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,7LiXEY3Gfly4+BUDOkBqZrY0czg0xjmE6UuYg69UhqTkI9gjO/LdBsVubL+rdt99F8LrKZxemdkgiShx3rU7e40A==910<SEC-DOCUMENT>0000351721-02-000008.txt : 2002041511<SEC-HEADER>0000351721-02-000008.hdr.sgml : 2002041512ACCESSION NUMBER: 0000351721-02-00000813CONFORMED SUBMISSION TYPE: 10-K14PUBLIC DOCUMENT COUNT: 115CONFORMED PERIOD OF REPORT: 2001123116FILED AS OF DATE: 200204011718FILER: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: 1934 Act31SEC FILE NUMBER: 000-1052132FILM NUMBER: 025976863334BUSINESS ADDRESS:35STREET 1: 6501 WINDCREST DRIVE SUITE 10036CITY: PLANO37STATE: TX38ZIP: 7502439BUSINESS PHONE: 97230980004041MAIL ADDRESS:42STREET 1: 6501 WINDCREST DRIVE SUITE 10043CITY: PLANO44STATE: TX45ZIP: 750244647FORMER COMPANY:48FORMER CONFORMED NAME: QUEST MEDICAL INC49DATE OF NAME CHANGE: 1992070350</SEC-HEADER>51<DOCUMENT>52<TYPE>10-K53<SEQUENCE>154<FILENAME>body.htm55<DESCRIPTION>FORM 10-K56<TEXT>57<HTML>58<HEAD>59<TITLE>ADVANCED NEUROMODULATION SYSTEMS, INC. FORM 10-Q</TITLE>60</HEAD>61<BODY>62<H1 ALIGN=CENTER><FONT SIZE=3>SECURITIES AND EXCHANGE COMMISSION</FONT></H1>63<H1 ALIGN=CENTER><FONT SIZE=3>Washington, D.C. 20549</FONT></H1>64<HR SIZE=1 WIDTH=15% ALIGN=CENTER>65<H1 ALIGN=CENTER><FONT SIZE=4>FORM 10-K</FONT></H1>66<HR SIZE=1 WIDTH=15% ALIGN=CENTER>67<H1 ALIGN=CENTER><FONT SIZE=3>[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR6815(d) OF THE<BR>SECURITIES EXCHANGE ACT OF 1934</FONT></H1>69<P ALIGN=CENTER><FONT SIZE=3>For the Fiscal Year Ended December 31,702001</FONT></P>71<P ALIGN=CENTER><FONT SIZE=3>OR</FONT></P>72<H1 ALIGN=CENTER><FONT SIZE=3>[ ] TRANSITION REPORT PURSUANT TO73SECTION 13 OR 15(d) OF THE<BR> SECURITIES EXCHANGE ACT OF 1934</FONT></H1>74<HR SIZE=1 WIDTH=15% ALIGN=CENTER>75<P ALIGN=CENTER><FONT SIZE=3>Commission file number 0-10521</FONT></P>76<H1 ALIGN=CENTER><FONT SIZE=4>ADVANCED NEUROMODULATION SYSTEMS, INC.</FONT></H1>77<P ALIGN=CENTER><FONT SIZE=3>Incorporated pursuant to the Laws of the State of78Texas</FONT></P>79<HR SIZE=1 WIDTH=15% ALIGN=CENTER>80<P ALIGN=CENTER><FONT SIZE=3>Internal Revenue Service — Employer81Identification No. 75-1646002</FONT></P>82<P ALIGN=CENTER><FONT SIZE=3>6501 Windcrest Drive, Plano, Texas 75024</FONT></P>83<P ALIGN=CENTER><FONT SIZE=3>(972) 309-8000</FONT></P>84<HR SIZE=1 WIDTH=15% ALIGN=CENTER>85<P><FONT SIZE=2>Indicate by check mark whether the registrant (1) has filed all86reports required to be filed by Section 13 or 15(d) of the Securities Exchange87Act of 1934 during the preceding 12 months (or for such shorter period that the88registrant was required to file such reports) and (2) has been subject to such89filing requirements for the past 90 days.90Yes [X] No [ ] </FONT></P>91<P><FONT SIZE=2>Indicate by check mark if disclosure of delinquent filers92pursuant to Item 405 of the S-K is not contained herein, and will not be93contained, to the best of registrant's knowledge, in definitive proxy or94information statements incorporated by reference in Part III of this Form 10-K95or any amendment to this Form 10-K. [ ]</FONT></P>96<P><FONT SIZE=2>Aggregate market value of the registrant’s Common97Stock held by non-affiliates of the registrant as of March 12, 2002:98$243,743,398</FONT></P>99<P><FONT SIZE=2>Number of shares outstanding of the registrant’s Common100Stock as of March 12, 2002: 9,119,957</FONT></P>101<P ALIGN=CENTER><FONT SIZE=2><B>DOCUMENTS INCORPORATED BY REFERENCE</B></FONT>102</P>103<P><FONT SIZE=2>Portions of the registrant’s definitive Proxy Statement104for the registrant's Annual Meeting of Stockholders to be held on June 5, 2002,105are incorporated by reference into Part III.</FONT></P>106<HR SIZE=5>107108<PAGE>109<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc.</B></P>110<P ALIGN=CENTER><B>Annual Report</B></P>111<P ALIGN=CENTER><B>Form 10-K</B></P>112<P ALIGN=CENTER><B>Year Ended December 31, 2001</B></P>113<P ALIGN=CENTER><B>PART I</B></P>114<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>115<TR>116<TD WIDTH=15%><B>ITEM 1.</B></TD>117<TD WIDTH=85%><B>BUSINESS</B></TD></TR></TABLE>118<P ALIGN=CENTER><B><U>General</U></B></P>119<P>We design, develop, manufacture and market advanced implantable120neuromodulation devices that deliver electrical current or drugs directly to121targeted areas of the body to manage chronic pain. Neuromodulation devices122include implantable neurostimulation devices, which deliver electric current123directly to targeted nerves, and implantable infusion pumps, which deliver124small, precisely controlled doses of drugs directly to targeted sites within the125body. Our principal product in 2001 was our <I>Renew</I>® radio-frequency126(RF) spinal cord stimulation device, which we have sold in the U.S. since June1271999. On November 21, 2001, the U.S. Food and Drug Administration (FDA) approved128our <I>Genesis</I>™ totally implantable pulse generator (IPG) spinal cord129stimulation device. We began selling <I>Genesis</I> in Europe in the first130quarter of 2001 and fully launched this product in the U.S. and Australia in131January 2002. We began selling our <I>AccuRx</I>™ fully implantable132constant rate drug infusion pump in international markets in the second quarter133of 2001, and are currently conducting clinical trials of <I>AccuRx</I> in the134United States.</P>135<P>Chronic pain is a critical health care issue today. About 80% of all doctor136visits in the U.S. relate to patient pain. In the U.S. alone, nearly 100 million137people suffer from chronic pain, and over half of chronic pain sufferers are138partially or totally disabled. In particular, back pain is the single largest139healthcare problem in the U.S. today. Chronic pain disables more people than140cancer or heart disease, and costs the American public more than both combined,141accounting for $100 billion in medical expenses in the U.S. annually.</P>142<P>Our customers are doctors who specialize in chronic pain. There are currently143approximately 3,000 accredited pain specialists in the U.S. alone, approximately14480% of which are anesthesiologists and 20% of which are neurosurgeons or145orthopedic surgeons.</P>146<P>In 2001, we estimate that approximately $520 million in neuromodulation147products were sold, up 21% from the previous year, and according to industry148analysts, product sales are expected to grow to about $1.1 billion by 2005,149based solely on treatment indications that the FDA has already approved. Based150on industry data and conversations with pain specialists, management believes151that at least 3 million chronic pain sufferers worldwide may be good candidates152for neuromodulation therapies, while in 2001, only about 50,000 patients153benefited from either neurostimulation devices or implantable drug infusion154pumps. We and one other company design, manufacture and market neurostimulation155products for the treatment of chronic pain, and we and two other companies156compete in the implantable drug pump segment of the neuromodulation market.</P>157<P>A number of factors are driving the growth of the neuromodulation market,158including the following:</P>159<UL>160<LI>The number of pain specialists worldwide who understand our products and161techniques is growing.162<LI>Advances in technology that have decreased the size of the devices and163increased the longevity of their power sources have led to better results for164patients.165<LI>Current research and development in the industry is leading to new clinical166applications that utilize existing neuromodulation products, including essential167tremor, Parkinson's Disease, angina, migraine headaches, peripheral vascular168disease, and sacral nerve stimulation for pelvic pain and incontinence.</UL>169<P ALIGN=CENTER>Page 1</P>170<HR>171172<PAGE>173<P>Our <I>Renew</I> device is the technology leader in the RF segment of the174neurostimulation market. <I>Renew's</I> advanced features provide more effective175treatment of complex and multi-extremity pain patterns and provide pain176specialists with significant flexibility in programming to accommodate a177patient's complex or changing pain patterns. <I>Renew</I> currently accounts for178over 50% of the worldwide RF market. Our new <I>Genesis</I> totally implantable179device offers several technological advances over our competitor's product. Our180<I>Genesis</I> IPG is smaller than the other eight channel IPGs on the market,181which results in greater patient comfort, and more flexible in its capability182to address different pain patterns. Finally, our <I>AccuRx</I> constant rate183implantable drug infusion pump incorporates a new polymeric diaphragm technology184that makes <I>AccuRx</I> more precise than our competitors' products.</P>185<P ALIGN=CENTER><B><U>Recent Developments</U></B></P>186<P>On November 21, 2001, the FDA approved the Pre-Market Approval (PMA)187application for our <I>Genesis</I> IPG. This approval enables us to commercially188market the <I>Genesis</I> IPG in the United States, which we formally commenced189in January 2002 and to participate in 100% of the neurostimulation market to190treat chronic pain of the trunk and limbs. Industry analysts estimate that the191worldwide IPG market is growing at a 26% annual rate and will approach $300192million in 2002. Until our launch of the <I>Genesis</I> IPG, only one other193company marketed an approved IPG device in the United States.</P>194<P>On January 2, 2001, we acquired the assets (primarily intellectual property195consisting of patents and know-how) of Implantable Devices Limited Partnership196(IDP) and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota197companies, for 119,100 shares of ANS common stock. Based on the closing price of198ANS common stock on December 29, 2000, the value of the stock issued to acquire199the assets was $2.43 million. IDP was formed in 1986 to commercialize certain200implantable infusion technologies developed at the University of Minnesota. We201entered a license agreement with IDP in 1995 to license rights to implantable202infusion pump technologies developed by IDP and ESOX for applications in pain203and cancer therapy. Under the license agreement, we were obligated to pay IDP204royalties on worldwide sales of implantable infusion pumps using IDP technology.205The January 2, 2001 acquisition canceled the license agreement, thereby206eliminating our future royalty obligations, and expanded our rights to use the207pump technologies in all applications through our acquisition of the208intellectual property. We completed development of our <I>AccuRx</I> fully209implantable constant rate infusion pump in late 2000 using technology we210licensed from IDP. We received CE mark approval to distribute the pump211internationally and commenced sales internationally during the second quarter of212fiscal 2001. We also received an Investigational Device Exemption (IDE) from the213FDA to initiate clinical trials in the United States. The clinical trials214include 109 patients and are being conducted in fifteen sites. The trials215commenced in the first quarter of 2001 and are progressing according to plan.216The data gathered during the trials will be used to support our PMA217application.</P>218<P>Also on January 2, 2001, we completed the acquisition of Hi-tronics Designs,219Inc. (HDI or Hi-tronics), a privately-held contract developer and original220equipment manufacturer (OEM) of electro-mechanical devices headquartered in Budd221Lake, New Jersey. We acquired HDI through a stock-for-stock merger in which we222issued 1,104,725 shares of ANS common stock. The transaction is accounted for on223a pooling of interests basis and accordingly, prior year results have been224restated. HDI developed and is the manufacturer of our <I>Genesis</I> IPG and is225also the O.E.M. manufacturer of the transmitter used with our <I>Renew</I>226radio-frequency spinal cord stimulation system. HDI was founded in 1987 and has227developed more than sixty medical devices for some of the leading medical device228companies in the fields of cardiology, neurology and orthopedics. The core229strength of HDI is in developing highly sophisticated electronic circuits with230very low power requirements, utilizing both discrete and highly integrated231technology. We believe this competency, when combined with our own strengths in232lead design and packaging, will allow us to develop more sophisticated products233in compressed, development-cycle timetables. In addition, the merger will result234in vertical integration benefits in manufacturing that should enhance margins on235our current and future products.</P>236<P ALIGN=CENTER>Page 2</P>237<HR>238239<PAGE>240<P ALIGN=CENTER><B><U>The Neuromodulation Market</U></B></P>241<P><B><I>Neurostimulation</I></B></P>242<P>Neurostimulation involves delivering small, mild electrical pulses to nerve243fibers along the spinal cord or peripheral nerves to inhibit or block the244sensation of pain. This stimulation of the pain-inhibiting pathways of the brain245masks the sensation of pain by generating a tingling sensation, or246"paresthesia." In general, neurostimulation is generally indicated for managing247neuropathic pain such as the chronic intractable pain of the trunk or limbs.248Patients with pain in a single location are ideal candidates for249neurostimulation, as are patients with failed back syndrome, complex regional250pain syndrome, disorders of the spinal nerve root and chronic inflammation and251scarring of the membranes surrounding the spinal cord.</P>252<P>Neurostimulation is a reversible therapy, and is tested on a patient before253the patient receives a permanent device. Prescribed for carefully-selected254patients, clinical results demonstrate that the majority of patients experience255a substantial reduction in pain, an increase in activity level, a reduction in256use of narcotics, a reduction in hospitalization and an overall reduction in257health care costs.</P>258<P>A neurostimulation device consists of one to four stimulating leads, which259are connected to an extension wire on one end and tethered to the patient260anatomy on the other end. The primary role of the lead is to stimulate the261spinal cord or peripheral nerve. Each lead holds up to 16 electrodes, which are262placed in the targeted area. The second element of the stimulator is the power263source that generates the electrical pulses. The device is programmed to264superimpose the stimulation pattern or paresthesia to offset the pain pattern of265the patient. The secondary goal of programming is to optimize the stimulation266while prolonging the life of the battery.</P>267<P>There are two types of neurostimulators currently on the market: RF and IPG268stimulators. An RF stimulator consists of an RF receiver and implanted leads,269and a transmitter with power source that is worn externally. The device is270powered with the help of an antenna, which is tethered on the patient's skin271with adhesive tape. In contrast, an IPG is completely internal and its power272source, leads and electrodes are all surgically implanted. The IPG segment of273the market is much larger, with approximately 80% of the neurostimulation274procedures performed involving IPG devices and the remainder involving RF275devices. Despite the likely dominance of IPG products due to the convenience of276a completely internalized system, we believe RF stimulation offers unique277advantages and that RF stimulators will continue to address a market need. While278the IPG device can help most patients, management believes that between 10-20%279of the chronic pain patient population would be better candidates for an RF280device. One reason is that only the RF device is currently indicated for281peripheral nerve stimulation, as opposed to spinal cord stimulation. However,282the main reasons RF devices will continue to be prescribed are the benefits to283be derived from its external battery:</P>284<P ALIGN=CENTER>Page 3</P>285<HR>286287<PAGE>288<UL>289<LI>The external battery power source allows the patient to recharge the device290by simply changing a special nine-volt battery, while the IPG requires surgical291intervention and replacement every two to four years (depending on mode and292intensity of use). The external power source makes the RF device less invasive293and more cost-efficient and, in those respects, more convenient than an IPG294device.295<LI>Because exhausting the rechargeable power source is not a concern, the RF296device can be programmed with a higher power and wider range of amplitude,297frequency and pulse width settings for a variety of programs controlled by the298patient. These features make the RF device more effective than an IPG device for299patients with complex pain patterns or who will require long-term stimulation300treatment.</UL>301<P>For these reasons, until rechargable batteries are available for IPGs or302until battery technology advances significantly, the RF device will continue to303be the best solution for patients with complex pain or widespread pain that304requires higher power levels. IPGs will be most often prescribed for patients305with simple unilateral and single extremity pain complaints or indications with306lower power requirements.</P>307<P>Industry analysts estimate that the worldwide neurostimulation market in 2001308was a $300 million market, and expect this market to grow at an annual rate of309about 23% to around $675 million in 2005, based solely on applications for the310devices that are currently approved by the FDA. We and one other company are the311only competitors who currently participate in this market. If new applications312are approved, the market may grow at a faster rate. New applications that are313currently in the development stages include sacral nerve stimulation for pelvic314pain, spinal cord stimulation for chronic intractable angina and peripheral315vascular disease, peripheral nerve stimulation for migraine headaches, deep316brain stimulation for epilepsy and cortical stimulation for strokes and other317indications.</P>318<P><B><I>Implantable Drug Pumps</I></B></P>319<P>Implantable drug pumps deliver medication directly into the spinal canal to320the site where it is needed. This intraspinal drug delivery creates a higher321drug concentration at the site, which can often provide faster relief with much322lower quantities of medication. For example, the difference in intraspinal323versus oral morphine dosage is 1:300. These lower dosages help to minimize any324side effects, and are more economical for the patient. Today, implantable325infusion pumps are used for the intraspinal delivery of morphine and baclofen326for the treatment of pain (such as cancer or arthritis pain) and spasticity, and327for the intra-arterial delivery of various drugs for chemotherapy.</P>328<P>As is neurostimulation, implantable drug pump therapy is fully reversible.329Prescribed for carefully selected patients, clinical results demonstrate that330the majority of patients experience a substantial reduction in pain, an increase331in activity level, a reduction in the use of narcotics, a reduction in332hospitalization and an overall reduction in health care costs.</P>333<P>Implantable drug pumps are made up of the pump itself and a catheter. The334pump is a hockey puck-shaped device containing a reservoir to hold the335prescribed drug and the mechanisms that regulate the drug's delivery rate. The336pump is implanted under the skin in the abdominal area and is connected to the337catheter. The catheter is a piece of soft, pliable tubing that is tunneled under338the skin into either the epidural or intrathecal space of the spinal column. The339pump is refilled by placing a needle through the skin into an access port on the340pump and injecting the drug into the reservoir.</P>341<P ALIGN=CENTER>Page 4</P>342<HR>343344<PAGE>345<P>Currently, there are two types of implantable drug pumps - constant rate and346programmable. Constant rate pumps provide drug infusion at a single, continuous347flow rate that cannot be changed once the pump has been implanted in the348patient. Programmable pumps allow the rate of drug delivery to be non-invasively349changed to meet the patient’s needs. The disadvantage of a programmable350pump is that it is battery-powered and must be surgically removed and replaced351after four to seven years. According to industry analysts, programmable drug352pumps make up approximately 90% of the implantable pump market, with constant353rate pumps accounting for the balance. Industry analysts estimate the worldwide354implantable drug pump market in 2001 was a $230 million market, and expect this355market to grow at an annual rate of about 19% to around $450 million by 2005.356If new applications are approved, the market may grow at a faster rate. New357applications that are currently being researched include different types of358chronic pain and, specifically related to programmable pumps, ALS (Lou Gehrig's359Disease), Parkinson's Disease, Huntington's Disease and Alzheimer's Disease.</P>360<P ALIGN=CENTER><B><U>Our Products</U></B></P>361<P>We currently have three main products on the market: our <I>Renew</I> RF and362<I>Genesis</I> IPG neurostimulation devices, which we are marketing in the U.S.363and internationally, and our <I>AccuRx</I> constant rate implantable drug pump,364which we currently market internationally and which is in clinical trials in the365U.S.</P>366<P><B><I>Renew</I></B></P>367<P><I>Renew</I> is the leading technology in the RF stimulation market, and in3682001 generated the majority of our revenues. We introduced <I>Renew</I> in the369U.S. during June 1999 and began selling it in international markets during 2000.370<I>Renew</I> is the latest generation device in the RF stimulation product line371in which we have been involved since acquiring our neuromodulation business in3721995.</P>373<P><I>Renew</I> offers leads with up to 16 closely-spaced electrodes, while our374competitor's product offers only up to eight electrodes. More electrodes results375in more effective treatment of complex and multi-extremity pain patterns, and376provides the doctor with increased flexibility in programming to accommodate a377patient's changing pain patterns. <I>Renew's</I> receiver has been designed for378ease of implantation, which reduces the time required to complete the procedure.379It is also the smallest receiver currently on the market, which results in380enhanced patient comfort. Additionally, it allows the use of from one to four381lead arrays, while our competitor's product offers a maximum of two. This choice382of lead arrays, combined with either an 8- or 16-channel model receiver (our383competitor offers only an 8-channel receiver), enables the doctor to choose from384the maximum number of alternatives to best treat complex pain. <I>Renew's</I>385transmitter provides the patient with a number of program choices for386stimulation. There are three stimulation modes (as compared with our387competitor's two modes), which include (1) our PC-Stim program, whereby patients388can manually select up to 24 programs to regulate their own therapy; (2) our389Multi-Stim program, which provides automatic delivery of multiple stimulation390programs important for the treatment of diffuse, multifocal pain patterns; and391(3) our C-Stim program, which provides a single, continuous stimulation program.392The transmitter also has easy-to-use controls and an interactive display that393includes a stimulation diagram for quick visual confirmation of pain coverage.394</P>395<P ALIGN=CENTER>Page 5</P>396<HR>397398<PAGE>399<P><B><I>Genesis</I></B></P>400<P>In late 2000, we received CE mark approval for our <I>Genesis</I> IPG and401began selling the product in international markets during the first quarter of4022001. On November 21, 2001, we received FDA approval of <I>Genesis</I>. This403approval allowed us to launch our participation in the largest segment of the404neuromodulation market with our U.S. roll-out of <I>Genesis</I> that began in405January 2002, and to participate in 100% of the neurostimulation market for406treating chronic pain of the trunk and limbs.</P>407<P>We believe <I>Genesis</I> offers several technological advances over our408competitor's product that should make it attractive to doctors and patients:</P>409<UL>410<LI><I>Genesis</I> is significantly smaller than the other eight channel IPGs on411the market, which should make <I>Genesis</I> more comfortable for the patient.412<LI><I>Genesis</I> provides the patient with the option to choose from up to 24413different stimulation programs, while the competing product has a more limited414menu and requires the patient to go to the doctor's office for reprogramming.415<LI><I>Genesis</I> provides the option of one Octapolar lead, which enables416doctors to rectify the problem of lead movement or "migration" (a problem in417about 10-15% of cases) through reprogramming.418<LI><I>Genesis</I> provides constant current delivery to protect against body419impedance that can cause over- or under-stimulation.</UL>420<P><B><I>PainDoc</I></B></P>421<P>We have also developed a Windows-based, computerized support system designed422to work with both <I>Renew</I> and <I>Genesis</I>, called <I>PainDoc</I>®.423<I>PainDoc</I> interfaces with our RF transmitter and IPG programmer to optimize424stimulation therapy and document treatment outcomes. This system allows the425doctor to interact with the patient to map the location and intensity of the426patient's pain and input this information into a standardized database. In427addition, <I>PainDoc</I> serves as a patient management system, enabling the428doctor to record the pain maps, assess stimulation coverage and overlap,429standardize clinical data collection, and archive and manage patient430information.<P>431<P><B><I>AccuRx</I></B></P>432<P>We received CE mark approval to distribute our <I>AccuRx</I> constant rate433drug pump internationally and began selling the pump in Europe in the second434quarter of fiscal 2001. We also received an investigational device exemption435(IDE) from the FDA to initiate clinical trials in the U.S. The clinical trials436include 109 patients, are being conducted in 15 sites and will provide data to437support our PMA for U.S. market introduction. The clinical trials commenced in438the first quarter of 2001, and the first pump was successfully implanted in439April 2001. </P>440<P>Until recently, all constant rate pumps have been powered by pressurized gas441in a chamber that surrounds the drug reservoir. When the drug is injected into442the reservoir, the gas is compressed. At body temperature, the gas expands,443pushing the drug out of the reservoir into the catheter. Unlike our competitors'444products, <I>AccuRx</I> is powered by a polymeric diaphragm. The advantage of445this design is that our pump is more precise, because its operation is not446affected by changes in the body's temperature or pressure. We completed447development of <I>AccuRx</I> in 2000, using technology we licensed from IDP for448pain and cancer therapy applications. On January 2, 2001, we acquired the449intellectual property rights from IDP for 119,100 shares of our common stock,450then valued at $2.43 million. By purchasing the intellectual property rights, we451eliminated future royalty obligations and expanded our rights to use the452<I>AccuRx</I> pump for any application.</P>453<P>Industry analysts estimate worldwide sales of constant rate implantable drug454pumps in 2001 were $28 million, up 16% from 2000. We have two competitors in455this segment of the market.</P>456<P ALIGN=CENTER>Page 6</P>457<HR>458459<PAGE>460<P ALIGN=CENTER><B><U>Other Business Matters</U></B></P>461<P><B><U>Research and Development</U></B></P>462<P>As of March 2002, we had an in-house research and development staff of 44463people, compared to 38 in March 2001. The 2002 total includes15 development464personnel and the 2001 total includes 12 development personnel employed by HDI.465In 2001, we spent $4.93 million (13.0% of total net revenue) on research and466development, compared to $3.85 million (12.1% of total net revenue) in 2000.467During 2002, we expect to increase our investment in research and development468and clinical trials and expect expenditures for the year to reach approximately469$6.1 million.</P>470<P>Our current research and development efforts include work on the following:471</P>472<UL>473<LI>next-generation IPG stimulation devices for spinal cord stimulation;474<LI>next-generation RF stimulation devices;475<LI>an IPG stimulation device for deep brain stimulation to address essential476tremor and tremor associated with Parkinson's Disease;477<LI>next-generation infusion pumps, including a prototype programmable pump that478will take several years to develop; and479<LI>clinical trials that we expect to initiate on several of our new products480upon approval from the FDA.</UL>481<P>Additionally, we are working on new applications for our IPG stimulation482platform outside our focus on chronic pain, including an application for483treating occipital headaches. During the first quarter of 2001, we initiated a484pilot clinical study in the U.S., which consists of ten patients at two sites,485to evaluate the efficacy of our <I>Genesis</I> IPG device for treating occipital486headaches. We expect to complete the pilot study during the second quarter of4872002. Data from the pilot study will be used to determine the parameters for a488larger pivotal clinical study to support a PMA application for our489<I>Genesis</I> IPG to treat occipital headaches. We are also evaluating other490new applications for our IPG stimulation platform including applications for491treating angina, peripheral vascular disease, peripheral nerve stimulation, and492urinary incontinence, any of which would require a PMA approval from the FDA. We493may seek strategic partners with established distribution systems to develop494these market opportunities.</P>495<P>Our HDI subsidiary developed and is the manufacturer of our <I>Genesis</I>496IPG, and is also the O.E.M. manufacturer of the transmitter used with497<I>Renew</I>. HDI has developed and introduced more than 60 medical devices for498leading medical device companies in the fields of cardiology, neurology and499orthopedics. HDI's core strength is in developing highly sophisticated500electromechanical devices featuring electronic circuits with very low power501requirements, utilizing both discrete and highly integrated technology. We502believe HDI's core competency, when combined with our own strengths in lead503design and packaging, will allow us to develop more sophisticated products in504compressed, development-cycle timetables. In 2001, HDI accounted for 27.6% of505our consolidated revenues.</P>506<P><B><U>Marketing and Sales</U></B></P>507<P><B><I>General</I></B></P>508<P>We target our marketing efforts at anesthesiologists, neurosurgeons and509orthopedic surgeons who specialize in pain management. Because most pain510practitioners implant both RF and IPG stimulators, we expect to leverage our RF511contacts and track record to establish our position in the IPG segment of the512market. Additionally, by rounding out our product offerings with our IPG device,513we expect that our sales representatives will now be able to expand their target514customer base to doctors who have historically preferred to implant only IPGs.515</P>516<P ALIGN=CENTER>Page 7</P><HR>517518<PAGE>519<P>We derive 90% of net revenues from product sales of our neurostimulation520systems from domestic sales and approximately 10% from export sales.</P>521<P><B><I>U.S.</I></B></P>522<P>In the domestic market, which accounts for the vast majority of our sales, we523employ a hybrid sales force of a total of about 80 independent specialty524distributors and commissioned sales agents, and five direct sales persons, all525of whom are focused on the chronic pain market. We have divided the domestic526market into three distributor territories, which employ a total of 24 pain527specialists who devote the majority of their selling efforts to our products. We528sell our products to these distributors at a discount from our list prices, and529the distributors sell the products to and collect revenues from the customers.530We obtain approximately 35% of our sales through our specialty distributors. In531addition, we have 23 sales agent territories that employ 56 sales agents with532expertise and focus on the pain management market who tend to sell our products533as their flagship product line. The sale of products using commissioned sales534agents contributes approximately 60% of our total sales.</P>535<P>We also employ four regional sales managers, who interact with our customers536and oversee the distributors and the sales agents, and a Vice President of North537American Sales, who coordinates the sales efforts of our distribution network in538North America.</P>539<P>Our domestic marketing programs include:</P>540<UL>541<LI>medical marketing programs intended to educate doctors and their staff about542successfully promoting their practices, efficiently educate patients about the543diagnosis and treatment of various conditions and effectively train office staff544to work with patients;545<LI>surgical training programs offered to doctors interested in improving their546surgical techniques;547<LI>education materials, such as brochures and videos, to educate patients and548doctors about treatment options and about our products in particular;549<LI>reimbursement assistance, with the help of outside consultants, to assist550patients and doctors in obtaining appropriate reimbursement for our products;551<LI>advisory boards composed of key U.S. and international opinion leaders who552provide us feedback about our current and future products, diagnostic and553treatment trends and other areas of interest; and554<LI>website marketing focused on educating both patients and doctors about our555product alternatives, reimbursement for our procedures and our marketing556programs.</UL>557<P><B><I>International</I></B></P>558<P>Internationally, we market our products through 20 specialty pain559distributors who represent us in 22 countries. Additionally in Germany, we560employ two sales agents and two direct sales representatives. Our international561distribution network reports to our Director of International Operations, who is562headquartered in the United Kingdom. We are in the process of training and563signing additional distributors to market our products in additional foreign564countries.</P>565<P><B><I>Customer Service</I></B></P>566<P>Our sales representatives are also responsible for training doctors and567nurses on programming and trouble-shooting any problems with our RF and IPG568devices. Both the RF and IPG devices have 24 different program settings, which569can be programmed and saved into memory. Therefore, a significant amount of570training of doctors and nurses is required for new users of our products.</P>571<P ALIGN=CENTER>Page 8</P><HR>572573<PAGE>574<P><B><I>Major Customers</I></B></P>575<P>During 2001 and 2000, we had one major customer that accounted for 10% or576more of our net revenue from our neuromodulation products segment. Sun Medical,577Inc., a specialty distributor of ANS stimulation products, accounted for $4.2578million, or 15% of our net revenue from the neuromodulation products segment for579the year ended December 31, 2001 and $3.2 million, or 14% of our net revenue580from the neuromodulation products segment for the year ended December 31, 2000.581While we believe our relations with Sun Medical are good, the loss of this582customer could have a material adverse effect on our business, financial583condition and results of operations. During 1999, we had two major customers584that accounted for 10% or more of our net revenue from the neuromodulation585products segment. Sun Medical, Inc. and Primesource Surgical, Inc., accounted586for $3.0 million and $2.3 million, respectively, or 15% and 11%, respectively,587of our net revenue from the neuromodulation products segment for the year ended588December 31, 1999.</P>589<P>During the year ended December 31, 2001, we had three major customers that590accounted for 10% or more of our net revenue from the HDI O.E.M. segment:591Medtronic, Inc. accounted for $6.3 million, or 60%; Arrow International, Inc.592accounted for $1.8 million or 17%; and Transneuronix, Inc. accounted for $1.1593million or 11%. For the year ended December 31, 2000, we had three major594customers that accounted for 10% or more of our net revenue from the HDI O.E.M.595segment: Medtronic, Inc. accounted for $4.3 million or 49%; Exogen accounted for596$2.1 million or 24%; and Cyberonics, Inc. accounted for $1.5 million or 17%. For597the year ended December 31, 1999, we had four major customers that accounted for59810% or more of our net revenue from the HDI O.E.M. segment: Exogen accounted for599$1.7 million or 27%; Medtronic, Inc. accounted for $1.7 million or 27%;600Cyberonics, Inc. accounted for $1.2 million or 19%; and EP MedSystems accounted601for $760,000 or 12%.</P>602<P><B><U>Manufacturing</U></B></P>603<P>We operate two manufacturing facilities, one in Plano, Texas and the other in604Hackettstown, New Jersey. Both of our manufacturing operations are required to605comply with the FDA's Quality System Regulations, commonly referred to as QSR.606QSR addresses design, controls, methods, facilities and quality assurance607controls used in manufacturing medical devices. In addition, we are subject to608compliance requirements of ISO 9001 certification and CE Mark directives for609international markets. Our Plano, Texas facility was re-certified to ISO 9001/EN61046001/ ISO 13485 in November 2001. HDI's manufacturing facility is also ISO 9001611certified and was re-certified in May 2000. Each facility is subject to612recurring surveillance audits by its notified body.</P>613<P>We manufacture and package the vast majority of our neurostimulation devices614and implantable drug pumps at our Plano facility. HDI manufactures a variety of615medical devices and products on an O.E.M. basis in Hackettstown.</P>616<P>For our implantable neurostimulation devices and drug pumps, our617manufacturing processes largely consist of the assembly of standard and custom618components, functional testing to ensure adherence to specifications and619inspection of completed products. Components are assembled in a "clean room"620environment designed and maintained to reduce product exposure to particulate621matter. We subcontract with various suppliers to provide us with the quantity of622component parts necessary to assemble our products and for sterilizing finished623product using ethylene oxide gas.</P>624<P>For our non-implantable (external) products, our manufacturing processes625largely consist of the assembly of standard and custom components, functional626testing to ensure adherence to specifications and inspection of completed627products. Like our implantable products, we rely on third party subcontractors628to supply us with standard and custom component parts.</P>629<P>We devote significant attention to quality assurance throughout all phases of630our manufacturing operation. In addition to product inspection and compliance631auditing, quality assurance supports process improvement, statistical problem632solving and product improvements.</P>633<P ALIGN=CENTER>Page 9</P><HR>634635<PAGE>636<P>Skills of assembly workers required for the manufacture of medical products637are similar to those required in typical assembly operations. We believe that638workers with these skills are readily available in the Dallas and New Jersey639geographical areas.</P>640<P>We believe we currently have in place the manufacturing capabilities to meet641the needs of the neuromodulation market in which we participate. We estimate642that our current manufacturing capacity is sufficient to handle a three-fold643increase in product volume.</P>644<P><B><U>Intellectual Property</U></B></P>645<P>We rely on a combination of patents, trade secrets, know-how, trademarks and646agreements to protect our intellectual property. We currently own 25 patents647covering our stimulation devices' electrode, receiver, transmitter and648programmer technology, our <I>PainDoc</I> computer system technology and our649fully-implantable infusion pump technology. These patents, in part, cover both650RF and IPG stimulation devices for a wide range of current and future651applications. We currently have 8 pending U.S. patent applications and 21652pending foreign patent applications. Among other things, these pending patent653applications cover new stimulation lead technology, implant accessories,654improved connector mechanisms and implantable drug delivery technology.</P>655<p>Additionally, we are exclusively licensing from third parties a patent656directed to advanced placement techniques and a patent directed to methods to657facilitate relieving the effects of chronic pelvic pain, such as interstitial658cystitis.</P>659<P>The validity of any patents issued to us may be challenged by others and we660could encounter legal and financial difficulties in enforcing our patent rights661against infringers. In addition, new technologies may be developed, or patents662may be obtained by others, which would render our patents obsolete. The loss of663any one patent would not have a material adverse effect on our current revenue664base. However, although we do not believe that patents are the sole determinant665of the commercial success of our products, the loss of a significant percentage666of our patents could have a material adverse effect on our business, financial667condition and results of operations.</P>668<P>We have developed technical knowledge which, although non-patentable, we669consider to be significant in enabling us to compete. However, the proprietary670nature of such knowledge may be difficult to protect. We have entered into671agreements with each of our key employees prohibiting such employees from672disclosing any of our confidential information or trade secrets or engaging in673any competitive business (as defined in the agreements) while the employee is674working for us and for a period of one year thereafter. In addition, these675agreements also provide that any inventions or discoveries by these individuals676relating to our business will be assigned to us and become our sole property.677</P>678<P>Claims by competitors and other third parties that our products allegedly679infringe the patent rights of others could adversely affect our revenues.680Although we are not currently a party to any patent infringement lawsuit and no681such claims have been made against us, we could become subject to such682litigation or claims. The interventional pain management market is characterized683by extensive patent and other intellectual property claims, which can create684greater potential than in less-developed markets for possible allegations of685infringement, particularly with respect to newly developed technology.686Intellectual property litigation is complex and expensive and its outcome is687difficult to predict. Any future litigation, regardless of outcome, could result688in substantial expense to us and significant diversion of the efforts of our689technical and management personnel. An adverse determination in any such690proceeding could subject us to significant liabilities to third parties, or691require us to seek licenses from third parties or pay royalties that may be692substantial. Furthermore, there can be no assurance that necessary licenses693would be available to us on satisfactory terms, or at all. Accordingly, an694adverse determination in a judicial or administrative proceeding or failure to695obtain necessary licenses could prevent us from manufacturing or selling certain696of our products, which could have a material adverse effect on our business,697financial condition and results of operations.</P>698<P ALIGN=CENTER>Page 10</P><HR>699700<PAGE>701<P><I>Renew</I>®, <I>Multistim</I>®, <I>PainDoc</I>®,702<I>Octrode</I>®, <I>ANS</I>® and <I>Advanced Neuromodulation703Systems</I>® are among our registered trademarks. U.S trademark applications704are pending for various trademarks that we believe have value (or will have705value) in the marketplace, including <I>Compustim</I>™,706<I>Genesis</I>™ , <I>DuraCath</I>™ and <I>AccuRx</I>™.</P>707<P><B><U>Competition</U></B></P>708<P>We are a small company competing in a large and rapidly growing market. Our709only significant competitor at this time is Medtronic, Inc., one of the world's710largest medical device companies, which has substantially greater resources and711marketing power than we do. Furthermore, the neuromodulation market is one of712Medtronic's fastest growing segments. Competitive pressures could increase in713the future as Medtronic attempts to secure and grow its position in714neuromodulation. Also, a market with projected growth like this market is bound715to attract other large companies; however, barriers to entry are high due to716long and expensive product development and approval cycles and the intellectual717property and patent positions that we and Medtronic currently hold.</P>718<P>We believe that the principal competitive factors in the neuromodulation719market are:</P>720<UL>721<LI>cost-effectiveness722<LI>impact on patient outcomes723<LI>product performance724<LI>quality725<LI>ease of use726<LI>technical innovation727<LI>customer service</UL>728<P>We intend to continue to compete on the basis of our high-performance729products, innovative technologies, manufacturing capabilities, close customer730relations and support, and our strategy to increase our offerings of products731within the neuromodulation market.</P>732<P><B><U>Government Regulation</U></B></P>733<P>The manufacture and sale of our products are subject to regulation by734numerous governmental authorities, principally the FDA and corresponding foreign735agencies. The research and development, manufacturing, promotion, marketing and736distribution of our products in the U.S. are governed by the Federal Food, Drug737and Cosmetic Act and the regulations promulgated thereunder (the "FDC Act and738Regulations"). We are subject to inspection by the FDA for compliance with such739regulations and procedures.</P>740<P>The FDA has traditionally pursued a rigorous enforcement program to ensure741that regulated entities comply with the FDC Act and Regulations. A company not742in compliance may face a variety of regulatory actions, including warning743letters, product detentions, device alerts, mandatory recalls or field744corrections, product seizures, rescission of marketing permits, injunctive745actions or civil penalties and criminal prosecutions of the company or746responsible employees, officers and directors. Our Texas facility was last747inspected in July 2001, and no major non-conformities were found. In September7482000, the FDA inspected HDI's New Jersey facility, and no major non-conformities749were found.</P>750<P ALIGN=CENTER>Page 11</P><HR>751752<PAGE>753<P>Under the FDA's requirements, a new medical device cannot be released for754commercial use until a PMA has been filed with the FDA and the FDA has approved755the device's release. If a manufacturer can establish that a newly developed756device is "substantially equivalent" to a legally marketed device, the757manufacturer may seek marketing clearance from the FDA to market the device by758filing a 510(k) premarket notification with the FDA, which usually takes less759time than a PMA. The process of obtaining FDA clearance can be lengthy,760expensive and uncertain. Either a 510(k) or a PMA, if granted, may include761significant limitations on the indicated uses for which a product may be762marketed, and FDA enforcement policy strictly prohibits the promotion of763approved medical devices for unapproved uses. In addition, product approvals can764be withdrawn for failure to comply with regulatory requirements or the765occurrence of unforeseen problems following initial marketing. Although all of766our currently marketed products, with the exception of our <I>Genesis</I> IPG,767have been the subject of successful 510(k) submissions, we believe that because768the products we are currently developing are more innovative, some of these769products will require a PMA submission process, which is lengthier and more770costly than the 510(k) process.</P>771<P>Our recent experience with our <I>Genesis</I> IPG device demonstrates that,772even when the 510(k) process appears to be the appropriate path to regulatory773approval, the FDA may disagree, and the entire process is unpredictable. In774February 1999, we met with the FDA to discuss the submission of a PMA775application for <I>Genesis</I>. The FDA recommended that we instead seek776reclassification of our <I>Genesis</I> device in order to be able to use the777510(k) filing process, and we promptly did so. On September 17, 1999, the FDA's778neurological panel recommended approval of our reclassification. One year later,779on September 6, 2000, the FDA published its position supporting the780reclassification of <I>Genesis</I> in the Federal Register, and allowed a 30-day781"comment period" for our competitors to comment on the decision. Medtronic782submitted a request to the FDA for a one-month extension to the comment period,783which was granted. On February 26, 2001, the FDA reversed its position and784denied our petition to reclassify <I>Genesis</I>. This decision by the FDA made785it necessary for us to file a PMA application for <I>Genesis</I>, which we786promptly did. We received PMA approval from the FDA on November 21, 2001.</P>787<P>We are also subject to regulation in each of the foreign countries in which788we sell our products with regard to product standards, packaging requirements,789labeling requirements, import restrictions, tariff regulations, duties and tax790requirements. Many of the regulations applicable to our products in such791countries are similar to those of the FDA. The national health or social792security organizations of certain countries require our products to be qualified793before they can be marketed in those countries. To date, we have not experienced794significant difficulty in complying with these regulations.</P>795<P>To position ourselves for access to European and other international markets,796we have maintained certification under the ISO 9000 Series of Standards. ISO7979000 is a set of integrated requirements, which, when implemented, form the798foundation and framework for an effective quality management system. These799standards were developed and published by the ISO, a worldwide federation of800national standard bodies, founded in Geneva, Switzerland in 1946. ISO has over80192 member countries. ISO certification is essential to enter European Community802markets.</P>803<P>In November 2001, our quality system was re-certified to ISO 9001/EN80446001/ISO 13485 certification. The ISO 9001 registration is the most stringent805standard in the ISO series. The German notified body TUV Product Services issued806the re-certification certificates. The ISO 9001 standard covers design,807production, installation and servicing of products. EN 46001 and ISO 13485 cover808the same elements as the ISO 9001 standard; however, their focus is on quality809systems for medical device manufacturing. In addition, we are certified to the810Active Implantable Medical Device Directive allowing us to market devices811throughout the European Community. We are subject to an annual audit by the812notified body to maintain our registrations.</P>813<P>The financial arrangements through which we market, sell and distribute our814products may be subject to certain federal and state laws and regulations in the815U.S. with respect to the provision of services or products to patients who are816Medicare or Medicaid beneficiaries. The "fraud and abuse" laws and regulations817prohibit the knowing and willful offer, payment or receipt of anything of value818to induce the referral of Medicare or Medicaid patients for services or goods.819In addition, the physician anti-referral laws prohibit the referral of Medicare820or Medicaid patients for certain "Designated Health Services" to entities in821which the referring physician has an ownership or compensation interest.822Violations of these laws and regulations may result in civil and criminal823penalties, including substantial fines and imprisonment. In a number of states,824the scope of fraud and abuse or physician anti-referral laws and regulations, or825both, have been extended to include the provision of services or products to all826patients, regardless of the source of payment, although there is variation from827state to state as to the exact provisions of such laws or regulations. In other828states, and on a national level, several health care reform initiatives have829been proposed that would have a similar impact. We believe that our operations830and our marketing, sales and distribution practices comply with applicable fraud831and abuse and physician anti-referral laws and regulations. Although we do not832believe that we will need to undertake any significant expense or modification833to our operations or our marketing, sales and distribution practices to comply834with federal and state fraud and abuse and physician anti-referral regulations835that are currently in effect or proposed, financial arrangements between836manufacturers of medical devices and other health care providers may be subject837to increasing regulation in the future. Compliance with such regulation could838adversely affect our marketing, sales and distribution practices, and may affect839us in other respects not presently foreseeable that could have an adverse impact840on our business, financial condition and results of operations.</P>841<P ALIGN=CENTER>Page 12</P><HR>842843<PAGE>844<P><B><U>Third-Party Reimbursement</U></B></P>845<P>Hospitals and ambulatory surgery centers are the primary purchasers of our846products, which then bill various third-party payors for the services provided847to the patients. These payors, which include Medicare, Medicaid, private848insurance companies, managed care and worker's compensation organizations,849reimburse part or all of the costs and fees associated with the procedures850performed with these devices. We estimate that one-third of total reimbursements851for our products come from each of Medicare/Medicaid, private insurance852companies and managed care organizations, and worker's compensation853organizations.</P>854<P>Medicare and Medicaid reimbursement for hospitals is based on a fixed amount855for admitting a patient with a specific diagnosis. Because of this fixed856reimbursement method, hospitals have incentives to use less costly methods in857treating Medicare and Medicaid patients, and will frequently make capital858expenditures to take advantage of less costly treatment technologies.859Frequently, reimbursement is reduced to reflect the availability of a new860procedure or technique, and as a result hospitals are generally willing to861implement new cost-saving technologies before these downward adjustments take862effect. Likewise, because the rate of reimbursement for certain doctors who863perform certain procedures has been and may in the future be reduced in the864event of further changes in the resource-based relative value scale method of865payment calculation, doctors may seek greater cost efficiency in treatment to866minimize any negative impact of reduced reimbursement. Any amendments to867existing reimbursement rules and regulations which restrict or terminate the868reimbursement eligibility (or the extent or amount of coverage) of medical869procedures using our products or the eligibility (or the extent or amount of870coverage) of our products could have an adverse impact on our business,871financial condition and results of operations. Third-party payors routinely872challenge the prices charged for medical products and services and may deny873reimbursement if they determine that a device was not used in accordance with874cost-effective treatment methods as determined by the payor, was experimental or875was used for an unapproved application.</P>876<P>Our stimulation devices, while cost-effective compared to repeat back877surgeries, have encountered some resistance by third-party payors. Although878Medicare, Medicaid and many private insurers reimburse for our stimulation879devices and procedures, especially after repeated back surgeries have failed to880relieve chronic pain, some managed care and private payors occasionally refuse881to reimburse or restrict reimbursement for stimulation devices. We cannot assure882you that third-party payors will continue to reimburse for our products, or that883their reimbursement levels will not adversely affect the profitability of our884products. In addition, because health care costs have risen so significantly885there have been and will continue to be proposals by legislators and regulators886to curb these costs. Legislative action limiting reimbursement for certain887procedures could have a material adverse effect on our business, financial888condition and results of operations.</P>889<P ALIGN=CENTER>Page 13</P><HR>890891<PAGE>892<P>In response to the focus of national attention on rising health care costs, a893number of changes to reduce costs have been proposed or have begun to emerge. In894addition to legislative and regulatory initiatives, the number of Americans895enrolling in some form of managed care plan continues to grow. It has become a896typical practice for hospitals to affiliate themselves with as many managed care897plans as possible. Higher managed care penetration typically drives down the898prices of health care procedures, which in turn places pressure on medical899supply prices. This causes hospitals to implement tighter vendor selection and900certification processes by reducing the number of vendors used, purchasing more901products from fewer vendors and trading discounts on price for guaranteed higher902volumes to vendors. Hospitals have also sought to control and reduce costs over903the last decade by joining group purchasing organizations or purchasing904alliances. We cannot predict what continuing or future impact existing or905proposed legislation, regulation or such third-party payor measures may have on906our future business, financial condition or results of operations.</P>907<P>Changes in reimbursement policies and practices of third-party payors could908have a substantial and material impact on sales of our products. The development909or increased use of more cost-effective treatments could cause such payors to910decrease or deny reimbursement to favor these other treatments.</P>911<P><B><U>Advisory Board</U></B></P>912<P>We have established the Advanced Neuromodulation Systems Advisory Board,913which is comprised of individuals with substantial expertise in neuromodulation914and pain management. Members of our management and scientific and technical915staff consult closely with members of the Advisory Board to identify specific916areas where techniques are changing and where existing products do not917adequately fulfill the needs of the pain physician. The Advisory Board helps918management evaluate new product ideas and concepts and, once a product is919approved for development, its subsequent design and development. The Advisory920Board may also participate in the clinical testing of products developed.</P>921<P>Certain members of the Advisory Board are employed by academic institutions922and may have commitments to or consulting or advisory agreements with other923entities that may limit their availability to us. The members of the Advisory924Board may also serve as consultants to other medical device companies. No member925of the Advisory Board is expected to devote more than a small amount of time to926ANS.</P>927<P><B><U>Employees</U></B></P>928<P>As of March 12, 2002, we employed 226 full-time employees, 44 in research and929development, 29 in sales and marketing, 133 in manufacturing and related930operations, and the remainder in executive and administrative positions. This931total includes 102 full-time employees at HDI, which we acquired on January 2,9322001. None of our employees is represented by a labor union and we consider our933employee relations to be good.</P>934<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>935<TR>936<TD WIDTH=15%><B>ITEM 2.</B></TD>937<TD WIDTH=85%><B>PROPERTIES</B></TD></TR></TABLE>938<P>We entered a 63 month lease agreement in February 1999 for our 40,000 square939foot corporate headquarters and manufacturing facility in Plano, Texas. Under940the terms of the lease agreement, which became effective on June 1, 1999, we941received three months of free rent and the monthly rental rate for the remaining942term of the lease is $48,308. The monthly rental rate includes certain operating943expenses such as property taxes on the facility, insurance, landscape and944maintenance and janitorial services. We also have a right of first refusal to945acquire the facility.</P>946<P ALIGN=CENTER>Page 14</P><HR>947948<PAGE>949<P>We also lease facilities in New Jersey as a result of our acquisition of950Hi-tronics Designs, Inc. on January 2, 2001. One of the facilities, located in951Budd Lake, New Jersey, is 8,800 square feet of office space that is used for952administration, design engineering, drafting, documentation and regulatory953affairs. The lease expires on May 31, 2003 and has a monthly rental rate of954$10,891. We also lease 15,000 square feet of space in Hackettstown, New Jersey955used for our O.E.M. manufacturing operations. The Hackettstown lease, which956expires on December 31, 2002, has a monthly rental rate of $9,636 and is957renewable for two additional one-year periods. In addition, on January 1, 2001,958Hi-tronics entered an agreement to lease an additional 2,200 square feet of959additional space in the Hackettstown facility adjacent to the 15,000 square feet960of manufacturing space. The lease expires on June 30, 2002 and has a monthly961rental rate of $2,269. All of the monthly rental rates include certain operating962expenses such as property taxes, insurance, utilities, landscape and maintenance963and janitorial services.</P>964<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>965<TR>966<TD WIDTH=15%><B>ITEM 3.</B></TD>967<TD WIDTH=85%><B>LEGAL PROCEEDINGS</B></TD></TR></TABLE>968<P>We are a party to product liability claims that arise in the ordinary course969of business related to our neurostimulation devices. Product liability insurers970have assumed responsibility for defending us against these claims, subject to971reservation of rights in certain cases. While historically, product liability972claims for our neurostimulation devices have not resulted in significant973monetary liability beyond our insurance coverage, we cannot assure you that we974will not incur significant monetary liability in the future if such insurance is975unavailable or inadequate for any reason, or that our current neurostimulation976business and future neuromodulation products will not be adversely affected by977these product liability claims. While we seek to maintain appropriate levels of978product liability insurance with coverage that we believe is comparable to that979maintained by companies similar in size and serving similar markets, we cannot980assure you that we will avoid significant future product liability claims981relating to our neurostimulation systems.</P>982<P>Except for the product liability claims discussed above, we are not currently983a party to any other pending legal proceeding. We maintain general liability984insurance against risks arising out of the normal course of business.</P>985<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>986<TR>987<TD WIDTH=15% VALIGN=TOP><B>ITEM 4.</B></TD>988<TD WIDTH=85%><B>SUBMISSION OF MATTERS TO A VOTE OF SECURITY989HOLDERS</B></TD></TR></TABLE>990<P>Inapplicable.</P>991<P ALIGN=CENTER>Page 15</P><HR>992993<PAGE>994<P ALIGN=CENTER><B>PART II</B></P>995<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>996<TR>997<TD WIDTH=15% VALIGN=TOP><B>ITEM 5.</B></TD>998<TD WIDTH=85%><B>MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED999STOCKHOLDER MATTERS</B></TD></TR></TABLE>1000<P>Our common stock is currently quoted on the Nasdaq National Market under the1001symbol "ANSI." On March 12, 2002, there were approximately 588 holders of record1002of our common stock. The following table sets forth the quarterly high and low1003closing sales prices for our common stock. These prices do not include1004adjustments for retail mark-ups, markdowns or commissions.</P>1005<PRE>10062000: High Low1007-------------- --------------1008First Quarter $ 19.38 $ 9.941009Second Quarter $ 18.38 $ 12.251010Third Quarter $ 21.50 $ 14.251011Fourth Quarter $ 23.19 $ 19.25101210132001: High Low1014-------------- --------------10151016First Quarter $ 26.88 $ 11.001017Second Quarter $ 26.00 $ 10.631018Third Quarter $ 25.85 $ 19.001019Fourth Quarter $ 35.55 $ 20.02102010212002: High Low1022-------------- --------------10231024First Quarter $ 36.20 $ 28.531025(through March 12, 2002)1026</PRE>1027<P>To date, we have not declared or paid any cash dividends on our common stock1028and the Board of Directors does not anticipate paying cash dividends on our1029common stock in the foreseeable future.</P>1030<P ALIGN=CENTER>Page 16</P><HR>10311032<PAGE>1033<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1034<TR>1035<TD WIDTH=15%><B>ITEM 6.</B></TD>1036<TD WIDTH=85%><B>SELECTED FINANCIAL DATA</B></TD></TR></TABLE>1037<PRE>1038----------------------------------------------------------------------1039Years Ended December 31,1040----------------------------------------------------------------------10412001 2000 1999 1998 19971042-------------- ------------- ------------- ------------- -------------1043(in thousands, except per share data)1044Statements of Income Data: (1) (2)10451046Net revenue (3) $ 37,916 $ 31,827 $ 26,879 $ 23,417 $ 19,1291047Total net revenue 37,916 31,827 35,779 26,517 19,1291048Gross profit 22,241 17,127 23,852 13,993 11,0411049Research and development expense 4,928 3,854 4,097 2,790 1,0911050Marketing, general and1051administrative and1052amortization expenses 14,504 12,328 11,286 10,701 8,3011053Income from operations 2,809 945 8,469 3,602 1,6491054Net income from continuing1055operations 1,518 832 5,817 2,327 4931056Loss from discontinued operations -- -- -- (212) (93)1057Gain on the sale of assets of1058discontinued operations -- -- -- 4,585 --1059Net income (loss) from1060discontinued operations -- -- -- 4,373 (93)1061Net income $ 1,518 $ 832 $ 5,817 $ 6,700 $ 40010621063Diluted income (loss) per1064share:1065Continuing operations $ .15 $ .09 $ .64 $ .24 $ .051066Discontinued operations $ -- $ -- $ -- $ .45 $ (.01)1067Net income (loss) $ .15 $ .09 $ .64 $ .69 $ .041068106910701071<PAGE>1072----------------------------------------------------------------------1073Years Ended December 31,1074----------------------------------------------------------------------10752001 2000 1999 1998 19971076-------------- ------------- ------------- ------------- -------------1077(in thousands)1078Balance Sheet Data(2):10791080Cash, cash equivalents,1081certificates of deposit and1082marketable securities $ 11,937 $ 11,599 $ 9,736 $ 13,982 $ 4,6301083Working capital 24,906 22,211 17,626 18,042 16,7021084Total assets 55,865 49,565 48,407 49,546 53,5481085Short-term notes payable and1086current maturities of1087long-term notes payable 52 30 -- 3,633 8,6331088Notes payable, excluding1089current maturities 137 212 -- 1,000 4,8691090Stockholders' equity $ 46,812 $ 40,442 $ 36,536 $ 34,769 $ 35,53010911092</PRE>1093<P>__________________________</P>1094<P>(1) On January 30, 1998, the Company sold its cardiovascular and intravenous1095fluid delivery product lines (CVS Operations). The CVS Operations have been1096accounted for as discontinued operations.</P>1097<P>(2) On January 2, 2001, the Company completed the acquisition of Hi-tronics1098Designs, Inc. The transaction was accounted for on a pooling of interests basis1099and accordingly, prior periods have been restated.</P>1100<P>(3) Net revenue excludes contract research and development revenue in 19981101and 1999 from our former agreement with Sofamor Danek. See Note 12 of the1102Notes to Consolidated Financial Statements.</P>11031104<P>The following is a reconciliation of previously reported amounts with1105restated amounts for total net revenue and net income(loss):</P>1106<PRE>1107------------------------------------------------------------------------------1108Years Ended December 31,1109------------------------------------------------------------------------------1110------------------------------------------------------------------------------11112000 1999 1998 19971112--------------- --------------- --------------- ---------------1113(in thousands)1114Reconciliation of total net revenue:11151116As previously reported by the Company $ 23,082 $ 29,478 $ 20,106 $ 14,7181117HDI, for the year ended November 30 $ 10,366 7,989 6,746 4,4111118Elimination of intercompany transactions $ (1,621) (1,688) (335) --1119Total net revenue as restated $ 31,827 $ 35,779 $ 26,517 $ 19,12911201121Reconciliation of net income (loss):1122As previously reported by the Company $ 954 $ 6,003 $ 6,959 $ 7241123HDI, for the year ended November 30 $ 28 328 (174) (231)1124Elimination of intercompany transactions $ (150) (514) (85) $ --1125Total net revenue as restated $ 832 $ 5,817 $ 6,700 $ 49311261127</PRE>112811291130<P ALIGN=CENTER>Page 17</P><HR>11311132<PAGE>1133<P></P>1134<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1135<TR>1136<TD WIDTH=15% VALIGN=TOP><B>ITEM 7.</B></TD>1137<TD WIDTH=85%><B>MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND1138RESULTS OF OPERATIONS</B></TD></TR></TABLE>1139<P>The following discussion of the financial condition and results of operations1140of the Company should be read in conjunction with the Consolidated Financial1141Statements of the Company and the related Notes.</P>1142<P><B>Critical Accounting Policies and Estimates</B></P>1143<P><I>General</I></P>1144<P>ANS' discussion and analysis of its financial condition and results of1145operations are based upon ANS' consolidated financial statements, which have1146been prepared in accordance with accounting principles generally accepted in the1147United States. The preparation of these financial statements requires management1148to make estimates and judgments that affect the reported amounts of assets,1149liabilities and related disclosure of contingent assets and liabilities at the1150date of the financial statements and the reported amounts of revenues and1151expenses during the reporting period. On an on-going basis, management evaluates1152its estimates and judgments, including those related to product returns, bad1153debts, inventories, intangible assets, warranty obligations and contingencies1154and litigation. Management bases its estimates on historical experience and on1155various other factors that are believed to be reasonable under the1156circumstances, the results of which form the basis for making judgments about1157the carrying value of assets and liabilities that are not readily apparent from1158other sources. Actual results may differ from these estimates under different1159assumptions or conditions.</P>1160<P>Management believes the following critical accounting policies affect its1161more significant judgments and estimates used in preparation of its consolidated1162financial statements.</P>1163<P><I>Revenue Recognition</I></P>1164<P>Revenue from the sale of our neuromodulation products and custom manufactured1165O.E.M. products at HDI is recognized when the goods are shipped to our1166customers. We record, as a reduction in revenue, a provision for estimated sales1167returns and allowances on these product sales in the same period as the related1168revenues are recorded. These estimates are based on historical sales returns,1169analysis of credit memo data and other known factors. If the historical data we1170use to calculate these estimates does not properly reflect future returns,1171revenue could be overstated.</P>1172<P>We also design and develop products at HDI under fixed price development1173agreements with third parties. Each development agreement reflects the terms and1174conditions of the project, including project objectives, product specifications,1175responsibilities for tasks, licenses and fields of use of intellectual1176properties, manufacturing rights and compensation to be paid to HDI, amongst1177other terms and conditions. A typical development project will take one to two1178years to complete and is undertaken in accordance with the Design Controls of1179the FDA's QSR and similar international standards. We recognize revenue and1180profit under the development agreements using the percentage-of-completion1181method, which relies on estimates of total expected revenue and costs. We follow1182this method since reasonably dependable estimates of revenue and costs1183applicable to various stages of a development agreement can be made. If we do1184not accurately estimate the resources required or the scope of work to be1185performed under a development agreement, then future profit margins and results1186of operations may be negatively impacted.</P>1187<P>In certain cases, HDI will undertake a development project on a cost plus1188basis. In this event, we periodically invoice the customer for actual time and1189material expended on the project at predetermined hourly billing rates and mark1190ups.</P>1191<P ALIGN=CENTER>Page 18</P><HR>11921193<PAGE>1194<P><I>Bad Debt</I></P>1195<P>We are required to estimate the collectibility of our trade receivables. A1196considerable amount of judgment is required in assessing the ultimate1197realization of the receivables including the current credit-worthiness of each1198customer. If the financial condition of our customers were to deteriorate,1199resulting in an impairment of their ability to make payments, additional1200allowances or write-offs may be required.</P>1201<P><I>Inventory</I></P>1202<P>Our reserve for excess and obsolete inventory is based upon forecasted demand1203for our products. If the demand for our products is less favorable than those1204projected by management, additional inventory write-downs or write-offs may be1205required.</P>1206<P><I>Intangible Assets</I></P>1207<P>Goodwill associated with the excess purchase price over the fair value of1208assets acquired and other identifiable intangible assets, such as patents,1209purchased technology, tradenames and covenants not to compete, are currently1210amortized on the straight-line method over their estimated useful lives.</P>1211<P>In assessing the recoverability of our intangible assets, we must make1212assumptions regarding estimated future cash flows and other factors to determine1213the fair value of the respective assets. If these estimates or their related1214assumptions change in the future, we may be required to record impairment1215charges for these assets not previously recorded.</P>1216<P><I>Warranty Obligations</I></P>1217<P>Our products are generally covered by a one-year warranty. We accrue a1218warranty reserve for estimated costs to provide warranty services. Our estimate1219of costs to service our warranty obligations is based on historical experience1220and expectation of future conditions. To the extent we experience increased1221warranty claim activity or increased costs associated with servicing those1222claims, our warranty accrual will increase resulting in decreased gross profit.1223</P>1224<P><I>Contingencies</I></P>1225<P>We are subject to proceedings, lawsuits and other claims related to our1226products and business. We are required to assess the likelihood of any adverse1227judgments or outcomes to these matters as well as potential ranges of probable1228losses. A determination of the amount of reserves required, if any, for these1229contingencies are made after careful analysis of each individual issue. The1230required reserves may change in the future due to new developments in each1231matter or changes in approach, such as a change in settlement strategy, in1232dealing with these matters.</P>1233<P>Currently, product liability claims are the only litigation to which we are a1234party. While historically our product liability claims have not resulted in1235significant monetary liability beyond our insurance coverage, an adverse1236judgment beyond our insurance coverage could have a material adverse impact on1237our results of operations and financial condition.</P>1238<P><B>Overview</B></P>1239<P>On November 21, 2001, the FDA approved the Pre-Market Approval (PMA)1240application for our <I>Genesis</I> IPG. This approval enables us to commercially1241market the <I>Genesis</I> IPG in the United States, which we formally commenced1242in January 2002 and to participate in 100% of the neurostimulation market to1243treat chronic pain of the trunk and limbs. Industry analysts estimate that the1244worldwide IPG market is growing at a 26% annual rate and will approach $3001245million in 2002. Until our launch of the <I>Genesis</I> IPG, only one other1246company marketed an approved IPG device in the United States.</P>1247<P ALIGN=CENTER>Page 19</P><HR>12481249<PAGE>1250<P>On January 2, 2001, we acquired the assets (primarily intellectual property1251consisting of patents and know-how) of Implantable Devices Limited Partnership1252(IDP) and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota1253companies, for 119,100 shares of ANS common stock. Based on the closing price of1254ANS common stock on December 29, 2000, the value of the stock issued to acquire1255the assets was $2.43 million. IDP was formed in 1986 to commercialize certain1256implantable infusion technologies developed at the University of Minnesota. We1257entered a license agreement with IDP in 1995 to license rights to implantable1258infusion pump technologies developed by IDP and ESOX for applications in pain1259and cancer therapy. Under the license agreement, we were obligated to pay IDP1260royalties on worldwide sales of implantable infusion pumps using IDP technology.1261The January 2, 2001 acquisition canceled the license agreement, thereby1262eliminating our future royalty obligations, and expanded our rights to use the1263pump technologies in all applications through our acquisition of the1264intellectual property. We completed development of our <I>AccuRx</I> fully1265implantable constant rate infusion pump in late 2000 using technology we1266licensed from IDP. We received CE mark approval to distribute the pump1267internationally and commenced sales internationally during the second quarter of1268fiscal 2001. We also received an Investigational Device Exemption (IDE) from the1269FDA to initiate clinical trials in the United States. The clinical trials1270include 109 patients and are being conducted in fifteen sites. The trials1271commenced in the first quarter of 2001 and are progressing according to plan.1272The data gathered during the trials will be used to support our PMA1273application.</P>1274<P>Also on January 2, 2001, we completed the acquisition of Hi-tronics Designs,1275Inc. (HDI or Hi-tronics), a privately-held contract developer and original1276equipment manufacturer (OEM) of electro-mechanical devices headquartered in Budd1277Lake, New Jersey. We acquired HDI through a stock-for-stock merger in which we1278issued 1,104,725 shares of ANS common stock. The transaction is accounted for on1279a pooling of interests basis and accordingly, prior year results have been1280restated. HDI developed and is the manufacturer of our <I>Genesis</I> IPG and is1281also the O.E.M. manufacturer of the transmitter used with our <I>Renew</I>1282radio-frequency spinal cord stimulation system. HDI was founded in 1987 and has1283developed more than sixty medical devices for some of the leading medical device1284companies in the fields of cardiology, neurology and orthopedics. The core1285strength of HDI is in developing highly sophisticated electronic circuits with1286very low power requirements, utilizing both discrete and highly integrated1287technology. We believe this competency, when combined with our own strengths in1288lead design and packaging, will allow us to develop more sophisticated products1289in compressed, development-cycle timetables. In addition, the merger will result1290in vertical integration benefits in manufacturing that should enhance margins on1291our current and future products.</P>1292<P>As a result of HDI's fiscal year ending on a different date than the1293Company's, for the one-month period ended December 31, 2000 the results of1294operations of HDI have been charged directly to retained earnings in the1295Consolidated Statement of Stockholders' Equity for the period ended December 31,12962001. During the month of December 2000, HDI recorded net revenue of $119,4811297and a loss before income tax benefit of $591,600. The net loss for the one-month1298period ended December 31, 2000 was $347,679. Results of HDI for this one-month1299period were negatively impacted by a problem with a component supplied by a1300vendor. This resulted in substantially lower than normal revenue since the1301products using the component could not be manufactured and delivered. The1302component problem was quickly resolved with the vendor and shipments of1303products using the component commenced in late January 2001.</P>1304<P>In June 1998, we entered into an agreement under which we would develop and1305manufacture products and systems for use in Deep Brain Stimulation ("DBS") for1306Sofamor Danek. See Note 12 - "Product Development Agreement" of the Notes to1307Consolidated Financial Statements. We received a payment of $4 million upon1308execution of the agreement that was being recognized into income as revenue1309based upon the estimated completion of the development project. During the year1310ended December 31, 1998, we recognized $3.1 million into income as revenue. The1311remaining $900,000 was recognized into income as revenue during January 1999 due1312to the termination of the agreement with Sofamor Danek as a result of the merger1313of Sofamor Danek and Medtronic, Inc. In connection with the termination, we also1314received an additional payment of $8 million from Sofamor Danek, which was1315recognized into income as revenue during January 1999.</P>1316<P ALIGN=CENTER>Page 20</P><HR>13171318<PAGE>1319<P><B>Results of Operations</B></P>1320<P><I>Comparison of the Years Ended December 31, 2001 and 2000</I></P>1321<P>We reported net income of $1.52 million or $.15 per diluted share in 20011322compared to $832,000 or $.09 per diluted share in 2000. The results for 20011323include a pretax expense of $484,000 for costs associated with our acquisition1324of HDI on January 2, 2001. These costs were expensed instead of capitalized1325because the acquisition is accounted for under the pooling of interests method.1326</P>1327<P>Total net revenue of $37.92 million for the year ended December 31, 20011328increased 19.1% from the comparable 2000 level of $31.83 million. This growth1329was attributable to both continued strong sales of our advanced neuromodulation1330products used to treat chronic pain, which increased 19.0% to $27.46 million,1331and higher sales at HDI, which increased 19.6% to $10.46 million. On November133221, 2001, we received approval from the FDA to begin marketing our1333<I>Genesis</I> IPG in the United States and the first implants occurred in late1334December 2001. We formally launched the <I>Genesis</I> IPG in the United States1335in January 2002.</P> <P>The launch of the <I>Genesis</I> IPG could temporarily1336impede growth in sales of <I>Renew</I> systems, which could affect the rate of1337our overall revenue and profitability growth. Although <I>Genesis</I> and1338<I>Renew</I> are targeted towards patients with different types of pain and1339<I>Genesis</I> is not intended to replace <I>Renew</I> in the neuromodulation1340market, some pain specialists may recommend <I>Genesis</I> to their patients1341when they would have otherwise recommended <I>Renew</I>, and consquently,1342<I>Genesis</I> may substitute for some sales of <I>Renew</I>. Although it is too1343early in the process to accurately predict the future impact of this factor,1344management believes that it is possible that sales of <I>Renew</I> may plateau1345or even decline modestly, at lease during the first several months of1346<I>Genesis</I> sales.<P>1347<P>Because neuromodulation devices have gained acceptance as a viable,1348efficacious and cost-effective treatment alternative for relieving chronic1349intractable pain and improving neurological function, we are continuing our1350efforts to expand our product offerings in the high-growth market of1351neuromodulation. Today, we are a market share and technology leader in the1352radio-frequency stimulation segment of the neuromodulation market, which1353industry analysts expect to approach $74 million in 2002, and we are now only1354the second market participant in the totally implantable stimulation segment1355which industry analysts expect to approach $300 million in 2002. Over the last1356three years, to position us to participate in the other larger and more rapidly1357growing segments of the neuromodulation market, we continued to aggressively1358invest in development projects for our technology platforms, including our IPG1359for spinal cord stimulation, IPG for deep brain stimulation and a fully1360implantable constant-rate infusion pump. Some of the fruits of our development1361efforts were realized during 2001 when we received CE mark approval and began1362commercialization of our <I>Genesis</I> IPG and <I>AccuRx</I> constant flow1363implantable infusion pump in international markets during the first half of 20011364and when we received FDA approval of our <I>Genesis</I> IPG in November 2001 and1365subsequently launched it in the United States in January 2002. In 2002, we plan1366to continue our development efforts on advanced technology platforms for1367stimulation and drug delivery therapies.</P>1368<P>Gross profit increased to $22.24 million in 2001 from $17.13 million in 20001369due to the increase in net revenue discussed above and an improvement in gross1370profit margins. Gross profit margin increased to 58.7% in 2001 compared to 53.8%1371in 2000, due to higher sales of the <I>Renew</I> radio frequency spinal cord1372stimulation system, which contributes higher margins than HDI product sales, a1373reduction in specialty distributor sales where we recognize lower margins than1374sales through commissioned sales agents and operational efficiencies from higher1375manufacturing volumes.</P>1376<P>Total operating expenses (the aggregate of research and development,1377marketing, amortization of intangibles and administrative expenses) increased to1378$19.43 million in 2001 compared to $16.18 million in 2000, and as a percentage1379of total net revenue, increased to 51.2% in 2001 from 50.8% in 2000. In 2001, we1380continued to invest in our product development pipeline and in infrastructure to1381enhance our sales and marketing capabilities.</P>1382<P ALIGN=CENTER>Page 21</P><HR>13831384<PAGE>1385<P>Research and development expense increased to $4.93 million in 2001, or 13.0%1386of 2001 total net revenue, from $3.85 million during 2000, or 12.1% of 20001387total net revenue. This increase in the absolute dollar amount in 2001 compared1388to 2000 was the result of higher consulting expense and test material expense.1389During 2001, these expenditures were directed toward development of our IPG1390stimulation system platforms for spinal cord stimulation, our next generation1391radio-frequency stimulation system platform, our proprietary constant-rate1392infusion pump and an IPG stimulation system for Deep Brain Stimulation.</P>1393<P>Marketing expense, as a percentage of total net revenue, increased from 21.5%1394in 2000 to 23.9% in 2001, and the absolute dollar amount increased from $6.851395million during 2000 to $9.06 million in 2001. This dollar increase during 20011396was attributable to higher commission expense from increased product sales and a1397change from distributors to commissioned sales agents in certain United States1398territories, higher salary and benefit expense from staffing additions in1399reimbursement and direct sales personnel, higher expense for education and1400training of new implanters and higher expense for new product introductions.</P>1401<P>General and administrative expense decreased to $3.96 million during 20011402from $4.24 million in 2000 and as a percentage of total net revenue, decreased1403to 10.4% in 2001 from 13.3% during 2000. The decrease in this expense during14042001 was principally the result of lower salary expense from a reduction in1405certain salaries of the former owners of HDI effective as of January 2001 when1406we acquired HDI.</P>1407<P>Amortization of goodwill and other intangibles increased to $1.49 million in14082001 from $1.23 million in 2000 primarily due to additional amortization expense1409for patents we acquired from ESOX on January 2, 2001.</P>1410<P>Other income decreased to an expense of $26,000 in 2001 from income of1411$546,000 in 2000 primarily as a result of an expense in 2001 of $484,000 for1412costs associated with the acquisition of HDI and lower interest income due to1413lower yields on invested funds.</P>1414<P>Income tax expense increased to $1.27 million in 2001 from $659,000 in 2000,1415and the overall effective tax rate was 45.5% in 2001 compared to 44.2% in 2000.1416Our expense for amortization of costs in excess of net assets acquired1417(goodwill) is not deductible for tax purposes, and, when combined with a1418provision for state taxes, results in the higher effective tax rate during both14192001 and 2000 compared to the U.S. statutory rate for corporations of 34%. In1420addition, approximately $234,000 of the $484,000 of costs incurred in the1421acquisition of HDI are not deductible for tax purposes, which also contributed1422to the higher effective tax rate during 2001 compared to the U.S. statutory rate1423of 34%.</P>1424<P><I>Comparison of the Years Ended December 31, 2000 and 1999</I><P>1425<P>We reported net income of $832,000 or $.09 per diluted share in 2000 compared1426to $5.82 million or $.64 per diluted share in 1999. The 1999 results benefited1427from $8.9 million of revenue recorded in connection with our former development1428agreement with Sofamor Danek.</P>1429<P>Total net revenue of $31.83 million for the year ended December 31, 2000, was1430$3.95 million below the comparable 1999 level of $35.78 million due to $8.91431million of net revenue in the 1999 period associated with our former development1432agreement with Sofamor Danek. Excluding the development agreement revenue, net1433revenue increased 18.4% to $31.83 million in 2000 from $26.88 million in 1999.1434This increase in net revenue was the result of higher unit sales volume of our1435<I>Renew</I> systems, which increased $2.5 million or 12.2% to $23.08 million.1436Sales at HDI also increased $2.45 million or 38.9% to $8.75 million.<P>1437<P>Gross profit decreased to $17.13 million in 2000 from $23.85 million in 19991438due to the decrease in total net revenue discussed above and a decrease in gross1439profit margins. Gross profit margin decreased to 53.8% in 2000 from 66.7% in14401999 due to higher revenue from HDI, whose O.E.M. sales contribute lower gross1441margins than our proprietary neuromodulation products and the contract revenue1442in 1999 from our development agreement with Sofamor Danek, which contributed1443higher gross margins. Gross profit margin from sales of the neuromodulation1444products remained approximately the same at 67.6% in the 2000 period compared to144567.8% in the 1999 period.</P>1446<P ALIGN=CENTER>Page 22</P><HR>14471448<PAGE>1449<P>Total operating expenses (the aggregate of research and development,1450marketing, amortization of intangibles and administrative expenses) increased to1451$16.18 million in 2000 from $15.38 million in 1999, and as a percentage of total1452net revenue, increased to 50.8% in 2000 from 43.0% in 1999.</P>1453<P>Research and development expense decreased in absolute dollars to $3.851454million in 2000, or 12.1% of 2000 total net revenue, from $4.10 million during14551999, or 11.4% of 1999 total net revenue. This decrease in absolute dollars1456during 2000 compared to 1999 was the result of lower consulting expense. During14572000, these expenditures were directed toward development of our IPG stimulation1458system for spinal cord stimulation, our next generation radio-frequency1459stimulation system, our proprietary constant-rate infusion pump and an IPG1460stimulation system for Deep Brain Stimulation.</P>1461<P>Marketing expense, as a percentage of total net revenue, increased from 17.6%1462in 1999 to 29.7% in 2000, while the absolute dollar amount increased from $6.291463million during 1999 to $6.85 million in 2000. This dollar increase during 20001464was attributable to higher commission expense from increased product sales and a1465change from distributors to commissioned sales agents in certain United States1466territories, higher expense for education and training of new implanters and1467higher convention expense.</P>1468<P>General and administrative expense increased from $3.81 million during 19991469to $4.24 million in 2000 and as a percentage of total net revenue, increased to147013.3% in 2000 from 10.6% during 1999. The increase of $435,000 in absolute1471dollar expense during 2000 was principally the result of higher legal expense,1472property tax expense, investor relations expense and consulting expense.</P>1473<P>Amortization of goodwill and other intangibles increased slightly to $1.231474million in 2000 from $1.19 million during 1999 due to expense for additional1475patents we licensed.</P>1476<P>Other income decreased to $546,000 in 2000 from $687,000 in 1999 primarily as1477a result of lower interest income due to lower funds available for investment.1478</P>1479<P>Income tax expense decreased to $659,000 in 2000 from $3.34 million in 19991480due to lower income before income taxes in 2000 compared to 1999, as the 19991481period included the $8 million termination payment from our former development1482agreement with Sofamor Danek. This represents effective tax rates of 43.6% in14832000 and 36.5% in 1999. Our expense for amortization of costs in excess of net1484assets acquired (goodwill) was not deductible for tax purposes, and, when1485combined with a provision for state taxes, resulted in the higher effective tax1486rate during both 2000 and 1999 compared to the U.S. statutory rate for1487corporations of 34%.</P>1488<P><B>Liquidity and Capital Resources</B></P>1489<P>At December 31, 2001 our working capital increased to $24.91 million from1490$22.21 million at year-end 2000. The ratio of current assets to current1491liabilities was 4.77:1 at December 31, 2001, compared to 5.37:1 at December 31,14922000. Cash, cash equivalents, certificates of deposit and marketable securities1493totaled $11.94 million at December 31, 2001 compared to $11.60 million at1494December 31, 2000.</P>1495<P ALIGN=CENTER>Page 23</P><HR>14961497<PAGE>1498<P>We increased our investment in inventories to $9.75 million at December 31,14992001, from $7.09 million at December 31, 2000. This increase from year-end 20001500was primarily the result of three factors. First, we increased our investment in1501consignment inventories as a result of adding fifteen commissioned sales agents1502during 2001 to whom we provide approximately $30,000 in consignment inventory1503each. Second, we purchased raw material and produced finished goods inventory1504for our <I>AccuRx</I> drug pump to support its launch internationally and for1505clinical trails in the United States. Third and most significantly, we purchased1506raw materials and produced finished goods of our <I>Genesis</I> IPG to support1507our international launch during 2001 and to prepare for our launch in the United1508States in January 2002.</P>1509<P>We spent $3.11 million during 2001 for capital expenditures, non-competes and1510license fees for additional patents and intellectual property we are licensing.1511Of these expenditures, $1.96 million was spent for manufacturing tooling and1512equipment for new products we developed, including the <I>Genesis</I> IPG and1513<I>AccuRx</I> drug pump, $500,000 was spent for computer equipment and office1514furniture, $557,000 was spent for license fees and non-competes and $85,000 was1515spent for leasehold improvements. </P>1516<P>We believe our current cash, cash equivalents, certificates of deposit and1517marketable securities and cash generated from operations will be sufficient to1518fund our current levels of operating needs and capital expenditures for the1519foreseeable future. We currently have no credit facilities in place. If we1520decide to acquire complementary businesses or product lines, or enter into joint1521ventures or strategic alliances that require substantial capital, we intend to1522finance those activities by the most attractive alternative available, which1523could be bank borrowings or the issuance1524of debt or equity securities.</P>1525<P><B>Cash Flows</B></P>1526<P>Net cash provided by operating activities was $3.06 million in 2001, $690,0001527in 2000 and $2.95 million in 1999. Net cash provided by operating activities1528increased from $690,000 in 2000 to $3.06 million in 2001, an increase of1529approximately $2.38 million. This increase in 2001 compared to 2000 was1530primarily the result of an increase in net income of $685,000 ($1.52 million in15312001 from $832,000 in 2000) and a $1.41 million decrease in the amount of cash1532used for changes in working capital components ($2.76 million in 2000 to $1.351533million in 2001). For 2000 compared to 1999, net cash provided by operating1534activities decreased from $2.95 million in 1999 to $690,000 in 2000, a decrease1535of approximately $2.26 million. This decrease in 2000 compared to 1999 was1536primarily the result of a $4.98 million decrease in net income ($832,000 in 20001537from $5.82 million in 1999) due to the 1999 period including the $8 million1538pretax termination payment from our former development agreement with Sofamor1539Danek. In 2000 however, we reduced the cash used for changes in working capital1540components from $5.13 million in 1999 to $2.76 million in 2000, a reduction of1541$2.37 million.</P>1542<P>Net cash used in investing activities was $3.09 million in 2001 and $2.941543million in 2000 while investing activities provided cash of $803,000 in 1999. In15442001, our primary investing activities using cash were the purchase of1545marketable securities ($3.90 million) and capital expenditures ($3.11 million)1546for additional manufacturing tooling and equipment, office furniture and1547equipment, non-compete agreements and licensing fees for patents, while maturing1548certificates of deposit and sales of marketable securities provided cash of1549$3.92 million. In 2000, our primary investing activities using cash were the1550purchase of marketable securities and certificates of deposit with maturities1551over 90 days ($2.23 million) and capital expenditures ($1.65 million) for1552additional manufacturing tooling and equipment, office furniture and equipment1553and licensing fees for patents, while maturing certificates of deposit and the1554sale of marketable securities provided cash of $949,000. In 1999, our primary1555investing activities using cash were the purchase of marketable securities1556($380,000) and capital expenditures ($5.64 million) for leasehold improvements1557and furnishings and equipment for our newly leased Plano, Texas facility,1558manufacturing tooling and equipment and licensing fees for patents, while we1559received net proceeds of $6.35 million from the sale of our facility to Atrion1560Corporation and $466,000 from the sale of marketable securities.</P>1561<P ALIGN=CENTER>Page 24</P><HR>15621563<PAGE>1564<P>Net cash provided by financing activities was $957,000 in 2001 and $2.571565million in 2000, while financing activities in 1999 used cash of $7.81 million.1566During 2001, we used $48,000 to reduce certain debt obligations, while we1567received approximately $1.0 million from the exercise of stock options. During15682000, we used $29,000 to reduce certain debt obligations, while we received $2.61569million of cash from the exercise of stock options ($1.93 million), the private1570placement of common stock ($400,000) and proceeds from a long-term note payable1571($270,000). During 1999, we used $3.63 million to repay our mortgage debt when1572we sold our facility to Atrion Corporation and $4.75 million for share1573repurchases, while we received approximately $573,000 from the exercise of stock1574options.</P>1575<P><B>Currency Fluctuations</B></P>1576<P>Substantially all of our international sales are denominated in U.S. dollars.1577Fluctuations in currency exchange rates in other countries could reduce the1578demand for our products by increasing the price of our products in the currency1579of the countries in which the products are sold, although we do not believe1580currency fluctuations have had a material effect on the Company's results of1581operations to date.</P>1582<P><B>Outlook and Uncertainties</B></P>1583<P>The following is a "safe harbor" statement under the Private Securities1584Litigation Reform Act of 1995: Certain matters discussed in this Annual Report1585on Form 10-K contain statements that constitute forward-looking statements1586within the meaning of Section 21E of the Securities Exchange Act of 1934, as1587amended. The words "expect," "estimate," "anticipate," "predict," "believe,"1588"plan," "will," "should," "intend," "new market," "potential market1589applications," and similar expressions and variations are intended to identify1590forward-looking statements. Such statements appear in a number of places in this1591Annual Report on Form 10-K and include statements regarding our intent, belief1592or current expectations with respect to, among other things: (i) trends1593affecting our financial condition or results of operations; (ii) our financing1594plans; and (iii) our business growth strategies. We caution our readers that any1595forward-looking statements are not guarantees of future performance and involve1596risks and uncertainties. Actual results may differ materially from those1597projected in the forward-looking statements as a result of various factors.1598These risks and uncertainties include the following:</P>1599<P><B>Failure of our <I>Genesis</I> IPG to gain market acceptance would1600adversely affect our revenues and profitability.</B></P>1601<P>We formally introduced our <I>Genesis</I> IPG device in the U.S. in January16022002. We believe that the potential for growth in the IPG segment of the1603neuromodulation market is much greater than in the RF segment. Accordingly, our1604ability to generate increased revenue and profitability, and thus our general1605success, will depend, in large part, on the market's acceptance of our new IPG1606device. As a new entrant into the IPG market, there are many reasons we might1607not achieve market acceptance on a timely basis, if at all, including the1608following:</P>1609<UL>1610<LI>competing products, technologies and therapies are available, and others may1611be introduced, that gain greater and faster doctor and patient acceptance than1612our IPG device; and1613<LI>our only competitor in the IPG market has had its IPG product on the market1614for some time and enjoys significant brand awareness among pain specialists.1615</UL>1616<P>If industry analysts are correct that the IPG segment of the neuromodulation1617will grow at a much faster rate than the RF segment, our failure to successfully1618market and sell our IPG device could negatively affect our revenue growth rate1619and our profitability.</P>1620<P ALIGN=CENTER>Page 25</P><HR>16211622<PAGE>1623<P><B>Our main competitor has significantly greater resources, which may make it1624difficult for us to successfully compete in the neurostimulation market.</B></P>1625<P>The medical device market is highly competitive, subject to rapid change and1626is significantly affected by new product introductions and other market1627activities of industry participants. Medtronic, Inc. is the largest and1628strongest competitor in the medical device sector, and is currently our sole1629competitor in the neurostimulation market. Medtronic is a large publicly-traded1630company and enjoys several competitive advantages over us, including:</P>1631<UL>1632<LI>substantially greater name recognition;1633<LI>greater resources for product research and development, sales and marketing,1634distribution, patent protection and pursuing regulatory approvals;1635<LI>a greater number of established relationships with health care1636professionals, customers and third-party payors; and1637<LI>multiple product lines and the ability to bundle products together or offer1638discounts, rebates or other incentives to secure a competitive advantage.</UL>1639<P>Medtronic, and possibly other future competitors, will continue to develop1640new products that compete directly with our products, and its greater resources1641may allow it to respond more quickly to new technologies, new treatment1642indications or changes in customer requirements. For all of these reasons, we1643may not be able to compete successfully against Medtronic or against similar1644future competitors.</P>1645<P><B>Any adverse changes in coverage or reimbursement amounts by Medicare,1646Medicaid, workers' compensation programs or private insurers, including1647insurance companies and HMOs, may limit our ability to market and sell our1648products.</B></P>1649<P>In the United States, our products are generally covered by Medicare,1650Medicaid and other third-party payors, such as workers' compensation programs,1651insurance companies and HMOs, which reimburse patients for all or part of the1652cost of the products. Third-party payors carefully scrutinize whether to cover1653new products and the level of reimbursement for covered products. If the1654neuromodulation market continues to grow, third-party payors may cut back their1655coverage of neuromodulation devices in an effort to control increasing costs. If1656Medicare or other third-party payors decide to eliminate, or reduce coverage1657amounts on patient reimbursements for our products, this could limit our1658ability to market and sell our products in the U.S., which would materially1659adversely affect our revenues and profitability.</P>1660<P>International market acceptance of our products may also depend, in part,1661upon the availability of reimbursement within prevailing health care payment1662systems. Reimbursement and health care payment systems in international markets1663vary significantly by country, and include both government-sponsored health care1664and private insurance. We may not obtain international reimbursement approvals1665in a timely manner, if at all. Our failure to receive international1666reimbursement approvals may negatively impact market acceptance of our products1667in the international markets in which those approvals are sought.</P>1668<P><B>If patients choose non-invasive alternatives to our products, our sales1669could be negatively impacted.</B></P>1670<P>We sell medical devices for invasive or minimally-invasive surgical1671procedures. If patients choose non-invasive alternatives to our products, this1672could negatively affect our sales. Patient acceptance of our products depends on1673a number of factors, including the failure of non-invasive therapies to help the1674patient, the degree of invasiveness involved in the procedures used to implant1675our products, the rate and severity of complications from the procedures used to1676implant our products and any adverse side effects caused by the implanting of1677our products.</P>1678<P ALIGN=CENTER>Page 26</P><HR>16791680<PAGE>1681<P>Patients are always more likely first to consider non-invasive alternatives1682to treat their pain. The first tier of therapies along the treatment continuum1683available to patients includes over-the-counter medications and physical1684therapy. If these therapies fail, patients generally try the second-tier of1685therapies, which includes non-steroidal anti-inflammatory drugs, TENS therapy1686(application of electrical impulses on the skin), psychological therapy and1687nerve blocks (injections that provide temporary pain relief). If these therapies1688were unsuccessful, patients might then try the third tier of therapies, which1689includes narcotic and opiod drugs, neurolysis (destruction of the affected1690nerve) and thermal procedures. If first-, second- and third-tier pain therapies1691are not effective, patients might then consider whether to use our products or1692undergo more invasive surgical procedures.</P>1693<P><B>If doctors do not recommend and endorse our products, our sales could be1694negatively impacted and we may be unable to increase our revenues and1695profitability.</B></P>1696<P>Our products are based on evolving concepts and techniques in pain1697management. Acceptance of our products depends on educating the medical1698community as to the distinctive characteristics, perceived benefits, clinical1699efficacy and cost-effectiveness of our products compared to alternative1700therapies and competing products, and on training pain specialists in the proper1701use of our products. In order for us to sell our products, we must successfully1702educate and train pain specialists so that these pain specialists will1703understand our products and feel comfortable recommending and endorsing them. We1704may not be able to accomplish this, and even if we are successful in educating1705and training pain specialists, there is no guarantee that we will obtain their1706recommendations and endorsements.</P>1707<P><B>If we fail to protect our intellectual property rights, our competitors1708may take advantage of our ideas and compete directly against us.</B></P>1709<P>We rely in part on patents, trade secrets and proprietary technology to1710remain competitive. We may not be able to obtain or maintain adequate U.S.1711patent protection for new products or ideas, or prevent the unauthorized1712disclosure or use of our technical knowledge or other trade secrets by1713employees. Additionally, the laws of foreign countries may not protect our1714intellectual property rights to the same extent as the laws of the U.S. Even if1715our intellectual property rights are adequately protected, litigation may be1716necessary to enforce them, which could result in substantial costs to us and1717substantial diversion of the attention of our management and key technical1718employees. If we are unable to adequately protect our intellectual property, our1719competitors could use our intellectual property to develop new products or1720enhance their existing products. This could harm our competitive position,1721decrease our market share or otherwise harm our business.</P>1722<P><B>Other parties may sue us for infringing their intellectual property1723rights.</B></P>1724<P>There has been a substantial amount of litigation in the medical technology1725industry regarding patents and intellectual property rights. We may be forced to1726defend ourselves against allegations that we are infringing the intellectual1727property rights of others. In addition, we may find it necessary, if threatened,1728to initiate a lawsuit seeking a declaration from a court that we are not1729infringing the intellectual property rights of others or that these rights are1730invalid or unenforceable. If we do not prevail in any litigation, in addition to1731any damages we might have to pay, we would be required to stop the infringing1732activity or obtain a license. Any required license may not be available to us on1733acceptable terms, if at all. In addition, some licenses may be non-exclusive,1734and, therefore, our competitors may have access to the same technology licensed1735to us. If we fail to obtain a required license or are unable to design around a1736patent, we may be unable to sell some of our products, which could adversely1737affect our revenues and profitability.</P>1738<P ALIGN=CENTER>Page 27</P><HR>17391740<PAGE>1741<P><B>Failure to obtain necessary government approvals for new products and for1742new applications for existing products would mean we could not sell those new1743products, or sell our existing products for those new applications.</B></P>1744<P>Our products are medical devices, which are subject to extensive government1745regulation in the United States and in foreign countries where we do business.1746Unless an exemption applies, each medical device that we wish to market in the1747United States must first receive either 510(k) clearance or PMA from the FDA1748with respect to each application for which we intend to market it. Either1749process can be lengthy and expensive. The FDA's 510(k) clearance process usually1750takes from four to twelve months from the date the application is complete, but1751may take longer. Additionally, 510(k) clearance can be revoked if safety or1752effectiveness problems develop. The PMA process is much more costly, lengthy and1753uncertain. It generally takes from one to three years from the date the1754application is complete; however, completing the PMA application is a process1755that can take numerous clinical trials and require the filing of amendments over1756time. The result of these lengthy approval processes is that a new product, or a1757new application for an existing product, cannot be brought to market for a1758number of years after it is developed. If we fail to obtain or maintain1759necessary government approvals of our new products or new applications for1760existing products on a timely and cost-effective basis, we will be unable to1761market the affected products for their intended applications in those1762jurisdictions.</P>1763<P><B>Modification of any marketed device could require a new 510(k) clearance1764or PMA or require us to cease marketing or recall the modified device until we1765obtain this clearance or approval.</B></P>1766<P>Any modification we want to make to an FDA-cleared or approved device that1767could significantly affect its safety or effectiveness, or that would constitute1768a major change in its intended use, would require a new 510(k) clearance, or1769possibly a new PMA. Under FDA procedures, we would make the initial1770determination of whether to seek a new 510(k) clearance or PMA, but the FDA1771could review our decision. If the FDA did not agree with our decision not to1772seek a new 510(k) clearance or PMA and decided to require us to seek either1773510(k) clearance or PMA for modifications we have already made to a1774previously-cleared product, we may be required to cease marketing or recall the1775modified device until we obtain this clearance or approval. We could also be1776subject to significant regulatory fines or penalties.</P>1777<P><B>We will be unable to sell our products if we fail to comply with1778manufacturing regulations.</B></P>1779<P>In order to commercially manufacture our products, we must comply with1780government manufacturing regulations that govern design controls, quality1781systems and documentation policies and procedures. The FDA and equivalent1782foreign governmental authorities periodically inspect our manufacturing1783facilities. Our failure to comply with these manufacturing regulations may1784prevent or delay our marketing or distribution of our products, which would1785negatively impact our business. For a description of the manufacturing1786regulations with which we must comply, see "Item 1 - Business - Government1787Regulation."</P>1788<P><B>Our products are subject to product recalls even after receiving FDA1789clearance or approval, which would harm our reputation.</B></P>1790<P>The FDA and similar governmental authorities in other countries have the1791authority to require the recall of our products in the event of material1792deficiencies or defects in design or manufacture. A government-mandated or our1793own voluntary recall could occur as a result of component failures,1794manufacturing errors or design defects. Any recall of product would divert1795managerial and financial resources and harm our reputation with customers.</P>1796<P ALIGN=CENTER>Page 28</P><HR>17971798<PAGE>1799<P><B>Our failure to comply with all applicable government regulations could1800subject us to numerous penalties, any of which could adversely affect our1801business.</B></P>1802<P>If we do not comply with all applicable government regulations, government1803authorities could do any of the following:</P>1804<UL>1805<LI>impose fines and penalties on us;1806<LI>prevent us from manufacturing our products;1807<LI>bring civil or criminal charges against us;1808<LI>delay the introduction of our new products into the market;1809<LI>recall or seize our products;1810<LI>disrupt the manufacture or distribution of our products; or1811<LI>withdraw or deny approvals for our products.</UL>1812<P>Any one of these results could materially and adversely affect our revenues1813and profitability.</P>1814<P><B>Our reliance on a single supplier for a component used in both of our main1815products could adversely affect our ability to deliver products on time.</B></P>1816<P>We rely on a single supplier for the computer chip used in the receivers of1817our RF device and the programmer of our IPG device. The supplier of this1818computer chip has indicated its desire to cease manufacturing and supplying the1819computer chip in the future, but to date has not determined when this will1820occur. The supplier has agreed to notify us when a date has been determined and1821allow us to place a final one-time purchase order for the computer chip. In the1822interim, we are maintaining a higher than normal inventory of the computer chip1823and are working to develop a new receiver design that does not use a custom1824computer chip. Until we develop this new receiver, any sudden disruption in1825supply from our current computer chip supplier could adversely affect our1826ability to deliver finished RF and IPG products on time.</P>1827<P><B>One specialty distributor currently accounts for a significant percentage1828of our neuromodulation products segment revenue.</B></P>1829<P>During 2001, we had one specialty distributor, Sun Medical, Inc., that1830accounted for $4.2 million, or 15%, of our net revenue from the neuromodulation1831products segment. While we believe that our relationship with Sun Medical is1832good, the loss of this distributor could adversely affect our revenues and1833profitability.</P>1834<P><B>The launch of <I>Genesis</I> could temporarily impede growth in sales of1835<I>Renew</I>, which would adversely affect our short-term revenues and1836profitability.</B></P> <P>Our <I>Genesis</I> device is currently the newest1837neurostimulation product on the market. Although <I>Genesis</I> and <I>Renew</I>1838are targeted towards patients with different types of pain and <I>Genesis</I> is1839not intended to replace <I>Renew</I> in the neurostimulation market, some pain1840specialists may recommend <I>Genesis</I> to their patients when they would have1841otherwise recommended <I>Renew</I>, and, consequently, <I>Genesis</I> may1842"cannibalize" or substitute for some sales of <I>Renew</I>. If this occurs, it1843could lead to a short-term slowdown in the growth in sales of <I>Renew</I>. If1844<I>Renew</I> sales growth slows and we do not gain enough market share through1845IPG sales to compensate for these lost sales, our short-term revenues and1846profitability would be adversely affected.</P>1847<P><B>Our inability to continue to develop innovative products in the1848neuromodulation market would adversely affect our business.</B></P>1849<P>The neuromodulation market is subject to rapid technological change and1850product innovation. Our competitors may succeed in developing or marketing1851products that will be technologically superior to ours. If we are unable to1852compete successfully in the development of new products, our products could be1853rendered obsolete or non-competitive. This would materially adversely affect our1854business.</P>1855<P ALIGN=CENTER>Page 29</P><HR>18561857<PAGE>1858<P></P>1859<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1860<TR>1861<TD WIDTH=15% VALIGN=TOP><B>ITEM 7A.</B></TD>1862<TD WIDTH=85%><B>QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK</B>1863</TD></TR></TABLE>1864<P>We do not use derivative financial instruments to manage the impact of1865interest rate changes on our investments or debt instruments.</P>1866<P>We invest our cash reserves in high quality short-term liquid money market1867instruments with major financial institutions, a high quality short-term1868municipal bond fund with a major financial institution and certificates of1869deposit with no more than $100,000 in any one financial institution. At December187031, 2001, we had $1,869,704 invested in money market funds, $1,518,295 in1871certificates of deposit with maturities less than 90 days from the purchase date1872and $4,530,095 in a tax-free municipal bond fund with daily liquidity. The rate1873of interest earned on these investments will vary with overall market rates. A1874hypothetical 100-basis point change in the interest rate earned on these1875investments would not have a material effect on our income or cash flows.</P>1876<P>We also have certain investments in available-for-sale securities. These1877investments primarily consist of investment grade municipal bonds with1878maturities less than one year from the date of purchase, a real estate1879investment trust traded on the New York Stock Exchange and FNMA and Federal Home1880Loan Notes with maturities less than one-year from the date of purchase. The1881cost of these investments is $2,183,921 and the fair value at December 31, 20011882was $2,151,722. The investments are subject to overall stock market and interest1883rate risk. A hypothetical 20% decrease in the value of these investments from1884the prices at December 31, 2001 would decrease the fair value by $430,344.</P>1885<P>In connection with our acquisition of HDI, we acquired responsibility for a1886note payable in a principal amount at December 31, 2001 of $189,722. The note is1887payable in monthly installments of principal and interest of $5,623, matures in1888March 2005 and bears interest at a fixed rate of 9%.</P>1889<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1890<TR>1891<TD WIDTH=15% VALIGN=TOP><B>ITEM 8.</B></TD>1892<TD WIDTH=85%><B>FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA</B></TD></TR>1893</TABLE>1894<P>The information required by this item is set forth in Appendices A, B and C.1895</P>1896<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1897<TR>1898<TD WIDTH=15% VALIGN=TOP><B>ITEM 9.</B></TD>1899<TD WIDTH=85%><B>CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND1900FINANCIAL DISCLOSURE</B></TD></TR></TABLE>1901<P>None.</P>1902<P ALIGN=CENTER><B>PART Ill</B></P>1903<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>1904<TR>1905<TD WIDTH=15% VALIGN=TOP><B>ITEM 10.</B></TD>1906<TD WIDTH=85%><B>DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT</B></TD>1907</TR></TABLE>1908<P>The information required by this item is contained under the captions1909"Election of Directors", "Executive Officers" and "Compliance With Section 16(a)1910of the Exchange Act" in our definitive proxy statement to be filed in connection1911with our 2002 annual meeting of stockholders, which information is incorporated1912herein by reference.</P>1913<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>1914<TR>1915<TD WIDTH=15%><B>ITEM 11.</B></TD>1916<TD WIDTH=85%><B>EXECUTIVE COMPENSATION</B></TD></TR></TABLE>1917<P>The information required by this item is contained under the captions1918"Compensation and Committees of the Board of Directors" and "Compensation of1919Executive Officers" in our definitive proxy statement to be filed in connection1920with our 2002 annual meeting of stockholders, which information is incorporated1921herein by reference. Information under the captions "Compensation Committee1922Report" and "Performance Graph" are not incorporated herein by reference,1923however.</P>1924<P ALIGN=CENTER>Page 30</P><HR>19251926<PAGE>1927<P></P>1928<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1929<TR>1930<TD WIDTH=15% VALIGN=TOP><B>ITEM 12.</B></TD>1931<TD WIDTH=85%><B>SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND1932MANAGEMENT</B></TD></TR></TABLE>1933<P>The information required by this item is contained under the caption1934"Security Ownership of Management and Principal Shareholders" in our definitive1935proxy statement to be filed in connection with our 2002 annual meeting of1936stockholders, which information is incorporated herein by reference.</P>1937<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1938<TR>1939<TD WIDTH=15%><B>ITEM 13.</B></TD>1940<TD WIDTH=85%><B>CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS</B></TD></TR>1941</TABLE>1942<P>Inapplicable.</P>1943<P ALIGN=CENTER><B>PART IV</B></P>1944<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1945<TR>1946<TD WIDTH=15% VALIGN=TOP><B>ITEM 14.</B></TD>1947<TD WIDTH=85%><B>EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM19488-K</B></TD></TR></TABLE>1949<P></P>1950<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1951<TR>1952<TD WIDTH=10%>(a)</TD>1953<TD WIDTH=90%>Documents filed as part of this report.</TD></TR></TABLE>1954<P></P>1955<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1956<TR>1957<TD WIDTH=10%> </TD>1958<TD WIDTH=10% VALIGN=TOP>1.</TD>1959<TD WIDTH=90%>Financial Statements:<BR>See Index to Financial Statements on the1960second page of Appendix A.</TD></TR>1961<TR>1962<TD> </TD>1963<TD></TD>1964<TD></TD></TR>1965<TR>1966<TD> </TD>1967<TD VALIGN=TOP>2.</TD>1968<TD>Financial Statement Schedules:*<BR>Schedule II - Valuation and Qualifying1969Accounts.<BR>See Appendix B.</TD></TR>1970</TABLE>1971<P></P>1972<P>*Those schedules not listed above are omitted as not applicable or not1973required.</P>1974<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1975<TR>1976<TD WIDTH=10%> </TD>1977<TD WIDTH=10%>3.</TD>1978<TD WIDTH=90%>Exhibits: See (c) below.</TD></TR></TABLE>1979<P></P>1980<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1981<TR>1982<TD WIDTH=10%>(b)</TD>1983<TD WIDTH=90%>Reports on Form 8-K.</TD></TR></TABLE>1984<P></P>1985<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1986<TR>1987<TD WIDTH=10%> </TD>1988<TD WIDTH=90%>The Company filed a report on Form 8-K on January 30, 20021989reporting certain amendments adopted by the Board of Directors on January 25,19902002 to the existing Rights Agreement between the Registrant and Computershare1991Investor Services LLC dated as of August 30, 1996.</TD></TR>1992<TR>1993<TD> </TD><TD></TD></TR>1994<TR>1995<TD WIDTH=10%>(c)</TD>1996<TD WIDTH=90%>Exhibits:</TD></TR></TABLE>1997<P></P>1998<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1999<TR>2000<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>2001<TD WIDTH=5%></TD>2002<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>2003</TABLE>2004<P></P>2005<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2006<TR>2007<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>2008<TD WIDTH=5%> </TD>2009<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by2010and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and2011Hi-tronics Designs, Inc.(10)</TD></TR>2012<TR>2013<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>2014<TD></TD>2015<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>2016<TR>2017<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>2018<TD></TD>2019<TD>Bylaws(11)</TD></TR>2020<TR>2021<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>2022<TD></TD>2023<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.2024and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>2025<TR>2026<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>2027<TD></TD>2028<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option2029Plan(2)</TD></TR></TABLE>2030<P ALIGN=CENTER>Page 31</P><HR>20312032<PAGE>2033<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2034<TR>2035<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>2036<TD WIDTH=5%></TD>2037<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>2038</TABLE>2039<P></P>2040<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2041<TR>2042<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>10.2 </TD>2043<TD WIDTH=5%> </TD>2044<TD WIDTH=85%>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>2045<TR>2046<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>2047<TD></TD>2048<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>2049<TR>2050<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>2051<TD></TD>2052<TD>Form of Directors Stock Option Agreement(1)</TD></TR>2053<TR>2054<TD ALIGN=RIGHT VALIGN=TOP>10.5 </TD>2055<TD></TD>2056<TD>Quest Medical, Inc. 1987 Stock Option Plan(4)</TD></TR>2057<TR>2058<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>2059<TD></TD>2060<TD>Form of 1987 Employee Stock Option Agreement(4)</TD></TR>2061<TR>2062<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>2063<TD></TD>2064<TD>Quest Medical, Inc. 1995 Stock Option Plan(4)</TD></TR>2065<TR>2066<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>2067<TD></TD>2068<TD>Form of 1995 Employee Stock Option Agreement(4)</TD></TR>2069<TR>2070<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>2071<TD></TD>2072<TD>Quest Medical, Inc. 1998 Stock Option Plan(7)</TD></TR>2073<TR>2074<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>2075<TD></TD>2076<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>2077<TR>2078<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>2079<TD></TD>2080<TD>Employment Agreement dated April 9, 1998 between Christopher G. Chavez and2081Quest Medical, Inc.(6)</TD></TR>2082<TR>2083<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>2084<TD></TD>2085<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest2086Medical, Inc.(6)</TD></TR>2087<TR>2088<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>2089<TD></TD>2090<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill III and2091Quest Medical, Inc.(6)</TD></TR>2092<TR>2093<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>2094<TD></TD>2095<TD>Form of Employment Agreement and Covenant Not to Compete, between the2096Company and key employees(1)</TD></TR>2097<TR>2098<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>2099<TD></TD>2100<TD>Lease Agreement dated as of February 4, 1999, between Advanced2101Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>2102<TR>2103<TD ALIGN=RIGHT VALIGN=TOP>11.1 </TD>2104<TD></TD>2105<TD>Computation of Earnings Per Share(13)</TD></TR>2106<TR>2107<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>2108<TD></TD>2109<TD>Subsidiaries(13)</TD></TR>2110<TR>2111<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>2112<TD></TD>2113<TD>Consent of Independent Auditors(13)</TD></TR></TABLE>2114<P>__________________________________</P>2115<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2116<TR>2117<TD WIDTH=5% VALIGN=TOP>(1) </TD>2118<TD WIDTH=2%></TD>2119<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on2120Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.2121</TD></TR>2122<TR>2123<TD>(2) </TD>2124<TD></TD>2125<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year2126ended December 31, 1987, and incorporated herein by reference.</TD></TR>2127<TR>2128<TD>(3) </TD>2129<TD></TD>2130<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,2131Registration No. 2-78186, and incorporated herein by reference.</TD></TR>2132<TR>2133<TD>(4) </TD>2134<TD></TD>2135<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,2136Registration No. 33-62991, and incorporated herein by reference.</TD></TR>2137<TR>2138<TD>(5) </TD>2139<TD></TD>2140<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September21413, 1996, and incorporated herein by reference.</TD></TR>2142<TR>2143<TD>(6) </TD>2144<TD></TD>2145<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the2146quarterly period ended March 31, 1998, and incorporated herein by reference.2147</TD></TR>2148<TR>2149<TD>(7) </TD>2150<TD></TD>2151<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated2152April 27, 1998, and incorporated herein by reference.</TD></TR>2153<TR>2154<TD>(8) </TD>2155<TD></TD>2156<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the2157year ended December 31, 1998, and incorporated herein by reference.</TD></TR>2158<TR>2159<TD>(9) </TD>2160<TD></TD>2161<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated2162April 17, 2000, and incorporated herein by reference.</TD></TR>2163<TR>2164<TD>(10)</TD>2165<TD></TD>2166<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January21679, 2001, and incorporated herein by reference. Upon request, the Company will2168furnish a copy of any omitted schedule to the Commission.</TD></TR>2169<TR>2170<TD>(11)</TD>2171<TD></TD>2172<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the2173year ended December 31, 2000, and incorporated herein by reference.</TD></TR>2174<TR>2175<TD>(12)</TD>2176<TD></TD>2177<TD>Filed as an Exhibit to the report of the company on Form 8-K dated January217830, 2002, and incorporated herein by reference.</TD></TR>2179<TR>2180<TD>(13)</TD>2181<TD></TD>2182<TD>Filed herewith.</TD></TR></TABLE>2183<P ALIGN=CENTER>Page 32</P><HR>21842185<PAGE>2186<P ALIGN=CENTER><U><B>Signatures</B></U></P>2187<P>Pursuant to the requirements of Section 13 or 15(d) of the Securities2188Exchange Act of 1934, the Company has duly caused this report to be signed on2189its behalf by the undersigned, thereunto duly authorized.</P>2190<P>Date: March 28, 2002</P>2191<P>ADVANCED NEUROMODULATION SYSTEMS, INC.</P>2192<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2193<TR>2194<TD WIDTH=40%></TD>2195<TD WIDTH=5%>By:</TD>2196<TD WIDTH=55%><U>/s/Christopher G. Chavez</U></TD></TR>2197<TR>2198<TD></TD>2199<TD></TD>2200<TD>Christopher G. Chavez</TD></TR>2201<TR>2202<TD></TD>2203<TD></TD>2204<TD>President and Chief Executive Officer</TD></TR></TABLE>2205<P></P>2206<P>Pursuant to the requirements of the Securities Exchange Act of 1934, this2207report has been signed by the following persons on behalf of the Company and in2208the capacities and on the dates indicated:</P>2209<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2210<TR>2211<TD WIDTH=25% ALIGN=CENTER><U>Signature</U></TD>2212<TD WIDTH=5%></TD>2213<TD WIDTH=45% ALIGN=CENTER><U>Title</U></TD>2214<TD WIDTH=5%></TD>2215<TD WIDTH=20% ALIGN=CENTER><U>Date</U></TD></TR>2216<TR>2217<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2218<TD ALIGN=LEFT VALIGN=TOP><U>/s/Christopher G. Chavez</U><BR>Christopher G.2219Chavez</TD>2220<TD></TD>2221<TD ALIGN=LEFT>Chief Executive Officer, President and Director of Advanced2222Neuromodulation Systems, Inc. (Principal Executive Officer)</TD>2223<TD></TD>2224<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2225<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2226<TD ALIGN=LEFT VALIGN=TOP><U>/s/F. Robert Merrill III</U><BR>F. Robert Merrill2227III</TD><TD></TD>2228<TD ALIGN=LEFT>Executive Vice President-Finance, Treasurer and Secretary of2229Advanced Neuromodulation Systems, Inc. (Principal Financial and Accounting2230Officer)</TD>2231<TD></TD>2232<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2233<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2234<TD ALIGN=LEFT VALIGN=TOP><U>/s/Hugh M. Morrison</U><BR>Hugh M. Morrison</TD>2235<TD></TD>2236<TD ALIGN=LEFT>Chairman of the Board and Director of Advanced Neuromodulation2237Systems, Inc.</TD>2238<TD></TD>2239<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2240<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2241<TD ALIGN=LEFT VALIGN=TOP><U>/s/Robert C. Eberhart</U><BR>Robert C. Eberhart2242</TD><TD></TD>2243<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2244</TD><TD></TD>2245<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2246<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2247<TD ALIGN=LEFT VALIGN=TOP><U>/s/Joseph E. Laptewicz</U><BR>Joseph E. Laptewicz2248</TD><TD></TD>2249<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2250</TD><TD></TD>2251<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2252<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2253<TD ALIGN=LEFT VALIGN=TOP><U>/s/A. Ronald Lerner</U><BR>A. Ronald Lerner2254</TD><TD></TD>2255<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2256</TD><TD></TD>2257<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2258<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2259<TD ALIGN=LEFT VALIGN=TOP><U>/s/Richard D. Nikolaev</U><BR>Richard D. Nikolaev2260</TD><TD></TD>2261<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2262</TD><TD></TD>2263<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR><TR>2264<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2265<TD ALIGN=LEFT VALIGN=TOP><U>/s/Michael J. Torma</U><BR>Michael J. Torma2266</TD><TD></TD>2267<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2268</TD><TD></TD>2269<TD ALIGN=CENTER VALIGN=TOP>March 28, 2002</TD></TR>2270</TABLE>2271<P ALIGN=CENTER>Page 33</P><HR>22722273<PAGE>2274<P ALIGN=RIGHT><B><U>Appendix A</U></B></P>2275<P></P><P></P>2276<P ALIGN=CENTER><B>Consolidated Financial Statements<BR>Independent2277Auditors’ Report<BR><BR>Three Years Ended December 31, 2001<BR><BR>2278Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>Item 8<BR><BR><BR>2279of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of issuer)<BR><BR><BR>2280<BR>Filed with the<BR><BR>Securities and Exchange Commission<BR><BR>Washington,2281D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange Act of 1934</B>2282</P><HR>22832284<PAGE>2285<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2286<BR>Table of Contents<BR>to<BR>Consolidated Financial Statements<BR><BR>2287Form 10-K - Item 8</B></P>2288<P></P><P></P><P></P><P></P>2289<P><B>Independent Auditors’ Report</B></P>2290<P></P><P></P>2291<P><B>Consolidated Financial Statements:</B></P>2292<P>Consolidated Balance Sheets - December 31, 2001 and 2000<BR>Consolidated2293Statements of Income - Years ended December 31, 2001, 2000 and 1999<BR>2294Consolidated Statements of Stockholders' Equity - Years ended December 31, 2001,22952000 and 1999<BR> Consolidated Statements of Cash Flows - Years ended December229631, 2001, 2000 and 1999<BR> Notes to Consolidated Financial Statements</P>2297<HR>22982299<PAGE>2300<P ALIGN=CENTER>Report of Independent Auditors</P>2301<P>The Board of Directors<BR>Advanced Neuromodulation Systems, Inc.</P>2302<P>We have audited the accompanying consolidated balance sheets of Advanced2303Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31,23042001 and 2000, and the related consolidated statements of income,2305stockholders’ equity and cash flows for each of the three years in the2306period ended December 31, 2001. Our audits also included the financial statement2307schedule listed in the Index at Item 14A. These consolidated financial2308statements and schedule are the responsibility of the Company’s management.2309Our responsibility is to express an opinion on these financial statements and2310schedule based on our audits.</P>2311<P>We conducted our audits in accordance with auditing standards generally2312accepted in the United States. Those standards require that we plan and perform2313the audit to obtain reasonable assurance about whether the financial statements2314are free of material misstatement. An audit includes examining, on a test basis,2315evidence supporting the amounts and disclosures in the financial statements. An2316audit also includes assessing the accounting principles used and significant2317estimates made by management, as well as evaluating the overall financial2318statement presentation. We believe that our audits provide a reasonable basis2319for our opinion.</P>2320<P>In our opinion, the financial statements referred to above present fairly, in2321all material respects, the consolidated financial position of Advanced2322Neuromodulation Systems, Inc. and subsidiaries at December 31, 2001 and 2000,2323and the consolidated results of their operations and their cash flows for each2324of the three years in the period ended December 31, 2001, in conformity with2325accounting principles generally accepted in the United States. Also, in our2326opinion, the related financial statement schedule, when considered in relation2327to the basic financial statements taken as a whole, presents fairly in all2328material respects the information set forth therein.</P>2329<P></P>2330<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2331<TR>2332<TD WIDTH=40%> </TD>2333<TD WIDTH=60%><U>/s/Ernst & Young LLP</U><BR>Ernst & Young LLP</TD></TR>2334</TABLE>2335<P></P>2336<P></P>2337<P>Dallas, Texas<BR>February 6, 2002</P>2338<HR>23392340<PAGE>2341<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2342Consolidated Balance Sheets<BR>December 31, 2001 and 2000</B></P>2343<PRE>23442345Assets 2001 20002346------------------ -------------------2347Current assets:2348Cash and cash equivalents $ 9,785,325 $ 9,528,7212349Certificates of deposit with maturities over 90 days at purchase -- 1,040,0002350Marketable securities 2,151,722 1,030,31823512352Receivables:2353Trade accounts, less allowance for doubtful2354accounts of $124,111 in 2001 and $213,249 in 2000 6,493,772 5,164,2312355Interest and other 235,594 734,5502356------------------ -------------------2357Total receivables 6,729,366 5,898,7812358------------------ -------------------23592360Inventories:2361Raw materials 4,685,586 3,432,3352362Work-in-process 1,723,419 1,075,1112363Finished goods 3,339,840 2,580,1932364------------------ -------------------2365Total inventories 9,748,845 7,087,6392366------------------ -------------------23672368Deferred income taxes 1,726,517 1,282,0722369Refundable income taxes 678,341 359,9532370Prepaid expenses and other current assets 685,169 1,064,8502371------------------ -------------------2372Total current assets 31,505,285 27,292,3342373------------------ -------------------23742375Equipment and fixtures:2376Furniture and fixtures 3,400,909 2,900,1492377Machinery and equipment 8,550,504 6,585,7742378Leasehold improvements 1,610,810 1,525,5422379------------------ -------------------238013,562,223 11,011,46523812382Less accumulated depreciation and amortization 6,353,920 4,390,1132383------------------ -------------------2384Net equipment and fixtures 7,208,303 6,621,3522385------------------ -------------------23862387Cost in excess of net assets acquired, net of accumulated2388amortization of $3,404,427 in 2001 and $2,847,824 in 2000 7,407,237 7,963,8402389Patents and licenses, net of accumulated amortization2390of $1,045,106 in 2001 and $674,220 in 2000 5,368,213 3,104,2542391Purchased technology from acquisitions, net of accumulated2392amortization of $1,800,000 in 2001 and2393$1,533,334 in 2000 2,200,000 2,466,6662394Tradenames, net of accumulated amortization of2395$843,736 in 2001 and $718,745 in 2000 1,656,264 1,781,2552396Other assets, net of accumulated amortization of2397$392,033 in 2001 and $221,320 in 2000 519,783 334,8652398------------------ -------------------2399$ 55,865,085 $ 49,564,5662400================== ===================2401</PRE>2402<P>See accompanying notes to consolidated financial statements.</P>2403<HR>24042405<PAGE>2406<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2407Consolidated Balance Sheets<BR>December 31, 2001 and 2000</B></P>2408<PRE>2409Liabilities and Stockholders' Equity 2001 20002410------------------ -------------------2411Current liabilities:2412Accounts payable $ 1,835,037 $ 1,269,1022413Accrued salary and employee benefit costs 2,112,127 1,293,0652414Accrued tax abatement liability 969,204 969,2042415Customer deposits 1,042,690 543,8852416Warranty reserve 383,477 422,1822417Other accrued expenses 204,151 487,2302418Current maturities of long-term note payable 52,325 29,6012419Income taxes payable --- 67,2402420------------------ -------------------2421Total current liabilities 6,599,011 5,081,5092422------------------ -------------------242324242425Deferred income taxes 2,316,796 2,354,1702426Long-term note payable 137,397 211,6812427Non-current customer deposits -- 1,475,39324282429Commitments and contingencies24302431Stockholders' equity:2432Common stock, $.05 par value2433Authorized-25,000,000 shares;2434Issued- 9,071,868 shares in 2001 and 8,883,059 in 2000 453,593 444,1532435Additional capital 38,670,248 34,469,4712436Retained earnings 7,709,290 6,539,2232437Accumulated other comprehensive income (loss), net of2438tax benefit of $10,949 in 2001 and $42,883 in 2000 (21,250) (83,241)2439Cost of common shares in treasury; 119,100 in 2000 -- (927,793)2440------------------ -------------------24412442Total stockholders' equity 46,811,881 40,441,813244324442445------------------ -------------------2446$ 55,865,085 $ 49,564,5662447================== ===================2448</PRE>2449<P>See accompanying notes to consolidated financial statements.</P>2450<HR>24512452<PAGE>2453<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2454Consolidated Statements of Income<BR>Years Ended December 31</B></P>2455<PRE>24562001 2000 19992457--------------------- --------------------- ---------------------24582459Net revenue $ 37,916,435 $ 31,826,998 $ 26,879,0192460Net revenue-contract research and development --- --- 8,900,0002461--------------------- --------------------- ---------------------2462Total net revenue 37,916,435 31,826,998 35,779,0192463--------------------- --------------------- ---------------------24642465Operating expenses:2466Cost of revenue 15,675,436 14,699,633 11,927,2602467General and administrative 3,957,867 4,243,720 3,808,2632468Research and development 4,928,432 3,854,084 4,096,5062469Amortization of goodwill 556,604 556,604 556,6042470Amortization of other intangibles 933,257 676,508 631,0852471Marketing 9,055,932 6,851,022 6,290,0042472--------------------- --------------------- ---------------------247335,107,528 30,881,571 27,309,7222474--------------------- --------------------- ---------------------24752476Income from operations 2,808,907 945,427 8,469,29724772478Other income (expense):2479Acquisition related costs (483,766) -- --2480Interest expense (24,346) (59,015) (147,061)2481Investment and other income, net 482,417 604,570 834,0272482--------------------- --------------------- ---------------------2483(25,695) 545,555 686,9662484--------------------- --------------------- ---------------------24852486Income before income taxes 2,783,212 1,490,982 9,156,2632487Income taxes 1,265,466 658,524 3,339,3412488--------------------- --------------------- ---------------------2489Net income $ 1,517,746 $ 832,458 $ 5,816,9222490===================== ===================== =====================24912492Net income per share:2493===================== ===================== =====================2494Basic $ .17 $ .10 $ .732495===================== ===================== =====================2496Diluted $ .15 $ .09 $ .642497===================== ===================== =====================2498</PRE>2499<P>See accompanying notes to consolidated financial statements.</P>2500<HR>25012502<PAGE>2503<P ALIGN=CENTER><B> Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2504Consolidated Statements of Cash Flows<BR> Years Ended December 31</B></P>2505<PRE>25062001 2000 19992507-------------------- ------------------- -------------------2508Cash flows from operating activities:2509Net income $ 1,517,746 $ 832,458 $ 5,816,9222510Adjustments to reconcile net income to net cash provided by2511operating activities:2512Depreciation 1,932,452 1,636,857 1,091,9942513Amortization 1,489,861 1,233,112 1,187,6892514Deferred income taxes (455,003) (330,804) (79,443)2515Non-operating gain included in net income -- (33,509) (47,389)2516Increase in inventory reserve 107,880 111,144 112,5002517Changes in operating assets and liabilities2518Receivables (1,027,050) (486,949) (1,295,739)2519Inventories (2,672,605) 270,190 (4,277,363)2520Refundable income taxes (318,388) (359,953) --2521Prepaid expenses and other current assets 564,866 144,880 (426,357)2522Customer deposits (706,916) (1,071,372) 1,368,0182523Income taxes payable 1,580,025 82,848 (1,481,786)2524Accounts payable 493,227 (1,348,526) 892,5362525Accrued expenses 553,380 9,892 648,5052526Deferred revenue -- -- (559,200)2527-------------------- ------------------- -------------------2528Total adjustments 1,541,729 (142,190) (2,866,035)2529-------------------- ------------------- -------------------2530Net cash provided by operating activities 3,059,475 690,268 2,950,8872531-------------------- ------------------- -------------------25322533Cash flows from investing activities:2534Purchases of certificates of deposit with maturities over 90 days -- (1,425,000) --2535Proceeds from certificates of deposits with maturities over 90 days 1,040,000 385,000 --2536Purchases of marketable securities (3,896,199) (808,760) (380,000)2537Net proceeds from sales of marketable securities 2,876,720 564,194 466,2172538Additions to equipment, fixtures and patent licenses (3,108,055) (1,653,194) (5,637,896)2539Net proceeds from sale of assets in 2000 and discontinued2540operations in 1999 -- 600 6,354,9652541-------------------- ------------------- -------------------2542Net cash provided by (used in) investing activities (3,087,534) (2,937,160) 803,2862543-------------------- ------------------- -------------------25442545Cash flows from financing activities:2546Decrease in short-term obligations -- -- (3,633,475)2547Payment of long-term notes (47,807) (28,718) --2548Proceeds from long-term note payable -- 270,000 --2549Net proceeds from private placement of common stock -- 400,000 --2550Exercise of stock options and warrants 1,004,914 1,929,450 573,2722551Purchase of treasury stock -- -- (4,752,311)2552-------------------- ------------------- -------------------2553Net cash provided by (used in) financing activities 957,107 2,570,732 (7,812,514)2554-------------------- ------------------- -------------------25552556Net increase (decrease) in cash and cash equivalents 929,048 323,840 (4,058,341)2557Net cash used by Hi-tronics in December 2000 (see Note 3) (672,444) -- --2558Cash and cash equivalents at beginning of year 9,528,721 9,204,881 13,263,22225592560-------------------- ------------------- -------------------2561Cash and cash equivalents at end of year $ 9,785,325 9,528,721 $ 9,204,8812562==================== =================== ===================25632564Supplemental cash flow information is presented below:25652566Income taxes paid $ 815,000 $ 1,138,685 $ 4,902,4112567==================== =================== ===================25682569Interest paid $ 24,346 $ 59,015 $ 147,0612570==================== =================== ===================25712572Non-cash activity:2573Stock issued for patents and intangible assets $ 2,426,662 $ -- $ --2574==================== =================== ===================2575</PRE>2576<P>See accompanying notes to consolidated financial statements.</P>2577<HR>25782579<PAGE>2580<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2581Consolidated Statements of Stockholders' Equity<BR>Three Years Ended December258231, 2001</B></P>2583<PRE>25842585Other2586Retained Comprehensive Total2587Common Stock Additional Earnings Income Treasury Stockholders'2588Shares Amount Capital (Deficit) (Loss) Stock Equity2589------------- ------------- ------------- ------------- ------------- ------------- -------------2590Balance at2591December 31, 1998 8,883,059 $ 444,153 $ 35,331,237 $ (110,157) $ (130,760) $ (765,424) $ 34,769,0492592Net income -- -- -- 5,816,922 -- -- 5,816,9222593Adjustment to2594unrealized losses2595on marketable2596securities -- -- -- -- (91,821) -- (91,821)2597-------------2598Comprehensive income 5,725,1012599-------------2600Issuance of 162,0682601shares from2602treasury for2603stock option2604exercises -- -- (954,221) -- -- 1,527,493 573,2722605Purchase of 602,2752606treasury shares,2607at cost -- -- -- -- -- (4,752,311) (4,752,311)2608Tax benefit from2609stock option2610exercises -- -- 221,096 -- -- -- 221,0962611------------- ------------- ------------- ------------- ------------- ------------- -------------2612Balance at2613December 31, 1999 8,883,059 444,153 34,598,112 5,706,765 (222,581) (3,990,242) 36,536,2072614Net income -- -- -- 832,458 -- -- 832,4582615Adjustment to2616unrealized losse2617on marketable2618securities -- -- -- -- 139,340 -- 139,3402619-------------2620Comprehensive income 971,7982621-------------2622Issuance of 32,9002623shares from2624treasury for2625private placement -- -- 100,000 -- -- 300,000 400,0002626Issuance of 337,9412627shares from2628treasury for2629stock option and2630warrant exercises -- -- (832,999) -- -- 2,762,449 1,929,4502631Tax benefit from2632stock option2633exercises -- -- 604,358 -- -- -- 604,3582634------------- ------------- ------------- ------------- ------------- ------------- -------------2635Balance at2636December 31, 2000 8,883,059 444,153 34,469,471 6,539,223 (83,241) (927,793) 40,441,8132637Net income -- -- -- 1,517,746 -- -- 1,517,7462638Net loss of2639Hi-tronics for2640December 2000 (see2641Note 3) -- -- -- (347,679) -- -- (347,679)2642Adjustment to2643unrealized losses2644on marketable2645securities -- -- -- -- 61,991 -- 61,9912646-------------2647Comprehensive income 1,232,0582648-------------2649Compensation expense2650resulting from2651changes to2652Hi-tronics stock2653options in December26542000 -- -- 37,029 -- -- -- 37,0292655Issuance of shares2656for stock option2657exercises 188,809 9,440 995,474 -- -- -- 1,004,9142658Tax benefit from2659stock option2660exercises -- -- 1,669,405 -- -- -- 1,669,4052661Issuance of 119,1002662shares from2663treasury for2664acquisition -- -- 1,498,869 -- -- 927,793 2,426,6622665------------- ------------- ------------- ------------- ------------- ------------- -------------2666Balance at2667December 31, 2001 9,071,868 $ 453,593 $ 38,670,248 $ 7,709,290 $ (21,250) $ -- $ 46,811,8812668============= ============= ============= ============= ============= ============= =============2669</PRE>2670<P>See accompanying notes to consolidated financial statements.</P>2671<HR>26722673<PAGE>2674<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2675Notes to Consolidated Financial Statements</B></P>2676<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2677<TR>2678<TD WIDTH=5%><B>(1)</B></TD>2679<TD WIDTH=95%><B>Business</B></TD></TR></TABLE>2680<P>Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS") designs,2681develops, manufactures and markets implantable neuromodulation devices. ANS2682devices are used primarily to manage chronic severe pain. ANS revenues are2683derived primarily from sales throughout the United States, Europe and Australia.2684</P>2685<P>On January 2, 2001, the Company acquired the assets (primarily intellectual2686property consisting of patents) of Implantable Devices Limited Partnership (IDP)2687and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota2688companies. See Note 3.</P>2689<P>On January 2, 2001, the Company completed the acquisition of Hi-tronics2690Designs, Inc. (HDI), a privately-held contract developer and original equipment2691manufacturer (O.E.M.) of electro-mechanical devices with headquarters in Budd2692Lake, New Jersey. See Note 3.</P>2693<P>The research and development, manufacture, sale and distribution of medical2694devices is subject to extensive regulation by various public agencies,2695principally the Food and Drug Administration and corresponding state, local and2696foreign agencies. Product approvals and clearances can be delayed or withdrawn2697for failure to comply with regulatory requirements or the occurrence of2698unforeseen problems following initial marketing.</P>2699<P>In addition, ANS neuromodulation products are purchased primarily by2700hospitals and other users who then bill various third-party payors including2701Medicare, Medicaid, private insurance companies and managed care organizations.2702These third-party payors reimburse fixed amounts for services based on a2703specific diagnosis. The impact of changes in third-party payor reimbursement2704policies and any amendments to existing reimbursement rules and regulations that2705restrict or terminate the eligibility of ANS products could have an adverse2706impact on the Company's financial condition and results of operations.</P>2707<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2708<TR>2709<TD WIDTH=5%><B>(2)</B></TD>2710<TD WIDTH=95%><B>Summary of Significant Accounting Policies</B></TD></TR>2711</TABLE>2712<P><B>Principles of Consolidation</B></P>2713<P>The consolidated financial statements include the accounts of Advanced2714Neuromodulation Systems, Inc. and all of its subsidiaries. All significant2715intercompany transactions and accounts have been eliminated in consolidation.2716</P>2717<P><B>Use of Estimates</B></P>2718<P>The preparation of financial statements in conformity with generally accepted2719accounting principles requires management to make estimates and assumptions that2720affect the amounts reported in the financial statements and accompanying notes.2721Actual results could differ from those estimates.</P>2722<P><B>Cash Equivalents</B></P>2723<P>The Company considers all highly liquid investments with maturities of three2724months or less at the time of purchase to be cash equivalents.</P>2725<P ALIGN=CENTER>Page 1</P>2726<HR>27272728<PAGE>2729<P><B>Revenue Recognition</B></P>2730<P>The Company recognizes revenue from neuro product sales when the goods are2731shipped to its customers. The Company recognizes revenue from custom2732manufactured products at HDI when the goods are shipped to the customer. HDI2733also develops products for certain customers under research and development2734contracts. HDI recognizes revenue under such development contracts based upon2735the percentage-of-completion method. Measurement of progress to completion is2736based upon costs incurred and estimated total costs.</P>2737<P><B>Marketable Securities</B></P>2738<P>The Company's marketable securities and debt securities are classified as2739available-for-sale and are carried at fair value with the unrealized gains and2740losses reported in a separate component of stockholders' equity entitled "Other2741comprehensive income". The cost of debt securities in this category is adjusted2742for amortization of premiums and accretion of discounts to maturity. Such2743amortization is included in investment income. Realized gains and losses and2744declines in value judged to be other than temporary are included in other2745income. The cost of securities sold is based on the specific identification2746method. Interest and dividends are included in investment income.</P>2747<P><B>Inventories</B></P>2748<P>Inventories are recorded at the lower of standard cost or market. Standard2749cost approximates actual cost determined on the first-in, first-out ("FIFO")2750basis. Cost includes the acquisition cost of raw materials and components,2751direct labor and overhead.</P>2752<P><B>Equipment and Fixtures</B></P>2753<P>Equipment and fixtures are stated at cost. Additions and improvements2754extending asset lives are capitalized while maintenance and repairs are expensed2755as incurred. The cost and accumulated depreciation of assets sold or retired are2756removed from the accounts and any gain or loss is reflected in the Statement of2757Income.</P>2758<P>Depreciation is provided using the straight-line method over the estimated2759useful lives of the various assets as follows:</P>2760<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2761<TR>2762<TD WIDTH=40%>Leasehold improvements</TD>2763<TD WIDTH=60% ALIGN=LEFT>3 to 5 years</TD>2764</TR>2765<TR>2766<TD>Furniture and fixtures</TD>2767<TD ALIGN=LEFT>2 to 10 years</TD>2768</TR>2769<TR>2770<TD>Machinery and equipment</TD>2771<TD ALIGN=LEFT>3 to 10 years</TD>2772</TR></TABLE>2773<P><B>Intangible Assets</B></P>2774<P>The excess of cost over the net assets of acquired businesses ("goodwill") is2775amortized on a straight-line basis over the estimated useful life of 20 years.2776</P>2777<P>The cost of purchased technology related to acquisitions is based on2778appraised values at the date of acquisition and is amortized on a straight-line2779basis over the estimated useful life (15 years) of such technology.</P>2780<P>The cost of purchased tradenames is based on appraised values at the date of2781acquisition and is amortized on a straight-line basis over the estimated useful2782life (20 years) of such tradenames.</P>2783<P>The cost of purchased patents is amortized on a straight-line basis over the2784estimated useful life (17 years) of such patents. The cost of certain licensed2785patents is amortized on a straight-line basis over the estimated useful life (202786years) of such patents. Costs of patents that are the result of internal2787development are charged to current operations.</P>2788<P ALIGN=CENTER>Page 2</P><HR>27892790<PAGE>2791<P>The Company assesses the recoverability of all its intangible assets2792primarily based on its current and anticipated future undiscounted cash flows.2793At December 31, 2001, the Company does not believe there has been any impairment2794of its intangible assets.</P>2795<P><B>Research and Development</B></P>2796<P>Product development costs including start-up and research and development are2797charged to operations in the year in which such costs are incurred.</P>2798<P><B>Advertising</B></P>2799<P>Advertising expense is charged to operations in the year in which such costs2800are incurred. Total advertising expense, included in marketing expense was2801$20,592, $24,716 and $40,440 at December 31, 2001, 2000 and 1999, respectively.2802</P>2803<P><B>Deferred Taxes</B></P>2804<P>Deferred income taxes are recorded based on the liability method and2805represent the tax effect of the differences between the financial and tax basis2806of assets and liabilities other than costs in excess of the net assets of2807businesses acquired.</P>2808<P><B>Stock-Based Compensation</B></P>2809<P>The Company has adopted the disclosure-only provisions of SFAS No. 123,2810"Accounting for Stock-Based Compensation", which disclosures are presented in2811Note 7, "Stockholders' Equity". Because of this election, the Company continues2812to account for its stock-based compensation plans under APB No. 25, "Accounting2813for Stock Issued to Employees". All of the Company's stock option grants are at2814exercise prices equal to the fair market value of the Company's stock on the2815date of grant, and therefore, no compensation expense is recorded.<P>2816<P><B>Earnings Per Share</B></P>2817<P>Basic earnings per share is computed based only on the weighted average2818number of common shares outstanding during the period, and the dilutive effect2819of stock options and warrants is excluded. Diluted earnings per share is2820computed using the additional dilutive effect, if any, of stock options and2821warrants using the treasury stock method based on the average market price of2822the stock during the period. Basic earnings per share for 2001, 2000 and 19992823are based upon 8,926,985, 8,507,048, and 8,679,952 shares, respectively. Diluted2824earnings per share for 2001, 2000, and 1999 are based upon 9,917,007, 9,398,934,2825and 9,105,289 shares, respectively. The following table presents the2826reconciliation of basic and diluted shares:</P>2827<P ALIGN=CENTER>Page 3</P><HR>28282829<PAGE>2830<PRE>28312001 2000 19992832--------- --------- ---------2833Weighted-average shares outstanding2834(basic shares) 8,926,985 8,507,048 8,679,95228352836Effect of dilutive instruments(1)2837Stock options 990,022 847,349 406,7012838Warrants --- 44,537 18,6362839--------- --------- ---------2840Dilutive potential common shares 990,022 891,886 425,3372841--------- --------- ---------2842Diluted shares 9,917,007 9,398,934 9,105,2892843========= ========= =========2844</PRE>2845<P>(1) See Note 7 for a description of these instruments.</P>2846<P>For 2001, 2000 and 1999 the incremental shares used for dilutive earnings per2847share relate to stock options and warrants whose exercise price was less than2848the average market price in the underlying quarterly computations. Options to2849purchase 24,750 shares at an average price of $19.79 per share were outstanding2850in 2001, 12,975 shares at an average price of $15.38 per share were outstanding2851in 2000, and options to purchase 250 shares at an average price of $8.94 per2852share were outstanding in 1999 but were not included in the computation of2853diluted earnings per share because the options' exercise prices were greater2854than the average market price of the common shares and, therefore, the effect2855would be antidilutive.</P>2856<P><B>Comprehensive Income</B></P>2857<P>Statement of Financial Accounting Standards No. 130 - "Reporting2858Comprehensive Income" - requires unrealized gains or losses on the Company's2859available for sale securities, and, for 2001, the effect of the change in fiscal2860year end of a company acquired (see Note 3) to be included in "Other2861comprehensive income" and be reported in the Consolidated Statements of2862Stockholders' Equity.</P>2863<P><B>New Accounting Standards</B></P>2864<P>In June 1998, the Financial Accounting Standards Board issued Statement of2865Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative2866Instruments and Hedging Activities." SFAS 133 requires companies to record2867derivatives on the balance sheet as assets or liabilities, measured at fair2868value. Gains or losses resulting from changes in the values of those derivatives2869would be accounted for depending on the use of the derivative and whether it2870qualifies for hedge accounting. SFAS 133, as amended by SFAS 138, is effective2871for fiscal years beginning after June 15, 2000. The adoption of SFAS 133 as of2872January 1, 2001 did not have an impact on the financial position or results of2873operations of the Company because the Company has no derivatives or hedges.</P>2874<P>In June 2001, the Financial Accounting Standards Board issued Statement of2875Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations" and2876Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and2877Other Intangible Assets". SFAS 141 and SFAS 142 are effective for fiscal years2878beginning after December 15, 2001. Under the new rules, goodwill and intangible2879assets deemed to have indefinite lives will no longer be amortized but will be2880subject to annual impairment tests in accordance with the statements. The2881Company has determined that its goodwill at December 31, 2001 is unimpaired and2882will eliminate amortization of the goodwill effective January 1, 2002. The2883Company recorded an expense of $556,604 in each of the three years ended2884December 31, 2001, 2000 and 1999 for amortization of goodwill.2885<P ALIGN=CENTER>Page 4</P><HR>28862887<PAGE>2888<P><B>Reclassification</B></P>2889<P>Certain prior period amounts have been reclassified to conform to2890current-year presentation.</P>2891<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2892<TR>2893<TD WIDTH=5%><B>(3)</B></TD>2894<TD WIDTH=95%><B>Acquistions</B></TD></TR></TABLE>2895<P>On January 2, 2001, the Company acquired the assets of Implantable Devices2896Limited Partnership (IDP) and ESOX Technology Holdings, LLC (ESOX), two2897privately held Minnesota companies, for 119,100 shares of the Company's common2898stock. Based on the closing price of ANS common stock on December 29, 2000, the2899value of the stock issued to acquire the assets was $2.43 million. The assets2900purchased consisted primarily of intellectual property and technology for the2901fully implantable constant-rate infusion pump that ANS has developed. Prior to2902the acquisition, the Company had licensed rights to the technology only for pain2903and cancer therapy applications.</P>2904<P>Also on January 2, 2001, the Company completed the acquisition of Hi-tronics2905Designs, Inc. (HDI), a privately-held contract developer and original equipment2906manufacturer (OEM) of electro-mechanical devices with headquarters in Budd Lake,2907New Jersey. The Company acquired all of HDI's outstanding stock through a merger2908in exchange for 1,104,725 shares of ANS common stock. The transaction was2909accounted for on a pooling of interests basis and accordingly, prior periods2910have been restated. HDI developed and manufactured the Company's totally2911implantable pulse generator (IPG) used in the treatment of chronic intractable2912pain and was also the O.E.M. manufacturer of the transmitter used with the2913Company's <I>Renew</I> radio-frequency spinal cord stimulation system.</P>2914<P>Prior to the Company's acquisition of HDI, HDI's fiscal year ended on2915November 30. The Consolidated Balance Sheet at December 31, 2000 combines the2916Balance Sheet of HDI at November 30, 2000 with the Balance Sheet of the Company2917at December 31, 2000. Beginning in 2001, the fiscal year-ends have been2918conformed to December 31. As a result, the results of operations of HDI for the2919one-month period ending December 31, 2000 have been recorded directly to2920retained earnings in the Consolidated Statement of Stockholders' Equity for the2921period ended December 31, 2001 and are not reflected in the Consolidated2922Statements of Income. Summary operating results of HDI for this one-month period2923ending December 31, 2000, were as follows:</P>2924<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2925<TR>2926<TD WIDTH=5%> </TD>2927<TD WIDTH=40%>Net revenue</TD>2928<TD WIDTH=2%>$</TD>2929<TD WIDTH=53%> 119,481</TD></TR>2930<TR>2931<TD> </TD>2932<TD>Loss before income tax benefit</TD>2933<TD>$</TD>2934<TD>(591,600)</TD></TR>2935<TR>2936<TD> </TD>2937<TD>Net loss</TD>2938<TD>$</TD>2939<TD>(347,679)</TD></TR></TABLE>2940<P>For the one-month period ended December 31, 2000, cash flows for HDI were as2941follows:</P>2942<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>2943<TR>2944<TD WIDTH=5%> </TD>2945<TD WIDTH=40%>Net cash used by operating activities</TD>2946<TD WIDTH=2%>$</TD>2947<TD WIDTH=53%>(647,210)</TD></TR>2948<TR>2949<TD> </TD>2950<TD>Net cash used by investing activities</TD>2951<TD>$</TD>2952<TD> (14,516)</TD></TR>2953<TR>2954<TD> </TD>2955<TD>Net cash used by financing activities</TD>2956<TD>$</TD>2957<TD> (10,718)</TD></TR>2958<TR>2959<TD> </TD>2960<TD>Net decrease in cash</TD>2961<TD>$</TD>2962<TD>(672,444)</TD></TR></TABLE>2963<P></P>2964The following is a reconciliation of previously reported amounts with restated2965amounts for total net revenue and net income:2966<PRE>29672000 19992968------------------ --------------------2969Total net revenue:2970As previously reported by the Company $23,081,624 $29,478,3842971HDI, for the year ended November 30 10,366,270 7,989,1772972Elimination of intercompany transactions (1,620,896) (1,688,542)2973------------------ --------------------2974As restated $31,826,998 $35,779,0192975================== ====================297629772000 19992978------------------ --------------------2979Net income:2980As previously reported by the Company $ 953,644 $ 6,003,2812981HDI, for the year ended November 30 28,833 328,0732982Elimination of intercompany transactions (150,019) (514,432)2983------------------ --------------------2984As restated $ 832,458 $ 9,398,9342985================== ====================29862987</PRE>2988<P>Prior to January 2, 2001, the Company and HDI, in the normal course of2989business, entered into certain transactions for development and manufacture2990related to the Company's products. These intercompany transactions have been2991eliminated.</P>299229932994<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2995<TR>2996<TD WIDTH=5%><B>(4)</B></TD>2997<TD WIDTH=95%><B>Note Payable</B></TD></TR></TABLE>2998<P>In connection with the acquisition of HDI (See Note 3), the Company acquired2999responsibility for a note payable with a principal balance of $189,722 at3000December 31, 2001. The note was entered into during March 2000, has a five-year3001term, and bears interest at a fixed rate of 9% per annum. The monthly3002installments for principal and interest are $5,623. The loan is collateralized3003by equipment purchased from the proceeds of the note and accounts receivable of3004HDI. Maturities of the note payable are as follows: $52,325 in 2002, $57,304 in30052003, $62,738 in 2004 and $17,355 in 2005.</P>3006<P ALIGN=CENTER>Page 5<P><HR>30073008<PAGE>3009<P></P>3010<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3011<TR>3012<TD WIDTH=5%><B>(5)</B></TD>3013<TD WIDTH=95%><B>Marketable Securities</B></TD></TR></TABLE>3014<P>The following is a summary of available-for-sale securities at December 31,30152001:</P>3016<PRE>30173018Gross Gross3019Unrealized Unrealized Estimated3020Cost Gains Losses Fair Value3021---------- ---------- ---------- ----------3022FNMA and Federal Home Loan Bank notes $1,038,783 $ -- $ 10,034 $1,028,7493023Investment grade municipal bonds 1,047,456 258 4,241 1,043,4733024Real estate investment trust 97,682 -- 18,182 79,5003025---------- ---------- ---------- ----------3026$2,183,921 $ 258 $ 32,457 $2,151,7223027========== ========== ========== ==========3028</PRE>3029<P>Estimated fair value for the real estate investment trust is determined by3030the closing price as reported on the New York Stock Exchange at each financial3031reporting period. In the case of the investment grade municipal bonds and FNMA3032and Federal Home Loan Bank notes, the brokerage firms holding such bonds and3033notes provide the values at each reporting period by utilizing a standard3034pricing service.</P>3035<P>At December 31, 2001, no individual security represented more than 25% of the3036total portfolio or 1% of total assets. The Company did not have any investments3037in derivative financial instruments at December 31, 2001.</P>3038<P>The following is a summary of available-for-sale securities at December 31,30392000:</P>3040<PRE>30413042Gross Gross3043Unrealized Unrealized Estimated3044Cost Gains Losses Fair Value3045---------- ---------- ---------- ----------3046Investment grade preferred security $ 250,000 $ -- $ 89,380 $ 160,6203047Investment grade municipal bonds 808,760 -- -- 808,7603048Real estate investment trust 97,682 -- 36,744 60,9383049---------- ---------- ---------- ----------3050$1,156,442 $ -- $ 126,124 $1,030,3183051========== ========== ========== ==========3052</PRE>3053<P>At December 31, 2000, no individual security represented more than 45% of the3054total portfolio or 1% of total assets. The Company did not have any investments3055in derivative financial instruments at December 31, 2000.</P>3056<P ALIGN=CENTER>Page 6</P><HR>30573058<PAGE>3059<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3060<TR>3061<TD WIDTH=5%><B>(6)</B></TD>3062<TD WIDTH=95%><B>Federal Income Taxes</B></TD></TR>3063</TABLE>3064<P>The significant components of the net deferred tax liability at December 31,3065were as follows:</P>3066<PRE>306730682001 20003069------------ ------------3070Deferred tax assets:30713072Net operating loss carry forwards $ 670,128 $ --3073Accrued expenses and reserves 870,720 842,5933074Marketable securities 10,949 42,8833075------------ ------------3076Total deferred tax asset 1,551,797 885,47630773078Deferred tax liabilities:30793080Purchased intangible assets (1,388,255) (1,116,851)3081Equipment and fixtures (895,390) (723,862)3082Other 140,686 (116,861)3083------------ ------------3084Total deferred tax liabilities (2,142,960) (1,957,574)3085------------ ------------30863087Net deferred tax liabilities $ (590,279) $(1,072,098)3088============ ============3089</PRE>3090<P>As of December 31, 2001, the Company had a net operating loss carry forward3091of approximately $1.8 million which expires in years through 2021. This net3092operating loss carry forward may be subject to Section 382 of the Internal3093Revenue Code or other provisions which may limit the use of the net operating3094loss carry forward in any tax year.3095<P>The provision for income taxes for the years ended December 31 consists of3096the following:</P>3097<PRE>30982001 2000 19993099----------- ----------- ----------3100Current $1,747,285 $ 841,390 $3,755,1133101Deferred (481,819) (182,866) (415,772)3102----------- ----------- ----------3103$1,265,466 $ 658,524 $3,339,3413104=========== =========== ==========3105</PRE>3106<P>A reconciliation of the provision for income taxes to the expense calculated3107at the U.S. statutory rate follows:</P>3108<PRE>31092001 2000 19993110----------- ----------- ----------3111Income tax expense at statutory rate $ 946,292 $ 506,934 $3,113,1293112Tax effect of:3113State taxes 42,959 4,581 183,6253114Nondeductible amortization of goodwill 189,245 189,279 189,2113115Other 86,970 (42,270) (146,624)3116----------- ----------- ----------3117Income tax expense $1,265,466 $ 658,524 $3,339,3413118=========== =========== ==========3119</PRE>3120<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3121<TR>3122<TD WIDTH=5%><B>(7)</B></TD>3123<TD><B>Stockholders' Equity</B></TD></TR></TABLE>3124<P>The Company has a Shareholder's Rights Plan, adopted in 1996 and amended in31252002, which permits shareholders to purchase shares of the Company's common3126stock at significant discounts in the event a person or group acquires more than312715% of the Company's common stock or announces a tender or exchange offer for3128more than 20% of the Company's common stock.</P>3129<P>At December 31, 2000, the Company had 119,100 treasury shares. These shares3130were reissued on January 2, 2002 in connection with the acquisition of assets.3131See Note 3.</P>3132<P ALIGN=CENTER>Page 7</P><HR>31333134<PAGE>3135<P>In 1998, the Company issued a five-year warrant to purchase 100,000 shares of3136common stock at an exercise price of $6.50 per share in connection with a3137$2,000,000 loan from a nonaffiliate shareholder. The warrant was exercised by3138the nonaffiliate shareholder in December 2000.</P>3139<P>The Company has various stock option plans pursuant to which stock options3140may be granted to key employees, officers, directors and advisory directors of3141the Company. The most recent of the plans, approved by the shareholders during31422000 (the "2000 Plan"), reserved 500,000 shares of common stock for options3143under the plan. In accordance with the 2000 Plan, on January 1 of each year3144(commencing in 2001), the aggregate number of shares of common stock reserved3145for options under the 2000 Plan is increased by the same percentage that the3146total number of issued and outstanding shares of common stock increased from the3147preceding January 1 to the following December 31 (if such percentage is3148positive). On January 1, 2002, options to purchase 95,538 shares of common stock3149were added to the 2000 Plan.</P>3150<P>Several of the plans allow for the grant of incentive stock options to key3151employees and officers intended to qualify for preferential tax treatment under3152Section 422 of the Internal Revenue Code of 1986. Under all of the Company's3153plans, the exercise price of options granted must equal or exceed the fair3154market value of the common stock at the time of the grant. Options granted to3155employees and officers expire ten years from the date of grant and for the most3156part are exercisable one-fourth each year over a four-year period of continuous3157service. Options granted to directors and advisory directors expire six years3158from the date of grant and for the most part are exercisable one-fourth each3159year over a four-year period of continuous service. Certain options, however,3160have a two-year or three-year vesting schedule.</P>3161<P>At December 31, 2001, under all of the Company's stock option plans,31621,669,175 shares had been granted and were outstanding, 2,234,997 shares of3163common stock had been issued upon exercise, and 74,402 shares were reserved for3164future grants.</P>3165<P>Data with respect to stock option plans of the Company are as follows:</P>3166<PRE>3167------------------------------------------------- -----------------------------3168Options Outstanding Exercisable Options3169------------------------------------------------- -----------------------------3170Weighted Weighted3171Average Average3172Shares Exercise Price Shares Exercise Price3173----------------- ------------ -------------- ------------ --------------3174January 1, 1999 1,068,215 $ 4.82 465,340 $ 4.583175Granted 447,102 $ 7.083176Exercised (162,068) $ 3.993177Forfeited (18,000) $ 8.143178----------------- ------------ -------------- ------------ --------------3179January 1, 2000 1,335,249 $ 5.63 563,333 $ 5.113180Granted 422,332 $ 14.213181Exercised (237,674) $ 5.503182Forfeited (55,270) $ 6.883183----------------- ------------ -------------- ------------ --------------3184January 1, 2001 1,464,637 $ 8.08 607,664 $ 5.233185Granted 413,500 $ 12.513186Exercised (188,809) $ 5.583187Forfeited (20,153) $ 8.703188----------------- ------------ -------------- ------------ --------------3189December 31, 2001 1,669,175 $ 9.44 750,215 $ 6.613190----------------- ============ ============== ============ ==============3191</PRE>3192<P ALIGN=CENTER>Page 8</P><HR>31933194<PAGE>3195<PRE>31963197Exercisable Options3198Options Outstanding at December 31, 2001 at December 31, 20013199- -------------------------------------------------------- ------------------------3200Weighted3201Average Weighted Weighted3202Range of Remaining Average Average3203Exercise Price Shares Life (Years) Exercise Price Shares Exercise Price3204- -------------- --------- ------------ -------------- -------- --------------3205$ 3.50 - 6.99 803,259 6.95 $ 5.46 625,384 $ 5.273206$ 7.00 - 10.49 88,959 8.30 $ 8.83 26,873 $ 8.523207$10.50 - 13.99 379,100 9.11 $ 11.13 24,275 $ 12.623208$14.00 - 17.49 274,607 8.57 $ 14.49 61,558 $ 14.493209$17.50 - 21.00 123,250 9.28 $ 19.37 12,125 $ 19.253210--------- ------------ -------------- -------- --------------32111,669,175 7.95 $ 9.44 750,215 $ 6.613212========= ============ ============== ======== ==============3213</PRE>3214<P>In accordance with APB No. 25, the Company has not recorded compensation3215expense for its stock option awards. As required by SFAS No. 123, the Company3216provides the following disclosure of hypothetical values for these awards. The3217weighted-average fair value of an option granted in 2001, 2000 and 1999 was3218$6.24, $5.76 and $2.73, respectively. For purposes of fair market value3219disclosures, the fair market value of an option grant was estimated using the3220Black-Scholes option pricing model with the following assumptions:</P>3221<PRE>32222001 2000 19993223--------- --------- ---------3224Risk-free interest rate 4.4% 5.9% 5.5%3225Average life of options (years) 3.0 3.0 3.03226Volatility 74.5% 52.4% 49.1%3227Dividend Yield -- -- --32283229</PRE>3230<P>Had the compensation expense been recorded based on these hypothetical3231values, pro forma net income (loss) for 2001, 2000 and 1999 would have been3232$(95,632), $(436,109) and $4,812,553, respectively, and pro forma diluted net3233income (loss) per common share for 2001, 2000 and 1999 would have been $(.01),3234$(.05) and $.53, respectively.</P>3235<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>3236<TR>3237<TD WIDTH=5%><B>(8)</B></TD>3238<TD WIDTH=95%><B>Commitments and Contingencies</B></TD></TR></TABLE>3239<P>On February 1, 1999, the Company sold its principal office and manufacturing3240facility in Allen, Texas to Atrion Corporation. Atrion leased space to the3241Company at the rate of $48,125 per month from February 1, 1999 through May 31,32421999. The Company entered into a sixty-three month lease agreement on 40,0003243square feet of space located in the North Dallas area during February 1999. The3244Company relocated its operations to the leased facility in May 1999 and the3245rental period under the lease commenced on June 1, 1999. Under the terms of the3246lease agreement, the Company received three months free rent and the monthly3247rental rate for the remaining term of the lease is $48,308. The monthly rental3248rate includes certain operating expenses such as property taxes on the facility,3249insurance, landscape and maintenance and janitorial services. The Company also3250has the first right of refusal to acquire the facility. Future minimum rental3251payments relating to the leased facility for the years ended December 31 are3252$579,696 in 2002 and 2003 and $386,464 in 2004.</P>3253<P>The Company also leases facilities in New Jersey as a result of the January32542001 acquisition of HDI. One of the facilities, located in Budd Lake, New Jersey3255is 8,800 square feet of office space that is used for administration, design3256engineering, drafting, documentation and regulatory affairs. The lease expires3257on May 31, 2003 and has a monthly rental rate of $10,891.The Company also leases325815,000 square feet of space in Hackettstown, New Jersey used for the O.E.M.3259manufacturing operations. The Hackettstown lease, which expires on December 31,32602002, has a monthly rental rate of $9,636 and is renewable for two additional3261one-year periods. In addition, during January 2001, the Company leased 2,2003262square feet of additional space in the Hackettstown facility adjacent to the326315,000 square feet of manufacturing space until June 30, 2002 at a monthly3264rental rate of $2,269. Future minimum rental payments relating to the leased3265facilities for HDI for the years ended December 31 are $259,938 in 2002 and3266$54,455 in 2003.</P>3267<P ALIGN=CENTER>Page 9</P><HR>32683269<PAGE>3270<P>The Company leases transportation equipment under non-cancelable operating3271leases until May 2002. Future minimum rental payments under non-cancelable3272transportation leases until the expiration of the leases in May 2002 are $5,889.3273</P>3274<P>The Company leases office equipment under non-cancelable operating leases3275expiring through 2004. Monthly payments on the office equipment leases are3276$3,600. Future minimum rental payments under non-cancelable equipment leases3277until the expiration of the leases are $41,000 in 2002, $29,000 in 2003 and3278$5,000 in 2004.</P>3279<P>Total rent expense for facilities, transportation and office equipment for3280the years ended December 31, 2001, 2000 and 1999 was $858,761, $791,192 and3281$736,536, respectively.</P>3282<P>The Company is a party to product liability claims related to ANS3283neurostimulation devices. Product liability insurers have assumed responsibility3284for defending the Company against these claims. While historically product3285liability claims for ANS neurostimulation devices have not resulted in3286significant monetary liability for the Company beyond its insurance coverage,3287there can be no assurances that the Company will not incur significant monetary3288liability to the claimants if such insurance is inadequate, and there can be no3289assurance that the Company's neurostimulation business and future ANS product3290lines will not be adversely affected by these product liability claims.</P>3291<P>Except for such product liability claims and other ordinary routine3292litigation incidental or immaterial to its business, the Company is not3293currently a party to any other pending legal proceeding. The Company maintains3294general liability insurance against risks arising out of the normal course of3295business.</P>3296<TABLE wIDTH=100% CELLPADDING=0 CELLSPACING=0>3297<TR>3298<TD WIDTH=5%><B>(9)</B></TD>3299<TD WIDTH=95%><B>Financial Instruments, Risk Concentration and Major Customers3300</B></TD></TR></TABLE>3301<P>In the United States, the Company's accounts receivable from its Neuro3302Products segment are due primarily from hospitals and distributors located3303throughout the country. Internationally, the Company's accounts receivable from3304its Neuro Products segment are due primarily from distributors located in Europe3305and Australia. For the HDI O.E.M segment, all of the accounts receivable are due3306from privately held and publicly traded medical device companies based in the3307United States. The Company generally does not require collateral for trade3308receivables. The Company maintains an allowance for doubtful accounts based upon3309expected collectibility. Any losses from bad debts have historically been within3310management's expectations.</P>3311<P>Net sales of implantable neurostimulation systems to one major customer for3312each of the years ended December 31, as a percentage of net revenue from the3313Neuro Products segment were as follows: 2001- 15% and 2000- 14%. Net sales of3314implantable neurostimulation systems to two major customers for the year ended3315December 31, 1999, as a percentage of net revenue from the Neuro Products3316segment were 15% and 11%, respectively.</P>3317<P>Net sales of O.E.M products and services to three major customers for the3318year ended December 31, 2001, as a percentage of net revenue from the HDI O.E.M.3319segment were 60 %, 17% and 11%, respectively. Net sales of O.E.M. products and3320services to three major customers for the year ended December 31, 2000, as a3321percentage of net revenue from the HDI O.E.M. segment were 49%, 24% and 17%,3322respectively. Net sales of O.E.M. products and services to four major customers3323for the year ended December 31, 1999, as a percentage of net revenue from the3324HDI O.E.M. segment were 27% , 27%, 19% and 12%, respectively.</P>3325<P>Foreign sales, primarily Europe and Australia, for the years ended December332631, 2001, 2000 and 1999 were approximately 10%, 7% and 7% of net revenue from3327the Neuro Products segment, respectively. The HDI O.E.M. segment had no foreign3328sales for the years ended December 31, 2001, 2000 and 1999, respectively.</P>3329<P ALIGN=CENTER>Page 10</P><HR>33303331<PAGE>3332<P></P>3333<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>3334<TR>3335<TD WIDTH=5%><B>(10)</B></TD>3336<TD WIDTH=95%><B>Employee Benefit Plans</B></TD></TR></TABLE>3337<P>The Company has a defined contribution retirement savings plan (the "Plan")3338available to substantially all employees of its Neuro Products segment. The Plan3339permits employees to elect salary deferral contributions of up to 15% of their3340compensation and requires the Company to make matching contributions equal to334150% of the participants' contributions to a maximum of 6% of the participants'3342compensation. As a result of the acquisition of HDI, the Company also has a3343defined contribution retirement savings plan (the "HDI Plan") available to3344substantially all employees of HDI. The HDI Plan permits employees to elect3345salary deferral contributions of up to 15% of their eligible compensation,3346subject to statutory limitations, and requires the Company to make matching3347contributions equal to 100% of the participants' contributions to a maximum of33485% of the participants' eligible compensation. The Board of Directors may change3349the percentage of matching contribution under either of the plans at their3350discretion. The expense of the Company's contribution for the years ended3351December 31 was $305,091 in 2001, $270,987 in 2000 and $230,410 in 1999.</P>3352<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3353<TR>3354<TD WIDTH=5%><B>(11)</B></TD>3355<TD WIDTH=95%><B>Sale of Facility/Accrued Tax Abatement Liability</B></TD></TR>3356</TABLE>3357<P>In January 1998, the Company sold its cardiovascular operations to Atrion3358Corporation, and granted Atrion a nine-month option to acquire the Company's3359principal office and manufacturing facility in Allen, Texas for $6.5 million.3360During October 1998, Atrion exercised its option to acquire the facility. When3361the facility was built in 1993, the Company entered a ten-year agreement with3362the City of Allen granting tax abatements to the Company if a minimum job base3363and personal property base were maintained in the City of Allen. The agreement3364provided for the repayment of abated taxes if the Company defaulted under the3365agreement. During 1998 the Company recorded a pretax expense of $969,204 in3366connection with the abated taxes. In April 1999, the Company was successful in3367petitioning the City of Allen to assign the abatement agreement to Atrion. In3368July 1999, the Company, Atrion and the City of Allen executed an assignment3369agreement under which Atrion (as successor in interest to the Company) must3370continue to meet the conditions of the original tax abatement agreement until3371August 2003. The City preserved its rights to collect previously abated taxes if3372Atrion fails to comply with its obligations any time prior to August 2003. The3373Company retains monetary liability for the amount of abated taxes, even after3374assignment, because pursuant to the purchase and sale agreement with Atrion, the3375Company indemnified Atrion from any tax abatement liabilities that accrued to3376the City of Allen prior to the sale of the cardiovascular operations in January33771998. If Atrion meets the minimum requirements under the agreement until August33782003, then no payment will be required. If no payment is required, the Company3379intends to reverse the potential obligation of $969,204 in September 2003.</P>3380<P>On February 1, 1999, the sale of the facility to Atrion was consummated. The3381Company repaid the mortgage debt on the facility at the closing of the3382transaction. After repayment of the mortgage debt and expenses related to the3383transaction, the Company received $2.7 million of net proceeds. No material gain3384or loss was recorded on the sale of the facility except related to the tax3385abatement liability described above. The Company moved its operations to a338640,000 square foot leased facility in the North Dallas area during May 1999.3387Until such time, the Company leased space from Atrion at a monthly expense of3388$48,175 and paid Atrion fifty percent of certain operating expenses. The expense3389of moving and transitioning into the new leased facility was immaterial.</P>3390<P ALIGN=CENTER>Page 11</P><HR>33913392<PAGE>3393<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3394<TR>3395<TD WIDTH=5%><B>(12)</B></TD>3396<TD WIDTH=95%><B>Product Development Agreement</B></TD></TR></TABLE>3397<P>In June 1998, the Company entered an agreement with Sofamor Danek Group, Inc.3398("Sofamor Danek") under which the Company agreed to develop and manufacture for3399Sofamor Danek, products and systems for use in Deep Brain Stimulation ("DBS").3400DBS products provide electrical stimulation to certain areas of the brain and3401are intended to relieve the effects of various neurological disorders, such as3402Parkinson's Disease and Essential Tremor. Under terms of the agreement, the3403Company granted Sofamor Danek exclusive worldwide rights to use, market and sell3404the DBS products developed and manufactured by ANS. The Company received a cash3405payment of $4 million upon execution of the agreement that was being recognized3406into income as revenue based upon the estimated percentage of completion of the3407development project. During the year ended December 31, 1998, the Company3408recognized $3.1 million into income as revenue. Due to the termination of the3409agreement discussed below, the remaining $900,000 was recognized into income as3410revenue during January 1999 and is included in the Statements of Income for the3411year ended December 31, 1999. The agreement also called for ANS to receive four3412additional payments of $2 million each, to be recognized into income upon the3413satisfactory completion of certain domestic and international regulatory3414milestones over the next several years.</P>3415<P>In December 1998, the Company and Sofamor Danek agreed to terminate the June34161998 DBS agreement due to the impending merger of Sofamor Danek and Medtronic,3417the Company's sole competitor in the DBS market. Under the termination3418agreement, Sofamor Danek agreed to accelerate payments due the Company in the3419amount of $8 million and the Company agreed to release Sofamor Danek from3420further contractual obligations. The Company received the $8 million payment3421from Sofamor Danek in January 1999. The $8 million payment was recognized into3422revenue during January 1999 and is included in the Statements of Income for the3423year ended December 31, 1999.</P>3424<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3425<TR>3426<TD WIDTH=5%><B>(13)</B></TD>3427<TD WIDTH=95%><B>Segment Information</B></TD></TR></TABLE>3428<P>The Company operates in two business segments. The Neuro Products segment3429designs, develops, manufactures and markets implantable medical devices that are3430used to manage chronic intractable pain and other disorders of the central3431nervous system through the delivery of electrical current or drugs directly to3432targeted nerve fibers. The HDI O.E.M. segment provides contract development and3433O.E.M. manufacturing of electro-mechanical devices.</P>3434<P>Segment data for the year ended December 31, 2001 is as follows:</P>3435<PRE>3436Neuro HDI Intercompany Consolidated3437Products O.E.M. Eliminations Total3438------------- ------------- ------------- -------------3439Revenue from external3440customers $ 27,460,618 $ 10,455,817 $ --- $ 37,916,4353441Intersegment revenues $ --- $ 2,862,652 $ (2,862,652) $ ---3442Segment income from3443operations $ 1,040,036 $ 1,768,871 $ --- $ 2,808,9073444Segment assets $ 51,246,012 $ 6,847,014 $ (2,227,941) $ 55,865,08534453446</PRE>3447<P>Segment data for the year ended December 31, 2000 is as follows:</P>3448<P ALIGN=CENTER>Page 12</P><HR>34493450<PAGE>3451<PRE>34523453Neuro HDI Intercompany Consolidated3454Products O.E.M. Eliminations Total3455------------- ------------- ------------- -------------3456Revenue from external3457customers $ 23,081,624 $ 8,745,374 $ --- $ 31,826,9983458Intersegment revenues $ --- $ 1,620,896 $ (1,620,896) $ ---3459Segment income from3460operations $ 1,108,894 $ 67,985 $ (231,452) $ 945,4273461Segment assets $ 45,371,687 $ 7,391,078 $ (3,198,199) $ 49,564,56634623463</PRE>3464<P>Segment data for the year ended December 31, 1999 is as follows:</P>3465<PRE>34663467Neuro HDI Intercompany Consolidated3468Products O.E.M. Eliminations Total3469------------- ------------- ------------- -------------3470Revenue from external3471customers $ 29,478,384 $ 6,300,635 $ --- $ 35,779,0193472Intersegment revenues $ --- $ 1,688,542 $ (1,688,542) $ ---3473Segment income from3474operations $ 8,842,197 $ 432,900 $ (805,800) $ 8,469,2973475Segment assets $ 43,554,774 $ 5,804,304 $ (952,152) $ 48,406,9263476</PRE>3477<P ALIGN=CENTER>Page 13</P><HR>34783479<PAGE>3480<P ALIGN=RIGHT><B><U>Appendix B</U></B></P>3481<P></P><P></P><P></P>3482<P ALIGN=CENTER><B>Schedule II - Valuation and Qualifying Accounts</B></P>3483<P></P><P></P>3484<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>3485Item 14<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>3486(Name of issuer)</B></P>3487<P></P><P></P>3488<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>3489<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange3490Act of 1934</B></P>3491<HR>34923493<PAGE>3494<PRE>3495Schedule II - Valuation and Qualifying Accounts3496Advanced Neuromodulation Systems, Inc. and Subsidiaries3497December 31, 200134983499Balance at Charged to3500Beginning Charged to Other Balance at3501Description of Year Expenses Accounts Deductions End of Year3502- ----------------------------------- ----------- ----------- ----------- ----------- -----------3503Year ended December 31, 2001:35043505Allowance for doubtful accounts $ 213,249 $ 10,000 $ -- $ 99,138 $ 124,1113506Reserve for obsolete inventory 310,243 107,880 124,673 293,4503507----------- ----------- ----------- ----------- ------------35083509Total $ 523,492 $ 117,880 $ -- $ 223,811 $ 417,5613510=========== =========== ============ =========== ============35113512Year ended December 31, 200035133514Allowance for doubtful accounts $ 140,824 $ 102,984 $ -- $ 30,559 $ 213,2493515Reserve for obsolete inventory 199,099 111,144 -- -- 310,2433516----------- ----------- ----------- ----------- ------------35173518Total $ 339,923 $ 214,128 $ -- $ 30,559 $ 523,4923519=========== =========== =========== =========== ============352035213522Year ended December 31, 1999:35233524Allowance for doubtful accounts $ 249,607 $ 35,756 $ -- $ 144,539 $ 140,8243525Reserve for obsolete inventory 86,599 112,500 -- -- 199,0993526----------- ----------- ----------- ----------- ------------35273528Total $ 336,206 $ 148,256 $ -- $ 144,539 $ 339,9233529=========== =========== =========== =========== ============3530</PRE><HR>35313532<PAGE>3533<P ALIGN=RIGHT><B><U>Appendix C</U></B></P>3534<P></P><P></P><P></P>3535<P ALIGN=CENTER><B>Quarterly Financial Data<BR>(unaudited)</B></P>3536<P></P><P></P>3537<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>3538Item 8<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of3539issuer)</B></P>3540<P></P><P></P>3541<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>3542<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange3543Act of 1934</B></P>3544<HR>3545<PRE>35462001 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.3547- --------------------------------------------- ------------- ------------- ------------- -------------3548Net revenue $ 8,340,810 $ 9,204,721 $ 9,899,973 $ 10,470,9313549Gross profit 4,768,021 5,270,066 5,830,956 6,371,9563550Income from operations 332,764 530,936 783,321 1,161,8863551Acquisition related costs (483,766) -- -- --3552Income (loss) from operations before income3553taxes (benefit) (13,160) 678,703 863,379 1,254,2903554- --------------------------------------------- ------------- ------------- ------------- -------------3555Net income (loss) $ (6,261) $ 368,514 $ 475,244 $ 680,2493556- --------------------------------------------- ------------- ------------- ------------- -------------35573558- --------------------------------------------- ------------- ------------- ------------- -------------3559Basic income per share $ -- $ 0.04 $ 0.05 $ 0.073560- --------------------------------------------- ------------- ------------- ------------- -------------35613562- --------------------------------------------- ------------- ------------- ------------- -------------3563Diluted income per share $ -- $ 0.04 $ 0.05 $ 0.073564- --------------------------------------------- ------------- ------------- ------------- -------------35653566356735682000 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.3569- --------------------------------------------- ------------- ------------- ------------- -------------3570Net revenue $ 7,427,624 $ 8,357,988 $ 8,176,084 $ 7,865,3023571Gross profit 3,983,099 4,630,029 4,307,024 4,207,2133572Income from operations 125,052 570,360 230,537 19,4783573Income from operations before income taxes 278,607 687,551 354,431 170,3933574- --------------------------------------------- ------------- ------------- ------------- -------------3575Net income $ 155,555 $ 383,880 $ 197,890 $ 95,1333576- --------------------------------------------- ------------- ------------- ------------- -------------35773578- --------------------------------------------- ------------- ------------- ------------- -------------3579Basic income per share $ 0.02 $ 0.05 $ 0.02 $ 0.013580- --------------------------------------------- ------------- ------------- ------------- -------------35813582- --------------------------------------------- ------------- ------------- ------------- -------------3583Diluted income per share $ 0.02 $ 0.04 $ 0.02 $ 0.013584- --------------------------------------------- ------------- ------------- ------------- -------------3585</PRE>35863587<PAGE>3588<P ALIGN=CENTER><B>INDEX TO EXHIBITS</B></P>3589<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3590<TR>3591<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>3592<TD WIDTH=5%></TD>3593<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>3594</TABLE>3595<P></P>3596<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3597<TR>3598<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>3599<TD WIDTH=5%> </TD>3600<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by3601and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and3602Hi-tronics Designs, Inc.(10)</TD></TR>3603<TR>3604<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>3605<TD></TD>3606<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>3607<TR>3608<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>3609<TD></TD>3610<TD>Bylaws(11)</TD></TR>3611<TR>3612<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>3613<TD></TD>3614<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.3615and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>3616<TR>3617<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>3618<TD></TD>3619<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option3620Plan(2)</TD></TR>3621<TR>3622<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>10.2 </TD>3623<TD WIDTH=5%> </TD>3624<TD WIDTH=85%>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>3625<TR>3626<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>3627<TD></TD>3628<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>3629<TR>3630<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>3631<TD></TD>3632<TD>Form of Directors Stock Option Agreement(1)</TD></TR>3633<TR>3634<TD ALIGN=RIGHT VALIGN=TOP>10.5 </TD>3635<TD></TD>3636<TD>Quest Medical, Inc. 1987 Stock Option Plan(4)</TD></TR>3637<TR>3638<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>3639<TD></TD>3640<TD>Form of 1987 Employee Stock Option Agreement(4)</TD></TR>3641<TR>3642<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>3643<TD></TD>3644<TD>Quest Medical, Inc. 1995 Stock Option Plan(4)</TD></TR>3645<TR>3646<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>3647<TD></TD>3648<TD>Form of 1995 Employee Stock Option Agreement(4)</TD></TR>3649<TR>3650<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>3651<TD></TD>3652<TD>Quest Medical, Inc. 1998 Stock Option Plan(7)</TD></TR>3653<TR>3654<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>3655<TD></TD>3656<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>3657<TR>3658<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>3659<TD></TD>3660<TD>Employment Agreement dated April 9, 1998 between Christopher G. Chavez and3661Quest Medical, Inc.(6)</TD></TR>3662<TR>3663<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>3664<TD></TD>3665<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and Quest3666Medical, Inc.(6)</TD></TR>3667<TR>3668<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>3669<TD></TD>3670<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill III and3671Quest Medical, Inc.(6)</TD></TR>3672<TR>3673<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>3674<TD></TD>3675<TD>Form of Employment Agreement and Covenant Not to Compete, between the3676Company and key employees(1)</TD></TR>3677<TR>3678<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>3679<TD></TD>3680<TD>Lease Agreement dated as of February 4, 1999, between Advanced3681Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>3682<TR>3683<TD ALIGN=RIGHT VALIGN=TOP>11.1 </TD>3684<TD></TD>3685<TD>Computation of Earnings Per Share(13)</TD></TR>3686<TR>3687<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>3688<TD></TD>3689<TD>Subsidiaries(13)</TD></TR>3690<TR>3691<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>3692<TD></TD>3693<TD>Consent of Independent Auditors(13)</TD></TR></TABLE>3694<P>__________________________________</P>3695<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3696<TR>3697<TD WIDTH=5% VALIGN=TOP>(1) </TD>3698<TD WIDTH=2%></TD>3699<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on3700Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.3701</TD></TR>3702<TR>3703<TD>(2) </TD>3704<TD></TD>3705<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year3706ended December 31, 1987, and incorporated herein by reference.</TD></TR>3707<TR>3708<TD>(3) </TD>3709<TD></TD>3710<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,3711Registration No. 2-78186, and incorporated herein by reference.</TD></TR>3712<TR>3713<TD>(4) </TD>3714<TD></TD>3715<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,3716Registration No. 33-62991, and incorporated herein by reference.</TD></TR>3717<TR>3718<TD>(5) </TD>3719<TD></TD>3720<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September37213, 1996, and incorporated herein by reference.</TD></TR>3722<TR>3723<TD>(6) </TD>3724<TD></TD>3725<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the3726quarterly period ended March 31, 1998, and incorporated herein by reference.3727</TD></TR>3728<TR>3729<TD>(7) </TD>3730<TD></TD>3731<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated3732April 27, 1998, and incorporated herein by reference.</TD></TR>3733<TR>3734<TD>(8) </TD>3735<TD></TD>3736<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the3737year ended December 31, 1998, and incorporated herein by reference.</TD></TR>3738<TR>3739<TD>(9) </TD>3740<TD></TD>3741<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated3742April 17, 2000, and incorporated herein by reference.</TD></TR>3743<TR>3744<TD>(10)</TD>3745<TD></TD>3746<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January37479, 2001, and incorporated herein by reference. Upon request, the Company will3748furnish a copy of any omitted schedule to the Commission.</TD></TR>3749<TR>3750<TD>(11)</TD>3751<TD></TD>3752<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the3753year ended December 31, 2000, and incorporated herein by reference.</TD></TR>3754<TR>3755<TD>(12)</TD>3756<TD></TD>3757<TD>Filed as an Exhibit to the report of the company on Form 8-K dated January375830, 2002, and incorporated herein by reference.</TD></TR>3759<TR>3760<TD>(13)</TD>3761<TD></TD>3762<TD>Filed herewith.</TD></TR></TABLE>3763<HR>37643765<PAGE>3766<P ALIGN=CENTER><B>EXHIBIT 11.1</B></P>37673768<PAGE>3769<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc.<BR>Computation of3770Income Per Share<BR>Years Ended December 31</B></P>3771<PRE>37723773377437752001 2000 19993776------------ ------------ ------------3777Basic income per share:37783779Weighted average common3780Shares outstanding 8,926,985 8,507,048 8,679,9523781------------ ------------ ------------37823783------------ ------------ ------------3784Net income $ 1,517,746 $ 832,458 $5,816,9223785------------ ------------ ------------3786Net income per share $ 0.17 $ 0.10 $ 0.733787------------ ------------ ------------37883789Diluted income per share:37903791Weighted average common3792shares outstanding 8,926,985 8,507,048 8,679,9523793Stock options and warrants-based3794on the treasury stock method3795using average market price 990,022 891,886 425,3373796------------ ------------ ------------3797Diluted common and common equivalent3798shares outstanding 9,917,007 9,398,934 9,105,2893799------------ ------------ ------------38003801------------ ------------ ------------3802Net income $ 1,517,746 $ 832,458 $5,816,9223803------------ ------------ ------------3804Net income per share $ 0.15 $ 0.09 $ 0.643805------------ ------------ ------------3806</PRE>38073808<PAGE>3809<P ALIGN=CENTER><B>EXHIBIT 21.1</B></P>38103811<PAGE>3812<P ALIGN=CENTER><B><U>SUBSIDIARIES</U></B></P>3813<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3814<TR>3815<TD WIDTH=40%>Hi-Tronics Designs, Inc.</TD>3816<TD WIDTH=60%>New Jersey Corporation</TD></TR></TABLE>38173818<PAGE>3819<P ALIGN=CENTER><B>EXHIBIT 23.1</B></P>38203821<PAGE>3822<P ALIGN=CENTER><B><U>Consent of Independent Auditors</U></B></P>3823<P>We consent to the incorporation by reference in the Registration Statements3824(Form S-8 - Nos. 2-82414, 2-91410, 33-235312, 33-00967 and 333-75879, and Form3825S-3 - Nos. 333-40927 and 333-53440) pertaining to the Advanced Neuromodulation3826Systems, Inc. 1979 Amended and Restated Employees' Stock Option Plan; the3827Advanced Neuromodulation Systems, Inc. Directors' Stock Option Plan; the3828Advanced Neuromodulation Systems, Inc. 1987 Employees' Stock Option Plan; the3829Advanced Neuromodulation Systems, Inc. 1995 Stock Option Plan; the Advanced3830Neuromodulation Systems, Inc. Sales and Marketing Employees Stock Option Plan;3831the Heaton Stock Option Plan; the Advanced Neuromodulation Systems, Inc. 19983832Stock Option Plan; the registration of 100,000 shares of Common Stock issued3833pursuant to a Common Stock Purchase Warrant between Advanced Neuromodulation3834Systems, Inc. and Robert L. Swisher, Jr., the registration of 1,223,825 shares3835of Common Stock issued pursuant to an Agreement and Plan of Merger dated3836November 30, 2000 between the Company and Hi-tronics Designs, Inc. and an Asset3837Purchase Agreement dated as of January 2, 2001 between the Company and3838Implantable Devices Limited Partnership, ESOX Technology Corporation and3839Implantable Devices, Inc. and the related Prospectuses of our report dated3840February 6, 2002, with respect to the consolidated financial statements and3841schedule of Advanced Neuromodulation Systems, Inc. and Subsidiaries, included in3842the Annual Report (Form 10-K) for the year ended December 31, 2001.</P>3843<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3844<TR>3845<TD WIDTH=40%> </TD>3846<TD WIDTH=60%><U>/s/Ernst & Young LLP</U><BR>Ernst & Young LLP</TD></TR>3847</TABLE>3848<P></P>3849<P>Dallas, Texas<BR>March 26, 2002</P>3850</BODY>3851</HTML>38523853</TEXT>3854</DOCUMENT>3855</SEC-DOCUMENT>3856-----END PRIVACY-ENHANCED MESSAGE-----385738583859