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

                                   FORM 10-KSB
(Mark One)
     [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
     For the fiscal year ended DECEMBER 31, 2000 OR
     [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
     For the transition period from                   to
                                    -----------------    --------------

         Commission File Number:  0-21142
                              NEMATRON CORPORATION
                 (Name of small business issuer in its charter)

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

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

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

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

       Title of Each Class                 Name of Exchange on Which Registered
       -------------------                 ------------------------------------
   Common Stock, no par value                  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. [ ]

         Issuer's revenues for its most recent fiscal year:  $20,420,752

         The aggregate market value of the voting stock held by non-affiliates
as of March 23, 2001, computed by reference to the closing price of such stock
on such date as quoted on The American Stock Exchange, was approximately
$6,056,000. 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
23, 2001 was 13,969,616.

         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 2001 Annual Meeting of Shareholders               Part III
(the "2001 Proxy Statement")

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                                     PART I
ITEM 1.  DESCRIPTION OF BUSINESS.

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


         CORPORATE HISTORY

         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 1995 and 1997,
the Company acquired four software development companies.

         During 2000, the Company completed the acquisition of A-OK Controls
Engineering, a control systems design and integration company headquartered in
Auburn hills, Michigan.

         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

         Nematron designs, manufactures and markets factory automation products,
including computer hardware and software products. Its industrial computers and
terminals are called Industrial Control Computers(TM) ("ICCs") and Industrial
Workstations(TM) ("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 focuses of ICCs and IWSs are on 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 commercial 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 five main software products, all of which were
developed by the Company or acquired in the past five years. These products,
used in the industrial and factory automation work place, are marketed under the
trade names OpenControl(TM), Hyperkernel(R), Paragon(TM), FloPro(R) and
AutoNet(TM). Additionally, most of the Company's IWS products contain
proprietary software embedded in the products as firmware that is not sold
separately. All five shrink-wrap products can be run on Nematron's 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


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SCADA package, which regulates control and management of process information.
The Company's FloPro software product is a flowchart programming and direct
machine control software product. The Company's AutoNet software product is a
test and measurement server which allows for data acquisition and real time
processing of data and for performing multiple functions at high speed.

         The Company has four primary locations - three 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, customer
service, product development, administration, finance, accounting, personnel,
purchasing, marketing, corporate-wide sales and international business
development. 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
and software manufacturing are conducted at its Foxboro, Massachusetts office.
Software engineers and other employees located in Foxboro are responsible for
software product development, enhancement, maintenance, and reproduction of
shrink-wrapped software. 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 a sales office near Toronto,
Canada and control system design and integration offices in Saginaw and Lansing,
Michigan.


         PRODUCTS, MARKET AND COMPETITION

         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, and 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 to be performed after the sale.

         Management believes, based on market research and reports of various
research analysts, that a large segment of the existing PLC market will over
many years migrate to PC-based control and operator interface solutions that
eliminate the PLC. The resulting market for industrial PC-based products will
expand significantly. In response to this evaluation of the market, the Company
will place substantial emphasis on further enhancements to IWSs 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 and smaller companies, including low-cost
producers in the Far East. 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

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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 5000, 6000 and 8000 series of ICCs were
     designed and developed by the Company in recent years and continue to be
     enhanced to keep abreast with the changing marketplace. ICC-5/6/8000
     products offer Pentium III processors as well as processors that have been
     guaranteed by Intel to be available for years to come. They are shipped
     with display options from 10.4" to 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 of these models 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 $4,500 to $13,000, varying primarily on the choice of display,
     processors, features and bundled software.

         THE i-SERIES PRODUCTS. The ICC-500i and 600i feature Celeron and
     Pentium processors with ISA passive backplane architecture and have the
     same high ratings as the ICC family products. These i-Series products are
     equipped with active matrix color displays, resistive touchscreen, two
     high-speed serial ports and two half-length ISA expansion slots. These
     units range in price from $4,500 to $10,000, varying primarily on the
     choice of display, processors, features and bundled software.

         THE e-SERIES PRODUCTS. The e-Series family of embedded industrial
     control computers gives users all the power of an Intel Celeron and Pentium
     III processor with the reliability and stability of embedded system
     technology. These e-Series products use non-rotating solid-state memory,
     allowing the products to be used without hard disks 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 innovative 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.

         DIGITAL MONITORS. Digital monitors, introduced to the marketplace in
     1999, are made for harsh industrial environments that demand sharp, clear
     displays not available through analog products. Digital signals, taken
     directly from the computer with no translation, provide exceptional clarity
     with no loss of signal even when mounted up to ten meters from the
     computer. Digital monitors are engineered with ease of use and inexpensive
     and easy maintenance in mind. Using the patented hinged form chassis and an
     innovative clip-mounting system, initial installation and recurring
     maintenance is a snap. These products are NEMA 4/4X12 rated and have the
     customary UL, cUL and CE certifications for use worldwide. These products
     range in price from $3,000 to $4,000 depending upon options selected.

         FLEXBOX(TM). Nematron's Flexbox product is an industrial rack-mount,
     wall-mount or bench-top PC featuring rugged construction, an ISA/PCI
     motherboard, front panel access to device bays and power switches, and an
     auto-switching power supply. These modular computers, equipped with Pentium
     III and Celeron processors, are often integrated into systems that include
     Nematron flat panel monitors or into other configuration that do not
     require a monitor. FlexBox products range in price from $2,500 to $8,000,
     depending upon processors, hardware features and software options.

         Revenues from the sale of industrial PC products and ICC products
amounted to approximately 40% and 70% of consolidated revenue in 2000 and 1999,
respectively. The Company expects that revenue from this product category in
2001 will approximate the same rate as in 2000. No other single model or product
family accounted for more than 15% of the Company's revenues during those
periods.

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         CHARACTER-BASED PLC WORKSTATIONS AND REMOTE MESSAGE UNIT PRODUCTS

         Character-based programmable logic controller ("PLC") workstations and
remote message unit products economically replace as few as five
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 $2,000.

         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.

         Sales of character-based PLC workstations and remote message unit
products in each of 2000 and 1999 amounted to less than 10% of consolidated
revenue. 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 necessary, acquire existing
product lines from third parties.

         INDUSTRIAL GRAPHICS TERMINALS AND PROGRAMMABLE OPERATOR INTERFACE
PRODUCTS

         Nematron's operator interface workstations, produced in some fashion
since 1983, are used for push button replacement and PLC interface applications.
The IWS-30 model is a low-cost unit with two-line alphanumeric displays and a
ten-key membrane keypad. The IWS-110 and IWS-120 models feature 27-position
keypads and four-line alphanumeric displays. These workstations connect with the
most popular PLCs and PCs of most manufacturers. The IWS-200 features a
graphical user interface that can be used to create pushbuttons, message and
numeric displays, indicators, and bar and trend graphs. All IWS product front
panels are NEMA 4/4X12 rated for use in harsh industrial environment.

         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.

         Sales of industrial graphics terminals and programmable operator
interface products in each of 2000 and 1999 amounted to less than 10% of
consolidated revenue. The Company expects a decrease of approximately 10% per
year in this market segment due to the anticipated availability of more
sophisticated technology at lower costs.

         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 in each of 2000 and 1999 amounted to less than 10% of
consolidated revenue. The Company expects that revenue from computer parts and
service will represent less than 10% of consolidated revenues in 2001.

         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



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product. All shrink-wrap products may be run on Nematron's computers or on
computers of most other manufacturers.

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

         Revenues derived from of software product sales, including associated
training and maintenance agreements, amounted to approximately 9% and 17% of the
Company's consolidated revenue in 2000 and 1999, respectively. The Company
expects that revenue from software products will represent approximately 10% of
consolidated revenues in 2001.

         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, enabling
     enterprise-wide access to plant floor data. With a high degree of
     flexibility, intuitive programming and advanced troubleshooting features,
     OpenControl assists manufacturers and OEMs to significantly reduce
     development time and minimize life cycle costs. Because OpenControl
     operates on PCs, users can leverage applications and technology to
     improvements in price/performance ratios and to 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 more machine
     throughput, reduced machine downtime and the ability to share factory data
     throughout the enterprise. With the recent introduction of a ladder logic
     editor, 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 ladder logic software. Several of the Company's
     competitors license the technology upon which OpenControl is based. The
     OpenControl product has many advantages over its competitors: the software
     is self-documenting, it allows for more efficient programming, it costs
     less than many other products, it operates on open PC architecture, and it
     reduces plant down time through diagnostic messages and fast execution
     time.

         REAL-TIME SUBSYSTEM.: Hyperkernel(R) is Nematron's software product
     that allows software developers to integrate highly deterministic real-time
     applications into Microsoft's 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. The Hyperkernel product 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 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
     Microsoft's Windows 3.1 operating systems.

         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. The Company's soft logic software is called
FloPro. FloPro is a flowchart programming system which 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

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Operation of Machines." The programming system is used to create, debug,
document and execute control applications in an open architecture environment.
Its open system architecture allows operators to interface it concurrently with
many different input/output systems, motion controllers, message units and RF
tag/bar code systems. FloPro simplifies machine control system development by
allowing the use of multiple flowcharts, each one handling a relatively simple
task, thus allowing for the concurrent development of applications by a team of
control engineers. These flowcharts communicate with each other in a
multi-tasking environment, which means that the control application is easy to
create and understand. Additionally, FloPro is self-documenting in that it is a
programming language based on the flowcharts; there is no need to translate the
flowcharts to ladder logic. The use of FloPro and a PC replaces the need for
PLCs and ladder logic for machine control applications. FloPro is in use at
several automotive component manufacturing facilities and controls thousands of
machines involved in the manufacture of engines and transmissions.

         TEST AND MEASUREMENT. The Company's AutoNet software product, a test
and measurement software, is sold to commercial and industrial companies
primarily for use in a test cell environment. AutoNet allows for data
acquisition and real time processing of high-speed data while performing
multiple functions. AutoNet graphically displays real time information through a
wide variety of configurable graphic instruments, trends and Cartesian plots.
AutoNet performs real-time mathematical, statistical and trigonometric
calculations for control, test sequencing, filtering and batch management of
data. It features color-coded annunciation of alarm information, diagnostic
files and automatic time stamps, and presents stored data in report, historical
graphics or ad hoc queries. AutoNet competes with products offered by other
companies, most notably Hewlett Packard and National Instruments. The AutoNet
product is unique in that it is a real time operating system, which operates at
a higher performance level than competitive products.

         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. Revenues
derived from system integration services, amounted to 30% and 11% of the
Company's consolidated revenue in 2000 and 1999, respectively. The Company
expects that revenue from system integration services will represent
approximately 30% of consolidated revenues in 2001. A-OK Controls competes with
many other locally-based system integrators of similar or smaller size and
capabilities.

         SALES CHANNELS

         Through 2000, the Company used three sales channels. The Company's
primary sales channels were a network of high-tech industrial distributors and a
corporate sales staff focused on major original equipment manufacturers ("OEMs")
of industrial processing systems and machines and to other major end users. To a
lesser extent, the Company markets certain products to private-label accounts
that remarket Nematron's products primarily through their own networks of
industrial electrical distributors. Beginning in 2001, the Company has begun to
sell its products through manufacturer representative firms. This sales channel
is jointly managed by Nematron and by managers of EXOR Electronic R&D, a Florida
based controls manufacturing company that has employed that sales channel for a
number of years.

         One distributor accounted for 13% and 30% of consolidated revenues in
2000 and 1999, respectively. This distributor resells products primarily to the
automotive industry, OEMs and machine tool builders. No other private label,
direct customer, or distributor accounted for more than 10% of total Company
sales in 2000 or 1999. The ICC product family, including ICC products bundled
with software products, accounted for approximately 18% and 70% of consolidated
revenues in 2000 and 1999, respectively. No other single model or product family
accounted for more than 15% of the Company's revenues during those periods.

         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. Prior to 2001, the Company employed regional sales managers
covering major geographic regions of the United States and Europe and several
sales

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managers who concentrate on key accounts nationwide. Beginning in 2001, the
Company switched from a direct sales approach to one using manufacturing
representation companies (totaling 15 entities) and its series of direct
distributors. The Company continues to employ strategic account sales staff.

         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. During 2000, the Company subcontracted certain of
the material acquisition and some of the assembly of certain high volume - low
mix ICC products to two subcontractors, one located in South Carolina and one in
the Czech Republic. Approximately 40% of 1999 consolidated revenues were derived
from sales of products assembled by these two subcontractors. In 2000, however,
less than 10% of consolidated revenues were derived from sales of products
assembled by subcontractors, as the Company terminated its subcontract agreement
with the South Carolina subcontractor concurrent with the completion in early
2000 of the Company's major OEM program. 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 performs 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, but loss of one or more suppliers of standard specialized and
unique components would have a near-term impact on operations would cause some
production delays.

         In addition, the Company employs 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 its environmental
chambers and electronic instrumentation to certify that its products meet the
severe industrial environments for which they are intended.

         PRODUCT DEVELOPMENT

         The Company maintains an active product development program and
continues to supplement existing research and development capabilities through
active recruiting of technical personnel and development of proprietary
technology. The Company has a substantial product development staff, including
electrical and electronic design engineers, mechanical design engineers,
software design engineers, product managers, application engineers and directly
associated staff members involved in technical documentation and product
support. The Company also periodically employs the services of unrelated
contract engineering companies on an as-needed basis. The Company also 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 Foxboro, Massachusetts and 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 2000 and 1999, the Company
expended approximately $1.9 million and $2.1 million, respectively, for direct
hardware and software product development and product design quality, including
those costs capitalized under Statement of Financial Accounting Standards No.
86. The Company sponsored all of such costs. These amounts represented 9% and 7%
of consolidated revenues in 2000 and 1999, respectively. The increase resulted
primarily to the decrease in revenues in 2000 compared to 1999.

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         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 17-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 has no patents on
other hardware products or computer software designs. 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, Imagination Systems and
Universal Automation, the Company also owns trademarks on certain of its
products, including Industrial Workstation, OpenControl, 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 are not a significant source of revenue to
the Company. The Company has licensed its soft logic technology to several
unrelated companies under royalty arrangements and licenses. These arrangements
and licenses have not been a significant source of revenue.

         EMPLOYEES

         The Company employs 172 full time employees as of December 31, 2000,
including 149 in Michigan, 11 in Foxboro, Massachusetts, 8 in the United
Kingdom, and 4 at other locations, primarily home offices of its sales staff.
None of the Company's employees are represented by a collective bargaining unit,
and the Company believes its employee relations are good.

         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
Company owned. A mortgage on the property comprises a portion of the security
for the Company's bank line of credit and term loans from LaSalle Business
Credit.

         The Company's Auburn Hills, Michigan facility consists of approximately
50,000 square feet of leased space in a single tenant office building. The
operating lease is non-cancelable through May 2008.

         The Company's Foxboro, Massachusetts's facility consists of
approximately 4,600 square feet of leased space in a three-story office
building. The operating lease is non-cancelable through June 2001.



                                       9

<PAGE>   10


         The Company's Waterlooville, United Kingdom facility consists of 2,100
square feet of leased space in a three-story office building. The operating
lease is non-cancelable through December 2009.

         The Company's Saginaw, Michigan facility consists of 5,000 square feet
of leased space in a three-story office building. The operating lease is
non-cancelable through January 2009.

         The Company's Lansing, Michigan facility consists of 1,550 square feet
of leased space in an office building. The operating lease is non-cancelable
through March 2003.


ITEM 3.  LEGAL PROCEEDINGS.

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


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

         Not applicable.

                                       10
<PAGE>   11


                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

              The Company's Common Stock is listed on The American Stock
Exchange (the "AMEX") under the symbol NMN, and began trading on that exchange
on November 23, 1999. Prior to January 20, 1999, the Company's Common Stock was
traded on the Nasdaq Stock Market's National Market under the symbol NEMA. On
January 21, 1999, the Company's Common Stock was delisted from the National
Market for failing to maintain the National Market's minimum tangible net worth
criteria. On that date, the Common Stock began trading on the Over-The-Counter
Bulletin Board (the "OTC BB") under the symbol NEMA, and remained on the OTC BB
until November 22, 1999 when it became listed for trading on the AMEX. The
following table sets forth, for the periods indicated, the closing price on the
AMEX and the National Market or the bid price on the OTC BB covering the periods
during which the Common Stock was traded thereon. The quotations on the OTC BB
reflect inter-dealer prices, without retail mark-up, markdown or commission, and
may not represent actual transactions.

<TABLE>
<CAPTION>
                     1999                   High              Low
                     ----                   ----              ---
<S>                                         <C>              <C>
                First Quarter               $1.97            $1.00
                Second Quarter               3.13             2.00
                Third Quarter                4.72             2.00
                Fourth Quarter               4.50             2.38

                     2000                   High               Low
                     ----                   ----               ---
                First Quarter               $3.87            $2.00
                Second Quarter               2.75             1.94
                Third Quarter                2.00             1.31
                Fourth Quarter               1.69             0.50
</TABLE>

         There are approximately 825 holders of record of the Company's Common
Stock as of March 15, 2001.

         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.

         In December, 2000, the Company issued 760,000 shares of its Common
Stock in a private placement transaction for a total of $914,000 in cash. The
Company issued the Common Stock to accredited investors without registration
under the Securities Act of 1933, as amended (the "Act"), in reliance upon
Section 4(2) of the Act and Regulation D promulgated thereunder. The Company
relied upon this exemption based upon the limited number of purchasers, the
provision of financial and other information concerning the Company to the
purchasers, investment representations made by the purchasers, the lack of
general solicitation, and actions taken by the Company to restrict resale of the
securities without registration, including the placement of restrictive legends
on the share certificates.


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

         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

                                       11

<PAGE>   12

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 which 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.


RESULTS OF OPERATIONS - YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED
DECEMBER 31, 1999

         Net revenues decreased to $20,421,000 in 2000 compared to $29,772,000
in 1999. This represents a decrease of $9,351,000, or 31.4%, compared to the
1999 level. Revenues decreased primarily because of a combination of sales
declines related to computer hardware and software, offset by revenue increases
from control design and system integration services and, to a lesser extent, by
revenue increases from repair services. Sales of bundled system and hardware
products declined by $13,225,000 and sales of software products declined by
$1,790,000 in 2000 compared to 1999, primarily because of the expiration of a
major supply program for bundled products, hardware and related software that
was delivered to OEMs. Revenues from the major supply program accounted for
$13.2 million in 1999 and fell to $3.0 million in 2000 during which the contract
expired. Additionally, revenues from distributors declined by $1,300,000 in 2000
compared to 1999, and revenues from three large customers declined by $900,000
as such customers experienced slow-downs in their businesses. Offsetting the
decreases in revenues from bundled system, hardware and software products was an
increase in revenues from repair services by $140,000 in 2000 compared to 1999,
and from revenues generated by control design and system integration services,
including revenues from the Company's wholly owned subsidiary, A-OK Controls,
which the Company acquired on June 30, 2000. Control design and system
integration services increased $5,525,000 in 2000 compared to 1999, including
$4,790,000 of revenues generated by A-OK Controls during the six-month period
ended December 31, 2000.

         Foreign revenues decreased to $5,339,000 in 2000 compared to
$11,999,000 in 1999 primarily because of the decrease in sales made to
foreign-based OEMs under the major program discussed above. Domestic revenues
decreased to $15,082,000 in 2000 compared to $17,773,000 in 1999 also because of
the decrease in sales made to domestic-based OEMs under the same program, but
offset in part by increases in control design and system integration services,
including those revenues generated by A-OK Controls.

         Management believes that revenues will increase in 2001 as a result of
increased marketing and sales efforts and the use of manufacturing
representative firms for its non-strategic sales efforts in 2001 compared to
using a direct sales staff in 2000. Additionally, management expects that
revenues from control design and system integration services will increase as a
result of including A-OK Controls operations for twelve months in 2001 compared
to including A-OK Control's revenues only for the six-month period from the date
of A-OK Controls acquisition in 2000.

         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, provisions for warranty costs on products sold, provisions for excess and
obsolete inventory and other direct and indirect costs of these departments and
activities. Cost of revenues increased to 75.4% of revenues in 2000 compared
67.1% in 1999. The increase results primarily from the decrease in revenues and
the adverse change in product mix resulting from the expiration of the major OEM
program in 2000 and the decrease in higher margin software sales. The decrease
in revenues resulted in a smaller revenue base over which to spread Company's
fixed costs. In addition, a significant portion of the sales in the major OEM
program during 1999 represented sales of higher margin bundled systems. The
margin deterioration was partially offset by the increase in higher margin
control design and system integration services. Management expects that the
change in product mix in 2001 towards an increased percentage of control system
and integration services will cause margins to improve moderately in 2001.

         Product development expenses decreased by $122,000 to $672,000 in 2000
compared to $794,000 in 1999. This represents a decrease of 15.4% from the 1999
level and results from a more efficient and effective development staff in 2000
compared to 1999. Management expects that product development expenses will
increase in 2001 compared to 2000 because the Company plans to hire additional
staff to enhance its existing software products.

                                       12

<PAGE>   13


         Selling, general and administrative expenses decreased to $6,456,000 in
2000 compared to $6,471,000 in 1999. This represents a decrease of $14,000, or
0.2% from the 1999 level and results from a staff reduction, lower discretionary
spending for advertising, and lower sales commissions, partially offset by
increases in general and administrative costs arising from the A-OK Controls
acquisition in mid-year. Without the addition of the A-OK costs, selling,
general and administrative expenses would have decreased by $735,000 in 2000
compared to 1999, and such amount represents a 11% decrease compared to the 1999
level. Decreased revenue levels caused management to reduce staff levels and to
decrease discretionary spending. Management expects that selling, general and
administrative expenses will increase in 2001 compared to 2000 because of
increases in marketing and sales efforts, increased sales commissions from
higher revenue levels and the inclusion of a full year of expenses relating to
the A-OK Controls operation.

         Interest expense increased to $563,000 in 2000 compared to $524,000 in
1999. This represents an increase of $39,000, or 7.4%, over the 1999 level. The
increase results from higher average borrowing levels in 2000 compared to 1999
and higher interest rates. Management expects that interest expense will
continue to increase in 2001 because of the financing needs it forecasts for
2001, caused in part by the losses the Company incurred in 2000.

         Other income (expense) - net totaled $449,000 of income in 2000
compared to $26,000 of expense in 1999. The income in 2000 results primarily
from the sale in the first quarter of 2000 of a domain name that the Company did
not use, and to a lesser extent, from rentals to third parties of office space
at the A-OK Controls facility. The other expense in 1999 resulted from sundry
transactions, none of which were significant.


LIQUIDITY AND CAPITAL RESOURCES

         Primary sources of liquidity are cash generated from operations, the
Company's $9.0 million line of credit and two term loans totaling $3.9 million
at December 31, 2000. The Company's operations generated $1,012,000 in cash
during 2000, primarily as a result of changes in working capital and the noncash
depreciation and amortization charges to operations, offset in part by the $1.9
million loss from operations. During 2000, the Company used $3.2 million of cash
in connection with its acquisition of A-OK Controls, $864,000 of cash for
additions to fixed assets and capitalized software development costs, and
$668,000 of cash for debt repayments and financing costs. Primary sources of
cash in 2000 were $914,000 from a private placement of common stock completed in
December, $1,500,000 from a term note with the Company's senior bank lender, and
$639,000 from credit line borrowings.

         In June 2000 the Company modified its existing Loan and Security
Agreement with LaSalle Business Credit, Inc. (the "Credit Agreement"). The
Credit Agreement provides for a $2.9 million term loan with interest at the
prime rate plus 1.5%, a $1.5 million term loan with interest at the prime rate
of interest plus 3.0%, and a $9.0 million revolving line of credit with interest
at the prime rate plus 1.5% (11.0% effective rate at December 31, 2000). The
line of credit borrowings are limited by a borrowing formula that allows for
advances up to 85% of eligible accounts receivable. The $2.9 million term loan
requires monthly principal payments of $16,100, plus a mandatory quarterly
prepayment of "Excess Cash Flow", as defined in the Credit Agreement. The $1.5
million term loan requires monthly principal payments of $62,500. As of December
31, 2000, the Company had borrowed $2,059,000 of its revolving credit facility
and $3,894,000 under its term loans. Based upon the borrowing formula, an
additional $727,000 may be borrowed as of December 31, 2000.

         Borrowings under the Credit Agreement are secured by substantially all
of the Company's assets and guaranteed by its domestic subsidiaries and their
assets. Borrowings under the Credit Agreement are due in full on November 12,
2002, but the due date may be extended for an additional one-year period unless
the lender has given prior notice of termination to the Company. The Credit
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 Credit
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 Credit 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 debt service and interest coverage covenants. Management is
hopeful, however, that a successful



                                       13

<PAGE>   14

capital infusion will cause the lender to continue its forbearance. In view of
the continuing default, the Company has classified all indebtedness to the
lender as current liabilities.

         Management can offer no assurance that the private placement of
securities will be successful, nor if the private placement occurs, that the
equity raised will be sufficient persuade the bank to continue its forbearance
on calling the debt because of the continuing covenant violations. If the
private placement is not successful, the Company will not have sufficient
liquidity to satisfy its liabilities and obligations as they become due and it
may be forced to curtail its operations.

UNCERTAINTIES RELATING TO FORWARD LOOKING STATEMENTS

         "Item 6. Management's Discussion and Analysis or Plan of Operation" and
other parts of this Form 10-KSB contain certain "forward-looking statements"
within the meaning of the Securities Act of 1934, as amended. While the
Company believes any forward-looking statements it has made are reasonable,
actual results could differ materially since the statements are based on current
management expectations and are subject to risks and uncertainties. These risks
and uncertainties include, but are not limited to the following:
               Uncertainties discussed elsewhere in "Management's Discussion and
               Analysis or Plan of Operation" and in "Description of Business"
               above;
               The potential inability to raise equity or debt financing in a
               sufficient amount to sustain operations and allow management to
               execute its strategies;
               The potential inability to modify bank covenants or continue the
               lender's forbearance exercising its remedies;
               The decline of economic conditions in general and conditions in
               the automotive manufacturing industry in particular;
               A reduction in demand for the Company's products and services;
               The inability of the Company to successfully implement its
               strategy to lead the industrial automation market migration from
               closed architecture PLCs to open architecture PC-based solutions;
               Changes in Company strategy;
               The potential inability of the Company to utilize the new
               manufacturers representative sales channel to increase sales over
               prior year levels;
               Reductions in product life cycles; Competitive factors (including
               the introduction or enhancement of competitive products);
               Pricing pressures that may result in materially reduced selling
               prices for the Company's products; Component price increases;
               Delays in introduction of planned hardware and software products;
               Software defects and latent technological deficiencies in new
               products;
               Unforeseen increases in operating expenses;
               Adverse fluctuations in foreign exchange rates; The inability to
               attract or retain sales and/or engineering talent;
               Changes in customer requirements; and Evolving industry
               standards.

                                       14
<PAGE>   15



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.





                                       15
<PAGE>   16


                                    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 2001 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 2001 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 2001 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 2001 Proxy Statement under the caption "Certain Relationships and
Related Transactions."


ITEM 13. EXHIBITS 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 filed the following current reports on Form 8-K during
              the fourth quarter of the Company's fiscal year ended December 31,
              2000.

                  Form 8-K/A, dated October 23, 2000 and filed October 26, 2000,
                  as an amendment to a Form 8-K filed July 14, 2000 reporting
                  the Company's acquisition of A-OK Controls Engineering, Inc.
                  The amendment contained the following pro forma financial
                  statements of the Company: Pro Forma Unaudited Consolidated
                  Statement of Operations for the year ended December 31, 1999,
                  Pro Forma Unaudited Consolidated Statement of Operations for
                  the six months ended June 30, 2000 and Notes to Pro Forma
                  Unaudited Consolidated Financial Information. The amendment
                  also contained the following financial statements of A-OK
                  Controls Engineering, Inc.: Balance Sheet as of November 30,
                  1999, Statement of Operations for the year ended November 30,
                  1999 and the seven months ended June 30, 2000 (unaudited),
                  Statement of Stockholder's Equity for the year ended November
                  30, 1999 and the seven months ended June 30, 2000 (unaudited),
                  Statement of Cash Flows for the year ended November 30, 1999
                  and the seven months ended June 30, 2000 (unaudited), and
                  Notes to Financial Statements.

                  Form 8-K, dated November 14, 2000 and filed November 21, 2000,
                  reporting information under Item 5 and containing no financial
                  statements.



                                       16

<PAGE>   17



                      NEMATRON CORPORATION AND SUBSIDIARIES

                                Table of Contents



                                                                           Page

Report of Independent Certified Public Accountants                          18

Consolidated Balance Sheet as of December 31, 2000                          19

Consolidated Statements of Operations for the years ended
     December 31, 1999 and 2000                                             20

Consolidated Statement of Stockholders' Equity for the years ended
     December 31, 1999 and 2000                                             21

Consolidated Statements of Cash Flows for the years ended
     December 31, 1999 and 2000                                            22-23

Notes to Consolidated Financial Statements                                 24-39







                                       17
<PAGE>   18





               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, 2000, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the two years ended December 31, 2000. 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 generally accepted auditing standards
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, 2000, and the results of their operations
and their cash flows for the two years ended December 31, 2000, in conformity
with generally accepted accounting principles 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 a loss from
operations in 2000, 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.



/s/ Grant Thornton LLP

February 28, 2001
Southfield, Michigan


                                       18
<PAGE>   19

                      NEMATRON CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                               DECEMBER 31, 2000

<TABLE>
<S>                                                                                                      <C>
                             ASSETS (NOTES 6 AND 8)
Current assets:
      Cash and cash equivalents                                                                          $     74,712
      Accounts receivable, net of allowance for doubtful accounts of $78,000                                5,407,593
      Inventories (Note 5)                                                                                  1,956,255
      Prepaid expenses and other current assets                                                               315,556
                                                                                                         ------------
                Total current assets                                                                        7,754,116
Property and equipment:
      Land                                                                                                    117,000
      Building and improvements                                                                             2,292,685
      Equipment                                                                                             6,837,434
                                                                                                         ------------
                                                                                                            9,247,119
      Less accumulated depreciation                                                                        (6,703,078)
                                                                                                         ------------
                Net property and equipment                                                                  2,544,041
Other assets:
      Software and related development costs, net of accumulated amortization of $2,805,592 (Note 3)        3,369,660
      Other intangible assets, net of accumulated amortization of $2,589,652 (Notes 3 and 4)                3,212,345
                                                                                                         ------------
                Net other assets                                                                            6,582,005
                                                                                                         ------------

                Total assets                                                                             $ 16,880,162
                                                                                                         ============

                      LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
      Note payable to bank (Note 6)                                                                      $  2,059,318
      Accounts payable                                                                                      1,642,039
      Deferred revenue and other accrued liabilities                                                        2,011,825
      Current maturities of long-term debt (Note 8)                                                         3,953,908
                                                                                                         ------------
                Total current liabilities                                                                   9,667,090
Commitments and contingencies (Note 13)                                                                          --
Stockholders' equity (Notes 4 and 7):
      Common stock, no par value; 30,000,000 shares authorized; 13,969,616 shares outstanding              30,892,089
      Accumulated comprehensive income (loss)                                                                  (1,606)
      Accumulated deficit                                                                                 (23,677,411)
                                                                                                         ------------
                Total shareholders' equity                                                                  7,213,072
                                                                                                         ------------

                Total liabilities and stockholders' equity                                               $ 16,880,162
                                                                                                         ============
</TABLE>

 See accompanying notes to consolidated financial statements.



                                       19

<PAGE>   20

                     NEMATRON CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                 FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000


<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                                            ------------------------------

                                                                1999              2000
                                                            ------------      ------------

<S>                                                         <C>               <C>
Net revenues (Notes 14 and 15)                              $ 29,772,129      $ 20,420,752

Cost of revenues                                              19,991,704        15,388,939
                                                            ------------      ------------

                Gross profit                                   9,780,425         5,031,813

Operating expenses:
      Product development costs                                  794,207           672,052
      Selling, general and administrative expenses             6,471,046         6,456,709
                                                            ------------      ------------

                Total operating expenses                       7,265,253         7,128,761
                                                            ------------      ------------

                Operating income (loss)                        2,515,172        (2,096,948)

Other income (expense):
      Interest expense                                          (523,839)         (562,756)
      Sundry income (expense), net                               (25,883)          449,167
                                                            ------------      ------------

                Total other expense                             (549,722)         (113,589)
                                                            ------------      ------------

                Income (loss) before income tax benefit        1,965,450        (2,210,537)

Income tax benefit, net (Note 9)                                  43,200           293,230
                                                            ------------      ------------

                Net income (loss)                           $  2,008,650      $ (1,917,307)
                                                            ============      ============

Income (loss) per share (Note 10):
      Basic                                                 $       0.19      $      (0.15)
                                                            ============      ============
      Diluted                                               $       0.18      $      (0.15)
                                                            ============      ============

</TABLE>











 See accompanying notes to consolidated financial statements.




                                       20


<PAGE>   21
                      NEMATRON CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000

<TABLE>
<CAPTION>
                                                                                 ACCUMULATED
                                                       COMMON STOCK             COMPREHENSIVE
                                              ------------------------------       INCOME         ACCUMULATED
                                                 SHARES           AMOUNT         ADJUSTMENT         DEFICIT              TOTAL
                                              ------------     -------------    ------------     -------------       --------------

<S>                                           <C>              <C>              <C>              <C>                 <C>
 Balance, January 1, 1999                        5,353,316      $ 24,664,809    $     (7,134)    $ (23,768,754)      $      888,921
 Conversion of convertible promissory
     notes and accrued interest thereon
     to Common Stock (Note 7)                    4,092,114         1,023,029                                              1,023,029
 Private placement of Common Stock
     (Note 6)                                    3,080,000         3,020,000                                              3,020,000
 Exercise of options (Note 7)                       80,000            20,000                                                 20,000
 Comprehensive income:
     Net income for the year ended
        December 31, 1999                                                                            2,008,650            2,008,650
     Foreign currency translation
        adjustment                                                                     9,003                                  9,003
                                                                                ------------     -------------       --------------
              Total comprehensive income                                               9,003         2,008,650            2,017,653
                                              ------------     -------------    ------------     -------------       --------------
 Balance, December 31, 1999                     12,605,430      $ 28,727,838    $      1,869     $ (21,760,104)      $    6,969,603

 Shares issued in exchange for equity
     of A-OK Controls Engineering, Inc.
     (Note 4)                                      604,186         1,250,000                                              1,250,000
 Private placement of common stock
     (Note 7)                                      760,000           914,251                                                914,251
 Comprehensive income:
     Net loss for the year ended
        December 31, 2000                                                                           (1,917,307)          (1,917,307)
     Foreign currency translation
        adjustment                                                                    (3,475)                                (3,475)
                                                                                ------------     -------------       --------------
              Total comprehensive loss                                                (3,475)       (1,917,307)          (1,920,782)
                                              ------------     -------------    ------------     -------------       --------------

 Balance, December 31, 2000                     13,969,616      $ 30,892,089    $     (1,606)    $ (23,677,411)      $    7,213,072
                                              ============     =============    ============     =============       ==============


</TABLE>



See accompanying notes to consolidated financial statements.





                                       21







<PAGE>   22
                     NEMATRON CORPORATION AND SUBSIDIARIES
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 1999 AND 2000

<TABLE>
<CAPTION>
                                                                                          Year Ended December 31,
                                                                                       ----------------------------
                                                                                          1999             2000
                                                                                       -----------      -----------
<S>                                                                                    <C>              <C>
Cash flows from operating activities:
     Net income (loss)                                                                 $ 2,008,650      $(1,917,307)
     Adjustments to reconcile net income (loss) to net cash flows
         provided by operating activities:
           Depreciation                                                                  1,003,515          624,237
           Amortization                                                                  1,174,672        1,260,433
           Loss on disposal of property and equipment                                       61,094           10,400
           Gain on the sale of domain name                                                    --           (375,000)
           Deferred income tax benefit                                                     (43,200)        (291,000)
           Changes in assets and liabilities that provided (used) cash:
               Accounts receivable                                                      (3,014,128)       2,955,257
               Inventories                                                                 212,687         (284,607)
               Prepaid expenses and other current assets                                   141,415          (10,933)
               Accounts payable                                                            347,736         (183,470)
               Deferred revenue and other accrued liabilities                              908,617         (776,330)
                                                                                       -----------      -----------
                   Net cash provided by (used in) operating activities                   2,801,058        1,011,680
Cash flows from investing activities:
     Acquisition of A-OK Controls Engineering, Inc., net of cash acquired (Note 4)            --         (3,189,586)
     Additions to capitalized software development costs                                  (603,688)        (704,040)
     Additions to property and equipment                                                  (175,325)        (160,267)
     Proceeds from sale of domain name                                                        --            375,000
     Proceeds from disposals of property and equipment                                      19,316            3,255
                                                                                       -----------      -----------
                   Net cash used in investing activities                                  (759,697)      (3,675,638)
Cash flows from financing activities:
     Proceeds from issuance of common stock                                              3,020,000          914,251
     Borrowings under long-tern debt agreements                                          2,900,000        1,500,000
     Proceeds from exercise of options and warrants                                         20,000             --
     Repayments of long-term debt                                                       (3,673,544)        (607,433)
     Net borrowings (repayments) under bank line of credit                              (2,715,457)         639,204
     Repayments of trade notes payable                                                  (1,123,956)            --
     Additions to other intangible assets                                                 (227,469)         (60,545)
                                                                                       -----------      -----------
                   Net cash provided by (used in) financing activities                  (1,800,426)       2,385,477
Foreign currency translation effect on cash                                                  9,003           (3,475)
                                                                                       -----------      -----------
Net increase (decrease) in cash and cash equivalents                                       249,938         (281,956)
Cash and cash equivalents at beginning of period                                           106,730          356,668
                                                                                       -----------      -----------

Cash and cash equivalents at end of period                                             $   356,668      $    74,712
                                                                                       ===========      ===========
</TABLE>




 See accompanying notes to consolidated financial statements.

                                       22




<PAGE>   23

                     NEMATRON CORPORATION AND SUBSIDIARIES
               Consolidated Statements of Cash Flows - Continued
                 For the Years Ended December 31, 1999 and 2000

<TABLE>
<CAPTION>

                                                                                               Year Ended December 31,
                                                                                         --------------------------------
                                                                                             1999                 2000
                                                                                         -----------          -----------
<S>                                                                                      <C>                  <C>
Non-Cash Financing and Investing Activities:
     Fair value of assets acquired from A-OK Controls, including goodwill                                     $ 6,643,854
     Less liabilities assumed                                                                                  (2,204,268)
     Less common stock issued                                                                                  (1,250,000)
                                                                                                              -----------
         Net cash paid for A-OK Controls (Note 4)                                                             $ 3,189,586
                                                                                                              ===========

     Equipment acquired under a capital lease to a finance company                                            $    16,538

     Conversion of stock subscriptions to common stock                                  $ 1,500,000                  --

     Conversion of promissory notes and accrued interest
          to common stock (Note 7)                                                        1,023,029                  --

     Decrease in debt and equipment for purchase price adjustment                            46,252                  --

Supplemental Disclosures of Cash Flow Information:
     Cash paid for interest                                                                 508,885               523,230

     Cash paid for income taxes                                                                --                  16,261

</TABLE>

 See accompanying notes to consolidated financial statements.





                                       23
<PAGE>   24


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


(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 products and other third parties.


(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 year ended December 31, 2000,
         the Company incurred a loss of $1.9 million which has 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
         bank has reserved its right to take any action permitted under the bank
         credit agreement, including requiring the Company to repay all amounts
         borrowed from the bank, such amount totaling $5,953,000 at December 31,
         2000. 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 intends to complete by April 30, 2001 a convertible
         subordinated promissory note offering of not less than $1.2 million,
         with $300,000 allocated to a potential acquisition of an industrial
         automation products supplier, and $900,000 added to working capital.

         Management plans to complete a private placement of equity totaling not
         less than $2.8 million during the second quarter of 2001, and to use
         the proceeds for working capital, including paying down the bank line,
         and for the creation of strategic alliances with automation products or
         system integration companies that will enhance Company revenues and
         operating results. The placement of convertible subordinated promissory
         notes, the private placement of equity and the acquisition of an
         industrial products supplier would cure the financial position covenant
         that the Company currently violates. Furthermore, management intends to
         negotiate with its 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 $4.0 million of
         convertible subordinated promissory notes and common stock prior to
         June 30, 2001.

         Management also plans to improve the Company's financial performance in
         2001 and eventually return to profitability. Management believes that
         the Company's revenues will be increased in 2001 in response to its new
         factory representation


                                       24


<PAGE>   25

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

         sales channel approach to the marketplace that was implemented on
         January 1, 2001, by an increased emphasis on foreign-based customers,
         and by the introduction of new industrial automation hardware products
         and enhanced software products beginning in the first quarter of 2001.
         Management also believes that the Company will control its expenses
         through the full year effect of staff reductions implemented throughout
         2000, through a more efficient sales organization and 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 or wind down
         operations in an orderly manner.


(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 formed in 1999; and A-OK Controls Engineering, Inc., a
         Michigan corporation the Company acquired on June 30, 2000. The
         operations of A-OK Controls are included in these consolidated
         statements since July 1, 2000. All significant intercompany
         transactions and balances have been eliminated in consolidation.

         Cash Equivalents

         The Company considers all highly liquid debt instruments with original
         maturities of three months or less at the date of purchase to be cash
         equivalents.

         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.

                                       25


<PAGE>   26

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

         Capitalization of computer software development costs begins upon
         establishment of technological feasibility. The establishment of
         technological feasibility and the ongoing assessment of recoverability
         of capitalized computer software development costs requires
         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 continually reviews the recoverability of
         capitalized software costs based on estimated cash flows. Software
         costs are written off, as amortization expense, at the time a
         determination has been made that the amounts are not recoverable.

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

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


<TABLE>
<CAPTION>
                                                          December 31,
                                                    1999                2000
                                                    ----                ----
<S>                                              <C>                 <C>
         Balance at beginning of year            $3,880,284          $3,617,553
         Additions                                  603,688             704,040
         Amortization                              (866,419)           (951,933)
                                                 ----------          ----------

         Balance at end of year                  $3,617,553          $3,369,660
                                                 ==========          ==========
</TABLE>

         Intangible Assets

         Intangible assets, which consist primarily of acquired intangible
         assets, including goodwill, 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 are twenty years for goodwill and range from five to ten years
         for other intangible assets.

         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 intangible assets for the periods presented is as follows:

<TABLE>
<CAPTION>
                                                         December 31,
                                                  1999                 2000
                                                  ----                 ----
<S>                                              <C>                 <C>
         Balance at beginning of year            $942,158          $   861,375
         Additions                                227,470            2,659,470
         Amortization                            (308,253)            (308,500)
                                                 --------          -----------

         Balance at end of year                  $861,375          $ 3,212,345
                                                 ========          ===========
</TABLE>



                                       26
<PAGE>   27

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


         Stock Option Plan

         The Company adheres to the guidance of Statement of Financial
         Accounting Standards No. 123, Accounting for Stock-Based Compensation
         ("SFAS 123"), which requires entities to recognize as compensation
         expense, over the vesting period, the fair value of all stock-based
         awards on the date of grant. Alternatively, SFAS No. 123 also allows
         entities to continue to apply the provisions of APB Opinion No. 25
         ("APB - 25")and provide for pro forma net income (loss) and pro forma
         earnings (loss) per share disclosures for employee stock option grants
         as if the fair-value-based method defined in SFAS No. 123 had been
         applied. The Company has elected to continue to apply the provisions of
         APB - 25 and provide the pro forma disclosure provisions of SFAS No.
         123 (See Note 11).

         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
         income (loss).

         Revenue Recognition

         Revenues from hardware product sales are recognized upon delivery and
         when collection is probable. Revenues from application and other
         services and repair of computers are recognized as the services are
         performed. Revenues from software and engineering development are
         recognized as the Company performs the services, in accordance with the
         contract terms. Revenues from extended warranty agreements covering
         software are recognized ratably over the terms of the agreement with
         the customer.

         Revenues from software license agreements and from bundled products
         (hardware products pre-loaded with software covered by applicable
         license agreements) and from systems sales (bundled products
         accompanied by post sale support activities) are 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.
         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.

         Research and Development Costs

         Research and development costs are expensed when incurred. These costs,
         representing hardware and software engineering wages, fringe benefits,
         and a portion of the Company's overhead, are included in the
         accompanying consolidated statements of operations as components of
         cost of revenues and product


                                       27

<PAGE>   28


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000



         development costs. Research and development costs were $1,514,000 and
         $1,860,000 for the years ended December 31, 1999 and 2000,
         respectively.

         Warranty Costs

         The Company provides for estimated warranty costs as products are
         shipped. Estimated warranty reserves are adjusted currently based upon
         projected levels of warranty repairs and estimated costs of materials,
         labor, and overhead costs to be incurred in meeting warranty
         obligations.

         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.

         Income (Loss) Per Share

         Income (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 year ended December 31, 2000, 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 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, obsolete and slow moving inventory, capitalized
         software and related development costs, intangible assets, warranty
         costs, returns and allowances, and deferred tax assets and liabilities.



                                       28
<PAGE>   29
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000



(4)      ACQUISITIONS

         Acquisition of A-OK Controls Engineering, Inc.

         On June 30, 2000, the Company completed its acquisition of A-OK
         Controls Engineering, Inc., an Auburn Hills, Michigan-based provider of
         automation controls engineering and systems integration services. The
         Company recorded this transaction using the purchase method of
         accounting.

         The purchase price was approximately $4,538,000, including expenses of
         approximately $186,000. Under the terms of the Stock Purchase
         Agreement, the Company issued 604,186 shares of its Common Stock to the
         former A-OK Controls shareholder in exchange for 100% of the
         outstanding equity of A-OK Controls. Additionally, the Company paid the
         former shareholder of A-OK Controls $2,750,000 cash and agreed to pay
         the remaining amount of $352,000 after December 31, 2000. A-OK Controls
         conducts its operations as a wholly owned subsidiary of the Company. In
         connection with the Stock Purchase Agreement, the Company also entered
         into a three-year employment agreement and a five-year agreement not to
         compete with A-OK Controls' former shareholder.

         The allocation of the total purchase price to assets acquired and
         liabilities assumed as of the June 30, 2000 acquisition date, are as
         follows:

<TABLE>
<S>                                                                        <C>
              Cash                                                         $   42,000
              Other current assets                                          3,490,000
              Equipment                                                       611,000
              Intangible assets, including goodwill                         2,599,000
              Current notes payable                                        (1,420,000)
              Other current liabilities                                      (675,000)
              Long-term debt                                                 (109,000)
                                                                           ----------

              Total purchase price                                         $4,538,000
                                                                           ==========
</TABLE>

         The following unaudited pro forma information presents a summary of
         consolidated results of operations for the years ended December 31,
         1999 and 2000 of the Company and A-OK Controls as if the acquisition
         had occurred as of the beginning of 1999, with pro forma adjustments to
         give effect to amortization of intangible assets, additional interest
         expense on funds borrowed for the A-OK Controls acquisition,
         differences in actual versus contractual compensation, and utilization
         of the Company's net operating loss carry-forwards.

<TABLE>
<CAPTION>
                                                                   December 31,
                                                             1999               2000
                                                             ----               ----
<S>                                                      <C>              <C>
              Net revenues                               $40,406,000      $25,420,000
              Net income (loss)                            2,402,000       (2,219,000)
              Net income (loss) per share:
                Basic                                          $0.21           ($0.16)
                Diluted                                        $0.20           ($0.16)

</TABLE>



                                       29
<PAGE>   30

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000



         Other

         On December 21, 2000, the Company was informed by an entity that had
         signed a merger agreement in November 2000, that such entity would not
         proceed with the merger of that entity into the Company. Consequently,
         the Company recorded expenses of approximately $120,000 in connection
         with the termination of the Merger Agreement.


(5)      INVENTORIES

         Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                                                          December 31,
                                                                              2000
                                                                           ----------
<S>                                                                        <C>
              Purchased parts and accessories                              $1,544,890
              Work in process                                                 105,742
              Finished goods and service stock                                305,623
                                                                           ----------

                        Total inventories                                  $1,956,255
                                                                           ==========
</TABLE>


(6)      NOTE PAYABLE TO BANK UNDER LINE OF CREDIT FACILITY

         The Company and its subsidiary, A-OK Controls, are parties to two loan
         and security agreements (the "Agreements") with a bank. The Agreements
         provide for a total of $9.0 million in two lines of credit, a $2.9
         million term loan and a $1.5 million special accommodation advance for
         the purpose of the Company's acquisition of A-OK Controls. The
         Agreement provide for credit facilities through November 2002, 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
         7 for additional information concerning 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 the sum of
         specified percentages of eligible accounts receivable, less the amount,
         if any, of outstanding letters of credit issued by the Company. Based
         upon such borrowing formula, approximately $727,000 of the available
         line is eligible for advance at December 31, 2000. Amounts borrowed
         under the line of credit facility total $2,059,318 at December 31,
         2000, and such borrowings bear interest at the prime rate plus 1.5%
         (11.0 % effective rate at December 31, 2000). The line of credit and
         the term loans (see Note 8) are collateralized by substantially all
         assets of the Company and a mortgage on the Company's Ann Arbor
         facility.


(7)      CONVERTIBLE PROMISSORY NOTES PAYABLE AND COMMON STOCK

         In December 1998, the Company issued convertible promissory notes (the
         "Notes") in the aggregate principal amount of $1 million with investors
         (collectively, the "Note Holders") pursuant to a private placement as
         the first stage of a capital



                                       30


<PAGE>   31


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


         transaction. During 1999, Noteholders converted $1,023,029 of the Notes
         and accrued interest thereon into 4,092,114 shares of Common Stock.

         On April 6, 1999 the Company's shareholders approved the issuance of
         shares pursuant to the two stage capital transaction. Stage one
         included the issuance of $1,000,000 of Notes, as described above, and
         stage two included the exercise of options included in such Notes and
         the private placement of additional shares of Common Stock. On April 7,
         1999 the Company completed the second stage of the capital transaction
         and issued a total of 3,080,000 shares of Common Stock at $1.00 per
         share upon the exercise of the options and the private placement. The
         Company recorded the second stage of the transaction net of $60,000 of
         costs associated with the private placement.

         On April 6, 1999, the Company's shareholders also approved an amendment
         to the Company's Articles of Incorporation to increase the number of
         authorized shares of Common Stock from 15,000,000 to 30,000,000.

         In December 2000, the Company issued 760,000 shares of Common Stock
         pursuant to a private placement to accredited investors, including
         three members of the Board of Directors who collectively purchased
         735,000 of the total shares issued. Net proceeds after expenses
         associated with the issuance totaled $914,251.


(8)      LONG-TERM DEBT

         Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                               December 31,
                                                                                                   2000
                                                                                                -----------
<S>                                                                                             <C>
         Term loan payable to a bank, interest at prime plus 1.5% per annum (11.0% effective
         rate at December 31, 2000), payable in monthly installments of $16,111 through
         November 2002, at which time the remaining principal and any interest thereon is due.
         The term loan is collateralized by substantially all assets of the Company and a
         mortgage on the Ann Arbor facility.                                                    $ 2,706,667
         Term loan payable to a bank, interest at prime plus 3.0% per annum (12.5% effective
         rate at December 31, 2000), payable in monthly installments of $62,500 through August
         2002, at which time the remaining principal and any interest thereon is due. The term
         loan is collateralized by substantially all assets of the Company and a mortgage on
         the Ann Arbor facility.                                                                  1,187,500
         Other notes payable                                                                         59,741
                                                                                                -----------

         Total long-term debt                                                                     3,953,908
         Less current maturities                                                                 (3,953,908)
                                                                                                -----------

         Total long-term debt, less current maturities                                          $       -0-
                                                                                                ===========
</TABLE>

         The Agreements, under which the Company has the line of credit (see
         Note 6) and the term loans, contain several financial covenants,
         including specified levels of tangible net worth, interest coverage and
         debt service coverage. The terms of the


                                       31

<PAGE>   32

                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


         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 these covenants as of
         December 31, 2000, the bank has issued a forbearance letter to the
         Company concerning these covenant violations. However, 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 concerning revising
         the Agreements and management is pursuing other solutions to the
         violations. The Company has classified all debt as a current liability.


(9)      TAXES ON INCOME

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


<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                                          1999              2000
                                                                          ----              ----

<S>                                                                       <C>              <C>
         Income tax expense (benefit) based on the federal
           statutory rate                                                  34.0 %           (34.0)%
         Generation (utilization) of net operating loss
           carryforwards                                                  (34.0)%            34.0 %
         Effect of impairment, amortization of intangible assets
           and alternative minimum tax                                     (8.3)%           (13.3)%
                                                                          -----             -----

         Effective tax rate                                                (8.3)%           (13.3)%
                                                                          =====             =====
</TABLE>

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

<TABLE>
<CAPTION>
                                                                          Year Ended December 31,
                                                                          -----------------------
                                                                           1999           2000
                                                                           ----           ----
<S>                                                                    <C>            <C>
         Domestic income (loss) before taxes on income                 $2,156,308     $(2,003,264)
         Foreign loss before taxes on income                             (190,858)       (207,273)
                                                                       ----------     -----------

         Total income (loss) before tax benefit                        $1,965,450     $(2,210,537)
                                                                       ==========     ===========
</TABLE>

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

         Temporary differences and net operating loss carryforwards, which give
         rise to the net deferred tax position, are as follows:




                                       32

<PAGE>   33


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

<TABLE>
<CAPTION>

                                                                                            December 31,
                                                                                                2000
                                                                                             ----------
<S>                                                                                          <C>
             Deferred tax assets:
                 Inventory valuation allowance                                              $   371,000
                 Accounts receivable allowance for doubtful accounts                             26,000
                 Property and equipment, principally depreciation                               216,000
                 Accrued expenses deductible when paid                                          108,000
                 Net operating loss carryforward                                              6,880,000
                                                                                            -----------
                      Total deferred tax assets                                               7,601,000
             Deferred tax liabilities - capitalized software development costs and
             other intangible assets                                                         (1,329,000)
                                                                                            -----------
                      Net deferred tax assets                                                 6,272,000
             Less valuation allowance against deferred tax assets                            (6,272,000)
                                                                                            -----------

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

         The valuation allowance against net deferred tax assets increased
         (decreased) by $(687,000) and $541,000 during the years ended December
         31, 1999 and 2000, respectively.

         At December 31, 2000, the Company has net operating loss carryforwards
         of approximately $20,200,000, which expire at various dates between
         2004 and 2020. Utilization 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 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)     EARNINGS PER SHARE

         Income (loss) per share ("EPS") is as follows:

<TABLE>
<CAPTION>
                                                                Income                             Income
                                                                 (Loss)            Shares          (Loss)
                                                              (Numerator)       (Denominator)    Per Share
                                                              -----------       -------------    ---------
<S>                                                           <C>                <C>               <C>
             Year ended December 31, 1999:
                Basic EPS:
                   Net income                                 $2,008,650         10,753,844        $0.19
                   Effect of dilutive securities:
                       Options                                    24,946            567,668        (0.01)
                                                              ----------         ----------        -----
                Diluted EPS:
                   Income available to common
                   shareholders plus assumed conversion       $2,033,596         11,321,512        $0.18
                                                              ==========         ==========        =====
</TABLE>

                                       33
<PAGE>   34


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


<TABLE>
<CAPTION>

                                                              Income                             Income
                                                              (Loss)            Shares           (Loss)
                                                           (Numerator)       (Denominator)     Per Share
                                                           -----------       -------------     ---------
<S>                                                           <C>                <C>               <C>
             Year ended December 31, 2000:
                Basic EPS:
                   Net loss                                $(1,917,307)         12,921,207        $(0.15)
                   Effect of dilutive securities                    -                   -             -
                                                           -----------          ----------        ------
                Diluted EPS:
                   Income available to common
                   shareholders plus assumed conversion    $(1,917,307)         12,921,207        $(0.15)
                                                           ===========          ==========        ======
</TABLE>

         For the year ended December 31, 1999, 799,037 options and 322,676
         warrants were outstanding but were not included in the computation of
         diluted earnings per share because the exercise prices of the excluded
         options and warrants were greater than the average market price of the
         common shares during the period. The options expire on various dates
         between 2003 and 2009, and the warrants expire between February 2000
         and October 2002.

         For the year ended December 31, 2000, 2,203,156 options and 197,678
         warrants were outstanding but were not included in the computation of
         diluted loss per share because the inclusion of such securities is
         antidilutive. The options expire on various dates between 2003 and
         2010, and the warrants expire in October 2002.


(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 one-third immediately and one-third on each successive anniversary
         date of the award, or are exercisable 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 26, 2003. As of December 31, 2000, awards to purchase an
         additional 69,003 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 be made by the



                                       34

<PAGE>   35


                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

         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, 2000,
         awards to purchase 891,200 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, 2000, an
         additional 10,844 options may be issued under the Directors Option
         Plan.

         Special Option Grants

         The Board of Directors has from time to time awarded special option
         grants to certain officers, key employees and others. The awards have
         been made separate from the plans described above.



                                       35

<PAGE>   36
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

         Information with respect to options under the plans and the special
         awards for the years ended December 31, 1999 and 2000, is as follows:


<TABLE>
<CAPTION>
                                        Outstanding                 Exercisable
                                ----------------------------   -------------------------
                                                 Weighted                      Weighted        Number
                                   Number         Average         Number        Average       Available
                                Outstanding   Exercise Price   Exercisable     Exercise       For Grant
                                -----------   --------------   -----------     --------       ---------
<S>                             <C>           <C>              <C>             <C>            <C>
      Balance January 1,
      1999                       1,428,894           $2.39        899,917          $2.00       225,309
      Adoption of Long-Term
      Incentive Plan                                                                         1,250,000
      Granted                    1,143,435           $2.35                                    (783,435)
      Exercisable                                                 473,396          $2.29
      Exercised                    (80,000)          $0.25        (80,000)         $0.25
      Forfeited                   (564,673)          $3.44       (161,140)         $3.44       564,673
                                ----------                      ---------                    ---------
      Balance, December 31,
      1999                       1,927,656           $2.18      1,132,173          $1.76     1,256,547
      Granted                      483,400           $2.09                                    (483,400)
      Exercisable                                                 276,681          $2.65
      Exercised                        -
      Forfeited                   (207,900)          $2.07         (4,300)         $2.50       207,900
                                ----------                      ---------                    ---------
      Balance, December 31,
      2000                       2,203,156           $2.14      1,404,554          $1.99       981,047
                                ==========                      =========                    =========

</TABLE>

 Information concerning outstanding options at December 31, 2000 is as follows:

<TABLE>
<CAPTION>
                                            Options Outstanding                Options Exercisable
                                -----------------------------------------    -------------------------
                                                 Weighted
                                 Number of        Average        Weighted      Number of      Weighted
                                  Options        Remaining       Average        Options       Average
      Range of Exercise         Outstanding    Contractual       Exercise     Exercisable     Exercise
         Prices                 at 12-31-00        Life           Price       at 12-31-00      Price
         ------                 -----------        ----           -----       -----------      -----
<S>                             <C>            <C>               <C>          <C>             <C>
      $0.75 to $1.94                800,000       7.23 years        $0.85        740,000        $0.78
      $2.00 to $2.75              1,253,750       8.69 years        $2.49        533,481        $2.57
      $3.00 to $5.50                 69,406       6.95 years        $4.57         51,073        $4.89
      $6.75 to $8.75                 80,000       6.19 years        $7.45         80,000        $7.45
                                -----------                                  -----------

      Total                       2,203,156       8.02 years        $2.14      1,404,554        $1.99
                                ===========                                  ===========
</TABLE>

         The Company applies APB - 25 in accounting for its stock option plans.
         Accordingly, no compensation cost has been recognized in the Company's
         financial statements. Had compensation cost been determined based on
         the fair value of such awards at the date of grant consistent with the
         provisions of SFAS No. 123, the Company's total and per share net
         income (loss) would have been as follows:




                                       36
<PAGE>   37
                      NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


<TABLE>
<CAPTION>

                                                                                 Year Ended December 31,
                                                                                 -----------------------
                                                                               1999                 2000
                                                                               ----                 ----
<S>                                                                        <C>                 <C>
       Net income (loss):
            As reported                                                    $2,008,650          $(1,917,307)
            Pro forma                                                      $1,062,196          $(2,249,320)
       Net income (loss) per share:
            As reported                                                         $0.19               $(0.15)
            Pro forma                                                           $0.10               $(0.17)
</TABLE>

       The fair values of options granted during periods presented were
       determined using the Black-Scholes option-pricing model based on the
       following assumptions:

<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                                                -----------------------
                                                                               1999                 2000
                                                                               ----                 ----
<S>                                                                        <C>                 <C>
       Risk-free interest rate                                                  6.17%                6.64%
       Dividend yield                                                           0.00%                0.00%
       Expected life                                                     3 to 6 years         3 to 6 years
       Expected volatility                                                    111.59%              106.16%
</TABLE>

       The weighted average fair values of options granted during 1999 and 2000
       were $2.58 and $1.82, respectively.

       401(k) Plan and Trust

       The Company has established a defined-contribution retirement plans 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.

       Under terms of the 401(k) plan in effect at Nematron, the Company may
       make a basic matching contribution and a discretionary contribution to
       the 401(k) plan. The Company matching contribution is 100% of a specified
       percentage of each employee's contribution limited to the first 5% of the
       employee's base salary. Company matching contributions were -0-% from
       January to May 1999, 2% from June 1999 to March 2000 and 3% from April
       2000 to December 2000. 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 one year of service. 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 A-OK Controls, the Company
       may make a basic matching contribution and a discretionary contribution
       to the 401(k) plan. The Company matching contribution is 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 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.
       The participant will be fully vested in the Company's contributions in
       the event of his or her death, disability or normal retirement.


                                       37

<PAGE>   38

                    NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000

       The Company's contributions to both of its 401(k) plans were $31,000 and
       $171,000 for the years ended December 31, 1999, and 2000, respectively.


(12)   WARRANTS

       The Company has issued warrants for the purchase of its common stock. The
       warrants were issued in connection with issuing subordinated debt in 1995
       and the acquisition of Intec Controls Corp. in 1997. Information with
       respect to such warrants is as follows:

<TABLE>
<CAPTION>
                                                          Subordinated         Intec
                                                               Debt         Acquisition         Total
                                                          ------------      -----------         -----
<S>                                                           <C>           <C>                 <C>
       Issue date                                             11-07-95        03-20-97
       Exercise price                                            $4.00           $6.73
       Expiration date                                        10-31-02        02-20-00

       Balance, January 1, 1998                                197,678         124,998         322,676
       Exercised in 1999                                           -               -               -
       Expired in 1999                                             -               -               -
                                                              --------       ---------         -------
       Balance, December 31, 1999                              197,678         124,998         322,676
       Exercised in 2000                                           -               -               -
       Expired in 2000                                             -          (124,998)       (124,998)
                                                              --------       ---------         -------
       Balance, December 31, 2000                              197,678             -0-         197,678
                                                              ========       =========         =======
</TABLE>

(13)   COMMITMENTS AND CONTINGENCIES

       The Company leases under operating leases its Auburn Hills and Saginaw,
       Michigan system integration facilities from the president of A-OK
       Controls, and leases its Lansing, Michigan, Foxboro, Massachusetts and
       United Kingdom facilities, as well as certain office equipment, from
       other 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,
       2000, is as follows:

<TABLE>
<CAPTION>
                                                 Related Party      Third Party Leases         Total
                                                 -------------      ------------------         -----
       Year ending December 31,
<S>               <C>                                  <C>                  <C>               <C>
                  2001                                 $397,800             $196,434          $594,234
                  2002                                  397,800              185,369           583,169
                  2003                                  397,800               96,258           494,058
                  2004                                  397,800               34,491           432,291
                  2005                                  397,800               34,491           432,291
       Thereafter                                     1,016,550              103,472         1,120,022
                                                     ----------            ---------       -----------
       Total minimum lease obligations               $3,005,550            $ 650,515       $ 3,656,065
                                                     ==========            =========       ===========
</TABLE>

       Total rental expense was $75,000 and $355,000 for the years ended
       December 31, 1999 and 2000, respectively.



                                       38

<PAGE>   39


                    NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000



(14)   SEGMENT INFORMATION

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

<TABLE>
<CAPTION>
                                                                               Year Ended December 31,
                                                                               -----------------------
                                                                                1999              2000
                                                                                ----              ----
<S>                                                                           <C>             <C>
             Foreign:
                 France                                                      $ 1,899,142       $ 1,525,060
                 Germany                                                       7,892,954         1,830,439
                 Other countries                                               2,206,728         1,983,720
                                                                             -----------       -----------
                        Total foreign revenue                                 11,998,824         5,339,219
             United States                                                    17,773,305        15,081,533
                                                                             -----------       -----------

             Total revenue                                                   $29,772,129       $20,420,752
                                                                             ===========       ===========
</TABLE>

       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 is as
       follows:

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                                  2000
                                                                                              ------------
<S>                                                                                            <C>
             Foreign countries                                                                 $   52,567
             United States                                                                      8,917,468
                                                                                               ----------

             Total                                                                             $8,970,035
                                                                                               ==========
</TABLE>


(15)   SIGNIFICANT CUSTOMERS

       The Company conducts its business through distributors, end users and
       other entities under purchase orders, supply contracts and other
       agreements. Information with respect to significant customers is as
       follows:

<TABLE>
<CAPTION>

                                                                                               Accounts
                                                                             Revenues         Receivable
                                                                               From               From
                                                           Number of        Customer(s)      Customer(s)at
                                                          Significant       During the           End of
                                                           Customers            Year              Year
                                                           ---------        -----------      --------------
<S>                                                        <C>              <C>               <C>
             Year ended December 31, 1999                     One           $8,931,000         $  748,000
             Year ended December 31, 2000                     Two           $7,230,000         $1,749,000
</TABLE>

       The Company derived approximately $13,200,000 and $4,000,000, of revenues
       under a supply agreement from a company in the automotive industry for
       the years ended December 31, 1999 and 2000, respectively. These revenues
       were derived from sales to certain machine tool builders and
       distributors, including certain significant customers included in the
       table above, that purchased Nematron products that the automotive company
       had specified for a major program.




                                       39
<PAGE>   40

                    NEMATRON CORPORATION AND SUBSIDIARIES
                   Notes to Consolidated Financial Statements
                           December 31, 1999 and 2000


                                   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 21, 2001
         ----------------------------------------                 --------------
         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.

<TABLE>
<CAPTION>

          Signature                                  Title                              Date
<S>                                  <C>                                           <C>
  /s/ Matthew S. Galvez              President, CEO and a Director                 March 21, 2001
-----------------------------------  (Principal Executive and Financial Officer)   --------------
Matthew S. Galvez

  /s/ David P. Gienapp               Vice President - Finance and Administration   March 21, 2001
-----------------------------------  (Principal Accounting Officer) and Secretary  --------------
David P. Gienapp

  /s/ Hugo E. Braun                  Director                                      March 21, 2001
-----------------------------------                                                --------------
Hugo E. Braun

  /s/ Joseph J. Fitzsimmons          Chairman of the Board and a Director          March 21, 2001
-----------------------------------                                                --------------
Joseph J. Fitzsimmons

  /s/ Garnel F. Graber               Director                                      March 21, 2001
-----------------------------------                                                --------------
Garnel F. Graber

  /s/ Stephen E. Globus              Director                                      March 21, 2001
-----------------------------------                                                --------------
Stephen E. Globus

  /s/ James A. Nichols               Director                                      March 21, 2001
-----------------------------------                                                --------------
James A. Nichols

  /s/ James H. Wicker                Director                                      March 21, 2001
-----------------------------------                                                --------------
James H. Wicker
</TABLE>

                                       40
<PAGE>   41


                      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, filed as Exhibit 2.1 to
              the Registrant's Form 10-QSB for the quarterly period ended June
              30, 2000 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          Term Loan and Warrant Purchase Agreement dated as of November 7,
              1995 between the Registrant and Onset BIDCO, The Capital Fund,
              Joseph Krinski Trust U/A Dated 6/20/91, Emily Krinski Trust U/A
              Dated 6/20/91, and Urban A. MacDonald filed as Exhibit 4.04 to the
              Registrant's Form S-2 Registration Statement dated June 6, 1996
              and incorporated herein by reference.
4.04          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.
4.05          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.
4.06          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
10.01*        Nematron Corporation 1993 Stock Option Plan, as amended and
              restated March 1997, filed as Exhibit 10.1 to the Registrant's
              Form 10-QSB for the quarterly period ended March 31, 1997 and
              incorporated herein by reference.
10.02*        Nematron Corporation 1993 Directors Option Plan, as amended and
              restated, filed as Exhibit 10.2 to the Registrant's Form 10-QSB
              for the quarterly period ended March 31, 1997 and incorporated
              herein by reference
10.03*        Nematron 401(k) Plan, filed as Exhibit 10.04 to the Registrant's
              Form 10-KSB for the year ended September 30, 1995 and incorporated
              herein by reference
10.04*        Nematron Corporation Long-Term Incentive Plan, filed as Exhibit
              10.03 to the Registrant's Form 10-QSB for the quarterly period
              ended March 31, 1999 and incorporated herein by reference.
10.05*        Employment Agreement entered into effective October 1, 1998 and
              dated July 26, 1999 by and between Matthew S. Galvez and the
              Registrant, filed as Exhibit 10.01 to the Registrant's Form 10-QSB
              for the quarterly period ended June 30, 1999 and incorporated
              herein by reference.
10.06*        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.
10.07*        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.
10.08*        Nonqualified Stock Option Agreement dated December 13, 1999
              between Matthew S. Galvez and the Registrant, filed as Exhibit
              10.08 to the Registrant's Form 10-KSB for the year ended December
              31, 1999 and incorporated herein by reference.
10.10         Registration Rights Agreement by and between Ronald C. Causley,
              Trustee of Ronald C. Causley Revocable Trust dated March 14, 1990,
              as amended and Nematron Corporation, filed as Exhibit 4.1 to the
              Registrant's Form 8-K filed July 14, 2000 and incorporated herein
              by reference.
21.01         Subsidiaries of Nematron Corporation.
23.01         Consent of Grant Thornton LLP.

* Management compensatory plan or arrangement.

                                     # # #


                                       41

<PAGE>   42


                                   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.






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