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

FORM 10-Q

(Mark One)

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

FOR THE PERIOD ENDED JULY 28, 2001

OR

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

For the transition period from ____________ to

Commission File Number 0-8141

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

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

5101 Shady Oak Road, Minnetonka, Minnesota 55343-4100
(address of principal executive offices)

Telephone (952) 352-4000 Fax (952) 352-4949 Internet www.norstan.com
(Registrant’s telephone number, facsimile number, Internet address)

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

 Yes   X  .  No     .

On September 4, 2001, there were 12,284,708 shares outstanding of the registrant’s common stock, par value $0.10 per share, its only class of equity securities.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	ITEM 1.
	ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES

PART I. FINANCIAL INFORMATION

ITEM 1.

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

UNAUDITED
(In thousands, except per share amounts)

				Three Months Ended
				July 28,			July 29,
				2001			2000
REVENUES
Communications Technology:
		Solutions and Services		$	51,264		$	62,144
		Resale			7,082			6,733
Network Services					6,000			7,560
Financial Services					1,730			2,349
			Total Revenues		66,076			78,786
COST OF SALES
Communications Technology:
		Solutions and Services			36,471			47,898
		Resale			4,322			4,020
Network Services					4,375			5,806
Financial Services					484			698
			Total Cost of Sales		45,652			58,422
GROSS MARGIN
Communications Technology:
		Solutions and Services			14,793			14,246
		Resale			2,760			2,713
Network Services					1,625			1,754
Financial Services					1,246			1,651
			Total Gross Margin		20,424			20,364
		Selling, General & Administrative Expenses			18,957			22,091
OPERATING INCOME (LOSS)					1,467			(1,727	)
		Interest Expense			(1,446	)		(2,083	)
		Other Income (Expense), Net			132			(8	)
INCOME (LOSS) FROM CONTINUING OPERATIONS
	BEFORE INCOME TAXES				153			(3,818	)
	Income tax provision (benefit)				—			—
INCOME (LOSS) FROM CONTINUING OPERATIONS					153			(3,818	)
DISCONTINUED OPERATIONS:
	Loss from operations of discontinued segment				—			(3,722	)
NET INCOME (LOSS)				$	153		$	(7,540	)
NET INCOME (LOSS) PER SHARE (BASIC & DILUTED):
	CONTINUING OPERATIONS			$	0.01		$	(0.35	)
	DISCONTINUED OPERATIONS				—			(0.34	)
EARNINGS PER SHARE				$	0.01		$	(0.69	)
WEIGHTED AVERAGE SHARES OUTSTANDING:
		BASIC			11,909			10,916
		DILUTED			12,398			10,916

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

1

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

			July 28,			April 30,
			2001			2001
			(Unaudited)			(Audited)
ASSETS
CURRENT ASSETS
	Cash		$	732		$	2,434
	Accounts receivable, net of allowances for doubtful accounts of $2,134 and $3,343			41,484			37,592
	Lease receivables			19,983			25,292
	Inventories			5,757			6,197
	Costs and estimated earnings in excess of billings of $5,880 and $4,583			5,974			8,231
	Prepaid expenses, deposits and other			4,939			5,594
	Net current assets of discontinued operations			1,393			320
		TOTAL CURRENT ASSETS		80,262			85,660
PROPERTY AND EQUIPMENT
	Furniture, fixtures and equipment			96,639			96,146
	Less-accumulated depreciation and amortization			(68,746	)		(66,492	)
		NET PROPERTY AND EQUIPMENT		27,893			29,654
OTHER ASSETS
	Lease receivables, net of current portion			26,939			30,635
	Goodwill, net of accumulated amortization of $6,380 and $6,380			3,909			3,896
	Deferred income taxes			12,014			12,039
	Net non-current assets of discontinued operations			7,721			7,549
	Other			495			406
		TOTAL OTHER ASSETS		51,078			54,525
TOTAL ASSETS			$	159,233		$	169,839

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

2

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

			July 28,			April 30,
			2001			2001
			(Unaudited)			(Audited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
	Current maturities of long-term debt		$	38,700		$	21,015
	Current maturities of discounted lease rentals			13,062			13,242
	Accounts payable			27,232			31,219
	Deferred revenue			22,968			22,105
	Accrued —
		Salaries and wages		4,845			5,669
		Warranty costs		1,969			2,042
		Other liabilities		7,567			6,434
	Billings in excess of costs and estimated earnings of $15,514 and $11,812			7,750			8,276
		TOTAL CURRENT LIABILITIES		124,093			110,002
LONG-TERM DEBT, net of current maturities				15,430			38,200
DISCOUNTED LEASE RENTALS, net of current maturities				11,116			13,552
SHAREHOLDERS’ EQUITY
	Common stock — $.10 par value; 40,000,000 authorized shares; 12,288,941 and 12,220,907 shares issued and outstanding			1,229			1,222
	Capital in excess of par value			55,483			55,298
	Accumulated deficit			(44,799	)		(44,952	)
	Unamortized cost of stock			(1,318	)		(1,438	)
	Accumulated other comprehensive loss			(2,001	)		(2,045	)
		TOTAL SHAREHOLDERS’ EQUITY		8,594			8,085
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY			$	159,233		$	169,839

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

3

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

UNAUDITED

(In thousands)

				Three Months Ended
				July 28,			July 29,
				2001			2000
OPERATING ACTIVITIES
		Net income (loss) from continuing operations		$	153		$	(3,818	)
		Adjustments to reconcile net income (loss) from continuing operations to net cash (used for) provided by continuing operations
			Restructuring costs paid		(751	)		—
			Depreciation and amortization		3,744			5,134
			Deferred income taxes		29			1,212
			Changes in operating items:
			Accounts receivable		(3,864	)		6,344
			Inventories		449			260
			Costs and estimated earnings in excess of billings		2,272			2,620
			Prepaid expenses, deposits and other		654			(504	)
			Accounts payable		(4,004	)		(3,013	)
			Deferred revenue		841			249
			Accrued liabilities		982			(1,489	)
			Billings in excess of costs and estimated earnings		(532	)		(4,116	)
			Net cash (used for) provided by operating activities		(27	)		2,879
INVESTING ACTIVITIES
		Additions to property and equipment, net			(1,907	)		(2,639	)
		Investment in lease contracts			(1,858	)		(7,566	)
		Proceeds from lease contracts			10,940			10,511
		Other, net			(32	)		(2,501	)
			Net cash provided by (used for) investing activities		7,143			(2,195	)
FINANCING ACTIVITIES
		Borrowings on long-term debt			82,407			52,843
		Repayments of long-term debt			(87,512	)		(47,337	)
		Borrowings on discounted lease rentals			—			4,033
		Repayments of discounted lease rentals			(2,647	)		(5,153	)
		Proceeds from sale of common stock			191			377
			Net cash (used for) provided by financing activities		(7,561	)		4,763
EFFECT OF EXCHANGE RATE CHANGES ON CASH					(12	)		(2	)
NET (DECREASE) INCREASE IN CASH FROM
	CONTINUING OPERATIONS				(457	)		5,445
NET CASH FLOW FROM DISCONTINUED OPERATIONS					(1,245	)		(3,123	)
CASH, BEGINNING OF PERIOD					2,434			—
CASH, END OF PERIOD				$	732		$	2,322

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

4

NORSTAN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JULY 28, 2001

UNAUDITED

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

PRINCIPLES OF CONSOLIDATION

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

DISCONTINUED OPERATIONS

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

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

      The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former President and the Company’s former Vice Chairman. Terms of the sale included a payment of $500,000 in cash at closing and delivery of a promissory note drawn in favor of the Company in the face amount of $1.5 million maturing on September 12, 2001. In connection with the transaction, the Company retained its rights to certain assets and assumed certain liabilities of Norstan Consulting.

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

5

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

			As of
			July 28,			April 30,
			2001			2001
Assets:
	Cash, accounts receivable and inventories		$	—		$	500
	Notes receivable, prepaids and other assets			10,058			10,809
Liabilities:
	Accounts payable			(39	)		(652	)
	Accrued —
		Salaries & wages		—			(1,367	)
		Future lease obligations		(794	)		(1,000	)
		Other liabilities		(111	)		(421	)
Net assets of discontinued operations				9,114			7,869
Less: Current portion				(1,393	)		(320	)
			$	7,721		$	7,549

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

	For the three months ended
	July 28,		July 29,
	2001		2000
Revenues	$	—	$	11,861
Cost of Sales		—		9,261
Gross margin		—		2,600
Sales, general and administrative expenses		—		6,210
Operating income (loss)		—		(3,610	)
Other income (expense), net		—		(112	)
Net income (loss) from discontinued operations	$	—	$	(3,722	)

FOREIGN CURRENCY

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

6

SUPPLEMENTAL CASH FLOW INFORMATION

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

		Three Months Ended
		July 28,		July 29,
		2001		2000
Cash paid for:
	Interest	$	1,788	$	3,572
	Income taxes	$	27	$	32

RECENTLY ISSUED ACCOUNTING STANDARDS

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

      On June 29, 2001, the Financial Accounting Standards Board approved two new statements, SFAS No. 141, “Business Combinations,” (“SFAS No. 141”) and SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”). Under SFAS No. 141, all business combinations will be accounted for under the purchase method beginning June 30, 2001. SFAS No. 142 includes requirements to test goodwill for impairment using a fair value approach, rather than amortizing the cost of goodwill over future periods. As a result, the Company’s amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of the new accounting standards. The Company adopted SFAS No. 142 in the first quarter of its fiscal year ending April 30, 2002. The Company’s annual goodwill amortization was approximately $450,000, which ceased effective May 1, 2001 upon adoption of the new rules. The Company is currently evaluating the impairment testing provisions of SFAS No. 142, and has not yet determined the effect of SFAS No. 142 on its consolidated financial position and results of operations. Should an impairment be determined to exist, the Company would record an impairment as a change in accounting principle and restate its first quarter results.

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

	Three Months Ended
	July 28,		July 29,
	2001		2000
Net income as reported	$	153	$	(7,540	)
Add back: Goodwill amortization		—		126
Adjusted net income (loss)	$	153	$	(7,414	)
Earnings per share as reported (Basic and Diluted):	$	0.01	$	(0.69	)
Goodwill amortization		—		0.01
Adjusted earnings per share (Basic and Diluted)	$	0.01	$	(0.68	)

7

USE OF ESTIMATES

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

EARNINGS PER SHARE DATA

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

COMPREHENSIVE INCOME

      The Company reports comprehensive income and its components pursuant to the requirements of SFAS No. 130, “Reporting Comprehensive Income”. This statement establishes standards for the reporting of comprehensive income and its components. For the Company, comprehensive income consists of net income (loss) adjusted for foreign currency translation adjustments. Comprehensive net income, as defined by SFAS No. 130, was approximately $197,000 for the three months ended July 28, 2001 and a net loss of $7.5 million for the similar period ended July 29, 2000.

RESTRUCTURING CHARGES

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

      During the fiscal quarter ended July 28, 2001, payments totaling $751,000 were charged against the restructuring reserve which was established as part of the above-described restructuring charge. At July 28, 2001, a reserve of approximately $432,000 remained for future payments to be made related to this restructuring charge (including severance costs of $30,000 and lease termination costs and other facility costs of $402,000). The Company believes these remaining costs will be incurred over the next twelve months.

VENDOR AGREEMENTS

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

8

INCOME TAXES

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

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

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

BANK FINANCING

      As of April 30, 2001, the Company had a $78.0 million credit agreement with certain banks. In December 2000, the Company entered into a restructured credit facility with the banks which consisted of the following components; A) $15.0 million term loan, B) $15.0 million term loan, C) $18.0 million term loan, and D) up to $30.0 million revolving line of credit based on the Company’s level of receivables and inventory. All components of this facility were to mature no later than June 29, 2001. The term loans bore interest at the banks’ reference rate plus 3.5% to 4.5% (11.0% to 12.0% at April 30, 2001) and the revolving facility bore interest at the banks’ reference rate plus 2.5% (10.0% at April 30, 2001). Certain portions of the borrowings under this facility have been classified as long-term as of April 30, 2001 as a result of the credit facility restructuring discussed below.

      On June 29, 2001, the Company entered into an agreement with the banks to restructure its existing senior debt facility. The new credit facility consists of the following components; A) $20.0 million term loan (“Term Loan A”) with various monthly principal payments due commencing on August 31, 2001 and ending on June 28, 2002, B) $15.4 million term loan (“Term Loan B”) with various principal payments due beginning on July 31, 2002, or earlier if Term Loan A is paid off early, and maturing on December 31, 2002, and C) up to a $30.0 million revolving line of credit based on the Company’s level of receivables and inventory. The revolving facility and Term Loan A bear interest at the banks’ reference rate plus 2.5%, while Term Loan B bears interest at the banks’ reference rate plus 4.0%. As of July 28, 2001, the company had outstanding borrowings of $51.5 million under this facility.

      Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the terms and conditions of the credit agreement, the Company is required to maintain minimum levels of EBITDA and achieve certain other financial ratios. The Company was out of compliance with certain of these requirements as of April 30, 2001. However, these matters were remedied as a result of the above mentioned restructuring. As of July 28, 2001, the Company was in compliance with all applicable financial covenants.

      Under the terms of the December 2000 and June 2001 restructured credit agreements, the banks are entitled to receive warrants to purchase shares of the Company’s common stock. As of April 30, 2001, 389,545 warrants had been issued to the banks at various prices between $0.94 and $1.13 per share. These warrants were recorded at their estimated fair value at the date of issuance, with the resulting costs (approximately $323,000) charged to expense over the term of the related agreements. In addition, on June 29, 2001, 100,000 warrants were issued at $2.80 per share. All shares of common stock underlying the warrants issued to the banks are subject to demand and incidental (piggyback) registration rights.

9

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

BUSINESS SEGMENTS

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

		For the Quarter Ended
		July 28,					July 29,
		2001					2000
				Operating					Operating
		Revenues		Income (Loss)			Revenues		Income (Loss)
Communications Technology:
	Solutions and Services	$	51,264	$	(19	)	$	62,144	$	(3,141	)
	Resale		7,082		999			6,733		897
Network Services			6,000		(145	)		7,560		(430	)
Financial Services			1,730		632			2,349		947
		$	66,076	$	1,467		$	78,786	$	(1,727	)

10

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

GENERAL

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

      The Company delivers its products and services through four business segments, Communications Technology Solutions and Services, Resale, Network Services and Financial Services, which accounted for 77.6%, 10.7%, 9.1% and 2.6% of Norstan’s revenues for the fiscal quarter ended July 28, 2001, respectively. Communications Technology Solutions offerings include customer contact-call centers, collaboration-conferencing and messaging, converged communication — IP telephony and PBX systems, infrastructure cabling, wiring, sound and signal and mobile business networking. Communications Technology Services offerings include project consulting, project management, installation, system monitoring and support services maintenance. Resale offers refurbished and re-certified voice and data products. Network Services offers multiple source local and long distance services and Financial Services supports the sales process by providing customized financing alternatives.

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

SUMMARY

      During the quarter ended July 28, 2001, the Company reported net income of $153,000 or $0.01 per common share, as compared to a net loss of $7.5 million or $0.69 per common share for the quarter ended July 29, 2000.

11

SELECTED CONSOLIDATED FINANCIAL DATA

			DOLLAR AMOUNTS AS A
			PERCENTAGE OF REVENUES						PERCENTAGE
			Three Months Ended						CHANGE
			July 28,			July 29,			Fiscal
			2001			2000			2002 vs. 2001
REVENUES
Communications Technology:
		Solutions and Services		77.6	%		78.9	%		(17.5	%)
		Resale		10.7			8.5			5.2
Network Services				9.1			9.6			(20.6	)
Financial Services				2.6			3.0			(26.4	)
		Total Revenues		100.0	%		100.0	%		(16.1	%)
COST OF SALES				69.1	%		74.2	%		(21.9	%)
GROSS MARGIN				30.9	%		25.8	%		0.3	%
SELLING, GENERAL &
	ADMINISTRATIVE EXPENSES			28.7	%		28.0	%		(14.2	%)
OPERATING INCOME (LOSS)				2.2	%		(2.2	%)		184.9	%
	Interest Expense and Other, Net			(2.0	%)		(2.7	%)		(37.2	%)
NET INCOME (LOSS) — Continuing Operations				0.2	%		(4.9	%)		104.0	%
NET INCOME (LOSS) — Discontinued Operations				—			(4.7	%)		—
NET INCOME (LOSS)				0.2	%		(9.6	%)		102.0	%

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

		Three Months Ended
		July 28,			July 29,
		2001			2000
GROSS MARGIN PERCENTAGES
Communications Technology:
	Solutions and Services		28.9	%		22.9	%
	Resale		39.0	%		40.3	%
Network Services			27.1	%		23.2	%
Financial Services			72.0	%		70.3	%

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RESULTS OF OPERATIONS

      REVENUES.   Revenues decreased 16.1% to $66.1 million in the first quarter of fiscal year 2002, compared to $78.8 million for the first quarter of fiscal year 2001.

      Revenues within the Communications Technology Solutions and Services segment decreased 17.5% to $51.3 million for the first quarter ended July 28, 2001, compared to $62.1 million for the similar period last year. This decrease was the result of lower revenues in Solutions’ product offerings including call centers, PBX systems, and conferencing. Within Services, increased service contract revenues offset decreases in moves, adds and changes and convergence services revenues.

      Resale revenues increased 5.2% to $7.1 million for the period ended July 28, 2001 as compared to $6.7 million for the same period ended July 29, 2000. This increase was due to increased revenues from Vibes Technologies.

      Network Services’ revenues decreased 20.6% to $6.0 million in the first quarter of fiscal year 2002, as compared to $7.6 million for the similar quarter last year due to the Company’s decreased emphasis on pursuing additional Network Services’ revenue. Financial Services’ revenues declined 26.4% to $1.7 million from $2.3 million a year ago. This decrease is attributed to the Company’s strategic decision not to offer financing directly to its customers. Norstan Financial Services has partnered with Fidelity Leasing to provide financial alternatives to its customers under a private label leasing program.

      GROSS MARGIN.   The Company’s gross margin was $20.4 million for the quarters ended July 28, 2001 and July 29, 2000. As a percent of total revenues, the gross margin increased to 30.9% for the three month period ended July 28, 2001, compared to 25.8% for the similar period ended July 29, 2000.

      Gross margin for Communications Technology Solutions and Services increased to 28.9% during the first quarter of fiscal year 2002, compared to 22.9% for the same period in fiscal year 2001. Solutions’ gross margin as a percent of revenues was 27.5% as compared to 19.3% a year ago while Services’ gross margin was 31.5% and 29.0% for the first quarter for fiscal years 2002 and 2001, respectively. These increases are the result of a change in the Company’s product/service mix, improved project management and greater focus on cost controls.

      Resale’s gross margin as a percent of revenues were relatively flat at 39.0% and 40.3% for the quarter ended July 28, 2001 and July 29, 2000, respectively.

      Network Services’ gross margin as a percent of revenues was 27.1% for the quarter ended July 28, 2001 as compared to 23.2% for the same quarter last year. Gross margin for Financial Services was 72.0% for the three months ended July 28, 2001 and 70.3% for the similar period ended July 29, 2000.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.   Selling, general and administrative expenses decreased 14.2% to $19.0 million in the first quarter of fiscal year 2002, from $22.1 million in the similar period last year. As a percent of revenues, selling, general and administrative expenses were 28.7% and 28.0% for the three month periods ended July 28, 2001 and July 29, 2000, respectively. The Company has taken measures to remove a significant amount of costs from its businesses over the past year. In addition, with the adoption of SFAS No. 142, the Company no longer records amortization expense related to previously recorded goodwill. The Company continues to monitor expenditures and is pursuing aggressive cost control measures.

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      INTEREST EXPENSE.   Interest expense was $1.4 million and $2.1 million for the three month periods ended July 28, 2001 and July 29, 2000, respectively. The decrease in interest expense was primarily the result of a decrease in the borrowings under the Company’s revolving long-term credit facilities which were at $51.5 million as of July 28, 2001 compared to $71.2 million as of July 29, 2000 as well as reduced weighted average interest rates.

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

      NET INCOME FROM CONTINUING OPERATIONS.   The Company reported net income from continuing operations of $153,000 or $0.01 per basic and diluted share for the quarter ended July 28, 2001, as compared to a net loss of $3.8 million or $0.35 per share for the same quarter last year.

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

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

      The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former President and the Company’s former Vice Chairman. Terms of the sale included a payment of $500,000 in cash at closing and delivery of a promissory note drawn in favor of the Company in the face amount of $1.5 million maturing on September 12, 2001. In connection with the transaction, the Company retained its rights to certain assets and assumed certain liabilities of Norstan Consulting.

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

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

	For the three months ended
	July 28,		July 29,
	2001		2000
Revenues	$	—	$	11,861
Cost of Sales		—		9,261
Gross margin		—		2,600
Sales, general and administrative expenses		—		6,210
Operating income (loss)		—		(3,610	)
Other income (expense), net		—		(112	)
Net income (loss) from discontinued operations	$	—	$	(3,722	)

      NET INCOME (LOSS).   For the quarter ended July 28, 2001, the Company reported net income of $153,000 or $0.01 per basic and diluted share, as compared to a net loss of $7.5 million or $0.69 per share in the same quarter last year.

LIQUIDITY AND CAPITAL RESOURCES

      For the quarter ended July 28, 2001, continuing operating activities utilized cash of $27,000 as compared to providing cash of $2.9 million in the similar period last year. Investing activities provided cash of $7.1 million in the current quarter as compared to utilizing cash of $2.2 million in the prior year’s first quarter. This change is the result of reduced spending on capital assets and significant reduction in investments in lease contracts. The funds provided by investing activities were utilized to repay the Company’s long-term debt. As a result, financing activities utilized cash of $7.6 million during the quarter ended July 28, 2001 as compared to providing cash of $4.8 million in the comparable quarter ended July 29, 2000.

      CAPITAL EXPENDITURES.   The Company used $1.9 million for capital expenditures during the three month period ended July 28, 2001, compared to $2.6 million in the similar period last year. This reduction was the result of increased focus on cost controls and better utilization of current resources. These expenditures were primarily for equipment costs incurred in connection with outsourcing and managed services arrangements.

      INVESTMENT IN LEASE CONTRACTS.   The Company has historically made a significant investment in lease contracts with its customers. As previously discussed, the Company is winding down its leasing activities. The additional investment made in lease contracts in the first three months of fiscal year 2002 totaled $1.9 million. Net lease receivables decreased to $46.9 million at July 28, 2001 from $55.9 million at April 30, 2001.

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      The Company utilizes its lease receivables and corresponding underlying equipment to borrow funds from financial institutions on a nonrecourse basis by discounting the stream of future lease payments. Proceeds from discounting are presented on the consolidated balance sheet as discounted lease rentals. Discounted lease rentals totaled $24.2 million at July 28, 2001 as compared to $26.8 million at April 30, 2001. Interest rates on these credit agreements at July 28, 2001 ranged from approximately 6.0% to 10.0%, while payments are due in varying monthly installments through November 2005. Payments due to financial institutions are made from monthly collections of lease receivables from customers. During July 2001, the Company also sold certain leases to a third party on a non-recourse basis. Total proceeds from this sale were $3.6 million which is included in “Proceeds from lease contracts” on the Consolidated Statements of Cash Flow. Subsequent to quarter end, the Company also sold a group of leases with total proceeds of $2.9 million.

BANK FINANCING

      As of April 30, 2001, the Company had a $78.0 million credit agreement with certain banks. In December 2000, the Company entered into a restructured credit facility with the banks which consisted of the following components; A) $15.0 million term loan, B) $15.0 million term loan, C) $18.0 million term loan, and D) up to $30.0 million revolving line of credit based on the Company’s level of receivables and inventory. All components of this facility were to mature no later than June 29, 2001. The term loans bore interest at the banks’ reference rate plus 3.5% to 4.5% (11.0% to 12.0% at April 30, 2001) and the revolving facility bore interest at the banks’ reference rate plus 2.5% (10.0% at April 30, 2001). Certain portions of the borrowings under this facility have been classified as long-term as of April 30, 2001 as a result of the credit facility restructuring discussed below.

      On June 29, 2001, the Company entered into an agreement with the banks to restructure its existing senior debt facility. The new credit facility consists of the following components; A) $20.0 million term loan (“Term Loan A”) with various monthly principal payments due commencing on August 31, 2001 and ending on June 28, 2002, B) $15.4 million term loan (“Term Loan B”) with various principal payments due beginning on July 31, 2002, or earlier if Term Loan A is paid off early, and maturing on December 31, 2002, and C) up to a $30.0 million revolving line of credit based on the Company’s level of receivables and inventory. The revolving facility and Term Loan A bear interest at the banks’ reference rate plus 2.5%, while Term Loan B bears interest at the banks’ reference rate plus 4.0%. As of July 28, 2001, the company had outstanding borrowings of $51.5 million under this facility.

      Annual commitment fees on the unused portions of the credit facility are 0.25%. Under the terms and conditions of the credit agreement, the Company is required to maintain minimum levels of EBITDA and achieve certain other financial ratios. The Company was out of compliance with certain of these requirements as of April 30, 2001. However, these matters were remedied as a result of the above mentioned restructuring. As of July 28, 2001, the Company was in compliance with all applicable financial covenants.

      Under the terms of the December 2000 and June 2001 restructured credit agreements, the banks are entitled to receive warrants to purchase shares of the Company’s common stock. As of April 30, 2001, 389,545 warrants had been issued to the banks at various prices between $0.94 and $1.13 per share. These warrants were recorded at their estimated fair value at the date of issuance, with the resulting costs (approximately $323,000) charged to expense over the term of the related agreements. In addition, on June 29, 2001, 100,000 warrants were issued at $2.80 per share. All shares of common stock underlying the warrants issued to the banks are subject to demand and incidental (piggyback) registration rights.

16

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

FORWARD-LOOKING STATEMENTS

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

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

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

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

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

17

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

      For variable rate debt, changes in interest rates generally do not affect the fair market value of the debt instrument, but does affect future results of operations and cash flows. The Company has variable rate debt of $52.5 million outstanding at July 28, 2001 with a weighted average interest rate of 9.6%. Assuming that the Company’s balance of variable rate debt remains constant at $52.5 million, each one-percent increase in interest rates would result in an annual increase in interest expense, and a corresponding decrease in cash flows of $525,000. Conversely, each one-percent decrease in interest rates would result in an annual decrease in interest expense, and a corresponding increase in cash flows of $525,000.

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

      FOREIGN CURRENCY RISK.   The Company is exposed to foreign currency rate risk. Substantially all foreign exchange exposure is the Canadian dollar. In general, with a net asset exposure, a weakening of the Canadian dollar relative to the U.S. dollar has a negative translation effect. Conversely, with a net asset exposure, a strengthening of the Canadian dollar would have the opposite effect. The average exchange rates for the Canadian dollar against the U.S. dollar during the year ended April 30, 2001 and for the three months ended July 28, 2001 remained relatively unchanged.

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

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

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

      The Company is pursuing various claims before the American Arbitration Association against the former owner of PRIMA Consulting (“PRIMA”) and certain former employees of PRIMA, which claims arise out of the Company’s September 1997 acquisition of PRIMA. The Company alleges that the respondents breached various covenants contained in agreements entered into in connection with the purchase transaction, aided and abetted tortious interference with those contracts and misappropriated trade secrets resulting in a substantial deterioration in the value of the acquired business. The Company further alleges an alternative claim of fraud in the inducement based on the former owner’s voiding of non-competes prior to Norstan’s acquisition of PRIMA. In addition, the Company has asserted claims in North Carolina federal district court against the new company established by the former owner of PRIMA for tortious interference with contracts and misappropriation of trade secrets.

      The Company is seeking to recover compensatory damages of approximately $22.5 million, together with punitive damages. Although management believes the Company’s claims are meritorious, there can be no assurance that the Company will prevail in the arbitration proceeding, or in the event that the Company does prevail in the arbitration proceeding, of the amount of any damages that may be awarded to the Company. Further, there can be no assurance that the respondents will have sufficient assets to satisfy any award received by the Company pursuant to the arbitration proceeding.

      In May 2000, Norstan was sued in the U.S. District Court for the District of Minnesota by a former sales representative who claims he is owed $458,675 in additional commissions. Norstan denies that the former sales representative is entitled to any additional commissions. Norstan filed a counterclaim, seeking reimbursement of overpayments that had been made to the sales representative. On July 26, 2001, the U.S. District Court entered summary judgment in favor of the former sales representative and against Norstan. The Company believes the ruling is in error and intends to file an appeal. However, there can be no assurance that the Company will be successful in its appeal. Management believes that the July 28, 2001 consolidated financial statements adequately reflect the Company’s exposure under this lawsuit.

19

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

      Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

      None.

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

      None.

ITEM 5. OTHER INFORMATION

      None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

      (a)   Exhibits.

      None.

      (b)   Reports on Form 8-K.

      None

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SIGNATURES

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

NORSTAN, INC.
Registrant

Date: September 11, 2001	By /s/ James C. Granger       James C. Granger       Chief Executive Officer and President       (Principal Executive Officer)
Date: September 11, 2001	By /s/ Scott G. Christian       Scott G. Christian       Executive Vice President and       Chief Financial Officer       (Principal Financial and Accounting Officer)

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