10-K 1 a2202305z10-k.htm 10-K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549



FORM 10-K

(Mark one)    

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010

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: 000-29758



DATALINK CORPORATION
(Exact name of registrant as specified in its charter)

MINNESOTA
(State or other jurisdiction of incorporation)
  41-0856543
(IRS Employer Identification Number)

8170 UPLAND CIRCLE
CHANHASSEN, MINNESOTA 55317-8589
(Address of Principal Executive Offices)

(952) 944-3462
(Registrant's Telephone Number, Including Area Code)

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

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value.

        Indicate by check mark if the registrant is a well known seasoned issuer as defined in Rule 405 of the Securities Act. Yes o No ý

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

        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 ý    No o

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. ý

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.

Large Accelerated Filer o   Accelerated Filer o   Non-Accelerated Filer o
(Do not check if a
smaller reporting company)
  Smaller Reporting Company ý

        Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý

        Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant at June 30, 2010: $41,485,345.

        At February 24, 2011, the number of shares outstanding of the registrant's classes of common stock was 13,680,181.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Registrant's Proxy Statement for its 2011 Annual Meeting of Stockholders are incorporated by reference to Part III of this Form 10-K.



NOTE REGARDING FORWARD-LOOKING STATEMENTS

        The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. This Annual Report contains forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from historical results or those anticipated. The words "aim, "believe," "expect," "anticipate," "intend," "estimate" and other expressions which indicate future events and trends identify forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending upon a variety of factors, including, but not limited to: the level of continuing demand for storage including the effects of current economic and credit conditions; competition and pricing pressures and timing of our installations that may adversely affect our revenues and profits; fixed employment costs that may impact profitability if we suffer revenue shortfalls; our ability to hire and retain key technical and sales personnel; our dependence on key suppliers; our ability to adapt to rapid technological change; risks associated with integrating current and possible futures acquisitions; fluctuations in our quarterly operating results; future changes in applicable accounting rules; and volatility in our stock price. Further, our revenues for any particular quarter are not necessarily reflected by our backlog of contracted orders, which also may fluctuate unpredictably.

        We use the terms "aim", "believe," "expect," "plan," "intend," "estimate" and "anticipate" and similar expressions to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions subject to risks and uncertainties. We do not intend to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.


PART I

Item 1.    Business.

Overview

        Datalink Corporation was incorporated in Minnesota in 1987. We provide solutions and services that make data centers more efficient, manageable and responsive to changing business needs. Focused on mid and large-size companies, we assess, design, deploy and support infrastructures such as servers, storage and networks, all of which are at the heart of the data center. We also resell hardware and software from the industry's leading original equipment manufacturer ("OEM's") as part of our customer offerings.

        Our portfolio of solutions and services spans four practices:

    Consolidation and virtualization

      Our consolidation and virtualization solutions and services allow data center infrastructures to be flexible, shared, and manageable. Our virtualization portfolio supports near-term needs (for example, virtualizing server and storage environments) and enables organizations to develop and execute long-term strategies for data center efficiency (for example, "private cloud" computing and data center build-outs). Our virtualization infrastructure assessments provide end-to-end views of existing resources, including servers (both physical and virtual), applications and storage.

    Data storage and protection

      Our enhanced data protection services and solutions help customers safeguard their information, as well as meet internal and external requirements for accessing, protecting, and retaining these assets. Our solutions include local and remote backup, disaster recovery, archive, and compliance. We align each solution with customer service level agreements and business needs in mind. Our backup audits and assessments provide customers with backup operation performance metrics and recommendations for improvement.

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    Advanced network infrastructures

      We assess, design, and deploy robust network infrastructures. We help companies consolidate, converge, and optimize their networks. Our solutions vary in scope from entire networks to enhanced router, switch, WLAN, security/VPN, and WAN optimization technologies. Our network architectural review services include an assessment of a customer's current network design, recommendations for improvement, and a roadmap for migrating to consolidated and converged network.

    Business continuity and disaster recovery solutions

      By integrating our best-practice methods and business continuity expertise into an individualized process, we turn business continuity and disaster recovery (BC/DR) into an overall change process. We believe this collaborative strategy helps organizations view their investments in enterprise technology not as individual servers or applications, but as a cohesive pool of computing resources able to rapidly adjust to new demands and reduce the risk of disruption.

        We offer a full suite of practice-specific consulting, analysis, design, implementation, management, and support services. We deliver these services through our experienced team. Our team consists of approximately 126 engineering professional and support services members that are based throughout the United States.

        We have physical laboratories customers can visit in Atlanta, Chicago, Minneapolis and Santa Clara. Our multi-site laboratories enable customers to participate in demonstrations of a wide variety of technologies, including: long distance site-to-site replication, data recovery, WAN optimization, de-duplication, and virtualization. Alternatively, customers can participate in a virtual demonstration from the convenience of their own office.

        In addition to demonstrations, we leverage these labs to test, validate and compare technologies from the leading manufacturers and software developers, perform configuration services, troubleshoot support issues and train our professional and support services teams.

Industry Highlights

        Mid and large size enterprises are increasingly focused on transforming their data centers in order to increase agility, enhance service levels, and reduce costs. Transformational technologies and approaches, like virtualization and private cloud computing, help achieve each of these objectives. Virtualization and private cloud computing enable organizations to more quickly adapt to changing business requirements, improve service levels via simplified management, and reduce costs through higher utilization rates.

        Gartner, Inc.(1), an industry analyst group ("Gartner"), reports that private clouds will be deployed by over 50% of the Global 1000 companies by 2013(2). We anticipate the virtualization of servers, storage and networks will primarily occur in stages, with a focus on building a foundation to support future private cloud strategies. We expect this will result in continued demand for shared storage, as well as backup and disaster recovery infrastructures tuned to virtualized server


(1)
The Gartner Report(s) described herein (the "Gartner Report(s)") represent(s) data, research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc. ("Gartner"), and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this Form 10-K) and the opinions expressed in the Gartner Report(s) are subject to change without notice.

(2)
Gartner, Inc., John Monroe, Pushan Rinnen, Sheila Child, Adam W. Couture, Valdis Filks, Stanley Zaffos, (December 14, 2009) "Gartner Predicts 2010: New Technologies and Service Delivery Models Will Transform the Storage Markets."

Gartner, Inc., David Mitchell Smith, David W. Cearley, Yefim V. Natis, Benoit J. Lheureux, Daryl C. Plummer, Matthew W. Cain, Donna Scott, (November 2010) "Gartner Predicts 2011: Cloud Computing is Still at the Peak of Inflated Expectations."

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environments. We also expect that the increased bandwidth requirements of virtualized and consolidated server environments will drive demand for top-of-rack converged networks.

        Information technology (IT) departments are faced with a daunting challenge of rapidly expanding amounts of data to manage. Gartner estimates that enterprise data will grow by 650% within five years(3). Coupled with this growth are increasing demands for availability of this data for day-to-day business and to meet regulatory requirements. At the same time, the worldwide economic downturn has caused IT departments to reduce IT spending and headcount. As a result, we expect customers will continue to look for alternatives to simplify management of storage, network and server infrastructures and increase productivity of existing IT teams.


(3)
Gartner, Inc., Gaymond Paquet, Gartner Webinar, (January 2010) "Technology Trends You Can't Afford to Ignore."

        Throughout recent periods of economic instability, companies continue to recognize the importance and value of data as a strategic and competitive asset. Employees, customers and suppliers demand uninterrupted access to mission-critical data 24 hours a day, 7 days a week. As a result, organizations continue to require flexible, scalable and highly available server, storage and network solutions.

        In 2011, we believe that capital investment priorities will include:

    Virtualization and consolidation

      Virtualization will play a key role in data center transformation strategies. Virtualization and cloud computing enable organizations to reduce costs, increase agility, and improve management and utilization.

      Our customers need a comprehensive virtualization strategy encompassing server, storage and network environments. Without this unified data center approach, companies cannot realize the full benefits of virtualization.

      We expect organizations will seek the professional services of a provider, like us, to assess their environment, conduct a gap analysis, and develop a private cloud computing migration path that will enable them to protect and leverage each investment as they migrate to cloud computing. We expect that most of our customers who choose to incorporate a private cloud architecture will do so either in a phased-in or total build out approach. We also expect that organizations will be seeking the services of a provider that has unified data center expertise (server, storage, networks) and provides a full life cycle of services from consulting and design to deployment and ongoing support.

    Enhanced data protection capabilities

      Increased need for high throughput performance, greater frequency of backups, quick restoration of data and stringent data availability requirements are key drivers in data center decision making. We expect these requirements will drive the continued migration to disk-based protection solutions. Many of our customers have deployed disk-based backup and recovery solutions. With the convergence of key technologies, such as data de-duplication, WAN optimization, and advanced heterogeneous replication and snapshot software, we expect the benefits customers receive from disk-based backup will increase, resulting in increased demand.

    Advanced network infrastructures

      We expect that two trends will drive the continued evolution of data center networking. First, the continued advancement of data center virtualization increases the need to update networking infrastructure to support increased bandwidth with networking infrastructure and management that is more integrated with server virtualization and private cloud initiatives. Second, those

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      seeking simplified management, cost reductions, and increased flexibility will consolidate and converge of disparate networks (e.g. storage, data management) and migrate to unified fabrics.

    Acceptance and growing need for data center services.

      We expect IT organizations to increasingly outsource data center infrastructure-related services, including consulting, implementation, management and support to a company who can provide a complete solution. An increased focus on technologies driving greater efficiency and business value, the growing complexity of networked environments and flat IT department headcount growth in light of current economic conditions facilitate this trend.

The Datalink Opportunity

        The movement toward computing environments that offer more adaptable and scalable IT services drives demand for data center-focused solutions and services providers, such as us. Both potential customers and data center infrastructure manufacturers are looking to providers, such as us, primarily for the following reasons:

        Pressures on Customers.    Migrating data centers to those that are more efficient, scalable, and flexible, is complex. As a result, we believe customers are looking for solution providers, to sort through their options, define migration plans, and execute accordingly. In addition, we believe organizations will increasingly look outside their in-house technical staff to leverage the expertise of companies, for strategy definition and execution. The downsizing of IT departments in light of current economic conditions also necessitates increased reliance on external service providers such as us.

        Pressures on Manufacturers.    We believe manufacturers increasingly rely on channel partners such as us for two principal reasons:

    Sophisticated, virtualized storage, network, and server solutions require the integration of highly specialized products made by a variety of manufacturers. A virtual data center, for instance, can utilize components such as software, disk systems, routers, switches, and servers, each from a different manufacturer. Manufacturers generally focus on only a portion of the overall data center, leaving companies like us to integrate comprehensive solutions from the best available products and technologies.

    Gross profit margins have been under pressure for many manufacturers. Because of the high cost of maintaining a large national sales and marketing organization, manufacturers have found value in leveraging the sales and marketing functions of channel partners, such as us.

        We believe we are uniquely positioned to capitalize on this significant opportunity for the following reasons:

        Expertise.    We have been implementing data center solutions for over 20 years. This experience has given us significant expertise in understanding and applying storage, server, and networking technologies either as individual technologies or in unified data center architecture. We continually invest in training to adapt to the ever-changing needs of our customers and capitalize on opportunities.

        Not Tied to One Manufacturer—Unlike many of our competitors, we are not tied to one or a limited number of manufacturers or particular technologies. This gives us the flexibility to be consultative in our approach. Our customers rely on us to choose the best available hardware and software and tailor it to their individual needs.

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The Datalink Solution

        We combine our expertise and comprehensive services portfolio with quality products from leading manufacturers to meet each customer's specific needs. Our services include:

Consulting

        Our consultants deliver highly customized research, advice, and action plans to help customers optimize their data centers. Our unbiased recommendations help customers respond to challenges in the following areas: data center optimization and consolidation, business continuity, disaster recovery, and IT governance.

Analysis

        At the beginning of an engagement, we place considerable emphasis on formulating a needs analysis based on each customer's business initiatives, operating environment and current and anticipated data storage and related server and networking requirements. While our focus is on each customer's unique situation, we bring to each engagement our extensive product knowledge and the experience we have gained from providing data storage solutions for over twenty years to customers in numerous industries.

        Our assessment services provide customers with objective guidance on developing virtualization and consolidation, backup and recovery, and advanced network infrastructures that optimize their resources, leverage their existing environments and facilitate cost-effective growth for the future. These services provide an independent viewpoint to align people, processes and technologies with business objectives. They also help organizations maximize current investments, outline recommendations for future purchases and provide assurance that server, storage and networking infrastructures are efficient, reliable and scalable.

Design

        Once we have completed our initial analysis, we begin the design phase of the project. Our professional services teams work together to design a system that meets the customer's server, storage and networking needs and budget. Our customers are able to choose from a wide range of technologies in order to fuse together the appropriate hardware, software and services for each project.

        We design data center infrastructures based on each customer's developed detailed business requirements. The engagement begins with a definition of the project's objectives, scope and key milestones. Our team then prepares an outline of the schedule and deliverables. Following a thorough analysis, the team prepares a comprehensive blueprint of the infrastructure, including a detailed design schematic, key implementation milestones and recommendations for handling potential configuration issues to ensure a smooth transition to new server, storage and networking environments.

Implementation

        Once we design a solution, we formulate a detailed project implementation plan with our customers to meet their financial and operating objectives and minimize disruption to their operations. We oversee the timely delivery of hardware and software products to the customer's location. We then coordinate the installation with our professional services teams, or personnel from equipment manufacturers, and complete the installation at the customer's site using industry best practices.

Support

        We provide our customers advanced 24 × 7 technical support from a team of customer support and field engineers. Our extensive experience with data center solutions enables our staff to deliver

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expert configuration and usage assistance, technical advice and prompt incident detection and resolution. The support team also acts as our primary interface with manufacturers' technical support organizations.

        Our support services offer additional flexible levels of service to help organizations maximize the return on their technology investments. We believe that our customer support program is one of very few customer service plans that provide support across multiple storage product lines and manufacturers.

        We provide our analysis, design, implementation, management and support services to customers through either a stand-alone services engagement or as a part of an overall project that includes a server, storage and networking solutions and services.

Management

        We relieve burdened internal IT teams with a growing portfolio of remotely managed services offerings. Our service offerings enhance the productivity of our customer's IT teams, as well as drive greater operational efficiency. Our backup reporting service enables customers to gain visibility of key performance metrics, enabling them to quickly pinpoint and resolve issues, improve operational efficiency, and mitigate risk. Our storage capacity manager reporting service provides visibility of key storage utilization metrics, enabling customers to improve utilization rates, improve application availability, and provide chargeback reporting. Reporting services, such as these, can be coupled with our OneCall support services, thereby providing the opportunity for proactive monitor and alert service by our team of experts. We also augment the staff of our customers by offering onsite professional services resources. These resources provide services including backup and recovery administration, project management, storage administration and our managed services offerings.

Our Strategy

        Our strategy is to improve our position as a data center solutions and services provider and to develop a customer-focused, high performance company with sustainable profitable growth. To achieve these objectives, we intend to build upon our record of successfully addressing the evolving needs of our customers. Key elements of our strategy include:

Increase Sales Team Productivity

        Although we believe that our sales productivity is high, we believe it can be improved. We continue to accelerate the learning and productivity curve of our newer sales professionals and enhance the skills of seasoned executives through implementation of techniques and best practices learned from our top producers.

Scale Existing Locations and Expand into New Locations via Acquisitions

        We continue to scale our existing geographic locations to increase market share, leverage fixed expenses and provide higher quality service levels. We expect to drive this growth by hiring experienced, quality account executives and field engineers to gain sales productivity and field engineering utilization. In the past we have made, and we intend to continue growth via select acquisitions. We seek acquisition targets that align closely with our data center portfolio offerings.

Expand Customer Support Revenues

        We have significantly increased our customer support capabilities and performance over the last several years and will continue to make this a focus. We believe that our customers appreciate our

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quality support services, which we believe will continue to be a key differentiator and growth driver for us.

Enhance Our Consulting and Professional Services Business

        Consulting services represents a sizable opportunity to drive additional professional services and follow-on hardware and software revenues in both existing and new accounts. Consulting services enable us to differentiate ourselves from our competition, as well as build executive-level relationships within the accounts we serve. In addition, by improving our assessment, audit and implementation service methodologies and sales tools, we plan to enhance our solution selling capabilities. We believe hiring additional experienced, data center consultants, and providing our sales teams with the tools they need to uncover consulting opportunities, will increase consulting services, with additional hardware and software revenues, in 2011.

Expand Managed Services Portfolio

        Providing our customers with value-driven, recurring services represents a significant opportunity for differentiation and growth for us along with increasing reoccurring revenue. We will launch a suite of managed services designed to free up the IT teams of our customers so that they can focus on high-impact projects, while at the same time helping them to drive greater data center efficiencies and services levels. Our managed services will initially span backup and network operations.

Suppliers and Products

        We do not manufacture server, storage, or networking products. Instead, we continually evaluate and test new and emerging technologies from leading manufacturers to ensure that our solutions incorporate state-of-the-art, high performance, cost-effective technologies. This enables us to maintain our technological leadership, identify new and innovative products and applications and objectively help our customers align their data center solutions with their business needs.

        We have strong, established relationships with the major storage, server, and networking hardware and software suppliers. Our expertise in open system environments includes UNIX, Microsoft Windows, Linux, Solaris, and in-depth knowledge of all major hardware and software technologies manufactured by industry leaders, such as NetApp, Inc., Hitachi Data Systems Corporation, Cisco Systems, Inc., Symantec Corporation, VMware, Inc., and Dell Inc. This expertise has earned us preferred status with many of our principal suppliers. Preferred status often enables us to participate in our suppliers' new product development, evaluation, introduction and marketing programs. These collaborations enable us to identify and market innovative new hardware and software products and exchange critical information in order to maximize customer satisfaction.

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        Some of our major suppliers and the products they provide are listed below:

Products
  Suppliers

Disk Storage

  EMC Corporation
Hitachi Data Systems Corporation
NetApp Inc.
Oracle Systems

Tape Automation

 

Oracle Systems
Quantum Corporation
Spectra Logic Corporation

Software

 

APTARE, Inc.
Akorri, Inc.
Oracle Systems
Sepaton Inc.
Symantec Corporation
VMware, Inc.

Servers

 

Cisco Systems, Inc.
Dell Inc.
Oracle Systems

Switches/Directors/Storage Networking

 

Brocade Communications Systems, Inc.
Cisco Systems, Inc.
F5 Networks, Inc.
Riverbed Technology, Inc.

Customers

        Customer engagements range from specialized professional assessment and design services, to complex, virtual data center implementations. We also provide hardware and software to our customers on an as-needed basis in order to enable one of our designs or to increase the capacity of their current infrastructures. We serve customers throughout the United States in a diverse group of data intensive industries. Our broad industry experience enables us to understand application and business issues specific to each customer and to design and implement appropriate networked storage solutions. We enjoy strong relationships with our customers, which are reflected by our repeat business.

Sales and Marketing

        We market and sell our products and services throughout the United States primarily through a direct sales force. In addition to our Minneapolis headquarters, as of December 31, 2010, we have 31 field sales offices, including home offices, in order to efficiently serve our customers' needs.

        Our field account executives and account associates work closely with our technical services team in evaluating the data center project needs of existing and prospective customers and in designing high quality, cost effective solutions. To ensure quality service, we assign each customer a specific field account executive and account associate. We believe that the average longevity of service of our sales force, and their close collaboration with our technical services team, are key factors to earning and retaining the trust and confidence of our customers. We believe this differentiates us from many other data center solution providers. Our accounts and technical teams generated a total of 272 new customers in 2010 and sold product and services to 1,352 current customers.

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        In addition to the efforts of our field account executives, account associates, and technical services team we engage in a variety of other marketing activities designed to attract new business and retain customer loyalty. We regularly execute integrated, demand creation campaigns, gain exposure through online and print trade publications, hold webcasts and informational seminars and publish whitepapers.

Competition

        We primarily compete with the direct sales forces of original equipment manufacturers ("OEM"). Besides our current technology partners, these OEM competitors include Hewlett-Packard Company and IBM. In addition, we compete with channel partners of technology OEMs. These include companies like Forsythe Technology, Inc., InterVision Systems Technologies Inc., Trace--3, Inc., Presidio, Incorporated, and Sirius Computer Solutions, Inc.

Employees

        As of December 31, 2010, we had a total of 299 employees, all of whom are full-time employees. We have no employment agreements with any of our employees, except for Mr. Lidsky, our President and Chief Executive Officer, Mr. Barnum, our Vice President of Finance and Chief Financial Officer and Mr. O'Grady, our Executive Vice President of Field Operations. None of our employees are unionized or subject to a collective bargaining agreement. We have experienced no work stoppages and believe that our employee relations are good.

Backlog

        We configure products to customer specifications and generally ship them shortly after we receive our customer's purchase order. Customers may change their orders with little or no penalty. We do not recognize revenue on hardware or software products until we have completed our required or contracted installation or configuration services in connection with the sale. Customer constraints, including customer readiness, and the availability of engineering resources significantly impacts when we can complete our installation and configuration services. Recent economic conditions have also led customers to curtail or delay capital spending projects, including server, storage and networking solutions. These factors, often beyond our control, prevent us from relying on backlog as a strong predictor of our future sales levels in any particular period. In this light, our backlog, which represents firm orders we expect to recognize as revenue within the next 90 days, was $47.0 million and $46.0 million at December 31, 2010 and 2009, respectively. Effective January 1, 2011, we are required to adopt new revenue recognition standards which change our revenue recognition policy to recognize product revenues upon shipment versus upon installation under our old revenue recognition method. This change in revenue recognition will significantly impact the value and content of our backlog going forward.

Acquisitions

        Reseller Business of Incentra, LLC.    In December 2009, we acquired the reseller business of Incentra, LLC ("Incentra"). Under the Asset Purchase Agreement, we paid Incentra $13.8 million. We paid $8.8 million at closing in cash, of which we held back $440,000 as security for certain indemnification obligations of Incentra. In addition, we paid Incentra $5.0 million for the working capital associated with Incentra's reseller business through the delivery of $2.0 million in cash and a $3.0 million secured promissory note paid on March 31, 2010. The promissory note is secured by the assets we purchased under the Asset Purchase Agreement. During 2010 the final working capital adjustment was agreed to and the amount held back for indemnification was released, the net effect was a decrease in the purchase price of $32,000. This acquisition doubles our presence in Chicago and the Northeast and provides us with a significant presence in the West. Our combined team now has expanded experience to design and implement complex data center solutions, which will deliver

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increased productivity and efficiency for our customers. This acquisition also added to our team of Cisco certified network engineers which allowed us to attain Cisco's Gold and Data Center Advanced Technology Partner certifications. We have experienced operational synergies and efficiencies through combined general and administrative corporate functions. Our results for 2009 reflect the addition of Incentra's reseller business for thirteen days. Please see Note 2 to our financial statements for further information.

        Networking Solutions Division of Cross Telecom.    In October 2009, we acquired the networking solutions division of Minneapolis-based Cross Telecom ("Cross"), which qualified as a business combination. We completed an asset purchase of $2.0 million paid in cash. Simultaneously, we entered into a reverse earn-out agreement with Cross where they agreed to purchase at least $1.8 million of Cisco networking products and services from us over the next three years. We believe the acquisition of this team of certified Cisco networking experts will be additive to our expertise in designing, implementing and managing sophisticated virtualized data center, storage and backup recovery solutions. In addition, we obtained Cross' Cisco Silver certification, a first step in the build out of our unified data center and networking practices.

        Merger with Midrange Computer Systems Inc.    In January 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. ("MCSI"), a storage consulting, solutions and service provider based in Chicago, Illinois. We believe the acquisition strengthened our presence in our then existing regional markets and expanded our reach into a number of then key new regional markets. We paid a purchase price of approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock. Our results of operations for 2007 reflect the addition of MCSI for eleven months.

Available Information

        Our website address is www.datalink.com. The material on our website is not part of this report. We make available at our website, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

        The public may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. All SEC filings are also available at the SEC's website at www.sec.gov.

Executive Officers of the Registrant

        Set forth below are the names, ages and titles of the persons serving as our executive officers:

Name
  Age   Position
Paul F. Lidsky   57   President and Chief Executive Officer

Gregory T. Barnum

 

56

 

Vice President, Finance and Chief Financial Officer

M. Shawn O'Grady

 

48

 

Executive Vice President, Field Operations

        Paul F. Lidsky was elected as a director in June 1998 and became our President and Chief Executive Officer in July 2009. Mr. Lidsky was the President and Chief Executive Officer of Calabrio, Inc. from October 2007 until July 2009. From December 2005 until September 2007, Mr. Lidsky served as Chief Operating Officer for Spanlink Communications, Inc. Between 2003 and 2004, Mr. Lidsky was President and Chief Executive Officer of Computer Telephony Solutions. From 2002 to 2003,

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Mr. Lidsky was President and Chief Executive Officer of VigiLanz Corporation. From 1997 until 2002, Mr. Lidsky was the President and Chief Executive Officer of OneLink Communications, Inc. Between 1985 and 1997, Mr. Lidsky was employed by Norstan, Inc, most recently as Executive Vice President of Strategy and Business Development.

        Gregory T. Barnum became our Vice President of Finance and Chief Financial Officer in March 2006. From January 2006 until the time he became our executive officer, he was a member of our Board of Directors. Prior to joining us, he served as Vice President of Finance, Chief Financial Officer and Corporate Secretary of Computer Network Technology Corporation from 1997 until the company's acquisition by McData Corporation in 2005. Between 1992 and 1997, Mr. Barnum served as Senior Vice President of Finance and Administration, Chief Financial Officer and Corporate Secretary of Tricord Systems, Inc., an enterprise server manufacturer. Between 1988 and 1992, he was Executive Vice President, Finance, Chief Financial Officer, Treasurer and Corporate Secretary of Cray Computer Corporation, a development stage company engaged in the design of supercomputers. Prior to that time, Mr. Barnum served in various accounting and financial management capacities for Cray Research, Inc., a manufacturer of supercomputers. Mr. Barnum is a graduate of the University of St. Thomas.

        M. Shawn O'Grady became our Executive Vice President, Field Operations in December 2009, upon our acquisition of the reseller business of Incentra, LLC. Prior to joining us, he served Incentra, LLC and its affiliates since 2005 in various executive positions, most recently, as its President and Chief Executive Officer. Incentra, LLC filed for bankruptcy protection in 2009 while Mr. O'Grady served as an officer. Prior to his employment with Incentra, Mr. O'Grady was employed by Siemens Business Services, the information technology services division of Siemens AG, since 2000 in various capacities including its Senior Vice President and Business Unit General Manager, Consulting and Integration.

Item 1A.    Risk Factors.

        As indicated in this Annual Report under the caption "Note Regarding Forward-Looking Statements," certain information contained in this Annual Report consists of forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements made in this Annual Report include the following:

Worldwide adverse economic conditions negatively impact our business.

        Over the past two years, financial markets in the United States, Europe and Asia have experienced extreme disruption, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. We have been impacted by these economic developments in that they continue to adversely affect the ability of our customers and suppliers to obtain financing for significant purchases and operations, and have reduced orders for our products and services. These economic conditions will continue to negatively impact us to the extent our customers defer purchasing decisions, thereby lengthening our sales cycles. In addition, our customers' may have constrained budgets affecting their ability to purchase our products at the same level. Our customers' ability to pay for our products and services may also be impaired, which may lead to an increase in our allowance for doubtful accounts and write-offs of accounts receivable. We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. Should these economic conditions result in us not meeting our revenue objectives, our operating results, financial condition and stock price could be adversely affected.

Competition could prevent us from increasing or sustaining our revenues or profitability.

        The enterprise-class information storage, server and networking market is rapidly evolving and highly competitive. As technologies change rapidly, we expect that competition will increase in the

12



future. Current economic conditions also place pressure on our competitors to lower their prices and seek opportunities of size and scale different than in the past. We compete with independent storage, server and networking system suppliers in the mid to large enterprise market and numerous value-added resellers, distributors and consultants. We also compete in the storage, server and networking systems market with computer platform suppliers. Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing and other resources than we do. As a result, they may respond more quickly to changes in economic conditions and customer requirements and to new or emerging technologies, devote greater resources to the development, promotion and sale of products and deliver competitive products at lower end-user prices.

        Our suppliers are often our competitors. We are not the exclusive reseller of any data storage, server or networking product we offer. Instead, our suppliers market their products through other independent data storage, server and networking solution providers, original equipment manufacturers, and through their own internal sales forces. We believe direct competition from our suppliers is likely to increase if, as expected, the server, storage and networking industries continues to consolidate and also converge with providers of server and networking technologies. This consolidation would likely result in fewer suppliers with greater resources to devote to internal sales and marketing efforts. In addition, our suppliers have established and will probably continue to establish cooperative relationships with other suppliers and other data storage, server and networking solution providers. These cooperative relationships are often intended to enable our suppliers to offer comprehensive storage, server and networking solutions, which compete with those we offer. If our relationships with our suppliers become adversarial, or terminated due to an acquisition of a supplier, it will be more difficult for us to stay ahead of industry developments and provide our customers with the type of service they expect from us. Furthermore, this could have a material negative impact on our revenues and profitability.

        In addition, most of our customers already employ in-house technical staffs. To the extent a customer's in-house technical staff develops sophisticated server, storage and networking systems expertise, the customer may be less likely to seek our services. Further, we compete with storage service providers who manage, store and backup their customers' data at off-site, networked data storage locations.

Our acquisition strategy poses substantial risks.

        As part of our growth strategy, we recently made two acquisitions and plan to continue to pursue acquisitions in the future. We may not be able to identify suitable acquisition candidates or, if suitable candidates are identified, we may not be able to complete the business combination on commercially acceptable terms. We may need to raise additional equity to consummate future acquisitions, which may not be feasible, could be on terms we do not consider favorable, would cause dilution to existing investors and could adversely affect our stock price. The process of exploring and pursuing acquisition opportunities requires significant management and financial resources, which diverts attention from our core operations.

        Even if we are able to consummate an acquisition that we believe will be successful, the transaction may present many risks. These risks include, among others: failing to achieve anticipated synergies and revenue increases; difficulty incorporating and integrating the acquired technologies or products with our existing product lines; coordinating, establishing or expanding sales, distribution and marketing functions, as necessary; disruption of our ongoing business and diversion of management's attention to transition or integration issues; unanticipated and unknown liabilities; the loss of key employees, customers, partners and channel partners of our company or of the acquired company; and difficulties implementing and maintaining sufficient controls, policies and procedures over the systems, products and processes of the acquired company. If we do not achieve the anticipated benefits of our acquisitions as rapidly or to the extent anticipated by our management and financial or industry

13



analysts or if others do not perceive the same benefits of the acquisition as we do, there could be a material, adverse effect on our business, financial condition, results of operations or stock price.

Our revenue recognition policies unpredictably defer reporting of our revenues.

        We sell complex enterprise-class data storage, server and networking solutions, which include installation and configuration services. We do not recognize revenues from our sale of hardware and software products to our customers until we complete our required installation or configuration of these products. Installation and configuration of these solutions requires significant coordination with our customers and vendors. In the current economic environment, we have observed an increasing number of large customers delaying the completion of internal projects that are prerequisites to our installation services. Therefore, even if we have shipped all products to our customers, we may be unable to control the timing of product installation and configuration. These delays can prevent us from recognizing revenue on products we ship and may adversely affect our quarterly reported revenues. As a result, our stock price may decline.

        Effective January 1, 2011, we adopted a new revenue recognition policy due to a change in generally accepted accounting principles, our revenue recognition policy will require us to recognize product revenues upon shipment versus upon installation under our old revenue recognition method. We cannot predict what impact this may have on our quarterly reported revenues going forward. As a result, our stock price may decline.

Our key vendors could change or discontinue their incentive programs, which could adversely affect our business.

        Several of our key vendors have offered incentive programs to us over the past several years based on our achievement of particular sales levels of their products and early pay discounts. In addition, they have offered margin enhancement programs which provide enhanced discounts for particular products or new customer orders. These programs contributed to our profitability in 2010, 2009 and 2008. We cannot assure that these programs will continue or that the sales quotas for our participation will not increase, adversely affecting our ability to take advantage of the incentives. If for any reason, we cannot obtain the same benefits from incentive programs as in the past, it may significantly impact our profitability in the future.

We derive a significant percentage of our revenues from a small number of customers.

        In 2010, 2009 and 2008, we had no customers that accounted for at least 10% of our revenues. However, our top five customers collectively accounted for 12%, 17%, and 15% of our 2010, 2009 and 2008 revenues, respectively. Because we intend to continue to seek out large projects, we expect that a significant percentage of our revenues will continue to come from a small number of customers, although the composition of our key customers is likely to change from year to year. Current economic conditions likely will continue to adversely affect the number of and size of large projects available for us. If we fail to obtain a growing number of large projects each year, our revenues and profitability will likely be adversely affected. In addition, our reliance on large projects makes it more likely that our revenues and profits will fluctuate unpredictably from quarter to quarter and year to year. Unpredictable revenue and profit fluctuations may make our stock price more volatile and lead to a decline in our stock price.

Our business depends on our ability to hire and retain technical personnel and highly qualified sales people.

        Our future operating results depend upon our ability to attract, retain and motivate qualified engineers and sales people with enterprise-class data storage, server and networking solutions

14



experience. If we fail to recruit and retain additional engineering and sales personnel, or if losses require us in the future to terminate employment of some of these personnel, we will experience greater difficulty realizing our business strategy, which could negatively affect our business, financial condition and stock price.

We generally do not have employment agreements with our key employees.

        Our future operating results depend in significant part upon the continued contributions of our executive officers, managers, sales people, engineers and other technical personnel, many of whom have substantial experience in our industry and would be difficult to replace. Except as to our President and Chief Executive Officer, Vice President of Finance and Chief Financial Officer, Executive Vice President of Field Operations, we do not have employment agreements with our employees. Accordingly, our employees may voluntarily leave us at any time and work for our competitors. Our growth strategy depends in part on our ability to retain our current employees and hire new employees. Any failure to retain our key employees will make it much more difficult for us to maintain our operations and attain our growth objectives and could therefore be expected to adversely affect our operating results, financial condition and stock price.

Our long sales cycle may cause fluctuating operating results, which may adversely affect our stock price.

        Our sales cycle is typically long and unpredictable, making it difficult to plan our business. Current economic conditions increased this uncertainty. Our long sales cycle requires us to invest resources in potential projects that may not occur. In addition, our long and unpredictable sales cycle may cause us to experience significant fluctuations in our future annual and quarterly operating results. It can also result in delayed revenues, difficulty in matching revenues with expenses and increased expenditures. Our business, operating results or financial condition and stock price may suffer as a result of any of these factors.

If the storage, server and networking solutions industries fails to develop compelling new technologies, our business may suffer.

        Rapid and complex technological change, frequent new product introductions and evolving industry standards increase demand for our services. Because of this, our future success depends in part on the storage, server and networking solutions industry's ability to continue to develop leading-edge storage and related server and networking technology solutions. Our customers utilize our services in part because they know that newer technologies offer them significant benefits over the older technologies they are using. If the data storage industry ceases to develop compelling new storage, server and networking solutions, or if a single data storage, server and networking standard becomes widely accepted and implemented, it will be more difficult to sell new data storage, server and networking systems to our customers. The continued tightened budgets among established data storage, server and networking technology manufacturers and the difficulty of raising new capital for innovative, start-up companies, under current economic conditions may also stifle development of new data storage, server and networking technologies.

Control by our existing stockholders could discourage the potential acquisition of our business.

        Currently, our executive officers and directors beneficially own approximately 22.2% of our outstanding common stock. Acting together, these insiders may be able to elect our entire Board of Directors and control the outcome of all other matters requiring stockholder approval. This voting concentration may also have the effect of delaying or preventing a change in our management or control or otherwise discourage potential acquirers from attempting to gain control of us. If potential

15



acquirers are deterred, you may lose an opportunity to profit from a possible acquisition premium in our stock price.

Our stock price is volatile.

        The market price of our common stock fluctuates significantly, and, especially in light of current stock market and worldwide economic conditions, may continue to be volatile. We cannot assure you that our stock price will increase, or even that it will not decline significantly from the price you pay. Our stock price may be adversely affected by many factors, including:

    actual or anticipated fluctuations in our operating results, including those resulting from changes in accounting rules;

    general market conditions, including the effects of current economic conditions;

    announcements of technical innovations;

    new products or services offered by us, our suppliers or our competitors;

    changes in estimates by securities analysts of our future financial performance;

    our compliance with SEC and Nasdaq rules and regulations, including the Sarbanes-Oxley Act of 2002;

    the timing of stock sales under 10b5-1 plans or otherwise; and

    war and terrorism threats.

Our governing documents and Minnesota law may discourage the potential acquisitions of our business.

        Our Board of Directors may issue additional shares of capital stock and establish their rights, preferences and classes, in some cases without stockholder approval. In addition, we are subject to anti-takeover provisions of Minnesota law. These provisions may deter or discourage takeover attempts and other changes in control of us not approved by our Board of Directors. If potential acquirers are deterred, you may lose an opportunity to profit from a possible acquisition premium in our stock price.

Future finite lived intangibles and goodwill impairment may unpredictably affect our financial results.

        We perform impairment analyses of our finite lived intangibles when a triggering event occurs and goodwill at least annually or when we believe there may be impairment. Future events could cause us to conclude that impairment indicators exist and that goodwill and/or the finite lived intangibles associated with our acquired businesses are impaired. With the overall decline in the stock market, over the past several years, future potential decline in our stock price and the continued impact of the global economic downturn, it may become more likely that we would need to write down the carrying value of our assets and incur a current period charge to our earnings. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

The sublessee for our corporate headquarters may be unable to make their lease payments or default on their lease agreement.

        In December 2004, we agreed to sublease approximately 52,000 of the 106,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term is co-terminal with our lease and is 85 months starting in April 2005 and ending in April 2012. The sublessee pays us rent ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. If the sublessee was unable to make their lease payments to us or defaulted on the lease agreement, our operating results or financial condition

16



and stock price may suffer as a result. The annual payments we expect to receive for our Chanhassen sublease is $950,000 for 2010 and 2011, respectively, and $317,000 for 2012.

Item 1B.    Unresolved Staff Comments.

        None.

Item 2.    Properties.

        We lease 106,000 square feet of an office and warehouse facility in Chanhassen, Minnesota. We occupy 54,000 of the 106,000 square feet as our corporate headquarters, including our principal technical operations and our integration, assembly and support service operations. As of December 31, 2010, our other 21 leased locations (which house sales and technical staffs) are small-to-medium-sized offices throughout the United States.

        In December 2004, we agreed to sublease approximately 52,000 of the 106,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term is co-terminal with our lease and is for 85 months starting in April 2005 and ending in April 2012. The sublessee will pay us rent ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. In the first quarter of 2005, we incurred a one-time, non-cash charge of $3.5 million related to the sublease and lot sale. We estimate we will obtain annual cost savings of $950,000 during the sublease term.

        Based on our present plans, we believe our current facilities, which are in reasonably good condition, will be adequate to meet our anticipated needs for at least the remaining terms of our leases.

Item 3.    Legal Proceedings.

        We are not currently involved in any material legal proceedings.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

        Our common stock is quoted on the Nasdaq Global Market under the symbol "DTLK". The table below sets forth, for the calendar quarters indicated, the high and low per share closing sale prices of our common stock as reported by the Nasdaq Global Market.

 
  High   Low  

Year Ended December 31, 2010

             

First Quarter

  $ 4.69   $ 4.16  

Second Quarter

    4.93     3.79  

Third Quarter

    3.92     2.93  

Fourth Quarter

    4.81     3.00  

Year Ended December 31, 2009

             

First Quarter

    3.50     2.50  

Second Quarter

    4.45     2.80  

Third Quarter

    4.26     3.05  

Fourth Quarter

    4.60     3.59  

        On February 24, 2011, the closing price per share of our common stock was $7.23. We urge potential investors to obtain current market quotations before making any decision to invest in our common stock. On February 24, 2011, there were approximately 101 holders of common stock, including record holders and stockholders whose shares are held by a bank, broker or other nominee. However, we estimate that our shares are held through a small number of record holders by over 1,544 beneficial owners.

        Except for distributions paid to our stockholders related to S corporation earnings generated prior to our initial public offering in 1999, we have paid no dividends on our common stock. We intend to retain future earnings for use in our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

        We did not purchase any of our securities during 2010, 2009, or 2008 nor did we have any unregistered sales of equity securities during 2010, 2009, or 2008. You can find additional information about our equity compensation plans in Part III, Item 11 of this Annual Report on Form 10-K.

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Item 6.    Selected Financial Data.

        You should read the information below with our "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements. We derived the data as of December 31, 2010 and 2009, and for 2010, 2009 and 2008, from our audited financial statements included in this Annual Report. We derived the data as of December 31, 2008, 2007 and 2006, and for 2007 and 2006, from our audited financial statements not included in this Annual Report. We acquired the reseller business of Incentra in December 2009, the networking division of Cross Telecom in October 2009 and MCSI in January 2007. They are included in our financial statements beginning on those dates.

 
  Year ended December 31,  
 
  2010   2009   2008   2007   2006  
 
  (in thousands, except per share data)
 

Statement of Operations Data:

                               

Net sales:

                               
 

Product sales

  $ 180,424   $ 94,788   $ 113,493   $ 111,201   $ 102,400  
 

Service sales

    113,255     83,294     82,104     66,571     43,583  
                       

Total net sales

    293,679     178,082     195,597     177,772     145,983  
                       

Cost of sales:

                               
 

Cost of product sales

    140,984     71,303     84,980     84,369     77,365  
 

Cost of services

    83,951     60,343     57,966     48,111     30,521  
 

Amortization of intangibles

    1,108                  
                       

Total cost of sales

    226,043     131,646     142,946     132,480     107,886  
                       

Gross profit

    67,636     46,436     52,651     45,292     38,097  
                       

Operating expenses:

                               
 

Sales and marketing

    32,353     21,408     23,368     22,067     15,985  
 

General and administrative

    14,092     11,943     11,902     11,720     10,434  
 

Engineering

    15,652     11,650     11,590     9,181     6,098  
 

Other income(5)

    (503 )                
 

Integration and transaction costs

    581     1,043         442      
 

Amortization of finite-lived intangibles(1)(2)(3)

    1,483     843     711     727      
                       

Total operating expenses

    63,658     46,887     47,571     44,137     32,517  
                       

Earnings (loss) from operations

    3,978     (451 )   5,080     1,155     5,580  

Interest income, net

    14     94     589     983     714  

Other expense

        (1 )   (37 )   (75 )    
                       

Earnings (loss) before income taxes

    3,992     (358 )   5,632     2,063     6,294  

Income tax expense (benefit)(4)

    1,690     197     2,236     864     (2,203 )
                       

Net earnings (loss)

  $ 2,302   $ (555 ) $ 3,396   $ 1,199   $ 8,497  
                       

Net earnings (loss) per common share:

                               
 

Basic

  $ 0.18   $ (0.04 ) $ 0.27   $ 0.10   $ 0.77  
 

Diluted

  $ 0.18   $ (0.04 ) $ 0.27   $ 0.10   $ 0.76  

Weighted average shares outstanding:

                               
 

Basic

    12,801     12,550     12,370     12,156     11,006  
 

Diluted

    12,981     12,550     12,495     12,392     11,127  

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  As of December 31,  
 
  2010   2009(6)   2008   2007   2006  
 
  (In thousands)
 

Selected Balance Sheet Data:

                               

Cash and investments

  $ 8,988   $ 15,631   $ 27,730   $ 25,164   $ 22,900  

Working capital

    21,636     14,702     23,735     15,992     19,654  

Total assets

    176,072     153,978     135,892     131,469     86,849  

Stockholders' equity

    47,455     43,415     42,519     38,244     27,322  

(1)
In January 2007, we acquired MCSI. Therefore its results of operations are only included from the acquisition date forward. We recorded finite lived intangibles, consisting of $4.3 million of customer relationships and $76,000 of backlog, which are amortized over their estimated lives of six years and two months, respectively. We incurred integration costs of $442,000 in conjunction with the acquisition of MCSI.

(2)
In October 2009, we acquired the networking solutions division of Minneapolis-based Cross Telecom. We have included its results of operations beginning on the acquisition date. We recorded finite lived intangibles, consisting of $67,000 for services agreement and $467,000 for certifications, which are amortized over their estimated lives of four years and two years, respectively.

(3)
In December 2009, we acquired the reseller business of Incentra. Therefore its results of operations are only included from the acquisition date forward. We recorded finite lived intangibles, consisting of $263,000 of trademarks, $1.1 million of backlog and $3.8 million of customer relationships, which are amortized over their estimated lives of three years, 1 year and 8 years, respectively. In 2009 and 2010, we incurred integration costs of $1.0 million and $581,000, respectively, in conjunction with the acquisition of Incentra's reseller business.

(4)
Prior to 2006 we recorded a valuation allowance for deferred tax assets. We continued to record a full valuation allowance against our deferred tax assets for 2003, 2004 and 2005 due to the uncertainty of the realization and timing of the benefits of those deferred tax assets as we had not achieved a sufficient level of sustained profitability. During 2006, management concluded that we had attained a sufficient level of sustained profitability and recorded a tax benefit of $2.2 million resulting principally from the reversal of our income tax valuation allowance.

(5)
In conjunction with our Cross acquisition, we entered into a reverse earn-out agreement, which required Cross to purchase at least $1.8 million of networking products and services from us over three years. Cross agreed to pay any shortfall between customer purchases and the guaranteed annual purchase amount. In September 2010, the first year of the three year reverse earn-out agreement came to an end and there was a shortfall paid by Cross of $503,000, which was recorded as other income since we had assumed that the revenue targets would be met and the reverse earn-out had no fair value.

(6)
Selected balance sheet data for 2009 has been updated for measurement period changes related to our Incentra acquisition. Due to the timing of the acquisition (closed December 2009), complexities and related integration we did not complete our final fair value assessment until late in 2010. Adjustments to provisional amounts during the measurement period, that were the result of information that existed as of the acquisition date, require the revision of comparative prior period financial information when reissued in subsequent financial statements. Accordingly our 2009 balance sheet was adjusted to account for these changes. The changes resulted in a $523,000 reduction in goodwill and did not impact our income statement.

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation.

        You should read the following discussion in conjunction with our financial statements and the related notes included in Item 8. The following information includes forward-looking statements, the realization of which may be affected by certain important factors discussed under "Risk Factors."

Overview

        We provide solutions and services that make data centers more efficient, manageable and responsive to changing business needs. Focused on mid and large-size companies, we assess, design, deploy, and support infrastructures—servers, storage and networks—at the heart of the data center. Our portfolio of solutions and services spans four practices: consolidation and virtualization, data storage protection, advanced network infrastructures and business continuity and disaster recovery solutions. We offer a full suite of practice-specific analysis, design, implementation, management, and support services.

        Our solutions can include hardware products, such as servers, disk arrays, tape systems, networking and interconnection components and software products. Our data center strategy is supported through multiple trends in the market in supporting the market and our customers with a single vendor to provide their data center infrastructure needs. As of December 31, 2010, we have 32 locations, including both leased facilities and home offices, throughout the United States. We historically have derived our greatest percentage of net sales from customers located in the central part of the United States.

        We sell support service contracts to most of our customers. In about half of the contracts that we sell, our customers purchase support services through us, customers receive the benefit of integrated system wide support. We have a qualified, independent support desk that takes calls from customers, diagnoses the issues they are facing and either solves the problem or coordinates with our and/or vendor technical staff to meet the customer's needs. Our support service agreements with our customers include an underlying agreement with the product manufacturer. The manufacturer provides on-site support assistance if necessary. We defer revenues and direct costs resulting from these contracts, and amortize these revenues and expenses into operations, over the term of the contracts, which are generally twelve months. The other half of the support service contracts that we sell are direct with the product manufacturers.

        The data center infrastructure solutions and services market is rapidly evolving and highly competitive. Our competition includes other independent storage, server and networking system integrators, high end value-added resellers, distributors, consultants and the internal sales force of our suppliers. Our ability to hire and retain qualified outside sales representatives and engineers with enterprise-class information storage, server and networking experience is critical to effectively competing in the marketplace and achieving our growth strategies.

        In the past, we have experienced fluctuations in the timing of orders from our customers, and we expect to continue to experience these fluctuations in the future. These fluctuations have resulted from, among other things, the time required to design, test and evaluate our data center infrastructure solutions before customers deploy them, the size of customer orders, the complexity of our customers' network environments, necessary system configuration to deploy our solutions and new product introductions by suppliers. Completion of our installation and configuration services may also delay recognition of revenues. Current economic conditions and competition also affect our customers' decisions and timing to place orders with us and the size of those orders. As a result, our net sales may fluctuate from quarter to quarter.

        We view the current data center infrastructure market as providing significant opportunity for growth. Currently, our market share is a small part of the overall market. However, the providers of

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the data center infrastructure industry's products and technologies are increasing their utilization of indirect sales approaches to broaden their reach and optimize their margins. Increasingly, they are turning to companies such as us to sell their products. While these trends provide opportunity for us, we must improve our business model to generate sustainable, profitable growth. Our model requires highly skilled sales and technical staff which results in substantial fixed costs for us. We believe the best way to improve our company and create long-term shareholder value is to focus on building scaleable capabilities and a leverageable cost structure. Our current strategies are focused on:

    Increasing our sales team productivity.

    Scaling our existing geographic locations.

    Expanding our customer support revenues.

    Enhancing our consulting and professional services business.

        To pursue these strategies, we are:

    Improving our training, tools and recruiting efforts for sales and technical teams to increase productivity.

    Investing in customer-facing teams to acquire top tier sales and technical talent which we believe will increase our market share in key locations.

    Deepening our presence in existing enterprise accounts and penetrating new enterprise accounts.

    Exploring potential acquisitions that we believe can strengthen our resources and capabilities in key geographic locations.

    Targeting high growth market segments and deploying new technologies which focus on cost saving technologies for our customers.

    Driving high levels of efficiency by streamlining our supply chain and expanding our professional services tools.

    Expanding our customer support capabilities and tools-based professional services offerings that we believe will provide more value to our customers.

        All of these plans have various challenges and risks associated with them, including those described under "Risk Factors" in this Annual Report and that:

    Continued worldwide economic troubles may adversely affect our customers' buying patterns.

    We may not increase our productivity and may lose, or not successfully recruit and retain key sales, technical or other personnel.

    Competition is intense and may adversely impact our profit margin. Customers have many options for data center products and services.

    We may not successfully identify acquisition candidates or profitably integrate any business we acquire.

Acquisitions

        Reseller Business of Incentra, LLC.    In December 2009, we acquired the reseller business of Incentra, LLC ("Incentra") which designs, procures, implements and supports data center solutions with storage, networking, security and servers from leading manufacturers. We did not acquire Incentra's managed services portfolio and related operations. We accomplished the acquisition through the purchase of substantially all of the assets of Incentra's reseller business pursuant to an asset purchase agreement.

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        Under the asset purchase agreement, we paid Incentra $13.8 million. We paid $8.8 million at closing in cash, of which we held back $440,000 as security for certain indemnification obligations of Incentra. In addition, we paid Incentra $5.0 million for the working capital associated with Incentra's reseller business through the delivery of $2.0 million in cash and a $3.0 million secured promissory note paid on March 31, 2010. The promissory note was secured by the assets we purchased under the asset purchase agreement. During 2010 the final working capital adjustment was agreed to and the amount held back for indemnification was released, the net effect was a decrease in the purchase price of $32,000.

        This acquisition doubles our presence in Chicago and the Northeast and provides us with a significant presence in the West. Our combined team now has expanded experience to design and implement complex data center solutions, which will deliver increased productivity and efficiency for our customers. We have experienced operational synergies and efficiencies through combined general and administrative corporate functions. Our results for 2009 reflect the addition of Incentra's reseller business for thirteen days. Please see Note 2 to our financial statements for further information.

        Networking Solutions Division of Cross Telecom.    In October 2009, we acquired the networking solutions division of Minneapolis-based Cross Telecom ("Cross"), which qualified as a business combination. We completed an asset purchase of $2.0 million, which was paid in cash. We believe the acquisition of this team of certified Cisco networking experts will be additive to our expertise in designing, implementing and managing sophisticated virtualized data center, storage and backup recovery solutions. In addition, we obtained Cross' Cisco Silver certification.

        Simultaneously, we entered into a reverse earn-out agreement with Cross where they agreed to purchase $1.8 million of Cisco networking products and services from us over the next three years. Cross has agreed to pay any shortfall between customer purchases and the guaranteed annual purchase amount. We believed that we would meet the revenue targets and accordingly, we determined that the reverse earn-out had no fair value at the date of this business combination or in any subsequent periods prior to the settlement date. We estimated the fair values of the assets acquired to goodwill and finite lived intangibles, which consisted of the services agreement and certifications. They have estimated lives of four and two years, respectively, and we are amortizing them using the straight line method.

        The first year of the three year reverse earn-out agreement came to an end at September 30, 2010. Per the services agreement any shortfall between customer purchases and the guaranteed annual purchase amount would be payable by Cross at that time. At September 30, 2010, there was a shortfall between customer purchases and the guaranteed annual purchase amount of $503,000. We determined that the revenue targets would be met and the reverse earn-out had no fair value. Therefore, the shortfall amount of $503,000 represented a change in fair value of the acquisition date reverse earn-out and in accordance with ASC 805-30-35 was classified as other income within operating expenses on our statement of operations. We believe that the revenue targets for the next two years will be met and accordingly the reverse earn-out was determined to have no fair value at December 31, 2010. Please see note 2 to our financial statements for further information.

        Merger with Midrange Computer Systems Inc.    In January 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. ("MCSI"), a storage consulting, solutions and service provider based in Chicago, Illinois. We believe the acquisition strengthened our presence in our then existing regional markets and expanded our reach into a number of then key new regional markets. We paid a purchase price of approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock. Our results of operations for 2007 reflect the addition of MCSI for eleven months.

23


Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which we have prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America. The preparation of these financial statements required us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities.

        Note 1 of the Notes to our Financial Statements describes the significant accounting policies we used in the preparation of our financial statements. We consider some of these significant accounting policies as "critical accounting policies". A "critical accounting policy" is both material to the presentation of our financial statements and requires our management to make difficult, subjective or complex judgments that could have a material effect on our financial condition or results of operations. More specifically, critical accounting policies require us to make assumptions about highly uncertain matters at the time of the estimate. They also require us to consider different estimates we could reasonably have used, or changes in our estimate that are reasonably likely to occur, which would have a material effect on our financial condition or results of operations.

        We cannot determine estimates and assumptions about future events and their effects with certainty. On an on-going basis, we evaluate our estimates against historical experience and various other assumptions we believe applicable and reasonable under the circumstances. Our estimates may change as new events occur, as we obtain additional information and as our operating environment changes. These changes have historically been minor and we have included them in our financial statements as soon as we learned of them. Our management reviews the development and selection of our critical accounting policies and estimates with our Audit Committee. We have consistently applied our critical accounting policies throughout our accompanying financial statements.

Results of Operations

        Our sales increased $115.6 million or 64.9% to $293.7 million for 2010 as compared to 2009. Our gross margin increased $21.2 million or 45.7% to $67.6 million for 2010 as compared to 2009. Our earnings from operations increased $4.4 million from a loss of $451,000 in 2009 to earnings of $4.0 million in 2010. The following table shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.

 
  Year Ended
December 31,
 
 
  2010   2009   2008  

Net sales

    100.0 %   100.0 %   100.0 %

Cost of sales

    77.0     73.9     73.1  
               

Gross profit

    23.0     26.1     26.9  
               

Operating expenses:

                   
 

Sales and marketing

    11.0     12.0     11.9  
 

General and administrative

    4.8     6.7     6.1  
 

Engineering

    5.3     6.5     5.9  
 

Other income

    (0.2 )        
 

Integration costs

    0.2     0.6      
 

Amortization of intangibles

    0.5     0.5     0.4  
               

Total operating expenses

    21.6     26.3     24.3  
               

Operating earnings (loss)

    1.4 %   (0.3 )%   2.6 %
               

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Comparison of 2010, 2009 and 2008

Sales, Gross Profit and Gross Profit Percentage:

        The following table shows, for the periods indicated, sales and gross profit information for our product and service sales.

 
  Year Ended
December 31,
 
 
  2010   2009   2008  
 
  (in thousands)
 

Product sales

  $ 180,424   $ 94,788   $ 113,493  

Service sales

    113,255     83,294     82,104  

Product gross profit

 
$

38,332
 
$

23,485
 
$

28,513
 

Service gross profit

    29,304     22,951     24,138  

Product gross profit as a percentage of product sales

   
21.2

%
 
24.8

%
 
25.1

%

Service gross profit as a percentage of service sales

    25.9 %   27.6 %   29.4 %

        Sales.    Our product sales increased 90.3% in 2010 from 2009 to $180.4 million, and decreased 16.5% in 2009 from 2008 to $94.8 million. Our service sales, which includes customer support, consulting and installation services, increased 36.0% in 2010 over 2009 to $113.3 million, and increased 1.4% in 2009 from 2008 to $83.3 million. Our 2009 results for both product sales and service sales include revenues of $4.4 million from the acquisition of Incentra's reseller business.

        The increase in our products sales in 2010 as compared to 2009, reflect the impact of our acquisition of Incentra in December 2009, a general increase in IT spending in 2010, and the impact of our diversification in the mix of product offerings due to our transition to servicing the complete data center. The decline in our product sales in 2009 as compared to 2008 reflects the continuing negative impact of the economic slowdown that many of our customers are experiencing. Our more recent product sales continue to reflect our customers' closer scrutiny of expenditures as they focus more attention on the actual or anticipated impact that current economic conditions may have on the growth and profitability of their businesses. This has created longer sales cycles with a number of large project delays. We cannot predict if spending will slow down among our customers in 2011.

        The increase in our services sales for 2010 over 2009 included an increase in customer support contract sales of $22.8 million or 31.1% over 2009 and an increase in installation and configuration services of $7.6 million or 77.8% over 2009. The increase in service sales in 2010 reflects the impact of our acquisition of Incentra in December 2009. For 2009, customer support contract sales increased $2.3 million or 3.3% over 2008 while installation and configuration service sales decreased $1.5 million or 13.4% mirroring our decrease in product sales over the same period. For both 2009, the slowdown in the growth of our customer support contract sales and installation and configuration services relates to the downturn in our product sales. We experienced a slight benefit in sales of customer support contracts related to 2008 product sales, which we recognize over the contract term. Without sustainable growth in our product sales going forward, we expect our customer support contracts sales may suffer and we cannot assure that our future customer support contract sales will not decline.

        We had no single customer account for 10% or greater of our sales for the years 2010, 2009 or 2008.

        Gross Profit.    Our total gross profit as a percentage of net sales was 23.0% in 2010, decreasing from 26.1% in 2009 and 26.9% in 2008. Our total gross profit for 2010 includes amortization of intangibles of $1.1 million related to order backlog acquired in connection with our Incentra acquisition. This finite lived intangible has an estimated life of one year and was fully amortized in 2010.

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        Product gross profit as a percentage of product sales was 21.2% in 2010 as compared to 24.8% in 2009 and 25.1% in 2008. Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers. Our product gross profit as a percentage of product sales for 2010 over 2009 was lower than prior years as we implemented our strategy of selling total solutions into the data center, which includes lower margin servers and networking solutions. Our product gross profit as a percentage of product sales decreased for 2009 over 2008 and 2010 over 2009 due to our continued focus on pursuing new customer account opportunities and pricing pressures from our customers due to the current economic downturn. We expect that as we continue implementing our strategy to sell comprehensive data center solutions with servers and networking products that our product gross margins for 2011 will be between 21% and 23%.

        Our product gross profit is also impacted by the various programs we have in place with our vendors that provide economic incentives for achieving various sales performance targets and early payment of invoices. Achieving these targets contributed favorably to our product gross profit by $4.1 million (3% of product cost sales), $2.0 million (3% of product cost sales) and $1.5 million in 2010, 2009 and 2008, respectively. These vendor programs constantly change and we negotiate them separately with each vendor. While we expect the incentive and early pay programs to continue, the vendors could modify or discontinue them, particularly in light of current economic conditions, which would unfavorably impact our product gross profit margins.

        Service gross profit as a percentage of service sales was 25.9% in 2010 as compared to 27.6% in 2009 and 29.4% in 2008. In 2010, our decrease in service gross profit is in part due to $853,000 of Incentra-related acquisition accounting adjustments to reduce acquired maintenance contracts to fair value. Excluding these adjustments, service gross profit margin would have been 26.6% for 2010. In addition, we have experienced a decrease in the mix or products we can provide first call maintenance support for which generally have higher margins. In 2009, our service gross profit decreased because our vendors delivered a greater percentage of our installation and configuration services, which typically carries a lower margin. We estimate that our service gross margins for 2011 will be between 27% and 30%.

Operating Expenses:

 
  Year Ended
December 31,
 
 
  2010   2009   2008  
 
  (in thousands)
 

Sales and marketing

  $ 32,353   $ 21,408   $ 23,368  

General and administrative

    14,092     11,943     11,902  

Engineering

    15,652     11,650     11,590  

Other income

    (503 )        

Integration and transaction costs

    581     1,043      

Amortization of intangibles

    1,483     843     711  
               

Total operating expenses

  $ 63,658   $ 46,887   $ 47,571  
               

        Sales and Marketing.    Sales and marketing expenses include wages and commissions paid to sales and marketing personnel, travel costs and advertising, promotion and hiring expenses. Sales and marketing expenses totaled $32.4 million, or 11.0% of net sales for 2010 as compared to $21.4 million, or 12.0% of net sales for 2009 and $23.4 million, or 11.9% of net sales for 2008. The increase in sales and marketing expenses in absolute dollars for 2010 over 2009 is due to an increase in compensation expenses in connection with our Incentra acquisition, which increased our sales and marketing headcount by approximately 73%. The decrease in sales and marketing expenses in absolute dollars for 2009 over 2008 is due to a $2.5 million reduction in variable compensation and commissions, in turn

26



related to the overall decline in revenues and gross profit in 2009. The decrease in sales and marketing expenses as a percentage of new sales from 2010 to 2009 reflects the improvement in revenues per employee we have realized as part of our growth strategy. The increase in sales and marketing expenses as a percentage of net sales from 2009 to 2008 is due to the overall decline in our revenue for 2009. As we continue to selectively hire additional outside sales representatives, our sales and marketing expenses may increase without a commensurate increase in sales.

        General and Administrative.    General and administrative expenses include wages for administrative personnel, professional fees, depreciation, communication expenses and rent and related facility expenses. General and administrative expenses increase to $14.1 million or 4.8% of net sales for 2010 as compared to $11.9 million, or 6.7% of net sales for 2009 and $11.9 million, or 6.1% of net sales for 2008. Our general and administrative expenses increased $2.1 million in 2010 as compared to 2009, but as a percentage of net sales it decreased to 4.8% from 6.7% in 2009. The increase in general administrative expenses for 2010 was due to increased rent and facility charges of $1.3 million for the addition of Incentra offices we acquired and expenses of $536,000 for our 2010 national sales meeting. The decrease in general and administrative expenses as a percentage of net sales, in 2010 as compared to 2009, reflects the impact of a modest increase in expenses related to the Incentra acquisition to support a significant increase in revenues. General and administrative expenses in 2009 included $558,000 of severance agreement payments for several of our former executives. Cost reduction efforts in 2009 resulted in savings of $205,000 by canceling our annual sales meeting. We also lowered our travel and entertainment, training and communication expenses by $149,000, $162,000 and $131,000, respectively. Our general and administrative expenses were higher as a percentage of net sales for 2009 as compared to 2008 due to the overall decline in our revenue for 2009.

        Engineering.    Engineering expenses include employee wages and travel, hiring and training expenses for our field and customer support engineers and technicians. We allocate engineering costs associated with installation and configuration services and with consulting services to our cost of service sales. Engineering expenses increased to $15.7 million, or 5.3% of net sales in 2010 compared to $11.7 million, or 6.5% of net sales in 2009 and $11.6 million, or 5.9% of net sales in 2008. The increase in engineering expenses in absolute dollars for 2010 over 2009 is primarily due to an increase in compensation expense in connection with our Incentra acquisition, which increased our engineering headcount by approximately 31%. The decrease in engineering expenses as a percentage of sales, for 2010 as compared to 2009, is primarily a result of a greater percentage of our engineering costs being allocated to our cost of service sales since a greater percentage of our installation and configuration services were performed by our engineering personnel. The slight increase in engineering expenses in absolute dollars for 2009 over 2008 is due to an increase in salaries and benefits of $289,000 as we continually invest in regional engineering support. The increase in engineering expenses as a percentage of sales for 2009 as compared to 2008 is primarily the result of investments in regional engineering support, regional management and customer support resources.

        Other Income.    For 2010, 2009 and 2008 we had other income of $503,000, $0 and $0, respectively. Our Cross acquisition included a reverse earn-out agreement, which required Cross to purchase at least $1.8 million of networking products and services from us over three years. Cross agreed to pay any shortfall between customer purchases and the guaranteed annual purchase amount. We believed that we would meet the revenue targets and accordingly, we determined that the reverse earn-out had no fair value at the date of this business combination or in any subsequent periods prior to the settlement date. At September 30, 2010 the first year of the three year reverse earn-out agreement came to an end and there was a shortfall between customer purchases and the guaranteed annual purchase of $503,000. Per the services agreement any shortfall between customer purchases and the guaranteed annual purchase amount would be payable by Cross at that time. Since we had assumed that the revenue targets would be met and the reverse earn-out had no fair value, the shortfall amount of $503,000 represented a change in fair value of the acquisition date reverse earn-out and, in accordance with

27



ASC 805-30-35 was classified as other income within operation expenses on our statement of operations.

        Integration and Transaction Costs.    We had integration expenses of $ 581,000 and $1.0 million in 2010 and 2009, respectively. We incurred the majority of these expenses for the acquisition of the reseller business of Incentra in December 2009. Integration expenses in 2009 for the Incentra transaction included audit, legal and other outside consulting fees, expenses for our transition services agreement with Incentra and severance payments. Integration expenses in 2010 for the Incentra acquisition are related to facility abandonment costs and our transition services agreement which consists of transition benefits, retention bonuses and severances of terminated employees, some of whom assisted with the initial integration of Incentra.

        Intangible Amortization.    We had expenses related to the amortization of finite-lived intangible assets of $1.5 million, $843,000 and $711,000 in 2010, 2009 and 2008, respectively. Amortization of intangible assets increased in 2010 and 2009 from 2008 due to the acquisition of the networking solutions division of Cross Telecom and the Incentra reseller business. The finite-lived intangibles we acquired in our acquisition of the networking solutions division of Cross Telecom consisted of a services agreement and certifications having estimated lives of four years and two years, respectively. The finite-lived intangibles we acquired in our Incentra reseller business acquisition consisted of trademarks, order backlog and customer relationships having estimated lives of three years, one year and eight years, respectively. Our amortization expenses also include the finite lived intangibles we acquired in our 2007 MCSI acquisition consisting of customer relationships and backlog having estimated lives of six years and two months, respectively. We are amortizing all of these finite-lived intangible assets using the straight line method. We expect amortization expense to be approximately $1.5 million in 2011.

        We assess the carrying amount of our goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment may have occurred. We have only one operating and reporting unit that earns revenues, incurs expenses and makes available discrete financial information for review by our chief operations decision maker. Accordingly, we complete our goodwill impairment testing on this single reporting unit. For 2010, 2009 and 2008, we determined that our goodwill was not impaired.

        Testing for goodwill impairment is a two step process. The first step screens for potential impairment. If there is an indication of possible impairment, we must complete the second step to measure the amount of impairment loss, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of our market capitalization with the carrying value of our net assets. If our total market capitalization plus a control premium is at or below the carrying value of our net assets, we perform the second step of the goodwill impairment test to measure the amount of impairment loss we record, if any. We consider goodwill impairment test estimates critical due to the amount of goodwill recorded on our balance sheet and the judgment required in determining fair value amounts.

        Since we have one reporting unit, we estimate our fair value based on our market capitalization plus a control premium. As of our measurement date, December 31, 2010, our market capitalization was well above our stockholders equity without a control premium. A control premium is the amount that a buyer would pay over a company's current market price based on its traded price per share (i.e. market capitalization) to acquire a controlling interest. Control premiums are justified by expected acquisition synergies, such as expected cash flow increases from cost savings and revenue enhancements. We determine the appropriate range of control premiums to apply by reviewing those paid over the past three years by similar companies with market capitalizations of between $20 million and $200 million.

        We cannot assure that future adverse economic conditions will not trigger future goodwill impairment testing or an impairment charge. In addition, we cannot assure that our business, or others

28



of similar size, would ever sell at a price reflecting our estimated control premium. We further cannot assure that our market capitalization represents the fair value of our reporting unit or that a sustained drop in our market capitalization would not cause any impairment. We will continue to monitor and evaluate the carrying value of our goodwill to determine whether interim asset impairment testing is warranted.

        We perform an impairment test for finite-lived intangible assets and other long-lived assets, such as fixed assets, whenever events or changes in circumstances indicate that we may not recover the carrying value of such assets. We recognize impairment based on the difference between the fair value of the asset and its carrying value. We generally measure fair value based on discounted cash flow analyses. For 2010, 2009 and 2008, we identified no triggering events that required us to evaluate the impairment of our long-lived assets.

Operating Earnings:

 
  Years Ended December 31,  
 
  2010   2009   2008  
 
  (in thousands)
 

Earnings (loss) from operations

  $ 3,978   $ (451 ) $ 5,080  

        We realized earnings from operations of $4.0 million and $5.1 million in 2010 and 2008, respectively. We realized a loss from operations of $451,000 in 2009. Our earnings from operations in 2010 are a result of our higher revenues and gross margins as we realized the benefits of our Incentra acquisition and the implementation of our strategy to sell product and services to support the entire data center. Our loss from operations in 2009 is a result of a decrease in our revenues and margins due to the current economic downturn and integration costs we incurred in conjunction with our acquisition of Incentra's reseller business. The increase in our earnings from operations in 2008 is a result of higher revenues and gross margins partially offset by higher operating expenses.

Income Taxes:

 
  Year Ended December 31,  
 
  2010   2009   2008  
 
  (in thousands)
 

Income tax expense

  $ 1,690   $ 197   $ 2,236  

        We had income tax expense of $1.7 million in 2010 which resulted in our estimated effective tax rate of 42%. We had income tax expense of $197,000 in 2009 which resulted in our estimated effective tax rate of (55%). For 2009, we had income tax expense despite our loss position due to certain permanent differences, including those for meals and entertainment and incentive stock compensation expense. We had income tax expense of $2.2 million in 2008 which resulted in our estimated effective tax rate of 40%. As of December 31, 2010, we had $4.6 million of federal net operating carryforwards which will fully expire in 2029. Also at that date, we had $6.9 million of state net operating loss carryforwards to offset future state taxable income. These state tax carryforwards expire between 2013 and 2028. For 2010 and 2009, respectively, we recorded approximately $15,800 and $1,300 to equity for tax benefits associated with the vesting of restricted stock and the exercise of stock options. For 2008, we recorded approximately $13,000 to equity for tax expenses associated with the exercise of stock options. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 40% to 44%.

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Quarterly Results and Seasonality

        The following table sets forth our unaudited quarterly financial data for each quarter of 2010 and 2009. We have prepared this unaudited information on the same basis as our audited information. In our opinion, we have made all adjustments (including all normal recurring adjustments) necessary to present fairly the information set forth below. The operating results for any quarter are not necessarily indicative of results for any future period.

 
  Quarter Ended  
 
  2010   2009  
 
  Mar. 31   Jun. 30   Sep. 30   Dec. 31   Mar. 31   Jun. 30   Sep. 30   Dec. 31  
 
  (in thousands)
 

Net sales

  $ 62,544   $ 70,875   $ 69,220   $ 91,040   $ 39,868   $ 43,697   $ 42,711   $ 51,806  

Gross profit

    14,332     16,760     16,665     19,879     10,573     11,640     10,959     13,264  

Operating earnings (loss)

    (1,535 )   (65 )   1,425     4,153     (856 )   383     (386 )   408  

Net earnings (loss)

    (891 )   5     771     2,417     (596 )   283     (84 )   (158 )

        We have experienced, and expect to continue to experience, quarterly variations in our net sales as a result of a number of factors, including the length of the sales cycle with customers for large data center evaluations and purchases, delays in data center installations or configurations, new product introductions by suppliers and their market acceptance, delays in product shipments or other quality control difficulties, and trends in the data center industry in general or the geographic and industry specific markets in which operate now or in the future. In addition, current economic conditions and competition also affect our customers' decisions to place or delay orders with us, and the size and scale of their orders. Further, our success in integrating any acquired business or in opening any new field offices could impact our operating results.

Liquidity and Capital Resources

 
  Year ended December 31,  
 
  2010   2009   2008  
 
  (in thousands)
 

Total cash provided by (used in):

                   

Operating activities

  $ (2,525 ) $ 686   $ 3,446  

Investing activities

    1,467     (14,008 )   204  

Financing activities

    (2,855 )   (34 )   (80 )
               

Increase (decrease) in cash and cash equivalents

  $ (3,913 ) $ (13,356 ) $ 3,570  
               

        Since our initial public offering in 1999 we have financed our operations and capital requirements through cash flows generated from operations. Our working capital was $21.6 million at December 31, 2010 as compared to $14.7 million at December 31, 2009. At December 31, 2010, our cash and cash equivalents balance was $8.9 million as compared to cash and cash equivalents of $12.9 million at December 31, 2009.

        Cash used in operating activities for 2010 was $2.5 million. Cash used in operating activities for 2010 was primarily impacted by:

    Our net earnings for the year of $2.3 million.

    Non cash charges of $2.6 million, $1.6 million and $945,000 for amortization of intangibles, stock compensation expense and depreciation, respectively.

    A net increase in working capital (accounts receivable, inventories and accounts payable) of $14.9 million reflecting our increase in revenues for the year

30


    A net $2.2 million increase in deferred customer support contracts. While we amortize the revenues from these contracts over the life of the contract, the customer typically pays for the contracts at the beginning of the contract period which favorably impacts our cash flows.

        Cash provided by operating activities for 2009 was $686,000. Cash provided by operating activities for 2009 was primarily impacted by:

    A net loss for the year of $555,000.

    An increase in deferred income taxes of $2.9 million primarily related to an accounting method change with the IRS for income tax purposes.

    A net decrease in working capital (accounts receivable, inventories and accounts payable) of $4.5 million reflecting our overall lower revenues for the year.

    A non-cash charge of $1.5 million for stock compensation expense.

    A non-cash charge of $1.7 million for depreciation and amortization of intangibles.

        Cash provided by operating activities for 2008 was $3.4 million. Cash provided by operating activities for 2008 was primarily impacted by:

    Net earnings for the year of $3.4 million.

    A net $934,000 increase in deferred customer support contracts. While we amortize the revenues from these contracts over the life of the contract, the customer typically pays for the contracts at the beginning of the contract period which favorably impacts our cash flows.

    A net decrease in working capital (accounts receivable, inventories and accounts payable) of $2.7 million reflecting increased sales activity over the prior year.

    A non-cash charge of $1.7 million for depreciation and amortization of intangibles.

        Cash provided by investing activities was $1.5 million in 2010 primarily from proceeds from short-term investments of $2.7 million offset by purchases of $1.3 million for upgraded computer equipment and leasehold improvements. Cash used in investing activities was $14.0 million in 2009. In 2009, our primary use of cash for investing activities was to complete our October 2009 acquisition for the networking solutions division of Minneapolis-based Cross Telecom and our December 2009 acquisition for the Incentra reseller business. In addition, we invested an additional $1.3 million in short-term investments. Cash provided by investing activities was $204,000 in 2008. In 2008, we had proceeds from the sale of short-term investments of $1.0 million offset by purchases of $800,000 for upgraded computer equipment and telephone systems and leasehold improvements.

        Cash used in financing activities in 2010, 2009 and 2008 was $2.8 million, $34,000 and $80,000, respectively. In 2010, we used $3.0 million of cash to repay our Incentra acquisition promissory note. In 2009 and 2008, we used cash primarily for the redemption of restricted shares for tax withholding payments.

        We have an eleven-year non-cancelable operating lease for our corporate headquarters in Chanhassen, Minnesota which expires in 2012. The lease requires annual base rental payments of approximately $1.3 million. In December 2004, we agreed to sublease approximately 52,000 of the 106,000 square feet we then occupied. The initial term of the sublease is co-terminal with our lease and is for 85 months starting in April 2005 and ending in April 2012. The sublease requires rent payments ranging from $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. For more information, see Note 5 of the Notes to our Financial Statements.

        In December 2009, we acquired the reseller business of Incentra, LLC ("Incentra"). Under the Asset Purchase Agreement, we paid Incentra $13.8 million. We paid $8.8 million at closing in cash, of

31



which we held back $440,000 as security for certain indemnification obligations of Incentra. In addition, we paid Incentra $5.0 million for the working capital associated with Incentra's reseller business through the delivery of $2.0 million in cash and a $3.0 million secured promissory note paid on March 31, 2010. The promissory note is secured by the assets we purchased under the Asset Purchase Agreement. During 2010 the final working capital adjustment was agreed to and the amount held back for indemnification was released, the net effect was a decrease in the purchase price of $32,000.

        In October 2009, we acquired the networking solutions division of Minneapolis-based Cross Telecom, which qualified as a business combination. This was an asset purchase for $2.0 million in cash.

        In January 2007, we acquired MCSI, a storage consulting, solutions and service provider based in Chicago, Illinois. We paid approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock.

        We are currently exploring the possibility of obtaining a secured credit facility for the purpose of smoothing our operating cash flows, particularly, if we elect to take advantage of early pay discounts with some of our vendors. Nevertheless, with our current cash position, we believe we have the liquidity to meet our operating needs for the foreseeable future. We have filed a shelf registration statement with the SEC to pursue possible future equity fundraising to support our acquisition strategy and increase our general working capital.

        We are currently exploring the possibility of a public offering of our common stock and common stock owned by Gregory Meland, our largest shareholder and a director. We plan to use the net proceeds from such offering for potential acquisitions of other businesses that will complement our current business model and growth plans. Any amount of the net proceeds of such offering not used for acquisitions will be used for general corporate purposes.

Off-Balance Sheet Arrangements

        We do not have any special purpose entities or off-balance sheet financing.

Contractual Obligations and Commitments

        As of December 31, 2010, our contractual cash obligations consist of future minimum lease payments due under non-cancelable operating leases as follows:

 
  Lease
Obligations
  Sublease
Agreements
  Net Lease
Obligations
 
 
  (in thousands)
 

2011

  $ 2,193   $ (719 ) $ 1,474  

2012

    1,064     (239 )   825  

2013

    428         428  

2014

    362         362  

2015

    21         21  

Thereafter

             
               

  $ 4,068   $ (958 ) $ 3,110  
               

        We periodically enter into purchase commitments with our suppliers under customary purchase order terms. We would recognize any significant losses implicit in these contracts in accordance with generally accepted accounting principles. At December 31, 2010, no such losses existed.

        We are planning for $1.5 million to $2.0 million of capital expenditures during 2011 primarily related to enhancements to our management information systems and upgraded computer equipment.

32


Critical Accounting Estimates

        The preparation of financial statements requires us to make estimates and assumptions that affect reported earnings. We evaluate these estimates and assumptions on an on-going basis based on historical experience and on other factors that we believe are reasonable. Estimates and assumptions include, but are not limited to, the areas of customer receivables, inventories, investments, income taxes, self-insurance reserves and commitments and contingencies. We believe that the following represent the areas where we use more critical estimates and assumptions in the preparation of our financial statements:

        Inventory Valuation.    We periodically review, estimate and adjust our reserves for obsolete or unmarketable inventory equal to the difference between the inventory cost and the estimated market value based upon assumptions about future demand and market conditions. Results could be materially different if demand for our products decreased because of economic or competitive conditions, length of industry downturn, or if products become obsolete because of technical advancements in the industry.

        Business Combinations.    We have acquired a number of businesses during the last several years, and we expect to acquire additional businesses in the future. In a business combination, we determine the fair value of all acquired assets, including identifiable intangible assets, and all assumed liabilities. We allocate the fair value of the acquisition to the acquired assets and assumed liabilities in amounts equal to the fair value of each asset and liability. We classify any remaining fair value of the acquisition as goodwill. This allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows we expect to generate with the acquired assets. We amortize certain identifiable, finite-life intangible assets, such as service agreements, certifications, trademarks, order backlog and customer relationships, on a straight-line basis over the intangible asset's estimated useful life. The estimated useful life of amortizable identifiable intangible assets ranges from one to eight years. We do not amortize goodwill or other intangible assets we determine to have indefinite lives. Accordingly, the accounting for acquisitions has had, and will continue to have, a significant impact on our operating results.

        During 2009, we applied business combination accounting to our acquisitions of the networking solutions division of Cross Telecom, and to our acquisition of the Incentra reseller business. See Note 2 to our financial statements included in this annual report on Form 10-K for more information about the application of business combination accounting to these acquisitions.

        Valuation of Goodwill.    In accordance with FASB ASC Topic 350 "Intangibles—Goodwill and Other," we assess the carrying amount of our goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment may have occurred. We have only one operating and reporting unit that earns revenues, incurs expenses and makes available discrete financial information for review by our chief operations decision maker. Accordingly, we complete our goodwill impairment testing on this single reporting unit.

        Testing for goodwill impairment is a two step process. The first step screens for potential impairment. If there is an indication of possible impairment, we must complete the second step to measure the amount of impairment loss, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of our market capitalization with the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets, we perform the second step of the goodwill impairment test to measure the amount of impairment loss we record, if any. We consider goodwill impairment test estimates critical due to the amount of goodwill recorded on our balance sheet and the judgment required in determining fair value amounts.

33


        Valuation of Long-Lived Assets, Including Finite-Lived Intangibles.    In accordance with FASB ASC Topic 360, "Property, Plant, and Equipment," we perform an impairment test for finite-lived intangible assets and other long-lived assets, such as fixed assets, whenever events or changes in circumstances indicate that we may not recover the carrying value of such assets.

        Stock-Based Compensation.    We utilize the fair value method of accounting to account for share-based compensation awards. This requires us to measure and recognize in our statements of operations the expense associated with all share-based payment awards made to employees and directors based on estimated fair values. We use the Black-Scholes model to determine the fair value of share-based payment awards. Our stock price, as well as assumptions regarding a number of highly complex and subjective variables, will affect our determination of fair value. We determine the fair value of restricted stock grants based upon the closing price of our stock on the grant date. We base recognition of compensation expense for our performance-based, non-vested shares on management's estimate of the probable outcome of the performance condition. Management reassesses the probability of meeting these performance conditions on a quarterly basis. Changes in management's estimate of meeting these performance conditions may result in significant fluctuations in compensation expense from period to period.

Recent Accounting Pronouncements

        See Note 1 to our Consolidated Financial Statements in Part II, Item 8 of this Report for a description of recent accounting pronouncements, including our expected adoption dates and estimated effects on our results of operations, financial condition, and cash flows.

Inflation

        We do not believe that inflation has had a material effect on our results of operations in recent years. We cannot assure you that inflation will not adversely affect our business in the future.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

        Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we do not believe that we have any material market risk exposure. Therefore, no quantitative tabular disclosures are required.

        The following discusses our exposure to market risk related to changes in interest rates, foreign exchange rates and equity prices.

        Interest rate risk.    As of December 31, 2010, we had $9.0 million of cash and money market accounts. A decrease in market rates of interest would have no material effect on the value of these assets or the related interest income due to the nature of money market accounts. We have no short or long-term debt.

        Foreign currency exchange rate risk.    We market and sell all of our products and services in the United States. Therefore, we are not currently exposed to any direct foreign currency exchange rate risk.

        Equity price risk.    We do not own any equity investments. Therefore, we are not currently exposed to any direct equity price risk.

34


Item 8.    Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
Datalink Corporation

We have audited the accompanying balance sheets of Datalink Corporation as of December 31, 2010 and 2009, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedule of Datalink Corporation listed in Item 15(a). These financial statements and financial statement schedule 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 the standards of the Public Company Accounting Oversight Board (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. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 Datalink Corporation as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ McGladrey & Pullen, LLP

Minneapolis, Minnesota
March 1, 2011

35



DATALINK CORPORATION

BALANCE SHEETS

(in thousands, except share data)

 
  December 31,  
 
  2010   2009  

             
Assets
   
   
 

Current assets:

             
 

Cash and cash equivalents

  $ 8,988   $ 12,901  
 

Short-term investments

        2,730  
 

Accounts receivable, net

    57,779     44,109  
 

Inventories

    2,210     1,561  
 

Current deferred customer support contract costs

    48,715     38,050  
 

Inventories shipped but not installed

    7,191     8,973  
 

Income tax receivable

    1,064     1,073  
 

Other current assets

    607     205  
           
   

Total current assets

    126,554     109,602  

Property and equipment, net

    2,126     1,808  

Goodwill

    23,146     23,178  

Finite-lived intangibles, net

    5,219     7,810  

Deferred customer support contract costs non-current

    18,742     11,186  

Other assets

    285     394  
           
   

Total assets

  $ 176,072   $ 153,978  
           

             

Liabilities and Stockholders' Equity

 

 


 

 


 

Current liabilities:

             
 

Accounts payable

  $ 28,749   $ 31,025  
 

Note payable due to seller of acquired business

        3,000  
 

Accrued commissions

    3,546     2,680  
 

Accrued sales and use taxes

    1,414     1,228  
 

Accrued expenses, other

    3,427     3,092  
 

Current deferred tax liability

    3,723     814  
 

Customer deposits

    2,209     3,994  
 

Current deferred revenue from customer support contracts

    61,571     48,765  
 

Other current liabilities

    279     302  
           
   

Total current liabilities

    104,918     94,900  

Deferred income tax liability

    203     1,357  

Deferred revenue from customer support contracts non-current

    23,284     13,850  

Other liabilities non-current

    212     456  
           
   

Total liabilities

    128,617     110,563  
           

Commitments and contingencies (Notes 5, 6, and 8)

             

Stockholders' equity:

             
 

Common stock, $0.001 par value, 50,000,000 shares authorized, 13,569,533 and 13,260,788 shares issued and outstanding as of December 31, 2010 and 2009, respectively

    14     13  
 

Additional paid-in capital

    43,332     41,595  
 

Retained earnings

    4,109     1,807  
           
   

Total stockholders' equity

    47,455     43,415  
           
   

Total liabilities and stockholders' equity

  $ 176,072   $ 153,978  
           

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

36



DATALINK CORPORATION

STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 
  Year Ended December 31,  
 
  2010   2009   2008  

Net sales:

                   
 

Product sales

  $ 180,424   $ 94,788   $ 113,493  
 

Service sales

    113,255     83,294     82,104  
               

Total net sales

    293,679     178,082     195,597  

Cost of sales:

                   
 

Cost of product sales

    140,984     71,303     84,980  
 

Cost of services

    83,951     60,343     57,966  
 

Amortization of intangibles

    1,108          
               

Total cost of sales

    226,043     131,646     142,946  
               

Gross profit

    67,636     46,436     52,651  

Operating expenses:

                   
   

Sales and marketing

    32,353     21,408     23,368  
   

General and administrative

    14,092     11,943     11,902  
   

Engineering

    15,652     11,650     11,590  
   

Integration and transaction costs

    581     1,043      
   

Amortization of intangibles

    1,483     843     711  
   

Other income

    (503 )        
               

Total operating expenses

    63,658     46,887     47,571  
               

Earnings (loss) from operations

    3,978     (451 )   5,080  

Interest income

    14     94     589  

Other expense

        (1 )   (37 )
               

Net earnings (loss) before income taxes

    3,992     (358 )   5,632  

Income tax expense

    1,690     197     2,236  
               

Net earnings (loss)

  $ 2,302   $ (555 ) $ 3,396  
               

Net earnings (loss) per common share:

                   
 

Basic

  $ 0.18   $ (0.04 ) $ 0.27  
 

Diluted

  $ 0.18   $ (0.04 ) $ 0.27  

Weighted average common shares outstanding:

                   
 

Basic

    12,801     12,550     12,370  
 

Diluted

    12,981     12,550     12,495  

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

37



DATALINK CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

 
  Common Stock    
   
   
 
 
  Additional
Paid-in Capital
  Retained
Earnings
(Deficit)
   
 
 
  Shares   Amount   Total  

Balances, December 31, 2007

    12,476   $ 12   $ 39,266   $ (1,034 ) $ 38,244  

Net earnings

                3,396     3,396  

Stock option and restricted stock expense

    486     1     959         960  

Redemption of restricted shares for tax withholding payments

    (52 )       (128 )       (128 )

Excess tax from stock compensation

            (13 )       (13 )

Common shares issued under exercise of stock options

    20         60         60  
                       

Balances, December 31, 2008

    12,930     13     40,144     2,362     42,519  

Net loss

                (555 )   (555 )

Stock option and restricted stock expense

    345         1,485         1,485  

Redemption of restricted shares for tax withholding payments

    (64 )       (208 )       (208 )

Common shares issued under exercise of stock options

    50         174         174  
                       

Balances, December 31, 2009

    13,261     13     41,595     1,807     43,415  

Net earnings

                2,302     2,302  

Stock option and restricted stock expense

    232         1,592         1,592  

Redemption of restricted shares for tax withholding payments

    (32 )       (203 )       (203 )

Common shares issued under exercise of stock options

    109         364         364  

Excess tax from stock compensation

              (16 )         (16 )
                       

Balances, December 31, 2010

    13,570   $ 14   $ 43,332   $ 4,109   $ 47,455  
                       

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

38



DATALINK CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

 
  Year Ended December 31,  
 
  2010   2009   2008  

Cash flows from operating activities:

                   
 

Net earnings (loss)

  $ 2,302   $ (555 ) $ 3,396  
 

Adjustments to reconcile net earnings to net cash provided by operating activities:

                   
   

Provision for bad debts

    73     57     88  
   

Depreciation

    945     838     966  
   

Amortization of finite lived intangibles

    2,591     843     711  
   

Amortization of discount on short-term investments

        (15 )   (1 )
   

Income taxes

    9          
   

Deferred income taxes

    1,755     2,866     (182 )
   

Amortization of sublease reserve

    (288 )   (310 )   (335 )
   

Stock based compensation expense

    1,592     1,485     959  
   

Loss on disposal of assets

            17  
 

Changes in operating assets and liabilities, net of effects of acquisition:

                   
   

Accounts receivable, net

    (13,742 )   (8,226 )   3,775  
   

Inventories

    1,133     1,098     3,617  
   

Deferred customer support contract costs/revenues, net

    2,234     (567 )   934  
   

Accounts payable

    (2,276 )   2,606     (10,014 )
   

Accrued expenses

    1,387     460     (594 )
   

Other

    (240 )   106     109  
               
     

Net cash provided by operating activities

    (2,525 )   686     3,446  
               

Cash flows from investing activities:

                   
 

Sale (purchases) of investments

    2,730     (1,257 )   1,004  
 

Purchases of property and equipment

    (1,263 )   (391 )   (800 )
 

Payment for acquisitions, net of cash acquired

        (12,360 )    
               
     

Net cash provided by (used in) investing activities

    1,467     (14,008 )   204  
               

Cash flows from financing activities:

                   
 

Payment of note payable due to seller of acquired business

    (3,000 )        
 

Excess tax from stock compensation

    (16 )       (13 )
 

Tax withholding payments reimbursed by restricted stock

    (203 )   (208 )   (128 )
 

Proceeds from issuance of common stock from option exercise

    364     174     60  
               
     

Net cash used in financing activities

    (2,855 )   (34 )   (80 )
               

Increase (decrease) in cash and cash equivalents

    (3,913 )   (13,356 )   3,570  

Cash and cash equivalents, beginning of year

    12,901     26,257     22,687  
               

Cash and cash equivalents, end of year

  $ 8,988   $ 12,901   $ 26,257  
               

Supplementary cash flow information:

                   

Cash paid for income taxes

   
509
   
278
   
2,727
 

Cash received for income tax refunds

    568     1,888      

Supplementary non-cash investing and financing activities:

                   

See Note 2 for non-cash information on our acquisitions

                   

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

39



DATALINK CORPORATION

NOTES TO FINANCIAL STATEMENTS

1.     Summary of Significant Accounting Policies:

    Description of Business:

        Datalink Corporation provides solutions and services that help make data centers more efficient, manageable and responsive to changing business needs. Focused on mid and large-size companies, we help companies migrate from physical to virtual data centers, ensure data protection and optimize enterprise networks. We derive our revenues principally from designing, installing and supporting data center solutions. Our solutions and services span three practices: consolidation and virtualization of data center infrastructures; enhanced data protection; and advanced network infrastructures. We are frequently engaged to provide assistance in the installation of data center solutions and to provide support services subsequent to the installation. Occasionally, we are engaged for consulting services.

    Recently Issued and Adopted Accounting Standard:

        In October 2009, the Financial Accounting Standards Boards ("FASB") amended the Accounting Standards Codification ("ASC") as summarized in Accounting Standards Update ("ASU") 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. Under ASU 2009-14, ASC Topic 985 has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product's essential functionality. Under ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are effective for deals entered into after January 1, 2011. Adoption may either be on a prospective basis or by retrospective application and we will be adopting prospectively. We are currently assessing the impact of these amendments to the ASC on its accounting and reporting systems and processes. We are currently evaluating the impact that the adoption of the ASC as of January 1, 2011 will have on our consolidated financial statements. We believe that application of these amendments will result in a substantial portion of our revenue and all related cost of sales being recognized at the time of sale. Currently certain revenue for hardware and essential software and associated cost of sales are deferred at the time of sale and recognized when installation or configuration services have been completed. As of December 31, 2010 we had recorded $8.8 million in revenues shipped but not installed that would have been recognized in the fourth quarter of 2010 if we had been recognizing revenue upon shipment.

        In January 2010, the FASB issued revised guidance on disclosures related to fair value measurements. This guidance requires new disclosures about significant transfers in and out of Level 1 and Level 2 and separate disclosures about purchases, sales, issuances, and settlements with respect to Level 3 measurements. The guidance also clarifies existing fair value disclosures about valuation techniques and inputs used to measure fair value. The new disclosures and clarifications of existing disclosures became effective for us beginning in the first quarter of 2010, except for the disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements, which will be effective for us in the first quarter of 2011. We do not expect the adoption to have a material impact on our financial statements.

40


    Cash and Cash Equivalents:

        Cash equivalents consist principally of money market funds with original maturities of three months or less, are readily convertible to cash and are stated at cost, which approximates fair value. We maintain our cash in bank deposit and money market accounts which, at times, may exceed federally insured limits. We have not experienced any losses in such accounts.

    Short-Term Investments:

        Our short-term investments consist principally of certificates of deposits. We categorize these investments as not available-for-sale securities and record them at fair market value. We classify investments with maturities of 90 days or less from the date of purchase as cash equivalents; investments with maturities of greater than 90 days from the date of purchase but less than one year generally as short-term investments; and investments with maturities of greater than one year from the date of purchase generally as long-term investments.

    Accounts Receivable, net:

        We carry trade receivables at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial condition and credit history and current economic conditions. We write off trade receivables when deemed uncollectible, which is generally in excess of a year past due provided we have no additional information to suggest we continue to expect customer payment. We record recoveries of trade receivables previously written off when received.

        We recorded accounts receivable net of the reserve for doubtful accounts of $204,000 and $629,000 at December 31, 2010 and 2009, respectively.

    Concentration of Credit Risk:

        We had no customers that comprised more than 10% of our sales in 2010, 2009 or 2008.

    Inventories:

        Inventories, including inventories shipped but not installed, principally consist of data storage products and components, valued at the lower of cost or market with cost determined on a first-in, first-out (FIFO) method. We reduced inventories for obsolete and slow moving reserves by $105,000 and $122,000 at December 31, 2010 and 2009, respectively.

    Property and Equipment:

        We state property and equipment, including purchased software, at cost. We provide for depreciation and amortization by charges to operations using the straight-line method over the estimated useful lives of the assets (ranging from 2 to 10 years). We amortize leasehold improvements on a straight-line basis over the shorter of their estimated useful lives or the underlying lease term. We remove the costs and related accumulated depreciation and amortization on asset disposals from the

41


accounts and include any gain or loss in operating expenses. We capitalize major renewals and betterments, but charge maintenance and repairs to current operations when incurred.

 
  December 31,  
 
  2010   2009  
 
  (in thousands)
 

Property and equipment:

             
 

Construction in process

  $ 304   $ 39  
 

Leasehold improvements

    1,704     1,487  
 

Furniture and fixtures

    2,180     2,067  
 

Equipment

    3,484     4,202  
 

Computers and software

    2,442     2,297  
           

    10,114     10,092  

Less accumulated depreciation and amortization

    7,988     8,284  
           

  $ 2,126   $ 1,808  
           

    Goodwill:

        We assess the carrying amount of our goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment may have occurred. We have only one operating and reporting unit that earns revenues, incurs expenses and makes available discrete financial information for review by our chief operations decision maker. Accordingly, we complete our goodwill impairment testing on this single reporting unit. Our measurement date is December 31, 2010.

        Testing for goodwill impairment is a two step process. The first step screens for potential impairment. If there is an indication of possible impairment, we must complete the second step to measure the amount of impairment loss, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of our market capitalization with the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets, we perform the second step of the goodwill impairment test to measure the amount of impairment loss we record, if any. We consider goodwill impairment test estimates critical due to the amount of goodwill recorded on our balance sheet and the judgment required in determining fair value amounts.

    Valuation of Long-Lived Assets:

        We perform an impairment test for finite-lived assets and other long-lived assets, such as fixed assets, whenever events or changes in circumstances indicate that we may not recover the carrying value of such assets. We recognize impairment based on the difference between the fair value of the asset and its carrying value. We generally measure fair value based on discounted cash flow analyses. For 2010, 2009 and 2008, we identified no triggering events that required us to evaluate the impairment of our long-lived assets.

    Stock Compensation Plans:

        We utilize the fair value method of accounting to account for share-based compensation awards. This requires us to measure and recognize in our statements of operations the expense associated with all share-based payment awards made to employees and directors based on estimated fair values. We use the Black-Scholes model to determine the fair value of share-based payment awards. Stock-based compensation expense was $1.5 million, $1.5 million and $959,000 for 2010, 2009 and 2008, respectively.

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    Income Taxes:

        We calculate income taxes using the asset and liability method of accounting for income taxes. Under the liability method, we record deferred income taxes to reflect the tax consequences in future years of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts using enacted tax rates for the years in which we expect these items to affect taxable income. We establish valuation allowances when necessary to reduce deferred tax assets to the amount we expect more likely than not to realize. Income tax expense (benefit) is the tax payable (receivable) for the period and the change during the period in deferred tax assets and liabilities.

    Uncertain Tax Positions:

        We utilize a two-step approach to recognizing and measuring uncertain tax positions (tax contingencies). The first step evaluates the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that we will sustain the position on audit, including resolution of related appeals or litigation processes. The second step measures the tax benefit as the largest amount more than 50% likely of being realized upon ultimate settlement. We include interest and penalties for our tax contingencies in income tax expense. At December 31, 2010 and 2009, we had no unrecognized tax benefits which would affect our effective tax rate if recognized.

    Use of Estimates:

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to estimates and assumptions include the reserve for doubtful accounts, reserve for obsolete and slow moving (excess) inventory and impairment analysis of goodwill and long-lived assets. Actual results could differ from those estimates.

    Revenue Recognition:

        Revenue Recognition.    We realize revenue from the design, installation and support of data center solutions, which may include hardware, software and services. We recognize revenue when we have met our obligations for installation or other services and collectability is reasonably assured.

        Product Sales.    We sell software and hardware products on both a "free-standing" basis without any services and as data center solutions bundled with its installation and configuration services ("bundled arrangements").

        Product Sales Without Service.    If we sell a software or hardware product and do not provide any installation or configuration services with it, we recognize the product revenues upon shipment.

        Product Sales With Service.    If we sell a bundled arrangement, then we defer recognizing any revenue on it until we finish its installation and/or configuration work. We account for the hardware, software and service elements of our bundled arrangements by applying the completed contract method. Factors we have considered in applying the completed contract method of accounting include (i) the relatively short duration of our contracts, (ii) the difficulty of estimating our revenues on a percentage-of-completion method and (iii) our use of acceptance provisions on larger bundled arrangements.

        Service Sales.    In addition to installation and configuration services that are part of our bundled arrangements described above, our service sales include customer support contracts and consulting

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services. On our balance sheet, deferred revenue relates to service sales for which our customer has paid us or has been invoiced but for which we have not yet performed the applicable services.

        Customer Support Contracts.    When we sell hardware and/or software products to our customers, we enter into service contracts with them. These contracts are support service agreements. A majority of the time, our internal support desk first assists the customer by performing an initial technical triage to determine the source of the problem and whether we can direct the customer on how to fix the problem. If we cannot solve the problem, we transfer the customer to the manufacturer or its designated service organization.

        When we do not provide "first call" assistance, usually because the manufacturer has not authorized us to do so, our customers call the manufacturer or its designated service organization directly for both the initial technical triage and any follow-up assistance. If the customer calls us first, we transfer the customer to the third party.

        In both scenarios above, we purchase third party support contracts from the manufacturers for their services. In accordance with our agreements, and consistent with standard industry practice, we prepay the third party based on its "list price" for maintenance on the specific hardware or software products we have sold, less our negotiated discounts with the third party. Terms are generally net 30 days. If we provide the initial "first call" services our discounts off of list price are more substantial. In all cases, we are the primary obligor in the transaction. The customer ultimately holds us responsible for fulfillment of the third party support contracts and we bear credit risk in the event of nonpayment by the customer.

        We report customer support contract revenue on a gross basis as there are sufficient indicators in accumulation that we should be reporting these revenues on a gross basis in accordance with ASC Topic 605-45, Reporting Revenue Gross as a Principle versus Net as an Agent (formerly EITF No. 99-19). We usually present quotations for maintenance arrangements to our customers without differentiating as to whether we, or a third party, are providing the service. Accordingly, we are, from our customers' perspectives, the primary obligor on our maintenance arrangements. We directly enter into the agreements with our customers to provide maintenance services. In all cases, we set the price to our customer for the maintenance arrangements, whether or not we provide our first call services, and bill our customers for the maintenance arrangement. We owe various third parties regardless of whether we collect from our customer. We are also contractually obligated to provide or arrange to provide these underlying support services to our customers in the unlikely event that the manufacturer or its designated service organization, fails to perform according to the terms of our contract.

        When we sell a service contract as part of a bundled arrangement, we use vendor specific objective evidence to allocate revenue to the service contract element. In all cases, we defer revenues and direct costs resulting from our service contracts and amortize them into operations over the term of the contracts, which are generally twelve months. We defer customer support costs under FTB 90-1 (ASC 310) and the FAQs under SAB 101 and SAB 104. The deferred costs we capitalize consist of direct and incremental costs we prepay to third parties for direct support to our customers under our contract terms. We defer our customer support contract revenues and their related costs because significant obligations remain after contract execution. For example, we provide routine help desk assistance to our customers and assist them in contacting our vendors for additional support services.

        Consulting Services.    Some of our customers engage us to analyze their existing data center architectures and offer our recommendations. Other customers engage us to assist them on-site with extended data center infrastructure projects, to support their data center environments and to help with long-term data center design challenges. For these types of consulting services that do not include the sale of hardware or software products, we recognize revenues as we perform these services.

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    Net Earnings Per Share:

        We compute basic net earnings per share using the weighted average number of shares outstanding. Diluted net earnings per share include the effect of common stock equivalents, if any, for each period. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless their effect is anti-dilutive. The following table computes basic and diluted net earnings per share:

 
  Year Ended December 31,  
 
  2010   2009   2008  
 
  (in thousands,
except per share data)

 

Net earnings (loss)

  $ 2,302   $ (555 ) $ 3,396  
               

Basic:

                   

Weighted average common shares outstanding

    13,570     13,261     12,930  

Weighted average common shares of non-vested stock

    (769 )   (711 )   (560 )
               

Shares used in the computation of basic net earnings per share

    12,801     12,550     12,370  
               

Net earnings (loss) per share—basic

  $ 0.18   $ (0.04 ) $ 0.27  
               

Diluted:

                   

Shares used in the computation of basic net earnings (loss) per share

    12,801     12,550     12,370  

Employee and non-employee director stock options

    51         80  

Non-vested stock

    129         45  
               

Shares used in the computation of diluted net earnings (loss) per share

    12,981     12,550     12,495  
               

Net earnings (loss) per share—diluted

  $ 0.18   $ (0.04 ) $ 0.27  
               

        We excluded the following non-vested common stock and options to purchase shares of common stock from the computation of diluted earnings per share as their effect would have been anti-dilutive:

 
  Year Ended December 31,  
 
  2010   2009   2008  

Non-vested common stock

    249,001     507,924     302,008  

Options to purchase shares of common stock

    140,202     327,687     549,107  

    Fair Value of Financial Instruments:

        At December 31, 2010 and 2009, the carrying values of current financial instruments such as cash and cash equivalents, short-term investments, accounts receivable, accounts payable, other current assets, accrued liabilities, other current liabilities and notes due to seller of acquired business approximated their market values, based on the short-term maturities of these instruments.

        We use the three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair values. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

    Level 1—Unadjusted quoted prices available in active markets for the identical assets or liabilities at the measurement date.

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    Level 2—Significant other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly.

    Level 3—Significant unobservable inputs that we cannot corroborate by observable market data and thus reflect the use of significant management judgment. We generally determine these values using pricing models based on assumptions our management believes other market participants would make.

        The fair value hierarchy requires the use of observable market data when available. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, we determine the fair value measurement based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. The following table sets forth, by level within the fair value hierarchy, the accounting of our financial assets and/or liabilities at fair value on a recurring basis as of December 31, 2010 according to the valuation techniques we used to determine their fair value(s).

 
  Fair Value Measurements as of December 31, 2010
(in thousands)
 
 
  12/31/2010   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
  Significant Other
Observable Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
 

Cash and cash equivalents

  $ 8,988   $ 8,988          

2.     Acquisitions

    Networking Solutions Division of Cross Telecom

        On October 1, 2009, we acquired the networking solutions division of Minneapolis-based Cross Telecom's ("Cross"), which qualified as a business combination. We completed an asset purchase of $2.0 million paid in cash. Simultaneously, Cross entered into an agreement with us to purchase at least $1.8 million of networking products and services from us over the next three years. Cross has agreed to pay any shortfall between customer purchases and the guaranteed annual purchase amount. We believed that we would meet the revenue targets and accordingly, we determined that the reverse earn-out had no fair value at the date of this business combination or in any subsequent periods prior to the settlement date. We determined that this earn-out liability is a Level 3 fair value measurement within the FASB's fair value hierarchy, and such liability is adjusted to fair value at each reporting date, with the adjustment reflected in operating expenses.

        The first year of the three year reverse earn-out agreement came to an end in September 2010. Per the services agreement any shortfall between customer purchases and the guaranteed annual purchase amount would be payable by Cross at that time. At September 30, 2010, there was a shortfall between customer purchases and the guaranteed annual purchase amount of $503,000. As discussed above, on October 1, 2009 we determined that the revenue targets would be met and the reverse earn-out had no fair value. Therefore, the shortfall amount of $503,000 represented a change in fair value of the acquisition date reverse earn-out and in accordance with ASC 805-30-35 was classified as other income within operating expenses on our statement of operations. We believe that the revenue targets for the next two years will be met and accordingly the reverse earn-out was determined to have no fair value at December 31, 2010.

        In connection with this acquisition, we allocated the total purchase consideration to the net assets acquired, including finite lived intangible assets, based on their respective fair values at the acquisition date.

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        We paid a premium for the net tangible and identified intangible assets (i.e. goodwill) acquired in the acquisition over their fair value because we believe this acquisition will add to our expertise in designing, implementing and managing sophisticated storage, backup and recovery infrastructures.

        The following table summarizes the allocation of the purchase price to the fair value of the assets acquired:

 
  (in thousands)  

Assets acquired and their fair values:

       

Property & equipment

  $ 47  

Finite-lived intangibles

    534  

Goodwill

    1,419  
       

Net purchase price

  $ 2,000  
       

        We allocated the purchase price for the Cross acquisition primarily by comparing our estimated cost to build the assets acquired against purchasing them. This enabled us to determine the allocation between finite lived intangibles and goodwill. The finite lived intangibles, which consisted of the services agreement and certifications have estimated lives of four and two years, respectively, and we are amortizing them using the straight line method (see Note 3). The goodwill we may deduct for tax purposes over a 15 year period.

    Reseller Business of Incentra, LLC

        On December 17, 2009, we acquired the reseller business of Incentra, which designs, procures, implements and supports data center solutions composed of technologies including storage, networking, security and servers from leading manufacturers. We did not acquire Incentra's managed services portfolio and related operations. We accomplished the acquisition through the purchase of substantially all of the assets of Incentra's reseller business pursuant to an Asset Purchase Agreement.

        Under the Asset Purchase Agreement, we paid Incentra $13.8 million. We paid $8.8 million at closing in cash, of which we held back $440,000 as security for certain indemnification obligations of Incentra. In addition, we paid Incentra $5.0 million for the working capital associated with Incentra's reseller business through the delivery of $2.0 million in cash and a $3.0 million secured promissory note paid on March 31, 2010. During 2010 the final working capital adjustment was agreed to and the amount held back for indemnification was released, the net effect was a decrease in the purchase price of $32,000.

        We estimated the fair value of the assets acquired and liabilities assumed of Incentra' primarily using a discounted cash flow approach with respect to identified intangible assets and goodwill. We based this approach upon our estimates of future cash flows from the acquired assets and liabilities and utilized a discount rate consistent with the inherent risk associated with the acquired assets and liabilities assumed.

        The fair value of the assets acquired included finite lived intangible assets, which consisted of trademarks, order backlog and customer relationships having estimated lives of three years, one year and eight years, respectively, and goodwill of approximately $4.0 million which will be deductible for tax purposes over a 15 year period. We paid a premium over the fair value of the net tangible and identified intangible assets acquired (i.e. goodwill), because we believe this acquisition expands our regional presence and customer portfolio and enables us to provide our customers with complete data center solutions. We anticipate operational synergies and efficiencies through combined general and administrative and corporate functions.

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        As of December 31, 2009, the fair value of the acquired assets was provisional as we had not yet completed our determination of the income tax basis of assets acquired and liabilities assumed and accordingly deferred income taxes had not been recorded. In addition, during 2010 we finalized the fair value determination for certain working capital assets and liabilities. Due to the timing of the acquisition (closed December 2009), complexities and related integration we did not complete our final fair value assessment until late in 2010. Adjustments to provisional amounts during the measurement period, that were the result of information that existed as of the acquisition date, require the revision of comparative prior period financial information when reissued in subsequent financial statements. Accordingly our 2009 balance sheet has been adjusted to account for these changes. The changes resulted in a $523,000 reduction in goodwill and did not impact our income statement.

        The following table summarizes the final allocation of the purchase price including measurement period adjustments:

 
  (in thousands)  

Assets acquired at their fair value:

       

Accounts receivable, net

  $ 10,699  

Inventory

    167  

Fixed assets

    119  

Finite-lived intangibles

    5,219  

Goodwill

    4,012  

Other assets

    250  
       

Total assets acquired

    20,466  

Liabilities assumed at their fair value:

       
 

Accounts payable

    4,603  
 

Deferred maintenance contracts, net

    705  
 

Accrued liabilities

    1,358  
       

Total liabilities assumed

    6,666  
       

Net purchase price

  $ 13,800  
       

        The finite lived intangibles which consisted of trademarks, order backlog and customer relationships have estimated lives of three years, one year and eight years, respectively, and we are amortizing them using the straight line method (see Note 3).

        Integration costs for 2010 and 2009 include salaries, benefits, retention bonuses and severances of exiting employees, some of whom assisted with the initial integration of Incentra. In addition, transaction costs for 2009 include legal, audit and other outside service fees necessary to complete our acquisition of Incentra, which were expensed. Total integration and transaction costs were $581,000 and $1.0 million during 2010 and 2009, respectively.

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        The pro forma unaudited results of operations assuming consummation of our Incentra acquisition as of January 1, 2009 and excluding any pro forma information for the Cross acquisition as that pro forma impact was not significant, are as follows:

 
  Years Ended
December 31,
 
 
  2009   2008  
 
  (in thousands, except
per share data)

 

Net sales

    268,470   $ 397,253  

Net earnings (loss)

    (6,942 )   2,414  

Per share data:

             

Basic earnings (loss)

    (0.55 ) $ 0.20  

Diluted earnings (loss)

    (0.55 ) $ 0.19  

        The pro forma unaudited results do not purport to be indicative of the results which we would have obtained had we completed the acquisition as of the pro forma date.

3.     Intangibles:

        We had goodwill assets with a recorded value of $23.1 million and $23.2 million as of December 31, 2010 and 2009, respectively. Goodwill activity is summarized as follows:

 
  (in thousands)  

January 1, 2009

  $ 17,748  

Additions

    5,953  

Measurement period adjustments

    (523 )
       

December 31, 2009

  $ 23,178  

Adjustments

    (32 )

Additions

     
       

December 31, 2010

  $ 23,146  
       

        We had finite-lived intangible assets with a net book value of $5.2 million and $7.8 million as of December 31, 2010 and 2009, respectively. The change in the net carrying amount of intangibles during 2010 and 2009 is as follows:

 
  Year Ended
December 31,
 
 
  2010   2009  
 
  (in thousands)
 

Beginning Balance

  $ 7,810   $ 2,900  

Recognized in connection with acquisitions

        5,753  

Amortization

    (2,591 )   (843 )

Impairment charges

         
           

Ending Balance

  $ 5,219   $ 7,810  
           

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        Identified finite-lived intangible asset balances are summarized as follows:

 
   
  As of December 31, 2010   As of December 31, 2009  
 
  Amortizable
Period
(years)
  Gross
Assets
  Accumulated
Amortization
  Net
Assets
  Gross
Assets
  Accumulated
Amortization
  Net
Assets
 

Customer relationships

  6-8   $ 8,110     (3,283 ) $ 4,827     8,110     (2,092 ) $ 6,018  

Services agreement

  4     67     (21 )   46     67     (4 )   63  

Certification

  2     467     (292 )   175     467     (59 )   408  

Trademarks

  3     263     (92 )   171     263     (4 )   259  

Order backlog

  1     1,108     (1,108 )       1,108     (46 )   1,062  
                               

Total identified intangible assets

      $ 10,015     (4,796 ) $ 5,219   $ 10,015     (2,205 ) $ 7,810  
                               

        Amortization expense related to finite-lived intangible assets for 2010, 2009 and 2008 was $2.6 million, $843,000 and $711,000, respectively. Amortization expense in 2010 and 2009 relates primarily to our acquisitions of MCSI in January 2007, the networking solutions division of Cross in October 2009 and the reseller business of Incentra in December 2009. Amortization expense in 2008 relates primarily to our acquisition of MCSI in January 2007. The finite lived intangibles we acquired related to the reseller business of Incentra consisted of trademarks, order backlog and customer relationships and have estimated lives of three years, one year and 8 years, respectively. The finite lived intangibles we acquired related to the networking solutions division of Cross consisted of the services agreement and certifications and have estimated lives of four years and 2 years, respectively. The finite lived intangibles we acquired related to our acquisition of MCSI consisted of customer relationships and backlog and have estimated lives of six years and two months, respectively. We are amortizing all finite lived intangibles using the straight line method. Expected amortization in each of the next five years is as follows:

 
  (in thousands)  

2011

    1,472  

2012

    1,292  

2013

    553  

2014

    481  

2015

    481  
       

  $ 4,279  
       

4.     Income Taxes:

        The reconciliation of the U.S. federal statutory tax rate to our effective income tax rate is as follows:

 
  2010   2009   2008  

Tax expense (benefit) at U.S. statutory rates

    34.0 %   (34.0 )%   34.0 %

State tax expense, net of federal tax effect

    4.7     11.9     3.7  

Nondeductible expenses and other

    3.0     22.9     2.0  

Incentive stock options

    0.6     54.1      
               

Effective tax rate

    42.3 %   54.9 %   39.7 %
               

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        Significant components of our deferred tax assets and liabilities are as follows:

 
  Year Ended
December 31,
 
 
  2010   2009  
 
  (in thousands)
 

Current deferred tax assets:

             
 

Allowance for doubtful accounts

  $ 91   $ 257  
 

Compensation accrual

    526     235  
 

Inventories

    47     54  
 

Deferred revenue

    6,119     6,533  
 

Deferred prepaids

    (10,846 )   (8,323 )
 

Net operating loss carryovers

    1,488     1,560  
 

Change in accounting method

    (1,202 )   (1,202 )
 

Other

    54     72  
           
   

Total current deferred tax assets (liabilities)

    (3,723 )   (814 )

Long-term deferred tax liabilities:

             
 

Net operating loss carryovers

    408     417  
 

Intangibles

    (760 )   (837 )
 

Property and equipment

    (9 )   37  
 

Sublease reserve

    133     242  
 

Section 481(a) adjustment non-current

        (1,202 )
 

Other

    25     (14 )
           
   

Total long-term deferred tax liabilities

    (203 )   (1,357 )
           

Net deferred tax assets (liabilities)

  $ (3,926 ) $ (2,171 )
           

        Our fiscal years 2008 and 2009 are under IRS examination. The IRS is examining our change in accounting methodology for deferred maintenance contracts. The timing of the resolution of this examination, as well as the amount and timing of any related settlement, is uncertain. We believe that before the end of fiscal year 2011, it is reasonably possible that this audit will conclude. We believe our reserves are adequate to cover any potential assessments that may result from this examination.

        The tax expense for 2010 and 2009 consists of the following:

 
  Year Ended
December 31,
 
 
  2010   2009  
 
  (in thousands)
 

Current income tax expense

  $ 13     109  

Deferred tax (expense) benefit

    1,677     88  
           

Income tax expense

  $ 1,690     197  
           

        In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that we will realize some portion or all of the deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. As of December 31, 2010, we have federal net operating carryforwards of approximately $4.6 million which fully expire in 2029. As of December 31, 2010, we have state net operating loss carryforwards of approximately $6.9 million, which are available to offset future state taxable income. If not used, the state net operating loss carryforwards will expire between 2013 and 2028. For 2010 and 2009, respectively, we recorded approximately $15,800 and $1,300 to equity for tax benefits associated with the vesting of restricted stock and the exercise of stock options. For 2008, we recorded approximately $13,000 to equity for tax expenses associated with the exercise of stock options. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 40% to 44%.

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5.     Lease Commitments:

        Our corporate headquarters including our principal technical and support services operations, are located in an office and warehouse facility in Chanhassen, Minnesota. As of December 31, 2010, our other 21 leased locations, housing sales and technical staff, are small to medium sized offices. We have regional hubs located in the Northeast, South, Mid Central, North Central and West.

        As of December 31, 2010, future minimum lease payments due under non-cancelable operating leases are as follows:

 
  Lease
Obligations
  Sublease
Agreements
  Net Lease
Obligations
 
 
  (in thousands)
 

2011

  $ 2,193   $ (719 ) $ 1,474  

2012

    1,064     (239 )   825  

2013

    428         428  

2014

    362         362  

2015

    21         21  
               

  $ 4,068   $ (958 ) $ 3,110  
               

        In December 2004, we agreed to sublease approximately 52,000 of the 106,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term is co-terminal with the original lease ending in April 2012. The sublessee pays us rent ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. The rent includes the costs of common area management, common systems repairs, real estate taxes and standard utilities.

        Total rent expense, net of sublease income of $663,000, $663,000 and $663,000 in 2010, 2009 and 2008, respectively, is as follows:

 
  Year Ended December 31,  
 
  2010   2009   2008  
 
  (in thousands)
 

Rent expense

  $ 2,386   $ 1,354   $ 1,235  
               

6.     Employee Benefit Plan:

        We have a defined contribution retirement plan for eligible employees. Employees may contribute up to 15% of their pretax compensation to the 401(k) portion of the plan. Since April 2006, we have matched 50% of an employee's contribution up to the first 6% of an employee's eligible compensation. The cost of our contributions to the 401(k) portion of the plan for 2010, 2009 and 2008 was $762,000, $640,000 and $568,000, respectively.

7.     Stockholders' Equity:

    Stock Compensation Plans:

        In May 2009, our shareholders approved our 2009 Incentive Compensation Plan ("2009 Plan"). The 2009 Plan replaced our existing 1999 Incentive Compensation Plan ("1999 Plan"), which terminated according to its terms on June 11, 2009. We reserved up to 1,000,000 initial shares of our common stock for possible issuance under the 2009 Plan. In May 2010, our shareholders approved an increase in the number of shares for possible issuance under the 2009 Plan from 1,000,000 shares to 1,500,000 shares. Awards under the 2009 Plan may consist of options (non-qualified and incentive stock options), stock appreciation rights, or SARs, restricted stock units, performance units, dividend

52


equivalents, annual incentive awards and other share-based awards as determined by our Compensation Committee. The terms and conditions of each award are set in an award agreement as determined by the Compensation Committee. As of December 31, 2010, there were 482,943 shares available for grant under the 2009 Plan.

        In August 2000, we adopted our 2000 Director Stock Option Plan (the "Director Plan"). The terms of the Director Plan as most recently amended in May 2007, allow for stock option grants to non-employee members of the Board of Directors. We have reserved 550,000 shares of common stock for issuance pursuant to the Director Plan, 161,034 of which were available for grant as of December 31, 2010.

    Non-Vested Stock Plans:

        On December 15, 2010, we awarded 229,000 shares on non-vested stock to certain employees. The non-vested stock vests over three years with one-third vesting each year if the individual is still employed by us. During the vesting period, the individual has voting rights and the right to receive dividends. However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they have vested. We are amortizing the $999,000 fair value of the non-vested shares on the date of grant ratably over the three-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $985,000 at December 31, 2010. For 2010, compensation expense related to these non-vested stock grants was $14,000.

        On August 17, 2010, we awarded 25,000 shares of non-vested stock to managers and certain employees. The grants vest upon the achievement of an on-time and on-budget implementation of the new Enterprise Resource Planning system. In addition, the individual employee must remain employed by us through February 1, 2012. We will amortize the $85,000 fair value of the non-vested shares on the date of grant ratably over the eighteen-month vesting period. Unrecognized compensation expense related to the non-vested stock grants was $57,000 at December 31, 2010. For 2010, compensation expense related to these non-vested stock grants was $28,000.

        On August 17, 2010, we awarded 42,307 shares of non-vested stock to executive management. The grants vest upon the achievement of our predetermined earnings from operations objective for the second-half of 2010 as approved by our Board of Directors, which have been achieved. In addition, the individual employee must remain employed by us through December 31, 2011. We will amortize the $144,000 fair value of the non-vested shares on the date of grant ratably over the eighteen-month vesting period. Unrecognized compensation expense related to the non-vested stock grants was $102,000 at December 31, 2010. For 2010, compensation expense related to these non-vested stock grants was $42,000.

        On February 2, 2010, we awarded 50,000 shares of non-vested stock to senior management and managers. The grants vest upon the achievement of our predetermined earnings from operations objective for 2010 as approved by our Board of Directors. In addition, the individual employee must remain employed by us through December 31, 2011. We are amortizing the $223,000 fair value of the non-vested shares over a two-year period that began on January 1, 2010, the date we reasonably believed that we would meet our earnings from operations objective for 2010. Unrecognized compensation expense related to the non-vested stock grants was $112,000 at December 31, 2010. For 2010, compensation expense related to these non-vested stock grants was $112,000.

        On December 14, 2009, we awarded 201,250 shares of non-vested stock to senior management and managers. The grants vest upon the achievement of our predetermined earnings from operations objective for 2010 as approved by our Board of Directors. In addition, the individual employee must remain employed by us through December 31, 2011. We are amortizing the $767,000 fair value of the non-vested shares over a two-year period that began on January 1, 2010, the date we reasonably

53



believed that we would meet our earnings from operations objective for 2010. Unrecognized compensation expense related to the non-vested stock grants was $316,000 at December 31, 2010. For 2010, compensation expense related to these non-vested stock grants was $316,000.

        On December 17, 2009, we awarded 132,500 shares of non-vested stock to senior management and managers that we hired in conjunction with our acquisition of the Incentra reseller business. The grant vests over four years with fifty percent after year two and twenty five percent after years three and four if the individual is still employed by us. During the vesting period, the individual has voting rights and the right to receive dividends. However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they have vested. We are amortizing the $521,000 fair value of the non-vested shares on the date of grant ratably over the four-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $344,000 and $496,000 at December 31, 2010 and December 31, 2009, respectively. For 2010 and 2009, compensation expense related to these non-vested stock grants was $122,000 and $5,000, respectively.

        On December 17, 2009, we awarded 30,000 shares on non-vested stock to certain employees. The grant vests over three years with one-third vesting each year if the individual is still employed by us. During the vesting period, the individual has voting rights and the right to receive dividends. However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they have vested. We are amortizing the $118,000 fair value of the non-vested shares on the date of grant ratably over the three-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $77,000 and $116,000 at December 31, 2010 and December 31, 2009, respectively. For 2010 and 2009, compensation expense related to this non-vested stock grant was $39,000 and $2,000, respectively.

        In 2008, we issued 26,609 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2008, total compensation expense for these awards was approximately $107,000. In 2009, we issued 41,922 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2009, total compensation expense for these awards was approximately $155,000. In 2010, we issued 37,030 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2010, total compensation expense for these awards was approximately $153,000.

        The following table summarizes our non-vested stock activity as of December 31, 2010:

 
  Number of Shares   Weighted Average
Grant-Date Fair Value
 

Non-vested stock at January 1, 2008

    689,625   $ 5.48  
 

Granted

      $  
 

Shares vested

    (134,951 ) $ 3.89  
 

Shares cancelled

    (76,916 ) $ 7.11  
           

Non-vested stock at January 1, 2009

    477,758   $ 5.66  
 

Granted

    358,750   $ 3.86  
 

Shares vested

    (206,625 ) $ 4.20  
 

Shares cancelled

    (54,084 ) $ 4.95  
           

Non-vested stock at January 1, 2010

    575,799   $ 4.65  
 

Granted

    351,307   $ 4.19  
 

Shares vested

    (147,880 ) $ 5.10  
 

Shares cancelled

    (132,169 ) $ 5.75  
           

Non-vested stock at December 31, 2010

    647,058   $ 4.04  
           

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    Stock Options:

        We had no stock option grants in 2010.

        In December 2009, we awarded 25,000 stock options to one of our managers. The stock options vest over three years with one-third vesting each year if the individual is still employed by us. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The weighted-average fair value per option at the date of grant was $2.35. We estimated the fair value for the stock option grant with the following average assumptions:

 
  2009

Risk-free interest rates

  2.7%

Expected dividend yield

  0

Expected volatility factor

  67%

Expected option holding period

  6 years

        In July 2009, we awarded 450,000 stock options to our president and chief executive officer. The stock options vest 25% per year over a term of four years, provided he continues employment with us through each relevant vesting date. Unvested stock options will immediately vest upon a change of control of us (as defined in his employment agreement) but only if he (i) is continuously employed to the date of the change of control, (ii) the change of control price (as defined in the employment agreement) exceeds $3.50 per share, (iii) our compensation committee authorizes the acceleration and vesting of the options and (iv) such acceleration and vesting will not cause the option to be subject to the adverse consequences described in Section 409A of the Internal Revenue Code. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The weighted-average fair value per option at the date of grant was $2.15. We estimated the fair value for the stock option grant with the following weighted average assumptions:

 
  2009

Risk-free interest rates

  2.8%

Expected dividend yield

  0

Expected volatility factor

  66%

Expected option holding period

  6 years

        In February 2008, we awarded 200,000 and 115,000 stock options to executive officers and managers, respectively. The stock options vest over three years with one-third vesting each year if the individual is still employed by us. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The weighted-average fair values per option at the date of grant were $2.52. We estimated the fair value for the stock option grants with the following weighted average assumptions:

 
  2008

Risk-free interest rates

  2.9%

Expected dividend yield

  0

Expected volatility factor

  71%

Expected option holding period

  6 years

        The risk-free rate is based on a treasury instrument whose term is consistent with the expected life of our stock options. Expected volatility is based on the historical volatility of our share price for the period prior to the option grant equivalent to the expected holding period of the options. The expected holding period and dividend yield are based on historical experience. Total stock-based compensation expense related to stock options was $335,000 at December 31, 2010. Unrecognized stock-based compensation expense related to stock options was $660,000 at December 31, 2010.

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        The following table summarizes activity under our stock option plans:

 
  Outstanding Options  
 
  Number of Shares   Range of
Exercise Prices
  Weighted Average
Exercise Price
 

Balance, December 31, 2007

    1,122,588   $1.44 - $18.13   $ 5.66  
 

Options granted

    315,000   $3.91   $ 3.91  
 

Options exercised

    (19,773 ) $1.80 - $4.36   $ 3.04  
 

Options cancelled

    (26,022 ) $3.32 - $18.13   $ 6.16  
               

Balance, December 31, 2008

    1,391,793   $1.44 - $18.13   $ 5.29  
 

Options granted

    475,000   $3.50   $ 3.50  
 

Options exercised

    (57,475 ) $3.32 - $4.01   $ 3.48  
 

Options cancelled

    (569,398 ) $3.16 - $18.13   $ 5.57  
               

Balance, December 31, 2009

    1,239,920   $1.44 - $18.13   $ 4.57  
 

Options granted

        $  
 

Options exercised

    (91,620 ) $3.32 - 4.36   $ 3.68  
 

Options cancelled

    (110,589 ) $3.16 - 18.13   $ 9.78  
               

Balance, December 31, 2010

    1,037,711   $1.44 - $9.81   $ 4.10  
               

Options exercisable as of December 31, 2008

    1,076,793   $1.44 - $18.13   $ 5.69  

Options exercisable as of December 31, 2009

    641,587   $1.44 - $18.13   $ 5.11  

Options exercisable as of December 31, 2010

    627,878   $1.44 - $9.81   $ 3.80  

        The following is a summary of options outstanding at December 31, 2010:

Stock
Options
  Range of Exercise
Price Per Share
  Weighted Average
Exercise Price
Per Share
  Weighted Average
Remaining Contractual
Life (Years)
 
  44,650   $1.44 - $3.00   $ 2.38     2.8  
  883,818   $3.01 - $6.00   $ 3.62     6.5  
  109,243   $6.01 - $9.81   $ 8.61     0.2  
               
  1,037,711   $1.44 - $9.81   $ 4.10     5.7  
               

        At December 31, 2010, 2009 and 2008, respectively, the aggregate intrinsic value of options outstanding and exercisable was $580,122, $361,178 and $40,150. Total intrinsic value of options exercised was $337,496, $199,768 and $60,019 for 2010, 2009 and 2008, respectively.

8.     Commitments and Contingencies

        We have change of control severance agreements and employment agreements in place with certain executive employees. Under the agreements, an executive is entitled to a severance payment in the event the executive (a) is terminated without cause by us in anticipation of, in connection with, at the time of or within two years after a change of control, or (b) resigns for good reasons arising in anticipation of, in connection with, at the time of or within two years after a change of control.

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9.     Quarterly Financial Information (unaudited)

 
  March 31   June 30   Sept 30   Dec 31  
 
  (in thousands, except per share data)
 

2010

                         

Net sales

  $ 62,544   $ 70,875   $ 69,220   $ 91,040  

Gross profit

    14,332     16,760     16,665     19,879  

Operating earnings (loss)

    (1,535 )   (65 )   1,425     4,153  

Net earnings (loss)

    (891 )   5     771     2,417  

Net earnings (loss) per share—basic

    (0.07 )   0.00     0.06     0.19  

Net earnings (loss) per share—diluted

    (0.07 )   0.00     0.06     0.19  

 

 
  March 31   June 30   Sept 30   Dec 31(a)  
 
  (in thousands, except per share data)
 

2009

                         

Net sales

  $ 39,868   $ 43,697   $ 42,711   $ 51,806  

Gross profit

    10,573     11,640     10,959     13,264  

Operating earnings (loss)

    (856 )   383     (386 )   408  

Net earnings (loss)

    (596 )   283     (84 )   (158 )

Net earnings (loss) per share—basic

    (0.05 )   0.02     (0.01 )   (0.01 )

Net earnings (loss) per share—diluted

    (0.05 )   0.02     (0.01 )   (0.01 )

(a)
Includes our acquisitions of the networking business of Cross Telecom in October 2009 and the reseller business of Incentra, LLC in December 2009.

10.   Subsequent Events

        None.

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Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

        None.

Item 9A.    Controls and Procedures

    (a)
    Evaluation of Disclosure Controls and Procedures

        Under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal financial officer), we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at December 31, 2010 to ensure that information we are required to disclose in reports that we file or submit is accumulated and communicated to our management, including our principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosures, and that such information is recorded, processed, summarized and reported within the time periods specific in the Securities and Exchange Commission rules and forms.

    (b)
    Management's Report on Internal Control over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controls are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2009. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.

        Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2010.

        This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our independent registered public accounting firm is not required to attest to management's report pursuant to Item 308(b) of Regulation S-K because we are not an accelerated filer or large accelerated filer.

    (c)
    Changes in Internal Control

        There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Item 9B.    Other Information

        Not Applicable.

58



PART III

Item 10.    Directors, Executive Officers and Corporate Governance of the Registrant.

        Information contained in Item 1 under the heading "Executive Officers," as well as under "Election of Directors," "Executive Compensation—Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our proxy statement for our 2011 annual meeting of shareholders, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Form 10-K (the "2011 Proxy Statement") is incorporated herein by reference.

        We have adopted a code of ethics that applies to our officers, including our principal executive, financial and accounting officers, and our directors and employees. We intend to make all required disclosures concerning any amendments to, or waivers from, our code of ethics by the filing current reports on Form 8-K.

Item 11.    Executive Compensation.

        We incorporate the information set forth under "Executive Compensation" and "Director Compensation" in our 2011 Proxy Statement herein by reference.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

        We incorporate the information set forth under "Outstanding Voting Securities and Voting Rights" in our 2011 Proxy Statement herein by reference.

        The following table provides certain information as of December 31, 2010 with respect to our equity compensation plans.

 
  Equity Compensation Plan Information  
Plan Category
  Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
  Weighted-average
exercise price of
outstanding options,
warrants and rights
  Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
the first column)
 

Equity compensation plans approved by security holders(1)

    1,037,711   $ 4.10     643,977  

Equity compensation plans not approved by security holders

             
               

Totals

    1,037,711   $ 4.10     643,977  
               

(1)
These equity compensation plans consist of our 1999 and 2009 Incentive Compensation Plans and our 2000 Director Stock Option Plan, each as amended.

Item 13.    Certain Relationships and Related Transactions.

        We incorporate the information required by this section by reference from the information set forth under "Certain Relationships and Related Transactions" and "Corporate Governance" in our 2011 Proxy Statement.

Item 14.    Principal Accountant Fees and Services.

        We incorporate the information required by this section by reference from the information set forth under "Auditing Matters" in our 2011 Proxy Statement.

59



PART IV

Item 15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a)
We are filing the following documents as part of this Form 10-K report:

1.
Financial Statements

      Reference is made to the Financial Statements of Datalink Corporation, under Item 7 in Part II of this Form 10-K.

    2.
    Financial Statement Schedules.

      The following financial statement schedule of Datalink Corporation for 2010, 2009 and 2008 is filed as part of this Annual Report and should be read in conjunction with the Financial Statements of Datalink Corporation.

    3.
    Exhibits.

      The exhibits filed with this report are set forth on the exhibit index filed as a part of this report immediately following the signatures to this report.

60



DATALINK CORPORATION
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008

Description
  Period   Balance at
Beginning
of Period
  Additions   Deductions(1)   Balance
at End
of Period
 

Allowance for Doubtful Accounts

    2010   $ 628,974   $ 72,668   $ 498,117   $ 203,526  

    2009     198,688     459,447     29,161     628,974  

    2008     112,492     88,336     2,140     198,688  

(1)
Deductions reflect write-offs of customer accounts receivables, net of recoveries.

61



SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

    DATALINK CORPORATION

 

 

 

 

 
Date: March 1, 2011        
    By:   /s/ PAUL F. LIDSKY

Paul F. Lidsky,
President and Chief Executive Officer

 

 

By:

 

/s/ GREGORY T. BARNUM

Gregory T. Barnum,
Vice President of Finance and Chief
Financial Officer

        Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature
 
Title
 
Date

 

 

 

 

 
/s/ PAUL F. LIDSKY

  President, Chief Executive Officer and Director (Principal Executive Officer)   March 1, 2011

/s/ GREGORY T. BARNUM


 

Vice President of Finance and Chief Financial Officer (Principal Financial Officer)

 

March 1, 2011

/s/ DENISE M. WESTENFIELD


 

Corporate Controller (Principal Accounting Officer)

 

March 1, 2011

/s/ GREG R. MELAND


 

Chairman of the Board and Director

 

March 1, 2011

/s/ BRENT G. BLACKEY


 

Director

 

March 1, 2011

/s/ MARGARET A. LOFTUS


 

Director

 

March 1, 2011

/s/ J. PATRICK O'HALLORAN


 

Director

 

March 1, 2011

/s/ JAMES E. OUSLEY


 

Director

 

March 1, 2011

/s/ ROBERT M. PRICE


 

Director

 

March 1, 2011

62



EXHIBIT INDEX

Exhibit
Number
  Title   Method of Filing
2.1   Agreement and Plan of Merger dated January 20, 2007, by and among Midrange Computer Solutions, Inc., Dan Kalin, Michael Spindler, Wayne Szczepanski and Lodi Vercelli, and Datalink Corporation and Datalink Acquisition LLC   10
2.2   Asset Purchase Agreement dated December 17, 2009, by and between Datalink Corporation
and Incentra, LLC
  14
3.1   Amended and Restated Articles of Incorporation of the Company   17
3.2   Amended and Restated Bylaws of the Company   19
4.1   Form of Common Stock Certificate   16
10.2 * 1999 Incentive Compensation Plan, as amended December 18, 2000   2
10.4   Form of Indemnification Agreement   1
10.5 * 2009 Incentive Compensation Plan, as amended May 13, 2010   15
10.13   Building Lease dated April 27, 2001, with Hoyt/DTLK LLC   18
10.22 * 2000 Director Stock Option Plan   Filed herewith
10.23 * Restricted Stock Award Agreement   3
10.24 * Change of Control Severance Agreement   4
10.25   Sublease Agreement dated December 15, 2004, with Checkpoint Security, Inc.   6
10.26   Vacant Land Purchase Agreement   7
10.27 * Correction to Restricted Stock Award Agreements dated August 13, 2004   8
10.28 * Employment Agreement dated March 14, 2006, with Gregory T. Barnum   9
10.29 * Employment Agreement dated February 16, 2007, with Robert R. Beyer   11
10.30 * Employment Agreement dated July 20, 2009, as amended, with Paul F. Lidsky   12
10.31 * Employment Agreement dated December 17, 2009, with M. Shawn O'Grady   13
14.1   Code of Conduct and Ethics Policy   5
23.1   Consent of McGladrey & Pullen, LLP   Filed herewith
31.1   Certifications by the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   Filed herewith
32.1   Certifications by the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   Filed herewith

*
Management contract or compensatory plan or arrangement.

1)
Incorporated by reference to exhibit 10.4 in our registration statement on Form S-1, Reg. No. 333-55935, filed on June 3, 1998.

2)
Incorporated by reference to our proxy statement for our 2001 annual meeting filed on April 6, 2001 (File No. 0-29758).

3)
Incorporated by reference to exhibit 10.23 in our Form 10-Q for the period ending September 30, 2004, filed on November 15, 2004 (File No. 0-29758).

4)
Incorporated by reference to exhibit 10.24 in our Form 10-Q for the period ending September 30, 2004, filed on November 15, 2004 (File No. 0-29758).

5)
Incorporated by reference to exhibit 14.1 in our Form 10-K for the period ended December 31, 2003, filed on March 24, 2004 (File No. 0-29758).

63


6)
Incorporated by reference to exhibit 10.25 in our Form 10-K for the period ended December 31, 2004, filed on March 31, 2005 (File No. 0-29758).

7)
Incorporated by reference to exhibit 10.26 in our Form 10-K for the period ended December 31, 2004, filed on March 31, 2005 (File No. 0-29758).

8)
Incorporated by reference to exhibit 10.25 in our Form 10-Q for the period ending September 30, 2005, filed on November 14, 2005 (File No. 0-29758).

9)
Incorporated by reference to exhibit 10.28 in our Form 8-K filed on March 17, 2006 (File No. 0-29758).

10)
Incorporated by reference to exhibit 2.1 in our Form 8-K filed on February 5, 2007 (File No. 0-29758).

11)
Incorporated by reference to exhibit 10.29 in our Form 8-K filed on February 20, 2007 (File No. 0-29758).

12)
Incorporated by reference to exhibit 10.1 in our Form 8-K filed on January 21, 2011 (File No. 0-29758).

13)
Incorporated by reference to exhibit 10.1 in our Form 8-K filed on December 22, 2009 (File No. 0-29758).

14)
Incorporated by reference to exhibit 2.1 in our Form 8-K filed on December 22, 2009 (File No. 0-29758).

15)
Incorporated by reference to exhibit 10.1 in our Form 8-K filed on May 17, 2010 (File No. 0-29758).

16)
Incorporated by reference to exhibit 4.1 in our amended registration statement on Form S-1/A, Reg. No. 333-55935, filed on July 16, 1998.

17)
Incorporated by reference to the exhibit of the same number in our Registration Statement on Form S-1, filed on June 3, 1998 (File No. 333-55935).

18)
Incorporated by reference to the same exhibit number in our Form 10-Q for the period ending March 31, 2001, filed on May 15, 2001 (File No. 0-29758).

19)
Incorporated by reference to exhibit 3.2 in our Form 8-K filed on February 18, 2011 (File No. 0-29758).

64




QuickLinks

NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I
PART II
Report of Independent Registered Public Accounting Firm
DATALINK CORPORATION BALANCE SHEETS (in thousands, except share data)
DATALINK CORPORATION STATEMENTS OF OPERATIONS (in thousands, except per share data)
DATALINK CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
DATALINK CORPORATION STATEMENTS OF CASH FLOWS (In thousands)
DATALINK CORPORATION NOTES TO FINANCIAL STATEMENTS
PART III
PART IV
DATALINK CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
SIGNATURES
EXHIBIT INDEX