Annual Report 2013
Dear Shareholders:
Four years ago, Datalink embarked on a growth strategy that involved diversifying our legacy storage business with new products and services to increase our footprint in the data center. That included embracing converged data center infrastructures, virtualization, cloud computing, and other new technologies that were beginning to transform the data center landscape. The plan has yielded steady annual business expansion ever since.
In 2013, the results included a 21% increase in overall revenues, a 28% increase in total services revenues, and a 39% increase in professional, managed, and advanced services that generate the highest margins. We expect another strong performance in 2014 as midmarket and large enterprises increase their reliance on Datalink to help them navigate the complexities of planning, deploying, and supporting the modern data center. We have become a true full-service data center provider, and we believe that will continue to fuel our growth.
2013 RESULTS
2013 was another record-setting year for Datalink. Revenues for the year ended December 31, 2013, reaching a record $594 million, a 21% gain over the previous year. That included a record $221 million in services revenues, with 26% and 39% increases in customer support and professional services, respectively.
One of the strongest engines of our growth continues to be the sale of converged data center infrastructures that bring new efficiencies to the data center while also expediting the launch of IT applications supporting new business initiatives. In 2013, Datalink generated a record $91 million from these integrated server, storage, network, and virtualization architectures. This is significant not only for its direct contribution to our revenues but also for the potential multiplier effect. Many converged infrastructure placements lead to the sale of additional high-margin services like data center migration and private or hybrid cloud enablement. Our 2013 converged data center performance, coupled with 2014 OUTLOOK standalone sales of various data center products, also strengthened our relationships with key strategic partners including NetApp®, With the successful execution of our growth strategy over the past four Cisco®, EMC®, Symantec®, and Hitachi Data Systems®. Today we years, we believe Datalink has positioned itself to take full advantage of are among NetApp’s top commercial resellers in the Americas, shifting trends in the data center marketplace in 2014 and beyond. Both a leading Cisco data center partner, a major Symantec national the converged data center market and private/hybrid cloud adoption partner, and a key NetApp/Cisco partner for the FlexPod® continue to grow, offering substantial opportunities for new and converged platform. These partnership successes are critical for add-on business. Many IT organizations continue to ask us to provide referral business and customer support. consulting support to plan, deploy, and manage new infrastructures. IT teams are also transitioning from technology providers to service 2013 also marked our strongest services performance to date, with brokers, requiring assistance in moving into their new roles. a 28% increase in total services revenues, 26% increase in customer support revenues, and 39% increase in professional services mentioned We believe Datalink has the people, expertise, products, and services above. Our services now support customers at all stages of the IT to meet these market needs, as well as a holistic and vendor-agnostic lifecycle, helping us almost double our services revenues since we view of the data center that has earned the company a reputation began our data center transformation strategy in 2010. as a trusted data center advisor. We also continue to expand our portfolio to address new developments. In early 2014, for example, Services currently delivered by Datalink range from “one call does it we announced an expansion of our cloud consulting services to aid IT all” support for converged infrastructures and a full suite of managed teams in their journey to become IT services organizations. services to advanced consulting services, including private and hybrid cloud strategy, data center relocation, system and application 2014 looks to be another year of excellent growth for the company. migration, and business continuity/disaster recovery planning. Many of While the increasing size and complexity of our engagements may these advanced services were added or enhanced in 2013 in a major lengthen sales cycles and thereby cause fluctuations in our quarterly investment designed to provide a revenue and profit stream that is not operating results, we believe all the pieces are in place for a strong affected by product sales or fulfillment. fiscal year. We have a talented executive and senior leadership team, an equally strong field organization, exceptional reference customers, All of these factors have combined to increase our relevance to proven success with extremely complex projects, and a scope of customers, allow us to sell into a more complex environment, and products and services that is unmatched by our competitors. With deliver solid growth through a combination of new and repeat business these strengths and our strategic advantages in the data center space, I and increased wallet share. In 2013, that manifested itself in a record have utmost confidence in Datalink’s performance in 2014 and beyond. number of repeat customers, a new benchmark in the number of customers who spent more than $1 million with us in a fiscal year, and a 35% increase in spend from roughly the same number of new customers as we acquired in 2012. Many of these customers also have multi-year roadmaps that will yield additional revenues in the future. Paul Lidsky President & Chief Executive Officer Datalink
Financial Highlights STATEMENT OF OPERATIONS 2013 2012 2011 2010 2009 (In thousands, except per share data) Revenues $ 594,184 $ 491,202 $ 380,027 $ 293,679 $ 178,082 Gross profit $ 133,858 $ 112,026 $ 89,612 $ 67,636 $ 46,436 Gross profit % 22.5% 22.8% 23.6% 23.0% 26.1% Earnings (loss) from operations $ 17,405 $ 17,718 $ 16,793 $ 3,978 $ (451) Net earnings (loss) $ 10,045 $ 10,535 $ 9,845 $ 2,302 $ (555) Net earnings (loss) per diluted share $ 0.52 $ 0.60 $ 0.61 $ 0.18 $ (0.04)
BALANCE SHEET (In thousands, except employee 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 Common stock outstanding 22,785 18,727 17,899 13,570 13,261 Number of employees 510 459 389 299 307 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K (Mark one) ፤ 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 អ 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 អ No ፤ 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 អ No ፤ 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 ፤ No អ 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 ፤ No អ 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. អ 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 អ Accelerated Filer ፤ Non-Accelerated Filer អ Smaller Reporting Company អ (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes អ No ፤ 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
$400
$350
$300
$250
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$0 12/08 12/09 12/10 12/11 12/12 12/13 Datalink Corporation NASDAQ Composite Russell7MAR201400284585 2000
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:
Less than More than Total 1 year 1-3 years 3-5 years 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 Retained Shares Amount Paid-in Capital Earnings 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):
Quoted Prices in Significant Active Markets Significant Other Unobservable Total at Fair for Identical Observable Inputs (In thousands) Value Assets (Level 1) Inputs (Level 2) (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):
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses 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:
Amortizable As of December 31, 2013 As of December 31, 2012 Period Gross Accumulated Net Gross Accumulated Net (years) Assets Amortization Assets Assets Amortization 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) — 3 months- Order backlog ...... 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 Sublease Net Lease Obligations Agreements 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:
Weighted Average Number of Shares 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 Restricted stock at January 1, 2013 ...... 1,247,668 $ 7.47 Granted ...... 480,908 $11.21 Shares vested ...... (316,000) $ 5.84 Shares cancelled ...... (231,061) $ 8.83 Restricted stock at December 31, 2013 ...... 1,181,515 $ 9.17
Stock Options: We had no stock option grants in 2013, 2012 or 2011. In December 2009, we awarded 25,000 stock options to one of our managers. The stock options vest over three years with one-third vesting each year if the individual is still employed by us. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The weighted- average fair value per option at the date of grant was $2.35. In July 2009, we awarded 450,000 stock options to our president and chief executive officer. The stock options vest 25% per year over a term of four years, provided he continues employment with us through each relevant vesting date. Unvested stock options will immediately vest upon a change of control of us (as defined in his employment agreement) but only if he (i) is continuously employed to the date of the change of control, (ii) the change of control price (as defined in the employment agreement) exceeds $3.50 per share, and (iii) such acceleration and vesting will not cause the option to be subject to the adverse consequences described in Section 409A of the Internal Revenue Code. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The weighted- average fair value per option at the date of grant was $2.15. Total stock-based compensation expense related to stock options was $134,000 and $242,000 and $264,000 for the years ended December 31, 2013, 2012 and 2011, respectively. At December 31, 2013 there were no unrecognized stock-based compensation expense related to stock options.
67 The following table summarizes activity under our stock option plans:
Outstanding Options Weighted Range of Average Number of Shares Exercise Prices Exercise Price Balance, December 31, 2010 ...... 1,037,711 $1.44 - $9,81 $4.10 Options granted ...... — — $ — Options exercised ...... (263,564) $1.44 - 8.44 $3.88 Options cancelled ...... (106,765) $3.46 - 9.81 $8.09 Balance, December 31, 2011 ...... 667,382 $1.44 - $5.21 $3.52 Options granted ...... — — $ — Options exercised ...... (95,092) $1.44 - $4.36 $3.66 Options cancelled ...... (4,250) $3.71 - $4.36 $4.06 Balance, December 31, 2012 ...... 568,040 $1.80 - $5.21 $3.49 Options granted ...... — — $ — Options exercised ...... (77,738) $1.80 - $5.00 $3.23 Options cancelled ...... (4,518) $3.32 - $3.85 $3.43 Balance, December 31, 2013 ...... 485,784 $1.80 - $5.00 $3.54 Options exercisable as of December 31, 2011 ...... 436,827 $1.44 - $5.21 $3.58 Options exercisable as of December 31, 2012 ...... 455,540 $1.80 - $5.21 $3.49 Options exercisable as of December 31, 2013 ...... 485,784 $2.68 - $5.21 $3.54 The weighted average remaining contractual life of options outstanding at December 31, 2013 was 5.34 years. At December 31, 2013, 2012 and 2011, respectively, the aggregate intrinsic value of options outstanding and exercisable was $3,577,239, $2,316,414 and $2,692,302. Total intrinsic value of options exercised was $568,335, $563,405, and $988,986 for 2013, 2012 and 2011, respectively.
10. Lease Receivables: We occasionally enter into sales-type lease agreements with our customers resulting from the sale of certain products. Our lease receivables are recorded at cost 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 this 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 $1.3 million and $1.0 million at December 31, 2013 and 2012, respectively, is reflected net of unearned income of $57,000 and $60,000 at December 31, 2013 and 2012, respectively. As of December 31, 2013, scheduled maturities of minimum lease payments receivable were as follows for the fiscal years ended December 31:
(in thousands) 2014 ...... 866 2015 ...... 444 2016 ...... 66 1,376 Less: Current portion ...... (866) Long-term sales-type lease receivable ...... $ 510
68 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 December 31, 2013, there were no amounts past due related to lease receivables.
11. Commitments and Contingencies: We have change of control severance agreements and employment agreements in place with certain executive employees. Under the agreements, an executive is entitled to a severance payment in the event the executive (a) is terminated without cause by us in anticipation of, in connection with, at the time of or within two years after a change of control, or (b) resigns for good reasons arising in anticipation of, in connection with, at the time of or within two years after a change of control.
12. Quarterly Financial Information (unaudited):
March 31 June 30 Sept 30 Dec 31 (in thousands, except per share data) 2013 Net sales ...... $133,518 $147,779 $139,519 $173,368 Gross profit ...... 29,833 33,561 29,805 40,659 Operating earnings ...... 1,966 4,936 1,155 9,348 Net earnings ...... 1,098 2,904 818 5,225 Net earnings per share—basic ...... 0.07 0.17 0.05 0.24 Net earnings per share—diluted ...... 0.07 0.16 0.05 0.24
March 31 June 30 Sep 30 Dec 31 (in thousands, except per share data) 2012 Net sales ...... $119,088 $120,042 $104,774 $147,298 Gross profit ...... 27,326 28,033 24,012 32,655 Operating earnings ...... 3,612 5,411 3,255 5,440 Net earnings ...... 2,161 3,219 1,923 3,232 Net earnings per share—basic ...... 0.13 0.19 0.11 0.19 Net earnings per share—diluted ...... 0.12 0.18 0.11 0.18
March 31 June 30 Sept 30 Dec 31 (in thousands, except per share data) 2011 Net sales ...... $85,694 $89,481 $90,140 $114,712 Gross profit ...... 20,755 21,679 21,240 25,938 Operating earnings ...... 3,000 4,379 4,859 4,555 Net earnings ...... 1,748 2,697 2,793 2,607 Net earnings per share—basic ...... 0.13 0.16 0.17 0.16 Net earnings per share—diluted ...... 0.12 0.16 0.16 0.15
13. Subsequent Events: None.
69 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.
Item 9A. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures Under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal financial officer), we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures were effective at December 31, 2013 to ensure that information we are required to disclose in reports that we file or submit is accumulated and communicated to our management, including our principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosures, and that such information is recorded, processed, summarized and reported within the time periods specific in the Securities and Exchange Commission rules and forms.
(b) Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controls are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (1992). Based on our evaluation under the framework in Internal Control—Integrated Framework (1992), our management concluded that our internal control over financial reporting was effective as of December 31, 2013. McGladrey LLP, the independent registered accounting firm who audited our financial statements, has also audited the effectiveness of our internal control over financial reporting as of December 31, 2013 as described in their report on the next page.
(c) Changes in Internal Control There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
70 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Datalink Corporation We have audited 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. Datalink Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Datalink Corporation maintained, in all material respects, effective 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. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements of Datalink Corporation as of December 31, 2013 and 2012 and for each of the three years in the period ended December 31, 2013, and our report dated March 17, 2014 expressed an unqualified opinion. /s/ McGladrey LLP Minneapolis, Minnesota March 17, 2014
71 Item 9B. Other Information. Not Applicable.
PART III Item 10. Directors, Executive Officers and Corporate Governance. Information contained in Part I, Item 1 of this Annual Report under the heading ‘‘Executive Officers,’’ as well as under ‘‘Election of Directors,’’ ‘‘Executive Compensation—Executive Officers’’ and ‘‘Section 16(a) Beneficial Ownership Reporting Compliance’’ in our proxy statement for our 2014 annual meeting of shareholders, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Form 10-K (the ‘‘2014 Proxy Statement’’) is incorporated herein by reference. We have adopted a code of ethics that applies to our officers, including our principal executive, financial and accounting officers, and our directors and employees. We intend to make all required disclosures concerning any amendments to, or waivers from, our code of ethics by the filing current reports on Form 8-K.
Item 11. Executive Compensation. We incorporate the information set forth under ‘‘Executive Compensation’’ and ‘‘Director Compensation’’ in our 2014 Proxy Statement herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. We incorporate the information set forth under ‘‘Outstanding Voting Securities and Voting Rights’’ and ‘‘Equity Compensation Plan Information at Fiscal Year Ended December 31, 2013’’ in our 2014 Proxy Statement herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence. We incorporate the information required by this section by reference from the information set forth under ‘‘Transactions with Related Parties’’ and ‘‘Corporate Governance’’ in our 2014 Proxy Statement.
Item 14. Principal Accountant Fees and Services. We incorporate the information required by this section by reference from the information set forth under ‘‘Auditing Matters’’ in our 2014 Proxy Statement.
PART IV Item 15. Exhibits and Financial Statement Schedules. (a) We are filing the following documents as part of this Form 10-K report: 1. Financial Statements Reference is made to the Financial Statements of Datalink Corporation, in Part II, Item 8 of this Annual Report.
72 2. Financial Statement Schedules. The following financial statement schedule of Datalink Corporation for 2013, 2012 and 2011 is filed as part of this Annual Report and should be read in conjunction with the Financial Statements of Datalink Corporation.
DATALINK CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011
Balance at Balance Beginning at End Description Period of Period Additions Deductions(1) of Period Allowance for Doubtful Accounts ...... 2013 $222,860 $115,354 $ 7,525 $330,689 2012 282,196 — 59,336 222,860 2011 203,526 84,515 5,845 282,196 Allowance for Inventory Obsolescence ...... 2013 $309,501 $151,986 $372,411 $ 89,076 2012 416,370 445,453 552,322 309,501 2011 105,191 374,264 63,085 416,370
(1) Deductions reflect write-offs of customer accounts receivables, net of recoveries. 3. Exhibits. The exhibits filed with this report are set forth on the exhibit index filed as a part of this report immediately following the signatures to this report.
73 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
DATALINK CORPORATION
Date: March 17, 2014 By: /s/ PAUL F. LIDSKY Paul F. Lidsky, President and Chief Executive Officer
By: /s/ GREGORY T. BARNUM Gregory T. Barnum, Vice President, Finance and Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ PAUL F. LIDSKY President, Chief Executive Officer and Director March 17, 2014 (Principal Executive Officer)
/s/ GREGORY T. BARNUM Vice President, Finance and Chief Financial Officer March 17, 2014 (Principal Financial Officer)
/s/ DENISE M. WESTENFIELD Vice President, Controller and Chief Accounting March 17, 2014 Officer (Principal Accounting Officer)
/s/ JAMES E. OUSLEY Chairman of the Board and Director March 17, 2014
/s/ BRENT G. BLACKEY Director March 17, 2014
/s/ MARGARET A. LOFTUS Director March 17, 2014
/s/ GREG R. MELAND Director March 17, 2014
/s/ J. PATRICK O’HALLORAN Director March 17, 2014
/s/ ROBERT M. PRICE Director March 17, 2014
74 EXHIBIT INDEX
Exhibit Number Title Method of Filing 2.1 Agreement and Plan of Merger dated January 30, 2007, by and among 8 Datalink Corporation, Datalink Acquisition, LLC, Midrange Computer Solutions, Inc., Dan Kalin, Michael Spindler, Wayne Szczepanski and Lodi Vercelli 2.2 Asset Purchase Agreement dated December 17, 2009, by and between 11 Datalink Corporation and Incentra, LLC 2.3 Asset Purchase Agreement dated October 3, 2011, by and among 25 Datalink Corporation, MV Sub, Inc., Midwave Corporation, James D. Leslie, individually and in his capacity as sellers agent, and Robert S. Krocak 2.4 Asset Purchase Agreement dated October 2, 2012, by and among 29 Datalink Corporation, STI Acquisition Corp., Strategic Technologies, Inc. and Midas Medici Group Holdings, Inc. 3.1 Amended and Restated Articles of Incorporation of the Company 14 3.2 Amended and Restated Bylaws of the Company 16 4.1 Form of Common Stock Certificate 13 10.1 Form of Indemnification Agreement 1 10.2* 2009 Incentive Compensation Plan, as amended May 13, 2010 12 10.3 Building Lease dated April 27, 2001, with Hoyt/DTLK LLC 15 10.4* Change of Control Severance Agreement 2 10.5 Sublease Agreement dated December 9, 2004, with Checkpoint 4 Security, Inc. 10.6 Vacant Land Purchase Agreement 5 10.7* Correction to Restricted Stock Award Agreements dated August 13, 2004 6 10.8* Employment Agreement dated March 14, 2006, with Gregory T. Barnum 7 10.9* Employment Agreement dated July 20, 2009, as amended, with Paul F. 9 Lidsky 10.10* Employment Agreement dated December 17, 2009, with M. Shawn 10 O’Grady 10.11* 2011 Incentive Compensation Plan 18 10.12* Form of Restricted Stock Award Agreement for Directors 19 10.13* Form of Restricted Stock Award Agreement for Employees 20 10.14* Form of Incentive Stock Option Agreement 21 10.15* Form of Non-Qualified Stock Option Agreement 22 10.16 Standard Form Industrial Building Lease dated June 24, 2011, with 23 Golden Triangle Tech Center Investors, LLC 10.17 Lease Termination Agreement dated October 4, 2011, with Golden 24 Triangle Tech Center Investors, LLC 10.18 Lease dated August 9, 2010, with IRET Properties 30 10.19 First Amendment to Lease dated December 20, 2010, with IRET 31 Properties 10.20 Credit Agreement by and between Datalink Corporation and Castle 28 Pines Capital LLC dated as of July 17, 2013 14.1 Code of Ethics 3 23.1 Consent of McGladrey LLP Filed herewith 31.1 Certifications by the Chief Executive Officer and Chief Financial Officer Filed herewith pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
75 Exhibit Number Title Method of Filing 32.1 Certifications by the Chief Executive Officer and Chief Financial Officer Filed herewith pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 101.INS XBRL Instance Document Filed herewith 101.SCH XBRL Taxonomy Extension Schema Document Filed herewith 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document Filed herewith 101.DEF XBRL Taxonomy Extension Definition Linkbase Document Filed herewith 101.LAB XBRL Taxonomy Extension Label Linkbase Document Filed herewith 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document Filed herewith
* Management contract or compensatory plan or arrangement. 1) Incorporated by reference to exhibit 10.4 in our registration statement on Form S-1, Reg. No. 333-55935, filed on June 3, 1998. 2) Incorporated by reference to exhibit 10.24 in our Form 10-Q for the period ending September 30, 2004, filed on November 15, 2004 (File No. 0-29758). 3) Incorporated by reference to exhibit 14.1 in our Form 10-K for the period ended December 31, 2003, filed on March 24, 2004 (File No. 0-29758). 4) Incorporated by reference to exhibit 10.25 in our Form 10-K for the period ended December 31, 2004, filed on March 31, 2005 (File No. 0-29758). 5) Incorporated by reference to exhibit 10.26 in our Form 10-K for the period ended December 31, 2004, filed on March 31, 2005 (File No. 0-29758). 6) Incorporated by reference to exhibit 10.25 in our Form 10-Q for the period ending September 30, 2005, filed on November 14, 2005 (File No. 0-29758). 7) Incorporated by reference to exhibit 10.28 in our Form 8-K filed on March 17, 2006 (File No. 0-29758). 8) Incorporated by reference to exhibit 2.1 in our Form 8-K filed on February 5, 2007 (File No. 0-29758). 9) Incorporated by reference to exhibit 10.1 in our Form 8-K filed on January 21, 2011 (File No. 0-29758). 10) Incorporated by reference to exhibit 10.1 in our Form 8-K filed on December 22, 2009 (File No. 0-29758). 11) Incorporated by reference to exhibit 2.1 in our Form 8-K filed on December 22, 2009 (File No. 0-29758). 12) Incorporated by reference to exhibit 10.1 in our Form 8-K filed on May 17, 2010 (File No. 0-29758). 13) Incorporated by reference to exhibit 4.1 in our amended registration statement on Form S-1/A, Reg. No. 333-55935, filed on July 16, 1998. 14) Incorporated by reference to the exhibit of the same number in our Registration Statement on Form S-1, filed on June 3, 1998 (File No. 333-55935). 15) Incorporated by reference to the same exhibit number in our Form 10-Q for the period ending March 31, 2001, filed on May 15, 2001 (File No. 0-29758). 16) Incorporated by reference to exhibit 3.2 in our Form 8-K filed on February 18, 2011 (File No. 0-29758).
76 17) Incorporated by reference to Appendix A in our proxy statement for our 2011 annual meeting, filed on March 31, 2011 (File No. 0-29758). 18) Incorporated by reference to exhibit 10.3 in our Form 10-Q for the period ended June 30, 2011, filed on August 11, 2011 (File No. 0-29758). 19) Incorporated by reference to exhibit 10.4 in our Form 10-Q for the period ended June 30, 2011, filed on August 11, 2011 (File No. 0-29758). 20) Incorporated by reference to exhibit 10.5 in our Form 10-Q for the period ended June 30, 2011, filed on August 11, 2011 (File No. 0-29758). 21) Incorporated by reference to exhibit 10.6 in our Form 10-Q for the period ended June 30, 2011, filed on August 11, 2011 (File No. 0-29758). 22) Incorporated by reference to exhibit 10.1 in our Form 10-Q for the period ended September 30, 2011, filed November 10, 2011 (File No. 0-29758). 23) Incorporated by reference to exhibit 10.2 in our Form 10-Q for the period ended September 30, 2011, filed November 10, 2011 (File No. 0-29758). 24) Incorporated by reference to exhibit 2.1 in our Form 8-K, filed on October 3, 2011 (File No. 0-29758). 25) Incorporated by reference to exhibit 2.1 in our Form 8-K, filed on October 4, 2012 (File No. 000-29758). 26) Incorporated by reference to exhibit 10.18 in our Form 10-K filed on March 15, 2012 (File No. 000-29758). 27) Incorporated by reference to exhibit 10.19 in our Form 10-K filed on March 15, 2012 (File No. 000-29758). 28) Incorporated by reference to exhibit 10.1 in our Form 8-K filed on July 18, 2013 (File No. 000-29758).
77 DATALINK CORPORATION 10050 Crosstown Circle, Suite 500 Eden Prairie, MN 55344
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD MAY 21, 2014
NOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of Datalink Corporation will be held at the Company’s offices, 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota, on Wednesday, May 21, 2014, at 3:00 p.m. Central Time. The proxy materials were either made available to you over the Internet or mailed to you beginning on or about April 8, 2014. At the Annual Meeting our shareholders will vote on: 1. the election of seven directors recommended by the Board of Directors, each to serve until the next Annual Meeting of Shareholders or until their successors are elected and duly qualified; 2. a non-binding advisory vote to approve executive officer compensation; 3. the ratification of the appointment of McGladrey LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2014; and 4. any other business as may properly come before the Annual Meeting of Shareholders. The Board of Directors recommends that shareholders vote FOR each of the following: 1. the director nominees named in the accompanying Proxy Statement; 2. the approval, on a non-binding advisory basis, of the compensation paid to our executive officers as disclosed in the Proxy Statement; and 3. the ratification of the selection of McGladrey LLP as our independent registered public accounting firm for fiscal 2014. Holders of our common stock at the close of business on March 26, 2014 will be entitled to vote at the Annual Meeting of Shareholders.
By Order of the Board of Directors,
25MAR201111141320 Gregory T. Barnum, Secretary Eden Prairie, Minnesota April 8, 2014
YOUR VOTE IS IMPORTANT Whether or not you plan to attend the Annual Meeting, we urge you to vote as soon as possible via the Internet as described in the Notice of Internet Availability of Proxy Materials (the ‘‘Notice’’). If you received a copy of the proxy card by mail, you may vote by Internet or telephone as instructed on the proxy card, or you may sign, date and mail the proxy card in the envelope provided. IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE ANNUAL MEETING OF SHAREHOLDERS ON MAY 21, 2014. Our Notice of Annual Meeting of Shareholders, Proxy Statement and 2013 Annual Report to Shareholders on Form 10-K are available at www.proxyvote.com. PROXY STATEMENT OF DATALINK CORPORATION 10050 Crosstown Circle, Suite 500 Eden Prairie, MN 55344 GENERAL INFORMATION This Proxy Statement is furnished to the shareholders of Datalink Corporation (‘‘we,’’ ‘‘us,’’ ‘‘our,’’ or ‘‘the Company’’) in connection with the solicitation of proxies by our Board of Directors to be voted at the Annual Meeting of Shareholders or any adjournments or postponements of that meeting. The Annual Meeting of Shareholders will be held at the Company’s offices, 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota, on Wednesday, May 21, 2014, at 3:00 p.m. Central Time. We will be using the ‘‘Notice and Access’’ method of furnishing proxy materials to you over the Internet this year. ‘‘Notice and Access’’ rules adopted by the United States Securities and Exchange Commission (the ‘‘SEC’’) permit us to furnish proxy materials, including this Proxy Statement and our Annual Report on Form 10-K for 2013, to our shareholders by providing access to such documents on the Internet instead of mailing printed copies. We believe that this process will provide you with a convenient and quick way to access your proxy materials and vote your shares, while allowing us to reduce the environmental impact of our Annual Meeting and the costs of printing and distributing the proxy materials. On or about April 8, 2014, we will mail to our shareholders a Notice of Internet Availability of Proxy Materials (the ‘‘Notice’’) containing instructions on how to access our Proxy Statement and Annual Report on Form 10-K and vote electronically over the Internet. The Notice identifies the items to be voted on at the Annual Meeting, but you cannot vote by marking the Notice and returning it. The Notice provides instructions on how to vote by Internet, by requesting and returning a paper proxy card or voting instruction card, or by submitting a ballot in person at the Annual Meeting. The Notice also contains instructions on how to receive a paper copy of the proxy materials. Most shareholders will not receive printed copies of the proxy materials unless they request them. If you would like to receive a paper or email copy of our proxy materials, you should follow the instructions for requesting such materials in the Notice. Any request to receive proxy materials by mail will remain in effect until you revoke it. Only holders of record of our common stock at the close of business on March 26, 2014 (the ‘‘Record Date’’) will be entitled to vote at the Annual Meeting of Shareholders and any postponements or adjournments of that meeting. On the Record Date, we had 22,525,367 outstanding shares. Each share of common stock is entitled to one vote, and there is no cumulative voting. You are voting on: • the election of seven directors recommended by the Board of Directors, each to serve until the next Annual Meeting of Shareholders or until their successors are elected and duly qualified; • a non-binding advisory vote to approve executive officer compensation as disclosed in this Proxy Statement; and • the ratification of the appointment of McGladrey LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2014. Our Board of Directors recommends that you vote your shares as follows: • FOR each of the nominees to the Board of Directors; • FOR approval of the non-binding advisory vote to approve executive officer compensation; and
1 • FOR the ratification of the appointment of McGladrey LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2014. If you are a shareholder whose shares are registered in your name, you may vote using any of the following methods: • Internet. You may vote by going to the web address www.proxyvote.com 24 hours a day, seven days a week, until 11:59 p.m. Eastern Time on May 20, 2014 and following the instructions for Internet voting shown on the Notice or your proxy card. • Telephone. You may vote by dialing 1-800-690-6903 24 hours a day, seven days a week, until 11:59 p.m. Eastern Time on May 20, 2014 and following the instructions for telephone voting shown on the Notice or your proxy card. • Mail. If you requested printed proxy materials or you receive a paper copy of the proxy card, then you may vote by completing, signing, dating and mailing the proxy card in the envelope provided. If you vote by Internet or telephone, please do not mail your proxy card. • In person at the Annual Meeting. If you are a shareholder whose shares are registered in your name, you may vote in person at the Annual Meeting. If you are a street-name shareholder (meaning that your shares are registered in the name of your bank or broker), you will receive instructions from your bank, broker or other nominee describing how to vote your shares. Whichever method you use, the named proxies will vote the shares of which you are the shareholder of record in accordance with your instructions. However, if no direction is given by a shareholder, the shares will be voted as recommended by our Board of Directors. By submitting your proxy, you authorize the proxies to use their judgment to determine how to vote on any other matter brought before the Annual Meeting, or any adjournments or postponements thereof. We do not know of any other business to be considered at the Annual Meeting. The giving of a proxy does not preclude the right to vote in person should a shareholder giving the proxy so desire. All shareholders as of the Record Date, or their duly appointed proxies, may attend the Annual Meeting. If you hold your shares in street name, then you must request a legal proxy from your broker or nominee to attend and vote at the Annual Meeting. Any shareholder giving a proxy may revoke it at any time prior to its use. You can revoke your proxy by: • submitting a new proxy with a more recent date than that of the first proxy given before 11:59 P.M. Eastern Time on May 20, 2014 by (1) following the Internet voting instructions or (2) following the telephone voting instructions; • completing, signing, dating and returning a new proxy card to us, which must be received by us before the time of the Annual Meeting; or • if you are a registered shareholder, by attending the Annual Meeting in person and delivering a proper written notice of revocation of your proxy. Attendance at the Annual Meeting will not by itself revoke a previously granted proxy. Unless you decide to vote your shares in person, you should revoke your prior proxy in the same way you initially submitted it—that is, by Internet, telephone or mail. The presence at the Annual Meeting of Shareholders, in person or by proxy, of the holders of a majority of the shares of our common stock outstanding on the Record Date will constitute a quorum, permitting the meeting to conduct its business. As of the Record Date, 22,525,367 shares of our common stock were issued and outstanding. A majority of those shares will constitute a quorum for the purpose of electing directors and adopting proposals at the Annual Meeting. If you submit a valid
2 proxy or attend the Annual Meeting, your shares will be counted to determine whether there is a quorum. Directors are elected by a plurality of the shares present in person or by proxy at the Annual Meeting and entitled to vote on the election of directors. A plurality means that the nominees with the greatest number of votes are elected as directors up to the maximum number of directors to be chosen at the Annual Meeting. In the election of directors, Proposal 1, you may vote FOR each of the nominees or your vote may be WITHHELD with respect to one or more of the nominees. A WITHHOLD vote will not have an impact on the election of directors. Any other action of the shareholders, except for Proposal 2, requires the affirmative FOR vote of the greater of (a) the holders of a majority of our common stock present in person or by proxy at the Annual Meeting and entitled to vote or (b) a majority of the minimum number of shares of common stock entitled to vote that would constitute a quorum. For Proposals 2 and 3 you may vote FOR, AGAINST or ABSTAIN. With respect to Proposal 2, we will consider our shareholders to have approved, on an advisory, non-binding basis, our executive officer compensation if the shares voted FOR the proposal exceed the shares voted AGAINST. A properly executed proxy marked ABSTAIN with respect to any proposal will be counted for purposes of determining whether there is a quorum and will be considered present in person or by proxy and entitled to vote, but will not be deemed to have been voted in favor of such proposal. Abstentions will have no effect on the voting for Proposal 1, the election of directors, or Proposal 2, the nonbinding advisory vote on executive officer compensation. Abstentions will have the same effect as voting AGAINST Proposal 3, the ratification of the selection of our independent registered public accounting firm and any other item properly presented at the Annual Meeting. A ‘‘broker non-vote’’ occurs when a nominee holding shares for a beneficial owner does not vote on a particular proposal because the nominee does not have or does not exercise discretionary voting power with respect to that item and has not received voting instructions from the beneficial owner. If a broker returns a ‘‘non-vote’’ proxy indicating a lack of authority to vote on a proposal, then the shares covered by such a ‘‘non-vote’’ proxy will be deemed present at the Annual Meeting for purposes of determining a quorum, but not present for purposes of calculating the vote with respect to any non-discretionary proposals. Nominees will not have discretionary voting power with respect to any matter to be voted upon at the Annual Meeting, other than Proposal 3, the ratification of the selection of our independent registered public accounting firm, as this is the only ‘‘routine’’ matter up for vote this year on which brokers have discretionary authority to vote. Since broker non-votes are treated as not present and entitled to vote on any ‘‘non-routine’’ matters, broker non-votes will have no effect on Proposal 1, the election of directors, Proposal 2, the nonbinding vote on executive officer compensation, or any other item properly presented at the Annual Meeting. If you do not vote shares that are registered in your name by voting in person at the Annual Meeting or by proxy through the Internet, telephone or mail as described on the Notice, the Internet voting site or, if you requested printed proxy materials or receive a paper copy of the proxy card, by following the instructions therein, your shares will not be counted in determining the presence of a quorum or in determining the outcome of the vote on the proposals presented at the Annual Meeting. If you hold shares through a broker, you will receive voting instructions from your broker. If you do not submit voting instructions to your broker and your broker does not have discretion to vote your shares on a particular matter, then your shares will not be counted in determining the outcome of the vote on that matter at the Annual Meeting, as discussed in the section above regarding ‘‘broker non-votes.’’ Your broker will not have discretion to vote your shares for any matter to be voted upon at the Annual Meeting other than Proposal 3, the ratification of the selection of our independent registered public accounting firm. Accordingly, it is important that you provide voting instructions to your broker for the matters to be voted upon at the Annual Meeting.
3 If you are a registered shareholder and submit a signed proxy card or submit your proxy by Internet or telephone but do not specify how you want to vote your shares on a particular matter, we will vote your shares as follows: • FOR each of the nominees to the Board of Directors; • FOR approval of the non-binding advisory vote to approve executive officer compensation; and • FOR the ratification of the selection of McGladrey LLP as the independent registered public accounting firm for fiscal 2014. If any matters not described in the Proxy Statement are properly presented at the Annual Meeting, the proxy holders will use their own judgment to determine how to vote your shares. If the Annual Meeting is adjourned, the proxy holders can vote your shares on the new meeting date as well, unless you have revoked your proxy instructions, as described above. We will bear the cost of soliciting proxies, including the preparation, assembly and mailing of the proxies, and the cost of forwarding the material to the beneficial owners of the common stock. Our directors, officers and regular employees may solicit proxies by telephone or personal conversation. No additional compensation will be paid to our directors, officers or other regular employees for such services. We may request banks, brokers and other custodians, nominees and fiduciaries to forward copies of our proxy material to their principals and to request authority for the execution of proxies. We may reimburse such persons for their expenses in doing so.
4 PROPOSAL ONE Election of Directors Proxies solicited by our Board of Directors (‘‘Board’’ or ‘‘Board of Directors’’) will, unless otherwise directed, be voted FOR the election of seven nominees to serve as directors for one-year terms expiring at the next annual meeting of shareholders and until a successor is elected and qualified, or earlier, if the director resigns, is removed or becomes disqualified. The Board has nominated all seven of our current directors to stand for reelection at the Annual Meeting of Shareholders. The seven nominees are Brent G. Blackey, Paul F. Lidsky, Margaret A. Loftus, Greg R. Meland, J. Patrick O’Halloran, James E. Ousley, and Robert M. Price. The Board believes that all of the nominees are available for election and will serve if elected. If for any reason any nominee becomes unavailable for election, the Board may designate substitute nominees or reduce the number of directors. In that event, the shares represented by the proxy cards returned to us will be voted for the substitute nominees, unless an instruction to the contrary is indicated on the proxy card.
Director Qualifications The following describes the key qualifications, business skills, experience and perspectives that each of our directors brings to our Board in addition to the information included in the biographical summaries provided below for each director.
Director Key Qualifications James E. Ousley ...... Distinguished career with extensive public company experience; extensive business leadership experience as chairman and/or chief executive officer of several major, global information technology and communications companies, including current service as Chairman of Datalink’s Board of Directors; strong business leadership, strategic and financial acumen; knowledge of the Company and industry through extensive Board and committee service. Paul F. Lidsky ...... Serves as the Chief Executive Officer of the Company with extensive knowledge and experience in the information technology and communications industry; knowledge of the Company’s operations, strategy and financial position; leadership experience and financial acumen as the chief executive officer and chief operating officer of several information technology companies; historical perspective of the Company through long-term Board and committee service. Brent G. Blackey ..... Extensive financial experience as a senior partner of an international auditing firm, particularly with public company financial accounting standards; experience in operational and strategic matters as the president and chief operating officer of a large, privately-held business; public company board experience, particularly on audit committees; knowledge of the Company and information technology industry through Board and committee service; offers a strong ethics and compliance focus and brings diverse perspective to the Board. Margaret A. Loftus .... Broad experience as a consultant and board member to several private technology companies; long-term service including as vice president of software of a publicly traded supercomputer technology company; knowledge and historical perspective of the Company and information technology industry through long-term Board and committee service.
5 Director Key Qualifications Greg R. Meland ...... Extensive experience with the Company since 1991 including serving as the Company’s former Chief Executive Officer and Chairman of the Board for a combined 14 years; in-depth knowledge of the Company’s operations and industry; historical perspective of the Company through long-term board service; brings perspective on shareholder value as he is the Company’s largest shareholder. J. Patrick O’Halloran . . Experience as a chief executive officer of a sophisticated automation system company; extensive experience as a partner at a global business consulting firm; knowledge of the information technology industry and of the Company’s industry and business through board and committee service; brings diverse perspective to the Board. Robert M. Price ...... Distinguished career with extensive public and private company board experience; leadership experience as a former chairman and chief executive officer of a major, global information technology company; strong business leadership, strategic, operational and financial acumen; knowledge of the Company and industry through extensive Board and committee service.
Director Biographical Information
Name Age Position James E. Ousley ...... 68 Non-Executive Chairman of the Board and Director Paul F. Lidsky ...... 60 President, Chief Executive Officer and Director Brent G. Blackey ...... 55 Director Margaret A. Loftus ...... 69 Director Greg R. Meland ...... 60 Director J. Patrick O’Halloran ...... 57 Director Robert M. Price ...... 83 Director James E. Ousley was elected as a director in June 1998 and is our Non-Executive Chairman. In April 2013, Mr. Ousley retired from his positions as Chief Executive Officer of Savvis, Inc., a business unit of CenturyLink, Inc., and President of the Enterprise Markets Group (‘‘EMG’’) for CenturyLink. Mr. Ousley was named president of EMG in March 2012. From 2009 to 2011 Mr. Ousley served as Chairman and CEO of Savvis, Inc., which was acquired by CenturyLink. Between 2002 and 2004, Mr. Ousley was President and Chief Executive Officer of Vytek Wireless Inc., which was acquired by Calamp, Inc. From 1999 to 2001, he served as President and Chairman of Syntegra (USA), a division of British Telecommunications plc. From 1991 to 1999, Mr. Ousley was President and Chief Executive Officer of Control Data Systems, which was acquired by British Telecommunications in August 1999. From 1968 to 1991, he held various sales and executive management positions with Control Data Corporation. Mr. Ousley currently serves on the Board of Directors of Icelero, Inc. and Pacnet, Inc. In addition, he previously served on the Board of Directors of Savvis, Inc., Actividentity Corporation, and Bell Microproducts Inc. Paul F. Lidsky was elected as a director in June 1998 and became our President and Chief Executive Officer in July 2009. Mr. Lidsky has served as a member of the Board of Directors of Image Sensing Systems, Inc. since June 2013. Mr. Lidsky was the President and Chief Executive Officer of Calabrio, Inc. from October 2007 until July 2009 and served as a member of Calabrio, Inc.’s Board of Directors until November 2013. 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,
6 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. Brent G. Blackey was elected as a director in April 2006. Since 2004, Mr. Blackey has served as President and Chief Operating Officer for Holiday Companies. Between 2002 and 2004 Mr. Blackey was a Senior Partner at the accounting firm of Ernst & Young LLP. Prior to 2002, Mr. Blackey served most recently as a Senior Partner at the accounting firm of Arthur Andersen LLP. Mr. Blackey serves on the Board of Directors of Cardiovascular Systems, Inc. In addition, Mr. Blackey serves on the University of Minnesota, Carlson School of Management Board of Overseers. Margaret A. Loftus was elected as a director in June 1998. Since 2005, Ms. Loftus has served as an independent consultant. Between 1989 and 2005, Ms. Loftus was an owner of Loftus Brown- Wescott, Inc., a business consulting firm, which she co-founded in 1989. Between 1976 and 1989, she was employed by Cray Research, Inc., most recently as Vice President of Software. Ms. Loftus serves on the Board of Directors for Unimax Systems Corporation and Proto Labs, Inc. In addition, previously she served on the Board of Directors of Analyst International Corporation. Greg R. Meland joined our board in 1999. Mr. Meland joined us in 1991 as our Vice President of Sales and Engineering. He became President and Chief Executive Officer in 1993. In December 2005, he became our Chairman of the Board. In May 2007, he retired as an employee and became our Non-Executive Chairman. Between 1979 and 1991, Mr. Meland served in various sales and marketing positions with the Imprimis disk drive subsidiary of Control Data Corporation (which was sold to Seagate in 1989). Mr. Meland is Mr. Price’s son-in-law. J. Patrick O’Halloran was elected as a director in August 2006. Since May 2012, Mr. O’Halloran has been performing consulting work. He served as the Chairman of Entiera, LLC from 2010 until it was sold in May 2012. Between January 2005 and June 2010, Mr. O’Halloran served as the Chief Executive Officer for Entiera, LLC. Between 1983 and 2004, Mr. O’Halloran served in a range of senior, international management positions at Accenture Ltd., most recently as Partner in charge of Accenture’s Customer Insight organization. In addition, he serves on the Board of Directors of Outsell, a private company based in Minnesota. Robert M. Price was elected as a director in June 1998 and served as our Chairman of the Board between June 1998 and December 2005. Mr. Price has been President of PSV, Inc. since 1990. Between 1961 and 1990, he served in various executive positions, including as Chairman and Chief Executive Officer, with Control Data Corporation. From 1991 to 2005, Mr. Price was a Senior Advisor and Professor at the Fuqua School of Business at Duke University, and is now Adjunct Professor of the Pratt School of Engineering at Duke University. Mr. Price is Mr. Meland’s father-in-law. In the last five years, Mr. Price has served on the Board of Directors of Affinity Technology Group, Inc. and PNM Resources, Inc. Mr. Price also serves on the Board of Directors of National Center for Social Entrepreneurs. OUR BOARD OF DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE ‘‘FOR’’ EACH OF THE NOMINEES LISTED ABOVE.
7 CORPORATE GOVERNANCE Corporate Governance Our Board of Directors is elected by the shareholders to govern our business and affairs. The Board selects the senior management team, which is charged with conducting our business. Having selected the senior management team, the Board acts as an advisor to senior management and monitors its performance. The Board reviews our strategies, financial objectives and operating plans. It also plans for management succession of senior management positions and oversees our compliance efforts. Members of the Board stay informed of our business by participating in regularly scheduled Board and committee meetings, through discussions with the Chief Executive Officer and other members of management and staff, and by reviewing other materials provided to them.
Board of Directors Meeting Attendance During 2013, our Board of Directors met seven times. Each director attended all of our board meetings and all committee meetings of which the director is a member. We do not have a formal policy regarding a Board member’s attendance at annual shareholder meetings; however, we encourage all Board members to attend our Annual Meeting of Shareholders and all Board members attended our Annual Meeting of Shareholders held in May 2013.
Director Independence Our Board of Directors reviews the independence of each director. During this review, our Board considers transactions and relationships between each director (and their immediate family and affiliates) and us, as well as our management to determine whether any such transactions or relationships are inconsistent with a determination that the director was independent. In February 2014, our Board conducted an annual review of director independence and determined that no transactions or relationships existed that would disqualify any of our directors under applicable rules and listing standards of the NASDAQ Global Market or require disclosure under Securities and Exchange Commission (‘‘SEC’’) rules, with the exception of Mr. Lidsky who is our Chief Executive Officer. Based on a review of information provided by the directors and other information we reviewed, our Board concluded that none of our other non-employee directors have any relationship with us other than as a director or shareholder. Based upon that finding, our Board of Directors determined that Messrs. Blackey, Meland, O’Halloran, Ousley, and Price and Ms. Loftus are ‘‘independent.’’
Board Leadership Structure Our Board is led by our independent and non-executive Chairman, Mr. Ousley. Mr. Ousley, as Chairman, has the responsibility to call and chair Board meetings, chairs our annual meeting, has primary responsibility in setting Board agendas in collaboration with our Chief Executive Officer, has the ability to represent us with external stakeholders if approved by our Board, has the responsibility to seek input from other independent directors, facilitate discussions among the independent directors, and communicate such viewpoints to our Chief Executive Officer. We believe that this leadership structure enhances the functionality of the Board, strengthens communications between the Board and our Chief Executive Officer, and strengthens the Board’s independence from management. In addition, this structure allows our Chief Executive Officer, Mr. Lidsky, to focus his efforts on running our business and managing us in the best interests of our shareholders, while we are able to benefit from Mr. Ousley’s prior experiences with other public company boards.
8 Board Oversight of Risk Management is responsible for our day-to-day risk management activities, and our Board’s role is to engage in informed risk oversight. In fulfilling this oversight role, our Board focuses on understanding the nature of our enterprise risks, including our operational, credit, liquidity, and legal risks and our strategic direction, as well as the adequacy of our risk management process and overall risk management system. In addition, the Audit Committee and Compensation Committee have risk oversight responsibilities in their respective areas of focus, which they report on to the full Board. There are a number of ways our Board performs this function, including the following: • at its regularly scheduled meetings, the Board receives management updates on our business operations, financial results and strategy and discusses risks related to the business; and • through management updates and committee reports, the Board monitors our risk management activities, including the enterprise risk management process, risks relating to our compensation programs, and financial and operational risks being managed by the Company.
Committees of Our Board of Directors Our Board of Directors has established an Audit Committee, a Compensation Committee, a Governance Committee and a Merger and Acquisition Committee. All members of the Audit Committee, Compensation Committee and Governance Committee meet the definition of ‘‘independent,’’ as set forth in the listing standards of the NASDAQ Global Market. The current composition and responsibilities of each committee is as follows:
Merger and Acquisition Audit Committee Compensation Committee Governance Committee Committee Brent G. Blackey (chair) James E. Ousley (chair) Margaret A. Loftus (chair) Paul F. Lidsky (chair) J. Patrick O’Halloran Brent G. Blackey Gregory M. Meland Gregory M. Meland James E. Ousley J. Patrick O’Halloran J. Patrick O’Halloran James E. Ousley Robert M. Price Audit Committee. Among other matters, the Audit Committee: • oversees the integrity of our financial statements and the adequacy of our internal controls; • evaluates the qualifications, independence and performance of our independent registered public accounting firm; • supervises management’s process for ensuring compliance by the Company with certain legal and regulatory requirements; • oversees the appointment, compensation, retention and oversight of the work of any independent registered public accounting firm engaged (including resolution of disagreements between management and the auditors regarding financial reporting) for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for us; • conducts discussions with management and our independent registered public accounting firm regarding any major issues as to the adequacy of our internal controls, any actions to be taken in light of significant or material control deficiencies and the adequacy of disclosures about changes in internal control over financial reporting; and • pre-approves all audit and non-audit services performed by our independent registered public accounting firm.
9 The purpose and responsibilities of our Audit Committee are set forth in more detail in the Audit Committee Charter. The Board of Directors has determined that each of the Audit Committee members meet the current independence and experience requirements of the NASDAQ Global Market and the applicable rules and regulations of the SEC. Additionally, the Board has determined that Mr. Blackey is an ‘‘audit committee financial expert’’ under the rules and regulations of the SEC. The Audit Committee is required to meet at least two times annually and held five meetings in fiscal year 2013. A report of the Audit Committee is set forth below in this Proxy Statement. Compensation Committee. Among other matters, the Compensation Committee: • is responsible for establishing compensation policy; • administers the compensation programs for our executive officers; • reviews and approves the goals and objectives relevant to compensation of our executive officers; • evaluates our executive officers’ performance in light of those goals and objectives; • determines and approves our executive officers’ compensation level based on this evaluation; • approves and recommends to our Board with respect to compensation of other key management, incentive compensation plans and equity-based plans; and • reviews the compensation of our non-employee directors on a periodic basis and makes recommendations regarding the compensation paid to our non-employee directors to the Board of Directors. In addition, the Compensation Committee may select and retain compensation consulting firms, legal counsel and other advisors as it determines appropriate after considering certain factors discussed in the Compensation Committee Charter to assist in performing its functions and responsibilities. The Compensation Committee has engaged the services of Towers Watson (the ‘‘Consultant’’) as its outside compensation consultant to assist it in analyzing elements of our compensation program and determining appropriate levels of compensation and benefits for our executives. As discussed in more detail in ‘‘Compensation Discussion and Analysis,’’ as part of this annual assessment, pursuant to the instructions given by the Compensation Committee, the Consultant compares our base salary, annual cash incentive bonuses, and long-term incentive award elements against a peer group of publicly traded companies. Our Compensation Committee may delegate authority to subcommittees consisting of one or more members when deemed appropriate by the Compensation Committee. The Compensation Committee may also delegate to the Chief Executive Officer the authority, within pre-existing guidelines established by the Compensation Committee and as permitted by applicable law, to approve equity compensation awards to employees other than executive officers. Any exercise of delegated authority will be reported to the Compensation Committee at its next regularly scheduled meeting. The Compensation Committee may also delegate non-discretionary administrative authority under our compensation and benefit plans in its discretion and consistent with any limitations specified in the applicable plans. The purpose and responsibilities of our Compensation Committee are set forth in more detail in the Compensation Committee Charter. Each member of our Compensation Committee meets the independence requirements of the NASDAQ Global Market, is a ‘‘non-employee director’’ as that term is defined in Rule 16b-3 under the Securities Exchange Act of 1934, and is an ‘‘outside director’’ as that term is used in Section 162(m) of the Internal Revenue Code. Our Compensation Committee held four meetings in fiscal year 2013.
10 Governance Committee. Among other matters, the Governance Committee: • identifies individuals qualified to become members of our Board; • oversees our corporate governance principles; and • provided all committee members are independent, acts as a Nominating Committee to present and recommend nominees to the Board. The purpose and responsibilities of our Governance Committee are set forth in detail in the Governance Committee Charter. This committee must have at least three members, a majority of which meet the independence requirements of the NASDAQ Global Market. Our Board of Directors has determined that all of the members of the Governance Committee meet the independence requirements of the NASDAQ Global Market. Our Governance Committee held two meetings in fiscal year 2013. Merger and Acquisition Committee. Among other matters, the Merger and Acquisition Committee: • investigates acquisition candidates and divestiture opportunities; • reviews our acquisition and divestiture strategies with management and our Board; and • recommends acquisition and divestiture strategies and acquisition candidates to the Board, as appropriate. Our Board of Directors established a Merger and Acquisition Committee in November 2008 pursuant to a written charter. The Merger and Acquisition Committee Charter requires that the committee be comprised of at least two members who are Board members. However, no member is required to meet the independence requirements of the NASDAQ Global Market or SEC rules. Our Merger and Acquisition Committee held no meetings in fiscal year 2013.
Director Nominations Our formal nominations process is included in our Governance Committee Charter, which provides that if all the Governance Committee members are independent, the Governance Committee acts as a Nominating Committee and recommends director nominees to the Board for approval, the annual slate of directors for election by the shareholders and candidates to be appointed by the Board to fill Board vacancies. If all Governance Committee members are not independent, the Governance Committee shall instead present prospective director nominees to our independent directors for their consideration and potential nomination, the prospective annual slate of directors and prospective candidates to be appointed by the Board to fill vacancies on the Board. All director nominees up for election at the 2013 Annual Meeting of Shareholders have been recommended for approval by our Governance Committee to our Board and approved as our director nominees by our Board. All such director nominees are standing for election.
Director Nominee Qualifications There are no formal, specific minimum qualifications to be met by director nominees to be considered a candidate, whether recommended by our Governance Committee, independent directors or shareholders. None of the Governance Committee, our independent directors, or our Board has any special policy for the consideration of diversity in identifying nominees for directors. The Board of Directors expects that our independent members, or any Nominating Committee, would identify and evaluate new candidates for directors based primarily on the following general criteria: • judgment, character, expertise, skills and knowledge useful to the oversight of our business;
11 • diversity of viewpoints, backgrounds, experiences and other demographics; • business or other relevant experience; and • the extent to which the interplay of the candidate’s expertise, skills, knowledge and experience with that of other directors will build a Board of Directors that is effective, collegial and responsive to our needs. The Board desires that all its members have: • the highest character and integrity, sound business judgment and an inquiring mind; • expertise that adds to the composition of the Board; • sufficient professional experience, education and interest in, and capacity for, understanding our operations; • a reputation for working constructively with others; • sufficient time to devote to Board matters; and • no conflict of interest that would interfere with performance as a director. The Governance Committee considers suggestions from many sources, including personal and business contacts and shareholders, regarding possible candidates for directors. The Governance Committee may, but has no current plans to, hire and pay a fee to consultants or search firms to assist in the process of identifying and evaluating candidates. No such consultants or search firms have been used in connection with this year’s election and, accordingly, no fees have been paid to consultants or search firms in the past year. Pursuant to our Bylaws, shareholders who wish to recommend individuals for consideration by our Governance Committee to become nominees for election to our Board of Directors may do so by submitting a written recommendation to our Governance Committee no later than February 20, 2015 at our principal executive offices located at 10050 Crosstown Circle, Suite 500, Eden Prairie, MN 55344. Submissions must comply with Section 1.13 of our Bylaws, which requires, among other information, a written recommendation and the reason for the recommendation, biographical information concerning the recommended individual, including age, a description of the recommended individual’s past five years of employment history, and any past and current board memberships. The submission must be accompanied by a written consent of the individual to stand for election if nominated by our Nominating Committee and to serve if elected by our Board of Directors or our shareholders, as applicable.
Code of Business Conduct and Ethics We adopted the Datalink Corporation Code of Conduct and Ethics Policy, a code of ethics that applies to all of our directors, officers and employees. A copy of our Code of Conduct and Ethics Policy is available on the Corporate Governance section of the Investor Information page on our website at www.datalink.com. We plan to disclose any substantive amendment to our Code of Conduct and Ethics Policy, or grant of any waiver therefrom applicable to our Chief Executive Officer, our Chief Financial Officer, our Chief Operating Officer, our Chief Accounting Officer and other persons performing similar functions on our website at the address described above.
Corporate Governance Documents Available on Our Website Copies of our Audit Committee Charter, Compensation Committee Charter, Governance Committee Charter and our Code of Conduct and Ethics Policy are available on the Corporate Governance section of the Investor Information page of our website at www.datalink.com. In addition,
12 any shareholder that wishes to obtain a hard copy of any of these corporate governance documents may do so without charge by writing us at our principal executive offices located at 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota 55344, Attention: Corporate Secretary.
Shareholder Communications with the Board of Directors Any shareholder who wishes to send communications to the Board of Directors should deliver such communications to the attention of the Chairman of the Board at our principal executive offices located at 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota 55344. The Chairman will relay to the full Board of Directors all shareholder communications he receives that are addressed to the Board of Directors.
13 DIRECTOR COMPENSATION The following table shows, for each of our non-employee directors, information concerning annual compensation earned for services in all capacities during the fiscal year ended December 31, 2013:
Fees Earned or Option Stock Awards Total Name Paid in Cash ($) Awards(1)($) ($)(2) ($) Brent G. Blackey ...... $52,500 — $70,710 $123,210 Margaret A. Loftus ...... $43,500 — $70,710 $115,210 Greg R. Meland ...... $42,125 — $70,710 $112,835 J. Patrick O’Halloran ...... $44,500 — $70,710 $114,210 James E. Ousley ...... $69,250 — $70,710 $139,960 Robert M. Price ...... $37,500 — $70,710 $108,210
(1) The aggregate number of total unexercised stock options outstanding as of December 31, 2013 for Mr. Blackey is 1,200 and for Ms. Loftus is 8,200. There are no unexercised stock options outstanding to Messrs. Meland, O’Halloran, Ousley or Price. (2) Values expressed represent the aggregate grant date fair value of stock awards granted during 2013 computed in accordance with the equity compensation accounting provisions of FASB ASC Topic 718 as discussed under Note 1 (‘‘Summary of Significant Accounting Policies—Stock Compensation Plans’’) and Note 9 (‘‘Stockholders’ Equity—Performance- based Restricted Stock Grants under our 2011 Plan, 2009 Plan, and Director Plan’’) to our financial statements for the fiscal year ended December 31, 2013. The aggregate number of vested and unvested restricted stock awards as of December 31, 2013 held by our directors was as follows: Mr. Blackey is 45,555 shares, Ms. Loftus is 39,381 shares, Mr. Meland is 34,500 shares, Mr. O’Halloran is 24,000 shares, Mr. Ousley is 38,250 shares and Mr. Price is 45,362 shares. Our officers who are also directors do not receive additional compensation for their service as directors. Effective May 12, 2011 and through December 31, 2013, our non-employee directors received the following: • an annual retainer of $25,000 and 6,000 shares of restricted stock; • a fee of $1,500 for attendance at meetings of the Board of Directors; • a fee of $1,000 for member attendance at a committee meeting; • an annual retainer of $6,000 for each non-employee director acting as a chairperson for a committee; and • an annual retainer of $15,000 for the person serving as the Vice Chairman and Non-Executive Chairman. Mr. Meland resigned from his position as the Non-Executive Chairman of the Board on May 22, 2013, and Mr. Ousley was elected to that position on the same date. As a result, Mr. Ousley’s annual retainer was increased from the $15,000 he would have received had he remained in his position as the Vice-Chairman of the Board to $30,000 for the period from May 22, 2013 through December 31, 2013. He received a prorated amount of the annual increase based on his term of service as the Non-Executive Chairman of the Board in 2013. Effective January 1, 2014, our non-employee directors receive the following: • an annual retainer of $50,000 and 6,000 shares of restricted stock;
14 • an annual retainer of $10,000 for the person serving as the chairperson of the Audit Committee, and an annual retainer of $6,000 for each non-employee director acting as the chairperson of the Compensation Committee, Governance Committee, and Merger and Acquisition Committee, respectively; and • an annual retainer of $50,000 for the person serving as the Non-Executive Chairman. We do not provide any form of incentive compensation or other form of stock-based or cash-based compensation or perquisites to our directors except as set forth above, although we do reimburse directors for reasonable expenses incurred in connection with out-of-town travel costs, lodging and other related expenses to and from Board meetings. We pay one-quarter of the annual retainers and attendance fees in arrears at the end of each calendar quarter. Directors may choose to receive deferred stock units (DSUs) in lieu of cash retainers. We issue the annual 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. We prorate the annual cash retainers for any departing or new directors during the applicable quarter.
15 PROPOSAL TWO Advisory Vote to Approve Executive Officer Compensation The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the ‘‘Dodd-Frank Act’’) added section 14A to the Securities and Exchange Act of 1934, as amended (the ‘‘Exchange Act’’), which requires that we provide our shareholders with the opportunity to vote to approve, on an advisory (non-binding) basis, the compensation of our Named Executive Officers as described in detail under the heading ‘‘Compensation Discussion and Analysis’’ (‘‘CD&A’’) and in other related tables and disclosures in this Proxy Statement. Consistent with the views expressed by shareholders at our Annual Meeting of Shareholders held on May 22, 2013, the Board of Directors has determined to seek an annual non-binding advisory vote from shareholders to approve the compensation of our Named Executive Officers as described in detail under the CD&A and other related tables and disclosures in this Proxy Statement. As described in our CD&A, our Named Executive Officer compensation policies and decisions are designed to attract, motivate and retain a highly capable and performance-focused executive team; promote a culture of employee owners whose financial interests are aligned with those of our shareholders; pay for performance such that total compensation reflects the individual performance of our executives and our relative performance; promote equity emphasis by tying executive officer compensation to the long-term enhancement of shareholder value; and take into account the potential stock dilution, cash flow, tax and reported earnings implications of the amount and types of executive officer compensation provided, consistent with the other objectives of our executive officer compensation program. To achieve these objectives, the Compensation Committee has designed and implemented an executive officer compensation program for executive officers consisting of a mix of the following items: • we make annual cash compensation decisions based on assessment of the Company’s performance against measurable financial goals; • we emphasize long-term compensation equity awards with a three-year vesting period to further emphasize long-term performance and executive officer commitment; • we have a compensation risk assessment process to determine that our incentive compensation programs are not reasonably likely to create a material risk to the Company; and • the Compensation Committee regularly engages third-party consultants to compile and analyze peer group information and assist in making decisions about executive officer compensation, equity-based and other incentive compensation plans and other compensation-related matters. This advisory vote gives our shareholders the opportunity to express their views on the compensation paid to our executive officers. Because your vote is advisory, it will not be binding upon the Company, the Compensation Committee or our Board. Our Board of Directors and our Compensation Committee value the opinions of our shareholders and will consider the vote when addressing executive officer compensation in the future. As a result, we are presenting this proposal which gives you as a shareholder the opportunity to approve our executive officer compensation as disclosed in this Proxy Statement by voting for or against the following resolution. RESOLVED, that the Company’s shareholders approve, on an advisory basis, the compensation of the Company’s Named Executive Officers as disclosed in the Company’s Proxy Statement for the 2014 Annual Meeting of Shareholders pursuant to the compensation disclosure rules of the Securities and Exchange Commission, including the Compensation Discussion and Analysis, the 2013 Summary Compensation Tables and the other related tables and disclosures. OUR BOARD OF DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE ‘‘FOR’’ THE APPROVAL, ON A NON-BINDING ADVISORY BASIS, OF THE COMPENSATION OF OUR NAMED EXECUTIVE OFFICERS AS DESCRIBED IN THE PROXY STATEMENT.
16 PROPOSAL THREE Ratification of Independent Registered Public Accounting Firm Our Audit Committee has designated McGladrey LLP to be our independent registered public accounting firm for the year ending December 31, 2014. Our Board of Directors will offer a resolution at our Annual Meeting of Shareholders to ratify this designation. McGladrey LLP has served as our independent registered public accounting firm since December 2004. Our organizational documents do not require that our shareholders ratify the selection of McGladrey LLP as our independent registered public accountants. We are doing so because our Board of Directors believes it is a matter of good corporate practice. If our shareholders do not ratify the selection, our Audit Committee will reconsider whether or not to retain McGladrey LLP, but still may retain them. Even if the selection is ratified, our Audit Committee, in its discretion, may change the appointment at any time during the year if it determines that such a change would be in the best interests of us and our shareholders. We anticipate that representatives of McGladrey LLP will be present at the meeting to respond to appropriate questions and, if they desire, to make a statement. OUR BOARD OF DIRECTORS RECOMMENDS THAT SHAREHOLDERS VOTE ‘‘FOR’’ RATIFICATION OF MCGLADREY LLP AS OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR FISCAL 2014.
17 AUDITING MATTERS Audit Committee Report The primary purpose of the Audit Committee is to assist the Board of Directors in fulfilling its oversight responsibilities relating to our accounting, reporting practices and the quality and integrity of our financial reports and our other publicly disseminated financial information. In this context, the Audit Committee has met with management (including the Chief Executive Officer and Chief Financial Officer) and McGladrey LLP, our independent registered public accounting firm. With respect to independence, the Audit Committee has determined that all of its members are independent within the meaning of NASDAQ Global Market rules. The Audit Committee held five meetings in fiscal year 2013 with McGladrey LLP, both in the presence of management and privately. The Audit Committee discussed the overall scope and plans for McGladrey LLP’s audit, the results of their examinations, their evaluations of our internal controls and the overall quality of our financial reports. The Audit Committee has (i) reviewed and discussed the audited financial statements of the Company as of December 31, 2013 and for the year then ended (the ‘‘Financial Statements’’) with management, which has represented that the Financial Statements were prepared in accordance with Generally Accepted Accounting Principles in the United States of America, (ii) discussed the Financial Statements with McGladrey LLP, including the matters required to be discussed by the statement on Auditing Standards No. 16 as adopted by the Public Company Accounting Oversight Board, and (iii) received the written disclosures and the letter from McGladrey LLP required by applicable requirements of the Public Company Accounting Oversight Board regarding the independent registered public accounting firm’s communications with the Audit Committee concerning independence and has discussed with McGladrey LLP their independence. The Audit Committee has also considered whether McGladrey LLP’s provision of non-audit services as described below under the heading ‘‘Fees’’ is compatible with maintaining McGladrey LLP’s independence. Based upon the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors, and the Board has approved, the inclusion in our Annual Report on Form 10-K for the year ended December 31, 2013 of our financial statements as audited by McGladrey LLP for filing with the SEC.
AUDIT COMMITTEE
Brent G. Blackey, Chairman J. Patrick O’Halloran James E. Ousley
FEES PAID TO INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM During the period covering the fiscal years ended December 31, 2013 and 2012, McGladrey LLP performed the following professional services:
Description of Fees Fiscal Year 2013 Fiscal Year 2012 Audit Fees ...... $422,000 $333,000 Audit-Related Fees ...... 45,000 42,000 Total Audit and Audit-Related Fees ...... 467,000 375,000 Tax Fees...... — — Total ...... $467,000 $375,000
18 Audit Fees McGladrey LLP’s fees for audit services include fees for the audit of our 2013 and 2012 annual financial statements and the 2013 and 2012 audit of our internal controls over financial reporting. Audit fees also include fees billed for professional services for the review of our financial statements included in our quarterly reports on Form 10-Q.
Audit-Related Fees Audit-related fees primarily related to registration statement filings and acquisition-related fees.
Tax Fees McGladrey LLP does not provide tax compliance, tax advice, tax planning or other tax related services to us.
Pre-Approval Policy The Audit Committee has not formally adopted a policy for pre-approval of all audit and non-audit services by McGladrey LLP, but it has routinely pre-approved all audit and permitted non-audit services to be performed for us by our independent registered public accounting firm.
19 COMPENSATION DISCUSSION AND ANALYSIS The following compensation discussion and analysis describes our compensation objectives and policies and the compensation awarded to the following executive officers (the ‘‘Named Executive Officers’’) during 2013: • Paul F. Lidsky—President and Chief Executive Officer; • Gregory T. Barnum—Vice President, Finance, Chief Financial Officer and Secretary; • M. Shawn O’ Grady—Chief Operating Officer; • Denise M. Westenfield—Vice President, Controller, Chief Accounting Officer and Assistant Secretary; • Karen E. Clary—Executive Vice President, Human Resources until June 2013; and • James D. Leslie—Executive Vice President, Advisory Services until June 2013. The Named Executive Officers were our only executive officers for the year ended December 31, 2013.
Executive Summary Our overall performance during 2013 exceeded the GAAP net revenue and operating income expectations we set for ourselves at the beginning of the year. In 2013, we continued to build on the data center solutions we initiated in 2010. In December 2012 the Compensation Committee reviewed and approved our operating plan for 2013 and set performance goals and compensation opportunities for our Named Executive Officers based upon such factors as the economic outlook at the beginning of 2013, as well as the Compensation Committee’s underlying philosophy of paying for superior performance. Consistent with that philosophy, our 2013 executive officer compensation program included net revenue and operating income financial performance objectives that were considered challenging to achieve at the time they were established. The Compensation Committee intends that our executive officer compensation program be market competitive, fairly reflect our performance over time and align the interests of our executive officers with the interests of our shareholders. Consistent with these principles, the Compensation Committee targets base salaries, annual incentive compensation and long-term incentive compensation for our Named Executive Officers at the market median. The amount actually paid upon the completion of the performance period may be higher or lower than the target based on actual performance over the specified performance period. Based upon the assessment of our overall performance, combined with a review of the economic environment, competitive trends and our internal operating plans, the Compensation Committee made the following decisions regarding compensation for certain Named Executive Officers: • our Chief Executive Officer received a 10% increase in his annual base salary in 2013 to $467,500, to bring his base salary closer to the market median and to reward him for our outstanding performance in 2012; • our Named Executive Officers, other than our Chief Executive Officer, received base salary increases for 2013 ranging from 7.5% to 19.6%, generally to maintain their base salary positions with respect to the market median; • the 2013 annual cash incentives paid to Messrs. Lidsky, Barnum and O’Grady pursuant to their respective employment agreements, paid out at a blended rate of 110.5% of the target bonus, as our GAAP net revenues were 108.6% of our target goal and our GAAP operating income was 113.6% of our target goal;
20 • the 2013 annual cash incentives paid to Ms. Westenfield paid out at a blended rate of 105.5% of the target bonus, as our non-GAAP net revenues were 108.6% of our target goal and our non-GAAP operating income was 103.8% of our target goal; and • we granted shares of restricted stock that vest based on the achievement of a one-year non-GAAP operating income target and continued service over a period of three years.
Compensation Objectives and Philosophy The primary objective of our executive officer compensation program is to attract and retain exceptional leaders and motivate them to behave like owners. When setting executive officer compensation, we apply a consistent approach for all Named Executive Officers and intend that the combination of compensation elements closely aligns each Named Executive Officer’s financial interest with those of our shareholders. The program is mainly designed to: • attract, motivate and retain a highly capable and performance-focused executive team; • promote a culture of employee owners whose financial interests are aligned with those of our shareholders; • pay for performance such that total compensation reflects the individual performance of our executives and our relative performance; • promote equity emphasis by tying executive officer compensation to the long-term enhancement of shareholder value; and • take into account the potential stock dilution, cash flow, tax and reported earnings implications of the amount and types of executive officer compensation provided, consistent with the other objectives of this program. Therefore, our executive officer compensation objectives and philosophy focus on rewarding performance and promoting share ownership. This means that shareholder returns, along with corporate, business unit, and individual performance, both short-term and long-term, determine the largest portion of executive pay. The Compensation Committee generally intends to target the total compensation paid to our Named Executive Officers at the market median for comparable positions at companies within our Peer Group (as defined and discussed in more detail below).
Elements of Compensation Paid Total direct compensation is comprised of base salary, annual cash incentive compensation and long-term incentive compensation in the form of equity. In addition, we provide retirement and welfare benefits and certain perquisites to our Named Executive Officers. While we aim to pay total direct compensation at the market median of our Peer Group, we do not, however, have specific policies governing the allocation of the total direct compensation opportunity among its various components.
Base Salary On an annual basis, the Compensation Committee determines base salaries for our Named Executive Officers. We use base salaries to provide competitive compensation to attract and retain talented executive officers. The Compensation Committee considers the following factors in setting annual base salaries: • the individual’s experience and scope of responsibility; • the individual’s level of performance; • any promotions or increases in responsibility; and • competitive salaries within the market, drawing on data from our Peer Group.
21 Based on these factors, for 2013, Mr. Lidsky’s annual base salary for fiscal 2013 was set at $467,500. This was a $42,500 increase over his fiscal 2012 base salary. In addition to rewarding Mr. Lidsky for his role in our performance during 2012, Mr. Lidsky’s base salary increased in 2013 in order to bring his base salary closer to the market median. For fiscal 2013, Mr. Barnum’s base salary was set at $330,000, which was a $30,000 increase over his fiscal 2012 base salary and Mr. O’Grady’s base salary was set at $330,000, which was a $30,000 increase over his fiscal 2012 base salary. The base salary increases for Messrs. Barnum and O’Grady were intended to reward them for their role in our performance during 2012 and bring their base salaries in line with the market median. Ms. Westenfield became our Vice President and Chief Accounting Officer on February 13, 2013, and her base salary for 2013 was $155,766. Ms. Clary began her employment with us in February 2012. Ms. Clary’s annual base salary for fiscal 2013 was set at $258,000. This was an $18,000 increase over her annualized fiscal 2012 base salary. The base salary increase for Ms. Clary was intended to reward her for her role in our performance during 2012 and bring her base salary in line with the market median. Ms. Clary left the company on June 26, 2013. Mr. Leslie became our Executive Vice President, Advisory Services on November 1, 2012. Mr. Leslie’s annual base salary for fiscal 2013 was set at $275,000. This was a $45,000 increase over his annualized fiscal 2012 base salary. The base salary increase for Mr. Leslie was intended to reward him for his role in our performance during 2012 and bring his base salary in line with the market median. Mr. Leslie left the company on June 30, 2013. Using similar factors in setting the base salaries for 2014, base salaries for Messrs. Lidsky, Barnum, and O’Grady and Ms. Westenfield have been set at $485,000, $340,000, $360,000, and $165,000, respectively.
Annual Cash Incentive We provide an annual cash incentive to our Named Executive Officers because it provides incentives to achieve annual financial and operational goals and links pay to the achievement of such goals. With the exception of Mr. Leslie and Ms. Westenfield, the annual cash incentive compensation element is provided for under each of our Named Executive Officer’s employment agreements. While not pursuant to an employment agreement, we provide an annual cash incentive compensation element to Mr. Leslie and Ms. Westenfield based on the same requirements applicable to our other Named Executive Officers. Annually, the Compensation Committee determines the performance measurements that will be considered in order for our Named Executive Officers to receive an annual cash incentive bonus. For fiscal 2013, 100% of the performance measures were based on financial goals. As discussed in more detail below, the financial goals were based on two corporate financial objectives. Target levels were set as a percentage of a Named Executive Officer’s base salary. The annual incentive bonus for 2013 was targeted at 80%, 55%, 60%, 40%, 60% and 50% of base salary for Messrs. Lidsky, Barnum, and O’Grady, Ms. Westenfield, Mr. Leslie and Ms. Clary, respectively. Each Named Executive Officer was eligible to receive the target annual incentive bonus if 100% of the financial objectives were achieved. If we achieved between 100% and 150% of the financial performance objectives, our Named Executive Officers could earn between 101% and 150% of the target annual incentive bonus depending on the matrix approved by our Compensation Committee in the beginning of 2012. If we met less than 100% but more than 80% of the financial performance objectives, then our Named Executive Officers could earn a bonus between 50% and 99% of the target annual incentive bonus, depending on the matrix approved by our Compensation Committee at the beginning of 2012. If we met less than 80% of the financial performance objectives, then our Named Executive Officers would not earn a bonus. Therefore, actual payouts of the annual cash incentive bonus may be more or less than the targeted potential payout due to the degree to which the various performance objectives are achieved. For 2013, the target level annual cash incentive bonus for Messrs. Lidsky, Barnum, O’Grady and Leslie and Ms. Clary would be earned for achievement of $547.7 million of GAAP net revenues and
22 $15.4 million of GAAP operating income. The actual payout of the 2013 cash incentive bonus was subject to adjustment if 100% of the bonus target is not achieved or is exceeded; however, Mr. Leslie was guaranteed an annual incentive of at least $25,000 for 2013. If Mr. Leslie did not remain employed with us during all of the fiscal year ending December 31, 2013, that guaranteed bonus would be prorated by the number of months he was employed with us during 2013. For 2013, we achieved $594.2 million of GAAP net revenues and $17.4 million of GAAP operating income. Therefore, our GAAP net revenue for 2013 was 108.5% of the target and our GAAP operating income was 113.0% of the target. Based upon the bonus matrix approved by the Compensation Committee at the beginning of 2012 our Named Executive Officers were paid an annual incentive bonus based on a blended 110.5% achievement of the targeted financial goals. Based on this performance, Messrs. Lidsky, Barnum, and O’Grady received cash incentive bonuses of $413,270, $200,558, and $218,790, respectively. Mr. Leslie left the company in June 2013, and as a result, he received $12,500 of his guaranteed cash incentive bonus, which was prorated based on the number of months he was employed with the company in 2013. Ms. Clary left the company in June 2013 and did not receive a cash incentive bonus. For 2013, the annual cash incentive bonus for Ms. Westenfield would be earned for achievement of $548.5 million of non-GAAP net revenues and $28.9 million of non-GAAP operating income, as internally computed. For purposes of this calculation, (i) non-GAAP net revenues is our GAAP net revenues adjusted for certain acquisition accounting adjustments and (ii) non-GAAP operating income is our operating income adjusted for certain acquisition accounting adjustments, and by excluding certain items, such as amortization expense for our intangible assets, stock based compensation amounts, integration and transaction costs, and income tax expense. In addition, both non-GAAP net revenues and non-GAAP operating income include the results from our acquisition of Strategic Technologies Inc. in October 2012. For 2013, we achieved $595.6 million of non-GAAP net revenues and $30.0 million of non-GAAP operating income. Therefore, our non-GAAP net revenue for 2013 was 108.6% of the target and our non-GAAP operating income was 103.8% of the target. Based upon the bonus matrix approved by the Compensation Committee at the beginning of 2012, Ms. Westenfield was paid an annual incentive bonus based on a blended 105.5% achievement of the targeted financial goals. Based on this performance, Ms. Westenfield received a cash incentive bonus of $66,745. In 2014, the performance criteria will consist of targets of non-GAAP net revenues and operating income. The target annual cash incentive bonus for Messrs. Lidsky, Barnum, and O’Grady and Ms. Westenfield has been set at 100%, 55%, 60% and 40%, respectively, of their base salaries. The actual payout of the 2014 cash incentive bonus will continue to be subject to adjustment if 100% of the bonus target is not achieved or is exceeded.
Equity Incentive Compensation We believe that enabling our Named Executive Officers to develop and maintain significant long-term ownership in the Company through grants made under our 2011 Plan aligns the interests of our Named Executive Officers with our shareholders’ interests by creating a close link between executive pay and shareholder return. In support of our emphasis on significant ownership by our Named Executive Officers, the Compensation Committee offers long-term incentive opportunities that encourage ownership, and therefore have exclusively granted restricted stock to our Named Executive Officers since 2010. Generally, the amount of compensation realized or potentially realizable does not directly impact the level at which future pay opportunities are set. However, when granting equity awards, the Compensation Committee reviews and considers restricted stock grant practices by the Peer Group and the number of outstanding and previously granted equity awards. There are no specific performance factors that the Compensation Committee assesses when making long-term equity incentive awards. However, in certain instances, the vesting of such awards is dependent upon the achievement of an objective based on our operating income, in addition to the requirement that the Named Executive Officer be employed by us on the vesting dates.
23 We do not have a policy with regard to the timing of the grants of our restricted stock and such grants are not made on a fixed schedule. Instead, our Compensation Committee has typically chosen to make restricted stock awards in connection with an individual’s initial employment with us, upon promotions or other changes in responsibilities, in recognition of significant achievements and generally when it believes that the number of unvested shares of restricted stock held by a key employee is insufficient to constitute an effective retention tool. On December 4, 2012, Messrs. Lidsky, Barnum, and O’Grady and Ms. Clary received restricted stock awards of 75,000 shares, 32,352 shares, 36,705 and 19,058 shares, respectively. Each of the grants to Messrs. Lidsky, Barnum, and O’Grady and Ms. Clary vest: (i) 50% upon the achievement of a GAAP operating income goal of $15.4 million for 2013 and continued employment through 2014, (ii) 25% on the second anniversary of the grant and (ii) 12.5% on each of the third and fourth anniversaries of the grant, provided that the individual remains employed by us on these vesting dates. In 2013, since our GAAP operating income was $17.4 million, we achieved 113.0% of our GAAP operating income goal. As a result, 50% of the shares granted to Messrs. Lidsky, Barnum and O’Grady on December 4, 2012 will vest on January 1, 2015, provided Messrs. Lidsky, Barnum, and O’Grady remain employed with us through December 31, 2014. The award granted to Ms. Clary was canceled upon her departure from the company on June 26, 2013. Although we consider these awards to have been earned based on 2013 operating income performance, under SEC rules they are required to be disclosed as 2012 awards because they were granted during that year. On December 23, 2013, Messrs. Lidsky, Barnum, and O’Grady were granted restricted stock awards of 88,077 shares, 39,294 shares, and 44,037 shares, respectively. Two-thirds of the shares subject to each of these awards vests based on our non-GAAP operating income performance for 2014 and continued service by the recipient (the ‘‘performance-based component’’) and one-third of the shares subject to each award vests based solely on the recipient’s continued service (the ‘‘time-based component’’). All of the shares subject to the performance-based component will be earned if we achieve 150% of our non-GAAP operating income target of $32.3 million for 2014, half will be earned if we achieve the target amount, 25% will be earned if we achieve 80% of the target amount, and none will be earned if our performance is below 80% of the target amount. Of the shares subject to the performance-based component that are earned, one-third of will vest upon announcement of the degree to which the non-GAAP operating income goal has been achieved, one-third will vest on the first anniversary of the announcement, and the last third will vest on the second anniversary of the announcement, assuming the individual remains employed by us on each vesting date. One-third of the shares subject to the time-based component will vest on each of the first three anniversaries of the grant date, provided that the individual remains employed by us on these vesting dates. The Summary Compensation Table and the other tables in the Executive Compensation section in the Proxy Statement reflect these grants of restricted stock that we made on December 23, 2013 to our Named Executive Officers that are intended to be earned based on 2014 performance. Therefore, please see the Alternative Summary Compensation Table below for disclosure of what the Summary Compensation Table would reflect if we reported equity awards in the year they were considered earned rather than in the year in which they were granted.
Retirement and Welfare Benefits We provide a full range of benefits to our Named Executive Officers, including the standard medical, dental and disability benefits available to our employees generally. We also sponsor a qualified 401(k) Plan in which our Named Executive Officers may participate on the same basis as our employees generally, and which allows participants to make plan contributions on a pre-tax basis and to which we make company-matching contributions of 50% of each employee’s contributions, up to 6% of salary and subject to limitations of the Code.
24 We do not maintain a defined benefit pension plan, a defined benefit supplemental pension plan, or a deferred compensation plan for our Named Executive Officers.
Perquisites We provide a limited number of perquisites to our Named Executive Officers, generally in an effort to remain competitive with similarly situated companies. Primarily, these perquisites consist of: • travel expenses for a company sponsored trip for employees that met certain sales goals for the year and their spouses (the President’s Club); • a car allowance; and • gross ups for income tax purposes for travel expenses related to the President’s Club.
Compensation Table Reflecting 2013 Stock Grants for 2013 Performance The following table presents an alternative portrayal of the compensation considered to have been earned during 2013 by our Named Executive Officers. The amounts in this table for 2013 are the same as those reflected in the Summary Compensation Table in the Executive Compensation section, except for the Stock Awards column and the salaries for Ms. Clary and Mr. Leslie. Ms. Clary and Mr. Leslie each left the company in June 2013. For purposes of this alternative presentation, the salaries for Ms. Clary and Mr. Leslie reflect what their annual salaries would have been had they remained with the company through December 31, 2013. In addition, we have not included the grant date fair value of the restricted stock awards described above that were granted on December 23, 2013 as we consider those awards part of the compensation package for 2014, but because of the timing of the grant are required to be disclosed in 2013 in the Summary Compensation Table in the Executive Compensation section. Instead, the following table includes the grant date fair value of the restricted stock awards described above that were granted on December 4, 2012, as we consider those awards to be part of the compensation package for 2013.
Non-Equity Stock Option Incentive Plan Salary Bonus Awards Awards Compensation All Other Total Name and Principal Position Year ($) ($) ($)(1) ($) ($)(2) Compensation(3) ($) Paul F. Lidsky ...... 2013 $467,500 $— $625,500 $— $413,270 $13,781 $1,520,051 President and Chief Executive Officer Gregory T. Barnum ...... 2013 $330,000 $— $269,816 $— $200,558 $13,350 $ 813,724 Vice President, Finance, Chief Financial Officer and Secretary M. Shawn O’Grady ...... 2013 $330,000 $— $306,120 $— $218,790 $18,563 $ 873,473 Chief Operating Officer Denise M. Westenfield ...... 2013 $155,766 $— $ — $— $ 66,745 $ 5,642 $ 228,153 Vice President, Controller, Chief Accounting Officer and Assistant Secretary Karen E. Clary(4) ...... 2013 $258,000 $— $158,944 $— $ — $ 7,388 $ 424,332 Executive Vice President, Human Resources James D. Leslie(5) ...... 2013 $275,000 $— $ — $— $ 12,500 $ 7,350 $ 294,850 Executive Vice President, Advisory Services
(1) The amounts in this column reflect the grant date fair values of restricted stock awards granted on December 4, 2012 as part of each individual’s 2013 compensation package and do not include the grant date fair values of
25 December 23, 2013 restricted stock grants that are reflected in the Stock Awards column of the Summary Compensation Table in the Executive Compensation section. (2) See Footnote (2) to the Summary Compensation Table in the Executive Compensation section. (3) See Footnote (3) to the Summary Compensation Table in the Executive Compensation section. (4) Ms. Clary left the company on June 26, 2013. The salary reflected in this table represents what her annual salary would have been had she remained with the company through December 31, 2013. (5) Mr. Leslie left the company on June 30, 2013. The salary reflected in this table represents what his annual salary would have been had he remained with the company through December 31, 2013.
Role of Compensation Committee and Executive Officer Compensation Consultant The Compensation Committee oversees the administration of the executive officer compensation program and determines the compensation of our Named Executive Officers. The Compensation Committee is solely composed of non-management directors, all of whom meet the independence requirements of applicable NASDAQ rules. The Compensation Committee engages Towers Watson (the ‘‘Consultant’’), to assist the Compensation Committee in discharging its responsibilities. The Compensation Committee provides the material elements of the instructions to the Consultant with respect to the performance of the Consultant’s duties under the engagement. Pursuant to these instructions the Consultant is to develop recommendations for the Compensation Committee related to all aspects of executive officer compensation programs. In fulfilling this role, and as discussed in more detail below, the Consultant assesses compensation programs within the Peer Group as well as reviews certain independent surveys on executive officer compensation. In addition, the Consultant works with management to obtain information necessary to develop its recommendations regarding the compensation that should be paid to our Named Executive Officers. Once the Consultant has developed such recommendations management presents such recommendations to the Compensation Committee for its consideration.
Process for Determining Executive Officer Compensation Typically, the Compensation Committee reviews and adjusts total direct compensation levels annually in December of each year. This practice was utilized when establishing the elements of 2013 executive total compensation. The Compensation Committee generally intends to target total direct compensation for our Named Executive Officers at the market median for comparable positions at companies within our Peer Group. Our Chief Executive Officer’s target total direct compensation is set by the Compensation Committee based on the Compensation Committee’s review of the competitive information prepared by the Consultant, assessment of the Chief Executive Officer’s individual performance in conjunction with our financial and operating performance, and each member’s good faith business judgment. A recommendation for the target total direct compensation of our other Named Executive Officers is made by the Chief Executive Officer after reviewing such executive’s and the Company’s performance in conjunction with such executive’s responsibilities when compared to the competitive information prepared by the Consultant. The compensation package for each of the other Named Executive Officers is established by the Compensation Committee, taking into consideration the recommendation of the Chief Executive Officer and the Named Executive Officer’s individual job responsibilities, experience and overall performance.
26 To facilitate this process, the Consultant summarizes the total direct compensation for each Named Executive Officer and this information is used by the Compensation Committee when setting target total direct compensation for the Chief Executive Officer and other Named Executive Officers. The summary outlines each Named Executive Officer’s annual target and actual pay as well as total accumulated pay under various individual and corporate performance scenarios, both recent and projected. The Compensation Committee meets with the Chief Executive Officer and other members of senior management, as appropriate, to discuss the application of competitive benchmarking. The Chief Executive Officer’s role is to contribute input and analysis to the Compensation Committee’s discussions. The Chief Executive Officer does not participate in the final determination of the amount or form of executive officer compensation but he does participate in the final recommendation (within ranges set by the Compensation Committee) of the amount and form of compensation to be paid to all other members of executive management and key managers, excluding himself.
Shareholder Vote At our last Annual Meeting of Shareholders held on May 22, 2013, we asked our shareholders to approve, by advisory vote, the compensation of our Named Executive Officers as described in the Compensation Discussion and Analysis, the compensation tables, and the related disclosures contained in our Proxy Statement for that annual meeting. The proposal was approved by our shareholders with a FOR vote of 98% of votes cast. In light of the overwhelming approval by our shareholders of our Named Executive Officers’ compensation, the Compensation Committee did not make changes in our compensation policies and practices in response to the shareholder vote. The Compensation Committee continues to evaluate and adjust the Company’s compensation practices as it deems appropriate to advance the best interests of the Company and its shareholders.
Market Benchmarking We begin the annual process by reviewing each of our current executive officers’ target total direct compensation in relation to compensation provided by comparably sized companies based on operating revenues and margins as identified by independent compensation surveys conducted by the Consultant (the ‘‘Surveys’’). We consider companies that average $470 million in revenue and average market capitalization of $390 million to be comparable to us for purposes of the Surveys. In 2013, we performed a similar analysis for Mr. Leslie and Ms. Clary, who both left the Company in June 2013. For Mr. Leslie and Ms. Clary, we reviewed target total direct annualized compensation in relation to compensation provided by comparably sized companies based on operating revenues and margins as identified by Radford compensation surveys. We also take into account, as an additional reference point, competitive compensation data from a selected group of peer companies (‘‘Peer Group’’), specifically Computer Storage & Peripherals, IT Consulting, and Technology Distribution companies. The companies comprising our Peer Group included the following:
Black Box Corporation Emtec, Inc. Intevac Inc. Ciber, Inc. Fusion-io, Inc. NCI, Inc. Computer Task Group Inc. The Hackett Group, Inc. PFSweb Inc. Digi International Inc. Dot Hill Systems Corp. ePlus Inc. Dynamics Research Corporation Hutchinson Technology Inc. Quantum Corporation Electronics for Imaging, Inc. Imation Corp. Video Display Corporation For 2013, the components of the Surveys included base salary and target bonus for annual incentive plans similar to our annual incentive plan. The information that we received from the Consultant as to the Peer Group data for positions similar to the positions held by our current Named Executive Officers is summarized in the table below. As demonstrated in the table below, the Compensation Committee adjusted base salaries based on Peer Group information, competitiveness of
27 our overall base salaries, and observed market trends and used its best judgment when setting their compensation. Overall for 2013, according to a 2012 study we received from the Consultant, we paid our Named Executives Officers in the 53rd percentile based on revenue growth, profitability and shareholder return.
Base Salary and Actual Base Salary Base Salary of Target Bonus of and Target Bonus Peer Group at Actual Base Salary for Peer Group at for the Named Executive Officer 50th Percentile Fiscal Year 2013 50th Percentile Fiscal Year 2013 Paul F. Lidsky ...... $560,000 $467,500 $905,000 $881,270 President and Chief Executive (42nd percentile) (49th percentile) Officer Gregory T. Barnum ...... $325,000 $330,000 $460,000 $530,558 Vice President, Finance, Chief (51st percentile) (58th percentile) Financial Officer and Secretary M. Shawn O’Grady ...... $380,000 $330,000 $550,000 $548,790 Chief Operating Officer (43rd percentile) (50th percentile) Denise M. Westenfield ...... $195,000 $155,766 $240,000 $224,907 Vice President, Controller, Chief (40th percentile) (47th percentile) Accounting Officer and Assistant Secretary Karen E. Clary(1) ...... $227,000 $258,000 $354,829 $400,545 Executive Vice President, Human (57th percentile) (56th percentile) Resources James D. Leslie(2) ...... $230,000 $275,000 $364,529 $457,325 Executive Vice President, Advisory (60th percentile) (63rd percentile) Services
(1) Ms. Clary left the company on June 26, 2013. The salary and bonus reflected in this table represents what her annual salary and bonus would have been had she remained with the company through December 31, 2013. (2) Mr. Leslie left the company on June 30, 2013. The salary and bonus reflected in this table represents what his annual salary and bonus would have been had he remained with the company through December 31, 2013.
Conflict of Interest Analysis Our Compensation Committee has considered the relationships that the Consultant has with the Company, the members of the Compensation Committee and our executive officers, as well as the policies that the Consultant has in place to maintain its independence and objectivity, and has determined that the work performed by the Consultant has raised no conflicts of interest.
Risk Assessment The Compensation Committee has reviewed the concept of risk as it relates to our compensation programs and does not believe our compensation programs encourage excessive or inappropriate risk. Overall, our internal risk assessment confirms that our compensation arrangements are low in risk and do not foster undue risk-taking, because they focus on performance of company-wide annual goals that are aligned with the long-term interests of our shareholders and have strong governance and control mechanisms. The Compensation Committee’s approach to long-term incentives is and will be predominantly risk-based equity and thus tied to shareholder returns.
28 Employment Agreements and Severance and Change in Control Benefits We have typically entered into employment agreements, which provide for certain severance and change in control benefits, with our executive officers. These agreements are discussed below under ‘‘Executive Compensation—Payments Upon Termination or Change in Control Provisions.’’ Our 2009 Incentive Compensation Plan (the ‘‘2009 Plan’’) and 2011 Incentive Compensation Plan (the ‘‘2011 Plan’’) also provide for accelerated vesting and exercisability of awards in certain circumstances involving a change in control. These provisions are discussed in more detail under ‘‘Executive Compensation—Payments Upon Termination or Change in Control Provisions.’’
Accounting and Tax Impacts of Executive Officer Compensation Section 162(m) of the Code generally precludes a public corporation from taking a federal income tax deduction for compensation paid in excess of $1,000,000 per year to certain covered officers unless the compensation in excess of $1,000,000 dollars qualifies as ‘‘performance-based’’ for purposes of Section 162(m). Our Compensation Committee considers our ability to fully deduct compensation in accordance with the $1,000,000 limitation of Section 162(m) in structuring our compensation programs. However, the Compensation Committee retains the authority to authorize the payment of compensation that may not be deductible if it believes such payments would be in the best interests of us and our shareholders. None of our Named Executive Officers have ever been compensated in a manner that would be non-deductible under Section 162(m).
COMPENSATION COMMITTEE REPORT The Compensation Committee of the Board of Directors of Datalink Corporation has reviewed and discussed with management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K and included in this Proxy Statement and incorporated by reference in the Company’s Annual Report on Form 10-K filed with the SEC on March 17, 2014. Based on this review and these discussions with management, the Compensation Committee recommended to the Board of Directors that this Compensation Discussion and Analysis be included in the Company’s 2014 Proxy Statement and incorporated by reference in the Company’s Annual Report on Form 10-K. Submitted by the Compensation Committee James E. Ousley, Chairman Brent G. Blackey J. Patrick O’Halloran
29 EXECUTIVE COMPENSATION Summary Compensation Table The following table presents compensation during the three most recent fiscal years of our Named Executive Officers, who are our only executive officers and, except for Ms. Clary and Mr. Leslie, were serving as executive officers at the end of 2013.
Non-Equity Incentive Stock Option Plan Salary Bonus Awards Awards Compensation All Other Name and Principal Position Year ($) ($) ($)(1) ($) ($)(2) Compensation(6) Total ($) Paul F. Lidsky ...... 2013 $467,500 $— $ 975,012 $— $413,270 $13,781 $1,869,563 President and Chief 2012 $425,000 $— $1,193,704 $— $323,000 $14,837 $1,956,541 Executive Officer 2011 $375,000 $— $ 673,900 $— $390,000 $17,413 $1,456,313 Gregory T. Barnum ...... 2013 $330,000 $— $ 434,985 $— $200,558 $13,350 $ 978,893 Vice President, Finance, Chief 2012 $300,000 $— $ 544,552 $— $156,750 $13,884 $1,015,186 Financial Officer and Secretary 2011 $262,000 $— $ 298,860 $— $170,300 $10,075 $ 741,235 M. Shawn O’Grady ...... 2013 $330,000 $— $ 487,490 $— $218,790 $18,563 $1,054,843 Chief Operating Officer 2012 $300,000 $— $ 672,732 $— $171,000 $22,232 $1,165,964 2011 $289,000 $— $ 251,980 $— $225,420 $24,577 $ 790,977 Denise M. Westenfield(3) ...... 2013 $155,766 $— $ — $— $ 66,745 $ 5,642 $ 228,153 Vice President, Controller, Chief Accounting Officer and Assistant Secretary Karen E. Clary(4) ...... 2013 $126,188 $— $ — $— $ — $ 7,388 $ 133,576 Executive Vice President, Human 2012 $220,000 $— $ 398,939 $— $114,000 $20,089 $ 753,028 Resources James D. Leslie(5) ...... 2013 $136,600 $— $ — $— $ 12,500 $ 7,350 $ 156,450 Executive Vice President, Advisory 2012 $230,000 $— $ 329,148 $— $ 87,400 $13,457 $ 660,005 Services
(1) Values expressed represent the aggregate grant date fair value of stock awards made during 2013, 2012 and 2011, computed in accordance with the equity compensation accounting provisions of FASB ASC Topic 718 as discussed under Note 1 (‘‘Summary of Significant Accounting Policies—Stock Compensation Plans’’) and Note 9 (‘‘Stockholders’ Equity— Performance-based Restricted Stock Grants under our 2011 Plan, 2009 Plan and Director Plan’’) to our financial statements for the fiscal years ended December 31, 2013, 2012 and 2011, disregarding the estimate of forfeitures related to service- based vesting. In accordance with FASB ASC Topic 718, we determine the fair value of restricted stock awards based on our stock price at the date of grant and recognize the expense for financial reporting purposes ratably over the vesting period. The grant date fair value of stock awards in 2012 for Messrs. Lidsky, Barnum and O’Grady reflects the fact that during that year, we transitioned from making annual equity awards early in a calendar year to make them late in a calendar year, resulting in each of these individuals receiving a restricted stock award in February 2012 (intended to be part of the 2012 compensation package) and a restricted stock award in December 2012 (intended to be part of the 2013 compensation package). With respect to each of Messrs. Lidsky, Barnum and O’Grady, the 2013 dollar value represents the aggregate grant date fair value for 88,077, 39,294 and 44,037 shares, respectively, of restricted stock granted on December 23, 2013, two-thirds of which are subject to performance-based and time-based vesting conditions, and one-third of which are subject only to time-based vesting conditions. The grant date fair value of the portion subject to performance-based vesting conditions has been calculated based on assumed achievement of the highest level of performance condition specified. The vesting provisions of these awards are described more fully in ‘‘Compensation Discussion and Analysis—Elements of Compensation Paid—Equity Incentive Compensation.’’ (2) Represents amounts of annual incentive compensation earned for 2013, 2012, and 2011, which were paid in February 2014, 2013, and 2012, respectively. As discussed in more detail above under ‘‘Elements of Compensation Paid—Annual Cash Incentive,’’ our Named Executive Officers may earn annual cash incentive compensation based on the achievement of a combination of financial and operating objectives. (3) Ms. Westenfield became our Vice President, Chief Accounting Officer and Assistant Secretary in February 2013. (4) Ms. Clary became our Executive Vice President, Human Resources in January 2012. She left the company in June 2013. The salary reflected in this table represents her salary through that date.
30 (5) Mr. Leslie became our Executive Vice President, Advisory Services in November 2012. He left the company in June 2013. The salary reflected in this table represents his salary through that date. (6) Amounts shown in this column include Company contributions to our 401(k) retirement plan, travel expenses for the annual President’s Club meeting, tax gross-up payments in connection with travel expenses for the President’s Club meeting for the Named Executive Officer and his/her spouse and a car allowance. The amounts shown in this column for 2013 are summarized as follows:
Employer Paid Long Contributions Tax Car President’s Term Commuting Name to 401(k) Plan Gross-Ups(1) Allowance Club(1) Disability Expenses Total Paul F. Lidsky ...... $ — $1,853 $6,000 $5,928 $— $— $13,781 Gregory T. Barnum ...... $7,350 $ — $6,000 $ — $— $— $13,350 M. Shawn O’Grady ...... $7,350 $1,191 $6,000 $4,022 $— $— $18,563 Denise M. Westenfield ..... $5,642 $ — $ — $ — $— $— $ 5,642 Karen E. Clary ...... $4,388 $ — $3,000 $ — $— $— $ 7,388 James D. Leslie ...... $7,350 $ — $ — $ — $— $— $ 7,350
(1) Represents the cost and tax gross up for a Company-sponsored awards trip to reward certain employees and their spouses who meet predetermined goals for the year.
Grants of Plan-Based Awards in 2013 The following table sets forth certain information with respect to our annual cash incentive bonus paid and restricted stock awards granted under our 2011 Plan during the year ended December 31, 2013 to our Named Executive Officers. See ‘‘Compensation Discussion and Analysis’’ for a description of the material factors necessary to understand the information in the table below:
All Other Stock Estimated Future Payouts Awards: Estimated Future Payouts Under Under Number of Grant Date Non-Equity Incentive Plan Equity Incentive Plan Shares of Fair Value Awards(1) Awards(2) Stock or of Stock Grant Threshold Maximum Threshold Target Maximum Units Awards Name Date ($) Target ($) ($) (#) (#) (#) (#)(3) ($)(4) Paul F. Lidsky ...... N/A $187,200 $374,400 $561,000 — — — — 12/23/13 — — — 14,680 29,359 58,718 29,359 $975,012 Gregory T. Barnum ...... N/A $90,750 $181,500 $272,250 — — — — 12/23/13 — — — 6,549 13,098 26,196 13,098 $434,985 M. Shawn O’Grady ...... N/A $99,000 $198,000 $297,000 — — — — 12/23/13 — — — 7,340 14,679 29,358 14,679 $487,490 Denise M. Westenfield ..... N/A $31,632 $ 63,265 $ 94,897 — — — — Karen E. Clary ...... N/A $64,500 $129,000 $193,500 — — — — James D. Leslie ...... N/A $82,500 $165,000 $247,500 — — — —
(1) These columns show the range of payouts based on our 2013 performance for our annual cash incentive bonus, as described in the section titled ‘‘Annual Cash Incentive’’ in the Compensation Discussion and Analysis. The cash incentive payments for our 2013 performance have been made based on the metrics described in ‘‘Elements of Compensation Paid—Annual Cash Incentive’’ in the Compensation Discussion & Analysis and are shown in the column ‘‘Non-Equity Incentive Plan Compensation’’ of the Summary Compensation Table. (2) These columns reflect the portion of a restricted stock award that is subject to both performance-based and time-based vesting conditions and was granted to each the three indicated Named Executive Officers on December 23, 2013 in accordance with our 2011 Plan and pursuant to our 2013 long-term equity incentive program, as described in the section titled ‘‘Elements of Compensation Paid—Equity Incentive Compensation’’ in the Compensation Discussion and Analysis. (3) This column reflects the portion of a restricted stock award that is subject to only time-based vesting conditions and was granted to each the three indicated Named Executive Officers on December 23, 2013 in accordance with our 2011 Plan and pursuant to our 2013 long-term equity incentive program, as described in the section titled ‘‘Elements of Compensation Paid—Equity Incentive Compensation’’ in the Compensation Discussion and Analysis. (4) The amounts represent the grant date fair value of both portions of each of the restricted stock awards described in notes (2) and (3) above, computed in accordance with FASB ASC Topic 718. Assumptions used in the calculation of these amounts are included in Note 9 (‘‘Stockholders’ Equity—Performance-based Restricted Stock Grants under our 2011 Plan, 2009 Plan, and Director Plan’’) to our financial statements for the fiscal year ended December 31, 2013.
31 Outstanding Equity Awards at 2013 Fiscal Year-End The following table sets forth certain information concerning equity awards outstanding to the Named Executive Officers at December 31, 2013.
Option Awards Stock Awards Equity Incentive Plan Awards: Equity Market or Incentive Payout Market Plan Awards: Value of Value of Number of Unearned Number of Number of Number of Shares or Unearned Shares, Securities Securities Shares or Units of Shares, Units Units or Underlying Underlying Option Units of Stock that or Other Other Unexercised Unexercised Exercise Option Stock that Have Not Rights that Rights that Options (#) Options (#) Price Expiration Have Not Vested Have Not Have Not Name Exercisable Unexercisable ($) Date Vested (#) ($)(1) Vested (#) Vested ($)(1) Paul F. Lidsky ...... 1,200(2) — 3.85 4/19/2014 — — — — 1,900(2) — 3.32 6/30/2014 — — — — 450,000(3) — 3.50 7/20/2019 — — — — 86,250(4) $940,125 — — 31,850(5) $347,165 — — 75,000(6) $817,500 — — 29,359(7) $320,013 58,718(8) $640,026 Gregory T. Barnum . . . — — — — 38,250(4) $416,925 — — 15,400(5) $167,860 — — 32,352(6) $352,637 — — 13,098(7) $142,768 26,196(8) $285,536 M. Shawn O’Grady . . . — — — — 32,250(4) $351,525 — — 20,550(5) $223,995 — — 36,705(6) $400,085 — — 14,679(7) $160,001 29,358(8) $320,002 Denise M. Westenfield . 9,000(9) — 3.91 1/18/2018 — — — — 12,000(10) $130,800 — — 20,000(11) $218,000 — —
(1) Market value of unvested restricted stock is based on a share price of $10.90, which was the closing price for a share of our common stock as reported by the NASDAQ Global Market on December 31, 2013. (2) Stock option awards were received while serving as a non-employee director and are fully vested. (3) Stock option award granted on July 20, 2009 is fully vested. (4) These remaining shares of a restricted stock award granted on January 18, 2011 vested on January 18, 2014. (5) Half of these remaining shares of a restricted stock award granted on February 22, 2012 vested on February 22, 2014 and the other half will vest on February 22, 2015, provided that the executive remains employed by us through that date. (6) Restricted stock award granted on December 4, 2012. 50% of these shares were earned since we achieved our 2013 GAAP operating income goal, and will vest on January 1, 2015 provided that the executive remains employed by us through December 31, 2014. An additional 25% will vest on the second anniversary of the grant date and 12.5% on each of the third and fourth anniversaries of the grant date, provided that the executive remains employed by us through such dates. (7) Represents one-third of the shares subject to a restricted stock award granted on December 23, 2013. One-third of these shares vest on each of the first three anniversaries of the grant date, provided that the individual remains employed by us through these vesting dates. (8) Represents two-thirds of the shares subject to a restricted stock award granted on December 23, 2013. Some or all of these shares will be earned to the extent we achieve our non-GAAP operating income target for 2014. To the extent these shares are earned, one-third of the earned amount will vest upon the announcement that we achieved the non-GAAP operating income target, one-third will vest on the first anniversary of the announcement, and the last third will vest on the second anniversary of the announcement, provided that the individual remains employed by us through these vesting dates. (9) Stock option awards were received while serving as an employee and are fully vested. (10) These remaining shares of a restricted stock award granted on July 19, 2011 will vest on July 19, 2014, assuming the executive remains employed by us through such date. (11) This restricted stock award was granted on December 3, 2012 and will vest as to 50% of the shares on the second anniversary of the grant date, and will vest as to 25% of the shares on the third and fourth anniversaries of the grant date.
32 Option Exercises and Stock Vested for 2013 The following table sets forth for our Named Executive Officers certain information with respect to restricted stock awards that vested and stock options that were exercised during 2013.
Option Awards Stock Awards Number of Number of Shares Value Shares Value Acquired on Realized on Acquired on Realized on Name Exercise (#) Exercise ($)(1) Vesting (#)(2) Vesting ($)(2) Paul F. Lidsky ...... — $— 53,750 $585,875 Gregory T. Barnum ...... — $— 12,750 $138,975 M. Shawn O’Grady ...... — $— 29,500 $321,550 Denise M. Westenfield ..... — $— 12,000 $130,800 Karen E. Clary ...... — $— — $ — James D. Leslie ...... — $— — $ —
(1) Amounts shown in this column are based on the difference between the fair market value of a share of our common stock on the date of exercise and the exercise price. (2) Amounts in this column are based on the $10.90 fair market value of a share of our common stock on December 31, 2013.
Payments Upon Termination or Change in Control Provisions Employment Agreements Paul F. Lidsky. On July 20, 2009, we entered into an employment agreement with Paul F. Lidsky, our President and Chief Executive Officer (the ‘‘Lidsky Employment Agreement’’). The Lidsky Employment Agreement was amended on January 17, 2011, had an initial two-year term, and is automatically renewed for additional two-year terms thereafter (or the first day of the month next following Mr. Lidsky’s 65th birthday if that occurs sooner), unless we give 90 days’ notice of our election not to renew. Pursuant to the Lidsky Employment Agreement, he is entitled to receive an annual cash bonus based on the achievement of the financial and operating objectives as described above under ‘‘Elements of Compensation Paid—Annual Cash Incentive,’’ and certain severance payments and benefits as described below under ‘‘Severance Payments and Change in Control Provisions.’’ In connection with the Lidsky Employment Agreement, we granted Mr. Lidsky an option to purchase 450,000 shares of our common stock at $3.50 per share, the closing price of our common stock on the NASDAQ Global Market on the date of the Lidsky Employment Agreement (the ‘‘Lidsky Stock Option’’). The Lidsky Stock Option is fully vested. Gregory T. Barnum. On March 14, 2006, we entered into an employment agreement with Gregory T. Barnum, our Vice President of Finance and Chief Financial Officer (the ‘‘Barnum Employment Agreement’’). Mr. Barnum’s initial two-year employment term automatically renews for additional two-year terms, subject to earlier termination under certain circumstances, including if we give 90 days’ notice of our election not to renew. Pursuant to the Barnum Employment Agreement, he is entitled to receive an annual cash bonus based on the achievement of the financial and operating objectives as described above under ‘‘Elements of Compensation Paid—Annual Cash Incentive,’’ and certain severance payments and benefits as described below under ‘‘Severance Payments and Change in Control Provisions.’’ In connection with the Barnum Employment Agreement, we granted Mr. Barnum 60,000 shares of restricted stock (the ‘‘Barnum Restricted Stock’’). The Barnum Restricted Stock has fully vested.
33 M. Shawn O’Grady. On December 17, 2009, we entered into an employment agreement with M. Shawn O’Grady, our Chief Operating Officer (the ‘‘O’Grady Employment Agreement’’). The O’Grady Employment Agreement had an initial two-year term, and is automatically renewed for additional two-year terms thereafter (or until the first day of the month following Mr. O’Grady’s 65th birthday if that occurs sooner), unless we give 90 days’ notice of our election not to renew. Pursuant to the O’Grady Employment Agreement, he is entitled to receive an annual cash bonus based on the achievement of the financial and operating objectives as described above under ‘‘Elements of Compensation Paid—Annual Cash Incentive,’’ and certain severance payments and benefits as described below under ‘‘Severance Payments and Change in Control Provisions.’’ In connection with the O’Grady Employment Agreement, we granted Mr. O’Grady 75,000 shares of restricted stock (the ‘‘O’Grady Restricted Stock’’). The O’Grady Restricted Stock is fully vested. Karen Clary. On January 16, 2012, we entered into an employment agreement with Karen Clary, our former Executive Vice President, Human Resources (the ‘‘Clary Employment Agreement’’), who left the Company on June 26, 2013. Ms. Clary was not entitled to receive any severance payments or benefits under the Clary Employment Agreement and forfeited the restricted stock award she had received in connection with the Clary Employment Agreement.
Severance Payments and Change of Control Provisions Under the Lidsky Employment Agreement, Mr. Lidsky is entitled to a severance payment if (i) he is terminated by us without Cause (see ‘‘Definition of Cause, Good Reason and Change of Control’’), (ii) he resigns for Good Reason (see ‘‘Definition of Cause, Good Reason and Change of Control’’), (iii) we terminate his employment in anticipation of, in connection with, at the time of or within 90 days after a Change of Control (see ‘‘Definition of Cause, Good Reason and Change of Control’’) or (iv) he resigns employment with us for Good Reason arising in anticipation of, in connection with, at the time of or within 90 days after a Change of Control. Under any of these conditions Mr. Lidsky would receive, provided he complies with certain confidentiality, non-competition and non-solicitation covenants, (i) his base salary accrued through the date of termination and reimbursement of expenses, (ii) any earned but unpaid annual bonus, (iii) a single lump sum equal to 11⁄2 times his annual base salary, and (iv) 18 months of premiums for COBRA health insurance continuation coverage subject to earlier termination if he is later employed and eligible to receive any health insurance benefits under another employer’s plans. Under the Barnum Employment Agreement, Mr. Barnum is entitled to a severance payment if (i) he is terminated by us without Cause, (ii) he resigns for Good Reason, (iii) we terminate his employment in anticipation of, in connection with, at the time of or within one year after a Change of Control or (iv) he resigns employment with us for Good Reason arising in anticipation of, in connection with, at the time of or within one year after a Change of Control. If any of these events occur, and provided he complies with certain confidentiality, non-competition and non-solicitation covenants, we are to pay Mr. Barnum (i) his base salary accrued through the date of termination and reimbursement of expenses, (ii) any earned but unpaid annual bonus, (iii) a lump sum payment equal to his annual base salary, and (iv) 12 months of premiums for COBRA health insurance continuation coverage, subject to earlier termination if he is later employed and eligible to receive any health insurance benefits under another employer’s plans. Under the O’Grady Employment Agreement, Mr. O’Grady is entitled to a severance payment if (i) he is terminated by us without Cause, (ii) he resigns for Good Reason, (iii) we terminate his employment in anticipation of, in connection with, at the time of or within 90 days after a Change of Control or (iv) he resigns employment with us for Good Reason arising in anticipation of, in connection with, at the time of or within 90 days after a Change of Control. Under any of these conditions Mr. O’Grady would receive, provided he complies with certain confidentiality,
34 non-competition and non-solicitation covenants, (i) his base salary accrued through the date of termination and reimbursement of expenses, (ii) any earned but unpaid annual bonus, (iii) a single lump sum equal to his annual base salary, and (iv) 12 months of premiums for COBRA health insurance continuation coverage subject to earlier termination if he is later employed and eligible to receive any health insurance benefits under another employer’s plans. None of our Named Executive Officers hold unexercisable stock options. Each Named Executive Officer holds unvested restricted stock that was granted pursuant to either our 2009 Plan or our 2011 Plan. For awards that were granted under our 2009 Plan, unless otherwise provided in the applicable award agreement, the Compensation Committee is expressly authorized upon a Change of Control to accelerate the vesting of an award, cause all restrictions to lapse and deem all performance goals to have been met. The Compensation Committee may also, in connection with a Change of Control, cause outstanding awards to be assumed or replaced with comparable awards or cancel and cash out in-the-money options and SARs. Unless provided in an award agreement or otherwise waived by the Compensation Committee, if a Named Executive Officer is terminated for any reason, other than in connection with a Change of Control, all unvested and unexercisable portions of any outstanding awards are immediately forfeited. Under our 2011 Plan, unless an award agreement provides otherwise, if there is a Change in Control that involves a Corporate Transaction (see ‘‘Definition of Cause, Good Reason and Change of Control’’) and the awards under the 2011 Plan are not continued, assumed or replaced in connection with the Corporate Transaction, then the Compensation Committee may provide that any or all awards become fully vested and, if applicable, exercisable for a certain period of time prior to the effective time of the Corporate Transaction. Alternatively, under these circumstances the Compensation Committee may cancel and cash out some or all outstanding awards. In the event awards are continued, assumed, or replaced and a participant is involuntarily terminated for reasons other than Cause within one year after the Corporate Transaction, then awards will immediately vest and become exercisable. In addition, if there is a Change in Control that does not involve a Corporate Transaction, then the Compensation Committee may provide that an award becomes fully vested and exercisable upon the Change in Control or upon the involuntary termination of the Named Executive Officer without Cause within one year of the Change of Control. Unless provided in an award agreement or determined otherwise by the Compensation Committee, if a Named Executive Officer is terminated for any reason, other than in connection with a Change of Control, all unvested and unexercisable portions of any outstanding awards are immediately forfeited. No severance payments are made to any of our Named Executive Officers upon their death or disability.
Noncompete and Nonsolicitation Covenants All of our Named Executive Officers have agreed in their respective employment agreements that during and for one year after termination of employment with us, they will be restricted from participating in certain competitive businesses and from soliciting our employees and customers.
Definition of Cause, Good Reason and Change of Control Under the employment agreements with our Named Executive Officers, ‘‘Cause’’ generally means one or more of the following events: • gross negligence in the performance or intentional nonperformance of the Named Executive Officer to perform his material duties under the employment agreement; • willful dishonesty, fraud or misconduct with respect to our business or affairs; • conviction of a felony crime; or • willful, material and irreparable breach of the employment agreement.
35 Under the employment agreements with our Named Executive Officers, ‘‘Good Reason’’ generally means one or more of the following events: • imposition by us of material and adverse changes in the Named Executive Officer’s principal duties; • certain reductions in the Named Executive Officer’s annual base salary; or • relocation of our offices to a location more than 50 miles from the prior location. Under the employment agreements with our Named Executive Officers and the 2009 Plan, a ‘‘Change of Control’’ generally means any of the following events: • following an extraordinary corporate transaction, a majority of our Board of Directors no longer consists of individuals who were directors on the date of the respective employment agreements or the effective date of the 2009 Plan; • the acquisition of our securities that results in any person owning more than 50% of either our outstanding voting securities or our common stock (other than persons who had beneficial ownership of 20% of our securities prior to such transaction); • subject to the exclusion of certain transactions detailed in the employment agreements, the sale or other disposition of all or substantially all of the assets of our company; or • the approval by our shareholders of a complete liquidation or our dissolution. Under the 2011 Plan, a ‘‘Change in Control’’ generally means any of the following events: • individuals who were directors as of the effective date of the 2011 Plan or became directors after the effective date and whose election was approved by at least a majority of the then existing directors are no longer a majority of the Board; • subject to certain exceptions as detailed in the 2011 Plan, the acquisition of our securities that results in any person owning more than 50% of the combined voting power of our voting securities; or • the sale or other disposition of all or substantially all of the assets of our company or a merger, consolidation, share exchange or similar transaction regardless of whether we are the surviving corporation (any of which is referred to as a ‘‘Corporate Transaction’’), unless, immediately following such transaction, the beneficial owners of our voting securities immediately prior to such transaction, own more than 50% of the combined voting power of the then outstanding voting securities of the surviving or acquiring corporation in substantially the same proportions as their ownership of our voting securities immediately prior to such transaction. The compensation amounts shown below are estimates of the amounts that would have become payable to each Named Executive Officer on December 31, 2013, in addition to any accrued and unpaid salary and bonus as of that date, if his or her employment had terminated on such date and
36 upon the conditions detailed in the footnotes below. The price per share of our common stock on December 31, 2013 was $10.90.
Termination Without Cause Termination or for Good Without Cause Reason after or For Good Change of Change of Benefits Reason(1) Control(2) Control(3) Paul F. Lidsky Cash Severance ...... $701,250 $ — $ 701,250 Restricted Stock ...... — 3,064,829 3,064,829 Medical and Dental Benefits ...... 20,483 — 20,483 TOTAL...... $721,733 $3,064,829 $3,786,562 Gregory T. Barnum Cash Severance ...... $330,000 $ — $ 330,000 Restricted Stock ...... — 1,365,726 1,365,726 Medical and Dental Benefits ...... 21,022 — 21,022 TOTAL...... $351,022 $1,365,726 $1,716,748 M. Shawn O’Grady Cash Severance ...... $330,000 $ — $ 330,000 Restricted Stock ...... — 1,455,608 1,455,608 Medical and Dental Benefits ...... 21,022 — 21,022 TOTAL...... $351,022 $1,455,608 $1,806,630 Denise M. Westenfield Restricted Stock ...... $ — $ 348,800 $ 348,800 TOTAL...... $ — $ 348,800 $ 348,800
(1) This column includes terminations without Cause or for Good Reason not in connection with a Change of Control. Under our 2009 Plan and 2011 Plan, all awards that are not vested upon any termination that is not related to a Change of Control are forfeited, unless the Compensation Committee determines that the awards become vested upon a termination. For purposes of this column, we have assumed that the Compensation Committee determined that all restricted stock issued to our Named Executive Officers pursuant to our 2009 Plan and 2011 Plan were forfeited upon a termination at December 31, 2013 that was not related to a Change of Control. (2) This column assumes that the Named Executive Officer remains employed with us following a Change of Control (as provided in each of the employment agreements we have with certain of our Named Executive Officers, our 2009 Plan and our 2011 Plan) that occurred on December 31, 2013. The awards under our 2009 Plan vest upon a Change of Control. The Compensation Committee may authorize accelerated vesting of awards under our 2011 Plan upon a Change of Control. For purposes of the awards granted under our 2011 Plan, we have assumed that the awards were not continued, assumed or replaced in connection with a Corporate Transaction and that the Compensation Committee provided that the awards vested prior to a Corporate Transaction that occurred on December 31, 2013. The result would be the same under our 2011 Plan if instead, at December 31, 2013, we experienced a Change of Control that did not involve a Corporate Transaction and the Compensation Committee determined awards would vest. (3) This column assumes that (a) a Change of Control as determined according to each Named Executive Officer’s Employment Agreement, our 2009 Plan and 2011 Plan occurred on
37 December 31, 2013 (b) we terminated the Named Executive Officer’s employment without Cause (or, for purposes of the Employment Agreements, the Named Executive Officer resigned for Good Reason) at the time of the Change of Control, (c) the Change in Control Price was obtained, (d) for purposes of the 2009 Plan, the awards vested upon a Change of Control, and (e) for purposes of the 2011 Plan awards were not continued, assumed or replaced and that the Compensation Committee provided that the awards vested prior to a Change of Control that was a Corporate Transaction or the Compensation Committee determined the vesting of the awards would be accelerated if the Change in Control was not a Corporate Transaction.
Compensation Committee Interlocks and Insider Participation James E. Ousley, Brent G. Blackey and J. Patrick O’Halloran served on our Board’s Compensation Committee for the year ended December 31, 2013. No member of our Compensation Committee currently has, or since the beginning of 2013 has had, any direct or indirect material interest in a transaction or proposed transaction with us that would require any disclosure. During 2013 none of our executive officers served as a member of the Board of Directors or Compensation Committee of any entity that has one or more executive officers who serve on our Compensation Committee.
38 OUTSTANDING VOTING SECURITIES AND VOTING RIGHTS The following table sets forth information regarding beneficial ownership of our common stock, as of February 28, 2014, by each person or group who is known by us to own beneficially more than 5% of our outstanding shares of common stock, each of the Named Executive Officers listed in the summary compensation table, each director and director nominee, and all of the Company’s executive officers and directors as a group. Unless otherwise noted, each person or group identified has sole voting and investment power with respect to the shares shown. Unless otherwise noted in the table, the mailing address for each individual listed in the table is: c/o Datalink Corporation, 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota 55344.
Name and Address of Beneficial Owner Number(1) Percent Beneficial Owners of More Than 5% FMR LLC(2) ...... 3,400,659 14.9% 240 Summer Street Boston, MA 02210 Wellington Management Company, LLP(3) ...... 1,988,075 8.7% 280 Congress Street Boston, MA 02210 Royce & Associates, LLC(4) ...... 1,196,490 5.3% 745 Fifth Avenue New York, NY 10151 BlackRock, Inc.(5) ...... 1,191,577 5.2% 40 East 52nd Street New York, NY 10022 Directors and Named Executive Officers James E. Ousley ...... 68,800 * Paul F. Lidsky(6) ...... 746,951 3.3% Gregory T. Barnum ...... 131,799 * M. Shawn O’Grady ...... 120,376 * Denise M. Westenfield ...... 42,374 * Brent G. Blackey(7) ...... 48,255 * Margaret A. Loftus(8) ...... 74,013 * Greg M. Meland ...... 1,508,426 6.6% J. Patrick O’Halloran ...... 21,500 * Robert M. Price ...... 38,812 * All executive officers and directors as a group (10 persons) .... 2,801,306 12.3%
* less than 1% (1) Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting power and investment power with respect to shares. Unless indicated by footnotes, each shareholder possesses sole voting and investment power over its shares. Shares issuable upon the exercise of outstanding stock options that are currently exercisable or become exercisable within 60 days from February 28, 2014 are considered outstanding for the purpose of calculating the percentage of common stock owned by a person and owned by a group, but not for the purpose of calculating the percentage of common stock owned by any other person. (2) Based on a Schedule 13G/A filed with the SEC on February 14, 2014.
39 (3) Based on a Schedule 13G/A filed with the SEC on February 14, 2014. (4) Based on a Schedule 13G filed with the SEC on January 8, 2014. (5) Based on a Schedule 13G/A filed with the SEC on January 28, 2014. (6) Includes 453,100 shares that Mr. Lidsky may acquire upon exercise of stock options within 60 days of February 28, 2014. (7) Includes 1,200 shares that Mr. Blackey may acquire upon exercise of stock options within 60 days of February 28, 2014. (8) Includes 8,200 shares that Ms. Loftus may acquire upon exercise of stock options within 60 days of February 28, 2014.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires our directors, executive officers and persons who own more than ten percent of a registered class of our equity securities to file with the SEC reports of initial ownership and reports of changes in ownership of our common stock and other equity securities. The SEC requires us to identify any of those persons who fail to file such reports on a timely basis. To our knowledge with respect to our directors and executive officers, and with respect to ten percent owners, based on our review of reports filed by them with the SEC, we believe all such filings were made on a timely basis in 2013.
TRANSACTIONS WITH RELATED PERSONS Since January 1, 2013, there were no transactions or currently proposed transactions, in which we were or are to be a participant and the amount involved exceeds $120,000 and in which any related person had or will have a direct or indirect material interest. Our Board of Directors adopted a written Related Person Transaction Approval Policy effective February 15, 2011. The policy encompasses any financial transaction, arrangement or relationship (including any indebtedness or guarantee of indebtedness) or any series of similar transactions, arrangements or relationships where we and the related person has a direct or indirect interest in the transaction which is at least $10,000 in value. Related persons include all directors and executive officers, any nominee for director, immediate family members of a director, executive officer or nominee for director and any shareholders of more than 5% of our common stock. Our Audit Committee must pre-approve any related person transactions. The Audit Committee will analyze the following factors, in addition to any other factors, in addition to any other factors the Audit Committee deems appropriate, in determining whether to approve the related party transition: • whether the terms are fair to the Company; • whether the transaction is material to the Company; • the role the related person has played in arranging the related person transaction; • the structure of the related person transaction; and • the interests of all related persons in the related person transaction. A related person transaction will only be approved by the Audit Committee if the Audit Committee determines that the related person transaction is beneficial to us and the terms of the related person transaction are fair to us.
40 OTHER MATTERS Other Business The Board of Directors knows of no other matters that will be presented for consideration at the Annual Meeting of Shareholders. If any other matters are properly brought before the meeting, the persons named in the accompanying proxy will have the discretionary authority to vote such proxy on such matters in accordance with their best judgment.
Annual Report on Form 10-K A copy of our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC, will be sent to any shareholder without charge upon written request addressed to: Investor Relations Datalink Corporation 10050 Crosstown Circle, Suite 500 Eden Prairie, MN 55344 (952) 944-3462 You may also obtain our Annual Report on Form 10-K over the Internet at the SEC’s Internet site, www.sec.gov. Additional copies of the Annual Report on Form 10-K, the Notice, this Proxy Statement and the accompanying proxy may be obtained from our Investor Relations department at the address above. Copies of exhibits to the Annual Report on Form 10-K may be obtained upon payment to us of the reasonable expense incurred in providing such exhibits.
Householding Information We have adopted a procedure approved by the SEC called ‘‘householding.’’ Under this procedure, certain shareholders of record who have the same address and last name and do not participate in electronic delivery of proxy materials will receive only one copy of our Annual Report and Proxy Statement, unless one or more of these shareholders notifies us that they would like to continue to receive individual copies. This will reduce our printing costs and postage fees. Shareholders who participate in householding will continue to receive separate proxy cards. If you and other shareholders of record with whom you share an address currently receive multiple copies of our Annual Report and/or Proxy Statement, or if you hold stock in more than one account, and in either case, you would like to receive only a single copy of the Annual Report or Proxy Statement for your household, please contact our Investor Relations representative by email at [email protected], by mail to the address listed on the cover of this Proxy Statement, Attention: Investor Relations, or by telephone at (952) 944-3462. If you participate in householding and would like to receive a separate copy of our 2013 Annual Report or this Proxy Statement, please contact us in the manner described in the immediately preceding paragraph. We will deliver the requested documents to you promptly upon receipt of your request.
41 SHAREHOLDER PROPOSALS FOR 2015 ANNUAL MEETING A shareholder intending to present a proposal to be included in our proxy materials for the 2015 Annual Meeting of Shareholders must deliver the proposal in writing to us no later than December 9, 2014. Shareholder proposals must comply with SEC regulations regarding the inclusion of shareholder proposals in company-sponsored proxy materials. Proposals should be addressed to our principal executive offices at 10050 Crosstown Circle, Suite 500, Eden Prairie, Minnesota 55344, Attention: Secretary. If the date of the 2015 Annual Meeting of Shareholders is moved more than 30 days before or after the anniversary date of the 2014 Annual Meeting of Shareholders, the deadline for inclusion of proposals in our Proxy Statement is instead a reasonable time before we begin to print and mail our proxy materials. We must receive notice of any other shareholder proposals, including proposals for director nominees, intended to be presented at our 2015 Annual Meeting of Shareholders in writing and delivered to our principal executive office no later than February 20, 2015. If the date of the 2015 Annual Meeting of Shareholders is moved more than 30 days before or after such anniversary date of the 2014 Annual Meeting of Shareholders, notice by a shareholder shall be timely only if so delivered or so mailed and received not less than 90 days before the 2015 Annual Meeting of Shareholders or, if later, within 10 days after the first public announcement of the date of 2015 Annual Meeting of Shareholders.
42 This page intentionally left blank This page intentionally left blank CORPORATE OFFICE TRADING OF COMMON STOCK ANNUAL MEETING Datalink Corporation The company’s common stock has traded on The company’s annual meeting of shareholders 10050 Crosstown Circle, Suite 500 the Nasdaq Global Marketsm tier of the Nasdaq will be held on Wednesday, May 21, 2014 at Eden Prairie, MN 55344 Stock Market® under the symbol “DTLK” since 3:00 p.m. CDT at our corporate office at 10050 August 6, 1999. On April 1, 2014, the number Crosstown Circle, Suite 500, Eden Prairie, MN. 952.279.5600 of holders of Datalink’s common stock was 800.448.6314 approximately 4,103, consisting of 103 record FORM 10-K 952.944.7869 fax holders and approximately 4,000 stockholders A copy of the company’s Form 10-K, as filed www.datalink.com whose shares were held by a bank, broker, or with the Securities and Exchange Commission, other nominee. EXECUTIVE OFFICERS is available at www.sec.gov or upon request by contacting: Paul F. Lidsky STOCK PRICES President and High and low sale prices for each quarter Investor Relations Chief Executive Officer during the years ended December 31, 2013 Datalink Corporation and 2012 as reported by the Nasdaq were: 10050 Crosstown Circle, Suite 500 Gregory T. Barnum Eden Prairie, MN 55344 Vice President of Finance, 2013 HIGH LOW 952.944.3462 Chief Financial Officer, and Secretary 952.944.7869 fax M. Shawn O’Grady 4th Qtr $ 14.25 $ 10.16 [email protected] Chief Operating Officer 3rd Qtr 14.07 10.99 INDEPENDENT ACCOUNTANTS Denise M. Westenfield 2nd Qtr 11.71 9.72 McGladrey LLP Vice President, Controller, Minneapolis, MN Chief Accounting Officer 1st Qtr 12.38 8.50 2012 HIGH LOW CORPORATE COUNSEL BOARD OF DIRECTORS Faegre Baker Daniels LLP 4th Qtr $ 8.69 $ 7.34 James E. Ousley (1)(2)(4) Minneapolis, MN Chairman of the Board 3rd Qtr 9.52 7.33 Director since 1998 TRANSFER AGENT AND REGISTRAR 2nd Qtr 10.85 9.03 Wells Fargo Shareowner Services Brent G. Blackey (1)(2) 1st Qtr 10.32 8.21 1110 Centre Pointe Curve, Suite 101 Director since 2006 Mendota Heights, MN 55120 Paul F. Lidsky (4) 800.468.9716 Director since 1998 Margaret A. Loftus (3) Director since 1998 Greg R. Meland (3)(4) Director since 1998 J. Patrick O’Halloran (1)(2)(3) Director since 2006 Robert M. Price (3) Director since 1998
(1) Audit Committee The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. This Annual Report (2) Compensation Committee contains forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties which could cause (3) Governance Committee actual results to differ materially from historical results or those anticipated. The words “aim,” “believe,” “expect,” “anticipate,” “intend,” (4) Mergers and Acquisitions Committee “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. 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. Factors that may cause actual results to differ from our assumptions and expectations include those set forth in our Annual Report Form 10-K. 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 our Annual Report Form 10-K. Corporate Headquarters 10050 Crosstown Circle, Suite 500 Eden Prairie, MN 55344 800.448.6314 | WWW.DATALINK.COM
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