10-K 1 a2218827z10-k.htm 10-K
QuickLinks -- Click here to rapidly navigate through this document


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, 2013

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

10050 Crosstown Circle, Suite 500
EDEN PRAIRIE, MINNESOTA 55344
(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.

Name of exchange on which registered: NASDAQ Global Market

        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 ý    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. o

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

        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, 2013: $169,511,107.

        At March 7, 2014, the number of shares outstanding of the registrant's classes of common stock was 22,770,272.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Registrant's Proxy Statement for its 2014 Annual Meeting of Shareholders 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 on Form 10-K (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 data center solutions and services including the effects of current economic and credit conditions and the ability of organizations to outsource data center infrastructure-related services to service providers such as us; the migration of organizations to virtualized server environments, including using a private cloud computing infrastructure; the extent to which customers deploy disk-based backup recovery solutions; the realization of the expected trends identified for advanced network infrastructures; reliance by manufacturers on their data service partners to integrate their specialized products; continued preferred status with certain principal suppliers; 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; continued productivity of our sales personnel; our dependence on key suppliers; our ability to adapt to rapid technological change; success of the implementation of our enterprise resource planning system; risks associated with integrating completed and future acquisitions; fluctuations in our quarterly operating results; future changes in applicable accounting rules; and volatility in our stock price. Further, our revenues are not necessarily reflected by our backlog of contracted orders, which also may fluctuate unpredictably.

        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. Additional factors that may cause actual results to differ from our assumptions and expectations include those set forth in our Form 10-K and Form 10-Qs that we file with the Securities and Exchange Commission. All forward-looking statements are quantified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to us, see the "Risk Factors" section of this Form 10-K.


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 midsize and large companies, we assess, design, deploy, manage, and support unified infrastructures such as servers, storage and networks. We leverage hardware and software from the industry's leading original equipment manufacturers (OEMs) as part of our data center optimization 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 consolidation solutions and services enable organizations to share server and storage resources, thereby reducing the number of systems to be managed and maintained. Virtualization refers to the various techniques or approaches of creating a virtual, rather than actual, version of an operating system, server, storage device, or network

1


      resources. 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). Cloud computing refers to the use of Internet-based computing, storage and connectivity for a variety of different services. 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 and storage 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 network-attached, direct-attached, and private cloud-based storage, 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. We also offer managed backup services whereby customers engage us to assume day-to-day management of their backup operations. In addition, we offer data capacity planning services that help organizations plan for data growth, as well as maximize utilization of all storage systems.

    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 a consolidated and converged network. We also provide contracts administration services as part of our SmartNet service.

    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 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 200 engineering professional and support services members that are based throughout the United States.

        We have a robust physical laboratory in Minneapolis that customers can visit. This lab enables customers to participate in physical demonstrations of a wide variety of technologies, including: site-to-site replication, data recovery, WAN optimization, de-duplication, and virtual data center architectures. Alternatively, customers can participate in a virtual demonstration from the convenience of their own office.

        In addition to demonstrations, we leverage this lab 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

        Midsize and large companies, which are typically greater than 500 employees, are increasingly focused on transforming their data centers in order to increase agility, enhance service levels, and reduce costs. These customers continue to invest in their data centers while at the same time taking

2


advantage of cloud computing that may include private, hybrid and public clouds. Information technology (IT) departments are faced with the daunting challenge of managing rapidly expanding amounts of data. In addition, IT departments face increasing demands for availability of this data for day-to-day business and to meet regulatory requirements. At the same time, organizations are seeking greater operational efficiency and lower costs. 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. 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.

        We anticipate that the virtualization of servers, storage and networks and migration to unified virtual data center architectures 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 environments. We also expect that the increased bandwidth requirements of high density virtualized server environments will drive demand for high bandwidth integrated converged networks.

        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.

        We believe that capital investment priorities of the customers in our industry will include:

    Data center transformation

      Virtualization will play a key role in data center transformation strategies. Virtualization along with private and hybrid 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 continue to seek the professional services of a provider, like us, to assess their environment, conduct a gap analysis, and develop virtual data center migration paths that will enable them to protect and leverage each investment as they migrate to a private-cloud computing infrastructure. We expect that most of our customers will continue to deploy virtual data center infrastructures in a phased-in or total build out approach. We also expect that organizations will continue to seek 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 complied with data center security are key drivers in data center decision making. We expect these requirements will continue to 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. The advancement of data center virtualization increases the need to update networking infrastructure

3


      to support increased bandwidth with networking infrastructure and management that is more integrated with server virtualization and private cloud initiatives. In addition, those seeking simplified management, cost reductions, and increased flexibility will consolidate and converge disparate networks (e.g. storage and 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 holistic solution. An increased focus on technologies that provide greater efficiency and business value, the growing complexity of networked environments and flat IT department headcount growth in light of current economic conditions should 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. Private cloud computing is transformational in nature. It impacts the relationship between the business and IT, as well as how IT organizations are structured and operate. 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.

        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, we believe 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 implemented 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.

4


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:

Advanced Services Consulting

        Our consultants deliver highly customized analysis, advice, and actionable recommendations to help customers transform, optimize and manage their data centers. Our independent recommendations help customers respond to challenges in the following areas: data center transformation, private and hybrid cloud service management and IT resiliency.

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 unified data center 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 center solutions for over twenty years to customers in numerous industries.

        Our assessment services provide customers with objective guidance on developing virtualization and consolidation, private and hybrid cloud, 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 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 around the clock technical support from a team of customer support and field engineers. Our extensive experience with data center solutions enables our staff to deliver expert configuration and usage assistance, technical advice and prompt incident detection and

5


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 managed services. Our services enhance the productivity of our customer's IT teams, as well as drive greater operational efficiency. Our monitoring and reporting services provide real-time data and historical analysis of the performance of unified data center infrastructures spanning storage, servers, and networks. We also offer data management services that enhance data protection capabilities. Finally, we offer a suite of managed infrastructure services which includes around the clock monitoring, management, and reporting. Managed 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.

Our Strategy

        Our strategy is to improve upon our position as a data center solutions and services provider and to continue 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 acquisitions to grow our business including our acquisitions of Midwave Corporation in 2011 and Strategic Technologies, Inc. in 2012 (each discussed in more detail below). We intend to continue to grow our business via select acquisitions. We seek acquisition targets that align closely with our data center portfolio offerings.

Expand Customer Support Revenues

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

6


Enhance and Expand Our Advanced Services 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. Our Advanced Services team offers a comprehensive portfolio of services that are aligned with business needs in the following areas:

    Data center transformation, including data center relocation, data migrations, infrastructure architecture, facilities strategy, and IT project management;

    Cloud service management, including IT as a service strategy, IT infrastructure library processes, services catalogs, and automation and orchestration; and

    IT resiliency, including business impact analysis, business continuity and disaster recovery plans, data protection strategy and security.

In 2013, we made a significant investment in building out our Advanced Services organization and its services portfolio. We hired a leadership team who are very experienced in building a consulting practice within a datacenter infrastructure and integration company. We also added several advanced services offerings and enhanced other offerings. These new offerings along with others previously built, represent a services catalog that provides a revenue and profit stream that is not dependent on product sales or fulfillment. By expanding our consulting methodologies and offerings, building additional sales tools and cross-training our infrastructure organization, we will be able to expand our solution selling capabilities. We believe hiring experienced data center consultants, and providing our sales teams with the tools they need to uncover consulting opportunities, will accelerate consulting services revenues and often times result in additional hardware and software revenues.

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 focus efforts around our expanded 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, archiving, server, storage and network operations.

Segment and Geographic Information

        We do not have any separate reportable segments. In addition, we have not generated any of our revenues outside of the United States and we do not have any long-lived assets located outside of the United States.

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. 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,

7


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.

        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
Quantum Corporation

Tape Automation

 

Oracle Systems
Quantum Corporation
Spectra Logic Corporation

Software

 

Oracle Systems
Sepaton Inc.
Symantec Corporation
VMware, Inc.

Servers

 

Cisco Systems, Inc.
Dell Inc.
Oracle Systems

Switches/Directors/Storage Networking

 

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

        We have not had difficulty in obtaining products that we use in our business from our current suppliers. In addition, we do not rely on one or a few suppliers for the products we use in our business.

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.

        In 2013, 2012, and 2011, we had no customers that accounted for 10% or more of our revenues. However, our top five customers collectively accounted for 10%, 11%, and 11% of our 2013, 2012, and 2011 revenues, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the historical revenue generated by our services.

Sales and Marketing

        We market and sell our products and services throughout the United States through a direct sales force. In addition to our Minneapolis headquarters, as of December 31, 2013, we have 36 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

8


account executive and account associate. Our sales and technical teams generated a total of 440 new customers in 2013 through a combination of acquisitions and organic growth and sold product and services to over 2,200 current customers. Our sales and technical teams generated a total of 452 new customers in 2012 and 290 new customers in 2011.

        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 generation campaigns, gain exposure through online and print trade publications, hold information seminars, and use social media channels to share information about topics, such as virtual data centers, private cloud computing, storage, data protection and disaster recovery and business continuity trends and best practices.

Competition

        Competition for the solutions we provide is fragmented, and we compete with numerous large and small competitors. For data center solutions we compete with other technology infrastructure solution providers and system integrators, and technology value added resellers that focus on providing data center solutions. Our competitors are primarily either resellers that provide solutions using many of the same products from the manufacturers that we represent such as Cisco, EMC, Hitachi, NetApp, Symantec, VMware or they also may provide solutions using other competing manufacturer's products such as IBM, HP and others. We may also compete directly against some of these manufacturers when they are involved in selling to the customer directly.

        We believe that the principal competitive factor when marketing our solutions is our overall business model where we are focused on making data centers more efficient, manageable and responsive to our customer's business needs. Other important factors include total cost, technical competence, the strength of our relationship with the customer, the quality of our support services, and the quality of our relationship with the manufacturer of the products being supplied as part of a data center solution.

Employees

        As of December 31, 2013, we had a total of 510 employees, all of which 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, Finance and Chief Financial Officer, and Mr. O'Grady, our Chief Operating Officer. None of our employees are unionized or subject to a collective bargaining agreement. We have experienced no work stoppages.

Backlog

        Effective January 1, 2011, our revenue recognition policy requires us to recognize product revenues upon shipment as compared to upon installation under our old revenue recognition method. 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. Customer constraints, including customer readiness, and the availability of engineering resources may impact when we can complete our installation and configuration services, which represent approximately 6% of our revenues. Therefore, we do experience a backlog of orders. Our backlog, which represents firm orders we expect to recognize as revenue within the next 90 days, was $77.4 million and $63.6 million at December 31, 2013 and 2012, respectively.

Acquisitions

        Strategic Technologies, Inc.    On October 4, 2012, we purchased substantially all of the assets and liabilities of Strategic Technologies, Inc. ("StraTech") from StraTech and Midas Medici Group Holdings, Inc. ("Midas," parent company of StraTech, and, together with StraTech, the "Sellers").

9


StraTech is an IT services and solutions firm that shares our focus on optimizing enterprise data centers and IT infrastructure through a common product and services portfolio designed to help customers increase business agility. We purchased StraTech for an estimated purchase price of approximately $11.9 million, comprised of a cash payment of approximately $13.2 million, which is offset by a receivable due from the Sellers of approximately $3.3 million, resulting from the preliminary estimated tangible net asset adjustment as defined by the asset purchase agreement. In addition, we issued 269,783 shares of our common stock with a value of approximately $2.0 million. Of those shares, 242,805 shares were deposited in an escrow account as security for certain indemnification obligations of the Sellers.

        Pursuant to the asset purchase agreement, Sellers were obligated to pay us an amount equal to the difference between the actual tangible net assets on the closing date and the Sellers' good faith estimated net tangible assets as set forth in the asset purchase agreement. We initially recorded a receivable due from Sellers of approximately $4.2 million related to this payment at the acquisition date. The Sellers provided us with a "Notice of Disagreement," which stated that they disputed the amount owed to us in connection with this reconciliation payment. The asset purchase agreement contained an arbitration provision for disputes over the value of tangible net assets. During the measurement period (up to one year from the acquisition date), the final tangible net asset adjustment was agreed to and the net effect was a decrease in the receivable due from Sellers of $936,000 and an increase in the purchase price for the same amount as reflected above.

        In January 2014, we reached a settlement agreement with the former owners of StraTech regarding the disputed amount owed to us in connection with the reconciliation payment mentioned above. Under the terms of the agreement, the former owners of StraTech agreed to release the entire 242,805 shares of Datalink common stock that were being held in escrow in exchange for a payment of $100,000 and the release of certain other claims. As of December 31, 2013, the remaining $3.3 million receivable due from the Sellers was deemed to be uncollectible and written down to the estimated realizable value, which is the fair value of the shares in escrow on December 31, 2013. The remaining receivable of $2,647,000 was reclassified from accounts receivable to equity within the December 31, 2013 balance sheet. The results for 2013 include a $611,000 charge for the write-down of the account receivable due from the Sellers of StraTech to the fair value of the stock on December 31, 2013 and reported as a non-operating expense on the statement of operations. Based on the value of our common stock on the date of the settlement agreement in January 2014, we will record a gain before tax of approximately $877,000 during the first quarter of 2014 as a result of the increase in our stock price from December 31, 2013 to the date we repossessed the shares in escrow.

        This acquisition expanded our market share and physical presence across the Eastern seaboard of the United States. The acquisition also allows us to diversify our product offerings from certain manufacturers and expand our high-margin professional and managed services business lines. We expect to experience operational synergies and efficiencies through combined general and administrative corporate functions. Our results for 2012 reflect the addition of StraTech for the fourth quarter. Please see Note 2 to our financial statements for further information.

        Midwave Corporation.    In October 2011, we entered into an asset purchase agreement with Midwave Corporation ("Midwave") and its shareholders. Under the asset purchase agreement we purchased and acquired from Midwave substantially all of the assets used in Midwave's business. Midwave is an IT consulting firm that both offers professional services and sells products to business' IT organizations utilizing the product portfolios of certain information technology manufacturers, in the specific domains of data center services, networking services, managed services and advisory services. We paid a purchase price of approximately $19.1 million, comprised of a cash payment delivered at closing of approximately $16.1 million and issued 220,988 shares of our common stock with a value of approximately $1.6 million and approximately $1.4 million related to working capital adjustments subsequent to closing.

10


        This acquisition expanded our footprint in Minnesota making us the dominant data center services and infrastructure provider in the region. The acquisition also doubled our Cisco technology and services revenues, expanded our managed services portfolio with the addition of a data center infrastructure monitoring service, added an established security practice including product, services and consulting and doubled the size of our consulting services team. We have experienced operational synergies and efficiencies through the combined general and administrative corporate functions in 2012 and 2013. Our results for 2011 and 2012 reflect the addition of Midwave during the fourth quarter of 2011. Please see Note 2 to our financial statements for further information.

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 current executive officers:

Name
  Age   Position
Paul F. Lidsky   60   President and Chief Executive Officer
Gregory T. Barnum   59   Vice President, Finance and Chief Financial Officer and Secretary

M. Shawn O'Grady

 

51

 

Chief Operating Officer

Denise M. Westenfield

 

50

 

Vice President, Controller and Chief Accounting Officer and Assistant Secretary

        None of our executive officers have any family relationships with any of the other executive officers or any of our directors.

        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, 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, Finance and Chief Financial Officer in March 2006 and our Secretary in February 2013. 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

11


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.

        M. Shawn O'Grady became our Executive Vice President, Field Operations in December 2009, upon our Incentra acquisition and was appointed as our Chief Operating Officer in November 2013. Prior to joining us, he served Incentra and its affiliates since 2005 in various executive positions, most recently, as its President and Chief Executive Officer. Incentra 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.

        Denise M. Westenfield became our Vice President, Controller, Chief Accounting Officer and Assistant Secretary in February 2013. She joined Datalink in May 2000 as our Corporate Controller and has served us in that capacity since that time. From 1991 to 2000, Ms. Westenfield was employed by Cummins Inc., in its power generation division, most recently as its business controller. Between 1986 and 1991, Ms. Westenfield served in various accounting and financial management capacities for Honeywell Inc. in its Military Avionics Division.

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 few 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 is highly competitive. As technologies change rapidly, we expect that competition will increase in the 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-

12


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, OEMs, 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, we could lose the preferred provider status we maintain with certain suppliers. If that were to occur, it would be more difficult for us to stay ahead of industry developments and provide our customers with the type of service and wide range of technology choices they expect from us.

        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.

Mergers or other strategic transactions involving our competitors could weaken our competitive position, which could harm our operating results.

        Our industry is highly fragmented, and we believe it is likely that our existing competitors will continue to consolidate or will be acquired. In addition, some of our competitors may enter into new alliances with each other or may establish or strengthen cooperative relationships with systems integrators, third-party consulting firms or other parties. Any such consolidation, acquisition, alliance or cooperative relationship could lead to pricing pressure and our loss of market share and could result in a competitor with greater financial, technical, marketing, service and other resources, all of which could have a material adverse effect on our business, operating results and financial condition.

Our business is dependent on the trend toward outsourcing data center infrastructure-related services.

        Our business and growth depend in large part on the industry trend toward outsourced data center infrastructure-related services. Outsourcing means that an entity contracts with a third party, such as us, to provide data center infrastructure-related services such as consulting, implementation, management and support. There can be no assurance that this trend will continue, as organizations may elect to perform such services themselves. A significant change in this trend could have a material adverse effect on our business, financial condition and results of operations. Additionally, there can be no assurance that our cross-selling efforts will cause clients to purchase additional services from us or adopt a single-source outsourcing approach.

13


Our financial results would suffer if the market for IT services and solutions does not continue to grow.

        Our services and solutions are designed to address the growing markets for data center consolidation and virtualization services (including private cloud computing), data center implementation services (including storage and data protection services and the implementation of virtualization solutions), and managed services (including operational support and client support). These markets are still evolving. A reduction in the demand for our services and solutions could be caused by, among other things, lack of client acceptance, weakening economic conditions, competing technologies and services or reductions in corporate spending. Our future financial results would suffer if the market for our data center services and solutions does not continue to grow.

With continued market demand for greater data center agility, scalability, and efficiency, we have been increasingly developing and marketing virtual data center and private cloud computing infrastructures and services. If businesses do not find our virtual data center and private cloud computing solutions compelling, our revenue growth and operating margins may decline.

        Our data center optimization portfolio is based on the virtualization of storage, computing, and network platforms within on-premises data centers. Our success depends on organizations and customers perceiving technological and operational benefits and cost savings associated with services-oriented, virtual data center and private cloud computing-based infrastructures. Although the use of virtualization technologies on servers has become broadly accepted for enterprise-level applications, the extent to which organizations will adopt virtualization across the data center and migrate to private cloud computing remains uncertain. Accordingly, as the market for our virtual data center and private cloud computing infrastructures matures and the scale of our business increases, the rate of growth in our infrastructure and services sales could be lower than those we have experienced in earlier periods. In addition, to the extent that our newer private cloud computing infrastructure solutions and services are adopted more slowly or less comprehensively than we expect, our revenue growth rates may slow materially or our revenue may decline substantially.

If we cannot successfully execute on our strategy to market and deliver new services and solutions, our revenue and gross margin may suffer.

        Our long-term strategy is focused on meeting increased customer demand for integrated IT solutions by leveraging the portfolio of products we offer from leading manufacturers with our own highly customized and innovative services. Our product margins are subject to pricing pressure from our suppliers. In recent years, competition for market share has resulted in increased pricing pressure from these suppliers, reducing the overall profitability of the products we sell. To offset this decline in product margins, we added or enhanced many of our advanced services offerings in a major investment designed to provide a revenue and profit stream that is not affected by product sales or fulfillment. To successfully execute on this strategy, we need to continue to invest, sell, deliver and expand our services portfolio. Any failure to successfully execute this strategy, including any failure to invest sufficiently in strategic growth areas, could adversely affect our business, results of operation and financial results.

Our acquisition strategy poses substantial risks.

        As part of our growth strategy, we made two acquisitions in 2009, one acquisition in October 2011, one acquisition in October 2012 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 acquisition on commercially acceptable terms. We may need to raise additional equity to consummate future acquisitions, which may not be feasible, may be on terms we do not consider favorable, would cause dilution to existing investors and could adversely affect our stock price. We also could incur substantial indebtedness in connection with an acquisition, which could decrease

14


the value of our equity. The process of exploring and pursuing acquisition opportunities requires significant management and financial resources, which diverts attention from our core operations.

        Integration of acquisitions is very challenging and we cannot assure you that any acquisition will increase our revenues, earnings or stock price. Even if we are able to consummate an acquisition, such as our recent acquisitions, 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 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 continued growth could strain our personnel and financial resources and infrastructure, and if we are unable to implement appropriate controls and procedures to manage our growth, we will not be able to implement our business plan successfully.

        Due to our recent acquisitions and continued rapid organic growth, we have experienced a period of rapid growth in our headcount and operations. To the extent that we are unable to sustain such growth, it will place a significant strain on our management, administrative, operational and financial infrastructure. Our success will depend in part upon the ability of our senior management to manage this growth effectively. To do so, we must continue to hire, train and manage new employees as needed. If our new hires perform poorly or do not achieve expected or forecasted utilization rates, or if we are unsuccessful in hiring, training, managing and integrating these new employees, or if we are not successful in retaining our existing employees, our future profitability and our business would be harmed. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. The headcount we are adding will increase our cost base, which will make it more difficult for us to offset any future revenue shortfalls by reducing expenses in the short term. If we fail to successfully manage our growth, we will be unable to execute our business plan.

Our ability to recognize revenue can be adversely affected by product availability.

        We sell complex enterprise-class data storage, server and networking solutions, which include installation and configuration services. We generally recognize revenues from our sale of hardware and software products when shipment has been completed. We rely on our vendors to supply the hardware and software products we sell. We cannot control the availability and shipment of these products. Delays due to component availability, natural disasters and other unforeseen events 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.

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 2013, 2012, and 2011. We

15


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 2013, 2012, and 2011, we had no customers that accounted for 10% or more of our revenues. However, our top five customers collectively accounted for 10%, 11%, and 11% of our 2013, 2012, and 2011 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 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 employees.

        Our future operating results depend in significant part upon the continued contributions of our executive officers, managers, salespeople, engineers and other technical personnel, many of whom have substantial experience in our industry and would be difficult to replace. Except for our President and Chief Executive Officer, Vice President, Finance and Chief Financial Officer, and Chief Operating Officer, 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 increase 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.

16


Our failure to raise additional capital or generate cash flows necessary to expand our operations and invest in new technologies could reduce our ability to compete successfully and adversely affect our results of operations.

        We may need to raise additional funds, and we may not be able to obtain additional debt or equity financing on favorable terms, if at all. If we raise additional equity financing, our security holders may experience significant dilution of their ownership interests and the value of shares of our common stock could decline. If we engage in debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness, force us to maintain specified liquidity or other ratios or restrict our ability to pay dividends or make acquisitions. If we need additional capital and cannot raise it on acceptable terms, we may not be able to, among other things:

    continue to expand our technology development, sales and marketing organizations;

    hire, train and retain employees; or

    respond to competitive pressures or unanticipated working capital requirements.

        Our inability to do any of the foregoing could reduce our ability to compete successfully and adversely affect our results of operations.

If the storage, server and networking solutions industries fail 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.

Our data center services and web site may be subject to intentional disruption.

        Although we believe we have sufficient controls in place to prevent intentional disruptions, such as software viruses specifically designed to impede the performance of our data center services, we may be affected by such efforts in the future. Further, despite the implementation of security measures, this infrastructure or other systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, programming errors, attacks by third parties or similar disruptive problems, resulting in the potential misappropriation of our proprietary information or interruptions of our services. Any compromise of our security, whether as a result of our own systems or systems that they interface with, could substantially disrupt our operations, harm our reputation and reduce demand for our services.

17


Our failure to protect the integrity and security of our customers' information and access to our customers' information systems could expose us to litigation, materially damage our reputation and harm our business, and the costs of preventing such a failure could adversely affect our results of operations.

        Our business involves the collection, processing and storage of our customers' confidential information. This sometimes requires us to receive direct access to our customers' information systems. We cannot be certain that our efforts to protect this confidential information and access will be successful. If any compromise of this information security were to occur, or if we fail to detect and appropriately respond to a significant data security breach, we could be subject to legal claims and government action, experience an adverse effect on our reputation and need to incur significant additional costs to protect against similar information security breaches in the future, each of which could adversely impact our financial condition, results of operations and growth prospects. In addition, because of the critical nature of data security, any perceived breach of our security measures could cause existing or potential customers not to use our solutions and could harm our reputation.

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

        Currently, our executive officers and directors beneficially own approximately 13.9% of our outstanding common stock. Acting together, these insiders may be able to significantly impact the election of our Board of Directors and may have a significant impact on the outcome of all other matters requiring shareholder approval. This voting concentration may also have the effect of delaying or preventing a change in our management or otherwise discourage potential acquirers from attempting to gain control of us. If potential 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 quarterly results of operations may fluctuate in the future, which could result in volatility in our stock price.

        Our quarterly revenues and results of operations have varied in the past and may fluctuate as a result of a variety of factors, including the success of our new offerings. If our quarterly revenues or results of operations fluctuate, the price of our common stock could decline substantially. Fluctuations

18


in our results of operations may be due to a number of factors, including, but not limited to, those listed below and identified throughout this "Risk Factors" section:

    our ability to retain and increase sales to customers and attract new customers;

    the timing and success of introductions of new solutions or upgrades by us or our competitors;

    the strength of the economy;

    changes in our pricing policies or those of our competitors;

    competition, including entry into the industry by new competitors and new offerings by existing competitors;

    the amount and timing of our expenses, including stock-based compensation and expenditures related to expanding our operations, supporting new customers or introducing new solutions; and

    changes in the payment terms for our solutions.

We do not intend to declare dividends on our stock in the foreseeable future.

        We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends on our common stock will be at the discretion of our board of directors and will depend upon our results of operations, earnings, capital requirements, financial condition, future prospects, contractual restrictions and other factors deemed relevant by our board of directors. Therefore, you should not expect to receive dividend income from shares of our common stock.

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 shareholder 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 without approval from 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 analyses of impairment to our finite-lived intangibles when a triggering event occurs and to our 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.

Item 1B.    Unresolved Staff Comments.

        None.

19



Item 2.    Properties.

        As a result of our acquisition of certain assets of Midwave in October 2011, as tenant, we were the successor interest to a lease ("Original Lease") dated August 9, 2010. The Original Lease was for 20,851 square feet of office space. In December 2011, we entered into a First Amendment to Lease (the "Amendment") to the Original Lease for approximately 32,906 additional square feet of office space ("Expansion Space"), which provided us with approximately 54,000 total square feet available for our operations. We moved our corporate headquarters to this location in March 2012. Under the terms of the Amendment, the term of the Original Lease was extended for 42 months from March 1, 2016 through August 31, 2019 and the term of the lease for the Expansion Space is for seven years and six months, which commenced on March 1, 2012. We have the option to extend the term of the Lease for an additional five year term as long as certain conditions are met.

        As a result of our acquisition of StraTech in October 2012, we are the successor in interest to six leases where StraTech was the tenant, with terms extending through October 2015. These facilities provide us with approximately 27,000 additional square feet of office space available for our operations in Georgia, Alabama, North Carolina, Florida, Maryland, and Tennessee.

        As of December 31, 2013, our other 29 leased locations (which house sales and technical staffs) are small-to-medium-sized offices throughout the United States with terms ending through 2019. Based on our present plans, we believe our current facilities will be adequate to meet our anticipated needs for at least the remaining terms of our respective leases.

Item 3.    Legal Proceedings.

        From time to time, we have been named as a defendant in legal actions arising from our normal business activities, none of which has had a material effect on our business, results of operations or financial condition. We believe that we have obtained adequate insurance coverage or rights to indemnification in connection with potential legal proceedings that may arise.

Item 4.    Mine Safety Disclosures.

        Not applicable.

20



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, 2013

             

First Quarter

  $ 12.38   $ 8.50  

Second Quarter

    11.71     9.72  

Third Quarter

    14.07     10.99  

Fourth Quarter

    14.25     10.16  

Year Ended December 31, 2012

             

First Quarter

  $ 10.32   $ 8.21  

Second Quarter

    10.85     9.03  

Third Quarter

    9.52     7.33  

Fourth Quarter

    8.69     7.34  

        On March 7, 2014, the closing price per share of our common stock was $15.22. We urge potential investors to obtain current market quotations before making any decision to invest in our common stock. On March 7, 2014, there were approximately 106 holders of common stock, including record holders. However, we estimate that our shares are held by over 4,600 beneficial owners.

        We have paid no dividends on our common stock since our initial public offering in 1999. 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 2013, 2012, or 2011.

        On October 4, 2012, we purchased substantially all of the assets and liabilities of Strategic Technologies, Inc. ("StraTech") from StraTech and Midas Medici Group Holdings, Inc. ("Midas," parent company of StraTech, and, together with StraTech, the "Sellers"). We purchased StraTech for an estimated purchase price of approximately $11.9 million, comprised of a cash payment of approximately $13.2 million, which is offset by a receivable due from the Sellers of approximately $3.3 million, resulting from the preliminary estimated tangible net asset adjustment as defined by the asset purchase agreement. In addition, we issued 269,783 shares of our common stock with a value of approximately $2.0 million. Of those shares, 242,805 shares were deposited in an escrow account as security for certain indemnification obligations of the Sellers. The issuance of such shares was exempt from the registration requirement of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof and Rule 506 promulgated under Regulation D because, among other things such issuance does not involve a public offering and the shares were issued solely to an accredited investor.

        In October 2011, we entered into an asset purchase agreement with Midwave and its shareholders. Under the asset purchase agreement, we acquired substantially all of the assets used in Midwave's business. We paid a purchase price of approximately $19.1 million for Midwave. This was comprised of a cash payment of approximately $16.1 million and issuance of 220,988 shares of our common stock with a value of approximately $1.6 million delivered at closing and approximately $1.4 million related to working capital adjustments subsequent to closing. We issued the common stock to Midwave on October 3, 2011. The issuance of such shares was exempt from the registration requirement of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof and Rule 506 promulgated under

21


Regulation D because, among other things such issuance did not involve a public offering and the shares were issued solely to an accredited investor.

        You can find additional information about our equity compensation plans in Part III, Item 11 of this Annual Report.

Stock Performance Graph

        The graph below shows a comparison for the period commencing on December 31, 2008 and ending on December 31, 2013 of the annual percentage change in the cumulative total shareholder return for our common stock, assuming the investment of $100.00 on December 31, 2008, with the cumulative total shareholder returns for the NASDAQ Composite Index and the Russell 2000 Index, assuming the investment of $100.00 respectively on December 31, 2008. The shareholder returns over the indicated periods below are weighted based on market capitalization at the beginning of each measurement point and are not indicative of, or intended to forecast, future performance of our common stock. Data for the NASDAQ Composite Index and the Russell 2000 Index assumes reinvestment of dividends. We have never declared or paid dividends on our common stock and have no present plans to do so.


COMPARISON OF 5 YEAR CUMMULATIVE TOTAL RETURN
Datalink Corporation, The NASDAQ Composite Index
And The Russell 2000 Index

GRAPHIC

 
  12/31/08   12/31/09   12/31/10   12/31/11   12/31/12   12/31/13  

Datalink Corporation

    100.00     135.31     145.94     258.13     267.19     340.63  

NASDAQ Composite

    100.00     144.88     170.58     171.30     199.99     283.39  

Russell 2000 Index

    100.00     127.17     161.32     154.59     179.86     249.69  

22


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. The statement of operations data for the years ended December 31, 2013, 2012, and 2011 and the balance sheet data as of December 31, 2013 and 2012 are derived from our audited financial statements included in this Annual Report. The statement of operations data for the years ended December 31, 2010 and 2009 and the balance sheet data as of December 31, 2011, 2010, and 2009 are derived from our audited financial statements not included in this Annual Report. We acquired StraTech in October 2012, Midwave in October 2011, Incentra in December 2009, and the networking solutions division of Cross in October 2009. They are included in our financial statements beginning on those dates.

 
  Year ended December 31,  
 
  2013   2012   2011   2010   2009  
 
  (in thousands, except per share data)
 

Statement of Operations Data:

                               

Net sales:

                               

Product sales

  $ 373,008   $ 319,041   $ 245,743   $ 180,424   $ 94,788  

Service sales

    221,176     172,161     134,284     113,255     83,294  
                       

Total net sales

    594,184     491,202     380,027     293,679     178,082  
                       

Cost of sales:

                               

Cost of product sales

    291,671     248,286     188,384     140,984     71,303  

Cost of services

    168,655     130,890     100,978     83,951     60,343  

Amortization of intangibles

            1,053     1,108      
                       

Total cost of sales

    460,326     379,176     290,415     226,043     131,646  
                       

Gross profit

    133,858     112,026     89,612     67,636     46,436  
                       

Operating expenses:

                               

Sales and marketing

    60,842     48,553     38,723     32,353     21,408  

General and administrative

    20,729     18,227     15,468     14,092     11,943  

Engineering

    27,536     22,974     17,535     15,652     11,650  

Other income(5)

            (1,127 )   (503 )    

Integration and transaction costs

    95     359     454     581     1,043  

Amortization of finite-lived intangibles(1)(2)(3)(4)

    7,251     4,195     1,766     1,483     843  
                       

Total operating expenses

    116,453     94,308     72,819     63,658     46,887  
                       

Earnings (loss) from operations

    17,405     17,718     16,793     3,978     (451 )

Loss on settlement related to StraTech acquisition

    (611 )                

Interest income, net

    76     59     50     14     94  

Interest/other expense

    (183 )   (56 )   (40 )       (1 )
                       

Earnings (loss) before income taxes

    16,687     17,721     16,803     3,992     (358 )

Income tax expense

    6,642     7,186     6,958     1,690     197  
                       

Net earnings (loss)

  $ 10,045   $ 10,535   $ 9,845   $ 2,302   $ (555 )
                       
                       

Net earnings (loss) per common share:

                               

Basic

  $ 0.53   $ 0.62   $ 0.62   $ 0.18   $ (0.04 )

Diluted

  $ 0.52   $ 0.60   $ 0.61   $ 0.18   $ (0.04 )

Weighted average shares outstanding:

                               

Basic

    19,078     17,114     15,803     12,801     12,550  

Diluted

    19,338     17,491     16,213     12,981     12,550  

23


 
  As of December 31,  
 
  2013   2012   2011   2010   2009(6)  
 
  (In thousands)
 

Selected Balance Sheet Data:

                               

Cash and investments

  $ 76,085   $ 10,315   $ 22,433   $ 8,988   $ 15,631  

Working capital

    91,254     34,059     37,881     21,636     14,702  

Total assets

    433,108     370,393     277,951     176,072     153,978  

Stockholders' equity

    145,796     95,383     80,185     47,455     43,415  

(1)
In October 2009, we completed our acquisition of the networking solutions division of Cross. 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.

(2)
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, one year and eight 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.

(3)
In October 2011, we acquired Midwave. Therefore its results of operations are only included from the acquisition date forward. We recorded finite-lived intangibles consisting of $478,000 of covenants not to compete, $1.1 million of order backlog and $5.1 million of customer relationships, which are amortized over their estimates lives of three years, three months and five years, respectively. In 2011, we incurred integration costs of $454,000 in conjunction with the acquisition of Midwave Corporation.

(4)
In October 2012, we acquired StraTech. Therefore its results of operations are only included from the acquisition date forward. We recorded finite-lived intangibles consisting of $15.9 million of customer relationships, which is amortized over its estimated life of five years. In 2012, we incurred integration costs of $359,000 in conjunction with the acquisition of StraTech.

(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 and 2011, the first and second years of the three year reverse earn-out agreement came to an end and there was a shortfall paid by Cross of $503,000 and $574,000, respectively, 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. In October 2011, we entered into an agreement with Cross to allow for an early buyout of the third year reverse earn-out agreement for which Cross paid $553,000.

(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 statement of operations.

24


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

        You should read the following discussion in conjunction with our financial statements and the related notes included in Item 8 of this Annual Report. 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 midsize and large companies, we assess, design, deploy, and support infrastructures such as servers, storage and networks. We also resell hardware and software from the industry's leading OEMs as part of our customer offerings. 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 consulting, 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 and involves supporting the market and our customers with a single vendor to provide their data center infrastructure needs. As of December 31, 2013, we have 36 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 support service contracts that we sell, our customers purchase support services through us, resulting in customers receiving 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. The other half of the support service contracts that we sell to our customers are direct with the product manufacturers. For all support service contracts we sell, 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 one to three years.

        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. 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.

25


        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 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 scalable capabilities and a leverageable cost structure. Our current strategies are focused on:

    Increasing our sales team productivity.

    Scaling our existing geographic locations and expanding into new locations.

    Expanding our customer support revenues.

    Expanding our consulting and professional services business.

    Expanding our managed services portfolios.

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.

    Making significant investments in our Advanced Services portfolio and building a team to deliver those services to create a high-margin, product-independent revenue stream for the future.

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

Acquisitions

        We have completed acquisitions to grow our business in the past and we intend to continue to grow our business by select acquisitions. Our recent acquisitions are described below.

        Strategic Technologies, Inc.    On October 4, 2012, we purchased substantially all of the assets and liabilities of Strategic Technologies, Inc. ("StraTech") from StraTech and Midas Medici Group Holdings, Inc. ("Midas," parent company of StraTech, and together with StraTech, the "Sellers"). StraTech is an IT services and solutions firm that shares our focus on optimizing enterprise data centers and IT infrastructure through a common product and services portfolio designed to help customers increase business agility. We purchased StraTech for an estimated purchase price of approximately

26


$11.9 million, comprised of a cash payment of approximately $13.2 million, which is offset by a receivable due from the Sellers of approximately $3.3 million, resulting from the preliminary estimated tangible net asset adjustment as defined by the asset purchase agreement. In addition, we issued 269,783 shares of our common stock with a value of approximately $2.0 million. Of those shares, 242,805 shares were deposited in an escrow account as security for certain indemnification obligations of the Sellers.

        Pursuant to the asset purchase agreement, Sellers were obligated to pay us an amount equal to the difference between the actual tangible net assets on the closing date and the Sellers' good faith estimated net tangible assets as set forth in the asset purchase agreement. We initially recorded a receivable due from Sellers of approximately $4.2 million related to this payment at the acquisition date. The Sellers provided us with a "Notice of Disagreement," which stated that they disputed the amount owed to us in connection with this reconciliation payment. The asset purchase agreement contained an arbitration provision for disputes over the value of tangible net assets. During the measurement period (up to one year from the acquisition date), the final tangible net asset adjustment was agreed to and the net effect was a decrease in the receivable due from Sellers of $936,000 and an increase in the purchase price for the same amount as reflected above.

        In January 2014, we reached a settlement agreement with the former owners of StraTech regarding the disputed amount owed to us in connection with the reconciliation payment mentioned above. Under the terms of the agreement, the former owners of StraTech agreed to release the entire 242,805 shares of Datalink common stock that were being held in escrow in exchange for a payment of $100,000 and the release of certain other claims. As of December 31, 2013, the remaining $3.3 million receivable due from the Sellers was deemed to be uncollectible and written down to the estimated realizable value, which is the fair value of the shares in escrow on December 31, 2013. The remaining receivable of $2,647,000 was reclassified from accounts receivable to equity within the December 31, 2013 balance sheet. The results for 2013 include a $611,000 charge for the write-down of the account receivable due from the Sellers to the fair value of the stock on December 31, 2013 and reported as a non-operating expense on the statement of operations. Based on the value of our common stock on the date of the settlement agreement in January 2014, we will record a gain before tax of approximately $877,000 during the first quarter of 2014 as a result of the increase in our stock price from December 31, 2013 to the date we repossessed the shares in escrow.

        This acquisition expanded our market share and physical presence across the Eastern seaboard of the United States. The acquisition also allows us to diversify our product offerings from certain manufacturers and expand our high-margin professional and managed services business lines. We expect to experience operational synergies and efficiencies through combined general and administrative corporate functions. Our results for 2012 reflect the addition of StraTech for the fourth quarter. Please see Note 2 to our financial statements for further information.

        Midwave Corporation.    In October 2011, we entered into an asset purchase agreement with Midwave and its shareholders. Under the asset purchase agreement we purchased and acquired from Midwave substantially all of the assets used in Midwave's business. Midwave is an information technology consulting firm that offers both professional services and sells products to business' information technology organizations utilizing the product portfolios of certain information technology manufacturers, in the specific domains of data center services, networking services, managed services and advisory services. We paid a purchase price of approximately $19.1 million, comprised of a cash payment of approximately $16.1 million delivered at closing and issued 220,988 shares of our common stock with a value of approximately $1.6 million and approximately $1.4 million related to working capital adjustments subsequent to closing.

        This acquisition expanded our footprint in Minnesota making us the dominant data center services and infrastructure provider in the region. The acquisition also doubled our Cisco technology and

27


services revenues, expanded our managed services portfolio with the addition of a data center infrastructure monitoring service, added an established security practice including product, services and consulting and doubled the size of our consulting services team. We have realized operational synergies and efficiencies through combined general and administrative corporate functions. Our results for 2011 reflect the addition of Midwave for the fourth quarter. Please see Note 2 to our financial statements for further information.

    2009 Acquisitions

        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 and have included the financial results of Incentra in our financial statements beginning on the acquisition date.

        On October 1, 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, 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. The agreement was entered into outside of the acquisition and was assigned no fair value. In September 2010 and 2011, the first and second years of the three-year agreement came to an end and there was a shortfall paid by Cross of $503,000 and $574,000, respectively, which was recorded as other income since we had assumed the revenue targets. In October 2011, we entered into an agreement with Cross to allow for an early buyout of the remaining year of the agreement for which Cross paid $553,000.

Critical Accounting Policies and 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:

        Revenue Recognition.    We generally recognize software and hardware revenue upon shipment, installation and configuration services upon completion and customer support contracts ratably over the term of the contract. In the current year, we began recognizing revenue on certain new professional service contracts that include milestones using a proportional performance method of revenue recognition. Revenues from these fixed price professional service contracts are recognized as services are performed based on the achievement of specified milestones within the contracts and when the customer acknowledges that such criteria have been satisfied. We invoice our customer on these projects as agreed-upon project milestones are achieved and accepted by the customer. Please see Note 1 to our financial statements in Part II, Item 8 of this Annual Report for a more detailed description of our revenue recognition policy.

        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 purchase price 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

28


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-lived 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 three months 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 2012 and 2011, we applied business combination accounting to our acquisitions of StraTech and Midwave. See Note 2 to our financial statements included in Part II, Item 8 of this Annual Report 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 sheets and the judgment required in determining fair value amounts.

        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 property and equipment, 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

        In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU No. 2013-11"). ASU No. 2013-11 provides

29


guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU No. 2013-11 will not have a significant impact on our consolidated financial statements.

        In July 2012, the FASB issued an update to ASC 350: Testing Indefinite-Lived Intangible Assets for Impairment. This update states that an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with ASC 350. Under the guidance in this update, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments to ASC 350 were effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this update did not have a material impact on our financial statements.

Results of Operations

        Our sales increased $103.0 million or 21.0% to $594.2 million for 2013 as compared to 2012. Our gross profit increased $21.8 million or 19.5% to $133.9 million for 2013 as compared to 2012. Our earnings from operations decreased $313,000 or 1.8% to $17.4 million for 2013 as compared to 2012. The following table shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.

 
  Year Ended December 31,  
 
  2013   2012   2011  

Net sales

    100.0 %   100.0 %   100.0 %

Cost of sales

    77.5     77.2     76.4  
               

Gross profit

    22.5     22.8     23.6  
               

Operating expenses:

                   

Sales and marketing

    10.2     9.9     10.2  

General and administrative

    3.5     3.7     4.1  

Engineering

    4.6     4.7     4.6  

Other income

            (0.3 )

Integration costs

    0.0     0.1     0.1  

Amortization of intangibles

    1.3     0.8     0.5  
               

Total operating expenses

    19.6     19.2     19.2  
               

Operating earnings

    2.9 %   3.6 %   4.4 %
               
               

30


Comparison of 2013, 2012 and 2011

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,  
 
  2013   2012   2011  
 
  (in thousands)
 

Product sales

  $ 373,008   $ 319,041   $ 245,743  

Service sales

    221,176     172,161     134,284  

Product gross profit

 
$

81,337
 
$

70,755
 
$

56,306
 

Service gross profit

    52,521     41,271     33,306  

Product gross profit as a percentage of product sales

   
21.8

%
 
22.2

%
 
22.9

%

Service gross profit as a percentage of service sales

    23.7 %   24.0 %   24.8 %

        Sales.    Our product sales increased 16.9% in 2013 from 2012 up to $373.0 million and increased 29.8% in 2012 from 2011 up to $319.0 million. Our service sales, which include customer support, consulting and installation services, increased 28.5% in 2013 over 2012 to $221.2 million, and, increased 28.2% in 2012 over 2011 to $172.2 million. Our 2013 results for both product sales and service sales include a full year of revenue from the StraTech acquisition in late 2012. Our 2012 results for both product sales and service sales include revenues of approximately $13.4 million from the acquisition of StraTech. Our 2013 and 2012 results include a full year of revenue from the Midwave acquisition while our 2011 results for both product sale and service sales include revenues of approximately $13.0 million from the acquisition of Midwave.

        The increase in our product sales in 2013 as compared to 2012 and 2012 as compared to 2011, respectively, reflects the impact of our StraTech acquisition in October 2012, continued growth in our customer base including growth in customers with multi-million dollar accounts with us, and market acceptance of our ongoing strategy to service the complete data center, as evidenced by increases in our storage and networking product sales. Our storage, server and network sales have increased as part of our strategy to deliver data center hardware, software and services. 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. We cannot assure that changes in customer spending or economic conditions will positively impact our future product revenues in 2014.

        The increase in our service sales in 2013 over 2012 included an increase in customer support contract sales of $36.2 million, or 26.0%, over 2012 and an increase in installation and configuration services of $12.8 million, or 39.3%, over 2012. Our service sales also increased in 2012 over 2011. The increase in our service sales in 2013 as compared to 2012 and 2012 as compared to 2011, respectively, reflects the impact of our StraTech acquisition in October 2012, accelerating momentum for our virtualized data center solutions, and major new services offerings, including unified monitoring and managed infrastructure services for the entire multi-vendor virtualized data center offerings and new managed services for backup, monitoring, archiving, cloud backup and cloud enablement services to help companies analyze the impact of cloud deployments on their business. The increase in our service sales in 2012 over 2011 included an increase in customer support contract sales of $25.5 million, or 22.4%, over 2011 and an increase in installation and configuration services of $10.3 million, or 67.8%, over 2011.With the growth in our product sales, we continue to successfully sell our installation and configuration services and customer support contracts. Without sustainable growth in our product sales

31


going forward, we expect that 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 either our product or service sales for the years 2013, 2012 or 2011. However, our top five customers collectively accounted for 10%, 11%, and 11% of our 2013, 2012, and 2011 revenues, respectively.

        Gross Profit.    Our total gross profit as a percentage of net sales was 22.5% in 2013, decreasing from 22.8% in 2012 and 23.6% in 2011.

        Product gross profit as a percentage of product sales was 21.8% in 2013 as compared to 22.2% in 2012 and 22.9% in 2011. Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers. The decrease in our product gross profit as a percentage of product sales in 2013 was due in part to lower gross margins across all of our hardware vendors and to a decrease in our storage revenues as a percentage of total revenues, which historically has carried higher gross margins. Our networking and server revenue stream increased to 20% of our total revenues in 2013, as compared with 17% in 2012. In addition, our customers are scrutinizing large storage purchases more than they have in the recent past, and we experienced reluctance from some of our vendors to assist with additional discounts in 2013. Our product gross profit as a percentage of product sales for 2012 over 2011 decreased primarily due to increase in our networking and server revenue stream, which historically has carried lower gross margins than our storage revenue stream. 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 2014 will be between 21% and 23%.

        Our product gross profit is also impacted by various vendor incentive programs that provide economic incentives for achieving various sales performance targets. Achieving these targets contributed favorably to our product gross profit by $7.4 million (3% of product cost of sales), $6.9 million (3% of product cost of sales), and $5.8 million (3% of product cost of sales) in 2013, 2012, and 2011, 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 23.7% in 2013 as compared to 24.0% in 2012 and 24.8% in 2011. In 2013, 2012 and 2011 the decrease in our service gross profit is primarily driven by a reduction in the gross margin percentage on professional services provided by Datalink as a result of adding new products and services to address rising market acceptance of unified data centers. In addition, we saw a continued increase in the sales of products on which we were not able to sell first call support. These sales generally carry lower gross margins. We estimate that our service gross margins for 2014 will continue to be between 23% and 25%.

        Our total gross profit for 2013, 2012 and 2011 includes amortization of intangibles of $0, $0, and $1.1 million, respectively, related to order backlog acquired in connection with our Midwave acquisition in 2011. These finite-lived intangible assets each have an estimated life of three months, and were each fully amortized in 2011.

32


Operating Expenses:

 
  Year Ended December 31,  
 
  2013   2012   2011  
 
  (in thousands)
 

Sales and marketing

  $ 60,842   $ 48,553   $ 38,723  

General and administrative

    20,729     18,227     15,468  

Engineering

    27,536     22,974     17,535  

Other income

            (1,127 )

Integration and transaction costs

    95     359     454  

Amortization of intangibles

    7,251     4,195     1,766  
               

Total operating expenses

  $ 116,453   $ 94,308   $ 72,819  
               
               

        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. We expense advertising costs as incurred. Sales and marketing expenses totaled $60.8 million, or 10.2% of net sales for 2013 as compared to $48.6 million, or 9.9% of net sales for 2012 and $38.7 million, or 10.2% of net sales for 2011. The increase in sales and marketing expenses in absolute dollars and as a percentage of sales for 2013 over 2012 and for 2012 over 2011 is due to an increase in our sales and marketing headcount from the StraTech acquisition and higher variable compensation and commissions, commensurate with the increase in sales for 2013. The decrease in sales and marketing expenses as a percentage of sales from 2012 to 2011, reflects the improvement in revenues per employee we have realized as part of our growth strategy. 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 increased to $20.7 million, or 3.5% of net sales, as compared to $18.2 million, or 3.7% of net sales, for 2012, and $15.5 million, or 4.1% of net sales, for 2011. Our general and administrative expense increased $2.5 million in 2013, but decreased as a percentage of sales to 3.5% from 3.7% over the same period. Our general and administrative expenses increased $2.8 million in 2012 as compared to 2011, but as a percentage of net sales it decreased to 3.7% from 4.1% over the same period. The increase in general and administrative expenses for 2013 was primarily due to an increase of $925,000 in facility and depreciation expenses commensurate with the increase in fixed assets resulting from our acquisitions of Midwave in October 2011 and StraTech in October 2012 and an increase of $706,000 in outside services. The increase in general and administrative expenses for 2012 was primarily due to an increase of $717,000 in salary and benefit expenses commensurate with the increase in headcount, an increase of $583,000 in depreciation expenses commensurate with the increase in fixed assets resulting from our acquisitions of Midwave in October 2011 and StraTech in October 2012, and an increase of $451,000 in consulting expenses. The decrease in general and administrative expenses as a percentage of sales from 2013 to 2012 and 2012 to 2011, respectively, reflects the operational synergies and efficiencies we have begun to realize through combined general and administrative corporate functions in 2013 and 2012.

        Engineering.    Engineering expenses include employee wages, bonuses 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 $27.5 million, or 4.6% of net sales in 2013 compared to $23.0 million, or 4.7% of net sales in 2012 and $17.5 million, or 4.6% of net sales in 2011. Our engineering expense increased $4.5 million in 2013, but decreased as a percentage of sales to 4.6%

33


from 4.7% over the same period. The increase in engineering expenses in absolute dollars and as a percentage of net sales for 2013 over 2012 is primarily due to an increase in salaries, benefits and bonuses of $9.0 million and travel expenses of $894,000 commensurate with the increase in engineering headcount from our StraTech acquisition and an increase of $4.3 million in outside consulting services as a result of adding new products and services to address rising market acceptance of unified data centers. These increases were partially offset by an increase of $10.3 million in engineering costs allocated to our cost of service sales, commensurate with the increase in our professional services sales. The increase in engineering expenses in absolute dollars and as a percentage of net sales for 2012 over 2011 is primarily due to the StraTech acquisition, which increased engineering headcount by approximately 25% in the fourth quarter of 2012.

        Other Income.    For 2013, 2012 and 2011, we had other income of $0, $0, and $1.1 million, 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 and 2011, as the first and second years of the three year reverse earn-out agreement came to an end, there was a shortfall between customer purchases and the guaranteed annual purchase of $574,000 and $503,000, respectively. 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 amounts of $574,000 and $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. In addition, in October 2011, we entered into an agreement with Cross to allow for an early buyout of the third year reverse earn-out agreement for which Cross paid $553,000. This early buyout also represented a change in fair value of the acquisition date and in accordance with ASC 805-30-35 was classified as other income within operating expenses on our statement of operations.

        Integration and Transaction Costs.    We had integration expenses of $95,000, $359,000 and $454,000 in 2013, 2012 and 2011, respectively. Integration expenses we incurred in 2013 and 2012 were related to the acquisition of StraTech in October 2012. In 2011, we incurred the majority of these expenses for the acquisition of Midwave in October 2011. Integration and transaction expenses in 2012 and 2011 for the StraTech and Midwave acquisitions included audit, legal and other outside consulting fees and expenses for our transition services agreements with former StraTech and Midwave employees.

        Intangible Amortization.    We had expenses related to the amortization of finite-lived intangible assets of $7.3 million, $4.2 million and $1.8 million in 2013, 2012 and 2011, respectively. Amortization of intangible assets increased in 2013, 2012 and 2011 due to the acquisitions of StraTech, Midwave, the networking solutions division of Cross and the Incentra reseller business. The finite-lived intangible asset we acquired in our acquisition of StraTech consisted of customer relationships having an estimated life of five years. We are amortizing these assets using an accelerated amortization method, to match the pattern in which the economic benefits of that asset are expected to be consumed. The finite-lived intangibles we acquired in our acquisition of Midwave consisted of covenants not to compete, order backlog and customer relationships having estimated lives of three years, three months and five years, respectively. The finite-lived intangibles we acquired in our 2009 acquisition of the networking solutions division of Cross 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. We are amortizing the finite-lived intangible assets we acquired in our acquisitions of Midwave, the networking solutions division of Cross and the Incentra reseller business primarily using the straight line method. We expect amortization expense to be approximately $5.3 million in 2014.

34


        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 2013, 2012, and 2011, we identified no triggering events that required us to evaluate the impairment of our long-lived assets.

Operating Earnings:

 
  Years Ended December 31,  
 
  2013   2012   2011  
 
  (in thousands)
 

Earnings from operations

  $ 17,405   $ 17,718   $ 16,793  

        We realized earnings from operations of $17.4 million, $17.8 million, and $16.8 million in 2013, 2012, and 2011, respectively. Our earnings from operations in 2013, 2012, and 2011 are a result of our higher revenues and gross profits as we realized the benefits of our StraTech, Midwave and Incentra acquisitions and the implementation of our strategy to sell products and services to support the entire data center.

Income Taxes:

 
  Year Ended December 31,  
 
  2013   2012   2011  
 
  (in thousands)
 

Income tax expense

  $ 6,642   $ 7,186   $ 6,958  

        We had income tax expense of $6.6 million in 2013 which resulted in our estimated effective tax rate of 39.8%. We had income tax expense of $7.2 million in 2012 which resulted in our estimated effective tax rate of 40.6%. We had income tax expense of $7.0 million in 2011 which resulted in our estimated effective tax rate of 41%. As of December 31, 2013, we had no federal net operating carryforwards. As of December 31, 2013, 2012, and 2011, we had $820,000, $1.1 million and $1.7 million, respectively, of state net operating loss carryforwards to offset future state taxable income. These state tax carryforwards expire between 2014 and 2028. For 2013, we recorded approximately $885,000 of tax benefits to equity associated with the exercise of stock options. For 2012, we recorded approximately $780,600 of tax benefits to equity associated with the exercise of stock options. For 2011, we recorded approximately $449,500 of tax benefits to equity 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 42%.

Quarterly Results

        The following table sets forth our unaudited quarterly financial data for each quarter of 2013 and 2012. 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

35


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  
 
  2013   2012  
 
  Mar. 31   Jun. 30   Sep. 30   Dec. 31   Mar. 31   Jun. 30   Sep. 30   Dec. 31  
 
  (in thousands)
 

Net sales

  $ 133,518   $ 147,779   $ 139,519   $ 173,368   $ 119,088   $ 120,042   $ 104,774   $ 147,298  

Gross profit

    29,833     33,561     29,805     40,659     27,326     28,033     24,012     32,655  

Operating earnings

    1,966     4,936     1,155     9,348     3,612     5,411     3,255     5,440  

Net earnings

    1,098     2,904     818     5,225     2,161     3,219     1,923     3,232  

        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 we 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,  
 
  2013   2012   2011  
 
  (in thousands)
 

Total cash provided by (used in):

                   

Operating activities

  $ 15,270   $ (1,184 ) $ 13,325  

Investing activities

    (53,769 )   (13,510 )   (22,130 )

Financing activities

    53,055     6,062     18,764  
               

Increase (decrease) in cash and cash equivalents

  $ 14,556   $ (8,632 ) $ 9,959  
               
               

        We finance our operations and capital requirements primarily through cash flows generated from operations. Our working capital was $91.3 million at December 31, 2013 as compared to $34.1 million at December 31, 2012. At December 31, 2013, our cash and cash equivalents balance was $24.9 million as compared to cash and cash equivalents of $10.3 million at December 31, 2012.

        Cash provided by operating activities for 2013 was $15.3 million. Cash provided by operating activities for 2013 was primarily impacted by:

    Our net earnings for the year of $10.0 million.

    A net $14.0 million increase in income taxes payable, partially offset by a $10.0 million decrease in deferred tax assets.

    Non-cash charges of $7.3 million, $4.0 million and $2.1 million for amortization of intangibles, stock compensation expense and depreciation, respectively.

    A net decrease of $12.9 million in accounts receivable, offset by increases in inventories, accounts payable and accrued expenses.

36


    A net $7.6 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 used in operating activities for 2012 was $1.2 million. Cash used in operating activities for 2012 was primarily impacted by:

    Our net earnings for the year of $10.5 million.

    Non-cash charges of $4.2 million, $2.6 million and $1.6 million for amortization of intangibles, stock compensation expense and depreciation, respectively.

    A net increase of $31.5 million in accounts receivable, reflecting our increase in revenues for the year, offset by increases in inventories, accounts payable and accrued expenses.

    A net $4.4 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 2011 was $13.3 million. Cash provided by operating activities for 2011 was primarily impacted by:

    Our net earnings for the year of $9.8 million.

    Non-cash charges of $2.8 million, $2.6 million and $1.0 million for amortization of intangibles, stock compensation expense and depreciation, respectively.

    A net increase in certain working capital items (accounts receivable, inventories, accounts payable and accrued expenses) of $5.9 million reflecting our increase in revenues for the year

    A net $2.5 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 used in investing activities was $53.8 million in 2013. In 2013, our primary use of cash for investing activities was for the purchase of $51.0 million of trading securities and the purchase of $2.7 million of property and equipment. Cash used in investing activities was $13.5 million in 2012. In 2012, our primary use of cash for investing activities was to complete our October 2012 acquisition of StraTech. Cash used in investing activities was $22.1 million in 2011. In 2011, our primary use of cash for investing activities was to complete our October 2011 acquisition of Midwave. In addition, we invested a net amount of $3.5 million in short-term investments.

        We are planning for approximately $3.0 million of capital expenditures during 2014 primarily related to enhancements to our management information systems and upgraded computer equipment.

        Cash provided by financing activities was $53.1 million in 2013. This was primarily attributable to $39.0 million of proceeds from our August 2013 stock offering and proceeds of $20.0 million under our floor plan line of credit, partially offset by $6.0 million of net payments under our Prior Credit Agreement. On August 8, 2013, we entered into an underwriting agreement relating to the public offering of 3,300,000 shares of our common stock at a price to the public of $11.00 per share, less underwriting discounts. In addition, we granted the underwriters a 30-day option to purchase up to an additional 495,000 shares at $11.00 per share to cover over-allotments, if any. On August 14, 2013, we completed the offering of 3,795,000 shares of common stock at a price to the public of $11.00 per share. The number of shares sold in the offering includes the underwriters' full exercise of their over-allotment option. Cash provided by financing activities was $6.1 million in 2012, primarily due to $6.0 million of borrowings on our line of credit in 2012. Cash provided by financing activities was $18.8 million in 2011. In March 2011, we completed a public offering of 4,266,500 shares of common

37


stock with a price to the public of $5.75 per share. We issued and sold 3,306,500 shares in the offering which resulted in $17.5 million in cash received by us.

        On July 17, 2013, we entered into a credit agreement with Castle Pines Capital LLC ("CPC"), an affiliate of Wells Fargo Bank, National Association. The credit agreement provides for a floor plan line of credit and a revolving facility in a maximum combined aggregate amount of $40 million. Borrowing under the revolving facility cannot exceed the lesser of (i) $40 million minus the amount outstanding under the floor plan line of credit or (ii) a borrowing base consisting of 85% of certain eligible accounts and 100% of channel financed inventory, subject to CPC's ability to impose reserves in the future. The floor plan line of credit finances certain purchases of inventory by us from vendors approved by CPC and the revolving facility is used for working capital purposes and permitted acquisitions.

        The amounts outstanding under the revolving facility will bear interest at a per annum rate of 2.0% above Wells Fargo's one-month LIBOR rate (approximately 0.17% at December 31, 2013). Advances under the floor plan line of credit will not bear interest so long as they are paid by the applicable payment due date and advances that remain outstanding after the applicable payment due date will bear interest at a per annum rate of LIBOR plus 4%. We are obligated to pay quarterly to CPC an unused commitment fee equal to 0.50% per annum on the average daily unused amount of the combined facility, with usage including the sum of any advances under either the floor plan line of credit or the revolving facility. The combined facility and certain bank product obligations owed to Wells Fargo and CPC or its affiliates are secured by substantially all of our assets. The credit agreement terminates on July 17, 2016 and we will be obligated to pay certain prepayment fees if the credit agreement is terminated prior to that date.

        The credit agreement contains customary representations, warranties, covenants and events of default, including but not limited to, covenants restricting our ability to (i) grant liens on our assets, (ii) make certain fundamental changes, including merging or consolidating with another entity or making any material change in the nature of our business, (iii) make certain dividends or distributions, (iv) make certain loans or investments, (v) guarantee or become liable in any way on certain liabilities or obligations of any other person or entity, or (vi) incur certain indebtedness. Our prior credit agreement (as discussed below) included similar restrictions.

        The credit agreement contains certain covenants regarding our financial performance, including (i) a minimum tangible net worth of at least $20 million, (ii) a maximum funded debt to EBITDA of no more than 3.00 to 1.00, and (iii) a minimum quarterly net income of at least $250,000.

        The credit agreement replaced the credit facility we had in place with Wells Fargo, which was terminated upon the effectiveness of the credit agreement. We did not incur any early termination fees or penalties in connection with the termination of the prior credit agreement. Wells Fargo serves and may continue to serve as our transfer agent and has performed and may continue to perform commercial banking and financial services for us for which they have received and may continue to receive customary fees. The prior credit agreement provided for a revolving line of credit for a total maximum borrowing amount of $20.0 million.

        We had outstanding advances of $6.0 million on the prior credit agreement at December 31, 2012. At December 31, 2013, we had no outstanding advances on the prior credit agreement or the revolving facility, but had outstanding advances of $20.0 million on the floor plan line of credit related to the purchase of inventory from a vendor.

        Our future capital requirements may vary materially from those now planned and will depend on many factors, including our strategy to continue to grow our business by select acquisitions. Historically, we have experienced an increase in our expenditures consistent with the growth of our operations and

38


we anticipate our expenditures will continue to increase as we grow our business by acquisitions or organically.

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, 2013, our contractual cash obligations consist of future minimum lease payments due by period under non-cancelable operating leases and amounts due under our line of credit agreement as follows:

 
  Total   Less than
1 year
  1-3 years   3-5 years   More than
5 years
 
 
  (in thousands)
 

Operating lease obligations

  $ 6,590   $ 2,164   $ 3,208   $ 1,218   $  

Sublease obligations

    (34 )   (34 )            
                       

Net operating lease obligations

    6,556     2,130     3,208     1,218      

Amount due under line of credit agreement

    19,977     19,977              
                       

Total

  $ 26,533   $ 22,107   $ 3,208   $ 1,218   $  

        We have classified the amount due under our line of credit agreement as a current liability within the balance sheet as we intend to pay off the balance within the next 12 months.

        As a result of our acquisition of certain assets of Midwave in October 2011, as tenant, we are the successor interest to the Original Lease. The Original Lease was for 20,851 square feet of office space. In December 2011, we entered into the Amendment to the Original Lease for the Expansion Space, which provided us with approximately 54,000 total square feet available for our operations. We moved our corporate headquarters to this new location in March 2012. Under the terms of the Amendment, the term of the Original Lease is extended for 42 months from March 1, 2016 through August 31, 2019 and the term of the lease for the Expansion Space is for seven years and six months, commencing on March 1, 2012. We have the option to extend the term of the Lease for an additional five year term as long as certain conditions are met.

        As a result of our acquisition of StraTech in October 2012, we are the successor in interest to six leases where StraTech was the tenant, with terms extending through October 2015. These facilities provide us with approximately 27,000 additional square feet of office space available for our operations in Georgia, Alabama, North Carolina, Florida, Maryland, and Tennessee.

        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, 2013, we were not obligated to purchase any goods or services from our suppliers and no such losses existed.

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.

39


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. We do not undertake any specific actions to cover our exposure to interest rate risk and we are not party to any interest rate risk management transactions.

        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, 2013, we had $51.2 million in short-term investments and $20.0 million in short-term debt. The impact on the income before income taxes of a 1% change in short-term interest rates would be approximately $312,000 based on our short-term investments and short-term debt balances as of December 31, 2013.

        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.

40


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, 2013 and 2012, and the related statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule of the Company 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 and schedule 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Datalink Corporation as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, 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.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Datalink Corporation's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, and our report dated March 17, 2014 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

/s/ McGladrey LLP

Minneapolis, Minnesota
March 17, 2014

41



DATALINK CORPORATION

BALANCE SHEETS

(in thousands, except share data)

 
  December 31,  
 
  2013   2012  

Assets

             

Current assets:

             

Cash and cash equivalents

  $ 24,871   $ 10,315  

Short term investments

    51,214      

Accounts receivable, net

    131,246     144,780  

Receivable due from seller of StraTech acquisition

        3,307  

Inventories, net

    4,120     2,554  

Current deferred customer support contract costs

    89,304     87,052  

Inventories shipped but not installed

    16,000     8,784  

Income tax receivable

        2,430  

Other current assets

    1,279     852  
           

Total current assets

    318,034     260,074  

Property and equipment, net

    6,722     6,082  

Goodwill

    37,780     37,780  

Finite-lived intangibles, net

    13,509     20,760  

Deferred customer support contract costs non-current

    49,044     40,771  

Deferred taxes

    7,116     4,471  

Long term lease receivable

    510      

Other assets

    393     455  
           

Total assets

  $ 433,108   $ 370,393  
           
           

Liabilities and Stockholders' Equity

   
 
   
 
 

Current liabilities:

             

Line of credit

  $   $ 6,000  

Floor plan line of credit

    19,977      

Accounts payable

    61,296     84,716  

Accrued commissions

    7,133     8,531  

Accrued sales and use taxes

    2,067     3,489  

Accrued expenses, other

    8,033     6,027  

Income tax payable

    11,586      

Deferred taxes

    1,694     9,034  

Customer deposits

    4,240     2,894  

Current deferred revenue from customer support contracts

    110,567     105,167  

Other current liabilities

    187     157  
           

Total current liabilities

    226,780     226,015  

Deferred revenue from customer support contracts non-current

    59,576     48,167  

Other liabilities non-current

    956     828  
           

Total liabilities

    287,312     275,010  
           

Commitments and contingencies (Notes 6, 7, and 8)

             

Stockholders' equity:

             

Common stock, $0.001 par value, 50,000,000 shares authorized, 22,785,422 and 18,726,723 shares issued and outstanding as of December 31, 2013 and 2012, respectively

    23     19  

Additional paid-in capital

    111,239     70,875  

Retained earnings

    34,534     24,489  
           

Total stockholders' equity

    145,796     95,383  
           

Total liabilities and stockholders' equity

  $ 433,108   $ 370,393  
           
           

   

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

42



DATALINK CORPORATION

STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 
  Year Ended December 31,  
 
  2013   2012   2011  

Net sales:

                   

Product sales

  $ 373,008   $ 319,041   $ 245,743  

Service sales

    221,176     172,161     134,284  
               

Total net sales

    594,184     491,202     380,027  

Cost of sales:

   
 
   
 
   
 
 

Cost of product sales

    291,671     248,286     188,384  

Cost of services

    168,655     130,890     100,978  

Amortization of intangibles

            1,053  
               

Total cost of sales

    460,326     379,176     290,415  
               

Gross profit

    133,858     112,026     89,612  

Operating expenses:

                   

Sales and marketing

    60,842     48,553     38,723  

General and administrative

    20,729     18,227     15,468  

Engineering

    27,536     22,974     17,535  

Other income

            (1,127 )

Integration and transaction costs

    95     359     454  

Amortization of intangibles

    7,251     4,195     1,766  
               

Total operating expenses

    116,453     94,308     72,819  
               

Earnings from operations

    17,405     17,718     16,793  

Loss on settlement related to StraTech acquisition

    (611 )        

Interest income

    76     59     50  

Interest/other expense, net

    (183 )   (56 )   (40 )
               

Net earnings before income taxes

    16,687     17,721     16,803  

Income tax expense

    6,642     7,186     6,958  
               

Net earnings

  $ 10,045   $ 10,535   $ 9,845  
               
               

Net earnings per common share:

                   

Basic

  $ 0.53   $ 0.62   $ 0.62  

Diluted

  $ 0.52   $ 0.60   $ 0.61  

Weighted average common shares outstanding:

   
 
   
 
   
 
 

Basic

    19,078     17,114     15,803  

Diluted

    19,338     17,491     16,213  

   

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

43



DATALINK CORPORATION

STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)

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

Balances, December 31, 2010

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

Net earnings

                9,845     9,845  

Stock option and restricted stock expense

    573     1     2,556         2,557  

Excess tax benefit from stock compensation

            450         450  

Tax withholding payments reimbursed by restricted stock

    (24 )       (174 )       (174 )

Common shares issued under exercise of stock options

    264         1,034         1,034  

Issuance of common stock for Midwave acquisition

    221         1,564         1,564  

Issuance of common stock for secondary offering, net of offering costs

    3,307     3     17,451         17,454  
                       

Balances, December 31, 2011

    17,911     18     66,213     13,954     80,185  

Net earnings

                10,535     10,535  

Stock option and restricted stock expense

    578     1     2,575         2,576  

Excess tax benefit from stock compensation

            780         780  

Tax withholding payments reimbursed by restricted stock

    (127 )       (1,065 )       (1,065 )

Common shares issued under exercise of stock options

    95         347         347  

Issuance of common stock for StraTech acquisition

    270         2,025         2,025  
                       

Balances, December 31, 2012

    18,727     19     70,875     24,489     95,383  

Net earnings

                10,045     10,045  

Stock option and restricted stock expense

    333         4,049         4,049  

Excess tax benefit from stock compensation

            885         885  

Tax withholding payments reimbursed by restricted stock

    (100 )       (1,080 )       (1,080 )

Common shares issued under exercise of stock options

    30         252         252  

Issuance of common stock for secondary offering, net of offering costs

    3,795     4     39,017         39,021  

Stock receivable from settlement of StraTech acquisition

            (2,647 )       (2,647 )

Measurement period adjustments for StraTech acquisition

            (112 )       (112 )
                       

Balances, December 31, 2013

    22,785   $ 23   $ 111,239   $ 34,534   $ 145,796  
                       
                       

   

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

44



DATALINK CORPORATION

STATEMENTS OF CASH FLOWS

(In thousands)

 
  Year Ended December 31,  
 
  2013   2012   2011  

Cash flows from operating activities:

                   

Net earnings

  $ 10,045   $ 10,535   $ 9,845  

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:

                   

Change in fair value of short-term investments

    (187 )        

Provision (benefit) for bad debts

    115     (6 )   84  

Depreciation

    2,102     1,627     1,045  

Amortization of finite-lived intangibles

    7,251     4,195     2,819  

Loss on settlement related to StraTech acquisition

    611          

Deferred income taxes

    (9,985 )   262     374  

Stock based compensation expense

    4,049     2,576     2,557  

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

                   

Accounts receivable, net

    12,909     (31,544 )   (33,019 )

Inventories

    (8,782 )   177     (2,114 )

Deferred customer support contract costs/revenues, net

    7,630     4,440     2,485  

Accounts payable

    (23,420 )   2,943     25,610  

Accrued expenses

    (814 )   4,629     3,605  

Income tax receivable/payable, net

    14,016     (2,025 )   659  

Other

    (270 )   1,007     (625 )
               

Net cash provided by (used in) operating activities

    15,270     (1,184 )   13,325  
               

Cash flows from investing activities:

                   

Maturities of short term investments

        1,192     6,492  

Sales of short term investments

        2,294      

Purchase of short term investments

    (51,027 )       (9,978 )

Purchases of property and equipment

    (2,742 )   (3,824 )   (1,102 )

Payment for acquisitions, net of cash acquired

        (13,172 )   (17,542 )
               

Net cash used in investing activities

    (53,769 )   (13,510 )   (22,130 )
               

Cash flows from financing activities:

                   

Proceeds from stock offering, net of offering costs

    39,021         17,454  

Net borrowings (payments) under line of credit

    (6,000 )   6,000      

Proceeds from floor plan line of credit

    19,977          

Excess tax from stock compensation

    885     780     450  

Tax withholding payments reimbursed by restricted stock

    (1,080 )   (1,065 )   (174 )

Proceeds from issuance of common stock from option exercise

    252     347     1,034  
               

Net cash provided by financing activities

    53,055     6,062     18,764  
               

Increase (decrease) in cash and cash equivalents

    14,556     (8,632 )   9,959  

Cash and cash equivalents, beginning of period

    10,315     18,947     8,988  
               

Cash and cash equivalents, end of period

  $ 24,871   $ 10,315   $ 18,947  
               
               

Supplementary cash flow information:

                   

Cash paid for income taxes

 
$

1,738
 
$

8,191
 
$

5,934
 

Cash received for income tax refunds

  $ 11   $ 25   $ 469  

Cash paid for interest expense

  $ 154   $ 25   $  

Supplementary non-cash investing and financing activities:

   
 
   
 
   
 
 

Stock issued as consideration for acquisition

  $   $ 2,025   $ 1,564  

Stock receivable for settlement of StraTech acquisition

  $ 2,647   $   $  

See Note 2 for non-cash information on our acquisitions

   
 
   
 
   
 
 

   

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

45



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 midsize and large 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 four practices: consolidation and virtualization of data center infrastructures; enhanced data protection; advanced network infrastructures; and business continuity and disaster recovery solutions. We are frequently engaged to consult and provide assistance in the installation of data center solutions and to provide support services subsequent to the installation.

    Recently Issued and Adopted Accounting Standard:

        In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU No. 2013-11"). ASU No. 2013-11 provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU No. 2013-11 will not have a significant impact on our consolidated financial statements.

        In July 2012, the FASB issued an update to ASC 350: Testing Indefinite-Lived Intangible Assets for Impairment. This update states that an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with ASC 350. Under the guidance in this update, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments to ASC 350 are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this update did not have a material impact on our financial statements.

    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 commercial paper and corporate bonds. We categorize these investments as trading securities and record them at fair value. We classify investments

46


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 accounts receivable 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 accounts receivable 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 accounts receivable previously written off when received.

        We recorded accounts receivable net of the reserve for doubtful accounts of $331,000 and $223,000 at December 31, 2013 and 2012, respectively.

    Concentration of Credit Risk:

        We had no customers that comprised more than 10% of our net sales in 2013, 2012 or 2011. However, our top five customers collectively accounted for 10%, 11%, and 11% of our 2013, 2012, and 2011 revenues, respectively.

    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 $89,000 and $310,000 at December 31, 2013 and 2012, 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 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,  
 
  2013   2012  
 
  (in thousands)
 

Property and equipment:

             

Construction in process

  $ 725   $ 1,987  

Leasehold improvements

    2,443     1,950  

Furniture and fixtures

    2,482     2,479  

Equipment

    7,260     6,123  

Computers and software

    5,433     3,061  
           

    18,343     15,600  

Less accumulated depreciation and amortization

    (11,621 )   (9,518 )
           

  $ 6,722   $ 6,082  
           
           

47


    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 31st of each year.

        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. At each of December 31, 2013 and 2012, we determined that our goodwill was not impaired.

    Valuation of Long-Lived Assets:

        We perform an impairment test for finite-lived assets and other long-lived assets, such as property and equipment and finite-lived intangible 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 2013 and 2012, 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 $4.0 million, $2.6 million and $2.6 million for 2013, 2012 and 2011, respectively.

    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 is the tax payable 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

48


interest and penalties for our tax contingencies in income tax expense. At December 31, 2013 and 2012, 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.

    Advertising Costs:

        Advertising and promotion costs are charged to operations as incurred. Advertising and promotion costs included in sales and marketing expense for 2013, 2012 and 2011 were $683,000, $559,000 and $728,000, respectively.

    Revenue Recognition:

        Product Sales.    We sell software and hardware products on both a "free-standing" basis without any services and as data center solutions bundled with installation and configuration services ("bundled arrangements"). Under either arrangement, we recognize revenue from the sales of products, primarily hardware and essential software, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. In customer arrangements where a formal acceptance of products is required by the customer, revenue is recognized upon meeting such acceptance criteria.

        Service Sales.    In addition to installation and configuration services provided by us or third party vendors as part of our bundled arrangements, our service sales include postcontract customer support ("PCS") and consulting 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. Revenue from extended service contracts is recognized ratably over the contract term, generally one to three years. Professional services are offered under time and material or fixed fee-based contracts or as part of multiple-element arrangements. Professional services revenue is recognized as services are performed when sold on a stand-alone basis. Our service sales include customer support contracts and consulting services.

    Postcontract 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

49


    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. 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 ("VSOE") to allocate revenue to the service contract element. In all cases, we defer revenues and incremental direct costs resulting from obtaining our service contracts and amortize them into operations over the term of the contracts, which are generally twelve months. We defer customer support costs as allowed under ASC Topic 605-10-S99 based on the guidance in ASC Topic 605-20. 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.

        Multiple Element Arrangements. In October 2009, the FASB amended the Accounting Standards Codification ("ASC") as summarized in Accounting Standards Update ("ASU") No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amended industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product's essential functionality, or what we refer to as essential software. We also sell non-essential software, which continues to be in the scope of ASC 985-605. ASU 2009-13 amended the accounting for multiple-element arrangements to provide guidance on how the deliverables in an arrangement should be separated and eliminates the use of the residual method. ASU 2009-13 also required an entity to allocate revenue using the relative selling price method.

        ASU 2009-13 establishes a hierarchy of evidence to determine the stand-alone selling price of a deliverable based on VSOE, third-party evidence ("TPE"), and the best estimate of selling price ("BESP"). If VSOE is available, it would be used to determine the selling price of a deliverable. If

50


VSOE is not available, the entity would determine whether TPE is available. If so, TPE must be used to determine the selling price. If TPE is not available, then the BESP would be used.

        In certain instances, we are not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to infrequent sales of each element separately, not pricing products within a narrow range, or only having a limited sales history. We have not consistently established VSOE for any of our products or services, except for PCS.

        When VSOE cannot be established, we attempt to determine the standalone selling price for each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our strategy differs from that of our peers and our offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products' selling prices are on a stand-alone basis. Therefore, we are typically not able to determine TPE.

        Since we are typically unable to determine VSOE or TPE, we use BESP in our allocation of the arrangement consideration where VSOE or TPE do not exist. Therefore, revenue from these multiple-element arrangements is allocated based on BESP, except for PCS which is allocated based on VSOE. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly customized offerings. We determine BESP for product or service using a cost-plus margin approach. When establishing the methodology used to calculate BESP we also considered multiple factors, including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. The determination of BESP is made through consultation with and formal approval by management.

        We regularly review VSOE, TPE and BESP and maintain internal controls over the establishment and updates of these estimates. We limit the amount of revenue recognized for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.

        We evaluate each deliverable in an arrangement to determine whether they represent a single unit of accounting. The delivered item constitutes a separate unit of accounting when it has stand-alone value and there are no customer-negotiated refunds or return rights for the delivered elements. If the arrangement includes a customer-negotiated refund or return right relative to the delivered item and the delivery and performance of the undelivered item is considered probable and substantially in our control, the delivered element would also constitute a separate unit of accounting. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and revenue recognition is determined for the combined unit as a single unit of accounting. Allocation of the consideration is determined at arrangement inception on the basis of each unit's relative selling price.

        Our multiple-element product offerings include networking hardware with embedded software products, professional services, and PCS, which are considered separate units of accounting. For fiscal year 2011 and future periods, pursuant to the guidance in ASU 2009-13, when a sales arrangement contains multiple elements, such as products, essential software, PCS and/or professional services, we will allocate revenues to each element based on the aforementioned selling price hierarchy.

        In multiple-element arrangements that include software that is not essential to the functionality of the products, revenue is initially allocated to each separate unit of accounting using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. Since non-essential software deliverables are in the scope of ASC 985-605, VSOE must exist to account for the non-essential software deliverables as separate units of accounting from one another

51


and further allocate the originally allocated non-essential software fee among the individual non-essential software deliverables. Since we were only able to establish VSOE for PCS, the amount allocated to the other non-essential software deliverables would be based on the residual method of allocation using VSOE for PCS. This allocated revenue is recognized once all non-essential software deliverables other than PCS are delivered.

        In 2013, we began recognizing revenue on certain new professional service contracts that include milestones using a proportional performance method of revenue recognition. Revenues from these fixed price professional service contracts are recognized as services are performed based on the achievement of specified milestones within the contracts and when the customer acknowledges that such criteria have been satisfied. We invoice our customer on these projects as agreed-upon project milestones are achieved and accepted by the customer. We recognized approximately $1.2 million of services revenues under this method during 2013.

    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,  
 
  2013   2012   2011  
 
  (in thousands,
except per share data)

 

Net earnings

  $ 10,045   $ 10,535   $ 9,845  
               
               

Basic:

                   

Weighted average common shares outstanding

    22,785     18,727     17,899  

Weighted average common shares of non-vested stock

    (3,707 )   (1,613 )   (2,096 )
               

Shares used in the computation of basic net earnings per share

    19,078     17,114     15,803  
               
               

Net earnings per share—basic

  $ 0.53   $ 0.62   $ 0.62  
               
               

Diluted:

                   

Shares used in the computation of basic net earnings per share

    19,078     17,114     15,803  

Employee and non-employee director stock options

    8     60     87  

Restricted stock that has not vested

    252     317     323  
               

Shares used in the computation of diluted net earnings per share

    19,338     17,491     16,213  
               
               

Net earnings per share—diluted

  $ 0.52   $ 0.60   $ 0.61  
               
               

        We excluded the following restricted stock grants that have not vested 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,  
 
  2013   2012   2011  

Non-vested common stock

    61,000     9,000     128,000  

Options to purchase shares of common stock

             

52


    Fair Value of Financial Instruments:

        Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value for assets and liabilities required or permitted to be recorded at fair value, we consider the principal or most advantageous market in which it would transact and the assumptions that market participants would use when pricing the asset or liability. We apply fair value measurements for both financial and nonfinancial assets and liabilities. We have no nonfinancial assets or liabilities that require measurement at fair value on a recurring basis as of December 31, 2013.

        The fair value of our financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, line of credit and accrued expenses, approximate cost because of their short maturities.

        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.

    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 according to the valuation techniques we used to determine their fair value(s):

(In thousands)
  Total at Fair
Value
  Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
  Significant Other
Observable
Inputs (Level 2)
  Significant
Unobservable
Inputs
(Level 3)
 

At December 31, 2013:

                         

Cash and cash equivalents

  $ 24,871   $ 24,871   $   $  

Short-term investments

    51,214     15,239     35,975      
                   
                   

Total assets measured at fair value

  $ 76,085   $ 40,110   $ 35,975   $  
                   
                   

At December 31, 2012:

                         

Cash and cash equivalents

  $ 10,315   $ 10,315   $   $  
                   

Total assets measured at fair value

  $ 10,315   $ 10,315   $   $  
                   
                   

53


2.     Acquisitions:

    Strategic Technologies, Inc.

        On October 4, 2012, we purchased substantially all of the assets and liabilities of Strategic Technologies, Inc. ("StraTech") from StraTech and Midas Medici Group Holdings, Inc. ("Midas," parent company of StraTech, and, together with StraTech, the "Sellers"). StraTech is an IT services and solutions firm that shares our focus on optimizing enterprise data centers and IT infrastructure through a common product and services portfolio designed to help customers increase business agility. We purchased StraTech for a purchase price of approximately $11.9 million, comprised of a cash payment of approximately $13.2 million, which is offset by a receivable due from the Sellers of approximately $3.3 million, resulting from the preliminary tangible net asset adjustment as defined by the asset purchase agreement. In addition, we issued 269,783 shares of our common stock with a value of approximately $2.0 million. Of those shares, 242,805 shares were deposited in an escrow account as security for certain indemnification obligations of the Sellers.

        Pursuant to the asset purchase agreement, Sellers were obligated to pay us an amount equal to the difference between the actual tangible net assets on the closing date and the Sellers' good faith estimated net tangible assets as set forth in the asset purchase agreement. We initially recorded a receivable due from Sellers of approximately $4.2 million related to this payment at the acquisition date. The Sellers provided us with a "Notice of Disagreement," which stated that they disputed the amount owed to us in connection with this reconciliation payment. The asset purchase agreement contained an arbitration provision for disputes over the value of tangible net assets. During the measurement period (up to one year from the acquisition date), the final tangible net asset adjustment was agreed to and the net effect was a decrease in the receivable due from Sellers of $936,000 and an increase in the purchase price for the same amount as reflected above.

        We estimated the fair value of the assets acquired and liabilities assumed of StraTech 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. As of December 31, 2012, the fair value of the acquired assets was provisional as we had not yet finalized net working capital adjustments that are included within the "Notice of Disagreement" discussed above. The total purchase price has been allocated to StraTech's net tangible and identifiable intangible assets based on their estimated fair values as of October 4, 2012, and has been adjusted through the measurement period (up to one year from the acquisition date). Adjustments to provisional amounts during the measurement period that were the result of information that existed as of the acquisitions date require the revision of comparative prior period financial information when reissued in subsequent financial statements. Accordingly, our 2012 balance sheet has been retroactively adjusted to account for those changes. The changes did not impact our Statement of Operations.

54


        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

  $ 9,539  

Deferred revenue costs

    8,521  

Equipment

    432  

Finite-lived intangibles

    15,920  

Goodwill

    5,334  

Other assets

    628  
       

Total assets acquired

    40,374  

Liabilities assumed at their fair value:

   
 
 

Accounts payable

    17,599  

Deferred revenue

    10,289  

Accrued expenses

    567  

Other liabilities

    29  
       

Total liabilities assumed

    28,484  
       

Net purchase price

  $ 11,890  
       
       

        The fair value of the assets acquired included a finite-lived intangible asset consisting of customer relationships that have an estimated life of five years and an indefinite-lived asset consisting of goodwill of approximately $5.0 million which will be deductible for tax purposes over a 15-year period. We are amortizing the finite-lived intangible asset we acquired in the StraTech acquisition over its useful life using an accelerated amortization method, to match the pattern in which the economic benefits of that asset are expected to be consumed. We paid a premium over the fair value of the net tangible and identified intangible assets acquired (i.e. goodwill) because this acquisition expanded our market share and physical presence across the Eastern seaboard of the United States and allows us to diversify our product offerings from certain manufacturers and expand our high-margin professional and managed services business lines. We expect to experience operational synergies and efficiencies through combined general and administrative corporate functions.

        The following table provides a reconciliation of the net purchase price for StraTech as compared to the cash payment for purchase:

 
  (in thousands)  

Payment in cash for purchase

  $ 13,172  

Less receivable due from seller

    (3,307 )

Plus value of shares issued

    2,025  
       

Net purchase price

  $ 11,890  
       
       

        Integration costs for 2013 and 2012 include salaries, benefits and retention bonuses of exiting employees, some of whom assisted with the initial integration of StraTech. In addition, transaction costs for 2012 include legal, audit and other outside service fees necessary to complete our acquisition of StraTech, which were expensed. Total integration and transaction costs were $95,000 and $359,000 during 2013 and 2012, respectively.

        In January 2014, we reached a settlement agreement with the former owners of StraTech regarding the disputed amount owed to us in connection with the reconciliation payment mentioned above. Under the terms of the agreement, the former owners of StraTech agreed to release the entire 242,805

55


shares of Datalink common stock that were being held in escrow in exchange for a payment of $100,000 and the release of certain other claims. As of December 31, 2013, the remaining $3.3 million receivable due from the Sellers was deemed to be uncollectible and written down to the estimated realizable value, which is the fair value of the shares in escrow on December 31, 2013. The remaining receivable of $2,647,000 was reclassified from accounts receivable to equity within the December 31, 2013 balance sheet. The results for 2013 include a $611,000 charge for the write-down of the account receivable due from the Sellers to the fair value of the stock on December 31, 2013 and reported as a non-operating expense on the statement of operations. Based on the value of our common stock on the date of the settlement agreement in January 2014, we will record a gain before tax of approximately $877,000 during the first quarter of 2014 as a result of the increase in our stock price from December 31, 2013 to the date we repossessed the shares in escrow.

    Midwave Corporation

        In October 2011, we entered into an asset purchase agreement with Midwave Corporation ("Midwave") and its shareholders. Under the asset purchase agreement we purchased and acquired from Midwave substantially all of the assets used in Midwave's business. Midwave is an information technology consulting firm that offers both professional services and sells products to business' information technology organizations utilizing the product portfolios of certain information technology manufacturers, in the specific domains of data center services, networking services, managed services and advisory services. We paid a purchase price of approximately $19.1 million, comprised of a cash payment of approximately $16.1 million and issued 220,988 shares of our common stock with a value of approximately $1.6 million delivered at closing and approximately $1.4 million related to working capital adjustments subsequent to closing.

        We estimated the fair value of the assets acquired and liabilities assumed of Midwave 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 covenants not to compete, order backlog and customer relationships having estimated lives of three years, three months and five years, respectively, and goodwill of approximately $9.3 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 makes us the dominant data center services and infrastructure provider in Minnesota. We also believe this acquisition doubles our Cisco technology and services revenue, expands our managed services portfolio, adds an established security practice and doubles the size of our consulting services team. We have begun to realize operational synergies and efficiencies through combined general and administrative and corporate functions in 2012.

56


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

 
  (in thousands)  

Assets acquired at their fair value:

       

Accounts receivable, net

  $ 11,575  

Deferred revenue costs

    33  

Equipment

    1,270  

Finite-lived intangibles

    6,635  

Goodwill

    9,300  

Other assets

    224  
       

Total assets acquired

    29,037  

Liabilities assumed at their fair value:

   
 
 

Accounts payable

    8,933  

Customer deposits

    122  

Deferred revenue

    16  

Accrued expenses

    860  
       

Total liabilities assumed

    9,931  
       

Net purchase price

  $ 19,106  
       
       

        The following table provides a reconciliation of the net purchase price for Midwave as compared to the cash payment for purchase:

 
  (in thousands)  

Net purchase price

  $ 19,106  

Less value of shares issued

    1,564  
       

Payment in cash for purchase

  $ 17,542  
       
       

        Integration costs for 2011 include salaries, benefits and retention bonuses of exiting employees, some of whom assisted with the initial integration of Midwave. In addition, transaction costs for 2011 include legal, audit and other outside service fees necessary to complete our acquisition of Midwave, which were expensed. Total integration and transaction costs were $454,000 during 2011. We recognized no integration and transactions costs related to the Midwave acquisition during 2012 and 2013.

3.     Short Term Investments:

        The following table summarizes our short term investments (in thousands):

 
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
 

December 31, 2013

                         

Commercial paper

  $ 35,979     5     9   $ 35,975  

Corporate bonds

    15,422         183     15,239  

        Our $51.2 million of short term investments are comprised of commercial paper and corporate bonds with maturities within one year and interest rates ranging from 0.8% to 5.5%. As of December 31, 2012, we had no short-term investments.

57


4.     Intangibles:

        We had goodwill assets with a recorded value of $37.8 million as of December 31, 2013 and 2012, respectively. Goodwill activity is summarized as follows:

 
  (in thousands)  

January 1, 2012

  $ 32,446  

Additions

    5,334  
       

December 31, 2012 and 2013

  $ 37,780  
       
       

        We had finite-lived intangible assets with a net book value of $13.5 million and $20.8 million as of December 31, 2013 and 2012, respectively. The change in the net carrying amount of intangibles during 2013 and 2012 is as follows:

 
  Year Ended
December 31,
 
 
  2013   2012  
 
  (in thousands)
 

Beginning Balance

  $ 20,760   $ 9,035  

Recognized in connection with acquisitions

        15,920  

Amortization

    (7,251 )   (4,195 )
           

Ending Balance

  $ 13,509   $ 20,760  
           
           

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

 
   
  As of December 31, 2013   As of December 31, 2012  
 
  Amortizable
Period
(years)
  Gross
Assets
  Accumulated
Amortization
  Net
Assets
  Gross
Assets
  Accumulated
Amortization
  Net
Assets
 

Customer relationships

  5-8   $ 29,133     (15,743 ) $ 13,390   $ 29,133     (8,665 ) $ 20,468  

Services agreement

  4     67     (67 )       67     (54 )   13  

Certification

  2     467     (467 )       467     (467 )    

Covenant not to compete

  3     478     (359 )   119     478     (199 )   279  

Trademarks

  3     263     (263 )       263     (263 )    

Order backlog

  3 months-
1 year
    2,162     (2,162 )       2,162     (2,162 )    
                               

Total identified intangible assets

      $ 32,570     (19,061 ) $ 13,509   $ 32,570     (11,810 ) $ 20,760  
                               
                               

        Amortization expense related to finite-lived intangible assets for 2013, 2012 and 2011 was $7.3 million, $4.2 million and $2.8 million, respectively. In 2013, amortization expense increased due a full year of amortization related to the StraTech acquisition in late 2012. The finite-lived intangible asset we acquired in the StraTech acquisition consisted of customer relationships having an estimated life of 5 years that we are amortizing over the useful life of the asset using an accelerated amortization method, to match the pattern in which the economic benefits are expected to be consumed. In 2011, amortization expense increased due to the acquisition of Midwave. The finite-lived intangibles we acquired in the Midwave acquisition consisted of covenants not to compete, order backlog and

58


customer relationships having estimated lives of three years, three months and five years, respectively. Expected amortization in each of the next five years is as follows:

 
  (in thousands)  

2014

  $ 5,293  

2015

    3,963  

2016

    2,937  

2017

    1,316  
       

  $ 13,509  
       
       

5.     Income Taxes:

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

 
  2013   2012   2011  

Tax expense at U.S. statutory rates

    35.0 %   35.0 %   35.0 %

State tax expense, net of federal tax effect

    3.3     5.0     5.2  

Meals and entertainment

    1.7     1.0     1.0  

Other

    (0.2 )   (0.4 )   0.2  
               

Effective tax rate

    39.8 %   40.6 %   41.4 %
               
               

        Net deferred tax assets (liabilities) consist of the following components as of December 31, 2013 and 2012:

 
  Year Ended
December 31,
 
 
  2013   2012  
 
  (in thousands)
 

Deferred income tax assets:

             

Allowance for doubtful accounts

  $ 133   $ 97  

Compensation accrual

    2,350     1,685  

Inventories

    42     128  

Deferred revenue

    16,608     12,542  

Net operating loss carryovers

    50     65  

Bonuses

    1,932     1,360  

Deferred rent

    135     162  

Tenant allowance

    189     227  

Intangibles

    2,280     744  

Other

    73     22  
           

Total deferred tax assets

    23,792     17,032  

Deferred income tax liabilities:

             

Prepaid expenses

    (382 )   (212 )

Deferred costs

    (14,916 )   (17,581 )

Deferred commission

    (1,547 )   (2,537 )

Section 481(a) adjustment

    (664 )   (1,065 )

Property and equipment

    (861 )   (200 )
           

Total deferred tax liabilities

    (18,370 )   (21,595 )
           

Net deferred income tax assets (liabilities)

  $ 5,422   $ (4,563 )
           
           

59


        The deferred tax amounts above have been classified in the accompanying balance sheets as follows for 2013 and 2012:

 
  Year Ended
December 31,
 
 
  2013   2012  
 
  (in thousands)
 

Current deferred tax liability

  $ (1,694 ) $ (9,034 )

Noncurrent deferred tax asset

    7,116     4,471  
           

Net deferred tax asset (liability)

  $ 5,422   $ (4,563 )
           
           

        The tax expense for 2013 and 2012 consists of the following:

 
  Year Ended
December 31,
 
 
  2013   2012  
 
  (in thousands)
 

Current income tax expense:

             

United States federal

    14,142     5,773  

State and local

    2,485     1,151  
           

Current income tax expense

  $ 16,627   $ 6,924  
           

Deferred income tax (benefit) expense:

             

United States federal

    (8,886 )   162  

State and local

    (1,099 )   100  
           

Deferred income tax (benefit) expense

    (9,985 )   262  
           

Income tax expense

  $ 6,642   $ 7,186  
           
           

        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, 2013, we have no federal net operating carryforwards. As of December 31, 2013, we have state net operating loss carryforwards of approximately $820,000, which are available to offset future state taxable income. If not used, the state net operating loss carryforwards will expire between 2014 and 2028. For 2013 we recorded approximately $885,000 to equity for tax expenses associated with the exercise of stock options. For 2012 we recorded approximately $781,000 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 42%.

        The tax years 2008-2012 remain open to examination by both the Federal government and by other major income taxing jurisdictions to which we are subject.

        Our ability to utilize a portion of our net operating loss carryforwards to offset future taxable income may be subject to certain limitations under Section 382 of the Internal Revenue Code due to changes in our equity ownership. We do not believe that an ownership change under Section 382 has occurred, and therefore, no such limitations exist.

6.     Lease Commitments:

        Our corporate headquarters including our principal technical and support services operations, are located in an office and warehouse facility in Eden Prairie, Minnesota. As of December 31, 2013, our

60


other 29 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 a result of our acquisition of StraTech in October 2012, we are the successor in interest to six leases where StraTech was the tenant. These facilities provide us with approximately 27,000 additional square feet of office space available for our operations in Georgia, Alabama, North Carolina, Florida, Maryland, and Tennessee.

        As a result of our acquisition of certain assets of Midwave in October 2011, as tenant, we are the successor interest to a lease ("Original Lease") dated August 9, 2010. The Original Lease was for 20,851 square feet of office space. In December 2011, we entered into a First Amendment to Lease (the "Amendment") to the Original Lease for approximately 32,906 additional square feet of office space ("Expansion Space"), which provides us with approximately 54,000 total square feet available for our operations. We moved our corporate headquarters to this new location in April 2012. Under the terms of the Amendment, the term of the Original Lease was extended for 42 months from March 1, 2016 through August 31, 2019 and the term of the lease for the Expansion Space is for seven years and six months, which commenced on March 1, 2012. We have the option to extend the term of the Original Lease for an additional five year term as long as certain conditions are met.

        As of December 31, 2013, future minimum lease payments due under non-cancelable operating leases are as follows:

 
  Lease
Obligations
  Sublease
Agreements
  Net Lease
Obligations
 
 
  (in thousands)
 

2014

  $ 2,164   $ (34 ) $ 2,130  

2015

    1,448         1,448  

2016

    941         941  

2017

    819         819  

Thereafter

    1,218         1,218  
               

  $ 6,590   $ (34 ) $ 6,556  
               
               

        Total rent expense, net of sublease income of $34,000, $219,000 and $663,000 in 2013, 2012 and 2011, respectively, is as follows:

 
  Year Ended December 31,  
 
  2013   2012   2011  
 
  (in thousands)
 

Rent expense

  $ 3,062   $ 2,578   $ 2,601  
               
               

7.     Employee Benefit Plan:

        We have a defined contribution retirement plan for eligible employees. Employees may contribute up to 60% 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 2013, 2012 and 2011 was $1.4 million, $1.1 million and $857,000, respectively.

61


8.     Line of Credit:

        On July 17, 2013, we entered into a credit agreement with Castle Pines Capital LLC ("CPC"), an affiliate of Wells Fargo Bank, National Association. The credit agreement provides for a floor plan line of credit and a revolving facility in a maximum combined aggregate amount of $40 million. Borrowing under the revolving facility cannot exceed the lesser of (i) $40 million minus the amount outstanding under the floor plan line of credit or (ii) a borrowing base consisting of 85% of certain eligible accounts and 100% of channel financed inventory, subject to CPC's ability to impose reserves in the future. The floor plan line of credit finances certain purchases of inventory by us from vendors approved by CPC and the revolving facility is used for working capital purposes and permitted acquisitions.

        The amounts outstanding under the revolving facility will bear interest at a per annum rate of 2.0% above Wells Fargo's one-month LIBOR rate (approximately 0.17% at December 31, 2013). Advances under the floor plan line of credit will not bear interest so long as they are paid by the applicable payment due date and advances that remain outstanding after the applicable payment due date will bear interest at a per annum rate of LIBOR plus 4%. We are obligated to pay quarterly to CPC an unused commitment fee equal to 0.50% per annum on the average daily unused amount of the combined facility, with usage including the sum of any advances under either the floor plan line of credit or the revolving facility. The combined facility and certain bank product obligations owed to Wells Fargo and CPC or its affiliates are secured by substantially all of our assets. The credit agreement terminates on July 17, 2016 and we will be obligated to pay certain prepayment fees if the credit agreement is terminated prior to that date.

        The credit agreement contains customary representations, warranties, covenants and events of default, including but not limited to, covenants restricting our ability to (i) grant liens on our assets, (ii) make certain fundamental changes, including merging or consolidating with another entity or making any material change in the nature of our business, (iii) make certain dividends or distributions, (iv) make certain loans or investments, (v) guarantee or become liable in any way on certain liabilities or obligations of any other person or entity, or (vi) incur certain indebtedness. Our prior credit agreement (as discussed below) included similar restrictions.

        The credit agreement contains certain covenants regarding our financial performance, including (i) a minimum tangible net worth of at least $20 million, (ii) a maximum funded debt to EBITDA of no more than 3.00 to 1.00, and (iii) a minimum quarterly net income of at least $250,000.

        The credit agreement replaced the credit facility we had in place with Wells Fargo, which was terminated upon the effectiveness of the credit agreement. We did not incur any early termination fees or penalties in connection with the termination of the prior credit agreement. Wells Fargo serves and may continue to serve as our transfer agent and has performed and may continue to perform commercial banking and financial services for us for which they have received and may continue to receive customary fees. The prior credit agreement provided for a revolving line of credit for a total maximum borrowing amount of $20.0 million.

        We had outstanding advances of $6.0 million on the prior credit agreement at December 31, 2012. At December 31, 2013, we had no outstanding advances on the prior credit agreement or the revolving facility. Of the $40 million maximum borrowing amount available under the combined floor plan line of credit and revolving facility, we had outstanding advances of $20.0 million on the floor plan line of credit related to the purchase of inventory from a vendor.

62


9.     Stockholders' Equity:

    Common Stock Offering:

        On August 8, 2013, we entered into an underwriting agreement relating to the public offering of 3,300,000 shares of our common stock at a price to the public of $11.00 per share, less underwriting discounts. In addition, we granted the underwriters a 30-day option to purchase up to an additional 495,000 shares at $11.00 per share to cover over-allotments, if any. On August 14, 2013, we completed the offering of 3,795,000 shares of common stock at a price to the public of $11.00 per share. The number of shares sold in the offering includes the underwriters' full exercise of their over-allotment option. We received proceeds from the common stock sold by us, net of offering costs, of approximately $39.0 million.

        On March 14, 2011, we completed a public offering of 4,266,500 shares of common stock with a price to the public of $5.75 per share. We issued and sold 3,306,500 shares in the offering and the selling shareholder sold 960,000 shares in the offering. We received proceeds from the common stock sold by us, net of offering costs of $17.5 million. We did not receive any proceeds from the shares sold by the selling shareholder.

    Stock Compensation Plans:

        In May 2011, our shareholders approved our 2011 Incentive Compensation Plan ("2011 Plan"). The 2011 plan replaced our existing 2009 Incentive Compensation Plan ("2009 Plan") and 2000 Director Stock Option Plan (the "Director Plan"), each of which terminated upon approval of the 2011 Plan on May 12, 2011. We reserved up to 750,000 initial shares of our common stock for possible issuance under the 2011 Plan and 303,943 shares remaining available for future grants under the 2009 Plan. Awards under the 2011 Plan may consist of options (non-qualified and incentive stock options), stock appreciation rights, or SARs, restricted stock units, performance units, dividend 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, 2013, there were 613,174 shares available for grant under the 2011 Plan.

    Time-based Restricted Stock Grants under our 2011 Plan:

        Under the 2011 Plan, eligible employees may be awarded shares of restricted stock. These shares generally vest three to four years after issuance, subject to continuous employment and certain other conditions. In 2013, 2012 and 2011, we issued 273,500, 279,428 and 140,000 shares, respectively, of time-based restricted stock to our executive management and certain other employees. Restricted shares are valued at the closing price of our stock on the date of grant and are expensed over the vesting period. Unrecognized compensation expense related to the non-vested stock grants was $3.4 million at December 31, 2013 and is expected to be recognized through October 2017. Compensation expense related to these restricted stock grants was $1.9 million in 2013, $910,000 in 2012 and $621,000 in 2011.

        In 2013, 2012 and 2011, we issued 36,000, 36,000 and 36,607 shares of common stock to members of the Board of Directors, respectively. Our non-employee directors receive 6,000 shares of restricted stock for their Board service. We issue the annual restricted stock grants on June 30 of each year and they vest one-quarter upon issuance and one-quarter on the following September 30, December 31, and March 31, respectively, provided that the director is still a member of the Board on that date. As of December 31, 2013, 9,000 shares of the 2013 restricted stock grant were not vested. The 2012 and 2011 awards to our directors have all vested. For 2013, 2012 and 2011, total compensation expense for these awards was approximately $424,000 $323,000 and $260,000, respectively.

63


    Performance-based Restricted Stock Grants under our 2011 Plan, 2009 Plan and Director Plan:

        Under the 2011 Plan, we are able to grant performance-based awards of restricted stock to our employees. The purpose of the performance-based grants is to retain key employees and to align key management with shareholders' interests.

        On December 23, 2013, we awarded 171,408 shares of restricted stock pursuant to our 2011 Plan to executive management. These shares vest as follows: two-thirds if we achieve 150% of the non-GAAP operating income target of $32.3 million for 2014, with such percentages adjusted according to the matrix approved by our compensation committee during the December 23, 2013 meeting (one-third of this subtotal will vest upon announcement of the non-GAAP operating income target, one-third will vest on the first anniversary of the announcement, and the last third of this subtotal will vest on the second anniversary of the announcement); one-third time-based vesting (one-third of this subtotal on the first anniversary of the grant date, one-third of this subtotal on the second anniversary of the grant date, and the last third of this subtotal on the third anniversary of the grant date), provided that the individual remains employed by us on these vesting dates. The total fair value of the shares that have not vested under this award is $1.9 million, comprised of $633,000 for the time-based awards and $1.3 million for the performance-based awards. We are amortizing the $633,000 fair value of the time-based shares that have not vested as follows: (1) $211,000 through the first anniversary of the grant date (2) $211,000 over the two-year vesting period and (3) $211,000 over the three-year vesting period. For the performance-based shares, we are only subjecting the portion that will be attained if the Company achieves 100% of non-GAAP operating income during 2014 to amortization, as this is the Company's best estimate of 2014 non-GAAP operating results as of December 31, 2013. The corresponding fair value of the performance-based shares executive management will receive if the Company achieves 100% of non-GAAP operating income during 2014 is $633,000 and will vest as follows: (1) $211,000 over the 14-month period for the achievement of the performance objectives and remaining employed by us through the announcement of 2014 financial results, (2) $211,000 over the two-year vesting period (3) $211,000 over the three-year vesting period. Unrecognized compensation expense related to both the performance-based and time-based restricted stock grants in this award was $1.9 million at December 31, 2013 and is expected to be recognized through February 2017. Compensation expense related to these restricted stock grants was $15,000 for the year ended December 31, 2013.

        On March 11, 2013, we awarded 36,000 shares of restricted stock pursuant to our 2011 Plan to certain managers. The restricted stock vests as follows: (1) fifty percent upon the achievement of our income or gross profit objectives for 2013 and remaining employed by us through December 31, 2014, (2) twenty five percent upon the second grant anniversary date (3) 12.5 percent upon the third grant anniversary date and (4) 12.5 percent upon the fourth grant anniversary date. We are amortizing the $382,000 fair value of the shares that have not vested as follows: (1) $191,000 over the 22-month period for the achievement of the performance objectives and remaining employed by us through December 31, 2014, (2) $95,000 over the two-year vesting period (3) $48,000 over the three-year vesting period and (4) $48,000 over the four-year vesting period. Unrecognized compensation expense related to the restricted stock grants was $238,000 at December 31, 2013 and is expected to be recognized through March 2017. Compensation expense related to these restricted stock grants was $144,000 for the year ended December 31, 2013.

        On December 4, 2012, we awarded approximately 163,000 shares of restricted stock pursuant to our 2011 Plan to executive management. The restricted stock vests as follows: (1) fifty percent upon the achievement of our predetermined earnings from operations objective for 2013 as approved by our Board of Directors and assuming the individual employee remains employed by us through December 31, 2014, (2) twenty five percent upon the second grant anniversary date, (3) 12.5 percent upon the third grant anniversary date and (4) 12.5 percent upon the fourth grant anniversary date. We are amortizing the $1.4 million fair value of the shares that have not vested as follows: (1) $680,000

64


over a 25-month period for the achievement of the performance objectives and assuming the individual employee remains employed by us through December 31, 2014, (2) $340,000 over the two-year vesting period, (3) $170,000 over the three-year vesting period and (4) $170,000 over the four-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $618,000 at December 31, 2013 and is expected to be recognized through November 2016. Compensation expense related to these restricted stock grants was $532,000 and $51,000 for the year ended December 31, 2013 and 2012, respectively.

        On October 4, 2012, we awarded 45,000 shares of restricted stock pursuant to our 2011 Plan to certain managers. The restricted stock vests as follows: (1) fifty percent upon the achievement of our income or gross profit objectives for 2012 and having remained employed by us through the announcement of the 2012 financial results, (2) twenty five percent upon the second grant anniversary date and (3) twenty five percent upon the third grant anniversary date. We are amortizing the $386,000 fair value of the shares that have not vested as follows: (1) $198,000 over the 4.5-month period for the achievement of the performance objectives and having remained employed by us through the announcement of 2012 financial results, (2) $99,000 over the two-year vesting period and (3) $99,000 over the three-year vesting period. Unrecognized compensation expense related to the restricted stock grants was $93,000 at December 31, 2013 and is expected to be recognized through September 2015. Compensation expense related to these restricted stock grants was $80,000 and $20,000 for the year ended December 31, 2013 and 2012, respectively.

        On February 22, 2012, we awarded approximately 173,000 shares of restricted stock pursuant to our 2011 Plan to certain members of our executive management team. The restricted stock vests as follows: (1) fifty percent upon the achievement of our predetermined earnings from operations objective for 2012 as approved by our Board of Directors and assuming the individual employee remained employed by us through December 31, 2013, (2) twenty five percent upon the second grant anniversary date and (3) twenty five percent upon the third grant anniversary date, provided in each case the individual is employed with us on each vesting date. We are amortizing the $1.5 million fair value of the shares that have not vested as follows: (1) $750,000 over the 22.5-month period for the achievement of the performance objectives and assuming the individual employee remained employed by us through December 31, 2013, (2) $375,000 over the two-year vesting period and (3) $375,000 over the three-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $128,000 at December 31, 2013 and is expected to be recognized through February 2015. Compensation expense related to these restricted stock grants was $191,000 and $286,000 for the year ended December 31, 2013 and 2012, respectively.

        On July 17, 2011, we awarded 215,000 shares of restricted stock pursuant to our 2011 Plan to certain managers. The restricted stock vests as follows: (1) 39,000 upon the achievement of our income or gross profit objectives for 2011, (2) 88,000 upon the second grant anniversary date and (3) 88,000 upon the third grant anniversary date. We are amortizing the $1.6 million fair value of the restricted shares that have not vested as follows: (1) $292,000 over a 6-month vesting period for the achievement of the performance objectives, (2) $658,000 over the two-year vesting period and (3) $658,000 over the three-year vesting period. Unrecognized compensation expense related to the restricted stock grants was $85,000 at December 31, 2013 and is expected to be recognized through June 2014. Compensation expense related to these restricted stock grants was $297,000, $309,000 and $566,000 for the years ended December 31, 2013, 2012 and 2011, respectively.

        On January 17, 2011, we awarded 209,000 shares of restricted stock pursuant to our 2011 Plan to executive management. The restricted stock vests as follows: (1) 104,500 shares upon the achievement of our predetermined earnings from operations objective for 2011 as approved by our Board of Directors and assuming the individual employee remained employed by us through December 31, 2013, (2) 52,250 upon the second grant anniversary date and (3) 52,250 upon the third grant anniversary date. We are amortizing the $1.2 million fair value of the restricted stock as follows: (1) $612,000 over

65


a 12 month vesting period for the achievement of the performance objectives, (2) $306,000 over the two-year vesting period and (3) $306,000 over the three-year vesting period. Unrecognized compensation expense related to the non-vested stock grants was $12,800 at December 31, 2013 and is expected to be recognized through January 2014. Compensation expense related to these restricted stock grants was $313,000, $459,000 and $440,000 for the years ended December 31, 2013, 2012 and 2011, respectively.

        On August 17, 2010, we awarded 25,000 shares of restricted stock pursuant to our 2009 Plan 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 ("ERP") system. In addition, the individual employee must have remained employed by us through February 1, 2012. We are amortizing the $85,000 fair value of the restricted stock on the date of grant ratably over the eighteen-month vesting period in accordance with specific vesting terms. There was no unrecognized compensation expense related to these restricted stock grants at December 31, 2013. For 2012 and 2011, compensation expense related to these restricted stock grants was $(56,000) and $53,000, respectively.

        On August 17, 2010, we awarded 42,307 shares of restricted stock pursuant to our 2009 Plan to executive management. The grants vested upon our achievement of the predetermined earnings from operations objective for the second-half of 2010 as approved by our Board of Directors. In addition, the individual must have remained employed by us through December 31, 2011. As of December 31, 2011, all of these awards are fully vested. We amortized the $144,000 fair value of the restricted stock over the eighteen-month vesting period in accordance with specified vesting terms. There was no unrecognized compensation expense related to these restricted stock grants at December 31, 2013 and 2012. For 2011, compensation expense related to these restricted stock grants was $102,000.

        On February 2, 2010, we awarded 25,000 shares of restricted stock pursuant to our 2009 Plan to senior management and managers. The grants vested upon our achievement of the predetermined earnings from operations objective for 2010 as approved by our Board of Directors. In addition, the individual employee must have remained employed by us through December 31, 2011. As of December 31, 2011, all of these awards are fully vested. We amortized the $112,000 fair value of the restricted stock over a two-year period that began on January 1, 2010. There was no unrecognized compensation expense related to these restricted stock grants at December 31, 2013 and 2012. For 2011, compensation expense related to these restricted stock grants was $(34,000).

        On December 14, 2009, we awarded 201,250 shares of restricted stock pursuant to our 2009 Plan to senior management and managers. The grants vested upon our achievement of the predetermined earnings from operations objective for 2010 as approved by our Board of Directors. In addition, the individual employee must have remained employed by us through December 31, 2011. As of December 31, 2011, all of these awards are fully vested. We amortized the $767,000 fair value of the restricted stock over a two-year period that began on January 1, 2010. There was no unrecognized compensation expense related to these restricted stock grants at December 31, 2013 and 2012. For 2011, compensation expense related to these restricted stock grants was $316,000.

66


        The following table summarizes our restricted stock activity for the periods indicated below:

 
  Number of Shares   Weighted Average
Grant-Date Fair Value
 

Restricted stock at January 1, 2011

    647,058   $ 4.04  

Granted

    564,000   $ 7.12  

Shares vested

    (75,000 ) $ 3.88  

Shares cancelled

    (57,000 ) $ 5.26  
           

Restricted stock at January 1, 2012

    1,079,058   $ 5.60  

Granted

    663,843   $ 8.58  

Shares vested

    (385,808 ) $ 5.66  

Shares cancelled

    (109,425 ) $ 7.12