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                                                                    EXHIBIT 10.4

                               SEVERANCE AGREEMENT


                  THIS AGREEMENT made as of this 16th day of November, 1998, by
and between N. C. JOSEPH LAI ("Lai") and CRITICARE SYSTEMS, INC., a Delaware
corporation ("Criticare").

                                     RECITAL

                  Lai presently holds the title of Senior Vice President, and is
willing to resign such position and his position as an international sales
representative in China (at or immediately after the conclusion of Criticare's
annual shareholder meeting) and assist Criticare with its efforts to retain and
transition management responsibilities to an acceptable replacement candidate.

                                   AGREEMENTS

                  It is agreed as follows:

                  1. Lai hereby resigns as Senior Vice President of Criticare
effective as of the close of business at Criticare's annual meeting of
stockholders, or any adjournment thereof, and Criticare hereby accepts such
resignation. It is expressly agreed that nothing contained in this Agreement nor
Lai's resignation shall affect Lai's right to indemnification for acts
undertaken on Criticare's behalf pursuant to Criticare's By-Laws or applicable
statutes.

                  2. Lai shall continue to be employed by Criticare as an
independent consultant and in such capacity shall support and assist Criticare's
new President with any reasonable requests with respect to the transition to new
management, including but not limited to, development and sales efforts in
China, introductions to employees, vendors, key customers and other persons
having important relationships with Criticare. In addition, he shall hold
himself available on reasonable advance notice and at reasonable times for
consultation on significant issues affecting Criticare.

                  3. In consideration of Lai's cooperation and consultation
efforts, he shall be entitled to receive and Criticare agrees to provide to Lai,
the following:

                     (a)      His normal monthly salary and commissions for the 
month of November and thereafter commencing December 1, 1998, Lai shall be paid
(i) commissions on sales to China under purchase orders accepted prior to the
date hereof, such payments to be made when such sales are collected, and (ii)
the sum of $5,000 per month for a period of 36 months.

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                     (b)      Lai shall pay to Criticare on or before November 
30, 1998 the principal amount and any accrued interest on Lai's obligation to
Criticare with respect to his loan to Immtech International, Inc., approximating
$10,000 (actual amount to be confirmed).

                     (c)      Effective as of November 30, 1998, Criticare shall
issue to Lai options exercisable for the number of shares of Criticare common
stock determined by dividing the amount paid to Criticare under subsection (b)
above by the exercise price of $2.0625 per share. Such options shall be
exercisable for a period of five years. Criticare will utilize its reasonable
best efforts to register shares issuable upon exercise of such options by
inclusion of same in any existing or future registration statement covering
employee options.

                     (d)      Lai hereby releases Criticare and forever remises
any claims he may have with respect to unpaid life insurance premiums for years
1994 and 1995 in the approximate amount of $62,800, and in return therefor
Criticare will transfer to Lai the following equipment: (i) three 507 EP Units,
(ii) three 506 DX Units, and (iii) four 503 Units, which Lai intends to donate
to a hospital in Toysan, Guangdon Province, China, to be used as a Criticare
reference account.

                     (e)      Lai may continue to occupy his current office for 
a period of 12 months; provided, however, such occupancy may be terminated at
any time after the expiration of 60 days by 60-day notice to Lai if deemed
advisable by the new President. Criticare shall also provide secretarial
services for Lai for a period of 12 months.

                     (f)      All fringe benefits currently provided to Lai 
shall be continued through September 30, 2001, and thereafter Lai and his spouse
shall be entitled to coverage under Criticare's group health and dental
insurance programs until he reaches age 65 or comparable coverage (including
coverage for any pre-existing conditions) is available through his then
employer. Criticare need only provide to Lai that coverage made available to its
key management employees (including any medical reimbursement plan but less any
deductible (which may be charged to Lai) ). In the event such group coverage is
not available, Criticare shall purchase or pay for an individual policy
providing comparable coverages. Company shall not in the future lease vehicles
from Lai and may, at any time, purchase vehicles presently under lease in
accordance with lease terms.

                  4. The existing directors agree that they will nominate Lai
for election as a director of Criticare when his current term expires, barring
the occurrence of an event which they reasonably believe renders him unsuitable
for such position.

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                  5. Lai agrees that the noncompetition provisions of his
Employment Agreement shall continue to apply. Lai further agrees that he will
not during the term of this Agreement solicit or attempt to hire any employees
of Criticare without the prior written consent of Criticare's Chairman of the
Board.

                  6. Any notice, request, approval, consent, demand, permission
or other communication required or permitted by this Agreement shall be
effective only if it is in a writing signed by the party giving same and shall
be deemed to have been sent, given and received only either (a) when personally
received by the intended recipient, or (b) three days after depositing in the
United States Mail, registered or certified mail, return receipt requested, with
first class postage prepaid, addressed as follows:

         If to Lai:                         N. C. Joseph Lai
                                            19660 Killarney Way
                                            Brookfield, WI 53005

         If to the Company:                 Criticare Systems, Inc.
                                            20925 Crossroads Circle
                                            Waukesha, WI 53186
                                            Attn:  President

or to such other address as the intended recipient may have theretofore
specified by notice given to the sender as provided in this section.

                  7. This Agreement requires the personal services of Lai, and
Lai's rights or obligations hereunder may not be assigned or delegated except as
set forth in this Agreement. Subject to the foregoing, this Agreement shall bind
and inure to the benefit of the parties and their respective successors and
assigns.

                  8. This Agreement contains the entire agreement between
Criticare and Lai with respect to the subject matter hereof, and merges and
supersedes all prior agreements, understandings or negotiations whatsoever with
respect to the subject matter hereof.

                  9. No amendments of this Agreement or any waiver of any of its
provisions shall be effective unless expressly stated in a writing signed by
both parties. No delay or omission in the exercise of any right, power or remedy
under or for this Agreement shall impair such right, power or remedy or be
construed as a waiver of any breach. Any waiver of a breach of any provision of
this Agreement shall not be treated as a waiver of any other provision of this

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Agreement or of any subsequent breach of the same or any other provision of this
Agreement.

                  10. If any provision of this Agreement shall be held illegal,
invalid or otherwise unenforceable under controlling law, the remaining
provisions of this Agreement shall not be affected thereby but shall continue in
effect.

                  11. This Agreement shall be governed by and construed and
enforced in accordance with the laws of the State of Wisconsin.

                             CRITICARE SYSTEMS, INC.

                             BY:  /s/ Emil H. Soika                     
                                --------------------------------------
                                 President and Chief Executive Officer

                              /s/ N.C. Joseph Lai                     
                              ----------------------------------------
                                      N. C. Joseph Lai

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