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

FORM 10-K

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

FOR THE FISCAL YEAR ENDED APRIL 30, 2001

OR

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

Commission file number 0-8141

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

5101 Shady Oak Road, Minnetonka, Minnesota 55343
(Address of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock ($.10 par value per share)
Common Stock Purchase Rights
(Title of class)

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

      As of July 13, 2001, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average high and low prices on such date as reported by the Nasdaq National Market System was approximately $36,715,000.

      As of July 13, 2001 there were outstanding 12,279,258 shares of the registrant’s common stock, par value $.10 per share, its only class of equity securities.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the registrant’s definitive proxy statement to be filed within 120 days after the end of the fiscal year covered by this report are incorporated by reference into Part III hereof.

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PART I

Item 1. Business.

BUSINESS

Summary

      Norstan 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. The Company is headquartered in Minneapolis, Minnesota.

      Norstan drives its business by delivering legendary service through the installation of a broad array of technology platforms, software solutions and on-going system maintenance needs. The Company currently works with more than 18,000 customers, ranging from start-up organizations to large global enterprises, drawing its customers from the banking/finance, healthcare, manufacturing, retail, government, education and non-profit sectors. The Company derives significant revenue from technology service support sales to a broad channel of manufacturers, resellers and distributors and through partnerships with manufacturers offering best of breed technology. Norstan also maintains a direct sales effort focused on Fortune 1000 companies, and an inside sales force focused on smaller opportunities. The Company’s remanufactured equipment segment supports the Company’s customer base, channel partners, resellers and distributors with efficient and reliable resale services.

      To address the complex communication requirements of its customers, Norstan provides a broad range of products and services through four interrelated business segments: Communications Technology Solutions and Services, Resale, Network Services and Financial Services which accounted for 78.8%, 8.8%, 9.2% and 3.2% of Norstan’s fiscal year 2001 revenues, respectively. Solutions and Services provides best-of-breed technologies and services focused on selected end-user customers throughout North America and technology implementation and support services for network providers, manufacturers, integrators, and resellers. Resale Services provides refurbished and re-certified voice and data products to end users. Network Services provides multiple source local and long distance services including related consulting and professional services. Financial Services supports the sales process by providing customers with customized financing alternatives.

      The Company maintains 30 sales and service locations in 28 cities throughout the United States and Canada. Norstan has served more than 18,000 customers across a broad range of industries and focuses its marketing efforts on middle-market and Fortune 1000 companies with complex technology and communication requirements. Current customers include Charles Schwab, Best Buy, IBM, and Harley-Davidson. Norstan’s strong emphasis on customer satisfaction is evidenced by a fiscal year 2001 survey of Norstan’s communication customers that found an overall satisfaction rating of 95.6%. This dedication to customer service, together with the Company’s breadth of service offerings has resulted in Norstan becoming the fourth largest communications services provider in North America. The Company believes that its outstanding customer service will enable Norstan to capture a greater portion of each customer’s communication budgets in the future as well as provide other growth opportunities through multi-channel marketing (see Norstan’s Growth Strategy).

      Norstan provides leading-edge technologies in its Solutions and Services and Resale segments. The Company has established strategic alliances with leading communication companies that enhance Norstan’s ability to offer best of breed solutions to its customers. Strategic partners include Siemens, VTEL, PictureTel, Latitude, Ericsson, Aspect, Blue Pumpkin, Nuance, Cisco Systems, Sprint, Lucent Technologies (formerly Octel), Captaris, Rockwell, SpeechWorks, Alcatel, Comdial and SpectraLink.

      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 two units that made up the Company’s IT consulting business, Connaissance Consulting and Norstan Consulting, were sold on February 7 and April 30, 2001, respectively. In addition to refocusing the Company’s strategy, lack of realized synergies between the Company’s communications and consulting businesses and recurring losses within the consulting businesses contributed to the decision to divest of this non-strategic business segment.

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Industry Overview

      Until recently, intense global competition and accelerating technological change have driven businesses to depend on technology-based solutions to enhance their competitive position, and to improve productivity and the quality of their products and services. The current economic conditions, however, have significantly slowed that trend. Companies that have traditionally relied on technology-based solutions as strategic business tools are frequently postponing or curtailing technology decisions. This has had a significant effect on both the business climate and the telecommunications industry.

      The effect of the economic slowdown on the telecommunications industry has been a slowing in the rate of technological change. As technology spending has decreased, the highly leveraged Competitive Local Exchange Carriers (CLECs) segment has become a casualty of an overabundance of network bandwidth. The decline of the dot-com industry has also contributed to the situation now where technology equipment manufacturers have excess inventories and bad debt write-offs.

      While customers continue to rely heavily on technology to reduce transaction costs by increasing operational efficiencies, the bias toward software-centric solutions in lieu of hardware continues. Notwithstanding the slow economic conditions, growth continues to occur in such areas as customer contact solutions, CTI (computer telephony integration), unified media, convergence (IP telephony), and mobility.

      Current financial pressures also are making it increasingly difficult for communications equipment manufacturers to support a direct distribution model. Most independent distribution channels lack an adequate geographic footprint, infrastructure, processes, and resources to effectively fulfill the manufacturer’s need to deploy complex high-end technology solutions. This has resulted in the need for systems integration and support services through third-party providers. A key competency being driven by the market is the ability to effectively integrate disparate technology platforms into enterprise-wide applications solutions.

      As a result of these factors, demand for communication services and products has been relatively flat. For calendar year 2000, Phillips InfoTech (InfoTech), a market research firm specializing in telecommunications market information, estimates that the U.S. market for voice and converged solutions peaked at $4.9 billion in 1999, and remained stable in 2000; various forecasting firms, including Phillips, Frost & Sullivan, Data Communications and Vertical Systems group, project that PBX system spending will decline through 2002, with a potential increase in 2003. New PBX systems shipments decreased 15.8% in 2000 over 1999. This decline in PBX spending is attributed to the development of combined voice and data technology in the form of IP Telephony. Accelerated growth in IP Telephony is expected to take hold in 2002 and to reach equal market share with PBX systems by 2004. Recent slowdowns in technology spending may delay this development, however. Field maintenance and repair is the largest, but slowest growing segment in services associated with the voice marketplace. This includes the maintenance and repair of PBX, Key/Hybrid, Voice Processing: IVR, CTI, ACD, and fax. Growth in 2000 was estimated by Blumberg & Associates at 0.7%, to $6.0 billion, with projected compound annual growth of approximately 3.3% through 2004. Growth in advanced or unified messaging is expected to grow at a compound annual rate of 75.0% through 2004, to $13.5 billion in annual revenue from $1.2 billion in spending in 2000. Spending in video conferencing totaled an estimated $1.5 billion in 2000, and is projected to grow at a compound rate of 20.8% through 2004, while the audio and data conferencing market is projected to grow to $3.0 billion in 2006 from $1.3 billion in 1999.

The Norstan Solution

      Norstan is a single-source provider of a wide range of communication software, services and equipment that enable its customers to compete and succeed in the global marketplace. The Company has leveraged its established reputation as a provider of premier communication products and services to deliver complex, high-end technology solutions to middle-market and Fortune 1000 companies. This broad range of offerings enables Norstan to serve as a single-source provider of communication solutions throughout the entire life cycle of a project. Norstan’s ability to serve as a single-source provider results in closer integration, reduced risk and greater management control for the customer. The Company believes that its customer relationships, its geographic reach and size, and its expertise in providing communication solutions will enable it to capitalize on the continuing growth and convergence of the hardware and software needs of middle-market and Fortune 1000 companies.

Norstan’s Business Strategy

      The Company’s objective is to become the leading provider of communications technology services to the enterprise market in North America. Key to the achievement of this objective are the following elements:

      Capitalize on the trend of “dis-integrating” by manufacturers and distributors in the converged communications and information technology areas. Equipment and software providers are increasingly outsourcing functions that are not core competencies. This trend has led to the rapid development of outsourced manufacturing, installation and ongoing services rather than the use of limited resources to maintain North American-wide installation and servicing organizations. Norstan is the largest, product independent, communications technology services organization targeting the enterprise customer in North America.

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      Focus on delivering integrated solutions to a select number of direct customers. Enterprise level customers are increasingly demanding integrated solutions that require providers to offer consulting, leading-edge technology and ongoing service to build and maintain complex communication systems. This requires expertise in selected practice areas, best of breed product independence and a servicing capability that spans a wide geography. Norstan specializes in attracting and retaining high value customers who demand a broad spectrum of expertise, including call centers, conferencing, converged communications, and infrastructure development.

      Capitalize on the growth and consolidation of the secondary market for re-sale and re-manufacture of voice and data equipment. The secondary market for telecommunications continues to grow and continues to be fragmented. The one exception to this fragmentation is the Norstan/Siemens operation which controls nearly 70% of the resale and re-manufacture of Siemens equipment in North America. Through its wholly-owned subsidiary, Vibes Technologies, Inc. (Vibes), Norstan believes it can provide a new level of integrated direct and web-based service to the secondary market for such products as those manufactured by Cisco, Avaya and Nortel.

      Provide superior customer service.   The Company’s dedication to providing service beyond its customers’ expectations has produced many favorable customer relationships and resulted in increased exposure to potential new customers. Norstan’s emphasis on customer satisfaction is evidenced by a fiscal year 2001 survey of Norstan’s customers, in which Norstan received an overall satisfaction rating of 95.6%. The Company believes that its reputation for superior service will lead to opportunities in its multi-channel marketing and cross-selling strategy designed to expand the products and services it sells to its customer base.

      Attract, develop and retain highly skilled professionals. The Company will continue to attract, develop and retain the highest caliber of personnel by providing a rewarding work environment, competitive pay and benefits, and opportunities for individual growth and development. Norstan has had a long history of creating a values-based culture that emphasizes ethical actions and respect for the individual.

Norstan’s Growth Strategy

      The Company expects growth from each of its three primary and inter-related business groups. Norstan’s Direct Solutions and Services business provides best-of-breed technologies and services focused on selected end-user customers throughout North America, its Channel Partner Services function specializes in technology implementation and support services for network providers, manufacturers, integrators, and resellers; and its Resale Services unit provides refurbished and re-certified voice and data products to end users.

      The largest of these units is the Company’s Direct Solutions and Services business, which has been organized into specific practice areas designed to provide opportunities for increased revenues from both new and existing customers. The Company has defined these practice areas as its Voice and Converged Solutions, Collaboration Solutions, Customer Contact Solutions, and Infrastructure and Services Solutions. Within each practice area the Company offers consulting, best-of-breed technologies and legendary customer service.

      Norstan has successfully developed new channel partnerships with Ericsson and Alcatel. In addition to the Company’s current direct enterprise marketing activities, Norstan is focused on marketing its industry-leading professional, consulting and traditional support services through a broad spectrum of enterprise solution providers. Such enterprise solution providers include CLECs, Incumbent Local Exchange Carriers (ILECs), Internet Service Providers (ISPs), and Applications Services Providers (ASPs) as well as other channel partners, such as Value-Added Resellers (VARs), Systems Integrators, and Manufacturer Direct channels.

      Services offered to these multi-channel partners include a complete spectrum of capabilities from applications planning through solution implementation, network monitoring, installation, support, upgrades and maintenance. According to industry studies by InfoTech, the combined markets for these services are projected to be $28.0 billion by 2004 and expected to grow at an average annual growth rate of nearly 40.0% between 2000 and 2004. InfoTech participated with Norstan in the development of the Company’s growth strategy.

      Finally, Norstan expects the re-sale of used telecommunication and data equipment to continue to grow and the segment to consolidate. Vibes is uniquely positioned to take advantage of this growth and consolidation with its state-of-the-art e-commerce web site. The combination of this web based approach and Norstan’s premier knowledge of the secondary market will provide the bases for growth in this business group.

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Products and Services

      Norstan provides customers with a broad range of communication and IT products and services to design, develop and implement technology solutions in a variety of customer environments. These products and services are delivered through the Company’s four business segments; Communications Technology Solutions and Services, Resale, Network Services and Financial Services:

      Communications Technology Solutions and Services & Resale

      Within its core Communications Technology segments are three interrelated business units:

	•		Direct Solutions and Services. Provides best-of-breed technologies and services focused on selected end-user customers throughout North America.
	•		Channel Partner Services. Technology implementation and support services for network providers, manufacturers, integrators, and resellers.
	•		Resale Services. Provides refurbished and re-certified voice and data products to end users.

      Norstan’s product and service offerings are centered around four Practice Areas:

•

Voice and Converged Solutions

	o		PBX Systems
	o		IP Telephony
	o		Wireless LANs

•

Collaboration Solutions

	o		Video Conferencing
	o		Audio Conferencing
	o		Data Collaboration
	o		Unified Messaging
	o		Voice Messaging

•

Customer Contact Solutions

	o		Call Center Switching Platforms
	o		Interactive Voice Response
	o		Speech Recognition
	o		CTI (Computer Telephony Integration)
	o		Workforce Management
	o		Quality Monitoring
	o		Intelligent Call Routing
	o		Media Blending / Web Enablement

•

Infrastructure and Services Solutions

	o		Structured Cabling
	o		Optical Networks
	o		Multimedia Solutions
	o		Remote System Monitoring & Diagnostic Analysis
	o		System Modifications (Moves, Adds, and Changes)
	o		Managed Communication Services
	o		24 x 7 Customer Support

      Within each Practice Area Norstan provides world class communications consulting services, leading edge technologies, and legendary implementation and support services.

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      Network Services

      Norstan Network Services provides multiple source local and long distance services and related consulting and professional services. Through strategic relationships with world class business partners, Network Services is able to deliver custom, flexible and unique solutions to the Company’s customers.

      Financial Services

      Norstan Financial Services provides Norstan customers with creative and flexible financial solutions for technology and business essential equipment acquisitions. These financial alternatives are offered under a private label leasing program through the partnership between Fidelity Leasing and Norstan Financial Services.

Customers

      Norstan focuses its marketing efforts on middle-market and Fortune 1000 companies with complex communication requirements. Norstan has served over 18,000 customers across a broad range of industries over the last three fiscal years. No single customer accounted for more than 5% of Norstan’s total revenue during any of the last three fiscal years.

A sample of current premier customers of the Company include the following:

Strategic Alliances

      The Company believes that its relationships with a wide range of leading technology companies enhance Norstan’s ability to deliver the appropriate solution to each customer. Strategic alliance partners include Siemens, VTEL, PictureTel, Latitude, Ericsson, Alcatel, Aspect, Blue Pumpkin, Nuance, Cisco Systems, Sprint, Lucent Technologies (formerly Octel), Captaris, Rockwell, SpeechWorks and SpectraLink. In addition, the Company distributes complimentary communication products that fit specific segments of the marketplace. These include hybrid switching systems, personal computer-based voice processing and video conferencing systems, as well as data communication products from Novell, Newbridge and others.

      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.

Sales and Marketing

      Throughout the United States and Canada, Norstan’s product and services offerings are brought to market through four separate but complimentary distribution channels. These include Direct Solutions Sales, Telesales, Channel Account Sales, and Web-based e-business Sales. These distribution channels are reflected in the Company’s core business units as follows:

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      This multi-channel distribution model uses the most cost-effective sales channels to bring the Company’s products and service offerings to market. Each channel is staffed with Sales Specialists who are highly focused in one of the four Norstan Practice Areas. In addition to having a comprehensive understanding of their specialty, these Specialists also have a sound understanding of all Norstan’s product and services offerings to recognize additional sales opportunities and maximize account share. Each Sales Specialist uses a comprehensive approach to evaluate each customer’s technology needs. The Sales Specialist begins with a detailed analysis of the customer’s current and future communication and IT systems requirements. After determining the customer’s needs, the Sales Specialist, together with a Norstan Solutions Engineer, develop a solution that satisfies current and anticipated requirements. Norstan’s operations team then works with the customer to plan the delivery and implementation of the solution and to identify required training. By planning the precise requirements of each phase of the solution delivery, Norstan’s specialists are able to minimize service interruption for the customer. Norstan also provides an ongoing support program tailored to meet the customer’s specific application requirements that incorporates remote diagnostics, in-field service and support, additional training and help desk support from Norstan’s customer support representatives.

      Norstan’s marketing strategy is designed to capture the maximum possible portion of Norstan’s existing customers’ communication and IT budgets and to identify and develop new customer relationships. Norstan has developed a team of highly trained Enterprise Account Managers (EAM) to focus on the Company’s largest and most strategic accounts. These EAMs work with the client’s senior level management to gain a comprehensive understanding of their business needs and to ensure the most effective deployment of Norstan’s resources relative to the account strategy. Norstan believes the use of EAMs will provide high quality sales and customer service and support Norstan’s ongoing marketing efforts, as satisfied customers are more likely to choose Norstan to supply additional communication and IT products and services.

Customer Service

      Norstan believes that providing exceptional customer service is an important element of its ability to compete effectively in the communication marketplace. Norstan has invested heavily in new technology designed to help resolve a substantial portion of customer support and service issues quickly and remotely. Norstan coordinates its customer service response through four remote diagnostics and dispatch centers located in the Minneapolis, Cleveland, Los Angeles, and Montreal areas. In fiscal year 2001, these centers handled more than 360,000 customer calls with approximately 60% of the service-related calls addressed remotely. By comparison, only 18% of customer calls were resolved remotely in fiscal year 1994. For calls requiring immediate on-site service and support, Norstan maintains a force of highly trained service technicians, design engineers and customer support representatives.

      Norstan has approximately 160 employees in its four remote diagnostics and dispatch centers devoted primarily to providing customer service, and has more than 400 service technicians in the field. With Norstan’s remote problem resolution capability and its staff of highly trained technicians, the Company is able to promptly resolve customer support requests. Norstan’s commitment to customer service is evidenced by a fiscal year 2001 survey of Norstan’s communication customers that found an overall satisfaction rating of 95.6%.

Locations

      The Company currently supports its clients with 30 sales and service locations in 28 cities within the United States and Canada, including the following:

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Employees

      The Company’s U.S. operations had a total of 1,406 employees as of April 30, 2001 consisting of 294 sales and marketing personnel, 703 operations, service and installation employees, 36 consulting employees and 373 administrative employees. Of these employees, approximately 89 were covered by collective bargaining agreements. The Company considers relations with its employees to be good and has not experienced any work stoppages.

      The Company’s Canadian operations had a total of 145 employees as of April 30, 2001, consisting of 39 sales and consulting personnel, 85 operations, service and installation employees, and 21 administrative personnel. The Company considers relations with the Canadian employees to be good and has not experienced any work stoppages.

Competition

      Norstan’s marketing strategy is designed to capture a larger portion of existing customers’ communication and IT budgets and to identify and develop new customer relationships. The Company competes with its customers’ internal resources, particularly when these resources represent a fixed cost to the customer. Such competition may impose additional pricing pressures on the Company. Subject to this competitive environment, the Company competes on the basis of: the depth and breadth of services and products offered; the ability to integrate IT and communication systems as the related technologies continue to converge; its reputation for providing superior customer service; and the number and strength of customer relationships.

      The Company also competes in its markets with Nortel Networks, of Brampton, Ontario; Avaya Communications, of Basking Ridge, NJ; Aspect Communications, of San Jose, CA, and Wiltel Communications, of Norcross, GA.

Intellectual Property Rights

      The Company relies upon a combination of nondisclosure and other contractual arrangements with certain key employees and business partners, and trade secret, copyright and trademark laws to protect its proprietary rights and the proprietary rights of third parties from whom the Company licenses intellectual property. Norstan enters into confidentiality agreements with certain of its employees and business partners and limits the distribution of proprietary information.

Government Regulation

      Except for the sale of long distance service, the Company is not subject to any government regulations that have a material impact on its operations. Effective May 1, 1992, the Company became a direct reseller of long distance network services and became subject to certain state tariff regulations throughout the United States. The Company is currently registered and certified to provide interstate services in all 50 states and intrastate services in 49 states. The Company is also subject to FCC regulations, which require the filing of federal tariffs.

Backlog

      As of April 30, 2001, the Company had signed contracts for telecommunications products aggregating approximately $18.9 million, substantially all of which are expected to be fulfilled by the end of fiscal 2002. As of April 30, 2000, the Company had signed contracts aggregating approximately $35.9 million, substantially all of which were fulfilled by the end of fiscal 2001. The usual time period between the execution of a contract and the completion of the installation is three to twelve months, depending on the size and complexity of the system.

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Item 2. Properties.

      The executive offices of the Company are located in Minnetonka, Minnesota, where the Company leases approximately 165,000 square feet of office space. The Company also has area headquarters in Brecksville, Ohio, and Phoenix, Arizona, where the Company leases approximately 42,750 and 34,400 square feet of office space, respectively. In addition to the space above, the Company leases sales and service offices in 21 other cities within the United States. In Canada, the Company leases approximately 28,800 square feet of office space in Toronto, Ontario, which serves as its Canadian headquarters. The Company also leases sales and service offices in three other cities within the Canadian provinces of Alberta, Quebec and British Columbia. The Company believes that the above-mentioned facilities are adequate and suitable for its current needs.

Item 3. Legal Proceedings.

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

      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, 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 April 30, 2001 consolidated financial statements adequately reflect the Company’s exposure under this lawsuit.

Item 4. Submission of Matters to a Vote of Security Holders.

      The Company did not submit any matters to a vote of security holders during the last quarter of the fiscal year covered by this report.

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PART II

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters.

Price Range of Common Stock

      The Company’s common stock is traded on the National Over-the-Counter market and is listed on the national market system of the National Association of Securities Dealers’ Automated Quotations System (“NASDAQ”) under the symbol “NRRD”. The following table sets forth the high and low sale prices for the Company’s common stock as reported by NASDAQ for each quarterly period during the two most recent fiscal years:

      The quotations reflect prices between dealers and do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.

      As of July 13, 2001, there were 3,004 holders of record of the Company’s common stock.

NASDAQ Listing Requirements

      Norstan’s common stock is currently listed on the NASDAQ National Market. NASDAQ imposes on its member companies certain continued listing requirements, including the maintenance of a minimum of $4.0 million in net tangible assets. As of April 30, 2001, the Company had net tangible assets of $4.2 million. In the event that Norstan’s net tangible assets fall below $4.0 million, Norstan may be delisted and may be required to reapply for listing of its common stock for either the National Market or the NASDAQ SmallCap Market. The Company is currently developing plans to maintain compliance; however, there can be no assurance that these plans will be successful.

Restrictions on the Payment of Dividends

      The Company has not recently declared or paid any cash dividends on the common stock and does not intend to pay cash dividends on the common stock in the foreseeable future. The Company currently expects to retain earnings to finance the operations and the expansion of its business. In addition, the Company’s current revolving long-term credit agreement prohibits the payment of cash dividends without the prior written consent of the lenders thereunder.

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Item 6. Selected Consolidated Financial Data.

      The selected consolidated financial data set forth below as of and for each of the fiscal years in the five-year period ended April 30, 2001 have been derived from the Company’s consolidated financial statements, which have been audited by Arthur Andersen LLP, independent public accountants. The selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included elsewhere in this report.

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Unaudited Quarterly Results

      The following table sets forth certain unaudited quarterly operating information for each of the eight quarters in the two year period ending April 30, 2001. This data includes, in the opinion of management, all normal recurring adjustments necessary for the fair presentation of the information for the periods presented when read in conjunction with the Company’s Consolidated Financial Statements and related Notes thereto. Results for any previous fiscal quarter are not necessarily indicative of results for the full year or for any future quarter.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General

      Norstan is a full service telecommunications company that delivers voice and data technologies and services, and remanufactured equipment to businesses and channel partners of all sizes. 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 78.8%, 8.8%, 9.2% and 3.2% of Norstan’s fiscal year 2001 revenues, 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.

Results of Operations

      The following table sets forth certain items from the Company’s consolidated statements of operations expressed as a percentage of total revenues:

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

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Fiscal 2001 Compared to Fiscal 2000

      Revenues.   Total revenues from continuing operations decreased 10.1% to $297.7 million in fiscal year 2001 from $331.2 million in fiscal year 2000.

      Revenues within the Communications Technology segment of Solutions and Services decreased 10.7% to $234.6 million in fiscal year 2001 from $262.6 million in fiscal year 2000. This decrease was the result of lower revenues in Solutions’ practice areas including, call centers, PBX systems, and conferencing and messaging. In addition, revenues from Services’ moves, adds and changes were down year-to-year. These decreases were somewhat offset by increased revenues in convergence and from the inclusion of revenues from the Company’s channel partners. In addition, the Company’s service contract revenue increased year-to-year.

      Resale revenues increased 1.1% to $26.3 million in fiscal 2001 as compared to $26.0 million in fiscal 2000. Revenues from Network Services were down 19.1% to $27.3 million in fiscal 2001 from $33.7 million in fiscal 2000 as a result of decreased emphasis on pursuing additional Network Services’ revenue. Financial Services’ fiscal 2001 revenue of $9.6 million was up 7.5% from $8.9 million in fiscal 2000.

      Gross Margin.   The Company’s gross margin was $82.8 million and $76.3 million for the fiscal years ended April 30, 2001 and 2000, respectively, an increase of 8.6%. As a percent of total revenues, gross margin was 27.8% for fiscal year 2001 compared to 23.0% for fiscal year 2000.

      Gross margin as a percent of revenues for Communications Technology Solutions and Services improved to 25.5% in fiscal 2001 as compared to 19.8% in fiscal 2000. This improvement was the result of increased margins in install, service, moves, adds and changes and other infrastructure practices.

      Resale’s gross margin improved to 37.5% of revenues in fiscal 2001 as compared to 34.7% in fiscal 2000. Network Services fiscal 2001 gross margin was 23.6% of revenues down from 26.6% in fiscal 2000. Gross margin for Financial Services were relatively flat between fiscal 2001 and 2000 at 69.8% and 69.5%, respectively.

      Selling, General and Administrative Expenses.   The Company’s selling, general and administrative expenses decreased $9.6 million or 9.4% during fiscal 2001 to $92.8 million as compared to $102.4 million in fiscal 2000. As a percent of revenues, selling, general and administrative expenses were relatively flat year-to-year at 31.2% and 30.9% for fiscal 2001 and fiscal 2000, respectively. The Company has taken measures to remove a significant amount of costs from its business over the past year including headcount reductions and closure of certain leased facilities. The Company continues to monitor expenditures and is pursuing aggressive cost control measures.

      Restructuring Charge.   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.

      Interest Expense.   Interest expense was $8.0 million for fiscal year 2001 as compared to $6.3 million for fiscal year 2000. Interest expense is incurred primarily in connection with the Company’s revolving credit line used for working capital purposes. Average month-end borrowings outstanding under the Company’s revolving long-term credit agreements were $68.9 million for fiscal year 2001 and $74.0 million for fiscal year 2000. Weighted average interest rates under the Company’s revolving long-term credit agreements were 11.7% for fiscal year 2001 as compared to 7.1% for fiscal year 2000.

      Other Income (Expense).   Net other expense of $1.1 million was incurred in fiscal 2001 as compared to $0.1 million in fiscal 2000. The increase in reported expense was primarily due to the write-off of $1.1 million in financing fees related to an unconsummated financing transaction that occurred in the second quarter of fiscal 2001.

      Income Taxes.   The Company provided no tax benefit on the loss in fiscal 2001, while the effective income tax rate was 20.0% for fiscal year 2000 and 43.5% for fiscal year 1999. The Company’s effective tax rate differs from the federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization, the impact of the fiscal 2000 goodwill writedown discussed below, as well as the impact of net operating loss carry forwards.

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      Net (Loss) from Continuing Operations.   A net loss of $20.3 million or $1.79 per basic and diluted share was incurred in fiscal year 2001, as compared to a net loss of $22.2 million or $2.05 per share in fiscal year 2000.

      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. In addition to refocusing the Company’s strategy, lack of realized synergies between the Company’s communications and consulting businesses and recurring losses within the consulting businesses contributed to the decision to divest of this non-strategic business segment.

      Divestiture of the IT consulting business began on February 7, 2001 with the sale of the Company’s 75% interest in Connaissance Consulting to Connaissance’s founder for up to $16.0 million. Terms of the sale required the 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 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 maturing on August 28, 2001. In addition, as part of the transaction, the Company retained its rights to certain assets and assumed certain liabilities of Norstan Consulting.

      The results 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 the consolidated financial statements have been restated to report separately the net assets and operating results of the discontinued businesses for all periods presented.

The results of operations from discontinued operations include the following charges:

      Restructuring Charge.   During the second quarter of fiscal 2000, the Company recorded a restructuring charge of approximately $2.0 million related to its Consulting business. 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).

      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.

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

      Net (Loss).   For fiscal 2001, the Company reported a net loss of $36.3 million or $3.19 per basic and diluted share as compared to $68.9 million or $6.37 per share for fiscal 2000.

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Fiscal 2000 Compared to Fiscal 1999

      Revenues.   Total revenues from continuing operations decreased 9.8% to $331.2 million in fiscal year 2000 from $367.4 million in fiscal year 1999.

      Communications Technology Solutions and Services revenues decreased 14.1% to $262.6 million in fiscal year 2000 from $305.5 million in fiscal 1999. Solutions revenues decreased as a result of weaker sales in most product lines including Siemens PBX, voice processing and conferencing. Also within this segment, Services revenues decreased on a year-to-year basis. Maintenance service contract revenues were flat while revenues from moves, adds and changes and cabling services were down as compared to fiscal 1999. Overall, performance in the Solutions and Services segment was negatively affected by significant management and organizational changes occurring during the fiscal year. In addition, customer concerns about the Year 2000 issue resulted in depleted budgets, postponed equipment purchases and installations and delayed communications and IT projects until after January 1, 2000.

      Revenues from Resale decreased 2.0% to $26.0 million in fiscal 2000 as compared to $26.5 million in fiscal 1999. Network Services revenues increased 23.2% to $33.7 million in fiscal 2000 from $27.4 million in fiscal year 1999. Revenues from Financial Services increased 11.8% to $8.9 million in fiscal 2000 from $8.0 million in fiscal year 1999. This increase was primarily attributable to the increased size of the Company’s leasing base.

      Gross Margin.   The Company’s gross margin was $76.3 million and $104.8 million for the fiscal years ended April 30, 2000 and 1999, respectively. As a percent of total revenues, gross margin was 23.0% for fiscal year 2000 compared to 28.5% for fiscal year 1999.

      Gross margin as a percent of revenues for Solutions and Services was 19.8% for fiscal year 2000 as compared to 26.8% for fiscal year 1999. This decreases was the result of staffing for higher volumes of revenues which did not materialize, charges associated with project cost overruns and revaluations of inventory which were recorded during the fiscal year. In addition, gross margin continues to be adversely affected by competitive price pressure on communication equipment and by increased product costs.

      Resale gross margin decreased $1.7 million from 40.3% of revenues in fiscal 1999 to 34.7% during fiscal 2000. Network Services gross margin as a percent of revenues was relatively level year-to-year at 26.6% and 26.9% for fiscal 2000 and fiscal 1999, respectively. Gross margin as a percent of revenues for Financial Services was 69.5% for fiscal year 2000 as compared to 62.7% for fiscal year 1999.

      Selling, General and Administrative Expenses.   Selling, general and administrative expenses increased 10.7% to $102.4 million in fiscal year 2000 from $92.6 million in fiscal year 1999. As a percent of revenues, selling, general and administrative expenses increased to 30.9% for fiscal year 2000, as compared to 25.2% for fiscal year 1999. The percentage increase was primarily due to the lower than planned sales volume in the Solutions and Services business segments. The Company budgeted for, staffed and built the infrastructure to support higher revenue levels which did not materialize during the fiscal year.

      Restructuring Charge.   During fiscal year 1999, the Company recorded a restructuring charge of $1.5 million relating to a workforce reduction. This resource reduction, primarily in the communications business, was made to bring the Company’s expense structure in line with anticipated growth. The restructuring charge related to the costs of severance and other employment termination benefits.

      Interest Expense.   Interest expense was $6.3 million for fiscal year 2000 as compared to $4.8 million for fiscal year 1999. Interest expense is incurred primarily in connection with the Company’s revolving credit line used for working capital purposes. Average month-end borrowings outstanding under the Company’s revolving long-term credit agreements were $74.0 million for fiscal year 2000 and $64.9 million for fiscal year 1999. Weighted average interest rates under the Company’s revolving long-term credit agreements were 7.1% for fiscal year 2000 as compared to 6.5% for fiscal year 1999.

      Income Taxes.   The Company’s effective income tax rate was 20.0% for fiscal year 2000 and 43.5% for fiscal year 1999. The Company’s effective tax rate differs from the federal statutory rate primarily due to state income taxes and the effect of nondeductible goodwill amortization, as well as the impact of the fiscal 2000 goodwill writedown discussed below in “Discontinued Operations”.

      Income from Continuing Operations.   Continuing operations incurred a net loss of $22.2 million or $2.05 per basic and diluted share in fiscal 2000, as compared to net income of $3.7 million or $0.35 per share in fiscal 1999.

      Discontinued Operations.   The results of operations from discontinued operations include the following charges:

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      Restructuring Charge.   During the second quarter of fiscal 2000, the Company recorded a restructuring charge of approximately $2.0 million related to its IT consulting business. 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).

      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 Company’s IT consulting businesses during fiscal 2000.

      Net Income (Loss).   A net loss of $68.9 million or $6.37 per basic and diluted share was incurred in fiscal year 2000, as compared to net income of $5.9 million or $0.56 per diluted share in fiscal year 1999.

Liquidity and Capital Resources

      During the fiscal years ended April 30, 2001 and 2000, the Company incurred significant net losses. Additionally, the Company has a working capital deficit of $24,342 at April 30, 2001. As discussed elsewhere in this section, the Company has taken numerous actions in efforts to conserve cash including the disposition of its unprofitable IT consulting operations and reducing costs in its continuing businesses. Furthermore, the Company has entered into a new banking agreement effective June 29, 2001. Management believes that these measures will provide sufficient operational improvements and liquidity to allow the Company to meet its cash flow needs through at least April 30, 2002. However, there can be no assurance that the Company will be successful in achieving these goals.

      Cash Flows.   Continuing operations provided net cash from operations of $32.5 million, $23.8 million and $7.5 million during fiscal 2001, 2000 and 1999, respectively. This improved operating performance was the result of aggressive asset management especially relating to accounts receivable, inventory and work-in-process. Net cash of $5.2 million was provided by investing activities in fiscal 2001, an improvement over $15.3 million and $34.5 million used for investing activities in fiscal 2000 and 1999, respectively. The decrease in net cash used for investing activities is the result of a significant reduction in capital expenditures and investment in lease contracts and an increase in collections from lease contracts. Financing activities utilized net cash of $25.3 million and $2.9 million in fiscal 2001 and 2000, respectively. Fiscal 1999 financing activities provided cash of $33.6 million. The high level of cash used for financing activities in fiscal 2001 was due to repayment of bank debt and discounted lease rentals. In addition, there were minimal discounted lease rental borrowings during fiscal 2001.

      Capital Expenditures.   The Company used $7.8 million for capital expenditures during fiscal year 2001 as compared to $10.1 million in fiscal year 2000 and $22.2 million in fiscal year 1999. These expenditures were primarily for capitalized costs incurred in connection with obtaining or developing internal use software and computer equipment.

      Investment in Lease Contracts.   During fiscal 2001, the Company continued to make investments in lease contracts with its customers. The additional investment made in lease contracts in fiscal year 2001 totaled $26.4 million as compared to $32.5 million in fiscal 2000 and $35.6 million in fiscal 1999. Net lease receivables decreased to $55.9 million at April 30, 2001 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 $26.8 million at April 30, 2001 as compared to $44.8 million at April 30, 2000. Interest rates on these credit agreements at April 30, 2001 ranged from 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. Financial Services offers competitive lease and equipment purchase financing through arrangements with outside financing sources.

      Capital Resources.   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.

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      On June 29, 2001, the Company entered into an agreement with the banks restructuring 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 beginning on August 31, 2001 and maturing 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%.

      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.

      Under the terms of the December 2000 and June 2001 restructured credit agreements, the banks are entitled to 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.

      The Company has implemented a restructuring plan developed with its investment advisor 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. However, there can be no assurance that these plans will be successful.

Forward-Looking Statements

      From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products and services, and other similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements including those made in this document. In order to comply with the terms of the Private Securities Litigation Reform Act, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. The risks and uncertainties that may affect the operations, performance, developments and results of the Company’s business include the following: national and regional economic conditions; pending and future legislation affecting the 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.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk.

General

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

Interest Rate Risk

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

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      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 $57.0 million outstanding at April 30, 2001 with a weighted average interest rate of 9.6%. Assuming that the Company’s balance of variable rate debt remains constant at $57.0 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 $570,000. 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 $570,000.

      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.

      The table appearing below presents principal amounts by year of anticipated maturity for the Company’s debt obligations and related average interest rates based on the weighted average interest rates at the end of the period. Variable interest rates disclosed do not attempt to project future interest rates. This information should be read in conjunction with Notes 7 and 8 of the Notes to Consolidated Financial Statements.

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 remained relatively unchanged.

      Assets and liabilities outside the United States are located primarily in Canada. The Company’s investments in foreign subsidiaries 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.

      During the years ended April 30, 2001, 2000 and 1999, the average exchange rates for the Canadian dollar strengthened (weakened) against the U.S. dollar as follows:

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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Item 8. Financial Statements and Supplementary Data.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Norstan, Inc.:

      We have audited the accompanying consolidated balance sheets of Norstan, Inc. (a Minnesota corporation) and Subsidiaries as of April 30, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended April 30, 2001. These financial statements and the schedule referred to below are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Norstan, Inc. and Subsidiaries as of April 30, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2001 in conformity with accounting principles generally accepted in the United States.

      Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Schedule of Valuation and Qualifying Accounts is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.

Arthur Andersen LLP

Minneapolis, Minnesota
June 29, 2001

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NORSTAN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)