Until recently, based upon pre-filing meetings and other discussions with representatives of the FDA as part of the pre-submission review process, we had been advised that we would have to file a PMA application for the ROBODOC System. Although we intended to file a PMA with the FDA in the second quarter of 1998, we decided to defer the filing to incorporate our pinless DigiMatch Single Surgery System technology, and possibly other technological developments, as part of the PMA application. Our pinless DigiMatch Single Surgery System eliminated a preliminary surgical procedure in which locator pins were placed in a patient's thigh bone prior to ROBODOC hip surgery. Incorporation of the DigiMatch technology necessitated further clinical trials conducted under an FDA approved Investigational Device Exemption (IDE) to demonstrate its safety and effectiveness.

Based upon our discussions with representatives of the FDA, it was suggested that if the ROBODOC System were reclassified from a Class III to a Class II device, it could be cleared for marketing in the U. S. through the 510(k) de novo premarket notification process. Data obtained for the new clinical trials will be used to support the reclassification of the ROBODOC System as a Class II device. In order to obtain FDA clearance of approval, we must demonstrate that the DigiMatch ROBODOC System is safe and effective for its intended use as an alternative to manual total hip replacement techniques. We cannot give you any assurance that

• the FDA will, in fact, reclassify the ROBODOC System as a Class II device
• the FDA will agree that the DigiMatch ROBODOC System is safe and effective, or
• if the FDA grants us permission to market the ROBODOC System in the U. S. , that it will not include unfavorable limitations or restrictions

We have two stock option plans--our 1995 Stock Option Plan and our 1998 Stock Option Plan. The plans authorize the issuance of incentive stock options, as defined in Section 422A of the Internal Revenue Code of 1986, non-qualified stock options, and in the case of the 1998 Plan stock appreciation rights, and in the case of the 1995 Plan stock purchase rights. Directors, employees (including officers) and consultants are eligible to participate in the plans. Consultants and directors who are not also employees of our company are eligible for grants of only non-qualified stock options and/or stock purchase rights. The plans are administered, and the terms of the options, stock appreciation or stock purchase rights are determined, by the Board and/or the Compensation Committee. The exercise price of each incentive stock option may not be less than 100% of the fair market value of a share of our common stock at the time of grant, except that in the case of a grant to an employee who owns 10% or more of the outstanding stock of our company or a subsidiary or parent of our company (a "10% Stockholder"), the exercise price may not be less than 110% of the fair market value on the date of grant. The aggregate fair market value of the shares covered by incentive stock options granted under the plans that become exercisable by a plan participant for the first time in any calendar year is subject to a $100,000 limitation. The exercise price of a non-qualified stock option, or a non-qualified stock option granted in tandem with a stock appreciation right, may not be less than 85% of the fair market value of a share of our common stock on the date of grant. In no event may an option or stock appreciation right have a term of more than 10 years, or 5 years with respect to incentive stock options granted to a 10% Stockholder, or vest at a rate less than 20% per year. Options granted under the plans are not transferable, other than by will or by the laws of descent and distribution. Non-qualified stock options and/or stock purchase rights may not be granted under the 1995 Plan after December 12, 2005 and options and/or stock purchase rights may not be granted under the 1998 Plan after January 23, 2008.

Our Board of Directors has adopted the 2000 Long-Term Performance Plan which provides for stock awards of up to 1,000,000 shares. The plan permits the grant of any form of award, including, but not limited to, stock options, stock appreciation rights and stock and cash awards, whether granted singly, in combination or in tandem. Stock options will be granted at an exercise price of not less than 100% of the fair market value of a share of our common stock on the date of grant. We expect that options and stock appreciation rights granted under the plan will typically be granted for periods of 10 years or less. The plan also permits the grant of other awards in stock or denominated in units of stock, which may be subject to restrictions or transfer and/or forfeiture provisions. The plan will be administered by the Compensation Committee. In administering the plan, the Committee has the full power to select participants, to interpret the provisions of the plan, to grant waivers of award restrictions, to continue or accelerate the exercisability, vesting or payment of an award and to adopt such rules, regulations and guidelines for carrying out the plan as the Committee may deem necessary or proper. The Committee may delegate certain of its duties, power and authority to officers of our company, pursuant to such conditions and limitations as the Committee may establish. Awards under the plan may be made to our employees and other individuals that perform services for us. Participants in the plan will be recommended by management, and the Committee intends to review and act on all grants and awards for officers and certain other senior management positions. The plan has been designed to meet the requirements of section 162(m) of the Internal Revenue Code for stock options and stock appreciation rights. In addition, the plan contains performance criteria for future long-term incentive awards to qualify those awards for tax deductibility under section 162(m). Those criteria consist of objective tests based on one or more of the following: earnings, cash flow, customer satisfaction, revenues, financial return ratios, market performance, shareholder return and/or value, operating profits, net profits, earnings per share, profit return and margins, stock price and working capital. The formula for any such award may include or exclude items to measure the specific objectives, such as losses from discontinued operations, extraordinary gains and losses, the cumulative effect of accounting changes, acquisitions or divestitures, foreign exchange impacts and any unusual, nonrecurring gain or loss. These terms apply to "covered employees" as defined in section 162(m), which include, our chief executive officer and our four other most highly compensated executive officers.

Under our stock award program, 500,000 shares of common stock may be granted to our employees (but not officers or directors) and consultants who perform services for us. The award program is administered by the Board and/or the Compensation Committee.

We also have an employee stock purchase plan that has not been implemented. The purchase plan provides that all employees (including officers and directors who are also employees) who have been in our employ and/or the employ of corporations in which we own 50% or more of the voting shares for six months or more are eligible to participate in the plan. Participants in the purchase plan will have deducted from their base weekly salaries a percentage or stated amount to be applied toward the purchase of shares of our common stock. We will, no less frequently than monthly, sell or cause to be sold to the plan full shares of our common stock in an amount equal to the then accumulated compensation deductions, based upon a price equal to 85% of the closing price of our common stock at the time the common stock is acquired. We will be deemed to be contributing 15% (85% of the purchase price of our common stock is to be borne by the participants) of the employee's contributions toward the purchase of such shares. We also will bear all administrative and commission costs in connection with the acquisition of our common stock and reasonable administrative costs, other than commissions, from a sale of our common stock or transfer to a participant.

The following table sets forth certain information concerning the beneficial ownership of common stock at October 23, 2000 by (i) each stockholder known by us to be a beneficial owner of more than five percent of our outstanding common stock, (ii) each of our directors, (iii) each of our executive officers listed in the Summary Compensation Table and (iv) all directors and officers as a group.

In November 1999, we entered into a distribution agreement that gave Spark 1st Vision GmbH & Co. KG, a German company, the exclusive right to distribute our products in Europe, the Middle East and Africa through 2003. Under the agreement, Spark 1^st Vision was obligated to purchase a minimum of 24 ROBODOC systems during 2000 and 32 ROBODOC systems during 2001. It also was required to pay us $200,000 per month for the first six months of 2000, $300,000 per month for the remainder of 2000, and $400,000 per month for 2001, offset by the purchase price of products purchased. Spark 1^st Vision's liability to us under the agreement was limited to $1 million, exclusive of the minimum purchase obligation. Spark 1^st Vision is controlled by Manfred Schmitt, a German venture capitalist. As of the date we entered into the distribution agreement, Mr. Schmitt beneficially owned slightly more than five percent of our common stock.

In May 2000, we terminated the agreement with Spark 1^st Vision. We received approximately $1,000,000 from Spark 1^st Vision in settlement of its obligations under the agreement.

Selling Securityholder

Triton West Group, Inc. is offering and selling shares of common stock we may sell to it from time to time under an equity line of credit agreement. We may sell up to $12,000,000 of our common stock to Triton at a purchase price of 85% of the lowest closing bid price of our common stock during the nine day trading period commencing two trading days before we deliver a purchase notice to Triton. At an assumed purchase price of $0.50 per share, we could sell up to 24,000,000 shares to Triton. However, under the terms of the agreement, the number of shares that Triton may acquire under the agreement may not exceed that number which would cause it to become the beneficial owner of more than 4.99% of the then issued and outstanding shares of common stock, or result in the issuance of more than an aggregate of 3,843,939 shares of common stock, representing 19.9% of the shares outstanding on the date of the private equity line of credit agreement, until stockholders approve the issuance of shares in excess of that number. Since there is no minimum purchase price, if the market price of the common stock declines below the assumed purchase price, the number of shares that the selling securityholder may acquire upon purchase will increase. If following a sustained increase in the market price of the common stock sufficient to offset the 15% discount used in computing the purchase price, the purchase price is higher than the assumed purchase price, the number of shares that the selling securityholder may acquire will decrease.

Other than a warrant to purchase 35,000 shares of common stock that it acquired in connection with the equity line agreement, Triton does not own any of our securities. Sophia Harris has voting and dispositive power with respect to the shares of common stock Triton may acquire from us under the equity line. Triton's address is c/o CFS Ltd., Harbor Centre, 48^th Floor, P.O. Box 613GT, Georgetown, Grand Cayman. Neither Triton, nor any of its officers, directors or affiliates has, or within the past three years has had, any position, office or other material relationship with us or any of our predecessors or affiliates.

Plan of Distribution

The selling securityholder may sell shares from time to time in public transactions, on or off The Nasdaq SmallCap Market, or private transactions, at prevailing market prices or at privately negotiated prices. Triton may sell its shares in the following types of transactions:

• ordinary brokerage transactions and transactions in which the broker solicits purchasers;
• a block trade in which the broker-dealer so engaged will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction;
• purchases by a broker or dealer as principal and resale by such broker or dealer for its account pursuant to this prospectus; and
• face-to-face transactions between sellers and purchasers without a broker-dealer.

The selling securityholder also may sell shares that qualify under Section 4(l) of the Securities Act or Rule 144. As used in this prospectus, the selling securityholder include donees, pledgees, distributees, transferees and other successors-in -interest of the selling securityholder named in this prospectus.

In effecting sales, brokers or dealers engaged by the selling securityholder may arrange for other brokers or dealers to participate in the resales. The selling securityholder may enter into hedging transactions with broker-dealers, and in connection with those transactions, broker-dealers may engage in short sales of the shares. The selling securityholder also may sell shares short and deliver the shares to close out such short positions, except that the selling securityholder has agreed that they will not enter into any put option or short position with respect to the common stock prior to the date of the delivery of a conversion notice. The selling securityholder also may enter into option or other transactions with broker-dealers which require the delivery to the broker-dealer of the shares, which the broker-dealer may resell under this prospectus. The selling securityholder also may pledge the shares to a broker or dealer and upon a default, the broker or dealer may effect sales of the pledged shares under this prospectus.

Brokers, dealers or agents may receive compensation in the form of commissions, discounts or concessions from selling securityholder in amounts to be negotiated in connection with the sale. Triton West Group is an "underwriters" within the meaning of the Securities Act of the shares of common stock offered and sold under this prospectus, and any commission, discount or concession they receive will be underwriting compensation. Any participating brokers or dealers may be deemed to be "underwriters" within the meaning of the Securities Act in connection with the distribution of shares under this prospectus, and any commission, discount or concession they receive may be deemed to be underwriting compensation.

Information as to whether the underwriters who may be selected by the selling securityholder, or any other broker-dealer, is acting as principal or agent for the selling securityholder, the compensation to be received by them, and the compensation to be received by other broker-dealers, in the event such compensation is in excess of usual and customary commissions, will, to the extent required, be set forth in a supplement to this prospectus. Any dealer or broker participating in any distribution of the shares may be required to deliver a copy of this prospectus, including a prospectus supplement, if any, to any person who purchases any of the shares from or through such dealer or broker.

We have advised the selling securityholder that during such time as it may be engaged in a distribution of the shares it is required to comply with Regulation M promulgated under the Securities Exchange Act. With certain exceptions, Regulation M precludes any selling securityholder, any affiliated purchasers and any broker-dealer or other person who participates in such distribution from bidding for or purchasing, or attempting to induce any person to bid for or purchase any security which is the subject of the distribution until the entire distribution is complete. Regulation M also prohibits any bids or purchases made in order to stabilize the price of a security in connection with the distribution of that security.

The authorized capital stock consists of 50,000,000 shares of common stock, $0.01 par value per share, and 1,000,000 shares of "blank check" preferred stock, par value $0.01 per share. As of October 23, 2000, 21,495,527 shares of common stock were issued and outstanding and 668 shares of our series G convertible preferred stock and 675 shares of our series H convertible preferred stock were outstanding. Our Board of Directors has adopted an amendment to our Restated Certificate of Incorporation increasing the number of shares of common stock that we may issue to 100,000,000 shares. This amendment is subject to approval of our stockholders at our next annual meeting of stockholders scheduled to be held on December 12, 2000.

The following are brief descriptions of our securities. The rights of the holders of shares of capital stock are established by our restated certificate of incorporation, as amended, our by-laws and Delaware law. The following statements do not purport to be complete or give full effect to statutory or common law, and are subject in all respects to the applicable provisions of the certificate of incorporation, by-laws and state law.

Holders of our common stock are entitled to one vote per share, and subject to the rights of holders of preferred stock, to receive dividends when, as and if declared by our Board of Directors and to share ratably in our assets legally available for distribution to holders of common stock in the event of the liquidation, dissolution or winding up of our company. Holders of the common stock do not have subscription, redemption, conversion or preemptive rights.

Each share of common stock is entitled to one vote on any matter submitted to the holders, except that holders are entitled to cumulate their votes in the election of directors. In other words, a stockholder may give one nominee a number of votes equal to the number of Directors to be elected multiplied by the number of votes to which the stockholder's shares are normally entitled, or he may distribute his votes among as many candidates as he sees fit. The candidates receiving the highest number of votes shall be elected. Our Board of Directors has adopted amendments to our Restated Certificate of Incorporation and Bylaws eliminating cumulative voting rights. These amendments are subject to approval of our stockholders at our next annual meeting of stockholders scheduled to be held on December 12, 2000. On all other matters which may properly come before the meeting, each share has one vote. The Board is empowered to fill any vacancies on the Board created by the resignation of Directors. Except as otherwise required by the Delaware General Corporation Law, all stockholder action (other than the election of the Directors, who are elected by a plurality vote) is subject to approval by a majority of the shares of common stock present at a stockholders' meeting at which a quorum (a majority of the issued and outstanding shares of the common stock) is present in person or by proxy, or by written consent pursuant to Delaware law. All shares of common stock outstanding are fully paid and non-assessable.

Options. We have outstanding options to purchase an aggregate of 1,752,098 shares of common stock, at exercise prices ranging from $0.07 to $8.63, which expire at various dates from 2000, to 2010. See "Management - Stock Option Plan."

Warrants. We have outstanding warrants to purchase an aggregate of 17,134,911 shares of common stock, at exercise prices ranging from $0.01 to $4.39, which expire at various dates through 2005. Warrants to purchase shares of common stock were issued in our initial public offering in November 1996. Adjusted in accordance with dilution provisions, these outstanding public warrants are now convertable into 6,112,552 shares of common stock. Each of these publicly-traded warrants entitles the registered holder thereof to purchase one share of common stock at $1.54 per share on or before November 19, 2001. The exercise price and the number of shares of common stock issuable upon the exercise of each warrant is subject to adjustment in the event of a stock split, stock dividend, recapitalization, merger, consolidation or certain other events. We may redeem the warrants, at a price of $0.10 per warrant, upon not less than 30 days prior written notice at any time on or before November 19, 2001; provided the average of the closing bid quotations of our common stock, during the period of twenty (20) consecutive trading days ending on the third day prior to the date upon which the notice of redemption is given, as reported on The Nasdaq SmallCap Market (or if the common stock is not quoted thereon), the closing sale price of the common stock on the Nasdaq National Market or other principal securities exchange upon which the common stock is then quoted or listed, or such other reporting system that provides closing sale prices for the common stock has been at least 150% of the then exercise price of the warrants.

We are authorized to issue up to 1,000,000 shares of preferred stock with such designation, rights and preferences as may be determined from time to time by our Board of Directors. Accordingly, the Board of Directors is empowered, without further stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could decrease the amount of earnings and assets available for distribution to holders of common stock or adversely affect the voting power or other rights of the holders of our common stock. In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of our company.

Since September 1998, we have received aggregate net proceeds of approximately $14.2 million from the sale of eight series of our convertible preferred stock. Information concerning these preferred stock financings is set forth below.

                                            Shares of
                                            Preferred
                                              Stock     Warrants      Gross
            Series        Date of Sale        Sold       Issued     Proceeds
        ------------- -------------------- ---------- ----------- ------------
              A        September 10, 1998      3,520      44,000  $ 3,520,000
              B        March 26, 1999          1,000      12,500    1,000,000
              C        June 10, 1999             750       9,375      750,000
              D        June 30, 1999           2,000      25,000    2,000,000
              E        July 30, 1999           3,000      37,500    3,000,000
              F        February 22, 2000       2,000     125,000    2,000,000
              G        May 30, 2000            1,800      63,000    1,800,000
              H        August 17, 2000         1,200     500,000    1,200,000

Each series of preferred stock has a stated value of $1,000 per share. All series, other than series H, were initially convertible into common stock at a conversion price equal to 85% of the lowest sale price of the common stock on the Nasdaq SmallCap Market over the five trading days preceding the date of conversion, subject to a maximum conversion price. The series H, and as a result of antidilution adjustments resulting from the issuance of the series H, since the issuance of the series H on August 17, 2000, the outstanding shares of series F and series G, are convertible into common stock at a conversion price equal to 80% of the lowest sale price of the common stock on the Nasdaq SmallCap Market over the five trading days prior to the date of conversion. The number of shares of common stock that may be acquired upon conversion is determined by dividing the stated value of the number of shares of preferred stock to be converted by the conversion price. As of October 23, 2000, 668 shares of series G preferred stock, and 675 shares of series H preferred stock were outstanding. No other shares of preferred stock are outstanding. On February 7, 2000 we redeemed the 1,085 shares of series E preferred stock outstanding for a total redemption price of $1,085,000, or $1,000 per share, the stated value of a share of series E preferred stock.

The maximum conversion prices for the outstanding preferred stocks are: series G--$1.63 per share; and series H--$1.06 per share.

There is no minimum conversion price for any series of preferred stock. Consequently, there is no limit on the number of shares of common stock that may be issued upon conversion, except that the terms of each series, set forth in the certificate of designations for that series, limit:

• The number of shares of common stock that a holder of preferred stock may acquire upon conversion, together with shares beneficially owned by the holder and its affiliates, to five percent (5%) of the total outstanding shares of common stock.
• The number of shares of common stock that the holders of a series of preferred stock may acquire upon conversion to that number of shares representing 19.9% of the shares outstanding on the date upon which that series was issued, until stockholders approve the issuance upon conversion of shares in excess of that number of shares. This limitation is required by the rules of The Nasdaq Stock Market, Inc.

The number of shares of common stock issued upon conversion of each series of preferred stock as of October 23, 2000 was as follows: series A - 2,867,135; series B - - 459,831; series C - 563,497; series D - 1,605,203; series E - 1,490,101; series F - 2,143,242; series G - 1,748,631; and series H - 1,699,365. The average actual conversion price for shares of each series of preferred stock converted into shares of common stock as of October 23, 2000 was as follows: series A - $1.23; series B - $2.17; series C - $1.33; series D -$1.25; series E - $1.22; series F - $0.93; series G - $0.65; and series H - $0.31.

The number of shares of common stock that may be acquired upon conversion of the outstanding shares of preferred stock as of October 23, 2000, based upon an assumed conversion prices of $0.50, is as follows: Series G - 1,335,880, and Series H - 1,350,000.

The market price of the common stock on the date of issue of each series of preferred stock was as follows: series A - $3.56; series B - $1.97; series C - $1.81; series D - $2.97; series E - $3.50, series F - $2.38; series G - $1.38; and series H - $0.81.

The conversion price of each series of preferred stock on the date of issue would have been as follows: series A - $2.76; series B - $1.49; series C - $1.41; series D - $2.23; series E - $2.87; series F - $1.22; series G - $1.06; and series H - $0.65. The number of shares of common stock into which the preferred stock would have been convertible on the date of issue would have been as follows: series A - 1,274,000; series B - 672,000; series C - 533,000; series D - 896,000, series E - 1,046,000; series F - 1,639,000; series G - 1,694,000; and series H - 1,846,000.

Holders of preferred stock are not entitled to dividends and have no voting rights, unless required by law or with respect to certain matters relating to the preferred stock.

We may redeem the preferred stock upon written notice to the holders of the preferred stock at any time after January 28, 2001 in the case of the series G preferred stock, and March 28, 2001 in the case of the series H preferred stock, and in each case, at a redemption price equal to the greater of $1,500 per share and the market value of the shares of common stock into which such shares of preferred stock could have been converted on the date of the notice of redemption based upon the closing price of the common stock on that date.

The conversion price and the number of shares of common stock that may be acquired upon conversion are subject to adjustment in the event of a stock split, stock dividend, reorganization, reclassification or issuance of shares of common stock (or securities convertible into or exercisable or exchangeable for common stock) prior to July 28, 2001 in the case of the series G preferred stock, and prior to September 28, 2001 in the case of the series H preferred stock, and in each case, at less than the then conversion price in transactions exempt from the registration requirements of the Securities Act if we grant the purchasers of such shares (or other securities) the right to demand registration of such shares.

We are subject to Section 203 of the Delaware General Corporation Law, the State of Delaware's "business combination" statute. In general, such statute prohibits a publicly held Delaware corporation from engaging in various "business combination" transactions with any "interested stockholder" for a period of three years after the date of the transaction in which the person became an "interested "stockholder," unless (i) the transaction in which the interested stockholder obtained such status or the "business combination" is approved by the Board of Directors prior to the date the interested stockholder obtained such status; (ii) upon consummation of the transaction which resulted in the stockholder becoming an "interested stockholder," the "interested stockholder" owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by (a) persons who are directors and officers and (b) employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer, or (iii) on or subsequent to such date the "business combination" is approved by the Board of Directors and authorized at an annual or special meeting of stockholders by the affirmative vote of at least 66^2/3 of the outstanding voting stock which is not owned by the "interested stockholder." A "business combination" includes mergers, asset sales and other transactions resulting in financial benefit to a stockholder. An "interested stockholder" is a person who, together with affiliates and associates, owns (or within three years, did own) 15% or more of a corporation's voting stock. The statute could prohibit or delay mergers or other takeover or change in control attempts with respect to our company and, accordingly, may discourage attempts to acquire us.

As of October 23, 2000 we had 21,495,527 shares of common stock outstanding, of which only 16,918,243 shares of common stock are transferable without restriction under the Securities Act. The remaining 4,577,284 shares, issued in private transactions, are "restricted securities" (as that term is defined in Rule 144 promulgated under the Securities Act) which may be publicly sold only if registered under the Securities Act or if sold in accordance with an applicable exemption from registration, such as Rule 144. In general, under Rule 144 as currently in effect, subject to the satisfaction of certain other conditions, a person, including an affiliate of our company, who has beneficially owned restricted securities for at least one year, is entitled to sell (together with any person with whom such individual is required to aggregate sales), within any three-month period, a number, of shares that does not exceed the greater of 1% of the total number of outstanding shares of the same class, or, if the common stock is quoted on Nasdaq or a national securities exchange, the average weekly trading volume during the four calendar weeks preceding the sale. A person who has not been an affiliate of our company for at least three months, and who has beneficially owned restricted securities for at least two years is entitled to sell such restricted securities under Rule 144 without regard to any of the limitations described above.

Since we have never paid any dividends on our common stock and we do not anticipate paying such dividends in the foreseeable future. We intend to retain earnings, if any, to finance our operations.

We distribute to our stockholders annual reports containing financial statements audited and reported upon by our independent certified public accountants after the end of each fiscal year, and makes available such other periodic reports as we deem to be appropriate or as may be required by law or by the rules or regulations of any stock exchange o which our common stock is listed. Our fiscal year end is December 31.

American Stock Transfer and Trust Company is the Transfer Agent for our common stock and Warrant Agent for our publicly-traded warrants

Where You Can Find More Information

We file reports, proxy statements and other information with the SEC. You may read and copy any document we file at the Public Reference Room of the SEC at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Regional Offices of the SEC at Seven World Trade Center, Suite 1300, New York, New York 10048 and at 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Please call 1-800-SEC-0330 for further information concerning the Public Reference Room. Our filings also are available to the public from the SEC's website at w,%A,w.sec.gov. We distribute to our stockholders annual reports containing audited financial statements.

Legal Matters

The validity of the shares of common stock offered hereby has been passed upon by Snow Becker Krauss P.C., 605 Third Avenue, New York, New York 10158.

Experts

Ernst & Young LLP, independent auditors, have audited our consolidated financial statements at December 31, 1999 and 1998, and for the years ended December 31, 1999, and 1998 as set forth in their report (which contains an explanatory paragraph describing conditions that raise substantial doubt about the Company's ability to continue as a going concern as described in Note 1 to the consolidated financial statements). We've included our consolidated financial statements in the prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing.

INTEGRATED SURGICAL SYSTEMS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Integrated Surgical Systems, Inc.

We have audited the accompanying consolidated balance sheet of Integrated Surgical Systems, Inc. as of December 31, 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1999 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Integrated Surgical Systems, Inc. at December 31, 1999, and the consolidated results of its operations and its cash flows for the years ended December 31, 1999 and 1998 in conformity with accounting principles generally accepted in the United States.

The accompanying financial statements have been prepared assuming that Integrated Surgical Systems, Inc. will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses and has an accumulated deficit of $45,800,979 as of December 31, 1999. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the uncertainties related to the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

Sacramento, California
March 10, 2000

INTEGRATED SURGICAL SYSTEMS, INC.

CONSOLIDATED BALANCE SHEET

DECEMBER 31, 1999

                                  ASSETS
Current assets:
  Cash and cash equivalents.................................  $  2,918,016
  Accounts receivable less allowance for doubtful accounts
     of $345,466............................................       634,216
  Inventory.................................................     3,332,191
  Other current assets......................................       526,927
                                                              ------------
Total current assets........................................     7,411,350
Net property and equipment..................................       905,001
Leased equipment, net.......................................       638,357
Long-term net investment in sales-type leases...............       433,985
Intangible assets, net......................................     2,175,938
Other assets................................................        12,558
                                                              ------------
                                                              $ 11,577,189
                                                              ============
                   LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $  1,648,124
  Value added taxes payable.................................        78,408
  Accrued payroll and related expenses......................       386,418
  Customer deposits.........................................     1,047,066
  Accrued product retrofit costs............................       207,953
  Current portion of bank loans.............................       114,433
  Other current liabilities.................................       485,893
                                                              ------------
Total current liabilities...................................     3,968,295
Note payable................................................       153,400
Commitments and contingencies (Notes 1, 10 and 11)
Stockholders' equity:
  Convertible preferred stock, $0.01 par value, 1,000,000
     shares authorized, 2,925 shares issued and outstanding
     ($2,925,000 aggregate liquidation value)...............            29
  Common stock, $0.01 par value, 50,000,000 shares
     authorized; 14,291,915 shares issued and outstanding...       142,919
  Additional paid-in capital................................    53,631,218
  Deferred stock compensation...............................       (10,513)
  Preferred stock discount..................................       (19,853)
  Accumulated other comprehensive loss......................      (487,327)
  Accumulated deficit.......................................   (45,800,979)
                                                              ------------
Total stockholders' equity..................................     7,455,494
                                                              ------------
                                                              $ 11,577,189
                                                              ============

See accompanying notes.

INTEGRATED SURGICAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

                                                                YEARS ENDED DECEMBER 31,
                                                              ----------------------------
                                                                  1999            1998
                                                              ------------    ------------
Net sales...................................................  $  6,240,842    $  6,146,434
Cost of sales...............................................     3,563,943       3,413,221
                                                              ------------    ------------
                                                                 2,676,899       2,733,213
Operating expenses:
  Selling, general and administrative.......................     6,589,222       6,347,592
  Research and development..................................     5,580,648       6,602,550
                                                              ------------    ------------
                                                                12,169,870      12,950,142
Other income (expense):
  Interest income...........................................       197,551         240,959
  Interest expense..........................................      (198,479)       (124,095)
  Foreign currency gain (loss)..............................      (183,197)        129,158
  Other, net................................................      (491,480)       (269,737)
                                                              ------------    ------------
Loss before provision for income taxes......................   (10,168,576)    (10,240,644)
Provision for income taxes..................................       (13,155)         27,235
                                                              ------------    ------------
Net loss....................................................   (10,155,421)    (10,267,879)
Preferred stock accretion...................................    (1,422,500)       (376,264)
                                                              ------------    ------------
Net loss applicable to common stockholders..................  $(11,577,921)   $(10,644,143)
                                                              ============    ============
Basic and diluted net loss per share........................  $      (1.47)   $      (1.91)
                                                              ============    ============
Shares used in computing basic net loss per share...........     7,896,171       5,584,639
                                                              ============    ============

See accompanying notes.

INTEGRATED SURGICAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                               CONVERTIBLE
                                             PREFERRED STOCK       COMMON STOCK        ADDITIONAL      DEFERRED     PREFERRED
                                             ---------------   ---------------------     PAID-IN        STOCK         STOCK
                                             SHARES   AMOUNT     SHARES      AMOUNT      CAPITAL     COMPENSATION    DISCOUNT
                                             ------   ------   ----------   --------   -----------   ------------   ----------
Balance at December 31, 1997...............      --     --      5,503,390     55,034   $38,219,836    $(239,530)            --
 Exercise of stock options.................      --     --        142,010      1,420        14,313           --             --
 Issuance of stock options to consultant...      --     --             --         --       208,386           --             --
 Sale of common stock warrants.............      --     --             --         --         6,930           --             --
 Sale of convertible preferred stock and
   warrants, net of offering expenses......   3,520     35          5,000         50     3,300,362           --             --
 Stock compensation expense................      --     --             --         --       (22,540)     153,892             --
 Preferred stock discount..................      --     --             --         --       616,000           --       (616,000)
 Preferred stock accretion.................      --     --             --         --            --           --        376,264
 Comprehensive loss:
   Net loss................................      --     --             --         --            --           --             --
   Unrealized gains of securities..........      --     --             --         --            --           --             --
   Foreign currency translation
     adjustments...........................      --     --             --         --            --           --             --
 Comprehensive loss........................      --     --             --         --            --           --             --
                                             ---------------------------------------------------------------------------------
Balance at December 31, 1998...............   3,520     35      5,650,400   $ 56,504   $42,343,287    $ (85,638)    $ (239,736)
 Exercise of stock options.................      --     --         80,546        806         4,982           --             --
 Stock compensation, non-employees.........      --     --         30,351        304       204,123           --             --
 Stock compensation, employees.............      --     --         10,335        103        48,175       75,125             --
 Sale of common stock and warrants.........      --     --      2,922,396     29,224     3,627,865           --             --
 Sale of convertible preferred stock and
   warrants, net of offering expenses......   6,750     67          9,640         96     6,255,978           --             --
 Conversions of preferred stock............  (7,345)   (73)     5,588,247     55,882       (55,809)          --             --
 Preferred stock discount..................      --     --             --         --     1,202,617           --     (1,202,617)
 Preferred stock accretion.................      --     --             --         --            --           --      1,422,500
 Comprehensive loss:
   Net loss................................      --     --             --         --            --           --             --
   Adjustment to unrealized gains on
     available-for-sale securities.........      --     --             --         --            --           --             --
   Foreign currency translation
     adjustments...........................      --     --             --         --            --           --             --
   Comprehensive loss......................      --     --             --         --            --           --             --
                                             ---------------------------------------------------------------------------------
Balance at December 31, 1999...............   2,925    $29     14,291,915   $142,919   $53,631,218    $ (10,513)    $  (19,853)
                                             =================================================================================


                                              ACCUMULATED
                                                 OTHER                         TOTAL
                                             COMPREHENSIVE   ACCUMULATED    STOCKHOLDERS
                                                INCOME         DEFICIT         EQUITY
                                             -------------   ------------   ------------
Balance at December 31, 1997...............   $   26,272     $(23,578,915)  $ 14,482,697
 Exercise of stock options.................           --               --         15,733
 Issuance of stock options to consultant...           --               --        208,386
 Sale of common stock warrants.............           --               --          6,930
 Sale of convertible preferred stock and
   warrants, net of offering expenses......           --               --      3,300,447
 Stock compensation expense................           --               --        131,352
 Preferred stock discount..................           --               --             --
 Preferred stock accretion.................                      (376,264)            --
 Comprehensive loss:
   Net loss................................           --      (10,267,879)   (10,267,879)
   Unrealized gains of securities..........       50,626               --         50,626
   Foreign currency translation
     adjustments...........................      130,318               --        130,318
                                                                            ------------
 Comprehensive loss........................           --               --    (10,086,935)
                                                                            ------------
                                             -------------------------------------------
Balance at December 31, 1998...............   $  207,216     $(34,223,058)  $  8,058,610
 Exercise of stock options.................           --               --          5,788
 Stock compensation, non-employees.........           --               --        204,427
 Stock compensation, employees.............           --               --        123,403
 Sale of common stock and warrants.........           --               --      3,657,089
 Sale of convertible preferred stock and
   warrants, net of offering expenses......           --               --      6,256,141
 Conversions of preferred stock............           --               --             --
 Preferred stock discount..................           --               --             --
 Preferred stock accretion.................           --       (1,422,500)            --
 Comprehensive loss:
   Net loss................................           --      (10,155,421)   (10,155,421)
   Adjustment to unrealized gains on
     available-for-sale securities.........      (50,626)              --        (50,626)
   Foreign currency translation
     adjustments...........................     (643,917)              --       (643,917)
                                                                            ------------
   Comprehensive loss......................           --               --    (10,849,964)
                                                                            ------------
                                             -------------------------------------------
Balance at December 31, 1999...............   $ (487,327)    $(45,800,979)  $  7,455,494
                                             ===========================================

See accompanying notes.

INTEGRATED SURGICAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

                                                                YEARS ENDED DECEMBER 31,
                                                              ----------------------------
                                                                  1999            1998
                                                              ------------    ------------
Cash flows from operating activities:
Net loss....................................................  $(10,155,421)   $(10,267,879)
Adjustments to reconcile net loss to net cash used in
  operating activities:
  Depreciation..............................................       576,812         579,666
  Amortization of intangible assets.........................       839,040         839,040
  Stock compensation, employees.............................       123,403         131,352
  Stock compensation, non-employees.........................       204,427         208,386
  Gain on short-term investments............................       (65,309)         50,626
  Equity in net loss of Marbella High Care B.V. ............            --         317,000
  Changes in operating assets and liabilities:
    Accounts receivable.....................................     1,214,882        (478,596)
    Inventory...............................................      (996,248)     (1,110,320)
    Other current assets....................................       (96,260)          9,188
    Accounts payable........................................       234,703          65,539
    Value added taxes payable...............................      (242,733)        (91,098)
    Accrued payroll and related expenses....................       (54,996)         54,655
    Customer deposits.......................................       109,418         757,604
    Accrued product retrofit costs..........................        72,605              --
    Other current liabilities...............................      (139,482)        262,217
    Note payable............................................            --            (203)
                                                              ------------    ------------
Net cash used in operating activities.......................    (8,375,159)     (8,672,823)
Cash flows from investing activities:
  Purchase of short-term investments........................            --      (2,024,278)
  Proceeds from sale of short-term investments..............     2,038,961              --
  Investment in Marbella High Care B.V. ....................            --        (563,273)
  Principal payments received on sales-type lease...........        92,489          88,425
  Purchases of property and equipment.......................      (410,384)     (1,746,127)
  Proceeds from sale of property and equipment..............        50,367              --
  Decrease (increase) in other assets.......................            --         (12,868)
                                                              ------------    ------------
Net cash provided (used) in investing activities............     1,771,433      (4,258,121)
Cash flows from financing activities:
  Proceeds from bank loans..................................        32,600         678,447
  Payments on bank loans....................................      (762,723)        (69,138)
  Proceeds from sale of preferred stock and warrants........     6,256,141       3,300,447
  Net proceeds from sale of common stock and warrants.......     3,657,089           6,930
  Proceeds from exercise of stock options...................         5,788          15,733
                                                              ------------    ------------
Net cash provided by financing activities...................     9,188,895       3,932,419
Effect of exchange rate changes on cash and cash
  equivalents...............................................       109,266         130,318
                                                              ------------    ------------
Net increase (decrease) in cash and cash equivalents........     2,694,435      (8,868,207)
Cash and cash equivalents at beginning of year..............       223,581       9,091,788
                                                              ------------    ------------
Cash and cash equivalents at end of year....................  $  2,918,016    $    223,581
                                                              ============    ============
Supplemental disclosure of cash flow information:
Cash paid for interest......................................  $     70,856    $    118,925

See accompanying notes.

INTEGRATED SURGICAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1999

1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Integrated Surgical Systems, Inc. (the "Company") was incorporated on October 1, 1990 in Delaware. The Company develops, manufactures, markets and services computer-controlled, image-directed robotic products for surgical applications. The Company's principal product is the ROBODOC(R) Surgical Assistant System (ROBODOC(R)), which is designed for orthopedic applications. ROBODOC(R) is currently marketed in Europe and the Middle East.

On September 5, 1997, the Company acquired all of Innovative Medical Machines International, S.A.'s issued and outstanding capital stock, stock warrants and convertible debt in a transaction accounted for as a purchase. In April 1999 Innovotive Medical Machines International S.A. was renamed Integrated Surgical Systems, S.A. (ISS-SA). ISS-SA develops, manufactures and markets image guided robotic devices for surgical applications. Its principal product is the NeuroMate(R), a computer controlled surgical robot supporting neurosurgical procedures.

On June 1, 1994, the Company acquired all shares of Gasfabriek Thijssen Holding BV (later renamed Integrated Surgical Systems BV), a non-operating Netherlands corporation, for approximately $4,000. The acquisition was accounted for as a purchase. Integrated Surgical Systems BV (ISS-BV) purchases and licenses products and technology from Integrated Surgical Systems, Inc. for distribution in Europe and other markets.

The Company has incurred recurring operating losses and has an accumulated deficit of $45,800,979 as of December 31, 1999. The report of independent auditors on the Company's December 31, 1999 financial statements includes an explanatory paragraph indicating there is substantial doubt about the Company's ability to continue as a going concern. The Company believes that it has developed a viable plan to address these issues and that its plan will enable the Company to continue as a going concern through the end of 2000. This plan includes the expansion of the geographical markets in which its products are sold, new applications for its products, the consummation of equity financings in amounts sufficient to fund further growth, attain its product development and marketing objectives and meet its working capital demands, and the reduction of certain operating expenses as necessary. Although the Company believes that its plan will be realized, there is no assurance that these events will occur. The financial statements do not include any adjustments to reflect the uncertainties related to the recoverability and classification of assets or the amounts and classification of liabilities that may result from the inability of the Company to continue as a going concern.

2. SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

FOREIGN CURRENCY TRANSLATION

The financial position and results of operations of ISS-SA and ISS-BV are measured using their respective local currencies. The subsidiary balance sheet accounts are translated at the year-end exchange rate and statement of operations amounts are translated at the average exchange rate for the period. Translation adjustments are recorded as a separate component of stockholders' equity. Foreign currency transaction gain (loss) was ($183,197) and $129,158 during the years ended December 31, 1999 and December 31, 1998, respectively.

REVENUE RECOGNITION

Revenues from sales without significant Company obligations beyond delivery are recognized upon delivery of the products and transfer of title. Revenues pursuant to agreements which include significant Company obligations beyond delivery are deferred until the Company's remaining obligations are insignificant. Revenues are recognized net of any deferrals for estimated future contractual liabilities. Estimated future product retrofit costs for ROBODOC(R) sold for clinical trials have been accrued in the accompanying financial statements. Future retrofit costs are those expected to be required to update ROBODOC(R) to the equivalent level of performance expected to be approved by the Food and Drug Administration ("FDA").

RESEARCH AND DEVELOPMENT

Software development costs incurred subsequent to the determination of the product's technological feasibility and prior to the product's general release to customers are not material to the Company's financial position or results of operations, and have been charged to research and development expense in the accompanying consolidated statements of operations. Grants received from third parties for research and development activities are recorded as reductions of expense over the term of the agreement as the related activities are conducted. Research and development costs are expensed as incurred.

CONCENTRATION OF CREDIT RISK AND SIGNIFICANT DISTRIBUTOR (SEE NOTE 15)

The Company sells its products to companies in the healthcare industry and performs periodic credit evaluations of its customers and generally does not require collateral. The Company believes that adequate provision for uncollectible accounts receivable has been made in the accompanying financial statements. The Company maintains substantially all of its cash at four financial institutions.

FINANCIAL STATEMENT ESTIMATES

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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.

CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

The Company invests its excess cash in various investment grade, interest-bearing securities. As of December 31, 1999, cash equivalents and short-term investments consisted of money market mutual funds. The Company has not experienced any losses on such investments.

Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. At December 31, 1999, the Company's entire portfolio of investments is classified as available-for-sale. These securities are stated at fair market value, determined based on quoted market prices, with the unrealized gains and losses reported in a separate component of stockholders' equity.

The amortized cost of debt securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, over the estimated life of the security. Such amortization is included in interest income. Realized gains are included in other income (expense) in the statement of operations. The cost of securities sold is based on the specific identification method.

For purposes of reporting cash flows, the Company considers highly liquid investments with original maturities of three months or less as cash equivalents.

FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying values of the bank loans approximate their fair values as of December 31, 1999, based on current incremental borrowing rates for similar types of borrowing arrangements.

Active markets for the Company's other financial instruments that are subject to the fair value disclosure requirements of Statement of Financial Accounting Standards No. 107, which consist of long-term lease receivables and notes payable, do not exist and there are no quoted market prices for these assets and liabilities. Accordingly, it is not practicable to estimate the fair values of such financial instruments because of the limited information available to the Company and because of the significance of the cost to obtain independent appraisals for this purpose.

INTANGIBLE ASSETS

The Company continually evaluates the value and future benefits of its intangible assets. The Company assesses recoverability from future operations using cash flows and income from operations of the related acquired business as measures. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, the carrying value would be reduced to estimated net realizable value if it becomes probable that the Company's best estimate for expected future cash flows of the related business would be less than the carrying amount of the related intangible assets. There have been no adjustments to the carrying amounts of intangible assets resulting from these evaluations as of December 31, 1999.

Intangible assets consist primarily of developed technology relating to the NeuroMate(R) system. In the opinion of the Company's management the developed technology was completed and had alternative future uses. Accumulated amortization on intangible assets was $1,957,760 on December 31, 1999. The estimated useful lives range from 3 to 5 years.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives of 3 to 5 years, or the lease term, whichever is shorter.

NET INVESTMENT IN SALES-TYPE LEASES

The net investment in sales-type leases consists of the following at December 31, 1999:

Total minimum lease payments receivable.....................  $ 686,444
Less unearned interest......................................    (78,062)
                                                              ---------
Net investment in sales type leases.........................    608,382
Less current portion (included in other current assets).....   (174,397)
                                                              ---------
Long-term net investment in sales-type leases...............  $ 433,985
                                                              =========

The following represents future minimum lease payments to be received by the Company under its net investment in sales-type leases as of December 31, 1999:

2000......................................................   240,667
2001......................................................   240,667
2002......................................................   205,111
                                                            --------
                                                            $686,444
                                                            ========

OPERATING LEASES

The Company leases certain of its ROBODOC systems to customers under cancelable operating leases. The typical lease period is 5 years and certain of the leases contain purchase options. The cost of equipment under operating leases as of December 31, 1999 was $774,029 and the related accumulated amortization thereon was $135,672.

INVENTORY

Inventory is recorded at the lower of cost (first-in, first-out method) or market and consists of materials and supplies used in the manufacture and service support of the ROBODOC(R) and NeuroMate(TM) Systems. Inventory consists of the following at December 31, 1999:

Raw materials...............................................    $1,766,365
Work-in process.............................................       742,663
Finished goods..............................................       823,163
                                                                ----------
                                                                $3,332,191
                                                                ==========

STOCK-BASED COMPENSATION

As permitted under the provisions of Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company has elected to account for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). Under the intrinsic value method, compensation cost is the excess, if any, of the quoted market price or fair value of the stock at the grant date or other measurement date over the amount an employee must pay to acquire the stock.

INCOME TAXES

The liability method is used to account for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are scheduled to be in effect when the differences are expected to reverse.

NET LOSS PER SHARE

In 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 128, Earnings per Share. Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts have been presented on the basis set forth in Statement 128 (Note 9).

SIGNIFICANT CUSTOMERS AND FOREIGN SALES

The Company recognized approximately 15% of its revenues from one customer during the year ended December 31, 1999 and 64% of its revenue from five customers each representing at least 10% of the Company's total revenue, during the year ended December 31, 1998. Foreign sales, substantially all to Western European countries, were approximately $5,794,000 and $6,005,000 for the years ended December 31, 1999 and December 31, 1998, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities" ("SFAS 133"), SFAS 133 establishes accounting and reporting standards of derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In July 1999, the Financial Accounting Standards Board issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133". SFAS 137 deferred the effective date until the first fiscal quarter of the fiscal year beginning after June 15, 2000. The Company will adopt SFAS 133 in its quarter ending March 31, 2001 and has not yet determined whether such adoption will have a material impact on the Company's financial statements.

In December, 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. The SAB states that all registrants are expected to apply the accounting and disclosures described it in. The SEC staff, however, will not object if registrants that have not applied this accounting do not restate prior financial statements provided they report a change in accounting principle in accordance with APB Opinion No. 20, Accounting Changes, by cumulative catch-up adjustment no later than the second fiscal quarter of the fiscal year beginning after December 15, 1999. The Company is currently evaluating the impact, if any, of SAB 101 on its financial statements.

RECLASSIFICATIONS

Certain amounts reported in prior years financial statements have been reclassified to conform with the 1999 presentation.

3. SHORT-TERM INVESTMENTS

The company held no marketable securities on December 31, 1999. As of December 31, 1998 marketable debt securities were all classified as available for sale and consisted of 1,849,000 shares of U.S. Treasury Strips and a 1-year certificate of deposit. The treasury strips had an original cost of $1,767,773 on August 11, 1998. The net unrealized holding gain as of December 31, 1998 of $50,626 was included as a separate component of stockholders' equity. The certificate of deposit had an original cost of $200,000.

All of these marketable securities were sold during 1999 and all remaining income was realized as interest income in the Statement of Operations.

4. PROPERTY AND EQUIPMENT

Property and equipment consists of the following at December 31, 1999:

ROBODOC and NeuroMate System equipment......................  $   937,201
Other equipment.............................................    1,722,089
Furniture and fixtures......................................      308,107
Leasehold improvements......................................       45,418
                                                              -----------
                                                                3,012,815
Less accumulated depreciation...............................   (2,107,814)
                                                              -----------
                                                              $   905,001
                                                              ===========

5. INVESTMENT IN MARBELLA HIGH CARE B.V.

As of December 31, 1999 the Company owned approximately 27% of the outstanding shares of Marbella High Care B.V. ("MBHC") and accounts for its investment under the equity method. The Company recorded expenses relating to its investment and advances in MBHC of $480,000 and $317,000 for years ended December 31, 1999 and 1998, respectively. These charges are included in other income (expense).

6. BANK LOANS AND NOTE PAYABLE

Bank loans consist of the following at December 31, 1999:

Revolving line of credit established in July 1996 for five
  years with an available amount of $107,380 at December 31,
  1999, with interest accruing at 7.15% per annum. The
  amount available decreases quarterly by 5% of the original
  amount beginning October 1996.............................   107,380
Bank term loan with monthly principal and interest payments
  of approximately $1,762 over three years from May 1997,
  with interest accruing at 5.75% per annum.................     7,053
                                                              --------
                                                               114,433
Less current portion........................................   114,433
                                                              --------
Long-term bank loans........................................  $      0
                                                              ========

The bank term loan is secured by substantially all of IMMI's tangible assets (with a net book value of approximately $1,041,000 at December 31, 1999) and is guaranteed by the Company.

The Company received an interest free loan with a balance of $153,400 at December 31, 1999 from a grant organization for the development of a new system. In the case of failure of the project, the Company will have to repay approximately $38,000 of the loan. If the Company sells either a license for the related technology, the prototype developed, or articles manufactured specifically for the research project, 50% of the revenue must be paid to the grant organization in the subsequent year, up to the balance of the loan amount outstanding. According to the contract, any such payments would be considered to be an advance repayment of the loan. The Company has not made any sales of this type through December 31, 1999.

7. STOCKHOLDERS' EQUITY

COMMON STOCK

As of December 31, 1999 the Company has reserved a total of 22,587,445 shares of common stock pursuant to Series D&E Convertible Preferred Stock, warrants and options outstanding and reserved for future issuance.

INITIAL PUBLIC OFFERING

In November 1996, the Company sold in its initial public offering, a total of 1,525,000 shares of common stock at $5.00 per share and 3,272,754 warrants at $0.10 per warrant. In addition, the Company sold to its underwriter warrants to purchase an additional 343,281 shares for total consideration of $10.00. The net proceeds after underwriters' commissions and fees and other costs associated with the offering were approximately $6,137,000.

The Company issued 708,540 warrents to underwirters to purchase Common Stock or warrents. Each warrant entitles the holder to purchase one share of Common Stock or warrents at an adjusted exercise price of $2.87 per share as of December 31, 1999, subject to future adjustment in certain events, at any time during the period commencing November 20, 1997, and thereafter for a period of four years. The warrants are subject to redemption by the Company at $0.10 per warrant at any time during the exercise period on not less than 30 days prior written notice to the holders of the warrants provided certain criteria regarding the price performance of the Company's common stock are met.

EUROPEAN OFFERING

On November 20, 1997, the Company sold 1,500,000 shares of Common Stock at approximately $7.00 per share in an offering to European investors (the "European Offering"). In addition, the Company sold to its underwriters in the European Offering warrants to purchase an additional 338,412 shares for nominal consideration. The net proceeds of the European Offering were approximately $8,440,000.

Each of the warrants issued to the European Offering underwriters entitles the holder to purchase one share of common stock at an adjusted exercise price of $3.70 per share as of December 31, 1999, subject to future adjustments in certain events, at any time during the period commencing November 21, 1998, and thereafter for a period of four years.

PREFERRED STOCK

As part of a Stock Purchase Agreement in December 1995 the Company sold a warrant for $1,333,333 to purchase 1,386,390 shares of Series D Preferred Stock at $0.01 per share, and in February 1996 sold a warrant for $666,667 to purchase 693,194 shares of Series D Preferred Stock at $0.01 to per share. On October 29, 1997, the Company and IBM executed an amendment to the Stock Purchase Agreement pursuant to which the Company and IBM agreed that these combined warrants to purchase 2,274,066 shares of Series D Preferred Stock would be exercisable only for 2,274,066 shares of Common Stock at $0.01 to $0.07 per share. The warrants expire on December 31, 2005 and have not been exercised as of December 31, 1999. Also on October 29, 1997, the Company delivered to CA IB Investmentbank AG ("CA IB") an agreement not to issue any shares of Common Stock, or any warrants, options or other rights to subscribe for or purchase shares of Series D Preferred Stock, or any other securities convertible into or exercisable or exchangeable for, Series D Preferred Stock, without the consent of CA IB. In addition, the Company's management caused the Board of Directors to present a resolution at the annual meeting of the Company's stockholders to amend the Company's Restated Certificate of Incorporation to eliminate the Series D Preferred Stock therefrom. On April 28, 1998 elimination of Series D Preferred Stock was adopted by the Company's stockholders.

In November 1996, the Board of Directors amended, and the stockholders subsequently approved, the Company's Articles of Incorporation to authorize 1,000,000 shares of undesignated preferred stock. Preferred stock may be issued from time to time in one or more series. The Board of Directors is authorized to determine the rights, preferences, privileges and restrictions granted to and imposed upon any wholly unissued series of preferred stock and designation of any such series without any vote or action by the Company's stockholders.

CONVERTIBLE PREFERRED STOCK

Since September 1998, we have received aggregate net proceeds of approximately $11.4 million from the sale of six series of our convertible preferred stock. Information concerning these convertible preferred stock financings is set forth below.

                             SHARES OF
                             PREFERRED
                               STOCK        NET
SERIES      DATE OF SALE       SOLD       PROCEEDS
- ------   ------------------  ---------   ----------
 A       September 10, 1998    3,520     $3,300,447
 B       March 26, 1999        1,000        916,918
 C       June 10, 1999           750        658,190
 D       June 30, 1999         2,000      1,861,549
 E       July 30, 1999         3,000      2,819,484
 F       February 22, 2000     2,000      1,880,000

Each series of convertible preferred stock has a stated value of $1,000 per share and is convertible into common stock at a conversion price equal to 85% of the lowest sale price of the Common Stock on the Nasdaq SmallCap Market over the five trading days preceding the date of conversion (the "Market Price") subject to a maximum conversion price. The number of shares of common stock that may be acquired upon conversion is determined by dividing the stated value of the number of shares of convertible preferred stock to be converted by the conversion price. As of December 31, 1999, 1,725 shares of series D convertible preferred stock and 1,200 shares of Series E convertible preferred stock were outstanding. No other shares of preferred stock were outstanding. On February 7, 2000 the Company redeemed the remaining outstanding shares of series E convertible preferred stock for a total redemption price of $1,185,000, or $1,000 per share, the stated value of a share of series E convertible preferred stock.

The maximum conversion price for the series D and series F preferred stock is $1.22 per share. There is no minimum conversion price for any series of convertible preferred stock.

Holders of series D convertible preferred stock may convert 25% of their shares commencing September 29, 1999, 50% of their shares commencing October 28, 1999, 75% of their shares commencing November 27, 1999 and 100% of their shares commencing December 27, 1999. The Company may require holders to convert all (but not less than all) of the Series D convertible preferred stock at any time after June 30, 2002, or buy out all outstanding shares, at the then conversion price.

The number of shares of Common Stock issued upon conversion of each series of convertible preferred stock as of December 31, 1999 was as follows: series A -- 2,867,135; series B -- 459,831; series C -- 563,497; series D -- 219,961; series E -- 1,477,823. The average actual conversion price for shares of each series of convertible preferred stock converted into shares of Common Stock as of December 31, 1999 was as follows: series A -- $2.23; Series B -- $2.17; Series C -- $1.33; Series D -- $1.61; Series E -- $1.22.

The value assigned to the beneficial conversion feature is based upon the quoted market price of the Company's Common Stock on the date the convertible preferred stock was sold which represents a discount to the value of each series of convertible preferred stock (the "Discount"). The Discount is being accreted using the straightline method over certain conversion periods. The following table sets forth information pertaining to the beneficial conversion feature for each series of convertible preferred stock.

                                                    VALUE ASSIGNED TO                 ACCRETION
                                              BENEFICIAL CONVERSION FEATURES    ----------------------
SERIES                                               AT DATE OF SALE              1998         1999
- ------                                        ------------------------------    --------    ----------
A...........................................             $616,000               $376,264    $  239,736
B...........................................              176,471                     --       176,471
C...........................................              143,793                     --       143,793
D...........................................              352,941                     --       352,941
E...........................................              529,559                     --       509,559
                                                         --------               --------    ----------
                                                        1,818,764                376,264     1,422,500

No series of convertible preferred stock entitles holders to dividends or voting rights, unless required by law or with respect to certain matters relating to a particular series of convertible preferred stock.

The Company may redeem the series D convertible preferred stock upon written notice to the holders of the series D convertible preferred stock at any time after the earlier of December 30, 1999 and the closing of a registered firm underwritten secondary offering of equity securities, at a redemption price equal to the greater of $1,500 per share and the Market Price of the shares of Common Stock into which such series D convertible preferred stock could have been converted on the date of the notice of redemption. All other series of convertible preferred stock have been converted as of December 31, 1999 except series E which was subsequently converted and redeemed in February, 2000.

The following table summarizes information about warrants issued in connection with each series of convertible preferred stock and outstanding as of December 31, 1999:

                                                        ISSUE              WARRANTS        EXERCISE
SERIES                                                   DATE               ISSUED          PRICE
- ------                                            ------------------    ---------------    --------
A...............................................  September 10, 1998        44,000          $2.00
B...............................................      March 26, 1999        12,500           2.28
C...............................................       June 10, 1999         9,375           2.15
D...............................................       June 30, 1999        25,000           3.41
E...............................................       July 30, 1999        37,500           4.39

The warrants are exercisable upon vesting and expire between March 5, 2002 and February 11, 2003. The exercise price and the number of shares of Common Stock issuable upon conversion are subject to adjustment based upon certain future events. None of the warrants had been exercised as of December 31, 1999.

ISSUANCE OF STOCK AND STOCK WARRANTS

In September 1997, the Company issued 4,500 shares of Common Stock and warrants to purchase 55,132 shares of Common Stock (with an aggregate estimated fair value of $93,885) to Rickel & Associates, Inc. for services performed in connection with the acquisition of IMMI. The warrants have an exercise price of $7.50 per share and expire in September 2002.

The Company issued shares of Common Stock to Trinity Capital Advisors, Inc. for financial advisory services performed in connection with each series of convertible preferred stock as follows:

                                   AGGREGATE ESTIMATED
             DATE       NUMBER OF     FAIR VALUE AT
SERIES      ISSUED       SHARES       DATE OF ISSUE
- ------      ------      ---------  -------------------
  A     September 1998    5,000          $20,625
  B       March 1999      1,429            2,903
  C       June 1999       1,071            1,941
  D       June 1999       2,856            8,479
  E      August 1999      4,284           13,923

On December 14, 1999 the Company issued and sold to ILTAG International Licensing Holding S.A.L., Bernd Herrmann and Urs Wettstein an aggregate of 2,922,396 shares of Common Stock and three-year warrants to purchase an additional 11,700,000 shares of common stock under a Stock and Warrant Purchase Agreement dated as of October 1, 1999. The purchase price for the shares and warrants was $4 million. The warrants vest immediately, are exercisable at $1.02656 per share and expire in December, 2002. The warrants are exercisable for three years after the date of issue. None of the warrants have been exercised as of December 31, 1999.

STOCK OPTION PLANS

The Company has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options.

The Company established a stock option plan in 1991 (the "1991 Plan") and on December 13, 1995, it established a new stock option plan (the "1995 Plan"). The Company adopted a third plan on April 28, 1998 (the "1998 Plan"). Certain employees of the Company surrendered their options under the 1991 Plan in return for new and additional options granted under the 1995 Plan. During the year ended December 31, 1998, the Company reduced the exercise prices of certain outstanding stock options with exercise prices ranging from $4.31 to $8.63 (377,752 options) to $3.00 per share which was the fair market value of common stock as determined by the Company's Board of Directors on the date of repricing. Officers, employees, directors and consultants to the Company may participate in the Plans. Options granted under the Plans may be incentive stock options or non-statutory stock options. 1,876,624 shares of the Company's common stock have been reserved for issuance under the Plans. Options granted generally have a term of ten years from the date of the grant. The exercise price of incentive stock options granted under the Plans may not be less than 100% of the fair market value of the Company's common stock on the date of the grant. The exercise price of non-statutory stock options granted under the Plans may not be less than 85% of the fair market value of the Company's common stock on the date of the grant. For a person who, at the time of the grant, owns stock representing 10% of the voting power of all classes of Company stock, the exercise price of the incentive stock options or the non-statutory stock options granted under the Plans may not be less than 110% of the fair market value of the common stock on the date of the grant.

Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS No. 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 1999 and 1998, respectively: risk-free interest rates of 6.0% and 5.0%; dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of 0.91 and 0.77; and an expected life of the option of 4 years.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period. The Company's pro forma information follows:

                                                      1999            1998
                                                  ------------    ------------
Pro forma net loss..............................  $(11,908,599)   $(10,997,076)
Pro forma basic net loss per share..............  $      (1.51)   $      (1.97)

The following summarizes activity under the Plans for the years ended December 31, 1998 and 1999:

                                                                      WEIGHTED
                                                      NUMBER OF       AVERAGE
                                                       SHARES      EXERCISE PRICE
                                                      ---------    --------------
Outstanding at December 31, 1997 (at $0.07 to $8.88
  per share)........................................  1,203,373        $1.97
  Granted (at $2.84 to $6.06 per share).............    724,252         3.23
  Canceled (at $.07 to $8.88 per share).............   (456,356)        5.33
  Exercised (at $.07 to $2.07 per share)............   (142,010)        0.11
                                                      ---------
Outstanding at December 31, 1998 (at $0.07 to $8.88
  per share)........................................  1,329,259        $1.93
                                                      ---------
  Granted (at .01 to 3.94 per share)................    167,288         2.41
  Canceled (at .01 to 8.63 per share)...............    (46,767)        4.43
  Exercised (at .01 to 0.10 per share)..............    (80,436)        0.07
Outstanding at December 31, 1999 (at .07 to 8.63 per
  share)............................................  1,369,344        $1.40
                                                      =========

All options granted in 1998 were granted with option prices equal to the fair market value of the Company's stock on the grant date. The weighted average exercise price of options granted in 1998 was $3.23 and the weighted average grant date fair value of these options was $1.47.

The weighted average exercise price of options granted in 1999 with option prices equal to the fair market value of the Company's stock on the grant date was $3.13 and the weighted average grant date fair value of these options was $2.08.

The weighted average exercise price of options granted in 1999 with option prices less than the fair market value of the company's stock on the date of grant was 1.50 and the weighted average grant date fair value of these options was 2.33.

The following summarizes information related to options outstanding and options exercisable at December 31, 1999:

                                            WEIGHTED AVERAGE
                              WEIGHTED         REMAINING                        WEIGHTED
 EXERCISE      OPTIONS        AVERAGE       CONTRACTUAL LIFE     OPTIONS        AVERAGE
  PRICE      OUTSTANDING   EXERCISE PRICE      (IN YEARS)      EXERCISABLE   EXERCISE PRICE
- ----------   -----------   --------------   ----------------   -----------   --------------
$0 - $ .99      639,531        $0.07              5.9            625,703         $0.07
$1 - $1.99       48,000        $1.74              9.6              4,000         $1.88
$2 - $2.99       45,056        $2.72              9.2             12,234         $2.65
$3 - $3.99      447,648        $3.12              8.7            162,161         $3.11
$4 - $4.99       40,500        $4.71              8.4             15,865         $4.73
$5 - $6.99      102,109        $5.33              7.0             73,722         $5.29
$7 - $8.88       46,500        $7.88              7.7             30,884         $7.91
              ---------        -----              ---            -------         -----
              1,369,344        $2.01              7.3            924,569         $1.40
              ---------        -----              ---            -------         -----

Of the options outstanding at December 31, 1999, options to purchase 924,569 shares of common stock were immediately exercisable at a weighted-average exercise price of $1.40 per share. A total of 216,926 shares were still available for grant under the 1995 Plan at December 31, 1999. A total of 290,354 shares were still available for grant under the 1998 Plan at December 31, 1999.

During the year ended December 31, 1996, the Company recorded deferred stock compensation of $783,666 relating to stock options granted during the period with exercise prices less than the estimated fair value of the Company's common stock, as determined by an independent valuation analysis, on the date of grant. The deferred stock compensation is being amortized into expense over the vesting period of the stock options which generally range from 3 to 5 years. Deferred compensation relating to stock options which vested immediately was expensed on the date of grant. The Company recorded a reduction of $5,675 and $22,540 in deferred stock compensation relating to canceled options in 1999 and 1998, respectively. Compensation expense of $69,450 and $131,352 was recorded during the years ended December 31, 1999 and 1998, respectively, relating to these options. The remaining $10,513 will be amortized into expense in future periods.

8. INCOME TAXES

The income tax provisions for the years ended December 31, 1999 and 1998 are comprised of currently payable state franchise taxes and currently payable foreign income taxes.

Deferred taxes result from temporary differences in the recognition of certain revenue and expense items for income tax and financial reporting purposes. The significant components of the Company's deferred taxes as of December 31, 1999 and 1998 are as follows:

                                                               1999           1998
                                                           ------------    -----------
Deferred tax assets:
  Net operating loss carryover...........................  $  8,085,000    $ 5,842,000
  Research and Development Credit........................     1,261,000        559,000
  Research and development...............................       417,000        285,000
  Accrued product retrofit costs.........................        83,000         54,000
  Inventory..............................................       192,000        330,000
  Depreciation...........................................       224,000        109,000
  Stock compensation.....................................       285,000        256,000
  Loss on investment.....................................       319,000        230,000
  Deferred income........................................       506,000        358,000
  Other..................................................       100,000       (311,000)
                                                           ------------    -----------
                                                             11,472,000      7,712,000
Less: Valuation allowance................................   (11,472,000)    (7,712,000)
                                                           ------------    -----------
Net deferred taxes.......................................  $         --    $        --
                                                           ============    ===========

The Company expects the carryforward amounts will not be utilized prior to the expiration of the carryforward periods.

The principal reasons for the difference between the effective income tax rate and the federal statutory income tax rate are as follows:

                                                             YEARS ENDED DECEMBER 31,
                                                            --------------------------
                                                               1999           1998
                                                            -----------    -----------
Federal benefit expected at statutory rates...............  $(3,445,977)   $(3,481,777)
Domestic net operating loss with no current benefit.......    2,978,323      3,012,575
Effect of foreign loss with no current benefit............      467,654        469,202
Other taxes...............................................      (13,155)        14,000
Foreign income taxes......................................           --         13,235
                                                            -----------    -----------
                                                            $   (13,155)   $    27,235
                                                            ===========    ===========

As a result of stock sales a change of ownership (as defined in Section 382 of the Internal Revenue Code of 1986, as amended) has occurred. As a result of this change, the Company's federal and state net operating loss carryforwards will be subject to a total annual limitation in the amount of approximately $400,000.

The Company has at December 31, 1999 a net operating loss carryover of approximately $22,712,000 for federal income tax purposes which expires between 2005 and 2014, a net operating loss carryforward of approximately $6,110,000 for state income tax purposes which expires through 2004, and a net operating loss carryforward of approximately $1,615,000 for foreign income tax purposes of which approximately $769,000 expires between 2000 and 2004. The Company has at December 31, 1999 research and development credit carryovers of approximately $572,000 and $689,000 for federal and state income tax purposes, respectively.

The Company paid $800 for income and franchise taxes during each of the two years ended December 31, 1999 and 1998. The valuation allowance increased by $2,194,000 in 1998 and $1,718,000 in 1997.

9. NET LOSS PER SHARE INFORMATION

As of December 31, 1999, outstanding options to purchase 1,369,344 shares of common stock (with exercise prices ranging from $0.01 to $8.88), outstanding warrants to purchase 18,820,560 shares of common stock (with exercise prices from $0.07 to $8.26) and 2,397,541 shares of common stock issuable upon conversion of Series D and E Preferred Stock could potentially dilute basic earnings per share in the future and have not been included in the computation of diluted net loss per share because to do so would have been antidilutive for the periods presented.

10. COMMITMENTS

The Company leases its U.S. facility under a non-cancelable operating lease. The lease is for a term of seven years and expires on June 2, 2005. The lease provides for rent of $29,229 per month during the first year of the lease (plus real estate taxes and assessments, utilities and maintenance), subject to adjustment in subsequent years for cumulative increases in the cost of living index, not to exceed 4% per year.

The Company leases its European facility under a non-cancelable operating lease. The lease is for a term of eight years and expires on 2006. The lease provides for rent of $7,197 per month.

Future payments under non-cancelable facility operating leases are approximately as follows:

2000...................................................       440,000
2001...................................................       450,000
2002...................................................       457,000
2003...................................................       465,000
2004...................................................       242,000
Thereafter.............................................       182,000
                                                           ----------
                                                           $2,236,000
                                                           ==========

Aggregate rental expense under these leases amounted to $422,000 and $309,000 during the years ended December 31, 1999 and 1998, respectively.

Future minimum payments under non-cancelable equipment operating leases are approximately as follows:

2000.....................................................     11,000
2001.....................................................     11,000
2002.....................................................     11,000
2003.....................................................     11,000
                                                             -------
                                                             $44,000
                                                             =======

Rental expense for these non-cancelable equipment operating leases during the years ended December 31, 1999 and 1998 was approximately $11,000 and $41,000, respectively.

11. CONTINGENCIES

The Company has from time to time been notified of various claims incidental to its business that are not the subject of pending litigation. While the results of claims cannot be predicted with certainty, the Company believes that the final outcome of all such matters will not have a materially adverse effect on its consolidated financial position, results of operations or cash flows.

12. NIST GRANT

During 1994, the Company received notification it was awarded a $1,960,000 National Institute of Science and Technology ("NIST") grant from the U.S. Department of Commerce ("USDC"). The grant is shared by the Company and two strategic partners to fund approximately 49% of a $4 million joint development project to adapt the ROBODOC System for use in hip revision surgery. The development project and related NIST Grant began in 1995 and ended in 1999. The Company received approximately $129,000 and $514,000 in proceeds under this grant during the years ended December 31, 1999, and 1998, respectively.

13. ANVAR GRANT

During 1996, IMMI received notification it was awarded a $222,492 grant from the French agency Agence Nationale de Valorisation de la Recherche ("ANVAR") which is a French national agency established to aid research and development projects. The grant is to fund the clinical tests to be performed at two university hospitals on the NeuroMate system over a period of fifteen months commencing March 1997. IMMI received $173,595 in proceeds under this grant during the year ended December 31, 1997. The grant income is being recognized ratably over the project period.

14. EMPLOYEE STOCK PURCHASE PLAN

Shareholders approved and the Board of Directors adopted the Company's Employee Stock Purchase Plan (the "Purchase Plan") at the annual Shareholders meeting held April 28, 1998. The Purchase Plan provides all eligible employees an opportunity to acquire a proprietary interest in the Company on a payroll deduction or other compensation basis at a 15% discount. The Purchase Plan is intended to qualify as an employee stock purchase plan under Section 423 of the Code. The Purchase Plan covers an aggregate of 300,000 shares of the Company's Common Stock. As of December 31, 1999, no offerings have been made to employees.

15. DISTRIBUTION AGREEMENT

The Company has entered into a distribution agreement, dated November 12, 1999, with Spark 1st Vision GmbH & Co. KG, a German company, that gives the distributor the exclusive right to distribute the Company's products in Europe, the Middle East and Africa through 2003. The distributor is obligated to purchase a minimum of 24 ROBODOC systems during 2000 and 32 ROBODOC systems during 2001. The distributor is required to pay the Company advance payments of $200,000 per month for the first six months of 2000, $300,000 per month for the remainder of 2000, and $400,000 per month for 2001, to be applied as a credit against the products purchased. However, the distributor has no minimum purchase or advance payment obligation after 2001, even though it will retain exclusive rights to distribute the Company's products in Europe, the Middle East and Africa through 2003. The distributor's only obligation to the Company after 2001 is to pay for products that it purchases. The distributor's liability to the Company under the distribution agreement is limited to $1 million, exclusive of the minimum purchase obligation. The Company will continue to receive service contract revenues and bear the cost of maintenance, training and customer support. The distribution agreement will eliminate marketing; sales and administrative expenses associated with the Company's European activities and provide the Company with a more predictable source of revenues based upon the minimum purchase commitments of the distributor. The Company believes that the terms of the distribution agreement are as fair to the Company as those that could have been obtained from an unaffiliated party.

As of March 30, 2000 the Company had only received the advance payments from the distributor for January , and had not received any orders for the Company's products from the distributor.

INTEGRATED SURGICAL SYSTEMS, INC.
Condensed Consolidated Balance Sheet
(Unaudited)

                                                         June 30,
                                                           2000
                                                       -------------
ASSETS
Current Assets:
  Cash and cash equivalents...........................   $1,055,615
  Accounts receivable less allowance for
    doubtful accounts of $327,765.....................      345,008
  Inventory...........................................    4,090,794
  Other current assets................................      802,493
                                                       -------------
Total current assets..................................    6,293,910
Property and equipment, net...........................      863,557
Leased equipment, net.................................      495,692
Long-term net investment in sales type leases.........      277,118
Intangible assets, net................................    1,758,980
Other assets..........................................       12,340
                                                       -------------
Total Assets..........................................   $9,701,597
                                                       =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable....................................     $583,682
  Value-added taxes payable...........................      110,582
  Accrued payroll and related expenses................      411,726
  Customer deposits...................................    1,330,700
  Accrued product retrofit costs......................      207,953
  Current portion of bank loans.......................       73,529
  Other current liabilities...........................      453,868
                                                       -------------
Total current liabilities.............................    3,172,040
                                                       -------------
Bank loans, long-term.................................       52,187
Note payable..........................................      145,600
Commitments and Contingencies
Stockholders' equity:
  Convertible preferred stock, $0.01 par value
  1,000,000 shares authorized; 2,529 shares issued
  and outstanding   ($2,528,750 aggregate liquidation
  value)..............................................           25
  Common stock, $0.01 par value, 50,000,000 shares
    authorized; 16,929,965 shares issued and
    outstanding ......................................      169,299
    Additional paid-in capital .......................   59,095,104
    Deferred stock compensation ......................       (5,256)
    Accumulated other comprehensive loss .............     (589,569)
    Accumulated deficit ..............................  (52,337,833)
                                                       -------------
Total stockholders' equity............................    6,331,770
                                                       -------------
Total liabilities and stockholder's equity ...........   $9,701,597
                                                       =============

See notes to consolidated financial statements.

INTEGRATED SURGICAL SYSTEMS, INC.
Condensed Consolidated Statements of Operations
(Unaudited)

                                 Three Months Ended         Six Months Ended
                                      June 30,                  June 30,
                             ------------------------- -------------------------
                                 2000         1999         2000         1999
                             ------------ ------------ ------------ ------------
Net sales...................  $1,310,882     $629,236   $2,041,026   $2,915,959
Cost of sales...............     556,153      446,238      898,493    1,551,617
                             ------------ ------------ ------------ ------------
 Gross margin                    754,729      182,998    1,142,533    1,364,342
                             ------------ ------------ ------------ ------------
Operating expenses:
 Selling, general and
   administrative...........   1,283,047    1,510,643    2,397,866    3,102,543
 Research and development...   1,285,020    1,196,240    3,032,413    2,825,946
                             ------------ ------------ ------------ ------------
Total operating expenses....   2,568,067    2,706,883    5,430,279    5,928,489
Other income (expense):
 Interest income............      18,632      103,088       38,182      140,216
 Other......................     893,746        6,718      717,347     (281,469)
                             ------------ ------------ ------------ ------------
Loss before provision for
  income taxes..............    (900,960)  (2,414,079)  (3,532,217)  (4,705,400)
Provision for income taxes..       6,000       15,565       15,000       30,259
                             ------------ ------------ ------------ ------------
Net loss....................    (906,960)  (2,429,644)  (3,547,217)  (4,735,659)
Preferred stock accretion...    (317,647)    (263,969)  (2,989,640)    (508,607)
                             ------------ ------------ ------------ ------------
Net loss applicable to
  common stockholders....... ($1,224,607) ($2,693,613) ($6,536,857) ($5,244,266)
                             ============ ============ ============ ============

Basic net loss per
  common share..............      ($0.07)      ($0.40)      ($0.40)      ($0.84)
Shares used in computing
  basic net loss per-share..  16,905,473    6,713,469   16,241,648    6,220,227
                             ============ ============ ============ ============

See notes to consolidated financial statements.

INTEGRATED SURGICAL SYSTEMS, INC.
Condensed Consolidated Statements of Cash Flows
Increase (Decrease) in Cash and Cash Equivalents
(Unaudited)

                                                    Six Months Ended
                                                        June 30,
                                                --------------------------
                                                     2000          1999
                                                ------------  ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss....................................... ($3,547,217)  ($4,735,659)
Adjustment to reconcile net loss to net cash
 used in operating activities:
   Depreciation................................     293,240       358,817
   Amortization of intangible assets...........     416,958       419,520
   Unrealized gain on securities...............         --        (50,626)
   Stock compensation..........................     199,835        79,984
Changes in operating assets and liabilities:
      Accounts Receivable......................      66,582       993,179
      Inventory................................    (828,790)     (884,543)
      Other current assets.....................     (89,379)       56,623
      Accounts payable.........................  (1,037,461)    1,299,435
      Value added taxes payable................      54,559        39,280
      Accrued payroll and related expenses.....      13,337       (21,162)
      Customer deposits........................    (106,147)      648,714
      Other current liabilities................     401,091       284,611
      Note Payable.............................         --         13,800
                                                ------------  ------------
Net cash used in operating activities..........  (4,163,392)   (1,498,027)
                                                ------------  ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in marketable securities............         --      1,978,582
Net investments in sales type leases...........         --       (319,753)
Principal payments received on sales type lease     147,503           --
Purchases of property and equipment............    (233,047)      (64,726)
Decrease in other assets.......................         --            218
                                                ------------  ------------
Net cash provided by (used in) investing
  activities...................................     (85,544)    1,594,321
                                                ------------  ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds (payments) bank loans.................     (35,278)     (744,953)
Proceeds from issuance of preferred stock......   3,480,096     3,405,912
Redemption of Series E preferred stock.........  (1,185,000)          --
Proceeds from exercise of stock options........      30,801        16,330
                                                ------------  ------------
Net cash provided by financing
  activities...................................   2,290,619     2,677,289
                                                ------------  ------------
Effect of exchange rate changes on cash
   and cash equivalents........................      95,916      (644,089)
                                                ------------  ------------
NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS..................................  (1,862,401)    2,129,494
Cash and cash equivalents at beginning
  of period....................................   2,918,016       223,581
                                                ------------  ------------
Cash and cash equivalents at end of period.....  $1,055,615    $2,353,075
                                                ============  ============

See notes to consolidated financial statements.

INTEGRATED SURGICAL SYSTEMS, INC.

Notes to Condensed Consolidated Financial Statements (unaudited)

June 30, 2000

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB. 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 adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2000 are not necessarily indicative of the results that may be expected for the year ended December 31, 2000. For further information, refer to the consolidated financial statements and footnotes thereto included in Integrated Surgical Systems, Inc.'s annual report on Form 10-KSB and Form 10-KSB/A for the year ended December 31, 1999.

In December, 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. The SAB states that all registrants are expected to apply the accounting and disclosures described in it. The SEC staff, however, will not object if registrants that have not applied this accounting do not restate prior financial statements provided they report a change in accounting principle in accordance with APB Opinion No. 20, Accounting Changes, by cumulative catch-up adjustment no later than the fourth fiscal quarter of the fiscal year beginning after December 15, 1999. The Company is currently evaluating the impact, if any, of SAB 101 on its financial statements.

The components of inventory consist of the following:

                                                 June 30,
                                                   2000
                                              -------------
        Raw materials........................ $  2,763,624
        Work in process......................      905,602
        Finished goods.......................      421,568
                                              -------------
                                              $  4,090,794
                                              =============

In February, 2000, the Company received net proceeds of approximately $1,880,000 from the sale of 2,000 shares of Series F Convertible Preferred Stock ("Series F Preferred Stock") and warrants ("Warrants") to purchase 12,500 shares of common stock ("Common Stock"), par value $.01 per share.

The Series F Preferred Stock is convertible into shares of Common Stock, at the option of the holder, subject to certain limitations, discussed below. The number of shares of Common Stock issuable upon conversion of the Series F Preferred Stock is equal to the quotient of (x) the product of $1,000 (the stated value of each share of Series F Preferred Stock) and the number of shares of Series F Preferred Stock to be converted and (y) 85% of the lowest sale price of the Common Stock on the Nasdaq SmallCap Market during the five trading days preceding the date of conversion (the "Market Price"), but in no event more than $1.22 (the "Conversion Price").

The Company may require holders to convert all (but not less than all) of the Series F Preferred Stock at any time after February 8, 2003, or buy out all outstanding shares, at the then Conversion Price.

The value assigned to the Beneficial Conversion Feature, as determined using the quoted market price of the Company's Common Stock on the date the Series F Preferred Stock was sold, amounted to approximately $2,652,000, which represents a discount to the value of the Series F Preferred Stock (the "Discount".) The Discount was charged against income in February 2000.

Holders of Series F Preferred Stock are not entitled to dividends and have no voting rights, unless required by law or with respect to certain matters relating to the Series F Preferred Stock.

The Company may redeem the Series F Preferred Stock upon written notice to the holders of the Series F Preferred Stock at any time after the earlier of August 8, 2000 and the closing of a registered secondary offering of equity securities, at a redemption price equal to the greater of $1,500 per share and the Market Price of the Shares of Common Stock into which such Series F Preferred Stock could have been converted on the date of the notice of redemption.

The Warrants are exercisable at any time during the period commencing August 8, 2000 and ending August 8, 2003, at an exercise price of $2.375, subject to adjustment. The Conversion Price and the number of shares of Common Stock issuable upon conversion are subject to adjustment based upon certain future events.

On May 30, 2000, the Company received net proceeds of $1,649,000 from the sale of 1,800 shares of Series G Convertible Preferred Stock ("Series G Preferred Stock") and warrants ("Warrants") to purchase 63,000 shares of common stock ("Common Stock"), par value $.01 per share.

The Series G Preferred Stock is convertible into shares of Common Stock, at the option of the holder, subject to certain limitations, discussed below. The number of shares of Common Stock issuable upon conversion of the Series G Preferred Stock is equal to the quotient of (x) the product of $1,000 (the stated value of each share of Series G Preferred Stock) and the number of shares of Series G Preferred Stock to be converted and (y) 85% of the lowest sale price of the Common Stock on the Nasdaq SmallCap Market during the five trading days preceding the date of conversion (the "Market Price"), but in no event more than $1.63 (the "Conversion Price").

The Company may require holders to convert all (but not less than all) of the Series G Preferred Stock at any time after November 30, 2003, or buy out all outstanding shares, at the then Conversion Price.

The value assigned to the Beneficial Conversion Feature, as determined using the quoted market price of the Company's common stock on the date the Series G Preferred Stock was sold, amounted to $318,000, which represents a discount to the value of the Series G Preferred Stock (the "Discount".) The Discount was accreted during the month of June, 2000.

Holders of Series G Preferred Stock are not entitled to dividends and have no voting rights, unless required by law or with respect to certain matters relating to the Series G Preferred Stock.

The Company may redeem the Series G Preferred Stock upon written notice to the holders of the Series G Preferred Stock at any time after the earlier of November 30, 2000 and the closing of a registered firm underwritten secondary offering of equity securities, at a redemption price equal to the greater of $1,500 per share and the Market Price of the Shares of Common Stock into which such Series G Preferred Stock could have been converted on the date of the notice of redemption.

The Warrants are exercisable at any time during the period commencing November 30, 2000 and ending November 30, 2003, at an exercise price of $1.625, subject to adjustment. The Conversion Price and the number of shares of Common Stock issuable upon conversion are subject to adjustment based upon certain future events.

As of June 30, 2000, outstanding options to purchase 1,762,098 shares of Common Stock (with exercise prices ranging from $0.07 to $8.63) and outstanding warrants to purchase 13,518,277 shares of Common Stock (with exercise prices ranging from $0.01 to $4.39) could potentially dilute basic earnings per share in the future and have not been included in the computation of diluted net loss per share because to do so would have been antidilutive for the periods presented.

As of January 1, 1998, the Company adopted Statement 130, Reporting Comprehensive Income. Statement 130 establishes new rules for the reporting and display of comprehensive income and its components. Statement 130 requires unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments, which prior to adoption were reported separately in stockholders' equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130.

The following table sets forth this computation of comprehensive loss:

                                 Three Months Ended         Six Months Ended
                                      June 30,                  June 30,
                             ------------------------- -------------------------
                                 2000         1999         2000         1999
                             ------------ ------------ ------------ ------------
Net loss....................   ($906,960) ($2,429,644) ($3,547,217) ($4,735,659)
Other comprehensive income
 (loss):
Unrealized gain (loss) on
  available for sale
  securities................           0            0            0       14,683
Foreign currency
  translation...............     (19,374)    (377,270)    (102,239)    (709,398)
                             ------------ ------------ ------------ ------------
Comprehensive loss..........   ($926,334) ($2,806,914) ($3,649,456) ($5,430,374)
                             ============ ============ ============ ============

On May 9, 2000 we entered into an agreement with Spark 1st Vision GmbH and Co. KG terminating the agreement that granted Spark 1st Vision exclusive distribution rights for our products in Europe, the Middle East and Africa. We received approximately $1,000,000 from Spark 1st Vision in connection with the termination in settlement of its obligations under the distribution agreement.