edX - TXT1x Data
-----BEGIN PRIVACY-ENHANCED MESSAGE-----1Proc-Type: 2001,MIC-CLEAR2Originator-Name: [email protected]3Originator-Key-Asymmetric:4MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen5TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB6MIC-Info: RSA-MD5,RSA,7ND80qcVv4S90yCiysSz2GG0vvESafcdpUNDPN/w2/XQQ13QRUiIHOz+AyMFeggHc8miqA2C9s1T7vdILKPOMC0Q==910<SEC-DOCUMENT>0000351721-00-000004.txt : 2000032911<SEC-HEADER>0000351721-00-000004.hdr.sgml : 2000032912ACCESSION NUMBER: 0000351721-00-00000413CONFORMED SUBMISSION TYPE: 10-K14PUBLIC DOCUMENT COUNT: 215CONFORMED PERIOD OF REPORT: 1999123116FILED AS OF DATE: 200003281718FILER:1920COMPANY DATA:21COMPANY CONFORMED NAME: ADVANCED NEUROMODULATION SYSTEMS INC22CENTRAL INDEX KEY: 000035172123STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841]24IRS NUMBER: 75164600225STATE OF INCORPORATION: TX26FISCAL YEAR END: 12312728FILING VALUES:29FORM TYPE: 10-K30SEC ACT:31SEC FILE NUMBER: 000-1052132FILM NUMBER: 5804033334BUSINESS ADDRESS:35STREET 1: ONE ALLENTOWN PARKWAY36CITY: ALLEN37STATE: TX38ZIP: 7500239BUSINESS PHONE: 97239098004041MAIL ADDRESS:42STREET 1: ONE ALLENTOWN PARKWAY43CITY: ALLEN44STATE: TX45ZIP: 750024647FORMER COMPANY:48FORMER CONFORMED NAME: QUEST MEDICAL INC49DATE OF NAME CHANGE: 1992070350</SEC-HEADER>51<DOCUMENT>52<TYPE>10-K53<SEQUENCE>154<DESCRIPTION>FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 199955<TEXT>565758<PAGE>59===============================================================================60SECURITIES AND EXCHANGE COMMISSION6162Washington, D.C. 205496364-----------------------65FORM 10-K6667|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE68SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year69Ended December 31, 19997071OR7273| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE74SECURITIES EXCHANCE ACT OF 193475For the transition period from to76Commission File Number: 0-105217778------------------------7980ADVANCED NEUROMODULATION SYSTEMS, INC.81(Exact name of registrant as specified in its charter)82<TABLE>83<S> <C>84TEXAS 75-164600285(State or other jurisdiction of (I.R.S. Employer86incorporation or organization) Identification No.)87886501 WINDCREST DRIVE,89PLANO, TEXAS 7502490(Address of principal executive offices) (Zip Code)91</TABLE>9293Registrant's telephone number, including area code: (972) 309-80009495SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:96<TABLE>97<S> <C>9899Title of Each Class Name of Each Exchange on Which Registered100------------------- -----------------------------------------101NONE NONE102</TABLE>103104SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:105Title of Class106Common Stock, $.05 Par Value107108------------------------109Indicate by checkmark whether the registrant (1) has filed all reports110required to be filed by Section 13 or 15(d) of the Securities Exchange Act of1111934 during the preceding 12 months (or for such shorter period that the112registrant was required to file such reports), and (2) has been subject to such113filing requirements for the past 90 days. Yes |X| No | |114115Indicate by checkmark if disclosure of delinquent filers pursuant to Item116405 of the S-K is not contained herein, and will not be contained, to the best117of registrant's knowledge, in definitive proxy or information statements118incorporated by reference in Part III of this Form 10-K or any amendment to this119Form 10-K. |X|120121Aggregate market value of the registrant's Common Stock held by122non-affiliates of the registrant as of March 20, 2000: $130,982,659123124Number of shares outstanding of the registrant's Common Stock as of125March 20, 2000: 7,462,706126------------------------127DOCUMENTS INCORPORATED BY REFERENCE128129Portions of the registrant's definitive Proxy Statement for the130registrant's Annual Meeting of Stockholders to be held on May 24, 2000, are131incorporated by reference into Part III.132133================================================================================134<PAGE>135136Advanced Neuromodulation Systems, Inc.137138Annual Report139140Form 10-K141142Year Ended December 31, 1999143144PART I145146ITEM 1. BUSINESS147148General149-------150151Advanced Neuromodulation Systems, Inc. designs, develops, manufactures and152markets advanced implantable neuromodulation devices that improve the quality of153life for people with disabling chronic pain or nervous system disorders.154Neuromodulation is the electrical or chemical modulation of the central nervous155system to significantly reduce chronic pain or improve neurological function.156Until June 1998, ANS was known as Quest Medical, Inc.157158Because neuromodulation devices have gained acceptance as a viable, efficacious159and cost-effective treatment alternative for relieving chronic intractable pain160and improving neurological function, we are continuing efforts to expand our161product offerings in the high growth market of neuromodulation. Today, we are a162market share and technology leader in the $42 million radio-frequency163stimulation segment of the neuromodulation market. In 1999, we continued to164accelerate our investment in development projects to position us to participate165in the other larger and more rapidly growing segments of the neuromodulation166market. Excluding vagus nerve stimulation for treating epilepsy, which we do not167currently anticipate addressing, industry analysts expect the neuromodulation168market to grow from $400 million in 1999 to nearly $900 million by 2003.169170Recent Developments171-------------------172173In January 1999, due to the merger of Sofamor Danek and Medtronic, Inc., we174terminated our June 1998 agreement with Sofamor Danek Group, Inc. ("Sofamor175Danek") under which we would develop and manufacture for Sofamor Danek, products176and systems for use in Deep Brain Stimulation. Under the terms of the177termination agreement, Sofamor Danek agreed to accelerate payments due to us in178the amount of $8 million. We received the $8 million payment during January 1999179when the merger of Sofamor Danek and Medtronic was consummated. See Item 7:180"Management's Discussion and Analysis of Financial Condition and Results of181Operations-Overview" and Note 10- "Product Development Agreement" of the Notes182to Consolidated Financial Statements.183184On February 1, 1999, we sold our principal office and manufacturing facility in185Allen, Texas to Atrion Corporation for $6.5 million. Atrion purchased the186Company's CVS Operations in January 1998. See Note 9- "Sale of CVS187Operations/Discontinued Operations" of the Notes to Consolidated Financial188Statements. The facility was approximately 107,000 square feet and was189constructed during 1993 on 19.2 acres of land that we acquired in 1985. We190repaid the outstanding mortgage debt on the facility of $3.6 million at closing191and received net proceeds of $2.7 million after paying expenses related to the192transaction. No material gain or loss was realized on the sale of the facility.193We leased space, furniture and equipment from Atrion until May 1999 at the194195-1-196197<PAGE>198199monthly rate of $48,125 and paid Atrion fifty percent of certain operating200expenses including utilities, janitorial services, landscaping services,201insurance and property taxes. At that time we moved our operations to a 40,000202square foot leased facility in Plano, Texas, a northeast suburb of Dallas. See203Item 2: "Properties".204205In September 1999, the Neurological Devices Panel of the Medical Devices206Advisory Committee recommended that the FDA reclassify Totally Implanted Spinal207Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs from a208Class III device to a Class II device. Class III devices typically require a209Pre-Market Approval (PMA), supplemented with clinical trials to prove safety and210effectiveness of the device. Class II devices typically require a Pre-Market211Notification (510(k)) to demonstrate substantial equivalence to an existing212legally marketed device prior to receiving market clearance by the FDA.213According to the FDA's 1999 ODE Annual Report, the average time for PMA's was21412.5 months (excluding the one-year typically required for clinical trials, or215approximately 24 months total). The ODE Annual Report reported the average216elapsed time for a 510(k) approval of 3.4 months in 1999.217218We expected to receive a final reclassification decision from the FDA in January2192000 but have experienced a delay that we believe is related to the FDA's220workload. We received a written progress report dated February 25, 2000 in which221the FDA stated that it had received adequate information to move forward toward222a final decision. The agency's letter further indicated that there may be223"special controls" available to ensure the safety and effectiveness of the IPG224device for treating pain of the trunk and/or limbs. We remain optimistic that225the FDA will follow the recommendation of its panel to reclassify the IPG and we226are prepared to move quickly to file the 510(k) Pre-Market Notification for227clearance to market the IPG in the United States if the FDA approves the228reclassification. The IPG segment of the neuromodulation market for spinal cord229stimulation to treat pain of the trunk and/or limbs is expected by industry230analysts to approach $140 million in 2000, is growing at a 25% to 30% annual231rate and is currently dominated by a single competitor, Medtronic, Inc.232233The Neuromodulation Market234--------------------------235236The neuromodulation market is comprised of implantable electrical stimulation237systems and fully implantable intrathecal (the fluid-filled area around the238spinal cord) drug pumps that modulate the central nervous system by delivering239precise doses of either electricity or pharmaceuticals directly to targeted240nerve sites.241242Four product technology platforms address the chronic intractable pain segment243of the neuromodulation market. These platforms are: (1) radio-frequency244stimulation systems for spinal cord stimulation, (2) implantable pulse generator245stimulation systems for spinal cord and deep brain stimulation, (3) fully246implantable constant rate intrathecal drug pumps and (4) fully implantable247programmable rate intrathecal drug pumps. Industry analysts estimate the market248at $400 million in 1999 and growing to nearly $900 million by 2003 solely on249current FDA approved indications. The growth in the market for stimulation250systems and intrathecal drug pumps is being driven by a number of factors251including:252253o New technology is increasing the capability of these devices254o New clinical applications for stimulation systems and intrathecal drug255pumps are being discovered and tested256257-2-258259<PAGE>260261o Improved outcomes are being driven by technology, patient selection262and improved techniques263o Stimulation and intrathecal drug pump devices are generally low risk and264cost effective and the therapies are reversible265o Patient awareness and advocacy is generally high266o The base of pain specialists and centers of excellence is growing267268Listed below are the estimated units and revenue by market segment in 1999 and2692003 for all manufacturers of such products. These estimates do not consider the270use of neuromodulation technology platforms for applications such as epilepsy,271depression, peripheral nerve stimulation, chronic intractable angina, chronic272headaches, functional stimulation, tens stimulation, peripheral vascular disease273and deep brain applications for disorders other than Parkinson's Disease and274Essential Tremor.275276Estimated, for all product manufacturers, by market segment:277278<TABLE>279<CAPTION>2802811999 2003282-------------------- --------------------283$ $284Units (000's) Units (000's)285--------- --------- --------- ---------286<S> <C> <C> <C> <C>287Radio-frequency stimulation288systems for spinal cord289stimulation 3,050 $ 42,000 6,100 $ 85,000290291Implantable pulse generator292stimulation systems for spinal293cord stimulation 12,850 109,000 26,325 250,000294295Implantable pulse generator296stimulation systems for deep brain297stimulation for Parkinson's Disease298and Essential Tremor 3,800 38,000 10,000 105,000299300Implantable pulse generator301stimulation systems for sacral nerve302stimulation for incontinence 1,650 14,000 6,325 60,000303304Fully implantable constant rate305intrathecal drug pumps 5,300 24,000 15,150 68,000306307Fully implantable programmable308rate intrathecal drug pumps 22,125 177,000 39,500 317,000309--------- --------- --------- ---------310Total .................... 48,775 $404,000 103,400 $885,000311--------- --------- --------- ---------312</TABLE>313314According to industry analysts, there are millions of patients who could benefit315from the use of stimulation or intrathecal drug pump devices. Thus, we believe316the market is under-served and under-penetrated. In 1999, only approximately31749,000 patients benefited from a stimulation system or intrathecal drug pump.318319Our growth strategy is to develop and license proprietary product platforms to320expand from our current participation in the radio-frequency stimulation segment321322-3-323324<PAGE>325326into the other major market segments of the neuromodulation market. Since most327pain practitioners implant all four of the product platforms (radio-frequency328stimulation systems, implantable pulse generator stimulation systems, fully329implantable constant-rate intrathecal drug pumps and fully implantable330programmable intrathecal drug pumps), we believe we are in a unique position to331leverage our distribution capabilities.332333Products334--------335336Stimulation Systems337338Stimulation devices electrically stimulate nerve fibers along the spinal cord to339reduce chronic severe neuropathic pain by "masking" the pain signals sent to the340brain. Neuropathic pain usually arises from nerve damage. Stimulation device341implantation manages the pain associated with failed back surgery syndrome342(FBSS), peripheral neuropathy, phantom limb or stump pain, ischemic pain and343reflex sympathetic dystrophy (RSD), also known as complex regional pain syndrome344(CRPS). Stimulation device implantation in the brain is being used to relieve345the effects of various neurological disorders, such as Parkinson's Disease and346Essential Tremor by delivering small electrical impulses to targeted structures347in the brain.348349The market for stimulation systems is currently divided between radio-frequency350stimulation systems, which use an external power source, and stimulation systems351that utilize implantable battery driven systems known as implantable pulse352generators (IPGs). According to industry analysts, lPG devices account for353around 80 percent of the number of spinal cord stimulation procedures performed,354with radio-frequency devices accounting for the remainder. We currently design,355develop, manufacture and market radio-frequency stimulation devices and are near356the completion of the development of an IPG device. The primary advantage of the357radio-frequency device revolves around the benefits of the system's external358battery. An external battery system allows the patient to recharge the device by359simply changing a special nine-volt battery. The IPG requires surgical360intervention, revision and replacement after two to four years. Due to its361inexpensive power system, the radio-frequency device can be programmed with a362wide range of amplitude, frequency and pulse width settings for a variety of363programs controlled by the patient. These features make the radio-frequency364devices the most cost efficient for long-term stimulation treatment. On the365other hand, IPG devices provide the convenience of a completely internalized366system, although they involve added long-term cost when repeat surgeries are367required to replace the IPG power source. Both radio-frequency systems and IPG368systems are useful to the pain physician. Radio-frequency systems are most often369prescribed for patients who have complex bilateral pain syndromes or widespread370pain that require high power levels. IPGs are most often prescribed for patients371with simple unilateral and single extremity pain complaints or indications with372low power requirements.373374Our radio-frequency stimulation systems consist of four primary components:375leads, a receiver, a transmitter and programmer. The leads are most commonly376placed percutaneously through the skin into the epidural space of the spinal377column. This procedure for lead placement is similar to that employed by378anesthesiologists in routine epidural procedures. Typically, one or two leads379are inserted; each of which has multiple electrodes that can be used to380stimulate the targeted nerve roots of the spinal cord. Laminotomy style (paddle)381leads are also available for neurosurgeons or orthopedic surgeons who prefer to382insert leads in an open surgical procedure approach. The leads are then383connected to a passive receiver, which is implanted under the skin on the side384of the abdomen. The receiver contains electronics that receive radio-frequency385386-4-387388<PAGE>389390energy and data from a source (the transmitter) outside the body, and delivers391the prescribed electrical pulses to the leads. The transmitter is approximately392the size of a pager, and is typically worn on a belt. Since it is external to393the body, the transmitter can be easily programmed and serviced as needed, and394its battery can be simply recharged or replaced.395396Our CompuStim(R) systems include four, seven, eight and sixteen electrodes on397one, two or more leads; simple and complex receivers; and an external398battery-powered transmitter. We believe that the CompuStim product line's399multi-electrode leads and advanced multiprogrammable technology have changed the400manner in which neuromodulation is performed worldwide. For example, our "Dual401Octrode" device, a system of dual leads with eight electrodes on each lead402introduced in 1995, creates a targeted current density that appears to be403especially effective in relieving complex and multi-extremity pain patterns.404Previously, quadrapolar stimulation systems only relieved the leg pain405associated with FBSS. Many experts support the view that the Dual Octrode device406provides improved pain relief to both the legs and the back. Dual Octrode407systems are enjoying increasing acceptance from the physician community and, in408our judgment, is the technological leader in the stimulation field. We believe409that the long-term results of stimulation in the treatment of pain have improved410as a result of the technological superiority of ANS products. Moreover, the ease411of use of the system has expanded the potential market for these products.412413In early 1999, we completed the development of our enhanced radio-frequency414stimulation system, the Renew(TM) System, and introduced the products in the415United States during June 1999. These products include enhancements that416simplify the procedure for implanters while providing improved function. We plan417to introduce the Renew System in international markets during 2000.418419In 1998, we licensed the rights to method patents for sacral nerve root420stimulation aimed at relieving the effects of chronic pelvic pain, including421interstitial cystitis. Interstitial cystitis is an extremely painful bladder422disease that afflicts approximately 450,000 people in the United States alone.423We believe our advanced radio-frequency stimulation devices can be effective in424treating pelvic pain indications including interstitial cystitis. In February4251999, we received conditional approval from the FDA to initiate a pilot study to426evaluate the use of our advanced radio-frequency stimulation systems to treat427interstitial cystitis. The pilot study is continuing and if successful, we will428seek approval from the FDA to initiate further clinical studies in the process429to receive a PMA approval to begin marketing in the United States.430431We believe our radio-frequency stimulation devices represent a strong base for432penetration of the broader neuromodulation market. We continued development of433an IPG stimulation system during 1999 to better serve the broad needs of the434pain management market. We expect to complete development of our IPG stimulation435system during April 2000. The IPG stimulation system will allow us to436participate in the largest segment of the stimulation market for spinal cord437stimulation and leverage our sales and marketing capabilities. In addition, the438IPG provides us with the opportunity to address a larger number of new439indications such as chronic intractable angina, urinary urge incontinence,440peripheral nerve stimulation and DBS for Essential Tremor and tremor associated441with Parkinson's Disease.442443-5-444445<PAGE>446447PainDoc(R)448449In early 1997 we began marketing PainDoc, a pen-based computer system that is450designed to assist physicians and their patients in optimizing the performance451of our stimulation devices both pre- and post-operatively. PainDoc interfaces452with our CompuStim and Renew transmitters to optimize stimulation therapy and453document treatment outcomes. PainDoc allows the physician to interact with the454patient to map the location and intensity of the patient's pain. The resulting455"pain map" is then used to assess and select the most effective stimulation456sets, or combination of multi-electrode stimulation arrays, to treat the pain.457The idea is to generate pain coverage that overlaps the patient's pain map. The458selected arrays (programs) are uploaded into the patient's CompuStim or Renew459transmitter. The physician can visually compare the patient's pain map against a460stimulation map and optimize the patient's stimulator setting to address the461patient's needs and assess whether desired levels of pain relief have been462obtained and whether excess stimulation has been delivered.463464PainDoc enables the physician to program up to 24 different stimulation sets465delivering electrical stimulation every 50 milliseconds to expand pain area466coverage and relief. We believe that PainDoc should also allow physicians to467create a broad-based database tool that, by using a standardized methodology,468will enable physicians to share and compare outcome data, which can then be used469to deliver more efficacious pain relief to individual patients. We believe that470PainDoc and ANS transmitter devices used in tandem significantly enhance the471effectiveness, flexibility and precision of managing chronic neuropathic pain.472We expect PainDoc to promote the selection of our devices for stimulation473procedures, especially as stimulation devices become more sophisticated and the474pain management process becomes more refined.475476We continue to make improvements to PainDoc and will continue to develop systems477that are easier to use and offer more capability.478479Intrathecal Drug Pumps480481Fully implantable intrathecal drug pumps are designed to deliver pharmaceuticals482directly into the intrathecal space (the fluid-filled area around the spinal483cord). With intrathecal drug delivery, the medication is delivered directly to484its site of action. This contrasts to oral or intravenous drug delivery, where485the medication is distributed systemically throughout the entire body. Since the486drug is being delivered directly to the site of action, a greater therapeutic487effect can be achieved with much lower quantities of medication, which reduces488the common side effects that can occur with oral medications. Today, intrathecal489drug pumps are used to deliver morphine for the treatment of pain and baclofen490for the treatment of spasticity.491492Intrathecal drug pump systems consist of the pump itself and a catheter. The493pump is a low profile cylinder shaped device (similar to the size of a hockey494puck) that contains a reservoir into which the drug to be delivered is injected495and mechanisms that regulate the rate of delivery of the drug. The pump is496implanted under the skin generally in the abdominal area and is connected to the497catheter. The catheter is a piece of silastic tubing that is tunneled under the498skin and into the spinal fluid space in the back where it delivers the drug from499the pump. The drug supply in the pump usually lasts one to three months. The500drug pump is refilled using a needle inserted through the skin into the pump's501access port. The drug is then injected through the needle into the reservoir.502503-6-504505<PAGE>506507The refill procedure is generally performed on an outpatient basis by a508physician or under the direct supervision of a physician.509510In 1999, industry analysts estimated the market for fully implantable511intrathecal drug pumps was $201 million and they expect the market to grow to512$385 million by the year 2003. The market for fully implantable intrathecal drug513pumps is currently divided between constant rate drug pumps and programmable514rate drug pumps. According to industry analysts, the programmable drug pumps515account for 81 percent of the number of intrathecal drug pump procedures516performed, with constant rate drug pumps accounting for the remainder.517Currently, Medtronic, Inc. is the sole worldwide provider of a programmable518intrathecal drug pump.519520The programmable rate drug pump is the most versatile type of implantable pump521since it allows the rate of drug delivery to be changed non-invasively to meet522varying patients' needs. Medtronic's programmable pump contains a battery and523motor. The battery delivers pulses of energy to the motor, which pushes the drug524from the pump into the catheter and into the spinal canal. The programmability525feature allows for time-modified delivery of the drug. For example, it can be526non-invasively programmed to deliver more medication at night and less in the527morning. Since the pump is powered with a battery, the entire pump typically528needs to be replaced every four to five years.529530Constant rate drug pumps are designed to provide drug infusion at a constant531rate. Once implanted, the medication flow rates remain the same. In order to532change medication rates, different drug concentrations can be mixed and changed533at refill. Constant rate pumps are typically powered by pressurized gas534contained in a compartment of the device. As the gas expands, the medication is535forced out of the drug reservoir through a flow restrictor and catheter and into536the spinal canal. When the drug reservoir is refilled, its power is537automatically recharged. Therefore constant rate pumps are less expensive and538have a longer implant life (eight to ten years) since there is no battery that539can be depleted.540541Management believes that the fully implantable intrathecal drug pump market542offers significant opportunity. In August 1998, we completed an agreement with543Tricumed Medizintechnik GmbH, a German corporation, granting ANS rights to544distribute Tricumed's fully implantable intrathecal drug pump products in545international markets including the United States, Canada, the United Kingdom,546France, Spain, Switzerland, South America, Australia and other world markets.547Tricumed manufactures a proprietary constant rate intrathecal drug pump548(Archimedes) that has received the CE mark (European) approval. Tricumed is also549developing a fully implantable programmable intrathecal drug pump (Micromedes).550Tricumed expects to complete development of the Micromedes pump and seek551regulatory approval in Europe (CE mark) during 2000. Both the Archimedes and552Micromedes pumps have proprietary engineered features that improve patient553convenience and reduce costs. If Tricumed successfully completes development of554the Micromedes and obtains the CE mark, we would commence marketing the555Micromedes pump internationally. We would also seek approval from the FDA to556initiate clinical trials in the United States, a step in the PMA process to557receive approval to market the Micromedes domestically. We commenced marketing558the Archimedes pump internationally in the first quarter of 1999.559560In 1999, we continued development of our own silastic spring fully implantable561constant rate intrathecal drug pump utilizing proprietary technology licensed562from the University of Minnesota. We expect to complete development of the pump563in the first half of 2000 and will seek approval from the FDA to initiate564565-7-566567<PAGE>568569clinical trials in the United States. We will seek CE mark approval to570distribute the pump internationally during the first half of 2000, with571international sales expected to commence by year-end 2000. Management believes572that its value-priced pump will expand the market for fully implantable573intrathecal drug pumps to price-sensitive markets including cancer pain therapy574and third world countries.575576Other Business Matters577----------------------578579Marketing and Major Customers580581Domestically, we utilize independent specialty distributors and commissioned582sales agents who are focused on the chronic pain market to sell our stimulation583systems. Currently, we have seven distributor territories, which employ a total584of forty-four pain specialists who devote the majority of their selling efforts585to ANS products. In addition, we have eleven sales agent territories that employ586twenty-one sales agents who are focused on the pain market and depend upon ANS587products as their flagship product line. We also have one direct sales588territory. We employ four regional sales managers who personally interact with589our customers and oversee the distributors, sales agents and direct590representative. We also employ a Vice-President of North American Sales who591coordinates the sales efforts of our distribution network in North America.592Internationally, we sell product to eleven specialty pain distributors who593represent ANS in twenty-one countries.594595The primary medical specialists we target in our marketing efforts are596anesthesiologists, neurosurgeons and orthopedic surgeons. Although neurosurgeons597were the first practitioners to use stimulation systems, anesthesiologists598(specializing in pain medicine) now account for a greater percentage of sales,599as the relative number of these practitioners has grown and as the understanding600and acceptance of stimulation treatment for chronic pain conditions has601increased. We derive 93 percent of net revenues from product sales of our602stimulation systems from domestic sales and approximately 7 percent from export603sales.604605During 1999, we had two major customers that accounted for 10 percent or more of606our net revenue from product sales. Sun Medical, Inc. and Primesource Surgical,607Inc., each a specialty distributor of ANS products, accounted for $3.0 million608and $2.3 million, respectively, or 15 percent and 11 percent, respectively, of609our net revenue from product sales for the year ended December 31, 1999. During6101998 and 1997, we had one major customer that accounted for 10 percent or more611of our net revenue from product sales. Sun Medical, Inc., a specialty612distributor of ANS products, accounted for $3.4 million and $3.7 million, or 20613percent and 25 percent of our net revenue from product sales for the years ended614December 31, 1998 and 1997, respectively. While we believe our relations with615Sun Medical and Primesource Surgical are good, the loss of one or both of these616customers could have a material adverse effect on our business, financial617condition and results of operations.618619Research and Development620621In 1999, we focused our research and development efforts on the continued622development of our enhanced radio-frequency stimulation systems and ongoing623research and development of new products for the neuromodulation market, such as624an implantable pulse generator stimulation system for spinal cord stimulation,625an implantable pulse generator stimulation system for Deep Brain Stimulation626("DBS") and a silastic spring constant rate intrathecal drug pump. We expended627$3.77 million (18.3 percent of net revenue from product sales) on our research628629-8-630631<PAGE>632633and development activities in 1999, compared to $2.80 million (16.5 percent of634net revenue from product sales) in 1998. We expect to increase our investment in635research and development and clinical trials during 2000 and expect expenditures636of approximately $4.0 million. These expenditures will be directed toward637completion of our silastic spring constant rate intrathecal drug pump, our638implantable pulse generator stimulation system for spinal cord stimulation, our639implantable pulse generator stimulation system for DBS and for the development640of next generation radio-frequency stimulation systems and implantable pulse641generator stimulation systems. These expenditures also include expenses for642clinical trials that we expect to initiate on several of our new products upon643approval from the FDA. The clinical trials are a necessary process to receive644approval from the FDA to begin marketing the products in the United States. As645of March 20, 2000, we had an in-house research and development staff of 29646personnel as compared to 25 in March 1999.647648We may seek strategic partners for DBS to replace our terminated agreement with649Sofamor Danek that could partially fund research and development expenditures650during 2000. In addition to DBS, we believe our implantable pulse generator651stimulation platform has market opportunities outside our focus of chronic pain,652including applications such as epilepsy, urinary incontinence, angina,653peripheral nerve stimulation and peripheral vascular disease. Any such market654expansion, however, would require PMA approvals from the FDA. We may also seek655strategic partners with established distribution systems to develop these market656opportunities outside the chronic pain market area, although there is no657assurance that we will be successful in negotiating and consummating agreements658with strategic partners.659660Manufacturing661662We manufacture and package our stimulation systems at our manufacturing facility663in Plano, Texas. This facility received ISO 9001 certification (for design and664manufacturing processes) in July 1999. See Item 1. "Business-Other Business665Matters-Government Regulations."666667Our manufacturing processes consist of the assembly of standard and custom668component parts and the testing of completed products. We subcontract with669various suppliers to provide us with the quantity of component parts necessary670to assemble our products. Almost all of these components are available from a671number of different suppliers, although certain components are purchased from672single sources. For example, we currently rely on a single supplier for a673computer chip used in the receiver of our stimulation systems. The supplier of674this computer chip has indicated its desire to cease manufacturing and supplying675the computer chip in the future, but to date has not determined when this will676occur. The supplier has agreed to notify us once a date has been determined and677allow us to place a final one-time purchase order for the computer chip. In the678interim, we are maintaining a higher than normal inventory of the computer chip.679In addition, we are developing a new receiver design that does not use any680custom computer chips. A sudden disruption in supply from the computer chip681supplier or another single-source supplier could adversely affect our ability to682deliver finished products on time.683684We devote significant attention to quality assurance. Our quality assurance685measures begin at the manufacturing level where components are assembled in a686"clean room" environment designed and maintained to reduce product exposure to687particulate matter. Products are tested throughout the manufacturing process for688adherence to specifications. Finished components are shipped to outside689processors for ethylene oxide gas sterilization.690691-9-692693<PAGE>694695Skills of assembly workers required for the manufacture of medical products are696similar to those required in typical assembly operations. We believe that697workers with these skills are readily available in the Dallas area.698699Competition700701In marketing our stimulation systems, we compete with one other significant702supplier, Medtronic, Inc. Medtronic has substantially greater financial703resources and engages in substantially greater research and development and704marketing efforts. Medtronic holds a substantial majority share of the705stimulation market and sells both radio-frequency stimulation systems and706implantable pulse generator stimulation systems. Medtronic also holds the707substantial majority share of the market for implantable intrathecal drug pumps708and is the sole marketer worldwide of fully implantable programmable intrathecal709drug pumps and implantable pulse generators.710711We believe that the principal competitive factors in the neuromodulation market712are cost-effectiveness, impact on patient outcomes, product performance,713quality, ease of use, technical innovation and customer service. We intend to714continue to compete on the basis of our high-performance products, innovative715technologies, manufacturing capabilities, close customer relations and support,716and our strategy to increase our offerings of products within the717neuromodulation market.718719Patents, Trademarks and Proprietary Information720721We currently own five United States patents and two foreign patents. In722management's view, these patents offer reasonable coverage of our stimulation723devices' electrode, receiver, transmitter and programmer technology as well as724advanced PainDoc computer system technology. These patents, in part, cover both725radio-frequency stimulation systems and implantable pulse generator stimulation726systems for a wide range of current and future applications. Pending patent727applications concern new stimulation lead technology, implant accessories, and728improved connector mechanisms.729730We also license four United States patents and one foreign patent from the731University of Minnesota relating to the constant rate intrathecal drug pump we732are currently developing.733734Additionally, we are exclusively licensing a patent directed to advanced735placement techniques and a patent directed to methods to facilitate relieving736the effects of chronic pelvic pain such as interstitial cystitis.737738The validity of any patents issued to us may be challenged by others and we739could encounter legal and financial difficulties in enforcing our patent rights740against infringers. In addition, there can be no assurance that other741technologies cannot or will not be developed or that patents will not be742obtained by others which would render our patents obsolete. The loss of any one743patent would not have a material adverse effect on our current revenue base.744Although we do not believe that patents are the sole determinant of the745commercial success of our products, the loss of a significant percentage of our746patents could have a material adverse effect on our business, financial747condition and results of operations.748749We have developed technical knowledge which, although non-patentable, we750consider as significant in enabling us to compete. However, the proprietary751752-10-753754<PAGE>755756nature of such knowledge may be difficult to protect. We have entered into an757agreement with each key employee prohibiting such employee from disclosing any758confidential information or trade secrets of the Company and prohibiting that759employee from engaging in any competitive business while the employee is working760for the Company and for a period of one year thereafter. In addition, these761agreements also provide that any inventions or discoveries by these individuals762relating to the business of the Company will be assigned to the Company and763become the Company's sole property.764765Claims by competitors and other third parties that our products allegedly766infringe the patent rights of others could have a material adverse effect on the767Company. The interventional pain management market is characterized by extensive768patent and other intellectual property claims, which can create greater769potential than in less developed markets for possible allegations of770infringement, particularly with respect to newly developed technology.771Intellectual property litigation is complex and expensive and its outcome is772difficult to predict. Any future litigation, regardless of outcome, could result773in substantial expense to the Company and significant diversion of the efforts774of the Company's technical and management personnel. An adverse determination in775any such proceeding could subject the Company to significant liabilities to776third parties, or require the Company to seek licenses from third parties or pay777royalties that may be substantial. Furthermore, there can be no assurance that778necessary licenses would be available to the Company on satisfactory terms or at779all. Accordingly, an adverse determination in a judicial or administrative780proceeding or failure to obtain necessary licenses could prevent the Company781from manufacturing or selling certain of its products, which could have a782material adverse effect on the Company's business, financial condition and783results of operations.784785COMPUSTIM(R), MULTISTIM(R), PAINDOC(R), UNISTIM(R) and OCTRODE(R) are among our786registered trademarks. Registration applications are pending for various787trademarks, which we believe, have value in the marketplace, including Advanced788Neuromodulation Systems, ANS and Renew.789790Government Regulation791792The manufacture and sale of our products are subject to regulation by numerous793governmental authorities, principally the FDA and corresponding foreign794agencies. The research and development, manufacturing, promotion, marketing and795distribution of our products in the United States are governed by the Federal796Food, Drug and Cosmetic Act and the regulations promulgated thereunder (the "FDC797Act and Regulations"). We are subject to inspection by the FDA for compliance798with such regulations and procedures.799800The FDA has traditionally pursued a rigorous enforcement program to ensure that801regulated entities such as the Company comply with the FDC Act and Regulations.802A company not in compliance may face a variety of regulatory actions, including803warning letters, product detentions, device alerts, mandatory recalls or field804corrections, product seizures, injunctive actions or civil penalties and805criminal prosecutions of the Company or responsible employees, officers and806directors. We were last inspected in the summer of 1996, and no major violations807were found.808809Under the FDA's requirements, a new medical device cannot be released for810commercial use until a pre-market approval application (a "PMA") has been filed811with the FDA and the FDA has approved the device's release. If a manufacturer812813-11-814815<PAGE>816817can establish that a newly developed device is "substantially equivalent" to a818legally marketed device, the manufacturer may seek marketing clearance from the819FDA to market the device by filing a 510(k) premarket notification with the FDA,820which usually takes less time than a PMA. The process of obtaining FDA clearance821can be lengthy, expensive and uncertain. Both a 510(k) and a PMA, if granted,822may include significant limitations on the indicated uses for which a product823may be marketed. FDA enforcement policy strictly prohibits the promotion of824approved medical devices for unapproved uses. In addition, product approvals can825be withdrawn for failure to comply with regulatory requirements or the826occurrence of unforeseen problems following initial marketing. Although all of827our currently marketed products have been the subject of successful 510(k)828submissions, we believe that because the products we are currently developing829are more innovative, some of these products will require the PMA submission830process, which is lengthier and more costly than the 510(k) process.831832We are also subject to regulation in each of the foreign countries in which we833sell our products with regard to product standards, packaging requirements,834labeling requirements, import restrictions, tariff regulations, duties and tax835requirements. Many of the regulations applicable to our products in such836countries are similar to those of the FDA. The national health or social837security organizations of certain countries require our products to be qualified838before they can be marketed in those countries. To date, we have not experienced839significant difficulty in complying with these regulations.840841To position ourselves for access to European and other international markets, we842have maintained certification under the ISO 9000 Series of Standards. ISO 9000843is a set of integrated requirements, which when implemented, form the foundation844and framework for an effective quality management system. These standards were845developed and published by the ISO, a worldwide federation of national standard846bodies, founded in Geneva, Switzerland in 1946. ISO has over 92 member847countries. ISO certification is essential to enter European Community markets.848849In July 1999, our quality system was re-certified to ISO 9001/EN 46001850certification. The ISO 9001 registration is the most stringent standard in the851ISO series and lasts for three years. The German notified body TUV Product852Services issued the re-certification certificates. The ISO 9001 standard covers853design, production, installation and servicing of products. The EN 46001 covers854the same elements as the ISO standard; however, the focus is on quality systems855for medical device manufacturing. In addition, we are certified to the Active856Implantable Medical Device Directive allowing us to market devices throughout857the European Community. We are subject to an annual audit by the notified body858to maintain our registrations.859860The financial arrangements through which we market, sell and distribute our861products may be subject to certain federal and state laws and regulations in the862United States with respect to the provision of services or products to patients863who are Medicare or Medicaid beneficiaries. The "fraud and abuse" laws and864regulations prohibit the knowing and willful offer, payment or receipt of865anything of value to induce the referral of Medicare or Medicaid patients for866services or goods. In addition, the physician anti-referral laws prohibit the867referral of Medicare or Medicaid patients for certain "Designated Health868Services" to entities in which the referring physician has an ownership or869compensation interest. Violations of these laws and regulations may result in870civil and criminal penalties, including substantial fines and imprisonment. In a871number of states, the scope of fraud and abuse or physician anti-referral laws872and regulations, or both, have been extended to include the provision of873services or products to all patients, regardless of the source of payment,874875-12-876877<PAGE>878879although there is variation from state to state as to the exact provisions of880such laws or regulations. In other states, and on a national level, several881health care reform initiatives have been proposed which would have a similar882impact. We believe that our operations and our marketing, sales and distribution883practices currently comply in all respects with all current fraud and abuse and884physician anti-referral laws and regulations, to the extent they are applicable.885Although we do not believe that we will need to undertake any significant886expense or modification to our operations or our marketing, sales and887distribution practices to comply with federal and state fraud and abuse and888physician anti-referral regulations currently in effect or proposed, financial889arrangements between manufacturers of medical devices and other health care890providers may be subject to increasing regulation in the future. Compliance with891such regulation could adversely affect our marketing, sales and distribution892practices, and may affect us in other respects not presently foreseeable, but893which could have an adverse impact on our business, financial condition and894results of operations.895896Third Party Reimbursement and Cost Containment897898Our products are purchased primarily by hospitals and ambulatory surgery899centers, which then bill various third-party payers for the services provided to900the patients. These payers, which include Medicare, Medicaid, private insurance901companies, managed care and worker's compensation organizations, reimburse part902or all of the costs and fees associated with the procedures performed with these903devices.904905Medicare and Medicaid reimbursement for hospitals is based on a fixed amount for906admitting a patient with a specific diagnosis. Because of this fixed907reimbursement method, hospitals have incentives to use less costly methods in908treating Medicare and Medicaid patients, and will frequently make capital909expenditures to take advantage of less costly treatment technologies.910Frequently, reimbursement is reduced to reflect the availability of a new911procedure or technique, and as a result hospitals are generally willing to912implement new cost-saving technologies before these downward adjustments take913effect. Likewise, because the rate of reimbursement for certain physicians who914perform certain procedures has been and may in the future be reduced in the915event of further changes in the resource-based relative value scale method of916payment calculation, physicians may seek greater cost efficiency in treatment to917minimize any negative impact of reduced reimbursement. Any amendments to918existing reimbursement rules and regulations which restrict or terminate the919reimbursement eligibility (or the extent or amount of coverage) of medical920procedures using our products or the eligibility (or the extent or amount of921coverage) of our products could have an adverse impact on our business,922financial condition and results of operations. Third-party payers are923increasingly challenging the prices charged for medical products and services924and may deny reimbursement if they determine that a device was not used in925accordance with cost-effective treatment methods as determined by the payer, was926experimental or was used for an unapproved application.927928Our stimulation systems, while cost-effective compared to repeat back surgeries,929have encountered some resistance to third party reimbursement. Although930Medicare, Medicaid and many private insurers reimburse for the stimulation931systems and procedure, especially after repeat back surgeries have failed to932relieve chronic pain, some managed care and private payers occasionally refuse933to reimburse for stimulation systems or restrict reimbursement. There can be no934assurance that in the future, third-party payers will continue to reimburse for935our products, or that their reimbursement levels will not adversely affect the936937-13-938939<PAGE>940941profitability of our products. In addition, health care costs have risen942significantly over the past decade, and there have been and will continue to be943proposals by legislators and regulators to curb these costs. Legislative action944limiting reimbursement for certain procedures could have a material adverse945effect on our business, financial condition and results of operations.946947In response to the focus of national attention on rising health care costs, a948number of changes to reduce costs have been proposed or have begun to emerge. In949addition to legislative and regulatory initiatives, there has also been a950significant increase in the number of Americans enrolling in some form of951managed care plan. It has become a typical practice for hospitals to affiliate952themselves with as many managed care plans as possible. Higher managed care953penetration typically drives down the prices of health care procedures, which in954turn places pressure on medical supply prices. This causes hospitals to955implement tighter vendor selection and certification processes, by reducing the956number of vendors used, purchasing more products from fewer vendors and trading957discounts on price for guaranteed higher volumes to vendors. Hospitals have also958sought to control and reduce costs over the last decade by joining group959purchasing organizations or purchasing alliances. We cannot predict what960continuing or future impact existing or proposed legislation, regulation or such961third-party payer measures may have on our future business, financial condition962or results of operations.963964Changes in reimbursement policies and practices of third-party payers could have965a substantial and material impact on sales of our products. The development or966increased use of more cost-effective treatments could cause such payers to967decrease or deny reimbursement to favor these other treatments.968969Employees970971As of March 20, 2000, we employed 108 full-time employees, 29 in research and972development, 23 in sales and marketing, 45 in manufacturing and related973operations, and the remainder in executive and administrative positions. None of974our employees is represented by a labor union and we consider our employee975relations to be good.976977Advisory Board978979We have established the Advanced Neuromodulation Systems Advisory Board, which980is comprised of individuals with substantial expertise in neuromodulation and981pain management. Members of our management and scientific and technical staff982consult closely with members of the Advisory Board to identify specific areas983where techniques are changing and where existing products do not adequately984fulfill the needs of the pain physician. The Advisory Board helps management985evaluate new product ideas and concepts and once a product is approved for986development, its subsequent design and development. The Advisory Board may also987participate in the clinical testing of products developed.988989Certain members of the Advisory Board are employed by academic institutions and990may have commitments to or consulting or advisory agreements with other entities991that may limit their availability to us. The members of the Advisory Board may992also serve as consultants to other medical device companies. No members of the993Advisory Board are expected to devote more than a small portion of their time to994the Company.995996-14-997998<PAGE>9991000ITEM 2. PROPERTIES10011002In connection with the January 1998 sale of our cardiovascular products1003division, we granted Atrion a nine-month option to acquire our principal office1004and manufacturing facility in Allen, Texas for $6.5 million. The facility covers1005approximately 107,000 square feet and was constructed during 1993 on 19.2 acres1006of land that we acquired in 1985. Atrion exercised the option to acquire the1007facility during October 1998 and the transaction closed on February 1, 1999. We1008repaid the outstanding mortgage debt on the facility of $3.6 million at closing1009and received net proceeds of $2.7 million after paying expenses related to the1010transaction. See Note 9- "Sale of CVS Operations/Discontinued Operations" of the1011Notes to Consolidated Financial Statements. No material gain or loss was1012realized on the sale of the facility. We leased space, furniture and equipment1013from Atrion until May 1999 at the monthly rate of $48,125 and paid Atrion fifty1014percent of certain operating expenses including utilities, janitorial services,1015landscaping services, insurance and property taxes. At that time we moved our1016operations to a 40,000 square foot leased facility in Plano, Texas, a northeast1017suburb of Dallas discussed below.10181019We entered a sixty-three month lease agreement in February 1999 for the Plano1020facility. Under terms of the lease agreement, which became effective on June 1,10211999, we received three months of free rent and the monthly rental rate for the1022remaining term of the lease is $48,308. The monthly rental rate includes certain1023operating expenses such as property taxes on the facility, insurance, landscape1024and maintenance and janitorial services. We also have a first right of refusal1025to acquire the facility. We spent approximately $2.4 million for furniture and1026equipment, leasehold improvements, computer systems, telephone systems and1027manufacturing clean room for the leased facility. The expense of moving and1028transitioning into the new facility was immaterial.10291030ITEM 3. LEGAL PROCEEDINGS10311032We are a party to product liability claims related to ANS' stimulation systems.1033Product liability insurers have assumed responsibility for defending us against1034these claims, subject to reservation of rights in certain cases. While1035historically product liability claims for our stimulation systems have not1036resulted in significant monetary liability beyond our insurance coverage, there1037can be no assurances that we will not incur significant monetary liability to1038the claimants if such insurance is unavailable or inadequate for any reason, or1039that our current stimulation business and future neuromodulation products will1040not be adversely affected by these product liability claims. While we seek to1041maintain appropriate levels of product liability insurance with coverage that we1042believe is comparable to that maintained by companies similar in size and1043serving similar markets, there can be no assurance that we will avoid1044significant future product liability claims relating to our stimulation systems.10451046Except for such product liability claims and other ordinary routine litigation1047incidental or immaterial to our business, we are not currently a party to any1048other pending legal proceeding. We maintain general liability insurance against1049risks arising out of the normal course of business.10501051ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS10521053Inapplicable.10541055-15-10561057<PAGE>10581059PART II10601061ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS10621063Our common stock is currently quoted on the Nasdaq National Market under the1064symbol "ANSI." Until June 30, 1998, the common stock was quoted on the Nasdaq1065National Market under the symbol "QMED". Our symbol was changed on July 1, 19981066in connection with our name change from Quest Medical, Inc. to Advanced1067Neuromodulation Systems, Inc. On March 20, 2000, there were approximately 6721068holders of record of our common stock. The following table sets forth the1069quarterly high and low closing sales prices for our common stock. These prices1070do not include adjustments for retail mark-ups, markdowns or commissions.10711072<TABLE>1073<CAPTION>107410751998: High Low1076---- -------------- --------------1077<S> <C> <C>1078First Quarter $ 8.75 $ 6.501079Second Quarter $ 10.00 $ 8.061080Third Quarter $ 10.00 $ 5.751081Fourth Quarter $ 6.75 $ 5.00108210831999: High Low1084---- -------------- --------------10851086First Quarter $ 8.19 $ 6.191087Second Quarter $ 9.56 $ 6.501088Third Quarter $ 11.44 $ 7.691089Fourth Quarter $ 9.38 $ 7.00109010912000: High Low1092---- -------------- --------------10931094First Quarter $ 19.00 $ 9.941095(through March 20, 2000)1096</TABLE>10971098To date, we have not declared or paid any cash dividends on our common stock and1099the Board of Directors does not anticipate paying cash dividends on our common1100stock in the foreseeable future.11011102During January 1998, the Board of Directors approved a stock repurchase program1103of up to 500,000 shares of our common stock and during August 1998 approved the1104repurchase of up to an additional 1,000,000 shares. In September 1999, the Board1105of Directors approved the repurchase of up to an additional 250,000 shares.1106During the year ended December 31, 1998, we repurchased 1,258,625 shares of our1107common stock at an aggregate cost of $9,411,055, or an average of $7.48 per1108share. During the year ended December 31, 1999, we repurchased 404,875 shares of1109our common stock at an aggregate cost of $2,952,311, or an average of $7.29 per1110share. In the aggregate, we have purchased 1,663,500 shares under the authorized1111repurchase programs and 86,500 shares are available for repurchase as of March111220, 2000. During the years ended December 31, 1999 and 1998, we issued 162,0681113and 184,874 shares respectively, from the treasury upon the exercise of stock1114options. At December 31, 1999, 1,316,558 shares remained in the treasury. Our1115purchases may be effected through open market purchases, block transactions,1116privately negotiated purchases or otherwise. Purchases of our common stock will1117be effected at prices and terms to be determined in light of then current1118circumstances, are completely discretionary and may be temporarily or1119permanently suspended at any time without notice.11201121-16-11221123<PAGE>11241125ITEM 6. SELECTED FINANCIAL DATA1126<TABLE>1127<CAPTION>11281129--------------------------------------------------------------------------1130Years Ended December 31,1131--------------------------------------------------------------------------11321999 1998 1997 1996 1995(1)1133-------------- -------------- -------------- -------------- --------------1134(in thousands, except per share data)1135<S> <C> <C> <C> <C> <C>1136Statement of Operations Data: (2)11371138Net revenue-product sales $ 20,578 $ 17,006 $ 14,718 $ 11,403 $ 10,4341139Total net revenue 29,478 20,106 14,718 11,403 10,4341140Gross profit-product sales 13,949 12,021 9,878 8,088 7,68211411142Research and development1143expense 3,773 2,801 977 1,316 8081144Purchased research and1145development -- -- -- -- 10,5001146Marketing, general and1147administrative and1148amortization expenses 10,235 8,486 6,815 6,257 3,7961149Earnings (loss) from operations 8,842 3,833 2,086 515 (7,421)11501151Net earnings (loss) from1152continuing operations 6,003 2,586 818 115 (8,906)1153Loss from discontinued1154operations -- (212) (93) (527) (1,199)1155Gain on the sale of assets of1156discontinued operations -- 4,585 -- -- --11571158Net earnings (loss) from1159discontinued operations -- 4,373 (93) (527) (1,199)1160Net earnings (loss) $ 6,003 $ 6,959 $ 724 $ (412) $ (10,374)11611162Diluted earnings (loss) per share:1163Continuing operations $ .75 $ .30 $ .09 $ .01 $ (1.42)1164Discontinued operations $ -- $ .51 $ (.01) $ (.06) $ (.19)1165Extraordinary item $ -- $ -- $ -- $ -- $ (.05)1166Net earnings (loss) $ .75 $ .81 $ .08 $ (.05) $ (1.66)1167</TABLE>11681169-17-11701171<PAGE>1172<TABLE>1173<CAPTION>11741175Years Ended December 31,1176---------------- ---------------- ---------------- ----------------- ----------------11771999 1998 1997 1996 19951178---------------- ---------------- ---------------- ----------------- ----------------1179(in thousands)1180<S> <C> <C> <C> <C> <C>1181Balance Sheet Data:11821183Cash, cash equivalents and1184marketable securities $ 8,752 $ 12,263 $ 2,204 $ 2,206 $ 3,9141185Working capital 16,178 16,426 14,128 11,088 12,1831186Total assets 43,555 45,485 48,982 47,188 44,4961187Short-term notes payable and1188current maturities of1189long-term notes payable -- 3,633 8,257 2,084 1,6161190Notes payable, excluding1191current maturities -- -- 3,635 11,912 8,5581192Stockholders' equity $ 37,038 $ 33,304 $ 33,906 $ 30,993 $ 30,8701193</TABLE>11941195- -----------------------1196(1)Includes results of ANS from March 31, 1995. The net loss for 1995 reflects a1197charge of $10,500, or $(1.68), for purchased in-process research and development1198incurred in connection with the ANS acquisition and an extraordinary charge of1199$269, or $(.05) per share, for the write-off of capitalized debt issuance costs1200due to early repayment of bank debt with the proceeds from a public offering1201completed in November 1995.12021203(2)On January 30, 1998, the Company sold its cardiovascular and intravenous1204fluid delivery product lines (CVS Operations). The CVS Operations have been1205accounted for as discontinued operations. See Note 9 of the Notes to1206Consolidated Financial Statements.12071208ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS1209OF OPERATIONS12101211The following discussion of the financial condition and results of operations of1212the Company should be read in conjunction with the Consolidated Financial1213Statements of the Company and the related Notes.12141215Overview12161217On January 30, 1998, we sold the assets of our CVS (cardiovascular) Operations,1218including our MPS(R) myocardial protection system product line, to Atrion1219Corporation. See Note 9 - "Sale of CVS Operations/ Discontinued Operations" of1220the Notes to Consolidated Financial Statements. We received approximately $231221million in cash from the sale. We also granted Atrion a nine-month option to1222acquire our principal office and manufacturing facility in Allen, Texas for $6.51223million. Atrion exercised the option to acquire the facility during October 19981224and the transaction closed on February 1, 1999. We repaid the outstanding1225mortgage debt on the facility at closing and received net proceeds of $2.71226million after paying expenses related to the transaction. No material gain or1227loss was realized on the sale of the facility. We leased space, furniture and1228equipment from Atrion until May 1999 at the monthly rate of $48,125 and paid1229Atrion fifty percent of certain operating expenses. At that time we moved our1230operations to a 40,000 square foot leased facility in Plano, Texas, a northeast1231suburb of Dallas. The expense of moving and transitioning into the new facility1232was immaterial.12331234Assets of the CVS Operations sold to Atrion primarily consisted of accounts1235receivable, inventories, furniture and fixtures, manufacturing tooling and1236equipment, and intangible assets including patents, trademarks and purchased1237technology. The intangible assets also included the rights to the name Quest12381239-18-12401241<PAGE>12421243Medical, Inc., our former name. We reported a pretax gain on the transaction of1244$7.1 million during the year ended December 31, 1998. This pretax gain is net of1245$1.0 million of compensation expense recorded as a result of changes made to the1246stock options held by employees of the CVS Operations. See Note 5 -1247"Stockholders' Equity" of the Notes to Consolidated Financial Statements. The1248pretax gain is also net of an expense of $969,000 recorded in connection with1249sale of the facility to Atrion which relates to abated property taxes. See Note12509 - "Sale of CVS Operations/Discontinued Operations" of the Notes to1251Consolidated Financial Statements. We utilized $9 million of the proceeds from1252the sale to retire debt and pay expenses related to the transaction.12531254The CVS Operations have been accounted for as discontinued operations in the1255Consolidated Financial Statements for the years ended December 31, 1998 and12561997.12571258In June 1998, we completed an agreement with Sofamor Danek under which we would1259develop and manufacture for Sofamor Danek, products and systems for use in Deep1260Brain Stimulation ("DBS"). See Note 10 - "Product Development Agreement" of the1261Notes to Consolidated Financial Statements. We received a payment of $4 million1262upon execution of the agreement that was being recognized into income as revenue1263based upon the estimated completion of the development project. During the year1264ended December 31, 1998, we recognized $3.1 million into income as revenue. The1265remaining $900,000 was recognized into income as revenue during January 1999 due1266to the termination of the agreement with Sofamor Danek as a result of the merger1267of Sofamor Danek and Medtronic, Inc. In connection with the termination, we also1268received an additional payment of $8 million from Sofamor Danek, which was1269recognized into income as revenue during January 1999.12701271The former agreement with Sofamor Danek fits with our strategy to strengthen and1272broaden our neuromodulation technology platforms and to ally ourselves with1273strategic partners who can help us leverage ANS' core technology into other1274significant market segments beyond our focus on the chronic pain segment of the1275neuromodulation market. We cannot assure you, however, that we will be1276successful in negotiating and consummating research and development agreements1277with other strategic partners.12781279In September 1999, the Neurological Devices Panel of the Medical Devices1280Advisory Committee recommended that the FDA reclassify Totally Implanted Spinal1281Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs from a1282Class III device to a Class II device. Class III devices typically require a1283Pre-Market Approval (PMA), supplemented with clinical trials to prove safety and1284effectiveness of the device, while Class II devices typically require a1285Pre-Market Notification (510(k)) to demonstrate substantial equivalence to an1286existing legally marketed device prior to receiving market clearance by the FDA.1287According to the FDA's 1999 ODE Annual Report, the average time for PMA's was128812.5 months (excluding the one-year typically required for clinical trials, or1289approximately 24 months total). The ODE Annual Report reported the average1290elapsed time for a 510(k) approval of 3.4 months in 1999.12911292We expected to receive a final reclassification decision from the FDA in January12932000 but have experienced a delay that we believe is related to the FDA's1294workload. We received a written progress report dated February 25, 2000 in which1295the FDA stated that it had received adequate information to move forward toward1296a final decision. The agency's letter further indicated that there may be1297"special controls" available to ensure the safety and effectiveness of the IPG1298device for treating pain of the trunk and/or limbs. We remain optimistic that12991300-19-13011302<PAGE>13031304the FDA will follow the recommendation of its panel to reclassify the IPG and1305are prepared to move quickly to file the 510(k) Pre-Market Notification for1306clearance to market the IPG in the United States if the FDA approves the1307reclassification. The IPG market for spinal cord stimulation to treat pain of1308the trunk and/or limbs is expected by industry analysts to approach $140 million1309in 2000, is growing at a 25% to 30% annual rate and is currently dominated by a1310single competitor, Medtronic, Inc.13111312Results of Operations13131314Comparison of the Years Ended December 31, 1999 and 199813151316We reported net earnings of $6.00 million or $.75 per diluted share in 19991317compared to $6.96 million or $.81 per diluted share in 1998. The 1998 results1318included net earnings of $4.4 million from the discontinued CVS Operations or1319$.51 per diluted share primarily due to an after-tax gain of $4.6 million on the1320sale of the discontinued operations. Net earnings from continuing operations1321increased to $6.00 million or $.75 per diluted share in 1999 compared to $2.591322million or $.30 per diluted share in 1998. Net earnings from continuing1323operations in 1999 and 1998 benefited from $8.9 million and $3.1 million,1324respectively, of revenue recorded in connection with our former agreement with1325Sofamor Danek.13261327Total net revenue from continuing ANS operations of $29.48 million for the year1328ended December 31, 1999, was $9.37 million, or 46.6 percent, above the1329comparable 1998 level of $20.11 million. The 1999 period includes $8.9 million1330of net revenue and the 1998 period includes $3.1 million of net revenue1331associated with our former development agreement for DBS products with Sofamor1332Danek. Net revenue from ANS product sales increased 21.0 percent to $20.581333million during 1999 compared to $17.01 million in 1998. This increase in net1334revenue from product sales was the result of higher unit sales volume of ANS'1335radio-frequency stimulation systems used to treat complex pain patterns. All of1336the $3.57 million increase in 1999 was the result of higher sales in the United1337States. During June 1999, we launched our enhanced radio-frequency stimulation1338system, the Renew(TM) System, in the United States. We will launch the Renew1339System in international markets during 2000.13401341Gross profit from product sales increased to $13.95 million in 1999 from $12.021342million in 1998 due to the increase in net revenue from product sales discussed1343above. Gross profit margin from product sales decreased to 67.8 percent in 19991344compared to 70.7 percent in 1998 due to (1) approximately $350,000 of additional1345costs we incurred from product transition and unexpected lower manufacturing1346yields related to the Renew System during the third quarter of 1999, (2) higher1347component costs for the Renew System, and (3) production downtime associated1348with our move to our new leased facility in May 1999.13491350Total operating expenses (the aggregate of research and development, marketing,1351amortization of intangibles and administrative expenses) increased to $14.011352million in 1999 compared to $11.29 million in 1998 and as a percentage of net1353revenue from product sales increased to 68.1 percent in 1999 from 66.4 percent1354in 1998.13551356Research and development expense increased to $3.77 million in 1999, or 18.31357percent of 1999 net revenue from product sales, from $2.80 million during 1998,1358or 16.5 percent of 1998 net revenue from product sales, reflecting our stepped1359up commitment to develop products that will expand our presence into other1360rapidly growing market segments of the neuromodulation market. This increase1361during 1999 compared to 1998 was the result of higher salary and benefit expense13621363-20-13641365<PAGE>13661367from staffing additions, increased consulting expense, and higher test material1368expense. These expenditures during 1999 were directed toward development of our1369Renew System, which we launched in the United States during June 1999, a1370silastic spring constant rate intrathecal drug pump, an IPG stimulation system1371for spinal cord stimulation and an IPG stimulation system for Deep Brain1372Stimulation. We expect to complete the development of our IPG stimulation system1373for spinal cord stimulation during April 2000, and if the FDA approves1374reclassification of the device, we anticipate obtaining 510(k) pre-market1375notification clearance during the second half of 2000 and would launch the IPG1376system domestically upon receipt of the clearance. In addition, we expect to1377receive CE mark approval for the IPG system in the second half of 2000, at which1378time we would launch it in European markets. We also expect to complete the1379development of our silastic spring constant rate intrathecal drug pump and begin1380clinical trials in the United States by the end of 2000. Similarly, we expect to1381receive CE mark approval on the constant-rate intrathecal drug pump by year-end13822000, at which time we would launch it in European markets.13831384Marketing expense, as a percentage of net revenue from product sales, increased1385to 30.6 percent in 1999 from 27.5 percent in 1998, and the absolute dollar1386amount increased from $4.68 million during 1998 to $6.29 million in 1999. This1387dollar increase during 1999 was attributable to higher commission expense from1388increased product sales and a change from distributors to commissioned sales1389agents in certain United States territories, higher salary and benefit expense1390from staffing additions, higher expense for education and training of new1391implanters and expense related to the launch of our Renew System.13921393General and administrative expense increased from $2.63 million during 1998 to1394$2.76 million in 1999 while as a percentage of net revenue from product sales,1395decreased to 13.4 percent in 1999 from 15.5 percent during 1998. The increase in1396the absolute dollars of expense of $124,000 during 1999 was principally the1397result of higher salary and benefit expense from staffing additions, higher1398expense related to investor relations and higher patent legal expense.13991400Amortization of ANS intangibles increased from $1.17 million in 1998 to $1.191401million during 1999 due to expense for additional patents we have licensed.14021403Other income increased to $706,000 in 1999 compared to $499,000 in 19981404primarily as a result of a $287,000 reduction in interest expense due to the1405repayment of our mortgage debt in February 1999 when we sold our facility to1406Atrion Corporation.14071408Income tax expense from continuing operations increased to $3.55 million in 19991409from $1.75 million in 1998 due to higher earnings from ANS operations. This1410represents effective tax rates of 37.1 percent in 1999 and 40.3 percent in 1998.1411Our expense for amortization of costs in excess of net assets acquired1412(goodwill) is not deductible for tax purposes, and, when combined with a1413provision for state taxes, results in the higher effective tax rate during both14141999 and 1998 compared to the U.S. statutory rate for corporations of 341415percent.14161417Comparison of the Years Ended December 31, 1998 and 199714181419We reported net earnings of $6.96 million or $.81 per diluted share in 19981420compared to $724,000 or $.08 per diluted share in 1997. The 1998 results1421included net earnings of $4.37 million from the discontinued CVS Operations or1422$.51 per diluted share primarily due to an after-tax gain of $4.59 million on1423the sale of the discontinued operations while the 1997 results included a loss14241425-21-14261427<PAGE>14281429of $93,000 or $(.01) per diluted share from the discontinued operations. Net1430earnings from continuing operations increased to $2.59 million or $.30 per1431diluted share in 1998 compared to $818,000 or $.09 per diluted share in 1997.14321433Total net revenue from continuing ANS operations of $20.11 million for the year1434ended December 31, 1998, was $5.39 million, or 37 percent, above the comparable14351997 level of $14.72 million. The 1998 period includes $3.10 million of net1436revenue associated with our former development agreement for DBS products with1437Sofamor Danek. Net revenue from ANS product sales increased 16 percent to $17.011438million during 1998 compared to $14.72 million in 1997. This increase in net1439revenue from product sales was the result of higher unit sales volume of ANS'1440radio-frequency stimulation systems used to treat complex pain patterns. Of the1441$2.29 million increase in 1998, $1.7 million was the result of higher sales in1442the United States and the remainder from higher sales internationally.14431444Gross profit from product sales increased to $12.0 million in 1998 from $9.91445million in 1997 due to the increase in net revenue from product sales discussed1446above and an increase in gross profit margin. Gross profit margin from product1447sales increased to 70.7 percent in 1998 compared to 67.1 percent in 1997 due,1448for the most part, to a $479,000 expense during 1997 for the write-off of ANS1449inventory of previous designs. Excluding such write-off in 1997, gross profit1450margin remained approximately the same, 70.4 percent in 1997 compared to 70.71451percent in the 1998 period.14521453Total operating expenses (the aggregate of research and development, marketing,1454amortization of intangibles and administrative expenses) increased to $11.31455million in 1998 compared to $7.8 million in 1997 and as a percentage of net1456revenue from product sales increased to 66.4 percent in 1998 from 52.9 percent1457in 1997.14581459Research and development expense increased to $2.80 million in 1998, or 16.51460percent of 1998 net revenue from product sales, from $977,000 during 1997, or14616.6 percent of 1997 net revenue from product sales, reflecting our stepped up1462commitment to develop products that will expand our presence into other market1463segments of the neuromodulation market. This increase during 1998 compared to14641997 was the result of higher salary and benefit expense from staffing1465additions, increased consulting expense, and higher test material expense. These1466expenditures during 1998 were directed toward development of our enhanced1467radio-frequency stimulation systems, which we introduced to the U.S. market in1468June 1999, a silastic spring constant rate intrathecal drug pump, an IPG1469stimulation system for spinal cord stimulation and an IPG stimulation system for1470Deep Brain Stimulation.14711472Marketing expense, as a percentage of net revenue from product sales, increased1473to 27.5 percent in 1998 from 27.0 percent in 1997, and the absolute dollar1474amount increased from $3.97 million during 1997 to $4.68 million in 1998. This1475dollar increase during 1998 was attributable to higher commissions from1476increased product sales, higher training expense for new users of ANS products1477and higher convention and promotional expense.14781479General and administrative expense increased from $1.76 million during 1997 to1480$2.63 million in 1998 and as a percentage of net revenue from product sales,1481increased to 15.5 percent in 1998 from 12.0 percent during 1997. This increase1482in expense during 1998 was principally the result of increased legal expense1483related to the various development agreements discussed above, increased1484recruiting and relocation expense and increased costs for existing employee1485benefit plans.14861487-22-14881489<PAGE>14901491Amortization of ANS intangibles increased from $1.09 million in 1997 to $1.171492million during 1998, mostly due to an expense associated with a non-compete1493agreement with the former president and chief executive officer.14941495Other income increased to $499,000 in 1998 compared to an expense of $536,000 in14961997 primarily as a result of two factors. First, interest expense decreased by1497$294,000 during 1998 compared to 1997 as a result of the repayment of short-term1498notes payable in January 1998 from the proceeds of the sale of the CVS1499Operations. Second, interest income increased by $720,000 in 1998 compared to15001997 due to higher funds available for investment due to the proceeds from the1501January 1998 sale of the CVS Operations.15021503Income tax expense from continuing operations increased to $1.75 million in 19981504from $733,000 in 1997 due to higher earnings from ANS operations. This1505represents effective tax rates of 40.3 percent in 1998 and 47.3 percent in 1997.1506Our expense for amortization of costs in excess of net assets acquired1507(goodwill) is not deductible for tax purposes, and, when combined with a1508provision for state taxes, results in the higher effective tax rate during both15091998 and 1997 compared to the U.S. statutory rate for corporations of 341510percent.15111512Liquidity and Capital Resources15131514At December 31, 1999 our working capital decreased slightly from $16.43 million1515at year-end 1998 to $16.18 million at year-end 1999. The ratio of current assets1516to current liabilities was 4.86:1 at December 31, 1999, compared to 2.68:1 at1517December 31, 1998. Cash, cash equivalents and marketable securities totaled1518$8.75 million at December 31, 1999 compared to $12.26 million at December 31,15191998.15201521In January 1999, we received the $8 million payment in connection with the1522termination of the DBS agreement with Sofamor Danek.15231524During February 1999, we completed the sale of our corporate facility to Atrion1525for $6.5 million. After repayment of the mortgage debt and expenses related to1526the transaction, we realized net proceeds of $2.7 million.15271528During September 1999, the Board of Directors authorized increasing our stock1529repurchase program by an additional 250,000 shares to a total of 1,750,0001530shares. During the year ended December 31, 1999, we repurchased 404,875 shares1531of our common stock at an aggregate cost of $2,952,311, or an average of $7.291532per share. In aggregate, we have purchased 1,663,500 shares under the authorized1533repurchase programs and 86,500 shares are available for repurchase as of March153417, 2000. During the years ended December 31, 1999 and 1998, we issued 162,0681535and 184,874 shares respectively, from our treasury upon the exercise of stock1536options. At December 31, 1999, 1,316,558 shares remained in the treasury.15371538We increased our investment in inventories by $3.36 million to $6.00 million at1539December 31, 1999, from $2.64 million at December 31, 1998. While this is a1540higher level of inventory than we plan to carry on an ongoing basis, several1541factors contributed to the increase. First, we are continuing to transition from1542our former radio-frequency systems to the Renew System. We are continuing to1543sell the former systems in international markets until the appropriate1544regulatory approvals are received. Second, we built inventory of Renew System15451546-23-15471548<PAGE>15491550components as part of a phased product and geographical launch. Third, we1551decided to increase our safety stock levels on critical single-sourced1552components due to electronic component shortages experienced during 1999.1553Fourth, we began building inventory in anticipation of our launch of the IPG in1554the second half of 2000. We estimate that our investment in inventory will1555decrease by approximately $1.0 million by year-end 2000.15561557We spent $5.91 million during 1999 for capital expenditures and license fees for1558additional patents and intellectual property we are licensing. Of such1559expenditures, approximately $2.4 million were for new furniture and equipment,1560computer systems, telephone system, manufacturing clean room and leasehold1561improvements for our new leased facility. We also spent $1.30 million during15621999 to license additional patents and intellectual property. The remaining1563expenditures of $2.21 million relate to manufacturing tooling and equipment for1564the Renew System and other new products we are developing. We expect capital1565expenditures and patent license fees to be substantially less in fiscal 2000 and1566have budgeted expenditures of approximately $1.7 million.15671568We believe our current cash, cash equivalents and marketable securities and cash1569generated from operations will be sufficient to fund all of our operating needs1570and capital expenditures for the foreseeable future.15711572Cash Flows15731574Net cash provided by continuing operations was $2.22 million in 1999, $6.931575million in 1998 and $2.11 million in 1997. Although net earnings from continuing1576operations increased to $6.00 million in 1999 from $2.59 million in 1998, net1577cash provided from continuing operations decreased by $4.71 million primarily1578due to changes in components of working capital. During 1999, we used cash to1579increase our investment in assets such as inventories, account receivable and1580prepaid expenses and other assets and to reduce our income taxes payable. For15811998 compared to 1997, net cash provided by continuing operations increased by1582$4.82 million reflecting improved operating results, deferred revenue associated1583with our former agreement with Sofamor Danek and an increase in our income taxes1584payable not due until March 1999. Net cash provided by discontinued operations1585decreased to $59,000 in 1998 compared to $391,000 in 1997. The 1998 period1586included only one month of results until the sale in January 1998.15871588Net cash provided by investing activities decreased to $447,000 in 1999 from1589$20.81 million in 1998 while we used cash in investing activities in 1997 of1590$5.74 million. The 1999 period reflects $6.35 million of net proceeds we1591received when we sold our facility to Atrion Corporation. We utilized $5.911592million in 1999 for capital expenditures for leasehold improvements, furnishings1593and equipment for our new leased facility, manufacturing tooling and equipment1594for our Renew System and new products we are developing and licensing fees for1595patents. The 1998 period reflects net proceeds of $21.8 million from the sale of1596discontinued operations. We utilized $1.68 million in 1998 for capital1597expenditures primarily for manufacturing tooling and equipment for the new1598products we are developing and license fees for patents we licensed. Primary1599uses of cash during 1997 were capital expenditures of $1.29 million and payments1600to the former owner of the neurostimulation business relating to patents and1601settlements of $4.47 million.16021603Net cash used in financing activities decreased to $6.01 million in 1999 from1604$16.85 million in 1998 while financing activities provided net cash of $3.291605million in 1997. During 1999, we received net cash of $573,000 from the exercise16061607-24-16081609<PAGE>16101611of stock options while $2.95 million was used for share repurchases and $3.631612million for the repayment of our mortgage debt. During 1998, we received net1613cash of $818,000 from the exercise of stock options while $9.41 million was used1614for share repurchases and $8.26 million to reduce debt. During 1997, we received1615cash of $922,000 from the exercise of stock options and $3.53 million from1616additional borrowings under short-term notes. We used $1.16 million during 19971617to repay debt.16181619Year 200016201621We believe our computer software programs, operating systems and manufacturing1622equipment are Year 2000 compliant and ready for use beyond the Year 2000.16231624We are not currently aware of any material Year 2000 problems relating to any of1625our material internal software programs, operating systems and manufacturing1626equipment. Our internal operations and business are also dependent upon the1627computer-controlled systems of third parties such as our suppliers, customers1628and other service providers. We believe that absent a systemic failure outside1629our control, such as a prolonged loss of electrical or telecommunications1630service, Year 2000 problems at third parties will not have a material impact on1631our operations. However, the failure of our internal systems or the systems of1632third parties to be Year 2000 compliant could result in disruptions to our1633operations, including, among other things, a temporary inability to process1634transactions, send invoices, manufacture products or engage in similar normal1635business activities. Therefore, depending on the scope and nature of the1636problems, we could be required to devote significant resources to correcting1637such problems. The costs associated with remediating any Year 2000 problems have1638not been material to date and although we do not anticipate that these costs1639will be material in the future, we cannot assure you that these costs will not1640be material.16411642Outlook and Uncertainties16431644The following is a "safe harbor" statement under the Private Securities1645Litigation Reform Act of 1995: The matters discussed in this Annual Report on1646Form 10-K contain statements that constitute forward-looking statements within1647the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.1648The words "expect," "estimate," "anticipate," "predict," "believe," "plan,"1649"will," "should," "intend" and similar expressions and variations thereof are1650intended to identify forward-looking statements. Such statements appear in a1651number of places in this Annual Report on Form 10-K and include statements1652regarding our intent, belief or current expectations with respect to, among1653other things: (i) trends affecting our financial condition or results of1654operations; (ii) our financing plans; and (iii) our business growth strategies.1655We caution our readers that any forward-looking statements are not guarantees of1656future performance and involve risks and uncertainties. Actual results may1657differ materially from those projected in the forward-looking statements as a1658result of various factors. These risks and uncertainties include the following:16591660Product Development and Market Acceptance. Our growth depends in part on our1661ability to develop and gain market acceptance of new products, including next1662generation ANS products. We cannot assure you that we will continue to develop1663successful products, that delays in product introduction will not be1664experienced, or that once such products are introduced, the market will accept1665them.16661667-25-16681669<PAGE>16701671Government Regulation. Our business is subject to extensive government1672regulation, principally by the FDA. The regulatory process, especially as it1673relates to product approvals, can be lengthy, expensive and uncertain. See1674Item 1-"Business-Government Regulation".16751676Single-Sourced Components. We rely on a single supplier for the computer chip1677used in the receiver of our stimulation systems. The supplier of this computer1678chip has indicated its desire to cease manufacturing and supplying the computer1679chip in the future, but to date, has not determined when this will occur. The1680supplier has agreed to notify us when a date has been determined and allow us to1681place a final one-time purchase order for the computer chip. In the interim, we1682are maintaining a higher than normal inventory of the computer chip and are1683developing a new receiver design that does not use a custom computer chip. A1684sudden disruption in supply from the computer chip supplier or another1685single-source supplier could adversely affect our ability to deliver finished1686products on time.16871688Competition and Technological Change. The medical device market is highly1689competitive. We compete with many larger companies that have access to greater1690capital, research and development, marketing, distribution and other resources1691than we do. In addition, our market is characterized by extensive research1692efforts and rapid product development and technological change, which could1693render our products obsolete or noncompetitive.16941695Intellectual Property Rights. We rely in part on patents, trade secrets and1696proprietary technology to remain competitive. It may be necessary to defend1697these rights or to defend against claims that we are infringing the rights of1698others. Intellectual property litigation and controversies are disruptive and1699expensive.17001701Cost Pressures on Medical Technology. The overall escalating cost of medical1702products and healthcare results in significant cost pressure. Third-party payers1703are under intense pressure to challenge the prices charged for medical products1704and services. We rely heavily on Medicare and Medicaid reimbursement. Any1705amendments to existing reimbursement rules and regulations which restrict or1706terminate the reimbursement eligibility (or the extent or amount of coverage) of1707medical procedures using our products or the eligibility (or the extent or1708amount of coverage) of our products could adversely impact our business,1709financial condition and results of operations.17101711Potential Product Liability. The testing, manufacturing, marketing and sale of1712medical devices entail substantial risks of liability claims or product recalls.17131714Reliance on Customer/Distributor. During 1999, we had two major customers that1715accounted for 10 percent or more of our net revenue. Sun Medical, Inc. and1716Primesource Surgical, Inc., each a specialty distributor of ANS products,1717accounted for $3.0 million and $2.3 million, respectively, or 14.6 percent and171811.2 percent, respectively, of ANS' net revenue from product sales for the year1719ended December 31, 1999. While we believe our relations with Sun Medical and1720Primesource Surgical are good, the loss of one or both of these customers could1721have a material adverse effect on our business, financial condition and results1722of operations.17231724Year 2000 Compliance. Although our Year 2000 readiness efforts were successful1725and we have not experienced any Year 2000 issues to date, we cannot assure you1726that Year 2000 issues will not occur at a later date that would have a material1727adverse impact on our results of operations, financial condition and cash flows.17281729-26-17301731<PAGE>17321733Other Uncertainties. We discuss other operating, financial or legal risks or1734uncertainties in this Form 10-K in specific contexts and in the Company's other1735periodic SEC filings. The Company is, of course, also subject to general1736economic risks, the risk of interruption in the source of supply, dependence on1737key personnel and other risks and uncertainties.17381739Currency Fluctuations17401741Substantially all of our international sales are denominated in U.S. dollars.1742Fluctuations in currency exchange rates in other countries could reduce the1743demand for our products by increasing the price of our products in the currency1744of the countries in which the products are sold, although we do not believe1745currency fluctuations have had a material effect on the Company's results of1746operations to date.17471748ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK17491750We do not use derivative financial instruments to manage the impact of interest1751rate changes on our investments or debt instruments.17521753We invest our cash reserves in high quality short-term liquid money market1754instruments with major financial institutions. At December 31, 1999, we had1755$7,192,687 invested in money market funds and $1,012,106 in a certificate of1756deposit with a maturity date of 90 days from the purchase date. The rate of1757interest earned on these investments will vary with overall market rates. A1758hypothetical 100-basis point change in the interest rate earned on these1759investments would not have a material effect on our income or cash flows.17601761We also have certain investments in available-for-sale securities. These1762investments primarily consist of real estate investment trusts and investment1763grade corporate preferred securities that are traded on the New York Stock1764Exchange. The cost of these investments is $764,195 and had a fair value at1765December 31, 1999 of $398,208. The investments are subject to overall stock1766market and interest rate risk. A hypothetical 20 percent decrease in the share1767prices of these investments from the prices at December 31, 1999 would decrease1768the fair value by $79,642.17691770At December 31, 1999, we had no debt instruments.17711772ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA17731774The information required by this item is set forth in Appendices A, B and C.17751776ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND1777FINANCIAL DISCLOSURE17781779None.17801781PART III17821783ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT17841785The information required by this item is contained under the captions "Election1786of Directors" and "Executive Officers" in our definitive proxy material which17871788-27-17891790<PAGE>17911792will be filed in connection with our 2000 annual meeting of stockholders, which1793information is incorporated herein by reference.17941795ITEM 11. EXECUTIVE COMPENSATION17961797The information required by this item is contained under the captions1798"Compensation and Committees of the Board of Directors" and "Compensation of1799Executive Officers" in our definitive proxy material which will be filed in1800connection with our 2000 annual meeting of stockholders, which information is1801incorporated herein by reference.18021803ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT18041805The information required by this item is contained under the caption "Security1806Ownership of Management and Principal Shareholders" in our definitive proxy1807material which will be filed in connection with our 2000 annual meeting of1808stockholders, which information is incorporated herein by reference.18091810ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS18111812The information required by this item is contained under the caption "Certain1813Relationships and Related Transactions" in our definitive proxy material which1814will be filed in connection with our 2000 annual meeting of stockholders, which1815information is incorporated herein by reference.18161817PART IV18181819ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K18201821(a) Documents filed as part of this report.182218231. Financial Statements:1824See Index to Financial Statements on the second page of1825Appendix A.182618272. Financial Statement Schedules:*1828Schedule II - Valuation and Qualifying Accounts.1829See Appendix B.18301831* Those schedules not listed above are omitted as not applicable or not1832required.183318343. Exhibits: See (c) below.18351836(b) Reports on Form 8-K.1837None.18381839(c) Exhibits:18401841-28-18421843<PAGE>184418452.1 Asset Purchase Agreement, dated December 29, 1997, by and1846among Quest Medical, Inc., QMI Medical, Inc. (formerly1847known as QMI Acquisition Corp.) and Atrion Corporation1848(including exhibits and schedules 2.1.1, 2.1.2, 2.3(a) and18492.3(b))(7)18503.1 Articles of Incorporation, as amended and restated(4)18513.2 Bylaws(1)18524.1 Rights Agreement dated as of August 30, 1996, between Quest1853Medical, Inc. and KeyCorp Shareholder Services, Inc. as1854Rights Agent(5)185510.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock1856Option Plan(2)185710.2 Form of 1979 Employees Stock Option Agreement(3)185810.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)1859(2)186010.4 Form of Directors Stock Option Agreement(1)186110.5 Quest Medical, Inc. 1987 Stock Option Plan(4)186210.6 Form of 1987 Employee Stock Option Agreement(4)186310.7 Quest Medical, Inc. 1995 Stock Option Plan(4)186410.8 Form of 1995 Employee Stock Option Agreement(4)186510.9 Quest Medical, Inc. 1998 Stock Option Plan(9)186610.10 Employment Agreement dated April 9, 1998 between Christopher1867G. Chavez and Quest Medical, Inc.(8186810.11 Employment Agreement dated April 9, 1998 between Scott F.1869Drees and Quest Medical, Inc.(8)187010.12 Employment Agreement dated April 9, 1998 between F. Robert1871Merrill III and Quest Medical, Inc.(8)187210.13 Form of Employment Agreement and Covenant Not to1873Compete, between the Company and key employees(1)187410.14 Form of License Agreement, dated January 30, 1998, by and1875between Quest Medical, Inc. and QMI Medical, Inc. (formerly1876known as QMI Acquisition Corp.)(6)187710.15 Form of Lease Agreement, dated January 30, 1998, by and1878between Quest Medical, Inc. and QMI Medical, Inc. (formerly1879known as QMI Acquisition Corp.)(6)188010.16 Form of Option Agreement, dated January 30, 1998, by and1881between Quest Medical, Inc. and QMI Medical, Inc. (formerly1882known as QMI Acquisition Corp.)(6)188310.17 Agreement, dated December 31, 1997, by and among Quest1884Medical, Inc., its subsidiaries and affiliates and Thomas C.1885Thompson(7)188610.18 Lease Agreement dated as of February 4, 1999, between Advanced1887Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(10)188811.1 Computation of Earnings Per Share(11)188921.1 Subsidiaries(11)189023.1 Consent of Independent Auditors(11)189127.1 Financial Data Schedule - December 31, 1999(11)18921893- -------------------------------------1894(1) Filed as an Exhibit to the Company's Registration Statement on Form1895S-18, Registration No. 2-71198-FW, and incorporated herein by1896reference.1897(2) Filed as an Exhibit to the report of the Company on Form 10-K for the1898year ended December 31, 1987, and incorporated herein by reference.1899(3) Filed as an Exhibit to the Company's Registration Statement on Form1900S-1, Registration No. 2-78186, and incorporated herein by reference.1901(4) Filed as an Exhibit to the Company's Registration Statement on Form1902SB-2, Registration No. 33-62991, and incorporated herein by reference.1903(5) Filed as an Exhibit to the report of the Company on Form 8-K dated1904September 3, 1996, and incorporated herein by reference.1905(6) Filed as an Exhibit to the report of the Company on Form 8-K dated1906February 13, 1998, and incorporated herein by reference. Upon request,1907the Company will furnish a copy of any omitted schedule to the1908Commission.1909(7) Filed as an Exhibit to the report of the Company on Form 10-K dated for1910the year ended December 31, 1997, and incorporated herein by reference.1911(8) Filed as an Exhibit to the report of the Company on Form 10-Q dated for1912the quarterly period ended March 31, 1998, and incorporated herein by1913reference.19141915-29-19161917<PAGE>19181919(9) Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A1920dated April 27, 1998, and incorporated herein by reference.1921(10) Filed as an Exhibit to the report of the Company on Form 10-K dated for1922the year ended December 31, 1998, and incorporated herein by reference.1923(11) Filed herewith.19241925-30-19261927<PAGE>19281929Signatures19301931Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange1932Act of 1934, the Company has duly caused this report to be signed on its behalf1933by the undersigned, thereunto duly authorized.19341935Date: March 27, 20001936ADVANCED NEUROMODULATION SYSTEMS, INC.19371938By: /s/Christopher G. Chavez1939------------------------1940Christopher G. Chavez1941President and Chief Executive Officer19421943Pursuant to the requirements of the Securities Exchange Act of 1934, this report1944has been signed by the following persons on behalf of the Company and in the1945capacities and on the dates indicated:19461947<TABLE>1948<CAPTION>19491950Signature Title Date1951--------- ----- ----1952<S> <C> <C>1953/s/Christopher G. Chavez Chief Executive Officer, President March 27, 20001954- ---------------------------- and, Director of Advanced1955Christopher G. Chavez Neuromodulation Systems, Inc.1956(Principal Executive Officer)19571958/s/F. Robert Merrill III Executive Vice President-Finance, March 27, 20001959- ---------------------------- Treasurer and Secretary of1960F. Robert Merrill III Advanced Neuromodulation Systems,1961Inc. (Principal Financial and1962Accounting Officer)19631964/s/Hugh M. Morrison Chairman of the Board and March 27, 20001965- ---------------------------- Director of Advanced1966Hugh M. Morrison Neuromodulation Systems, Inc.19671968/s/Robert C. Eberhart Director of Advanced March 27, 20001969- ---------------------------- Neuromodulation Systems, Inc.1970Robert C. Eberhart19711972/s/Joseph E. Laptewicz, Jr. Director of Advanced March 27, 20001973- ---------------------------- Neuromodulation Systems, Inc.1974Joseph E. Laptewicz, Jr.19751976/s/A. Ronald Lerner Director of Advanced March 27, 20001977- ---------------------------- Neuromodulation Systems, Inc.1978A. Ronald Lerner19791980/s/Richard D. Nikolaev Director of Advanced March 27, 20001981- ---------------------------- Neuromodulation Systems, Inc.1982Richard D. Nikolaev19831984/s/Michael J. Torma Director of Advanced March 27, 20001985- ---------------------------- Neuromodulation Systems, Inc.1986Michael J. Torma1987</TABLE>19881989-31-19901991<PAGE>19921993Appendix A1994----------19951996199719981999200020012002Consolidated Financial Statements20032004Independent Auditors' Report20052006Three Years Ended December 31, 199920072008Forming a Part of the Annual Report20092010Form 10-K20112012Item 820132014of20152016ADVANCED NEUROMODULATION SYSTEMS, INC.20172018(Name of issuer)20192020Filed with the20212022Securities and Exchange Commission20232024Washington, D.C. 2054920252026under20272028The Securities and Exchange Act of 193420292030<PAGE>20312032Advanced Neuromodulation Systems, Inc. and Subsidiaries20332034Table of Contents20352036to20372038Consolidated Financial Statements20392040Form 10-K - Item 820412042Independent Auditors' Report20432044Consolidated Financial Statements:20452046Consolidated Balance Sheets - December 31, 1999 and 19982047Consolidated Statements of Operations - Years ended December 31, 1999, 1998 and204819972049Consolidated Statements of Stockholders' Equity - Years ended December 31,20501999, 1998 and 19972051Consolidated Statements of Cash Flows - Years ended December205231, 1999, 1998 and 19972053Notes to Consolidated Financial Statements20542055<PAGE>20562057Report of Independent Auditors20582059The Board of Directors2060Advanced Neuromodulation Systems, Inc.20612062We have audited the accompanying consolidated balance sheets of Advanced2063Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31,20641999 and 1998, and the related consolidated statements of operations,2065stockholders' equity and cash flows for each of the three years in the period2066ended December 31, 1999. Our audits also included the financial statement2067schedule listed in the Index at Item 14A. These consolidated financial2068statements and schedule are the responsibility of the Company's management. Our2069responsibility is to express an opinion on these financial statements and2070schedule based on our audits.20712072We conducted our audits in accordance with auditing standards generally accepted2073in the United States. Those standards require that we plan and perform the audit2074to obtain reasonable assurance about whether the financial statements are free2075of material misstatement. An audit includes examining, on a test basis, evidence2076supporting the amounts and disclosures in the financial statements. An audit2077also includes assessing the accounting principles used and significant estimates2078made by management, as well as evaluating the overall financial statement2079presentation. We believe that our audits provide a reasonable basis for our2080opinion.20812082In our opinion, the financial statements referred to above present fairly, in2083all material respects, the consolidated financial position of Advanced2084Neuromodulation Systems, Inc. and subsidiaries at December 31, 1999 and 1998,2085and the consolidated results of their operations and their cash flows for each2086of the three years in the period ended December 31, 1999, in conformity with2087accounting principles generally accepted in the United States. Also, in our2088opinion, the related financial statement schedule, when considered in relation2089to the basic financial statements taken as a whole, presents fairly in all2090material respects the information set forth therein.20912092/s/ERNST & YOUNG LLP2093--------------------2094ERNST & YOUNG LLP20952096Dallas, Texas2097February 25, 200020982099<PAGE>21002101Advanced Neuromodulation Systems, Inc. and Subsidiaries2102Consolidated Balance Sheets2103December 31, 1999 and 199821042105<TABLE>2106<CAPTION>21072108Assets 1999 19982109- ------ ------------ ------------2110<S> <C> <C>2111Current assets:2112Cash and cash equivalents $ 8,353,658 $ 11,697,2092113Marketable securities 398,208 566,07221142115Receivables:2116Trade accounts, less allowance for doubtful accounts2117of $140,824 in 1999 and $249,607 in 1998 3,785,719 3,135,6152118Interest and other 70,965 124,5112119------------ ------------2120Total receivables 3,856,684 3,260,1262121------------ ------------2122Inventories:2123Raw materials 3,014,908 1,010,8652124Work-in-process 626,402 415,4422125Finished goods 2,357,907 1,216,9552126------------ ------------2127Total inventories 5,999,217 2,643,2622128------------ ------------21292130Deferred income taxes 654,086 887,60921312132Prepaid expenses and other current assets 1,107,380 852,02521332134Net assets of building and land sold in 1999 -- 6,310,9852135------------ ------------2136Total current assets 20,369,233 26,217,2882137------------ ------------2138Equipment and fixtures:2139Furniture and fixtures 3,240,322 882,9682140Machinery and equipment 3,599,338 2,066,5142141Leasehold improvements 711,271 --2142------------ ------------21437,550,931 2,949,48221442145Less accumulated depreciation and amortization 1,862,361 1,060,8902146------------ ------------2147Net equipment and fixtures 5,688,570 1,888,5922148------------ ------------21492150Cost in excess of net assets acquired, net of accumulated2151amortization of $2,291,220 in 1999 and $1,734,6172152in 1998 8,520,444 9,077,0472153Patents and licenses, net of accumulated amortization2154of $472,708 in 1999 and $302,281 in 1998 4,071,196 3,054,2832155Purchased technology from acquisitions, net of accumulated2156amortization of $1,266,667 in 1999 and2157$1,000,000 in 1998 2,733,333 3,000,0002158Tradenames, net of accumulated amortization of2159$593,750 in 1999 and $468,750 in 1998 1,906,250 2,031,2502160Other assets, net of accumulated amortization of2161$137,985 in 1999 and $68,993 in 1998 265,748 216,9082162------------ ------------2163$ 43,554,774 $ 45,485,3682164============ ============2165</TABLE>21662167See accompanying notes to consolidated financial statements.21682169<PAGE>21702171Advanced Neuromodulation Systems, Inc. and Subsidiaries2172Consolidated Balance Sheets2173December 31, 1999 and 199821742175<TABLE>2176<CAPTION>21772178Liabilities and Stockholders' Equity 1999 19982179- ------------------------------------ ------------ ------------2180<S> <C> <C>2181Current liabilities:2182Accounts payable $ 1,765,377 $ 904,8992183Accrued salary and employee benefit costs 793,275 562,6182184Accrued tax abatement liability 969,204 969,2042185Income taxes payable 511,848 2,276,6552186Other accrued expenses 151,372 544,2952187Deferred revenue -- 900,0002188Mortgage notes on building and land sold in 1999 -- 3,633,4752189------------ ------------2190Total current liabilities 4,191,076 9,791,1462191------------ ------------21922193Deferred income taxes 2,325,403 2,390,47521942195Commitments and contingencies21962197Stockholders' equity:2198Common stock, $.05 par value2199Authorized-25,000,000 shares;2200Issued-8,708,367 shares 435,418 435,4182201Additional capital 40,423,457 41,156,5822202Retained earnings (deficit) 5,694,422 (308,859)2203Accumulated other comprehensive income (loss), net of2204tax benefit of $124,437 in 1999 and $67,363 in 1998 (241,550) (130,760)2205Cost of common shares in treasury; 1,316,558 shares2206in 1999 and 1,073,751 shares in 1998 (9,273,452) (7,848,634)2207------------ ------------22082209Total stockholders' equity 37,038,295 33,303,7472210------------ ------------2211$43,554,774 $45,485,3682212============ ============2213</TABLE>22142215See accompanying notes to consolidated financial statements.22162217<PAGE>22182219Advanced Neuromodulation Systems, Inc. and Subsidiaries2220Consolidated Statements of Operations2221Years Ended December 3122222223<TABLE>2224<CAPTION>222522261999 1998 19972227------------ ------------ ------------2228<S> <C> <C> <C>2229Net revenue-product sales $20,578,384 $17,006,407 $14,717,7212230Net revenue-contract research and development 8,900,000 3,100,000 --2231------------ ------------ ------------2232Total net revenue 29,478,384 20,106,407 14,717,7212233------------ ------------ ------------22342235Operating expenses:2236Cost of product sales 6,628,983 4,985,887 4,839,2612237General and administrative 2,756,931 2,633,250 1,760,0612238Research and development 3,772,579 2,801,175 976,9002239Amortization of intangibles 1,187,689 1,170,585 1,085,8712240Marketing 6,290,004 4,682,423 3,969,3202241------------ ------------ ------------224220,636,186 16,273,320 12,631,4132243------------ ------------ ------------2244Earnings from operations 8,842,198 3,833,087 2,086,30822452246Other income (expense):2247Loss on sale of marketable securities -- (4,381) (25,659)2248Interest expense (44,861) (331,468) (625,321)2249Investment and other income, net 751,238 834,772 115,1972250------------ ------------ ------------2251706,377 498,923 (535,783)2252------------ ------------ ------------2253Earnings from continuing operations2254before income taxes 9,548,575 4,332,010 1,550,52522552256Income taxes 3,545,294 1,746,304 733,0142257------------ ------------ ------------2258Net earnings from continuing operations 6,003,281 2,585,706 817,5112259------------ ------------ ------------22602261Loss from discontinued operations, net of income2262tax benefits of $129,711 in 1998 and $15,909 in 1997 -- (211,634) (93,490)22632264Gain on sale of assets of discontinued operations, net of2265income tax expense of $2,473,293 in 1998 -- 4,585,130 --2266------------ ------------ ------------2267Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)2268------------ ------------ ------------2269Net earnings $ 6,003,281 $ 6,959,202 $ 724,0212270============ ============ ============22712272Basic earnings (loss) per share:22732274Continuing operations $ .79 $ .31 $ .102275============ ============ ============2276Discontinued operations $ -- $ .53 $ (.01)2277============ ============ ============2278Net earnings $ .79 $ .84 $ .092279============ ============ ============2280Diluted earnings (loss) per share:22812282Continuing operations $ .75 $ .30 $ .092283============ ============ ============2284Discontinued operations $ -- $ .51 $ (.01)2285============ ============ ============2286Net earnings $ .75 $ .81 $ .082287============ ============ ============2288</TABLE>22892290See accompanying notes to consolidated financial statements.22912292<PAGE>22932294Advanced Neuromodulation Systems, Inc. and Subsidiaries2295Consolidated Statements of Cash Flows2296Years Ended December 3122972298<TABLE>2299<CAPTION>230023011999 1998 19972302------------ ------------ ------------2303<S> <C> <C> <C>2304Cash flows from operating activities:2305Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,5112306Adjustments to reconcile earnings from continuing2307operations to net cash provided by operating activities:2308Depreciation 816,125 615,388 438,0562309Amortization 1,187,689 1,170,585 1,085,8712310Deferred income taxes 225,525 103,267 717,1042311Non-operating loss included in net earnings -- 4,381 25,6552312Increase in inventory reserve -- 52,818 534,6192313Changes in assets and liabilities2314Receivables (596,558) (748,442) (130,283)2315Inventories (3,355,955) 200,834 (500,835)2316Prepaid expenses and other current assets (254,427) (383,940) (302,558)2317Income taxes payable (1,543,713) 1,605,319 --2318Accounts payable 860,478 649,802 (513,704)2319Accrued expenses (220,897) 177,904 (62,529)2320Deferred revenue (900,000) 900,000 --2321------------ ------------ ------------2322Net cash provided by continuing operations 2,221,548 6,933,622 2,108,9072323Net cash provided by discontinued operations -- 59,049 391,0962324------------ ------------ ------------2325Net cash provided by operating activities 2,221,548 6,992,671 2,500,0032326------------ ------------ ------------23272328Cash flows from investing activities:23292330Net proceeds from sales of marketable securities -- 851,621 1,403,6072331Purchases of marketable securities -- (106,001) (1,379,065)2332Additions to property, plant , equipment and patent2333licenses - continuing operations (5,907,550) (1,678,842) (545,193)2334Additions to property, plant and equipment -2335discontinued operations -- (12,060) (745,729)2336Net proceeds from sale of assets of discontinued2337operations 6,354,965 21,754,181 --2338Payments related to 1995 acquisition -- -- (4,472,197)2339Other -- -- (594)2340------------ ------------ ------------2341Net cash provided by (used in) investing2342activities 447,415 20,808,899 (5,739,171)2343------------ ------------ ------------23442345Cash flows from financing activities:23462347Net increase (decrease) in short-term obligations (3,633,475) (8,081,763) 3,531,7632348Payment of long-term notes -- (177,137) (1,163,349)2349Exercise of stock options 573,272 817,766 922,3862350Purchase of treasury stock (2,952,311) (9,411,055) --2351------------ ------------ ------------2352Net cash provided by (used in) financing2353activities (6,012,514) (16,852,189) 3,290,8002354------------ ------------ ------------2355Net increase (decrease) in cash and cash equivalents (3,343,551) 10,949,381 51,6322356Cash and cash equivalents at beginning of year 11,697,209 747,828 696,1962357------------ ------------ ------------2358Cash and cash equivalents at end of year $ 8,353,658 $11,697,209 $ 747,8282359============ ============ ============23602361Supplemental cash flow information is presented below:23622363Income taxes paid $ 4,863,482 $ 37,715 $ --2364============ ============ ============2365Interest paid $ 44,861 $ 370,304 $ 994,2942366============ ============ ============2367</TABLE>23682369See accompany notes to consolidated financial statements.23702371<PAGE>23722373Advanced Neuromodulation Systems, Inc. and Subsidiaries2374Consolidated Statements of Stockholders' Equity2375Three Years Ended December 31, 19992376<TABLE>2377<CAPTION>2378Retained Other Total2379Common Stock Additional Earnings Comprehensive Treasury Stockholders'2380Shares Amount Capital (Deficit) Income (Loss) Stock Equity2381------------- ------------- ------------- ------------- ------------- ------------- -------------2382<S> <C> <C> <C> <C> <C> <C> <C>2383Balance at2384December 31, 1996 8,338,510 $ 416,926 $ 38,699,517 $ (7,992,082) $ (130,878) $ -- $ 30,993,4832385Net earnings -- -- -- 724,021 -- -- 724,0212386Adjustment to2387unrealized losses on2388marketable securities -- -- -- -- 92,384 -- 92,3842389-------------2390Comprehensive Income 816,4052391-------------2392Shares issued upon2393exercise of stock2394options 296,999 14,849 907,537 -- -- -- 922,3862395Tax benefit from2396employee stock option2397exercises -- -- 1,173,663 -- -- -- 1,173,6632398------------- ------------- ------------- ------------- ------------- ------------- -------------2399Balance at2400December 31, 1997 8,635,509 431,775 40,780,717 (7,268,061) (38,494) -- 33,905,9372401Net earnings -- -- -- 6,959,202 -- -- 6,959,2022402Adjustment to2403unrealized losses on2404marketable securities -- -- -- -- (92,266) -- (92,266)2405-------------2406Comprehensive Income 6,866,9362407-------------2408Shares issued upon2409exercise of stock2410options 72,858 3,643 160,554 -- -- -- 164,1972411Tax benefit from2412employee stock option2413exercises -- -- 119,509 -- -- -- 119,5092414Compensation expense2415resulting from2416changes to stock2417options -- -- 1,004,654 -- -- -- 1,004,6542418Issuance of 184,8742419shares from treasury2420for stock option2421exercises -- -- (908,852) -- -- 1,562,421 653,5692422Purchase of 1,258,6252423treasury shares,2424at cost -- -- -- -- -- (9,411,055) (9,411,055)2425------------- ------------- ------------- ------------- ------------- ------------- -------------2426Balance at2427December 31, 1998 8,708,367 435,418 41,156,582 (308,859) (130,760) (7,848,634) 33,303,7472428Net earnings -- -- -- 6,003,281 -- -- 6,003,2812429Adjustment to unrealized2430losses on marketable2431securities -- -- -- -- (110,790) -- (110,790)2432-------------2433Comprehensive income 5,892,4912434-------------2435Tax benefit from employee2436stock option exercises -- -- 221,096 -- -- -- 221,0962437Issuance of 162,0682438shares from treasury2439for stock option2440exercises -- -- (954,221) -- -- 1,527,493 573,2722441Purchase of 404,8752442treasury shares,2443at cost -- -- -- -- -- (2,952,311) (2,952,311)2444Balance at ------------- ------------- ------------- ------------- ------------- ------------- -------------2445December 31, 1999 8,708,367 $ 435,418 $ 40,423,457 $ 5,694,422 $ (241,550) $ (9,273,452) $ 37,038,2952446============= ============= ============= ============= ============= ============= =============2447</TABLE>24482449See accompanying notes to consolidated financial statements.24502451<PAGE>24522453Advanced Neuromodulation Systems, Inc. and Subsidiaries2454Notes to Consolidated Financial Statements24552456(1) Business24572458Continuing Operations24592460Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS") designs,2461develops, manufactures and markets implantable neuromodulation devices. ANS2462devices are used primarily to manage chronic severe pain. ANS revenues are2463derived primarily from sales throughout the United States, Europe and Australia.24642465The neuromodulation business, described above, was acquired in March 1995. All2466other businesses of the Company were sold in January 1998 as described below2467under Discontinued Operations.24682469The research and development, manufacture, sale and distribution of medical2470devices is subject to extensive regulation by various public agencies,2471principally the Food and Drug Administration and corresponding state, local and2472foreign agencies. Product approvals and clearances can be delayed or withdrawn2473for failure to comply with regulatory requirements or the occurrence of2474unforeseen problems following initial marketing.24752476In addition, ANS products are purchased primarily by hospitals and other users2477who then bill various third-party payers including Medicare, Medicaid, private2478insurance companies and managed care organizations. These third-party payers2479reimburse fixed amounts for services based on a specific diagnosis. The impact2480of changes in third-party payer reimbursement policies and any amendments to2481existing reimbursement rules and regulations that restrict or terminate the2482eligibility of ANS products could have an adverse impact on the Company's2483financial condition and results of operations.24842485Discontinued Operations24862487On January 30, 1998, the Company sold its cardiovascular and intravenous fluid2488product lines ("CVS Operations"), including its MPS(R) myocardial protection2489system product line, to Atrion Corporation (see Note 9 - "Sale of CVS2490Operations/Discontinued Operations"). The CVS Operations have been accounted for2491as discontinued operations in the Consolidated Statements of Operations for the2492years ended December 31, 1998 and 1997. During October 1998, Atrion also2493exercised an option to acquire the Company's land, office and manufacturing2494facility for $6.5 million. The transaction was closed on February 1, 1999. Net2495assets of the land and facility have been presented on the Consolidated Balance2496Sheet at December 31, 1998 as net assets of building and land sold in 1999.24972498(2) Summary of Significant Accounting Policies24992500Principles of Consolidation25012502The consolidated financial statements include the accounts of Advanced2503Neuromodulation Systems, Inc. and all of its subsidiaries. All significant2504inter-company transactions and accounts have been eliminated in consolidation.250525062507-1-2508<PAGE>25092510Advanced Neuromodulation Systems, Inc. and Subsidiaries2511Notes to Consolidated Financial Statements25122513Use of Estimates25142515The preparation of financial statements in conformity with generally accepted2516accounting principles requires management to make estimates and assumptions that2517affect the amounts reported in the financial statements and accompanying notes.2518Actual results could differ from those estimates.25192520Cash Equivalents25212522The Company considers all highly liquid investments with maturities of three2523months or less at the time of purchase to be cash equivalents.25242525Revenue Recognition25262527The Company recognizes revenue from product sales when the goods are shipped to2528its customers. The Company recognizes revenue from research and development2529contracts based upon the estimated percentage of completion of the development2530project which is determined by hours completed as a percentage of the total2531estimated hours under the product development plan.25322533Marketable Securities25342535The Company's marketable securities and debt securities are classified as2536available-for-sale and are carried at fair value with the unrealized gains and2537losses reported in a separate component of stockholders' equity entitled "Other2538comprehensive income". The amortized cost of debt securities in this category is2539adjusted for amortization of premiums and accretion of discounts to maturity.2540Such amortization is included in investment income. Realized gains and losses2541and declines in value judged to be other than temporary are included in other2542income. The cost of securities sold is based on the specific identification2543method. Interest and dividends are included in investment income.25442545Inventories25462547Inventories are recorded at the lower of standard cost or market. Standard cost2548approximates actual cost determined on the first-in, first-out ("FIFO") basis.2549Cost includes the acquisition cost of raw materials and components, direct labor2550and overhead.25512552Equipment and Fixtures25532554Equipment and fixtures are stated at cost. Additions and improvements extending2555asset lives are capitalized while maintenance and repairs are expensed as2556incurred. The cost and accumulated depreciation of assets sold or retired are2557removed from the accounts and any gain or loss is reflected in the Statement of2558Operations.25592560Depreciation is provided using the straight-line method over the estimated2561useful lives of the various assets as follows:25622563Leasehold improvements 5 years2564Furniture and fixtures 2 to 10 years2565Machinery and equipment 3 to 10 years256625672568-2-2569<PAGE>25702571Advanced Neuromodulation Systems, Inc. and Subsidiaries2572Notes to Consolidated Financial Statements25732574Intangible Assets25752576The excess of cost over the net assets of acquired businesses ("goodwill") is2577amortized on a straight-line basis over the estimated useful life of 20 years.25782579The cost of purchased technology related to acquisitions is based on appraised2580values at the date of acquisition and is amortized on a straight-line basis over2581the estimated useful life (15 years) of such technology.25822583The cost of purchased tradenames is based on appraised values at the date of2584acquisition and is amortized on a straight-line basis over the estimated useful2585life (20 years) of such tradenames.25862587The cost of purchased patents is amortized on a straight-line basis over the2588estimated useful life (17 years) of such patents. The cost of certain licensed2589patents is amortized on a straight-line basis over the estimated useful life (202590years) of such patents while the cost of certain other licensed patents is2591amortized on a units of production method. Costs of patents that are the result2592of internal development are charged to current operations.25932594The Company assesses the recoverability of all its intangible assets primarily2595based on its current and anticipated future undiscounted cash flows. At December259631, 1999, the Company does not believe there has been any impairment of its2597intangible assets.25982599Research and Development26002601Product development costs including start-up and research and development are2602charged to operations in the year in which such costs are incurred.26032604Advertising26052606Advertising expense is charged to operations in the year in which such costs are2607incurred. Total advertising expense included in marketing expense from2608continuing operations was $40,440, $21,843 and $14,746 at December 31, 1999,26091998 and 1997, respectively.26102611Deferred Taxes26122613Deferred income taxes are recorded based on the liability method and represent2614the tax effect of the differences between the financial and tax basis of assets2615and liabilities other than costs in excess of the net assets of businesses2616acquired.26172618Stock-Based Compensation26192620The Company has adopted the disclosure-only provisions of SFAS No. 123,2621"Accounting for Stock-Based Compensation", which disclosures are presented in2622Note 5, "Stockholders' Equity". Because of this election, the Company continues2623to account for its stock-based compensation plans under APB No. 25, "Accounting2624for Stock Issued to Employees". All of the Company's stock option grants are at2625exercise prices equal to the fair market value of the Company's stock on the2626date of grant, and therefore, no compensation expense is recorded.26272628-3-2629<PAGE>263026312632Earnings Per Share26332634Basic earnings per share is computed based only on the weighted average number2635of common shares outstanding during the period, and the dilutive effect of stock2636options and warrants is excluded. Diluted earnings per share is computed using2637the additional dilutive effect, if any, of stock options and warrants using the2638treasury stock method based on the average market price of the stock during the2639period. Basic earnings (loss) per share for 1999, 1998 and 1997 are based upon26407,583,159, 8,314,290 and 8,428,393 shares, respectively. Diluted earnings (loss)2641per share for 1999, 1998 and 1997 are based upon 8,003,087, 8,544,040 and26428,858,086 shares, respectively. The following table presents the reconciliation2643of basic and diluted shares:26442645<TABLE>2646<CAPTION>26471999 1998 19972648--------- --------- ---------2649<S> <C> <C> <C>2650Weighted-average shares outstanding2651(basic shares) 7,583,159 8,314,290 8,428,3932652Effect of dilutive instruments(1)2653Stock options 401,292 214,806 412,9962654Warrants 18,636 14,944 16,6972655--------- --------- ---------2656Dilutive potential common shares 419,928 229,750 429,6932657--------- --------- ---------2658Diluted shares 8,003,087 8,544,040 8,858,0862659========= ========= =========2660</TABLE>26612662(1) See Note 5 for a description of these instruments.26632664For 1999, 1998 and 1997, the incremental shares used for dilutive earnings2665(loss) per share relate to stock options and warrants whose exercise price was2666less than the average market price in the underlying quarterly computations.2667Options to purchase 250 shares at an average price of $8.94 per share were2668outstanding in 1999, 215,981 shares at an average price of $9.02 per share were2669outstanding in 1998, and options to purchase 148,313 shares at an average price2670of $10.80 per share were outstanding in 1997 but were not included in the2671computation of diluted earnings (loss) per share because the options' exercise2672prices were greater than the average market price of the common shares and,2673therefore, the effect would be antidilutive.26742675Comprehensive Income26762677Statement of Financial Accounting Standards No. 130 - "Reporting Comprehensive2678Income" - was adopted by the Company as of January 1, 1998. The new rules2679require the reporting and display of comprehensive income and its components;2680however, the adoption of this statement had no impact on the Company's net2681earnings or stockholders' equity. SFAS No. 130 requires unrealized gains or2682losses on the Company's available for sale securities, which prior to adoption2683were reported separately in shareholders' equity, to be included in "Other2684comprehensive income". Prior period financial statements have been reclassified2685to conform to the requirements of SFAS No. 130. Total comprehensive income is2686reported in the Consolidated Statements of Stockholders' Equity.26872688Reclassification26892690Certain prior period amounts have been reclassified to conform to current-year2691presentation.26922693-4-2694<PAGE>26952696Advanced Neuromodulation Systems, Inc. and Subsidiaries2697Notes to Consolidated Financial Statements26982699(3) Marketable Securities27002701The following is a summary of available-for-sale securities at December 31,27021999:27032704<TABLE>2705<CAPTION>2706Gross Gross2707Unrealized Unrealized Estimated2708Cost Gains Losses Fair Value2709---------- ---------- ---------- ----------2710<S> <C> <C> <C> <C>2711Investment grade preferred securities $ 554,596 $ -- $ 275,107 $ 279,4892712Publicly traded limited partnerships 51,875 -- 27,815 24,0602713Real estate investment trusts 141,590 -- 47,143 94,4472714Other 16,134 -- 15,922 2122715---------- ---------- ---------- ----------2716$ 764,195 $ -- $ 365,987 $ 398,2082717========== ========== ========== ==========2718</TABLE>27192720Estimated fair value is determined by the closing prices of the respective2721available-for-sale securities as reported on the New York and NASDAQ stock2722exchange markets at each financial reporting period.27232724At December 31, 1999, no individual security represented more than 40 percent of2725the total portfolio or 1 percent of total assets. The Company did not have any2726investments in derivative financial instruments at December 31, 1999.27272728The following is a summary of available-for-sale securities at December 31,27291998:27302731<TABLE>2732<CAPTION>2733Gross Gross2734Unrealized Unrealized Estimated2735Cost Gains Losses Fair Value2736---------- ---------- ---------- ----------2737<S> <C> <C> <C> <C>2738Investment grade preferred securities $ 557,596 $ -- $ 127,763 $ 429,8332739Publicly traded limited partnerships 51,875 -- 28,440 23,4352740Real estate investment trusts 141,590 -- 29,232 112,3582741Other 13,134 -- 12,688 4462742---------- ---------- ---------- ----------2743$ 764,195 $ -- $ 198,123 $ 566,0722744========== ========== ========== ==========2745</TABLE>27462747At December 31, 1998, no individual security represented more than 40 percent of2748the total portfolio or 1 percent of total assets. The Company did not have any2749investments in derivative financial instruments at December 31, 1998.27502751-5-2752<PAGE>27532754Advanced Neuromodulation Systems, Inc. and Subsidiaries2755Notes to Consolidated Financial Statements27562757(4) Federal Income Taxes27582759The significant components of the net deferred tax liability at December 31,2760were as follows:27612762<TABLE>2763<CAPTION>2764Deferred tax assets: 1999 19982765------------ ------------2766<S> <C> <C>2767Tax credit and net operating loss carry forwards $ 36,649 $ --2768Deferred revenue -- 306,0002769Accrued expenses and reserves 496,213 572,0302770Unrealized loss on marketable securities 124,437 67,3622771------------ ------------2772Total deferred tax asset 657,299 945,39227732774Deferred tax liabilities:27752776Purchased intangible assets (1,670,250) (1,710,625)2777Excess of tax over book depreciation (597,425) (602,383)2778Other (60,940) (135,250)2779------------ ------------2780Total deferred tax liability (2,328,615) (2,448,258)2781------------ ------------2782Net deferred tax asset (liability) $(1,671,316) $(1,502,866)2783============ ============2784</TABLE>27852786The provision for income taxes on earnings from continuing operations for the2787years ended December 31 consists of the following:27882789<TABLE>2790<CAPTION>27911999 1998 19972792----------- ----------- -----------2793<S> <C> <C> <C>2794Current $ 3,682,727 $ 2,005,713 $ --2795Deferred (137,433) (259,409) 733,0142796----------- ----------- -----------2797$ 3,545,294 $ 1,746,304 $ 733,0142798=========== =========== ===========2799</TABLE>28002801A reconciliation of the provision for income taxes on earnings from continuing2802operations to the expense calculated at the U.S. statutory rate follows:280328042805<TABLE>2806<CAPTION>28071999 1998 19972808----------- ----------- -----------2809<S> <C> <C> <C>2810Income tax expense at statutory rate $ 3,246,515 $ 1,472,883 $ 527,1792811Tax effect of:2812State taxes 183,625 117,900 --2813Nondeductible amortization of goodwill 189,211 189,245 185,2002814Other (74,057) (33,724) 20,6352815----------- ----------- -----------2816Income tax expense $ 3,545,294 $ 1,746,304 $ 733,0142817=========== =========== ===========2818</TABLE>28192820In 1998, the Company utilized net operating loss carry forwards of $4,277,5402821and general business credits and alternative minimum tax credits of $1,038,6692822to reduce its tax liabilities. At December 31, 1999, the Company had general2823business credits of $36,649 to reduce its tax liabilities.28242825-6-2826<PAGE>28272828Advanced Neuromodulation Systems, Inc. and Subsidiaries2829Notes to Consolidated Financial Statements28302831(5) Stockholders' Equity28322833The Company has a Shareholder's Rights Plan, adopted in 1996, which permits2834shareholders to purchase shares of the Company's common stock at significant2835discounts in the event a person or group acquires more than 15 percent of the2836Company's common stock or announces a tender or exchange offer for more than 202837percent of the Company's common stock.28382839During the year ended December 31, 1998, the Company repurchased 1,258,6252840shares of its common stock at an aggregate cost of $9,411,055 and during the2841year ended December 31, 1999, the Company repurchased 404,875 shares of its2842common stock at an aggregate cost of $2,952,311. During the years ended December284331, 1999 and 1998, the Company issued 162,068 and 184,874 shares respectively,2844from its treasury upon the exercise of stock options. At December 31, 1999,28451,316,558 shares remained in the treasury.28462847In 1998, the Company issued a five-year warrant to purchase 100,000 shares of2848common stock at an exercise price of $6.50 per share in connection with a2849$2,000,000 loan from a nonaffiliate shareholder. The warrant is outstanding at2850December 31, 1999.28512852The Company has various stock option plans pursuant to which stock options may2853be granted to key employees, officers, directors and advisory directors of the2854Company. The most recent of the plans, approved by the shareholders during 19982855(the "1998 Plan"), reserved 800,000 shares of common stock for options under the2856plan; provided, however, that on January 1 of each year (commencing in 1999),2857the aggregate number of shares of common stock reserved for options under the28581998 Plan shall be increased by the same percentage that the total number of2859issued and outstanding shares of common stock increased from the preceding2860January 1 to the following December 31 (if such percentage is positive). No2861additional options were added to the 1998 Plan on January 1, 1999 or January 1,28622000. Several of the plans allow for the grant of incentive stock options to key2863employees and officers intended to qualify for preferential tax treatment under2864Section 422 of the Internal Revenue Code of 1986. Under all of the Company's2865plans, the exercise price of options granted must equal or exceed the fair2866market value of the common stock at the time of the grant. Options granted to2867employees and officers expire ten years from the date of grant and for the most2868part are exercisable one-fourth each year over a four-year period of continuous2869service. Options granted to directors and advisory directors expire six years2870from the date of grant and for the most part are exercisable one-fourth each2871year over a four-year period of continuous service. Certain options, however,2872have a two-year vesting schedule.28732874At December 31, 1999, under all of the Company's stock option plans, 1,220,6472875shares have been granted and are outstanding, 1,808,514 shares of common stock2876have been issued upon exercise, and 94,601 shares were reserved for future2877grants.28782879-7-2880<PAGE>28812882Advanced Neuromodulation Systems, Inc. and Subsidiaries2883Notes to Consolidated Financial Statements28842885Data with respect to stock option plans of the Company are as follows:28862887<TABLE>2888<CAPTION>2889----------------------------- -----------------------------2890Options Outstanding Exercisable Options2891----------------------------- -----------------------------2892Weighted Weighted2893Average Average2894Shares Exercise Price Shares Exercise Price2895------------ -------------- ------------ --------------2896<S> <C> <C> <C> <C>2897January 1, 1997 1,175,188 $ 5.16 663,459 $ 3.512898Granted 66,500 $ 6.162899Exercised (296,999) $ 3.352900Rescinded (111,417) $ 6.362901------------ -------------- ------------ --------------29022903January 1, 1998 833,272 $ 5.68 568,285 $ 4.662904Granted 1,352,800 $ 6.122905Exercised (257,732) $ 3.492906Rescinded (860,125) $ 8.102907------------ -------------- ------------ --------------29082909January 1, 1999 1,068,215 $ 4.82 465,340 4.582910Granted 332,500 $ 6.732911Exercised (162,068) $ 3.992912Rescinded (18,000) $ 8.142913------------ -------------- ------------ ---------------2914December 31, 1999 1,220,647 $ 5.40 499,397 $ 4.832915------------ -------------- ------------ --------------2916</TABLE>29172918<TABLE>2919<CAPTION>2920Exercisable Options at2921Options Outstanding at December 31, 1999 December 31, 19992922- -------------------------------------------------------- -----------------------2923Weighted2924Average Weighted Weighted2925Range of Remaining Average Average2926Exercise Price Shares Life (Years) Exercise Price Shares Exercise Price2927- -------------- --------- ------------ -------------- -------- --------------2928<S> <C> <C> <C> <C> <C>2929$ 1.45 - 2.25 1 030 1.18 $ 1.94 1 030 $ 1.942930$ 2.25 - 3.50 15,450 1.18 $ 2.91 15,450 $ 2.912931$ 3.50 - 5.25 870,167 8.48 $ 4.94 480,417 $ 4.882932$ 5.25 - 8.00 333,000 9.27 $ 6.72 2,500 $ 7.132933$ 8.00 - 12.25 1,000 9.61 $ 8.94 -- $ --2934--------- ----------- -------------- -------- --------------29351,220,647 8.60 $ 5.40 499,397 $ 4.832936--------- ----------- -------------- -------- --------------2937</TABLE>29382939Exercisable options at January 1, 1999 and 1998 included options for 134,904 and2940306,297 shares, respectively, with a weighted average exercise price of $4.532941per share at January 1, 1999 and $4.22 per share at January 1, 1998, which were2942held by employees who terminated employment with the Company on January 30, 19982943in connection with the sale of the CVS Operations (see Note 9 - "Sale of CVS2944Operations/Discontinued Operations"). The Company accelerated the vesting of the2945unvested portion of these terminated employee options as a result of the sale.2946The Company also extended the normal 90-day exercise period subsequent to2947termination to January 30, 1999 for these options.29482949In November 1998, the Board of Directors authorized the repricing of options for2950certain employees, advisory directors and directors under several of the Plans.2951Stock options were rescinded for these participants and a new option was granted2952at the then fair market value of the common stock of $5.00 per share. Data with2953respect to the option repricing during November 1998 is as follows:29542955-8-2956<PAGE>29572958Advanced Neuromodulation Systems, Inc. and Subsidiaries2959Notes to Consolidated Financial Statements29602961<TABLE>2962<CAPTION>29631998 Option Repricing Data2964--------------------------------------------------------------2965Range of Exercise Weighted Average2966Price Before Exercise Price2967Repricing Shares Before Repricing2968--------------------- ------------------ ---------------------2969<S> <C> <C>2970$ 5.75 - 7.75 293,000 $ 6.282971$ 7.75 - 9.75 408,500 $ 8.582972$ 9.75 - 11.75 77,000 $ 10.252973$ 11.75 - 12.25 15,000 $ 12.132974------------------ ---------------------2975793,500 $ 7.962976------------------ ---------------------2977</TABLE>29782979In accordance with APB No. 25, the Company has not recorded compensation expense2980for its stock option awards. As required by SFAS No. 123, the Company provides2981the following disclosure of hypothetical values for these awards. The2982weighted-average fair value of an option granted in 1999, 1998 and 1997 was2983$2.73, $2.30 and $2.37, respectively. For purposes of fair market value2984disclosures, the fair market value of an option grant was estimated using the2985Black-Scholes option pricing model with the following assumptions:298629872988<TABLE>2989<CAPTION>29901999 1998 19972991------ ------ ------2992<S> <C> <C> <C>2993Risk-free interest rate ....... 5.5% 4.6% 6.1%2994Average life of options (years) 3.0 3.0 3.02995Volatility .................... 49.1% 49.2% 48.0%2996Dividend Yield ................ -- -- --2997</TABLE>29982999Had the compensation expense been recorded based on these hypothetical values,3000pro forma net earnings for 1999, 1998 and 1997 would have been $5,047,706,3001$6,457,825 and $519,731, respectively, and pro forma diluted net earnings per3002common share for 1999, 1998 and 1997 would have been $.63, $.76 and $.06,3003respectively. Because option grants prior to 1995 are not considered in the pro3004forma amounts, as permitted by SFAS No. 123, the pro forma effects on net3005earnings (loss) are not likely to be representative of the effects on reported3006amounts in future years.30073008(6) Commitments and Contingencies30093010On February 1, 1999, the Company sold its principal office and manufacturing3011facility in Allen, Texas to Atrion Corporation. Atrion leased space to the3012Company at the rate of $48,125 per month from February 1, 1999 through May 31,30131999. The Company entered into a sixty-three month lease agreement on 40,0003014square feet of space located in the North Dallas area during February 1999. The3015Company relocated its operations to the leased facility in May 1999 and the3016rental period under the lease commenced on June 1, 1999. Under the terms of the3017lease agreement, the Company received three months free rent and the monthly3018rental rate for the remaining term of the lease is $48,308. The monthly rental3019rate includes certain operating expenses such as property taxes on the facility,3020insurance, landscape and maintenance and janitorial services. The Company also3021has the first right of refusal to acquire the facility. Future minimum rental3022payments relating to the leased facility for the years ended December 31 are3023$579,696 in 2000, 2001, 2002 and 2003 and $386,464 in 2004.30243025-9-3026<PAGE>30273028Advanced Neuromodulation Systems, Inc. and Subsidiaries3029Notes to Consolidated Financial Statements30303031In addition, the Company leases transportation equipment under non-cancelable3032operating leases. Future minimum rental payments under non-cancelable3033transportation leases for the years ended December 31 are $17,667 in 2000 and30342001 and $5,104 in 2002.30353036Total rent expense included in continuing operations for the years ended3037December 31, 1999, 1998 and 1997 was $533,600, $8,782 and $8,617, respectively.30383039The Company is a party to product liability claims related to ANS3040neurostimulation devices. Product liability insurers have assumed responsibility3041for defending the Company against these claims. While historically product3042liability claims for ANS neurostimulation devices have not resulted in3043significant monetary liability for the Company beyond its insurance coverage,3044there can be no assurances that the Company will not incur significant monetary3045liability to the claimants if such insurance is inadequate or that the Company's3046neurostimulation business and future ANS product lines will not be adversely3047affected by these product liability claims.30483049Except for such product liability claims and other ordinary routine litigation3050incidental or immaterial to its business, the Company is not currently a party3051to any other pending legal proceeding. The Company maintains general liability3052insurance against risks arising out of the normal course of business.30533054(7) Financial Instruments, Risk Concentration and Major Customers30553056In the United States, the Company's accounts receivable are due primarily from3057hospitals and distributors located throughout the country. Internationally, the3058Company's accounts receivable are due primarily from distributors located in3059Europe and Australia. The Company generally does not require collateral for3060trade receivables. The Company maintains an allowance for doubtful accounts3061based upon expected collectibility. Any losses from bad debts have historically3062been within management's expectations.30633064Net sales of implantable neurostimulation systems to two major customers for the3065year ended December 31, 1999, as a percentage of net revenue from product sales3066from continuing operations, were 15 percent and 11 percent, respectively. Net3067sales of implantable neurostimulation systems to one major customer for each of3068the years ended December 31, as a percentage of net revenue from product sales3069from continuing operations were as follows: 1998 - 20 percent and 1997- 253070percent. Foreign sales, primarily Europe and Australia, for the years ended3071December 31, 1999, 1998 and 1997 were approximately 7 percent, 10 percent and 83072percent of net revenue from product sales from continuing operations,3073respectively.30743075(8) Employee Benefit Plans30763077The Company has a defined contribution retirement savings plan (the "Plan")3078available to substantially all employees. The Plan permits employees to elect3079salary deferral contributions of up to 15 percent of their compensation and3080requires the Company to make matching contributions equal to 50 percent of the3081participants' contributions to a maximum of 6 percent of the participants'3082compensation. The Board of Directors may change the percentage of matching3083contribution at their discretion. The expense of the Company's contribution for3084continuing operations was $158,842 in 1999, $119,543 in 1998 and $72,635 in30851997.30863087-10-3088<PAGE>30893090Advanced Neuromodulation Systems, Inc. and Subsidiaries3091Notes to Consolidated Financial Statements30923093(9) Sale of CVS Operations/Discontinued Operations30943095On January 30, 1998, the Company sold its cardiovascular and intravenous fluid3096product lines, including its Myocardial Protection System product line, to3097Atrion Corporation. The Company received approximately $23 million from the sale3098and utilized $8.0 million of the proceeds to retire debt and $1.2 million to pay3099expenses related to the transaction. The remaining proceeds are being used for3100working capital for the expanding ANS business and stock repurchases as deemed3101appropriate by the Board of Directors. The Company reported a net gain (after3102income tax expense) from the sale of $4.6 million. This gain is net of a pre-tax3103expense of $969,204, discussed below, recorded in connection with the sale of3104the corporate facility to Atrion in February 1999. The gain is also net of a3105pre-tax compensation expense of $1,004,654 recorded as a result of changes made3106to the options held by employees of the CVS Operations (see Note 5 -3107"Stockholders' Equity"). The Company also reported a net loss for the CVS3108Operations of approximately $211,634 in January 1998 prior to the sale.31093110As part of the sale of the CVS Operations to Atrion, the Company granted Atrion3111a nine-month option to acquire the Company's principal office and manufacturing3112facility in Allen Texas for $6.5 million. During October 1998, Atrion exercised3113its option to acquire the facility. When the facility was built in 1993, the3114Company entered a ten-year agreement with the City of Allen granting tax3115abatements to the Company if a minimum job base and personal property base were3116maintained in the City of Allen. The agreement provided for the repayment of3117abated taxes if the Company defaulted under the agreement. As mentioned above,3118during 1998 the Company recorded a pretax expense of $969,204 in connection with3119the abated taxes. In April 1999, the Company was successful in petitioning the3120City of Allen to assign the abatement agreement to Atrion. In July 1999, the3121Company, Atrion and the City of Allen executed an assignment agreement under3122which Atrion (as successor in interest to the Company) must continue to meet the3123conditions of the original tax abatement agreement until August 2003. The City3124preserved its rights to collect previously abated taxes if Atrion fails to3125comply with its obligations any time prior to August 2003. The Company retains3126monetary liability for the amount of abated taxes, even after assignment,3127because pursuant to the purchase and sale agreement with Atrion, the Company3128indemnified Atrion from any tax abatement liabilities that accrued to the City3129of Allen prior to the sale of the CVS Operations in January 1998. If Atrion3130meets the minimum requirements under the agreement until August 2003, then no3131payment will be required. If no payment is required, the Company intends to3132reverse the obligation of $969,204 in September 2003.31333134On February 1, 1999, the sale of the facility to Atrion was consummated. Net3135assets of the facility sold to Atrion have been presented on the Consolidated3136Balance Sheet at December 31, 1998, as "Net assets of building and land sold in31371999". The Company repaid the mortgage debt on the facility at the closing of3138the transaction. After repayment of the mortgage debt and expenses related to3139the transaction, the Company received $2.7 million of net proceeds. No material3140gain or loss was recorded on the sale of the facility except related to the tax3141abatement liability described above. The Company moved its operations to a314240,000 square foot leased facility in the North Dallas area during May 1999.3143Until such time, the Company leased space from Atrion at a monthly expense of3144$48,175 and paid Atrion fifty percent of certain operating expenses. The expense3145of moving and transitioning into the new leased facility was immaterial.31463147Operating results of the CVS Operations have been reclassified and reported as3148discontinued operations. Summary operating results for the years ended December314931, 1998 and 1997 for the CVS Operations were as follows (the 1998 period3150includes results for one month until the sale on January 30, 1998):31513152-11-3153<PAGE>31543155Advanced Neuromodulation Systems, Inc. and Subsidiaries3156Notes to Consolidated Financial Statements3157<TABLE>3158<CAPTION>31591998 19973160------------ ------------3161<S> <C> <C>3162Revenue ....................... $ 1,111,992 $ 14,306,1273163Gross profit .................. 206,481 6,500,6543164Earnings (loss) from operations (307,120) 333,2003165Interest expense .............. (34,225) (442,599)3166------------ ------------3167Loss before income tax benefit (341,345) (109,399)3168Income tax benefit ............ (129,711) (15,909)3169------------ ------------3170Net loss ...................... $ (211,634) $ (93,490)3171============ ============3172</TABLE>31733174The above operating results of the CVS Operations reflect the revenues and3175expenses of the CVS Operations including direct and indirect expenses of the3176Operations that are paid by the Company and charged directly to the CVS3177Operations. General overhead of the Company includes charges for regulatory,3178general corporate management, accounting and payroll services, human resources,3179management information systems and facilities expenses. These expenses were3180charged to the CVS Operations in amounts that approximate the discreet3181identifiable costs of the CVS Operations that will not continue after the sale.3182Management believes that the expenses charged to the CVS Operations on this3183basis are not materially different from the costs that would have been incurred3184had the CVS Operations borne such expenses on a direct basis.31853186Interest expense on the Company's corporate facility has been allocated to the3187CVS Operations based on space utilization. Interest expense on the Company's3188general credit facilities was allocated to the CVS Operations based on the ratio3189of the net assets of the CVS Operations to the total net assets of the Company.31903191(10) Product Development Agreement31923193In June 1998, the Company entered an agreement with Sofamor Danek Group, Inc.3194("Sofamor Danek") under which the Company agreed to develop and manufacture for3195Sofamor Danek, products and systems for use in Deep Brain Stimulation ("DBS").3196DBS products provide electrical stimulation to certain areas of the brain and3197are intended to relieve the effects of various neurological disorders, such as3198Parkinson's Disease and Essential Tremor. Under terms of the agreement, the3199Company granted Sofamor Danek exclusive worldwide rights to use, market and sell3200the DBS products developed and manufactured by ANS. The Company received a cash3201payment of $4 million upon execution of the agreement that was being recognized3202into income as revenue based upon the estimated percentage of completion of the3203development project. During the year ended December 31, 1998, the Company3204recognized $3.1 million into income as revenue. Due to the termination of the3205agreement discussed below, the remaining $900,000 was recognized into income as3206revenue during January 1999 and is included in the Statements of Operations for3207the year ended December 31, 1999. The agreement also called for ANS to receive3208four additional payments of $2 million each, to be recognized into income upon3209the satisfactory completion of certain domestic and international regulatory3210milestones over the next several years.32113212In December 1998, the Company and Sofamor Danek agreed to terminate the June32131998 DBS agreement due to the impending merger of Sofamor Danek and Medtronic,3214the Company's sole competitor in the DBS market. Under the termination3215agreement, Sofamor Danek agreed to accelerate payments due the Company in the3216amount of $8 million and the Company agreed to release Sofamor Danek from3217further contractual obligations. The Company received the $8 million payment3218from Sofamor Danek on January 28, 1999, the day after the completion of the3219merger. The $8 million payment was recognized into revenue during January 19993220and is included in the Statements of Operations for the year ended December 31,32211999.32223223-12-3224<PAGE>3225Appendix B3226----------3227322832293230Schedule II - Valuation and Qualifying Accounts3231323232333234Forming a Part of the Annual Report32353236Form 10-K32373238Item 1432393240of32413242ADVANCED NEUROMODULATION SYSTEMS, INC.32433244(Name of issuer)32453246Filed with the32473248Securities and Exchange Commission32493250Washington, D.C. 2054932513252under32533254The Securities and Exchange Act of 193432553256<PAGE>32573258Schedule II - Valuation and Qualifying Accounts3259Advanced Neuromodulation Systems, Inc. and Subsidiaries3260December 31, 19993261<TABLE>3262<CAPTION>3263Balance at Charged to Balance3264Beginning of Charged to Other at End of3265Description Period Expenses Accounts Deductions Period3266- ----------------------------------- ----------- ----------- ----------- ----------- -----------3267<S> <C> <C> <C> <C> <C>3268Year ended December 31, 1999:32693270Continuing Operations:3271---------------------3272Allowance for doubtful accounts $ 249,607 $ 35,756 $ -- $ 144,539 $ 140,8243273Reserve for obsolete inventory 86,599 -- -- -- 86,5993274----------- ----------- ----------- ----------- -----------3275Total $ 336,206 $ 35,756 $ -- $ 144,539 $ 227,4233276=========== =========== =========== =========== ===========3277Year ended December 31, 1998:3278Continuing Operations:3279---------------------3280Allowance for doubtful accounts $ 212,375 $ 25,000 $ -- $ (12,232)(1) $ 249,607(1)3281Reserve for obsolete inventory 56,005 50,709 -- 20,115 86,5993282----------- ----------- ----------- ----------- -----------3283Total $ 268,380 $ 75,709 $ -- $ 7,883 $ 336,2063284=========== =========== =========== =========== ===========3285Discontinued Operations:3286-----------------------3287Allowance for doubtful accounts $ 30,610 $ 96,238 $ -- $ 126,848 $ --3288Reserve for obsolete inventory 154,347 -- -- 154,347 --3289----------- ----------- ----------- ----------- -----------3290Total $ 184,957 $ 96,238 $ -- $ 281,195 $ --3291=========== =========== =========== =========== ===========3292Year ended December 31, 1997:3293Continuing Operations:3294---------------------3295Allowance for doubtful accounts $ 160,000 $ 64,453 $ -- $ 12,078 $ 212,3753296Reserve for obsolete inventory -- 534,619 -- 478,614 56,0053297----------- ----------- ----------- ----------- -----------3298Total $ 160,000 $ 599,072 $ -- $ 490,692 $ 268,3803299=========== =========== =========== =========== ===========3300Discontinued Operations:3301-----------------------3302Allowance for doubtful accounts $ 14,337 $ 54,098 $ -- $ 37,825 $ 30,6103303Reserve for obsolete inventory 230,472 151,168 -- 227,293 154,3473304----------- ----------- ----------- ----------- -----------3305Total $ 244,809 $ 205,266 $ -- $ 265,118 $ 184,9573306=========== =========== =========== =========== ===========3307</TABLE>33083309(1) Includes $96,238 transferred from discontinued operations for accounts3310remaining with the Company.33113312<PAGE>33133314Appendix C3315----------331633173318Quarterly Financial Data33193320(unaudited)33213322Forming a Part of the Annual Report33233324Form 10-K33253326Item 833273328of33293330ADVANCED NEUROMODULATION SYSTEMS, INC.33313332(Name of issuer)33333334Filed with the33353336Securities and Exchange Commission33373338Washington, D.C. 2054933393340under33413342The Securities and Exchange Act of 193433433344<PAGE>3345<TABLE>3346<CAPTION>33471999 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.3348- --------------------------------------------- ------------- ------------- ------------- -------------3349<S> <C> <C> <C> <C>3350Net revenue- product sales $ 4,595,238 $ 5,169,614 $ 5,488,479 $ 5,325,0533351Total net revenue 13,495,238 5,169,614 5,488,479 5,325,0533352Gross profit- product sales 3,235,058 3,583,979 3,413,948 3,716,4163353Earnings (loss) from operations 8,775,155 161,881 (70,851) (23,987)3354Earnings from operations before income taxes 8,957,826 375,382 97,758 117,6093355- --------------------------------------------- ------------- ------------- ------------- -------------3356Net earnings $ 5,446,358 $ 222,494 $ 216,135 $ 118,2943357- --------------------------------------------- ------------------ ------------------- ----------------33583359Basic earnings per share:3360- --------------------------------------------- ------------- ------------- ------------- -------------3361Net earnings $ 0.70 $ 0.03 $ 0.03 $ 0.023362- --------------------------------------------- ------------- ------------- ------------- -------------33633364Diluted earnings per share:3365- --------------------------------------------- ------------- ------------- ------------- -------------3366Net earnings $ 0.67 $ 0.03 $ 0.03 $ 0.023367- --------------------------------------------- ------------- ------------- ------------- -------------3368336933701998 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.3371- --------------------------------------------- ------------- ------------- ------------- -------------33723373Net revenue- product sales $ 4,423,455 $ 4,730,672 $ 3,706,402 $ 4,145,8783374Total net revenue 4,423,455 5,330,672 5,006,402 5,345,8783375Gross profit- product sales 3,165,823 3,493,103 2,657,313 2,704,2813376Earnings from operations 771,403 1,356,560 865,004 840,1203377Earnings from continuing operations before3378income taxes 847,373 1,520,187 1,032,775 931,6753379Net earnings from continuing operations 501,644 921,188 613,637 549,2373380Net earnings (loss) from discontinued3381operations 4,988,941 -- -- (615,445)3382- --------------------------------------------- ------------- ------------- ------------- -------------3383Net earnings (loss) $ 5,490,585 $ 921,188 $ 613,637 $ (66,208)3384- --------------------------------------------- ------------- ------------- ------------- -------------33853386Basic earnings (loss) per share:3387Continuing operations $ 0.06 $ 0.11 $ 0.07 $ 0.073388Discontinued operations $ 0.58 $ -- -- $ (0.08)3389------------- ------------- ------------- -------------3390Net earnings (loss) $ 0.64 $ 0.11 0.07 $ (0.01)3391- --------------------------------------------- ------------- ------------- ------------- -------------33923393Diluted earnings (loss) per share:3394Continuing operations $ 0.06 $ 0.10 0.07 $ 0.073395Discontinued operations $ 0.56 $ -- -- $ (0.08)3396- --------------------------------------------- ------------- ------------- ------------- -------------3397Net earnings (loss) $ 0.62 $ 0.10 $ 0.07 $ (0.01)3398- --------------------------------------------- ------------- ------------- ------------- -------------3399</TABLE>34003401<PAGE>34023403INDEX TO EXHIBITS34043405Exhibit3406Number Description3407------- -----------340834092.1 Asset Purchase Agreement, dated December 29, 1997, by and among3410Quest Medical, Inc., QMI Medical, Inc. (formerly known as QMI3411Acquisition Corp.) and Atrion Corporation (including exhibits and3412schedules 2.1.1, 2.1.2, 2.3(a) and 2.3.(b))(7)34133.1 Articles of Incorporation, as amended and restated(4)34143.2 Bylaws(1)34154.1 Rights Agreement dated as of August 30, 1996, between Quest3416Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights3417Agent(5)341810.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock3419Option Plan(2)342010.2 Form of 1979 Employees Stock Option Agreement(3)342110.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)342210.4 Form of Directors Stock Option Agreement(1)342310.5 Quest Medical, Inc. 1987 Stock Option Plan(4)342410.6 Form of 1987 Employee Stock Option Agreement(4)342510.7 Quest Medical, Inc. 1995 Stock Option Plan(4)342610.8 Form of 1995 Employee Stock Option Agreement(4)342710.9 Quest Medical, Inc. 1998 Stock Option Plan(9)342810.10 Employment Agreement dated April 9, 1998 between Christopher G.3429Chavez and Quest Medical, Inc.(8)343010.11 Employment Agreement dated April 9, 1998 between Scott F. Drees3431and Quest Medical, Inc.(8)343210.12 Employment Agreement dated April 9, 1998 between F. Robert3433Merrill III and Quest Medical, Inc.(8)343410.13 Form of Employment Agreement and Covenant Not to Compete, between3435the Company and key employees(1)343610.14 Form of License Agreement, dated January 30, 1998, by and between3437Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI3438Acquisition Corp.)(6)343910.15 Form of Lease Agreement, dated January 30, 1998, by and between3440Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI3441Acquisition Corp.)(6)344210.16 Form of Option Agreement, dated January 30, 1998, by and between3443Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI3444Acquisition Corp.)(6)344510.17 Agreement, dated December 31, 1997, by and among Quest Medical,3446Inc., its subsidiaries and affiliates and Thomas C. Thompson(7)344710.18 Lease Agreement dated as of February 4, 1999, between Advanced3448Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(10)344911.1 Computation of Earnings Per Share(11)345021.1 Subsidiaries(11)345123.1 Consent of Independent Auditors(11)345227.1 Financial Data Schedule - December 31, 1999(11)34533454- -------------------------------------34553456(1) Filed as an Exhibit to the Company's Registration Statement on Form S-18,3457Registration No. 2-71198-FW, and incorporated herein by reference.3458(2) Filed as an Exhibit to the report of the Company on Form 10-K for the year3459ended December 31, 1987, and incorporated herein by reference.3460(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1,3461Registration No. 2-78186, and incorporated herein by reference.3462(4) Filed as an Exhibit to the Company's Registration Statement on Form SB-2,3463Registration No. 33-62991, and incorporated herein by reference.3464(5) Filed as an Exhibit to the report of the Company on Form 8-K dated3465September 3, 1996, and incorporated herein by reference.3466(6) Filed as an Exhibit to the report of the Company on Form 8-K dated3467February 13, 1998, and incorporated herein by reference.3468Upon request, the Company will furnish a copy of any omitted schedule to3469the Commission.3470(7) Filed as an Exhibit to the report of the Company on Form 10-K dated for3471the year ended December 31, 1997, and incorporated herein by reference.3472(8) Filed as an Exhibit to the report of the Company on Form 10-Q dated for3473the quarterly period ended March 31, 1998, and incorporated herein by3474reference.3475(9) Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A3476dated April 27, 1998, and incorporated herein by reference.3477(10) Filed as an Exhibit to the report of the Company on Form 10-K dated for3478the year ended December 31, 1998, and incorporated herein by reference.3479(11) Filed herewith.348034813482<PAGE>34833484EXHIBIT 11.134853486<PAGE>34873488Advanced Neuromodulation Systems, Inc.3489Computation of Earnings Per Share3490Years Ended December 313491<TABLE>3492<CAPTION>34931999 1998 19973494------------ ------------ ------------3495<S> <C> <C> <C>3496Basic earnings (loss) per share:34973498Weighted average common3499shares outstanding 7,583,159 8,314,290 8,428,3933500------------ ------------ ------------3501Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,5113502Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)3503------------ ------------ ------------3504Net earnings $ 6,003,281 $ 6,959,202 $ 724,0213505------------ ------------ ------------350635073508Net earnings from continuing operations3509per share $ 0.79 $ 0.31 $ 0.103510Net earnings (loss) from discontinued operations3511per share -- 0.53 (0.01)3512------------ ------------ ------------3513Net earnings per share $ 0.79 $ 0.84 $ 0.093514------------ ------------ ------------351535163517Diluted earnings (loss) per share:35183519Weighted average common3520shares outstanding 7,583,159 8,314,290 8,428,3933521Stock options and warrants--based on the treasury3522stock method using average market price 419,928 229,750 429,6933523------------ ------------ ------------3524Diluted common and common equivalent3525shares outstanding 8,003,087 8,544,040 8,858,0863526------------ ------------ ------------352735283529Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,5113530Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)3531------------ ------------ ------------3532Net earnings $ 6,003,281 $ 6,959,202 $ 724,0213533------------ ------------ ------------353435353536Net earnings from continuing operations3537per share $ 0.75 $ 0.30 $ 0.093538Net earnings (loss) from discontinued operations3539per share -- 0.51 (0.01)3540------------ ------------ ------------3541Net earnings per share $ 0.75 $ 0.81 $ 0.083542------------ ------------ ------------3543</TABLE>35443545<PAGE>35463547EXHIBIT 21.135483549<PAGE>35503551SUBSIDIARIES35523553The Company has no "significant subsidiaries" as defined in Rule 1-02 (w) of3554Regulation S-X.35553556<PAGE>35573558EXHIBIT 23.135593560<PAGE>35613562Consent of Independent Auditors35633564We consent to the incorporation by reference in the Registration Statements3565(Form S-8 - Nos. 2-82414, 2-91410, 33-235312, 33-00967 and 333-75879, and Form3566S-3 - No. 33-40927) pertaining to the Advanced Neuromodulation Systems, Inc.35671979 Amended and Restated Employees' Stock Option Plan; the Advanced3568Neuromodulation Systems, Inc. Directors' Stock Option Plan; the Advanced3569Neuromodulation Systems, Inc. 1987 Employees' Stock Option Plan; the Advanced3570Neuromodulation Systems, Inc. 1995 Stock Option Plan; the Advanced3571Neuromodulation Systems, Inc. Sales and Marketing Employees Stock Option Plan;3572the Heaton Stock Option Plan; the Advanced Neuromodulation Systems, Inc. 19983573Stock Option Plan; the registration of 100,000 shares of Common Stock issued3574pursuant to a Common Stock Purchase Warrant between Advanced Neuromodulation3575Systems, Inc. and Robert L. Swisher, Jr. and the related Prospectuses of our3576report dated February 25, 2000, with respect to the consolidated financial3577statements of Advanced Neuromodulation Systems, Inc. and Subsidiaries, included3578in the Annual Report (Form 10-K) for the year ended December 31, 1999.35793580/s/ Ernst & Young LLP3581---------------------3582Ernst & Young LLP35833584Dallas, Texas3585March 27, 200035863587</TEXT>3588</DOCUMENT>3589<DOCUMENT>3590<TYPE>EX-273591<SEQUENCE>23592<DESCRIPTION>FDS --3593<TEXT>35943595<TABLE> <S> <C>359635973598<ARTICLE> 53599<LEGEND>3600Exhibit 27.1, Financial Data Sheet3601</LEGEND>3602<CIK> 00003517213603<NAME> Advanced Neuromodulation Systems, Inc.360436053606<S> <C>3607<PERIOD-TYPE> YEAR3608<FISCAL-YEAR-END> DEC-31-19993609<PERIOD-START> JAN-01-19993610<PERIOD-END> DEC-31-19993611<CASH> 8,353,6583612<SECURITIES> 398,2083613<RECEIVABLES> 3,926,5433614<ALLOWANCES> 140,8243615<INVENTORY> 5,999,2173616<CURRENT-ASSETS> 20,369,2333617<PP&E> 7,550,9313618<DEPRECIATION> 1,862,3613619<TOTAL-ASSETS> 43,554,7743620<CURRENT-LIABILITIES> 4,191,0763621<BONDS> 03622<PREFERRED-MANDATORY> 03623<PREFERRED> 03624<COMMON> 435,4183625<OTHER-SE> 36,602,8773626<TOTAL-LIABILITY-AND-EQUITY> 43,554,7743627<SALES> 20,578,3843628<TOTAL-REVENUES> 29,478,3843629<CGS> 6,628,9833630<TOTAL-COSTS> 14,007,2033631<OTHER-EXPENSES> (751,238)3632<LOSS-PROVISION> 03633<INTEREST-EXPENSE> 44,8613634<INCOME-PRETAX> 9,548,5753635<INCOME-TAX> 3,545,2943636<INCOME-CONTINUING> 6,003,2813637<DISCONTINUED> 03638<EXTRAORDINARY> 03639<CHANGES> 03640<NET-INCOME> 6,003,2813641<EPS-BASIC> .793642<EPS-DILUTED> .753643364436453646</TABLE>3647</TEXT>3648</DOCUMENT>3649</SEC-DOCUMENT>3650-----END PRIVACY-ENHANCED MESSAGE-----365136523653