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

                                   FORM 10-KSB
(Mark One)

      |X|   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
            EXCHANGE ACT OF 1934

      For the fiscal year ended DECEMBER 31, 2003         OR

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

      For the transition period from                to
                                    ---------------    --------------

      Commission File Number: 0-21142

                              NEMATRON CORPORATION
                 (Name of small business issuer in its charter)

           MICHIGAN                                      38-2483796
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
 incorporation or organization)

                 5840 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
               (Address of principal executive offices) (Zip Code)

                                 (734) 214-2000
                           (Issuer's telephone number)

         Securities registered under Section 12(b) of the Exchange Act:

   Title of Each Class                   Name of Exchange on Which Registered
   -------------------                   ------------------------------------
Common Stock, no par value                 Over the Counter Bulletin Board

       Securities registered under Section 12(g) of the Exchange Act: NONE

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

      Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. |X|

      Issuer's revenues for its most recent fiscal year: $13,536,877

      The aggregate market value of the voting stock held by non-affiliates as
of March 26, 2004, computed by reference to the closing price of such stock on
such date as quoted on the OTCBB, was approximately $1,023,000. For purposes of
this computation only, all executive officers, directors and beneficial owners
of more than 5% of the outstanding Common Stock are assumed to be affiliates.

      The number of shares outstanding of the issuer's Common Stock on March 26,
2004 was 15,744,472.

         TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT | | Yes |X|  No

                    DOCUMENTS INCORPORATED BY REFERENCE: None

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                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS.

            This item contains forward-looking statements that involve
uncertainties. Actual results could differ materially from those in the forward
looking statements due to a number of uncertainties, including, but not limited
to those discussed below and in Part II, Item 6 "Management's Discussion and
Analysis or Plan of Operation - Uncertainties Relating to Forward Looking
Statements."

            CORPORATE HISTORY AND OVERVIEW OF PLANS SUBSEQUENT TO DATE OF FILING
FORM 10-KSB

            Nematron Corporation ("Nematron" or the "Company") was incorporated
in Michigan in October 1983. In 1986, the Company became a wholly owned
subsidiary of Interface Systems, Inc. ("Interface"). On February 26, 1993, the
Company became an independent publicly-traded company as a result of a spin-off
from Interface, which was effected by the distribution of 100% of the shares of
the Company on a pro rata basis to Interface's shareholders. Between the years
1995 and 2001, the Company acquired six closely held software development
companies, including A-OK Controls Engineering, Inc. ("A-OK Controls") in 2000
and Optimation, Inc. ("Optimation") in 2001. A-OK Controls is a Michigan-based
company that provides control systems design and integration services to the
industrial controls marketplace, and Optimation is an Alabama-based company that
develops, produces and markets industrial communications and display products
for industrial automation.

            On January 13, 2004, the Company's shareholders, at its annual
meeting, approved several proposals, including proposals to:

      -     Sell substantially all of the Company's assets and liabilities (the
            "Net Asset Sale") to a purchaser whose owners are the Company's
            senior and subordinated debt holders (the "Purchaser");

      -     Approve a five to one reverse stock split with respect to the
            Company's Common Stock and an amendment to the Company's Amended and
            Restated Articles of Incorporation to effect the reverse stock
            split;

      -     Approve the purchase of 5,248,257 shares of the Company's Common
            Stock by Dorman Industries, LLC ("Dorman") which would result in
            Dorman owning, on a fully diluted basis, approximately 62.5% of the
            outstanding Common Stock;

      -     Amend the Company's Articles of Incorporation to change the
            Company's name to Sandston Corporation

            The agreements necessary to effect the above proposals have not been
signed as of the date of this filing. However, Company management expects that
such agreements will become effective on March 31, 2004. Following the Net Asset
Sale, the five for one reverse stock split and the purchase of additional shares
by Dorman, Stanton Corporation, the continuing entity, will remain a publicly
owned entity, controlled by Dorman. Sandston will not own any assets except
approximately $80,000 in cash and certain intangible assets such as its value as
a public shell entity. Dorman intends to use Sandston and its public shell as a
platform to build long-term shareholder value by acquiring and/or investing in,
and operating strategically positioned companies with above average operating
profits. Sandston is expected to target companies with solid operating
performances that are well managed and in several operating groups. The targeted
companies are generally expected to have the following characteristics: sales
volumes between $20 million and $250 million; value added manufacturing,
distribution and business services; fragmented industries; experienced
management; and consistent historical financial performance. At this time,
neither the Company nor any of its officers and directors has had any
preliminary contact or discussions with, nor have they developed any plans or
proposals with, any companies regarding the possibility of a combination,
acquisition or merger. To the Company's knowledge, Dorman and its management
have also not had any preliminary contacts, nor developed any plans regarding
any acquisition or merger.

            Throughout this Form 10-KSB the Company will discuss forward looking
information as if operations will continue, since the Net Asset Sale has not yet
been consumated.

            The Company's principal executive offices are located at 5840
Interface Drive, Ann Arbor, Michigan 48103, and its telephone number is (734)
214-2000.

            GENERAL OVERVIEW

            Nematron designs, manufactures and markets factory automation
products, including computer hardware and software products. Its industrial
computers and terminals are called Industrial Control ComputersTM ("ICCs") and
Industrial WorkstationsTM ("IWSs"), which are "ruggedized" computers with
built-in displays, keyboards or other forms of operator interface. ICCs and IWSs
are used by operators in industrial processing and in factory floor environments
to


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monitor and control machine and cell level operations. Nematron's software
products are sold to industrial users for direct machine control, supervisory
control, operator interface and data acquisition and transmission.

            The primary focus of ICC and IWS products is on control applications
where the extremes of temperature, shock, vibration, high humidity, airborne
contaminants, physical abuse or hard use require the use of equipment that has
been specially designed to operate more reliably than office-grade equivalents.
The Company's industrial computer products are used in industrial manufacturing
and process automation, specifically relating to direct machine control and
operator-machine interface applications. The Company incorporates electronic
technology and software in its ICCs and IWSs to satisfy a broad variety of
customer applications. The applications may range from the replacement of
traditional hardwired push buttons, lights and gauges that can be used with a
single machine or local process, to advanced industrial computer-based systems
that provide supervisory control, direct control and networking capabilities
over a large number of machines.

            The Company has four main software products that are used in the
industrial and factory automation workplace. These products are marketed under
the following trade names: OpenControlTM, Hyperkernel(R), Paragon TM, and
FloPro(R). Additionally, most of the Company's IWS products contain proprietary
software embedded in the products as firmware that is not sold separately. All
of the products may be run on Nematron's industrial computers or those of most
other manufacturers.

            The Company's OpenControl software product allows operators to
leverage PC-based software packages, such as Windows NT and many popular
Supervisory Control and Data Acquisition ("SCADA") and Human-Machine Interface
("HMI") programs. OpenControl allows the use of standard networking products and
connectivity to the Internet or corporate-wide Intranet systems using a modular
approach for open control architecture applications. Hyperkernel allows software
developers to integrate highly deterministic real-time applications into
Microsoft's Windows NT operating system and enables devices such as robots,
process controllers and motion control systems to be configured as application
servers on any standard network system. The Company's Paragon software product
is a SCADA package, which regulates control and management of process
information. The Company's FloPro software product is a DOS-based flowchart
programming and direct machine control software product.

            The Company has five primary locations - four in the United States
and one in Europe. The Company's corporate headquarters are in Ann Arbor,
Michigan and employees located there are responsible for computer assembly,
software reproduction, software development, customer service, product
development, administration, finance, accounting, personnel, purchasing,
marketing, corporate-wide sales and international business development. Certain
of the Company's products are assembled by staff in Huntsville, Alabama, as are
the marketing and accounting functions for these products. The Company's control
design and integration business is headquartered in Auburn Hills, Michigan.
Personnel located in Auburn Hills are responsible for the design of automation
control systems and for integration of control systems at its customers'
facilities. The Company's software development is conducted primarily at its
office in Foxboro, Massachusetts. Software engineers and technical support staff
located in Foxboro are responsible for software product development,
enhancement, maintenance, and customer technical support. The Company's sales
and support operations for the European marketplace are conducted in
Waterlooville, Hampshire, The United Kingdom, through its Nematron Limited
subsidiary. Located south of London, its principal functions are European sales,
distribution management, application engineering, technical support and customer
service. Nematron Limited is primarily operated as a cost center since
allocation of gross product margins and operating and administrative expenses
cannot be reasonably allocated to that entity or by region. The Company also
maintains control system design and integration offices in Saginaw, Michigan.

            PRODUCTS, MARKET AND COMPETITION

            INDUSTRIAL COMPUTERS AND HARDWARE PRODUCTS

            The Company designs and manufactures operator terminals for reliable
performance in harsh industrial environments. Its products range from simple and
inexpensive programmable logic controllers and push button interfaces to
sophisticated industrial control computers. Each operator terminal provides a
display that shows the status of the process and a keyboard or a touch screen
that allows personnel to control the process. These terminals all come in a
rugged package that withstands extremes of temperature, humidity, vibration,
shock, and electrical interference. Each product class includes a range of
display options, prices, and capabilities. Industrial computers and hardware
products account for approximately 45 and 40%, of consolidated revenues in 2003
and 2002, respectively.


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            Virtually all of the Company's products use flat panel displays that
offer considerable space savings and increased reliability and clarity than the
older technology CRT displays. These products also provide immunity to shock,
vibration and electromagnetic interference. They are particularly well suited
for applications with physical space limitations and with hazardous environments
such as chemical plants, as well as in the presence of high electrical currents
such as in aluminum and steel processing applications.

            While price and features can be important factors in a customer's
purchase decision, reliability consistently ranks the highest. As a result, the
Company expends significant effort on design verification and testing of new
products and purchased components and assembled products. In addition,
management believes the Company is able to price its products competitively
because of their higher quality, and hence lower warranty and repair work is
required after the sale.

            Management believes, based on market research and reports of various
research analysts, that a large segment of the existing programmable logic
controller ("PLC") market will over many years migrate to PC-based control and
operator interface solutions that replace the PLC. The resulting market for
industrial PC-based products should expand significantly. In response to this
evaluation of the market, the Company has placed substantial emphasis on making
enhancements to IWS and ICC products as cost-effective replacements for
existing, lower functionality, products that complement as well as replace PLCs.

            Many competitors participate in the industrial PC product market,
most notably IBM, Allen-Bradley, Siemens, Schneider and many smaller companies,
including low-cost producers in Asia. Many segments in this market are highly
price-sensitive, especially in environments where desktop type products perform
adequately. As the market expands, numerous competitive offerings will probably
appear, putting downward pressure on prices and gross profit margins. The
Company intends to continue providing industrial PC products with unique and
valued features for reliable operation in factories and other harsh
environments.

            INDUSTRIAL PC PRODUCTS AND INDUSTRIAL CONTROL COMPUTER PRODUCTS

            THE ICC FAMILY OF PRODUCTS. The ICC product family was designed and
developed by the Company in the last five years and they continue to be enhanced
to keep abreast with the changing marketplace. ICC products offer Intel
Celeron(R) and Pentium III(R) processors, display options from 10.4", 12.1" and
15.0" as well as a screenless version, plus a motherboard featuring PCI/ISA bus
architecture. The front panels of these units have integrated keypads and are
rated UL Type 4/4X/12 (watertight and dust-tight) construction. Each model is UL
safety rated and is certified to the CE Mark. Several unique and innovative
features have been designed into the ICC family of products. These features
include Nematron's patented hinged chassis and a system that automatically
tracks product and application use variables that provides information
concerning maintenance cycles and environmental usage. These units range in
price from $2,500 to $7,000, varying primarily on the choice of display,
processors, features and bundled software.

            THE E-SERIES PRODUCTS. The e-Series industrial PCs gives users all
the power of an Intel Celeron(R) and Pentium III(R) processor with the
reliability, stability and fast boot-up of embedded system technology. These
e-Series products use non-rotating solid-state memory, allowing the products to
be used without a hard disk or other moving parts. These products run the
Windows NT embedded operating system, and they may be bundled with Nematron or
third party software products. These state-of-the-art embedded products feature
an innovatively hinged chassis with downward facing connections for easy cable
routing and cabinet mounting. Additionally, Ethernet connectivity is standard
and this allows seamless integration with other plant floor installations. These
units range in price from $2,000 to $3,000, varying primarily on the choice of
display, processors, features and bundled software.

            THE DELTA SERIES PRODUCTS. The Delta Series is a line of compact
touch-only industrial PCs and flat panel monitors. These products are available
in PCI, PC/104 and monitor-only configurations, and each can be configured with
10.4", 12.1" or 15.0" integral displays. The Delta PC and Delta PC/104 computers
feature a selection of Intel Celeron(R) and Pentium III(R) processors chosen
from Intel's Embedded Architecture list. If the environment is too harsh for
rotating media, the standard hard drive can be replaced with up to 512 MB of
solid-state flash memory. If space is tight, it can be ordered as a screenless
node computer with a separate monitor. And if an application requires two
operator stations, the PC's integral display can be mirrored on a remote
touchscreen monitor, thereby eliminating the need for a separate HMI panel.
These units range in price from $2,000 to $4,000, varying primarily on the
choice of display, processors, features and bundled software.


                                                                               4
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            INDUSTRIAL MONITORS. The flat panel monitors are engineered for
harsh industrial environments. The monitors, available with optional touchscreen
and stainless steel bezel, are ideal for both factory floor and control room
applications. The analog video signal remains strong and clear up from 6 to 75
feet from the computer depending on the video cable used with the monitor. The
monitors features a patent-pending hinged chassis that can be quickly and easily
removed for maintenance and backlight replacement. The monitors are NEMA 4/4X12
rated when properly mounted, and have the customary UL, cUL and CE
certifications for use worldwide. These products, which may be mounted on
panels, racks or arms, range in price from $1,000 to $3,000 depending upon
options selected.

            SHOEBOX AND RACKMOUNT INDUSTRIAL PCS. ShoeBox and RackMount
industrial computers combine practical design with all the processing power of
Intel Celeron(R) and Pentium III(R) processors. These processors are
complimented with built-in Ethernet, USB communications, hot-swapping cooling
fans, external audio output and front access keyport and mouse ports. The
popular form factor of the desktop ShoeBox offers five full-length slots, while
the 4U RackMount is designed for applications which require up to ten option
boards. The innovative chassis design focuses on ease of installation and
maintenance, as well as system flexibility to provide a high quality
multi-purpose platform. These products range in price from $2,000 to $3,500
depending upon options selected.

            Revenues from the sale of industrial PC products and ICC products
amounted to approximately 25% and 22% of consolidated revenue in 2003 and 2002,
respectively. The Company expects that revenue from this product category in
2004 will approximate the same percentage of total revenue as in 2003.

            CHARACTER-BASED PLC WORKSTATIONS AND REMOTE MESSAGE UNIT PRODUCTS

            Character-based PLC workstations and remote message unit products
economically replace electro-mechanical push buttons, while also providing
message display and alarm annunciation functions. All products in this class
include flat panel displays. The Company internally developed the proprietary
software for the products in the lower price range of this class of product.
Most of these products are used with small PLCs for simple machine control, such
as packaging equipment and small fabricating machines. Products in this class
range in price from less than $500 to $1,500.

            Most of the Company's competitors in this segment are small
companies with limited resources and market share. A few competitors, such as
Allen-Bradley, Cutler-Hammer and GE Fanuc, have substantially greater resources
than the Company and offer competitive products in the upper end of the price
range.

            Collectively, sales of character-based PLC workstations and remote
message unit products amounted to less than 10% of consolidated revenue in 2003
and 2002. The Company expects a modest growth rate in this market segment in the
next year based upon its market research. The growth rate could accelerate if
the market embraces the concept of small footprint operating systems and
languages that can communicate with Windows NT-based control software. The
Company plans to increase its efforts to develop and market new embedded
software products, enhance existing products and if appropriate, acquire
existing product lines from third parties.

            INDUSTRIAL GRAPHICS TERMINALS AND PROGRAMMABLE OPERATOR INTERFACE
PRODUCTS

            Nematron's operator interface workstations ("IWS"), produced in some
fashion since 1983, are used for push button replacement and PLC interface
applications. The IWS products are low-cost units featuring alphanumeric
displays and keypad. These workstations connect with the most popular PLCs and
PCs of most manufacturers. One of the IWS models features a graphical user
interface that can be used to create push buttons, message and numeric displays,
indicators, and bar and trend graphs. All of the IWS product's front panels are
NEMA 4/4X12 rated for use in harsh industrial environments.

            Nematron's operator interface terminals marketed under the
OptiMate(R) brand name include a family of fifteen operator panels. These panels
interface to any controller with a user-controlled serial port and to most major
PLCs. They can be used individually or in a combination, and are configurable
and adaptable to nearly any application. These products deliver high performance
at a low price point in the marketplace. The OptiMate product line was acquired
in connection with the Company's acquisition of Optimation on March 30, 2001.

            The Pointe Controller is a new class of control device that
integrates the flexibility, power and communications of PC-based control systems
with the ease and dependability of traditional PLCs. Pointe Controller
technology brings together local I/O control, enterprise connectivity and
advanced e-control software architecture in a product effective in stand-alone
applications, distributed control and enterprise wide e-control networks. The
Pointe Controller products, with intelligent node control features, provide
localized modular control along with a high-speed data interface for real-


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time communication using industry standard communication protocols to share
information throughout the control network or enterprise wide IT system. Sales
of the Pointe Controller began in 2003.

            Nematron's OptiLogic Remote Terminal Unit(TM) provides point of use
I/O and operator panel capabilities with a high-speed link to a PC. OptiLogic
delivers the highest levels of flexibility, ease of use and performance at the
lowest cost of any PC-based distributed I/O subsystem on the market. The
OptiLogic RTU is modular in design, allowing the engineer to plug together any
combination of analog and digital inputs and outputs that will fit in available
slots. The card cage base snaps onto a standard DIN rail for back panel
mounting, and if an operator panel is required, the base snaps onto a variety of
available OptiLogic operator panels which in turn can be panel mounted. The
Ethernet connection provides a base 10BaseT connection to the network. The
OptiLogic product line was acquired in connection with the Company's acquisition
of Optimation on March 30, 2001.

            Because several dozen large and small companies offer competing
products in this market, competition is intense. Every major PLC company
competes in this market, either with its own designs or with private-labeled
products. Significant competitors include Allen-Bradley, Siemens and
Cutler-Hammer, as well as dozens of smaller entities.

            Collectively, sales of industrial graphics terminals and
programmable operator interface products amounted to approximately 15% and 13%
of consolidated revenue in 2032 and 2002, respectively. The Company expects a
modest growth rate in this market segment in the next year based upon its market
research.

            COMPUTER HARDWARE PARTS AND SERVICE

            The Company maintains an inventory of spare parts and service stock
and employs trained service technicians and support personnel whose functions
include technical advice regarding product applications, service and repair of
returned hardware products. Revenues from the service and repair of industrial
hardware products amounted to approximately 11% and 10% of consolidated revenue
in 2003 and 2002, respectively. The Company expects that revenue from computer
parts and service will represent less than 10% of consolidated revenues in 2004.

            SOFTWARE PRODUCTS

            The software products described below represent the products
resulting from the Company's strategic focus of being a high value-added
provider of bundled industrial PC hardware and Microsoft operating system-based
software solutions. The Company believes that these software products are on the
leading-edge of products offered in the industrial automation software
marketplace. The Company's software products are used in the industrial and
factory automation workplace around the world in a variety of unique and proven
applications. Additionally, many of the IWS hardware products discussed above
contain proprietary software embedded in the products as firmware that is not
sold as a separate product. All of these products may be run on Nematron's
computers or on computers of most other manufacturers.

            Several large and small companies offer competing software products
in this market and competition is intense. Many competitors market their own
products or with private-labeled products, and such products perform the same
functions as certain of the Company's products. Significant competitors include
Intellution, Siemens and Wonderware.

            Revenues derived from software product sales, including associated
training and maintenance agreements, amounted to approximately 6% and 10% of
consolidated revenue in 2003 and 2002, respectively. The Company expects a
modest growth rate in this market segment in the next year based upon its market
research.

            LOGIC CONTROL. OpenControl(TM) is Nematron's software product for
programming and debugging machine control logic. It allows users to replace
proprietary PLC technology with an open, Windows-based system that enables
enterprise-wide access to plant floor data. With a high degree of flexibility,
intuitive programming and advanced troubleshooting features, OpenControl allows
manufacturers and OEMs to significantly reduce development time and minimize
life cycle costs. Because OpenControl operates on PCs, users can leverage
commercial applications and third party technology to improve price/performance
ratios and to utilize a workforce increasingly literate in PC technology.
OpenControl utilizes intuitive flowchart programming tools that are a natural
and visual way of describing and documenting machine control procedures. This
approach encourages program simplicity and readability while offering users
flexibility, greater machine throughput, reduced machine downtime and the
ability to share factory data enterprise-wide or over the Internet to suppliers
and customers. With the introduction of a ladder logic editor in 2000, PLC users
are able to transition easily to the latest direct machine control technology.


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            OpenControl competes with several products offered by other
companies in the soft-logic marketplace, some of which are much larger than
Nematron. The soft-logic marketplace is an emerging market that is expected to
grow significantly in the next several years as PCs and soft-logic software
programs replace PLCs and cumbersome ladder logic software. Several of the
Company's competitors license the technology upon which OpenControl is based.
Management believes that the OpenControl product has many advantages over its
competitors: self-documenting, more efficient programming methods, less costly
than many other products, utilizes open PC architecture, fast execution times
and it reduces plant down time through diagnostic messages. When OpenControl is
bundled with a Nematron ICC, bundled pricing is especially attractive compared
to systems supplied by multiple vendors. OpenControl is in use at several
automotive component manufacturing facilities and controls thousands of machines
involved in the manufacture of engines and transmissions.

            REAL-TIME SUBSYSTEM: Hyperkernel(R) is Nematron's software product
that allows software developers to integrate highly deterministic real-time
applications into the Microsoft Windows NT operating system. This real-time
subsystem enables devices, such as robots, process controllers and motion
control systems, to be configured as application servers on any standard network
system to ensure performance and reliability on mission-critical applications.
Hyperkernel includes features such as high-speed timers, memory management,
interrupt handlers, inter-process communication, file system services, task
scheduling and prioritization.

            The technology provides true client/server capabilities for complex
software applications. The Hyperkernel RTSS for the Microsoft Windows NT
operating system utilizes a sophisticated message-passing architecture for
inter-process communications, which is the key difference between Hyperkernel
and similar products developed to operate under DOS or the Microsoft Windows 3.1
operating system.

            With the Hyperkernel product, development in a mainstream operating
system architecture is now practical. Hyperkernel is offered as a stand-alone
product directly on Nematron's web site and is also an integral part of the
OpenControl software product.

            HMI/SCADA: Paragon(R) is Nematron's software product for HMI
(human-machine interface) and SCADA (supervisory control and data acquisition).
Along with powerful HMI capabilities, Paragon performs very sophisticated
control and management of process information, delivering high performance and
reliability in networked applications with a scaleable database design. The open
modular design and dynamic connectivity of Paragon simplify the integration into
enterprise-wide networks. Paragon supports seamless cross-platform communication
among operating systems from Windows NT to Windows 95 and OS/2 on the same
network.

            FLOWCHART PROGRAMMING AND CONTROL. The Company's soft-logic software
is called FloPro. FloPro is a flowchart programming system that executes from
personal computers. FloPro is based upon the technology in Patent Number
4,852,047 "Continuous Flow Chart, Improved Data Format and Debugging System for
Programming and Operation of Machines." The programming system is used to
create, debug, document and execute control applications in an open architecture
environment. Its open system architecture allows operators to interface it
concurrently with many different input/output systems, motion controllers,
message units and RF tag/bar code systems. FloPro simplifies machine control
system development by allowing the use of multiple flowcharts, each one handling
a relatively simple task, thus allowing for the concurrent development of
applications by a team of control engineers. These flowcharts communicate with
each other in a multi-tasking environment, which means that the control
application is easy to create and understand. Additionally, FloPro is
self-documenting in that it is a programming language based on the flowcharts;
there is no need to translate the flowcharts to ladder logic. The use of FloPro
and a PC replaces the need for PLCs and ladder logic for machine control
applications. FloPro is in use at several automotive component manufacturing
facilities and controls thousands of machines involved in the manufacture of
engines and transmissions.

            SYSTEM DESIGN AND INTEGRATION SERVICES

            The Company provides a variety of services, including control system
consulting and design services, application engineering and control system
integration services, information technology integration and program support and
management directly and through its A-OK Controls subsidiary. The Company's
engineers are experienced in a range of projects, from single-cell applications
to large-scale global control system implementations. In addition to its own
staff, the Company contracts with certified system integrators and third parties
with industry specialists to supplement Nematron's staff as necessary. A-OK
Controls competes with many other locally based system integrators of similar or
smaller size and capabilities. Revenues derived from system integration services
amounted to 38% and 39% of


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the Company's consolidated revenue in 2003 and 2002, respectively. The Company
expects a modest growth rate in this market segment in the next year based upon
its market research.

            SALES CHANNELS

            The Company employs four sales channels for product sales and
distribution. The Company's primary sales channels are a network of high-tech
industrial distributors, several manufacturer representative firms and a
corporate sales staff focused on major original equipment manufacturers ("OEMs")
of industrial processing systems and machines and to other major end users.
Beginning in 2001, with its acquisition of Optimation, the Company began
marketing its Optimation-brand products, OptiLogic and OptiMate, through
catalogs, direct marketing and the Internet. The Company's distributors are
typically companies with non-exclusive written agreements that purchase
inventory and resell it to their customers. In addition, distributors typically
provide varying amounts of customer training, application engineering, and
support. The Company has approximately 40 domestic distributor branches and
approximately 25 distributor branches in 8 countries internationally.

            No private label, direct customer, or distributor accounted for more
than 10% of total Company sales in 2003 or 2002. The ICC product family,
including ICC products bundled with software products, accounted for
approximately 11% and 12% of consolidated revenues in 2003 and 2002,
respectively. No other single model or product family accounted for more than
10% of the Company's revenues during those periods.

            MANUFACTURING, ASSEMBLY AND SUPPLY

            The Company performs final assembly and testing for most of its
hardware products. The assembly process encompasses the assembly of sheet metal
or plastic parts, keypads, displays, electronic circuit boards and other
component parts into finished products. In addition, the Company performs some
limited cable manufacturing and wave soldering, and assembles engineering
prototypes for new products. In 2000, the Company began subcontracting certain
of the material acquisition and some of the assembly of certain high volume -
low mix ICC products to a subcontractor located in the Czech Republic. In 2003
and 2002, less than 10% of consolidated revenues were derived from sales of
products assembled by the subcontractor. For products assembled in-house, the
Company purchases substantially all components. It uses a number of independent
firms for these purchases and is not materially dependent upon any third party
that supplies these services. Some specialized components used in the Company's
products are currently purchased from single or limited sources of supply. The
Company believes that the loss of one or more suppliers of standard components
would not have a material long-term impact on its operations, as standard
components may be obtained from a number of sources. For its specialized and
unique components, the loss of one or more suppliers of standard specialized and
unique components would have a near-term impact on operations and would cause
some production delays.

            The Company owns and utilizes a variety of assembly and test
equipment to reduce the cost of and ensure the quality of the designed and
assembled products and components. The Company employs environmental chambers
and electronic instrumentation to certify that its products meet the severe
industrial environments for which they are intended.

            PRODUCT DEVELOPMENT

            The Company maintains an active product development program and
continues to supplement existing research and development capabilities through
its technical personnel and the continuing development of new proprietary
technology. The Company's product development staff includes electrical,
application, mechanical and software engineers, product managers and directly
associated staff members involved in technical documentation and product
support. The Company may also employ third-party contract engineering companies
on an as-needed basis. The Company has assigned certain of its engineers to
quality control to assure the long term quality and reliability of the Company's
products. The Company conducts its software development activities in both Ann
Arbor, Michigan and Foxboro, Massachusetts, and it conducts its hardware
development and quality control and testing activities testing in Ann Arbor,
Michigan.

            The Company emphasizes product development and quality and the
employment of highly skilled and motivated individuals in the product
development and quality assurance areas. Management believes that its product
development


                                                                               8
<PAGE>
staff is an important factor in the Company's ability to compete in the markets
in which its products are sold. During 2003 and 2002, the Company expended
approximately $1.0 million and $1.4 million, respectively, for direct hardware
and software product development and product design quality. The Company
sponsored all of such costs. These amounts represent approximately 7.3% and 9.1%
of consolidated revenues in 2003 and 2002, respectively.

            INTELLECTUAL PROPERTY

            The Company's FloPro software product, which is sold as a separate
product but is also the underlying technology incorporated into the Company's
OpenControl product, is based upon the technology specified in a 20-year patent
issued in 1989 for continuous flow chart, improved data formatting and a
debugging system for programming and operations of machines. In 1997, the
Company received a 20-year patent for a chassis hinged mechanism used on its ICC
and certain other products. In 1999, the Company received a 20-year patent for a
unique and effective method of logging and retrieving computer system parameters
to assist with examining environmental variables, operating times and
temperature ranges. In 2000, the Company received a 20-year patent for a front
mounted chassis assembly for a display screen. The Company filed a patent
application for its Hyperkernel real-time extension to Windows NT during fiscal
1996. The Company has an active technology committee that meets regularly with
its patent counsel to review trademark and patent potential.

            In addition to trademarks on the trade names under which the Company
does or did business, including Nematron, NemaSoft, Optimation, Imagination
Systems and Universal Automation, the Company also owns trademarks on certain of
its products, including Industrial Workstation, OpenControl, OptiMate,
OptiLogic, Industrial Control Computers, Hyperkernel, Paragon, FloPro, AutoNet
and Nematron PowerVIEW, FlexBox and QuickShip.

            The Company's software products are sold under licenses to use the
products as specified in the underlying contract. Certain of the licenses for
the use of the FloPro software product are site licenses for unlimited use of
the master copy of the product in a specified building, plant or group of
plants. Revenue from site licenses has not been a significant source of revenue
to the Company in the last two years. The Company has licensed its soft-logic
technology to several unrelated companies under royalty arrangements and
licenses. These arrangements and licenses also have not been a significant
source of revenue.

            EMPLOYEES

            The Company employed 109 full time employees as of December 31,
2003, including 92 in Michigan, 4 in Foxboro, Massachusetts, 7 in Huntsville,
Alabama and 6 in the United Kingdom. None of the Company's employees are
represented by a collective bargaining unit, and the Company believes its
employee relations are good. Following the Net Asset Sale, the Company expects
that all its employees will become employees of the company to be formed by the
Purchaser.

            ENVIRONMENTAL COMPLIANCE

            The Company's products comply with federal, state and/or local laws
and regulations that have been enacted or adopted relating to the discharge of
materials into the environment, or otherwise relating to the protection of the
environment. The Company believes that continuing efforts and expenditures
incurred to maintain compliance with such laws and regulations will not have a
material effect on capital expenditures, earnings or the competitive position of
the Company.

ITEM 2. DESCRIPTION OF PROPERTIES.

            The Company's headquarters and principal assembly facility is in Ann
Arbor, Michigan in a two-story building containing a total of approximately
51,000 square feet of space. Of this space, approximately 6,400 square feet
remain unfinished and available for future office or assembly expansion. This
facility, located on approximately five acres of land, has been designed such
that further expansion of up to 20,000 square feet may be accommodated. The Ann
Arbor facility was designed and built to the Company's specifications and is
owned by the Company. A mortgage on the


                                                                               9
<PAGE>
property comprises a portion of the security for the Company's bank line of
credit and a loan from Chelsea State Bank. All other properties are leased, as
follows:

<TABLE>
<CAPTION>
               Location                           Square Feet     Lease Expiration              Building Type
               --------                           -----------     ----------------              -------------
<S>                                               <C>             <C>                           <C>
    Auburn Hills, Michigan                          50,000        May 2008                      Single tenant
    Foxboro, Massachusetts                           1,200        Month-to-month                 Multi-tenant
    Huntsville, Alabama                              7,300        July 2005                      Multi-tenant
    Saginaw, Michigan                                5,000        January 2009                   Multi-tenant
    Waterlooville, United Kingdom                    2,100        December 2009                  Multi-tenant
</TABLE>

            The Company's property will be included in the Net Asset Sale to the
Purchaser and the Purchaser will also assume the leases described above.

ITEM 3. LEGAL PROCEEDINGS.

            The Company is not involved in any legal proceedings other than
routine, non-material litigation incidental to the business.

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

            Not applicable.


                                                                              10
<PAGE>
                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

            The Company's Common Stock has been listed on the OTC Bulletin Board
(the "OTCBB") under the symbol NMNN since January 15, 2004. From November 22,
1999 through January 14, 2004, the Company's Common Stock was listed on The
American Stock Exchange (the "AMEX") under the symbol NMN. The following table
sets forth, for the periods indicated, the closing price on the AMEX.

<TABLE>
<CAPTION>
         2003                       High                          Low
         ----                       ----                          ---
<S>                                <C>                           <C>
    First Quarter                  $0.10                         $0.05
    Second Quarter                  0.38                          0.07
    Third Quarter                   0.34                          0.13
    Fourth Quarter                  0.29                          0.21
</TABLE>

<TABLE>
<CAPTION>
         2002                       High                          Low
         ----                       ----                          ---
<S>                                <C>                           <C>
    First Quarter                  $0.42                         $0.25
    Second Quarter                  0.39                          0.19
    Third Quarter                   0.20                          0.10
    Fourth Quarter                  0.10                          0.10
</TABLE>

            There are approximately 650 holders of record of the Company's
Common Stock as of March 26, 2004.

            The Company has never paid cash dividends and does not expect to pay
cash dividends in the foreseeable future. Certain Company bank financing
covenants prohibit the payment of dividends. See the Long-Term Debt footnote of
the Notes to Consolidated Financial Statements.

            The Company did not issue any shares of its Common Stock during 2003
or 2002.

            At various dates between March 2001 and July 2003, the Company sold
subordinated convertible notes and warrants in order to fund losses from
operations and to pay obligations as they became due. No other sources of funds
were available to the Company. The subordinated notes and warrants were sold to
three members of the Board of Directors or their affiliates. The terms of the
subordinated convertible notes allows the holders thereof, in the event of an
equity offering, to convert any or all of the outstanding principal of the notes
and accrued interest thereon into the securities offered in such financing at
the offering price per share of such financing. The underlying modified
agreement further provides that the principal and accrued interest payable under
the notes may be converted in whole or part into shares of Series A Preferred
Shares beginning on September 1, 2002 at $0.10 per share. Provisions of the
Series A Preferred Shares include: a) participation in dividends, if any, with
the Common Stock shareholders; b) a liquidation preference up to the initial
purchase price of the Series A Preferred Shares; c) the Series A Preferred
Shares may be converted into Common Stock on a one-to-one basis; d) full voting
powers; e) the holders of Series A Preferred Shares shall have the right to
elect one person to the Board of Directors; f) the consent of a majority in
interest of the Series A Preferred will be required to (i) purchase or redeem
any Common or Preferred Stock, (ii) authorize or issue any senior or parity
securities, (iii) declare or pay dividends on or make any distribution on
account of the Common Stock, (iv) merge, consolidate or sell or assign all or
substantially all of the Company's assets, (v) increase or decrease authorized
Preferred Stock and (vi) amend Articles or Incorporation to change the rights,
preferences, privileges or limitations of any Preferred Stock; g) the conversion
price for the Series A Preferred shall be subject to proportional antidilution
protection for stock splits, stock dividends, etc. and in the event that the
Company issues additional shares of Common Stock or Common Stock equivalents
(other than shares issues to officers or employees of the Company pursuant to
plans approved by the Company's board of directors) at a purchase price less
than the applicable Series A Preferred conversion price, the Series A Preferred
Stock conversion price shall be adjusted to that same lower purchase price; and
h) each holder of Series A Preferred Stock shall have the right to participate
in any Company financing up to its pro-rata ownership.

            The notes sold included detachable warrants. The warrants, which are
non-assignable, initially allowed the holders to purchase Common Stock at $0.10
per share (the "Per Share Warrant Price") in an amount of 20% of the principal
of the notes and accrued interest thereon for a period of five years from the
date of the advance (the


                                                                              11
<PAGE>
"Warrants"). In connection with the October 2002 modification, the securities
into which the Warrants could be converted were changed to Series A Preferred
Stock as described above.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

            The following discussion and analysis contains a number of "forward
looking statements" about the Net Asset Sale and the Company within the meaning
of the Section 21E of the Securities Exchange Act of 1934, as amended, with
respect to expectations for future periods which are subject to various
uncertainties explained herein and in "Management's Discussion and Analysis or
Plan of Operation - Uncertainties Relating to Forward Looking Statements."

            Statements containing the words "believes," "anticipates,"
"estimates," "expects," "intends," "plans," "seeks," "will," "may," "should,"
"would," "projects," "predicts," "continues," and similar expressions or the
negative of these terms constitute forward-looking statements that involve risks
and uncertainties.

            We intend such forward-looking statements to be covered by the safe
harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995, and are including this statement for
purposes of invoking these safe harbor provisions. Such statements are based on
current expectations and are subject to risks, uncertainties and changes in
condition, significance, value and effect, including those discussed in the
section entitled "Risk Factors" contained herein. Such risks, uncertainties and
changes in condition, significance, value and effect could cause the Company's
actual results to differ materially from those anticipated events. Except as may
be required under federal law, we undertake no obligation to update publicly any
forward-looking statements for any reason, even if new information becomes
available or other events occur.

            Throughout this Form 10-KSB the Company will discuss forward
looking information as if operations will continue, since the Net Asset Sale, as
described on page 2 of this Form 10-KSB, has not yet been consumated.

OVERVIEW

            Management's operating strategy is to incorporate its software
products into the Company's hardware product offerings and to vertically
integrate its product offerings to include both hardware and software products
used in the industrial automation marketplace. Additionally, the Company intends
to expand its product offerings to include additional design and system
integration services as well as products complimentary to its existing product
offerings. The Company's marketing and sales efforts to existing and new
customers include stand-alone computers, software products, bundled products and
automation design and integration services. The Company intends to continue the
development of new computer hardware products, and will pursue the enhancement
of its current software products. Additionally, the Company has identified new
markets for its products and will pursue new business from customers that offer
the greatest likelihood of large unit volume. Management anticipates moderate
growth in the industrial software marketplace and intends, through concentrated
development and aggressive marketing and sales efforts, to capture an increasing
percentage of that market.

RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED
DECEMBER 31, 2002

Revenues

            Net revenues decreased to $13,537,000 in 2003 compared to
$14,867,000 in 2002. This represents a decrease of $1,330,000, or 8.9%, compared
to the 2002 level. Of the total revenue decrease, $704,000 was attributable to
the lower sales of control design and system integration services, $660,000 was
attributable to sales of software while all other product categories increased
$34,000. All of the declines are attributable primarily to the decline in demand
from customers in the industrial controls marketplace who postponed or canceled
capital spending plans.

            Foreign revenues decreased to $3,148,000 in 2003 compared to
$3,472,000 in 2002. This represents a decrease of $324,000, or 9.3%, compared to
the 2002 level. Domestic revenues decreased to $10,388,000 in 2003 compared to
$11,396,000 in 2002. This represents a decrease of $1 008,000, or 8.8%, compared
to the 2002 level.

            Critical accounting policies relative to revenues that involve
management estimates include recognizing revenue from sales of software license
agreements, software maintenance agreements, bundled products (hardware products
pre-loaded with software) and bundled systems (bundled products accompanied by
post-sale support activities). Revenues from these product types are deferred
until all conditions in Statement of Position 97-2, Software Revenue
Recognition,


                                                                              12
<PAGE>
are met. Such conditions include persuasive evidence that an arrangement exists,
the delivery of the products, the performance of all obligations so that
remaining obligations are no longer significant, and determination that
collection of the amount due from the customer is probable. Revenue from sales
of both software license and maintenance agreements are initially deferred and
recognized ratably over the licensing or maintenance periods. Revenue from sales
of bundled products and systems is initially deferred, and the recognition of
revenues is dependent on, among other things, estimates of revenue attributed to
individual components of the total products and services to be rendered under
the sales agreement. Management has determined that the most equitable method of
assigning a revenue amount to each system component (product, software license
or post-sales service) is in relation to the published or established list price
for each such component, and recognizing a percentage of total revenue for a
system when the individual component is delivered or performed. Management
believes that ascribing revenue values on a basis other than established list
price would be arbitrary and result in significantly different amounts of
revenue recognized from sales of bundled and system sales.

            The Company has established programs, which, under specified terms
and limited conditions, enable its distributors to return limited amounts of
product. The effect of these programs, which is not a material amount, is
estimated, and current period revenues and cost of revenues are reduced
accordingly during each period presented.

            Management believes that revenues will increase moderately in 2004
as a result of the Company's increased marketing and sales efforts, and from
revenues to be generated from sales of products introduced in 2003 and from new
products scheduled for release in 2004. Additionally, management expects that
revenues from control design and system integration services will increase as a
result of an expectation of a return to more normal levels of activity compared
to the depressed level of services ordered by customers in 2003 during a
recessionary economic period.

            Cost of Revenues

            Cost of revenues includes costs related to raw materials and
component parts, direct assembly labor, hardware design engineering labor,
control system and integration services labor, overhead, amortization of
capitalized software costs, write-downs of previously capitalized software
development costs, provisions for warranty costs on products sold, provisions
for excess and obsolete inventory and other direct and indirect costs of these
departments and activities. Cost of revenues increased to 76.8% of revenues in
2003 compared 75.5% in 2002. The increase in cost of sales percentage in 2003
compared to 2002 results primarily from a shift in product mix to moderately
lower gross margin products, offset in part by lower material costs and by fixed
cost reductions implemented in 2003.

            Critical accounting policies relative to cost of revenues which
involve management estimates include an estimate of the costs of repairing and
servicing products sold under warranty, the amount and period of capitalized
software development costs and the estimate of slow-moving, excess and obsolete
inventory.

            Warranty costs are estimated based upon historical information,
including units repaired under warranty as a percentage of total units sold,
costs to repair such units and data concerning sales and repairs by year of
sale. Based upon a six-year rolling historical average of the percentage of
units actually repaired under warranty, management has estimated the number of
units that will be returned for warranty repair. Management has applied the most
current year per-unit cost to the estimated number of units to be repaired in
future periods under warranty, and has established a warranty reserve at year
end. Generally, hardware products are warranted for an eighteen-month period
from date of installation, except where longer periods are agreed to under
specific sales agreements. Warranty expenses in 2003 and 2002 were $60,000 and
$154,000, respectively, and the year-end warranty accrual at December 31, 2003
and 2002 was $255,000. The use of different factors or different periods to
determine rolling average warranty unit percentages would impact the year-end
reserve for warranty accrual. Since the percentage of units repaired under
warranty has been decreasing over the last ten years, the use of a longer
rolling average period would result in a higher year-end warranty reserve, the
cost of which is a component of cost of revenues. Using a ten-year rolling
average period would result in no significant increase in cost of revenues.

            The capitalization of software development costs, including
developer salaries and other payroll related costs plus third party development
costs, begins upon establishment of technological feasibility of the product
under development. The establishment of technological feasibility, the period
over which such costs are amortized and the ongoing assessment of recoverability
of capitalized software development costs requires considerable judgment by
management. This judgment includes certain external factors, including, but not
limited to, estimated future gross revenues, estimated economic life of the
product, and changes in software and hardware technology. The Company annually
reviews the recoverability of capitalized software costs based on estimated cash
flows. Software costs are written off at the time a determination has been made
that the amounts are not recoverable. During 2003 and 2002, the


                                                                              13
<PAGE>
Company did not capitalize any software development costs and amortized $176,000
and $312,000, respectively, of such costs. The establishment of the date of
technological feasibility involves considerable judgment, and the earlier that
such a date is set would result in a larger pool of costs that will be
capitalized, and a later date would result in a smaller pool of such costs
subject to amortization. Management has estimated the economic life of each
product, and major enhancement thereto, for which costs have been capitalized,
and such economic lives average six years. Shorter economic lives of software
products would accelerate amortization, and longer economic lives would decrease
annual amortization amounts that are a component of costs of revenues.
Management forecasts annually the estimated revenues to be received from
software product sales over their estimated lives, reduced by the related
estimated direct costs to manufacture and reproduce each product, sales expenses
and commissions. If the net realizable value determination requires a charge to
operations for impairment, a write-down is made. No write-downs of capitalized
software development costs were necessary in 2003 or 2002.

            The recorded historical carrying amount of inventories are reduced
by provisions for the costs of estimated slow moving, excess and obsolete
inventory. Management makes this determination based upon an item-by-item review
of quantities on hand compared to estimated future usage for sales and service.
Inventory reserves at the end of 2003 and 2002 totaled $901,000 and $828,000,
respectively. The increase in reserves in 2003 compared to 2002 results from the
identification of additional potentially obsolete material during the current
year as raw material usage has changed moderately. The determination that future
usage would differ from amounts determined by management would result in
different year-end reserves and correspondingly different charges to cost of
revenues for the periods presented.

            Management expects that gross profit margins will improve in 2004
compared to 2003 resulting from a positive change in product mix towards higher
margin computer products, lower material costs, the continued reduction of fixed
costs in 2004, and higher revenue levels over which to spread fixed costs.

            Product development expenditures - software development

            Software product development expenditures decreased by $151,000 to
$570,000 in 2003 compared to $721,000 in 2002. This represents a decrease of
20.9% from the 2002 level and results from lower development activity, lower
expenditures for occupancy and operations and lower staff levels. Management
expects that product development expenses in 2004 will approximate the 2003
level.

            As discussed above under Costs of Revenues, the Company had in prior
years capitalized costs and expenses of certain software development activities
related to new product development beginning upon the establishment of
technological feasibility of the developed product. All other costs and
expenses, including those incurred prior to technological feasibility and after
product release and those incurred in support and maintenance and minor
enhancements, are expensed at the time such costs and expenses are incurred.
Consequently, the determination of technological feasibility, which requires
considerable judgment, is a key factor in management determination's of whether
costs are expensed or capitalized. As discussed above, the Company did not
capitalize any software development costs in 2003 or 2002, as the development
activities performed in those years related to normal and recurring product
enhancements compared to the development of new products.

            Selling, General and Administrative Expenses

            Selling, general and administrative expenses decreased to $4,170,000
in 2003 compared to $5,101,000 in 2002. This represents a decrease of $931,000,
or 18.2% from the 2002 level. This decrease results primarily from staff
reductions, lower discretionary spending for marketing activities, lower sales
commissions, and the absence of $150,000 of goodwill impairment recorded in
2002.

            Critical accounting policies relative to selling, general and
administrative expenses and which involve management estimates include the
period over which certain intangible assets are amortized, the amount of the
reserve for doubtful accounts receivable and the period over which property and
equipment are amortized.

            Effective January 1, 2002, the Company adopted the provisions of
FASB Statement No. 142, Goodwill and Other Intangible Assets, the Company ceased
amortizing goodwill in accordance with provisions of the pronouncement. However,
goodwill is subject to certain impairment tests at least annually. In connection
with the Company's annual budgeting and forecasting processes, all of the
goodwill recorded on the parent company's books, resulting from a 1997
acquisition, was found to be impaired. The Company recorded a goodwill
impairment loss of $150,000 in 2002 to eliminate all remaining goodwill in the
parent company's accounts.


                                                                              14
<PAGE>
            The Company has recorded other intangible assets, including the
costs of acquired patents, direct expenses of registering internally developed
patents, deferred loan costs and certain other acquired intangible assets
relating to the Company's acquisitions in prior years. The costs of the acquired
intangible assets relating to the technical workforce and distribution network
and the related amortization period were established based upon a third party
analysis of the net assets. The costs of other intangible assets are amortized
to operations over periods assigned by management. Management has assigned an
amortization period equal to the remaining period of the bank debt at the time
such costs were incurred, five years for the acquired distribution network, six
years for the acquired technical workforce and ten years for patent costs. The
estimate of economic lives of each of these intangible assets was based on
several factors, including estimates of the projected term of the senior debt,
the costs that the Company avoided by acquiring the establishing product
distributors and resellers, the costs the Company avoided by acquiring a
technical workforce and acquired employees' projected turnover, salary and
benefit rates. The Company charged to operations in 2003 and 2002 a total of
$186,000 and $194,000, respectively, for amortization of intangible assets.
Effective January 1, 2002, when the Company adopted the provisions of FASB
Statement No. 142, the Company reclassified the unamortized acquired technical
workforce and distribution network to goodwill, and as indicated above, it
ceased amortizing goodwill in accordance with provisions of FASB Statement No.
142. The use of different periods over which to amortize all intangible assets
would result in different amounts charged to selling, general and administrative
expenses in each period presented. Under the provisions of FASB Statement No.
142, goodwill is subject to certain impairment tests at least annually. In
connection with the Company's annual budgeting and forecasting processes, all of
the goodwill recorded on the parent company's books, resulting from a 1997
acquisition, was found to be impaired. The Company recorded a goodwill
impairment loss of $150,000 in 2002 to eliminate all remaining goodwill in the
parent company's accounts, and such amount is included in selling, general and
administrative expenses.

            The Company monitors its accounts receivable and charges to expense
an amount equal to its estimate of uncollectible accounts. The Company recorded
insignificant amounts of bad debts during 2003 and 2002, and its reserves for
bad debts as of the end of 2003 and 2002 were $81,000 and $75,000, respectively.
The use of different estimates for future uncollectible accounts would result in
different charges to selling, general and administrative expenses in each period
presented.

            The Company depreciates its property and equipment over estimated
useful lives established by management. Management has determined that useful
lives of three to ten years for equipment and furniture and thirty-three years
for its building are appropriate assignable lives. The use of shorter or longer
lives would result in different depreciation amounts charged to operations
during the periods presented. The Company has also elected to depreciate its
property and equipment over the assigned lives using the straight-line
depreciation period. Total depreciation expense charged to operations in 2003
and 2002 was $283,000 and $410,000, respectively, with the decrease in 2003
attributable to the effect of fully depreciated assets and the decreasing amount
of capital additions in recent years. The use of accelerated methods of
depreciation would result in higher depreciation charges in each period
presented.

            Management expects that selling, general and administrative expenses
will decrease moderately in 2004 compared to 2003 because of planned decreases
in discretionary expenditures.

            Interest Expense

            Interest expense increased to $1,349,000 in 2003 compared to
$928,000 in 2002. Included in interest expense for 2003 and 2002 is $383,000 and
$192,000, respectively, of non-cash interest expense related to the beneficial
conversion feature of warrants and convertible notes sold during the periods
presented. Without the effect of the non-cash interest charge for the beneficial
conversion features, interest would have been $966,000 and $736,000 in 2003 and
2002, respectively. The $230,000 increase in interest expense represents 31.3%
increase in 2003 compared to 2002, and this results from the effect of higher
average borrowing levels in 2003 compared to 2002. Management expects that
interest expense will increase in 2004 because of continuing needs for third
party financing, offset in part by scheduled pay downs of debt in 2004.

            Sundry Income (Expense), Net

            Sundry income (expense) totaled $19,000 income in 2003 compared to
$(9,000) expense in 2002. There were no significant items of other revenue or
expense in either period.


                                                                              15
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

            Primary sources of liquidity are cash generated from operations, and
from advances available under the financing agreement and a convertible
subordinated debt arrangement with a related party. The Company's operations
used $1,550,000 of cash during 2003, primarily as a result of the effect of the
$2,925,000 loss from operations offset by a $344,000 decrease in working capital
deficit and the $1,030,000 of noncash depreciation, amortization, impairment,
loss on property disposals and interest charges to operations. During 2003, the
Company used $30,000 of cash for additions to fixed assets and $1,519,000 of
cash for debt repayments. Primary sources of cash in 2003 were $1,334,000 from
the proceeds of sales of subordinated promissory notes and warrants and
$1,953,000 from borrowings under a related party promissory note.

            The Company is a party to a Promissory Note with North Coast
Technology Investors, LLP ("NCTI"), an entity of which Mr. Braun, a former
member of the Board of Directors, is a partner. NCTI also is a subordinated note
holder. Under the terms of the Promissory Note, borrowings are due on demand and
bear interest at 9.0% per annum. A maximum of $2,000,000 may be borrowed under
the Promissory Note agreement. Borrowings under the Promissory Note are
collateralized by substantially all assets of the Company and a second position
on the mortgage note securing the Company's Ann Arbor facility. Total borrowings
under the Promissory Note at December 31, 2003 are $1,953,000.

            The Company's wholly owned subsidiary, Optimation, is party to a
loan and security agreement with an Alabama-based bank (the "Optimation Loan
Agreement"). The Optimation Loan Agreement, amended through October 3, 2003,
provided for a total line of credit of $108,750 on that date and which reduces
in availability equal to principal repayments made (the "Facility"). The amount
available under the Facility is limited by a borrowing formula based on eligible
accounts receivable and inventory. Borrowings under the Facility total $63,750
at December 31, 2003, and such borrowings bear interest at the prime rate plus
..50% (5.00% effective rate at December 31, 2003), but not less than 5.0% per
annum. The Optimation Loan Agreement provides for the Facility through April 30,
2004 and requires monthly repayments of $15,000 in January through March 2004
with a final payment of $18,750 on April 30, 2004. The Optimation Loan Agreement
prohibits the transfer of funds from Optimation to the parent company except for
customary inter-company cost reimbursements. The Facility is collateralized by
substantially all assets of Optimation, a guaranty by the parent company
Nematron and a partial guaranty by Optimation's president.

            In July 2003 the Board of Directors unanimously approved a motion to
negotiate and close the sale of substantially all of the Company's assets to an
entity to be formed by the senior and subordinated debt holders (the
"Purchaser"), to be paid by the Purchaser entirely with debt assumption. At the
Annual Meeting of Shareholders held on January 13, 2004 (the Annual Meeting"),
the shareholders approved a proposal to sell substantially all of the Company's
assets in consideration of the assumption of all its liabilities, including
senior debt, subordinated debt and all other liabilities (the "Net Asset Sale").
The total consideration will be equal to the total amount of all of the
Company's liabilities, which at December 31, 2003 were approximately $13.4
million. This price would exceed the book value of the Company's assets, by
approximately $3.2 million. The Net Asset Sale will result in the Company not
owning any assets except $30,000 in cash the Company expects to retain and
certain intangible assets such as its value as a public shell entity. The
Company will not, however, have any liabilities (other than contingent
liabilities where the Company has not been released by the creditor), all of
them being assumed by the Purchaser.

            The shareholders also approved, at the Annual Meeting, a proposal to
amend the Company's Articles of Incorporation to affect a reverse stock split
whereby five outstanding shares of Common Stock would become one share of
outstanding Common Stock ("one-for-five reverse stock split"). This one-for-five
reverse stock split will create a sufficient number of authorized but unissued
shares of Common Stock in order to consummate the following transaction also
approved at the Annual Meeting.

            Following the Net Asset Sale as described above, the Company will
become what is commonly known as a "public shell." Dorman Industries, LLC has
agreed to purchase, on a post-reverse stock split basis, a total of 5,248,257
shares of the Company's Common Stock from the Company for $50,000 (the
"Purchase"). The Purchase result in Dorman Industries owning, on a fully diluted
basis, approximately 62.5% of the Company's Common Stock following the
one-for-five reverse stock split. Concurrent with the Purchase, the new Board of
Directors elected at the Annual Meeting will assume management of the Company.
Dorman Industries intends to use the Company and its "public shell" as a
platform to build long-term shareholder value by acquiring and/or investing in,
and operating strategically positioned companies with capable of generating
above average operating profits. No assurances can be given that Dorman
Industries will be successful in connection with its future plans for the
Company.


                                                                              16
<PAGE>
            Neither the Net Asset Sale nor the Purchase, as described above, has
closed, although management expects that the transactions will close on March
31, 2004.

            Management believes successful implementation of the plans and
transactions set forth above will enable the Company to continue as a going
concern. If the Company is not successful in executing these plans, management
may be forced to curtail operations and either sell the Company, sell product
lines or wind down operations.

UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS

            "Item 6. Management's Discussion and Analysis or Plan of Operation"
and other parts of this Form 10-KSB contain certain "forward-looking statements"
within the meaning of the Securities Act of 1934, as amended. . While the
Company believes any forward-looking statements it has made are reasonable,
actual results could differ materially since the statements are based on current
management expectations and are subject to risks and uncertainties. These risks
and uncertainties include, but are not limited to the following:

                  -     Uncertainties discussed elsewhere in "Management's
                        Discussion and Analysis or Plan of Operations" and in
                        "Description of Business" above;

                  -     The potential inability to close the Net Asset Sale as
                        described above;

                  -     The continued forbearance by the Company's subordinated
                        lenders of their right to call the subordinated debt due
                        to nonpayment of principal and interest due currently;

                  -     A further decline of economic conditions in general and
                        in the automotive industry in particular;

                  -     Delays in introduction of planned hardware and software
                        product offerings;

                  -     Reductions in product life cycles;

                  -     Changes in customer requirements or reductions in demand
                        for the Company's products and services;

                  -     The inability of the Company to successfully implement
                        its strategy to participate effectively in the
                        industrial automation market migration from closed
                        architecture PLCs to open architecture PC-based
                        solutions or to effectively changes its corporate
                        strategy to capitalize on market changes;

                  -     Competitive factors (including the introduction or
                        enhancement of competitive products);

                  -     Product pricing decreases and component price increases
                        that may result in materially reduced gross profit
                        margins for the Company's products;

                  -     Latent defects in the code underlying its software
                        products or latent technological deficiencies in
                        existing and new hardware products;

                  -     Unforeseen increases in operating expenses or adverse
                        fluctuations in foreign exchange rates;

                  -     The inability to attract or retain management, sales or
                        engineering talent;

                  -     Evolving industrial automation industry standards.


                                                                              17
<PAGE>
ITEM 7. FINANCIAL STATEMENTS

            The financial statements filed herewith are set forth in the Index
to Consolidated Financial Statements (on page F-1) of the separate financial
section which follows this report, and are incorporated herein by reference.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

         Not applicable.

                                    PART III

ITEM 8A. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Our management, with the
participation of our principal executive officer and principal financial
officer, has evaluated the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended) as of the end of the
period covered by this annual report. Based on this evaluation, our principal
executive officer and principal financial officer concluded that these
disclosure controls and procedures are effective and designed to ensure that the
information required to be disclosed in our reports filed or submitted under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the requisite time periods.

In connection with its audit of the Company's consolidated financial statements
for the year ended December 31, 2003, Grant Thornton LLP ("Grant Thronton"), the
Company's independent accountants, advised the Audit Committee and management of
a deficiency involving internal control that Grant Thornton considered to be a
reportable condition under standards established by the American Institute of
Certified Public Accountants. Grant Thornton reported that during 2003 an error
was made in the application of Emerging Issues Task Force Consensus 00-27,
"Application of Issue No. 98-5 to certain Convertible Instruments" ("EITF
00-27") in the determination of the value of the beneficial conversion features
connected with the issuance of convertible securities with detachable warrants,
which resulted in an audit adjustment increasing interest expense and common
stock by $286,000. This is a complex area of accounting involving the
computation of intrinsic values inherent in relative values of the instruments.
The Company considered this matter in connection with the preparation of the
December 31, 2003 consolidated financial statements included in this Form 10-KSB
and recorded the adjustment proposed by Grant Thornton. The Company also
determined that the financial statements of quarterly periods within the year
ended December 31, 2003, as previously reported on Forms 10-QSB, were affected
by this misapplication of EITF 00-27. In response to the observations made by
Grant Thornton, in 2004 the Company will implement certain enhancements to its
internal controls and procedures, which it believes addresses the matter raised
by Grant Thornton.

(b) Changes in internal controls. There was no change in our internal control
over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended) identified in connection with the
evaluation of our internal control performed during our fourth quarter that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(A) OF THE EXCHANGE ACT.

            Directors of the Company

            Certain information relating to the persons who are the directors of
the Company is set forth below.

<TABLE>
<CAPTION>
                                                                                      Director      Term
     Name                       Age          Principal Occupation                      Since       Expires
     ----                       ---          --------------------                      -----       -------
<S>                             <C>   <C>                                             <C>          <C>
Ronald C. Causley               61    President of A-OK Controls Engineering,          2002         2005
                                      Inc., a wholly owned subsidiary of the
                                      Company, and a Director

Joseph J. Fitzsimmons           69    Retired Executive of Bell & Howell Company       1997         2004
                                      and its subsidiary, University Microfilms
                                      International, a provider of technology
                                      services to libraries and other
                                      organizations

Matthew S. Galvez               48    Chief Executive Officer of the Company,          1998         2004
                                      and a Director

Stephen E. Globus               57    Chairman of the Board of Globus Growth           1998         2006
                                      Group, a venture capital company, a
                                      director of Plasmaco, Inc., and a Director
</TABLE>

            Ronald C. Causley was appointed to the Board of Directors in
February 2002 to fill a vacancy on the Board. Mr. Causley is the President of
A-OK Controls Engineering, Inc., an industrial controls design and application
company and a wholly-owned subsidiary of Nematron. Mr. Causley is the founder of
A-OK Controls, which was incorporated in 1976, and he has served as its
President since its inception.

            Joseph J. Fitzsimmons became a director in March 1997. Mr.
Fitzsimmons is a retired executive of Bell & Howell Company and University
Microfilms International ("UMI"), a subsidiary of Bell & Howell. From January
1994 through June 1995 when he retired, Mr. Fitzsimmons was Corporate Vice
President of Bell & Howell and Chairman of UMI. From March 1987 through December
1993, Mr. Fitzsimmons was Corporate Vice President of Bell & Howell and
President and Chief Executive Officer of UMI, a leading provider of technology
services to libraries and other organizations regarding acquiring, preserving
and distributing literature.

            Matthew S. Galvez became a director in August 1998 upon his joining
the Company as its Chief Operating Officer. In October 1998, Mr. Galvez was
appointed to the office of the President and CEO of the


                                                                              18
<PAGE>
Company. In November 2003 Mr. Galvez resigned as President of the Company and
joined Millstone Merchant Partners, an investment banking company, as a managing
director. Mr. Galvez served as Chief Executive Officer of ISDA & Co., a
privately held apparel company, from June 1994 until June 1998. From 1990 until
June 1994, Mr. Galvez was a director and Chief Financial Officer of
Manufacturers Products Corporation, a supplier of plastic products to the
automotive industry. In 1994 he became Chief Executive Officer of that company
as well. Prior to 1990, Mr. Galvez was Executive Vice President - Corporate
Operations and General Counsel to a developer and supplier of graphics
translation software for the industrial marketplace and served as an officer of
two acquisition funds. Mr. Galvez serves as Chairman and a Director of Waltec
Plastics Co. in Midland, Ontario, Canada, and IMC Plastics in Los Angeles,
California.

            Stephen E. Globus became a director in December 1998. He has been
Chairman of the Board of Globus Growth Group, Inc., a New York - based venture
capital company specializing in providing startup and seed capital, since 1984.
He is also a director of Plasmaco, Inc., a flat computer screen manufacturer
owned by Matsushita (Panasonic). Mr. Globus is the founder of several privately
held biotechnology companies, including Kimeragen, Inc., NuGene Technologies,
Inc., Thermaphore Sciences, Inc. and Genitope, Inc.

            Executive Officers

            The Company has two executive officers that serve in their positions
at the pleasure of the Board of Directors. Mr. Matthew S. Galvez, 48, is the
Chief Executive Officer, and Mr. Jeffrey K. Crowell, 58, is the President and
Chief Operating Officer. See "Directors of the Company" for further information
concerning Mr. Galvez. Mr. Crowell was appointed President and COO in November
2003. Prior to his appointment, Mr. Crowell was president and CEO of General
Netware, Inc., a privately held consulting company, since 2000. Prior to joining
General Netware, Mr. Crowell was a managing director of Computer Sciences
Corporation, a public company.

            Compliance with Section 16(a) of the Securities Exchange Act of 1934

            Section 16(a) of the Securities Act of 1934 requires all Company
executive officers and directors and persons who own more than ten percent of a
registered class of the Company's equity securities to file reports of their
ownership with the Securities and Exchange Commission. Executive officers,
directors and greater than ten percent shareholders are required by SEC
regulation to furnish the Company with copies of all Section 16(a) reports they
file. Specific due dates for these reports have been established and the Company
is required to report any delinquent filings and failures to file such reports.

            Based solely on its review of the copies of such reports received by
it and written representations of its executive officers and incumbent
directors, the Company believes that during the year ended December 31, 2003,
all filing requirements under Section 16(a) applicable to its executive
officers, directors and greater than ten percent beneficial owners were complied
with.

            The Company does not have an "Audit Committee Financial Expert"
serving on its audit committee. Since the Company has been actively exploring
the sale of substantially all of its assets since July 2003, the Board of
Directors believed that it was more important to focus its energy on
accomplishing this goal, rather than attempting to find a new, potentially
short-term director and audit committee member, who would be willing to serve
on the Board of Directors and Audit Committee under these circumstances and who
could satisfy the Securities and Exchange Commission's definition of an "Audit
Committee Financial Expert." When the Company completes the Asset Sale and
acquires new operating lines of business, it is expected that the director
search process will include looking for a person who can meet the standards of
an Audit Committee Financial Expert.

            The Sarbanes-Oxley Act and related rules adopted by the SEC require
publicly traded companies to disclose whether they have adopted a code of
ethics that applies to a company's principal executive officer, principal
financial officer and principal accounting officer or controller, or person's
performing similar functions. The rules also define what constitutes a code of
ethics. Although the Company has adopted Standards of Conduct that apply to all
employees, and that address some of the same principles as a code of ethics,
the Company has not yet adopted a code of ethics that meets the SEC's rules.

            As discussed above, since the Company has been actively exploring
the sale of substantially all of its assets since July 2003, the Board of
Directors believed that it was more important to focus its energy on
accomplishing this goal, rather than putting their time and energy, and
management time and energy, into drafting a code of ethics that may not satisfy
the needs and requirements of the Company's new directors and shareholders.

                                                                              19
<PAGE>
ITEM 10 EXECUTIVE COMPENSATION

            Summary

            The following table sets forth information for the periods indicated
concerning the aggregate compensation paid by the Company and its subsidiaries
to the Company's Executive Officers (the "Named Executives").

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                              Long Term
                                                                             Compensation
                                                Annual Compensation             Awards           All Other
      Name and Principal                         -------------------            ------          Compensation
          Occupation              Year        Salary ($)      Bonus ($)       Options (#)          ($) (1)
          ----------              ----        ----------      ---------       -----------          -------
<S>                               <C>         <C>             <C>             <C>               <C>
  Matthew S. Galvez,              2003         $189,000          $-0-                -0-           $13,649
    President and Chief           2002         $200,000          $-0-                -0-           $16,400
    Executive Officer             2001         $200,000          $-0-                -0-           $20,445

  Jeffrey K. Crowell,             2003          $14,500          $-0-                -0-           $   909
    President and Chief
    Operating Officer
</TABLE>

(1)   All Other Compensation in the table above includes the following:

<TABLE>
<CAPTION>
                                                              Housing              Auto         401(k) Plan
                                                             Allowance           Allowance         Match
                                                             ---------           ---------         -----
<S>                              <C>                         <C>                 <C>            <C>
     Mr. Galvez                  2003                          $9,495             $4,154           $3,000
                                 2002                           8,600              4,800            3,000
                                 2001                           9,576              4,800            6,069

     Mr. Crowell                 2003                             909                 -0-              -0-
</TABLE>

            Options

            The following table sets forth information concerning options
granted to the Named Executives in the year ended December 31, 2003.

                        OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                       Individual Grants
                           -----------------------------------------
                                Number of         Percent of Total
                               Securities        Options Granted To      Exercise or
                           Underlying Options    Employees In Fiscal      Base Price       Expiration
            NAME                Granted                 Year              ($/Share)           DATE
                                --------                ----              ---------           ----
<S>                        <C>                   <C>                     <C>               <C>
   Matthew S. Galvez               -0-                  -0-%                  --               --
   Jeffrey K. Crowell              -0-                  -0-%                  --               --
</TABLE>

            The Named Executives did not exercise any options in the year ended
December 31, 2002. The following table provides information with respect to
unexercised options held by the Named Executives as of December 31, 2002.


                                                                              20
<PAGE>
               AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
                             YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                                           Value of Unexercised
                                   Number of Securities Underlying             In-the-Money
                                 Unexercised Options at Year-End (#)     Options at Year End ($) (2)
                                 -----------------------------------     ---------------------------
            Name                 Exercisable (1)      Unexercisable     Exercisable    Unexercisable
            ----                 ---------------      -------------     -----------    -------------
<S>                              <C>                  <C>               <C>             <C>
   Matthew S. Galvez                860,000                -0-              $-0-            $-0-
   Jeffrey K. Crowell                    -0-               -0-              $-0-            $-0-
</TABLE>

(1)   Share information is after the one-for-five reverse stock split.

(2)   Value of unexercised in-the-money options is determined by multiplying the
      number of shares subject to the option by the difference between the
      closing price of the Common Stock on the OTCBB at the end of 2003 and the
      option exercise price.

            Employment Agreement

            None of the Named Executives have an employment agreement with the
Company.

            Compensation of Directors

            Each director who is not an officer or employee of the Company is
eligible to receive for his services as such a fee of $1,000 per meeting
attended and $500 for each committee meeting attended. Committee chairs receive
an additional $250 for each committee meeting. The directors waived the director
fees for meetings held during quarterly periods during which the Company
reported a loss from operations, which were all quarters of the last three
years. Directors who are officers or employees of the Company receive no
additional compensation for their service as a director, although they are
reimbursed for their reasonable travel expenses when meetings are held in a
location other than the metropolitan area in which they reside.

            The Company has a 1993 Directors Stock Option Plan (the "Directors
Plan"). Pursuant to the provisions of the Directors Plan, each director is
automatically and without discretion awarded options to purchase 900 shares of
Common Stock (as adjusted for the one-for-five reverse stock split), with an
exercise price equal to 110% of the fair market value per share on the grant
date, beginning on the date of the Company's 2000 annual meeting of shareholders
and every three years thereafter. The options are exercisable annually in
increments of 33 1/3% beginning on the grant date, the first anniversary of the
date of the grant and the second anniversary of the grant. All options granted
under the Directors Plan expire on the fifth anniversary of the date the option
was granted. The ability to exercise these options may be accelerated in the
event of a change in control of the Company (as defined in the Directors Plan).
No options were granted during 2002 or 2003.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

            The following table sets forth information as of December 31, 2003
with respect to the beneficial ownership of Common Stock by current directors,
each executive officer named in the Summary Compensation Table under "Executive
Compensation", all current directors and executive officers as a group and all
other persons known by the Company to beneficially own more than 5% of its
outstanding Common Stock (each, a "5% Owner"). Except as noted below, each
shareholder exercises sole voting and investment power with respect to the
shares beneficially owned.

            The share information included in the following table has been
adjusted for the one-for-five reverse stock split approved by the shareholders
at the Annual Meeting of Shareholders held on January 13, 2004.


                                                                              21
<PAGE>
<TABLE>
<CAPTION>
                                                   Number of Shares
              Name                                Beneficially Owned                    Percent of Class (9)
              ----                                ------------------                    --------------------
<S>                                               <C>                                   <C>
Directors and Management:
          Ronald C. Causley                             753,585   (1)                           19.95%
          Joseph J. Fitzsimmons                         379,513   (2)                           10.77%
          Stephen E. Globus                             257,040   (3)                            8.16%
          Matthew S. Galvez                             172,020   (4)                            5.18%
          Jeffrey K. Crowell                                 -0-                                 0.00%
          John H. Dunlap                                     -0-                                 0.00
          All directors and executive
            officers as group (4 persons)             1,562,165   (5)                           36.02%

5% Owners:
          Hugo E. Braun                              20,251,242   (6)                           87.33%
          James A. Nichols                              918,004   (7)                           25.01%
          J. Eric May, Trustee Under
            Declaration of Trust                        298,685   (8)                            9.49%
</TABLE>

(1)   The shares shown in the table for Mr. Causley include (i) 124,817 shares
      of Common Stock owned outright, (ii) options to purchase 6,000 shares of
      Common Stock, which are currently exercisable or are exercisable within
      sixty days under the Long-Term Incentive Plan; (iii) warrants to purchase
      a maximum of 50,000 shares of Common Stock issued in March 2002 in
      connection with the Company's issuance of subordinated notes and warrants;
      and (iv) rights to convert the principal amount of $125,000 of
      subordinated convertible notes and accrued interest thereon to 572,768
      shares of Common Stock at the lowest closing price per share, adjusted for
      the effects of the one-for-five reverse stock split, during the period
      that the note is outstanding. Mr. Causley's address is 4375 Giddings Road,
      Auburn Hills, MI 48326.

(2)   The shares shown in the table for Mr. Fitzsimmons include (i) 3,000 shares
      of Common Stock owned outright, (ii) options under the Directors Option
      Plan to purchase 4,233 shares of Common Stock, which are currently
      exercisable or are exercisable within sixty days; and (iii) warrants to
      purchase a maximum of 30,000 shares of Common Stock issued in March 2002
      in connection with the Company's issuance of subordinated notes and
      warrants, and (iv) rights to convert the principal amount of $75,000 of
      subordinated convertible notes and accrued interest thereon to 342,280
      shares of Common Stock at the lowest closing price per share, adjusted for
      the effects of the one-for-five reverse stock split, during the period
      that the note is outstanding. Mr. Fitzsimmons' address is 5840 Interface
      Drive, Ann Arbor, MI 48103.

(3)   The shares shown in the table for Mr. Globus include (i) 51,012 shares of
      Common Stock owned outright by Mr. Globus, (ii) 136,472 shares of Common
      Stock owned by companies and partnerships over which Mr. Globus exercises
      voting and investment power, (iii) 68,663 shares of Common Stock owned by
      certain relatives of Mr. Globus over which Mr. Globus exercises beneficial
      ownership, and (iv) options to purchase 900 shares of Common Stock which
      are currently exercisable or are exercisable within sixty days. Mr.
      Globus' address is 44 West 24th Street, New York, NY 10010.

(4)   The shares shown in the table for Mr. Galvez include (i) 20 shares of
      Common Stock owned outright, and (ii) options to purchase 172,000 shares
      of Common Stock, which are currently exercisable or are exercisable within
      sixty days. Mr. Galvez's address is 1775 Eye Street NW, Suite 800,
      Washington, DC 20006.

(5)   The shares shown in the table for all current directors and executive
      officers as a group include the shares described in footnotes (1) through
      (5).


                                                                              22
<PAGE>
(6)   The shares shown in the table for Mr. Braun include (i) 210,000 shares of
      Common Stock owned by North Coast and Access Venture Fund L.P. ("North
      Coast"), of which Mr. Braun is a partner, (ii) currently exercisable
      warrants to purchase 100,000 shares of Common Stock pursuant to a warrant
      issued to North Coast in March 2001, (iii) currently exercisable warrants
      to purchase 1,464,870 shares of Common Stock pursuant to a warrant issued
      to North Coast in connection with issuances of subordinated debt and
      warrants under a $3 million borrowing arrangement between the Company and
      North Coast, (iv) rights to convert the principal amount of $750,000 of
      subordinated convertible notes and accrued interest thereon to 3,827,672
      shares of Common Stock at the lowest closing price per share, adjusted for
      the effects of the one-for-five reverse stock split, during the period
      that the notes are outstanding, and (v) rights to convert the principal
      amount of $3,111,500 of subordinated convertible notes and accrued
      interest thereon to 14,648,700 shares of Common Stock at the lowest
      closing price per share, adjusted for the effects of the one-for-five
      reverse stock split, during the period that the note is outstanding . If
      such warrants, rights and options were exercised, Mr. Braun would have
      sole voting rights and shared investment power with respect to the
      underlying shares. Mr. Braun's address is 206 South Fifth Avenue, Suite
      550, Ann Arbor, MI 48104

(7)   The shares shown in the table for Mr. Nichols include (i) 346,741 shares
      of Common Stock owned outright, (ii) 48,890 shares of Common Stock owned
      by an investment club of which Mr. Nichols is a member, (iii) currently
      exercisable warrants to purchase 13,333 shares of Common Stock, and (iv)
      rights to convert the principal amount of $100,000 subordinated
      convertible notes to 509,040 shares of Common Stock at the lowest closing
      price per share, adjusted for the effects of the one-for-five reverse
      stock split, during the period that the note is outstanding. Mr. Nichols'
      address is 3707 West Maple Road, Bloomfield Hills, MI 48301.

(8)   The shares shown in the table for Mr. May, Trustee include 298,685 shares
      of Common Stock owned by J. Eric May, Trustee Under Declaration of Trust.
      Mr. May's address is c/o Wilmington Trust Company, 1100 North Market
      Street, Wilmington, DE 19890.

(9)   The number of shares and percentages have been determined as of December
      31, 2003. At that date 3,148,894 shares of stock outstanding (as adjusted
      for the effects of the one-for-five reverse stock split) used in
      calculating the percentage ownership of a beneficial owner assumes that
      all options and warrants to acquire shares of Common Stock held by such
      beneficial owner (but not those held by any other person) that were
      exercisable on, or become exercisable within 60 days of, December 31, 2003
      are exercised.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

            The discussion in this Item 12 includes share information that has
been adjusted for the one-for-five reverse stock split approved by the
shareholders at the Annual Meeting of Shareholders held on January 13, 2004.

            10% CONVERTIBLE SUBORDINATED PROMISSORY NOTE - MR. HUGO BRAUN, A
FORMER DIRECTOR

            In March 2001, the Company completed a sale of $1.2 million
principal amount of Convertible Subordinated Promissory Notes and Warrants to
purchase a total of 160,000 shares of Common Stock to certain accredited
investors, including North Coast Technology Investors LP ("North Coast"), of
which Mr. Hugo Braun, a former Company Director, is a partner. The Convertible
Subordinated Promissory Notes, which are secured by a second lien on the
Company's assets and are subordinated in right of payment to the Company's
senior lender, bear interest at 10% and were due on August 31, 2001 (the "10%
Notes"). The 10% Notes are currently due and payable, but are subordinated to
the Company's senior lender. The 10% Notes are prepayable at any time without
penalty upon prior written notice as provided in the Notes. The holders of the
10% Notes are not permitted to transfer them without the Company's prior written
consent. The holders of the 10% Notes could have converted the principal and
accrued interest thereon into shares of a planned equity offering, if such
offering was completed by August 31, 2001. After that, the principal and accrued
interest thereon may be converted into shares of Common Stock. The number of
shares of Common Stock issuable upon exercise of the


                                                                              23
<PAGE>
Conversion Option is equal to (x) the sum of the principal and interest then due
and payable, divided by (y) the Common Stock Conversion Price. The Common Stock
Conversion Price was initially set at $1.20 and is adjusted to the lowest
closing price of the Common Stock if the closing price fell below $1.20 for five
consecutive trading days. The lowest closing price of the Common Stocks traded
on the AMEX or on the OTCBB during the period the Convertible Promissory Notes
have been outstanding has been $0.25 (as adjusted for the effects of the
one-for-five reverse stock split approved by the shareholders on January 13,
2004). Information concerning the 10% Notes and Warrants sold to North Coast is
as follows:

<TABLE>
<S>                                                                           <C>
         10% Notes purchased                                                  $  750,000
         Warrants purchased, convertible into Common shares                      100,000
         Common Stock, which may be obtained through
            exercise of the Conversion Option - $0.25 per share                3,827,672
         Interest accrued and unpaid since date of note                         $206,900
</TABLE>

            14% CONVERTIBLE SUBORDINATED PROMISSORY NOTE - MR. HUGO BRAUN, A
FORMER DIRECTOR

            In March 2002, the Company executed a Convertible Subordinated
Promissory Note with North Coast that documented the terms of an agreement that
was informally in place beginning in October 2001. The agreement has been
modified through April 2003. The agreement provides for a maximum of $3,000,000
to be available to the Company as funds are needed and not available from the
Company's senior lender or other sources. North Coast is under no obligation to
fund the Company's advance request. The Convertible Subordinated Promissory
Note, which is secured by a second lien on the Company's assets and is
subordinated in right of payment to the Company's bank lender, bear interest at
14% and advances thereunder are due demand (the "14% Note"). Advances made under
the 14% Note are prepayable at any time without penalty upon prior written.
North Coast is not permitted to transfer the 14% Note without the Company's
prior written consent. Pursuant to the terms of the 14% Note, because Nematron
did not complete an equity financing pursuant to which it received gross
proceeds of at least $1.5 million on or before August 31, 2002, the principal
and interest due and payable under this Note may be converted by North Coast, in
whole or in part, into shares of Series A Preferred Stock of Nematron beginning
on September 1, 2002, upon at least three (3) business days prior written notice
from North Coast to Nematron and prior to the payment of 14% Note in full.

            A summary of the terms of the Series A Preferred is as follows:

            DIVIDENDS: No dividends will be required to be paid by the Company.
If any dividends are paid on the Company's common stock ("Common"), the holders
of the Series A Preferred shall be entitled to receive dividends in preference
to any dividend on the Common in an amount per share equal to or greater than
any dividend paid on the Common.

            LIQUIDATION PREFERENCE: In the event of any liquidation or winding
up of the Company, the holders of the Series A Preferred shall be entitled to
receive in preference to the holders of Common an amount equal to the original
issue price for the Series A Preferred Stock. Thereafter, any remaining
liquidation proceeds will be distributed to the holders of the Series A
Preferred and the Common on a pro rata basis. A merger, consolidation or
reorganization in which the shareholders of the Company own less than 50% of the
voting power of the surviving company and any transaction or series of related
transactions in which in excess of 50% of the Company's voting power is
transferred shall be treated as a liquidation.

            CONVERSION: Each holder of Series A Preferred shall have the right
to convert its shares at any time into shares of Common at the initial
conversion rate of 1:1. The conversion rates shall be subject from time to time
to antidilution adjustments as set forth below.

            VOTING RIGHTS: The holder of each share of Series A Preferred shall
have the right to that number votes equal to the number of shares of Common
issuable upon conversion of the Series A Preferred. The Series A Preferred shall
vote with Common on all matters except as specifically provided herein or as
otherwise required by law.


                                                                              24
<PAGE>
            BOARD OF DIRECTORS: The holders of the Series A Preferred shall have
the right to elect one member to the Company's Board of Directors. If the
holders of the Series A Preferred choose not to exercise this right, the Series
A Preferred shall vote with Common in the election of directors.

            PROTECTIVE PROVISIONS: Consent of a majority in interest of the
Series A Preferred will be required to (a) purchase or redeem any Common or
Preferred Stock, (b) authorize or issue any senior or parity securities, (c)
declare or pay dividends on or make any distribution on account of the Common,
(d) merge, consolidate or sell or assign all or substantially all of the
Company's assets, (e) increase or decrease authorized Preferred Stock and (f)
amend Articles or Incorporation to change the rights, preferences, privileges or
limitations of any Preferred Stock.

            ANTIDILUTION: The conversion price for the Series A Preferred shall
be subject to proportional antidilution protection for stock splits, stock
dividends, etc. In the event that the Company issues additional shares of Common
or Common equivalents (other than shares issues to officers or employees of the
Company pursuant to plans approved by the Company's board of directors) at a
purchase price less than the applicable Series A Preferred conversion price, the
Series A Preferred conversion price shall be adjusted to that same lower
purchase price.

            RIGHTS OF FIRST REFUSAL: Each holder of Series A Preferred shall
have the right to participate in any Company financing up to its pro-rata
ownership.

            INFORMATION RIGHTS: Holders of Series A Preferred Stock shall have
the right to receive annual and quarterly financial statements and an annual
business plan.

            Information concerning the 14% Notes and Warrants sold to North
Coast is as follows:

<TABLE>
<S>                                                                                        <C>
         Advances made under the 14% Note purchased                                        $ 3,111,500
         Warrants purchased, convertible into Common shares                                  1,464,870
         Series A Preferred Stock issuable upon conversion of the 14% Note                  14,648,700
         Interest accrued and unpaid on Subordinated Promissory Notes                      $   550,675
</TABLE>

            8% CONVERTIBLE SUBORDINATED PROMISSORY NOTE - MR. RONALD C. CAUSLEY
            AND MR. JOSEPH J. FITZSIMMONS, DIRECTORS

            In March 2002, the Company completed a sale of $200,000 principal
amount of Convertible Subordinated Promissory Notes and Warrants to Ronald C.
Causley and Joseph J. Fitzsimmons, directors of the Company. The Convertible
Subordinated Promissory Notes, which are secured by a second lien on the
Company's assets and are subordinated in right of payment to the Company's bank
lender, bear interest at 8% and are due on October 31, 2002 (the "8% Notes").
The Company did not repay the 8% Notes and the agreement was amended on that
date and the warrant conversion price and the conversion rights were modified to
the same terms as the 14% Notes to North Coast discussed above. The 8% Notes may
be prepaid at any time without penalty upon prior written notice. The holders of
the 8% Notes are not permitted to transfer them without the Company's prior
written consent. Information concerning the 8% Notes and Warrants sold to Mr.
Causley and Mr. Fitzsimmons is as follows:

<TABLE>
                                                                       Ronald C.         Joseph J.
                                                                       Causley          Fitzsimmons
                                                                       -------          -----------
<S>                                                                    <C>              <C>
      Convertible Subordinated Promissory Notes purchased              $125,000         $ 75,000
      Warrants purchased, convertible into Common shares                 50,000           30,000
      Series A Preferred Stock issuable upon conversion of the Notes    572,768          342,280
      Interest accrued and unpaid since date of note                   $ 18,192         $ 10,570
</TABLE>


                                                                              25
<PAGE>
            ACQUISITION DEBT - MR. RONALD C. CAUSLEY, A DIRECTOR

            Pursuant to the terms of the Purchase Agreement by and between the
Company, A-OK Controls Engineering, Inc. ("A-OK Controls") and Ronald C. Causley
dated June 30, 2000 under which the Company purchased 100% of the equity of A-OK
Controls Engineering, Inc. from its sole stockholder, Mr. Causley on that date,
Nematron agreed to pay the final cash installment related to the purchase price
within 60 days of closing. Such amount, totaling $351,867, was not paid and has
accrued interest at 9% per annum since that date. Interest accrued and unpaid
during 2002 and 2003 was $37,759 and $41,302, respectively. Total accrued and
unpaid interest due to Mr. Causley as of December 31, 2003 is $129,716.

            OPERATING LEASES AND AMOUNTS DUE - MR. RONALD C. CAUSLEY, A DIRECTOR

            The Company's wholly owned subsidiary, A-OK Controls, leases under
ten-year operating leases its Auburn Hills and Saginaw, Michigan system
integration offices from Mr. Ronald C. Causley. Management believes that these
leases, which were executed prior to the Company's acquisition of A-OK Controls,
represent fair market lease rates. Lease expense on these related party leases
totaled approximately $397,800 and $496,700 in 2002 and 2003 respectively. The
lease on the Saginaw facility requires monthly lease payments of $3,150 through
January 2009, and the lease on the Auburn Hills facility requires monthly lease
payments of $30,000 through May 2008. Minimum lease payments through the
expiration dates of the leases total $1,812,150. A-OK Controls suspended making
the required lease payments to Mr. Causley during 2003 and at December 31, 2003
is in arrears a total of $502,900.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

            (a)   The exhibits filed herewith are set forth in the Index to
                  Exhibits (on the first page of the separate exhibit section,
                  which follows the financial section of this report) and are
                  incorporated herein by reference.

            (b)   The Company did not file any current reports on Form 8-K
                  during the fourth quarter of the Company's fiscal year ended
                  December 31, 2003.

ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES.

Audit Fees

Our independent accountants, Grant Thornton LLP, provided audit and other
services during the years ended December 31, 2002 and 2003 as follows:

<TABLE>
<CAPTION>

                                              2002              2003
                                              ----              ----
<S>                                         <C>               <C>
          Audit Fees                        $50,000           $75,000
          Audit Related Fees                  5,000             5,000
          Tax Fees                              -0-            25,000
          All Other Fees                        -0-               -0-
</TABLE>

          Audit Fees. This category includes the fees for the audit of our
          consolidated financial statements and the quarterly reviews of interim
          financial statements. This category also includes advice on audit and
          accounting matters that arose during or as a result of the audit or
          the review of interim financial statements and services in connection
          with SEC filings.

          Audit Related Fees. This category includes the fees paid to audit the
          Company's 401(k) Plan.

          Tax Fees. This includes the filing of Amended MSBT 1998, 1999 & 2000
          returns for Nematron and A-OK Controls.

          All Other Fees. There were no other fees paid to Grant Thornton LLP.

          Effective May 6, 2003, the Securities and Exchange Commission adopted
rules that require that before Grant Thornton LLP is engaged by the Company or
its subsidiaries to render any auditing or permitted non-audit related service,
the engagement be approved by the company's audit committee or entered into
pursuant to pre-approval policies and procedures established by the audit
committee, provided the policies and procedures are detailed as to the
particular service, the audit committee is informed of each service, and such
policies and procedures do not include delegation of the audit committee's
responsibilities to management.

          The audit committee requires advance approval of all audit,
audit-related, tax, and other services performed by the independent auditor.
Unless the specific service has been previously pre-approved with respect to
that year, the audit committee must approve the permitted service before the
independent auditor is engaged to perform it. The audit committee has delegated
to the chair of the audit committee authority to approve permitted services
provided that the chair reports any decisions to the committee at its next
scheduled meeting.

          The audit committee has considered the nature and amount of the fees
billed by Grant Thornton LLP, and believes that the provision of the services
for activities unrelated to the audit is compatible with maintaining Grant
Thornton LLP's independence.

                                                                              26
<PAGE>
                                   SIGNATURES

            In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized

NEMATRON CORPORATION

By:   /s/ Jeffrey K. Crowell                     Dated:  March 30, 2004
    ---------------------------------------
    Jeffrey K. Crowell, President and COO

And

      /s/ Matthew S. Galvez                      Dated:  March 30, 2004
    ---------------------------------------
    Matthew S. Galvez, CEO and a Director

            In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant in the capacities and
on the dates indicated.

<TABLE>
<CAPTION>
         Signature                                 Title                                Date

<S>                                  <C>                                           <C>
  /s/ Tina M. Raiford                Vice President, Accounting and                March 30, 2004
---------------------------------    Corporate Controller
Tina M. Raiford                      (Principal Accounting Officer)


  /s/ Ronald C. Causley              Director                                      March 30, 2004
---------------------------------
Ronald C. Causley

  /s/ Joseph J. Fitzsimmons          Chairman of the Board                         March 30, 2004
---------------------------------    and a Director
Joseph J. Fitzsimmons

  /s/ Stephen E. Globus              Director                                      March 30, 2004
---------------------------------
Stephen E. Globus
</TABLE>


                                                                              27
<PAGE>


                      NEMATRON CORPORATION AND SUBSIDIARIES

                                INDEX TO EXHIBITS

Exhibit
Number                            Description of Exhibit
------                            ----------------------

2.01          Stock Purchase Agreement dated as of June 30, 2000 by and among
              the Ronald C. Causley, Trustee of the Ronald C. Causley Revocable
              Trust dated March 14, 1990, as amended, Ronald C. Causley,
              individually, and Nematron Corporation, together with Exhibits: a)
              Registration Rights Agreement by and between Ronald C. Causley,
              Trustee of Ronald C. Causley Revocable Trust dated March 14, 1990,
              as amended and Nematron Corporation; b) Employment Agreement
              between Ronald C. Causley and A-OK Controls Engineering, Inc. and
              c) Agreement not to Compete between Ronald C. Causley, A-OK
              Controls Engineering, Inc. and Nematron Corporation, filed as
              Exhibit 2.01 to the Registrant's Form 10-QSB for the quarterly
              period ended June 30, 2000 and incorporated herein by reference.

2.02          Stock Purchase Agreement dated as of March 30, 2001 by and among
              Nematron Corporation, Optimation, Inc., Dennis A. Sierk, Sheila D.
              Sierk, Charles Garrett and Kerry Garrett, filed as Exhibit 2.01 to
              the Registrant's Form 10-QSB for the quarterly period ended March
              31, 2001 and incorporated herein by reference.

3.01          Amended and Restated Articles of Incorporation, as amended, filed
              as Exhibit 3.1 to the Registrant's Form 10-QSB for the quarterly
              period ended September 30, 1999 and incorporated herein by
              reference.

3.02          Amended and Restated Bylaws, as amended, filed as Exhibit 3.02 to
              the Registrant's Form 10-KSB for the year ended December 31, 1999
              and incorporated herein by reference.

4.01          Loan and Security Agreement dated as of November 12, 1999 by and
              among LaSalle Business Credit, Inc. and the Registrant for a $10.9
              million credit facility, filed as Exhibit 4.1 to the Registrant's
              Form 10-QSB for the quarterly period ended September 30, 1999 and
              incorporated herein by reference.

4.02          Amended and Restated Loan and Security Agreement dated as of June
              30, 2000 by and among LaSalle Business Credit, Inc. and the
              Registrant for a $8.3 million credit facility, filed as Exhibit
              4.1 to the Registrant's Form 10-QSB for the quarterly period ended
              June 30, 2000 and incorporated herein by reference.

4.03          Loan and Security Agreement dated as of June 30, 2000 by and among
              LaSalle Business Credit, Inc. and the A-OK Controls Engineering,
              Inc. for a $3.0 million credit facility, filed as Exhibit 4.2 to
              the Registrant's Form 10-QSB for the quarterly period ended June
              30, 2000 and incorporated herein by reference

4.04          First Amendment to Amended and Restated Loan and Security
              Agreement dated as of March 1, 2001, by and between Nematron
              Corporation and LaSalle Business Credit, Inc., as Lender, filed as
              Exhibit 4.1 to the Registrant's Form 10-QSB for the quarterly
              period ended March 31, 2001 and incorporated herein by reference.

4.05          First Amendment to Loan and Security Agreement dated as of March
              1, 2001, by and between Nematron Corporation and A-OK Controls
              Engineering, Inc. and LaSalle Business Credit, Inc., as Lender,
              filed as Exhibit 4.2 to the Registrant's Form 10-QSB for the
              quarterly period ended March 31, 2001 and incorporated herein by
              reference.

4.06          Second Amendment and Waiver to Amended and Restated Loan and
              Security Agreement dated as of April 12, 2001, by and between
              Nematron Corporation and LaSalle Business Credit, Inc., as Lender,
              filed as Exhibit 4.3 to the Registrant's Form 10-QSB for the
              quarterly period ended March 31, 2001 and incorporated herein by
              reference.

4.07          Second Amendment and Waiver to Loan and Security Agreement dated
              as of April 12, 2001, by and between Nematron Corporation and A-OK
              Controls Engineering, Inc. and LaSalle Business Credit, Inc., as
              Lender, filed as Exhibit 4.4 to the Registrant's Form 10-QSB for
              the quarterly period ended March 31, 2001 and incorporated herein
              by reference.

4.08          Third Amendment to Amended and Restated Loan and Security
              Agreement between LaSalle Business Credit, Inc. and the Registrant
              dated October 17, 2002, filed as Exhibit 4.3 to the Registrant's
              Form 10-QSB for the quarterly period ended September 30, 2002 and
              incorporated herein by reference.


                                                                              28
<PAGE>
Exhibit
Number                             Description of Exhibit
------                             ----------------------

4.09          Third Amendment to Amended and Restated Loan and Security
              Agreement between LaSalle Business Credit, Inc. and A-OK Controls
              Engineering, Inc. dated October 17, 2002, filed as Exhibit 4.4 to
              the Registrant's Form 10-QSB for the quarterly period ended
              September 30, 2002 and incorporated herein by reference.

4.10          Security Agreement dated as of April 12, 2001, by Optimation, Inc.
              in favor of LaSalle Business Credit, Inc., filed as Exhibit 4.5 to
              the Registrant's Form 10-QSB for the quarterly period ended March
              31, 2001 and incorporated herein by reference.

4.11          Form of Convertible Subordinated Promissory Note dated between
              March 21 and April 6, 2001, by and between Nematron Corporation
              and Noteholders, and schedule of Noteholders and amounts, filed as
              Exhibit 4.6 to the Registrant's Form 10-QSB for the quarterly
              period ended March 31, 2001 and incorporated herein by reference.

4.12          Form of Warrant Agreement dated between March 21 and April 6,
              2001, by and between Convertible Subordinated Noteholders and
              Nematron Corporation, and schedule of amounts of Warrants by
              Warrant holder, filed as Exhibit 4.7 to the Registrant's Form
              10-QSB for the quarterly period ended March 31, 2001 and
              incorporated herein by reference.

4.13          Subordinated Promissory Note dated October 1, 2001, by and between
              North Coast Technology Investors LP and Nematron Corporation,
              filed as Exhibit 4.14 to the Registrant's Form 10-KSB for the year
              ended December 31, 2001 and incorporated herein by reference.

4.14          Form of Subordinated Promissory Note dated between March 6 and
              March 28, 2002, by and between Nematron Corporation and
              Noteholders, and schedule of Noteholders and amounts, filed as
              Exhibit 4.1 to the Registrant's Form 10-QSB for the quarterly
              period ended March 31, 2002 and incorporated herein by reference.

4.15          Form of Warrant Agreement dated between March 6 and March 28,
              2002, by and between Convertible Subordinated Noteholders and
              Nematron Corporation, and schedule of amounts of Warrants by
              Warrant holder, filed as Exhibit 4.2 to the Registrant's Form
              10-QSB for the quarterly period ended March 31, 2002 and
              incorporated herein by reference. 4.16 Subordinated Promissory
              Note between North Coast Technology Investors, L.P. and the
              Registrant dated October 28, 2002, filed as Exhibit 4.5 to the
              Registrant's Form 10-QSB for the quarterly period ended September
              30, 2002 and incorporated herein by reference.

4.17          Subordinated Promissory Note between North Coast Technology
              Investors, L.P. and the Registrant dated as of April 14, 2003 in
              the amount of $3,000,000.

4.18          Promissory Note between North Coast Technology Investors, L.P. and
              the Registrant dated as of July 31, 2003 in the amount of
              $1,700,000 payable on demand with interest at 9.0% per annum,
              filed as Exhibit 4.4 to the Registrant's Form 10-QSB for the
              quarterly period ended September 30, 2003 and incorporated herein
              by reference.

4.19          Mortgage between North Coast Technology Investors, L.P. and the
              Registrant dated as of July 31, 2003, filed as Exhibit 4.3 to the
              Registrant's Form 10-QSB for the quarterly period ended September
              30, 2003 and incorporated herein by reference.

4.19          Security Agreement between North Coast Technology Investors, L.P.
              and the Registrant dated as of July 31, 2003, pursuant to which
              Nematron grants a continuing security interest in Collateral to
              secure the payment of liabilities, filed as Exhibit 4.2 to the
              Registrant's Form 10-QSB for the quarterly period ended September
              30, 2003 and incorporated herein by reference.

4.20          Variable Rate Term Note in the amount of $2,700,000 between
              Chelsea State Bank and the Registrant dated September 30, 2002,
              filed as Exhibit 4.0 to the Registrant's Form 10-QSB for the
              quarterly period ended September 30, 2002 and incorporated herein
              by reference.

4.21          Revolving Credit and Security Agreement dated July 9, 1999, by and
              between Optimation, Inc. and Compass Bank, filed as Exhibit 4.8 to
              the Registrant's Form 10-QSB for the quarterly period ended March
              31, 2001 and incorporated herein by reference.


                                                                              29
<PAGE>
<Table>
<Caption>
Exhibit
Number                            Description of Exhibit
------                            ----------------------
<S>    <C>
4.20    Modification Agreement and Amendment to Loan Documents dated July 19, 2000,
        by and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.9 to
        the Registrant's Form 10-QSB for the quarterly period ended March 31, 2001
        and incorporated herein by reference.

4.21    Modification Agreement and Amendment to Loan Documents dated July 9, 2001, by
        and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.0 to the
        Registrant's Form 10-QSB for the quarterly period ended June 30, 2001 and
        incorporated herein by reference.

4.22    Modification Agreement and Amendment to Loan Documents dated February 25, 2002,
        by and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.19 to the
        Registrant's Form 10-KSB for the year ended December 31, 2001 and
        incorporated herein by reference.

4.23    Modification Agreement and Amendment to Loan Documents dated July 9, 2002, by
        and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.0  to the
        Registrant's Form 10-QSB for the quarterly period ended June 30, 2002 and
        incorporated herein by reference.

4.24    Loan Modification Agreement and Amendment to Loan Documents dated October 4, 2002,
        by and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.2 to the
        Registrant's Form 10-QSB for the quarterly period ended September 30, 2002 and
        incorporated herein by reference.

4.25    Loan Modification Agreement and Amendment to Loan Documents dated October 3, 2003,
        by and between Optimation, Inc. and Compass Bank, filed as Exhibit 4.1 to the
        Registrant's Form 10-QSB for the quarterly period ended September 30, 2003 and
        incorporated herein by reference.

10.01*  Nematron Corporation 1993 Stock Option Plan, as amended and restated March 1997,
        filed as Exhibit 10.1 to the Registrant's Form 10-QSB for the quarterly period
        ended March 31, 1997 and incorporated herein by reference.

10.02*  Nematron Corporation 1993 Directors Option Plan, as amended and restated, filed
        as Exhibit 10.2 to the Registrant's Form 10-QSB for the quarterly period ended
        March 31, 1997 and incorporated herein by reference.

10.03*  Nematron 401(k) Plan, filed as Exhibit 10.04 to the Registrant's Form 10-KSB for
        the year ended September 30, 1995 and incorporated herein by reference.

10.04*  Nematron Corporation Long-Term Incentive Plan, filed as Exhibit 10.03 to the
        Registrant's Form 10-QSB for the quarterly period ended March 31, 1999 and
        incorporated herein by reference.

10.05*  Employment Agreement entered into effective October 1, 1998 and dated July 26,
        1999 by and between Matthew S. Galvez and the Registrant, filed as Exhibit 10.01
        to the Registrant's Form 10-QSB for the quarterly period ended June 30, 1999 and
        incorporated herein by reference.

10.06*  Employment Agreement entered into effective March 30, 2001 and dated March 30,
        2001 by and between Dennis A. Sierk and the Registrant, filed as Exhibit 10.01
        to the Registrant's Form 10-QSB for the quarterly period ended March 31, 2001
        and incorporated herein by reference.

10.07*  Nonqualified Stock Option Agreement dated October 13, 1998 between Matthew S.
        Galvez and the Registrant, filed as Exhibit 10.02 to the Registrant's
        Form 10-QSB for the quarterly period ended June 30, 1999 and  incorporated
        herein by reference.

10.08*  Nonqualified Stock Option Agreement dated December 3, 1998 between Matthew S.
        Galvez and the Registrant, filed as Exhibit 10.02 to the Registrant's
        Form 10-QSB for the quarterly period ended June 30, 1999 and incorporated herein
        by reference.

10.09*  Nonqualified Stock Option Agreement dated December 13, 1999 between Matthew S.
        Galvez and the Registrant, filed as Exhibit 10.08 to the Registrant's Form 10-KSB
        for the year ended December 31, 1999 and incorporated herein by reference.

10.10   Registration Rights Agreement by and between Ronald C. Causley, Trustee of
        Ronald C. Causley Revocable Trust dated March 14, 1990, as amended and Nematron
        Corporation, filed as Exhibit 4.1 to the Registrant's Form 8-K filed July 14, 2000
        and incorporated herein by reference.

21.01   Subsidiaries of Nematron Corporation.

23.01   Consent of Grant Thornton LLP.

31.01   Certification of CEO, COO and VP-Accounting pursuant to 18 U.S.C. Section 1350,
        as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.02   Certification of CEO, COO and VP-Accounting pursuant to 18 U.S.C. Section 1350,
        as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.03   Certification of CEO, COO and VP-Accounting pursuant to 18 U.S.C. Section 1350,
        as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.01   Certification of CEO, COO and VP-Accounting pursuant to 18 U.S.C. Section 1350,
        as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
</Table>
*  Management compensatory plan or arrangement.
                                                                              30
<PAGE>
                                   UNDERTAKING

            The Company will furnish to any shareholder a copy of any of the
exhibits listed above upon written request and upon payment of a specified
reasonable fee, which fee shall be equal to the Company's reasonable expenses in
furnishing the exhibit to the shareholder. Requests for exhibits and information
regarding the applicable fee shall be direct to: Ms. Tina M. Raiford, Vice
President - Accounting, at the address of the principal executive offices set
forth on the cover of this Report on Form 10-KSB.


                                                                              31
<PAGE>
                        CONSOLIDATED FINANCIAL STATEMENTS
                                  AND REPORT OF
                    INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

                      NEMATRON CORPORATION AND SUBSIDIARIES

                           DECEMBER 31, 2002 AND 2003


                                                                              32
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES

                                Table of Contents

<TABLE>
<CAPTION>
                                                                                       Page
                                                                                       ----
<S>                                                                                 <C>
Report of Independent Certified Public Accountants                                      F-2

Consolidated Balance Sheet as of December 31, 2003                                      F-3

Consolidated Statements of Operations for the years ended
December 31, 2002 and 2003                                                              F-4

Consolidated Statement of Stockholders' Equity (Deficit) for the years ended
December 31, 2002 and 2003                                                              F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 2002 and 2003                                                              F-6

Notes to Consolidated Financial Statements                                          F-7 to F-27
</TABLE>


                                      F-1
<PAGE>
               Report of Independent Certified Public Accountants

THE BOARD OF DIRECTORS
Nematron Corporation:

We have audited the accompanying consolidated balance sheet of Nematron
Corporation and Subsidiaries as of December 31, 2003, and the related
consolidated statements of operations, stockholders' deficit, and cash flows for
each of the two years in the period ended December 31, 2003. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Nematron Corporation
and Subsidiaries as of December 31, 2003, and the results of their operations
and their cash flows for the two years ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a deficit in working capital, has experienced cash flow
difficulties and is in default of its subordinated debt agreements with its
lenders. These matters raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans with respect to these matters
are also discussed in Note 2. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.


 /s/ Grant Thornton LLP

March 12, 2004
Southfield, Michigan


                                      F-2
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 2003

                            ASSETS (NOTES 5, 7 AND 8)

<TABLE>
<S>                                                                                    <C>
Current assets:
     Cash                                                                              $    207,139
     Accounts receivable, net of allowance for doubtful accounts of $81,000 (Note 3)      3,087,911
     Inventories (Note 4)                                                                 1,498,800
     Prepaid expenses and other current assets                                              150,218
                                                                                       ------------
             Total current assets                                                         4,944,068
Property and equipment:
     Land                                                                                   117,000
     Building and improvements                                                            2,292,685
     Equipment                                                                            7,029,596
                                                                                       ------------
                                                                                          9,439,281
     Less accumulated depreciation                                                       (7,843,152)
                                                                                       ------------
             Net property and equipment                                                   1,596,129
Note receivable from customer (Note 3)                                                       51,132
Software and related development costs, net of
     accumulated amortization of $6,263,597 (Note 3)                                        398,138
Goodwill, net of accumulated amortization of $2,547,233 (Note 3)                          2,922,122
Other intangible assets, net of accumulated amortization of $856,615 (Note 3)               217,952
                                                                                       ------------

             Total assets                                                              $ 10,129,541
                                                                                       ============

                            LIABILITIES AND STOCKHOLDERS' DEFICIT

Current liabilities:
     Promissory notes payable to related party under financing agreement (Note 5)      $  1,952,528
     Note payable to bank under lines of credit agreements (Note 5)                          63,750
     Accounts payable                                                                     1,363,150
     Deferred revenue and other accrued liabilities (Note 6)                              2,940,562
     Subordinated debt (Note 7)                                                           4,511,500
     Current maturities of long-term debt (Note 8)                                          173,667
                                                                                       ------------
                Total current liabilities                                                11,005,157
Long-term debt (Note 8)                                                                   2,332,723
                                                                                       ------------
             Total liabilities                                                           13,337,880
Commitments and contingencies (Note 13)                                                          --
Stockholders' deficit (Notes 3, 7, 11 and 12):
     Common stock, no par value; 30,000,000 shares authorized;
         3,148,894 shares outstanding (Note 2)                                           33,629,784
     Accumulated comprehensive loss                                                         (64,757)
     Accumulated deficit                                                                (36,773,366)
                                                                                       ------------
             Total stockholders' deficit                                                 (3,208,339)
                                                                                       ------------

             Total liabilities and stockholders' deficit                               $ 10,129,541
                                                                                       ============
</TABLE>

          See accompanying notes to consolidated financial statements.


                                      F-3
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2003

<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                                         -----------------------
                                                          2002            2003
                                                          ----            ----
<S>                                                   <C>             <C>
Net revenues                                          $ 14,867,215    $ 13,536,877

Cost of revenues                                        11,220,688      10,391,454
                                                      ------------    ------------

             Gross profit                                3,646,527       3,145,423

Operating expenses:
     Product development costs - software                  721,323         570,247
     Selling, general and administrative expenses        5,101,003       4,170,109
                                                      ------------    ------------

             Total operating expenses                    5,822,326       4,740,356
                                                      ------------    ------------

             Operating loss                             (2,175,799)     (1,594,933)

Other expense:
     Interest expense (Notes 5, 7 and 8)                  (928,046)     (1,349,254)
     Sundry expense, net of sundry income                   (9,101)         19,000
                                                      ------------    ------------

             Total other expense                          (937,147)     (1,330,254)
                                                      ------------    ------------

             Loss before income taxes                   (3,122,946)     (2,925,187)

Income taxes (Note 9)                                           --              --
                                                      ------------    ------------

             Net loss                                 $ (3,122,946)   $ (2,925,187)
                                                      ============    ============

Loss per share - basic and diluted (Notes 3 and 10)   $      (0.99)   $      (0.93)
                                                      ============    ============
</TABLE>

See accompanying notes to consolidated financial statements.


                                      F-4
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                 FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2003

<TABLE>
<CAPTION>
                                                                        Accumulated
                                                  Common Stock          Comprehensive
                                                  ------------          Income (Loss)     Accumulated
                                             Shares         Amount        Adjustment        Deficit         Total
                                             ------         ------        ----------        -------         -----
                                            (Note 2)
<S>                                       <C>             <C>           <C>               <C>             <C>
Balance, January 1, 2002                     3,148,894    $ 33,054,089    $     18,096    $(30,735,233)   $  2,336,952
Beneficial conversion feature of
     convertible subordinated notes and
     warrants (Note 7)                                         192,257                                         192,257
Comprehensive loss:
     Net loss for the year ended
        December 31, 2002                                                                   (3,112,946)     (3,112,946)
     Foreign currency translation
         adjustment                                                              7,549                           7,549
                                                                                                          ------------
              Total comprehensive loss                                                                      (3,105,397)
                                                                                                          ------------

Balance, December 31, 2002                   3,148,894      33,246,346          25,645     (33,848,179)       (576,188)

Beneficial conversion feature of
     convertible subordinated notes and
     warrants (Note 7)                                         383,438                                         383,438
Comprehensive loss:
     Net loss for the year ended
         December 31, 2003                                                                 (2,925,187)     (2,925,187)
     Foreign currency translation
         adjustment                                                            (90,402)                       (90,402)
                                                                                                          ------------
Total comprehensive loss                                                                                    (3,015,589)
                                          ------------    ------------    ------------    ------------    ------------

Balance, December 31, 2003                   3,148,894    $ 33,629,784    $    (64,757)   $(36,773,366)   $ (3,208,339)
                                          ============    ============    ============    ============    ============
</TABLE>

See accompanying notes to consolidated financial statements.


                                      F-5
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2003

<TABLE>
<CAPTION>
                                                                                    YEAR ENDED DECEMBER 31,
                                                                                    -----------------------
                                                                                      2002           2003
                                                                                      ----           ----
<S>                                                                               <C>            <C>
Cash flows from operating activities:
    Net loss                                                                      $(3,112,946)   $(2,925,187)
    Adjustments to reconcile net loss to net cash flows
       used in operating activities:
           Depreciation of property and equipment                                     410,030        283,273
           Amortization of intangible assets                                          505,666        362,476
           Non-cash interest expense for beneficial conversion
              feature (Note 7)                                                        192,257        383,438
           Impairment of goodwill (Note 3)                                            150,000             --
           Loss on disposal of property and equipment                                  20,558          1,258
           Changes in current assets and liabilities that provided (used) cash:
              Accounts receivable                                                     937,756       (804,652)
              Inventories                                                             262,391        155,044
              Prepaid expenses and other current assets                                17,469         22,332
              Accounts payable                                                        130,302        283,102
              Deferred revenue and other accrued liabilities                         (103,364)       689,058
                                                                                  -----------    -----------
                  Net cash used in operating activities                              (589,881)    (1,549,858)
Cash flows from investing activities:
    Purchases of property and equipment                                               (92,138)       (30,267)
    Collections on long-term note receivable                                            4,220          8,008
    Proceeds from disposals of property and equipment                                   1,253             --
                                                                                  -----------    -----------
                  Net cash used in investing activities                               (86,665)       (22,259)
Cash flows from financing activities:
    Net borrowings under related party promissory note                                     --      1,952,528
    Proceeds from issuance of subordinated notes and warrants                       1,679,000      1,332,500
    Borrowings under long-term debt agreements                                      2,700,000             --
    Repayments of borrowings under bank line of credit                               (865,158)    (1,333,567)
    Repayments of long-term debt                                                   (2,999,482)      (185,605)
    Additions to intangible assets                                                    (33,287)            --
                                                                                  -----------    -----------
                  Net cash provided by financing activities                           481,073      1,765,856
Foreign currency translation effect on cash                                             7,549        (90,402)
                                                                                  -----------    -----------
Net increase (decrease) in cash and cash equivalents                                 (187,924)       103,337
Cash at beginning of year                                                             291,726        103,802
                                                                                  -----------    -----------

Cash at end of year                                                               $   103,802    $   207,139
                                                                                  ===========    ===========

Supplemental Disclosures of Cash Flow Information:
    Cash paid for interest                                                        $   458,825    $   382,302
    Cash paid for income taxes                                                    $        --    $        --
</TABLE>

See accompanying notes to consolidated financial statements.


                                      F-6
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

(1)   BUSINESS

      Nematron Corporation (the "Company") designs, manufactures, and markets
      environmentally ruggedized computers and computer displays known as
      industrial workstations; designs, develops, and markets software for
      worldwide use in factory automation and control and in test and
      measurement environments; and provides application engineering support to
      customers of its own and third parties' products.

(2)   GOING CONCERN MATTERS

      The accompanying financial statements have been prepared on a going
      concern basis, which contemplates the realization of assets and the
      satisfaction of liabilities in the normal course of business. As shown in
      the financial statements, during the years ended December 31, 2002 and
      2003, the Company incurred losses of $3.1 million and $2.9 million,
      respectively, which have contributed to the Company's difficulties in
      generating sufficient cash flow to finance operations. Additionally, as
      discussed in Note 6, the Company has been in continuing default of the
      repayment provisions of its subordinated debt agreements, and it does not
      have the capital necessary to remedy the default. Because of the default
      on its subordinated loans in the principal amount of $4,511,500, along
      with accrued interest of approximately $910,700, the debt holders have the
      right to call the debt and to foreclose on all the assets of the Company.
      These factors, among others, raise substantial doubt about the Company's
      ability to continue as a going concern. The accompanying financial
      statements do not include any adjustments that might result from the
      outcome of this uncertainty.

      Management's plans with respect to these matters include the following:

      In July 2003 the Board of Directors unanimously approved a motion to
      negotiate and close the sale of substantially all of the Company's assets
      to an entity to be formed by the senior and subordinated debt holders (the
      "Purchaser"), to be paid by the Purchaser entirely with debt assumption.
      At the Annual Meeting of Shareholders held on January 13, 2004 (the Annual
      Meeting"), the shareholders approved a proposal to sell substantially all
      of the Company's assets in consideration of the assumption of all its
      liabilities, including senior debt, subordinated debt and all other
      liabilities (the "Net Asset Sale"). The total consideration will be equal
      to the total amount of all of the Company's liabilities, which at December
      31, 2003 were approximately $13.4 million. This price would exceed the
      book value of the Company's assets, by approximately $3.2 million. The Net
      Asset Sale will result in the Company not owning any assets except $30,000
      in cash the Company expects to retain and certain intangible assets such
      as its value as a public shell entity. The Company will not, however, have
      any liabilities (other than contingent liabilities where the Company has
      not been released by the creditor), all of them being assumed by the
      Purchaser.

      The shareholders also approved, at the Annual Meeting, a proposal to amend
      the Company's Articles of Incorporation to affect a reverse stock split
      whereby five outstanding shares of Common Stock would become one share of
      outstanding Common Stock ("one-for-five reverse stock split"). This
      one-for-five reverse stock split will create a sufficient number of
      authorized but unissued shares of Common Stock in order to consummate the
      following transaction also approved at the Annual Meeting.


                                      F-7
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      Following the Net Asset Sale as described above, the Company will become
      what is commonly known as a "public shell." Dorman Industries, LLC has
      agreed to purchase, on a post-reverse stock split basis, a total of
      5,248,257 shares of the Company's Common Stock from the Company for
      $50,000 (the "Purchase"). The Purchase will result in Dorman Industries
      owning, on a fully diluted basis, approximately 62.5% of the Company's
      Common Stock following the one-for-five reverse stock split. Concurrent
      with the Purchase, the new Board of Directors elected at the Annual
      Meeting will assume management of the Company. Dorman Industries intends
      to use the Company and its "public shell" as a platform to build long-term
      shareholder value by acquiring and/or investing in, and operating
      strategically positioned companies with capable of generating above
      average operating profits. No assurances can be given that Dorman
      Industries will be successful in connection with its future plans for the
      Company.

      Neither the Net Asset Sale nor the Purchase, as described above, has
      closed, although management expects that the transactions will close on
      March 31, 2004.

      Management believes successful implementation of the plans and
      transactions set forth above will enable the Company to continue as a
      going concern. If the Company is not successful in executing these plans,
      management may be forced to curtail operations and either sell the
      Company, sell product lines or wind down operations.

(3) SUMMARY OF ACCOUNTING PRINCIPLES

      Principles of Consolidation

      The accompanying consolidated financial statements include the accounts of
      the Company and its wholly owned subsidiaries: Nematron Limited, a United
      Kingdom corporation; Nematron Canada, Inc., a Canadian corporation; A-OK
      Controls Engineering, Inc., a Michigan corporation, and Optimation, Inc.,
      an Alabama corporation. All significant intercompany transactions and
      balances have been eliminated in consolidation.

      Accounts Receivable

      The majority of accounts receivable are due from companies in the machine
      tool and automotive industries and from other manufacturing entities that
      operate in factory automation, control and test and measurement
      environments. Credit is extended based on evaluation of a customers'
      financial condition and collateral is not required of the customer.
      Accounts receivable are due generally within 30 to 60 days of the date of
      billing, based upon either the Company's standard terms or terms
      negotiated with the customer. Accounts outstanding longer than the
      contractual payment terms are considered past due. The Company determines
      its allowance for uncollectible accounts by considering a number of
      factors, including the length of time receivables are past due, the
      Company's previous loss history, the customer's current ability to pay its
      obligation to the Company and the condition of the general economy and the
      customer's industry as a whole. The Company writes off accounts receivable
      when they become uncollectible, and payments subsequently received on such
      receivables are credited to the allowance for doubtful accounts. The
      Company generally does not


                                      F-8
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      accrue interest on past due accounts receivable because of the uncertainty
      of collection of interest, although the Company's standard terms allow for
      such a charge.

      Accounts receivable consist of the following:

<TABLE>
<CAPTION>
                                                    December 31,
                                                    ------------
                                                 2002           2003
                                                 ----           ----
<S>                                          <C>            <C>
      Billed trade receivables               $ 1,994,236    $ 2,477,571
      Unbilled trade receivables                 423,164        691,340
                                             -----------    -----------
        Total                                  2,417,400      3,168,911
      Less allowance for doubtful accounts       (75,000)       (81,000)
                                             -----------    -----------

      Balance at end of year                 $ 2,342,400    $ 3,087,911
                                             ===========    ===========
</TABLE>

      Billed trade receivables represent amounts invoiced to customers for goods
      delivered or services performed. Unbilled trade receivables represent
      amounts due from customers for work performed pursuant to the customers'
      time-and-material purchase orders but which were not invoiced until
      shortly after each month end in accordance with the terms of the
      customers' purchase orders.

      Changes in the Company's allowance for doubtful accounts are as follows:

<TABLE>
<CAPTION>
                                         December 31,
                                         ------------
                                       2002        2003
                                       ----        ----
<S>                                  <C>         <C>
      Balance at beginning of year   $ 70,000    $ 75,000
        Bad debt expense               45,000      19,000
        Accounts written off          (40,000)    (13,000)
                                     --------    --------

      Balance at end of year         $ 75,000    $ 81,000
                                     ========    ========
</TABLE>

      Note Receivable

      The Company has an interest-bearing note receivable from a commercial
      supplier. A machine used to produce the parts collateralizes the note.
      Payments on the note are due at the time that the Company pays the vendor
      for delivered products. The note bears interest at a commercial rate but
      the Company has suspended recording interest income until it is received.
      Based upon projected product delivery dates, the note, totaling $51,132 at
      December 31, 2003, is classified as a non-current asset.

      Inventories

      Inventories are carried at the lower of cost or market. Cost is determined
      by the first in, first out method. Provision is made to reduce inventories
      (including demonstration units) to net realizable value for excess and/or
      obsolete inventories based upon an item-by-item review of quantities on
      hand compared to estimated future usage for sales and service.


                                      F-9
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      Property and Equipment

      Property and equipment are stated at cost. Depreciation is provided over
      the estimated useful lives of the assets, ranging from three years for
      certain factory and office equipment to thirty-three years for the
      Company's headquarters and assembly facility. Depreciation is computed
      using the straight-line method for financial reporting purposes and
      accelerated methods, for tax reporting purposes.

      Software Development Costs

      Certain computer software development costs, primarily salaries, wages and
      other payroll costs, and purchased software technology were capitalized
      prior to January 1, 2002, but no costs have been capitalized since that
      date. Capitalization of computer software development costs began upon
      establishment of technological feasibility. The establishment of
      technological feasibility and the ongoing assessment of recoverability of
      capitalized computer software development costs required considerable
      judgment by management with respect to certain external factors,
      including, but not limited to, anticipated future gross revenues,
      estimated economic life, and changes in software and hardware technology.
      The Company annually reviews the recoverability of capitalized software
      costs based on estimated cash flows. Software costs are written off at the
      time a determination has been made that the amounts are not recoverable.

      Amortization of capitalized computer software development costs is
      provided on a product-by-product basis using the greater of the amount
      computed using (a) the ratio that current gross revenues for each product
      bear to the total of current and anticipated future gross revenues for
      that product, or (b) the straight-line method over the remaining estimated
      economic lives of the respective products, ranging from two to five years.

      A summary of capitalized software and related development costs for the
      years presented are as follows:

<TABLE>
<CAPTION>
                                         December 31,
                                         ------------
                                       2002         2003
                                       ----         ----
<S>                                  <C>          <C>
      Balance at beginning of year   $ 886,286    $ 574,407
      Amortization                    (311,879)    (176,269)
                                     ---------    ---------

      Balance at end of year         $ 574,407    $ 398,138
                                     =========    =========
</TABLE>

      Estimated amortization of software development costs is $149,300, $149,300
      and $99,538 for the years ending December 31, 2004, 2005 and 2006,
      respectively.

      Goodwill

      Goodwill was recorded in connection with the Company's acquisition of
      other entities during the years 1995 through 2001, and prior to January 1,
      2002, the Company was amortizing goodwill over periods ranging from
      fifteen to twenty years. Effective with the adoption of FASB Statement No.
      142, Goodwill and Other Intangible Assets, that the Company adopted on
      January 1, 2002, the Company ceased amortizing goodwill in


                                      F-10
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      accordance with provisions of the pronouncement. However, goodwill is
      subject to certain impairment tests at least annually. The Company
      recorded a goodwill impairment loss of $150,000 in 2002 to eliminate all
      remaining goodwill related to a 1997 acquisition, and such amount is
      included in selling, general and administrative expenses.

      A summary of activity in the goodwill account for the years presented is
      as follows:

<TABLE>
<CAPTION>
                                            December 31,
                                            ------------
                                         2002          2003
                                         ----          ----
<S>                                  <C>            <C>
      Balance at beginning of year   $ 3,072,122    $2,922,122
      Impairment loss                   (150,000)           --
                                     -----------    ----------

      Balance at end of year         $ 2,922,122    $2,922,122
                                     ===========    ==========
</TABLE>

      Intangible Assets

      Intangible assets, which consist primarily of acquired intangible assets,
      patent costs and deferred financing charges, are carried at cost less
      accumulated amortization, which is calculated on a straight-line basis
      over the estimated useful lives of the assets. The estimated useful lives
      of the assets range from three to ten years.

      The carrying value of intangible assets is periodically reviewed, and
      impairments are recognized when the expected future cash flows derived
      from such intangible assets are less than their carrying value.

      A summary of activity in the intangible asset account for the years
      presented is as follows:

<TABLE>
<CAPTION>
                                          December 31,
                                          ------------
                                        2002         2003
                                        ----         ----
<S>                                  <C>          <C>
      Balance at beginning of year   $ 564,658    $ 404,159
      Additions                         33,287           --
      Amortization                    (193,786)    (186,207)
                                     ---------    ---------

      Balance at end of year         $ 404,159    $ 217,952
                                     =========    =========
</TABLE>

      Estimated amortization of intangible assets is $135,000 and $82,952 for
      the years ending December 31, 2004 and 2005, respectively.

      Product Warranties

      The Company records a liability for an estimate of costs that it expects
      to incur under its basic limited warranty when product revenue is
      recognized. Factors affecting the Company's warranty liability include the
      number of units sold, the length of the warranty period, historical and
      anticipated rates of claims, and historical and estimated costs per claim.
      The Company periodically assesses the adequacy of its warranty liability
      based on changes in these factors. The changes in the Company's product
      warranty liability are as follows:



                                      F-11
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

<TABLE>
<CAPTION>
                                                    December 31,
                                                    ------------
                                                 2002         2003
                                                 ----         ----
<S>                                           <C>          <C>
      Balance at beginning of year            $ 255,000    $ 255,000
      Expense for new warranties issued         153,468       55,052
      Expense for revisions of prior years'
         warranties                                 861        4,531
      Warranty claims                          (154,329)     (59,573)
                                              ---------    ---------

      Balance at end of year                  $ 255,000    $ 255,000
                                              =========    =========
</TABLE>

      Stock Option Plans

      At December 31, 2003, the Company has stock-based compensation plans,
      which are described more fully in Note 11. The Company accounts for those
      plans under the recognition and measurement principles of APB Opinion No.
      25, Accounting for Stock Issued to Employees, and related Interpretations.
      No stock-based compensation cost is reflected in operations, as all option
      grants under those plans had an exercise price equal to or greater than
      the market value of the underlying common stock on the date of the grant.
      The following table illustrates the effect on net loss and loss per share,
      adjusted for the one-for-five reverse stock split, if the Company had
      applied the fair value recognition provisions of Statement of Financial
      Accounting Standards No. 123, Accounting for Stock-Based Compensation to
      stock-based compensation.

<TABLE>
<CAPTION>
                                                      Year Ended December 31
                                                      ----------------------
                                                        2002           2003
                                                        ----           ----
<S>                                                 <C>            <C>
      Net loss:
           As reported                              $(3,112,946)   $(2,925,187)
           Deduct: Total stock-based employee
             compensation expense determined
             under the fair values method for all
             awards                                    (243,327)      (151,454)
                                                    -----------    -----------
           Pro forma                                $(3,356,273)   $(3,076,641)
                                                    ===========    ===========
      Net loss per share:
           As reported                              $     (0.99)   $     (0.93)
           Pro forma                                $     (1.07)   $     (0.98)
</TABLE>

      No options were granted in 2003 or 2002.

      Foreign Currency Translation

      The assets and liabilities of the Company's foreign subsidiaries, Nematron
      Limited and Nematron Canada, Inc., are denominated in foreign currencies
      and are translated into United States dollars at exchange rates in effect
      on the balance sheet date. These entities' revenue and expenses are
      translated into United States dollars using a weighted average exchange
      rate during the periods presented. Gains or losses resulting from
      translating foreign currency financial statements into United States
      dollars are recorded as a separate component of stockholders' equity.
      Gains or losses resulting from foreign currency transactions are not
      significant and included in net loss.




                                      F-12
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

Revenue Recognition

      The Company recognizes revenue using varying methods based upon the
      revenue type. A summary of revenue types and the method of recognizing
      revenues in the statement of operations are as follows:

<TABLE>
<CAPTION>
                  Revenue Type                                       Revenue Recognition Method
                  ------------                                       --------------------------

<S>                                                    <C>
         Hardware product sales                        Upon delivery, when collection is probable
         Application and other services,               As the services are performed, when collection is
           including repairs of computers              probable
         Extended warranty agreements                  Ratably over the terms of the agreement with the
           covering software                           customer
         Software license agreements                   Deferred until all conditions in Statement of Position
                                                       97-2, Software Revenue Recognition ("SOP 97-2") are
                                                       met.  Such conditions include the delivery of the
                                                       product, the performance of all obligations so that
                                                       remaining obligations are no longer significant, and
                                                       collectibility is probable
         Bundled products (hardware products           Deferred until all conditions in SOP 97-2 are met
           pre-loaded with software covered by
           license agreements)
         Systems sales (bundled products plus          Deferred until all conditions in SOP 97-2 are met
           post sale support activities)
</TABLE>

      The Company has established programs that, under specified terms and
      limited conditions, enable its distributors to return limited amounts of
      product. The effect of these programs, which is not a material amount, is
      estimated, and current period revenues and cost of revenues are reduced
      accordingly.

      Research and Development Costs

      Research and development costs are expensed when incurred. These costs
      include certain engineering wages, fringe benefits, and direct costs.
      Hardware and software engineering costs are included in the accompanying
      consolidated statements of operations as components of cost of revenues
      and product development costs, respectively. Research and development
      costs were $742,000 and $1,409,000 for the years ended December 31, 2002
      and 2003, respectively.

      Income Taxes

      Income taxes are accounted for under the asset-and-liability method.
      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. Such deferred income tax asset and liability computations are
      based on enacted tax laws and rates. A valuation allowance is established
      when necessary to reduce deferred income tax assets to the amount expected
      to be realized.


                                      F-13
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      Loss Per Share

      The Company's Board of Directors and shareholders approved a one-for-five
      reverse stock split with respect to the Company's Common Stock and an
      enabling amendment to the Company's Amended and Restated Articles of
      Incorporation. The date of record for the noe-for-five reverse stock split
      is March 30, 2004. All share and per share amounts reflected on the
      accompanying consolidated statement of operations gives effect to the
      one-for-five reverse stock split for 2002 and 2003.

      Loss per share is calculated using the weighted average number of common
      shares outstanding during the period and adjusted for the assumed
      conversion of dilutive stock options and warrants. Since net losses were
      incurred in the years ended December 31, 2002 and 2003, no conversion of
      dilutive stock options and warrants was assumed in the loss per share
      calculation, as the effect would be anti-dilutive.

      Fair Value

      Financial instruments of the Company, consisting principally of cash,
      accounts receivable, note receivable, accounts payable, and debt, are
      recorded at estimated fair value. The Company has determined the estimated
      fair value amounts using available market information and available
      valuation methodologies.

      Use of Estimates

      Management of the Company has made a number of estimates and assumptions
      relating to the reporting of assets and liabilities and the disclosure of
      contingent assets and liabilities to prepare these consolidated financial
      statements in conformity with generally accepted accounting principles.
      Actual results could differ from those estimates. Estimates are used in
      the determination of the allowance for doubtful accounts, reserves for
      obsolete and slow-moving inventory, the amount of software development
      costs capitalized, if any, the net realizable value of capitalized
      software development costs, periods over which to charge depreciation,
      amortization and intangible assets, future outlays for warranty costs,
      amounts of future returns and price allowances, and carrying amounts of
      deferred tax assets and liabilities.

      Recent Accounting Pronouncements

      Accounting for Certain Financial Instruments with Characteristics of both
      Liabilities and Equity

      In May 2003 the FASB issued Statement 150 ("SFAS 150") Accounting for
      Certain Financial Instruments with Characteristics of both Liabilities and
      Equity. This Statement establishes standards for how an issuer classifies
      and measures certain financial instruments with characteristics of both
      liabilities and equity. It requires that an issuer classify a financial
      instrument that is within its scope as a liability (or an asset in some
      circumstances). This Statement was effective for financial instruments
      entered into or modified after May 31, 2003, and otherwise was effective
      at the beginning of the first interim period beginning after June 15,
      2003. The adoption of this statement did not impact the Company's
      financial position.


                                      F-14
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      In June 2002 the FASB issued Statement 146 ("SFAS 146"), Accounting for
      Costs Associated with Exit or Disposal Activities, which is effective for
      exit or disposal activities that are initiated after December 31, 2002.
      This Statement addresses financial accounting and reporting for costs
      associated with exit or disposal activities and nullifies Emerging Issues
      Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain
      Employee Termination Benefits and Other Costs to Exit an Activity
      (including Certain Costs Incurred in a Restructuring). SFAS 146 requires
      that a liability for a cost associated with an exit or disposal activity
      be recognized when the liability is incurred. Under Issue 94-3, a
      liability for an exit cost as defined in Issue No. 94-3 was recognized at
      the date of an entity's commitment to an exit plan. The adoption of this
      pronouncement did not have a material impact on the Company's financial
      position or results of operations.

      In May 2003 the Emerging Issues Task Force reached a consensus opinion on
      EITF 00-21, Revenue Arrangements with Multiple Deliverables. The consensus
      provides that revenue arrangements with multiple deliverables should be
      divided into separate units of accounting if certain criteria are met. The
      consideration for the arrangement should be allocated to the separate
      units of accounting based on their relative fair values, with different
      provisions if the fair value of all deliverables are not known or if the
      fair value is contingent on delivery of specified items or performance
      conditions. Applicable revenue recognition criteria should be considered
      separately for each separate unit of accounting. EITF 00-21 is effective
      for revenue arrangements entered into in fiscal periods beginning after
      June 15, 2003. Entities may elect to report the changes as a cumulative
      effect adjustment in accordance with APB Opinion 20, Accounting Changes.
      The adoption EITF 00-21 did not have an effect on the Company's financial
      position or results of operations.

(4)   INVENTORIES

      Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                              December 31, 2003
                                              -----------------
<S>                                           <C>
       Purchased parts and accessories           $  991,002
       Work in process                              195,062
       Finished goods and service stock             312,736
                                                 ----------

                 Total inventories               $1,498,800
                                                 ==========
</TABLE>

      Changes in the Company's allowance for obsolete inventories are as
      follows:

<TABLE>
<CAPTION>
                                                          December 31,
                                                          ------------
                                                    2002               2003
                                                    ----               ----
<S>                                               <C>                 <C>
      Balance at beginning of year                $ 799,700           $778,700
        Provision for obsolete inventory             50,000             72,500
        Disposal of obsolete inventory              (71,000)                --
                                                  ---------           --------

      Balance at end of year                      $ 778,700           $851,200
                                                  =========           ========
</TABLE>


                                      F-15
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

(5)   NOTES PAYABLE

      Promissory Note Payable to Related Party

      The Company is a party to a Promissory Note with North Coast Technology
      Investors, LLP ("NCTI"), an entity of which Mr. Braun, a former member of
      the Board of Directors, is a partner. NCTI also is a subordinated note
      holder. Under the terms of the Promissory Note, borrowings are due on
      demand and bear interest at 9.0% per annum. A maximum of $2,000,000 may be
      borrowed under the Promissory Note agreement. Borrowings under the
      Promissory Note are collateralized by substantially all assets of the
      Company and a second position on the mortgage note securing the Company's
      Ann Arbor facility. Total borrowings under the Promissory Note at December
      31, 2003 is $1,952,528.

      Note Payable to Bank

      The Company's wholly owned subsidiary, Optimation, is party to a loan and
      security agreement with an Alabama-based bank (the "Optimation Loan
      Agreement"). The Optimation Loan Agreement, amended through October 3,
      2003, provides for a total line of credit of $108,750 on that date and
      which reduces in availability equal to principal repayments made (the
      "Facility"). The amount available under the Facility is limited by a
      borrowing formula based on eligible accounts receivable and inventory.
      Borrowings under the Facility total $63,750 at December 31, 2003, and such
      borrowings bear interest at the prime rate plus .50% (5.00% effective rate
      at December 31, 2003), but not less than 5.0% per annum. The Facility,
      which expires April 30, 2004 requires monthly repayments of $15,000 with a
      final payment of $18,750 due on April 30, 2004. The Optimation Loan
      Agreement prohibits the transfer of funds from Optimation to the parent
      company except for customary inter-company cost reimbursements. The
      Facility is collateralized by substantially all assets of Optimation, a
      guaranty by the parent company Nematron and a partial guaranty by
      Optimation's president.

      Expired Agreements

      The Company and its subsidiary, A-OK Controls, were parties to two loan
      and security agreements (the "Agreements") with a bank. The Agreements as
      amended through July 15, 2003, provided for total borrowings of $1.2
      million through July 15 and $900,000 when they expired by their terms on
      July 31, 2003. The Company repaid $500,000 of the amounts it had borrowed
      under the Agreements on July 15, 2003 and repaid the remaining outstanding
      balance on July 31, 2003. Amounts used for the repayments were borrowed
      under the Promissory Note agreement with NCTI.

(6)   ACCRUED LIABILITIES AND RELATED PARTY TRANSACTION

      The Company has entered into borrowing arrangements with certain related
      parties, as discussed in Notes 5 and 7. These related parties include Mr.
      Hugo Braun, a former director, and related entities, and Mr. Joseph J.
      Fitzsimmons and Mr. Ronald C. Causley, directors. The Company is also a
      party to certain lease agreements with Mr. Causley, as discussed in Note
      13, and it continues to be liable for the purchase price adjustment due
      Mr. Causley for the 2000 purchase of A-OK Controls. The Company


                                      F-16
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      has recorded these liabilities in deferred revenue and accrued liabilities
      at December 31, 2003, as follows:

<TABLE>
<S>                                                           <C>
      Amounts due to related parties:
        Accrued interest                                      $  900,636
        Lease payments in arrears                                502,910
        Purchase price adjustement                               351,867
                                                              ----------
          Total due to related parties                         1,755,413
      Other accrued liabilities and deferred revenue           1,185,149
                                                              ----------

      Balance at end of year                                  $2,940,562
                                                              ==========
</TABLE>

(7)   SUBORDINATED DEBT

      Subordinated debt consists of the following:

<TABLE>
<CAPTION>
                                                                                                   December 31,
                                                                                                       2003
                                                                                                       ----
<S>                                                                                                <C>
          Convertible subordinated promissory notes, interest at 10% per annum, due
          August 31, 2001.  Accrued interest and the princi-pal of the note may be
          converted into common stock at the lower of $0.45 per share, as adjusted on
          a pro forma basis for the one-for-five reverse stock split, or the lowest
          price of the underlying common stock during the period the notes are
          outstanding.                                                                              $1,200,000

          Convertible subordinated promissory notes, interest at 8% per annum, due
          October 15, 2002.  The notes may be converted into preferred stock during
          the period the notes are outstanding, and the terms of the preferred stock,
          if issued, would allow the holders to convert the preferred stock into
          common stock on a one-for-one basis.
                                                                                                       200,000

          Convertible subordinated promissory notes, interest at 14% per annum, due on
          demand.  The notes may be converted into preferred stock during the period
          the notes are outstanding, and the terms of the preferred stock, if issued,
          would allow the holders to convert the preferred stock into common stock on
          a one-for-one basis.
                                                                                                     3,111,500
                                                                                                    ----------

          Total                                                                                     $4,511,500
                                                                                                    ==========
</TABLE>


                                      F-17
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      The 10% Convertible Subordinated Promissory Notes

      The 10% convertible subordinated notes due August 31, 2001 (the "10%
      Notes") included detachable warrants. The warrants, which are
      non-assignable, initially allowed the holders to purchase Common Stock at
      $1.50 per share as adjusted on a pro forma basis for the one-for-five
      reverse stock split (the "Per Share Warrant Price") at any time until
      March 31, 2006 (the "Warrants"). If at any time prior to the exercise of
      the Warrants the daily closing price of the Common Stock falls below the
      Per Share Warrant Price for five consecutive days, the Per Share Warrant
      Price will be adjusted downward to the lowest price during such five
      trading day period. As the lowest price per share has been $0.25, as
      adjusted on a pro forma basis for the one-for-five reverse stock split,
      the Per Share Warrant Price has been adjusted to that amount.

      The 14% Subordinated Promissory Notes

      The 14% subordinated promissory notes due on demand (the "14% Notes") were
      issued pursuant to an agreement initially dated in October 2001 and
      modified in May 2002, October 2002 and April 2003. The modified agreement
      allows the Company to draw amounts up to $3 million upon request and upon
      approval by the 14% Note holder upon its sole discretion. On a temporary
      basis the 14% note holder has allowed the borrowings to exceed the $3
      million maximum stated in the agreement. In the event of any equity
      financing by the Company, the 14% Note holder may convert any or all of
      the outstanding principal of the 14% Note and accrued interest thereon
      into the securities offered in such financing at the offering price per
      share. The modified agreement further provides that the principal and
      accrued interest payable under the 14% Note may be converted in whole or
      part into shares of Series A Preferred Shares beginning on September 1,
      2002 at $0.50 per share, as adjusted on a pro forma basis for the
      one-for-five reverse stock split. Provisions of the Series A Preferred
      Shares include: a) participation in dividends, if any, with the Common
      Stock shareholders; b) a liquidation preference up to the initial purchase
      price of the Series A Preferred Shares; c) a conversion feature allowing
      conversion into Common Stock on a one-to-one basis; d) full voting powers;
      e) the right to elect one person to the Board of Directors; f) the consent
      of a majority in interest of the Series A Preferred will be required to
      (i) purchase or redeem any Common or Preferred Stock, (ii) authorize or
      issue any senior or parity securities, (iii) declare or pay dividends on
      or make any distribution on account of the Common Stock, (iv) merge,
      consolidate or sell or assign all or substantially all of the Company's
      assets, (v) increase or decrease authorized Preferred Stock and (vi) amend
      Articles or Incorporation to change the rights, preferences, privileges or
      limitations of any Preferred Stock; g) the conversion price for the Series
      A Preferred shall be subject to proportional antidilution protection for
      stock splits, stock dividends, etc. and in the event that the Company
      issues additional shares of Common Stock or Common Stock equivalents
      (other than shares issues to officers or employees of the Company pursuant
      to plans approved by the Company's board of directors) at a purchase price
      less than the applicable Series A Preferred conversion price, the Series A
      Preferred Stock conversion price shall be adjusted to that same lower
      purchase price; and h) each holder of Series A Preferred Stock shall have
      the right to participate in any Company financing up to its pro-rata
      ownership. Certain of the advances taken uder the 14% Notes in 2003
      contained a beneficial conversion feature, as the per share conversion
      price was less than the fair value of the Company's Common Stock on the
      date of the advance. These beneficial conversion


                                      F-18
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      features total $286,498 which has been charged to interest expense and
      credited to shareholders' deficit.

      The 14% Notes sold included detachable warrants. The warrants, which are
      non-assignable, initially allowed the holders to purchase Common Stock at
      $0.50 per share, as adjusted on a pro forma basis for the one-for-five
      reverse stock split (the "Per Share Warrant Price") in an amount of 20% of
      the principal of the 14% Notes and accrued interest thereon for a period
      of five years from the date of the advance (the "Warrants"). In connection
      with the October 2002 modification the securities into which the Warrants
      could be converted were changed to Series A Preferred Stock as described
      above. Because the Per Share Warrant Price was less than the closing price
      of the Common Stock, as traded on the American Stock Exchange, on the
      dates that certain of the advances were made by the 14% Note holder in
      2002 and 2003, the Warrants were ascribed values of $185,780 and $96,940
      in 2002 and 2003, respectively, and such amounts were credited to
      shareholders equity, and the 14% Notes were ascribed values of $1,593,220
      and $949,062 in 2002 and 2003, respectively. The Warrant values of
      $185,780 and $96,940 were charged to interest expense in 2002 and 2003,
      respectively.

      The 8% Subordinated Promissory Notes

      The 8% subordinated promissory notes due October 15, 2002 (the "8% Notes")
      included detachable warrants. The warrants, which are non-assignable,
      initially allowed the 8% Notes holders to purchase Common Stock at $1.10
      per share, as adjusted on a pro forma basis for the one-for-five reverse
      stock split (the "Per Share Warrant Price") at any time until March 31,
      2007 (the "Warrants"). The Company did not repay the 8% Notes when due and
      in connection with the noteholders' forbearance, the conversion feature
      was modified to allow conversion into the same securities and at the same
      price as that set forth in the 14% Notes described above. Because the Per
      Share Warrant Price was less than the closing price of the Common Stock,
      as traded on the American Stock Exchange, on the dates the warrants were
      earned over their initial term, the Warrants were ascribed a value of
      $6,477 and the Subordinated Notes were ascribed a value of $193,523. The
      $6,477 was charged to interest expense and credited to shareholders'
      equity in 2002.

      A total of $750,000 of the 10% Notes and all of the 8% Notes and 14% Notes
      were issued to Board members or their affiliates. At December 31, 2003, a
      total of $910,656 of interest has been accrued for convertible
      subordinated promissory notes, including $786,355 related to notes due to
      related parties.


                                      F-19
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

(8)   LONG-TERM DEBT

      Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                            December 31, 2003
                                                                                            -----------------
<S>                                                                                         <C>
              Variable rate term loan payable to a bank, interest at prime plus 3.5%
              per annum (7.5% effective rate at December 31, 2003), payable in monthly
              installments of $31,000 through October 2005, at which time the remaining
              principal and interest is due.  The term loan is collateralized by a
              mortgage on the Ann Arbor facility.
                                                                                               $2,490,805

              Other notes payable, secured by equipment                                            15,585
                                                                                               ----------
              Total long-term debt                                                              2,506,390
              Less current maturities                                                            (173,667)
                                                                                               ----------

              Total long-term debt, less current maturities                                    $2,332,723
                                                                                               ==========
</TABLE>

      Scheduled maturities of long-term debt are as follows:

<TABLE>
<CAPTION>
              Year ending December 31,
<S>                                                                                            <C>
                  2004                                                                         $  173,667
                  2005                                                                          2,325,781
                  2006                                                                              6,942
                                                                                               ----------

              Total                                                                            $2,506,390
                                                                                               ==========
</TABLE>

(9)   TAXES ON INCOME

      The following reconciles the statutory federal income tax rate to the
      Company's effective tax rate:

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                                      -----------------------
                                                                         2002          2003
                                                                         ----          ----
<S>                                                                   <C>             <C>
            Income tax benefit based on the federal statutory rate       (34.0)%       (34.0)%
            Increase in valuation allowance                               34.0%         34.0%
                                                                        ------        ------

            Effective tax rate                                             0.0%          0.0%
                                                                        ======        ======
</TABLE>

      The domestic and foreign components of loss before taxes on income are as
      follows:

<TABLE>
<CAPTION>
                                                          Year Ended December 31,
                                                          -----------------------
                                                          2002              2003
                                                          ----              ----
<S>                                                   <C>               <C>
            Domestic loss before taxes on income      $(2,971,866)      $(2,877,613)
            Foreign loss before taxes on income          (141,080)          (47,574)
                                                      -----------       -----------

            Total loss before tax benefit             $(3,112,946)      $(2,925,187)
                                                      ===========       ===========
</TABLE>

      Deferred income taxes result from temporary differences in the recognition
      of income and expenses for financial and income tax purposes. Temporary
      differences and net


                                      F-20
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      operating loss carryforwards, which give rise to the net deferred tax
      position, as of December 31, 2003, are as follows:

<TABLE>
<S>                                                                                    <C>
            Deferred tax assets:
                Accounts receivable allowance for doubtful accounts                    $     27,000
                Inventory valuation allowance                                               309,000
                Property and equipment, principally depreciation                            233,000
                Accrued expenses deductible when paid                                       155,000
                Net operating loss carryforward                                           9,990,000
                                                                                       ------------
                     Total deferred tax assets                                           10,714,000
            Deferred tax liabilities - capitalized software development costs and
            other intangible assets                                                        (382,000)
                                                                                       ------------
                     Net deferred tax assets                                             10,332,000
            Less valuation allowance against deferred tax assets                        (10,332,000)
                                                                                       ------------

            Net deferred tax position                                                  $         -0-
                                                                                       ============
</TABLE>

      The valuation allowance against net deferred tax assets increased by
      $825,000 and $899,000 during the years ended December 31, 2002 and 2003,
      respectively.

      At December 31, 2003, the Company has net operating loss carryforwards of
      approximately $29,400,000, which expire at various dates between 2004 and
      2023. Utilization of certain of these carryforwards is subject to annual
      limitations under current IRS regulations. The Company has established a
      valuation allowance for the entire amount of the net deferred tax assets,
      as realization of these assets is dependent upon generating sufficient
      taxable income prior to their expiration.

(10)  LOSS PER SHARE

      The weighted average shares outstanding used in computing loss per share,
      as adjusted for the one-for-five reverse stock split was 3,148,894 in 2002
      and 2003. Prior to the approval by the Board of Directors and shareholders
      of a one-for-five reverse stock split, there were 15,744,472 shares
      outstanding.

      For the years ended December 31, 2002 and 2003, outstanding options and
      warrants were not included in the computation of diluted loss per share
      because the inclusion of such securities is antidilutive. Information
      relative to the excluded options and warrants, adjusted for the
      one-for-five reverse stock split approved on January 13, 2004, is as
      follows:

<TABLE>
<CAPTION>
                                               Outstanding Options               Outstanding Warrants
                                                  (See Note 11)                     (See Note 12)
                                                  -------------                     -------------
                                                           Expiration                        Expiration
          Year Ended                          Amount          Dates            Amount           Dates
          ----------                          ------          -----            ------           -----
<S>                                           <C>          <C>                <C>            <C>
          December 31, 2002                   403,506      2003 to 2011         958,267       2006 to 2007
          December 31, 2003                   355,270      2005 to 2011       1,491,267       2006 to 2008
</TABLE>


                                      F-21
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

(11)  EMPLOYEE BENEFIT PLANS

      All option and share amounts reflected in the following disclosures have
      been adjusted for the one-for-five reverse stock split approved by the
      shareholders at the Annual Meeting held on January 13, 2004.

      1993 Stock Option Plan

      The Company's 1993 Stock Option Plan (the "1993 Plan") provided for the
      granting of options to purchase a total of 190,000 shares of common stock
      to key employees. The exercise price for each option granted under the
      1993 Plan cannot be less than the fair market value of the common stock on
      the date of the grant.

      The 1993 Plan gives the Compensation Committee of the Board of Directors
      latitude in deciding the vesting period. Options generally vested either
      (a) one-third immediately and one-third on each successive anniversary
      date of the award, or (b) vested over three years at the rate of one-third
      per year beginning on the day after the first anniversary of the date of
      the award. Under provisions of the 1993 Plan, shares subject to an option
      award become immediately exercisable upon a change in control of the
      Company. Options remaining unexercised on the tenth anniversary of the
      date of the grant will expire. No options could be granted after February
      2003 and 102,991 options available for grant at that date were cancelled.

      Long-Term Incentive Plan

      The Company's Long-Term Incentive Plan (the "Incentive Plan"), adopted in
      April 1999, provides for the granting of awards to purchase a total of
      250,000 shares of common stock to key employees and others. Awards may be
      made by the Compensation Committee of the Board of Directors in the form
      of incentive stock options, non-qualified stock options, restricted stock
      or performance shares, provided that the Committee may not grant options
      to any salaried employee during any three-year period to purchase more
      than 100,000 shares.

      The exercise price for each option granted under the Incentive Plan cannot
      be less than the fair market value of the common stock on the date of the
      grant. The Incentive Plan's Committee has latitude in setting the vesting
      and exercise periods, but generally the options vest over a three-year
      period and have a ten-year term.

      The Incentive Plan authorizes the Committee to grant restricted stock
      awards pursuant to which shares of Common Stock will be awarded, subject
      to restrictions on transfer that lapse over a period of time or upon
      achievement of performance goals, as determined by the Committee.
      Participants who receive restricted stock grants are entitled to dividend
      and voting rights on the awarded shares prior to the lapse of restrictions
      on such awards.

      The Committee is also authorized to grant performance share awards under
      the Incentive Plan that are payable at the discretion of the Committee in
      cash, shares of Common Stock, or a combination of each, upon achievement
      of performance goals established by the Committee. The Committee will
      determine the terms and conditions of restricted stock and performance
      share awards, including the acceleration or lapse of any restrictions or
      conditions of such awards. As of December 31, 2003,


                                      F-22
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      awards to purchase 151,120 shares of common stock may be made under the
      Incentive Plan.

      Directors Option Plan

      The Company's 1993 Directors Stock Option Plan (the "Directors Option
      Plan") provides for the granting of options to purchase a total of 24,000
      shares of common stock. The exercise price for each option granted
      beginning April 1997 under the Directors Option Plan is equal to 110% of
      the closing price of the stock on the grant date. The exercise price for
      options granted prior to April 1997 was the greater of the fair market
      value or book value of the Company's common stock on the date of the
      award.

      The Directors Option Plan provides that beginning April 1997, each
      qualified director will be granted an option to purchase 900 shares of
      common stock every three years. Prior to April 1997, each qualified
      director was granted annually an option to purchase 200 shares of common
      stock. Options granted in April 1997 and thereafter are exercisable in
      one-third increments beginning on the date of the grant. Options granted
      prior to April 1997 are exercisable at any time beginning six months after
      the date of the grant. Options expire five years from the date of the
      grant. As of December 31, 2003, an additional 20,800 options may be issued
      under the Directors Option Plan.

      Special Option Grants

      The Board of Directors has from time to time awarded special option grants
      to certain officers, key employees and others. The awards have been made
      separate from the plans described above. Information with respect to
      options under the plans and the special awards for the years ended
      December 31, 2002 and 2003, is as follows:

<TABLE>
<CAPTION>
                                       Outstanding                   Exercisable
                               ----------------------------   ----------------------------
                                               Weighted                       Weighted         Number
                                  Number        Average         Number         Average        Available
                               Outstanding   Exercise Price   Exercisable   Exercise Price    For Grant
                               -----------   --------------   -----------   --------------    ---------
<S>                            <C>           <C>              <C>           <C>               <C>
      Balance, 1-1-2002           432,588       $   9.00         318,705       $   9.95         204,252
      Granted                          --                                                            --
      Exercisable                                                 42,991       $   8.75
      Exercised                        --                                                            --
      Forfeited                   (29,083)      $  12.15         (20,809)      $  12.15          29,083
                                  -------                        -------                        -------
      Balance, 12-31-2002         409,506       $   8.60         340,887       $   9.25         233,335
      Granted                          --                                                            --
      Exercisable                                                 36,101       $   6.06
      Exercised                        --                                                            --
      Forfeited                   (48,236)      $  14.44         (45,052)      $  15.12          48,236
      Effect of plan
      provision
      limiting awards                  --                             --                       (102,991)
                                  -------                        -------                        -------

      Balance, 12-31-2003         355,270       $   7.81         331,936       $   8.06         171,920
                                  =======                        =======                        =======
</TABLE>


                                      F-23
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      Information concerning outstanding options at December 31, 2003 is as
      follows:

<TABLE>
<CAPTION>
                                            Options  Outstanding               Options Exercisable
                               -----------------------------------------     --------------------------
                                                 Weighted
                                                  Average       Weighted                      Weighted
                                 Number of       Remaining       Average      Number of        Average
          Range of Exercise       Options      Contractual      Exercise       Options        Exercise
                Prices          Outstanding        Life           Price      Exercisable        Price
                ------          -----------        ----           -----      -----------        -----
<S>                             <C>            <C>              <C>          <C>              <C>
            $3.75 to  $5.00        218,000       5.42 years       $ 4.00       194,666          $ 3.95
            $9.70 to $13.75        127,320       5.69 years       $12.38       127,320          $12.38
           $23.75 to $43.75          9,950       2.88 years       $32.92         9,950          $32.92
                                   -------                                     -------

         Total                     355,270       5.45 years       $ 7.81       331,936          $ 8.05
                                   =======                                     =======
</TABLE>

      401(k) Plan and Trust

      The Company has established defined-contribution retirement plans for all
      eligible employees. Effective January 1, 2002, Nematron and A-OK Controls
      merged their 401(k) plans into one plan covering all eligible employees.
      Under the combined plan, the Company may make a basic matching
      contribution and a discretionary contribution to the 401(k) plan. The
      Company's matching contribution is 50% of each participant's contribution
      to the 401(k) plan up to a maximum of $3,000 per participant. A 401(k)
      plan participant becomes vested in the Company's contribution on his or
      her behalf at a rate of 20% for each year of service beginning with the
      completion of two years of service. Employees of Nematron and A-OK
      Controls that continued to be covered under the combined plan maintained
      the vesting schedule of their original plan. The participant will be fully
      vested in the Company's contributions in the event of his or her death,
      disability or normal retirement. The Company made matching contributions
      to the combined plan in 2002 but suspending the matching contribution for
      all of 2003.

      The Company's Optimation subsidiary sponsors a Savings Incentive Match
      Plan for Employees of Small Employers ("SIMPLE Plan") under section 408(p)
      of the Internal Revenue Code. Under the SIMPLE Plan, all employees who
      receive at least $4,000 in compensation are eligible to participate in the
      plan, and employee deferrals and employer matching contributions, up to a
      maximum of 3% of each participant's compensation, are contributed to each
      employee's SIMPLE IRA.

      The Company's contributions to its 401(k) plans and the SIMPLE Plan were
      $194,000 and $7,700 for the years ended December 31, 2002, and 2003,
      respectively.

(12)  WARRANTS

      The Company has issued warrants for the purchase of its common and
      preferred stock in connection with the following subordinated debt
      transactions. The following disclosures have been adjusted for the
      one-for-five reverse stock split.


                                      F-24
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

<TABLE>
<CAPTION>
      Issue                             Description of Debt
      -----                             -------------------
<S>             <C>
        A       Subordinated debt issued in November 1995, repaid in 1997
        B       10% Convertible Subordinated Promissory Notes (See Note 6)
        C       14% Convertible Subordinated Promissory Notes (See Note 6)
        D        8% Convertible Subordinated Promissory Notes (See Note 6)
</TABLE>

<TABLE>
<CAPTION>
                Issue                 A               B                 C                 D            Total
                                      -               -                 -                 -            -----
<S>                               <C>             <C>              <C>                <C>             <C>
       Issue                       Nov. 1995      March 2001       Oct. 2001 to       March 2002
       dates                                                        July 2003

       Exercise price              $20.00           $0.45             $0.50             $0.50
       Expiration dates           Oct. 2002       March 2006       Oct. 2006 to       March 2006
                                                                    July 2008

       Balance 1-01-2002             39,535         160,000            66,667                           266,202
       Expired                      (39,535)                                                            (39,535)
       Issued                            --              --           591,600           140,000         731,600
                                   --------        --------         ---------           -------       ---------
       Balance 12-31-2002                --         160,000           658,267           140,000         958,267
                                   ========
       Issued                                            --           533,000                --         533,000
                                                   --------         ---------           -------       ---------
       Balance 12-31-2003                           160,000         1,191,267           140,000       1,491,267
                                                   ========         =========           =======       =========
</TABLE>

(13)  COMMITMENTS AND CONTINGENCIES

      The Company leases under operating leases its Auburn Hills and Saginaw,
      Michigan system integration facilities from the president of A-OK
      Controls, and leases its other facilities and certain office equipment
      from unrelated entities. The leases on the facilities expire at various
      dates from 2008 through 2010, and the equipment operating leases expire at
      various dates in 2007 and 2008.

      A summary of commitments under noncancelable leases as of December 31,
      2003, is as follows:

<TABLE>
<CAPTION>
                                               Related Party    Third Party
                                                   Leases          Leases           Total
                                                   ------          ------           -----
<S>                                              <C>             <C>             <C>
            Year ending December 31,
                       2004                      $  492,800      $  101,100      $  593,900
                       2005                         492,800          76,800         569,600
                       2006                         492,800          48,300         541,100
                       2007                         492,800          44,800         537,600
                       2008                         267,800          37,300         305,100
                       Thereafter                     3,600          37,000          40,600
                                                 ----------      ----------      ----------
            Total minimum lease obligations      $2,242,600      $  345,300      $2,587,900
                                                 ==========      ==========      ==========
</TABLE>


                                      F-25
<PAGE>
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2002 and 2003

      Total rental expense for the years ended December 31, 2002 and 2003 is as
      follows:

<TABLE>
<CAPTION>
                                                 Related Party          Third Party
                                                     Leases               Leases               Total
                                                     ------               ------               -----
<S>                                              <C>                    <C>                 <C>
       Year ending December 31,
                  2002                               $397,800             $267,200          $665,000
                  2003                                496,700              143,000           639,700
</TABLE>

      The Company has included in accrued liabilities at December 31, 2002 and
      2003 a total of $10,000 and $502,910, respectively, of rentals in arrears
      payable to a related party.

(14)  SEGMENT INFORMATION

      The Company operates in one market segment - factory automation. Net
      revenues include export sales to various countries. A summary of both
      foreign and domestic revenues is as follows:

<TABLE>
<CAPTION>
                                                    Year Ended December 31,
                                                    -----------------------
                                                     2002             2003
                                                     ----             ----
<S>                                               <C>              <C>
            Foreign:
                France                            $ 1,149,241      $ 1,128,098
                Other countries                     2,322,282        2,020,386
                                                  -----------      -----------
                       Total foreign revenue        3,471,523        3,148,484
            United States                          11,395,692       10,388,393
                                                  -----------      -----------

            Total revenue                         $14,867,215      $13,536,877
                                                  ===========      ===========
</TABLE>

      Long-lived assets include property and equipment, capitalized software
      development costs, goodwill and other intangible assets. A summary of
      foreign and domestic long-lived assets at depreciated or amortized cost at
      December 31, 2003 is as follows:

<TABLE>
<S>                                                       <C>
            Foreign countries                             $   33,343
            United States                                  5,152,130
                                                          ----------

            Total                                         $5,185,473
                                                          ==========
</TABLE>

(15)  SIGNIFICANT CUSTOMER

      The Company conducts its business through distributors, end users and
      other entities under purchase orders, supply contracts and other
      agreements. The Company had one significant customer in 2002 and 2003 that
      accounted for $5,091,000 and $5,014,000 of revenue, respectively. Accounts
      receivable from that customer totaled $906,000 and $1,002,000 at December
      31, 2002 and 2003, respectively.


                                      F-26