Norstan (NRRD) 10-Q 2002 Q3 Quarterly report

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

FORM 10-Q

     (Mark One)

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

FOR THE PERIOD ENDED JANUARY 26, 2002

OR

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

For the transition period from                     to

Commission File Number 0-8141

NORSTAN, INC.
(Exact name of registrant as specified in its charter)

Minnesota	41-0835746
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

5101 Shady Oak Road, Minnetonka, Minnesota 55343-4100

(address of principal executive offices)

Telephone (952) 352-4000 Fax (952) 352-4949 Internet www.norstan.com

(Registrant’s telephone number, facsimile number, Internet address)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes .    No .

On March 4, 2002, there were 12,341,534 shares outstanding of the registrant’s common stock, par value $0.10 per share, its only class of equity securities.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
ITEM 1.

NORSTAN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED

(In thousands, except per share amounts)					Three Months Ended						Nine Months Ended
					January 26,			January 27,			January 26,			January 27,
					2002			2001			2002			2001
REVENUES
Communications Technology:
	Solutions and Services				$	53,811		$	54,472		$	158,355		$	177,673
	Resale					7,672			6,227			22,758			19,823
Network Services						4,768			7,085			16,332			22,065
Financial Services						1,084			2,458			4,341			6,885
				Total Revenues		67,335			70,242			201,786			226,446
COST OF SALES
Communications Technology:
	Solutions and Services					39,510			40,496			113,280			134,799
	Resale					5,018			4,089			14,472			12,219
Network Services						3,200			5,189			11,639			16,659
Financial Services						133			922			871			2,087
				Total Cost of Sales		47,861			50,696			140,262			165,764
GROSS MARGIN
Communications Technology:
	Solutions and Services					14,301			13,976			45,075			42,874
	Resale					2,654			2,138			8,286			7,604
Network Services						1,568			1,896			4,693			5,406
Financial Services						951			1,536			3,470			4,798
			Total Gross Margin			19,474			19,546			61,524			60,682
		Selling, General & Administrative Expenses				18,460			23,176			57,803			68,592
OPERATING INCOME (LOSS)						1,014			(3,630	)		3,721			(7,910	)
		Interest Expense				(1,127	)		(2,084	)		(3,823	)		(6,279	)
		Other Income (Expense), Net				273			(5	)		750			(1,032	)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES						160			(5,719	)		648			(15,221	)
		Income Tax (Benefit) Provision				—			—			—			—
INCOME (LOSS) FROM CONTINUING OPERATIONS						160			(5,719	)		648			(15,221	)
DISCONTINUED OPERATIONS:
		Loss from operations of discontinued segment				—			(2,585	)		—			(8,354	)
NET INCOME (LOSS)					$	160		$	(8,304	)	$	648		$	(23,575	)
NET INCOME (LOSS) PER SHARE — (BASIC & DILUTED)
	CONTINUING OPERATIONS				$	0.01		$	(0.50	)	$	0.05		$	(1.36	)
	DISCONTINUED OPERATIONS					—			(0.23	)		—			(0.74	)
EARNINGS PER SHARE					$	0.01		$	(0.73	)	$	0.05		$	(2.10	)
WEIGHTED AVERAGE SHARES -
	BASIC					12,055			11,425			12,024			11,222
	DILUTED					12,769			11,425			12,633			11,222

The accompanying notes are an integral part of these consolidated financial statements.

1

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

			January 26,			April 30,
			2002			2001
			(Unaudited)			(Audited)
ASSETS
CURRENT ASSETS
	Cash		$	3,039		$	2,434
	Accounts receivable, net of allowances for doubtful accounts of$1,537and$3,343			45,627			37,592
	Lease receivables			13,539			25,292
	Inventories			4,532			6,197
	Costs and estimated earnings in excess of billings of$9,704and$4,583			4,894			8,231
	Prepaid expenses, deposits and other			6,894			5,594
	Net current assets of discontinued operations			2,833			320
		TOTAL CURRENT ASSETS		81,358			85,660
PROPERTY AND EQUIPMENT
	Furniture, fixtures and equipment			98,002			96,146
	Less-accumulated depreciation and amortization			(74,924	)		(66,492	)
		NET PROPERTY AND EQUIPMENT		23,078			29,654
OTHER ASSETS
	Lease receivables, net of current portion			18,308			30,635
	Goodwill, net of accumulated amortization of$6,380			3,857			3,896
	Deferred income taxes			12,246			12,039
	Net non-current assets of discontinued operations			4,318			7,549
	Other			202			406
		TOTAL OTHER ASSETS		38,931			54,525
TOTAL ASSETS			$	143,367		$	169,839

The accompanying notes are an integral part of these consolidated balance sheets.

2

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

				January 26,			April 30,
				2002			2001
				(Unaudited)			(Audited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
	Current maturities of long-term debt			$	42,612		$	21,015
	Current maturities of discounted lease rentals				9,527			13,242
	Accounts payable				22,913			31,219
	Deferred revenue				24,032			22,105
	Accrued -
		Salaries and wages			8,559			5,669
		Warranty costs			1,521			2,042
		Other liabilities			8,038			6,434
	Billings in excess of costs and estimated earnings of$23,415 and$11,812				8,989			8,276
			TOTAL CURRENT LIABILITIES		126,191			110,002
LONG-TERM DEBT, net of current maturities					55			38,200
DISCOUNTED LEASE RENTALS, net of current maturities					7,557			13,552
SHAREHOLDERS’ EQUITY
	Common stock — $.10 par value; 40,000,000 authorized shares;12,378,101and12,220,907shares issued and outstanding				1,238			1,222
	Capital in excess of par value				55,769			55,298
	Accumulated deficit				(44,303	)		(44,952	)
	Unamortized cost of stock				(880	)		(1,438	)
	Accumulated other comprehensive loss				(2,260	)		(2,045	)
			TOTAL SHAREHOLDERS’ EQUITY		9,564			8,085
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY				$	143,367		$	169,839

The accompanying notes are an integral part of these consolidated balance sheets.

3

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

UNAUDITED

(In thousands)

				Nine Months Ended
				January 26,			January 27,
				2002			2001
OPERATING ACTIVITIES
	Net income (loss) from continuing operations			$	648		$	(15,221	)
	Adjustments to reconcile net income (loss) from continuing operations to net cash provided by continuing operations:
		Restructuring costs paid			(974	)		—
		Depreciation and amortization			11,078			14,129
		Deferred income taxes			(316	)		1,025
		Changes in operating items:
			Accounts receivable		(6,675	)		15,105
			Inventories		1,641			4,622
			Costs and estimated earnings in excess of billings		3,320			4,543
			Prepaid expenses, deposits and other		(1,301	)		(2,999	)
			Accounts payable		(8,243	)		5,048
			Deferred revenue		2,007			2,577
			Accrued liabilities		4,971			22
			Billings in excess of costs and estimated earnings		729			(5,530	)
		Net cash provided by operating activities			6,885			23,321
INVESTING ACTIVITIES
	Additions to property and equipment, net				(3,665	)		(8,326	)
	Investment in lease contracts				(2,719	)		(23,018	)
	Proceeds from lease contracts				18,773			24,731
	Other, net				(101	)		(287	)
		Net cash provided by (used for) investing activities			12,288			(6,900	)
FINANCING ACTIVITIES
	Proceeds from the sale of leases				6,429			—
	Borrowings on long-term debt				236,492			155,277
	Repayments of long-term debt				(253,032	)		(152,425	)
	Borrowings on discounted lease rentals				—			3,981
	Repayments of discounted lease rentals				(9,630	)		(15,615	)
	Proceeds from sale of common stock				487			1,072
		Net cash used for financing activities			(19,254	)		(7,710	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH					(32	)		7
NET CASH FLOW FROM CONTINUING OPERATIONS					(113	)		8,718
NET CASH FLOW FROM DISCONTINUED OPERATIONS					718			(7,914	)
CASH, BEGINNING OF PERIOD					2,434			(18	)
CASH, END OF PERIOD				$	3,039		$	786

The accompanying notes are an integral part of these consolidated financial statements.

4

NORSTAN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JANUARY 26, 2002

UNAUDITED

     The information furnished in this report is unaudited and reflects normal recurring adjustments and such other adjustments which, in the opinion of management, are necessary to present fairly the operating results for the interim periods. The operating results for the interim periods presented are not necessarily indicative of the operating results to be expected for the full fiscal year. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended April 30, 2001.

PRINCIPLES OF CONSOLIDATION

     The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

DISCONTINUED OPERATIONS

     During fiscal 2001, the Company divested its IT consulting business in order to focus on its core competencies of providing communications technology services and solutions to channel partners and select enterprise customers. The Company’s inability to realize synergies between its communications and IT consulting businesses and recurring losses generated by the consulting business contributed to the Company’s decision to divest itself of this non-strategic business segment.

     The Company’s divestiture of its IT consulting business began on February 7, 2001 with the sale of the Company’s 75 percent interest in Connaissance Consulting to Connaissance’s founder. Terms of the sale included a payment of $3.0 million in cash at closing and delivery of promissory notes drawn in favor of the Company with an aggregate face amount of $13.0 million maturing on various dates, commencing on April 30, 2001 and ending December 31, 2005.

     The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former President and the Company’s former Vice Chairman. Terms of the sale included a payment of $500,000 in cash at closing and delivery of a promissory note drawn in favor of the Company in the face amount of $1.5 million which matured in September, 2001 and remains partially unpaid. The promissory note is secured by certain assets of the business. In January 2002, the former Norstan Consulting business ceased operations. The Company then took possession of the remaining receivables associated with this business in order to satisfy the $1.5 million promissory note. Through January 26, 2002, approximately $884,000 has been collected. The Company continues to pursue its collection efforts related to the outstanding note balance and believes the ultimate expense to the Company of any uncollected amounts will not be significant.

5

     The results of operations of these two business units have historically been reported as the Company’s “Consulting” business segment. Pursuant to the sale transactions described above, the Consulting business segment’s results of operations are reported as discontinued operations at April 30, 2001 and for future periods. The Company’s consolidated financial statements have been restated to report separately the net assets and operating results of the discontinued businesses for all periods presented.

Net assets of discontinued operations include the following (in thousands):

			As of
			January 26,			April 30,
			2002			2001
Assets:
	Cash, accounts receivable and inventories		$	—		$	500
	Notes receivable, prepaids and other assets			8,192			10,809
Liabilities:
	Accounts payable			—			(652	)
	Accrued -
		Salaries & wages		—			(1,367	)
		Future lease obligations		(1,041	)		(1,000	)
		Other liabilities		—			(421	)
Net assets of discontinued operations				7,151			7,869
Less: Current portion				(2,833	)		(320	)
			$	4,318		$	7,549

Summary operating results of the discontinued operations are as follows (in thousands):

	For the periods ended
	January 27, 2001
	Three			Nine
	Months			Months
Revenues	$	8,837		$	32,276
Cost of sales		7,240			24,130
Gross margin		1,597			8,146
Sales, general and administrative expenses		4,206			16,365
Operating loss		(2,609	)		(8,219	)
Other income (expense), net		24			(135	)
Net loss from discontinued operations	$	(2,585	)	$	(8,354	)

FOREIGN CURRENCY

     For the Company’s foreign operations, assets and liabilities are translated at exchange rates as of the balance sheet date, and revenues and expenses are translated at average exchange rates prevailing during the period. Translation adjustments are recorded as a separate component of shareholders’ equity.

6

SUPPLEMENTAL CASH FLOW INFORMATION

     Supplemental disclosure of cash flow information is as follows (in thousands):

		Nine Months Ended
		January 26,		January 27,
		2002		2001
Cash paid for:
	Interest	$	4,651	$	8,979
	Income taxes	$	177	$	128

RECENTLY ISSUED ACCOUNTING STANDARDS

     Statement of Financial Accounting Standards No. 133 (SFAS No. 133), “Accounting for Derivative Instruments and Hedging Activities”, was issued in June 1998 and amended by SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities — Deferral of the Effective Date of SFAS No. 133” to require adoption at the beginning of the Company’s fiscal year ending April 30, 2002. The standard requires every derivative to be recorded on the balance sheet as either an asset or liability measured at fair value with changes in the derivative’s fair value recognized in earnings unless specific hedge accounting criteria are satisfied. The Company’s adoption of SFAS No. 133 on May 1, 2001 did not have a material effect on its financial position or results of operations.

     On June 29, 2001, the Financial Accounting Standards Board approved two new statements, SFAS No. 141, “Business Combinations,” (“SFAS No. 141”) and SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Under SFAS No. 141, all business combinations will be accounted for under the purchase method beginning June 30, 2001. SFAS No. 142 includes requirements to test goodwill for impairment using a fair value approach, rather than amortizing the cost of goodwill over future periods. As a result, the Company’s amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of the new accounting standard. The Company adopted SFAS No. 142 in the first quarter of its fiscal year ending April 30, 2002. The Company’s annual goodwill amortization was approximately $450,000, which ceased effective May 1, 2001 upon adoption of the new rules.

     The following tables set forth pro forma net income and earnings per share (in thousands except per share amounts):

	Nine Months Ended
	January 27,
	2001
Net income (loss) as reported	$	(23,575	)
Add back: Goodwill amortization		378
Adjusted net income (loss)	$	(23,197	)
Earnings (loss) per share as reported (basic and diluted)	$	(2.10	)
Goodwill amortization		.03
Adjusted earnings (loss) per share (basic and diluted)	$	(2.07	)

7

USE OF ESTIMATES

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the periods presented. Estimates are used for such items as allowances for doubtful accounts, inventory reserves, depreciable lives of property and equipment, warranty reserves and others. Ultimate results may differ from those estimates.

EARNINGS PER SHARE DATA

     The Company reports net income (loss) per share pursuant to the requirements of the Statement of Financial Accounting Standards No. 128 “Earnings per Share” (“SFAS No. 128”). SFAS No. 128 requires presentation of basic and diluted earnings (loss) per share (EPS). Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted EPS reflects potential dilution from outstanding stock options and other securities using the treasury stock method.

COMPREHENSIVE INCOME

     The Company reports comprehensive income and its components pursuant to the requirements of SFAS No. 130, “Reporting Comprehensive Income”. For the Company, comprehensive income consists of net income (loss) adjusted for foreign currency translation adjustments. Comprehensive income, as defined by SFAS No. 130, was approximately $39,000 for the three months ended January 26, 2002 and a net loss of $8.2 million for the similar period ended January 27, 2001. For the nine month period ended January 26, 2002, the Company had comprehensive income of $433,000 as compared to a comprehensive loss of $23.7 million for the similar period last year.

RESTRUCTURING CHARGES

     During the fourth quarter of fiscal year 2001, the Company recorded a restructuring charge of approximately $1.2 million relating to a workforce reduction and closure of certain facilities. This charge included the costs of severance ($683,000) and lease terminations and other facility costs ($500,000) related to non-strategic businesses including Network Services and Financial Services and for continued cost reductions in the Communications Technology businesses.

     During the nine months ended January 26, 2002, payments totaling $974,000 were charged against the restructuring reserve which was established as part of the above-described restructuring charge. At January 26, 2002, a reserve of approximately $209,000 remained for future payments to be made related to this restructuring charge.

VENDOR AGREEMENTS

     Norstan has been a distributor of Siemens communication equipment since 1976 and is Siemens’ largest independent distributor in North America. The term of the current distributor agreement with Siemens, signed in January 1999, is five years. Norstan and Siemens are also parties to an agreement scheduled to expire on July 27, 2003 pursuant to which Norstan is authorized to refurbish and sell previously owned Siemens equipment.

8

INCOME TAXES

     Deferred income taxes are provided for differences between the financial reporting basis and tax basis of the Company’s assets and liabilities at currently enacted tax rates.

     Realization of the Company’s net deferred tax asset is dependent on the Company’s ability to generate sufficient future taxable income. Although realization is not assured, the Company believes that it is more likely than not that the recorded asset will be realized. Should the Company’s operating strategies fail to produce sufficient taxable income in the future, the Company would record an additional valuation allowance in the appropriate future reporting period, as required by accounting principles generally accepted in the United States.

     The Company did not record any income tax provision related to the current year’s net income or income tax benefit for the previous year’s net losses based on projections of the full fiscal year’s results and the effective tax rate, also reflecting the effect of operating loss carryforwards generated in prior fiscal years.

BANK FINANCING

     On June 29, 2001, the Company entered into an agreement with the banks to restructure its existing senior debt facility. The new credit facility consists of the following components: A) $20.0 million term loan (“Term Loan A”) with various monthly principal payments due commencing on August 31, 2001 and ending on June 28, 2002, B) $15.4 million term loan (“Term Loan B”) with various principal payments due beginning on July 31, 2002, or earlier if Term Loan A is paid off early, and maturing on December 31, 2002, and C) up to a $30.0 million revolving line of credit based on the Company’s level of receivables and inventory and maturing on June 28, 2002. The revolving facility and Term Loan A bear interest at the banks’ reference rate (4.75% at January 26, 2002) plus 2.5%, while Term Loan B bears interest at the banks’ reference rate plus 4.0%. As of January 26, 2002, the company had outstanding borrowings of $42.4 million under this facility.

     Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the terms and conditions of the credit agreement, the Company is required to maintain minimum levels of EBITDA and achieve certain other financial ratios. As of January 26, 2002, the Company was in compliance with all applicable financial covenants.

     Under the terms of the restructured credit agreements, the banks received warrants to purchase shares of the Company’s common stock. As of April 30, 2001, 389,545 warrants had been issued to the banks at various prices between $0.94 and $1.13 per share. In addition, on June 29, 2001, 100,000 warrants were issued at $2.80 per share. These warrants were recorded at their estimated fair value at the dates of issuance. All shares of common stock underlying the warrants issued to the banks are subject to demand and incidental (piggyback) registration rights.

9

     The Company has implemented a restructuring plan to address its future liquidity and capital resource requirements. Management believes that a combination of A) cash expected to be generated from operations, B) borrowing capacity available under the financing arrangements discussed above, C) other debt facilities, D) issuance of debt or equity securities, E) lease financing, and F) cash to be generated from the sale or divestiture of certain assets of the Company, will be adequate to meet the anticipated liquidity and capital resource requirements of its business through at least April 30, 2002. The Company intends to enter into a new and/or restructured credit facility prior to June 28, 2002. The Company has not developed specific plans for the issuance or sale of debt or equity securities and there can be no assurance that if the Company is required to raise capital through such means that the Company will be successful in this regard.

BUSINESS SEGMENTS

     The Company delivers its products and services through four business segments, Communications Technology Solutions and Services, Resale, Network Services and Financial Services. The Company’s interim disclosures under the requirements of SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information,” are as follows (in thousands):

		For the Quarter Ended
		January 26,						January 27,
		2002						2001
					Operating					Operating
			Revenues		Income (Loss)			Revenues		Income (Loss)
Communications Technology:
	Solutions and Services		$	53,811	$	(327	)	$	54,472	$	(3,913	)
	Resale			7,672		747			6,227		187
Network Services				4,768		214			7,085		(735	)
Financial Services				1,084		380			2,458		831
Totals			$	67,335	$	1,014		$	70,242	$	(3,630	)

		For the Nine Months Ended
		January 26,						January 27,
		2002						2001
					Operating					Operating
			Revenues		Income (Loss)			Revenues		Income (Loss)
Communications Technology:
	Solutions and Services		$	158,355	$	(329	)	$	177,673	$	(10,512	)
	Resale			22,758		2,481			19,823		1,583
Network Services				16,332		19			22,065		(1,783	)
Financial Services				4,341		1,550			6,885		2,802
Totals			$	201,786	$	3,721		$	226,446	$	(7,910	)

10

SUBSEQUENT EVENTS

Sale of Network Services Business

     On February 4, 2002, the Company announced that it had entered into a definitive agreement to sell its Network Services business (Norstan Network Services, Inc.) to NetWolves Corporation for $7.5 million. The terms of the purchase agreement provide that $3.75 million is to be paid at closing and the remaining $3.75 million is due one year from the closing, evidenced by a non-interest bearing promissory note. The Company has received a deposit of $400,000, which is refundable only under certain circumstances. Any gain related to this transaction will be recorded upon closing and as cash is received. Norstan Network Services, Inc. provides multiple source long distance services and related consulting and professional services. Closure of this transaction is subject to certain conditions, including regulatory approval, and is expected to be completed within approximately 90 days.

Arbitration Settlement

     On February 25, 2002, the Company was awarded $7.2 million in an arbitration proceeding against the former owner of PRIMA Consulting and certain former employees of PRIMA. This award represents damages resulting from these individuals’ failure to comply with the terms of non-compete agreements created in connection with Norstan’s purchase of PRIMA in 1997. The award includes $1.2 million in fees paid to attorneys, expert witnesses and costs of the arbitration. The Company and the former owner of PRIMA Consulting are negotiating a structured payment of the arbitration award. While the Company is optimistic that a satisfactory payment plan can be negotiated, there can be no assurance that such negotiation or other actions that may be taken by the Company will culminate in the Company’s receipt of all or any significant portion of the arbitration award. Any gain related to this reward will be recorded in the period in which cash is received.

11

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

     Norstan, Inc. (“Norstan” or the “Company”) is a full-service telecommunications solutions company that delivers voice and data technologies and services, and remanufactured equipment to select corporate end-users and channel partners. Norstan also offers a full range of technologies for call center design, messaging, infrastructure, conferencing, and mobility. Norstan manages the operations of its subsidiaries, Norstan Communications, Inc., Norstan Canada, Ltd., Norstan Financial Services, Inc., Norstan Network Services, Inc., Vibes Technologies, Inc., Norstan International, Inc., and Norstan-UK Limited. The Company is headquartered in Minneapolis, Minnesota, with sales and service offices in 30 locations in the United States and Canada.

     The Company delivers its products and services through four business segments: Communications Technology Solutions and Services, Resale, Network Services and Financial Services, which accounted for 79.9%, 11.4%, 7.1% and 1.6% of Norstan’s revenues for the fiscal quarter ended January 26, 2002, respectively. Communications Technology Solutions offerings include customer contact (call centers), collaboration (conferencing and messaging), converged communication (IP telephony and PBX systems), infrastructure (cabling, wiring, sound and signal) and enterprise mobility (mobile business networking). Communications Technology Services offerings include project consulting, project management, installation, system monitoring and support services maintenance. Resale offers refurbished and re-certified voice and data products. Network Services offers multiple source local and long distance services and Financial Services supports the sales process by providing customized financing alternatives.

     In fiscal year 2001, the Company changed its reportable operating segments to reflect how it evaluates its operating performance and allocates resources. Prior to fiscal year 2001, the Company’s reportable segments included Consulting, Communications and Financial Services. As of April 30, 2001, the Company divested its IT consulting business. Accordingly, the net assets and operating results have been separately reported as discontinued operations.

SUMMARY

     During the quarter ended January 26, 2002, the Company reported net income of $160,000 or $0.01 per common share, as compared to a net loss of $8.3 million or $0.73 per common share for the quarter ended January 27, 2001. For the nine month period ended January 26, 2002, the Company reported net income of $648,000 or $0.05 per common share, as compared to a net loss of $23.6 million, or $2.10 per share, for the similar period last year.

12

SELECTED CONSOLIDATED FINANCIAL DATA

				DOLLAR AMOUNTS AS A									DOLLAR AMOUNTS AS A
				PERCENTAGE OF REVENUES						PERCENTAGE			PERCENTAGE OF REVENUES						PERCENTAGE
				Three Months Ended						CHANGE			Nine Months Ended						CHANGE
				January 26,			January 27,			Fiscal			January 26,			January 27,			Fiscal
				2002			2001			2002 vs. 2001			2002			2001			2002 vs. 2001
REVENUES:
Communications Technology:
		Solutions and Services			79.9	%		77.5	%		(1.2	%)		78.5	%		78.5	%		(10.9	%)
		Resale			11.4	%		8.9	%		23.2	%		11.3	%		8.8	%		14.8	%
Network Services					7.1	%		10.1	%		(32.7	%)		8.1	%		9.7	%		(26.0	%)
Financial Services					1.6	%		3.5	%		(55.9	%)		2.1	%		3.0	%		(37.0	%)
			Total Revenues		100.0	%		100.0	%		(4.1	%)		100.0	%		100.0	%		(10.9	%)
COST OF SALES					71.1	%		72.2	%		(5.6	%)		69.5	%		73.2	%		(15.4	%)
GROSS MARGIN					28.9	%		27.8	%		(0.4	%)		30.5	%		26.8	%		1.4	%
SELLING, GENERAL & ADMINISTRATIVE EXPENSES					27.4	%		33.0	%		(20.3	%)		28.6	%		30.3	%		(15.7	%)
OPERATING INCOME (LOSS)					1.5	%		(5.2	%)		N/A			1.8	%		(3.5	%)		N/A
	Interest Expense and Other, Net				(1.3	%)		(2.9	%)		(59.1	%)		(1.5	%)		(3.2	%)		58.0	%
NET INCOME (LOSS)
	Continuing Operations				0.2	%		(8.1	%)		N/A			0.3	%		(6.7	%)		N/A
	Discontinued Operations				—			(3.7	%)		N/A			—			(3.7	%)		N/A
NET INCOME (LOSS)					0.2	%		(11.8	%)		N/A			0.3	%		(10.4	%)		N/A

The following table sets forth, for the periods indicated, the gross margin percentages for Company’s business segments (continuing operations):

		Three Months Ended						Nine Months Ended
		January 26,			January 27,			January 26,			January 27,
		2002			2001			2002			2001
GROSS MARGIN PERCENTAGES
Communications Technology:
	Solutions and Services		26.6	%		25.7	%		28.5	%		24.1	%
	Resale		34.6	%		34.3	%		36.4	%		38.4	%
Network Services			32.9	%		26.8	%		28.7	%		24.5	%
Financial Services			87.7	%		62.5	%		79.9	%		69.7	%

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RESULTS OF OPERATIONS

     REVENUES.Revenues decreased 4.1% to $67.3 million in the third quarter of fiscal year 2002, compared to $70.2 million for the third quarter of fiscal year 2001. For the comparable nine month periods ended January 26, 2002 and January 27, 2001, revenues decreased 10.9% to $201.8 million as compared to $226.4 million.

     Revenues within the Communications Technology Solutions and Services segment decreased 1.2% to $53.8 million for the third quarter ended January 26, 2002, compared to $54.5 million for the similar period last year. Revenues decreased 10.9% to $158.4 million for the nine month period ended January 26, 2002 from $177.7 million for the same period last year. During the current fiscal quarter, revenues from Solutions’ product offerings were relatively flat compared to the similar quarter last year with increases in call center solutions offsetting lower revenues in PBX systems and conferencing equipment sales. Services revenues were down 6.6% as a significant decrease in moves, adds and changes (MAC) revenues was only somewhat offset by increased service contract revenues. For the comparable nine month periods, Solutions’ revenues were down 26.9% including lower revenues of PBX systems, call centers and conferencing solutions. Service revenues were slightly down with the decrease in MAC revenues offset by increased service contract revenues.

     While the Company’s revenues have stabilized over the past few quarters, the continued slow economy has had a negative effect on revenues from the Company’s Solutions product offerings and MAC service offerings. However, the Company’s new business model, concentrating on its core competencies, continues to gain traction with a renewed focus on providing direct solutions to select enterprise customers, communications technology solutions and services to channel partners and the remanufacture and resale of business communications products. The Company continues to pursue channel partners and other strategic relationships as evidenced by the new relationship with Nortel Networks announced in the Company’s second quarter. In addition, the Company recently announced that it has broadened its channel strategy by adding five new strategic relationships during the last quarter and expanded its relationship with Alcatel. These relationships have the potential to expand the Company’s geographic reach and capabilities within its Communications Technology Solutions and Services segment. The Company has recently opened sales offices in Dallas, Texas, Irvine, California and New York, New York.

     Resale revenues increased 23.2% to $7.7 million for the quarter ended January 26, 2002 as compared to $6.2 million for the same period ended January 27, 2001. For the comparable nine month periods ended January 26, 2002 and January 27, 2001, revenues within this segment increased 14.8% to $22.8 million as compared to $19.8 million. These increases were due to increased revenues from Vibes Technologies, the Company’s integrated direct and web-based e-commerce business which remanufactures and resells voice and data equipment.

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     Network Services’ revenues decreased 32.7% to $4.8 million in the third quarter of fiscal year 2002, as compared to $7.1 million for the similar quarter last year. During the comparable nine month periods ended January 26, 2002 and January 27, 2001, revenues decreased 26.0% to $16.3 million from $22.1 million. These decreases were due to the Company’s decreased emphasis on pursuing additional Network Services’ revenue. On February 4, 2002, the Company announced that it had entered into a definitive agreement to sell its Network Services business (Norstan Network Services, Inc.) to NetWolves Corporation for $7.5 million. The terms of the purchase agreement provide that $3.75 million is to be paid at closing and the remaining $3.75 million is due one year from the closing, evidenced by a non-interest bearing promissory note. The Company has received a deposit of $400,000, which is refundable only under certain circumstances. Any gain related to this transaction will be recorded upon closing and as cash is received. Norstan Network Services, Inc. provides multiple source long distance services and related consulting and professional services. Closure of this transaction is subject to certain conditions, including regulatory approval, and is expected to be completed within approximately 90 days.

     Financial Services’ revenues declined 55.9% to $1.1 million as compared to $2.5 million a year ago. For the nine month period ended January 26, 2002, revenues decreased 37.0% to $4.3 million as compared to $6.9 million for the similar period last year. These decreases were attributed to the Company’s strategic decision not to offer financing directly to its customers. Norstan Financial Services has partnered with Fidelity Leasing to provide financial alternatives to its customers under a private label leasing program. Revenues from Financial Services will continue to decline as it winds down.

     GROSS MARGIN.The Company’s gross margin was $19.5 million for the quarters ended January 26, 2002 and January 27, 2001. For the nine month period ended January 26, 2002, gross margin increased 1.4%, to $61.5 million as compared to $60.7 million for the similar period last year. As a percent of total revenues, gross margin improved to 28.9% and 30.5% for the three and nine month periods ended January 26, 2002 as compared to 27.8% and 26.8% for the similar periods ended January 27, 2001.

     Gross margin as a percent of revenues for Communications Technology Solutions and Services was 26.6% and 28.5% for the three and nine month periods ended January 26, 2002 as compared to 25.7% and 24.1% for the comparable periods ended January 27, 2001. These increases are the result of a change in the Company’s product/service mix, improved project management and continued efforts to control and/or reduce operating expenses over the past year. In addition, the Company has been diligent in evaluating new sales on the basis of the quality of revenue offered.

     Resale’s gross margin as a percent of revenues was 34.6% and 36.4% for the three and nine month periods ended January 26, 2002 compared to 34.3% and 38.4% for the similar periods ended January 27, 2001.

     Network Services’ gross margin as a percent of revenues was 32.9% and 28.7% for the three and nine month periods ended January 26, 2002 compared to 26.8% and 24.5% for the comparable periods ended January 27, 2001. Gross margin as a percent of revenues for Financial Services was 87.7% and 79.9% for the three and nine month periods ended January 26, 2002 and 62.5% and 69.7% for the similar period ended January 27, 2001.

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     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.Selling, general and administrative expenses decreased 20.4% to $18.5 million in the third quarter of fiscal year 2002, from $23.2 million in the similar period last year. For the nine month period ended January 26, 2002, selling, general and administrative expenses decreased 15.7% to $57.8 million compared to $68.6 million for the same period last year. As a percent of revenues, selling, general and administrative expenses were 27.4% and 28.7% for the three and nine month periods ended January 26, 2002 compared to 33.0% and 30.3% for the similar periods last year. The Company has implemented a restructuring plan that has removed a significant amount of costs from its businesses over the past year. A majority of these efforts are complete and the current overall levels of selling, general and administrative expense are in-line with the Company’s refocused business model. In addition, with the adoption of SFAS No. 142, the Company no longer records amortization expense related to previously recorded goodwill. The Company continues to monitor expenditures and pursue cost control measures as applicable.

     INTEREST EXPENSE.Interest expense decreased 45.9% to $1.1 million for the quarter ended January 26, 2002 from $2.1 million for the same quarter last year. For the nine month period ended January 26, 2002 interest expense decreased 39.1% to $3.8 million from $6.3 million in the comparable nine month period ended January 27, 2001. The decrease in interest expense was primarily the result of a decrease in borrowings under the Company’s revolving long-term credit facilities, which were at $42.4 million as of January 26, 2002 compared to $66.4 million as of January 27, 2001 as well as reduced weighted average interest rates. Continued reductions in interest expense are anticipated as the Company pursues its objective of decreasing its interest bearing indebtedness.

     INCOME TAXES.The Company did not record any income tax provision related to the current quarter’s or year-to-date net income or income tax benefit for the previous year’s net loss based on projections of the full fiscal year’s results and the effective tax rate, also reflecting the effect of operating loss carryforwards generated in prior fiscal years.

     NET INCOME FROM CONTINUING OPERATIONS.The Company reported net income from continuing operations of $160,000 or $0.01 per basic and diluted share for the quarter ended January 26, 2002, as compared to a net loss of $5.7 million or $0.50 per share for the same quarter last year. For the nine month period ended January 26, 2002, net income from continuing operations was $648,000 or $0.05 per basic and diluted share compared to a net loss of $15.2 million or $1.36 per share for the comparable period ended January 27, 2001.

     DISCONTINUED OPERATIONS.During fiscal 2001, the Company divested its IT consulting business in order to focus on its core competencies of providing communications technology services and solutions to channel partners and select enterprise customers. The Company’s inability to realize synergies between its communications and IT consulting businesses and recurring losses generated by the consulting business contributed to the Company’s decision to divest itself of this non-strategic business segment.

     The Company’s divestiture of its IT consulting business began on February 7, 2001 with the sale of the Company’s 75 percent interest in Connaissance Consulting to Connaissance’s founder. Terms of the sale included a payment of $3.0 million in cash at closing and delivery of promissory notes drawn in favor of the Company with an aggregate face amount of $13.0 million maturing on various dates, commencing on April 30, 2001 and ending December 31, 2005.

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     The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former President and the Company’s former Vice Chairman. Terms of the sale included a payment of $500,000 in cash at closing and delivery of a promissory note drawn in favor of the Company in the face amount of $1.5 million which matured in September, 2001 and remains partially unpaid. The promissory note is secured by certain assets of the business. In January 2002, the former Norstan Consulting business ceased operations. The Company then took possession of the remaining receivables associated with this business in order to satisfy the $1.5 million promissory note. Through January 26, 2002, approximately $884,000 has been collected. The Company continues to pursue its collection efforts related to the outstanding note balance and believes the ultimate expense to the Company of any uncollected amounts will not be significant.

     The results of operations of these two business units have historically been reported as the Company’s “Consulting” business segment. Pursuant to the sale transactions described above the Consulting business segment’s results of operations are reported as discontinued operations at April 30, 2001 and for future periods. The Company’s consolidated financial statements have been restated to report separately the net assets and operating results of the discontinued businesses for all periods presented.

     Summary operating results of the discontinued operations are as follows (in thousands):

	For the periods ended
	January 27, 2001
	Three			Nine
	Months			Months
Revenues	$	8,837		$	32,276
Cost of sales		7,240			24,130
Gross margin		1,597			8,146
Sales, general and administrative expenses		4,206			16,365
Operating loss		(2,609	)		(8,219	)
Other income (expense), net		24			(135	)
Net loss from discontinued operations	$	(2,585	)	$	(8,354	)

     NET INCOME (LOSS).For the quarter ended January 26, 2002, the Company reported net income of $160,000 or $0.01 per basic and diluted share, as compared to a net loss of $8.3 million or $0.73 per share in the same quarter last year. For the nine month period ended January 26, 2002, the Company reported net income of $648,000 or $0.05 per basic and diluted share, as compared to a net loss of $23.6 million or $2.10 per share in the comparable period last year.

17

LIQUIDITY AND CAPITAL RESOURCES

     For the nine months ended January 26, 2002, continuing operating activities provided cash of $6.9 million compared to $23.3 million in the similar period last year. This decrease is mainly due to activity in both comparable periods relating to accounts receivable and accounts payable. Investing activities provided cash of $12.3 million in the current nine month period as compared to utilizing cash of $6.9 million in the similar period last year. This change is the result of reduced spending on capital assets and significant reduction in investments in lease contracts as the Company’s leasing activity winds down. The funds provided by current operations and investing activities were used to repay the Company’s long-term debt. As a result, financing activities utilized cash of $19.3 million during the nine months ended January 26, 2002 as compared to $7.7 million in the comparable nine month period ended January 27, 2001. Earnings before interest, taxes, depreciation and amortization (EBITDA) from continuing operations for the nine month period ended January 26, 2002 was $15.5 million as compared to $5.2 million for the comparable period last year.

     CAPITAL EXPENDITURES.The Company used $3.7 million for capital expenditures during the nine month period ended January 26, 2002, compared to $8.3 million in the similar period last year. This reduction was the result of increased focus on cost controls and better utilization of current resources. These expenditures were primarily for telecommunication and conferencing equipment costs incurred in connection with outsourcing and managed services arrangements.

     INVESTMENT IN LEASE CONTRACTS.The Company has historically made a significant investment in lease contracts with its customers. As previously discussed, the Company is winding down its leasing activities. The additional investment made in lease contracts in the first nine months of fiscal year 2002 totaled $2.7 million as compared to $23.0 million in the comparable period of fiscal 2001. Net lease receivables decreased to $31.8 million at January 26, 2002 from $55.9 million at April 30, 2001.

     The Company utilizes its lease receivables and corresponding underlying equipment to borrow funds from financial institutions on a nonrecourse basis by discounting the stream of future lease payments. Proceeds from discounting are presented on the consolidated balance sheet as discounted lease rentals. Discounted lease rentals totaled $17.1 million at January 26, 2002 as compared to $26.8 million at April 30, 2001. Interest rates on these credit agreements at January 26, 2002 ranged from approximately 6.0% to 10.0%, while payments are due in varying monthly installments through November 2005. Payments due to financial institutions are made from monthly collections of lease receivables from customers. The Company also sold certain leases to a third party on a non-recourse basis during July and August 2001. Total proceeds from these sales were $6.4 million which is reflected on the Consolidated Statements of Cash Flow in “Financing Activities”.

18

BANK FINANCING

     On June 29, 2001, the Company entered into an agreement with the banks to restructure its existing senior debt facility. The new credit facility consists of the following components; A) $20.0 million term loan (“Term Loan A”) with various monthly principal payments due commencing on August 31, 2001 and ending on June 28, 2002, B) $15.4 million term loan (“Term Loan B”) with various principal payments due beginning on July 31, 2002, or earlier if Term Loan A is paid off early, and maturing on December 31, 2002, and C) up to a $30.0 million revolving line of credit based on the Company’s level of receivables and inventory and maturing on June 28, 2002. The revolving facility and Term Loan A bear interest at the banks’ reference rate (4.75% at January 26, 2002) plus 2.5%, while Term Loan B bears interest at the banks’ reference rate plus 4.0%. As of January 26, 2002, the company had outstanding borrowings of $42.4 million under this facility.

     Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the terms and conditions of the credit agreement, the Company is required to maintain minimum levels of EBITDA and achieve certain other financial ratios. As of January 26, 2002 the Company was in compliance with all applicable financial covenants.

     Under the terms of the restructured credit agreements, the banks received warrants to purchase shares of the Company’s common stock. As of April 30, 2001, 389,545 warrants had been issued to the banks at various prices between $0.94 and $1.13 per share. In addition, on June 29, 2001, 100,000 warrants were issued at $2.80 per share. These warrants were recorded at their estimated fair value at the dates of issuance. All shares of common stock underlying the warrants issued to the banks are subject to demand and incidental (piggyback) registration rights.

     The Company has implemented a restructuring plan to address its future liquidity and capital resource requirements. Management believes that a combination of A) cash expected to be generated from operations, B) borrowing capacity available under the financing arrangements discussed above, C) other debt facilities, D) issuance of debt or equity securities, E) lease financing, and F) cash to be generated from the sale or divestiture of certain assets of the Company, will be adequate to meet the anticipated liquidity and capital resource requirements of its business through at least April 30, 2002. The Company intends to enter into a new and/or restructured credit facility prior to June 28, 2002. The Company has not developed specific plans for the issuance or sale of debt or equity securities and there can be no assurance that if the Company is required to raise capital through such means that the Company will be successful in this regard.

19

RECENTLY ISSUED ACCOUNTING STANDARDS

     On June 29, 2001, the Financial Accounting Standards Board approved two new statements, SFAS No. 141, “Business Combinations,” (“SFAS No. 141”) and SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Under SFAS No. 141, all business combinations will be accounted for under the purchase method beginning June 30, 2001. SFAS No. 142 includes requirements to test goodwill for impairment using a fair value approach, rather than amortizing the cost of goodwill over future periods. As a result, the Company’s amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of the new accounting standards. The Company adopted SFAS No. 142 in the first quarter of its fiscal year ending April 30, 2002. The Company’s annual goodwill amortization was approximately $450,000, which ceased effective May 1, 2001 upon adoption of the new rules.

     The following tables set forth pro forma net income and earnings per share (in thousands except per share amounts):

	Nine Months Ended
	January 27, 2001
Net income (loss) as reported	$	(23,575	)
Add back: Goodwill amortization		378
Adjusted net income (loss)	$	(23,197	)
Earnings (loss) per share as reported (basic and diluted)	$	(2.10	)
Goodwill amortization		.03
Adjusted earnings (loss) per share (basic and diluted)	$	(2.07	)

FUTURE ACCOUNTING CHANGES AND DEVELOPMENTS

     The Securities and Exchange Commission recently issued an interpretive financial reporting release entitled “Cautionary Advice Regarding Disclosure About Critical Accounting Policies (FR-60) and a companion release “Commission Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations (FR-61). The Company is presently reviewing the suggested disclosures as set forth therein and will include such disclosures as deemed appropriate in the Company’s Form 10-K filing for the fiscal year ending April 30, 2002.

20

FORWARD-LOOKING STATEMENTS

     From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, product pricing, management of growth, integration of acquisitions, technological developments, new products and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements including those made in this document. In order to comply with the terms of the Private Securities Litigation Reform Act, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements.

     The risks and uncertainties that may affect the operations, performance, developments and results of the Company’s business include the following: ability to obtain adequate financing, national and regional economic conditions; pending and future legislation affecting the IT and telecommunications industries; the Company’s business in Canada; stability of foreign governments; market acceptance of the Company’s products and services; the Company’s continued ability to provide integrated communication solutions for customers in a dynamic industry; and other competitive factors.

     Because these and other factors could affect the Company’s operating results, past financial performance should not necessarily be considered as a reliable indicator of future performance, and investors should not use historical trends to anticipate future period results.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     GENERAL. Market risk represents the risk of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates and equity prices. Changes in these factors could cause fluctuations in the results of the Company’s operations and cash flows. In the ordinary course of business, the Company is exposed to foreign currency and interest rate risks. These risks primarily relate to the sale of products and services to foreign customers and changes in interest rates on the Company’s long-term debt obligations, discounted lease rentals, capital leases and other long-term debt obligations.

     INTEREST RATE RISK.For fixed rate debt, changes in interest rates generally affect the fair market value of the debt instrument, but not results of operations or cash flows. The Company does not have an obligation to prepay any fixed rate debt prior to maturity, and therefore, interest rate risk and changes in the fair market value of fixed rate debt will not have an effect on results of operations or cash flows until the Company decides, or is required, to refinance such debt.

     For variable rate debt, changes in interest rates generally do not affect the fair market value of the debt instrument, but does affect future results of operations and cash flows. The Company has variable rate debt of $42.4 million outstanding at January 26, 2002 with a weighted average interest rate of 7.8%. Assuming that the Company’s balance of variable rate debt remains constant at $42.4 million, each one-percent increase in interest rates would result in an annual increase in interest expense, and a corresponding decrease in cash flows of $424,000. Conversely, each one-percent decrease in interest rates would result in an annual decrease in interest expense, and a corresponding increase in cash flows of $424,000.

21

     The Company periodically finances customer equipment purchases with fixed rate, sales-type leases. The resulting stream of future lease payments is, in turn, used to borrow funds from financial institutions at fixed rates on a nonrecourse basis. The Company is not exposed to interest rate risk in connection with these arrangements because: (i) both the leases and the debt are at fixed interest rates; and (ii) Norstan typically enters into lending arrangements shortly after execution of the related leases.

     FOREIGN CURRENCY RISK.The Company is exposed to foreign currency rate risk. Substantially all foreign exchange exposure is the Canadian dollar. In general, with a net asset exposure, a weakening of the Canadian dollar relative to the U.S. dollar has a negative translation effect. Conversely, with a net asset exposure, a strengthening of the Canadian dollar would have the opposite effect. The average exchange rates for the Canadian dollar against the U.S. dollar during the year ended April 30, 2001 and for the nine months ended January 26, 2002 remained relatively unchanged.

     Assets and liabilities outside the United States are located primarily in Canada. The Company’s investments in its foreign subsidiary with a functional currency other than the U.S. dollar are not hedged. The potential loss in fair value resulting from a hypothetical 10% adverse change in the Canadian dollar exchange rate would not materially affect the Company’s consolidated financial position, results of operations or cash flows. Any gain or loss in fair value, associated with the Canadian dollar, in the Consolidated Balance Sheets of the Company would be recorded as a separate component of shareholders’ equity.

     DERIVATIVE FINANCIAL INSTRUMENTS. The Company currently does not have any derivative financial instruments in place to manage interest costs, but may consider utilizing such instruments in the future as a means to manage interest rate risk.

22

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     The Company is involved in legal actions in the ordinary course of its business. Although the outcome of any such legal action cannot be predicted, in the opinion of management there is no legal proceeding pending against or involving the Company for which the outcome is likely to have a material adverse effect upon the consolidated financial position or results of operations of the Company.

     The Company pursued various claims before the American Arbitration Association against the former owner of PRIMA Consulting (“PRIMA”) and certain former employees of PRIMA, arising out of the Company’s September 1997 acquisition of PRIMA.

     On February 25, 2002, the Company was awarded $7.2 million by the panel of arbitrators selected by the American Arbitration Association. The award includes approximately $1.2 million in fees paid to attorneys, expert witnesses and costs of the arbitration. The Company is currently negotiating with Mr. Vadini to arrange for a structured payment of the arbitration award. Although the Company is optimistic that a satisfactory payment plan will result from the parties’ discussions, there can be no assurance that such negotiations or other such actions that may be taken by the Company will culminate in the Company’s receipt of all or any significant portion of the arbitration award.

     In addition, the Company has asserted claims in North Carolina federal district court against the new company established by the former owner of PRIMA for tortious interference with contracts and misappropriation of trade secrets.

     In May 2000, Norstan was sued in the U.S. District Court for the District of Minnesota by a former sales representative claiming additional commissions owed of $458,675. Norstan denies that the former sales representative is entitled to any additional commissions. Norstan filed a counterclaim, seeking reimbursement of overpayments that had been made to the sales representative. On July 26, 2001, the U.S. District Court entered summary judgment in favor of the former sales representative and against Norstan. The Company believes the ruling is in error and has filed an appeal. However, there can be no assurance that the Company will be successful in its appeal. Management believes that the January 26, 2002 consolidated financial statements adequately reflect the Company’s exposure under this lawsuit.

23

ITEM 2.	CHANGES IN SECURITIES AND USE OF PROCEEDS
	Not applicable.
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES
	None.
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	None.
ITEM 5.	OTHER INFORMATION
	None.
ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K
(a)	Exhibits.
	None.
(b)	Reports on Form 8-K.
	None

24

S I G N A T U R E S

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NORSTAN, INC.
	Registrant
Date: March 11, 2002	By	/s/ James C. Granger
		James C. Granger
		Chief Executive Officer and President
		(Principal Executive Officer)
Date: March 11, 2002	By	/s/ Scott G. Christian
		Scott G. Christian
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

25