**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


________________________





**FORM
      10-K**





**FOR
      ANNUAL AND TRANSITION REPORTS**


**PURSUANT
      TO SECTIONS 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


(Mark
      One)





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





For
      the
      fiscal year ended June 30, 2007





[  ]           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 1-31943





Criticare
                Systems, Inc(Exact
                Name of Registrant as Specified in Its
                Charter)





Delaware
            
            39-1501563(State
                or Other Jurisdiction of
              Incorporation
                or Organization)
            
            (I.R.S.
                Employer Identification No.)








20925 Crossroads
                Circle, Suite 100, Waukesha, Wisconsin
            
            53186(Address
                of Principal Executive Offices)
            
            (Zip
                Code)





Registrant's
      telephone number, including area
      code:  262-798-8282





Securities
      registered pursuant to Section 12(b) of the Act:





Title
                of Each Class
            Name
                of Each Exchange on
              Which
                RegisteredVoting
                Common Stock, $.04 par value (together with associated Preferred
                Stock
                Purchase Rights)
            American
                Stock Exchange








Securities
      registered pursuant to Section 12(g) of the Act:





None





Indicate
      by check mark if the
      registrant is a well-known seasoned issuer, as defined in Rule 405 of the
      Securities Act.


Yes  [   ]  No  [
      X ]





Indicate
      by check mark if the
      registrant is not required to file reports pursuant to Section 13 or Section
      15(d) of the Exchange Act.


Yes  [   ]  No  [
      X ]





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





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





Indicate
      by check mark whether the
      registrant is a large accelerated filer, an accelerated filer, or a
      non-accelerated filer.  See definition of "accelerated filer and large
      accelerated filer" in Exchange Act Rule 12b-2.  (Check
      one)




Large
      accelerated filer
      [   ]                                Accelerated
      filer [ 
 ]                                           Non-accelerated
      filer [ X ]





Indicate
      by check mark whether the
      registrant is a shell company (as defined in Rule 12b-2 of the Exchange
      Act).





Yes  [   ]  No  [
      X ]





The
      aggregate market value of the
      voting common stock held by nonaffiliates of the registrant as of December
      29,
      2006 (the last business day of the registrant’s most recently completed second
      fiscal quarter) was  $35,549,668.  Shares of voting common
      stock held as of December 29, 2006 by any person who was an executive officer
      or
      director of the Registrant as of December 29, 2006 has been excluded from this
      computation because such persons may be deemed to be affiliates.  This
      determination of affiliate status is not a conclusive determination for other
      purposes.





On
      August 31, 2007, there were
      12,318,219 shares of the registrant's $.04 par value voting common stock
      outstanding.




2


DOCUMENTS
      INCORPORATED BY REFERENCE





Portions
      of the Proxy Statement for the
      Annual Meeting of the Stockholders of the Registrant to be held November 27,
      2007 are incorporated by reference into Part III of this report.





As
      used
      in this report, the terms "we," "us," "our," "Criticare" and the "Company"
      mean
      Criticare Systems, Inc. and its subsidiaries, unless the context indicates
      another meaning, and the term "common stock" means our common stock, par value
      $0.04 per share.





**Special
      Note Regarding Forward-Looking Statements**





A
      number of the matters and subject
      areas discussed in this report that are not historical or current facts deal
      with potential future circumstances and developments.  These include
      anticipated product introductions, expected future financial results, liquidity
      needs, financing ability, management's or the Company's expectations and beliefs
      and similar matters discussed in this report.  These statements may be
      identified by the use of forward-looking words or phrases such as "anticipate,"
      "believe," "could," "expect," "intend," "may," "hope," "plan," "potential,"
      "should," "estimate," "predict," "continue," "future," "will," "would" or the
      negative of these terms or other words of similar meaning.  Such
      forward-looking statements are inherently subject to known and unknown risks
      and
      uncertainties.  Our actual results and future developments could
      differ materially from the results or developments expressed in, or implied
      by,
      these forward-looking statements.  Factors that may cause actual
      results to differ materially from those contemplated by such forward-looking
      statements include, but are not limited to, those described under the caption
      "Risk Factors" in Item 1A of this report.  We undertake no obligation
      to make any revisions to the forward-looking statements contained in this filing
      or to update them to reflect events or circumstances occurring after the date
      of
      this filing.







3


PART
      I





Item
      1.     BUSINESS.





Criticare
      designs, manufactures and
      markets vital signs and gas monitoring instruments and related noninvasive
      sensors used to monitor patients in many healthcare
      environments.  Since a patient's oxygen, anesthetic gas and carbon
      dioxide levels can change dramatically within minutes, causing severe side
      effects or death, continuous monitoring of these parameters is
      increasing.  The Company's monitoring equipment improves patient
      safety by delivering accurate, comprehensive and instantaneous patient
      information to the clinician.  The Company's products also allow
      hospitals to contain costs primarily by substituting cost-effective reusable
      pulse oximetry sensors for disposable sensors, controlling the use of costly
      anesthetics and increasing personnel productivity.





To
      meet the needs of end-users in a
      wide variety of patient environments, the Company has developed a broad line
      of
      patient monitors which combine one or more of its patented or other proprietary
      technologies, for monitoring oxygen saturation, carbon dioxide and anesthetic
      agents, with standard monitoring technologies that provide electrocardiogram
      ("ECG"), invasive and noninvasive blood pressures, temperature, heart rate
      and
      respiration rate. The Company's VitalView telemetry system allows one nurse
      to
      monitor up to sixteen patients simultaneously from a convenient central
      location.  This allows hospitals to move out of the intensive care
      unit those patients that require continuous monitoring, but do not need all
      of
      an intensive care unit's extensive and costly personnel and equipment
      resources.  In fiscal 2006, the Company released a new, next
      generation portable vital signs monitor (VitalCareTM 506N3)
      and a new,
      next generation portable multi-parameter vital signs monitor (nGenuity
      8100E).





Criticare
      is implementing several business initiatives as part of its strategy to develop
      and distribute products for highly technical, growth oriented niche
      markets.  Management believes that in order to be successful,
      marketing, distribution and sales partnerships in these areas are
      required.  That effort has resulted in the execution of a number of
      agreements with original equipment manufacturers ("OEMs").  To
      capitalize on these business initiatives, modules and stand-alone monitors
      were
      developed and marketed for specific OEM customers. The Company views OEM
      agreements as a complementary component to our strategy to develop products
      for
      highly technical niche markets, and the OEM business has been a significant
      driver of the Company’s growth.





4


The
      first
      of these initiatives involves monitoring products for anesthesia
      gases.  In fiscal 2003, the Company introduced an anesthesia
      monitoring product line for sale both under the Criticare brand name and for
      sale to OEMs.  Production shipments to our newest OEM partner, Fukuda
      Denshi, Inc. of Japan, began in August 2007.  A second initiative is
      the development of a highly specialized monitoring system for medical imaging
      applications in an MRI environment.  In 2003, Criticare entered into
      an agreement with an OEM, Medrad, Inc. ("Medrad"), to jointly develop and
      exclusively sell a highly specialized medical monitoring product to
      Medrad.  In July 2004, Criticare shipped the initial prototypes of
      this monitoring product to Medrad and production shipments began in January
      2005.  Sales to Medrad have grown quickly and Medrad has become the
      Company's largest customer in fiscal 2007, fiscal 2006 and fiscal
      2005. Following the acquisition, in July 2004, of Alaris Medical Systems,
      Inc. ("Alaris"), a long-time OEM customer, by Cardinal Health, Inc., the third
      initiative was implemented to develop an Acute Care distribution network in
      the
      U.S. to sell to markets previously served through Alaris.  Following
      such acquisition, Cardinal Health exited the vital signs monitor business and
      signed a transition agreement with the Company, which enabled our new Acute
      Care
      distribution network the opportunity to sell to the former Alaris customer
      base.  In conjunction with the transition agreement, in September
      2005, we introduced a new portable vital signs monitor for the Acute Care
      market.  Sales for the Acute Care market during fiscal 2007 and fiscal
      2006 have approached the largest revenue year Criticare experienced under the
      Alaris OEM agreement and greatly exceeded our expectations.





According
      to the guidance set by
      Statement of Financial Accounting Standards No. 131, the Company operates
      in one business segment in the healthcare environment.  The chief
      operating decision maker does not utilize segmented financial statements in
      making decisions about resource allocation because the business activities
      that
      generate revenue do not have expenses specifically associated with
      them.  Therefore, no segment data is disclosed in the notes to the
      financial statements in Item 8.  However, the Company's customer base
      is differentiated by region (see note 10 in the notes to the financial
      statements in Item 8 for an analysis of sales by geographic area).





The
      Company was incorporated under the
      laws of the State of Delaware in October 1984.





Products





Criticare
      markets a broad range of
      vital signs and gas monitoring products designed to address the needs of a
      variety of end-users in different patient environments.  Criticare's
      monitors display information graphically and numerically.  Many of the
      Company’s new products, as well as those in development, focus on anesthesia
      related monitoring, as management believes this is a high growth area with
      relatively few competitors.  All Criticare monitors incorporate
      adjustable visual and audible alarms to provide reliable patient-specific
      warnings of critical conditions, and most of the Company's monitors record
      up to
      60 hours of trend data.  Criticare monitors are available with
      printer capability to provide permanent records of patient data.





5


VitalCareTM
506N3
      Portable Vital Signs Monitors.  The Portable Vital Signs Monitor
      provides maximum versatility and cost effectiveness in a small, compact,
      portable, full-featured vital signs monitor configured to meet specific clinical
      needs.  The unit is available in multiple configurations, with a
      choice of Criticare or Nellcor oximetry, ComfortCuffTM noninvasive blood pressure
      and temperature (either FILAC FasTempTM or Alaris TurboTemp).  This
      unit is ideal for spot checking or continuously monitoring patients’ vital
      signs.





nGenuity  8100E
      Multi
      Parameter Vital Signs Monitors.  The full-featured Multi Parameter
      Vital Signs Monitor combines ECG, ComfortCuffTM  noninvasive blood pressure,
      DOXTM digital oximetry, heart rate, temperature, respiration rate, and nurse call
      interface for a complete vital signs monitor for physician offices, clinics,
      transport and hospital applications.  Optional features include
      arrhythmia and ST analysis and an integrated printer.





PoetTM
Plus
      8100 Vital Signs
      Monitors.  The full-featured CSI 8100 Vital Signs Monitor provides
      maximum flexibility for hospital, transport and outpatient care
      settings.  The unit's custom configurations include ECG, ComfortCuffTM
noninvasive blood pressure, DOXTM digital oximetry, heart rate, temperature,
      respiration rate, and nurse call interface.  Optional features include
      CO2, CO2/O2
      and invasive blood
      pressure monitoring and an integrated printer.  The 8100 is well
      suited for busy departments that require basic vital signs monitoring to
      conscious sedation.





PoetTM
IQ
      8500 and PoetTM IQ2 8500Q
      Anesthetic Gas Monitors.  The PoetTM IQ 8500 gas monitor is used in
      conjunction with the PoetTM Plus 8100 Vital Signs Monitor to provide a unique
      combination of leading edge vital signs technology and anesthesia gas monitoring
      in a compact, modular system.  The PoetTM IQ2 8500Q Gas Monitor
      provides leading edge anesthesia gas monitoring in a compact stand alone
      monitor.  The operating systems of both monitors consist of an
      integrated, solid state module based upon a proprietary infrared technology
      developed by Criticare.  The operating systems automatically monitor
      up to five anesthetic agents plus nitrous oxide, oxygen, and carbon
      dioxide.  The systems also utilize a unique, disposable water trap
      component that is proprietary to the Company.  These products are
      marketed as  configurable systems for applications by OEMs and as
      Criticare branded products.  The systems’ reliable performance, ease
      of use, flexible design, and affordable cost make them the ideal monitoring
      solutions for anesthesia applications in hospitals and surgical
      centers.





Model
      503DX and 504DX Pulse
      Oximeters.  Criticare's complete line of pulse oximeters meets the
      needs of virtually all clinical environments, including: adult, pediatric and
      neonatal intensive care units, operating rooms, emergency rooms, nursing homes,
      physicians' offices and ambulances.  The line is designed to provide
      accuracy and convenience at a competitive cost to the end-user.





6


VitalViewTM
Central
      Monitoring
      Station.  The VitalView central station makes it possible for one
      nurse or technician to monitor up to sixteen patients
      simultaneously.  The VitalView can receive, display and store data
      from a wide variety of Criticare monitors and patient-borne multiple parameter
      telemetry devices for continuous, comprehensive vital signs
      monitoring.  In addition, the VitalView can be used as a wireless
      device or hardwired and has ST and arrhythmia analysis
      capabilities.





Pulse
      Oximetry
      Sensors.  Criticare has designed proprietary, noninvasive sensors
      that can be used on any patient, from a premature infant to a full-grown
      adult.  Criticare's line of reusable pulse oximetry sensors offers
      users significant cost savings compared to disposables.  Criticare's
      reusable sensors generally last longer than the one-year warranty period and
      are
      easily and inexpensively cleaned between uses.  Criticare's reusable
      sensors include a finger sensor for routine applications and a multisite sensor
      for increased placement flexibility.  The multisite sensor is fully
      immersible, allowing for sterilization between patients.  The Company
      also sells a range of disposable sensors designed for single use in cases where
      the facility would prefer to use a patient charge disposable
      product.





WaterChekTM/Chek-Mate
      Filter
      System.  The Company's patented, disposable Water Chek system
      separates a patient's respiratory secretions from a breath sample before it
      enters the gas monitor for analysis.  The Company's proprietary,
      disposable Chek-Mate filter enhances the removal of moisture from the sample,
      while preventing cross-contamination.  This system allows the monitor
      to operate effectively regardless of humidity or patient
      condition.  The self-sealing feature also protects the healthcare
      provider from potential contamination.





Marketing
      and Sales





Domestic
      Sales.  At
      August 31, 2007, the Company's domestic sales force consisted of three employees
      and 54 independent dealers.  The Company's sales force and
      independent dealers market the Company's vital signs monitors and pulse
      oximeters primarily to surgery centers, dental and physician offices, and
      nursing homes.





The
      Company sells some of its higher-end monitors (anesthetic agent monitors and
      VitalView central stations) to domestic hospitals. With the development of
      an
      Acute Care distribution network, the Company is working to achieve a significant
      presence in U.S. hospitals that generally purchase medical equipment through
      large group purchasing organizations (GPOs).  These GPOs contract
      large medical equipment suppliers who can provide not only medical monitors,
      but
      also other medical equipment and service needs (such as CT scanners and MRI
      equipment). In addition, Cardinal Health and Criticare signed a transition
      agreement which enabled Criticare’s new Acute Care distribution network the
      opportunity to sell to the former Alaris customer base.  Alaris,
      formerly the Company’s largest customer, was acquired by Cardinal Health in
      2004, and Cardinal Health subsequently made the decision to exit from vital
      signs monitor sales activities, since those products no longer fit within its
      core business strategy.





7


Criticare
      is implementing several business initiatives as part of its strategy to develop
      products for highly technical, growth oriented niche markets.  Management
      believes that in order to be successful, marketing and sales partnerships in
      these areas are required.  That effort resulted in the execution of a
      number of OEM agreements.





To
      capitalize on these business initiatives, the Company began to focus on selling
      to OEMs with the hiring of a senior manager, in 1999, to lead this
      effort.  Modules and stand-alone monitors were developed and marketed
      for specific OEM customers. The Company views OEM agreements as a critical
      component to our strategy to develop products for highly technical niche
      markets, and the OEM business has been a significant driver of the Company’s
      growth with net sales of $7.3 million or 23.3% of total net sales in fiscal
      2007, $6.8 million or 21.7% of total net sales in fiscal 2006 and $6.1 million
      or 22.9% of total net sales in fiscal 2005. In particular, sales of the
      Company’s newly developed anesthesia products and a highly specialized
      monitoring system for medical imaging applications are expected to continue
      to
      be mainly for new OEM partners.  In July 2004, Criticare shipped the
      initial prototypes of this monitoring product to Medrad.  Medrad, the
      Company's OEM partner for medical imaging applications**,** was the
      Company's largest customer in fiscal 2007, 2006, and 2005, accounting for net
      sales of approximately $6.3 million in fiscal 2007, which represented 20.0%
      of
      the Company's total net sales in fiscal 2007.





International
      Sales.  One of the Company's principal marketing strategies has
      been to target international markets, particularly Europe, Latin America and
      the
      Pacific Rim countries.  During fiscal 2007, Criticare sold its
      products, principally to hospitals, in over 71****countries
      through over 93 independent dealers.





Most
      of
      the Company's international order processing, invoicing, collection and customer
      service functions are handled directly from the Company's headquarters in
      Waukesha, Wisconsin.  Criticare believes demand for the Company's
      products in international markets is primarily driven by cost containment
      concerns, and increased interest in using quality patient monitoring products
      for improved patient outcomes.





In
      fiscal 2007, 34.0% of
      Criticare's net sales, or $10.7 million, was attributable to international
      sales, of which 53.4% was from sales in Europe and the Middle East, 11.6%
      was from sales to Pacific Rim countries and 35.0% was from sales to
      Canada and Central and South America.  In fiscal 2006 and 2005, 40.1%
      and 43.5%, respectively, of Criticare's net sales were attributable to
      international sales. Other than inventory and accounts receivable for the
      Company’s branch office in India totaling approximately $0.4 million, there
      are no material identifiable assets of the Company located in foreign
      markets. The Company primarily sells its products in United States dollars
      and is therefore not subject to currency risks other than currency fluctuations
      from its operation in India; however, an increase in the value of the United
      States dollar relative to foreign currencies could make the Company's products
      less price competitive in those markets.  In addition, significant
      devaluation of certain foreign currencies could adversely affect the
      collectibility of accounts receivable from international
      customers.  The Company analyzes this risk before making shipments to
      countries it views as unstable.




8





Service,
      Support and
      Warranty.  Criticare believes that customer service is a key
      element of its marketing program. At August 31, 2007, the Company had a
      customer service and technical support staff of 19 people at its
      Waukesha, Wisconsin facility.  Customer service support is available
      24 hours a day, seven days a week, in which numerous customers’ technical
      problems are resolved over the telephone.  The customer service staff
      also provides periodic training and education of the direct sales force who
      in
      turn provide training to the dealers and end-users.





Criticare's
      monitors and sensors are
      generally warranted against defects for one year.  If a problem
      develops with a Criticare product while under warranty, the Company typically
      provides a replacement unit until the product can be repaired at the Company's
      facility. The Company offers extended warranties and service contracts on all
      of
      its monitors.





Manufacturing





Historically,
      Criticare had
      manufactured and assembled its products internally, principally at the Company's
      facility in Waukesha, Wisconsin.  Due mainly to pricing pressures on
      monitoring systems worldwide, in fiscal 2001 the Company entered into an
      agreement with two offshore contract manufacturing firms located in Taiwan
      and
      Ireland, respectively, that exclusively manufacture medical devices in a
      regulated environment.  During fiscal 2005, the Company ended the
      supply agreement with the contract manufacturing firm in Ireland.  The
      contract manufacturing firm in Taiwan also has manufacturing capabilities in
      China. A portion of Criticare’s production has been transitioned to China to
      continue to receive favorable pricing.  The Company works closely with
      this firm to maintain product quality and reliability.  This firm
      performs the same rigorous quality control testing at its facilities that
      Criticare had done in the past at its own facility.  With the majority
      of the Company’s manufacturing outsourced as of the end of calendar 2001,
      Criticare concentrates on product enhancements and new product development,
      customer service, and increased involvement with its OEM
      customers.  The Company manufactures and assembles all proprietary
      medical devices and "made in the USA" requirements at the Company’s facility in
      Waukesha, Wisconsin.  In addition, the Company continues limited
      production of new products internally during the development phase and for
      a
      short period after commercial introduction until production can be effectively
      transitioned to offshore manufacturers.





Any
      inability of the offshore
      manufacturer to deliver products on a timely basis could have a material adverse
      effect on the Company.  However, the manufacturer has the ability to
      produce the Company’s products in Taiwan and China.  Therefore, the
      Company is not totally reliant on a single plant or single source to supply
      product.  This factor, combined with the Company’s ability to continue
      to manufacture at its headquarters in Waukesha, Wisconsin, reduces the Company’s
      risk of supply interruption.




9





The
      Company has achieved certification
      under the International Organization for Standardization’s (ISO) standard
      13485:2003.  The offshore contract manufacturing firm has achieved
      certification under ISO's standards 13485 and 2000.  See
      "Regulation."





Research,
      Development and Engineering





Criticare
      has focused its research,
      development and engineering expenditures on products designed to meet identified
      market demands.  The Company seeks to apply its expertise in gas
      monitoring, vital signs monitoring, and related sensor technology to develop
      new
      products and adapt existing products for new markets.  At August 31,
      2007, the Company had an in-house research, development and engineering staff
      of 18 people.  The Company's research, development and
      engineering expenditures were $2.4 million in fiscal 2007, $2.4 million in
      fiscal 2006 and $2.6 million in fiscal 2005.





Research
      and development efforts for
      fiscal 2007 focused on the development and release our next generation full
      featured vital signs monitor, our design of a high quality, reasonably featured
      and low cost portable vital signs monitor, and an upgrade to the portable
      multi-parameter vital signs monitor to provide a option with CO2. Research
      and development efforts for fiscal 2006 focused on the development and release
      our next generation portable multi-parameter vital signs monitor
      (nGenuity  8100E), our next generation portable vital signs monitor
      (VitalCareTM 506N3), and an upgrade to the MRI monitor to provide additional
      technological enhancements.  Research and development efforts for
      fiscal 2005 focused on the development and release of the Veris MRI compatible
      vital signs monitor.





Competition





The
      markets for the Company's products
      are highly competitive.  Many of Criticare's competitors, including
      the principal ones described below, have greater financial resources, more
      established brand identities and reputations, longer histories in the medical
      equipment industry and larger direct and more experienced sales forces than
      Criticare.  In these respects, such companies have a competitive
      advantage over Criticare.  In addition, internationally there are many
      in-country manufacturers that supply duty and tariff-free low cost monitors
      that
      make it difficult for the Company to be price competitive in these
      countries.





The
      Company competes primarily on the basis of product features, the quality and
      value of its products (i.e., their relative price compared to performance
      features provided), and the effectiveness of its sales and marketing
      efforts.  The Company believes that its principal competitive
      advantages are provided by its focus on cost containment, provided in part
      by
      its outsourcing a large portion of its manufacturing, its patented and other
      proprietary technology and software for noninvasive, continuous monitoring
      of
      oxygen, anesthetic gases, carbon dioxide and noninvasive blood pressure, the
      efficiency and speed of its research and development efforts, and its
      established international presence.





10


The
      Company believes that the worldwide
      anesthetic agent and carbon dioxide monitor markets are comparatively
      fragmented, with Datex/Ohmeda, a subsidiary of General Electric Company, Andros
      Incorporated, and Dräger Medical as the principal competitors.  The
      market for vital signs monitors includes competitors such as General Electric
      Company,  Dräger Medical, Datascope Corp., Philips Electronics, Welch
      Allyn Inc., Mindray Medical International Limited, CAS Medical Systems, Inc.,
      Nihon Kohden Corporation and Spacelabs Medical, Inc., a subsidiary of OSI
      Systems, Inc.  Internationally, the market for vital signs monitors
      includes the competitors mentioned above, as well as in-country manufacturers
      that supply low cost monitors that are not required to comply with the rigorous
      regulations of the U.S. Food and Drug Administration ("FDA").





Regulation





As
      a manufacturer of medical diagnostic
      equipment, the Company is regulated by the FDA and similar foreign governmental
      agencies.  In producing its products, the Company must comply with a
      variety of regulations, including the good manufacturing practices regulations
      of the FDA.  In addition, it is subject to periodic inspections by the
      FDA.  If the FDA believes that its legal requirements have not been
      fulfilled, it has extensive enforcement powers, including the ability to ban
      or
      recall products from the market and to prohibit the operation of manufacturing
      facilities.  The Company believes its products comply with applicable
      FDA regulations in all material respects.  In addition, the Company
      received ISO 9002 certification on April 29, 1993, ISO 9001 certification
      on July 8, 1994 and ISO 13485:2003 certification on January 16,
      2006.





Under
      the Federal Food, Drug and
      Cosmetic Act, all medical devices are classified as Class I, Class II
      or Class III, depending upon the level of regulatory control to which they
      will be subjected.  Class III devices, which are the most highly
      controlled devices, are subject to premarket approval by the FDA prior to
      commercial distribution in the United States.





The
      Company's current products have not
      been subject to the FDA's comprehensive Class III premarket approval
      requirements, but are generally subject to premarket notification
      requirements.  If a new device is substantially equivalent to a device
      that did not require premarket approval, premarket review is satisfied through
      a
      procedure known as a "510(k) submission," under which the applicant provides
      product information supporting its claim of substantial
      equivalence.  The FDA may also require that it be provided with
      clinical trial results showing the device's safety and efficacy.





The
      Company believes that the products
      it is currently developing generally will be eligible for the 510(k) submission
      procedure and, therefore, will not be subject to lengthy premarket approval
      procedures.  However, these products are still being developed and
      there can be no assurance that the FDA will determine that the products may
      be
      marketed without premarket approval.




11





Criticare
      seeks, where appropriate, to
      comply with the safety standards of Underwriters' Laboratories and the Canadian
      Standards Association and the standards of the European Union.  To
      date, the Company has not experienced significant regulatory expense or delay
      in
      the foreign markets in which it sells its products.  Industry and
      professional groups such as the American Society of Anesthesiologists, to the
      extent they have the power to mandate certain practices or procedures as part
      of
      their profession's standard of care, are also a source of indirect regulation
      of
      the Company's business.





Patents
      and Trademarks





The
      Company believes one of its
      principal competitive advantages is provided by its patented and other
      proprietary technology including its sensor technology, infrared specific
      anesthetic gas monitoring technology, UltraSync signal processing software
      and
      disposable respiratory secretion filter system. The Company has
      20****issued U.S. patents and 1 U.S. patent pending. The
      Company's U.S. patents expire between 2007 and 2022.  Criticare also
      has 14 issued foreign patents and 9 foreign patent applications
      pending.  There is no assurance that any patents held or secured by
      the Company will provide any protection or commercial or competitive benefit
      to
      the Company.  There is also no assurance that the Company's products
      will not infringe upon patents held by others.  The Company is the
      owner of United States trademark registrations for "CRITICARE", "POET", "POET
      IQ", "MPT", "REMOTEVIEW", "MICROVIEW", "VITALVIEW", "SCHOLAR", and
      "WATERCHEK".





The
      Company also relies upon trade
      secret protection for certain of its proprietary technology.  Although
      the Company requires all employees to sign confidentiality agreements, no
      assurance can be given that such agreements can be effectively enforced or
      that
      others will not independently develop substantially equivalent proprietary
      information and techniques or otherwise gain access to or disclose the Company's
      trade secrets.





Employees





At
      August 31, 2007 Criticare, had 95
      employees in the U.S., including 18 in research, development and engineering,
      19
      in customer service and support, 27 in manufacturing and operations, 14 in
      administration, 9 in sales and marketing, and 8 in quality
      control.  Criticare also utilizes four international country managers
      that work as independent contractors to support its international sales
      efforts.  The Company also has an operation in India with 3
      employees.





12


Many
      of the Company's technical
      employees are highly skilled.  The Company believes that its continued
      success depends in part on its ability to continue to attract qualified
      management, marketing and technical personnel.  None of the Company's
      employees are subject to a collective bargaining agreement.  The
      Company believes that its relations with its employees are good.





Backlog





Criticare's
      backlog on June 30, 2007
      and 2006 was $4,789,244 and $5,260,197, respectively.  The
      backlog is driven by the extended delivery schedule from Medrad, which totaled
      $1,170,546 as of June 30, 2007 and $4,100,984 as of June 30,
      2006.  Criticare generally delivers its products out of inventory when
      specified by the customer.  The Company does not believe that its
      backlog at any date is indicative of its future sales.





Item
      1A.  RISK FACTORS





An
      investment in our common stock is subject to risks inherent in our business,
      including the risks described below.  The risks described below are
      not the only risks we face.  Additional risks that we do not yet know
      of or that we currently think are immaterial may also impair our business
      operations.  If any of the events or circumstances described in the
      following risks actually occur, our business, financial condition or results
      of
      operations could be materially adversely affected.  In such cases, the
      trading price of our common stock could decline.





**Risks
      Related to Our Business**





**Our
      net sales and profitability depend on our ability to conceive, design and market
      new products.**





The
      introduction of new products is
      critical to our growth strategy.  Our future success will depend in
      large part upon our ability to conceive, design, and market new products and
      upon market acceptance of our existing and future products. Any significant
      delays in the introduction of, or the failure to introduce, new products or
      additions to our existing product lines or the failure of our existing or future
      products to maintain or receive market acceptance could have a material adverse
      effect on our net sales and profitability.





**Our
      future success will depend on our ability to compete effectively in our
      industry.**





The
      medical equipment industry is
      highly competitive.  Many of our competitors have greater financial
      and other resources, more established brand identities and reputations, greater
      development capabilities, more experience in testing products and obtaining
      regulatory approvals, and larger and more experienced sales forces than us.
      In
      these respects, such companies have a competitive advantage over us. In
      addition, internationally there are many in-country manufacturers that supply
      duty and tariff-free low cost monitors that make it difficult for us to be
      price
      competitive in these countries.  The medical equipment market is also
      experiencing increasing customer concentration, due to the emergence of large
      purchasing groups, which can increase the barriers for a small company such
      as
      Criticare.  If we cannot compete successfully in the future, our net
      sales and profitability will likely decline.





13


**Our
      business may be adversely affected by the highly regulated environment in which
      we operate.**





Our
      products are subject to regulation
      by the United States Food and Drug Administration and comparable foreign
      governmental authorities.  These regulations can be burdensome and
      may:





●
            substantially
                delay or prevent the introduction of new
                products;


●
            materially
                increase the costs of any new product
                introductions;


●
            interfere
                with or require cessation of product manufacturing and marketing;
                and


●
            result
                in product recalls.





Additionally,
      adoption of new
      regulations or modifications to applicable regulations could harm our
      business.  Some of the legislative and regulatory changes may benefit
      us and our competitors; other changes, however, could have a material adverse
      effect on our business, financial condition and results of operation and/or
      provide an advantage to certain of our competitors.





**Since
      we sell product in foreign markets, we are subject to foreign currency and
      other
      international business risks that could adversely affect our operating
      results.**





International
      sales account for a
      significant portion of our total net sales each fiscal year.  We
      expect that international sales will continue to constitute a significant
      portion of our business.  Although our net sales are primarily
      denominated in United States dollars and are not subject to significant currency
      risks, an increase in the value of the United States dollar relative to foreign
      currencies in our international markets could make our products less price
      competitive in such markets.  Our international sales are subject to
      the risks inherent in doing business abroad, including:




●
              complications
                  in complying with the laws and policies of the United States and
                  foreign
                  governments affecting foreign trade, including duties, quotas,
                  taxes and
                  export controls;
 ●
              unexpected
                  changes in international regulatory requirements and
                  tariffs;
 ●
              difficulties
                  in staffing and managing foreign
                  operations;
 ●
              political
                  or economic changes, especially in developing nations;
                  and
 ●
              price
                  controls and other restrictive actions by foreign
                  governments.







14


Any
      of these risks might disrupt sales
      of our products, increase our expenses or decrease our revenues.





**Our
      reliance on offshore contract manufacturing makes our business susceptible
      to
      numerous risks that could affect our profitability.**





In
      response to pricing pressure, in
      fiscal 2001 we entered into agreements for offshore contract
      manufacturing.  We completed the transition of the offshore production
      of substantially all of our established product lines at the end of calendar
      2001.  Currently, our offshore manufacturing is handled by a contract
      manufacturing firm in Taiwan that also has manufacturing capabilities in
      China.  Any inability of the offshore manufacturer to deliver products
      on a timely basis could have a material adverse effect on us.





Our
      reliance on offshore contract
      manufacturing will subject us to numerous risks, including the
      following:





●
            economic
                and political instability in the countries where the contract
                manufacturing firms are located;


●
            restrictive
                actions by foreign governments;


●
            the
                laws and policies of the United States affecting the importation
                of goods
                (including duties, quotas and
                taxes);


●
            production
                delays and cost overruns;


●
            quality
                control; and


●
            foreign
                trade and tax laws.





**We
      depend on a major customer for a significant portion of our
      sales.**





In
      fiscal 2007, our largest customer
      accounted for net sales of approximately $6.3 million, which represented
      20.0% of our total net sales.  We also had a receivable balance with
      this customer of approximately $1.6 million as of June 30, 2007, which
      represented 27.7% of our total receivables as of that date.  An
      adverse change in our relationship with or the financial viability of our
      largest customer could have a material adverse effect on our net sales and
      profitability.





**As
      a manufacturer and marketer of medical equipment, we could experience product
      liability claims.**





The
      nature of our products may expose
      us to significant product liability risks.  Although, we maintain
      product liability insurance, we can make no assurance that we will be able
      to
      maintain this insurance on acceptable terms or that the insurance will provide
      adequate coverage against product liability claims.  A successful
      product liability claim against us in excess of our insurance coverage could
      be
      extremely damaging to us.  Even if a product liability claim is
      without merit, the claim could harm our reputation and divert management's
      attention and resources from our business.






15





**Our
      success depends on our ability to protect our intellectual
      property.**





We
      rely on our patented and other
      proprietary technology including:





●
            our
                sensor technology;


●
            infrared
                specific anesthetic gas monitoring
                technology;


●
            UltraSync
                signal processing software; and


●
            disposable
                respiratory secretion filter
                system.





The
      actions taken by us to protect our
      proprietary rights may not be adequate to prevent imitation of our products,
      processes or technology.  We can not assure you that:





●
            our
                proprietary information will not become known to
                competitors;


●
            others
                will not independently develop substantially equivalent or better
                products
                that do not infringe on our intellectual property rights;
                or


●
            others
                will not challenge or assert rights in, and ownership of, our patents
                and
                other proprietary rights.





**Health
      care cost containment programs could adversely affect our domestic
      sales.**





The
      cost of a significant portion of
      medical care in the United States is funded by government or other insurance
      programs.  Additional limits imposed by such programs on health care
      cost reimbursements may further impair the ability of hospitals and other health
      care providers to purchase equipment such as our products and could reduce
      our
      domestic sales.





**Our
        controls and procedures may be ineffective.**





Our
      management regularly reviews and
      updates our internal control over financial reporting, disclosure controls
      and
      procedures, and corporate governance policies and procedures. We are in the
      process of documenting and testing our internal control procedures in order
      to
      satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which will
      require annual management assessments of the effectiveness of our internal
      control over financial reporting beginning with our annual report for fiscal
      2008 and annual attestation reports by our independent auditors addressing
      the
      effectiveness of our internal control over financial reporting beginning with
      our annual report for fiscal 2009.  We expect our efforts to achieve
      initial compliance with these provisions will require a significant commitment
      of management resources and will result in significant additional expenses
      over
      the next two fiscal years.  We may not be able to achieve and maintain
      effective internal control over financial reporting in accordance with Section
      404 of the Sarbanes-Oxley Act by the required deadlines.  Further, any
      system of controls, no matter how well designed and operated, is based partly
      on
      certain assumptions and can provide only reasonable, not absolute, assurances
      that the objectives of the system are met.  Any failure or
      circumvention of our controls and procedures or failure to comply with
      regulations related to controls and procedures could have a material adverse
      effect on our business, results of operations, and financial
      condition.




16





**Risks
      Related to an Investment in our Common Stock**





**The
      trading price of our common stock has been volatile and investors in our common
      stock may experience substantial losses.**





The
      market price of our common stock has experienced significant volatility from
      time to time.  There may be volatility in the market price of our
      common stock due to factors that may or may not relate to our performance.
      The
      trading price of our common stock could decline or fluctuate in response to
      a
      variety of such factors, including:





●
            the
                timing of announcements by us or our competitors concerning significant
                acquisitions, financial performance or the introduction of new innovative
                products or services;


●
            fluctuation
                in our quarterly operating results;


●
            fluctuations
                in demand for our products;


●
            fluctuations
                in interest rates;


●
            substantial
                sales of our common stock; or


●
            general
                stock market or other economic
                conditions.





You
      may
      be unable to sell your stock at or above your purchase price.





**Various
      restrictions in our certificate of incorporation and by-laws, our rights plan
      and Delaware law could prevent or delay a change in control of us which is
      not
      supported by our Board of Directors.**





Provisions
      of our certificate of
      incorporation and by-laws may make it more difficult for a third party to gain
      control or acquire us without the consent of our board of directors, even if
      such a transaction may be perceived as beneficial to our
      stockholders.  These provisions include a Board of Directors divided
      into three classes of directors serving staggered terms of three years
      each.





Each
      currently outstanding share of our
      common stock includes, and each newly issued share of our common stock will
      include, one preferred share purchase right.  The rights are attached
      to and trade with the shares of common stock and generally are not
      exercisable.  The rights will become exercisable the tenth business
      day after a person or group acquires 20% or more of our common stock or makes
      an
      offer to acquire 30% or more of our common stock.  When exercisable,
      each right entitles the holder to purchase for $25, subject to adjustment,
      1/100th of a
      share of preferred stock for each share of common stock owned.  The
      rights have anti-takeover effects and generally will cause substantial dilution
      to a person or group that attempts to acquire control of us without conditioning
      the offer on either redemption of the rights or amendment of the rights to
      prevent this dilution.  The rights could have the effect of delaying
      or preventing a change of control.  The rights are scheduled to expire
      on March 27, 2017.




17





We
      are also subject to Section 203 of
      the Delaware General Corporation Law which prohibits a merger, consolidation,
      asset sale or other similar business combination between Criticare and any
      stockholder of 15% or more of our common stock for a period of three years
      after
      the stockholder acquires 15% or more of our common stock, unless (1) the
      transaction is approved by our board of directors before the stockholder
      acquires 15% or more of our common stock, (2) upon completing the transaction
      the stockholder owns at least 85% of our common stock outstanding at the
      commencement of the transaction, or (3) the transaction is approved by our
      board
      of directors and the holders of 66 2/3% of our common stock excluding shares
      of
      our common stock owned by the stockholder.





Item
      1B.  UNRESOLVED STAFF
      COMMENTS





Not
      applicable.





Item
      2.     PROPERTIES.





In
      August 2002, the Company leased
      approximately 37,000 square feet of a building in Waukesha, Wisconsin to serve
      as the Company’s headquarters, warehouse, manufacturing, research and
      development and service facility.  The lease originally was to expire
      on August 30, 2007, but the Company exercised its option to extend the lease
      for
      an additional three years so that the lease now expires on August 31,
      2010.  The Company currently leases approximately 32,000 square feet,
      with rent currently totaling $23,545 per month.  The Company has also
      leased approximately 8,800 square feet of a building near the Company's
      headquarters to serve as an additional warehouse facility.  This lease
      expires on August 31, 2010, with rent totaling $4,925 per month for the term
      of
      the lease.





Item
      3.     LEGAL PROCEEDINGS.





In
      the normal course of business
      Criticare may be involved in various legal proceedings from time to
      time.  Criticare does not believe it is currently involved in any
      claim or action the ultimate disposition of which would have a material adverse
      effect on the Company.





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





No
      matters were submitted to a vote of
      security holders during the fourth quarter of the fiscal year ended June 30,
      2007.




18


PART
      II





Item
                5.
            MARKET
                FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY SECURITIES.





The
      Company's common
      stock  trades on the American Stock Exchange under the symbol
“CMD”.  As of June 30, 2007, there were approximately 183 holders
      of record of the common stock.  The Company has never paid dividends
      on its common stock and has no plans to pay cash dividends in the foreseeable
      future.  The following table shows the high and low closing prices of
      the Company's common stock as reported by the American Stock Exchange for the
      periods indicated.





Years
                Ended June 30,2007
            
            
            2006Quarter
                Ended:
            
            High
            
            
            Low
            
            
            High
            
            
            LowSeptember
                30
            
            $
            4.25
            
            
            $
            2.79
            
            
            $
            5.34
            
            
            $
            4.14December
                31
            
            $
            4.25
            
            
            $
            2.94
            
            
            $
            5.15
            
            
            $
            4.62March
                31
            
            $
            3.83
            
            
            $
            3.11
            
            
            $
            5.30
            
            
            $
            4.55June
                30
            
            $
            3.81
            
            
            $
            3.20
            
            
            $
            5.09
            
            
            $
            3.58





Item
                6.
            SELECTED
                FINANCIAL DATA.





The
      following table sets forth selected
      financial data with respect to the Company for each of the periods indicated,
      which should be read along with our consolidated financial statements and the
      notes to those statements and with “Management’s Discussion and Analysis of
      Financial Condition and Results of Operations.”





Years
                Ended June 30,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Net
                sales
            
            $
            31,431,810
            
            
            $
            31,350,919
            
            
            $
            26,781,627
            
            
            $
            28,591,481
            
            
            $
            28,562,943Net
                income
                (loss)
            
            
            348,027
            
            
            
            212,118
            
            
            
            (422,245
            )
            
            
            (2,100,573
            )
            
            
            (938,596
            )Net
                income (loss) per common share--basic
                and
                diluted
            
            $
            0.03
            
            
            $
            0.02
            
            
            $
            (0.04
            )
            
            $
            (0.19
            )
            
            $
            (0.08
            )Average
                shares outstanding--basic
            
            
            12,299,411
            
            
            
            12,069,060
            
            
            
            11,514,786
            
            
            
            11,240,685
            
            
            
            11,071,735diluted
            
            
            12,332,296
            
            
            
            12,256,431
            
            
            
            11,514,786
            
            
            
            11,240,685
            
            
            
            11,071,735Stockholders'
                equity
            
            $
            16,310,754
            
            
            $
            15,853,086
            
            
            $
            14,209,140
            
            
            $
            13,789,300
            
            
            $
            15,034,208Long-term
                obligations
            
            
            59,678
            
            
            
            134,485
            
            
            
            210,592
            
            
            
            286,417
            
            
            
            38,662Working
                capital
            
            
            14,049,063
            
            
            
            13,322,276
            
            
            
            12,339,332
            
            
            
            11,756,441
            
            
            
            12,895,476Total
                assets
            
            
            21,648,523
            
            
            
            22,979,078
            
            
            
            19,060,473
            
            
            
            19,542,341
            
            
            
            18,762,327





19





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




The
      following discussion is intended to provide an analysis of our financial
      condition and results of operations and should be read in conjunction with
      our
      financial statements and the notes to our financial statements included in
      Item
      8 of this report.  The discussion also includes forward-looking
      statements.  As indicated on the cover page of this report under
      "Special Note Regarding Forward-Looking Statements," undue reliance should
      not
      be placed on forward-looking statements.





**Overview**





Criticare
      designs, manufactures and markets vital signs and gas monitoring instruments
      and
      related noninvasive sensors used to monitor patients in many healthcare
      environments.  The Company sells its products both in the U.S. and in
      international markets to customers such as hospitals, surgery centers, dental
      and physicians offices, and nursing homes.  Criticare is implementing
      several business initiatives as part of its strategy to develop and distribute
      products for highly technical, growth oriented niche
      markets.  Management believes that in order to be successful,
      marketing and sales partnerships in these areas are required.  That
      effort resulted in the execution of a number of OEM agreements.





Criticare
      is implementing several new business initiatives as part of its strategy to
      develop and distribute products for highly technical growth oriented niche
      markets.  To capitalize on these business initiatives, modules and
      stand-alone monitors were developed and marketed for specific OEM customers.
      The
      Company views OEM agreements as a critical component to our strategy to develop
      products for highly technical niche markets, and the OEM business has been
      a
      significant driver of the Company’s growth with net sales of $7,335,059 or
      23.3% of total net sales in fiscal 2007, $6,814,623 or 21.7% of total net sales
      in fiscal 2006 and $6,132,122 or 22.9% of total net sales in fiscal
      2005.





20


The
      first
      of these initiatives involves monitoring products for anesthesia
      gases.  In fiscal 2003, the Company introduced an anesthesia
      monitoring product line for sale both under the Criticare brand name and for
      sale to OEMs.  Production shipments to our newest OEM partner, Fukuda
      Denshi, Inc. of Japan, began in August 2007.  A second initiative is
      the development of a highly specialized monitoring system for medical imaging
      applications in an MRI environment.  In 2003, Criticare entered into
      an agreement with Medrad to jointly develop and exclusively sell a highly
      specialized medical monitoring product to Medrad.  In July 2004,
      Criticare shipped the initial prototypes of this monitoring product to Medrad
      and production shipments began in January 2005. Medrad was the Company's
      largest customer in fiscal 2007,  2006 and 2005, accounting
      for 20.0%, 16.5% and 11.6%, respectively, of the Company's net sales in
      those fiscal years.  Following the acquisition, in July 2004, of
      Alaris Medical Systems, Inc., a long-time OEM customer, by Cardinal Health,
      Inc., the third initiative was implemented to develop an Acute Care distribution
      network in the U.S. to sell to markets and group purchasing organizations
      (GPO’s) previously served through Alaris.  Following such acquisition,
      Cardinal Health exited the vital signs monitor business and signed a transition
      agreement with the Company, which enabled our new Acute Care distribution
      network the opportunity to sell to the former Alaris customer
      base.  In conjunction with the transition agreement, in September
      2005, we introduced a new portable vital signs monitor for the Acute Care
      market.  Sales for the Acute Care market totaled approximately $3.16
      million during fiscal 2007 and $3.49 million during the introduction year of
      fiscal 2006. This key initiative will remain ongoing as the Company works
      to obtain and maintain tier I and tier II GPO contracts which will allow the
      net
      sales for the Acute Care network to exceed the largest revenue year Criticare
      experienced under the Alaris OEM agreement.





The
      Company posted total net sales of $7,640,927 for the fourth quarter of fiscal
      2007, which were 7.7% higher than the $7,095,962 in net sales for the same
      period of fiscal 2006, principally due to the strong OEM and international
      sales
      in fiscal 2007.  The Company reported a net loss of $(365,709) for the
      fourth quarter of fiscal 2007 as compared to a net loss of $(524,220) for the
      fourth quarter for fiscal 2006. For the full year, the Company had total
      net sales of  $31,431,810 in fiscal 2007 compared to net sales of
      $31,350,919 in fiscal 2006. Additionally, for the second consecutive year
      the Company posted net income, with net income of $348,027 in fiscal 2007
      compared to net income of $212,118 in fiscal 2006.





21


**Results
      of Operations**





The
      following table sets forth, for the
      periods indicated, certain items from the Company's Consolidated Statements
      of
      Operations expressed as percentages of net sales.


****


**Percentage
                of Net Sales**
              **Years
                Ended June 30,****2007**
            
            
            **2006**
            
            
            **2005**Net
                sales
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %Cost
                of goods
                sold
            
            
            62.5
            
            
            
            61.6
            
            
            
            60.9Gross
                profit
            
            
            37.5
            
            
            
            38.4
            
            
            
            39.1Operating
                expenses:Sales
                and
                marketing
            
            
            19.1
            
            
            
            22.2
            
            
            
            21.2Research,
                development and
                engineering
            
            
            7.6
            
            
            
            7.5
            
            
            
            9.8Administrative
            
            
            10.9
            
            
            
            10.1
            
            
            
            10.8Total
            
            
            37.6
            
            
            
            39.8
            
            
            
            41.8Loss
                from
                operations
            
            
            (0.1
            )
            
            
            (1.4
            )
            
            
            (2.7
            )Interest
                expense
            
            
            0.0
            
            
            
            (0.1
            )
            
            
            (0.1
            )Interest
                income
            
            
            0.4
            
            
            
            0.3
            
            
            
            0.2Foreign
                currency exchange gain
                (loss)
            
            
            0.5
            
            
            
            (0.3
            )
            
            
            0.5Other
                income
            
            
            0.3
            
            
            
            2.2
            
            
            
            0.5Income
                (loss) before income
                taxes
            
            
            1.1
            
            
            
            0.7
            
            
            
            (1.6
            )Income
                tax
                provision
            
            
            --
            
            
            
            --
            
            
            
            --Net
                income
                (loss)
            
            
            1.1
            %
            
            
            0.7
            %
            
            
            (1.6
            )%





**Fiscal
      Year Ended June 30, 2007 Compared to June 30, 2006**





Net
      sales increased $80,891 to
      $31,431,810 for fiscal 2007 compared to $31,350,919 for fiscal 2006. The
      increase resulted from a 5.3% increase in the average sales price per unit,
      which was partially offset by a 3.9% decrease in accessory sales and a 1.0%
      decrease in the number of units shipped in the current year. The increased
      sales were driven by a $1,093,031 increase in domestic alternate care sales
      and
      a $520,436 increase in OEM sales, which were partially offset by a $1,027,626
      decrease in international sales and a $335,453 decrease in acute care sales
      during fiscal 2007.  OEM sales in fiscal 2007 were $7,335,000 and
      represented 23.3% of total net sales, compared to $6,815,000 (21.7% of total
      net
      sales) in fiscal 2006.  The OEM sales of $6,290,137 to Medrad in
      fiscal 2007, for medical imaging applications, increased $1,110,258 from fiscal
      2006.  The increased domestic alternate care sales was due to a number
      of factors, including Criticare’s release of our next generation portable
      multi-parameter vital signs monitor and the initial order to replace all vital
      signs monitors in over 50 domestic plasma collection
      centers.  International sales were lower than expected, due in large
      part to a $1,874,000 partial shipment of an order from the ministry of health
      of
      the Republic of Iraq which shipped in the fourth quarter of fiscal 2007, but
      which did not meet all the strict criteria for revenue recognition in accordance
      with SAB No. 104.  Due to the size and risks associated with a
      contract of this nature, the Company obtained a confirmed letter of credit
      to
      secure payment.  As a result, while the order met the revenue
      recognition criteria of ensuring collectibility, the terms of the letter of
      credit did not allow the transfer of title to occur until after June 30,
      2007.The
      majority of this sale will be included in the first quarter results for fiscal
      2008.





22


The
      gross profit percentage of 37.5%
      realized in fiscal 2007 decreased from the 38.4% generated in the prior
      year.  Margins decreased in the current year as the positive effect of
      a slight change in product mix was offset the continued upward shift in fixed
      overhead costs to meet the increased quality and production demands of our
      OEM
      customers and the increased overhead costs associated with manufacturing
      start-up costs related to our new portable multi-parameter vital signs
      monitor.





Charges
      to cost of goods sold for
      potentially obsolete inventory totaled $ 167,144 in fiscal 2007 compared to
      $56,622 in fiscal 2006.   Inventory considered obsolete will be
      disposed of and removed from Criticare’s warehouse during fiscal
      2008.





Operating
      expenses for the year ended
      June 30, 2007 decreased $672,357 from fiscal 2006 due mainly to a decrease
      of
      $941,355 in sales and marketing expenses, which was partially offset by an
      increase of $257,165 in administrative expenses.  The increase of
      $257,165 in administrative expenses was due to the $451,564 of expenses incurred
      during the year in connection with the two consent solicitation actions
      initiated by BlueLine Partners and the subsequent settlement of those actions
      in
      the third quarter.  The decrease of $941,355 in sales and marketing
      expenses was due mainly to a $528,709 decrease in bad debt expenses from the
      reserve established in fiscal 2006 of a portion of the receivable due from
      one
      of our distributors with no corresponding reserve in fiscal 2007, a
      $135,676 decrease in India operation expenses, a $112,695 decrease in
      commissions earned and a $83,178 decrease in advertising and trade show expenses
      for the year ended June 30, 2007.  In fiscal 2006, the Company
      reserved a portion of the receivable due from the distributor referred to in
      the
      previous sentence, in the amount of $529,700.  Due to a reduction in
      the receivable from the distributor, the reserve has been reduced to $227,638
      as
      of June 30, 2007.





Total
      other income for the fiscal year
      ended June 30, 2007 decreased $273,525 from fiscal 2006.  This
      decrease was mainly due to the $300,000 received pursuant to a patent license
      agreement in fiscal 2006 with no corresponding income in fiscal 2007, and a
      decrease of $295,400 in royalty income partially offset by an increase of
      $41,395 in interest income and a foreign currency exchange gain of $171,361
      in
      fiscal 2007 related to the Company’s operation in India, which had a foreign
      currency exchange loss of $(108,225) in fiscal 2006.





Loss
      from
      operations of $(38,055) for the year ended June 30, 2007 decreased $409,434
      as
      compared to a loss from operations of $(447,489) for the same period in fiscal
      2006, which was the result of a decrease of $672,357 in operating expenses
      and a
      decrease in gross profit of $262,923.  The decreased loss from
      operations was partially offset by the decrease in other income of $273,525,
      resulting in net income of $348,027 for the year ended June 30, 2007 as compared
      to net income of $212,118 for fiscal 2006.





23


**Fiscal
      Year Ended June 30, 2006 Compared to June 30, 2005**





Net
      sales increased $4,569,292 to
      $31,350,919 for fiscal 2006 compared to $26,781,627 for fiscal
      2005.  The increase resulted from a 3.5% increase in the number of
      units shipped, a 11.7% increase in the average sales price per unit and a 6.5%
      increase in accessory sales in the current year.  The increased sales
      were in part the result of $3,492,754 in acute care sales, which are a
      successful result of Criticare’s business initiative to develop an acute care
      distribution network in the U.S. to sell to markets previously served through
      Alaris.  Additionally, the increased sales were driven by a $827,941
      increase in international sales and a $682,501 increase in OEM sales, which
      were
      partially offset by a $1,025,778 decrease in domestic alternate care sales
      during fiscal 2006.   The international sales increased despite a
      $357,972 reduction of sales in India during fiscal 2006.  The OEM
      sales of $5,179,879 to Medrad, for medical imaging applications, was partially
      offset by reduced sales of $2,034,468 to Alaris, formerly our largest OEM
      customer, during fiscal 2006.  The decrease in domestic alternate care
      sales was due to a number of factors, including Criticare’s movement to exit the
      defibrillator market due to the continued trend of direct sales by defibrillator
      manufacturers rather than through an establish distribution network, the
      postponed sales of patient monitors awaiting the release of our next generation
      portable multi-parameter vital signs monitor and the overall maturation of
      the
      oral surgery market.  OEM sales in fiscal 2006 were $6,815,000 and
      represented 21.7% of total net sales, compared to $6,132,000 (22.9% of total
      net
      sales) in fiscal 2005.





The
      gross profit percentage of 38.4%
      realized in fiscal 2006 decreased from the 39.1% generated in the prior
      year.  The margins decreased in the current period as the positive
      effect of a slight change in product mix was offset by the adverse effect of
      increased overhead costs associated with the manufacturing start-up costs
      related to our new portable vital signs monitor and the portable multi-parameter
      vital signs monitor, the replacement of a key supplier and with an upward shift
      in the fixed overhead costs to meet the increased quality and production demands
      of our OEM customers.





Charges
      to cost of goods sold for potentially obsolete inventory totaled $56,622 in
      fiscal 2006 compared to $281,003 for fiscal 2005.  Inventory
      considered obsolete will be disposed of and removed from Criticare’s warehouse
      during fiscal 2007.





24


Operating
      expenses for the year ended
      June 30, 2006 increased $1,293,377 from fiscal 2005 as an increase of $1,279,806
      in sales and marketing and $271,193 in  administrative expenses was
      partially offset by a $257,622 reduction in research, development and
      engineering expenses.  The increase of $1,279,806 in sales and
      marketing expenses was due mainly to a $354,918 increase in the commissions
      earned due to increased sales and a $148,113 increase in India operation
      expenses, combined with a $98,277 increase in advertising, trade shows and
      sales
      promotion and a $19,154 increase in license fees spending for the year ended
      June 30, 2006.  In addition, due to the political climate currently in
      Mexico and the age of the receivable, we have reserved a portion of
      a receivable from one of our distributors in the amount of $529,700,
      which has significantly increased our  sales and marketing
      expenses.  Administrative expenses increased by $271,193 mainly due to
      an increase of $316,096 in compensation expenses of which $172,988 was
      recognized in conjunction with stock options under SFAS 123(R), an increase
      of
      $38,406 in license fees and an increase of $37,500 in board of director fees,
      which was partially offset by a $99,211 reduction in legal fees and a $26,506
      reduction in recruiting fees.  The increase in operating expenses was
      partially offset by a decrease of $257,622 in research, development and
      engineering expenses.  In the first quarter of fiscal 2005, Criticare
      received funding of $125,000 from our largest OEM customer to jointly develop
      a
      highly specialized monitoring system for medical imaging applications, which
      reduced the research, development and engineering expenses for the year ended
      June 30, 2005 as compared to the year ended June 30, 2006.





Total
      other income for the fiscal year
      ended June 30, 2006 increased $355,657 from fiscal 2005.  This
      increase was mainly due to the $300,000 received pursuant to a patent license
      agreement, an increase of $136,297 in royalty income and an increase of $36,120
      in interest income, partially offset by a foreign currency exchange loss of
      $(108,225) related to the Company’s operation in India, which had a foreign
      currency exchange gain of $131,885 in fiscal 2005.





The
      $1,572,083 and $355,657 increase in gross profit and total other income,
      respectively, partially offset by the increased operating expenses of
      $1,293,377, resulted in net income of $212,118 for the year ended June 30,
      2006
      as compared to a net loss of $(422,245) for fiscal 2005.





25


**Critical
      Accounting Policies**





The
      Company’s discussion and analysis
      of its financial condition and results of operations are based upon the
      Company’s consolidated financial statements, which have been prepared in
      accordance with accounting principles generally accepted in the United
      States.  The preparation of these financial statements requires the
      Company to make estimates and judgments that affect the reported amounts of
      assets, liabilities, revenues and expenses, and related disclosure of contingent
      assets and liabilities.  On an on-going basis, the Company evaluates
      its estimates, including those related to bad debts, sales returns, inventories,
      and warranty obligations.  The Company bases its estimates on
      historical experience and on various other assumptions that are believed to
      be
      reasonable under the circumstances, the results of which form the basis for
      making judgments about the carrying values of assets and liabilities that are
      not readily apparent from other sources.  Actual results may differ
      from these estimates.  The Company believes the following accounting
      policies require its more significant judgments and estimates used in the
      preparation of its financial statements.





**Revenue
      Recognition**





Revenues
      and the costs of products sold are recognized as the related products are
      shipped or installed, if there are significant installation
      costs.  Revenue is recognized in accordance with SAB No. 104, when all
      four elements for revenue recognition have been met.  This revenue
      recognition policy is utilized for shipment of product to customers including
      both distributors and end-users.





**Estimating
      Allowances for Doubtful Accounts and Sales Returns**





The
      Company maintains allowances for
      doubtful accounts for estimated losses resulting from the inability of its
      customers to make required payments.  Management analyzes specific
      accounts receivable as well as historical bad debts, customer concentrations,
      customer credit-worthiness, current economic trends, foreign currency movements,
      and changes in its customer payment terms when evaluating the allowance for
      doubtful accounts.  If the financial condition of any of the Company’s
      customers were to deteriorate, resulting in impairment of their ability to
      make
      payments, additional allowances may be required.





The
      Company also maintains a sales returns reserve in order to estimate potential
      future product returns related to current period revenue.  Management
      analyzes historical returns, current economic trends, changes in customer
      demand, and acceptances of the Company’s products when evaluating the adequacy
      of the sales returns reserve.  Significant management judgments and
      estimates must be made and used in connection with establishing the sales
      returns reserve in any accounting period.  Material differences may
      result in the timing of the Company’s revenue if management made different
      judgments or utilized different estimates.





26


**Valuation
      of
      Inventories**





Inventories
      are stated at the lower of
      cost or market, with cost determined on the first-in, first-out
      method.  The Company maintains a reserve for obsolete inventory that
      it utilizes to write down inventories for estimated obsolescence or unmarketable
      inventory equal to the difference between the carrying value of the inventory
      and the estimated market value.  The Company determines the adequacy
      of the obsolescence reserve by considering historical annual usage of component
      parts and finished goods as well as assumptions about market conditions and
      forecasted demand.  When items are physically disposed of the amounts
      are written off against the reserve.  If future product demand is
      lower than expected or if market conditions are less favorable than those
      projected by the Company, additional charges to increase the obsolescence
      reserve may be required.





During
      fiscal 2007, the reserve for
      obsolete inventory was increased $15,000 to $375,000 at June 30, 2007 due
      to normal variations in the inventory mix. During fiscal 2006, the reserve
      for obsolete inventory was decreased $78,300 to $360,000 at June 30, 2006 due
      mainly to the disposal of obsolete inventory that had been reserved for in
      prior
      years.





**Product
      Warranty**





The
      Company provides for the estimated
      cost of product warranties at the time products are shipped based upon its
      historical experience providing warranty coverage. The Company’s warranty
      obligations are affected by product failure rates, material usage and service
      delivery costs incurred in correcting a product failure.  If actual
      product failure rates, material usage or service delivery costs differ from
      current projections, revisions to the estimated warranty reserve would be
      required.





**Liquidity
      and Capital Resources**





As
      of June 30, 2007, the Company had a
      cash balance of $4,635,823 as compared with its fiscal 2006 year-end cash
      balance of $3,793,781.  The Company has continued to maintain a bank
      debt free balance sheet.





With
      the
      Company’s return to profitability, Criticare has been able to increase its cash
      position by an aggregate of $896,998 over the last three fiscal
      years.  Non-cash expenses consisting primarily of depreciation
      expense, share based compensation expense as a result of SFAS 123(R), provision
      for obsolete inventory and provision for doubtful accounts decreased the
      Company’s profitability by an aggregate of $3,379,846 over the last three fiscal
      years, but did not impact the Company’s cash flows.  Over the last
      three fiscal years, the Company has been able to fund $1,192,915 of capital
      spending primarily with $2,147,192 of cash provided by the exercise of stock
      options over that period.






27




In
      fiscal
      2007, $1,255,824 of cash was generated from operations.  This increase
      in cash was primarily driven by a combination of the reduction of the inventory,
      which was increased in fiscal 2006 due to the release of the next generation
      portable multi-parameter vital signs monitor, and the profitability of the
      Company.  The cash generated from operations was partially offset by
      capital spending of $407,473 and $11,493 of cash used in financing
      activities.  In fiscal 2007, $62,655 of cash was generated from the
      issuance of 11,500 shares of common stock upon the exercise of stock
      options.  In fiscal 2006, $1,213,677 of cash was generated from the
      issuance of 473,045 shares of common stock upon the exercise of stock options,
      most of which were scheduled to expire in less than one year.  This
      cash partially offset the $408,544 of cash used in operations and the $669,275
      of capital spending in fiscal 2006.  Cash used in operations in fiscal
      2006 was primarily driven by the inventory investment in the new, next
      generation portable multi-parameter vital signs monitor. In fiscal 2005,
      $688,724 of cash was generated from the issuance of 280,337 shares of common
      stock upon the exercise of stock options and an additional $131,250 of cash
      was
      generated from the issuance of 70,000 shares of common stock upon the exercise
      of stock warrants, most of which were scheduled to expire in less than one
      year.  This cash partially offset the $726,064 of cash used in
      operations and the $116,167 of capital spending in fiscal 2005.





The
      Company believes all near term future capital and liquidity requirements will
      be
      satisfied by cash generated from operations, proceeds received from the issuance
      of common stock related to the exercise of stock options, and its current cash
      balances.  No major capital equipment expenditures are expected in the
      Company’s next fiscal year ending June 30, 2008.  The Company also has
      a $2,000,000 line of credit currently in place that could be utilized, if
      necessary.  At June 30, 2007, there were no borrowings outstanding
      under this line of credit.  The credit facility has covenants which
      require minimum income or liquidity levels.  The Company was in
      compliance with the covenants at June 30, 2007.  This line expires in
      June 2008.




The
      following table summarizes the Company’s contractual cash obligations at June
      30, 2007 in the categories set forth below, and the effect such obligations
      are
      expected to have on its liquidity and cash flow in future fiscal
      periods:





Total
            
            
            2008
            
            
            2009
            
            
            2010
            
            
            2011
            
            
            2012
                and ThereafterOperating
                leases
            
            $
            1,187,990
            
            
            $
            378,597
            
            
            $
            383,459
            
            
            $
            365,270
            
            
            $
            60,664
            
            
            
            --Capital
                leases
            
            
            145,200
            
            
            
            82,560
            
            
            
            52,140
            
            
            
            10,500
            
            
            
            --
            
            
            
            --Contract
                Mfg obligations
            
            
            350,000
            
            
            
            350,000
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Other
                long-term obligations
            
            
            5,476
            
            
            
            5,476
            
            
            
            --
            
            
            
            --
            
            
            
            --
            
            
            
            --Total
                contractual obligations
            
            $
            1,688,666
            
            
            $
            816,633
            
            
            $
            435,599
            
            
            $
            375,770
            
            
            $
            60,664
            
            
            
            --





28





Item
                7A.
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK.





The
      Company has a demand line of credit
      facility with a commercial bank with interest payable monthly at 25 basis points
      below the bank's reference rate.  The Company had no borrowings
      outstanding under this bank facility at June 30, 2007, 2006 and
      2005.  Due historically to the lack of need to borrow from this credit
      facility and due to the Company’s current cash position, the Company is not
      subject to financial risk on this obligation if interest rates in the market
      change significantly.





The
      Company’s net sales are primarily
      denominated in United States dollars, except for a small amount of net sales
      from the Company’s operations in India which are denominated in Indian
      rupees.  As a result, part of the Company’s accounts receivable are
      denominated in rupees and translated into U.S. dollars for financial reporting
      purposes.  A 10% change in the exchange rate of the U.S. dollar with
      respect to the Indian rupee would not have a material adverse effect on the
      Company’s financial condition or results of operations for the fiscal year
      ended June 30, 2007.  The Company does not use any hedges or other
      derivative financial instruments to manage or reduce exchange rate
      risk.




29





Item
                8.
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY
                DATA.





FINANCIAL
      STATEMENTS





**CRITICARE
      SYSTEMS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


**JUNE
      30, 2007 AND 2006**





ASSETS
                (Note 6)
            
            2007
            
            
            2006CURRENT
                ASSETS:Cash
                and cash equivalents (Notes 1 and 10)
            
            $
            4,635,823
            
            
            $
            3,793,781Accounts
                receivable, less allowance for doubtful accountsof
                $497,638 and $829,700, respectively (Note 1)
            
            
            5,991,999
            
            
            
            6,446,637Other
                receivables (Note 1)
            
            
            251,950
            
            
            
            331,722Short-term
                note receivable (Note 1)
            
            
            50,000
            
            
            
            50,000Inventories
                (Notes 1 and 2)
            
            
            8,177,523
            
            
            
            9,464,037Prepaid
                expenses
            
            
            219,859
            
            
            
            227,606Total
                current assets
            
            
            19,327,154
            
            
            
            20,313,783PROPERTY,
                PLANT AND EQUIPMENT (Note 1):Machinery
                and equipment
            
            
            3,415,501
            
            
            
            3,157,328Furniture
                and fixtures
            
            
            946,668
            
            
            
            952,193Leasehold
                improvements
            
            
            290,084
            
            
            
            243,604Demonstration
                and loaner monitors
            
            
            2,025,924
            
            
            
            1,997,844Production
                tooling
            
            
            2,389,507
            
            
            
            2,294,360Property,
                plant and equipment – cost
            
            
            9,067,684
            
            
            
            8,645,329Less
                accumulated depreciation
            
            
            6,877,295
            
            
            
            6,193,015Property,
                plant and equipment – net
            
            
            2,190,389
            
            
            
            2,452,314OTHER
                ASSETS:License
                rights and patents – net (Notes 1 and 3)
            
            
            55,980
            
            
            
            62,981Long-term
                note receivable (Note 1)
            
            
            75,000
            
            
            
            150,000Total
                other assets
            
            
            130,980
            
            
            
            212,981TOTAL
                ASSETS
            
            $
            21,648,523
            
            
            $
            22,979,078





See
      notes
      to consolidated financial statements.





30




LIABILITIES
                AND STOCKHOLDERS' EQUITY
            
            2007
            
            
            2006CURRENT
                LIABILITIES:Accounts
                payable
            
            $
            3,826,834
            
            
            $
            5,408,746Accrued
                liabilities:Compensation
                and commissions
            
            
            836,720
            
            
            
            914,889Product
                warranties (Notes 1 and 4)
            
            
            349,000
            
            
            
            425,000Other
            
            
            191,389
            
            
            
            174,667Obligations
                under capital lease (Note 12)
            
            
            74,148
            
            
            
            68,205Total
                current liabilities
            
            
            5,278,091
            
            
            
            6,991,507LONG-TERM
                LIABILITIES:Obligations
                under capital lease, less current portion (Note 12)
            
            
            59,678
            
            
            
            133,826Other
                long-term obligations
            
            
            --
            
            
            
            659Total
                long-term liabilities
            
            
            59,678
            
            
            
            134,485COMMITMENTS
                AND CONTINGENCIES (Notes 7, 9 and 12)TOTAL
                LIABILITIES
            
            
            5,337,769
            
            
            
            7,125,992STOCKHOLDERS'
                EQUITY (Notes 1 and 8):Preferred
                stock - $.04 par value, 500,000 shares authorized,no
                shares issued or outstanding
            
            
            --
            
            
            
            --Common
                stock - $.04 par value, 15,000,000 shares authorized, 12,409,631
                and12,398,131
                shares issued, and 12,313,321 and 12,291,454 outstanding,
                respectively
            
            
            496,385
            
            
            
            495,925Additional
                paid-in capital
            
            
            26,338,267
            
            
            
            26,156,864Common
                stock held in treasury (96,310 and 106,677 shares,
                respectively)
            
            
            (356,502
            )
            
            
            (375,813
            )Retained
                earnings (accumulated deficit)
            
            
            (10,088,767
            )
            
            
            (10,436,794
            )Cumulative
                translation adjustment
            
            
            (78,629
            )
            
            
            12,904Total
                stockholders' equity
            
            
            16,310,754
            
            
            
            15,853,086TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            21,648,523
            
            
            $
            22,979,078




See
      notes
      to consolidated financial statements.




31


**CRITICARE
      SYSTEMS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**YEARS
      ENDED JUNE 30, 2007, 2006 AND 2005**





**2007**
            
            
            **2006**
            
            
            **2005****NET
                SALES (**Notes 1, 10 and 11**)**
            
            $
            31,431,810
            
            
            $
            31,350,919
            
            
            $
            26,781,627**COST
                OF GOODS SOLD**
            
            
            19,652,167
            
            
            
            19,308,353
            
            
            
            16,311,144**GROSS
                PROFIT**
            
            
            11,779,643
            
            
            
            12,042,566
            
            
            
            10,470,483**OPERATING
                EXPENSES:**Sales
                and marketing (Note 1)
            
            
            6,008,956
            
            
            
            6,950,311
            
            
            
            5,670,505Research,
                development and engineering (Note 1)
            
            
            2,374,345
            
            
            
            2,362,512
            
            
            
            2,620,134Administrative
                (Note 9)
            
            
            3,434,397
            
            
            
            3,177,232
            
            
            
            2,906,039Total
            
            
            11,817,698
            
            
            
            12,490,055
            
            
            
            11,196,678**LOSS
                FROM OPERATIONS**
            
            
            (38,055
            )
            
            
            (447,489
            )
            
            
            (726,195
            )**OTHER
                (EXPENSE) INCOME:**Interest
                expense (Note 12)
            
            
            (14,354
            )
            
            
            (19,820
            )
            
            
            (28,848
            )Interest
                income
            
            
            136,225
            
            
            
            94,830
            
            
            
            58,710Foreign
                currency exchange gain (loss) (Note 1)
            
            
            171,361
            
            
            
            (108,225
            )
            
            
            131,885Other
                income (Note 14)
            
            
            92,850
            
            
            
            692,822
            
            
            
            142,203Total
            
            
            386,082
            
            
            
            659,607
            
            
            
            303,950**INCOME
                (LOSS) BEFORE INCOME TAXES**
            
            
            348,027
            
            
            
            212,118
            
            
            
            (422,245
            )**INCOME
                TAX PROVISION (**Notes 1 and 5**)**
            
            
            --
            
            
            
            --
            
            
            
            --**NET
                INCOME (LOSS)**
            
            $
            348,027
            
            
            $
            212,118
            
            
            $
            (422,245
            )**NET
                INCOME (LOSS) PER COMMON SHARE (**Note
                1**):**Basic
                and diluted
            
            $
            0.03
            
            
            $
            0.02
            
            
            $
            (0.04
            )**WEIGHTED
                AVERAGE NUMBER OF COMMON****SHARES
                OUTSTANDING (**Note 1**):**Basic
            
            
            12,299,411
            
            
            
            12,069,060
            
            
            
            11,514,786Diluted
            
            
            12,332,296
            
            
            
            12,256,431
            
            
            
            11,514,786





See
      notes
      to consolidated financial statements.





32


**CRITICARE
      SYSTEMS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS' EQUITY**


**YEARS
      ENDED JUNE 30, 2007, 2006 AND 2005**





RetainedAdditional
            
            
            Common
                Stock
            
            
            Earnings
            
            
            Cumulative
            
            
            TotalCommon
                Stock
            
            
            Paid-In
            
            
            Treasury
            
            
            (Accumulated
            
            
            Translation
            
            
            Stockholders’Shares
            
            
            Amount
            
            
            Capital
            
            
            Shares
            
            
            Cost
            
            
            Deficit)
            
            
            Adjustment
            
            
            Equity**Balance,
                June 30, 2004**
            
            
            11,574,749
            
            
            $
            462,990
            
            
            $
            23,965,900
            
            
            
            124,728
            
            
            $
            (409,439
            )
            
            $
            (10,226,667
            )
            
            $
            (3,482
            )
            
            $
            13,789,302Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (422,245
            )
            
            
            
            
            
            
            (422,245
            )Cumulative
                translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (4,630
            )
            
            
            (4,630
            )Comprehensive
                income/(loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (426,875
            )Exercise
                of options
            
            
            280,337
            
            
            
            11,213
            
            
            
            677,511
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            688,724Exercise
                of warrants
            
            
            70,000
            
            
            
            2,800
            
            
            
            128,450
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            131,250Employee
                common stockpurchased
                from treasury
            
            
            
            
            
            
            
            
            
            
            4,134
            
            
            
            (12,135
            )
            
            
            22,605
            
            
            
            
            
            
            
            
            
            
            
            26,739**Balance,
                June 30, 2005**
            
            
            11,925,086
            
            
            $
            477,003
            
            
            $
            24,775,995
            
            
            
            112,593
            
            
            $
            (386,834
            )
            
            $
            (10,648,912
            )
            
            $
            (8,112
            )
            
            $
            14,209,140Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            212,118
            
            
            
            
            
            
            
            212,118Cumulative
                translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            21,016
            
            
            
            21,016Comprehensive
                income/(loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            233,134Exercise
                of options
            
            
            473,045
            
            
            
            18,922
            
            
            
            1,194,755
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,213,677Stock-based
                employee
              compensation
            
            
            
            
            
            
            
            
            
            
            172,988
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            172,988Employee
                common stockpurchased
                from treasury
            
            
            
            
            
            
            
            
            
            
            13,126
            
            
            
            (5,916
            )
            
            
            11,021
            
            
            
            
            
            
            
            
            
            
            
            24,147**Balance,
                June 30, 2006**
            
            
            12,398,131
            
            
            $
            495,925
            
            
            $
            26,156,864
            
            
            
            106,677
            
            
            $
            (375,813
            )
            
            $
            (10,436,794
            )
            
            $
            12,904
            
            
            $
            15,853,086Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            348,027
            
            
            
            
            
            
            
            348,027Cumulative
                translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (91,533
            )
            
            
            (91,533
            )Comprehensive
                income/(loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            256,494Exercise
                of options
            
            
            11,500
            
            
            
            460
            
            
            
            32,873
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            33,333Stock-based
                employee
              compensation
            
            
            
            
            
            
            
            
            
            
            138,519
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            138,519Employee
                common stock
              purchased from treasury
            
            
            
            
            
            
            
            
            
            
            10,011
            
            
            
            (10,367
            )
            
            
            19,311
            
            
            
            
            
            
            
            
            
            
            
            29,322**Balance,
                June 30, 2007**
            
            
            12,409,631
            
            
            $
            496,385
            
            
            $
            26,338,267
            
            
            
            96,310
            
            
            $
            (356,502
            )
            
            $
            (10,088,767
            )
            
            $
            (78,629
            )
            
            $
            16,310,754





See
      notes
      to consolidated financial statements.





33


**CRITICARE
      SYSTEMS, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**YEARS
      ENDED JUNE 30, 2007, 2006 AND 2005**





**2007**
            
            
            **2006**
            
            
            **2005****OPERATING
                ACTIVITIES:**Net
                income (loss)
            
            $
            348,027
            
            
            $
            212,118
            
            
            $
            (422,245
            )Adjustments
                to reconcile net income (loss) to net cashprovided by (used in) operating activities:Depreciation
            
            
            457,440
            
            
            
            650,142
            
            
            
            588,559Amortization
            
            
            7,001
            
            
            
            7,002
            
            
            
            7,002Share
                based compensation
            
            
            138,519
            
            
            
            172,988
            
            
            
            --Provision
                for doubtful accounts
            
            
            (44,221
            )
            
            
            559,206
            
            
            
            87,695Provision
                for obsolete inventory
            
            
            167,144
            
            
            
            56,622
            
            
            
            281,003Note
                receivable
            
            
            --
            
            
            
            (200,000
            )
            
            
            --Changes
                in assets and liabilities:Accounts
                receivable
            
            
            402,143
            
            
            
            (158,411
            )
            
            
            (445,243
            )Other
                receivables
            
            
            154,772
            
            
            
            313,757
            
            
            
            (285,673
            )Inventories
            
            
            1,331,328
            
            
            
            (4,392,330
            )
            
            
            197,563Prepaid
                expenses
            
            
            7,747
            
            
            
            27,498
            
            
            
            109,271Accounts
                payable
            
            
            (1,581,913
            )
            
            
            2,375,187
            
            
            
            (203,846
            )Accrued
                liabilities
            
            
            (132,163
            )
            
            
            (32,323
            )
            
            
            (640,150
            )Net
                cash provided by (used in) operating activities
            
            
            1,255,824
            
            
            
            (408,544
            )
            
            
            (726,064
            )**INVESTING
                ACTIVITIES:**Purchases
                of property, plant and equipment, net
            
            
            (407,473
            )
            
            
            (669,275
            )
            
            
            (116,167
            )Net
                cash used in investing activities
            
            
            (407,473
            )
            
            
            (669,275
            )
            
            
            (116,167
            )**FINANCING
                ACTIVITIES:**Retirement
                of obligation under capital lease
            
            
            (74,148
            )
            
            
            (68,205
            )
            
            
            (57,712
            )Proceeds
                from issuance of common stock
            
            
            62,655
            
            
            
            1,237,824
            
            
            
            846,713Net
                cash (used in) provided by financing activities
            
            
            (11,493
            )
            
            
            1,169,619
            
            
            
            789,001**EFFECT
                OF EXCHANGE RATE CHANGES ON CASH**
            
            
            5,184
            
            
            
            21,016
            
            
            
            (4,630
            )**NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS**
            
            
            842,042
            
            
            
            112,816
            
            
            
            (57,860
            )**CASH
                AND CASH EQUIVALENTS, BEGINNING OF YEAR**
            
            
            3,793,781
            
            
            
            3,680,965
            
            
            
            3,738,825**CASH
                AND CASH EQUIVALENTS, END OF YEAR**
            
            $
            4,635,823
            
            
            $
            3,793,781
            
            
            $
            3,680,965**SUPPLEMENTAL
                CASH FLOW INFORMATION:**Cash
                paid for:Income taxes paid—net
            
            $
            10,547
            
            
            $
            3,910
            
            
            $
            2,506Interest
            
            
            14,355
            
            
            
            19,820
            
            
            
            26,596





See
      notes
      to consolidated financial statements.





34


**NOTES
      TO FINANCIAL STATEMENTS**





**CRITICARE
      SYSTEMS, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**YEARS
      ENDED JUNE 30, 2007, 2006 AND 2005**





**1.   SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES**





**Nature
      of Business** -- Criticare Systems, Inc. designs, manufactures and
      markets patient monitoring equipment and related accessories to the health
      care
      community worldwide and is headquartered in Waukesha, Wisconsin.  The
      Company sells domestically primarily to oral and stand-alone general surgery
      centers and hospitals through regional sales managers and a dealer
      network.  Internationally, the Company sells mainly to hospitals
      through country managers and a worldwide dealer network.  In addition,
      the Company sells modules and stand-alone monitors worldwide to original
      equipment manufacturers (“OEMs”).





**Principles
      of Consolidation** -- The consolidated financial statements include the
      accounts of Criticare Systems, Inc. and its wholly owned subsidiaries (the
      "Company").  All significant intercompany accounts and transactions
      have been eliminated.





**Cash
      Equivalents** -- The Company considers all investments with purchased
      maturities of less than three months to be cash equivalents.





**Accounts
      Receivable and Allowance for Doubtful Accounts --** Accounts receivable
      are customer obligations due under normal trade terms.  The Company
      sells its products to distributors, OEMs, and end users in medical facilities
      such as hospitals, surgery centers, nursing homes, and physician
      offices.  The Company performs continuing credit evaluations of its
      customers’ financial condition, and although it generally does not require
      collateral, letters of credit may be required from customers in certain
      circumstances.





Management
      reviews accounts receivable on a monthly basis to determine if any receivables
      will potentially be uncollectible.  The Company includes any accounts
      receivable balances that are determined to be uncollectible, along with a
      general reserve, in its overall allowance for doubtful accounts.  The
      general reserve in the allowance for doubtful accounts is calculated based
      upon
      the accounts receivable balance and the historical effectiveness of Criticare’s
      collection of those receivables.  The general reserve as of June 30,
      2007 and 2006 is $70,000 and $100,000, respectively.  After all
      attempts to collect a receivable have failed, the receivable is written off
      against the allowance.  Based on the information available, the
      Company believes its allowance for doubtful accounts as of June 30, 2007 and
      2006 is adequate.  However, actual write-offs might exceed the
      recorded allowance.





35


**Inventories**
      -- Inventories are stated at the lower of cost or market, with cost determined
      on the first-in, first-out method.





**Other
      Receivables**--****Other receivables as of June 30,
      2007 and 2006 consist mainly of tender deposits in the amount of $116,458 and
      $130,880, respectively, bank guarantees in the amount of $26,725 and $28,917,
      respectively.





**Note
      Receivable**--****Note receivable as of June 30, 2007
      and 2006 is the result of the grant of a non-exclusive license with quarterly
      payments ending January 1, 2010.  This license agreement is treated,
      for accounting purposes, as a non-interest bearing note.  The future
      maturities of the note receivable are $50,000 in each of the fiscal years 2008
      and 2009 and $25,000 in 2010.  The balance of the short-term note on
      each of June 30, 2007 and 2006 was $50,000.  The balance of the
      long-term note on June 30, 2007 and 2006 respectively, was $75,000 and
      $150,000.





**Property,
      Plant and Equipment** -- Property, plant and equipment is recorded at
      cost.  Each member of the Company's sales force is provided with
      demonstration monitors to assist them in their sales efforts.  The
      Company also has loaner monitors which are used to temporarily replace a
      customer's unit when it is being repaired or upgraded.  Depreciation
      is provided over the estimated useful lives of the assets.  The
      estimated useful lives of other property and equipment are as
      follows:




Classification
              
              Estimated
                Useful
                  LivesMachinery
                  and equipment
              
              5–7
                  yearsFurniture
                  and fixtures
              
              5
                  yearsLeasehold
                  improvements
              
              4–5
                  yearsDemonstration
                  and loaner monitors
              
              4 yearsProduction
                  tooling
              
              5–7
                  years


The
      Company periodically assesses the recoverability of long-lived assets, including
      property and equipment and intangibles, subject to amortization, in accordance
      with the Statement of Financial Accounting Standards No. 144, “Accounting for
      the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
      Of”
(“SFAS No. 144”), when indications of potential impairment exist.  The
      amount of any impairment is calculated as the shortfall of the estimated fair
      market value from the carrying value of the related asset.  Management
      considers such factors as current operating results, trends, and future
      prospects, in addition to other economic factors in performing this
      analysis.  No such impairments exist at June 30, 2007 and
      2006.  As of July 1, 2005, in accordance with the Statement of
      Financial Accounting Standards No. 86, Accounting for the Costs of Computer
      Software to be Sold, Leased or Otherwise Marketed” (“SFAS No. 86”), the Company
      will accumulate and amortize the software costs on a product-by product basis
      after the technological feasibility of the product has been
      established.  Amortization of the costs will be equal to the
      straight-line amortization of the costs over the estimated economic life of
      the
      product.  As of June 30, 2007 and 2006, the Company had
      capitalized $108,720 of software costs.  Amortization of $21,744 and
      $10,872 was recorded in fiscal 2007 and fiscal 2006, respectively.





36


**License
      Rights and Patents** -- The Company adopted SFAS 142, “Goodwill and Other
      Intangible Assets,” during the period ended June 30, 2003 to account for its
      license rights and patents.  License rights and patents are carried at
      cost and are amortized using the straight-line method over their estimated
      useful life as follows:




Classification
              
              Estimated
                Useful
                  LivesLicense
                  rights and patents
              
              17
                  years




License
      rights and patents are evaluated for impairment when events or changes in
      circumstances indicate that the carrying amounts of the assets may not be
      recoverable through the estimated undiscounted future cash flows resulting
      from
      the use of these assets.  When any such impairment exists, the related
      assets will be written down to fair value.





**Revenue
      Recognition** -- Revenues and the costs of products sold are recognized
      as the related products are shipped or installed, if there are significant
      installation costs.  This revenue recognition policy is utilized for
      shipment of product to customers, including both distributors and
      end-users.  Revenue is recognized, in accordance with SAB No. 104,
      when all four elements for revenue recognition have been met.





**Shipping
      Costs**--****Any shipping costs that are billable to
      the customer are included in revenue and all****shipping
      costs are included in cost of goods sold in the accompanying consolidated
      statements of operations.





**Product
      Warranties** -- Estimated costs for product warranties are accrued for
      and charged to operations, as revenues for the related products are
      recognized.





**Marketing
      Expenses** -- Marketing expenses include all of the Company's sales
      related costs.  Bad debt expense(recoveries) totaled
      $(44,221) , $559,206 and $87,695 in fiscal 2007, 2006 and 2005,
      respectively.





**Advertising
      Costs**-- Advertising costs are expensed as
      incurred.  Advertising costs totaled $61,807, $97,460 and $68,120 for
      the years ended June 30, 2007, 2006 and 2005, respectively.





**Research
      and Development Expenses** -- Research and development costs are charged
      to operations as incurred.  Such expenses totaled $2,275,053,
      $2,304,226 and $2,561,386 in fiscal 2007, 2006 and 2005,
      respectively.





37


**Income
      Taxes** -- The Company accounts for income taxes using an asset and
      liability approach.  Deferred income tax assets and liabilities are
      computed for differences between the financial statements and tax basis of
      assets and liabilities that will result in taxable or deductible amounts in
      the
      future based on enacted tax laws and rates applicable to the periods in which
      the differences are expected to affect taxable income.  The Company
      pays income taxes in certain states that require an annual minimum
      tax.  These taxes are included in administrative expenses in the
      consolidated statements of operations.





**Translation
      of Foreign Currency**-- The Company follows the translation policy as
      provided by Financial Accounting Standards No. 52, “Foreign Currency
      Translation” in translating the financial statements of its operation in India
      from Indian rupees to U.S. dollars.  Accordingly, assets and
      liabilities are translated at the rate of exchange at the balance sheet
      date.  Income and expense items are translated at the average exchange
      rate prevailing throughout the year.  The results are shown as a
      component of other comprehensive income.





**Net
      Income (Loss) Per Common Share** -- Basic income (loss) per share is
      computed using the weighted average number of common shares outstanding during
      the periods.  Diluted income (loss) per share is computed using the
      weighted average number of common and dilutive common equivalent shares
      outstanding during the periods.  For fiscal 2007 and fiscal 2006, the
      number of diluted weighted average common shares outstanding would be higher
      by
      122,750 and 28,000 shares, respectively, without this anti-dilutive
      impact.  The basic and diluted weighted average number of common
      shares outstanding in the financial statements are the same in fiscal year
      2005 because including a diluted calculation in a loss position would produce
      an
      anti-dilutive per share amount. The number of diluted weighted average
      common shares outstanding would be higher by 131,230 shares in 2005 without
      this anti-dilutive impact.





**Stock
      Options**-- The Company grants options to purchase Criticare Systems,
      Inc. common shares under stock option plans that are described more fully in
      Note 8. Prior to fiscal 2006, the Company had adopted the disclosure-only
      provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS
      No. 148, “Accounting for Stock-Based Compensation—Transition and
      Disclosure”.  Effective July 1, 2005, the Company adopted the fair
      value recognition provisions of SFAS No. 123 (R), “Share-Based
      Payment”.  Under the modified prospective method of adoption selected
      by the Company, compensation cost recognized in fiscal 2007 and 2006 is the
      same
      as that which would have been recognized had the recognition provisions of
      SFAS
      No. 123 been applied from its original effective date.  Results for
      the prior year have not been restated.  If the Company had elected to
      recognize compensation cost for the options granted during the year ended June
      30, 2005, consistent with the method prescribed by SFAS No. 123, net loss
      and net loss per share would have been changed to the pro forma amounts
      indicated below:




38





**Year
              Ended June 30,****2005**Net
                loss--as reported
            
            $
            (422,245
            )Add:
                Stock-based employee compensation
              expense included in reported net loss
            
            
            --Deduct:
                Total stock-based employee compensation
              expense determined under fair value based
              method for all awards
            
            
            (211,498
            )Net
                loss – pro forma
            
            $
            (633,743
            )Basic
                net loss per share – as reported
            
            $
            (0.04
            )Diluted
                net loss per share – as reported
            
            $
            (0.04
            )Basic
                net loss per share – pro forma
            
            $
            (0.06
            )Diluted
                net loss per share – pro forma
            
            $
            (0.06
            )





**Fair
      Value of Financial Instruments** -- The Company's financial instruments
      under SFAS No. 107 "Disclosure About Fair Value of Financial Instruments,"
      includes cash, accounts receivable, accounts payable, borrowings under line
      of
      credit facility and long-term debt.  The Company believes that the
      carrying amounts of these accounts are a reasonable estimate of their fair
      value
      because of the short-term nature of such instruments or, in the case of
      long-term debt because of interest rates available to the Company for similar
      obligations.





**Comprehensive
      Income** -- Comprehensive income consists of net income and foreign
      currency translation adjustments, and is presented in the consolidated
      statements of stockholders' equity.





**Use
      of Estimates** -- The preparation of financial statements in conformity
      with generally accepted accounting principles requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period.  Actual results could differ from those
      estimates.





**Reclassifications**-- Certain amounts for fiscal 2005 and fiscal 2006 have been
      reclassified to conform to the fiscal 2007 presentation.





39


**2.**
            **INVENTORIES**





Inventories
                consist of the following as of June
                30:





**2007**
            
            
            **2006**Component
                parts
            
            $
            2,507,293
            
            
            $
            2,605,751Work
                in process
            
            
            1,106,885
            
            
            
            1,470,893Finished
                units
            
            
            4,938,345
            
            
            
            5,747,393Total
                inventories
            
            
            8,552,523
            
            
            
            9,824,037Less:  reserve
                for obsolescence
            
            
            375,000
            
            
            
            360,000Net
                inventory
            
            $
            8,177,523
            
            
            $
            9,464,037





**3.  
      LICENSE RIGHTS AND PATENTS**





The
      components of and changes in the carrying amount of license rights and patents
      are as follows as of June 30:





**2007**
            
            
            **2006**License
                rights and patents
            
            $
            196,777
            
            
            $
            196,777Accumulated
                amortization
            
            
            (140,797
            )
            
            
            (133,796
            )Net
                license rights and patents
            
            $
            55,980
            
            
            $
            62,981





Future
      amortization of license and patents is as follows at June 30, 2007:





Year
                ended June 30,2008
            
            $
            7,0012009
            
            
            7,0012010
            
            
            7,0012011
            
            
            7,0012012
            
            
            7,001Thereafter
            
            
            20,975Total
            
            $
            55,980





Approximately
      $7,000 of amortization was charged to operations in each of the fiscal years
      ended June 30, 2007, 2006 and 2005.





**4.  
      PRODUCT WARRANTY**





The
      Company’s products are subject to a standard warranty of 12 months, and
      therefore reserves are established for the estimated future costs of repair
      or
      replacement and included in cost of sales at the time the related sale is
      recognized.  These reserves are adjusted based on management’s best
      estimates of future warranty costs after considering historical and projected
      product failure rates and product repair costs.  In the event that
      actual experience differs from these best estimates, changes in the Company’s
      warranty reserves might become necessary.  The Company also sells
      extended warranties, which result in a deferral of revenue, amortized over
      the
      extended warranty period.





40


Changes
      in the Company’s warranty reserve for fiscal years 2007 and 2006 are as
      follows:





**2007**
            
            
            **2006**Balance,
                beginning of year
            
            $
            425,000
            
            
            $
            452,000Warranties
                issued
            
            
            181,328
            
            
            
            244,093Settlements
            
            
            (257,328
            )
            
            
            (271,093
            )Changes
                in estimated pre-existing warranties
            
            
            --
            
            
            
            --Balance,
                end of year
            
            $
            349,000
            
            
            $
            425,000





The
                Company’s warranty settlements for fiscal 2005 totaled
                $289,955.





**5.**
            **INCOME
                TAXES**





The
      Company accounts for income taxes using an asset and liability approach, which
      generally requires the recognition of deferred income tax assets and liabilities
      based upon the expected future income tax consequences of events that have
      previously been recognized in the Company's financial statements or tax
      returns.  In addition, a valuation allowance is recognized if it is
      more likely than not that some or all of the deferred income tax asset will
      not
      be realized.  A valuation allowance is used to offset the related net
      deferred income tax assets due to uncertainties of realizing the benefits of
      certain net operating loss and tax credit carryforwards.





The
      valuation allowance was decreased $268,000 in 2007 and increased $263,000 in
      2006.





Significant
      components of the Company's deferred income tax assets and deferred income
      tax
      liabilities are as follows:





**June
                30,**
            
            
            **June
                30,**
            
            
            **June
                30,****2007**
            
            
            **2006**
            
            
            **2005**Deferred
                income tax assets:Accounts receivable and sales allowances
            
            $
            211,000
            
            
            $
            341,000
            
            
            $
            148,000Inventory allowances
            
            
            180,000
            
            
            
            183,000
            
            
            
            196,000Product warranties
            
            
            139,000
            
            
            
            167,000
            
            
            
            177,000Other accrued liabilities
            
            
            144,000
            
            
            
            139,000
            
            
            
            146,000Compensation
            
            
            125,000
            
            
            
            71,000
            
            
            
            9,000Federal net operating loss carryforwards
            
            
            5,882,000
            
            
            
            5,958,000
            
            
            
            6,004,000State net operating loss carryforwards
            
            
            505,000
            
            
            
            591,000
            
            
            
            601,000Federal tax credit carryforwards
            
            
            132,000
            
            
            
            143,000
            
            
            
            198,000Excess of book over tax depreciation and amortization
            
            
            269,000
            
            
            
            258,000
            
            
            
            116,000Investment losses not deducted
            
            
            118,000
            
            
            
            118,000
            
            
            
            118,000Total deferred income tax assets
            
            
            7,705,000
            
            
            
            7,969,000
            
            
            
            7,713,000Deferred
                income tax liabilities:Excess of tax over book depreciation and amortization
            
            
            0
            
            
            
            0
            
            
            
            0Prepaid expenses
            
            
            (39,000
            )
            
            
            (38,000
            )
            
            
            (42,000
            )Total deferred income tax liabilities
            
            
            (39,000
            )
            
            
            (38,000
            )
            
            
            (42,000
            )Valuation
                allowance
            
            
            (7,666,000
            )
            
            
            (7,931,000
            )
            
            
            (7,671,000
            )Net
                deferred income taxes recognized in the
              consolidated
                balance sheets
            
            $
            0
            
            
            $
            0
            
            
            $
            0





41


At
      June
      30, 2007, the Company had federal net operating loss carryforwards of
      approximately $17,301,000 which expire in 2008 through 2027.  At June
      30, 2007, the Company had available for federal income tax purposes
      approximately $87,000 of alternative minimum tax credit carryforwards which
      carry forward indefinitely and approximately $45,000 of tax credit carryforwards
      which expire in 2009.  The Company also has approximately $10,187,000
      of state net operating loss carryforwards, which expire in 2008 through 2021,
      available to offset certain future state taxable income.





The
                income tax provision consists of the
                following:





**2007**
            
            
            **2006**
            
            
            **2005**CurrentFederal
            
            $
            0
            
            
            $
            0
            
            
            $
            0State
            
            
            0
            
            
            
            0
            
            
            
            0Total income tax provision
            
            $
            0
            
            
            $
            0
            
            
            $
            0





A
                reconciliation of the provision for income taxes (benefit) at the
                federal
                statutory income tax rate to the effective income tax rate
                follows:





**2007**
            
            
            **2006**
            
            
            **2005**Federal
                statutory income tax rate
            
            
            34.0
            %
            
            
            34.0
            %
            
            
            34.0
            %State
                taxes net of federal benefit
            
            
            5.2
            
            
            
            5.2
            
            
            
            5.2Expired
                net operating loss and credits
            
            
            26.8
            
            
            
            25.7
            
            
            
            0.0Permanent
                items
            
            
            9.8
            
            
            
            (187.5
            )
            
            
            49.8Valuation
                adjustment
            
            
            (75.8
            )
            
            
            122.6
            
            
            
            (89.0
            )Effective
                income tax rate
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %





**6.**
            **LINE
                OF CREDIT FACILITY**





At
                June 30, 2007, the Company had a $2,000,000 demand line of credit
                facility
                with a commercial bank to meet its short-term borrowing
                needs.  Borrowings against the line are payable on demand with
                interest payable monthly at the bank's reference rate, less 0.25%
                (8.00%
                as of June 30, 2007).  As of June 30, 2007 and 2006 there
                were no borrowings against the line.  Borrowings under the line
                of credit facility are collateralized by substantially all assets
                of the
                Company.  The credit facility has covenants which require
                minimum income or liquidity levels.  The Company was in
                compliance with the covenants at June 30,
                2007.





**7.**
            **CONTINGENCIES**





From
      time
      to time, various lawsuits arise out of the normal course of
      business.  These proceedings are handled by outside
      counsel.  Currently management is not aware of any claim or action
      pending against the Company that would have a material adverse effect on the
      Company.





42


**8.**
            **STOCKHOLDERS'
                EQUITY**





**Stock
      Options**– At the December 1, 2005 annual meeting of the stockholders of
      the Company, the stockholders approved an amendment of the Criticare Systems,
      Inc. 2003 Stock Option Plan (the “2003 Plan”) to increase the number of shares
      of common stock available for future grants by 500,000 shares to 930,000 shares
      and to authorize grants of restricted stock and stock appreciation rights under
      the plan. During the annual stockholders meeting held on November 14, 2003,
      the
      Company’s stockholders approved the original 2003 Plan.  This 2003
      Plan replaced the 1992 Employee Stock Option Plan and the 1992 Non-Employee
      Stock Option Plan (collectively, the “1992 Plans”) and 179,380 reserved shares
      of common stock available under the 1992 Plans were moved to the 2003
      Plan.  The stockholders also approved 250,620 shares being available
      for future grants in addition to the 179,380 shares currently available, for
      a
      total of 430,000 shares authorized for issuance under the 2003
      Plan.  The Company also has options outstanding under two plans which
      existed prior to the approval of the 1992 Plans, the 1987 Employee Stock
      Option Plan and the 1987 Non-Employee Stock Option Plan (collectively with
      the
      1992 Plans, the "Old Plans").  As a result of the approval of the 2003
      Plan, no new stock options can be granted under the Old Plans, although the
      Company can regrant existing stock options under the Old Plans to extend the
      terms of such options. The Board of Directors has authorized in connection
      with these stock option plans the issuance of 3,210,620 reserved shares of
      common stock, of which 427,440 reserved shares remain available for
      future issuance at June 30, 2007. The Board of Directors increased the
      number of reserved shares for issuance under the Plans from 1,720,000 to
      2,220,000 during 2001, from 2,220,000 to 2,460,000 during 2002, from 2,460,000
      to 2,710,620 during 2003, and from 2,710,620 to 3,210,620 during
      2005.  The compensation cost that has been charged against income for
      the 2003 Plan and the Old Plans was $138,519 and $172,988 for the years ended
      June 30, 2007 and 2006, respectively.  No income tax benefit was
      recognized in the income statement for share-based compensation arrangements
      due
      to the valuation allowance.  The activity during 2005, 2006 and 2007
      for the above plans is summarized as follows:





**Number
                of**
            
            
            **Stock
                Options**
            
            
            **Weighted
                Avg.****Shares**
            
            
            **Price
                Range**
            
            
            **Exercise
                Price**Outstanding
                at June 30, 2004
            
            
            1,429,895
            
            
            $
            1.88-4.40
            
            
            $
            2.75Granted
            
            
            96,000
            
            
            
            2.25-5.13
            
            
            
            2.97Cancelled
            
            
            (189,200
            )
            
            
            2.88-3.75
            
            
            
            3.16Exercised
            
            
            (280,337
            )
            
            
            1.88-4.30
            
            
            
            2.46Outstanding
                at June 30, 2005
            
            
            1,056,358
            
            
            
            1.88-5.13
            
            
            
            2.77Granted
            
            
            45,000
            
            
            
            4.60-5.19
            
            
            
            4.90Cancelled
            
            
            (84,625
            )
            
            
            1.88-3.42
            
            
            
            2.51Exercised
            
            
            (473,045
            )
            
            
            1.88-4.40
            
            
            
            2.57Outstanding
                at June 30, 2006
            
            
            543,688
            
            
            
            2.25-5.19
            
            
            
            3.17Granted
            
            
            79,000
            
            
            
            3.36-3.76
            
            
            
            3.61Cancelled
            
            
            (13,315
            )
            
            
            2.25-3.60
            
            
            
            3.00Exercised
            
            
            (11,500
            )
            
            
            2.88-3.05
            
            
            
            2.90Outstanding
                at June 30, 2007
            
            
            597,873
            
            
            $
            2.51-5.19
            
            
            $
            3.24





43


The
                following table summarizes the option details as of June 30,
                2007:





Shares
            
            
            Weighted
                Average
            
            
            Weighted
            
            
            AggregateOutstanding
            
            
            Remaining Contractual
            
            
            Average
                Exercise
            
            
            Intrinsic
                ValueAt
                June 30, 2007
            
            
            Life-Years
            
            
            Price
            
            
            at
                June 30, 2007Options
                Outstanding
            
            
            597,873
            
            
            
            6.31
            
            
            $
            3.24
            
            
            $
            175,662Options
                Exercisable
            
            
            372,425
            
            
            
            5.19
            
            
            $
            3.07
            
            
            $
            131,938





Option
      awards are granted with an exercise price equal to the market price of the
      Company’s stock at the date of the grant; those option awards generally vest
      based upon 4 years of continuous service and have 5 and 10 year contractual
      terms for the Old Plans and 2003 Plan, respectively, as determined by the
      Compensation Committee of the Company's Board of Directors.  Certain
      option awards provide for accelerated vesting if there is a change in
      control.





The
      Company has adopted the fair value recognition provisions of SFAS No. 123 (R),
      “Share-Based Payment”.  Under the modified prospective method of
      adoption selected by the Company, compensation cost recognized in fiscal 2007
      and fiscal 2006 is the same as that which would have been recognized had the
      recognition provisions of SFAS No. 123 been applied from its original effective
      date.  The fair value of stock options is the estimated fair value at
      the grant date using the Black Scholes option-pricing model.  The fair
      value of each option award is estimated on the date of the grant using the
      Black-Scholes option-pricing model that uses the assumptions noted in the
      following table.  Expected volatilities are based on historical
      volatility of the Company’s stock and other factors.  The Company uses
      historical data to estimate option exercise and employee termination within
      the
      valuation model.  The expected term of options granted is derived from
      the analysis of the Company’s historical patterns and represents the period of
      time that options granted are expected to be outstanding.  The
      risk-free rate for periods within the expected life of the option is based
      on
      the U.S. Treasury yield curve in effect at the time of the grant.  The
      weighted average fair market value of the options granted during fiscal 2007,
      2006 and 2005, along with the assumptions used, follows below:




**Years
                  Ended June 30,****2007**
              
              
              **2006**
              
              
              **2005**Weighted
                  average fair market value of options
                granted
                  during the fiscal year ended June 30
              
              $
              2.27
              
              
              $
              2.90
              
              
              $
              1.62Assumptions
                  used:Expected
                  volatility
              
              
              51.0
              %
              
              
              45.0
              %
              
              
              55.0
              %Risk-free
                  interest rate
              
              
              4.73
              %
              
              
              4.29
              %
              
              
              3.74
              %Expected
                  option life (in years)
              
              
              9.00
              
              
              
              8.88
              
              
              
              6.25Dividend
                  yield
              
              
              0
              
              
              
              0
              
              
              
              0Forfeiture
                  rate
              
              
              0
              
              
              
              0
              
              
              
              0


44


The
      total
      intrinsic value of the options exercised during the years ended June 30, 2007,
      2006 and 2005 was $10,253, $1,132,994 and $377,138, respectively.





The
      following table summarizes the status of the Company’s nonvested shares as of
      June 30, 2007, and changes during the year ended June 30, 2007:





**Number
                of**
            
            
            **Weighted-Average
                Grant****Nonvested
                Shares**
            
            **Shares**
            
            
            **Date
                Fair Value**Nonvested
                at June 30, 2006
            
            
            300,699
            
            
            $
            3.30Granted
            
            
            79,000
            
            
            
            3.61Cancelled
            
            
            (5,815
            )
            
            
            2.82Vested
            
            
            (148,436
            )
            
            
            3.15Nonvested
                at June 30, 2007
            
            
            225,448
            
            
            $
            3.51





As
      of
      June 30, 2007, there was $221,937 of total unrecognized compensation cost
      related to nonvested share-based compensation arrangements granted under the
      2003 Plan and Old Plans.  That cost is expected to be recognized over
      a weighted-average period of 1.40 years.  The total fair value of the
      shares vested during the years ended June 30, 2007 and 2006 was $160,333 and
      $139,392, respectively.





**Stock
      Warrants** -- In February 1998, the Company executed a warrant agreement
      with a consultant.  The warrant agreement provided for the issuance of
      warrants to purchase up to 150,000 shares of common stock at a price of $3.00
      per share.  The warrant was exercisable as to 30,000 shares upon
      execution of the agreement and the warrants to purchase the remaining 120,000
      shares were to be exercisable if certain performance parameters were achieved
      by
      February 1999.  No such parameters were achieved.  These
      warrants expired in February 2003, but were amended.  The 30,000
      warrants were extended for an additional five years with an exercise price
      of
      $2.88 per share which represented the closing price of the Company’s stock on
      the date the warrants were amended.  The fair value of the extended
      warrants, based on the estimated fair value using the Black-Scholes pricing
      model, totaled $24,990 and was expensed during the year in which they were
      extended, fiscal 2003.





In
      December 2000, the Company executed another warrant agreement with the
      consultant.  The warrant agreement provided for the issuance of
      warrants to purchase up to 70,000 shares of common stock at a price of $1.875
      per share.  The warrant vested over a four year period in four equal
      increments each year on the anniversary date of the warrant.  The
      warrant was to terminate as to any shares that were unvested at the time the
      consultant ceased to provide consulting services to the Company.  As
      of December 21, 2004, the warrant had fully vested.  During fiscal
      2005, this warrant was exercised in full to purchase 70,000
      shares.  The fair value of this warrant was the estimated fair value
      using the Black-Scholes pricing model.





45


**Preferred
      Stock** -- The Company's Board of Directors has the authority to
      determine the relative rights and preferences of any series it may establish
      with respect to the 500,000 shares of $.04 par value authorized preferred
      shares.  As of June 30, 2007, no preferred stock was issued or
      outstanding.





On
      March
      27, 1997, the Board of Directors of the Company declared a dividend of one
      preferred share purchase right (a "Right") for each outstanding share of common
      stock of the Company.  The dividend was made on April 24, 1997 to the
      stockholders of record on that date to purchase Preferred Stock ("Preferred")
      upon the occurrence of certain events.  Each share of common stock
      that shall become outstanding between the record date and the earliest of the
      distribution date, redemption date and the final expiration date shall be issued
      one Right.  The Rights will be exercisable the tenth business day
      after a person or group acquires 20% of the Company's common stock, or makes
      an
      offer to acquire 30% or more of the Company's common stock.  When
      exercisable, each right entitles the holder to purchase for $25, subject to
      adjustment, one-hundredth of a share of Preferred for each share of common
      stock
      owned.  Each share of Preferred will be entitled to a minimum
      preferential quarterly dividend of $25 per share, but not less than an aggregate
      dividend of 100 times the common stock dividend.  Each share will have
      100 votes, voting together with the common stock.  In the event of any
      merger, each share of Preferred will be entitled to receive 100 times the amount
      received per share of common stock.  The Rights expire on March 27,
      2017.





**Common
      Stock Held in Treasury --**At June 30, 2007 and 2006, the Company held
      in Treasury 96,310 and 106,677 shares of common stock, respectively, shown
      at
      cost.  On February 28, 2002, the Criticare Board of Directors approved
      the purchase in the open market of up to 500,000 shares of Criticare common
      stock.  The Company has purchased 180,063 shares of common stock as of
      June 30, 2007.  At June 30, 2007 and 2006, the Company held in
      Treasury 76,223 shares of common stock purchased in accordance with this
      stock buyback program.





**Employee
      Stock Purchase Plan --**The Company has an Employee Stock Purchase Plan
      to provide employees of the Company with an opportunity to purchase common
      stock
      of the Company through accumulated payroll deductions.  The plan
      allows eligible employees to purchase shares of the Company’s common stock
      through monthly offering periods.  The purchase price for each share
      of common stock purchased equals 85% of the last quoted sales price of a share
      of the Company’s common stock as reported by the American Stock Exchange on the
      first day of the monthly offering period or the last day of the monthly offering
      period, whichever is lower.  Compensation expense under this plan is
      immaterial.  The Company is authorized to issue 500,000 shares of
      common stock under the plan.  As of June 30, 2007, the Company
      had issued a total of 83,753 shares of common stock under the plan, and had
      416,247 shares of common stock authorized for future issuance under the
      plan.  The plan will terminate on July 1, 2009, unless sooner
      terminated by the Board of Directors.





46


**9.   EMPLOYEE
      BENEFIT PLAN**





The
      Company has a 401(k) plan which covers substantially all
      employees.  Company contributions to the plan are discretionary and
      determined annually by the Company's Board of Directors.  The
      Company's contributions were approximately $103,000, $104,000 and $97,000 in
      2007, 2006 and 2005, respectively.





**10. BUSINESS
      AND CREDIT CONCENTRATIONS**





Financial
      instruments which potentially subject the Company to concentrations of credit
      risk consist of cash, certificates of deposit, and accounts
      receivable.  These financial instruments are carried at approximate
      fair value, less appropriate allowance, due to their short
      maturities.





The
      Company maintains cash balances which at times may exceed federally insured
      limits.  As of June 30, 2007 and 2006, the Company held $4,692,519 and
      $3,764,888, respectively, in excess of federally insured limits.  The
      Company’s management evaluates the creditworthiness of the financial
      institutions in which it places its cash.  The Company has not
      experienced any losses in such accounts and does not believe it is exposed
      to
      any significant credit risk for cash accounts.





The
      Company is a manufacturer of medical monitors and telemetry products whose
      customers include hospitals and alternative health care sites throughout the
      world.  Although the Company's products are sold primarily to health
      care providers, concentrations of credit risk with respect to trade accounts
      receivable are limited due to the Company's large number of customers, their
      geographic dispersion, and the Company’s credit evaluation
      process.  Due in part to the risks involved in conducting business
      internationally, the Company currently coordinates substantially all
      international sales, distribution and credit activities through its headquarters
      in Waukesha, Wisconsin.  Other than inventory, other receivables and
      accounts receivable for the Company’s operation in India totaling approximately
      $660,000, identifiable assets located outside of the United States are
      insignificant in relation to the Company's total assets.  Net sales
      into geographic area are as follows:





**2007**
            
            
            **2006**
            
            
            **2005**Europe
                and Middle East
            
            $
            5,712,000
            
            
            $
            7,355,000
            
            
            $
            7,182,000Pacific
                Rim
            
            
            1,240,000
            
            
            
            1,692,000
            
            
            
            1,787,000Canada
                and Central and South America
            
            
            3,747,000
            
            
            
            3,516,000
            
            
            
            2,689,000Export
                net sales
            
            $
            10,699,000
            
            
            $
            12,563,000
            
            
            $
            11,658,000U.S.
                net sales
            
            
            20,733,000
            
            
            
            18,788,000
            
            
            
            15,124,000Total
                net sales
            
            $
            31,432,000
            
            
            $
            31,351,000
            
            
            $
            26,782,000





Note:  Sales
                in Europe and the Middle East have been combined above due to joint
                sales
                responsibility in these areas.  No foreign country made up more
                than 10% of the Company’s total net
                sales.





47


**11. OTHER
      BUSINESS CONCENTRATIONS**





During
      2003, the Company entered into an OEM agreement with a customer to jointly
      develop and exclusively sell a highly specialized medical monitoring product
      to
      the OEM.  In July 2004, Criticare shipped the initial prototypes of
      this monitoring product to this OEM and in January 2005 production shipments
      began.  Sales to this customer approximated $6,326,000 in fiscal 2007,
      $5,177,000 in fiscal 2006, and $3,100,000 in fiscal 2005, which represented
      20.0%, 16.5% and 11.6%, respectively, of the Company's total net
      sales.  The Company had a receivable balance from this customer of
      $1,641,260 on June 30, 2007, $939,270 on June 30, 2006, and $1,373,836 on June
      30, 2005 which represented 27.7%, 15.2% and 20.1%, respectively, of the
      Company's total receivables as of those dates.





In
      fiscal
      2001, the Company entered into agreements with two offshore contract
      manufacturing firms to supply finished products.  During fiscal 2005,
      the Company ended the supply partnership agreement with one of the contract
      manufacturing firms.  A summary of the purchases and outstanding
      payables to these two companies for the years ended June 30, 2007, 2006 and
      2005
      follows below:





**2007**
            
            
            **2006**
            
            
            **2005**Supplier
                I - Purchases
            
            $
            5,648,427
            
            
            $
            9,324,825
            
            
            $
            6,193,106%
                of total purchases
            
            
            22.4
            %
            
            
            32.3
            %
            
            
            29.5
            %Accounts
                payable balance
            
            $
            1,369,312
            
            
            $
            973,625
            
            
            $
            610,479%
                of total payables
            
            
            35.8
            %
            
            
            18.0
            %
            
            
            20.1
            %





**12. COMMITMENTS**





The
      Company leases various equipment under both operating leases and a capital
      lease, which expire at various dates through fiscal 2011.





On
      January 19, 2004, the Company entered into a lease agreement for the hardware
      and software for a new business system.  This lease has been accounted
      for as a capital lease in accordance with SFAS No. 13, “Accounting for
      Leases”.  The following is an analysis of this capital
      lease:





June
                30, 2007
            
            
            June
                30,2006Machinery
                and equipment
            
            $
            333,840
            
            
            $
            333,840Less
                accumulated depreciation
            
            
            (166,920
            )
            
            
            (119,228
            )Net
            
            $
            166,920
            
            
            $
            214,612





Depreciation
      expense was $47,691 in fiscal 2007, 2006 and 2005.





48


The
      Company’s Waukesha building lease was to expire in August 2007, but the Company
      has exercised its option to extend the lease for an additional three
      years.  The lease expires in August 2010 with the Company now leasing
      approximately 53% of the building’s square footage.  The Company has
      also leased an additional warehouse facility.  This lease also expires
      in August 2010.  Rent expense was $335,318 in fiscal 2007, $339,024 in
      fiscal 2006 and $337,281 in fiscal 2005 for the building lease and all other
      lease commitments.





The
      following is a schedule by years of the future minimum lease payments under
      this
      capital lease and future minimum rental payments required under operating
      leases, together with the present value of the net minimum lease payments at
      June 30, 2007:





Fiscal
                year ending June 30
            
            Capital
              Lease
            
            
            Operating
              Leases2008
            
            $
            82,560
            
            
            $
            378,5972009
            
            
            52,140
            
            
            
            383,4592010
            
            
            10,500
            
            
            
            365,2702011
            
            
            --
            
            
            
            60,6642012
                and thereafter
            
            
            --
            
            
            
            --Total
                minimum lease payments
            
            $
            145,200
            
            
            $
            1,187,990Less
                amount representing interest
            
            
            (11,374
            )Present
                value of net minimum lease payments
            
            $
            133,826Less
                current portion at June 30, 2007
            
            
            74,148Long-term
                portion at June 30, 2007
            
            $
            59,678





During
      fiscal 2001, the Company entered into supply partnership agreements with two
      offshore contract manufacturing firms that exclusively manufacture medical
      devices in a regulated environment.  These two firms manufacture
      specific products designated by the Company in accordance with formal purchase
      orders.  The initial term of the agreements is for a period of three
      years and is automatically extended for additional periods of two years each,
      unless either party gives written notice at least sixty days prior to the end
      of
      the initial term or the then current extension term.  During fiscal
      2005, the Company ended the supply partnership agreement with one of the
      contract manufacturing firms.  To ensure an adequate supply of
      products manufactured by the remaining contract manufacturer is maintained,
      the
      agreement with this manufacturer, requires that this firm keeps on hand in
      its
      finished goods inventories one full month of supply of all products under
      current purchase orders.  At June 30, 2007 and 2006, a one month
      supply of product maintained at the firm would total approximately $350,000
      and
      $555,000, respectively.  In the event the Company would cancel a
      purchase order under the agreement, the Company would be required to purchase
      at
      cost all raw materials, work-in-progress and finished goods inventories for
      that
      purchase order.  The total work-in-process and raw material
      inventories for the agreement is approximately $350,000.  In addition,
      any property or equipment that this firm purchased specifically for the
      production of the Company's products would be purchased, by the Company, at
      mutually agreed upon prices in the event of termination of the
      agreement.  There have not been any purchase order cancellations under
      this agreement.





49


**13.****QUARTERLY
      RESULTS** - Unaudited





The
      following table contains quarterly information, which includes all adjustments,
      consisting only of normal recurring adjustments, that the Company considers
      necessary for a fair presentation.





**Quarters
                Ended (Unaudited)****June
                30,**
            
            
            **March
                31,**
            
            
            **Dec.
                31,**
            
            
            **Sept.
                30,**
            
            
            **June
                30,**
            
            
            **March
                31,**
            
            
            **Dec.
                31,**
            
            
            **Sept.
                30,****2007**
            
            
            **2007**
            
            
            **2006**
            
            
            **2006**
            
            
            **2006**
            
            
            **2006**
            
            
            **2005**
            
            
            **2005****(in
                thousands, except per share data)**Net
                sales
            
            $
            7,641
            
            
            $
            7,121
            
            
            $
            8,463
            
            
            $
            8,207
            
            
            $
            7,096
            
            
            $
            7,812
            
            
            $
            8,771
            
            
            $
            7,672Gross
                profit
            
            
            2,366
            
            
            
            2,877
            
            
            
            3,416
            
            
            
            3,121
            
            
            
            2,442
            
            
            
            3,089
            
            
            
            3,576
            
            
            
            2,935Net
                income (loss)
            
            
            (366
            )
            
            
            30
            
            
            
            351
            
            
            
            333
            
            
            
            (524
            )
            
            
            (8
            )
            
            
            607
            
            
            
            137Net
                income (loss) percommon
                share:—Basic
                and diluted
            
            
            (0.03
            )
            
            
            0.00
            
            
            
            0.03
            
            
            
            0.03
            
            
            
            (0.04
            )
            
            
            (0.00
            )
            
            
            0.05
            
            
            
            0.01





The
      Company typically receives a substantial volume of its quarterly sales orders
      at
      or near the end of each quarter.  In anticipation of meeting this
      expected demand, the Company usually builds a significant inventory of finished
      products throughout each quarter.  If the expected volume of sales
      orders is not received during the quarter, or is received too late to allow
      the
      Company to ship the products ordered during the quarter, the Company's quarterly
      results and stock of finished inventory can be significantly
      affected.  During the fourth quarter of fiscal 2006, the Company
      reevaluated the allowance for doubtful accounts and increased the allowance
      by
      $529,700.





**14.****OTHER INCOME**





Royalty
      income was $18,100, $313,500 and $177,203 for the years ended June 30, 2007,
      2006 and 2005, respectively.  The Company recognized $300,000 of
      income pursuant to a patent license agreement for the year ended June 30,
      2006.





50


**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and Stockholders of Criticare Systems, Inc.


Waukesha,
      Wisconsin





We
      have
      audited the accompanying consolidated balance sheets of Criticare Systems,
      Inc.
      and subsidiaries as of June 30, 2007 and 2006, and the related consolidated
      statements of operations, stockholders' equity, and cash flows for each of
      the
      three years in the period ended June 30, 2007.  These financial
      statements are the responsibility of the Company's management.  Our
      responsibility is to express an opinion on these financial
      statements  based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States).  Those standards require
      that we plan and perform the audit to obtain reasonable assurance about whether
      the financial statements  are free of material
      misstatement.  The Company is not required to have, nor were we
      engaged to perform, an audit of its internal control over financial
      reporting.  Our audits included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting.  Accordingly, we express no such opinion.  An
      audit includes examining, on a test basis, evidence supporting the amounts
      and
      disclosures in the financial statements, assessing the accounting principles
      used and significant estimates made by management, as well as evaluating the
      overall financial statement presentation.  We believe that our audits
      provide a reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Criticare Systems, Inc.
      and
      subsidiaries at June 30, 2007 and 2006, and the results of its operations and
      its cash flows for each of the three years in the period ended June 30, 2007,
      in
      conformity with accounting principles generally accepted in the United States
      of
      America.





/s/
      BDO
      Seidman, LLP


Milwaukee,
      Wisconsin


September
      24, 2007





51





Item 9.
            CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON    ACCOUNTING
                AND FINANCIAL DISCLOSURE.





Not
                applicable.





Item 9A.
            CONTROLS
                AND PROCEDURES.





As
      of the end of the period covered by
      this report, the Company carried out an evaluation, under the supervision and
      with the participation of the Company’s management, including the Company’s
      Chief Executive Officer and the Company’s Vice President – Finance, of the
      Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and
      15d-15(e) under the Securities Exchange Act of 1934, as
      amended).  Based upon this evaluation, the Company’s Chief Executive
      Officer and Vice President – Finance concluded that, as of the end of such
      period, the Company’s disclosure controls and procedures were effective in
      recording, processing, summarizing and reporting, on a timely basis, information
      required to be disclosed by the Company in reports that the Company files with
      or submits to the Securities and Exchange Commission.  It should be
      noted that in designing and evaluating the disclosure controls and procedures,
      management recognized that any controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives, and management necessarily was required to apply
      its
      judgment in evaluating the cost-benefit relationship of possible controls and
      procedures.  The Company has designed its disclosure controls and
      procedures to reach a level of reasonable assurance of achieving the desired
      control objectives and based upon the evaluation described above, the Company’s
      Chief Executive Officer and Vice President – Finance concluded that the
      Company’s disclosure controls and procedures were effective at reaching that
      level of reasonable assurance.





There
      was no change in the Company’s
      internal control over financial reporting (as defined in Rules 13a-15(f) and
      15d-15(f) under the Securities Exchange Act of 1934, as amended) during the
      Company’s most recently completed fiscal quarter that has materially affected,
      or is reasonably likely to materially affect, the Company’s internal control
      over financial reporting.





Item
      9B.   OTHER INFORMATION.





Not
      applicable.


52





PART
      III





Item
      10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
      GOVERNANCE.





Information
      regarding the executive
      officers and directors of the Company is incorporated herein by reference to
      the
      discussions under "Election of Directors," "Section 16(a) Beneficial Ownership
      Reporting Compliance," "Executive Officers," "Audit Committee Matters—Audit
      Committee Financial Expert" and "Corporate Governance Matters—Code of Business
      Ethics" in the Company's Proxy Statement for the 2007 Annual Meeting of
      Stockholders which will be filed on or before October 29, 2007 (the
      "Criticare Proxy Statement").





The
      Audit
      Committee of the Company's Board of Directors is an "audit committee" for
      purposes of Section 3(a)(58)(A) of the Securities Exchange Act of
      1934.  The members of the Audit Committee are Dr. Higgins D. Bailey,
      Jeffrey T. Barnes, Dr. N.C. Joseph Lai and Robert E. Munzenrider
      (Chairman).





Item
      11.   EXECUTIVE COMPENSATION.





Information
      regarding executive
      compensation is incorporated herein by reference to the discussion under
      "Executive Compensation" and "Director Compensation" in the Criticare Proxy
      Statement.





The
      information incorporated by
      reference from the "Report of the Compensation Committee" in the Criticare
      Proxy
      Statement shall not be deemed "filed" for purposes of Section 18 of the
      Securities Exchange Act of 1934, nor shall it be deemed incorporated by
      reference in any filing under the Securities Act of 1933 or the Securities
      Exchange Act of 1934, except as shall be expressly set forth by specific
      reference in such filing.





Item
                12.
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS.





Information
      regarding security
      ownership of certain beneficial owners and management is incorporated herein
      by
      reference to the discussion under "Security Ownership" in the Criticare Proxy
      Statement.





The
      following table summarizes share
      information for the Company’s equity compensation plans as of June 30, 2007,
      including the 2003 Stock Option Plan, the 1992 Employee Stock Option Plan,
      the
      1992 Non-Employee Stock Option Plan, the 1987 Employee Stock Option Plan, the
      1987 Non-Employee Stock Option Plan and the Company’s Employee Stock
      Purchase Plan.




53





**Equity
                Compensation Plan
                Information**





Plan
                category
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
            Weighted
                average exercise price of outstanding options, warrants and
                rights
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities in first
                column)Equity
                compensation plans approved by security holders
            597,873
                shares
            $3.24
                per share
            843,687
                sharesEquity
                compensation plans not approved by security holders
            30,000
                shares
            $2.88
                per share
            0
                sharesTotal
            627,873
                shares
            $3.22
                per share
            843,687
                shares




As
      noted in the table above, the
      Company has issued warrants to a consultant which have not been approved by
      the
      Company’s stockholders.  The Company extended warrants for the
      purchase of 30,000 shares of Common Stock issued to the consultant expiring
      in
      February 2003 for an additional five years with an exercise price of $2.88
      per
      share.





Item
                13.
            CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
                INDEPENDENCE.





Information
      regarding review and
      approval of related party transactions is incorporated herein by reference
      to
      the discussion under "Corporate Governance Matters-Review and Approval of
      Related Person Transactions" in the Criticare Proxy Statement.





Information
      regarding director independence is incorporated herein by reference to the
      discussion under "Corporate Governance Matters-Director Independence" in the
      Criticare Proxy Statement.





Item
      14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES.





Information
      regarding the fees and
      services of the independent registered public accounting firm is incorporated
      herein by reference to the discussion under “Audit Committee Matters—Fees of
      Independent Registered Public Accounting Firm” in the Criticare Proxy
      Statement.





54


PART
      IV





Item
                15.
            EXHIBITS
                AND FINANCIAL STATEMENT
                SCHEDULES





(a)           
      The following documents are filed as part of this report:





1.
            Financial
                Statements.  The following consolidated financial statements
                of the Company are included in Item 8 of this
                report.





Consolidated
      Balance Sheets - as of
      June 30, 2007 and 2006.





Consolidated
      Statements of Operations - for the years ended June 30, 2007, 2006 and
      2005.





Consolidated
      Statements of Stockholders' Equity - for the years ended June 30, 2007,
      2006 and 2005.





Consolidated
      Statements of Cash Flows - for the years ended June 30, 2007, 2006 and
      2005.





Notes
      to consolidated financial
      statements.





Report
      of
      Independent Registered Public Accounting Firm.





2.    Financial Statement Schedules:





Report
      of Independent Registered Public
      Accounting Firm.





Financial
      Statement Schedule for the
      years ending June 30, 2007, 2006 and 2005:





Schedule
              Number
            Description
            PageII
            Valuation
                and Qualifying
              Accounts
                and Reserves
            62





All
      other schedules for which provision
      is made in the applicable accounting regulations of the Securities and Exchange
      Commission are not required under the related instructions, are inapplicable
      or
      the required information is shown in the financial statements or notes thereto,
      and therefore have been omitted.





55


3.    Exhibits:





3.1           Restated
      Certificate of Incorporation of the Company (incorporated by reference to the
      Registration Statement on Form S-1, Registration
      No. 33-13050).





3.2           Restated
      By-Laws of the Company (incorporated by reference to the Company's Current
      Report on Form 8-K filed on March 17, 2006).





4.1           Specimen
      Common Stock certificate (incorporated by reference to the Registration
      Statement filed on Form S-1, Registration No. 33-13050).





4.2           Amended
      and Restated Rights Agreement, dated as of March 27, 2007, between the Company
      and LaSalle Bank National Association, as rights agent (incorporated by
      reference to the Company's Current Report on Form 8-K filed on March 27,
      2007).





10.1*       2003
      Stock Option Plan, as amended (and form of stock option grant agreement, stock
      appreciation right grant agreement and restricted stock grant agreement)
      (incorporated by reference to the Company's Current Report on Form 8-K
      filed on December 7, 2005).





10.2*       1999
      Employee Stock Purchase Plan (incorporated by reference to the Company's Annual
      Report on Form 10-K for the year ended June 30, 1999).





10.3*       1992
      Employee Stock Option Plan (incorporated by reference to the Company's
      Registration Statement on Form S-8, Registration
      No. 33-60644).





10.4*       1992
      Nonemployee Stock Option Plan (incorporated by reference to the Company's
      Registration Statement on Form S-8, Registration
      No. 33-60214).





10.5*       1987
      Employee Stock Option Plan (incorporated by reference to the Company's
      Registration Statement on Form S-8, Registration
      No. 33-33497).





10.6*      
1987
      Nonemployee Stock Option Plan (incorporated by reference to the Company's
      Registration Statement on Form S-8, Registration
      No. 33-40038).





10.7*       Form
      of Executive Officer and Director Indemnity Agreement (incorporated by reference
      to the Company's Registration Statement on Form S-1, Registration
      No. 33-13050).





10.8*       Employment
      Agreement of Emil H. Soika (incorporated by reference to the Company's Current
      Report on Form 8-K filed on September 8, 2005).





56




10.9*       Employment
        Agreement of Drew M. Diaz (incorporated by reference to the Company's Annual
        Report on Form 10-K for the year ended June 30, 2006).
 
 10.10       Supply
        Partnership Agreement, dated as of August 1, 2000, between the Company and
        BioCare Corporation (incorporated by reference to the Company’s Annual Report on
        Form 10-K for the year ended June 30, 2001).
 
 10.11*     Employment Agreement of Joseph P.
        Lester (incorporated by reference to the Company’s Quarterly Report on Form 10-Q
        for the quarter ended September 30, 2002).
 
 10.12*     
        Employment Agreement of Deborah A. Zane (incorporated by reference to the
        Company's Annual Report on Form 10-K for the year ended June 30,
        2005).
 
 10.13*      Employment
        Agreement of Joel D. Knudson (incorporated by reference to the Company's
        Annual
        Report on Form 10-K for the year ended June 30, 2005).
 
 10.14*      Employment
        Agreement of Michael Larsen (incorporated by reference to the Company's Annual
        Report on Form 10-K for the year ended June 30, 2005).
 
 10.15*      Amendment
        to Employment Agreement of Emil H. Soika effective September 28, 2006
        (incorporated by reference to the Company’s Annual Report on Form 10-K for the
        year ended June 30, 2006).
 
 10.16*      Amendment
        to Employment Agreement of Joseph P. Lester effective September 28, 2006
        (incorporated by reference to the Company’s Annual Report on Form 10-K for the
        year ended June 30, 2006).
 
 10.17*      Amendment
        to Employment Agreement of Deborah A. Zane effective September 28, 2006
        (incorporated by reference to the Company’s Annual Report on Form 10-K for the
        year ended June 30, 2006).
 
 10.18*      Amendment
        to Employment Agreement of Joel D. Knudson effective September 28, 2006
        (incorporated by reference to the Company’s Annual Report on Form 10-K for the
        year ended June 30, 2006).




57


10.19*     Amendment to Employment Agreement of
      Michael T. Larsen effective September 28, 2006 (incorporated by reference
      to the Company’s Annual Report on Form 10-K for the year ended June 30,
      2006).





21            Subsidiaries.





23.1         Consent
      of BDO Seidman, LLP.







31.1         Certification
      of Emil H. Soika, President and Chief Executive Officer (Principal Executive
      Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.





31.2         Certification
      of Joel D. Knudson, Vice President – Finance and Secretary (Principal Financial
      Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.





32**        Certification
      of Principal Executive Officer and Principal Financial Officer pursuant to
      18
      U.S.C. Section 1350.


__________________


*
      Management contract or compensatory plan or arrangement.





**
      This
      Certification is not “filed” for purposes of Section 18 of the Securities
      Exchange Act of 1934, as amended, or incorporated by reference into any filing
      under the Securities Act of 1933, as amended, or the Securities Exchange Act
      of
      1934, as amended.





(b)           Exhibits.





The
      response to this
      portion of Item 15 is submitted as a separate section of this
      report.





(c)           Financial
      Statement Schedules.





The
      response to this
      portion of Item 15 is submitted as a separate section of this
      report.





58


SIGNATURES





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





CRITICARE
      SYSTEMS, INC.





By/s/
      Emil H.
      Soika


Emil
      H.
      Soika, President


and
      Chief
      Executive Officer





Date:  September
      27, 2007








POWER
      OF
      ATTORNEY





KNOW
      ALL
      MEN BY THESE PRESENTS, that each person whose signature appears below
      constitutes and appoints Emil H. Soika and Joel D. Knudson, and each of them,
      as
      his true and lawful attorneys-in-fact and agents, with full power of
      substitution and resubstitution, for him and in his name, place and stead,
      in
      any and all capacities, to sign any and all amendments to this Annual Report
      on
      Form 10-K and to file the same, with all exhibits thereto and other
      documents in connection therewith, with the Securities and Exchange Commission,
      granting unto said attorneys-in-fact and agents, and each of them full power
      and
      authority to do and perform each and every act and thing requisite and necessary
      to be done in connection therewith, as fully to all intents and purposes as
      he
      might or could do in person, hereby ratifying and confirming all that said
      attorneys-in-fact and agents, or any of them, or their or his substitute or
      substitutes, may lawfully do or cause to be done by virtue hereof.





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




Signature
            
            Title
            
            Date/s/
              Emil H. Soika
            
            President,
                Chief Executive Officer
            
            September
                27, 2007Emil
                H. Soika
            
            and
                Director (Principal ExecutiveOfficer)/s/
              Joel D. Knudson
            
            Vice
                President-Finance and Secretary
            
            September
                27, 2007Joel
                D. Knudson
            
            (Principal
                Financial and AccountingOfficer)






59




/s/
              N.C. Joseph Lai
            
            Director
            
            September
                27, 2007N.C.
                Joseph Lai, Ph.D./s/
              Jeffrey T. Barnes
            
            Director
            
            September
                27, 2007Jeffrey
                T. Barnes/s/
              Robert E. Munzenrider
            
            Director
            
            September
                27, 2007Robert
                E. Munzenrider/s/
              William M. Moore
            
            Director
            
            September
                27, 2007William
                M. Moore








60


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders of


Criticare
      Systems, Inc.


Waukesha,
      Wisconsin





The
      audits referred to in our report dated September 24, 2007 relating to the
      consolidated financial statements of Criticare Systems, Inc., which is contained
      in Item 8 of this Form 10-K included the audit of the financial statement
      schedule listed in Item 15.  This financial statement schedule is the
      responsibility of the Company's management.  Our responsibility is to
      express an opinion on this financial statement schedule based upon our
      audits.





In
      our
      opinion, such financial statement schedule presents fairly, in all material
      respects, the information set forth therein.







/s/
      BDO
      Seidman, LLP


Milwaukee,
      Wisconsin


September
      24, 2007





61


SCHEDULE II





CRITICARE
      SYSTEMS, INC.





VALUATION
      AND QUALIFYING ACCOUNTS


FOR
      THE
      YEARS ENDED JUNE 30, 2007, 2006 AND 2005








Column
                A
            
            Column
                B
            
            
            Column
                C
            
            
            Column
                D
            
            
            Column
                EDescription
            
            Balance
                at
              Beginning
              of
                Period
            
            
            Charged
                to
              Costs
                and
              Expenses
            
            
            Deductions
            
            
            Balance
                at
              End
                of
              PeriodYEAR
                ENDED JUNE 30, 2005:Allowance
                for doubtful accounts
            
            $
            260,000
            
            
            $
            87,695
            
            
            $
            47,695
            
            
            $
            300,000Reserve
                for sales returns and
              allowances
            
            $
            77,945
            
            
            $
            --
            
            
            $
            --
            
            
            $
            77,945Reserve
                for obsolete inventory
            
            $
            610,000
            
            
            $
            281,003
            
            
            $
            452,703
            
            
            $
            438,300YEAR
                ENDED JUNE 30, 2006:Allowance
                for doubtful accounts
            
            $
            300,000
            
            
            $
            559,206
            
            
            $
            29,506
            
            
            $
            829,700Reserve
                for sales returns and
              allowances
            
            $
            77,945
            
            
            $
            --
            
            
            $
            37,945
            
            
            $
            40,000Reserve
                for obsolete inventory
            
            $
            438,300
            
            
            $
            56,622
            
            
            $
            134,922
            
            
            $
            360,000YEAR
                ENDED JUNE 30, 2007:Allowance
                for doubtful accounts
            
            $
            829,700
            
            
            $
            (44,221
            )
            
            $
            287,841
            
            
            $
            497,638Reserve
                for sales returns and
              allowances
            
            $
            40,000
            
            
            $
            --
            
            
            $
            --
            
            
            $
            40,000Reserve
                for obsolete inventory
            
            $
            360,00
            
            
            $
            167,144
            
            
            $
            152,144
            
            
            $
            375,000








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