<PAGE>   1
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                    FORM 10-K

(Mark One)
  [x]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                                   ACT OF 1934

For the fiscal year ended NOVEMBER 30, 1998 OR

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

For the transition period from       TO              Commission File No. 0-19095
                               ------   ------

                             SOMANETICS CORPORATION
             (Exact name of Registrant as specified in its charter)

<TABLE>
<CAPTION>
                 MICHIGAN                                          38-2394784
<S>                                                    <C>
(State or other jurisdiction of incorporation or       (I.R.S. Employer Identification No.)
               organization)
</TABLE>
                                                                   48083-4208
   1653 EAST MAPLE ROAD, TROY, MICHIGAN                            (Zip Code)
 (Address of principal executive offices)

       Registrant's telephone number, including area code: (248) 689-3050

        Securities registered pursuant to Section 12(b) of the Act: NONE

           Securities registered pursuant to Section 12(g) of the Act:
                     COMMON SHARES, PAR VALUE $.01 PER SHARE
       --------------------------------------------------------------------
                                (Title of Class)


Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes    X      No      
                                        -------      -------

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the Common Shares held by non-affiliates of the
Registrant as of February 12, 1999, computed by reference to the closing sale
price as reported by Nasdaq on such date, was approximately $16,300,900.

         The number of the Registrant's Common Shares outstanding as of
                        February 12, 1999 was 6,035,597

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 1999 Annual Meeting of Shareholders,
scheduled to be held April 13, 1999, are incorporated by reference in Part III,
if the Proxy Statement is filed no later than March 30, 1999.





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<PAGE>   2
                             SOMANETICS CORPORATION

                           ANNUAL REPORT ON FORM 10-K

                   FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1998

                                TABLE OF CONTENTS




<TABLE>
<CAPTION>
                                                          PART I
                                                                                                                   PAGE
<S>            <C>                                                                                                  <C>
   Item 1.     Business  ....................................................................................        2
   Item 2.     Properties....................................................................................       14
   Item 3.     Legal Proceedings.............................................................................       14
   Item 4.     Submission of Matters to a Vote of Security Holders...........................................       14
   Supplemental Item.  Executive Officers of the Registrant..................................................       15
                                                          PART II
   Item 5.     Market for Registrant's Common Equity and Related Shareholder Matters.........................       17
   Item 6.     Selected Financial Data.......................................................................       18
   Item 7.     Management's Discussion and Analysis of Financial Condition and Results of Operations.........       19
   Item 7A     Quantitative and Qualitative Disclosures About Market Risk....................................       25
                                                            
   Item 8.     Financial Statements and Supplementary Data...................................................       26
   Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..........       40
                                                          PART III
  Item 10.     Directors and Executive Officers of Registrant................................................       41
  Item 11.     Executive Compensation........................................................................       41
  Item 12.     Security Ownership of Certain Beneficial Owners and Management................................       41
  Item 13.     Certain Relationships and Related Transactions................................................       41
                                                          PART IV
  Item 14.     Exhibits, Financial Statement Schedules and Reports on Form 8-K...............................       42
</TABLE>




<PAGE>   3



                                     PART I

ITEM 1.  BUSINESS



THE COMPANY

    Somanetics Corporation ("Somanetics" or the "Company") was incorporated in
1982 and develops, manufactures and markets the INVOS(R) Cerebral Oximeter (the
"Cerebral Oximeter"), the only FDA-cleared, non-invasive patient monitoring
system that continuously measures changes in the blood oxygen level in the adult
brain. The Cerebral Oximeter was developed to meet the need for information
about oxygen in the brain, the organ least tolerant of oxygen deprivation. Brain
oxygen information, therefore, is important, especially in surgical procedures
requiring general anesthesia and in other critical care situations with a high
risk of brain oxygen imbalances. The Company targets surgical procedures with a
high risk of brain oxygen imbalances, such as cardiovascular and vascular
surgeries and surgeries on elderly patients involving abnormal blood pressure.
Surgeons, anesthesiologists and other medical professionals use the Cerebral
Oximeter to identify brain oxygen imbalances and take corrective action,
potentially improving patient outcome and reducing the cost of care.

    The Cerebral Oximeter is a relatively inexpensive, portable and easy-to-use
monitoring system placed at a patient's bedside in hospital critical care areas,
especially operating rooms, recovery rooms, intensive care units ("ICUs") and
emergency rooms. It is comprised of (i) a portable unit including a computer and
a display monitor, (ii) dual single-use, disposable sensors, the SomaSensors(R),
(iii) proprietary software and (iv) a preamplifier cable. SomaSensors can be
adhered to both sides of a patient's forehead to offer bi-lateral monitoring and
are connected to the computer through the preamplifier cable. The computer uses
the Company's proprietary software to analyze information received from the
SomaSensor and provides a continuous digital and trend display on the monitor of
an index of the oxygen saturation in the area of the brain under the SomaSensor.
Users of the Cerebral Oximeter will be required to purchase disposable
SomaSensors on a regular basis because of their single-use nature. Shipments of
the model 4100 Cerebral Oximeter began in the first quarter of fiscal 1998.

    The Company's objective is to establish the Cerebral Oximeter as a "standard
of care" in surgical procedures requiring general anesthesia and in other
critical care situations.


MARKET OVERVIEW

INDUSTRY BACKGROUND

    The brain is the human organ least tolerant of oxygen deprivation. Without
sufficient oxygen, brain damage may occur within a few minutes, which can result
in paralysis, severe and complex disabilities or death. Undetected brain hypoxia
(insufficiency of oxygen delivery) and ischemia (tissue oxygen starvation due to
the obstruction of the inflow of arterial blood) are common causes of brain
damage and death during and after many surgical procedures and in other critical
care situations. A December 1996 article in The New England Journal of Medicine
reported on a 24-institution study and concluded that adverse cerebral outcomes
after coronary artery bypass graft surgery are relatively common and serious and
are associated with substantial increases in death, length of hospitalization
and use of intermediate- or long-term care facilities. Adverse cerebral outcomes
occurred in 6.1% of the patients included in the study. Additional studies have
estimated that a higher percentage of patients experience some neurological
decline after heart surgery and that insufficiency of oxygen delivery to the
brain is a frequent cause of this problem. The New England Journal article
concluded that new diagnostic and therapeutic strategies must be developed to
lessen such injury.

    Oxygen is carried to the brain by hemoglobin in the blood. Hemoglobin passes
through the lungs, bonds with oxygen and is pumped by the heart through arteries
and capillaries to the brain. Brain cells extract the oxygen and the blood
carries away carbon dioxide through the capillaries and veins back to the lungs.
Brain oxygen imbalances can be caused by several factors, including changes in
oxygen saturation (the percentage of hemoglobin contained






                                       2
<PAGE>   4


in a given amount of blood which carries oxygen) in the arteries, blood flow to
the brain, hemoglobin concentration and oxygen consumption by the brain.

    Brain oxygen information is important in surgical procedures requiring
general anesthesia, in other critical care situations with a high risk of brain
oxygen imbalances, as well as in the treatment of patients with head injuries or
strokes. These procedures include cardiovascular and vascular surgeries,
surgeries on elderly patients involving abnormal blood pressure, any
neurosurgery, major surgeries involving the neck, transplant surgeries,
treatment of patients with diseases resulting from high blood pressure, lung
problems, or head, organ or heart injuries and treatment of patients suffering
from strokes. These patients are most commonly found in operating rooms as well
as in the other critical care areas of hospitals, especially recovery rooms,
ICUs and emergency rooms. The Company believes that medical professionals need
immediate and continuous information about changes in the oxygen levels in the
blood in the brain to identify brain oxygen imbalances. After they are alerted
to such imbalances, medical professionals have the information to take
corrective action through the introduction of medications, anesthetic agents or
mechanical intervention, potentially improving patient outcome and reducing the
costs of care. Immediate and continuous information about changes in brain
oxygen levels also provides immediate feedback regarding the adequacy of the
selected therapy. Equally important, without information about brain oxygen
levels, therapy that may not be necessary might be initiated to assure adequate
brain oxygen levels. Unnecessary therapy can have an adverse impact on patient
safety and increase hospital costs.

    A 1997 independent industry report estimates that there are approximately
62,000 operating rooms worldwide performing approximately 48 million surgeries
involving general anesthesia every year. Industry sources estimate that, in
1993, there were more than 4.4 million surgeries involving the heart or the
blood vessels around the heart in the United States. Such surgeries include more
than 600,000 open heart surgeries and 89,000 endarterectomies (the removal of
blockage in the artery). Industry sources estimate, based on a 1985 survey, that
there were more than 26,800 operating rooms in the United States and, based on a
1993 survey, that there were more than 6,100 ICU's in the United States with
more than 90,000 beds.

    Currently, several different methods are used to detect one or more of the
factors affecting brain oxygen levels or the effects of brain oxygen imbalances.
These methods include invasive jugular bulb catheter monitoring, transcranial
Doppler, electroencephalograms ("EEG"), intracranial pressure monitoring and
neurological examination. These methods have not been widely adopted to monitor
brain oxygen levels in critical care situations for a variety of reasons. The
use of any of these methods is limited because it is either expensive, difficult
or impractical to use as a brain monitor, invasive, not available under certain
circumstances (such as when the patient is unconscious or has suppressed neural
activity), not able to measure all of the factors that may affect brain oxygen
imbalances, not organ specific, not able to provide continuous information or
able to measure only the effects of brain oxygen imbalances.

    Arterial oxygen saturation is only one of the factors that can affect oxygen
imbalances in the brain. Pulse oximetry measures oxygen saturation in the
arteries. It is non-invasive, uses optical spectroscopy and has become a
standard of care for measuring arterial oxygen saturation in critical care
situations. However, pulse oximeters require a strong pulse, making them
unavailable during bypass surgeries, surgeries involving induced hypothermia or
any other time the patient does not have a strong peripheral pulse. Pulse
oximeters provide information about the oxygen saturation of the arteries in a
finger or earlobe, not oxygen imbalances in the brain. Changes in the oxygen
balance in the brain may not have any affect on the oxygen levels in a finger or
earlobe. For example, a blocked artery to the brain would affect oxygen in the
brain, but would not affect the amount of oxygen in the arteries in the finger.

    The Cerebral Oximeter is the only FDA-cleared, non-invasive monitoring
system that provides continuous information about changes in the blood oxygen
level in the adult brain. It is easy to use and relatively inexpensive and
provides medical professionals with new information to help them identify brain
oxygen imbalances. This information may facilitate timely intervention, provide
feedback regarding the adequacy of the selected therapy and provide medical
professionals with additional assurance when they make decisions regarding the
need for therapy, thereby potentially improving patient outcome and reducing the
cost of care.





                                       3
<PAGE>   5



MARKET TRENDS

    The Company believes the market for its product is driven by the following
market trends:

    Less Invasive Medical Procedures. The Company believes there is a trend
toward less invasive medical procedures. Notable examples include laparoscopic
procedures in general surgery and arthroscopic procedures in orthopedic surgery.
Such procedures are designed to reduce trauma, thereby decreasing complications,
reducing pain and suffering, speeding recovery and decreasing costs associated
with patient care. The Company also believes that there is a trend to minimize
invasive procedures relating to the brain to increase the safety of patients and
medical professionals, reduce recovery time and minimize costs.

    Demand to Reduce Health Care Costs. Hospitals in the United States are
increasingly faced with direct economic incentives to control health care costs
and improve the efficiency of health care through improved labor productivity,
shortened hospital stays and more selective performance of medical procedures
and use of facilities and equipment. Hospitals often receive a fixed fee from
Medicare, managed care organizations and private insurers based on the disease
diagnosed, rather than based on the services actually performed. Therefore,
hospitals are increasingly focused on avoiding unexpected costs, such as those
associated with increased hospital stays resulting from patients with brain
damage or other adverse outcomes following surgery. This focus on avoiding
unexpected costs is especially pronounced in the operating room and other
hospital critical care areas due to their high operating costs. The economic and
human costs of brain damage can be tremendous. Even short extensions of hospital
stays resulting from brain damage can be expensive. In addition, overtreating a
patient as a result of lack of knowledge about brain oxygen levels can result in
unnecessary costs.

    Organ-Specific Monitoring; Current Emphasis on the Brain. The Company
believes that physicians and hospitals are increasingly interested in monitoring
the status of specific organs in the body, especially the brain. It also
believes there is an increased interest in understanding how the brain functions
and in finding ways to prevent injury to, and cures to diseases affecting, the
brain. The Company believes that this interest has led to a greater focus on
monitoring the brain, both to determine how it functions and to monitor the
effects of various actions on the brain.

    Aging Population. According to the Administration on Aging, United States
Department of Health and Human Services, approximately 33.5 million persons in
the United States were age 65 or older in 1995, representing 13% of the
population. The number of Americans age 65 or older increased by approximately
2.3 million, or 7%, between 1990 and 1995, compared to an increase of 5% for the
under-65 population. The Administration on Aging predicts that the number of
Americans age 65 or older will increase to approximately 34.7 million by the
year 2000 and to approximately 53.2 million by the year 2020. The Company
believes that older patients require a higher level of medical care using more
procedures in which the patient or the procedure involves a risk of brain oxygen
imbalances. Medical and surgical procedure growth rate has remained steady
recently, and industry analysts expect this trend to continue.

BUSINESS STRATEGY

    The Company's objective is to establish the Cerebral Oximeter as a "standard
of care" in surgical procedures requiring general anesthesia and in other
critical care situations. Key elements of the Company's strategy are as follows:

    Target Surgical Procedures With a High Risk of Brain Oxygen Imbalances. The
Company targets surgical procedures with a high risk of brain oxygen imbalances,
such as cardiovascular and vascular surgeries and surgeries on elderly patients
involving abnormal blood pressure. The Company believes that the medical
professionals involved in these surgeries are the most aware of the risks of
brain damage resulting from brain oxygen imbalances. Therefore, the Company
believes that it will be easier to demonstrate the clinical benefits of the
Cerebral Oximeter and potentially gain market acceptance for its product in
connection with these surgeries.

    Demonstrate Clinical Benefits and Promote Acceptance of the Cerebral
Oximeter. The Company sponsors clinical studies using the Cerebral Oximeter to
provide additional evidence of its benefits. The resulting publication of any
favorable peer-reviewed papers is used to help convince the medical community of
the clinical benefits of the






                                       4
<PAGE>   6

Cerebral Oximeter. The Company also promotes acceptance of the Cerebral Oximeter
in the medical community by encouraging surgeons, anesthesiologists and nurses
in leading hospitals, whose opinions and practices the Company believes are
valued by other hospitals and physicians, to use the Cerebral Oximeter on a
trial basis. The Company believes that successful evaluations of the Cerebral
Oximeter by these medical professionals will accelerate the acceptance of the
Cerebral Oximeter by other medical professionals. The Company is sponsoring
discussions among physicians who have used the Cerebral Oximeter about its
clinical benefits.

    Expand Marketing and Sales Activities. The Company has established a
distribution network consisting of its direct sales employees and distributors.
The Company is expanding its marketing and sales efforts to increase the medical
community's exposure to its INVOS technology and the Cerebral Oximeter,
including continued participation in trade shows and medical conferences and
increased product evaluations. The Company is aggressively marketing its product
through its existing sales force and leverages its sales resources through the
use of its distributors, including Baxter Limited in Japan.

    Develop Additional Applications of the Cerebral Oximeter. The Company is in
the process of developing product-line extensions of the Cerebral Oximeter for
use on children and newborns. The Company believes that these natural extensions
of its existing product will increase the market for the Cerebral Oximeter
without the more significant development efforts required for entirely new
products. Research being conducted on children and newborns is expected to
result in a Somasensor that can fit smaller heads. The Company believes that
non-invasive monitoring is especially important in this patient population, as
they generally have lower oxygen reserves than adults, have less blood volume
from which to make invasive blood gas measurements and are less tolerant of
painful skin punctures and infections.

    License Its Technology to Medical Device Manufacturers. The Company plans to
license its Cerebral Oximeter technology to other medical device manufacturers
to expand the installed base of Cerebral Oximeters and increase the demand for
SomaSensors. Such a license might be made to a company interested in
incorporating the Cerebral Oximeter into a multi-function monitor. The Company
believes that such an arrangement could provide another distribution channel for
the Company's Cerebral Oximeter. The Company, however, has no current
commitments for any such licenses.

PRODUCT AND TECHNOLOGY

THE CEREBRAL OXIMETER

    The Company's Cerebral Oximeter is the only FDA-cleared, non-invasive
patient monitoring system that provides continuous information about changes in
the blood oxygen level in the adult brain. It is a portable and easy-to-use
monitoring system that is placed at a patient's bedside in hospital critical
care areas, especially operating rooms, recovery rooms, ICUs and emergency
rooms. Surgeons, anesthesiologists and other medical professionals use the
information provided by the Cerebral Oximeter to identify brain oxygen
imbalances and take corrective action, potentially improving patient outcome and
reducing the cost of care. Once the cause of a cerebral oxygen imbalance is
identified and therapy is initiated, the Cerebral Oximeter provides immediate
feedback regarding the adequacy of the selected therapy. It can also provide
medical professionals with an additional level of assurance when they make
decisions regarding the need for therapy.

    Unlike certain existing monitoring methods, the Cerebral Oximeter functions
even when the patient is unconscious, lacks a strong peripheral pulse or has
suppressed neural activity. The measurement made by the Cerebral Oximeter is
dominated by the blood in the veins. Therefore, it responds to the changes in
factors that affect the balance between cerebral oxygen supply and demand,
including changes in arterial oxygen saturation, cerebral blood flow, hemoglobin
concentration and cerebral oxygen consumption. The Cerebral Oximeter responds to
global changes in brain oxygen levels and to events that affect the brain oxygen
levels in the region beneath the SomaSensor.

    The Cerebral Oximeter monitoring system is comprised of (i) a portable unit
including a computer and a display monitor, (ii) dual single-use, disposable
sensors, the SomaSensors, (iii) proprietary software and (iv) a preamplifier
cable. SomaSensors can be adhered to both sides of a patient's forehead to offer
bi-lateral monitoring and are connected to the computer through the preamplifier
cable. The SomaSensor continuously transmits and receives






                                       5
<PAGE>   7

predetermined wavelengths of light sent through the scalp, muscle and skull into
the brain tissue. The computer receives the information about the intensity of
the light scattered by the blood and tissue in the area being monitored. The
computer uses the Company's proprietary software to analyze this information and
provide a continuous digital and trend display on the monitor of an index of the
oxygen saturation in the area of the brain under the SomaSensor.

    The portable unit includes a menu-driven user interface which provides easy
access for setting high and low audible alarms and permits a customized display
format and data retrieval. Single-function keys offer a convenient means of
powering the Cerebral Oximeter, silencing alarms, marking important events and
printing results that can be stored for up to 24 hours and retrieved by a
variety of standard, commercially available printers. The model 4100 Cerebral
Oximeter measures approximately 9 inches wide, 8 inches high, and 8 inches deep
and weighs approximately 15 pounds.

    The suggested list prices for the model 4100 Cerebral Oximeter and the
SomaSensor in the United States are $11,995 and $35, respectively. Users of the
Cerebral Oximeter will be required to purchase disposable SomaSensors on a
regular basis. The SomaSensor may only be used once because after one use it may
become contaminated and its effectiveness is not warranted by the Company. The
Company provides a one-year warranty on the Cerebral Oximeter, which the Company
will satisfy by repairing or exchanging those units in need of repair. The
Company also expects to offer maintenance agreements and service for the
Cerebral Oximeter for a fee after the warranty expires.

    The following table summarizes the principal features and related benefits
of the Cerebral Oximeter:


<TABLE>
<CAPTION>
               FEATURES                                            BENEFITS
      ---------------------------                 -------------------------------------------
<S>   <C>                                         <C>      
      FDA-cleared                                 - Access to United States and certain foreign markets
      Non-invasive                                - Consistent with market trend toward less invasive medical
                                                    procedures
                                                  - No risk to patients and medical professionals
                                                  - No added patient recovery costs
      Continuous Information                      - Immediate information regarding brain oxygen imbalances
                                                  - Real-time guide to therapeutic interventions
      New Organ-Specific Information              - Provides information about oxygen imbalances in both sides
                                                    of the brain
      Relatively Inexpensive                      - Low cost relative to other brain monitors and medical
                                                    devices 
                                                  - Small portion of the cost of the procedures in 
                                                    which it is used
                                                  - New information can potentially improve patient outcome and
                                                    reduce the cost of care
      Easy-to-Use                                 - Does not require a trained technician to operate or interpret
                                                  - Automatic SomaSensor calibration
                                                  - Simple user interface and controls
                                                  - Audible alarm limits
      Effective in Difficult Circumstances        - Provides information when
                                                    the patient is unconscious,
                                                    lacks a strong peripheral
                                                    pulse or has suppressed
                                                    neural activity,
                                                    specifically during cardiac
                                                    arrest, hypothermia,
                                                    hypertension, hypotension
                                                    and hypovolemia
                                                  - Indicates oxygen imbalances in the brain, not just blood
                                                    flow, oxygenation of the arteries or the effects of
                                                    imbalances
      Portable                                    - Placed at patient's bedside
</TABLE>



OPTICAL SPECTROSCOPY TECHNOLOGY

    The Company's proprietary In Vivo Optical Spectroscopy ("INVOS") technology
is based primarily on the physics of optical spectroscopy. Optical spectroscopy
is the interpretation of the interaction between matter and







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<PAGE>   8

light. Spectrometers and spectrophotometers function primarily by shining light
through matter and measuring the extent to which such light is transmitted
through, or scattered or absorbed by, matter. Physicians and scientists can use
spectrophotometers to examine human blood and tissue. Although most human tissue
is opaque to ordinary light, certain wavelengths penetrate tissue more easily
than others. Therefore, by shining light of appropriate wavelengths into the
body and measuring its transmission, scattering and absorption, or a
combination, physicians can obtain information about the matter under analysis.
Optical spectroscopy generates no ionizing radiation and produces no known
hazardous effects.

    Optical spectroscopy was first used clinically in the 1940s at the
Sloan-Kettering Institute for cancer research. The pulse oximeter uses optical
spectroscopy to determine the oxygen saturation of the blood in the arteries in
peripheral tissue, such as in a finger or an earlobe. By identifying the
hemoglobin and the oxygenated hemoglobin and measuring the relative amounts of
each, oxygen saturation of hemoglobin can be measured. However, the use of
optical spectroscopy in the body has not generally been useful when the
substances to be measured are surrounded by, are behind, or are near bone,
muscle or other tissue, because the transmission, scattering and absorption of
the transmitted light produces extraneous data that interferes with analysis of
the data from the area being examined.

INVOS TECHNOLOGY

    The Cerebral Oximeter is based on INVOS technology. In 1982, the Company
commenced research and development efforts in connection with a spectroscopic
instrument for the measurement of breast tissue abnormalities. The Company's
first product, the Somanetics INVOS 2100 System (the "INVOS 2100"), used the
same INVOS technology as the Cerebral Oximeter. Subsequently, the Company
commenced analysis of the application of INVOS technology to the measurement of
changes in cellular metabolism in the brain. Early studies conducted in
conjunction with the Henry Ford Neurosurgical Institute demonstrated the ability
of the Company's INVOS technology to make certain measurements which were highly
correlated to controlled changes in animal brain cell metabolism. In 1988, the
Company began clinical studies of the Cerebral Oximeter on human patients in
operating rooms, emergency rooms and ICUs at Henry Ford Hospital and later at
Bowman Gray School of Medicine and Mount Sinai Medical Center.

    Like other applications of optical spectroscopy, INVOS technology also
analyzes various characteristics of human blood and tissue by measuring and
analyzing low-intensity visible and near-infrared light transmitted into
portions of the body. It measures the composition of substances by detecting the
effect they have on light. The INVOS technology measurement is made by
transmitting low-intensity visible and near-infrared light through a portion of
the body and detecting the manner in which the molecules of the exposed
substance interact with light at specific wavelengths. INVOS technology detects
this interaction by measuring the intensity of the various wavelengths of light
received by light sensors. By measuring the effect on specific wavelengths of
light caused by oxygenated hemoglobin contained in blood in the region of the
brain being monitored, the Cerebral Oximeter can monitor changes in the
approximate oxygen saturation of the hemoglobin in such region of the brain.

    The Company has developed a method of reducing extraneous spectroscopic data
caused by surrounding bone, muscle and other tissue. This method allows data to
be gathered from areas of the body which previously could not be analyzed using
optical spectroscopy. The dual detector design of the SomaSensor enables the
measurement of scattered light intensities from the intermediate tissues of
skin, muscle and skull in a separate process. The depth of penetration of the
light signal is related to the distance between the light source and the shallow
and deep detectors. While both detectors receive similar information about the
tissue outside the brain, the detector further from the light source receives
more information specific to the brain than does the detector closer to the
light source. By subtracting the two measurements, INVOS technology is able to
suppress the influence of the tissues outside the brain to provide a measurement
of changes in brain oxygen saturation.








                                       7
<PAGE>   9


RESEARCH AND DEVELOPMENT

    The Company is currently focusing its research and development efforts on
product-line extensions of the Cerebral Oximeter for use on children and
newborns and enhancements to the SomaSensor. The Company is currently sponsoring
clinical studies of the Cerebral Oximeter for use on children and newborns, and
is redesigning the SomaSensor for use on smaller heads. The Company believes
that non-invasive monitoring is especially important in this patient population,
as they generally have lower oxygen reserves than adults, have less blood volume
from which to make invasive blood gas measurements, and are less tolerant of
painful skin punctures and infections.

    In addition to the Company's internal research and development activities,
the Company has entered into a consulting arrangement with NeuroPhysics
Corporation pursuant to which the Company is funding a portion of NeuroPhysics'
research into the feasibility and development of prototypes of four new
products. The United States government is also funding a portion of the research
pursuant to two research grants. NeuroPhysics has granted the Company certain
ownership and commercialization rights in the new products, subject to the
rights of the United States government and royalties payable to NeuroPhysics.
The new products are intended to be non-invasive, in vivo, near-infrared
spectroscopy devices that (i) monitor liver oxygenation for assessing and
controlling hemorrhagic shock (shock resulting from loss of blood), (ii) locate
and assess subdural hematomas (bleeding between the brain and the skull) in head
trauma patients, (iii) monitor certain blood gasses and (iv) monitor fetal
cerebral blood oxygenation during labor and delivery.

    In October 1997, NeuroPhysics Corporation was awarded a $746,000 Phase II
contract from the National Institute of Neurological Disorders and Stroke of the
National Institutes of Health. This award follows the completion of a Phase I
contract during which NeuroPhysics demonstrated the conceptual feasibility of
its non-invasive method for monitoring fetal cerebral oxygen during labor and
delivery. The Phase II award is being used to continue the development of this
technology, assemble a prototype fetal cerebral oximeter based on the new
method, and conduct animal and human studies. If Phase II is successful, it is
expected to be followed by the development of a product and clinical trials in
Phase III.

    The Company is considering giving a 120-day notice to terminate the
consulting arrangement with NeuroPhysics Corporation because of the cost to the
Company to pursue these new products. During the 120-day period, the Company
would pursue alternative funding options to preserve the nature of the
relationship with NeuroPhysics Corporation and the prospects of these four new
products.

    During fiscal years 1998, 1997 and 1996 the Company spent $664,874, $736,427
and $235,354, respectively, on research, development and engineering.

MARKETING, SALES AND DISTRIBUTION

MARKETING

    The Cerebral Oximeter is for use on patients at risk of brain oxygen
imbalances. These patients are most commonly found in operating rooms amongst
those undergoing general anesthesia for various surgical procedures as well as
in the other critical care areas of hospitals, especially recovery rooms, ICUs
and emergency rooms. After the Cerebral Oximeter is accepted in hospitals,
future markets might include free-standing operating rooms, clinics, ambulances
and nursing homes.

    The Company markets the Cerebral Oximeter primarily to cardiovascular and
vascular surgeons, neurosurgeons and anesthesiologists. The Company believes
that these specialists are the medical professionals most aware of the risks of
brain damage resulting from brain oxygen imbalances. The Company and its
distributors have concentrated their sales efforts on the major teaching
hospitals in the United States and selected foreign markets in which the Company
has commenced commercial sales, and on other large United States hospitals,
especially those the Company considers opinion leaders. In addition, the Company
is sponsoring discussions among physicians who have used the Cerebral Oximeter
about its clinical benefits.









                                       8
<PAGE>   10

    The Company believes that favorable peer review is a key element to a
product's success in the medical equipment industry. Accordingly, the Company
supports clinical research programs with third-party clinicians and researchers
intended to demonstrate the need for, and clinical benefits of, the Cerebral
Oximeter with the specific objective of publishing the results in peer-reviewed
journals. The research consists primarily of comparing the measurements obtained
from the Cerebral Oximeter to the data obtained from existing diagnostic
methods, including EEG, transcranial Doppler and invasive jugular bulb catheter
monitoring or reports of the results of the use of the Cerebral Oximeter in
various procedures. The Company attends trade shows and medical conferences in
order to introduce and promote the Cerebral Oximeter and to meet medical
professionals with an interest in submitting peer-reviewed papers to appropriate
medical journals and to major national meetings. In fiscal year 1998, a total of
44 presentations concerning the Cerebral Oximeter (some of which contained the
same subject matter) were made at 32 meetings, and 19 peer-reviewed articles
mentioning the Cerebral Oximeter were published. Also, in October 1998, at the
American Society of Anesthesiologists annual meeting, a researcher received the
first place award from the Society for Technology in Anesthesia for research
related to cerebral oximetry.

SALES AND DISTRIBUTION

    The Company sells the Cerebral Oximeter through its direct sales force and
independent distributors. The Company has engaged distributors to provide it
with increased geographic coverage and local sales contacts. In the United
States, the Company sells the Cerebral Oximeter through its 20 direct
salespersons and 3 clinical specialists covering 36 states exclusively and
supporting four independent distributors in the other 14 states and Puerto Rico.
Sales compensation and incentive plans are designed to motivate the Company's
direct sales force by making half of their targeted compensation dependent on
meeting targeted sales levels. The Company believes that the minimum selling
cycle for new medical devices is approximately six to nine months.

    In March 1997, the Company entered into a marketing arrangement with Health
Services Corporation of America, the representative of a buying group for many
small hospitals and extended care facilities. Health Services Corporation of
America informs its member hospital administrators that the Company is its sole
supplier of cerebral oximetry equipment and forwards the Company's marketing
materials to such administrators. In exchange, for its marketing assistance, the
Company's product will be available to the members of the buying group at a
discount.

    The Company did not have any backlog of firm orders as of January 20, 1999.
Its backlog of firm orders for its model 4100 Cerebral Oximeter as of January
20, 1998 is a result of the time between the product's introduction in October
1997 and its first shipment in the first quarter of fiscal 1998. The Company
does not believe that its backlog is indicative of trends in its business.

    Internationally, the Company has distribution agreements with 13 independent
distributors covering 51 countries for the model 4100 Cerebral Oximeter. In
March 1995, the Company engaged Baxter Limited as its exclusive distributor in
Japan. In January 1999, Baxter Limited was licensed by the Japanese Ministry of
Health and Welfare (JMH&W) to market the INVOS 4100 Cerebral Oximeter in Japan.

    During fiscal 1998, the Company began a no-cap sales program whereby the
Company ships the model 4100 Cerebral Oximeter to the customer at no charge, in
exchange for the customer agreeing to purchase a minimum quantity of
SomaSensors, on a monthly basis, at a premium for a stated period of time.
Currently, the Company expenses the cost of the Cerebral Oximeter upon shipment,
and recognizes revenue as the SomaSensors are shipped to the customer.

    For a description of sales to major customers, see Note 10 of Notes to
Financial Statements included in Item 8 of this Report. The Company's
distributor in Japan was the Company's largest customer in fiscal 1997 and 1996.
The Company is dependent on its sales to Baxter Limited in Japan, and the loss
of Baxter Limited as a customer would have an adverse effect on the Company's
business, financial condition and results of operations.

    The Company's export sales for the fiscal years ended November 30, 1998,
1997 and 1996 were approximately $959,000, $689,000 and $745,000, respectively.
See Note 10 of Notes to Financial Statements. For a description of the breakdown
of sales between model 4100 Cerebral Oximeters, model 3100A Cerebral Oximeters,
model 4100 exchanges and refurbished model 3100 Cerebral Oximeters, and
SomaSensors, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Results of Operations."









                                       9
<PAGE>   11

MANUFACTURING

    The Company assembles the Cerebral Oximeter in its facilities in Troy,
Michigan, from components purchased from outside suppliers. The Company
assembles the Cerebral Oximeter to control its quality and costs and to permit
it to make changes to the Cerebral Oximeter faster than it could with
third-party assembly. The Company believes that each component is generally
available from several potential suppliers. The SomaSensor, the printed circuit
boards, other mechanical components and the unit enclosure are the primary
components that must be manufactured according to specifications provided by the
Company. Although the Company is currently dependent on one manufacturer of the
SomaSensor, the Company believes that several potential suppliers are available
to assemble the components of the Cerebral Oximeter. The Company would, however,
require approximately three to four months to change SomaSensor suppliers. The
Company does not currently intend to manufacture on a commercial scale the
disposable SomaSensor or the components of the Cerebral Oximeter.

    On June 11, 1998, the Company received ISO 9001 certification and met the
requirements under the European Medical Device Directive to use the CE Mark,
thereby allowing the Company to continue to market its products in the European
Economic Community.

COMPETITION

    The Company does not believe there is currently any direct commercial
competition for the Cerebral Oximeter. The Company believes, however, that the
market for cerebral oximetry products is in the early stages of its development
and, if it develops, may become highly competitive. The Company is aware of
foreign companies that have sold products relating to cerebral metabolism
monitoring for research or evaluation.

    The medical equipment industry is characterized by intense competition and
extensive research and development. Other companies and individuals are engaged
in research and development of non-invasive cerebral oximeters, and the Company
believes there are many other potential entrants into the market. Some of these
potential competitors have well established reputations, customer relationships
and marketing, distribution and service networks, and have substantially longer
histories in the medical equipment industry, larger product lines and greater
financial, technical, manufacturing, research and development and management
resources than those of the Company. Many of these potential competitors have
long-term product supply relationships with the Company's potential customers.
These potential competitors may succeed in developing products that are at least
as reliable and effective as the Company's product, that make additional
measurements, or that are less costly than the product developed by the Company.
These potential competitors may be more successful than the Company in
manufacturing and marketing their products and may be able to take advantage of
the significant time and effort invested by the Company to gain medical
acceptance of cerebral oximetry. In addition, two patents issued to an
unaffiliated third party and relating to cerebral oximetry expired in 1998,
making that technology generally available and potentially helping the
development of competing products. See "Market Overview."

    The Company also competes indirectly with the numerous companies that sell
various types of medical equipment to hospitals for the limited amount of
funding allocated to capital equipment in hospital budgets. The market for
medical equipment is subject to rapid change due to an increasingly competitive,
cost-conscious environment and to government programs intended to reduce the
cost of medical care. Many of these manufacturers of medical equipment are
large, well-established companies whose resources, reputations and ability to
leverage existing customer relationships may give them a competitive advantage
over the Company. The Company's product and technology also compete indirectly
with many other methods currently used to measure blood oxygen levels or the
effects of low blood oxygen levels.

    The Company believes that a manufacturer's reputation for producing
accurate, reliable and technically advanced products, references from users,
features (speed, safety, ease of use, patient convenience and range of
applicability), product effectiveness and price are the principal competitive
factors in the medical equipment industry.








                                       10
<PAGE>   12

PROPRIETARY RIGHTS INFORMATION

    The Company has fourteen United States patents and fifteen related patents
in various foreign countries. The Company's patents basically cover methods and
apparatus for introducing light into a body part and receiving, measuring and
analyzing the resulting light and its interaction with tissue. Such methods also
involve receiving, measuring and analyzing the light transmissivity of various
body parts of a single subject, as well as of body parts of different subjects
which provides a standard against which a single subject can be compared.
Although the Company believes that one or more of its issued patents cover some
of the underlying technology used in the Cerebral Oximeter, only nine of the
issued patents expressly refer to examination of the brain or developments
involving the Cerebral Oximeter.

    The Company's initial United States patent, covering the in vivo tissue
examination technology developed in conjunction with the INVOS 2100 and its
predecessor, the SOMA 100, was allowed and issued in 1986 and will expire on
October 14, 2003. The corresponding Canadian patent was issued in 1987, the
corresponding European Community patent was issued in 1990 with related patents
issued in the ten Western European countries which were then member states, and
the corresponding Japanese patent was issued in 1991. The Company's fourteen
additional United States patents expire on various dates from February 2005 to
December 2014. The Company also has three patent applications pending in the
United States and several pending patent applications filed in various foreign
countries, with respect to other aspects of its technology relating to the
interaction of light with tissue.

    Notwithstanding the Company's patents as noted above, many other patents
have previously been issued to third parties involving optical spectroscopy and
the interaction of light with tissue, some of which relate to the use of optical
spectroscopy in the area of brain metabolism monitoring, the primary use of the
Cerebral Oximeter. No patent infringement claims have been asserted against the
Company.

    In addition to its patent rights, the Company has obtained United States
Trademark registrations for its trademarks "SOMANETICS," "SOMAGRAM," "INVOS,"
"SOMASENSOR" and "WINDOW TO THE BRAIN," and has also obtained registrations of
its basic mark, "SOMANETICS," in thirteen foreign countries.

    The Company also relies on trade secret, copyright and other laws and on
confidentiality agreements to protect its technology, but believes that neither
its patents nor other legal rights will necessarily prevent third parties from
developing or from using similar or related technology to compete against the
Company's product. Moreover, the Company's technology primarily represents
improvements or adaptations of known optical spectroscopy technology, which
might be duplicated or discovered through its patents, reverse engineering or
both.

GOVERNMENT REGULATION

    The testing, manufacture and sale of the Company's products are subject to
regulation by numerous governmental authorities, principally the FDA and
corresponding state and foreign agencies. Pursuant to the Federal Food, Drug,
and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates
the preclinical and clinical testing, manufacture, labeling, distribution and
promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices,
withdrawal of marketing clearances or approvals and criminal prosecution.

    A medical device may be marketed in the United States only with prior
authorization from the FDA unless it is subject to a specific exemption. Devices
classified by the FDA as posing less risk than class III devices are categorized
as class I or II and are eligible to seek "510(k) clearance." Such clearance
generally is granted when submitted information establishes that a proposed
device is "substantially equivalent" in intended use to a class I or II device
already legally on the market or to a "preamendment" class III device (i.e., one
that has been in commercial distribution since before May 28, 1976) for which
the FDA has not called for PMA applications (as defined below). The FDA in
recent years has been requiring a more rigorous demonstration of substantial
equivalence than in the past, including requiring clinical trial data in some
cases. For any devices that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect safety or
effectiveness, or constitute a major change in the intended use of the device,
will require new 510(k) submissions. The Company believes that it now usually
takes from three to six months from the date of submission to obtain 510(k)
clearance,









                                       11
<PAGE>   13

but it can take substantially longer. There can be no assurance that any of the
Company's devices or device modifications will receive 510(k) clearance in a
timely fashion, or at all. The Cerebral Oximeter has been categorized as a class
II device.

    A device requiring prior marketing authorization that does not qualify for
510(k) clearance is categorized as class III, which is reserved for devices
classified by FDA as posing the greatest risk (e.g., life-sustaining,
life-supporting or implantable devices), or devices that are not substantially
equivalent to a legally marketed class I or class II device. A class III device
generally must receive approval of a premarket approval ("PMA") application,
which requires proving the safety and effectiveness of the device to the FDA.
The process of obtaining PMA approval is expensive and uncertain. The Company
believes that is usually takes from one to three years after filing, but it can
take longer.

    If human clinical trials of a device are required, whether for a 510(k) or a
PMA application, and the device presents a "significant risk," the sponsor of
the trial (usually the manufacturer or the distributor of the device) will have
to file an investigational device exemption ("IDE") application prior to
commencing human clinical trials. The IDE application must be supported by data,
typically including the results of animal and laboratory testing. If the IDE
application is approved by the FDA and one or more appropriate Institutional
Review Boards ("IRBs"), human clinical trials may begin at a specific number of
investigational sites with a specific number of patients, as approved by the
FDA. If the device presents a "nonsignificant risk" to the patient, a sponsor
may begin the clinical trial after obtaining approval for the study by the IRB
at each clinical site without the need for FDA approval.

    In June 1992, the Company received 510(k) clearance from the FDA to market
the Cerebral Oximeter in the United States for use on adults. The Company began
commercial shipments of Cerebral Oximeters and SomaSensors in May 1993. In
November 1993, the Company received notification that the FDA had rescinded the
Company's 510(k) clearance to market the Cerebral Oximeter. As a result, all
commercial sales of the Company's product were suspended. In February 1994, the
Company resumed marketing its product in several foreign countries. In June
1996, the Company received 510(k) clearance from the FDA to market the Cerebral
Oximeter, including the SomaSensor, in the United States. In October 1997, the
Company obtained FDA clearance for new advances in its INVOS technology that are
incorporated in its model 4100 Cerebral Oximeter. The model 4100 Cerebral
Oximeter was introduced in October 1997 and shipments began in the first quarter
of fiscal 1998.

    In October 1997, the Company obtained FDA clearance for advances in its
INVOS technology that are incorporated in its model 4100 Cerebral Oximeter. The
Company has made additional changes to the model 3100A Cerebral Oximeter that
resulted in the model 4100 Cerebral Oximeter. The Company does not believe that
these changes affect the safety or efficacy of the Cerebral Oximeter and,
therefore, the Company believes that these changes do not require the submission
of a new 510(k) notice. There can be no assurance, however, that the FDA would
agree with the Company's determination not to submit a new 510(k) notice for the
model 4100 Cerebral Oximter or that the FDA would not require the Company to
submit a new 510(k) notice for any changes made to the device. If the FDA
requires the Company to submit a new 510(k) notice for its model 4100 Cerebral
Oximeter or for any device modification, the Company may be prohibited from
marketing the modified device until the 510(k) notice is cleared by the FDA.

    Any devices manufactured or distributed by the Company pursuant to FDA
clearances or approvals are subject to pervasive and continuing regulation by
the FDA and certain state agencies. Manufacturers of medical devices for
marketing in the United States are required to adhere to applicable regulations
setting forth detailed Quality System Regulation ("QSR") requirements, which
include testing, control, documentation and other quality assurance procedures.
Manufacturers must also comply with Medical Device Reporting requirements that a
firm report to the FDA any incident in which its product may have caused or
contributed to a death or serious injury, or in which its product malfunctioned
and, if the malfunction were to recur, it would be likely to cause or contribute
to a death or serious injury. Labeling and promotional activities are subject to
scrutiny by the FDA and, in certain circumstances, by the Federal Trade
Commission. Current FDA enforcement policy prohibits the marketing of approved
medical devices for unapproved uses.

    The Company is subject to routine inspection by the FDA and certain state
agencies for compliance with QSR requirements and other applicable regulations.
The most recent FDA QSR inspection occurred in May 1997. The Company also is
subject to numerous federal, state and local laws relating to such matters as
safe working









                                       12
<PAGE>   14

conditions, manufacturing practices, environmental protection, fire hazard
control and disposal of hazardous or potentially hazardous substances.

    If any of the Company's FDA clearances are denied or rescinded, sales of the
Company's product in the United States would be prohibited during the period the
Company does not have such clearances. In such cases the Company would consider
shipping its product internationally and/or assembling it overseas if
permissible and if the Company determines its product to be ready for commercial
shipment. The FDA's current policy is that a medical device that is not in
commercial distribution in the United States, but which needs 510(k) clearance
to be commercially distributed in the United States, can be exported without the
submission of an export request and prior FDA clearance provided that (i) a
company believes the device can be found to be substantially equivalent through
a 510(k) submission, (ii) the device is labeled and intended for export only,
(iii) the device is in accord with the specifications of the foreign purchaser
and (iv) other conditions of the export provisions of the Food, Drug and
Cosmetic Act have been met.

    Congress recently enacted the FDA Modernization Act of 1997. This law is
intended to make the regulatory process more consistent and efficient. It is too
early to determine whether, or how, these new requirements will affect the
Company.

SEASONALITY

     The Company's business is seasonal. The Company's third quarter sales have
typically been lower, compared to other fiscal quarters, principally because the
fiscal quarter coincides with the summer vacation season, especially in Europe,
the United States and Japan.

INSURANCE

    Because the Cerebral Oximeter is intended to be used in hospital critical
care units with patients who may be seriously ill or may be undergoing dangerous
procedures, the Company may be exposed to serious potential products liability
claims. The Company has obtained products liability insurance with a liability
limit of $2,000,000. The Company also maintains coverage for property damage or
loss, general liability, business interruption, travel-accident, directors' and
officers' liability and workers' compensation. The Company does not maintain
key-man life insurance.

EMPLOYEES

    As of February 1, 1999, the Company employed 46 full-time individuals,
including 26 in sales and marketing, five in research and development, eight in
general and administration and seven in manufacturing, quality and service, and
two part-time employees. The Company also uses two consultants. The Company
believes that its future success is dependent, in large part, on its ability to
attract and retain highly qualified managerial, marketing and technical
personnel. The Company's employees are not represented by a union or subject to
a collective bargaining agreement. The Company believes that its relations with
its current employees are good.

FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES

    The Company is located in Troy, Michigan and has no other locations. The
Company's export sales for the fiscal years ended November 30, 1998, 1997 and
1996 were approximately $959,000, $689,000 and $745,000, respectively. See Note
10 of Notes to Financial Statements included in Item 8 of this Report.











                                       13
<PAGE>   15


ITEM 2.  PROPERTIES

    The Company leases 23,392 square feet of office, manufacturing and warehouse
space in Troy, Michigan, of which approximately 12,000 square feet is office
space for sales and marketing, engineering, accounting and other administrative
activities. The lease agreement was extended in fiscal 1997, with the extension
commencing January 1, 1998 and expiring December 31, 1999. The extension also
provides the Company with an option to extend for another year under the same
terms and conditions. The minimum monthly lease payment for the extended term is
approximately $14,700, excluding other occupancy costs. The Company believes
that, depending on sales of the Cerebral Oximeter, its current facility is more
than suitable and adequate for its current needs, including assembly of the
Cerebral Oximeter by the Company and conducting Company operations in compliance
with prescribed FDA/QSR guidelines and will allow for substantial expansion of
the Company's business and number of employees. Effective March 1, 1998, the
Company discontinued subleasing a portion of its warehouse space. Prior to March
1, 1998, this space was sublet on a month-to-month basis for $2,700 per month.

ITEM 3.  LEGAL PROCEEDINGS

    None.

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

    No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year ended November 30, 1998.
























                                       14
<PAGE>   16



SUPPLEMENTAL ITEM.  EXECUTIVE OFFICERS OF THE REGISTRANT

    The current executive officers of the Company and the positions held by them
are as follows:


<TABLE>
<CAPTION>
                                 Executive
          Name                 Officer Since    Age                     Position
          ----                 -------------    ---                     --------
<S>                                <C>          <C>   <C>                                     
Bruce J. Barrett                   6/94         39    President and Chief Executive Officer
Raymond W. Gunn                    2/91         40    Executive Vice President, Chief Financial Officer, and Treasurer
Richard S. Scheuing                1/98         43    Vice President, Research and Development
Mary Ann Victor                    1/98         41    Vice President, Communications and Administration, and Secretary
Ronald A. Widman                   1/98         48    Vice President, Medical Affairs
Pamela A. Winters                  1/98         40    Vice President, Operations
</TABLE>


Officers of the Company serve at the discretion of the Board of Directors.

BIOGRAPHICAL INFORMATION

     Mr. Bruce J. Barrett has served as the Company's President and Chief
Executive Officer and as director of the Company since June 1, 1994. Mr. Barrett
previously served, from June 1993 until May 31, 1994, as the Director, Hospital
Products Division for Abbott Laboratories, Ltd., a health care equipment
manufacturer and distributor, and from September 1989 until May 1993 as the
Director, Sales and Marketing for Abbott Critical Care Systems, a division of
Abbott Laboratories, Inc., a health care equipment manufacturer and distributor.
While at Abbott Critical Care Systems, Mr. Barrett managed Abbott's invasive
oximetry products for approximately four years. From September 1981 until June
1987, he served as the group product manager of hemodynamic monitoring products
of Baxter Edwards Critical Care, an affiliate of Baxter International, Inc.,
another health care equipment manufacturer and distributor. Mr. Barrett received
a B.S. degree in marketing from Indiana State University and an M.B.A. degree
from Arizona State University.

     Mr. Raymond W. Gunn, CPA, has served as the Company's Executive Vice
President since May 1993 and as its Chief Financial Officer and Treasurer since
February 1991. From May 1993 until January 1998, he also served as the Company's
Secretary. From November 1992 to May 1993, he served as the Company's Vice
President, Finance and Administration and Assistant Secretary. From February
1991, to November 1992, Mr. Gunn served as the Company's Vice President,
Finance. His prior experience includes serving as a financial manager with Pulte
Home Corporation and a senior accountant with Deloitte Haskins & Sells. Mr. Gunn
received a B.S. degree in management from Oakland University.

     Messrs. Gunn and Barrett are each parties to employment agreements with the
Company pursuant to which they are required to be elected to the offices they
currently hold.

     Mr. Richard S. Scheuing has served as the Company's Vice President,
Research and Development since January 1998. From March 1993 to January 1998, he
served as the Company's Director of Research and Development. He joined the
Company in 1991 as its Director of Mechanical Engineering. He is an inventor on
four of the Company's issued patents, and one patent that is pending. Before
joining the Company, he was Director of Mechanical Engineering for Irwin
Magnetic Systems, Inc. from 1987 until 1991 and was a Development Engineer with
the Sarns division of Minnesota Mining and Manufacturing Company ("3M") from
1982 to 1987. He received a B.S. degree in mechanical engineering from the
University of Michigan.















                                       15
<PAGE>   17




     Ms. Mary Ann Victor has served as the Company's Vice President,
Communications and Administration and Secretary since January 1998. From July
1997 until January 1998 she served as the Company's Director, Communications and
Administration and was a consultant to the Company from September 1996 until
July 1997. She also served as Somanetics' Director of Corporate Communications
from July 1991 until February 1994. Prior experience includes serving as
Director of Investor Relations with the Taubman Company from February to May
1994, legal assistant from June 1994 to November 1994 and then attorney from
November 1994 to September 1995 with Varnum Riddering Schmidt & Howlett, and
Human Resources Consultant in the Actuarial Benefits and Compensation Consulting
Group of Deloitte & Touche LLP from September 1995 to September 1996. Ms. Victor
received a B.S. in political science from the University of Michigan and a J.D.
from the University of Detroit.

     Mr. Ronald A. Widman has served as the Company's Vice President, Medical
Affairs since January 1998. From August 1994 to January 1998, he served as the
Company's Director of Medical Affairs. Before joining the Company as Marketing
Manager in 1991, he was employed by Mennen Medical, Inc., a manufacturer and
marketer of medical monitoring and diagnostic devices, for 12 years, where he
held various positions in domestic and international medical product marketing,
including Senior Product Manager from 1982 until 1991. He is the author of
several papers and articles related to medical care and monitoring devices.

    Ms. Pamela A. Winters has served as the Company's Vice President, Operations
since January 1998. From February 1996 to January 1998, she served as the
Company's Director of Operations. From May 1992 to February 1996, she served as
the Company's Manager of Quality Assurance. From October 1991 to May 1992, Ms.
Winters served as the Company's Quality Assurance Supervisor. Ms. Winters is
pursuing a B.S. degree in management from University of Phoenix.










                                       16
<PAGE>   18



                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS


    The Common Shares trade on The Nasdaq SmallCap Market under the trading
symbol "SMTS." The following table sets forth, for the periods indicated, the
range of high and low closing sales prices as reported by Nasdaq. The prices set
forth below have been adjusted to give effect to the 1-for-10 reverse stock
split of the Common Shares effected on April 10, 1997.


<TABLE>
<CAPTION>
                                                                          HIGH         LOW
                                                                          ----         ---
                   <S>                                                 <C>         <C>     
                     Fiscal Year Ended November 30, 1997
                       First Quarter..................................  $  15.00    $   5.63
                       Second Quarter.................................     11.25        3.38
                       Third Quarter..................................      4.19        3.13
                       Fourth Quarter.................................      8.13        3.00

                     Fiscal Year Ended November 30, 1998
                       First Quarter..................................  $   6.50    $   4.50
                       Second Quarter ................................      6.50        4.13
                       Third Quarter .................................      5.00        2.13
                       Fourth Quarter ................................      2.25        1.56
</TABLE>



    As of February 12, 1999, the Company had 597 shareholders of record.

    The Company has never paid cash dividends on its Common Shares and does not
expect to pay such dividends in the foreseeable future. The Company currently
intends to retain any future earnings for use in the Company's business. The
payment of any future dividends will be determined by the Board in light of the
conditions then existing, including the Company's financial condition and
requirements, future prospects, restrictions in future financing agreements,
business conditions and other factors deemed relevant by the Board.
















                                       17
<PAGE>   19


ITEM 6.  SELECTED FINANCIAL DATA

    The following selected financial data as of November 30, 1998, 1997, 1996,
1995 and 1994, and for each of the years in the five-year period ended November
30, 1998 have been derived from the audited financial statements of the Company,
certain of which appear in Item 8 of this Report, together with the report of
Deloitte & Touche LLP, independent auditors, whose report includes an
explanatory paragraph relating to an uncertainty concerning the Company's
ability to continue as a going concern. The selected financial data should be
read in conjunction with the financial statements and notes thereto included in
Item 8 of this Report and with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in Item 7 of this
Report.


<TABLE>
<CAPTION>
                                                                    FISCAL YEAR ENDED NOVEMBER 30,
                                                     ----------------------------------------------------------
                                                     1998            1997          1996          1995         1994
                                                     ----            ----          ----          ----         ----
                                                                  (in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:                                                                               
<S>                                                <C>             <C>            <C>          <C>           <C>    
Net revenues (1)............................        $2,491         $ 1,212        $   778      $ 1,336       $   938
Cost of sales...............................         1,326             631            385          658           464
Gross margin................................         1,165             580            393          678           474
Research, development and  engineering
     expenses...............................           665             736            235          286           550
Selling, general, and administrative 
     expenses...............................         6,347           6,238          3,550        3,303         4,347
Net loss....................................        (5,470)         (6,155)        (3,304)      (2,818)       (4,332)
Net loss per Common Share - Basic and                                                                       
      Diluted (2)...........................         (1.01)          (1.88)         (1.77)       (1.67)        (3.41)

Weighted average number of Common Shares
     outstanding (2)........................         5,422           3,272          1,867        1,684         1,270
</TABLE>



<TABLE>
<CAPTION>
                                                                            AT NOVEMBER 30,
                                                      ----------------------------------------------------------
                                                      1998           1997         1996         1995         1994
                                                      ----           ----         ----         ----         ----
                                                                             (in thousands)
    BALANCE SHEET DATA:
<S>                                               <C>            <C>           <C>         <C>           <C>      
    Cash and marketable securities.............   $   6,894      $   4,603     $   3,292   $     941     $   2,405
    Working capital............................       7,633          4,511         3,862       1,846         2,982
    Total assets...............................       9,047          5,677         4,672       2,861         4,327
    Total liabilities..........................         629            788           618         568           808
    Long-term debt and redeemable Convertible
        Preferred Shares.......................         -             -            -              20            20
    Accumulated deficit (4)....................     (41,836)       (36,367)      (30,211)    (26,907)      (24,089)
    Shareholders' equity (3) (4)...............       8,418          4,889         4,054       2,294         3,519
</TABLE>


(1)  Net revenues recorded in fiscal years 1998, 1997, 1996, 1995 and 1994
     relate primarily to the sale of Cerebral Oximeters and SomaSensors for
     commercial use. For a description of the current status of the Company's
     loss of, and regaining, FDA clearance to market the Cerebral Oximeter in
     the United States, see "Business -- Government Regulation," and
     "Management's Discussion and Analysis of Financial Condition and Results of
     Operations -- Liquidity and Capital Resources." Thus, the selected
     financial data presented above may not be indicative of the results to be
     expected for fiscal 1999.
(2)  See Note 4 of Notes to Financial Statements included in Item 8 of this
     Report for information with respect to the calculation of per share data.
     The net loss per Common Share data and weighted average number of Common
     Shares outstanding data have been adjusted to give retroactive effect to
     the 1-for-10 reverse stock split effected April 10, 1997. During the first
     quarter of fiscal 1998, the Company adopted SFAS No. 128, "Earnings Per
     Share." The adoption of SFAS No. 128 had no impact on the reported loss per
     share for all periods presented.
(3)  See Statements of Shareholders' Equity of the Financial Statements included
     in Item 8 of this Report for an analysis of Common Share transactions for
     the period from December 1, 1995 through November 30, 1998.
(4)  The Company believes its accumulated deficit has increased and
     shareholders' equity has decreased since November 30, 1998.










                                       18
<PAGE>   20



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         The following Management's Discussion and Analysis of Financial
Condition and Results of Operations includes forward-looking statements with
respect to the Company's future financial performance. These forward-looking
statements are subject to various risks and uncertainties, including the factors
described under the caption "Risk Factors" and elsewhere in the Company's
Registration Statement on Form S-1 (file no. 333-47225) effective April 2, 1998
and elsewhere in this Report, that could cause actual results to differ
materially from historical results or those currently anticipated.

RESULTS OF OPERATIONS

OVERVIEW

    Somanetics Corporation develops, manufactures and markets the INVOS Cerebral
Oximeter, the only FDA-cleared, non-invasive patient monitoring system that
continuously measures changes in the blood oxygen level in the adult brain. In
June 1996, the Company received clearance from the FDA to market the Cerebral
Oximeter and the related disposable SomaSensor in the United States. In October
1997, the Company obtained FDA clearance for new advances in its INVOS
technology that are incorporated in its model 4100 Cerebral Oximeter. The model
4100 Cerebral Oximeter was introduced in October 1997 and shipments began in the
first quarter of fiscal 1998.

    During fiscal 1997 and fiscal 1996, the Company's primary activities
consisted of research and development of the INVOS technology, the Cerebral
Oximeter and the related disposable SomaSensor. During fiscal 1998, the
Company's primary activities consisted of sales and marketing of the model 4100
Cerebral Oximeter. The Company emerged from the development stage in 1997 and
had an accumulated deficit of $41,836,368 through November 30, 1998. The Company
believes that its accumulated deficit will continue to increase for the
foreseeable future.

    The Company derives its revenues from sales of Cerebral Oximeters and
SomaSensors to its distributors and, since the June 1996 FDA clearance, to
hospitals in the United States through its direct sales employees. The Company
recognizes revenues when it ships its product to its distributors or to
hospitals. Payment terms are generally net 30 days for United States sales and
net 60 days or longer for international sales. The Company's primary expenses,
excluding the cost of its product, are selling, general and administrative and
research, development and engineering, which are generally expensed as incurred.
Since May 1994, the Company has exchanged model 3100A Cerebral Oximeters for its
model 3100 Cerebral Oximeters. Until shipments of the model 4100 Cerebral
Oximeter began in the first quarter of fiscal 1998, the Company refurbished the
model 3100 Cerebral Oximeters it received and sold them approximately at cost in
countries that do not require compliance with the standards met by the model
3100A. During fiscal 1998, the Company offered to exchange model 4100 Cerebral
Oximeters for model 3100A Cerebral Oximeters (which the Company scraps) and cash
equal to the difference in sales prices of the two models. Such sales reduce the
Company's average unit sales price and overall gross margin. Also, during fiscal
1998, the Company began a no-cap sales program whereby the Company ships the
model 4100 Cerebral Oximeter to the customer at no charge, in exchange for the
customer agreeing to purchase a minimum quantity of SomaSensors, on a monthly
basis, at a premium for a stated period of time. Currently, the Company expenses
the cost of the Cerebral Oximeter upon shipment, and recognizes revenue as the
SomaSensors are shipped to the customer.

FISCAL YEAR ENDED NOVEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED
NOVEMBER 30, 1997

    Net revenues increased approximately $1,279,000, or 106%, from $1,211,784 in
the fiscal year ended November 30, 1997 to $2,490,851 in the fiscal year ended
November 30, 1998. The increase in net revenues was primarily attributable to an
approximately $1,009,000 (193%) increase in United States sales, from
approximately $523,000 in fiscal 1997 to approximately $1,532,000 in fiscal
1998, and an approximately $270,000 (39%) increase in international sales, from
approximately $689,000 in fiscal 1997 to approximately $959,000 in fiscal 1998.
The increase in net revenues is primarily attributable to stocking orders for
the model 4100 Cerebral Oximeter from both existing distributors and new
international distributors, purchases of the model 4100 by customers in the
United States, and an 8% increase in the average selling price of Cerebral
Oximeters due to (i) a change in the mix between







                                       19
<PAGE>   21

sales directly to hospitals and sales through distributors and (ii) the higher
price of the new model 4100 Cerebral Oximeter, partially offset by no-cap sales
shipments and exchanges of model 4100 Cerebral Oximeters for model 3100A
Cerebral Oximeters with existing customers. The sales increase was also
partially offset by approximately $233,000 of reduced shipments to Baxter
Limited in Japan, which is delaying purchases until shipment of the model 4100
Cerebral Oximeter is permitted in Japan pursuant to Japanese Ministry of Health
and Welfare approval.

    Approximately 39% of the Company's net revenues in fiscal 1998 were export
sales, as compared to approximately 57% in fiscal 1997. Sales of model 4100
Cerebral Oximeters, model 4100 exchanges and refurbished model 3100 Cerebral
Oximeters, model 3100A Cerebral Oximeters, and SomaSensors comprised
approximately 61%, 8%, 3% and 28%, respectively, of the Company's fiscal year
1998 net revenues, and 0%, 10%, 60% and 30%, respectively, of the Company's
fiscal year 1997 net revenues. One United States distributor accounted for
approximately 10% of net revenues for fiscal year 1998; however, this
distributor relationship was terminated during the third quarter of fiscal 1998
as part of the Company's planned expansion of the direct sales force within
several domestic territories. Two international distributors and one domestic
distributor accounted for approximately 28%, 11%, and 12%, respectively, of net
revenues for fiscal year 1997. Effective March 1, 1999, the Company will
increase the price of the Cerebral Oximeter and Somasensor. This price increase
will not apply to any existing sales quotations which were issued prior to March
1, 1999.

    Gross margin as a percentage of net revenues for the fiscal years ended
November 30, 1998 and 1997 was approximately 47% and 48%, respectively. Gross
margin as a percentage of net revenues decreased in fiscal 1998 from fiscal 1997
primarily because of the higher cost to the Company of the model 4100 Cerebral
Oximeter as compared to the cost of the model 3100A and refurbished model 3100,
no-cap sales shipments for 1998, and the higher cost to the Company of the
SomaSensor in fiscal 1998. This decrease was partially offset by the higher
average selling price realized in fiscal 1998 by the Company for the new model
4100 Cerebral Oximeter and SomaSensor.

    The Company's research, development and engineering expenses decreased
approximately $72,000, or 10%, from $736,427 for the fiscal year ended November
30, 1997 to $664,874 for the fiscal year ended November 30, 1998. The decrease
is primarily attributable to approximately $118,000 in consulting fees and costs
of development materials in fiscal 1997 in connection with the model 4100
Cerebral Oximeter, partially offset by an increase of approximately $38,000
related to development materials and costs associated with the Company's new
sensor development projects in fiscal 1998.

    Selling, general and administrative expenses increased approximately
$108,000 or 2%, from $6,238,330 for the fiscal year ended November 30, 1997 to
$6,346,595 for the fiscal year ended November 30, 1998. The increase in selling,
general and administrative expenses for fiscal 1998 is primarily attributable to
(i) a $657,000 increase in salaries, wages, commissions and related expenses as
a result of the additional employees, principally sales and marketing, hired
during fiscal 1998 (from 40 employees as of November 30, 1997, to 50 employees
as of November 30, 1998, most of whom were on the payroll for the majority of
fiscal 1998), and (ii) a $311,000 increase in selling-related expenses,
primarily attributable to employee travel, industry trade shows, marketing and
advertising. These increases were partially offset by (i) a $432,000 decrease in
miscellaneous expense primarily related to inventory obsolescence reserves
recorded during the third and fourth quarters of fiscal 1997, (ii) a $188,000
decrease in professional service fees and regulatory certification fees, (iii) a
$176,000 decrease in bad debts expense primarily related to reserves recorded
during the fourth quarter of fiscal 1997, and (iv) a $68,000 decrease in
clinical research expenses for fiscal 1998.

FISCAL YEAR ENDED NOVEMBER 30, 1997 COMPARED TO FISCAL YEAR ENDED NOVEMBER 30, 
1996

    Net revenues increased approximately $434,000, or 56%, from $778,200 in
the fiscal year ended November 30, 1996 to $1,211,784 in the fiscal year ended
November 30, 1997. The increase in net revenues was primarily attributable to
an increase in United States sales for fiscal 1997 of approximately $490,000,
from approximately $33,000 in fiscal 1996 to approximately $523,000 in fiscal
1997. The sales increase was partially offset by a $56,000 decrease in
international sales in fiscal 1997 compared to fiscal 1996, primarily due to
reduced shipments to Baxter Limited in Japan, which is delaying purchases until
shipment of the model 4100 Cerebral Oximeter is permitted in Japan, and a 21%
decrease in the average selling price of Cerebral Oximeters in fiscal 1997
compared to fiscal 1996







                                       20
<PAGE>   22

primarily as a result of lower international prices for the Cerebral Oximeter,
partially offset by increased prices realized by the Company as a result in a
change in the mix between sales directly to hospitals and sales through
distributors.

    Approximately 57% of the Company's net revenues in fiscal 1997 were export
sales, as compared to approximately 96% in fiscal 1996. Sales of model 3100A
Cerebral Oximeters, SomaSensors, and refurbished model 3100 Cerebral Oximeters
comprised approximately 60%, 30% and 10%, respectively, of the Company's fiscal
year 1997 net revenues, and 63%, 23% and 14%, respectively, of the Company's
fiscal year 1996 net revenues. Two international distributors and one domestic
distributor accounted for approximately 28%, 11%, and 12%, respectively, of net
revenues for fiscal year 1997, and two international distributors accounted for
approximately 62% and 15%, respectively, of net revenues for fiscal year 1996.

    Gross margin as a percentage of net revenues for the fiscal years ended
November 30, 1997 and 1996 was approximately 48% and 51%, respectively. Gross
margin as a percentage of net revenues decreased in fiscal 1997 from fiscal 1996
primarily because the Company realized lower average selling prices for model
3100A Cerebral Oximeters in fiscal 1997, the cost to the Company of the
SomaSensor was higher in fiscal 1997, and SomaSensors were a larger portion of
overall sales. This decrease was partially offset by the decrease in the portion
of net revenues attributable to refurbished model 3100 Cerebral Oximeters in
fiscal 1997.

    The Company's research, development and engineering expenses increased
approximately $501,000, or 213%, from $235,354 for the fiscal year ended
November 30, 1996 to $736,427 for the fiscal year ended November 30, 1997. The
increase in fiscal 1997 is primarily attributable to increased costs of
development materials and consulting fees in connection with new product
development, principally the next generation adult Cerebral Oximeter, increased
clinical testing, and an increase in research, development, and engineering
personnel from two employees at November 30, 1996 to five employees at November
30, 1997.

    Selling, general and administrative expenses increased approximately
$2,688,000, or 76%, from $3,549,939 for the fiscal year ended November 30, 1996
to $6,238,330 for the fiscal year ended November 30, 1997. The increase for
fiscal 1997 is primarily attributable to (i) a $1,539,000 increase in salaries,
wages, incentive compensation and related expenses as a result of the additional
personnel hired during fiscal 1997 (from 30 employees as of November 30, 1996,
eight of which were hired during the fourth quarter of fiscal 1996, to 40
employees as of November 30, 1997, most of whom were on the payroll for the
entire fiscal 1997), (ii) a $446,000 increase in selling-related expenses
primarily as a result of increased expenses for employee travel, medical
affairs, marketing, clinical research, and sales demonstration equipment use,
and industry trade shows and advertising, (iii) a $280,000 increase in
miscellaneous expense primarily related to inventory obsolescence reserves
recorded during the third and fourth quarters of fiscal 1997, (iv) a $152,000
increase in bad debts expense, and (v) a $276,000 increase in other personnel
and office-related expenses, including temporary services, telephone, recruiting
and training, and office supplies.

EFFECTS OF INFLATION

    The Company does not believe that inflation has had a significant impact on
its financial position or results of operations in the past three years.

LIQUIDITY AND CAPITAL RESOURCES

    Net cash used in operations during fiscal 1998 was approximately $6,200,000.
Cash was used primarily to (i) fund the Company's net loss, including selling,
general and administrative expenses and research, development and engineering
expenses (approximately $5,376,000, net of depreciation and amortization
expense), (ii) increase accounts receivable (approximately $424,000) primarily
due to higher sales in the fourth quarter of fiscal 1998 than in the fourth
quarter of fiscal 1997, (iii) increase inventories of the model 4100 Cerebral
Oximeter and its components (approximately $228,000), and (iv) decrease accounts
payable and accrued liabilities (approximately $159,000), resulting from the use
of some of the proceeds from the public offering. Management expects working
capital requirements to increase if sales increase. The Company capitalized
approximately $374,000 of costs for model 4100 Cerebral Oximeters being used as
demonstration units during fiscal 1998. The Company expects to depreciate these
costs as a marketing expense over three years.










                                       21
<PAGE>   23




     Capital expenditures in fiscal 1998 were approximately $509,000, net of
depreciation for demonstration units as a marketing expense (approximately
$83,000) primarily for (i) model 4100 demonstration units (approximately
$374,000), (ii) computer hardware and software (approximately $100,000), and
(iii) tooling to manufacture the model 4100 Cerebral Oximeter and for the
Company's sensor development projects (approximately $92,000).

    The Company's principal sources of operating funds have been the proceeds of
equity investments from sales of the Company's Common Shares. See Statements of
Shareholders' Equity of the Company's Financial Statements included in Item 8 of
this Report. On April 8, 1998, the Company completed the public offering of
1,750,000 newly-issued Common Shares, at a price of $5.75 per share, for gross
proceeds of $10,062,500, through an offering underwritten by Brean Murray & Co.,
Inc. The net proceeds to the Company, after deducting the underwriting discount
and the expenses of the offering, were approximately $9,100,000.

    On June 12, 1998, the Company entered into a $2,000,000 Revolving Note and a
Pledge Agreement with Fifth Third Bank of Northwestern Ohio, N.A. The principal
amount outstanding under the note bears interest, payable monthly, at the bank's
prime rate (7.75% as of February 1, 1999), is collateralized by all property of
the Company held at the bank, including marketable securities, and is intended
to be used for general corporate purposes, if necessary. The Company has not
borrowed any money under the line of credit. The line of credit expires March
31, 1999. Before that date, the bank may, but is not obligated to, lend the
Company such amounts as may from time to time be requested by the Company, up to
$2,000,000 if no Event of Default shall exist. Events of default include failure
to furnish satisfactory additional security on demand or the bank deeming itself
insecure. The Company has no other loan commitments.

    As of November 30, 1998, the Company had working capital of $7,633,313,
cash, cash equivalents and marketable securities of $6,893,771, total current
liabilities of $629,154 and shareholders' equity of $8,417,793.

    The Company expects that its primary needs for liquidity in fiscal 1999 will
be (i) to fund its losses and sustain its operations, including funding (a)
marketing costs for the Cerebral Oximeter; (b) further development and testing
of enhancements to, and product extensions of, the Cerebral Oximeter and
SomaSensor; and (c) additional research and development projects and (ii) for
working capital, including increased accounts receivable and inventories of
components and sales units to satisfy expected sales orders. In addition,
management has budgeted approximately $66,000 for capital expenditures during
fiscal 1999, primarily for manufacturing tooling for the Cerebral Oximeter and
SomaSensor.

    The Company believes that cash, cash equivalents and marketable securities
on hand at November 30, 1998 will be sufficient to sustain the Company's
operations at budgeted levels and its need for liquidity into the second quarter
of fiscal 2000. By that time the Company will be required to raise additional
cash either through additional sales of its product, through sales of
securities, by incurring indebtedness or by some combination of the foregoing.
If the Company is unable to raise additional cash by that time, it will be
required to reduce or discontinue its operations.

    The estimated length of time current cash, cash equivalents and marketable
securities will sustain the Company's operations is based on certain estimates
and assumptions made by the Company. Such estimates and assumptions are subject
to change as a result of actual experience. There can be no assurance that
actual capital requirements necessary to market the Cerebral Oximeter and
SomaSensor, to develop enhancements to, and product extensions of, the Cerebral
Oximeter, to conduct research and development concerning additional potential
applications of the Company's technology and for working capital will not be
substantially greater than current estimates.

    The Company does not believe that product sales will be sufficient to fund
the Company's operations in fiscal 1999.

    Also, as of November 30, 1998, there were 60,400 redeemable warrants
outstanding, exercisable at $20.00 per share until July 13, 2000, and 55,120
redeemable warrants outstanding exercisable at $17.50 per share until April 1,
2001. These warrants were issued in the Company's 1995 and April 1996 Regulation
S securities offerings. The conditions permitting the Company to redeem these
warrants have not been met as of February 1, 1999. In addition, the placement
agents and their transferees hold warrants to purchase 64,394 Common Shares
exercisable at $12.50 per share and 15,000 warrants exercisable at $14.40 per
share. Also, the underwriter of the 1997 public offering








                                       22
<PAGE>   24

received warrants to purchase 200,000 Common Shares exercisable at $4.80 per
share. It is unlikely that these warrants will be exercised if the exercise
price exceeds the market price of the Common Shares.

    The Company's only current loan commitment is described above.

    There can be no assurance that even if the Company receives additional
capital, it will be able to achieve the level of sales necessary to sustain its
operations. There can be no assurance that the Company will be able to obtain
any funds on terms acceptable to the Company and at times required by the
Company through sales of the Company's product, sales of securities or loans in
sufficient quantities. The report of the Company's Independent Auditors contains
an explanatory paragraph relating to the uncertainty concerning the Company's
ability to continue as a going concern. See "Independent Auditors Report"
accompanying the Financial Statements in Item 8 of this Report.

    The Company's ability to use its accumulated net operating loss
carryforwards to offset future income, if any, for income tax purposes, is
limited due to the initial public offering of its securities in March 1991. See
Note 6 of Notes to Financial Statements included in Item 8 of this Report.

    YEAR 2000 COMPLIANCE

    The Company does not expect that the cost of converting its computer systems
to year 2000 compliance will be material to its financial condition or results
of operations. The Company, together with its independent network consultant,
has completed the evaluation of its hardware and software, and has begun the
process of purchasing the hardware and software necessary to replace what was
determined to be non-compliant. As of November 30, 1998, the Company had spent
approximately $80,000 towards the replacement of non-compliant hardware and
software, and estimates that the total costs associated with the implementation
of the new computer system, including hardware, software, and related consulting
fees, will approximate $100,000. The Company began implementation of some new
hardware and software during the fourth quarter of fiscal 1998, and anticipates
completing the conversion by the second quarter of fiscal 1999. Because the
Company expects its system to be year 2000 compliant by the second quarter of
fiscal 1999, it has not prepared a contingency plan and does not currently
believe that a contingency plan is necessary. The Company has considered the
cost of upgrading its older products to make them year 2000 compliant, and does
not believe that such costs will be material to the Company's financial
condition or results of operations. The Company has also corresponded with its
major vendors, as well as a sampling of both its United States and international
customers, to determine their state of readiness with respect to year 2000
compliance. Based on the responses from the vendors and customers, the Company
does not anticipate any material disruption to its operations as a result of
year 2000 compliance failure, and does not expect any material effect to its
financial condition or results of operations.

    NEW ACCOUNTING PRONOUNCEMENTS

    In March 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." This Statement establishes standards for computing and presenting
earnings per share ("EPS") and applies to all entities with publicly-held common
shares or potential common shares. This Statement replaces the presentation of
primary EPS and fully-diluted EPS with a presentation of basic EPS and diluted
EPS, respectively. Basic EPS excludes dilution and is computed by dividing
earnings available to common shareholders by the weighted-average number of
common shares outstanding for the period. Similar to fully diluted EPS, diluted
EPS reflects the potential dilution of securities that could share in the
earnings. During the first quarter of fiscal 1998, the Company adopted SFAS No.
128. The adoption of SFAS No. 128 had no impact on the reported loss per share
for all periods presented.

    In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997.
This Statement establishes standards for reporting and display of comprehensive
income and its components in financial statements. The Statement is effective
for the Company's financial statements for the year ending November 30, 1999.








                                       23
<PAGE>   25



     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which is effective for fiscal years
beginning after December 15, 1997. This statement establishes standards for the
way a public business enterprise reports certain information about operating
segments, and discloses enterprise-wide information about the company's products
and services, activities in different geographic areas, and the company's
reliance on major customers. The statement is effective for the Company's
financial statements for the year ending November 30, 1999.























                                       24

<PAGE>   26





ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      The table below provides information about the Company's financial
instruments that are sensitive to changes in interest rates, consisting of
investments in corporate bonds and other fixed income securities. For these
financial instruments, the table presents principal cash flows and related
weighted average interest rates by expected maturity dates. Weighted average
variable rates are based on implied forward rates in the yield curve at the
reporting date. Weighted average fixed rates are based on the contract rates.
The actual cash flows of all instruments are denominated in U.S. dollars. The
Company invests its cash on hand not needed in current operations in fixed
income securities generally maturing within one year from the date of
acquisition.





<TABLE>
<CAPTION>
                                                                          November 30, 1998

                                                                       Expected Maturity Dates

                                   1999         2000       2001      2002        2003      Thereafter        Total        Fair Value
                                   ----         ----       ----      ----        ----      ----------        -----        ----------
<S>                              <C>            <C>        <C>        <C>         <C>         <C>         <C>             <C>       
Marketable Securities:                                                                                                      

 Short-term Debt:
    Fixed Rate ($)............   $4,013,198      -          -          -           -             -        $4,013,198      $4,013,718
       Average interest rate..        7.10%     N/A        N/A        N/A         N/A           N/A            7.10%
    Variable Rate ($).........   $1,000,006      -          -          -           -             -        $1,000,006      $  903,744
       Average interest rate..        9.71%     N/A        N/A        N/A         N/A           N/A            9.71%
</TABLE>




















                                       25
<PAGE>   27

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


Independent Auditors' Report


To the Board of Directors and Shareholders of
Somanetics Corporation
Troy, Michigan


We have audited the accompanying balance sheets of Somanetics Corporation (the
"Company") as of November 30, 1998 and 1997, and the related statements of
operations, shareholders' equity, and cash flows for each of the three years in
the period ended November 30, 1998. Our audits also included the financial
statement schedule listed in the index at Item 14. These financial statements
and the financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and the financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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, such financial statements present fairly, in all material
respects, the financial position of the Company at November 30, 1998 and 1997,
and the results of its operations and its cash flows for each of the three years
in the period ended November 30, 1998 in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, conditions exist which raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans concerning
these matters are also described in Note 2. The financial statements do not
include any adjustments that might result from the outcome of these
uncertainties.


/s/ DELOITTE & TOUCHE LLP
-------------------------
DELOITTE & TOUCHE LLP

Detroit, Michigan
January 11, 1999











                                       26
<PAGE>   28



                             SOMANETICS CORPORATION

                                 BALANCE SHEETS





<TABLE>
<CAPTION>
                                                                                           November 30,
                                                                              ----------------------------------------
    ASSETS                                                                          1998                   1997
                                                                              ------------------      ----------------
<S>                                                                              <C>                    <C>        
    CURRENT ASSETS:
   Cash and cash equivalents (Note 4 ) .....................................     $ 1,976,829            $ 2,132,376
   Marketable Securities (Note 4) ..........................................       4,916,942              2,470,780
   Accounts receivable, net of allowance for doubtful accounts of
      approximately $153,000 and $166,000 at November 30, 1998
      and 1997, respectively (Note 9) ......................................         615,682                191,698
   Inventory, net (Note 4 ) ................................................         660,964                433,014
   Prepaid expenses ........................................................          92,050                 71,581
                                                                                 -----------            -----------
      Total current assets .................................................       8,262,467              5,299,449
                                                                                 -----------            -----------
PROPERTY AND EQUIPMENT: (Note 4 )
   Machinery and equipment .................................................       1,309,539                722,905
   Furniture and fixtures ..................................................         184,949                184,351
   Leasehold improvements ..................................................         166,770                166,770
                                                                                 -----------            -----------
      Total ................................................................       1,661,258              1,074,026
   Less accumulated depreciation and amortization ..........................        (957,083)              (784,860)
                                                                                 -----------            -----------
      Net property and equipment ...........................................         704,175                289,166
                                                                                 -----------            -----------
OTHER ASSETS:
   Patents and trademarks, net (Note 4) ....................................          65,305                 72,217
   Other ...................................................................          15,000                 16,600
                                                                                 -----------            -----------
      Total other assets ...................................................          80,305                 88,817
                                                                                 -----------            -----------
TOTAL ASSETS................................................................     $ 9,046,947            $ 5,677,432
                                                                                 ===========            ===========

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
   Accounts payable ........................................................     $   262,932            $   341,500
   Accrued liabilities (Notes 5 and 7) .....................................         366,222                446,976
                                                                                 -----------            -----------
      Total current liabilities ............................................         629,154                788,476
                                                                                 -----------            -----------
COMMITMENTS AND CONTINGENCIES (Note 7) .....................................              --                     --
SHAREHOLDERS' EQUITY: (Notes 3 and 11)
   Preferred shares; authorized,  1,000,000 shares of $.01 par value; no
       shares issued or outstanding ........................................              --                     -- 
   Common shares; authorized, 20,000,000 shares of $.01 par value; issued
       and outstanding, 6,035,597 and 4,285,334 shares at
       November 30, 1998 and 1997, respectively ............................          60,356                 42,853
   Additional paid-in capital ..............................................      50,290,067             41,212,639
   Accumulated unrealized losses on Investments.............................         (96,262)                    --           
   Accumulated deficit .....................................................     (41,836,368)           (36,366,536)
                                                                                 -----------            -----------
      Total shareholders' equity ...........................................       8,417,793              4,888,956
                                                                                 -----------            -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  ...............................      $ 9,046,947            $ 5,677,432
                                                                                 ===========            ===========
</TABLE>





                        See notes to financial statements








                                       27
<PAGE>   29


                             SOMANETICS CORPORATION


                            STATEMENTS OF OPERATIONS







<TABLE>
<CAPTION>
                                                               For the Years Ended November 30,       
                                                               ----------------------------------------
                                                            1998                1997              1996
                                                     -------------------------------------------------------

<S>                                                        <C>               <C>                 <C>        
NET REVENUES (Notes 4 and 10) .........................   $ 2,490,851        $ 1,211,784         $   778,200
COST OF SALES .........................................     1,326,160            631,425             385,136
                                                          -----------        -----------         ----------- 
   Gross margin .......................................     1,164,691            580,359             393,064
                                                          -----------        -----------         -----------

OPERATING EXPENSES:
   Research, development and engineering
     (Note 4) .........................................       664,874            736,427             235,354
   Selling, general and administrative
     (Note 9) .........................................     6,346,595          6,238,330           3,549,939
                                                          -----------        -----------         -----------
     Total operating expenses .........................     7,011,469          6,974,757           3,785,293
                                                          -----------        -----------         -----------

OPERATING LOSS ........................................    (5,846,778)        (6,394,398)         (3,392,229)
                                                           ----------         ----------         ----------- 
OTHER INCOME (EXPENSE):
   Interest income ....................................       368,846            206,663              61,603
   Interest expense ...................................            --                 --                (449)
   Other ..............................................         8,100             32,252              27,372
                                                          -----------         -----------        ------------  
     Total other income ...............................       376,946            238,915              88,586
                                                          -----------         -----------        -----------
NET LOSS ..............................................   $(5,469,832)      $ (6,155,483)        $(3,303,703)
                                                          ===========       ============         ===========
NET LOSS PER COMMON SHARE -
  BASIC AND DILUTED (Note 4) ..........................       $ (1.01)      $      (1.88)        $     (1.77)
                                                          ===========       ============         ===========
WEIGHTED AVERAGE NUMBER OF
   COMMON SHARES OUTSTANDING
   (Note 4) ...........................................     5,421,795          3,271,642           1,866,751
                                                          ===========       ============         ===========
</TABLE>







                        See notes to financial statements











                                       28
<PAGE>   30


                             SOMANETICS CORPORATION

                       STATEMENTS OF SHAREHOLDERS' EQUITY




<TABLE>
<CAPTION>
                                                                                              Accumulated                   TOTAL
PRICE                             ADDITIONAL                                                  Unrealized                    SHARE
                                                 PER        SHARES       SHARE      PAID-IN   Losses on      ACCUMULATED   HOLDERS'
                                                SHARE       (NOTE 3)     VALUE      CAPITAL   Investments      DEFICIT      EQUITY
                                                -----      --------      -----      -------   -----------    ---------     --------
 
<S>                                           <C>           <C>         <C>       <C>         <C>         <C>           <C>
     Balance at December 1, 1995.............               1,776,855   $17,769   $29,183,236             $(26,907,350)  $2,293,655

       Exercise of stock options for cash.... $8.40-14.70       7,717        77        75,030                                75,107
       For cash, less issuance costs of          
         $143,587............................    12.50        114,240     1,143     1,283,270                             1,284,413
       Exercise of warrants for cash, less
         issuance costs  of $16,350.......... 17.50-20.00      19,698       197       339,886                               340,083
       For cash, less issuance costs of          
         $650,872............................    11.50        366,841     3,668     3,564,135                             3,567,803
       Redemption of Class B Warrants........     0.50                               (203,759)                             (203,759)
       Net loss..............................                                                               (3,303,703)  (3,303,703)
                                                           ----------  --------   -----------  --------  -------------  ----------
     Balance at November 30, 1996............               2,285,351    22,854    34,241,798              (30,211,053)   4,053,599

     Redemption of fractional shares.........                     (17)       (1)         (377)                                 (378)
     For cash, less issuance costs of             
         $1,008,782..........................     4.00      2,000,000    20,000     6,971,218                             6,991,218
       Net loss..............................                                                               (6,155,483)  (6,155,483)
                                                           ----------  --------   -----------  --------  ------------   ----------
     Balance at November 30, 1997............               4,285,334    42,853    41,212,639               (6,366,536)   4,888,956

     Exercise of stock options for cash......     4.75            263         3         1,345                                 1,348
     For cash, less issuance costs of             
         $968,917............................     5.75      1,750,000    17,500     9,076,083                             9,093,583
     Accumulated unrealized losses 
      on Investments.........................                                                   (96,262)                    (96,262)
          Net loss...........................                                                               (5,469,832)  (5,469,832)
                                                           ----------  --------   -----------  --------  ------------   ----------
     Balance at November 30, 1998............               6,035,597  $ 60,356   $50,290,067  $(96,262)  $ (41,83,368)  $8,417,793
                                                           ==========  ========   ===========  ========  ============   ==========
</TABLE>








                        See notes to financial statements











                                       29
<PAGE>   31



                             SOMANETICS CORPORATION

                            STATEMENTS OF CASH FLOWS



<TABLE>
<CAPTION>
                                                                      For the Years Ended November 30,       
                                                                   ---------------------------------------------
                                                                      1998           1997            1996 
                                                                      ----           -----           -----
<S>                                                             <C>             <C>             <C>          
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss.............................................        $ (5,469,832)   $ (6,155,483)   $ (3,303,703)
   Adjustments to reconcile net loss to net cash
          used in operations:
      Depreciation and amortization.....................              93,537          50,497          66,222
      Changes in assets and liabilities:
          Accounts receivable (increase) decrease.......            (423,984)           (262)        252,423
          Inventory (increase) decrease ................            (227,950)        498,121           5,286
          Prepaid expenses (increase) decrease .........             (20,469)         (6,146)          6,726
          Other assets decrease.........................               8,512           6,912          88,016
          Accounts payable increase (decrease)..........             (78,568)        (22,532)        232,631
          Accrued liabilities increase (decrease).......             (80,754)        192,866        (162,246)
                                                                ------------    ------------     ----------- 
      Net cash (used in) operations.....................          (6,199,508)     (5,436,027)     (2,814,645)
                                                                ------------    ------------     ----------- 

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of marketable securities...................          (5,013,204)     (2,470,780)             --
   Proceeds from sale of marketable securities..........           2,470,780              --              --
   Acquisition of property and equipment (net)..........            (508,546)       (243,568)        (68,914)
   Proceeds under note receivable-related party.........                  --              --         190,240
                                                                ------------    ------------     -----------
      Net cash provided by (used in) investing 
          activities ...................................          (3,050,970)     (2,714,348)        121,326
                                                                ------------    ------------     -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of Common Shares..............           9,094,931       6,991,218       5,267,406
   Redemption of Redeemable Convertible Preferred 
          Shares........................................                  --              --         (19,843)
   Redemption of Class B Warrants and fractional                
          shares........................................                  --            (378)       (203,759)
   Proceeds from notes payable and long-term debt.......                  --              --         205,000
   Repayment of notes payable and long-term debt........                  --              --        (205,000)
                                                                ------------    ------------      ----------
      Net cash provided by financing activities.........           9,094,931       6,990,840       5,043,804
                                                                ------------    ------------      ----------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....            (155,547)     (1,159,535)      2,350,485

CASH AND CASH EQUIVALENTS, BEGINNING OF
  PERIOD................................................           2,132,376       3,291,911         941,426
                                                                ------------    ------------      ----------

CASH AND CASH EQUIVALENTS, END OF
   PERIOD...............................................        $  1,976,829    $  2,132,376     $ 3,291,911
                                                                ============    ============     ===========
</TABLE>


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
   Cash paid for interest for the years ended November 30, 1998, 1997 and 1996
   approximated $0, $0 and $450, respectively.



   

                     See notes to financial statements













                                       30
<PAGE>   32

                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


1. ORGANIZATION AND OPERATIONS

     Somanetics Corporation (the "Company"), a Michigan corporation formed in
January 1982, develops, manufactures and markets the INVOS Cerebral Oximeter
(the "Cerebral Oximeter"), the only FDA-cleared, non-invasive patient monitoring
system that continuously measures changes in the blood oxygen level in the adult
brain. The Cerebral Oximeter is based on the Company's proprietary In Vivo
Optical Spectroscopy ("INVOS(R)") technology. INVOS analyzes various
characteristics of human blood and tissue by measuring and analyzing
low-intensity visible and near-infrared light transmitted into portions of the
body. The Company has incurred research, product development and other expenses
involved in designing, developing, marketing and selling its product, as well as
devoting efforts to raising capital.

2. FINANCIAL STATEMENT PRESENTATION

    The Company has not achieved sales necessary to support operations. The
Company has incurred an accumulated deficit of $41,836,368 through November 30,
1998. The Company had working capital of $7,633,313, cash, cash equivalents and
marketable securities of $6,893,771, total current liabilities of $629,154 and
shareholders' equity of $8,417,793, as of November 30, 1998.

    On June 6, 1996 and October 13, 1997 the Company received clearance from the
FDA to market its model 3100A adult Cerebral Oximeter and enhancements to its
Cerebral Oximeter, respectively, in the United States. The Company's current
financial condition and results of operations and the status of its product
marketing efforts and sales have been affected by the process of obtaining such
clearances.

    As of February 1, 1999, the Company had 13 international distributors for
the model 4100 Cerebral Oximeter, 4 United States distributors (including Puerto
Rico), 20 direct sales personnel, 3 clinical specialists, and 1 international
sales consultant. During fiscal 1998, the Company sold its product to 17 of its
international distributors and three of its United States distributors, and
devoted most of its marketing to introducing cerebral oximetry patient
monitoring into the operating rooms of hospitals. There can be no assurance that
the Company will be successful or profitable in marketing the Cerebral Oximeter
and the related SomaSensor.

    Management believes that markets exist for the product the Company has
developed; however, there is an inherent uncertainty associated with the success
of such product. The likelihood of success of the Company must be considered in
view of the Company's limited resources and current financial condition, the
problems and expenses frequently encountered in connection with formation of a
new business, the ability to raise new funds, the development and application of
new technology and the competitive environment in which the Company operates.

    The net proceeds from the public offerings of Common Shares in June 1997 and
April 1998 (Note 3) were sufficient to fund the Company's working capital
requirements for the fiscal year ended November 30, 1998. Current sales are not
sufficient to fund operations. During fiscal 1998, the Company received
approximately $9.1 million in net proceeds from the sale of Common Shares in a
public offering registered under the Securities Act of 1933 (Note 3).

    The Company believes that the cash, cash equivalents and marketable
securities on hand at November 30, 1998 will be sufficient to sustain the
Company's operations at budgeted levels and its needs for liquidity into the
second quarter of fiscal 2000. By that time the Company will be required to
raise additional cash either through additional sales of its product, through
sales of securities, by incurring indebtedness or by some combination of the
foregoing. If the Company is unable to raise additional cash by that time, it
will be required to reduce or discontinue its operations.










                                       31
<PAGE>   33



                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


    The estimated length of time current cash, cash equivalents and marketable
securities will sustain the Company's operations is based on certain estimates
and assumptions made by the Company. Such estimates and assumptions are subject
to change as a result of actual experience. There can be no assurance that
actual capital requirements necessary to market the Cerebral Oximeter and
SomaSensor, to develop enhancements to, and product extensions of, the Cerebral
Oximeter, to conduct research and development concerning additional potential
applications of the Company's technology and for working capital will not be
substantially greater than current estimates.

    The Company does not believe that product sales will be sufficient to fund
the Company's operations in fiscal 1999.

    On June 12, 1998, the Company entered into a $2,000,000 Revolving Note and a
Pledge Agreement with Fifth Third Bank of Northwestern Ohio, N.A. The principal
amount outstanding under the note bears interest, payable monthly, at the bank's
prime rate (7.75% as of February 1, 1999), is collateralized by all property of
the Company held at the bank, including marketable securities, and is intended
to be used for general corporate purposes, if necessary. The Company has not
borrowed any money under the line of credit. The line of credit expires March
31, 1999. Before that date, the bank may, but is not obligated to, lend the
Company such amounts as may from time to time be requested by the Company, up to
$2,000,000 if no Event of Default shall exist. Events of default include failure
to furnish satisfactory additional security on demand or the bank deeming itself
insecure. The Company has no other loan commitments.

    There can be no assurance that even if the Company receives additional
capital, it will be able to achieve the level of sales necessary to sustain its
operations. There can be no assurance that the Company will obtain any funds on
terms acceptable to the Company and at times required by the Company through
sales of the Company's product, sales of securities or loans in sufficient
quantities.

    These factors, among others, raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments relating to the recoverability and classification of asset
carrying amounts or the amount and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.


3. STOCK OFFERINGS AND COMMON SHARES

    On April 2, 1996, the Company completed the placement of 57,120 Units, at a
price of $25.00 per Unit, for gross proceeds of $1,428,000, through an offering
complying with Regulation S under the Securities Act of 1933, as amended ("the
Act"). The net proceeds to the Company, after deducting the placement agents'
fee and the expenses of the offering, were approximately $1,284,000. Each Unit
consists of two newly-issued Common Shares, par value $.01 per share, and one
warrant to purchase one Common Share.

    The Warrants are immediately exercisable and transferable separately from
the Common Shares. Each Warrant entitles the holder to purchase one Common Share
at an initial exercise price of $17.50 per share, subject to adjustment, at any
time through April 1, 2001, unless earlier redeemed. The Warrants are redeemable
for $.10 by the Company at any time if certain conditions are met; these
conditions have not been met as of February 1, 1999.

    The Company also granted the placement agent warrants to purchase 11,424
Common Shares at $12.50 per share exercisable during the four-year period
beginning April 2, 1997.

    Also, on November 21, 1996, the Company completed the placement of 366,841
newly-issued Common Shares at a price of $11.50 per share through an offering
complying with Regulation S under the Act. The net proceeds to the Company were
approximately $3,568,000.












                                       32
<PAGE>   34

                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


    During fiscal 1996, 14,600 warrants issued in the Company's 1995 Regulation
S Offering and exercisable at $20.00 per share, and 2,000 warrants issued in the
Company's April 1996 Regulation S Offering and exercisable at $17.50 per share,
were exercised, and the Company paid the placement agent in such offerings a
$16,350 fee in connection with those exercises. As of November 30, 1998, there
were 60,400 redeemable warrants outstanding exercisable at $20.00 per share
until July 13, 2000 and 55,120 redeemable warrants outstanding exercisable at
$17.50 per share until April 1, 2001. These warrants were issued in the
Company's 1995 and April 1996 Regulation S Offerings. The conditions permitting
the Company to redeem these warrants have not been met as of February 1, 1999.
In addition, Rauscher Pierce & Clark, Inc. and Rauscher Pierce & Clark Limited
(collectively, the "Placement Agent") and their transferees hold warrants to
purchase 52,970 Common Shares exercisable at $12.50 per share, 15,000 Common
Shares exercisable at $14.40 per share and 11,424 Common Shares exercisable at
$12.50 per share. There can be no assurance that additional warrants will be
exercised and it is unlikely that they will be exercised if the exercise price
exceeds the market price of the Common Shares. The Company has the right to
reduce the exercise price of these warrants.

     On January 15, 1997, the Company's Board of Directors approved an amendment
and restatement of the Company's Restated Articles of Incorporation to (i)
effect a one-for-ten reverse stock split of the Company's Common Shares while
keeping 6,000,000 authorized Common Shares, at a par value of $0.01, and (ii)
remove provisions relating to the Convertible Preferred Shares redeemed February
28, 1996, all subject to shareholder approval at the 1997 Annual Meeting of
Shareholders. The Company's shareholders approved such amendment and restatement
at the 1997 Annual Meeting of Shareholders on March 25, 1997, and the reverse
stock split became effective on April 10, 1997. All information contained in
these financial statements gives retroactive effect to the 1-for-10 reverse
stock split effected April 10, 1997.

    On June 4, 1997, the Company completed the public offering of 2,000,000
newly issued Common Shares at a price of $4.00 per share, for gross proceeds of
$8,000,000, through an offering underwritten by Brean Murray & Co., Inc. The net
proceeds to the Company, after deducting the underwriting discount and the
estimated expenses of the offering, were approximately $7,000,000. The Company
also granted the underwriter warrants to purchase 200,000 Common Shares at $4.80
per share exercisable during the four-year period beginning May 30, 1998.

    On January 15, 1998, the Company's Board of Directors approved an amendment
and restatement of the Company's Restated Articles of Incorporation to (i)
increase the Company's authorized Common Shares from 6,000,000 to 20,000,000
shares, and (ii) remove provisions referring to the reverse stock split effected
April 10, 1997, all subject to shareholder approval at the 1998 Annual Meeting
of Shareholders. The Company's shareholders approved such amendment and
restatement at the 1998 Annual Meeting of Shareholders on March 17, 1998.

    On April 8, 1998, the Company completed the public offering of 1,750,000
newly-issued Common Shares at a price of $5.75 per share, for gross proceeds of
$10,062,500, through an offering underwritten by Brean Murray & Co., Inc. The
net proceeds to the Company, after deducting the underwriting discount and the
estimated expenses of the offering, were approximately $9,100,000.













                                       33
<PAGE>   35


                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


    Common shares reserved for future issuance upon exercise of stock options
and warrants as discussed above at November 30, 1998, are as follows:


<TABLE>
<S>             <C>                                                                             <C>  
                1983 Stock Option Plan....................................................      9,317
                1991 Incentive Stock Option Plan..........................................    110,289
                1993 Director Stock Option Plan...........................................      2,498
                1997 Stock Option Plan....................................................    744,800
                Options Granted Independent of Option Plans...............................    170,578
                Placement Agent Warrants..................................................     79,394
                Regulation S Warrants.....................................................    115,520
                Underwriter Warrants......................................................    200,000
                                                                                            ---------
                          Total reserved for future issuance..............................  1,432,396
                                                                                            =========
</TABLE>


4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    Cash Equivalents consist of short-term, interest-bearing investments
maturing within three months of their acquisition by the Company.

    Marketable Securities consist eighty percent of AAA rated corporate bonds
and twenty percent of lower rated, fixed income securities, classified as
available for sale, maturing approximately six months to one year from the date
of acquisition and are stated at the lower of cost or fair market value.

    Inventory is stated at the lower of cost or market on a first-in, first-out
(FIFO) basis. Inventory consists of:


<TABLE>
<CAPTION>
                                                                                 NOVEMBER 30,
                                                                             1998           1997
                                                                             ----           ----

<S>          <C>                                                         <C>              <C>       
             Finished goods..........................................    $  224,313       $  100,224
             Work in process.........................................       226,554          174,363
             Purchased components....................................       348,321          514,725
                                                                         ----------       ----------
               Sub-total.............................................       799,188          789,312
             Less reserve for obsolete and excess inventory..........      (138,224)        (356,298)
                                                                         ----------       ----------
                    Total............................................    $  660,964       $  433,014
                                                                         ==========       ==========
</TABLE>


    Property and Equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets, which range from three to five years.

    Patents and Trademarks are recorded at cost and are being amortized on the
straight-line method over 17 years. Accumulated amortization was $46,428 and
$39,516 at November 30, 1998 and 1997, respectively.

    Revenue Recognition occurs upon shipment to customers.

    Research, Development and Engineering costs are expensed as incurred.

    Loss Per Common Share - basic and diluted is computed using the weighted
average number of common shares outstanding during each period. During the first
quarter of fiscal 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share." The adoption of SFAS No. 128
had no impact on the reported loss per share for all periods presented. Common
Shares issuable under stock options and warrants have been considered in the
computation of the net loss per Common Share - diluted, but have not been
included because such inclusion would be antidilutive. As of November 30, 1998
and November 30, 1997, the Company had













                                       34
<PAGE>   36

                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


outstanding 1,393,651 and 949,831, respectively, of warrants and options to
purchase Common Shares. On April 10, 1997, the Company effected a 1-for-10
reverse stock split (Note 3).

    Accounting Pronouncements In June 1997, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income," which is effective for fiscal years
beginning after December 15, 1997. This Statement establishes standards for
reporting and display of comprehensive income and its components in financial
statements. The Statement is effective for the Company's financial statements
for the year ending November 30, 1999.

     In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which is effective for fiscal years
beginning after December 15, 1997. This statement establishes standards for the
way a public business enterprise reports certain information about operating
segments, and discloses enterprise-wide information about the company's products
and services, activities in different geographic areas, and the company's
reliance on major customers. The statement is effective for the Company's
financial statements for the year ending November 30, 1999.

    Use Of 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, the
disclosure of contingent assets and liabilities, and the reported amounts of
revenues and expenses for each fiscal period. Actual results could differ from
those estimated.

    Reclassifications Certain reclassifications have been made to the financial
statements for 1997 to conform to 1998 presentation.

5. ACCRUED LIABILITIES

    Accrued liabilities consist of the following:



<TABLE>
<CAPTION>
                                                                           NOVEMBER 30,
                                                                       1998          1997
                                                                       ----       -------

<S>            <C>                                                 <C>             <C>     
               Professional Fees.................................  $112,902        $120,726
               Clinical Research.................................    19,165          43,330
               Product Upgrades..................................    21,297          25,842
               Warranty..........................................    37,487          31,166
               Accrued Insurance.................................    42,204          29,768
               Accrued Incentive.................................    34,000          50,500
               Accrued Sales Commissions.........................    99,167          48,994
               Other.............................................         -          96,650
                                                                   --------        --------
                    Total........................................  $366,222        $446,976
                                                                   ========        ========
</TABLE>














                                       35
<PAGE>   37


                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


6. INCOME TAX

    Deferred income taxes reflect the estimated future tax effect of (i)
temporary differences between the amount of assets and liabilities for financial
reporting purposes and such amounts as measured by tax laws and regulations and
(ii) net operating loss and tax credit carryforwards. The Company's deferred tax
assets primarily represent the tax benefit of net operating loss carryforwards
and research and general business tax credit carryforwards. The Company had
deferred tax assets of approximately $14,233,000 and $12,440,000 for the years
ended November 30, 1998 and 1997, respectively, which were entirely offset by
valuation allowances, due to the uncertainty of utilizing such assets against
future earnings, prior to their expiration. The components of deferred income
tax assets as of November 30, 1998 and 1997 were as follows:



<TABLE>
<CAPTION>
                                                                                  NOVEMBER 30,
                                                                               1998         1997
                                                                                 (IN THOUSANDS)
<S>            <C>                                                          <C>          <C>     
               Net operating loss carryforwards...........................  $ 13,763     $ 11,943
               Accrued liabilities........................................       158          230
               Research and general business tax credit carryforwards.....       312          267
                                                                             -------      -------
                    Subtotal..............................................    14,233       12,440
               Valuation allowance........................................   (14,233)     (12,440)
                                                                             -------      -------
                    Deferred tax asset....................................   $    --      $    --
                                                                             =======      =======
</TABLE>


    As of November 30, 1998, net operating loss carryforwards of approximately
$40.5 million were available for Federal income tax purposes. The Company's
ability to use the net operating loss carryforwards incurred on or before March
27, 1991 (the date the Company completed its initial public offering) is limited
to approximately $296,000 per year. Research and business general tax credits of
$312,000 are also available to offset future taxes. These losses and credits
expire, if unused, at various dates from 1999 through 2013.

    Utilization of the Company's net operating loss carryforwards, tax credit
carryforwards and certain future deductions could be restricted, in the event of
future changes in the Company's equity structure, by provisions contained in the
Tax Reform Act of 1986.

    7. COMMITMENTS AND CONTINGENCIES

    On September 10, 1991 the Company entered into a lease agreement for a
23,392 square foot, stand-alone office, assembly and warehouse facility. The
current lease, as amended, expires December 31, 1999 and grants the Company a
one-year renewal option.

    Operating and building lease expense for the years ended November 30, 1998,
1997 and 1996 was approximately $184,600, $175,700, and $173,500 respectively.
Approximate future minimum lease commitments are as follows:

               YEAR ENDED NOVEMBER 30,                            
               -----------------------                            
                  1999.........................................  $  176,400
                  2000.........................................      14,700
                                                                 ----------
                         Total.................................  $  191,100
                                                                 ==========

    In December 1991, the Company amended and restated its profit sharing plan
to include a 401(k) plan covering substantially all employees. Under provisions
of the plan, participants may contribute, annually, between 1% and 15% of their
compensation. The Company, at the discretion of its Board of Directors, may
contribute matching contributions or make other annual discretionary
contributions to the plan, all of which, together with the participants'
contribution, cannot exceed 15% of the total compensation paid by the Company to
eligible employees.











                                       36
<PAGE>   38

                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS

No Company matching or discretionary contributions were made to the plan for the
years ended November 30, 1998, 1997 or 1996.

    As of November 30, 1998, the Company had employment agreements with Bruce J.
Barrett, its President and Chief Executive Officer ("Mr. Barrett"), and Raymond
W. Gunn, its Executive Vice President and Chief Financial Officer ("Mr. Gunn").
The employment agreements, as amended, expire April 30, 2000 for Mr. Barrett and
Mr. Gunn, unless earlier terminated as provided in the agreements. Messrs.
Barrett and Gunn were entitled to receive annual base salaries which at November
30, 1998 were $204,750 and $110,250, respectively, plus potential discretionary
bonuses. Both parties have agreed not to compete with the Company during
specified periods.

    The Company may become subject to product liability claims by patients or
physicians, and may become a defendant in product liability or malpractice
litigation. The Company has obtained product liability insurance and an umbrella
policy. There can be no assurance that the Company will be able to maintain such
insurance or that such insurance would be sufficient to protect the Company
against such product liability.

8. STOCK OPTION PLANS

    In January 1983, February 1991, and January 1997, the Company adopted stock
option plans (the "1983 Plan," the "1991 Plan," and the "1997 Plan,"
respectively) for key management employees, directors, consultants and advisors
of the Company. The plans provide for the issuance of options by the Company to
purchase a maximum of 15,668 Common Shares under the 1983 Plan, 115,000 Common
Shares under the 1991 Plan, and 745,000 Common Shares under the 1997 Plan. In
addition, the Company granted options to employees independent of the plans
("Non-Plan"). Awards and expirations under the 1983 Plan, 1991 Plan, 1997 Plan,
and Non-Plan during the years ended November 30, 1998, 1997 and 1996 are listed
below.

    At November 30, 1998, no additional options may be granted under the 1983
Plan, 14,667 Common Shares were available for options to be granted under the
1991 Plan, and 24,078 Common Shares were available under the 1997 Plan.

    In January 1993, the Company adopted the Somanetics Corporation 1993
Director Stock Option Plan (the "Directors Plan"). The Directors Plan provided
up to 24,000 Common Shares for the grant of options to purchase 1,500 shares
every three years beginning June 30, 1993, to each director who was not an
officer or employee of the Company. In addition, each director who was not an
officer or employee of the Company and who first became a director of the
Company after the date the Directors Plan was adopted was automatically granted
an option to purchase a pro-rata portion of 1,500 Common Shares. At its January
15, 1998 meeting, the Company's Board of Directors terminated the Directors
Plan, except as to options previously granted under the Directors Plan.
Therefore, no additional options may be granted under the Directors Plan.

    In October 1995, SFAS No. 123, "Accounting for Stock-Based Compensation,"
was issued which encourages, but does not require, companies to record
compensation expense for the fair value of stock options and other equity
instruments granted under stock-based employee compensation arrangements. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation costs for stock options are measured as the excess, if
any, of the market price of the Company's stock at the date of the grant over
the amount an employee must pay to acquire the stock. No compensation expense
has been charged against income for stock option grants.

     Had compensation expense for the Company's stock options been determined
based on the fair value of the options on the grant date pursuant to the
methodology of SFAS No. 123, the Company's net loss for 1998, 1997 and 1996 on a
pro forma basis would have increased by approximately $1,589,000 to
$(7,059,000), or $(1.30) per Common Share, increased by approximately $901,000
to $(7,057,000), or $(2.16) per Common Share, and increased by approximately
$628,000 to $(3,932,000), or $(2.11) per Common Share, respectively. The fair
value











                                       37
<PAGE>   39


                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
1998, 1997 and 1996: expected volatility (the measure by which the stock price
has fluctuated or is expected to fluctuate during the period) 72.34% for 1998
(88.26% for 1997 and 1996), risk-free interest rate of 5% for 1998 (6% for 1997
and 1996), expected lives of 4 years and dividend yield of 0%.

    The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts.

    A summary of the Company's stock option activity and related information for
years ended November 30, 1998, 1997 and 1996 follows:



<TABLE>
<CAPTION>
                                1998                             1997                             1996
                      -------------------------        -------------------------       -------------------------
                                         WEIGHTED                         WEIGHTED                       WEIGHTED
                                          AVERAGE                         AVERAGE                        AVERAGE
                             COMMON      EXERCISE      COMMON             EXERCISE        COMMON         EXERCISE
                             SHARES        PRICE       SHARES              PRICE          SHARES          PRICE

 Options outstanding
<S>                          <C>            <C>        <C>                 <C>            <C>            <C>   
   December 1,.........      554,917        $8.23      295,517             $12.38         234,702(1)     $13.76
   Options granted.....      476,122         5.82      306,850               5.08         165,335          9.56
   Options exercised...         (263)        4.75           --                 --          (6,936)         9.34
   Options canceled....      (32,039)       16.68      (47,450)             15.21         (97,584)        11.20
                            --------        -----     --------             ------         -------        ------
 Options outstanding
  November 30,(2)(3)...      998,737         6.81      554,917               8.23         295,517         12.38
                            ========        =====     ========             ======         =======        ======
 Options exercisable
   November 30, .......      356,589        $9.70      218,847             $13.76         177,509        $13.08
                            ========        =====     ========             ======         =======        ======
</TABLE>

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

(1)  Plus 13,239 redeemable Convertible Preferred Shares, which were redeemed on
     February 28, 1996.

(2)  Exercise dates range from February 21, 1991 to April 2, 2008.

(3)  As of November 30, 1998, options  outstanding have exercise prices between
     $4.00 and $42.50, and a weighted average remaining contractual life of 8.18
     years.

Also, see Note 11 for approval of an amendment to the 1997 Stock Option Plan.

9. RELATED PARTY TRANSACTIONS

    The Company received legal services from certain shareholders. Services from
such parties amounted to approximately $195,500, $365,800 and $348,570 during
the years ended November 30, 1998, 1997 and 1996, respectively.

    The Company recognized no revenue in the fiscal 1997 and 1996, respectively,
from Somatek, Inc., one of the Company's former United States distributors whose
principal owner is a director of the Company. Effective February 28, 1997 the
Company terminated its distribution agreement with Somatek, Inc. The Company
wrote off approximately $12,500 and $68,000 of trade receivables from Somatek,
Inc. in fiscal 1997 and 1996, respectively, in exchange for the return of
Cerebral Oximeters.











                                       38
<PAGE>   40



                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS


10. MAJOR CUSTOMERS AND FOREIGN SALES

    The Company had one United States distributor which accounted for
approximately 10% of net revenues for the year ended November 30, 1998; however,
this distributor relationship was terminated during the third quarter of fiscal
1998 as part of the Company's planned expansion of the direct sales force within
several domestic territories. Two international distributors and one United
States distributor accounted for approximately 28% (Japan), 11% (Latin America)
and 12% (United States), respectively, of total sales for the year ended
November 30, 1997, and two distributors accounted for approximately 62% (Japan)
and 15% (Latin America), respectively, of total sales for fiscal year 1996.

    Additionally, total sales to foreign customers for the years ended November
30, 1998, 1997 and 1996 include approximately $959,000, $689,000 and $745,000,
respectively.

11. SUBSEQUENT EVENTS (UNAUDITED)

    On January 21, 1999, the Company's Board of Directors approved an amendment
to the Somanetics Corporation 1997 Stock Option Plan to increase the number of
Common Shares reserved for issuance pursuant to the exercise of options granted
under the 1997 Plan by 295,000 shares, from 745,000 to 1,040,000 shares, subject
to shareholder approval at the 1999 Annual Meeting of Shareholders.











                                       39
<PAGE>   41




ITEM. 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
         
NONE


























                                       40
<PAGE>   42


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The information required by this Item 10 regarding executive officers of
the Company is included in the Supplemental Item in Part I of this Report, and
is incorporated in this Item 10 by reference. The information required by this
Item 10 regarding directors of the Company will be set forth under the caption
"Election of Directors" in the Company's Proxy Statement in connection with the
1999 Annual Meeting of Shareholders scheduled to be held April 13, 1999, and is
incorporated in this Item 10 by reference. The information required by this Item
10 concerning compliance with Section 16(a) of the Securities Exchange Act of
1934 will be set forth under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement in connection with the
1999 Annual Meeting of Shareholders scheduled to be held April 13, 1999, and is
incorporated in this Item 10 by reference.

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this Item 11 concerning executive compensation
will be set forth under the caption "Executive Compensation" in the Company's
Proxy Statement in connection with the 1999 Annual Meeting of Shareholders
scheduled to be held April 13, 1999, and is incorporated in this Item 11 by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this Item 12 concerning security ownership of
certain beneficial owners and management will be set forth under the captions
"Voting Securities and Principal Holders" and "Election of Directors" in the
Company's Proxy Statement in connection with the 1999 Annual Meeting of
Shareholders scheduled to be held April 13, 1998, and is incorporated in this
Item 12 by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item 13 concerning certain relationships
and related transactions, if any, will be set forth under the caption "Certain
Transactions" or "Compensation Committee Interlocks and Insider Participation"
in the Company's Proxy Statement in connection with the 1999 Annual Meeting of
Shareholders scheduled to be held April 13, 1999, and is incorporated in this
Item 13 by reference.
















                                       41
<PAGE>   43


                                     PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)      (1)      Financial Statements

                  The following financial statements of the Company are included
                  in response to Item 8 of this Report:

                           Independent Auditors' Report
                           Balance Sheets - November 30, 1998 and 1997
                           Statements of Operations - For Each of the Three
                           Years in the Period Ended November 30, 1998
                           Statements of Shareholders' Equity  - For Each of the
                           Three Years in the Period Ended November 30, 1998
                           Statements of Cash Flows - For Each of the Three 
                           Years in the Period Ended November 30, 1998
                           Notes to Financial Statements

         (2)      Financial Statement Schedule

                  The following financial statement schedule of the Company is
                  included in response to Item 8 of this Report:

                           Schedule II - Valuation and Qualifying Accounts and
                                    Reserves for the Years Ended November 30,
                                    1998, 1997 and 1996.

         (3)      Exhibits

                  The Exhibits to this Report are as set forth in the "Index to
                  Exhibits" on pages 45 to 49 of this Report. Each management
                  contract or compensatory plan or arrangement filed as an
                  exhibit to this Report is identified in the "Index to
                  Exhibits" with an asterisk before the exhibit number.

(b)      Reports on Form 8-K

         No reports on Form 8-K were filed by the Company during the fourth
         quarter of the fiscal year ended November 30, 1998.















                                       42
<PAGE>   44




          SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
              FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996






<TABLE>
<CAPTION>
                                                                COLUMN B                 COLUMN C             COLUMN D      COLUMN E
                                                                --------       ---------------------------    --------      --------
                                                                                         ADDITIONS                          
                                                                               ---------------------------                   
                                                                                  (2)           CHARGED TO                 
                                                               BALANCE AT      CHARGED TO         OTHER        (1)(3)     BALANCE AT
                                                               BEGINNING       COSTS AND        ACCOUNTS,    DEDUCTIONS,    END OF
                                                               OF PERIOD       EXPENSES         DESCRIBE      DESCRIBE      PERIOD
                                                               ---------       --------         --------      --------      ------
<S>                                                           <C>             <C>                           <C>           <C>      
          Allowance for doubtful accounts:                                                                     
            Year ended November 30, 1998.........             $  165,990      $   4,319            --       $  17,707     $ 152,602
            Year ended November 30, 1997.........                 46,047        176,790            --          56,847       165,990
            Year ended November 30, 1996.........                193,766         46,056            --         193,775        46,047

          Note: (1) Write-off uncollectible accounts, net of recoveries                                        
          Note: (2) Reserve of additional uncollectible accounts, net of                                       
          recoveries

          Inventory reserve for obsolescence:                                                                  
            Year ended November 30, 1998.........             $  356,298      $  40,817            --       $ 258,891     $ 138,224
            Year ended November 30, 1997.........                200,450        442,448            --         286,600       356,298
            Year ended November 30, 1996.........                 95,078        170,554            --          65,182       200,450
</TABLE>



          Note: (3) Write-off obsolete, excess inventory, net of recoveries
















                                       43
<PAGE>   45




                                   SIGNATURES


     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                             Somanetics Corporation
Date:  February 12, 1999                     By: /s/ Bruce J. Barrett
                                             -----------------------------------
                                             Bruce J. Barrett
                                             President & Chief Executive Officer



     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
Signature                               Title                                    Date
---------                               -----                                    ----


<S>                                     <C>                                      <C>          
  /s/ Bruce J. Barrett                  President and Chief Executive Officer    February 12, 1999
------------------------                and a Director (Principal Executive
Bruce J. Barrett                        Officer)
                                                                           

  /s/ H. Raymond Wallace                Chairman of the Board of Directors       February 12, 1999
------------------------
H. Raymond Wallace

  /s/ Raymond W. Gunn                   Executive Vice President and Chief       February 12, 1999
------------------------                Financial Officer (Principal Financial
 Raymond W. Gunn                        Officer)
                                        

  /s/ William M. Iacona                 Corporate Controller (Principal          February 12, 1999
------------------------                Accounting Officer)
 William M. Iacona                      

  /s/ Daniel S. Follis                  Director                                 February 12, 1999
------------------------
 Daniel S. Follis

  /s/ James I. Ausman                   Director                                 February 12, 1999
------------------------
James I. Ausman, M.D., Ph.D.

  /s/ Robert R. Henry                   Director                                 February 12, 1999
------------------------
 Robert R. Henry
</TABLE>













                                       44
<PAGE>   46




                                               EXHIBIT INDEX

                                EXHIBIT              DESCRIPTION
                                -------  ---------------------------------------

                                  3(i)   Restated Articles of Incorporation of
                                         Somanetics Corporation, incorporated by
                                         reference to Exhibit 3(i) to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended February 28,
                                         1998.
                                  3(ii)  Amended and Restated Bylaws of
                                         Somanetics Corporation, incorporated by
                                         reference to Exhibit 4.1 to the
                                         Company's Registration Statement on
                                         Form S-8 filed with the Securities and
                                         Exchange Commission on June 16, 1995.
                                 10.1    Lease Agreement, dated September 10,
                                         1991, between Somanetics Corporation
                                         and WS Development Company incorporated
                                         by reference to Exhibit 10.3 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1991.
                                 10.2    Extension of Lease, between Somanetics
                                         Corporation and WS Development Company,
                                         dated July 22, 1994, incorporated by
                                         reference to Exhibit 10.11 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.
                                 10.3    Change in ownership of Lease Agreement
                                         for 1653 E. Maple Road, Troy, MI 48083,
                                         dated September 12, 1994, between
                                         Somanetics Corporation and First
                                         Industrial, L.P., incorporated by
                                         reference to Exhibit 10.12 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August
                                         31, 1994.
                                 10.4    Second Addendum, between Somanetics
                                         Corporation and First Industrial
                                         Mortgage Partnership, L.P., dated April
                                         14, 1997, incorporated by reference. to
                                         Exhibit 10.1 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended May 31, 1997.
                                *10.5    Somanetics Corporation Amended and
                                         Restated 1983 Stock Option Plan,
                                         incorporated by reference to Exhibit
                                         10.4 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1991.
                                *10.6    Somanetics Corporation Amended and
                                         Restated 1991 Incentive Stock Option
                                         Plan, incorporated by reference to
                                         Exhibit 10.5 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1991.
                                *10.7    Fourth Amendment to Somanetics
                                         Corporation 1991 Incentive Stock Option
                                         Plan, incorporated by reference to
                                         Exhibit 10.7 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1992.
                                *10.8    Amended and Restated Fifth Amendment to
                                         Somanetics Corporation 1991 Incentive
                                         Stock Option Plan, incorporated by
                                         reference to Exhibit 10.10 to the
                                         Company's Annual Report on Form 10-K
                                         for the fiscal year ended November 30,
                                         1995.
                                *10.9    Somanetics Corporation 1993 Director
                                         Stock Option Plan, incorporated by
                                         reference to Exhibit 10.8 to the
                                         Company's Annual Report on Form 10-K
                                         for the fiscal year ended November 30,
                                         1992.
                                *10.10   Somanetics Corporation 1997 Stock
                                         Option Plan, incorporated by reference
                                         to Exhibit 10.9 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1996.
                                *10.11   First Amendment to Somanetics
                                         Corporation 1997 Stock Option Plan,
                                         incorporated by reference to Exhibit
                                         10.11 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1997.
                                *10.12   Second Amendment to Somanetics
                                         Corporation 1997 Stock Option Plan.
                                *10.13   Somanetics Corporation 1998 Employee
                                         Incentive Compensation Plan,
                                         incorporated by reference to Exhibit
                                         10.13 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1997.
                                *10.14   Somanetics Corporation 1999 Employee
                                         Incentive Compensation Plan.
















                                       45
<PAGE>   47


                                  EXHIBIT INDEX

                                EXHIBIT                DESCRIPTION
                                -------  ---------------------------------------
                               *10.15    Employment Agreement, dated as of
                                         December 1, 1992, between Somanetics
                                         Corporation and Raymond W. Gunn,
                                         incorporated by reference to Exhibit
                                         10.14 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1992.
                               *10.16    Employment Agreement, dated May 13,
                                         1994, between Somanetics Corporation
                                         and Bruce J. Barrett, incorporated by
                                         reference to Exhibit 10.1 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended May 31, 1994.
                               *10.17    Amendment to Employment Agreement,
                                         dated as of February 23, 1994, between
                                         Somanetics Corporation and Raymond W.
                                         Gunn, incorporated by reference to
                                         Exhibit 10.19 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1993.
                               *10.18    Amendment to Employment Agreement,
                                         dated as of July 21, 1994, between
                                         Somanetics Corporation and Bruce J.
                                         Barrett, incorporated by reference to
                                         Exhibit 10.1 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended August 31, 1994.
                               *10.19    Amendment to Employment Agreement,
                                         dated as of July 21, 1994, between
                                         Somanetics Corporation and Raymond W.
                                         Gunn, incorporated by reference to
                                         Exhibit 10.3 to the Company's Quarterly
                                         report on Form 10-Q for the quarter
                                         ended August 31, 1994.
                               *10.20    Amendment to Employment Agreement,
                                         dated as of December 1, 1995, between
                                         Somanetics Corporation and Raymond W.
                                         Gunn, incorporated by reference to
                                         Exhibit 10.20 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1995.
                               *10.21    Amendment to Employment Agreement,
                                         dated as of November 18, 1996, between
                                         Somanetics Corporation and Raymond W.
                                         Gunn, incorporated by reference to
                                         Exhibit 10.20 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1996.
                               *10.22    Amendment to Employment Agreement,
                                         dated as of April 24, 1997, between
                                         Somanetics Corporation and Bruce J.
                                         Barrett., incorporated by reference to
                                         Exhibit 10.21 to Amendment No. 1 to the
                                         Registration Statement on Form S-1(file
                                         no. 333-25275), filed with the
                                         Securities and Exchange Commission on
                                         May 30, 1997.
                               *10.23    Amendment to Employment Agreement,
                                         dated as of April 24, 1997, between
                                         Somanetics Corporation and Raymond W.
                                         Gunn, incorporated by reference to
                                         Exhibit 10.22 to Amendment No. 1 to the
                                         Registration Statement on Form S-1
                                         (file no. 333-25275), filed with the
                                         Securities and Exchange Commission on
                                         May 30, 1997.
                               *10.24    Stock Option Agreement, dated May 16,
                                         1994, between Somanetics Corporation
                                         and Bruce J. Barrett, incorporated by
                                         reference to Exhibit 10.7 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.
                               *10.25    Stock Option Agreement, dated July 21,
                                         1994, between Somanetics Corporation
                                         and Bruce J. Barrett, incorporated by
                                         reference to Exhibit 10.4 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.
                               *10.26    Stock Option Agreement, dated July 21,
                                         1994, between Somanetics Corporation
                                         and Gary D. Lewis, incorporated by
                                         reference to Exhibit 10.5 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.








                               *10.27    Stock Option Agreement, dated July 21,
                                         1994, between Somanetics Corporation
                                         and Raymond W. Gunn, incorporated by
                                         reference to Exhibit 10.6 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.















                                       46
<PAGE>   48



                                  EXHIBIT INDEX

                                EXHIBIT               DESCRIPTION
                                -------  ---------------------------------------
                               *10.28    Stock Option Agreements, dated July 20,
                                         1995, between Somanetics Corporation
                                         and Richard Farkas, incorporated by
                                         reference to Exhibit 10.28 to the
                                         Company's Annual Report on Form 10-K
                                         for the fiscal year ended November 30,
                                         1995.
                               *10.29    Form of Stock Option Agreement, dated
                                         December 22, 1995, between Somanetics
                                         Corporation and various employees,
                                         incorporated by reference to Exhibit
                                         10.29 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1995.
                               *10.30    Form of Stock Option Agreement, dated
                                         December 22, 1995, between Somanetics
                                         Corporation and various officers,
                                         incorporated by reference to Exhibit
                                         10.30 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1995.
                               *10.31    Form of new Stock Option agreement,
                                         dated December 22, 1995, between
                                         Somanetics Corporation and various
                                         employees, incorporated by reference to
                                         Exhibit 10.31 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1995.
                               *10.32    Form of Stock Option Agreement, dated
                                         January 5, 1996, between Somanetics
                                         Corporation and two officers,
                                         incorporated by reference to Exhibit
                                         10.32 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1995.
                               *10.33    Form of Stock Option Agreement, dated
                                         as of April 24, 1997, between
                                         Somanetics Corporation and twenty-three
                                         employees, incorporated by reference to
                                         Exhibit 10.32 to the Registration
                                         Statement on Form S-1(file no.
                                         333-25275), filed with the Securities
                                         and Exchange Commission on May 30,
                                         1997.
                               *10.34    Consulting Agreement, dated February
                                         28, 1983, as amended, between
                                         Somanetics Corporation and Hugh F.
                                         Stoddart, incorporated by reference to
                                         Exhibit 10.13 to the Company's Annual
                                         Report on Form 10-K for the fiscal year
                                         ended November 30, 1991.
                               *10.35    Consulting Order, dated as of October
                                         1, 1996, among Somanetics Corporation
                                         and NeuroPhysics Corporation, Hugh F.
                                         Stoddart and Hugh A. Stoddart, Ph.D.,
                                         as Consultants, incorporated by
                                         reference to Exhibit 10.2 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1996.
                               *10.36    Amendment to Stock Option Agreement,
                                         dated as of February 1, 1995, between
                                         Somanetics Corporation and Gary D.
                                         Lewis, amending July 21, 1994 Stock
                                         Option Agreement, incorporated by
                                         reference to Exhibit 10.31 to
                                         Post-Effective Amendment No. 5 to the
                                         Company's Registration Statement on
                                         Form S-1(file no. 33-38438) filed with
                                         the Securities and Exchange Commission
                                         on March 30, 1995.
                                10.37    Current Form of Somanetics Corporation
                                         Confidentiality Agreement used for
                                         testing hospitals and clinics,
                                         incorporated by reference to Exhibit
                                         10.22 to the Company's Annual Report on
                                         Form 10-K for the fiscal year ended
                                         November 30, 1992.
                                10.38    Current Form of Somanetics Corporation
                                         Confidentiality Agreement used for the
                                         Company's employees and agents,
                                         incorporated by reference to Exhibit
                                         10.3 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         August 31, 1992.
                                10.39    Assignments, dated October 6, 1983,
                                         January 23, 1986, February 11, 1986 and
                                         February 11, 1986, from Gary D. Lewis
                                         to Somanetics Corporation in connection
                                         with the Company's INVOS technology,
                                         incorporated by reference to Exhibit
                                         10.17 to the Company's Registration
                                         Statement on Form S-1 (file no.
                                         33-38438).









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<PAGE>   49





                                  EXHIBIT INDEX

                                EXHIBIT               DESCRIPTION
                                -------  ---------------------------------------
                                10.40    Assignments, dated October 5, 1983,
                                         August 28, 1985, February 11, 1986,
                                         February 12, 1986, and September 24,
                                         1986, from Hugh F. Stoddart to
                                         Somanetics Corporation in connection
                                         with the Company's INVOS technology,
                                         incorporated by reference to Exhibit
                                         10.18 to the Company's Registration
                                         Statement on Form S-1 (file no.
                                         33-38438).
                                10.41    Warrant Agreement, dated as of August
                                         2, 1994, between Somanetics Corporation
                                         and Rauscher Pierce & Clark Limited,
                                         incorporated by reference to Exhibit
                                         10.15 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         August 31, 1994.
                                10.42    Form of Warrant to Purchase Common
                                         Stock of Somanetics Corporation, dated
                                         as of August 2, 1994, between
                                         Somanetics Corporation and Rauscher
                                         Pierce & Clark Limited, incorporated by
                                         reference to Exhibit 10.16 to the
                                         Company's Quarterly Report on Form 10-Q
                                         for the quarter ended August 31, 1994.
                                10.43    Form of Warrant, between Somanetics
                                         Corporation and purchasers of Units in
                                         the 1995 Regulation S Offering,
                                         incorporated by reference to Exhibit
                                         10.4 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         August 31, 1995.
                                10.44    Warrant Agreement, dated as of July 14,
                                         1995, between Somanetics Corporation
                                         and Rauscher Pierce & Clark Limited,
                                         incorporated by reference to Exhibit
                                         10.5 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         August 31, 1995.
                                10.45    Warrant to Purchase Common Stock of
                                         Somanetics Corporation, dated as of
                                         July 14, 1995, between Somanetics
                                         Corporation and Rauscher Pierce & Clark
                                         Limited, incorporated by reference to
                                         Exhibit 10.6 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended August 31, 1995.
                                10.46    Form of Warrant between Somanetics
                                         Corporation and purchasers of Units in
                                         the April 1996 Regulation S Offering,
                                         incorporated by reference to Exhibit
                                         10.3 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         February 29, 1996.
                                10.47    Warrant Agreement, dated as of April 2,
                                         1996, between Somanetics Corporation
                                         and Rauscher Pierce & Clark Limited,
                                         incorporated by reference to Exhibit
                                         10.4 to the Company's Quarterly Report
                                         on Form 10-Q for the quarter ended
                                         February 29, 1996.
                                10.48    Warrant to Purchase Common Stock of
                                         Somanetics Corporation, dated as of
                                         April 2, 1996, between Somanetics
                                         Corporation and Rauscher Pierce & Clark
                                         Limited, incorporated by reference to
                                         Exhibit 10.5 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended February 29, 1996.
                                10.49    Form of Underwriting Agreement, dated
                                         May 30, 1997, between Somanetics
                                         Corporation and Brean Murray & Co.,
                                         Inc., incorporated by reference to
                                         Exhibit 1.1 to Amendment No. 1 to the
                                         Registration Statement on Form S-1
                                         (file no. 333-25275), filed with the
                                         Securities and Exchange Commisiion
                                         on May 30, 1997.
                                10.50    Form of Warrant Agreement and Warrant,
                                         dated June 4, 1997, between Somanetics
                                         Corporation and Brean Murray & Co.,
                                         Inc., incorporated by reference to
                                         Exhibit 10.60 to Amendment No. 1 to the
                                         Registration Statement on Form S-1
                                         (file no. 333-25275), filed with the
                                         Securities and Exchange Commisiion on
                                         May 30, 1997.
                                10.51    Form of Underwriting Agreement, dated
                                         April 3, 1998, between Somanetics
                                         Corporation and Brean Murray & Co.,
                                         Inc., incorporated by reference to
                                         Exhibit 10.1 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended February
                                         28, 1998.












                                       48
<PAGE>   50

                                  EXHIBIT INDEX

                                EXHIBIT               DESCRIPTION
                                -------  ---------------------------------------
                                10.52    Revolving Note from Somanetics
                                         Corporation to Fifth Third Bank of
                                         Northwestern Ohio, N.A., dated June 12,
                                         1998, incorporated by reference to
                                         Exhibit 10.1 to the Company's Quarterly
                                         Report on Form 10-Q for the quarter
                                         ended August
                                         31, 1998.
                                23.1     Consent of Deloitte & Touche LLP.
                                27.1     Financial data Schedule.
































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