<PAGE>   1


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q

                                   (Mark One)

(x) Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934

                 For the quarterly period ended AUGUST 31, 2000

                                       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 number 0-19095

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

                MICHIGAN                                38-2394784
    (State or other jurisdiction of                  (I.R.S. Employer
    incorporation or organization)                  Identification No.)

                              1653 EAST MAPLE ROAD,
                                 TROY, MICHIGAN
                                   48083-4208
                    (Address of principal executive offices)
                                   (Zip Code)

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

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

        Number of common shares outstanding at October 9, 2000: 6,528,391


<PAGE>   2





                          PART I FINANCIAL INFORMATION

                             SOMANETICS CORPORATION



                                 BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                                    August 31,               November 30,
ASSETS                                                                                2000                       1999
                                                                                -----------------         -----------------
<S>                                                                            <C>                        <C>
CURRENT ASSETS:                                                                    (Unaudited)                 (Audited)
    Cash and cash equivalents..........................................         $       307,466           $     1,423,423
    Marketable securities..............................................                 268,021                   833,736
    Accounts receivable, net of allowance for doubtful accounts of
       approximately $0 and $0 at August 31, 2000 and
       November 30, 1999, respectively.................................                 672,849                   764,153
    Inventory, net.....................................................               1,015,513                   611,332
    Prepaid expenses...................................................                  72,820                    89,702
                                                                                ---------------           ---------------
       Total current assets............................................               2,336,669                 3,722,346
                                                                                ---------------           ---------------
PROPERTY AND EQUIPMENT (at cost):
    Machinery and equipment............................................               1,469,000                 1,397,214
    Furniture and fixtures.............................................                 183,497                   183,497
    Leasehold improvements.............................................                 165,642                   165,642
                                                                                ---------------           ---------------
       Total...........................................................               1,818,139                 1,746,353
    Less accumulated depreciation and amortization.....................              (1,325,619)               (1,097,695)
                                                                                ---------------           ---------------
       Net property and equipment......................................                 492,520                   648,658
                                                                                ---------------           ---------------
OTHER ASSETS:
    Intangible assets, net.............................................               1,095,261                    58,393
    Other..............................................................                  15,000                    15,000
                                                                                ---------------           ---------------
       Total other assets..............................................               1,110,261                    73,393
                                                                                ---------------           ---------------
TOTAL ASSETS...........................................................         $     3,939,450           $     4,444,397
                                                                                ===============           ===============

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
    Accounts payable...................................................         $       405,648           $       498,008
    Accrued liabilities................................................                  96,010                   263,895
                                                                                ---------------           ---------------
       Total current liabilities.......................................                 501,658                   761,903
                                                                                ---------------           ---------------
COMMITMENTS AND CONTINGENCIES..........................................                 -                          -
SHAREHOLDERS' EQUITY:
    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, 6,528,391 shares at August 31, 2000
       and 6,035,597 shares at November 30, 1999.......................                  65,284                    60,356
    Additional paid-in capital.........................................              52,754,627                50,290,067
    Accumulated unrealized losses on investments.......................                 (76,460)                 (166,270)
    Accumulated deficit................................................             (49,305,659)              (46,501,659)
                                                                                ---------------           ---------------
       Total shareholders' equity......................................               3,437,792                 3,682,494
                                                                                ---------------           ---------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............................         $     3,939,450           $     4,444,397
                                                                                ===============           ===============
</TABLE>


                        See notes to financial statements

                                       2

<PAGE>   3


                             SOMANETICS CORPORATION

                            STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>


                                                               Three Months                       Nine Months
                                                             Ended August 31,                  Ended August 31,
                                                     -------------------------------    -------------------------------
                                                          2000              1999             2000             1999
                                                     -------------     -------------    -------------    --------------
<S>                                                  <C>               <C>             <C>               <C>

   NET REVENUES................................      $   1,006,408     $     877,346    $   3,474,089    $ 2,829,563
   COST OF SALES...............................            421,479           458,095        1,633,306      1,424,041
                                                     --------------    -------------    -------------    -----------

   GROSS MARGIN................................            584,929           419,251        1,840,783      1,405,522
                                                     --------------    -------------    -------------    -----------

   OPERATING EXPENSES:
      Research, development and engineering....            110,594           145,340          326,119        431,821
      Selling, general and administrative......          1,491,742         1,366,573        4,399,670      4,689,806
                                                     -------------     -------------    -------------    -----------
          Total operating expenses.............          1,602,336         1,511,913        4,725,789      5,121,627
                                                     -------------     -------------    -------------    -----------

   OPERATING LOSS..............................         (1,017,407)       (1,092,662)      (2,885,006)    (3,716,105)
                                                     -------------     -------------    -------------    -----------

   OTHER INCOME:
      Interest income..........................             22,220            57,571           81,006        231,099
                                                     -------------     -------------    --------------   -----------
          Total other income...................             22,220            57,571           81,006        231,099
                                                     -------------     -------------    --------------   -----------
   NET LOSS....................................      $    (995,187)    $  (1,035,091)   $  (2,804,000)   $(3,485,006)
                                                     -------------     -------------    -------------    -----------

   NET LOSS PER COMMON SHARE -
       BASIC AND DILUTED.......................      $       (0.15)    $       (0.17)   $       (0.45)   $     (0.58)
                                                     -------------     -------------    -------------    -----------
   WEIGHTED AVERAGE SHARES
       OUTSTANDING.............................          6,487,871         6,035,597        6,227,996      6,035,597
                                                     =============     =============    =============    ===========

</TABLE>




                       See notes to financial statements


                                       3
<PAGE>   4


                             SOMANETICS CORPORATION

                            STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<TABLE>
<CAPTION>

                                                                                    For the Nine Month
                                                                                 Periods Ended August 31,
                                                                            --------------------------------
                                                                                 2000             1999
                                                                            --------------     -------------
<S>                                                                        <C>                 <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss....................................................             $  (2,804,000)      $ (3,485,006)
  Adjustments to reconcile net loss to net cash used in
    operations:
      Depreciation and amortization...........................                   306,268            216,798
      Changes in assets and liabilities:
          Accounts receivable (increase) decrease.............                    91,304            (98,965)
          Inventory (increase)................................                  (404,181)          (128,224)
          Prepaid expenses (increase) decrease................                    16,882            (25,820)
          Other assets (increase).............................                   (46,789)               -
          Accounts payable increase (decrease)................                   (92,360)            74,523
          Accrued liabilities (decrease)......................                  (167,885)          (214,014)
                                                                           -------------       ------------
            Net cash (used in) operations.....................                (3,100,761)        (3,660,708)
                                                                           -------------       ------------


CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sale of marketable securities.................                   655,525          3,503,198
  Acquisition of property and equipment, net..................                   (90,101)          (157,604)
                                                                          --------------       ------------
            Net cash provided by investing activities.........                   565,424          3,345,594
                                                                          --------------       ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common shares, net................                 1,419,380                -
                                                                          --------------       ------------
            Net cash provided by financing activities.........                 1,419,380                -
                                                                          --------------       ------------

NET (DECREASE) IN CASH AND CASH
  EQUIVALENTS.................................................                (1,115,957)          (315,114)

CASH AND CASH EQUIVALENTS, BEGINNING
  OF PERIOD  .................................................                 1,423,423       $  1,976,829
                                                                          --------------       ------------

CASH AND CASH EQUIVALENTS, END
  OF PERIOD...................................................            $      307,466       $  1,661,715
                                                                          ==============       ============

Non cash investing activities:
  Issuance of warrants and stock options in connection with
  license acquisition (Note 3) ...............................            $    1,050,107

</TABLE>


                        See notes to financial statements

                                       4
<PAGE>   5


                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)

                                 AUGUST 31, 2000



1.       ORGANIZATION AND OPERATIONS

         We are a Michigan corporation that was formed in January 1982. We
develop, manufacture and market the INVOS(R) Cerebral Oximeter, the only
non-invasive patient monitoring system commercially available in the United
States that continuously measures changes in the blood oxygen level in the adult
brain. The Cerebral Oximeter is based on our proprietary In Vivo Optical
Spectroscopy, or INVOS, 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. We are also developing the
CorRestore(TM) patch, which is being developed for use in heart surgeries called
surgical anterior ventricular restoration, or SAVR. See Part II, Item 5 "Other
Information." We have incurred expenses in designing, developing, marketing and
selling our products, and in raising capital for our business.


2.       FINANCIAL STATEMENT PRESENTATION

         We prepared our unaudited interim financial statements pursuant to the
Securities and Exchange Commission's rules. Accordingly, they do not include all
of the information and footnotes normally included in our annual financial
statements prepared in accordance with generally accepted accounting principles.
We believe, however, that the disclosures are adequate to make the information
presented not misleading.

         The unaudited interim financial statements in this report reflect all
adjustments which are, in our opinion, necessary to a fair statement of the
results for the interim periods presented. All of these adjustments that are
material are of a normal recurring nature. Our operating results for the
nine-month period ended August 31, 2000, do not necessarily indicate the results
that you should expect for the year ending November 30, 2000, although we expect
to continue to incur operating losses for the foreseeable future. You should
read the unaudited interim financial statements together with the financial
statements and related footnotes for the year ended November 30, 1999 included
in our Annual Report on Form 10-K for the fiscal year ended November 30, 1999.

         We have incurred an accumulated deficit of $49,305,659 through August
31, 2000. We had working capital of $1,835,011, cash, cash equivalents, and
marketable securities of $575,487, total current liabilities of $501,658 and
shareholders' equity of $3,437,792 as of August 31, 2000.

         We believe that markets exist for the products we have developed and
are developing; however, whether our products will be successful is uncertain.
You should consider the following factors in evaluating the likelihood of our
success: our limited resources and current financial condition, the problems and
expenses frequently encountered by companies forming a new business, our ability
to develop, apply and market new technology, and our industry and competitive
environment.

         For further discussion of our financial condition, including recent
sales of securities, our working capital, our liquidity resources, requirements
and plans, and our ability to continue as a going concern, please refer to
"Liquidity and Capital Resources" in "Management's Discussion and Analysis of
Financial Condition and Results of Operations."


                                       5

<PAGE>   6


                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)

                                 AUGUST 31, 2000


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Marketable Securities consist 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 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>

                                                 August 31, 2000            November 30, 1999
                                                 ---------------            -----------------
<S>                                              <C>                        <C>

           Finished goods...................        $  131,810                  $  107,820
           Work in process..................            85,259                      38,682
           Purchased components.............           798,444                     464,830
                                                    ----------                  ----------
                Total.......................        $1,015,513                  $  611,332
                                                    ==========                  ==========

</TABLE>

         Intangible Assets consist of patents and trademarks, and license
acquisition costs. Patents and trademarks are recorded at cost and are being
amortized on the straight-line method over 17 years. License acquisition costs
are related to our acquisition of exclusive, worldwide, royalty-bearing licenses
to specified rights relating to the CorRestore patch and related products and
accessories and consulting services. These costs consist of professional service
fees recorded at cost, management's estimate of the fair value of the ten-year
vested stock options to purchase 50,000 common shares at $3.00 a share granted
to one of our directors in connection with the transaction, and management's
estimate of the fair value of the 300,000 common share vested portion of the
five-year warrants to purchase up to 400,000 common shares at $3.00 a share
issued in the transaction. These costs are being amortized on the straight-line
method over 5 years. Intangible assets consist of:

<TABLE>
<CAPTION>


                                                 August 31, 2000            November 30, 1999
                                                 ---------------            -----------------
<S>                                              <C>                        <C>

           License acquisition costs........          $ 1,096,898                $      -
           Patents and trademarks...........              111,733                   111,733
                                                      -----------                ----------
                Sub-total...................            1,208,631                   111,733
           Less accumulated amortization....             (113,369)                  (53,340)
                                                      -----------                ----------
                Total.......................          $ 1,095,261                $   58,393
                                                      ===========                ==========

</TABLE>

         Loss Per Common Share - basic and diluted, is computed using the
weighted average number of common shares outstanding during each period. Common
shares issuable under stock options and warrants have not been included in the
computation of the net loss per Common Share - diluted, because such inclusion
would be antidilutive. As of August 31, 2000 and August 31, 1999, we had
outstanding 2,262,081 and 1,557,481, respectively, of warrants and options to
purchase common shares.

         Reclassifications - Certain reclassifications have been made to the
financial statements for 1999 to conform to the 2000 presentation.



                                       6

<PAGE>   7




                             SOMANETICS CORPORATION

                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)

                                 AUGUST 31, 2000


4.       ACCRUED LIABILITIES

         Accrued liabilities consist of the following:

<TABLE>
<CAPTION>

                                                        August 31, 2000          November 30, 1999
                                                        ---------------          -----------------
<S>                                                     <C>                      <C>

         Professional Fees.......................         $  23,250                    $  88,250
         Accrued Incentive.......................            18,373                       -
         Accrued Sales Commissions...............            48,087                      133,863
         Accrued Insurance.......................                50                       20,082
         Accrued Warranty........................             6,250                       11,700
         Other...................................            -                            10,000
                                                           --------                    ---------
              Total..............................         $  96,010                    $ 263,895
                                                          =========                    =========

</TABLE>

5.       COMMITMENTS AND CONTINGENCIES

         We may become subject to products liability claims by patients or
physicians, and may become a defendant in products liability or malpractice
litigation. We have obtained products liability insurance and an umbrella
policy; however, we might not be able to maintain such insurance or such
insurance might not be sufficient to protect us against products liability.

6.       STOCK OPTIONS

         On April 18, 2000, our shareholders 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 1,040,000 to 1,335,000 shares.

         Effective February 16, 2000, we granted 10-year options under the 1997
Stock Option Plan to purchase 126,000 common shares to nine of our key employees
(including officers) and one of our consultants at an exercise price of $2.88
per share (the closing sale price of the common shares as of the date of grant).
Effective April 18, 2000, we granted to five of our directors, who are not
officers or employees, 10-year options under the 1997 Stock Option Plan to
purchase 2,000 common shares each at an exercise price of $3.375 per share (the
closing sale price of the common shares as of the date of grant). Effective May
31, 2000, we granted to one of our directors 10-year options under the 1997
Stock Option Plan to purchase an aggregate of 100,000 common shares, 50,000 at
an exercise price of $4.36 per share in connection with the Private Equity Line
Agreement with Kingsbridge Capital Limited and 50,000 at an exercise price of
$3.00 per share in connection with the CoRestore License Acquisition. Both
exercise prices were more than the closing sale price of the common shares on
the date of grant.

7.       SUBSEQUENT EVENTS

         On September 15, 2000, the Company received FDA clearance to market the
model 5100 Cerebral Oximeter in the United States. The model 5100 has the added
capability of being able to monitor pediatric patients.



                                       7

<PAGE>   8


                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

         Some of the statements in this report are forward-looking statements.
These forward-looking statements include statements relating to our performance
in this Management's Discussion and Analysis of Financial Condition and Results
of Operations. In addition, we may make forward-looking statements in future
filings with the Securities and Exchange Commission and in written material,
press releases and oral statements issued by us or on our behalf.
Forward-looking statements include statements regarding the intent, belief or
current expectations of us or our officers, including statements preceded by,
followed by or including forward-looking terminology such as "may," "will,"
"should," "believe," "expect," "anticipate," "estimate," "continue," "predict"
or similar expressions, with respect to various matters.

         It is important to note that our actual results could differ materially
from those anticipated from the forward-looking statements depending on various
important factors. These important factors include our history of losses and
ability to continue as a going concern, our current dependence on the Cerebral
Oximeter and SomaSensor, the challenges associated with developing new products,
the uncertainty of acceptance of our products by the medical community, the
lengthy sales cycle for our products, competition in our markets, our need for
additional financing, our dependence on our distributors, and the other factors
discussed under the caption "Risk Factors" and elsewhere in our Registration
Statement on Form S-1 (file no. 333-33262) effective March 31, 2000 and
elsewhere in this report, including Part II, Item 5 of this report.

         All forward-looking statements in this report are based on information
available to us on the date of this report. We do not undertake to update any
forward-looking statements that may be made by us or on our behalf in this
report or otherwise. In addition, please note that matters set forth under the
caption "Risk Factors" in our registration statement and in Part II, Item 5 of
this report constitute cautionary statements identifying important factors with
respect to the forward-looking statements, including certain risks and
uncertainties, that could cause actual results to differ materially from those
in such forward-looking statements.

RESULTS OF OPERATIONS

OVERVIEW

         We develop, manufacture and market the INVOS Cerebral Oximeter, the
only non-invasive patient monitoring system commercially available in the United
States that continuously measures changes in the blood oxygen level in the adult
brain. We are also developing the CorRestore(TM) patch, which is being developed
for use in heart surgeries called surgical anterior ventricular restoration, or
SAVR. In June 1996, we received clearance from the FDA to market the Cerebral
Oximeter and the related disposable SomaSensor in the United States. In October
1997, we obtained FDA clearance for new advances in our INVOS technology that
are incorporated in our model 4100 Cerebral Oximeter. The model 4100 Cerebral
Oximeter was introduced in October 1997 and we began shipping the model 4100 in
the first quarter of fiscal 1998. During the third quarter of fiscal 1999, we
introduced our new model 5100 Cerebral Oximeter at an international trade show,
and began international shipments of the model 5100 in August 1999. The model
5100 Cerebral Oximeter has the added capability of being able to monitor
pediatric patients. In September 2000, we received clearance from the FDA to
market the model 5100 Cerebral Oximeter in the United States. In June 2000, we
entered into a license agreement for the CorRestore patch, which requires
testing and FDA clearance or approval before we can sell it in the United
States.

                                       8

<PAGE>   9





                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

         During fiscal 1999 and the first three quarters of fiscal 2000, our
primary activities consisted of sales and marketing of the model 4100 Cerebral
Oximeter and the related disposable SomaSensor. We had an accumulated deficit of
$49,305,659 through August 31, 2000. We believe that our accumulated deficit
will continue to increase for the foreseeable future.

         We derive our revenues from sales of Cerebral Oximeters and SomaSensors
to our distributors and to hospitals in the United States through our direct
sales employees. We recognize revenues when we ship our products to our
distributors or to hospitals. Payment terms are generally net 30 days for United
States sales and net 60 days or longer for international sales. Our primary
expenses, excluding the cost of our products, are selling, general and
administrative and research, development and engineering, which we generally
expense as incurred. Beginning in the third quarter of fiscal 1999, we offered
to Baxter Limited in Japan to exchange model 4100 Cerebral Oximeters for model
3100A Cerebral Oximeters (which we scrap) and cash equal to the difference in
sales prices of the two models, as a result of the Japanese Ministry of Health
and Welfare approval in the first quarter of fiscal 1999 to market the model
4100 in Japan. Such sales reduce our average unit sales price and overall gross
margin. Also, during fiscal 1998, we began a no-cap sales program whereby we
ship the model 4100 Cerebral Oximeter to the customer at no charge, in exchange
for the customer agreeing to purchase at a premium a minimum monthly quantity of
SomaSensors.


THREE MONTHS ENDED AUGUST 31, 2000 COMPARED TO THREE MONTHS ENDED AUGUST 31,
1999

         Our net revenues increased approximately $129,000, or 15%, from
$877,346 in the three-month period ended August 31, 1999 to $1,006,408 in the
three-month period ended August 31, 2000. The increase in net revenues is
primarily attributable to

         -    an increase in United States sales of approximately $80,000, from
              approximately $557,000 in the third quarter of fiscal 1999 to
              approximately $637,000 in the third quarter of fiscal 2000,
              primarily due to increased purchases of the disposable SomaSensor,
              and
         -    an increase in international sales of approximately $49,000, from
              approximately $320,000 in the third quarter of fiscal 1999 to
              approximately $369,000 in the third quarter of fiscal 2000,
              primarily due to an additional stocking order for model 5100
              Cerebral Oximeters and SomaSensors by Nellcor Puritan Bennett
              Export, Inc.


The increase in net revenues was achieved despite decreased purchases of the
model 4100 by Baxter Limited in Japan attributable to the exchange purchases
made in the third quarter of fiscal 1999 as a result of Japanese Ministry of
Health and Welfare approval in fiscal 1999 to market the model 4100 in Japan.

         Approximately 37% of our net revenues in the third quarter of fiscal
2000 and the third quarter of fiscal 1999 were export sales. Sales of
SomaSensors, model 4100 Cerebral Oximeters, model 5100 Cerebral Oximeters, and
model 4100 exchanges as a percentage of net revenues were as follows:


                                       9

<PAGE>   10


                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

<TABLE>
<CAPTION>


                                                                     PERCENT OF NET REVENUE
                                                                    THIRD QUARTER OF FISCAL
              PRODUCT                                           2000                       1999
              -------                                     -----------------         -----------------
<S>                                                       <C>                       <C>

              SomaSensors........................                59%                        53%
              Model 4100 Cerebral Oximeters......                23%                        32%
              Model 5100 Cerebral Oximeters......                18%                         3%
              Model 4100 Exchanges...............                 0%                        12%
                                                          -----------------         -----------------
                  Total..........................               100%                       100%
                                                          =================         =================
</TABLE>


One international distributor accounted for approximately 22% of net revenues
for the three months ended August 31, 2000, and one international distributor
accounted for approximately 25% of net revenues for the three months ended
August 31, 1999.

         Gross margin as a percentage of net revenues was approximately 58% for
the quarter ended August 31, 2000 and approximately 48% for the quarter ended
August 31, 1999. This increase is attributable to shipments of our new model
SomaSensor in fiscal 2000, which is less costly to manufacture than the old
model SomaSensors sold in the third quarter of fiscal 1999, and fewer model 4100
exchanges.

         Our research, development and engineering expenses decreased
approximately $35,000, or 24%, from $145,340 for the three months ended August
31, 1999 to $110,594 for the three months ended August 31, 2000. The decrease is
primarily attributable to an approximately $40,000 decrease in consulting fees
associated with the termination of our consulting order with NeuroPhysics
Corporation. We expect our research, development and engineering expenses to
increase significantly in connection with development and clinical testing of
the CorRestore patch in fiscal 2000 and fiscal 2001.

         Selling, general and administrative expenses increased approximately
$125,000, or 9%, from $1,366,573 for the three months ended August 31, 1999 to
$1,491,742 for the three months ended August 31, 2000. The increase in selling,
general and administrative expense is primarily attributable to

         -    an $86,000 increase in selling-related expenses, primarily related
              to marketing and promotional materials for Nellcor Puritan Bennett
              Export, Inc., and employee travel expenses,
         -    a $78,000 realized loss on the sale of marketable securities in
              the third quarter of fiscal 2000,
         -    a $55,000 increase in intangible amortization expense related to
              the amortization of license acquisition costs, and
         -    a $53,000 increase in product manufacturing and warranty expenses
              for the Cerebral Oximeter and SomaSensor, including tooling,
              supplies, regulatory, and testing.

These increases were incurred despite a $124,000 decrease in salaries, wages,
commissions and related expenses, primarily as a result of a reduction in the
number of employees, principally sales and marketing, since September 1, 1999
(from an average of 43 employees for the quarter ended August 31, 1999 to an
average of 40 employees for the quarter ended August 31, 2000) and reduced sales
commissions.

                                       10

<PAGE>   11


                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

         For the three-month period ended August 31, 2000, we realized a 4%
decrease in our net loss over the same period in fiscal 1999. The decrease is
primarily attributable to

         -    a 15% increase in net revenues, and
         -    a 10% increase in gross margin percentage.

The decreased net loss was achieved despite

         -    a 6% increase in operating expenses, and
         -    decreased interest income.

NINE MONTHS ENDED AUGUST 31, 2000 COMPARED TO NINE MONTHS ENDED AUGUST 31, 1999

         Our net revenues increased approximately $645,000, or 23%, from
$2,829,563 in the nine-month period ended August 31, 1999 to $3,474,089 in the
nine-month period ended August 31, 2000. The increase in net revenues is
primarily attributable to

         -    an increase in international sales of approximately $354,000, from
              approximately $1,235,000 in the first three quarters of fiscal
              1999 to approximately $1,589,000 in the first three quarters of
              fiscal 2000, primarily due to the stocking orders for model 4100
              and model 5100 Cerebral Oximeters and SomaSensors by Nellcor
              Puritan Bennett Export, Inc., and
         -    an increase in United States sales of approximately $291,000, from
              approximately $1,594,000 in the first three quarters of fiscal
              1999 to approximately $1,885,000 in the first three quarters of
              fiscal 2000, primarily due to increased purchases of the
              disposable SomaSensor.

The increase in net revenues was achieved despite

         -    decreased purchases of the model 4100 by Baxter Limited in Japan
              attributable to the initial stocking purchases and exchange
              purchases made in the first three quarters of fiscal 1999 as a
              result of Japanese Ministry of Health and Welfare approval in
              fiscal 1999 to market the model 4100 in Japan,
         -    an 11% decrease in the average selling price of Cerebral Oximeters
              primarily as a result of the initial stocking purchase by Nellcor
              Puritan Bennett Export, Inc., at lower per unit prices, for use as
              demonstration equipment by its sales personnel, and a change in
              the sales mix in the United States between direct purchases of the
              model 4100 and no-cap placements of the model 4100, and
         -    a 9% decrease in the average selling price of SomaSensors
              primarily as a result of the initial stocking purchase by Nellcor
              Puritan Bennett Export, Inc., at lower per unit prices, for use as
              demonstration equipment by its sales personnel.

         Approximately 46% of our net revenues in the first three quarters of
fiscal 2000 were export sales, compared to approximately 44% of our net revenues
in the first three quarters of fiscal 1999. Sales of SomaSensors, model 4100
Cerebral Oximeters, model 5100 Cerebral Oximeters, and model 4100 exchanges as a
percentage of net revenues were as follows:

                                       11

<PAGE>   12







                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

<TABLE>
<CAPTION>

                                                                     PERCENT OF NET REVENUE
                                                                 FIRST THREE QUARTERS OF FISCAL
              PRODUCT                                           2000                       1999
              -------                                     -----------------         -----------------
<S>                                                       <C>                       <C>

              SomaSensors........................                51%                        43%
              Model 4100 Cerebral Oximeters......                30%                        52%
              Model 5100 Cerebral Oximeters......                17%                         1%
              Model 4100 Exchanges...............                 2%                         4%
                                                          -----------------         -----------------
                  Total..........................               100%                       100%
                                                          =================         =================

</TABLE>

Two international distributors accounted for approximately 20% and 14%,
respectively, of net revenues for the nine months ended August 31, 2000, and one
international distributor accounted for approximately 26% of net revenues for
the nine months ended August 31, 1999.

         Gross margin as a percentage of net revenues was approximately 53% for
the nine months ended August 31, 2000 and approximately 50% for the nine months
ended August 31, 1999. Although we realized a lower average selling price for
Cerebral Oximeters and SomaSensors in the first nine months of fiscal 2000,
gross margin as a percentage of net revenues increased primarily due to
shipments of our new model SomaSensor in fiscal 2000, which is less costly to
manufacture than the old model SomaSensors sold in the first nine months of
fiscal 1999.

         Our research, development and engineering expenses decreased
approximately $106,000, or 24%, from $431,821 for the nine months ended August
31, 1999 to $326,119 for the nine months ended August 31, 2000. The decrease is
primarily attributable to an approximately $115,000 decrease in consulting fees
associated with the termination of our consulting order with NeuroPhysics
Corporation.

         Selling, general and administrative expenses decreased approximately
$290,000, or 6%, from $4,689,806 for the nine months ended August 31, 1999 to
$4,399,670 for the nine months ended August 31, 2000. The decrease in selling,
general and administrative expense is primarily attributable to

         -    a $597,000  decrease in salaries,  wages,  commissions and related
              expenses,  primarily  as a result of a reduction  in the number of
              employees,  principally  sales and marketing,  since  September 1,
              1999 (from an average of 47  employees  for the nine months  ended
              August 31, 1999 to an average of 41 employees  for the nine months
              ended August 31, 2000) and reduced sales commissions, and
         -    a $42,000  decrease in  professional  service fees  primarily as a
              result of decreased business consulting fees during the first nine
              months of fiscal 2000.

These decreases were incurred despite

         -    a $132,000 realized loss on the sale of marketable securities in
              the first three quarters of fiscal 2000,
         -    a $130,000 increase in selling-related expenses, primarily related
              to marketing and promotional materials and training for Nellcor
              Puritan Bennett Export, Inc., and employee travel expenses,
         -    a $55,000 increase in intangible amortization expense related to
              the amortization of license acquisition costs, and


                                       12

<PAGE>   13



                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000


         -    a $49,000 increase in clinical research expenses, primarily
              related to the model 5100 Cerebral Oximeter.

         For the nine-month period ended August 31, 2000, we realized a 20%
decrease in our net loss over the same period in fiscal 1999. The decrease is
primarily attributable to

         -    a 23% increase in net revenues, and
         -    an 8% decrease in operating expenses.

The decreased net loss was achieved despite decreased interest income.


LIQUIDITY AND CAPITAL RESOURCES

         Net cash used in operations during the nine-month period ended August
31, 2000 was approximately $3,101,000. Cash was used primarily to

         -    fund our net loss, primarily selling, general and administrative
              expenses and research, development and engineering expenses,
              totaling approximately $2,498,000, before depreciation and
              amortization expense,
         -    increase inventories by approximately $404,000, primarily due to
              purchases of long lead time SomaSensor and Cerebral Oximeter
              components,
         -    decrease accounts payable by approximately $92,000 as a result of
              payments made in fiscal 2000,
         -    decrease accrued liabilities by approximately $168,000 as a result
              of payments made in fiscal 2000, and
         -    increase other assets by approximately $47,000 as a result of
              professional service fees capitalized as part of our license
              acquisition costs.

These uses of cash were partially offset by

         -    an approximately $91,000 decrease in accounts receivable as a
              result of improved collections in fiscal 2000, and
         -    an approximately $17,000 decrease in prepaid expenses.

         We expect our working capital requirements to increase if sales
increase. Capital expenditures in the first nine months of fiscal 2000 were
approximately $90,000. These expenditures were primarily approximately $68,000
for model 4100 demonstration units and no-cap units. We expect our capital
requirements to increase as a result of the costs of developing and testing the
CorRestore patch. We disposed of approximately $30,000 in obsolete inventory
during the first nine months of fiscal 2000; these assets were fully reserved
and had no book value.

         On March 6, 2000, we entered into the Private Equity Line Agreement
with Kingsbridge Capital Limited, a private institutional investor. Pursuant to
the Private Equity Line Agreement we may issue and sell, from time to time,
common shares for cash consideration up to an aggregate of $15 million. As
required by the Private Equity Line Agreement, we have filed a registration
statement to permit Kingsbridge to resell to the public any shares that we sell
to it pursuant to the Private Equity Line Agreement. Until March 31, 2002, we
may sell, or "put," common shares to Kingsbridge from time to time in amounts
and at times we select at our discretion, subject to specific restrictions set
forth in the Private Equity Line Agreement. The price for these

                                         13

<PAGE>   14


                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

sales is between 86% and 90% of the then current average market price of our
common shares. The actual percentage will depend on an average market price of
our common shares. In addition, we must pay Brean Murray & Co., Inc. a 3.5%
commission in connection with these sales. We must also pay additional expenses
in connection with these sales. We are not permitted to sell more than 19.9% of
our outstanding common shares pursuant to this arrangement unless we first
obtain shareholder approval under The Nasdaq SmallCap Market rules.

         Puts can be made every 15 trading days in amounts ranging from a
minimum of $10,000 to a maximum of $1,000,000. The amounts depend on the then
current trading volume and average market price of our common shares at the time
of each put. We are required to put at least $7,500,000 of our common shares to
Kingsbridge over the life of the Private Equity Line Agreement or pay
Kingsbridge the discount on the unsold shares. As of October 6, 2000, we have
issued 492,794 common shares under the Private Equity Line Agreement. Under the
Private Equity Line Agreement, the average market price of our common shares for
purposes of calculating the purchase price to be paid by Kingsbridge is the
average of the lowest trade prices of the common shares as reported by Bloomberg
L.P. on each of five days on which The Nasdaq SmallCap Market is open for
trading. The five days are the two trading days before the day on which we
deliver notice to Kingsbridge that we are exercising a put, the trading day on
which we deliver the put notice, and the two trading days after the trading day
on which we deliver the put notice.

         The Private Equity Line Agreement provides that we may not put our
common shares to Kingsbridge unless the following conditions are satisfied or
waived (none of which is within Kingsbridge's control):

         -    the registration statement must have been declared effective by
              the SEC and must remain effective;
         -    the representations and warranties made by us in the Private
              Equity Line Agreement must be accurate in all material respects as
              of the date of each put and as of the date of the closing of the
              sale. One of our representations is that since November 30, 1999
              there has been no material adverse change in our business,
              operations, properties, prospects or financial condition, except
              as disclosed in the registration statement or specified periodic
              reports filed with the SEC pursuant to the Securities Exchange Act
              of 1934;
         -    we must have performed and complied with in all material respects
              all obligations under the Private Equity Line Agreement, the
              warrant and the Registration Rights Agreement entered into between
              us and Kingsbridge in connection with the Private Equity Line
              Agreement that are required to be performed as of the date of each
              put and as of the date of the closing of the sale;
         -    no statute, rule, regulation, executive order, decree, ruling or
              injunction may be in effect that prohibits or directly and
              adversely affects any of the transactions contemplated by the
              Private Equity Line Agreement;
         -    our common shares must not have been delisted from The Nasdaq
              SmallCap Market nor suspended from trading;
         -    the issuance of the common shares must not violate the shareholder
              approval requirements of The Nasdaq SmallCap Market;
         -    the number of shares to be put to Kingsbridge, together with any
              shares then held by Kingsbridge, must not exceed 9.9% of our
              common shares that would be outstanding upon completion of the
              put; and
         -    the average trading volume of our common shares for 26 of the 30
              consecutive trading days immediately preceding a put must be at
              least 30,000 shares a day. The two highest and the two lowest
              trading volume days are excluded.


                                       14

<PAGE>   15




                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

         In consideration for Kingsbridge's commitment under the Private Equity
Line Agreement, we issued a warrant to Kingsbridge on March 6, 2000. The warrant
entitles the holder to purchase 200,000 common shares at a purchase price of
$4.36 per share. The warrant is exercisable at any time until September 3, 2005.
The warrant contains standard provisions that protect the holder against
dilution by adjustment of the exercise price and the number of shares issuable
pursuant to the warrant if any of the following occurs:

         -    stock split
         -    reverse  stock split,
         -    stock dividend,
         -    reclassification,
         -    merger,
         -    statutory share exchange,
         -    similar transactions affecting our common shares, or
         -    specified issuances of common shares, convertible or exchangeable
              securities, options and warrants at less than the market price of
              the common shares, as defined in the Private Equity Line
              Agreement.

The warrant also provides for adjustments if we pay liquidating dividends. No
adjustments are required for instruments or benefits issued under any of our
stock option plans or in consideration or our acquisition of all or any part of
the assets of another person. The exercise price of the warrant is payable
either in cash or by a cashless exercise in which the number of common shares
underlying the warrant having an aggregate fair market value at the time of
exercise equal to the aggregate exercise price are cancelled as payment of the
exercise price.

         On April 13, 2000, we completed the sale of 167,131 common shares to
Kingsbridge Capital Limited, pursuant to the Private Equity Line Agreement, at a
price of $3.59 per share, for gross proceeds of $600,000, on May 11, 2000, we
completed the sale of 148,148 common shares to Kingsbridge Capital Limited, at a
price of $2.70, for gross proceeds of $400,000, and on June 22, 2000, we
completed the sale of 177,515 common shares to Kingsbridge Capital Limited, at a
price of $3.38, for gross proceeds of $600,000. Our net proceeds, after
deducting the commissions and the estimated expenses of the offerings, were
approximately $1,419,000.

         As of August 31, 2000, we had working capital of $1,835,011, cash, cash
equivalents and marketable securities of $575,487, total current liabilities of
$501,658 and shareholder's equity of $3,437,792.

         We believe that the cash, cash equivalents and marketable securities on
hand at August 31, 2000, together with the estimated net proceeds from the sales
of the remaining 507,206 common shares over time to Kingsbridge Capital Limited
pursuant to the Private Equity Line Agreement described above based on current
market prices, will be adequate to satisfy our operating and capital
requirements through December 2000. By that time we will be required to raise
additional cash either through additional sales of our products, through sales
of securities, by incurring indebtedness or by some combination of these
alternatives. If we are unable to raise additional cash by that time, we will be
required to reduce or discontinue our operations.

         The estimated length of time current cash, cash equivalents and
marketable securities will sustain our operations is based on estimates and
assumptions we have made. These estimates and assumptions are subject to change
as a result of actual experience. Changes in the market price or trading volume
of our common shares could reduce the proceeds we receive for selling those
common shares under the Private Equity Line Agreement, decrease the number of
shares we can sell in a particular period or both. Actual capital requirements
necessary to

                                       15

<PAGE>   16



                             SOMANETICS CORPORATION

                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

                                 AUGUST 31, 2000

market the Cerebral Oximeter and SomaSensor, to develop and test the CorRestore
patch, to undertake other product development activities, and for working
capital might be substantially greater than current estimates.

         We do not believe that product sales will be sufficient to fund our
operations in fiscal 2000 or fiscal 2001.

         As of August 31, 2000, we had 55,120 redeemable warrants outstanding
exercisable at $17.50 per share until April 1, 2001. These warrants were issued
in our 1996 Regulation S securities offering. The conditions permitting us to
redeem these warrants have not been met as of October 6, 2000. In addition, the
placement agents and their transferees hold warrants to purchase 11,424 common
shares exercisable at $12.50 per share until April 1, 2001. Also, the
underwriter of the June 1997 public offering received warrants to purchase
200,000 common shares exercisable at $4.80 per share until May 29, 2002. In
addition, Kingsbridge Capital Limited received warrants to purchase 200,000
common shares exercisable at $4.36 per share until September 3, 2005 pursuant to
the Private Equity Line Agreement. It is unlikely that these warrants will be
exercised if the exercise price exceeds the market price of the common shares.
Also, CorRestore, LLC and its agent, Wolfe & Company, received warrants to
purchase 400,000 common shares exercisable at $3.00 per share until June 2, 2005
pursuant to the CorRestore license agreement, and, subject to shareholder
approval, when specified events occur we agreed to issue them five-year warrants
to purchase an additional 2,100,000 common shares exercisable at $3.00 per share
pursuant to the CorRestore license agreement.

         We are also a party to the Private Equity Line Agreement described
above. We may sell up to an aggregate of $13,400,000 more of our common shares
under the Private Equity Line Agreement. However, we must obtain shareholder
approval and register under the Securities Act of 1933 any common shares we sell
pursuant to the Private Equity Line Agreement beyond the remaining 507,206
already registered common shares.

         We have engaged Brean Murray & Co, Inc. as our exclusive placement
agent in connection with a private placement or public offering of newly-issued
securities. Final terms and conditions of the offering will be subject to, among
other things, the satisfactory completion by Brean Murray of such inquiry and
investigation of the transactions and of us as Brean Murray deems reasonably
appropriate and to the absence in Brean Murray's reasonable determination of a
material adverse change in the conditions in the markets for the offering or the
financial markets generally. In addition, the type and amount of securities, if
any, that might ultimately be issued in any such offering have not yet been
determined and will be dependent on negotiations with the underwriter, any
private placement investor, market conditions and our then current estimate of
the proceeds necessary or desired to sustain our operations. There can be no
assurance that such offering will occur or that we will be able to raise any
capital or capital in amounts we desire, or on terms and conditions acceptable
to us.

         We have no loan commitments.

         Even if we receive additional capital, we might not be able  to
achieve the level of sales necessary to sustain our operations, and we will
incur the costs of developing and testing the CorRestore patch before we realize
any revenues from the patch. We might not be able to obtain any funds on terms
acceptable to us and at times required by us through sales of our products,
sales of securities or loans in sufficient quantities. Our Independent Auditors'
report in our Annual Report on Form 10-K for the fiscal year ended November 30,
1999 contains an explanatory paragraph relating to an uncertainty concerning our
ability to continue as a going concern.


                                       16

<PAGE>   17


ITEM 3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      The table below provides information about our 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 current rates. The actual cash flows of all instruments are
denominated in U.S. dollars. We invest our cash on hand not needed in current
operations in fixed income securities generally maturing within one year from
the date of acquisition.




<TABLE>
<CAPTION>

                                                                 AUGUST 31, 2000

                                                            EXPECTED MATURITY DATES

                                  2000        2001       2002        2003    2004      THEREAFTER        TOTAL         FAIR VALUE
                                  ----        ----       ----        ----    ----      ----------        -----         ----------
<S>                             <C>           <C>        <C>         <C>     <C>       <C>             <C>            <C>

MARKETABLE SECURITIES:
----------------------

Short-term Debt:
 Variable Rate ($)............  $344,481         -          -          -        -            -          $344,481       $268,021
  Average interest rate.......     12.18%      N/A        N/A        N/A      N/A          N/A             12.18%

</TABLE>

    During the third quarter of fiscal 2000, we liquidated some of our
investments in corporate bonds and other fixed income securities to provide cash
to finance our operations. The average interest rate increased primarily because
of a general increase in interest rates.


                                       17

<PAGE>   18



PART II OTHER INFORMATION

Item 2.  Changes in Securities and Use of Proceeds

         The following securities of ours were issued by us during the third
quarter of fiscal 2000 without being registered under the Securities Act:

1.       In connection with our CorRestore license, on June 2, 2000, we issued
to CorRestore, LLC and Wolfe & Company five-year warrants to purchase an
aggregate of 400,000 of our common shares at a price of $3.00 a share. The
warrants became exercisable to purchase 300,000 shares immediately and become
exercisable to purchase an additional 50,000 shares when we receive clearance or
approval from the FDA to market the CorRestore patch in the United States and
another 50,000 shares when we receive CE certification for the CorRestore patch.
The warrants expire when the license terminates, except that the vested portion
of the warrants remain exercisable for an additional 90 days or, if termination
is a result of specified breaches by us, for the remaining term of the warrants.
The warrants contain provisions that protect against dilution by adjustment of
the exercise price and the number of shares issuable under the warrants upon the
occurrence of specified events, such as a merger, stock split, reverse stock
split, stock dividend, or recapitalization. The warrants were not registered,
but were issued in reliance upon the exemptions from registration contained in
Sections 4(2) and 4(6) of the Securities Act.

2.       Pursuant to the CorRestore license agreement, we have also agreed,
subject to shareholder approval, to grant CorRestore, LLC and Wolfe & Company
additional five-year warrants to purchase an aggregate of 2,100,000 common
shares at $3.00 a share, to be granted when we receive clearance or approval
from the FDA to market the CorRestore patch in the United States. The warrants
will become exercisable based on our cumulative net sales of the CorRestore
patch products. All of the warrants become exercisable if our cumulative net
sales of the CorRestore patch products are at least $80 million. The warrants
expire when the license terminates, except that the vested portion of the
warrant remains exercisable for an additional 90 days or, if termination is a
result of specified breaches by us, for the remaining term of the warrants. The
warrants are not registered, but are expected to be issued in reliance upon the
exemptions from registration contained in Sections 4(2) and 4(6) of the
Securities Act.

3.       Pursuant to the Private Equity Line Agreement, on June 22, 2000, we
issued and sold 177,515 common shares, par value $0.01 a share, to Kingsbridge
Capital Limited for $3.38 a share. The purchase price paid by Kingsbridge was
88% of an average market price of the common shares. We paid $21,000 in
commissions to Brean Murray & Co., Inc. in connection with this sale. The common
shares were sold to Kingsbridge in reliance on the exemptions from registration
contained in Sections 4(2) and 4(6) of the Securities Act. We have filed a
registration statement under the Securities Act of 1933 to permit Kingsbridge to
resell these shares to the public.


Item 5.  Other Information

THE CORRESTORE PATCH

         We are developing the CorRestore(TM) patch, a new cardiac implant
designed by CorRestore, LLC, for use in heart surgeries called surgical anterior
ventricular restoration, or SAVR. During SAVR, the surgeon restores, or
remodels, an enlarged, poor functioning left ventricle to more normal size and
function by inserting an implant, in most instances, or closing the defect
directly. We entered into a license agreement as of June 2, 2000 giving us
exclusive, worldwide, royalty-bearing licenses to specified rights relating to
the CorRestore patch, subject to the terms and conditions of the license
agreement. Our objective is to obtain regulatory clearance or approval to sell
the CorRestore patch and other regulatory approvals necessary to market outside
the United States and to have the patch used in SAVR surgeries. Our initial
target market is SAVR surgeries on patients with dilated ischemic cardiomyopathy
due to a previous myocardial infarction involving the anterior wall of the
ventricle. Ischemic cardiomyopathy is a damaged heart muscle caused by the
obstruction of the inflow of blood from the arteries, resulting in an enlarged
ventricle. Myocardial infarction is the death of an area of the middle muscle
layer in the heart wall.

                                       18

<PAGE>   19





MARKET OVERVIEW

         Congestive heart failure is when the heart is unable to pump enough
blood to meet the circulation needs of the body. It is the number one cause of
death for persons over age 65. Approximately 5,000,000 persons in the United
States have been diagnosed with congestive heart failure, and each year an
estimated 550,000 additional persons in the United States are diagnosed with
this condition. An estimated 30% of those with congestive heart failure are in
Class III or IV, based on the New York Heart Association classifications. These
classifications divide patients into four classes based on how debilitating
their condition is. Of these patients in Classes III and IV, only approximately
61% survive one year after they are diagnosed with congestive heart failure,
and, for all classes, there is a 40% annualized rate of admission to the
hospital for congestive heart failure.

         One of the many causes of congestive heart failure is dilated
cardiomyopathy, which is generally a disease that damages the heart muscle,
resulting in an enlarged ventricle. The left ventricle is the chamber of the
heart that pumps the blood through the body. Most cases of congestive heart
failure result from the failure of the left ventricle and the resulting backup
of fluid in the lungs. As a result of dilated cardiomyopathy, the muscles in the
ventricle become thinner and weaker, the ventricle becomes enlarged, and it is
not able to pump blood through the body with enough force. Often the body reacts
with short-term solutions that further damage the muscle. Drug therapies can be
used to treat congestive heart failure, but they often only relieve symptoms or
reduce the body's reactions to the problem with the pump.

         Ventricular remodeling is a surgical technique that can be used to
treat some patients suffering from congestive heart failure. It involves
reducing the size of the ventricle to restore more normal function. During SAVR,
the surgeon restores, or remodels, an enlarged, poor functioning left ventricle
to more normal size and function by inserting an implant, in most instances, or
closing the defect directly. Two heart surgeons and their company, CorRestore
LLC, have designed and patented a patch for use in SAVR that they believe is
easier to implant and provides a better seal against leaks at the perimeter than
existing patches, which are formed by the surgeon during the surgery out of
dacron or bovine pericardium tissue. These existing patches take time for the
surgeon to form, can be difficult to insert, and can leak around the edges. One
study of SAVR surgeries using existing dacron patches indicates a higher
12-month and 18-month survival rate and a lower hospital re-admission rate for
patients undergoing SAVR.

         We believe that the trends in aging of the population and the demand to
reduce health care costs, and the increased survival rate after initial heart
problems, will increase the number of persons diagnosed with congestive heart
failure and will increase the demand for procedures that can increase the
survival rate and decrease the hospital re-admission rate for these patients.


BUSINESS STRATEGY

         Our objective is to obtain regulatory clearance or approval to sell the
CorRestore patch and to have the patch used in SAVR surgeries. Key elements of
our strategy are as follows:

         Obtain Regulatory Clearance or Approval for the CorRestore Patch. We
are currently working with the inventors to design and execute the preliminary
and definitive clinical tests necessary to obtain regulatory approvals for the
CorRestore patch, including FDA clearance and CE certification. We currently
believe that the CorRestore patch is eligible to seek 510(k) clearance to market
the product in the United States. If human clinical trials are required by the
FDA, we will have to file IDE applications with the FDA before beginning the
human clinical trials. However, the FDA could require a PMA application, which
would require significantly more time and expense. We expect to discuss the
regulatory requirements for the CorRestore patch with the FDA before filing an
IDE application. Assuming the FDA requires 510(k) clearance and not PMA
approval, and human clinical trials are not required, we expect the process of
development, testing, application, clearance and preparing to manufacture the
product to take approximately one year and to cost us approximately $2,000,000.
If the 510(k) process requires human clinical trials, we expect the process of
development, testing, application, clearance and

                                       19

<PAGE>   20


preparing to manufacture the product to take approximately two years and to cost
us approximately $3,800,000. If PMA approval is required, the time and cost of
development, testing, application, clearance and preparing to manufacture the
product could be significantly greater. These expenditures will require us to
raise additional capital.

         Target Surgical Procedures Where Benefits Have Been Demonstrated. Our
initial target market is SAVR surgeries on Class III and IV congestive heart
failure patients with dilated ischemic cardiomyopathy due to a previous
myocardial infarction in the anterior wall of the left ventricle. Dilated
ischemic cardiomyopathy is a damaged heart muscle caused by the obstruction of
the inflow of blood from the arteries and resulting in an enlarged ventricle.
Myocardial infarction is death of an area of the middle muscle layer in the
heart wall. One study of SAVR surgeries on these patients, using patches that
were formed by the surgeon during the surgery out of dacron, indicates a higher
12-month and 18-month survival rate and a lower hospital re-admission rate for
patients undergoing SAVR. These existing patches take time for the surgeon to
form, can be difficult to insert, and can leak around the edges. Therefore, we
believe it will be possible to demonstrate the clinical benefits of the
CorRestore patch and to gain market acceptance for this product in connection
with these surgeries.

         Demonstrate the Clinical Benefits and Promote Acceptance of the
CorRestore Patch. We intend to sponsor clinical studies using the CorRestore
patch to provide additional evidence of its benefits. The resulting publication
of any favorable papers can be used to help convince the medical community of
the clinical benefits of the CorRestore patch. We also expect to promote the
acceptance of the CorRestore patch in the medical community by encouraging
cardiac surgeons in leading hospitals, whose opinions and practices we believe
are valued by other hospitals and physicians, to use the CorRestore patch. We
believe that the successful evaluations of the CorRestore patch by these medical
professionals will accelerate the acceptance of the CorRestore patch by other
medical professionals.

         Invest in Marketing and Sales Activities. Once the CorRestore patch may
be marketed and sold in the United States, we expect to use our existing
distribution network of direct sales employees to distribute the product in the
United States. We expect to be dependent on international distributors for
international sales of the CorRestore patch products. We also expect to invest
in marketing and sales efforts to increase the medical community's exposure to
the CorRestore patch, including participation in trade shows, conducting
seminars and direct advertising. We expect to realize some synergies with our
Cerebral Oximeter selling efforts because our sales personnel will be calling on
some of the same customers to sell both products.

         Establish an Insurance Reimbursement Code for SAVR. We desire to obtain
a reimbursement code for SAVR from private and government insurers. These codes
permit medical insurance reimbursement for this procedure. We believe
reimbursement would increase use of the procedure and the CorRestore patch. We
might not be able to get a reimbursement code for SAVR, and sales of CorRestore
patches could be harmed if we fail to obtain these codes.


PRODUCT

         We are developing the CorRestore patch for use in SAVR surgeries.
During SAVR, the surgeon restores, or remodels, an enlarged, poor functioning
left ventricle to more normal size and function by inserting an implant, in most
instances, or closing the defect directly. SAVR is currently generally performed
using a patch that is formed by the surgeon during the surgery out of dacron or
bovine pericardium tissue. These existing patches take time for the surgeon to
form, can be difficult to insert, and can leak around the edges.

         As a result of these problems, the inventors developed a non-circular
bovine pericardium, or cow heart-sac, tissue patch with an integrated soft
dacron suture ring. It is being developed to make SAVR easier for the surgeon
and to provide a better seal on the edges of the patch to minimize leaking. The
inventors and their company, CorRestore LLC, filed for a patent with respect to
their patch, which was issued in part in February 2000 and expires in May 2018.
Other claims under the patent application are still pending. The claims allowed
relate primarily to the product design of a soft suture ring integrated with a
patch.

                                       20

<PAGE>   21


         We plan to offer kits containing the patches, needles, strips of
pericardium, sizers, holders and sutures to hospitals performing SAVR. We
currently expect the retail price of these kits to be $3,500 to $5,000, although
we have done only preliminary market research regarding our proposed pricing.
See "Competition." Prices to distributors will be significantly discounted from
the retail price. Because of the requirements for sterility and pursuant to our
license agreement, the patches and kits will be manufactured for us by PM
Devices, Inc. We will be dependent on PM Devices, Inc. to develop and conduct
the in vitro and animal testing required for FDA clearance or approval of the
CorRestore patch and to manufacture our entire requirements for the patches. We
have already entered into a Contract Development and Manufacturing Agreement
with PM Devices, Inc.

LICENSE AGREEMENT

         We entered into a license agreement as of June 2, 2000 with the
inventors and their company, CorRestore LLC. The license grants us exclusive,
worldwide, royalty-bearing licenses to specified rights relating to the
CorRestore patch and related products and accessories for SAVR, subject to the
terms and conditions of the license agreement. The license also grants us the
right to use the names of the inventors and CorRestore on patch products, as
trademarks and in advertising, as long as they do not object to such use within
20 days after the proposed use is submitted to them. We also have specified
rights to future developments relating to the patch products if we incorporate
the developments in the patch products, begin testing them, receive clearances
to market them and actually begin marketing them within specified time periods.
Transfer and sublicensing of our licenses are restricted by the license
agreement.

         Pursuant to the license agreement, CorRestore LLC has agreed to provide
us with various consulting services for up to 10 days during each of our fiscal
years during the term of the licenses. These services include the following
relating to the CorRestore patch:

-   assisting us in designing and executing the clinical tests necessary to
    demonstrate the safety and efficacy of the CorRestore patch or to obtain
    regulatory approvals;
-   assisting us in preparing and defending applications for regulatory
    approvals and patent and other intellectual property applications;
-   training our personnel and customers in the use of the CorRestore patch;
-   providing ongoing technical and general consulting and advice;
-   assisting with product designs; and
-   consulting with us in connection with regulatory applications, marketing
    efforts and efforts to obtain insurance reimbursement codes.

We have agreed to pay all of the expenses of such consultation, of clinical
testing of the CorRestore patch and of the existing patent and future patent
applications or registrations after the date of the license. We are dependent on
the inventors for further development of the CorRestore patch, training doctors
in SAVR and training our personnel and customers in the use of the CorRestore
patch.

         In exchange for the license and consulting services, we agreed to the
following compensation for CorRestore, LLC and its agent, Wolfe & Company:

-   A royalty of 10% of our net sales of products subject to the licenses, for
    the term of the patent relating to the CorRestore patch, or for 10 years
    from the date of the first commercial sale if the patent is determined to be
    invalid.
-   Five-year warrants to purchase up to 400,000 common shares at $3.00 a share.
    The warrants became exercisable to purchase 300,000 shares immediately and
    become exercisable to purchase an additional 50,000 shares when we receive
    clearance or approval from the FDA to market the CorRestore patch in the
    United States and another 50,000 shares when we receive CE certification for
    the CorRestore patch. The warrant expires when the license terminates,
    except that the vested portion of the warrant remains exercisable for an
    additional 90 days or, if the licenses terminate because of specified
    breaches by us, for the remaining term of the warrant.
-   Subject to shareholder approval, five-year warrants to purchase 2,100,000
    common shares at $3.00 a share, to be granted when we receive clearance or
    approval from the FDA to market the CorRestore patch in the

                                       21

<PAGE>   22


United States. The warrants will become exercisable based on our cumulative net
sales of the CorRestore patch products as follows:

<TABLE>
<CAPTION>

                                                              Additional Portion
                                      Net Sales                    of Shares
                                      ---------                    ---------
<S>                                                           <C>

                                     $5,000,000                     233,330
                                    $10,000,000                     233,330
                                    $20,000,000                     233,340
                                    $35,000,000                     350,000
                                    $55,000,000                     466,000
                                    $80,000,000                     584,000
</TABLE>

     The warrant expires when the license terminates, except that the vested
     portion of the warrant remains exercisable for an additional 90 days or, if
     the licenses terminate because of specified breaches by us, for the
     remaining term of the warrant. CorRestore, LLC may terminate our licenses
     if we do not obtain shareholder approval for the issuance of this warrant.
-    A consulting fee of $25,000 a year to each of the inventors until we sell
     1,000 CorRestore patches.

         We have also agreed to increase the size of our Board of Directors and
add CorRestore's designee as a director, if CorRestore designates a person by
June 2, 2001. We have also agreed to cooperate with CorRestore to establish a
mutually acceptable medical advisory board to provide us with information and
advice regarding the CorRestore patch. The inventors and CorRestore LLC also
agreed to specified confidentiality, non-competition and non-solicitation
provisions in the license agreement and we agreed to specified confidentiality
provisions in the license agreement.

         CorRestore, LLC and the inventors may terminate the licenses as
follows:

-    In their sole discretion, within 120 days after we consummate specified
     types of business combination transactions with another entity and the
     holders of our common shares immediately before the transaction hold less
     than 50% of the surviving entity's or its ultimate parent's outstanding
     voting securities immediately after the transaction, but only if (1) the
     transaction is consummated before June 2, 2002, and (2) the consideration
     received by our shareholders in the transaction has a fair market value of
     less than $10.00 a share.
-    In their sole discretion, if Bruce J. Barrett ceases to be our chief
     executive officer or ceases to be responsible for our activities relating
     to the licenses, but only if (1) one of these events happens before June 2,
     2005, and (2) CorRestore, LLC, or either of the inventors exercises the
     right to terminate within 120 days after the event occurs.
-    In their sole discretion, if we materially breach specified covenants in
     the license agreement and fail to cure the breach within 90 days (30 days
     for payment obligations) after CorRestore, LLC notifies us of the breach,
     but only if CorRestore, LLC exercises its right to terminate within 120
     days after the 90-day cure period expires.
-    In their sole discretion, if we do not obtain shareholder approval of the
     issuance of the warrants to purchase 2,100,000 common shares on or before
     the date we must issue the warrants.
-    In their sole discretion, if our common shares are delisted from The Nasdaq
     Stock Market and are not re-listed within 90 days, but only if CorRestore,
     LLC exercises its right to terminate within 120 days after the 90-day
     period expires.
-    In their sole discretion, if we make an assignment for the benefit of our
     creditors or voluntarily commence any bankruptcy, receivership, insolvency
     or liquidation proceedings and the action is not reversed or terminated
     within 90 days, but only if CorRestore, LLC exercises its right to
     terminate within 120 days after the 90-day period expires.
-    CorRestore, LLC may exclude specified countries from the geographic scope
     of the license if we have not begun marketing the CorRestore patch products
     or begun the process of obtaining necessary regulatory approval to sell
     CorRestore patch products in that country within one year after the date we
     file a 510(k) clearance application or PMA approval application with the
     FDA with respect to the CorRestore patch products. The countries may be
     excluded from the license only if we fail to cure the breach of this
     provision within 90 days after CorRestore, LLC notifies us of the breach.

                                       22

<PAGE>   23



-    CorRestore, LLC may change our licenses to be non-exclusive for
     developments that we do not incorporate in the patch products, begin
     marketing or testing, receive clearances to market or IDE approvals and
     actually begin marketing within specified time periods.
-    Our licenses become non-exclusive for products that we do not begin
     marketing and selling in the United States within 30 days after we receive
     510(k) clearance or approval of a PMA application from the FDA to market
     the applicable product in the United States.

         We may terminate the licenses as follows:

-    In our sole discretion, within 120 days after we sign a definitive
     agreement for specified types of business combination transactions with
     another entity and the holders of our common shares immediately before the
     transaction hold less than 50% of the surviving entity's or its ultimate
     parent's outstanding voting securities immediately after the transaction.
     If we use this provision to terminate the licenses, we must pay $1,000,000
     to CorRestore, LLC and the inventors.
-    In our sole discretion, if CorRestore, LLC or either of the inventors
     materially breaches specified covenants in the license agreement and fails
     to cure such breach within 90 days after we notify the applicable party of
     the breach, but only if we exercise our right to terminate within 120 days
     after the 90-day cure period expires.

COMPETITION

         The CorRestore patch will compete against existing patches, which are
formed by the surgeon during SAVR surgeries out of dacron or bovine pericardium
tissue. These existing patches take time for the surgeon to form, can be
difficult to insert, and can leak around the edges. Although we believe the
CorRestore patch has important advantages over patches that are currently used,
including its ease of use and better seal against leaks at the edge, existing
patches are significantly less expensive. In addition to promoting SAVR in
general as a treatment for congestive heart failure, we will have to convince
users that the advantages of the CorRestore patch outweigh its additional cost.
At least one study using dacron patches indicates that they are effective. SAVR
is in the early stages of its development and, if it develops, the market for
patches used in SAVR might become highly competitive. There are many larger
companies in this industry that have significantly larger research and
development budgets than ours. Competitors may be able to develop additional or
better treatments for congestive heart failure.

         We believe that a manufacturer's reputation for producing effective,
sterile, reliable and technically advanced and patented products, clinical
literature, association with leaders in the field, references from users,
surgeon convenience and price are the principal competitive factors in the
medical supply industry.

INSURANCE

         Because the Cerebral Oximeter and the CorRestore patch are intended to
be used in hospital critical care units with patients who may be seriously ill
or may be undergoing dangerous procedures, we might be exposed to serious
potential products liability claims. We have obtained products liability
insurance with a liability limit of $2,000,000. We expect to increase this
coverage when we begin human clinical trials, if they are required, or when we
begin selling the CorRestore patches because of the higher risk associated with
this product. We also maintain coverage for property damage or loss, general
liability, business interruption, travel-accident, directors' and officers'
liability and workers' compensation. We do not maintain key-man life insurance.

PROPERTIES

         We believe that, depending on sales of the Cerebral Oximeter, our
current facility is more than suitable and adequate for our current needs,
including our assembly of the Cerebral Oximeter, storing inventories of
CorRestore patch products and conducting our operations in compliance with
prescribed FDA QSR guidelines, and will allow for substantial expansion of our
business and number of employees.

                                       23

<PAGE>   24





RISK FACTORS

         The following are risk factors relating to our CorRestore patch:

WE HAVE INCURRED LOSSES IN EVERY YEAR OF OUR EXISTENCE AND EXPECT OUR LOSSES TO
CONTINUE IN FISCAL 2000; OUR ABILITY TO CONTINUE AS A GOING CONCERN IS
UNCERTAIN.

         We have incurred net losses in every year of our existence. From our
inception on January 15, 1982 through August 31, 2000, we incurred an
accumulated deficit of $49,305,659, including a net loss of $4,665,291 for the
year ended November 30, 1999 and $2,804,000 for the nine months ended August 31,
2000. Companies such as ours frequently encounter delays, expenses, problems and
uncertainties in developing products and markets for new products. We do not
believe that our product sales will be sufficient to support our operations in
fiscal 2000 or fiscal 2001, for many reasons, including:

         -    the need for customer education about the clinical benefits of the
              Cerebral Oximeter,
         -    the lengthy sales cycle for the Cerebral Oximeter,
         -    the expected costs of developing the CorRestore patch,
              product-line extensions of the Cerebral Oximeter for use on
              newborns, other non-brain tissue applications of our INVOS
              technology and enhancements to the Cerebral Oximeter and
              SomaSensor,
         -    our need to attract and service a customer base, and
         -    our ability to manufacture our products on a commercial scale in a
              cost-effective manner.

For the foreseeable future, we believe that we will continue to incur net
losses. It is possible that we will never become profitable. Due to our history
of losses and our current financial condition, our independent auditors' report
includes an explanatory paragraph referring to an uncertainty concerning our
ability to continue as a going concern. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

WE MIGHT NOT BE ABLE TO SUCCESSFULLY DEVELOP AND MARKET THE CORRESTORE PATCH.

         We are developing the CorRestore patch for use in SAVR surgeries. We
must further develop the patch, perform clinical testing, obtain FDA clearance
or approval to sell the CorRestore patch in the United States and obtain
approvals to sell the CorRestore patch outside of the United States. The time
and expense necessary to develop the CorRestore patch are not certain. In
addition, we have no previous experience in developing, manufacturing or
marketing surgical patches, and the following are some of the risks we face:

         -    we might not be able to develop an effective patch;
         -    clinical tests required to obtain regulatory approval might be
              significantly more expensive or time consuming than we expect;
         -    we might not be able to obtain FDA clearance or approval to market
              the patch in the United States, for various reasons, including if
              clinical tests do not show the patch to be safe and effective, if
              the FDA deems the data unsuitable, or if the FDA requires
              additional or follow-up testing;
         -    the final product might not be economical to manufacture or
              market;
         -    we will be dependent on third parties to perform the clinical
              tests and to manufacture the patch; and
         -    third parties might introduce equivalent, superior or less
              expensive products.

Therefore, we might not be successful in marketing this product even if we
receive clearance or approval to sell it.

DEVELOPMENT OF THE CORRESTORE PATCH COULD ADVERSELY AFFECT OPERATING RESULTS,
DISTRACT MANAGEMENT AND DILUTE SHAREHOLDERS.

         Assuming the FDA requires 510(k) clearance and not PMA approval, and
human clinical trials are not required, we expect the process of development,
testing, application, clearance and preparing to manufacture the product to take
approximately one year and to cost us approximately $2,000,000. If the 510(k)
process requires human clinical trials, we expect the process of development,
testing, application, clearance and preparing to

                                       24

<PAGE>   25


manufacture the product to take approximately two years and to cost us
approximately $3,800,000. We we will not be able to sell the patch in the United
States until FDA clearance or approval is obtained. Our efforts to develop and
market this patch could disrupt our ongoing Cerebral Oximeter business and
distract our management and employees, and they are expected to increase our
expenses significantly. In addition, pursuant to our CorRestore licenses, we
have granted warrants to purchase 400,000 common shares at an exercise price of
$3.00 a share, and have agreed to issue warrants to purchase an additional
2,100,000 common shares, subject to obtaining shareholder approval, at an
exercise price of $3.00 a share. These warrants will increase our expenses and
could dilute the interests of our existing shareholders. We might be required to
issue additional common shares to finance the development of the CorRestore
patch, which could further dilute the interests of our existing shareholders.

OUR PRODUCTS ARE NEW AND MIGHT NOT BE ACCEPTED BY THE MEDICAL COMMUNITY.

         To date, the medical community has had little exposure to us or our
technology. Because the medical community is often skeptical of new companies
and new technologies, members of the medical community might not perceive a need
for the Cerebral Oximeter or the CorRestore patch or be convinced of their
clinical benefits. In addition, hospital purchasing decisions for equipment like
the Cerebral Oximeter are often made by hospital purchasing committees that
might not include the user of the equipment. In such a case, the committees must
be convinced to purchase our product. Even if we are successful in convincing
physicians, other medical professionals and their hospital purchasing committees
of the need for the Cerebral Oximeter, they might be unwilling or unable to
commit funds to the purchase of the Cerebral Oximeter due to limited budgets or
decreases in capital expenditures. In many cases, these limits are due to
hospital cost controls, increased managed care and fixed reimbursements for the
medical procedures in which the Cerebral Oximeter is used. If our products fail
to achieve market acceptance, our business, financial condition and results of
operations could be adversely affected.

WE ARE LARGELY DEPENDENT ON OTHERS TO DEMONSTRATE THE CLINICAL BENEFITS OF SAVR
SURGERY, TO TRAIN SURGEONS AND TO OBTAIN REIMBURSEMENT CODES FOR THE PROCEDURE.

         We are dependent on positive results of clinical research to convince
heart surgeons of the clinical benefits of SAVR, and we are dependent on others
to help train surgeons in the procedure. Even if surgeons are convinced of the
benefits of SAVR and are trained to perform it, we must convince them to use the
CorRestore patch in the procedure, rather than a less expensive substitute. In
addition, patients might be unwilling to undergo the procedure unless insurers
are willing to reimburse them for the cost of the procedure.


THE MEDICAL PRODUCTS INDUSTRY IS INTENSELY COMPETITIVE.

         We believe that the markets for cerebral oximetry products and the
CorRestore patch, if they develop, may become highly competitive. We know of
foreign companies that have sold products relating to cerebral metabolism
monitoring for research or evaluation. In addition, if and when the CorRestore
patch is developed, it will compete against existing patches, which are formed
by the surgeon during SAVR surgeries out of dacron or bovine pericardium tissue.
These existing patches take time for the surgeon to form, can be difficult to
insert, and can leak around the edges. Although we believe the CorRestore patch
has important advantages over patches that are currently used, existing patches
are significantly less expensive and at least one study using dacron patches
indicates that they are effective.

         The medical products 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
extensive research and development is ongoing regarding congestive heart
failure. We believe there are many other potential entrants into our markets.
Some of these potential competitors have well-established reputations, customer
relationships and marketing, distribution and service networks. Some of them
have substantially longer histories in the medical products industry, larger
product lines, and greater financial, technical, manufacturing, research and
development and management resources than we do. Many of these potential
competitors have long-term product supply relationships with our potential
customers. These potential competitors might succeed in developing products that
are at least as reliable and effective as our products, that

                                       25

<PAGE>   26


make additional measurements, that are less costly than our products, or that
provide alternatives to our products, such as additional or better treatments
for congestive heart failure.

         These potential competitors may be more successful than we are in
manufacturing and marketing their products, and may be able to take advantage of
the significant time and effort we have invested to gain medical acceptance of
cerebral oximetry and the time and effort we expect to invest to gain medical
acceptance of SAVR and the CorRestore patch. In addition, one patent issued to
an unaffiliated third party and relating to cerebral oximetry expired in 1999,
two patents issued to an unaffiliated third party and relating to cerebral
oximetry expired in 1998, and two patents issued to an unaffiliated third party
and relating to cerebral oximetry expire in 2000. These expiring patents will
make that technology generally available and potentially help the development of
competing products. Successful commercial development of competing products
could lead to loss of market share and lower margins and have an adverse effect
on our business, financial condition and results of operations.

         We also compete indirectly with numerous companies that sell 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 us. Our products and
technology also compete indirectly with many other methods currently used to
measure blood oxygen levels or the effects of low blood oxygen levels.

WE EXPECT TO NEED SUBSTANTIAL ADDITIONAL FINANCING TO FUND OUR OPERATIONS.

         We will require substantial additional capital to further develop our
products, to commercialize our products and to sustain our operations. If we
sell the remaining 507,206 common shares to Kingsbridge pursuant to the Private
Equity Line Agreement, based on current market prices, we expect that the net
proceeds of those sales will be adequate to satisfy our operating and capital
requirements through December 2000. By that time, we will be required to raise
additional cash either though additional sales of our products, through sales of
securities, by incurring indebtedness or by some combination of these
alternatives. We do not believe that our product sales will be sufficient to
sustain our operations at that time and we have no current commitments for any
debt financing. We have engaged Brean Murray & Co, Inc. as our exclusive
placement agent in connection with a private placement or public offering of
newly-issued securities. Final terms and conditions of the offering will be
subject to, among other things, the satisfactory completion by Brean Murray of
such inquiry and investigation of the transactions and of us as Brean Murray
deems reasonably appropriate and to the absence in Brean Murray's reasonable
determination of a material adverse change in the conditions in the markets for
the offering or the financial markets generally. In addition, the type and
amount of securities, if any, that might ultimately be issued in any such
offering have not yet been determined and will be dependent on negotiations with
the underwriter, any private placement investor, market conditions and our then
current estimate of the proceeds necessary or desired to sustain our operations.
There can be no assurance that such offering will occur or that we will be able
to raise any capital or capital in amounts we desire, or on terms and conditions
acceptable to us. We have no other current commitments for any additional sales
of securities, other than pursuant to the Private Equity Line Agreement if we
obtain shareholder approval to issue additional shares. In the past, we have
raised required capital through sales of additional equity securities. If we are
unable to raise additional cash by that time, we will be required to reduce or
discontinue our operations.

         Changes in the market price or trading volume of our common shares
could reduce the proceeds we receive for selling those common shares, decrease
the number of shares we can sell in a particular period or both. In addition,
changes in our business or business plans or unexpected expenses could change
our cash needs. Our future cash needs will depend on many factors, including:

         -    the cost of developing and testing the CorRestore patch,
         -    the time and cost involved in obtaining regulatory approvals;
         -    the cost of marketing and assembly activities,
         -    whether we can successfully market our products,


                                     26

<PAGE>   27





         -    the rate of market acceptance of our products,
         -    the scope of our research and development programs,
         -    the length of time required to collect accounts receivable, and
         -    competing technological and market developments.

Each of these factors could shorten the length of time our cash and cash
equivalents on hand and the cash we receive from sales of our common shares
under the Private Equity Line Agreement will sustain our operations. When we
need additional financing, it might not be available on terms acceptable to us
or at the times we require it, if at all, and such financing will likely dilute
the interests of existing shareholders. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

OUR PERFORMANCE DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN KEY PERSONNEL.

         Our future performance depends in significant part on the continued
service of our senior management, including Bruce J. Barrett, President and
Chief Executive Officer, and various scientific, technical and manufacturing
personnel. Our loss of any of these key personnel could have an adverse effect
on us. In addition, CorRestore, LLC may terminate its licenses with us if Bruce
J. Barrett ceases to be our Chief Executive Officer or ceases to be responsible
for our activities relating to the license at any time before June 2, 2005. We
do not maintain key-man life insurance on any of our key personnel. In addition,
competition for qualified employees is intense, and if we are unable to attract,
retain and motivate additional, highly-skilled employees required for the
expansion of our operations, our business, financial condition and results of
operations could be adversely affected. Our ability to retain existing employees
and attract new employees might be adversely affected by our current financial
situation. We cannot assure you that we will be able to retain our existing
personnel or attract additional, qualified persons when required and on
acceptable terms.

WE ARE DEPENDENT ON OUR DISTRIBUTORS FOR OUR INTERNATIONAL SALES.

         We are dependent on our distributors to generate international sales of
Cerebral Oximeters and we expect to depend on distributors for international
sales of the CorRestore patch if and when it is developed. We believe that our
current distributors are knowledgeable, and we have a training program for new
distributors concerning our technology and our Cerebral Oximeter and SomaSensor.
However, independent distributors might not have sufficient knowledge about, or
familiarity with, our technology or products to demonstrate adequately their
operation and clinical benefits. If our distributors fail to market, promote and
sell our products adequately, our business, financial condition and results of
operations would be adversely affected.

         We might not be able to engage additional distributors on a timely
basis, enter into other third-party marketing arrangements, or retain or replace
our existing distributors, when required. If we are unable to engage, replace or
retain distributors, our ability to market and sell our products internationally
could be adversely affected. In addition, any required distributor terminations
could increase our costs. Even if we are able to engage and retain distributors,
they might incur conflicting obligations to sell other companies' products or
they might distribute other products that provide greater revenues than are
provided by our products.

         One international distributor accounted for approximately 23% of our
net revenues for fiscal 1999. In addition, in fiscal 2000 we entered into an
exclusive distributor agreement with Nellcor Puritan Bennett Export, Inc.
currently covering 39 countries for our Cerebral Oximeter. The loss of either of
these distributors could have an adverse effect on our business, financial
condition and results of operations.


NEW PRODUCT DEVELOPMENT IS EXPENSIVE AND MIGHT NOT RESULT IN COMMERCIALLY VIABLE
PRODUCTS.

         We have invested substantial resources to develop the Cerebral Oximeter
and the related disposable SomaSensor. We expect to continue to invest
substantial resources to develop:

         -    the CorRestore patch,
         -    product-line extensions of the Cerebral Oximeter for use on
              newborns,

                                       27

<PAGE>   28


         -    other non-brain tissue applications of INVOS technology, and
         -    enhancements to the Cerebral Oximeter and SomaSensor.

New products require extensive testing and regulatory clearance before they can
be marketed, and substantial customer education concerning the product's use,
advantages and effectiveness. In addition, sales of our cerebral oximetry
products might be limited because of resistance to major capital equipment
expenditures by hospital purchasing committees. Sales of all of our products
might be limited because hospitals might fear that the cost of a new device or
product will lower its profits because medical insurers generally fix
reimbursement amounts for the procedures in which our products might be used. We
might not be able to develop commercially viable products. In addition, we are
dependent on third parties to develop and test the CorRestore patch.

PATIENTS MIGHT ASSERT PRODUCTS LIABILITY CLAIMS AGAINST US.

         Because we test, market and sell a patient monitoring device and a
heart patch, patients might assert products liability claims against us. The
Cerebral Oximeter is used in operating rooms and other critical care hospital
units with patients who might be seriously ill or might be undergoing dangerous
procedures. The CorRestore patch is expected to be used on seriously ill
patients undergoing a dangerous procedure. On occasion, patients on whom the
Cerebral Oximeter is being used, or in whom a CorRestore patch is implanted, may
be injured or die as a result of their medical treatment or condition. We might
be sued because of such injury or death, and regardless of whether we are
ultimately determined to be liable, we might incur significant legal expenses
not covered by insurance. In addition, products liability litigation could
damage our reputation and impair our ability to market our products. Litigation
could also impair our ability to retain products liability insurance or make our
insurance more expensive. We have products liability insurance with a liability
limit of $2,000,000. This insurance is costly and even though it has been
obtained, we might not be able to retain it. Even if we are able to retain this
insurance, it might not be sufficient to protect us in the event of a major
defect in the Cerebral Oximeter or the CorRestore patch. If we are subject to an
uninsured or inadequately insured products liability claim based on the
performance of the Cerebral Oximeter or the CorRestore patch, our business,
financial condition and results of operations could be adversely affected.

WE ARE DEPENDENT ON THIRD PARTIES FOR MANUFACTURING OUR PRODUCTS AND TESTING THE
CORRESTORE PATCH.

         We are dependent on various suppliers for manufacturing the components
for our Cerebral Oximeter and the related disposable SomaSensor. We believe that
each component is generally available from several potential suppliers. However,
engaging additional or replacing existing suppliers of custom-designed
components is costly and time consuming. We do not intend to maintain
significant inventories of components, Cerebral Oximeters or SomaSensors.
Therefore, we might incur delays in meeting delivery deadlines if a particular
supplier is unable or unwilling to meet our requirements. We estimate that it
would require approximately three to four months to change SomaSensor suppliers.
In addition, we do not have direct control over the activities of our suppliers
and are dependent on them for quality control, capacity, processing technologies
and, in required cases, compliance with FDA Quality System Regulation
requirements. If we cannot replace suppliers on a timely basis when necessary,
our business, financial condition and results of operations may be adversely
affected. In addition, because we do not have long-term agreements with our
suppliers, we might be subject to unexpected price increases which might
adversely affect our profit margins.

         We will be dependent on a third party to test and manufacture the
CorRestore patch. Our license agreement limits the parties that we may engage.
We have engaged PM Devices, Inc. to manufacture the CorRestore patch. The
ultimate success of our CorRestore business is dependent on our ability to
manage the manufacturer of the CorRestore patch. If we are unsuccessful in
managing the manufacturer of the CorRestore patch, our business could be
adversely affected.


                                       28

<PAGE>   29









Item 6.  Exhibits and Reports on Form 8-K

(a)      Exhibits

          27.1     Financial Data Schedule.

(b)      Reports on Form 8-K

         No reports on Form 8-K were filed by us during the quarter for which
         this report is filed.





                                       29



<PAGE>   30



                                   SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                       Somanetics Corporation
                                       --------------------------
                                       (Registrant)




Date:    October 9, 2000               By:/s/ Bruce J. Barrett
         ------------------               --------------------------------------
                                       Bruce J. Barrett
                                       President and Chief Executive Officer
                                       (Duly Authorized and Principal Financial
                                       Officer)



                                       30
<PAGE>   31



                                  EXHIBIT INDEX



EXHIBIT                                             DESCRIPTION
---------                                           -----------
27.1           Financial Data Schedule.




                                       31