<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934. (NO FEE REQUIRED)
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 Identification Number)
of incorporation)
7423 WASHINGTON AVENUE SOUTH
MINNEAPOLIS, MN 55439
(Address of Principal Executive Offices)
(612) 944-3462
(Registrants Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: Common
Stock, $0.001 par value.
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]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of
<PAGE> 2
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At November 16, 1999, the latest practicable date, the aggregate market
value of the voting and non-voting common equity held by non-affiliates of the
registrant was: $85,159,460
At November 16, 1999, the number of shares outstanding of each of the
registrant's classes of common stock was: 8,772,537
Documents incorporated by reference:
(1) Not Applicable
(2) Not Applicable
(3) Certain portions of the definitive Prospectus filed with the
Securities and Exchange Commission on August 6, 1999, pursuant to Rule 424(b)(1)
under the Securities Act of 1933, SEC File No. 333-55935 (the "Definitive
Prospectus") are incorporated by reference as indicated in Parts I, II, III and
IV below.
EXPLANATORY NOTE
This Form 10-K relates to fiscal years prior to consummation of Datalink
Corporation's initial public offering. Datalink is filing this report solely
because Datalink's registration statement on 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-K
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. The Company recommends that readers refer to the
discussion of these and other
2
<PAGE> 3
risks as contained in the Definitive Prospectus under the caption "Risk Factors"
beginning on page 6.
PART I
ITEM 1. BUSINESS.
The information contained under the caption "Business" beginning at
page 26 of the Definitive Prospectus is incorporated herein by reference.
ITEM 2. PROPERTIES.
The information contained under the caption "Facilities" beginning at
page 34 of the Definitive Prospectus is incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS.
As of the date hereof, the Company is not involved in any material
legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted during the fourth quarter of the Company's
1998 fiscal year to a vote of security holders, through the solicitation of
proxies or otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There was no established public trading market for the Company's Common
Stock during the Company's 1998 fiscal year. At December 31, 1998, there were 10
holders of the Company's Common Stock.
The information contained under the caption "Termination of S
Corporation Status and Put Option and Dividend Policy" on page 13 of the
Definitive Prospectus is incorporated herein by reference.
In connection with the acquisition of assets of Direct Connect Systems,
Inc. ("DCSI") in July 1998, the Company issued 200,000 shares of Common Stock to
four former stockholders of DCSI, each of whom was an accredited investor. The
Company believes the sale of these shares was exempt from registration under
Section 4(2) of the Securities Act. In August 1999, pursuant to the original
acquisition agreement, the Company issued an additional 26,668 shares of the
Company's Common Stock to these former DCSI stockholders.
3
<PAGE> 4
ITEM 6. SELECTED FINANCIAL DATA.
The information contained in the first paragraph and under the
following captions of the section entitled "Selected Historical Financial Data"
beginning at page 17 of the Definitive Prospectus is incorporated herein by
reference:
-- "Statement of Operations Data" for the Years Ended December 31, 1994
through 1998 and related footnotes and
-- "Balance Sheet Data" at December 31, 1994, 1995, 1996, 1997 and 1998
and related footnotes.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The information contained under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations" beginning at page
19 of the Definitive Prospectus, exclusive of the section labeled "Comparison of
Six Months Ended June 30, 1999 and 1998" on pages 20-21, is incorporated herein
by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following financial statements and information contained in the
Definitive Prospectus are incorporated herein by reference:
-- the "Report of Independent Accountants" at page F-5;
-- the "Consolidated Balance Sheets" on page F-6;
-- the "Year Ended December 31," columns labeled "1998," "1997" and
"1996" on page F-7 entitled "Consolidated Statements of Operations;"
-- the "Consolidated Statement of Stockholders' Equity (Deficiency) on
page F-8, excluding the table information below the line labeled "Balances,
December 31, 1998;"
-- the "Year Ended December 31," columns labeled "1998," "1997" and
1996" 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.
4
<PAGE> 5
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The information contained under the caption "Change of Accountants" on
page 46 of the Definitive Prospectus is incorporated herein by reference.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information contained under the caption "Management" beginning at
page 35 of the Definitive Prospectus is incorporated herein by reference.
Section 16(a) Beneficial Ownership Reporting Compliance. During the
year ended December 31, 1998 (which was prior to Datalink's initial public
offering), the following persons failed to timely file a Form 3 report under the
Securities Exchange Act of 1934, as amended: Greg R. Meland, Robert D. DeVere,
Stephen M. Howe, Scott D. Robinson, Robert M. Price, James E. Ousley, Margaret
A. Loftus and Paul F. Lidsky.
ITEM 11. EXECUTIVE COMPENSATION.
The information contained under the captions "Director Compensation" on
page 36 and "Executive Compensation" on page 37 on the Definitive Prospectus is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained under the caption "Principal Stockholders" on
page 41 of the Definitive Prospectus is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under the caption "Certain Transactions" beginning at
page 39 of the Definitive Prospectus is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
1. FINANCIAL STATEMENTS. The following financial statements contained in
the Definitive Prospectus are filed as part of this report (as incorporated
by reference above):
5
<PAGE> 6
-- the "Report of Independent Accountants" at page F-5;
-- the "Consolidated Balance Sheets" on page F-6;
-- the "Year Ended December 31," columns labeled "1998," "1997" and "1996"
on page F-7 entitled "Consolidated Statements of Operations;"
-- the "Consolidated Statement of Stockholders' Equity (Deficiency) on page
F-8, excluding the table information below the line labeled "Balances, December
31, 1998;"
-- the "Year Ended December 31," columns labeled "1998," "1997" and 1996"
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.
2. FINANCIAL STATEMENT SCHEDULES. The "Report of Independent Accountants on
Financial Statement Schedule" and the "Schedule II -- Valuation and Qualifying
Accounts for the Years Ended December 31, 1997 and 1998" beginning at page S-1
of Amendment No. 5 to the Registration Statement on Form S-1, SEC Reg. No.
333-55935 ("Amendment No. 5"), is filed herewith and incorporated herein by
reference.
3. (a) EXHIBITS. The following exhibits are filed as part of this Form 10-K:
<TABLE>
<CAPTION>
Exhibit Method of
Number Title Filing
------ ----- ------
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation of
the Company *
3.2 Restated Bylaws of the Company *
4.1 Form of Common Stock Certificate *
10.1 Employee Stock Purchase Plan *
10.2 1999 Incentive Compensation Plan *
10.3 Credit Agreement with Norwest Bank Minneapolis,
N.A. *
10.4 Form of Indemnification Agreement *
10.5 Lease Agreement with Washington Avenue L.L.P. *
10.6 Deferred Compensation Agreement with
Stanley I. Clothier *
10.7 Agreement and Plan of Reorganization with
Direct Connect Systems, Inc. (excluding Schedules
and Exhibits which the Registrant will provide to
the Commission upon request) *
10.8 Second Lease Agreement with Washington Avenue
L.L.P. *
</TABLE>
6
<PAGE> 7
<TABLE>
<S> <C> <C>
10.9 Lease Extension Agreement with Washington Avenue
L.L.P. *
16.1 Letter from Hansen, Jergenson, Nergaard & Co.,
LLP regarding change in certifying accountant *
23.1 Consent of PriceWaterhouseCoopers LLP Filed herewith
23.2 Consent of Hansen, Jergenson, Nergaard & Co.,
LLP Filed herewith
27.1 Financial Data Schedule (Edgar filing only)
99.1 Pages of the Definitive Prospectus and of
Amendment No. 5 (deemed to be filed
only to the extent as incorporated by
reference into this report above) Filed herewith
</TABLE>
- -----------
* Incorporated by reference to the exhibit of the same number in the Company's
Registration Statement on Form S-1, Reg. No. 333-55935
(b) REPORTS OF FORM 8-K. No reports on Form 8-K were filed during the last
quarter of the period covered by this report.
7
<PAGE> 8
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Date: November 12, 1999
By: /s/ Greg R. Meland
--------------------------------------------
Greg R. Meland, Chief Executive Officer
By: /s/ Daniel J. Kinsella
--------------------------------------------
Daniel J. Kinsella, Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Greg R. Meland President and Chief November 12, 1999
- --------------------------------- Executive Officer
Greg R. Meland and Director (Principal
Executive
Officer)
/s/ Daniel J. Kinsella Chief Financial Officer November 12, 1999
- --------------------------------- (Principal Financial
Daniel J. Kinsella And Accounting Officer)
/s/ Robert M. Price Director November 12, 1999
- ---------------------------------
Robert M. Price
/s/ James E. Ousley Director November 12, 1999
- ---------------------------------
James E. Ousley
/s/ Margaret A. Loftus Director November 12, 1999
- ---------------------------------
Margaret A. Loftus
/s/ Paul F. Lidsky Director November 12, 1999
- ---------------------------------
Paul F. Lidsky
</TABLE>
8
<PAGE> 1
Exhibit 23.1 Consent of PricewaterhouseCoopers LLP
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Annual Report
on Form 10-K of Datalink Corporation for the year ended December 31, 1998 of our
reports dated March 4, 1999, except as to the information contained in Note 11
for which the date is July 15, 1999, included in its Registration Statement on
Form S-1 (No. 333-55935) dated July 16, 1999 relating to the consolidated
financial statements and financial statements schedule for the three years ended
December 31, 1998 listed in Part II, Item 8 of this Annual Report on Form 10-K.
We also consent to the incorporated references to us under the heading "Item 6
- -- Selected Financial Data" in this Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
July 16, 1999
<PAGE> 1
Exhibit 23.2 Consent of Hansen, Jergenson, Nergaard & Co., LLP
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporated references to our firm under the captions
"Item 6 -- Selected Financial Data" and "Item 9 -- Changes in and Disagreements
With Accountants on Accounting and Financial Disclosure" in this Annual Report
on Form 10-K.
/s/ Hansen, Jergenson, Nergaard & Co. LLP
Minneapolis, Minnesota
July 16, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,797,724
<SECURITIES> 0
<RECEIVABLES> 15,714,174
<ALLOWANCES> 84,214
<INVENTORY> 6,694,870
<CURRENT-ASSETS> 25,407,744
<PP&E> 3,728,216
<DEPRECIATION> 1,261,270
<TOTAL-ASSETS> 32,143,877
<CURRENT-LIABILITIES> 18,731,198
<BONDS> 0
19,059,410
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 32,143,877
<SALES> 87,951,650
<TOTAL-REVENUES> 87,951,650
<CGS> 65,739,837
<TOTAL-COSTS> 15,252,058
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 280,555
<INCOME-PRETAX> 6,679,200
<INCOME-TAX> 147,746
<INCOME-CONTINUING> 6,531,454
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,531,454
<EPS-BASIC> 0.93
<EPS-DILUTED> 0.93
</TABLE>
<PAGE> 1
EXHIBIT 99.1
TERMINATION OF S CORPORATION STATUS AND PUT OPTION AND DIVIDEND POLICY
In January 1988, the Company elected to be treated as an S corporation and
since then has been, and through the closing date of the offering will be,
subject to taxation under Subchapter S of the Code and comparable state tax
regulations. As a result, the Company's earnings have been taxed for federal and
state income tax purposes directly to the stockholders rather than to the
Company. Upon conversion from S corporation to C corporation status, the Company
will become subject to federal and state corporate income taxes.
In connection with the termination of the Company's S corporation status
upon the closing of this offering, the Company will make a distribution to the
current stockholders of all previously taxed, but undistributed, S corporation
earnings of the Company. As of June 30, 1999, such earnings were estimated at
approximately $8.6 million. The actual amount of the distribution will be
adjusted to reflect the taxable income and any stockholder distributions from
July 1, 1999 through the termination of the S corporation status. Following the
termination of its S corporation status, the Company will record a net deferred
tax liability on its balance sheet which will ultimately reduce stockholders'
equity. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations" and Note 3 of the Notes to the
Company's Consolidated Financial Statements.
The Company is obligated to redeem shares of the Company's Common Stock
held by its current stockholders upon the occurrence of certain events. Because
the Company's Common Stock is subject to these put options, the accreted value
of the Common Stock has been excluded from stockholders' equity. These put
options will be terminated contemporaneously with the closing of this offering.
See "Selected Historical Financial Data," "Capitalization" and Notes 3 and 9 of
the Notes to the Company's Consolidated Financial Statements.
The Company currently intends to retain any net income for use in its
business and does not anticipate paying any cash dividends on its capital stock
in the foreseeable future other than in connection with the termination of the
Company's S corporation status. Any future declaration and payment of dividends
will be subject to the discretion of the Company's Board of Directors, will be
subject to applicable law and will depend upon the Company's results of
operations, earnings, financial condition, cash requirements, future prospects
and other factors deemed relevant by the Board of Directors. In addition, the
Credit Agreement prohibits the Company from paying dividends to C corporation
stockholders.
13
<PAGE> 2
SELECTED HISTORICAL FINANCIAL DATA
The following table sets forth certain selected historical financial data
of Datalink as of and for each of the five years in the period ended December
31, 1998 and as of June 30, 1999 and for the six month periods ended June 30,
1998 and 1999. The selected historical financial data as of December 31, 1995,
1996, 1997 and 1998 and for each of the four years in the period ended December
31, 1998 have been derived from the historical financial statements of Datalink,
audited by PricewaterhouseCoopers LLP, independent accountants. The selected
historical financial data as of and for the year ended December 31, 1994 have
been derived from the historical financial statements of Datalink, audited by
Hansen, Jergenson, Nergaard & Co., L.L.P. The selected historical financial data
as of June 30, 1999 and for the six month periods ended June 30, 1998 and 1999
have been derived from unaudited financial statements of the Company which have
been prepared on the same basis as the audited financial statements and, in the
opinion of the Company, reflect all adjustments necessary (consisting only of
normal recurring adjustments) for the fair presentation of the Company's
financial position and results of operations for such periods. Results for
interim periods are not necessarily representative of the results to be expected
for a full year, and historical results are not necessarily indicative of the
results of operations to be expected in the future. The information contained in
the following table should also be read in conjunction with "Capitalization,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical financial statements and related notes included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------- -----------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales.................... $32,333 $38,048 $54,652 $71,255 $87,952 $36,627 $55,526
Cost of sales................ 25,907 30,356 42,872 55,719 65,740 27,644 41,263
------- ------- ------- ------- ------- ------- -------
Gross profit............... 6,426 7,692 11,780 15,536 22,212 8,983 14,263
------- ------- ------- ------- ------- ------- -------
Operating expenses:
Sales and marketing........ 1,891 2,487 3,607 5,191 7,754 3,055 5,533
General and
administrative.......... 1,912 2,118 2,382 3,010 5,403 1,713 3,610
Engineering................ 343 467 633 926 1,362 691 1,390
Offering costs(1).......... 733 173
------- ------- ------- ------- ------- ------- -------
Total operating expenses..... 4,146 5,072 6,622 9,127 15,252 5,459 10,706
------- ------- ------- ------- ------- ------- -------
Operating income............. 2,280 2,620 5,158 6,409 6,960 3,524 3,557
Interest expense, net........ 243 306 286 333 281 105 183
------- ------- ------- ------- ------- ------- -------
Income before income taxes... 2,037 2,314 4,872 6,076 6,679 3,419 3,374
Income tax expense........... 148 (517)
------- ------- ------- ------- ------- ------- -------
Net income(2)................ $ 2,037 $ 2,314 $ 4,872 $ 6,076 $ 6,531 $ 3,419 $ 3,891
======= ======= ======= ======= ======= ======= =======
Historical net income per
share, basic and diluted... $ 0.30 $ 0.34 $ 0.71 $ 0.88 $ 0.93 $ 0.50 $ 0.61
======= ======= ======= ======= ======= ======= =======
Weighted average shares
outstanding, basic and
diluted.................... 6,900 6,900 6,900 6,900 6,993 6,900 6,361
------- ------- ------- ------- ------- ------- -------
Pro forma income taxes(3).... 2,672 1,333 1,417
------- ------- -------
Pro forma net income......... $ 3,860 $ 2,086 $ 2,474
======= ======= =======
Pro forma net income per
share, basic and
diluted(4)................. $ 0.47 $ 0.26 $ 0.33
======= ======= =======
Shares used in computing pro
forma net income per
share(4)................... 8,232 8,139 7,600
======= ======= =======
</TABLE>
17
<PAGE> 3
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
-----------------------------------------------------
PRO FORMA
------------------------------------------
AS OF DECEMBER 31, TERMINATION TERMINATION OF
----------------------------------------------- OF PUT S CORPORATION AS
1994 1995 1996 1997 1998 ACTUAL OPTIONS(5) STATUS(6) ADJUSTED(7)
------- ------- ------- ------- ------- -------- ----------- -------------- -----------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash.................... $ 294 $ 111 $ 222 $ 1,163 $ 2,798 $ -- $ -- $ -- $ 2,965
Working capital......... 2,424 3,003 5,330 6,761 6,677 5,049 5,049 (3,144) 14,641
Total assets............ 9,314 8,689 15,355 18,705 32,144 29,964 29,964 30,411 33,376
Note payable to former
stockholder(8)........ 3,020 3,020 3,020 3,020
Common stock, subject to
put option............ 3,425 5,351 9,339 13,874 19,059 21,419 -- -- --
Stockholders' equity
(deficiency).......... (1,331) (2,286) (3,296) (5,744) (6,341) (11,475) 9,944 842 18,627
</TABLE>
- ------------
(1) Reflects legal, accounting and other costs associated with the Company's
initial public offering, which was postponed due to market conditions.
(2) For the periods presented, the Company was an S corporation and,
accordingly, was not subject to federal and state income taxes. Until its
merger into Datalink in January 1999, DCSI was a C corporation. Accordingly,
a provision for income taxes resulting from the operations of DCSI from the
date of the acquisition, July 15, 1998, through December 31, 1998 is
included in the financial data for the year ended December 31, 1998.
Beginning with the merger of DCSI into Datalink in January of 1999, the
taxable income of DCSI 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 which, net of a current income tax provision
of $63, resulted in a net income tax benefit of $517 for the six month
period ended June 30, 1999.
(3) Pro forma income taxes have been computed as if the Company was subject to
federal and state income taxes for the periods presented, based on the tax
laws in effect during those periods. See Notes 2 and 3 of the Notes to the
Company's Consolidated Financial Statements.
(4) 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 of $7.50 per share (before
deducting the underwriting discounts) to fund a distribution to the current
stockholders of all previously taxed, but undistributed, S Corporation
earnings, estimated at $8,640 had the termination occurred on June 30, 1999.
The Company does not have any common stock equivalents. See "Termination of
S Corporation Status and Put Option and Dividend Policy" and Note 3 of the
Notes to the Company's Consolidated Financial Statements.
(5) Adjusted to give pro forma effect to the reclassification of the Company's
Common Stock subject to put option into stockholders' equity, reflecting
termination of these put options upon the closing of this offering. See
"Termination of S Corporation Status and Put Option and Dividend Policy" and
Note 9 of the Notes to the Company's Consolidated Financial Statements.
(6) Adjusted to give pro forma effect to (i) the pro forma adjustment described
in (5) above, (ii) a final S corporation distribution payable to the current
stockholders, representing all previously taxed, but undistributed, S
corporation earnings, estimated at $8,640 had the termination occurred on
June 30, 1999 and (iii) a net deferred tax liability which will be recorded
by the Company as a result of the termination of its S corporation status,
estimated at $462 had such termination occurred on June 30, 1999. See
"Termination of S Corporation Status and Put Option and Dividend Policy" and
Note 3 of the Notes to the Company's Consolidated Financial Statements.
(7) Adjusted to give effect to (i) the pro forma adjustments described in (6)
above and (ii) the sale by the Company of 2,600 shares of Common Stock
offered hereby and the application of the estimated net proceeds therefrom.
See "Use of Proceeds" and "Capitalization."
(8) Reflects a $3,020 note issued to a former stockholder of the Company in
connection with the redemption of 1,096 shares of the Company's Common
Stock, effective February 28, 1999. See Note 9 of Notes to the Company's
Consolidated Financial Statements.
18
<PAGE> 4
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 networked
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.
19
<PAGE> 5
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>
SIX MONTHS
ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------- -----------------
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 75.5 74.3
----- ----- ----- ----- -----
Gross profit.................................. 21.6 21.8 25.2 24.5 25.7
----- ----- ----- ----- -----
Operating expenses:
Sales and marketing........................... 6.6 7.3 8.8 8.3 10.0
General and administrative.................... 4.4 4.2 6.1 4.7 6.5
Engineering................................... 1.2 1.3 1.6 1.9 2.5
Offering costs................................ 0.8 0.3
----- ----- ----- ----- -----
Total operating expenses................... 12.2 12.8 17.3 14.9 19.3
----- ----- ----- ----- -----
Operating income................................ 9.4% 9.0% 7.9% 9.6% 6.4%
===== ===== ===== ===== =====
</TABLE>
COMPARISON OF SIX MONTHS ENDED JUNE 30, 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 $18.9
million, or 51.6%, to $55.5 million for the six months ended June 30, 1999, from
$36.6 million for the comparable period in 1998. The increased sales were
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 six months ended June 30, 1999, from 24.5% 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 10.0% of net sales for the six months ended June
30, 1999, compared to 8.3% of net sales for the comparable period in 1998. The
Company has incurred increased costs relating to the hiring of 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.
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 six months ended June 30,
1999, compared to 4.7% of net sales for the comparable period in 1998. Of the
increased general and administrative expenses, approximately $397,561 or 0.7% of
net sales for the six months ended June 30, 1999 was
20
<PAGE> 6
amortization of identifiable intangible 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 and communications 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
and professional services expenses 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 2.5% of net sales for the six months ended June 30, 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 6.4% of net sales for the six
months ended June 30, 1999 compared to 9.6% for the comparable period in 1998.
The Company's operating income as a percentage of net sales in the 1999 period
would have been 6.7% if the expenses related to offering costs were excluded.
The higher gross profit margin in 1999 was offset by increased operating
expenses. 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 $63,000, resulted in a net income tax benefit of
$517,000 for the six month period ended June 30, 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 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.
21
<PAGE> 7
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 and second
quarters 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 JUN. 30
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............ $23,485 $27,840 $25,682 $29,844
Gross profit......... 6,000 7,229 6,611 7,652
Operating income..... 1,622 1,814 1,443 2,114
Net income........... 1,265 1,847 1,925 1,966
</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> 8
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 $5.0 million, $6.7 million and $6.8 million at
June 30, 1999 and December 31, 1998 and 1997, respectively. The Company's
current ratio was 1.3, 1.4 and 1.6 at June 30, 1999 and December 31, 1998 and
1997, respectively.
Cash used in operating activities was $1.9 million for the six months ended
June 30, 1999. The use of cash in operating activities during the first six
months of 1999 was primarily due to payment of accounts payable. The high level
of accounts payable at December 31, 1998 was generated by the purchase of
inventory to support the Company's sales at calendar year end which were
particularly strong. Additionally, at the end of 1998, certain payments to
vendors were delayed as a result of the integration of the Company's and DCSI's
accounting operations. Cash used in investing activities was $397,000 for the
six months ended June 30, 1999 resulting from the Company's purchases of new
computer equipment. Cash used in financing activities was $537,000 for the six
months ended June 30, 1999. The cash used in financing activities was due to
$3.6 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 offset by borrowings under the Credit Agreement and a
book cash overdraft of $147,000.
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 June 30, 1999, the Company's borrowings consisted of $6.2 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 June 30, 1999, such earnings were estimated at
approximately $8.6 million. The actual amount of the distribution will be
adjusted to reflect the taxable income and any stockholder distributions from
July 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
23
<PAGE> 9
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.
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
24
<PAGE> 10
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.
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> 11
BUSINESS
THE COMPANY
Datalink analyzes, custom designs, integrates or assembles, installs and
supports high-end Open Systems storage solutions for end-users, VARs and OEMs.
Datalink has become a leading independent networked storage solutions provider
by matching its technical expertise and quality products with comprehensive
service and support to meet each customer's specific needs. The Company's
storage solutions are designed to provide the optimal combination of
performance, capacity, high availability, disaster recovery, multi-platform
support, permanence, scalability, centralized management and cost.
INDUSTRY OVERVIEW
The reliable access to and management of data is critical and represents a
key competitive advantage to business, government, educational and nonprofit
organizations. In recent years, virtually all organizations have increased their
use of computers for collecting, analyzing and distributing information to
improve productivity. Historically, most computing environments were controlled
by expensive, host-based mainframes and minicomputers having proprietary
operating systems ("Closed Systems"). In a Closed Systems computing environment,
end-user applications were limited by the hardware and operating system
architectures offered by the manufacturer. As the number of applications grew
and the need to distribute computing power directly to users became increasingly
important, organizational demand for an appropriate systems solution dictated
operating architectures linking multiple application, file, database and
communications servers to networked computers ("Open Systems"). The increased
use of Open Systems hardware and software computing environments creates the
need for flexible and comprehensive data storage solutions capable of serving
multiple and evolving computer platforms. Open Systems architecture permits
organizations to utilize hardware and software products from various suppliers
in order to share, manage and protect mission critical information throughout
the organization.
In addition to the challenges presented by the Open Systems computing
environment, computer processing power has continued to increase at a rapid rate
with the ongoing introduction of new and more powerful central processing units
("CPUs"). Application software developers are taking advantage of CPU
advancements by introducing powerful, easier to use, graphically oriented,
memory intensive software packages. These software applications have resulted in
the automation of an increasing number of mission-critical business
applications, including on-line transaction processing, the Internet, intranets,
pre-press, multimedia, imaging and data warehousing. This automation expands the
need for on-line storage, uninterrupted access to data and fail-safe methods to
backup and archive such data. Although substantial, the increase in storage
device performance has lagged the increase in processing power, creating an
input/output performance gap that continues to widen. This performance gap has
increased the need for high performance storage systems that accelerate on-line
access to stored data while providing continuous protection of this data.
The increasing demand for and complexity of information storage systems has
outpaced the ability of in-house MIS departments to adequately serve their
organizations. Accordingly, organizations rely on external providers to
research, design, implement and support information storage solutions that
incorporate the best hardware and software technologies available and are
compatible with organizations' often large and complex computer networks and
operating system architectures. At the same time, reduced profit margins have
led suppliers to downsize their sales and marketing forces. As a result, both
customers and suppliers increasingly seek independent solutions providers, such
as Datalink, with knowledge and experience in Open Systems data storage.
As Open Systems information storage needs continue to grow, industry
experts predict the increasing deployment of SANs which will link physically
separated storage and backup devices to servers and each other through a
dedicated, high-speed network. The Company believes that SANs will be enabled
principally by Fibre Channel technology. Fibre Channel allows high speed
connections of up to 100 MB per second each between and among a greater number
of hosts and storage technologies on the SAN. The Company expects that SANs will
enable organizations to implement scaleable storage and backup solutions that
are faster,
26
<PAGE> 12
easier to manage and protect, offer a higher degree of data availability and can
be shared by a greater multiple of servers than current distributed Open Systems
storage systems.
According to IDC, the worldwide market for SAN hubs and switches was
approximately $0.1 billion in 1998 and is expected to grow at an annual compound
rate of 109% to approximately $1.9 billion by 2002. According to Dataquest, the
worldwide RAID storage market for UNIX and Windows NT operating platforms was
approximately $15.0 billion in 1998 and is expected to grow at an annual
compound rate of 22% to approximately $39.8 billion by 2003. According to SRC,
an independent market research firm, the worldwide market for tape automation
backup storage products was approximately $1.6 billion in 1996 and is expected
to grow at an annual compound rate of 18% to approximately $4.4 billion by 2002.
According to Dataquest, the worldwide storage management software market was
approximately $2.6 billion in 1998 and is expected to grow at an annual compound
rate of 21% to approximately $6.6 billion by 2003.
THE DATALINK SOLUTION
Datalink analyzes, custom designs, integrates or assembles, installs and
supports high-end Open Systems storage solutions for end-users, VARs and OEMs.
Datalink has become a leading independent storage solutions provider by matching
its technical expertise and quality products with comprehensive service and
support to meet each customer's specific needs. The Company's storage solutions
are designed to provide the optimal combination of performance, capacity, high
availability, disaster recovery, multi-platform support, permanence,
scalability, centralized management and cost. Datalink's strengths include the
following:
Comprehensive Storage Solutions. As a leading independent information
storage solutions provider, Datalink tailors state-of-the-art information
storage systems to meet the specific needs of each end-user, VAR and OEM. The
Company does not manufacture products, but rather works closely with end-users
and VARs to assess their information storage and retrieval requirements and then
designs, integrates, installs and supports information storage solutions.
Datalink's solutions incorporate the best available hardware and software
products on the market from technological leaders including ATL Products, Inc.,
a division of Quantum Corporation, Brocade Communication Systems, Inc.,
CLARiiON, a division of Data General Corporation, Computer Network Technology
Corp., Hitachi Data Systems Corporation, Legato Systems, Inc., Network
Appliance, Inc., Storage Technology Corporation and VERITAS Software
Corporation. For OEM customers, Datalink's team of design and application
engineers custom design and test storage subsystems. The Company assembles these
products for integration into the OEM's own products. Datalink's storage
solutions incorporate a broad range of scaleable and high-performance
technologies including SAN, NAS, RAID, hard disk, magnetic tape, CD-ROM and
optical storage products. The Company also matches storage management software
technologies, including backup and recovery, disaster recovery, HSM, archive,
management and configuration, high availability and media management products,
to the specific needs of its customers. Datalink's expertise extends to all
major Open Systems operating systems and hardware platforms.
Technological Leadership. Datalink provides a high level of technical
expertise to its customers through its 34 technical services professionals. The
Company's engineers each specialize in Open Systems operating platforms and
technologies, affording the in-depth knowledge and hands-on experience required
to provide comprehensive Open Systems storage solutions. The engineers
continually evaluate and test emerging and existing technologies to ensure the
Company consistently delivers the best available hardware and software products
to its customers. Because of Datalink's established, strong relationships with
the major information storage hardware and software suppliers, the Company often
participates in suppliers' new product development, evaluation, introduction,
marketing and quality control programs. This collaboration with suppliers
enables the Company to identify and market innovative new hardware and software
products, exchange critical information and implement joint corrective action
programs in order to maximize quality.
Superior Service and Technical Support. Datalink's engineers work closely
with the field account executives and inside sales representatives to provide
superior technical design and support services. To serve its customers' needs,
Datalink operates 20 locations throughout the United States, ten of which also
serve as regional technical centers with in-house engineering capabilities.
Datalink further differentiates itself by maintaining ISO 9001 registration for
its principal facility. The Company utilizes ISO 9001 standards
27
<PAGE> 13
throughout its organization to consistently maintain high quality design,
development, integration and manufacturing, installation and service processes.
The Company's emphasis on providing high quality customer services enhances its
sales and marketing efforts and supplier relationships.
BUSINESS STRATEGY
Datalink's objective is to grow at a rate exceeding that of the industry
and to strengthen its position as a leading independent Open Systems storage
solutions provider. To achieve this objective, the Company intends to build upon
its record of successfully addressing the evolving information storage
management needs of its customers. Key elements of this strategy are:
Leverage Market Presence. Datalink intends to expand its business by
broadening its relationships with existing customers and by utilizing its market
presence and technical expertise to attract new customers. The Company believes
that the longevity of service of its sales representatives and engineering staff
will continue to be critical to building and maintaining long-term, trusting
relationships with Datalink's existing and prospective customers. In addition,
the Company's broad experience in a diverse group of data intensive industries
enables Datalink to understand application and business issues specific to
customers operating within a given industry and to design and implement the
appropriate storage solution.
Maintain Technological Leadership. Datalink intends to continue to develop
leading-edge networked storage solutions for its customers. Datalink intends to
continually develop and add expertise to its engineering staff and to continue
its close working relationships with its suppliers in order to maintain
expertise in Open Systems storage solution design and implementation.
Provide Professional Consulting and Project Management Services. Datalink
intends to continue expanding its ability to provide its customers with
comprehensive professional consulting and project management services. Utilizing
the expertise of its professional engineers, Datalink assists its customers in
the total assessment, planning, design, implementation and ongoing management of
enterprise-wide networked data storage solutions.
Expand Geographically. Datalink intends to continue its geographic
expansion throughout the United States and believes significant opportunity also
exists to serve the global data storage needs of its multinational corporate
customers and prospective customers. The Company intends to expand by opening
new sales and regional technical center offices, by adding personnel to existing
offices and by acquiring businesses perceived by management to complement the
Company's strategic business objectives. Since January 1998, Datalink has
increased the number of its regional offices from nine to 19, including its
expansion into the southeastern United States as a result of the July 1998
acquisition of DCSI.
Maintain Superior Service and Support. Datalink intends to maintain and
continually improve its high standards for superior technical and sales service
and support. The Company intends to continue use of its ISO 9001 quality system
and procedures and to continue recruiting and retaining experienced sales and
technical team members.
TECHNICAL SERVICES AND PROJECT MANAGEMENT
Datalink's engineers, technicians and customer support personnel take an
active role in all phases of designing, delivering and supporting networked
storage solutions for the Company's customers in a manner that maximizes system
availability and performance. The Company combines its Open Systems experience,
high level technical skills and responsiveness to provide its customers with the
utmost in comprehensive service, training and support. Datalink's technical
support and customer service functions operate under ISO 9001 standards of
operation to ensure the highest quality.
End-User and VAR Services. Datalink's engineers work closely with the field
account executives and inside sales representatives to determine each customer's
specific needs. After gaining a thorough understanding of the customers' needs,
Datalink's engineers analyze available hardware and software technologies and,
together with the field account executives, develop a specifically tailored,
state-of-the-art networked storage solution. In order to assure quality, the
Datalink technical team performs the installation, customer specific
configuration and functional testing of each networked storage solution. Once
installation is complete, Datalink's engineers conduct comprehensive, on-site
storage solution training for customers and provide
28
<PAGE> 14
ongoing technical support. In addition, the Company periodically provides
advanced in-house and out service training courses.
OEM Services. Datalink's engineering team enhances the capabilities of its
OEM customers by designing custom storage subassemblies and enclosures to each
customers' specifications. When requested by the customer, Datalink obtains the
necessary agency and governmental approvals relating to safety and radio
frequency emissions and immunity (including Underwriter's Laboratory and
European "CE" certifications) for the subassemblies it designs. Datalink fully
documents all custom subassemblies for ease of replication and service.
Technical Support. Datalink's technical support services provide
comprehensive, proactive and responsive assistance. The Company's customer help
desk acts as a single point of contact during regular business hours for all
ongoing support, repair and maintenance services. The help desk is staffed by
technical support analysts trained to solve technical issues and to assist the
Company's engineering staff in troubleshooting escalated problems. The help desk
staff also acts as Datalink's primary interface with suppliers' technical
support organizations.
Datalink's team of engineers augments the help desk staff in providing
advanced technical support when required. Each engineer specializes in Open
Systems operating platforms and technologies, affording the in-depth knowledge
and hands-on experience required to provide comprehensive Open Systems storage
solutions.
Maintenance and Repair Services. Datalink supports and administers the
pass-through of its suppliers' own standard warranties which run from one to
five years. In addition, Datalink provides a suite of comprehensive maintenance
and repair service options under the Company's DataCare(TM) service program. The
Company offers a variety of on-site service options, including four-hour
guaranteed response time service seven days per week, 24 hours per day. The
Company contracts with a number of its suppliers and other independent service
organizations to provide on-site maintenance and repair services dispatched by
the Company. For customers that do not have on-site service, Datalink's Advance
Exchange program delivers replacement products and subassemblies on the next
business day.
PRODUCTS
Datalink continually updates its product offerings to incorporate
advancements by its suppliers in storage technology. Datalink's engineering,
sales and marketing teams design creative solutions that include hardware,
software, storage networking and interface products selected in response to each
customer's specific requirements. These products include the following:
Hardware Products. Datalink selects from among a variety of storage
products and subassemblies sold by leading suppliers that offer differing
performance characteristics and costs. These storage products and subassemblies
include SAN and NAS devices, magnetic (hard) disk, magnetic tape and optical
disk storage technologies.
SAN TECHNOLOGIES. A SAN consists of a scalable pool of file or
block-oriented storage connected by Fibre Channel or other dedicated
communication links. This pool of storage resides on its own subnetwork and
can be shared by multiple servers. Ultimately, any server can access any
storage device and storage can be balanced among the storage devices.
Similarly, storage devices can be used to back up each other. SAN
technology offers greater distance, performance, reliability and management
capabilities than other existing technologies.
NAS TECHNOLOGIES. NAS devices use Thin Server technology to translate
block-oriented storage data contained on various data storage devices into
file-oriented storage data usable by end users on their local area network.
NAS technology enables "hot" attachment of storage devices to the network.
HARD DISK TECHNOLOGIES. Hard disk storage is typically used for
on-line, high performance storage of large amounts of information. Hard
disk storage products include disk drives, disk farms and RAID storage
systems. RAID systems allocate data across multiple hard disk drives and
allow the server to access these drives simultaneously, thus increasing
system storage and input/output performance. RAID
29
<PAGE> 15
algorithms allow lost data on any drive to be recreated, thus ensuring the
integrity of RAID-protected data even in the event of a disk drive failure.
In addition, RAID systems can incorporate redundant power, cooling and
processing components for additional fault tolerance. The most advanced
RAID systems now include capabilities to copy data remotely for data
protection. Such advanced systems also enable internal copying of data to
permit the testing of new applications without the risk of destroying the
original data.
MAGNETIC TAPE TECHNOLOGIES. Magnetic tape storage technologies are
typically integrated into environments that require backing up large
amounts of information to protect from accidental data loss and facilitate
disaster recovery. Due to its high capacity and relatively lower cost,
magnetic tape storage is also effective for near on-line, archive and HSM
activities. A variety of tape drive technologies are available, including
those utilizing digital linear tape, advanced intelligent tape ("AIT"), 8mm
tape, 4mm digital data storage ("DDS"), high performance helical scan and
9840 tape technologies. Magnetic tape autoloaders and libraries integrate
multiple tape drives and media cartridges with robotics to increase
capacity and automation.
OPTICAL DISK TECHNOLOGIES. Optical disk technologies are a
cost-effective solution for near on-line and archive storage. Optical disk
technologies include magneto-optical ("MO"), write-once-read-many ("WORM")
and compact disk-read only memory ("CD-ROM") products. Capacities range
from 650 megabytes (CD-ROM) to 5.2 GB (MO optical disk) per cartridge. A
developing optical technology, digital versatile disk ("DVD"), is expected
to offer approximately 7.2 times the storage capacity of a single CD-ROM.
Similar to magnetic tape systems, multiple optical disks can be combined in
a jukebox to permit automated access and increased capacity.
Software Products. Datalink integrates software management tools into its
customer solutions from leading storage software developers. The latest advances
include enterprise storage solutions for backup and recovery, disaster recovery,
HSM, archive, management and configuration, high availability and media
management capabilities. These tools enable system administrators to allocate
the use of storage technologies among user groups or tasks, centrally manage
distributed, networked storage technologies, retrieve, transfer and backup data
from and between several devices, perform "hot" database backups during business
hours, run management reports and establish standard policies. Software
advancements also enable these tools to integrate into centralized management
frameworks. These expanded management capabilities have been enhanced through
the deployment of SANs.
Interface Products. Systems administrators traditionally have connected
storage technologies directly to servers utilizing "point-to-point" connections
via the Small Computer Systems Interface ("SCSI"), and its successor, Ultra
SCSI. Because of distance limitations and limited bandwidth, SCSI-based
connections do not allow storage technologies to be easily shared with other
servers. With the innovation of Fibre Channel, a new serial interface, networks
can transfer data to disk and RAID storage subsystems at higher speeds, over
greatly increased distances and among a greater number of server and other
device connections than through the use of SCSI or Ultra SCSI interfaces.
Datalink currently deploys Fibre Channel interfaces with high-end, hard disk and
RAID storage systems and also with tape drives and libraries through Fibre
Channel to SCSI bridge products.
CUSTOMERS
Datalink serves large end-user, VAR and OEM customers throughout the United
States in a diverse group of data intensive industries. Datalink's broad
industry experience enables the Company to understand application and business
issues specific to each customer and to design and implement appropriate
networked storage solutions. The Company enjoys strong relationships with its
customers, which is reflected in significant
30
<PAGE> 16
repeat business. No single customer represented more than 5% of the Company's
net sales in 1998, 1997 or 1996. Some of the customers of the Company include
the following:
END-USER CUSTOMERS
<TABLE>
<CAPTION>
COMPUTER TECHNOLOGY CONSUMER PRODUCTS EDUCATION
------------------- ----------------- ---------
<S> <C> <C>
Gateway 2000, Inc. Dayton Hudson Corporation University of Chicago
Imation, Inc. Michelin Tire Corp. University of Minnesota
Silicon Graphics Tyson Foods Corp. University of Washington
</TABLE>
<TABLE>
<CAPTION>
FINANCIAL SERVICES GOVERNMENT HEALTH CARE
------------------ ---------- -----------
<S> <C> <C>
Chicago Board of Trade Fermi National Accelerator Laboratory Baptist Memorial Healthcare
Edward Jones National Aeronautics Space Eli Lilly and Company
Administration
Swiss Bank Corporation United States Coast Guard Mayo Clinic Foundation
</TABLE>
<TABLE>
<CAPTION>
INSURANCE INTERNET SERVICE PROVIDERS PROFESSIONAL SERVICES
--------- -------------------------- ---------------------
<S> <C> <C>
CNA Financial Corporation BellSouth.net Comdisco, Inc.
SAFECO Corporation GTE Internetworking/BBN IBM Global Services
The Kemper Insurance Companies HotOffice Technologies, Inc. KPMG Peat Marwick LLP
</TABLE>
<TABLE>
<CAPTION>
TELECOMMUNICATIONS TRANSPORTATION UTILITIES
------------------ -------------- ---------
<S> <C> <C>
Ameritech Corp. The Boeing Company Florida Power Corporation
Motorola, Inc. Northwest Airlines Corporation Dominion Resources, Inc.
Sprint Corporation UAL Corporation Northern States Power Company
</TABLE>
VAR CUSTOMERS
<TABLE>
<S> <C> <C>
Andersen Worldwide, S.C. Electronic Data Systems McKesson HBOC Inc.
Corporation
Computerized Medical Systems Forsythe McArthur Associates Inacom Corp.
</TABLE>
OEM CUSTOMERS
<TABLE>
<S> <C> <C>
GE Medical Systems Lucent Technologies, Inc. Rockwell International Corporation
Lockheed Martin Corporation National Computer Systems, Inc. Siemens Medical Systems, Inc.
</TABLE>
31
<PAGE> 17
SALES AND MARKETING
The Company markets and sells its products and services throughout the
United States primarily through a direct sales force. The 34 field account
executives are teamed with 21 inside sales representatives. In addition to its
Minneapolis headquarters, the Company has 19 field sales offices in order to
serve its customers' needs more efficiently. Nine of the field sales offices
serve as regional technical centers and are staffed with their own engineers.
These field sales offices are located in the following metropolitan areas:
<TABLE>
<CAPTION>
FIELD LOCATION YEAR ESTABLISHED
-------------- ----------------
<S> <C>
Chicago, Illinois........................................... 1989
St. Louis, Missouri......................................... 1990
Milwaukee, Wisconsin........................................ 1992
Seattle, Washington......................................... 1992
Atlanta, Georgia............................................ 1993*
Charlotte, North Carolina................................... 1995*
Grand Rapids, Michigan...................................... 1995
Indianapolis, Indiana....................................... 1995
Washington, D.C. ........................................... 1996
Denver, Colorado............................................ 1997
Melbourne, Florida.......................................... 1997*
New York, New York.......................................... 1997
Tampa, Florida.............................................. 1997*
San Jose, California........................................ 1998
Boston, Massachusetts....................................... 1998
Birmingham, Alabama......................................... 1998
Nashville, Tennessee........................................ 1998
Los Angeles, California..................................... 1998
Phoenix, Arizona............................................ 1999
</TABLE>
- ------------
* Represents a field office acquired by Datalink in July 1998 as a result of
the DCSI acquisition.
The field account executives and inside sales representatives work closely
with the Company's engineering team in evaluating the Open Systems storage needs
of existing and prospective customers and in designing high quality, cost
effective solutions. To ensure quality service, Datalink assigns each customer a
specific field account executive and inside sales representative. The inside
sales representatives proactively share responsibility with the field account
executives in soliciting new and repeat business and in maintaining consistent
customer contact. The Company believes that the longevity of service of its
sales force is a key factor to earning and retaining the trust and confidence of
the Company's customers and differentiates Datalink from many other storage
solution providers that have greater sales force turnover.
In addition to the efforts of its field account executives and inside sales
representatives, Datalink engages in a variety of other marketing activities
designed to attract new business and retain customer loyalty. The Company
regularly attends major trade shows, conducts in-house and out service training
and informational seminars, publishes a quarterly newsletter and advertises its
services in several targeted national business publications.
INTEGRATION AND ASSEMBLY OPERATIONS
Datalink assembles and integrates hardware and software products and
subassemblies acquired from the Company's various suppliers. The Company designs
customized enclosures for most OEM products. The assembled units are then
subjected to a system level test to ensure performance to specifications in the
anticipated end-user computing environment. The Company's integration and
assembly operations are also ISO 9001 registered. In accordance with these
standards, the Company has designed its integration and assembly operations with
similar quality procedures to those of its hardware suppliers. Datalink's close
working relationship with its suppliers generally enables the Company to
exchange critical information and
32
<PAGE> 18
implement joint corrective action programs to ensure the quality of its finished
products, to reduce costs and the investment in inventory and to access critical
products and subassemblies for large or unanticipated orders when required. The
Company believes that its current facilities are adequate to meet its
integration and assembly needs in the foreseeable future.
ISO 9001 QUALITY SYSTEM
In May 1996, Datalink completed an approximately three-year process of
obtaining an ISO 9001 Certificate of Registration from KPMG Quality Registrar
for its quality system described under the American National Standards
Institute. This internationally recognized endorsement of ongoing quality
management is designed to assure consistent quality products and services. The
Company believes its ISO 9001 registration represents a substantial competitive
advantage to Datalink in attracting and retaining business.
Datalink employs ISO 9001 standards of operation for its design,
development, integration and assembly, installation and service processes. These
quality initiatives streamline the quality assurance programs and implementation
procedures for the Company's customers. Datalink's quality assurance team
constantly monitors the Company's processes and procedures, identifies areas for
improvement and efficiently implements corrective and preventive actions.
Suppliers to the Company are required to be ISO 9001 registered or otherwise
meet Datalink's rigid supplier qualification standards.
SUPPLIER RELATIONSHIPS
As an independent solutions provider, Datalink continually evaluates and
tests new and emerging technologies from other companies to ensure that the
Company's solutions incorporate state-of-the-art, high-end, cost-effective Open
Systems technologies. This enables Datalink to maintain its technological
leadership in Open Systems storage solutions, to identify new and innovative
products and applications and to maintain confidence among the Company's
customers and suppliers in the Company's expertise.
Datalink has strong, established relationships with the major information
storage hardware and software suppliers. The Company's expertise in Open System
environments, including UNIX, Windows NT and Novell NetWare, and in-depth
knowledge of all major hardware platforms, including Digital, Hewlett-Packard,
IBM, Silicon Graphics and Sun, has earned Datalink preferred status with its
principal suppliers. This enables the Company to often participate in these
suppliers' new product development, evaluation, introduction, marketing and
quality control programs. These collaborations enable the Company to identify
and market innovative new hardware and software products, exchange critical
information and implement joint corrective action programs in order to maximize
quality. In addition, the Company's close working relationships with its
principal suppliers fosters substantial cross-marketing opportunities.
Datalink's strategic suppliers include the following:
<TABLE>
<CAPTION>
TECHNOLOGY STRATEGIC SUPPLIER
- ---------- ------------------
<S> <C>
SAN Hardware Brocade Communication Systems, Inc.
Computer Network Technology Corp.
NAS Products Network Appliance, Inc.
RAID Technologies CLARiiON, a division of Data General Corporation
Hitachi Data Systems Corporation
Storage Management Software Legato Systems, Inc.
VERITAS Software Corporation
Tape Automation Products ATL Products, Inc., a division of Quantum
Corporation
Storage Technology Corporation
Optical Technologies NSM Jukebox GmbH
Plasmon IDE, Inc.
</TABLE>
33
<PAGE> 19
COMPETITION
The market for Open Systems storage is intensely competitive. Datalink
competes against independent storage system suppliers to the high-end Open
Systems market, including Box Hill Systems Corp., EMC Corporation, MTI
Technology Corporation and numerous VARs, resellers, distributors and
consultants. The Company also competes in the storage systems market with
general purpose computer suppliers such as Compaq, Dell, Hewlett-Packard, IBM,
Silicon Graphics and Sun. In addition, the Company's customers and prospective
customers may elect to develop in-house storage systems expertise.
Many of the Company's current and potential competitors have significantly
greater financial, technical, marketing, purchasing and other resources than the
Company, and as a result, may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, to devote greater resources
to the development, promotion and sale of products than the Company or to
deliver competitive products at a lower end-user price. Some of Datalink's
competitors include its suppliers, who may dedicate or acquire greater sales and
marketing resources in the future to provide Open Systems storage solutions than
at present and could terminate their relationships with the Company. Other
suppliers may also enter the market and compete with the Company. Datalink
expects competition will increase as a result of industry consolidation. Current
and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of the Company's prospective customers.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. Increased competition
may result in price reductions, reduced operating margins and loss of market
share, any of which could have a material adverse effect on the Company's
business, operating results or financial condition. See "Risk
Factors--Competition."
EMPLOYEES
As of July 15, 1999, Datalink had a total of 135 full-time employees, of
whom 34 were engaged in engineering and technical support, 65 were engaged in
sales and marketing and 36 were engaged in customer service, integration and
assembly operations and general management and administration. The Company's
future performance depends in significant part upon the continued service of its
key technical and senior management personnel. None of the Company's employees
are unionized or subject to a collective bargaining agreement. The Company has
experienced no work stoppages and believes that its employee relations are good.
FACILITIES
Datalink's principal engineering operations and its integration, assembly
and customer service operations are located at the Company's 37,200 square foot,
leased executive and administrative facility in Minneapolis, Minnesota. The
leases, which expire in December 2002, provide the Company with certain rights
to take additional space in the building. The Company's landlord is a
partnership whose partners primarily consist of Datalink's current stockholders.
See "Certain Transactions." The Company also leases certain remote facilities
for its field sales and engineering personnel. Datalink believes that these
facilities are adequate for its needs in the foreseeable future and that it will
be able to locate suitable additional facilities as the Company expands
geographically.
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<PAGE> 20
MANAGEMENT
The names and ages of the executive officers and directors of the Company,
and their positions and offices presently held, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Greg R. Meland............................ 46 President, Chief Executive Officer and
Director
Daniel J. Kinsella........................ 40 Chief Financial Officer
Stephen M. Howe........................... 41 Vice President--Sales
Scott D. Robinson......................... 39 Vice President--Engineering
Michael J. Jaeb........................... 49 Vice President--Operations and
Administration
Robert M. Price........................... 68 Chairman of the Board and Director
James E. Ousley*.......................... 53 Director
Margaret A. Loftus*....................... 54 Director
Paul F. Lidsky*........................... 45 Director
</TABLE>
- ------------
* Member of Audit and Compensation Committees.
Greg R. Meland joined Datalink in 1991 as its Vice President of Sales and
Engineering and became President and Chief Executive Officer in 1993. Between
1979 and 1991, Mr. Meland served in various sales and marketing positions with
the Imprimis disk drive subsidiary of Control Data Corporation (which was sold
to Seagate in 1989), most recently as the North Central U.S. Director of Sales.
Daniel J. Kinsella joined Datalink in 1999 as its Chief Financial Officer.
Between 1998 and 1999, he was Chief Financial Officer of Lloyd's Barbeque
Company. Mr. Kinsella served in various finance roles for Grist Mill Company
between 1989 and 1998, most recently as its Chief Financial Officer, Treasurer
and Secretary. From 1984 to 1989, Mr. Kinsella was the Director of Financial
Reporting for Inter-Regional Financial Group, Inc. Between 1980 and 1984, he was
employed by Touche Ross & Company, most recently as an audit manager. Mr.
Kinsella is a Certified Public Accountant.
Stephen M. Howe joined Datalink in 1989 as a field account executive and
became Vice President--Sales in 1997. Between 1982 and 1989, he was employed by
Teltrend Inc., a telecommunications equipment manufacturer, most recently as
Assistant Vice President of Operations. Mr. Howe was a sales representative for
Hamilton Avnet Corp., an electronics distributor, between 1980 and 1982.
Scott D. Robinson joined Datalink in 1989 as its Chief Engineer and became
Vice President--Engineering in 1993. Between 1983 and 1989, he was employed by
Minnesota Mining and Manufacturing Company, most recently as an Advanced
Electrical Engineer in the Digital Imaging Applications Center. Mr. Robinson
received his B.S. in Electrical Engineering in 1982 from Marquette University
and his M.S. in Electrical Engineering in 1989 from the University of Minnesota.
Michael J. Jaeb joined Datalink in 1999 as its Vice President--Operations
and Administration. Between 1987 and 1999, Mr. Jaeb was employed with Aetrium
Incorporated, a manufacturer of semiconductor test handling and reliability test
equipment, most recently as Corporate Vice President of Human Resources and
Administration. From 1979 to 1987, he held various professional and management
positions with Control Data Corporation, Micro Component Technology, Inc. and
Varitronics, Inc.
Robert M. Price was elected as the Chairman of the Board and a director of
Datalink in June 1998. Mr. Price has been President of PSV, Inc., a technology
consulting business located in Burnsville, Minnesota, since 1990. Between 1961
and 1990, he served in various executive positions, including as Chairman and
Chief Executive Officer, with Control Data Corporation. Mr. Price also serves on
the Board of Directors of International Multifoods Corporation, Tupperware
Incorporated, Fourth Shift Corporation, Affinity Technology Group, Inc., and
Public Service Company of New Mexico. Mr. Price is Mr. Meland's father-in-law.
James E. Ousley was elected as a director of Datalink in June 1998. Since
1992, Mr. Ousley has been President and Chief Executive Officer of Control Data
Systems, Inc., a leading systems integrator and provider of electronic commerce
solutions. Between 1968 and 1992, Mr. Ousley served in various sales,
35
<PAGE> 21
marketing and operational executive positions with Control Data Corporation,
most recently as President of the Computer Products Group. Mr. Ousley is also a
director of Bell Microproducts, Inc. and ActiveCard, Inc.
Margaret A. Loftus was elected as a director in June 1998. Ms. Loftus is an
owner in Loftus Brown-Wescott, Inc., a business consulting firm, which she
co-founded in 1989. Between 1976 and 1988, she was employed by Cray Research,
Inc., most recently as Vice President of Software. Ms. Loftus is also a director
of Analysts International Corporation.
Paul F. Lidsky was elected as a director of Datalink in June 1998. Since
1997, Mr. Lidsky has been the President and Chief Executive Officer of OneLink
Communications, Inc., a telecommunications company. Between 1992 and 1997, Mr.
Lidsky was employed by Norstan, Inc., a comprehensive technology services
company, most recently as Executive Vice President of Strategy and Business
Development. Mr. Lidsky is also a director of OneLink Communications, Inc. and
Ancor Communications, Incorporated.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has established a Compensation Committee and an
Audit Committee. Mr. Ousley, Ms. Loftus and Mr. Lidsky are the members of the
Compensation and Audit Committees. The Compensation Committee will review on
behalf of, and make recommendations to, the Board of Directors with respect to
the compensation of executive officers and will administer the Company's
Incentive Compensation Plan and make recommendations to the Board of Directors
with respect to the plan and the grant of options to persons eligible under the
plan. The Audit Committee's functions will include recommending to the Board of
Directors the engagement of the Company's independent accountants, assessing the
independence of such accountants and reviewing with such accountants the plans
for and the results and scope of their auditing engagement and certain other
matters relating to their services to the Company.
DIRECTOR COMPENSATION
In June 1999, the Company's Board of Directors authorized the grant,
coincident with the closing of the Company's initial public offering, to each of
Mr. Price, Mr. Ousley, Ms. Loftus and Mr. Lidsky of stock options to purchase
9,000 shares of the Company's Common Stock. Such options, if ultimately granted,
will have exercise prices equal to the initial public offering price per share
on the cover page of this Prospectus. These options, if ultimately granted, will
vest on the date of the closing of this offering and will expire in June 2009.
The Company intends to make an annual grant of 3,000 options commencing on the
date of the Company's 2001 annual stockholders' meeting to nonaffiliated,
nonemployee directors. The subsequent annual options will be exercisable
commencing one year after the date of grant; provided, however, that if a
director fails to serve until the annual stockholder's meeting immediately
succeeding the grant of the options, the number of shares of Common Stock that
may be purchased by such director shall be pro rated based upon the length of
time such departing director actually served. The subsequent annual options will
be exercisable at the fair market value of the Company's Common stock on the
date of grant and expire ten years after the date of grant. All directors will
be reimbursed for expenses incurred in connection with attendance at Board and
committee meetings.
INDEMNIFICATION AGREEMENTS
The Company has entered into an agreement with each director providing for
indemnification to the fullest extent permitted under Minnesota law against
liability for damages and expenses, including attorneys' fees, arising out of
threatened, pending or completed legal actions, suits or proceedings by reason
of the fact that such person is or was a director, officer or employee of the
Company. The agreement will permit the director to demand certain advances
against, or the creation of a trust for, expenses to be incurred in defending
any covered claim. Insofar as the indemnification agreement may cover
liabilities arising under the Securities Act the Company has been advised that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
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<PAGE> 22
EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth certain
information regarding compensation paid during each of the Company's last three
years to (i) the Company's Chief Executive Officer and (ii) the Company's other
executive officers whose salary, bonus and other compensation exceeded $100,000
in 1998.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-----------------------------------
OTHER ANNUAL ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY COMPENSATION(1) COMPENSATION(2)
--------------------------- ---- -------- --------------- ---------------
<S> <C> <C> <C> <C>
Greg R. Meland,.......................... 1998 $250,000 $ 23,000 $8,000
President and Chief Executive Officer(3) 1997 83,000 141,000 7,750
1996 75,000 122,000 7,750
Robert D. DeVere(4)...................... 1998 $124,000 $ 6,000 $6,710
Former Chief Financial Officer 1997 93,000 6,000 5,786
1996 86,000 6,000 5,592
Stephen M. Howe,......................... 1998 $ 90,000 $110,000 $8,814
Vice President--Sales(3) 1997 77,000 113,000 7,750
1996 69,000 94,000 7,706
Scott D. Robinson,....................... 1998 $130,000 $ 6,000 $6,754
Vice President--Engineering 1997 102,000 6,000 5,872
1996 95,000 6,000 5,853
</TABLE>
- ------------
(1) Includes car allowance of $6,000 for each named executive officer.
(2) Represents matching and profit sharing contributions made by the Company to
each named executive officer's account under the Company's 401(k) Plan.
(3) Other annual compensation includes sales commissions for each of these
executive officers.
(4) Effective February 28, 1999, Mr. DeVere resigned from the Company and the
Company redeemed his 1,095,720 shares of Common Stock. See Note 9 of Notes
to the Company's Consolidated Financial Statements.
Employment Arrangements. The Company does not have employment,
non-competition or non-disclosure agreements with any of its executive officers
or employees, other than certain non-competition agreements entered into in
connection with the DCSI acquisition.
STOCK INCENTIVE PLANS
The Company's Employee Stock Purchase Plan (the "Purchase Plan") and the
Incentive Compensation Plan (the "Incentive Compensation Plan" and with the
Purchase Plan collectively referred to as the "Stock Incentive Plans") were
adopted by the Company and its stockholders in June 1998 and June 1999,
respectively. The Stock Incentive Plans provide the employees of the Company an
opportunity to invest in shares of Common Stock. In some instances, these
purchases may be on terms more favorable than would otherwise be available. The
Company believes that, by aligning the interests of the participants and the
Company, the implementation of the Stock Incentive Plans will strengthen the
commitment of the participants to the Company's success.
Purchase Plan. The Company has reserved 250,000 shares of Common Stock for
issuance under the Purchase Plan, subject to equitable adjustments as the
Compensation Committee (as defined above) may deem necessary to prevent dilution
or the enlargement of rights of participants as a result of, among other things,
changes in the Company's capitalization or corporate structure. The Purchase
Plan will be administered by the Compensation Committee and is intended to
qualify under Section 423 of the Code. Pursuant to the Purchase Plan, each
eligible employee, as of the start of any purchase period, will be granted an
option to purchase a designated number of shares of Common Stock. The purchase
price of shares of Common Stock to
37
<PAGE> 23
participating employees will be 85% of the lower of the fair market value of the
Company's Common Stock on the first and last trading days of the relevant
purchase period. Payments for shares purchased under the Purchase Plan will be
made in the time and manner specified by the Compensation Committee. An employee
may terminate his or her participation in the Purchase Plan by giving a notice
of withdrawal to the Company sufficiently in advance of the last trading day of
the relevant purchase period, and all funds contributed to date will be refunded
to such employee.
Employees are eligible to participate in the Purchase Plan if they (i) are
customarily employed by the Company for more than twenty hours per week and five
months in any calendar year and (ii) will not, immediately upon purchasing
shares under the Purchase Plan, own directly or indirectly 5% or more of the
total combined voting power of all outstanding shares of all classes of stock of
the Company. Notwithstanding the foregoing, no employee may purchase shares
under the Purchase Plan (or any other plan of the Company intended to qualify
under Section 423 of the Code) in any calendar year with an aggregate fair
market value (as determined on the first day of the relevant purchase period) in
excess of the lesser of 10% of such employee's salary or the maximum value
allowed under the Code. Participation in the Purchase Plan ends automatically
upon termination of employment with the Company. Rights granted under the
Purchase Plan are not transferable other than by will or the laws of descent and
distribution.
The Board may at any time amend or terminate the Purchase Plan so long as
such amendment or termination does not result in the failure of rights issued
under the Purchase Plan to meet the requirements for employee stock purchase
plans as defined in Section 423 of the Code.
Incentive Compensation Plan. The Company has reserved 1,350,000 shares of
Common Stock for issuance under the Incentive Compensation Plan. The Incentive
Compensation Plan will be administered by the Compensation Committee. The
Compensation Committee will have full authority, subject to the provisions of
the Incentive Compensation Plan, to determine, among other things, the persons
to whom awards under the Incentive Compensation Plan ("Awards") will be made,
the exercise price, vesting, size and type of such Awards, and the specific
performance goals, restrictions on transfer and circumstances for forfeiture
applicable to Awards.
Awards may be made to employees and non-employee directors of the Company
or affiliates and other individuals designated by the Compensation Committee. A
variety of Awards may be granted under the Incentive Compensation Plan including
stock options, stock appreciation rights ("SARs"), restricted stock, performance
shares, performance units, cash-based awards, phantom shares and other
share-based awards as the Compensation Committee may determine. Stock options
granted under the Incentive Compensation Plan may be either incentive stock
options intended to qualify under Section 422 of the Code or nonqualified stock
options not so intended.
Provisions regarding the extent to which a participant shall have the right
to exercise and/or receive payment for any Award following termination of the
participant's employment, directorship or other relationship with the Company
shall be determined at the discretion of the Board. In the event of a "change of
control" (as defined in the Incentive Compensation Plan), (i) all outstanding
options and SARs granted under the Incentive Compensation Plan will become
immediately exercisable and remain exercisable throughout their entire term,
(ii) any performance-based conditions imposed with respect to outstanding Awards
shall be deemed to be fully earned and a pro rata portion of each such
outstanding Award granted for all outstanding performance periods shall become
payable in shares of Common Stock, in the case of Awards denominated in shares
of Common Stock, and in cash, in the case of Awards denominated in cash, with
the remainder of such Award being canceled for no value and (iii) all
restrictions imposed on restricted stock that are not performance-based shall
lapse. The Board may make equitable adjustments, including with respect to the
number and kind of shares issuable under, and the exercise price relating to,
Awards as the Board may deem necessary to prevent dilution or accretion of the
rights of participants under the Incentive Compensation Plan as a result of
changes in the Company's corporate structure or capitalization.
Awards under the Incentive Compensation Plan are not transferable other
than by will or by the laws of descent and distribution, unless otherwise
provided by the Board. The Board may amend or terminate the Incentive
Compensation Plan except that no amendment shall be made without stockholder
approval if such
38
<PAGE> 24
approval is necessary to comply with any applicable regulatory or tax
requirements. Notwithstanding the foregoing, in no event may an Award be granted
under the Incentive Compensation Plan after June 2009.
In June 1999, the Company's Board of Directors authorized the grant to four
non-employee directors, coincident with the closing of the Company's initial
public offering, of options to purchase 36,000 shares of the Company's Common
Stock. Such options, authorized under the Incentive Compensation 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 grant.
In June and July 1999, the Company's Board of Directors authorized the
grant to employees, coincident with the closing of the Company's initial public
offering, of options to purchase an aggregate of 711,300 shares of the Company's
Common Stock. Such options, authorized under the Incentive Compensation Plan, if
ultimately granted, will have exercise prices equal to the initial public
offering price per share, and will vest 25% annually and expire 10 years after
the date of the Board's authorization of the option grants.
THE 401(K) PLAN
The Company has a defined contribution salary deferral plan, the Datalink
Corporation 401(k) Plan (the "401(k) Plan"), which is intended to qualify under
Sections 401(a) and 401(k) of the Code. Company employees are eligible to
participate in the 401(k) Plan beginning on the first day of the quarter
immediately succeeding the commencement of their employment with the Company.
Participants may make elective salary reduction contributions to the 401(k) Plan
up to a maximum of 10% of their eligible annual compensation, subject to a
dollar limit established by law (which limit was $10,000 in 1998). Pursuant to
the terms of the 401(k) Plan, the Company is required to match 50% of the
participants' contribution up to the first 6% of the participants' eligible
compensation. In addition, at the discretion of the Board of Directors, the
Company may contribute to a profit sharing portion of the 401(k) Plan to the
extent permitted by the Code.
Participants are fully vested at all times in the amounts they contribute
to the 401(k) Plan and are always 100% vested upon early or normal retirement.
Participants vest at a rate of 20% per year and are fully vested in the
Company's matching and discretionary profit sharing contributions after five
years. Benefits under the 401(k) Plan generally are distributable after the age
of 59 1/2 or become payable upon separation from service, retirement, death or
disability.
CERTAIN TRANSACTIONS
In February 1997, the Company entered into a lease agreement for its
principal executive offices with Edina Southwest Partners, a Minnesota general
partnership ("Edina Partners"). In June 1997, Edina Partners sold the property
containing the Company's principal executive offices (the "Property") to 7423
Washington Avenue L.L.P., a Minnesota limited liability partnership ("Washington
Avenue L.L.P."), of which five of the Company's current stockholders own, in the
aggregate, approximately 85% of the units of interest. Contemporaneously with
the purchase of the Property, Washington Avenue L.L.P. executed promissory notes
in favor of Norwest Bank Minnesota, N.A. (the "Norwest Note") and Stanley I.
Clothier, Trustee of the Stanley I. Clothier Revocable Trust (the "Clothier
Note"). The Company has agreed to guarantee the payments under these notes.
Contemporaneously with the closing of this offering, the Company's obligations
to guarantee these notes will terminate. As of June 30, 1999, the balances on
the Norwest Note and Clothier Note were approximately $872,000 and $1.3 million,
respectively. During July 1998, the Company entered into a second lease
agreement with Washington Avenue L.L.P. for additional office and warehouse
space. In March 1999, the leases were extended through December 2002.
Additionally, the Washington Avenue L.L.P. agreement provides that in the
event that gross revenues of the partnership are insufficient to pay the
operating costs of the Property and other necessary business or administrative
expenses, the partners, individually and as current stockholders of Datalink,
agree to take any and all steps necessary to cause the Company to increase its
lease payments on the space it is occupying or to lease additional space in the
Property in order to fund such deficit. Contemporaneously with the closing of
this offering, the Company's obligations to fund such deficit will terminate.
The rent paid by the Company to
39
<PAGE> 25
Washington Avenue L.L.P. in 1996, 1997 and 1998 and the first six months of 1999
was approximately $129,000, $197,000, $233,000 and $95,000, respectively.
The Company entered into a deferred compensation agreement with Mr.
Clothier, a current stockholder and a former officer and director of the
Company, whereby the Company is obligated to pay Mr. Clothier (or a designated
beneficiary) $7,000 per month for 60 months beginning January 1996. Interest
expense under this agreement was approximately $25,000, $20,000, $10,000 and
$7,000 for the years ended December 31, 1997 and 1998 and for the six months
ended June 30, 1998 and 1999, respectively.
All material and affiliated transactions and loans made after the date of
this Prospectus will be made or entered into on terms that are no less favorable
to the Company than those that can be obtained from unaffiliated third parties,
and all such future material affiliated transactions and loans, and any
forgiveness of loans, must be approved by a majority of the independent,
non-affiliated members of the Board of Directors who do not have an interest in
the transaction.
40
<PAGE> 26
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to beneficial
ownership of the Common Stock as of the date of this Prospectus and as adjusted
for the sale of the 2,600,000 shares offered hereby, by: (i) each person who
beneficially owns 5% or more of the Common Stock, (ii) each of the Company's
executive officers and directors and (iii) by all executive officers and
directors of the Company as a group. Unless otherwise noted, each person or
group identified has sole voting and investment power with respect to the shares
shown.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF SHARES
BENEFICIALLY OWNED(1) BENEFICIALLY OWNED(1)
--------------------------- ---------------------------
PRIOR TO AFTER PRIOR TO AFTER
NAME OF BENEFICIAL OWNER THE OFFERING THE OFFERING THE OFFERING THE OFFERING
------------------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Greg R. Meland(2)........................ 3,450,690 3,450,690 57.5% 39.8%
Daniel J. Kinsella....................... -- -- * *
Stephen M. Howe(2)....................... 712,080 712,080 11.9% 8.2%
Joseph J. Kaye(2)(3)..................... 712,080 627,080 11.9% 7.2%
Scott D. Robinson(2)(4).................. 584,430 572,930 9.7% 6.6%
Michael J. Jaeb.......................... -- -- * *
Stanley I. Clothier(2)(5)................ 345,000 345,000 5.7% 4.0%
Robert M. Price(6)....................... 9,000 9,000 * *
James E. Ousley(6)....................... 9,000 9,000 * *
Margaret A. Loftus(6).................... 9,000 9,000 * *
Paul F. Lidsky(6)........................ 9,000 9,000 * *
All executive officers and directors as a
group (9 persons)(6)................... 4,783,200 4,771,700 79.2% 54.8%
</TABLE>
- ------------
* less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and includes voting power and investment
power with respect to shares. Shares issuable upon the exercise of
outstanding stock options that are currently exercisable or become
exercisable within 60 days from the date hereof, are considered outstanding
for the purpose of calculating the percentage of Common Stock owned by such
person and owned by a group, but not for the purpose of calculating the
percentage of Common Stock owned by any other person.
(2) The address of each of these individuals is: c/o Datalink Corporation, 7423
Washington Avenue South, Minneapolis, Minnesota 55439.
(3) The number of shares beneficially owned by Mr. Kaye after the offering gives
effect to certain gifts and includes (i) 313,540 shares to be owned by Mr.
Kaye's spouse and a trust over which she will exercise voting and investment
discretion and (ii) 100,000 shares to be owned by a trust over which Mr.
Kaye will exercise voting and investment discretion.
(4) The number of shares beneficially owned by Mr. Robinson after the offering
gives effect to certain gifts and includes (i) 286,465 shares to be owned by
Mr. Robinson's spouse and a trust over which she will exercise voting and
investment discretion and (ii) 100,000 shares to be owned by a trust over
which Mr. Robinson will exercise voting and investment discretion.
(5) Mr. Clothier has granted the Underwriters a 30-day option to purchase up to
15,000 of his shares solely to cover over-allotments. The table assumes that
this option is not exercised.
(6) As to individuals, includes 9,000 options to be granted which such director
may exercise upon the closing of this offering. As to the group, includes
36,000 options to be granted which directors may exercise upon the closing
of this offering.
41
<PAGE> 27
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of Datalink Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity (deficiency)
and cash flows present fairly, in all material respects, the financial position
of Datalink Corporation and its subsidiary as of December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 4, 1999, except
as to the information
contained in Note 11
for which the date
is July 15, 1999
F-5
<PAGE> 28
DATALINK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, 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
Accounts receivable, net........... 11,280,738 15,629,960 $16,076,385 $16,076,385
Inventories........................ 4,661,378 6,694,870 7,011,620 7,011,620
Other current assets............... 78,705 263,103 537,778 537,778
Deferred income taxes.............. 22,087 $ 447,279 447,279
----------- ----------- ----------- ----------- -----------
Total current assets............. 17,183,928 25,407,744 23,625,783 447,279 24,073,062
Property and equipment, net.......... 1,478,122 2,466,946 2,460,472 2,460,472
Intangibles, net..................... 4,219,584 3,822,023 3,822,023
Other................................ 42,503 49,603 55,714 55,714
----------- ----------- ----------- ----------- -----------
Total assets..................... $18,704,553 $32,143,877 $29,963,992 $ 447,279 $30,411,271
=========== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIENCY)
Current liabilities:
Book cash overdraft................ $ 146,501 $ 146,501
Line of credit..................... $ 3,935,417 $ 3,210,355 6,180,489 6,180,489
Accounts payable................... 4,928,617 13,253,656 8,055,758 8,055,758
Accrued expenses................... 1,493,317 2,186,972 2,487,945 2,487,945
Note payable to former stockholder,
current portion.................. 1,610,621 1,610,621
Capital lease obligation, current
portion.......................... 13,876 19,443 19,443
Deferred compensation, current
portion.......................... 65,242 66,339 76,200 76,200
Distribution payable to
stockholders..................... $ 8,640,000 8,640,000
----------- ----------- ----------- ------------ ----------- -----------
Total current liabilities........ 10,422,593 18,731,198 18,576,957 8,640,000 27,216,957
Note payable to former stockholder,
less current portion............... 1,409,293 1,409,293
Capital lease obligation, less
current portion.................... 12,502
Deferred compensation, less current
portion............................ 151,697 79,621 34,327 34,327
Deferred income taxes................ 601,739 908,985 908,985
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 June 30, 1999,
respectively....................... 13,873,980 19,059,410 21,418,562 $(21,418,562)
Stockholders' equity (deficiency):
Common stock, $0.001 par value,
50,000,000 shares authorized,
6,004,280 shares issued and
outstanding as of June 30,
1999............................. 6,004 6,004
Retained earnings (accumulated
deficit)......................... (5,743,717) (6,340,593) (11,475,147) 21,412,558 (9,101,706) 835,705
----------- ----------- ----------- ------------ ----------- -----------
Total stockholders' equity
(deficiency)................... (5,743,717) (6,340,593) (11,475,147) 21,418,562 (9,101,706) 841,709
----------- ----------- ----------- ------------ ----------- -----------
Total liabilities and
stockholders' equity
(deficiency)................... $18,704,553 $32,143,877 $29,963,992 $ $ 447,279 $30,411,271
=========== =========== =========== ============ =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE> 29
DATALINK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------- --------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales..................... $54,651,868 $71,255,299 $87,951,650 $36,627,004 $55,525,577
Cost of sales................. 42,872,380 55,719,303 65,739,837 27,644,047 41,262,621
----------- ----------- ----------- ----------- -----------
Gross profit............. 11,779,488 15,535,996 22,211,813 8,982,957 14,262,956
Operating expenses:
Sales and marketing......... 3,606,567 5,191,040 7,753,711 3,054,351 5,532,927
General and
administrative........... 2,382,166 3,010,450 5,403,562 1,713,109 3,610,323
Engineering................. 632,660 926,008 1,362,047 691,007 1,390,281
Offering costs.............. 732,738 172,628
----------- ----------- ----------- ----------- -----------
Operating income......... 5,158,095 6,408,498 6,959,755 3,524,490 3,556,797
Interest expense.............. 285,905 332,562 280,555 105,496 183,370
----------- ----------- ----------- ----------- -----------
Income before income taxes.... 4,872,190 6,075,936 6,679,200 3,418,994 3,373,427
Income tax expense
(benefit)................... 147,746 (517,340)
----------- ----------- ----------- ----------- -----------
Net income.................... $ 4,872,190 $ 6,075,936 $ 6,531,454 $ 3,418,994 $ 3,890,767
=========== =========== =========== =========== ===========
Historical net income per
share, basic and diluted.... $ 0.71 $ 0.88 $ 0.93 $ 0.50 $ 0.61
=========== =========== =========== =========== ===========
Weighted average shares
outstanding, basic and
diluted.................. 6,900,000 6,900,000 6,993,151 6,900,000 6,361,448
Pro forma data (unaudited see
Note 3):
Income before income taxes
on S corporation
income................... $ 6,531,454 $ 3,418,994 $ 3,890,767
Pro forma income taxes...... 2,671,680 1,333,408 1,416,839
----------- ----------- -----------
Pro forma net income........ $ 3,859,774 $ 2,085,586 $ 2,473,928
=========== =========== ===========
Pro forma net income per
share basic and
diluted.................. $ 0.47 $ 0.26 $ 0.33
=========== =========== ===========
Shares used in computing pro
forma net income per share
(see Note 3)................ 8,231,860 8,138,710 7,600,158
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-7
<PAGE> 30
DATALINK CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL EARNINGS
------------------- PAID IN (ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT) TOTAL
---------- ------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995...... 6,900,000 $ (2,285,575) $ (2,285,575)
Net income....................... 4,872,190 4,872,190
Cash dividends of $0.27 per
share.......................... (1,894,600) (1,874,600)
Accretion of common stock
value.......................... (3,987,994) (3,987,994)
---------- ----- ----------- ------------ ------------
Balances, December 31, 1996...... 6,900,000 (3,295,979) (3,295,979)
Net income....................... 6,075,936 6,075,936
Cash dividends of $0.58 per
share.......................... (3,988,299) (3,988,299)
Accretion of common stock
value.......................... (4,535,375) (4,535,375)
---------- ----- ----------- ------------ ------------
Balances, December 31, 1997...... 6,900,000 (5,743,717) (5,743,717)
Net income....................... 6,531,454 6,531,454
Cash dividends of $0.39 per
share.......................... (2,679,100) (2,679,100)
Issuance of shares in acquisition
(Note 12)...................... 200,000 $ 200 $ 1,999,800 2,000,000
Cash dividends of $0.18 per
share.......................... (1,263,800) (1,263,800)
Accretion of common stock
value.......................... (200) (1,999,800) (3,185,430) (5,185,430)
---------- ----- ----------- ------------ ------------
Balances, December 31, 1998...... 7,100,000 (6,340,593) (6,340,593)
Net income (unaudited)........... 3,890,767 3,890,767
Cash dividends of $0.14 per share
(unaudited).................... (998,260) (998,260)
Repurchase of common stock
(unaudited).................... (1,095,720) (3,019,914) (3,019,914)
Cash dividends of $0.44 per share
(unaudited).................... (2,647,995) (2,647,995)
Accretion of common stock value
(unaudited).................... (2,359,152) (2,359,152)
---------- ----- ----------- ------------ ------------
Balances, June 30, 1999
(unaudited).................... 6,004,280 $ $ $(11,475,147) $(11,475,147)
========== ===== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-8
<PAGE> 31
DATALINK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------ ---------------------------
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 $ 3,418,994 $ 3,890,767
Adjustments to reconcile net
income to net cash provided
by (used in) operating
activities:
Provision for bad debts.... 69,109 27,235 24,214 15,000
Depreciation and
amortization............. 146,648 177,302 393,193 109,482 403,907
Amortization of
intangibles.............. 375,700 397,561
Loss on disposal of
property and equipment... 9,527 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) (988,995) (446,425)
Inventories................ (2,921,963) 1,350,013 (413,277) 48,325 (316,750)
Other current assets....... (36,031) (3,554) (143,087) (598,025) (274,675)
Other assets............... 4,556 (10,916) 2,549 (2,047) (6,111)
Accounts payable........... 3,106,571 (150,824) 6,022,951 546,196 (5,197,898)
Accrued expenses........... 599,324 333,239 301,430 (194,148) 300,973
Income taxes payable....... (353,237)
Deferred compensation...... (56,206) (59,058) (70,979) (31,809) (35,433)
------------ ------------ ------------ ------------ ------------
Net cash provided by (used
in) operating
activities............... 2,462,589 4,557,082 11,469,310 2,323,571 (1,863,736)
------------ ------------ ------------ ------------ ------------
Cash flows from investing
activities:
Purchase of property and
equipment.................. (337,363) (766,436) (1,140,539) (389,629) (397,433)
Net assets acquired, net of
cash acquired.............. (3,095,619)
------------ ------------ ------------ ------------ ------------
Net cash used in investing
activities................. (337,363) (766,436) (4,236,158) (389,629) (397,433)
------------ ------------ ------------ ------------ ------------
Cash flows from financing
activities:
Proceeds from borrowings on
line of credit............. 52,657,600 70,372,500 79,119,139 35,997,000 60,182,000
Principal payments on line of
credit..................... (52,777,009) (69,233,611) (80,762,323) (37,110,388) (57,211,866)
Dividends paid................ (1,894,600) (3,988,299) (3,942,900) (2,679,100) (3,646,255)
Principal payments on capital
lease obligations.......... (12,451) (6,935)
Book cash overdraft........... 1,044,136 146,501
------------ ------------ ------------ ------------ ------------
Net cash used in financing
activities............... (2,014,009) (2,849,410) (5,598,535) (2,748,352) (536,555)
------------ ------------ ------------ ------------ ------------
Increase (decrease) in cash... 111,217 941,236 1,634,617 (814,410) (2,797,724)
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 $ 348,697 $
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-9
<PAGE> 32
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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 June 30, 1999 and for the six months ended
June 30, 1998 and 1999 are unaudited. In the opinion of management, this
financial information has been prepared on the same basis as the audited
information and includes all adjustments, consisting of normal recurring
adjustments, necessary to fairly present the financial information set forth
herein. The results of operations for the six months ended June 30, 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> 33
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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 $62,312, is included in the Company's results of
operations for the six months ended June 30, 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> 34
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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> 35
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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 June 30, 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
$8,640,000 had the termination occurred on June 30, 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 $461,706 as
of June 30, 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 July 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 July 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 six months ended June 30, 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 $461,706 as of June 30, 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 $8,640,000 (or
1,238,710 shares) had the termination occurred on June 30, 1999. The Company
does not have any common stock equivalents.
F-13
<PAGE> 36
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
4. SELECTED BALANCE SHEET INFORMATION:
The following provides additional balance sheet information as of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- JUNE 30,
1997 1998 1999
---- ---- --------
<S> <C> <C> <C>
Accounts receivable:
Accounts receivable................................. $11,340,738 $15,714,174 $16,117,546
Less allowance for doubtful accounts................ 60,000 84,214 41,161
----------- ----------- -----------
$11,280,738 $15,629,960 $16,076,385
=========== =========== ===========
Property and equipment:
Leasehold improvements.............................. $ 223,356 $ 317,361 $ 321,663
Equipment........................................... 761,059 1,120,976 1,259,733
Computers and purchased software.................... 1,262,249 2,289,879 2,544,253
----------- ----------- -----------
2,246,664 3,728,216 4,125,649
Less accumulated depreciation and amortization...... 768,542 1,261,270 1,665,177
----------- ----------- -----------
$ 1,478,122 $ 2,466,946 $ 2,460,472
=========== =========== ===========
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....................... 375,700 773,261
----------- -----------
$ 4,219,584 $ 3,822,023
=========== ===========
Accrued expenses:
Commissions......................................... $ 942,051 $ 1,333,704 $ 1,665,148
Other............................................... 551,266 853,268 822,797
----------- ----------- -----------
$ 1,493,317 $ 2,186,972 $ 2,487,945
=========== =========== ===========
</TABLE>
5. BORROWING ARRANGEMENTS:
Effective June 1, 1999, 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 June 30, 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
$6,180,489 as of December 31, 1998 and June 30, 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 June 30, 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> 37
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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 and $1,499,000 as of December
31, 1997 and 1998, respectively, which was held in a restricted collateral cash
account. As of June 30, 1999, the Company had $68,000 of such restricted cash
which was netted against the book cash overdraft. 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 $19,443, all of which is
current as of June 30, 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 $110,527 as of December 31, 1997 and 1998 and June
30, 1999, respectively, with interest computed at 10%.
Interest expense related to the agreement was $24,942, $20,021, $10,191 and
$6,567 for the years ended December 31, 1997 and 1998 and for the six months
ended June 30, 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 June 30, 1999, the
balances of the notes payable to the bank and the stockholder were approximately
$872,000 and $1.3 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> 38
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
Total rent expense, including certain lessor operating costs charged to the
Company, is as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31 JUNE 30,
-------------------------------- --------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Related party............................. $128,573 $197,363 $233,254 $ 83,248 $ 94,932
Other..................................... 90,361 119,620 219,494 68,973 183,163
-------- -------- -------- -------- --------
$218,934 $316,983 $452,748 $152,221 $278,095
======== ======== ======== ======== ========
</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 six
months ended June 30, 1998 and 1999, was $97,350, $126,404, $157,866, $93,769
and $152,391, 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, 1998 and for the six
months ended June 30, 1999, was $156,500, $164,350, $311,000 and $189,957,
respectively. The Company did not make any profit sharing contributions as of
June 30, 1998.
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> 39
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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
$21,418,562 as of December 31, 1996, 1997, 1998 and June 30, 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 June 30, 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,
$28,196 and $35,653 as of December 31, 1997, and 1998 and June 30, 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>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------ --------------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash paid for interest........... $ 286,745 $ 327,496 $ 295,044 $ 100,709 $ 169,645
Cash paid for taxes.............. 549,400 62,312
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
F-17
<PAGE> 40
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 1998 AND 1999 IS UNAUDITED)
variety of awards including stock options, stock appreciation rights, restricted
stock, performance shares, 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 711,300 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> 41
DATALINK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF JUNE 30, 1999 AND FOR THE
SIX MONTHS ENDED JUNE 30, 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.
F-19
<PAGE> 42
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
In connection with our audits of the consolidated financial statements of
Datalink Corporation as of December 31, 1997 and 1998, and for each of the three
years in the period ended December 31, 1998, which financial statements are
included in the Prospectus, we have audited the financial statement schedule
listed in Item 16(b) herein.
In our opinion, this financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material aspects, the information required to be included therein.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 4, 1999, except
as to the information
contained in Note 11
to the consolidated
financial statements,
for which the date is
July 15, 1999.
S-1
<PAGE> 43
DATALINK CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING OF (1) END OF
DESCRIPTION PERIOD ADDITIONS DEDUCTIONS PERIOD
- ------------------------------------------------------- ------------ --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts................ 1996 $ 45,000 $ 69,109 $ 54,109 $ 60,000
1997 60,000 27,235 27,235 60,000
1998 60,000 24,214 -- 84,214
Allowance for Inventory Obsolescence........... 1996 $ 10,000 $181,661 $ 91,661 $100,000
1997 100,000 -- 75,000 25,000
1998 25,000 177,187 162,187 40,000
</TABLE>
- ------------
(1) Deductions reflect write-offs of customer accounts receivable, net of
recoveries or disposals of inventories, net of obsolescence reserve
adjustments.
S-2
