<PAGE>   1
MISSION STATEMENT
                                   [CSI LOGO]

                FOUNDED IN 1984, CRITICARE SYSTEMS, INC. (CSI) IS

             DEDICATED TO ADDRESSING THE NEEDS OF A RAPIDLY CHANGING

                    HEALTH CARE SYSTEM BY DESIGNING, MANUFACTURING,

                  AND MARKETING COST-EFFECTIVE PATIENT MONITORING

              SYSTEMS AND NONINVASIVE SENSORS--USING PROPRIETARY

                  TECHNOLOGY-THAT REDUCE HEALTH CARE COSTS AND

                           IMPROVE PATIENT MANAGEMENT.

================================================================================
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>


                                                               Years Ended June 30,
------------------------------------------------------------------------------------------------------------------
                                    1998              1997             1996              1995             1994
------------------------------------------------------------------------------------------------------------------
<S>                               <C>              <C>               <C>              <C>              <C>        
Net Sales                         $27,908,364      $26,235,355       $31,528,266      $28,660,275      $30,114,679

Income (Loss) Before Income
  Taxes and Extraordinary Gain      $(499,276)      (2,749,435)       (4,280,989)         175,643          114,141

Net Income (Loss)                   $(499,276)      (2,179,489)       (4,330,989)         105,643           64,141

Net Income (Loss) Per
  Common Share-Basic and
  Diluted                              ($0.06)           (0.30)            (0.63)            0.02             0.01

Average Shares
  Outstanding                       8,309,240        7,267,184         6,913,557        6,764,236        6,719,979

Stockholders' Equity              $17,282,997       14,227,135        13,917,549       17,130,449       17,022,753

Long-term Obligations              $3,165,258        5,110,934         4,669,975        3,646,867        3,835,751

Working Capital                   $13,716,891       12,053,165        10,282,033       13,401,741       13,258,880

Total Assets                      $24,726,819       25,145,066        27,075,922       25,468,428       25,171,231
</TABLE>



                                       2
<PAGE>   2

LETTER TO STOCKHOLDERS


Dear Fellow Stockholders:

During this past fiscal year, your Company continued its strategy to capitalize
on the opportunities that "managed care" represents. In contrast to the previous
"fee for service" system, managed care and its "cousin" capitation, limit
reimbursement levels on a per patient basis. In order to reduce the cost of care
under these conditions, health care providers strive to reduce the average
length of a hospital stay, decrease the number of elective procedures performed,
and more rigorously evaluate whether a patient qualifies for hospitalization.

The effect of all of this is that fewer patients are ultimately hospitalized,
but their acuity levels are higher, meaning that they are more seriously ill.
While a hospital's census may be lower than before, the arrival of managed care
has created a greater need for monitoring. Criticare's answer to this dilemma
was the introduction of MPT(TM) Multiple Parameter Telemetry, the world's first
patient-borne monitor that permits a physician to continually assess a patient's
cardiovascular and pulmonary status (i.e., ECG, blood pressure, pulse rate, and
oxygen saturation) anywhere in the hospital. This continuous surveillance of
vital signs permits more rapid assessment and timely treatment of adverse
conditions to improve clinical outcomes.

During our first year of marketing the MPT, we have focused on penetrating key
institutions that are reputed to be technology leaders in the health care
industry. The first article describing the benefits of MPT was published this
past summer. We expect more to follow in the coming months.

Our product development efforts have turned toward a new line of portable,
handheld products which we expect to be ready for shipment in the second fiscal
quarter of 1999. A natural spin-off of these products will include OEM modules
for several of our proprietary technologies as we anticipate expanding our share
of OEM markets.

Regarding Criticare's investment in Immtech, the Board of Directors approved a
spin-off of 750,000 Immtech common shares to Company shareholders in the form
of a stock dividend. The spin-off is expected to be consummated immediately
prior to the effectiveness of a public offering of Immtech common shares and
warrants. It is subject to a number of conditions, including a filing with the
Securities and Exchange Commission. However, no assurance can be given at this
time that the spin-off will be consummated.

While our past year's sales and earnings do not yet fully reflect the potential
impact that telemetry systems will ultimately contribute to revenues, we are
confident that the Company is well positioned to capitalize further on the
changing healthcare environment during this coming year. We are happy to report,
however, that efforts to streamline operations have been successful. Operating
expenses were significantly reduced due to various cost cutting measures
and our current ratio improved to a level of 4.2 as compared to 3.1 one year
ago.

On behalf of the management and the Board of Directors, we would like to thank
our devoted associates, our loyal customers, our quality-conscious vendors, and
our dedicated stockholders for their continued support.

Sincerely,



Gerhard J. Von der Ruhr                                 N.C. Joseph Lai, Ph.D.
President and Chief Executive Officer                   Senior Vice President


                                       3


<PAGE>   3







                         [PICTURES OF COMPANY PRODUCTS]






                                       4
<PAGE>   4










                         [PICTURES OF COMPANY PRODUCTS]






                                       5
<PAGE>   5











                         [PICTURES OF COMPANY PRODUCTS]





                                       6
<PAGE>   6
MANAGEMENT'S DISCUSSION AND ANALYSIS        

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.

<TABLE>
<CAPTION>

                                                                           PERCENTAGES OF NET SALES
                                                                               YEAR ENDED JUNE 30,                              
            --------------------------------------------------------------------------------------------
                                                                         1998          1997         1996
            --------------------------------------------------------------------------------------------
<S>                                                                     <C>           <C>          <C>    
            Net sales                                                   100.0%        100.0%       100.0% 
            Cost of goods sold                                           53.3          53.6         52.5
            --------------------------------------------------------------------------------------------
            Gross profit                                                 46.7          46.4         47.5
            --------------------------------------------------------------------------------------------
            
            Operating expenses:
            Marketing                                                    26.7          33.4         37.1
            Research, development and engineering                        11.7           8.8          8.1
            Administrative                                                7.2           9.6          6.0
            --------------------------------------------------------------------------------------------
            Total                                                        45.6          51.8         51.2
            --------------------------------------------------------------------------------------------
            
            Income (loss) from operations                                 1.1          (5.4)        (3.7)
            Interest expense                                             (2.9)         (4.0)        (1.4)
            Interest income                                                .4            .1           .1
            Equity in loss of investments                                 (.4)         (1.2)        (8.6)
            --------------------------------------------------------------------------------------------
            Loss before income taxes and
                extraordinary gain                                       (1.8)        (10.5)       (13.6)
            --------------------------------------------------------------------------------------------
            Income tax provision                                           --            --           .1
            Extraordinary gain on extinguishment of debt                   --           2.2           --
            --------------------------------------------------------------------------------------------
            Net loss                                                     (1.8)%        (8.3)%      (13.7)%
            --------------------------------------------------------------------------------------------
</TABLE>

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

Net sales for the twelve months ended June 30, 1998 increased 6.3% to
$27,908,364 from $26,235,355 for the twelve months ended June 30, 1997. The
sales increase is attributable to the alternate care sales and new OEM sales.

The gross profit percentage remained relatively consistent at 46.7% versus 46.4%
in fiscal 1997. Margins in domestic hospital, alternate care, and international
all remained relatively consistent with those of the prior year.

Operating expenses of $12,731,695 decreased 6.3% from fiscal 1997 levels. In
addition, operating expenses as a percentage of sales decreased to 45.6% from
51.8% in fiscal 1997. The largest savings occurred in the marketing expenses
where spending levels were reduced by approximately $1,300,000. The reduction in
marketing expenses was primarily related to international spending. The Company
consolidated several international functions at the home office in the United
States. This resulted in a savings of over $850,000. Administrative expenses for
fiscal 1998 decreased by 20.4% from fiscal 1997 levels, due to liquidation
expenses incurred in fiscal 1997 related to Criticare International. The reduced
expenses in marketing and administration were partially offset by an increase of
41.3% in research, development, and engineering expenses, which resulted from a
$900,000 charge associated with the acquisition of in-process technology related
to the transmission of clinical data.

Interest expense decreased during fiscal 1998 due to no borrowings on the line
of credit during the year. Interest income increased during fiscal 1998 due to
higher cash balances on hand throughout the year. Equity in the loss of
investments relates to a $120,000 advance provided to Immtech International,
Inc.

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

Net sales for the twelve months ended June 30, 1997 decreased 17% to $26,235,355
from $31,528,266 for the twelve months ended June 30, 1996. Domestic hospital
sales decreased 40%, due to lower unit sales in all products and continued
competitive pricing conditions. In addition, marketing and sales efforts in this
division were concentrated on the market introduction of the
MPT(TM)/VitalView(TM) telemetry product. Alternate care sales decreased 12% and
international sales decreased 8%, due primarily to lower oximeter and gas
monitor sales due to a combination of competitive pricing and market demand
conditions in these two market areas.


                                        7

<PAGE>   7
MD&A (CONT'D)

The gross profit percentage decreased to 46.4% in fiscal 1997 from 47.5% in
fiscal 1996. This decrease was due primarily to increased manufacturing expenses
related to new product introductions, the effect of lower sales volume on fixed
manufacturing expenses and continued price competition in the oximetry product
line affecting both the alternate care and international sales markets. Although
the Company has developed and released lower cost vital signs and telemetry
monitors and continues to develop lower cost oximeter and gas products, the
effect of pricing competition may continue to negatively affect gross profit
margins.

Operating expenses of $13,591,892 for fiscal 1997 decreased 16% from $16,155,513
for fiscal 1996. As a percentage of net sales, operating expenses increased to
51.8% in fiscal 1997 from 51.2% in fiscal 1996. Marketing expenses for fiscal
1997 decreased 25% to $8,761,731 from $11,686,368 for fiscal 1996 due primarily
to decreased sales commissions related to the lower sales volume and lower
advertising and sales promotion expenses. Research, development and engineering
expenses for fiscal 1997 decreased 10%, or $248,057 from fiscal 1996 expense
levels due to slightly lower staffing and project expenses. Administrative
expenses increased 32% or $609,073 when compared to fiscal 1996 due to an
increased provision for doubtful accounts receivable of $236,382 and costs
associated with a judgment against and the liquidation of Criticare
International GmbH Marketing Services ("Criticare International") of $417,553
offset in part by lower insurance costs.

Interest expense increased during fiscal 1997 due to increased short-term line
of credit borrowings and the interest and purchase discount associated with the
$2,500,000 convertible debentures issued during February 1997. Interest income
declined slightly due to lower cash balances invested during fiscal 1997. Equity
in loss of investments for fiscal 1997 included cash advances of $24,000 to
Immtech International, Inc. and a $300,000 charge related to the write-off of an
investment in a sleep apnea company compared to the fiscal 1996 charge of
$2,716,163 related to cash advances to and the purchase of 2,200,000 shares of
Immtech International, Inc. preferred stock.

Extraordinary gain on extinguishment of debt in the amount of $569,946 resulted
from the exchange of 200,000 shares of newly issued restricted Criticare common
stock in full payment of the $1,240,000 promissory note plus accrued interest of
approximately $110,000 associated with the fiscal 1996 purchase of Immtech
International, Inc. preferred stock.

QUARTERLY RESULTS

The following table contains unaudited quarterly information, which includes all
adjustments, consisting only of normal recurring adjustments, that the Company
considers necessary for a fair presentation. The Company recorded a charge of
$900,000 for the purchase of patented technology in the quarter ended June 30,
1998 and charges of $418,000 for a judgment against and the liquidation of
Criticare International and $300,000 for the write-off of the Intercare
Technologies, Inc. investment in the quarter ended June 30, 1997. These items
were unusual, nonrecurring adjustments.

<TABLE>
<CAPTION>

                                                                    QUARTERS ENDED
                          Sept. 30,     Dec. 31,     March 31,     June 30,     Sept. 30,    Dec. 31,     March 31,     June 30,
                             1996        1996         1997           1997         1997         1997          1998         1998
                                                        (in thousands, except per share data)
<S>                       <C>          <C>           <C>           <C>           <C>          <C>          <C>          <C>    
Net sales                 $ 6,478      $ 6,581       $ 5,481       $ 7,695       $ 7,544      $ 7,138      $ 6,279      $ 6,947
Gross profit                3,124        3,061         2,444         3,547         3,506        3,273        2,919        3,340
Income (loss) from
  operations                  230         (151)         (618)         (877)          586          422           70         (772)

Extraordinary gain
   on extinguishment
   of debt                     --           --           570            --            --           --           --           --
Net income (loss)              51         (297)         (284)       (1,649)          172          132           19         (822)
Net income (loss)
   per common
   share--Basic               .01         (.04)         (.04)         (.23)          .02          .02          .00         (.10)
        --Diluted             .01         (.04)         (.04)         (.23)          .02          .02          .00         (.10)

</TABLE>


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.

                                       8

<PAGE>   8
LIQUIDITY AND CAPITAL RESOURCES

In fiscal 1998, the Company generated $448,434 from operating activities,
$194,431 from the exercise of stock options, $120,000 from the issuance of
common stock, and $82,000 from the exercise of warrants. The Company used
$147,441 for retirement of long-term debt, $288,285 for capital expenditures and
$120,000 for advances to Immtech International, Inc. These sources and uses of
cash resulted in a net positive cash flow of $289,139 for the 1998 fiscal year.

In fiscal 1997, the Company generated $1,491,171 from operating activities,
$2,500,000 from the issuance of convertible debentures, $400,919 from the
exercise of stock options and $180,000 from the exercise of warrants. The
Company used $2,300,000 for the retirement of borrowings under the bank line of
credit facility, $220,657 for costs associated with the issuance of the
convertible debentures, $217,619 for retirement of long-term debt, $175,600 for
capital expenditures and $24,000 for advances to Immtech International, Inc.
These sources and uses of cash resulted in a net positive cash flow of
$1,634,214 for the 1997 fiscal year.

The mortgage note requires monthly debt service payments of approximately
$35,000 with a final payment of approximately $2,702,000 due in December 2002.

The Company expects its continued programs to increase accounts receivable
collections, decrease inventory levels, reduce product development tooling
requirements, stabilize sales demonstration equipment levels and eliminate
advances to Immtech International, Inc. will have a positive affect on cash flow
activities in the next fiscal year. Consequently, the Company believes its
research and development activities and other capital and liquidity requirements
for the next one to two years will be satisfied by cash generated from
operations and other borrowings. During fiscal 1998, the Company also had access
to a commercial bank line of credit of up to $4,000,000. At June 30, 1998, there
were no borrowings outstanding on the line of credit. The Company violated a
convenant related to achieving certain income levels. The bank waived compliance
with this covenant subsequent to year end. This line expires in November 1998.
The Company currently expects that this line will be renewed.

The Company's Board of Directors has approved a spin-off of 750,000 Immtech
common shares to Company shareholders in the form of a stock dividend. The
spin-off is expected to be consummated immediately prior to the effectiveness of
a public offering of Immtech common shares and warrants. The spin-off is subject
to a number of conditions, including a filing with the Securities and Exchange
Commission, and no assurances can be given that the spin-off will be
consummated.

YEAR 2000 PREPARATIONS

The Company has developed a plan to address company-wide Year 2000 readiness.
The Year 2000 issue relates to computer hardware and software and other systems
designed to use two digits rather than four digits to define the applicable
year. As a result, the Year 2000 would be translated as two zeroes. Because the
Year 1900 could also be translated as two zeroes, systems which use two digits
could read the date incorrectly for a number of date-sensitive applications
resulting in potential calculation errors or the shutdown of major systems. The
Company is in the process of updating its internal computer software, other
information technology and other operating systems for the purposes of Year 2000
compliance. The Company will also address the Year 2000 compliance of the
Company's new and existing products. The Company currently expects to complete
its Year 2000 compliance plan during fiscal 1999 and does not expect that its
costs to become Year 2000 compliant will be material to its financial condition
or results of operations.

The Company's operations may also be adversely affected to the extent that
suppliers and other third parties are not Year 2000 compliant. The Company
intends to circulate surveys to its key third party vendors during fiscal 1999
to assess the Year 2000 compliance status of the operating systems of such
vendors and the potential impact on the Company of non-compliance. However, a
number of risks relating to the Year 2000 issue may be out of the Company's
control, including reliance on outside links for essential services such as
communications and power. There can be no assurance that a failure of systems of
third parties on which the Company's systems and operations will rely to be Year
2000 compliant will not have a material adverse effect on the Company's
business, financial condition or operating results.

FORWARD-LOOKING STATEMENTS

A number of the matters and subject areas discussed in this Annual Report that
are not historical or current facts deal with potential future circumstances and
developments. These include expected future financial results, liquidity needs,
financing ability, Year 2000 compliance, management's or the Company's
expectations and beliefs and similar matters discussed in Management's
Discussion and Analysis or elsewhere in this Annual Report. The discussions of
such matters and subject areas are qualified by the inherent risk and
uncertainties surrounding future expectations generally, and also may materially
differ from the Company's actual future experience.

The Company's business, operations and financial performance are subject to
certain risks and uncertainties which could result in material differences in
actual results from management's or the Company's current expectations. These
risks and uncertainties include, but are not limited to, general economic
conditions, demand for the Company's products and costs of operations.



                                       9

<PAGE>   9
BALANCE SHEETS

CRITICARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1998 AND 1997



<TABLE>
<CAPTION>

ASSETS                                                          1998          1997
-------------------------------------------------------------------------------------
<S>                                                         <C>           <C>
CURRENT ASSETS (NOTE 5):
Cash and cash equivalents (Note 1)                          $ 2,729,998   $ 2,440,859
Accounts receivable, less allowance for doubtful accounts
 of $300,000 and $467,000, respectively                       6,921,713     7,182,237
Other receivables                                               322,976       236,855
Inventories (Notes 1 and 2)                                   7,682,471     7,730,591
Prepaid expenses                                                338,297       269,620
-------------------------------------------------------------------------------------
Total  current  assets                                       17,995,455    17,860,162
-------------------------------------------------------------------------------------

PROPERTY, PLANT AND EQUIPMENT (NOTES 1 AND 5):
Land                                                            925,000       925,000
Building                                                      3,600,000     3,600,000
Machinery and equipment                                       1,796,120     1,674,488
Furniture and fixtures                                          712,428       617,451
Demonstration and loaner monitors                             1,783,611     1,781,698
Production tooling                                            2,005,834     2,137,986
-------------------------------------------------------------------------------------
Property, plant and equipment - cost                         10,822,993    10,736,623
Less accumulated depreciation                                 4,210,622     3,691,894
-------------------------------------------------------------------------------------
Property,  plant  and  equipment - net                        6,612,371     7,044,729
-------------------------------------------------------------------------------------

INVESTMENTS (NOTES 1, 3 AND 5)                                     --            --
-------------------------------------------------------------------------------------


OTHER ASSETS (NOTES 1 AND 5):
License rights and patents - net                                118,993       124,882
Convertible debenture issuance costs - net                         --         115,293
-------------------------------------------------------------------------------------
Total  other  assets                                            118,993       240,175
-------------------------------------------------------------------------------------

TOTAL                                                       $24,726,819   $25,145,066
=====================================================================================
</TABLE>

See notes to consolidated financial statements.




                                       10

<PAGE>   10
<TABLE>
<CAPTION>



LIABILITIES AND STOCKHOLDERS' EQUITY                                               1998               1997
---------------------------------------------------------------------------------------------------------------

CURRENT LIABILITIES:
<S>                                                                             <C>               <C>         
Accounts payable                                                                $ 2,305,721       $  3,112,112
 Accrued liabilities:
    Compensation and commissions                                                    819,886          1,000,552
    Product warranties (Note 1)                                                     328,000            370,000
    Other (Note 7)                                                                  715,603          1,176,891
 Current maturities of long-term debt (Note 5)                                      109,354            147,442
---------------------------------------------------------------------------------------------------------------
Total  current  liabilities                                                       4,278,564          5,806,997
---------------------------------------------------------------------------------------------------------------



LONG-TERM DEBT, LESS CURRENT MATURITIES (NOTE 5)                                  3,165,258          3,274,611
---------------------------------------------------------------------------------------------------------------

CONVERTIBLE DEBENTURES (NOTE 6)                                                          --          1,836,323
---------------------------------------------------------------------------------------------------------------

CONTINGENCIES (NOTE 7)


STOCKHOLDERS' EQUITY (NOTES 5, 6 AND 8):
Preferred stock - $.04 par value, 500,000 shares authorized,
    no shares issued or outstanding                                                      --                 --
Common stock - $.04 par value, 10,000,000 shares authorized,
    8,351,151 and 7,796,465 shares issued and outstanding, respectively             334,046            311,859
Additional paid-in capital                                                       17,964,250         14,469,406
Retained earnings (accumulated deficit)                                          (1,015,299)          (516,023)
Cumulative translation adjustments                                                       --            (38,107)
----------------------------------------------------------------------------------------------------------------
Total  stockholders'  equity                                                     17,282,997         14,227,135
---------------------------------------------------------------------------------------------------------------


TOTAL                                                                           $24,726,819        $25,145,066
===============================================================================================================
</TABLE>




                                       11

<PAGE>   11
OPERATIONS

CRITICARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1998, 1997 AND 1996

<TABLE>
<CAPTION>

                                                        1998              1997              1996
<S>                                                <C>               <C>               <C>        
NET SALES (NOTE 10)                                $ 27,908,364      $ 26,235,355      $ 31,528,266

COST OF GOODS SOLD                                   14,870,453        14,059,508        16,531,970
---------------------------------------------------------------------------------------------------

GROSS PROFIT                                         13,037,911        12,175,847        14,996,296
---------------------------------------------------------------------------------------------------


OPERATING EXPENSES:
Marketing                                             7,454,619         8,761,731        11,686,368
Research, development and engineering (Note 8)        3,278,714         2,320,655         2,568,712
Administrative                                        1,998,362         2,509,506         1,900,433
---------------------------------------------------------------------------------------------------
Total                                                12,731,695        13,591,892        16,155,513
---------------------------------------------------------------------------------------------------

INCOME (LOSS) FROM OPERATIONS                           306,216        (1,416,045)       (1,159,217)
---------------------------------------------------------------------------------------------------

OTHER INCOME (EXPENSE):
Interest expense                                       (797,376)       (1,048,391)         (447,348)
Interest income                                         111,884            39,001            41,739
Equity in loss of investments (Notes 1 and 3)          (120,000)         (324,000)       (2,716,163)
---------------------------------------------------------------------------------------------------
Total                                                  (805,492)       (1,333,390)       (3,121,772)
---------------------------------------------------------------------------------------------------

LOSS BEFORE INCOME TAXES
    AND EXTRAORDINARY GAIN                             (499,276)       (2,749,435)       (4,280,989)

INCOME TAX PROVISION (NOTES 1 AND 4)                       --                --              50,000
---------------------------------------------------------------------------------------------------

LOSS BEFORE EXTRAORDINARY GAIN                         (499,276)       (2,749,435)       (4,330,989)

EXTRAORDINARY GAIN ON EXTINGUISHMENT
    OF DEBT (NOTE 5)                                       --             569,946              --
---------------------------------------------------------------------------------------------------

NET LOSS                                           $   (499,276)     $ (2,179,489)     $ (4,330,989)
===================================================================================================

LOSS PER COMMON SHARE--
BASIC AND DILUTED: (NOTE 1)
Before extraordinary gain                          $       (.06)     $       (.38)     $       (.63)
Extraordinary gain                                         --                 .08              --   
---------------------------------------------------------------------------------------------------
NET LOSS PER COMMON SHARE                          $       (.06)     $       (.30)     $       (.63)
===================================================================================================

WEIGHTED AVERAGE NUMBER OF COMMON
    SHARES OUTSTANDING (NOTE 8):
Basic                                                 8,309,240         7,267,184         6,913,557
Diluted                                               8,309,240         7,267,184         6,913,557
===================================================================================================

</TABLE>

See notes to consolidated financial statements.


                                       12

<PAGE>   12
STOCKHOLDERS' EQUITY

CRITICARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1998, 1997 AND 1996



<TABLE>
<CAPTION>


                                                                 Additional   Retained Earnings  Cumulative     Total
                                         Common Stock             Paid-In       (Accumulated    Translation   Stockholders' 
                                    Shares         Amount         Capital          Deficit)     Adjustments     Equity
--------------------------------------------------------------------------------------------------------------------------    

<S>                               <C>              <C>          <C>            <C>             <C>            <C>        
BALANCE, JUNE 30, 1995            6,697,218        $267,889     $10,884,910    $5,994,455      $ (16,805)     $17,130,449

Common stock issued in connection
   with an acquisition              333,154          13,326         882,674                                       896,000
Exercise of options and warrants     97,900           3,916         227,534                                       231,450
Foreign currency translation
   adjustments                                                                                    (9,361)          (9,361)
Net loss                                                                       (4,330,989)                     (4,330,989)
-------------------------------------------------------------------------------------------------------------------------

BALANCE, JUNE 30, 1996            7,128,272         285,131      11,995,118     1,663,466        (26,166)      13,917,549

Common stock issued in connection
   with extinguishment of debt      200,000           8,000         772,000                                       780,000
Exercise of options and warrants    252,020          10,081         570,838                                       580,919
Convertible debentures converted
   to common stock, net of $61,872
   of unamortized issuance costs    216,173           8,647       1,047,075                                     1,055,722
Issuance of warrants for services                                    84,375                                        84,375
Foreign currency translation
   adjustments                                                                                   (11,941)         (11,941)
Net loss                                                                       (2,179,489)                     (2,179,489)

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


BALANCE, JUNE 30, 1997            7,796,465        $311,859     $14,469,406     $(516,023)      $(38,107)     $14,227,135

Issuance of common stock             20,425             817         119,183                                       120,000
Exercise of options and warrants    126,500           5,060         271,371                                       276,431
Convertible debentures converted
   to common stock, net of $100,822
   of unamortized issuance costs    407,761          16,310       2,181,225                                     2,197,535
Commitment to issue common
   stock for patented technology                                    900,000                                       900,000
Issuance of warrants for services                                    23,065                                        23,065
Foreign currency translation
   adjustments                                                                                    38,107           38,107
Net loss                                                                         (499,276)                       (499,276)
-------------------------------------------------------------------------------------------------------------------------


BALANCE, JUNE 30, 1998            8,351,151        $334,046     $17,964,250   $(1,015,299)            --      $17,282,997
=========================================================================================================================   
</TABLE>


See notes to consolidated financial statements.


                                                     13




<PAGE>   13

CASH FLOWS

CRITICARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1998, 1997 AND 1996

<TABLE>
<CAPTION>


                                                                              1998         1997          1996
OPERATING ACTIVITIES:
<S>                                                                      <C>            <C>            <C>
Net loss                                                                 $  (499,276)   $(2,179,489)   $(4,330,989)
Adjustments to reconcile net loss to net cash
   provided by (used in) operating activities:
       Depreciation                                                          721,476        709,618        601,682
       Amortization                                                           21,440         74,749         44,706
       Interest and discount accrued on convertible debentures               462,034        451,438             --
       Provision for doubtful accounts                                        99,000        366,505        130,123
       Expense related to equity in loss of investments                      120,000        324,000      2,716,163
       Expense related to issuance of warrants for services                   23,065         84,375             --
       Expense related to commitment to issue common stock
           for patented technology                                           900,000             --             --
       Extraordinary gain on extinguishment of debt                               --       (569,946)            --
       Changes in assets and liabilities:
            Accounts receivable                                              161,524      2,321,416     (1,391,941)
            Other receivables                                                (86,121)       117,783        (75,180)
            Inventories                                                       46,207         93,351       (911,053)
            Prepaid expenses                                                 (68,677)       (81,488)       (21,160)
            Accounts payable                                                (768,284)      (509,017)       938,269
            Accrued liabilities                                             (683,954)       287,876        531,777
------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities                          448,434      1,491,171     (1,767,603)
-------------------------------------------------------------------------------------------------------------------

INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net                             (287,205)      (134,785)    (1,576,304)
Purchase of license rights                                                    (1,080)       (40,815)            --
Advances to Immtech International, Inc.                                     (120,000)       (24,000)      (580,163)
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                       (408,285)      (199,600)    (2,156,467)
-------------------------------------------------------------------------------------------------------------------

FINANCING ACTIVITIES:
Borrowings (payments) under line of credit facility                               --     (2,300,000)     2,300,000
Proceeds from the issuance of convertible debentures                              --      2,500,000             --
Principal payments on long-term debt                                        (147,441)      (217,619)      (199,013)
Convertible debenture issuance costs                                              --       (220,657)            --
Proceeds from issuance of common stock                                       396,431        580,919        231,450
------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities                                    248,990        342,643      2,332,437
------------------------------------------------------------------------------------------------------------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                         289,139      1,634,214     (1,591,633)

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                               2,440,859        806,645      2,398,278
------------------------------------------------------------------------------------------------------------------

CASH AND CASH EQUIVALENTS, END OF YEAR                                   $ 2,729,998    $ 2,440,859    $   806,645
==================================================================================================================

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for:
   Income taxes (refunded) paid--net                                     $     8,525    $   (87,626)   $   133,783
   Interest                                                                  335,342        456,880        414,784
Noncash investing and financing activities:
   Common stock issued in connection with extinguishment of debt                  --        780,000             --
   Common stock issued upon conversion of convertible debentures,
       net of $100,822 and $61,872 of unamortized issuance costs           2,197,535      1,055,722             --
   Issuance of warrants for services                                          23,065         84,375             --
   Commitment to issue common stock for patented technology                  900,000             --             --
   Purchase of preferred stock of Immtech International, Inc. and a
       note receivable in exchange for common stock and a note payable
        
        Common stock                                                              --             --        896,000
        Note payable                                                              --             --      1,240,000
==================================================================================================================
</TABLE>

See notes to consolidated financial statements.

                                       14
                                        
<PAGE>   14
NOTES TO FINANCIAL STATEMENTS


CRITICARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1998, 1997  AND 1996


1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
     include the accounts of Criticare Systems, Inc. (the "Company") and its
     wholly owned subsidiaries: Criticare International GmbH Marketing Services
     ("Criticare International"), CSI Trading, Inc. ("CSI Trading"), Criticare
     Service GmbH, Criticare Biomedical, Inc. ("Criticare Biomedical"), Sleep
     Care, Inc. ("Sleep Care"), Criticare (FSC), Inc. and CSI International
     Corp. (DISC). Criticare International was liquidated during fiscal 1998.
     CSI Trading was incorporated in November 1996 to assist with European
     marketing activities. 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.

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

     INVESTMENTS -- The Company accounts for its investment in Intercare
     Technologies, Inc. ("Intercare") on the cost method and accounts for its
     investment in Immtech International, Inc. ("Immtech") and Blatz House
     Offices Limited Partnership (the "Blatz Partnership") on the equity method
     (see Note 3).

     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. Also, the
     Company 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 building is
     being depreciated over 40 years, and the remaining assets are being
     depreciated over three to seven years, using primarily the straight-line
     method.

     LICENSE RIGHTS AND PATENTS -- License rights and patents are amortized over
     the estimated useful lives of the related agreements using primarily the
     straight-line method. Approximately $7,000, $9,000, and $42,000 of
     amortization was charged to operations in 1998, 1997 and 1996,
     respectively. Accumulated amortization approximated $78,000 and $71,000 at
     June 30, 1998 and 1997, respectively.

     CONVERTIBLE DEBENTURE ISSUANCE COSTS -- Convertible debenture issuance
     costs were amortized over the two-year term of the debentures.
     Approximately $15,000 and $46,000 of amortization was charged to operations
     in 1998 and 1997. The prorata amount of unamortized debenture issuance
     costs were charged to additional paid-in-capital upon conversion of the
     debentures to common stock. Unamortized debenture issuance costs charged to
     additional paid-in capital amounted to $100,822 and $61,872 during 1998 and
     1997. (See Note 6.)

     GOODWILL -- Goodwill relating to the excess of the cost over the fair value
     of the net assets of an acquired subsidiary was amortized on the
     straight-line method over approximately five years. Approximately $20,000
     and $29,000 of amortization was charged to operations in 1997 and 1996,
     respectively. The goodwill was fully amortized as of June 30, 1997.

     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.

     PRODUCT WARRANTIES -- Estimated costs for product warranties are accrued
     for and charged to operations as the related products are shipped.

     RESEARCH AND DEVELOPMENT EXPENSES -- Research and development costs are
     charged to operations as incurred. Such expenses approximated $3,156,000,
     $2,175,000 and $2,400,000 in 1998, 1997 and 1996, respectively. The 1998
     amount includes $900,000 related to certain acquired patented technology
     which was charged to operations as in-process research and development
     costs at the time of the acquisition. (See Note 8.)

     INCOME TAXES -- The Company accounts for income taxes using an asset and
     liability approach. Deferred income tax assets and liabilities are computed
     annually for differences between the financial statement and tax bases 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.

     FOREIGN CURRENCY TRANSLATION -- The effects of unrealized exchange rate
     fluctuations from translating foreign currency assets and liabilities into
     United States dollars are accumulated as cumulative translation adjustments
     in stockholders' equity. Realized gains and losses from foreign currency
     transactions are included in operating results for the period.


                                       15

<PAGE>   15

NOTES (CONT'D)

     NET INCOME (LOSS) PER COMMON SHARE -- On July 1, 1997, the Company adopted
     SFAS No. 128, "Earnings Per Share." Under SFAS No. 128, the Company changed
     the method used to compute earnings per share and restated all prior
     periods. The Company now reports basic and diluted earnings per share in
     place of primary and fully diluted earnings per share.

     FAIR VALUE OF FINANCIAL STATEMENTS -- The Company's financial instruments
     under Statement of Financial Account Standards ("SFAS") No. 107 "Disclosure
     About Fair Value of Financial Instruments," includes cash, accounts
     receivable, accounts payable, borrowings under line of credit facility,
     long-term debt and convertible debentures. 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 and convertible debentures, because of interest rates
     available to the Company for similar obligations.

     APPROVED ACCOUNTING STANDARDS -- In 1997, the Financial Accounting Standard
     Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income" and
     SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
     Information" which will be effective for the Company in fiscal 1999. The
     Company is currently evaluating the impact of adopting SFAS Nos. 130 and
     131. In 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
     Pensions and Other Postretirement Benefits." This statement is required to
     be adopted in fiscal 1999. SFAS No. 132 will have no impact on the
     Company's financial statements as the Company does not have a pension plan
     and it does not provide postretirement benefits. In 1998, the FASB also
     issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
     Activities." This statement is required to be adopted in fiscal 2000. The
     Company is currently in the process of evaluating the impact of adopting
     SFAS No. 133.

     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.

2.   INVENTORIES

     Inventories consist of the following:

<TABLE>
<CAPTION>
                                                1998                    1997
<S>                                          <C>                     <C>  
              Component parts                $2,647,231              $2,867,884
              Work in process                 1,409,187               1,843,018
              Finished units                  3,626,053               3,019,689
              -----------------------------------------------------------------
              Total inventories              $7,682,471              $7,730,591
              -----------------------------------------------------------------
</TABLE>

3.   INVESTMENTS

     INTERCARE TECHNOLOGIES, INC. -- During 1992, the Company's subsidiary,
     Sleep Care, transferred certain assets to Intercare Technologies, Inc.
     ("Intercare") in exchange for 75,000 shares of convertible preferred stock
     of Intercare with an estimated fair value of $300,000, at that time. In
     connection with the transfer, Sleep Care licensed to Intercare the rights
     to certain intellectual property and technology, primarily license rights
     and patents, related to products previously marketed by Sleep Care. In
     exchange for the license rights, the Company is to receive royalties of 5%
     of the gross revenues from sales of products licensed under the agreement.
     Royalty income approximated $33,000 in 1996. No income was recognized
     during 1998 and 1997. The assets retained by Sleep Care were fully
     amortized as of June 30, 1996. Amortization of the intellectual property
     approximated $8,000 in 1996. During the year ended June 30, 1997,
     management of the Company concluded the investment in Intercare was
     impaired and the carrying value of the investment was reduced from $300,000
     to zero.

     IMMTECH INTERNATIONAL, INC. -- During 1989, the Company acquired an initial
     investment interest in the common stock of Immtech International, Inc.
     ("Immtech") for $500,000. Immtech is a biopharmaceutical company focusing
     on the discovery and development of therapeutic products for the treatment
     of opportunistic diseases and cancer in patients with compromised immune
     responses. Immtech has two separate platform technologies for developing
     drugs, one based on developing a new class of molecules as pharmaceuticals
     and a second for developing a series of biological proteins that work in
     conjunction with the immune system.

     On December 21, 1995, the Company's subsidiary, Criticare Biomedical,
     purchased from Marquette Venture Partners II, L.P. and MVP Affiliates Fund,
     L.P. (collectively, the "Sellers") 1,000,000 shares of the $.01 par value
     Series A Preferred Stock ("Series A"), 1,200,000 shares of the $.01 par
     value Series B Preferred Stock ("Series B") of Immtech and a promissory
     note payable by Immtech to the Sellers in the principal amount of $50,000
     for approximately $2,136,000 payable in the form of 333,154 shares of the
     Company's common stock and a note payable for $1,240,000. Subsequent to
     June 30, 1998, the Series A and B preferred stock was exchanged for
     1,569,364 shares of Immtech's common stock. The Series A and Series B
     preferred stock were originally convertible by the holders to an equivalent
     number of shares of Immtech common stock and were redeemable at the option
     of the holders in December 1997.

                                       16

<PAGE>   16
     The Series A and Series B preferred stock had cumulative dividend
     preferences at a rate of 8% per annum. The Series A and Series B preferred
     stock contained voting rights equivalent to the number of shares of common
     stock issuable upon conversion.

     The acquisition price was assigned a value of approximately $2,136,000
     based upon an estimate by Company management of the fair value of the
     consideration given by the Company. The investment in Immtech is accounted
     for using the equity method. The purchase price was allocated to in-process
     research and development and charged to expense as an investment loss upon
     the consummation of the agreement. There was no significant tax benefit
     available on this charge.

     The following is a summary of the Company's investment in and advances to
     Immtech as of June 30, 1998 and 1997:

     Investment in Immtech:         
<TABLE>
<CAPTION>

                                                                                  1998                    1997
             <S>                                                            <C>                     <C>
              Common Stock                                                    $  500,000              $  500,000
              Series A and B preferred stock                                   2,086,000               2,086,000
              --------------------------------------------------------------------------------------------------
              Total                                                            2,586,000               2,586,000
              Advances to Immtech                                                863,940                 743,940
              --------------------------------------------------------------------------------------------------
              Total                                                            3,449,940               3,329,940
              Less investment losses recognized                               (3,449,940)             (3,329,940)
              --------------------------------------------------------------------------------------------------
              Net investment                                                  $        0              $        0
              --------------------------------------------------------------------------------------------------
</TABLE>   

     The Series A and Series B preferred stock owned by the Company had a stated
     redemption value of approximately $3,398,000 and $3,150,000 as of June 30,
     1997 and 1996, respectively. The Company has recognized investment losses
     related to the investment in Immtech of $120,000, $24,000 and $2,716,163 in
     1998, 1997 and 1996, respectively. As of June 30, 1998, the Company owned
     approximately 5.3% and 65% of Immtech's issued and outstanding common and
     preferred stock respectively, or approximately 30% of the common stock on a
     fully diluted and as converted basis.

     Immtech was incorporated in 1984. Thus far, Immtech has directed its
     efforts toward research and development, hiring scientific and management
     personnel, arranging for facilities and conducting clinical trials. Immtech
     has no products currently available for sale, and none are expected to be
     commercially available for several years. Immtech has a March 31 fiscal
     year end.

     Since inception, Immtech has incurred accumulated losses of approximately
     $13,262,000 through March 31, 1998. Immtech is expected to continue to
     incur significant losses during the next several years. In addition, as of
     March 31, 1998, Immtech's current liabilities exceeded its current assets
     by approximately $3,639,000 and Immtech had a common stockholders'
     deficiency of approximately $9,022,000. In addition, Immtech was not in
     compliance with certain of its note agreements. These factors, among
     others, indicate that Immtech may be unable to continue as a going concern.

     Immtech's ability to continue as a going concern is dependent upon its
     ability to generate sufficient funds to meet its obligations as they become
     due and ultimately, to obtain profitable operations. Immtech's financial
     plans for the forthcoming year include the continuing efforts to obtain
     additional equity financing.

     The following is summarized financial information for Immtech at March 31,
     1998 and 1997 and for the years then ended.
<TABLE>
<CAPTION>

                                                                                   1998                    1997
             <S>                                                              <C>                     <C>
              Current assets                                                  $   14,000              $   93,000
              Noncurrent assets                                                   57,000                  96,000
              Current liabilities                                              3,653,000               3,139,000
              Noncurrent liabilities                                               --                      --
              Redeemable preferred stock                                       5,440,000               5,108,000
              Common stockholders' equity (deficit)                           (9,022,000)             (8,058,000)
              Revenues                                                            20,000                  15,000
              Net loss                                                        (1,146,000)             (1,351,000)
              Net loss attributable to common stockholders                    (1,477,000)             (1,619,000)
</TABLE>

     Subsequent to June 30, 1998, the Company purchased certain intangible
     assets and an additional 172,414 shares of Immtech common stock for
     $150,000. On July 24, 1998 (the "Effective Date"), Immtech completed a
     recapitalization (the "Recapitalization") pursuant to which: (i) Immtech
     effected a 0.645260-for-1 reverse stock split of all of the shares of
     common stock issued and outstanding immediately prior to the Effective
     Date, resulting in the reduction in the number of issued and outstanding
     shares of common stock from 2,305,166 to 1,487,431 (the "Reverse Stock
     Split"); (ii) Immtech's debtholders converted approximately $2,780,000 in
     stockholder advances (including the Company's advances), notes payable and
     related accrued interest outstanding immediately prior to the Effective
     Date into 1,209,962 shares of Immtech common stock (after giving effect to
     the Reverse Stock Split); (iii) Immtech's Series A Preferred stockholders
     converted 1,794,550 shares of Series A Preferred Stock issued and
     outstanding immediately prior to the Effective Date into 1,157,951 shares
     of common stock (after giving effect to the Reverse Stock Split); (iv)
     Immtech's Series B Preferres stockholders converted 1,600,000 shares of
     Series B Preferred Stock issued and outstanding immediately prior to the
     Effective Date into 1,232,138 shares of common stock (after giving effect
     to the Reverse Stock Split).
                                       17

<PAGE>   17
NOTES (CONT'D)


     Contemporaneously with the completion of the Recapitalization, Immtech
     issued and sold 1,150,000 shares of common stock for $0.87 per share, or
     aggregate consideration to Immtech of $1,000,000 to certain accredited
     investors. After the Recapitalization and issuance of 1,150,000 shares of
     common stock, the Company owned 2,187,684 shares of Immtech's issued and
     outstanding common stock, or approximately 28% on a fully-diluted basis.

     BLATZ PARTNERSHIP -- The Company is the sole limited partner in a real
     estate limited partnership which owns the Blatz Phase II Commercial Office
     Buildings located in Milwaukee, Wisconsin. Under terms of the Partnership
     Agreement (the "Agreement"), profits and losses (other than those resulting
     from a sale or refinancing of the Project) are to be allocated 40% to the
     general partners and 60% to the Company.

     The carrying value of the investment is zero. Recognition of any income by
     the Company for its interest in the Blatz Partnership will occur only after
     the Blatz Partnership has earnings in excess of previously unrecorded
     losses.


     The following is summarized financial information for the Blatz Partnership
     at June 30, 1998 and 1997 and for the years then ended:


<TABLE>
                                                               1998                    1997
         <S>                                                 <C>                  <C>        
         Current assets                                       $504,000             $   360,000
         Noncurrent assets                                   3,644,000               3,975,000
         Current liabilities                                 1,911,000               1,689,000
         Noncurrent liabilities                              4,679,000               4,679,000
         Net deficit                                        (2,442,000)             (2,033,000)
         Revenues                                              742,000                 799,000
         Net loss                                             (453,000)               (349,000)
</TABLE>

4.   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 on 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.

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


<TABLE>
<CAPTION>
                                                                   JUNE 30,            JUNE 30,           JULY 1,
                                                                     1998                1997              1996

<S>                                                              <C>                <C>                  <C>       
     Deferred income tax assets:
         Accounts receivable and sales allowances                $  156,000         $   237,000       $  312,000
         Inventory allowances                                       110,000             207,000           43,000
         Product warranties                                         128,000             144,000          117,000
         Other accrued liabilities                                   86,000              98,000           80,000
         Federal net operating loss carryforwards                 1,870,000           1,717,000          736,000
         State net operating loss carryforwards                     270,000             255,000          188,000
         Federal tax credit carryforwards                           152,000             198,000          198,000
         Investment losses not deducted                           1,481,000           1,434,000        1,307,000
-----------------------------------------------------------------------------------------------------------------
         Total deferred income tax assets                         4,253,000           4,290,000        2,981,000
-----------------------------------------------------------------------------------------------------------------

     Deferred income tax liabilities:
         Excess of tax over book depreciation and amortization     (596,000)         (1,007,000)        (928,000)
-----------------------------------------------------------------------------------------------------------------
         Prepaid expenses                                            (3,000)             (6,000)          (5,000)
-----------------------------------------------------------------------------------------------------------------
         Total deferred income tax liabilities:                    (599,000)         (1,013,000)        (933,000)
-----------------------------------------------------------------------------------------------------------------

     Valuation allowance                                         (3,654,000)         (3,277,000)      (2,048,000)
-----------------------------------------------------------------------------------------------------------------
     Net deferred income taxes recognized in the
         consolidated balance sheets                             $        0         $         0       $        0
-----------------------------------------------------------------------------------------------------------------
</TABLE>





                                       18

<PAGE>   18
     At June 30, 1998, the Company had Federal net operating loss carryforwards
     of approximately $5,500,000 which expire in 2008 through 2013. At June 30,
     1998, the Company had available for federal income tax purposes
     approximately $41,000 of alternative minimum tax credit carryforwards which
     carry forward indefinitely and approximately $111,000 tax credit
     carryforwards which expire in the years 2007 through 2009. The Company also
     has approximately $5,400,000 of state net operating loss carryforwards,
     which expire in 2002 through 2013, available to offset certain future state
     taxable income.

     The income tax provision consists of the following:

<TABLE>
<CAPTION>
                                                                         1998             1997             1996
     <S>                                                                <C>             <C>              <C>    
     Current
         Federal                                                        $   0           $     0          $35,000
         State                                                              0                 0           15,000
-----------------------------------------------------------------------------------------------------------------
         Total income tax provision                                     $   0           $     0          $50,000
-----------------------------------------------------------------------------------------------------------------
</TABLE>

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

<TABLE>
<CAPTION>
                                                                         1998              1997              1996
         <S>                                                            <C>               <C>               <C>    
         Federal statutory income tax rate                              (34.0)%           (34.0)%           (34.0)%
         Losses for which no benefit was provided                        30.9              29.1              13.4
         Non-deductible losses of subsidiaries                                              4.0              21.6
         Other--net                                                       3.1                .9                .1
------------------------------------------------------------------------------------------------------------------
         Effective income tax rate                                          0%                0%              1.1%
------------------------------------------------------------------------------------------------------------------
</TABLE>


5.   LINE OF CREDIT FACILITY AND LONG-TERM DEBT

<TABLE>
<CAPTION>
     Long-term debt consists of the following:                                           1998             1997
<S>                                                                                   <C>              <C>       
         Mortgage note, 9.625%, due in monthly installments of $34,983 with a
            final payment of $2,688,336 due in December 2002, collateralized by
            real estate with a carrying value of
            approximately $4,024,000 at June 30, 1997                                 $3,274,612       $3,366,046
         Bank note 8.5%, due in monthly installments of $11,440 through                                             
            November 1997, collateralized by certain machinery and                                                  
            equipment with a carrying value of approximately $52,000                                                
            at June 30, 1997                                                                  --           56,007   
------------------------------------------------------------------------------------------------------------------
         Total                                                                         3,274,612        3,422,053   
         Less current maturities                                                         109,354          147,442   
------------------------------------------------------------------------------------------------------------------
         Long-term debt                                                               $3,165,258       $3,274,611 
------------------------------------------------------------------------------------------------------------------  
</TABLE>

     Aggregate annual principal payments required under terms of the long-term
debt agreements are as follows:

<TABLE>
<CAPTION>
               YEARS ENDING JUNE 30,              PRINCIPAL PAYMENTS
                     <S>                           <C>
                     1999                          $   109,354
                     2000                              120,356
                     2001                              132,465
                     2002                              145,793
                     2003                            2,766,644
               -----------------------------------------------------
                     Total                           $3,274,612
</TABLE>

     At June 30, 1998, the Company had a $4,000,000 demand line of credit
     facility with a commercial bank to meet its short-term borrowing needs.
     Borrowings against the line were payable on demand with interest payable
     monthly at the bank's reference rate (8.75% as of June 30, 1998). As of
     June 30, 1998, there were no borrowings against the line. The line expires
     on November 15, 1998. Borrowings under the line of credit facility are
     collateralized by substantially all assets of the Company.

     In March 1997, the Company satisfied the $1,240,000 promissory note plus
     interest accrued on the note of approximately $110,000 in exchange for
     200,000 shares of newly issued common stock. Under the provisions of the
     agreement, the shares must be held for one full year prior to resale. In
     conjunction with this transaction, the Company recorded an extraordinary
     gain on the extinguishment of debt of $569,946 for the outstanding
     indebtedness under the promissory note in excess of the estimated fair
     market value of the restricted stock.


                                            19

<PAGE>   19
NOTES (CONT'D)


6.   CONVERTIBLE DEBENTURES

     In February 1997, the Company issued $2,500,000 of convertible debentures.
     The debentures had a two year term to maturity with a stated annual
     interest rate of 8%, payable in shares of common stock at the conversion
     date or maturity date. The holders of the debentures had the option to
     convert up to $1,250,000 of the debentures and accrued interest to common
     stock of the Company sixty-one (61) days after the February 1997 closing
     date at a conversion price equal to a 20% discount from the average closing
     bid price of the Company's common stock for the five days preceding the
     conversion date. Debentures aggregating $550,000 were converted under the
     20% discount conversion feature. The remaining debentures and accrued
     interest were converted to common stock of the Company at a conversion
     price equal to a 25% discount from the average closing bid price of the
     Company's common stock for the five days preceding the conversion date. For
     the years ended June 30, 1998 and 1997, $1,650,000 and $850,000 of
     debentures were converted to 407,761 and 216,173 shares of common stock
     with a fair market value of $2,298,357 and $1,117,594 as of the conversion
     dates.

     Proceeds from the issuance of the debentures were recorded as a liability
     at the issuance date. The conversion discount was amortized and reported as
     additional interest expense over the life of the debentures. Additional
     interest expense was recognized for any unamortized discount as of the
     conversion date. The debentures were included in the accompanying June 30,
     1997 consolidated balance sheet at the issuance price, plus any accrued
     interest and amortized discount.


7.   CONTINGENCIES

     The Company is involved in various lawsuits that have arisen from the
     normal conduct of business. These proceedings are handled by outside
     counsel. In the opinion of management, the ultimate resolution of these
     matters will not have a material effect on the consolidated financial
     statements.

     The Company has received two grants from the State of Wisconsin for
     research and development of certain products. The grants are to be repaid
     only upon successful completion and marketing of the related product.
     Repayment of these grants is to be made on a sales by unit basis, up to an
     aggregate of $600,000. Repayments approximated $14,000 and $30,000 in 1997
     and 1996, respectively, and in the aggregate, approximated $246,000 as of
     June 30, 1998. The repayments are charged to expense as the related
     products are sold. The Company has been awarded a third grant from the
     State of Wisconsin for an amount up to $100,000 which requires repayment of
     the grant amount plus interest at 8%, plus payment of a royalty in the
     amount of 1% of net sales of the related product for a five-year period, as
     defined. No funds have been received under this grant at June 30, 1998.


8.   STOCKHOLDERS' EQUITY

     STOCK OPTIONS -- In December 1992, the Board of Directors approved a new
     Employee Stock Option Plan and Non-Employee Stock Option Plan. No new stock
     options can be granted under the Employee Stock Option Plan and
     Non-Employee Stock Option Plan which existed prior to the approval of the
     new plans. The Board of Directors has authorized in connection with these
     new plans the issuance of 1,220,000 reserved shares of common stock of
     which 198,650 reserved shares of common stock remain available for future
     issuance under the stock option plans at June 30, 1998. The activity during
     1996, 1997 and 1998 for the above plans are summarized as follows:

<TABLE>
<CAPTION>
                                                 NUMBER OF        STOCK OPTIONS        WEIGHTED AVG.
                                                   SHARES          PRICE RANGE         EXERCISE PRICE
         <S>                                       <C>               <C>                   <C>
         Outstanding at July 1, 1995               1,040,900         $1.88-8.50            $2.30
          Granted                                    246,000          2.13-3.75             2.82
          Cancelled                                 (123,580)         2.00-5.75             2.25
          Exercised                                  (93,900)         2.00-2.63             2.38
        ----------------------------------------------------------------------------------------------
         Outstanding at June 30, 1996              1,069,420          1.88-8.50             2.45
          Granted                                    250,500          2.50-5.25             2.64
          Cancelled                                 (113,500)         2.00-8.50             3.38
          Exercised                                 (162,020)         2.00-2.63             2.47
        ----------------------------------------------------------------------------------------------
         Outstanding at June 30, 1997              1,044,400          1.88-5.25             2.40
          Granted                                     60,000          3.00-3.25             3.13
          Cancelled                                 (179,200)         2.00-5.25             2.38
          Exercised                                  (85,500)         2.00-2.75             2.27
        ----------------------------------------------------------------------------------------------
         Outstanding at June 30, 1998                839,700          1.88-3.63             2.50
        ----------------------------------------------------------------------------------------------
         Exercisable at June 30, 1998                645,700          1.88-3.63             2.38
        ----------------------------------------------------------------------------------------------
</TABLE>

The following table summarizes information about stock options outstanding as of
June 30, 1998:

                                       20

<PAGE>   20
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                              OPTIONS OUTSTANDING                                   OPTIONS EXERCISABLE
-----------------------------------------------------------------------------------------------------------------
                                     Weighted Average
                       Shares           Remaining           Weighted            Shares
    Range of        Outstanding        Contractual       Average Exercise     Exercisable        Weighted Average
Exercise Prices   at June 30, 1998     Life-Years            Price        at June 30, 1998        Exercise Price
-----------------------------------------------------------------------------------------------------------------
<S>                     <C>                <C>              <C>                 <C>                 <C>     
  $1.88-2.50            551,400            2.07             $2.21               443,900             $2.16
   2.51-3.63            288,300            2.79              2.91               201,800              2.87   
-----------------------------------------------------------------------------------------------------------------
   1.88-3.63            839,700            2.31              2.50               645,700              2.38
-----------------------------------------------------------------------------------------------------------------
</TABLE>

Outstanding options have fixed terms and are exercisable over a period
determined by the Compensation Committee of the Company's Board of Directors but
no longer than five years after the date of grant. A substantial portion of the
options issued are contingent on future services or future events.

At June 30, 1998, 1,038,350 shares of common stock were reserved under the above
plans.

The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," but applies Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its plans. If the Company had elected to
recognize compensation cost for the options granted during the years ended June
30, 1998, 1997, and 1996, 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:

<TABLE>
<CAPTION>

                                                                       YEARS ENDED JUNE 30,
                                                              1998            1997          1996
            <S>                                          <C>              <C>           <C>
            Net loss--as reported                          $(499,276)     $(2,179,489)  $(4,330,989)
            Net loss--pro forma                            $(779,276)     $(2,325,795)  $(4,390,340)
            Net loss per common share--as reported             $(.06)           $(.30)        $(.63)
            Net loss per common share--pro forma               $(.09)           $(.32)        $(.64)
            Assumptions used:
                Expected volatility                               14%              58%           58%
                Risk-free interest rate                            5%               6%            6%
                Expected option life (in years)                    3                3             3
</TABLE>


The fair value of stock options used to compute pro forma net loss and net loss
per common share is the estimated present value at the grant date using the
Black-Scholes option-pricing model. The pro forma effect on net loss for 1998,
1997, and 1996 is not representative of the pro forma effect in future years
because it does not take into consideration pro forma compensation cost related
to grants made prior to 1996.

STOCK WARRANTS -- In September 1995, 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 the common stock of the Company, exercisable
at a price of $2.00 per share. The warrant was exercisable as to 37,500 shares
upon execution of the agreement and the warrants to purchase the remaining
112,500 shares were to become exercisable if certain performance parameters were
achieved by September 1996. Such parameters were not met as of such date. In
January 1997, the agreement was extended and the parameters were changed. During
the year ended June 30, 1997, the Company recognized $84,375 of expense related
to the value of the services performed by the consultant under the extended
agreement. By June 30, 1997, warrants to purchase the remaining 112,500 shares
of common stock at a price of $2.00 per share became exercisable. The warrant
holder exercised rights and purchased 41,000, 90,000, and 4,000 shares of common
stock at $2.00 per share during the years ended June 30, 1998, 1997, and 1996,
respectively. Warrants to purchase 15,000 shares of common stock at $2.00 per
share were exercisable as of June 30, 1998. Such warrants expire in September
2000.

In February 1998, the Company executed a similar warrant agreement with the
consultant. The warrant agreement provides 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 is exercisable as to 30,000 shares upon execution of the agreement and
the warrants to purchase the remaining 120,000 shares will be exercisable if
certain performance parameters are achieved by February 1999. No such parameters
were achieved by June 30, 1998. During the year ended June 30, 1998, the Company
recognized $23,065 of expense related to the value of the services performed
under the agreement. As of June 30, 1998, 30,000 warrants were exercisable. Such
warrants expire in February 2003.

COMMITMENT TO ISSUE SHARES OF COMMON STOCK -- In April 1998, the Company agreed
to and accepted the patent rights assigned to them by a third party with respect
to certain technology related to the transmission of clinical data. In
consideration for the patent, the Company has agreed to provide the third party
with 400,000 shares of common stock payable over a four-year time period with
additional consideration of up to 112,000 shares contingent upon the achievement
of certain sales levels. The Company recorded a charge to operations of $900,000
in fiscal 1998 with respect to the value of the in-process technology which was
expensed as research and development costs. The 400,000 shares to be issued have
been considered to be outstanding shares for purposes of computing basic and
diluted income (loss) per common share. 

                                       21

<PAGE>   21
NOTES (CONT'D)

     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. No preferred stock is 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. 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 April 1, 2007.

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 $77,000, $81,000, and $61,000 in 1998, 1997 and 1996,
     respectively.

10.  BUSINESS AND CREDIT CONCENTRATIONS
     The Company's customers include domestic hospitals, domestic alternative
     health care sites and foreign health care markets. 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 and their geographic dispersion.

     The Company currently coordinates substantially all international sales and
     distribution activities. Such activities were previously provided by the
     Company with the assistance of Criticare International. Identifiable assets
     located outside of the United States are insignificant in relation to the
     Company's total assets. Net export sales by geographic area are as follows:

<TABLE>
<CAPTION>


                                                              1998                1997                1996
<S>                                                       <C>                  <C>              <C>         
            Europe and Middle East                        $ 5,464,000         $ 5,606,000        $ 6,417,000
            Pacific Rim                                     3,895,000           3,784,000          4,147,000
            Canada and Central and South America            3,414,000           3,867,000          4,012,000
            ------------------------------------------------------------------------------------------------
            Net Export Sales                              $12,773,000         $13,257,000        $14,576,000
            ------------------------------------------------------------------------------------------------

</TABLE>

INDEPENDENT AUDITORS' REPORT                                      

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

We have audited the accompanying consolidated balance sheets of Criticare
Systems, Inc. and subsidiaries as of June 30, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended June 30, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Criticare Systems, Inc. and
subsidiaries at June 30, 1998 and 1997 and the results of operations and their
cash flows for each of the three years in the period ended June 30, 1998, in
conformity with generally accepted accounting principles.




                                                           Deloitte & Touche LLP
                                                           Milwaukee, Wisconsin
                                                           August 20, 1998


                                       22
<PAGE>   22
FACT SHEET / DIRECTORS AND OFFICERS

FACT SHEET AS OF JULY 1, 1998
COMMON STOCK MARKET PRICE RANGE
AND DIVIDEND POLICY                                                             
                                                                                
Criticare Systems, Inc. common stock is traded on the Nasdaq                    
National Market (Symbol CXIM). As of June 30, 1998, there were                  
approximately 316 holders of record of Criticare's common stock. The            
Company has never paid dividends on its common stock and has no                 
plans to pay cash dividends in the foreseeable future.                          
                                                                                
<TABLE>
<CAPTION>                                                     
                                       YEAR ENDED JUNE 30,                      
                              1998                            1997              
<S>                    <C>            <C>            <C>             <C>    
Quarter Ended:         High           Low            High            Low        
September 30           $8             $4-3/8         $3-1/4          $2-3/8     
December 31            $6-5/8         $2-13/16       $3-1/16         $2-3/8     
March 31               $4-3/8         $2-5/8         $7-7/16         $2-1/2     
June 30                $3-3/4         $2-11/16       $6-1/16         $4-3/4     
                                                                                
                                                                                
</TABLE>                                            
                                                                                
NASDAQ SYMBOL: CXIM                                                             
                                                                                
CORPORATE GENERAL COUNSEL                   TRANSFER AGENT AND REGISTRAR        
Reinhart, Boerner, Van Deuren,              Firstar Trust Company               
Norris & Rieselbach, s.c.                   Milwaukee, Wisconsin                
Milwaukee, Wisconsin                                                            
                                            AUDITORS                            
                                            Deloitte & Touche LLP               
PATENT, TRADEMARK AND                       Milwaukee, Wisconsin                
COPYRIGHT COUNSEL                                                               
Reinhart, Boerner, Van Deuren,              CORPORATE HEADQUARTERS              
Norris & Rieselbach, s.c.                   20925 Crossroads Circle             
Milwaukee, Wisconsin                        Waukesha, WI 53186 U.S.A.           
                                                                                
                                                                                
                                                                                
ANNUAL MEETING OF STOCKHOLDERS                                                  
The annual meeting of stockholders will be held on Thursday,                    
November 12, 1998 at 9:00 a.m. at the Milwaukee Athletic Club,                  
758 North Broadway, Milwaukee, Wisconsin.                                       
                                                                                
                                                                                
FORMS 1O-K AND 1O-Q                                                             
The Company has filed an annual report with the Securities                      
and Exchange Commission on Form 1O-K. The Company also                          
files quarterly reports on Form 1O-Q. Stockholders may obtain                   
copies of these reports, without charge, by writing:                            
     Secretary                                                                  
     Criticare Systems, Inc.                                                    
     20925 Crossroads Circle                                                    
     Waukesha, Wisconsin 53186                                                  
     U.S.A.                                                                     
                                                                                

DIRECTORS

Milton Datsopoulos
Attorney and Partner
Datsopoulos, Macdonald & Lind

Karsten Houm
Management Consultant


N.C. Joseph Lai, Ph.D.
Vice Chairman of the Board,
Secretary,
Senior Vice President
Criticare Systems, Inc.

Gerhard J. Von Der Ruhr
Chairman of the Board, Treasurer,
President
Criticare Systems, Inc.

Officers and Senior Staff
Andrew Diaz
Vice President
International Sales

N.C.Joseph Lai, Ph.D.
Vice Chairman of the Board
Senior Vice President

Michael T. Larsen
Vice President 
Quality Control/Quality Assurance

Gloria Najera
Vice President
Operations

Stephen D. Okland
Vice President
Domestic Sales


Joseph M. Siekierski
Vice President-Finance
Assistant Secretary

Gerhard J. Von Der Ruhr
Chairman of the Board
President





                                       23