Datalink (DTLK) 10-Q 2009 Q2 Quarterly report

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: June 30, 2009
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.  Yes  x  No  o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filer o	Accelerated Filer o
Non-Accelerated Filer o	Smaller Reporting Company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): 

Yes  o  No  x

As of August 14, 2009, 12,934,535 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 2009 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 impact of the worldwide adverse economic conditions on technology spending; 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 sales representatives and key technical and other personnel; our dependence on key suppliers; our ability to adapt to rapid technological change; risks associated with current and possible future acquisitions; fluctuations in our quarterly operating results; future changes in applicable accounting rules; and volatility in our stock price, particularly in light of the substantial decline in worldwide stock markets.  Further, our revenues for any particular quarter are not necessarily reflected by our backlog of contracted orders, which also may fluctuate unpredictably.

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PART I. FINANCIAL INFORMATION

Item 1.   Financial Statements

Datalink Corporation

Balance Sheets

(In thousands, except share data)

	June 30, 2009 (Unaudited)		December 31, 2008
Assets
Current assets
Cash and cash equivalents	$	26,331	$	26,257
Short term investments	—		1,473
Accounts receivable, net	17,387		28,366
Inventories	2,352		1,230
Deferred customer support contract costs	42,875		43,674
Inventories shipped but not installed	5,871		10,235
Current deferred income taxes	1,417		1,417
Income tax receivable	280		14
Other current assets	367		219
Total current assets	96,880		112,885
Property and equipment, net	1,697		2,088
Goodwill	17,748		17,748
Finite life intangibles, net	2,545		2,900
Other assets	233		271
Total assets	$	119,103	$	135,892
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	12,165	$	23,377
Accrued commissions	1,085		1,328
Accrued sales and use tax	218		403
Accrued expenses, other	2,399		3,451
Sublease reserve current	299		311
Customer deposits	3,647		6,073
Deferred revenue from customer support contracts	55,415		56,915
Total current liabilities	75,228		91,858
Deferred rent	127		157
Deferred income tax liability	723		723
Sublease reserve non-current	491		635
Total liabilities	76,569		93,373
Stockholders’ equity
Common stock, $.001 par value, 50,000,000 shares authorized, 12,921,709 and 12,930,264 shares issued and outstanding as of June 30, 2009 and December 31, 2008, respectively	13		13
Additional paid in capital	40,472		40,144
Retained earnings	2,049		2,362
Total stockholders’ equity	42,534		42,519
Total liabilities and stockholders’ equity	$	119,103	$	135,892

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 June 30,				Six Months Ended June 30,
	2009		2008		2009			2008
Net sales:
Products	$	22,915	$	29,052	$	42,167		$	57,578
Services	20,782		20,655		41,398			39,854
	43,697		49,707		83,565			97,432
Cost of sales:
Cost of products	17,062		21,759		31,462			42,826
Cost of services	14,995		14,616		29,890			28,268
Total cost of sales	32,057		36,375		61,352			71,094
Gross profit	11,640		13,332		22,213			26,338
Operating expenses:
Sales and marketing	5,275		5,923		10,776			11,760
General and administrative	2,835		2,901		5,765			6,074
Engineering	2,970		2,807		5,790			5,965
Amortization of intangibles	177		177		355			355
	11,257		11,808		22,686			24,154
Earnings (loss) from operations	383		1,524		(473		)	2,184
Interest income, net	22		135		61			333
Earnings (loss) before income taxes	405		1,659		(412		)	2,517
Income tax expense (benefit)	122		680		(99		)	1,032
Net earnings (loss)	$	283	$	979	$	(313	)	$	1,485
Net earnings (loss) per common share:
Basic	$	0.02	$	0.08	$	(0.03	)	$	0.12
Diluted	0.02		0.08		(0.03		)	0.12
Weighted average common shares outstanding:
Basic	12,444		12,357		12,450			12,361
Diluted	12,514		12,519		12,450			12,482

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

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Datalink Corporation

Statements of Cash Flows

(In thousands)

(Unaudited)

	Three Months Ended June 30,
	2009			2008
Cash flows from operating activities:
Net earnings (loss)	$	(313	)	$	1,485
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
Provision for bad debts	9			82
Depreciation	421			488
Amortization of intangibles	355			355
Amortization of discount on short term investments	—			—
Deferred rent	(30		)	(40		)
Amortization of sublease reserve	(156		)	(169		)
Stock based compensation expense	506			466
Changes in operating assets and liabilities
Accounts receivable	10,970			8,800
Inventories	3,242			714
Deferred costs/revenues/customer deposits, net	(3,127		)	496
Accounts payable	(11,212		)	(8,234		)
Accrued expenses	(1,480		)	(1,211		)
Other	(376		)	27
Net cash provided by (used in) operating activities	(1,191		)	3,259
Cash flows from investing activities:
Proceeds from sale (purchase) of investments	1,473			2,477
Purchase of property and equipment	(30		)	(365		)
Net cash provided by investing activities	1,443			2,112
Cash flows from financing activities:
Excess tax from stock compensation	(108		)	18
Tax withholding payments reimbursed by restricted stock	(70		)	(68		)
Net cash used in financing activities	(178		)	(50		)
Increase in cash and cash equivalents	74			5,321
Cash and cash equivalents, beginning of period	26,257			22,687
Cash and cash equivalents, end of period	$	26,331		$	28,008
Supplementary cash flow information:
Cash paid for income taxes	273			—

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

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Datalink Corporation

Notes To Financial Statements

(Unaudited)

1.             Basis of Presentation

We have prepared the interim financial statements included in this Form 10-Q without 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 2008 Annual Report on Form 10-K.

The financial statements presented herein as of June 30, 2009, and for the three and six months ended June 30, 2009 and 2008, 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.

Based on internal reviews of our accounting policies and financial presentation, we have made a classification change relating to customer payments for orders that we have shipped but not installed.  At June 30, 2009 and December 31, 2008, respectively, we had customer payments for orders that we have shipped but not installed of $3.6 million and $6.1 million.  In the past we had included customer prepayments in accounts receivable.  Our new policy is to classify customer deposits as its own current liability.  Accordingly, we changed the previously reported December 31, 2008 balance sheet to reflect this reclassification.  This reclassification increased both current assets and current liabilities proportionally and therefore did not change our previously reported working capital.

We have evaluated the period after our balance sheet date through August 14, 2009, which is the date that we had financial statements available for issue, and determined that there were no subsequent events or transactions that required recognition or disclosure in our financial statements.

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 2008 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 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 (loss) per share:

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	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2009			2008			2009			2008
	(in thousands, except per share data)
Net earnings (loss)	$	283		$	979		$	(313	)	$	1,485
Basic:
Weighted average common shares outstanding	12,922			12,479			12,922			12,479
Weighted average common shares of non-vested stock	(478		)	(122		)	(472		)	(118		)
Shares used in the computation of basic net earnings (loss) per share	12,444			12,357			12,450			12,361
Net earnings (loss) per share — basic	$	0.02		$	0.08		$	(0.03	)	$	0.12
Diluted:
Shares used in the computation of basic net earnings (loss) per share	12,444			12,357			12,450			12,361
Employee and non-employee director stock options	42			109			—			85
Non-vested stock	28			53			—			36
Shares used in the computation of diluted net earnings (loss) per share	12,514			12,519			12,450			12,482
Net earnings (loss) per share - diluted	$	0.02		$	0.08		$	(0.03	)	$	0.12

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

	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Non-vested common stock	130,000	135,334	347,049	281,084
Options to purchase shares of common stock	752,353	527,205	837,079	554,155

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:

Total stock-based compensation expense related to non-vested stock was $147,000 and $153,000 for the three months ended June 30, 2009 and 2008, respectively.  Total stock-based compensation expense related to non-vested stock was $294,000 and $306,000 for the six months ended June 30, 2009 and 2008, respectively.

The following table summarizes our non-vested stock activity for the six months ended June 30, 2009:

	Number of Shares		WeightedAverage Grant-Date Fair Value
Non-vested stock at January 1, 2009	477,758		$	5.66
Granted	—		$	—
Cancelled	(18,667	)	3.61
Shares vested	(87,875	)	$	5.65
Non-vested stock at June 30, 2009	371,216		$	5.58

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Stock Options:

The following table represents stock option activity for the six months ended June 30, 2009:

	Number of Shares		WeightedAverage Exercise Price		WeightedAverage RemainingContract Life in Years
Outstanding options as of January 1, 2009	1,391,793		$	5.29
Options granted	—		$	—
Options exercised	—		$	—
Options cancelled	(21,814	)	$	5.04
Outstanding options as of June 30, 2009	1,369,979		$	5.29	4.03
Exercisable options as of June 30, 2009	1,165,979		5.53		2.71

Total stock-based compensation expense related to stock options was $64,000 and $66,000 for the three months ended June 30, 2009 and 2008, respectively.  Total stock-based compensation expense related to stock options was $129,000 for the six months ended June 30, 2009 and 2008.  Unrecognized stock-based compensation expense related to stock options was $407,000 at June 30, 2009 which we will amortize ratably through January 2011.

Other:

During the three months ended June 30, 2009 and 2008, we recognized expense of $45,000 and $27,000 related to the issuance of 10,500 and 5,791 shares of fully vested common stock to members of our Board of Directors.  During the six months ended June 30, 2009 and 2008, we recognized expense of $82,000 and $50,000 related to the issuance of 23,422 and 11,674 shares of fully vested common stock to members of our Board of Directors.

4.             Income Taxes

We base the provision for income taxes upon estimated annual effective tax rates in the tax jurisdictions in which we operate.  For the three months ended June 30, 2009 and 2008, the effective tax rate was 30% and 41%, respectively.  For the six months ended June 30, 2009 and 2008, the effective tax rate was 24% and 41%, respectively.  The lower tax rate for the three and six months ended June 30, 2009 as compared to the same periods in 2008  resulted primarily from an increase in stock-based compensation expense as a result of a shortfall recognized in excess of the APIC pool for incentive stock options and vested restricted stock under SFAS 123(R).  In accordance, with APB No. 28 and FIN 18, the impact of the shortfall was recorded as a discrete item and recognized in the current period.  At June 30, 2009, excluding the impact of discrete items, our estimated annual effective tax rate for 2009 is 51% compared to our annual effective tax rate for 2008 of 40%.

As part of the process of preparing financial statements, we estimate federal and state income taxes. Management estimates the actual current tax exposure together with assessing temporary differences resulting from different treatment for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which we include within our balance sheet. Management must then assess the likelihood that we will utilize deferred tax assets to offset future taxable income during the periods in which these temporary differences are deductible.  For the three months ended June 30, 2009, we recorded income tax expense of $122,000 with an effective tax rate of 30%.  In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 51%.

On January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”).  At the adoption date of January 1, 2007 and at June 30, 2009 and 2008, 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 June 30, 2009 and 2008, we had no accrued interest or penalties related to uncertain tax positions. The tax years 2005-2008 remain open to examination by both the Federal government and by other major income taxing jurisdictions to which we are subject.

5.             Goodwill

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), we are required to 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.

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Testing for goodwill impairment is a two step process. The first step screens for potential impairment and 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 June 30, 2009 and 2008, we determined that our goodwill was not impaired.

6.Valuation of Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), we are required to perform an impairment test for finite-lived assets and other long-lived assets, such as fixed assets, whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.  At each of June 30, 2009 and 2008, we determined that no triggering events had occurred during the quarter and our long-lived assets were not impaired.

7.Recently Issued Accounting Standards

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”). SFAS 165 establishes accounting and reporting standards for events that occur after the balance sheet date but before financial statements are issued or are available for issue. In addition, SFAS 165 requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date, that is, whether the selected date represents the date the entity issued its financial statements or had them available for issue. SFAS 165 became effective for fiscal years and interim periods ending after June 15, 2009. The adoption of SFAS 165 did not have a material impact on our financial statements.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 168”), which establishes the FASB Accounting Standards CodificationTM (“Codification”).  The Codification supersedes all existing accounting standard documents and will become the single source of authoritative non-governmental U.S. GAAP. All other accounting literature not included in the Codification will be considered non-authoritative. The Codification was implemented on July 1, 2009 and will be effective for interim and annual periods ending after September 15, 2009.  We expect to conform our financial statements and related notes to the new Codification for the quarter ending September 30, 2009.

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

OVERVIEW

We are an independent architect of enterprise-class information storage infrastructures. 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.  IDC estimates that digital information will occupy 988 billion gigabytes, by 2010.  As of June 30, 2009, we have 19 locations 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.  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 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

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installation and configuration services may also delay recognition of revenues.  Current economic conditions and competition also affect our customers’ decisions and timing to place orders with us and the size of those orders.  As a result, our net sales may fluctuate from quarter to quarter.

We view the current data 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:

·Investing in customer-facing teams to attract 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.

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

·Reducing our cost structure and realigning resources to improve efficiencies.

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

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

To pursue these strategies, we are:

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

·Focusing on corporate expense reductions.

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

·Meeting with potential acquisition candidates.

All of these plans have various challenges and risks associated with them, including that:

·The worldwide economic downturn adversely affects our customers’ buying patterns.

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

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

RESULTS OF OPERATIONS

We ended the second quarter of 2009 with a backlog of $28 million, which represents firm orders we expect to recognize as revenue in the next 90 days.  This compares to a backlog of $33 million as of December 31, 2008 and $29 million as of March 31, 2009.  In the current environment, we are seeing the negative impact of the worldwide economic downturn affect many of our customers, resulting in greater scrutiny given to storage spending projects and providing us with less visibility into their purchasing plans.  We have also had some customers decide to significantly delay the implementation of projects which they have already purchased and paid for.  We cannot predict what impact these economic uncertainties will have on our profitability going forward.

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009		2008
Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	73.4		73.2		73.4		73.0
Gross profit	26.6		26.8		26.6		27.0
Operating expenses:
Sales and marketing	12.0		11.9		12.9		12.1
General and administrative	6.5		5.8		6.9		6.2
Engineering	6.8		5.6		6.9		6.1
Amortization of intangibles	0.4		0.4		0.4		0.4
Total operating expenses	25.7		23.7		27.1		24.8
Earnings (loss) from operations	0.9	%	3.1	%	(0.5	)%	2.2	%

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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 EndedJune 30,						Six Months EndedJune 30,
	2009			2008			2009			2008
	(in thousands)
Product sales	$	22,915		$	29,052		$	42,167		$	57,578
Service sales	20,782			20,655			41,398			39,854
Product gross profit	$	5,853		$	7,293		$	10,705		$	14,752
Service gross profit	5,787			6,039			11,508			11,586
Product gross profit as a percentage of product sales	25.5		%	25.1		%	25.4		%	25.6		%
Service gross profit as a percentage of service sales	27.8		%	29.2		%	27.8		%	29.1		%

Net Sales.  Our total net sales decreased by $6.0 million for the three months ended June 30, 2009, or 12.1%, from $49.7 million for the comparable quarter in 2008.  Our total net sales decreased by $13.9 million for the six months ended June 30, 2009, or 14.2%, from $97.4 million for the comparable period in 2008.  Our product sales decreased $6.1 million, or 21.1%, to $22.9 million for the three months ended June 30, 2009, from $29.1 million for the comparable quarter in 2008.  Our product sales decreased $15.4 million for the six months ended June 30, 2009, or 26.8%, from $57.6 million for the comparable period in 2008.  Our service sales increased $127,000, or 6.1%, to $20.8 million for the three months ended June 30, 2009 from $20.7 million for the comparable quarter in 2008.  Our service sales increased $1.5 million, or 3.9%, to $41.4 million for the six months ended June 30, 2009 from $39.9 million for the comparable period in 2008.

The decline in our product revenues for the three and six months ended June 30,  2009, as compared to the same periods in 2008 reflects the continuing negative impact of the economic slowdown that many of our customers are experiencing.  We expect our product revenues will 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.

Our service sales increase for the three and six months ended June 30, 2009, as compared to the same periods in 2008 was due primarily to an increase in customer support contracts of $824,000 and $2.1 million, respectively.  We continue to benefit from sales of customer support contracts related to 2008 product sales, which are recognized over the contract term.  With the decrease in product revenues in late 2008 and into 2009, we cannot assure that our future service sales will not similarly decline.

We had no single customer account for 10% or greater of our revenues for either of the three or six months ended June 30, 2009 or 2008.

Gross Profit.  Our total gross profit as a percentage of net sales decreased to 26.6% for the quarter ended June 30, 2009, as compared to 26.8% for the comparable quarter in 2008.  Total gross profit as a percentage of net sales decreased to 26.6% for the period ended June 30, 2009, as compared to 27.0% for the comparable quarter in 2008.  Product gross profit as a percentage of product sales increased to 25.5% in the second quarter of 2009 from 25.1% for the comparable quarter in 2008.  Product gross profit as a percentage of product sales decreased to 25.4% for the six months ended June 30, 2009 from 25.6% for the comparable period in 2008.  Service gross profit as a percentage of service sales decreased to 27.8% for the second quarter of 2009 from 29.2% for the comparable quarter in 2008.  Service gross profit as a percentage of service sales decreased to 27.8% for the six months ended June 30, 2009 from 29.1% for the comparable period in 2008.

Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers.  Our product gross profit is also impacted by various vendor incentive programs that provide economic incentives for achieving various sales performance targets.  Vendor incentives were $436,000 and $237,000, respectively, for the three month periods ended June 30, 2009 and 2008.  Vendor incentives were $1.0 million and $1.1 million, respectively, for the six month periods ended June 30, 2009 and 2008.  Several of our vendors have also tightened eligibility for their programs in the current economic climate and may further change or terminate their programs at any time.  Accordingly, we cannot assure that we will achieve and receive similar vendor incentives in the future.  We estimate that our product gross margins for the remainder of 2009 will be approximately 24% to 25%.

Our service gross profit as a percentage of service sales for the three months ended June 30, 2009 decreased 1.4% as compared to the same period in 2008.  Our service gross profit as a percentage of services sales for the six months ended June 30, 2009 decreased 1.3%

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as compared to the same period in 2008.  The primary reason for the decrease in service gross profit as a percentage of service sales for both the three and six month periods ended June 30, 2009, as compared to the same periods in 2008, is a slight increase in the percentage of overall services delivered by our vendors which typically carries a lower margin.

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 $5.3 million, or 12.0% of net sales for the quarter ended June 30, 2009, compared to $5.9 million, or 11.9% of net sales for the second quarter in 2008.  Sales and marketing expenses totaled $10.8 million, or 12.9% of net sales for the six months ended June 30, 2009, compared to $11.8 million, or 12.1% of net sales for the comparable period in 2008.

Sales and marketing expenses decreased $648,000 and $984,000 for the three and six month periods ended June 30, 2009, as compared to the same periods in 2008.  With our decline in overall revenue for both the three and six month periods ending June 30, 2009, as compared to the same periods in 2008, we had a decrease in variable compensation for commissions.

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 6.5% of net sales for the quarter ended June 30, 2009, compared to $2.9 million, or 5.8% of net sales for the second quarter in 2008.  General and administrative expenses were $5.8 million, or 6.9% of net sales for the six months ended June 30, 2009, compared to $6.1 million or 6.2% of net sales for the comparable period in 2008.

General and administrative expenses decreased $66,000 for the three months ended June 30, 2009, as compared to the same period in 2008.  We attribute this primarily to a decrease in travel and entertainment expense of $70,000 due to our cost reduction initiatives.  General and administrative expenses decreased $309,000 for the six months ended June 30, 2009, as compared to the same period in 2008.  We attribute this primarily to the cancellation of our annual sales meeting resulting in savings of $205,000 and a decrease in training expenses of $130,000.

Engineering.  Engineering expenses include employee wages, bonuses and travel, hiring and training expenses for our field and customer support engineers and technicians.  Engineering expenses were $3.0 million, or 6.8% of net sales for the quarter ended June 30, 2009, compared to $2.8 million, or 5.6% of net sales for the second quarter in 2008.  Engineering expenses were $5.8 million, or 6.9% of net sales for the six months ended June 30, 2009, compared to $6.0 million, or 6.1% of net sales for the comparable period in 2008.

Engineering expenses increased $163,000 for the three months ended June 30, 2009, as compared to the same period in 2008.  This is primarily due to a decrease in our allocation of engineering costs associated with installation and configuration services and with consulting services to our cost of service sales of $532,000.  This was offset by a decrease in travel and entertainment expense of $129,000 and variable compensation expense of $29,000.  Engineering expenses decreased $175,000 for the six months ended June 30, 2009, as compared to the same period in 2008.  This is primarily due to a decrease in travel and entertainment expense of $194,000.

Amortization of Intangibles.  We had $178,000 of intangible asset amortization expenses for each of the three month periods ended June 30, 2009 and 2008.  We had $355,000 of intangible asset amortization for each of the six month periods ended June 30, 2009 and 2008.  The identifiable intangible asset and subsequent amortization is due to our acquisition of MCSI on January 31, 2007.

Earnings (Loss) from Operations.  We had earnings from operations of $383,000 for the three months ended June 30, 2009 and earnings from operations of $1.5 million for the three months ended June 30, 2008.  The second quarter 2009 and 2008 earnings from operation are a result of higher revenues and margins with a decrease in operating expenses for 2009 and a limited increase in operating expenses for 2008.  We had a loss from operations of $473,000 for the six months ended June 30, 2009 and earnings from operations of $2.2 million for the six months ended June 30, 2008.  The loss from operations for the six month period ended June 30, 2009 is a result of a decrease in our revenues and margins due to the current economic downturn.  The earnings from operations for the six month period ended June 30, 2008 is a result of higher revenues and margins with a limited increase in operating expenses.

Income Taxes.  We had income tax expense of $122,000 and $680,000 for the three months ended June 30, 2009 and 2008, respectively.  We had income tax benefit of $99,000 for the six months ended June 30, 2009 and income tax expense of $1.0 million for the six months ended June 30, 2009.  Our estimated effective tax rate for the second quarter of 2009 is 30%.  Our estimated effective tax rate for 2008 was 40%.  In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate of approximately 51%.

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LIQUIDITY AND CAPITAL RESOURCES

Net cash used by operating activities was $1.2 million for the six months ended June 30, 2009 as compared to net cash provided by operating activities of $3.3 million for the six months ended June 30, 2008.  Significant items which impacted our operating cash flows as of June 30, 2009 were:

·A net loss of $313,000.

·A decrease in accrued expenses primarily related to variable compensation of $1.5 million.

Net cash provided by investing activities was $1.4 million for the six months ended June 30, 2009.  Net cash provided by investing activities was $2.1 million for the six months ended June 30, 2008.  This cash was primarily provided by the sale of short-term investments for both 2009 and 2008.  We are planning for $150,000 of capital expenditures for the remainder of 2009 related primarily to computer and communication system upgrades or other management information system enhancements.

Net cash used in financing activities was $178,000 for the six months ended June 30, 2009, from tax withholding payments reimbursed by restricted stock and a tax adjustment for stock based compensation. Net cash used in financing activities was $50,000 for the six months ended June 30, 2008, from tax withholding payments reimbursed by restricted stock.

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.

Our contractual cash obligations consist of future minimum lease payments due under non-cancelable operating leases.  These obligations are for the last six months of 2009 and each of the full years thereafter as follows:

	(in thousands)
	LeaseObligations		SubleaseAgreements			Net LeaseObligations
2009	$	907	$	(384	)	$	523
2010	1,674		(752		)	922
2011	1,596		(719		)	877
2012	592		(239		)	353
Thereafter	—		—			—
	$	4,769	$	(2,094	)	$	2,675

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 June 30, 2009.  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”).

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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.

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.

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

Valuation of Goodwill.  We test goodwill for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests an impairment exists. Testing for goodwill impairment is a two step process. The first step screens for potential impairment and 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.  With the worldwide decline in stock prices, the potential for this is increased.  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.

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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.  The downturn in the U.S. economy makes it increasingly difficult for us to accurately predict our future cash flows.  To the extent our 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.

Stock-Based Compensation.  We adopted the provisions of FASB No. 123R, Share Based Payment on January 1, 2006. SFAS 123(R) 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.  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.

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

Interest Rate Risk.  As of June 30, 2009, we had $26.3 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 operation 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 Commission (“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.

We are involved in certain legal actions, all of which have arisen in the ordinary course of business.  Management believes that the ultimate resolution of such matters is unlikely to have a material adverse effect on our consolidated results of operation and/or financial condition.

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, 2008.

Dependence on Significant Customers.  We had no single customer account for 10% or greater of our revenues for the three or six months ended June 30, 2009 and 2008, respectively.

Our Profitability Depends in Part on Vendor Incentive Programs.  Several of our key vendors regularly provide us with economic incentives for achieving various sales performance targets on their product.  The vendors may terminate or change these programs at any time.  We cannot assure that these vendor incentive programs will continue to provide us with rebates at current levels, or at all.  To the extent that we do not qualify for vendor incentives, or they are cut back, our profitability may suffer.

Effect of Recession on Data Storage Spending.  Initially in response to credit risks in the subprime mortgage marketplace, lenders 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.  In addition, the general downturn in consumer spending associated with the current recession affects adversely the decisions of our customers as to capital spending projects, including for data storage.

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.

At the Annual Meeting of Shareholders held on May 13, 2009, our shareholders elected Brent G. Blackey, Paul F. Lidsky, Margaret A. Loftus, Greg R. Meland, J. Patrick O’Halloran, James E. Ousley, Robert M. Price and Charles B. Westling as directors with the following votes:

	For	Withheld
Brent G. Blackey	9,848,215	1,409,000
Paul F. Lidsky	10,216,227	1,040,988
Margaret A. Loftus	9,654,646	1,602,569
Greg R. Meland	9,532,354	1,724,861
J. Patrick O’Halloran	10,258,727	998,488
James E. Ousley	9,346,572	1,910,643
Robert M. Price	7,936,381	3,320,834
Charles B. Westling	10,025,919	1,231,296

Item 5.  Other Information

None

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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:   August 14, 2009	Datalink Corporation
	By:	/s/ Gregory T. Barnum
		Gregory T. Barnum, Vice President Finance and Chief Financial Officer

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