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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

Commission File Number 000-22755

COMPUTER MOTION, INC.

130-B Cremona Drive
Goleta, CA 93117

(805) 968-9600
(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 [  ]

Indicate by check mark if the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [  ] No [x]

The number of shares of the Registrant’s Common Stock, $.001 par value, as of May 12, 2003 was 21,405,128 shares.

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COMPUTER MOTION, INC.
INDEX TO FORM 10-Q
QUARTER ENDED MARCH 31, 2003

INDEX

PAGE

PART I. — FINANCIAL INFORMATION

Item 1.

Financial Statements

Condensed Consolidated Statements of Operations

3

Condensed Consolidated Balance Sheets

4

Condensed Consolidated Statements of Cash Flows

5

Notes to Condensed Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

34

Item 4.

Controls and Procedures

34

PART II. — OTHER INFORMATION

Item 1.

Litigation

35

Item 2.

Changes in Securities and Use of Proceeds

36

Item 6.

Exhibits and Reports on Form 8-K

37

SIGNATURE

38

CERTIFICATIONS

39

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COMPUTER MOTION, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
(unaudited)

		Three Months Ended
		March 31,
		2003				2002
Revenue		$	7,011			$	5,691
Cost of revenue			2,740				2,645
Gross profit			4,271				3,046
Gross profit %			61	%			54	%
Research & development expense			2,701				2,652
Selling, general & administrative expense			5,693				4,525
Merger expense			544				—
Litigation provision			3,039				291
Total operating expense			11,977				7,468
Loss from operations			(7,706	)			(4,422	)
Interest income			6				12
Interest expense			(132	)			(13	)
Foreign currency translation loss			(28	)			(27	)
Other expense			(4	)			(2	)
Total other income/(expense)			(158	)			(30	)
Loss before income tax provision			(7,864	)			(4,452	)
Income tax provision			10				6
Net loss			(7,874	)			(4,458	)
Dividend to Series B preferred stockholders			—				4,978
Dividend to Series C / D preferred stockholders			1,375				—
Net loss available to common stockholders		$	(9,249	)		$	(9,436	)
Weighted average common shares outstanding used to compute net loss per share — basic and diluted			17,694				14,467
Net loss per share — basic and diluted		$	(0.52	)		$	(0.65	)

See accompanying notes to condensed consolidated financial statements

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COMPUTER MOTION, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value)

			March 31,				December 31,
			2003				2002 (1)
ASSETS
Current assets:
	Cash and cash equivalents		$	1,269			$	2,606
	Restricted cash			2,298				98
	Accounts receivable, net of allowance for doubtful accounts and returns of $1,326 at March 31, 2003 and $781 at December 31, 2002			8,665				6,786
	Inventories			7,174				5,866
	Other current assets			1,036				1,471
Total current assets				20,442				16,827
Property and equipment:
	Furniture and fixtures			1,899				1,896
	Computer equipment			3,128				3,050
	Machinery and equipment; (including demo equipment)			7,994				7,419
	Accumulated depreciation			(8,141	)			(7,398	)
Property and equipment, net				4,880				4,967
Other assets				54				56
Total assets			$	25,376			$	21,850
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Note payable to stockholder		$	—			$	1,000
	Bridge loan payable			2,300				—
	Accounts payable			9,069				3,541
	Accrued expenses			8,340				7,953
	Deferred revenue			2,649				2,461
Total current liabilities				22,358				14,955
Deferred revenue				1,057				1,226
Other liabilities				—				18
Total liabilities				23,415				16,199
Series D convertible preferred stock, $.001 par value authorized 10,750 shares, outstanding at 3/31/03 - 8,798 shares				12,755				—
Stockholders’ equity:
	Series C convertible preferred stock, $.001 par value authorized 10,750 shares, authorized 10,500 shares, outstanding 3/31/03 - 0 ; 12/31/02 - 6,299 shares		$	—			$	9,017
	Series C convertible preferred stock, 1,071 shares subscribed at 12/31/02			—				1,499
	Common stock, $.001 par value, authorized - 50,000 shares; Outstanding 3/31/03 - 19,221; 12/31/2002 - 17,627 shares			19				18
	Additional paid-in capital			115,401				112,157
	Deferred compensation			(257	)			(262	)
	Accumulated deficit			(125,923	)			(116,674	)
	Other comprehensive loss			(34	)			(104	)
Total stockholders’ equity				(10,794	)			5,651
Total liabilities & stockholders’ equity			$	25,376			$	21,850

(1)

Derived from audited financial statements as of December 31, 2002

See accompanying notes to condensed consolidated financial statements

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COMPUTER MOTION INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

				Three Months Ended
				March 31,
				2003				2002
Cash Flows from Operating Activities:
	Net loss			$	(7,874	)		$	(4,458	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and Amortization			748				511
		Provision for Doubtful Accounts			100				—
		Common stock issued for services			—				1,395
		Amortization of Deferred Compensation			5				44
		Unexercised MBO Options			34				—
	Decrease (Increase) in:
		Accounts receivable			(1,979	)			779
		Inventories			(1,308	)			295
		Prepaid expenses			435				(160	)
	Increase (Decrease) in:
		Accounts payable			5,528				(2,974	)
		Accrued expenses			387				(92	)
		Other liabilities			—				(12	)
		Deferred revenue			19				(233	)
Net cash used in operating activities					(3,905	)			(4,905	)
Cash Flows from Investing Activities:
	Purchase of property and equipment				(659	)			(212	)
Net cash used in investing activities					(659	)			(212	)
Cash Flows from Financing Activities:
	Proceeds from bridge loan				2,300				—
	Payment of dividend				(21	)			—
	Repayment of note payable to stockholder				—				(900	)
	Proceeds from note payable—Accounts receivable financing				—				133
	Proceeds from preferred stock issuance, net of expenses				861				—
	Proceeds from common stock issued and warrants exercised, net of repurchases				2,101				10,527
	Proceeds from common stock — Societe Generale (Equity Line)				—				508
	Proceeds from common stock — ESPP plan				44				61
	Proceeds from exercise of stock options				90				60
	Comprehensive loss and other				52				227
Net cash provided by financing activities					5,427				10,616
Net increase in cash, cash equivalents and restricted cash					863				5,499
Cash, cash equivalents and restricted cash at beginning of period					2,704				1,067
Cash, cash equivalents and restricted cash at end of period				$	3,567			$	6,566

See accompanying notes to condensed consolidated financial statements

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COMPUTER MOTION, INC.
Notes to Condensed Consolidated Financial Statements

Note 1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements of Computer Motion, Inc. (the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the financial information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

     The operating results of the interim periods presented are not necessarily indicative of the results expected for the entire fiscal year ending December 31, 2003 or for any other interim period. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the audited financial statements and notes thereto for the fiscal year ended December 31, 2002 included in the Company’s Annual Report on Form 10-K/A, filed with the Securities and Exchange Commission (“SEC”) on May 12, 2003. As shown in the accompanying consolidated financial statements, the Company continues to incur losses and negative cash flows from operations. At March 31, 2003, the Company had cash and cash equivalents of approximately $3.6 million. The Company is currently consuming cash at a rate of approximately $1.5 million per month. The combination of these factors raises substantial doubt about the Company’s ability to continue as a going concern. Management believes that it will be unable to fund its operations for the next twelve months with its current cash and cash equivalents. Management’s plans in regard to these items include the following: Obtain cash proceeds under the working capital line of credit with Intuitive Surgical, Inc. (“Intuitive Surgical”) dated March 6, 2003 (see Note 5); and obtain cash proceeds from the exercise of the Company’s Series C Convertible Preferred Stock and other warrants. These plans are intended to enable the Company to continue its operations through March 31, 2004. The Company’s need for additional financing will depend upon numerous factors, including, but not limited to, the progress and scope of ongoing research and development projects, the costs of training physicians to become proficient in the use of the Company’s products and procedures, the ability to obtain required FDA approvals, the ability to successfully defend itself in any current or future patent litigation and the ability of the Company’s customers to obtain medical reimbursement from third party payors.

     The Company applies the provisions of Staff Accounting Bulletin No. 101 (SAB 101) when recognizing revenue. SAB 101 states that revenue generally is realized or realizable and earned when all of the following criteria are met: a) persuasive evidence of an arrangement exists, b) delivery has occurred or the services have been rendered, c) the seller’s price to the buyer is fixed or determinable, and d) collectibility is reasonably assured.

     The Company recognizes revenue from the sale of products to end-users, including supplies and accessories, once shipment has occurred, as the Company’s general terms are FOB shipping point. In those few cases where the customers’ terms are FOB destination, revenue is not recognized until the Company receives a signed delivery and acceptance certificate, and all of the conditions of SAB 101 as identified above have been met. Revenue is recognized from the performance of services as the services are performed.

     The Company recognizes revenue from the sale of products to distributors, including supplies and accessories, once shipment has occurred and all of the conditions of SAB 101 have been met. The Company’s distributors do not have rights of return or cancellation. Revenue from distributors, which does not meet all of the requirements of SAB 101, is deferred and recognized upon the sale of the product to the end user.

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     Revenues from product sales to financing institutions are not recognized by the Company until a purchase order is received, the product has been shipped and the funding by the financing institution has been approved. The Company recognized revenues from sales to third party financing institutions of $163,000 and $233,000 for the quarters ended March 31, 2003 and 2002, respectively.

     Revenues for transactions that include multiple elements such as systems, training, product warranties, instruments, accessory kits and service contracts are allocated to each element based on its relative fair value (or in the absence of fair value, the residual method) and recognized when the revenue recognition criteria have been met for each element. The Company recognizes revenue for delivered elements only when the following criteria are satisfied: (1) undelivered elements are not essential to the functionality of delivered elements, (2) uncertainties regarding customer acceptance are resolved and (3) the fair value for all undelivered elements is known. The Company defers revenue from the sale of extended warranties, product upgrades and other contractual items and recognizes them over the life of the contract, when service is performed or upon shipment to the customer, as applicable. The value allocated to elements in a multiple element arrangement is based on objective evidence of relative fair value of each element.

     Shipments of products to be used for demonstration purposes or prototype products used in development programs are reflected as consigned inventory and are included in the property and equipment balance in the accompanying consolidated balance sheets.

     The Company records revenue, net of commissions paid to agents, in accordance with Emerging Issues Task Force (EITF) No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.”

     The Company believes that Statement of Position 97-2, “Software Revenue Recognition” (SOP 97-2), is not applicable to the sale of the Company’s products in accordance with the guidance in paragraphs 2 and 4 of SOP 97-2. The software sold is considered by the Company to be incidental to the products sold and is not a significant focus of the marketing efforts of the Company nor is the software sold separately. In addition, post contract customer support is not sold by the Company in conjunction with the software. As such, the Company does not separately account for the sale of the software.

Note 2. Net Loss Per Share

     Statement of Financial Accounting Standard (“SFAS”) No. 128, “Earnings Per Share,” requires presentation of both basic and diluted net loss per share in the financial statements. The Company’s basic net loss per share is the same as its diluted net loss per share because inclusion of outstanding stock options and warrants in the calculation is antidilutive. Basic and diluted loss per share is calculated by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period.

     The net loss per share for the quarter ended March 31, 2003 has been adjusted to include the present value of the dividends paid on the shares of the Company’s Series C (D) Convertible Preferred Stock of $260,000, the write off of the beneficial conversion feature of such shares of $629,000 and the present value of warrants issued in conjunction with these shares of $486,000. The Company is required to recognize these items as a dividend in the net loss computation for loss per share.

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Note 3. Inventories

     Inventories, which include materials, labor and overhead, are stated at the lower of cost or market. The Company uses the first-in, first-out (FIFO) method to value inventories. The components of inventories are as follows:

Note 4. Employee Option Plans

     The Company’s employee stock purchase savings plan allows participating employees to purchase, through payroll deductions, shares of common stock at 85% of the fair market value at specified dates. Under the terms of the plan, 400,000 shares of common stock have been reserved for purchase by plan participants. Purchases are made bi-annually on January 1 and July 1 for the previous six-month period.

     The Company maintains a management by objectives program under which non-executive employees may receive up to 10% of their base salary as a bonus if certain objectives are met. During 2002, the Company suspended cash payments for bonuses earned under this plan and issued options to purchase common stock at an exercise price of $.00. The number of shares issued to each employee is determined by the amount of their

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bonus divided by the fair market value of the Company’s common stock on the date of grant. The Company recognized $125,000 in compensation expense for the full fair market value of options granted during the quarter ended March 31, 2003.

     Under SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company has elected to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related accounting interpretations.

     Accordingly, no compensation expense has been recognized related to the granting of stock options, except as noted above. If compensation expense related to stock options was determined based upon their grant date fair value consistent with the methodology prescribed under SFAS No. 123 the Company’s net loss and net loss per share would have been increased by $1,060,000 ($.06 per share), and $1,143,000 ($.08 per share) for the quarters ended March 31, 2003 and 2002, respectively. The fair market value of the warrants and stock options at the grant date was estimated using the Black-Scholes valuation model with the following weighted average assumptions:

Note 5. Loan and Security Agreements

     On February 13, 2003, the Company entered into a Loan and Security Agreement with Agility Capital, LLC, for a short-term bridge loan in the aggregate principal amount of $2,300,000. Interest on the loan will accrue at a rate of 9% per annum and is payable monthly. In connection with the bridge loan, the Company issued a warrant to purchase up to an aggregate of 500,000 shares of the Company’s common stock at an exercise price of $.97 per share. The Company valued the warrants using the Black-Scholes option pricing model. The fair value of the warrants was recorded as a debt issuance cost and was recorded as deferred interest expense and additional paid-in capital in accordance with APB 14. The deferred interest expense is being amortized to interest expense over the life of the loan.

     In connection with the proposed merger involving Intuitive Surgical (see Note 10), Computer Motion and Intuitive Surgical have entered into a Loan and Security Agreement, under which Intuitive Surgical has agreed to provide a short-term secured bridge loan of up to $7.3 million. The loan will terminate and all outstanding amounts will become due and payable 120 days following termination of the merger agreement (the “Maturity Date”). Under the terms of the Loan and Security Agreement, the Company is required to pay off the Loan and Security Agreement with Agility Capital, LLC, with its initial borrowings. Interest on the loan will accrue at a rate of 8% per annum and will be payable on the Maturity Date. At March 31, 2003 no funds had been borrowed against this secured bridge loan.

Note 6. Series D Convertible Preferred Stock

     As set forth in the purchase agreement signed in connection with the Series C Financing, Mr. Duggan (or his affiliates or designees) agreed to purchase an aggregate amount of Series C stock totaling $1,999,200, $999,600 of which was paid by the conversion of an outstanding promissory note from the Company to Mr. Duggan. Following the receipt of stockholder approval on January 27, 2003, Mr. Duggan and his designees purchased an additional $999,600 of Series C Convertible Preferred Stock.

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     In accordance with the Certificate of Designations and the Side Agreement, the shares of Series C Convertible Preferred Stock bear a cumulative dividend at a rate of 12% per annum until January 31, 2003, and 8% per annum thereafter. In the event shares of Series C Convertible Preferred Stock are not converted or redeemed in accordance with the Certificate of Designations by October 31, 2004, the cumulative dividend rate will be adjusted upward to 12% per annum thereafter. Dividends on the Series C-1 Convertible Preferred Stock may be paid by the Company, at its option, through the issuance of shares of Common Stock or in cash, and dividends on the Series C-2 Convertible Preferred Stock may only be paid in cash.

     In accordance with the Certificate of Designations, in the event the Company proposes to enter into a Change of Control Transaction (as defined below) and if not previously converted, the holders of shares of Series C Convertible Preferred Stock may elect to convert such shares of Series C Convertible Preferred Stock into a number of common shares equal to 135% of the amount into which such shares of Series C Convertible Preferred Stock would otherwise be convertible.

     On March 6, 2003, all holders of Series C Convertible Preferred Stock agreed to exchange their shares for newly issued shares of Series D Convertible Preferred Stock. The terms of the Series D Convertible Preferred Stock eliminated certain provisions that were contained in the terms of the Series C Convertible Preferred Stock that could have restricted the ability of the Company to enter into the merger agreement with Intuitive Surgical. The shares of the Series D Convertible Preferred Stock will convert into shares of common stock immediately prior to the consummation of the merger described above. Pursuant to the terms of the Exchange Agreement, in the event the Company does not consummate the merger by September 30, 2003, the Company will file its Certificate of Designations Setting Forth the Preferences, Rights and Limitations of the Series E Convertible Preferred Stock with the Secretary of State of Delaware, and, thereupon outstanding shares of Series D-1 Convertible Preferred Stock and Series D-2 Convertible Preferred Stock will be exchanged for share of a like number of Series E-1 Convertible Preferred Stock and Series E-2 Convertible Preferred Stock. As an inducement to the holders of shares of Series C Convertible Preferred Stock to enter into the Exchange Agreement, the Company has agreed to lower the exercise price of all outstanding Series C-1 warrants and Series C-2 warrants to $1.50 per share, provided that such holders exercise such warrants prior to 10 days following the mailing of a proxy statement relating to the Company’s meeting of stockholders to approve the merger. The Company accounted for the reduction of the exercise price as a significant modification and a new measurement date. The Company valued the warrants using the option pricing model as of March 6, 2003, the date of the repricing, noting the fair value was less than the original value of the warrants as calculated on the issuance date during the fourth quarter of 2002. As such, no additional expense was recorded for the warrants as of the date of the conversion.

Note 7. Segments of Business