<PAGE> 1
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: March 31, 1999
or
[ ] 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: 00114367
DATALINK CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-0856543
(State or other jurisdiction) (IRS Employer
of Incorporation) Identification Number)
7423 WASHINGTON AVENUE SOUTH
MINNEAPOLIS, MN 55439
(Address of Principal Executive Offices)
(612) 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 No X
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APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 8,772,537 shares as of
November 16, 1999.
EXPLANATORY NOTE
This Form 10-Q relates to quarterly periods prior to consummation of
Datalink Corporation's initial public offering. Datalink is filing this report
solely because Datalink's registration statement of Form 8-A under the
Securities Exchange Act of 1934, as amended, became effective on August 4, 1998,
sixty days after its initial filing.
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, which reflect the Company's views with
respect to 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
Company's dependence on supplier relationships, competition in the market for
open systems storage, competitive pricing pressures, dependence of the Company
on key personnel, possible strain placed on the Company's resources by growth
and expansion, the Company's reliance of its suppliers to meet the needs of
rapid technological change, risks associated with possible future acquisitions,
fluctuations in quarterly operating results, risk associated with the Company's
use of proceeds from its initial public offering, the possibility of denial of
the Company's prior S corporation status by the Internal Revenue Service for any
or all of the periods during which the Company claimed such status and the
consequent tax burden on its income and the impact of Year 2000 issues on the
Company and its operations.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
The following financial statements and information contained in Amendment
No. 4 to the Registration Statement on Form S-1 filed with the Securities and
Exchange Commission on June 15, 1999, SEC File No. 333-55935 (the "S-1
Amendment"), for Datalink Corporation are incorporated herein by reference:
-- the "Consolidated Balance Sheets" on page F-6, excluding the information
under the column "1997";
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<PAGE> 3
-- the columns labeled "Three Months Ended March 31, 1998 and 1999" on page
F-7 entitled "Consolidated Statements of Operations;"
-- the columns labeled "Three Months Ended March 31, 1998 and 1999" on page
F-9 entitled "Consolidated Statements of Cash Flows" and
-- the "Notes to Consolidated Financial Statements" beginning on page F-10
and continuing through and including page F-19.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The information contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section of the S-1 Amendment is
incorporated herein by reference except for (i) the 1998, 1997 and 1996
full-year information under the caption "Results of Operations" and (ii) the
information under the caption "Comparison of Years Ended December 31, 1998, 1997
and 1996." References to the "offering" mean Datalink's initial public offering
of its Common Stock.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
As of the date hereof, the Company is not involved in any material
legal proceedings.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted during the first quarter of the Company's
1999 fiscal year to a vote of security holders, through the solicitation of
proxies or otherwise.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
27.1 - Financial Data Schedule (Edgar filing only)
99.1 - Pages of the S-1 Amendment (deemed to be filed only to the
extent as incorporated by reference into this report above).
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(b) Reports on Form 8-K: The Company did not file any current reports on
Form 8-K during the first three months of the Company 1999 fiscal year.
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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.
DATALINK CORPORATION
By /s/ Daniel J. Kinsella
-------------------------------------------
Daniel J. Kinsella, Chief Financial Officer
Date: November 16, 1999
-5-
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 587,983
<SECURITIES> 0
<RECEIVABLES> 17,052,627
<ALLOWANCES> 234,214
<INVENTORY> 6,821,578
<CURRENT-ASSETS> 24,597,040
<PP&E> 3,888,257
<DEPRECIATION> 1,470,521
<TOTAL-ASSETS> 31,089,806
<CURRENT-LIABILITIES> 18,603,749
<BONDS> 0
20,476,156
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 31,089,806
<SALES> 25,682,293
<TOTAL-REVENUES> 25,682,293
<CGS> 19,071,452
<TOTAL-COSTS> 4,800,048
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 73,880
<INCOME-PRETAX> 1,736,913
<INCOME-TAX> (556,093)
<INCOME-CONTINUING> 2,293,006
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,293,006
<EPS-BASIC> 0.34
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<PAGE> 1
EXHIBIT 99.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements, including the Notes thereto, and the other
information included herein. The following information also includes
forward-looking statements, the realization of which may be impacted by certain
important factors discussed under "Risk Factors."
OVERVIEW
Datalink analyzes, custom designs, integrates or assembles, installs and
supports high-end Open Systems storage solutions using products and
subassemblies manufactured by various suppliers in order to meet its customers'
requirements. The Company has developed engineering, sales and support
capabilities to become an expert in applying the best available storage
technologies manufactured by the leading data storage hardware and software
companies to solve its customers' growing data storage needs. These technologies
include SAN, NAS, RAID, hard disk, magnetic tape, CD-ROM and optical products.
The Company also incorporates storage management software technologies,
including backup and recovery, disaster recovery, HSM, archive, management and
configuration, high availability and media management products, to meet the
specific needs of its customers. The Company's net sales and net income have
grown at a compound annual rate of 28% and 34%, respectively, over the five year
period ended December 31, 1998.
The Company was founded in 1963 as Stan Clothier Co., Inc. and operated as
a manufacturer's representative for technology products and components. In 1987,
the Company was renamed Datalink Corporation to reflect the Company's transition
to a distributor of data storage products. Beginning with the hiring of Greg R.
Meland in 1991, the current management team recognized that rapid and complex
changes in data storage technology would lead businesses and organizations
increasingly to seek external expertise to address their data storage needs.
Accordingly, the Company made the strategic decision to focus on providing its
customers with complete data storage solutions encompassing the best technology
available. By developing engineering expertise and high quality customer service
and support, Datalink became a leader in providing data storage solutions.
Datalink's customers include end-users, VARs and OEMs. The Company works
closely with end-users and VARs to assess their informational storage and
retrieval requirements and to design, integrate, install and support information
storage solutions incorporating the best hardware and software products on the
market. For OEM customers, the Company's team of design and application
engineers custom design storage subsystems, which are integrated into the OEM's
own products. In general, the Company realizes higher gross margins on net sales
to end-users and OEMs based on the high value-added nature of such sales.
Datalink sells its products through its direct sales force located in
Minneapolis and 19 field offices. The Company has continued to grow its sales
force through the DCSI acquisition and opening new sales office locations in
anticipation of increased demand for the Company's products and services. The
Company selects new sales office locations based upon perceived demand for the
Company's products and services. Datalink has experienced, and expects to
continue to experience, an increase in sales and marketing expenses
disproportionate to the increase of net sales in connection with the opening of
new sales offices. This is due primarily to the lead time, six months or longer,
generally associated with generating business in the new territory.
As part of its business strategy, in July 1998, the Company acquired DCSI,
a Marietta, Georgia-based firm engaged in the analysis, custom design,
integration and support of high-end Open Systems data solutions principally for
end users in the southeastern United States. DCSI's net sales for 1997 were
$11.8 million.
As an independent storage solutions provider, Datalink updates its product
offerings to incorporate advancements by its suppliers of hardware and software
technology. Although the Company often has advance knowledge of forthcoming
product releases because of its close working relationship with its suppliers,
the impact of these advancements on the Company's results of operations are
often difficult to predict. The Company's customers may delay purchases upon
learning of actual or rumored new product introductions. In addition, changes in
technology may significantly affect the pricing or profitability of products.
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<PAGE> 2
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain selected
financial data expressed as a percentage of net sales.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
----------------------------- -----------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales....................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................................... 78.4 78.2 74.8 76.6 74.3
----- ----- ----- ----- -----
Gross profit.................................. 21.6 21.8 25.2 23.4 25.7
----- ----- ----- ----- -----
Operating expenses:
Sales and marketing........................... 6.6 7.3 8.8 8.6 8.4
General and administrative.................... 4.4 4.2 6.1 5.8 6.5
Engineering................................... 1.2 1.3 1.6 1.9 3.0
Offering costs................................ 0.8 0.7
----- ----- ----- ----- -----
Total operating expenses................... 12.2 12.8 17.3 16.3 18.6
----- ----- ----- ----- -----
Operating income................................ 9.4% 9.0% 7.9% 7.1% 7.1%
===== ===== ===== ===== =====
</TABLE>
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 AND 1998
Net Sales. Net sales include sales of products and software integrated for
end-user and VAR customers, products assembled by the Company for OEM customers
and revenues from billable installation, repair and maintenance services.
Datalink recognizes product revenues as its products are shipped or following
customer acceptance for products under evaluation. Net sales increased $9.1
million, or 54.7%, to $25.7 million for the three months ended March 31, 1999,
from $16.6 million for the comparable period in 1998. The increased sales are
primarily attributable to the July 1998 acquisition of DCSI, the hiring of
DCSI's and other new sales and engineering personnel and the opening of new
sales offices. Additionally, the higher sales reflect the increasing demand for
more complex data storage products, which has resulted in higher equipment,
software and services revenues.
Gross Profit. Gross profit as a percentage of net sales increased to 25.7%
for the three months ended March 31, 1999, from 23.4% for the comparable period
in 1998. This increase was principally attributable to the Company's increased
percentage of sales of large, sophisticated storage systems to end-user
customers which typically have generated higher margins than sales to VAR and
OEM customers.
Sales and Marketing. Sales and marketing expenses include wages and
commissions paid to the Company's sales and marketing personnel, travel and
entertainment costs and advertising, promotion and trade show expenses. Sales
and marketing expenses totalled 8.4% of net sales for the three months ended
March 31, 1999, compared to 8.6% of net sales for the comparable period in 1998.
The Company has hired new sales and marketing personnel in addition to absorbing
the incremental costs related to the operations of DCSI. Approximately 70% of
sales and marketing costs are directly variable with sales. These variable costs
have remained relatively constant as a percentage of net sales between the two
periods. Additionally, the Company has increased net sales at a rate slightly
greater than the growth in fixed sales and marketing expense.
General and Administrative. General and administrative expenses include
wages for administrative personnel, profit sharing contributions, professional
fees, communication expenses and rent and related facility expenses. General and
administrative expenses were 6.5% of net sales for the three months ended March
31,
20
<PAGE> 3
1999, compared to 5.8% of net sales for the comparable period in 1998. Of the
increased general and administrative expenses, approximately $193,000 or 0.8% of
net sales for the three months ended March 31, 1999 was amortization of
identifiable assets and goodwill related to the Company's acquisition of DCSI.
Depreciation expense related to the Company's new information systems
implemented in late 1998 increased significantly from the comparable period in
1998. In addition, rent expense increased relative to the comparable period in
1998 due primarily to the acquisition of DCSI and the opening of additional
sales offices. Profit sharing expense also increased relative to the comparable
period in 1998.
Engineering. Engineering expenses include employee wages, travel and
training expenses for the Company's professional engineers and technicians and
professional fees to obtain various independent laboratory certifications of
storage subsystems designed by the Company for OEM customers. Engineering
expenses increased to 3.0% of net sales for the three months ended March 31,
1999, compared to 1.9% of net sales for the comparable period in 1998. The
Company has continued to add new engineering personnel and has increased the
compensation levels for its engineers in order to more effectively compete for
engineering human resources. Additionally, the Company's costs for engineering
travel have increased as sales have increased.
Offering Costs. The Company incurred approximately $173,000 of expenses in
the first quarter of 1999 in conjunction with the Company's contemplated initial
public offering. As required, these costs were expensed in the first quarter
when a determination was made that the offering would be delayed more than 90
days.
Operating Income. Operating income totaled 7.1% of net sales for the three
months ended March 31, 1999 and 1998. The Company's operating income as a
percentage of net sales in the 1999 period would have been 7.7% if the expenses
related to offering costs were excluded. The higher gross profit margin in 1999
was offset by increased engineering and general and administrative costs. The
Company expects gross profit margins may increase further as the Company
increasingly sells complex data storage solutions to end-user customers.
However, improved gross profit margins may be offset by higher costs to develop,
implement and support these high-end data storage solutions.
Income Taxes. In January 1999, DCSI was merged into Datalink, an S
corporation. Until its merger into Datalink, DCSI was a C corporation and
accordingly its income was subject to U.S. and state income taxes. Beginning
with the merger of DCSI into Datalink, the taxable income is reported as part of
the Company's S Corporation taxable income. Accordingly, the Company eliminated
DCSI's net deferred income tax liabilities of $580,000 which, net of a current
income tax provision of $24,000, resulted in a net income tax benefit of
$556,000 for the three month period ended March 31, 1999. Most of this income
tax benefit will be reversed upon the completion of the offering because the
Company will lose its S Corporation status and accordingly, will need to
establish its deferred tax assets and liabilities.
COMPARISON OF YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Net Sales. Net sales increased 23.4% to $88.0 million in 1998 and increased
30.4% to $71.3 million in 1997. Net sales were $54.7 million in 1996. These
increases were principally attributable to an increase in sales of large RAID
and tape backup storage systems to end-user customers. The increase in sales in
1998 was also attributable to the July 1998 acquisition of DCSI, the hiring of
DCSI's and other new sales and engineering personnel and the opening of new
sales offices.
Gross Profit. Gross profit as a percentage of net sales increased to 25.2%
in 1998 from 21.8% in 1997 and 21.6% in 1996. These increases were primarily due
to the Company's increasing sales of large storage systems to end-user customers
which typically have generated higher margins than sales to VAR and OEM
customers.
Sales and Marketing. Sales and marketing expenses increased 49.4% to $7.8
million in 1998 and increased 43.9% to $5.2 million in 1997. Sales and marketing
expenses were $3.6 million in 1996. As a percentage of net sales, sales and
marketing expenses were 8.8% in 1998, 7.3% in 1997 and 6.6% in 1996. The
increases as a percentage of net sales over these years were principally
attributable to an increase in commissions paid to the Company's sales
representatives on large storage system sales to end-user customers
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<PAGE> 4
and to the hiring of new sales representatives in anticipation of future growth.
In addition, during 1998, the Company absorbed the incremental costs related to
the operations of DCSI.
General and Administrative. General and administrative expenses increased
79.5% to $5.4 million in 1998 compared to 1997 and increased 26.4% to $3.0
million in 1997 compared to $2.4 million in 1996. As a percentage of net sales,
general and administrative expenses were 6.1% in 1998, 4.2% in 1997 and 4.4% in
1996. The dollar increase in general and administrative expenses was primarily
attributable to increases in administrative personnel and related expenses. In
1998, the Company also incurred $376,000 of amortization expense due to the
amortization of identifiable assets and goodwill resulting from the July 1998
acquisition of DCSI.
Engineering. Engineering expenses increased 47.1% to $1.4 million in 1998
as compared to 1997 and increased 46.3% to $926,000 in 1997 as compared to
$633,000 in 1996. Engineering expenses as a percentage of net sales were 1.6% in
1998, 1.3% in 1997 and 1.2% in 1996. The dollar increase over these years was
primarily attributable to the addition of new engineering personnel and
increased travel expenses.
Offering Costs. The Company incurred approximately $733,000 of expenses in
1998 in conjunction with the Company's contemplated initial public offering. As
required, these previously deferred costs were expensed in 1998 when a
determination was made that the offering would be delayed more than 90 days.
Operating Income. Operating income increased 8.6% to $7.0 million in 1998
as compared to 1997 and 24.3% to $6.4 million in 1997 as compared to $5.2
million in 1996. As a percentage of net sales, operating income was 7.9% in
1998, 9.0% in 1997 and 9.4% in 1996. The decrease in operating income as a
percentage of net sales in 1998 was principally attributable to the investment
in sales and marketing expenses in anticipation of future sales growth, offering
costs related to the Company's delayed initial public offering and amortization
expenses related to the DCSI acquisition. The increase in operating income as a
percentage of net sales in 1996 was principally attributable to the significant
increase in net sales.
QUARTERLY RESULTS AND SEASONALITY
The following table sets forth certain unaudited quarterly financial data
of the Company for each quarter of 1996, 1997 and 1998 and the first quarter of
1999. In the opinion of the Company's management, this unaudited information has
been prepared on the same basis as the audited information and includes all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the information set forth therein. The operating results for any
quarter are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------------------------------------------------------------
1996 1997 1998
----------------------------------------- ----------------------------------------- -------------------
MAR. 31 JUN. 30 SEP. 30 DEC. 31 MAR. 31 JUN. 30 SEP. 30 DEC. 31 MAR. 31 JUN. 30
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............ $10,842 $12,686 $13,871 $17,253 $15,266 $15,999 $19,269 $20,721 $16,599 $20,028
Gross profit......... 2,190 2,784 3,033 3,773 3,260 3,543 4,044 4,689 3,876 5,107
Operating income..... 834 1,351 1,141 1,832 1,077 1,660 1,586 2,085 1,173 2,351
Net income........... 771 1,271 1,075 1,755 1,004 1,567 1,489 2,016 1,118 2,301
<CAPTION>
QUARTER ENDED
------------------------------
1998 1999
------------------- --------
SEP. 30 DEC. 31 MAR. 31
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Net sales............ $23,485 $27,840 $25,682
Gross profit......... 6,000 7,229 6,611
Operating income..... 1,622 1,814 1,811
Net income........... 1,265 1,847 2,293
</TABLE>
The Company has experienced and expects to continue to experience quarterly
variations in its net sales as a result of a number of factors including, among
other things, the length of the sales cycle with end-user customers for large
storage system evaluations and purchases, the significant lead time in designing
storage subsystems for OEM customers, new product introductions by suppliers and
the market acceptance thereof, delays in product shipments or other quality
control difficulties, the ability of Datalink to integrate any acquired
businesses, product returns, trends in the Open Systems storage industry in
general, the geographic and industry specific market in which Datalink is
presently active, or may be in the future, and the opening of new field sales
offices. Net sales also tend to be lower in the summer months and higher in the
quarter ending December 31 reflecting the timing of purchase decisions by the
Company's customers.
22
<PAGE> 5
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations and capital
requirements through cash flows generated from operations and supplemental bank
borrowings. Working capital was $6.0 million, $6.8 million and $6.7 million at
March 31, 1999 and December 31, 1998 and 1997, respectively. The Company's
current ratio was 1.3, 1.4 and 1.6 at March 31, 1999 and December 31, 1998 and
1997, respectively.
Cash used in operating activities was $5.1 million for the three months
ended March 31, 1999. The use of cash in operating activities was primarily due
to the timing of payments to vendors at calendar year end which resulted in an
unusually high level of accounts payable at December 31, 1998. Cash used in
investing activities was $160,000 for the three months ended March 31, 1999
resulting primarily from the Company's purchases of new computer equipment. Cash
provided by financing activities was $3.1 million for the three months ended
March 31, 1999 generated primarily from borrowings under the Credit Agreement,
offset by $1.0 million of dividends paid to the stockholders primarily to
provide liquidity to pay their income tax liabilities resulting from the
Company's S corporation taxable income.
Cash provided by operating activities for 1998, 1997 and 1996 was $11.5
million, $4.6 million and $2.5 million, respectively, reflecting the Company's
increasing sales and net income. Cash used in investing activities during 1998,
1997 and 1996 was $4.2 million, $766,000 and $337,000, respectively. These uses
reflected $3.1 million applied to acquire the net assets in the DCSI
transaction, expenditures for computer and office equipment and improvements to
support increasing sales volumes, including the opening of new field sales
offices. Cash used in financing activities in 1998, 1997 and 1996 was $5.6
million, $2.8 million and $2.0 million, respectively. These uses of cash relate
primarily to net repayments of borrowings under the Credit Agreement and to
dividends paid to the stockholders. These dividends totaled $3.9 million, $4.0
million and $1.9 million in 1998, 1997 and 1996, respectively, and were
distributed to the stockholders primarily to provide liquidity to pay their
income tax liabilities resulting from the Company's S corporation taxable
income.
At March 31, 1999, the Company's borrowings consisted of $5.6 million owed
under the Credit Agreement. The Credit Agreement permits the Company to borrow
up to $10.0 million on a revolving basis with borrowings limited by eligible
accounts receivable and inventories. The Company intends to use a portion of the
net proceeds of this offering to repay all borrowings under the Credit
Agreement.
Effective February 28, 1999, the Company redeemed 1,095,720 shares held by
a former stockholder and issued a $3.0 million note payable in four installments
through February 2002. See Note 9 of the Notes to the Company's Consolidated
Financial Statements.
The Company plans to use a portion of the net proceeds of this offering to
fund the final S corporation distribution to the current stockholders. This
distribution will constitute all of the previously taxed, but undistributed, S
corporation earnings. As of March 31, 1999, such earnings were estimated at
approximately $10.7 million. The actual amount of the distribution will be
adjusted to reflect the taxable income and any stockholder distributions from
April 1, 1999 through the termination of the S corporation status upon the
closing of this offering.
The Company believes that funds generated from operations, together with
the net proceeds of this offering and available credit under its Credit
Agreement will be sufficient to finance its current operations and planned
capital expenditure requirements for at least the next twelve months.
Inflation. The Company does not believe that inflation has had a material
effect on its results of operations in recent years; however, there can be no
assurance that the Company's business will not be adversely affected by
inflation in the future.
Year 2000 Disclosure. Many currently installed computer systems and
software products are dependent upon internal calendars coded to accept only two
digit entries in the date code field. In order to distinguish 21st century dates
from 20th century dates, computer systems and software products must accept four
digit entries in the date code field. As a result, computer systems and software
used by many companies may need to be upgraded to comply with Year 2000
requirements.
23
<PAGE> 6
The Company believes that all of its financial reporting and resource
planning systems are Year 2000 compliant except for its property and equipment
accounting software which the Company plans to replace during 1999 at a cost of
less than $5,000. The Company has recently installed a new primary financial
reporting software which has been certified Year 2000 compliant by its vendor.
Effective January 1, 1999, the Company transitioned all DCSI accounting and
reporting to the Company's systems. The Company's other software is generally
certified by the vendors to be Year 2000 compliant or is not considered critical
to the Company's operations.
External professionals and internal information systems and engineering
personnel have assessed the Company's internal-use computer software and
equipment. Generally, the Company believes that its internal use computer
equipment is Year 2000 compliant and its internal-use software, principally its
operating system, networking software, office application suite and electronic
mail applications have been certified by the vendors to be Year 2000 compliant,
or updates for Year 2000 readiness have been made available by the vendors for
downloading over the Internet. In such instances, the Company plans to use its
internal information systems and engineering personnel to complete Year 2000
readiness downloads during 1999. The Company does not expect to incur any
material costs in completing these efforts.
The Company's operations are not dependent on any form of electronic data
interchange with its customers or vendors, other than the cash balance reporting
system made available to the Company by its bank. The Company's bank has
certified that its systems have the ability to process dates beyond the Year
2000.
The Company has completed an assessment of the Year 2000 compliance of its
vendors' products. The Company has surveyed each of its major vendors and, as
part of its ongoing quality efforts, has obtained a "statement of Year 2000
compliance" from virtually all of its current storage equipment and software
vendors. Accordingly, the Company believes that all of its current vendors
supply Year 2000 compliant products for installation at customer sites. The
Company requires such a statement of compliance before installing any vendor's
equipment or software at a customer site. Although the Company has no written
assurance from its vendors and provides no assurance to its customers about the
Year 2000 readiness of products installed prior to obtaining such statements of
compliance, all of the Company's standard sales agreements explicitly indicate
that the Company is not the original equipment manufacturer nor the software
developer/manufacturer of the equipment and software installed at customer
sites. Terms of the Company's current standard sales agreements explicitly state
that the Company is not responsible for the Year 2000 compliance of the
equipment and software installed at customer sites.
If any products or subassemblies sold by the Company to its customers were
to fail, the Company could be liable to its customers for damages and costs to
the extent that the Company's vendors do not cover such liabilities. In
addition, if the Company fails to complete its Year 2000 readiness efforts for
its internal use systems or if any of its customers or vendors fail to complete
any required Year 2000 remediation of their systems, the Company could suffer
delays in product delivery or experience delays in customer payments. Any such
product or system failures could have a material adverse effect on the Company's
financial condition, results of operations or liquidity.
At this time, the Company believes it is unnecessary to adopt a contingency
plan covering the possibility that the Company's computer systems, or those of
its vendors or customers, will not be at an adequate stage of Year 2000
readiness by the end of 1999. However, as part of its Year 2000 readiness
efforts, the Company will continue to consider the need for a contingency plan
based on the Company's periodic evaluation of target dates for completion of its
readiness efforts.
Recently Issued Accounting Standards. Effective with its year end 1998
financial statements, the Company adopted Statement of Financial Accounting
Standard No. 131 (SFAS No. 131), "Disclosure About Segments of an Enterprise and
Related Information," which requires disclosure of segment data in a manner
consistent with that used by an enterprise for internal management reporting and
decision making. The Company reports its operations as a single segment under
SFAS No. 131.
24
<PAGE> 7
Effective with its year end 1998 financial statements, the Company adopted
SFAS No. 130, "Reporting Comprehensive Income," which established standards for
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. The Company's comprehensive income is
equal to its net income for all periods presented.
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" ("SOP No. 98-1"). SOP
No. 98-1 requires entities to capitalize certain costs related to internal-use
software once certain criteria have been met. The Company adopted SOP 98-1
beginning on January 1, 1999. The adoption did not have a material impact on the
Company's financial position or results of operations.
In December 1998, the AICPA issued SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions" ("SOP
98-9"). SOP 98-9 amends SOP 97-2 and SOP 98-4 by extending the deferral of the
application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal
years beginning on or before March 15, 1999. All other provisions of SOP 98-9
are effective for transactions entered into in fiscal years beginning after
March 15, 1999. The Company has not had significant software sales to date and
management does not expect the adoption of SOP 98-9 to have a significant effect
on its financial condition or results of operations.
25
<PAGE> 8
DATALINK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, 1999
---------------------------------------------------------
PRO FORMA ADJUSTMENTS
-----------------------------
TERMINATION TERMINATION OF
DECEMBER 31, OF S CORPORATION
------------------------- PUT OPTIONS STATUS PRO FORMA
1997 1998 ACTUAL (NOTE 3) (NOTE 3) (NOTE 3)
---- ---- ------ ----------- -------------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash............................... $ 1,163,107 $ 2,797,724 $ 587,983 $ 587,983
Accounts receivable, net........... 11,280,738 15,629,960 16,818,413 16,818,413
Inventories........................ 4,661,378 6,694,870 6,821,578 6,821,578
Other current assets............... 78,705 263,103 369,066 369,066
Deferred income taxes.............. 22,087 $ 436,274 436,274
----------- ----------- ----------- ----------- -----------
Total current assets............. 17,183,928 25,407,744 24,597,040 436,274 25,033,314
Property and equipment, net.......... 1,478,122 2,466,946 2,417,736 2,417,736
Intangibles, net..................... 4,219,584 4,026,950 4,026,950
Other................................ 42,503 49,603 48,080 48,080
----------- ----------- ----------- ----------- -----------
Total assets..................... $18,704,553 $32,143,877 $31,089,806 $ 436,274 $31,526,080
=========== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIENCY)
Current liabilities:
Book cash overdraft................ 1,641,548 1,641,548
Line of credit..................... 3,935,417 3,210,355 5,649,852 5,649,852
Accounts payable................... 4,928,617 13,253,656 8,024,952 8,024,952
Accrued expenses................... 1,493,317 2,186,972 1,605,037 1,605,037
Note payable to former stockholder,
current portion.................. 1,610,621 1,610,621
Capital lease obligation, current
portion.......................... 13,876 13,876 13,876
Deferred compensation, current
portion.......................... 65,242 66,339 57,863 57,863
Distribution payable to
stockholders..................... 10,734,907 10,734,907
----------- ----------- ----------- ------------ ----------- -----------
Total current liabilities........ 10,422,593 18,731,198 18,603,749 10,734,907 29,338,656
Note payable to former stockholder,
less current portion............... 1,409,293 1,409,293
Capital lease obligation, less
current portion.................... 12,502 12,502 12,502
Deferred compensation, less current
portion............................ 151,697 79,621 70,613 70,613
Deferred income taxes................ 601,739 806,221 806,221
Commitments and contingencies
Common stock, subject to put option;
$0.001 par value, 50,000,000 shares
authorized, 6,900,000, 7,100,000,
and 6,004,280 shares issued and
outstanding at December 31, 1997
and 1998 and March 31, 1999,
respectively....................... 13,873,980 19,059,410 20,476,156 $(20,476,156)
Stockholders' equity (deficiency):
Common stock, $0.001 par value,
50,000,000 shares authorized,
6,004,280 shares issued and
outstanding as of March 31,
1999............................. 6,004 6,004
Retained earnings (accumulated
deficit)......................... (5,743,717) (6,340,593) (9,482,507) 20,470,152 (11,104,854) (117,209)
----------- ----------- ----------- ------------ ----------- -----------
Total stockholders' equity
(deficiency)................... (5,743,717) (6,340,593) (9,482,507) $ 20,476,156 (11,104,854) (111,205)
----------- ----------- ----------- ------------ ----------- -----------
Total liabilities and
stockholders' equity
(deficiency)................... $18,704,553 $32,143,877 $31,089,806 $ 436,274 $31,526,080
=========== =========== =========== ============ =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE> 9
DATALINK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------- --------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales..................... $54,651,868 $71,255,299 $87,951,650 $16,598,745 $25,682,293
Cost of sales................. 42,872,380 55,719,303 65,739,837 12,722,934 19,071,452
----------- ----------- ----------- ----------- -----------
Gross profit............. 11,779,488 15,535,996 22,211,813 3,875,811 6,610,841
Operating expenses:
Sales and marketing......... 3,606,567 5,191,040 7,753,711 1,426,889 2,160,258
General and
administrative........... 2,382,166 3,010,450 5,403,562 961,465 1,691,106
Engineering................. 632,660 926,008 1,362,047 314,844 776,056
Offering costs.............. 732,738 172,628
----------- ----------- ----------- ----------- -----------
Operating income......... 5,158,095 6,408,498 6,959,755 1,172,613 1,810,793
Interest expense.............. 285,905 332,562 280,555 54,861 73,880
----------- ----------- ----------- ----------- -----------
Income before income taxes.... 4,872,190 6,075,936 6,679,200 1,117,752 1,736,913
Income tax expense
(benefit)................... 147,746 (556,093)
----------- ----------- ----------- ----------- -----------
Net income.................... $ 4,872,190 $ 6,075,936 $ 6,531,454 $ 1,117,752 $ 2,293,006
=========== =========== =========== =========== ===========
Historical net income per
share, basic and diluted.... $ 0.71 $ 0.88 $ 0.93 $ 0.16 $ 0.34
=========== =========== =========== =========== ===========
Weighted average shares
outstanding, basic and
diluted.................. 6,900,000 6,900,000 6,993,151 6,900,000 6,722,585
Pro forma data (unaudited see
Note 3):
Income before income taxes
on S corporation
income................... $ 6,531,454 $ 1,117,752 $ 2,293,006
Pro forma income taxes...... 2,671,680 435,923 729,503
----------- ----------- -----------
Pro forma net income........ $ 4,007,520 $ 681,829 $ 1,007,410
=========== =========== ===========
Pro forma net income per
share basic and
diluted.................. $ 0.48 $ 0.08 $ 0.13
=========== =========== ===========
Shares used in computing pro
forma net income per share
(see Note 3)................ 8,275,696 8,182,545 8,005,130
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-7
<PAGE> 10
DATALINK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ ---------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income.................... $ 4,872,190 $ 6,075,936 $ 6,531,454 $ 1,117,752 $ 2,293,006
Adjustments to reconcile net
income to net cash provided
by (used in) operating
activities:
Provision for bad debts.... 69,109 27,235 24,214 150,000
Depreciation and
amortization............. 146,648 177,302 393,193 55,020 209,251
Amortization of
intangibles.............. 375,700 192,634
Loss on disposal of
property and equipment... 4,599 598
Deferred income taxes...... (52,460) (579,652)
Changes in operating assets
and liabilities:
Accounts receivable........ (3,321,609) (3,191,818) (1,153,740) 3,024,478 (1,338,453)
Inventories................ (2,921,963) 1,350,013 (413,277) (232,697) (126,708)
Other current assets....... (36,031) (3,554) (143,087) (348,542) (105,963)
Other assets............... 4,556 (10,916) 2,549 (2,047) 1,523
Accounts payable........... 3,106,571 (150,824) 6,022,951 (689,681) (5,228,704)
Accrued expenses........... 599,324 333,239 301,430 (335,100) (581,935)
Income taxes payable....... (353,237)
Deferred compensation...... (56,206) (59,058) (70,979) (21,030) (17,484)
------------ ------------ ------------ ------------ ------------
Net cash provided by (used
in) operating
activities............... 2,462,589 4,557,082 11,469,310 2,568,750 (5,132,485)
------------ ------------ ------------ ------------ ------------
Cash flows from investing
activities:
Purchase of property and
equipment.................. (337,363) (766,436) (1,140,539) (247,307) (160,041)
Net assets acquired, net of
cash acquired.............. (3,095,619)
------------ ------------ ------------ ------------ ------------
Net cash used in investing
activities................. (337,363) (766,436) (4,236,158) (247,307) (160,041)
------------ ------------ ------------ ------------ ------------
Cash flows from financing
activities:
Proceeds from borrowings on
line of credit............. 52,657,600 70,372,500 79,119,139 17,376,000 29,034,000
Principal payments on line of
credit..................... (52,777,009) (69,233,611) (80,762,323) (20,256,314) (26,594,583)
Dividends paid................ (1,894,600) (3,988,299) (3,942,900) (1,008,100) (998,260)
Principal payments on capital
lease obligations.......... (12,451)
Book cash overdraft........... 546,432 1,641,548
------------ ------------ ------------ ------------ ------------
Net cash (used in) provided
by financing
activities............... (2,014,009) (2,849,410) (5,598,535) (3,341,982) 3,082,785
------------ ------------ ------------ ------------ ------------
Increase (decrease) in cash... 111,217 941,236 1,634,617 (1,020,539) (2,209,741)
Cash, beginning of period....... 110,654 221,871 1,163,107 1,163,107 2,797,724
------------ ------------ ------------ ------------ ------------
Cash, end of period............. $ 221,871 $ 1,163,107 $ 2,797,724 $ 142,569 $ 587,983
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-9
<PAGE> 11
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
1. DESCRIPTION OF BUSINESS:
Datalink Corporation (the "Company") analyzes, custom designs, integrates
or assembles, installs and supports high-end Open Systems data storage solutions
for end-users, value-added resellers and original equipment manufacturers. In
May 1996, the Company received an ISO 9001 registration.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of the Company
and, from July 15, 1998 through January 3, 1999, its wholly-owned subsidiary,
Direct Connect Systems, Inc. ("DCSI") (see Note 12). All significant
intercompany accounts and transactions have been eliminated in consolidation.
INTERIM FINANCIAL STATEMENTS:
The financial statements as of March 31, 1999 and for the three months
ended March 31, 1998 and 1999 are unaudited. In the opinion of management, this
financial information includes all adjustments, consisting of normal recurring
adjustments, necessary to fairly present the financial information set forth
herein. The results of operations for the three months ended March 31, 1999, are
not necessarily indicative of the results to be expected for the full year.
CASH:
The Company maintains its cash principally with one financial institution.
INVENTORIES:
Inventories, principally consisting of data storage products and
components, are valued at the lower of cost or market with cost determined on a
first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT:
Property and equipment, including purchased software, are stated at cost.
Depreciation and amortization are provided by charges to operations using the
straight-line method over the estimated useful lives of the assets (ranging from
3 to 10 years). Leasehold improvements are amortized on a straight-line basis
over the shorter of their estimated useful lives or the underlying lease term.
The costs and related accumulated depreciation and amortization on asset
disposals are removed from the accounts and any gain or loss is included in
operations. Major renewals and betterments are capitalized, while maintenance
and repairs are charged to current operations when incurred.
INTANGIBLES:
Identifiable intangible assets and goodwill are amortized on a
straight-line basis over their estimated useful lives of 3 to 7 years.
VALUATION OF LONG-LIVED ASSETS:
The Company periodically, at least quarterly, analyzes its long-lived
assets for potential impairment, assessing the appropriateness of lives and
recoverability of unamortized balances through measurement of undiscounted
operating cash flows on a basis consistent with generally accepted accounting
principles.
F-10
<PAGE> 12
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
INCOME TAXES:
The Company has elected to be taxed as an S corporation under the
provisions of the Internal Revenue Code (the "Code") and comparable state income
tax law. Under those provisions, the Company's income is reported on the
individual tax returns of the Company's stockholders. As such, the Company is
generally not subject to corporate income taxes. Therefore, except as described
below, no provision or liability for income taxes is reflected in the financial
statements for the Company.
As of December 31, 1998, DCSI was a C corporation and accordingly, was
subject to corporate income taxes. A provision for taxes resulting from the
taxable income of DCSI for the period from July 15, 1998 through December 31,
1998 is included in the Company's consolidated financial statements. Effective
January 4, 1999, DCSI merged into the Company and, therefore, became part of the
S corporation. Accordingly, effective January 4, 1999, none of the consolidated
income of the Company is subject to corporate income taxes and all of the
deferred tax assets and liabilities described below were eliminated which
resulted in a one-time tax benefit of $579,652 which, along with a current
income tax provision of $23,559, is included in the Company's results of
operations for the three months ended March 31, 1999.
Prior to January 4, 1999, deferred income tax liabilities and assets were
recognized for the tax consequences in future years of differences between the
tax bases of DCSI's assets and liabilities and their financial reporting amounts
at each year end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Prior to January 4, 1999, income tax expense consists of the tax payable for
DCSI for the period and the change during the period in its deferred tax assets
and liabilities.
As of December 31, 1998, the Company has a deferred tax asset of $22,087
related primarily to DCSI's allowance for doubtful accounts and inventory
capitalization and a deferred tax liability of $601,739 related primarily to
acquired identifiable intangible assets and property and equipment, resulting in
a net deferred tax liability of $579,652.
Concurrent with the closing of the Company's proposed initial public
offering (the "Offering") (see Note 11), the Company's S corporation status will
terminate and its taxable income will be subject to federal and state C
corporation income tax regulation.
REVENUE RECOGNITION:
The Company recognizes product revenue as its products are shipped or
following customer acceptance for products under evaluation. The Company
provides an allowance for estimated returns when revenues are recognized.
Software solution and consulting service revenue is recognized as such services
are rendered. Revenues and expenses related to sales of maintenance contracts
fulfilled by third parties are recognized upon execution of the contracts.
OFFERING COSTS:
Costs related to the Company's initial public offering incurred during 1998
and the first quarter of 1999 totaling $732,738 and $172,628, respectively, were
initially deferred, but were expensed during the third quarter of 1998 and the
first quarter of 1999, respectively, when the offering was delayed due to market
conditions.
F-11
<PAGE> 13
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
NET INCOME PER SHARE:
Basic net income per share is computed using the weighted average number of
shares outstanding. The diluted net income per share includes the effect of
common stock equivalents, if any, for each period. The Company does not have any
common stock equivalents.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK:
The Company's customer base is diversified; however, a substantial portion
of its customers are located in the upper Midwest. The Company does not require
collateral for customer accounts receivable. The Company performs ongoing credit
evaluations of its customers' financial condition and establishes allowances for
estimated uncollectible accounts when necessary.
BUSINESS SEGMENTS:
Effective with its year end 1998 financial statements, the Company adopted
SFAS No. 131, "Disclosure About Segments of an Enterprise and Related
Information," which requires disclosure of segment data in a manner consistent
with that used by an enterprise for internal management reporting and decision
making. The Company reported its operations as a single segment under SFAS No.
131.
COMPREHENSIVE INCOME:
Effective with its year end 1998 financial statements, the Company adopted
SFAS No. 130, "Reporting Comprehensive Income," which established standards for
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. The Company's comprehensive income is
equal to its net income for all periods presented.
OTHER RECENTLY ISSUED ACCOUNTING STANDARDS:
In March 1998, the AICPA issued SOP No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," ("SOP No. 98-1"). SOP
No. 98-1 requires entities to capitalize certain costs related to internal-use
software once certain criteria have been met. The Company adopted SOP 98-1
beginning on January 1, 1999. The adoption did not have a material impact on the
Company's financial position or results of operations.
In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions," ("SOP
98-9"). SOP 98-9 amends SOP 97-2 and SOP 98-4 by extending the deferral of the
application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal
years beginning on or before March 15, 1999. All other provisions of SOP 98-9
are effective for transactions entered into in fiscal years beginning after
March 15, 1999. The Company has not had significant software sales to date and
management does not expect the adoption of SOP 98-9 to have a significant effect
on its financial condition or results of operations.
F-12
<PAGE> 14
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
3. PRO FORMA DATA (UNAUDITED):
PRO FORMA BALANCE SHEET DATA:
The pro forma balance sheet of the Company as of March 31, 1999 reflects
(i) the reclassification of common stock subject to put option to stockholders'
equity to reflect termination of the put options concurrent with the Offering
(see Note 9), (ii) a distribution payable to the stockholders of the Company of
all previously taxed, but undistributed, S corporation earnings (estimated at
$10,734,907 had the termination occurred on March 31, 1999), and (iii) a net
deferred tax liability which will be recorded by the Company upon termination of
its S corporation status as a result of the Offering (estimated at $370,000 as
of March 31, 1999).
The net deferred income tax liability will represent the tax effect of the
cumulative differences between the financial reporting and income tax bases of
assets and liabilities as of the termination of the S corporation status, and
will be recorded as an income tax expense in the quarter in which the Offering
is completed. Deferred income taxes result from temporary differences between
financial reporting and income tax reporting based on enacted rates in effect
for periods in which these differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to an
amount expected to be realized. Income tax expense is the tax payable for the
period plus the change during the period in deferred tax assets and liabilities.
The actual deferred tax assets and liabilities recorded will be adjusted to
reflect the effect of operations from April 1, 1999 through the actual
termination of the S corporation status. In addition, the actual amount of the
distribution will be adjusted to reflect the S corporation's pro rata portion of
the Company's 1999 taxable income and any stockholder distributions from April
1, 1999 through the termination of the S corporation status.
PRO FORMA STATEMENT OF OPERATIONS DATA:
Concurrent with the Offering, the Company will terminate its status as an S
corporation and will be subject to federal and state income taxes. Accordingly,
for informational purposes, the accompanying statements of operations for the
years ended December 31, 1998 and the three months ended March 31, 1998 and
1999, include a pro forma adjustment for the income taxes which would have been
recorded if the Company had been a C corporation, based on the tax laws in
effect during the period. The pro forma adjustment for income taxes does not
include a one-time income tax expense related to the recognition of a net
deferred tax liability which will be recorded by the Company upon terminating
its S corporation status (estimated at $370,000 as of March 31, 1999).
PRO FORMA NET INCOME PER SHARE:
Pro forma net income per share is computed by dividing pro forma net income
by the weighted average number of shares outstanding for the period, after
giving effect to the estimated number of shares that would be required to be
sold at the initial public offering price, after deducting the underwriting
discount, to fund the distribution to the current stockholders of all previously
taxed, but undistributed, S corporation earnings, estimated at $10,734,907 (or
1,282,546 shares) had the termination occurred on March 31, 1999. The Company
does not have any common stock equivalents.
F-13
<PAGE> 15
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
4. SELECTED BALANCE SHEET INFORMATION:
The following provides additional balance sheet information as of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- MARCH 31,
1997 1998 1999
---- ---- ---------
<S> <C> <C> <C>
Accounts receivable:
Accounts receivable................................. $11,340,738 $15,714,174 $17,052,627
Less allowance for doubtful accounts................ 60,000 84,214 234,214
----------- ----------- -----------
$11,280,738 $15,629,960 $16,818,413
=========== =========== ===========
Property and equipment:
Leasehold improvements.............................. $ 223,356 $ 317,361 $ 317,361
Equipment........................................... 761,059 1,120,976 1,220,580
Computers and purchased software.................... 1,262,249 2,289,879 2,350,316
----------- ----------- -----------
2,246,664 3,728,216 3,888,257
Less accumulated depreciation and amortization...... 768,542 1,261,270 1,470,521
----------- ----------- -----------
$ 1,478,122 $ 2,466,946 $ 2,417,736
=========== =========== ===========
Intangibles:
Customer base....................................... $ 700,000 $ 700,000
Noncompetition agreements........................... 500,000 500,000
Assembled workforce................................. 490,000 490,000
Trademark and tradename............................. 450,000 450,000
Goodwill............................................ 2,455,284 2,455,284
----------- -----------
4,595,284 4,595,284
Less accumulated amortization....................... 375,700 568,334
----------- -----------
$ 4,219,584 $ 4,026,950
=========== ===========
Accrued expenses:
Commissions......................................... $ 942,051 $ 1,333,704 $ 982,089
Other............................................... 551,266 853,268 622,948
----------- ----------- -----------
$ 1,493,317 $ 2,186,972 $ 1,605,037
=========== =========== ===========
</TABLE>
5. BORROWING ARRANGEMENTS:
Effective June 1, 1998, the Company renewed its revolving credit agreement
with a bank (the "Credit Agreement"). Under the Credit Agreement, the Company
may borrow up to $10,000,000 ($8,000,000 as of December 31, 1997), with
borrowings limited to the sum of 80% of eligible accounts receivable plus 35% of
eligible inventories, as defined. As of March 31, 1999, the amount available
under the borrowing base formula funds was the total $10,000,000 available under
the Credit Agreement. Borrowings under the Credit Agreement were $3,210,355 and
$5,649,852 as of December 31, 1998 and March 31, 1999, respectively, with
interest at the bank's reference rate. Borrowings under the Credit Agreement
were $3,935,417 as of December 31, 1997, with interest at the bank's reference
rate plus 0.25%. The bank's reference rate was 7.75% as of March 31, 1999 and
December 31, 1998 and 8.5% as of December 31, 1997.
The line of credit is collateralized by substantially all assets of the
Company. The agreement includes various covenants, including requirements to
maintain certain levels of net income and tangible net worth and
F-14
<PAGE> 16
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
limitations on the payment of dividends and property and equipment acquisitions.
Included in cash on the balance sheet is $260,000, $1,499,000 and $558,000 as of
December 31, 1997 and 1998 and March 31, 1999, respectively, which was held in a
restricted collateral cash account. These amounts were applied to reduce bank
borrowings in the month following the period end.
The Company's long-term capital lease obligations consist of capital leases
for office equipment with outstanding balances totaling $26,378, of which
$13,876 is current, as of March 31, 1999.
6. DEFERRED COMPENSATION AGREEMENT:
The Company has a deferred compensation agreement with a retired officer
who is also a stockholder. The Company is obligated to pay the retired officer
(or a designated beneficiary) $7,000 per month for 60 months beginning January
1996. The Company's obligation under the agreement is not funded. The present
value of the Company's liability related to the deferred compensation agreement
was $216,939, $145,960 and $128,464 as of December 31, 1997 and 1998 and March
31, 1999, respectively, with interest computed at 10%.
Interest expense related to the agreement was $24,942, $20,021, $5,111 and
$4,605 for the years ended December 31, 1997 and 1998 and for the three months
ended March 31, 1998 and 1999, respectively.
7. LEASE COMMITMENTS AND CONTINGENCIES:
As of December 31, 1998, the Company leased an office and warehouse
facility under terms of operating leases with a partnership in which a
stockholder of the Company is a general partner. During 1997, the office and
warehouse facility were sold to a limited liability partnership in which a
majority of the limited partners are stockholders of the Company. In connection
with the purchase of the property, the limited liability partnership executed
promissory notes in favor of a bank and a stockholder of the Company. The
Company has guaranteed payments due under these notes. As of March 31, 1999, the
balances of the notes payable to the bank and the stockholder were $802,000 and
$1.4 million, respectively.
In the first quarter of 1999, the Company extended these lease agreements
through December 2002. The extended agreements provide for options to extend the
leases for two additional three-year terms at the option of the Company. The
Company also leases office space from nonaffiliated entities under operating
lease agreements that expire at various dates through 2000. The Company also
leases office and manufacturing facilities, along with office equipment, for
DCSI under operating leases which expire at various dates through 2001. In
addition to minimum rents, the leases require the Company to pay certain
operating costs of the lessor.
As of December 31, 1998, future minimum lease payments due under
noncancellable operating leases are as follows:
<TABLE>
<CAPTION>
RELATED
YEAR ENDED PARTY OTHER TOTAL
---------- ------- ----- -----
<S> <C> <C> <C>
1999..................................................... $151,464 $123,601 $275,065
2000..................................................... 156,008 100,868 256,876
2001..................................................... 156,008 1,020 157,028
2002..................................................... 156,008 156,008
-------- -------- --------
$619,488 $225,489 $844,977
======== ======== ========
</TABLE>
F-15
<PAGE> 17
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
Total rent expense, including certain lessor operating costs charged to the
Company, is as follows:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31 ENDED MARCH 31,
-------------------------------- --------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Related party............................. $128,573 $197,363 $233,254 $ 58,750 $ 75,000
Other..................................... 90,361 119,620 219,494 42,376 83,342
-------- -------- -------- -------- --------
$218,934 $316,983 $452,748 $101,126 $158,342
======== ======== ======== ======== ========
</TABLE>
8. EMPLOYEE BENEFIT PLAN:
The Company has a defined contribution retirement plan for eligible
employees. Employees may contribute up to 10% of their pretax compensation to
the 401(k) portion of the plan. The Company is required to match 50% of an
employee's contribution up to the first 6% of an employee's eligible
compensation. The cost of the Company's contributions to the 401(k) portion of
the plan for the years ended December 31, 1996, 1997 and 1998 and for the three
months ended March 31, 1998 and 1999, was $97,350, $126,404, $157,866, $49,872
and $72,991, respectively.
At the discretion of the Board of Directors, the Company may also make
profit sharing contributions to the plan, to the extent permitted by the
Internal Revenue Code. The cost of the Company's profit sharing contributions to
the plan for the years ended December 31, 1996, 1997 and 1998, and for the three
months ended March 31, 1999 was $156,500, $164,350, $311,000 and $89,807,
respectively.
As of December 31, 1998, the Company also maintained the defined
contribution retirement plan of DCSI. In the first quarter of 1999, the DCSI
plan was merged into the Company's plan. The cost of the Company's contributions
to the DCSI plan for the period from July 15 through December 31, 1998 was
$1,007.
9. COMMON STOCK BUY-SELL AGREEMENT:
The Company and all of its stockholders have entered into Stock Purchase
Agreements (the "Agreements") that restrict the right of each stockholder to
dispose of or encumber any shares of the Company's common stock and dictates
terms for transfer of the shares. Upon the death, disability or termination of
employment, each stockholder is required to put his or her shares to the
Company, and the Company is obligated to purchase all shares owned by that
stockholder at a price determined pursuant to terms of the Agreements. In
connection therewith, the value of the common stock subject to put options has
been accreted to the value determined according to terms of the Agreements.
Effective November 1, 1996, one of the Agreements was amended to allow a retired
stockholder to retain his shares until either he or his legal representative
require the Company to purchase his shares, or until his death.
Effective February 28, 1999, the Company redeemed 1,095,720 shares held by
a former stockholder under terms of the Agreements. Pursuant to the terms of the
Agreements, the Company has issued a $3,019,914 note payable to this former
stockholder. The note provides for interest on the outstanding balance at the
prime rate beginning August 28, 1999. A principal payment of $905,974 is due on
August 28, 1999 with the remaining principal balance due in three installments
of $704,647 plus any accrued interest on February 28, 2000, 2001 and 2002.
F-16
<PAGE> 18
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
In connection with the Offering and pursuant to accounting rules and
regulations applicable to public companies, the Company has adjusted its
financial statements to reclassify the carrying value of common stock pursuant
to the Agreements out of stockholders' equity. The effect of this adjustment was
to increase the carrying value of common stock subject to the put options, and
decrease stockholders' equity by $9,338,605, $13,873,980, $19,059,410 and
$20,476,156 as of December 31, 1996, 1997, 1998 and March 31, 1999,
respectively. The Company's earnings available to common stockholders is the
same as the Company's net income because the accretion of the common stock to
its put option value results from the same put option terms for all common
stockholders. Accordingly, the accretion of the common stock to its put option
value is allocable to all of the Company's common stockholders.
As of March 31, 1999, the Company is the owner and beneficiary of term life
insurance policies with face values ranging from approximately $3.0 million to
$17.9 million insuring four of its stockholders. The Company is also the owner
and beneficiary of disability insurance policies with coverage ranging from
$105,000 to $4.0 million insuring four of its stockholders. Any proceeds from
these life and disability insurance policies, prior to completion of the
Offering, would be used to fund at least a portion of the Company's obligations
under the Agreements in the event of death or disability.
The Company is also the owner and beneficiary of two life insurance
policies with a combined face value of $1.0 million insuring the life of the
retired stockholder. The cash surrender value of these policies was $25,547,
$19,796 and $19,796 as of December 31, 1997, and 1998 and March 31, 1999,
respectively, and is included in other assets on the consolidated balance sheet.
10. SUPPLEMENTAL CASH FLOW INFORMATION:
The following provides supplemental information concerning the statements
of cash flows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------------------- ------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash paid for interest............... $286,745 $327,496 $ 295,044 $ 49,372 $ 69,207
Cash paid for taxes.................. 549,400 23,559
Significant noncash financing and
investing transactions:
Stock issued to purchase DCSI........ 2,000,000
Repurchase of stock in exchange for
note............................... 3,019,914
</TABLE>
11. RECAPITALIZATION:
The Company is contemplating an initial public offering of 2,600,000 shares
of its common stock (the "Offering"). In connection therewith, on June 1, 1998,
the Company's Board of Directors and stockholders approved an amendment to the
Company's Certificate of Incorporation to increase the number of authorized
shares of common stock to 50,000,000 and change the par value of the common
stock to $0.001. Pursuant to the Company's amended Certificate of Incorporation,
all such authorized shares are deemed to be common stock until otherwise
designated by the Board of Directors. Also on June 1, 1998, the Company's Board
of Directors and stockholders authorized a 690-for-1 stock split of its common
stock. The stock split has been retroactively reflected in the accompanying
financial statements.
In connection with the Offering, the Company has reserved an aggregate of
1,350,000 shares of common stock for issuance pursuant to the Company's
Incentive Compensation Plan. The terms of the plan allow for a variety of awards
including stock options, stock appreciation rights, restricted stock,
performance shares,
F-17
<PAGE> 19
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
performance units, cash-based awards, phantom shares and other share-based
awards as determined by the Company's Compensation Committee (the Committee).
Also, in connection with the Offering, the Company has reserved 250,000 shares
of common stock for issuance pursuant to the Company's Employee Stock Purchase
Plan. Under terms of the Employee Stock Purchase Plan, eligible employees will
be granted an option to purchase a designated number of shares of common stock
at a purchase price determined by the Committee, but at no less than 85% of the
lower of the market price on the first or last day of the purchase period.
The Company's Board of Directors has authorized the grant to each of four
directors of options to purchase 9,000 shares of the Company's common stock,
coincident with the closing of the Company's initial public offering. Such
options, authorized under the Incentive Plan, if ultimately granted, will have
exercise prices equal to the initial public offering price per share, vest upon
their grant and will expire 10 years after the date of the Board's authorization
of the option grants.
The Company's Board of Directors has also authorized the grant to employees
of options to purchase 715,425 shares of the Company's common stock, coincident
with the closing of the Company's initial public offering. Such options,
authorized under the Incentive Plan, if ultimately granted, will have exercise
prices equal to the initial public price per share, and will vest 25% annually
and expire 10 years after the date of the Board's authorization of the option
grants.
12. BUSINESS ACQUISITION:
On July 15, 1998, the Company acquired DCSI, a Marietta, Georgia-based firm
engaged in the analysis, custom design, integration and support of high-end Open
Systems data storage solutions principally for end-users located in the
Southeastern portion of the United States. In addition to its Marietta
headquarters, DCSI had field sales offices in Herndon, Virginia, Charlotte,
North Carolina, and Melbourne and Tampa, Florida.
Under terms of the acquisition, the Company acquired all of DCSI's capital
stock in exchange for $2 million cash and 200,000 shares of the Company's common
stock, with a negotiated fair value of $2 million. In order to maintain the fair
value of the common stock at $2 million, the number of shares is subject to
adjustment: (i) in the event that the Company does not complete its initial
public offering or (ii) if the completed initial public offering price is less
than $10.00 per share. Such adjustment in the number of shares issued, if any,
would be reflected in stockholders' equity but would not affect the originally
recorded cost of the DCSI acquisition. Under terms of the acquisition, certain
DCSI employees were also paid an aggregate of $500,000 under noncompetition
agreements.
The acquisition was accounted for using the purchase method of accounting.
Accordingly, the purchase price was allocated to the estimated fair value of the
assets acquired and liabilities assumed. The results of operations of DCSI have
been included with the operating results of the Company beginning on July 15,
1998.
F-18
<PAGE> 20
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF MARCH 31, 1999 AND FOR THE
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 IS UNAUDITED)
The following table presents the purchase price allocation of the acquired,
identifiable intangible assets of DCSI:
<TABLE>
<S> <C>
Cash and fair value of Company's common stock issued........ $4,000,000
Direct acquisition costs.................................... 677,324
DCSI liabilities assumed.................................... 3,960,128
----------
Total purchase price...................................... $8,637,452
==========
Estimated fair value of tangible assets acquired............ $5,153,888
Estimated fair value of identifiable intangible assets...... 1,640,000
Goodwill.................................................... 2,455,284
Deferred tax liabilities related to identifiable
intangibles............................................... (611,720)
----------
$8,637,452
==========
</TABLE>
The purchase price allocated to intangible assets and goodwill and their
respective amortization periods are as follows:
<TABLE>
<CAPTION>
ALLOCATION ESTIMATED LIFE
---------- --------------
<S> <C> <C>
Customer base............................................... $ 700,000 5 years
Assembled workforce......................................... 490,000 5 years
Trademark and tradename..................................... 450,000 7 years
Goodwill.................................................... 2,455,284 7 years
</TABLE>
The $500,000 cost of noncompetition agreements has been capitalized and
will be amortized on a straight-line basis over their underlying three-year
terms.
The following unaudited pro forma condensed results of operations have been
prepared to give effect to the acquisition of DCSI as if the acquisition
occurred as of the beginning of the years presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998
---- ----
<S> <C> <C>
Net sales................................................... $83,078,070 $97,130,997
Net income.................................................. $ 5,563,562 $ 6,934,262
Net income per share, basic and diluted..................... $ 0.78 $ 0.98
</TABLE>
The unaudited pro forma condensed results of operations are not necessarily
indicative of results that would have occurred had the acquisitions been in
effect for the periods presented, nor are they necessarily indicative of the
results that will be obtained in the future.
13. SUBSEQUENT EVENT (UNAUDITED):
In April 1999, the Company paid $1,207,101 of dividends to its
stockholders.
F-19
