DTLK Datalink Corp.

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x      Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended:  September 30, 2014

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)

10050 Crosstown Circle, Suite 500

EDEN PRAIRIE, MINNESOTA 55344

(Address of Principal Executive Offices)

(952) 944-3462

(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant 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 Regulation 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 x  No 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.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

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

As of November 4, 2014, 23,034,583 shares of the registrant’s common stock, $.001 par value, were outstanding.

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DATALINK CORPORATION

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PART I. FINANCIAL INFORMATION

Item 1.   Financial Statements

Datalink Corporation

Balance Sheets

(In thousands, except share data)

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

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Datalink Corporation

Statements of Operations

(In thousands, except per share data)

(Unaudited)

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

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Datalink Corporation

Statements of Cash Flows

(In thousands)

(Unaudited)

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

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Datalink Corporation

Notes to Financial Statements

(Unaudited)

1.                                      Basis of Presentation

We have prepared the interim financial statements included in this Form 10-Q without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  We have condensed or omitted certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, pursuant to such rules and regulations.  You should read these financial statements in conjunction with the financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.

The financial statements presented herein as of September 30, 2014, and for the three months and nine months ended September 30, 2014 and 2013, reflect, in the opinion of management, all adjustments (which consist only of normal, recurring adjustments) necessary for a fair presentation of the financial position and the results of operations and cash flows for the periods presented. Management makes estimates and assumptions affecting the amounts of assets, liabilities, revenues and expenses we report, and our disclosure of contingent assets and liabilities at the date of the financial statements.  The results of the interim periods are not necessarily indicative of the results for the full year.  Accordingly, you should read these condensed financial statements in conjunction with the audited financial statements and the related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.  Actual results could differ materially from these estimates and assumptions.

Recently Issued Accounting Standards

In June 2014, the FASB issued Accounting Standards Update 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period (“ASU 2014-12”), which requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. Thus, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2015. Entities can apply the amendment either a) prospectively to all awards granted or modified after the effective date or b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. We currently do not anticipate the adoption of this standard will have a material impact on our condensed consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU No. 2014-09”). The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. This ASU is intended to provide a more robust framework for addressing revenue issues; improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets; and provide more useful information to users of financial statements through improved revenue disclosure requirements. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2016. We are currently determining our implementation approach and assessing the impact on our consolidated financial statements.

2.                                      Net Earnings per Share

We compute basic net earnings per share using the weighted average number of shares outstanding.  Stock awards are included in the computation of basic net earnings per share only after the shares become vested. Included in the number of average common shares outstanding as of the three months ended September 30, 2014 and 2013 were 1.2 million shares and 3.1 million shares, respectively, which were unvested and therefore excluded from the computation of basic net earnings per share.  Included in the number of average common shares outstanding as of the nine months ended September 30, 2014 and 2013 were 1.2 million shares and 4.4 million shares, respectively, which were unvested and therefore excluded from the computation of basic net earnings per share. Diluted net earnings per share include the potentially dilutive impact of share-based awards outstanding at period end, consisting of the incremental shares assumed to be issued upon the exercise of stock options and the incremental shares assumed to be issued under performance share and restricted stock unit arrangements.  Diluted net earnings 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:

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We excluded the following restricted stock grants from the computation of diluted earnings per share as their effect would have been anti-dilutive or because they had not yet been issued as of September 30, 2014 and 2013:

3.                                      Stock-Based Compensation

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.

Restricted Stock:

Total stock-based compensation expense related to restricted stock was $880,000 and $989,000 for the three months ended September 30, 2014 and 2013, respectively.  Total stock-based compensation expense related to restricted stock was $2.4 million and $2.5 million for the nine months ended September 30, 2014 and 2013, respectively.  Unrecognized stock-based compensation expense related to restricted stock was $6.1 million at September 30, 2014, which we will amortize ratably through August 2018.

The following table summarizes our restricted stock activity for the nine months ended September 30, 2014:

Stock Options:

We recognized no stock-based compensation expense related to stock options for the three and nine months ended September 30, 2014. Total stock-based compensation expense related to stock options was $14,000 and $134,000 for the three and nine months ended September 30, 2013, respectively.  There was no unrecognized stock-based compensation expense related to stock options at September 30, 2014.

The following table represents stock option activity for the nine months ended September 30, 2014:

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Other:

Effective January 1, 2014 and pursuant to Deferred Stock Unit (“DSU”) Master Agreements, each member of the board of directors may elect to receive DSUs with a fair value equivalent to a percentage of each quarterly installment of the annual cash retainer for non-employee directors to which that member would otherwise be entitled for service as a Datalink director during 2014. In addition, each member of the board of directors may elect to receive a DSU award equal to a percentage of the award of shares of Restricted Stock to which that member would otherwise have been entitled as the equity component of the 2014 annual retainer. The DSUs and DSU awards vest and become non-forfeitable on each of June 30, 2014, September 30, 2014, December 31, 2014 and March 31, 2015, provided the board member remains in service with us. We will issue one share in payment and settlement of each vested DSU subject to the Master DSU Agreement following a termination of that board member’s service with us.

We recognized expense of $114,000 and $122,000 during the three months ended September 30, 2014 and 2013 related to awards of 10,746 shares and 9,000 shares, respectively, of fully vested common stock to members of our Board of Directors.  Of the 10,746 shares of fully vested stock awarded to member of our Board of Directors during the three months ended September 30, 2014, 5,088 shares were DSUs. During the nine months ended September 30, 2014 and 2013, we recognized expense of $342,000 and $326,000, respectively, related to awards of 29,820 shares and 27,000 shares, respectively, of fully vested common stock to members of our Board of Directors.  Of the 29,820 shares of fully vested stock awarded to members of our Board of Directors during the nine months ended September 30, 2014, 10,662 shares were DSUs.

4.                                      Income Taxes

We base the provision for income taxes upon estimated annual effective tax rates in the tax jurisdictions in which we operate.  For the three months ended September 30, 2014 and 2013, our effective tax rate was 40.8% and 37.6%, respectively, excluding discrete items.  Our effective tax rate for each of the nine month periods ended September 30, 2014 and 2013 rate was 40.5%, excluding discrete items.  We recognized benefits from discrete item adjustments of approximately $842,000 and $101,000 during the three months ended September 30, 2014 and 2013, respectively. These adjustments decreased our effective tax rate to 22.3% and 28.6% for the three months ended September 30, 2014 and 2013, respectively. We recognized benefits from discrete item adjustments of approximately $856,000 and $101,000 during the nine months ended September 30, 2014 and 2013, respectively. These adjustments decreased our effective tax rate to 32.7% and 39.2% for the nine months ended September 30, 2014 and 2013, respectively. The decrease in the tax rate was primarily related to two discrete events. One was the establishment of a deferred tax asset related to the excess tax goodwill on the StraTech settlement agreement.  The other was related to amended returns filed to account for changes in state apportionment.  We expect our annual effective tax rate for 2014 to be 35.9% after discrete items.

As part of the process of preparing financial statements, we estimate federal and state income taxes. Management estimates the actual current tax exposure together with assessing temporary differences resulting from different treatment for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we include within our balance sheet. Management must then assess the likelihood that we will utilize deferred tax assets to offset future taxable income during the periods in which we may deduct these temporary differences.  For the three and nine months ended September 30, 2014, we recorded income tax expense of $1.0 million and $3.6 million, respectively, with effective tax rates of 22.3% and 32.7%.

We assess our uncertain tax positions for tax years that are still open for examination.  As of September 30, 2014 and 2013, we had no unrecognized tax benefits which would affect our effective tax rate if recognized.

We classify interest and penalties arising from the underpayment of income taxes in the statement of operations under general and administrative expenses. As of September 30, 2014 and 2013, we had no accrued interest or penalties related to uncertain tax positions. 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 is 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.

5.                                      Acquisitions

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 was offset by a receivable due from the Sellers of approximately $3.3 million, resulting from the preliminary tangible net asset

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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, the 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 the 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 the 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 was determined to be 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. Based on the value of our common stock on the date of the settlement agreement in January 2014, we recorded a gain before tax of approximately $876,000 during the nine months ended September 30, 2014 as a result of the increase in our stock price from December 31, 2013 to the date we repossessed the shares in escrow.

6.                                      Goodwill and Finite-Lived Intangible Assets

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 perform an impairment test for finite-lived assets, such as intangible assets, and other long-lived assets, such as fixed assets, whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.  Circumstances that could represent triggering events and therefore require an interim impairment test of goodwill or evaluation of our finite-lived intangible assets or other long-lived assets include the following:  loss of key personnel, unanticipated competition, higher or earlier than expected customer attrition, deterioration of operating performance, significant adverse industry, economic or regulatory changes or a significant decline in market capitalization.

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.

In conducting the annual impairment test of our goodwill, qualitative factors are first examined to determine whether the existence of events, or circumstances, indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If it is determined that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a two-step impairment test is applied.  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.

Goodwill was $37.8 million as of each of September 30, 2014 and December 31, 2013. We conducted our annual goodwill impairment test as of December 31, 2013, our last measurement date.  Based on this analysis, we determined that there was no impairment to goodwill.  We will continue to monitor conditions and changes that could indicate impairment of our recorded goodwill.

At each of September 30, 2014 and December 31, 2013, we determined that no triggering events had occurred during the quarter and our finite-lived assets and long-lived assets were not impaired.

The carrying amount and accumulated amortization of our intangible assets that were subject to amortization at each balance sheet date are as follows:

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Amortization expense for identified intangible assets is summarized below:

Based on the identified intangible assets recorded at September 30, 2014, future amortization expense for the next five years is as follows:

7.                                      Short-Term Investments

Our short-term investments consist of commercial paper, corporate bonds and interest-bearing CDs. We categorize these investments as trading securities and record them at fair value. We classify investments with maturities of 90 days or less from the date of purchase as cash equivalents; investments with maturities of greater than 90 days from the date or 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. The following table summarizes our short-term investments:

Our $36.0 million of short-term investments are comprised of commercial paper, corporate bonds and interest-bearing CDs with maturities within one year and interest rates ranging from 0.51% to 4.95%.

8.                                      Fair Value Measurements

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 September 30, 2014.

The fair value of our financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, line of credit and accrued liabilities, 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.

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

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

The fair value hierarchy requires the use of observable market data when available.  In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, we determine the fair value measurement based on the lowest level input that is significant to the fair value measurement in its entirety.  Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.  The following table sets forth, by level within the fair value hierarchy, the accounting of our financial assets and/or liabilities at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 according to the valuation techniques we used to determine their fair value(s).

9.                                      Leases Receivable and Leases Payable

We occasionally enter into sales-type lease agreements with our customers resulting from the sale of certain products. Our lease receivables are recorded at net realizable value within the accounts receivable and long-term lease receivables balances on our balance sheet and are due in installments over the lives of the leases. Cash received and applied against the receivable balance is recorded within changes in operating assets and liabilities in the net cash provided by operating activities section of the statement of cash flows.  Finance income is derived over the term of the sales-type lease arrangement as the unearned income on financed sales-type leases is earned. Unearned income is amortized over the life of the lease using the interest method.  The present value of net investment in sales-type lease receivables of $6.4 million and $1.3 million at September 30, 2014 and December 31, 2013, respectively, is reflected net of unearned income of $494,000 and $57,000 at September 30, 2014 and December 31, 2013, respectively. As of September 30, 2014, scheduled maturities of minimum lease payments receivable were as follows for the fiscal years ended December 31:

Lease receivables are individually evaluated for impairment. In the event we determine that a lease receivable may not be paid, we include in our allowance an amount for the outstanding balance related to the lease receivable. At September 30, 2014, there were no amounts past due related to lease receivables.

Our lease receivables typically generate monthly cash inflows with average lease durations of 24 to 36 months. To better match cash outflows related to these receivables, we occasionally finance the equipment associated with our leases receivable through sales-leaseback arrangements over a period commensurate with the receivable. Gains associated with these sales are deferred in accordance with the accounting for sales-leaseback transactions and are amortized over the lives of the related lease agreements.  As of September 

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30, 2014, our contractual cash obligations for future minimum lease payments were as follows for the fiscal years ended December 31:

10.                               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 (“Wells Fargo”).  The Credit Agreement provides for a channel finance facility (“Channel Finance Facility”) and a revolving facility (“Revolving Facility” and, together with the Channel Finance Facility, “Combined 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 Channel Finance Facility 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 Channel Finance Facility will finance certain purchases of inventory by us from vendors approved by CPC and the Revolving Facility may be 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 0.16% at September 30, 2014).  Advances under the Channel Finance Facility 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 Channel Finance Facility or the Revolving Facility.  The Combined Facility and certain bank product obligations owed to Wells Fargo or its affiliates are secured by substantially all of our personal property. 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. The Prior Credit Agreement (as defined 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.

Of the $40 million maximum borrowing amount available under the combined Channel Finance Facility and Revolving Facility, we had outstanding advances of $15.0 million and $20.0 million on the Channel Finance Facility at September 30, 2014 and December 31, 2013, respectively, related to the purchase of inventory from a vendor.

11.                              12-Month Earnings Statement

Pursuant to section 11 of the Securities Act of 1933 and Rule 158 promulgated thereunder, the following is an unaudited earnings statement for the twelve months ended September 30, 2014.

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12.                               Subsequent Event

On October 18, 2014, we entered into an agreement and plan of merger with Bear Data Solutions, Inc. (“Bear Data”). Our wholly owned subsidiary was merged with and into Bear Data, with Bear Data surviving as a wholly owned subsidiary of Datalink Corporation. Bear Data is primarily an IT services firm, serving California-based customers from offices in San Francisco, San Jose, Irvine and San Diego. A large portion of its revenues is derived from networking products including Cisco wireless, routing and core switches. The aggregate purchase price for Bear Data was approximately $18.5 million, comprised of a $16.8 million cash payment and $1.7 million in our common stock. We will record a one-time acquisition-related charge of approximately $750,000 during the fourth quarter of 2014.

In connection with the acquisition, we issued an aggregate of 125,000 shares of our restricted stock to twelve Bear Data employees. One-half of the restricted shares will vest after two years of service to Datalink and the remaining shares will vest in equal portions at the completion of service during each of years three and four. We issued these restricted shares outside of our stockholder-approved equity plans in accordance with Nasdaq rules for “inducement grants.” We reported the terms of this transaction on our Current Report on Form 8-K filed with the SEC on October 20, 2014 (File No. 000-29758).

Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

NOTE REGARDING FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. This Quarterly Report on Form 10-Q contains forward-looking statements, (i) the anticipated timing of the acquisition, (ii) the expected impact of the acquisition on Datalink, (iii) Datalink’s plans with respect to the acquired business and (iv) our internal projects of certain anticipated 2014 results, which reflect our views regarding future events and financial performance. 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 our enterprise resource planning system; risks associated with integrating completed and future acquisitions (including a failure of anticipated synergies to materialize); the ability to execute our acquisition strategy; fluctuations in our quarterly operating results; market acceptance of our managed services offerings, including first call support services; future changes in applicable accounting rules; and volatility in our stock price.  Further, our revenues for any particular quarter are not necessarily reflected by our backlog of contracted orders, which also may fluctuate unpredictably.

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 risks, uncertainties and other factors are included in the “Risk Factors” section on our Annual Report on Form 10-K for the year ended December 31, 2013.  All forward-looking statements are quantified by, and should be considered in conjunction with, such cautionary statements. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission that advises interested parties of the risks and factors that may affect our business.

OVERVIEW

We provide independent, comprehensive solutions and services that make data centers more efficient, manageable and responsive to changing business needs.  Focused on mid- and large-size companies, we consult, assess, design, deploy, implement, support, and

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manage critical data center infrastructures such as servers, storage, networks and cloud. Our solutions ensure that our customers’ information technology strategies align with business needs and maximize efficiency. Each solution is built using a customized platform of hardware and software from multiple technology vendors.  We leverage hardware and software from industry-leading original equipment manufacturers as part of our data center offerings and provide ongoing support for all of the solutions and services we offer. Our portfolio of solutions and services spans five practices: consolidation and virtualization, data storage and protection, advanced network infrastructures, business continuity and cloud enablement.  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 September 30, 2014, 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, 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 compete in the marketplace and achieve 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.

RESULTS OF OPERATIONS

The following table shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.

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