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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 AUGUST 2, 2003

OR

o 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)

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes o No x

On September 2, 2003, there were 12,978,050 shares outstanding of the registrant’s common stock, par value $0.10 per share, its only class of equity securities.

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INDEX

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PART I. FINANCIAL INFORMATION
ITEM 1.

NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
(In thousands, except per share amounts)

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

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NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

UNAUDITED
(In thousands, except share amounts)

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

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NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
UNAUDITED
(In thousands, except share amounts)

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

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NORSTAN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED

(In thousands)

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

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NORSTAN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 identified herein pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. This report should be read in conjunction with our Annual Report on Form 10-K for the year ended April 30, 2003. The operating results for the interim periods presented are not necessarily indicative of the operating results to be expected for the full fiscal year. When we refer to the “Company”, “Norstan”, “we”, “us” or “our”, we mean Norstan, Inc. and its subsidiaries.

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Principles of Consolidation:

     The accompanying consolidated financial statements include the accounts of Norstan, Inc. 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 accounting principles generally accepted in the United States of America 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 valuation, depreciable lives of property and equipment, valuation of deferred tax assets, warranty reserves, estimates of percentage of completion under long-term contracts and others. Ultimate results may differ from those estimates.

Goodwill:

     The components of goodwill and other intangible assets were as follows (in thousands):

     The change in the gross carrying amounts of goodwill and other intangible assets for the three months ended August 2, 2003 were as follows (in thousands):

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Warranty:

     We are subject to warranty claims for products and overall solutions that may fail to perform as expected due to design, installation or manufacturing deficiencies. Customers continue to require their outside suppliers to guarantee or warrant their products/solutions and bear the cost of repair or replacement of such products/solutions. Depending on the terms under which we supply products/solutions to our customers, a customer may hold us responsible for some or all of the repair, replacement or redesign/reinstallation costs of defective products/solutions, when the product/solution supplied did not perform as represented. We generally provide customers a warranty on products consistent with the warranty we receive from the original equipment manufacturer. In most instances, the original equipment manufacturer bears the cost to replace defective products. We provide the necessary labor to redesign, reinstall or replace products/solutions that did not perform as represented. Our policy is to reserve for estimated future costs based upon historical trends of actual costs incurred. The warranty reserve is included in other accrued liabilities within our consolidated balance sheet.

     The following table presents a summary of the warranty provision (in thousands):

Foreign Currency:

     For our Canadian 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 within accumulated other comprehensive income (loss).

Earnings Per Share Data:

     Norstan 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.

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     A reconciliation of EPS calculations under SFAS No. 128 was as follows (in thousands, except per share amounts):

     For the quarters ended August 2, 2003 and July 27, 2002, common share equivalents of 3.3 million and 1.2 million, respectively, have been excluded from the computation of diluted earnings per share, as required under SFAS No. 128, as the effect of their inclusion would be anti-dilutive.

Comprehensive Income:

     We report comprehensive income and its components pursuant to the requirements of SFAS No. 130 “Reporting Comprehensive Income”. For Norstan, comprehensive income consists of net income (loss) adjusted for foreign currency translation adjustments. Comprehensive income, as defined by SFAS No. 130, was a loss of approximately $1.9 million for the quarter ended August 2, 2003 and income of approximately $2.2 million for the similar period ended July 27, 2002.

Supplemental Cash Flow Information:

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

Vendor Agreements:

     We have been a distributor of Siemens communication equipment since 1976 and are one of Siemens’ largest independent distributors 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 pursuant to which we are authorized to refurbish and market previously owned Siemens equipment through an alliance with Siemens. This agreement was recently extended for a one-year period and currently runs through July 2004.

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NOTE 2 — ACQUISITION:

     On March 7, 2003, we announced that we purchased from NetCom Systems, Inc. certain assets including intellectual property, effective March 1, 2003 related to NetCom’s voice over Internet Protocol (IP) telephony applications software operations. The acquisition consideration totaled $3.0 million, consisting of a cash payment of $1.1 million at closing, $1.1 million paid in the first quarter of fiscal 2004 and guaranteed payments of $800,000 payable over the next two years. The purchase agreement provides that we may pay additional purchase consideration up to $3.0 million based on the amount of new software license fees received by Norstan during the two-year period following the closing. At our discretion, up to 50 percent of any contingent consideration may be paid in shares of Norstan’s common stock. We have and will continue to fund the purchase of these assets from borrowings under our revolving credit facility or through the issuance of equity securities. We have also hired certain key NetCom personnel who were involved in development of IP telephony applications software. In fiscal 2003, we recorded $2.6 million for intangible assets relating to proprietary technology and $400,000 in goodwill relating to the $3.0 million acquisition consideration.

NOTE 3 — DISCONTINUED OPERATIONS:

Network Services:

     On February 4, 2002, Norstan announced that it had entered into a definitive agreement to sell our Network Services business to NetWolves Corporation (NASDAQ: WOLV) for $7.5 million. The transaction was effective on July 1, 2002. Pursuant to the terms of the purchase agreement, $3.75 million was received at closing and the remaining $3.75 million was due one year from closing, evidenced by a non-interest bearing promissory note in favor of Norstan. We recorded a pre-tax gain on this sale of $2.7 million in the first quarter of fiscal 2003 based on the $3.75 million cash received. During the fourth quarter of fiscal 2003, we received payment of $2.9 million in cash and other non-monetary assets in early settlement of the promissory note. We recorded a pre-tax gain of $2.8 million in the fourth quarter of fiscal 2003 based on the receipt of cash received in settlement of the promissory note. The non-monetary asset, consisting of 300,000 shares of unregistered NetWolves Corporation common stock, has been reflected at a zero value until such time as the unregistered common stock is monetized or monetizable. Network Services provided multiple source long distance services and related consulting and professional services. Because of the sale of this business unit, Network Services results of operations have been reported as discontinued operations for all periods presented.

Consulting:

     During fiscal 2001, we divested our IT consulting business to focus on our core competencies of providing communications technology services and solutions to channel partners and direct enterprise customers. The absence of realized synergies between our communications and IT consulting businesses and recurring losses within the consulting business contributed to the decision to divest of this non-strategic business segment.

     Divestiture of Norstan’s IT consulting business began on February 7, 2001 with the sale of our 75% interest in Connaissance Consulting to Connaissance’s founder. Terms of the sale required the purchaser to remit $3.0 million in cash at closing and deliver promissory notes drawn in favor of Norstan with an aggregate face amount of $13.0 million maturing on various dates, commencing on April 30, 2001 and ending December 31, 2005. To date, $1.0 million has been collected on one of the notes and the remaining $12.0 million has been fully reserved for.

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     The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former president and the Company’s former vice chairman. Terms of the sale required the 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. As of April 30, 2002, the $1.5 million promissory note had been paid in full.

     The results of these two business units have historically been reported as our “Consulting” business segment. With these sales, Consulting’s results are reported as discontinued operations for all periods presented.

Financial Information Related to Discontinued Operations:

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

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

     In addition to the operating results above, we recorded a net gain on the disposal of discontinued operations of $154,000, net of tax, during the first quarter of fiscal 2004. This gain on disposal resulted from the sale of a certain property received by Norstan as part of the Vadini arbitration settlement of February 25, 2002.

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     We also recorded a net gain on the disposal of discontinued operations of $2.1 million in the first quarter of fiscal 2003. The gain on disposal included the following: (i) a gain on the sale of Norstan’s Network Services business of $2.1 million, net of tax, (ii) a $104,000 gain, net of tax, related to payments on the promissory note received by the Company as part of the Vadini settlement, and (iii) a $269,000 loss, net of tax, related to additional costs incurred in the disposition of Connaissance Consulting.

     The after-tax gain on the sale of the Network Services business reflects the reversal of a $1.6 million tax valuation allowance which had been previously established for the Company’s capital loss carryforwards. The sale of the Network Services business allowed us to fully utilize these capital loss carryforwards. Accordingly, this valuation allowance was reversed through discontinued operations.

NOTE 4 — INCOME TAXES:

     Deferred income taxes are provided for differences between the financial statement carrying amounts and the tax basis of assets and liabilities at currently effective income tax rates.

     Realization of our net deferred tax assets is dependent on our ability to generate sufficient future taxable income. Should operating strategies fail to produce sufficient taxable income in the future, we would record an additional valuation allowance in the appropriate future reporting period, as required by generally accepted accounting principles. Norstan’s U.S. net operating loss carryforwards expire from 2020 to 2021, and the Canadian net operating loss carryforwards expire through fiscal 2008.

     For the three months ended August 2, 2003, we recorded a tax benefit of 39.0% on the net loss incurred from continuing operations. In addition, a tax provision of 39.0% was recorded on the gain on disposal of discontinued operations.

NOTE 5 — STOCK-BASED COMPENSATION:

     We apply APB Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for our stock-based compensation 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” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”, our net income (loss) (in thousands) and net income (loss) per common share would have decreased to the following pro forma amounts:

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NOTE 6 — DEBT OBLIGATIONS:

     On July 12, 2002, we entered into a $30.0 million credit agreement with certain banks consisting of the following components: A) a $21.0 million revolving line of credit, with availability based on eligible receivables and inventory, as defined, and B) a $9.0 million term loan with quarterly payments of $1.0 million beginning October 25, 2002. The revolving line was to mature on June 28, 2004 and the term note was to mature on October 29, 2004. The term note was subject to certain prepayment provisions in the event that we received cash from the collection of the promissory note related to the sale of Network Services.

     The revolving credit facility and term loan bore interest at the bank’s reference rate plus 1.0% or Eurodollar rate advance plus 3.0% through January 31, 2003, and at the bank’s reference rate plus 0.5% or Eurodollar rate advance plus 2.5% through April 30, 2003. Annual commitment fees ranged from 0.375% to 0.25%. Under this agreement we were required to maintain, on a quarterly basis, minimum levels of earnings before income taxes and achieve certain other financial ratios.

     On July 15, 2003, we entered into an amendment related to the above agreement. Under this amendment, all amounts outstanding under the above mentioned term loan were converted to borrowings under the revolving credit facility. As of the date of this amendment, the maximum capacity of the revolving credit facility was established at $24.0 million and reduces to $22.5 million as of January 31, 2004, with availability based on eligible receivables and inventory, as defined. The revolving credit agreement matures on June 28, 2004 and accordingly, the related debt of $18.4 million is classified as current as of August 2, 2003.

     The amended revolving credit facility currently bears interest at the banks’ reference rate plus 0.5% or Eurodollar rate advance plus 2.5% with provisions for future rate changes based on certain of our financial ratios. Annual commitment fees continue to range from 0.375% to 0.25%. The amended agreement revised certain financial covenants for fiscal 2004, and requires that the we maintain, on a quarterly basis, minimum levels of earnings before income taxes and achieve certain other financial ratios. The Company had complied with or has obtained the appropriate waivers for such requirements as of August 2, 2003.

     As we look forward to the covenant requirements contained in our amended revolving credit facility related to the second quarter of fiscal 2004, we anticipate being out of compliance with certain of those covenants. This is principally a result of continued downward pressure on margins in certain business units, our continued growth and expansion in new markets and the restructuring charge referred to in Note 8. We are in discussion with our current lenders regarding these anticipated events of non-compliance. In addition, we are in discussion with certain financial institutions with respect to financing our credit needs on a long-term basis. We believe that a combination of cash expected to be generated from operations, borrowing capacity available under the financing arrangements discussed above, and cash received from other transactions, including the issuance of debt or equity securities, will be adequate to meet the liquidity and capital resource requirements of our business until at least April 30, 2004. However, there can be no assurance as to the outcome of our attempt to obtain waivers for the anticipated events of non-compliance or our refinancing efforts, whether adequate financing will be available to support our cash flow needs through April 30, 2004 or that other assumptions used by us in formulating our assessment will prove accurate.

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NOTE 7 — BUSINESS SEGMENTS:

     Norstan delivers its products and services through three business segments, Communications Technology Solutions and Services, Resale Services and Financial Services. Interim disclosures under the requirements of SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information,” were as follows (in thousands):

NOTE 8 — SUBSEQUENT EVENT:

     Subsequent to quarter end, as part of the Company’s continued focus on right-sizing our cost model to ensure long term profitability, we anticipate recording a restructuring charge in the second quarter of fiscal 2004 ranging from $1.5 to $2.0 million, related to a reduction in work force of approximately 75 to 100 people. The execution of these actions is anticipated to be completed by the end of our second fiscal quarter.

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

     Norstan, Inc. (“Norstan”, the “Company”, “we”, “us”, or “our”) is a full-service communications solutions and services company delivering voice and data technologies and services, and remanufactured equipment to select corporate end-users, channel partners and the public sector. We also offer a full range of technologies for call center design, IP telephony/PBX, messaging, infrastructure, conferencing, and enterprise mobility. Norstan operates principally through its subsidiaries: Norstan Communications, Inc., Norstan Canada, Ltd., Norstan Financial Services, Inc. and Vibes Technologies, Inc. We are headquartered in Minnetonka, Minnesota with sales and services locations throughout the United States and Canada. Our common stock is listed on the Nasdaq Stock Market under the symbol NRRD.

     Norstan drives its business by delivering communications solutions and services through the installation of a broad array of technology platforms, software solutions and on-going system maintenance needs. We currently work with approximately 2,500 key direct customers, servicing over 18,000 sites, drawing customers from the banking/finance, healthcare, manufacturing, retail, government, education, utilities, finance/insurance and non-profit sectors. Additionally, we sell technology services support to a broad channel of manufacturers, resellers and distributors, through relationships with manufacturers offering best-in-class technology. We maintain a direct sales effort focused on Fortune 2000 and middle market companies and the public sector. Our remanufactured equipment segment supports Norstan’s customer base, channel partners, resellers, distributors and other end-users with efficient and reliable resale products.

     To address the complex communications requirements of our customers, Norstan provides a broad range of products and services through three interrelated business segments: Communications Technology Solutions and Services, Resale Services, and Financial Services which accounted for 86.2%, 12.8%, and 1.0% of our revenues for the fiscal quarter ended August 2, 2003, respectively. Communications Technology Solutions and Services provides best-in-class technologies and services focused on selected enterprise customers throughout the U.S. and Canada, technology implementation and support services for network providers, manufacturers, integrators, and resellers, and hardware and software applications that support voice over Internet Protocol (IP). Resale Services provides refurbished and re-certified voice and data products. Financial Services supports our sales process by providing customized financing alternatives.

SUMMARY

     During the quarter ended August 2, 2003, the Company reported a net loss of $1.9 million or $0.15 per diluted share, as compared to net income of $2.2 million or $0.17 per diluted share for the comparable quarter ended July 27, 2002.

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SELECTED CONSOLIDATED FINANCIAL DATA

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

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RESULTS OF OPERATIONS

     REVENUES. Revenues increased 9.2% to $56.9 million in the first quarter of fiscal 2004, as compared to $52.1 million for the first quarter of fiscal 2003.

     Revenues within our Communications Technology Solutions and Services segment increased 11.9% to $49.1 million for the first quarter of fiscal 2004, compared to $43.8 million for the similar period last year. Within this segment, revenues from Solutions’ were up 36.8% for the comparable quarters ended August 2, 2003 and July 27, 2002 as the prior year’s first quarter revenues were relatively low. This increase was also due to enhanced revenues from some of our more recent product offerings and call center and IP telephony product offerings which were somewhat offset by decreases in revenues from our traditional product offerings. Services’ revenues were relatively flat for the comparable three month periods. Increased revenues from channel services and managed communications along with revenues from our new Convergence Development Group offset lower revenues from service contracts, moves, adds and changes (MAC), consulting and conferencing. Our service contract and MAC revenues continue trending down as we experience some erosion in our customer base as a result of competitive market conditions, technological changes and overall economic conditions.

     While profitable revenue growth continues to be a challenge in a persistently weak economy, we are positioning the business to take advantage when market conditions improve. These initiatives include growth through expansion and acquisition.

	•		We continue our expansion into tier one cities such as New York, Los Angeles and Dallas and more recently Atlanta, Chicago, Detroit, Philadelphia and San Francisco.
	•		We continue to develop channel partner relationships as well as cultivating opportunities with existing partners.
	•		Our relationships with Nortel Networks and Cisco Systems have expanded our geographic reach and are providing new sales opportunities.
	•		Acquisition of NetCom’s voice over IP application software development group offers true value-add to our sales distribution channels.
	•		In addition, we implemented our Sales Services Specialists initiative in fiscal 2003 to sell our service capabilities to customers in new and existing geographies.

     Current overall economic conditions continued to effect our financial performance throughout the first quarter of fiscal 2004. Overall levels of business capital spending in all market sectors, especially in the information technology and telecommunications services industries, continue to negatively affect our results of operations. However, we believe that when the economy strengthens and capital spending improves, customers will invest in communications systems and infrastructure.

     For the quarter ended August 2, 2003, Resale Services’ revenues decreased 1.8% to $7.3 million as compared to $7.4 million in the first quarter of fiscal 2003. Revenues from Vibes Technologies, our integrated direct and web-based e-commerce business which remanufactures and resells voice and data equipment, were up 7.1% year-over-year while our Siemens Resale Services group experienced a 12.8% decrease in revenues. Revenues in this segment were affected by the overall economy as well as the maturity of certain equipment supported by the Resale Services group. Opportunities for growth within this segment include the addition of new product offerings in the portfolio of refurbished and re-certified voice and data products as well as pursuing business in the federal space with a General Services Administration contract.

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     Financial Services’ revenues declined 34.2% to $564,000 for the first quarter of fiscal 2004 as compared to $857,000 a year ago. This decrease was attributed to our strategic decision to discontinue offering financing directly to our customers. Norstan Financial Services has associated with Citicapital Technology Finance, Inc. to provide financial alternatives to our customers under a private label leasing program. Revenues from Financial Services will continue to decline over the next few fiscal years as its operations wind down.

     GROSS MARGIN. Gross margin was $16.0 million for the first quarter of fiscal 2004, down 3.3% as compared to $16.5 million for the similar period last year. As a percent of total revenues, gross margin was down 3.6 percentage points to 28.1% for the first quarter of fiscal 2004 as compared to 31.7% for the first quarter of fiscal 2003.

     Gross margin percentages for any specific period of time are affected by numerous factors, including without limitation competitive market pricing, product and/or service mix, labor utilization, cost overruns, and operations spending.

     Gross margin as a percent of revenues for our Communications Technology Solutions and Services segment was 26.3% for the first quarter of fiscal 2004, as compared to 30.2% for the similar period last year.

     Solutions’ margins were 21.1% for the first quarter of fiscal 2004, as compared to 25.0% for the similar period last year. This year-over-year decrease was generally the result of continued pricing pressure at the point of sale, changing product mix, current economic conditions and cost overruns on certain projects. Solutions’ margins will continue to experience downward pressure in the current challenging economic environment and with our changing product mix. Services’ margins were 29.9% for the current three month period as compared to 32.8% for the similar period last year. This decline is generally due to lower than planned labor productivity and decreased MAC volumes                      Services’ margins will continue to be subject to downward pressure from customer price sensitivity and as a result of our changing mix of service and product offerings.

     Resale’s gross margin as a percent of revenues was 33.1% for the quarter ended August 2, 2003 as compared to 33.9% for the similar period last year. This change is generally the result of variations in the mix of products sold during the comparable periods.

     Gross margin as a percent of revenues for Financial Services was 114.4% for the first quarter of fiscal 2004 and 89.0% for the similar period last year. This increase in gross margin is due primarily to the continued winding down of Financial Services’ operations and the run-out of its portfolio.

     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased 19.7% to $18.8 million in the first quarter of fiscal 2004, from $15.7 million in the similar period last year. As a percent of revenues, selling, general and administrative expenses were 33.1% for the first quarter of fiscal 2004 as compared to 30.2% for the similar period last year. These increases are primarily the result of the strategic investments we have made in the last year related to marketing and business development including expansion into tier one cities, IP applications, and service sales initiatives. These investments, while expected to provide a long-term benefit to our future performance, may continue to adversely affect our financial results.

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     INTEREST EXPENSE. Interest expense decreased 35.3% to $448,000 for the first quarter of fiscal 2004 from $692,000 for the similar period last year. The decrease in interest expense was primarily the result of reduced weighted average interest rates and a decrease in borrowings under the Company’s revolving long-term credit facilities, which were $18.4 million as of August 2, 2003 compared to $19.5 million as of July 27, 2002.

     INCOME TAXES. Deferred income taxes are provided for differences between the financial statement carrying amounts and the tax basis of assets and liabilities at currently enacted tax rates. For the first quarter of fiscal 2004, we recorded a tax benefit of 39.0% on the net loss incurred from continuing operations and a 39.0% tax provision on the gain on disposal of discontinued operations.

     NET INCOME (LOSS) FROM CONTINUING OPERATIONS. We incurred a net loss from continuing operations of $2.0 million or $0.16 per diluted share for the first quarter of fiscal 2004, as compared to net income of $43,000 or less than $0.01 per diluted share for the similar period last year.

     DISCONTINUED OPERATIONS.

Network Services:

     On February 4, 2002, Norstan announced that it had entered into a definitive agreement to sell its Network Services business to NetWolves Corporation (NASDAQ: WOLV) for $7.5 million. The transaction was effective on July 1, 2002. Pursuant to the terms of the purchase agreement, $3.75 million was received at closing and the remaining $3.75 million was due one year from closing, evidenced by a non-interest bearing promissory note in favor of Norstan. We recorded a pre-tax gain on this sale of $2.7 million in the first quarter of fiscal 2003 based on the $3.75 million cash received. During the fourth quarter of fiscal 2003, we received payment of $2.9 million in cash and other non-monetary assets in early settlement of the promissory note. We recorded a pre-tax gain of $2.8 million in the fourth quarter of fiscal 2003 based on the receipt of cash received in settlement of the promissory note. The non-monetary asset, consisting of 300,000 shares of unregistered NetWolves Corporation common stock, has been reflected at a zero value until such time as the unregistered common stock is monetized or monetizable. Network Services provided multiple source long distance services and related consulting and professional services. Because of the sale of this business unit, Network Services results of operations have been reported as discontinued operations for all periods presented.

Consulting:

     During fiscal 2001, we divested our IT consulting business to focus on our core competencies of providing communications technology services and solutions to channel partners and direct enterprise customers. The absence of realized synergies between our communications and IT consulting businesses and recurring losses within the consulting business contributed to the decision to divest of this non-strategic business segment.

     Divestiture of Norstan’s IT consulting business began on February 7, 2001 with the sale of our 75% interest in Connaissance Consulting to Connaissance’s founder. Terms of the sale required the purchaser to remit $3.0 million in cash at closing and deliver promissory notes drawn in favor of Norstan with an aggregate face amount of $13.0 million maturing on various dates, commencing on April 30, 2001 and ending December 31, 2005. To date, $1.0 million has been collected on one of the notes and the remaining $12.0 million has been fully reserved for.

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     The divestiture concluded with the sale of Norstan Consulting on April 30, 2001 to a management group led by Norstan Consulting’s former president and the Company’s former vice chairman. Terms of the sale required the payment of $500,000 in cash at closing and delivery of a promissory note drawn in favor of Norstan in the face amount of $1.5 million. As of April 30, 2002, the $1.5 million promissory note had been paid in full.

     The results of these two business units have historically been reported as our “Consulting” business segment. With these dispositions, Consulting’s results are reported as discontinued operations for all periods presented.

Financial Information Related to Discontinued Operations:

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