-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C9RKexamSc3PPJdaYfsD6ZApwb23gLHTN02ULWnFn6qXdWhWbM+RH4S5sAs4l8aL 8smaAHhaCBtmVZ7g0fEaRQ== 0000950124-98-004028.txt : 19980803 0000950124-98-004028.hdr.sgml : 19980803 ACCESSION NUMBER: 0000950124-98-004028 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19980430 FILED AS OF DATE: 19980729 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORSTAN INC CENTRAL INDEX KEY: 0000072418 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 410835746 STATE OF INCORPORATION: MN FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-08141 FILM NUMBER: 98673543 BUSINESS ADDRESS: STREET 1: 605 N HIGHWAY 169 STREET 2: 12TH FL CITY: PLYMOUTH STATE: MN ZIP: 55441 BUSINESS PHONE: 6124201100 MAIL ADDRESS: STREET 1: NORSTAN INC STREET 2: 6900 WEDGEWOOD ROAD CITY: MAPLE GROVE STATE: MN ZIP: 55311 FORMER COMPANY: FORMER CONFORMED NAME: NORSTAN RESEARCH & DEVELOPMENT CO DATE OF NAME CHANGE: 19770926 FORMER COMPANY: FORMER CONFORMED NAME: NORSTAN MANUFACTURING CO INC DATE OF NAME CHANGE: 19750918 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED APRIL 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-8141 NORSTAN, INC. (Exact name of registrant as specified in its chapter) MINNESOTA 41-0835746 (I.R.S. Employer identification (State of incorporation) No.)
605 NORTH HIGHWAY 169, TWELFTH FLOOR, PLYMOUTH, MINNESOTA 55441 (Address of principal executive offices) The Company's phone number: 612-513-4500 The Company's internet address: WWW.NORSTAN.COM Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK ($.10 PAR VALUE PER SHARE) COMMON STOCK PURCHASE RIGHTS (Title of class) 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 [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K. [ ] As of July 27, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average high and low prices on such date as reported by the Nasdaq National Market System was approximately $178,941,000. As of July 27, 1998, there were outstanding 10,474,281 shares of the registrant's common stock, par value $.10 per share, its only class of equity securities. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement to be filed within 120 days after the end of the fiscal year covered by this report are incorporated by reference into Part III hereof. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- PART I ITEM 1. Business.................................................... 1 Summary..................................................... Industry Overview........................................... The Norstan Solution........................................ Norstan's Business Strategy................................. Norstan's Growth Strategy................................... Products and Services....................................... Customers and Engagements................................... Strategic Alliances......................................... Sales and Marketing......................................... 1 Customer Service............................................ Locations................................................... Human Resources............................................. Competition................................................. Intellectual Property Rights................................ Government Regulation....................................... Backlog..................................................... ITEM 2. Properties.................................................. 2 ITEM 3. Legal Proceedings........................................... 3 ITEM 4. Submission of Matters to a Vote of Security Holders......... 3 PART II ITEM 5. Market for the Company's Common Equity and Related Shareholder Matters......................................... 4 ITEM 6. Selected Consolidated Financial Data........................ 5 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for the Fiscal Years 1998, 1997, and 1996.................................................... 6 ITEM 8. Financial Statements and Supplementary Data................. 8 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 9 PART III ITEM 10. Directors and Executive Officers of the Registrant.......... 9 ITEM 11. Executive Compensation...................................... 9 ITEM 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 9 ITEM 13. Certain Relationships and Related Transactions.............. 9 PART IV ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 10 SIGNATURES............................................................ 11
i 3 PART I ITEM 1. BUSINESS. BUSINESS SUMMARY Norstan is a leading provider of communications and information technology ("IT") solutions for over 18,000 customers in the United States, Canada and England. To address the complex communications requirements of its customers, Norstan provides a broad range of products and services, including telephone systems, call center systems, voice processing, network integration, voice and video conferencing, and facilities management services. Norstan's network of over 800 field technicians and service consultants delivers communications services to its customers. In addition, the Company provides a wide array of IT solutions through Norstan IT Consulting Services. These solutions include the design, implementation, maintenance and modification of IT applications and systems. Norstan IT Consulting Services currently employs over 700 consultants and generated a 70% increase in revenues during fiscal year 1998. As communications and information technologies converge, Norstan's strategy is to expand the breadth of its IT services offerings to serve as a single-source provider of leading technology solutions to its customers. The Company delivers its products and services through three business units, Global Services, Communications Solutions and Financial Services, which accounted for approximately 48%, 50% and 2% of Norstan's fiscal year 1998 revenues, respectively. Global Services includes Norstan IT Consulting Services and Communications Services. Norstan IT Consulting Services provides IT services including enterprise resource planning ("ERP") and sales management package implementation, groupware consulting, Internet/intranet/e-commerce solutions, computer telephony integration ("CTI") and outsourced facilities management. Communications Services provides customer support services for communications systems, including maintenance services, systems modifications and long distance services. Communications Solutions provides a broad array of solutions including telephone systems, integrated voice processing, call center technologies and video/audio/data conferencing solutions. Financial Services supports the sales process by providing customized financing alternatives. The Company believes that its breadth of product and service offerings fosters long-term customer relationships, affords cross-selling opportunities and minimizes the Company's dependence on any single technology or industry. The Company operates in 68 locations in 58 cities throughout the United States and Canada. Norstan has served over 18,000 customers across a broad range of industries in the last three years and focuses its marketing efforts on middle-market and Fortune 500 companies with complex technology and communications requirements. Current customers include British Petroleum, IBM, Kaiser Permanente, John Deere, US Bancorp, 3M and Harley-Davidson. The Company believes that its installed base of communications systems customers will offer extensive opportunities for cross-selling IT consulting services. Management also believes that Norstan IT Consulting Services customers will be a source of additional communications business. Norstan's strong emphasis on customer satisfaction is evidenced by a survey of Norstan's communications customers, in which Norstan received an overall satisfaction rating of 93% in fiscal year 1998. The Company believes that its outstanding customer service will enable Norstan to capture a greater portion of each customer's communications and IT budgets in the future. Norstan provides leading-edge technologies in both its IT and communications operations. The Company has established strategic alliances with leading IT and communications companies that allow Norstan to offer objective solutions to its customers. IT strategic alliance partners include IBM, Siebel Systems, Oracle, Lotus, PeopleSoft, Tivoli, Novell and Microsoft. Communications strategic alliance partners include Siemens, Aspect, VTEL, PictureTel, Latitude, Cisco Systems, Sprint, Lucent Technologies (formerly Octel) and Applied Voice Technology. 1 4 INDUSTRY OVERVIEW In the current climate of intense global competition and accelerating technological change, businesses increasingly depend upon technology-based solutions to enhance their competitive position, and to improve their productivity and the quality of their products and services. Today's business environment mandates the availability of efficient voice and video communication channels and information in formats suited to a wide variety of users. Accordingly, businesses are looking to a variety of new technologies to enhance the performance of their communications systems and to allow IT systems to collect, analyze and communicate information within the enterprise and among customers and suppliers. An organization's ability to integrate and deploy new communications and IT technologies in a unified and cost-effective manner has become critical to competing successfully in today's rapidly changing business environment. While organizations recognize the importance of communications and IT systems in this business environment, the selection, implementation, customization and maintenance of these systems is becoming more complex and the resources required to perform these tasks are becoming increasingly scarce. Faced with a shortage of qualified technical resources and great demands to implement the latest technology, customers are increasingly relying on outside vendors to provide the necessary resources. By outsourcing communications and IT services, companies are able to focus on their core businesses; access specialized technical skills; implement communications and IT solutions more rapidly; benefit from flexible staffing; and reduce the cost of recruiting, training and retaining communications and IT professionals. As a result of these factors, demand for IT and communications services and products has grown significantly. In 1998, the worldwide market for IT services is estimated at $350 billion and is projected to grow to $620 billion by 2002 according to Dataquest. Dataquest also estimates that the market for these services is projected to grow at a 15% compound annual growth rate. For calendar year 1998, industry sources estimate that the U.S. market for switching, networking and application equipment is over $17 billion, and the U.S. market for telecommunications maintenance and professional services is estimated to be approximately $4 billion. As customers seek the competitive advantages that advanced communications and computer telephony integration can deliver, growth of certain segments of call processing are expected to be particularly strong. Between 1996 and 2000, the U.S. market for voice mail, interactive voice response units, networking equipment, and other telecommunications peripherals and applications is expected to grow at a compound annual growth rate of approximately 12%. By 2000, the U.S. market for these associated applications and peripherals is projected to be over $14 billion. The markets and technologies for communications equipment and IT applications and systems continue to converge as communications equipment migrates from proprietary switches to software-driven systems operating on standardized computer platforms. As a result, businesses are integrating their communications and IT systems. In addition, many middle-market and Fortune 500 companies rely on multiple, often specialized, providers to help implement and manage their communications and IT systems. The Company believes that relying on multiple service providers, where there is no distinct responsible party, creates vendor relationships that are difficult and expensive to manage and adversely impacts the quality and compatibility of communications and IT solutions. As previously separate communications and IT technologies converge and their interoperability increases, more organizations will seek a unified technology solution. Norstan believes that these organizations will attempt to reduce costs and management complexity by establishing relationships with a small number of providers that offer a broad range of both communications and IT products and services throughout the full life cycle of a project. THE NORSTAN SOLUTION The Company is a single-source provider of a wide range of communications and IT solutions that enable its customers to compete and succeed in the global marketplace. The Company has leveraged its established reputation as a provider of premier communications products and services, along with the capability of its more than 700 IT consultants, to deliver a unified communications and IT solution to middle-market and Fortune 500 companies. This broad range of offerings enables Norstan to serve as a single-source provider of communications and IT solutions throughout the entire life cycle of a project. Norstan's ability to serve as a 2 5 single-source provider results in closer integration, reduced risk and greater management control for the customer. The Company believes that its customer relationships, its geographic reach and size, and its expertise in providing both communications and IT solutions will enable it to capitalize on the continuing growth and convergence of communications and IT needs of middle-market and Fortune 500 companies. NORSTAN'S BUSINESS STRATEGY The Company's objective is to become a leading provider of communications and IT offerings to middle-market and Fortune 500 companies. The Company's strategy to achieve this objective includes the following key elements: Capitalize on the Accelerating Convergence of Communications and Information Technologies. Norstan's established communications expertise, coupled with its IT consulting capabilities, positions the Company to exploit the convergence of voice, video and information technologies onto a single platform. Norstan believes that it is one of the few firms offering this combination of skills and services, enabling the Company to serve as a single-source provider of a unified technology solution. Increase Focus on Providing Technology Services. As communications and information technologies converge, the Company intends to increase its percentage of revenues derived from technology services, which typically command higher margins than product sales. Management believes that its increased focus on technology services will enhance its overall profitability. Over the last three fiscal years, revenues from Norstan's Global Services business unit increased at a 27% annual compound growth rate and accounted for over 48% of revenues in fiscal year 1998. Offer a Broad Range of Communications and IT Solutions. Norstan's broad range of voice, video and data solutions allows the Company to serve as a single-source provider for its customers' communications and IT needs. The ability to provide consulting services, hardware, software, training and on-going support enables Norstan to offer a unified communications and IT solution throughout the life cycle of a project. This capability will become increasingly important as communications and information technologies continue to converge and customers look to retain a single-source provider for all their communications and IT needs. Attract, Develop and Retain Highly Skilled Professionals. The Company seeks to attract, develop and retain the highest caliber of communications and IT consultants. Norstan places a strong emphasis on the career development and training of its IT consultants through its Team Manager program. Team Managers provide career guidance and ensure that employees maintain skills in state-of-the-art technologies. Norstan offers a competitive combination of employee benefits and incentives, including employee stock option and stock purchase programs, as well as incentive compensation based on the amount billed by individual consultants. Provide Superior Customer Service. Norstan believes its dedication to providing service beyond its customers' expectations has produced many favorable customer relationships and resulted in increased exposure to potential customers. Norstan's strong emphasis on customer satisfaction is evidenced by a survey of Norstan's communications customers, in which Norstan received an overall satisfaction rating of 93% in fiscal year 1998. The Company believes that its reputation for superior service will lead to opportunities for cross-selling additional products and services to its customer base. Offer Leading-Edge Technologies. Norstan maintains several strategic alliances with business partners that allow it to offer leading-edge technologies. IT strategic alliance partners include IBM, Siebel Systems, Oracle, Lotus, PeopleSoft, Tivoli, Novell and Microsoft. Communications strategic alliance partners include Siemens, Aspect, VTEL, PictureTel, Latitude, Cisco Systems, Sprint, Lucent Technologies (formerly Octel) and Applied Voice Technology. These strategic alliances provide the Company with access to training, product support and current technology as well as the use of the "business partner" designation in marketing the Company's products and services. The Company intends to strengthen its existing alliances and pursue additional alliances with leading technology companies. 3 6 NORSTAN'S GROWTH STRATEGY To achieve its growth objectives, the Company has adopted the following strategies: Pursue Complementary IT Services Acquisitions. To capitalize on the highly fragmented nature of the IT services industry, the Company intends to grow Norstan IT Consulting Services through acquisitions. Building on its experience of acquiring communications companies over the last ten years, Norstan has completed three acquisitions of IT services businesses since 1996. The Company will target additional acquisitions that provide complementary expertise, expand its domestic and international geographic presence, diversify its customer base and increase its consulting resources. Continue Internal Growth of Norstan IT Consulting Services. The Company seeks to continue the rapid growth of Norstan IT Consulting Services by opening branch locations in targeted geographic markets. During fiscal year 1998, Norstan IT Consulting Services generated 37.5% internal revenue growth and opened four new branch locations in Atlanta, St. Louis, Chicago and Phoenix. Norstan has targeted six to eight potential markets for future branch locations over the next twelve months. In addition, the Company intends to leverage existing communications locations through cross-selling efforts and the aggressive recruitment of IT consultants. From the June 1996 acquisition of Connect through the end of fiscal year 1998, Norstan IT Consulting Services has increased its number of consultants at a compound annual growth rate of 55.0%, excluding other acquisitions. Leverage Existing Customer Relationships. Norstan intends to grow its technology services business by leveraging the Company's existing base of over 18,000 customers. These relationships provide Norstan with significant advantages in marketing new communications and IT services and solutions. Management believes the convergence of communications and information technologies, together with the Company's high level of customer satisfaction, will position Norstan to become a preferred provider of both communications and IT solutions. PRODUCTS AND SERVICES Norstan provides customers with a single source for a broad range of communications and IT products and services to design, develop and implement technology solutions in a variety of customer environments. These products and services are delivered through three business units, Global Services, Communications Solutions and Financial Services. 4 7 Global Services. Global Services, which represented 48% of the Company's fiscal year 1998 revenues, consists of two operating groups: Norstan IT Consulting Services and Communications Services. The following table summarizes the products and services provided by these two groups. - ---------------------------------------------------------------------------------------------------- GLOBAL SERVICES - ---------------------------------------------------------------------------------------------------- NORSTAN IT CONSULTING SERVICES CATEGORY OF SERVICE DESCRIPTION OF SERVICES Business Transformation Services - Develop strategic IT plans - Provide business transformation and process reengineering consulting services - Provide information management consulting - Provide vertical industry solutions focused on the healthcare and financial services industries - ---------------------------------------------------------------------------------------------------- Enterprise Business Solutions - Customize packaged software solutions, including ERP and customer management solutions - Develop and implement call center strategies and solutions - Develop Internet/intranet/e-commerce solutions - Provide network and system strategies - ---------------------------------------------------------------------------------------------------- Information Technology Services - Design and develop applications - Provide data integration services - Perform network and messaging services - Provide operating systems and migration services - Analyze customer businesses and systems - Provide project management services for IT operations - ---------------------------------------------------------------------------------------------------- Managed Services - Manage networks and systems - Support and maintain applications - Provide support for network and client/server systems - Perform product procurement and integration - Provide standard/custom technical education and training services - Manage customer communications operations - ------------------------------------------ COMMUNICATIONS SERVICES CATEGORY OF SERVICE DESCRIPTION OF SERVICES Communications Maintenance - Provide maintenance services on customers' Services communications systems hardware - ---------------------------------------------------------------------------------------------------- Moves, Adds and Changes - Transfer telephone systems to new user locations - Add telephones or expansion cards in a telephone system - Change system and user features - ---------------------------------------------------------------------------------------------------- Long Distance Services - Offer a full range of long distance and network services - ------------------------------------------
5 8 Communications Solutions. Communications Solutions, which represented 50% of the Company's fiscal year 1998 revenues, focuses on the design, sale and implementation of communications and other technology equipment. Communications Solutions provides the following products and services: - ---------------------------------------------------------------------------------------------------- COMMUNICATIONS SOLUTIONS CATEGORY OF PRODUCT OR SERVICE DESCRIPTION OF PRODUCTS AND SERVICES Telephone Systems - Design, install and implement telephone switching systems - Supply telephone switching systems - ---------------------------------------------------------------------------------------------------- Call Center Systems - Design, install and implement call center systems - Supply call center systems - ---------------------------------------------------------------------------------------------------- Call Processing Systems - Design, install and implement voice response and voice messaging products - Supply voice response and voice messaging products - ---------------------------------------------------------------------------------------------------- Conferencing Systems - Design, install and implement conferencing systems - Provide audio, video and data conferencing products - ---------------------------------------------------------------------------------------------------- Refurbished Equipment - Refurbish and resell previously owned Siemens, Nortel, Iwatsu, Aspect and Isoetec products - ------------------------------------------
Financial Services. Financial Services, which represented 2% of the Company's fiscal year 1998 revenues, provides customers with efficient and competitive financing for the purchase or lease of products and services. Financial Services supports the sales process by offering customized lease structures that eliminate the need for third-party financing. CUSTOMERS Norstan focuses its marketing efforts on middle-market and Fortune 500 companies with complex communications and IT requirements. Norstan has served over 18,000 customers across a broad range of industries over the last three fiscal years. No single customer accounted for more than 5% of Norstan's total revenue during any of the last three fiscal years. Norstan customers during fiscal year 1998 included the following: NORSTAN IT CONSULTING SERVICES 3M Grand Metropolitan Michelin American Express Harley-Davidson Nationwide Insurance AT&T IBM State Farm Insurance British Petroleum Invacare SuperValu Cargill John Deere US Bancorp GMAC Kaiser Permanente Williams-Sonoma
COMMUNICATIONS SERVICES AND COMMUNICATIONS SOLUTIONS American Freightways Cargill Imation British Petroleum Fortis Insurance Medtronic Best Buy Harley-Davidson Marquette University CIBC IBM US Bancorp
6 9 STRATEGIC ALLIANCES The Company believes that its relationships with a wide range of leading technology companies position Norstan to deliver the appropriate solution to each customer. IT strategic alliance partners include IBM, Siebel Systems, Oracle, Lotus, PeopleSoft, Tivoli, Novell and Microsoft. In addition, Siebel Systems, a leading customer care and sales automation software provider, has recently granted Premier Consulting Partner status to Connaissance Consulting (a majority-owned Norstan affiliate). Communications strategic alliance partners include Siemens, Aspect, VTEL, PictureTel, Latitude, Cisco Systems, Sprint, Lucent Technologies (formerly Octel) and Applied Voice Technology. In addition, the Company distributes complementary communications products that fit specific segments of the marketplace. These include hybrid switching systems, personal computer-based voice processing and video conferencing systems, as well as data communications products from Novell, Newbridge, Bay Networks, Compaq, Lotus and others. Norstan has been a distributor of Siemens communications equipment since 1976 and is Siemens' largest independent distributor in North America. The current distributor agreement with Siemens, which commenced in July 1993, has been renewed through July 27, 1999 while a new distribution agreement is being negotiated. Norstan and Siemens have also renewed an agreement through July 27, 2003 under which Norstan is an authorized agent for the refurbishment and sale of previously owned Siemens equipment. SALES AND MARKETING Norstan has approximately 500 sales and marketing personnel within the United States and Canada. The sales force includes product and service specialists with expertise in IT consulting services, video conferencing, call centers, telecommunications, education and training, and other areas. These specialists partner with the sales representatives to develop integrated technology solutions to address the specific technology needs of Norstan's customers. Norstan uses several techniques to pursue new customer opportunities, including telemarketing, seminars, participation in trade shows and advertising. Norstan's sales representatives and specialists use a comprehensive approach to evaluate each customer's technology needs. The sales representative begins with a detailed analysis of the customer's current and future communications and IT systems requirements. After determining the customer's needs, the sales representative and product specialist develop a solution that satisfies current and anticipated requirements. Norstan's consulting and operations teams then work with the customer to plan the delivery and implementation of the solution and to identify required training. By planning the precise requirements of each phase of the solution delivery, Norstan's specialists are able to minimize service interruption for the customer. Norstan also provides an ongoing support program tailored to meet the customer's specific application requirements that incorporates remote diagnostics, in-field service and support, additional training and help desk support from Norstan's customer support representatives. Norstan's marketing strategy is to capture a larger portion of existing customers' communications and IT budgets and to identify and develop new customer relationships. In particular, the Company believes that its installed base of communications systems customers offers extensive opportunities for the marketing of IT consulting services. Management also believes that Norstan IT Consulting Services will be a source of additional communications business. Norstan anticipates that its high quality customer service will support ongoing marketing efforts, as satisfied customers are more likely to choose Norstan to supply additional communications and IT products and services. Also, Norstan is investing in sales management automation systems, which will further efforts to cross-sell the depth and breadth of its product offerings to existing customers. CUSTOMER SERVICE Norstan believes that providing exceptional customer service is an important element of its ability to compete effectively in the communications and IT marketplace. Norstan has invested heavily in new technology that is designed to enable the Company to resolve a substantial portion of customer support and 7 10 service issues quickly and remotely. Norstan coordinates its customer service response through three remote diagnostics and dispatch centers located in the Minneapolis, Cleveland and Toronto areas. In fiscal year 1998, these centers handled over 250,000 customer calls with approximately 46% of the service-related calls addressed remotely. Only 18% of customer calls were resolved remotely in fiscal year 1994. The Company's goal for fiscal year 1999 is to resolve in excess of 50% of service calls remotely. For calls requiring immediate on-site service and support, Norstan maintains a highly trained force of service technicians, design engineers and customer support representatives. Norstan has over 125 employees in its three remote diagnostics and dispatch centers devoted primarily to providing customer service and has 500 service technicians in the field. With Norstan's remote problem resolution capability and its highly trained staff of technicians, Norstan is able to promptly resolve customer support requests. Norstan's commitment to customer service is evidenced by a recent survey of Norstan's Communications Solutions customers that found an overall satisfaction rating of 93% in fiscal year 1998. LOCATIONS The Company currently supports its Norstan IT Consulting Services, Communications Services and Communications Solutions customers with locations in the United States and Canada. Norstan IT Consulting Services plans to add approximately six to eight additional locations during fiscal year 1999. The Company maintains the following 68 locations in 58 cities: NORSTAN IT CONSULTING SERVICES Atlanta, GA Baltimore, MD Champaign, IL Charlotte, NC Chicago, IL Cincinnati, OH Cleveland, OH Columbia, SC Columbus, OH Denver, CO Des Moines, IA Greensboro, NC Greenville, SC Indianapolis, IN Milwaukee, WI Minneapolis, MN Omaha, NE Phoenix, AZ Pittsburgh, PA Raleigh, NC Richmond, VA San Francisco, CA St. Louis, MO COMMUNICATIONS SERVICES AND COMMUNICATIONS SOLUTIONS Albuquerque, NM Amarillo, TX Appleton, WI Austin, TX Baton Rouge, LA Birmingham, AL Calgary, Alberta Cedar Rapids, IA Chicago, IL Cincinnati, OH Cleveland, OH Columbus, OH Davenport, IA Dayton, OH Des Moines, IA Edmonton, Alberta El Paso, TX Fargo, ND Las Vegas, NV Lexington, KY Little Rock, AR London, Ontario Louisville, KY Lubbock, TX Madison, WI Milwaukee, WI Minneapolis, MN Mobile, AL Montreal, Quebec New Orleans, LA Oklahoma City, OK Omaha, NE Ottawa, Ontario Phoenix, AZ Pittsburgh, PA Rochester, MN Shreveport, LA Sioux Falls, SD Springdale, AR Toledo, OH Toronto, Ontario Tucson, AZ Tulsa, OK Vancouver, British Columbia Winnipeg, Manitoba HUMAN RESOURCES As of June 30, 1998, Norstan had 2,971 employees, of which over 700 were IT consulting personnel and approximately 840 were communications field technicians and service consultants. U.S. operations totaled 8 11 2,749 employees, including 135 who are covered by collective bargaining agreements. The Company's Canadian operations had a total of 222 employees. The Company's success depends in large part on its ability to attract, develop, motivate and retain highly skilled IT consultants. Qualified technical employees are in great demand and are likely to remain a limited resource for the foreseeable future. To retain these resources, Norstan places a strong emphasis on the career development and training of its IT consultants and has implemented several unique programs, including its Team Manager initiative. Team Managers ensure that employee skills remain current with the industry and that the employee is given adequate development experiences to create a fulfilling work environment. Norstan also offers a competitive combination of employee benefits and incentives, including employee stock options, stock purchase programs and an attractive revenue-sharing arrangement whereby an individual consultant's base compensation is supplemented with a percentage of the revenue that the individual bills. Finally, Norstan IT Consulting Services has developed a proprietary program in which key individuals in the organization are charged with and rewarded for the successful opening of new branch office locations. This program helps Norstan IT Consulting Services retain personnel and expand its geographic reach. Norstan also dedicates significant resources to recruiting consultants with specific technical and industry expertise. In connection with its hiring efforts, the Company employs internal recruiters and relies on personal and business contacts to recruit professionals through referrals, contacts at trade shows and job fairs. The Company uses formal training programs to further develop its professional resources. The Company also uses mentoring by placing junior IT professionals under the guidance of senior IT professionals on certain customer engagements. In addition, in order to expand the skills and develop the careers of the Company's consultants and technical staff, the Company recently introduced computer-based training resources covering 450 course topics. COMPETITION The communications industry is intensely competitive and rapidly changing. Norstan's primary competitors in this area include Lucent Technologies, Nortel and the RBOCs. Many of its competitors have longer operating histories, greater financial and human resources, and greater name recognition than Norstan. The passage of the Telecommunications Act of 1996 has fostered competition by providing access to a number of entities that were previously precluded from the industry. As a result of this legislation, the pace of consolidation in the industry has accelerated. These changes in the regulatory environment could potentially affect Norstan's ability to compete successfully. The market for IT services includes a large number of competitors, is subject to rapid change and is highly competitive. Primary competitors include participants from a variety of market segments, including national accounting firms, systems consulting and implementation firms, application software firms, service groups of computer equipment companies, facilities management companies, general management consulting firms and programming companies. Many of these competitors have significantly greater financial, technical and marketing resources and greater name recognition than the Company. In addition, the Company competes with its customers' internal resources, particularly when these resources represent a fixed cost to the customer. Such competition may impose additional pricing pressures on the Company. See "Risk Factors -- Competition." Subject to this competitive environment, the Company competes on the basis of: (i) the depth and breadth of services and products offered; (ii) the ability to integrate IT and communications systems as the related technologies continue to converge; (iii) its reputation for providing superior customer service; and (iv) the number and strength of customer relationships. INTELLECTUAL PROPERTY RIGHTS The Company relies upon a combination of nondisclosure and other contractual arrangements with certain key employees, and trade secret, copyright and trademark laws to protect its proprietary rights and the proprietary rights of third parties from whom the Company licenses intellectual property. Norstan enters into 9 12 confidentiality agreements with certain of its employees and limits the distribution of proprietary information. See "Risk Factors -- Limited Protection of Intellectual Property Rights." GOVERNMENT REGULATION Except for the sale of long distance service, the Company is not subject to any government regulations that have a material impact on its operations. Effective May 1, 1992, the Company became a direct reseller of long distance network services and accordingly became subject to certain state tariff regulations throughout the United States. The Company is currently registered and certified to provide interstate services in all 50 states and intrastate services in 47 states. The Company is also subject to FCC regulations, which require the filing of federal tariffs. BACKLOG As of April 30, 1998, the Company had signed contracts for telecommunications products aggregating approximately $46.2 million, substantially all of which are expected to be fulfilled by the end of fiscal 1999. As of April 30, 1997, the Company had signed contracts aggregating approximately $47.3 million, substantially all of which were fulfilled by the end of fiscal 1998. The usual time period between the execution of a contract and the completion of the installation is one to six months, depending on the size and complexity of the system. 10 13 ITEM 2. PROPERTIES. The executive offices of the Company are located in Plymouth, Minnesota, where the Company leases approximately 53,400 square feet of office space. The Company expects to move into new headquarters located in Hopkins, Minnesota in the quarter ending October 31, 1998. The Company leases approximately 165,000 square feet of office space in this new location. The Company also has area headquarters in Brecksville, Ohio, and Phoenix, Arizona, where the Company leases approximately 61,250 and 34,400 square feet of office space, respectively. In addition to the space above, the Company leases sales and service offices in 47 other cities within the United States. In Canada, the Company leases approximately 30,400 square feet of office space in North York, Ontario, which serves as its Canadian headquarters. The Company also leases sales and service offices in seven other cities within the Canadian provinces of Alberta, Manitoba, Ontario, Quebec and British Columbia. The Company believes that the above-mentioned facilities are adequate and suitable for its current needs. ITEM 3. LEGAL PROCEEDINGS. The Company is involved in legal actions in the ordinary course of its business. Although the outcomes of any such legal actions 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 business, operating results and financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company did not submit any matters to a vote of security holders during the last quarter of the fiscal year covered by this report. 11 14 PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. PRICE RANGE OF COMMON STOCK The Company's common stock is traded on the National Over-the-Counter market and is listed on the national market system of the National Association of Securities Dealers' Automated Quotations System ("NASDAQ") under the symbol "NRRD". The following table sets forth the high and low sale prices for the Company's common stock as reported by NASDAQ for each quarterly period during the two most recent fiscal years(1):
HIGH LOW ---- --- FISCAL YEAR ENDED APRIL 30, 1998: First Quarter............................................... 18 1/2 14 Second Quarter.............................................. 25 1/2 17 1/2 Third Quarter............................................... 25 1/2 22 Fourth Quarter.............................................. 29 21 7/8 FISCAL YEAR ENDED APRIL 30, 1997: First Quarter............................................... 19 1/2 13 1/8 Second Quarter.............................................. 20 1/4 15 Third Quarter............................................... 18 3/4 15 1/2 Fourth Quarter.............................................. 17 1/4 13 3/4
The quotations reflect prices between dealers and do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. As of July 27, 1998, there were 4,239 holders of record of the Company's common stock. RESTRICTIONS ON THE PAYMENT OF DIVIDENDS The Company has not recently declared or paid any cash dividends on the common stock and does not intend to pay cash dividends on the common stock in the foreseeable future. The Company currently expects to retain earnings to finance expansion of its business. In addition, the Company's current revolving long-term credit agreement prohibits the payment of cash dividends without the prior written consent of the lenders thereunder. ISSUANCE OF UNREGISTERED SECURITIES The Company issued 151,515 unregistered shares of its common stock on January 2, 1998 in connection with the Company's acquisition of PRIMA. A portion of such shares were derivated into an escrow account established to provide a source of payment for indemnification claims made by the Company, if any. The escrow account will close on March 31, 1999 and all shares of the Company's common stock remaining there, if any, will be distributed to the registered holders. During the escrow period, registered holders have all the rights of a shareholder, including the right to vote such shares, however, they many not sell, transfer, pledge or otherwise encumber the shares. Such shares were issued pursuant to Regulation D promulgated by the Securities and Exchange Commission under the authority of the Securities Act of 1933, as amended. 12 15 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA. The selected consolidated financial data set forth below as of and for each of the fiscal years in the five-year period ended April 30, 1998 have been derived from the Company's consolidated financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. The selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the notes thereto included elsewhere in this report.
FISCAL YEARS ENDED APRIL 30, ---------------------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenues: Global Services IT Consulting Services............................. $ -- $ 7,931 $ 14,426 $ 54,467 $ 92,746 Communications Services............................ 100,080 110,638 121,971 131,596 127,197 -------- -------- -------- -------- -------- Total Global Services............................ 100,080 118,569 136,397 186,063 219,943 Communications Solutions............................. 127,514 166,675 179,332 205,983 228,979 Financial Services................................... 4,305 5,001 5,635 6,029 7,443 -------- -------- -------- -------- -------- Total revenues................................... 231,899 290,245 321,364 398,075 456,365 -------- -------- -------- -------- -------- Cost of sales: Global Services IT Consulting Services............................. -- 6,417 11,000 43,315 66,457 Communications Services............................ 61,289 70,224 86,669 93,880 89,550 -------- -------- -------- -------- -------- Total Global Services............................ 61,289 76,641 97,669 137,195 156,007 Communications Solutions............................. 92,621 123,158 130,090 150,204 168,965 Financial Services................................... 1,766 2,308 2,221 2,160 2,444 -------- -------- -------- -------- -------- Total cost of sales.............................. 155,676 202,107 229,980 289,559 327,416 -------- -------- -------- -------- -------- Gross margin........................................... 76,223 88,138 91,384 108,516 128,949 Selling, general and administrative expenses........... 65,137 74,725 75,973 89,311 103,709 Restructuring charge................................... -- -- -- -- 14,667 -------- -------- -------- -------- -------- Operating income....................................... 11,086 13,413 15,411 19,205 10,573 Interest expense....................................... (832) (1,587) (1,351) (1,866) (3,909) Interest and other income (expense), net............... (106) (54) 89 (22) (18) -------- -------- -------- -------- -------- Income before cumulative effect of accounting change and provision for income taxes....................... 10,148 11,772 14,149 17,317 6,646 Provision for income taxes............................. 4,161 4,709 5,660 7,100 2,791 -------- -------- -------- -------- -------- Income before cumulative effect of accounting change... 5,987 7,063 8,489 10,217 3,855 Cumulative effect of change in accounting for income taxes (1)............................................ (375) -- -- -- -- -------- -------- -------- -------- -------- Net income............................................. $ 5,612 $ 7,063 $ 8,489 $ 10,217 $ 3,855 ======== ======== ======== ======== ======== Net income per share -- Basic.......................... $0.70 $0.86 $1.00 $1.12 $0.40 ======== ======== ======== ======== ======== Net income per share -- Diluted........................ $0.67 $0.82 $0.94 $1.08 $0.39 ======== ======== ======== ======== ======== Weighted average shares -- Basic....................... 8,017 8,242 8,526 9,140 9,719 ======== ======== ======== ======== ======== Weighted average shares -- Diluted..................... 8,402 8,621 8,985 9,418 9,917 ======== ======== ======== ======== ========
AS OF APRIL 30, ---------------------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital........................................ $ 32,961 $ 32,183 $ 24,899 $ 37,484 $ 58,568 Total assets........................................... 149,662 161,709 160,988 224,173 275,608 Long-term debt, net of current maturities.............. 18,218 16,465 -- 18,284 52,440 Discounted lease rentals, net of current maturities.... 18,845 16,313 15,961 24,043 20,883 Shareholders' equity................................... 47,658 56,984 67,517 84,370 97,671 Cash dividends declared and paid....................... -- -- -- -- --
- ------------------------- (1) On May 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." As a result, the Company recorded a one-time charge of $375,000, or $.05 per share, in fiscal 1994 for the cumulative effect of the change in method of accounting for income taxes. (2) On June 20, 1996, the Company's Board of Directors approved a two-for-one stock split effected in the form of a stock dividend. The stock split has been retroactively reflected in the selected consolidated financial data presented above. 13 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Norstan is a technology services company providing IT and communications systems solutions to over 18,000 customers in the United States, Canada and England. Headquartered in Minneapolis, Minnesota, with sales and service offices located in 68 locations in the United States and Canada, the Company sells its products and services to a wide variety of customers across numerous industries. The Company provides IT consulting and communications services, communications and technology products and financing alternatives through its three business units, Global Services, Communications Solutions (formerly known as Communications Systems) and Financial Services, which accounted for approximately 48%, 50% and 2% of Norstan's fiscal year 1998 revenues, respectively. In order to enhance overall profitability, the Company intends to increase its percentage of revenues derived from technology services, which typically command higher margins than product sales. Due to the Company's continuing expansion and growth in the area of IT consulting services, financial results for Global Services are now reported as: (i) IT Consulting Services and (ii) Communications Services. Norstan IT Consulting Services provides IT services including ERP and sales management package implementation, groupware consulting, Internet/intranet/e-commerce solutions, CTI and outsourced facilities management. Communications Services provides customer support services for communications systems, including maintenance services, systems modifications and long distance services. Communications Solutions provides a broad array of solutions including telephone systems, integrated voice processing, call center technologies and video/audio/data conferencing solutions. The name change from Communications Systems to Communications Solutions more accurately reflects the Company's commitment to provide its customers with design, installation and implementation services as well as the hardware and software components necessary for successful implementation of complex communications systems. Financial Services supports the sales process by providing customized financing alternatives. The Company believes that its breadth of product and service offerings fosters long-term client relationships, affords cross-selling opportunities and minimizes the Company's dependence on any single technology or industry. During fiscal year 1998, Norstan recorded a restructuring charge of $14.7 million in connection with management's plan to reduce costs, consolidate and reorganize operations, and improve operating efficiencies. Restructuring efforts focused primarily on the following: (i) consolidation of seven semi-autonomous geographic sales and service organizations into a single, more focused sales and operations organization; (ii) the consolidation of 36 warehouses and parts locations into three strategically located distribution centers; and (iii) the reorganization and integration of the Company's IT consulting services operations, including the Norstan Call Center Solutions Group, Connect and PRIMA, into a single, customer-focused organization. The restructuring charge relates primarily to the write-down of certain assets to their fair market values ($12.2 million), severance and employee benefit costs ($1.2 million) and lease termination costs ($1.3 million). Net income and net income per diluted share before the restructuring charge for the year ended April 30, 1998 were $12,362,000 and $1.25 per share, respectively. 14 17 RESULTS OF OPERATIONS The following table sets forth certain items from the Company's consolidated statements of operations expressed as a percentage of total revenues:
YEARS ENDED APRIL 30, ----------------------------- 1996 1997 1998 Revenues: Global Services IT Consulting Services................................. 4.5% 13.7% 20.3% Communications Services................................ 37.9 33.0 27.9 ----- ----- ----- Total Global Services................................ 42.4 46.7 48.2 Communications Solutions.................................. 55.8 51.8 50.2 Financial Services........................................ 1.8 1.5 1.6 ----- ----- ----- Total revenues......................................... 100.0 100.0 100.0 Cost of sales: Global Services IT Consulting Services................................. 3.4 10.9 14.6 Communications Services................................ 27.0 23.6 19.6 ----- ----- ----- Total Global Services................................ 30.4 34.5 34.2 Communications Solutions.................................. 40.5 37.7 37.0 Financial Services........................................ 0.7 0.5 0.5 ----- ----- ----- Total cost of sales.................................... 71.6 72.7 71.7 ----- ----- ----- Gross margin................................................ 28.4 27.3 28.3 Selling, general and administrative expenses................ 23.6 22.5 22.8 Restructuring charge........................................ -- -- 3.2 ----- ----- ----- Operating income............................................ 4.8% 4.8% 2.3% ===== ===== ===== Net income.................................................. 2.6% 2.6% 0.8% ===== ===== =====
The following table sets forth the gross margin percentages for Global Services, Communications Solutions and Financial Services.
YEARS ENDED APRIL 30, -------------------------- 1996 1997 1998 Gross margin percentage: Global Services IT Consulting Services................................. 23.7% 20.5% 28.3% Communications Services................................ 28.9 28.7 29.6 Total Global Services................................ 28.4 26.3 29.1 Communications Solutions.................................. 27.5 27.1 26.2 Financial Services........................................ 60.6 64.2 67.2
FISCAL 1998 COMPARED TO FISCAL 1997 Revenues. Revenues increased 14.6% to $456.4 million in fiscal year 1998 from $398.1 million in fiscal year 1997. The increase was attributable to growth in each of Norstan's three business units. Revenues from Global Services increased 18.2% to $219.9 million in fiscal year 1998 from $186.1 million in fiscal year 1997. Revenues from IT Consulting Services increased 70.3% to $92.7 million in fiscal year 1998 from $54.5 million in fiscal year 1997. This increase was a result of: (i) the acquisition of PRIMA in September 1997 which contributed $17.9 million of revenue in fiscal year 1998; and (ii) internal revenue growth of 37.5%. Revenues from Communications Services decreased 3.3% to $127.2 million in fiscal year 1998 from $131.6 million in fiscal year 1997. The decrease in Communications Services revenues resulted from the sale of the Company's stand-alone cabling business in June 1997, which contributed approximately $5.0 million in revenues during fiscal year 1997. 15 18 Revenues from Communications Solutions increased 11.2% to $229.0 million in fiscal year 1998 from $206.0 million in fiscal year 1997. The increase was attributable to increased sales volumes in the Siemens PBX, videoconferencing and refurbished equipment products through sales to new customers as well as growth with existing customer relationships. Revenues from Financial Services increased 23.5% to $7.4 million in fiscal year 1998 from $6.0 million in fiscal year 1997. This increase is primarily attributable to the increased size of the Company's leasing base. Gross Margin. The Company's gross margin was $128.9 million and $108.5 million for the fiscal years ended April 30, 1998 and 1997, respectively. As a percent of total revenues, gross margin was 28.3% for fiscal year 1998 compared to 27.3% for fiscal year 1997. Gross margin as a percent of revenues for Global Services was 29.1% for fiscal year 1998 as compared to 26.3% for fiscal year 1997. The gross margin for IT Consulting Services increased to 28.3% for fiscal year 1998 from 20.5% for fiscal year 1997. The improved margin is a result of operating efficiencies gained as the IT Consulting Services segment continued to grow as well as from an increased emphasis on time-and-materials engagements. The gross margin for Communications Services increased to 29.6% for fiscal year 1998 from 28.7% for fiscal year 1997. Gross margin as a percent of revenues for Communications Solutions was 26.2% for fiscal year 1998 as compared to 27.1% for fiscal year 1997. The decrease in gross margin for fiscal year 1998 as compared to fiscal year 1997 is primarily due to overall increases in product costs as a result of changes in the sales mix and increased labor costs from subcontractors and overtime due to the high level of installations during 1998. The overall decline in gross margin was partially offset by improved margin in the sales of refurbished equipment. Gross margin as a percent of revenues for Financial Services was 67.2% for fiscal year 1998 as compared to 64.2% for fiscal year 1997. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 16.1% to $103.7 million in fiscal year 1998 from $89.3 million in fiscal year 1997. As a percent of revenues, selling, general and administrative expenses remained relatively consistent at 22.7% for fiscal year 1998, as compared to 22.4% for fiscal year 1997. Restructuring Charge. During fiscal year 1998, Norstan recorded a restructuring charge of $14.7 million in connection with management's plan to reduce costs, consolidate and reorganize operations, and improve operating efficiencies. Restructuring efforts focused primarily on the following: (i) consolidation of seven semi-autonomous geographic sales and service organizations into a single, more focused sales and operations organization; (ii) the consolidation of 36 warehouses and parts locations into three strategically located distribution centers; and (iii) the reorganization and integration of the Company's IT consulting services operations, including the Norstan Call Center Solutions Group, Connect and PRIMA, into a single, customer- focused organization. The restructuring charge relates primarily to the write-down of certain assets to their fair market values ($12.2 million), severance and employee benefit costs ($1.2 million) and lease termination costs ($1.3 million). Interest Expense. Interest expense was $3.9 million for fiscal year 1998 as compared to $1.9 million for fiscal year 1997. This increase was primarily the result of higher borrowing levels in fiscal year 1998 to fund the PRIMA acquisition as well as for working capital purposes. Average month-end borrowings outstanding under the Company's revolving long-term credit agreements (excluding amounts borrowed to finance leasing activities) were $53.2 million for fiscal year 1998 and $24.5 million for fiscal year 1997. Weighted average interest rates under the Company's revolving long-term credit agreements were 7.0% for fiscal year 1998 as compared to 7.5% for fiscal year 1997. Income Taxes. The Company's effective income tax rate was 42% for fiscal year 1998 and 41% for fiscal year 1997. The Company's effective tax rate differs from the federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization. Net Income. Net income was $3.9 million or $0.39 per diluted share in fiscal year 1998, which includes the $14.7 million restructuring charge representing $0.86 per diluted share, as compared to $10.2 million or 16 19 $1.08 per diluted share in fiscal year 1997. Net income and net income per diluted share before the restructuring charge for the year ended April 30, 1998 were $12,362,000 and $1.25 per share, respectively. FISCAL 1997 COMPARED TO FISCAL 1996 Revenues. Total revenues increased 23.9% to $398.1 million in fiscal year 1997 from $321.4 million in fiscal year 1996. Revenues from Global Services increased 36.4% to $186.1 million in fiscal year 1997 from $136.4 million in fiscal year 1996. Revenues from IT Consulting Services increased 277.6% to $54.5 million in fiscal year 1997 from $14.4 million in fiscal year 1996. This increase was a result of the acquisition of Connect in June 1996, which contributed $33.8 million of revenue in fiscal year 1997, and the over 70% growth experienced in the Company's outsourcing business. Revenues from Communications Services increased 7.9% to $131.6 million in fiscal year 1997 from $122.0 million in fiscal year 1996, due primarily to growth in communications maintenance services and network services. Revenues from Communications Solutions increased 14.9% to $206.0 million in fiscal year 1997 from $179.3 million in fiscal year 1996. The increase resulted primarily from increased sales volume of refurbished equipment and videoconferencing products. Revenues from Financial Services increased 7.0% to $6.0 million in fiscal year 1997 from $5.6 million in fiscal year 1996. The increase was attributable to the increased size of the Company's leasing base. Gross Margin. The Company's gross margin was $108.5 million in fiscal year 1997 and $91.4 million in fiscal year 1996. As a percent of total revenues, gross margin was 27.3% for fiscal year 1997 and 28.4% for fiscal year 1996. Gross margin as a percent of revenues for Global Services was 26.3% for fiscal year 1997 compared to 28.4% for fiscal year 1996. The gross margin for IT Consulting Services decreased to 20.5% for fiscal year 1997 from 23.7% for fiscal year 1996. This decrease is primarily attributable to non-recurring operating costs and inefficiencies relating to the reorganization of the Company's IT consulting operations as well as from decreased margins on certain fixed-price contracts. Communications Services' gross margin remained relatively constant at 28.7% for fiscal year 1997 as compared to 28.9% for fiscal year 1996. Gross margin as a percent of revenues for Communications Solutions was 27.1% for fiscal year 1997 as compared to 27.5% for fiscal year 1996. The change in the gross margin as a percentage of revenue was the result of shifts in the product mix and competitive market conditions. Gross margin as a percent of revenues for Financial Services was 64.2% for fiscal year 1997 as compared to 60.6% for fiscal year 1996. The increase in gross margin percentage for fiscal year 1997 as compared to fiscal year 1996 was the result of decreasing interest rates. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 17.6% to $89.3 million in fiscal year 1997 from $76.0 million in fiscal year 1996. As a percent of revenues, selling, general and administrative expenses decreased to 22.4% for fiscal year 1997 from 23.6% for fiscal year 1996. The decrease as a percentage of revenues resulted from continued efforts to contain costs and volume-related efficiencies, as sales volume increased without proportional increases in expenses. Interest Expense. Interest expense was $1.9 million for fiscal year 1997 as compared to $1.4 million for fiscal year 1996. Weighted average interest rates under the Company's revolving long-term credit agreements were 7.5% for fiscal year 1997 as compared to 8.2% for fiscal year 1996. Average month-end borrowings outstanding under the Company's revolving long-term credit agreements (excluding amounts borrowed to finance leasing activities) were $24.5 million for fiscal year 1997 and $15.8 million for fiscal year 1996. Income Taxes. The Company's effective income tax rate was 41% for fiscal year 1997 and 40% for fiscal year 1996. The Company's effective tax rate differs from the federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization. 17 20 Net Income. Net income was $10.2 million or $1.08 per diluted share in 1997 and $8.5 million or $0.94 per diluted share in 1996. UNAUDITED QUARTERLY RESULTS The following table sets forth certain unaudited quarterly operating information for each of the eight quarters in the period ending April 30, 1998. This data includes, in the opinion of management, all normal recurring adjustments necessary for the fair presentation of the information for the periods presented when read in conjunction with the Company's Consolidated Financial Statements and related Notes thereto. Results for any previous fiscal quarter are not necessarily indicative of results for the full year or for any future quarter. The Company has historically experienced a seasonal fluctuation in its operating results, with a larger proportion of its revenues and operating income occurring during the fourth quarter of the fiscal year.
QUARTERS ENDED -------------------------------------------------------------------------------- AUG. 3, NOV. 2, FEB. 1, APR. 30, AUG. 2, NOV. 1, JAN. 31, APR. 30, 1996 1996 1997 1997 1997 1997 1998 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues: Global Services IT Consulting Services...... $ 9,363 $13,682 $15,328 $16,094 $15,026 $22,038 $25,186 $30,496 Communications Services..... 31,562 32,076 31,918 36,040 33,023 30,508 30,968 32,698 ------- ------- ------- ------- ------- ------- ------- ------- Total Global Services..... 40,925 45,758 47,246 52,134 48,049 52,546 56,154 63,194 Communications Solutions...... 49,820 48,483 45,405 62,275 45,212 56,719 53,979 73,069 Financial Services............ 1,486 1,412 1,424 1,707 2,181 1,657 1,634 1,971 ------- ------- ------- ------- ------- ------- ------- ------- Total revenues............ 92,231 95,653 94,075 116,116 95,442 110,922 111,767 138,234 Cost of sales................... 66,900 68,548 68,014 86,097 68,356 80,488 79,861 98,711 ------- ------- ------- ------- ------- ------- ------- ------- Gross margin.................... 25,331 27,105 26,061 30,019 27,086 30,434 31,906 39,523 Selling, general and administrative expenses....... 22,180 21,944 20,935 24,252 23,157 24,399 24,923 31,230 Restructuring charge............ -- -- -- -- -- -- -- 14,667 ------- ------- ------- ------- ------- ------- ------- ------- Operating income (loss)......... 3,151 5,161 5,126 5,767 3,929 6,035 6,983 (6,374) Interest expense................ (241) (520) (571) (534) (594) (847) (1,242) (1,226) Interest and other income (expense)..................... 7 (28) (11) 10 48 69 55 (190) ------- ------- ------- ------- ------- ------- ------- ------- Income (loss) before income taxes......................... 2,917 4,613 4,544 5,243 3,383 5,257 5,796 (7,790) Income taxes.................... 1,225 1,937 1,829 2,109 1,387 2,155 2,521 (3,272) ------- ------- ------- ------- ------- ------- ------- ------- Net income (loss)............... $ 1,692 $ 2,676 $ 2,715 $ 3,134 $ 1,996 $ 3,102 $ 3,275 $(4,518) ======= ======= ======= ======= ======= ======= ======= ======= Net income before restructuring charge........................ $ 3,991 ======= Net income (loss) per share -- diluted....................... $ 0.19 $ 0.29 $ 0.29 $ 0.33 $ 0.21 $ 0.32 $ 0.33 $ (0.45) ======= ======= ======= ======= ======= ======= ======= ======= Net income per share before restructuring charge -- diluted....................... $ 0.39 =======
LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities decreased in fiscal year 1998 as compared to fiscal years 1997 and 1996 as a result of increases in accounts receivable, costs and estimated earnings in excess of billings and income taxes receivable. Net cash used in investing activities remained constant in fiscal years 1998 and 1997 and increased from fiscal year 1996 as a result of increased capital expenditures and investments in lease contracts, as noted below, and due to acquisitions during 1998 and 1997. Net cash provided by financing activities increased during fiscal years 1998 and 1997 as compared to 1996 due to increased long-term borrowings related to acquisitions and to support the overall growth of the Company. Capital Expenditures. The Company used $19.9 million for capital expenditures during fiscal year 1998 as compared to $24.2 million in fiscal year 1997 and $14.4 million in fiscal year 1996. These expenditures were 18 21 primarily for capitalized costs incurred in connection with obtaining or developing internal use software, computer equipment, facility expansion and telecommunications equipment used in outsourcing arrangements and as spare parts. Investment in Lease Contracts. The Company has also made a significant investment in lease contracts with its customers. The additional investment made in lease contracts in fiscal year 1998 totaled $28.0 million. Net lease receivables increased to $53.7 million at April 30, 1998 from $49.4 million at April 30, 1997. The Company utilizes its lease receivables and corresponding underlying equipment to borrow funds from financial institutions on a nonrecourse or recourse 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 $35.6 million at April 30, 1998. Interest rates on these credit agreements at April 30, 1998 ranged from 6.0% to 10.0%, while payments are due in varying monthly installments through August 2005. Payments due to financial institutions are made from monthly collections of lease receivables from customers. Capital Resources. The Company has an $80.0 million unsecured revolving long-term credit agreement with certain banks. Up to $30.0 million of borrowings under this agreement may be in the form of commercial paper. In addition, sublimits also exist related to the Company's support of its leasing activities. Borrowings under this agreement are due May 31, 2001, and bear interest at the banks' reference rate (8.50% at April 30, 1998), except for LIBOR, CD and commercial paper based options, which generally bear interest at a rate lower than the banks' reference rate (5.9% to 6.7% at April 30, 1998). Total consolidated borrowings under this agreement at April 30, 1997 and 1998 were $17.9 million and $52.4 million. There were no borrowings on account of the Company's leasing activities at April 30, 1997 and 1998. Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the agreement, the Company is required to maintain minimum levels of EBITDA and certain other financial ratios. The Company has complied with or has obtained the appropriate waivers for such requirements as of April 30, 1998. Management of the Company believes that a combination of cash generated from operations, existing bank facilities and additional borrowing capacity, in aggregate, are adequate to meet the anticipated liquidity and capital resource requirements of its business. Sources of additional financing, if needed, may include further debt financing, or the sale of equity or other securities. ACQUISITIONS On June 19, 1998, the Company merged with Wordlink in a transaction accounted for under the pooling-of-interests method. Wordlink delivers network integration, groupware messaging, Internet/intranet/ e-commerce and education solutions to customers operating in a multi-vendor network environment. The agreement provided for the conversion of all shares of Wordlink common stock and all vested Wordlink stock options issued and outstanding into approximately $10.3 million of Common Stock. All outstanding Wordlink unvested stock options were converted to the equivalent value of Norstan stock options. Wordlink's stockholders' equity and operating results were not material in relation to the Company's financial statements. As such, the Company will record the combination without restating prior periods' consolidated statements of operations to reflect the pooling-of-interests combination. On September 30, 1997, the Company acquired PRIMA in a transaction accounted for under the purchase method. PRIMA provides IT consulting services, including information systems planning and development, consulting and programming services for collaborative computing solutions, and ERP integration services. The acquisition consideration totaled approximately $27.5 million, consisting of $19.5 million in cash, $6.3 million of Common Stock and $1.7 million paid to certain members of PRIMA management under non-compete agreements. In addition, the Company agreed to pay up to $3.5 million in contingent consideration over a three-year period ending April 30, 2000 if certain financial performance targets are achieved. This transaction resulted in the recording of $24.9 million in goodwill and other intangible assets that are being amortized on a straight-line basis over 15 years and three years, respectively. On June 4, 1996, the Company acquired Connect in a transaction accounted for under the purchase method. Connect is a provider of consulting, design and implementation services for local and wide area networks, Internets and intranets, client/server applications and workgroup computing. The acquisition 19 22 consideration totaled approximately $15.0 million, consisting of $12.0 million in cash, $2.0 million of Common Stock and $1.0 million payable to certain members of Connect management under non-compete agreements. In addition, the Company agreed to pay up to $4.0 million in contingent consideration over a three-year period ending April 30, 1999, if certain financial performance targets are achieved (as of April 30, 1998, $2.0 million of such consideration had been paid and the remaining $2.0 million has been earned and accrued). This transaction resulted in the recording of $18.4 million in goodwill and other intangible assets that are being amortized on a straight-line basis over 15 years and three years, respectively. IMPACT OF YEAR 2000 The Company has completed an assessment and will modify or replace portions of its hardware and software so that its computer systems will function properly with respect to dates in 2000 and thereafter. The Company has also had discussions with its significant suppliers to ensure that those parties have appropriate plans to remediate Year 2000 issues where their systems and products interface with the Company's systems or otherwise impact its operations or that of its customers. The Company is assessing the extent to which its operations are vulnerable should those organizations fail to properly remediate either their computer systems or their current product offerings available to the Company's customers. The Company's comprehensive Year 2000 initiative is being managed by a team of internal staff with the assistance of an outside consultant. The Company is well under way with its efforts, which are scheduled to be completed by mid-1999. The cost of the Year 2000 initiative is estimated to be approximately $2 million to be incurred over the next two fiscal years. While the Company believes its planning efforts are adequate to address its Year 2000 concerns, the Year 2000 readiness of the Company's customers, and the hardware and software offerings from the Company's suppliers and business partners may vary. Although the Company does not believe that the Year 2000 matters discussed above will have a material impact on its business, financial condition and results of operations, it is uncertain as to what extent the Company may be affected by such matters. FORWARD-LOOKING STATEMENTS From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, Year 2000 compliance 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: national and regional economic conditions; pending and future legislation affecting the IT and telecommunications industries; the Company's business in Canada and England; stability of foreign governments; market acceptance of the Company's products and services; the Company's continued ability to provide integrated communications 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. 20 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE CONSOLIDATED FINANCIAL STATEMENTS: Report of Independent Public Accountants.................... 22 Consolidated Statements of Operations for the years ended April 30, 1996, 1997 and 1998............................. 23 Consolidated Balance Sheets as of April 30, 1997 and 1998... 24 Consolidated Statements of Shareholders' Equity for the years ended April 30, 1996, 1997 and 1998................. 25 Consolidated Statements of Cash Flows for the years ended April 30, 1996, 1997 and 1998............................. 26 Notes to Consolidated Financial Statements.................. 27
FINANCIAL STATEMENT SCHEDULES: All schedules have been omitted as not required, not applicable or because the information to be presented is included in the consolidated financial statements and related notes. 21 24 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Norstan, Inc.: We have audited the accompanying consolidated balance sheets of Norstan, Inc. (a Minnesota corporation) and Subsidiaries as of April 30, 1997 and 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended April 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Norstan, Inc. and Subsidiaries as of April 30, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 1998 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, June 12, 1998 22 25 NORSTAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED APRIL 30, ------------------------------ 1996 1997 1998 REVENUES Global Services IT Consulting Services................................. $ 14,426 $ 54,467 $ 92,746 Communications Services................................ 121,971 131,596 127,197 -------- -------- -------- Total Global Services................................ 136,397 186,063 219,943 Communications Solutions.................................. 179,332 205,983 228,979 Financial Services........................................ 5,635 6,029 7,443 -------- -------- -------- Total revenues......................................... 321,364 398,075 456,365 -------- -------- -------- COST OF SALES Global Services IT Consulting Services................................. 11,000 43,315 66,457 Communications Services................................ 86,669 93,880 89,550 -------- -------- -------- Total Global Services................................ 97,669 137,195 156,007 Communications Solutions.................................. 130,090 150,204 168,965 Financial Services........................................ 2,221 2,160 2,444 -------- -------- -------- Total cost of sales.................................... 229,980 289,559 327,416 -------- -------- -------- GROSS MARGIN................................................ 91,384 108,516 128,949 Selling, general and administrative expenses.............. 75,973 89,311 103,709 Restructuring charge...................................... -- -- 14,667 -------- -------- -------- OPERATING INCOME............................................ 15,411 19,205 10,573 Interest expense.......................................... (1,351) (1,866) (3,909) Interest and other income (expense), net.................. 89 (22) (18) -------- -------- -------- INCOME BEFORE PROVISION FOR INCOME TAXES.................... 14,149 17,317 6,646 Provision for income taxes................................ 5,660 7,100 2,791 -------- -------- -------- NET INCOME.................................................. $ 8,489 $ 10,217 $ 3,855 ======== ======== ======== NET INCOME PER SHARE -- BASIC............................... $ 1.00 $ 1.12 $ 0.40 ======== ======== ======== NET INCOME PER SHARE -- DILUTED............................. $ 0.94 $ 1.08 $ 0.39 ======== ======== ======== WEIGHTED AVERAGE SHARES -- BASIC............................ 8,526 9,140 9,719 ======== ======== ======== WEIGHTED AVERAGE SHARES -- DILUTED.......................... 8,985 9,418 9,917 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 23 26 NORSTAN, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
AS OF APRIL 30, -------------------- 1997 1998 ASSETS CURRENT ASSETS Cash...................................................... $ 5,147 $ 1,869 Accounts receivable, net of allowances for doubtful accounts of $1,783 and $1,171........................... 76,027 97,206 Current lease receivables................................. 19,595 18,751 Inventories............................................... 7,636 10,008 Costs and estimated earnings in excess of billings of $11,948 and $17,335..................................... 11,556 19,091 Deferred income tax benefits.............................. 3,954 2,488 Prepaid expenses, deposits and other...................... 2,925 8,108 -------- -------- Total current assets............................... 126,840 157,521 -------- -------- PROPERTY AND EQUIPMENT Machinery and equipment................................... 93,895 75,712 Less -- accumulated depreciation and amortization......... (48,409) (37,713) -------- -------- Net property and equipment.............................. 45,486 37,999 -------- -------- OTHER ASSETS Goodwill, net of accumulated amortization of $5,443 and $7,979.................................................. 21,264 43,206 Lease receivables, net of current portion................. 29,775 34,998 Other..................................................... 808 1,884 -------- -------- Total other assets................................. 51,847 80,088 -------- -------- $224,173 $275,608 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of long-term debt...................... $ 389 $ 3,257 Current maturities of discounted lease rentals............ 13,878 14,758 Accounts payable.......................................... 24,486 24,135 Deferred revenue.......................................... 18,680 19,953 Accrued liabilities Salaries and wages...................................... 13,065 15,123 Warranty costs.......................................... 2,348 1,776 Other liabilities....................................... 10,721 10,509 Billings in excess of costs and estimated earnings of $12,829 and $16,390..................................... 5,789 9,442 -------- -------- Total current liabilities.......................... 89,356 98,953 LONG-TERM DEBT, net of current maturities................... 18,284 52,440 DISCOUNTED LEASE RENTALS, net of current maturities......... 24,043 20,883 DEFERRED INCOME TAXES....................................... 8,120 5,661 -------- -------- COMMITMENTS AND CONTINGENCIES (NOTES 3 AND 11) SHAREHOLDERS' EQUITY Common stock -- $.10 par value; 40,000,000 authorized shares; 9,387,458 and 9,963,716 shares issued and outstanding............................................. 939 996 Capital in excess of par value............................ 34,556 44,741 Retained earnings......................................... 50,192 54,048 Unamortized cost of stock................................. (142) (641) Foreign currency translation adjustments.................. (1,175) (1,473) -------- -------- Total shareholders' equity......................... 84,370 97,671 -------- -------- $224,173 $275,608 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 24 27 NORSTAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK FOREIGN -------------------- CAPITAL IN CURRENCY SHARES EXCESS OF RETAINED UNAMORTIZED TRANSACTION OUTSTANDING AMOUNT PAR VALUE EARNINGS COST OF STOCK ADJUSTMENTS TOTAL BALANCE, APRIL 30, 1995..... 4,215 $422 $26,031 $31,486 $(149) $ (806) $56,984 Stock issued for employee benefit plans........... 144 14 2,024 -- 55 -- 2,093 Foreign currency translation adjustments............. -- -- -- -- -- (49) (49) Effect of two-for-one stock split............. 4,359 436 (436) -- -- -- -- Net income................ -- -- -- 8,489 -- -- 8,489 ----- ---- ------- ------- ----- ------- ------- BALANCE, APRIL 30, 1996..... 8,718 872 27,619 39,975 (94) (855) 67,517 Stock issued for employee benefit plans........... 531 53 4,951 -- (48) -- 4,956 Stock issued for acquisition............. 138 14 1,986 -- -- -- 2,000 Foreign currency translation adjustments............. -- -- -- -- -- (320) (320) Net income................ -- -- -- 10,217 -- -- 10,217 ----- ---- ------- ------- ----- ------- ------- BALANCE, APRIL 30, 1997..... 9,387 939 34,556 50,192 (142) (1,175) 84,370 Stock issued for employee benefit plans........... 258 25 3,892 1 (499) -- 3,419 Stock issued for acquisition............. 319 32 6,293 -- -- -- 6,325 Foreign currency translation adjustments............. -- -- -- -- -- (298) (298) Net income................ -- -- -- 3,855 -- -- 3,855 ----- ---- ------- ------- ----- ------- ------- BALANCE, APRIL 30, 1998..... 9,964 $996 $44,741 $54,048 $(641) $(1,473) $97,671 ===== ==== ======= ======= ===== ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 25 28 NORSTAN, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED APRIL 30, ----------------------------------- 1996 1997 1998 OPERATING ACTIVITIES Net income............................................ $ 8,489 $ 10,217 $ 3,855 Adjustments to reconcile net income to net cash provided by operating activities: Restructuring charge............................... -- -- 14,667 Depreciation and amortization...................... 12,517 16,964 21,115 Deferred income taxes.............................. (465) (45) 1,944 Changes in operating items, net of acquisition effects: Accounts receivable.............................. (3,961) (16,319) (18,803) Inventories...................................... 167 3,532 (2,397) Costs and estimated earnings in excess of billings...................................... 5,715 (6,371) (7,584) Prepaid expenses, deposits and other............. (111) (386) 498 Accounts payable................................. (1,403) 7,047 (745) Deferred revenue................................. 2,815 468 1,291 Accrued liabilities.............................. 1,252 2,514 (5,823) Income taxes payable/receivable.................. 510 (144) (6,136) Billings in excess of costs and estimated earnings...................................... 2,445 1,223 3,665 --------- --------- --------- Net cash provided by operating activities..... 27,970 18,700 5,547 --------- --------- --------- INVESTING ACTIVITIES Additions to property and equipment, net.............. (14,385) (24,219) (19,873) Cash paid for acquisitions, net of cash acquired...... -- (11,794) (20,450) Investment in lease contracts......................... (17,622) (31,545) (28,049) Collections from lease contracts...................... 18,240 21,949 23,589 Other, net............................................ (178) 314 (124) --------- --------- --------- Net cash used for investing activities............. (13,945) (45,295) (44,907) --------- --------- --------- FINANCING ACTIVITIES Repayment of debt assumed in acquisition.............. -- (1,743) (2,013) Borrowings on long-term debt.......................... 112,435 227,820 290,181 Repayments of long-term debt.......................... (128,993) (210,161) (253,102) Borrowings on discounted lease rentals................ 13,173 22,396 13,472 Repayments of discounted lease rentals................ (12,767) (12,583) (15,717) Proceeds from sale of common stock.................... 1,615 3,017 2,868 Tax benefits from shares issued to employees.......... 340 1,869 385 --------- --------- --------- Net cash provided by (used for) financing activities....................................... (14,197) 30,615 36,074 --------- --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH................. (3) (6) 8 --------- --------- --------- NET INCREASE (DECREASE) IN CASH......................... (175) 4,014 (3,278) CASH, BEGINNING OF YEAR................................. 1,308 1,133 5,147 --------- --------- --------- CASH, END OF YEAR....................................... $ 1,133 $ 5,147 $ 1,869 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 26 29 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- NATURE OF BUSINESS: Norstan is a technology services company providing information technology ("IT") and communications systems solutions to over 18,000 customers in the United States, Canada and England. Norstan, Inc. ("Norstan" or the "Company") manages the operations of its subsidiaries, Norstan Communications, Inc. ("NCI"), Norstan Canada Inc. ("NCDA"), Connect Computer Company ("Connect"), Vadini, Inc. (d/b/a PRIMA Consulting, Inc.) ("PRIMA"), Connaissance Consulting, LLC ("Connaissance"), Norstan Financial Services, Inc. ("NFS"), Norstan Network Services, Inc. ("NNS"), Norstan Network Services, Inc. of New Hampshire, Norstan International, Inc. ("NII") and Norstan-UK Limited. The Company is headquartered in Minneapolis, Minnesota, with sales and service offices in 68 locations in the United States and Canada. The Company provides IT consulting and communications services, communications and technology products and competitive financing through its three operating units, Global Services, Communications Solutions and Financial Services. Through strategic partnerships and acquisitions, the Company has become a single-source provider for its customers' integrated voice, video and data network solutions. NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: 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. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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 could differ from those estimates. Revenue Recognition: Global Services' revenues from IT consulting, application development and systems integration are recognized as services are provided. Revenues from maintenance service contracts, moves, adds, and changes, resale of long distance services, and network integration services, are also recognized as the services are provided. Communications Solutions' revenues from the sale and installation of products and systems are recognized under the percentage-of-completion method of accounting for long-term contracts, while revenues generated from the secondary equipment market are recognized upon performance of contractual obligations, which is generally upon installation or shipment. Financial Services' revenues are recognized over the life of the related lease receivables using the effective interest method. In addition, Norstan grants credit to customers and generally does not require collateral or any other security to support amounts due, other than equipment originally leased. Fair Value of Financial Instruments: Fair values of long-term obligations, lease receivables and trade receivables were estimated at their carrying values at April 30, 1997 and 1998, and were estimated in accordance with the requirements of Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures about Fair Value of Financial Instruments." 27 30 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Inventories: Inventories include purchased parts and equipment and are stated at the lower of cost, determined on a first-in, first-out basis, or realizable market value. Property and Equipment: Property and equipment are stated at cost and include expenditures that increase the useful lives of existing property and equipment. Maintenance, repairs and minor renewals are charged to operations as incurred. Generally, when property and equipment are disposed of, the related cost and accumulated depreciation are removed from the respective accounts and any gain or loss is reflected in the results of operations. For capitalized telecommunications equipment used as spare parts, the composite depreciation method is used whereby the cost of property retired less any salvage value is charged against accumulated depreciation and no gain or loss is recognized. The net book value of capitalized telecommunications equipment was $16,605,000 and $6,410,000 as of April 30, 1997 and 1998, respectively (see Note 3). Machinery and equipment is depreciated over the estimated useful lives of two to ten years under the straight-line method for financial reporting purposes. Accelerated methods of depreciation are used for income tax reporting. In the event that facts and circumstances indicate that the carrying amount of property may not be recoverable, an evaluation would be performed using such factors as recent operating results, projected cash flows and management's plans for future operations. Goodwill: Goodwill is being amortized on a straight-line basis over 15-20 years. The Company periodically evaluates whether events or circumstances have occurred that may indicate that the remaining estimated useful lives may warrant revision or that the remaining goodwill balance may not be fully recoverable. In the event that factors indicate that the goodwill in question should be evaluated for possible impairment, a determination of the overall recoverability would be made. Foreign Currency: For the Company's foreign operations, assets and liabilities are translated at year-end exchange rates, and revenues and expenses are translated at average exchange rates prevailing during the year. Translation adjustments are recorded as a separate component of shareholders' equity. 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. Earnings Per Share Data and Stock Split: In the fiscal year ended April 30, 1998, the Company adopted SFAS No. 128 "Earnings per Share," which requires disclosure of basic earnings per share ("EPS") and diluted EPS, which replaces the existing primary EPS and fully diluted EPS, as defined by Accounting Principles Board ("APB") Opinion No. 15. Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted EPS is computed similarly to EPS as previously reported provided that, when applying the treasury stock method to common equivalent shares, the Company must use its average share price for the period rather than the more dilutive greater of the average share price or end-of-period share price required by APB Opinion No. 15. 28 31 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) As a result of the adoption of SFAS No. 128, the Company's reported earnings per share for all prior periods were restated. The effect of this accounting change on reported EPS data is as follows:
YEARS ENDED APRIL 30, ----------------- 1996 1997 Primary EPS as reported..................................... $0.94 $1.08 Effect of SFAS No. 128...................................... 0.06 0.04 ----- ----- Basic EPS as restated....................................... $1.00 $1.12 ===== ===== Fully diluted EPS as reported............................... $0.94 $1.08 Effect of SFAS No. 128...................................... -- -- ----- ----- Diluted EPS as restated..................................... $0.94 $1.08 ===== =====
A reconciliation of EPS calculations under SFAS No. 128 is as follows (in thousands, except per share amounts):
YEARS ENDED APRIL 30, ------------------------- 1996 1997 1998 Net income.................................................. $8,489 $10,217 $3,855 ====== ======= ====== Weighted average common shares outstanding -- Basic......... 8,526 9,140 9,719 Effect of dilutive securities: Stock option plans........................................ 452 269 196 Employee stock purchase plan.............................. 7 9 2 ------ ------- ------ Weighted average common shares outstanding --Diluted... 8,985 9,418 9,917 ====== ======= ====== Net income per share -- Basic............................... $ 1.00 $ 1.12 $ 0.40 ====== ======= ====== Net income per share -- Diluted............................. $ 0.94 $ 1.08 $ 0.39 ====== ======= ======
On June 20, 1996, the Company's Board of Directors approved a two-for-one stock split effected in the form of a stock dividend. The stock split has been retroactively reflected in the accompanying consolidated financial statements and related notes. All share and per share data have been restated to reflect the stock split. Supplemental Cash Flow Information: Supplemental disclosure of cash flow information is as follows (in thousands):
YEARS ENDED APRIL 30, ------------------------ 1996 1997 1998 Cash paid for: Interest.................................................. $3,608 $3,996 $6,457 Income taxes.............................................. 5,218 4,995 5,545 Non-cash investing and financing activities: Stock issued for acquisitions............................. $ -- $2,000 $6,325 Earnout and noncompete agreements related to acquisitions........................................... $ -- $2,667 $2,333
Recently Issued Accounting Standards: In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130, establishes requirements for disclosure of comprehensive income 29 32 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) and becomes effective for the Company's fiscal year ended April 30, 1999. Reclassification of earlier financial statements for comparative purposes is required. The Company believes SFAS No. 130 will not have a significant impact on the Company's financial statements. The Company adopted Statement of Position ("SOP") 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use," effective May 1, 1997. The SOP requires the Company to capitalize certain costs incurred in connection with developing or obtaining internal-use software. The Company capitalized approximately $6.0 million of costs associated with internal-use software developed or obtained during fiscal year 1998. NOTE 3 -- RESTRUCTURING: During fiscal year 1998, the Company recorded a restructuring charge of $14.7 million in connection with management's plan to reduce costs, consolidate and reorganize operations, and improve operating efficiencies. Restructuring efforts focused primarily on the following: (i) consolidation of seven semi-autonomous geographic sales and service organizations into a single, more focused sales and operations organization; (ii) the consolidation of 36 warehouses and parts locations into three strategically located distribution centers; and (iii) the reorganization and integration of the IT consulting services operations, including the Norstan Call Center Solutions Group, Connect, and PRIMA into a single, customer-focused organization. The restructuring charge relates primarily to the write-down of certain assets to their fair market values ($12.2 million), severance and employee benefit costs ($1.2 million), and lease termination costs ($1.3 million). NOTE 4 -- ACQUISITIONS: On June 4, 1996, the Company acquired Connect in a transaction accounted for under the purchase method. Connect is a provider of consulting, design and implementation services for local and wide area networks, Internets and intranets, client/server applications and workgroup computing. The acquisition consideration totaled approximately $15.0 million, consisting of $12.0 million in cash, $2.0 million of Norstan Common Stock and $1.0 million payable to certain members of Connect management under non-compete agreements. In addition, the Company agreed to pay up to $4.0 million in contingent consideration over a three-year period ending April 30, 1999, if certain financial performance targets are achieved (as of April 30, 1998, $2.0 million of such consideration had been paid and the remaining $2.0 million has been earned and accrued). This transaction resulted in the recording of $18.4 million in goodwill and other intangible assets, which are being amortized on a straight-line basis over 15 years and three years, respectively. On September 30, 1997, the Company acquired PRIMA in a transaction accounted for under the purchase method. PRIMA provides IT consulting services, including information systems planning and development, consulting and programming services for collaborative computing solutions and ERP integration services. The acquisition consideration totaled approximately $27.5 million, consisting of $19.5 million in cash, $6.3 million of Norstan Common Stock and $1.7 million paid to certain members of PRIMA management under non-compete agreements. In addition, the Company agreed to pay up to $3.5 million in contingent consideration over a three-year period ending April 30, 2000 if certain financial performance targets are achieved. This transaction resulted in the recording of $24.9 million in goodwill and other intangible assets, which are being amortized on a straight-line basis over 15 years and three years, respectively. Pro forma information for Connect and PRIMA in the year of acquisition has not been disclosed as such information was not materially different from the Company's results of operations. In June 1998, the Company merged with Wordlink in a transaction accounted for under the pooling-of-interests method. Wordlink delivers network integration, groupware messaging, Internet/intranet/ e-commerce and education solutions to business clients operating in a multi-vendor network environment. The 30 33 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) agreement calls for all shares of Wordlink common stock and all vested stock options issued and outstanding to be converted into approximately $10.3 million of Norstan common stock. All outstanding Wordlink unvested stock options were converted to the equivalent value of Norstan stock options. Wordlink's stockholders' equity and operating results were not material in relation to the Company's financial statements. As such, the Company will record the combination without restating prior periods' financial statements. NOTE 5 -- LEASE RECEIVABLES: The Company provides financing for the Company's customers and has financed customer equipment purchases in the amounts of $17,622,000, $31,545,000, and $28,049,000 during fiscal years ended April 30, 1996, 1997 and 1998, respectively. Leases are primarily accounted for as sales-type leases for financial reporting purposes. The components of lease receivables outstanding are summarized as follows (in thousands):
AS OF APRIL 30, ------------------- 1997 1998 Gross lease receivables..................................... $ 53,258 $ 58,136 Residual values............................................. 9,048 8,297 Less: Unearned income........................................... (11,091) (11,039) Allowance for financing losses............................ (1,845) (1,645) -------- -------- Total lease receivables - net............................... 49,370 53,749 Less -- current maturities.................................. (19,595) (18,751) -------- -------- Long-term lease receivables................................. $ 29,775 $ 34,998 ======== ========
The aggregate amount of gross lease receivables maturing in each of the five years following April 30, 1998 is as follows (in thousands):
YEARS ENDING APRIL 30, AMOUNT 1999...................................................... $22,654 2000...................................................... 16,666 2001...................................................... 10,500 2002...................................................... 5,709 2003 and thereafter....................................... 2,607 ------- $58,136 =======
31 34 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 -- DEBT OBLIGATIONS: Long-Term Debt: Long-term debt consists of the following (in thousands):
AS OF APRIL 30, ----------------- 1997 1998 Bank financing: Revolving credit agreement................................ $ 6,920 $ 385 Certificates of deposit and commercial paper.............. 11,000 52,000 Capital lease obligations and other long-term debt.......... 753 3,312 ------- ------- Total long-term debt........................................ 18,673 55,697 Less -- current maturities.................................. (389) (3,257) ------- ------- $18,284 $52,440 ======= =======
Bank Financing: The Company has an $80.0 million unsecured revolving long-term credit agreement with certain banks. Up to $30.0 million of borrowings under this agreement may be in the form of commercial paper. In addition, up to $8.0 million and $6.0 million may be used to support the leasing activities of NFS and NCDA, respectively. Borrowings under this agreement are due May 31, 2001, and bear interest at the banks' reference rate (8.50% at April 30, 1998), except for LIBOR, CD and commercial paper based options, which generally bear interest at a rate lower than the banks' reference rate (5.9% to 6.7% at April 30, 1998). Total consolidated borrowings under this agreement at April 30, 1997 and 1998 were $17.9 million and $52.4 million. There were no borrowings on account of NFS or NCDA at April 30, 1997 and 1998. Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the agreement, the Company is required to maintain minimum levels of EBITDA and certain other financial ratios. The Company has complied with or has obtained the appropriate waivers for such requirements as of April 30, 1998. Short-Term Borrowings: In addition to borrowing funds under its revolving credit agreement, the Company periodically borrows funds from banks on a short-term basis for working capital purposes. There were no short-term borrowings during 1998 and 1996. Short-term borrowing amounts during fiscal year 1997 were as follows: Maximum amount outstanding during the year.................. $2,325,000 Average borrowings during the year.......................... $ 29,600 Weighted average interest rates during the year............. 8.36%
NOTE 7 -- DISCOUNTED LEASE RENTALS: NFS and NCDA utilize their lease receivables and corresponding underlying equipment to borrow funds from financial institutions at fixed rates on a nonrecourse or recourse basis by discounting the stream of future lease payments. Proceeds from discounting are recorded on the consolidated balance sheet as discounted lease rentals. Interest rates on these credit agreements range from 6% to 10% and payments are generally due in varying monthly installments through August 2005. 32 35 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Discounted lease rentals consisted of the following (in thousands):
AS OF APRIL 30, -------------------- 1997 1998 Nonrecourse borrowings...................................... $ 37,329 $ 35,635 Recourse borrowings......................................... 592 6 -------- -------- Total discounted lease rentals.............................. 37,921 35,641 Less -- current maturities.................................. (13,878) (14,758) -------- -------- $ 24,043 $ 20,883 ======== ========
Aggregate maturities of discounted lease rentals as of April 30, 1998 are as follows (in thousands):
YEARS ENDING APRIL 30, AMOUNT 1999........................................................ $14,758 2000........................................................ 9,978 2001........................................................ 6,438 2002........................................................ 3,222 2003 and thereafter......................................... 1,245 ------- $35,641 =======
NOTE 8 -- INCOME TAXES: The domestic and foreign components of income before the provision for income taxes are as follows (in thousands):
YEARS ENDED APRIL 30, ---------------------------- 1996 1997 1998 Domestic.................................................. $13,365 $16,215 $5,914 Foreign................................................... 784 1,102 732 ------- ------- ------ $14,149 $17,317 $6,646 ======= ======= ======
The provision (benefit) for income taxes consisted of the following (in thousands):
YEARS ENDED APRIL 30, -------------------------- 1996 1997 1998 Current Domestic.................................................. $5,656 $7,361 $ 410 Foreign................................................... 469 (216) 437 ------ ------ ------ 6,125 7,145 847 ------ ------ ------ Deferred Domestic.................................................. (235) (572) 2,840 Foreign................................................... (230) 527 (896) ------ ------ ------ (465) (45) 1,944 ------ ------ ------ Provision for income taxes............................. $5,660 $7,100 $2,791 ====== ====== ======
33 36 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The differences between the effective tax rate and income taxes computed using the federal statutory rate were as follows:
YEARS ENDED APRIL 30, ------------------------ 1996 1997 1998 Federal statutory rate...................................... 35% 35% 35% State income taxes, net of federal tax benefit.............. 4 5 5 Goodwill and other, net..................................... 1 1 2 -- -- -- 40% 41% 42% == == ==
The tax effects of significant temporary differences representing deferred tax assets and liabilities are as follows as of April 30 (in thousands):
1997 1998 Accelerated depreciation.................................... $(30,613) $(34,627) Amortization of intangible assets........................... (497) 146 Capital and operating leases................................ 21,394 27,335 Long-term contract costs.................................... (147) (753) Inventory and warranty reserves............................. 891 480 Allowance for doubtful accounts............................. 1,470 1,116 Vacation reserves........................................... 1,226 1,016 Self insurance reserve...................................... 578 457 Other, net.................................................. 1,762 1,893 Valuation allowance......................................... (230) (236) -------- -------- Net deferred tax liabilities........................... $ (4,166) $ (3,173) ======== ========
NOTE 9 -- STOCK OPTIONS AND STOCK PLANS: The 1986 Long-Term Incentive Plan of Norstan, Inc. ("1986 Plan") provided for the granting of non-qualified stock options, incentive stock options and restricted stock. The 1986 Plan, as amended in fiscal year 1994, provided for a maximum of 1,600,000 shares to be granted to key employees in the form of stock options or restricted stock. As of September 20, 1995, with the adoption of a successor plan, no additional grants will be issued under the 1986 Plan. The Norstan, Inc. 1995 Long-Term Incentive Plan ("1995 Plan") permits the granting of non-qualified stock options, incentive stock options, stock appreciation rights and restricted stock, providing for a maximum of 1,200,000 shares to be granted as performance awards and other stock-based awards. Stock options are granted at a price equal to the market price on the date of grant, and are generally exercisable at 20%-25% per year and expire after ten years. At April 30, 1998, 298,500 shares were available for future grants. During June 1998, the Company granted 535,500 stock options of which approximately 244,000 are contingent upon future shareholder approval. The Restated Non-Employee Directors' Stock Plan ("Directors' Plan") provides for a maximum of 292,000 shares to be granted. As determined by the Board of Directors, options for 20,000 shares are to be granted to each non-employee director of the Company upon election and additional discretionary stock options may be amended upon board approval. These options are granted at a price equal to the market price on the date of grant, exercisable at 20% to 25% per year and expire after ten years. In addition, the Directors' Plan provides for the payment of an annual retainer to each non-employee director on the date of each annual meeting of shareholders. As of April 30, 1998, 14,440 shares had been issued as annual retainers and 92,060 shares were available for future grant/payment under the Directors' Plan. 34 37 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Shares subject to option are summarized as follows:
1995 PLAN 1986 PLAN DIRECTORS' PLAN -------------------------- -------------------------- -------------------------- WEIGHTED WEIGHTED WEIGHTED STOCK AVERAGE STOCK AVERAGE STOCK AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE BALANCE -- APRIL 30, 1995...... N/A N/A 644,400 $ 4.23 140,000 $ 3.86 Options granted.............. -- -- 225,000 11.87 20,000 12.50 Options canceled............. -- -- (29,400) 9.18 -- -- Options exercised............ -- -- (162,100) 2.84 -- -- -------- ------ -------- ------ -------- ------ BALANCE -- APRIL 30, 1996...... N/A N/A 677,900 6.88 160,000 4.94 Options granted.............. 310,500 $15.01 -- -- -- -- Options canceled............. -- -- (96,000) 9.62 -- -- Options exercised............ -- -- (296,100) 3.49 (120,000) 3.24 -------- ------ -------- ------ -------- ------ BALANCE -- APRIL 30, 1997...... 310,500 15.01 285,800 9.49 40,000 10.06 Options granted.............. 647,000 17.76 -- -- 25,500 20.06 Options canceled............. (104,900) 15.62 (62,200) 10.86 -- -- Options exercised............ (15,300) 15.01 (103,400) 7.00 -- -- -------- ------ -------- ------ -------- ------ BALANCE -- APRIL 30, 1998...... 837,300 $17.06 120,200 $10.92 65,500 $13.96 ======== ====== ======== ====== ======== ====== Options exercisable at: April 30, 1996............... N/A N/A 375,936 $ 4.23 140,000 $ 4.00 ======== ====== ======== ====== ======== ====== April 30, 1997............... -- $ -- 103,036 $ 7.43 28,000 $ 9.02 ======== ====== ======== ====== ======== ====== April 30, 1998............... 57,100 $14.72 46,640 $10.79 39,500 $11.47 ======== ====== ======== ====== ======== ======
Additional information regarding options outstanding/exercisable at April 30, 1998 is as follows:
WEIGHTED NUMBER OF WEIGHTED AVERAGE NUMBER OF WEIGHTED OPTIONS EXERCISE PRICE AVERAGE REMAINING OPTIONS AVERAGE OUTSTANDING RANGE EXERCISE PRICE CONTRACTUAL LIFE EXERCISABLE EXERCISE PRICE 1995 PLAN.............. 150,000 $14.13-$14.19 $14.16 9.00 years 20,000 $14.19 226,300 $15.00-$16.00 $15.03 8.35 years 37,100 $15.01 321,000 $17.50 $17.50 9.26 years -- $ -- 140,000 $19.50-$28.25 $22.44 9.57 years -- $ -- ------- ------------- ------ ---------- ------ ------ 837,300 $14.13-$28.25 $17.06 9.02 years 57,100 $14.72 ======= ============= ====== ========== ====== ====== 1986 PLAN.............. 17,200 $ 4.25-$6.88 $ 5.17 3.65 years 6,640 $ 4.25 103,000 $11.88 $11.88 7.11 years 40,000 $11.88 ------- ------------- ------ ---------- ------ ------ 120,200 $ 4.25-$11.88 $10.92 6.61 years 46,640 $10.79 ======= ============= ====== ========== ====== ====== DIRECTORS' PLAN........ 20,000 $ 7.63 $ 7.63 4.70 years 20,000 $ 7.63 20,000 $12.50 $12.50 7.39 years 12,000 $12.50 25,500 $20.06 $20.06 9.41 years 7,500 $20.06 ------- ------------- ------ ---------- ------ ------ 65,500 $ 7.63-$20.06 $13.96 7.36 years 39,500 $11.47 ======= ============= ====== ========== ====== ======
The Company has awarded restricted stock grants to selected employees under the 1986 Plan and the 1995 Plan. Recipients of restricted stock awards under these plans were not required to make any payments for the stock or provide consideration other than the rendering of services. Shares of stock awarded under the plans are subject to certain restrictions on transfer and all or part of the shares awarded to an employee may be subject to forfeiture upon the occurrence of certain events, including termination of employment. Through April 30, 1998, 140,706 shares and 59,100 shares have been awarded under the 1986 Plan and the 1995 Plan, respectively. The fair market value of the shares granted under these plans is amortized over a three- to four-year period. Amortization of $137,000, $70,000, and $165,800 has been charged to operations in 1996, 1997 and 1998, respectively. 35 38 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has maintained an Employee Stock Purchase Plan (the "Employee Stock Plan") since 1980 that allows employees to set aside up to 10% of their earnings for the purchase of shares of the Company's common stock. The Employee Stock Plan was amended effective July 1998 to allow shares to be purchased quarterly rather than annually under the Employee Stock Plan at a price equal to 85% of the low market price on the last day of the quarter rather than the last day of the calendar year. During fiscal year 1998, 100,813 shares were issued under this plan and, at April 30, 1998, 483,773 shares were available for future issuance. The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the accompanying statements of operations. Had compensation cost been recognized based on the fair values of options at the grant dates consistent with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net income (in thousands) and net income per common share would have been decreased to the following pro forma amounts:
YEARS ENDED APRIL 30, ------------------------- 1996 1997 1998 Net income: As reported............................................... $8,489 $10,217 $3,855 Pro forma................................................. 7,964 9,360 1,968 Net income per common share: As reported basic.................................................. $ 1.00 $ 1.12 $ 0.40 diluted................................................ 0.94 1.08 0.39 Pro forma basic.................................................. $ 0.93 $ 1.02 $ 0.20 diluted................................................ 0.89 0.99 0.20
Because the SFAS No. 123 method of accounting has not been applied to options granted prior to May 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The weighted average fair values of options granted and Employee Stock Plan shares were as follows:
EMPLOYEE 1995 PLAN 1986 PLAN DIRECTORS' PLAN STOCK PLAN Fiscal 1996 grants................................ -- $6.49 $ 7.29 $2.15 Fiscal 1997 grants................................ $7.95 N/A -- $2.96 Fiscal 1998 grants................................ $8.99 N/A $11.63 $5.54
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in fiscal years 1996, 1997 and 1998:
YEARS ENDED APRIL 30, --------------------------- 1996 1997 1998 Risk-free interest rate............................. 5.74% 6.28% 6.06% Expected life of options............................ 7 years 7 years 7 years Expected life of Employee Stock Plan................ 1 year 1 year 1 year Expected volatility................................. 57% 35% 36% Expected dividend yield............................. -- -- --
36 39 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The tax benefits associated with the exercise of stock options or issuance of shares under the Company's stock option plans, not related to expenses recognized for financial reporting purposes, have been credited to capital in excess of par value in the accompanying consolidated balance sheets. NOTE 10 -- 401(K) PLAN: The Company has 401(k) profit-sharing plans (the "401(k) Plans") covering substantially all full-time employees. Eligible employees may elect to defer up to 15% of their eligible compensation. The Company may make discretionary matching contributions of up to 6% of each plan participant's eligible compensation. Company contributions to the 401(k) Plans were $1,267,000, $1,746,000 and $1,822,000 for the years ending April 30, 1996, 1997 and 1998, respectively. NOTE 11 -- COMMITMENTS AND CONTINGENCIES: Legal Proceedings: The Company is involved in legal actions in the ordinary course of its business. Although the outcomes of any such legal actions 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. Operating Lease Commitments: The Company and its subsidiaries conduct a portion of their operations in leased facilities. Most of the leases require payment of maintenance, insurance, taxes and other expenses in addition to the minimum annual rentals. Lease expense, as recorded in the accompanying consolidated statements of operations, was $10,501,000, $10,914,000, and $11,494,000 in fiscal years 1996, 1997, and 1998, respectively. Future minimum lease payments under noncancelable leases with initial or remaining terms of one year or more were as follows at April 30, 1998 (in thousands):
YEARS ENDING APRIL 30, AMOUNT 1999........................................................ $ 7,270 2000........................................................ 6,515 2001........................................................ 5,319 2002........................................................ 4,182 2003 and thereafter......................................... 18,611 ------- $41,897 =======
Vendor Agreements: Under its agreement with Siemens, the Company purchases communications equipment and products for field application and installation. The current distributor agreement with Siemens, which commenced in July 1993, has been renewed through July 27, 1999 while a new distribution agreement is being negotiated. Shareholder Rights Plan: The Company has a shareholder rights plan, as amended in March 1998 (the "Plan"), which expires in 2008. Under the Plan, shareholders are deemed the owners of "Rights" attaching to each share of common stock. Upon any person (an "Acquiring Person") becoming the owner of 15% or more of the issued and outstanding shares of the Company's common stock (a "Stock Acquisition Date"), each Right will enable the holder to purchase an additional share of the Company's common stock at a price equal to 50% of the then current market price. In the event that the Company is acquired in a merger or other business combination transaction where the Company is not the surviving corporation or 50% or more of the Company's assets or 37 40 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) earnings power is sold, each Right entitles the holder to receive, upon exercise of the Right at the then current purchase price of the Right, common stock of the acquiring entity that has a value of two times the purchase price of the Right. The Plan also authorizes the Company, under certain circumstances, to redeem the Rights at a redemption price of $0.01 per Right and, following any Stock Acquisition Date, to exchange one share of the Company's common stock for each Right held by a shareholder other than an Acquiring Person. NOTE 12 -- BUSINESS SEGMENTS AND GEOGRAPHIC AREAS: The Company operates in three business segments, Global Services, Communications Solutions, and Financial Services. Due to the Company's continuing expansion and growth in the area of IT consulting services, financial results for Global Services are now reported as (i) IT Consulting Services and (ii) Communication Services. Norstan IT Consulting Services provides IT services including ERP and sales management package implementation, groupware consulting, Internet/intranet/e-commerce solutions, CTI and outsourced facilities management. Communications Services provides customer support services for communications systems, including maintenance services, systems modifications and long distance services. Communications Solutions provides a broad array of solutions including telephone systems, integrated voice processing, call center technologies and video/audio/data conferencing solutions. The name change from Communications Systems to Communications Solutions more accurately reflects the Company's commitment to provide its customers with design, installation and implementation services as well the hardware and software components necessary for successful implementation of complex communications systems. Financial Services supports the sales process by providing customized financing alternatives. The Company believes that its breadth of product and service offerings fosters long-term client relationships, affords cross-selling opportunities and minimizes the Company's dependence on any single technology or industry. 38 41 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company elected early adoption of SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," effective April 30, 1998. Adoption of this statement required the Company to provide the disclosure of segment information but did not require significant changes in the way geographic information was disclosed. Disclosures under SFAS No. 131 are as follows:
GLOBAL SERVICES ------------------------------ TOTAL IT CONSULTING COMMUNICATIONS GLOBAL COMMUNICATIONS FINANCIAL SERVICES SERVICES SERVICES SOLUTIONS SERVICES CORPORATE TOTAL (IN THOUSANDS) 1996: Revenue.................. $14,426 $121,971 $136,397 $179,332 $ 5,635 $ -- $321,364 Operating income......... 685 6,141 6,826 6,368 2,217 -- 15,411 Depreciation and amortization........... 389 4,262 4,651 4,350 13 3,503 12,517 Identifiable assets...... 4,081 42,459 46,540 40,807 36,916 36,725 160,988 Capital expenditures..... 475 4,714 5,189 4,900 20 4,276 14,385 1997: Revenue.................. $54,467 $131,596 $186,063 $205,983 $ 6,029 $ -- $398,075 Operating income......... 3,239 6,395 9,634 6,754 2,817 -- 19,205 Depreciation and amortization........... 2,245 4,938 7,183 5,117 14 4,650 16,964 Identifiable assets...... 26,865 51,463 78,328 49,000 47,928 48,917 224,173 Capital expenditures..... 2,202 7,335 9,537 7,400 14 7,268 24,219 1998: Revenue.................. $92,746 $127,197 $219,943 $228,979 $ 7,443 $ -- $456,365 Operating income(1)...... 6,976 (678) 6,298 199 4,076 -- 10,573 Depreciation and amortization........... 4,434 5,730 10,164 5,657 15 5,279 21,115 Identifiable assets...... 63,554 55,465 119,019 52,000 52,616 51,973 275,608 Capital expenditures..... 2,115 5,998 8,113 5,900 20 5,840 19,873
- --------------- (1) Segment totals include allocation of the fiscal year 1998 restructuring charge of $14,667,000. Operating income of each segment, prior to the allocation of the restructuring charge to each unit, was as follows: IT Consulting Services -- $8,130,000; Communications Services -- $7,425,000; Total Global Services -- $15,555,000; Communications Solutions -- $5,609,000; and Financial Services -- $4,076,000. (See Note 3.) 39 42 NORSTAN, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table sets forth the Company's operations and related asset information by geographic area as of and for the years ended April 30 (in thousands):
1996 1997 1998 REVENUES: United States................................. $287,171 $365,796 $423,446 Canada........................................ 34,193 32,279 32,919 -------- -------- -------- $321,364 $398,075 $456,365 ======== ======== ======== NET INCOME: United States................................. $ 7,943 $ 9,426 $ 4,679 Canada........................................ 546 791 (824) -------- -------- -------- $ 8,489 $ 10,217 $ 3,855 ======== ======== ======== ASSETS: United States................................. $142,151 $207,942 $258,192 Canada........................................ 18,837 16,231 17,416 -------- -------- -------- $160,988 $224,173 $275,608 ======== ======== ========
40 43 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. No changes in or disagreements with accountants which required reporting on Form 8-K have occurred within the two-year period ended April 30, 1998. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to the directors and executive officers of the Company, set forth under "Information Concerning Directors, Nominees and Executive Officers" and under "Compliance with Section 16 (a)" in the Company's definitive proxy statement for the annual meeting of shareholders to be held September 24, 1998, is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. Information with respect to Executive Compensation set forth under "Executive Compensation" in the Company's definitive proxy statement for the annual meeting of shareholders to be held September 24, 1998, other than the subsections captioned "Report of the Compensation and Stock Option Committee" and "Performance Graph", is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information with respect to security ownership of certain beneficial owners and management, set forth under "Beneficial Ownership of Principal Shareholders and Management" in the Company's definitive proxy statement for the annual meeting of shareholders to be held September 24, 1998, is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information with respect to certain relationships and related transactions, set forth under "Information Concerning Directors, Nominees and Executive Officers" in the Company's definitive proxy statement for the annual meeting of shareholders to be held September 24, 1998, is incorporated herein by reference. 41 44 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (A) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS. 1. Financial Statements See Index to Consolidated Financial Statements and Financial Statement Schedules on page of this report. 2. Financial Statement Schedules All schedules to the Consolidated Financial Statements normally required by the applicable accounting regulations are omitted since the required information is included in the Consolidated Financial Statements or the Notes thereto or is not applicable. 3. Exhibits See Index to Exhibits on page of this report. (B) REPORTS ON FORMS 8-K. No reports on Form 8-K were filed by the Company during the last quarter of the fiscal year covered by this report. 42 45 SIGNATURES Pursuant to the requirements of Section 13 or Section 15(d) 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. Dated: July 22, 1998 NORSTAN, INC. Registrant By /s/ DAVID R. RICHARD ------------------------------------ David R. Richard Chief Executive Officer, President and Director By /s/ KENNETH S. MACKENZIE ------------------------------------ Kenneth S. MacKenzie Chief Financial Officer (Principal Financial and Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE DATE --------- ---- /s/ PAUL BASZUCKI July 22, 1998 - ----------------------------------------------------- Paul Baszucki Chairman of the Board July 22, 1998 - ----------------------------------------------------- Richard Cohen Vice-Chairman of the Board /s/ DAVID R. RICHARD July 22, 1998 - ----------------------------------------------------- David R. Richard CEO, President and Director July 22, 1998 - ----------------------------------------------------- Dr. Jagdish N. Sheth Director /s/ CONNIE M. LEVI July 23, 1998 - ----------------------------------------------------- Connie M. Levi Director /s/ GERALD D. PINT July 23, 1998 - ----------------------------------------------------- Gerald D. Pint Director /s/ HERBERT F. TRADER July 23, 1998 - ----------------------------------------------------- Herbert F. Trader Director
43 46 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE - ----------- ----------- ---- 3(a) Restated Articles of Incorporation of the Company, as amended [filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended April 30, 1988 (File No. 0-8141) and incorporated herein by reference]; Amendments adopted September 9, 1993 and June 20, 1996 [filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended April 30, 1996 (File No. 0-8141) and incorporated herein by reference]............... 3(b) Bylaws of the Company [filed as Exhibit 3(b) to the Company's Annual Report on Form 10-K for the year ended April 30, 1993 (File No. 0-8141) and incorporated herein by reference]; Amendments adopted August 8, 1995 [filed as Exhibit 3(b) to the Company's Annual Report on Form 10-K for the year ended April 30, 1996 (File No. 0-8141) and incorporated herein by reference]; Amendments adopted September 20, 1995, July 30, 1996 and April 9, 1997......... 3(c) Rights Agreement dated May 17, 1988 between Norstan, Inc. and Norwest Bank Minnesota, N.A. [filed as Exhibit 1 to the Company's Registration Statement on Form 8-A (File No. 0-8141) and incorporated herein by reference]............... 10(a) Agreement for ROLM Authorized Distributors, effective July 27, 1993, between Norstan Communications, Inc. and ROLM Company [filed as Exhibit 10(a) to the Company's Annual Report on Form 10-K for the year ended April 30, 1993 (File No. 0-8141) and incorporated herein by reference]........... 10(b) Credit Agreement dated as of July 23, 1996, among Norstan, Inc., First Bank National Association, and Harris Trust and Savings Bank and the Sumitomo Bank Limited, Chicago Branch; First Amendment to Credit Agreement dated October 11, 1996 [filed as Exhibit 10 to the Company's quarterly report on Form 10-Q for the period ended August 3, 1996 (File No. 0-8141) and incorporated herein by reference]............... 10(c) Loan and Security Agreement dated April 29, 1993, between Norstan Financial Services, Inc. and Sanwa Business Credit Corporation [filed as Exhibit 10(b) to the Company's Current Report on Form 8-K, dated April 29, 1993 (File No. 0-8141) and incorporated herein by reference]; First Amendment dated December 30, 1993 [filed as Exhibit 10(c) to the Company's Annual Report on Form 10-K for the year ended April 30, 1994 (File No. 0-8141) and incorporated herein by reference]..... 10(d)(1) 1990 Employee Stock Purchase Plan of Norstan, Inc., as amended May 29, 1998........................................ 10(e)(1) Norstan, Inc. 1986 Long-Term Incentive Plan, as amended [filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended April 30, 1993 (File No. 0-8141) and incorporated herein by reference]; Amendments adopted August 8, 1995 and July 30, 1996 [filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended April 30, 1996 (File No. 0-8141) and incorporated herein by reference]........................................ 10(f)(1) Norstan, Inc. Restated Non-Employee Directors' Stock Plan, [filed as Exhibit 28.1 to the Company's Registration Statement on Form S-8 dated September 27, 1995 (File No. 0-8141) and incorporated herein by reference]............... 10(g)(1) Norstan, Inc. 1995 Long-Term Incentive Plan [filed as Exhibit 28.1 to the Company's Registration Statement on Form S-8 dated September 27, 1995 (File No. 0-8141) and incorporated herein by reference]; Amendment adopted July 30, 1996 [filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended April 30, 1996 (File No. 0-8141) and incorporated herein by reference]; Amendment adopted August 16, 1996.....................................
44 47
EXHIBIT NO. DESCRIPTION PAGE - ----------- ----------- ---- 10(h)(1) Employment Agreement dated April 7, 1995 between Paul Baszucki and the Company [filed as Exhibit 10(h) to the Company's Annual Report on Form 10-K for the year ended April 30, 1995 (File No. 0-8141) and incorporated herein by reference].................................................. 10(i)(1) Employment Agreement dated April 7, 1995 between Richard Cohen and the Company [filed as Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended April 30, 1995 (File No. 0-8141) and incorporated herein by reference].................................................. 10(j)(1) Employment Agreement dated April 30, 1997 between David R. Richard and the Company..................................... 10(k) Agreement and Plan of Merger dated May 24, 1996 among the Company, Connect Computer Company and CCC Acquisition Subsidiary, Inc. [filed as Exhibit 2 to the Company's Current Report on Form 8-K dated June 4, 1996 (File No. 0-8141) and incorporated herein by reference]............... 10(l)(1) Third Amendment to Credit Agreement, dated as of March 20, 1998, by and among the Company, certain banks as signatories thereto (the "Banks") and First Bank National Association, as one of the Banks and as agent for the Banks.............. 10(m) Lease Agreement, dated December 23, 1997, by and between Thomas Edward Limited Partnership and the Company........... 22 Subsidiaries of Norstan, Inc................................ 23(a) Consent of Independent Public Accountants................... 27 Financial Data Schedule.....................................
A copy of any of the exhibits listed or referred to above will be furnished at a reasonable cost to any shareholder of the Company, upon receipt of a written request from such person for any such exhibit. Such request should be sent to Norstan, Inc., 605 North Highway 169, Twelfth Floor, Plymouth, Minnesota 55441, Attention: Investor Relations. (1) Items that are management contracts or compensatory plans or arrangements required to be filed as an exhibit pursuant to Item 14(c) of this Form 10-K. 45 EX-10.(D)(1) 2 EXHIBIT 10(D)(1) 1 EXHIBIT 10(D)(1) 1990 EMPLOYEE STOCK PURCHASE PLAN OF NORSTAN, INC. As Amended May 29, 1998 1. Purpose. The purpose of this 1990 Employee Stock Purchase Plan (the "Plan") is to secure to Norstan, Inc. (the "Company"), its Subsidiaries and its shareholders the advantages of the incentive inherent in stock ownership on the part of the employees of the Company and its Subsidiaries and to provide the employees with a proprietary interest in and a greater concern for the welfare of the Company as an incentive to continued service with the Company and its Subsidiaries. 2. Stock Subject to the Plan. A total of 1,856,000 shares of the common stock, par value $.10 per share ("Common Stock"), of the Company may be issued under this Plan (after giving effect to a two-for-one split of the Company's Common Stock on July 31, 1996), subject to adjustment as provided herein. 3. Eligibility. Any employee of the Company or its Subsidiaries who has attained the age of 18 and completed one month of employment is eligible to participate in this Plan. For purposes of this Plan, "Subsidiary" means any entity, at least 75% of the outstanding voting stock or voting power of which is beneficially owned, directly or indirectly, presently or in the future, by the Company. 4. Participation. Any eligible employee may elect to participate in this Plan at any time during the continuance of this Plan by delivering to the Company an authorization for payroll deductions, executed by the participating employee (the "Participant"), in such form as may be prescribed by the Company from time to time. An employee's participation in this Plan is entirely voluntary. Each employee shall understand that there are risks involved in stock ownership and that the Company, its Subsidiaries and their officers and directors are making no recommendations to their employees regarding the purchase of shares of the Company, which is a personal decision for each employee. 5. Employee Contributions. A Participant shall, by completing the form described in paragraph 4 hereof, authorize payroll deductions in an amount specified by the Participant in said form. No payroll deduction shall be less than $10.00 per pay period, nor more, per pay period, than 10% of the gross pay of the Participant. Such authorization form shall be effective only for the calendar year specified therein. Subsequent to the completion of such authorization form, not more than one change in the authorized payroll deduction may be made by the Participant in each such calendar year. -1- 2 6. Stock Purchase; Purchase Price. After the end of each calendar quarter, the amounts contributed hereunder by each Participant shall be applied to purchase from the Company authorized but unissued shares of Common Stock, provided that the Participant has been continuously employed by the Company or its Subsidiaries through the end of such calendar quarter. The purchase price for the shares purchased hereunder shall be 85% of the low price for the Common Stock reported on NASDAQ on the last business day of such calendar quarter. 7. Refund of Employee Contributions. At any time prior to the end of a calendar quarter, all amounts contributed hereunder by a Participant by authorized payroll deductions shall be refunded without interest to the Participant at his or her request. If a Participant's employment with the Company or its Subsidiaries is terminated for any reason, or upon the death of the Participant, all amounts deducted under this Plan from the Participant's gross pay during the calendar quarter in which such termination or death occurs shall be refunded, without interest, to the Participant. If the Board of Directors of the Company suspends or terminates this Plan as hereinafter provided, it shall have the power to cause all amounts deducted hereunder from the Participants' gross pay during the calendar quarter in which such suspension or termination occurs to be refunded, without interest, to the Participants. 8. Income Tax Consequences. Each Participant shall understand that, under the Internal Revenue Code of 1986, as amended, where stock is transferred by an employer to an employee for an amount less than the fair market value of stock, the employee must include in his or her income the difference between the fair market value and the amount paid by the employee for the stock. In connection with the purchase of shares by a Participant pursuant to this Plan, the Company shall have the right to withhold from the Participant's other compensation, or to require the Participant to remit to the Company, an amount sufficient to satisfy any applicable federal, state or local tax withholding requirements. 9. Reports. The Company shall provide to each Participant under this Plan a copy of the Company's Annual Report to Shareholders each year during the continuance of this Plan. 10. Assignment. The interest of a Participant hereunder with respect to any shares is not subject to the claims of creditors, or to assignment or transfer other than by will or the laws of descent and distribution. 11. Dilution or Other Adjustments; Dividends. In the event of any change in the capital structure of the Company, including but not limited to a change resulting from a stock dividend or split-up, or combination or reclassification of shares, the Board of Directors shall make such adjustments with respect to the shares subject to this Plan, or any provision of this Plan, as it deems equitable to prevent dilution or enlargement of the interests of Participants in this Plan. -2- 3 12. Merger, Consolidation, Reorganization, Liquidation. If the Company or any of its Subsidiaries shall become a party to any corporate merger, consolidation, major acquisition of property for stock, reorganization, liquidation, or similar transaction, the Board of Directors shall have the power to make such arrangements as it deems necessary, which may include termination of this Plan, with respect to the amounts deducted hereunder from the Participants' gross pay, and such arrangements shall be binding upon all persons, including without limitation, the Company, its shareholders, and any Participant in this Plan. 13. Administration of the Plan. This Plan shall be administered by the Board of Directors of the Company; however, the Board of Directors may, from time to time, delegate its administrative or other duties under the Plan to an agent. The Board of Directors shall have full power and authority to construe, interpret and administer this Plan and to make determinations which shall be final, conclusive and binding upon all persons, including without limitation, the Company, its shareholders, and any Participant in this Plan. The Board of Directors shall have the power to provide regulations for the administration of this Plan and to make any changes in such regulations as from time to time it deems necessary. 14. Amendment and Termination. The Board of Directors shall have the right at any time during the continuance of this Plan to amend, modify, supplement, suspend or terminate this Plan, provided that in the absence of the approval of the holders of a majority of the shares of Common Stock present in person or by proxy at a duly constituted meeting of shareholders of the Company, no such amendment, modification or supplement shall (i) increase the aggregate number of shares which may be issued under this Plan, unless such increase is by reason of any change in capital structure referred to in paragraph 11 hereof or (ii) materially modify the requirements of plan eligibility. 15. Transition Provisions. After June 30, 1998, the amounts contributed by each Participant under the Plan prior to June 30, 1998 shall be applied to purchase from the Company authorized but unissued shares of Common Stock, provided that the Participant has been continuously employed by the Company or its Subsidiaries through June 30, 1998. The purchase price for the shares purchased shall be 85% of the low price for the Common Stock reported on NASDAQ on June 30, 1998. At any time prior to June 30, 1998, all amounts contributed by each Participant under the Plan by authorized payroll deductions shall be refunded without interest to the Participant at his or her request. After June 30, 1998, all purchases shall be governed by this Plan as amended and effective on July 1, 1998. 16. Securities Laws. The issuance of shares of Common Stock pursuant to this Plan shall be subject to all applicable laws, rules and regulations; and shares shall not be issued hereunder except upon approval of appropriate governmental agencies or stock exchanges as may be required. -3- 4 17. Miscellaneous. a. A prospectus covering the shares offered under this Plan shall be given to each employee who is eligible to participate herein. b. Each employee who becomes a Participant in this Plan shall be deemed to have accepted all the terms and conditions contained in this Plan, and shall be fully bound thereby. c. This Plan shall be subject to changes, if any, which may be ordered by the United States Securities and Exchange Commission or the appropriate regulatory authorities in any states in which this Plan is registered or filed. d. This Plan shall be construed according to the laws of the State of Minnesota. 18. Effective Date. This Plan, as amended, was adopted at meetings of Board of Directors on March 12, 1998 and May 29, 1998 and shall be effective on July 1, 1998. The Plan, in its original form, was effective as of June 26, 1989, the date of its adoption by the Board of Directors and subsequently amended on July 14, 1993. 19. Compliance with Section 16(b). In the case of employees who are or may be subject to Section 16 of the Securities Exchange Act of 1934 (the "Act"), it is the intent of the Company that the Plan and any award granted hereunder satisfy and be interpreted in a manner that satisfies the applicable requirements of Rule 16b-3, so that such persons will be entitled to the benefits of Rule 16b-3 or other exemptive rules under Section 16 of the Act and will not be subjected to liability thereunder. If any provision of the Plan or any award would otherwise conflict with the intent expressed herein, that provision, to the extent possible, shall be interpreted and deemed so as to avoid such conflict. To the extent of any remaining irreconcilable conflict with such intent, such provision or award shall be deemed void as applicable to employees who are or may be subject to Section 16 of the Act. -4- EX-10.(L)(1) 3 EXHIBIT 10(L)(1) 1 EXHIBIT 10(L)(1) THIRD AMENDMENT TO CREDIT AGREEMENT THIS THIRD AMENDMENT TO CREDIT AGREEMENT is dated as of March 20, 1998 ("this Amendment") by and among NORSTAN, INC., a Minnesota corporation (the "Borrower"), the banks which are signatories hereto (each individually, a "Bank," and collectively, the "Banks"), and FIRST BANK NATIONAL ASSOCIATION, a national banking association, one of the Banks, as agent for the Banks (in such capacity, the "Agent"). RECITALS A. The Borrower, the Banks and the Agent are parties to a Credit Agreement dated as of July 23, 1996, as amended by a First Amendment dated as of October 11, 1996, and a Second Amendment dated as of September 26, 1997 (as so amended, the "Credit Agreement"). B. The parties hereto desire to amend the Credit Agreement in certain respects. NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows: Section 1. Definitions. Capitalized terms used herein and not otherwise defined herein, but which are defined in the Credit Agreement, shall have the meanings ascribed to such terms in the Credit Agreement unless the context otherwise requires. Section 2. Amendments to Credit Agreement. Subject to Section 6 hereof, the Credit Agreement is hereby amended as follows: (a) The definition of "Guarantors" set forth in Recital B of the Credit Agreement is amended to include "Vadini, Inc., a North Carolina corporation, d/b/a PRIMA Consulting Inc. ("PRIMA")," "Norstan International, Inc., a Minnesota corporation ("Norstan International")" and Norstan-UK, Limited, a corporation incorporated in London, England ("Norstan - UK")." (b) The definitions of "Adjusted Leverage Ratio," "Applicable Margin," "Cash Flow Leverage Ratio," "Interest Coverage Ratio" and "Tangible Net Worth" set forth in Section 1.1 of the Credit Agreement are amended in their entireties to read as follows: (i) "Adjusted Leverage Ratio": At the time of any determination, the ratio of (a) Total Indebtedness less Indebtedness of NFS to (b) Tangible Net 2 Worth, all as determined in accordance with GAAP (but determined using the equity method of accounting with respect to NFS). (ii) "Applicable Margin": With respect to: Pricing Level IV: (a) Reference Rate Advances: 0.05% (b) CD Rate Advances: 1.25% (c) Eurodollar Rate Advances: 1.25% Pricing Level III: (a) Reference Rate Advances: 0.25% (b) CD Rate Advances: 1.0% (c) Eurodollar Rate Advances: 1.0% Pricing Level II: (a) Reference Rate Advances: 0.0% (b) CD Rate Advances: 0.75% (c) Eurodollar Rate Advances: 0.75% Pricing Level I: (a) Reference Rate Advances: 0.0% (b) CD Rate Advances: 0.50% (c) Eurodollar Rate Advances: 0.50% (iii) "Cash Flow Leverage Ratio": As of the last day of any fiscal quarter, the ratio of (a) the sum (without duplication) of the aggregate principal amount of all outstanding Capitalized Lease Obligations of the Borrower and the Subsidiaries and that portion of Total Indebtedness bearing interest determined as of that date, to (b) EBITDA for the four consecutive fiscal quarters ending on that date, all as determined in accordance with GAAP (but determined using the equity method of accounting with respect to NFS). (iv) "Interest Coverage Ratio": As of the last day of any fiscal quarter, the ratio of (a) EBITDA for the four consecutive fiscal quarters ending on that date, to (b) Interest Expense, in each case determined for said period in accordance with GAAP (but determined using the equity method of accounting with respect to NFS). -2- 3 (v) "Tangible Net Worth": As of any date of determination, the sum of the amounts set forth on the consolidated balance sheet of the Borrower as the sum of the common stock, preferred stock, additional paid-in capital, retained earnings, unamortized cost of stock and foreign currency translation adjustments of the Borrower (excluding treasury stock), less the book value of all assets of the Borrower and its Subsidiaries that would be treated as intangibles under GAAP, including all such items as goodwill, trademarks, trade names, service marks, copyrights, patents, licenses, unamortized debt discount and expenses and the excess of the purchase price of the assets of any business acquired by the Borrower or any of its Subsidiaries over the book value of such assets. (c) Section 1.1 of the Credit Agreement is amended by inserting therein the following definitions of "Net Proceeds" and "Pricing Level" in appropriate alphabetical order: "Net Proceeds": With respect to the sale or disposition of property, sale of capital stock and offering of debt securities by the Borrower, or other non-recurring event, an amount equal to (a) the cash (including deferred cash proceeds) and other consideration received by the Borrower in connection with such transaction or event, minus (b) the sum of (i) the unpaid principal-balance on the date of any such sale or offering of any Indebtedness that is secured by a Lien not proscribed by Section 6.12 and affecting such property, and which is required to be repaid on the date of such sale or offering, (ii) any closing costs or selling costs arising in connection with such sale or offering, and (iii) any sales or income tax paid or payable by the Borrower in connection with such transaction or event (excluding any tax for which the Borrower is reimbursed by the purchaser). "Pricing Level": Shall mean that level of pricing in effect for any fiscal quarter determined in accordance with the following: Pricing Level IV: Shall be in effect during any fiscal quarter if the Cash Flow Leverage Ratio as of the last day of the most recently completed fiscal quarter was greater than or equal to 2.75 to 1.0. Pricing Level III: Shall be in effect during any fiscal quarter if the Cash Flow Leverage Ratio as of the last day of the most recently completed fiscal quarter was no less than 2.0 to 1.0 and no greater than 2.74 to 1.0. Pricing Level II: Shall be in effect during any fiscal quarter if the Cash Flow Leverage Ratio as of the last day of the most recently completed fiscal quarter was no less than 1.0 to 1.0 and no greater than 1.99 to 1.0. -3- 4 Pricing Level I: Shall be in effect during any fiscal quarter if the Cash Flow Leverage Ratio as of the last day of the most recently completed fiscal quarter was less than 1.0 to 1.0. (d) Section 2.5 of the Credit Agreement is amended by adding thereto the following subsection 2.5(f) at the end thereof: 2.5(f) Subject to the last two sentences of this Section 2.5(f), any change in the interest rate applicable to an Advance due to a change in the Pricing Level shall, for CD Rate Advances and Eurodollar Rate Advances, be effective on the first day after delivery of the financial statements described in Section 5.1(c) and shall continue until the day on which such statements are delivered for the following fiscal quarter. Notwithstanding the foregoing, if the Borrower has not furnished the quarterly financial statements and reports required under Sections 5.1(c) and 5.1(d) for any fiscal quarter by the sixtieth day after the end of such fiscal quarter, the Applicable Margin shall be calculated as if the Cash Flow Leverage Ratio for such fiscal quarter was greater than or equal to 2.75 to 1.0 for the period from the sixty-first day after the end of such fiscal quarter until such date on which such financial statements and reports are delivered. (e) Section 2.7 of the Credit Agreement is amended in its entirety to read as follows: Section 2.7 Prepayment of the Revolving Commitment. 2.7(i) Mandatory Prepayment. On the date of the occurrence of any of the following events, the Borrower shall prepay the Revolving Loans in an aggregate amount of 100% of the Net Proceeds received in cash by the Borrower as a result of any of the following events: (A) sales of assets of the Borrower, other than sales of inventory, in excess of $1,000,000 in the aggregate during any fiscal year of the Borrower, to the extent the resulting Net Proceeds are not used to purchase similar assets within one year from the date of such sales, and (B) any public or private sale or offering by the Borrower of its capital stock or debt securities. 2.7(ii) Optional Prepayments. The Borrower may prepay Reference Rate Advances, in whole or in part, at any time, without premium or penalty. Except upon an acceleration following an Event of Default or upon termination of the Revolving Commitments in whole, the Borrower may pay Eurodollar Rate Advances and CD Rate Advances only on the last day of the Interest Period applicable thereto. Any such prepayment must, in the case of a Eurodollar Rate Advance or a CD Rate Advance, be accompanied by accrued and unpaid interest -4- 5 on the amount prepaid. Each prepayment shall be in an aggregate amount for all the Banks of $300,000 ($200,000, in the case of a Reference Rate Advance) or an integral multiple of $100,000 in excess thereof. Amounts paid (unless following an acceleration or upon termination of the Revolving Commitments in whole) or prepaid on Advances under this Section 2.7 may be reborrowed upon the terms and subject to the conditions and limitations of this Agreement. Amounts paid or prepaid on the Advances under this Section 2.7 shall be for the account of each Bank in proportion to its share of outstanding Revolving Loans. (f) Sections 2.14(a) and (b) of the Credit Agreement are amended in their entireties to read as follows: 2.14(a) The Company shall pay quarterly in arrears on the last day of each calendar quarter and on the Termination Date, a Letter of Credit Fee in an amount determined by applying a rate per annum equal to the Applicable Margin with respect to Eurodollar Rate Advances then in effect to the average daily aggregate principal amount of Commercial Paper Notes (Midwest) issued by the Borrower and outstanding under the Commercial Paper Program, all as more specifically set forth in the Commercial Paper Program Documents. 2.14(b) For each Standby Letter of Credit issued, the company shall pay in advance, on the date of issuance thereof and on the date of any extension thereof, a fee (a "Letter of Credit Fee") in an amount determined by applying a rate per annum equal to the Applicable Margin with respect to Eurodollar Rate Advances then in effect to the original face amount of the Standby Letter of Credit for the period from the date of issuance or extension to the scheduled expiration date of such Letter of Credit. (g) Section 2.18 of the Credit Agreement is amended by deleting therefrom the date "July 31, 1999" and inserting in its place the date "May 31, 2001". (h) Section 6.4 of the Credit Agreement is amended in its entirety to read as follows: Section 6.4 Change in Nature of Business. The Borrower will not, and will not permit any Subsidiary to, make any material change in the nature of the business of the Borrower or such Subsidiary, as carried on at the date hereof, except for changes in business related to the communications and information technology industries. (i) Section 6.5 of the Credit Agreement is amended in its entirety to read as follows: -5- 6 Section 6.5 Subsidiaries. After the date of this Agreement, the Borrower will not, and will not permit any Subsidiary to, form or acquire any corporation which would thereby become a Subsidiary, unless (a) 100% of the issued and outstanding capital stock of such Subsidiary is owned by Norstan, Inc. or by a 100%-owned Subsidiary of Norstan, Inc., (b) each line of business of such Subsidiary is within the communications and information technology industries and (c) the aggregate amount of the Borrower's Investment or Investments in all such Subsidiaries shall not exceed the amounts set for in Section 6.10(1). (j) Section 6.8 of the Credit Agreement is amended in its entirety to read as follows: Section 6.8 Capital Expenditures. The Borrower will not, and will not permit any Subsidiary to, make Capital Expenditures in an amount exceeding, on a consolidated basis in any fiscal year, an amount equal to (a) seven percent (7%) of the consolidated revenues of the Borrower and the Subsidiaries as reported in their consolidated financial statements for the preceding fiscal year, plus (b) for the fiscal year ending April 30, 1998 only, Capital Expenditures attributable to the PRIMA Acquisition. (k) Section 6.10(k) of the Credit Agreement is amended in its entirety to read as follows: 6.10(k) Loans and advances by the Borrower to Norstan Communications, Inc., Norstan Network Services, Inc., Connect Computer Company, PRIMA, Norstan-UK and Norstan International and (for purposes other than to finance lease account receivables, as specified in 6.10(j) above) to Norstan Canada; (l) Section 6.10(l) of the Credit Agreement is amended in its entirety to read as follows: 6.10(l) Purchases or acquisitions by the Borrower of substantially all of the real and personal property of, or the capital stock of, another Person engaged in the communications and information technology industries; provided that (i) the purchase price paid for such assets shall not exceed, in the aggregate (including any contingent payments based on profitability of the assets acquired) for any such purchase or acquisition, $15,000,000; (ii) there shall be no more than three such separate purchases or acquisitions during any consecutive twelve month period; (iii) no Default or Event of Default has occurred or would occur as a result thereof; (iv) the Borrower will deliver to the Lender pro forma financial statements demonstrating in reasonable detail that the Borrower would have complied with Sections 6.16, 6.17, 6.18, and 6.19 had such purchase or acquisition been consummated prior to the end of the -6- 7 most recently completed fiscal quarter, and that based on the Borrower's projections, the Borrower will comply with Sections 6.16, 6.17, 6.18 and 6.19 at the end of the current fiscal quarter after giving effect to such purchase or acquisition; and (v) EBITDA for the Person so acquired was not less than $1 for the four most recently completed fiscal quarters of such Person prior to the date of such purchase or acquisition; (m) Section 6.11(k) of the Credit Agreement is amended in its entirety to read as follows: 6.11(k) Unsecured Indebtedness of the Borrower (other than as permitted by other clauses of this Section 6.11); provided, however, that the aggregate principal amount of such Indebtedness outstanding at any time shall not exceed $10,000,000. (n) Sections 6.15, 6.16, 6.17, 6.18, 6.19, 6.20 and 6.21 of the Credit Agreement are amended in their entireties to read as follows: Section 6.15 Intentionally Omitted. Section 6.16 Minimum EBITDA. The Borrower will not permit EBITDA as of the last day of any fiscal quarter for the four consecutive fiscal quarters then ended to be less than (i) $35,000,000 from April 30, 1998 through April 29, 1999, (ii) $40,000,000 at the end of any fiscal quarter ending on or after April 30, 1999 through April 29, 2000, and (iii) $45,000,000 at the end of any fiscal quarter thereafter. Section 6.17 Cash Flow Leverage Ratio. The Borrower will not permit the Cash Flow Leverage Ratio, as of the last day of any fiscal quarter, to be more than 3.00 to 1.0. Section 6.18 Adjusted Leverage Ratio. The Borrower will not permit the Adjusted Leverage Ratio to be more than 3.00 to 1.0 as of the end of any fiscal quarter. Section 6.19 Interest Coverage Ratio. The Borrower will not permit the Interest Coverage Ratio, as of the last day of any fiscal quarter, to be less than 8.0 to 1.0. Section 6.20 Ratio of NFS Total Senior Debt to NFS Tangible Net Worth. The Borrower will not permit the ratio of the NFS Total Senior Debt to the NFS Tangible Net Worth to be more than 12.0 to 1.0 at any time. -7- 8 Section 6.21 NFS Total Reserve as Percentage of NFS Total Gross Investment. The Borrower will not permit the NFS Total Reserve to be less than 2.0% of the NFS Total Gross Investment at any time. (o) Each reference to "ROLM Company" set forth in Section 7.1(n) of the Credit Agreement shall mean a reference to "Siemens Business Communications Systems, Inc." (p) Exhibit 1.1A to the Credit Agreement is deleted and Exhibit 1.1A to this Amendment is inserted in its place and Exhibit 1.1C to the Credit Agreement is deleted and Exhibit 1.1C to this Amendment is inserted in its place. (q) Schedules 4.19, 6.10, 6.11, 6.12 and 6.13 to the Credit Agreement are deleted and Schedules 4.19, 6.10, 6.11, 6.12 and 6.13 to this Amendment are inserted in lieu therefor. Section 3. Termination of PRIMA Bridge Loan Facility. On the effective date of this Amendment the PRIMA Bridge Loan Facility and the Credit Agreement dated as of September 26, 1997 and the Loan Documents as defined therein are hereby terminated. As of such date, the outstanding principal balance of the PRIMA Bridge Loan shall be deemed outstanding under the Credit Agreement as amended hereby and shall bear interest and be repaid in accordance therewith. All accrued and unpaid interest and unpaid Unused Revolving Commitment Fees (as defined in the PRIMA Bridge Loan Facility Credit Agreement) on the PRIMA Bridge Loan Facility shall be paid by the Borrower on such date. On the effective date of this Amendment, the Banks shall pay such amounts to each other as required so that each Bank's percentage of the Revolving Outstandings is equal to each Bank's Revolving Commitment Percentage. Section 4. Representations and Warranties of the Borrower. To induce the Banks and the Agent to execute and deliver this Amendment (which representations and warranties shall survive the execution and delivery of this Amendment), the Borrower represents and warrants to the Agent and the Banks that: (a) this Amendment and the New Notes (as defined below in Section 6(b) hereof) have been duly authorized, executed and delivered by it and this Amendment and the New Notes constitute the legal, valid and binding obligation of the Borrower enforceable against the Borrower in accordance with their terms, subject to limitations as to enforceability which might result from bankruptcy, insolvency, reorganization, moratorium or similar laws or equitable principles relating to or limiting creditors' rights generally; (b) the Credit Agreement, as amended by this Amendment, constitutes the legal, valid and binding obligation of the Borrower enforceable against the -8- 9 Borrower in accordance with its terms, subject to limitations as to enforceability which might result from bankruptcy, insolvency, reorganization, moratorium or similar laws or equitable principles relating to or limiting creditors' rights generally; (c) the execution, delivery and performance by the Borrower of the Amendment and the New Notes (i) have been duly authorized by all requisite corporate action and, if required, shareholder action, (ii) do not require the consent or approval of any governmental or regulatory body or agency, and (iii) will not (A) violate (1) any provision of law, statute, rule or regulation or its certificate of incorporation or bylaws, (2) any order of any court or any rule, regulation or order of any other agency or government binding upon it, or (3) any provision of any material indenture, agreement or other instrument to which it is a party or by which any of its properties or assets are or may be bound, or (B) result in a breach of or constitute (alone or with due notice or lapse of time or both) a default under any indenture, agreement or other instrument referred to in clause (iii)(A)(3) of this Section 4(c); (d) as of the date hereof, no unwaived Default or Event of Default has occurred which is continuing; and (e) all the representations and warranties contained in Section 4 of the Credit Agreement are true and correct in all material respects with the same force and effect as if made by the Borrower on and as of the date hereof. Section 5. Waiver. The Borrower has informed the Banks that the Adjusted Leverage Ratio for the period ended November 1, 1997 was 2.1 to 1.0 which is in excess of the maximum level of 2.0 to 1.0 allowed under Section 6.18 of the Credit Agreement. Upon satisfaction of the conditions set forth in Section 6 of this Amendment, the Banks hereby waive Event of Default under the Credit Agreement described in the immediately preceding sentence for the period ended November 1, 1997. This waiver is limited to the express terms hereof and shall not extend to any other Default, Event of Default or any other period. This waiver shall not be and shall not be deemed to be a course of dealing upon which the Borrower may rely with respect to any other Default, Event of Default or request for a waiver and the Borrower hereby expressly waives any such claim. Section 6. Conditions to Effectiveness of this Amendment. This Amendment shall not become effective until, and shall become effective when, each and every one of the following conditions shall have been satisfied: (a) executed counterparts of this Amendment, duly executed by the Borrower and each of the Banks, shall have been delivered to the Agent; -9- 10 (b) executed Revolving Notes (the "New Notes") in the form of Exhibit 1.1C shall have been received by the Agent on behalf of each of the Banks. (c) the Agent shall have received from each of the Guarantors, other than PRIMA, Norstan International and Norstan-UK, a Consent and Agreement of Guarantor in the form of Attachment 1 hereto (the "Guarantor Agreements") duly completed and executed by such Guarantor; (d) the Agent shall have received from each of PRIMA, Norstan International and Norstan-UK a duly executed Guaranty in the form of Exhibit A hereto; (e) the Agent shall have received a copy of the resolutions of the Board of Directors of the Borrower authorizing the execution, delivery and performance by the Borrower of this Amendment, certified by its Secretary or an Assistant Secretary, together with a certificate of the Secretary or an Assistant Secretary of the Borrower certifying as to the incumbency and the true signatures of the officers authorized to execute this Amendment on behalf of the Borrower; (f) a copy of the corporate resolution of each of PRIMA, Norstan International and Norstan-UK authorizing the execution, delivery and performance of its respective Guaranty; (g) an incumbency certificate for each of PRIMA, Norstan International and Norstan-UK showing the names and titles and bearing the signatures of its officers authorized to execute its respective Guaranty, certified as of the Closing Date by the Secretary or an Assistant Secretary of PRIMA, Norstan International and Norstan-UK, respectively; (h) a copy of the Articles of Incorporation of each of PRIMA, Norstan International and Norstan-UK with all amendments thereto, certified by the appropriate governmental official of the jurisdiction of its incorporation as of a date not more than ten days prior to the date hereof; (i) a certificate of good standing for each of PRIMA, Norstan International and Norstan-UK in the jurisdiction of its incorporation, certified by the appropriate governmental officials as of a date not more than ten days prior to the date hereof; (j) a copy of the bylaws of each of PRIMA, Norstan International and Norstan-UK, certified as of the Closing Date by the Secretary or an Assistant Secretary of PRIMA, Norstan International and Norstan-UK, respectively; and -10- 11 (d) This Amendment shall be governed by, and construed in accordance with, the internal law, and not the law of conflicts, of the State of Minnesota, but giving effect to federal laws applicable to national banks. (e) This Amendment shall be binding upon the Borrower, the Agent and the Banks and their respective successors and assigns, and shall inure to the benefit of the Borrower, the Agent and the Banks and the successors and assigns of the Agent and the Banks. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK.] -12- 12 IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the day and year first above written. NORSTAN, INC. By Robert J. Vold -------------------------------- Its Treasurer ----------------------------- FIRST BANK NATIONAL ASSOCIATION, as a Bank and as Agent By David Shipiro -------------------------------- Its Commercial Banking Officer ----------------------------- HARRIS TRUST AND SAVING BANK By Catherine Ciolek -------------------------------- Its Vice President ----------------------------- THE SUMITOMO BANK, LIMITED, CHICAGO BRANCH By Jeffrey P. Norton -------------------------------- Its Vice President ----------------------------- By John W. Howard, Jr. -------------------------------- Its Vice President & Manager ----------------------------- [Signature Page to Third Amendment to Credit Agreement] S-1 EX-10.(M) 4 EXHIBIT 10.(M) 1 EXHIBIT 10(M) L E A S E ARTICLE 1. LEASE TERMS 1.1 LANDLORD AND TENANT. This lease ("Lease") is entered into this 23RD DAY OF DECEMBER, 1997 by and between Thomas Edward Limited Partnership, a Minnesota Limited Partnership, ("Landlord") and Norstan, Inc., a Minnesota Corporation ("Tenant"). 1.2 PREMISES. Landlord hereby rents, leases, lets and demises to tenant the following property ("Premises") consisting of (i): Approximately 85,819 square feet of office space on floors one, two, three and four as depicted on the floor plans attached hereto as EXHIBIT A ("Phase I Premises") and (ii): Approximately 148,302 square feet consisting of the future floor 5, the second floor warehouse annex, the third floor warehouse annex and the warehouse area as depicted on EXHIBIT B attached hereto ("Phase II Premises") in the property located at 5101 SHADY OAK ROAD IN MINNETONKA, MINNESOTA ("Building"). A site plan of the building and a description of the shell improvements to the future fifth (5th) floor portion of the Premises are attached hereto as EXHIBITS C AND D. All other areas of the Premises shall be delivered in the "as is" condition except as depicted in sections 6.1, 6.2, 6.3, and 6.4. The total square foot area of the Phase I and Phase II Premises is approximately 234,121 square feet. The square foot area of the building is currently 198,011 square feet, and will increase to approximately 234,121 square feet upon addition of the future fifth floor. For the purposes of this Lease, the determination of the number of square feet in the Premises, and the number of square feet in the Building shall be made using the "BOMA" measurement method. "As-built" measurements will be taken of the Buildings and Premises as soon as construction has progressed to the point where such measurement is possible. Landlord will certify such "as-built" measurements to Tenant, which measurements Tenant shall have the right to review and confirm. In the event that Landlord and Tenant are unable to agree upon the "as built" measurements, landlord and Tenant agree to adhere to the measurements determined by a neutral third party, which third party shall be determined mutually by Tenant and Landlord. Landlord and Tenant shall thereafter execute an addendum to this Lease in the form of attached EXHIBIT E, confirming said measurements and adjusting (i) the area of the Building and Premises, (ii) the Base Rent, and (iii) Tenant's pro rata share, to reflect the actual rentable square foot area of the Building and Premises, and such addendum shall thereupon be deemed attached hereto, incorporated herein, and by this reference made a part of this Lease. Until such time as said as-built measurements are available, Tenant agrees that the estimated square footage of the Premises and Building as set forth in this section shall be utilized to compute Base Rent, Tenant's pro-rata share of Operating Expenses, and any other sums due hereunder based in whole or in part on the square footage of the Premises or the Building. 1.3 LEASE TERM. The term of this Lease shall commence on JULY 1, 1998 ("Commencement Date") and shall terminate 161 MONTHS thereafter on NOVEMBER 30, 2011, unless sooner terminated as hereinafter provided. The Landlord shall deliver the Phase I Premises on the commencement Date and the Phase II Premises on the Commencement of Lease Month eighteen (18). Upon written notice to Landlord prior to February 13, 1998, Tenant shall have the option to delay its occupancy of portions of the Phase I Premises by substituting some or all of the Phase II second floor annex, third floor annex, or if available the Phase II warehouse into the Premises. No such substitution shall result in a reduction of the initial area of the Premises below 85,819 square feet. Upon receipt of notice from Tenant indicating the areas to be substituted, Landlord and Tenant shall enter into an addendum to the Lease to reflect the newly constituted Premises and if the substitution results in a net increase in the area of the Premises, the addendum will adjust the area of the Premises and pro-rata share of operating expenses, and will adjust the Base Rental Rate to reflect the net gain area at a Base Rental Rate of $3.85 per square foot in addition to the Base Rent depicted in section 1.4. In the event of a substitution (i) the Tenant improvement allowance described in section 6.3 shall be available for the substitution space, and (ii) the Phase I area which was subject to the substitution shall be delivered to Tenant no later than December 1, 1999, and (iii) the Tenant improvement allowance described in section 6.2 shall be available for the Phase I area, which was subject to the substitution. In the event that Tenant does not vacate the Premises upon the expiration or termination of this Lease, Tenant shall be a tenant at will for the holdover period and all of the terms and provisions of this Lease shall be applicable during that period, except that Tenant shall pay Landlord as base rental for the period of such holdover an amount equal to one and one half (1 1/2) times the base rent which would have been payable by Tenant had the holdover period been a part of the original term of this Lease, together with all additional rent as provided in this Lease. Tenant agrees to vacate and deliver the Premises to Landlord upon Tenant's receipt of notice from Landlord to vacate. The rental payable during the holdover period shall be payable to Landlord on demand. No holding over by Tenant, whether with or without the consent of Landlord, shall operate to extend the term of this Lease. Tenant, upon written notice to Landlord, shall have the right to accelerate the delivery date for and its occupancy of the Phase I area which was subject to a substitution, the second floor annex, third floor annex 2 of Phase II, or the future fifth floor or warehouse area during the first eighteen (18) months of the Lease. In the event Tenant exercises this right, Landlord shall be obligated to and shall deliver such areas to Tenant as soon as such areas can be accessed and improved by Landlord for occupancy by Tenant. Upon delivery of such areas, the Tenant's Base Rent and pro rata share of operating expenses shall be increased to reflect the addition of such space to the Premises effective as of the date of delivery. Base Rent shall be adjusted based upon the applicable rental rates set forth in section 1.4. Landlord agrees to allow Tenant to occupy the Premises for the purpose of installing its furnishings, fixtures and equipment for a thirty (30) day period immediately preceding the Commencement Date, ("early occupancy period"). During the first fifteen (15) days of the early occupancy period the Tenant's installation workers shall cooperate and coordinate their work with Landlord's contractor such that Tenant's work will not interfere with the completion of Landlord's work. During the last fifteen (15) days of the early occupancy period, the Tenant shall have exclusive occupancy of the Premises, subject to Landlord's right of access for the purpose of maintenance of the premises and completion of punch list items thereon. Tenant's early occupancy shall be subject to all of the terms and conditions of this lease, except payment of rent and operating expenses.
1.4 BASE RENT. The Initial Base Rent is: Months Monthly Base Rent Per Sq. Ft. ------ ----------------- ----------- 1-17 $ 42,909.50 $6.00 18-48 $100,282.38 $5.12 49-96 $106,746.43 $5.45 97-161 $113,209.97 $5.78
Such Base Rent is subject to adjustment as provided in sections 1.2, 6.2, and 6.3. Option Terms: 162-221 MARKET MARKET 222-281 MARKET MARKET Base Rent payable during the term of this Lease is based on the following rates for each area of the Premises:
Months Phase I Phase II Phase II Phase II ------ Premises Premises Premises Premises -------- (5th Floor) (annex) (whse.) ----------- -------- -------- 1-17 $6.00 psf N/A N/A N/A 18-48 $6.00 psf $7.00 psf $3.85 psf $3.85 psf 49-96 $6.50 psf $7.50 psf $4.00 psf $4.00 psf 97-161 $7.00 psf $8.00 psf $4.15 psf $4.15 psf
Such Base Rent is subject to adjustment as provided in sections 6.2 and 6.3. 1.5 PERMITTED USE: OFFICE AND WAREHOUSE FUNCTIONS RELATED TO SERVICES AND PRODUCTS OF COMMUNICATION. 1.6 SECURITY DEPOSIT: INTENTIONALLY OMITTED 1.7 PRO RATA SHARE: FORTY-THREE FOURTEEN ONE-HUNDREDTHS PERCENT (43.34%), adjusting to one-hundred percent (100%) upon occupancy of the Phase II Premises. * subject to adjustment as provided in Section 2.2 hereof. 1.8 ADDRESSES. LANDLORD'S ADDRESS: TENANT'S ADDRESS: --------- ------------------- ----------------- Thomas Edwards Limited Partnership Norstan, Inc. C/O CSM CORPORATION, INC. 5101 Shady Oak Road 2575 UNIVERSITY AVE. W., SUITE 150 Minnetonka, MN 55343 ST. PAUL, MN 55114-1024 ARTICLE 2. RENT, OPERATING EXPENSES AND SECURITY DEPOSIT 2.1 BASE RENT. Tenant agrees to pay monthly as base rent during the term of this Lease the sum of -2- 3 money set forth in Section 1.4 of this Lease, which amount shall be payable to Landlord at the address shown above. One monthly installment shall be due and payable on or before the Commencement Date; provided, if the Commencement Date should be a date other than the first day of a calendar month, the monthly rental set forth above shall be prorated to the end of that calendar month. All succeeding installments of rent shall be due and payable on or before the first day of each succeeding calendar month during the term of this Lease. Tenant shall pay, as additional rent, all other sums due under this Lease. Except as otherwise provided in this section, if Landlord, for any reason whatsoever (other than Tenant's default), cannot deliver possession of the Premises to the Tenant on the Commencement Date, this Lease shall not be void or voidable, nor shall Landlord be liable for any loss or damage resulting therefrom (except as depicted in this section), nor shall the expiration of the term be extended, but all rent shall be abated until Landlord delivers possession. Landlord and Tenant agree that payment of Base Rent and operating expenses payable under the Lease shall commence upon expiration of the early occupancy period described in section 1.3 of this Lease. Landlord agrees to provide Tenant 15 days prior written notice of the date on which the early occupancy period will commence. In the event that Landlord has not delivered the Phase I Premises on or before July 1, 1 998, subject to force majeure or Tenant caused delays, Landlord agrees to pay Tenant's base rent, operating expense charges and holdover rent charges, if applicable at Tenant's existing Wedgewood facility from July 1, 1998 until such time that Landlord delivers the Phase I Premises to Tenant. Tenant Represents that the scheduled Base Rent obligation under the Wedgewood Lease is $61,382.46 per month and the Tenant's estimated 1997 contribution to operating expenses is $47,221.07 per month. Tenant agrees that Landlord's liability shall not exceed 150% of the scheduled Base Rent and 100% of the 1998 estimated operating expenses, monthly. If Landlord is unable to deliver the Phase I Premises to Tenant on or before July 1, 1998, Tenant may request partial occupancy of the Premises on a floor by floor basis until such time as the entire Premises are available, and Landlord will permit such occupancy subject to availability and city approval. Should Landlord fail to deliver the Phase I Premises to Tenant on or before September 1, 1998, subject to force majeure or Tenant caused delays, Tenant may terminate this Lease with no further obligation upon delivery of written notice to Landlord on or before September 5, 1998, whereupon this Lease shall be null and void and of no force and effect. 2.2 OPERATING EXPENSES. Tenant shall also pay as additional rent Tenant's pro rata share of the operating expenses of Landlord for the Building. Landlord may invoice Tenant monthly for Tenant's pro rata share of the estimated operating expenses for each calendar year, which amount shall be adjusted once per year by Landlord based upon anticipated operating expenses. Within six (6) months following the close of each calendar year, Landlord shall provide Tenant an accounting showing in reasonable detail the computations of additional rent due under this Section. In the event the accounting shows that the total of the monthly payments made by Tenant exceeds the amount of additional rent due by Tenant under this Section, the accounting shall be accompanied by evidence of a credit to Tenant's next rental due. In any event the accounting shows that the total of the monthly payments made by Tenant is less than the amount of additional rent due by Tenant under this Section, the accounting shall be accompanied by an invoice for the additional rent. Notwithstanding any other provisions in this Lease, during the year in which this Lease terminates, Landlord, prior to the termination date, shall invoice Tenant for Tenant's pro rata share of the then current estimate for operating expenses. If this Lease shall terminate on a day other than the last day of a calendar year, the amount of any additional rent payable by Tenant applicable to the year in which the termination shall occur shall be prorated on the ratio that the number of days from the Commencement of the calendar year to and including such termination date bears to 365. Tenant agrees to pay any additional rent due under this Section within thirty (30) days following receipt of the invoice or accounting showing additional rent due. Within ninety (90) days of receipt of the operating expense reconciliation for the previous year, Tenant shall have the right to audit Landlord's books and records as they pertain to operating expenses for the immediate preceding calendar year, in Landlord's office and with reasonable notice. If Tenant does not provide notice to Landlord within ninety (90) days of its intent to audit, Tenant shall automatically waive and release its right to audit for the preceding calendar year. The cost of said audit shall be borne by Tenant unless the audit discloses that Tenant has overpaid its proportionate share of operating expenses for the calendar year in question by more than five percent (5%), in which case the reasonable expense of the audit shall be borne by Landlord. If the audit reveals that Landlord's actual statement was incorrect in any amount, the resulting excess or deficiency shall be paid by or reimbursed to Tenant as the case may be. Tenant's pro rata share set forth in Section 1.7 shall, subject to reasonable adjustment by Landlord, be equal to a percentage based upon a fraction, the numerator of which is the net rentable area of the Premises as set forth and the denominator of which shall be the net rentable area of the completed -3- 4 portions of the building (i.e., the fifth floor will be excluded from this computation until completed), as the same may change from time to time. 2.3 DEFINITION OF OPERATING EXPENSES. The term "operating expenses" includes all reasonable expenses incurred by Landlord with respect to the maintenance and operation of the Building, including, but not limited to, the following: maintenance, repair and replacement costs; electricity, fuel, water, sewer, gas and other common Building utility charges; equipment used for maintenance and operation of the Building; operational expenses; exterior window washing and janitorial services; trash and snow removal; landscaping and pest control; management fees not to exceed three percent (3%) of gross rents (exclusive of the amortization of the Tenant Improvement Allowance depicted in sections 6.2 and 6.3), wages and benefits payable to employees of Landlord whose duties are directly connected with the operation and maintenance of the Building; all services, supplies, repairs, replacements or other expenses for maintaining and operating the Building or project including parking and common areas; improvements made to the Building which are required under any governmental law or regulation that was not applicable to the Building at the time it was constructed; installation of any device or other equipment which improves the operating efficiency of any system within the Premises and thereby reduces operating expenses; all other expenses which would generally be regarded as operating, repair, replacement and maintenance expenses; all real property taxes and installments of special assessments, including dues and assessments by means of deed restrictions and/or owners' associations which accrue against the Building during the term of this Lease and legal fees incurred in connection with actions to reduce the same so long as any reduction associated with said action accrues to Tenant; and all insurance premiums Landlord is required to pay or deems necessary to pay, including fire and extended coverage, and rent loss and public liability insurance, with respect to the Building. Roof replacements shall be amortized over the useful life of the roof. Parking lot replacements shall be recovered in the year the work was performed so long as no more than 20% of the Parking area is replaced in one calendar year. The cost of Parking lot replacement involving replacement of in excess of 20% of the parking area in any year shall be amortized over the useful life of the replacement. Notwithstanding the above, Landlord agrees that the total cost of operating expenses including property taxes for the building shall not exceed the following during the calendar years 1998-2000: CALENDAR YEAR OPERATING EXPENSES 1998 $329,000.00 1999 $342,400.00 2000 $356,100.00 Provided that increases in property taxes resulting from the addition of the fifth floor shall not be subject to the cap, and shall be recoverable as operating expenses without regard to the cap. 2.4 INCREASE IN INSURANCE PREMIUMS. During any part of the Lease Term during which the building is being operated as a multi-tenant facility, if an increase in any insurance premiums paid by Landlord for the Building is caused by Tenant's use of the Premises. If Tenant vacates the Premises and causes an increase in such premiums, then Tenant shall pay as additional rent the amount of such increase to Landlord. 2.5 SECURITY DEPOSIT. Intentionally deleted. ARTICLE 3. OCCUPANCY AND USE 3.1 USE. Tenant warrants and represents to Landlord that the Premises shall be used and occupied only for the purpose as set forth in Section 1.5. Tenant shall occupy the Premises, conduct its business and control its agents, employees, invitees and visitors in such a manner as is lawful, reputable and will not create a nuisance. Tenant shall not permit any operation which emits any odor or matter which intrudes into other portions of the Building or otherwise interfere with, annoy or disturb any other lessee in its normal business operations or Landlord in its management of the Building. Tenant shall not permit any waste on the Premises to be used in any way which would, in the reasonable opinion of Landlord, be extra hazardous on account of fire or which would, in any way, increase or render void the fire insurance on the Building. 3.2 SIGNS. No sign of any type or description shall be erected, placed or painted in or about the Premises or Building which are visible from the exterior of the Premises, except those signs submitted to Landlord in writing, and which signs are in conformance with Landlord's sign criteria, if any, established for the Building. Notwithstanding the above, Landlord agrees that, subject to city approval, Tenant shall have the right to install and maintain two (2) building signs and one ground monument sign within the project in a size, location and design reasonably acceptable to Landlord. -4- 5 3.3 COMPLIANCE WITH LAWS, RULES, REGULATIONS. Tenant, at Tenant's sole cost and expense, shall comply with all laws, ordinances, orders, rules and regulations of state, federal, municipal or other agencies or bodies having jurisdiction over the use, condition or occupancy of the Premises. Tenant will comply with the reasonable rules and regulations of the Building adopted by Landlord. Landlord shall have the right at all times to change and amend the rules and regulations in any reasonable manner and with reasonable notice as may be deemed advisable for the safety, care, cleanliness, preservation of good order and operation or use of the Building or the Premises. All rules and regulations of the Building will be sent by Landlord to Tenant in writing and shall thereafter be carried out and observed by Tenant. 3.4 WARRANTY OF POSSESSION. Landlord warrants that it has the right and authority to execute this Lease, and Tenant, upon payment of the required rents and subject to the terms, conditions, covenants and agreements contained in this Lease, shall have possession of the Premises during the full term of this Lease as well as any extension or renewal thereof. Landlord shall not be responsible for the acts or omissions of any other lessee or third party that may interfere with Tenant's use and enjoyment of the Premises. 3.5 RIGHT OF ACCESS. Landlord or its authorized agents shall at any and all reasonable times and with reasonable notice have the right to enter the Premises to inspect the same, to show the Premises to prospective purchasers, mortgagees, insurers other interested parties or in the last six (6) months of the Lease prospective lessees, and to alter, improve or repair the Premises or any other portion of the Building. Tenant hereby waives any claim for damages for injury or inconvenience to or interference with Tenant's business, any loss of occupancy or use of the Premises, and any other loss occasioned thereby unless such loss is caused by the gross negligence of the Landlord. Landlord shall have the right to use any and all means which Landlord may deem proper to open any door in an emergency without liability therefor. Tenant shall permit Landlord to erect, use, maintain and repair pipes, cables, conduits, plumbing, vents and wires in, to and through the Premises as often and to the extent that Landlord may now or hereafter deem to be necessary or appropriate for the proper use, operation and maintenance of the Building. ARTICLE 4. UTILITIES AND ACTS OF OTHERS 4.1 BUILDING SERVICES. Tenant shall pay when due, all charges for utilities furnished to or for the use or benefit of Tenant or the Premises. Tenant shall have no claim for rebate of rent on account of any interruption in service, unless such interruption was caused by the gross negligence of Landlord. 4.2 THEFT OR BURGLARY. Landlord shall not be liable to Tenant for losses to Tenant's property or personal injury caused by criminal acts or entry by unauthorized persons into the Premises or the Building, unless such loss or injury was caused by the gross negligence of Landlord. ARTICLE 5. REPAIRS AND MAINTENANCE 5.1. LANDLORD REPAIRS. Landlord shall not be required to make any improvements, replacements or repairs of any kind or character to the Premises or the Building during the term of this Lease except as are set forth in this Section. Landlord shall maintain only the roof, foundation, parking and common areas, the structural soundness of the exterior walls, doors, corridors, and other structures serving the Premises, provided, that Landlord's cost of maintaining, replacing and repairing the items set forth in this Section are operating expenses subject to the additional rent provisions in Section 2.2 and 2.3. Landlord shall not be liable to Tenant, except as expressly provided in this Lease, for any damage or inconvenience, and Tenant shall not be entitled to any abatement or reduction of rent by reason of any repairs, alterations or additions made by Landlord under this Lease, unless such damage or inconvenience constitutes a constructive eviction of Tenant and is the result of Landlord's negligent acts or omissions. Notwithstanding the above, Landlord shall be responsible, at its sole expense, for repair and replacement of the structural elements of the building shell, and for replacement, if necessary of the cooling tower and boiler, electric transformers and switch gear provided that normal maintenance and repair of the cooling tower and boiler including minor replacements shall be performed by Tenant at Tenant's expense. Landlord's repair and replacement of the roof and normal maintenance of the structural components of the exterior of the building shall be a component of and included in operating expenses under section 2.3. 5.2 TENANT REPAIRS. Tenant shall, at all times throughout the term of this Lease, including renewals and extensions, and at its sole expense, keep and maintain the Premises in a clean, safe, sanitary and first class condition and in compliance with all applicable laws, codes, ordinances, rules and regulations. Tenant's obligations hereunder shall include, but not be limited to, the maintenance, repair and replacement, if necessary, of all heating, ventilation, air conditioning, lighting and plumbing fixtures and equipment, fixtures, motors and machinery, all interior walls, partitions, doors and windows, including the regular painting thereof, all exterior entrances, windows, doors and docks and the replacement of all broken glass. When used in this provision, the term "repairs" shall include replacements or renewals when necessary, and all -5- 6 such repairs made by the Tenant shall be equal in quality and class to the original work. The Tenant shall keep and maintain all portions of the Premises and the sidewalk and areas adjoining the same in a clean and orderly condition, free of accumulation of dirt, rubbish, ice and snow in accumulations of less than one (1) inch. If Tenant fails, refuses or neglects to maintain or repair the Premises as required in this Lease after notice shall have been given Tenant, in accordance with this Lease, Landlord may make such repairs without liability to Tenant for any loss or damage that may accrue to Tenant's merchandise, fixtures or other property or to Tenant's business by reason thereof, and upon completion thereof, Tenant shall pay to Landlord all costs plus fifteen percent (15%) for overhead incurred by Landlord in making such repairs upon presentation to Tenant of bill therefor. 5.3. TENANT DAMAGES. Tenant shall not allow any damage to be committed on any portion of the Premises or Building or common areas, and at the termination of this lease, by lapse of time or otherwise, Tenant shall deliver the Premises to Landlord in as good condition as existed at the Commencement Date of this Lease, ordinary wear and tear excepted. The cost and expense of repairs necessary to restore the condition of the Premises shall be borne by Tenant. ARTICLE 6. ALTERATIONS AND IMPROVEMENTS 6.1 LANDLORD IMPROVEMENTS. Landlord shall complete the exterior site and parking lot improvements to the west of the Premises as depicted on EXHIBIT C and the majority of the fifth floor construction on or before July 1, 1998. Landlord shall exercise reasonable efforts to minimize disruption of Tenant's business activities during Landlord's completion of work after July 1, 1998, provided that most work may be completed during normal construction hours. Landlord shall complete the exterior site and parking lot improvements to the southeast of the Premises as depicted on EXHIBIT C on or before December 1, 1999. In the event that Tenant elects to accelerate its Phase II Premises occupancy, and the area of accelerated occupancy exceeds 35,000 square feet, Landlord agrees to complete the exterior improvements to the southeast of the Premises as depicted on EXHIBIT C no later than 90 days after Tenant's notice of projected occupancy of the Phase II Premises, except that Landlord shall not be required to perform such work during the calendar months of November, December, January, February, March and April. 6.2 PHASE I PREMISES INTERIOR IMPROVEMENTS. On or before February 13, 1998 Tenant shall submit to Landlord construction drawings for the Phase I improvements, which plans shall be subject to Landlord's review and approval, which approval shall not be unreasonably withheld. In the event that acceptable working drawings are not received by Landlord on or before February 13, 1998, then Landlord's obligation to pay Tenant's base rent, operating expenses and holdover costs for the Wedgewood facility, pursuant to section 2.1 hereof, shall be delayed one (1) day for each day after February 13, 1998 that Tenant has failed to provide acceptable working drawings to Landlord, provided that the delay contributes to the late delivery of the Premises. Landlord agrees to seek competitive bids for the construction of the Phase I improvements based on a standard construction schedule. Landlord and Tenant agree to mutually select contractor(s) to perform the improvements and enter into a contract(s) for the improvements at a mutually agreed upon price. Any changes to the scope of work must be made through written change orders signed by Tenant. Landlord and Tenant agree that Landlord shall have the sole discretion to schedule the construction work including fast tracking of the construction of the improvements, provided that fast track costs shall not be a component of the improvement allowance depicted in this section, and Landlord shall endeavor to deliver the Premises on or before July 1, 1998. Landlord shall provide an allowance of up to $17.50 per square foot towards construction of the improvements of the Premises described as Phase I in section 1.2 of the Lease (Phase I Improvements), which allowance shall be paid directly to the contractor under customary and normal construction lending procedures. Upon completion of the Phase I Improvements, Landlord shall provide Tenant documentation of final construction costs, with back up and detail information related thereto. Tenant agrees to immediately reimburse Landlord for any costs for construction of the Phase I Improvements in excess of the allowance set forth above. Landlord and Tenant agree that the Phase I Tenant Improvement costs incurred by Landlord, up to $17.50 per square foot, shall be amortized over the initial term of this lease at a 9% annual interest rate. The amortization shall be paid monthly in addition to and as a part of the Base Rent for the premises. Landlord and Tenant agree to promptly enter into an addendum to the lease in a form similar to EXHIBIT E, to confirm such increase in the Base Rent. 6.3 PHASE II PREMISES INTERIOR IMPROVEMENTS. On or before May 31, 1999, Tenant shall submit to Landlord construction drawings for the leasehold improvements to the second (2nd) floor warehouse annex, the third (3rd) floor warehouse annex the future fifth (5th) floor, and for conversion of up to 14,000 square feet of the 83,000 square foot warehouse area currently occupied by K-Tel International, Inc., to -6- 7 office space (the "Phase II Improvements"), which plans shall be subject to Landlord's review and approval, which approval shall not be unreasonably withheld. Landlord agrees to seek competitive bids for the construction of the Phase If improvements based on a standard construction schedule and Landlord and Tenant agree to mutually select contractors to perform the improvements. Landlord shall provide an allowance of up to $25.00 per square foot towards construction of the Phase II Improvements, which allowance shall be paid directly to the contractor under customary and normal construction lending procedures; provided that said allowance shall only be applicable and payable with respect to Phase II Improvements which are commenced prior to December 1, 1999. Upon completion of the Phase II Improvements, Landlord shall provide Tenant documentation of final construction costs, with back up and detail information related thereto. Tenant agrees to immediately reimburse Landlord for any costs for construction of the Phase II Improvements in excess of the allowance set forth above. Landlord and Tenant agree that the Phase II Tenant Improvement costs incurred by Landlord, up to $25.00 per square foot, shall be amortized over the remaining initial term of this lease at a 9% interest rate. The amortization shall be paid monthly in addition to and as a part of the Base Rent for the premises. Landlord and Tenant agree to promptly enter into an addendum to the lease in a form similar to EXHIBIT E, to confirm such increase in the Base Rent. 6.4 BUILDING CODE COMPLIANCE ALLOWANCE. Landlord shall provide Tenant an allowance of $100,000.00 towards the cost of any modifications required to comply with current building codes, including but not limited to requirements of the Americans With Disabilities Act. This allowance shall not include nor be applicable to costs of relocation of the sprinkler system lateral runs or heads to accommodate specific space plan designs. In the event that the cost of modifications required to comply with current building codes is expected to exceed $100,000.00, Tenant may terminate this Lease with no further obligation on or before February 13, 1998 with written notice delivered to Landlord on or before February 17, 1998. If Tenant exercises its option to terminate depicted in this section, Landlord shall have the right to fund the cost over $100,000.00 and Tenant's option to terminate shall be null and void. 6.5 ADDITIONAL TENANT IMPROVEMENTS. After the original construction of the Phase I and Phase II improvements, tenant shall not make or allow to be made any alterations or physical additions in or to the Premises without first obtaining the written consent of Landlord, which consent may not be unreasonably denied. Any alterations, physical additions or improvements to the Premises made by Tenant shall at once become the property of Landlord and shall be surrendered to Landlord upon the termination of this Lease; provided, however, Landlord, at its option, may, as a condition of its approval of the alteration or addition, require Tenant to remove any physical additions and/or repair any alterations in order to restore the Premises to the conditions existing at the time Tenant took possession, all costs of removal and/or alterations to be borne by Tenant. This clause shall not apply to moveable equipment or furniture owned by Tenant, which may be removed by Tenant at the end of the term of this Lease. 6.6 TENANT IMPROVEMENT WARRANTY. Landlord agrees that all Tenant improvement work performed in and about the Premises will be warranted for a period of twelve (12) months following the completion of the work. The warranty shall not be applicable to repairs necessitated by normal wear and tear or Tenant-caused damages. ARTICLE 7. CASUALTY AND INSURANCE 7.1 SUBSTANTIAL DESTRUCTION. If all or a substantial portion of the Premises or the Building should be totally destroyed by fire or other casualty, or if the Premises or the Building should be damaged so that rebuilding cannot reasonably be completed within one hundred eighty (180) working days after the date of written notification by Tenant to Landlord of the destruction, or if insurance proceeds are not made available to Landlord, or are inadequate, for restoration, this Lease shall terminate at the option of Landlord by written notice to Tenant within sixty (60) days following the occurrence, and the rent shall be abated for the unexpired portion of the Lease effective as of the date of the written notification. 7.2 PARTIAL DESTRUCTION. If the Premises should be partially damaged by fire or other casualty, and rebuilding or repairs can reasonably be completed within one hundred eighty (180) working days from the date of written notification by Tenant to Landlord of the destruction, and insurance proceeds are adequate and available to Landlord for restoration, this Lease shall not terminate, and Landlord shall at its sole risk and expense proceed with reasonable diligence to rebuild or repair the Building or other improvements to substantially the same condition in which they existed prior to the damage. If the Premises are to be rebuilt or repaired and are untenantable in whole or in part following the damage, and the damage or destruction -7- 8 was not caused or contributed to by act or negligence of Tenant, its agents, employees, invitees or those for whom Tenant is responsible, the rent payable under this Lease during the period for which the Premises are untenantable shall be adjusted to such an extent as may be fair and reasonable under the circumstances. In the event that Landlord fails to complete the necessary repairs or rebuilding within one hundred eighty (180) working days from the date of written notification by Tenant to Landlord of the destruction, Tenant may at its option terminate this Lease by delivering written notice of termination to Landlord, whereupon all rights and obligations under this Lease shall cease to exist. 7.3 PROPERTY INSURANCE. Landlord shall not be obligated in any way or manner to insure any personal property (including, but not limited to, any furniture, machinery, goods or supplies) of Tenant upon or within the Premises, any fixtures installed or paid for by Tenant upon or within the Premises, or any improvements which Tenant may construct on the Premises. Tenant shall maintain property insurance on its personal property and shall also maintain plate glass insurance. Tenant shall have no right in or claim to the proceeds of any policy of insurance maintained by Landlord even if the cost of such insurance is borne by Tenant as set forth in Article 2. 7.4 WAIVER OF SUBROGATION. Anything in this Lease to the contrary withstanding, Landlord and Tenant hereby waive and release each other of and from any and all right of recovery, claim, action or cause of action, against each other, their agents, officers and employees, for any loss or damage that may occur to the Premises, the improvements of the Building or personal property within the Building, by reason of fire or the elements, regardless of cause or origin, including negligence of Landlord or Tenant and their agents, officers and employees. Landlord and Tenant agree immediately to give their respective insurance companies which have issued policies of insurance covering all risk of direct physical loss, written notice of the terms of the mutual waivers contained in this Section. 7.5 HOLD HARMLESS. Landlord shall not be liable to Tenant's employees, agents, invitees, licensees or visitors, or to any other person, for an injury to person or damage to property on or about the Premises caused by any act or omission of Tenant, its agents, servants or employees, or of any other person entering upon the Premises under express or implied invitation by Tenant, or caused by the improvements located on the Premises becoming out of repair, the failure or cessation of any service provided by Landlord (including security service and devices), or caused by leakage of gas, oil, water or steam or by electricity emanating from the Premises. Tenant agrees to indemnify and hold harmless Landlord of and from any loss, attorney's fees, expenses or claims arising out of any such damage or injury. Tenant shall not be liable to Landlord or its employees, agents, invitees, licensees or visitors, or to any other person, for an injury to person or damage to property in the Building or common areas serving the Building caused by any act or omission of Landlord, its agents, servants or employees. Landlord agrees to indemnify and hold harmless Tenant of and from any loss, attorneys' fees, expenses or claims arising out of any such damage or injury. 7.6 PUBLIC LIABILITY INSURANCE. Tenant shall during the term hereof keep in full force and effect at its expense a policy or policies of public liability insurance with respect to the Premises and the business of Tenant, on terms and with companies approved in writing by Landlord, in which Landlord shall be covered by being named as an additional insured party, under reasonable limits of liability not less than $2,000,000, or such greater coverage as Landlord may reasonably require, combined single limit coverage for injury or death. Such policy or policies shall provide that thirty (30) days' written notice must be given to Landlord prior to cancellation thereof. Tenant shall furnish evidence satisfactory to Landlord at the time this Lease is executed that such coverage is in full force and effect. 7.8 LANDLORD'S INSURANCE. Landlord shall maintain in full force and effect during the lease term: an "all risk" commercial property insurance coverage policy in the amount of the full replacement value of the Building, as the value may exist from time to time. ARTICLE 8. CONDEMNATION 8.1 SUBSTANTIAL TAKING. If all or a substantial part of the Premises are taken for any public or quasi-public use under any governmental law, ordinance or regulation, or by right of eminent domain or by purchase in lieu thereof, and the taking would prevent or materially interfere with the use of the Premises for the purpose for which it is then being used, this Lease shall terminate and the rent shall be abated during the unexpired portion of this Lease effective on the date physical possession is taken by the condemning authority. Tenant shall have no claim to the condemnation award or proceeds in lieu thereof, except that Tenant shall be entitled to maintain an action for and recover a separate award as permitted under applicable law. -8- 9 8.2 PARTIAL TAKING. If all or a substantial part of the Premises are taken for any public or quasi-public use under any governmental law, ordinance or regulation, or by right of eminent domain or by purchase in lieu thereof, and this Lease is not terminated as provided in Section 8.1 above, the rent payable under this Lease during the unexpired portion of the term shall be adjusted to such an extent as may be fair and reasonable under the circumstances. Tenant shall have no claim to the condemnation award or proceeds in lieu thereof, except that Tenant shall be entitled to maintain an action for and recover a separate award as permitted under applicable law. ARTICLE 9. ASSIGNMENT OR SUBLEASE 9.1 LANDLORD ASSIGNMENT. Landlord shall have the right to sell, transfer or assign, in whole or in part, its rights and obligations under this Lease and in the Building. Any such sale, transfer or assignment shall operate to release Landlord from any and all liabilities under this Lease arising after the date of such sale, assignment or transfer. 9.2 TENANT ASSIGNMENT. Tenant shall not assign, in whole or in part, this Lease, or allow it to be assigned, in whole or in part, by operation of law or otherwise or mortgage or pledge the same, or sublet the Premises, in whole or in part, without the prior written consent of Landlord, which consent shall not be unreasonably withheld, and in no event shall said such assignment or sublease ever release Tenant or any guarantor from any obligation or liability hereunder. No assignee or sublessee of the Premises or any portion thereof may assign or sublet the Premises or any portion thereof, without Landlord's prior written consent. 9.3 CONDITIONS OF ASSIGNMENT. If Tenant desires to assign or sublet all or any part of the Premises, it shall so notify Landlord at least fifteen (15) days in advance of the date on which Tenant desires to make such assignment or sublease. Tenant shall provide Landlord with a copy of the proposed assignment or sublease and such information as Landlord might request concerning the proposed sublessee or assignee to allow Landlord to make informed judgments as to the financial condition, reputation, operations and general desirability of the proposed sublessee or assignee. Within seven (7) days after Landlord's receipt of Tenant's proposed assignment or sublease and all required information concerning the proposed sublease or assignee, Landlord shall have the following options: (1) cancel this Lease as to the Premises or portion thereof proposed to be assigned or sublet; (2) consent to the proposed assignment or sublease, and, if the rent due and payable by any assignee or sublessee under any such permitted assignment or sublease (or a combination of the rent payable under such assignment or sublease plus any bonus or any other consideration or any payment incident thereto) exceeds the rent payable under this Lease for such space after subtracting costs of procurement of sublessee, Tenant shall pay to Landlord half (1/2) of such excess rent and other excess consideration within ten (10) days following receipt thereof by Tenant; or (3) refuse, with reasonable discretion and judgement, to consent to the proposed assignment or sublease. Upon the occurrence of an event of default, if all or any part of the Premises are then assigned or sublet, Landlord, in addition to any other remedies provided by this Lease or provided by law, may, at its option, collect directly from the assignee or sublessee all rents becoming due to Tenant by reason of the assignment or sublease, and Landlord shall have a security interest in all properties on the Premises to secure payment of such sums. Any collection directly by Landlord from the assignee or sublessee shall not be construed to constitute a novation or a release of Tenant or any guarantor from the further performance of its obligations under this Lease. 9.4 RIGHTS OF MORTGAGE. Tenant accepts this Lease subject and subordinate to any recorded mortgage presently existing or hereafter created upon the Building and to all existing recorded restrictions, covenants, easements and agreements with respect to the Building. Landlord is hereby irrevocably vested with full power and authority to subordinate Tenant's interest under this Lease to any first mortgage lien hereafter placed on the Premises, and Tenant agrees upon demand to execute additional instruments subordinating this Lease as Landlord may require. If the interests of Landlord under this Lease shall be transferred by reason of foreclosure or other proceedings for enforcement of any first mortgage or deed of trust on the Premises, Tenant shall be bound to the transferee (sometimes called the "Purchaser") at the option of the Purchaser, under the terms, covenants and conditions of this Lease for the balance of the term remaining, including any extensions or renewals, with the same force and effect as if the Purchaser were Landlord under this Lease, and, if requested by the Purchaser, Tenant agrees to attorn to the Purchaser, including the first mortgagee under any such mortgage if it be the Purchaser, as its Landlord. Notwithstanding the foregoing, Tenant shall not be disturbed in its possession of the Premises so long as Tenant is not in default hereunder. 9.5 TENANT'S STATEMENT. Tenant agrees to furnish, from time to time, within ten (10) days after receipt of a request from Landlord or Landlord's mortgagee, a statement certifying, if applicable, the following: Tenant is in possession of the Premises; the Premises are acceptable; the Lease is in full force and effect; the Lease is unmodified; Tenant claims no present charge, lien, or claim or offset against rent; -9- 10 the rent is paid for the current month, but is not prepaid for more than one month and will not be prepaid for more than one month in advance; there is no existing default by reason of some act or omission by Landlord; and such other matters as may be reasonably required by Landlord or Landlord's mortgagee. Tenant's failure to deliver such statement, in addition to being a default under this Lease, shall be deemed to establish conclusively that this Lease is in full force and effect except as declared by Landlord, that Landlord is not in default of any of its obligations under this Lease, and that Landlord has not received more than one month's rent in advance. Tenant agrees to furnish, from time to time, within ten (10) days after receipt of a request from Landlord, a current financial statement of Tenant, certified as true and correct by Tenant. ARTICLE 10. LANDLORD'S LIEN AND SECURITY AGREEMENT 10.1 LANDLORD'S LIEN. Intentionally Deleted ARTICLE 1 1. DEFAULT AND REMEDIES 11.1 DEFAULT BY TENANT. The following shall be deemed to be events of default ("Default") by Tenant under this Lease: (1) Tenant shall fail to pay when due any installment of rent or any other payment required pursuant to this Lease within five (5) days of written notice from Landlord; (2) Tenant shall fail to comply with any term, provision or covenant of this Lease, other than the payment of rent, and the failure is not cured within ten (10) days after written notice to Tenant; (3) Tenant shall file a petition or if an involuntary petition is filed against Tenant, or becomes insolvent, under any applicable federal or state bankruptcy or insolvency law or admit that it cannot meet its financial obligations as they become due; or a receiver or trustee shall be appointed for all or substantially all of the assets of Tenant; or Tenant shall make a transfer in fraud of creditors or shall make an assignment for the benefit of creditors; or (4) Tenant shall do or permit to be done any act which results in a lien being filed against the Premises or the Building and/or project of which the Premises are a part. In the event that an order for relief is entered in any case under Title 11, U.S.C. (the "Bankruptcy Code") in which Tenant is the debtor and: (A) Tenant as debtor-in-possession, or any trustee who may be appointed in the case (the "Trustee") seeks to assume the lease, then Tenant, or Trustee if applicable, in addition to providing adequate assurance described in applicable provisions of the Bankruptcy Code, shall provide adequate assurance to Landlord of Tenant's future performance under the Lease by depositing with Landlord a sum equal to the lesser of twenty-five percent (25%) of the rental and other charges due for the balance of the Lease term or six (6) months' rent ("Security"), to be held (without any allowance for interest thereon) to secure Tenant's obligation under the Lease, and (B) Tenant, or Trustee if applicable, seeks to assign the Lease after assumption of the same, then Tenant, in addition to providing adequate assurance described in applicable provisions of the Bankruptcy Code, shall provide adequate assurance to Landlord of the proposed assignee's future performance under the Lease by depositing with Landlord a sum equal to the Security to be held (without any allowance or interest thereon) to secure performance under the Lease. Nothing contained herein expresses or implies, or shall be construed to express or imply, that Landlord is consenting to assumption and/or assignment of the Lease by Tenant, and Landlord expressly reserves all of its rights to object to any assumption and/or assignment of the Lease. Neither Tenant nor any Trustee shall conduct or permit the conduct of any "fire", "bankruptcy", "going out of business" or auction sale in or from the Premises. 11.2 REMEDIES FOR TENANT'S DEFAULT. Upon the occurrence of a Default as defined above, Landlord may elect (i) to cancel and terminate this Lease and this Lease shall not be treated as an asset of Tenant' bankruptcy estate or (ii) to terminate Tenant's right to possession only without canceling and terminating Tenant's continued liability under this lease. Notwithstanding the fact that initially Landlord elects under (ii) to terminate Tenant's right to possession only, Landlord shall have the continuing right to cancel and terminate this Lease by giving three (3) days' written notice to Tenant of such further election, and shall have the right to pursue any remedy at law or in equity that may be available to Landlord. In the event of election under (ii) to terminate Tenant's right to possession only, Landlord may, at Landlord's option, enter the Premises and take and hold possession thereof, without such entry into possession terminating this Lease or releasing Tenant in whole or in part from Tenant's obligation to pay all amounts hereunder for the full stated term. Upon such reentry, Landlord may remove all persons and property from the Premises and such property may be removed and stored in a public warehouse or elsewhere at the cost and for the account of Tenant, without becoming liable for any loss or damage which may be occasioned thereby. Such reentry shall be conducted in the following manner: without resort to judicial process or notice of any kind if Tenant has abandoned or voluntarily surrendered possession of the Premises; and, otherwise, by resort to judicial process. Upon and after entry into possession without termination of the Lease, Landlord may, but is not obligated to, relet the Premises, or any part thereof, to any one other than -10- 11 the Tenant, for such time and upon such terms as Landlord, in Landlord's sole discretion, shall determine. Landlord may make alterations and repairs to the Premises to the extent deemed by Landlord necessary or desirable to relet the Premises. Upon such reentry, Tenant shall be liable to Landlord as follows: A. For all attorneys' fees incurred by Landlord in connection with exercising any remedy hereunder; B. For the unpaid installments of base rent, additional rent or other unpaid sums which were due prior to such reentry, including interest and late payment fees, which sums shall be payable immediately. C. For the installments of base rent, additional rent, and other sums falling due pursuant to the provisions of this Lease for the period after reentry during which the Premises remain vacant, including late payment charges and interest, which sums shall be payable as they become due hereunder. D. For all expenses incurred in releasing the Premises, including leasing commissions, attorneys' fees, and costs of alteration or repairs, which shall be payable by Tenant as they are incurred by Landlord; and E. While the Premises are subject to any new lease or leases made pursuant to this Section, for the amount by which the monthly installments payable under such new lease or leases is less than the monthly installment for all charges payable pursuant to this Lease, which deficiencies shall be payable monthly. Notwithstanding Landlord's election to terminate Tenant's right to possession only, and notwithstanding any reletting without termination, Landlord, at any time thereafter, may elect to terminate this Lease, and to recover (in lieu of the amounts which would thereafter be payable pursuant to the foregoing, but not in diminution of the amounts payable as provided above before termination), as damages for loss of bargain and not as a penalty, an aggregate sum equal to the amount by which the present value of the rental value of the Premises for the unexpired portion of the term of this Lease at the time of such election, is less than the Present Value of the Base Rent, additional rent and all other charges which would have been payable by Tenant for the unexpired portion of the term of this Lease, using a nine percent (9%) discount rate, which deficiency and all expenses incident thereto, including commissions, attorneys' fees, expenses of alterations and repairs, shall be due to Landlord as of the time Landlord exercises said election, notwithstanding that the term had not expired. If Landlord, after such reentry, leases the Premises, then the rent payable under such new lease shall be conclusive evidence of the rental value of the Premises for the unexpired portion of the term of this Lease, so long as the rental rate for the new Lease is commercially reasonable. If this Lease shall be terminated by reason of bankruptcy or insolvency of Tenant, Landlord shall be entitled to recover from Tenant or Tenant's estate, as liquidated damages for loss of bargain and not as a penalty, the amount determined by the immediately preceding paragraph. 11.3 LANDLORD'S RIGHT TO PERFORM FOR ACCOUNT OF TENANT. If Tenant shall be in Default under this Lease, Landlord may cure the Default at any time for the account and at the expense of Tenant. If Landlord cures a Default on the part of Tenant, Tenant shall reimburse Landlord upon demand for any amount expended by Landlord in connection with the cure, including, without limitation, attorneys' fees and interest. 11.4 INTEREST, ATTORNEY'S FEES AND LATE CHANGE . In the event of a Default by Tenant: (1) if a monetary default, interest shall accrue on any sum due and unpaid at the rate of the lesser of fifteen percent (1 5%) per annum or the highest rate permitted by law and, if Landlord places in the hands of an attorney the enforcement of all or any part of this Lease, the collection of any rent due or to become due or recovery of the possession of the Premises, Tenant agrees to pay Landlord's costs of collection, including reasonable attorney's fees for the services of the attorney, whether suit is actually filed or not. Other remedies for nonpayment of rent notwithstanding, if the monthly rental payment or any other payment due from Tenant to Landlord is not received by Landlord on or before the seventh (7th) day of the month for which the rent is due, a late payment charge of five percent (5%) of such past due amount shall become due and payable in addition to such amounts owed under this Lease. 11.5 ADDITIONAL REMEDIES, WAIVERS, ETC. A. The rights and remedies of Landlord set forth herein shall be in addition to any other right and -11- 12 remedy now and hereafter provided by law. All rights and remedies shall be cumulative and not exclusive of each other. Landlord may exercise its rights and remedies at any times, in any order, to any extent, and as often as Landlord deems advisable without regard to whether the exercise of one right or remedy precedes, concurs with or succeeds the exercise of another. B. A single or partial exercise of a right or remedy shall not preclude a further exercise thereof, or the exercise of another right or remedy from time to time. C. No delay or omission by Landlord in exercising a right or remedy shall exhaust or impair the same or constitute a waiver of, or acquiesce to, a Default. D. No waiver of Default shall extend to or affect any other Default or impair any right or remedy with respect thereto. E. No action or inaction by Landlord shall constitute a waiver of Default. F. No waiver of a Default shall be effective unless it is in writing and signed by Landlord. ARTICLE 12. RELOCATION 12.1 RELOCATION OPTION. Intentionally Deleted ARTICLE 13. AMENDMENT AND LIMITATION OF WARRANTIES 13.1 ENTIRE AGREEMENT. IT IS EXPRESSLY AGREED BY TENANT, AS A MATERIAL CONSIDERATION FOR THE EXECUTION OF THIS LEASE, THAT THIS LEASE, WITH THE SPECIFIC REFERENCES TO WRITTEN EXTRINSIC DOCUMENTS, IS THE ENTIRE AGREEMENT OF THE PARTIES: THAT THERE ARE, AND WERE, NO VERBAL REPRESENTATIONS, WARRANTIES, UNDERSTANDINGS, STIPULATIONS, AGREEMENTS OR PROMISES PERTAINING TO THIS LEASE OR TO THE EXPRESSLY MENTIONED WRITTEN EXTRINSIC DOCUMENTS NOT INCORPORATED IN WRITING IN THIS LEASE. 13.2 AMENDMENT. THIS LEASE MAY NOT BE ALTERED, WAIVED, AMENDED OR EXTENDED EXCEPT BY AN INSTRUMENT IN WRITING SIGNED BY LANDLORD AND TENANT. 13.3 LIMITATION OF WARRANTIES. LANDLORD AND TENANT EXPRESSLY AGREE THAT THERE ARE AND SHALL BE NO IMPLIED WARRANTIES OR MERCHANTABILITY, HABITABILITY, FITNESS FOR A PARTICULAR PURPOSE OR OF ANY OTHER KIND ARISING OUT OF THIS LEASE, AND THERE ARE NO WARRANTIES WHICH EXTEND BEYOND THOSE EXPRESSLY SET FORTH IN THIS LEASE. ARTICLE 14. MISCELLANEOUS 14.1 SUCCESSORS AND ASSIGNS. This Lease shall be binding upon and inure to the benefit of Landlord and Tenant and their respective heirs, personal representatives, successors and assigns. It is hereby covenanted and agreed that should Landlord's interest in the Premises cease to exist for any reason during this Lease, then notwithstanding the happening of such event this Lease nevertheless shall remain unimpaired and in full force and effect, and Tenant hereunder agrees to attorn to the then owner of the Premises. 14.2 USE OR RENT TAX. If applicable in the jurisdiction where the Premises are issued, Tenant shall pay and be liable for all rental, sales and use taxes or other similar taxes, if any, levied or imposed by any city, state, county or other governmental body having authority, such payments to be in addition to all other payments required to be paid to Landlord under the terms of this Lease. Any such payment shall be paid concurrently with the payment of the rent, additional rent, operating expenses or other charge upon which the tax is based as set forth above. 14.3 ACT OF GOD. Neither Tenant nor Landlord shall not be required to perform any non-monetary covenant or obligation in this Lease, or be liable in damages to the other party, so long as the performance or non-performance of the covenant or obligation is delayed, caused or prevented by an act of God, force majeure or by the other party. -12- 13 14.4 HEADINGS. The section headings appearing in this Lease are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or intent of any Section. 14.5 NOTICE. All rent and other payments required to be made by Tenant shall be payable to Landlord at the address set forth in Section 1.8. All payments required to be made by Landlord to Tenant shall by payable at the address set forth in Section 1.8, or at any other address within the United States as Tenant may specify from time to time by written notice. Any notice or document required or permitted to be delivered by the terms of this Lease shall be deemed to be delivered (whether or not actually received) when deposited in the United States Mail, postage prepaid, certified mail, return receipt requested, addressed to the parties at the respective addresses set forth in Section 1.8. 14.6 TENANT'S AUTHORITY. If Tenant executes this Lease as a corporation, each of the persons executing this Lease on behalf of Tenant does hereby personally represent and warrant that Tenant is a duly authorized and existing corporation, that Tenant is qualified to do business in the state in which the Premises are located, that the corporation has full right and authority to enter into this Lease, and that each person signing on behalf of the corporation is authorized to do so. 14.7 HAZARDOUS SUBSTANCES. Tenant, its agents or employees, shall not bring or permit to remain on the Premises or Building any asbestos, petroleum or petroleum products, explosives, toxic materials, or substances defined as hazardous wastes, hazardous materials, or hazardous substances under any federal, state, or local law or regulation ("Hazardous Materials"). Tenant's violation of the foregoing prohibition shall constitute a material breach and default hereunder and Tenant shall indemnify, hold harmless and defend Landlord from and against any claims, damages, penalties, liabilities, and costs (including reasonable attorney fees and court costs) caused by or arising out of (i) a violation of the foregoing prohibition by Tenant or (ii) the presence of any Hazardous Materials on, under, or about the Premises or the Building during the term of the Lease caused by or arising, in whole or in part, out of the actions of Tenant, its agents or employees. Tenant shall clean up, remove, remediate and repair any soil or ground water contamination and damage caused by the presence and any release of any Hazardous Materials in, on, under or about the Premises or the Building during the term of the Lease caused by or arising, in whole or in part, out of the actions of Tenant, its agents or employees, in conformance with the requirements of applicable law. Tenant shall immediately give Landlord written notice of any suspected breach of this paragraph; upon learning of the presence of any release of any Hazardous Materials, and upon receiving any notices from governmental agencies pertaining to Hazardous Materials which may affect the Premises or the Building. The obligations of Tenant hereunder shall survive the expiration of earlier termination, for any reason, of this Lease. Landlord agrees to indemnify and hold Tenant harmless from any and all claims, damages, penalties, liabilities or costs arising by reason of the existence of hazardous substances on or about the Building prior to Tenant's occupancy thereof. 14.8 SEVERABILITY. If any provision of this Lease or the application thereof to any person or circumstances shall be invalid or unenforceable to any extent, the remainder of this Lease and the application of such provisions to other persons or circumstances shall not be affected thereby and shall be enforced to the greatest extent permitted by law. 14.9 LANDLORD'S LIABILITY. If Landlord shall be in default under this Lease and, if as a consequence of such default, Tenant shall recover a money judgment against Landlord, such judgment shall be satisfied only out of the right, title and interest of Landlord in the Building as the same may then be encumbered and neither Landlord nor any person or entity comprising Landlord shall be liable for any deficiency. In no event shall Tenant have the right to levy execution against any property of Landlord nor any person or entity comprising Landlord other than its interest in the Building as herein expressly provided. 14.10 BROKERAGE. Landlord and Tenant each represents and warrants to the other that there is no obligation to PAY any brokerage fee, commission, finder's fee or other similar charge in connection with this Lease, other than fees due to KURT KNOFF AND MARIA MAUGHN OF CB COMMERCIAL/MADISON COMMERCIAL which are the responsibility of LANDLORD. Each party covenants that it will defend, indemnify and hold harmless the other party from and against any loss or liability by reason of brokerage or similar services alleged to have been rendered to, at the instance of, or agreed upon by said indemnifying party. Notwithstanding anything herein to the contrary, Landlord and Tenant agree that there shall be no brokerage fee or commission due on expansions, options or renewals by Tenant. 14.1 1 MANAGEMENT AGENT. Landlord hereby notifies Tenant that the person authorized to execute this Lease and manage the Premises is CSM Corporation, a Minnesota corporation, which has been appointed to act as the agent in leasing management and operation of the Building for owner and is authorized to accept service of process and receive or give receipts for notices and demands on behalf of Landlord. Landlord reserves the right to change the identity and status of its duly authorized agent upon written notice -13- 14 to Tenant. 14.12 OPTION TO EXTEND. Tenant may extend the term of this Lease for two (2) additional sixty (60) month terms under the same conditions contained herein, except that the Base Rental shall be adjusted to reflect the prevailing market rate for comparable space in the Minneapolis southwest suburbs. In no case shall the adjusted Base Rent be less than the latest Base Rent paid by Tenant during the primary term of the lease or extension thereof. Tenant may exercise its option to extend the term of the Lease upon twelve (12) months prior written notice to Landlord, stating its irrevocable exercise of its option to extend the term of the Lease. In the event that Tenant falls to deliver timely notice of its exercise of this option, Tenant's right and option to extend shall be deemed null and void. It shall be a condition of the exercise of this option that Tenant not be in default in the performance of its obligations under this Lease. 14.13 ARCHITECTURAL/DESIGN/CONSTRUCTION AGREEMENT. Landlord will provide tenant a $2.00/square foot allowance to be applied towards architectural design, and Tenant's project management fees incurred by Tenant in connection with the design and construction of Phase I and Phase 11 Premises including but not limited to all costs of interior design, construction drawings and supervision of the construction of the interior office improvements, all of which shall be paid by tenant, but excluding the design and construction of the structural components of the fifth floor expansion which shall be paid by Landlord. The allowance shall be payable to Tenant in two equal payments, the first half payment shall be due to Tenant after landlord's receipt of acceptable Phase I construction drawings, and the second half shall be due after the receipt of acceptable Phase 11 construction drawings. 14.14 PARKING. Landlord agrees to provide at no expense to Tenant except as depicted in sections 2.2 and 2.3, Tenant 583 parking spaces west of premises and 45 existing parking spaces southeast of the Premises depicted on EXHIBIT C upon lease commencement. Sixty-two additional spaces southeast of the Premises will be provided at no expense to Tenant except as depicted in sections 2.2 and 2.3 prior to the commencement of the Lease month 18 in the area marked "New Parking" on EXHIBIT C. Additional parking spaces will be provided by Landlord at Tenant's request. The location, scope and cost of the additional parking spaces shall be mutually agreed upon by Landlord and Tenant, with Landlord's costs associated with the construction of the additional parking area being paid by Tenant monthly as additional Base Rent over the remaining term of the Lease, based on an amortization of such costs over the remaining term of the Lease amortized at a 10 1/2% interest rate, which payments shall commence on the first day of the month first following the date of completion of the additional parking area. 14.15 TERMINATION OF K-TEL INTERNATIONAL LEASE. Landlord and Tenant acknowledge that Landlord Has the option to terminate the Lease between K-tel International, Inc. and Thomas Edward Limited Partnership pursuant to section 7 of the Addendum to said Lease. Landlord agrees to exercise its option to terminate said lease effective July 31, 1998, provided that Tenant, by written notice to Landlord delivered before January 20, 1998, requests such termination, which request shall include a payment by Tenant to Landlord of $35,000, to reimburse Landlord for the termination fee that Landlord will be required to pay K-Tel International by reason of such early termination. In the event that Tenant requests that Landlord terminate the Lease with K-Tel International, Inc. as aforesaid, then Tenant's obligation to pay Base Rent and additional rent with respect to the warehouse space vacated by K-Tel International, under the same terms and conditions contained herein, shall commence August 1, 1998. 14.16 LANDLORD DEFAULT. In the event that landlord is in default of its obligations under this Lease and has not cured said default, or made reasonable effort towards curing said default within thirty (30) days of receipt of written notice from Tenant, then Tenant shall have the right to cure said default and withhold an amount equal to the reasonable cost of curing said default from Tenant's next rent payment due. 14.17 OPTION TO TERMINATE. In the event that Landlord has not secured approval of its application for rezoning of the Building to an industrial planned unit development and approval of fifth floor on or before February 13, 1998, Tenant may, by written notice to landlord given not later than February 1 8, 1 998, (i) elect to terminate this Lease, in which case this Lease shall be null and void and of no further force and effect, or, (ii) elect to have this Lease remain in full force and effect, as to all of the Premises described in section 1.2 hereof, except the future fifth (5th) floor, in which case the Landlord shall have no obligations with respect to the construction and delivery of the future fifth (5th) floor and the area of the Premises, the Base Rental Rate, and Tenant's prorated share of operating expenses shall be adjusted to reflect the omission of the future floor five from the Premises. For the purposes of clause (ii) above, Landlord and Tenant agree that the future floor five area is 36,110 square feet and that the Base Rental Rate for floor five (5) is $7.00 per square foot for lease months 1 8 through 48, $7.50 per square foot for Lease months 49 through 96 and $8.00 per square foot for Lease months 97-161. In the event that Tenant makes the election -14- 15 described in clause (ii) above, Tenant further agrees to comply with any conditions or limitations on office/warehouse mix imposed by the city of Minnetonka, with respect to the use of the Premises. 14.18 SUBMISSION OF LEASE. Submission of this Lease to Tenant for signature does not constitute a reservation of space or an option to lease. This Lease is not effective until execution by and delivery to both Landlord and Tenant. IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease effective the day and year first above written. LANDLORD: TENANT: THOMAS EDWARD LIMITED PARTNERSHIP NORSTAN, INC. BY: /s/ BY: /s/ ---------------------------------- -------------------------------- ITS: Partner ITS: CFO ---------------------------------- -------------------------------- -15- 16 EXHIBIT A 1 OF 4 [MAP] 17 EXHIBIT A 2 OF 4 [MAP] 18 EXHIBIT A 3 OF 4 [MAP] 19 EXHIBIT A 4 OF 4 [MAP] 20 EXHIBIT B 1 OF 3 [MAP] 21 EXHIBIT B 2 OF 3 [MAP] 22 EXHIBIT B 3 OF 3 [MAP] 23 EXHIBIT C [MAP] 24 EXHIBIT D LANDLORD IMPROVEMENTS For NORSTAN, INC. Modern Merchandising Building Minnetonka, Minnesota Prepared by CSM CORPORATION December 22, 1997 The landlord will provide the following improvements to the tenant at landlords expense: 1. Exterior shell shall be structural steel and insulated metal frame walls with brick veneer exterior. Interior elevations of the exterior walls shall be plain exposed gypsum board, taped and sanded to the roof deck (paint ready). 2. Exterior Window systems shall be thermally broken aluminum storefront glazing, units with thermal insulated, reflective glass. 3. Shell building existing ceilings is an exposed prime painted structural steel and metal deck with a single ply EPDM membrane, insulated roof system. 4. Shell building floor is the existing 3 V-," inch reinforced, concrete floor. 5. Brass upright sprinkler heads for minimum (light hazard) density requirements (laterals only, no drops) are included as part of shell building construction. 6. Four (4) toilet rooms, stacked above the corresponding toilets below, finished to "paint-ready" condition are included as part of the shell building construction. These shall include: (7) water closets, (1) urinal (6) lavatories, toilet partitions and accessories. Toilet rooms shall receive Dal Tile (group 1, group 2 colors) or equivalent, a 4'-4" high wainscot of ceramic tile on plumbing wall and wall adjacent to toilet only. Water closets shall be building standard pressure-assisted tank type units. Lavatories shall be wall mounted type. One budding standard handicap electric water cooler is included. Toilet accessories include handicap crab bars as required by applicable code, toilet paper holders, feminine napkin holders, soap dispensers, and paper towel dispensers. 7. A 600 ampere 480/277 volt main electrical service to a 480/277 volt distribution panel for the landlord supplied HVAC equipment within the premises is included in the shell building construction. 8. Gas heating/electric cooling roof top heating and air conditioning units (excluding distribution ductwork and diffusers) designed to supply approx. 1 ton tempered air per 400 square feet of floor area, shall be included as part of the shell building construction. 9. Modifications to the existing two-gang elevator to provide one (1) additional stop, shall be provided as part of the shell building construction. 25 All other improvements shall be at tenant's sole expense, including but not limited to the following: A. Gypsum wall construction. B. Interior doors. C. Interior hardware. D. Interior hollow metal frames. E. Tenant finish Heating, Ventilation, and Air Conditioning. F. Muzak or telephone communication systems. G. Security systems or access control systems. H. Appliances, vending machines, kitchen equipment. I. Office furniture, moveable partitions, etc. J. Extra cooling capacity for tenant furnished equipment K. Millwork/Built ins: counters, cabinets, shelving, closets, etc. L. Computer terminal outlets, wiring, or systems. M. Tenant finish electrical items, i.e., light fixtures, power feeds, outlets, disconnects, etc., except as listed within the above Landlords scope of work. N. Plumbing rough ins, connections, stub ups, Vent risers, fixtures, etc.. 0. Ramps and/or overhead doors to accommodate Drive-in capability, dock revelers, shelters, etc. P. Tenant signage. Q. Additional structural reinforcement for tenant's roof top units, including roof curb, roof deck penetration, and roof repair. These items shall be performed by the owners shell building, roofing contractor in order to maintain the roof warranty. R. Increased City of Minnetonka, Sewer Access Charge (SAC) over and above $0.38 per square foot. S. Gas piping to tenant equipment. A meter socket is provided at the nearest building manifold location. T. Construction general conditions, including but not limited to: building permits, field supervision, Clean up, dumpsters, and project management, except as listed within the above Landlords scope of work. 26 ADDENDUM TO LEASE This is an ADDENDUM to that certain Lease dated December 23, 1997, ('Lease") by and between Thomas Edward Limited Partnership, a Minnesota Limited Partnership, ("Landlord") and Norstan, Inc., a Minnesota corporation, ("Tenant"), and is entered into effective this 6th day of January, 1998. In consideration of the mutual covenants herein contained, and other good and valuable consideration, Landlord and Tenant hereby confirm and/or agree as follows: 1. SECTION 1.4 PREMISES. Landlord and Tenant acknowledge and confirm that the rentable area of the Premises, according to "as-build" measurements, is as follows: First Floor Office 4,641 Square Feet Second Floor Office 7,098 Square Feet Third Floor Office 37,970 Square Feet Fourth Floor Office 36,110 Square Feet Fifth Floor Office 36,110 Square Feet Second Floor Warehouse Annex 14,617 Square Feet Third Floor Warehouse Annex 14,575 Square Feet Warehouse Area 83,000 Square Feet Total: 234,121 Square Feet (Pending verification of the fifth floor office area) 2. SECTION 1.7 PRO RATA SHARE. Landlord and Tenant acknowledge and confirm that Tenant's pro rata share of operating expenses shall be forty-three and thirty-four one hundredths (43.34%), (adjusting to 100% upon occupancy of the Phase III premises). 3. MISCELLANEOUS. If any provision of the Lease is inconsistent with the provisions contained herein, then and in such event the provisions of this Addendum shall control. Except as expressly modified herein, all other terms and conditions of the Lease shall remain unchanged, and in full force and effect. LANDLORD: TENANT: Thomas Edward Limited Partnership Norstan, Inc. BY: /s/ BY: /s/ -------------------------- ------------------------------ ITS: Partner ITS: CFO -------------------------- ------------------------------ 27 EXHIBIT E ADDENDUM TO LEASE This is an ADDENDUM to that certain Lease dated __________________, ("Lease") by and between CSM ______________, INC., a Minnesota corporation, ("Landlord") and ____________________, a _________________ corporation. ("Tenant"), and is entered into effective this day of 1998. In consideration of the mutual covenants herein contained, and other good and valuable consideration, Landlord and Tenant hereby confirm and/or agree as follows: 1. SECTION 1.2 PREMISES. Landlord and Tenant acknowledge and confirm that the rentable area of the Premises, according to "as-built" measurements, is ____________. 2. SECTION 1.4 BASE RENT. The Base Rent for the Lease Term shall be: Lease Monthly Annual Per Months Base Rent Base Rent Sg. Ft. The Landlord and Tenant acknowledge and agree that the above stated Base Rent reflects and incorporates the adjustments required by Section of the Lease. 3. SECTION 1.7 PRO RATA SHARE. Landlord and Tenant acknowledge and confirm that Tenant's pro rata share of operating expenses shall be _________________ percent (____%). 4. MISCELLANEOUS. If any provision of the Lease is inconsistent with the provisions contained herein, then and in such event the provisions of this Addendum shall control. Except as expressly modified herein, all other terms and conditions of the Lease shall remain unchanged, and in full force and effect. LANDLORD: TENANT: CSM , INC. --------------- ------------------------------------ BY BY: -------------------------- --------------------------------- ITS: ITS: ------------------------- -------------------------------- EX-22 5 EXHIBIT 22 1 EXHIBIT 22 SUBSIDIARIES OF NORSTAN, INC.
PERCENTAGE OF STATE OF VOTING SECURITIES NAME INCORPORATION OWNED BY THE COMPANY ---- ------------- -------------------- Norstan Communications, Inc. Minnesota 100% Norstan Financial Services, Inc. Minnesota 100% Norstan Canada Inc. Minnesota 100% Norstan Network Services, Inc. Minnesota 100% Connect Computer Company Minnesota 100% Vadini, Inc. (d/b/a PRIMA Consulting) Minnesota 100% Norstan International, Inc. Minnesota 100% Norstan Network Services, Inc. of New Hampshire New Hampshire 100% Norstan Information Systems, Inc. Minnesota 100% Summit Gear, Inc. Minnesota 100%
EX-23.(A) 6 EXHIBIT 23.(A) 1 EXHIBIT 23(A) CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K into the Company's previously filed Registration Statements on Form S-8 relating to the 1986 Long-Term Incentive Plan of Norstan, Inc. (Registration Nos. 33-30323 and 33-72928), the 1990 Employee Stock Purchase and Bonus Plan of Norstan, Inc. (Registration Nos. 33-32310, 33-44470 and 33-72926), the 1995 Long-Term Incentive Plan of Norstan, Inc. (Registration No. 33-62957), and the Restated Non-Employee Directors' Stock Plan of Norstan, Inc. (Registration No. 33-62971). ARTHUR ANDERSEN LLP Minneapolis, Minnesota, July 23, 1997 EX-27 7 EXHIBIT 27
5 1,000 YEAR APR-30-1998 MAY-01-1997 APR-30-1998 1,869 0 98,377 (1,171) 10,008 157,521 75,712 (37,713) 275,608 98,953 73,323 0 0 996 96,675 275,608 228,979 456,365 168,965 445,792 118,376 0 3,927 6,646 2,791 3,855 0 0 0 3,855 0.40 0.39
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