<PAGE>   1

                                                                    EXHIBIT 13.1


This discussion contains forward looking statements that involve risks and
uncertainties. The Company's actual results may differ materially due to factors
that include, but are not limited to, the risks discussed herein under "Risk
Factors," as well as those discussed in the "Risk Factors" section of the
Company's Annual Report on Form 10-K.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Computer Motion, Inc. (the "Company") develops and markets proprietary robotic
and computerized surgical systems that are intended to enhance a surgeon's
performance and centralize and simplify a surgeon's control of the operating
room ("OR"). The Company believes that its products will provide surgeons with
the precision and dexterity necessary to perform complex, minimally invasive
surgical procedures, as well as enable surgeons to control critical devices in
the OR through simple verbal commands. The Company believes that its products
will broaden the scope and increase the effectiveness of minimally invasive
surgery, improve patient outcomes, and create a safer, more efficient and cost
effective OR.

The Company's AESOP(R) robotic endoscope positioning system allows direct
surgeon control of the endoscope through simple verbal commands, eliminating the
need for a member of a surgical staff to manually control the camera, while
providing a more stable and sustainable endoscopic image.

The Company's ZEUS(TM) Robotic Surgical System is comprised of three
surgeon-controlled robotic arms, one of which positions the endoscope and two of
which manipulate surgical instruments. The Company believes that ZEUS will
improve a surgeon's dexterity and precision and enhance visualization of, and
access to, confined operative sites.

The Company's HERMES(TM) Control Center is designed to enable a surgeon to
directly control multiple OR devices, including various laparoscopic,
arthroscopic and video devices, as well as the Company's robotic devices,
through simple verbal commands.

The Company has sustained significant losses since inception and expects to
continue to incur losses due to research and development efforts, costs
associated with obtaining regulatory approvals and clearances, continued
marketing expenditures to increase sales and other costs associated with the
Company's anticipated growth. Furthermore, the Company anticipates that its
operating results may fluctuate significantly from quarter to quarter in the
future, depending on a number of factors, many of which are outside the
Company's control. These factors include timing and results of clinical trials,
delays associated with FDA and other clearance processes, changes in pricing
policy by the Company or its competitors, the number, timing and significance of
product enhancements and new products by the Company and its competitors, health
care reimbursement policies and product quality issues.


RESULTS OF OPERATIONS

REVENUE - Revenue increased $3,975,000 (60%) to $10,586,000 in 1998 from
$6,611,000 in 1997. The increase resulted from a $2,486,000, or 46%, increase in
AESOP revenue and a $1,510,000, or 687%, increase in HERMES revenue. AESOP
robotic arm unit sales and average selling prices increased by 8% and 34%,
respectively and were favorably impacted by the commercial introduction of the
AESOP 3000 in the fourth quarter of 1997. HERMES revenue related mainly to
initial commercial sales to Stryker Corporation, the Company's distributor of
HERMES. Development revenue associated with pre-clinical ZEUS activities in 1998
totaled $986,000, a slight decrease from the prior year.

Revenue increased $2,554,000 (63%) to $6,611,000 in 1997 from $4,057,000 in
1996. The increase resulted almost entirely from a $2,360,000, or 81%, increase
in AESOP revenue. AESOP robotic arm unit sales and average selling prices
increased by 34% and 49%, respectively and were favorably impacted by the
commercial introductions of the AESOP 2000 in the fourth quarter of 1996 and the
AESOP 3000 in the fourth quarter of 1997. Development revenue associated with
pre-clinical ZEUS activities in 1997 totaled $1,008,000, a 35% increase over the
prior year. Development revenue associated with HERMES was $220,000 in 1997, a
16% increase over the prior year.

GROSS PROFIT - Gross profit increased $2,346,000 (63%) to $6,094,000 in 1998
from $3,748,000 in 1997. Gross margin increased to 57.6% in 1998 as compared to
56.7% in 1997. The increase in gross margin was primarily due to significantly
increased AESOP average selling prices and 

<PAGE>   2

some efficiencies of scale associated with increased unit production, offset in
part by costs associated with the ZEUS product line as older products in the
field were replaced with upgraded or new products. Pressure on gross margins
will continue until the Company receives FDA clearance for ZEUS and is able to
produce and sell at a greater volume.

Gross profit increased $2,318,000 (162%) to $3,748,000 in 1997 from $1,430,000
in 1996. Gross margin increased to 56.7% in 1997 as compared to 35.2% in 1996.
The increase in gross margin was primarily due to significantly increased AESOP
average selling prices, as well as efficiencies of scale associated with
increased unit production.

SELLING, GENERAL AND ADMINISTRATIVE - Selling, general and administrative
expenses increased $3,327,000 (43%) to $11,117,000 in 1998 as compared to
$7,790,000 in 1997. The increase was due mainly to the addition of sales and
marketing personnel and related recruiting and relocation costs, greater travel
and business expenses, and higher commissions based on the increased sales.

Selling, general and administrative expenses increased $3,646,000 (88%) to
$7,790,000 in 1997 as compared to $4,144,000 in 1996. Non-cash compensation
charges related to the grant of stock, warrants and stock options of $1,057,000
in 1997 accounted for a significant portion of the increase. The balance of the
increase was due to the addition of sales and managerial personnel and related
recruiting and relocation costs, greater travel and business expenses, higher
commissions based on the increased sales, and the cost of several conferences,
including the Company's own international congress on computers and robotics.

RESEARCH AND DEVELOPMENT - Research and development expenses increased
$3,756,000 (91%) to $7,905,000 in 1998 as compared to $4,149,000 in 1997,
primarily as a result of additional personnel and increased research and
development efforts with respect to HERMES and ZEUS, as well as for building
additional research and development, new product introduction, regulatory and
clinical affairs infrastructure.

Research and development expenses increased $2,790,000 (205%) to $4,149,000 in
1997 as compared to $1,359,000 in 1996, primarily as a result of increased
research and development efforts with respect to AESOP, HERMES, and most
particularly ZEUS, as well as for building additional research and development
and regulatory infrastructure.

OTHER INCOME - Other income was $1,408,000 in 1998 compared to other expense of
$1,015,000 in 1997. Other income in 1998 was almost entirely interest income
derived from proceeds from the Company's initial public offering which was
completed in August 1997. Other expense in 1997 included the amortization of
$1,000,000 of financing costs attributable to the fixed conversion feature of a
convertible debenture and $442,000 of financing costs attributable to warrants
issued in connection with bridge debt, and was net of $776,000 of interest
income derived primarily from investing the proceeds of the Company's initial
public offering. Other expense of $485,000 in 1996 included $189,000 of
financing costs attributable to warrants issued with bridge debt and $252,000 of
interest expense, and was net of interest income of $14,000 derived from
interest earned on operating bank accounts.

INCOME TAXES - Minimal provisions for state income taxes have been recorded on
the Company's pre-tax losses to date. At December 31, 1998, the Company had
federal and state net operating loss carryforwards of approximately $28,000,000
and $8,000,000, respectively which are available to offset future federal and
state taxable income. Federal carryforwards expire fifteen years after the year
of loss and state carryforwards expire five years after the year of loss. The
Company has provided a full valuation allowance on the deferred income tax asset
because of the uncertainty regarding its realization.


FINANCIAL CONDITION

Since its inception, the Company's expenses have exceeded its revenues,
resulting in an accumulated deficit of $33,198,000 as of December 31, 1998.
Until its initial public offering, the Company had primarily relied on proceeds
from issuance of preferred and common stock and bridge debt financing to fund
its operations.

During the third quarter 1997, the Company filed an S-1 registration statement
with the Securities and Exchange Commission (Registration No. 333-29505) for
2,875,000 shares of its common stock. The registration statement was granted
effectiveness and the Company completed its initial public offering ("IPO") in
August 1997 by selling 2,500,000 shares of its common stock at $14.00 per share,
less underwriting discounts and commissions of $.98 per share, to its
underwriters, Montgomery Securities and Piper Jaffray, Inc. The Company received
net proceeds of $32,550,000 from this sale before deducting offering expenses.
Effective upon the closing of the IPO, all of the outstanding shares of
convertible preferred stock of the Company were converted into 2,344,387 shares
of common stock.

In September 1997, the underwriters exercised their option to purchase an
additional 375,000 shares of common stock directly from the Company at a price
of $14.00 per share, less underwriting 

<PAGE>   3

discounts and commissions of $.98 per share. The Company received net proceeds
of $4,883,000 from this sale before deducting offering expenses.

In conjunction with completing the IPO, the Company incurred total direct
offering expenses of $728,000. Total net proceeds to the Company from the IPO
and the exercise of the over-allotment option, after deducting underwriting
discounts and commissions and total direct offering expenses, were $36,705,000.

The Company has used $3,250,000 of the net proceeds from the IPO to repay
certain outstanding indebtedness, certain holders of which were officers,
directors and persons owning in excess of ten percent of the Company's common
stock, and $2,274,000 to make capital purchases from unrelated third parties.
Proceeds from the IPO are also funding the Company's current operating losses.
Proceeds remaining from the IPO have been invested in short-term investment
grade debt securities.

At December 31, 1998, the Company's current ratio (current assets divided by
current liabilities) was 7.8 to 1 versus 14.9 to 1 at December 31, 1997,
reflecting the initial public offering proceeds and the use thereof.

For the year ended December 31, 1998, the Company's use of cash in operating
activities of $12,500,000 was primarily attributable to the net loss and also to
increases in accounts receivable and inventory in support of the Company's
revenue growth.

Cash outflow from purchases of plant and equipment was $1,784,000 in 1998. The
Company currently has no material commitments for capital expenditures, but is
seeking to procure additional leased space in anticipation of continued business
growth. For the year ended December 31, 1998, net cash provided by financing
activities of $2,863,000 was almost entirely attributable to the exercise of
stock options and warrants totaling $2,841,000.

The Company's operations to date have consumed substantial amounts of cash, and
the Company expects its capital and operating expenditures to continue to
increase. The Company believes that the net proceeds of its initial public
offering should be adequate to fund its expected operating losses and satisfy
its capital requirements, at a minimum, through 1999. The Company's need for
additional financing will depend upon numerous factors, including, but not
limited to, the extent and duration of the Company's future operating losses,
the level and timing of future revenues and expenditures, the progress and scope
of clinical trials, the timing and costs required to receive both United States
and international governmental approvals or clearances, market acceptance of new
products, the results and scope of ongoing research and development projects,
the costs of training physicians to become proficient in the use of the
Company's products and procedures, and the cost of developing appropriate sales
and marketing capabilities. To the extent that existing resources are
insufficient to fund the Company's activities, the Company may seek to raise
additional funds through public or private financing. There can be no assurance
that additional financing, if required, would be available on acceptable terms,
if at all. If adequate funds are not available, the Company's business,
financial condition and results of operations would be materially adversely
affected.

The Company's financial instruments include cash and short-term investment grade
debt securities. At December 31, 1998, the carrying values of the Company's
financial instruments approximated their fair values based on current market
prices and rates. It is the Company's policy not to enter into derivative
financial instruments. The Company does not currently have material foreign
currency exposure as the majority of its international transactions are
denominated in U.S. currency. Accordingly, the Company does not have significant
overall currency exposure at December 31, 1998.


RISK FACTORS

The Company operates in a rapidly changing environment that involves a number of
risks, some of which are beyond the Company's control. The following discussion
summarizes some of these risks which could affect the Company's actual future
results and could cause them to differ materially from any forward-looking
statements made by the Company.

The Company has a limited operating history and has not yet made a profit. The
HERMES and ZEUS product lines are important to the Company's future success and
neither product has achieved market acceptance. ZEUS has not achieved United
States regulatory clearance. Government regulation of the medical device
industry is strict and the regulatory clearance process is generally lengthy,
expensive and uncertain. There are alternative treatments and procedures to
using the Company's products. The Company's products are subject to rapid
technological change. The success of the Company, in part, is based on its
ability to obtain patent protection for its products. The Company is dependent
on sole source suppliers for principal components of its AESOP and ZEUS product
lines. The Company's anticipated growth will place significant demands on the
Company's management and resources, particularly in research and development and
sales and marketing.

A more detailed discussion of factors that could affect the Company's future
results can be found in the "Risk Factors" section of the Company's Annual
Report on Form 10-K for the year ended December 31, 1998.

<PAGE>   4

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                 --------------------------------------------------
                                                     1998               1997               1996
                                                 ------------       ------------       ------------
<S>                                              <C>                <C>                <C>         
Revenue                                          $ 10,586,000       $  6,611,000       $  4,057,000
Cost of revenue                                     4,492,000          2,863,000          2,627,000
                                                 ------------       ------------       ------------
Gross profit                                        6,094,000          3,748,000          1,430,000
                                                 ------------       ------------       ------------

Research and development expense                    7,905,000          4,149,000          1,359,000
Selling, general and administrative expense        11,117,000          7,790,000          4,144,000
                                                 ------------       ------------       ------------
Loss from operations                              (12,928,000)        (8,191,000)        (4,073,000)
                                                 ------------       ------------       ------------

Other expense (income)                             (1,408,000)         1,015,000            485,000
                                                 ------------       ------------       ------------
Loss before taxes                                 (11,520,000)        (9,206,000)        (4,558,000)
                                                 ------------       ------------       ------------

Income tax provision                                   25,000             13,000              1,000
                                                 ------------       ------------       ------------
Net loss                                         $(11,545,000)      $ (9,219,000)      $ (4,559,000)
                                                 ------------       ------------       ------------

Net loss per share - basic and diluted           $      (1.45)      $      (2.12)      $      (2.68)
                                                 ------------       ------------       ------------

Shares outstanding for per share purposes           7,959,000          4,343,000          1,701,000
                                                 ============       ============       ============
</TABLE>

                 See accompanying notes to financial statements.


REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

Board of Directors of Computer Motion, Inc.

We have audited the accompanying consolidated balance sheets of Computer Motion,
Inc. and subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Computer Motion,
Inc. as of December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.


/s/ ARTHUR ANDERSEN LLP
---------------------------------
ARTHUR ANDERSEN LLP
Woodland Hills, California
February 2, 1999

<PAGE>   5

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                    DECEMBER 31,
                                                                          -------------------------------
                                                                              1998               1997
                                                                          ------------       ------------
<S>                                                                       <C>                <C>         
ASSETS
Current assets
   Cash and cash equivalents                                              $  5,577,000       $ 22,555,000
   Marketable securities                                                    15,736,000         10,179,000
   Accounts receivable, net of allowance for doubtful
     accounts of $254,000 in 1998 and $62,000 in 1997                        2,856,000          1,804,000
   Inventories
     Raw materials                                                           1,588,000            688,000
     Work in process                                                           344,000             70,000
     Finished goods                                                          1,349,000            234,000
                                                                          ------------       ------------
   Total inventories                                                         3,281,000            992,000
   Prepaid expenses                                                            347,000            283,000
                                                                          ------------       ------------
Total current assets                                                        27,797,000         35,813,000
                                                                          ------------       ------------

Property and equipment
   Furniture and fixtures                                                      950,000            617,000
   Computer equipment                                                        1,307,000            741,000
   Machinery and equipment                                                   1,807,000            936,000
   Accumulated depreciation                                                 (1,689,000)        (1,186,000)
                                                                          ------------       ------------
Property and equipment, net                                                  2,375,000          1,108,000
                                                                          ------------       ------------

Other assets                                                                   272,000            392,000
                                                                          ------------       ------------

Total assets                                                              $ 30,444,000       $ 37,313,000
                                                                          ============       ============


LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities
   Accounts payable                                                       $  1,623,000       $  1,218,000
   Accrued expenses                                                          1,951,000          1,180,000
                                                                          ------------       ------------
Total current liabilities                                                    3,574,000          2,398,000
                                                                          ------------       ------------

Shareholders' equity
   Common stock -- $.001 par value
     Authorized -- 25,000,000 shares
     Outstanding -- 1998 - 8,353,725 shares; 1997 - 7,670,589 shares             8,000              8,000
   Additional paid-in capital                                               60,813,000         58,341,000
   Deferred compensation                                                      (753,000)        (1,781,000)
   Accumulated deficit                                                     (33,198,000)       (21,653,000)
                                                                          ------------       ------------
Total shareholders' equity                                                  26,870,000         34,915,000
                                                                          ------------       ------------

Total liabilities and shareholders' equity                                $ 30,444,000       $ 37,313,000
                                                                          ============       ============

</TABLE>

                 See accompanying notes to financial statements.

<PAGE>   6

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                PREFERRED        COMMON       ADDITIONAL          DEFERRED        ACCUMULATED        SHAREHOLDERS'
                                  STOCK          STOCK      PAID-IN CAPITAL     COMPENSATION        DEFICIT        EQUITY (DEFICIT)
                               -----------       ------      --------------     ------------      ------------     ----------------
<S>                            <C>               <C>        <C>                 <C>               <C>              <C>          
Balance December 31, 1995      $ 2,606,000       $   --      $         --       $        --       $( 7,875,000)      $( 5,269,000)
                               -----------       ------      ------------       -----------       ------------       ------------ 
Stock issued                       785,000           --           118,000                --                 --            903,000
Exercise of options                     --           --            42,000                --                 --             42,000
Value of warrants issued in
   connection with debt                 --           --           632,000                --                 --            632,000
Deferred compensation                   --           --           515,000          (515,000)                --                 --
Redemption premium                 325,000        2,000          (770,000)               --                 --           (443,000)
Net loss                                --           --                --                --         (4,559,000)        (4,559,000)
                               -----------       ------      ------------       -----------       ------------       ------------ 
Balance December 31, 1996        3,716,000        2,000           537,000          (515,000)       (12,434,000)        (8,694,000)
                               -----------       ------      ------------       -----------       ------------       ------------ 

Common stock issued                     --        1,000         1,216,000                --                 --          1,217,000
Stock issued on IPO                     --        3,000        36,737,000                --                 --         36,740,000
Conversion of preferred to
   common, net of issuances     (3,716,000)       2,000        12,176,000                --                 --          8,462,000
Exercise of options                     --           --           272,000                --                 --            272,000
Exercise of warrants, net of
   issuances                            --           --           168,000                --                 --            168,000
Deferred compensation, net of
   amortization                         --           --         2,323,000        (1,266,000)                --          1,057,000
Conversion of debt to common            --           --         5,074,000                --                 --          5,074,000
Redemption premium                      --           --          (240,000)               --                 --           (240,000)
Stock purchase plan                     --           --            78,000                --                 --             78,000
Net loss                                --           --                --                --         (9,219,000)        (9,219,000)
                               -----------       ------      ------------       -----------       ------------       ------------ 
Balance December 31, 1997               --        8,000        58,341,000        (1,781,000)       (21,653,000)        34,915,000
                               -----------       ------      ------------       -----------       ------------       ------------ 

Common stock issued                     --           --            46,000                --                 --             46,000
Exercise of options                     --           --         1,094,000                --                 --          1,094,000
Exercise of warrants                    --           --         1,471,000                --                 --          1,471,000
Amortization of deferred
   compensation                         --           --          (400,000)        1,028,000                 --            628,000
Stock purchase plan                     --           --           276,000                --                 --            276,000
IPO expenses and other                  --           --           (15,000)               --                 --            (15,000)
Net loss                                --           --                --                --        (11,545,000)       (11,545,000)
                               -----------       ------      ------------       -----------       ------------       ------------ 
Balance December 31, 1998      $        --       $8,000      $ 60,813,000       $(  753,000)      $(33,198,000)      $ 26,870,000
                               ===========       ======      ============       ===========       ============       ============
</TABLE>

<TABLE>
<CAPTION>
                                          COMMON SHARES                       PREFERRED SHARES
                             ---------------------------------------      -------------------------
                               1996           1997           1998           1996            1997
                             ---------      ---------      ---------      ---------      ----------
<S>                          <C>            <C>            <C>            <C>             <C>      
Beginning balance            1,695,173      1,734,289      7,670,589      1,393,114       1,474,545
                             ---------      ---------      ---------      ---------      ----------
Issued                          25,890        125,734         91,747         81,431         323,871
Issued on IPO                       --      2,875,000             --             --              --
Exercise of options             13,226        187,653        254,780             --              --
Conversion of preferred             --      2,344,387             --             --      (1,798,416)
Exercise of warrants                --         31,051        309,827             --              --
Conversion of debt                  --        363,743             --             --              --
Stock purchase plan                 --          8,732         26,782             --              --
                             ---------      ---------      ---------      ---------      ----------
Ending balance               1,734,289      7,670,589      8,353,725      1,474,545              --
                             =========      =========      =========      =========      ==========
</TABLE>

                 See accompanying notes to financial statements.

<PAGE>   7

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                       YEARS ENDED DECEMBER 31,
                                                          -------------------------------------------------
                                                              1998               1997              1996
                                                          ------------       ------------       -----------
<S>                                                       <C>                <C>                <C>
Cash Flows from Operating Activities:
   Net loss                                               $(11,545,000)      $( 9,219,000)      $(4,559,000)
   Adjustments to reconcile net loss to net cash
    used in operating activities:
     Depreciation and amortization                             518,000            379,000           346,000
     Provision for doubtful accounts                           298,000             28,000            70,000
     Loss on sale of fixed assets                                5,000              1,000             8,000
     Common stock issued for services                           46,000             66,000            23,000
     Financing cost of warrants issued with debt
      and fixed conversion of convertible debenture                 --          1,442,000           189,000
     Compensation for stock options, warrants and
      common stock issued below fair market value              628,000          1,057,000                --
   Working capital changes:
     Accounts receivable                                    (1,350,000)          (747,000)         (818,000)
     Inventories                                            (2,289,000)          (347,000)          149,000
     Prepaid expenses                                          (65,000)          (195,000)          (32,000)
     Accounts payable                                          405,000            316,000           678,000
     Accrued expenses                                          849,000            212,000           459,000
                                                          ------------       ------------       -----------
Net cash used in operating activities                      (12,500,000)        (7,007,000)       (3,487,000)
                                                          ------------       ------------       -----------

Cash Flows from Investing Activities:
   Purchases of property and equipment                      (1,784,000)          (816,000)         (116,000)
   Proceeds from sale of property and equipment                     --                 --            14,000
   Purchases of short-term investments                      (5,557,000)       (10,179,000)               --
                                                          ------------       ------------       -----------
Net cash used in investing activities                       (7,341,000)       (10,995,000)         (102,000)
                                                          ------------       ------------       -----------

Cash Flows from Financing Activities:
   Net proceeds from (repayment of) debt                       (78,000)        (4,488,000)        3,209,000
   Proceeds from common stock and warrant
    issuance, net of repurchases                             1,747,000          5,470,000             1,000
   Proceeds from IPO, net of expenses                          (35,000)        36,740,000                --
   Proceeds from preferred stock issuance                           --          2,341,000           785,000
   Proceeds from exercise of stock options                   1,094,000            272,000            42,000
   Other                                                       135,000           (211,000)          (79,000)
                                                          ------------       ------------       -----------
Net cash provided by financing activities                    2,863,000         40,124,000         3,958,000
                                                          ------------       ------------       -----------

Net increase (decrease) in cash and cash equivalents       (16,978,000)        22,122,000           369,000
Cash and cash equivalents, beginning of year                22,555,000            433,000            64,000
                                                          ------------       ------------       -----------
Cash and cash equivalents, end of year                    $  5,577,000       $ 22,555,000       $   433,000
                                                          ============       ============       ===========

</TABLE>


                 See accompanying notes to financial statements.

<PAGE>   8

NOTE 1: SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATION - Computer Motion, Inc. develops and markets proprietary
robotic and computerized surgical systems that enhance a surgeon's performance
and centralize and simplify a surgeon's control of the operating room. The
Company's primary efforts are directed toward developing and commercializing
medical robots and intuitive interface modalities which will enable new
minimally invasive surgical procedures and enhance the surgical team's overall
productivity. The Company's objective is to be the world's leading provider of
robotic and computerized surgical systems.

Like other companies at this stage of development, the Company's future success
is subject to numerous risks including the uncertainty of design, development
and manufacturing of new products, regulatory clearances and approvals,
developing its markets, acceptance of its products, reimbursement for its
products, financing its operations, managing its growth and competition.

CONSOLIDATION - The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, Computer Motion S.A. Intercompany
transactions and balances have been eliminated in consolidation. Certain
reclassifications of previously reported amounts have been made to conform with
the current year presentation.

USE OF ESTIMATES - Preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

REVENUE RECOGNITION - The Company recognizes revenue as products are shipped and
as services are performed. The Company also recognizes revenue under contracts
with healthcare institutions to research, develop and test certain Company
products which have not yet received regulatory clearances.

FOREIGN CURRENCY TRANSLATION - The assets and liabilities of Computer Motion
S.A. are translated into U.S. dollars at exchange rates in effect on reporting
dates, while capital accounts are translated at historical rates. Income
statement items are translated at average exchange rates in effect during the
financial statement period.

NET LOSS PER SHARE - Basic net loss per share is the same as diluted net loss
per share since inclusion of the Company's outstanding stock options and
warrants in the calculation is antidilutive. Net loss per share is based on the
weighted average number of common shares outstanding during the financial
statement period.

CASH EQUIVALENTS - Cash equivalents, consisting of liquid investments with a
maturity of three months or less when purchased, are stated at cost which
approximates market.

INVENTORIES - Inventories are stated at the lower of cost or market. Cost is
determined under the average cost method. Allowances are made for slow-moving,
obsolete, unsalable or unusable inventories.

PROPERTY AND EQUIPMENT - Property and equipment are stated at cost and are
depreciated using the straight line method based on useful lives of seven years
for leasehold improvements and three to seven years for machinery and equipment.
Accelerated depreciation is used by the Company for tax accounting purposes
only.

RESEARCH AND DEVELOPMENT - Research and development expense includes all
expenditures for general research into scientific phenomena, development of
useful ideas into merchantable products and continuing support and upgrading of
various products, as well as expenditures related to regulatory and clinical
activities. All such expense is charged to operations as incurred.

PATENTS - Patents, which are included in other assets, consist primarily of
legal fees and are stated at cost. Patents are amortized on a straight-line
basis over seventeen years.


NOTE 2: STOCK PURCHASE AND OPTION PLANS

STOCK PURCHASE - The Company's employee stock purchase plan allows participating
employees to purchase, through payroll deductions, shares of the Company's
common stock at 85% of the fair market value at specified dates. Under the terms
of the plan, 129,668 shares of the Company's common stock have been reserved for
purchase by plan participants. Employees purchased 26,782 and 8,732 shares in
1998 and 1997, respectively. At December 31, 1998, 94,154 shares were available
for purchase under the plan.

STOCK OPTIONS - Under the terms of the Company's stock incentive plans,
2,593,361 shares of common stock have been reserved for issuance to 

<PAGE>   9

directors, officers, employees and service providers upon the grant of
restricted stock or the exercise of stock options. Stock options are generally
exercisable over periods up to 10 years from date of grant and may be "incentive
stock options" or "non-qualified stock options." At December 31, 1998, there
were a maximum of 429,617 shares available for grant and 1,665,448 options
outstanding, of which 627,837 shares were exercisable at a weighted price of
$4.68 per share. The weighted average contractual life of options outstanding at
December 31, 1998 was 8.3 years. Stock option activity was as follows:

<TABLE>
<CAPTION>
                                                WEIGHTED
                              OPTIONS          AVG. PRICE
                            OUTSTANDING        PER SHARE
                            -----------        ----------
<S>                         <C>                <C>
Balance - 12/31/95             623,884           $ 2.72

Granted                        961,859           $ 4.57
Canceled                      (230,757)          $ 2.95
Exercised                      (13,226)          $ 3.20
                             ---------           ------
Balance - 12/31/96           1,341,760           $ 4.01
                             ---------           ------

Granted                        650,789           $ 8.44
Canceled                       (71,421)          $ 4.57
Exercised                     (187,653)          $ 1.45
                             ---------           ------
Balance - 12/31/97           1,733,475           $ 6.34
                             ---------           ------

Granted                        657,950           $10.61
Canceled                      (471,197)          $ 9.12
Exercised                     (254,780)          $ 4.30
                             ---------           ------
Balance - 12/31/98           1,665,448           $ 7.10
                             =========           ======
</TABLE>


Pursuant to the terms of the plans, optionees can use cash, previously owned
shares or a combination of cash and previously owned shares to reimburse the
Company for the cost of the option and the related tax liabilities. Shares
acquired from the optionee are valued at fair market value on the transaction
date.

In the opinion of management, all options have been granted at not less than
fair market value at dates of grant. When stock options are exercised, the par
value of the shares issued is credited to common stock and the excess of the
proceeds over the par value is credited to additional paid-in capital. When
non-qualified stock options are exercised, or when incentive stock options are
exercised and sold within a one-year period, the Company realizes income tax
benefits based on the difference between the fair market value of the stock on
the date of exercise and the stock option exercise price. These tax benefits do
not affect the income tax provision, but rather are credited directly to
additional paid-in capital.

The Company has issued certain common stock and warrants and granted certain
stock options at prices perceived by the Securities and Exchange Commission to
be less than the estimated fair market value of the common stock. The difference
between the issuance or grant price and the estimated fair market value at date
of issuance or grant is reflected as compensation expense. Compensation expense
of $650,000 and $1,057,000 was recognized in 1998 and 1997, respectively. At
December 31, 1998, deferred (unamortized) compensation expense relating to stock
options was $753,000 and will be recognized as compensation expense over the
balance of the vesting periods of the stock options.

Under Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," the Company has elected to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related accounting interpretations. Accordingly, no compensation
expense has been recognized related to the granting of stock options, except as
noted above. If compensation expense related to stock options was determined
based upon their grant date fair market value consistent with the methodology
prescribed under SFAS No. 123, the Company's net loss and basic loss per share
would have been increased by $1,295,000 ($.16 per share), $718,000 ($.17 per
share) and $239,000 ($.14 per share) for 1998, 1997 and 1996, respectively. The
fair market value of the warrants and stock options at the grant date was
estimated using the Black-Scholes model with the following weighted average
assumptions:

<TABLE>
<CAPTION>
                                1998          1997          1996
                                ----          ----          ----
<S>                              <C>           <C>           <C>
Expected life (years)            7.0           7.0           7.0
Interest rate                    5.5%          6.0%          7.5%
Volatility                        40%           10%            0%
Dividend yield                     0%            0%            0%
</TABLE>


NOTE 3: COMMON STOCK WARRANTS

The Company has issued warrants to purchase common shares which are exercisable
over periods of up to 7 years from date of issuance. At December 31, 1998,
1,317,083 warrants were exercisable. Warrant activity was as follows:

<PAGE>   10

<TABLE>
<CAPTION>
                                                           WEIGHTED
                                          WARRANTS        AVG. PRICE
                                         OUTSTANDING      PER SHARE
                                         -----------      ----------
<S>                                      <C>               <C>
Balance - 12/31/95                          163,792        $   4.57
                                         ----------        --------

Granted                                   1,137,496        $   5.27
                                         ----------        --------
Balance - 12/31/96                        1,301,288        $   5.18
                                         ----------        --------

Granted                                     356,673        $   7.43
Exercised                                   (31,051)       $   5.23
                                         ----------        --------
Balance - 12/31/97                        1,626,910        $   5.34
                                         ----------        --------

Exercised                                  (309,827)       $   4.75
                                         ----------        --------
Balance - 12/31/98                        1,317,083        $   5.48
                                         ==========        ========
</TABLE>


NOTE 4: INCOME TAXES

Income taxes for all years presented consisted of minimum state income taxes
only. Net deferred income tax assets at December 31, 1998 and 1997 consisted of
the following:

<TABLE>
<CAPTION>
                                           1998               1997
                                       ------------        -----------
<S>                                    <C>                 <C>        
Allowance for doubtful accounts        $    102,000        $    25,000
Accrued liabilities                          80,000             67,000
Deferred rent                                53,000             39,000
Depreciation and amortization                74,000             20,000
Uniform capitalization costs                337,000             60,000
Net operating loss carryforwards          9,950,000          7,761,000
Tax credits                                 771,000            390,000
Other                                        52,000              7,000
                                       ------------        -----------
Total deferred income tax asset          11,419,000          8,369,000
Valuation reserve                       (11,419,000)        (8,369,000)
                                       ------------        -----------
Net deferred income tax asset          $         --        $        --
                                       ============        ===========
</TABLE>


The income tax provision reconciles to the amount computed by applying the
federal statutory rate to loss before taxes as follows:

<TABLE>
<CAPTION>
                                                           1998             1997             1996
                                                        -----------      -----------      -----------
<S>                                                     <C>              <C>              <C>         
Expected federal benefit                                $(3,917,000)     $(3,222,000)     $(1,595,000)
State income taxes, net of federal income tax effect         25,000           13,000            1,000
Tax benefits not recognized                               3,917,000        3,222,000        1,595,000
                                                        -----------      -----------      -----------
Income tax provision                                    $    25,000      $    13,000      $     1,000
                                                        ===========      ===========      ===========
</TABLE>


At December 31, 1998, the Company had federal and state net operating loss (NOL)
carryforwards of approximately $28,000,000 and $8,000,000, respectively and
research and development tax credit carryforwards of approximately $771,000. The
federal tax credit and NOL carryforwards expire fifteen years from the year of
loss and are restricted if significant changes in Company ownership occur. The
state NOL carryforwards expire five years from the year of loss.

Realization of deferred tax assets is dependent on generating sufficient taxable
income during the periods in which the temporary differences will reverse. The
amount of the deferred tax assets considered realizable could be adjusted if
estimates of future taxable income during the reversal periods are revised.


NOTE 5: FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET RISK

DEBT - Warrants to purchase 1,064,645 shares of Company common stock were issued
in 1996 in connection with bridge financing debt. Under SFAS No. 123, the fair
market value of these warrants at the date of issuance totaling $632,000 was
recorded as additional paid-in capital and deferred financing cost. During 1997
and 1996, financing costs of $1,442,000 and $189,000, respectively were
expensed.

FINANCIAL INSTRUMENTS - Marketable securities consisted of bank certificates of
deposit, commercial paper, auction market preferred stock and corporate bonds,
all of which by policy must mature within 360 days. Under Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," all marketable securities are classified as held to
maturity and are carried at amortized cost which closely approximates fair
market value. No net realized gains or losses were recorded in any year.

The Company's investment portfolio at December 31, 1998 and 1997 consisted of
the following:

<TABLE>
<CAPTION>
                                   1998              1997
                                -----------       -----------
<S>                             <C>               <C>        
Certificates of deposit         $ 1,000,000       $ 7,998,000
Commercial paper                  8,686,000         9,005,000
Auction market preferreds                --         4,250,000
Corporate bonds                   9,068,000         8,032,000
Cash                              2,350,000         3,245,000
Interest receivable                 209,000           204,000
                                -----------       -----------
Total                           $21,313,000       $32,734,000
                                ===========       ===========
</TABLE>

<PAGE>   11

CONCENTRATION OF CREDIT RISK - Trade accounts receivable and certain marketable
securities are the financial instruments which may subject the Company to
concentration of credit risk. Although the Company does not anticipate
collection problems with its receivables, payment is contingent to a certain
extent upon the economic condition of the hospitals which purchase the Company's
products. The credit risk associated with receivables is limited due to
dispersion of the receivables over a number of customers in a number of
geographic areas. The Company monitors the credit worthiness of its customers to
which it grants credit terms in the normal course of business. Marketable
securities are placed with high credit qualified financial institutions and
Company policy limits the credit exposure to any one financial instrument;
therefore, credit loss is reduced.


NOTE 6: COMMITMENTS AND CONTINGENCIES

LEASES - Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$629,000, $364,000 and $214,000, respectively. As of December 31, 1998, the
Company had the following minimum lease payments for certain facilities and
equipment under operating leases: 1999-$688,000; 2000-$703,000; 2001-$690,000;
2002-$283,000; and nothing in 2003 and thereafter.

LEGAL MATTERS - While there are no pending legal actions against the Company,
the Company may become party to various legal proceedings in the normal course
of business.


NOTE 7: FINANCING ARRANGEMENTS

The Company has arrangements with several third party financial institutions,
whereby the Company sells its leases, mainly without recourse. The Company
recognized approximately $3,511,000, $1,331,000 and $494,000 in revenues from
leases sold in 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997,
approximately $256,000 and $255,000, respectively had not been collected on
leases sold with recourse for which the Company is contingently liable.


NOTE 8: PROFIT SHARING PLAN

The Company's defined contribution profit sharing plan includes features under
Section 401(k) of the Internal Revenue Code. All employees are eligible to
participate in the plan after meeting certain minimum service requirements.
Employees may make discretionary contributions to the plan subject to Internal
Revenue Code limitations. Employer contributions to the plan were $56,000 in
1998 and zero in 1997. For 1999, the Company anticipates contributing 25% of the
first four percent of a participant's salary contribution to the plan. Plan
participants are fully vested in their contributions to the plan and employer
contributions vest over two years.


NOTE 9: GEOGRAPHIC AREA

The Company operates in a single industry segment, the medical device industry.
Export sales from the United States were $1,225,000, $1,871,000 and $1,147,000
in 1998, 1997 and 1996, respectively.


NOTE 10: SHAREHOLDERS' EQUITY

The Company reincorporated in Delaware and effected a reverse stock split of its
existing common and preferred stock of 1 for 1.928 shares in August 1997. This
reincorporation and reverse stock split have been retroactively reflected in the
accompanying financial statements. All shares of preferred stock were converted
to common stock upon the Company's initial public offering in August 1997.

PREFERRED STOCK - At December 31, 1998, the Company had 5,000,000 shares of
undesignated preferred stock authorized and available for future issuance, none
of which had been issued. The Company's Board of Directors, at its sole
discretion, may determine, fix and alter dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any such series,
and may determine the designation, terms and conditions of the issuance of any
such shares.

COMMON STOCK - During the year ended December 31, 1998, stock option and warrant
exercises and issuances of common stock under the Company's Employee Stock
Purchase Plan increased the number of common shares by 591,389. Effective May
1997, a corporation which had invested $4,000,000 in the form of a convertible
note converted its note and all accrued interest thereon into 363,743 shares of
the Company's common stock. Financing costs of $1,000,000 relating to the fixed
conversion feature of this note were expensed in 1997.

<PAGE>   12

NOTE 11: VENDORS

The robotic arm which is the major component of the Company's AESOP product is
purchased from a sole supplier. The Company believes that other suppliers would
be available for the component if necessary.


NOTE 12: QUARTERLY FINANCIAL DATA (UNAUDITED)

Quarterly data for 1998 and 1997 was as follows:

<TABLE>
<CAPTION>
                       FIRST QUARTER    SECOND QUARTER   THIRD QUARTER    FOURTH QUARTER
                       -------------    --------------   -------------    --------------
<S>                     <C>              <C>              <C>              <C>        
Year Ended December 31, 1998:
     Revenue            $ 2,077,000      $ 2,274,000      $ 2,807,000      $ 3,428,000
     Gross profit       $ 1,184,000      $ 1,323,000      $ 1,589,000      $ 1,998,000
     Net loss           $(2,730,000)     $(3,004,000)     $(2,994,000)     $(2,817,000)
     Loss per share     $     (0.35)     $     (0.38)     $     (0.37)     $     (0.35)
                        -----------      -----------      -----------      ----------- 

Year Ended December 31, 1997:
     Revenue            $ 1,373,000      $ 1,483,000      $ 1,685,000      $ 2,070,000
     Gross profit       $   722,000      $   759,000      $ 1,007,000      $ 1,260,000
     Net loss           $(1,530,000)     $(3,380,000)     $(2,185,000)     $(2,124,000)
     Loss per share     $     (0.88)     $     (1.76)     $     (0.36)     $     (0.28)
                        ===========      ===========      ===========      =========== 
</TABLE>

Full year 1997 loss per share was lower than the sum of the reported 1997
quarterly loss per share amounts due to significant changes in the number of
outstanding shares.