<PAGE>   1

                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                           ---------------------------

                                    FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934

            FOR THE TRANSITION PERIOD FROM ___________ TO ___________


                         Commission file number: 0-24663

                           ---------------------------

                          ASPECT MEDICAL SYSTEMS, INC.
             (Exact Name of Registrant as Specified in Its Charter)

            DELAWARE                                   04-2985553
 (State or Other Jurisdiction of          (I.R.S. Employer Identification No.)
 Incorporation or Organization)


141 NEEDHAM STREET, NEWTON, MASSACHUSETTS               02464-1505
(Address of Principal Executive Offices)                (Zip Code)

                                 (617) 559-7000
               Registrant's Telephone Number, Including Area Code

                           ---------------------------

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

                                 YES [X] NO [ ]

The Registrant had 17,663,134 shares of Common Stock, $0.01 par value per share,
outstanding as of August 8, 2001.


<PAGE>   2


                          ASPECT MEDICAL SYSTEMS, INC.

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

                                                                                                        Page
                                                                                                        ----

<S>                                                                                                       <C>
PART I.   FINANCIAL INFORMATION                                                                           1

Item 1.   Financial Statements (Unaudited)                                                                1

          Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000                           1

          Consolidated Statements of Operations for the Three and Six Months Ended
          June 30, 2001 and July 1, 2000                                                                  2

          Consolidated Statements of Cash Flows for the Six Months Ended
          June 30, 2001 and July 1, 2000                                                                  3

          Notes to Consolidated Financial Statements                                                      4

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations           9

Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                      22

PART II.  OTHER INFORMATION                                                                               23

Item 1.   Legal Proceedings                                                                               23

Item 2.   Changes in Securities and Use of Proceeds                                                       23

Item 3.   Defaults Upon Senior Securities                                                                 23

Item 4.   Submission of Matters to a Vote of Security Holders                                             23

Item 5.   Other Information                                                                               24

Item 6.   Exhibits and Reports on Form 8-K                                                                24

SIGNATURE                                                                                                 25
</TABLE>



<PAGE>   3


                         PART I -- FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                              June 30,         December 31,
                                                                                2001               2000
                                                                           -------------       -------------
                                                                            (Unaudited)
<S>                                                                        <C>                 <C>
ASSETS
Current assets:
   Cash and cash equivalents                                               $  21,394,709       $  23,776,617
   Marketable securities                                                      26,723,745          34,712,325
   Accounts receivable, net of allowance of $422,000 at June 30, 2001
     and December 31, 2000                                                     6,016,518           3,665,572
   Current portion of investment in sales-type leases                          1,503,650           1,677,312
   Inventory                                                                   6,257,757           4,764,479
   Other current assets                                                        1,324,536           1,542,597
                                                                           -------------       -------------
           Total current assets                                               63,220,915          70,138,902
Property and equipment, net                                                    6,482,628           6,807,192
Long-term investment in sales-type leases                                      1,856,242           2,465,139
Other long-term assets                                                         1,249,276                  --
                                                                           -------------       -------------
           Total assets                                                    $  72,809,061       $  79,411,233
                                                                           =============       =============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Current portion of long-term debt                                       $     906,837       $   2,530,707
   Working capital line of credit                                              3,000,000                  --
   Accounts payable                                                            2,356,193           1,877,295
   Accrued liabilities                                                         6,629,561           6,473,887
   Deferred revenue                                                              296,437             802,489
                                                                           -------------       -------------
           Total current liabilities                                          13,189,028          11,684,378
                                                                           -------------       -------------
Deferred revenue                                                               1,318,538           1,136,676
Long-term debt                                                                 1,342,750           2,616,657
                                                                           -------------       -------------
Commitments and contingencies
Stockholders' equity:
   Preferred Stock, $.01 par value; 5,000,000 shares authorized, no
     shares issued or outstanding                                                     --                  --
   Common Stock, $.01 par value; 60,000,000 shares authorized,
     17,631,941 and 17,377,257 shares issued and outstanding at June
     30, 2001 and December 31, 2000, respectively                                176,319             173,773
   Additional paid-in capital                                                125,812,672         124,934,402
   Warrants                                                                      121,684             121,684
   Notes receivable from employees and directors                                (338,051)           (510,787)
   Deferred compensation                                                         (58,080)            (75,043)
   Accumulated other comprehensive income                                         41,449              63,029
   Accumulated deficit                                                       (68,797,248)        (60,733,536)
                                                                           -------------       -------------
           Total stockholders' equity                                         56,958,745          63,973,522
                                                                           -------------       -------------
           Total liabilities and stockholders' equity                      $  72,809,061       $  79,411,233
                                                                           =============       =============
</TABLE>


        The accompanying notes are an integral part of these consolidated
                             financial statements.


                                       1

<PAGE>   4

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                             Three Months Ended                  Six Months Ended
                                       ------------------------------      -----------------------------
                                       June 30, 2001     July 1, 2000      June 30, 2001    July 1, 2000
                                       -------------     ------------      -------------    ------------
                                        (Unaudited)       (Unaudited)       (Unaudited)      (Unaudited)

<S>                                     <C>               <C>               <C>               <C>
Revenue                                 $ 8,973,021       $11,066,167       $17,835,841       $20,725,544
Costs and expenses:
    Costs of revenue                      2,880,525         3,382,298         5,651,137         6,465,435
    Research and development              1,822,437         1,448,930         3,618,560         2,802,749
    Sales and marketing                   7,226,062         5,212,576        14,186,981         9,926,629
    General and administrative            2,034,921         1,725,900         4,089,518         2,994,513
                                        -----------       -----------       -----------       -----------
          Total costs and expenses       13,963,945        11,769,704        27,546,196        22,189,326
                                        -----------       -----------       -----------       -----------

Loss from operations                     (4,990,924)         (703,537)       (9,710,355)       (1,463,782)
Interest income                             828,816         1,266,716         1,869,491         2,254,731
Interest expense                           (104,397)         (170,173)         (222,848)         (372,143)
                                        -----------       -----------       -----------       -----------
Net income (loss)                       $(4,266,505)      $   393,006       $(8,063,712)      $   418,806
                                        ===========       ===========       ===========       ===========

Net income (loss) per share:
    Basic                               $     (0.24)      $      0.02       $     (0.46)      $      0.03
    Diluted                             $     (0.24)      $      0.02       $     (0.46)      $      0.03

Shares used in computing net
    income (loss) per share:
    Basic                                17,540,372        16,933,787        17,499,628        14,249,675
    Diluted                              17,540,372        19,395,504        17,499,628        16,749,812
</TABLE>


              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                       2


<PAGE>   5


                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                                              Six Months Ended
                                                                        ------------------------------
                                                                        June 30, 2001     July 1, 2000
                                                                        -------------     ------------
                                                                         (Unaudited)       (Unaudited)

<S>                                                                     <C>                <C>
Cash flows from operating activities:
   Net income (loss)                                                    $ (8,063,712)      $    418,806
   Adjustments to reconcile net income (loss) to net cash used for
     operating activities -
     Depreciation and amortization                                         1,250,646            723,320
     Provision for doubtful accounts                                              --             15,000
     Compensation expense related to stock options                            36,042            402,174
     Changes in assets and liabilities -
       Increase in accounts receivable                                    (2,233,538)        (2,273,218)
       Increase in inventory                                              (1,493,278)        (1,460,090)
       Decrease (increase) in other assets                                    89,424           (245,842)
       Decrease (increase) in investment in sales-type leases                782,559           (122,021)
       Increase in accounts payable                                          478,898            324,116
       Increase (decrease) in accrued liabilities                            155,674           (170,414)
       Decrease in deferred revenue                                         (324,190)          (596,033)
                                                                        ------------       ------------
          Net cash used for operating activities                          (9,321,475)        (2,984,202)
                                                                        ------------       ------------

Cash flows from investing activities:
   Loans to related parties                                               (1,120,639)                --
   Acquisition of property and equipment                                    (926,082)        (3,608,546)
   Purchases of marketable securities                                    (11,150,394)       (46,397,516)
   Proceeds from sales and maturities of marketable securities            19,117,395         20,750,000
                                                                        ------------       ------------
          Net cash provided by (used for) investing activities             5,920,280        (29,256,062)
                                                                        ------------       ------------

Cash flows from financing activities:
   Proceeds from working capital line of credit                            3,000,000                 --
   Principal payments on equipment loan                                     (720,670)          (360,335)
   Principal payments on term loan                                        (1,884,933)          (471,230)
   Proceeds from sale of investment in sales-type leases                     283,528          1,020,070
   Principal payments on debt related to investment in sales-type
     leases                                                                 (575,703)          (347,330)
   Proceeds from issuance of common stock                                    744,329         54,971,766
   Payments received on notes receivable from employees and
     directors                                                               172,736             26,157
                                                                        ------------       ------------
          Net cash provided by financing activities                        1,019,287         54,839,098
                                                                        ------------       ------------
Net (decrease) increase in cash and cash equivalents                      (2,381,908)        22,598,834
Cash and cash equivalents, beginning of period                            23,776,617         13,535,364
                                                                        ------------       ------------
Cash and cash equivalents, end of period                                $ 21,394,709       $ 36,134,198
                                                                        ============       ============

Supplemental disclosure of cash flow information:
   Interest paid                                                        $    246,027       $    365,693
                                                                        ============       ============
</TABLE>


        The accompanying notes are an integral part of these consolidated
                             financial statements.


                                       3

<PAGE>   6

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


(1)  Basis of Presentation

     The accompanying unaudited consolidated financial statements of Aspect
Medical Systems, Inc. and subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all normal, recurring adjustments considered
necessary for a fair presentation have been included. The financial statements
should be read in conjunction with the audited financial statements for the year
ended December 31, 2000 included in the Company's Annual Report on Form 10-K
filed with the Securities and Exchange Commission (the "SEC"). Interim results
of operations are not necessarily indicative of the results to be expected for
the full year or any other interim period.

(2)  Computation of Net Income (Loss) Per Share

     In accordance with Statement of Financial Accounting Standards (SFAS) No.
128, Earnings Per Share, basic income (loss) per share amounts for the three and
six months ended June 30, 2001 and July 1, 2000 were computed by dividing net
income (loss) by the weighted average common shares outstanding during the
periods presented. Diluted income (loss) per share amounts for the periods
presented were computed by dividing net income (loss) by the weighted average
common and dilutive potential common shares outstanding, computed in accordance
with the treasury stock method. The computation of basic and diluted income
(loss) per share amounts are as follows:

<TABLE>
<CAPTION>
                                                          Three Months Ended                 Six Months Ended
                                                   -------------------------------      -------------------------------
                                                   June 30, 2001      July 1, 2000      June 30, 2001      July 1, 2000
                                                   -------------      ------------      -------------      ------------
                                                    (Unaudited)        (Unaudited)       (Unaudited)        (Unaudited)
<S>                                                 <C>                <C>               <C>                <C>
BASIC INCOME (LOSS) PER SHARE
   COMPUTATION
   Numerator:
   Net income (loss) available to common
     stockholders                                   $ (4,266,505)      $    393,006      $ (8,063,712)      $    418,806
                                                    ------------       ------------      ------------       ------------
  Denominator:
  Weighted average common shares outstanding          17,540,372         16,933,787        17,499,628         14,249,675
                                                    ------------       ------------      ------------       ------------
  Basic income (loss) per share                     $      (0.24)      $       0.02      $      (0.46)      $       0.03
                                                    ============       ============      ============       ============
DILUTED INCOME (LOSS) PER SHARE
   COMPUTATION
   Numerator:
   Net income (loss) available to common
     stockholders                                   $ (4,266,505)      $    393,006      $ (8,063,712)      $    418,806
                                                    ------------       ------------      ------------       ------------
  Denominator:
  Weighted average common shares outstanding          17,540,372         16,933,787        17,499,628         14,249,675
  Dilutive effect of assumed exercise of
     warrants                                                 --            124,977                --            123,938
  Dilutive effect of assumed exercise of stock
     options                                                  --          2,255,113                --          2,281,278
  Dilutive effect of restricted stock                         --             81,627                --             94,921
                                                    ------------       ------------      ------------       ------------
  Weighted average common and dilutive
     potential common shares outstanding              17,540,372         19,395,504        17,499,628         16,749,812
                                                    ------------       ------------      ------------       ------------
  Diluted income (loss) per share                   $      (0.24)      $       0.02      $      (0.46)      $       0.03
                                                    ============       ============      ============       ============
</TABLE>


                                       4

<PAGE>   7


                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


     The Company has excluded all shares of restricted common stock that are
subject to repurchase by the Company from the weighted average number of common
shares outstanding. For the three and six months ended June 30, 2001, the
Company has excluded 1,158,000 and 1,140,000 shares, respectively, related to
restricted common stock subject to repurchase and common stock issuable pursuant
to the exercise of stock options and warrants from the calculation of the
Company's diluted earnings per share because the inclusion of these shares would
have been antidilutive as a result of the Company's net loss position.


(3)  Revenue Recognition

     Revenue from equipment sales, disposable product sales and sales-type
leases is recognized at the time of shipment. Payments received prior to
shipment are recorded as deferred revenue. The Company has entered into certain
licensing and distribution agreements for which payments received in advance are
recorded as deferred revenue. Revenue under these agreements is recognized as
earned pursuant to the terms of the respective agreements. The Company provides
for the cost of warranty at the time of product shipment.


(4)  Use of Estimates

     The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.


(5)  Comprehensive Income (Loss)

     SFAS No. 130, Reporting Comprehensive Income, requires disclosure of all
components of comprehensive income (loss) on an annual and interim basis.
Comprehensive income (loss) is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. The Company's total comprehensive income (loss) is as
follows:

<TABLE>
<CAPTION>
                                             Three Months Ended                 Six Months Ended
                                       ------------------------------     ------------------------------
                                       June 30, 2001     July 1, 2000     June 30, 2001     July 1, 2000
                                       -------------     ------------     -------------     ------------
                                        (Unaudited)       (Unaudited)      (Unaudited)       (Unaudited)

<S>                                     <C>               <C>               <C>               <C>
Net income (loss)                       $(4,266,505)      $   393,006       $(8,063,712)      $   418,806
Other comprehensive income (loss):
    Unrealized loss on marketable
      securities                            (18,402)          (39,806)          (21,580)          (82,605)
                                        -----------       -----------       -----------       -----------
Comprehensive income (loss)             $(4,284,907)      $   353,200       $(8,085,292)      $   336,201
                                        ===========       ===========       ===========       ===========
</TABLE>



                                       5

<PAGE>   8

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


(6)  Investment in Sales-Type Leases

     The Company leases equipment to customers under sales-type leases. The
components of the Company's net investment in sales-type leases are as follows:

<TABLE>
<CAPTION>
                                             June 30,        December 31,
                                               2001             2000
                                            -----------      ------------
                                            (Unaudited)

<S>                                          <C>             <C>
Total minimum lease payments receivable      $4,141,671      $5,143,738
  Less-- unearned interest                      781,779       1,001,287
                                             ----------      ----------
Net investment in sales-type leases           3,359,892       4,142,451
  Less-- current portion                      1,503,650       1,677,312
                                             ----------      ----------
                                             $1,856,242      $2,465,139
                                             ==========      ==========
</TABLE>


(7)  Inventory

     Inventory consists of the following:

<TABLE>
<CAPTION>
                                              June 30,      December 31,
                                                2001            2000
                                             -----------    ------------
                                             (Unaudited)

<S>                                          <C>             <C>
Raw materials                                $2,711,557      $2,200,119
Work-in-progress                                138,201           1,742
Finished goods                                3,407,999       2,562,618
                                             ----------      ----------
                                             $6,257,757      $4,764,479
                                             ==========      ==========
</TABLE>


(8)  Segment Information and Enterprise Reporting

     The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, effective for fiscal years beginning after
December 31, 1997. The Company operates in one reportable segment as it has one
family of anesthesia monitoring systems. The Company does not disaggregate
financial information by product or geographically, other than export sales by
region and sales by product, for management purposes. Substantially all of the
Company's assets are located within the United States. All of the Company's
products are manufactured in the United States.


                                       6

<PAGE>   9


                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


     Revenue by geographic destination and as a percentage of total revenue is
as follows:

<TABLE>
<CAPTION>
                                        Three Months Ended                   Six Months Ended
                                  -------------------------------     ------------------------------
                                  June 30, 2001      July 1, 2000     June 30, 2001     July 1, 2000
                                  -------------      ------------     -------------     ------------
                                   (Unaudited)        (Unaudited)      (Unaudited)       (Unaudited)
<S>                                 <C>               <C>               <C>               <C>
Geographic Area by Destination
   Domestic                         $ 6,708,441       $ 9,337,416       $13,503,761       $17,603,035
   International                      2,264,580         1,728,751         4,332,080         3,122,509
                                    -----------       -----------       -----------       -----------
                                    $ 8,973,021       $11,066,167       $17,835,841       $20,725,544
                                    ===========       ===========       ===========       ===========
<CAPTION>

                                        Three Months Ended                    Six Months Ended
                                  --------------------------------      ------------------------------
                                  June 30, 2001       July 1, 2000      June 30, 2001     July 1, 2000
                                  -------------       ------------      -------------     ------------
                                   (Unaudited)        (Unaudited)        (Unaudited)       (Unaudited)

Geographic Area by Destination
   Domestic                                  75%               84%               76%               85%
   International                             25                16                24                15
                                    -----------       -----------       -----------       -----------
                                            100%              100%              100%              100%
                                    ===========       ===========       ===========       ===========
</TABLE>


     No individual country accounted for more than 10% of the Company's total
revenue for the three and six months ended June 30, 2001 and July 1, 2000.


(9)  Initial Public Offering

     On February 2, 2000, the Company completed the initial public offering of
its common stock. Upon the closing of the initial public offering, the Company
issued 3,500,000 shares of its common stock at an offering price of $15.00 per
share and all of the Company's convertible preferred stock automatically
converted into 11,067,238 shares of common stock. On February 4, 2000, the
underwriters exercised in full their over-allotment option to purchase an
additional 525,000 shares at $15.00 per share. Cash proceeds from the sale of
the 4,025,000 shares of common stock, net of the underwriters' discount and
offering expenses, totaled approximately $54.6 million. Also upon closing of the
Company's initial public offering, the authorized capital stock of the Company
consisted of 60,000,000 shares of common stock and 5,000,000 shares of preferred
stock. No shares of preferred stock are outstanding and the terms of the
preferred stock have not been designated.


(10) Related Party Transactions

     In April 2001, the Company loaned, on a full recourse basis, an aggregate
of $1,081,000, to an officer, certain employees and a consultant of the Company.
The loans, included in other assets in the accompanying balance sheet as of June
30, 2001, are payable over periods ranging from four to five years and are in
each case secured by assets of the borrower, including shares of the Company's
common stock owned by the borrower.


                                       7

<PAGE>   10

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


(11) Loan Agreements

     In May 2001, the Company paid the outstanding principal on both the
equipment portion and term loan portion of its loan agreement with a commercial
bank. Following the termination of the loan agreement, the Company entered into
an agreement with another commercial bank for a revolving line of credit. The
revolving line of credit is for $5,000,000 and expires in May 2002 and, subject
to annual review by the commercial bank, may be extended at the discretion of
the commercial bank. Interest on any borrowings under the revolving line of
credit is, at the election of the Company, either the prime rate or at LIBOR
plus 2.25%. Up to $1,500,000 of the $5,000,000 revolving line of credit is
available for standby letters of credit.

     The revolving line of credit agreement contains restrictive covenants that
require the Company to maintain liquidity and net worth ratios and is secured by
certain investments of the Company. At June 30, 2001, $3,000,000 of the
revolving line of credit was outstanding, and the Company was in compliance with
all covenants contained in the revolving line of credit agreement.



                                       8


<PAGE>   11



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

     This Quarterly Report on Form 10-Q contains, in addition to historical
information, forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
involve risks and uncertainties and are not guarantees of future performance.
Our actual results could differ significantly from the results discussed in such
forward-looking statements. In addition, subsequent events and developments may
cause our expectations to change. While we may elect to update these
forward-looking statements, we specifically disclaim any obligation to do so,
even if our expectations change. See "Factors Affecting Future Operating
Results" below.


OVERVIEW

     We develop, manufacture and market an anesthesia monitoring system that we
call the BIS system. The BIS system is based on our patented core technology,
the BIS index. The BIS system provides new information about a patient's status
that allows clinicians to better assess and manage a patient's level of
consciousness in the operating room and intensive care settings and administer
the precise amount of anesthesia needed by each patient. Our proprietary BIS
system includes our BIS monitor or BIS Module Kit, which allows original
equipment manufacturers to incorporate the BIS index into their monitoring
products, and our disposable BIS Sensors. Our latest generation monitor, the
A-2000 BIS Monitor, was cleared for marketing by the Food and Drug
Administration, or the FDA, in February 1998. Our other monitor products are the
A-1000 Monitor, the A-1050 EEG Monitor with BIS and the BIS Module Kit. After
the introduction of the A-2000 BIS Monitor, we ceased active marketing in the
United States of the A-1050 EEG Monitor. In addition to the disposable BIS
Sensor, we offer the Zipprep EEG Electrode.

     We follow a system of fiscal quarters as opposed to calendar quarters.
Under this system, the first three quarters of each fiscal year end on the
Saturday closest to the end of the calendar quarter and the last quarter of the
fiscal year always ends on December 31.

     We offer customers the option either to purchase the BIS monitors outright
or to acquire the BIS monitors pursuant to a sales-type lease agreement whereby
the customer contractually commits to purchase a minimum number of BIS Sensors
per BIS monitor per year. Under this agreement, customers purchase BIS Sensors
and the BIS monitor for the purchase price of the BIS Sensors plus an additional
charge per BIS Sensor to pay for the purchase price of the BIS monitor and
related financing costs over the term of the agreement. These customers are
granted an option to purchase the BIS monitor at the end of the term of the
agreement, which is typically three to five years. Revenue related to BIS
monitors sold pursuant to sales-type leases is recognized at the time of
shipment of the BIS monitors. Sales-type leases accounted for approximately 1%
and 6% of revenue in the three months and 1% and 8% in the six months ended June
30, 2001 and July 1, 2000, respectively.

     Under certain circumstances, we also offer customers the opportunity to use
the BIS monitors under our Equipment Placement program, which we refer to as the
EP program. Under the EP program, these customers are granted the right to use
the BIS monitors for a mutually agreed-upon period of time. During this period,
these customers purchase BIS Sensors at a price that includes a premium above
the list price of the BIS Sensors to cover the rental of the equipment, but
without any minimum purchase commitments. At the end of this period, these
customers have the option of purchasing the BIS monitors, continuing to use them
under the EP program or returning them to us.

     We derive our revenue primarily from sales of monitors, including related
accessories, BIS Module Kits, and sales of disposable sensors. In the three
months ended June 30, 2001 and July 1, 2000, revenue from the sale of monitors
and BIS Module Kits represented approximately 30% and 48%, respectively, of our
revenue, and revenue from the sale of disposable sensors represented
approximately 70% and 52%, respectively, of our revenue. In the six months ended
June 30, 2001 and July 1, 2000, revenue from the sale of monitors and BIS Module
Kits represented approximately 31% and 47%, respectively, of our revenue, and
revenue from the sale of disposable sensors represented approximately 69% and
53%, respectively, of our revenue. We believe that, as a result of increases in
our installed base resulting from the sale of monitors, placements under the EP
program, placements of BIS Module Kits by our original equipment manufacturers
and the recent receipt by our Japanese distributor of marketing clearance from
Japan's Ministry of Health, Labor and Welfare to sell the A-2000 BIS Monitor in
Japan, revenue from the sale of disposable sensors, as a percentage of total
revenue will remain steady in the third fiscal quarter of 2001.


                                       9


<PAGE>   12


     Revenue from domestic sales in the three months ended June 30, 2001 and
July 1, 2000 was approximately $6.7 million and $9.3 million, respectively,
which represented approximately 75% and 84%, respectively, of our revenue. For
the six months ended June 30, 2001 and July 1, 2000, revenue from domestic sales
was approximately $13.5 million and $17.6 million, respectively, which
represented approximately 76% and 85%, respectively, of our revenue. Revenue
from international sales in the three months ended June 30, 2001 and July 1,
2000 was approximately $2.3 million and $1.7 million, respectively, which
represented approximately 25% and 16%, respectively, of our revenue. Revenue
from international sales in the six months ended June 30, 2001 and July 1, 2000
was approximately $4.3 million and $3.1 million, respectively, which represented
approximately 24% and 15%, respectively, of our revenue.

     In December 1998 and March 1999, we established subsidiaries in The
Netherlands and the United Kingdom, respectively, to facilitate our entry into
the international market. We are developing our international sales and
distribution program through a combination of distributors and marketing
partners, including companies with which we have entered into original equipment
manufacturer relationships. We expect to enhance our international third-party
distribution program through direct sales efforts and to support our customers
with clinical specialists. In January 1998, we entered into a distribution
agreement with Nihon Kohden Corporation to distribute BIS monitors in Japan. In
March 2000, Japan's Ministry of Health, Labor and Welfare approved our A-1050
EEG Monitor with BIS for marketing in Japan. In May 2001, Japan's Ministry of
Health, Labor and Welfare approved our A-2000 BIS Monitor for marketing in
Japan. As a result of the approval of the A-2000 BIS Monitor, we shipped 225
A-2000 BIS Monitors to Japan which increased revenue from Japan by 14% as
compared to the second quarter of 2000. Sales to Nihon Kohden represented
approximately 37% and 19%, respectively, of international revenue for the three
and six month periods ended June 30, 2001 and approximately 42% and 54%,
respectively, of international revenue for the three and six months period ended
July 1, 2000. Effective September 1, 2000, we entered into an agreement with
Datex-Ohmeda Division of Instrumentarium Corporation under which Datex-Ohmeda
acts as a nonexclusive distributor of our A-2000 BIS Monitor and related
products in some territories outside the United States.


RESULTS OF OPERATIONS

     The following table presents, for the periods indicated, information
expressed as a percentage of revenue. This information has been derived from our
consolidated statements of operations included elsewhere in this Quarterly
Report on Form 10-Q. You should not draw any conclusions about our future
results from the results of operations for any period.


<TABLE>
<CAPTION>
                                             Three Months Ended        Six Months Ended
                                            --------------------      ------------------
                                            June 30,     July 1,      June 30,   July 1,
                                              2001        2000          2001      2000
                                            --------     -------      --------   -------
<S>                                           <C>          <C>          <C>        <C>
Revenue                                       100%         100%         100%       100%
Costs and expenses:
    Costs of revenue                           32           31           32         31
    Research and development                   20           13           20         14
    Sales and marketing                        81           47           79         48
    General and administrative                 23           15           23         14
                                              ---          ---          ---        ---
             Total costs and expenses         156          106          154        107
                                              ---          ---          ---        ---

Loss from operations                          (56)          (6)         (54)        (7)
Interest income, net                            8           10            9          9
                                              ---          ---          ---        ---
Net income (loss)                             (48)%          4%         (45)%        2%
                                              ===          ===          ===        ===
</TABLE>


                                       10

<PAGE>   13



THREE AND SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE AND SIX MONTHS ENDED
JULY 1, 2000

Revenue. Our revenue decreased to approximately $9.0 million in the three months
ended June 30, 2001 from approximately $11.1 million in the three months ended
July 1, 2000, a decrease of approximately 19%. Our revenue decreased to
approximately $17.8 million in the six months ended June 30, 2001 from
approximately $20.7 million in the six months ended July 1, 2000, a decrease of
approximately 14%. Revenue from the sale of monitors and BIS Module Kits
decreased to approximately $2.7 million in the three months ended June 30, 2001
from approximately $5.3 million in the three months ended July 1, 2000, a
decrease of approximately 48%. For the six months ended June 30, 2001, revenue
from the sale of monitors and BIS Module Kits decreased to approximately $5.5
million from approximately $9.7 million in the six months ended July 1, 2000, a
decrease of approximately 43%. There were three primary factors that contributed
to the decrease in revenue for the three and six month periods ended June 30,
2001 as compared to the three and six month periods ended July 1, 2000. First,
many of our customers obtained monitors under our Equipment Placement program
which was introduced in the second half of 2000 and which had an adverse impact
on our revenue from the sale of monitors. Under the Equipment Placement program,
monitors are placed free of charge for customers willing to purchase sensors for
a premium price. Second, because of the approval by the FDA of a competitive
monitoring product, domestic customers have elected to delay purchase decisions
until they have an opportunity to evaluate the competitive product. Third,
revenue from Japan decreased approximately 51% in the six months ended June 30,
2001 as compared to the six months ended July 1, 2000 primarily because there
was no revenue from Japan in the first quarter of 2001 as our Japanese
distributor delayed purchases while awaiting marketing approval for our A-2000
BIS Monitor from Japan's Ministry of Health, Labor and Welfare, which was
received in May 2001. The decrease in revenue from monitors and monitor related
accessories for the three and six month periods ended June 30, 2001, was offset
by an increase in sensor revenue of approximately 8% and 12%, respectively, over
the three and six month periods ended July 1, 2000.

     Revenue from the sale of disposable sensors increased to approximately $6.3
million in the three months ended June 30, 2001 from approximately $5.8 million
in the three months ended July 1, 2000, an increase of approximately 8%. Revenue
from the sale of disposable sensors increased to approximately $12.3 million in
the six months ended June 30, 2001 from approximately $11.0 million in the six
months ended July 1, 2000, an increase of approximately 12%. The increase in
revenue from the sale of disposable sensors was primarily attributable to an
increase of approximately 7% and 10%, respectively, in the number of disposable
sensors sold as a result of growth in the installed base of monitors and BIS
Module Kits compared to the three and six month periods ended July 1, 2000.

     Our gross profit was approximately 68% of revenue in the three and six
months ended June 30, 2001 as compared to a gross profit of approximately 69% of
revenue in the three and six months ended July 1, 2000. The decrease in gross
profit for the three and six months ended June 30, 2001 was primarily the result
of the additional cost of sales related to the depreciation on monitors placed
under our Equipment Placement program and monitors used by customers for
evaluation purposes and the lower gross margin on the BIS Module Kits. Going
forward, we expect that sales of higher-margin disposable sensors, as a
percentage of revenue, will continue to represent the majority of our sales as
the installed base of monitors and BIS Module Kits continues to grow and we
increase our investments in sales and marketing in an effort to enhance the use
of the BIS system, and accordingly, to increase sensor volume and revenue.

Research and Development. Research and development expenses increased to
approximately $1.8 million in the three months ended June 30, 2001 from
approximately $1.4 million in the three months ended July 1, 2000, an increase
of approximately 26%. Research and development expenses increased to
approximately $3.6 million in the six months ended June 30, 2001 from
approximately $2.8 million in the six months ended July 1, 2000, an increase of
approximately 29%. The increase in research and development expenses for the
three and six months ended June 30, 2001 as compared to the three and six months
ended July 1, 2000, was primarily attributable to an increase of approximately
49% and 43%, respectively, in research and development personnel and related
payroll and other expenses, an increase of approximately 24% and 17%,
respectively, in clinical study expenses, and an increase of approximately 30%
and 17%, respectively, in external consultants and contractor expenses. In
addition, the increase in research and development expenses for the three and
six months ended June 30, 2001 as compared to the three and six months ended
July 1, 2000, was attributable to increased costs incurred in connection with
the continued product development efforts related to the BIS Sensor XP and BIS
Pediatric Sensor, each of which was recently approved by the FDA, the BIS Module
Kit and product improvement efforts related to the A-2000 BIS Monitor. We expect
research and development expenses to increase slightly as we continue to invest
in the development of product improvements, product extensions and new
applications for our technology.


                                       11

<PAGE>   14



Sales and Marketing. Sales and marketing expenses increased to approximately
$7.2 million in the three months ended June 30, 2001 from approximately $5.2
million in the three months ended July 1, 2000, an increase of approximately
39%. Sales and marketing expenses increased to approximately $14.2 million in
the six months ended June 30, 2001 from approximately $10.0 million in the six
months ended July 1, 2000, an increase of approximately 43%. The increase in
sales and marketing expenses in the three and six months ended June 30, 2001 as
compared to the three and six months ended July 1, 2000 was primarily
attributable to an increase of approximately 42% and 52%, respectively, in sales
and marketing personnel and related payroll and other expenses, an increase of
approximately 26% and 23%, respectively, in external consultant expenses
primarily relating to our investment in new sales and marketing programs, an
increase of approximately 12% and 10%, respectively, in operating expenses
associated with our international subsidiaries, and an increase of approximately
6% and 5%, respectively, in fees and commissions related to the agreements with
group purchasing organizations, original equipment manufacturers and
distributors. We expect sales and marketing expenses to increase as we continue
to expand our international operations, leverage our existing relationships with
group purchasing organizations, pursue additional relationships with group
purchasing organizations, enhance our sales and marketing programs and engage in
activities to further educate and promote the use of the BIS system by our
customers.

General and Administrative. General and administrative expenses increased to
approximately $2.0 million in the three months ended June 30, 2001 from
approximately $1.7 million in the three months ended July 1, 2000, an increase
of approximately 18%. General and administrative expenses increased to
approximately $4.1 million in the six months ended June 30, 2001 from
approximately $3.0 million in the six months ended July 1, 2000, an increase of
approximately 37%. The increase in general and administrative expenses in the
three and six months ended June 30, 2001 as compared to the three and six months
ended July 1, 2000 was attributable to an increase of approximately 41% and 18%,
respectively, in general and administrative personnel and related payroll and
other expenses. The increase also included an increase in expenses related to
enhancements of our investor relations capabilities, insurance expenses, other
professional services, and information systems of approximately 51% and 44%,
respectively. We expect general and administrative expenses to increase as we
increase the number of personnel and related resources required to support our
growth.

Interest Income (Expense). Net interest income decreased to approximately
$724,000 in the three months ended June 30, 2001 from approximately $1.1 million
in the three months ended July 1, 2000, a decrease of approximately 34%. Net
interest income decreased to approximately $1.7 million in the six months ended
June 30, 2001 from approximately $1.9 million in the six months ended July 1,
2000, a decrease of approximately 13%. Interest income decreased to
approximately $829,000 in the three months ended June 30, 2001 from
approximately $1.3 million in the comparable period in 2000, a decrease of
approximately 35%. Interest income decreased to approximately $1.9 million in
the six months ended June 30, 2001 from approximately $2.3 million in the six
months ended July 1, 2000, a decrease of approximately 17%. The decrease in
interest income is primarily attributable to lower cash and investment balances
resulting from continued operating losses and other uses of cash and lower
interest rates on our investments. Interest expense decreased to approximately
$104,000 in the three months ended June 30, 2001 from approximately $170,000 in
the comparable period in 2000, a decrease of approximately 39%. Interest expense
decreased to approximately $223,000 in the six months ended June 30, 2001 from
approximately $372,000 in the six months ended July 1, 2000, a decrease of
approximately 40%. The decrease in interest expense in the three and six months
ended June 30, 2001 was a result of the repayment of our equipment and term
loans in May 2001 in addition to lower average outstanding debt obligations
resulting from payments under our other debt obligations.

Net Income (Loss). As a result of the factors discussed above, in the three and
six months ended June 30, 2001, we had a net loss of approximately $4.3 million
and $8.1 million, respectively, as compared to net income of approximately
$393,000 and $419,000 in the three and six months ended July 1, 2000,
respectively.



                                       12


<PAGE>   15


LIQUIDITY AND CAPITAL RESOURCES

     From our inception through January 2000, we financed our operations
primarily from the sale of convertible preferred stock. Through June 30, 2001,
we raised approximately $67.6 million from private equity financings and have
received approximately $3.4 million in equipment financing and approximately
$3.7 million of financing related to our investments in sales-type leases. We
also received approximately $2.8 million of financing under a term loan in
December 1999. The outstanding principal on the equipment and term loans was
paid in May 2001. In February 2000, we closed our initial public offering of an
aggregate of 4,025,000 shares of common stock and received net proceeds of
approximately $54.6 million. In May 2001, we entered into an agreement with a
commercial bank for a $5.0 million revolving line of credit which expires in May
2002. At June 30, 2001, $3.0 million was outstanding under this line of credit.

     Working capital at June 30, 2001 was approximately $50.0 million compared
to approximately $58.5 million at December 31, 2000. The decrease in working
capital from December 31, 2000 to June 30, 2001 was primarily attributable to
continued net operating losses of approximately $8.1 million.

     We used approximately $9.3 million of cash for operations in the six months
ended June 30, 2001 as compared to approximately $3.0 million in the six months
ended July 1, 2000. Cash used for operations during this period was primarily
driven by operating losses, increases in net accounts receivable of
approximately $2.2 million, inventory of approximately $1.5 million, and a
decrease in deferred revenue of approximately $324,000, offset by a decrease in
investment in sales-type leases of approximately $783,000.

     We received approximately $5.9 million of cash from investing activities in
the six months ended June 30, 2001 as compared to using approximately $29.3
million in the six months ended July 1, 2000. The cash received from investing
activities in the six months ended June 30, 2001 was primarily the result of the
sales and maturities of our investments in marketable securities as compared to
the investment of the proceeds from our initial public offering of common stock
in the six months ended July 1, 2000. Capital expenditures were approximately
$926,000 for the six months ended June 30, 2001 primarily for improvements to
our information systems and additions to demonstration equipment as compared to
approximately $3.6 million in the six months ended July 1, 2000 which was used
primarily for manufacturing equipment and leasehold improvements to our new
facility. In April 2001, we loaned, on a full recourse basis, an aggregate of
$1,081,000, to an officer, certain employees and a consultant. The loans are
payable over periods ranging from four to five years and each is secured by
assets of the borrower, including shares of our common stock owned by the
borrower.

     We received approximately $1.0 million of cash from financing activities in
the six months ended June 30, 2001 as compared to receiving approximately $54.8
million of cash from financing activities in the six months ended July 1, 2000.
The cash received from financing activities in the six months ended June 30,
2001 was primarily a result of proceeds from our working capital line of credit
of $3.0 million and the issuance of shares of our common stock upon the
exercise of stock options, partially offset by payments of principal on debt.
Cash received for the six months ended July 1, 2000 was a result of the closing
of our initial public offering of common stock.

     At June 30, 2001, we did not have any commitments for capital expenditures;
however, we anticipate that the level of capital expenditures in the third
fiscal quarter of 2001 will remain consistent with that of the second fiscal
quarter which was approximately $450,000.

     We believe that the financial resources available to us, including our
current working capital and availability under our revolving line of credit,
will be sufficient to finance our planned operations and capital expenditures at
least through 2001. However, our future liquidity and capital requirements will
depend upon numerous factors, including the resources required to further
develop our marketing and sales organization domestically and internationally,
to expand manufacturing capacity, to finance our sales-type lease program and EP
program and to meet market demand for our products.



                                       13

<PAGE>   16



INCOME TAXES

     We have net operating loss and research and development tax credit
carryforwards for federal income tax purposes that will expire commencing in the
year 2002 through the year 2019 if not utilized.

     The net operating loss and research and development tax credit
carryforwards are subject to review by the Internal Revenue Service. Ownership
changes, as defined under Section 382 in the Internal Revenue Code, may limit
the amount of these tax attributes that can be utilized annually to offset
future taxable income or tax liabilities. The amount of the annual limitation is
determined based on our value immediately prior to the ownership change.
Subsequent ownership changes may further affect the limitation in future years.


CONVERSION TO EURO

     Eleven of the 15 members of the European Union have agreed to adopt the
Euro as their legal currency. Our current information systems allow us to
process Euro-denominated transactions. We are also assessing the business
implications of the conversion to the Euro, including long-term competitive
implications and the effect of market risk with respect to financial
instruments. Substantially all of our international sales are denominated in
United States dollars. We do not believe the Euro will have a significant effect
on our business, financial condition or results of operations. We will continue
to assess the impact of Euro conversion issues as the applicable accounting,
tax, legal and regulatory guidance evolves.


RECENT ACCOUNTING PRONOUNCEMENTS

     In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivatives and Hedging Activities, which establishes accounting and reporting
standards of derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. In June 1999, the FASB
issued SFAS No. 137, Accounting for Derivatives and Hedging Activities --
Deferral of the Effective Date of FASB Statement No. 133, which defers the
effective date of SFAS No. 133 to be effective for all fiscal quarters beginning
after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities - an Amendment of
FASB Statement No. 133, which amends the accounting and reporting standards of
SFAS No. 133 for certain derivative instruments and certain hedging activities.
Effective January 1, 2001, we adopted SFAS No. 133, as amended. The adoption of
SFAS No. 133, as amended, did not have a material effect on our financial
condition and results of operations as we do not currently hold any derivative
instruments or engage in hedging activities.

     In December 1999, the Securities and Exchange Commission, or SEC, issued
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements, which provides guidance related to revenue recognition in financial
statements filed with the SEC. SAB No. 101 requires companies to report any
changes in revenue recognition as a cumulative change in accounting principle at
the time of implementation in accordance with Accounting Principles Board
Opinion No. 20, Accounting Changes. Effective January 1, 2000, we adopted SAB
No. 101. The adoption of SAB No. 101 did not have a material impact on our
results of operations, cash flows or financial position.

     In October 2000, the FASB issued SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities - a replacement
of FASB Statement No. 125. SFAS No. 140 reviews criteria for accounting
securitizations, other financial asset transfers and collateral, and introduces
new disclosures. The new disclosure requirements must be implemented for fiscal
years ending after December 15, 2000. The other provisions of SFAS No. 140 apply
prospectively to the transfer of financial assets and extinguishments of
liabilities occurring after March 31, 2001. SFAS No. 140 carries forward most of
the provisions of SFAS No. 125 without amendment. This pronouncement did not
have a material impact on our results of operations, cash flows or financial
position as we have not currently transferred any financial assets.



                                       14


<PAGE>   17



FACTORS AFFECTING FUTURE OPERATING RESULTS

     This Quarterly Report on Form 10-Q includes forward looking statements,
including information relating to our ability to achieve profitability,
information with respect to market acceptance of our BIS system, continued
growth in sales of our BIS monitors and BIS Sensors, our dependence on the BIS
system, our ability to remain competitive and achieve future growth, information
with respect to other plans and strategies for our business and factors that may
influence our revenue for the fiscal quarter ending September 29, 2001. The
following factors represent current challenges to us that create risk and
uncertainty. Failure to adequately overcome any of the following challenges
could have a material adverse effect on our results of operations, business or
financial condition.

WE WILL NOT BE PROFITABLE IF HOSPITALS AND ANESTHESIA PROVIDERS DO NOT BUY AND
USE OUR BIS SYSTEM IN SUFFICIENT QUANTITIES.

     Customers may determine that the cost of the BIS system exceeds cost
savings in drugs, personnel and post-anesthesia care recovery resulting from use
of the BIS system. In addition, hospitals and anesthesia providers may not
accept the BIS system as an accurate means of assessing a patient's level of
consciousness during surgery. If extensive or frequent malfunctions occur, these
providers may also conclude that the BIS system is unreliable. If hospitals and
anesthesia providers do not accept the BIS system as cost-effective, accurate or
reliable, they will not buy and use the BIS system in sufficient quantities to
enable us to be profitable.

WE DEPEND ON OUR BIS SYSTEM FOR SUBSTANTIALLY ALL OF OUR REVENUE, AND IF THE BIS
SYSTEM DOES NOT GAIN WIDESPREAD MARKET ACCEPTANCE, THEN OUR REVENUE WILL NOT
GROW.

     We began selling our current BIS system in early 1998. To date, we have not
achieved widespread market acceptance of the BIS system. Because we depend on
our BIS system for substantially all of our revenue and we have no other
significant products, if we fail to achieve widespread market acceptance we will
not be able to sustain or grow our product revenue.

CASES OF SURGICAL AWARENESS DURING MONITORING WITH THE BIS SYSTEM COULD LIMIT
MARKET ACCEPTANCE OF BIS SYSTEMS AND COULD EXPOSE US TO PRODUCT LIABILITY
CLAIMS.

     Clinicians have reported to us a total of 76 cases of possible surgical
awareness during surgical procedures monitored with the BIS system as of June
30, 2001. In most of the 76 cases that were reported to us, when BIS index
values were recorded at the time of awareness, high BIS index values were noted,
indicating that the BIS index correctly identified the increased risk of
awareness in these patients. However, in a small number of these reported cases,
surgical awareness may not have been detected by monitoring with the BIS system.
Not all cases of surgical awareness during surgical procedures monitored with
the BIS system may be reported to us, and we have not systematically solicited
reports of surgical awareness. Anesthesia providers and hospitals may elect not
to purchase and use BIS systems if there is adverse publicity resulting from the
report of cases of surgical awareness that were not detected during procedures
monitored with the BIS system. If anesthesia providers and hospitals do not
purchase and use the BIS system, then we may not sustain or grow our product
revenue. Although we do not claim that patient monitoring with the BIS system
will reduce the incidence of surgical awareness, we may be subject to product
liability claims for cases of surgical awareness during surgical procedures
monitored with the BIS system. These claims could require us to spend
significant time and money in litigation or to pay significant damages.



                                       15

<PAGE>   18


WE MAY NOT BE ABLE TO COMPETE WITH NEW PRODUCTS OR ALTERNATIVE TECHNIQUES
DEVELOPED BY OTHERS, WHICH COULD IMPAIR OUR ABILITY TO REMAIN COMPETITIVE AND
ACHIEVE FUTURE GROWTH.

     The medical industry in which we market our products is characterized by
rapid product development and technological advances. Our revenue has been
adversely affected by commercial introduction of an FDA-approved competitive
anesthesia monitoring product. If we do not compete effectively with this new
monitoring product, our revenue will be adversely affected. Our current or
planned products are at risk of obsolescence from:

     -    other new monitoring products, based on new or improved technologies,
     -    new products or technologies used on patients or in the operating room
          during surgery in lieu of monitoring devices,
     -    electrical or mechanical interference from new or existing products or
          technologies,
     -    alternative techniques for evaluating the effects of anesthesia,
     -    significant changes in the methods of delivering anesthesia, and
     -    the development of new anesthetic agents.

     We may not be able to improve our products or develop new products or
technologies quickly enough to maintain a competitive position in our markets
and continue to grow our business.

IF WE DO NOT SUCCESSFULLY DEVELOP AND INTRODUCE ENHANCED OR NEW PRODUCTS WE
COULD LOSE REVENUE OPPORTUNITIES AND CUSTOMERS.

     As the market for our BIS system matures, we need to develop and introduce
new products for anesthesia monitoring or other applications. We face at least
the following risks:

     -    we may not successfully adapt the BIS system to function properly in
          the intensive care unit, for procedural sedation, when used with
          anesthetics we have not tested or with patient populations we have not
          studied, such as infants, and
     -    our technology is complex, and we may not be able to develop it
          further for applications outside anesthesia monitoring.

     If we do not successfully adapt the BIS system for new products and
applications both within and outside the field of anesthesia monitoring, then we
could lose revenue opportunities and customers.

IF WE DO NOT DEVELOP AND IMPLEMENT A SUCCESSFUL SALES AND MARKETING STRATEGY, WE
WILL NOT EXPAND OUR BUSINESS.

     In 2000 we experienced higher than anticipated turnover in our direct sales
force and we underestimated the impact that this turnover in our direct sales
force would have on our sales efforts. In the third fiscal quarter of 2001, we
are reorganizing our sales force under a new vice president of North American
field operations. Until the reorganization is complete and newly hired sales
representatives become experienced with respect to our products, customer base
and sales programs, our sales efforts will be adversely affected. If the
reorganization is not completed in a timely and successful manner and we
continue to experience high turnover in our direct sales force, we will not be
able to sustain and grow our product revenue. In addition, our current sales and
marketing operation is not sufficient to achieve the level of market awareness
and sales we need to expand our business. We have only limited sales and
marketing experience both in the United States and internationally and may not
be successful in developing and implementing our strategy. We need to:

     -    provide or assure that distributors and original equipment
          manufacturers provide the technical and educational support customers
          need to use the BIS system successfully,
     -    promote frequent use of the BIS system so that sales of our disposable
          BIS Sensors increase,
     -    establish and implement successful marketing and sales programs that
          encourage our customers to purchase our products or the products that
          are made by original equipment manufacturers incorporating our
          technology,
     -    manage geographically dispersed operations, and
     -    modify our products for foreign markets.


                                       16


<PAGE>   19



IN ORDER TO REACH THE LEVEL OF SALES WE NEED TO ACHIEVE PROFITABILITY, WE NEED
TO FURTHER DEVELOP OUR DIRECT AND INDIRECT SALES CHANNELS.

     In order to increase our sales, we need to continue to add domestic and
international distributors, original equipment manufacturers and other sales
channels and increase sales through these channels. In addition, we need to hire
and train more sales representatives. We are also reorganizing our sales
organization and implementing new sales and marketing programs and clinical
education programs to promote the use of our BIS system by our customers. If we
do not further develop our direct and indirect sales channels and successfully
implement the new sales organization and new sales and marketing programs and
clinical education program that encourage our customers to purchase and use our
products, we will not reach the level of sales necessary to achieve
profitability.

OUR THIRD-PARTY DISTRIBUTION AND ORIGINAL EQUIPMENT MANUFACTURER RELATIONSHIPS
COULD NEGATIVELY AFFECT OUR PROFITABILITY, CAUSE SALES OF OUR PRODUCTS TO
DECLINE AND BE DIFFICULT TO TERMINATE IF WE ARE DISSATISFIED.

     Sales through distributors could be less profitable than direct sales.
Sales of our products through multiple channels could also confuse customers and
cause the sale of our products to decline. We do not control our original
equipment manufacturers and distribution partners. Our partners could sell
competing products, may not incorporate our technology into their products in a
timely manner and may devote insufficient sales efforts to our products. Our
partners are generally not required to purchase minimum quantities. As a result,
even if we are dissatisfied with the performance of our partners, we may be
unable to terminate our agreements with these partners or enter into alternative
arrangements.

WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR INTERNATIONAL
EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND MAINTAINING
FOREIGN OPERATIONS.

     A component of our growth strategy is to expand our presence in foreign
markets. We conduct international business primarily in Europe and Japan and we
are attempting to increase the number of countries in which we do business. It
is costly to establish international facilities and operations and to promote
the BIS system in international markets. In addition, we have little experience
in marketing and distributing products for these markets. Revenue from
international activities may not offset the expense of establishing and
maintaining these foreign operations.

WE MAY NOT BE ABLE TO MEET THE UNIQUE OPERATIONAL, LEGAL AND FINANCIAL
CHALLENGES THAT WE WILL ENCOUNTER IN OUR INTERNATIONAL OPERATIONS, WHICH MAY
LIMIT THE GROWTH OF OUR BUSINESS.

     We are increasingly subject to a number of challenges which specifically
relate to our international business activities. These challenges include:

     -    failure of local laws to provide the same degree of protection against
          infringement of our intellectual property,
     -    protectionist laws and business practices that favor local
          competitors, which could slow our growth in international markets,
     -    difficulties in terminating or modifying distributor arrangements
          because of restrictions in markets outside the United States,
     -    less acceptance by foreign anesthesia providers of the use of
          disposable products similar to the BIS Sensor,
     -    delays in regulatory approval of our products,
     -    currency conversion issues arising from sales denominated in
          currencies other than the United States dollar,
     -    longer sales cycles to sell products like the BIS system to hospitals
          and outpatient surgical centers, which could slow our revenue growth
          from international sales, and
     -    longer accounts receivable payment cycles and difficulties in
          collecting accounts receivable.

     If we are unable to meet and overcome these challenges, our international
operations may not be successful which would limit the growth of our business.


                                       17

<PAGE>   20


WE MAY EXPERIENCE CUSTOMER DISSATISFACTION AND OUR REPUTATION COULD SUFFER IF WE
FAIL TO MANUFACTURE ENOUGH PRODUCTS TO MEET OUR CUSTOMERS' DEMANDS.

     We rely on third-party manufacturers to assemble and manufacture the
components of our BIS monitors and a portion of our BIS Sensors. We manufacture
substantially all BIS Sensors in our own manufacturing facility. We have only
one manufacturing facility. If we fail to produce enough products at our own
manufacturing facility or at a third-party manufacturing facility or experience
a termination or modification of any manufacturing arrangement with a third
party, we may be unable to deliver products to our customers on a timely basis.
Our failure to deliver products on a timely basis could lead to customer
dissatisfaction and damage our reputation.

OUR RELIANCE ON SOLE SUPPLIERS COULD ADVERSELY AFFECT OUR ABILITY TO MEET OUR
CUSTOMERS' DEMANDS FOR OUR PRODUCTS IN A TIMELY MANNER OR WITHIN BUDGET.

     Some of the components that are necessary for the assembly of our BIS
system, including some of the components used in the BIS Sensor, are currently
provided to us by separate sole suppliers or a limited group of suppliers. We
purchase components through purchase orders rather than long-term supply
agreements and generally do not maintain large volumes of inventory. We have
experienced shortages and delays in obtaining some of the components of our BIS
systems in the past, and we may experience similar delays or shortages in the
future. The disruption or termination of the supply of components could cause a
significant increase in the costs of these components, which could affect our
profitability. A disruption or termination in the supply of components could
also result in our inability to meet demand for our products, which could lead
to customer dissatisfaction and damage our reputation. Furthermore, if we are
required to change the manufacturer of a key component of the BIS system, we may
be required to verify that the new manufacturer maintains facilities and
procedures that comply with quality standards and with all applicable
regulations and guidelines. The delays associated with the verification of a new
manufacturer could delay our ability to manufacture BIS systems in a timely
manner or within budget.

WE MAY BE REQUIRED TO BRING LITIGATION TO ENFORCE OUR INTELLECTUAL PROPERTY
RIGHTS, WHICH MAY RESULT IN SUBSTANTIAL EXPENSE AND MAY DIVERT OUR ATTENTION
FROM THE IMPLEMENTATION OF OUR BUSINESS STRATEGY.

     We believe that the success of our business depends, in part, on obtaining
patent protection for our products, defending our patents once obtained and
preserving our trade secrets. We rely on a combination of contractual
provisions, confidentiality procedures and patent, trademark and trade secret
laws to protect the proprietary aspects of our technology. These legal measures
afford only limited protection and competitors may gain access to our
intellectual property and proprietary information. Litigation may be necessary
to enforce our intellectual property rights, to protect our trade secrets and to
determine the validity and scope of our proprietary rights. Any litigation could
result in substantial expense and diversion of our attention from the growth of
the business and may not be adequate to protect our intellectual property
rights.

WE MAY BE SUED BY THIRD PARTIES WHICH CLAIM THAT OUR PRODUCTS INFRINGE ON THEIR
INTELLECTUAL PROPERTY RIGHTS, PARTICULARLY BECAUSE THERE IS SUBSTANTIAL
UNCERTAINTY ABOUT THE VALIDITY AND BREADTH OF MEDICAL DEVICE PATENTS.

     We may be exposed to litigation by third parties based on claims that our
products infringe the intellectual property rights of others. This risk is
exacerbated by the fact that the validity and breadth of claims covered in
medical technology patents involve complex legal and factual questions for which
important legal principles are unresolved. Any litigation or claims against us,
whether or not valid, could result in substantial costs, could place a
significant strain on our financial resources and could harm our reputation. In
addition, intellectual property litigation or claims could force us to do one or
more of the following:

     -    cease selling, incorporating or using any of our products that
          incorporate the challenged intellectual property, which would
          adversely affect our revenue,
     -    obtain a license from the holder of the infringed intellectual
          property right, which license may not be available on reasonable
          terms, if at all, and
     -    redesign our products, which would be costly and time-consuming.


                                       18

<PAGE>   21



WE COULD BE EXPOSED TO SIGNIFICANT PRODUCT LIABILITY CLAIMS WHICH COULD DIVERT
MANAGEMENT ATTENTION AND ADVERSELY AFFECT OUR CASH BALANCES, OUR ABILITY TO
OBTAIN AND MAINTAIN INSURANCE COVERAGE AT SATISFACTORY RATES OR IN ADEQUATE
AMOUNTS AND OUR REPUTATION.

     The manufacture and sale of our products expose us to product liability
claims and product recalls, including those which may arise from misuse or
malfunction of, or design flaws in, our products or use of our products with
components or systems not manufactured or sold by us. Product liability claims
or product recalls, regardless of their ultimate outcome, could require us to
spend significant time and money in litigation or to pay significant damages. We
currently maintain insurance; however, it might not cover the costs of any
product liability claims made against us. Furthermore, we may not be able to
obtain insurance in the future at satisfactory rates or in adequate amounts. In
addition, publicity pertaining to the misuse or malfunction of, or design flaws
in, our products could impair our ability to successfully market and sell our
products.

SEVERAL CLASS ACTION LAWSUITS HAVE BEEN FILED AGAINST THE UNDERWRITERS OF OUR
INITIAL PUBLIC OFFERING WHICH MAY RESULT IN NEGATIVE PUBLICITY AND POTENTIAL
LITIGATION AGAINST US THAT WOULD BE COSTLY TO DEFEND AND THE OUTCOME OF WHICH IS
UNCERTAIN AND MAY HARM OUR BUSINESS.

     The underwriters of our initial public offering are named as defendants in
several purported class action complaints which have been filed allegedly on
behalf of certain persons who purchased shares of our common stock between
January 28, 2000 and December 6, 2000. These complaints allege violations of the
Securities Act of 1933 and the Securities Exchange Act of 1934. Primarily they
allege that there was undisclosed compensation received by our underwriters in
connection with our initial public offering. While we and our officers and
directors have not been named as defendants in these suits, based on comparable
lawsuits filed against other companies, there can be no assurance that we and
our officers and directors will not be named in similar complaints in the
future.

     We can provide no assurance as to the outcome of these complaints or any
potential suit against us or our officers and directors. Any conclusion of these
matters in a manner adverse to us would have a material adverse affect on our
financial position and results of operations. In addition, the costs to us of
defending any litigation or other proceeding, even if resolved in our favor,
could be substantial. Such litigation could also substantially divert the
attention of our management and our resources in general. Uncertainties
resulting from the initiation and continuation of any litigation or other
proceedings and the negative publicity associated with this litigation could
harm our ability to compete in the marketplace.

FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS COULD CAUSE OUR STOCK PRICE TO
DECREASE.

     Our operating results have fluctuated significantly from quarter to quarter
in the past and are likely to vary in the future. These fluctuations are due to
several factors relating to the sale of our products, including the timing and
volume of customer orders for our BIS system, implementation of our EP program,
use of and demand for our BIS Sensors, customer cancellations, introduction of
competitive products, changes in management, turnover in our sales force,
reductions in orders by our distribution partners and the timing and amount of
our expenses. Because of these fluctuations, it is likely that in some future
quarter or quarters our operating results could again fall below the
expectations of securities analysts or investors. If our quarterly operating
results are below expectations in the future, the market price of our stock
would also be likely to decrease. In addition, because we do not have a
significant backlog of customer orders for our BIS system, revenue in any
quarter depends on orders received in that quarter. Our quarterly results may
also be adversely affected because some customers may have inadequate financial
resources to purchase our products or may fail to pay for our products after
receiving them. In particular, hospitals are increasingly experiencing financial
constraints, consolidations and reorganizations as a result of cost containment
measures and declining third-party reimbursement for services, which may result
in decreased product orders or an increase in bad debts in any quarter.


                                       19


<PAGE>   22



VARIOUS MARKET FACTORS MAY ADVERSELY AFFECT OUR QUARTERLY OPERATING RESULTS
DURING THE THIRD FISCAL QUARTER OF 2001 AND FOR THE YEAR ENDING DECEMBER 31,
2001.

     Various factors may adversely affect our quarterly operating results during
the third fiscal quarter of 2001 and the year ending December 31, 2001. We are
facing increased competition in the domestic level of consciousness monitoring
market as a result of a new monitoring system approved by the FDA in mid-2000.
Second, during 2000 we experienced higher than anticipated turnover in our
direct sales force and in the third fiscal quarter of 2001 we are reorganizing
our sales and clinical organizations. This may adversely impact our revenue for
the third fiscal quarter of 2001, depending in part on both the timing of when
newly hired sales representatives become experienced with respect to our
products, customer base and sales programs. Third, in 2000 we underestimated the
amount of clinical education necessary to bring our installed base up to
expected sensor utilization levels. This may adversely impact our revenue for
the third fiscal quarter of 2001, depending in part on the timing and
effectiveness of our new clinical education programs. The continuation of
difficult worldwide economic conditions, reductions in hospital purchasing
programs and placement of monitors under our EP program may also adversely
impact our revenue for the third fiscal quarter of 2001.

WE MAY NOT RESERVE AMOUNTS ADEQUATE TO COVER PRODUCT OBSOLESCENCE, CLAIMS AND
RETURNS, WHICH COULD RESULT IN UNANTICIPATED EXPENSES AND FLUCTUATIONS IN
OPERATING RESULTS.

     Depending on factors such as the timing of our introduction of new products
which utilize our BIS technology, as well as warranty claims and product
returns, we may need to reserve amounts in excess of those currently reserved
for product obsolescence, excess inventory, warranty claims and product returns.
These reserves may not be adequate to cover all costs associated with these
items. If these reserves are inadequate, we would be required to incur
unanticipated expenses which could result in unexpected fluctuations in
quarterly operating results.

WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY, WHICH COULD RESULT IN PRICE
REDUCTIONS AND DECREASED DEMAND FOR OUR PRODUCTS.

     We are facing increased competition in the domestic level of consciousness
monitoring market as a result of a new monitoring system approved by the FDA in
mid-2000. This product is marketed by a well-established medical products
company with significant resources. We may not be able to compete effectively
with this and other potential competitors. We may also face substantial
competition from companies which may develop sensor products that compete with
our proprietary BIS Sensors for use with our BIS monitors or with third-party
monitoring systems or anesthesia delivery systems that incorporate the BIS
index. We also expect to face competition from companies currently marketing
conventional electroencephalogram, or EEG, monitors using standard and novel
signal-processing techniques. Other companies may develop anesthesia-monitoring
systems that perform better than the BIS system and/or sell for less. In
addition, one or more of our competitors may develop products that are
substantially equivalent to our FDA-approved products, in which case they may be
able to use our products as predicate devices to more quickly obtain FDA
approval of their competing products. Medical device companies developing these
and other competitive products may have greater financial, technical, marketing
and other resources than we do. Competition in the sale of anesthesia-monitoring
systems could result in price reductions, fewer orders, reduced gross margins
and loss of market share.


                                       20

<PAGE>   23



OUR ABILITY TO MARKET AND SELL OUR PRODUCTS AND GENERATE REVENUE DEPENDS UPON
RECEIPT OF DOMESTIC AND FOREIGN REGULATORY APPROVAL OF OUR PRODUCTS AND
MANUFACTURING OPERATIONS.

     Before we can market new products in the United States we must obtain
clearance from the United States Food and Drug Administration, or FDA. If the
FDA concludes that any of our products do not meet the requirements to obtain
clearance of a premarket notification under Section 510(k) of the Food, Drug and
Cosmetic Act, then we would be required to file a premarket approval
application. The approval process for a premarket approval application is
lengthy, expensive and typically requires extensive preclinical and clinical
trial data. We may not obtain clearance of a 510(k) notification or approval of
a premarket approval application with respect to any of our products on a timely
basis, if at all. If we fail to obtain timely clearance or approval for our
products, we will not be able to market and sell our products, which will limit
our ability to generate revenue. We may also be required to obtain clearance of
a 510(k) notification from the FDA before we can market certain previously
marketed products which we modify after they have been cleared. We have made
certain enhancements to our currently marketed products which we have determined
do not necessitate the filing of a new 510(k) notification. However, if the FDA
does not agree with our determination, it will require us to file a new 510(k)
notification for the modification and we may be prohibited from marketing the
modified device until we obtain FDA clearance.

     The FDA also requires us to adhere to current Good Manufacturing Practices
regulations, which include production design controls, testing, quality control,
storage and documentation procedures. The FDA may at any time inspect our
facilities to determine whether adequate compliance has been achieved.
Compliance with current Good Manufacturing Practices regulations for medical
devices is difficult and costly. In addition, we may not continue to be
compliant as a result of future changes in, or interpretations of, regulations
by the FDA or other regulatory agencies. If we do not achieve continued
compliance, the FDA may withdraw marketing clearance or require product recall.
When any change or modification is made to a device or its intended use, the
manufacturer may be required to reassess compliance with current Good
Manufacturing Practices regulations, which may cause interruptions or delays in
the marketing and sale of our products.

     Sales of our products outside the United States are subject to foreign
regulatory requirements that vary from country to country. The time required to
obtain approvals from foreign countries may be longer than that required for FDA
approval, and requirements for foreign licensing may differ from FDA
requirements.

     The federal, state and foreign laws and regulations regarding the
manufacture and sale of our products are subject to future changes, as are
administrative interpretations of regulatory agencies. If we fail to comply with
applicable federal, state or foreign laws or regulations, we could be subject to
enforcement actions, including product seizures, recalls, withdrawal of
clearances or approvals and civil and criminal penalties.

IF WE DO NOT RETAIN OUR SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES, WE MAY NOT BE
ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY.

     Our president and chief executive officer, Nassib Chamoun, joined us at our
inception in 1987. Our chairman, J. Breckenridge Eagle, began serving as a
director in 1988. Many other members of our management and key employees have
extensive experience with us and other companies in the medical device industry.
Our success is substantially dependent on the ability, experience and
performance of these members of our senior management and other key employees.
Because of their ability and experience, if we lose one or more of the members
of our senior management or other key employees, our ability to successfully
implement our business strategy could be seriously harmed.

IF WE DO NOT ATTRACT AND RETAIN SKILLED PERSONNEL, WE WILL NOT BE ABLE TO EXPAND
OUR BUSINESS.

     Our products are based on complex signal-processing technology.
Accordingly, we require skilled personnel to develop, manufacture, sell and
support our products. Our future success will depend largely on our ability to
continue to hire, train, retain and motivate additional skilled personnel,
particularly sales representatives and clinical specialists who are responsible
for customer education and training and post-installation customer support. We
continue to experience difficulty in recruiting and retaining skilled personnel
because the pool of experienced persons is small and we compete for personnel
with other companies, many of which have greater resources than we do.
Consequently, if we are not able to attract and retain skilled personnel, we
will not be able to expand our business.


                                       21


<PAGE>   24



FAILURE OF USERS OF THE BIS SYSTEM TO OBTAIN ADEQUATE REIMBURSEMENT FROM
THIRD-PARTY PAYORS COULD LIMIT MARKET ACCEPTANCE OF THE BIS SYSTEM, WHICH COULD
PREVENT US FROM ACHIEVING PROFITABILITY.

     Anesthesia providers are generally not reimbursed separately for patient
monitoring activities utilizing the BIS system. For hospitals and outpatient
surgical centers, when reimbursement is based on charges or costs, patient
monitoring with the BIS system may reduce reimbursements for surgical
procedures, because charges or costs may decline as a result of monitoring with
the BIS system. Failure by hospitals and other users of the BIS system to obtain
adequate reimbursement from third-party payors, or any reduction in the
reimbursement by third-party payors to hospitals and other users as a result of
using the BIS system could limit market acceptance of the BIS system, which
could prevent us from achieving profitability.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We are exposed to financial market risks, including changes in foreign
currency exchange rates and interest rates. Most of our revenue, expenses and
capital spending are transacted in U.S. dollars. However, a portion of our
revenue is transacted in Euros and the expenses and capital spending of our
international subsidiaries are transacted in local currency. As a result,
changes in foreign currency exchange rates or weak economic conditions in
foreign markets could affect our financial results. We do not use derivative
instruments to hedge our foreign exchange risk. Our exposure to market risk for
changes in interest rates relates primarily to our cash and cash equivalent
balances, marketable securities and our investment in sales-type leases. The
majority of our investments are in short-term instruments and subject to
fluctuations in U.S. interest rates and market conditions. Due to the nature of
our short-term investments, we believe that there is no material risk exposure.



                                       22

<PAGE>   25


                          PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

        None.


ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

            On February 2, 2000, we sold 3,500,000 shares of our common stock,
        at an initial public offering price of $15.00 per share, pursuant to a
        Registration Statement on Form S-1 (Registration No. 333-86295), which
        was declared effective by the Securities and Exchange Commission on
        January 27, 2000. On February 4, 2000, the underwriters exercised in
        full their over-allotment option to purchase an additional 525,000
        shares of our common stock at $15.00 per share. The managing
        underwriters of our initial public offering were Morgan Stanley & Co.
        Incorporated, Deutsche Bank Securities Inc. and U.S. Bancorp Piper
        Jaffray Inc.

            The aggregate gross proceeds raised in the offering were
        approximately $60.4 million. Our total expenses in connection with the
        offering were approximately $5.7 million, of which $4.2 million was for
        underwriting discounts and commissions and, based on our reasonable
        estimate, approximately $1.5 million was for other expenses. Our net
        proceeds from the offering were approximately $54.6 million. From
        January 27, 2000 through June 30, 2001, we used approximately $6.1
        million of the net proceeds for the acquisition of machinery and
        equipment and for leasehold improvements to our new facility in Newton,
        Massachusetts. In addition, from January 27, 2000 through June 30, 2001,
        we used approximately $20.5 million of the net proceeds for general
        corporate purposes, including working capital, product development,
        increasing our sales and marketing capabilities and expanding our
        international operations. As of June 30, 2001, we had approximately
        $28.0 million of proceeds remaining from the offering, and pending use
        of the proceeds, we have invested these funds in short-term,
        interest-bearing, investment-grade securities.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES

        None.


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

            On May 22, 2001, we held our 2001 annual meeting of stockholders. At
        the meeting, the following matters were approved by the vote specified
        below:

        1.  Stephen E. Coit, Richard J. Meelia and Donald R. Stanski were
            elected to serve as Class I Directors of Aspect, to serve until our
            2004 annual meeting of stockholders or until their successors are
            duly elected and qualified. Mr. Coit received 14,549,743 shares of
            common stock voting in favor of his election, and 387,397 shares of
            common stock were withheld. Mr. Meelia received 14,551,410 shares of
            common stock voting in favor of his election, and 385,730 shares of
            common stock were withheld. Dr. Stanski received 14,551,523 shares
            of common stock voting in favor of his election, and 385,617 shares
            of common stock were withheld. In addition, the terms of the
            following directors continued after our 2001 annual meeting of
            stockholders: Nassib G. Chamoun, Boudewijn L.P.M. Bollen, J.
            Breckenridge Eagle, Edwin M. Kania and Lester John Lloyd.

        2.  Adoption of our 2001 Stock Incentive Plan authorizing the issuance
            of 2,000,000 shares of our common stock pursuant to awards granted
            under the terms and conditions of the plan. The votes cast were as
            follows: 9,969,728 shares of common stock were voted for the
            adoption of the plan, 2,816,043 shares of common stock were voted
            against the adoption of the plan and 505,263 shares of common stock
            abstained from the vote. There were 1,646,122 shares of common stock
            subject to non-votes.

        3.  The ratification of Arthur Andersen LLP as our independent auditors
            for the fiscal year ending December 31, 2001. The votes were cast as
            follows: 14,930,735 shares of common stock were voted for the
            ratification, 2,163 shares of common stock were voted against the
            ratification and 4,242 shares of common stock abstained from the
            vote.


                                       23

<PAGE>   26


ITEM 5. OTHER INFORMATION

        None.


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

        (a) Exhibits

            10.1    Revolving Credit Facility, dated as of May 16, 2001, by and
                    between the Registrant and Fleet National Bank, together
                    with Promissory Note, dated May 16, 2001, by and between the
                    Registrant and Fleet National Bank and Pledge Agreement,
                    dated as of May 16, 2001, by and between the Registrant and
                    Fleet National Bank.

        (b) Reports on Form 8-K

            We did not file any reports on Form 8-K during the quarter ended
June 30, 2001.


                                       24

<PAGE>   27




                                    SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                ASPECT MEDICAL SYSTEMS, INC.




Date:  August 13, 2001          By: /s/ J. Neal Armstrong
                                    --------------------------------------------
                                    J. Neal Armstrong
                                    Vice President and Chief Financial Officer
                                    (Principal Financial and Accounting Officer)




                                       25


<PAGE>   28



                                  EXHIBIT INDEX

EXHIBIT
NUMBER    EXHIBIT
-------   -------
 10.1     Revolving Credit Facility, dated as of May 16, 2001, by and between
          the Registrant and Fleet National Bank, together with Promissory Note,
          dated May 16, 2001, by and between the Registrant and Fleet National
          Bank and Pledge Agreement, dated as of May 16, 2001, by and between
          the Registrant and Fleet National Bank.