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,7RZtrab/uAyl8UMxNK7fYyYkX+k6QV+QUOR8++EIuSuHrODZirS0pSUw+4Meh4MRP89SoasVcUYiGGFtssk8VDjQ==910<SEC-DOCUMENT>0000351721-03-000081.txt : 2003033111<SEC-HEADER>0000351721-03-000081.hdr.sgml : 2003033112<ACCEPTANCE-DATETIME>2003032817324213ACCESSION NUMBER: 0000351721-03-00008114CONFORMED SUBMISSION TYPE: 10-K15PUBLIC DOCUMENT COUNT: 116CONFORMED PERIOD OF REPORT: 2002123117FILED AS OF DATE: 200303311819FILER:2021COMPANY DATA:22COMPANY CONFORMED NAME: ADVANCED NEUROMODULATION SYSTEMS INC23CENTRAL INDEX KEY: 000035172124STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841]25IRS NUMBER: 75164600226STATE OF INCORPORATION: TX27FISCAL YEAR END: 12312829FILING VALUES:30FORM TYPE: 10-K31SEC ACT: 1934 Act32SEC FILE NUMBER: 000-1052133FILM NUMBER: 036265173435BUSINESS ADDRESS:36STREET 1: 6501 WINDCREST DRIVE SUITE 10037CITY: PLANO38STATE: TX39ZIP: 7502440BUSINESS PHONE: 97230980004142MAIL ADDRESS:43STREET 1: 6501 WINDCREST DRIVE SUITE 10044CITY: PLANO45STATE: TX46ZIP: 750244748FORMER COMPANY:49FORMER CONFORMED NAME: QUEST MEDICAL INC50DATE OF NAME CHANGE: 1992070351</SEC-HEADER>52<DOCUMENT>53<TYPE>10-K54<SEQUENCE>155<FILENAME>k1003282003.htm56<DESCRIPTION>FORM 10-K57<TEXT>58<HTML>59<HEAD>60<TITLE>ADVANCED NEUROMODULATION SYSTEMS, INC. FORM 10-Q</TITLE>61</HEAD>62<BODY>63<H1 ALIGN=CENTER><FONT SIZE=3>SECURITIES AND EXCHANGE COMMISSION</FONT></H1>64<H1 ALIGN=CENTER><FONT SIZE=3>Washington, D.C. 20549</FONT></H1>65<HR SIZE=1 WIDTH=15% ALIGN=CENTER>66<H1 ALIGN=CENTER><FONT SIZE=4>FORM 10-K</FONT></H1>67<HR SIZE=1 WIDTH=15% ALIGN=CENTER>68<H1 ALIGN=CENTER><FONT SIZE=3>[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR6915(d) OF THE<BR>SECURITIES EXCHANGE ACT OF 1934</FONT></H1>70<P ALIGN=CENTER><FONT SIZE=3>For the Fiscal Year Ended December 31,712002</FONT></P>72<P ALIGN=CENTER><FONT SIZE=3>OR</FONT></P>73<H1 ALIGN=CENTER><FONT SIZE=3>[ ] TRANSITION REPORT PURSUANT TO74SECTION 13 OR 15(d) OF THE<BR> SECURITIES EXCHANGE ACT OF 1934</FONT></H1>75<HR SIZE=1 WIDTH=15% ALIGN=CENTER>76<P ALIGN=CENTER><FONT SIZE=3>Commission file number 0-10521</FONT></P>77<H1 ALIGN=CENTER><FONT SIZE=4>ADVANCED NEUROMODULATION SYSTEMS, INC.</FONT></H1>78<P ALIGN=CENTER><FONT SIZE=3>Incorporated pursuant to the Laws of the State of79Texas</FONT></P>80<HR SIZE=1 WIDTH=15% ALIGN=CENTER>81<P ALIGN=CENTER><FONT SIZE=3>Internal Revenue Service — Employer82Identification No. 75-1646002</FONT></P>83<P ALIGN=CENTER><FONT SIZE=3>6501 Windcrest Drive, Plano, Texas 75024</FONT></P>84<P ALIGN=CENTER><FONT SIZE=3>(972) 309-8000</FONT></P>85<HR SIZE=1 WIDTH=15% ALIGN=CENTER>86<P><FONT SIZE=2>Indicate by check mark whether the registrant (1) has filed all87reports required to be filed by Section 13 or 15(d) of the Securities Exchange88Act of 1934 during the preceding 12 months (or for such shorter period that the89registrant was required to file such reports) and (2) has been subject to such90filing requirements for the past 90 days.91Yes [X] No [ ] </FONT></P>92<P><FONT SIZE=2>Indicate by check mark if disclosure of delinquent filers93pursuant to Item 405 of the S-K is not contained herein, and will not be94contained, to the best of registrant's knowledge, in definitive proxy or95information statements incorporated by reference in Part III of this Form 10-K96or any amendment to this Form 10-K. [ ]</FONT></P>97<P><FONT SIZE=2>Aggregate market value of the registrant’s Common98Stock held by non-affiliates of the registrant as of June 30, 2002:99$349,090,251</FONT></P>100<P><FONT SIZE=2>Number of shares outstanding of the registrant’s Common101Stock as of March 17, 2003: 12,476,795</FONT></P>102<P ALIGN=CENTER><FONT SIZE=2><B>DOCUMENTS INCORPORATED BY REFERENCE</B></FONT>103</P>104<P><FONT SIZE=2>Portions of the registrant’s definitive Proxy Statement105for the registrant's Annual Meeting of Stockholders to be held on June 4, 2003,106are incorporated by reference into Part III.</FONT></P>107<HR SIZE=5>108109<PAGE>110<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc.</B></P>111<P ALIGN=CENTER><B>Annual Report</B></P>112<P ALIGN=CENTER><B>Form 10-K</B></P>113<P ALIGN=CENTER><B>Year Ended December 31, 2002</B></P>114<P ALIGN=CENTER><B>PART I</B></P>115<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>116<TR>117<TD WIDTH=15% VALIGN=TOP><B>ITEM 1.</B></TD>118<TD WIDTH=85%><B>BUSINESS</B></TD></TR></TABLE>119<P><B>Overview</B></P>120<P>We design, develop, manufacture and market advanced implantable121neuromodulation devices that improve the quality of life for people suffering122from chronic pain. Neuromodulation devices include implantable neurostimulation123devices, which deliver electric current directly to targeted nerves, and124implantable drug pumps, which deliver small, precisely controlled doses of drugs125directly to targeted sites within the body. Our products utilize innovative126technologies that offer advanced programming features, user-friendly interfaces127and smaller implanted devices, resulting in greater patient comfort. We are128leveraging our neuromodulation product platforms to develop new pain management129products and to expand into new applications.</P>130<P>We market our products to physicians who specialize in managing chronic pain.131We define chronic pain as pain that persists or recurs for more than six months,132is resistant to conservative therapies and significantly restricts a patient's133normal activities. There are approximately 3,000 pain management specialists in134the U.S., approximately 80% of whom are anesthesiologists and approximately 20%135of whom are neurosurgeons or orthopedic surgeons, and the number of pain136management specialists is growing steadily.</P>137<P>We currently market three principal product lines: our <I>Renew®</I>138radio frequency (RF) system, our <I>Genesis®</I> and <I>GenesisXP™</I>139implantable pulse generator (IPG) systems and our <I>AccuRx®</I> implantable140drug pump. We have sold <I>Renew</I> in the U.S. since June 1999 for treatment141of chronic pain of the trunk and limbs. Renew's advanced features effectively142manage complex and multi-extremity pain patterns and provide pain management143specialists with significant programming flexibility. We began selling144<I>Genesis</I> in Europe in the first quarter of 2001 and in the U.S. and145Australia in January 2002 for treatment of chronic pain of the trunk and limbs.146We believe that <I>Genesis</I> offers a superior size-to-function ratio, greater147patient comfort, more flexibility in addressing different pain patterns and148other technological advances, which provide us with a competitive advantage.149Additionally, we recently received approval from the U.S. Food and Drug150Administration (FDA) to market an enhanced version of <I>Genesis</I>, the151<I>GenesisXP</I> IPG system for treatment of chronic pain of the trunk and152limbs, which we launched in the U.S. in the fourth quarter of 2002. The153<I>GenesisXP</I> offers substantially more battery capacity than <I>Genesis</I>154resulting in enhanced longevity and/or additional power to treat more complex155pain. We began selling <I>AccuRx</I> in certain international markets in the156second quarter of 2001 and recently completed all implants in a 109 patient157clinical trial we are conducting of <I>AccuRx</I> in the U.S. under an158investigational device exemption (IDE) from the FDA. <I>AccuRx</I> is smaller159than the other constant rate drug pumps currently on the market, and it160incorporates a new polymeric diaphragm technology that makes it more precise161under varying conditions than other constant rate drug pumps. We expect to file162our pre-market approval (PMA) application for <I>AccuRx</I> with the FDA later163in 2003.</P>164<P ALIGN=CENTER>Page 1</P>165<HR>166167<PAGE>168<P>Our Hi-tronics Designs, Inc. (HDI) subsidiary, which we acquired in January1692001, designs and manufactures medical devices for us, and for other companies170on an O.E.M. (original equipment manufacturer) basis. HDI's core strength is in171developing highly-sophisticated electromechanical devices featuring electronic172circuits with very low power requirements. We acquired HDI to leverage its173expertise in development and manufacturing and benefit from its technology174platforms.</P>175<P><B>The Neuromodulation Market Opportunity</B></P>176<P>When treating patients suffering from chronic pain, pain management177specialists can select from several therapy options, ranging from the least178invasive and lowest-cost therapies to the most aggressive and expensive179therapies. Initially, patients typically try over-the-counter medications and180physical therapy. If these therapies fail, patients generally try some181combination of prescription medications, TENS therapy (application of electrical182impulses to the skin), psychological therapy and nerve blocks (injections that183provide temporary pain relief). If these therapies do not succeed in relieving184pain, patients may then try narcotic and opioid drugs, neurolysis (destruction185of the affected nerve) and thermal procedures. At some point during their course186of treatment, patients may use neuromodulation products or undergo more invasive187surgical procedures.</P>188<P>Patients who opt for neurostimulation or drug pumps to treat chronic pain189typically range in age from 25 to 55, have suffered back or neck injuries or190otherwise suffer from degenerative spine conditions, and are in constant pain191that has not been alleviated by other therapies, including back surgeries. A192growing number of patients are choosing neuromodulation over prolonged systemic193use of narcotic or opioid drugs, which have negative side effects, or back194surgeries involving vertebral fusion or nerve destruction, which are195irreversible and often unsuccessful.</P>196<P>The use of neuromodulation devices to manage chronic pain is growing rapidly.197According to an independent study, spinal cord stimulation products were198forecasted to account for $293.2 million in revenues in 2002 in the United199States, up from $239.8 million in 2001. Total neurostimulation revenues for all200currently approved indications in the U.S. (including deep brain stimulation,201sacral nerve stimulation and other applications) were forecasted to account for202$435.7 million in 2002, up from $337.1 million, according to the same study. A203separate study reported that in 2001, worldwide sales of drug pumps were204approximately $230 million.</P>205<P>The primary factors driving this growth include the following:</P>206<UL>207<LI><I>Increased physician and patient awareness of the benefits of208neuromodulation.</I> Neuromodulation can manage pain effectively, is minimally209invasive, has few side effects and is generally reversible. As physicians and210their patients are becoming more aware of these benefits and more accepting of211this treatment option, neuromodulation is being used earlier in the process of212managing chronic pain. Consequently, the number of pain management specialists213worldwide who understand and are trained to use neuromodulation products and214techniques is growing steadily.215<LI><I>Expanded indications for the use of neuromodulation products.</I>216Neuromodulation products have demonstrated success in the treatment of217indications outside of chronic pain. The recent approval by other companies of218the use of these products to address new indications, including essential219tremor, Parkinson's Disease, and incontinence, as well as future approvals to220treat angina and severe headaches, should expand the neuromodulation market.221<LI><I>Technological advances in neuromodulation products.</I> Advances in222technology have decreased the size of neuromodulation devices, increased the223longevity of their power sources and enhanced programmability and other224functional components of the devices, leading to better results for patients.225<LI><I>Patients' increased focus on quality of life.</I> In the past, chronic226pain sufferers were often resigned to long-term use of pain-killing drugs, often227bedridden and unable to maintain a normal lifestyle. Today, many chronic pain228patients hope to resume an active lifestyle following an injury or illness, and229thus more likely to consider and accept neuromodulation therapy.</UL>230<P ALIGN=CENTER>Page 2</P>231<HR>232233<PAGE>234<P><B>Our Strategy</B></P>235<P>Our objective is to be a leading provider of a full range of innovative236neuromodulation devices for the management of chronic pain and nervous system237disorders. To achieve this objective, we are pursuing the following business238strategies:</P>239<UL>240<LI><I>Expand our presence in the chronic pain market.</I> Through the recent241launches of our IPG systems, we have entered a market that is estimated to be242four times larger than the RF market, and thus significantly expanded our243potential market opportunity. We intend to increase our penetration of the244chronic pain market by enhancing our sales and marketing resources. We also245intend to leverage our relationships with pain management specialists as well as246our favorable track record with our RF systems to grow our market share in the247IPG portion of the neurostimulation market and to further strengthen our248position in the RF portion of this market.249<LI><I>Pursue regulatory approvals for new treatment indications.</I> We believe250our neurostimulation technology platforms have broad applicability for multiple251treatment indications beyond chronic pain conditions. We will pursue regulatory252approvals for new clinical applications to treat disorders affecting large253patient populations, including essential tremor, Parkinson's Disease, pelvic254pain and severe headaches, where neuromodulation has demonstrated success.255<LI><I>Continue to build and expand our technology leadership.</I> We have256focused on building a corporate infrastructure and core competency in research257and development, manufacturing, sales and marketing, reimbursement and258regulatory affairs to provide our customers with the highest quality products259and services. We believe this strategy will enable us to expand our existing260product platforms into new applications and product offerings. We will continue261to invest significant resources in the development of our infrastructure and262technology platforms to maintain our reputation as a leader in the263neuromodulation market.264<LI><I>Evaluate and pursue acquisitions and strategic alliances.</I> We will265pursue acquisitions and strategic alliances that complement our existing266neuromodulation business, products and technology platforms and that enhance our267product development, technological and marketing capabilities.</UL>268<P><B>Our Products</B></P>269<P>Within the neuromodulation market, there are two main categories of270treatment: neurostimulation, in which an implanted device delivers electrical271current directly to targeted nerve sites, and implantable drug pumps, in which272an implanted pump delivers drugs directly to a targeted site. We currently273market products in both of these treatment categories.</P>274<P><B><I>Neurostimulation Therapy Overview</I></B></P>275<P>Neurostimulation involves delivering small, mild electrical pulses to the276spinal cord or peripheral nerves to inhibit or block the sensation of pain. This277stimulation of nerves at or near the site where pain is perceived masks the278sensation of pain by generating a tingling sensation or "paresthesia."279Neurostimulation is generally used to manage sharp, intense and constant pain280arising from nerve damage or nervous system disorders.</P>281<P ALIGN=CENTER>Page 3</P>282<HR>283284<PAGE>285<P>A neurostimulation system typically consists of a pulse generator that286produces electrical current, and an external or internal power source. The pulse287generator is generally implanted under the patient's skin in the abdominal area.288Leads, which are catheters that contain electrodes and connecting wires, extend289from the pulse generator to the targeted therapy site in the epidural space290along the spinal cord. The electrodes are centered on the therapy site and291deliver electrical current from the pulse generator to the prescribed area. An292external programmer allows the physician and patient to adjust the electrical293current to the electrodes to optimize the therapeutic effect.</P>294<P>Implant procedures are most often performed at hospitals on an outpatient295basis, with a small percentage of procedures also performed at ambulatory296surgery centers and at hospitals on an inpatient basis. In most cases, a patient297will receive a trial device for a period of up to two weeks. Based on our298experience, more than 70% of patients who undergo a trial procedure elect to299receive a permanent implant. Implant procedures cost between $30,000 and300$50,000, including the cost of the system. The cost of the system generally301ranges from $10,000 to $20,000, depending on whether an RF or IPG system is302used, the components utilized and the sophistication of the system selected.</P>303<P>Clinical results demonstrate that the majority of patients who are implanted304with a neurostimulation system experience a substantial reduction in pain, an305increase in activity level, a reduction in use of narcotics and a reduction in306hospitalization. We believe these benefits translate into an overall reduction307in healthcare costs as well as a significant improvement in the patient's308quality of life.</P>309<P><B><I>Our Neurostimulation Products</I></B></P>310<P>We currently have two neurostimulation product platforms that we market311worldwide: our <I>Renew</I> RF system, which uses an external power source, and312our family of totally implantable IPG systems, <I>Genesis</I> and <I>GenesisXP.313</I></P>314<P><I>Renew</I></P>315<P><I>Renew</I> is the latest generation system in our RF stimulation product316line and is the leading technology in the RF stimulation market. We introduced317<I>Renew</I> in the U.S. during June 1999 and began selling it in international318markets during 2000. The <I>Renew</I> system consists of an implanted RF319receiver/pulse generator and leads, and a transmitter containing a power source320that is worn externally. The system is powered with the help of an antenna that321is attached to the patient's skin with adhesive tape. Because <I>Renew</I> has a322rechargeable, external power source, we believe it is best suited for patients323with complex, changing or multi-extremity pain patterns that require higher324power levels for treatment.</P>325<P><I>Genesis</I></P>326<P>In late 2000, we received regulatory approvals to begin selling our327<I>Genesis</I> IPG system in certain international markets, and we commenced328sales during the first quarter of 2001. On November 21, 2001, we received FDA329approval of <I>Genesis</I> for treatment of chronic pain of the trunk and limbs,330and we launched <I>Genesis</I> in the U.S. in January 2002. Additionally, we331recently received approval from the FDA to market an enhanced version of332<I>Genesis</I>, the <I>GenesisXP</I> IPG system for the treatment of chronic333pain of the trunk and limbs, which we launched in the U.S. in the fourth quarter334of 2002. The <I>GenesisXP</I> offers substantially more battery capacity than335<I>Genesis</I>, resulting in enhanced longevity and/or additional power to treat336more complex pain. As a result, we now participate in the largest part of the337implantable neurostimulation market, as approximately 80% of neurostimulation338implantation procedures performed involve IPG systems and the remainder involve339RF systems.</P>340<P ALIGN=CENTER>Page 4</P>341<HR>342343<PAGE>344<P>Like other IPGs, <I>Genesis</I> is totally implanted and contains a power345source with a life of two to five years, depending on stimulation parameters.346Generally, simple, localized pain sufferers require less power output than347complex, multi-site pain sufferers. These patients and their physicians will348usually select an IPG in order to benefit from the convenience of a totally349implantable system.</P>350<P><B><I>Our Neurostimulation Technologies</I></B></P>351<P>Although our <I>Renew</I> and <I>Genesis</I> systems differ in certain352significant respects, they share similar technology platforms and benefits,353including:</P>354<UL>355<LI><I>Greatest number of electrodes.</I> Our <I>Renew</I> system is the only356product on the market that can accommodate up to 16 electrodes. In addition, our357IPG systems not only allow the use of two quadrapolar, or 4-electrode, leads,358but also allow the use of one octapolar, or 8-electrode, lead. A greater number359of electrodes results in more comprehensive coverage along the spine, and360provides physicians with increased flexibility in accommodating a patient's361changing pain patterns. This advantage may also enable a physician to address362the problem of lead "migration", or lead movement along the spine after implant,363noninvasively by reprogramming the patient's stimulation, rather than using an364invasive procedure to revise the placement of the lead. We estimate that lead365migration occurs in 10% to 15% of cases.366<LI><I>Advanced programmability.</I> Our technologies allow physicians to367program the system for rapid and sequential delivery of multiple stimulation368programs to cover large, complex pain patterns. Additionally, our systems enable369a large number of program choices that allow patients to select a number of370different stimulation programs to optimize treatment as pain patterns change. We371have also developed <I>PainDoc®</I>, a Windows-based proprietary372computerized support system that serves as a programming tool for <I>Renew</I>,373<I>Genesis</I> and <I>GenesisXP</I>.374<LI><I>Innovative and patented technology.</I> Our neurostimulation devices375offer our advanced patented technology, which allows programmability of each376individual electrode to a "tri-state" position, either positive, negative or377neutral. This provides added flexibility in directing the flow of stimulation378and is a valuable tool in addressing lead migration.379<LI><I>Reduced size of implanted device.</I> Our <I>Renew</I> receiver, our380<I>Genesis</I> IPG and <I>GenesisXP</I> offer smaller "size-to-power" ratios381than comparable products currently on the market, which results in enhanced382patient comfort.383<LI><I>Ease of lead implantation.</I> Our leads are designed for ease of384implantation, which makes the procedure easier for physicians to perform and385reduces the time required to complete the procedure.386<LI><I>User-friendly interface.</I> Our neurostimulation devices have387easy-to-use controls and interactive displays that include a stimulation diagram388for quick visual confirmation of stimulation coverage.</UL>389<P ALIGN=CENTER>Page 5</P>390<HR>391392<PAGE>393<PAGE>394<P>The following table summarizes some of the key features of the <I>Renew</I>395and <I>Genesis</I> systems:</P>396<PRE>397PRODUCT FEATURES RENEW GENESIS398- ----------------------------- ----------------------------- ------------------------------399Implanted Elements receiver/pulse generator, Pulse generator/power400leads supply, leads401402External Elements programmer, Programmer403transmitter/power supply,404antenna405406Battery external, rechargeable and internal with 2-5 year life,407replaceable depending on program408settings and system use409410Programming Control Up to 24 programs, plus Up to 24 programs411some patient control412413Lead and Electrode Capacity 1 to 4 leads utilizing up 1 or 2 leads utilizing up to414to 16 electrodes 8 electrodes415</PRE>416<P><B><I>Our Implantable Drug Pump Product - AccuRx</I></B></P>417<P>Implantable drug pumps deliver precise doses of medication directly to a418targeted site. This direct drug delivery creates a higher drug concentration at419the site, which can often provide faster relief with much lower quantities of420medication. For example, the difference in intraspinal versus oral morphine421dosage is approximately 1:300. These lower dosages help to minimize side422effects, and are more economical for the patient and the third-party423reimbursement system. Today, implantable drug pumps are used for the delivery of424morphine for the treatment of pain (such as cancer or arthritis pain), baclofen425for spasticity and other movement disorders, and for the intra-arterial delivery426of various drugs for chemotherapy.</P>427<P>Implantable drug pumps consist of the pump and a catheter. The pump contains428a reservoir that holds the drug and regulates the drug's delivery rate. The pump429is implanted under the skin in the abdominal area and is connected to the430catheter, which is tunneled under the skin into either the epidural or431intrathecal space of the spinal column. Implantation procedures are most often432performed at hospitals on an outpatient basis, with a small percentage of433procedures also performed at ambulatory surgery centers and at hospitals on an434inpatient basis. The pump is refilled by placing a needle through the skin into435an access port on the pump and injecting the drug into the reservoir.</P>436<P>Currently, there are two basic types of implantable drug pumps - constant437rate and programmable. Constant rate pumps provide drug infusion at a single,438continuous flow rate that cannot be changed once the pump has been implanted in439the patient. Programmable pumps allow the rate of drug delivery to be440non-invasively changed to meet the patient's needs. According to an industry441report, in 2001, worldwide sales of programmable drug pumps were approximately442$207 million, as compared with worldwide sales of constant rate drug pumps of443$23 million.</P>444<P ALIGN=CENTER>Page 6</P>445<HR>446447<PAGE>448<P>We currently offer one drug pump product, our <I>AccuRx</I> constant rate449drug pump. We received regulatory approvals to distribute <I>AccuRx</I> in450certain international markets for the delivery of morphine and began selling451<I>AccuRx</I> in those markets in the second quarter of fiscal 2001. We also452received an IDE from the FDA to initiate clinical trials in the U.S. for the453delivery of morphine. The clinical trials included 15 sites and 109 patients,454all of whom have now been implanted with <I>AccuRx</I> systems. These trials455will provide data to support our PMA for U.S. market introduction. We expect to456file our PMA application with the FDA later in 2003.</P>457<P><I>AccuRx</I> is currently the only constant rate drug pump that is powered458by our proprietary polymeric diaphragm, rather than by pressurized gas in a459chamber surrounding the drug reservoir. The advantages of this design are that460our pump is more precise under varying conditions (because its operation is not461affected by changes in the body's temperature or pressure), simpler to462manufacture, smaller than other drug pumps on the market and can hold more drug463for its size than competing products.</P>464<P><B>Financial Segments</B></P>465<P>We operate in two business segments. The Neuro Products segment designs,466develops, manufactures and markets implantable medical devices that are used to467manage chronic intractable pain and other disorders of the central nervous468system through the delivery of electrical current or drugs directly to targeted469nerve fibers. The HDI O.E.M. segment provides contract development and O.E.M.470manufacturing of electro-mechanical devices. See Note 12 to the Consolidated471Financial Statements for segment financial data for the years ended December 31,4722002, 2001 and 2000.</P>473<P><B>Sales and Marketing</B></P>474<P><B><I>General</I></B></P>475<P>We target our sales and marketing efforts at pain management specialists,476which include anesthesiologists, neurosurgeons and orthopedic surgeons. Because477most pain management specialists implant both RF and IPG devices, as well as478drug pumps, we expect to leverage our relationships and experience with pain479management specialists and track record with our RF systems to establish our480position in the IPG portion of the neurostimulation market. Additionally, by481rounding out our product offerings with our IPG systems, we are now able to482target physicians who have historically implanted only IPGs.</P>483<P>In 2002, we derived 92% of our net revenues for neuromodulation products from484domestic sales and approximately 8% from international sales.</P>485<P><B><I>U.S.</I></B></P>486<P>With our March 2003 acquisition of Sun Medical's pain management business, we487have expanded our domestic sales force. In the domestic market, we currently use488a hybrid sales force, which now consists of 25 direct sales people (including 10489people we hired from Sun Medical), 15 people employed by 2 independent490distributors, and 48 commissioned sales agents. We typically have contracts with491all of our distributors and sales agents that provide for exclusive territories492and sales quotas.</P>493<P>Our independent distributors cover defined geographic territories, focus494predominantly on the chronic pain market and devote the majority of their495selling efforts to our products. We sell our products to our distributors at a496discount from our list prices, and, in turn, the distributors sell the products,497invoice their customers and collect their receivables.</P>498<P>Our sales agents cover defined geographic territories and focus predominantly499on the pain management market. Many of our sales agents sell our products as500their flagship product line. We pay our sales agents commissions at contractual501rates, and we invoice and collect revenues from end users.</P>502<P ALIGN=CENTER>Page 7</P>503<HR>504505<PAGE>506<P>We also employ seven regional sales managers who interact with our customers507and oversee our independent distributors, commissioned sales agents and direct508sales people, a Director of North American Sales and a Vice President of North509American Sales, who both coordinate the sales efforts of our distribution510network in North America.</P>511<P>Our domestic marketing programs include:</P>512<UL>513<LI>medical marketing programs intended to educate physicians and their staffs514about our products and their use;515<LI>surgical training programs offered to physicians interested in improving516their surgical techniques;517<LI>education materials, such as brochures and videos, to educate patients and518physicians;519<LI>reimbursement assistance, with the help of outside consultants, to assist520physicians in obtaining appropriate reimbursement for our products and their521services;522<LI>consulting relationships with opinion leaders who provide us feedback about523our current and future products, diagnostic and treatment trends and other areas524of interest;525<LI>web site marketing focused on educating both physicians and patients about526our product alternatives, reimbursement for our procedures and our company;527<LI>medical journal advertisements; and528<LI>involvement in medical device societies and conferences.</UL>529<P><B><I>International</I></B></P>530<P>Internationally, we market our products through 18 independent distributors531who represent us in 22 countries. We are represented by direct salespersons532employed by us in Germany. Our Director of International Operations, who is533based in the United Kingdom, manages our international distribution network. We534are in the process of training and signing independent distributors to market535our products in additional countries.</P>536<P><B><I>Customer Service</I></B></P>537<P>Our sales representatives are responsible for training physicians and nurses538on programming and trouble-shooting any problems with our RF and IPG systems.539Both the RF and IPG systems have up to 24 different program settings, which can540be programmed and saved into memory. Therefore, significant training of541physicians and nurses is required for new users of our product. We typically542provide a warranty against defects in workmanship and materials for one year543from the date of sale of our products to end-users.</P>544<P><B><I>Major Customers</I></B></P>545<P>During 2002, 2001 and 2000, we had one major customer that accounted for 10%546or more of our net revenue from our Neuro Products segment. Sun Medical, Inc., a547specialty distributor, accounted for $6.3 million, or 13.5% of our Neuro548Products segment revenue for the year ended December 31, 2002, $4.2 million, or54915% of our Neuro Products segment revenue for the year ended December 31, 2001550and $3.2 million, or 14% of our Neuro Products segment revenue for the year551ended December 31, 2000. In March 2003, we acquired Sun Medical's pain552management business and hired substantially all of the salespeople who had553accounted for those sales. See Note 13 of the Notes to Consolidated Financial554Statements.</P>555<P ALIGN=CENTER>Page 8</P>556<HR>557558<PAGE>559<P>During the year ended December 31, 2002, we had two major customers that560accounted for $9.52 million, or 89.3% of net revenue from our O.E.M. segment.561Medtronic, Inc., our most significant competitor, accounted for $6.74 million,562or 63.2% and Arrow International, Inc. accounted for $2.78 million, or 26.1%.563During the year ended December 31, 2001, we had three major customers that564accounted for 10% or more of net revenue from our O.E.M. segment: Medtronic,565Inc. accounted for $6.3 million, or 60%; Arrow International, Inc. accounted for566$1.8 million or 17%; and Transneuronix, Inc. accounted for $1.1 million or 11%.567For the year ended December 31, 2000, we had three major customers that568accounted for 10% or more of net revenue from our O.E.M. segment: Medtronic,569Inc. accounted for $4.3 million, or 49%; Exogen accounted for $2.1 million, or57024%; and Cyberonics, Inc. accounted for $1.5 million, or 17%.</P>571<P><B>Research and Development</B></P>572<P>We currently have an in-house research and development staff of 55 people. In5732002, we spent $5.84 million (10.2% of total net revenue) on research and574development, and we expect to increase our investment in research and575development and clinical trials for 2003 to approximately $7.9 million.</P>576<P>Our current research and development efforts include work on the following:577</P>578<UL>579<LI>An IPG stimulation system to address occipital headaches (frequent severe580headaches that begin in the back of the head and migrate forward). During the581first quarter of 2001, we initiated a pilot clinical study in the U.S., which582consisted of 10 patients at 2 sites, to evaluate the efficacy of <I>Genesis</I>583for treating occipital headaches. We completed the pilot study during the second584quarter of 2002, and the data will be used to determine the parameters for a585larger pivotal clinical study to support a PMA application for <I>Genesis</I> to586treat occipital headaches. There are approximately one million patients in the587U.S. alone who suffer from occipital headaches.588<LI>IPG stimulation systems for deep brain stimulation to address essential589tremor, Parkinson's Disease and other indications.590<LI>New applications of our neurostimulation systems to address angina,591peripheral vascular disease and sacral nerve stimulation for pelvic pain and592incontinence.593<LI>Next-generation IPG and RF neurostimulation systems.594<LI>Next-generation drug pumps, including a prototype programmable pump that595will take several years to develop, and new applications for drug pumps.596<LI>Clinical trials that we expect to initiate on several of our new products597upon IDE approval from the FDA.</UL>598<P ALIGN=CENTER>Page 9</P>599<HR>600601<PAGE>602<P><B><I>Hi-tronics Designs, Inc.</I></B></P>603<P>Our HDI subsidiary developed and is the manufacturer of our <I>Genesis</I>604IPG and <I>GenesisXP</I> IPG, and is also the manufacturer of the transmitter605used with <I>Renew</I>. HDI's core strength is in developing highly606sophisticated electromechanical devices featuring electronic circuits with very607low power requirements, utilizing both discrete and highly integrated608technology. Combined with our capabilities in the design and manufacture of609implantable leads, electronic device control and communication systems and610implantable drug pumps, we believe this expertise will allow us to develop more611sophisticated products in less time.</P>612<P>As an O.E.M. manufacturer, HDI has developed and introduced more than 60613medical devices for leading medical device companies in the fields of614cardiology, neurology and orthopedics. Through HDI, we offer our customers615complete development and manufacturing services, beginning with product616definition and design and continuing through validation, prototyping, regulatory617approval and manufacturing. In 2002, our O.E.M. operations accounted for 18.6%618of our consolidated revenues. We expect this percentage to continue to decrease619as our neuromodulation sales continue to grow and as we continue to utilize more620of HDI's manufacturing and development capabilities for our own needs.</P>621<P><B><I>Manufacturing</I></B></P>622<P>We operate two manufacturing facilities: one in Plano, Texas and the other in623Hackettstown, New Jersey. We assemble and package the majority of our624neurostimulation devices and implantable drug pumps at our Plano facility. We625also manufacture a variety of medical devices and products on an O.E.M. basis in626our Hackettstown facility.</P>627<P>Our manufacturing processes largely consist of the assembly of standard and628custom components that we purchase from third-party subcontractors, functional629testing to ensure adherence to specifications and inspection of completed630products, and the manufacture of our own leads and drug pumps. Our implantable631devices are assembled and sterilized in a "clean room" environment designed and632maintained to reduce product exposure to particulate matter.</P>633<P>We rely on third-party suppliers for most of our products' components and on634single suppliers for several critical components used in our main products,635including the computer chip used in the receiver of our RF system, the computer636chip used in the IPG programmer and <I>Renew</I> transmitter, the batteries used637in our IPG systems and the medical-grade polyurethane (bionate) that we and our638competitors use in our products. We have been notified by the supplier of the639computer chip used in the receiver of our RF system that it will cease640manufacturing and supplying the computer chip in the future, but to date it has641not determined when this will occur. This supplier has agreed to allow us to642place a final one-time purchase order for the computer chip. In the interim, we643are maintaining a higher than normal inventory of the computer chip and are644working to develop a new product design that uses an alternative computer chip.645</P>646<P>We currently have sufficient manufacturing capacity to support our business647plan until we construct and relocate to our new corporate headquarter facility648in mid-2004. See Item 2 "Facilities". We have no backlog.</P>649<P><B><I>Intellectual Property</I></B></P>650<P>We rely on a combination of patents, trade secrets, know-how, trademarks and651agreements to protect our intellectual property. We currently own or hold652exclusive field of use licenses to 26 U.S. and 7 foreign patents relating to our653stimulation systems' electrode, receiver, transmitter and programmer technology654and our fully-implantable drug pump technology. These and other co-owned and655non-exclusively licensed patents cover important aspects of both our RF and IPG656stimulation systems for a wide range of current and future applications. We657currently have 35 pending U.S. patent applications assigned to us, and 18658pending foreign patent applications. Among other things, these pending patent659applications cover new stimulation lead technology, implant accessories,660improved connector mechanisms and implantable drug delivery technology.</P>661<P ALIGN=CENTER>Page 10</P>662<HR>663664<PAGE>665<P>We have developed technical knowledge, which, although non-patentable, we666consider to be significant in enabling us to compete. However, the proprietary667nature of such knowledge may be difficult to protect. We have entered into668agreements with each of our key employees prohibiting such employees from669disclosing any of our confidential information or trade secrets or engaging in670any competitive business (as defined in the agreements) while the employee is671working for us and for a period of one year thereafter. In addition, these672agreements also provide that any inventions or discoveries by these individuals673relating to our business will be assigned to us and become our sole property.674<P>675<P>We own a number of U.S. trademark registrations, including676<I>AccuRx</I>®, <I>Advanced Neuromodulation Systems</I>®, <I>ANS &677Design</I>®, <I>PainDoc</I>®, <I>Renew</I>®, and678<I>Genesis</I>®. U.S. trademark applications are pending for various679trademarks that we believe have value (or will have value) in the marketplace,680including <I>Life Gets Better</I>™. We also own trademark registrations and681applications in countries outside of the U.S.</P>682<P><B>Competition</B></P>683<P>We are a small company competing in a large and rapidly growing market. We684believe that the principal competitive factors in the neuromodulation market are685the quality, performance, cost-effectiveness, ease of use, customer service and686technical innovation of neuromodulation devices and the existence and benefits687of cost-effective alternative therapies.</P>688<P>Our only significant competitor at this time in the neurostimulation portion689of the market is Medtronic, one of the world's largest medical device companies,690which has substantially greater resources and marketing power than we do. The691neuromodulation market is one of Medtronic's fastest growing segments.692Competitive pressures could increase in the future as Medtronic attempts to693secure and grow its position in the neuromodulation market. In the constant rate694drug pump portion of the market, our principal competitors are Medtronic and695Johnson & Johnson.</P>696<P>We believe the neuromodulation market is a high growth-potential market and697that other companies are attempting and will attempt in the future to bring new698products or therapies into this market. Barriers to entry by new competitors are699high, due to a long and expensive product development and regulatory approval700process and the intellectual property and patent positions existing in the701market. However, other medical device companies may be able to enter the702neuromodulation market by leveraging their existing technologies into703neuromodulation platforms, thereby decreasing the time and resources required to704enter the market. For example, we are aware that Advanced Bionics, Inc., a705privately-held California-based company that currently manufactures and markets706a cochlear implant, is developing and may be testing an IPG system for the707treatment of chronic pain.</P>708<P><B>Government Regulation</B></P>709<P>In the U.S., we are subject to regulation by numerous governmental710authorities, principally the FDA. The research and development, manufacturing,711promotion, marketing and distribution of our products in the U.S. are governed712by the Federal Food, Drug and Cosmetic Act and the regulations promulgated713thereunder (the FDC Act and Regulations). We are subject to inspection by the714FDA for compliance with the procedures set forth in the FDC Act and Regulations.715Both of our manufacturing operations are required to comply with the FDA's716Quality System Regulations, commonly referred to as QSR. QSR addresses design717controls and methods, facilities and quality assurance controls used in718manufacturing medical devices.</P>719<P ALIGN=CENTER>Page 11</P>720<HR>721722<PAGE>723<P>The FDA has traditionally pursued a rigorous enforcement program to ensure724that regulated entities comply with the FDC Act and Regulations. A company not725in compliance may face a variety of regulatory actions, including warning726letters, product detentions, device alerts, mandatory recalls or field727corrections, product seizures, rescission of marketing permits, injunctive728actions or civil penalties and criminal prosecutions of the company or729responsible employees, officers and directors. The FDA last inspected our Plano730facility in March 2003 and our Budd Lake and Hackettstown facilities in July7312002, and no Inspectional Observations were found at any of these locations.</P>732<P>The process of obtaining FDA clearance can be lengthy, expensive and733uncertain. Under the FDA's requirements, a new medical device cannot be released734for commercial use until a PMA application has been filed with the FDA and the735FDA has approved the device's release. If a manufacturer can establish that a736newly developed device is "substantially equivalent" to a legally marketed737device, the manufacturer may seek marketing clearance from the FDA to market the738device by filing a 510(k) premarket notification with the FDA, which usually739takes less time than a PMA. Either a 510(k) or a PMA, if granted, may include740significant limitations on the indicated uses for which a product may be741marketed, and FDA enforcement policy strictly prohibits the promotion of742approved medical devices for unapproved uses. In addition, product approvals can743be withdrawn for failure to comply with regulatory requirements or the744occurrence of unforeseen problems following initial marketing. Although all of745our currently marketed products, with the exception of our <I>Genesis</I> and746<I>GenesisXP</I> IPGs, have been the subject of successful 510(k) submissions,747we believe that because the products we are currently developing are more748innovative, some of these products will require us to undertake the lengthier749and more costly PMA submission process.</P>750<P>On October 26, 2002, President Bush signed The Medical Device User Fee and751Modernization Act of 2002 (MDUFMA), amending the Federal Food, Drug, and752Cosmetic Act.</P>753<P>Under MDUFMA, we and other medical device manufacturers with gross sales or754receipts of $30 million or more will be required to pay a user fee to the FDA755for PMA and 510(k) reviews. According to the FDA, the user fees provided by756MDUFMA, and the additional appropriations that go with the new law, are intended757to ensure that safe and effective medical treatments will reach patients more758rapidly, provide greater certainty that manufacturers will receive timely, high759quality reviews, and provide resources to ensure that devices marketed in the760United States continue to meet high standards for safety and effectiveness. The761fee for PMA applications is $154,000 and the fee for 510(k) applications is762$2,187. Fees for supplements range from $11,088 to $154,000, depending on the763type of supplement. The FDA will adjust these fees each year to account for764inflation, changes in workloads, and other factors. The FDA will announce the765new fees for the next fiscal year in a Federal Register notice by August 1 of766each year. Although MDUFMA requires that a fee must be paid for each premarket767application, premarket report, supplement or 510(k) submitted on or after768October 1, 2002, under the provisions of the new legislation, before the FDA can769begin collecting fees, Congress must also pass an appropriation act providing770for the new medical device fees. The FDA must also develop systems to collect,771safeguard, process, and account for fees. For these reasons, the FDA has not yet772commenced collecting these fees. While we do not anticipate that compliance with773MDUFMA will have a material adverse effect on our financial results, MDUFMA will774increase the cost of regulatory compliance.</P>775<P>Medical device laws are also in effect in many of the countries outside the776U.S. in which we do business. These laws range from comprehensive device777approval and quality system requirements for some or all of our products to778simpler requests for product data or certifications. The number and scope of779these requirements are increasing and, as we expand our business into new780jurisdictions, we will be subject to additional laws. In June 1998, the European781Union Medical Device Directive became effective, and all medical devices sold in782Europe must now meet the Medical Device Directive standards and receive CE Mark783certification. CE Mark certification involves a comprehensive quality system784program and submission of data on a product to the Notified Body in Europe. The785Medical Device Directive and the ISO 13485 standard are recognized international786quality standards that are designed to ensure that companies develop and787manufacture quality medical devices. Our Plano facility was audited in November7882002, and our Budd Lake and Hackettstown facilities were audited in April 2002,789for compliance with the Medical Device Directive and ISO 13485, and all three790facilities are certified to these standards.</P>791<P ALIGN=CENTER>Page 12</P>792<HR>793794<PAGE>795<P>The financial arrangements through which we market, sell and distribute our796products are subject to federal and state laws and regulations in the U.S. with797respect to patients who are Medicare or Medicaid beneficiaries. These laws798include "fraud and abuse" and physician anti-referral laws and regulations.799Violations of these laws and regulations may result in civil and criminal800penalties, including substantial fines and imprisonment. In a number of states,801the scope of fraud and abuse or physician anti-referral laws and regulations, or802both, have been extended to include all patients, as opposed to just Medicare803and Medicaid beneficiaries. Additionally, our financial arrangements with our804customers may be subject to increasing regulation in the future, due to proposed805health reform initiatives. Although we do not believe that we will need to806undertake any significant expense or modification to our manufacturing807operations or the conduct of our business to comply with current or proposed808federal or state fraud and abuse or physician anti-referral laws or regulations,809if we do not comply with any such laws or regulations, our business practices810could be adversely affected, and we may also be affected in other respects not811presently foreseeable that could have an adverse impact on our business,812financial condition and results of operations.</P>813<P><B>Third-Party Reimbursement</B></P>814<P>Hospitals and ambulatory surgery centers are the primary purchasers of815neuromodulation products. These primary purchasers then bill various third-party816payors for the neuromodulation products and procedures they provide to their817patients. In the U.S., these third-party payors include Medicare and Medicaid,818private insurance companies and managed care organizations, and workers'819compensation programs. Third-party payors carefully scrutinize whether to cover820new products and the level of reimbursement for covered products, and coverages821and reimbursement levels for neuromodulation products vary among these three822primary purchasing groups and the healthcare setting in which physicians perform823procedures, and change from year to year.</P>824<P>Internationally, reimbursement levels and coverages for neuromodulation825products vary significantly among the countries in which we do business due to826the wide variety of health care payment systems in these countries, which827include both government-sponsored health care and private insurance.</P>828<P>We currently employ seven individuals within our sales and marketing829department who work solely on issues related to third-party reimbursement. The830responsibilities of these employees include assisting and training physician831practices and medical facility staffs in obtaining pre-authorization and832confirmation of amount of reimbursement for our products, working with833third-party payors as they periodically evaluate reimbursement coverages and834levels, and communicating updates on reimbursement information to our sales835force.</P>836<P><B>Employees</B></P>837<P>As of February 27, 2003, we employed 291 full-time employees, including 55 in838research and development, 59 in sales and marketing (including support839personnel), 152 in manufacturing and related operations, and the remainder in840executive and administrative positions. None of our employees are represented by841a labor union and we consider our employee relations to be good.</P>842<P ALIGN=CENTER>Page 13</P>843<HR>844845<PAGE>846<P><B>Website and Availability of SEC Reports.</B></P>847<P>Our website is located at www.ans-medical.com. We post our most recent annual848report on Form 10-K and quarterly reports on Form 10-Q filed subsequent to our849most recent annual report on Form 10-K on our website under the heading850Investors/Financial Information, and make our current reports on Form 8-K and851other SEC filings available through our website by way of a link to852www.freeedgar.com under the heading "Click here for additional financial853information." We have began posting our current reports on Form 8-K on our854website when we electronically file them with the SEC.</P>855<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>856<TR>857<TD WIDTH=15% VALIGN=TOP><B>ITEM 2.</B></TD>858<TD WIDTH=85%><B>FACILITIES</B></TD></TR></TABLE>859<P>We entered a 63-month lease agreement, which became effective on June 1,8601999, for our 40,000 square foot corporate headquarters and manufacturing861facility in Plano, Texas. In September 2002, we amended our lease agreement to862add approximately 9,700 square feet of office space located in the same complex863as our 40,000 square foot corporate headquarters. The lease on the additional864space expires during August 2004, the same as the corporate headquarters865facility. We have two five-year renewal options on the facilities.</P>866<P>Because we expect our business to continue to grow at rates that will demand867added office and facility space, we acquired approximately 10 acres of land in868December 2002 for approximately $3.19 million. The land is located in Plano,869Texas near our current corporate headquarters. We intend to build a new870corporate headquarters facility on the land and relocate to the new facility871upon the expiration of our lease in August 2004. We are designing the new872facility to accommodate planned growth within a five-year horizon and anticipate873that the facility once constructed, will be 140,000 to 150,000 square feet and874will cost between $16 million and $17 million.</P>875<P>We also lease facilities in New Jersey as a result of our acquisition of HDI.876One of the facilities, located in Budd Lake, New Jersey, is 10,348 square feet877of office space that is used for administration, design engineering, drafting,878documentation and regulatory affairs. We renewed the lease in March 2002 and the879lease now expires on February 28, 2004. Our Budd Lake lease contains no renewal880option. We also lease 18,582 square feet of space in Hackettstown, New Jersey881used for our O.E.M. manufacturing operations. We renewed the Hackettstown lease882on December 31, 2002 and the lease now expires on December 31, 2005 and is883renewable for one additional three-year period.</P>884<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>885<TR>886<TD WIDTH=15% VALIGN=TOP><B>ITEM 3.</B></TD>887<TD WIDTH=85%><B>LEGAL PROCEEDINGS</B></TD></TR></TABLE>888<P>We are a party to product liability claims and other ordinary routine889litigation claims arising in the ordinary course of business related to our890neurostimulation devices. Our product liability insurers have assumed891responsibility for defending us against product liability claims, subject to892reservation of rights in certain cases. Historically, product liability claims893for our neurostimulation devices have not resulted in significant monetary894liability beyond our insurance coverage. We seek to maintain appropriate levels895of product liability insurance with coverage that we believe is comparable to896that maintained by companies similar in size and serving similar markets.</P>897<P>Except for ordinary course product liability claims and other ordinary898routine litigation incidental to our business, we are not currently a party to899any other pending legal proceeding. We maintain general liability insurance900against risks arising out of the normal course of business.</P>901<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>902<TR>903<TD WIDTH=15% VALIGN=TOP><B>ITEM 4.</B></TD>904<TD WIDTH=85%><B>SUBMISSION OF MATTERS TO A VOTE OF905SECURITY HOLDERS</B></TD></TR></TABLE>906<P>Inapplicable.</P>907<P ALIGN=CENTER>Page 14</P>908<HR>909910<PAGE>911<P ALIGN=CENTER><B>PART II</B></P>912<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>913<TR>914<TD WIDTH=15% VALIGN=TOP><B>ITEM 5.</B></TD>915<TD WIDTH=85%><B>MARKET FOR REGISTRANT'S COMMON EQUITY916AND RELATED STOCKHOLDER MATTERS</B></TD></TR></TABLE>917<P>Our common stock is currently quoted on the Nasdaq National Market under the918symbol "ANSI." On March 17, 2003, there were approximately 578 holders of record919of our common stock. The following table sets forth the quarterly high and low920closing sales prices for our common stock. These prices do not include921adjustments for retail mark-ups, markdowns or commissions.</P>922<PRE>9239242001: High Low925-------------- --------------926First Quarter $ 26.88 $ 11.00927Second Quarter $ 26.00 $ 10.63928Third Quarter $ 25.85 $ 19.00929Fourth Quarter $ 35.55 $ 20.029309312002: High Low932-------------- --------------933934First Quarter $ 36.20 $ 28.52935Second Quarter $ 33.80 $ 28.50936Third Quarter $ 36.92 $ 24.92937Fourth Quarter $ 37.73 $ 28.519389392003: High Low940-------------- --------------941942First Quarter943(through March 17, 2003) $ 38.84 $ 34.16944</PRE>945<P>To date, we have not declared or paid any cash dividends on our common stock946and the Board of Directors does not anticipate paying cash dividends on our947common stock in the foreseeable future.</P>948<P>Listed below is summary information on the Company's stock option plans as of949December 31, 2002:</P>950<PRE>951Equity Compensation Plan Information952953Number of securities954remaining available955Number of for future issuance956securities to be under equity957issued upon Weighted-average compensation958exercise of out- exercise price of plans (excluding)959standing options, outstanding options securities reflected960Plan category warrants and rights warrants and rights in column (a)961- ------------------- ------------------- ------------------- --------------------962Equity compensation963plans approved by964security holders(2) 1,599,794 $13.24 26,950965966Equity compensation967plans not approved968by security holders969(1)(2) 426,625 $22.40 6,192970------------------- ------------------- --------------------971Total 2,026,419 $15.17 33,142972------------------- ------------------- --------------------973974(1) Executive officers and members of the Board of Directors are not eligible to975receive stock option grants under non-shareholder approved plans.976(2) Certain of the plans allow the aggregate number of shares of common stock977reserved for options under the plan to be increased by the same percentage that978the total number of issued and outstanding shares of common stock increased from979the preceding January 1 to the following December 31 (if such percentage is980positive).981</PRE>982<P ALIGN=CENTER>Page 15</P>983<HR>984985<PAGE>986<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>987<TR>988<TD WIDTH=15% VALIGN=TOP><B>ITEM 6.</B></TD>989<TD WIDTH=85%><B>SELECTED FINANCIAL DATA</B></TD></TR></TABLE>990<PRE>991----------------------------------------------------------------------992Years Ended December 31,993----------------------------------------------------------------------9942002 2001 2000 1999 1998995-------------- ------------- ------------- ------------- -------------996(in thousands, except per share data)997Statements of Income Data: (1) (2)998999Net revenue (3) $ 57,372 $ 37,916 $ 31,827 $ 26,879 $ 23,4171000Total net revenue 57,372 37,916 31,827 35,779 26,5171001Gross profit 36,713 22,241 17,127 23,852 17,0931002Research and development expense 5,843 4,928 3,854 4,097 2,7901003Marketing, general and1004administrative and amortization1005expenses 21,622 14,504 12,328 11,286 10,7011006Income from operations 9,248 2,809 945 8,469 3,6021007Net income from continuing1008operations 6,684 1,518 832 5,817 2,3271009Loss from discontinued operations -- -- -- -- (212)1010Gain on the sale of assets of1011discontinued operations -- -- -- -- 4,5851012Net income from discontinued1013operations -- -- -- -- 4,3731014Net income $ 6,684 $ 1,518 $ 832 $ 5,817 $ 6,7001015Diluted income per share:1016Continuing operations $ .56 $ .15 $ .09 $ .64 $ .241017Discontinued operations $ -- $ -- $ -- $ -- $ .451018Net income $ .56 $ .15 $ .09 $ .64 $ .6910191020----------------------------------------------------------------------1021Years Ended December 31,1022----------------------------------------------------------------------10232002 2001 2000 1999 19981024-------------- ------------- ------------- ------------- -------------1025(in thousands)1026Balance Sheet Data(2):10271028Cash, cash equivalents,1029certificates of deposit and1030marketable securities $ 96,770 $ 11,937 $ 11,599 $ 9,736 $ 13,9821031Working capital 114,280 24,906 22,211 17,626 18,0421032Total assets 158,344 55,865 49,565 48,407 49,5461033Short-term notes payable and1034current maturities of1035long-term notes payable -- 52 30 -- 3,6331036Notes payable, excluding1037current maturities -- 137 212 -- 1,0001038Stockholders' equity $ 145,045 $ 46,812 $ 40,442 $ 36,536 $ 34,7691039__________________________1040(1) On January 30, 1998, we sold our cardiovascular and intravenous fluid1041delivery product lines (CVS Operations). The CVS Operations have been accounted1042for as discontinued operations.1043(2) On January 2, 2001, we completed the acquisition of Hi-tronics Designs, Inc.1044The transaction was accounted for on a pooling of interests basis and1045accordingly, prior periods have been restated.1046(3) Net revenue excludes contract research and development revenue in 1998 and10471999 from our former agreement with Sofamor Danek.1048</PRE>1049<P ALIGN=CENTER>Page 16</P>1050<HR>10511052<PAGE>1053<P>The following is a reconciliation of previously reported amounts with1054restated amounts for total net revenue and net income:</P>1055<PRE>10561057Years Ended December 31,1058-----------------------------------------10592000 1999 19981060------------- ------------- -------------1061(in thousands)1062Reconciliation of total net revenue:1063As previously reported by the Company $ 23,082 $ 29,478 $ 20,1061064HDI, for the year ended November 30 10,366 7,989 6,7461065Elimination of intercompany transactions (1,621) (1,688) (335)1066------------- ------------- -------------1067Total net revenue as restated $ 31,827 $ 35,779 $ 26,5171068============= ============= =============1069Reconciliation of net income:1070As previously reported by the Company $ 954 $ 6,003 $ 6,9591071HDI, for the year ended November 30 28 328 (174)1072Elimination of intercompany transactions (150) (514) (85)1073------------- ------------- -------------1074Net income as restated $ 832 $ 5,817 $ 6,7001075============= ============= =============1076</PRE>1077<P ALIGN=CENTER>Page 17</P>1078<HR>10791080<PAGE>1081<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>1082<TR>1083<TD WIDTH=15% VALIGN=TOP><B>ITEM 7.</B></TD>1084<TD WIDTH=85%><B>MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND1085RESULTS OF OPERATIONS</B></TD></TR></TABLE>1086<P>The following discussion of the financial condition and results of operations1087of the Company should be read in conjunction with the Consolidated Financial1088Statements of the Company and the related Notes.</P>1089<P><B>Background</B></P>1090<P>We entered the neuromodulation market in 1995 through the acquisition of a1091company that had developed and marketed a radio-frequency (RF) neurostimulation1092system. In 1998, we elected to reposition our business to focus exclusively on1093the neuromodulation market. Implementation of this strategy involved selling our1094cardiovascular and intravenous fluid product lines in January 1998. Through our1095initiatives, we developed and launched our next generation neurostimulation1096system, the <I>Renew</I>® RF spinal cord stimulation system, in 1999. We1097also recently developed our <I>Genesis</I>® and <I>GenesisXP</I>™1098totally implantable pulse generator (IPG) spinal cord stimulation systems. We1099began selling <I>Genesis</I> in Europe in 2001 and in the U.S. in 20021100subsequent to the FDA's approval of our PMA application in November 2001, and1101our <I>GenesisXP</I> IPG system following FDA approval, in the fourth quarter of11022002.</P>1103<P>In 2000, we completed development of <I>AccuRx</I>, our constant rate1104implantable drug pump, in part using proprietary technology we licensed from1105Implantable Devices Limited Partnership (IDP). We initiated U.S. clinical trials1106of <I>AccuRx</I> under an Investigational Device Exemption (IDE) in the first1107quarter of 2001, and began selling <I>AccuRx</I> in certain international1108markets in the second quarter of 2001. On January 2, 2001, we strengthened our1109position in the neuromodulation market by acquiring the assets of IDP and ESOX1110Technology Holdings, LLC (ESOX) for 119,100 shares of our common stock valued at1111approximately $2.43 million. This acquisition provided us with intellectual1112property surrounding implantable drug pump technologies in all applications,1113including pain and cancer therapy.</P>1114<P>Also on January 2, 2001, we completed the acquisition of HDI, a1115privately-held O.E.M. developer and manufacturer, for approximately 1.1 million1116shares of our common stock. We accounted for this acquisition using the pooling1117of interests method and, accordingly, the financial information for all periods1118prior to the acquisition has been restated. Prior to the acquisition, HDI1119developed and manufactured our <I>Genesis</I> IPG as well as the transmitter for1120our <I>Renew</I> system. Acquiring HDI provided us with additional in-house1121expertise in the design and manufacture of highly sophisticated1122electromechanical devices. Combined with our capabilities in the design and1123manufacture of implantable leads, electronic device control and communication1124systems and implantable drug pumps, we believe HDI's expertise will allow us to1125develop more sophisticated products in less time. Additionally, HDI continues to1126provide contract development and manufacturing services to third parties, which1127we report as a separate segment for financial reporting purposes (the O.E.M.1128segment). For the year ended December 31, 2002, our O.E.M. segment provided1129$10.66 million or 18.6% of our total revenue. In the future, we expect our1130O.E.M. segment revenue to decrease as a percentage of our total revenue as we1131grow revenue from our proprietary neurostimulation systems and drug pumps and1132increasingly utilize HDI's research and development capabilities for internal1133product development.</P>1134<P>In November 2002, we completed the acquisition of MicroNet Medical, Inc., a1135privately-held developer of medical devices based on proprietary micro-lead1136technology. MicroNet developed a line of very thin and steerable spinal cord1137stimulation leads called <I>Axxess</I>™. These leads are the smallest1138neurostimulation leads on the market, which we believe offers advantages in1139certain applications. Under the terms of the transaction, which we structured as1140a merger, we acquired only MicroNet's proprietary technology and certain1141associated tangible assets. MicroNet's operations, other tangible assets,1142certain liabilities and certain employees became part of a separate unaffiliated1143company. We assumed no material debt, liabilities, or overhead in the1144transaction. At closing, we paid the former MicroNet shareholders $500,000 in1145cash and 156,302 shares of our common stock with a value at the time of issuance1146of $4,648,421. In addition, we incurred expenses of $859,460, including an1147investment-banking fee of $600,000. In March 2003, subsequent to the 2002 fiscal1148year, we paid the former MicroNet shareholders an aggregate of 28,346 shares of1149our common stock with a value at the time of issuance and release from escrow of1150$1,020,173 upon the successful completion of half of the first product1151milestone, and the former MicroNet shareholders may receive additional shares of1152our common stock if certain additional product, regulatory approval and sales1153milestones are met. The aggregate value of the additional potential milestone1154earnout payments was $9 million as measured at the time the transaction was1155completed. Important additional product milestone deadlines occur twelve and1156eighteen months following the closing, while other milestones depend on the1157receipt of regulatory approvals and meeting an aggregate sales milestone. All1158milestones must be met within the next four to five years, depending on the1159milestone.</P>1160<P ALIGN=CENTER>Page 18</P>1161<HR>11621163<PAGE>1164<P> Our current neuromodulation product line includes our <I>Genesis</I> IPG1165system, <I>GenesisXP</I> IPG system, <I>Renew</I> RF system and <I>AccuRx</I>1166constant rate drug pump. With the launch of our <I>Genesis</I> and1167<I>GenesisXP</I> IPG systems, we now compete in 100% of the implantable1168neurostimulation market to treat chronic pain of the trunk and limbs. The launch1169of the <I>Genesis</I> IPG and <I>GenesisXP</I> IPG in 2002 slowed our growth1170rate in sales of <I>Renew</I> systems from an average percentage growth rate of1171the mid-teens over the past several years to single-digit growth in 2002.1172Management believes this trend may continue in 2003 and has assumed similar1173single-digit growth in <I>Renew</I> sales during 2003.</P>1174<P><B>Critical Accounting Policies and Estimates</B></P>1175<P><I>General</I></P>1176<P>Our discussion and analysis of our financial condition and results of1177operations are based upon our consolidated financial statements, which have been1178prepared in accordance with accounting principles generally accepted in the1179United States. The preparation of these financial statements requires management1180to make estimates and judgments that affect the reported amounts of assets,1181liabilities and related disclosure of contingent assets and liabilities at the1182date of the financial statements and the reported amounts of revenue and1183expenses during the reporting period. On an on-going basis, management evaluates1184its estimates and judgments, including those related to product returns, bad1185debts, inventories, intangible assets, warranty obligations and contingencies1186and litigation. Management bases its estimates on historical experience and on1187various other factors that are believed to be reasonable under the1188circumstances, the results of which form the basis for making judgments about1189the carrying value of assets and liabilities that are not readily apparent from1190other sources. Actual results may differ from these estimates under different1191assumptions or conditions.</P>1192<P>Management believes the following critical accounting policies affect its more1193significant judgments and estimates used in preparation of its consolidated1194financial statements.</P>1195<P><I>Revenue Recognition</I></P>1196<P>We generate revenues from product sales to end customers, product sales to1197distributors, and development contracts. We recognize revenue from neuro product1198sales when the goods are shipped to our customers or distributors, provided an1199arrangement exists, the fee is fixed and determinable, and collectibility is1200reasonably assured. Certain of our customers are third-party payors who1201reimburse fixed amounts for services based on a specific diagnosis. Revenue is1202recognized on these third-party payor sales based on the sales price less a1203contractual adjustment, which is based on our history of reimbursement with the1204third-party payor, provided all other revenue recognition criteria are met. We1205record, as a reduction in revenue a provision for estimated sales returns and1206adjustments on these product sales in the same period as the related revenue is1207recorded. These estimates are based on historical sales returns, analysis of1208credit memo data, and other known factors. Payment received in advance of1209revenue recognition requirements are recorded as deferred revenue on the1210consolidated balance sheet. We recognize revenue from custom manufactured1211products at HDI when the goods are shipped to the customer. HDI also develops1212products for certain customers under fixed price research and development1213contracts. We recognize revenue and profit under the development agreements1214using the percentage-of-completion method, which relies on estimates of total1215expected revenue and costs. We follow this method since reasonably dependable1216estimates of revenue and costs applicable to various stages of a development1217agreement can be made. If we do not accurately estimate the resources required1218or the scope of work to be performed under a development agreement, then future1219profit margins and results of operations may be negatively impacted. In certain1220cases, HDI will undertake a development project on a cost plus basis. In these1221cases, we invoice and recognize revenue for actual time and material expended on1222the project at contractual hourly billing rates and markups.</P>1223<P ALIGN=CENTER>Page 19</P>1224<HR>12251226<PAGE>1227<P><I>Bad Debt</I></P>1228<P>We are required to estimate the collectibility of our trade receivables. A1229considerable amount of judgment is required in assessing the ultimate1230realization of the receivables, including the current credit-worthiness of each1231customer, the aging of receivables and our historical experience. If the1232financial condition of our customers were to deteriorate, resulting in an1233impairment of their ability to make payments, additional allowances or1234write-offs may be required.</P>1235<P><I>Inventory Reserve</I></P>1236<P>Our reserve for excess and obsolete inventory is based upon forecasted demand1237for our products. If the demand for our products is less favorable than those1238projected by management, additional inventory write-downs or write-offs may be1239required.</P>1240<P><I>Intangible Assets</I></P>1241<P>Goodwill associated with the excess purchase price over the fair value of1242assets acquired was amortized using the straight-line method through December124331, 2001 over the estimated life of 20 years.</P>1244<P>On January 1, 2002, we adopted Statement of Financial Accounting Standards1245No. 141, "Business Combinations" and Statement of Financial Accounting Standards1246No. 142, "Goodwill and Other Intangible Assets." Under the new accounting rules,1247goodwill and intangible assets deemed to have indefinite lives are no longer1248amortized but will be subject to annual impairment tests in accordance with the1249statements. We determined that our goodwill at December 31, 2001 was unimpaired1250and eliminated amortization of the goodwill effective January 1, 2002. Prior to1251the adoption of these statements, our amortization expense for goodwill was1252$556,604 on an annual basis.</P>1253<P>Other identifiable definite-lived intangible assets, such as patents,1254purchased technology, trademarks and covenants not to compete, are amortized1255using the straight-line method over their useful lives.</P>1256<P>In assessing the recoverability of our intangible assets, we must make1257assumptions regarding estimated future cash flows and other factors to determine1258the fair value of the respective assets. If these estimates or their related1259assumptions change in the future, we may be required to record impairment1260charges for these assets.</P>1261<P ALIGN=CENTER>Page 20</P>1262<HR>12631264<PAGE>1265<P><I>Warranty Obligations</I></P>1266<P>Our products are generally covered by a one-year warranty. We accrue a1267warranty reserve for estimated costs to provide warranty services. Our estimate1268of costs to service our warranty obligations is based on historical experience1269and expectation of future conditions. To the extent we experience increased1270warranty claim activity or increased costs associated with servicing those1271claims, our warranty accrual will increase resulting in decreased gross profit.1272<P><I>Contingencies</I></P>1273<P>We are subject to proceedings, lawsuits and other claims related to our1274products and business. We are required to assess the likelihood of any adverse1275judgments or outcomes to these matters as well as potential ranges of probable1276losses. A determination of the amount of reserves required, if any, for these1277contingencies are made after careful analysis of each individual issue. The1278required reserves may change in the future due to new developments in each1279matter or changes in approach, such as a change in settlement strategy, in1280dealing with these matters.</P>1281<P>Currently, product liability claims and other ordinary routine litigation1282incidental to our business are the only litigation to which we are a party.1283While historically our product liability claims have not resulted in significant1284monetary liability beyond our insurance coverage, an adverse judgment beyond our1285insurance coverage could have a material adverse impact on our results of1286operations and financial condition.</P>1287<P><I>Stock Compensation</I></P>1288<P>See Note 7 to the Consolidated Financial Statements for a discussion of the1289application of Statement of Financial Accounting Standards (SFAS) No. 123,1290"Accounting for Stock-Based Compensation" and SFAS 148, "Accounting for1291Stock-Based Compensation - an Amendment of FASB Statement No. 123" to our stock1292compensation programs.</P>1293<P><B>Results of Operations</B></P>1294<P><I>Comparison of the Years Ended December 31, 2002 and 2001</I></P>1295<P><I>Net income.</I> We reported net income of $6.68 million, or $.56 per1296diluted share, in 2002 compared to $1.52 million, or $.15 per diluted share, in12972001. Financial results in 2002 reflect the January 2002 U.S. launch of our1298<I>Genesis</I> IPG system and December 2002 U.S. launch of our <I>GenesisXP</I>1299IPG system. Results for the 2001 period reflect amortization expense for1300goodwill of $556,604.The 2002 results contain no similar expense since we1301eliminated the amortization of goodwill on January 1, 2002 when we adopted the1302new accounting standards for intangible assets described above. If the1303amortization expense for goodwill were eliminated from the 2001 period, pro1304forma net income would be $2.07 million and pro forma net income per diluted1305share would be $.21.</P>1306<P><I>Net revenue.</I> Net revenue increased 51.3% to $57.37 million compared to1307$37.92 million in the comparable 2001 period. Net revenue of our neuromodulation1308products increased 70.1% to $46.71 million in 2002 from $27.46 million in 20011309due to the U.S. launch of our <I>Genesis</I> IPG system in January 2002 and our1310<I>GenesisXP</I> IPG system in December 2002. Net revenue from our HDI O.E.M.1311business increased marginally to $10.66 million in 2002 from $10.46 million in13122001 as we continue to focus more of HDI's resources on our own manufacturing1313and research and development needs.</P>1314<P>The launch of the <I>Genesis</I> IPG in 2002 slowed our growth rate in sales1315of <I>Renew</I> systems from an average percentage growth rate in the mid-teens1316over the past several years to single-digit growth in 2002. Management believes1317this trend may continue in 2003 and has assumed similar single-digit growth in1318<I>Renew</I> sales during 2003.</P>1319<P ALIGN=CENTER>Page 21</P>1320<HR>13211322<PAGE>1323<P><I>Gross profit.</I> Gross profit increased to $36.71 million in 2002 from1324$22.24 million in 2001 due to the increase in net revenue discussed above and an1325improvement in gross profit margins. Gross profit margins increased to 64.0% in13262002, compared to 58.7% in 2001, due to higher sales of our neuromodulation1327products, which contribute higher margins than O.E.M. product sales, higher1328neuromodulation product sales from direct sales and commissioned agents, which1329contribute higher margins than distributor sales, and operational efficiencies1330gained from higher manufacturing volumes.</P>1331<P><I>Operating expenses.</I> Total operating expenses (the aggregate of1332research and development, sales and marketing, general and administrative and1333amortization of intangibles expense) increased to $27.47 million in 2002,1334compared to $19.43 million in 2001. However, as a percentage of net revenue,1335these expenses decreased to 47.9% in 2002 from 51.3% in 2001 due to leveraging1336of research and development expense, leveraging of general and administrative1337expense, and to a lesser extent, eliminating amortization expense of goodwill.1338</P>1339<P><I>Sales and marketing.</I> Sales and marketing expense, as a percentage of1340net revenue, increased to 26.0% in 2002 from 23.9% in 2001, and the absolute1341dollar amount increased to $14.93 million in 2002 compared to $9.06 million1342during 2001. This dollar increase during 2002 compared to 2001 was principally1343attributable to higher salary and benefit expense from staffing additions in1344direct sales, reimbursement and sales support positions, higher commission1345expense from increased product sales, and higher sample and promotional expense1346in support of the <I>Genesis</I> and <I>GenesisXP</I> IPG launches.</P>1347<P><I>Research and development.</I> Research and development expense increased1348to $5.84 million, or 10.2% of net revenue, from $4.93 million, or 13.0% of net1349revenue, during the same period in 2001. This increase in the absolute dollar1350amount in 2002 compared to 2001 was principally attributable to higher salary1351and benefit expense from staffing additions, higher test material expense and1352higher expense associated with our clinical trials of <I>AccuRx</I>. We continue1353to focus our development efforts on further broadening and strengthening our1354product technology platforms both for stimulation devices as well as implantable1355drug pumps.</P>1356<P><I>General and administrative.</I> General and administrative expense1357increased to $5.74 million during 2002 from $3.96 million in 2001 and, as a1358percentage of net revenue, decreased to 10.0% in 2002 from 10.4% in 2001. The1359increase in the absolute dollar amount in 2002 compared to 2001 was principally1360attributable to higher salary expense from staffing additions (including a new1361executive officer position), higher employee benefit costs, higher bonus1362expense, higher property tax expense and higher fees for accounting and tax1363services.</P>1364<P><I>Amortization of intangibles.</I> No amortization expense of goodwill was1365recorded in 2002 due to the adoption of Statement of Financial Accounting1366Standards No. 141 and Statement of Financial Accounting Standards No. 142 on1367January 1, 2002. During 2001, we recorded $557,000 for amortization expense of1368goodwill.</P>1369<P>Amortization of other intangibles increased modestly in 2002 to $952,000 from1370$933,000 in 2001 due to additional amortization expense for intangible assets1371acquired in November 2002 when we completed the acquisition of MicroNet Medical,1372Inc. As a result of the MicroNet acquisition, we expect amortization expense to1373increase in 2003 by approximately $400,000, excluding additional amortization1374expense that may be generated as we acquire additional intangible assets. We1375expect to acquire the additional intangible assets as milestones are met1376pursuant to the purchase agreement. As the milestones are met, we will be1377required to issue additional shares of our common stock as earn-out1378consideration.</P>1379<P ALIGN=CENTER>Page 22</P>1380<HR>13811382<PAGE>1383<P><I>Other income.</I> Other income increased to $923,000 in 2002 from an1384expense of $26,000 in 2001 primarily attributable to a $451,000 increase in1385interest income due to higher funds available for investment from our public1386offering during the second quarter of 2002 and the expense in 2001 of $484,0001387for costs associated with the acquisition of HDI. These costs were expensed1388instead of capitalized because the acquisition was accounted for under the1389pooling of interests method.</P>1390<P><I>Income tax expense.</I> Income tax expense increased to $3.49 million in13912002 from $1.27 million in 2001, and the overall effective tax rate was 34.3% in13922002 compared to 45.5% in 2001. The decrease in the effective tax rate in 20021393compared to 2001 was the result of three factors. First, our amortization of1394goodwill in the 2001 period was not deductible for tax purposes. Second, the HDI1395acquisition costs expensed in the 2001 period of $484,000 were not fully1396deductible for tax purposes. Finally, the 2002 period included tax-free interest1397income.</P>1398<P><I>Comparison of the Years Ended December 31, 2001 and 2000</I></P>1399<P><I>Net income.</I> We reported net income of $1.52 million, or $.15 per1400diluted share, in 2001 compared to $832,000, or $.09 per diluted share, in 2000.1401The results for 2001 include a pretax expense of $484,000 for costs associated1402with our acquisition of HDI on January 2, 2001. These costs were expensed1403instead of capitalized because the acquisition was accounted for under the1404pooling of interests method.</P>1405<P><I>Net revenue.</I> Net revenue of $37.92 million for the year ended December140631, 2001 increased 19.1% from the comparable 2000 level of $31.83 million. This1407growth was attributable to both continued strong sales of our advanced1408neuromodulation products used to treat chronic pain, which increased 19.0% to1409$27.46 million, and higher sales at HDI, which increased 19.6% to $10.461410million. On November 21, 2001, we received approval from the FDA to begin1411marketing our <I>Genesis</I> IPG in the United States, and the first implants1412occurred in late December 2001. We formally launched the <I>Genesis</I> IPG in1413the United States in January 2002.</P>1414<P><I>Gross profit.</I> Gross profit increased to $22.24 million in 2001 from1415$17.13 million in 2000 due to the increase in net revenue discussed above and an1416improvement in gross profit margins. Gross profit margins increased to 58.7% in14172001, compared to 53.8% in 2000, due to higher sales of our <I>Renew</I> system,1418which contributes higher margins than HDI product sales, a reduction in1419specialty distributor sales where we recognize lower margins than sales through1420commissioned sales agents and operational efficiencies from higher manufacturing1421volumes.</P>1422<P><I>Operating expenses.</I> Total operating expenses (the aggregate of1423research and development, sales and marketing, amortization of intangibles and1424general and administrative expenses) increased to $19.43 million in 2001,1425compared to $16.18 million in 2000, and, as a percentage of net revenue,1426increased to 51.2% in 2001 from 50.8% in 2000. In 2001, we continued to invest1427in our product development pipeline and in infrastructure to enhance our sales1428and marketing capabilities.</P>1429<P><I>Sales and marketing.</I> Sales and marketing expense, as a percentage of1430net revenue, increased to 23.9% in 2001 from 21.5% in 2000, and the absolute1431dollar amount increased to $9.06 million in 2001 from $6.85 million during 2000.1432This dollar increase during 2001 was attributable to higher commission expense1433from increased product sales and a change from distributors to commissioned1434sales agents in certain United States territories, higher salary and benefit1435expense from staffing additions in reimbursement and direct sales personnel,1436higher expense for education and training of new implanters and higher expense1437for new product introductions.</P>1438<P ALIGN=CENTER>Page 23</P>1439<HR>14401441<PAGE>1442<P><I>Research and development.</I> Research and development expense increased1443to $4.93 million in 2001, or 13.0% of net revenue, from $3.85 million, or 12.1%1444of net revenue, during the same period in 2000. This increase in the absolute1445dollar amount in 2001 compared to 2000 was the result of higher consulting1446expense and test material expense. During 2001, these expenditures were directed1447toward development of our IPG stimulation system platforms for spinal cord1448stimulation, our next generation RF system platform, our proprietary constant1449rate drug pump and an IPG system for deep brain stimulation.</P>1450<P><I>General and administrative.</I> General and administrative expense1451decreased to $3.96 million during 2001 from $4.24 million in 2000 and, as a1452percentage of net revenue, decreased to 10.4% in 2001 from 13.3% during 2000.1453The decrease in this expense during 2001 was principally the result of lower1454salary expense from a reduction in certain salaries of the former owners of HDI1455when we acquired HDI in January 2001.</P>1456<P><I>Amortization of intangibles.</I> Amortization of goodwill and other1457intangibles increased to $1.49 million in 2001 from $1.23 million in 20001458primarily due to additional amortization expense for patents we acquired from1459ESOX on January 2, 2001.</P>1460<P><I>Other income.</I> Other income decreased to an expense of $26,000 in 20011461from income of $546,000 in 2000, primarily as a result of an expense in 2001 of1462$484,000 for costs associated with the acquisition of HDI and lower interest1463income due to lower yields on invested funds.</P>1464<P><I>Income tax expense.</I> Income tax expense increased to $1.27 million in14652001 from $659,000 in 2000, and the overall effective tax rate was 45.5% in 20011466compared to 44.2% in 2000. Our expense for amortization of costs in excess of1467net assets acquired, or goodwill, is not deductible for tax purposes, and, when1468combined with a provision for state taxes, results in the higher effective tax1469rate during both 2001 and 2000 compared to the U.S. statutory rate for1470corporations of 34%. In addition, approximately $234,000 of the $484,000 of1471costs incurred in the acquisition of HDI are not deductible for tax purposes,1472which also contributed to the higher effective tax rate during 2001 compared to1473the U.S. statutory rate of 34%.</P>1474<P><B>Liquidity and Capital Resources</B></P>1475<P>At December 31, 2002 our working capital increased to $114.28 million from1476$24.91 million at year-end 2001. The ratio of current assets to current1477liabilities was 13.15:1 at December 31, 2002, compared to 4.77:1 at December 31,14782001. Cash, cash equivalents, certificates of deposit and marketable securities1479totaled $96.77 million at December 31, 2002 compared to $11.94 million at1480December 31, 2001.</P>1481<P>During the second quarter of 2002, we completed an underwritten public1482offering of 2,875,000 shares of common stock managed by U.S. Bancorp Piper1483Jaffray, CIBC World Markets and Gerard Klauer Mattison as underwriters. We1484received net proceeds from the offering of approximately $83.2 million. We1485intend to use the proceeds from the offering for general corporate purposes,1486including expanding our worldwide sales and marketing resources, funding product1487development, pursuing regulatory approvals and pursuing strategic acquisitions1488of product lines, businesses, companies, services or technologies that1489complement our current business through mergers, acquisitions, joint ventures or1490otherwise. We discuss below certain transactions and investments we have made1491since the public offering in which we have used cash. In addition, in March14922003, we acquired Sun Medical's pain management business, which will expand our1493direct domestic salesforce, for approximately $5.1 million in cash. In January14942003, we invested $1 million in cash in Innovative Spinal Technologies, Inc., a1495start-up company that develops spine technologies, products and services through1496intellectual property development and contract research.</P>1497<P ALIGN=CENTER>Page 24 </P>1498<HR>14991500<PAGE>1501<P>We increased our investment in inventories to $13.72 million at December 31,15022002, from $9.75 million at December 31, 2001. This increase from year-end 20011503was primarily the result of two factors. First, we increased our investment in1504consignment inventories as a result of adding additional commissioned sales1505agents during 2002 to whom we provide consignment inventory. Second, we1506increased our investment in raw materials and finished goods for our1507<I>Genesis</I> and <I>GenesisXP</I> IPG systems to support our successful launch1508of these products in the U.S. market.</P>1509<P>Our investment in trade accounts receivable increased to $10.85 million at1510December 31, 2002, from $6.49 million at December 31, 2001 due to the increase1511in sales of our neuromodulation products resulting from the launch of the1512<I>Genesis</I> and <I>GenesisXP</I> IPG systems. Our days sales outstanding1513decreased from 57 days at year-end 2001 to 55 days at year-end 2002.</P>1514<P>In November 2002, we completed the acquisition of MicroNet Medical, Inc. At1515closing we paid the former MicroNet shareholders $500,000 in cash and 156,3021516shares of our common stock with a value at the time of issuance of $4,648,421.1517In addition, we incurred expenses of $859,460, including an investment-banking1518fee of $600,000. As previously noted, in March 2003, we paid the former MicroNet1519shareholders an aggregate of 28,346 shares of our common stock with a value at1520the time of issuance and release from escrow of $1,020,173 upon the successful1521completion of half of the first product milestone, and the former MicroNet1522shareholders may receive additional shares of our common stock if certain1523additional product, regulatory approval and sales milestones are met. The1524aggregate value of the additional potential milestone earnout payments was $91525million as measured at the time the transaction was completed. Important1526additional product milestone deadlines occur twelve and eighteen months1527following the closing, while other milestones depend on the receipt of1528regulatory approvals and meeting an aggregate sales milestone. All milestones1529must be met within the next four to five years, depending on the milestone.</P>1530<P>We spent $2.94 million during 2002 for capital expenditures primarily for new1531furniture and equipment for personnel we hired during 2002 and additional1532manufacturing tooling and equipment to support our current products.</P>1533<P>Because we expect our business to continue to grow at rates that will demand1534added office and facility space, we acquired approximately 10 acres of land in1535December 2002 for approximately $3.19 million. The land is located in Plano,1536Texas, near our current corporate headquarters. Our current lease on our 50,0001537square foot corporate headquarters expires in August 2004. We intend to build a1538new corporate headquarters facility on the land and relocate to the new facility1539upon the expiration of our lease in August 2004. We are designing the new1540facility to accommodate planned growth within a five-year horizon and anticipate1541that the facility will contain 140,000 to 150,000 square feet and cost between1542$16 million and $17 million. While we have not yet determined the method by1543which we will finance the facility, we believe our cash position and overall1544balance sheet position provides us with various financing alternatives,1545including financing the facility from our current cash, financing through a debt1546vehicle such as a mortgage or other form of note, or a sale-and-leaseback1547transaction.</P>1548<P>Liquidity may also be enhanced based on our ability to utilize all or part of1549a net operating loss of $3.4 million to offset future taxable income. We1550acquired the net operating loss in connection with the MicroNet Medical1551acquisition and its utilization may be subject to a limitation under Section 3821552of the Internal Revenue Code.</P>1553<P>We believe our current cash, cash equivalents, marketable securities and cash1554generated from operations will be sufficient to fund our current levels of1555operating needs and capital expenditures for the foreseeable future. We1556currently have no credit facilities in place. If we decide to acquire1557complementary businesses, product lines or technologies, or enter into joint1558ventures or strategic alliances that require substantial capital, we intend to1559finance those activities by the most attractive alternative available, which1560could include utilizing our current cash, bank borrowings, or the issuance of1561debt or equity securities.</P>1562<P ALIGN=CENTER>Page 25</P>1563<HR>15641565<PAGE>1566<P><B>Cash Flows</B></P>1567<P>Net cash provided by operating activities was $7.47 million in 2002, $3.061568million in 2001 and $690,000 in 2000. Net cash provided by operating activities1569increased from $3.06 million in 2001 to $7.47 million in 2002, an increase of1570approximately $4.41 million. This increase in 2002 compared to 2001 was1571principally attributable to a $5.17 million increase in net income from $1.521572million in 2001 to $6.68 million in 2002. Net cash provided by operating1573activities increased from $690,000 in 2000 to $3.06 million in 2001, an increase1574of approximately $2.38 million. This increase in 2001 compared to 2000 was1575primarily the result of an increase in net income of $685,000 and a $1.411576million decrease in the amount of cash used for changes in working capital1577components.</P>1578<P>Net cash used in investing activities was $91.14 million in 2002, $3.091579million in 2001 and $2.94 million in 2000. In 2002, our primary investing1580activities using cash were the purchase of marketable securities ($188.391581million) the purchase of land ($3.19 million), capital expenditures ($2.941582million) and cash used in the purchase of MicroNet Medical, Inc. ($1.361583million), while net proceeds from the sale of marketable securities provided1584cash of $104.75 million. In 2001, our primary investing activities using cash1585were the purchase of marketable securities ($3.90 million) and capital1586expenditures ($3.11 million) for additional manufacturing tooling and equipment,1587office furniture and equipment, non-compete agreements and licensing fees for1588patents, while maturing certificates of deposit and sales of marketable1589securities provided cash of $3.92 million. In 2000, our primary investing1590activities using cash were the purchase of marketable securities and1591certificates of deposit with maturities over 90 days ($2.23 million) and capital1592expenditures ($1.65 million) for additional manufacturing tooling and equipment,1593office furniture and equipment and licensing fees for patents, while maturing1594certificates of deposit and the sale of marketable securities provided cash of1595$949,000.</P>1596<P>Net cash provided by financing activities was $84.86 million in 2002,1597$957,000 in 2001 and $2.57 million in 2000. During 2002, we used $190,000 to1598repay our entire outstanding long-term debt, while we received $83.18 million in1599net proceeds from a public offering and $1.87 million from the exercise of stock1600options. During 2001, we used $48,000 to reduce certain debt obligations, while1601we received approximately $1.0 million from the exercise of stock options.1602During 2000, we used $29,000 to reduce certain debt obligations, while we1603received $2.6 million of cash from the exercise of stock options ($1.931604million), the private placement of common stock ($400,000) and proceeds from a1605long-term note payable ($270,000).</P>1606<P><B>Currency Fluctuations</B></P>1607<P>Substantially all of our international sales are denominated in U.S. dollars.1608Fluctuations in currency exchange rates in other countries could reduce the1609demand for our products by increasing the price of our products in the currency1610of the countries in which the products are sold, although we do not believe1611currency fluctuations have had a material effect on the Company's results of1612operations to date.</P>1613<P ALIGN=CENTER>Page 26</P>1614<HR>16151616<PAGE>1617<P><B>Outlook and Uncertainties</B></P>1618<P><I>The following is a "safe harbor" statement under the Private Securities1619Litigation Reform Act of 1995: Certain matters discussed in this Annual Report1620on Form 10-K contain statements that constitute forward-looking statements1621within the meaning of Section 21E of the Securities Exchange Act of 1934, as1622amended. The words "expect," "estimate," "anticipate," "predict," "believe,"1623"plan," "will," "should," "intend," "would," "scheduled," "new market,"1624"potential market applications," and similar expressions and variations are1625intended to identify forward-looking statements. Such statements appear in a1626number of places in this Annual Report on Form 10-K and include statements1627regarding our intent, belief or current expectations with respect to, among1628other things: (i) trends affecting our financial condition or results of1629operations; (ii) our financing plans; and (iii) our business growth strategies.1630We caution our readers that any forward-looking statements are not guarantees of1631future performance and involve risks and uncertainties. Actual results may1632differ materially from those projected in the forward-looking statements as a1633result of various factors. These risks and uncertainties include the following:1634</I></P>1635<P><B><I>Failure of our <I>Genesis</I> and <I>GenesisXP</I> IPG systems to gain1636and maintain market acceptance would adversely affect our revenue growth and1637profitability.</I></B></P>1638<P>We formally introduced our <I>Genesis</I> IPG system in the U.S. in January16392002 and our <I>GenesisXP</I> IPG system (offering increased battery capacity1640and longevity) in the U.S. in December 2002. We believe that the size and1641potential for growth of the IPG portion of the neurostimulation market are1642greater than in the RF portion. Accordingly, our ability to generate increased1643revenue and profitability, and thus our general success, will depend, in large1644part, on the market's acceptance of our IPG systems. As a new entrant into the1645IPG portion of the neurostimulation market, there are many reasons we might not1646achieve market acceptance on a timely basis, if at all, including the following:1647</P>1648<UL>1649<LI>competing products, technologies and therapies are available, and others may1650be introduced that gain greater and faster physician and patient acceptance than1651our IPG systems; and1652<LI>our only competitor in the IPG portion of the market has had its IPG product1653on the market for some time and enjoys significant brand awareness and other1654advantages among pain management specialists.</UL>1655<P>If the IPG portion of the neurostimulation market grows at a faster rate than1656the RF portion, our failure to successfully market and sell our IPG systems1657could negatively affect our revenue growth and profitability.</P>1658<P><B><I>Because our main competitor has significantly greater resources than we1659do and new competitors may enter the neuromodulation market, it may be difficult1660for us to compete in this market.</I></B></P>1661<P>The medical device market is highly competitive, subject to rapid change and1662significantly affected by new product introductions and other market activities1663of industry participants. Medtronic, Inc. is one of the largest competitors in1664the medical device sector, and is currently our sole competitor in the1665neurostimulation market and our largest competitor in the implantable drug pump1666market. Medtronic is a large publicly-traded company and enjoys several1667competitive advantages over us, including:</P>1668<UL>1669<LI>substantially greater name recognition;1670<LI>greater resources for product research and development, sales and marketing,1671distribution, patent protection and pursuing regulatory approvals;1672<LI>a greater number of established relationships with health care professionals1673and third-party payors; and1674<LI>multiple product lines and the ability to bundle products together or offer1675discounts, rebates or other incentives to secure a competitive advantage.</UL>1676<P ALIGN=CENTER>Page 27</P>1677<HR>16781679<PAGE>1680<P>Medtronic will continue to develop new products that compete directly with1681our products, and its greater resources may allow it to respond more quickly to1682new technologies, new treatment indications or changes in customer requirements.1683Further, we generally price our products at a premium to those of Medtronic.1684Additionally, because the neuromodulation market is a high growth-potential1685market, other companies may attempt to bring new products or therapies into this1686market. For example, we are aware that Advanced Bionics, Inc., a privately-held1687company that currently manufactures and markets a cochlear implant product, is1688developing and may be testing an IPG system for the treatment of chronic pain.1689For all of these reasons, we may not be able to compete successfully against1690Medtronic or against future competitors.</P>1691<P><B><I>If pain management specialists do not recommend and endorse our1692products, our sales could be negatively impacted and we may be unable to1693increase our revenues and profitability.</I></B></P>1694<P>Our products are based on evolving concepts and techniques in pain1695management. Acceptance of our products depends on educating the medical1696community as to the distinctive features, benefits, clinical efficacy, safety1697and cost-effectiveness of our products compared to alternative therapies and1698competing products, and on training pain management specialists in the proper1699use of our products. To sell our products, we must successfully educate and1700train pain management specialists so that they will understand our products and1701feel comfortable recommending and endorsing them. We may not be able to1702accomplish this, and even if we are successful in educating and training pain1703management specialists, there is no guarantee that we will obtain their1704recommendations and endorsements.</P>1705<P><B><I>The launch of Genesis and GenesisXP and other market1706factors could impede growth in or reduce sales of Renew, which would1707adversely affect our revenues and profitability.</I></B></P>1708<P>Our<I>Genesis</I> and <I>GenesisXP</I> IPG systems are currently the newest1709neurostimulation products on the market. Although <I>Genesis</I> and our1710<I>Renew</I> RF system are targeted towards patients with different types of1711pain and <I>Genesis</I> is not intended to replace <I>Renew</I> in the1712neurostimulation market, some pain management specialists may recommend1713<I>Genesis</I> to their patients when they would have otherwise recommended1714<I>Renew</I>, and, consequently, <I>Genesis</I> may "cannibalize" or substitute1715for some sales of <I>Renew</I>. Further, we believe our principal market1716competitor has chosen to emphasize the IPG as the therapy of choice in the1717neurostimulation market. These factors could lead to a slowdown in growth, or a1718reduction, in sales of <I>Renew</I> and similar RF-based neurostimulation1719products. Although <I>Renew</I> and <I>Genesis</I> are targeted for different1720patients, sales growth of <I>Renew</I> has slowed since the launch of <I>1721</I>Genesis. If <I>Renew</I> sales growth continues to slow or sales are1722reduced, and we do not gain enough market share through IPG sales to compensate1723for these reduced sales, our revenues and profitability will be adversely1724affected.</P>1725<P><B><I>If patients choose less invasive or less expensive alternatives to our1726products, our sales could be negatively impacted.</I></B></P>1727<P>We sell medical devices for invasive and minimally-invasive surgical1728procedures. Patient acceptance of our products depends on a number of factors,1729including device and associated procedure costs, the failure of less invasive1730therapies to help the patient, the degree of invasiveness involved in the1731procedures used to implant our products, the rate and severity of complications1732from the procedures used to implant our products and any adverse side effects1733caused by the implanting of our products. If patients choose to use existing1734less invasive or less expensive alternatives to our products, or if effective1735new alternatives are developed, our revenues and profitability could be1736materially adversely affected.</P>1737<P ALIGN=CENTER>Page 28</P>1738<HR>17391740<PAGE>1741<P><B><I>Any adverse changes in coverage or reimbursement amounts by Medicare1742and Medicaid, private insurance companies and managed care organizations, or1743workers' compensation programs could limit our ability to market and sell our1744products.</I></B></P>1745<P>In the U.S., our products are generally covered by Medicare and Medicaid and1746other third-party payors, such as private insurance companies and managed care1747organizations, and workers' compensation programs, which reimburse patients for1748all or part of the cost of our products and related medical procedures. The cost1749of our products and related procedures are significant, and third-party payors1750carefully scrutinize whether to cover new products and the level of1751reimbursement for covered products. From time to time, payors may refuse to1752reimburse our customers for all or a portion of the cost of our products, and we1753may discount our product cost below expected selling prices or offer other1754payment accommodations to customers in order to increase the likelihood of1755reimbursement. Further, for certain types of procedures, gaps exist between the1756rate of reimbursement paid by Medicare and Medicaid and the rates paid by1757private insurers. In addition, gaps exist in reimbursement levels depending on1758the health care setting in which physicians perform procedures using our1759products. In the future, these gaps may narrow and public and private payors may1760reduce levels of reimbursement for neuromodulation devices in an effort to1761control increasing costs. If Medicare or other third-party payors decide to1762eliminate or reduce coverage amounts on patient reimbursements for our products,1763this could limit our ability to market and sell our products in the U.S., which1764would materially adversely affect our revenues and profitability. In November17652002, for example, the Center for Medicare and Medicaid Services (CMS) issued a1766final ruling establishing new 2003 reimbursement rates for Medicare hospital1767outpatient procedures. Reimbursement levels for permanent implants of spinal1768cord stimulation devices in the hospital outpatient setting were reduced as a1769result of the ruling. CMS could decide to further reduce reimbursement rates for1770our products in the same or other patient settings in 2004 and beyond.</P>1771<P>International market acceptance of our products may also depend, in part,1772upon the availability of reimbursement within prevailing health care payment1773systems. Reimbursement and health care payment systems in international markets1774vary significantly by country, and include both government-sponsored health care1775and private insurance. We may not obtain international reimbursement approvals1776in a timely manner, if at all. Where reimbursement in foreign markets is1777available, it tends to be at levels significantly below those in the U.S. Our1778failure to receive international reimbursement approvals may negatively impact1779market acceptance of our products in the international markets in which those1780approvals are sought.</P>1781<P><B><I>If we fail to protect our intellectual property rights, our competitors1782may take advantage of our ideas and compete directly against us.</I></B></P>1783<P>We rely in part on patents, certain of which are due to expire between 20041784and 2006, as well as trade secrets and proprietary technology, to remain1785competitive. We may not be able to obtain or maintain adequate U.S. patent1786protection for new products or ideas, or prevent the unauthorized disclosure or1787use of our technical knowledge or other trade secrets by employees.1788Additionally, the laws of foreign countries may not protect our intellectual1789property rights to the same extent as the laws of the U.S. Even if our1790intellectual property rights are adequately protected, litigation may be1791necessary to enforce them, which could result in substantial costs to us and1792substantial diversion of the attention of our management and key technical1793employees. If we are unable to adequately protect our intellectual property, our1794competitors could use our intellectual property to develop new products or1795enhance their existing products. This could harm our competitive position,1796decrease our market share or otherwise harm our business.</P>1797<P ALIGN=CENTER>Page 29</P>1798<HR>17991800<PAGE>1801<P><B><I>Other parties may sue us for infringing their intellectual property1802rights, or we may have to sue them to protect our intellectual property rights.1803</I></B></P>1804<P>There has been a substantial amount of litigation in the medical technology1805industry regarding patents and intellectual property rights. The neuromodulation1806market is characterized by extensive patent and other intellectual property1807rights, which can create greater potential than in less-developed markets for1808possible allegations of infringement, particularly with respect to1809newly-developed technology. We may be forced to defend ourselves against1810allegations that we are infringing the intellectual property rights of others.1811In addition, we may find it necessary, if threatened, to initiate a lawsuit1812seeking a declaration from a court that we are not infringing the intellectual1813property rights of others or that these rights are invalid or unenforceable, or1814to protect our own intellectual property rights. Intellectual property1815litigation is expensive and complex and its outcome is difficult to predict. If1816we do not prevail in any litigation, in addition to any damages we might have to1817pay, we would be required to stop the infringing activity, obtain a license, or1818concede intellectual property rights. Any required license may not be available1819to us on acceptable terms, if at all. In addition, some licenses may be1820nonexclusive, and, therefore, our competitors may have access to the same1821technology licensed to us. If we fail to obtain a required license or are unable1822to design around a patent, we may be unable to sell some of our products, which1823could adversely affect our revenues and profitability.</P>1824<P><B><I>Failure to obtain necessary government approvals for new products or1825for new applications for existing products would mean we could not sell those1826new products, or sell our existing products for those new applications.1827</I></B></P>1828<P>Our products are medical devices, which are subject to extensive government1829regulation in the U.S. and in foreign countries where we do business. Unless an1830exemption applies, each medical device that we wish to market in the U.S. must1831first receive either a premarket approval (PMA) or a 510(k) clearance from the1832FDA with respect to each application for which we intend to market it. Either1833process can be lengthy and expensive. According to the FDA, the average 510(k)1834review period was 100 days in 2002, but reviews may take longer and approvals1835may be revoked if safety or effectiveness problems develop. The PMA process is1836much more costly, lengthy and uncertain. According to the FDA, the average PMA1837submission-to-decision period was 364 days in 2002; however, reviews may take1838much longer and completing a PMA application can require numerous clinical1839trials and require the filing of amendments over time. The result of these1840lengthy approval processes is that a new product, or a new application for an1841existing product, often cannot be brought to market for a number of years after1842it is developed. Additionally, we anticipate that many of the products we bring1843to market in the future will require us to seek PMA approvals rather than 510(k)1844clearances. If we fail to obtain or maintain necessary government approvals of1845our new products or new applications for existing products on a timely and1846cost-effective basis, we will be unable to market the affected products for1847their intended applications.</P>1848<P><B><I>Modification of any marketed device could require a new 510(k)1849clearance or PMA or require us to cease marketing or recall the modified device1850until we obtain this clearance or approval.</I></B></P>1851<P>Any modification we want to make to an FDA-cleared or approved device that1852could significantly affect its safety or effectiveness, or that would constitute1853a major change in its intended use, would require a new 510(k) clearance, or1854possibly a new or supplemental PMA. Under FDA procedures, we would make the1855initial determination of whether to seek a new 510(k) clearance or PMA, but the1856FDA could review our decision. If the FDA disagrees with our decision not to1857seek a new 510(k) clearance or PMA and requires us to seek either 510(k)1858clearance or PMA for modifications we have already made to a previously-cleared1859product, we might be required to cease marketing or recall the modified device1860until we obtain this clearance or approval. We could also be subject to1861significant regulatory fines or penalties.</P>1862<P ALIGN=CENTER>Page 30</P>1863<HR>18641865<PAGE>1866<P><B><I>We will be unable to sell our products if we fail to comply with1867manufacturing regulations.</I></B></P>1868<P>To commercially manufacture our products, we must comply with government1869manufacturing regulations that govern design controls, quality systems and1870documentation policies and procedures. The FDA and equivalent foreign1871governmental authorities periodically inspect our manufacturing facilities. Our1872failure to comply with these manufacturing regulations may prevent or delay our1873marketing or distribution of our products, which would negatively impact our1874business.</P>1875<P><B><I>Our products are subject to product recalls even after receiving FDA1876clearance or approval, which would negatively affect our financial performance1877and could harm our reputation.</I></B></P>1878<P>Any of our products may be found to have significant deficiencies or defects1879in design or manufacture. The FDA and similar governmental authorities in other1880countries have the authority to require the recall of any such defective1881product. A government-mandated or voluntary recall could occur as a result of1882component failures, manufacturing errors or design defects. We do not maintain1883insurance to cover losses incurred as a result of product recalls. Any product1884recall would divert managerial and financial resources and negatively affect our1885financial performance, and could harm our reputation with customers.</P>1886<P><B><I>We are subject to potential product liability and other claims and we1887may not have the insurance or other resources to cover the cost of any1888successful claim.</I></B></P>1889<P>Defects in our implantable medical devices could subject us to potential1890product liability claims that our devices were ineffective or caused some harm1891to the human body. Our current product liability litigation involves assertions1892that our products did not perform as intended and, in some cases, that they1893caused discomfort or harm to the patient. Our product liability insurance may1894not be adequate to cover current or future claims. Product liability insurance1895is expensive and, in the future, may not be available on terms that are1896acceptable to us, if it is available to us at all. Plaintiffs may also advance1897other legal theories supporting their claims that our products or actions1898resulted in some harm. A successful claim brought against us in excess of our1899insurance coverage could significantly harm our business and financial1900condition.</P>1901<P><B><I>We are subject to substantial government regulation and our failure to1902comply with all applicable government regulations could subject us to numerous1903penalties, any of which could adversely affect our business.</I></B></P>1904<P>We are subject to numerous government regulations relating to, among other1905things, our ability to sell our products, third-party reimbursement, fraud and1906abuse of Medicare or Medicaid and patient privacy. If we do not comply with all1907applicable government regulations, government authorities could do any of the1908following:</P>1909<UL>1910<LI>impose fines and penalties on us;1911<LI>prevent us from manufacturing our products;1912<LI>bring civil or criminal charges against us;1913<LI>delay the introduction of our new products into the market;1914<LI>recall or seize our products;1915<LI>disrupt the manufacture or distribution of our products; or1916<LI>withdraw or deny approvals for our products.</UL>1917<P ALIGN=CENTER>Page 31</P>1918<HR>19191920<PAGE>1921<P>Any one of these results could materially adversely affect our revenues and1922profitability and harm our reputation.</P>1923<P><B><I>Our reliance on single suppliers for critical components used in our1924main products could adversely affect our ability to deliver products on time.1925</I></B></P>1926<P>We rely on single suppliers for several critical components used in our main1927products, including the computer chip used in the receiver of our RF system, the1928computer chip used in the IPG programmer and <I>Renew</I> transmitter, the1929batteries used in our IPG system and the medical-grade polyurethane (bionate)1930that we use in all of our products. If any of our sole-source suppliers were to1931stop supplying us with critical components, our manufacturing operations and our1932business could be materially harmed, at least in the short term while we located1933alternative suppliers or modified our product designs to eliminate the need for1934these components.</P>1935<P>The sole supplier of the computer chip used in the receiver of our RF system1936has indicated its desire to cease manufacturing and supplying the computer chip1937in the future, but to date has not determined when this will occur. This1938supplier has agreed to notify us when a date has been determined and allow us to1939place a final one-time purchase order for the computer chip. In the interim, we1940are maintaining a higher than normal inventory of the computer chip and are1941working to develop a new product design that uses an alternative computer chip.1942Until we develop this new design, any sudden disruption in supply from our1943current computer chip supplier could adversely affect our ability to deliver1944finished RF products on time.</P>1945<P><B><I>One distributor currently accounts for a significant percentage of our1946revenue from our neuromodulation products segment, and our major competitor in1947the neuromodulation market currently accounts for a significant percentage of1948our revenue from our O.E.M. segment.</I></B></P>1949<P>During 2002, we had one independent distributor, Sun Medical, Inc., that1950accounted for $6.33 million, or 13.5%, of our net revenue from our1951neuromodulation products segment. In March 2003, we acquired Sun Medical's pain1952management business and hired substantially all of the salespeople who had1953generated those sales, but we continue to rely in large part on two other1954distributors and on numerous independent sales representatives to buy and/or1955sell our products. The loss of a major distributor or sales representative, or a1956significant decrease in their sales volumes, could materially adversely affect1957our revenues and profitability, at least in the short term.</P>1958<P>In addition, during 2002, we had two major customers that accounted for $9.521959million, or 89.3%, of our net revenue from our O.E.M. segment. Medtronic, Inc.,1960our most significant competitor, accounted for $6.74 million, or 63.2% and Arrow1961International, Inc. accounted for $2.78 million, or 26.1%. Either of these1962customers could cease doing business with us at any time. If this were to occur,1963our revenues and profitability could be materially adversely affected, at least1964in the short term.</P>1965<P><B><I>We are dependent upon the success of neuromodulation technology. Our1966inability to continue to develop innovative neuromodulation products, or the1967failure of the neuromodulation market to develop as we anticipate, would1968adversely affect our business.</I></B></P>1969<P>Our current products focus on the treatment of chronic pain using1970neuromodulation. Our development efforts focus on leveraging our neuromodulation1971expertise. The neuromodulation market is subject to rapid technological change1972and product innovation. Our competitors may succeed in developing or marketing1973products, using neuromodulation technology or other technologies, that may be1974superior to ours. If we are unable to compete successfully in the development of1975new neuromodulation products, or if new and effective therapies not based on1976neuromodulation are developed, our products could be rendered obsolete or1977non-competitive. This would materially adversely affect our business.</P>1978<P ALIGN=CENTER>Page 32</P>1979<HR>19801981<PAGE>1982<P><B><I>Our success will depend on our ability to attract and retain key1983personnel and scientific staff.</I></B></P>1984<P>We believe our future success will depend on our ability to manage our growth1985successfully, including attracting and retaining scientists, engineers and other1986highly-skilled personnel. Our key employees are subject to confidentiality,1987trade secret and non-competition agreements, but may terminate their employment1988with us at any time. Hiring qualified management and technical personnel is1989difficult due to the limited number of qualified professionals. Competition for1990these types of employees is intense in the medical device field. If we fail to1991attract and retain personnel, particularly management and technical personnel,1992we may not be able to continue to succeed in the neuromodulation market.</P>1993<P><B><I>If we choose to acquire complementary businesses, products or1994technologies instead of developing them ourselves, we may be unable to complete1995these acquisitions or to successfully integrate an acquired business, product or1996technology in a cost-effective and non-disruptive manner.</I></B></P>1997<P>Our success depends on our ability to continually enhance and broaden our1998product offerings in response to changing technologies, customer demands and1999competitive pressures. Accordingly, we may, as we have in the past, acquire2000complementary businesses, products or technologies instead of developing them2001ourselves. We do not know if we will be able to identify prospective acquisition2002targets or complete any future acquisitions, or whether we will be able to2003successfully integrate any acquired business, operate it profitably or retain2004its key employees. Integrating any business, product or technology we acquire2005could be expensive and time-consuming, disrupt our ongoing business and distract2006our management and key technical personnel. If we are unable to integrate any2007acquired entities, products or technologies effectively, our business will2008suffer. In addition, any impairment of goodwill or other intangible assets or2009charges resulting from the costs of acquisitions could harm our business and2010operating results.</P>2011<P><B><I>We are subject to additional risks associated with international2012operations.</I></B></P>2013<P>Internationally, we market our products through 18 independent distributors2014who represent us in 22 countries except in Germany where we are represented by2015direct salespersons. In 2002, 8% of our sales revenue from our neuromodulation2016products segment came from international sales. International sales are subject2017to a number of additional risks, including the following:</P>2018<UL>2019<LI>establishment by foreign regulatory agencies of requirements different from2020those in place in the U.S.;2021<LI>fluctuations in exchange rates of the U.S. dollar against foreign currencies2022that may affect demand for our products overseas;2023<LI>export license requirements, changes in tariffs, and other general trade2024restrictions;2025<LI>difficulties in staffing and managing international operations;2026<LI>political or economic instability; and2027<LI>lower and more restrictive third-party reimbursement for our products.</UL>2028<P>Any of these risks could make it difficult or impossible for us to continue2029to expand our overseas operations, which could have an adverse effect on our2030revenues.</P>2031<P ALIGN=CENTER>Page 33</P>2032<HR>20332034<PAGE>2035<P><B><I>Our operations are conducted at three locations, and a disaster at any2036of these facilities could result in a prolonged interruption of our business.2037</I></B></P>2038<P>We currently conduct all of our development, manufacturing and management2039activities at our facilities in Plano, Texas and Budd Lake and Hackettstown, New2040Jersey. However, a natural disaster, such as a tornado, fire or flood, or a2041man-made disaster, could cause substantial delays in our operations, damage or2042destroy our manufacturing equipment or inventory and cause us to incur2043significant additional expenses. A disaster could seriously harm our business2044and affect our reputation with customers. The insurance we maintain may not be2045adequate to cover our losses in any particular case.</P>2046<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2047<TR>2048<TD WIDTH=15% VALIGN=TOP><B>ITEM 7A.</B></TD>2049<TD WIDTH=85%><B>QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK</B>2050</TD></TR></TABLE>2051<P>We invest our cash reserves in high quality short-term liquid money market2052instruments with major financial institutions, a high quality short-term2053municipal bond fund with a major financial institution and certificates of2054deposit. At December 31, 2002, we had $443,174 invested in money market funds,2055$1,636,938 in certificates of deposit with maturities less than 90 days from the2056purchase date and $5,636,212 in a tax-free municipal bond fund with daily2057liquidity. The rate of interest earned on these investments will vary with2058overall market rates. A hypothetical 100-basis point change in the interest2059rates earned on these investments would not have a material effect on our income2060or cash flows.</P>2061<P>We also have certain investments in available-for-sale securities. These2062investments primarily consist of investment grade municipal bonds with2063maturities less than one year from the date of purchase, 7-day and 35-day AAA2064municipal bond floaters and Freddie Mac and Federal Home Loan Notes with2065maturities less than one-year from the date of purchase. The cost of these2066investments is $85,817,984 and the fair value at December 31, 2002 was2067$85,796,944. The investments are subject to overall bond market and interest2068rate risk, however the Company believes the risk to be limited since a large2069portion of the investments, $82,825,000, are in 7-day and 35-day municipal2070floaters which have no principal risk. The investment grade municipal bonds and2071Freddie Mac and Federal Home Loan Bank notes may have risk of principal2072depending on the overall bond market. A hypothetical 10% decrease in the value2073of these investments from their prices at December 31, 2002 would decrease the2074fair value by $297,194.</P>2075<P>We do not use derivative financial instruments to manage the impact of2076interest rate changes on our investments or debt instruments.</P>2077<P>At December 31, 2002, we had no interest bearing debt.</P>2078<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2079<TR>2080<TD WIDTH=15% VALIGN=TOP><B>ITEM 8.</B></TD>2081<TD WIDTH=85%><B>FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA</B></TD></TR>2082</TABLE>2083<P>The information required by this item is set forth in Appendices A, B and C.2084</P>2085<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2086<TR>2087<TD WIDTH=15% VALIGN=TOP><B>ITEM 9.</B></TD>2088<TD WIDTH=85%><B>CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND2089FINANCIAL DISCLOSURE</B></TD></TR></TABLE>2090<P>None.</P>2091<P ALIGN=CENTER>Page 34</P>2092<HR>20932094<PAGE>2095<P ALIGN=CENTER><B>PART III</B></P>2096<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2097<TR>2098<TD WIDTH=15% VALIGN=TOP><B>ITEM 10.</B></TD>2099<TD WIDTH=85%><B>DIRECTORS AND EXECUTIVE OFFICERS OF THE2100REGISTRANT</B></TD></TR></TABLE>2101<P>The information required by this item is contained under the captions2102"Election of Directors", "Executive Officers" and "Section 16(a) Beneficial2103Ownership Reporting Compliance" in our definitive proxy statement to be filed in2104connection with our 2003 annual meeting of shareholders, which information is2105incorporated herein by reference.</P>2106<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2107<TR>2108<TD WIDTH=15% VALIGN=TOP><B>ITEM 11.</B></TD>2109<TD WIDTH=85%><B>EXECUTIVE COMPENSATION</B></TD></TR></TABLE>2110<P>The information required by this item is contained under the captions2111"Compensation and Committees of the Board of Directors" and "Compensation of2112Executive Officers" in our definitive proxy statement to be filed in connection2113with our 2003 annual meeting of shareholders, which information is incorporated2114herein by reference. Information under the captions "Compensation Committee2115Report" and "Performance Graph" are not incorporated herein by reference.</P>2116<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2117<TR>2118<TD WIDTH=15% VALIGN=TOP><B>ITEM 12.</B></TD>2119<TD WIDTH=85%><B>SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT2120AND RELATED STOCKHOLDER MATTERS</B></TD></TR></TABLE>2121<P>The information required by this item is contained under the caption2122"Security Ownership of Management and Principal Shareholders" in our definitive2123proxy statement to be filed in connection with our 2003 annual meeting of2124shareholders, which information is incorporated herein by reference.</P>2125<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2126<TR>2127<TD WIDTH=15% VALIGN=TOP><B>ITEM 13.</B></TD>2128<TD WIDTH=85%><B>CERTAIN RELATIONSHIPS AND RELATED2129TRANSACTIONS</B></TD></TR></TABLE>2130<P>Inapplicable.</P>2131<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2132<TR>2133<TD WIDTH=15% VALIGN=TOP><B>ITEM 14.</B></TD>2134<TD WIDTH=85%><B>CONTROLS AND PROCEDURES</B></TD></TR>2135<TR>2136<TD> </TD><TD></TD></TR>2137<TR>2138<TD VALIGN=TOP>(a)</TD>2139<TD> Evaluation of disclosure controls and procedures. Based on their most2140recent review, which was completed within 90 days of the filing of this annual2141report, the Company's Disclosure Committee, which is comprised of our Chief2142Executive Officer, Christopher G. Chavez, Chief Financial Officer, F. Robert2143Merrill III and General Counsel, Kenneth G. Hawari, concluded that the Company's2144disclosure controls and procedures are effective to ensure that information2145required to be disclosed by the Company in the reports that it files or submits2146under the Securities Exchange Act of 1934, as amended, is accumulated and2147communicated to such officers as is appropriate to allow timely decisions2148regarding required disclosure, and that these controls and procedures are2149effective to ensure that such information is recorded, processed, summarized and2150reported within the time periods specified in the SEC's rules and forms.</TD>2151</TR>2152<TR>2153<TD> </TD><TD></TD></TR>2154<TR>2155<TD VALIGN=TOP>(b)</TD>2156<TD>Changes in internal controls. Since the date of the evaluation described2157above, there have not been any significant changes in the Company's internal2158accounting controls or in other factors (including any corrective actions with2159regard to significant deficiencies or material weaknesses) that could2160significantly affect those controls.</TD></TR></TABLE>2161<P ALIGN=CENTER>Page 35</P>2162<HR>21632164<PAGE>2165<P ALIGN=CENTER><B>PART IV</B><P>2166<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2167<TR>2168<TD WIDTH=15% VALIGN=TOP><B>ITEM 15.</B></TD>2169<TD WIDTH=85%><B>EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM21708-K</B></TD></TR></TABLE>2171<P></P>2172<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2173<TR>2174<TD WIDTH=10%>(a)</TD>2175<TD WIDTH=90%>Documents filed as part of this report.</TD></TR></TABLE>2176<P></P>2177<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2178<TR>2179<TD WIDTH=10%> </TD>2180<TD WIDTH=10% VALIGN=TOP>1.</TD>2181<TD WIDTH=90%>Financial Statements:<BR>See Index to Financial Statements on the2182second page of Appendix A.</TD></TR>2183<TR>2184<TD> </TD>2185<TD></TD>2186<TD></TD></TR>2187<TR>2188<TD> </TD>2189<TD VALIGN=TOP>2.</TD>2190<TD>Financial Statement Schedules:*<BR>Schedule II - Valuation and Qualifying2191Accounts.<BR>See Appendix B.</TD></TR>2192</TABLE>2193<P></P>2194<P>*Those schedules not listed above are omitted as not applicable or not2195required.</P>2196<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2197<TR>2198<TD WIDTH=10%> </TD>2199<TD WIDTH=10%>3.</TD>2200<TD WIDTH=90%>Exhibits: See (c) below.</TD></TR></TABLE>2201<P></P>2202<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2203<TR>2204<TD WIDTH=10%>(b)</TD>2205<TD WIDTH=90%>Reports on Form 8-K.</TD></TR></TABLE>2206<P></P>2207<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2208<TR>2209<TD WIDTH=10%> </TD>2210<TD WIDTH=90%>(1) The Company filed a report on Form 8-K on November 5, 20022211reporting that the Company entered into an agreement to acquire MicroNet2212Medical, Inc., a privately-held Minnesota corporation. </TD></TR>2213<TR>2214<TD WIDTH=10%> </TD>2215<TD WIDTH=90%>(2) The Company filed a report on Form 8-K on November 26, 20022216reporting the completion of the MicroNet Medical, Inc. acquisition.</TD></TR>2217<TR>2218<TD WIDTH=10%> </TD>2219<TD WIDTH=90%>(3 The Company filed a report on Form 8-K on December 3, 20022220reporting that Anthony J. Varrichio, an executive vice president of the Company,2221entered into a "Preset Diversification Program" (PDP), a stock disposition plan2222intended to qualify for the safe harbor offered by Rule 10b5-1 under the2223Securities Exchange Act of 1934, as amended.</TD></TR>2224<TR>2225<TD> </TD><TD></TD></TR>2226<TR>2227<TD WIDTH=10%>(c)</TD>2228<TD WIDTH=90%>Exhibits:</TD></TR></TABLE>2229<P></P>2230<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2231<TR>2232<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>2233<TD WIDTH=5%></TD>2234<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>2235</TABLE>2236<P></P>2237<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2238<TR>2239<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>2240<TD WIDTH=5%> </TD>2241<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by2242and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and2243Hi-tronics Designs, Inc.(10)</TD></TR>2244<TR>2245<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.2 </TD>2246<TD WIDTH=5%> </TD>2247<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 4, 2002, by and2248amoung Advanced Neuromodulaiton Systems, Inc., MicroNet Acquisition, Inc. and2249MicroNet Medical, Inc. (14)</TD></TR>2250<TR>2251<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>2252<TD></TD>2253<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>2254<TR>2255<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>2256<TD></TD>2257<TD>Bylaws(11)</TD></TR>2258<TR>2259<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>2260<TD></TD>2261<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.2262and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>2263<TR>2264<TD ALIGN=RIGHT VALIGN=TOP>4.2 </TD>2265<TD></TD>2266<TD>Amendment To Rights Agreement dated as of January 25, 2002 between Advanced2267Neuromodulation Systems, Inc. and Computershare Investor Services LLC (formerly2268KeyCorp Shareholder Services, Inc) (12)</TD></TR>2269<TR>2270<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>2271<TD></TD>2272<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option2273Plan(2)</TD></TR></TABLE>2274<P ALIGN=CENTER>Page 36</P><HR>22752276<PAGE>2277<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2278<TR>2279<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>2280<TD WIDTH=5%></TD>2281<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>2282</TABLE>2283<P></P>2284<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2285<TR>2286<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>10.2 </TD>2287<TD WIDTH=5%> </TD>2288<TD WIDTH=85%>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>2289<TR>2290<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>2291<TD></TD>2292<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>2293<TR>2294<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>2295<TD></TD>2296<TD>Form of Directors Stock Option Agreement(1)</TD></TR>2297<TR>2298<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>2299<TD></TD>2300<TD>Quest Medical, Inc. 1995 Stock Option Plan (4)</TD></TR>2301<TR>2302<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>2303<TD></TD>2304<TD>Form of 1995 Employee Stock Option Plan(4)</TD></TR>2305<TR>2306<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>2307<TD></TD>2308<TD>Quest Medical, Inc. 1998 Stock Option Plan (7)</TD></TR>2309<TR>2310<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>2311<TD></TD>2312<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>2313<TR>2314<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>2315<TD></TD>2316<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and2317Quest Medical, Inc.(6)</TD></TR>2318<TR>2319<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>2320<TD></TD>2321<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill and Quest2322Medical, Inc.(6)</TD></TR>2323<TR>2324<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>2325<TD></TD>2326<TD>Employment Agreement dated April 1, 2002 between Christopher G. Chavez and2327Advanced Neuromodulation Systems, Inc.(13)</TD></TR>2328<TR>2329<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>2330<TD></TD>2331<TD>Employment Agreement dated April 1, 2002 between Kenneth G. Hawari and2332Advanced Neuromodulation Systems, Inc.(13)</TD></TR>2333<TR>2334<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>2335<TD></TD>2336<TD>Special Termination Agreement dated April 1, 2002 between Christopher G.2337Chavez and Advanced Neuromodulation Systems, Inc.(13)</TD></TR>2338<TR>2339<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>2340<TD></TD>2341<TD>Special Termination Agreement dated April 1, 2002 between Kenneth G.2342Hawari and Advanced Neuromodulation Systems, Inc.(13)</TD></TR>2343<TR>2344<TD ALIGN=RIGHT VALIGN=TOP>10.16</TD>2345<TD></TD>2346<TD>Form of Employment Agreement and Covenant Not to Compete, between the2347Company and key employees(1)</TD></TR>2348<TR>2349<TD ALIGN=RIGHT VALIGN=TOP>10.17</TD>2350<TD></TD>2351<TD>Lease Agreement dated as of February 4, 1999, between Advanced2352Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>2353<TR>2354<TD ALIGN=RIGHT VALIGN=TOP>10.18</TD>2355<TD></TD>2356<TD>Second Amendment to Lease Agreement dated as of September 1, 2002, between2357Advanced Neuromodulation Systems, Inc. and Plano R&D Associates, LTD. (15)2358</TD>2359</TR>2360<TR>2361<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>2362<TD></TD>2363<TD>Subsidiaries(13)</TD></TR>2364<TR>2365<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>2366<TD></TD>2367<TD>Consent of Independent Auditors(15)</TD></TR>2368<TR>2369<TD ALIGN=RIGHT VALIGN=TOP>99.1 </TD>2370<TD></TD>2371<TD>Certification of the Chief Executive Officer(15)</TD></TR>2372<TR>2373<TD ALIGN=RIGHT VALIGN=TOP>99.1 </TD>2374<TD></TD>2375<TD>Certification of the Chief Financial Officer(15)</TD></TR>2376</TABLE>2377<P>__________________________________</P>2378<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2379<TR>2380<TD WIDTH=5% VALIGN=TOP>(1) </TD>2381<TD WIDTH=2%></TD>2382<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on2383Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.2384</TD></TR>2385<TR>2386<TD>(2) </TD>2387<TD></TD>2388<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year2389ended December 31, 1987, and incorporated herein by reference.</TD></TR>2390<TR>2391<TD>(3) </TD>2392<TD></TD>2393<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,2394Registration No. 2-78186, and incorporated herein by reference.</TD></TR>2395<TR>2396<TD>(4) </TD>2397<TD></TD>2398<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,2399Registration No. 33-62991, and incorporated herein by reference.</TD></TR>2400<TR>2401<TD>(5) </TD>2402<TD></TD>2403<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September24043, 1996, and incorporated herein by reference.</TD></TR>2405<TR>2406<TD>(6) </TD>2407<TD></TD>2408<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the2409quarterly period ended March 31, 1998, and incorporated herein by reference.2410</TD></TR>2411<TR>2412<TD>(7) </TD>2413<TD></TD>2414<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated2415April 27, 1998, and incorporated herein by reference.</TD></TR>2416<TR>2417<TD>(8) </TD>2418<TD></TD>2419<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the2420year ended December 31, 1998, and incorporated herein by reference.</TD></TR>2421<TR>2422<TD>(9) </TD>2423<TD></TD>2424<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated2425April 17, 2000, and incorporated herein by reference.</TD></TR>2426<TR>2427<TD>(10)</TD>2428<TD></TD>2429<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January24309, 2001, and incorporated herein by reference. Upon request, the Company will2431furnish a copy of any omitted schedule to the Commission.</TD></TR>2432<TR>2433<TD>(11)</TD>2434<TD></TD>2435<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the2436year ended December 31, 2000, and incorporated herein by reference.</TD></TR>2437<TR>2438<TD>(12)</TD>2439<TD></TD>2440<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January244130, 2002, and incorporated herein by reference.</TD></TR>2442<TR>2443<TD>(13)</TD>2444<TD></TD>2445<TD>Filed as an Exhibit to the report of the Company on Form 10-Q for the2446quarter ended March 31, 2002, and incorporated herein by reference.2447</TD></TR>2448<TR>2449<TD>(14)</TD>2450<TD></TD>2451<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated November245226, 2002, and incorporated herein by reference.2453</TD></TR>2454<TR>2455<TD>(15)</TD>2456<TD></TD>2457<TD>Filed herewith.</TD></TR></TABLE>2458<P ALIGN=CENTER>Page 37 </P>2459<HR>24602461<PAGE>2462<P ALIGN=CENTER><U><B>Signatures</B></U></P>2463<P>Pursuant to the requirements of Section 13 or 15(d) of the Securities2464Exchange Act of 1934, the Company has duly caused this report to be signed on2465its behalf by the undersigned, thereunto duly authorized.</P>2466<P>Date: March 28, 2003</P>2467<P>ADVANCED NEUROMODULATION SYSTEMS, INC.</P>2468<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2469<TR>2470<TD WIDTH=40%></TD>2471<TD WIDTH=5%>By:</TD>2472<TD WIDTH=55%><U>/s/Christopher G. Chavez</U></TD></TR>2473<TR>2474<TD></TD>2475<TD></TD>2476<TD>Christopher G. Chavez</TD></TR>2477<TR>2478<TD></TD>2479<TD></TD>2480<TD>President and Chief Executive Officer</TD></TR></TABLE>2481<P></P>2482<P>Pursuant to the requirements of the Securities Exchange Act of 1934, this2483report has been signed by the following persons on behalf of the Company and in2484the capacities and on the dates indicated:</P>2485<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2486<TR>2487<TD WIDTH=25% ALIGN=CENTER><U>Signature</U></TD>2488<TD WIDTH=5%></TD>2489<TD WIDTH=45% ALIGN=CENTER><U>Title</U></TD>2490<TD WIDTH=5%></TD>2491<TD WIDTH=20% ALIGN=CENTER><U>Date</U></TD></TR>2492<TR>2493<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2494<TD ALIGN=LEFT VALIGN=TOP><U>/s/Christopher G. Chavez</U><BR>Christopher G.2495Chavez</TD>2496<TD></TD>2497<TD ALIGN=LEFT>Chief Executive Officer, President and Director of Advanced2498Neuromodulation Systems, Inc. (Principal Executive Officer)</TD>2499<TD></TD>2500<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2501<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2502<TD ALIGN=LEFT VALIGN=TOP><U>/s/F. Robert Merrill III</U><BR>F. Robert Merrill2503III</TD><TD></TD>2504<TD ALIGN=LEFT>Executive Vice President-Finance, Treasurer and Secretary of2505Advanced Neuromodulation Systems, Inc. (Principal Financial and Accounting2506Officer)</TD>2507<TD></TD>2508<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2509<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2510<TD ALIGN=LEFT VALIGN=TOP><U>/s/Hugh M. Morrison</U><BR>Hugh M. Morrison</TD>2511<TD></TD>2512<TD ALIGN=LEFT>Chairman of the Board and Director of Advanced Neuromodulation2513Systems, Inc.</TD>2514<TD></TD>2515<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2516<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2517<TD ALIGN=LEFT VALIGN=TOP><U>/s/Robert C. Eberhart</U><BR>Robert C. Eberhart2518</TD><TD></TD>2519<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2520</TD><TD></TD>2521<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2522<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2523<TD ALIGN=LEFT VALIGN=TOP><U>/s/Joseph E. Laptewicz</U><BR>Joseph E. Laptewicz2524</TD><TD></TD>2525<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2526</TD><TD></TD>2527<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2528<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2529<TD ALIGN=LEFT VALIGN=TOP><U>/s/A. Ronald Lerner</U><BR>A. Ronald Lerner2530</TD><TD></TD>2531<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2532</TD><TD></TD>2533<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2534<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2535<TD ALIGN=LEFT VALIGN=TOP><U>/s/Richard D. Nikolaev</U><BR>Richard D. Nikolaev2536</TD><TD></TD>2537<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2538</TD><TD></TD>2539<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR><TR>2540<TD> </TD><TD></TD><TD></TD><TD></TD><TD></TD></TR><TR>2541<TD ALIGN=LEFT VALIGN=TOP><U>/s/Michael J. Torma</U><BR>Michael J. Torma2542</TD><TD></TD>2543<TD ALIGN=LEFT VALIGN=TOP>Director of Advanced Neuromodulation Systems, Inc.2544</TD><TD></TD>2545<TD ALIGN=CENTER VALIGN=TOP>March 28, 2003</TD></TR>2546</TABLE>2547<P ALIGN=CENTER>Page 38</P><HR>2548<HR>25492550<PAGE>2551<P ALIGN=CENTER><U>§302 Certification of Chief Executive Officer</U></P>2552<P>I, Christopher G. Chavez, certify that:</P>2553<P>1. I have reviewed this annual report on Form 10-K of Advanced2554Neuromodulation Systems, Inc.;</P>2555<P>2. Based on my knowledge, this annual report does not contain any untrue2556statement of a material fact or omit to state a material fact necessary to make2557the statements made, in light of the circumstances under which such statements2558were made, not misleading with respect to the period covered by this annual2559report;</P>2560<P>3. Based on my knowledge, the financial statements, and other financial2561information included in this annual report, fairly present in all material2562respects the financial condition, results of operations and cash flows of the2563registrant as of, and for, the periods presented in this annual report;</P>2564<P>4. The registrant's other certifying officers and I are responsible for2565establishing and maintaining disclosure controls and procedures (as defined in2566Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:</P>2567<P>a) designed such disclosure controls and procedures to ensure that material2568information relating to the registrant, including its consolidated subsidiaries,2569is made known to us by others within those entities, particularly during the2570period in which this annual report is being prepared;</P>2571<P>b) evaluated the effectiveness of the registrant's disclosure controls and2572procedures as of a date within 90 days prior to the filing date of this2573annual report (the "Evaluation Date"); and</P>2574<P>c) presented in this annual report our conclusions about the2575effectiveness of the disclosure controls and procedures based on our evaluation2576as of the Evaluation Date;</P>2577<P>5. The registrant's other certifying officers and I have disclosed, based on2578our most recent evaluation, to the registrant's auditors and the audit committee2579of registrant's board of directors (or persons performing the equivalent2580function):</P>2581<P>a) all significant deficiencies in the design or operation of internal2582controls which could adversely affect the registrant's ability to record,2583process, summarize and report financial data and have identified for the2584registrant's auditors any material weaknesses in internal controls; and</P>2585<P>b) any fraud, whether or not material, that involves management or other2586employees who have a significant role in the registrant's internal controls; and2587</P>2588<P>6. The registrant's other certifying officers and I have indicated in this2589annual report whether or not there were significant changes in internal2590controls or in other factors that could significantly affect internal controls2591subsequent to the date of our most recent evaluation, including any corrective2592actions with regard to significant deficiencies and material weaknesses.</P>2593<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>2594<TR>2595<TD WIDTH=40%></TD>2596<TD WIDTH=60%> </TD></TR>2597<TR>2598<TD> </TD><TD></TD></TR>2599<TR>2600<TD> </TD><TD></TD></TR>2601<TR>2602<TD>Date: March 28, 2003</TD>2603<TD><U>/s/ Christopher G. Chavez</U></TD></TR>2604<TR>2605<TD></TD><TD>Name: Christopher G. Chavez<BR>2606Title: Chief Executive Officer</TD></TR></TABLE>2607<HR>26082609<PAGE>2610<P ALIGN=CENTER><U>§302 Certification of Chief Executive Officer</U></P>2611<P>I, F. Robert Merrill III, certify that:</P>2612<P>1. I have reviewed this annual report on Form 10-K of Advanced2613Neuromodulation Systems, Inc.;</P>2614<P>2. Based on my knowledge, this annual report does not contain any untrue2615statement of a material fact or omit to state a material fact necessary to make2616the statements made, in light of the circumstances under which such statements2617were made, not misleading with respect to the period covered by this annual2618report;</P>2619<P>3. Based on my knowledge, the financial statements, and other financial2620information included in this annual report, fairly present in all material2621respects the financial condition, results of operations and cash flows of the2622registrant as of, and for, the periods presented in this annual report;</P>2623<P>4. The registrant's other certifying officers and I are responsible for2624establishing and maintaining disclosure controls and procedures (as defined in2625Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:</P>2626<P>a) designed such disclosure controls and procedures to ensure that material2627information relating to the registrant, including its consolidated subsidiaries,2628is made known to us by others within those entities, particularly during the2629period in which this annual report is being prepared;</P>2630<P>b) evaluated the effectiveness of the registrant's disclosure controls and2631procedures as of a date within 90 days prior to the filing date of this2632annual report (the "Evaluation Date"); and</P>2633<P>c) presented in this annual report our conclusions about the2634effectiveness of the disclosure controls and procedures based on our evaluation2635as of the Evaluation Date;</P>2636<P>5. The registrant's other certifying officers and I have disclosed, based on2637our most recent evaluation, to the registrant's auditors and the audit committee2638of registrant's board of directors (or persons performing the equivalent2639function):</P>2640<P>a) all significant deficiencies in the design or operation of internal2641controls which could adversely affect the registrant's ability to record,2642process, summarize and report financial data and have identified for the2643registrant's auditors any material weaknesses in internal controls; and</P>2644<P>b) any fraud, whether or not material, that involves management or other2645employees who have a significant role in the registrant's internal controls; and2646</P>2647<P>6. The registrant's other certifying officers and I have indicated in this2648annual report whether or not there were significant changes in internal2649controls or in other factors that could significantly affect internal controls2650subsequent to the date of our most recent evaluation, including any corrective2651actions with regard to significant deficiencies and material weaknesses.</P>2652<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>2653<TR>2654<TD WIDTH=40%></TD>2655<TD WIDTH=60%> </TD></TR>2656<TR>2657<TD> </TD><TD></TD></TR>2658<TR>2659<TD> </TD><TD></TD></TR>2660<TR>2661<TD>Date: March 28, 2003</TD>2662<TD><U>/s/ F. Robert Merrill III</U></TD></TR>2663<TR>2664<TD></TD><TD>Name: F. Robert Merrill III<BR>2665Title: Chief Financial Officer</TD></TR></TABLE>2666<HR>26672668<PAGE>2669<P ALIGN=RIGHT><B><U>Appendix A</U></B></P>2670<P></P><P></P>2671<P ALIGN=CENTER><B>Consolidated Financial Statements<BR>Independent2672Auditors’ Report<BR><BR>Three Years Ended December 31, 2002<BR><BR>2673Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>Item 8<BR><BR><BR>2674of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of issuer)<BR><BR><BR>2675<BR>Filed with the<BR><BR>Securities and Exchange Commission<BR><BR>Washington,2676D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange Act of 1934</B>2677</P><HR>26782679<PAGE>2680<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2681<BR>Table of Contents<BR>to<BR>Consolidated Financial Statements<BR><BR>2682Form 10-K - Item 8</B></P>2683<P></P><P></P><P></P><P></P>2684<P><B>Report of Ernst & Young LLP, Independent Auditors</B></P>2685<P></P><P></P>2686<P><B>Consolidated Financial Statements:</B></P>2687<P>Consolidated Balance Sheets - December 31, 2002 and 2001<BR>Consolidated2688Statements of Income - Years ended December 31, 2002, 2001 and 2000<BR>2689Consolidated Statements of Cash Flows - Years ended December269031, 2002, 2001 and 2000<BR>Consolidated Statements of Stockholders' Equity -2691Years ended December 31, 2002, 2001 and 2000<BR> <BR> Notes to Consolidated2692Financial Statements</P>2693<HR>26942695<PAGE>2696<P ALIGN=CENTER><B>Report of Ernst & Young LLP, Independent Auditors</B></P>2697<P>The Board of Directors</P>2698<P>Advanced Neuromodulation Systems, Inc.</P>2699<P>We have audited the accompanying consolidated balance sheets of Advanced2700Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31,27012002 and 2001, and the related consolidated statements of income, stockholders'2702equity and cash flows for each of the three years in the period ended December270331, 2002. Our audits also included the financial statement schedule listed in2704the Index at Item 15(a). These consolidated financial statements and schedule2705are the responsibility of the Company's management. Our responsibility is to2706express an opinion on these financial statements and schedule based on our2707audits.</P>2708<P>We conducted our audits in accordance with auditing standards generally2709accepted in the United States. Those standards require that we plan and perform2710the audit to obtain reasonable assurance about whether the financial statements2711are free of material misstatement. An audit includes examining, on a test basis,2712evidence supporting the amounts and disclosures in the financial statements. An2713audit also includes assessing the accounting principles used and significant2714estimates made by management, as well as evaluating the overall financial2715statement presentation. We believe that our audits provide a reasonable basis2716for our opinion.</P>2717<P>In our opinion, the financial statements referred to above present fairly, in2718all material respects, the consolidated financial position of Advanced2719Neuromodulation Systems, Inc. and subsidiaries at December 31, 2002 and 2001,2720and the consolidated results of their operations and their cash flows for each2721of the three years in the period ended December 31, 2002, in conformity with2722accounting principles generally accepted in the United States. Also, in our2723opinion, the related financial statement schedule, when considered in relation2724to the basic financial statements taken as a whole, presents fairly in all2725material respects the information set forth therein.</P>2726<P>As discussed in Note 2 to the consolidated financial statements, in 2002 the2727Company, as required by the recently issued standard for accounting for goodwill2728and other intangible assets, changed its method of accounting for goodwill and2729other intangible assets.</P>2730<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>2731<TR>2732<TD WIDTH=40%> </TD>2733<TD WIDTH=60%><U>/s/Ernst & Young LLP</U><BR>Ernst & Young LLP</TD></TR>2734</TABLE>2735<P></P>2736<P></P>2737<P>Dallas, Texas<BR>March 27, 2003</P>2738<HR>27392740<PAGE>2741<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2742Consolidated Balance Sheets<BR>December 31, 2002 and 2001</B></P>2743<PRE>27442002 20012745------------- ------------2746Current assets:2747Cash and cash equivalents $ 10,972,974 $ 9,785,3252748Marketable securities 85,796,944 2,151,72227492750Receivables:2751Trade accounts, less allowance2752for doubtful accounts of $295,3912753in 2002 and $124,111 in 2001 10,847,237 6,493,7722754Interest and other 189,017 235,5942755------------- ------------2756Total receivables 11,036,254 6,729,3662757------------- ------------2758Inventories:2759Raw materials 7,141,338 4,685,5862760Work-in-process 2,364,386 1,723,4192761Finished goods 4,217,222 3,339,8402762------------- ------------2763Total inventories 13,722,946 9,748,8452764------------- ------------2765Deferred income taxes 1,122,617 1,726,5172766Refundable income taxes -- 678,3412767Prepaid expenses and other current2768assets 1,032,883 685,1692769------------- ------------2770Total current assets 123,684,618 31,505,2852771------------- ------------2772Property, equipment and fixtures:2773Land 3,191,427 --2774Furniture and fixtures 4,022,901 3,400,9092775Machinery and equipment 10,343,953 8,550,5042776Leasehold improvements 1,702,965 1,610,8102777------------- ------------277819,261,246 13,562,2232779Less accumulated depreciation and2780amortization 8,653,255 6,353,9202781------------- ------------2782Net property, equipment and fixtures 10,607,991 7,208,3032783------------- ------------27842785Cost in excess of net assets acquired, net 7,407,237 7,407,2372786Patents and licenses, net of accumulated2787amortization of $1,435,835 in 20022788and $1,045,106 in 2001 5,323,417 5,368,2132789Purchased technology from acquisitions,2790net of accumulated amortization of2791$2,098,200 in 2002 and $1,800,000 in 2001 9,033,472 2,200,0002792Tradenames, net of accumulated amortization2793of $969,952 in 2002 and $843,736 in 2001 1,701,154 1,656,2642794Other assets, net of accumulated2795amortization of $529,102 in 20022796and $392,033 in 2001 586,238 519,7832797------------- ------------2798$158,344,127 $55,865,0852799============= ============28002801See accompanying notes to consolidated financial statements.2802</PRE>2803<HR>28042805<PAGE>2806<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2807Consolidated Balance Sheets (continued)<BR>December 31, 2002 and 2001</B></P>2808<PRE>28092810Liabilities and Stockholders' 2002 20012811------------- ------------2812Current liabilities:2813Accounts payable $ 2,392,579 $ 1,835,0372814Accrued salary and employee benefit2815costs 3,077,603 1,826,4232816Accrued tax abatement liability 969,204 969,2042817Accrued commissions 794,521 285,7042818Income taxes payable 822,228 --2819Deferred revenue 646,577 1,042,6902820Warranty reserve 402,259 383,4772821Other accrued expenses 299,905 204,1512822Current maturities of long-term note2823payable -- 52,3252824------------- ------------2825Total current liabilities 9,404,876 6,599,0112826------------- ------------282728282829Deferred income taxes 3,731,939 2,316,7962830Long-term note payable -- 137,3972831Non-current deferred revenue 162,504 --28322833Commitments and contingencies28342835Stockholders' equity:2836Common stock, $.05 par value2837Authorized -25,000,000 shares;2838Issued - 12,350,676 shares2839in 2002 and 9,071,868 in 2001 617,534 453,5932840Additional capital 130,047,411 38,670,2482841Retained earnings 14,393,748 7,709,2902842Accumulated other comprehensive income2843(loss), net of tax benefit of $7,1552844in 2002 and $10,949 in 2001 (13,885) (21,250)2845------------- -----------------2846Total stockholders' equity 145,044,808 46,811,8812847------------- -----------------2848$158,344,127 $55,865,0852849============= =================28502851See accompanying notes to consolidated financial statements.2852</PRE>2853<HR>28542855<PAGE>2856<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2857Consolidated Statements of Income<BR>Years Ended December 31</B></P>2858<PRE>28592002 2001 20002860------------- ------------ ------------2861Net revenue $ 57,372,013 $37,916,435 $ 31,826,9982862Cost of revenue 20,658,798 15,675,436 14,699,6332863------------- ------------ ------------2864Gross profit 36,713,215 22,240,999 17,127,3652865------------- ------------ ------------2866Operating expenses:2867Sales and marketing 14,931,826 9,055,932 6,851,0222868Research and development 5,842,576 4,928,432 3,854,0842869General and administrative 5,738,392 3,957,867 4,243,7202870Amortization of other intangibles 952,214 933,257 676,5082871Amortization of goodwill -- 556,604 556,6042872------------- ------------ ------------287327,465,008 19,432,092 16,181,9382874------------- ------------ ------------2875Income from operations 9,248,207 2,808,907 945,42728762877Other income (expense):2878Acquisition related costs -- (483,766) --2879Interest expense (10,759) (24,346) (59,015)2880Investment and other income, net 933,668 482,417 604,5702881------------- ------------ ------------2882922,909 (25,695) 545,5552883------------- ------------ ------------28842885Income before income taxes 10,171,116 2,783,212 1,490,9822886Income taxes 3,486,658 1,265,466 658,5242887------------- ------------ ------------2888Net income $ 6,684,458 $ 1,517,746 832,4582889============= ============ ============2890Net income per share:2891============= ============ ============2892Basic $ .61 $ .17 .102893============= ============ ============2894Diluted $ .56 $ .15 .092895============= ============ ============28962897See accompanying notes to consolidated financial statements.2898</PRE>2899<HR>29002901<PAGE>2902<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2903Consolidated Statements of Cash Flows<BR>Years Ended December 31</B></P>2904<PRE>29052002 2001 20002906-------------- ------------ ------------2907Cash flows from operating activities:2908Net income $ 6,684,458 $ 1,517,746 $ 832,4582909Adjustments to reconcile net income to net2910cash provided by operating activities:2911Depreciation 2,299,335 1,932,452 1,636,8572912Amortization 952,214 1,489,861 1,233,1122913Deferred income taxes 645,134 (455,003) (330,804)2914Non-operating loss (gain) included in net2915income 8,666 -- (33,509)2916Increase in inventory reserve 51,403 107,880 111,1442917Changes in operating assets and2918liabilities:2919Receivables (4,306,888) (1,027,050) (486,949)2920Inventories (4,025,504) (2,672,605) 270,1902921Refundable income taxes 678,341 (318,388) (359,953)2922Prepaid expenses and other current2923assets (387,323) 564,866 144,8802924Customer deposits (680,756) (706,916) (1,071,372)2925Income taxes payable 822,228 (89,380) (521,510)2926Tax benefit from stock option2927exercises 1,847,438 1,669,405 604,3582928Accounts payable 557,542 493,227 (1,348,526)2929Accrued expenses 1,874,533 553,380 9,8922930Deferred revenue 447,147 -- --2931------------- ------------ ------------2932Total adjustments 783,510 1,541,729 (142,190)2933------------- ------------ ------------2934Net cash provided by operating2935activities 7,467,968 3,059,475 690,2682936------------- ------------ ------------29372938Cash flows from investing activities:2939Purchases of certificates of deposit with2940maturities over 90 days -- -- (1,425,000)2941Proceeds from certificates of deposits with2942maturities over 90 days -- 1,040,000 385,0002943Purchases of marketable securities (188,390,536) (3,896,199) (808,760)2944Net proceeds from sales of marketable2945securities 104,747,808 2,876,720 564,1942946Purchase of land (3,191,427) -- --2947Additions to equipment, fixtures and2948patent licenses (2,942,227) (3,108,055) (1,653,194)2949Acquisition of MicroNet (1,359,460) -- --2950Net proceeds from sale of assets -- -- 6002951------------- ------------ ------------2952Net cash used in investing2953activities (91,135,842) (3,087,534) (2,937,160)2954------------- ------------ ------------29552956Cash flows from financing activities:2957Payment of long-term notes (189,722) (47,807) (28,718)2958Proceeds from long-term note payable -- -- 270,0002959Net proceeds from public offering of2960common stock 83,175,353 -- --2961Net proceeds from private placement of2962common stock -- -- 400,0002963Exercise of stock options and warrants 1,869,892 1,004,914 1,929,4502964------------- ------------ ------------2965Net cash provided by financing2966activities 84,855,523 957,107 2,570,7322967------------- ------------ ------------2968Net increase in cash and cash equivalents 1,187,649 929,048 323,8402969Net cash used by Hi-tronics in December 20002970(see Note 3) -- (672,444) --2971Cash and cash equivalents at beginning of year 9,785,325 9,528,721 9,204,8812972------------- ------------ ------------2973Cash and cash equivalents at end of year $ 10,972,974 $ 9,785,325 $ 9,528,7212974============= ============ ============29752976Supplemental cash flow information is2977presented below:29782979Income taxes paid (refund) $ (415,311) $ 815,000 $ 1,138,6852980============= ============ ============2981Interest paid $ 10,759 $ 24,346 $ 59,0152982============= ============ ============2983Non-cash activity:2984Stock issued for patents and intangible assets $ 4,648,421 $ 2,426,662 $ --2985============= ============ ============29862987See accompanying notes to consolidated financial statements.2988</PRE>2989<HR>29902991<PAGE>2992<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>2993Consolidated Statements of Stockholders' Equity<BR>2994Three Years Ended December 31, 2002</B></P>2995<PRE>29962997Other2998Retained Comprehensive Total2999Common Stock Additional Earnings Income Treasury Stockholders'3000Shares Amount Capital (Deficit) (Loss) Stock Equity3001------------- ------------- ------------- ------------- ------------- ------------- -------------3002Balance at3003December 31, 1999 8,883,059 $ 444,153 $ 34,598,112 $ 5,706,765 $ (222,581) $ (3,990,242) $ 36,536,2073004Net income -- -- -- 832,458 -- -- 832,4583005Adjustment to3006unrealized losses3007on marketable3008securities -- -- -- -- 139,340 -- 139,34030093010Comprehensive income 971,7983011-------------3012Issuance of 32,9003013shares from treasury3014for private placement -- -- 100,000 -- -- 300,000 400,0003015Issuance of 337,9413016shares from treasury3017for stock option and3018warrant exercises -- -- (832,999) -- -- 2,762,449 1,929,4503019Tax benefit from3020stock option3021exercises -- -- 604,358 -- -- -- 604,3583022------------- ------------- ------------- ------------- ------------- ------------- -------------3023Balance at3024December 31, 2000 8,883,059 444,153 34,469,471 6,539,223 (83,241) (927,793) 40,441,8133025Net income -- -- -- 1,517,746 -- -- 1,517,7463026Net loss of Hi-tronics3027for December 20003028(see Note 3) -- -- -- (347,679) -- -- (347,679)3029Adjustment to3030unrealized losses3031on marketable3032securities -- -- -- -- 61,991 -- 61,9913033-------------3034Comprehensive income 1,232,0583035-------------3036Compensation expense3037resulting from3038changes to3039Hi-tronics stock3040options in3041December 2000 -- -- 37,029 -- -- -- 37,0293042Issuance of shares for3043stock option3044exercises 188,809 9,440 995,474 -- -- -- 1,004,9143045Tax benefit from stock3046option exercises -- -- 1,669,405 -- -- -- 1,669,4053047Issuance of 119,1003048shares from treasury3049for acquisition -- -- 1,498,869 -- -- 927,793 2,426,6623050------------- ------------- ------------- ------------- ------------- ------------- -------------3051Balance at3052December 31, 2001 9,071,868 453,593 38,670,248 7,709,290 (21,250) -- 46,811,8813053Net income -- -- -- 6,684,458 -- -- 6,684,4583054Adjustment to3055unrealized losses3056on marketable3057securities -- -- -- -- 7,365 -- 7,3653058-------------3059Comprehensive income 6,691,8233060-------------3061Sale of newly issued3062common stock in a3063public offering, net3064of offering costs 2,875,000 143,750 83,031,603 -- -- -- 83,175,3533065Issuance of shares for3066stock option3067exercises 247,506 12,376 1,857,516 -- -- -- 1,869,8923068Issuance of 156,3023069shares for3070acquisition 156,302 7,815 4,640,606 -- -- -- 4,648,4213071Tax benefit from stock3072option exercises -- -- 1,847,438 -- -- -- 1,847,4383073------------- ------------- ------------- ------------- ------------- ------------- -------------3074Balance at3075December 31, 2002 12,350,676 $ 617,534 $ 130,047,411 $ 14,393,748 $ (13,885) $ -- $ 145,044,8083076============= ============= ============= ============= ============= ============= =============30773078See accompanying notes to consolidated financial statements.3079</PRE>30803081<PAGE>3082<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3083Notes to Consolidated Financial Statements</B></P>3084<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3085<TR>3086<TD WIDTH=5%><B>(1)</B></TD>3087<TD WIDTH=95%><B>Business</B></TD></TR></TABLE>3088<P>Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS") designs,3089develops, manufactures and markets implantable neuromodulation devices. ANS3090devices are used primarily to manage chronic severe pain. ANS revenues are3091derived primarily from sales throughout the United States, Europe and Australia.3092</P>3093<P>On November 26, 2002, the Company acquired MicroNet Medical, Inc., a3094privately-held developer of medical devices based on proprietary micro-lead3095technology based in St. Paul, Minnesota. See Note 3.</P>3096<P>On January 2, 2001, the Company acquired the assets (primarily intellectual3097property consisting of patents) of Implantable Devices Limited Partnership (IDP)3098and ESOX Technology Holdings, LLC (ESOX), two privately held Minnesota3099companies. See Note 3.</P>3100<P>On January 2, 2001, the Company completed the acquisition of Hi-tronics3101Designs, Inc. (HDI), a privately-held contract developer and original equipment3102manufacturer (O.E.M.) of electro-mechanical devices with headquarters in Budd3103Lake, New Jersey. See Note 3.</P>3104<P>The research and development, manufacture, sale and distribution of medical3105devices is subject to extensive regulation by various public agencies,3106principally the Food and Drug Administration and corresponding state, local and3107foreign agencies. Product approvals and clearances can be delayed or withdrawn3108for failure to comply with regulatory requirements or the occurrence of3109unforeseen problems following initial marketing.</P>3110<P>In addition, ANS neuromodulation products are purchased primarily by3111hospitals and other users who then bill various third-party payors including3112Medicare, Medicaid, private insurance companies and managed care organizations.3113These third-party payors reimburse fixed amounts for services based on a3114specific diagnosis. The impact of changes in third-party payor reimbursement3115policies and any amendments to existing reimbursement rules and regulations that3116restrict or terminate the eligibility of ANS products could have an adverse3117impact on the Company's financial condition and results of operations.</P>3118<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3119<TR>3120<TD WIDTH=5%><B>(2)</B></TD>3121<TD WIDTH=95%><B>Summary of Significant Accounting Policies</B></TD></TR>3122</TABLE>3123<P><B>Principles of Consolidation</B></P>3124<P>The consolidated financial statements include the accounts of Advanced3125Neuromodulation Systems, Inc. and all of its subsidiaries. All significant3126intercompany transactions and accounts have been eliminated in consolidation.3127</P>3128<P><B>Use of Estimates</B></P>3129<P>The preparation of financial statements in conformity with generally accepted3130accounting principles requires management to make estimates and assumptions that3131affect the amounts reported in the financial statements and accompanying notes.3132Actual results could differ from those estimates.</P>3133<HR>31343135<PAGE>3136<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3137Notes to Consolidated Financial Statements (continued)</B></P>3138<P><B>Reclassification</B></P>3139<P>Certain amounts in the prior years financial statements have been3140reclassified to conform to the Company's 2002 presentation.</P>3141<P><B>Cash Equivalents</B></P>3142<P>The Company considers all highly liquid investments with maturities of three3143months or less at the time of purchase to be cash equivalents.</P>3144<P><B>Revenue Recognition</B></P>3145<P>The Company generates revenues from product sales to end customers, product3146sales to distributors, and development contracts. The Company recognizes revenue3147from neuro product sales when the goods are shipped to its customers or3148distributors, provided an arrangement exists, the fee is fixed and determinable,3149and collectibility is reasonably assured. Certain of the Company's customers are3150third-party payors who reimburse fixed amounts for services based on a specific3151diagnosis. Revenue is recognized on these third-party payor sales based on the3152sales price less a contractual adjustment, which is based on the Company's3153history of reimbursement with the third-party payor, provided all other revenue3154recognition criteria are met. The Company records, as a reduction in revenue a3155provision for estimated sales returns and adjustments on these product sales in3156the same period as the related revenue is recorded. These estimates are based on3157historical sales returns, analysis of credit memo data, and other known factors.3158Payments received in advance of revenue recognition requirements are recorded as3159deferred revenue on the consolidated balance sheet. The Company recognizes3160revenue from custom manufactured products at HDI when the goods are shipped to3161the customer. HDI also develops products for certain customers under fixed price3162research and development contracts. The Company recognizes revenue and profit3163under the development agreements using the percentage-of-completion method,3164which relies on estimates of total expected revenue and costs. The Company3165follows this method since reasonably dependable estimates of revenue and costs3166applicable to various stages of a development agreement can be made. If the3167Company does not accurately estimate the resources required or the scope of work3168to be performed under a development agreement, then future profit margins and3169results of operations may be negatively impacted. In certain cases, HDI will3170undertake a development project on a cost plus basis. In these cases, the3171Company invoices and recognizes revenue for actual time and material expended on3172the project at contractual hourly billing rates and markups.</P>3173<P><B>Marketable Securities</B></P>3174<P>The Company's marketable securities and debt securities are classified as3175available-for-sale and are carried at fair value with the unrealized gains and3176losses reported in a separate component of stockholders' equity entitled "Other3177comprehensive income". The cost of debt securities in this category is adjusted3178for amortization of premiums and accretion of discounts to maturity. Such3179amortization is included in investment income. Realized gains and losses and3180declines in value judged to be other than temporary are included in other3181income. The cost of securities sold is based on the specific identification3182method. Interest and dividends are included in investment income.</P>3183<P><B>Accounts Receivable</B></P>3184<P>The Company estimates the collectibility of its trade receivables. A3185considerable amount of judgment is required in assessing the ultimate3186realization of the receivables, including the current credit-worthiness of each3187customer. The Company's historical bad debt experience has been within3188management's expectations.</P>3189<HR>31903191<PAGE>3192<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3193Notes to Consolidated Financial Statements (continued)</B></P>3194<P><B>Inventories</B></P>3195<P>Inventories are recorded at the lower of standard cost or market. Standard3196cost approximates actual cost determined on the first-in, first-out ("FIFO")3197basis. Cost includes the acquisition cost of raw materials and components,3198direct labor and overhead. The Company reserves for excess and obsolete3199inventory based upon forecasted demand for its products.</P>3200<P><B>Equipment and Fixtures</B></P>3201<P>Equipment and fixtures are stated at cost. Additions and improvements3202extending asset lives are capitalized while maintenance and repairs are expensed3203as incurred. The cost and accumulated depreciation of assets sold or retired are3204removed from the accounts and any gain or loss is reflected in the Statement of3205Income.</P>3206<P>Depreciation is provided using the straight-line method over the estimated3207useful lives of the various assets as follows:</P>3208<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3209<TR>3210<TD WIDTH=40%>Leasehold improvements</TD>3211<TD WIDTH=60% ALIGN=LEFT>the lesser of 3 to 5 years or the term of the lease3212</TD>3213</TR>3214<TR>3215<TD>Furniture and fixtures</TD>3216<TD ALIGN=LEFT>2 to 10 years</TD>3217</TR>3218<TR>3219<TD>Machinery and equipment</TD>3220<TD ALIGN=LEFT>3 to 10 years</TD>3221</TR></TABLE>3222<P><B>Intangible Assets</B></P>3223<P>Goodwill represents the excess of the purchase price over the fair value of3224net assets of acquired businesses. Effective January 1, 2002 the Company adopted3225Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and3226other Intangible Assets". Under the provision of SFAS 142, goodwill and3227intangible assets deemed to have indefinite lives are no longer amortized but3228are subject to annual impairment tests in accordance with the statement.</P>3229<P>The Company's initial review for impairment of goodwill and other intangible3230assets performed during 2002 indicated no impairment of these assets as of3231January 1, 2002. During the first quarter of 2003, the Company performed its3232annual review for impairment of goodwill and other intangible assets as of3233December 31, 2002 and, based on this review, no impairment was recorded. The3234Company must make assumptions regarding estimated future cash flows and other3235factors to determine the fair value of the respective assets in assessing the3236recoverability of its goodwill and other intangibles. If these estimates or the3237related assumptions change, the Company may be required to record impairment3238charges for these assets in the future.</P>3239<HR>32403241<PAGE>3242<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3243Notes to Consolidated Financial Statements (continued)</B></P>3244<P>Prior to the adoption of SFAS 142, amortization expense was recorded for3245goodwill and other intangibles with indefinite lives. The following table sets3246forth a reconciliation of net earnings and net earnings per share information3247for the three years ended December 31, 2002 as though SFAS 142 had been in3248effect at the beginning of fiscal 2000:</P>32493250<PRE>3251Year Ended December 31,3252-----------------------------------32532002 2001 20003254----------- ----------- -----------3255Reported net income $ 6,684,458 $ 1,517,746 $ 832,4583256Goodwill amortization --- 556,604 556,6043257----------- ----------- -----------3258Adjusted net income $ 6,684,458 $ 2,074,350 $ 1,389,0623259=========== =========== ===========3260Basic net income per share:3261Reported $ .61 $ .17 $ .103262Goodwill amortization --- .06 .063263----------- ----------- -----------3264Adjusted $ .61 $ .23 $ .163265=========== =========== ===========3266Diluted net income per share:3267Reported $ .56 $ .15 $ .093268Goodwill amortization --- .06 .063269----------- ----------- -----------3270Adjusted $ .56 $ .21 $ .153271=========== =========== ===========3272</PRE>3273<P>In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or3274Disposal of Long-Lived Assets". This Statement addresses financial accounting3275and reporting for the impairment of long-lived assets, including definite-lived3276intangible assets, and the disposal of long-lived assets and discontinued3277operations. The Company adopted SFAS No. 144, which supersedes SFAS No. 121, on3278January 1, 2002.</P>3279<P>The cost of purchased technology related to acquisitions is based on3280appraised values at the date of acquisition and is amortized on a straight-line3281basis over the estimated useful life (15-20 years) of such technology.</P>3282<P>The cost of purchased tradenames is based on appraised values at the date of3283acquisition and is amortized on a straight-line basis over the estimated useful3284life (20 years) of such tradenames.</P>3285<P>The cost of purchased patents is amortized on a straight-line basis over the3286estimated useful life (17 years) of such patents. The cost of certain licensed3287patents is amortized on a straight-line basis over the estimated useful life (203288years) of such patents. Costs of patents that are the result of internal3289development are charged to current operations.</P>3290<P>The Company assesses the recoverability of its definite-lived intangible3291assets primarily based on its current and anticipated future undiscounted cash3292flows. At December 31, 2002, the Company does not believe there has been any3293impairment of its intangible assets.</P>3294<P>The Company expects to record annual amortization expense of approximately3295$1,269,792 in 2003, $1,232,324 in 2004, $1,201,936 in 2005, $1,198,948 in 20063296and $1,198,052 in 2007 related to its intangible assets as of December 31, 2002.3297</P>3298<HR>32993300<PAGE>3301<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3302Notes to Consolidated Financial Statements (continued)</B></P>3303<P><B>Warranty Obligations</B></P>3304<P>The Company's products are generally covered by a one-year warranty. The3305Company accrues a warranty reserve for estimated costs to provide warranty3306services. The estimated costs to service the Company's warranty obligations are3307based on historical experience and expectation of future conditions.</P>3308<P><B>Research and Development</B></P>3309<P>Product development costs including start-up and research and development are3310charged to operations in the year in which such costs are incurred.</P>3311<P><B>Advertising</B></P>3312<P>Advertising expense is charged to operations in the year in which such costs3313are incurred. Total advertising expense, included in marketing expense was3314$74,673, $20,592 and $24,716 at December 31, 2002, 2001 and 2000, respectively.3315</P>3316<P><B>Deferred Taxes</B></P>3317<P>Deferred income taxes are recorded based on the liability method and3318represent the tax effect of the differences between the financial and tax basis3319of assets and liabilities other than costs in excess of the net assets of3320businesses acquired.</P>3321<P><B>Based Compensation</B></P>3322<P>The Company has adopted the disclosure-only provisions of SFAS No. 123,3323"Accounting for Stock-Based Compensation", which disclosures are presented in3324Note 7, "Stockholders' Equity". Because of this election, the Company continues3325to account for its stock-based compensation plans under APB No. 25, "Accounting3326for Stock Issued to Employees". All of the Company's stock option grants are at3327exercise prices equal to the fair market value of the Company's stock on the3328date of grant, and therefore, no compensation expense is recorded.</P>3329<P>Stock compensation issued to non-employees is measured at fair value over the3330service period and recorded as compensation expense in the Statement of Income.3331<P>3332<P><B>Earnings Per Share</B></P>3333<P>Basic earnings per share is computed based only on the weighted average3334number of common shares outstanding during the period. Diluted earnings per3335share is computed using the additional dilutive effect, if any, of stock options3336and warrants using the treasury stock method based on the average market price3337of the stock during the period. Basic earnings per share for 2002, 2001 and 20003338are based upon 10,900,040, 8,926,985, and 8,507,048 shares, respectively.3339Diluted earnings per share for 2002, 2001 and 2000 are based upon 11,891,637,33409,917,007, and 9,398,934 shares, respectively. The following table presents the3341reconciliation of basic and diluted shares:</P>3342<PRE>33432002 2001 20003344---------- --------- ---------3345Weighted-average shares outstanding3346(basic shares) 10,900,040 8,926,985 8,507,0483347Effect of dilutive instruments(1)3348Stock options 991,597 990,022 847,3493349Warrants --- --- 44,5373350---------- --------- ---------3351Dilutive potential common shares 991,597 990,022 891,8863352---------- --------- ---------3353Diluted shares 11,891,637 9,917,007 9,398,9343354========== ========= =========33553356(1) See Note 7 for a description of these instruments.3357</PRE>3358<HR>33593360<PAGE>3361<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3362Notes to Consolidated Financial Statements (continued)</B></P>3363<P>For 2002, 2001 and 2000 the incremental shares used for dilutive earnings per3364share relate to stock options and warrants whose exercise price was less than3365the average market price in the underlying quarterly computations. Options to3366purchase 24,750 shares at an average price of $19.79 per share were outstanding3367in 2001 and options to purchase 12,975 shares at an average price of $15.38 per3368share were outstanding in 2000 but were not included in the computation of3369diluted earnings per share because the options' exercise prices were greater3370than the average market price of the common shares and, therefore, the effect3371would be antidilutive. In 2002, all options were included in the computation of3372diluted earnings per share.</P>3373<P>Following is the Company's computation of basic and diluted income per share3374for the years ended December 31:</P>3375<PRE>33762002 2001 20003377----------- ---------- ----------3378Basic income per share:33793380Weighted average common3381Shares outstanding 10,900,040 8,926,985 8,507,0483382----------- ---------- ----------3383----------- ---------- ----------3384Net income $ 6,684,458 $1,517,746 $ 832,4583385----------- ---------- ----------3386Net income per share $ 0.61 $ 0.17 $ 0.103387----------- ---------- ----------3388Diluted income per share:33893390Weighted average common3391shares outstanding 10,900,040 8,926,985 8,507,0483392Stock options and warrants - based3393on the treasury stock method3394using average market price 991,597 990,022 891,8863395----------- ---------- ----------3396Diluted common and common equivalent3397shares outstanding 11,891,637 9,917,007 9,398,9343398----------- ---------- ----------33993400----------- ---------- ----------3401Net income $ 6,684,458 $1,517,746 $ 832,4583402----------- ---------- ----------3403Net income per share $ 0.56 $ 0.15 $ 0.093404----------- ---------- ----------3405</PRE>3406<P><B>Comprehensive Income</B></P>3407<P>Statement of Financial Accounting Standards No. 130 - "Reporting3408Comprehensive Income" - requires unrealized gains or losses on the Company's3409available for sale securities, and, for 2001, the effect of the change in fiscal3410year end of a company acquired (see Note 3) to be included in "Other3411comprehensive income" and be reported in the Consolidated Statements of3412Stockholders' Equity.</P>3413<HR>34143415<PAGE>3416<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3417Notes to Consolidated Financial Statements (continued)</B></P>3418<P><B>New Accounting Standards</B></P>3419<P>In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based3420Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123."3421This standard amends SFAS No. 123, "Accounting for Stock-Based Compensation" to3422provide alternative methods of transition for a voluntary change to the fair3423value based method of accounting for stock-based employee compensation and3424amends the disclosure requirements of SFAS No. 123 to require prominent3425disclosures in both annual and interim financial statements about the method of3426accounting for stock-based employee compensation and the effect of the method3427used on reported results. This statement is effective for financial statements3428with fiscal years ending after December 15, 2002 and is effective for financial3429reports containing condensed financial statements for interim periods beginning3430after December 15, 2002 with earlier application permitted.</P>3431<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3432<TR>3433<TD WIDTH=5%><B>(3)</B></TD>3434<TD WIDTH=95%><B>Acquisitions</B></TD></TR>3435</TABLE>3436<P>On November 26, 2002, the Company completed the acquisition of MicroNet3437Medical, Inc., a privately-held developer of medical devices based on3438proprietary micro-lead technology based in St. Paul Minnesota. Under the terms3439of the transaction, which was structured as a merger, the Company acquired only3440MicroNet's proprietary technology and certain associated tangible assets. At3441closing, the Company paid the former MicroNet shareholders $500,000 in cash and3442156,302 shares of ANS common stock valued at $4,648,421. The Company also paid3443acquisition related costs of $859,460. The allocation of the purchase price as3444of December 31, 2002 is as follows: purchased technology $5,761,558, tradenames3445$138,181 and non-compete agreements $108,142. In addition to the initial3446purchase price paid at closing, if certain product, regulatory and sales3447milestones are met, ANS could pay an additional number of shares of common stock3448with an aggregate value of up to $9,000,000. All milestones must be met within3449the next four to five years, depending on the milestone.</P>3450<P>On January 2, 2001, the Company acquired the assets of Implantable Devices3451Limited Partnership (IDP) and ESOX Technology Holdings, LLC (ESOX), two3452privately held Minnesota companies, for 119,100 shares of the Company's common3453stock. Based on the closing price of ANS common stock on December 29, 2000, the3454value of the stock issued to acquire the assets was $2.43 million. The assets3455purchased consisted primarily of intellectual property and technology for the3456fully implantable constant-rate infusion pump that ANS has developed. Prior to3457the acquisition, the Company had licensed rights to the technology only for pain3458and cancer therapy applications.</P>3459<P>Also on January 2, 2001, the Company completed the acquisition of Hi-tronics3460Designs, Inc. (HDI), a privately-held contract developer and original equipment3461manufacturer (O.E.M.) of electro-mechanical devices with headquarters in Budd3462Lake, New Jersey. The Company acquired all of HDI's outstanding stock through a3463merger in exchange for 1,104,725 shares of ANS common stock. The transaction was3464accounted for on a pooling of interests basis and accordingly, prior periods3465have been restated. HDI developed and manufactured the Company's totally3466implantable pulse generator (IPG) used in the treatment of chronic intractable3467pain and was also the O.E.M. manufacturer of the transmitter used with the3468Company's <I>Renew</I> radio-frequency spinal cord stimulation system.</P>3469<P>Prior to the Company's acquisition of HDI, HDI's fiscal year ended on3470November 30. The Consolidated Balance Sheet at December 31, 2000 combines the3471Balance Sheet of HDI at November 30, 2000 with the Balance Sheet of the Company3472at December 31, 2000. Beginning in 2001, the fiscal year-ends have been3473conformed to December 31. As a result, the results of operations of HDI for the3474one-month period ending December 31, 2000 have been recorded directly to3475retained earnings in the Consolidated Statement of Stockholders' Equity for the3476period ended December 31, 2001 and are not reflected in the Consolidated3477Statements of Income. Summary operating results of HDI for this one-month period3478ending December 31, 2000, were as follows:</P>3479<HR>34803481<PAGE>3482<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3483Notes to Consolidated Financial Statements (continued)</B></P>3484<PRE>3485Net revenue $ 119,4813486Loss before income tax benefit (591,600)3487Net loss (347,679)34883489For the one-month period ended December 31, 2000, cash flows for HDI were as follows:34903491Net cash used by operating activities $(647,210)3492Net cash used by investing activities (14,516)3493Net cash used by financing activities (10,718)3494Net decrease in cash $(672,444)3495</PRE>3496<P>The following is a reconciliation of previously reported amounts with3497restated amounts for total net revenue and net income:</P>3498<PRE>349920003500------------3501Total net revenue:3502As previously reported by the Company $23,081,6243503HDI, for the year ended November 30 10,366,2703504Elimination of intercompany transactions (1,620,896)3505------------3506As restated $31,826,9983507============3508350920003510------------3511Net income:3512As previously reported by the Company $ 953,6443513HDI, for the year ended November 30 28,8333514Elimination of intercompany transactions (150,019)3515------------3516As restated $ 832,4583517============3518</PRE>3519<P>Prior to January 2, 2001, the Company and HDI, in the normal course of3520business, entered into certain transactions for development and manufacture3521related to the Company's products. These intercompany transactions have been3522eliminated.</P>3523<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3524<TR>3525<TD WIDTH=5%><B>(4)</B></TD>3526<TD WIDTH=95%><B>Note Payable</B></TD></TR>3527</TABLE>3528<P>In connection with the acquisition of HDI (See Note 3), the Company acquired3529responsibility for a note payable with a principal balance of $189,722 at3530December 31, 2001. The note was repaid in its entirety during June 2002.</P>3531<HR>35323533<PAGE>3534<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3535Notes to Consolidated Financial Statements (continued)</B></P>3536<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3537<TR>3538<TD WIDTH=5%><B>(5)</B></TD>3539<TD WIDTH=95%><B>Marketable Securities</B></TD></TR>3540</TABLE>3541<P>The following is a summary of available-for-sale securities at December 31,35422002:</P>3543<PRE>35443545Gross Gross3546Unrealized Unrealized Estimated3547Cost Gains Losses Fair Value3548----------- ---------- ---------- -----------3549Freddie Mac and Federal Home Loan3550Bank notes $ 770,814 $ -- $ 15,474 $ 755,3403551Investment grade municipal bonds35522,222,170 5,349 10,915 2,216,60435537-day and 35-day AAA municipal bond3554floaters 82,825,000 -- -- 82,825,0003555----------- ---------- ---------- -----------3556$85,817,984 $ 5,349 $ 26,389 $85,796,9443557=========== ========== ========== ===========3558</PRE>3559<P>Estimated fair value for the investment grade municipal bonds, 7-day and356035-day municipal bond floaters and Freddie Mac and Federal Home Loan Bank notes3561is provided by the brokerage firms holding such bonds and notes at each3562reporting period by utilizing a standard pricing service.</P>3563<P>At December 31, 2002, no individual security represented more than 6.5% of3564the total portfolio or 3.5% of total assets. The Company did not have any3565investments in derivative financial instruments at December 31, 2002.</P>3566<P>The following is a summary of available-for-sale securities at December 31,35672001:</P>3568<PRE>35693570Gross Gross3571Unrealized Unrealized Estimated3572Cost Gains Losses Fair Value3573----------- ---------- ---------- ----------3574FNMA and Federal Home Loan Bank notes $ 1,038,783 $ -- $ 10,034 $1,028,7493575Investment grade municipal bonds 1,047,456 258 4,241 1,043,4733576Real estate investment trust 97,682 -- 18,182 79,5003577----------- ---------- ---------- ----------3578$ 2,183,921 $ 258 $ 32,457 $2,151,7223579=========== ========== ========== ==========3580</PRE>3581<P>At December 31, 2001, no individual security represented more than 25% of the3582total portfolio or 1% of total assets. The Company did not have any investments3583in derivative financial instruments at December 31, 2001.</P>3584<HR>35853586<PAGE>3587<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3588Notes to Consolidated Financial Statements (continued)</B></P>3589<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3590<TR>3591<TD WIDTH=5%><B>(6)</B></TD>3592<TD WIDTH=95%><B>Federal Income Taxes</B></TD></TR>3593</TABLE>3594<P>The significant components of the net deferred tax liability at December 31,3595were as follows:</P>3596<PRE>359735982002 20013599------------ ------------3600Deferred tax assets:36013602Net operating loss carry forwards $ 1,181,086 $ 670,1283603Accrued expenses and reserves 1,051,871 870,7203604Marketable securities 8,303 10,9493605Other 141,809 141,5693606------------ ------------3607Total deferred tax assets 2,383,069 1,693,3663608------------ ------------3609Deferred tax liabilities:36103611Purchased intangible assets (4,464,083) (1,388,255)3612Equipment and fixtures (528,308) (895,390)3613------------ ------------3614Total deferred tax liabilities (4,992,391) (2,283,645)3615------------ ------------3616Net deferred tax liabilities $ (2,609,322) $ (590,279)3617============ =============3618</PRE>3619<P>As of December 31, 2002, the Company had a net operating loss carry forward3620of approximately $3.4 million which expires in years through 2021. This net3621operating loss carry forward was acquired by the Company in connection with the3622MicroNet Medical acquisition and its utilization in any future year may be3623subject to a limitation under Section 382 of the Internal Revenue Code or other3624provisions which may limit the use of the net operating loss carry forward in3625any tax year.</P>3626<P>The provision (benefit) for income taxes for the years ended December 313627consists of the following:</P>3628<PRE>36292002 2001 20003630----------- ----------- ----------3631Current $ 2,841,524 $ 1,747,285 $ 841,3903632Deferred 645,134 (481,819) (182,866)3633----------- ----------- ----------3634$ 3,486,658 $ 1,265,466 $ 658,5243635=========== =========== ===========3636</PRE>3637<P>A reconciliation of the provision for income taxes to the expense calculated3638at the U.S. statutory rate follows:</P>3639<PRE>36402002 2001 20003641----------- ----------- ----------3642Income tax expense at statutory rate $ 3,458,179 $ 946,292 $ 506,9343643Tax effect of:3644State taxes 275,481 42,959 4,5813645Nondeductible amortization of goodwill -- 189,245 189,2793646Tax-exempt interest (291,745) -- --3647Other 44,743 86,970 (42,270)3648----------- ----------- ----------3649Income tax expense $ 3,486,658 $ 1,265,466 $ 658,5243650=========== =========== ===========3651</PRE>3652<HR>36533654<PAGE>3655<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3656Notes to Consolidated Financial Statements (continued)</B></P>3657<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3658<TR>3659<TD WIDTH=5%><B>(7)</B></TD>3660<TD WIDTH=95%><B>Stockholders' Equity</B></TD></TR>3661</TABLE>3662<P>The Company has a Shareholder's Rights Plan, adopted in 1996 and amended in36632002, which permits shareholders to purchase shares of the Company's common3664stock at significant discounts in the event a person or group acquires more than366515% of the Company's common stock or announces a tender or exchange offer for3666more than 20% of the Company's common stock.</P>3667<P>At December 31, 2000, the Company had 119,100 treasury shares. These shares3668were reissued on January 2, 2001 in connection with the acquisition of assets.3669See Note 3.</P>3670<P>The Company issued 2,875,000 shares of common stock during May 2002 in an3671underwritten public offering. The Company received net proceeds from the3672offering of approximately $83.2 million.</P>3673<P>The Company has various stock option plans pursuant to which stock options3674may be granted to key employees, officers, directors and advisory directors of3675the Company. The most recent of the plans, approved by the shareholders during36762000 (the "2000 Plan"), reserved 500,000 shares of common stock for options3677under the plan. In accordance with the 2000 Plan, on January 1 of each year3678(commencing in 2001), the aggregate number of shares of common stock reserved3679for options under the 2000 Plan is increased by the same percentage that the3680total number of issued and outstanding shares of common stock increased from the3681preceding January 1 to the following December 31 (if such percentage is3682positive). At December 31, 2002, the 2000 Plan had a total number of shares3683reserved of 613,638. On January 1, 2003, options to purchase 221,769 shares of3684common stock were added to the 2000 Plan.</P>3685<P>Several of the plans allow for the grant of incentive stock options to key3686employees and officers intended to qualify for preferential tax treatment under3687Section 422 of the Internal Revenue Code of 1986. Under all of the Company's3688plans, the exercise price of options granted must equal or exceed the fair3689market value of the common stock at the time of the grant. Options granted to3690employees and officers expire ten years from the date of grant and for the most3691part are exercisable one-fourth each year over a four-year period of continuous3692service. Options granted to directors and advisory directors expire six years3693from the date of grant and for the most part are exercisable one-fourth each3694year over a four-year period of continuous service. Certain options, however,3695have a two-year or three-year vesting schedule.</P>3696<P>At December 31, 2002, under all of the Company's stock option plans,36972,026,419 shares had been granted and were outstanding, 2,482,503 shares of3698common stock had been issued upon exercise, and 33,142 shares were reserved for3699future grants.</P>3700<HR>37013702<PAGE>3703<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3704Notes to Consolidated Financial Statements (continued)</B></P>3705<P>Data with respect to stock option plans of the Company are as follows:</P>3706<PRE>3707------------------------------------------------- -----------------------------3708Options Outstanding Exercisable Options3709------------------------------------------------- -----------------------------3710Weighted Weighted3711Average Average3712Shares Exercise Price Shares Exercise Price3713----------------- ------------ -------------- ------------ --------------3714January 1, 2000 1,335,249 $ 5.63 563,333 $ 5.113715Granted 422,332 $ 14.213716Exercised (237,674) $ 5.503717Forfeited (55,270) $ 6.883718----------------- ------------ -------------- ------------ --------------3719January 1, 2001 1,464,637 $ 8.08 607,664 $ 5.233720Granted 413,500 $ 12.513721Exercised (188,809) $ 5.583722Forfeited (20,153) $ 8.703723----------------- ------------ -------------- ------------ --------------3724January 1, 2002 1,669,175 $ 9.44 750,215 $ 6.613725Granted 617,000 $ 27.543726Exercised (247,506) $ 7.313727Forfeited (12,250) $ 17.193728----------------- ------------ -------------- ------------ --------------3729December 31, 2002 2,026,419 $ 15.17 869,738 $ 8.653730-------------------------------- ============== ============ ==============373137323733Exercisable Options3734Options Outstanding at December 31, 2002 at December 31, 20023735- -------------------------------------------------------- ------------------------3736Weighted3737Average Weighted Weighted3738Range of Remaining Average Average3739Exercise Price Shares Life (Years) Exercise Price Shares Exercise Price3740- -------------- --------- ------------ -------------- -------- --------------3741$ 5.00-7.49 623,684 5.57 $ 5.54 561,184 $ 5.423742$ 7.50-10.49 79,706 6.28 $ 8.80 39,691 $ 8.593743$10.50-13.99 338,047 7.53 $ 11.12 92,497 $ 11.583744$14.00-17.49 263,107 7.06 $ 14.50 119,241 $ 14.503745$17.50-21.00 106,875 8.30 $ 19.36 31,625 $ 19.373746$21.01-30.00 615,000 8.92 $ 27.54 25,500 $ 28.463747- -------------- --------- ------------ -------------- -------- --------------37482,026,419 7.28 $ 15.17 869,738 $ 8.653749========= ============ ============== ======== ==============3750</PRE>3751<P>In accordance with APB No. 25, the Company has not recorded compensation3752expense for its stock option awards. As required by SFAS No. 123, the Company3753provides the following disclosure of hypothetical values for these awards. The3754weighted-average fair value of an option granted in 2002, 2001 and 2000 was3755$13.17, $6.24 and $5.76, respectively. For purposes of fair market value3756disclosures, the fair market value of an option grant was estimated using the3757Black-Scholes option pricing model with the following assumptions:</P>3758<PRE>37592002 2001 20003760---------- -------- ---------3761Risk-free interest rate 4.5% 4.4% 5.9%3762Average life of options (years) 3.0 3.0 3.03763Volatility 67.6% 74.5% 52.4%3764Dividend Yield -- -- --3765</PRE>3766<HR>37673768<PAGE>3769<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3770Notes to Consolidated Financial Statements (continued)</B></P>3771<P>Had the compensation expense been recorded based on these hypothetical3772values, pro forma net income (loss) for 2002, 2001 and 2000 would have been3773$4,576,659, $(95,632) and $(436,109), respectively, and pro forma diluted net3774income (loss) per common share for 2002, 2001 and 2000 would have been $.38,3775$(.01) and $(.05), respectively.</P>3776<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3777<TR>3778<TD WIDTH=5%><B>(8)</B></TD>3779<TD WIDTH=95%><B>Commitments and Contingencies</B></TD></TR>3780</TABLE>3781<P>On February 1, 1999, the Company sold its principal office and manufacturing3782facility in Allen, Texas to Atrion Corporation. Atrion leased space to the3783Company at the rate of $48,125 per month from February 1, 1999 through May 31,37841999. The Company entered into a sixty-three month lease agreement on 40,0003785square feet of space located in the North Dallas area during February 1999. The3786Company relocated its operations to the leased facility in May 1999 and the3787rental period under the lease commenced on June 1, 1999. Under the terms of the3788lease agreement, the Company received three months free rent and the monthly3789rental rate for the remaining term of the lease is $48,308, subject to certain3790annual adjustments for increases in expenses for common area maintenance and3791property taxes. The monthly rental rate was increased to $50,951 in January37922002. In September 2002, the Company amended its lease agreement to add3793approximately 9,700 square feet of office space located in the same complex as3794its 40,000 square foot corporate headquarters. The lease on the additional space3795expires during August 2004, the same as the corporate headquarters facility. The3796monthly rental rate on the 9,700 square feet of office space is $11,485. Future3797minimum rental payments relating to the leased facilities for the years ended3798December 31 are $749,244 in 2003 and $499,496 in 2004.</P>3799<P>The Company also leases facilities in New Jersey as a result of the January38002001 acquisition of HDI. One of the facilities, located in Budd Lake, New3801Jersey, is 10,348 square feet of office space that is used for administration,3802design engineering, drafting, documentation and regulatory affairs. The lease3803expires on February 28, 2004 and has a monthly rental rate of $9,615. The3804Company also leases 18,582 square feet of space in Hackettstown, New Jersey used3805for the O.E.M. manufacturing operations. The Hackettstown lease, which expires3806on December 31, 2005, has a monthly rental rate of $9,517 and is renewable for3807one additional three-year period. Future minimum rental payments relating to the3808leased facilities for HDI for the years ended December 31 are $229,584 in 2003,3809$133,434 in 2004 and $114,204 in 2005.</P>3810<P>The Company leases transportation equipment under non-cancelable operating3811leases with expirations ranging from March 2005 until October 2006. Future3812minimum rental payments under non-cancelable transportation leases for the years3813ended December 31 are $47,768 in 2003, $47,768 in 2004, $26,496 in 2005 and3814$8,481 in 2006.</P>3815<P>The Company leases office equipment under non-cancelable operating leases3816expiring through 2004. Monthly payments on the office equipment leases are3817$2,412. Future minimum rental payments under non-cancelable equipment leases3818until the expiration of the leases are $28,938 in 2003 and $4,824 in 2004.</P>3819<P>Total rent expense for facilities, transportation and office equipment for3820the years ended December 31, 2002, 2001 and 2000 was $1,063,097, $858,761 and3821$791,192, respectively.</P>3822<P>The Company is a party to product liability claims related to ANS3823neurostimulation devices. Product liability insurers have assumed responsibility3824for defending the Company against these claims. While historically product3825liability claims for ANS neurostimulation devices have not resulted in3826significant monetary liability for the Company beyond its insurance coverage,3827there can be no assurances that the Company will not incur significant monetary3828liability to the claimants if such insurance is inadequate, and there can be no3829assurance that the Company's neurostimulation business and future ANS product3830lines will not be adversely affected by these product liability claims.</P>3831<HR>38323833<PAGE>3834<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3835Notes to Consolidated Financial Statements (continued)</B></P>3836<P>Except for such product liability claims and other ordinary routine3837litigation incidental or immaterial to its business, the Company is not3838currently a party to any other pending legal proceeding. The Company maintains3839general liability insurance against risks arising out of the normal course of3840business.</P>3841<P>Certain of the Company's distributor sales agreements contain an early3842termination provision that permits the Company to terminate the agreement3843without cause by paying an early termination fee equal to 25% of the prior3844year's sales to the distributor. The termination fee for the Company's two3845existing distributors would range from $392,000 to $1,157,000. In addition,3846under the Company's sales agreements with its independent sales agents, the3847Company can terminate those agreements without cause by paying an early3848termination fee equal to 100% of the commissions that would otherwise be payable3849on sales in the territory for the 90 days after termination and 50% of the3850commission that would otherwise be payable on sales in the territory for the 903851day period after the first 90 day period.</P>3852<P>In addition, under its distributor agreements, sales agent agreements and3853certain other ordinary course commercial contracts with third parties, the3854Company typically agrees to indemnify the other contracting party from damages3855and costs that may arise from product liability claims. The terms of the3856agreements and contracts vary and the potential exposure under these indemnities3857cannot reasonably be estimated or determined. Historically, product liability3858claims for our neurostimulation devices have not resulted in significant3859monetary liability beyond our insurance coverage. We seek to maintain3860appropriate levels of product liability insurance with coverage that we believe3861is comparable to that maintained by companies similar in size and serving3862similar markets.</P>3863<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3864<TR>3865<TD WIDTH=5%><B>(9)</B></TD>3866<TD WIDTH=95%><B>Financial Instruments, Risk Concentration and Major Customers3867</B></TD></TR>3868</TABLE>3869<P>In the United States, the Company's accounts receivable from its Neuro3870Products segment are due primarily from hospitals, insurance companies and3871distributors located throughout the country. Internationally, the Company's3872accounts receivable from its Neuro Products segment are due primarily from3873distributors located in Europe and Australia. For the HDI O.E.M segment, all of3874the accounts receivable are due from privately held and publicly traded medical3875device companies based in the United States. The Company generally does not3876require collateral for trade receivables. The Company maintains an allowance for3877doubtful accounts based upon expected collectibility. Any losses from bad debts3878have historically been within management's expectations.</P>3879<P>Net sales of implantable neurostimulation systems to one major customer, Sun3880Medical, Inc., for each of the years ended December 31, as a percentage of net3881revenue from the Neuro Products segment, were as follows: 2002- 14%, 2001- 15%3882and 2000- 14%. In March 2003, the Company acquired Sun Medical's pain management3883business and hired substantially all of that business' salesforce.</P>3884<P>Net sales of O.E.M. products and services to two major customers for the year3885ended December 31, 2002, as a percentage of net revenue from the HDI O.E.M.3886segment were 63% and 26%, respectively. Net sales of O.E.M products and services3887to three major customers for the year ended December 31, 2001, as a percentage3888of net revenue from the HDI O.E.M. segment were 60%, 17% and 11%, respectively.3889Net sales of O.E.M. products and services to three major customers for the year3890ended December 31, 2000, as a percentage of net revenue from the HDI O.E.M.3891segment were 49%, 24% and 17%, respectively.</P>3892<P>Foreign sales, primarily Europe and Australia, for the years ended December389331, 2002, 2001 and 2000 were approximately 8%, 10% and 7% of net revenue from3894the Neuro Products segment, respectively. The HDI O.E.M. segment had no foreign3895sales for the years ended December 31, 2002, 2001 and 2000, respectively.</P>3896<HR>38973898<PAGE>3899<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3900Notes to Consolidated Financial Statements (continued)</B></P>3901<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3902<TR>3903<TD WIDTH=5%><B>(10)</B></TD>3904<TD WIDTH=95%><B>Employee Benefit Plans3905</B></TD></TR>3906</TABLE>3907<P>The Company has a defined contribution retirement savings plan (the "Plan")3908available to substantially all employees of its Neuro Products segment. The Plan3909permits employees to elect salary deferral contributions of up to 15% of their3910compensation and requires the Company to make matching contributions equal to391150% of the participants' contributions to a maximum of 6% of the participants'3912compensation. As a result of the acquisition of HDI, the Company also has a3913defined contribution retirement savings plan (the "HDI Plan") available to3914substantially all employees of HDI. The HDI Plan permits employees to elect3915salary deferral contributions of up to 15% of their eligible compensation,3916subject to statutory limitations, and requires the Company to make matching3917contributions equal to 100% of the participants' contributions to a maximum of39185% of the participants' eligible compensation. The Board of Directors may change3919the percentage of matching contribution under either of the plans at their3920discretion. The expense of the Company's contribution for the years ended3921December 31 was $346,125 in 2002, $305,091 in 2001 and $270,987 in 2000.</P>3922<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3923<TR>3924<TD WIDTH=5%><B>(11)</B></TD>3925<TD WIDTH=95%><B>Sale of Facility/Accrued Tax Abatement Liability3926</B></TD></TR>3927</TABLE>3928<P>In January 1998, the Company sold its cardiovascular operations to Atrion3929Corporation, and granted Atrion a nine-month option to acquire the Company's3930principal office and manufacturing facility in Allen, Texas for $6.5 million.3931During October 1998, Atrion exercised its option to acquire the facility. When3932the facility was built in 1993, the Company entered a ten-year agreement with3933the City of Allen granting tax abatements to the Company if a minimum job base3934and personal property base were maintained in the City of Allen. The agreement3935provided for the repayment of abated taxes if the Company defaulted under the3936agreement. During 1998 the Company recorded a pretax expense of $969,204 in3937connection with the abated taxes. In April 1999, the Company was successful in3938petitioning the City of Allen to assign the abatement agreement to Atrion. In3939July 1999, the Company, Atrion and the City of Allen executed an assignment3940agreement under which Atrion (as successor in interest to the Company) must3941continue to meet the conditions of the original tax abatement agreement until3942August 2003. The City preserved its rights to collect previously abated taxes if3943Atrion fails to comply with its obligations any time prior to August 2003. The3944Company retains monetary liability for the amount of abated taxes, even after3945assignment, because pursuant to the purchase and sale agreement with Atrion, the3946Company indemnified Atrion from any tax abatement liabilities that accrued to3947the City of Allen prior to the sale of the cardiovascular operations in January39481998. If Atrion meets the minimum requirements under the agreement until August39492003, then no payment will be required. If no payment is required, the Company3950intends to reverse the potential obligation of $969,204 in September 2003, which3951would result in the reporting of "other income" in this amount in the3952Consolidated Statement of Income.</P>3953<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>3954<TR>3955<TD WIDTH=5%><B>(12)</B></TD>3956<TD WIDTH=95%><B>Segment Information3957</B></TD></TR>3958</TABLE>3959<P>The Company operates in two business segments. The Neuro Products segment3960designs, develops, manufactures and markets implantable medical devices that are3961used to manage chronic intractable pain and other disorders of the central3962nervous system through the delivery of electrical current or drugs directly to3963targeted nerve fibers. The HDI O.E.M. segment provides contract development and3964O.E.M. manufacturing of electro-mechanical devices.</P>3965<HR>39663967<PAGE>3968<P ALIGN=CENTER><B>Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>3969Notes to Consolidated Financial Statements (continued)</B></P>3970<P>Intersegment revenue from HDI is billed at cost with no intercompany mark-up.3971</P>3972<P>Segment data as of and for the year ended December 31, 2002 is as follows:3973</P>3974<PRE>3975Neuro HDI Intercompany Consolidated3976Products O.E.M. Eliminations Total3977------------- ------------- ------------- -------------3978Revenue from external3979customers $ 46,712,158 $ 10,659,855 $ --- $ 57,372,0133980Intersegment revenues $ --- $ 5,663,216 $ (5,663,216) $ ---3981Segment income from3982operations $ 7,013,895 $ 2,234,312 $ --- $ 9,248,2073983Segment assets $ 154,451,136 $ 8,982,629 $ (5,089,638) $ 158,344,1273984</PRE>3985<P>Segment data as of and for the year ended December 31, 2001 is as follows:</P>3986<PRE>3987Neuro HDI Intercompany Consolidated3988Products O.E.M. Eliminations Total3989------------- ------------- ------------- -------------3990Revenue from external3991customers $ 27,460,618 $ 10,455,817 $ --- $ 37,916,4353992Intersegment revenues $ --- $ 2,862,652 $ (2,862,652) $ ---3993Segment income from3994operations $ 1,040,036 $ 1,768,871 $ --- $ 2,808,9073995Segment assets $ 51,246,012 $ 6,847,014 $ (2,227,941) $ 55,865,0853996</PRE>3997<P>Segment data as of and for the year ended December 31, 2000 is as follows:</P>3998<PRE>3999Neuro HDI Intercompany Consolidated4000Products O.E.M. Eliminations Total4001------------- ------------- ------------- -------------4002Revenue from external4003customers $ 23,081,624 $ 8,745,374 $ --- $ 31,826,9984004Intersegment revenues $ --- $ 1,620,896 $ (1,620,896) $ ---4005Segment income from4006operations $ 1,108,894 $ 67,985 $ (231,452) $ 945,4274007Segment assets $ 45,371,687 $ 7,391,078 $ (3,198,199) $ 49,564,5664008</PRE>4009<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4010<TR>4011<TD WIDTH=5%><B>(13)</B></TD>4012<TD WIDTH=95%><B>Subsequent Event4013</B></TD></TR>4014</TABLE>4015<P>In January 2003, the Company made a minority investment of $1 million in cash4016to purchase common stock in Innovative Spinal Technologies, Inc., a start-up4017company that develops spine technologies, products and services through4018intellectual property development and contract research.</P>4019<P>In March 2003, the Company acquired the assets of the pain management4020business of Sun Medical, Inc. for approximately $5.1 million in cash. Sun4021Medical was the largest distributor of the Company's Neuro Products and4022accounted for $6.33 million, or 13.5% of revenue of the Neuro Products segment4023during the twelve months ended December 31, 2002. As part of the acquisition,4024the Company hired substantially all of the salespersons who worked for Sun4025Medical's pain management business. The assets acquired consisted primarily of4026customer lists, non-competes, inventory, contracts, equipment and other4027intangible assets but specifically excludes cash and accounts receivable as of4028the closing date.</P>4029<HR>40304031<PAGE>4032<P ALIGN=RIGHT><B><U>Appendix B</U></B></P>4033<P></P><P></P><P></P>4034<P ALIGN=CENTER><B>Schedule II - Valuation and Qualifying Accounts</B></P>4035<P></P><P></P>4036<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>4037Item 14<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>4038(Name of issuer)</B></P>4039<P></P><P></P>4040<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>4041<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange4042Act of 1934</B></P>4043<HR>40444045<PAGE>4046<P ALIGN=CENTER><B>Schedule II - Valuation and Qualifying Accounts<BR>4047Advanced Neuromodulation Systems, Inc. and Subsidiaries<BR>December 31, 20024048</B></P>4049<PRE>4050Balance at Charged to4051Beginning Charged to Other Balance at4052Description of Year Expenses Accounts Deductions End of Year4053- ----------------------------------- ----------- ----------- ----------- ----------- -----------4054Year ended December 31, 2002:40554056Allowance for doubtful accounts $ 124,111 $ 186,336 $ -- $ 15,056 $ 295,3914057Reserve for obsolete inventory 293,450 121,528 -- 112,698 302,2804058----------- ----------- ----------- ----------- -----------4059Total $ 417,561 $ 307,864 $ -- $ 127,754 $ 597,6714060=========== =========== =========== =========== ===========40614062Year ended December 31, 2001:40634064Allowance for doubtful accounts $ 213,249 $ 10,000 $ -- $ 99,138 $ 124,1114065Reserve for obsolete inventory 310,243 107,880 -- 124,673 293,4504066----------- ----------- ----------- ----------- -----------40674068Total $ 523,492 $ 117,880 $ -- $ 223,811 $ 417,5614069=========== =========== =========== =========== ===========40704071Year ended December 31, 2000:40724073Allowance for doubtful accounts $ 140,824 $ 102,984 $ -- $ 30,559 $ 213,2494074Reserve for obsolete inventory 199,099 111,144 -- -- 310,2434075----------- ----------- ----------- ----------- -----------40764077Total $ 339,923 $ 214,128 $ -- $ 30,559 $ 523,4924078=========== =========== =========== =========== ===========4079</PRE>4080<HR>40814082<PAGE>4083<P ALIGN=RIGHT><B><U>Appendix C</U></B></P>4084<P></P><P></P><P></P>4085<P ALIGN=CENTER><B>Quarterly Financial Data<BR>(unaudited)</B></P>4086<P></P><P></P>4087<P ALIGN=CENTER><B>Forming a Part of the Annual Report<BR><BR>Form 10-K<BR><BR>4088Item 8<BR><BR><BR>of<BR><BR>ADVANCED NEUROMODULATION SYSTEMS, INC.<BR>(Name of4089issuer)</B></P>4090<P></P><P></P>4091<P ALIGN=CENTER><B>Filed with the<BR><BR>Securities and Exchange Commission<BR>4092<BR>Washington, D.C. 20549<BR><BR><BR>under<BR><BR>The Securities Exchange4093Act of 1934</B></P>4094<HR>40954096<PAGE>4097<PRE>40982002 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.4099- --------------------------------------------- ------------- ------------- ------------- -------------41004101Net revenue $ 11,472,646 $ 13,423,371 $ 14,327,505 $ 18,148,4914102Gross profit 6,958,486 8,359,944 9,474,096 11,920,6894103Income from operations 1,239,225 2,084,679 2,532,874 3,391,4294104Income from operations before income taxes 1,308,425 2,227,928 2,905,351 3,729,4124105Net income $ 836,976 $ 1,448,441 $ 1,942,303 $ 2,456,7384106- --------------------------------------------- ------------- ------------- ------------- -------------4107Basic income per share $ 0.09 $ 0.14 $ 0.16 $ 0.204108- --------------------------------------------- ------------- ------------- ------------- -------------4109- --------------------------------------------- ------------- ------------- ------------- -------------4110Diluted income per share $ 0.08 $ 0.13 $ 0.15 $ 0.194111- --------------------------------------------- ------------- ------------- ------------- -------------411241132001 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.4114- --------------------------------------------- ------------- ------------- ------------- -------------41154116Net revenue $ 8,340,810 $ 9,204,721 $ 9,899,973 $ 10,470,9314117Gross profit 4,768,021 5,270,066 5,830,956 6,371,9564118Income from operations 332,764 530,936 783,321 1,161,8864119Acquisition related costs (483,766) -- -- --4120Income (loss) from operations before income4121taxes (benefit) (13,160) 678,703 863,379 1,254,2904122Net income (loss) $ (6,261) $ 368,514 $ 475,244 $ 680,2494123- --------------------------------------------- ------------- ------------- ------------- -------------4124Basic income per share $ -- $ 0.04 $ 0.05 $ 0.074125- --------------------------------------------- ------------- ------------- ------------- -------------4126- --------------------------------------------- ------------- ------------- ------------- -------------4127Diluted income per share $ -- $ 0.04 $ 0.05 $ 0.074128- --------------------------------------------- ------------- ------------- ------------- -------------4129</PRE>4130<HR>41314132<PAGE>4133<P ALIGN=CENTER><B>INDEX TO EXHIBITS</B></P>4134<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4135<TR>4136<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>4137<TD WIDTH=5%></TD>4138<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>4139</TABLE>4140<P></P>4141<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4142<TR>4143<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.1 </TD>4144<TD WIDTH=5%> </TD>4145<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 30, 2000, by4146and amoung Advanced Neuromodulation Systems, Inc., ANS Acquisition Corp, and4147Hi-tronics Designs, Inc.(10)</TD></TR>4148<TR>4149<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>2.2 </TD>4150<TD WIDTH=5%> </TD>4151<TD WIDTH=85%>Agreement and Plan of Merger, dated as of November 4, 2002, by and4152amoung Advanced Neuromodulaiton Systems, Inc., MicroNet Acquisition, Inc. and4153MicroNet Medical, Inc. (14)</TD></TR>4154<TR>4155<TD ALIGN=RIGHT VALIGN=TOP>3.1 </TD>4156<TD></TD>4157<TD>Articles of Incorporation, as amended and restated(11)</TD></TR>4158<TR>4159<TD ALIGN=RIGHT VALIGN=TOP>3.2 </TD>4160<TD></TD>4161<TD>Bylaws(11)</TD></TR>4162<TR>4163<TD ALIGN=RIGHT VALIGN=TOP>4.1 </TD>4164<TD></TD>4165<TD>Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc.4166and KeyCorp Shareholder Services, Inc. as Rights Agent(5)</TD></TR>4167<TR>4168<TD ALIGN=RIGHT VALIGN=TOP>4.2 </TD>4169<TD></TD>4170<TD>Amendment To Rights Agreement dated as of January 25, 2002 between Advanced4171Neuromodulation Systems, Inc. and Computershare Investor Services LLC (formerly4172KeyCorp Shareholder Services, Inc) (12)</TD></TR>4173<TR>4174<TD ALIGN=RIGHT VALIGN=TOP>10.1 </TD>4175<TD></TD>4176<TD>Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option4177Plan(2)</TD></TR></TABLE>4178<P ALIGN=CENTER>Page 36</P><HR>41794180<PAGE>4181<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4182<TR>4183<TD WIDTH=10% ALIGN=RIGHT>Exhibit<BR><U>Number</U></TD>4184<TD WIDTH=5%></TD>4185<TD WIDTH=85% ALIGN=CENTER><U>Description</U></TD></TR>4186</TABLE>4187<P></P>4188<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4189<TR>4190<TD WIDTH=10% ALIGN=RIGHT VALIGN=TOP>10.2 </TD>4191<TD WIDTH=5%> </TD>4192<TD WIDTH=85%>Form of 1979 Employees Stock Option Agreement(3)</TD></TR>4193<TR>4194<TD ALIGN=RIGHT VALIGN=TOP>10.3 </TD>4195<TD></TD>4196<TD>Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)</TD></TR>4197<TR>4198<TD ALIGN=RIGHT VALIGN=TOP>10.4 </TD>4199<TD></TD>4200<TD>Form of Directors Stock Option Agreement(1)</TD></TR>4201<TR>4202<TD ALIGN=RIGHT VALIGN=TOP>10.6 </TD>4203<TD></TD>4204<TD>Quest Medical, Inc. 1995 Stock Option Plan (4)</TD></TR>4205<TR>4206<TD ALIGN=RIGHT VALIGN=TOP>10.7 </TD>4207<TD></TD>4208<TD>Form of 1995 Employee Stock Option Plan(4)</TD></TR>4209<TR>4210<TD ALIGN=RIGHT VALIGN=TOP>10.8 </TD>4211<TD></TD>4212<TD>Quest Medical, Inc. 1998 Stock Option Plan (7)</TD></TR>4213<TR>4214<TD ALIGN=RIGHT VALIGN=TOP>10.9 </TD>4215<TD></TD>4216<TD>Advanced Neuromodulation Systems, Inc. 2000 Stock Option Plan(9)</TD></TR>4217<TR>4218<TD ALIGN=RIGHT VALIGN=TOP>10.10</TD>4219<TD></TD>4220<TD>Employment Agreement dated April 9, 1998 between Scott F. Drees and4221Quest Medical, Inc.(6)</TD></TR>4222<TR>4223<TD ALIGN=RIGHT VALIGN=TOP>10.11</TD>4224<TD></TD>4225<TD>Employment Agreement dated April 9, 1998 between F. Robert Merrill and Quest4226Medical, Inc.(6)</TD></TR>4227<TR>4228<TD ALIGN=RIGHT VALIGN=TOP>10.12</TD>4229<TD></TD>4230<TD>Employment Agreement dated April 1, 2002 between Christopher G. Chavez and4231Advanced Neuromodulation Systems, Inc.(13)</TD></TR>4232<TR>4233<TD ALIGN=RIGHT VALIGN=TOP>10.13</TD>4234<TD></TD>4235<TD>Employment Agreement dated April 1, 2002 between Kenneth G. Hawari and4236Advanced Neuromodulation Systems, Inc.(13)</TD></TR>4237<TR>4238<TD ALIGN=RIGHT VALIGN=TOP>10.14</TD>4239<TD></TD>4240<TD>Special Termination Agreement dated April 1, 2002 between Christopher G.4241Chavez and Advanced Neuromodulation Systems, Inc.(13)</TD></TR>4242<TR>4243<TD ALIGN=RIGHT VALIGN=TOP>10.15</TD>4244<TD></TD>4245<TD>Special Termination Agreement dated April 1, 2002 between Kenneth G.4246Hawari and Advanced Neuromodulation Systems, Inc.(13)</TD></TR>4247<TR>4248<TD ALIGN=RIGHT VALIGN=TOP>10.16</TD>4249<TD></TD>4250<TD>Form of Employment Agreement and Covenant Not to Compete, between the4251Company and key employees(1)</TD></TR>4252<TR>4253<TD ALIGN=RIGHT VALIGN=TOP>10.17</TD>4254<TD></TD>4255<TD>Lease Agreement dated as of February 4, 1999, between Advanced4256Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD. (8)</TD></TR>4257<TR>4258<TD ALIGN=RIGHT VALIGN=TOP>10.18</TD>4259<TD></TD>4260<TD>Second Amendment to Lease Agreement dated as of September 1, 2002, between4261Advanced Neuromodulation Systems, Inc. and Plano R&D Associates, LTD. (15)4262</TD>4263</TR>4264<TR>4265<TD ALIGN=RIGHT VALIGN=TOP>21.1 </TD>4266<TD></TD>4267<TD>Subsidiaries(13)</TD></TR>4268<TR>4269<TD ALIGN=RIGHT VALIGN=TOP>23.1 </TD>4270<TD></TD>4271<TD>Consent of Independent Auditors(15)</TD></TR>4272<TR>4273<TD ALIGN=RIGHT VALIGN=TOP>99.1 </TD>4274<TD></TD>4275<TD>Certification of the Chief Executive Officer(15)</TD></TR>4276<TR>4277<TD ALIGN=RIGHT VALIGN=TOP>99.1 </TD>4278<TD></TD>4279<TD>Certification of the Chief Financial Officer(15)</TD></TR>4280</TABLE>4281<P>__________________________________</P>4282<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4283<TR>4284<TD WIDTH=5% VALIGN=TOP>(1) </TD>4285<TD WIDTH=2%></TD>4286<TD WIDTH=93%>Filed as an Exhibit to the Company's Registration Statement on4287Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference.4288</TD></TR>4289<TR>4290<TD>(2) </TD>4291<TD></TD>4292<TD>Filed as an Exhibit to the report of the Company on Form 10-K for the year4293ended December 31, 1987, and incorporated herein by reference.</TD></TR>4294<TR>4295<TD>(3) </TD>4296<TD></TD>4297<TD>Filed as an Exhibit to the Company's Registration Statement on Form S-1,4298Registration No. 2-78186, and incorporated herein by reference.</TD></TR>4299<TR>4300<TD>(4) </TD>4301<TD></TD>4302<TD>Filed as an Exhibit to the Company's Registration Statement on Form SB-2,4303Registration No. 33-62991, and incorporated herein by reference.</TD></TR>4304<TR>4305<TD>(5) </TD>4306<TD></TD>4307<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated September43083, 1996, and incorporated herein by reference.</TD></TR>4309<TR>4310<TD>(6) </TD>4311<TD></TD>4312<TD>Filed as an Exhibit to the report of the Company on Form 10-Q dated for the4313quarterly period ended March 31, 1998, and incorporated herein by reference.4314</TD></TR>4315<TR>4316<TD>(7) </TD>4317<TD></TD>4318<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated4319April 27, 1998, and incorporated herein by reference.</TD></TR>4320<TR>4321<TD>(8) </TD>4322<TD></TD>4323<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the4324year ended December 31, 1998, and incorporated herein by reference.</TD></TR>4325<TR>4326<TD>(9) </TD>4327<TD></TD>4328<TD>Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A dated4329April 17, 2000, and incorporated herein by reference.</TD></TR>4330<TR>4331<TD>(10)</TD>4332<TD></TD>4333<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January43349, 2001, and incorporated herein by reference. Upon request, the Company will4335furnish a copy of any omitted schedule to the Commission.</TD></TR>4336<TR>4337<TD>(11)</TD>4338<TD></TD>4339<TD>Filed as an Exhibit to the report of the Company on Form 10-K dated for the4340year ended December 31, 2000, and incorporated herein by reference.</TD></TR>4341<TR>4342<TD>(12)</TD>4343<TD></TD>4344<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated January434530, 2002, and incorporated herein by reference.</TD></TR>4346<TR>4347<TD>(13)</TD>4348<TD></TD>4349<TD>Filed as an Exhibit to the report of the Company on Form 10-Q for the4350quarter ended March 31, 2002, and incorporated herein by reference.4351</TD></TR>4352<TR>4353<TD>(14)</TD>4354<TD></TD>4355<TD>Filed as an Exhibit to the report of the Company on Form 8-K dated November435626, 2002, and incorporated herein by reference.4357</TD></TR>4358<TR>4359<TD>(15)</TD>4360<TD></TD>4361<TD>Filed herewith.</TD></TR></TABLE>4362<P ALIGN=CENTER>Page 37 </P>4363<HR>43644365<PAGE>4366<P ALIGN=CENTER><B>EXHIBIT 10.18</B></P>4367<HR>43684369<PAGE>4370<P ALIGN=CENTER><B><U>SECOND AMENDMENT TO LEASE AGREEMENT</U></B></P>4371<P>THIS SECOND AMENDMENT TO LEASE AGREEMENT ("Second Amendment") is entered into4372to be effective as of September 1, 2002, by and between PLANO R&D ASSOCIATES,4373LTD., a Texas limited partnership ("Landlord") and ADVANCED NEUROMODULATION4374SYSTEMS, INC., a Texas corporation ("Tenant").</P>4375<P><U>Recitals</U></P>4376<P>A. Legacy Lincoln I, Ltd., Landlord's4377predecessor-in-interest, leased to tenant approximately 40,680 square feet of4378Net Rentable Area (the "Premises") in Building D located at 6501 Windcrest of4379that certain project known as "Lincoln R&D at Legacy: in Plano, Texas4380pursuant to a certain Lease Agreement dated February 4, 1999 (the "Original4381Lease"). The Original Lease was amended pursuant to a certain First Amendment to4382Lease Agreement dated April 21, 1999 (the "First Amendment"), which together4383with the Original Lease is hereunder called the "Lease". Unless otherwise4384defined in this Second Amendment, the terms used in this Second Amendment shall4385have the same meanings as ascribed to such terms in the Lease.</P>4386<P>B. Tenant now desires to expand the Premises by4387leasing additional space containing 9,672 square feet of net Rentable Area in4388Building C of the Project located at 6509 Windcrest ("Expansion Premises"). A4389Site Plan depicting the Premises and the Expansion Premises is attached hereto4390as Exhibit "A" and made a part hereof for all purposes.</P>4391<P>C. Landlord is willing to lease the Expansion4392Premises to Tenant, and Tenant is willing to lease and take from Landlord the4393Expansion Premises, all upon the terms and conditions set forth in this Second4394Amendment.</P>4395<P><U>Agreements</U></P>4396<P>NOW, THEREFORE, for and in consideration of the foregoing recitals, together4397with other good and valuable consideration, the receipt and sufficiency of which4398are hereby acknowledged, Landlord and tenant hereby agree as follows:</P>4399<P>1. Landlord herby leases to Tenant, and Tenant4400hereby leases and takes from Landlord, the Expansion Premises, on the terns and4401conditions set forth in the Lease, as amended by the First Amendment and the4402Second Amendment. Upon execution of this Second Amendment, the Premises will be4403deemed to include the Expansion Premises, unless different terms apply to the4404Expansion Premises under the terms of this Second Amendment.</P>4405<P>2. The Term of the Lease as it relates to the4406Expansion Premises shall begin on September 1, 2002 ("Expansion Premises4407Commencement Date") and end coterminously with the last day of the Term for the4408Premises.</P>4409<P>3. Tenant shall pay to landlord with respect to4410the Expansion Premises, Base Rent, in advance, without demand, deduction or4411setoff, equal to $11,485.50/month ($14.25/SF/Year), with the first such monthly4412installment being due and payable on the Expansion Premises Commencement Date,4413and like monthly installments of Base Rent being due and payable on the first4414day of each month thereafter during the remainder of the Term.</P>4415<P>4. For purposes of determining "Tenant's4416Proportionate Share" of Operating Expenses, the Premises shall be deemed to4417include the Expansion Premises and Section 2(h) of the Lease shall be amended to4418change Tenant's Proportionate Share from 22.32% to 27.62%. Additionally, the4419Base year for the Expansion Premises shall be the actual Operating Expenses for4420the calendar year 2002.</P>4421<P>5. Tenant acknowledges that it has inspected the4422Expansion Premises and is accepting it "As Is" except as otherwise provided in4423the Lease. Tenant shall not be entitled to any cash allowance with respect to4424the Expansion Premises.</P>4425<P>6. Each of the parties represents and warrants4426to the other that except as expressly set forth in this Paragraph 6, such party4427has not dealt with any broker, agent or other person in connection with this4428Second Amendment through the acts of or employment of either party, and each4429party hereby agrees to indemnify, defend and hold the other party harmless from4430all liability arising from any claim for brokerage commissions of any kind4431(including, without limitation, attorneys' fees incurred in connection4432therewith( in connection with this Second Amendment, which claim arises4433(directly or indirectly) out of an agreement, contract, course of dealings or4434relationship between Tenant and the claiming party.</P>4435<P>Notwithstanding anything to the contrary contained herein, Tenant has4436retained Henry S. Miller Commercial as its broker (the "Broker"). Landlord4437agrees to pay all brokerage commissions that may be due to the Broker in4438connection with this Second Amendment pursuant to a separate agreement entered4439into between Landlord and Broker.</P>4440<P>7. Except as provided otherwise in this Second4441Amendment, all of the terms and provisions of the Lease shall apply and be in4442effect with respect to the Expansion Premises in the same manner and to the same4443extent that they apply and are in effect with respect to the Premises.</P>4444<P>8. Except as modified hereby, the Lease, as to4445both the Premises and the Expansion Premises, remains unchanged and in full4446force and effect, and by their execution hereof, Landlord and Tenant ratify and4447confirm all of the terms and provisions thereof.</P>4448<P>9. If for any reason Landlord is unable to4449deliver possession of the Premises to Tenant on the Expansion Premises4450Commencement Date, then the Expansion Premises Commencement Date shall be4451extended to the date Landlord can deliver the Premises to Tenant, and Landlord4452shall have no liability to Tenant for such delay, except that Tenant shall have4453no obligation to pay rent until the actual Expansion Premises Commencement Date.4454<P>4455<HR>44564457<PAGE>4458<P>IN WITNESS WHEREOF, Landlord and Tenant have executed this Second Amendment4459as of the day and year first above written.</P>4460<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4461<TR>4462<TD WIDTH=30%> </TD>4463<TD WIDTH=70%><U>LANDLORD:</U><BR>PLANO R&D ASSOCIATES, LTD.,<BR>a Texas4464limited partnership</TD></TR>4465</TABLE>4466<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4467<TR>4468<TD WIDTH=30%> </TD>4469<TD WIDTH=10%> </TD>4470<TD WIDTH=60%>By: LINCOLN-LEGACY TECH I, LTD.,<BR>4471a Texas limited partnership, General Partner</TD></TR>4472<TR>4473<TD> </TD>4474<TD> </TD>4475<TD>By: LINCOLN GP LEGACY TECH I, INC.,<BR>4476a Texas Corporation, General Partner</TD></TR></TABLE>4477<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4478<TR>4479<TD WIDTH=30%> </TD>4480<TD WIDTH=70%>By: <U>/s/ Thomas H. Kuhlmann</U><BR>Name: Thomas H. Kuhlmann<BR>4481Title: Vice President</TD></TR>4482<TR>4483<TD> </TD><TD></TD></TR>4484<TR>4485<TD> </TD><TD></TD></TR>4486<TR>4487<TD> </TD>4488<TD><U>TENANT:</U><BR>4489ADVANCED NEUROMODULATION SYSTEMS, INC.,<BR>4490a Texas corporation</TD></TR>4491<TR>4492<TD> </TD><TD></TD></TR>4493<TR>4494<TD> </TD>4495<TD>By: <U>/s/ Stuart B. Johnson</U><BR>Name: Stuart B. Johnson<BR>4496Title: Vice President Operations</TD></TR></TABLE>4497<HR>44984499<PAGE>4500<P ALIGN=CENTER><B>EXHIBIT 21.1</B></P>4501<HR>45024503<PAGE>4504<P ALIGN=CENTER><B><U>SUBSIDIARIES</U></B></P>4505<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4506<TR>4507<TD WIDTH=40%>Hi-Tronics Designs, Inc.</TD>4508<TD WIDTH=60%>New Jersey Corporation</TD></TR>4509<TR>4510<TD>MicroNet Medical, Inc.</TD>4511<TD>Minnesota Corporation</TD></TR>4512</TABLE>4513<HR>45144515<PAGE>4516<P ALIGN=CENTER><B>EXHIBIT 23.1</B></P>4517<HR>45184519<PAGE>4520<P ALIGN=CENTER><B><U>Consent of Independent Auditors</U></B></P>4521<P>We consent to the incorporation by reference in the Registration Statements4522(Form S-8 No. 2-82414) pertaining to the Advanced Neuromodulation Systems, Inc.45231979 Amended and Restated Employees' Stock Option Plan; (Form S-8 No. 2-91410)4524pertaining to the Advanced Neuromodulation Systems, Inc. Directors' Stock Option4525Plan; (Form S-8 No. 333-00967) pertaining to the Advanced Neuromodulation4526Systems, Inc. 1995 Stock Option Plan and the Advanced Neuromodulation Systems,4527Inc. Sales and Marketing Employees Stock Option Plan; (Form S-8 No. 333-75879)4528pertaining to the Advanced Neuromodulation Systems, Inc. 1998 Stock Option Plan;4529(Form S-8 No. 333-61240) pertaining to the Advanced Neuromodulation Systems,4530Inc. 2000 Stock Option Plan; (Form S-8 No. 333-85968) pertaining to the Advanced4531Neuromodulation Systems, Inc. 2001 Employee Stock Option Plan; (Form S-3 No.4532333-40927) pertaining to the registration of 100,000 shares of Common Stock4533issued pursuant to a Common Stock Purchase Warrant between Advanced4534Neuromodulation Systems, Inc. and Robert L. Swisher, Jr.; (Form S-3 No.4535333-53440) pertaining to the registration of 1,223,825 shares of Common Stock4536issued pursuant to an Agreement and Plan of Merger dated November 30, 20004537between the Company and Hi-tronics Designs, Inc. and an Asset Purchase Agreement4538dated as of January 2, 2001 between the Company and Implantable Devices Limited4539Partnership, ESOX Technology Corporation and Implantable Devices, Inc.; (Form4540S-3 No. 333-101911) pertaining to the registration of 156,302 shares of Common4541Stock issued pursuant to an Agreement and Plan of Merger dated November 4, 20024542between the Company and MicroNet Medical, Inc. and the related Prospectuses of4543our report dated March 27, 2003, with respect to the consolidated financial4544statements and schedule of Advanced Neuromodulation Systems, Inc. and4545Subsidiaries, included in the Annual Report (Form 10-K) for the year ended4546December 31, 2002.</P>4547<TABLE WIDTH=100% CELLPADDING=0 CELLSPACING=0>4548<TR>4549<TD WIDTH=40%> </TD>4550<TD WIDTH=60%><U>/s/Ernst & Young LLP</U><BR>Ernst & Young LLP</TD></TR>4551</TABLE>4552<P></P>4553<P>Dallas, Texas<BR>March 27, 2003</P>4554<HR>45554556<PAGE>4557<P ALIGN=CENTER><B>EXHIBIT 99.1</B></P>4558<HR>45594560<PAGE>4561<P ALIGN=CENTER><B>CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350<BR>4562(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)</B></P>4563<P>In connection with the Annual Report of Advanced Neuromodulation Systems,4564Inc. (the "Company") on Form 10-K for the period ending December 31, 2002 as4565filed with the Securities and Exchange Commission on the date hereof (the4566"Report"), I, Christopher G. Chavez, Chief Executive Officer of the Company,4567certify to the best of my knowledge and in my capacity as an officer of the4568Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the4569Sarbanes-Oxley Act of 2002, that:</P>4570<P>1. The Report fully complies with the4571requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934,4572as amended; and</P>4573<P>2. The information contained in the Report4574fairly presents, in all material respects, the financial condition and results4575of operations of the Company as of the dates and for the periods expressed in4576the Report.</P>4577<P>IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective4578as of March 28, 2003.</P>4579<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>4580<TR>4581<TD WIDTH=40%></TD>4582<TD WIDTH=60%> </TD></TR>4583<TR>4584<TD> </TD><TD></TD></TR>4585<TR>4586<TD> </TD><TD></TD></TR>4587<TR>4588<TD> </TD>4589<TD><U>/s/ Christopher G. Chavez</U></TD></TR>4590<TR>4591<TD></TD><TD>Name: Christopher G. Chavez<BR>4592Title: Chief Executive Officer</TD></TR></TABLE>4593<P>Note: The foregoing certification is being furnished solely pursuant to 184594U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of45952002, and is not being filed as part of the Form 10-K or as a separate4596disclosure document.</P>4597<HR>45984599<PAGE>4600<P ALIGN=CENTER><B>EXHIBIT 99.2</B></P>4601<HR>46024603<PAGE>4604<P ALIGN=CENTER><B>CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350<BR>4605(AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002)</B></P>4606<P>In connection with the Annual Report of Advanced Neuromodulation Systems,4607Inc. (the "Company") on Form 10-K for the period ending December 31, 2002 as4608filed with the Securities and Exchange Commission on the date hereof (the4609"Report"), I, F. Robert Merrill III, Chief Financial Officer of the Company,4610certify to the best of my knowledge and in my capacity as an officer of the4611Company, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the4612Sarbanes-Oxley Act of 2002, that:</P>4613<P>1. The Report fully complies with the4614requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934,4615as amended; and</P>4616<P>2. The information contained in the Report4617fairly presents, in all material respects, the financial condition and results4618of operations of the Company as of the dates and for the periods expressed in4619the Report.</P>4620<P>IN WITNESS WHEREOF, the undersigned has executed this Certificate, effective4621as of March 28, 2003.</P>4622<TABLE WIDTH=100% CELLSPACING=0 CELLPADDING=0>4623<TR>4624<TD WIDTH=40%></TD>4625<TD WIDTH=60%> </TD></TR>4626<TR>4627<TD> </TD><TD></TD></TR>4628<TR>4629<TD> </TD><TD></TD></TR>4630<TR>4631<TD> </TD>4632<TD><U>/s/ F. Robert Merrill III</U></TD></TR>4633<TR>4634<TD></TD><TD>Name: F. Robert Merrill III<BR>4635Title: Chief Financial Officer</TD></TR></TABLE>4636<P>Note: The foregoing certification is being furnished solely pursuant to 184637U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of46382002, and is not being filed as part of the Form 10-K or as a separate4639disclosure document.</P>4640</BODY>4641</HTML>46424643</TEXT>4644</DOCUMENT>4645</SEC-DOCUMENT>4646-----END PRIVACY-ENHANCED MESSAGE-----464746484649