FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
x Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended: September 30, 2007
or
o Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission file number: 00029758
DATALINK CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA | | 41-0856543 |
(State or other jurisdiction of Incorporation) | | (IRS Employer Identification Number) |
| | |
8170 UPLAND CIRCLE |
CHANHASSEN, MINNESOTA 55317-8589 |
(Address of Principal Executive Offices) |
|
(952) 944-3462 |
(Registrant’s Telephone Number, Including Area Code) |
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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer:
Large Accelerated Filer o | Accelerated Filer o | Non-Accelerated Filer x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
As of November 9, 2007, 12,476,419 shares of the registrant’s common stock, $.001 par value, were outstanding.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. This report on Form 10-Q contains forward-looking statements, including our internal projections of anticipated 2007 results, which reflect our views regarding future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from historical results or those anticipated. The words “aim, “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions which indicate future events and trends identify forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending upon a variety of factors, including, but not limited to: the level of continuing demand for storage, including the effects of economic conditions; competition and pricing pressures and timing of our installations that may adversely affect our revenues and profits; fixed employment costs that may impact profitability if we suffer revenue shortfalls; revenue recognition policies that may unpredictably defer reporting of our revenues; our ability to hire and retain key technical and sales personnel; our dependence on key suppliers; our ability to adapt to rapid technological change; risks associated with integrating our MCSI acquisition and possible future acquisitions; fluctuations in our quarterly operating results; future changes in applicable accounting rules; and volatility in our stock price. We may not achieve significant future revenues from one of our customers that accounted for approximately 12 percent of our first quarter 2007 revenues. Further, our revenues for any particular quarter are not necessarily reflected by our backlog of contracted orders, which also may fluctuate unpredictably. In addition, we cannot assure that we will successfully and profitably integrate MCSI’s customers and personnel into our business or increase our gross margins with MCSI’s historical customers and prospects.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Datalink Corporation
Balance Sheets
(In thousands, except share data)
| | September 30,
2007
(Unaudited) | | December 31,
2006 | |
Assets | | | | | |
Current assets | | | | | |
Cash and cash equivalents | | $ | 22,099 | | $ | 22,900 | |
Accounts receivable, net | | 18,720 | | 22,195 | |
Inventories | | 2,589 | | 1,593 | |
Deferred customer support contract costs | | 35,097 | | 25,876 | |
Inventories shipped but not installed | | 6,385 | | 3,502 | |
Current deferred income taxes | | 1,645 | | 1,442 | |
Other current assets | | 377 | | 225 | |
Total current assets | | 86,912 | | 77,733 | |
Property and equipment, net | | 2,473 | | 1,942 | |
Goodwill | | 17,680 | | 5,500 | |
Finite life intangibles, net | | 3,788 | | — | |
Deferred income taxes | | — | | 1,320 | |
Other assets | | 346 | | 354 | |
Total assets | | $ | 111,199 | | $ | 86,849 | |
| | | | | |
Liabilities and Stockholders’ Equity | | | | | |
Current liabilities | | | | | |
Accounts payable | | $ | 22,487 | | $ | 19,753 | |
Accrued commissions | | 1,374 | | 1,734 | |
Accrued income tax | | 5 | | 200 | |
Accrued sales and use tax | | 950 | | 785 | |
Accrued expenses, other | | 2,052 | | 1,775 | |
Sublease reserve current | | 341 | | 360 | |
Deferred revenue from customer support contracts | | 45,689 | | 33,472 | |
Total current liabilities | | 72,898 | | 58,079 | |
Deferred rent | | 186 | | 167 | |
Deferred income tax liability | | 512 | | — | |
Sublease reserve non-current | | 1,029 | | 1,281 | |
Total liabilities | | 74,625 | | 59,527 | |
| | | | | |
Commitments and contingencies | | | | | |
| | | | | |
Stockholders’ equity | | | | | |
Common stock, $.001 par value, 50,000,000 shares authorized, 12,466,818 and 11,228,890 shares issued and outstanding as of September 30, 2007 and December 31, 2006, respectively | | 12 | | 11 | |
Additional paid in capital | | 39,016 | | 29,544 | |
Accumulated deficit | | (2,454 | ) | (2,233 | ) |
Total stockholders’ equity | | 36,574 | | 27,322 | |
Total liabilities and stockholders’ equity | | $ | 111,199 | | $ | 86,849 | |
The accompanying notes are an integral part of these financial statements.
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Datalink Corporation
Statements of Operations
(In thousands, except per share data)
(Unaudited)
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
Net sales: | | | | | | | | | |
Products | | $ | 27,705 | | $ | 22,163 | | $ | 79,617 | | $ | 76,387 | |
Services | | 18,143 | | 11,010 | | 47,480 | | 30,903 | |
| | 45,848 | | 33,173 | | 127,097 | | 107,290 | |
Cost of sales: | | | | | | | | | |
Cost of products | | 20,989 | | 16,625 | | 60,760 | | 57,784 | |
Cost of services | | 13,002 | | 7,621 | | 34,459 | | 21,587 | |
Total cost of sales | | 33,991 | | 24,246 | | 95,219 | | 79,371 | |
Gross profit | | 11,857 | | 8,927 | | 31,878 | | 27,919 | |
Operating expenses: | | | | | | | | | |
Sales and marketing | | 5,543 | | 3,893 | | 16,134 | | 11,997 | |
General and administrative | | 2,773 | | 2,392 | | 8,950 | | 7,722 | |
Engineering | | 2,238 | | 1,575 | | 6,890 | | 4,517 | |
Integration costs | | — | | — | | 442 | | — | |
Amortization of intangibles | | 178 | | — | | 550 | | — | |
| | 10,732 | | 7,860 | | 32,966 | | 24,236 | |
Earnings (loss) from operations | | 1,125 | | 1,067 | | (1,088 | ) | 3,683 | |
Interest income, net | | 252 | | 189 | | 700 | | 439 | |
Earnings (loss) before income taxes | | 1,377 | | 1,256 | | (388 | ) | 4,122 | |
Income tax expense (benefit) | | 533 | | — | | (167 | ) | — | |
Net earnings (loss) | | $ | 844 | | $ | 1,256 | | $ | (221 | ) | $ | 4,122 | |
| | | | | | | | | |
Net earnings (loss) per common share: | | | | | | | | | |
Basic | | $ | 0.07 | | $ | 0.12 | | $ | (0.02 | ) | $ | 0.39 | |
Diluted | | 0.07 | | 0.11 | | (0.02 | ) | 0.38 | |
Weighted average common shares outstanding: | | | | | | | | | |
Basic | | 12,292 | | 10,845 | | 12,106 | | 10,663 | |
Diluted | | 12,476 | | 11,410 | | 12,106 | | 10,957 | |
The accompanying notes are an integral part of these financial statements.
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Datalink Corporation
Statements of Cash Flows
(In thousands)
(Unaudited)
| | Nine Months Ended
September 30, | |
| | 2007 | | 2006 | |
Cash flows from operating activities: | | | | | |
Net earnings (loss) | | $ | (221 | ) | $ | 4,122 | |
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: | | | | | |
Provision for bad debts | | 33 | | 27 | |
Depreciation | | 800 | | 758 | |
Amortization of intangibles | | 550 | | — | |
Deferred income taxes | | (239 | ) | — | |
Deferred rent | | 19 | | (88 | ) |
Amortization of sublease reserve | | (271 | ) | (233 | ) |
Stock based compensation expense | | 383 | | 193 | |
Loss on disposal of assets | | 38 | | — | |
Changes in operating assets and liabilities, net of effects from purchase of MCSI: | | | | | |
Accounts receivable | | 4,706 | | 8,298 | |
Inventories | | (78 | ) | 126 | |
Deferred customer support contract costs/revenues, net | | 2,598 | | 1,259 | |
Accounts payable | | (5,704 | ) | (8,145 | ) |
Accrued expenses | | (591 | ) | (485 | ) |
Other | | (50 | ) | 86 | |
Net cash provided by operating activities | | 1,973 | | 5,918 | |
| | | | | |
Cash flows from investing activities: | | | | | |
Purchase of property and equipment | | (1,074 | ) | (470 | ) |
Payment for purchase of MCSI, net of cash acquired | | (1,837 | ) | — | |
Net cash used in investing activities | | (2,911 | ) | (470 | ) |
| | | | | |
Cash flows from financing activities: | | | | | |
Proceeds from issuance of common stock | | 277 | | 2,313 | |
Tax withholding payments reimbursed by restricted stock | | (140 | ) | — | |
Net cash provided by financing activities | | 137 | | 2,313 | |
| | | | | |
Increase (decrease) in cash and cash equivalents | | (801 | ) | 7,761 | |
Cash and cash equivalents, beginning of period | | 22,900 | | 13,434 | |
Cash and cash equivalents, end of period | | $ | 22,099 | | $ | 21,195 | |
The accompanying notes are an integral part of these financial statements.
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Datalink Corporation
Notes To Financial Statements
(In thousands, except share and per share data)
(Unaudited)
1. Basis of Presentation
We have prepared the interim financial statements included in this Form 10-Q without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). We have condensed or omitted certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and related notes thereto included in our 2006 Annual Report on Form 10-K.
The financial statements presented herein as of September 30, 2007, and for the three and nine months ended September 30, 2007 and 2006, reflect, in the opinion of management, all adjustments (which consist only of normal, recurring adjustments) necessary for a fair presentation of the financial position and the results of operations and cash flows for the periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.
Management is required to make certain estimates and assumptions which affect the amounts of assets, liabilities, revenues and expenses we have reported, and our disclosure of contingent assets and liabilities at the date of the financial statements. The results of the interim periods are not necessarily indicative of the results for the full year. Accordingly, these condensed financial statements should be read in conjunction with the audited financial statements and the related notes included in our 2006 Annual Report on Form 10-K. Actual results could differ materially from these estimates and assumptions.
2. Net Earnings (Loss) per Share
We compute basic net earnings (loss) per share using the weighted average number of shares outstanding. Diluted net earnings (loss) per share, includes the effect of common stock equivalents, if any, for each period. We calculate the number of additional shares by assuming that each holder exercised his or her outstanding stock options and that each used the proceeds from such exercise to acquire shares of common stock at the average market price during the reporting period. Due to the net loss for the nine months ended September 30, 2007, common stock equivalents of 300,000 would have been anti-dilutive and, as a result, we excluded them from the calculation of diluted loss per share.
3. Stock Based Compensation
Stock Compensation Plans:
We account for stock based compensation in accordance with SFAS No. 123 (Revised 2004), “Share-Based Payments,” (“SFAS 123R”), which requires the measurement and recognition of compensation costs at fair value for all share-based payments, including stock options and non-vested stock.
Non-vested Stock:
In February 2007, we awarded 75,000 shares of non-vested stock to an executive. The grant vests over 4 years, with 50 percent after year two, 25 percent after year three and 25 percent after year four if the executive is still employed by us. During the vesting period, the executive has voting rights and the right to receive dividends. However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they vest. We are amortizing the $665,000 value of the restricted shares on the date of grant ratably over the four year vesting period. Unrecognized compensation expense related to the restricted stock grant was $561,000 at September 30, 2007.
In March and April 2007, respectively, we awarded 120,000 and 129,000 shares of non-vested stock to executive officers and managers and gave our CEO the authority to grant an additional 7,750 restricted shares of our common stock to yet to be named key employees. The vesting of these restricted stock awards is based upon the achievement of our predetermined earnings from operations objective for fiscal 2007 as approved by our board of directors (the “2007 Objective”).
If our 2007 actual earnings from operations equals or exceeds our 2007 Objective, all restricted shares awarded will vest two-thirds (2/3) upon our public announcement of our 2007 results. Additionally, if our 2007 actual earnings from operations exceed by 25% or more our 2007 Objective, 50% of the additional one-third (1/3) of these awards will immediately vest on the public announcement date. The remaining 50% of the one-third (1/3) award will vest upon the public announcement of our 2009 results, provided the
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recipient has been in our continuous employment on such date without regard to additional performance objectives. Otherwise, this portion of the award automatically expires.
If our 2007 results do not meet our 2007 Objective (the difference being the “2007 Shortfall”), then two-thirds (2/3) of these awards will vest upon the public announcement of our financial results for 2008 or 2009 when such results (either alone or together) equal or exceed our 2008 and 2009 predetermined financial objectives (either alone or together) by the amount of the 2007 Shortfall. If these awards do not fully vest by our public announcement of our 2009 results, these awards will automatically expire.
For our executive officers, vesting accelerates 100% upon a change of control, if we terminate their employment without cause or if they voluntarily terminate their employment for good reason. Recipients will receive dividends on the awarded shares only if vested and be entitled to vote them whether or not vested.
The fair value of these non-vested shares was $959,000 and $840,000, respectively, on the date of grant. We recognize compensation expense based on management’s estimate of the probable outcome of the performance condition. We may adjust the amount of expense recognized in future reporting periods for subsequent changes in the estimated or actual outcome. Based on the progress towards the 2007 Objective, we determined that the vesting of the non-vested shares is not probable as of September 30, 2007. Accordingly, we have not recognized any compensation expense related to these grants. Unrecognized compensation expense related to the restricted stock grant was $959,000 and $840,000, respectively, at September 30, 2007.
Total stock-based compensation expense related to non-vested stock was $125,800 and $60,600 for the three months ended September 30, 2007 and 2006, respectively. Total stock-based compensation expense related to non-vested stock was $382,900 and $123,900 for the nine months ended September 30, 2007 and 2006, respectively.
The following table summarizes our non-vested stock activity for the nine months ended September 30, 2007:
| | Number of Shares | | Weighted Average
Grant-Date Fair Value | |
Non-vested stock at January 1, 2007 | | 223,000 | | $ | 4.35 | |
Granted | | 281,000 | | $ | 7.77 | |
Cancelled | | (8,750 | ) | 4.44 | |
Shares vested | | (54,500 | ) | $ | 4.35 | |
Non-vested stock at September 30, 2007 | | 440,750 | | $ | 6.53 | |
Stock Options:
The following table represents stock option activity for the nine months ended September 30, 2007:
| | Number of Shares | | Weighted
Average
Exercise Price | | Weighted Average
Remaining
Contract Life in
Years | |
Outstanding options as of January 1, 2007. | | 1,250,428 | | $ | 5.00 | | | |
Options granted | | — | | $ | — | | | |
Options exercised | | (70,688 | ) | $ | 3.98 | | | |
Options cancelled | | (45,900 | ) | $ | 12.97 | | | |
Outstanding and exercisable options as of September 30, 2007 | | 1,133,840 | | $ | 4.74 | | 4.59 | |
We recognized no stock based compensation expense related to stock options during the three and nine months ending September 30, 2007 and 2006, respectively.
4. Income Taxes
As part of the process of preparing financial statements, we are required to estimate income taxes, both state and federal. This process involves management estimating the actual current tax exposure together with assessing temporary differences resulting from different treatment for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we include within the balance sheet. Management must then assess the likelihood that we will utilize deferred tax assets to offset future taxable income during the periods in which these temporary differences are deductible. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 43%. For the three months ended September 30, 2007, we recorded income tax expense of $533,000, with an effective tax rate of 39%. For the nine months ended September 30, 2007 we recorded an
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income tax benefit of $167,000 using an effective tax rate of 43%. Our effective tax rate increased for the nine months ended September 30, 2007, as the significance of our permanent differences was greater than originally anticipated.
Effective January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 requires a company to determine whether it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. If the more-likely-than-not threshold is met, a company must measure the tax position to determine the amount to recognize in the financial statements.
At the adoption date of January 1, 2007 and at September 30, 2007, we had no unrecognized tax benefits which would affect our effective tax rate if recognized.
We classify interest and penalties arising from the underpayment of income taxes in the statement of income under general and administrative expenses. As of September 30, 2007, we had no accrued interest or penalties related to uncertain tax positions. The tax year 2003-2006 federal return remains open to examination and the tax years 2003-2006 remain open to examination by other major income taxing jurisdictions to which we are subject.
5. Acquisition
On January 31, 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago, Illinois. We believe the acquisition has strengthened our presence in existing regional markets and expanded our reach into a number of key new regional markets. We paid a purchase price of approximately $14 million for MCSI, consisting of $5.0 million cash ($4.5 million of which we paid at closing to the former MCSI shareholders and $500,000 of which we deposited in escrow) and 1,163,384 shares of our common stock (1,047,459 shares of which we issued at closing to the former MCSI shareholders and 116,384 shares of which we deposited in escrow).
In connection with this acquisition, we allocated the total purchase consideration to the net assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date, resulting in goodwill of approximately $12.1 million which we do not expect to deduct for income tax purposes. The following table summarizes the preliminary allocation of the purchase price to the fair value of the assets and liabilities acquired:
| | (in thousands) | |
Assets acquired | | | |
Cash | | $ | 3,466 | |
Accounts receivable | | 1,262 | |
Inventory & inventory shipped but not installed | | 3,800 | |
Property, plant & equipment | | 296 | |
Identifiable intangible assets | | | |
Customer relationships | | 4,262 | |
Backlog | | 76 | |
Goodwill | | 12,180 | |
Other assets | | 94 | |
Total assets acquired | | 25,436 | |
Liabilities assumed | | | |
Accounts payable | | 8,432 | |
Deferred maintenance contracts, net | | 399 | |
Accrued liabilities | | 479 | |
Deferred tax liability obligations | | 1,868 | |
Total liabilities assumed | | 11,178 | |
Net purchase price | | $ | 14,258 | |
The finite lived intangibles which consisted of customer relationships and backlog have estimated lives of six years and two months, respectively and we are amortizing them using the straight line method.
The pro forma unaudited results of operations for the three and nine months ended September 30, 2007 and 2006, assuming consummation of the purchase of the assets from MCSI as of January 1, 2006, are as follows:
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| | Three Months ended
September 30, | | Nine Months ended
September 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
| | (in thousands, except share data) | |
Net sales. | | $ | 45,848 | | $ | 47,760 | | $ | 131,252 | | $ | 144,902 | |
Net income (loss) | | 844 | | 2,312 | | (1,069 | ) | 5,364 | |
| | | | | | | | | |
Per share data: | | | | | | | | | |
Basic earnings (loss) | | $ | 0.07 | | $ | 0.19 | | $ | (0.09 | ) | $ | 0.45 | |
Diluted earnings (loss) | | $ | 0.07 | | $ | 0.18 | | $ | (0.09 | ) | $ | 0.44 | |
Integration expenses, including the salaries, benefits, retention bonuses and severances of MCSI employees, some which assisted with the initial integration but were ultimately not retained by us, were zero for the three month period ended September 30, 2007 and were $442,000 for the nine month period ended September 30, 2007.
The pro forma unaudited results do not purport to be indicative of the results which would have been obtained had the acquisition been completed as of the beginning of the earliest period presented. Furthermore, the purchase price allocation is preliminary and subject to change. When we determine the final purchase price allocation, we may change the unaudited pro forma combined results of operations presented above.
6. Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which provides guidance on how to measure assets and liabilities that use fair value. SFAS 157 will apply whenever another U.S. GAAP standard requires (or permits) assets or liabilities to be measured at fair value, but does not expand the use of fair value to any new circumstances. This standard also will require additional disclosures in both annual and quarterly reports. SFAS 157 will be effective for financial statements issued for fiscal years beginning after November 15, 2007. We will adopt the standard beginning in the first quarter of 2008. We are currently evaluating the impact of adopting SFAS 157 on our financial statements.
In February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 creates a “fair value option” under which we may elect to record certain financial assets or liabilities at fair value upon their initial recognition. We would then recognize subsequent changes in fair value in earnings as those changes occur. We would make the election of the fair value option on a contract-by contract basis, supported by concurrent documentation or a preexisting documented policy. SFAS 159 requires an entity to separately disclose the fair value of these items on the balance sheet or in the footnotes to the financial statements and to provide information that would allow the financial statement user to understand the impact on earnings from changes in the fair value. SFAS 159 is effective for us beginning with fiscal year 2008. We are currently evaluating the impact that the adoption of SFAS 159 may have on our financial statements.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
The following information should be read in conjunction with the unaudited financial statements and the notes thereto included in Item 1 of this Quarterly Report and with the “Forward-Looking Statements” section in this filing and in our other filings with the U.S. Securities and Exchange Commission.
We are an independent architect of enterprise-class information storage infrastructures. We have 21 locations throughout the United States, with the highest concentration of revenues in the central states. We derive our revenues principally from designing, installing and supporting data storage systems. Our solutions can include hardware products, such as disk arrays, tape systems and interconnection components and storage management software products. The market for data storage products and services is large. International Data Corporation (IDC) estimates that digital information will occupy more than six times its current quantity, or 988 billion gigabytes, by 2010.
We sell support service contracts to most of our customers. When customers purchase support services through us, customers receive the benefit of integrated system wide support. We have a qualified, independent support desk that takes calls from customers, diagnoses the issues they are facing and either solves the problem or coordinates with Datalink 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
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manufacturer provides on-site support assistance if necessary. We defer revenues and direct costs resulting from these contracts, and amortize these revenues and expenses into operations, over the term of the contracts, which are generally twelve months.
The enterprise-class information storage market is rapidly evolving and highly competitive. Our competition includes other independent storage 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 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 storage solutions before customers deploy them, the size of customer orders, the complexity of our customers’ network environments, necessary system configuration to deploy our solutions and new product introductions by suppliers. Completion of our installation and configuration services may also delay recognition of revenues. Economic conditions and competition also affect our customers’ decisions to place orders with us. As a result, our net sales may fluctuate from quarter to quarter.
We view the current data storage market as providing significant opportunity for growth. Currently, Datalink’s market share is a small part of the overall market. However, the providers of the data storage 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 Datalink to sell their products. While these trends provide opportunity for Datalink, we must improve our business model to generate sustainable, profitable growth. Our model requires highly skilled sales and technical staff which results in substantial fixed costs for us. We believe the best way to improve our company and create long-term shareholder value is to focus on building scaleable capabilities and a leverageable cost structure. Our current strategies are focused on:
• Increasing productivity of our sales and technical teams in our existing locations.
• Deepening our presence in existing enterprise accounts and penetrating new enterprise accounts.
• Growing our customer support revenue and market share. We believe that our customer support services offerings are becoming increasingly attractive to companies looking for system-wide integrated support.
• Increasing our professional services revenues. We believe there is an opportunity to sell more of our data storage services such as implementation services, storage environment assessments and on-site data storage management and architecture services.
• Exploring potential regional acquisitions that we believe can strengthen our resources and capabilities in key geographic locations. On January 31, 2007, we acquired Midrange Computer Solutions, Inc., a storage consulting, solutions and service provider based in Chicago, Illinois.
To pursue these strategies, we are:
• Improving our training, tools and recruiting efforts for sales and engineering teams to increase productivity.
• Hiring additional customer support staff and enhancing the customer support staff’s communications and call management capabilities.
• Developing more effective delivery capabilities for professional services and solutions.
• Focusing on successful completion of our MCSI integration efforts.
All of these plans have various challenges and risks associated with them, including that:
• We may not increase our productivity and may lose, or not successfully recruit and retain key sales, technical or other personnel.
• Competition is intense and may adversely impact our profit margin. Customers have many options for data storage products and services.
• We may not successfully complete the integration of MCSI. Our failure to meet the challenges involved in integrating the operations of MCSI with Datalink successfully or otherwise to realize any of the anticipated benefits of the merger could seriously harm our business.
RESULTS OF OPERATIONS
The following table shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
Net sales | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of sales | | 74.1 | | 73.1 | | 74.9 | | 74.0 | |
Gross profit | | 25.9 | | 26.9 | | 25.1 | | 26.0 | |
Operating expenses: | | | | | | | | | |
Sales and marketing | | 12.1 | | 11.7 | | 12.7 | | 11.2 | |
General and administrative | | 6.0 | | 7.2 | | 7.0 | | 7.2 | |
Engineering | | 4.9 | | 4.8 | | 5.4 | | 4.2 | |
Integration costs | | — | | — | | 0.3 | | — | |
Amortization of intangibles | | 0.4 | | — | | 0.4 | | — | |
Total operating expenses | | 23.4 | | 23.7 | | 25.8 | | 22.6 | |
Operating earnings (loss) | | 2.5 | % | 3.2 | % | (0.7 | )% | 3.4 | % |
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The following table shows, for the periods indicated, revenue and gross profit information for our product and service sales.
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2007 | | 2006 | | 2007 | | 2006 | |
Product sales | | $ | 27,705 | | $ | 22,163 | | $ | 79,617 | | $ | 76,387 | |
Service sales | | 18,143 | | 11,010 | | 47,480 | | 30,903 | |
| | | | | | | | | |
Product gross profit | | $ | 6,716 | | $ | 5,538 | | $ | 18,857 | | $ | 18,603 | |
Service gross profit | | 5,141 | | 3,389 | | 13,021 | | 9,316 | |
| | | | | | | | | |
Product gross profit as a percentage of product sales | | 24.2 | % | 25.0 | % | 23.7 | % | 24.4 | % |
Service gross profit as a percentage of service sales | | 28.3 | % | 30.8 | % | 27.4 | % | 30.1 | % |
Net Sales. Our total net sales increased by $12.7 million for the three months ended September 30, 2007, or 38.2%, from $33.2 million for the comparable quarter in 2006. Our total net sales increased $19.8 million for the nine months ended September 30, 2007, or 18.5% from $107.3 million for the comparable period in 2006. Our product sales increased $5.5 million, or 25.0%, to $27.7 million for the three months ended September 30, 2007, from $22.2 million for the comparable quarter in 2006. Our product sales increased $3.2 million, or 4.2%, to $79.6 million for the nine months ended September 30, 2007, from $76.4 million for the nine months ended September 30, 2006. Our service sales increased $7.1 million, or 64.8%, to $18.1 million for the three months ended September 30, 2007 from $11.0 million for the comparable quarter in 2006. Our service sales increased $16.6 million, or 53.6%, to $47.5 million for the nine months ended September 30, 2007, from $30.9 million for the nine months ended September 30, 2006.
The majority of our increase in product sales for the three and nine month periods ended September 30, 2007, as compared to the same periods in 2006, was due to the acquisition of MCSI. Without the impact from the acquisition, our product sales would have had a modest increase for the three month period ended September 30, 2007, as compared to the same period in 2006 and our product sales would have decreased slightly for the nine month period ended September 30, 2007, as compared to the same period in 2006. Our product revenues continue to reflect what we believe to be a slow down in IT and storage spending with some of our larger customers, as they have become more cautious about the economy and their individual growth prospects throughout 2007. This has created longer sales cycles with a number of large project delays. We do not know whether this spending slow down among our customers will continue. Our product sales for the three and nine month periods ended September 30, 2007, as compared to the same periods in 2006, reflects the addition of MCSI revenues for three and eight months, respectively.
Our service sales increase for the three and nine month periods ended September 30, 2007 as compared to the same periods in 2006 was due to an increase in customer support contracts of $5.2 million and $15.4 million, respectively. The majority of our increase in customer support contract revenues was due to the acquisition of MCSI. In addition, with the growth in our product revenues, we have experienced a corresponding growth in our customer support contract revenues. Our service sales for the three and nine month periods ended September 30, 2007, as compared to the same periods in 2006, reflects the addition of MCSI revenues for three and eight months, respectively.
We had no single customer account for greater than 10% of our revenues for the three months ended September 30, 2007, the nine months ended September 30, 2007 and the three months ended September 30, 2006. We derived 16% of our revenues for the nine months ended September 30, 2006, from AT&T Inc. We cannot assure that this customer will account for a substantial portion of our future sales.
Gross Profit. Our total gross profit as a percentage of net sales decreased to 25.9% for the quarter ended September 30, 2007, as compared to 26.9% for the comparable quarter in 2006. Our total gross profit as a percentage of net sales decreased to 25.1% for the nine months ended September 30, 2007, as compared to 26.0% for the nine months ended September 30, 2006. Product gross profit as
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a percentage of product sales decreased to 24.2% in the third quarter of 2007 from 25.0% for the comparable quarter in 2006. Product gross profit as a percentage of product sales decreased to 23.7% for the nine months ended September 30, 2007 from 24.4% for the comparable period in 2006. Service gross profit as a percentage of service sales decreased to 28.3% for the third quarter of 2007 from 30.8% for the comparable quarter in 2006. Service gross profit as a percentage of service sales decreased to 27.4% for the nine months ended September 30, 2007 from 30.1% for the nine months ended September 30, 2006.
Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers. For the three months ended September 30, 2007 as compared to the same period in 2006, our product gross profit as a percentage of product sales decreased slightly due to our continuing efforts to gradually improve the margins realized by the MCSI sales force as they become more familiar with our product and services offerings. For the nine months ended September 30, 2007 as compared to the same periods in 2006, we attribute the decrease in product gross profit as a percentage of product sales to the additional MCSI revenues, which historically had lower product margins. Our efforts to successfully integrate the MCSI sales force, leveraging product and service offerings across our vendors, has gradually improved the gross margins realized by the MCSI sales force, but are not at legacy Datalink levels yet and cannot assure our MCSI sales force will reach those targets.
Our service gross profit as a percentage of service sales for the three and nine month periods ended September 30, 2007 as compared to the same periods in 2006 decreased 2.5% and 2.7%, respectively. We experienced a decrease in gross margin for the three and nine months ended September 30, 2007 primarily due to a $176,000 and $587,000 reduction in revenues and corresponding margins for the MCSI acquisition to reflect the fair value of maintenance contracts we acquired.
Sales and Marketing. Sales and marketing expenses include wages and commission paid to sales and marketing personnel, travel costs and advertising, promotion and hiring expenses. Sales and marketing expenses totaled $5.5 million, or 12.1% of net sales for the quarter ended September 30, 2007, compared to $3.9 million, or 11.7% of net sales for the third quarter in 2006. Sales and marketing expenses totaled $16.1 million, or 12.7% of net sales for the nine months ended September 30, 2007, compared to $12.0 million, or 11.2% of net sales for the nine months ended September 30, 2006.
Sales and marketing expenses increased $1.6 million and $4.1 million for the three and nine month periods ended September 30, 2007, respectively, as compared to the same periods in 2006. The increase in expenses is primarily due to an increase in salaries and benefits. We increased our headcount with the MCSI acquisition and we also added new regional and executive managers for our sales organization. Our sales and marketing expenses for the three and nine month periods ended September 30, 2007, as compared to the same periods in 2006, reflects the addition of MCSI expenses for three and eight months, respectively.
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 were $2.8 million, or 6.0% of net sales for the quarter ended September 30, 2007, compared to $2.4 million, or 7.2% of net sales for the third quarter in 2006. General and administrative expenses were $9.0 million, or 7.0% of net sales for the nine months ended September 30, 2007, compared to $7.7 million, or 7.2% of net sales for the same period in 2006.
General and administrative expenses increased $381,000 for the three months ended September 30, 2007, as compared to the same period in 2006. We attribute the increase to an increase in facility and communication expenses of $222,000, an increase in salaries and benefits of $41,000 with select headcount additions, an increase in meeting expenses of $40,000, and an increase in board of director compensation expenses of $20,000. General and administrative expenses increased $1.2 million for the nine month period ended September 30, 2007, as compared to the same period in 2006. The increase was due to an increase in salaries of $496,000 with select headcount additions, an increase in board of director compensation expenses of $106,000, an increase in facility, communication and supplies expenses of $554,000 and an increase in training expenses of $27,000. The increase in headcount, facility, communication and supplies expenses are primarily due to the acquisition of MCSI.
Engineering. Engineering expenses include employee wages and travel, hiring and training expenses for our field and customer support engineers and technicians. Engineering expenses were $2.2 million or 4.9% of net sales for the quarter ended September 30, 2007, compared to $1.6 million, or 4.7% of net sales for the third quarter in 2006. Engineering expenses were $6.9 million, or 5.4% of net sales for the nine months ended September 30, 2007, compared to $4.5 million, or 4.2% of net sales for the same period in 2006.
Engineering expenses increased $663,000 and $2.4 million, respectively, for the three and nine month periods ended September 30, 2007 as compared to the same period in 2006. The increase in expenses is primarily due to an increase in salaries and benefits for MCSI personnel and the addition of regional managers for our engineering organization. Our engineering expenses for the three and nine month ended September 30, 2007, reflect the addition of MCSI expenses for three and eight months, respectively.
Integration Costs. Integration expenses include salaries and benefits of MCSI employees who assisted with the initial integration but whom we ultimately did not retain, together with retention bonuses and severances. We had no integration expenses for the three
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months ended September 30, 2007. Integration expenses for the nine months ended September 30, 2007, were $442,000 related to the January 31, 2007 acquisition of MCSI. We had no integration expenses for the three and nine month periods ended September 30, 2006.
Amortization of Intangibles. We had intangible asset amortization expense for the three month period ended September 30, 2007 and 2006 of $178,000 and $0, respectively. We had intangible asset amortization expense for the nine month periods ended September 30, 2007 and 2006 of $550,000 and $0, respectively. The increase in the identifiable intangible asset and subsequent amortization is due to our acquisition of MCSI on January 31, 2007. Because the purchase price allocation is preliminary in nature, the amortization expense is based on an estimate. Accordingly, we may change the future amortization expense related to these finite lived intangibles.
Operating Earnings (Loss). We had operating earnings of $1.1 million for the three months ended September 30, 2007 and 2006, respectively. We had an operating loss of $1.1 million for the nine months ended September 30, 2007 as compared to operating earnings of $3.7 million for the same period in 2006. The flat operating earnings for the three month period ended September 30, 2007 as compared to the same period in 2006 is a result of higher revenues and margins offset by an increase in operating expenses related to our acquisition of MCSI. The decrease of $4.8 million for the nine month period ended September 30, 2007 as compared to the same period in 2006 is primarily a result of the lower margins and increased operating expenses related to our acquisition of MCSI, including integration costs and intangible amortization. We also believe our performance reflects a slow down in IT and storage spending with some of our large customers, as they have become more cautious about the economy and their individual growth prospects. This has created longer sales cycles with a number of large project delays.
Income Taxes. We had income tax expense of $533,000 and an income tax benefit of $167,000 for the three and nine month periods ended September 30, 2007, as a result of our estimated effective tax rate of 43%. Our effective tax rate increased for the nine months ended September 30, 2007, as the significance of our permanent differences was greater than originally anticipated. We had no income tax expense for the three and nine month periods ended September 30, 2006 due to a reduction in the deferred tax asset offset by a decrease in the valuation allowance. Prior to the fourth quarter of 2006, we recorded a full valuation allowance against our deferred tax assets due to the uncertainty of the realization and timing of the benefits from those deferred tax assets, as we had not achieved a sufficient level of sustained profitability. In the fourth quarter of 2006, management concluded that we had attained a sufficient level of sustained profitability to allow the reversal of our remaining $2.8 million valuation allowance. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 43%.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $2.0 million for the nine months ended September 30, 2007 as compared to net cash provided by operating activities of $5.9 million for the nine months ended September 30, 2006. Significant items which impacted our operating cash flows as of September 30, 2007 were:
• A net loss of $221,000.
• A $2.6 million net increase in deferred customer support contracts. While we amortize the revenues from these contracts over the life of the contract, the customer almost always pays for the contracts at the beginning of the contract period which favorably impacts our cash flows.
• A net decrease in cash of approximately $1.1 million for accounts receivable, inventory and accounts payable. This was primarily due to a decrease in accounts receivable related to lower than normal days sales outstanding of 37 at the end of the quarter, offset by an increase in accounts payable.
• An increase in amortization of intangibles of $550,000 due to our acquisition of MCSI.
Net cash used in investing activities was $2.9 million for the nine months ended September 30, 2007. We used this cash primarily for the acquisition of MCSI, leasehold improvements and upgraded computer equipment. We are planning for $150,000 of capital expenditures for the remainder of 2007 related primarily to computer upgrades or other management information system enhancements.
Net cash provided by financing activities was $137,000 for the nine months ended September 30, 2007, from the exercise of stock options. Net cash provided by financing activities was $2.3 million for the nine months ended September 30, 2006, from the exercise of stock options and warrants.
We have elected not to pursue a credit facility at this time. With our current cash position, we believe we have the liquidity to meet our operating needs for the foreseeable future. We have no outstanding debt, and if the need should arise to borrow funds, we believe that we could obtain a secured facility.
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Our contractual cash obligations consist of future minimum lease payments due under non-cancelable operating leases. These obligations are as of September 30, 2007, for the remainder of 2007 and each of the full years thereafter as follows:
| | (in thousands) | |
| | Lease
Obligations | | Sublease
Agreements | | Net Lease
Obligations | |
2007 | | $ | 817 | | $ | (186 | ) | $ | 631 | |
2008 | | 1,917 | | (719 | ) | 1,198 | |
2009 | | 1,814 | | (719 | ) | 1,095 | |
2010 | | 1,674 | | (719 | ) | 955 | |
2011 | | 1,596 | | (719 | ) | 877 | |
Thereafter | | 592 | | (239 | ) | 353 | |
| | $ | 8,410 | | $ | (3,301 | ) | $ | 5,109 | |
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, establishment of vendor specific objective evidence of fair value for customer contracts with multiple elements, inventories, income taxes, self-insurance reserves and commitments and contingencies.
Our significant accounting policies and estimates are summarized in our annual financial statements. Some of our accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. We believe these estimates and assumptions are reasonable based on the facts and circumstances as of September 30, 2007. However, actual results may differ from these estimates under different assumptions and circumstances.
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 realize revenue from the design, installation and support of data storage solutions, which may include hardware, software and services. We recognize revenue when we have met our obligations for installation or other services and collectability is reasonably assured.
Product Sales. We sell software and hardware products on both a “free-standing” basis without any services and as data storage solutions bundled with our installation and configuration services (“bundled arrangements”).
Product Sales Without Service. If we sell a software or hardware product and do not provide any installation or configuration services with it, we recognize the product revenues upon shipment.
Product Sales With Service. If we sell a bundled arrangement, then we defer recognizing any revenues on it until we finish our installation and/or configuration work. We account for the hardware, software and service elements of our bundled arrangements by applying the provisions of Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP 98-9.
Pursuant to the provisions of SOP 97-2, we apply contract accounting to our bundled arrangements. In accordance with SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts,” we apply the completed contract method. Factors we have considered in applying the completed contract method accounting include (i) the relatively short duration of our contracts, (ii) the difficulty of estimating our revenues on a percentage-of-completion method and (iii) our use of acceptance provisions on larger bundled arrangements.
Service Sales. In addition to installation and configuration services that are part of our bundled arrangements described above, our service sales include customer support contracts and consulting 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.
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Customer Support Contracts. We sell service contracts to most of our customers. These contracts are support service agreements. We have an internal support desk that provides integrated customer support services, including configuration and usage assistance, technical advice and prompt incident detection and resolution. Our technical staff first assists a customer in identifying the source of system problems and in determining whether there is defective hardware or software. If our customer requires on-site maintenance or repair services, we arrange for a service call pursuant to underlying third-party support service agreements we have with our hardware and software vendors.
When we sell a service contract as part of a bundled arrangement, we use vendor specific objective evidence to allocate revenue to the service contract element. In all cases, we defer revenues and direct costs resulting from our service contracts and amortize them into operations over the term of the contracts, which are generally twelve months. We are contractually obligated to provide or arrange to provide these underlying support services to our customers in the unlikely event that the hardware or software vendor, or its designee, fails to perform according to the terms of its contact.
Consulting Services. Some of our customers engage us to analyze their existing storage architectures and offer our recommendations. Other customers engage us to assist them on-site with extended data storage projects, to support their data storage environments and to help with long-term data storage 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.
Gross Reporting of Revenues. We report our revenues from the sale of hardware and software products on a gross, rather than a net, basis. In reporting our revenues on a gross basis, we considered that:
• We are the primary obligor to our customers. We are responsible for fulfillment, including the acceptability of the products and services to our customers.
• We have the risk of loss for inventory and credit.
• We establish the prices for our products and services with our customers.
• We are responsible for the installation and configuration services ordered by our customers.
Commission Expense. We utilize a direct sales force to generate virtually all of our revenues. We pay our sales people a combination of base salary and commissions. We pay commissions based on the amount of gross profit generated from the products and services sold. We match commissions to the appropriate transactions and recognize commission expense at the time we recognize the related revenues and gross profit.
Inventory. We periodically review, estimate and adjust our reserves for obsolete or unmarketable inventory equal to the difference between the inventory cost and the estimated market value based upon assumptions about future demand and market conditions. Results could be materially different if demand for our products decreased because of economic or competitive conditions, length of industry downturn, or if products become obsolete because of technical advancements in the industry.
Valuation of Goodwill and Other Intangible Assets. We test goodwill for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests an impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on total market capitalization as compared to the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets, it may prompt us to engage a third party valuation firm to perform a valuation of us to further assess whether our goodwill or other intangibles are impaired pursuant to SFAS 142. We consider our 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.
Income Taxes. We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities. We regularly assess the likelihood that we will recover our deferred tax assets from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. In future periods of earnings, we will report income taxes at normalized rates.
Valuation of Long-Lived Assets, Including Finite-Lived Intangibles. We evaluate long-lived assets and intangible assets with finite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are required based on current events and circumstances. We base the evaluation on our projection of the undiscounted future operating cash flows of the underlying assets. To the extent such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amounts of related assets, we record a charge to reduce the carrying amount to its estimated fair value. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. We consider the estimates associated with the asset impairment tests critical due to the judgments required in determining fair value amounts, including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss.
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Allocation of Purchase Price Paid for the MCSI Acquisition. As a result of our acquisition of MCSI, as described in Note 6 to the annual financial statements, we were required to allocate the consideration paid between tangible assets, identifiable intangible assets and goodwill. We are determining the amount of purchase price allocated to finite lived intangible assets by estimating the future cash flows of each asset and discounting the net cash flows back to their present values. The discount rate we are using to calculate the present value of the various intangibles is in accordance with accepted valuation methods. Because the acquisition was recently completed, our estimated allocation of the purchase price is preliminary in nature.
Stock-Based Compensation. We adopted the provisions of FASB No. 123R, Share Based Payment on January 1, 2006. FASB 123R 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. SFAS 123(R) requires the use of an option pricing 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. Recognition of compensation expense for our performance based non-vested shares will be based on management’s estimate of the probable outcome of the performance condition. Management will reassess 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
All of our operations are based in the U.S. and all of our transactions are denominated in U.S. dollars. Our interest income is sensitive to changes in the general level of U.S. interest rates. However, due to the nature of our short-term investments, we have concluded they have no material market risk. The following is a discussion of our exposure to market risk related to changes in interest rates, foreign exchange rates and equity prices.
Interest rate risk. As of September 30, 2007 we had $22.1 million of cash and money market accounts. A decrease in market rates of interest on these accounts would have no material effect on the value of our assets or the related interest income. We have no short or long-term debt.
Foreign currency exchange rate risk. We market and sell all of our products 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.
Item 4. Disclosure Controls and Procedures.
Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and option of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”).
The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures were operating effectively such that the information relating to Datalink Corporation, required to be disclosed in our Securities and Exchange Commissions (“SEC”) reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were operating effectively.
Changes in internal control over financial reporting. There was no change in our internal control over financial reporting during our most recently competed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
As of the date of this filing, we are not involved in any material legal proceedings. We also were not involved in any material legal proceedings that were terminated during the third quarter of 2007.
Item 1A. Risk Factors.
Except as provided below, there has not been a material change to the risk factors as set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2006.
Dependence on Significant Customers. We derived 16% of our revenues for the nine months ended September 30, 2006 from AT&T Inc. We had no single customer account for greater than 10% of our revenues for the three or nine months ended September 30, 2007, or for the three months ended September 30, 2006. We cannot provide assurance that this customer will account for a substantial portion of our future sales.
Effect of Credit Market Tightening on Data Storage Spending. In response to credit risks in the subprime mortgage marketplace, lenders recently have generally made credit less available, and more expensive, for corporate borrowers, including our customers. A reduction in the availability or an increase in the price of borrowed funds could adversely affect our customers’ decisions or timing to purchase our data storage products and services.
Item 2. Changes in Securities and Use of Proceeds.
None
Item 3. Defaults Upon Senior Securities.
None
Item 4. Submission of Matters to a vote of Security Holders.
None
Item 5. Other Information
None
Item 6. Exhibits
(a) Exhibits
31.1 | | Certifications by the President and Chief Executive Officer and Vice President Finance and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | |
32.1 | | Certifications by the President and Chief Executive Officer and Vice President Finance and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (This Exhibit is “furnished” pursuant to SEC rules, but is deemed not “filed”.) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated:November 14, 2007 | Datalink Corporation |
| |
| |
| By: | /s/ Gregory T. Barnum |
| Gregory T. Barnum, Vice President Finance and |
| Chief Financial Officer |
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