OVERVIEW

You should read the following information in conjunction with the unaudited financial statements and the notes thereto included in Item 1 of this Quarterly Report and with the "Forward-Looking Statements" section in this filing and in our other filings with the U.S. Securities and Exchange Commission.

We are an independent architect of enterprise-class information storage infrastructures. We derive our revenues principally from designing, installing and supporting data storage systems. Our solutions can include hardware products, such as disk arrays, tape systems and interconnection components and storage management software products. The market for data storage products and services is large.

IDC estimates that digital information will occupy 988 billion gigabytes, by 2010. As of September 30, 2008, we have 18 locations throughout the United States with the highest concentration of revenues in the central states.

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

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

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

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

† Increasing productivity of our sales, technical and customer support teams in our existing locations.

† Deepening our presence in existing enterprise accounts and penetrating new enterprise accounts.

† Targeting high growth market segments and deploying new technologies.

† Growing our customer support revenue and market share. We believe that our customer support services offerings are becoming increasingly attractive to companies looking for system-wide integrated support.

† Increasing our professional services revenues. We believe there is an opportunity to sell more of our data storage services such as implementation services, storage environment assessments and on-site data storage management, architecture and monitoring services.

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

To pursue these strategies, we are:

†

† Improving our training, tools and recruiting efforts for sales and engineering teams to increase productivity.

† Hiring additional customer support staff and enhancing the customer support staff's communications and call management capabilities.

† Developing more effective delivery capabilities for professional services and solutions.

† Meeting regularly with potential acquisition candidates.

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

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

† Competition is intense, particularly in the current economic environment, and may adversely impact our profit margin. Customers have many options for data storage products and services.

RESULTS OF OPERATIONS

On January 30, 2007, we entered into an agreement and plan of merger with Midrange Computer Systems Inc. (MCSI), a storage consulting solutions and services provider. Our results of operations for the three and nine months ended September 30, 2007 reflect the addition of MCSI for three and eight months, respectively.

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

                                    Three Months Ended      Nine Months Ended
                                      September 30,           September 30,
                                    2008         2007        2008        2007
Net sales                             100.0 %      100.0 %    100.0 %     100.0 %
Cost of sales                          72.5         74.1       72.8        74.9
Gross profit                           27.5         25.9       27.2        25.1
Operating expenses:
Sales and marketing                    11.8         12.1       12.0        12.7
General and administrative              6.3          6.0        6.2         7.0
Engineering                             5.6          4.9        6.0         5.4
Integration costs                         -            -          -         0.3
Amortization of intangibles             0.4          0.4        0.4         0.4
Total operating expenses               24.1         23.4       24.6        25.8
Earnings (loss) from operations         3.4 %        2.5 %      2.6 %      (0.7 )%

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

                                           Three Months Ended         Nine Months Ended
                                             September 30,              September 30,
                                           2008          2007          2008         2007
                                                          (in thousands)
Product sales                           $    28,832    $  27,705    $   86,410    $ 79,617
Service sales                                21,148       18,143        61,002      47,480

Product gross profit                    $     7,414    $   6,716    $   22,166    $ 18,857
Service gross profit                          6,343        5,141        17,929      13,021

Product gross profit as a percentage
of product sales                               25.7 %       24.2 %        25.7 %      23.7 %
Service gross profit as a percentage
of service sales                               30.0 %       28.3 %        29.4 %      27.4 %

Net Sales. Our total net sales increased by $4.1 million for the three months ended September 30, 2008, or 9.0%, from $45.8 million for the comparable quarter in 2007. Our total net sales increased $20.3 million for the nine months ended September 30, 2008, or 16.0% from $127.1 million for the comparable period in 2007. Our product sales increased $1.1 million, or 4.1%, to $28.8 million for the three months ended September 30, 2008, from $27.7 million for the comparable quarter in 2007. Our product sales increased $6.8 million, or 8.5%, to $86.4 million for the nine months ended September 30, 2008, from $79.6 million for the nine months ended September 30, 2007. Our service sales increased $3.0 million, or 16.6%, to $21.1 million for the three months ended September 30, 2008 from $18.1 million for the comparable quarter in 2007. Our service sales increased $13.5 million, or 28.5%, to $61.0 million for the nine months ended September 30, 2008, from $47.5 million for the nine months ended September 30, 2007.

We experienced a modest increase in our product sales for the three and nine month periods ended September 30, 2008, as compared to the same periods in 2007. We continue to see growth in product sales from the successful integration and training from our MCSI acquisition 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. Our bookings activity for the first nine months of this year remained steady, and we ended the third quarter with backlog of $31 million.

Our service sales increase for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007 was due to primarily to an increase in customer support contracts of $3.2 million and $12.1 million, respectively. In addition, our installation and configuration service sales increased $972,000 for the nine month period ended September 30, 2008 as compared to the same period in 2007. With the growth in our product revenues, we continue to successfully sell our installation and configuration services and customer support contracts.

We had no single customer account for 10% or greater of our revenues for the three and nine months ended September 30, 2008 and 2007, respectively.

Gross Profit. Our total gross profit as a percentage of net sales increased to 27.5% for the quarter ended September 30, 2008, as compared to 25.9% for the comparable quarter in 2007. Our total gross profit as a percentage of net sales increased to 27.2% for the nine months ended September 30, 2008, as compared to 25.1% for the nine months ended September 30, 2007. Product gross profit as a percentage of product sales increased to 25.7% in the third quarter of 2008 from 24.2% for the comparable quarter in 2007. Product gross profit as a percentage of product sales increased to 25.7% for the nine months ended September 30, 2008 from 23.7% for the comparable period in 2007. Service gross profit as a percentage of service sales increased to 30.0% for the third quarter of 2008 from 28.3% for the comparable quarter in 2007. Service gross profit as a percentage of service sales increased to 29.4% for the nine months ended September 30, 2008 from 27.4% for the nine months ended September 30, 2007.

Our product gross profit as a percentage of product sales is impacted by the mix and type of projects we complete for our customers. For the three and nine months ended September 30, 2008 as compared to the same period in 2007, our product gross profit as a percentage of product sales increased 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. Our product gross profits are also impacted by various vendor incentive programs that provide economic incentives for achieving various sales performance targets. Achieving these targets contributed favorably to our product gross profit by $241,000 and $601,000, respectively, for the three month periods ended September 30, 2008 and 2007. In addition, these vendor incentives contributed favorably to our product gross profit by $1.3 million for each of the nine month periods ended September 30, 2008 and 2007. Our vendors may change or terminate these programs at any time, and, accordingly, we cannot assure that we will achieve and receive similar vendor incentives in the future.

Our service gross profit as a percentage of service sales for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007 increased 1.7% and 2.0%, respectively. The percentage increase in 2008 over 2007 was impacted by reductions in revenues and corresponding margins due to the MCSI acquisition purchase accounting adjustment to reflect the fair value of maintenance contracts we acquired. For the three months ended September 30, 2008 and 2007, the impact was $34,800 and $176,000, respectively. For the nine months ended September 30, 2008 and 2007, the impact was $129,000 and $587,000, respectively.

Sales and Marketing. Sales and marketing expenses include wages and commission paid to sales and marketing personnel, travel costs and advertising, promotion and hiring expenses. Sales and marketing expenses totaled $5.9 million, or 11.8% of net sales for the quarter ended September 30, 2008, compared to $5.5 million, or 12.1% of net sales for the third quarter in 2007. Sales and marketing expenses totaled $17.6 million, or 12.0% of net sales for the nine months ended September 30, 2008, compared to $16.1 million, or 12.7% of net sales for the nine months ended September 30, 2007.

Sales and marketing expenses increased $336,000 and $1.5 million for the three and nine month periods ended September 30, 2008, respectively, as compared to the same periods in 2007. The increase in expenses relates primarily to variable compensation for commissions and bonuses for our performance during the first nine months of 2008.

General and Administrative. General and administrative expenses include wages for administrative personnel, professional fees, depreciation, communication expenses and rent and related facility expenses. General and administrative expenses were $3.2 million, or 6.3% of net sales for the quarter ended September 30, 2008, compared to $2.8 million, or 6.0% of net sales for the third quarter in 2007. General and administrative expenses were $9.2 million, or 6.3% of net sales for the nine months ended September 30, 2008, compared to $9.0 million, or 7.0% of net sales for the same period in 2007.

General and administrative expenses increased $394,000 and $291,000 for the three and nine months ended September 30, 2008, as compared to the same periods in 2007. We attribute this primarily to an increase in training expenses of $91,000, an increase in telephone expenses of $57,000, an increase in variable compensation expense of $42,000 and an increase in placement fees for new hires of $35,000.

Engineering. Engineering expenses include employee wages, bonuses and travel, hiring and training expenses for our field and customer support engineers and technicians. Engineering expenses were $2.8 million, or 5.7% of net sales for the quarter ended September 30, 2008, compared to $2.2 million, or 4.9% of net sales for the third quarter in 2007. Engineering expenses were $8.8 million, or 6.0% of net sales for the nine months ended September 30, 2008, compared to $6.9 million, or 5.4% of net sales for the same period in 2007.

Engineering expenses increased $586,000 and $1.9 million, respectively, for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007. This is primarily due to an increase in salaries, benefits and bonuses as we continue to

focus on investing in our customer support and field engineering capabilities and services offerings to deliver more value to our customers.

Integration Costs. Integration costs include salaries and benefits of MCSI employees who assisted with the initial integration but whom we ultimately did not retain, together with retention bonuses and severances. Integration costs for the nine months ended September 30, 2007 were $442,000 related to the January 31, 2007 acquisition of MCSI. We had no integration costs in 2008 or during the three months ended September 30, 2007.

Amortization of Intangibles. We had $178,000 of intangible asset amortization expenses for each of the three month periods ended September 30, 2008 and 2007. We had intangible asset amortization expense for the nine month periods ended September 30, 2008 and 2007 of $533,000 and $550,000, respectively. The identifiable intangible asset and subsequent amortization is due to our acquisition of MCSI on January 31, 2007.

Earnings (Loss) from Operations. We had earnings from operations of $1.7 million for the three months ended September 30, 2008 and earnings from operations of $1.1 million for the three months ended September 30, 2007. We had earnings from operations of $3.9 million for the nine months ended September 30, 2008 as compared to a loss from operations of $1.1 million for the same period in 2007. The increase in earnings from operations for the three and nine month periods ended September 30, 2008 as compared to the same periods in 2007 is a result of higher revenues and margins with a limited increase in operating expenses.

Income Taxes. We had income tax expense of $742,000 and $533,000 for the three month periods ended September 30, 2008 and 2007, respectively. We had income tax expense of $1.8 million and an income tax benefit of $167,000 for the nine month periods ended September 30, 2008 and 2007, respectively. Our estimated effective tax rate for 2008 was 41%. Our estimated effective tax rate for 2007 was 40%. In future periods of taxable earnings, we expect to continue reporting an income tax provision using an effective tax rate of approximately 41%.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities was $1.2 million for the nine months ended September 30, 2008 as compared to $2.0 million for the nine months ended September 30, 2007. Significant items which impacted our operating cash flows as of September 30, 2008 were:

† Net income of $2.6 million.

† A $534,000 net increase in deferred customer support contracts. While we recognize the revenues from these contracts over the life of the contract, the customer almost always pays for the contracts at the beginning of the contract period which favorably impacts our cash flows.

† A net decrease in cash of approximately $2.9 million for accounts receivable, inventory and accounts payable. This was primarily due to the timing of three large accounts receivable collections in the amount of $3.5 million not received prior to quarter end. These three large accounts receivable balances were collected subsequent to quarter end.

Net cash provided by investing activities was $1.9 million for the nine months ended September 30, 2008. This cash was primarily provided by the sale of a short-term investment. Net cash used in investing activities was $2.9 million for the nine months ended September 30, 2007. We used this cash primarily for the acquisition of MCSI, leasehold improvements and upgraded computer equipment. We are planning for $100,000 of capital expenditures for the remainder of 2008 related primarily to computer and communication system upgrades or other management information system enhancements.

Net cash used in financing activities was $7,000 for the nine months ended September 30, 2008, from tax withholding payments reimbursed by restricted stock. Net cash provided by financing activities was $137,000 for the nine months ended September 30, 2007, from the exercise of stock options offset by tax withholding payments reimbursed by restricted stock.

We have elected not to pursue a credit facility at this time. With our current cash position, we believe we have the liquidity to meet our operating needs for the foreseeable future. We have no outstanding debt, and if the need should arise to borrow funds, we believe that we could obtain a secured facility.

Our contractual cash obligations consist of future minimum lease payments due under non-cancelable operating leases. These obligations are as of September 30, 2008, for the remainder of 2008 and each of the full years thereafter as follows:

                            (in thousands)
                 Lease         Sublease       Net Lease
              Obligations     Agreements     Obligations
2008         $         461   $       (192 ) $         269
2009                 1,814           (768 )         1,046
2010                 1,674           (752 )           922
2011                 1,596           (719 )           877
2012                   592           (239 )           353
Thereafter               -              -               -
             $       6,137   $     (2,670 ) $       3,467

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements requires us to make estimates and assumptions that affect reported earnings. We evaluate these estimates and assumptions on an on-going basis based on historical experience and on other factors that we believe are reasonable. Estimates and assumptions include, but are not limited to, the areas of customer receivables, establishment of vendor specific objective evidence of fair value for customer contracts with multiple elements, inventories, income taxes, self-insurance reserves and commitments and contingencies.

Our significant accounting policies and estimates are summarized in our annual financial statements. Some of our accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. We believe these estimates and assumptions are reasonable based on the facts and circumstances as of September 30, 2008. However, actual results may differ from these estimates under different assumptions and circumstances.

We believe that the following represent the areas where we use more critical estimates and assumptions in the preparation of our financial statements:

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

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

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

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

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

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

Customer Support Contracts. We sell service contracts to most of our customers. These contracts are support service agreements. We have an internal support desk that provides integrated customer support services, including configuration and usage assistance, technical advice and prompt incident detection and resolution. Our technical staff first assists a

customer in identifying the source of system problems and in determining whether there is defective hardware or software. If our customer requires on-site maintenance or repair services, we arrange for a service call pursuant to underlying third-party support service agreements we have with our hardware and software vendors.

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

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

Gross Reporting of Revenues. We report our revenues from the sale of hardware and software products on a gross, rather than a net, basis. In reporting our revenues on a gross basis, we considered that:

† We are the primary obligor to our customers. We are responsible for fulfillment, including the acceptability of the products and services to our customers.

†          We have the risk of loss for inventory and credit.

†          We establish the prices for our products and services with our
customers.

†          We are responsible for the installation and configuration services