NORSTAN INC, 10-Q, 2000-12-12

NORSTAN INC
10-Q, 2000-12-12
TELEPHONE INTERCONNECT SYSTEMS

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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 OCTOBER 28, 2000

/ /	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
(State or other jurisdiction of
incorporation or organization)

41-0835746
(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 December 4, 2000, there were 11,479,568 shares outstanding of the registrant's common stock, par value $0.10 per share, its only class of equity securities.

PART I. FINANCIAL INFORMATION

ITEM 1.

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

UNAUDITED

(In thousands, except per share amounts)

			Three Months Ended						Six Months Ended
			October 28, 2000			October 30, 1999			October 28, 2000			October 30, 1999
REVENUES
	Communications		$	75,340		$	86,073		$	151,777		$	171,023
	Consulting			11,578			27,987			23,439			56,983
	Financial Services			2,078			2,184			4,427			4,442

		Total Revenues		88,996			116,244			179,643			232,448

COST OF SALES
	Communications			56,179			71,810			113,903			132,786
	Consulting			7,629			18,545			16,890			36,721
	Financial Services			467			675			1,165			1,373

		Total Cost of Sales		64,275			91,030			131,958			170,880

GROSS MARGIN
	Communications			19,161			14,263			37,874			38,237
	Consulting			3,949			9,442			6,549			20,262
	Financial Services			1,611			1,509			3,262			3,069

		Total Gross Margin		24,721			25,214			47,685			61,568

	Selling, General & Administrative Expenses			29,273			37,720			57,574			70,553
	Restructuring Charge			—			1,969			—			1,969

OPERATING INCOME (LOSS)				(4,552	)		(14,475	)		(9,889	)		(10,954	)
	Interest Expense			(2,060	)		(1,390	)		(4,078	)		(2,816	)
	Other Income (Expense), Net			(1,119	)		597			(1,304	)		135

INCOME (LOSS) BEFORE TAXES				(7,731	)		(15,268	)		(15,271	)		(13,635	)
	Income Tax (Benefit) Provision			—			(3,053	)		—			(2,302	)

NET INCOME (LOSS)			$	(7,731	)	$	(12,215	)	$	(15,271	)	$	(11,333	)

NET INCOME (LOSS) PER SHARE—
	BASIC		$	(0.69	)	$	(1.13	)	$	(1.38	)	$	(1.06	)

	DILUTED		$	(0.69	)	$	(1.13	)	$	(1.38	)	$	(1.06	)

WEIGHTED AVERAGE SHARES—
	BASIC			11,183			10,763			11,089			10,731

	DILUTED			11,183			10,763			11,089			10,731

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

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

			October 28, 2000			April 30, 2000
			(Unaudited)
ASSETS
CURRENT ASSETS
	Cash		$	3,717		$	29
	Accounts receivable, net of allowances for doubtful accounts of $4,422 and $5,628			63,862			74,106
	Lease receivables			23,236			25,859
	Inventories			9,417			12,799
	Costs and estimated earnings in excess of billings of $14,911 and $14,986			11,954			15,252
	Deferred income taxes			6,600			7,468
	Prepaid expenses, deposits and other			14,113			11,819

		TOTAL CURRENT ASSETS		132,899			147,332

PROPERTY AND EQUIPMENT
	Furniture, fixtures and equipment			106,574			104,070
	Less-accumulated depreciation and amortization			(69,361	)		(61,886	)

		NET PROPERTY AND EQUIPMENT		37,213			42,184

OTHER ASSETS
	Lease receivables, net of current portion			42,535			41,874
	Goodwill, net of amortization of $6,143 and $5,926			4,163			4,462
	Deferred income taxes			3,535			3,320
	Other			2,721			4,421

		TOTAL OTHER ASSETS		52,954			54,077

TOTAL ASSETS			$	223,066		$	243,593

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

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

				October 28, 2000			April 30, 2000
				(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
	Current maturities of long-term debt			$	73,289		$	1,194
	Current maturities of discounted lease rentals				18,663			20,550
	Accounts payable				30,960			32,463
	Deferred revenue				20,583			20,696
	Accrued—
		Salaries and wages			9,600			8,332
		Warranty costs			1,782			1,790
		Other current liabilities			6,157			6,850
	Billings in excess of costs and estimated earnings of $20,443 and $20,624				12,017			15,635

			TOTAL CURRENT LIABILITIES		173,051			107,510

LONG-TERM DEBT, net of current maturities					638			67,445
DISCOUNTED LEASE RENTALS, net of current maturities					19,378			24,285
OTHER LIABILITIES					1,860			1,864

SHAREHOLDERS' EQUITY
	Common stock—$.10 par value; 40,000,000 authorized shares; 11,755,518 and 11,239,113 shares issued and outstanding				1,176			1,124
	Capital in excess of par value				55,045			53,520
	Retained earnings (deficit)				(23,946	)		(8,682	)
	Unamortized cost of stock				(2,128	)		(1,707	)
	Accumulated other comprehensive income (loss)				(2,008	)		(1,766	)

			TOTAL SHAREHOLDERS' EQUITY		28,139			42,489

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY				$	223,066		$	243,593

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

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

UNAUDITED

(In thousands)

				Six Months Ended
				October 28, 2000			October 30, 1999
OPERATING ACTIVITIES
	Net loss			$	(15,271	)	$	(11,333	)
	Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
		Restructuring charges			—			1,969
		Restructuring costs paid			(359	)		(697	)
		Depreciation and amortization			10,700			12,054
		Deferred income taxes			605			605
		Changes in operating items:
			Accounts receivable		10,001			(4,045	)
			Inventories		3,340			(2,037	)
			Costs and estimated earnings in excess of billings		3,161			4,757
			Prepaid expenses, deposits and other		(2,919	)		(6,536	)
			Accounts payable		(1,458	)		4,489
			Deferred revenue		(48	)		(480	)
			Accrued liabilities		956			(536	)
			Income taxes payable/receivable		563			(1,329	)
			Billings in excess of costs and estimated earnings		(3,526	)		(701	)

		Net cash provided by (used for) operating activities			5,745			(3,820	)

INVESTING ACTIVITIES
	Additions to property and equipment, net				(4,796	)		(7,089	)
	Investment in lease contracts				(15,313	)		(13,713	)
	Collections from lease contracts				17,069			12,601
	Other, net				1,439			762

		Net cash used for investing activities			(1,601	)		(7,439	)

FINANCING ACTIVITIES
	Borrowings of long-term debt				93,694			119,495
	Repayments of long-term debt				(88,313	)		(105,425	)
	Borrowing of discounted lease rentals				4,012			6,750
	Repayments of discounted lease rentals				(10,668	)		(10,915	)
	Proceeds from sale of common stock				768			783

		Net cash (used for) provided by financing activities			(507	)		10,688

EFFECT OF EXCHANGE RATE CHANGES ON CASH					51			3

NET INCREASE (DECREASE) IN CASH					3,688			(568	)
CASH, BEGINNING OF PERIOD					29			867

CASH, END OF PERIOD				$	3,717		$	299

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

NORSTAN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

OCTOBER 28, 2000

UNAUDITED

The information furnished in this report is unaudited and reflects all adjustments which are normal recurring adjustments and, which in the opinion of management, are necessary to fairly present 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 most recent "Annual Report on Form 10-K."

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.

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.

SUPPLEMENTAL CASH FLOW INFORMATION

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

		Six Months Ended
		October 28, 2000		October 30, 1999
Cash paid for:
	Interest	$	6,314	$	4,241
	Income taxes	$	69	$	1,287

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 met. SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. SAB No. 101 is effective for the Company's fiscal quarter ending April 30, 2001. SAB No. 101 is not expected to have a material effect on the Company's financial position or results of operations.

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.

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. Basic and diluted EPS are equal for all periods presented in the accompanying financial statements because of the net losses incurred in each period.

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 loss, as defined by SFAS No. 130, was approximately $8.0 million for the three months ended October 28, 2000 and $12.0 million for the similar period ended October 30, 1999. For the six month periods ended October 28, 2000 and October 30, 1999, comprehensive loss was $15.5 million and $11.5 million, respectively.

RESTRUCTURING CHARGES

During the second quarter of fiscal 2000, the Company recorded a restructuring charge of approximately $2.0 million related to its Consulting business. The emphasis of the restructuring was to consolidate branch offices and reduce certain general and administrative costs. Norstan Consulting has transitioned to a project-based business model in which the physical presence of geographic branches has become far less important than the ability to move skilled consulting resources to customer engagements. The $2.0 million charge consisted of noncancelable lease obligations for branch offices to be closed ($1.0 million), software and other asset write-offs ($800,000), and severance costs ($200,000).

During the six month periods ended October 28, 2000 and October 30, 1999, payments totaling $359,000 and $697,000 were charged against the restructuring reserve which was established as part of the above-described restructuring charge. At October 28, 2000, a reserve of approximately $279,000 remained for future payments to be made related to this restructuring charge.

WRITEDOWN OF GOODWILL

During the fourth quarter of fiscal year 2000, the Company recorded a charge of $32.2 million to write down goodwill created in connection with its consulting business acquisitions, principally as a result of significant operating losses and negative cash flows incurred in the Consulting business segment during fiscal 2000.

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 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.

INCOME TAXES

The Company did not record any income tax benefit related to the current quarter's loss or for the six months then ended. For the three and six months ended October 30, 1999, the Company's effective income tax rate was 20.0% and 17.0%, respectively, which differed from the federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization.

Realization of the 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.

BANK FINANCING

As of October 28, 2000, the Company had a $78.0 million revolving credit agreement with certain banks. Sublimits exist related to the Company's support of its leasing activities. Borrowings under this agreement bear interest at rates based on the banks' reference rate. The interest rate on borrowings outstanding as of October 28, 2000 was 12.0%. Total consolidated borrowings under this agreement at October 28, 2000 and April 30, 2000 were $69.9 million and $66.8 million, respectively. 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 achieve certain other financial ratios.

As of October 28, 2000, the Company was in violation of certain covenants under this credit agreement. The Company has been provided a series of temporary forbearance periods with respect to these covenant violations, the latest of which expires on December 20, 2000.

The Company announced in August, 2000, that it intended to refinance the revolving credit agreement with new lenders. That transaction was not consummated as originally anticipated because the actual amount of funds available to Norstan under the proposed arrangement fell short of what was necessary to refinance the full amount of the Company's existing facility. As a result of the termination of this financing commitment, the Company wrote off $1.1 million of related financing fees in the quarter ended October 28, 2000. This write-off is reflected in other income (expense) in the accompanying financial statements. Norstan now anticipates entering into an agreement with its existing bank group, to restructure and/or extend its existing credit facility through June 29, 2001, subject to certain required payments due prior to that time.

The Company intends to complete its negotiations with its bank group and close on the restructured facility by the end of December, 2000. Because of the status of the above financing arrangement, the related debt has been classified as current in the accompanying October 28, 2000 consolidated balance sheet.

Management of the Company believes that a combination of cash expected to be generated from operations, borrowing capacity available under the financing arrangements discussed above, other debt facilities, issuance of debt or equity securities, and lease financing will be adequate to meet the anticipated liquidity and capital resource requirements of its business through at least April 30, 2001. However, there can be no assurance as to the outcome of the Company's current refinancing efforts or whether adequate financing will be available to support the Company's cash flow needs beyond the current forbearance period, as discussed above. As a result of the foregoing, the Company has been advised by its independent public accountants that if these liquidity matters are not adequately resolved prior to the completion of their audit of the Company's financial statements for the year ending April 30, 2001, their auditor's report on those financial statements may need to make reference to such liquidity matters.

BUSINESS SEGMENTS

The Company delivers its products and services through three business segments, Communications, Consulting 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 Three Months Ended
	October 28, 2000					October 30, 1999
	Revenues		Operating Income (Loss)			Revenues		Operating Income (Loss)
Communications	$	75,340	$	(2,497	)	$	86,073	$	(5,834	)
Consulting		11,578		(3,107	)		27,987		(9,584	)
Financial Services		2,078		1,052			2,184		943

Totals	$	88,996	$	(4,552	)	$	116,244	$	(14,475	)

	For the Six Months Ended
	October 28, 2000					October 30, 1999
	Revenues		Operating Income (Loss)			Revenues		Operating Income (Loss)
Communications	$	151,777	$	(3,910	)	$	171,023	$	(1,458	)
Consulting		23,439		(8,012	)		56,983		(11,376	)
Financial Services		4,427		2,033			4,442		1,880

Totals	$	179,643	$	(9,889	)	$	232,448	$	(10,954	)

SUBSEQUENT EVENT

On December 5, 2000, the Company announced a reorganization of its business units to further sharpen the Company's focus on its expanded expertise in e-business solutions and to streamline its sales and administration. This reorganization will result in the reduction of about 70 existing positions at the Company and a charge is expected to be taken in the third quarter of fiscal 2001 to reflect related expenses.

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

GENERAL

Norstan is a single-source provider of leading-edge technology solutions and world-class technology services including converged voice and data infrastructure, information technology, networking, internet conferencing, communication solutions and e-business solutions to more than 18,000 business clients worldwide. To address the complex communication requirements of its customers, Norstan provides a broad range of products and services through three business segments; Communications, Consulting and Financial Services which accounted for 84.7%, 13.0% and 2.3% of Norstan's revenues for the fiscal quarter ended October 28, 2000, respectively. Within the Communications business segment; Communication Solutions offers a comprehensive portfolio of technology solutions including IP Telephony, traditional PBXs, unified messaging, long distance and conferencing and call center solutions; Communication Services provides a full array of customer support services including maintenance and support services, systems modifications and managed communication services; Advanced Services Group provides unified media and converged infrastructure solutions, Voice-Over Data Networking and IP Telephony services and Conferencing Solutions offers audio and video bridging services, internet conferencing, webcasting, consulting services and conferencing products. The Consulting business segment provides e-business solutions including e-commerce consulting services, e-business integration services, knowledge management consulting services, customer relationship management solutions and infrastructure services. The Financial Services segment supports the sales process by providing customized financing alternatives.

SUMMARY

During the quarter ended October 28, 2000, the Company reported a net loss of $7.7 million or $0.69 per common share, as compared to a net loss of $12.2 million or $1.13 per common share for the quarter ended October 30, 1999.

SELECTED CONSOLIDATED FINANCIAL DATA

			DOLLAR AMOUNTS AS A PERCENTAGE OF REVENUES						DOLLAR AMOUNTS AS A PERCENTAGE OF REVENUES
			Three Months Ended				PERCENTAGE CHANGE		Six Months Ended				PERCENTAGE CHANGE
			October 28, 2000		October 30, 1999		Fiscal 2001 vs. 2000		October 28, 2000		October 30, 1999		Fiscal 2001 vs. 2000
REVENUES:
	Communications		84.7	%	74.0	%	(12.5	)%	84.5	%	73.6	%	(11.3	)%
	Consulting		13.0	%	24.1	%	(58.6	)%	13.0	%	24.5	%	(58.9	)%
	Financial Services		2.3	%	1.9	%	(4.9	)%	2.5	%	1.9	%	(0.3	)%

		Total Revenues	100.0	%	100.0	%	(23.4	)%	100.0	%	100.0	%	(22.7	)%
COST OF SALES			72.2	%	78.3	%	(29.4	)%	73.5	%	73.5	%	(22.8	)%

GROSS MARGIN			27.8	%	21.7	%	(2.0	)%	26.5	%	26.5	%	(22.6	)%
SELLING, GENERAL & ADMINISTRATIVE EXPENSES			32.9	%	32.5	%	(22.4	)%	32.1	%	30.4	%	(18.4	)%
RESTRUCTURING CHARGE			—		1.7	%	(100.0	)%	—		0.8	%	(100.0	)%

OPERATING INCOME (LOSS)			(5.1	)%	(12.5	)%	(68.6	)%	(5.5	)%	(4.7	)%	(9.7	)%
	Interest Expense and Other, Net		(3.6	)%	(0.6	)%	300.9	%	(3.0	)%	(1.2	)%	100.7	%

INCOME (LOSS) BEFORE TAXES			(8.7	)%	(13.1	)%	(49.4	)%	(8.5	)%	(5.9	)%	12.0	%
	Income Tax (Benefit) Provision		—		2.6	%	(100.0	)%	—		1.0	%	(100.0	)%

NET INCOME (LOSS)			(8.7	)%	(10.5	)%	(36.7	)%	(8.5	)%	(4.9	)%	34.8	%

The following table sets forth, for the periods indicated, the gross margin percentages for Communications, Consulting and Financial Services.

		Three Months Ended				Six Months Ended
		October 28, 2000		October 30, 1999		October 28, 2000		October 30, 1999
GROSS MARGIN PERCENTAGES:
	Communications	25.4	%	16.6	%	25.0	%	22.4	%
	Consulting	34.1	%	33.7	%	27.9	%	35.6	%
	Financial Services	77.5	%	69.1	%	73.7	%	69.1	%

RESULTS OF OPERATIONS

REVENUES. Revenues decreased 23.4% to $89.0 million in the second quarter of fiscal year 2001 as compared to $116.2 million for the second quarter of fiscal year 2000. For the comparable six month periods ended October 28, 2000 and October 30, 1999, revenues decreased 22.7% to $179.6 million as compared to $232.4 million.

Revenues from Communications decreased 12.5% to $75.3 million for the second quarter ended October 28, 2000 as compared to $86.1 million for the similar period last year. For the comparable six month periods ended October 28, 2000 and October 30, 1999, revenues within this segment decreased 11.3% to $151.8 million as compared to $171.0 million. In general, these decreases were the result of lower revenues in install, service, moves, adds and changes and network services revenue, somewhat offset by increases in resale revenues. Install revenues were down 18.1% and 18.3% for the quarter and six month periods ended October 28, 2000, respectively, as compared to the similar periods ended October 30, 1999. Similarly, service and moves, adds and changes revenues decreased 6.1% and 6.8% for the comparable periods. Network services revenues decreased 19.7% and 15.8%, respectively. Resale revenues increased 9.9% and 7.8% for the comparable three and six month periods.

Revenues from Consulting decreased 58.6% to $11.6 million in the second quarter ended October 28, 2000 from $28.0 million in the similar period last year. Consulting revenues decreased 58.9% to $23.4 million during the six months ended October 28, 2000 as compared to $57.0 million for the similar period ended October 30, 1999. These decreases are the result of significantly lower volume at Norstan Consulting, which has reduced its workforce by approximately two-thirds over the past year as it has transitioned its business to a national practice focusing on e-business, customer relationship management and strategic advisory service practices. These decreases were only somewhat offset by increases in Connaissance Consulting revenues.

Revenues from Financial Services decreased $106,000 or 4.9% in the second quarter of fiscal year 2001 as compared to the similar quarter last year. For the comparable six month periods, Financial Services' revenues were essentially flat.

GROSS MARGIN. The Company's gross margin decreased $493,000 to $24.7 million for the quarter ended October 28, 2000 as compared to $25.2 million for the similar quarter last year. As a percent of total revenues, gross margin increased to 27.8% for the three month period ended October 28, 2000 as compared to 21.7% for the similar period ended October 30, 1999. For the six months ended October 28, 2000, gross margins decreased $13.9 million, or 22.6%, to $47.7 million as compared to $61.6 million for the similar period last year. As a percent of total revenues, gross margin was 26.5% for both six month periods.

The gross margin for Communications increased to 25.4% during the second quarter of fiscal year 2001 as compared to 16.6% for the same period in fiscal year 2000. For the comparable six month periods, Communications' gross margins increased to 25.0% as compared to 22.4%. These increases in

Communications' gross margin percentages were the result of improvements in install, service and moves, adds and changes margins over the comparable three and six month periods.

Install margins increased to 25.3% from 13.8% for the second quarter of fiscal 2001. For the comparable six month periods, install margins increased to 21.7% from 20.4%. Service and MAC margins increased to 27.2% from 15.1% for the second quarter of fiscal 2001 and was up to 27.7% as compared to 23.1% for the comparable six month periods. During these periods, network services margins were relatively flat while resale margins were down slightly.

Gross margins for Consulting was 34.1% and 27.9% for the three and six month periods ended October 28, 2000 as compared to 33.7% and 35.6% for the similar periods last year. As Consulting has undergone significant transitions during fiscal 2001, margin comparisons to fiscal 2000 are difficult to make. However, as Consulting's new focus has taken foothold, gross margins for the second quarter of 2001 have improved significantly from the 21.9% reported for first quarter as a result of improved utilization and higher average billing rates.

Gross margin as a percent of revenues for Financial Services was 77.5% and 73.7% for the three and six month periods ended October 28, 2000 as compared to 69.1% for both the three and six month periods last year.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses decreased 22.4% to $29.3 million in the second quarter of fiscal year 2001 as compared to $37.7 million in the similar period last year. As a percent of revenues, selling, general and administrative expenses were relatively flat at 32.9% and 32.5% for the comparable three month periods ended October 28, 2000 and October 30, 1999.

For the six month periods ended October 28, 2000 and October 30, 1999, selling, general and administrative expenses decreased $13.0 million, or 18.4%, to $57.6 million from $70.6 million. As a percent of revenues, selling, general and administrative expenses were 32.9% and 32.1% for the three and six month periods ended October 28, 2000 and 32.5% and 30.4% for the similar periods last year. While the Company has taken measures to remove a significant amount of costs from its businesses over the past year, the selling, general and administrative percentages have increased slightly due to the lower volume of revenue. The Company continues to monitor expenditures and is focused on overall cost control measures.

RESTRUCTURING CHARGES. During the second quarter of fiscal 2000, the Company recorded a restructuring charge of approximately $2.0 million related to its Consulting business. The emphasis of the restructuring was to consolidate branch offices and reduce certain general and administrative costs. Norstan Consulting has transitioned to a project-based business model in which the physical presence of geographic branches has become far less important than the ability to move skilled consulting resources to customer engagements. The $2.0 million charge consisted of noncancelable lease obligations for branch offices to be closed ($1.0 million), software and other asset write-offs ($800,000), and severance costs ($200,000).

INTEREST EXPENSE. Interest expense was $2.1 million and $1.4 million for the three month periods ended October 28, 2000 and October 30, 1999, respectively, and $4.1 million and $2.8 million for the respective six month periods. These increases were primarily the result of higher average borrowing levels during the three and six month periods related to working capital requirements, as well as higher interest rates on the Company's credit facility.

INCOME TAXES. The Company did not record any income tax benefit related to the current quarter's loss or for the six months then ended. For the three and six months ended October 30, 1999, the Company's effective income tax rate was 20.0% and 17.0%, respectively, which differ from the

federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization.

NET INCOME (LOSS). In the second quarter of fiscal 2001, the Company reported a net loss of $7.7 million or $0.69 per share, as compared to a net loss of $12.2 million or $1.13 per share for the second quarter of fiscal 2000. For the six months ended October 28, 2000, the Company reported a net loss of $15.3 million, or $1.38 per share, as compared to a net loss of $11.3 million, or $1.06 per share, for the similar period last year.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operations improved significantly for the six months ended October 28, 2000 as compared to the similar period last year. Operating activities provided cash of $5.7 million currently as compared to utilizing cash of $3.8 million during the comparable period last year. This improvement was the result of increased and continued focus on asset management. Net cash used for investing activities decreased to $1.6 million for the six months ended October 28, 2000 as compared to $7.4 million for the similar period ended October 30, 1999. Financing activities utilized $0.5 million in cash as compared to providing $10.7 million in cash during the prior period.

CAPITAL EXPENDITURES. The Company used $4.8 million for capital expenditures during the six months ended October 28, 2000, as compared to $7.1 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 capitalized costs incurred in connection with obtaining or developing internal use software, computer equipment and system integration.

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 the first six months of fiscal year 2001 totaled $15.3 million. Net lease receivables decreased to $65.8 million at October 28, 2000 from $67.7 million at April 30, 2000.

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 $38.0 million at October 28, 2000 as compared to $44.8 million at April 30, 2000. Interest rates on these credit agreements at October 28, 2000 ranged from approximately 6.0% to 10.0%, while payments are due in varying monthly installments through November 2005. Payments due to financial institutions are made from monthly collections of lease receivables from customers. The Company anticipates entering into additional lease financing transactions in the third quarter of fiscal 2001.

BANK FINANCING

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

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 to foreign customers and changes in interest rates on obligations under the Company's long-term debt obligations, discounted lease rentals, capital leases and other long-term debt obligations.

The potential loss from a hypothetical 10% adverse change in foreign currency rates on the Company's foreign installment contracts at October 28, 2000 would not materially affect the Company's consolidated financial position, results of operations or cash flows.

The Company's current unsecured revolving long-term credit agreement carries interest rate risk that is generally related to the banks' reference rate. If this rate were to change while the Company was borrowing under the agreement, interest expense would increase or decrease accordingly. As of October 28, 2000, total consolidated borrowings under this agreement were $69.9 million.

The Company has no earnings or cash flow exposure due to market risks on its discounted lease rentals or its capital lease and other long-term debt obligations as a result of the fixed-rate nature of these obligations. However, interest rate changes would affect the fair market value of the lease rentals, capital leases and other long-term debt obligations. At October 28, 2000, the Company had fixed rate lease rentals of $38.0 million and capital lease and other long-term debt obligations of $4.0 million.

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.

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

(a): On September 14, 2000, the annual meeting of shareholders of the Company (the "Annual Meeting") was held.
(b): At the Annual Meeting, the following directors were elected:

Paul Baszucki		Gerald D. Pint
Richard Cohen		Dr. Jagdish N. Sheth
Connie M. Levi		Herbert F. Trader
Alan L. Mendelson		Mercedes Walton

(c)

The following items were voted upon at the Annual Meeting:

(1): Election of Directors:

Name	Votes For	Votes Withheld
Paul Baszucki	8,466,508	1,089,647
Richard Cohen	8,469,781	1,086,374
Connie M. Levi	8,420,855	1,135,300
Alan L. Mendelson	8,473,474	1,082,681
Gerald D. Pint	8,421,054	1,135,101
Dr. Jagdish N. Sheth	8,475,062	1,081,093
Herbert F. Trader	8,417,908	1,138,247
Mercedes Walton	8,473,208	1,082,947

(2): The shareholders approved an amendment to the Company's 1995 Long-Term Incentive Plan to increase the number of shares of common stock issuable thereunder from 2,400,000 to 2,900,000 shares. A total of 4,414,757 shares were voted for the amendment to this plan, 1,823,459 shares were voted against, and 22,829 abstained.
(3): The shareholders approved an amendment to the Company's Restated Non-Employee Directors' Stock Plan to increase the number of shares of common stock issuable thereunder from 150,000 to 250,000 shares. A total of 4,869,304 shares were voted for the amendment to this plan, 1,366,601 shares were voted against, and 25,140 abstained.
(4): The shareholders approved an amendment to the 2000 Employee Stock Purchase Plan of Norstan, Inc. increasing the number of shares of common stock issuable thereunder from 400,000 to 800,000 shares. A total of 5,970,699 shares were voted for the amendment to this plan, 258,372 shares were voted against, and 31,974 abstained.
(5): The shareholders approved the appointment of Arthur Andersen LLP as independent auditors for the fiscal year ending April 30, 2001. A total of 9,436,845 shares were voted for the appointment of Arthur Andersen LLP, 89,292 shares were voted against and 30,018 abstained.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits.

Exhibit 10.		Employment Agreement dated October 27, 2000 between James C. Granger and the Company
Exhibit 27.		Financial Data Schedule

(b)

Reports on Form 8-K.

None

S I G N A T U R E S

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

	NORSTAN, INC. Registrant
Date: December 12, 2000	By	/s/ JAMES C. GRANGER James C. Granger Chief Executive Officer and President
Date: December 12, 2000	By	/s/ RICHARD COHEN Richard Cohen Chief Financial Officer (Principal Financial and Accounting Officer)

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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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K