UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D. C. 20549



FORM 10-K

(Mark one)ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934For The Transition Period
From                        To


Commission file number: 000-29758



DATALINK CORPORATION(Exact name of registrant as specified in its charter)

MINNESOTA

41-0856543(State or other jurisdiction of incorporation)

(IRS Employer Identification Number)


8170 UPLAND CIRCLE
CHANHASSEN, MINNESOTA 55317-8589(Address of Principal Executive Offices)

(952) 944-3462(Registrant's Telephone Number, Including Area Code)

Securities
registered pursuant to Section 12(b) of the Act:None.

Securities
registered pursuant to Section 12(g) of the Act:Common Stock, $0.001 par value.

Indicate
by check mark if the registrant is a well known seasoned issuer as defined in Rule 405 of the Securities
Act. Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o    No ý

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 ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)
is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company.

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

Smaller reporting company ý


Indicate
by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange
Act). Yes o    No ý

Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant at June 30, 2008:
$39,169,625.

At
March 16, 2009, the number of shares outstanding of the registrant's classes of common stock was 12,920,378.

DOCUMENTS INCORPORATED BY REFERENCE

Portions
of the Registrant's Proxy Statement for its 2009 Annual Meeting of Stockholders are incorporated by reference to Part III of this Form 10-K.



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NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. We have based these forward looking statements on our current expectations and
projections about future events, including, among other things: the level of continuing demand for storage, including the impact of the worldwide adverse economic conditions on technology spending;
competition and pricing pressures and timing of our installations that may adversely affect our revenues and profits; fixed employment costs that may impact profitability if we suffer revenue
shortfalls; revenue recognition policies that may unpredictably defer reporting of our revenues; our ability to hire and retain sales representatives and key technical and other personnel; our
dependence on key suppliers; our ability to adapt to rapid technological change; risks associated with current and possible future acquisitions; fluctuations in our quarterly operating results; future
changes in applicable accounting rules; and volatility in our stock price, particularly in light of the substantial decline in worldwide stock markets. You may find these statements throughout this
Annual Report and specifically in the sections entitled "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." Our actual results may
differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in "Risk Factors" and elsewhere in this Annual Report.

We
use the terms "aim", "believe," "expect," "plan," "intend," "estimate" and "anticipate" and similar expressions to identify forward-looking statements. These statements reflect our
current views with respect to future events and are based on assumptions subject to risks and uncertainties. We do not intend to update or revise any forward-looking statements whether as a result of
new information, future events or otherwise.

PART I

Item 1.    Business.

Overview

An information storage architect since 1987, we help organizations store, manage, and protect one of their most critical
assetsinformation. Our solutions and services span four practice areas:



We
offer a comprehensive suite of services spanning analysis, design, implementation, management and support. Our highly skilled technical services and practice management teams test and
compare data storage technologies available from the leading manufacturers and software developers. Once a product is approved for our solution sets, our technical services team has the flexibility to
choose from the best of these storage technologies to solve our customers' growing data storage needs. In addition, our support staff ensures the continued success of our data storage solutions for
each customer. We believe these value-added services and our adherence to the highest quality standards have resulted in superior levels of customer satisfaction.

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The Data Storage Industry

Information technology (IT) departments are faced with a daunting challenge of rapidly expanding amounts of data to manage. Coupled
with this growth are increasing demands for availability of this data for day-to-day business and to meet regulatory requirements. At the same time, the worldwide economic
downturn has caused IT departments to reduce IT spending and headcount. As a result, we expect customers will continue to look for alternatives to dramatically simplify management of storage
infrastructures and increase productivity of existing IT teams.

To
address the increased need for efficiency, we anticipate that organizations will continue to consolidate and virtualize their server environments. We expect this will result in
continued demand and requirements for shared storage infrastructures tuned to virtualized server environments. With a unified virtualization strategy, organizations will improve management and
utilization, as well as reduce costs.

We
expect that disk-based data protection, SAN/NAS convergence, storage management software, and storage services will also be affected by the economic downturn and will show
little or no growth in 2009. Nevertheless, organizations recognize the importance and value of data as a strategic and competitive asset. Employees, customers and suppliers demand uninterrupted access
to mission-critical data 24 hours a day, 7 days a week. As a result, the ability to efficiently store, manage, and
protect this data will continue as one of the most important aspects of business-critical decision-making, increasing the need for high-performance, scalable and highly available
solutions.

In
light of the importance of data to businesses, we believe that organizations will continue to dedicate a significant percentage of their information technology budgets, which we
expect to be flat to down from 2008 levels, to data storage projects. We believe that capital investment priorities will include:



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The Datalink Opportunity

The increased need for data storage and the development of sophisticated, enterprise-class information data storage systems have
created a demand for independent data storage solution providers, such as Datalink. Both potential customers and data storage device manufacturers are looking to independent storage solutions
providers such as Datalink primarily for the following reasons:

Pressures on Customers.We believe organizations will increasingly look outside their in-house technical staff to independent
information
storage architects, such as Datalink, for specialized expertise. Networked storage architecture design is complex. Advanced functionalities, such as disk-based backup and recovery and
virtualization, further increase the level of complexity. Although organization-wide data storage solutions, such as SANs, are designed to ease data management functions, these systems are
difficult to understand and implement because they integrate diverse operating systems, hardware and software. In addition, there continues to be a steady influx of new products and technologies
introduced to the market. In-house information technology departments prefer to focus their efforts on mission-critical applications. Accordingly, they often turn to outside storage
experts that are able to research, design, implement and support networked storage solutions. The downsizing of IT departments in light of current economic conditions also necessitates increased
reliance on external service providers such as us.

Pressures on Manufacturers.We believe manufacturers increasingly rely on channel partners such as us for three principal
reasons:



We
believe we are uniquely positioned to capitalize on this significant opportunity for the following reasons:

Expertise.We have been implementing sophisticated data storage solutions for over twenty years. This experience has given us
significant expertise
in understanding and applying data storage technologies and has allowed us to earn and retain the trust and confidence of our customers and suppliers. We invest in and train resources to differentiate
our company, adapt to the ever-changing needs of our customers and capitalize on opportunities.

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Independence.Unlike many of our competitors, we are independent of any manufacturer or particular
technology. Our customers are increasingly using open systems computing architectures, which can combine products from multiple manufacturers. Our customers value our independence and rely on us to
choose the best available hardware and software and tailor it to their individual needs.

The Datalink Solution

We combine our technical expertise, the best products from leading manufacturers and comprehensive services to meet each customer's
specific needs. Our services include:

Analysis

At the beginning of an engagement, we place considerable emphasis on formulating a needs analysis based on each customer's business
initiatives, operating environment and current and anticipated data storage requirements. While our focus is on each customer's unique situation, we bring to each engagement our extensive product
knowledge and the experience we have gained from providing data storage solutions for over twenty years to customers in numerous industries.

Datalink
assessment services provide customers with objective guidance on developing data storage strategies that optimize their resources, leverage their existing environments and
facilitate cost-effective growth for the future. These services provide an independent viewpoint to align people, processes and technologies with business objectives. These services help
organizations maximize current investments, outline recommendations for future purchases and provide assurance that storage infrastructures are efficient, reliable and scalable.

Design

Once we have completed our initial analysis, we begin the design phase of the project. Our professional services teams work together to
design a system that meets the customer's data storage needs and budget. Our independence permits us to choose from a wide range of technologies in order to fuse together the appropriate hardware,
software and services for each project.

Datalink
designs storage infrastructures based on each customer's developed detailed business requirements. The engagement begins with a definition of the project's objectives, scope and
key milestones. The Datalink team then prepares an outline of the schedule and deliverables. Following a thorough analysis, the team prepares a comprehensive blueprint of the storage solution,
including a detailed design schematic, key implementation milestones and recommendations for handling potential configuration issues to ensure a smooth transition to the new storage environment.

Implementation

Once we design and test a system, we formulate a detailed project implementation plan with our customers to meet their financial and
operating objectives and minimize disruption to their operations. We oversee the timely delivery of hardware and software products to the customer's location. We then coordinate the installation with
our technical services team, or personnel from the equipment manufacturer, and complete the installation at the customer's site using industry best practices.

Management

We augment the staff of our customers by offering onsite professional services resources. These resources provide such services as
backup and recovery administration, project management and storage administration. With the burden removed from internal IT teams, customers realize improved productivity and system performance.

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Support

We provide our customers advanced technical support from a team of customer support and field engineers. Our extensive experience in
data storage systems enables our staff to deliver expert configuration and usage assistance, technical advice and prompt incident
detection and resolution. The support team also acts as our primary interface with manufacturers' technical support organizations.

Datalink
support services offer additional flexible levels of service to help organizations maximize the return on their storage technology investments. We believe that our customer
support program is one of very few customer service plans that provide support across multiple storage product lines and manufacturers.

We
provide our analysis, design, implementation, management and support services to customers through either a stand-alone services engagement or as a part of an overall project that
includes a storage solution and services.

Our Strategy

Our strategy is to improve our position as a leading, independent information storage architect and to develop a customer-focused, high
performance company with sustainable profitable growth. To achieve these objectives, we intend to build upon our record of successfully addressing the evolving enterprise-class information storage
management needs of our customers. Key elements of our strategy include:

Increase Sales Team Productivity

Although we believe that Datalink's sales productivity is high, we believe it can be enhanced. We continue to accelerate the learning
and productivity curve of our newer sales professionals and enhance the skills of seasoned executives through implementation of techniques and best practices learned from our top producers.

Scale Existing Locations

We intend to focus on our existing geographic locations to increase market share, leverage fixed expenses and provide higher quality
service levels. Datalink will drive this
growth by hiring experienced, quality account executives and storage engineers to gain sales productivity and field engineering utilization.

Expand Customer Support Revenues

We have significantly increased our customer support capabilities and performance over the last several years and will continue to make
this a focus. Our customers appreciate our quality support initiatives, which we believe will continue to be a key differentiator and growth driver for Datalink.

Enhance Our Professional Services Business

There is significant opportunity to sell more of our storage services expertise to customers. By improving our assessment, storage
audit and implementation service methodologies and sales tools, we plan to enhance our solution selling capabilities and continue to drive gross margins to higher levels.

Pursue Acquisitions

We believe there is an opportunity to strengthen our resources and presence in key geographies through the acquisition of select
competitors. On January 31, 2007, we acquired Midrange Computer Solutions Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago, Illinois. The acquisition of
MCSI increased our revenue base by approximately one-third, expanding the number

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of
enterprise accounts we serve and extending our presence geographically in the Northeast, Midwest, and California. We continue to look for other acquisition opportunities.

Suppliers and Products

As an independent information storage architect, we do not manufacture data storage products. Instead, we continually evaluate and test
new and emerging technologies from leading manufacturers to ensure that our solutions incorporate state-of-the-art, high performance, cost-effective
technologies. This enables us to maintain our technological leadership, identify new and innovative products and applications and objectively help our customers align their data storage solutions with
their business needs.

We
have strong, established relationships with the major enterprise-class information storage hardware and software suppliers. Our expertise in open system environments includes UNIX,
Microsoft Windows, Linux, VMware and in-depth knowledge of all major hardware platforms manufactured by industry leaders, including Hewlett-Packard Company, International Business Machines
Corp. and Sun Microsystems, Inc. This expertise has earned us preferred status with many of our principal suppliers. Preferred status often enables us to participate in our suppliers' new
product development, evaluation, introduction and marketing programs. These collaborations enable us to identify and market innovative new hardware and software products and exchange critical
information in order to maximize customer satisfaction.

Some
of our major suppliers and the products they provide are listed:

Products

SuppliersDisk Storage

Data Domain
EMC Corporation
Hitachi Data Systems Corporation
International Business Machines Corp.
NetApp Inc.
Sun Microsystems, Inc.Tape Automation

Quantum Corporation
Spectra Logic Corporation
Sun Microsystems, Inc.Software

APTARE, Inc.
EMC Corporation
Symantec Corporation
VMware, Inc.Switches/Directors/Storage Networking

Brocade Communications Systems, Inc.
Cisco Systems, Inc.
F5 Networks, Inc.
Riverbed Technology, Inc.


Customers

Our customers trust us with their most demanding data storage projects. Customer engagements range from specialized professional
assessment and design services, to complex organization-wide SAN implementations. We serve customers throughout the United States in a diverse group of data intensive industries. Our broad
industry experience enables us to understand application and business issues specific to each customer and to design and implement appropriate networked storage solutions. We enjoy strong
relationships with our customers, which are reflected by our significant repeat business.

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Sales and Marketing

We market and sell our products and services throughout the United States primarily through a direct sales force. In addition to our
Minneapolis headquarters, as of December 31, 2008, we have 18 field sales offices in order to efficiently serve our customers' needs.

Our
field account executives and account associates work closely with our technical services team in evaluating the enterprise-class information storage needs of existing and prospective
customers and in designing high quality, cost effective solutions. To ensure quality service, we assign each customer a specific field account executive and account associate. We believe that the
average longevity of service of our sales force, and their close collaboration with our technical services team, are key factors to earning and retaining the trust and confidence of our customers. We
believe this differentiates us from many other storage solution providers.

In
addition to the efforts of our field account executives, inside account associates, and technical services team we engage in a variety of other marketing activities designed to
attract new business and retain customer loyalty. We regularly execute integrated, demand creation campaigns, gain exposure through online and print trade publications, hold webcasts and informational
seminars and publish whitepapers and a quarterly newsletter.

Competition

Datalink primarily competes with the direct sales forces of storage OEM's. Besides Datalink's current technology partners, these OEM
competitors include Hewlett-Packard Company and Dell Computer Corporation. In addition, we compete with channel partners of storage OEM's. These include Forsythe Technology, Inc., Incentra
Solutions, Inc., InterVision Systems Technologies Inc., Trace--3, Inc., Presidio, Incorporated, and Sirius Computer Solutions, Inc.

Employees

As of December 31, 2008, we had a total of 208 full-time employees. We have no employment agreements with any of our
employees, except for Mr. Barnum, our Chief Financial Officer and Mr. Beyer, our Senior Vice President of Field Operations. None of our employees are unionized or subject to a collective
bargaining agreement. We have experienced no work stoppages and believe that our employee relations are good.

Backlog

We configure products to customer specifications and generally ship them shortly after we receive our customer's purchase order.
Customers may change their orders with little or no penalty. We do not recognize revenue on hardware or software products until we have completed our required or contracted installation or
configuration services in connection with the sale. Customer constraints, including customer readiness, and the availability of engineering resources can have a significant impact on when we can
complete an installation and configuration service. The economic downturn has also led customers to curtail or delay capital spending projects, including data storage. These factors, which can be
beyond our control, prevent us from relying on backlog as a strong predictor of our future sales levels in any particular period. Our backlog, which represents firm orders expected to be recognized as
revenue within the next 90 days, was $33.0 million and $31.0 million at December 31, 2008 and 2007, respectively.

Available Information

Our website address is www.datalink.com. The material on our website is not part of this report. We make available at our website, free
of charge, our Annual Reports on Form 10-K, Quarterly

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Reports
on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

The
public may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street NE, Washington, DC 20549. The public may obtain information
on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. All SEC filings are also available at the SEC's website at www.sec.gov.

Item 1A.    Risk Factors.

As indicated in this Annual Report under the caption "Note Regarding Forward-Looking Statements," certain information contained in this
Annual Report consists of forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements made in this Annual Report include the
following:

Worldwide adverse economic conditions negatively impact our business.

As widely reported, financial markets in the United States, Europe and Asia have been experiencing extreme disruption in recent months,
including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of
others. We are impacted by these economic developments in that they adversely affect the ability of our customers and suppliers to obtain financing for significant purchases and operations, and could
result in a decrease in orders for our products and services. These economic conditions also will negatively impact us to the extent our
customers defer purchasing decisions, thereby lengthening our sales cycles. In addition, our customers' may have constrained budgets affecting their ability to purchase our products at the same level.
Our customers' ability to pay for our products and services may also be impaired, which may lead to an increase in our allowance for doubtful accounts and write-offs of accounts
receivable. If we identify an acquisition of interest, we may find that it is difficult to obtain debt financing to consummate any transaction. We are unable to predict the likely duration and
severity of the current disruption in financial markets and adverse economic conditions in the U.S. Should these economic conditions result in us not meeting our revenue objectives, our operating
results, financial condition and stock price could be adversely affected.

Competition could prevent us from increasing or sustaining our revenues or profitability.

The enterprise-class information storage market is rapidly evolving and highly competitive. As technologies change rapidly, we expect
that competition will increase in the future. Current economic conditions also place pressure on our competitors to lower their prices and seek opportunities of size and scale different than in the
past. We compete with independent storage system suppliers to the mid to large enterprise market and numerous value added resellers, distributors and consultants. We also compete in the storage
systems market with computer platform suppliers. Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing and other resources than we do. As
a result, they may respond more quickly to changes in economic conditions and customer requirements and to new or emerging technologies, devote greater resources to the development, promotion and sale
of products and deliver competitive products at lower end-user prices.

Our
suppliers are often our competitors. We are not the exclusive reseller of any data storage product we offer. Instead, our suppliers market their products through other independent
data storage solution providers, original equipment manufacturers and through their own internal sales forces. We believe direct competition from our suppliers is likely to increase if, as expected,
the data storage industry continues to consolidate. This consolidation would likely result in fewer suppliers with greater resources to devote to internal sales and marketing efforts. In addition, our
suppliers have established

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and
will probably continue to establish cooperative relationships with other suppliers and other data storage solution providers. These cooperative relationships are often intended to enable our
suppliers to offer comprehensive storage solutions, which compete with those we offer. If our relationships with our suppliers become adversarial, it will be more difficult for us to stay ahead of
industry developments and provide our customers with the type of service they expect from us.

In
addition, most of our customers already employ in-house technical staffs. To the extent a customer's in-house technical staff develops sophisticated storage
systems
expertise, the customer may be less likely to seek our services. Further, we compete with storage service providers who manage, store and backup their customers' data at off-site,
networked data storage locations.

We derive a significant percentage of our revenues from a small number of customers.

In 2008 and 2007, we had no customers that accounted for at least 10% of our revenues. In addition, our top five customers collectively
accounted for 15%, 21%, and 28% of our 2008, 2007 and 2006 revenues, respectively. Because we intend to continue to seek out large projects, we expect that a significant percentage of our revenues
will continue to come from a small number of customers, although the composition of our key customers is likely to change from year to year. Current economic conditions likely will adversely affect
the number of and size of large projects available for us. If we fail to obtain a growing number of large projects each year, our revenues and profitability will likely be adversely affected. In
addition, our reliance on large projects makes it more likely that our revenues and profits will fluctuate unpredictably from quarter to quarter and year to year. Unpredictable revenue and profit
fluctuations may make our stock price more volatile and lead to a decline in our stock price.

Our revenue recognition policies unpredictably defer reporting of our revenues.

We sell complex enterprise-class information storage solutions, which include installation and configuration services. We do not
recognize revenues from our sale of hardware and software products to our customers until we complete our required installation or configuration of these products. Installation and configuration of
these solutions requires significant coordination with our customers and vendors. In the current economic environment, we have observed an increasing number of large customers delaying the completion
of internal projects that are prerequisites to our installation of data storage solutions. Therefore, even if we have shipped all products to our customers, we may be unable to control the timing of
product installation and configuration. These delays can prevent us from recognizing revenue on products we ship and may adversely affect our quarterly reported revenues. As a result, our stock price
may decline.

Our key vendors could change or discontinue their incentive programs, which could adversely affect our business.

Several of our key vendors have offered incentive programs to us over the past several years based on our achievement of particular
sales levels of their products. In addition, they have offered margin enhancement programs which provide enhanced discounts for particular
products or new customer orders. These programs contributed to our profitability in 2008, 2007 and 2006. We cannot assure that these programs will continue or that the sales quotas for our
participation will not increase, adversely affecting our ability to take advantage of the incentives. If for any reason, we cannot obtain the same benefits from incentive programs as in the past, it
may significantly impact our profitability in the future.

Our business depends on our ability to hire and retain technical personnel and highly qualified sales people.

Our future operating results depend upon our ability to attract, retain and motivate qualified engineers and sales people with
enterprise-class information storage solutions experience. If we fail to

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recruit
and retain additional engineering and sales personnel, or if losses require us in the future to terminate employment of some of these personnel, we will experience greater difficulty realizing
our business strategy, which could negatively affect our business, financial condition and stock price.

We generally do not have employment agreements with our key employees.

Our future operating results depend in significant part upon the continued contributions of our executive officers, managers,
salespeople, engineers and other technical personnel, many of whom have substantial experience in our industry and would be difficult to replace. Except as to our Chief Financial Officer and Senior
Vice President of Field Operations, we do not have employment agreements with our officers or employees, including our executive officers. Accordingly, our employees may voluntarily leave us at any
time and work for our competitors. Our growth strategy depends in part on our ability to retain our current employees and hire new employees. Any failure to retain our key employees will make it much
more difficult for us to maintain our operations and attain our growth objectives and could therefore be expected to adversely affect our operating results, financial condition and stock price.

Our long sales cycle may cause fluctuating operating results, which may adversely affect our stock price.

Our sales cycle is typically long and unpredictable, making it difficult to plan our business. Recent economic conditions are
increasing this uncertainty. Our long sales cycle requires us to invest resources in potential projects that may not occur. In addition, our long and unpredictable sales cycle may cause us to
experience significant fluctuations in our future annual and quarterly operating results. It can also result in delayed revenues, difficulty in matching revenues with expenses and increased
expenditures. Our business, operating results or financial condition and stock price may suffer as a result of any of these factors.

If the data storage industry fails to develop compelling new storage technologies, our business may suffer.

Rapid and complex technological change, frequent new product introductions and evolving industry standards increase demand for our
services. Because of this, our future success depends in part on the data storage industry's ability to continue to develop leading-edge storage technology solutions. Our customers utilize
our services in part because they know that newer technologies offer them significant benefits over the older technologies they are using. If the data storage industry ceases to develop compelling new
storage solutions, or if a single data storage standard becomes widely accepted and implemented, it will be more difficult to sell new data storage systems to our customers. Tightened budgets among
established data storage technology manufacturers and the difficulty of raising new capital for innovative, start-up companies, under current economic conditions may also stifle
development of new data storage technologies.

Risks associated with acquisitions.

As part of our growth strategy, we may pursue acquisitions. We may not be able to identify suitable acquisition candidates or, if
suitable candidates are identified, we may not be able to complete the business combination on commercially acceptable terms. Tightened credit markets in the current economic climate may make it
difficult for us to obtain debt financing for any acquisition. The process of exploring and pursuing acquisition opportunities may result in devotion of significant management and financial resources.

Even
if we are able to consummate an acquisition that we believe will be successful, the transaction may present many risks. These risks include, among others: failing to achieve
anticipated

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synergies
and revenue increases; difficulty incorporating and integrating the acquired technologies or products with our existing product lines; coordinating, establishing or expanding sales,
distribution and marketing functions, as necessary; disruption of our ongoing business and diversion of management's attention to transition or integration issues; unanticipated and unknown
liabilities; the loss of key employees, customers, partners and channel partners of our company or of the acquired company; and difficulties implementing and maintaining sufficient controls, policies
and procedures over the systems, products and processes of the acquired company. If we do not achieve the anticipated benefits of our acquisitions as rapidly or to the extent anticipated by our
management and financial or industry analysts, or if others do not perceive the same benefits of the acquisition as we do, there could be a material, adverse effect on the our business, financial
condition or results of operations.

Control by our existing stockholders could discourage the potential acquisition of our business.

Currently, our executive officers and directors beneficially own approximately 26% of our outstanding common stock. Acting together,
these insiders may be able to elect our entire Board of Directors and control the outcome of all other matters requiring stockholder approval. This voting concentration may also have the effect of
delaying or preventing a change in our management or control or otherwise discourage potential acquirers from attempting to gain control of us. If potential acquirers are deterred, you may lose an
opportunity to profit from a possible acquisition premium in our stock price.

Our stock price is volatile.

The market price of our common stock fluctuates significantly, and, especially in light of current stock market and worldwide economic
conditions, may continue to be volatile. We cannot assure you that our stock price will increase, or even that it will not decline significantly from the price you pay. Our stock price may be
adversely affected by many factors, including:



Our governing documents and Minnesota law may discourage the potential acquisitions of our business.

Our Board of Directors may issue additional shares of capital stock and establish their rights, preferences and classes, in some cases
without stockholder approval. In addition, we are subject to anti-takeover provisions of Minnesota law. These provisions may deter or discourage takeover attempts and other changes in
control of us not approved by our Board of Directors. If potential acquirers are deterred, you may lose an opportunity to profit from a possible acquisition premium in our stock price.

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Future finite life intangibles and goodwill impairment may unpredictably affect our financial results.

We perform impairment analyses of our finite life intangibles and goodwill at least annually or when we believe there may be
impairment. Future events could cause us to conclude that impairment indicators exist and that goodwill and/or the finite life intangibles associated with our acquired businesses is impaired. With the
overall decline in the stock market, the decline in our stock price and the impact of the global economic downturn, it may become more likely that we would need to write down the carrying value of our
assets and incur a current period charge to our earnings. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

The sublessee for our corporate headquarters may be unable to make their lease payments or default on their lease agreement.

In December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied as our corporate headquarters
in Chanhassen, Minnesota. The initial sublease term is co-terminal with our lease and is 85 months starting in April 2005 and ending in April 2012. The sublessee pays us rent
ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000 per month by the end of the term. If the sublessee was unable to make their lease payments to us or
defaulted on the lease agreement, our operating results or financial condition and stock price may suffer as a result. The annual payments we expect to receive for our Chanhassen sublease is $950,000
for 2009, 2010 and 2011, respectively.

Item 1B.    Unresolved Staff Comments.

None.

Item 2.    Properties.

We occupy 49,000 square feet of an office and warehouse facility in Chanhassen, Minnesota as our corporate headquarters, including our
principal technical operations and our integration, assembly and support service operations. As of December 31, 2008, our other 18 locations which house sales and technical staff are
small-to-medium-sized offices throughout the United States.

In
December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term
is co-terminal with our lease and is for 85 months starting in April 2005 and ending in April 2012. The sublessee will pay us rent ranging from approximately $55,000 per month at
the beginning of the term to approximately $60,000 per month by the end of the term. In the first quarter of 2005, we incurred a one-time, non-cash charge of
$3.5 million related to the sublease and lot sale. We estimate we will obtain annual cost savings of $950,000 during the sublease term.

Based
on our present plans, we believe our current facilities, which are in reasonably good condition, will be adequate to meet our anticipated needs for at least the remaining terms of
our leases.

Item 3.    Legal Proceedings.

We are not currently involved in any material legal proceedings. We also had no material legal proceedings that terminated during the
fourth quarter of 2008.

Item 4.    Submission of Matters to a Vote of Security Holders.

We submitted no matters during the fourth quarter of 2008 to a vote of security holders, through the solicitation of proxies or
otherwise.

13

---





PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock is quoted on the Nasdaq Global Market under the symbol "DTLK". The table below sets forth, for the calendar quarters
indicated, the high and low per share closing sale prices of our common stock as reported by the Nasdaq Global Market.

High

LowYear Ended December 31, 2008First Quarter

$
4.28

$
3.63Second Quarter


4.95


3.78Third Quarter


6.26


4.25Fourth Quarter


4.05


2.34Year Ended December 31, 2007First Quarter


9.30


7.23Second Quarter


8.77


5.36Third Quarter


6.72


4.40Fourth Quarter


5.00


3.61


On
March 16, 2009, the closing price per share of our common stock was $2.57. We urge potential investors to obtain current market quotations before making any decision to invest
in our common stock. On March 16, 2009, there were approximately 80 holders of common stock, including record holders and stockholders whose shares are held by a bank, broker or other nominee.
However, we estimate that our shares are held through a small number of record holders by over 1,495 beneficial owners.

Except
for distributions paid to our stockholders related to S corporation earnings generated prior to our initial public offering in 1999, we have paid no dividends on our common stock.
We intend to retain future earnings for use in our business, and we do not anticipate paying any cash dividends on our common stock in the foreseeable future.

We
did not purchase any of our securities during 2008 nor did we have any unregistered sales of equity securities during 2008. You can find additional information about our equity
compensation plans in Part III, Item 12 of this Annual Report on Form 10-K.

14

---



Stock Performance Graph

The U.S. Securities and Exchange Commission requires that we provide a line-graph presentation comparing cumulative
stockholder returns on an indexed basis with the Nasdaq Composite Index and either a nationally recognized industry standard or an index of peer companies selected by us. The Board of Directors
previously approved the use of the Russell 2000 Index as our industry standard index. The table below compares the cumulative total return assuming $100 was invested as of December, 31, 2003, in our
common stock, the Russell 2000 Index and the Nasdaq Composite Index. The graph assumes the reinvestment of all dividends. The Indexes are weighted based on market capitalization at the time of each
reported data point.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*  Among Datalink Corporation, The NASDAQ Composite Index  And The Russell 2000 Index

CHART

---

* $100 invested on 12/31/03 in stock & index-including reinvestment of dividends.
Fiscal year ending December 31.

15

---



Item 6.    Selected Financial Data.

You should read the information below with our "Management's Discussion and Analysis of Financial Condition and Results of Operations"
and our financial statements. We derived the data as of December 31, 2008 and 2007, and for the years ended December 31, 2008, 2007 and 2006, from our financial statements that are
included in this Annual Report. We derived the data as of December 31, 2006, 2005 and 2004, and for the years ended December 31, 2005 and 2004, from our financial statements not included
in this Annual Report.

Year ended December 31,2008

2007

2006

2005

2004(in thousands, except per share data)Statement of Operations Data:Net sales:Product sales

$
113,493

$
111,201

$
102,400

$
81,582

$
63,235Service sales


82,104


66,571


43,583


35,531


30,048Total net sales


195,597


177,772


145,983


117,113


93,283Cost of sales:Cost of product sales


84,980


84,369


77,365


62,147


48,568Cost of services


57,966


48,111


30,521


24,321


21,175Total cost of sales


142,946


132,480


107,886


86,468


69,743Gross profit


52,651


45,292


38,097


30,645


23,540Operating expenses:Sales and marketing


23,368


22,067


15,985


15,062


12,438General and administrative


11,902


11,720


10,434


9,954


10,366Engineering


11,590


9,181


6,098


5,121


3,764Integration costs





442








Charge for sublease reserve(1)











3,502


Restructuring charges














(63
)Amortization of finite-lived intangibles(2)


711


727





224


261Total operating expenses


47,571


44,137


32,517


33,863


26,766Earnings (loss) from operations


5,080


1,155


5,580


(3,218
)

(3,226
)Interest income, net


589


983


714


303


83Other income (expense)


(37
)

(75
)







Earnings (loss) before income taxes


5,632


2,063


6,294


(2,915
)

(3,143
)Income tax (expense) benefit(3)


(2,236
)

(864
)

2,203





Net earnings (loss)

$
3,396

$
1,199

$
8,497

$
(2,915
)
$
(3,143
)Net earnings (loss) per common share:Basic

$
0.27

$
0.10

$
0.77

$
(0.28
)
$
(0.31
)Diluted

$
0.27

$
0.10

$
0.76

$
(0.28
)
$
(0.31
)Weighted average shares outstanding:Basic


12,370


12,156


11,006


10,318


10,286Diluted


12,495


12,392


11,127


10,318


10,286


16

---





As of December 31,2008

2007

2006

2005

2004(In thousands)Selected Balance Sheet Data:Cash and investments

$
27,730

$
25,164

$
22,900

$
13,434

$
12,663Working capital


21,027


15,992


19,011


9,385


10,007Total assets


129,819


131,469


86,849


63,143


47,069Stockholders' equity


42,519


38,244


27,322


15,835


18,512


---

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation.

You should read the following discussion in conjunction with our financial statements and the related notes included in Item 8.
The following information includes forward-looking statements, the realization of which may be affected by certain important factors discussed under "Risk Factors."

OVERVIEW

We are an independent architect of enterprise-class information storage infrastructures. We derive our revenues principally from
designing, installing and supporting data storage systems. Our solutions can include hardware products, such as disk arrays, tape systems and interconnection components and storage management software
products. The market for data storage products and services is large. IDC estimates that digital information will occupy more than six times its current quantity, or 988 billion gigabytes, by
2010. As of December 31, 2008, we have 19 locations throughout the United States. We historically have derived our greatest percentage of net sales from customers located in the central part of
the United States.

We
sell support service contracts to most of our customers. When customers purchase support services through us, customers receive the benefit of integrated system wide support. We have
a qualified,
independent support desk that takes calls from customers, diagnoses the issues they are facing and either solves the problem or coordinates with Datalink and/or vendor technical staff to meet the
customer's needs. Our support service agreements with our customers include an underlying agreement with the product manufacturer. The manufacturer provides on-site support assistance if
necessary. We defer revenues and direct costs resulting from these contracts, and amortize these revenues and expenses into operations, over the term of the contracts, which are generally twelve
months.

17

---



The enterprise-class information storage market is rapidly evolving and highly competitive. Our competition includes other independent storage system integrators, high end value added
resellers, distributors, consultants and the internal sales force of our suppliers. Our ability to hire and retain qualified outside sales representatives and engineers with enterprise-class
information storage experience is critical to effectively competing in the marketplace and achieving our growth strategies.

In
the past, we have experienced fluctuations in the timing of orders from our customers, and we expect to continue to experience these fluctuations in the future. These fluctuations
have resulted from, among other things, the time required to design, test and evaluate our data storage solutions before customers deploy them, the size of customer orders, the complexity of our
customers' network environments, necessary system configuration to deploy our solutions and new product introductions by suppliers. Completion of our installation and configuration services may also
delay recognition of revenues. Current economic conditions and competition also affect our customers' decisions and timing to place orders with us and the size of those orders. As a result, our net
sales may fluctuate from quarter to quarter.

We
view the current data storage market as providing significant opportunity for growth. Currently, Datalink's market share is a small part of the overall market. However, the providers
of the data storage industry's products and technologies are increasing their utilization of indirect sales approaches to broaden their reach and optimize their margins. Increasingly, they are turning
to companies such as Datalink to sell their products. While these trends provide opportunity for Datalink, we must improve our business model to generate sustainable, profitable growth. Our model
requires highly skilled sales and technical staff which results in substantial fixed costs for us. We believe the best way to improve our company and create long-term shareholder value is
to focus on building scaleable capabilities and a leverageable cost structure. Our current strategies are focused on:



To
pursue these strategies, we are:



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



18

---





In
January 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago,
Illinois. We believe the acquisition has strengthened our presence in existing regional markets and expanded our reach into a number of key new regional markets. We paid a purchase price of
approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock. Our results of operations for 2007 reflect the addition of MCSI for eleven
months.

Results of Operations

We ended 2008 with a record backlog of $33.0 million, which represents firm orders expected to be recognized as revenue in the
next 90 days. However, we are seeing the negative impact of the worldwide economic downturn affect many of our customers, resulting in greater scrutiny given to storage spending projects and
providing us with less visibility into their purchasing plans. We have also had some customers decide to significantly delay the implementation of projects for which they have already purchased and
paid for the product. We cannot predict what impact these economic uncertainties will have on our profitability going forward.

Our
sales for 2008 increased $17.8 million or 10.0% to $195.6 million for 2008 as compared to 2007. Our gross margin increased $7.4 million or 16.2% to
$52.7 million for 2008 as compared to 2007. Our earnings from operations increased $3.9 million from $1.2 million in 2007 to $5.1 million in 2008. The following table
shows, for the periods indicated, certain selected financial data expressed as a percentage of net sales.

Years Ended December 31,2008

2007

2006Net sales


100.0
%

100.0
%

100.0
%Cost of sales


73.1


74.5


73.9Gross profit


26.9


25.5


26.1Operating expenses:Sales and marketing


11.9


12.4


10.9General and administrative


6.1


6.6


7.2Engineering


5.9


5.2


4.2Integration costs





0.2


Amortization of intangibles


0.4


0.4


Total operating expenses


24.3


24.8


22.3Operating earnings


2.6
%

0.7
%

3.8
%


19

---



Comparison of Years Ended December 31, 2008, 2007 and 2006

The following table shows, for the periods indicated, revenue and gross profit information for our product and service sales.

Years Ended December 31,2008

2007

2006Product sales

$
113,493

$
111,201

$
102,400Service sales


82,104


66,571


43,583Product gross profit

$
28,513

$
26,832

$
25,035Service gross profit


24,138


18,460


13,062Product gross profit as a percentage of product sales


25.1
%

24.1
%

24.4
%Service gross profit as a percentage of service sales


29.4
%

27.7
%

30.0
%


Net Sales.Our product sales increased 2.1% in 2008 from 2007 to $113.5 million, and increased 8.6% in 2007 from 2006 to
$111.2 million. Our service sales, which includes customer support, consulting and installation services, increased 23.3% in 2008 from 2007 to $82.1 million, and increased 52.7% in 2007
from 2006 to $66.6 million.

The
modest increase in our product sales in 2008 as compared to 2007 is primarily from the successful integration of MCSI and increased storage spending in the marketplace. In addition,
our product revenues continue to reflect our customers' closer scrutiny of expenditures as they focus more attention on the actual or anticipated impact that current economic conditions may have on
the growth and profitability of their business. The increase in our product sales in 2007 as compared to 2006 is primarily due to the acquisition of MCSI in January 2007. Product sales growth
decreased from 25.5% in 2006 to 8.6% in 2007 and 2.1% in 2008 continuing to reflect what we believe to be a slow down in IT and storage spending with some of our larger customers, as they have become
more cautious about the economy and their individual growth prospects. This has created longer sales cycles with a number of large project delays. We believe that this spending slow down among our
customers will continue in 2009.

The
increase in our service revenues for 2008 over 2007 and 2007 over 2006 reflects an increase in our customer support contract revenues and installation and configuration service
revenues. For 2008, customer support contract revenues increased $14.7 million or 26.1% over 2007 and installation and configuration service revenues increased $1.1 million or 15.8%. For
2007 customer support contract revenues increased $21.4 million or 61.7% over 2006 and installation and configuration service revenues increased $1.3 million or 82.3%. For 2008, the slow
down in the growth of our customer support and installation and configuration services is due to both the acquisition of MCSI in 2007 and the slow down in the growth of our product revenues. We expect
to see flat to declining customer support and installation and configuration services in 2009 as spending on product declines due to current economic conditions. The majority of our increase in
customer support contract revenues in 2007 was due to the acquisition of MCSI.

We
derived approximately 13.9% of our sales from our customer, AT&T Inc., during 2006. We do not expect that this customer will account for a substantial portion of our future
sales. We had no customers that comprised more than 10% of our sales in 2008 or 2007.

Gross Profit.Our total gross profit as a percentage of net sales was 26.9% in 2008 increasing from 25.5% in 2007 and 26.1% in 2006.

Product
gross profit as a percentage of product sales increased to 25.1% in 2008 as compared to 2007 and decreased to 24.1% in 2007 as compared to 24.4% in 2006. Our product gross profit
as a percentage of product sales is impacted by the mix and type of projects we complete for our customers.

20

---



Our
product gross profit as a percentage of product sales increased for 2008 over 2007 due to the continuing efforts by our sales force to sell higher margin storage solutions. This included the
increased percentage of our product sales coming from disk sales which have historically experienced higher margins. With the current economic downturn, we expect a decline in the number and
profitability of disk sales. Our product gross profit as a percentage of product sales decreased for 2007 over 2006 due to the additional MCSI revenues which historically had lower product margins.
Our efforts to successfully integrate the MCSI sales force, by leveraging product and service offerings across our vendors, has gradually improved the gross margins realized by the MCSI sales force.
We have various programs in place with our vendors that provide economic incentives for achieving various sales performance targets. Achieving these targets contributed favorably to our product gross
profit by $1.5 million, $2.0 million and $1.5 million in 2008, 2007 and 2006, respectively. These vendor incentive programs constantly change and we negotiate them separately with
each vendor. While we expect the incentive programs to continue, the vendors could modify or discontinue them, particularly in light of current economic conditions, which would unfavorably impact our
product gross profit margins. We estimate that our product gross margins will be approximately 24% to 25% going forward.

Service
gross profit as a percentage of service sales was 29.4% in 2008 as compared to 27.7% in 2007 and 30.0% in 2006. In 2008, we had $509,000 less in MCSI acquisition purchase
accounting adjustments that required us to reduce revenues and corresponding margins to reflect the fair value of acquired maintenance contracts. Accordingly, for 2008, our gross profit percentage of
service sales returned to our historical range of between 29% and 30%. The percentage decrease in 2007 as compared to 2006 is primarily due to a $664,000 reduction in revenues and corresponding
margins for the MCSI acquisition to reflect the fair value of maintenance contracts we acquired.

Sales and Marketing.Sales and marketing expenses include wages and commissions paid to sales and marketing personnel, travel costs and
advertising,
promotion and hiring expenses. Sales and marketing expenses totaled $23.4 million, or 11.9% of net sales for 2008 as compared to $22.1 million, or 12.4% of net sales for 2007 and
$16.0 million, or 10.9% of net sales for 2006. The increase in sales and marketing expense in absolute dollars for 2008 over 2007 is primarily a result of higher commission expense of
$1.3 million which is due to our increase in revenues for the year. The increase in sales and marketing expense in absolute dollars for 2007 over 2006 is primarily a result of higher commission
expense of $1.6 million and compensation expense of $3.7 million. The increase in commission expense is due to our increase in revenues for the year. The increase in compensation expense
is due to our acquisition of MCSI which increased our sales and marketing headcount by approximately 45%. The decrease in sales and marketing expense as a percentage of net sales from 2008 to 2006
reflects better leverage of our fixed costs as revenues increased in 2008. The increase in sales and marketing expense as a percentage of net sales from 2007 to 2006 reflects primarily the increase in
sales and marketing headcount as a result of our MCSI acquisition, and investments in sales management. As we continue to selectively hire additional outside sales representatives, our sales and
marketing expenses may increase without a commensurate increase in sales. We are carefully monitoring our travel and other sales and marketing expenses in light of current economic conditions.

General and Administrative.General and administrative expenses include wages for administrative personnel, professional fees,
depreciation,
communication expenses and rent and related facility expenses. General and administrative expenses increased to $11.9 million, or 6.1% of net sales for 2008 compared to $11.7 million, or
6.6% of net sales for 2007 and $10.4 million, or 7.2% in 2006. The modest increase in general and administrative expense in absolute dollars for 2008 as compared to 2007 is primarily due to an
increase in variable compensation expense of $300,000 related to exceeding 2008 performance objectives. The increase in general and administrative expenses in absolute dollars for 2007 as compared to
2006 is primarily due to an increase in facility expenses of $496,000 with the acquisition of MCSI in January 2007, an increase in audit fees and outside consulting fees for Sarbanes-Oxley compliance
of $213,000, an increase in compensation expense of $200,000 and an

21

---



increase
in depreciation expense of $120,000. Our general and administrative expenses were lower as a percentage of net sales for 2008 as compared to 2007, and 2007 as compared to 2006, primarily due
to more controlled spending coupled with an increase in revenues.

Engineering.Engineering expenses include employee wages and travel, hiring and training expenses for our field and customer support
engineers and
technicians. We allocate engineering costs associated with installation and configuration services and with consulting services to our cost of service sales. Therefore, if we incur a slowdown in
product sales during 2009 because of current economic conditions, we will have higher engineering expenses. Engineering expenses increased to $11.6 million, or 5.9% of net sales in 2008
compared to $9.2 million, or 5.2% of net sales in 2007 and $6.1 million, or 4.2% of net sales in 2006. The increase in engineering expenses in absolute dollars for 2008 over 2007 is due
primarily to an increase in compensation expense of $1.6 million for additional regional and customer support resources and an increase in variable compensation expense of $751,000 related to
exceeding 2008 performance objectives. The increase in engineering expenses in absolute dollars for 2007 over 2006 is due primarily to an increase in compensation expense of $3.6 million
related to our MCSI acquisition. The MCSI acquisition increased our engineering headcount approximately 26%. The increase in engineering expenses as a percentage of sales for 2008 as compared to 2007
and 2007 as compared to 2006 is primarily the result of investments in regional engineering support, regional management and customer support resources.

Integration Costs.We had integration expenses of $442,000 in 2007 related to the January 31, 2007 acquisition of MCSI. Integration
expenses
include salaries and benefits of MCSI employees who assisted with the initial integration but whom we ultimately did not retain, together with retention bonuses and severance payments.

Intangible Amortization.We had expenses related to the amortization of finite-lived intangible assets of $711,000, $727,000 and $0 in
2008, 2007 and
2006, respectively. Amortization of intangible assets decreased to $711,000 in 2008 from $727,000 in 2007 due to the amortization of backlog which was completed in 2007. Amortization of intangible
assets increased to $727,000 in 2007 from $0 in 2006. The increase in finite-lived intangible assets and subsequent amortization is due to our acquisition of MCSI on January 31, 2007. The
finite lived intangibles we acquired, consisting of customer relationships and backlog, have estimated lives of six years and two months, respectively, and we are amortizing them using the straight
line method. For 2008, 2007 and 2006, we determined that our goodwill was not impaired.

In
accordance with SFAS No. 142,Goodwill and Other Intangible Assets(SFAS 142), we are required to assess the carrying
amount of our finite life intangibles and goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment may have occurred.

The
assessment to determine if a potential impairment of goodwill exists involves comparing our market capitalization to the carrying value of our net assets. Historically, our market
capitalization has been well above the carrying value of our net assets and there has been no indication of potential impairment. However, during the fourth quarter of fiscal 2008 the price of our
common stock was
significantly impacted by the volatility in the U.S. equity markets. The price of our common stock reached a low of $2.34 during the fourth quarter of fiscal 2008, remained below $3.00 per share for
an extended period of time during the fourth quarter of 2008 and closed at $3.20 on December 31, 2008. These lows in the price of our common stock have coincided with the stock markets'
52 week lows recorded as the financial crisis has intensified. As of December 31, 2008 our market capitalization was approximately $41.4 million as compared to our stockholders'
equity at December 31, 2008 of $42.5 million.

22

---



We
believe that the fair value of our company exceeds our market capitalization because our fair value should include a control premium. A control premium is the amount that a buyer is
willing to pay over the current market price of a company as indicated by the traded price per share (i.e. market capitalization), in order to acquire a controlling interest. The premium is
justified by the expected synergies, such as the expected increase in cash flow resulting from cost savings and revenue enhancements. We believe a control premium of 20 to 40 percent is
appropriate for our company. Applying a control premium of 20 to 40 percent results in a revised market capitalization of approximately $49.7 million to $57.9 million,
respectively, which is in excess of our stockholders' equity at December 31, 2008 of $42.5 million and indicates there is not an impairment of goodwill as of December 31, 2008.
However, we can provide no assurance that these continuing conditions would not trigger goodwill impairment testing in the future or whether we may record an impairment charge. We will continue to
monitor and evaluate the carrying value of our goodwill to determine whether interim asset impairment testing is warranted. Since December 31, 2008, our stock price has fluctuated between a low
of $2.52 per share to a high of $3.50 per share.

In
accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets(SFAS 144), we
are required to perform an impairment test for long-lived assets on an annual basis or whenever events or changes in circumstances indicate that the carrying value of such assets may not
be recoverable. Impairment is recognized based on the difference between the fair value of the asset and its carrying value, and fair value is generally measured based on discounted cash flow
analyses. For 2008, 2007 and 2006, we determined that our long-lived assets were not impaired.

Operating Earnings.We realized operating earnings of $5.1 million in 2008, $1.2 million in 2007 and $5.6 million in
2006. The
increase in our operating earnings in 2008 as compared to 2007 is a result of higher revenues and gross margins partially offset by higher operating expenses. The decrease in our operating earnings in
2007 as compared to 2006 is due to our lower gross margin and increased operating expenses in 2007 primarily as a result of our acquisition of MCSI.

Income Taxes.We had income tax expense of $2.2 million in 2008 which resulted in our estimated effective tax rate of 40%. We had
income tax
expense of $864,000 in 2007 which resulted in our estimated effective tax rate of 42%. We had an income tax benefit of $2.2 million in 2006. Prior to fiscal 2006, we recorded a full valuation
allowance against our deferred tax assets due to the uncertainty of the realization and timing of the benefits from those deferred tax assets as we had not achieved a sufficient level of sustained
profitability. During 2006, we utilized approximately $4.8 million of our net operating loss carryforwards. Furthermore, we concluded that we had attained a sufficient level of sustained
profitability to reverse the remaining $2.8 million valuation allowance. We utilized approximately $1.9 million and $4.8 million of our federal net operating loss carryforwards in
2007 and 2006, respectively. As of December 31, 2007, we fully utilized our federal net operating loss carryforwards. As of December 31, 2008 we have state net operating loss
carryforwards of approximately $843,000, which are available to offset future state taxable income. If not used, these state net operating loss carryforwards will expire between 2013 and 2024. For
2008, 2007 and 2006, respectively, we recorded approximately $2,000, $104,000 and $392,000 to equity for tax benefits associated with the exercise of stock options. In future periods of taxable
earnings, we expect to report an income tax provision using an effective tax rate of approximately 40%.

23

---





Quarterly Results and Seasonality

The following table sets forth our unaudited quarterly financial data for each quarter of 2008 and 2007. We have prepared this
unaudited information on the same basis as the audited information. In our opinion, we have made all adjustments (including all normal recurring adjustments) necessary to present fairly the
information set forth below. The operating results for any quarter are not necessarily indicative of results for any future period.

Quarters Ended2008

2007Mar. 31

Jun. 30

Sep. 30

Dec. 31

Mar. 31

Jun. 30

Sep. 30

Dec. 31(in thousands)Net sales

$
47,725

$
49,707

$
49,980

$
48,185

$
40,911

$
40,338

$
45,848

$
50,675Gross profit


13,006


13,332


13,757


12,556


9,874


10,147


11,857


13,414Operating earnings (loss)


660


1,524


1,709


1,187


(1,450
)

(763
)

1,125


2,243Net earnings (loss)


505


979


1,068


843


(719
)

(346
)

844


1,420


We
have experienced, and expect to continue to experience, quarterly variations in our net sales as a result of a number of factors, including the length of the sales cycle with
customers for large storage system evaluations and purchases, delays in storage system installations or configurations, new product introductions by suppliers and their market acceptance, delays in
product shipments or other quality control difficulties, trends in the enterprise-class information storage industry in general or the geographic and industry specific markets in which we are
currently active, or may be in the future. In addition, current economic conditions and competition also affect our customers' decisions to place or delay orders with us, and the size and scale of
their orders. Further, our success in integrating any acquired business or in opening any new field offices could impact our operating results.

Liquidity and Capital Resources

Since our initial public offering we have financed our operations and capital requirements through cash flows generated from
operations. Our working capital was $21.0 million at December 31, 2008 as compared to $16.0 million at December 31, 2007. Our current ratio was 1.2:1 at December 31,
2008 and 2007. At December 31, 2008, our cash and cash equivalents balance was $26.3 million as compared to cash and cash equivalents of $22.7 million at December 31, 2007.

Cash
provided by operating activities for 2008 was $3.4 million. Cash provided by operating activities for 2008 was primarily impacted by:



Cash
provided by operating activities for 2007 was $5.1 million. Cash provided by operating activities for 2007 was primarily impacted by:



24

---





Cash
provided by operating activities for 2006 was $7.3 million. Cash provided by operating activities for 2006 was primarily impacted by:



Cash
provided by investing activities was $204,000 in 2008. Cash used in investing activities was $5.5 million in 2007 and $562,000 in 2006. In 2008, we had proceeds from the sale
of short term investments of $1.0 million offset by purchases of $800,000 for upgraded computer equipment, upgraded telephone systems and leasehold improvements. In 2007, we used this cash
primarily for the acquisition of MCSI, purchase of a short-term investment, and leasehold improvements and upgraded computer equipment. In 2006, we used cash primarily to purchase computer
equipment and provide further enhancements to our business reporting tools.

Cash
used in financing activities in 2008 was $80,000 primarily for the redemption of restricted shares for tax withholding payments. Cash provided by financing activities in 2007 and
2006 was $254,000 and $2.7 million, respectively, all of which we received from the exercise of stock options and warrants.

We
have an eleven-year non-cancelable operating lease for our corporate headquarters in Chanhassen, Minnesota which expires in 2012. The lease requires annual
base rental payments of approximately $1.3 million. In December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied. The initial term of the sublease is
co-terminal with our lease and is for 85 months starting in April 2005 and ending in April 2012. The sublease requires rent payments ranging from $55,000 per month at the beginning
of the term to approximately $60,000 per month by the end of the term. For more information, see Note 5 of the Notes to our Financial Statements.

On
January 31, 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting, solutions and service provider based
in Chicago, Illinois. We paid approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock.

We
believe that our current cash balance and funds generated from operations will finance our current operations and planned capital expenditures for at least the next twelve months. We
believe if the need should arise to borrow funds, we could obtain a secured facility. However, the current state of the financial markets could impact our ability to obtain future funding.

Off-Balance Sheet Arrangements

We do not have any special purpose entities or off-balance sheet financing.

25

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Contractual Obligations and Commitments

As of December 31, 2008, our contractual cash obligations consist of future minimum lease payments due under
non-cancelable operating leases as follows:

Lease
Obligations

Sublease
Agreements

Net Lease
Obligations(in thousands)2009

$
1,814

$
(768
)
$
1,0462010


1,674


(752
)

9222011


1,596


(719
)

8772012


592


(239
)

3532013








Thereafter








$
5,676

$
(2,478
)
$
3,198


From
time to time we enter into purchase commitments with our suppliers under customary purchase order terms. We would recognize any significant losses implicit in these contracts in
accordance with generally accepted accounting principles. At December 31, 2008, no such losses existed.

In
December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term
is co-terminal with our lease and is 85 months starting in April 2005 and ending in April 2012. The sublessee pays us rent ranging from approximately $55,000 per month at the
beginning of the term to approximately $60,000 per month by the end of the term. The rent includes the costs of common area management, common systems repairs, real estate taxes and standard
utilities.

We
are planning for $500,000 to $1.0 million of capital expenditures during 2009 primarily related to enhancements to our management information systems and upgraded computer
equipment.

Critical Accounting Estimates

The preparation of financial statements requires us to make estimates and assumptions that affect reported earnings. We evaluate these
estimates and assumptions on an on-going basis based on historical experience and on other factors that we believe are reasonable. Estimates and assumptions include, but are not limited
to, the areas of customer receivables, inventories, investments, income taxes, self-insurance reserves and commitments and contingencies. We believe that the following represent the areas
where we use more critical estimates and assumptions in the preparation of our financial statements:

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

Valuation of Goodwill.We test goodwill for impairment annually or more frequently if changes in circumstance or the occurrence of
events suggests an
impairment exists. Testing for goodwill impairment is a two step process. The first step screens for potential impairment and if there is an indication of possible impairment we must complete the
second step to measure the amount of impairment loss, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of our market
capitalization with the carrying value of our net

26

---



assets.
If our total market capitalization is at or below the carrying value of our net assets, we perform the second step of the goodwill impairment test to measure the amount of impairment loss we
record, if any. With the worldwide decline in stock prices, the potential for this is increased. We consider goodwill impairment test estimates critical due to the amount of goodwill recorded on our
balance sheet and the judgment required in determining fair value amounts.

Valuation of Long-Lived Assets, Including Finite-Lived Intangibles.We evaluate long-lived assets and intangible assets with
finite lives for impairment, as well as the related amortization periods, to determine whether adjustments to these amounts or useful lives are
required based on current events and circumstances. We base the evaluation on our projection of the undiscounted future operating cash flows of the underlying assets. The downturn in the U.S. economy
may make it increasingly difficult for us to accurately predict our future cash flows. To the extent our projections indicate that future undiscounted cash flows are not sufficient to recover the
carrying amounts of related assets, we record a charge to reduce the carrying amount to its estimated fair value. The test for impairment requires us to make several estimates about fair value, most
of which are based on projected future cash flows. We consider the estimates associated with the asset impairment tests critical due to the judgments required in determining fair value amounts,
including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss.

Stock-Based Compensation.We adopted the provisions of FASB No. 123R, Share Based Payment on January 1, 2006. SFAS 123(R)
requires us to measure and recognize in our statements of operations the expense associated with all share-based payment awards made to employees and directors based on estimated fair values.
SFAS 123(R) requires the use of an option pricing model to determine the fair value of share-based payment awards. Our stock price, as well as assumptions regarding a number of highly complex
and subjective variables, will affect our determination of fair value. We base recognition of compensation expense for our performance-based, non-vested shares on management's estimate of
the probable outcome of the performance condition. Management reassesses the probability of meeting these performance conditions on a quarterly basis. Changes in management's estimate of meeting these
performance conditions may result in significant fluctuations in compensation expense from period to period.

Recent Accounting Pronouncements

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements ("SFAS 157"), which provides guidance
on how to measure assets and liabilities that use fair value. SFAS 157 applies whenever another U.S. GAAP standard requires (or permits) measurement of assets or liabilities at fair
value, but does not expand the use of fair value to any new circumstances. We also adopted FASB Staff Position ("FSP") No. FAS 157-2,Effective Date of FASB
Statement No.157, which allows us to partially defer the adoption of SFAS 157. This FSP defers the effective date of SFAS 157 for nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years. Nonfinancial assets and nonfinancial liabilities include all assets and liabilities other than those meeting the definition of
a financial asset or financial liability as defined in paragraph 6 of Statement No. 159,The Fair Value Option for Financial Assets and Financial
Liabilities. The adoption of SFAS No. 157 and FSP No. 157-2 had no impact on our financial statements.

In
December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS 141R") which establishes principles and requirements for how the acquirer of a business
recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. The statement also provides guidance for
recognizing and measuring the goodwill acquired in the business combination and for disclosure to enable evaluation of the nature and financial effects of the business combination. SFAS 141R is
effective for us as to

27

---



business
combinations we make beginning in 2009. Accordingly, until January 1, 2009, we recorded and disclose any business combinations we engage in by following existing GAAP. We are
evaluating the impact of SFAS No. 141R, but do not currently expect it to have a significant impact on our financial statements when effective. However, the nature and magnitude of the specific
future effects will depend upon the nature, terms and size of any acquisitions we consummate after the effective date.

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160").
SFAS 160 introduces significant changes in the accounting and reporting for business acquisitions and noncontrolling interest in a subsidiary. SFAS 160 also changes the accounting and
reporting for the deconsolidation of a subsidiary. Companies are required to adopt the new standard for fiscal years beginning after January 1, 2009. We adopted this standard as of
January 1, 2009 and do not expect it to have an impact on our financial statements.

In
April 2008, the FASB issued Staff Position FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). The FSP
amends the factors considered in developing renewal or extension assumptions for determining the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible
Assets." The FSP's intent is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the
fair value of the asset under other accounting principles generally accepted in the U.S. Companies must adopt the FSP for fiscal years and interim periods beginning after December 15, 2008.
Early adoption is prohibited. Companies must apply the guidance for determining the useful life of a recognized intangible asset prospectively to intangible assets acquired after the effective date.
Companies must also apply certain disclosure requirements prospectively to all intangible assets recognized as of, and subsequent to, the effective date. We adopted this standard as of
January 1, 2009 and do not expect it to have a significant impact on our financial statements.

Inflation

We do not believe that inflation has had a material effect on our results of operations in recent years. We cannot assure you that
inflation will not adversely affect our business in the future.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our
investments are in short-term instruments. Due to the nature of our short-term investments, we do not believe that we have any material market risk exposure. Therefore, no
quantitative tabular disclosures are required.

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

Interest rate risk.As of December 31, 2008, we had $26.3 million of cash and money market accounts and $1.5 million of
short
term investments consisting primarily of certificates of deposit. A decrease in market rates of interest would have no material effect on the value of these assets or the related interest income due
to the nature of money market accounts. We have no short or long-term debt.

Foreign currency exchange rate risk.We market and sell all of our products and services in the United States. Therefore, we are not
currently
exposed to any direct foreign currency exchange rate risk.

Equity price risk.We do not own any equity investments. Therefore, we are not currently exposed to any direct equity price risk.

28

---





Item 8.    Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

To
the Board of Directors and Shareholders of
Datalink Corporation

We
have audited the accompanying balance sheets of Datalink Corporation as of December 31, 2008 and 2007 and the related statements of income, stockholders' equity and cash flows for each of
the years in the three year period ended December 31, 2008. 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 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Datalink Corporation as of December 31, 2008 and 2007, and the
results of its operations and its cash flows for each of the years in the three year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United
States of America.

We
were not engaged to examine management's assertion about the effectiveness of Datalink Corporation's internal control over financial reporting as of December 31, 2008 included in this annual
report on Form 10-K, under the caption "Management's Report on Internal Control over Financial Reporting" and, accordingly, we do not express an opinion thereon.

/s/MCGLADREY & PULLEN, LLP

Minneapolis,
Minnesota
March 25, 2009

29

---





DATALINK CORPORATION        BALANCE SHEETS        (In thousands, except share data)

December 31,2008

2007AssetsCurrent assets:Cash and cash equivalents

$
26,257

$
22,687Short term investments


1,473


2,477Accounts receivable, net


22,293


26,156Inventories


1,230


6,034Deferred customer support contract costs


43,674


39,707Inventories shipped but not installed


10,235


9,048Current deferred income taxes


1,417


1,049Income tax receivable


14


Other current assets


219


350Total current assets


106,812


107,508Property and equipment, net


2,088


2,270Goodwill


17,748


17,748Finite-lived intangibles, net


2,900


3,611Other assets


271


332Total assets

$
129,819

$
131,469Liabilities and Stockholders' EquityCurrent liabilities:Accounts payable

$
23,377

$
33,391Accrued commissions


1,328


2,038Accrued income taxes





283Accrued sales and use taxes


403


1,167Accrued expenses, other


3,451


2,288Sublease reserve current


311


335Deferred revenue from customer support contracts


56,915


52,014Total current liabilities


85,785


91,516Deferred rent


157


226Deferred income tax liability


723


537Sublease reserve non-current


635


946Total liabilities


87,300


93,225Commitments and contingencies (Notes 5, 6, and 9)Stockholders' equity:Common stock, $0.001 par value, 50,000,000 shares authorized, 12,930,264 and 12,476,419 shares issued and outstanding as of December 31, 2008 and 2007,
 respectively


13


12Additional paid-in capital


40,144


39,266Retained earnings (accumulated deficit)


2,362


(1,034
)Total stockholders' equity


42,519


38,244Total liabilities and stockholders' equity

$
129,819

$
131,469


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

30

---





DATALINK CORPORATION        STATEMENTS OF INCOME        (In thousands, except per share data)

Year Ended December 31,2008

2007

2006Net sales:Product sales

$
113,493

$
111,201

$
102,400Service sales


82,104


66,571


43,583Total net sales


195,597


177,772


145,983Cost of sales:Cost of product sales


84,980


84,369


77,365Cost of services


57,966


48,111


30,521Total cost of sales


142,946


132,480


107,886Gross profit


52,651


45,292


38,097Operating expenses:Sales and marketing


23,368


22,067


15,985General and administrative


11,902


11,720


10,434Engineering


11,590


9,181


6,098Integration costs





442


Amortization of intangibles


711


727


Earnings from operations


5,080


1,155


5,580Interest income


589


983


714Other income (expense)


(37
)

(75
)

Net earnings before income taxes


5,632


2,063


6,294Income tax (expense) benefit


(2,236
)

(864
)

2,203Net earnings

$
3,396

$
1,199

$
8,497Net earnings per common share:Basic

$
0.27

$
0.10

$
0.77Diluted

$
0.27

$
0.10

$
0.76Weighted average common shares outstanding:Basic


12,370


12,156


11,006Diluted


12,495


12,392


11,127


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

31

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DATALINK CORPORATION        STATEMENTS OF STOCKHOLDERS' EQUITY        (In thousands)

Common Stock



Retained
Earnings/
(Accumulated
Deficit)Additional
Paid-in CapitalShares

Amount

TotalBalances, December 31, 2005


10,404

$
10

$
26,555

$
(10,730
)
$
15,835Net earnings











8,497


8,497Stock option and restricted stock expense


254





293





293Common shares issued upon exercise of warrants


200





900





900Tax benefit from stock based compensation








392





392Common shares issued under exercise of stock options


371


1


1,404





1,405Balances, December 31, 2006


11,229


11


29,544


(2,233
)

27,322Net earnings











1,199


1,199Issuance of common stock for MCSI acquisition


1,164


1


8,952





8,953Stock option and restricted stock expense


11





516





516Redemption of restricted shares for tax withholding payments








(140
)




(140
)Tax benefit from stock based compensation








104





104Common shares issued under exercise of stock options


72





290





290Balances, December 31, 2007


12,476


12


39,266


(1,034
)

38,244Net earnings











3,396


3,396Stock option and restricted stock expense


486


1


959





960Redemption of restricted shares for tax withholding payments


(52
)




(128
)




(128
)Tax expense from stock based compensation








(13
)




(13
)Common shares issued under exercise of stock options


20





60





60Balances, December 31, 2008


12,930

$
13

$
40,144

$
2,362

$
42,519


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

32

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DATALINK CORPORATION        STATEMENTS OF CASH FLOWS        (In thousands)

Year Ended December 31,2008

2007

2006Cash flows from operating activities:Net earnings

$
3,396

$
1,199

$
8,497Adjustments to reconcile net earnings to net cash provided by operating activities:Provision for bad debts


125


36


36Depreciation


966


1,101


985Amortization of intangibles


711


727


Amortization of discount on short term investments


(1
)

(31
)

Deferred income taxes


(182
)

421


(2,762
)Deferred rent


(69
)

59


(122
)Amortization of sublease reserve


(335
)

(360
)

(384
)Stock based compensation expense


960


516


293Loss on disposal of assets


16


60


111Changes in operating assets and liabilities, net of effects of acquisition:Accounts receivable


3,738


(2,950
)

(3,558
)Inventories


3,617


(6,186
)

800Deferred customer support contract costs/revenues, net


934


4,313


2,729Accounts payable


(10,014
)

5,334


93Accrued expenses


(594
)

800


527Other


178


11


86Net cash provided by operating activities


3,446


5,050


7,331Cash flows from investing activities:Proceeds from sale (purchases) of investments


1,004


(2,446
)

Purchases of property and equipment


(800
)

(1,234
)

(562
)Payment for acquisition of MCSI, net of cash acquired





(1,841
)

Net cash provided by (used in) investing activities


204


(5,521
)

(562
)Cash flows from financing activities:Tax benefit (expense) from stock based compensation


(13
)

104


392Tax withholding payments reimbursed by restricted stock


(128
)

(140
)

Proceeds from issuance of common stock from option exercise


60


290


2,305Net cash provided by (used in) financing activities


(80
)

254


2,697Increase (decrease) in cash and cash equivalents


3,570


(213
)

9,466Cash and cash equivalents, beginning of year


22,687


22,900


13,434Cash and cash equivalents, end of year

$
26,257

$
22,687

$
22,900Supplementary cash flow information:Cash paid for income taxes


2,727


58


Supplementary non-cash investing and financing activities:See Note 8 for non-cash information for the acquisition of MCSI


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

33

---





DATALINK CORPORATION        NOTES TO FINANCIAL STATEMENTS

1.     Description of Business:

Datalink Corporation is an independent architect of enterprise-class information storage infrastructures. We derive our revenues principally from designing,
installing and supporting data storage systems. Our solutions can include hardware products, such as disk arrays, tape systems and interconnection components, and storage management software products.
We are frequently engaged to provide assistance in the installation of solutions and to provide support services subsequent to the installation. Occasionally, we are engaged for consulting services.

2.     Summary of Significant Accounting Policies:



Cash equivalents consist principally of money market funds with original maturities of three months or less, are readily convertible to
cash and are stated at cost, which approximates fair value. We maintain our cash in bank deposit and money market accounts which, at times, may exceed federally insured limits. We have not experienced
any losses in such accounts.



Our short term investments consist principally of certificates of deposits. These investments are categorized as not
available-for-sale securities and recorded at fair market value, as defined by SFAS No. 157. Investments with maturities of 90 days or less from the date of
purchase are classified as cash equivalents; investments with maturities of greater than 90 days from the date of purchase but less than one year are generally classified as
short-term investments; and investments with maturities of greater than one year from the date of purchase are generally classified as long-term investments.



We carry trade receivables at original invoice amount less an estimate made for doubtful receivables based on a review of all
outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial
condition and credit history and current economic conditions. We write off trade receivables when deemed uncollectible. We record recoveries of trade receivables previously written off when received.

We
recorded accounts receivable net of the reserve for doubtful accounts of $199,000 and $112,000 at December 31, 2008 and 2007, respectively.



During 2006, net sales from our customer AT&T Inc. were approximately 13.9% of total net sales. There was no accounts receivable
from AT&T Inc. at December 31, 2006. We had no other customers that comprised more than 10% of our sales in 2008, 2007 or 2006.



Inventories, including inventories shipped but not installed, principally consist of data storage products and components, valued at
the lower of cost or market with cost determined on a first-in, first-out (FIFO) method. We reduced inventories for obsolete and slow moving reserves by $100,000 and $185,000
at December 31, 2008 and 2007, respectively.

34

---





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 2 to 10 years). We amortize leasehold improvements on a
straight-line basis over the shorter of their estimated useful lives or the underlying lease term. We remove the costs and related accumulated depreciation and amortization on asset
disposals from the accounts and include any gain or loss in operating expenses. We capitalize major renewals and betterments, but charge maintenance and repairs to current operations when incurred.

December 31,2008

2007(In thousands)Property and equipment:Construction in process

$
87

$
76Leasehold improvements


1,473


1,359Furniture and fixtures


2,016


1,913Equipment


3,684


3,433Computers and software


2,273


2,1099,533


8,890Less accumulated depreciation and amortization


7,445


6,620$
2,088

$
2,270




In accordance with SFAS No. 142,Goodwill and Other Intangible Assets(SFAS 142), we are required to assess the carrying amount of our goodwill for potential impairment annually or more frequently if events or a change in circumstances indicate that impairment
may have occurred.

Testing
for goodwill impairment is a two step process. The first step screens for potential impairment and if there is an indication of possible impairment we must complete the second
step to measure the amount of impairment loss, if any. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of our market capitalization with
the carrying value of our net assets. If our total market capitalization is at or below the carrying value of our net assets, we perform the second step of the goodwill impairment test to measure the
amount of impairment loss we record, if any. We consider goodwill impairment test estimates critical due to the amount of goodwill recorded on our balance sheet and the judgment required in
determining fair value amounts.

Historically,
our market capitalization has been well above the carrying value of our net assets and there has been no indication of potential impairment. However, during the fourth
quarter of 2008, the price of our common stock was significantly impacted by the volatility in the U.S. equity markets. The price of our common stock reached a low of $2.34 during the fourth quarter
of 2008, remained below $3.00 per share for an extended period of time during the fourth quarter of 2008 and closed at $3.20 on December 31, 2008. These lows in the price of our common stock
have coincided with the stock markets' 52 week lows recorded as the financial crisis has intensified. As of December 31, 2008, our market capitalization was approximately
$41.4 million as compared to our stockholders' equity at December 31, 2008 of $42.5 million.

We
believe that the fair value of our company exceeds our market capitalization because our fair value should include a control premium. A control premium is the amount that a buyer is
willing to pay over the current market price of a company as indicated by the traded price per share (i.e. market

35

---



capitalization),
in order to acquire a controlling interest. The premium is justified by the expected synergies, such as the expected increase in cash flow resulting from cost savings and revenue
enhancements. We believe a control premium of 20 to 40 percent is appropriate for our company. Applying a control premium of 20 to 40 percent results in a revised market capitalization
of approximately $49.7 million to $57.9 million, respectively, which is in excess of our stockholders' equity at December 31, 2008 of $42.5 million and indicates there is
not an impairment of goodwill as of December 31, 2008. However, we can provide no assurance that these continuing conditions would not trigger goodwill impairment testing in the future or
whether we may record an impairment charge. We will continue to monitor and evaluate the carrying value of our goodwill to determine whether interim asset impairment testing is warranted. Since
December 31, 2008, our stock price has fluctuated between a low of $2.52 per share to a high of $3.50 per share.



In accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived
Assets(SFAS 144), we are required to perform an impairment test for long-lived assets on an annual basis or whenever events or changes in circumstances
indicate that the carrying value of such assets may not be recoverable. Impairment is recognized based on the difference between the fair value of the asset and its carrying value, and fair value is
generally measured based on discounted cash flow analyses. For 2008, 2007 and 2006, we determined that our long-lived assets were not impaired.



We account for stock based compensation in accordance with SFAS 123(R) which requires recognition of share-based payments,
including grants of stock options, in the statement of operations as an operating expense based on their fair values over the requisite service period. Stock-based compensation expense recognized
under SFAS 123(R) was $959,000, $516,000 and $293,000 for 2008, 2007 and 2006, respectively.



We calculate income taxes in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes," which requires the
use of the asset and liability method of accounting for income taxes. Under the liability method, we record deferred income taxes to reflect the tax consequences in future years of temporary
differences between the tax bases of assets and liabilities and their financial reporting amounts using enacted tax rates for the years in which we expect these items to affect taxable income. We
establish valuation allowances when necessary to reduce deferred tax assets to the amount we expect more likely than not to realize. Income tax (benefit) expense is the tax payable (receivable) for
the period and the change during the period in deferred tax assets and liabilities.



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
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. Significant items subject to estimates and assumptions include the reserve for doubtful accounts, reserve for
obsolete and slow moving (excess) inventory and impairment of goodwill and long-lived assets. Actual results could differ from those estimates.

36

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Revenue Recognition.We realize revenue from the design, installation and support of data storage solutions, which may include hardware,
 software and
services. We recognize revenue when we have met our obligations for installation or other services and collectability is reasonably assured.

Product Sales.We sell software and hardware products on both a "free-standing" basis without any services and as data storage
solutions
bundled with its installation and configuration services ("bundled arrangements").

Product Sales Without Service.If we sell a software or hardware product and do not provide any installation or configuration services
with it, we
recognize the product revenues upon shipment.

Product Sales With Service.If we sell a bundled arrangement, then we defer recognizing any revenue on it until we finish its
installation and/or
configuration work. We account for the hardware, software and service elements of its bundled arrangements by applying the provisions of Statement of Position (SOP) 97-2, Software Revenue
Recognition, as amended by SOP 98-4 and SOP 98-9.

Pursuant
to the provisions of SOP 97-2, we apply contract accounting to bundled arrangements. In accordance with SOP 81-1, "Accounting for
Performance of Construction Type and Certain Production Type Contracts," we apply the completed contract method. Factors we have considered in applying the completed contract method of accounting
include (i) the relatively short duration of our contracts, (ii) the difficulty of estimating our revenues on a percentage-of-completion method and
(iii) our use of acceptance provisions on larger bundled arrangements.

We
recognize shipping revenues as a component of product sales and recognize shipping expenses as a component of cost of products sold.

Service Sales.In addition to installation and configuration services that are part of our bundled arrangements described above, our
service sales
include customer support contracts and consulting services. On our balance sheet, deferred revenue relates to service sales for which our customer has paid us or has been invoiced but for which we
have not yet performed the applicable services.

Customer Support Contracts.We sell service contracts to most of our customers. These contracts are support service agreements. We have
an internal
support desk that provides integrated customer support services, including configuration and usage assistance, technical advice and prompt incident detection and resolution. Our technical staff first
assists a customer in identifying the source of system problems and in determining whether there is defective hardware or software. If our customer requires on-site maintenance or repair
services, we arrange for a service call pursuant to underlying third-party support service agreements we have with our hardware and software vendors.

When
we sell a service contract as part of a bundled arrangement, we use vendor specific objective evidence to allocate revenue to the service contract element. In all cases, we defer
revenues and direct costs resulting from our service contracts and amortize them into operations over the term of the contracts, which are generally twelve months. We are contractually obligated to
provide or arrange to provide these underlying support services to our customers in the unlikely event that the hardware or software vendor, or its designee, fails to perform according to the terms of
our contract.

Consulting Services.Some of our customers engage us to analyze their existing storage architectures and offer our recommendations.
Other customers
engage us to assist them on-site with extended data storage projects, to support their data storage environments and to help with long-term data storage design challenges. For
these types of consulting services that do not include the sale of hardware or software products, we recognize revenues as we perform these services.

37

---





We compute basic net earnings per share using the weighted average number of shares outstanding. Diluted net earnings per share include
the effect of common stock equivalents, if any, for each period. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless their effect is
anti-dilutive. The following table computes basic and diluted net earnings per share:

Year Ended December 31,2008

2007

2006(in thousands, except per share data)Net earnings

$
3,396

$
1,199

$
8,497Basic:Weighted average common shares outstanding


12,930


12,998


11,239Weighted average common shares of non-vested stock


(560
)

(842
)

(233
)Shares used in the computation of basic net earnings per share


12,370


12,156


11,006Net earnings per sharebasic

$
0.27

$
0.10

$
0.77Diluted:Shares used in the computation of basic net earnings per share


12,370


12,156


11,006Employee and non-employee director stock options


80


236


112Non-vested stock


45





9Shares used in the computation of diluted net earnings per share


12,495


12,392


11,127Net earnings per sharediluted

$
0.27

$
0.10

$
0.76


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

Year Ended December 31,2008

2007

2006Non-vested common stock


302,008


206,000


0Options to purchase shares of common stock


549,107


561,255


472,324




At December 31, 2008 and 2007, the carrying values of current financial instruments such as cash and cash equivalents, short
term investments, accounts receivable, accounts payable, other current assets, accrued liabilities and other current liabilities, approximated their market values, based on the short-term
maturities of these instruments.

In
September 2006 the Financial Accounting Standards Board (FASB) issued SFAS 157, "Fair Value Measurements". SFAS 157
defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurement. SFAS 157 also emphasizes that fair value is a market-based
measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. Under SFAS 157, fair value measurements are
disclosed by level within that hierarchy. The FASB approved a one-year deferral for the implementation of SFAS 157 with regard to nonfinancial assets and liabilities that are not
recognized or disclosed at fair value in the financial statements on a recurring basis. The adoption of SFAS 157 for financial assets and financial liabilities, effective January 1,
2008, did not have a significant impact on

38

---



our
consolidated financial position and results of operations. We are currently assessing the potential effect of the adoption of the remaining provisions of SFAS 157 on our financial position,
results of operations and cash flows.

Market
price observability is impacted by a number of factors, including the type of asset or liability and their characteristics. This hierarchy prioritizes the inputs into three broad
levels as follows:



We
endeavor to use the best information available in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is
significant to the fair value measurement. As of December 31, 2008, our only financial asset accounted for at fair value on a recurring basis is our short term investments, which consist
principally of certificates of deposits. These investments are categorized as not available-for-sale securities and recorded at fair market value, as defined by SFAS
No. 157. We determined that the fair value of the short term investments falls within Level 2 in the fair value hierarchy. The application of SFAS 157 did not change our valuation
techniques from prior periods.

3.     Finite-lived Intangibles, net:

Amortization expense related to finite-lived intangible assets for 2008, 2007 and 2006 was $711,000, $727,000 and $0, respectively. Amortization expense in 2008
and 2007 relates primarily to our acquisition of MCSI in January 2007. The finite lived intangibles we acquired consisted of customer relationships and backlog and have estimated lives of six years
and two months, respectively. We are amortizing them using the straight line method. At December 31, 2008 the only remaining unamortized finite-lived intangible consists of customer
relationships of $2.9 million, net of accumulated amortization of $1.4 million, which has an estimated life of six years. Expected amortization in each of the next five years is as
follows:

(in thousands)2009


7102010


7102011


7102012


7102013


60$
2,900


39

---



4.     Income Taxes:

The reconciliation of the U.S. federal statutory tax rate to our effective income tax rate is as follows:

2008

2007

2006Tax expense at U.S. statutory rates


34.0
%

34.0
%

34.0
%State tax expense, net of federal tax effect


3.7


4.6


4.6Nondeductible expenses and other


2.0


7.8


3.1Benefit of net operating loss carryforward








(36.2
)Change in valuation allowance








(40.5
)Unrecorded minimum tax credit utilized





(4.5
)

Effective tax rate


39.7
%

41.9
%

(35.0
)%


Significant
components of our deferred tax assets and liabilities are as follows:

Year Ended
December 31,2008

2007(in thousands)Current deferred tax asset:Allowance for doubtful accounts

$
96

$
70Compensation accrual


359


206Inventories


44


89Deferred revenue


918


684Total current deferred tax asset


1,417


1,049Long-term deferred tax liability:Net operating loss carryovers


40


140Intangibles


(1,110
)

(1,167
)Property and equipment


(13
)

(5
)Sublease reserve


360


495Total long-term deferred tax liability


(723
)

(537
)Net deferred tax asset

$
694

$
512


The
tax expense for the years ended December 31, 2008 and 2007 consists of the following:

2008

2007(in thousands)Current income tax expense

$
2,366


438Deferred tax (expense) benefit


(130
)

426Income tax expense

$
2,236


864


The
valuation allowance for deferred tax assets as of December 31, 2005 was $4.8 million. The net change in the total valuation allowance as of December 31, 2006 was
a decrease of $4.8 million. We determined that we did not require any valuation allowance at December 31, 2008, 2007 and 2006.

In
assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that we will realize some portion or all of the deferred tax assets. The
ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Prior to 2006, we
recorded a full valuation allowance against our deferred tax assets due to the uncertainty of the realization and timing

40

---



of
the benefits from those deferred tax assets, as we had not achieved a sufficient level of sustained profitability. During 2006, we utilized approximately $4.8 million of our net operating
loss carryforwards. Furthermore, we concluded that we had attained a sufficient level of sustained profitability to reverse the remaining $2.8 million valuation allowance. We utilized
approximately $1.9 million and $4.8 million of our federal net operating loss carryforwards in 2007 and 2006, respectively. As of December 31, 2007, we fully utilized our federal
net operating loss carryforwards. As of December 31, 2008 we have state net operating loss carryforwards of approximately $843,000, which are available to offset future state taxable income. If
not used, these state net operating loss carryforwards will expire between 2013 and 2024. For 2008, 2007 and 2006, respectively, we recorded approximately $2,000, $104,000 and $392,000 to equity for
tax benefits associated with the exercise of stock options.

5.     Lease Commitments:

Our corporate headquarters including our principal technical operations and our integration, assembly and support services operations, are located in an office
and warehouse facility in Chanhassen, Minnesota. As of December 31, 2008, our other 18 locations, including sales and technical staff, are small to medium sized offices. Regional hubs are
located within each of our regions in the East, Central and West.

As
of December 31, 2008, future minimum lease payments due under non-cancelable operating leases are as follows:

Lease
Obligations

Sublease
Agreements

Net Lease
Obligations(in thousands)2009

$
1,814

$
(768
)
$
1,0462010


1,674


(752
)

9222011


1,596


(719
)

8772012


592


(239
)

3532013








Thereafter








$
5,676

$
(2,478
)
$
3,198


In
December 2004, we agreed to sublease approximately 55,000 of the 104,000 square feet we then occupied as our corporate headquarters in Chanhassen, Minnesota. The initial sublease term
is co-terminal with the original lease ending in April 2012. The sublessee pays us rent ranging from approximately $55,000 per month at the beginning of the term to approximately $60,000
per month by the end of the term. The rent includes the costs of common area management, common systems repairs, real estate taxes and standard utilities.

Total
rent expense, net of sublease income of $663,000, $663,000 and $663,000 in 2008, 2007 and 2006, respectively, is as follows:

Year Ended December 31,2008

2007

2006(In thousands)Rent expense

$
1,235

$
1,802

$
1,422


6.     Employee Benefit Plan:

We have a defined contribution retirement plan for eligible employees. Employees may contribute up to 15% of their pretax compensation to the 401(k) portion of
the plan. Since April 2006, we have

41

---



matched
50% of an employee's contribution up to the first 6% of an employee's eligible compensation. The cost of our contributions to the 401(k) portion of the plan for 2008, 2007 and 2006, was
$568,000, $554,000 and $276,000, respectively.

7.     Stockholders' Equity:



In May, 2001, we reserved an aggregate of 3,000,000 shares of common stock for issuance pursuant to our Incentive Compensation Plan
(the "Incentive Plan"), 558,394 of which were available for grant as of December 31, 2008. The terms of the plan allow for a variety of awards including incentive stock options, nonqualified
stock options, stock appreciation rights, non-vested stock, performance shares, performance units, cash-based awards, phantom shares and other share-based awards, as determined
by the Compensation Committee (the "Committee").

In
August 2000, we adopted our 2000 Director Stock Option Plan (the "Director Plan"). The terms of the Director Plan as most recently amended in May 2007, allow for stock option grants
to non-employee members of the Board of Directors. We have reserved 550,000 shares of common stock for issuance pursuant to the Director Plan, 203,986 of which were available for grant as
of December 31, 2008.



In February 2007, we awarded 75,000 shares of non-vested stock to an executive. The grant vests over four years, with
50 percent after year two, 25 percent after year three and 25 percent after year four if the executive is still employed by us. During the vesting period, the executive has voting
rights and the right to receive dividends. However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until
they vest. We are amortizing the $665,000 value of the restricted shares on the date of grant ratably over the four year vesting period. Unrecognized compensation expense related to the restricted
stock grant was $353,000 and $520,000 at December 31, 2008 and 2007, respectively. For the year ended December 31, 2008 and 2007, compensation expense related to this
non-vested stock grant was $166,000 and $146,000, respectively.

In
March and April 2007, respectively, we awarded 120,000 and 86,000 shares of non-vested stock to senior management and managers and gave our CEO the authority to grant an
additional 7,750 restricted shares of our common stock to yet to be named key employees. Partial vesting of these restricted stock awards was based upon the achievement of our predetermined earnings
from operations objective for 2007 as approved by our board of directors (the "2007 Objective"). We did not meet the 2007 Objective. Based on the award grant conditions, one-third of the
awards expired on February 6, 2008, the date we publicly announced our 2007 financial results. Accordingly, at December 31, 2007, we did not recognize any compensation expense related to
these canceled, non-vested stock grants.

The
remaining two-thirds of these awards may vest upon the public announcement of our financial results for 2009 if such results (either alone or together) equal or exceed
our 2008 and 2009 predetermined financial objectives (either alone or together) by the amount of the shortfall against the 2007 Objective. If these awards do not fully vest by our public announcement
of our 2009 results, these awards will automatically expire. Unrecognized compensation expense related to the remaining two-thirds restricted stock grant was $1.2 million at
December 31, 2008 and 2007, respectively.

In
December 2007, we awarded 250,000 shares of non-vested stock to certain employees. The non-vested stock vests over three years with one-third
vesting each year if the individual is still employed by us. During the vesting period, the individual has voting rights and the right to receive

42

---



dividends.
However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they have vested. We are
amortizing the $902,000 fair value of the non-vested shares on the date of grant ratably over the three-year vesting period. Unrecognized compensation expense related to the
non-vested stock grants was $667,000 and $893,000 at December 31, 2008 and 2007, respectively. For 2008 and 2007, respectively, compensation expense related to these
non-vested stock grants was $226,000 and $10,000.

In
March and April 2006, we awarded 60,000 and 163,000 shares of non-vested stock, respectively, to executive and senior management. The non-vested stock vests
over four years with one-fourth vesting each year if the individual is still employed by us. During the vesting period, the individual has voting rights and the right to receive dividends.
However, we will retain the dividends until the shares have vested. The shares may not be sold, assigned, transferred, pledged or otherwise encumbered until they have vested. We are amortizing the
$926,000 fair value of the non-vested shares on the date of grant ratably over the four year vesting period. Unrecognized compensation expense related to the non-vested stock
grants was $266,000, $509,000 and $786,000 at December 31, 2008, 2007 and 2006, respectively. For 2008, 2007 and 2006, respectively, compensation expense related to these non-vested
stock grants was $217,000, $233,000 and $185,000.

In
2006, we issued 13,563 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2006, total compensation expense for these awards was
approximately $101,000. In 2007, we issued 24,942 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2007, total compensation expense for these awards
was approximately $127,000. In 2008, we issued 26,609 shares of common stock to members of the Board of Directors which were fully vested upon grant. For 2008, total compensation expense for these
awards was approximately $107,000.

The
following table summarizes our non-vested stock activity as of December 31, 2008:

Number of Shares

Weighted Average
Grant-Date Fair ValueNon-vested stock at January 1, 2006




$
Granted


223,000

$
4.35Shares vested




$
Non-vested stock at January 1, 2007


223,000

$
4.35Granted


531,000

$
5.81Shares vested


(54,500
)
$
4.35Shares cancelled


(9,875
)
$
4.35Non-vested stock at January 1, 2008


689,625

$
5.48Granted




$
Shares vested


(134,951
)
$
3.89Shares cancelled


(76,916
)

7.11Non-vested stock at December 31, 2008


477,758

$
5.66




In February 2008, we awarded 200,000 and 115,000 stock options to executive officers and managers, respectively. The stock options vest
over three years with one-third vesting each year if the individual is still employed by us. We use the Black-Scholes option pricing model to estimate the fair value of stock options. The
weighted-average fair values per option at the date of grant were $2.52 and

43

---



$1.34
for 2008 and 2006, respectively. We had no stock option grants in 2007. We estimated the fair value for the stock option grants with the following weighted average assumptions:

2008

2006Risk-free interest rates

2.9%

5.08%Expected dividend yield

0

0Expected volatility factor

71%

104%Expected option holding period

6 years

5 years


The
risk-free rate is based on a treasury instrument whose term is consistent with the expected life of our stock options. Expected volatility is based on the historical
volatility of our share price for the period prior to the option grant equivalent to the expected holding period of the options. The expected holding period and dividend yield are based on historical
experience. We are amortizing the $794,000 fair value of stock options on the date of grant ratably over the three year vesting period. Total stock-based compensation expense related to stock options
was $243,000 at December 31, 2008. Unrecognized stock-based compensation expense related to stock options was $551,000 at December 31, 2008.

The
following table summarizes activity under our stock option plans:

Outstanding OptionsNumber of Shares

Range of
Exercise Prices

Weighted
Average
Exercise PriceBalance, December 31, 2005


1,775,137

$1.44 - $18.13

$
5.54Options granted


6,500

$4.11 - $5.21

$
4.63Options exercised


(371,316
)
$1.44 - $8.91

$
3.69Options cancelled


(159,893
)
$2.01 - $18.13

$
7.16Balance, December 31, 2006


1,250,428

$1.44 - $18.13

$
5.83Options granted






$
Options exercised


(74,489
)
$1.44 - 7.71

$
4.03Options cancelled


(53,351
)
$3.32 - 18.13

$
12.01Balance, December 31, 2007


1,122,588

$1.44 - $18.13

$
5.66Options granted


315,000

$3.91

$
3.91Options exercised


(19,773
)
$1.80 - 4.36

$
3.04Options cancelled


(26,022
)
$3.32 - 18.13

$
6.16Balance, December 31, 2008


1,391,793

$1.44 - $18.13

$
5.29Options exercisable as of December 31, 2006


1,250,428

$1.44 - $18.13

$
5.83Options exercisable as of December 31, 2007


1,122,588

$1.44 - $18.13

$
5.66Options exercisable as of December 31, 2008


1,076,793

$1.44 - $18.13

$
5.69


The
following is a summary of options outstanding at December 31, 2008:

Stock
Options

Range of Exercise
Price Per Share

Weighted Average
Exercise Price
Per Share

Weighted Average
Remaining Contractual
Life (Years)988,588

$  1.44 - $  6.00

$
3.92


5.8357,338

$  6.01 - $  9.81

$
7.88


1.335,750

$  9.82 - $15.25

$
13.51


1.610,117

$15.26 - $18.13

$
17.83


1.21,391,793

$  1.44 - $18.13

$
5.29


4.5


44

---





At December 31, 2008, 2007 and 2006, respectively, the aggregate intrinsic value of options outstanding and exercisable was $40,150, $159,250 and $3,600,008. Total intrinsic value
of options exercised was $60,019, $299,841 and $1,371,235 for 2008, 2007 and 2006, respectively. The weighted average grant date fair value of options granted during 2008 and 2006 was $2.52 and $1.33,
respectively. We did not grant any options in 2007.

As
of December 31, 2007 and 2006, we had no unrecognized compensation costs related to non-vested stock option awards. We recorded $0 and $9,000 of related stock
option compensation expense for 2007 and 2006, respectively.

8.     Acquisition

On January 31, 2007, we acquired Midrange Computer Systems Inc. (MCSI), a storage consulting, solutions and service provider based in Chicago,
Illinois. We believe the acquisition has strengthened our presence in existing regional markets and expanded our reach into a number of key new regional markets. We paid a purchase price of
approximately $14.3 million for MCSI, consisting of $5.0 million cash and 1,163,384 shares of our common stock.

In
connection with this acquisition, we allocated the total purchase consideration to the net assets and liabilities acquired, including identifiable intangible assets, based on their
respective fair values at the acquisition date, resulting in goodwill of approximately $12.2 million which is non-deductible for income tax purposes. The following table summarizes
the allocation of the purchase price to the fair value of the assets and liabilities acquired:

(in thousands)Assets acquiredCash

$
3,466Accounts receivable


1,047Inventory & inventory shipped but not installed


3,800Property, plant & equipment


255Finite-lived intangibles


4,338Goodwill


12,248Other assets


94Total assets acquired


25,248Liabilities assumedAccounts payable


8,304Deferred maintenance contracts, net


398Accrued liabilities


462Deferred tax liability obligations


1,824Total liabilities assumed


10,988Net purchase price

$
14,260


The
following table provides a reconciliation of the net purchase price for MCSI as compared to the cash payment for purchase:

(in thousands)Net purchase price

$
14,260Less value of shares issued


8,953Less cash acquired in acquisition


3,466Payment for purchase

$
1,841


45

---



The
finite lived intangibles which consisted of customer relationships and backlog have estimated lives of six years and two months, respectively and we are amortizing them using the
straight line method (see Note 2).

The
pro forma unaudited results of operations as of December 31, 2007 and 2006, assuming consummation of the acquisition of MCSI as of January 1, 2006, are as follows:

Year Ended
December 31,2007

2006(in thousands, except per share data)Net sales

$
181,927

$
201,078Net income


351


10,001Per share data:Basic earnings

$
0.03

$
0.84Diluted earnings

$
0.03

$
0.82


Integration
expenses, including the salaries, benefits, retention bonuses and severances of MCSI employees, some of whom assisted with the initial integration but were ultimately not
retained by us, were $442,000 for 2007.

The
pro forma unaudited results do not purport to be indicative of the results which we would have obtained had we completed the acquisition as of January 1, 2006.

9.     Commitments and Contingencies

We have change of control severance agreements and employment agreements in place with certain executive employees. Under the agreements, an executive is entitled
to a severance payment in the event the executive (a) is terminated without cause by us in anticipation of, in connection with, at the time of or within two years after a change of control, or
(b) resigns for good reasons arising in anticipation of, in connection with, at the time of or within two years after a change of control.

10.   Quarterly Financial Information (unaudited)

March 31

June30

Sept 30

Dec 31(in thousands, except per share data,)2008Net sales

$
47,725

$
49,707

$
49,980

$
48,185Gross profit


13,006


13,332


13,757


12,556Operating earnings


660


1,524


1,709


1,187Net earnings


505


979


1,068


843Net earnings per sharebasic


0.04


0.08


0.09


0.07Net earnings per sharediluted


0.04


0.08


0.08


0.072007Net sales

$
40,911

$
40,338

$
45,848

$
50,675Gross profit


9,874


10,147


11,857


13,414Operating earnings (loss)


(1,450
)

(763
)

1,125


2,243Net earnings (loss)


(719
)

(346
)

844


1,420Net earnings (loss) per sharebasic


(0.06
)

(0.03
)

0.07


0.12Net earnings (loss) per sharediluted


(0.06
)

(0.03
)

0.07


0.11


46

---



11.   Recently Issued Accounting Standards

In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS 141R") which establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. The statement also
provides guidance for recognizing and measuring the goodwill acquired in the business combination and for disclosure to enable evaluation of the nature and financial effects of the business
combination. SFAS 141R is effective for us as to business combinations we make beginning in 2009. We are evaluating the impact of SFAS No. 141R, but do not currently expect it to have a
significant impact on our financial statements when effective. However, the nature and magnitude of the specific future effects will depend upon the nature, terms and size of any acquisitions we
consummate after the effective date.

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160").
SFAS 160 introduces significant changes in the accounting and reporting for business acquisitions and noncontrolling interest ("NCI") in a subsidiary. SFAS 160 also changes the
accounting and reporting for the deconsolidation of a subsidiary. Companies are required to adopt the new standard for fiscal years beginning after January 1, 2009. We adopted this standard as
of January 1, 2009 and do not expect it to have an impact on our financial statements.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133"
("SFAS 161"), which changes the disclosure requirements for derivative instruments and hedging activities. SFAS 161 requires an entity to provide enhanced disclosures about
(a) how and why the entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items under Statement 133 and its related
interpretations and (c) how derivative instruments and related hedged items affect the entity's financial position, financial performance and cash flows. Companies are required to adopt
SFAS 161 for fiscal years beginning after November 15, 2008. We adopted this standard as of January 1, 2009 and do not expect it to have an impact on our financial statements.

In
April 2008, the FASB issued Staff Position FSP FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). The FSP
amends the factors considered in developing renewal or extension assumptions for determining the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible
Assets." The FSP's intent is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the
fair value of the asset under other accounting principles generally accepted in the U.S. Companies must adopt the FSP for fiscal years and interim periods beginning after December 15, 2008.
Early adoption is prohibited. Companies must apply the guidance for determining the useful life of a recognized intangible asset prospectively to intangible assets acquired after the effective date.
Companies must also apply certain disclosure requirements prospectively to all intangible assets recognized as of, and subsequent to, the effective date. We adopted this standard as of
January 1, 2009 and do not expect it to have an impact on our financial statements.

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A.    Controls and Procedures



We
maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized and reported
within

47

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the
time periods specified in the Securities and Exchange Commission's rules and forms. Our disclosure controls and procedures are also designed to accumulate and communicate information to our
management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our
disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control
objectives. Accordingly, management must apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Within
the 90 days prior to the filing of this report, we carried out an evaluation under the supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the
Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure
controls and procedures are effective at the reasonable assurance level in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.



Our
management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controls are designed to provide reasonable assurance
regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

All
internal controls, no matter how well designed, have inherent limitations. Therefore, even those controls determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

Under
the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, we assessed the effectiveness of
our internal control over financial reporting as of December 31, 2008. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) inInternal ControlIntegrated Framework.

Based
on our evaluation under the framework inInternal ControlIntegrated Framework, our management concluded that our
internal control over financial reporting was effective as of December 31, 2008.

This
Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.
Management's report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management's report in this report.



There
has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially
affect, our internal controls over financial reporting.

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Item 9B.    Other Information

Not Applicable.

PART III

Item 10.    Directors and Executive Officers of the Registrant.

Information contained under "Election of Directors," "Executive CompensationExecutive Officers" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in our Proxy Statement for our 2009 Annual Meeting of Stockholders (the "2009 Proxy Statement") is incorporated herein by reference.

We
have adopted a Code of Ethics that applies to our officers, including our principal executive, financial and accounting officers, and our directors and employees. We intend to make
all required disclosures concerning any amendments to, or waivers from, our Code of Ethics by the filing of Current Reports under the cover of Form 8-K.

Item 11.    Executive Compensation.

We incorporate the information set forth under "Executive Compensation" and "Director Compensation" in our 2009 Proxy Statement herein
by reference.

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

We incorporate the information set forth under "Outstanding Voting Securities and Voting Rights" in our 2009 Proxy Statement herein by
reference.

The
following table provides certain information as of December 31, 2008 with respect to our equity compensation plans.

Equity Compensation Plan InformationPlan Category

Number of securities to be issued upon exercise of outstanding options, warrants and rights

Weighted-average exercise of outstanding options, warrants and rights

Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column)Equity compensation plans approved by security holders(1)


1,391,793

$
5.29


762,380Equity compensation plans not approved by security holders








Totals


1,391,793

$
5.29


762,380


---

Item 13.    Certain Relationships and Related Transactions.

We incorporate the information required by this section by reference from the information set forth under "Transactions with Related
Persons" in our 2009 Proxy Statement.

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Item 14.    Principal Accountant Fees and Services.

We incorporate the information required by this section by reference from the information set forth under "Auditing Matters" in our
2009 Proxy Statement.

Item 15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K.



50

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DATALINK CORPORATION  SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS  FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

Description

Period

Balance at
Beginning
of Period

Additions

Deductions(1)

Balance
at End
of PeriodAllowance for Doubtful Accounts


2008

$
112,492

$
88,336

$
2,140

$
198,6882007


108,254


36,332


32,094


112,4922006


71,665


57,928


21,339


108,254Allowance for Inventory Obsolescence


2008

$
185,682

$
188,643

$
274,163

$
100,1622007


50,826


258,074


123,218


185,6822006


99,840


47,022


96,036


50,826Allowance for Valuation of Deferred Tax Asset


2008

$


$


$


$
2007











2006


4,827,367





4,827,367





---

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM  ON FINANCIAL STATEMENT SCHEDULE

To
the Board of Directors
Datalink Corporation

Our
audits were conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States) and were made for the purpose of forming an opinion on the
basic financial statements of Datalink Corporation taken as a whole. The supplemental Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and
is not a part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements for the years ended
December 31, 2008, 2007 and 2006, and in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

/s/
McGLADREY & PULLEN, LLP

Minneapolis,
Minnesota
March 25, 2009

52

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3.Exhibits.The following exhibits are filed as part of this
Form 10-K:

Exhibit Number

Title

Method of Filing2.1

Agreement and Plan of Merger dated January 20, 2007 by and among Midrange Computer Solutions, Inc., Dan Kalin, Michael Spindler, Wayne Szczepanski and Lodi Vercelli and Datalink Corporation and Datalink
Acquisition LLC

103.1

Amended and Restated Articles of Incorporation of the Company

13.2

Restated Bylaws of the Company

14.1

Form of Common Stock Certificate

110.2

1999 Incentive Compensation Plan, as amended on December 18, 2000

210.4

Form of Indemnification Agreement

110.18

2000 Director Stock Option Plan

210.20

2002 Amendments to the 2000 Director Stock Option Plan

310.22

Amended and Restated 2000 Director Stock Option Plan

410.23

Restricted Stock Award Agreement

510.24

Change of Control Severance Agreement

510.25

Sublease Agreement dated December 15, 2004 with Checkpoint Security, Inc.

710.26

Vacant Land Purchase Agreement

710.27

Correction to Restricted Stock Award Agreements dated August 13, 2004

810.28

Employment Agreement dated March 14, 2006 with Gregory T. Barnum

910.29

Employment Agreement dated February 16, 2007 with Robert R. Beyer

1114.1

Code of Ethics

623.1

Consent of McGladrey & Pullen, LLP

Filed herewith31.1

Certifications by the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed herewith32.1

Certifications by the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Filed herewith99.2

Audit Committee Charter (Revised May 4, 2006)

12


---

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

DATALINK CORPORATIONDate: March 26, 2009By:

/s/ CHARLES B. WESTLING Charles B. Westling, President and Chief Executive OfficerBy:

/s/ GREGORY T. BARNUM Gregory T. Barnum, Vice President of Finance and Chief Financial Officer


Pursuant
to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.

Signature

Title

Date/s/ CHARLES B. WESTLING

President, Chief Executive Officer and Director (Principal Executive Officer)

March 26, 2009/s/ GREGORY T. BARNUM

Vice President of Finance and Chief Financial Officer (Principal Financial Officer)

March 26, 2009/s/ DENISE M. WESTENFIELD

Corporate Controller (Principal Accounting Officer)

March 26, 2009/s/ GREG R. MELAND

Chairman of the Board and Director

March 26, 2009/s/ BRENT G. BLACKEY

Director

March 26, 2009/s/ PAUL F. LIDSKY

Director

March 26, 2009/s/ MARGARET A. LOFTUS

Director

March 26, 2009/s/ J. PATRICK O'HALLORAN

Director

March 26, 2009/s/ JAMES E. OUSLEY

Director

March 26, 2009/s/ ROBERT M. PRICE

Director

March 26, 2009


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