===============================================================================
                                  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, 2002 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       (I.R.S. Employer Identification No.)
        of 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 Section12(b) of the Exchange Act:
          Title of Each Class           Name of Exchange on Which Registered
          -------------------           ------------------------------------
      Common Stock, no par value            The American Stock Exchange

       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:  $14,867,215

         The aggregate market value of the voting stock held by non-affiliates
as of March 28, 2003, computed by reference to the closing price of such stock
on such date as quoted on The American Stock Exchange, was approximately
$787,,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
28, 2003 was 15,744,472.

        TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT [ ] Yes [ X ] No

                     DOCUMENTS INCORPORATED BY REFERENCE
                                                   Part of Form 10-KSB Into
              Document                        Which the Document is Incorporated
              --------                        ----------------------------------
Portions of Definitive Proxy Statement
for the 2003 Annual Meeting of Shareholders                  Part III
(the "2003 Proxy Statement")
================================================================================



<PAGE>

                                     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

         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.

         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
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,

                                       2
<PAGE>

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.

         Virtually all of the Company's newer 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.

                                       3
<PAGE>

         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 units, introduced in
2001, 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.

         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 22% and 24% of consolidated revenue in 2002 and 2001,
respectively. The Company expects that revenue from this product category in
2003 will approximate the same percentage of total revenue as in 2002.

         Pointe Controller

         Nematron introduced the Pointe Controller in the fourth quarter of 2002
as 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-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.

         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.

                                       4
<PAGE>

         Collectively, sales of character-based PLC workstations and remote
message unit products amounted to approximately 22% and 24% of consolidated
revenue in 2002 and 2001, respectively. The Company expects a slow 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.

         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 13% and 10% of
consolidated revenue in 2002 and 2001, respectively. The Company expects that
this segment will increase in 2003 as new products in this category are
developed and released next year.

         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 10% and 8% of consolidated revenue
in 2002 and 2001,respectively. The Company expects that revenue from computer
parts and service will represent less than 10% of consolidated revenues in 2003.

         Software Products
         -----------------
         The software products described below, all of which were acquired or
developed by the Company since 1995, represent the cornerstone of the Company's
shift in its strategic focus. Prior to 1995, the Company relied solely on sales
of IWS products. Since 1995 the Company's strategy has been to position itself
as a high value-added provider of bundled industrial PC hardware and Microsoft
operating system-based software solutions. With the following software products
and their continued enhancements, the Company now offers leading-edge industrial
automation software. 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



                                       5
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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 10% and 9% of
consolidated revenue in 2002 and 2001, respectively. The Company expects that
revenue from software products will represent approximately 10% of consolidated
revenues in 2003.

         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.

         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



                                       6
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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 39% and 45% of the Company's consolidated revenue in 2002 and 2001,
respectively. The Company expects that revenue from system integration services
will represent approximately 36% of consolidated revenues in 2003.

         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 2002 or 2001. The ICC product family,
including ICC products bundled with software products, accounted for
approximately 12% and 15% of consolidated revenues in 2002 and 2001,
respectively. No other single model or product family accounted for more than
12% 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 2002
and 2001, 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.

                                       7
<PAGE>


         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 staff is an important factor in the Company's ability to compete in
the markets in which its products are sold. During 2002 and 2001, the Company
expended approximately $1.4 million and $1.6 million, respectively, for direct
hardware and software product development and product design quality, including
those costs capitalized in 2001 under Statement of Financial Accounting
Standards No. 86. The Company sponsored all of such costs. These amounts
represent approximately 9.5% and 9.1% of consolidated revenues in 2002 and 2001,
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 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 124 full time employees as of December 31, 2002,
including 105 in Michigan, 4 in Foxboro, Massachusetts, 8 in Huntsville, Alabama
and 7 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.

                                       8
<PAGE>

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

               Location            Square Feet  Lease Expiration  Building Type
               --------            -----------  ----------------  -------------
    Auburn Hills, Michigan           50,000     May 2008          Single tenant
    Foxboro, Massachusetts            1,200     April 2003         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


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.





                                       9
<PAGE>

                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters

         The Company's Common Stock has been listed on The American Stock
Exchange (the "AMEX") under the symbol NMN since November 22, 1999. The
following table sets forth, for the periods indicated, the closing price on the
AMEX.
               2002                       High                          Low
               ----                       ----                          ---
          First Quarter                  $0.42                         $0.25
          Second Quarter                  0.39                          0.19
          Third Quarter                   0.20                          0.10
          Fourth Quarter                  0.10                          0.10

               2001                       High                          Low
               ----                       ----                          ---
          First Quarter                  $0.85                         $0.52
          Second Quarter                  1.13                          0.50
          Third Quarter                   0.60                          0.24
          Fourth Quarter                  0.39                          0.18

         There are approximately 825 holders of record of the Company's Common
Stock as of March 28, 2003.

         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 the
year ended December 31, 2002.

         At various dates between January 2, 2002 and December 27, 2002, 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 "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.

                                       10
<PAGE>



Item 6.  Management's Discussion and Analysis or Plan of Operations

         The following discussion and analysis contains a number of "forward
looking statements" within the meaning 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."

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 its shift of business
away from dominance by computer hardware sales, and will pursue the development
of new software products and the enhancement of 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 significant 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.

         The results of operations include the operations of Optimation
beginning March 30, 2001, the date of acquisition by Nematron.

Results of Operations - Year Ended December 31, 2002 Compared to Year Ended
December 31, 2001

Revenues

         Net revenues decreased to $14,867,000 in 2002 compared to $17,542,000
in 2001. This represents a decrease of $2,675,000, or 15.2%, compared to the
2001 level. Of the total revenue decrease, $1,999,000 was attributable to the
demand for control design and system integration services, $779,000 was
attributable to sales of computer hardware and $62,000 was attributable to sales
of software. Revenues from repair services increased $165,000. 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, while the increase in repair services arose from increase demand to
repair customers' older computer and HMI units.

         Foreign revenues increased to $3,472,000 in 2002 compared to $2,037,000
in 2001 primarily because of the increase in sales made to two large customers
in France and England that had resumed their capital equipment projects that
were postponed in 2001. Additionally, with the introduction of contract
manufacturing facilities in the Czech Republic in late 2001, the Company's
computer products became more price competitive in 2002 and demand for these
cost effective products increased in 2002. Domestic revenues decreased to
$11,397,000 in 2002 compared to $15,505,000 in 2001 as the overall market for
machine control products in the United States shrunk significantly.

         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, 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.

                                       11
<PAGE>

         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 in 2003 as a result of
the Company's increased marketing and sales efforts, and from revenues to be
generated from sales of products released late in 2002 and from new products
scheduled for release in early 2003. 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 2002 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 decreased to 75.5% of revenues in 2002 compared
92.8% in 2001. In 2001, the Company recorded a $1.9 million write-down of
previously capitalized software development costs to net realizable value, and
this had an effect on cost of revenue of 10.8%. Without the effect of the write
down, the cost of sales percentage would have been 81.9% in 2001. Comparing the
75.5% cost of sales percentage in 2002 with the 81.9% pro forma cost of sales
percentage in 2001 reveals a 6.4% decrease in cost of sales percentage on a
year-to-year basis, and this results from product mix, lower material costs in
2002 and fixed cost reductions implemented in 2002.

         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 2002 and 2001 were $154,000 and
$137,000, respectively, and the year-end warranty accrual at December 31, 2002
and 2001 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,
begin 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 2002 and 2001, the Company
capitalized software development costs of $-0- and $486,000, respectively, and
amortized $312,000 and $1,069,000, 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. In connection with the Company's long-term strategic
planning and its 2002 budgeting processes initiated in the fourth quarter of
2001, management determined that the net realizable value of capitalized
software attributed to one product was less than the carrying amount recorded
for the product. This net realizable value determination included estimated
revenues to be received from that product's sales over its estimated life,

                                       12
<PAGE>

reduced by the related estimated direct costs to manufacture and reproduce the
product, sales expenses and commissions. Consequently, in the fourth quarter of
2001, the Company wrote off to cost of revenues a total of $1.9 million of
previously capitalized costs to write down the carrying cost of the intangible
asset to net realizable value. The Company made similar calculations of
estimated future net revenue from capitalized costs for software products in
2002, and determined that no write-downs were necessary. Following the write
down of the carrying costs by $1.9 million, further capitalization was suspended
because the capitalization of additional costs would increase the carrying value
to an amount in excess of its net realizable value.

         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 2002 and 2001 totaled $828,000 and $801,000,
respectively. The increase in reserves in 2002 compared to 2001 results from the
identification of additional potentially obsolete material in 2002. 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 2003
compared to 2002 resulting from a positive change in product mix towards higher
margin computer products, lower material costs, the continued reduction of fixed
costs in 2003, and higher revenue levels over which to spread fixed costs.

         Product development expenditures - software development

         Software product development expenditures increased by $130,000 to
$721,000 in 2002 compared to $591,000 in 2001. This represents an increase of
22.1% from the 2001 level and results from the Company expensing 100% of its
software development expenditures in 2002 whereas in 2001 the Company
capitalized $486,000 of its expenditures. Total software development
expenditures, including amounts capitalized in 2001, totaled $721,000 and
$1,077,000 in 2002 and 2001, respectively. The decrease in 2002, representing
33.1% of its 2001 expenditures, results from a smaller development staff and
fixed cost controls implemented in 2002. Management expects that product
development expenses in 2003 will approximate the 2002 level.

         As discussed above under Costs of Revenues, the Company capitalizes the
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 capitalized $-0- and
$486,000 in 2002 and 2001, respectively, and the 2001 costs were not recorded as
expenses during 2001. Had management determined that technological feasibility
had not been reached for the products under development, such costs would have
been charged to operations.

         Selling, General and Administrative Expenses

         Selling, general and administrative expenses decreased to $5,101,000 in
2002 compared to $6,071,000 in 2001. This represents a decrease of $970,000, or
16.1% from the 2001 level. This decrease results primarily from staff
reductions, lower discretionary spending for marketing activities, lower sales
commissions, and the absence of $159,000 of amortization of goodwill that was
recorded in 2001, partially offset by$150,000 of goodwill impairment recorded in
the fourth quarter of 2002 and increases in general and administrative costs
arising from the effects of including Optimation's selling and administrative
costs for twelve months in 2002 versus nine months in 2001. Nematron acquired
Optimation on March 30, 2001, and its operations are included in consolidated
operations since that date. Without the effect of the Optimation costs for a
three-month period, selling, general and administrative expenses would have
decreased by $1,189,000 in 2002 compared to 2001, and such amount represents a
19.6% decrease compared to the 2001 level.

         Critical accounting policies relative to selling, general and
administrative expenses and which involve management estimates include, for
2001, the period over which to amortize goodwill, and for 2002 and 2001, 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.

         The Company recorded $2,299,000 and $835,000 of goodwill resulting from
the acquisitions of A-OK Controls in 2000 and Optimation in 2001, respectively.
The Company determined that the appropriate periods over which to amortize
goodwill resulting from the acquisitions of A-OK Controls and Optimation was
twenty and fifteen years, respectively. Using such periods, the Company charged
to operations in 2001 a total of $157,000. The use of shorter or longer periods

                                       13
<PAGE>

over which to amortize goodwill would have changed the amortization expense
included in selling, general and administrative expenses in 2001. 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.

         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 acquired intangible assets relating to
an acquired technical workforce and distribution network from the Company's 1997
acquisition of Intec Controls. 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 all
assets acquired in 1997. 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 when it acquired an entity in 1997 and acquired employees'
projected turnover, salary and benefit rates. The Company charged to operations
in 2002 and 2001 a total of $194,000 and $314,000, 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 2002 and 2001, and its reserves for
bad debts as of the end of 2002 and 2001were $75,000 and $70,000, 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 it
property and equipment over the assigned lives using the straight-line
depreciation period. Total depreciation expense charged to operations in 2002
and 2001 was $410,000 and $524,000, respectively, with the decrease in 2002
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 increase moderately in 2003 compared to 2002 because of increases in
marketing and sales efforts and increased sales commissions from higher revenue
levels, offset by planned decreases in discretionary expenditures.

         Interest Expense

         Interest expense decreased to $928,000 in 2002 compared to $1,588,000
in 2001. Included in interest expense for 2002 and 2001 is $192,000 and
$884,000, 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 $736,000 and $704,000 in 2002 and
2001, respectively. The $32,000 increase in interest expense represents 4.6%
increase in 2002 compared to 2001, and this results from the effect of higher

                                       14
<PAGE>

average bank borrowing levels in 2002 compared to 2001. Management expects that
interest expense will increase in 2003 because of continuing needs to draw on
all available bank lines of credit, offset in part by scheduled pay downs of
debt in 2003 will cause average borrowing levels to decrease in 2003.

         Sundry Expense, Net of Sundry Income

         Sundry expense totaled $9,000 in 2002 compared to $77,000 in 2001.
There were no significant items of other revenue or expense in either period.

Liquidity and Capital Resources

         Primary sources of liquidity are cash generated from operations, the
Company's three lines of credit totaling $2.7 million (as of March 28, 2003) and
from advances available under a convertible subordinated debt arrangement with
an affiliate of a member of the Board of Directors. The Company's operations
used $586,000 of cash during 2002, primarily as a result of the effect of the
$3,113,000 loss from operations offset by a $1,248,000 decrease in working
capital deficit and the $1,279,000 of noncash depreciation, amortization,
impairment, loss on property disposals and interest charges to operations.
During 2002, the Company used $92,000 of cash for additions to fixed assets and
$3,865,000 of cash for debt repayments. Primary sources of cash in 2002 were
$1,679,000 from the proceeds of sales of subordinated promissory notes and
warrants and $2,700,000 from a mortgage note from a bank.

         The Company has a Loan and Security Agreement (the "LBCI Agreement")
with LaSalle Business Credit, Inc. ("LBCI"). The LBCI Agreement provides for a
$2,500,000 revolving line of credit with interest at the prime rate plus 4.5%
(9.25% effective rate). The LBCI line of credit borrowings are limited by a
borrowing formula that allows for advances up to 85% of eligible accounts
receivable. As of December 31, 2002, the Company had borrowed $1,127,000 of its
revolving credit facility, and based upon the borrowing formula underlying the
LBCI credit line, an additional $142,000 may be borrowed under the LBCI credit
line as of December 31, 2002.

         Borrowings under the Credit Agreement are secured by substantially all
of the Company's assets and a second mortgage on the Company's Ann Arbor
facilities and are guaranteed by its domestic subsidiaries and their assets.
LBCI has notified the Company that it should seek other sources of financing,
and that it will continue to lend to the Company under the terms of the LBCI
Agreement until an alternative lender is identified. The LBCI Agreement includes
various affirmative and negative covenants limiting the Company's ability to
take certain actions, including the payment of cash dividends, requiring the
Company to maintain specified levels of tangible net worth, debt service
coverage and interest coverage, and limiting capital expenditures and software
development expenditures to specified levels.

         The Company is not in compliance with the tangible net worth, debt
service and interest coverage financial covenants contained in the LBCI
Agreement. The lender has issued a forbearance letter to the Company concerning
these covenant violations. However, in such letter, the lender has specifically
reserved its right to take any action permitted under the LBCI Agreement and
related agreements in the future without any notice to the Company. The lender
and management are discussing management plans to cure the defaults, including,
without limitation, a capital infusion by accredited investors. This capital
infusion, if successful, may cure the tangible net worth covenant, but it will
not cure the operating covenants that were not met for the last two years.
Management is hopeful, however, that a capital infusion, if successful, will
cause the lender to continue its forbearance.

         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 has been renewed on a 90-day
revolving basis since the Company acquired Optimation in March 2001. The
Optimation Loan Agreement, amended through October 4, 2002, provides for a total
line of credit of $335,000 that reduces in amount with all principal repayments
made (the "Optimation credit facility"). The amount available under the
Optimation credit facility is limited by a borrowing formula that allows for
advances up to a maximum of the sum of a specified percentage of eligible
accounts receivable and a specified amount of inventory. Amounts borrowed under
the Optimation line of credit facility total $270,000 at December 31, 2002, and
such borrowings bear interest at the prime rate plus .50% (5.25% effective rate
at December 31, 2002), but not less than 5.0% per annum. The Optimation Loan
Agreement provided for the credit facility through January 3, 2003, and it was
renewed on that date for an additional 90-day period in the initial amount of
$270,000 on substantially the same terms and conditions as the current facility.
The Optimation Loan Agreement requires monthly repayments of $15,000 during its
90-day period, and further, prohibits the transfer of funds from Optimation to
the parent company except for customary inter-company cost reimbursements. The
Optimation line of credit is collateralized by substantially all assets of

                                       15
<PAGE>

Optimation, a guaranty by Nematron and a partial guaranty by Optimation's
president. The Company expects that the Optimation Loan Agreement will be
renewed on successive 90-day periods until the balance of the line is reduced to
zero.

         Over the last two years, the Company has been attempting to raise
additional financing with accredited investors in the range of $2,000,000 to
$3,000,000 in the form of preferred or common stock or subordinated debt with
detachable warrants. Based upon the Company's current projections, the Company
will require financing in excess of estimated available bank financing in the
range of $300,000 to $500,000 in 2003. Included in the Company's projection is
management's assumption that the credit line borrowings from LBCI will be
available with either LBCI or another lender on substantially the same terms as
the current arrangement.

         Management can offer no assurance that the private placement of equity
or subordinated notes will be successful, nor if the private placement of
subordinated notes or preferred stock occurs, that the equity or debt and raised
will be sufficient to persuade LBCI to continue its forbearance on demanding
repayment of LBCI debt because of the continuing covenant violations. If the
private placement is not successful or if necessary funds cannot be obtained,
the Company will not have sufficient liquidity to satisfy its liabilities and
obligations as they become due and it may be forced to cease or curtail its
operations or to sell product lines, subsidiaries or the entire entity to a
third party.

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 raise additional equity or debt financing in a
      sufficient amount to sustain operations and allow management to execute
      its strategies;

-     The potential inability to convince the lead bank, LBCI, to continue its
      forbearance exercising its remedies available to it resulting from loan
      covenant violations;

-     A further decline of economic conditions in general and conditions in the
      automotive manufacturing 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.

                                       16
<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 9.  Directors, Executive Officers, Promoters and Control Persons;
         Compliance With Section 16(a) of the Exchange Act.

           The information required by this item is incorporated by reference to
the Company's 2003 Proxy Statement under the captions "Election of Directors"
(excluding the Report of the Audit Committee) and "Section 16(a) Beneficial
Ownership Reporting Compliance."



Item 10.   Executive Compensation

         The information required by this item is incorporated by reference to
the Company's 2003 Proxy Statement under the caption "Executive Compensation."



Item 11. Security Ownership of Certain Beneficial Owners and Management

         The information required by this item is incorporated by reference to
the Company's 2003 Proxy Statement under the caption "Security Ownership of
Certain Beneficial Owners and Management."



Item 12.  Certain Relationships and Related Transactions.

         The information required by this item is incorporated by reference to
the Company's 2003 Proxy Statement under the caption "Certain Relationships and
Related Transactions."



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,
              2002.



Item 14.  Controls and Procedures.

         Disclosure Controls and Procedures

         The Company maintains controls and procedures designed to ensure that
it is able to collect the information that is required to be disclosed in the
report it files with the SEC, and to process, summarize and disclose this
information within the time period specified in the rules of the SEC. The
Company's Chief Executive and Chief Financial Officers are responsible for
establishing, maintaining and enhancing these procedures. They are also
responsible, as required by the rules established by the SEC, for the evaluation
of the effectiveness of these procedures.

                                       17
<PAGE>


         Based on their evaluation of the Company's disclosure controls and
procedures which took place as of a date within 90 days of the filing of this
report, the Chief Executive and Chief Financial Officers believe that these
procedures are effective to ensure that the Company is able to collect, process
and disclose the information it is required to disclose in the reports it files
with the SEC within the required time period.

         Internal Controls

         The Company maintains a system of internal controls designed to provide
reasonable assurance that transactions are executed in accordance with
management's general or specific authorization; transactions are recorded as
necessary to (1) permit preparation of financial statements in conformity with
generally accepted accounting principles, and (2) maintain accountability for
assets. Access to assets is permitted only in accordance with management's
general or specific authorization.

         Since the date of the most recent evaluation of the Company's internal
controls by the Chief Executive and Chief Financial Officers, there have been no
changes in such controls or in other factors that could have significantly
affected those controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.







                                       18
<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/ Matthew S. Galvez                            Dated:  March 28, 2003
    ------------------------------------                     --------------
    Matthew S. Galvez, President and CEO

         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.

         Signature                 Title                               Date

  /s/ Matthew S. Galvez     President, CEO and a Director         March 28, 2003
---------------------------                                       --------------
Matthew S. Galvez           (Principal Executive and Financial Officer)

  /s/ David P. Gienapp      Vice President - Finance and          March 28, 2003
---------------------------  Administration                       --------------
David P. Gienapp            (Principal Accounting Officer) and Secretary

  /s/ Hugo E. Braun          Director                             March 28, 2003
---------------------------                                       --------------
Hugo E. Braun

  /s/ Ronald C. Causley      Director                             March 28, 2003
---------------------------                                       --------------
Ronald C. Causley

  /s/ Joseph J. Fitzsimmons  Chairman of the Board and a Director March 28, 2003
---------------------------                                       --------------
Joseph J. Fitzsimmons

  /s/ Stephen E. Globus      Director                             March 28, 2003
---------------------------                                       --------------
Stephen E. Globus

  /s/ Steven J. Quamme       Director                             March 28, 2003
---------------------------                                       --------------
Steven J. Quamme




                                       19
<PAGE>


                                  CERTIFICATION
            Pursuant to Section 302 of the Sarbanes Oxley Act of 2002




I, Matthew S. Galvez, certify that:

1.       I have reviewed this annual report on Form 10-KSB of Nematron
         Corporation;
2.       Based on my knowledge, this annual report does not contain any
         untrue statement of a material fact or omit to state a material
         fact necessary to make the statements made, in light of the
         circumstances under which such statements were made, not misleading
         with respect to the period covered by this annual report;
3.       Based on my knowledge, the financial statements, and other
         financial information included in this annual report, fairly
         present in all material respects the financial condition, results
         of operations and cash flows of the registrant as of, and for, the
         periods presented in this annual report;
4.       The registrant's other certifying officer and I (herein the
         "Certifying Officers") are responsible for establishing and
         maintaining disclosure controls and procedures (as defined in
         Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
         have:
         a) designed such internal controls to ensure that material
            information relating to the registrant, including its
            consolidated subsidiaries, (collectively the "Company") is
            made known to the Certifying Officers by others within the
            Company, particularly during the period in which this annual
            report is being prepared;
         b) evaluated the effectiveness of the registrant's internal controls as
            of a date within 90 days prior to the filing date of this annual
            report (the "Evaluation Date"); and
         c) presented in this annual report the conclusions of the Certifying
            Officers about the effectiveness of the disclosure controls and
            procedures based on our evaluation as of the Evaluation Date;
5.       The registrant's Certifying Officers have disclosed, based on our
         most recent evaluation, to the registrant's auditors and the audit
         committee of the registrant's board of directors:
         a) all significant deficiencies (if any) in the design or
            operation of internal controls which could adversely affect
            the registrant's ability to record, process, summarize and
            report financial data and have identified for the registrant's
            auditors any material weaknesses in internal controls; and
         b) any fraud, whether or not material, that involves management or
            other employees who have a significant role in the registrant's
            internal controls; and
6.       The registrant's Certifying Officers have indicated in this annual
         report whether or not there were significant changes in internal
         controls or in other factors that could significantly affect
         internal controls subsequent to the date of our most recent
         evaluation, including any corrective actions with regard to
         significant deficiencies and material weaknesses.


Date: March 28, 2003
--------------------

/s/ Matthew S. Galvez
---------------------
Matthew S. Galvez
Chief Executive Officer


See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report as an Exhibit.



                                       20
<PAGE>


                                  CERTIFICATION
            Pursuant to Section 302 of the Sarbanes Oxley Act of 2002




I, David P. Gienapp, certify that:

1.       I have reviewed this annual report on Form 10-KSB of Nematron
         Corporation;
2.       Based on my knowledge, this annual report does not contain any
         untrue statement of a material fact or omit to state a
         material fact necessary to make the statements made, in light
         of the circumstances under which such statements were made,
         not misleading with respect to the period covered by this
         annual report;
3.       Based on my knowledge, the financial statements, and other
         financial information included in this annual report, fairly
         present in all material respects the financial condition,
         results of operations and cash flows of the registrant as of,
         and for, the periods presented in this annual report;
4.       The registrant's other certifying officer and I (herein the
         "Certifying Officers") are responsible for establishing and
         maintaining disclosure controls and procedures (as defined in
         Exchange Act Rules 13a-14 and 15d-14) for the registrant and
         we have:
         a) designed such internal controls to ensure that material
            information relating to the registrant, including its
            consolidated subsidiaries, (collectively the "Company") is
            made known to the Certifying Officers by others within the
            Company, particularly during the period in which this
            annual report is being prepared;
         b) evaluated the effectiveness of the registrant's internal controls
            as of a date within 90 days prior to the filing date of
            this annual report (the "Evaluation Date"); and
         c) presented in this annual report the conclusions of the Certifying
            Officers about the effectiveness of the disclosure controls and
            procedures based on our evaluation as of the Evaluation Date;
5.        The registrant's Certifying Officers have disclosed, based on
          our most recent evaluation, to the registrant's auditors and
          the audit committee of the registrant's board of directors:
         a) all significant deficiencies (if any) in the design or
            operation of internal controls which could adversely
            affect the registrant's ability to record, process,
            summarize and report financial data and have identified
            for the registrant's auditors any material weaknesses in
            internal controls; and
         b) any fraud, whether or not material, that involves management or
            other employees who have a significant role in the registrant's
            internal controls; and
6.       The registrant's Certifying Officers have indicated in this
         annual report whether or not there were significant changes in
         internal controls or in other factors that could significantly
         affect internal controls subsequent to the date of our most
         recent evaluation, including any corrective actions with
         regard to significant deficiencies and material weaknesses.


Date: March 28, 2003
--------------------


/s/ David P. Gienapp
--------------------

David P. Gienapp
Chief Financial Officer


See also the certification pursuant to Section 906 of the Sarbanes Oxley Act of
2002, which is also attached to this report as an Exhibit.





                                       21
<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.
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.

                                       22
<PAGE>

Exhibit
Number                       Description of Exhibit
------                       ----------------------
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 Amended  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 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.
4.18 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.
4.19 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.
4.20 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.
4.21 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.
4.22 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.
4.23 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.
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.

                                       23
<PAGE>

Exhibit
Number                       Description of Exhibit
------                       ----------------------
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.
10.10Registration 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.
99.01Certification  of CEO  and CFO  Pursuant  to 18  U.S.C.  Section  1350,  as
     Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Management compensatory plan or arrangement.
                                     o o o










                                       24
<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: Mr. David P. Gienapp, Vice
President - Finance and Administration, at the address of the principal
executive offices set forth on the cover of this Report on Form 10-KSB.




















                                       25
<PAGE>



                        Consolidated Financial Statements
                                  and Report of
                    Independent Certified Public Accountants

                      Nematron Corporation and Subsidiaries

                           December 31, 2001 and 2002


















                                       26
<PAGE>


                      NEMATRON CORPORATION AND SUBSIDIARIES

                                Table of Contents



                                                                    Page

Report of Independent Certified Public Accountants                   F-2

Consolidated Balance Sheet as of December 31, 2002                   F-3

Consolidated Statements of Operations for the years ended
December 31, 2001 and 2002                                           F-4

Consolidated Statement of Stockholders' Equity (Deficit)
for the years ended December 31, 2001 and 2002                       F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 2001 and 2002                                       F-6 to F-7

Notes to Consolidated Financial Statements                       F-8 to F-30
















                                       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, 2002, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the two years ended December 31, 2002. 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, 2002, and the results of their operations
and their cash flows for the two years ended December 31, 2002, 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 loan agreement with its primary bank
lender. 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.

As discussed in Note 3 to the consolidated financial statements, the Company
adopted Statement No. 142, "Goodwill and Intangible Assets", on January 1, 2002.


/s/ Grant Thornton LLP
----------------------

March 21, 2003
Southfield, Michigan


                                       F-2
<PAGE>

                      Nematron Corporation and Subsidiaries
                           Consolidated Balance Sheet
                                December 31, 2002

                             Assets (Notes 6 and 8)
Current assets:
  Cash                                                              $103,802
  Accounts receivable, net of allowance for
    doubtful accounts of $75,000                                   2,342,400
  Inventories (Note 5)                                             1,653,844
  Prepaid expenses and other current assets                          172,550
                                                                 -----------
          Total current assets                                     4,272,596
Property and equipment:
  Land                                                               117,000
  Building and improvements                                        2,292,685
  Equipment                                                        7,004,181
                                                                 -----------
                                                                   9,413,866
  Less accumulated depreciation                                   (7,563,474)
                                                                 -----------
          Net property and equipment                               1,850,392
Software and related development costs, net of
  accumulated amortization of $6,087,328 (Note 3)                    574,407
Goodwill and other intangible assets, net of
  accumulated amortization of $2,547,233 (Note 3)                  2,922,122
Other intangible assets, net of
  accumulated amortization of $858,328 (Note 3)                      404,159
                                                                 -----------
          Total assets                                           $10,023,676
                                                                 ===========

                      Liabilities and Stockholders' Deficit

Current liabilities:
  Notes payable to banks under lines of credit
    agreements (Note 6)                                          $1,397,317
  Accounts payable                                                1,582,958
  Deferred revenue and other accrued liabilities                  1,748,594
  Subordinated debt (Note 7)                                      3,179,000
  Current maturities of long-term debt (Note 8)                     169,255
                                                                -----------
         Total current liabilities                                8,077,124
Long-term debt (Note 8)                                           2,522,740
                                                                -----------
         Total liabilities                                       10,599,864
Commitments and contingencies (Note 13)                                 -
Stockholders' deficit (Notes 4, 7, 11 and 12):
  Common stock, no par value; 30,000,000 shares authorized;
    15,744,472 shares outstanding                                33,246,346
  Accumulated comprehensive income                                   25,645
  Accumulated deficit                                           (33,848,179)
                                                                -----------
         Total stockholders' deficit                               (576,188)
                                                                -----------
         Total liabilities and stockholders' deficit            $10,023,676
                                                                ===========

See accompanying notes to consolidated financial statements.

                                       F-3
<PAGE>

                      Nematron Corporation and Subsidiaries
                      Consolidated Statements of Operations
                 For the Years Ended December 31, 2001 and 2002

                                                     Year Ended December 31,
                                                     -----------------------
                                                      2001              2002
                                                      ----              ----

Net revenues (Notes 14 and 15)                     $17,541,766      $14,867,215

Cost of revenues, including $1,900,000 write-off
  of capitalized software development costs in
  2001 (Note 3)                                     16,273,116       11,220,688
                                                   -----------      -----------
         Gross profit                                1,268,650        3,646,527

Operating expenses:
  Product development costs - software                 590,769          721,323
  Selling, general and administrative expenses       6,071,447        5,101,003
                                                   -----------      -----------
         Total operating expenses                    6,662,216        5,822,326
                                                   -----------      -----------
         Operating loss                             (5,393,566)      (2,175,799)

Other expense:
  Interest expense (Notes 6, 7 and 8)               (1,587,615)        (928,046)
  Sundry expense, net of sundry income                 (76,641)          (9,101)
                                                   -----------      -----------

         Total other expense                        (1,664,256)        (937,147)
                                                   -----------      -----------
         Loss before income taxes                   (7,057,822)      (3,112,946)
Income taxes (Note 9)                                      -                -
                                                   -----------      -----------
         Net loss                                  $(7,057,822)     $(3,112,946)
                                                   ===========      ===========

Loss per share - basic and diluted (Note 10)       $     (0.46)     $     (0.20)
                                                   ============     ===========






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, 2001 and 2002
<TABLE>
<CAPTION>


                                                                        Accumulated
                                                  Common Stock         Comprehensive
                                                  ------------             Income      Accumulated
                                               Shares        Amount      Adjustment       Deficit         Total
                                               ------        ------      ----------       -------         -----
<S>                                          <C>           <C>            <C>          <C>              <C>
Balance, January 1, 2001                     13,969,463    $30,892,089    $(1,606)     $(23,677,411)    $7,213,072
Shares issued in exchange for equity
     of Optimation, Inc. (Note 4)             1,483,680      1,000,000                                   1,000,000
Private placement of common stock
     (Note 7)                                   291,329        278,000                                     278,000
Beneficial conversion feature of
     convertible subordinated notes and
     warrants (Note 7)                                         884,000                                     884,000
Comprehensive loss:
     Net loss for the year ended
        December 31, 2001                                                                (7,057,822)    (7,057,822)
     Foreign currency translation
         adjustment                                                        19,702                           19,702
                                                                                                        ----------
              Total comprehensive loss                                                                  (7,038,120)
                                             ----------    -----------    -------      ------------     ----------
Balance, December 31, 2001                   15,744,472     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                   15,744,472    $33,246,346    $25,645      $(33,848,179)     $(576,188)
                                             ==========    ===========    =======      ============      =========





</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, 2001 and 2002

                                                        Year Ended December 31,
                                                        -----------------------
                                                          2001           2002
                                                          ----           ----
Cash flows from operating activities:
  Net loss                                            $(7,057,822)  $(3,112,946)
  Adjustments to reconcile net loss to net cash flows
    provided by (used in) operating activities:
      Depreciation                                        523,993       410,030
      Amortization                                      1,541,989       505,666
      Impairment of goodwill (Note 3)                         -         150,000
      Write-off of capitalized software development
        costs (Note 3)                                  1,900,000           -
      Non-cash interest expense for beneficial
        conversion feature                                884,000       192,257
      Loss on disposal of property and equipment           13,467        20,558
      Changes in current assets and liabilities that
        provided (used) cash:
        Accounts receivable                             2,305,308       941,976
        Inventories                                     1,458,339       262,391
        Prepaid expenses and other current assets         129,637        17,469
        Accounts payable                                 (286,567)      130,302
        Deferred revenue and other accrued liabilities   (560,202)     (103,364)
                                                        ---------     ---------
         Net cash provided by (used in)
         operating activities                             852,142      (585,661)
Cash flows from investing activities:
  Additions to property and equipment                    (118,663)      (92,138)
  Proceeds from disposals of property and equipment           450         1,253
  Additions to capitalized software development costs    (486,482)          -
  Acquisition of Optimation, Inc., net of cash
    acquired (Note 4)                                    (278,877)          -
                                                        ---------     ---------
         Net cash used in investing activities           (883,572)      (90,885)
Cash flows from financing activities:
  Borrowings under long-term debt agreements                  -       2,700,000
  Proceeds from issuance of subordinated notes
    and warrants (Note 7)                               1,500,000     1,679,000
  Proceeds from issuance of common stock (Note 7)         278,000           -
  Repayments of long-term debt                         (1,050,976)   (2,999,482)
  Net repayments of borrowings under bank line
    of credit                                            (436,843)     (865,158)
  Additions to other intangible assets                    (61,439)      (33,287)
                                                        ---------     ---------
         Net cash provided by financing activities        228,742       481,073
Foreign currency translation effect on cash                19,702         7,549
                                                        ---------     ---------
Net increase (decrease) in cash and cash equivalents      217,014      (187,924)
Cash at beginning of year                                  74,712       291,726
                                                        ---------     ---------
Cash at end of year                                      $291,726      $103,802
                                                        =========     =========


See accompanying notes to consolidated financial statements.

                                       F-6
<PAGE>

                      Nematron Corporation and Subsidiaries
                      Consolidated Statements of Cash Flows
                 For the Years Ended December 31, 2001 and 2002


                                                       Year Ended December 31,
                                                       -----------------------
                                                          2001          2002
                                                          ----          ----
Non-Cash Financing and Investing Activities:
  Fair value of assets acquired from Optimation,
    Inc., including goodwill                           $2,459,727
  Less liabilities assumed                             (1,180,850)
  Less common stock issued                             (1,000,000)
                                                       ----------
    Net cash paid for Optimation, Inc. (Note 4)        $  278,877    $     -
                                                       ==========

Equipment acquired under capital leases                $   45,213    $     -

Supplemental Disclosures of Cash Flow Information:
  Cash paid for interest                               $  587,152    $ 458,825
  Cash paid for income taxes                           $      -      $     -













See accompanying notes to consolidated financial statements.





                                       F-7
<PAGE>

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

(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, 2001 and
       2002, the Company incurred losses of $7.1 million and $3.1 million,
       respectively, which have contributed to the Company's difficulties in
       generating sufficient cash flow to finance operations. Additionally, as
       discussed in Note 8, the Company is in violation of certain financial
       position and operating covenants contained in the bank credit agreement
       with its senior bank lender. The senior bank lender has reserved its
       right to take any action permitted under the bank credit agreement,
       including requiring the Company to repay all amounts borrowed under the
       line of credit with the bank totaling $1,127,317 at December 31, 2002.
       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:

       Management plans to complete a private placement of convertible
       subordinated debt or preferred stock totaling not less than $3.0 million
       by the end of the second quarter 2003, and in connection therewith, to
       either a) enter into a revised lending agreement with its lead bank to
       continue the bank's forbearance and to adjust certain financial
       covenants, or b) enter into a credit agreement with another financing
       source. Proceeds of the debt and/or equity would be used for working
       capital, reducing the bank line, investments in new technology-based
       products or creation of strategic alliances with automation product or
       integration companies that will enhance Company's revenues and operating
       results. Management believes that the placement of convertible
       subordinated promissory notes or preferred stock would cure the financial
       position covenants that the Company currently violates. Furthermore,
       management intends to negotiate with its current senior bank lender a
       forbearance agreement that will permit the Company to postpone compliance
       with the operating and financial covenants with which the Company is in
       violation. Management believes that a modification of the loan covenants
       is possible, assuming that the Company is able to complete the placement
       of equity securities in the amount, form and timing as contemplated.

       Management also plans to improve the Company's financial performance in
       2003 and eventually return to profitability. Management believes that the
       Company's revenues will increase in 2003 in response to an expanded
       distribution sales channel, by an increased emphasis on foreign-based
       customers, and by the introduction of new industrial automation hardware
       products and enhanced software products in early 2003. Management also
       believes that the Company will continue to control its expenses through

                                       F-8
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       cost containment initiatives, through a more efficient sales channel and
       through product cost reductions.

       Management believes successful implementation of the plans 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 the Company acquired on March
       30, 2001. The operations of Optimation are included in these consolidated
       statements since March 31, 2001.  See Note 4 for a description of the
       Optimation acquisition. 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 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:
                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Billed trade receivables                      $2,733,420    $1,994,236
         Unbilled trade receivables                       620,956       423,164
                                                       ----------    ----------
           Total                                        3,354,376     2,417,400
         Less allowance for doubtful accounts             (70,000)      (75,000)
                                                       ----------    ----------
         Balance at end of year                        $3,284,376    $2,342,400
                                                       ==========    ==========

                                       F-9
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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:

                                                             December 31,
                                                             ------------
                                                           2001          2002
                                                           ----          ----
         Balance at beginning of year                     $60,000       $70,000
           Bad debt expense                                52,000        45,000
           Accounts written off                           (42,000)      (40,000)
                                                         --------      --------
         Balance at end of year                           $70,000       $75,000
                                                          =======       =======

       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.

       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 and Related Development Costs
       --------------------------------------
       Certain computer software development costs, primarily salaries, wages
       and other payroll costs, and purchased software technology have been
       capitalized prior to January 1, 2002. 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.

       In connection with the Company's long-term strategic planning and 2002
       budgeting processes initiated in the fourth quarter of 2001, management
       determined that the net realizable value of capitalized software
       attributed to one product was less than the carrying amount recorded for
       the product. This net realizable value determination included estimated

                                       F-10
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       revenues to be received from that product's sales over its estimated
       life, reduced by the related estimated sales expenses and commissions.
       Consequently, in the fourth quarter of 2001, the Company charged
       $1,900,000 to cost of revenues to reduce the carrying cost to estimated
       fair value. As a result of the write down of carrying costs to estimated
       fair value, the Company has suspended adding to the carrying amount of
       capitalized software development costs as such additions would create
       additional net book value in excess of estimated fair value. If in the
       future, however, market conditions change and a higher estimated fair
       value results, the Company will resume capitalizing current period
       qualifying software development costs in conformity with its accounting
       policy, provided that the net book value of the software product does not
       exceed the then estimated fair value.

       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:
                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Balance at beginning of year                  $3,369,660      $886,286
         Additions                                        486,482           -
         Amortization                                  (1,069,856)     (311,879)
         Write down of capitalized costs to
           net realizable value                        (1,900,000)           -
                                                         --------      --------
         Balance at end of year                          $886,286      $574,407
                                                         ========      ========

       A summary of estimated amortization of software development costs until
       the capitalized costs are fully amortized is as follows:

              Year ending December 31,
                       2003                                            $177,000
                       2004                                             150,000
                       2005                                             150,000
                       2006                                              97,407
                                                                       --------
              Total                                                    $574,407
                                                                       ========

       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 accordance
       with provisions of the pronouncement. However, goodwill is subject to
       certain impairment tests at least annually. In connection with the

                                       F-11
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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.

       A summary of activity in the goodwill account for the years presented is
       as follows:
                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Balance at beginning of year                  $2,395,550    $3,072,122
         Additions                                        835,130           -
         Amortization                                    (158,558)          -
         Impairment loss                                      -        (150,000)
                                                       ----------    ----------
         Balance at end of year                        $3,072,122    $2,922,122
                                                       ==========    ==========

       A reconciliation of loss reported in the consolidated statements of
       operations to the loss adjusted for the effect of goodwill amortization
       for the years presented is as follows:
                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Net loss:
            Reported net loss                         $(7,057,822)  $(3,112,946)
            Goodwill amortization                         158,558           -
                                                      -----------    ----------
            Adjusted net loss                         $(6,899,264)  $(3,112,946)
                                                      ===========    ==========
          Basic and diluted loss per share:
            Reported net loss                              $(0.46)       $(0.20)
            Goodwill amortization                            0.01            -
                                                           ------        ------
            Adjusted net loss                              $(0.45)       $(0.20)
                                                           ======        ======

       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:

                                       F-12
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Balance at beginning of year                    $816,795      $564,658
         Additions                                         61,438        33,287
         Amortization                                    (313,575)     (193,786)
                                                         --------      --------
         Balance at end of year                          $564,658      $404,159
                                                         ========      ========

       A summary of estimated amortization of intangible assets is as follows:

         Year ending December 31,
              2003                                                     $186,000
              2004                                                      135,000
              2005                                                       83,159
                                                                       --------
              Total                                                    $404,159
                                                                       ========

       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:

                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Balance at beginning of year                    $165,000      $255,000
         Expense for new warranties issued                228,967       153,468
         Expense related to revisions of prior
            year warranties                                (2,310)          861
         Warranty claims                                 (136,657)     (154,329)
                                                         --------     ---------
         Balance at end of year                          $255,000      $255,000
                                                         ========      ========

       Stock Option Plans
       ------------------
       At December 31, 2002, the Company has four 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

                                       F-13
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       on the date of the grant. The following table illustrates the effect on
       net loss and loss per share if the Company had applied the fair value
       recognition provisions of Statement of Financial Accounting Standards No.
       123, Accounting for Stock-Based Compensation ("SFAS 123") to stock-based
       compensation.

                                                             December 31,
                                                             ------------
                                                          2001          2002
                                                          ----          ----
         Net loss:
           As reported                                $(7,057,822)  $(3,112,946)
           Pro forma                                  $(7,380,859)  $(3,356,273)
         Net loss per share:
           As reported                                     $(0.46)       $(0.20)
           Pro forma                                       $(0.48)       $(0.21)

       No options were granted in 2002. The fair values of options granted
       during 2001 were determined using the Black-Scholes option-pricing model
       with the following assumptions:
         Risk-free interest rate                                          5.26%
         Dividend yield                                                   0.00%
         Expected life                                             3 to 6 years
         Expected volatility                                            102.05%

       The weighted average fair value of options granted during 2001 was $0.63.

       Foreign Currency Translation
       ----------------------------
       The assets and liabilities of the Company's foreign subsidiaries,
       Nematron Limited and Nematron Canada, Inc., denominated in foreign
       currencies, are translated at exchange rates in effect on the balance
       sheet date, and revenue and expenses are translated using a weighted
       average exchange rate during the periods presented. Gains or losses
       resulting from translating foreign currency financial statements are
       recorded as a separate component of stockholders' equity. Gains or losses
       resulting from foreign currency transactions are included in net loss.

       Revenue Recognition
       -------------------
       Revenue is recognized 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:

               Revenue Type                  Revenue Recognition Method
               ------------                  --------------------------
         Hardware product sales       Upon delivery, when collection is probable
         Application and other        As the services are performed, when
          services, including         collection isprobable
          repairs of computers
         Extended warranty agreements Ratably over the terms of the agreement
         covering software            with the 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

                                       F-14
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

               Revenue Type                 Revenue Recognition Method
               ------------                 --------------------------
         Bundled products (hardware   Deferred until all conditions in SOP 97-2
         products pre-loaded with     are met.
         software covered by license
         agreements)
         Systems sales (bundled       Deferred until all conditions in SOP 97-2
         poducts plus post sale       are met.
         support activities)

       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 $1,604,000 and $1,409,000 for the years ended December 31,
       2001 and 2002, 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.

       Loss Per Share
       --------------
       Loss per share is calculated using the weighted average number of common
       shares outstanding during the period, adjusted for the assumed conversion
       of dilutive stock options and warrants. Since net losses were incurred in
       the years ended December 31, 2001 and 2002, 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, accounts payable, and debt, are recorded at
       estimated fair value. The Company, using available market information and
       available valuation methodologies, has determined the estimated fair
       value amounts.

       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

                                       F-15
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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 Costs Associated with Exit or Disposal Activities

       In June 2002, the FASB issued Statement 146, Accounting for Costs
       Associated with Exit or Disposal Activities. This statement requires
       entities to recognize costs associated with exit or disposal activities
       when liabilities are incurred rather than when the entity commits to an
       exit or disposal plan, as currently required. Examples of costs covered
       by this guidance include one-time employee termination benefits, costs to
       terminate contracts other than capital leases, costs to consolidate
       facilities or relocate employees, and certain other exit or disposal
       activities. This statement is effective for fiscal years beginning after
       December 31, 2002, and will impact any exit or disposal activities the
       Company initiates after that date.

       Accounting for Debt Extinguishments

       In April 2002, the FASB issued Statement 145, Rescission of FASB
       Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical
       Corrections ("SFAS 145"). Among other provisions, SFAS 145 rescinds FASB
       Statement 4, Reporting Gains and Losses from Extinguishment of Debt.
       Accordingly, gains or losses from extinguishment of debt should not be
       reported as extraordinary items unless the extinguishment qualifies as an
       extraordinary item under the criteria of Accounting Principles Board
       Opinion 30, Reporting the Results of Operations--Reporting the Effects of
       Disposal of a Segment of a Business, and Extraordinary, Unusual and
       Infrequently Occurring Events and Transactions ("APB 30"). Gains or
       losses from extinguishment of debt, which do not meet the criteria of APB
       30, should be reclassified to income from continuing operations in all
       prior periods presented. The provisions of SFAS 145 were effective for
       fiscal years beginning after May 15, 2002. The Company has not
       experienced any instances of early extinguishment of debt, but will apply
       the provisions of SFAS 145 to all future debt extinguishments.

       Stock-Based Employee Compensation

       In December 2002, the FASB issued Statement 148 ("SFAS 148"), Accounting
       for Stock-Based Compensation -- Transition and Disclosure: an amendment
       of FASB Statement 123 ("SFAS 123"), to provide alternative transition
       methods for a voluntary change to the fair value based method of
       accounting for stock-based employee compensation. In addition, SFAS 148
       amends the disclosure requirements of SFAS 123 to require prominent
       disclosures in annual financial statements about the method of accounting
       for stock-based employee compensation and the pro forma effect on
       reported results of applying the fair value based method for entities
       that use the intrinsic value method of accounting. The pro forma effect
       disclosures are also required to be prominently disclosed in interim
       period financial statements. This statement is effective for financial
       statements for fiscal years ending after December 15, 2002 and is

                                       16
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       effective for financial reports containing condensed financial statements
       for interim periods beginning after December 15, 2002, with earlier
       application permitted. The Company does not plan a change to the fair
       value based method of accounting for stock-based employee compensation
       and has included the disclosure requirements of SFAS 148 in the
       accompanying financial statements.

       Accounting for Guarantees

       In November 2002, FASB Interpretation 45, Guarantor's Accounting and
       Disclosure Requirements for Guarantees, Including Indirect Guarantees of
       Indebtedness of Others ("FIN 45"), was issued. FIN 45 requires a
       guarantor entity, at the inception of a guarantee covered by the
       measurement provisions of the interpretation, to record a liability for
       the fair value of the obligation undertaken in issuing the guarantee. FIN
       45 applies prospectively to guarantees the Company issues or modifies
       subsequent to December 31, 2002, but has certain disclosure requirements
       effective for interim and annual periods ending after December 15, 2002.
       The Company has never issued guarantees and does not anticipate FIN 45
       will have a material effect on its 2003 financial statements.

       Variable Interest Entities

       In January 2003, the FASB issued FASB Interpretation 46 ("FIN 46"),
       Consolidation of Variable Interest Entities. FIN 46 clarifies the
       application of Accounting Research Bulletin 51, Consolidated Financial
       Statements, for certain entities that do not have sufficient equity at
       risk for the entity to finance its activities without additional
       subordinated financial support from other parties or in which equity
       investors do not have the characteristics of a controlling financial
       interest ("variable interest entities"). Variable interest entities
       within the scope of FIN 46 will be required to be consolidated by their
       primary beneficiary. The primary beneficiary of a variable interest
       entity is determined to be the party that absorbs a majority of the
       entity's expected losses, receives a majority of its expected returns, or
       both. FIN 46 applies immediately to variable interest entities created
       after January 31, 2003, and to variable interest entities in which an
       enterprise obtains an interest after that date. It applies in the first
       fiscal year or interim period beginning after June 15, 2003, to variable
       interest entities in which an enterprise holds a variable interest that
       it acquired before February 1, 2003. The Company has not engaged in
       transactions covered by FIN 46 but will apply the provisions of FIN 46 to
       all future applicable transactions, if any.

       Revenue Recognition

       In November 2002, 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 change as a cumulative effect adjustment in

                                       F-17
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       accordance with APB Opinion 20, Accounting Changes. The Company has not
       determined the effect of adoption of EITF 00-21 on its financial
       statements or the method of adoption it will use.

       Consideration Received from a Vendor

       In November 2002 the Emerging Issues Task Force reached a consensus
       opinion on EITF 02-16, "Accounting by a Customer (including a reseller)
       for Certain Consideration Received from a Vendor." EITF 02-16 requires
       that cash payments, credits, or equity instruments received as
       consideration by a customer from a vendor should be presumed to be a
       reduction of cost of sales when recognized by the customer in the income
       statement. In certain situations, the presumption could be overcome and
       the consideration recognized either as revenue or a reduction of a
       specific cost incurred. The consensus should be applied prospectively to
       new or modified arrangements entered into after December 31, 2002. The
       Company does not believe that the effects of EITF 02-16 will be material.

(4)    Acquisition of Optimation, Inc.
       -------------------------------
       On March 30, 2001, the Company completed its acquisition of Optimation,
       Inc., a Huntsville, Alabama-based company that develops, produces and
       markets industrial communications and display products for industrial
       automation. The Company recorded this transaction using the purchase
       method of accounting.

       The purchase price was approximately $1,660,000, including expenses of
       approximately $60,000. Under the terms of the related Optimation Stock
       Purchase Agreement, the Company issued 1,483,680 shares of its common
       stock to the former Optimation shareholders in exchange for 100% of the
       outstanding equity of Optimation. Additionally, the Company paid the
       former Optimation shareholders $600,000 over the 21-month period ending
       December 31, 2002. In connection with the Optimation Stock Purchase
       Agreement, the Company also entered into three-year employment agreements
       and three-year agreements not to compete with Optimation's president and
       vice-president, both of whom were Optimation shareholders.

       The allocation of the total purchase price to assets acquired and
       liabilities assumed as of the March 30, 2001 acquisition date are as
       follows:

         Cash                                                       $   21,000
         Other current assets                                        1,605,000
         Equipment                                                      19,000
         Goodwill                                                      835,000
         Current notes payable                                        (640,000)
         Other current liabilities                                    (137,000)
         Long-term debt                                                (43,000)
                                                                    ----------
         Total purchase price                                       $1,660,000
                                                                    ==========

       The following unaudited pro forma information presents a summary of
       consolidated results of operations for the year ended December 31, 2001
       of the Company as if the acquisition of Optimation had occurred as of the

                                       F-18
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       beginning of 2001, with pro forma adjustments to give effect to
       amortization of intangible assets and utilization of the Company's net
       operating loss carry-forwards.
                                                                    December 31,
                                                                        2001
                                                                        ----
         Net revenues                                               $17,953,000
         Net loss                                                    (7,049,000)
         Net loss per share:
           Basic                                                         $(0.44)
           Diluted                                                       $(0.44)

(5)    Inventories
       -----------
       Inventories are summarized as follows:
                                                                    December 31,
                                                                        2002
                                                                        ----
         Purchased parts and accessories                             $1,085,811
         Work in process                                                247,730
         Finished goods and service stock                               320,303
                                                                     ----------
         Total inventories                                           $1,653,844
                                                                     ==========

(6)    Notes Payable to Banks Under Line of Credit Facilities
       ------------------------------------------------------
       The Company and its subsidiary, A-OK Controls, are parties to two loan
       and security agreements (the "Agreements") with a Wisconsin-based bank.
       The Agreements, as amended through October 2002, provide for a total of
       $2.5 million in two lines of credit. The Agreements provide for credit
       facilities through November 2003, and may be extended for an additional
       one-year period at the option of the Company, unless the lender gives
       prior notice of termination. See Note 8 for additional information
       concerning the term loans and the Agreements.

       The amount available under the line of credit is limited by a borrowing
       formula that allows for advances up to a maximum of a specified
       percentage of eligible accounts receivable, less the amount, if any, of
       outstanding letters of credit issued by the Company. Based upon such
       borrowing formula, approximately $142,000 of the available line is
       eligible for advance at December 31, 2002. Amounts borrowed under the
       line of credit facility total $1,127,317 at December 31, 2002, and such
       borrowings bear interest at the prime rate plus 4.50% (9.25 % effective
       rate at December 31, 2002). The line of credit is collateralized by
       substantially all assets of the Company and a second position on the
       mortgage on the Company's Ann Arbor facility.

       The Agreements contain several financial covenants, including specified
       levels of tangible net worth, interest coverage and debt service
       coverage. The terms of the Agreement also prohibit the payment of
       dividends, limit the amount of annual capital expenditures and include
       other restrictive covenants. Although the Company is not in compliance
       with the tangible net worth, interest coverage and debt service coverage
       covenants as of December 31, 2002, the bank issued a forbearance letter

                                       F-19
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       to the Company in October 2002 concerning these covenant violations. In
       such letter, the bank has specifically reserved its right to take any
       action permitted under the Agreements in the future without any notice to
       the Company. The bank and management are in discussion to revise the
       Agreements and management is pursuing other solutions to the violations,
       including the private placement of additional capital.

       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 has been renewed on a 90-day
       revolving basis since the Company acquired Optimation in March 2001. The
       Optimation Loan Agreement, amended through October 4, 2002, provides for
       a total line of credit of $335,000 that reduces in amount with all
       principal repayments made (the "Optimation credit facility"). The amount
       available under the Optimation credit facility is limited by a borrowing
       formula that allows for advances up to a maximum of the sum of a
       specified percentage of eligible accounts receivable and a specified
       amount of inventory. Amounts borrowed under the Optimation line of credit
       facility total $270,000 at December 31, 2002, and such borrowings bear
       interest at the prime rate plus .50% (5.25% effective rate at December
       31, 2002), but not less than 5.0% per annum. The Optimation Loan
       Agreement provides for the credit facility through January 3, 2003, and
       it was renewed on that date for an additional 90-day period in the
       initial amount of $270,000 on substantially the same terms and conditions
       as the current facility. The Optimation Loan Agreement requires monthly
       repayments of $15,000 during its 90-day period, and further, prohibits
       the transfer of funds from Optimation to the parent company except for
       customary inter-company cost reimbursements. The Optimation line of
       credit is collateralized by substantially all assets of Optimation, a
       guaranty by Nematron and a partial guaranty by Optimation's president.
       The Company expects that the Optimation Loan Agreement will be renewed on
       successive 90-day periods until the balance of the line is reduced to
       zero.

(7)    Common and Preferred Stock and Subordinated Debt
       ------------------------------------------------
       Common Stock Issuances
       ----------------------
       In May 2001, the Company issued 41,329 shares of Common Stock in return
       for investment banking services valued at $28,000. In June 2001, the
       Company sold 250,000 shares of Common Stock at $1.00 per share pursuant
       to a private placement.

                                       F-20
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       Subordinated Debt
       -----------------
       Subordinated debt consists of the following:
                                                                    December 31,
                                                                        2002
                                                                        ----
       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 $0.09 per share 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.                1,779,000
                                                                      ---------
       Total                                                         $3,179,000
                                                                     ==========
       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
       $0.30 per share (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, as traded on the
       American Stock Exchange, 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 $0.09, the Per Share Warrant Price has been
       adjusted to that amount. 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 notes were sold during March 2001, the
       Warrants were ascribed a value of $342,000 and such amount was credited
       to shareholders equity, and the 10% Notes were ascribed a value of
       $858,000. The $342,000 was charged to interest over the term of the 10%
       Notes, resulting in a total non-cash charge to interest expense of
       $342,000 in 2001.

       The beneficial conversion feature attributable to the difference between
       the ascribed value of the 10% Notes and the underlying number of common
       shares into which the 10% Notes could have been converted also amounted
       to $342,000 and has been charged to interest expense and credited to
       shareholders' equity. The terms of the 10% Notes contemplated the
       conclusion of a stock offering prior to August 31, 2001 in which the 10%

                                       F-21
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       Note holders could participate, and absent the completion of a stock
       offering, the conversion rate would be set at $0.30 per share. The
       offering did not occur, and as a result, the aggregate difference between
       the conversion price and the stock price at that date, amounting to
       $200,000, was charged to interest expense and credited to shareholders'
       equity over the March to August 2001 term of the 10% Notes.

       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 March and October 2002. The modified agreement allows the
       Company to draw up to $2 million upon request and upon approval by the
       14% Note holder upon its sole discretion. 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 $0.10 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) 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.

       The 14% 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 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, the Warrants were ascribed a value of $185,781 and such
       amount was credited to shareholders equity, and the 14% Notes were
       ascribed a value of $1,593,219. The $185,781 was charged to interest
       expense in 2002.

                                       F-22
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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 $0.22 per share (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 over the March to October
       2002 term of the 8% Notes.

       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,
       2002, a total of $366,918 of interest has been accrued for convertible
       subordinated promissory notes, including $287,617 related to notes due to
       related parties.

(8)    Long-Term Debt
       --------------
       Long-term debt consists of the following:
                                                                    December 31,
                                                                        2002
                                                                        ----
         Variable rate term loan payable to a bank, interest
         at prime plus 3.5% per annum (8.25% effective rate
         at December 31, 2002), 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.  $2,663,056

         Other notes payable, secured by equipment                       28,939
                                                                     ----------
         Total long-term debt                                         2,691,995
         Less current maturities                                       (169,255)
                                                                     ----------
         Total long-term debt, less current maturities               $2,522,740
                                                                     ==========

       Scheduled maturities of long-term debt are as follows:

         Year ending December 31,
              2003                                                     $169,255
              2004                                                      172,903
              2005                                                    2,344,996
              2006                                                        4,841
                                                                     ----------
              Total                                                  $2,691,995
                                                                     ==========

                                       F-23
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

(9)    Taxes on Income
       ---------------
       The following reconciles the statutory federal income tax rate to the
       Company's effective tax rate:
                                                         Year Ended December 31,
                                                         -----------------------
                                                             2001      2002
                                                             ----      ----
         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%
                                                             ====      ====

       The domestic and foreign components of loss before taxes on income are as
       follows:
                                                        Year Ended December 31,
                                                        -----------------------
                                                          2001          2002
                                                          ----          ----
         Domestic loss before taxes on income         $(6,877,512)  $(2,971,866)
         Foreign loss before taxes on income             (180,310)     (141,080)
                                                      -----------   -----------
         Total loss before tax benefit                $(7,057,822)  $(3,112,946)
                                                      ===========    ==========

       Deferred income taxes result from temporary differences in the
       recognition of income and expenses for financial and income tax purposes.
       Temporary differences and net operating loss carryforwards, which give
       rise to the net deferred tax position, as of December 31, 2002, are as
       follows:

         Deferred tax assets:
           Accounts receivable allowance for doubtful accounts        $  25,000
           Inventory valuation allowance                                285,000
           Property and equipment, principally depreciation             219,000
           Accrued expenses deductible when paid                        146,000
           Net operating loss carryforward                            9,149,000
                                                                      ---------
             Total deferred tax assets                                9,824,000
           Deferred tax liabilities - capitalized software
           development costs and other intangible assets               (391,000)
                                                                      ---------
           Net deferred tax assets                                    9,433,000
           Less valuation allowance against deferred tax assets      (9,433,000)
                                                                      ---------
           Net deferred tax position                                  $    -0-
                                                                      =========

       The valuation allowance against net deferred tax assets increased by
       $2,336,000 and $825,000 during the years ended December 31, 2001 and
       2002, respectively.

       At December 31, 2002, the Company has net operating loss carryforwards of
       approximately $26,900,000, which expire at various dates between 2004 and
       2022. Utilization of certain of these carryforwards is subject to annual
       limitations under current IRS regulations. The Company has established a
       valuation allowance for the estimated amount of the total limitation on

                                       F-24
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       the utilization of the net operating loss carryforwards. Realization of
       net deferred tax assets associated with the net operating loss
       carryforwards 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
       were 15,259,188 and 15,744,472 in 2001 and 2002, respectively.

       For the years ended December 31, 2001 and 2002, 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 is as follows:

                              Outstanding Options      Outstanding Warrants
                                (See Note 11)             (See Note 12)
                            ---------------------     ----------------------
                                       Expiration                 Expiration
       Year Ended           Amount        Dates       Amount         Dates

       December 31, 2001   2,162,942   2003 to 2011  1,331,011    2002 to 2006
       December 31, 2002   2,017,528   2003 to 2011  4,791,333    2002 to 2007

(11)   Employee Benefit Plans
       ----------------------
       1993 Stock Option Plan
       ----------------------
       The Company's 1993 Stock Option Plan (the "1993 Plan") provides for the
       granting of options to purchase a total of 950,000 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 vest either
       (a) one-third immediately and one-third on each successive anniversary
       date of the award, or (b) vest 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 will 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 may be granted after February
       2003. As of December 31, 2002, awards to purchase an additional 420,303
       shares of common stock may be made under the 1993 Plan.

       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
       1,250,000 shares of common stock to key employees and others. Awards may

                                       F-25
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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 500,000 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, 2002, awards to purchase
       680,200 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
       120,000 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 4,500 shares of
       common stock every three years. Prior to April 1997, each qualified
       director was granted annually an option to purchase 1,000 shares of
       common stock. Options granted in April 1997 or 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, 2002, an additional 66,172 options
       may be issued under the Directors Option Plan.

                                       F-26
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       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, 2001 and 2002, is as follows:

                              Outstanding            Exercisable
                         --------------------  ----------------------
                                     Weighted               Weighted    Number
                                      Average                Average   Available
                           Number    Exercise    Number      Exercise     For
                         Outstanding   Price   Exercisable    Price      Grant
                         -----------   -----   -----------    -----      -----
      Balance,
      January 1, 2001     2,203,156    $2.14    1,404,554      $1.99    981,047
      Granted               390,000    $0.84                           (390,000)
      Exercisable                                 339,313      $2.24
      Exercised                                                            -
      Forfeited            (430,214)   $2.24     (150,340)     $2.61    430,214
                          ---------             ---------             ---------
      Balance,
      December 31, 2001   2,162,942    $1.80    1,593,527      $1.99  1,021,261
      Granted                   -                                           -
      Exercisable                                 214,956      $1.75
      Exercised                        -                                    -
      Forfeited            (145,414)   $2.43     (104,046)     $2.43    145,414
                          ---------             ---------             ---------
      Balance,
      December 31, 2002   2,017,528    $1.72    1,704,437      $1.85  1,166,675
                          =========             =========             =========

      Information concerning outstanding options at December 31, 2002 is as
      follows:
                           Options Outstanding              Options Exercisable
                     ------------------------------------  ---------------------
                                     Weighted
                                      Average    Weighted               Weighted
         Range of     Number of      Remaining   Average   Number of    Average
         Exercise      Options      Contractual  Exercise   Options     Exercise
          Prices     Outstanding      Life        Price   Exercisable    Price

      $0.75 to $1.50   1,155,000    6.87 years    $0.81      886,665      $0.80
      $1.94 to $2.75     769,450    6.59 years    $2.49      724,694      $2.52
          $5.50           39,078    4.84 years    $5.19       39,078      $5.19
      $6.75 to $8.75      54,000    4.38 years    $7.60       54,000      $7.60
                       ---------                           ---------
      Total            2,017,528    6.66 years    $1.72    1,704,437      $1.85
                       =========                           =========

       401(k) Plan and Trust
       ---------------------
       The Company has established a defined-contribution retirement plan for
       all eligible employees. Participants may make basic contributions of up
       to 15 percent of their compensation, pursuant to section 401(k) of the
       Internal Revenue Code.
                                       F-27
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       Beginning on 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.

       Under terms of the 401(k) plan in effect at Nematron prior to January 1,
       2002, Nematron may make a basic matching contribution and a discretionary
       contribution to the 401(k) plan. Nematron's matching contribution was
       100% of a specified percentage of each employee's contribution limited to
       the first 5% of the employee's base salary. Nematron's matching
       contributions were 3% in 2001. A 401(k) plan participant becomes vested
       in Nematron's contribution on his or her behalf at a rate of 20% for each
       year of service beginning with the completion of one year of service. The
       participant will be fully vested in Nematron's contributions in the event
       of his or her death, disability or normal retirement.

       Under terms of the 401(k) plan in effect at A-OK Controls prior to
       January 1, 2002, A-OK Controls may make a basic matching contribution and
       a discretionary contribution to the 401(k) plan. A-OK Control's matching
       contribution was 50% of each participant's contribution to the 401(k)
       plan up to a maximum of $2,500 per participant. A 401(k) plan participant
       becomes vested in A-OK Control'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. The participant will be fully vested in A-OK Control's
       contributions in the event of his or her death, disability or normal
       retirement.

       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
       $231,000 and $194,000 for the years ended December 31, 2001, and 2002,
       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:

                                       F-28
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

         Issue               Description of Debt
         -----               -------------------
           A    Subordinated debt issued in November 1995, repaid in 1997
           B    10% Convertible Subordinated Promissory Notes (See Note 7)
           C    14% Convertible Subordinated Promissory Notes (See Note 7)
           D     8% Convertible Subordinated Promissory Notes (See Note 7)

       Information with respect to outstanding warrants is as follows:

       Issue            A          B           C              D           Total
                        -          -           -              -           -----
       Issue                               10-05-01 to  03-07-02 to
       dates        11-07-95    03-31-01     12-27-02     03-28-02
       Exercise
        price         $4.00       $0.09        $0.10        $0.10
       Expiration                          10-05-06 to
        dates       10-31-02    03-31-06     12-27-07     03-31-06
       Balance
        01-01-2001   197,678                                            197,678
       Issued                    800,000      333,333                 1,133,333
                     -------     -------      -------                 ---------
       Balance,
        12-31-2001   197,678     800,000      333,333                 1,331,011
       Expired      (197,678)                                          (197,678)
       Issued            -           -      2,958,000      700,000    3,658,000
                    --------     -------    ---------      -------    ---------
       Balance,
        12-31-2002       -       800,000    3,291,333      700,000    4,791,333
                    ========     =======    =========      =======    =========

(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 Lansing, Michigan, Foxboro, Massachusetts,
       Huntsville, Alabama and United Kingdom facilities, as well as certain
       office equipment, from unrelated entities. The leases on the facilities
       expire at various dates through December 2008, and the equipment
       operating leases expire at various dates through October 2003.

       A summary of commitments under noncancelable leases as of December 31,
       2002, is as follows:
                                         Related Party  Third Party
                                             Leases       Leases       Total
       Year ending December 31,
            2003                            $397,800     $109,900     $507,700
            2004                             397,800       83,500      481,300
            2005                             397,800       63,200      461,000
            2006                             397,800       34,700      432,500
            2007                             397,800       34,700      432,500
            Thereafter                       221,000       69,300      290,300
                                          ----------     --------   ----------
       Total minimum lease obligations    $2,210,000     $395,300   $2,605,300
                                          ==========     ========   ==========

                                       F-29
<PAGE>

                     NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 2001 and 2002

       Total rental expense was $618,300 and $665,000 for the years ended
       December 31, 2001 and 2002, respectively.


(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:

                                                         Year Ended December 31,
                                                         -----------------------
                                                            2001         2002
                                                            ----         ----
         Foreign:
           France                                      $ 1,168,437  $ 1,149,241
           Other countries                                 868,313    2,322,282
                                                       -----------  -----------
             Total foreign revenue                       2,036,750    3,471,523
         United States                                  15,505,016   11,395,692
                                                       -----------  -----------
             Total revenue                             $17,541,766  $14,867,215
                                                       ===========  ===========

       Long-lived assets include property and equipment, capitalized software
       development costs and other intangible assets. A summary of both foreign
       and domestic long-lived assets at depreciated or amortized cost at
       December 31, 2002 is as follows:

         Foreign countries                                           $   31,049
         United States                                                5,720,031
                                                                     ----------
             Total                                                   $5,751,080
                                                                     ==========

(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 2001 and 2002
       that accounted for $6,888,000 and $5,091,000 of revenue, respectively.
       Accounts receivable from that customer totaled $1,175,000 and $906,000
       at December 31, 2001 and 2002, resectively.












                                       F-30
<PAGE>