<PAGE>   1
                       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 MARCH 31, 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
      Incorporation or Organization)                         Identification No.)


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 17,522,491 shares of Common Stock, $0.01 par value per share,
outstanding as of May 9, 2001.


<PAGE>   2



                          ASPECT MEDICAL SYSTEMS, INC.

                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----
PART I.   FINANCIAL INFORMATION                                               1

Item 1.   Financial Statements (Unaudited)                                    1

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

          Consolidated Statements of Operations for the
          Three Months Ended March 31, 2001 and April 1, 2000                 2

          Consolidated Statements of Cash Flows for the
          Three Months Ended March 31, 2001 and April 1, 2000                 3

          Notes to Consolidated Financial Statements                          4

Item 2.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations                                 8

Item 3.   Quantitative and Qualitative Disclosures About Market Risk         20

PART II.  OTHER INFORMATION                                                  21

Item 1.   Legal Proceedings                                                  21

Item 2.   Changes in Securities and Use of Proceeds                          21

Item 3.   Defaults Upon Senior Securities                                    21

Item 4.   Submission of Matters to a Vote of Security Holders                21

Item 5.   Other Information                                                  21

Item 6.   Exhibits and Reports on Form 8-K                                   21

SIGNATURE                                                                    22



<PAGE>   3


                         PART I -- FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                             March 31,        December 31,
                                                               2001              2000
                                                            -----------      ------------
                                                            (Unaudited)
<S>                                                         <C>               <C>

ASSETS
Current assets:
   Cash and cash equivalents                                $ 25,865,778      $ 23,776,617
   Marketable securities                                      27,206,383        34,712,325
   Accounts receivable, net of allowance of $422,000 at
     March 31, 2001 and December 31, 2000                      4,445,858         3,665,572
   Current portion of investment in sales-type leases          1,591,801         1,677,312
   Inventory                                                   5,147,657         4,764,479
   Other current assets                                        1,580,168         1,542,597
                                                            ------------      ------------
           Total current assets                               65,837,645        70,138,902
Property and equipment, net                                    6,698,156         6,807,192
Long-term investment in sales-type leases                      2,136,670         2,465,139
                                                            ------------      ------------
           Total assets                                     $ 74,672,471      $ 79,411,233
                                                            ============      ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Current portion of long-term debt                        $  2,417,808      $  2,530,707
   Accounts payable                                            1,896,092         1,877,295
   Accrued liabilities                                         5,945,875         6,473,887
   Deferred revenue                                              430,989           802,489
                                                            ------------      ------------
           Total current liabilities                          10,690,764        11,684,378
                                                            ------------      ------------
Deferred revenue                                               1,324,176         1,136,676
Long-term debt                                                 2,277,166         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, 17,502,590 and 17,377,257 shares
     issued and outstanding at March 31, 2001 and
     December 31, 2000, respectively                             175,026           173,773
   Additional paid-in capital                                125,132,072       124,934,402
   Warrants                                                      121,684           121,684
   Notes receivable from employees and directors                (510,787)         (510,787)
   Deferred compensation                                         (66,738)          (75,043)
   Accumulated other comprehensive income                         59,851            63,029
   Accumulated deficit                                       (64,530,743)      (60,733,536)
                                                            ------------      ------------
           Total stockholders' equity                         60,380,365        63,973,522
                                                            ------------      ------------
           Total liabilities and stockholders' equity       $ 74,672,471      $ 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
                                                        -------------------------------
                                                        March 31, 2001    April 1, 2000
                                                        --------------    -------------
                                                         (Unaudited)       (Unaudited)
<S>                                                       <C>              <C>

Revenue                                                   $ 8,862,820      $ 9,659,377
Costs and expenses:
    Costs of revenue                                        2,770,612        3,083,137
    Research and development                                1,796,123        1,353,819
    Sales and marketing                                     6,960,919        4,714,053
    General and administrative                              2,054,597        1,268,613
                                                          -----------      -----------
          Total costs and expenses                         13,582,251       10,419,622
                                                          -----------      -----------

Loss from operations                                       (4,719,431)        (760,245)
Interest income                                             1,040,675          988,015
Interest expense                                             (118,451)        (201,970)
                                                          -----------      -----------
Net income (loss)                                         $(3,797,207)     $    25,800
                                                          ===========      ===========
Net income (loss) per share:
    Basic                                                 $     (0.22)     $      0.00
    Diluted                                               $     (0.22)     $      0.00

Shares used in computing net income (loss) per share:
    Basic                                                  17,458,433       11,594,734
    Diluted                                                17,458,433       14,115,682


</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>
                                                                         Three Months Ended
                                                                  -------------------------------
                                                                  March 31, 2001    April 1, 2000
                                                                  --------------    -------------
                                                                   (Unaudited)       (Unaudited)
<S>                                                                <C>              <C>

Cash flows from operating activities:
   Net income (loss)                                               $(3,797,207)     $     25,800
   Adjustments to reconcile net income (loss) to net cash
     used for operating activities -
     Depreciation and amortization                                     583,923           349,915
     Compensation expense related to stock options                      16,544           192,529
     Changes in assets and liabilities -
       Increase in accounts receivable                                (780,286)         (770,044)
       Increase in inventory                                          (383,178)       (1,218,876)
       Increase in other current assets                                (37,571)         (462,756)
       Decrease (increase) in investment in sales-type leases          413,980          (214,074)
       Increase in accounts payable                                     18,797           683,639
       Decrease in accrued liabilities                                (528,012)         (390,414)
       Decrease in deferred revenue                                   (184,000)         (455,967)
                                                                   -----------      ------------
          Net cash used for operating activities                    (4,677,010)       (2,260,248)
                                                                   -----------      ------------
Cash flows from investing activities:
   Acquisition of property and equipment                              (474,887)       (1,691,091)
   Purchases of marketable securities                                     --         (38,478,620)
   Proceeds from sales and maturities of marketable securities       7,502,764         1,000,000
                                                                   -----------      ------------
          Net cash provided by (used for) investing activities       7,027,877       (39,169,711)
                                                                   -----------      ------------
Cash flows from financing activities:
   Principal payments on equipment loan                               (180,167)         (180,167)
   Principal payments on term loan                                    (235,617)         (235,617)
   Proceeds from sale of investment in sales-type leases               283,528           278,248
   Principal payments on debt related to investment in
     sales-type leases                                                (320,134)         (204,888)
   Proceeds from issuance of common stock                              190,684        55,048,395
   Payments received on notes receivable from employees and
     directors                                                            --               7,000
                                                                   -----------      ------------
          Net cash (used for) provided by financing activities        (261,706)       54,712,971
                                                                   -----------      ------------
Net increase in cash and cash equivalents                            2,089,161        13,283,012
Cash and cash equivalents, beginning of period                      23,776,617        13,535,364
                                                                   -----------      ------------
Cash and cash equivalents, end of period                           $25,865,778      $ 26,818,376
                                                                   ===========      ============
Supplemental disclosure of cash flow information:
   Interest paid                                                   $   144,941      $    209,970
                                                                   ===========      ============

</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. (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 for the three months
ended March 31, 2001 and April 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 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 is as follows:

<TABLE>
<CAPTION>
                                                                  Three Months Ended
                                                             ------------------------------
                                                             March 31, 2001   April 1, 2000
                                                             --------------   -------------
                                                               (Unaudited)     (Unaudited)
<S>                                                           <C>              <C>

BASIC INCOME (LOSS) PER SHARE COMPUTATION
   Numerator:
   Net income (loss) available to common stockholders         $(3,797,207)     $    25,800
                                                              -----------      -----------
  Denominator:
  Weighted average common shares outstanding                   17,458,433       11,594,734
                                                              -----------      -----------
  Basic income (loss) per share                               $     (0.22)     $      0.00
                                                              ===========      ===========
DILUTED INCOME (LOSS) PER SHARE COMPUTATION
   Numerator:
   Net income (loss) available to common stockholders         $(3,797,207)     $    25,800
                                                              -----------      -----------
  Denominator:
  Weighted average common shares outstanding                   17,458,433       11,594,734
  Dilutive effect of assumed exercise of warrants                    --            123,393
  Dilutive effect of assumed exercise of stock options               --          2,308,131
  Dilutive effect of restricted stock                                --             89,424
                                                              -----------      -----------
  Weighted average common and dilutive potential common
      shares outstanding                                       17,458,433       14,115,682
                                                              -----------      -----------
  Diluted income (loss) per share                             $     (0.22)     $      0.00
                                                              ===========      ===========
</TABLE>




                                       4
<PAGE>   7
                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
                                  (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 months ended March 31, 2001, the Company has
excluded 1,110,000 shares 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)    Reclassifications

       Certain amounts in the prior year's financial statements have been
reclassified to conform with the current year presentation.

(6)    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
                                                -----------------------------
                                                March 31, 2001  April 1, 2000
                                                --------------  -------------
                                                  (Unaudited)    (Unaudited)
<S>                                              <C>              <C>

Net income (loss)                                $(3,797,207)     $ 25,800
Other comprehensive income (loss):
    Unrealized loss on marketable securities          (3,178)      (42,799)
                                                 -----------      --------
Comprehensive loss                               $(3,800,385)     $(16,999)
                                                 ===========      ========
</TABLE>




                                       5
<PAGE>   8
                  ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
                                  (UNAUDITED)



(7)    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>
                                                      March 31,    December 31,
                                                        2001          2000
                                                     ----------    -----------
                                                     (Unaudited)
<S>                                                  <C>            <C>

Total minimum lease payments receivable              $4,581,807     $5,143,738
  Less -- unearned interest                             853,336      1,001,287
                                                     ----------     ----------
Net investment in sales-type leases                   3,728,471      4,142,451
  Less -- current portion                             1,591,801      1,677,312
                                                     ----------     ----------
                                                     $2,136,670     $2,465,139
                                                     ==========     ==========
</TABLE>

(8)    Inventory

       Inventory consists of the following:

<TABLE>
<CAPTION>
                                                      March 31,    December 31,
                                                        2001          2000
                                                     ----------    -----------
                                                     (Unaudited)
<S>                                                  <C>            <C>

Raw materials                                        $2,618,403     $2,200,119
Work-in-progress                                        156,975          1,742
Finished goods                                        2,372,279      2,562,618
                                                     ----------     ----------
                                                     $5,147,657     $4,764,479
                                                     ==========     ==========
</TABLE>


(9)    Segment Information and Enterprise Reporting

       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 -- (Continued)
                                  (UNAUDITED)


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

<TABLE>
<CAPTION>
                                                        Three Months Ended
                                                   -----------------------------
                                                   March 31, 2001  April 1, 2000
                                                   --------------  -------------
                                                     (Unaudited)    (Unaudited)
<S>                                                  <C>            <C>

Geographic Area by Destination
   Domestic                                          $6,795,320     $8,265,619
   International                                      2,067,500      1,393,758
                                                     ----------     ----------
                                                     $8,862,820     $9,659,377
                                                     ==========     ==========


<CAPTION>
                                                        Three Months Ended
                                                   -----------------------------
                                                   March 31, 2001  April 1, 2000
                                                   --------------  -------------
                                                     (Unaudited)    (Unaudited)
<S>                                                  <C>            <C>
Geographic Area by Destination
   Domestic                                             77%             86%
   International                                        23              14
                                                       ---             ---
                                                       100%            100%
                                                       ===             ===
</TABLE>

       Approximately 13% of the Company's revenue was derived from sales to
Germany.

(10)   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.

(11)   Subsequent Event

       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 are payable over periods ranging from four to five years and are
secured by assets of the borrowers, including shares of the Company's common
stock owned by the borrowers.




                                       7
<PAGE>   10



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 enables anesthesia providers to assess
and manage a patient's level of consciousness during surgery. 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. The BIS system is based on our
patented core technology, the BIS index. 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 months as opposed to calendar months. Under
this system, the first eleven months of each fiscal year end on the Saturday
closest to the end of the calendar month and the last month 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 2%
and 10% of revenue in the three months ended March 31, 2001 and April 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 receive 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 March 31, 2001 and April 1, 2000, revenue from the sale of monitors
and BIS Module Kits represented approximately 32% and 46%, respectively, of our
revenue, and revenue from the sale of disposable sensors represented
approximately 68% and 54%, respectively, of our revenue. We believe that, as a
result of continued revenue from the sale of BIS Module Kits and the recent
receipt by our Japanese distributor of marketing approval from Japan's Ministry
of Health 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
or decline slightly in the second fiscal quarter of 2001.



                                       8
<PAGE>   11

       Revenue from domestic sales in the three months ended March 31, 2001 and
April 1, 2000 was approximately $6.8 million and $8.3 million, respectively,
which represented approximately 77% and 86%, respectively, of our revenue.
Revenue from international sales in the three months ended March 31, 2001 and
April 1, 2000 was approximately $2.1 million and $1.4 million, respectively,
which represented approximately 23% and 14%, respectively, of our revenue.
Revenue from international sales in the three months ended March 31, 2001
included revenue from the sale of BIS Module Kits to an original equipment
manufacturer. The Company believes that approximately 70% of the original
equipment manufacturer's BIS modules will be placed in the United States and
will contribute to domestic sensor revenue in future quarters.

       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 and Welfare approved our A-1050 EEG
Monitor with BIS for marketing in Japan. Sales to Nihon Kohden represented
approximately 68% of international revenue in the three months ended April 1,
2000. There was no revenue from the sale of monitors or disposable sensors to
Nihon Kohden in the three months ended March 31, 2001, as Nihon Kohden postponed
new purchases until such time that they receive marketing approval for the
A-2000 BIS Monitor. In May 2001, Japan's Ministry of Health and Welfare approved
our A-2000 BIS Monitor for marketing in Japan, and as a result of this approval,
we believe that we will begin shipment of A-2000 BIS Monitors to Japan in the
second fiscal quarter of 2001. Effective September 1, 2000, we entered into an
agreement with Datex-Ohmeda Division of Instrumentarium Corporation under which
Datex-Ohmeda has agreed to act 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
                                                  ------------------------------
                                                  March 31, 2001   April 1, 2000
                                                  --------------   -------------
<S>                                                     <C>             <C>

Revenue                                                 100%            100%
Costs and expenses:
    Costs of revenue                                     31              32
    Research and development                             20              14
    Sales and marketing                                  79              49
    General and administrative                           23              13
                                                       ----            ----
             Total costs and expenses                   153             108
                                                       ----            ----

Loss from operations                                    (53)             (8)
Interest income, net                                     10               8
                                                       ----            ----
Net income (loss)                                       (43)%             0%
                                                       ====            ====

</TABLE>



                                       9
<PAGE>   12


THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED APRIL 1, 2000

Revenue. Our revenue decreased to approximately $8.9 million in the three months
ended March 31, 2001 from approximately $9.7 million in the three months ended
April 1, 2000, a decrease of approximately 8%. Revenue from the sale of monitors
and BIS Module Kits decreased to approximately $2.8 million in the three months
ended March 31, 2001 from approximately $4.4 million in the three months ended
April 1, 2000, a decrease of approximately 37%. The decrease in revenue from the
sale of monitors and BIS Module Kits was the result of a decrease of
approximately 52% in the number of monitors sold, partially offset by
approximately $774,000 of revenue from the sale of BIS Module Kits. There were
two primary factors that contributed to the decrease in revenue from monitor
sales in the three months ended March 31, 2001 as compared to the three months
ended April 1, 2000. First, as a result of the FDA approval of a competitive
monitoring product, domestic customers have elected to delay purchase decisions
until they have had an opportunity to evaluate the competitive product. Second,
during the three months ended March 31, 2001, we did not have any revenue from
the sale of monitors to our Japanese distributor, which in the three months
ended April 1, 2000, accounted for approximately $838,000 of our international
revenue from the sale of monitors. This decrease in revenue from the reduction
in the sale of monitors in Japan was partially offset by an increase of
approximately $651,000 in international revenue from the sale of monitors
outside of Japan. This increase in international revenue from the sale of
monitors resulted from an increase of approximately 368% in the number of
international monitors sold outside of Japan.

       Revenue from the sale of disposable sensors increased to approximately
$6.1 million in the three months ended March 31, 2001 from approximately $5.3
million in the three months ended April 1, 2000, an increase of approximately
16%. The increase in revenue from the sale of disposable sensors was primarily
attributable to an increase of approximately 13% in the number of disposable
sensors sold as a result of growth in the installed base of monitors.

       Our gross profit was approximately 69% of revenue in the three months
ended March 31, 2001 as compared to a gross profit of approximately 68% of
revenue in the three months ended April 1, 2000. This slight increase in the
gross profit percentage in the three months ended March 31, 2001 as compared to
the three months ended April 1, 2000 was primarily attributable to an increase
in sales of disposable sensors, which have a higher profit margin than monitors,
as a percentage of revenue. Disposable sensors accounted for approximately 69%
of the increase in gross profit and BIS Module Kits accounted for the remaining
increase in gross profit in the three months ended March 31, 2001 as compared to
the three months ended April 1, 2000. 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 continue to increase our investments in clinical
education in an effort to enhance 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 March 31, 2001 from
approximately $1.4 million in the three months ended April 1, 2000, an increase
of approximately 33%. The increase in research and development expenses for the
three months ended March 31, 2001 as compared to the three months ended April 1,
2000, was attributable to an increase of approximately 36% in research and
development personnel and related payroll and other expenses, an increase of
approximately 11% in clinical studies, and 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 as we
continue to invest in the development of product improvements, product
extensions and new applications for our technology.



                                       10
<PAGE>   13



Sales and Marketing. Sales and marketing expenses increased to approximately
$7.0 million in the three months ended March 31, 2001 from approximately $4.7
million in the three months ended April 1, 2000, an increase of approximately
48%. The increase in sales and marketing expenses in the three months ended
March 31, 2001 as compared to the three months ended April 1, 2000 was
attributable to an increase of approximately 45% in sales and marketing
personnel and related payroll and other expenses, an increase of approximately
20% in external consultant and contractor expenses primarily relating to our
investment in new sales and marketing programs, an increase of approximately 7%
in operating expenses associated with our international subsidiaries, and an
increase of approximately 5% 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, increase 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 $2.1 million in the three months ended March 31, 2001 from
approximately $1.3 million in the three months ended April 1, 2000, an increase
of approximately 62%. The increase in general and administrative expenses in the
three months ended March 31, 2001 as compared to the three months ended April 1,
2000 was attributable to an increase of approximately 32% in general and
administrative personnel and related payroll and other expenses, excluding a
decrease of approximately $176,000 in compensation related to stock option
grants. The increase also included an increase of approximately $159,000 in
professional services fees and an increase of approximately $203,000 in expenses
related to our annual report and other fees and expenses related to being a
public company. 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 increased to approximately
$922,000 in the three months ended March 31, 2001 from approximately $786,000 in
the three months ended April 1, 2000, an increase of approximately 17%. Interest
income increased to approximately $1.0 million in the three months ended March
31, 2001 from approximately $988,000 in the comparable period in 2000, an
increase of approximately 5%. The increase in interest income was primarily
attributable to a higher average balance of cash and investments partially
offset by a decline in the interest rates on certain of our investments.
Interest expense decreased to approximately $118,000 in the three months ended
March 31, 2001 from approximately $202,000 in the comparable period in 2000, a
decrease of approximately 41%. The decrease in interest expense in the three
months ended March 31, 2001 was a result of lower average outstanding debt
obligations resulting from payments under our debt obligations partially offset
by additional debt obligations related to the sale of a portion of our
investments in sales-type leases. We expect interest income to decrease in the
second quarter of 2001 as compared to the interest income in the second quarter
of 2000 as a result of lower cash and investments balances resulting from
continued operating losses and other uses of cash and lower market interest
rates.

Net Income (Loss). As a result of the factors discussed above, in the three
months ended March 31, 2001 we had a net loss of approximately $3.8 million as
compared to net income of approximately $26,000 in the three months ended April
1, 2000.


LIQUIDITY AND CAPITAL RESOURCES

       From our inception through January 2000, we financed our operations
primarily from the sale of convertible preferred stock. Through March 31, 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. 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. At March 31, 2001, we had committed approximately
$10,000 primarily for the purchase of equipment related to improvements in our
monitor and disposable sensor production lines.



                                       11
<PAGE>   14



       Working capital at March 31, 2001 was approximately $55.1 million
compared to approximately $58.5 million at December 31, 2000. The decrease in
working capital from December 31, 2000 to March 31, 2001 was primarily
attributable to continued net operating losses of approximately $3.8 million,
increases in accounts receivable of approximately $780,000 and inventory of
approximately $383,000 and decreases in accrued liabilities of approximately
$528,000 and deferred revenue of approximately $184,000, offset by a decrease in
investment in sales-type leases of approximately $414,000.

       We used approximately $4.7 million of cash for operations in the three
months ended March 31, 2001 as compared to approximately $2.3 million in the
three months ended April 1, 2000. Cash used for operations during this period
was primarily driven by operating losses, increases in net accounts receivable
and inventory and a decrease in accrued liabilities and deferred revenue, offset
by a decrease in investment in sales-type leases.

       We received approximately $7.0 million of cash from investing activities
in the three months ended March 31, 2001 as compared to using approximately
$39.2 million in the three months ended April 1, 2000. The cash received from
investing activities in the three months ended March 31, 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 three months ended April 1, 2000. Capital expenditures
were approximately $475,000 for the three months ended March 31, 2001 primarily
for improvements to our information systems and additions to demonstration
equipment as compared to approximately $1.7 million in the three months ended
April 1, 2000 which was used primarily for manufacturing equipment and leasehold
improvements to our new facility.

       We used approximately $262,000 of cash for financing activities in the
three months ended March 31, 2001 as compared to receiving approximately $54.7
million of cash from financing activities in the three months ended April 1,
2000. Cash used for financing activities in the three months ended March 31,
2001 was primarily the result of payments on our debt obligations as compared to
cash received from the closing of our initial public offering in the three
months ended April 1, 2000.

       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 are secured by assets
of the borrowers, including shares of our common stock owned by the borrowers.

       We anticipate that the level of capital expenditures in the second fiscal
quarter of 2001 will remain consistent with that of the first fiscal quarter.

       We believe that the financial resources available to us, including our
current working capital, together with the proceeds from selling our investments
in sales-type leases, 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.


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.




                                       12
<PAGE>   15



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. We do
not believe that this pronouncement will have a material impact on our results
of operations, cash flows or financial position as we have not currently
transferred any financial assets.

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 June 30, 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.



                                       13
<PAGE>   16

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 68 cases of possible surgical
awareness during surgical procedures monitored with the BIS system as of March
31, 2001. In most of the 68 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.

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.



                                       14
<PAGE>   17


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. Until the newly hired sales
representatives become experienced with respect to our products, customer base
and sales programs, our sales efforts will be adversely affected. If 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,

       -      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.

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 persons and clinical specialists. We are also 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 new sales and marketing
programs and clinical education programs, 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.



                                       15
<PAGE>   18



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,

       -      less acceptance by foreign anesthesia providers of the use of
              disposable products similar to the BIS Sensor,

       -      delays in regulatory approval of our products;

       -      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.

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.



                                       16
<PAGE>   19



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.

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.

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, 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.



                                       17
<PAGE>   20

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

       Various factors may adversely affect our quarterly operating results
during the second 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. This may adversely impact our revenue for the second
fiscal quarter of 2001, depending in part on both the timing of when the newly
hired sales representatives become experienced with respect to our products,
customer base and sales programs and if the high turnover in our direct sales
force continues. 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 second fiscal
quarter of 2001, depending in part on the timing and effectiveness of our new
clinical education programs.

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 developing 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.



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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.



                                       19
<PAGE>   22

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, investment in sales-type leases and our
commercial loan agreement with Imperial Bank. 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.





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<PAGE>   23


                          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 March 31, 2001, we used approximately $5.6
        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 March 31,
        2001, we used approximately $11.1 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 March 31, 2001, we had
        approximately $37.9 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

        None.


ITEM 5. OTHER INFORMATION

        None.


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

        (a)     Exhibits

                3.1     Amended and Restated By-Laws of the Registrant.

                10.1    Promissory Note, dated April 10, 2001 made in favor of
                        Registrant by Nassib G. Chamoun, together with Pledge
                        Agreement, dated as of April 10, 2001, by and between
                        the Registrant and Nassib G. Chamoun.

        (b)     Reports on Form 8-K

        We did not file any reports on Form 8-K during the quarter ended March
        31, 2001.



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<PAGE>   24

                                    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:  May 11, 2001             By: /s/ J. Neal Armstrong
                                    --------------------------------------------
                                    J. Neal Armstrong
                                    Vice President and Chief Financial Officer
                                    (Principal Financial and Accounting Officer)



                                       22
<PAGE>   25



                                  EXHIBIT INDEX

EXHIBIT
NUMBER    EXHIBIT
------    -------

  3.1     Amended and Restated By-Laws of the Registrant.

 10.1     Promissory Note, dated April 10, 2001 made in favor of Registrant by
          Nassib G. Chamoun, together with Pledge Agreement, dated as of April
          10, 2001, by and between the Registrant and Nassib G. Chamoun.