically try over-the-counter medications and physical therapy. If these therapies fail, patients generally try some combination of prescription medications, TENS therapy (application of electrical impulses to the skin), psychological therapy and nerve blocks (injections that provide temporary pain relief). If these therapies do not succeed in relieving pain, patients may then try narcotic and opioid drugs, neurolysis (destruction of the affected nerve) and thermal procedures. At some point during their course of treatment, patients may use neuromodulation products or undergo more invasive surgical procedures.

Patients who opt for neurostimulation or drug pumps to treat chronic pain typically range in age from 25 to 55, have suffered back or neck injuries or otherwise suffer from degenerative spine conditions, and are in constant pain that has not been alleviated by other therapies, including back surgeries. A growing number of patients are choosing neuromodulation over prolonged systemic use of narcotic or opioid drugs, which have negative side effects, or back surgeries involving vertebral fusion or nerve destruction, which are irreversible and often unsuccessful.

The use of neuromodulation devices to manage chronic pain is growing rapidly. According to an independent study, spinal cord stimulation products were forecasted to account for $293.2 million in revenues in 2002 in the United States, up from $239.8 million in 2001. Total neurostimulation revenues for all currently approved indications in the U.S. (including deep brain stimulation, sacral nerve stimulation and other applications) were forecasted to account for $435.7 million in 2002, up from $337.1 million, according to the same study. A separate study reported that in 2001, worldwide sales of drug pumps were approximately $230 million.

The primary factors driving this growth include the following:

• Increased physician and patient awareness of the benefits of neuromodulation. Neuromodulation can manage pain effectively, is minimally invasive, has few side effects and is generally reversible. As physicians and their patients are becoming more aware of these benefits and more accepting of this treatment option, neuromodulation is being used earlier in the process of managing chronic pain. Consequently, the number of pain management specialists worldwide who understand and are trained to use neuromodulation products and techniques is growing steadily.

• Expanded indications for the use of neuromodulation products. Neuromodulation products have demonstrated success in the treatment of indications outside of chronic pain. The recent approval by other companies of the use of these products to address new indications, including essential tremor, Parkinson’s Disease, and incontinence, as well as future approvals to treat angina and severe headaches, should expand the neuromodulation market.

• Technological advances in neuromodulation products. Advances in technology have decreased the size of neuromodulation devices, increased the longevity of their power sources and enhanced programmability and other functional components of the devices, leading to better results for patients.

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• Patients’ increased focus on quality of life. In the past, chronic pain sufferers were often resigned to long-term use of pain-killing drugs, often bedridden and unable to maintain a normal lifestyle. Today, many chronic pain patients hope to resume an active lifestyle following an injury or illness, and thus more likely to consider and accept neuromodulation therapy.

Our Strategy

Our objective is to be a leading provider of a full range of innovative neuromodulation devices for the management of chronic pain and nervous system disorders. To achieve this objective, we are pursuing the following business strategies:

• Expand our presence in the chronic pain market. Through the recent launches of our IPG systems, we have entered a market that is estimated to be four times larger than the RF market, and thus significantly expanded our potential market opportunity. We intend to increase our penetration of the chronic pain market by enhancing our sales and marketing resources. We also intend to leverage our relationships with pain management specialists as well as our favorable track record with our RF systems to grow our market share in the IPG portion of the neurostimulation market and to further strengthen our position in the RF portion of this market.

• Pursue regulatory approvals for new treatment indications. We believe our neurostimulation technology platforms have broad applicability for multiple treatment indications beyond chronic pain conditions. We will pursue regulatory approvals for new clinical applications to treat disorders affecting large patient populations, including essential tremor, Parkinson’s Disease, pelvic pain and severe headaches, where neuromodulation has demonstrated success.

• Continue to build and expand our technology leadership. We have focused on building a corporate infrastructure and core competency in research and development, manufacturing, sales and marketing, reimbursement and regulatory affairs to provide our customers with the highest quality products and services. We believe this strategy will enable us to expand our existing product platforms into new applications and product offerings. We will continue to invest significant resources in the development of our infrastructure and technology platforms to maintain our reputation as a leader in the neuromodulation market.

• Evaluate and pursue acquisitions and strategic alliances. We will pursue acquisitions and strategic alliances that complement our existing neuromodulation business, products and technology platforms and that enhance our product development, technological and marketing capabilities.

Our Products

Within the neuromodulation market, there are two main categories of treatment: neurostimulation, in which an implanted device delivers electrical current directly to targeted nerve sites, and implantable drug pumps, in which an implanted pump delivers drugs directly to a targeted site. We currently market products in both of these treatment categories.

Neurostimulation Therapy Overview

Neurostimulation involves delivering small, mild electrical pulses to the spinal cord or peripheral nerves to inhibit or block the sensation of pain. This stimulation of nerves at or near the site where pain is perceived masks the sensation of pain by generating a tingling sensation or “paresthesia.” Neurostimulation is generally used to manage sharp, intense and constant pain arising from nerve damage or nervous system disorders.

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A neurostimulation system typically consists of a pulse generator that produces electrical current, and an external or internal power source. The pulse generator is generally implanted under the patient’s skin in the abdominal area. Leads, which are catheters that contain electrodes and connecting wires, extend from the pulse generator to the targeted therapy site in the epidural space along the spinal cord. The electrodes are centered on the therapy site and deliver electrical current from the pulse generator to the prescribed area. An external programmer allows the physician and patient to adjust the electrical current to the electrodes to optimize the therapeutic effect.

Implant procedures are most often performed at hospitals on an outpatient basis, with a small percentage of procedures also performed at ambulatory surgery centers and at hospitals on an inpatient basis. In most cases, a patient will receive a trial device for a period of up to two weeks. Based on our experience, more than 70% of patients who undergo a trial procedure elect to receive a permanent implant. Implant procedures cost between $30,000 and $50,000, including the cost of the system. The cost of the system generally ranges from $10,000 to $20,000, depending on whether an RF or IPG system is used, the components utilized and the sophistication of the system selected.

Clinical results demonstrate that the majority of patients who are implanted with a neurostimulation system experience a substantial reduction in pain, an increase in activity level, a reduction in use of narcotics and a reduction in hospitalization. We believe these benefits translate into an overall reduction in healthcare costs as well as a significant improvement in the patient’s quality of life.

Our Neurostimulation Products

We currently have two neurostimulation product platforms that we market worldwide: our Renew RF system, which uses an external power source, and our family of totally implantable IPG systems, Genesis and GenesisXP.

Renew

Renew is the latest generation system in our RF stimulation product line and is the leading technology in the RF stimulation market. We introduced Renew in the U.S. during June 1999 and began selling it in international markets during 2000. The Renew system consists of an implanted RF receiver/pulse generator and leads, and a transmitter containing a power source that is worn externally. The system is powered with the help of an antenna that is attached to the patient’s skin with adhesive tape. Because Renew has a rechargeable, external power source, we believe it is best suited for patients with complex, changing or multi-extremity pain patterns that require higher power levels for treatment.

Genesis

In late 2000, we received regulatory approvals to begin selling our Genesis IPG system in certain international markets, and we commenced sales during the first quarter of 2001. On November 21, 2001, we received FDA approval of Genesis for treatment of chronic pain of the trunk and limbs, and we launched Genesis in the U.S. in January 2002. Additionally, we recently received approval from the FDA to market an enhanced version of Genesis, the GenesisXP IPG system for the treatment of chronic pain of the trunk and limbs, which we launched in the U.S. in the fourth quarter of 2002. The GenesisXP offers substantially more battery capacity than Genesis, resulting in enhanced longevity and/or additional power to treat more complex pain. As a result, we now participate in the largest part of the implantable neurostimulation market, as approximately 80% of neurostimulation implantation procedures performed involve IPG systems and the remainder involve RF systems.

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Like other IPGs, Genesis is totally implanted and contains a power source with a life of two to five years, depending on stimulation parameters. Generally, simple, localized pain sufferers require less power output than complex, multi-site pain sufferers. These patients and their physicians will usually select an IPG in order to benefit from the convenience of a totally implantable system.

Our Neurostimulation Technologies

Although our Renew and Genesis systems differ in certain significant respects, they share similar technology platforms and benefits, including:

• Greatest number of electrodes. Our Renew system is the only product on the market that can accommodate up to 16 electrodes. In addition, our IPG systems not only allow the use of two quadrapolar, or 4-electrode, leads, but also allow the use of one octapolar, or 8-electrode, lead. A greater number of electrodes results in more comprehensive coverage along the spine, and provides physicians with increased flexibility in accommodating a patient’s changing pain patterns. This advantage may also enable a physician to address the problem of lead “migration”, or lead movement along the spine after implant, noninvasively by reprogramming the patient’s stimulation, rather than using an invasive procedure to revise the placement of the lead. We estimate that lead migration occurs in 10% to 15% of cases.

• Advanced programmability. Our technologies allow physicians to program the system for rapid and sequential delivery of multiple stimulation programs to cover large, complex pain patterns. Additionally, our systems enable a large number of program choices that allow patients to select a number of different stimulation programs to optimize treatment as pain patterns change. We have also developed PainDoc®, a Windows-based proprietary computerized support system that serves as a programming tool for Renew, Genesis and GenesisXP.

• Innovative and patented technology. Our neurostimulation devices offer our advanced patented technology, which allows programmability of each individual electrode to a “tri-state” position, either positive, negative or neutral. This provides added flexibility in directing the flow of stimulation and is a valuable tool in addressing lead migration.

• Reduced size of implanted device. Our Renew receiver, our Genesis IPG and GenesisXP offer smaller “size-to-power” ratios than comparable products currently on the market, which results in enhanced patient comfort.

• Ease of lead implantation. Our leads are designed for ease of implantation, which makes the procedure easier for physicians to perform and reduces the time required to complete the procedure.

• User-friendly interface. Our neurostimulation devices have easy-to-use controls and interactive displays that include a stimulation diagram for quick visual confirmation of stimulation coverage.

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     The following table summarizes some of the key features of the Renew and Genesis systems:

PRODUCT FEATURES	RENEW	GENESIS
Implanted Elements	receiver/pulse generator, leads	Pulse generator/power supply, leads
External Elements	programmer, transmitter/power supply, antenna	Programmer
Battery	external, rechargeable and replaceable	internal with 2-5 year life, depending on program settings and system use
Programming Control	Up to 24 programs, plus some patient control	Up to 24 programs
Lead and Electrode Capacity	1 to 4 leads utilizing up to 16 electrodes	1 or 2 leads utilizing up to 8 electrodes

Our Implantable Drug Pump Product — AccuRx

Implantable drug pumps deliver precise doses of medication directly to a targeted site. This direct drug delivery creates a higher drug concentration at the site, which can often provide faster relief with much lower quantities of medication. For example, the difference in intraspinal versus oral morphine dosage is approximately 1:300. These lower dosages help to minimize side effects, and are more economical for the patient and the third-party reimbursement system. Today, implantable drug pumps are used for the delivery of morphine for the treatment of pain (such as cancer or arthritis pain), baclofen for spasticity and other movement disorders, and for the intra-arterial delivery of various drugs for chemotherapy.

Implantable drug pumps consist of the pump and a catheter. The pump contains a reservoir that holds the drug and regulates the drug’s delivery rate. The pump is implanted under the skin in the abdominal area and is connected to the catheter, which is tunneled under the skin into either the epidural or intrathecal space of the spinal column. Implantation procedures are most often performed at hospitals on an outpatient basis, with a small percentage of procedures also performed at ambulatory surgery centers and at hospitals on an inpatient basis. The pump is refilled by placing a needle through the skin into an access port on the pump and injecting the drug into the reservoir.

Currently, there are two basic types of implantable drug pumps — constant rate and programmable. Constant rate pumps provide drug infusion at a single, continuous flow rate that cannot be changed once the pump has been implanted in the patient. Programmable pumps allow the rate of drug delivery to be non-invasively changed to meet the patient’s needs. According to an industry report, in 2001, worldwide sales of programmable drug pumps were approximately $207 million, as compared with worldwide sales of constant rate drug pumps of $23 million.

We currently offer one drug pump product, our AccuRx constant rate drug pump. We received regulatory approvals to distribute AccuRx in certain international markets for the delivery of morphine and began selling AccuRx in those markets in the second quarter of fiscal 2001. We also received an

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IDE from the FDA to initiate clinical trials in the U.S. for the delivery of morphine. The clinical trials included 15 sites and 109 patients, all of whom have now been implanted with AccuRx systems. These trials will provide data to support our PMA for U.S. market introduction. We expect to file our PMA application with the FDA later in 2003.

AccuRx is currently the only constant rate drug pump that is powered by our proprietary polymeric diaphragm, rather than by pressurized gas in a chamber surrounding the drug reservoir. The advantages of this design are that our pump is more precise under varying conditions (because its operation is not affected by changes in the body’s temperature or pressure), simpler to manufacture, smaller than other drug pumps on the market and can hold more drug for its size than competing products.

Financial Segments

We operate in two business segments. The Neuro Products segment designs, develops, manufactures and markets implantable medical devices that are used to manage chronic intractable pain and other disorders of the central nervous system through the delivery of electrical current or drugs directly to targeted nerve fibers. The HDI O.E.M. segment provides contract development and O.E.M. manufacturing of electro-mechanical devices. See Note 12 to the Consolidated Financial Statements for segment financial data for the years ended December 31, 2002, 2001 and 2000.

Sales and Marketing

General

We target our sales and marketing efforts at pain management specialists, which include anesthesiologists, neurosurgeons and orthopedic surgeons. Because most pain management specialists implant both RF and IPG devices, as well as drug pumps, we expect to leverage our relationships and experience with pain management specialists and track record with our RF systems to establish our position in the IPG portion of the neurostimulation market. Additionally, by rounding out our product offerings with our IPG systems, we are now able to target physicians who have historically implanted only IPGs.

In 2002, we derived 92% of our net revenues for neuromodulation products from domestic sales and approximately 8% from international sales.

U.S.

With our March 2003 acquisition of Sun Medical’s pain management business, we have expanded our domestic sales force. In the domestic market, we currently use a hybrid sales force, which now consists of 25 direct sales people (including 10 people we hired from Sun Medical), 15 people employed by 2 independent distributors, and 48 commissioned sales agents. We typically have contracts with all of our distributors and sales agents that provide for exclusive territories and sales quotas.

Our independent distributors cover defined geographic territories, focus predominantly on the chronic pain market and devote the majority of their selling efforts to our products. We sell our products to our distributors at a discount from our list prices, and, in turn, the distributors sell the products, invoice their customers and collect their receivables.

Our sales agents cover defined geographic territories and focus predominantly on the pain management market. Many of our sales agents sell our products as their flagship product line. We pay

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our sales agents commissions at contractual rates, and we invoice and collect revenues from end users.

We also employ seven regional sales managers who interact with our customers and oversee our independent distributors, commissioned sales agents and direct sales people, a Director of North American Sales and a Vice President of North American Sales, who both coordinate the sales efforts of our distribution network in North America.

Our domestic marketing programs include:

• medical marketing programs intended to educate physicians and their staffs about our products and their use;

• surgical training programs offered to physicians interested in improving their surgical techniques;

• education materials, such as brochures and videos, to educate patients and physicians;

• reimbursement assistance, with the help of outside consultants, to assist physicians in obtaining appropriate reimbursement for our products and their services;

• consulting relationships with opinion leaders who provide us feedback about our current and future products, diagnostic and treatment trends and other areas of interest;

• web site marketing focused on educating both physicians and patients about our product alternatives, reimbursement for our procedures and our company;

• medical journal advertisements; and

• involvement in medical device societies and conferences.

International

Internationally, we market our products through 18 independent distributors who represent us in 22 countries. We are represented by direct salespersons employed by us in Germany. Our Director of International Operations, who is based in the United Kingdom, manages our international distribution network. We are in the process of training and signing independent distributors to market our products in additional countries.

Customer Service

Our sales representatives are responsible for training physicians and nurses on programming and trouble-shooting any problems with our RF and IPG systems. Both the RF and IPG systems have up to 24 different program settings, which can be programmed and saved into memory. Therefore, significant training of physicians and nurses is required for new users of our product. We typically provide a warranty against defects in workmanship and materials for one year from the date of sale of our products to end-users.

Major Customers

During 2002, 2001 and 2000, we had one major customer that accounted for 10% or more of our net revenue from our Neuro Products segment. Sun Medical, Inc., a specialty distributor, accounted for $6.3 million, or 13.5% of our Neuro Products segment revenue for the year ended December 31, 2002,

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$4.2 million, or 15% of our Neuro Products segment revenue for the year ended December 31, 2001 and $3.2 million, or 14% of our Neuro Products segment revenue for the year ended December 31, 2000. In March 2003, we acquired Sun Medical’s pain management business and hired substantially all of the salespeople who had accounted for those sales. See Note 13 of the Notes to Consolidated Financial Statements.

During the year ended December 31, 2002, we had two major customers that accounted for $9.52 million, or 89.3% of net revenue from our O.E.M. segment. Medtronic, Inc., our most significant competitor, accounted for $6.74 million, or 63.2% and Arrow International, Inc. accounted for $2.78 million, or 26.1%. During the year ended December 31, 2001, we had three major customers that accounted for 10% or more of net revenue from our O.E.M. segment: Medtronic, Inc. accounted for $6.3 million, or 60%; Arrow International, Inc. accounted for $1.8 million or 17%; and Transneuronix, Inc. accounted for $1.1 million or 11%. For the year ended December 31, 2000, we had three major customers that accounted for 10% or more of net revenue from our O.E.M. segment: Medtronic, Inc. accounted for $4.3 million, or 49%; Exogen accounted for $2.1 million, or 24%; and Cyberonics, Inc. accounted for $1.5 million, or 17%.

HDI currently manufactures two products for Medtronic, one of which accounts for substantially all of the revenue generated from this customer. This product is manufactured under an exclusive Supply Agreement that expires on January 1, 2005. The terms of the Supply Agreement require Medtronic to purchase its requirements for the device from us through March 31, 2004 and then at least 50% of its requirements through January 1, 2005. The device is sold in the cardiology market and is not competitive with any of our products. The Supply Agreement provides that either party may terminate the agreement prior to January 1, 2005 in the event of a material breach or nonperformance. Additionally, Medtronic can terminate the Supply Agreement prior to January 1, 2005 by paying us a termination fee. Arrow International has engaged HDI to develop a new cardiology product under a Product Development and Manufacturing Agreement. Development is likely to be completed during 2003. At the conclusion of the development, Arrow will likely seek PMA approval from FDA to market and sell the device. Under the agreement with Arrow, HDI has ongoing rights to manufacture the products for clinical trials and subsequent market release if the product is approved.

Research and Development

We currently have an in-house research and development staff of 55 people. In 2002, we spent $5.84 million (10.2% of total net revenue) on research and development, and we expect to increase our investment in research and development and clinical trials for 2003 to approximately $7.9 million.

Our current research and development efforts include work on the following:

• An IPG stimulation system to address occipital headaches (frequent severe headaches that begin in the back of the head and migrate forward). During the first quarter of 2001, we initiated a pilot clinical study in the U.S., which consisted of 10 patients at 2 sites, to evaluate the efficacy of Genesis for treating occipital headaches. We completed the pilot study during the second quarter of 2002, and the data will be used to determine the parameters for a larger pivotal clinical study to support a PMA application for Genesis to treat occipital headaches. There are approximately one million patients in the U.S. alone who suffer from occipital headaches.

• IPG stimulation systems for deep brain stimulation to address essential tremor, Parkinson’s Disease and other indications.

• New applications of our neurostimulation systems to address angina, peripheral vascular disease and sacral nerve stimulation for pelvic pain and incontinence.

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• Next-generation IPG and RF neurostimulation systems.

• Next-generation drug pumps, including a prototype programmable pump that will take several years to develop, and new applications for drug pumps.

• Clinical trials that we expect to initiate on several of our new products upon IDE approval from the FDA.

Hi-tronics Designs, Inc.

Our HDI subsidiary developed and is the manufacturer of our Genesis IPG and GenesisXP IPG, and is also the manufacturer of the transmitter used with Renew. HDI’s core strength is in developing highly sophisticated electromechanical devices featuring electronic circuits with very low power requirements, utilizing both discrete and highly integrated technology. Combined with our capabilities in the design and manufacture of implantable leads, electronic device control and communication systems and implantable drug pumps, we believe this expertise will allow us to develop more sophisticated products in less time.

As an O.E.M. manufacturer, HDI has developed and introduced more than 60 medical devices for leading medical device companies in the fields of cardiology, neurology and orthopedics. Through HDI, we offer our customers complete development and manufacturing services, beginning with product definition and design and continuing through validation, prototyping, regulatory approval and manufacturing. In 2002, our O.E.M. operations accounted for 18.6% of our consolidated revenues. We expect this percentage to continue to decrease as our neuromodulation sales continue to grow and as we continue to utilize more of HDI’s manufacturing and development capabilities for our own needs.

Manufacturing

We operate two manufacturing facilities: one in Plano, Texas and the other in Hackettstown, New Jersey. We assemble and package the majority of our neurostimulation devices and implantable drug pumps at our Plano facility. We also manufacture a variety of medical devices and products on an O.E.M. basis in our Hackettstown facility.

Our manufacturing processes largely consist of the assembly of standard and custom components that we purchase from third-party subcontractors, functional testing to ensure adherence to specifications and inspection of completed products, and the manufacture of our own leads and drug pumps. Our implantable devices are assembled and sterilized in a “clean room” environment designed and maintained to reduce product exposure to particulate matter.

We rely on third-party suppliers for most of our products’ components and on single suppliers for several critical components used in our main products, including the computer chip used in the receiver of our RF system, the computer chip used in the IPG programmer and Renew transmitter, the batteries used in our IPG systems and the medical-grade polyurethane (bionate) that we and our competitors use in our products. We have been notified by the supplier of the computer chip used in the receiver of our RF system that it will cease manufacturing and supplying the computer chip in the future, but to date it has not determined when this will occur. This supplier has agreed to 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 working to develop a new product design that uses an alternative computer chip.

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We currently have sufficient manufacturing capacity to support our business plan until we construct and relocate to our new corporate headquarter facility in mid-2004. See Item 2 “Facilities”. We have no backlog.

Intellectual Property

We rely on a combination of patents, trade secrets, know-how, trademarks and agreements to protect our intellectual property. We currently own or hold exclusive field of use licenses to 26 U.S. and 7 foreign patents relating to our stimulation systems’ electrode, receiver, transmitter and programmer technology and our fully-implantable drug pump technology. These and other co-owned and non-exclusively licensed patents cover important aspects of both our RF and IPG stimulation systems for a wide range of current and future applications. We currently have 35 pending U.S. patent applications assigned to us, and 18 pending 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.

U.S. Patent No. 4,793,353 covers a non-invasive multiprogrammable tissue stimulator and method wherein only the programming data need be transmitted. The programming data may define the stimulator’s electrode selection, electrode polarity as either positive, negative or high impedence state, and simulation pulse parameter. This patent is scheduled to expire on December 27, 2005. The expiration of this patent may allow competitors to offer programmable stimulators that define electrode selection, polarity and stimulation pulse parameters, and thus could have an adverse effect on our business. A request for an extension of the term of this patent has been filed with the United States Patent Office pursuant to a federal statute that permits us to seek such an extension based on a regulatory approval delay. A final ruling on the extension request has not been made at the present time. While six other U.S. patents owned or licensed by us are due to expire prior to 2006, the expiration of these other patents would not have a material effect on our ability to protect the intellectual property rights currently utilized in our business, because the patents cover technologies that are not currently utilized in our existing products or services.

We have developed technical knowledge, which, although non-patentable, we consider to be significant in enabling us to compete. However, the proprietary nature of such knowledge may be difficult to protect. We have entered into agreements with each of our key employees prohibiting such employees from disclosing any of our confidential information or trade secrets or engaging in any competitive business (as defined in the agreements) while the employee is working for us and for a period of one year thereafter. In addition, these agreements also provide that any inventions or discoveries by these individuals relating to our business will be assigned to us and become our sole property.

We own a number of U.S. trademark registrations, including AccuRx®, Advanced Neuromodulation Systems®, ANS & Design®, PainDoc®, Renew®, and Genesis®. U.S. trademark applications are pending for various trademarks that we believe have value (or will have value) in the marketplace, including Life Gets Better™. We also own trademark registrations and applications in countries outside of the U.S. One of our trademarks, “Quattrode,” is due to expire prior to 2006. Two trademarks, PC-Stim and Compustim, will require a Section 8 statement of use prior to 2006. We intend to renew the marks prior to their expiration and retain our trademark registration rights.

Competition

We are a small company competing in a large and rapidly growing market. We believe that the principal competitive factors in the neuromodulation market are the quality, performance, cost-effectiveness, ease of use, customer service and technical innovation of neuromodulation devices and the existence and benefits of cost-effective alternative therapies.

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Our only significant competitor at this time in the neurostimulation portion of the market is Medtronic, one of the world’s largest medical device companies, which has substantially greater resources and marketing power than we do. The neuromodulation market is one of Medtronic’s fastest growing segments. Competitive pressures could increase in the future as Medtronic attempts to secure and grow its position in the neuromodulation market. In the constant rate drug pump portion of the market, our principal competitors are Medtronic and Johnson & Johnson.

We believe the neuromodulation market is a high growth-potential market and that other companies are attempting and will attempt in the future to bring new products or therapies into this market. Barriers to entry by new competitors are high, due to a long and expensive product development and regulatory approval process and the intellectual property and patent positions existing in the market. However, other medical device companies may be able to enter the neuromodulation market by leveraging their existing technologies into neuromodulation platforms, thereby decreasing the time and resources required to enter the market. For example, we are aware that Advanced Bionics, Inc., a privately-held California-based company that currently manufactures and markets a cochlear implant, is developing and may be testing an IPG system for the treatment of chronic pain.

Government Regulation

In the U.S., we are subject to regulation by numerous governmental authorities, principally the FDA. The research and development, manufacturing, promotion, marketing and distribution of our products in the U.S. 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 the procedures set forth in the FDC Act and Regulations. Both of our manufacturing operations are required to comply with the FDA’s Quality System Regulations, commonly referred to as QSR. QSR addresses design controls and methods, facilities and quality assurance controls used in manufacturing medical devices.

The FDA has traditionally pursued a rigorous enforcement program to ensure that regulated entities 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, rescission of marketing permits, injunctive actions or civil penalties and criminal prosecutions of the company or responsible employees, officers and directors. The FDA last inspected our Plano facility in March 2003 and our Budd Lake and Hackettstown facilities in July 2002, and no Inspectional Observations were found at any of these locations.

The process of obtaining FDA clearance can be lengthy, expensive and uncertain. Under the FDA’s requirements, a new medical device cannot be released for commercial use until a PMA application 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. Either a 510(k) or a PMA, if granted, may include significant limitations on the indicated uses for which a product may be marketed, and 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, with the exception of our Genesis and GenesisXP IPGs, 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 us to undertake the lengthier and more costly PMA submission process.

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On October 26, 2002, President Bush signed The Medical Device User Fee and Modernization Act of 2002 (MDUFMA), amending the Federal Food, Drug, and Cosmetic Act.

Under MDUFMA, we and other medical device manufacturers with gross sales or receipts of $30 million or more will be required to pay a user fee to the FDA for PMA and 510(k) reviews. According to the FDA, the user fees provided by MDUFMA, and the additional appropriations that go with the new law, are intended to ensure that safe and effective medical treatments will reach patients more rapidly, provide greater certainty that manufacturers will receive timely, high quality reviews, and provide resources to ensure that devices marketed in the United States continue to meet high standards for safety and effectiveness. The fee for PMA applications is $154,000 and the fee for 510(k) applications is $2,187. Fees for supplements range from $11,088 to $154,000, depending on the type of supplement. The FDA will adjust these fees each year to account for inflation, changes in workloads, and other factors. The FDA will announce the new fees for the next fiscal year in a Federal Register notice by August 1 of each year. Although MDUFMA requires that a fee must be paid for each premarket application, premarket report, supplement or 510(k) submitted on or after October 1, 2002, under the provisions of the new legislation, before the FDA can begin collecting fees, Congress must also pass an appropriation act providing for the new medical device fees. The FDA must also develop systems to collect, safeguard, process, and account for fees. For these reasons, the FDA has not yet commenced collecting these fees. While we do not anticipate that compliance with MDUFMA will have a material adverse effect on our financial results, MDUFMA will increase the cost of regulatory compliance.

Medical device laws are also in effect in many of the countries outside the U.S. in which we do business. These laws range from comprehensive device approval and quality system requirements for some or all of our products to simpler requests for product data or certifications. The number and scope of these requirements are increasing and, as we expand our business into new jurisdictions, we will be subject to additional laws. In June 1998, the European Union Medical Device Directive became effective, and all medical devices sold in Europe must now meet the Medical Device Directive standards and receive CE Mark certification. CE Mark certification involves a comprehensive quality system program and submission of data on a product to the Notified Body in Europe. The Medical Device Directive and the ISO 13485 standard are recognized international quality standards that are designed to ensure that companies develop and manufacture quality medical devices. Our Plano facility was audited in November 2002, and our Budd Lake and Hackettstown facilities were audited in April 2002, for compliance with the Medical Device Directive and ISO 13485, and all three facilities are certified to these standards.

The financial arrangements through which we market, sell and distribute our products are subject to federal and state laws and regulations in the U.S. with respect to patients who are Medicare or Medicaid beneficiaries. These laws include “fraud and abuse” and physician anti-referral laws and regulations. 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 all patients, as opposed to just Medicare and Medicaid beneficiaries. Additionally, our financial arrangements with our customers may be subject to increasing regulation in the future, due to proposed health reform initiatives. Although we do not believe that we will need to undertake any significant expense or modification to our manufacturing operations or the conduct of our business to comply with current or proposed federal or state fraud and abuse or physician anti-referral laws or regulations, if we do not comply with any such laws or regulations, our business practices could be adversely affected, and we may also be affected in other respects not presently foreseeable that could have an adverse impact on our business, financial condition and results of operations.

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Third-Party Reimbursement

Hospitals and ambulatory surgery centers are the primary purchasers of neuromodulation products. These primary purchasers then bill various third-party payors for the neuromodulation products and procedures they provide to their patients. In the U.S., these third-party payors include Medicare and Medicaid, private insurance companies and managed care organizations, and workers’ compensation programs. Third-party payors carefully scrutinize whether to cover new products and the level of reimbursement for covered products, and coverages and reimbursement levels for neuromodulation products vary among these three primary purchasing groups and the healthcare setting in which physicians perform procedures, and change from year to year.

Internationally, reimbursement levels and coverages for neuromodulation products vary significantly among the countries in which we do business due to the wide variety of health care payment systems in these countries, which include both government-sponsored health care and private insurance.

We currently employ seven individuals within our sales and marketing department who work solely on issues related to third-party reimbursement. The responsibilities of these employees include assisting and training physician practices and medical facility staffs in obtaining pre-authorization and confirmation of amount of reimbursement for our products, working with third-party payors as they periodically evaluate reimbursement coverages and levels, and communicating updates on reimbursement information to our sales force.

Employees

As of February 27, 2003, we employed 291 full-time employees, including 55 in research and development, 59 in sales and marketing (including support personnel), 152 in manufacturing and related operations, and the remainder in executive and administrative positions. None of our employees are represented by a labor union and we consider our employee relations to be good.

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Website and Availability of SEC Reports

Our website is located at www.ans-medical.com. We post our most recent annual report on Form 10-K and quarterly reports on Form 10-Q filed subsequent to our most recent annual report on Form 10-K on our website under the heading Investors/Financial Information, and make our current reports on Form 8-K and other SEC filings available through our website by way of a link to www.freeedgar.com under the heading “Click here for additional financial information.” We have began posting our current reports on Form 8-K on our website when we electronically file them with the SEC.

ITEM 2. FACILITIES

We entered a 63-month lease agreement, which became effective on June 1, 1999, for our 40,000 square foot corporate headquarters and manufacturing facility in Plano, Texas. In September 2002, we amended our lease agreement to add approximately 9,700 square feet of office space located in the same complex as our 40,000 square foot corporate headquarters. The lease on the additional space expires during August 2004, the same as the corporate headquarters facility. We have two five-year renewal options on the facilities.

Because we expect our business to continue to grow at rates that will demand added office and facility space, we acquired approximately 10 acres of land in December 2002 for approximately $3.19 million. The land is located in Plano, Texas near our current corporate headquarters. We intend to build a new corporate headquarters facility on the land and relocate to the new facility upon the expiration of our lease in August 2004. We are designing the new facility to accommodate planned growth within a five-year horizon and anticipate that the facility once constructed, will be 140,000 to 150,000 square feet and will cost between $16 million and $17 million.

We also lease facilities in New Jersey as a result of our acquisition of HDI. One of the facilities, located in Budd Lake, New Jersey, is 10,348 square feet of office space that is used for administration, design engineering, drafting, documentation and regulatory affairs. We renewed the lease in March 2002 and the lease now expires on February 28, 2004. Our Budd Lake lease contains no renewal option. We also lease 18,582 square feet of space in Hackettstown, New Jersey used for our O.E.M. manufacturing operations. We renewed the Hackettstown lease on December 31, 2002 and the lease now expires on December 31, 2005 and is renewable for one additional three-year period.

ITEM 3. LEGAL PROCEEDINGS

We are a party to product liability claims and other ordinary routine litigation claims arising in the ordinary course of business related to our neurostimulation devices. Our product liability insurers have assumed responsibility for defending us against product liability claims, subject to reservation of rights in certain cases. Historically, product liability claims for our neurostimulation devices have not resulted in significant monetary liability beyond our insurance coverage. We seek to maintain appropriate levels of product liability insurance with coverage that we believe is comparable to that maintained by companies similar in size and serving similar markets.

Except for ordinary course product liability claims and other ordinary routine litigation incidental to our business, 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.

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

Inapplicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is currently quoted on the Nasdaq National Market under the symbol “ANSI.” On March 17, 2003, there were approximately 578 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.

2001:	High		Low
First Quarter	$	26.88	$	11.00
Second Quarter	$	26.00	$	10.63
Third Quarter	$	25.85	$	19.00
Fourth Quarter	$	35.55	$	20.02

2002:	High		Low
First Quarter	$	36.20	$	28.52
Second Quarter	$	33.80	$	28.50
Third Quarter	$	36.92	$	24.92
Fourth Quarter	$	37.73	$	28.51

2003:	High		Low
First Quarter (through March 17, 2003)	$	38.84	$	34.16

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.

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Equity Compensation Plan Information

As of December 31, 2002

						Number of securities
						remaining available
		Number of securities				for future issuance
		to be issued upon		Weighted-average		under equity compensation
		exercise of outstanding		exercise price of		plans (excluding
		options, warrants		outstanding options,		securities reflected in
Plan category		and rights		warrants and rights		column (a))
Equity compensation plans approved by security holders(2)			1,599,794	$	13.24		26,950
Equity compensation plans not approved by security holders(1)(2)			426,625	$	22.40		6,192
	Total		2,026,419	$	15.17		33,142

(1)	Executive officers and members of the Board of Directors are not eligible to receive stock option grants under non-shareholder approved plans.
(2)	Certain of the plans allow the aggregate number of shares of common stock reserved for options under the plan to 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).

Equity Compensation Plans Not Approved by Security Holders. In April 2001, the Board of Directors adopted the 2001 Employee Stock Option Plan (the 2001 Plan). The purpose of the 2001 Plan is to furnish additional equity incentives to key employees of the Company, other than executive officers of the Company. Members of the Board of Directors are also ineligible to participate in the 2001 Plan. The additional equity incentives are designed to increase shareholder value and to advance the interests of the Company by furnishing incentives to attract and retain the best available personnel for positions of substantial responsibility and to provide incentives to such personnel to promote the success of the business of the Company and its subsidiaries. The total number of shares of common stock issuable under the 2001 Plan is 180,000, subject to an adjustment on January 1 of each year (commencing on January 1, 2002), when the aggregate number of shares of common stock then issuable upon the exercise of options will 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 the percentage is positive). On January 1, 2002 and 2003, 33,192 shares and 77,048 shares, respectively were added to the 2001 Plan pursuant to this provision. All options granted under the 2001 Plan will be “nonqualified stock options” under the Internal Revenue Code of 1986, as amended from time to time. All stock option grants under the 2001 Plan 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. The exercise price of an option granted under the 2001 Plan is determined by the Stock Option Committee, but in no event can be less than the fair market value of the common stock at the time the stock option is granted.

In June 2002, the Board of Directors adopted the 2002 Stock Option Plan (the 2002 Plan). The purpose of the 2002 Plan is to furnish additional equity incentives to advisory directors, consultants and key employees of the Company, other than executive officers of the Company. Members of the Board of Directors are also ineligible to participate in the 2002 Plan. The additional equity incentives are

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designed to increase shareholder value and to advance the interests of the Company by furnishing incentives to attract and retain the best available advisory directors, consultants and key employees for positions of substantial responsibility and to provide incentives to such advisory directors, consultants and key employees to promote the success of the business of the Company and its subsidiaries. The total number of shares of common stock issuable under the 2002 Plan is 225,000, subject to an adjustment on January 1 of each year (commencing on January 1, 2003), when the aggregate number of shares of common stock then issuable upon the exercise of options will 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 the percentage is positive). On January 1, 2003, 81,315 shares were added to the 2002 Plan pursuant to this provision. All options granted under the 2002 Plan will be “nonqualified stock options” under the Internal Revenue Code of 1986, as amended from time to time. All stock option grants under the 2002 Plan expire six years from the date of grant for advisory directors and consultants and ten years from the date of grant for key employees. For the most part, stock option grants to key employees under the 2002 Plan are exercisable one-fourth each year over a four-year period of continuous service while stock option grants to advisory directors and consultants vary from one-half each year over a two-year period of service to one-fourth each year over a four-year period of service. The exercise price of an option granted under the 2002 Plan is determined by the Stock Option Committee, but in no event can be less than the fair market value of the common stock at the time the stock option is granted.

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ITEM 6. SELECTED FINANCIAL DATA

			Years Ended December 31,
			2002		2001		2000			1999		1998
			(in thousands, except per share data)
Statements of Income Data:(1)(2)
	Net revenue(3)		$	57,372	$	37,916	$	31,827		$	26,879	$	23,417
	Total net revenue			57,372		37,916		31,827			35,779		26,517
	Gross profit			36,713		22,241		17,127			23,852		17,093
	Research and development expense			5,843		4,928		3,854			4,097		2,790
	Marketing, general and administrative and amortization expenses			21,622		14,504		12,328			11,286		10,701
	Income from operations			9,248		2,809		945			8,469		3,602
	Net income from continuing operations			6,684		1,518		832			5,817		2,327
	Loss from discontinued operations			—		—		—			—		(212	)
	Gain on the sale of assets of discontinued operations			—		—		—			—		4,585
	Net income from discontinued operations			—		—		—			—		4,373
	Net income		$	6,684	$	1,518	$	832		$	5,817	$	6,700
	Diluted income per share:
		Continuing operations	$	.56	$	.15	$	.09	$		.64	$	.24
		Discontinued operations	$	—	$	—	$	—	$		—	$	.45
		Net income	$	.56	$	.15	$	.09	$		.64	$	.69

		December 31,
		2002		2001		2000		1999		1998
		(in thousands)
Balance Sheet Data(2):
	Cash, cash equivalents, certificates of deposit and marketable securities	$	96,770	$	11,937	$	11,599	$	9,736	$	13,982
	Working capital		114,280		24,906		22,211		17,626		18,042
	Total assets		158,344		55,865		49,565		48,407		49,546
	Short-term notes payable and current maturities of long-term notes payable		—		52		30		—		3,633
	Notes payable, excluding current maturities		—		137		212		—		1,000
	Stockholders’ equity	$	145,045	$	46,812	$	40,442	$	36,536	$	34,769

(1)	On January 30, 1998, we sold our cardiovascular and intravenous fluid delivery product lines (CVS Operations). The CVS Operations have been accounted for as discontinued operations.
(2)	On January 2, 2001, we completed the acquisition of Hi-tronics Designs, Inc. The transaction was accounted for on a pooling of interests basis and accordingly, prior periods have been restated.
(3)	Net revenue excludes contract research and development revenue in 1998 and 1999 from our former agreement with Sofamor Danek.

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The following is a reconciliation of previously reported amounts with restated amounts for total net revenue and net income:

		Years Ended December 31,
		2000			1999			1998
		(in thousands)
Reconciliation of total net revenue:
	As previously reported by the Company	$	23,082		$	29,478		$	20,106
	HDI, for the year ended November 30		10,366			7,989			6,746
	Elimination of intercompany transactions		(1,621	)		(1,688	)		(335	)
	Total net revenue as restated	$	31,827		$	35,779		$	26,517
Reconciliation of net income:
	As previously reported by the Company	$	954		$	6,003		$	6,959
	HDI, for the year ended November 30		28			328			(174	)
	Elimination of intercompany transactions		(150	)		(514	)		(85	)
	Net income as restated	$	832		$	5,817		$	6,700

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Background

We entered the neuromodulation market in 1995 through the acquisition of a company that had developed and marketed a radio-frequency (RF) neurostimulation system. In 1998, we elected to reposition our business to focus exclusively on the neuromodulation market. Implementation of this strategy involved selling our cardiovascular and intravenous fluid product lines in January 1998. Through our initiatives, we developed and launched our next generation neurostimulation system, the Renew® RF spinal cord stimulation system, in 1999. We also recently developed our Genesis® and GenesisXP™ totally implantable pulse generator (IPG) spinal cord stimulation systems. We began selling Genesis in Europe in 2001 and in the U.S. in 2002 subsequent to the FDA’s approval of our PMA application in November 2001, and our GenesisXP IPG system following FDA approval, in the fourth quarter of 2002.

In 2000, we completed development of AccuRx, our constant rate implantable drug pump, in part using proprietary technology we licensed from Implantable Devices Limited Partnership (IDP). We initiated U.S. clinical trials of AccuRx under an Investigational Device Exemption (IDE) in the first quarter of 2001, and began selling AccuRx in certain international markets in the second quarter of 2001. On January 2, 2001, we strengthened our position in the neuromodulation market by acquiring the assets of IDP and ESOX Technology Holdings, LLC (ESOX) for 119,100 shares of our common stock valued at approximately $2.43 million. This acquisition provided us with intellectual property surrounding implantable drug pump technologies in all applications, including pain and cancer therapy.

Also on January 2, 2001, we completed the acquisition of HDI, a privately-held O.E.M. developer and manufacturer, for approximately 1.1 million shares of our common stock. We accounted for this acquisition using the pooling of interests method and, accordingly, the financial information for all periods prior to the acquisition has been restated. Prior to the acquisition, HDI developed and manufactured our Genesis IPG as well as the transmitter for our Renew system. Acquiring HDI provided us with additional in-house expertise in the design and manufacture of highly sophisticated electromechanical devices. Combined with our capabilities in the design and manufacture of implantable leads, electronic device control and communication systems and implantable drug pumps, we believe HDI’s expertise will allow us to develop more sophisticated products in less time. Additionally, HDI continues to provide contract development and manufacturing services to third parties, which we report as a separate segment for financial reporting purposes (the O.E.M. segment). For the year ended December 31, 2002, our O.E.M. segment provided $10.66 million or 18.6% of our total revenue. In the future, we expect our O.E.M. segment revenue to decrease as a percentage of our total revenue as we grow revenue from our proprietary neurostimulation systems and drug pumps and increasingly utilize HDI’s research and development capabilities for internal product development.

In November 2002, we completed the acquisition of MicroNet Medical, Inc., a privately-held developer of medical devices based on proprietary micro-lead technology. MicroNet developed a line of very thin and steerable spinal cord stimulation leads called Axxess™. These leads are the smallest neurostimulation leads on the market, which we believe offers advantages in certain applications. Under the terms of the transaction, which we structured as a merger, we acquired only MicroNet’s proprietary technology and certain associated tangible assets. MicroNet’s operations, other tangible assets, certain liabilities and certain employees became part of a separate unaffiliated company. We assumed no material debt, liabilities, or overhead in the transaction. At closing, we paid the former

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MicroNet shareholders $500,000 in cash and 156,302 shares of our common stock with a value at the time of issuance of $4,648,421. In addition, we incurred expenses of $859,460, including an investment-banking fee of $600,000. In March 2003, subsequent to the 2002 fiscal year, we paid the former MicroNet shareholders an aggregate of 28,346 shares of our common stock with a value at the time of issuance and release from escrow of $1,020,173 upon the successful completion of half of the first product milestone, and the former MicroNet shareholders may receive additional shares of our common stock if certain additional product, regulatory approval and sales milestones are met. The aggregate value of the additional potential milestone earnout payments was $9 million as measured at the time the transaction was completed. Important additional product milestone deadlines occur twelve and eighteen months following the closing, while other milestones depend on the receipt of regulatory approvals and meeting an aggregate sales milestone. All milestones must be met within the next four to five years, depending on the milestone.

Our current neuromodulation product line includes our Genesis IPG system, GenesisXP IPG system, Renew RF system and AccuRx constant rate drug pump. With the launch of our Genesis and GenesisXP IPG systems, we now compete in 100% of the implantable neurostimulation market to treat chronic pain of the trunk and limbs. The launch of the Genesis IPG and GenesisXP IPG in 2002 slowed our growth rate in sales of Renew systems from an average percentage growth rate of the mid-teens over the past several years to single-digit growth in 2002. Management believes this trend may continue in 2003 and has assumed similar single-digit growth in Renew sales during 2003.

Critical Accounting Policies and Estimates

General

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

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

Revenue Recognition

We generate revenues from product sales to end customers, product sales to distributors, and development contracts. We recognize revenue from neuro product sales when the goods are shipped to our customers or distributors, provided an arrangement exists, the fee is fixed and determinable, and collectibility is reasonably assured. Certain of our customers are third-party payors who reimburse fixed amounts for services based on a specific diagnosis. Revenue is recognized on these third-party payor sales based on the sales price less a contractual adjustment, which is based on our history of reimbursement with the third-party payor, provided all other revenue recognition criteria are met. We record, as a reduction in revenue a provision for estimated sales returns and adjustments on these product sales in the same period as the related revenue is recorded. These estimates are based on

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historical sales returns, analysis of credit memo data, and other known factors. Payment received in advance of revenue recognition requirements are recorded as deferred revenue on the consolidated balance sheet. We recognize revenue from custom manufactured products at HDI when the goods are shipped to the customer. HDI also develops products for certain customers under fixed price research and development contracts. We recognize revenue and profit under the development agreements using the percentage-of-completion method, which relies on estimates of total expected revenue and costs. We follow this method since reasonably dependable estimates of revenue and costs applicable to various stages of a development agreement can be made. If we do not accurately estimate the resources required or the scope of work to be performed under a development agreement, then future profit margins and results of operations may be negatively impacted. In certain cases, HDI will undertake a development project on a cost plus basis. In these cases, we invoice and recognize revenue for actual time and material expended on the project at contractual hourly billing rates and markups.

Bad Debt

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

Inventory Reserve

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

Intangible Assets

Goodwill associated with the excess purchase price over the fair value of assets acquired was amortized using the straight-line method through December 31, 2001 over the estimated life of 20 years.

On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 141, “Business Combinations” and Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” Under the new accounting rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but will be subject to annual impairment tests in accordance with the statements. We determined that our goodwill at December 31, 2001 was unimpaired and eliminated amortization of the goodwill effective January 1, 2002. Prior to the adoption of these statements, our amortization expense for goodwill was $556,604 on an annual basis.

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

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

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Warranty Obligations

Our products are generally covered by a one-year warranty. We accrue a warranty reserve for estimated costs to provide warranty services. Our estimate of costs to service our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty accrual will increase resulting in decreased gross profit.

Contingencies

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

Currently, product liability claims and other ordinary routine litigation incidental to our business are the only litigation to which we are a party. While historically our product liability claims have not resulted in significant monetary liability beyond our insurance coverage, an adverse judgment beyond our insurance coverage could have a material adverse impact on our results of operations and financial condition.

Stock Compensation

See Note 7 to the Consolidated Financial Statements for a discussion of the application of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” and SFAS 148, “Accounting for Stock-Based Compensation — an Amendment of FASB Statement No. 123” to our stock compensation programs.

Results of Operations

Comparison of the Years Ended December 31, 2002 and 2001

Net income. We reported net income of $6.68 million, or $.56 per diluted share, in 2002 compared to $1.52 million, or $.15 per diluted share, in 2001. Financial results in 2002 reflect the January 2002 U.S. launch of our Genesis IPG system and December 2002 U.S. launch of our GenesisXP IPG system. Results for the 2001 period reflect amortization expense for goodwill of $556,604.The 2002 results contain no similar expense since we eliminated the amortization of goodwill on January 1, 2002 when we adopted the new accounting standards for intangible assets described above. If the amortization expense for goodwill were eliminated from the 2001 period, pro forma net income would be $2.07 million and pro forma net income per diluted share would be $.21.

Net revenue. Net revenue increased 51.3% to $57.37 million compared to $37.92 million in the comparable 2001 period. Net revenue of our neuromodulation products increased 70.1% to $46.71 million in 2002 from $27.46 million in 2001 due to the U.S. launch of our Genesis IPG system in January 2002 and our GenesisXP IPG system in December 2002. Net revenue from our HDI O.E.M. business increased marginally to $10.66 million in 2002 from $10.46 million in 2001 as we continue to focus more of HDI’s resources on our own manufacturing and research and development needs.

The launch of the Genesis IPG in 2002 slowed our growth rate in sales of Renew systems from an average percentage growth rate in the mid-teens over the past several years to single-digit growth in

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2002. Management believes this trend may continue in 2003 and has assumed similar single-digit growth in Renew sales during 2003.

Gross profit. Gross profit increased to $36.71 million in 2002 from $22.24 million in 2001 due to the increase in net revenue discussed above and an improvement in gross profit margins. Gross profit margins increased to 64.0% in 2002, compared to 58.7% in 2001, due to higher sales of our neuromodulation products, which contribute higher margins than O.E.M. product sales, higher neuromodulation product sales from direct sales and commissioned agents, which contribute higher margins than distributor sales, and operational efficiencies gained from higher manufacturing volumes.

Operating expenses. Total operating expenses (the aggregate of research and development, sales and marketing, general and administrative and amortization of intangibles expense) increased to $27.47 million in 2002, compared to $19.43 million in 2001. However, as a percentage of net revenue, these expenses decreased to 47.9% in 2002 from 51.3% in 2001 due to leveraging of research and development expense, leveraging of general and administrative expense, and to a lesser extent, eliminating amortization expense of goodwill.

Sales and marketing. Sales and marketing expense, as a percentage of net revenue, increased to 26.0% in 2002 from 23.9% in 2001, and the absolute dollar amount increased to $14.93 million in 2002 compared to $9.06 million during 2001. This dollar increase during 2002 compared to 2001 was principally attributable to higher salary and benefit expense from staffing additions in direct sales, reimbursement and sales support positions, higher commission expense from increased product sales, and higher sample and promotional expense in support of the Genesis and GenesisXP IPG launches.

Research and development. Research and development expense increased to $5.84 million, or 10.2% of net revenue, from $4.93 million, or 13.0% of net revenue, during the same period in 2001. This increase in the absolute dollar amount in 2002 compared to 2001 was principally attributable to higher salary and benefit expense from staffing additions, higher test material expense and higher expense associated with our clinical trials of AccuRx. We continue to focus our development efforts on further broadening and strengthening our product technology platforms both for stimulation devices as well as implantable drug pumps.

General and administrative. General and administrative expense increased to $5.74 million during 2002 from $3.96 million in 2001 and, as a percentage of net revenue, decreased to 10.0% in 2002 from 10.4% in 2001. The increase in the absolute dollar amount in 2002 compared to 2001 was principally attributable to higher salary expense from staffing additions (including a new executive officer position), higher employee benefit costs, higher bonus expense, higher property tax expense and higher fees for accounting and tax services.

Amortization of intangibles. No amortization expense of goodwill was recorded in 2002 due to the adoption of Statement of Financial Accounting Standards No. 141 and Statement of Financial Accounting Standards No. 142 on January 1, 2002. During 2001, we recorded $557,000 for amortization expense of goodwill.

Amortization of other intangibles increased modestly in 2002 to $952,000 from $933,000 in 2001 due to additional amortization expense for intangible assets acquired in November 2002 when we completed the acquisition of MicroNet Medical, Inc. As a result of the MicroNet acquisition, we expect amortization expense to increase in 2003 by approximately $400,000, excluding additional amortization expense that may be generated as we acquire additional intangible assets. We expect to acquire the additional intangible assets as milestones are met pursuant to the purchase agreement. As the milestones are met, we will be required to issue additional shares of our common stock as earn-out consideration.

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Other income. Other income increased to $923,000 in 2002 from an expense of $26,000 in 2001 primarily attributable to a $451,000 increase in interest income due to higher funds available for investment from our public offering during the second quarter of 2002 and the expense in 2001 of $484,000 for costs associated with the acquisition of HDI. These costs were expensed instead of capitalized because the acquisition was accounted for under the pooling of interests method.

Income tax expense. Income tax expense increased to $3.49 million in 2002 from $1.27 million in 2001, and the overall effective tax rate was 34.3% in 2002 compared to 45.5% in 2001. The decrease in the effective tax rate in 2002 compared to 2001 was the result of three factors. First, our amortization of goodwill in the 2001 period was not deductible for tax purposes. Second, the HDI acquisition costs expensed in the 2001 period of $484,000 were not fully deductible for tax purposes. Finally, the 2002 period included tax-free interest income.

Comparison of the Years Ended December 31, 2001 and 2000

Net income. We reported net income of $1.52 million, or $.15 per diluted share, in 2001 compared to $832,000, or $.09 per diluted share, in 2000. The results for 2001 include a pretax expense of $484,000 for costs associated with our acquisition of HDI on January 2, 2001. These costs were expensed instead of capitalized because the acquisition was accounted for under the pooling of interests method.

Net revenue. Net revenue of $37.92 million for the year ended December 31, 2001 increased 19.1% from the comparable 2000 level of $31.83 million. This growth was attributable to both continued strong sales of our advanced neuromodulation products used to treat chronic pain, which increased 19.0% to $27.46 million, and higher sales at HDI, which increased 19.6% to $10.46 million. On November 21, 2001, we received approval from the FDA to begin marketing our Genesis IPG in the United States, and the first implants occurred in late December 2001. We formally launched the Genesis IPG in the United States in January 2002.

Gross profit. Gross profit increased to $22.24 million in 2001 from $17.13 million in 2000 due to the increase in net revenue discussed above and an improvement in gross profit margins. Gross profit margins increased to 58.7% in 2001, compared to 53.8% in 2000, due to higher sales of our Renew system, which contributes higher margins than HDI product sales, a reduction in specialty distributor sales where we recognize lower margins than sales through commissioned sales agents and operational efficiencies from higher manufacturing volumes.

Operating expenses. Total operating expenses (the aggregate of research and development, sales and marketing, amortization of intangibles and general and administrative expenses) increased to $19.43 million in 2001, compared to $16.18 million in 2000, and, as a percentage of net revenue, increased to 51.2% in 2001 from 50.8% in 2000. In 2001, we continued to invest in our product development pipeline and in infrastructure to enhance our sales and marketing capabilities.

Sales and marketing. Sales and marketing expense, as a percentage of net revenue, increased to 23.9% in 2001 from 21.5% in 2000, and the absolute dollar amount increased to $9.06 million in 2001 from $6.85 million during 2000. This dollar increase during 2001 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 in reimbursement and direct sales personnel, higher expense for education and training of new implanters and higher expense for new product introductions.

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Research and development. Research and development expense, as a percentage of net revenue, increased to 13.0% in 2001 from 12.1% in 2000, and the absolute dollar amount increased to $4.93 million in 2001 from $3.85 million during the same period in 2000, an increase of approximately $1.08 million. This dollar increase during 2001 compared to 2000 was principally due to higher salary expense from staffing additions, higher expense for software development and design engineering consultants used in development of our stimulation and pump products, higher expense for consultants used for regulatory submissions for our IPG, higher expense for prototype tooling, prototype parts and testing of materials used in our stimulation and pump products under development and higher expense associated with our clinical trial of the AccuRx drug pump initiated in the first quarter of 2001. Our research and development efforts in 2001 were directed toward development of our IPG stimulation platforms for spinal cord stimulation, our next generation RF system platform, our AccuRx proprietary constant rate drug pump and an IPG system for deep brain stimulation.

General and administrative. General and administrative expense decreased to $3.96 million during 2001 from $4.24 million in 2000 and, as a percentage of net revenue, decreased to 10.4% in 2001 from 13.3% during 2000. The decrease in this expense during 2001 was principally the result of lower salary expense from a reduction in certain salaries of the former owners of HDI when we acquired HDI in January 2001.

Amortization of intangibles. Amortization of goodwill and other intangibles increased to $1.49 million in 2001 from $1.23 million in 2000 primarily due to additional amortization expense for patents we acquired from ESOX on January 2, 2001.

Other income. Other income decreased to an expense of $26,000 in 2001 from income of $546,000 in 2000, primarily as a result of an expense in 2001 of $484,000 for costs associated with the acquisition of HDI and lower interest income due to lower yields on invested funds.

Income tax expense. Income tax expense increased to $1.27 million in 2001 from $659,000 in 2000, and the overall effective tax rate was 45.5% in 2001 compared to 44.2% in 2000. Our expense for amortization of costs in excess of net assets acquired, or 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 2001 and 2000 compared to the U.S. statutory rate for corporations of 34%. In addition, approximately $234,000 of the $484,000 of costs incurred in the acquisition of HDI are not deductible for tax purposes, which also contributed to the higher effective tax rate during 2001 compared to the U.S. statutory rate of 34%.

Liquidity and Capital Resources

At December 31, 2002 our working capital increased to $114.28 million from $24.91 million at year-end 2001. The ratio of current assets to current liabilities was 13.15:1 at December 31, 2002, compared to 4.77:1 at December 31, 2001. Cash, cash equivalents, certificates of deposit and marketable securities totaled $96.77 million at December 31, 2002 compared to $11.94 million at December 31, 2001.

During the second quarter of 2002, we completed an underwritten public offering of 2,875,000 shares of common stock managed by U.S. Bancorp Piper Jaffray, CIBC World Markets and Gerard Klauer Mattison as underwriters. We received net proceeds from the offering of approximately $83.2 million. We intend to use the proceeds from the offering for general corporate purposes, including expanding our worldwide sales and marketing resources, funding product development, pursuing regulatory approvals and pursuing strategic acquisitions of product lines, businesses, companies, services or technologies that complement our current business through mergers, acquisitions, joint ventures or otherwise. We discuss below certain transactions and investments we have made since the public offering in which we have used cash. In addition, in March 2003, we acquired Sun Medical’s pain

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management business, which will expand our direct domestic salesforce, for approximately $5.1 million in cash. In January 2003, we invested $1 million in cash in Innovative Spinal Technologies, Inc., a start-up company that develops spine technologies, products and services through intellectual property development and contract research.

We increased our investment in inventories to $13.72 million at December 31, 2002, from $9.75 million at December 31, 2001. This increase from year-end 2001 was primarily the result of two factors. First, we increased our investment in consignment inventories as a result of adding additional commissioned sales agents during 2002 to whom we provide consignment inventory. Second, we increased our investment in raw materials and finished goods for our Genesis and GenesisXP IPG systems to support our successful launch of these products in the U.S. market.

Our investment in trade accounts receivable increased to $10.85 million at December 31, 2002, from $6.49 million at December 31, 2001 due to the increase in sales of our neuromodulation products resulting from the launch of the Genesis and GenesisXP IPG systems. Our days sales outstanding decreased from 57 days at year-end 2001 to 55 days at year-end 2002.

In November 2002, we completed the acquisition of MicroNet Medical, Inc. At closing we paid the former MicroNet shareholders $500,000 in cash and 156,302 shares of our common stock with a value at the time of issuance of $4,648,421. In addition, we incurred expenses of $859,460, including an investment-banking fee of $600,000. As previously noted, in March 2003, we paid the former MicroNet shareholders an aggregate of 28,346 shares of our common stock with a value at the time of issuance and release from escrow of $1,020,173 upon the successful completion of half of the first product milestone, and the former MicroNet shareholders may receive additional shares of our common stock if additional product and sales milestones are met. The aggregate value of the additional potential milestone earnout payments was $9 million as measured at the time the transaction was completed. The product and sales milestones referred to above consist of three principal product milestones and a sales milestone. Each of the product milestones has three to four sub-milestones that relate to the delivery of specific products, including four quadrapolar leads (Milestone I), two octapolar leads (Milestone II) and a four channel lead and an eight channel lead designed for use in deep brain stimulation (Milestone III). The product sub-milestones are met if and when we are able to submit, and if and when we receive, regulatory approvals for products that have been adapted for use with our electrical stimulation devices. The sales milestone will be met if and when we and our subsidiaries generate $5 million in cumulative net sales of MicroNet lead products during the four years following the closing of the MicroNet transaction.

We spent $2.94 million during 2002 for capital expenditures primarily for new furniture and equipment for personnel we hired during 2002 and additional manufacturing tooling and equipment to support our current products.

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

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

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

Cash Flows

Net cash provided by operating activities was $7.47 million in 2002, $3.06 million in 2001 and $690,000 in 2000. Net cash provided by operating activities increased from $3.06 million in 2001 to $7.47 million in 2002, an increase of approximately $4.41 million. This increase in 2002 compared to 2001 was principally attributable to a $5.17 million increase in net income from $1.52 million in 2001 to $6.68 million in 2002. Net cash provided by operating activities increased from $690,000 in 2000 to $3.06 million in 2001, an increase of approximately $2.38 million. This increase in 2001 compared to 2000 was primarily the result of an increase in net income of $685,000 and a $1.41 million decrease in the amount of cash used for changes in working capital components.

Net cash used in investing activities was $91.14 million in 2002, $3.09 million in 2001 and $2.94 million in 2000. In 2002, our primary investing activities using cash were the purchase of marketable securities ($188.39 million) the purchase of land ($3.19 million), capital expenditures ($2.94 million) and cash used in the purchase of MicroNet Medical, Inc. ($1.36 million), while net proceeds from the sale of marketable securities provided cash of $104.75 million. In 2001, our primary investing activities using cash were the purchase of marketable securities ($3.90 million) and capital expenditures ($3.11 million) for additional manufacturing tooling and equipment, office furniture and equipment, non-compete agreements and patents, while maturing certificates of deposit and sales of marketable securities provided cash of $3.92 million. In 2000, our primary investing activities using cash were the purchase of marketable securities and certificates of deposit with maturities over 90 days ($2.23 million) and capital expenditures ($1.65 million) for additional manufacturing tooling and equipment and office furniture and equipment, while maturing certificates of deposit and the sale of marketable securities provided cash of $949,000. The non-compete agreements discussed in this section for fiscal year 2001 relate to a $200,000 expenditure incurred in 2001 to purchase a non-compete agreement from a former distributor of our Neuro Products. In reference to the patents, we incurred $191,000 in cash expenditures (in addition to the stock we issued with a value of $2,426,662) related to the

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purchase of ESOX in January 2001, which was allocated to the patents we acquired in the transaction. Prior to the transaction, we had licensed the technology from ESOX. The patents we acquired in the ESOX transaction relate to our implantable drug pump technologies. We are currently seeking FDA approval to commercialize an implantable drug pump in the United States.

Net cash provided by financing activities was $84.86 million in 2002, $957,000 in 2001 and $2.57 million in 2000. During 2002, we used $190,000 to repay our entire outstanding long-term debt, while we received $83.18 million in net proceeds from a public offering and $1.87 million from the exercise of stock options. During 2001, we used $48,000 to reduce certain debt obligations, while we received approximately $1.0 million from the exercise of stock options. During 2000, we used $29,000 to reduce certain debt obligations, while we received $2.6 million of cash from the exercise of stock options ($1.93 million), the private placement of common stock ($400,000) and proceeds from a long-term note payable ($270,000).

Currency Fluctuations

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

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Outlook and Uncertainties

The following is a “safe harbor” statement under the Private Securities Litigation Reform Act of 1995: Certain 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,” “would,” “scheduled,” “new market,” “potential market applications,” and similar expressions and variations 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:

Failure of our Genesis and GenesisXP IPG systems to gain and maintain market acceptance would adversely affect our revenue growth and profitability.

We formally introduced our Genesis IPG system in the U.S. in January 2002 and our GenesisXP IPG system (offering increased battery capacity and longevity) in the U.S. in December 2002. We believe that the size and potential for growth of the IPG portion of the neurostimulation market are greater than in the RF portion. Accordingly, our ability to generate increased revenue and profitability, and thus our general success, will depend, in large part, on the market’s acceptance of our IPG systems. As a new entrant into the IPG portion of the neurostimulation market, there are many reasons we might not achieve market acceptance on a timely basis, if at all, including the following:

• competing products, technologies and therapies are available, and others may be introduced that gain greater and faster physician and patient acceptance than our IPG systems; and

• our only competitor in the IPG portion of the market has had its IPG product on the market for some time and enjoys significant brand awareness and other advantages among pain management specialists.

If the IPG portion of the neurostimulation market grows at a faster rate than the RF portion, our failure to successfully market and sell our IPG systems could negatively affect our revenue growth and profitability.

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

The medical device market is highly competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. Medtronic, Inc. is one of the largest competitors in the medical device sector, and is currently our sole competitor in the neurostimulation market and our largest competitor in the implantable drug pump market. Medtronic is a large publicly-traded company and enjoys several competitive advantages over us, including:

• substantially greater name recognition;

• greater resources for product research and development, sales and marketing, distribution, patent protection and pursuing regulatory approvals;

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• a greater number of established relationships with health care professionals and third-party payors; and

• multiple product lines and the ability to bundle products together or offer discounts, rebates or other incentives to secure a competitive advantage.

Medtronic will continue to develop new products that compete directly with our products, and its greater resources may allow it to respond more quickly to new technologies, new treatment indications or changes in customer requirements. Further, we generally price our products at a premium to those of Medtronic. Additionally, because the neuromodulation market is a high growth-potential market, other companies may attempt to bring new products or therapies into this market. For example, we are aware that Advanced Bionics, Inc., a privately-held company that currently manufactures and markets a cochlear implant product, is developing and may be testing an IPG system for the treatment of chronic pain. For all of these reasons, we may not be able to compete successfully against Medtronic or against future competitors.

If pain management specialists do not recommend and endorse our products, our sales could be negatively impacted and we may be unable to increase our revenues and profitability.

Our products are based on evolving concepts and techniques in pain management. Acceptance of our products depends on educating the medical community as to the distinctive features, benefits, clinical efficacy, safety and cost-effectiveness of our products compared to alternative therapies and competing products, and on training pain management specialists in the proper use of our products. To sell our products, we must successfully educate and train pain management specialists so that they will understand our products and feel comfortable recommending and endorsing them. We may not be able to accomplish this, and even if we are successful in educating and training pain management specialists, there is no guarantee that we will obtain their recommendations and endorsements.

The launch of Genesis and GenesisXP and other market factors could impede growth in or reduce sales of Renew, which would adversely affect our revenues and profitability.

Our Genesis and GenesisXP IPG systems are currently the newest neurostimulation products on the market. Although Genesis and our Renew RF system are targeted towards patients with different types of pain and Genesis is not intended to replace Renew in the neurostimulation market, some pain management specialists may recommend Genesis to their patients when they would have otherwise recommended Renew, and, consequently, Genesis may “cannibalize” or substitute for some sales of Renew. Further, we believe our principal market competitor has chosen to emphasize the IPG as the therapy of choice in the neurostimulation market. These factors could lead to a slowdown in growth, or a reduction, in sales of Renew and similar RF-based neurostimulation products. Although Renew and Genesis are targeted for different patients, sales growth of Renew has slowed since the launch of Genesis. If Renew sales growth continues to slow or sales are reduced, and we do not gain enough market share through IPG sales to compensate for these reduced sales, our revenues and profitability will be adversely affected.

If patients choose less invasive or less expensive alternatives to our products, our sales could be negatively impacted.

We sell medical devices for invasive and minimally-invasive surgical procedures. Patient acceptance of our products depends on a number of factors, including device and associated procedure costs, the failure of less invasive therapies to help the patient, the degree of invasiveness involved in the procedures used to implant our products, the rate and severity of complications from the procedures

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used to implant our products and any adverse side effects caused by the implanting of our products. If patients choose to use existing less invasive or less expensive alternatives to our products, or if effective new alternatives are developed, our revenues and profitability could be materially adversely affected.

Any adverse changes in coverage or reimbursement amounts by Medicare and Medicaid, private insurance companies and managed care organizations, or workers’ compensation programs could limit our ability to market and sell our products.

In the U.S., our products are generally covered by Medicare and Medicaid and other third-party payors, such as private insurance companies and managed care organizations, and workers’ compensation programs, which reimburse patients for all or part of the cost of our products and related medical procedures. The cost of our products and related procedures are significant, and third-party payors carefully scrutinize whether to cover new products and the level of reimbursement for covered products. Further, for certain types of procedures, gaps exist between the rate of reimbursement paid by Medicare and Medicaid and the rates paid by private insurers. In addition, gaps exist in reimbursement levels depending on the health care setting in which physicians perform procedures using our products. In the future, these gaps may narrow and public and private payors may reduce levels of reimbursement for neuromodulation devices in an effort to control increasing costs. If Medicare or other third-party payors decide to eliminate or reduce coverage amounts on patient reimbursements for our products, this could limit our ability to market and sell our products in the U.S., which would materially adversely affect our revenues and profitability. In November 2002, for example, the Center for Medicare and Medicaid Services issued a final ruling establishing new 2003 reimbursement rates for Medicare hospital outpatient procedures, including spinal cord stimulation procedures. Reimbursement levels for permanent implants of spinal cord stimulation devices in the hospital outpatient setting were moderately reduced as a result of the ruling, which decreased the amount that hospitals would be reimbursed by Medicare for these procedures. However, because the new rates continue to provide hospitals with adequate margins to cover their facility costs and yield a fair profit to the hospitals, the new rates have not had an adverse effect on the prices we charge hospitals for our systems. If in the future CMS reduces rates to such an extent that hospitals’ ability to continue operating profitably in these procedures were at risk, then there could be price pressure on our products at that time.

International market acceptance of our products may also depend, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country, and include both government-sponsored health care and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. Where reimbursement in foreign markets is available, it tends to be at levels significantly below those in the U.S. Our failure to receive international reimbursement approvals may negatively impact market acceptance of our products in the international markets in which those approvals are sought.

If we fail to protect our intellectual property rights, our competitors may take advantage of our ideas and compete directly against us.

We rely in part on patents, trade secrets and proprietary technology to remain competitive. We may not be able to obtain or maintain adequate U.S. patent protection for new products or ideas, or prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by employees. Additionally, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. Even if our intellectual property rights are adequately protected, litigation may be necessary to enforce them, which could result in substantial costs to us and substantial diversion of the attention of our management and key technical employees. If we are unable to

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adequately protect our intellectual property, our competitors could use our intellectual property to develop new products or enhance their existing products. This could harm our competitive position, decrease our market share or otherwise harm our business.

U.S. Patent No. 4,793,353 covers a non-invasive multiprogrammable tissue stimulator and method wherein only the programming data need be transmitted. The programming data may define the stimulator’s electrode selection, electrode polarity as either positive, negative or high impedence state, and simulation pulse parameter. This patent is scheduled to expire on December 27, 2005. The expiration of this patent may allow competitors to offer programmable stimulators that define electrode selection, polarity and stimulation pulse parameters, and thus could have an adverse effect on our business. A request for an extension of the term of this patent has been filed with the United States Patent Office pursuant to a federal statute that permits us to seek such an extension based on a regulatory approval delay. A final ruling on the extension request has not been made at the present time. While six other U.S. patents owned or licensed by us are due to expire prior to 2006, the expiration of these other patents would not have a material effect on our ability to protect the intellectual property rights currently utilized in our business, because the patents cover technologies that are not currently utilized in our existing products or services.

Other parties may sue us for infringing their intellectual property rights, or we may have to sue them to protect our intellectual property rights.

There has been a substantial amount of litigation in the medical technology industry regarding patents and intellectual property rights. The neuromodulation market is characterized by extensive patent and other intellectual property rights, which can create greater potential than in less-developed markets for possible allegations of infringement, particularly with respect to newly-developed technology. We may be forced to defend ourselves against allegations that we are infringing the intellectual property rights of others. In addition, we may find it necessary, if threatened, to initiate a lawsuit seeking a declaration from a court that we are not infringing the intellectual property rights of others or that these rights are invalid or unenforceable, or to protect our own intellectual property rights. Intellectual property litigation is expensive and complex and its outcome is difficult to predict. If we do not prevail in any litigation, in addition to any damages we might have to pay, we would be required to stop the infringing activity, obtain a license, or concede intellectual property rights. Any required license may not be available to us on acceptable terms, if at all. In addition, some licenses may be nonexclusive, and, therefore, our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around a patent, we may be unable to sell some of our products, which could adversely affect our revenues and profitability.

Failure to obtain necessary government approvals for new products or for new applications for existing products would mean we could not sell those new products, or sell our existing products for those new applications.

Our products are medical devices, which are subject to extensive government regulation in the U.S. and in foreign countries where we do business. Unless an exemption applies, each medical device that we wish to market in the U.S. must first receive either a premarket approval (PMA) or a 510(k) clearance from the FDA with respect to each application for which we intend to market it. Either process can be lengthy and expensive. According to the FDA, the average 510(k) review period was 100 days in 2002, but reviews may take longer and approvals may be revoked if safety or effectiveness problems develop. The PMA process is much more costly, lengthy and uncertain. According to the FDA, the average PMA submission-to-decision period was 364 days in 2002; however, reviews may take much longer and completing a PMA application can require numerous clinical trials and require the filing of amendments over time. The result of these lengthy approval processes is that a new product, or a new application for an existing product, often cannot be brought to market for a number

34

of years after it is developed. Additionally, we anticipate that many of the products we bring to market in the future will require us to seek PMA approvals rather than 510(k) clearances. If we fail to obtain or maintain necessary government approvals of our new products or new applications for existing products on a timely and cost-effective basis, we will be unable to market the affected products for their intended applications.

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

Any modification we want to make to an FDA-cleared or approved device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, would require a new 510(k) clearance, or possibly a new or supplemental PMA. Under FDA procedures, we would make the initial determination of whether to seek a new 510(k) clearance or PMA, but the FDA could review our decision. If the FDA disagrees with our decision not to seek a new 510(k) clearance or PMA and requires us to seek either 510(k) clearance or PMA for modifications we have already made to a previously-cleared product, we might be required to cease marketing or recall the modified device until we obtain this clearance or approval. We could also be subject to significant regulatory fines or penalties.

We will be unable to sell our products if we fail to comply with manufacturing regulations.

To commercially manufacture our products, we must comply with government manufacturing regulations that govern design controls, quality systems and documentation policies and procedures. The FDA and equivalent foreign governmental authorities periodically inspect our manufacturing facilities. Our failure to comply with these manufacturing regulations may prevent or delay our marketing or distribution of our products, which would negatively impact our business.

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

Any of our products may be found to have significant deficiencies or defects in design or manufacture. The FDA and similar governmental authorities in other countries have the authority to require the recall of any such defective product. A government-mandated or voluntary recall could occur as a result of component failures, manufacturing errors or design defects. We do not maintain insurance to cover losses incurred as a result of product recalls. Any product recall would divert managerial and financial resources and negatively affect our financial performance, and could harm our reputation with customers.

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

Defects in our implantable medical devices could subject us to potential product liability claims that our devices were ineffective or caused some harm to the human body. Our current product liability litigation involves assertions that our products did not perform as intended and, in some cases, that they caused discomfort or harm to the patient. Our product liability insurance may not be adequate to cover current or future claims. Product liability insurance is expensive and, in the future, may not be available on terms that are acceptable to us, if it is available to us at all. Plaintiffs may also advance other legal theories supporting their claims that our products or actions resulted in some harm. A successful claim brought against us in excess of our insurance coverage could significantly harm our business and financial condition.

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

We are subject to numerous government regulations relating to, among other things, our ability to sell our products, third-party reimbursement, fraud and abuse of Medicare or Medicaid and patient privacy. If we do not comply with all applicable government regulations, government authorities could do any of the following:

• impose fines and penalties on us;

• prevent us from manufacturing our products;

• bring civil or criminal charges against us;

• delay the introduction of our new products into the market;

• recall or seize our products;

• disrupt the manufacture or distribution of our products; or

• withdraw or deny approvals for our products.

Any one of these results could materially adversely affect our revenues and profitability and harm our reputation.

Our reliance on single suppliers for critical components used in our main products could adversely affect our ability to deliver products on time.

We continue to rely upon sole source suppliers for certain materials and services used in manufacturing our products, including the custom chip used in the receiver of our RF system, the computer chip used in the IPG programmer and Renew transmitter, the batteries used in our IPG system and the medical-grade polyurethane (bionate) that we use in all of our products, for reasons of quality assurance, component availability or cost effectiveness. We work closely with our vendors to assure continuity of supply while maintaining high quality and reliability. With the exception of the custom chip used in our RF receiver, which we discuss below, we believe that alternative suppliers exist for the other components used to manufacture our products. FDA requirements regarding the design and manufacture of our products require an investment in time and money to establish additional or replacement sources for certain components or materials. We believe that in some cases, the cost of pursuing and qualifying alternative sources and/or redesigning specific components of our products would significantly outweigh the benefits of doing so and consume significant resources that are better devoted to other aspects of our business. Similarly, qualifying alternative sources or product designs require costly and time-consuming regulatory submissions and approvals that again may not be justified from a cost-benefit standpoint for all components used in our products. The reduction or interruption in supply, or our inability to develop alternative sources of supply, could adversely affect our operations.

Although there are currently no alternative suppliers for the custom chip used in our RF system, we have sufficient chips in stock to meet our near-term requirements and will be able to order more chips to meet our future needs. In the meantime, we are designing and developing our own replacement chip. The sole supplier of this chip first indicated its desire to cease manufacturing and supplying the RF system chip several years ago. The supplier has continued to supply the chip, however, and to

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date has not determined if and when it will cease to supply the chip. The supplier has agreed to notify us when it does decide to cease supplying the chip and has promised to permit us to place a final one-time purchase order for the chip. In the interim, we have maintained and will continue to maintain a higher than normal inventory of the chip. We currently have enough of the chips in stock to meet our requirements through the end of 2003, and we recently placed an order with the supplier to supply our requirements through the end of 2005. Our engineers are developing a new chip to be used with our next-generation RF receiver. Our engineers estimate that this new chip and the next-generation RF receiver would be completed and have received the appropriate regulatory approvals by the second half of 2005. Consequently, under the circumstances, we do not believe that a single source of supply for the RF system chip poses a serious risk to our business. Our RF system sales accounted for approximately 60% of our total Neuro Product segment sales in 2002, and approximately 49% of our total sales.

One distributor currently accounts for a significant percentage of our revenue from our neuromodulation products segment, and our major competitor in the neuromodulation market currently accounts for a significant percentage of our revenue from our O.E.M. segment.

During 2002, we had one independent distributor, Sun Medical, Inc., that accounted for $6.33 million, or 13.5%, of our net revenue from our neuromodulation products segment. In March 2003, we acquired Sun Medical’s pain management business and hired substantially all of the salespeople who had generated those sales, but we continue to rely in large part on two other distributors and on numerous independent sales representatives to buy and/or sell our products. The loss of a major distributor or sales representative, or a significant decrease in their sales volumes, could materially adversely affect our revenues and profitability, at least in the short term.

In addition, during 2002, we had two major customers that accounted for $9.52 million, or 89.3%, of our net revenue from our O.E.M. segment. Medtronic, Inc., our most significant competitor, accounted for $6.74 million, or 63.2% and Arrow International, Inc. accounted for $2.78 million, or 26.1%. Either of these customers could cease doing business with us at any time. If this were to occur, our revenues and profitability could be materially adversely affected, at least in the short term.

We are dependent upon the success of neuromodulation technology. Our inability to continue to develop innovative neuromodulation products, or the failure of the neuromodulation market to develop as we anticipate, would adversely affect our business.

Our current products focus on the treatment of chronic pain using neuromodulation. Our development efforts focus on leveraging our neuromodulation expertise. The neuromodulation market is subject to rapid technological change and product innovation. Our competitors may succeed in developing or marketing products, using neuromodulation technology or other technologies, that may be superior to ours. If we are unable to compete successfully in the development of new neuromodulation products, or if new and effective therapies not based on neuromodulation are developed, our products could be rendered obsolete or non-competitive. This would materially adversely affect our business.

Our success will depend on our ability to attract and retain key personnel and scientific staff.

We believe our future success will depend on our ability to manage our growth successfully, including attracting and retaining scientists, engineers and other highly-skilled personnel. Our key employees are subject to confidentiality, trade secret and non-competition agreements, but may terminate their employment with us at any time. Hiring qualified management and technical personnel is difficult due to the limited number of qualified professionals. Competition for these types of employees is intense in the medical device field. If we fail to attract and retain personnel, particularly management and technical personnel, we may not be able to continue to succeed in the neuromodulation market.

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

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. Accordingly, we may, as we have in the past, acquire complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to identify prospective acquisition targets or complete any future acquisitions, or whether we will be able to successfully integrate any acquired business, operate it profitably or retain its key employees. Integrating any business, product or technology we acquire could be expensive and time-consuming, disrupt our ongoing business and distract our management and key technical personnel. If we are unable to integrate any acquired entities, products or technologies effectively, our business will suffer. In addition, any impairment of goodwill or other intangible assets or charges resulting from the costs of acquisitions could harm our business and operating results.

We are subject to additional risks associated with international operations.

Internationally, we market our products through 18 independent distributors who represent us in 22 countries except in Germany where we are represented by direct salespersons. In 2002, 8% of our sales revenue from our neuromodulation products segment came from international sales. International sales are subject to a number of additional risks, including the following:

• establishment by foreign regulatory agencies of requirements different from those in place in the U.S.;

• fluctuations in exchange rates of the U.S. dollar against foreign currencies that may affect demand for our products overseas;

• export license requirements, changes in tariffs, and other general trade restrictions;

• difficulties in staffing and managing international operations;

• political or economic instability; and

• lower and more restrictive third-party reimbursement for our products.

Any of these risks could make it difficult or impossible for us to continue to expand our overseas operations, which could have an adverse effect on our revenues.

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

We currently conduct all of our development, manufacturing and management activities at our facilities in Plano, Texas and Budd Lake and Hackettstown, New Jersey. However, a natural disaster, such as a tornado, fire or flood, or a man-made disaster, could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory and cause us to incur significant additional expenses. A disaster could seriously harm our business and affect our reputation with customers. The insurance we maintain may not be adequate to cover our losses in any particular case.

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We may be obligated to issue shares of our common stock in the future and the number of shares could increase if our stock price decreases.

In connection with the acquisition of MicroNet Medical, Inc. in November 2002, as part of the purchase price, we agreed to pay the former MicroNet shareholders additional shares of our common stock if certain product, regulatory approval and sales milestones are met. The aggregate value of the additional potential milestone earnout payments payable in shares of our common stock was $9 million as measured at the time the transaction was completed. Of this $9 million in additional shares, we issued a fixed number of shares totaling 89,606 with an aggregate value at closing of $3 million into an escrow account. If and when specified product and regulatory milestones are achieved, we will release a specified and fixed number of shares of common stock from escrow to the former MicroNet shareholders. In addition, if and when those same product and regulatory milestones are achieved, we will also issue at that time a number of shares of our common stock with an aggregate value of up to $3 million. Finally, if and when we generate $5 million in cumulative net sales of MicroNet lead products during the four years following the closing, we will issue at that time a number of shares of our common stock with an aggregate value of $3 million. Thus, we agreed to issue shares of our common stock with an aggregate value of up to $6 million in the future upon the achievement of specific milestones, the number of shares of which will depend on the average trading price of our common stock. The average trading price for this purpose is the per share average closing price of our common stock on the Nasdaq National Market for the 30 consecutive trading days immediately prior to two business days before the applicable milestone payment date. Because the number of shares we could be required to issue depends on the average trading price at the time of payment, if the average trading price of our common stock declines significantly, we could be required to issue more shares of our common stock. For example, if our stock price were $40 per share and we were required to issue $3 million of our common stock on satisfaction of the sales milestone, we would be required to issue 75,000 shares of our common stock to the former MicroNet shareholders. If our stock price declined 50% from that level to $20 per share, however, we would be required to issue twice as many shares, or 150,000 shares.

On March 1, 2003, two parts of one of the product milestones were satisfied, entitling the former MicroNet shareholders to $1 million in milestone payments payable in shares of our common stock. Accordingly, we issued an additional 13,412 shares of our common stock to the former MicroNet shareholders (valued at the average trading price on the date of issuance of $37.28 per share, for an aggregate of $500,000 in our common stock), and instructed our escrow agent to release from escrow 14,934 shares of our common stock from escrow. As a result, our remaining obligation is to issue up to an additional $5.5 million in common stock and release 74,672 shares of common stock from escrow if certain additional product, regulatory approval and sales milestones are met. Important additional product milestone deadlines occur in November 2003 and May 2003, while other milestones depend on the receipt of regulatory approvals and meeting the aggregate net sales milestone referred to above. All milestones must be met by November 2006 or November 2007, depending on the milestone.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We invest our cash reserves in high quality short-term liquid money market instruments with major financial institutions, a high quality short-term municipal bond fund with a major financial institution and certificates of deposit. At December 31, 2002, we had $443,174 invested in money market funds, $1,636,938 in certificates of deposit with maturities less than 90 days from the purchase date and $5,636,212 in a tax-free municipal bond fund with daily liquidity. The rate of interest earned on these investments will vary with overall market rates. A hypothetical 100-basis point change in the interest rates earned on these investments would not have a material effect on our income or cash flows.

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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, 7-day and 35-day AAA municipal bond floaters and Freddie Mac and Federal Home Loan Notes with maturities less than one-year from the date of purchase. The cost of these investments is $85,817,984 and the fair value at December 31, 2002 was $85,796,944. The investments are subject to overall bond market and interest rate risk, however the Company believes the risk to be limited since a large portion of the investments, $82,825,000, are in 7-day and 35-day municipal floaters which have no principal risk. The investment grade municipal bonds and Freddie Mac and Federal Home Loan Bank notes may have risk of principal depending on the overall bond market. A hypothetical 10% decrease in the value of these investments from their prices at December 31, 2002 would decrease the fair value by $297,194.

We do not use derivative financial instruments to manage the impact of interest rate changes on our investments or debt instruments.

At December 31, 2002, we had no interest bearing debt.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by this item is set forth in Appendices A, B and C.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is contained under the captions “Election of Directors”, “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement to be filed in connection with our 2003 annual meeting of shareholders, which information is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

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 statement to be filed in connection with our 2003 annual meeting of shareholders, which information is incorporated herein by reference. Information under the captions “Compensation Committee Report” and “Performance Graph” are not incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is contained under the caption “Security Ownership of Management and Principal Shareholders” in our definitive proxy statement to be filed in connection with our 2003 annual meeting of shareholders, which information is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Inapplicable.

ITEM 14. CONTROLS AND PROCEDURES

(a)

Evaluation of disclosure controls and procedures. Based on their most recent review, which was completed within 90 days of the filing of this annual report, the Company’s Chief Executive Officer, Christopher G. Chavez, and Chief Financial Officer, F. Robert Merrill III, concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to such officers as is appropriate to allow timely decisions regarding required disclosure, and that these controls and procedures are effective to ensure that such information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b)

Changes in internal controls. Since the date of the evaluation described above, there have not been any significant changes in the Company’s internal accounting controls or in other factors (including any corrective actions with regard to significant deficiencies or material weaknesses) that could significantly affect those controls.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Documents filed as part of this report.

1.	Financial Statements:
	See Index to Financial Statements on the second page of Appendix A.
2.	Financial Statement Schedules:* Schedule II — Valuation and Qualifying Accounts.
	See Appendix B.
	*Those schedules not listed above are omitted as not applicable or not required.
3.	Exhibits: See (c) below.

(b) Reports on Form 8-K.

(1)	The Company filed a report on Form 8-K on November 5, 2002 reporting that the Company entered into an agreement to acquire MicroNet Medical, Inc., a privately-held Minnesota corporation.
(2)	The Company filed a report on Form 8-K on November 26, 2002 reporting the completion of the MicroNet Medical, Inc. acquisition.
(3)	The Company filed a report on Form 8-K on December 3, 2002 reporting that Anthony J. Varrichio, an executive vice president of the Company, entered into a “Preset Diversification Program” (PDP), a stock disposition plan intended to qualify for the safe harbor offered by Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.

(c) Exhibits:

Exhibit
Number	Description
2.1	Agreement and Plan of Merger, dated as of November 30, 2000, by and among Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp. and Hi-tronics Designs, Inc.(10)
2.2	Agreement and Plan of Merger, dated as of November 4, 2002, by and among Advanced Neuromodulation Systems, Inc., MicroNet Acquisition, Inc. and MicroNet Medical, Inc.(14)
3.1	Articles of Incorporation, as amended and restated(11)
3.2	Bylaws(11)
4.1	Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights Agent(5)
4.2	Amendment To Rights Agreement dated as of January 25, 2002 between Advanced Neuromodulation Systems, Inc. and Computershare Investor Services LLC (formerly KeyCorp Shareholder Services, Inc)(12)
10.1	Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option Plan(2)
10.2	Form of 1979 Employees Stock Option Agreement(3)
10.3	Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)
10.4	Form of Directors Stock Option Agreement(1)

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Exhibit
Number	Description
10.6	Quest Medical, Inc. 1995 Stock Option Plan(4)
10.7	Form of 1995 Employee Stock Option Agreement(4)
10.8	Quest Medical, Inc. 1998 Stock Option Plan(7)
10.9	Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)
10.10	Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest Medical, Inc.(6)
10.11	Employment Agreement dated April 9, 1998 between F. Robert Merrill III and Quest Medical, Inc.(6)
10.12	Employment Agreement dated April 1, 2002 between Christopher G. Chavez and Advanced Neuromodulation Systems, Inc.(13)
10.13	Employment Agreement dated April 1, 2002 between Kenneth G. Hawari and Advanced Neuromodulation Systems, Inc.(13)
10.14	Special Termination Agreement dated April 1, 2002 between Christopher G. Chavez and Advanced Neuromodulation Systems, Inc.(13)
10.15	Special Termination Agreement dated April 1, 2002 between Kenneth G. Hawari and Advanced Neuromodulation Systems, Inc.(13)
10.16	Form of Employment Agreement and Covenant Not to Compete, between the Company and key employees(1)
10.17	Lease Agreement dated as of February 4, 1999, between Advanced Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(8)
10.18	Second Amendment to Lease Agreement dated as of September 1, 2002, between Advanced Neuromodulation Systems, Inc. and Plano R&D Associates, LTD.(15)
10.19	Escrow Agreement dated November 25, 2002, among Advanced Neuromodulation Systems, Inc., Thomas E. Brust and Computershare Trust Company(16)
21.1	Subsidiaries(15)
23.1	Consent of Independent Auditors(16)
99.1	Certification of the Chief Executive Officer(16)
99.2	Certification of the Chief Financial Officer(16)

(1)	Filed as an Exhibit to the Company’s Registration Statement on Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.
(2)	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.
(3)	Filed as an Exhibit to the Company’s Registration Statement on Form S-1, Registration No. 2-78186, and incorporated herein by reference.
(4)	Filed as an Exhibit to the Company’s Registration Statement on Form SB-2, Registration No. 33-62991, and incorporated herein by reference.
(5)	Filed as an Exhibit to the report of the Company on Form 8-K dated September 3, 1996, and incorporated herein by reference.
(6)	Filed as an Exhibit to the report of the Company on Form 10-Q for the quarter ended March 31, 1998, and incorporated herein by reference.
(7)	Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 27, 1998, and incorporated herein by reference.
(8)	Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 1998, and incorporated herein by reference.
(9)	Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 17, 2000, and incorporated herein by reference.
(10)	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.
(11)	Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 2000, and incorporated herein by reference.
(12)	Filed as an Exhibit to the report of the Company on Form 8-K dated January 30, 2002, and incorporated herein by reference.
(13)	Filed as an Exhibit to the report of the Company on Form 10-Q for the quarter ended March 31, 2002, and incorporated herein by reference.
(14)	Filed as an Exhibit to the report of the Company on Form 8-K dated November 26, 2002, and incorporated herein by reference.
(15)	Previously filed.
(16)	Filed herewith.

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Signatures

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.

ADVANCED NEUROMODULATION SYSTEMS, INC.

	By:	/s/ Christopher G. Chavez
Date: May 9, 2003	Christopher G. Chavez President and Chief Executive Officer

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:

Signature	Title	Date
/s/ Christopher G. Chavez Christopher G. Chavez	Chief Executive Officer, President and Director of Advanced Neuromodulation Systems, Inc. (Principal Executive Officer)	May 9, 2003
/s/ F. Robert Merrill III F. Robert Merrill III	Executive Vice President-Finance, Chief Financial Officer and Treasurer of Advanced Neuromodulation Systems, Inc. (Principal Financial and Accounting Officer)	May 9, 2003
/s/ Hugh M. Morrison Hugh M. Morrison	Chairman of the Board and Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003
/s/ Robert C. Eberhart Robert C. Eberhart	Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003
/s/ Joseph E. Laptewicz, Jr. Joseph E. Laptewicz, Jr.	Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003
/s/ A. Ronald Lerner A. Ronald Lerner	Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003
/s/ Richard D. Nikolaev Richard D. Nikolaev	Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003
/s/ Michael J. Torma Michael J. Torma	Director of Advanced Neuromodulation Systems, Inc.	May 9, 2003

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§302 Certification of Chief Executive Officer

I, Christopher G. Chavez, certify that:

1.     I have reviewed this annual report on Form 10-K of Advanced Neuromodulation Systems, Inc.;

2.     Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.     Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.     The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 9, 2003
	/s/ Christopher G. Chavez Name: Christopher G. Chavez Title: Chief Executive Officer

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§302 Certification of Chief Financial Officer

I, F. Robert Merrill III, certify that:

1.     I have reviewed this annual report on Form 10-K of Advanced Neuromodulation Systems, Inc.;

2.     Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.     Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.     The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 9, 2003
	/s/ F. Robert Merrill III Name: F. Robert Merrill III Title: Chief Financial Officer

46

Appendix A

Consolidated Financial Statements
Independent Auditors’ Report

Three Years Ended December 31, 2002

Forming a Part of the Annual Report on

Form 10-K

Item 8

of

ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)

Filed with the

Securities and Exchange Commission

Washington, D.C. 20549

under

The Securities Exchange Act of 1934

Advanced Neuromodulation Systems, Inc. and Subsidiaries

Table of Contents
to
Consolidated Financial Statements

Form 10-K — Item 8

Report of Ernst & Young LLP, Independent Auditors

Consolidated Financial Statements:

Consolidated Balance Sheets — December 31, 2002 and 2001

Consolidated Statements of Income — Years ended December 31, 2002, 2001 and 2000

Consolidated Statements of Cash Flows — Years ended December 31, 2002, 2001 and 2000

Consolidated Statements of Stockholders’ Equity — Years ended December 31, 2002, 2001 and 2000

Notes to Consolidated Financial Statements

Report of Ernst & Young LLP, Independent Auditors

The Board of Directors
Advanced Neuromodulation Systems, Inc.

We have audited the accompanying consolidated balance sheets of Advanced Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). 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.

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.

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, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, 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.

As discussed in Note 2 to the consolidated financial statements, in 2002 the Company, as required by the recently issued standard for accounting for goodwill and other intangible assets, changed its method of accounting for goodwill and other intangible assets.

/s/ Ernst & Young LLP

Ernst & Young LLP

Dallas, Texas
March 27, 2003

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2002 and 2001

				2002		2001
Assets
Current assets:
	Cash and cash equivalents			$	10,972,974	$	9,785,325
	Marketable securities				85,796,944		2,151,722
	Receivables:
		Trade accounts, less allowance for doubtful accounts of $295,391 in 2002 and $124,111 in 2001			10,847,237		6,493,772
		Interest and other			189,017		235,594
			Total receivables		11,036,254		6,729,366
	Inventories:
		Raw materials			7,141,338		4,685,586
		Work-in-process			2,364,386		1,723,419
		Finished goods			4,217,222		3,339,840
			Total inventories		13,722,946		9,748,845
	Deferred income taxes				1,122,617		1,726,517
	Refundable income taxes				—		678,341
	Prepaid expenses and other current assets				1,032,883		685,169
			Total current assets		123,684,618		31,505,285
Property, equipment and fixtures:
	Land				3,191,427		—
	Furniture and fixtures				4,022,901		3,400,909
	Machinery and equipment				10,343,953		8,550,504
	Leasehold improvements				1,702,965		1,610,810
					19,261,246		13,562,223
	Less accumulated depreciation and amortization				8,653,255		6,353,920
			Net property, equipment and fixtures		10,607,991		7,208,303
Cost in excess of net assets acquired, net					7,407,237		7,407,237
Patents and licenses, net of accumulated amortization of $1,435,835 in 2002 and $1,045,106 in 2001					5,323,417		5,368,213
Purchased technology from acquisitions, net of accumulated amortization of $2,098,200 in 2002 and $1,800,000 in 2001					9,033,472		2,200,000
Tradenames, net of accumulated amortization of $969,952 in 2002 and $843,736 in 2001					1,701,154		1,656,264
Other assets, net of accumulated amortization of $529,102 in 2002 and $392,033 in 2001					586,238		519,783
				$	158,344,127	$	55,865,085

See accompanying notes to consolidated financial statements.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets (continued)
December 31, 2002 and 2001

			2002			2001
Liabilities and Stockholders’ Equity
Current liabilities:
	Accounts payable		$	2,392,579		$	1,835,037
	Accrued salary and employee benefit costs			3,077,603			1,826,423
	Accrued tax abatement liability			969,204			969,204
	Accrued commissions			794,521			285,704
	Income taxes payable			822,228			—
	Deferred revenue			646,577			1,042,690
	Warranty reserve			402,259			383,477
	Other accrued expenses			299,905			204,151
	Current maturities of long-term note payable			—			52,325
		Total current liabilities		9,404,876			6,599,011
Deferred income taxes				3,731,939			2,316,796
Long-term note payable				—			137,397
Non-current deferred revenue				162,504			—
Commitments and contingencies
Stockholders’ equity:
	Common stock, $.05 par value
		Authorized -25,000,000 shares; issued - 12,350,676 shares in 2002 and 9,071,868 in 2001		617,534			453,593
	Additional capital			130,047,411			38,670,248
	Retained earnings			14,393,748			7,709,290
	Accumulated other comprehensive income (loss), net of tax benefit of $7,155 in 2002 and $10,949 in 2001			(13,885	)		(21,250	)
		Total stockholders’ equity		145,044,808			46,811,881
			$	158,344,127		$	55,865,085

See accompanying notes to consolidated financial statements.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31

			2002			2001			2000
Net revenue			$	57,372,013		$	37,916,435		$	31,826,998
Cost of revenue				20,658,798			15,675,436			14,699,633
		Gross profit		36,713,215			22,240,999			17,127,365
Operating expenses:
	Sales and marketing			14,931,826			9,055,932			6,851,022
	Research and development			5,842,576			4,928,432			3,854,084
	General and administrative			5,738,392			3,957,867			4,243,720
	Amortization of other intangibles			952,214			933,257			676,508
	Amortization of goodwill			—			556,604			556,604
				27,465,008			19,432,092			16,181,938
		Income from operations		9,248,207			2,808,907			945,427
Other income (expense):
	Acquisition related costs			—			(483,766	)		—
	Interest expense			(10,759	)		(24,346	)		(59,015	)
	Investment and other income, net			933,668			482,417			604,570
				922,909			(25,695	)		545,555
Income before income taxes				10,171,116			2,783,212			1,490,982
Income taxes				3,486,658			1,265,466			658,524
Net income			$	6,684,458		$	1,517,746		$	832,458
Net income per share:
	Basic		$	.61		$	.17		$	.10
	Diluted		$	.56		$	.15		$	.09

See accompanying notes to consolidated financial statements.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31

					2002			2001			2000
Cash flows from operating activities:
	Net income				$	6,684,458		$	1,517,746		$	832,458
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation				2,299,335			1,932,452			1,636,857
		Amortization				952,214			1,489,861			1,233,112
		Deferred income taxes				645,134			(455,003	)		(330,804	)
		Non-operating loss (gain) included in net income				8,666			—			(33,509	)
		Increase in inventory reserve				51,403			107,880			111,144
		Changes in operating assets and liabilities:
			Receivables			(4,306,888	)		(1,027,050	)		(486,949	)
			Inventories			(4,025,504	)		(2,672,605	)		270,190
			Refundable income taxes			678,341			(318,388	)		(359,953	)
			Prepaid expenses and other current assets			(387,323	)		564,866			144,880
			Customer deposits			(680,756	)		(706,916	)		(1,071,372	)
			Income taxes payable			822,228			(89,380	)		(521,510	)
			Tax benefit from stock option exercises			1,847,438			1,669,405			604,358
			Accounts payable			557,542			493,227			(1,348,526	)
			Accrued expenses			1,874,533			553,380			9,892
			Deferred revenue			447,147			—			—
				Total adjustments		783,510			1,541,729			(142,190	)
				Net cash provided by operating activities		7,467,968			3,059,475			690,268
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					—			1,040,000			385,000
	Purchases of marketable securities					(188,390,536	)		(3,896,199	)		(808,760	)
	Net proceeds from sales of marketable securities					104,747,808			2,876,720			564,194
	Purchase of land					(3,191,427	)		—			—
	Additions to equipment, fixtures and intangible assets					(2,942,227	)		(3,108,055	)		(1,653,194	)
	Acquisition of MicroNet					(1,359,460	)		—			—
	Net proceeds from sale of assets					—			—			600
				Net cash used in investing activities		(91,135,842	)		(3,087,534	)		(2,937,160	)
Cash flows from financing activities:
	Payment of long-term notes					(189,722	)		(47,807	)		(28,718	)
	Proceeds from long-term note payable					—			—			270,000
	Net proceeds from public offering of common stock					83,175,353			—			—
	Net proceeds from private placement of common stock					—			—			400,000
	Exercise of stock options and warrants					1,869,892			1,004,914			1,929,450
				Net cash provided by financing activities		84,855,523			957,107			2,570,732
Net increase in cash and cash equivalents						1,187,649			929,048			323,840
Net cash used by Hi-tronics in December 2000 (see Note 3)						—			(672,444	)		—
Cash and cash equivalents at beginning of year						9,785,325			9,528,721			9,204,881
Cash and cash equivalents at end of year					$	10,972,974		$	9,785,325		$	9,528,721
Supplemental cash flow information is presented below:
	Income taxes paid (refund)				$	(415,311	)	$	815,000		$	1,138,685
	Interest paid				$	10,759		$	24,346		$	59,015
Non-cash activity:
	Stock issued for patents and intangible assets				$	4,648,421		$	2,426,662		$	—

See accompanying notes to consolidated financial statements.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
Three Years Ended December 31, 2002

												Other
												Comprehensive						Total
		Common Stock				Additional			Retained			Income			Treasury			Stockholders'
		Shares		Amount		Capital			Earnings			(Loss)			Stock			Equity
Balance at December 31, 1999			8,883,059	$	444,153	$	34,598,112		$	5,706,765		$	(222,581	)	$	(3,990,242	)	$	36,536,207
	Net income		—		—		—			832,458			—			—			832,458
	Adjustment to unrealized losses on marketable securities		—		—		—			—			139,340			—			139,340
	Comprehensive income																		971,798
	Issuance of 32,900 shares from treasury for private placement		—		—		100,000			—			—			300,000			400,000
	Issuance of 337,941 shares from treasury for stock option and warrant exercises		—		—		(832,999	)		—			—			2,762,449			1,929,450
	Tax benefit from stock option exercises		—		—		604,358			—			—			—			604,358
Balance at December 31, 2000			8,883,059		444,153		34,469,471			6,539,223			(83,241	)		(927,793	)		40,441,813
	Net income		—		—		—			1,517,746			—			—			1,517,746
	Net loss of Hi-tronics for December 2000 (see Note 3)		—		—		—			(347,679	)		—			—			(347,679	)
	Adjustment to unrealized losses on marketable securities		—		—		—			—			61,991			—			61,991
	Comprehensive income																		1,232,058
	Compensation expense resulting from changes to Hi-tronics stock options in December 2000		—		—		37,029			—			—			—			37,029
	Issuance of shares for stock option exercises		188,809		9,440		995,474			—			—			—			1,004,914
	Tax benefit from stock option exercises		—		—		1,669,405			—			—			—			1,669,405
	Issuance of 119,100 shares from treasury for acquisition		—		—		1,498,869			—			—			927,793			2,426,662
Balance at December 31, 2001			9,071,868		453,593		38,670,248			7,709,290			(21,250	)		—			46,811,881
	Net income		—		—		—			6,684,458			—			—			6,684,458
	Adjustment to unrealized losses on marketable securities		—		—		—			—			7,365			—			7,365
	Comprehensive income																		6,691,823
	Sale of newly issued common stock in a public offering, net of offering costs		2,875,000		143,750		83,031,603			—			—			—			83,175,353
	Issuance of shares for stock option exercises		247,506		12,376		1,857,516			—			—			—			1,869,892
	Issuance of 156,302 shares for acquisition		156,302		7,815		4,640,606			—			—			—			4,648,421
	Tax benefit from stock option exercises		—		—		1,847,438			—			—			—			1,847,438
Balance at December 31, 2002			12,350,676	$	617,534	$	130,047,411		$	14,393,748		$	(13,885	)	$	—		$	145,044,808

See accompanying notes to consolidated financial statements.

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

(1) Business

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.

On November 26, 2002, the Company acquired MicroNet Medical, Inc., a privately-held developer of medical devices based on proprietary micro-lead technology based in St. Paul, Minnesota. See Note 3.

On January 2, 2001, the Company acquired the assets (primarily intellectual property consisting of patents) of Implantable Devices Limited Partnership (IDP) and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota companies. See Note 3.

On January 2, 2001, the Company completed the acquisition of Hi-tronics Designs, Inc. (HDI), a privately-held contract developer and original equipment manufacturer (O.E.M.) of electro-mechanical devices with headquarters in Budd Lake, New Jersey. See Note 3.

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

In addition, ANS neuromodulation 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.

(2) Summary of Significant Accounting Policies

Principles of Consolidation

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

Use of Estimates

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.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Reclassification

Certain amounts in the prior years financial statements have been reclassified to conform to the Company’s 2002 presentation.

Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.

Revenue Recognition

The Company generates revenues from product sales to end customers, product sales to distributors, and development contracts. The Company recognizes revenue from neuro product sales when the goods are shipped to its customers or distributors, provided an arrangement exists, the fee is fixed and determinable, and collectibility is reasonably assured. Certain of the Company’s customers are third-party payors who reimburse fixed amounts for services based on a specific diagnosis. Revenue is recognized on these third-party payor sales based on the sales price less a contractual adjustment, which is based on the Company’s history of reimbursement with the third-party payor, provided all other revenue recognition criteria are met. The Company records, as a reduction in revenue a provision for estimated sales returns and adjustments on these product sales in the same period as the related revenue is recorded. These estimates are based on historical sales returns, analysis of credit memo data, and other known factors. Payments received in advance of revenue recognition requirements are recorded as deferred revenue on the consolidated balance sheet. The Company recognizes revenue from custom manufactured products at HDI when the goods are shipped to the customer. HDI also develops products for certain customers under fixed price research and development contracts. The Company recognizes revenue and profit under the development agreements using the percentage-of-completion method, which relies on estimates of total expected revenue and costs. The Company follows this method since reasonably dependable estimates of revenue and costs applicable to various stages of a development agreement can be made. If the Company does not accurately estimate the resources required or the scope of work to be performed under a development agreement, then future profit margins and results of operations may be negatively impacted. In certain cases, HDI will undertake a development project on a cost plus basis. In these cases, the Company invoices and recognizes revenue for actual time and material expended on the project at contractual hourly billing rates and markups.

Marketable Securities

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 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.

Accounts Receivable

The Company estimates the collectibility of its trade receivables. A considerable amount of judgment is required in assessing the ultimate realization of the receivables, including the current credit-worthiness

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

of each customer. The Company’s historical bad debt experience has been within management’s expectations.

Inventories

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. The Company reserves for excess and obsolete inventory based upon forecasted demand for its products.

Equipment and Fixtures

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 Income.

Depreciation is provided using the straight-line method over the estimated useful lives of the various assets as follows:

Leasehold improvements
Furniture and fixtures
Machinery and equipment the lesser of 3 to 5 years or the term of the lease
2 to 10 years
3 to 10 years

Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of net assets of acquired businesses. Effective January 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and other Intangible Assets”. Under the provision of SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the statement.

The Company’s initial review for impairment of goodwill and other intangible assets performed during 2002 indicated no impairment of these assets as of January 1, 2002. During the first quarter of 2003, the Company performed its annual review for impairment of goodwill and other intangible assets as of December 31, 2002 and, based on this review, no impairment was recorded. The Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets in assessing the recoverability of its goodwill and other intangibles. If these estimates or the related assumptions change, the Company may be required to record impairment charges for these assets in the future.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Prior to the adoption of SFAS 142, amortization expense was recorded for goodwill and other intangibles with indefinite lives. The following table sets forth a reconciliation of net earnings and net earnings per share information for the three years ended December 31, 2002 as though SFAS 142 had been in effect at the beginning of fiscal 2000:

		Year Ended December 31,
		2002		2001		2000
Reported net income		$	6,684,458	$	1,517,746	$	832,458
Goodwill amortization			—		556,604		556,604
Adjusted net income		$	6,684,458	$	2,074,350	$	1,389,062
Basic net income per share:
	Reported	$	.61	$	.17	$	.10
	Goodwill amortization		—		.06		.06
	Adjusted	$	.61	$	.23	$	.16
Diluted net income per share:
	Reported	$	.56	$	.15	$	.09
	Goodwill amortization		—		.06		.06
	Adjusted	$	.56	$	.21	$	.15

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”. This Statement addresses financial accounting and reporting for the impairment of long-lived assets, including definite-lived intangible assets, and the disposal of long-lived assets and discontinued operations. The Company adopted SFAS No. 144, which supersedes SFAS No. 121, on January 1, 2002.

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.

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 (15-20 years) of such tradenames.

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. Costs of patents that are the result of internal development are charged to current operations.

The Company assesses the recoverability of its definite-lived intangible assets primarily based on its current and anticipated future undiscounted cash flows. At December 31, 2002, the Company does not believe there has been any impairment of its intangible assets.

The Company expects to record annual amortization expense of approximately $1,269,792 in 2003, $1,232,324 in 2004, $1,201,936 in 2005, $1,198,948 in 2006 and $1,198,052 in 2007 related to its intangible assets as of December 31, 2002.

Warranty Obligations

The Company’s products are generally covered by a one-year warranty. The Company accrues a warranty reserve for estimated costs to provide warranty services. The estimated costs to service the

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Company’s warranty obligations are based on historical experience and expectation of future conditions.

Research and Development

Product development costs including start-up and research and development are charged to operations in the year in which such costs are incurred.

Advertising

Advertising expense is charged to operations in the year in which such costs are incurred. Total advertising expense, included in marketing expense was $74,673, $20,592 and $24,716 at December 31, 2002, 2001 and 2000, respectively.

Deferred Taxes

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.

Stock-Based Compensation

The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, which disclosures are presented in Note 7, “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.

Stock compensation issued to non-employees is measured at fair value over the service period and recorded as compensation expense in the Statement of Income.

Earnings Per Share

Basic earnings per share is computed based only on the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the additional dilutive effect, if any, of stock options and warrants using the treasury stock method based on the average market price of the stock during the period. Basic earnings per share for 2002, 2001 and 2000 are based upon 10,900,040, 8,926,985, and 8,507,048 shares, respectively. Diluted earnings per share for 2002, 2001 and 2000 are based upon 11,891,637, 9,917,007, and 9,398,934 shares, respectively. The following table presents the reconciliation of basic and diluted shares:

		2002		2001		2000
Weighted-average shares outstanding(basic shares)			10,900,040		8,926,985		8,507,048
Effect of dilutive instruments(1)
	Stock options		991,597		990,022		847,349
	Warrants		—		—		44,537
	Dilutive potential common shares		991,597		990,022		891,886
Diluted shares			11,891,637		9,917,007		9,398,934

⁽¹⁾ See Note 7 for a description of these instruments.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

For 2002, 2001 and 2000 the incremental shares used for dilutive earnings per share relate to stock options and warrants whose exercise price was less than the average market price in the underlying quarterly computations. Options to purchase 24,750 shares at an average price of $19.79 per share were outstanding in 2001 and options to purchase 12,975 shares at an average price of $15.38 per share were outstanding in 2000 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. In 2002, all options were included in the computation of diluted earnings per share.

Following is the Company’s computation of basic and diluted income per share for the years ended December 31:

		2002		2001		2000
Basic income per share:
	Weighted average common Shares outstanding		10,900,040		8,926,985		8,507,048
	Net income	$	6,684,458	$	1,517,746	$	832,458
	Net income per share	$	0.61	$	0.17	$	0.10
Diluted income per share:
	Weighted average common shares outstanding		10,900,040		8,926,985		8,507,048
	Stock options and warrants—based on the treasury stock method using average market price		991,597		990,022		891,886
	Diluted common and common equivalent shares outstanding		11,891,637		9,917,007		9,398,934
	Net income	$	6,684,458	$	1,517,746	$	832,458
	Net income per share	$	0.56	$	0.15	$	0.09

Comprehensive Income

Statement of Financial Accounting Standards No. 130 — “Reporting Comprehensive Income” — requires unrealized gains or losses on the Company’s available for sale securities, and, for 2001, the effect of the change in fiscal year end of a company acquired (see Note 3) to be included in “Other comprehensive income” and be reported in the Consolidated Statements of Stockholders’ Equity.

New Accounting Standards

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123.” This standard amends SFAS No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123 to require prominent

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for financial statements with fiscal years ending after December 15, 2002 and is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002 with earlier application permitted.

(3) Acquisitions

On November 26, 2002, the Company completed the acquisition of MicroNet Medical, Inc., a privately-held developer of medical devices based on proprietary micro-lead technology based in St. Paul Minnesota. Under the terms of the transaction, which was structured as a merger, the Company acquired only MicroNet’s proprietary technology and certain associated tangible assets. At closing, the Company paid the former MicroNet shareholders $500,000 in cash and 156,302 shares of ANS common stock valued at $4,648,421. The Company also paid acquisition related costs of $859,460. The allocation of the purchase price as of December 31, 2002 is as follows: purchased technology $5,761,558, tradenames $138,181 and non-compete agreements $108,142. In addition to the initial purchase price paid at closing, if certain product, regulatory and sales milestones are met, ANS could pay an additional number of shares of common stock with an aggregate value of up to $9,000,000. All milestones must be met within the next four to five years, depending on the milestone.

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.

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 (O.E.M.) of electro-mechanical devices with headquarters in Budd Lake, New Jersey. The Company acquired all of HDI’s outstanding stock through a merger in exchange for 1,104,725 shares of ANS common stock. The transaction was accounted for on a pooling of interests basis and accordingly, prior periods have been restated. HDI developed and manufactured the Company’s totally implantable pulse generator (IPG) used in the treatment of chronic intractable pain and was also the O.E.M. manufacturer of the transmitter used with the Company’s Renew radio-frequency spinal cord stimulation system.

Prior to the Company’s acquisition of HDI, HDI’s fiscal year ended on November 30. The Consolidated Balance Sheet at December 31, 2000 combines the Balance Sheet of HDI at November 30, 2000 with the Balance Sheet of the Company at December 31, 2000. Beginning in 2001, the fiscal year-ends have been conformed to December 31. As a result, the results of operations of HDI for the one-month period ending December 31, 2000 have been recorded directly to retained earnings in the Consolidated Statement of Stockholders’ Equity for the period ended December 31, 2001 and are not reflected in the Consolidated Statements of Income. Summary operating results of HDI for this one-month period ending December 31, 2000, were as follows:

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Net revenue	$	119,481
Loss before income tax benefit		(591,600	)
Net loss		(347,679	)

For the one-month period ended December 31, 2000, cash flows for HDI were as follows:

Net cash used by operating activities		$	(647,210	)
Net cash used by investing activities			(14,516	)
Net cash used by financing activities			(10,718	)
	Net decrease in cash	$	(672,444	)

The following is a reconciliation of previously reported amounts with restated amounts for total net revenue and net income:

		2000
Total net revenue:
	As previously reported by the Company	$	23,081,624
	HDI, for the year ended November 30		10,366,270
	Elimination of intercompany transactions		(1,620,896	)
	As restated	$	31,826,998

		2000
Net income:
	As previously reported by the Company	$	953,644
	HDI, for the year ended November 30		28,833
	Elimination of intercompany transactions		(150,019	)
	As restated	$	832,458

Prior to January 2, 2001, the Company and HDI, in the normal course of business, entered into certain transactions for development and manufacture related to the Company’s products. These intercompany transactions have been eliminated.

(4) Note Payable

In connection with the acquisition of HDI (See Note 3), the Company acquired responsibility for a note payable with a principal balance of $189,722 at December 31, 2001. The note was repaid in its entirety during June 2002.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

(5) Marketable Securities

The following is a summary of available-for-sale securities at December 31, 2002:

			Gross		Gross
			Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Freddie Mac and Federal Home Loan Bank notes	$	770,814	$	—	$	15,474	$	755,340
Investment grade municipal bonds		2,222,170		5,349		10,915		2,216,604
7-day and 35-day AAA municipal bond floaters		82,825,000		—		—		82,825,000
	$	85,817,984	$	5,349	$	26,389	$	85,796,944

Estimated fair value for the investment grade municipal bonds, 7-day and 35-day municipal bond floaters and Freddie Mac and Federal Home Loan Bank notes is provided by the brokerage firms holding such bonds and notes at each reporting period by utilizing a standard pricing service.

At December 31, 2002, no individual security represented more than 6.5% of the total portfolio or 3.5% of total assets. The Company did not have any investments in derivative financial instruments at December 31, 2002.

The following is a summary of available-for-sale securities at December 31, 2001:

			Gross		Gross
			Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
FNMA and Federal Home Loan Bank notes	$	1,038,783	$	—	$	10,034	$	1,028,749
Investment grade municipal bonds		1,047,456		258		4,241		1,043,473
Real estate investment trust		97,682		—		18,182		79,500
	$	2,183,921	$	258	$	32,457	$	2,151,722

At December 31, 2001, no individual security represented more than 25% of the total portfolio or 1% of total assets. The Company did not have any investments in derivative financial instruments at December 31, 2001.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

(6) Federal Income Taxes

The significant components of the net deferred tax liability at December 31, were as follows:

		2002			2001
Deferred tax assets:
	Net operating loss carry forwards	$	1,181,086		$	670,128
	Accrued expenses and reserves		1,051,871			870,720
	Marketable securities		8,303			10,949
	Other		141,809			141,569
	Total deferred tax assets		2,383,069			1,693,366
Deferred tax liabilities:
	Purchased intangible assets		(4,464,083	)		(1,388,255	)
	Equipment and fixtures		(528,308	)		(895,390	)
	Total deferred tax liabilities		(4,992,391	)		(2,283,645	)
	Net deferred tax liabilities	$	(2,609,322	)	$	(590,279	)

As of December 31, 2002, the Company had a net operating loss carry forward of approximately $3.4 million which expires in years through 2021. This net operating loss carry forward was acquired by the Company in connection with the MicroNet Medical acquisition and its utilization in any future year may be subject to a limitation under Section 382 of the Internal Revenue Code or other provisions which may limit the use of the net operating loss carry forward in any tax year.

The provision (benefit) for income taxes for the years ended December 31 consists of the following:

	2002		2001			2000
Current	$	2,841,524	$	1,747,285		$	841,390
Deferred		645,134		(481,819	)		(182,866	)
	$	3,486,658	$	1,265,466		$	658,524

A reconciliation of the provision for income taxes to the expense calculated at the U.S. statutory rate follows:

		2002			2001		2000
Income tax expense at statutory rate		$	3,458,179		$	946,292	$	506,934
Tax effect of:
	State taxes		275,481			42,959		4,581
	Nondeductible amortization of goodwill		—			189,245		189,279
	Tax-exempt interest		(291,745	)		—		—
	Other		44,743			86,970		(42,270	)
Income tax expense		$	3,486,658		$	1,265,466	$	658,524

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

(7) Stockholders’ Equity

The Company has a Shareholder’s Rights Plan, adopted in 1996 and amended in 2002, 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% of the Company’s common stock or announces a tender or exchange offer for more than 20% of the Company’s common stock.

At December 31, 2000, the Company had 119,100 treasury shares. These shares were reissued on January 2, 2001 in connection with the acquisition of assets. See Note 3.

The Company issued 2,875,000 shares of common stock during May 2002 in an underwritten public offering. The Company received net proceeds from the offering of approximately $83.2 million.

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. In accordance with the 2000 Plan, on January 1 of each year (commencing in 2001), the aggregate number of shares of common stock reserved for options under the 2000 Plan is 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). At December 31, 2002, the 2000 Plan had a total number of shares reserved of 613,638. On January 1, 2003, options to purchase 221,769 shares of common stock were added to the 2000 Plan.

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 or three-year vesting schedule.

At December 31, 2002, under all of the Company’s stock option plans, 2,026,419 shares had been granted and were outstanding, 2,482,503 shares of common stock had been issued upon exercise, and 33,142 shares were reserved for future grants.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Data with respect to stock option plans of the Company are as follows:

Options Outstanding						Exercisable Options
				Weighted				Weighted
				Average				Average
	Shares			Exercise Price		Shares		Exercise Price
January 1, 2000		1,335,249		$	5.63		563,333	$	5.11
Granted		422,332		$	14.21
Exercised		(237,674	)	$	5.50
Forfeited		(55,270	)	$	6.88
January 1, 2001		1,464,637		$	8.08		607,664	$	5.23
Granted		413,500		$	12.51
Exercised		(188,809	)	$	5.58
Forfeited		(20,153	)	$	8.70
January 1, 2002		1,669,175		$	9.44		750,215	$	6.61
Granted		617,000		$	27.54
Exercised		(247,506	)	$	7.31
Forfeited		(12,250	)	$	17.19
December 31, 2002		2,026,419		$	15.17		869,738	$	8.65

								Exercisable Options at
Options Outstanding at December 31, 2002								December 31, 2002
				Weighted
				Average		Weighted				Weighted
Range of Exercise				Remaining		Average				Average
Price		Shares		Life (Years)		Exercise Price		Shares		Exercise Price
$	5.00-7.49		623,684		5.57	$	5.54		561,184	$	5.42
$	7.50-10.49		79,706		6.28	$	8.80		39,691	$	8.59
$	10.50-13.99		338,047		7.53	$	11.12		92,497	$	11.58
$	14.00-17.49		263,107		7.06	$	14.50		119,241	$	14.50
$	17.50-21.00		106,875		8.30	$	19.36		31,625	$	19.37
$	21.01-30.00		615,000		8.92	$	27.54		25,500	$	28.46
			2,026,419		7.28	$	15.17		869,738	$	8.65

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 2002, 2001 and 2000 was $13.17, $6.24 and $5.76, 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:

	2002			2001			2000
Risk-free interest rate		4.5	%		4.4	%		5.9	%
Average life of options (years)		3.0			3.0			3.0
Volatility		67.6	%		74.5	%		52.4	%
Dividend Yield		—			—			—

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Had the compensation expense been recorded based on these hypothetical values, pro forma net income (loss) for 2002, 2001 and 2000 would have been $4,576,659, $(95,632) and $(436,109), respectively, and pro forma diluted net income (loss) per common share for 2002, 2001 and 2000 would have been $.38, $(.01) and $(.05), respectively.

(8) Commitments and Contingencies

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, subject to certain annual adjustments for increases in expenses for common area maintenance and property taxes. The monthly rental rate was increased to $50,951 in January 2002. In September 2002, the Company amended its lease agreement to add approximately 9,700 square feet of office space located in the same complex as its 40,000 square foot corporate headquarters. The lease on the additional space expires during August 2004, the same as the corporate headquarters facility. The monthly rental rate on the 9,700 square feet of office space is $11,485. Future minimum rental payments relating to the leased facilities for the years ended December 31 are $749,244 in 2003 and $499,496 in 2004.

The Company also leases facilities in New Jersey as a result of the January 2001 acquisition of HDI. One of the facilities, located in Budd Lake, New Jersey, is 10,348 square feet of office space that is used for administration, design engineering, drafting, documentation and regulatory affairs. The lease expires on February 28, 2004 and has a monthly rental rate of $9,615. The Company also leases 18,582 square feet of space in Hackettstown, New Jersey used for the O.E.M. manufacturing operations. The Hackettstown lease, which expires on December 31, 2005, has a monthly rental rate of $9,517 and is renewable for one additional three-year period. Future minimum rental payments relating to the leased facilities for HDI for the years ended December 31 are $229,584 in 2003, $133,434 in 2004 and $114,204 in 2005.

The Company leases transportation equipment under non-cancelable operating leases with expirations ranging from March 2005 until October 2006. Future minimum rental payments under non-cancelable transportation leases for the years ended December 31 are $47,768 in 2003, $47,768 in 2004, $26,496 in 2005 and $8,481 in 2006.

The Company leases office equipment under non-cancelable operating leases expiring through 2004. Monthly payments on the office equipment leases are $2,412. Future minimum rental payments under non-cancelable equipment leases until the expiration of the leases are $28,938 in 2003 and $4,824 in 2004.

Total rent expense for facilities, transportation and office equipment for the years ended December 31, 2002, 2001 and 2000 was $1,063,097, $858,761 and $791,192, respectively.

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,

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

and there can be no assurance that the Company’s neurostimulation business and future ANS product lines will not be adversely affected by these product liability claims.

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

Certain of the Company’s distributor sales agreements contain an early termination provision that permits the Company to terminate the agreement without cause by paying an early termination fee equal to 25% of the prior year’s sales to the distributor. The termination fee for the Company’s two existing distributors would range from $392,000 to $1,157,000. In addition, under the Company’s sales agreements with its independent sales agents, the Company can terminate those agreements without cause by paying an early termination fee equal to 100% of the commissions that would otherwise be payable on sales in the territory for the 90 days after termination and 50% of the commission that would otherwise be payable on sales in the territory for the 90 day period after the first 90 day period.

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

(9)  Financial Instruments, Risk Concentration and Major Customers

In the United States, the Company’s accounts receivable from its Neuro Products segment are due primarily from hospitals, insurance companies and distributors located throughout the country. Internationally, the Company’s accounts receivable from its Neuro Products segment are due primarily from distributors located in Europe and Australia. For the HDI O.E.M segment, all of the accounts receivable are due from privately held and publicly traded medical device companies based in the United States. 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.

Net sales of implantable neurostimulation systems to one major customer, Sun Medical, Inc., for each of the years ended December 31, as a percentage of net revenue from the Neuro Products segment, were as follows: 2002- 14%, 2001- 15% and 2000- 14%. In March 2003, the Company acquired Sun Medical’s pain management business and hired substantially all of that business’ salesforce.

Net sales of O.E.M. products and services to two major customers for the year ended December 31, 2002, as a percentage of net revenue from the HDI O.E.M. segment were 63% and 26%, respectively. Net sales of O.E.M products and services to three major customers for the year ended December 31, 2001, as a percentage of net revenue from the HDI O.E.M. segment were 60%, 17% and 11%, respectively. Net sales of O.E.M. products and services to three major customers for the year ended December 31, 2000, as a percentage of net revenue from the HDI O.E.M. segment were 49%, 24% and 17%, respectively.

Foreign sales, primarily Europe and Australia, for the years ended December 31, 2002, 2001 and 2000 were approximately 8%, 10% and 7% of net revenue from the Neuro Products segment, respectively.

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

The HDI O.E.M. segment had no foreign sales for the years ended December 31, 2002, 2001 and 2000, respectively.

(10)  Employee Benefit Plans

The Company has a defined contribution retirement savings plan (the “Plan”) available to substantially all employees of its Neuro Products segment. The Plan permits employees to elect salary deferral contributions of up to 15% of their compensation and requires the Company to make matching contributions equal to 50% of the participants’ contributions to a maximum of 6% of the participants’ compensation. As a result of the acquisition of HDI, the Company also has a defined contribution retirement savings plan (the “HDI Plan”) available to substantially all employees of HDI. The HDI Plan permits employees to elect salary deferral contributions of up to 15% of their eligible compensation, subject to statutory limitations, and requires the Company to make matching contributions equal to 100% of the participants’ contributions to a maximum of 5% of the participants’ eligible compensation. The Board of Directors may change the percentage of matching contribution under either of the plans at their discretion. The expense of the Company’s contribution for the years ended December 31 was $346,125 in 2002, $305,091 in 2001 and $270,987 in 2000.

(11)  Sale of Facility/Accrued Tax Abatement Liability

In January 1998, the Company sold its cardiovascular operations to Atrion Corporation, and granted Atrion a nine-month option to acquire the Company’s principal office and manufacturing facility in Allen, Texas for $6.5 million. During October 1998, Atrion exercised its option to acquire the facility. When the facility was built in 1993, the Company entered a ten-year agreement with the City of Allen granting tax abatements to the Company if a minimum job base and personal property base were maintained in the City of Allen. The agreement provided for the repayment of abated taxes if the Company defaulted under the agreement. During 1998 the Company recorded a pretax expense of $969,204 in connection with the abated taxes. In April 1999, the Company was successful in petitioning the City of Allen to assign the abatement agreement to Atrion. In July 1999, the Company, Atrion and the City of Allen executed an assignment agreement under which Atrion (as successor in interest to the Company) 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 cardiovascular 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 potential obligation of $969,204 in September 2003, which would result in the reporting of “other income” in this amount in the Consolidated Statement of Income.

(12)  Segment Information

The Company operates in two business segments. The Neuro Products segment designs, develops, manufactures and markets implantable medical devices that are used to manage chronic intractable pain and other disorders of the central nervous system through the delivery of electrical current or drugs directly to targeted nerve fibers. The HDI O.E.M. segment provides contract development and O.E.M. manufacturing of electro-mechanical devices.

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

Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

Segment data as of and for the year ended December 31, 2002 is as follows:

	Neuro		HDI		Intercompany			Consolidated
	Products		O.E.M.		Eliminations			Total
Revenue from external customers	$	46,712,158	$	10,659,855	$	—		$	57,372,013
Intersegment revenues	$	—	$	5,663,216	$	(5,663,216	)	$	—
Segment income from operations	$	7,013,895	$	2,234,312	$	—		$	9,248,207
Segment assets	$	154,451,136	$	8,982,629	$	(5,089,638	)	$	158,344,127

Segment data as of and for the year ended December 31, 2001 is as follows:

	Neuro		HDI		Intercompany			Consolidated
	Products		O.E.M.		Eliminations			Total
Revenue from external customers	$	27,460,618	$	10,455,817	$	—		$	37,916,435
Intersegment revenues	$	—	$	2,862,652	$	(2,862,652	)	$	—
Segment income from operations	$	1,040,036	$	1,768,871	$	—		$	2,808,907
Segment assets	$	51,246,012	$	6,847,014	$	(2,227,941	)	$	55,865,085

Segment data as of and for the year ended December 31, 2000 is as follows:

	Neuro		HDI		Intercompany			Consolidated
	Products		O.E.M.		Eliminations			Total
Revenue from external customers	$	23,081,624	$	8,745,374	$	—		$	31,826,998
Intersegment revenues	$	—	$	1,620,896	$	(1,620,896	)	$	—
Segment income from operations	$	1,108,894	$	67,985	$	(231,452	)	$	945,427
Segment assets	$	45,371,687	$	7,391,078	$	(3,198,199	)	$	49,564,566

(13) Subsequent Events

In January 2003, the Company made a minority investment of $1 million in cash to purchase common stock in Innovative Spinal Technologies, Inc., a start-up company that develops spine technologies, products and services through intellectual property development and contract research.

In March 2003, the Company acquired the assets of the pain management business of Sun Medical, Inc. for approximately $5.1 million in cash. Sun Medical was the largest distributor of the Company’s Neuro Products and accounted for $6.33 million, or 13.5% of revenue of the Neuro Products segment during the twelve months ended December 31, 2002. As part of the acquisition, the Company hired substantially all of the salespersons who worked for Sun Medical’s pain management business. The assets acquired consisted primarily of customer lists, non-competes, inventory, contracts, equipment and other intangible assets but specifically excludes cash and accounts receivable as of the closing date.

Appendix B

Schedule II — Valuation and Qualifying Accounts

Forming a Part of the Annual Report

Form 10-K

Item 14

of

ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)

Filed with the

Securities and Exchange Commission

Washington, D.C. 20549

under

The Securities Exchange Act of 1934

Schedule II — Valuation and Qualifying Accounts
Advanced Neuromodulation Systems, Inc. and Subsidiaries
December 31, 2002

			Balance at				Charged to
			Beginning of		Charged to		Other				Balance at
Description			Year		Expenses		Accounts		Deductions		End of Year
Year ended December 31, 2002:
	Allowance for doubtful accounts		$	124,111	$	186,336	$	—	$	15,056	$	295,391
	Reserve for obsolete inventory			293,450		121,528		—		112,698		302,280
		Total	$	417,561	$	307,864	$	—	$	127,754	$	597,671
Year ended December 31, 2001:
	Allowance for doubtful accounts		$	213,249	$	10,000	$	—	$	99,138	$	124,111
	Reserve for obsolete inventory			310,243		107,880		—		124,673		293,450
		Total	$	523,492	$	117,880	$	—	$	223,811	$	417,561
Year ended December 31, 2000:
	Allowance for doubtful accounts		$	140,824	$	102,984	$	—	$	30,559	$	213,249
	Reserve for obsolete inventory			199,099		111,144		—		—		310,243
		Total	$	339,923	$	214,128	$	—	$	30,559	$	523,492

Appendix C

Quarterly Financial Data
(unaudited)

Forming a Part of the Annual Report

Form 10-K

Item 8

of

ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)

Filed with the

Securities and Exchange Commission

Washington, D.C. 20549

under

The Securities Exchange Act of 1934

2002	1st Qtr.		2nd Qtr.		3rd Qtr.		4th Qtr.
Net revenue	$	11,472,646	$	13,423,371	$	14,327,505	$	18,148,491
Gross profit		6,958,486		8,359,944		9,474,096		11,920,689
Income from operations		1,239,225		2,084,679		2,532,874		3,391,429
Income from operations before income taxes		1,308,425		2,227,928		2,905,351		3,729,412
Net income	$	836,976	$	1,448,441	$	1,942,303	$	2,456,738
Basic income per share	$	0.09	$	0.14	$	0.16	$	0.20
Diluted income per share	$	0.08	$	0.13	$	0.15	$	0.19

2001	1st Qtr.			2nd Qtr.		3rd Qtr.		4th Qtr.
Net revenue	$	8,340,810		$	9,204,721	$	9,899,973	$	10,470,931
Gross profit		4,768,021			5,270,066		5,830,956		6,371,956
Income from operations		332,764			530,936		783,321		1,161,886
Acquisition related costs		(483,766	)		—		—		—
Income (loss) from operations before income taxes (benefit)		(13,160	)		678,703		863,379		1,254,290
Net income (loss)	$	(6,261	)	$	368,514	$	475,244	$	680,249
Basic income per share	$	—		$	0.04	$	0.05	$	0.07
Diluted income per share	$	—		$	0.04	$	0.05	$	0.07

INDEX TO EXHIBITS

Exhibit
Number	Description
2.1	Agreement and Plan of Merger, dated as of November 30, 2000, by and among Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp. and Hi-tronics Designs, Inc.(10)
2.2	Agreement and Plan of Merger, dated as of November 4, 2002, by and among Advanced Neuromodulation Systems, Inc., MicroNet Acquisition, Inc. and MicroNet Medical, Inc.(14)
3.1	Articles of Incorporation, as amended and restated(11)
3.2	Bylaws(11)
4.1	Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights Agent(5)
4.2	Amendment To Rights Agreement dated as of January 25, 2002 between Advanced Neuromodulation Systems, Inc. and Computershare Investor Services LLC (formerly KeyCorp Shareholder Services, Inc)(12)
10.1	Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option Plan(2)
10.2	Form of 1979 Employees Stock Option Agreement(3)
10.3	Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)
10.4	Form of Directors Stock Option Agreement(1)
10.6	Quest Medical, Inc. 1995 Stock Option Plan(4)
10.7	Form of 1995 Employee Stock Option Agreement(4)
10.8	Quest Medical, Inc. 1998 Stock Option Plan(7)
10.9	Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)
10.10	Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest Medical, Inc.(6)
10.11	Employment Agreement dated April 9, 1998 between F. Robert Merrill III and Quest Medical, Inc.(6)
10.12	Employment Agreement dated April 1, 2002 between Christopher G. Chavez and Advanced Neuromodulation Systems, Inc.(13)
10.13	Employment Agreement dated April 1, 2002 between Kenneth G. Hawari and Advanced Neuromodulation Systems, Inc.(13)
10.14	Special Termination Agreement dated April 1, 2002 between Christopher G. Chavez and Advanced Neuromodulation Systems, Inc.(13)
10.15	Special Termination Agreement dated April 1, 2002 between Kenneth G. Hawari and Advanced Neuromodulation Systems, Inc.(13)
10.16	Form of Employment Agreement and Covenant Not to Compete, between the Company and key employees(1)
10.17	Lease Agreement dated as of February 4, 1999, between Advanced Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(8)
10.18	Second Amendment to Lease Agreement dated as of September 1, 2002, between Advanced Neuromodulation Systems, Inc. and Plano R&D Associates, LTD.(15)
10.19	Escrow Agreement dated November 25, 2002, among Advanced Neuromodulation Systems, Inc., Thomas E. Brust and Computershare Trust Company(16)
21.1	Subsidiaries(15)
23.1	Consent of Independent Auditors(16)
99.1	Certification of the Chief Executive Officer(16)
99.2	Certification of the Chief Financial Officer(16)

(1)	Filed as an Exhibit to the Company’s Registration Statement on Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.
(2)	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.
(3)	Filed as an Exhibit to the Company’s Registration Statement on Form S-1, Registration No. 2-78186, and incorporated herein by reference.

(4)	Filed as an Exhibit to the Company’s Registration Statement on Form SB-2, Registration No. 33-62991, and incorporated herein by reference.
(5)	Filed as an Exhibit to the report of the Company on Form 8-K dated September 3, 1996, and incorporated herein by reference.
(6)	Filed as an Exhibit to the report of the Company on Form 10-Q for the quarter ended March 31, 1998, and incorporated herein by reference.
(7)	Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 27, 1998, and incorporated herein by reference.
(8)	Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 1998, and incorporated herein by reference.
(9)	Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated April 17, 2000, and incorporated herein by reference.
(10)	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.
(11)	Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 2000, and incorporated herein by reference.
(12)	Filed as an Exhibit to the report of the Company on Form 8-K dated January 30, 2002, and incorporated herein by reference.
(13)	Filed as an Exhibit to the report of the Company on Form 10-Q for the quarter ended March 31, 2002, and incorporated herein by reference.
(14)	Filed as an Exhibit to the report of the Company on Form 8-K dated November 26, 2002, and incorporated herein by reference.
(15)	Previously filed.
(16)	Filed herewith.

EX-10.19 3 d05661a1exv10w19.htm EX-10.19 ESCROW AGREEMENT

EXHIBIT 10.19

ESCROW AGREEMENT

     THIS ESCROW AGREEMENT (this “Agreement”) dated November 25, 2002 is entered into by and among Advanced Neuromodulation Systems, Inc., a Texas corporation (“Parent”), Thomas E. Brust, as a duly appointed representative (the “Representative”) of all of the shareholders of MicroNet Medical, Inc., a Minnesota corporation (“Company”) and Computershare Trust Company, Inc. as escrow agent (the “Escrow Agent”). Parent, the Representative and the Escrow Agent are collectively referred to in this Agreement as the “parties.”

RECITALS

     Pursuant to that certain Agreement and Plan of Merger dated as of November 4, 2002, by and among Parent, MicroNet Acquisition, Inc., a Delaware corporation and wholly-owned subsidiary of Parent (“Merger Sub”), Company and certain shareholders of Company (the “Merger Agreement”), Merger Sub is merging with and into Company (the “Merger”), with Company being the Surviving Corporation and wholly-owned subsidiary of Parent. In accordance with the terms of the Merger Agreement, the issued and outstanding shares of common stock, $0.01 par value per share, of Company, other than those constituting Dissenting Shares will be converted into the right to receive shares of common stock, $0.05 par value, of Parent, all as set forth in the Merger Agreement.

     The Merger Agreement provides that an escrow fund comprised of shares of Parent Common Stock to be issued to the shareholders of the Company as of the Effective Time of the Merger (the “Company Shareholders”) will be established to provide payment to the Company Shareholders if and when certain Milestones are achieved as set forth in Article II of the Merger Agreement and (b) security to Parent with respect to the potential indemnification obligations of the Company Shareholders.

     NOW, THEREFORE, for good, valid and binding consideration, the receipt and adequacy of which is hereby acknowledged, the parties, intending to be legally bound by this Agreement, agree as follows:

     1.     Except as otherwise defined in this Agreement, the capitalized terms used in this Agreement have the meanings ascribed to them in the Merger Agreement.

     2.     Pursuant to the terms and conditions of the Merger Agreement, 89,606 Shares (having an aggregate value of $3,000,000, based on the Average Trading Price on the Closing Date) have been issued as part of the Merger Consideration in the names of the respective Company Shareholders, in accordance with their pro rata ownership of Company, and have been delivered to the Escrow Agent (together with any shares of capital stock, cash or other property, such Shares as may be converted or exchanged after the date hereof, by stock split or otherwise, the “Escrowed Shares”). The Escrowed Shares will be held by the Escrow Agent upon the terms and conditions contained in this Agreement and will be released by the Escrow Agent in accordance with this Agreement. The Escrowed Shares and all dividends or other economic benefits (but no other benefits, including but not limited to voting or transfer rights) associated with the Escrowed Shares will accrue to the Escrowed Shares for the benefit of the applicable Company Shareholders from the Closing Date, will be deposited into the Escrow Account and will be subject to forfeiture in the

1

event the Milestones are not timely achieved, as provided in Section 2.01 of the Merger Agreement. The Escrow Agent agrees that it does not and will not have any right of setoff or other rights or claims with respect to the Escrowed Shares.

     3.     In accordance with Article II of the Merger Agreement, if and when each Milestone is achieved, Parent will promptly instruct the Escrow Agent in substantially the form of Exhibit A attached to this Agreement (a “Certificate of Instruction”) that the applicable number of the Escrowed Shares, as set forth in Exhibit B attached to this Agreement, plus any accrued dividends or other economic benefits thereon, are to be released to the respective Company Shareholders. The Escrow Agent, upon receipt of the Certificate of Instruction from Parent, will, not later than ten business days following its receipt of such Certificate of Instruction, release to the applicable Company Shareholders such number of Escrowed Shares, plus any accrued dividends or other economic benefits thereon.

     4.     In accordance with and subject to the limitations of Article VIII of the Merger Agreement, Parent and the Surviving Corporation are authorized to setoff and apply Claims of any Indemnified Party against Parent’s obligation to release any or all of the Escrowed Shares from the Escrow Account. If Parent notifies the Escrow Agent by a Certificate of Instruction of its intention to apply the Escrowed Shares against any such Claim, the Escrow Agent will, not later than three business days following its receipt thereof give written notice to the Representative of its receipt, together with a copy of such Certificate of Instruction. Concurrently with the delivery of the Certificate of Instruction to the Escrow Agent, Parent will deliver to the Representative written notice setting forth in reasonable detail the facts giving rise to Parent’s right of setoff contained in the Certificate of Instruction.

          (a) If the Escrow Agent (i) has not, within 30 days after it has given such notice to the Representative, received from the Representative a certificate in substantially the form of Exhibit C attached to this Agreement (an “Objection Certificate”) in respect of the Certificate of Instruction to which such notice relates, or (ii) has received such an Objection Certificate within such 30 days but thereafter receives a copy of a joint notice signed by the Representative and by Parent, or a final award of an arbitrator pursuant to Section 11.01 of the Merger Agreement to the effect that the Owed Amount (as defined in the Certificate of Instruction) referred to in such Certificate of Instruction or a specified portion thereof constitutes a Claim which may be setoff and against which Parent may apply all or a portion of the Escrowed Shares, such shares being valued for this purpose at the Average Trading Price prior to the date of setoff, then the Escrow Agent will, on the business day following the expiration of ten days or the receipt by the Escrow Agent of such joint notice or award, as applicable, release to Parent a number of Escrowed Shares valued at the Average Trading Share Price before the date of setoff.

          (b) Upon receipt of an Objection Certificate, the Escrow Agent will, not later than three business days following receipt thereof, give written notice to Parent of its receipt together with a copy of the Objection Certificate. The Representative and Parent will resolve any Dispute with respect to all or a specified portion of an Owed Amount in accordance with Section 11.01 of the Merger Agreement. If Parent and the Representative engage in mediation and/or arbitration, the Escrow Agent will have no duty or obligation with respect to such mediation and/or arbitration other than to retain the Escrowed Shares in safekeeping until it receives a copy of the arbitration award or a joint notice as described in Section 4(a) of this Agreement. Each of the

2

Parent (on the one hand) and the Representative (on the other) agrees to pay 50% of such reasonable fees and expenses incurred, if any, in connection with such dispute resolution process.

          (c) Upon receipt by the Escrow Agent of a copy of a joint notice from Parent and the Representative, or an arbitration award to the effect that the Owed Amount (or a specified portion thereof) referred to in a Certificate of Instruction in respect of which the Escrow Agent had received an Objection Certificate is not an amount properly payable as a Claim against which the Escrowed Shares may be applied, such Certificate of Instruction (or such specified portion of the Owed Amount set forth therein) will be deemed canceled. The Escrow Agent will have no duty to determine if the arbitration award is final or binding, but may act in accordance therewith.

          (d) Upon determining that it has no right of setoff with respect to an Owed Amount referred to in a Certificate of Instruction or a specified portion of the Owed Amount set forth therein, Parent will promptly give notice in writing to the Escrow Agent to cancel such Certificate of Instruction (or such specified portion).

     5.     On the fifth year anniversary of the Closing of the Merger (the “Expiration Date”), the Escrow Agent will release to Parent for cancellation any Escrowed Shares, together with all accrued dividends or economic benefits arising therefrom, then remaining in the Escrow Account and the Company Shareholders will have no rights with respect thereto. After such release, the Parent will distribute any earned Escrowed Shares to the Company Shareholders, if such Company Shareholders are so entitled. Notwithstanding the foregoing, if prior to the Expiration Date, a Change in Control (as defined in Section 2.01(c)(v) of the Merger Agreement) occurs, Parent will immediately send a Certificate of Instruction to the Escrow Agent authorizing the release of the Escrowed Shares to the Company Shareholders. Upon the release by the Escrow Agent to Parent or the Company Shareholders, as applicable, of all the Escrowed Shares, together with any accrued dividends or other economic benefits thereon, this Agreement will automatically terminate, except for the provisions affecting the reimbursement of expenses, indemnity and fees of the Escrow Agent.

     6.     The duties and obligations of the Escrow Agent will be determined solely by the provisions of this Agreement, and the Escrow Agent will not be liable except for the performance of such duties and obligations as are specifically set forth in this Agreement, with no duties to be implied. In furtherance and not in limitation of the foregoing:

          (a) the Escrow Agent will be fully protected in relying in good faith upon any written certification, notice, direction, request, waiver, consent, receipt or other document that the Escrow Agent believes to be genuine and duly authorized, executed and delivered;

          (b) the Escrow Agent will not be liable for any error of judgment, or for any act done or omitted by it, or for any mistake in fact or law, or for anything that it may do or refrain from doing in connection therewith, including its own mere negligence. The Escrow Agent will, however, be liable for its willful misconduct, recklessness or gross negligence. The Company Shareholders, through the Representative, and Parent, jointly and severally, agree to indemnify Escrow Agent for, and to hold it harmless against, any damages, liability or expense (including, without limitation, reasonable attorneys’ fees) incurred by it without gross negligence, recklessness or willful misconduct on its part arising out of or in connection with its entering into this Agreement

3

and carrying out its duties hereunder, including the costs and expenses of defending itself against any claim of liability arising out of this Agreement, it being the express intent to indemnify and hold the Escrow Agent harmless against its own mere negligence. The costs and expenses of enforcing the right of indemnification will also be paid by Parent and the Company Shareholders through the Representative, jointly and severally. This right of indemnification will survive the termination of this Escrow Agreement and the removal or resignation of the Escrow Agent;

          (c) the Escrow Agent may seek the advice of legal counsel in the event of any dispute or question as to the construction of any of the provisions of this Agreement or its duties hereunder, and it will incur no liability and will be fully protected in respect of any action taken, omitted or suffered by it in good faith in accordance with the opinion of such counsel;

          (d) in the event that the Escrow Agent is, in any instance and in good faith, uncertain as to its duties or rights under this Agreement, it will be entitled to refrain from taking any action in that instance and its sole obligation, subject to those of its duties under this Agreement as to which there is no such uncertainty, will be to keep safely all property held in escrow until it is directed otherwise in writing by the Representative and Parent or by a final order or judgment of a court of competent jurisdiction which is accompanied by a legal opinion of the presenting party satisfactory to the Escrow Agent to the effect that such opinion or judgment is final and enforceable and is not subject to further appeal;

          (e) the Escrow Agent will not be required to institute legal proceedings of any kind and will not be required to initiate or defend any legal proceedings, which may be instituted against it in respect of the subject matter of this Agreement. In the event of any conflicting or inconsistent claims or demands being made in connection with the subject matter of this Agreement, however, or in the event that the Escrow Agent is in doubt as to what action it should take under this Agreement, the Escrow Agent is hereby authorized to petition any court of competent jurisdiction for instructions or to interplead the funds or assets so held into such court. The parties agree to the jurisdiction of such court over their persons as well as the Escrowed Shares, waive personal service of process, and agree that service of process by certified or registered mail, return receipt requested, to the business addresses set forth in this Agreement will constitute adequate service. The Company Shareholders through the Representative, on the one hand, and Parent, on the other hand, jointly and severally agree to indemnify and hold the Escrow Agent harmless from any liability or damages occasioned thereby and to pay any and all of its costs, expenses, and reasonable attorneys’ fees incurred in any such action and agree that, upon the filing of such petition or interpleader action, the Escrow Agent, its servants, agents, employees or officers will be relieved of further liability; and

          (f) all parties acknowledge and agree that the Escrow Agent is acting solely and exclusively as a custodian under this Agreement.

     7. The Escrow Agent is entitled to its reasonable fees and costs, including reasonable attorneys’ fees, as set forth in Attachment I. Fees are payable in advance as compensation for the ordinary administrative services to be rendered under this Agreement, and Parent agrees to pay such fees and expenses. In no case will the Escrow Agent satisfy such obligations by offset against the Escrowed Shares.

4

     8.     The Representative and Parent severally agree to provide to the Escrow Agent all instruments and documents within their respective powers to provide which may be necessary for the Escrow Agent to perform its duties and responsibilities hereunder.

     9.     Any notices or other communication required or permitted under this Agreement must be in writing and must be delivered personally, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Notices will not be deemed to be given until actually received.

(a)	If to Parent to:
	Advanced Neuromodulation Systems, Inc. 6501 Windcrest Drive Suite 100 Plano, Texas 75024 Facsimile No.: (972) 309-8150 Attention: Kenneth G. Hawari
	with a copy to:
	Hughes & Luce, LLP 1717 Main Street Suite 2800 Dallas, Texas 75201 Facsimile No.: (214) 939-5849 Attention: Laura M. Kalesnik
(b)	If to the Representative to:
	MicroNet Medical, Inc. 1839 Buerkle Road St. Paul, Minnesota 55110 Facsimile No.: (651) 773-3190 Attention: Mr. Thomas E. Brust
	with a copy to:
	Oppenheimer, Wolff & Donnelly, LLP Plaza VII Suite 3300 45 South Seventh Street Minneapolis, Minnesota 55402 Facsimile No.: (612) 607-7100 Attention: D. William Kaufman
(c)	If to Escrow Agent to:
	Computershare Trust Company, Inc. 350 Indiana Street

5

Suite 800
Golden, CO 80401
Facsimile No.: (303) 262-0700
Attention: John Wahl

     Any party may, by notice given in accordance with this Section 9 to the other parties, designate another address or person for receipt of notices under this Agreement.

     10.     The Escrow Agent may resign at any time by giving written notice of its resignation to the other parties at their addresses set forth in this Agreement at least ten business days prior to the date such resignation is to take effect. Upon the effective date of such resignation, all property then held by the Escrow Agent under this Agreement will be delivered by it to such person as may be designated in writing by each of the other parties (and the parties will use reasonable best efforts to name a successor escrow agent prior to the date specified for the Escrow Agent’s resignation to take effect), whereupon all of the Escrow Agent’s obligations under this Agreement will, except as hereinafter provided, cease and terminate. If no successor escrow agent has been designated by such date, all obligations of the Escrow Agent under this Agreement will nevertheless, except as hereinafter provided, cease and terminate. The Escrow Agent’s sole responsibility thereafter will be to keep safely all property then held by it and to deliver the same to a person designated by each of the other parties or in accordance with the directions of a final order or judgment of a court of competent jurisdiction. A termination under this paragraph will in no way discharge the provisions of this Agreement affecting the reimbursement of expenses, indemnity and fees of the Escrow Agent.

     11.     THIS AGREEMENT WILL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE SUBSTANTIVE LAWS (BUT NOT THE CHOICE OF LAW PROVISIONS) OF THE STATE OF DELAWARE.

     12.     The obligations of the parties (including the Escrow Agent) are unique in that time is of the essence, and any delay in performance under this Agreement by any party will result in irreparable harm to the other parties. Accordingly, any party may seek specific performance and/or injunctive relief before any court of competent jurisdiction in order to enforce this Agreement or to prevent violations of the provisions of this Agreement, and no party may object to specific performance or injunctive relief as an appropriate remedy. The Escrow Agent acknowledges that its obligations under this Agreement, as well as the obligations of the Representative and Parent, are subject to the equitable remedies of specific performance and injunctive relief.

     13.     This Agreement may be amended, superseded, canceled, renewed or extended, and its terms may be waived, only by a written instrument executed by the parties, or in the case of a waiver, by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege under this Agreement will operate as a waiver thereof, nor will any waiver on the part of any party of any such right, power or privilege, or any single or partial exercise of any such right, power or privilege, preclude any further exercise thereof or the exercise of any other such right, power, or privilege. No waivers of or exceptions to any term, condition or provision of this Agreement, in any one or more instances, will be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision.

6

     14.     This Agreement will be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns and legal representatives. Neither this Agreement nor any of the rights, interests or obligations under this Agreement may be assigned by any party without the prior written consent of the other parties. No person or entity will be deemed a third-party beneficiary of this Agreement, the Escrow Agent will have no duties or obligations to any such person and the Escrow Agent may disregard any instruction from such person.

     15.     This Agreement may be executed by the parties in separate counterparts, each of which when so executed and delivered will be an original, but all such counterparts will together constitute one and the same instrument. Counterpart signature pages may be executed and delivered by facsimile transmission.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

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     IN WITNESS WHEREOF, the parties have duly executed this Agreement on the day and year first above written.

ADVANCED NEUROMODULATION SYSTEMS, INC.
By:   Name: Title:	/s/ Christopher G. Chavez Christopher G. Chavez President and Chief Executive Officer
By:	/s/ Thomas E. Brust Thomas E. Brust, in his individual capacity and as a Representative
COMPUTERSHARE TRUST COMPANY, INC.
By:   Name: Title:	/s/ John M. Wahl John M. Wahl Trust Officer
By:   Name: Title:	/s/ K. Gwinn K. Gwinn VP

8

ATTACHMENT I

ESCROW AGENT FEE SCHEDULE

Account Acceptance Fee	$	2,500
Annual Administrative Fee	$	2,500
Overnight Delivery Charges	At Cost
Out-of-Pocket Expenses	At Cost

1

EXHIBIT A

CERTIFICATE OF INSTRUCTION

TO

COMPUTERSHARE TRUST COMPANY, INC.,

as Escrow Agent

     The undersigned, Advanced Neuromodulation Systems, Inc., a Texas corporation (“Parent”), pursuant to Section 3 or Section 4 of the Escrow Agreement dated as of November 25, 2002 (the “Escrow Agreement”), by and among Parent, the Representative and you as the Escrow Agent (terms defined in the Escrow Agreement have the same meanings when used herein), hereby:

     (a) certifies that (i)      Shares of Parent Common Stock are owed to the Company Shareholders as payment for the achievement of a Milestone pursuant to Section 3 of the Escrow Agreement, and (ii) instructs you to release to the Company Shareholders from the Escrowed Shares such number of shares of Escrowed Shares; or

     (b) certifies that (i) $     (the “Owed Amount”) has been incurred by Parent as a Claim, which may be setoff and against which Parent may apply the Escrowed Shares pursuant to Section 4 of the Escrow Agreement and Parent has given the Representative written notice thereof and of its intent to apply the Escrowed Shares against such Claim, which written notice sets forth in reasonable detail the facts giving rise to the liability for such payment, and (ii) instructs you to release to Parent from the Escrowed Shares      Shares of Parent Common Stock in satisfaction of such Claim.

     (c) certifies that Average Trading Price of the Escrowed Shares is $          per share.

	ADVANCED NEUROMODULATION SYSTEMS, INC.
	By:
	Name:
	Title:
Date:

EXHIBIT B

ESCROWED SHARES SCHEDULE

	DOLLAR		PERCENTAGE OF			NUMBER OF
MILESTONE	VALUE		ESCROW PAYMENT			SHARES
MILESTONE I
510(k) Submission	$	250,000.00		8.333	%		7,467
510(k) Clearance	$	250,000.00		8.333	%		7,467
PMA Submission	$	250,000.00		8.333	%		7,467
PMA Approval	$	250,000.00		8.333	%		7,468
MILESTONE II
510(k) Submission	$	250,000.00		8.333	%		7,467
510(k) Clearance	$	250,000.00		8.333	%		7,467
PMA Submission	$	250,000.00		8.333	%		7,467
PMA Approval	$	250,000.00		8.333	%		7,468
MILESTONE III
IDE Submission	$	333,333.33		11.111	%		9,956
PMA Submission	$	333,333.33		11.111	%		9,956
PMA Approval	$	333,333.33		11.111	%		9,956
TOTAL	$	3,000,000		100	%		89,606

EXHIBIT C

OBJECTION CERTIFICATE

TO

COMPUTERSHARE TRUST COMPANY, INC.,

as Escrow Agent

     The undersigned Representative, pursuant to Section 4 of the Escrow Agreement dated as of November 25, 2002 (the “Escrow Agreement”), by and among Parent, the Representative and you as the Escrow Agent (terms defined in the Escrow Agreement have the same meanings when used herein), hereby:

     (a) certifies that (i) the [Owed Amount/$         of the Owed Amount] referred to in the certificate to you of dated          , 20     , is not a Claim against which Parent may apply the Escrowed Shares in accordance with the Escrow Agreement, and (ii) the undersigned has delivered to Parent a written statement dated              , 20      , setting forth in reasonable detail the facts supporting the statement contained in clause (i) above; and

     (b) objects to your making payment, and instructs you to not make such payment, to Parent of the [Owed Amount/$         of the Owed Amount] as provided in such certificate of Parent.

	By:	[            ], Representative
Date:

EX-23.1 4 d05661a1exv23w1.htm EX-23.1 CONSENT OF INDEPENDENT AUDITORS

EXHIBIT 23.1

Consent of Independent Auditors

     We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 2-82414) pertaining to the Advanced Neuromodulation Systems, Inc. 1979 Amended and Restated Employees’ Stock Option Plan; (Form S-8 No. 2-91410) pertaining to the Advanced Neuromodulation Systems, Inc. Directors’ Stock Option Plan; (Form S-8 No. 333-00967) pertaining to the Advanced Neuromodulation Systems, Inc. 1995 Stock Option Plan and the Advanced Neuromodulation Systems, Inc. Sales and Marketing Employees Stock Option Plan; (Form S-8 No. 333-75879) pertaining to the Advanced Neuromodulation Systems, Inc. 1998 Stock Option Plan; (Form S-8 No. 333-61240) pertaining to the Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan; (Form S-8 No. 333-85968) pertaining to the Advanced Neuromodulation Systems, Inc. 2001 Employee Stock Option Plan; (Form S-3 No. 333-40927) pertaining to 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.; (Form S-3 No. 333-53440) pertaining to 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.; (Form S-3 No. 333-101911) pertaining to the registration of 156,302 shares of Common Stock issued pursuant to an Agreement and Plan of Merger dated November 4, 2002 between the Company and MicroNet Medical, Inc. and the related Prospectuses of our report dated March 27, 2003, with respect to the consolidated financial statements and schedule of Advanced Neuromodulation Systems, Inc. and Subsidiaries, included in the Annual Report (Form 10-K/A) for the year ended December 31, 2002.

/s/ Ernst & Young LLP
Ernst & Young LLP

Dallas, Texas
May 8, 2003 EX-99.1 5 d05661a1exv99w1.htm EX-99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER

EXHIBIT 99.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)

     In connection with the Annual Report of Advanced Neuromodulation Systems, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Christopher G. Chavez, Chief Executive Officer of the Company, certify to the best of my knowledge and in my capacity as an officer of the Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     1.     The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

     2.     The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.

     IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective as of May 9, 2003.

/s/ Christopher G. Chavez

Name: Christopher G. Chavez
Title: Chief Executive Officer

     Note: The foregoing certification is being furnished solely pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and is not being filed as part of the Form 10-K or as a separate disclosure document. EX-99.2 6 d05661a1exv99w2.htm EX-99.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER

EXHIBIT 99.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)

     In connection with the Annual Report of Advanced Neuromodulation Systems, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, F. Robert Merrill III, Chief Financial Officer of the Company, certify to the best of my knowledge and in my capacity as an officer of the Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     1.     The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

     2.     The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.

     IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective as of May 9, 2003.

/s/ F. Robert Merrill III
Name: F. Robert Merrill III
Title: Chief Financial Officer

     Note: The foregoing certification is being furnished solely pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and is not being filed as part of the Form 10-K or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----

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EX-99.1

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