**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-K**




(Mark
      One)




**x**
            **ANNUAL
                REPORT UNDER SECTION 13 OR 15(d) OF THE********SECURITIES****EXCHANGE
                ACT OF 1934**




For
      the
      fiscal year ended December 31, 2006




**o**
              **TRANSITION REPORT
                  UNDER SECTION 13 OR 15(d) OF THE********SECURITIES****EXCHANGE
                  ACT OF 1934**




For
      the
      transition period from ___________ to ___________





Commission
      File Number 0-16423




**SAN
      Holdings, Inc.**


(Exact
      name of registrant  as
      specified in its Charter)




**Colorado**
            **84-0907969**(State
                of incorporation)
            (I.R.S.
                Employer
              Identification
                No.)




9800
      Pyramid Court, Suite 130, Englewood, CO 80112
             
(303) 660-3933


(Address
      including zip code, area code and telephone number of Registrant’s principal
      executive offices.)




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




Securities registered pursuant to Section 12(g) of the Act:




Title
                of Each Class
            Name
                of Each Exchange on Which RegisteredCommon
                stock, no par value
            OTC
                Bulletin Board




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 x




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 x




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
      past 12 months (or for such shorter period that the registrant was required
      to
      file such reports), and (2) has been subject to such filing requirements for
      the
      past 90 days. Yes x  No
o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of the 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. o




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




Large
      accelerated filer o Accelerated
      filer o Non-accelerated filer x




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




The aggregate market value of the voting and non-voting common equity held by
      non-affiliates of
      the
      registrant, computed
      by reference to the
      average closing bid and asked prices the
      price
      at which the common equity was last sold as of the last business day of the
      registrant’s most recently completed second fiscal quarter (June 30,
      2006) ,
      was
      approximately  $8.9
      million.




As
      of
      March 30, 2007, 96,953,611 shares of the registrant’s common stock were
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE: Information required by Part III of this Form 10-K
      (Items 10, 11, 12, 13, and 14) is hereby incorporated by reference to the
      specified portions of the registrant’s Definitive Proxy Statement for the 2007
      Annual Shareholder Meeting, which Definitive Proxy Statement shall be filed
      with
      the Securities and Exchange Commission within 120 days of the end of the fiscal
      year in which this report relates.










**SAN
      HOLDINGS, INC.**


**FORM
      10-K**




**TABLE
      OF CONTENTS**


**Item
                  No.**
              
              
              PageForward-Looking
                  Statements
              
              2**Part
                  I**1.
              Business
              
              21A.
              Risk
                  Factors
              
              81B.
              Unresolved
                  Staff Comments
              
              152.
              Properties
              
              153.
              Legal
                  Proceedings
              
              154.
              Submission
                  of Matters to a Vote of Security Holders
              
              15**Part
                  II**5.
              Market
                  for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                  Purchases of Equity Securities
              
              166.
              Selected
                  Financial Data
              
              187.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              
              217A.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              
              448.
              Financial
                  Statements and Supplementary Data
              
              449.
              Changes
                  in and Disagreements with Accountants on Accounting and Financial
                  Disclosure
              
              449A.
              Controls
                  and Procedures
              
              449B.
              Other
                  Information
              
              44**Part
                  III**10.
              Directors,
                  Executive Officers and Corporate Governance
              
              4511.
              Executive
                  Compensation
              
              4512.
              Security
                  Ownership of Certain Beneficial Owners and Management and
                  Related Stockholder Matters
              
              4513.
              Certain
                  Relationships and Related Transactions, and Director
                  Independence
              
              4514.
              Principal
                  Accountant Fees and Services
              
              45**Part
                  IV**15
              Exhibits
                  and Financial Statement Schedules
              
              46


1





**FORWARD-LOOKING
      STATEMENTS**





This report contains
      “forward-looking statements” within the meaning of the Private Securities
      Litigation Reform Act of 1995. In many but not all cases you can identify
      forward-looking statements by words such as “ anticipate ,”
      “ believe ,”
      “ could ,”
      “ estimate ,”
      “ expect,”
      “intend,” “may,” “plan,” “potential,” “should,” “will” and “would” or the
      negative of these terms or other similar
      expressions.  These
      forward-looking statements include statements regarding our expectations,
      beliefs, or intentions about the future, and are based on information available
      to us at this time. We assume no obligation to update any of these statements
      and specifically decline any obligation to update or correct any forward-looking
      statements to reflect events or circumstances after the date of such statements
      or to reflect the occurrence of anticipated or unanticipated events. Actual
      events and results could differ materially from our expectations as a result
      of
      many factors, including those identified in the section titled “ Item 1A. Risk
      Factors” and
      other sections of this report .
      We urge
      you to review and consider those factors, and those identified from time to
      time
      in our reports and filings with the Securities
      and Exchange Commission (“SEC”) ,
      for
      information about risks and uncertainties that may affect our future results.
      All forward-looking statements we make after the date of this filing are also
      qualified by this cautionary statement and identified risks.




**PART
      I**





**Item
      1. Business**




**Overview
      and Background**




When
      used
      in this report, the terms “we,” “our,” “us,” “our company,” “the Company” and
“SANZ” refer to SAN Holdings, Inc., a Colorado corporation, and our
      subsidiaries, unless the context indicates otherwise. SANZ provides
      enterprise-level data storage and data management solutions to commercial and
      government clients. We focus on the design, delivery and management of data
      storage systems, especially those that are built using a network architecture.
      Because we often design and deliver systems that include technologies from
      multiple suppliers, we are known in the industry as a “storage solution
      provider.” In addition, we have developed and sell a proprietary data-management
      software application designed specifically for the Geospatial Information
      Systems (“GIS”) market.





SANZ
      was
      formed as a Colorado corporation in 1983. Our current business operations
      commenced in 2000 when we acquired three companies in the data storage products
      and solutions business. In late 2001 we acquired (either by asset acquisition
      or
      subsidiary merger) two additional storage solution providers, ECOSoftware
      Systems, Inc. and ITIS Services, Inc. (“ITIS”). In 2003, we
      merged with Solunet Storage Holding Corp. (“Solunet Storage Holding”) and,
      indirectly, its operating subsidiary Solunet Storage, Inc. (“Solunet Storage”),
      which was another storage solution provider, and like SANZ was based in the
      greater Denver area. Solunet Storage commenced its operations upon the
      acquisition of substantially all of the assets of StorNet, Inc. in September
      2002 in a private foreclosure transaction. At the time of the merger with SANZ,
      Solunet Storage Holding was owned by Sun Solunet, LLC (“Sun Solunet”), an
      affiliate of Sun Capital Partners, Inc. (“Sun Capital”), a private investment
      firm located in Boca Raton, Florida .
      Because
      the transaction with Solunet Storage Holding was accounted for as a reverse
      acquisition, the consolidated financial statements of Solunet Storage Holding
      have been adopted as the historical financial statements of SANZ for all periods
      prior to April 1, 2003.





From
      the
      time that we commenced our current business operations in 2000 until 2003,
      our
      primary operating subsidiary had the legal name “Storage Area Networks, Inc.”
Over this period, we increasingly used the name “SANZ” as a trade name in the
      conduct of our business. In 2003 we changed the legal name of Storage Area
      Networks, Inc. to “SANZ Inc.” to align the legal name with the trade name used
      in operations.





Our
      principal executive offices are located at 9800 Pyramid Court, Suite 130,
      Englewood, CO 80112. Our telephone number is (303) 660-3933. We maintain a
      site
      on the World Wide Web at www.sanz.com. The information contained in our website
      is not incorporated into and should not be deemed a part of this
      report.




2




**Products
      and Services**




Beginning
      in 2005, we are reporting our operations as two business segments: (1) a
      data storage integrator (“Storage Solutions”); and (2) a spatial data
      management software and service provider (“EarthWhere”). Through these two
      business segments we provide the following products and services in the course
      of our business:





·
            ***Data
                storage solutions***that we design and deliver as a project customized to meet a client’s
                specific needs, including both data storage networks and data
                backup/recovery systems;





·
            ***Maintenance
                and customer support services***on
                storage hardware and software;





·
            ***Storage-related
                professional services***;





·
            ***A
                proprietary data management software product known as
                “EarthWhere*TM*****”***
                (“EarthWhere”),which facilitates imagery data access and provisioning for geospatial
                digital imagery users(principally satellite and aerial imagery and map data);





·
            ***Maintenance
                and customer support services***on
                our EarthWhere software product;
                and





·
            ***Geospatial
                imagery data management consulting
                services.***





We
      report
      the first three products and services in our “Storage Solutions” segment and the
      latter three in our “EarthWhere” segment. For financial information regarding
      these two segments, please see Note 11 to our consolidated financial statements
      included in “Item
      15.
      Exhibits and Financial Statement Schedules” and
      “ Item
      7. Management’s
      Discussion and Analysis of Financial Condition and Results of Operations—Segment
      Information.”





*Data
      Storage Network and Backup and Recovery Systems.*  We
      design, deliver and manage data storage solutions based on storage area network
      and network attached storage architectures, as well as related data backup
      and
      disaster recovery systems. We sell these solutions to both commercial and
      government customers throughout the United States. We
      believe the market
      for data storage solutions is broad-based and expanding, though it is influenced
      by fluctuations in capital spending generally and in information technology
      ( “ IT ” )
      spending in particular.





Network
      storage systems are secondary, high-speed computer networks dedicated to data
      storage and backup functions. Demand for data storage is the result of the
      growth of data-intensive applications, from areas such as document imaging,
      pharmaceutical development, electronic banking, satellite imagery manipulation
      and scientific research, to applications as common as email. In addition to
      our
      clients’ fundamental need to store increasing quantities of data, the ability to
      access that data rapidly (referred to as “availability”) also drives
      infrastructure requirements, as today’s businesses depend on rapid response
      times in many functions, both for internal operations and to enable
      responsiveness to customers and vendors. Moreover, regulatory and geopolitical
      developments over the past several years have converged with general business
      requirements to cause businesses to recognize the need for effective data
      archiving and the corresponding need for rapid recovery of that data in the
      event of disaster or other failure. Consolidating data storage in networks
      at
      centralized data centers is one way to address each of these
      requirements by
      increasing the accessibility of data to multiple end-users, maintaining
      effective archives of that data and at the same time offering potential for
      lower costs through increased utilization and more efficient management.





Networked
      storage architectures have become accepted solutions for data storage, and
      are
      increasingly adopted because they address many of the storage-related challenges
      arising in today’s open systems networks, including:





·
            The
                generally higher cost of direct-attached storage environments due
                to
                inefficient storage utilization and high maintenance costs in those
                environments;


·
            The
                isolation and resulting performance inefficiencies of direct-attached
                storage environments that result from restrictive server-to-storage
                connectivity and incompatible storage
                protocols;


·
            The
                often greater complexity of upgrading server and storage capacities
                in
                direct-attachedenvironments;and


·
            The
                generally greater complexity of providing comprehensive data security,
                protection and disaster recovery functionalities in direct-attached
                environments.




3




By
      centralizing data storage functions, storage networks create a reservoir of
      storage resources that can be shared both locally and over long distances,
      thereby increasing resource utilization and allowing the data to be shared,
      managed and accessed by diverse end-users. Because the personnel and other
      costs
      of managing a computer infrastructure are sometimes greater than the hardware
      and software costs, this increased manageability also provides opportunities
      for
      cost savings over traditional direct-attached storage.





Data
      backup and disaster recovery systems are natural adjuncts to data storage
      systems. We design and implement these in both networked and direct-attached
      environments, depending on the client’s requirements. These systems create
      repositories for maintaining additional electronic copies of an organization’s
      data, which can guard against both small-scale failures, such as the malfunction
      of a single computer, and large-scale disasters, such as the destruction of
      an
      entire data center. There now exists a variety of technologies for building
      such
      backup and disaster recovery systems, including both tape and disk systems .





*Maintenance
      and Customer Support Services.* Because
      of the complexity of data storage hardware and software, clients generally
      purchase maintenance and support contracts on those products. We operate a
      “technical services center,” a call center in which our own engineers field
      support calls from clients with respect to many of the products that we sell.
      Depending on the nature of the client’s issue (among other factors, whether the
      problem is caused by hardware or by software), our engineers may resolve the
      call remotely or may pass the call on to the product vendor to send a technician
      into the field to fix the issue. This process is referred to in the industry
      as
      taking “first call.” We generally receive higher gross margins on first call
      service contracts than on service contracts provided directly by product
      manufacturers.




*Storage-Related
      Professional Services.* In many
      cases, we provide systems design recommendations and similar expertise to our
      clients as part of the sales process. In other cases, however, clients engage
      us
      as consultants to obtain our specialized expertise, including such projects
      as
      assessing the adequacy of their systems, advising them on systems design,
      providing implementation services and providing ongoing operational support.
      We
      have continued to apply efforts to build our revenue from professional services,
      which increased approximately
      15% from 2005 to 2006, and 53% from 2004 to 2005. In 2006, our revenue from
      professional services represented 11% of total revenue as compared to 9.5%
      of
      total revenue in 2005 and 5.5% of total revenue in 2004.





*EarthWhere
      Software and Services.* EarthWhere
      is our proprietary software application, which is designed to facilitate a
      user’s provisioning and distribution of stored geospatial data (e.g., satellite
      and aerial imagery, map data, etc.). We sell EarthWhere predominantly to
      government agencies and companies who use geospatial digital imagery in their
      business or mission. These uses may include, among many others: agricultural
      crop management, environmental remediation, land use planning, military mission
      planning, and transportation management.  EarthWhere provides
      these users of geospatial data what
      we
      believe is a
      much
      more efficient way to retrieve, combine and otherwise manipulate datasets in
      a
      client-server and web-enabled environment.





We
      began
      developing EarthWhere in 2001, when our experience in designing data storage
      solutions led us to undertake the development of several products tailored
      to
      deliver optimized data storage and data management for particular market
      segments that we
      believe were
      not
      being adequately served by the conventional products available in the
      marketplace. We originally sought to develop integrated solution products,
      or
“storage appliances, ” that
      combined proprietary software with third-party hardware in an appliance designed
      to fulfill a market segment’s unique data storage and management requirements.
      After an initial development period, we concluded that producing and selling
      full-scale storage appliances (including the integrated hardware) under our
      own
      brand was not cost-justified. At the same time, however, we also determined
      that
      the proprietary software we had developed presented substantial sales
      opportunities as a stand-alone product. In 2003, we
      released the
      proprietary software under
      the name EarthWhere. In 2004, we took the further step of filing for U.S. patent
      protection on certain aspects of the EarthWhere software .
      The government’s review and subsequent patent prosecution process generally takes a
      number of years before any resulting patent will be issued. In 2005, we filed
      for U.S. patent protection on the technology which allows SANZ to embed custom
      or third-party components into EarthWhere, an important step as we begin to
      develop technology partners and to market the resulting products. In 2005,
      we
      also filed for similar patent protection in Europe. The Company believes that
      the award of U.S. patent protection, while potentially helpful to its long
      term
      product positioning, is neither fundamental nor critical to the success of
      its
      strategy for developing its EarthWhere software and services
      business.




4





Sales
      of
      EarthWhere software, lead, in some cases, to opportunities for storage solutions
      sales. We have found that sales of EarthWhere software also provide
      opportunities for additional revenue from implementation services and other
      GIS-related consulting services as described below.
      Revenue from EarthWhere software license sales and services have increased
      over
      the course of 2006, 2005 and 2004. Total EarthWhere license and services revenue
      for each of those years is $2,125,000, $1,932,000 and $749,000, respectively.
      In
      2006, we continued to invest in higher levels of research and development,
      sales
      and marketing and professional services.




**Markets
      for Our Products and Services**




*Storage
      Solutions Customers.*  We
      serve
      clients in both government and commercial markets. In particular, we continue
      to
      generate a significant portion of our revenue in the Federal government sector
      and operate an office of approximately 30 people in Vienna, Virginia. The
      majority of these personnel are billable engineers and consultants, and for
      2006
      the majority of our professional services revenue was from Federal government
      agencies and Federal prime contractor customers. Our Federal government clients
      are agencies typically involved in national defense, homeland security,
      government logistics, financial regulation and legislative operations. Our
      revenue from the Federal government for 2006 accounted for approximately 27%
      of
      total storage solutions revenue, of which approximately 27% consisted of sales
      directly to the Federal government and the remaining 73% consisted of sales
      to
      third parties acting as prime contractors.





Although
      the majority of our total government sales are to the Federal government, we
      also sell to state and local governments. Our commercial business sales are
      primarily to small to mid-size (“SMB”) customers in a variety of industries,
      including oil and gas, healthcare, financial services, data processing services
      and telecommunications. Our commercial Storage Solutions business is regional
      in
      nature, and we have a presence in the following metropolitan locations—Seattle,
      Washington, San Jose, California, Denver, Colorado, Houston, Texas, Dallas,
      Texas, Akron, Ohio and Fairfield County, Connecticut. Our largest regional
      offices are in Texas and Colorado. All of our storage solutions sales are within
      the United States.





*EarthWhere
      Software Customers.* EarthWhere provides users of geospatial data (principally satellite and aerial
      imagery and map data) an efficient way to retrieve, combine and otherwise
      manipulate their datasets. Applications for this product range from Federal
      government uses such as defense surveillance and land-use management, to local
      government uses such as fire control and city planning, to commercial market
      uses such as oil and gas development.





Currently,
      we believe that the substantial majority of the potential market for EarthWhere
      is within the Federal government, including a variety of defense agencies,
      intelligence agencies and civilian agencies. We also believe that there exists
      a
      commercial market for EarthWhere  within
      companies that themselves produce geospatial imagery data or sell such data
      to
      end users, and to end users of imagery data such as companies in the natural
      resources and agriculture industries. Our
      revenue from the Federal government for 2006 accounted for approximately 68%
      of
      total EarthWhere revenue, of which approximately 76% consisted of sales directly
      to the Federal government and the remaining 24% consisted of sales to third
      parties acting as prime contractors.




**Technology
      Partners and Sales Model**




*Storage
      Solutions Technology Partners.* SANZ
      is
      an independent storage solution provider. We offer “best of breed” solutions to
      our customers by integrating product offerings from our technology product
      partners. Our choice of product solutions changes from time to time based on
      a
      variety of factors, including our technological assessment of those products,
      the acceptance of those products in the marketplace, pricing and our
      relationships with partners and/or their distributors. Some of our current
      key
      partners and distributors are:





·
              EMC/EMC
                  Software Group
 ·
              Network
                  Appliance
 ·
              Hitachi
                  Data Systems
 ·
              Data
                  Domain
 ·
              Avnet
 ·
              Sun
                  Microsystems (including Sun-branded Hitachi Data Systems
                  products)
  5


In
      addition to these large manufacturers, we often test products offered both
      by
      smaller manufacturers and by other large manufacturers, and we establish new
      relationships when we believe those products would be beneficial to our
      clients.





We
      believe we have good relationships with our technology partners and distributors
      as mentioned above. From time to time, our technology partners engage us for
      the
      expertise we bring to a technology team, in particular in mixed technology
      environments, where individual manufacturers often lack the skills necessary
      to
      work with the full range of software and hardware components presented in a
      sophisticated solution.





*Storage
      Solutions Sales Model.* We
      design and deliver storage solutions customized to each client’s situation by
      working with our clients to understand both their current and their projected
      data storage needs and the business drivers that affect those needs. In some
      situations, we are retained by clients in a consulting role to assist them
      in
      performing a comprehensive assessment of their existing infrastructure and
      to
      develop a roadmap for transition to meet their identified needs. In a majority
      of cases, however, our clients come to us with a narrower storage need, and
      we
      design a solution as a part of the sales process. In both types of engagement,
      we often provide engineering services to implement the system and, at times,
      we
      are also engaged to provide operational support of the system after
      implementation.





We
      employ
      a direct sales model, but from time to time we engage in cooperative selling
      with our technology partners, nearly all of whom have sales personnel who are
      tasked to support channel partners such as SANZ. In some of the sales
      opportunities, we call upon our technology partners for direct support in the
      sales process, the implementation process or to provide lease financing for
      large projects.





In
      a full
      storage solution implementation, our engineering staff design a “best of breed”
system to meet the client’s business and technology needs, select and acquire
      the hardware and software components from our technology suppliers and
      coordinate installation and testing of the system at the client’s facility. To
      support our ability to deliver complex technical solutions, we operate testing
      laboratories (of varying sizes) at our offices in Dallas, TX, Houston, TX,
      Englewood, CO and Vienna, VA. These are used to test proposed solutions and
      to
      demonstrate those solutions to prospective clients. At times, we augment our
      own
      engineering resources by engaging our vendors’ engineers or other subcontractors
      to perform installations or other tasks on a case-by-case basis. We have
      developed our product and service offerings specifically to be able to engage
      a
      client at any point in the evolution of their storage requirements, and to
      continue to provide solutions as the client’s needs change in scope. At times,
      our clients’ needs are more limited and do not involve design and installation
      of a full solution. In these cases (such as follow-on sales of additional goods
      to existing customers), our role may be more limited and consist simply of
      reselling third-party hardware or software for inclusion in an existing
      system.





*EarthWhere
      Sales Model.* For
      sales of our EarthWhere software, we principally employ a direct sales model.
      Currently, our direct sales efforts are focused within the United States. To
      date, all of our EarthWhere sales have been within the United
      States.




6




**Significant
      Customers**




Federal
      government agencies in the aggregate accounted for approximately 10% and 17%
      of
      our total company revenue in 2006 and 2005, respectively. While we currently
      do
      not have any expectation that the U.S. Federal government will cease or
      significantly reduce its levels of business with us, if it were to do so, that
      reduction could have a material adverse effect on our business. Another
      customer, All Points Logistics, a third-party contractor for a U.S. Department
      of Defense agency, accounted for approximately 8.5% of our total company revenue
      in 2006 and 12% of our total company revenue in 2005.




**Seasonality**





Historically,
      our sales have weighted towards the last month of our fiscal quarters, primarily
      due to the typical quarter-end buying cycle in the information technology
      sector. Although not the case in 2006, in 2005 and 2004, our third quarter
      sales
      were higher than sales in other fiscal quarters for those years, primarily
      as
      the result of the growth of our Federal sector, coupled with the September
      30
      fiscal year end of the Federal government. We believe that this trend is likely
      to continue based on the current size of our Federal sector and the Federal
      governments’ historical spending levels during the last quarter of its fiscal
      year.





**Backlog**





Our
      backlog, defined as customer orders received with firm delivery dates, generally
      within 90 days of receipt of a customer order, was $3.5 million and $1.9 million
      at December 31, 2006 and December 31, 2005, respectively.





**Competition**





*Data
      Storage Solutions.* The
      market for data storage is served by many manufacturers, value added resellers,
      storage solution providers and storage service providers, and is generally
      highly competitive. Major computer system firms all offer storage systems along
      with their server, workstation and desktop computer systems. To some extent,
      our
      products and services compete with those systems.





We
      also
      face direct competition from manufacturers specializing in storage technology
      products. Some of these manufacturers are EMC/EMC Software Group, Hitachi Data
      Systems, Sun Microsystems, and Network Appliance.  Some
      product companies address the market with a direct sales model, some employ
      a
      channel partner-only strategy, while most use a hybrid strategy that includes
      both. As noted below under “Item
      1A.
      Risk Factors , ” many or
      all of these manufacturers have greater financial and other resources than
      we
      have.





A
      number
      of these competitors also are key technology suppliers of SANZ. Those that
      are
      not provide competition in our accounts and markets. In some cases, in large
      legacy accounts of our technology partners, we will face competition directly
      from those suppliers. A large number of private company value-added resellers
      (“VARs”) serve as sales and distribution outlets for the manufacturers listed
      above, and although many of these offer only component sales and distribution,
      we sometimes compete with these companies at the client-user level. We also
      face
      competition from other resellers offering the same or similar equipment from
      the
      same technology partners. In general, these competitors are
      regional. We also
      compete with companies that characterize themselves as storage solution
      providers, in whole or in part, such as GTSI, MTI, Cranel and
      Datalink.





The
      methods of competition vary widely between accounts and between individual
      sales
      opportunities, but in general include a blend of product performance, service
      and price. We seek to provide a high level of expertise and service to our
      customers rather than merely reselling products at the lowest possible cost.
      We
      have found that a reasonable number, though clearly not all, customers for
      these
      types of products place value on the engineering expertise and service that
      we
      provide during and after the sales process, and accordingly will purchase from
      SANZ as a full solution provider, rather than from a low-cost component
      reseller. In the Federal government marketplace, we have sought to differentiate
      ourselves from other solution providers by maintaining General Services
      Administration (“GSA”) schedules for many of the products we sell, which
      facilitates the purchasing process for many government customers. In addition,
      through our Solunet Storage subsidiary, we hold and maintain a Top Secret
      Federal Facility Clearance and certain personnel hold Secret and Top Secret
      Clearances. These enable us to provide services on projects that are restricted
      to holders of these clearances.




7





*EarthWhere.* While
      there are other software products in the marketplace that provide a limited
      portion of the overall functionality provided by EarthWhere, **** we
      are
      unaware of any other software application that is commercially available at
      this
      time that seeks to provide all or most of EarthWhere’s functionalities. However,
      there are other software development companies with substantial expertise in
      the
      GIS field, some of whom have greater resources than SANZ. It is possible that
      one of them, or a company not currently active in the GIS field, could develop
      and release a product that competes directly with EarthWhere in the
      future.




**Research
      and Development**




Our
      research and development expenditures in 2006, 2005 and 2004 were approximately
      $960,000, $1,130,000, and $589,000, respectively. All amounts incurred relate
      to
      EarthWhere  software
      development efforts. During 2006, we continued to enhance the functionality
      of
      EarthWhere with the release of version 4.1. We anticipate continuing further
      development efforts for EarthWhere. While it is also possible that we may seek
      to develop additional storage-related software tools for vertical markets
      outside of the geospatial imagery sector as we identify new opportunities,
      currently, we do not have any development efforts unrelated to
      EarthWhere.




**Employees**




As
      of
      December 31, 2006, we employed 133 full-time people. None of our employees
      are
      subject to collective bargaining agreements. We believe that our relations
      with
      our employees are good.




**Item
      1A. Risk Factors**





In
      addition to the other information in this report, the following factors should
      be considered in evaluating our business and financial condition. We believe
      the
      risks and uncertainties described below may materially affect SANZ’ liquidity
      and operating results. There also could be additional risks and uncertainties
      that we are currently unaware of, or that we are aware of but currently do
      not
      consider to be material. These could become important in the future or prove
      to
      be material and affect our financial condition or results of operations.





***Our
      ability to continue as a going concern is in doubt and we may not be successful
      in generating revenue and gross profit at levels sufficient to cover our
      operating costs and cash investment requirements.***





Our
      consolidated financial statements as presented in Item 15 of this report have
      been prepared in conformity with US GAAP, which contemplate our continuation
      as
      a going concern. However, the report of our independent registered public
      accounting firm on our consolidated financial statements, as of and for the
      year
      ended December 31, 2006, contains an explanatory paragraph expressing
      substantial doubt as to our ability to continue as a going concern. The “going
      concern” qualification results from, among other things, the substantial losses
      from operations that we have incurred since inception, our current liquidity
      position, net losses of approximately $33.0 million for the year ended December
      31, 2006, which included non-cash charges of $22.3 million related to goodwill
      and intangible impairments, negative working capital (current liabilities in
      excess of current assets) of $7.1 million as of December 31, 2006 and other
      factors described in Note 2 to our consolidated financial statements included
      in
“Item 15. Exhibits and Financial Statement Schedules” and in “Item 7.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations—Liquidity and Capital Resources.” Accordingly, as of December 31,
      2006, the recoverability of a major portion of the recorded asset amounts,
      including goodwill, is dependent on our continuing operations, which in turn
      is
      dependent on our ability to maintain our current financing arrangements and
      our
      ability to become profitable in our future operations.





In
      our
      Storage Solutions segment, we continue to focus on growing our professional
      services revenue as an important means for increasing gross profits. Carrying
      higher gross margins than resale of third-party hardware and software,
      professional services revenue is dependent upon hiring qualified consultants
      and
      engineers, managing utilization of billable staff, the successful completion
      of
      projects and the timing of obtaining new engagements. Our EarthWhere segment
      must continue to increase its revenue from software license sales and
      professional services to cover the increasing investment in development, sales
      and marketing. If we are not successful in these initiatives, it may be
      necessary to reduce costs, primarily through personnel cuts.




8





Ongoing
      concerns about our financial condition could also impact our dealings with
      third
      parties, such as customers, suppliers and creditors, and the continuation of
      such concerns could have a material adverse effect on our business and results
      of operations in the future. Future liquidity issues could prevent us from
      making timely payments to our suppliers which could restrict our ability to
      obtain products and meet our customers’ demands, which could materially and
      adversely impact our revenue, results of operations and financial condition,
      our
      competitive position in our market, and possibly our ability to continue
      operations.





***We
      expect to need to raise additional capital to fund our
      operations.***





From
      inception through December 31, 2006, we have invested approximately $11 million
      in our EarthWhere business, the majority of which has been funded from bank
      debt
      borrowings, guaranteed by Sun
      Capital Partners II, LP (“Sun Capital II”) ,
      an
      affiliate of our majority shareholder, Sun Solunet. To fund future investment
      in
      our EarthWhere business and to provide us with additional working capital,
      in
      March, April and May, 2006, we completed three closings of a private placement
      transaction exempt from registration under the Securities Act of 1933, as
      amended (the “Securities Act”), pursuant to Section 4(2) and Regulation D
      promulgated thereunder (the “2006 private placement”). The securities issued by
      us in the 2006 private placement transaction consisted of shares of a newly
      designed series A convertible preferred stock (“series A preferred stock”) and
      common stock purchase warrants sold to a limited number of outside, “accredited
      investors” and our management, which generated approximately $4.3 million in
      cash, net of placement agent and legal fees. Also as part of the transaction
      and
      under the same pricing terms, net of the placement agent fees, Sun Solunet
      converted $8.0 million of our outstanding debt into our convertible preferred
      stock and warrants. Additionally, we agreed with Sun Solunet to execute a new
      borrowing agreement whereby the remaining Sun Solunet debt of $5.0 million
      was
      converted to a three-year term note. Principal and accrued interest are due
      in
      March 2009.





We
      entered into a settlement agreement with substantially all of the investors
      in
      the 2006 private placement to, among other things, clarify our obligations
      under
      a registration rights agreement entered into in connection with the 2006 private
      placement and to limit the accrued liquidated damages we had to pay investors
      in
      the 2006 private placement under that agreement (to include liquidated damages
      plus accrued interest through November 15, 2006). In connection with the
      settlement agreement, on December 8, 2006 we issued to the investors that were
      a
      party to the agreement promissory notes in the aggregate principal amount of
      approximately $1.1 million that accrue interest at 12% per annum and are payable
      on March 8, 2008. The 2006 private placement, including this settlement
      agreement, is described in more detail under the section titled “Item 7.
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations—Liquidity and Capital Resources—Private Placement.”





Our
      current sources of cash include our Wells Fargo Bank, National Association
      (“Wells Fargo”) credit facility, a revolving credit facility with Harris N.A.
      (the “2006 Harris facility”) in the amount of $4.5 million, of which $1.5
      million is guaranteed by Sun Capital II and the remaining $3.0 million is
      secured by cash collateral posted by Sun Capital II in a collateral account
      maintained by Harris, and our current credit lines with our suppliers. We
      believe that these liquidity sources are adequate to fund our operations,
      assuming that we operate at current gross profit levels and that Sun Capital
      II
      continues to provide us with liquidity as they have done historically. However,
      there can be no assurance that we will operate at sufficient gross profit levels
      or that Sun Capital II will continue to provide us with liquidity, in which
      case
      it would be necessary to further cut costs, raise additional debt or equity
      capital, or sell assets. Additionally, based on our current liquidity, we may
      need to raise additional capital to pay the promissory notes issued in
      satisfaction of liquidated damages owed to the investors in the 2006 private
      placement described above. No assurance can be given that additional financing
      will be available or that, if available, it will be on terms favorable to
      us.





***Due
      to the “project based” nature of our Storage Solutions segment and “early stage”
of our EarthWhere segment, we have difficulty predicting revenue for future
      periods, which may result in expense levels unsupported by actual
      revenues.***





We
      have
      experienced, and expect to continue to experience, significant period-to-period
      fluctuations in our revenue and operating results. As a consequence, financial
      results from any one period may not be indicative of results that will be
      realized in future periods.




9





A
      number
      of factors may contribute to fluctuations in our revenue and operating results.
      Significant among these factors is the increasing size of individual customer
      orders received; we now frequently receive orders of more than $1 million in
      a
      single transaction. The timing of large orders from customers and the product
      integration cycle of those orders can cause significant fluctuations from period
      to period. Other factors include the tendency of customers to change their
      order
      requirements frequently with little or no advance notice to us; deferrals of
      customer orders in anticipation of new products, services, or product
      enhancements from us or our competitors; and the rate at which new markets
      emerge for products we are currently developing. Additionally, our EarthWhere
      segment is still in an “early stage,” and has yet to perform at a consistent and
      ratable operating level.




***A
      material portion of our sales are to the U.S. Federal government, and if we
      lost
      the ability to sell to the government our sales would decline
      significantly.***





A pproximately
      29% of our 2006 consolidated sales were to Federal government customers or
      to
      support Federal government projects. While it is not legally necessary to be
      an
      approved vendor in order to sell to the government, we have established GSA
      schedules with respect to many of the products we sell. GSA schedules are
      product and price lists that are periodically reviewed and approved by the
      GSA
      as the basis for purchases by Federal government agencies. Those GSA schedules
      greatly facilitate our sales to Federal government end-users. If the GSA were
      to
      refuse to renew those GSA schedules, we could lose some of our Federal
      government revenue base, and our business and results of operations could be
      materially and adversely affected. SANZ’ GSA schedule was most recently renewed
      in February 2003 and is valid through February 2008, unless terminated by
      GSA.





***Our
      operations currently rely on continued access to bank debt and trade credit
      from
      suppliers. If we lose access to such debt, our operations may be significantly
      impaired.***





We
      have a
      $12 million revolving credit facility with Wells Fargo, however, funds available
      to us under the credit line are limited by the amount of eligible accounts
      receivable we hold at any given time. Additionally, fluctuations in the timing
      of customer orders can adversely affect our ability to draw on the line when
      required. Wells Fargo may declare the loan in default if we do not meet certain
      financial covenants. In the past, we have periodically been in default under
      the
      covenants, and have required waivers from Wells Fargo. If we were to not be
      in
      compliance with financial covenants and were unable to obtain a waiver, and
      if
      Wells Fargo were to accelerate the loan, we would need to obtain cash from
      other
      sources to repay the loan. At December 31, 2006, we had $6.2 million of
      outstanding debt and $5.0 million of availability on our revolving credit
      facility with Wells Fargo. Additionally, at that date, we had a working capital
      deficit (current liabilities greater than current assets) of $7.1
      million.





Further,
      we purchase over half of our products from one supplier—Avnet, Inc. (“Avnet”).
      In 2005, we executed a security agreement with Avnet, whereby our indebtedness
      with Avnet is secured, except for $1.0 million. This security interest is
      subordinate to the security interest held by Wells Fargo under its credit
      facility with us, pursuant to an intercreditor agreement between Wells Fargo
      and
      Avnet. We purchase most of our other products from our other suppliers on open
      trade credit terms. Avnet and most of our suppliers set dollar limits on the
      trade credit they will afford us at any given time. If Avnet or our other
      significant suppliers were to cease to sell to us on trade credit terms, or
      were
      to substantially lower the credit limits they have set on our accounts, we
      would
      need to accelerate our payments to those vendors, creating additional demands
      on
      our cash resources, or we would need to find other sources for those
      goods.





***We
      have experienced a material weakness in our internal controls. If we fail to
      maintain an effective system of internal controls over financial reporting,
      we
      may not be able to accurately report our financial results or prevent fraud.
      As
      a result, current and potential shareholders could lose confidence in our
      financial reporting, which would negatively impact the value of our common
      stock.***




Effective
      internal controls over financial reporting are necessary for us to provide
      reliable financial reports, effectively prevent fraud and operate successfully
      as a public company. If we cannot provide reliable financial reports or prevent
      fraud, our reputation and operating results will be harmed. We restated our
      consolidated financial statements as of and for the three months ended March
      31,
      2006 related to our accounting for the March 2006 closing of the 2006 private
      placement. The adjustments involved the valuation and classification of amounts
      assigned to our series A preferred stock and warrants issued in the March 2006
      closing of the 2006 private placement. On June 20, 2006, our Audit Committee
      concluded that it was appropriate to restate our financial statements to reflect
      this revised accounting and financial reporting. Management evaluated the impact
      of this restatement on our assessment of internal control over financial
      reporting and concluded that the control deficiency related to the accounting
      for, and reporting of, convertible preferred stock transactions and derivative
      financial instruments represented a material weakness as of March 31, 2006.
      No
      other material weaknesses were identified as a result of management’s
      assessment.




10





To
      remediate the aforementioned deficiency, and to strengthen internal control
      over
      financial reporting for convertible preferred stock transactions and derivative
      financial instruments, in the second quarter of 2006, we implemented additional
      review procedures over the evaluation and application of relevant accounting
      pronouncements, rules, regulations and interpretations at the time these
      transactions, or other complex transactions, are contemplated and completed.
      These additional procedures include consultation with outside resources as
      may
      be deemed appropriate. As reported in our Quarterly Report on Form 10-Q for
      the
      fiscal quarter ended June 30, 2006, as amended, based on the remediation efforts
      in the second quarter of 2006, we believe that the material weakness was
      remediated in the June 2006 quarter.





We
      cannot
      be certain that these measures, and any other steps we may take, will ensure
      that we implement and maintain adequate controls over our financial processes
      and reporting in the future. Any failure to implement required new or improved
      controls, or difficulties encountered in their implementation, could harm our
      operations or results or cause us to fail to meet our reporting obligations.
      Ineffective internal controls over financial reporting could cause investors
      to
      lose confidence in our reported financial information, which would likely have
      a
      negative effect on the trading price of our common stock or could affect our
      ability to access the capital markets.





***Deemed
      dividends related to the beneficial conversion feature of our outstanding
      convertible series A preferred stock adversely affected earnings for the March
      2006 quarter and may adversely affect earnings in future
      periods.*** ******





As
      part
      of the first closing of the 2006 private placement on March 2, 2006 described
      earlier in this report, we issued convertible series A preferred stock and
      warrants. The net proceeds of $10.5 million from the first closing were
      allocated to the warrants based on their estimated fair value of $6.0 million,
      with the balance of the net proceeds of $4.5 million allocated to the
      convertible series A preferred stock. After this allocation, we calculated
      the
      effective conversion price of the convertible series A preferred stock, which
      was less than the closing price of our common stock on March 2, 2006. The
      difference between the effective conversion price of the series A preferred
      stock and the closing price of our common stock on this date resulted in a
      beneficial conversion feature. We calculated this beneficial conversion feature
      at $4.5 million and recorded it as a deemed dividend to preferred stockholders.
      The deemed dividend is included in the net loss available to common stockholders
      and the basic and diluted net loss per share calculation in 2006. We may record
      additional deemed dividends in future periods if we issue convertible securities
      at a discounted price. See Note 4 to our consolidated financial statements
      included in “Item 15. Exhibits and Financial Statement Schedules.”




***There
      are risks associated with introducing new products. If we are not successful
      with those product introductions, we will not realize on our investment in
      developing those products.***





The
      first
      version of our EarthWhere software product became “generally available” in 2003
      and we recorded license and services revenue during 2006, 2005, 2004 and 2003
      of
      approximately $2.1 million, $1.9 million, $749,000 and $87,000, respectively.
      From inception through December 31, 2006, we have invested approximately $11
      million in the EarthWhere business, several times the amount of the revenue
      generated.





We
      will
      continue to evaluate opportunities to develop other product solutions, and
      if we
      choose to develop other such products we will incur expenses in those
      development efforts. Market acceptance of new products may be slow or less
      than
      we expect. Our products also may not perform in a manner that is required by
      the
      market, or our competitors may be more effective in reaching the market segments
      we are targeting with these products. Slow market acceptance of these products
      will delay or eliminate our ability to recover our investment in these products.
      During any period that we unsuccessfully seek to market these products, we
      will
      also incur marketing costs without corresponding revenue.




11





***Our
      ability to grow our business depends on relationships with others. If we were
      to
      lose those relationships, we could lose our ability to sell certain of our
      products.***





Most
      of
      our revenue and a majority of our gross profit come from selling integrated
      solutions, consisting of combinations of hardware and software products produced
      by others. While our relationships change from time to time, some of our most
      significant technology partners at this time are Network Appliance, EMC/EMC
      Software Group, Hitachi Data Systems and Sun Microsystems. If a given technology
      partner changes its marketing strategy and de-emphasizes its use of marketing
      partners such as SANZ, our ability to generate revenue from reselling its
      products would diminish and our operations and results of operations would
      be
      materially and adversely affected.





***We
      are a relatively small company with limited resources compared to some of our
      current and potential competitors, which may hinder our ability to compete
      effectively.***





Some
      of
      our current and potential competitors have longer operating histories,
      significantly greater resources, broader name recognition, and a larger
      installed base of customers than we have. As a result, these competitors may
      have greater credibility with our existing and potential customers. They also
      may be able to adopt more aggressive pricing policies and devote greater
      resources to the development, promotion and sale of their products than we
      can
      to ours, which would allow them to respond more quickly than us to new or
      emerging technologies or changes in customer requirements. In addition, some
      of
      our current and potential competitors have already established supplier or
      joint
      development relationships with decision makers at our current or potential
      customers.




***We
      may be unable to hire and retain key personnel.***





Our
      future success depends on our ability to attract qualified storage technology
      and geospatial imagery personnel. We may be unable to attract these necessary
      personnel. If we fail to attract or retain skilled employees, or if a key
      employee fails to perform in his or her current position, we may be unable
      to
      generate sufficient revenue to offset our operating costs.





***We
      have a single controlling shareholder, who has the power to elect a majority
      of
      our board of directors and control the strategic direction of
      SANZ.***





As
      of
      March 30, 2007, Sun Solunet owns
      approximately 61% of our outstanding common stock assuming all securities held
      by Sun Solunet and other holders that are convertible into common stock or
      exercisable for common stock were converted or exercised. These
      shares give Sun Solunet the power to elect a majority of our board of
      directors and, through that board control, control our operations. The ability
      of other shareholders to influence our direction (for example, through the
      election of directors) is therefore limited or not available.




***Sales
      of common stock by our controlling shareholder may result in a change of
      control.***




As
      of
      March 30, 2007, Sun Solunet is our controlling shareholder. Sun Solunet is
      a
      selling stockholder in a resale registration statement that we filed as required
      by the terms of the 2006 private placement under which it may offer and sell
      approximately 55.9 million shares of our common stock that it holds by the
      related prospectus. Sun Solunet may cause us to have a change of control if
      they
      sell enough of our common stock by that prospectus or by other means. We are
      not
      aware of any present intention of Sun Solunet to cause us to have a change
      of
      control and we are not aware of any other arrangements that may result in a
      change of control.





***We
      have a thinly-traded stock and public sale of shares by Sun Solunet could cause
      the market price of our shares to drop significantly.***





As
      of
      March 30, 2007, Sun Solunet owns
      approximately 61% of our outstanding common stock assuming all securities held
      by Sun Solunet and other holders that are convertible into common stock or
      exercisable for common stock were converted or exercised. If Sun Solunet were
      to
      begin selling shares in the market rather than hold all of those shares over
      a
      longer term, the added available supply of shares could cause the market price
      of our shares to drop. Furthermore, in light of the large number of shares
      that
      it holds and its generally lower acquisition cost of those shares, Sun Solunet
      could be willing to sell its shares at a price lower than the
      currently-prevailing market price, thereby depressing that price.




12




***The
      sale of securities by investors in the 2006 private placement could cause
      dilution of existing holders of our common stock by decreasing the price of
      our
      common stock.***





The
      market price of our common stock could be adversely affected by sales of
      substantial amounts of common stock in the public market from investors in
      the
      2006 private placement, including Sun Solunet, by the perception that those
      types of sales could occur or by the fact or perception of events which would
      have a dilutive effect on the market for our common stock. As of March
      30 ,
      2007 ,
      we had
      96.8 million shares of our common stock outstanding. If all of our outstanding
      preferred stock is converted and all of our outstanding options and warrants
      were exercised, we could have up to approximately 326 million shares of common
      stock outstanding. Future transactions with other investors could further
      depress the price of our common stock because of additional
      dilution.





***Our
      common stock price could be affected by the ability of holders of our common
      stock to sell their stock.***





The
      market price of our common stock may be influenced by the ability of common
      stock holders to sell their stock. As of March 30 ,
      2007 ,
      approximately 40 million shares of our common stock were freely transferable
      and
      constitute the “float” in the public market for our common stock. The “float”
for our common stock will increase to a total of approximately 53 million shares
      assuming the conversion of all securities issued in the 2006 private placement
      that were registered for resale under a registration statement that was declared
      effective by the SEC in January of 2007.




***We
      could issue preferred stock that could adversely affect the rights of our common
      stockholders.***





We
      are
      authorized to issue up to 10,000,000 shares of our preferred stock, no par
      value
      per share. Our articles of incorporation give our board of directors the
      authority to issue preferred stock without approval of our common stockholders.
      We may issue preferred stock to finance our operations or for other purposes.
      We
      may authorize the issuance of our preferred stock in one or more series. In
      addition, we may set several of the terms of the preferred stock,
      including:




·
              dividend
                  and liquidation preferences,
 ·
              voting
                  rights,
 ·
              conversion
                  terms and privileges,
 ·
              redemption
                  terms and privileges, and
 ·
              other
                  privileges and rights of the shares of each authorized
                  series.


At
      any
      time our board of directors may issue additional shares of preferred stock
      having, if so designated by our board of directors at the time of issuance,
      dividend, liquidation, voting or other rights superior to those of the common
      stock. Such issuances could cause the market price of our common stock to
      decrease.




The
      issuance of large blocks of preferred stock could have a dilutive effect on
      our
      existing shareholders and it could negatively impact our existing stockholders’
liquidation preferences. In addition, while we include preferred stock in our
      capitalization to improve our financial flexibility, we could possibly issue
      our
      preferred stock to third parties as a method of discouraging, delaying or
      preventing a change in control in our present management.




***Deemed
      dividends related to beneficial conversion feature of our outstanding
      convertible series A preferred stock may adversely affect the price of our
      common stock.***





As
      described earlier in this report, the effective conversion price of the
      convertible series A preferred stock issued on March 2, 2006 in the 2006 private
      placement was less than the closing price of our common stock on March 2, 2006
      which required us to record a deemed dividend to preferred shareholders. The
      deemed dividend is described in Note 4 to our consolidated financial statements
      included in “Item 15. Exhibits and Financial Statement Schedules.” The market
      price of our common stock may be adversely affected by the fact that the
      effective conversion price is less than the market price of our common
      stock.


13


***Future
      issuances of securities could adversely affect the interests of our existing
      shareholders.***





In
      prior
      years, we issued securities both to generate cash and to acquire other companies
      and assets. As noted above, in March, April and May 2006, we issued convertible
      preferred stock and common stock purchase warrants as part of the 2006 private
      placement, which generated cash and reduced our debt. We may need to issue
      additional equity securities to provide cash and to fund any future
      acquisitions. Additionally, management may in the future deem raising capital
      through the sale of securities to be preferable to bank financing. Funds raised
      through the issuance of equity securities or securities convertible into, or
      exercisable for, our common stock could dilute the percentage ownership of
      existing shareholders, or result in our issuance of securities with rights,
      preferences or privileges which may be senior to those of shares of our common
      stock.





***The
      resale of our common stock by investors may be limited because of its low price
      which could make it more difficult for broker/dealers to sell our common
      stock.***





The
      Securities Enforcement and Penny Stock Reform Act of 1990, as amended, requires
      additional disclosure relating to the market for penny stocks in connection
      with
      trades in any stock defined as a penny stock. Regulations enacted by the SEC
      generally define a penny stock as an equity security that has a market price
      of
      less than $5.00 per share, subject to some exceptions. Unless an exception
      applies, a disclosure schedule explaining the penny stock market and the risks
      associated with investing in penny stocks must be delivered before any
      transaction in penny stock can occur. Our common stock is currently subject
      to
      the SEC’s “penny stock” rules and it is anticipated that trading in our common
      stock will continue to be subject to the penny stock rules for the foreseeable
      future.





Until
      such time as our common stock meets an exception to the penny stock regulations
      cited above, trading in our securities is covered by Rule 15g-2 and Rule 15g-9
      promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange
      Act”). Under Rule 15g-2, before a broker/dealer can consummate a trade in a
      penny stock, the broker/dealer must send additional disclosure, receive a
      written acknowledgement of such disclosure from the purchaser of the penny
      stock, and wait two business days from the date the additional disclosure was
      sent. Under Rule 15g-9, broker/dealers who recommend penny stocks to persons
      who
      are not established customers or accredited investors must make a special
      determination in writing for the purchaser that the investment is suitable,
      and
      must also obtain the purchaser’s written agreement to a transaction before the
      sale.





The
      regulations could limit the ability of broker/dealers to sell our securities
      and
      thus the ability of purchasers of our securities to sell their securities in
      the
      secondary market for so long as our common stock has a market price of less
      than
      $5.00 per share.




***We
      do not expect to pay cash dividends in the foreseeable
      future.***





We
      have
      never paid cash dividends on our common stock. We do not expect to pay cash
      dividends on our common stock at any time in the foreseeable future since we
      will use all of our earnings, if any, to finance current operations and the
      possible expansion of our operations. The future payment of dividends directly
      depends upon our future earnings, capital requirements, financial requirements
      and other factors that our board of directors will consider. Since we do not
      anticipate paying cash dividends on our common stock, return on your investment,
      if any, will depend solely on an increase, if any, in the market value of our
      common stock.


14


**Item
      1B. Unresolved Staff Comments**





Not
      applicable.





**Item
      2. Properties**





We do
      not
      own any real property. We occupy approximately 14,949
      squar e
      feet of
      leased office and data center space in Englewood, Colorado. This facility serves
      as our headquarters, and it houses most of our financial, administration and
      order processing functions, regional sales functions, and EarthWhere development
      functions. We are currently leasing this facility under a three-year lease
      which
      expires on January 14, 2009, for a monthly rent of approximately $21,000 plus
      the costs of utilities, property taxes, insurance, repair and maintenance
      expenses and common area utilities.





We
      currently have five other regional engineering and sales offices (excluding
      one-person offices or home offices in more remote locations), all located in
      leased premises. The following table is a summary of the locations, functions,
      approximate square footage and estimated utilization of our leased
      properties:





**Location**
            
            **Function**
            
            **Square
                Footage**
            
            **Utilization**Englewood,
                CO
            
            Headquarters,
                executive and administrative offices, as well as data center and
                research
                and development
            
            14,949
            
            85%Richardson,
                TX
            
            Call
                center, data center, engineering management and regional sales
                office
            
            9,546
            
            90%Vienna,
                VA
            
            Engineering
                management and regional sales office
            
            6,550
            
            95%Stafford,
                TX
            
            Regional
                sales office
            
            3,422
            
            90%Campbell,
                CA
            
            Regional
                sales office
            
            1,680
            
            75%Seattle,
                WA
            
            Regional
                sales office
            
            1,967
            
            100%




We
      believe that our properties, equipment, fixtures and other assets are adequately
      insured against loss, that suitable alternative facilities are readily available
      if the lease agreements described above are not renewed, and that our existing
      facilities are adequate to meet current requirements.




**Item
      3. Legal Proceedings**





None.





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





No
      matters were submitted to a vote of security holders during the fourth quarter
      of 2006.




15


**PART
      II**





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





Our
      common stock is presently quoted on the over-the-counter bulletin board
      maintained by the National Association of Securities Dealers, Inc. under the symbol “SANZ.” The following table shows the
      high and low bid quotations for our common stock in each quarter in 2006 and
      2005. These over-the-counter market quotations reflect inter-dealer prices,
      without retail mark-up, markdown or commission and may not represent actual
      transactions. The trading market in our securities may at times be moderately
      illiquid due to low dollar volume.





Common
                StockHigh
            
            Low**2006**First
                Quarter
            
            $
            0.27
            
            $
            0.17Second
                Quarter
            
            
            0.40
            
            
            0.21Third
                Quarter
            
            
            0.27
            
            
            0.14Fourth
                Quarter
            
            
            0.24
            
            
            0.14**2005**First
                Quarter
            
            
            0.45
            
            
            0.28Second
                Quarter
            
            
            0.33
            
            
            0.18Third
                Quarter
            
            
            0.29
            
            
            0.20Fourth
                Quarter
            
            
            0.24
            
            
            0.18





On
      March
      23, 2007, the last reported sale price for our common stock was $0.13.





**Holders**





As
      of
      March 23 ,
      2007 ,
      there
      were approximately 97.0 million shares of our common stock outstanding, held
      of
      record by approximately 350 registered holders. Registered holders include
      brokerage firms and clearinghouses holding our shares for their clientele,
      with
      each brokerage firm and clearinghouse considered as one holder.





**Transfer
      Agent**





The
      transfer agent for our common stock is Computershare Trust Company, Inc., 350
      Indiana Street, Suite 800, Golden, CO 80401.




**Dividend
      Policy**





We
      have
      never declared or paid any cash dividends on our common stock. We currently
      intend to retain future earnings, if any, for the operation and development
      of
      our business, and do not intend to pay any dividends in the foreseeable
      future .





**Issuer
      Purchases of Equity Securities**





There
      have been no repurchases of the Company’s equity securities.




16





**Stock
      Performance**





The
      information in this section is furnished because we deliver this report to
      our
      shareholders (in lieu of delivering an annual report to shareholders) in
      connection with our 2007 Annual Proxy Statement in order to satisfy our
      obligations under Rule 14a-3 promulgated under the Exchange Act.





The
      information in this section is not soliciting material, is furnished and not
      deemed filed with the SEC and is not to be incorporated by reference into any
      of
      our filings under the Securities Act or the Exchange Act, whether made before
      or
      after the date hereof and irrespective of any general incorporation language
      contained in such filing.





The
      following graph compares the performance of our common stock from December
      31,
      2001 through December 31, 2006, against the performance of (a) the Nasdaq
      Composite Index and (b) the Russell 2000 Index for the same period. The Russell
      2000 index was determined to be the closest of the available indices to the
      Company’s size, and was chosen in lieu of a Peer Group. The graph assumes an
      investment of $100 at December 31, 2001. We paid no dividends during the periods
      shown. The performance on the indices is shown on a total return
      basis.




**Comparison
      of 5 Year Cumulative Total Return**


**among
      SAN Holdings, Inc., the Nasdaq Composite Index and the Russell 2000
      Index**











17




**Item
      6. Selected Financial Data**





The
      fiscal year 2006, 2005, and 2004 statements of operations data, and the 2006
      and
      2005 balance sheet data, have been derived from our consolidated financial statements and notes appearing in “Item 15. Exhibits and
      Financial Statement Schedules” (“Item 15”) .
      The
      statement of operations and balance sheet data for 2003 and 2002 have been
      derived from our historical financial statements for those years.





Solunet
      Storage Holding Corp. (“Solunet Storage Holding”) is the accounting predecessor
      to SAN Holdings, Inc. (“SANZ”). Effective April 1, 2003, SANZ completed a
      business combination with Solunet Storage Holding, which was accounted for
      as a
      reverse acquisition, with Solunet Storage Holding treated as the acquirer for
      accounting purposes. As a result, for all periods prior to April 1, 2003, the
      financial statements of Solunet Storage Holding have been adopted as SANZ’
historical financial statements. Solunet
      Storage Holding commenced operations on September 26, 2002, when it acquired
      certain assets of StorNet, Inc. (“StorNet”) from its secured lender in a private
      foreclosure sale. The results of Solunet Storage Holding’s operations for 2002
      consist solely of operations for the period from September 26, 2002 to December
      31, 2002.





StorNet
      is considered to be an accounting predecessor of Solunet Storage Holding, and
      thus of SANZ. The results of operations of StorNet are presented as prior period
      financial statements. Because StorNet went through a foreclosure and liquidation
      on September 26, 2002, its financial statements have been prepared on a
      liquidation basis of accounting for the period from January 1, 2002 through
      September 25, 2002, and are therefore not fully comparable to the other years
      and periods presented.





The
      following table (in thousands, except per share data) should be read in
      conjunction with our consolidated financial statements and associated notes
      found in Item 15 .




Years
                Ended December 31,
            
            Sept.
                26, 2002 to
              Dec.
                31,**Consolidated
                  Statement of Operations Data**
            
            2006
            
            2005
            
            2004
            
            2003
            
            2002Revenue
            
            $
            58,745
            
            $
            59,115
            
            $
            66,158
            
            $
            55,497
            
            $
            11,554Loss
                from operations (1)
            
            
            (26,599
            )
            
            (11,283
            )
            
            (3,509
            )
            
            (5,225
            )
            
            (5,627
            )Net
                loss (1) (2) (3)
            
            
            (32,957
            )
            
            (15,803
            )
            
            (6,750
            )
            
            (5,938
            )
            
            (5,813
            )Net
                loss available to common
              shareholders
                (4)
            
            
            (37,836
            )
            
            (15,803
            )
            
            (6,750
            )
            
            (5,938
            )
            
            (5,813
            )Basic
                and diluted loss per share
            
            $
            (0.33
            )
            $
            (0.15
            )
            $
            (0.08
            )
            $
            (0.12
            )
            $
            (0.29
            )**Balance
                Sheet Data:**Working
                capital (deficit)
            
            
            (7,072
            )
            
            (19,626
            )
            
            (16,029
            )
            
            (12,225
            )
            
            (2,038
            )Total
                assets
            
            
            22,155
            
            
            41,217
            
            
            53,272
            
            
            60,469
            
            
            12,320Total
                long-term obligations (5)
            
            
            6,814
            
            
            -
            
            
            -
            
            
            -
            
            
            4,000Total
                stockholders’
              equity
                (deficit)
            
            
            (9,858
            )
            
            6,841
            
            
            19,767
            
            
            24,048
            
            
            (4,813
            )




18




StorNet,
                  Inc.**Consolidated
                  Statement of Operations Data**
              
              Jan.
                  1, 2002 to
                Sept.
                  25, 2002Revenue
              
              $
              42,446Loss
                  from operations
              
              
              (9,556
              )Net
                  loss
              
              
              (10,362
              )Basic
                  and diluted loss per share
              
              $
              (0.52
              )**Balance
                  Sheet Data:**Working
                  capital (deficit)
              
              
              (32,876
              )Total
                  assets
              
              
              10,997Total
                  long-term debt
              
              
              -Total
                  stockholders’ deficit
              
              
              (32,087
              )





(1)
            The
                2006 and 2005 losses from operations and net losses included charges
                in
                the amount of $22.3 million and $9.2 million, respectively, for goodwill
                and intangible asset impairment related to our Storage Solutions
                segment.
                See a further discussion of this impairment in “Item 7. Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations.”




(2)
            The
                2006 net loss included (a) charges in the amount of $1.3 million
                forthe
                change in estimated fair value of derivative financial instruments
                (stock
                purchase warrants issued in the March, April and May closings of
                the 2006
                private placement transaction), and for the fair value of derivative
                financial instruments (stock purchase warrants issued in the April
                and May
                closings of the 2006 private placement transaction) issued in excess
                of
                net cash proceeds; (b) a charge in the amount of $2.3 million related
                to
                an agreement to reprice warrants issued in the 2006 private placement
                transaction related to the settlement of liquidated damages (warrants
                were
                repriced on November 15, 2006); and (c) a settlement in the amount
                of $1.1
                million for liquidated damages payable under the registration rights
                agreement executed in the 2006 private placement transaction.
                See a further discussion of these charges in “Item 7. Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations.”




(3)
            The
                2005 and 2004 net losses included charges of $2.9 million and $2.5
                million, respectively, related to the obligation to issue stock purchase
                warrants to our majority shareholder, Sun Solunet, pursuant to a
                debt
                guaranty provided by Sun Capital II, an affiliate of Sun Solunet,
                on our
                revolving credit lines with Harris. See a further discussion in“Item
                7. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations.”




(4)
            The
                2006 net loss available to common shareholders included a deemed
                dividend
                of $4.5 million related to the beneficial conversion feature of the
                convertible series A preferred stock issued in the March closing
                of the
                2006 private placement transaction and accrued common stock dividends
                on
                the series A preferred stock issued in the March, April and May closingsof
                the 2006 private placement transaction in the amount of
                $340,000.
                See a further discussion in “Item 7. Management’s Discussion and Analysis
                of Financial Condition and Results of
                Operations.”




(5)
            Total
                long-term obligations at December 31, 2006 included $5.7 million
                for a
                three-year term loan we have with Sun Solunet (the “Sun Term Loan”),
                $762,000 of notes payable related to liquidated damages payable to
                related
                parties and $372,000 of notes payable related to liquidated damages
                payable to outside investors in the three closings of the 2006 private
                placement transaction.




19




**Supplementary
      Data - Quarterly Financial Information (Unaudited)**





The
      consolidated results of operations on a quarterly basis were as follows (in
      thousands, except per share amounts).





For
                the three months ended**2006**
            
            March
                31
            
            June
                30
            
            Sept.
                30
            
            Dec.
                31Net
                sales
            
            $
            14,272
            
            $
            13,906
            
            $
            14,780
            
            $
            15,787Gross
                Profit
            
            
            3,507
            
            
            3,245
            
            
            3,607
            
            
            3,676Net
                loss (1)
            
            
            (5,617
            )
            
            (334
            )
            
            (3,545
            )
            
            (23,461
            )Net
                loss available to common shareholders (2)
            
            
            (10,156
            )
            
            (334
            )
            
            (3,545
            )
            
            (23,801
            )Net
                loss per share, basic and diluted
            
            $
            (0.09
            )
            $
            (0.00
            )
            $
            (0.03
            )
            $
            (0.20
            )




**2005**
            
            March
                31
            
            June
                30
            
            Sept.
                30
            
            Dec.
                31Net
                sales
            
            $
            15,516
            
            $
            13,273
            
            $
            18,039
            
            $
            12,287Gross
                Profit
            
            
            3,757
            
            
            3,186
            
            
            4,543
            
            
            3,352Net
                loss (3)
            
            
            (1,513
            )
            
            (1,560
            )
            
            (506
            )
            
            (12,224
            )Net
                loss per share, basic and diluted
            
            $
            (0.01
            )
            $
            (0.01
            )
            $
            (0.00
            )
            $
            (0.11
            )




(1)
            The
                first quarter 2006 net loss included a charge of $4.0 million for
                the
                change in the estimated fair value of our warrants issued in March
                of
                2006. The second quarter 2006 net loss included a benefit of $2.7
                million
                for the change in the estimated fair value of our warrants issued
                in
                March, April and May of 2006 in the 2006 private placement and a
                charge of
                $0.9 million for the fair value of the warrants issued in April and
                May of
                2006 in the 2006 private placement in excess of the net cash proceeds
                raised. The third quarter 2006 net loss included (a) a benefit of
                $0.9
                million for the change in the estimated fair value of the warrants
                issued
                in March, April and May of 2006 in the 2006 private placement;(b)
                a charge in the amount of $2.3 million related to an agreement to
                reprice
                warrants issued in the 2006 private placement related to the settlement
                of
                liquidated damages (warrants were repriced on December 8, 2006);
                and (c) a
                settlement in the amount of $1.1 million for liquidated damages under
                the
                registration rights agreement executed in connection with the 2006
                private
                placement.
                The fourth quarter 2006 net loss included a charge in the amount
                of $22.3
                million for goodwill and intangible asset impairment related to our
                Storage Solutions segment. See a further discussion in “Item 7.
                Management’s Discussion and Analysis of Financial Condition and Results of
                Operations.”




(2)
            The
                first quarter 2006 net loss available to common shareholders included
                a
                deemed dividend of $4.5 million related to the beneficial conversion
                feature of the convertible series A preferred stock issued in March
                of
                2006 in the 2006 private placement. See a further discussion in “Item 7.
                Management’s Discussion and Analysis of Financial Condition and Results of
                Operations.”




The
      fourth quarter 2006 net loss available to common shareholders included accrued
      common stock dividends on the series A preferred stock issued in the March,
      April and May closings of
      the
      2006 private placement transaction in the amount of $340,000 .
      See a
      further discussion in “Item 7. Management’s Discussion and Analysis of Financial
      Condition and Results of Operations.”




(3)
            The
                first, second and fourth quarters of 2005 included charges of $1.0
                million, $0.5 million and $1.3 million, respectively, related to
                stock
                purchase warrants issued to Sun Solunet in consideration for a guaranty
                provided by Sun Capital II on our revolving credit lines with Harris.
                See
                a further discussion in “Item 7. Management’s Discussion and Analysis of
                Financial Condition and Results of
                Operations.”




The
      fourth quarter of 2005 included a charge in the amount of $9.2 million for
      goodwill impairment related to our Storage Solutions segment. See a further
      discussion in “Item 7. Management’s Discussion and Analysis of Financial
      Condition and Results of Operations.”




20


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




**General**





Our
      current business operations commenced in 2000. Effective April 1, 2003, we
      completed the acquisition of Solunet Storage Holding and, indirectly, its
      operating subsidiary Solunet Storage, Inc. (“Solunet Storage”). As
      discussed in Note 1 to our consolidated financial statements included in Item
      15
      of this report, this transaction has been accounted for as an acquisition of
      SANZ by Solunet Storage Holding, and as a result, the financial statements
      of
      Solunet Storage Holding have been adopted as the historical financial statements
      of SANZ for all periods prior to April 1, 2003. SANZ includes its wholly-owned
      subsidiary, SANZ Inc., and its wholly-owned subsidiary, Solunet
      Storage.




**Products
      and Services**





In
      the
      course of our business, we provide the following products and services, which
      are reported as two business segments in our financial statements included
      in
      Item 15 of this report:





·
            ***Data
                storage solutions***that we design and deliver as a customized project to meet a client’s
                specific needs, including both data storage networks and data
                backup/recovery systems;





·
            ***Maintenance******and
                customer support services***on
                storage hardware and software;





·
            ***Storage-related
                professional services***;





·
            ***A
                proprietary data management software product known as
                “EarthWhere*TM”**(“EarthWhere”), which facilitates imagery data access and provisioning for
                geospatial digital imagery users (principally satellite and aerial
                imagery
                and map data);





·
            ***Maintenance
                and customer support services***on
                our EarthWhere software product;
                and





·
            ***Geospatial
                imagery data management consulting
                services.***





We
      report
      the first three products and services in our “Storage Solutions” segment and the
      latter three in our “EarthWhere” segment.





SANZ’
      Storage Solutions Business:





SANZ provides
      enterprise-level data storage and data management solutions to commercial and
      government clients. We design, deliver, service and sometimes manage data
      storage systems, especially those that are built using a network architecture.
      The data storage and services market is large, with spending estimated to exceed
      $40 billion by 2007. International Data Corporation (IDC) projects data growth
      at an annual compound rate of approximately 8-10% through 2007.
      While  this
      market is large and broad-based as a result of the fundamental need by all
      industries and government agencies to better manage ever increasing amounts
      of
      data, it is subject to fluctuations in capital spending in general and in
      information technology spending in particular. Because
      we typically design solutions that integrate multiple technologies for our
      clients, we are known in the industry as a “storage solution provider.” Our
      client-specific solution designs may include a variety of storage elements
      or
      subsystems from a single technology partner, or may be comprised of a mix of
      elements from a broad range of component suppliers. Clients often choose to
      conduct business with SANZ because of our ability to offer solutions that are
      based on a comprehensive understanding of the wide range of storage technologies
      and products that are available, and our ability to select from among those
      sometimes competing offerings, an optimized price-performance combination for
      the client’s specific needs.




21





Because
      of our need to have a broad, concurrent understanding of many data storage
      technologies, our business requires a significant continued investment in
      well-trained engineering personnel and a high level of experience and training
      in our sales and support staff. We also invest in testing new product offerings
      and operate testing laboratories (of varying sizes) at our offices in Texas,
      Colorado and Virginia. These facilities are used to test proposed solutions
      and
      to demonstrate those solutions to prospective clients.





In
      many
      cases, we provide solution design recommendations to our clients as part of
      the
      sales process. In other cases, clients engage us as consultants, using our
      specialized expertise in such projects as : assessing
      the adequacy of clients’ current data storage infrastructures; advising them on
      new data management systems design; providing implementation services and
      providing ongoing operational support.





As
      an
      important part of our general business strategy, we have concentrated
      on growing the
      technical professional services content of our Storage Solutions business,
      which
      has increased from $3.3 million in 2004 to $4.8 million in 2005, and to $5.4
      million in 2006, representing a 64% increase from 2004 to 2006. Sales of
      professional services generally provide higher gross margins than the resale
      of
      third-party hardware and software. At the same time, building out and
      maintaining a professional services staff requires additional management systems
      for recruiting, retention, and utilization of employees.





Because
      of the technical complexity of data storage hardware and software products
      and
      systems, clients generally purchase maintenance and support contracts on those
      products. We provide these services from our Richardson, Texas based “technical
      services center,” a call center in which our own engineers field support calls
      from clients with respect to many of the products that we sell. Depending on
      the
      nature of the client’s issue, our engineers may resolve the call remotely or may
      pass on the call to the product vendor to send a technician into the field
      to
      fix the issue. This process is referred to in the industry as taking “first
      call.” The ongoing communication with the client associated with taking first
      call also helps us in our efforts to maintain a close relationship with the
      client as its “trusted advisor,” and helps us, from time to time, to identify
      new sales opportunities within the client.





We
      market
      our Storage Solutions products and services primarily to Federal government and commercial enterprises. We view these two market segments as having distinct needs, and
      as
      a result, made
      changes in our organization in late 2004 to address these markets with
      specifically dedicated resources. The Federal market for SANZ is generally
      highly centralized in the Washington DC area; typically involves larger contract
      awards and longer sales cycles of up to 12 months; requires that we maintain
      presence on certain Federal procurement vehicles
      (e.g., GSA Schedules) that generally limit available margin on third-party
      product resale; and typically provides greater opportunity for higher levels
      of
      professional services revenue.





The commercial market
      for SANZ is much more geographically diverse; normally involves smaller average
      project size with shorter sales cycles; faces certain market access limitations
      from our technology partners as most reserve many of the Fortune 1000 accounts
      for their direct sales efforts instead of channel management; typically supports
      higher available margin on third-party product re-sale; and generally provides
      less opportunity for sales of professional services. It is
      our strategy to maintain and increase our market
      share in both of these markets and continue to build on our reputation for
      providing highly cost effective, comprehensive data management solutions in
      a
      full service model.




To
      improve our financial performance, we are focused on organizational
      productivity. We are striving to increase the individual productivity of our
      sales staff and the billable utilization of our existing engineering staff.
      In
      parallel, we are focused on increasing the percentage of revenue from our higher
      margin services business and reducing the costs of our back-office and support
      operations through improved application of systems and technology.





SANZ’
      EarthWhere software and services business:





As
      an
      outgrowth of our understanding of data management processes and requirements,
      we
      have developed and sell a proprietary data-management software application
      designed specifically for managing geospatial imagery data. EarthWhere is
      designed to facilitate a user’s provisioning and distribution of stored
      geospatial data (e.g., satellite and aerial imagery, map data, etc.).




22





We
      are
      currently marketing EarthWhere predominantly to government agencies that use
      geospatial digital imagery in their business or mission. These users may
      include:


·
              Military
                  mission planners who use images to better plan operations and assess
                  results;
 
 ·
              Intelligence
                  operatives and planners who use images to monitor condition changes
                  in
                  their surveillance objectives;
 
 ·
              Environmental
                  condition analysts who use hyper-spectral analysis of imagery to
                  monitor
                  changes in conditions;
 
 ·
              Agricultural
                  scientists and planners who use imagery to monitor farm production
                  compliance, soil conditions, and land
                  contours;
 
 ·
              Border
                  patrol enforcement teams who use imagery to plan for more effective
                  “route” control and intercept;
 
 ·
              Emergency
                  management teams who use imagery to address issues of evacuation
                  route
                  planning; and


·
              Municipal planning, taxing and control organizations
                that
                use imagery to address zoning compliance and other real estate development
                issues.
  While
        there are no specific market estimates for software products and services
        that
        provide the EarthWhere functionality, the market for geospatial imagery data
        is
        estimated by the American Society for Photogrammetry and Remote Sensing
        (“ASPRS”) to exceed $3 billion annually, and to be growing at approximately 9-14%
        per
        year. Another source, Cary & Associates, estimated the total Federal
        spending on “Geo Technology,” which includes imagery, IT delivery systems, and
        personnel involved in the management and use of imagery, etc., at approximately
        $6 billion.





The
      current business process that is used to deliver geospatial imagery to meet
      the
      needs of its users is complex. A critical element in that process, given the
      state of current technology, is the role of the highly trained imagery analyst,
      who must retrieve the correct imagery data and apply sophisticated software
      tools to create the exact image needed by the “business user,” no matter how
      simple or complex. Th is
      process  is
      typically slow, time intensive (therefore costly), and often fails to meet
      timing or general mission needs of the business
      user .





SANZ
      management believes that the introduction of EarthWhere as a data provisioning
      application offers dramatic improvement to the process for delivering data
      to
      the imagery analyst and making some of his/her tasks much easier. In actual
      process impact tests at the United States Department of Agriculture
      Farm  Service
      Agency Aerial Photography Field Office (“USDA APFO”) and other users, the
      application of EarthWhere improved productivity of some operations by as much
      as
      20 to 1 (“USDA APFO/EarthWhere sales order fulfillment project—Case study,
      version 1.5,” March 15, 2005). Improving the productivity of the imagery analyst
      increases his/her ability to respond to the mission objectives of the business
      user and correspondingly support an expanding user market.





We
      recorded our first product sale of EarthWhere in 2003. To date,
      we have made sales to a number of Federal agencies that hold significant
      potential for broad application of the EarthWhere software product. In 2006,
      we
      focused our technical and business development efforts on achieving sales in
      the
      Department of Defense and Intelligence Community. We believe that these market
      segments hold the largest near term potential for growth.





The
      sales
      cycle for an “enterprise class” software product typically exceeds 12 months
      from initial introduction to full deployment. Our experience has been that
      EarthWhere sales cycles tend to follow this pattern. A relatively small license
      sale that supports a typical “department” use is priced in the range of
      $100,000. We expect to increase revenue in 2007 as we continue to invest in
      building out our position in the Defense and Intelligence Community and move
      some of our existing clients from department to “enterprise” use of the
      product.




23





As
      part
      of our software sale, we provide installation and support services. We have
      also
      found that some of our clients and prospective clients have a need for business
      process re-engineering and other consulting services, which we also
      provide.





Currently
      we believe that we have nominal direct competition for the EarthWhere product
      as
      a “Commercial Off the Shelf Technology.” We sometimes face indirect competition
      where mature users of geospatial imagery have developed custom “in house”
systems that perform some or all of the functions of our product.





We
      continue to invest significantly in the product development of EarthWhere,
      which
      we expect will be necessary to continue to maintain a
      competitive position. We account for software development costs according to accounting
      principles generally accepted in the United States (“US GAAP”). In 2006 and
      2005, we capitalized $898,000 and $911,000 of software development costs,
      respectively, and expensed $62,000 and $219,000 in research and development
      costs, respectively, related to EarthWhere.





While
      we
      expect increases in sales of EarthWhere software and related services, this
      part
      of our business is still in
      the
      development stage and no assurance can be made that we will meet our sales
      objectives .
      If we
      fail to meet our sales objectives, the cash requirements for development will
      place a significant burden on our cash resources.




**Segment
      Information**




The
      Company currently operates and reports in two business segments—Storage
      Solutions and EarthWhere. The two reportable segments disclosed in this document
      are based on our current management organizational structure. A detailed
      description of the products and services, as well as financial data, for each
      segment can be found in Note 11 to our consolidated financial statements
      included in Item 15 of this report. Based on the way in which management reviews
      and evaluates segment performance, the segment operating results shown below
      for
      2006, 2005 and 2004 do not include non-allocated corporate expenses, interest
      expense, charges for debt guaranty warrants, charges related to the 2006 private
      placement transaction and other income and expense. Such items are only
      considered when evaluating the results of the consolidated company. Future
      changes to this organizational structure may result in changes to the reportable
      segments disclosed.





Storage
      Solutions





(in
                thousands)
            
            **2006**
            
            **2005**
            
            **2004**Net
                revenueProduct
                sales and vendor supplied services
            
            $
            43,734
            
            $
            43,333
            
            $
            53,970Consulting
                and engineering services
            
            
            5,397
            
            
            4,773
            
            
            3,272Maintenance
                services and contract fees
            
            
            6,508
            
            
            8,895
            
            
            7,763Total
                net revenue
            
            
            55,639
            
            
            57,001
            
            
            65,005Gross
                Profit
            
            
            12,752
            
            
            13,440
            
            
            13,388Loss
                from operations (1)
            
            $
            (22,903
            )
            $
            (8,851
            )
            $
            (1,578
            )





(1)
      For
      2006 and 2005, loss from operations included non-cash charges for goodwill
      and
      intangible asset impairment in the amount of $22.3 million and $9.2 million,
      respectively.





Storage
      Solutions revenue decreased by approximately 2% and gross profit decreased
      by
      approximately 5% from 2005 to 2006. Product sales and vendor supplied services
      remained flat year on year. The decrease in gross profit is primarily a result
      of the Storage Solutions segment’s continued pricing pressures, which is
      reflected in
      part
      by several multi-million dollar transactions in 2006 which carried gross margins
      ranging from 8 to 16%, as compared to a $4.4 million order in 2005 that carried
      approximately a 28% gross margin. Consulting and engineering services revenue increased by 13% year on year,
      reflecting our continued focus on increasing this higher-margin sector of our
      business. The primary reason for the year on year decrease in maintenance
      services and contract fees was a change in the mix of “first call” maintenance
      services and third party maintenance contract fees. Overall maintenance billings
      increased from 2005 to 2006, but the percentage of first call maintenance
      services to third party maintenance contract fees was approximately 60/40 in
      2005 compared with 40/60 in 2006. Since maintenance contract fees are recorded
      net of cost of goods, the result was a decrease in reported maintenance revenue.




24





EarthWhere





(in
                thousands)
            
            **2006**
            
            **2005**
            
            **2004**Net
                revenueEarthWhere
                licenses and services
            
            $
            2,125
            
            $
            1,932
            
            $
            749Other
                hardware and software
            
            
            981
            
            
            182
            
            
            404Total
                net revenue
            
            
            3,106
            
            
            2,114
            
            
            1,153Gross
                Profit
            
            
            1,283
            
            
            1,398
            
            
            562Loss
                from operations
            
            $
            (2,929
            )
            $
            (1,732
            )
            $
            (1,453
            )





EarthWhere
      revenue increased by 47% from 2005 to 2006, and sales of our software licenses
      increased by 10% year on year. In addition, our EarthWhere consulting and
      engineering service revenue increased by 25% from 2005 to 2006. The decrease
      in
      gross profit year on year is partially due to the increase in amortization
      of
      capitalized software costs, which is recorded as cost of goods, from $134,000
      in
      2005 to $376,000 in 2006.





We
      have
      continued to significantly increase our investment in expanding the EarthWhere
      business, with the number of dedicated EarthWhere employees increasing from
      15
      to 26 to 31 at December 31, 2004, 2005 and 2006, respectively. Operating
      expenses, including an allocation for general and administrative expenses,
      increased from $2.1 million in 2004 to $3.3 million in 2005 and to $4.1 million
      in 2006.





**Critical
      Accounting Policies and Estimates**





We
      prepare our financial statements in accordance with US
      GAAP .
      The
      accounting policies most fundamental to understanding our financial statements
      are those relating to recognition of revenue, to our use of estimates, to the
      capitalization of software development costs, to the accounting for derivative
      financial instruments and those relating to the impairment testing of goodwill
      and intangible assets.





***Revenue
      Recognition***





Our
      revenue recognition policy is significant because the amount and timing of
      revenue is a key component of our results of operations. Revenue results are
      difficult to forecast, primarily because we are a project-based business, and
      any shortfall in revenue or delay in recognizing revenue could cause our
      operating results to vary significantly from period to period. Additionally,
      we
      use estimates in allocating revenue among the multiple elements of a sale
      arrangement. Also, we make estimates and judgments regarding revenue recognition
      as to when a particular services engagement is completed.





We
      recognize revenue from the design, installation and support of data storage
      solutions, which may include hardware, software and services. Our revenue
      recognition policies are based on the guidance in Staff Accounting Bulletin
      No.
      104, “Revenue Recognition,” (“SAB 104”) in conjunction with Emerging Issues Task
      Force (“EITF”) Issue Number 00-21, “Revenue Arrangements with Multiple
      Deliverables” (“EITF 00-21”), the American Institute of Certified Public
      Accountants’(“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue
      Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software
      Revenue Recognition, with Respect to Certain Transactions,” and EITF 03-5,
“Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables
      in an Arrangement Containing More-Than-Incidental Software,” and EITF 99-19,
“Reporting Revenue Gross as a Principal versus Net as an Agent.”





We
      recognize revenue when:


·
              persuasive
                  evidence of an arrangement exists,
 ·
              delivery
                  has occurred or services have been rendered,
 ·
              the
                  sales price is fixed or determinable, and
 ·
              collectibility
                  of the resulting accounts receivable is reasonably assured.





25




Our
      revenue is derived from two segments—Storage Solutions and EarthWhere—and from
      four sources:





(1)
        the
        resale of computer hardware, software and related vendor supplied
        services;
 (2)
        the
        sale of our proprietary software product, EarthWhere;
 (3)
        professional services, including installation, assessment, and on-site
        consulting; and
 (4)
        the
        sale of maintenance and technical support agreements on data storage devices
        and
        software.


Storage
      Solutions Product Sales (Hardware/Software)





Our
      Storage Solutions arrangements may include multiple elements, including the
      resale of third-party computer hardware, software and maintenance support.
      We
      account for the software and software-related elements in accordance with SOP
      97-2. We determine the fair value of the non-software elements in accordance
      with EITF 00-21 and account for them in accordance with SAB 104.





We
      recognize revenue from the resale of data storage systems upon either (i) the
      shipment of goods for freight-on-board (“FOB”) origin shipments or (ii) the
      delivery of goods to the customer for FOB destination shipments, provided that
      no significant uncertainties regarding customer acceptance exist, and depending
      on the terms of the contract and applicable commercial law. Based on our
      history, customer acceptance clauses are rare, and in the event of a sales
      arrangement which includes a customer acceptance clause, we recognize revenue
      upon the earlier of receipt of written acceptance or when the acceptance period
      has lapsed.





Our
      Storage Solutions arrangements may include multiple elements, including the
      resale of third-party computer hardware, software, maintenance support, and
      professional services (e.g., assessment, training and installation).
      Arrangements generally fall into one of the following scenarios:





(a)
            The
                software and maintenance elements are more than incidental to the
                product
                as a whole, and essential to the functionality of the hardware. In
                this
                type of arrangement, and in accordance with EITF 03-5, the hardware
                is
                considered software-related, and we account for the entire arrangement
                -
                hardware, software and related maintenance support - in accordance
                with
                SOP 97-2. Since these arrangements involve the resale of third-party
                elements, we have published price lists from our vendors for these
                products and services, and accordingly, we establish vendor specific
                objective evidence (“VSOE”) of fair value for these elements from these
                price lists.





(b)
            The
                software and maintenance are incidental to the product as a whole.





(c)
            The
                resale of hardware contains no software. Multiple elements in these
                arrangements may include the sale of professional services (i.e.
                installation) and maintenance contracts on the hardware
                elements.





In
      accordance with EITF 03-5, when the hardware is a non-software element and
      any
      software or software-related elements are not more than incidental to the
      product as a whole as in cases (b) and (c) above, the arrangements do not fall
      under the scope of SOP 97-2, and are accounted for in accordance with SAB 104
      and EITF 00-21.





For
      arrangements that include the resale and installation of third-party data
      storage systems (i.e., stand-alone hardware or hardware with incidental software
      and maintenance, as cited in b. and c. above) denominated as a single, lump-sum
      price, we allocate the aggregate arrangement revenue among the multiple elements
      based on their relative fair values in accordance with EITF 00-21. We determine
      relative fair value for each revenue element based on published price lists
      from
      our vendors for these products and/or services.





When
      some
      elements are delivered prior to others in a multiple element arrangement,
      revenue for the delivered elements is separately recognized, provided all of
      the
      following criteria are met:


·
              the
                  delivered item has value to the customer on a stand-alone
                  basis,
 ·
              there
                  is objective and reliable evidence of the fair value of the undelivered
                  item(s), and
 ·
              delivery
                  or performance of the undelivered item(s) is considered probable
                  and
                  substantially in the control of the
                  vendor.
  26
  Undelivered
        revenue elements typically include installation, training, and other
        professional services.





The
      amount of revenue allocated to delivered items is limited to the amount that
      is
      not contingent upon the delivery of additional items or meeting other specified
      performance conditions. For undelivered services revenue, we use a residual
      method of allocating revenue, and defer revenue for the estimated fair value
      of
      the undelivered services. We estimate the fair value of the undelivered services
      based on separate service offerings with customers. For undelivered elements
      other than services, we allocate revenue to the separate elements based on
      their
      relative fair values.





EarthWhere
      License Fees





We
      recognize revenue on EarthWhere license fees in accordance with SOP 97-2, as
      amended by SOP 98-9.





For
      EarthWhere license agreements that do not require significant modifications
      or
      customization of the software, we recognize software license revenue when
      persuasive evidence of an agreement exists, delivery of the product has
      occurred, the license fee is fixed or determinable and collection is probable.
      Consulting and maintenance services are billed separately from the license.
      Acceptance provisions included in a software license agreement generally grant
      customers a right of refund or replacement only if the licensed software does
      not perform in accordance with its published specifications. Based on our
      history, the likelihood of non-acceptance in these situations is remote, and
      we
      recognize revenue when all other criteria of revenue recognition are met. If
      the
      likelihood of non-acceptance is determined to be other than remote, we recognize
      revenue upon the earlier of receipt of written acceptance or when the acceptance
      period has lapsed.





Our
      EarthWhere software license agreements may include multiple products and
      services, including maintenance, and we determine the fair value of and
      recognize revenue from the various elements of the arrangements in accordance
      with SOP 97-2 and 98-9. We establish VSOE of fair value for our EarthWhere
      software licenses through our price list which is published with the General
      Services Administration (“GSA Price List”) for sale to Federal government
      customers. Typically, we sell our EarthWhere licenses along with a maintenance
      agreement; however, if we sell a license separately, without maintenance, it
      is
      sold at the same price according to the GSA Price List. In cases where we can
      establish VSOE only for the undelivered elements in a arrangement (i.e.
      maintenance), we apply the residual method to recognize revenue for the
      delivered elements in accordance with SOP 98-9.





Professional
      Services





Revenue
      from professional services, excluding maintenance services, and which include
      installation, assessment, training and resident services, is recognized as
      the
      related services are completed.





Maintenance
      Services





We
      provide “first call” technical support for certain third-party hardware and
      software products that we sell. Additionally, on our EarthWhere product, we
      provided maintenance services and post-contract customer support along with
      unspecified upgrades and enhancements. Revenue from maintenance contacts is
      recognized on a straight-line basis over the contractual term of the contacts.
      Likewise, we defer the costs of maintenance contracts and amortize them on
      a
      straight-line basis over their contractual terms.




Maintenance
      Contract Fees





For
      third-party products for which we do not perform first call maintenance, we
      often resell the vendor’s maintenance contract for a fee. On these arrangements,
      we recognize revenue at the inception of the contract, net of the cost of the
      contract, in accordance with EITF 99-19.




27


***Use
      of Estimates***





The
      preparation of our financial statements in conformity with US GAAP requires
      us
      to make estimates, judgments and assumptions that affect the reported amounts
      of
      assets and liabilities, the reported amount of revenue and expenses during
      the
      reporting period, and the disclosure of contingent assets and liabilities at
      the
      date of the financial statements. Some of these estimates, judgments and
      assumptions relate to expected outcomes or uncertainties of specified events.
      Others relate to the anticipated dollar amounts arising out of events that
      are
      reasonably certain to occur. The areas in which we most frequently are required
      to make such estimates, judgments and assumptions are assessment of the carrying
      value of goodwill, the recoverability and the useful lives of intangible assets
      and other long-term assets, allowances for credit losses on accounts receivable,
      allowances for impairment in the value of inventory, recognition of revenue,
      and
      the capitalization of software development costs.





We
      believe that the estimates, judgments and assumptions upon which we rely are
      reasonable based on the information available to us at the time that those
      estimates, judgments and assumptions are made, and they are continually
      evaluated based on available information and experience. In the case of
      estimated or assumed amounts, the actual results or outcomes are often different
      from the estimated or assumed amounts. These differences are usually minor
      and
      are included in our consolidated financial statements as soon as they are known.
      However, to the extent that there are material differences between these
      estimates, judgments and assumptions and actual results, our financial
      statements will be affected.





Goodwill





Goodwill
      represents the excess of the purchase price over the fair value of identifiable
      tangible and intangible net assets relating to business acquisitions. Historically,
      goodwill has been a significant component of our total assets. We
      account for goodwill and intangible assets in accordance with Statement of
      Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”
(“SFAS 142”). SFAS 142 requires that goodwill be tested for impairment at least
      annually.





We
      review
      the carrying value of goodwill annually and use the last date of our fiscal
      year
      (December 31) as the measurement date. Under certain circumstances, SFAS 142
      requires an assessment of goodwill impairment more frequently. The performance
      of the impairment test involves a two-step process. The first step (“Step I
      test”) of the impairment test involves comparing the fair value of the company’s
      reporting unit with the reporting unit’s carrying amount, including goodwill. If
      the carrying amount of the reporting unit exceeds its fair value, the second
      step (“Step II test”) is performed to determine the amount of the impairment
      loss. The impairment loss is determined by comparing the implied fair value
      of
      our goodwill with the carrying amount of that goodwill. We believe that our
      estimates of fair value are reasonable. Changes in estimates of such fair value,
      however, could affect the calculation.





In
      2005,
      we began segment reporting, and, at that time, determined that, as defined
      under
      SFAS 142, we had two reporting units - Storage Solutions and EarthWhere.
      Accordingly, we allocated our recorded goodwill to both of these reporting
      units
      based on the percentage of gross profit generated by each reporting unit for
      the
      year ended December 31, 2004, the most recent year prior to our commencement
      of
      segment reporting. We believed that this was the most appropriate financial
      measure for allocation purposes based on the different stages of the reporting
      units’ businesses. This resulted in approximately 4% or $1.3 million of the
      total goodwill asset allocated to our EarthWhere reporting unit.





As
      of
      December 31, 2006 and 2005, we reviewed goodwill associated with both of our
      reporting units for impairment, and, as part of our assessments of both years,
      we engaged an independent valuation firm (“independent firm”). For purposes of
      preparing its valuations, the independent firm requested that we provide them
      with certain information, including but not limited to projections of our 2006
      financial results. The independent firm performed its valuations using primarily
      discounted cash flow and comparable public company analyses. For both 2006
      and
      2005, the result of the Step I test for our Storage Solutions reporting unit
      was
      that the carrying amount of this reporting unit exceeded its fair value. Because
      of the impairment determined under the Step I test, we were required to complete
      the Step II test, which involved a valuation of this reporting unit’s assets and
      liabilities, including intangibles. Based on the Step II analysis, as of
      December 31, 2006 and 2005, we recorded impairment charges for goodwill related
      to our Storage Solutions reporting unit in the amount of $21.5 and $9.2 million,
      respectively.




28





As
      of
      December 31, 2006 and 2005, we concluded that the recorded goodwill for our
      EarthWhere reporting unit was not impaired.





The
      independent valuation of our two reporting units was based on both historical
      and projected results provided by us. Our projected operating results
      encompassed assumptions and estimates regarding our revenue levels, gross
      margins associated with revenue components, operating expense levels and capital
      expenditure levels. Our actual operating results and cash flows from operations
      and investing activities could vary materially, and if materially less than
      projected results may indicate that the carrying value of our goodwill assets
      may be further impaired. Our common stock is currently thinly-traded and future
      assessments of the carrying value of our goodwill assets would likely be based
      on discounted cash flow analysis.





Our
      goodwill impairment charge recorded in the 2006 results of operations was
      primarily a result of: (1) our projected 2006 financial results provided to
      the
      independent firm for purposes of preparing its valuations exceeding our actual
      2006 financial results; (2) a reduction in our projected financial results
      provided to the independent firm for purposes of preparing its valuations made
      as of December 31, 2006 for the fiscal years 2007 through 2015 as compared
      to
      projected financial results made as of December 31, 2005 for those same years;
      and (3) management’s assessment of the current operating performance of the
      Storage Solutions reporting unit. Based on these factors, as well as the
      independent firm’s valuation, we concluded that the goodwill asset for the
      entire Storage Solutions reporting unit was fully impaired, and wrote off the
      remaining balance in 2006.




Intangible
      and Other Long-Lived Assets





Generally,
      intangible assets other than goodwill are amortized over their useful lives.
      Determining the useful life of most such intangible assets requires an estimate
      by management. Our intangible assets that are subject to amortization include
      trade names and customer lists. The usefulness of customer lists declines
      gradually due to customer turnover. In the case of trade names, if a decline
      occurs, it is more likely to occur as a single event at an as-yet unknown time
      (e.g., as a consequence of a future rebranding). While it is not possible to
      know when such a change may occur in the future, we have estimated a median
      date
      based on our current business plans for such names and the general practices
      in
      the marketplace.





We
      evaluate the carrying value of long-lived assets, including intangibles subject
      to amortization, whenever events or changes in circumstances indicate the
      carrying amount may not be fully recoverable. If that analysis indicates that
      an
      impairment has occurred, we measure the impairment based on a comparison of
      discounted cash flows or fair values, whichever is more readily determinable,
      to
      the carrying value of the related asset.





At
      December 31, 2006, in conjunction with the independent valuation of goodwill
      as
      described in “—Goodwill” above, we recorded a charge in the amount of $800,000
      for the impairment of the SANZ commercial trade name.





Derivative
      Financial Instruments





During
      2006, the accounting for financial instruments and potential derivatives was
      significant to our financial statements because the accounting for such
      instruments requires the use of management’s significant estimates and
      assumptions. This accounting policy is also significant because of the potential
      fluctuations in the estimated fair value from period to period, which are
      recorded as a benefit (charge) to net loss on the statement of operations.
      We
      estimated the fair value of the warrants issued in the 2006 private placement
      using the Black-Scholes option pricing model. This model requires the use of
      significant estimates and assumptions related to the estimated term of the
      financial instruments, the volatility of the price of our common stock, and
      interest rates, among other items. Fluctuations in these assumptions may have
      a
      significant impact on the estimated fair value of financial instruments, which,
      in turn, may have a significant impact on our reported financial condition
      and
      results of operations. As of December 31, 2006, all warrants issued in the
      2006
      private placement were reclassified to equity and were no longer subject to
      these fluctuations in fair value. Our accounting for derivative instruments
      is
      discussed further in Note 4 to our consolidated financial statements included
      in
      Item 15 of this report.


29


Accounts
      Receivable





We
      utilize a specific reserve methodology for our accounts receivable, in which
      we
      periodically review each of those accounts based on aging, the financial status
      of the client and other known factors that may indicate that an account has
      become uncollectible. In doing so, we make judgments about our ability to
      collect outstanding receivables and apply a reserve where we believe our ability
      to collect a specified receivable has become doubtful. We also consider our
      exposure to a single client. This process of reviewing our accounts receivable
      involves the application of management’s judgment and estimates regarding a
      future event, i.e., the likelihood of collection of a receivable and whether
      or
      not collection will be of the full amount owed. If our judgment does not
      accurately predict our future ability to collect those outstanding receivables,
      whether because the data on which we rely in making that judgment proves to
      be
      inaccurate or otherwise, additional provisions for doubtful accounts may become
      needed and the future results of operations could be materially affected.





Historically,
      our credit losses have not been material. Total write-offs for the years 2003
      through 2006 were insignificant. As of December 31, 2006 and 2005, our total
      allowance for doubtful accounts was $143,000, and $168,000, respectively,
      representing approximately 0.9% and 1.4% of our total accounts receivable,
      respectively. We do not anticipate any material change to our estimates or
      assumptions in this critical accounting area.





Inventory





We
      also
      utilize a specific reserve methodology for our inventory, in which we
      periodically review our inventory to assess whether, due to aging, changes
      in
      technology, our effectiveness in marketing a given type of product to our usual
      client base or other factors, our ability to sell that inventory for at least
      our carrying value has become impaired. This process involves the application
      of
      management’s judgment and estimates regarding a future event, i.e., the
      likelihood of the sale of an item of inventory and an estimate of the price
      at
      which such sale will occur. If our judgment does not accurately predict our
      future ability to sell that inventory or the price at which we will sell it,
      whether because the data on which we rely in making that judgment proves to
      be
      inaccurate or otherwise, we may have to reduce the carrying value of that
      inventory, and our future results of operations could be materially
      impacted.





Historically,
      our inventory write-offs have not been materially different from our estimated
      reserves. We have continued to reduce our inventory levels since 2004, further
      reducing the materiality of required reserves. We do not anticipate
      significantly increasing average inventory levels or any materially changing
      to
      our estimates or assumptions in this critical accounting area.





Expense
      Classification





Our
      recognition of revenue from services that we perform with our internal staff
      also involves certain estimates, judgments and assumptions. Among these are
      estimates and assumptions used in reallocating an appropriate portion of our
      operating expenses pertaining to employee compensation and related expenses
      to
“cost of sales.” If we are incorrect in those estimates and assumptions, our
      financial statements may inaccurately overstate gross profit and simultaneously
      overstate operating expense, or vice versa. The net effect of either outcome
      would, however, be neutral to net income.





***Software
      Development Costs***





We
      expense the costs of developing computer software to be sold, leased or
      otherwise marketed until technological feasibility is established and we
      capitalize all costs incurred from that time until the software is available
      for
      general customer release or ready for its intended use, at which time
      amortization of the capitalized costs begins. We determine technological
      feasibility for our computer software products based upon the earlier of the
      achievement of: (a) a detailed program design free of high-risk development
      issues; or (b) completion of a working model. Costs of major enhancements
      to existing products are capitalized while routine maintenance of existing
      products is charged to expense as incurred. We also contract with third parties
      to develop or test software that will be sold to customers and generally
      capitalize these third-party costs. The establishment of the technological
      feasibility and the ongoing assessment of the recoverability of capitalized
      computer software development costs require considerable judgment by management
      with respect to certain external factors, including, but not limited to,
      technological feasibility, anticipated future gross revenue, estimated economic
      life and changes in software and hardware technology.




30


We
      amortize capitalized software costs on a product-by-product basis over their
      expected useful life, which is generally three years. The annual amortization
      related to software to be sold is the greater of the amount computed using
      (a)
      the ratio that current gross revenue for a product compares to the total of
      current and anticipated future gross revenue for that product or (b) the
      straight-line method over the remaining estimated economic life of the
      product.





The
      capitalization and carrying value of software development costs involves
      estimates, judgments and assumptions in determining technological feasibility
      and expected useful life of a product.





***Recent
      Accounting Pronouncements***





In
      February 2006, the FASB issued Statement of Financial Accounting Standard No.
      155 (“SFAS 155”), “Accounting for Certain Hybrid Financial Instruments—An
      Amendment of FASB Statements No. 133 and 140,” to simplify and make more
      consistent the accounting for certain financial instruments. Specifically,
      SFAS
      155 amends SFAS 133 to permit fair value remeasurement for any hybrid financial
      instrument with an embedded derivative that otherwise would require bifurcation,
      provided that the whole instrument is accounted for on a fair value basis.
      Prior
      to fair value measurement, however, interests in securitized financial assets
      must be evaluated to identify interests containing embedded derivatives
      requiring bifurcation. The amendments to SFAS 133 also clarify that
      interest-only and principal-only strips are not subject to the requirements
      of
      SFAS 133, and that concentrations of credit risk in the form of subordination
      are not embedded derivatives. Finally, SFAS 155 amends Statement of Financial
      Accounting Standards No. 140, “Accounting for the Impairment or Disposal of
      Long-lived Assets,” to allow a qualifying special-purpose entity (SPE) to hold a
      derivative financial instrument that pertains to a beneficial interest other
      than another derivative financial instrument. SFAS 155 applies to all financial
      instruments acquired or issued after the beginning of an entity’s first fiscal
      year that begins after September 15, 2006, with earlier application allowed.
      The
      adoption of this accounting pronouncement did not have a material impact on
      our
      consolidated financial statements.





In
      June
      2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes—an interpretation of FASB Statement No. 109, ‘Accounting for Income
      Taxes’” (“FIN 48”), which clarifies the accounting for uncertainty in income
      taxes recognized in a company’s financial statements. FIN 48 prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. FIN 48 provides guidance regarding the recognition of a tax position
      based on a “more likely than not” recognition threshold; that is, evaluating
      whether the position is more likely than not of being sustained upon examination
      by the appropriate taxing authorities, based on the technical merits of the
      position. FIN 48 also provides guidance on de-recognition, classification,
      interest and penalties, accounting in interim periods and disclosure. The
      provisions of FIN 48 are effective for fiscal years beginning after December
      15,
      2006 with the cumulative effect of the change in accounting principle recorded
      as an adjustment to opening retained earnings. We believe that the adoption
      of
      this pronouncement will not have a material impact on our consolidated financial
      statements.





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive
      guidance on the SEC’s views regarding the process of quantifying materiality of
      financial statement misstatements. SAB 108 is effective for fiscal years ending
      after November 15, 2006, with early application for the first interim period
      ending after November 15, 2006. The adoption of this accounting pronouncement
      did not have a material impact on our consolidated financial statements.





In
      September 2006, the FASB issued Statement of Financial Accounting Standard
      No.
      157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value,
      establishes a framework for measuring fair value in generally accepted
      accounting principles, and expands disclosures about fair value measurements.
      We
      are currently evaluating the potential impact SFAS 157 will have on our
      financial statements.




31




In
      June
      2006, the FASB ratified EITF Issue No. 06-3 “How Taxes Collected from
      Customers and Remitted to Governmental Authorities Should Be Presented in the
      Income Statement (That Is, Gross Versus Net Presentation)” (EITF 06-3). The
      scope of EITF 06-3 includes any tax assessed by a governmental authority that
      is
      directly imposed on a revenue-producing activity between a seller and a customer
      and may include, but is not limited to, sales, use, value added, and some excise
      taxes. EITF 06-3 also concluded that the presentation of taxes within its scope
      on either a gross (included in revenues and costs) or net (excluded from
      revenues) basis is an accounting policy decision subject to appropriate
      disclosure. We currently present all taxes on a net basis and have elected
      not
      to change our presentation method. EITF 06-3 is effective for interim and annual
      reporting periods beginning after December 15, 2006, with earlier
      application permitted.




**Liquidity
      and Capital Resources**





**Liquidity**





As
      of
      December 31, 2006, we had $5.0 million of undrawn availability on our borrowing
      facility with Wells Fargo Bank, National Association (“Wells Fargo”), and as of
      March 31, 2007, we had $2.1 million drawn and $2.2 million of undrawn
      availability on this facility. Our ability to borrow under the Wells Fargo
      facility is subject to maintaining our accounts receivable balance at current
      levels, as well as complying with the financial covenants we have made to the
      lender. If we are unable to comply with our financial covenants to Wells Fargo,
      the facility could cease to be available to us. On April 2, 2007, we and Wells
      Fargo executed an amendment to the current facility, which extended its duration
      through May 2010. On April 13, 2007, we obtained a waiver of default from Wells
      Fargo waiving the event of default that would have resulted under the facility
      as a result of the “going concern” qualification on our independent registered
      public accounting firm’s report on our financial statements for the fiscal year
      ended December 31, 2006.





At
      December 31, 2006, we also held a $5.0 million three-year term loan (“Sun Term
      Loan”) with our majority shareholder, Sun Solunet that is payable in full in March
      2009.





At
      December 31, 2006, we had $1.5 million of borrowings outstanding on a $1.5
      million credit facility (the “Harris 2006 Facility”) with Harris N.A.
      (“Harris”). Borrowings under the Harris 2006 Facility bore interest at prime and
      are payable upon demand by Harris. We obtained this facility to provide
      additional working capital. On March 13 and March 23, 2007, we increased our
      borrowing availability with Harris through amendments to the Harris 2006
      Facility in the amounts of $1.5 million and $1.5 million, respectively. As
      of the
      date of this report, we had principal borrowings outstanding under the Harris
      2006 Facility of $4.5 million.





Our
      consolidated financial statements as presented in Item 15 of this report have
      been prepared in conformity with US GAAP, which contemplate our continuation
      as
      a going concern. However, the
      report of our independent registered public accounting firm on our consolidated
      financial statements, as of and for the year ended December 31, 2006, contains
      an explanatory paragraph expressing substantial doubt as to our ability to
      continue as a going concern. The “going concern” qualification results from,
      among other things, our current liquidity position, net losses and other factors
      described in this item and in Note 2 to our consolidated financial statements
      included in “Item 15. Exhibits and Financial Statement Schedules.” We have
      incurred substantial losses from operations since inception and have incurred
      a
      net loss of $33.0 million for the year ended December 31, 2006, which included
      non-cash charges of $22.3 million related to goodwill and intangible asset
      impairments. In addition, as of December 31, 2006, we have negative working
      capital (current liabilities in excess of current assets) of $7.1 million,
      an
      accumulated deficit of $72.1 million and a stockholders’ deficit of $9.9
      million. Accordingly, as of December 31, 2006, the recoverability of a major
      portion of the recorded asset amounts, including goodwill, is dependent on
      our
      continuing operations, which in turn is dependent on our ability to maintain
      our
      current financing arrangements and our ability to become profitable in our
      future operations. Our consolidated financial statements do not include any
      adjustments relating to the recoverability and classification of recorded asset
      amounts or amounts and classification of liabilities that might be necessary
      if
      we were unable to continue as a going concern.





Ongoing
      concerns about our financial condition could impact our dealings with third
      parties, such as customers, suppliers and creditors, and the continuation of
      such concerns could have a material adverse effect on our business and results
      of operations in the future. Future liquidity issues could prevent us from
      making timely payments to our suppliers which could restrict our ability to
      obtain products and meet our customers’ demands, which could materially and
      adversely impact our revenue, results of operations and financial condition,
      our
      competitive position in our market, and possibly our ability to continue
      operations.




32




We
      continue to attempt to improve our liquidity through improving our operating
      results and exploring debt and equity capital opportunities. Key operating
      performance improvement levers continue to include sustaining or moderately
      increasing existing revenue levels, achieving higher revenue gross margins
      from
      increased services revenue and EarthWhere software license sales, and
      maintaining operating expenses as a percentage of gross profit at the same
      or
      lower percentage. We have also continued to invest in our EarthWhere business,
      in particular in the product development and professional services areas. At
      the
      current revenue levels for EarthWhere, such investment requires significant
      cash. Increased revenue from EarthWhere software sales would substantially
      improve operating cash flow.





Assuming
      continuation of our current credit facilities with Wells Fargo and Harris,
      current business trends and supplier relations, we believe that our liquidity
      sources are adequate to fund our operations for the next twelve months, assuming
      that we operate at current gross profit levels and that Sun Capital II continues
      to provide us with liquidity as they have done historically. However, there
      can
      be no assurance that we will operate at sufficient gross profit levels or that
      Sun Capital II will continue to provide us with liquidity, in which case it
      would be necessary to further cut costs, raise additional debt or equity
      capital, or sell assets. If we do seek to raise debt or equity capital, there
      is
      no assurance that it will be available on favorable terms or in an amount
      sufficient to avoid further cost-cutting.





**Private
      Placement**





On
      March
      2, April 18 and May 4, 2006, we completed three closings of a private placement
      transaction exempt from registration under the Securities Act pursuant to
      Section 4(2) and Regulation D promulgated thereunder (the 2006 private
      placement) with third-party investors, our executive management and Sun Solunet.
      We raised approximately $12.3 million, comprised of $4.3 million of cash, net
      of
      placement agent and legal fees of approximately $784,000, and Sun Solunet
      converted $8.0 million of the Sun Loan (as defined below) to equity. We repaid
      $1.0 million of the outstanding Sun Loan to Sun Solunet, and the remaining
      $5.0
      million of outstanding debt on the Sun Loan was converted to the Sun Term Loan,
      bearing interest at prime plus 1.0%. We used the net cash proceeds of
      approximately $4.3 million from the 2006 private placement for general working
      capital needs and
      funding our operating loss for the year ended December 31, 2006 .
      In
      consideration for the net proceeds of approximately $12.3 million, we issued
      a
      total of 277.6 units (“2006 units”), each 2006 unit consisting of:





(a)
            one
                share of our newly designated convertible series A preferred stock,
                no par
                value per share, initially convertible into 333,333 shares of our
                common
                stock at an exercise price of $0.15 per share, no par value per share;





(b)
            a
                warrant to purchase 166,667 shares of common stock exercisable for
                five
                years from the Closing Date at an initial exercise price of $0.30
                per
                share (the “2006 A warrants”);





(c)
            a
                warrant to purchase 166,667 shares of common stock exercisable for
                five
                years from the Closing Date at an initial exercise price of $0.50
                per
                share (the “2006 B warrants”) (together with the warrants described in
                clause (b) above, the “2006 private placement
                warrants”).





As
      discussed in Note 4 to our consolidated financial statements included in Item
      15
      of this report, one of the agreements executed in the 2006 private placement
      was
      a registration rights agreement dated as of March 2, 2006 among SANZ and each
      of
      the investors in the 2006 private placement (the “2006 registration rights
      agreement”). The 2006 registration rights agreement required us to pay
      liquidated damages (2% per month in the form of cash) to the investors in the
      2006 private placement in the event we failed to register the underlying shares
      of common stock that we were required to issue upon conversion of the series
      A
      preferred stock and the exercise of the 2006 A warrants and 2006 B warrants
      within 150 days of the respective Closing Dates. Under the 2006 registration
      rights agreement, we became obligated to pay liquidated damages 150 days after
      each of the Closing Dates. The first of these dates was August 1, 2006. The
      liquidated damages were payable on each monthly anniversary until the
      registration statement was declared effective by the SEC. In addition, interest
      accrued on the liquidated damages at a rate of 12% per annum, if the payments
      were not made within seven days after the date payable.




33




On
      November 22, 2006, we entered into an agreement (the “2006 settlement
      agreement”) with substantially all of the investors in the 2006 private
      placement, which, among other things, clarified our responsibilities with
      respect to the ongoing obligation to register shares of common stock for resale,
      modified the calculation of liquidated damages and interest relating thereto
      payable to such investors and set forth the mechanics for payment of such
      liquidated damages and interest. Under the terms of the 2006 settlement
      agreement, we were obligated to pay liquidated damages and interest accrued
      through November 15, 2006 (the “Liquidated Damages”), and thereafter have no
      further obligation to any of such investors in the 2006 private placement to
      pay
      liquidated damages. In the third quarter of 2006, we accrued $1,117,000 of
      Liquidated Damages, which represented the approximate total amount due as of
      November 15, 2006, and of which approximately $751,000 and $366,000 were payable
      to related parties and the other investors in the 2006 private placement,
      respectively, and, as a result of the 2006 settlement agreement, are payable
      15
      months from the date of issuance of the 2006 private placement promissory notes
      (as defined below). Additionally, and as part of the 2006 settlement agreement,
      we agreed to permanently reduce the exercise price of the 2006 B warrants from
      $0.50 per share to $0.20 per share. This modification resulted in a non-cash
      charge in the amount of $2,314,000 for 2006 to reflect the agreement to reprice
      the 2006 B warrants as of November 15, 2006. The 2006 settlement agreement
      and
      modification of the 2006 B warrants in November 2006 were in satisfaction of
      our
      obligations under the 2006 registration rights agreement and, as a result,
      under
      current US GAAP, we accrued $3.4 million ($1.1 million of Liquidated Damages
      and
      $2.3 million related to repricing of the 2006 B warrants) in our 2006 fiscal
      third quarter.





On
      December 8, 2006, we issued an unsecured promissory note (collectively, the
      “2006 private placement promissory notes”) to each of the investors that was a
      party to the 2006 settlement agreement for the payment of the Liquidated Damages
      to such investor. The terms of each 2006 private placement promissory note
      provided that: (1) payments would be made by us in cash, or, at the option
      of
      the investor, in shares of our common stock (the terms of any issuance of common
      stock to be mutually agreed upon by the us and the investor); (2) the 2006
      private placement promissory note would be due and payable 15 months from the
      date that it was issued; and (3) interest on the principal amount of the 2006
      private placement promissory note would accrue at a rate of 12% per annum and
      would be due and payable as specified in (2) above.




**Cash
      and Cash Flows**




At
      December 31, 2006, we had $-0- in cash and cash equivalents, and we had undrawn
      availability of $5.0 million on our Wells Fargo credit facility. As of
      March 31, 2007, we had $2.1 million drawn and $2.2 million of undrawn
      availability on this facility.




For
      the
      year ended December 31, 2006, net cash used in operating activities was $3.5
      million. Our significant use of cash from operations for the year ended December
      31, 2006 was the net loss incurred for the period of $33.0 million, less
      non-cash charges of $22.3 million for goodwill and intangible asset impairments,
      $3.6 million for the change in estimated fair value of derivative financial
      instruments (2006 private placement warrants issued in the March, April and
      May
      closings of the 2006 private placement), for the fair value of derivative
      financial instruments (2006 private placement warrants) issued in excess of
      net
      cash proceeds and for the agreement to reprice certain of the 2006 B warrants
      issued in the 2006 private placement in settlement of future liquidated damages,
      less $1.1 million for a charge for the settlement of liquidated damages, less
      $1.2 million in depreciation and amortization and less a $375,000 non-cash
      expense for share-based compensation. Another significant use of cash was an
      increase in accounts receivable of $3.6 million, due to higher invoicing in
      December 2006 as compared to December 2005. This use of cash was partially
      offset by an increase in accounts payable of $3.6 million, due to the timing
      of
      vendor payments and the increased invoicing in December 2006 as compared to
      December 2005.





Cash
      used
      in investing activities was $1.2 million in 2006, consisting of $333,000 for
      the
      purchase of property and equipment and $898,000 for the capitalization of costs
      for software developed for resale, discussed further below under the section
      “—Capital Expenditures.”





Cash
      provided by financing activities totaled $4.7 million in 2006, consisting of
      net cash
      proceeds of $4.3 million from the 2006 private placement, net payments of $1.1
      million on our Wells Fargo facility and net borrowings of $1.5 million on
      our Harris 2006 facility due to the timing of our working capital needs.





34





**Debt
      Facilities**





Wells
      Fargo Line of Credit





We
      have a
      revolving credit line with Wells Fargo to borrow up to $12.0 million, which
      is
      secured by substantially all assets of SANZ Inc., our wholly-owned subsidiary,
      and Solunet Storage, Inc. (a wholly-owned subsidiary of SANZ Inc.)
      (collectively, “SANZ Inc. et al” or the “Borrowers”). The funds available under
      the credit facility are limited to 85% of the amount of eligible accounts
      receivable, which consist of substantially all accounts receivable, subject
      to
      exclusions for invoices aged over 90 days, otherwise-current receivables from
      customers with material amounts outstanding over 90 days and subject to a
      percentage limit of accounts receivable from a single customer. Borrowings
      against receivables owed directly by Federal government end-users are further
      limited to 80% of the eligible accounts receivable up to $500,000 in the
      aggregate unless we have obtained an “assignment of claim” executed by the
      government agency. Receivables from commercial entities acting as prime
      contractors for Federal government end-users are not subject to this sub-limit.
      Borrowings against receivables on maintenance services and maintenance contract
      fees are limited to 35% of the eligible accounts receivable up to $1,000,000
      in
      the aggregate.





As
      of
      December 31, 2006, based on our eligible collateral at that date, we had $11.2
      million available for borrowing on the Wells Fargo credit facility, of which
      $6.2 million was drawn and $5.0 million remained available. As
      of
      March 31, 2007, we had $2.1 million drawn and $2.2 million of undrawn
      availability on this facility. Wells
      Fargo may declare the loan in default if we do not meet certain financial
      performance measures. At December 31, 2006, we were in compliance with all
      covenants as set for 2006. As of December 31, 2006 and for the year then ended,
      this credit facility bore interest at the rate of prime plus 5.0% (13.25 at
      December 31, 2006).





On
      April
      2, 2007, we and Wells Fargo executed an amendment to this credit facility
      agreement. This amendment extended the credit facility through May 2010 and
      set
      financial covenants for 2007, which are effective beginning March 31, 2007.
      Borrowings under this facility bear interest at prime plus 3.0%. Financial
      covenants for 2007 are as follows: (1) minimum net income (loss) on a year
      to
      date basis, calculated quarterly; (2) minimum net worth plus “subordinated debt”
(measured in the aggregate, with amounts advanced to SANZ Inc. et al from SANZ
      being defined as subordinated debt), calculated on a monthly basis; (3) minimum
      availability, calculated monthly; (4) capital expenditure limit, calculated
      on
      an annual basis; and (5) a minimum cash infusion from SANZ or an outside source
      if SANZ Inc. et al. generates a net loss in a given quarter and have generated
      a
      net loss on a year to date basis at that time, in an amount equal to the lesser
      of the quarterly net loss or the year to date net loss. On
      April
      13, 2007, we obtained a waiver of default from Wells Fargo waiving the event
      of
      default that would have resulted under the facility as a result of the “going
      concern” qualification on our independent registered public accounting firm’s
      report on our financial statements for the fiscal year ended December 31,
      2006.





Each
      Borrower maintains a separate borrowing base; however, total borrowings under
      the facility are limited to $12 million. Additionally, each Borrower is required
      to guaranty the other’s debt. Cash transfers from SANZ Inc. to Solunet Storage
      are limited to the funding of Solunet Storage’s operating expenses and to a
      minimum availability on the date of any such transfer.





Sun
      Loan and Sun Term Loan





On
      November 23, 2005, Harris
      assigned its credit facility (the “Harris 2004-2005 Facility”) with us to Sun
      Solunet, the Company’s majority shareholder. At this date, Sun Solunet purchased
      the outstanding principal balance of $11,999,965 plus accrued interest in the
      amount of $138,038, and the Company became obligated to Sun Solunet (said
      principal and accrued interest referred to as the “Sun Loan”). At December 31,
      2005, the Company had $13.1 million outstanding and due to Sun Solunet on the
      Sun Loan.





On
      February 6, 2006, the Sun Loan was amended in order to increase the borrowing
      availability from $13.0 million to $14.0 million. In addition to increasing
      our
      borrowing availability, this amendment changed the maturity date to December
      31,
      2006 and permitted accrual of interest to the principal amount of the loan
      until
      maturity.





Effective
      March 2, 2006, as part of the first closing of the 2006 private placement,
      Sun
      Solunet converted $8.0 million of the Sun Loan, and we paid down $1.0 million
      of
      the Sun Loan. On April 19, 2006, the Company and Sun Solunet executed an
      amendment to the Sun Loan agreement, which reduced the loan balance from $13.0
      million to $5.0 million and modified the loan from a revolving line of credit
      to
      a term loan (the “Sun Term Loan”) maturing on March 2, 2009. The parties agreed
      that Sun Solunet had no additional lending obligation to us under the credit
      facility. Also as part of the new agreement, we were no longer obligated to
      issue debt guaranty warrants to Sun Solunet. This amendment formalized the
      agreement with respect to the Sun Loan that had been previously made in the Credit
      Support Termination Agreement on March 2, 2006. The Sun Term Loan bears interest
      at prime plus 1.0% (9.25% at December 31, 2006) and all interest accrues and
      is
      payable on the maturity date. As of December 31, 2006, we had $5.0 million
      in
      principal and $680,000 of accrued interest due on the Sun Term
      Loan.




35




Harris
      2006 Facility





On
      October 27, 2006, we entered into the Harris 2006 Facility, which allowed for
      borrowings up to $1.5 million. Borrowings under the Harris 2006 Facility bear
      interest at prime (8.25% at December 31, 2006) and are payable upon demand
      by
      Harris. The purpose of obtaining this facility was to provide additional working
      capital to us and our subsidiaries. This credit facility is unsecured, is not
      limited by availability under a borrowing base, and does not require the
      maintenance of specified financial covenants. As a condition precedent to
      obtaining the Harris 2006 Facility, Sun Capital Partners II, LP, (“Sun Capital
      II”) an affiliate of Sun Solunet, entered into an ongoing guaranty of $1.5
      million of the debt incurred by us under this facility. Additionally, Sun
      Capital II agreed that, upon the written request of SANZ, it would provide
      SANZ
      with sufficient funds to repay the debt outstanding under the credit facility
      in
      the event that Harris required repayment of such debt or, at Sun Capital II’s
      election, pay the outstanding debt directly to Harris; provided that in no
      event
      would Sun Capital II’s obligation exceed the amount of Sun Capital II’s
      guaranty. This guaranty expires on December 31, 2007. As of December 31, 2006,
      we had principal borrowings outstanding under the Harris 2006 Facility of $1.5
      million.





On
      March
      13 and March 23, 2007, we increased our borrowing availability with Harris
      through amendments to the Harris 2006 Facility in the amounts of $1.5 million
      and $1.5 million, respectively. The $3 million of available borrowings under
      these amendments was for additional working capital, and was secured by cash
      collateral posted by Sun Capital II in a collateral account maintained by
      Harris. Total borrowings allowed under the Harris 2006 Facility, as amended,
      were $4.5 million, all of which were outstanding as of March 30, 2007.





Other
      Financing





In
      October 2005, SANZ Inc. executed a security agreement with Avnet, its largest
      supplier, granting a security interest in all of its assets. Pursuant to the
      security agreement, SANZ Inc’s indebtedness with Avnet is secured, except for
      $1,000,000. The security agreement specifies events of default, including but
      not limited to any failure by SANZ Inc. to maintain total cash and customer
      receivables (less indebtedness of SANZ Inc. to Wells Fargo) in an amount that
      is
      at least equal to the amount of outstanding trade accounts payable to Avnet,
      less $2,000,000. The security interest granted to Avnet is subordinate to the
      security interest granted to Wells Fargo by SANZ Inc. in connection with its
      principal borrowing facility with Wells Fargo and to evidence the subordination,
      Avnet and Wells Fargo entered into an intercreditor agreement. As of December
      31, 2006, we were in compliance with all of the provisions of the security
      agreement with Avnet.




**Capital
      Expenditures**





During
      the years ended December 31, 2006 and 2005, we purchased approximately $333,000
      and $318,000, respectively, of property and equipment for cash. For 2007, we
      anticipate spending between $300,000 and $400,000 on property and equipment.
      During 2006 and 2005 we also invested approximately $898,000 and $911,000,
      respectively, in capitalized software development costs. We expect to capitalize
      additional software development costs in 2007 of approximately $900,000. We
      expect to fund these capital expenditures from our
      Wells
      Fargo facility and our Harris 2006 facility.




36




**Contractual
      Obligations**





We
      are
      committed to make payments on certain long-term obligations and accrued
      liabilities. Our cash payments due under contractual obligations as of December
      31, 2006 were as follows:




Cash
                payment obligations(due by period)
              (In
                thousands)
            
            Less
                than 1 Year
            
            1
                -
                3 Years
            
            3
                -
                5 Years
            
            TotalLong-term
                debt obligations-
                related party (1)
            
            $
            -
            
            $
            6,442
            
            $
            -
            
            $
            6,442-
                outside investors (2)
            
            
            -
            
            
            372
            
            
            -
            
            
            372Line
                of credit obligations (3)
            
            
            7,703
            
            
            -
            
            
            -
            
            
            7,703Operating
                lease obligations
              (operating
                locations)
            
            
            718
            
            
            653
            
            
            -
            
            
            1,371Other
            
            
            27
            
            
            17
            
            
            -
            
            
            44$
            8,448
            
            $
            7,484
            
            $
            -
            
            $
            15,932





(1)
            The
                long-term debt obligations—related
                party were comprised of $5.7 million due to Sun Solunet under the
                three-year Sun Term Loan; $744,000 due to Sun Solunet and $18,000
                due to
                management as notes payable related to the liquidated damages of
                the
                registration rights agreement.





(2)
            The
                long-term debt obligations—outside investors consisted of $372,000 due to
                outside investors as notes payable related to the liquidated damages
                of
                the registration rights agreement.





(3)
            The
                line of credit obligations were comprised of $6.2 million due to
                Wells
                Fargo and $1.5 million due to Harris. Effective March 2007, the Wells
                Fargo credit facility was renewed and extended through May 2010.On
                March 13 and March 23, 2007 the Harris 2006 facility was amended to
                increase our borrowing availability in the amounts of $1.5 million
                and
                $1.5 million, respectively.The Harris 2006 facility is evidenced by a demand note and of the
                borrowings thereunder, $1.5 million is guaranteed by Sun Capital
                II and
                the remaining $3.0 million is secured by cash collateral posted by
                Sun
                Capital II in a collateral account maintained by
                Harris.





As
      previously disclosed in our periodic reports, Mr. Jenkins resigned as our Chief
      Executive Officer, President and Chairman on March 12, 2007. In connection
      therewith, Mr. Jenkins and SANZ entered into a separation and general release
      agreement (the “Separation Agreement”) dated March 12, 2007 and effective on May
      11, 2007 (the “Separation Date”). Pursuant to the Separation Agreement, Mr.
      Jenkins remains our employee (with the same base salary and benefits) until
      the
      Separation Date. Thereafter, subject to the satisfaction of certain conditions,
      Mr. Jenkins is entitled to 12 months of severance payments and benefits equal
      to
      his base salary and benefits that were in effect prior to his resignation.
      Our
      board of directors, including our compensation committee, also extended the
      vesting period of options to purchase 1,100,000 shares (275,000 of which were
      unvested) of our common stock at an exercise price of $0.40 per share issued
      under our 2003 Stock Option Plan until the Separation Date. Our board, including
      our compensation committee, also extended the exercise period on these options
      as well as options to purchase 500,000 shares of our common stock at an exercise
      price of $0.29 per share granted under our 2001 Stock Option Plan held by Mr.
      Jenkins that have vested as of the Separation Date to May 11, 2008.




**Off-Balance
      Sheet Arrangements**





We
      do not
      maintain any off-balance sheet arrangements that have, or that are reasonably
      likely to have, a material current or future effect on our financial condition,
      revenues or expenses, results of operations, liquidity, capital expenditures
      or
      capital resources.





37


**Results
      of Operations**




**Selected
      Consolidated Statements of Operations Data**





The
      following tables present Consolidated Statements of Operations data for the
      years ended December 31, 2006 and December 31, 2005 based on the percentage
      of
      revenue for each line item, as well as the dollar and percentage change of
      each
      of the items.





***Results
      of Operations for the Year Ended December 31, 2006***


***Compared
      to the Year Ended December 31, 2005***





(In
                thousands, except for percentages)
            
            **For
                the year ended December 31,**
            
            **$
                Change**
            
            **%
                Change****2006**
            
            %
                of rev
            
            **2005**
            
            %
                of rev
            
            **2005
                - 2006**
            
            **2005
                - 2006****Revenue**Product
                sales and vendor supplied services
            
            $
            45,530
            
            
            77.5
            %
            $
            44,446
            
            
            75.2
            %
            $
            1,084
            
            
            2.4
            %Consulting
                and engineering services
            
            
            6,450
            
            
            11.0
            
            
            5,612
            
            
            9.5
            
            
            838
            
            
            14.9Maintenance
                services and contract fees
            
            
            6,765
            
            
            11.5
            
            
            9,057
            
            
            15.3
            
            
            (2,292
            )
            
            (25.3
            )Total
                revenue
            
            
            **58,745**
            
            
            100.0
            
            
            **59,115**
            
            
            100.0
            
            
            **(370**
            **)**
            
            (0.6
            )**Gross
                Profit (% of respective revenue)**Product
                sales and vendor supplied services
            
            
            9,013
            
            
            19.8
            
            
            9,921
            
            
            22.3
            
            
            (908
            )
            
            (9.2
            )Consulting
                and engineering services
            
            
            2,566
            
            
            39.8
            
            
            2,117
            
            
            37.7
            
            
            449
            
            
            21.2Maintenance
                services and contract fees
            
            
            2,456
            
            
            36.3
            
            
            2,800
            
            
            30.9
            
            
            (344
            )
            
            (12.3
            )Total
                gross profit
            
            
            **14,035**
            
            
            23.9
            
            
            **14,838**
            
            
            25.1
            
            
            **(803**
            **)**
            
            (5.4
            )**Operating
                expenses**Selling,
                engineering,general
                and administrative
            
            
            17,532
            
            
            29.8
            
            
            15,822
            
            
            26.8
            
            
            1,710
            
            
            10.8Charge
                for goodwill impairment
            
            
            21,519
            
            
            36.6
            
            
            9,200
            
            
            15.6
            
            
            12,319
            
            
            133.9Charge
                for impairment of intangible asset
            
            
            800
            
            
            1.4
            
            
            -
            
            
            -
            
            
            800
            
            
            100.0Depreciation
                and amortization of intangibles
            
            
            783
            
            
            1.4
            
            
            1,099
            
            
            1.8
            
            
            (316
            )
            
            (28.8
            )Total
                operating expenses
            
            
            **40,634**
            
            
            69.2
            
            
            **26,121**
            
            
            44.2
            
            
            **14,513**
            
            
            55.6**Loss
                from operations**
            
            
            **(26,599**
            **)**
            
            (45.3
            )
            
            **(11,283**
            **)**
            
            (19.1
            )
            
            **(15,316**
            **)**
            
            135.7Other
                income (expense)Interest
                expense
            
            
            (1,474
            )
            
            (2.5
            )
            
            (1,610
            )
            
            (2.7
            )
            
            136
            
            
            (8.4
            )Charge
                for warrants issued to
              related
                party for debt guaranty
            
            
            -
            
            
            -
            
            
            (2,877
            )
            
            (4.9
            )
            
            2,877
            
            
            (100.0
            )Charge
                for change in estimated fair value ofderivative
                financial instruments - Warrants
            
            
            (374
            )
            
            (0.6
            )
            
            -
            
            
            -
            
            
            (374
            )
            
            100.0Charge
                for fair value of Warrants in
              excess
                of net cash proceeds
            
            
            (924
            )
            
            (1.6
            )
            
            -
            
            
            -
            
            
            (924
            )
            
            100.0Charge
                due to the agreement to reprice
              Warrants
            
            
            (2,314
            )
            
            (3.9
            )
            
            -
            
            
            -
            
            
            (2,314
            )
            
            100.0Liquidated
                damages payable under
              registration
                rights agreement
            
            
            (1,117
            )
            
            (1.9
            )
            
            -
            
            
            -
            
            
            (1,117
            )
            
            100.0Other
                income (expense)
            
            
            (110
            )
            
            (0.2
            )
            
            1
            
            
            0.0
            
            
            (111
            )
            
            (111.0
            )Loss
                before income taxes
            
            
            (32,912
            )
            
            (56.0
            )
            
            (15,769
            )
            
            (26.7
            )
            
            (17,143
            )
            
            108.7Income
                tax (expense) benefit
            
            
            (45
            )
            
            (0.1
            )
            
            (34
            )
            
            (0.0
            )
            
            (11
            )
            
            32.4**Net
                loss**
            
            **$**
            **(32,957**
            **)**
            
            (56.1
            )
            **$**
            **(15,803**
            **)**
            
            (26.7
            )
            **$**
            **(17,154**
            **)**
            
            108.5Deemed
                dividend related to beneficial
              conversion
                feature of convertible
              series
                Apreferred
                stock
            
            
            (4,539
            )
            
            (7.7
            )
            
            **-**
            
            
            -
            
            
            (4,539
            )
            
            100.0Common
                stock dividends accrued for
              holders
                ofconvertible
                seriesA
              preferred
                stock
            
            
            (340
            )
            
            (0.6
            )
            
            **-**
            
            
            -
            
            
            (340
            )
            
            100.0**Net
                loss available to common shareholders**
            
            **$**
            **(37,836**
            **)**
            
            (64.4
            )%
            **$**
            **(15,803**
            **)**
            
            (26.7
            )%
            **$**
            **(22,033**
            **)**
            
            139.4
            %





38





***Revenue*** .
      Revenue
      from hardware/software sales increased for 2006 as compared to 2005 by
      approximately 2%, primarily from an increase in revenue from our EarthWhere
      segment offset by a decrease in product sales in our Storage Solutions segment.
      It is important to note that a significant percentage (approximately 85% for
      both 2006 and 2005) of our total revenue continues to be project-based, and
      as
      such quarterly results may vary significantly.





Revenue
      from consulting and engineering services (“professional services”), which is
      also project-based, increased approximately 15% from 2005 to 2006, primarily
      from an increase in our Federal government Storage Solutions professional
      services. As a percentage of total revenue, revenue from professional services
      increased from 9.5% in 2005 to 11% in 2006. We continue to emphasize revenue
      growth from professional services as a means of achieving greater gross
      profit.





Revenue
      from maintenance services and maintenance contract fees (“first call”
maintenance services and the resale of vendor maintenance contracts) decreased
      by approximately 25% from 2005 to 2006, primarily due to product mix - a higher
      percentage of maintenance contract fees (which are reported net of cost of
      revenue) versus maintenance services in 2006 as compared to 2005. Gross
      maintenance billings increased slightly year on year.





***Gross
      Profit and Margin*** .
      Gross
      profit for 2006 decreased approximately 5.4% from 2005, or approximately
      $800,000. The decrease was primarily attributable to lower revenue and lower
      gross margins from product sales and vendor supplied services. Our total gross
      margin decreased from 25.1% in 2005
      to
      23.9% in 2006, a decrease which was due primarily to a combination of lower
      gross margins on Storage Solutions’ product sales partially offset by higher
      gross margins on maintenance revenue. Gross margins on maintenance revenue
      increased in 2006 compared to 2005 in part due to a higher percentage of sales
      of vendor maintenance contracts, as noted above, which are reported on a net
      revenue basis. As we are primarily a project-based business, gross margins
      fluctuate from project to project, and, depending on mix, may fluctuate from
      quarter to quarter.





***Operating
      Expenses*** . ****** Operating
      expenses are comprised of selling, marketing, engineering, general and
      administrative (“SG&A”) expenses, as well as depreciation and amortization
      expense. SG&A expenses increased approximately 11% from 2005 to 2006,
      primarily from the continued investment in expanding our EarthWhere
      segment. Higher
      engineering personnel costs in our Federal government business and
      under-utilization of these resources in the first half of the year also
      contributed to higher SG&A expenses in 2006. Our
      average headcount for 2006 was 131, of which 29 were in our EarthWhere segment,
      83 in our Storage Solutions segment, and 19 in G&A personnel. This compares
      to an average headcount for 2005 of 119, of which 21 were in our EarthWhere
      segment, 76 in our Storage Solutions segment and 22 in G&A. In addition, we
      recorded an employee severance charge of approximately $200,000 in June
      2006.





Share-Based
      Compensation Expense .
      On
      January 1, 2006, we adopted the provisions of Statement of Financial Accounting
      Standard No. 123 (revised) (“SFAS 123R”), “Share-Based Payment,” using the
      modified prospective method, which requires that compensation expense be
      recorded for all unvested stock options and restricted stock over the remaining
      award service period.





For
      2006,
      we recorded share-based compensation expense of $375,000, which is included
      in
      SG&A expense. The expense recorded during the year related to the current
      period compensation expense for stock options granted in the second quarter
      and
      for unvested stock options granted in prior years as calculated under the
      provisions of Statement of Financial Accounting Standard No. 123 (“SFAS 123”),
“Accounting for Stock-Based Compensation.” In accordance with SFAS 123R, we
      accounted for options granted in prior years using the fair value pricing model
      used at the grant date to calculate the pro-forma compensation expense required
      for disclosure under SFAS 123, adjusted to include a provision for estimated
      forfeitures. During 2006, we estimated forfeitures at 20% annually, based on
      historical trends related to employee turnover and the market price of the
      Company’s common stock. At December 31, 2006, we adjusted the share-based
      compensation expense for actual forfeitures that occurred as of that date.
      As
      our policy for 2007, we will continue to record expense based on estimated
      forfeitures, but will adjust for actual forfeitures at the end of the vesting
      period for each tranche of options. We consider revisions to our assumptions
      in
      estimating forfeitures on an ongoing basis. We used the Black-Scholes option
      pricing model, as we believe this model best reflects our historical option
      exercise patterns, with
      weighted average assumptions as disclosed in Note 5 of our consolidated
      financial statements included in Item 15 of this report.




39





As
      we are
      applying the modified prospective method of adoption, there was no share-based
      compensation expense recorded in 2005. As disclosed in Note 5 of our
      consolidated financial statements included in Item 15 of this report, had we
      applied the fair-value recognition provisions of SFAS 123 in 2005, we would
      have
      recorded $246,000 of share-based compensation expense in 2005. The
      total
      compensation cost related to nonvested options not yet recognized at December
      31, 2006 was $1.3 million and the weighted-average period over which this
      expense is expected to be recognized is approximately 3.3 years. The total
      fair
      value of options vested during 2006 was $365,000.





Depreciation
      and Amortization. Depreciation and amortization of intangibles for 2006 decreased as compared
      to
      2005, due in part to the completion of amortization of certain intangible assets
      acquired as part of the Solunet Storage acquisition in 2003, as well as the
      full
      depreciation in 2005 and 2006 of certain property and equipment acquired in
      2002
      and 2003.





***Charge
      for Goodwill and Intangible Asset Impairments*** .
      As
      previously discussed under this Item, in 2006, we recorded a $21.5 million
      charge for goodwill impairment for our Storage Solutions operating segment.
      In
      addition, we recorded impairment of $800,000 for a trade name in 2006. For
      2005,
      we recorded a $9.2 million charge for goodwill impairment for this operating
      segment





***Interest
      Expense*** .
      Interest expense for 2006 decreased approximately 8% as compared to 2005. The
      decrease is due to lower average borrowings in 2006, as a result of the
      conversion of $8 million of debt converted by Sun Solunet as part of the 2006
      private placement in 2006. The effect on interest expense due to the decrease
      in
      average borrowings was partially offset by higher interest rates, which
      increased on average by nearly 190 basis points in 2006 as compared to
      2005. Average debt outstanding for 2006 was $11.7 million as compared to
      $16.9 million for 2005.





***Charge
      for Change in Estimated Fair Value of Derivative Financial
      Instruments—Warrants*** .
      We
      estimate the fair value of derivative financial instruments at each reporting
      period, and the net change in the estimated fair value is recorded as a benefit
      (charge) to the statement of operations. On July 28, 2006 at our annual meeting
      of shareholders, shareholders approved an increase in our authorized capital,
      and we concluded that the criteria for equity classification of the 2006 private
      placement warrants were met as of that date. In accordance with US GAAP, we
      estimated the fair value of the 2006 private placement warrants at July 28,
      2006, recorded the net change in the estimated fair value of $943,000 as a
      benefit to the statement of operations in the third quarter of 2006, and
      reclassified the 2006 private placement warrants to stockholders’ equity. For
      2006, the charge for the change in estimated fair value of the 2006 private
      placement warrants totaled $374,000. See further discussion of the 2006 private
      placement warrants in Note 4 to our consolidated financial statements included
      in Item 15 of this report.





***Charge
      for Fair Value of 2006 Private Placement Warrants in Excess of
      Proceeds*** .
      We
      recorded the 2006 private placement warrants issued in the April and May 2006
      closings of the 2006 private placement at an initial fair value of approximately
      $2.6 million. Because the estimated fair value of the 2006 private placement
      warrants exceeded the net cash proceeds of $1.7 million, we recorded a charge
      in
      the statement of operations of $924,000 for the difference between the estimated
      fair value of the 2006 private placement warrants and the net cash proceeds
      raised. See further discussion of the 2006 private placement warrants in Note
      4
      to our consolidated financial statements included in Item 15 of this
      report.





***Liquidated
      Damages and Charge for the Agreement to Reprice the 2006 B
      Warrants*** .
      For
      2006, we recorded $1.1 million of liquidated damages in the form of unsecured,
      promissory notes to the investors in the 2006 private placement transaction.
      In
      addition to this amount, we have recorded accrued interest on the 2006 private
      placement promissory notes at the rate of 12% per annum from November 15 through
      December 31, 2006. Also, we recorded a non-cash charge of $2.3 million as a
      result of the agreement to reprice the 2006 B warrants on November 15, 2006.
      See
      Note 4 to our consolidated financial statements included in Item 15 of this
      report.




40




***Other
      Income (Expense)*** .
      During
      our September quarter of 2006, we reduced the recorded value of an investment
      in
      a private company based on an assessment and estimate of the investment’s
      current marketability at September 30, 2006. Accordingly, we recorded a charge
      in the amount of $100,000 related to this investment.





***Deemed
      Dividend Related to Beneficial Conversion Feature of Convertible Series A
      Preferred Stock*** .
      As part
      of the 2006 private placement, we issued convertible series A preferred stock,
      which contained a beneficial conversion feature, based on the difference between
      the closing price of the Company’s common stock and the effective conversion
      price of the convertible series A preferred stock on the Closing Dates of the
      transaction. The beneficial conversion feature for the March closing was
      measured at $4.5 million and was recorded as a deemed dividend to preferred
      stockholders in the March 2006 quarter. No deemed dividend was recorded for
      the
      April and May closings based on the $-0- ascribed to the series A preferred
      stock for those closings. The deemed dividend is included in the net loss
      available to common stockholders and the basic and diluted net loss per share
      calculation in 2006. See further discussion of the 2006 private placement in
      Note 4 to our consolidated financial statements included in Item 15 of this
      report.





***Common
      Stock Dividends Accrued for Holders of Convertible Series A Preferred
      Stock**.* The
      convertible series A preferred stock issued in the 2006 private placement
      carries a 3% cumulative dividend, payable in shares of the Company’s common
      stock. Dividends are required to be declared and authorized by the Company’s
      board of directors on each July 31 and January 31 anniversary, beginning on
      July
      31, 2006. For the year ended December 31, 2006, we recorded common stock
      dividends in the amount of approximately $340,000, which included 704,799 shares
      declared on July 31, 2006 and an additional amount for the period from August
      1
      to December 31, 2006. See further discussion of the 2006 private placement
      in
      Note 4 to our consolidated financial statements included in Item 15 of this
      report.





41




***Results
      of Operations for the Year Ended December 31, 2005***


***Compared
      to Results of Operations for the Year Ended December 31, 2004***





(In
                thousands, except for percentages)
            
            **For
                the year ended December 31,**
            
            **$
                Change**
            
            **%
                Change****2005**
            
            %
                of rev
            
            **2004**
            
            %
                of rev
            
            **2005-2004**
            
            **2005-2004****Revenue**Product
                sales and vendor supplied
              services
            
            $
            44,446
            
            
            75.2
            %
            $
            54,690
            
            
            82.7
            %
            $
            (10,244
            )
            
            (18.7
            )%Consulting
                and engineering services
            
            
            5,612
            
            
            9.5
            
            
            3,680
            
            
            5.5
            
            
            1,932
            
            
            52.5Maintenance
                services and contract
              fees
            
            
            9,057
            
            
            15.3
            
            
            7,788
            
            
            11.8
            
            
            1,269
            
            
            16.3Total
                Revenue
            
            
            **59,115**
            
            
            100.0
            
            
            **66,158**
            
            
            100.0
            
            
            **(7,043**
            **)**
            
            (10.6
            )**Gross
                Profit (% of respective**
              **revenue)**Product
                sales and vendor supplied
              services
            
            
            9,921
            
            
            22.3
            
            
            9,939
            
            
            18.2
            
            
            (18
            )
            
            (0.2
            )Consulting
                and engineering services
            
            
            2,117
            
            
            37.7
            
            
            1,549
            
            
            42.1
            
            
            568
            
            
            36.7Maintenance
                services and contract
              fees
            
            
            2,800
            
            
            30.9
            
            
            2,462
            
            
            31.6
            
            
            338
            
            
            13.7Total
                Gross Profit
            
            
            **14,838**
            
            
            25.1
            
            
            **13,950**
            
            
            21.1
            
            
            **888**
            
            
            6.4**Operating
                expenses**Selling,
                general and administrative
            
            
            15,822
            
            
            26.8
            
            
            14,893
            
            
            22.5
            
            
            929
            
            
            6.2Charge
                for goodwill impairment
            
            
            9,200
            
            
            15.6
            
            
            -
            
            
            0.0
            
            
            9,200
            
            
            100.0Severance
                and closed office expense
            
            
            -
            
            
            0.0
            
            
            1,226
            
            
            1.9
            
            
            (1,226
            )
            
            (100.0
            )Acquisition-related
                costs
            
            
            -
            
            
            0.0
            
            
            34
            
            
            0.0
            
            
            (34
            )
            
            (100.0
            )Depreciation
                and amortization ofintangibles
            
            
            1,099
            
            
            1.8
            
            
            1,306
            
            
            2.0
            
            
            (207
            )
            
            (15.8
            )Total
                operating expenses
            
            
            **26,121**
            
            
            44.2
            
            
            **17,459**
            
            
            26.4
            
            
            **8,662**
            
            
            49.6**Loss
                from operations**
            
            
            **(11,283**
            **)**
            
            (19.1
            )
            
            **(3,509**
            **)**
            
            (5.3
            )
            
            **(7,774**
            **)**
            
            221.5Other
                income (expense)Interest
                expense
            
            
            (1,610
            )
            
            (2.7
            )
            
            (1,221
            )
            
            (1.8
            )
            
            (389
            )
            
            31.9Charge
                for warrants issued to related partyfor
                debt guaranty
            
            
            (2,877
            )
            
            (4.9
            )
            
            (2,469
            )
            
            (3.7
            )
            
            (408
            )
            
            16.5Other
                income (expense)
            
            
            1
            
            
            0.0
            
            
            121
            
            
            0.1
            
            
            (120
            )
            
            (99.2
            )Loss
                before income taxes
            
            
            (15,769
            )
            
            (26.7
            )
            
            (7,078
            )
            
            (10.7
            )
            
            (8,691
            )
            
            122.8Income
                tax (expense) benefit
            
            
            (34
            )
            
            (0.0
            )
            
            328
            
            
            0.5
            
            
            (362
            )
            
            (110.4
            )**Net
                loss**
            
            **$**
            **(15,803**
            **)**
            
            (26.7
            )%
            **$**
            **(6,750**
            **)**
            
            (10.2
            )%
            **$**
            **(9,053**
            **)**
            
            134.1
            %




***Revenue*** .
      Revenue
      for the year ended December 31, 2005 decreased by approximately 11% from the
      prior year. For 2005, our sales of products (hardware and software) and vendor
      supplied services decreased by 19% from 2004, but revenue from professional
      services increased by 53% year on year, and as a percentage of total revenue,
      increased approximately 72%. The year on year decrease in hardware/software
      sales reflects market trends including the continued shift in product mix from
      tape to disk and continued downward trends on price per unit capacity.





The
      year
      on year improvement in professional services revenue is the result of the
      Company’s continued commitment to grow this generally higher margin sector of
      our business. Our year on year growth was heavily concentrated in Federal sector
      of our Storage Solutions segment and EarthWhere segment, which had increases
      of
      approximately 120% and 40%, respectively, versus an approximately 40% decrease
      in the Storage Solutions commercial sector for the same period. Revenue from
      maintenance services and maintenance contract fees increased by 16% from 2004
      to
      2005, and as a percentage of total revenue, increased approximately 30%.
      Individually, maintenance service revenue increased 14% and maintenance contract
      fees increased 21% from 2004 to 2005.




42




***Gross
      Profit and Margin*** .
      Gross
      profit for the year ended December 31, 2005 was up 6.4% or $888,000 compared
      to
      the prior year. The increase in gross profit from 2004 was attributable to
      a
      $2.4 million favorable variance from higher overall gross margin for 2005,
      offset by an unfavorable $1.5 million variance from lower revenue in 2005 versus
      2004.





Gross
      margin increased from 21.1% in 2004 to 25.1% in 2005. Gross margins on product
      sales and vendor supplied services were higher in 2005, primarily from a
      favorable product mix and certain high-margin large orders in 2005. Increased
      sales of EarthWhere software licenses ($926,000 in 2005 versus $316,000 in
      2004)
      also contributed to the improved gross margin in 2005. Gross margin on
      consulting and engineering services was lower in 2005, primarily due to the
      utilization of outside contractors on a significant Federal government Storage
      Solutions project. The maintenance revenue gross margins decreased slightly
      in
      2005 compared to 2004 due to changes in product mix.





***Operating
      Expenses*** . ****** Operating
      expenses comprise SG&A expenses, as well as depreciation, amortization and
      other non-cash expenses. For
      the
      year ended December 31, 2005, SG&A expense including severance and closed
      office accrued expenses decreased approximately 2% as compared to the prior
      year. This decrease is primarily a result of cost reductions made during the
      second half of 2004 in our Storage Solutions segment (three office closures
      and
      related employee reductions) and employee reductions during this same period
      in
      corporate general and administrative departments. These decreases were offset
      by
      increased spending during 2005 in expanding our EarthWhere segment and
      increasing our headcount in the consulting and engineering group in our Federal
      sector. Our
      average headcount for the year ended December 31, 2005 was 113, of which 21
      were
      in our EarthWhere segment and 73 were in our Storage Solutions segment. This
      compares to year-end average headcount at December 31, 2004, which was 107,
      of
      which 10 were in our EarthWhere segment and 76 were in our Storage Solutions
      segment.





Depreciation
      and amortization of intangibles for 2005 decreased as compared to 2004, due
      in
      part to the completion of amortization of certain intangible assets recorded
      as
      part of the Solunet Storage merger in 2003.





***Charge
      for Goodwill Impairment*** .
      As
      previously discussed under this Item, in 2005, we recorded a $9.2 million charge
      for goodwill impairment for our Storage Solutions operating
      segment.





***Interest
      Expense*** .
      Interest expense for 2005 increased approximately 32% as compared to 2004.
      The
      increase is due to higher average borrowings in 2005 as well as to higher
      interest rates, which increased on average by nearly 2 points in 2005
      compared to 2004. Average debt outstanding in 2005 was $16.9 million as compared
      to $16.2 million in 2004. The increased average debt outstanding was
      primarily the result of the continued investment in our EarthWhere segment. Interest
      expense in 2005 and 2004 included approximately $150,000 paid to an affiliate
      of
      Sun Solunet for loan guaranties issued on our behalf by Sun Capital
      II.





***Charge
      for Warrants Issued to Related Party for Debt Guaranty*** .
      In
      March, May, June and November 2005 and in consideration for the Harris debt
      guaranty provided by Sun Capital II, we were obligated to issue and issued
      to
      Sun Solunet four stock purchase warrants to purchase an aggregate of 12,351,199
      shares of our common stock, with an exercise price of $0.001 per share. These
      warrants were immediately exercisable upon issuance. Based on the number of
      shares issued pursuant to the warrants, we recorded non-cash charges which
      aggregated approximately $2,877,000, calculated as the number of shares issued
      multiplied by the closing market price of SANZ’ common stock as of the dates of
      issuance of the respective warrants.





43




**Item
      7A. Quantitative and Qualitative Disclosures about Market
      Risk**





We
      are
      exposed to market risk from changes in interest rates on our outstanding bank
      debt. At December 31, 2006, we had $12.7 million in variable, prime rate based
      bank debt. At December 31, 2006, the Sun Term Loan of $5.0 million bore
      interest at the rate of prime plus 1.0% (or 9.25%), the Harris 2006 Facility
      of
      $1.5 million (amended subsequent to December 31, 2006 to increase our
      borrowing availability to an aggregate of $4.5 million in March of 2007) bore
      interest at prime (or 8.25%) and our Wells Fargo line of credit of $6.2 million
      bore interest at the rate of prime plus 5.0% (or 13.25%). At December 31, 2006,
      a hypothetical 100 basis point increase in the prime rate would result in
      additional interest expense of $127,000 on an annualized basis, assuming
      estimated borrowing amounts of $5.0 million for the Sun Term Loan, $1.5 million
      for the Harris 2006 Facility and $6.2 million for Wells Fargo. Currently, we
      do
      not utilize interest rate swaps or other types of financial derivative
      instruments.




**Item
      8. Financial Statements and Supplementary Data**





The
      financial statements required pursuant to this item are included in Part IV
      of
      this report and
      begin on page F-1. The supplementary financial information required by this
      item
      is included in “Item 6. Selected
      Financial Data — Supplementary
      Data — Quarterly
      Financial Information (Unaudited).”




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





None.





**Item** **9A.
      Controls and Procedures**





*Disclosure
      Controls and Procedures.* We
      have
      adopted and maintain disclosure controls and procedures (as such term is defined
      in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
      as
      amended (the “Exchange Act”)) that are designed to ensure that information
      required to be disclosed in our reports under the Exchange Act, is recorded,
      processed, summarized and reported within the time periods required under the
      SEC’s rules and forms and that the information is gathered and communicated to
      our management, including our Chief Executive Officer and Chief Financial
      Officer, as appropriate, to allow for timely decisions regarding required
      disclosure.





As
      required by SEC Rule 13a-15(b), we carried out an evaluation under the
      supervision and with the participation of our management, including the Chief
      Executive Officer (Principal
      Executive Officer) and Chief Financial Officer ( Principal
      Financial Officer ) ,
      of the
      effectiveness of the design and operation of our disclosure controls and
      procedures pursuant to Exchange Act Rule 13a-14 as of the end of the period
      covered by this report. Based
      on
      the foregoing, our
      Chief Executive Officer and Chief Financial Officer have
      concluded that our
      disclosure controls and procedures are effective in timely alerting them to
      material information required to be included in our periodic SEC filings and
      to
      ensure that information required to be disclosed in our periodic SEC filings
      is
      accumulated and communicated to our management, including our Chief Executive
      Officer and Chief Financial Officer, to allow timely decisions regarding
      required disclosure.





*Internal
      Control Over Financial Reporting.* There
      was
      no change in our internal control over financial reporting that occurred during
      the fiscal quarter ended December 31, 2006 that has materially affected, or
      is
      reasonably likely to materially affect, our internal control over financial
      reporting.




**Item
      9B. Other Information**





None.





44





**PART
      III**





Information
      required by this Part III (Items 10, 11, 12, 13, and 14) is hereby
      incorporated by reference to the corresponding sections or subsections of our
      Definitive Proxy Statement for the 2007 Annual Shareholder Meeting (“2007 Proxy
      Statement”), which Definitive Proxy Statement shall be filed with the Securities
      and Exchange Commission within 120 days of the end of the fiscal year in which
      this Report relates.





**Item
      10. Directors, Executive Officers and Corporate Governance**





The
      information required by this Item 10 is incorporated by reference to the
      information in our 2007 Proxy Statement.





**Item
      11. Executive Compensation**





The
      information required by this Item 11 is incorporated by reference to the
      information in our 2007 Proxy Statement.





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





The
      information required by this Item 12 is incorporated by reference to the
      information in our 2007 Proxy Statement.





**Item
      13. Certain Relationships and Related Transactions, and Director
      Independence**





The
      information required by this Item 13 is incorporated by reference to the
      information in our 2007 Proxy Statement.





**Item
      14. Principal Accountant Fees and Services**





The
      information required by this Item 14 is incorporated by reference to the
      information in our 2007 Proxy Statement.





45




**Part
      IV**





**Item
      15.** **Exhibits
      and** **Financial Statement Schedules** ****





(a)
      The
      financial statements, financial statement schedules and
      exhibits listed below are filed as part of this Annual Report on Form
      10-K.





**(1)
      Financial Statements**





Report
                of Independent Registered Public Accounting Firm
            
            F-1Consolidated
                Balance Sheets, December 31, 2006 and December 31, 2005
            
            F-2Consolidated
                Statements of Operations for the Years ended December 31,
                2006,
              December
                31, 2005 and December 31, 2004
            
            F-3Consolidated
                Statements of Stockholders’ Equity (Deficit) for the Years ended December
                31, 2006,
              December
                31, 2005 and December 31, 2004
            
            F-5Consolidated
                Statements of Cash Flows for the Years ended December 31,
                2006,
              December
                31, 2005 and December 31, 2004
            
            F-6Notes
                to Consolidated Financial Statements
            
            F-8





**(2)
       Financial Statement Schedules**





Financial
      statement schedules are omitted because they are not required or are not
      applicable, or the required information is provided in our consolidated
      financial statements or notes thereto described in Item 15(a)(1) above.




46




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





The
      Board
      of Directors and Stockholders


SAN
      Holdings, Inc.





We
      have
      audited the accompanying consolidated balance sheets of SAN Holdings, Inc.
      and
      subsidiaries as of December 31, 2006 and 2005, and the related consolidated
      statements of operations, stockholders’ equity/ (deficit) and cash flows for
      each of the three years in the period ended December 31, 2006. 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. The Company is not required to
      have, nor were we engaged to perform an audit of its internal control over
      financial reporting. Our audit included consideration of internal control over
      financial reporting as a basis for designing audit procedures that are
      appropriate in the circumstances, but not for the purpose of expressing an
      opinion on the effectiveness of the Company’s internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, 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 consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of SAN Holdings, Inc. and
      subsidiaries as of December 31, 2006 and 2005, and the results of their
      operations and their cash flows for each of the three years in the period ended
      December 31, 2006, in conformity with accounting principles generally accepted
      in the United States of America.





As
      discussed in Note 3 to the consolidated financial statements, the Company
      adopted the Statement of Financial Accounting Standards No. 123(R), Share-Based
      Payment, on a modified prospective basis as of January 1, 2006.





The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 2, the
      Company has incurred a net loss of $32,957,000 during the year ended December
      31, 2006, and, as of that date, the Company has an accumulated deficit of
      $72,140,000, negative working capital of $7,072,000 and no cash on hand. These
      factors, among others, as discussed in Note 2 to the financial statements,
      raise
      substantial doubt about the Company’s ability to continue as a going concern.
      Management’s plans in regard to these matters are also described in Note 2. The
      consolidated financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.






/s/
      Grant
      Thornton LLP




Denver,
      Colorado


April
      16,
      2007




F-1


**SAN
      Holdings, Inc.**


**Consolidated
      Balance Sheets**


(In
      thousands, except share data)





December
                31,2006
            
            2005ASSETSCurrent
                assetsCash
                and cash equivalents
            
            $
            -
            
            $
            6Accounts
                receivable, net of allowance for doubtful accounts of$143
                and $168, respectively
            
            
            15,384
            
            
            11,832Inventories,
                net of valuation allowance of $6 and $29,respectively
            
            
            234
            
            
            176Deferred
                maintenance contracts
            
            
            1,865
            
            
            2,060Prepaid
                expenses and other current assets
            
            
            644
            
            
            676Total
                current assets
            
            
            18,127
            
            
            14,750Property
                and equipment, net
            
            
            472
            
            
            673Capitalized
                software, net
            
            
            1,394
            
            
            872Goodwill
            
            
            1,289
            
            
            22,808Intangible
                assets, net
            
            
            666
            
            
            1,736Other
                assets
            
            
            207
            
            
            378Total
                long-term assets
            
            
            4,028
            
            
            26,467TOTAL
                ASSETS
            
            $
            22,155
            
            $
            41,217LIABILITIES
                AND STOCKHOLDERS’ EQUITY (DEFICIT)Line
                of credit - Wells Fargo Bank, National Association
            
            $
            6,203
            
            $
            7,292Line
                of credit - Sun Solunet, LLC - related party
            
            
            -
            
            
            13,109Line
                of credit - Harris N.A.
            
            
            1,500
            
            
            -Accounts
                payable
            
            
            12,191
            
            
            8,610Accrued
                expenses
            
            
            2,438
            
            
            2,560Deferred
                revenue
            
            
            2,867
            
            
            2,805Total
                current liabilities
            
            
            25,199
            
            
            34,376Long-term
                debt - Sun Solunet, LLC - related party
            
            
            5,680
            
            
            -Long-term
                notes payable - related parties
            
            
            762
            
            
            -Long-term
                notes payable - outside investors
            
            
            372
            
            
            -Total
                liabilities
            
            
            32,013
            
            
            34,376Commitments
                and contingencies (Note 8)Stockholders’
                equity (deficit)Preferred
                stock; no par value; 10,000,000 shares authorized;
              Series
                A, 3% cumulative convertible preferred stock, 400 shares
              designated
                and 277.6 and -0- shares issued and outstanding,
              respectively,
                (liquidation preference of $13,055) (Note 4)
            
            
            9,078
            
            
            -Common
                stock; no par value, 400,000,000 shares authorized,
              95,811,278
                shares issued and outstanding
            
            
            32,917
            
            
            32,577Warrants
                and stock options
            
            
            20,287
            
            
            8,568Accumulated
                deficit
            
            
            (72,140
            )
            
            (34,304
            )Total
                stockholders’ equity (deficit)
            
            
            (9,858
            )
            
            6,841TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
            
            $
            22,155
            
            $
            41,217




The
      accompanying notes are an integral part of the consolidated financial
      statements.




F-2





**SAN
      Holdings, Inc.**


**Consolidated
      Statements of Operations**


(In
      thousands, except share and per share data)




Years
                Ended December 31,2006
            
            2005
            
            2004RevenueProduct
                sales and vendor supplied services
            
            $
            45,530
            
            $
            44,446
            
            $
            54,690Consulting
                and engineering services
            
            
            6,450
            
            
            5,612
            
            
            3,680Maintenance
                services and maintenance contract fees
            
            
            6,765
            
            
            9,057
            
            
            7,788Total
                revenue
            
            
            58,745
            
            
            59,115
            
            
            66,158Cost
                of revenueProduct
                sales and vendor supplied services
            
            
            36,517
            
            
            34,525
            
            
            44,751Consulting
                and engineering services
            
            
            3,884
            
            
            3,495
            
            
            2,131Maintenance
                services and maintenance contract fees
            
            
            4,309
            
            
            6,257
            
            
            5,326Total
                cost of revenue
            
            
            44,710
            
            
            44,277
            
            
            52,208Gross
                profit
            
            
            14,035
            
            
            14,838
            
            
            13,950Operating
                expensesSelling,
                engineering, general and administrative
            
            
            17,532
            
            
            15,822
            
            
            14,927Charge
                for goodwill impairment
            
            
            21,519
            
            
            9,200
            
            
            -Charge
                for impairment of intangible asset
            
            
            800
            
            
            -
            
            
            -Severance
                and closed office expense
            
            
            -
            
            
            -
            
            
            1,226Depreciation
                and amortization of intangibles
            
            
            783
            
            
            1,099
            
            
            1,306Total
                operating expenses
            
            
            40,634
            
            
            26,121
            
            
            17,459Loss
                from operations
            
            
            (26,599
            )
            
            (11,283
            )
            
            (3,509
            )Other
                income (expense)Interest
                expenseSun
                Solunet, LLC - related party
            
            
            (732
            )
            
            (259
            )
            
            (150
            )Bank
                and other
            
            
            (742
            )
            
            (1,351
            )
            
            (1,071
            )Total
                interest expense
            
            
            (1,474
            )
            
            (1,610
            )
            
            (1,221
            )Charge
                for warrants issued to related party for debt guaranty
            
            
            -
            
            
            (2,877
            )
            
            (2,469
            )Benefit
                (charge) for change in estimated fair value ofderivative
                financial instruments - Warrants (Note 4)-
                related parties
            
            
            (1,191
            )
            
            -
            
            
            --
                outside investors
            
            
            817
            
            
            -
            
            
            -Charge
                for fair value of Warrants in excess of net cashproceeds
                (Note 4)
            
            
            (924
            )
            
            -
            
            
            -Charge
                due to the agreement to reprice Warrants (Note 4)-
                related parties
            
            
            (1,489
            )
            
            -
            
            
            --
                outside investors
            
            
            (825
            )
            
            -
            
            
            -





The
      accompanying notes are an integral part of the consolidated financial
      statements.


F-3





**SAN
      Holdings, Inc.**


**Consolidated
      Statements of Operations**


(In
      thousands, except share and per share data)





Years
                Ended December 31,2006
            
            2005
            
            2004Liquidated
                damages payable under registrationrights
                agreement (Note 4)-
                related parties
            
            
            (751
            )
            
            -
            
            
            --
                outside investors
            
            
            (366
            )
            
            -
            
            
            -Other
                income (expense)
            
            
            (110
            )
            
            1
            
            
            121Loss
                before income taxes
            
            
            (32,912
            )
            
            (15,769
            )
            
            (7,078
            )Income
                tax (expense) benefit
            
            
            (45
            )
            
            (34
            )
            
            328Net
                loss
            
            $
            (32,957
            )
            $
            (15,803
            )
            $
            (6,750
            )Deemed
                dividend related to beneficial conversion feature ofconvertible
                Series A Preferred Stock (Note 4)
            
            
            (4,539
            )
            
            -
            
            
            -Common
                stock dividends accrued for holders of convertibleSeries
                A Preferred Stock (Note 4)
            
            
            (340
            )
            
            -
            
            
            -Net
                loss available to common shareholders
            
            $
            (37,836
            )
            $
            (15,803
            )
            $
            (6,750
            )Basic
                and diluted net loss per share
            
            $
            (0.33
            )
            $
            (0.15
            )
            $
            (0.08
            )Weighted
                average shares outstanding - basic and diluted
            
            
            116,175,389
            
            
            108,446,023
            
            
            86,254,827





The
      accompanying notes are an integral part of the consolidated financial
      statements.


F-4


**SAN
      Holdings, Inc.**


**Consolidated
      Statements of Stockholders’ Equity (Deficit)**


(In
      thousands, except share data)




Series
                A Preferred Stock
            
            Series
                B
              Preferred
                Stock
            
            Common
                Stock
            
            Warrants
                and
            
            Accumulated
            
            Total
                Stockholders’ EquityShares
            
            Amount
            
            Shares
            
            Amount
            
            Shares
            
            Amount
            
            options
            
            Deficit
            
            (Deficit)Balances,
                January 1, 2004
            
            
            -
            
            $
            -
            
            
            748.07306
            
            $
            12,718
            
            
            58,407,625
            
            $
            19,859
            
            $
            3,222
            
            $
            (11,751
            )
            $
            24,048Conversion
                of Series B preferred stock to common stock
            
            
            
            
            
            
            
            
            (748.07306
            )
            
            (12,718
            )
            
            37,403,653
            
            
            12,718
            
            
            
            
            
            
            
            
            -Charge
                for warrant issued to related party for debt guaranty
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,469
            
            
            
            
            
            2,469Net
                loss for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (6,750
            )
            
            (6,750
            )Balances,
                December 31, 2004
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            95,811,278
            
            
            32,577
            
            
            5,691
            
            
            (18,501
            )
            
            19,767Charge
                for warrants issued to related party for debt guaranty
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,877
            
            
            
            
            
            2,877Net
                loss for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (15,803
            )
            
            (15,803
            )Balances,
                December 31, 2005
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            95,811,278
            
            
            32,577
            
            
            8,568
            
            
            (34,304
            )
            
            6,841Beneficial
                conversion feature of convertible Series A Preferred Stock
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (4,539
            )
            
            (4,539
            )Reclassification
                of Series A Preferred Stock from temporary equity to permanent
                equity
            
            
            277.6
            
            
            9,078
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,078Reclassification
                of Warrants from liabilities to permanent equity
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,030
            
            
            
            
            
            9,030Repricing
                of Warrants
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,314
            
            
            
            
            
            2,314Share-based
                compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            375
            
            
            
            
            
            375Common
                stock dividends accrued for holders of convertible Series A Preferred
                Stock (Note 4)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            340
            
            
            
            
            
            (340
            )
            
            -Net
                loss for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (32,957
            )
            
            (32,957
            )Balances,
                December 31, 2006
            
            
            277.6
            
            $
            9,078
            
            
            -
            
            $
            -
            
            
            95,811,278
            
            $
            32,917
            
            $
            20,287
            
            $
            (72,140
            )
            $
            (9,858
            )





The
      accompanying notes are an integral part of the consolidated financial
      statements.




F-5


**SAN
      HOLDINGS, INC.**


**Consolidated
      Statements of Cash Flows**


(In
      thousands)





Years
                Ended December 31,2006
            
            2005
            
            2004Cash
                flows from operating activities:Net
                loss
            
            $
            (32,957
            )
            $
            (15,803
            )
            $
            (6,750
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Charge
                for goodwill impairment
            
            
            21,519
            
            
            9,200
            
            
            —Charge
                for impairment of intangible asset
            
            
            800
            
            
            -
            
            
            -Depreciation
                and amortization
            
            
            1,200
            
            
            1,233
            
            
            1,406Write-off
                of capitalized software development costs
            
            
            -
            
            
            99
            
            
            -Loss
                on disposal of property and equipment
            
            
            13
            
            
            1
            
            
            113Share-based
                compensation
            
            
            375
            
            
            -
            
            
            -Charge
                for warrant issued to related party for debt guaranty
            
            
            -
            
            
            2,877
            
            
            2,469Charge
                for change in estimated fair value of derivative financialinstruments
                - Warrants - related parties (Note 4)
            
            
            1,191
            
            
            -
            
            
            -Benefit
                for change in estimated fair value of derivative financialinstruments
                - Warrants - outside investors (Note 4)
            
            
            (817
            )
            
            -
            
            
            -Charge
                for fair value of Warrants in excess of net cash proceeds (Note
                4)
            
            
            924
            
            
            -
            
            
            -Charge
                due to agreement to reprice Warrants (Note 4)-
                related parties
            
            
            1,489
            
            
            -
            
            
            --
                outside investors
            
            
            825
            
            
            -
            
            
            -Charge
                for liquidated damages payable under registration rightsagreement-
                related parties
            
            
            751
            
            
            -
            
            
            --
                outside investors
            
            
            366
            
            
            -
            
            
            -Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (3,552
            )
            
            1,265
            
            
            2,115Inventories
            
            
            (58
            )
            
            310
            
            
            608Deferred
                maintenance contracts
            
            
            195
            
            
            854
            
            
            (285
            )Prepaid
                expenses and other current assets
            
            
            32
            
            
            (164
            )
            
            624Other
                assets
            
            
            138
            
            
            6
            
            
            (265
            )Accounts
                payable
            
            
            3,581
            
            
            (3,843
            )
            
            (692
            )Accrued
                expenses
            
            
            466
            
            
            (91
            )
            
            (150
            )Deferred
                revenue
            
            
            62
            
            
            (1,137
            )
            
            (80
            )Net
                cash used in operating activities
            
            
            (3,457
            )
            
            (5,193
            )
            
            (887
            )Cash
                flows from investing activities:Purchase
                of property and equipment, net
            
            
            (333
            )
            
            (318
            )
            
            (372
            )Capitalized
                software costs
            
            
            (898
            )
            
            (911
            )
            
            (53
            )Net
                cash used in investing activities
            
            
            (1,231
            )
            
            (1,229
            )
            
            (425
            )Cash
                flows from financing activities:Issuance
                of convertible Series A Preferred Stock, net of issuance costs
            
            
            4,271
            
            
            -
            
            
            -Net
                borrowings (payments) on line of credit -Wells
                Fargo Bank National Association
            
            
            (1,089
            )
            
            533
            
            
            (1,494
            )Net
                borrowings on line of credit - Sun Solunet, LLC - related
                party
            
            
            -
            
            
            967
            
            
            -Net
                borrowings (payments) on line of credit - Harris N.A.
            
            
            1,500
            
            
            4,442
            
            
            (500
            )Net
                cash provided by (used in) financing activities
            
            
            4,682
            
            
            5,942
            
            
            (1,994
            )





The
      accompanying notes are an integral part of the consolidated financial
      statements.


F-6


**SAN
      HOLDINGS, INC.**


**Consolidated
      Statements of Cash Flows**


(In
      thousands)





Years
                Ended December 31,2006
            
            2005
            
            2004Net
                decrease in cash and cash equivalents
            
            
            (6
            )
            
            (480
            )
            
            (3,306
            )Cash
                and cash equivalents at beginning of year
            
            
            6
            
            
            486
            
            
            3,792Cash
                and cash equivalents at end of year
            
            $
            -
            
            $
            6
            
            $
            486Supplemental
                disclosure of other cash flow information:Interest
                paid
            
            $
            862
            
            $
            1,578
            
            $
            1,193Taxes
                paid
            
            
            45
            
            
            34
            
            
            -Supplemental
                disclosure of non-cash investing and financing activities:Conversion
                of Sun Solunet, LLC debt to convertible Series A PreferredStock
            
            $
            8,000
            
            $
            -
            
            $
            -Allocation
                of proceeds from Series A Preferred Stock to Warrantsissued
                to:-related parties
            
            
            4,465
            
            
            -
            
            
            --
                outside investors
            
            
            4,191
            
            
            -
            
            
            -Deemed
                dividend related to beneficial conversion feature ofconvertible
                Series A Preferred Stock (Note 4)
            
            
            4,539
            
            
            -
            
            
            -Common
                stock dividends accrued for holders of convertibleSeries
                A Preferred Stock (Note 4)
            
            
            340
            
            
            -
            
            
            -Transfer
                of inventory to property and equipment
            
            
            -
            
            
            20
            
            
            352Assignment
                of Harris N.A. line of credit to Sun Solunet, LLC
            
            
            -
            
            
            12,142
            
            
            -





The
      accompanying notes are an integral part of the consolidated financial
      statements.


F-7




**SAN
      Holdings, Inc.**




Notes
      to
      Consolidated Financial Statements




**NOTE
      1 - BASIS OF PRESENTATION**





SAN
      Holdings, Inc. (“SANZ,” the “Company,” or “we”), a Colorado corporation, was
      formed on July 1, 1983. SANZ includes the accounts of its wholly-owned
      subsidiary, SANZ Inc. (formerly known as Storage Area Networks, Inc.) and the
      wholly-owned subsidiary of SANZ Inc., Solunet Storage, Inc. (“Solunet Storage”).
      The Company operates as two business segments: (1) a data storage systems
      integrator and (2) a data management software and services provider.





Effective
      April 1, 2003, SANZ completed a business combination with Solunet Storage
      Holding Corp. (“Solunet Storage Holding”), which was majority-owned by Sun
      Solunet, LLC (“Sun Solunet”), an affiliate of a private equity fund. Upon the
      completion of the business combination, Sun Solunet became the majority
      stockholder of SANZ. The
      business combination was accounted for as a reverse acquisition, with Solunet
      Storage Holding treated as the acquirer for accounting purposes. As a result,
      for all periods prior to April 1, 2003, the financial statements of Solunet
      Storage Holding have been adopted as SANZ’ historical financial statements. In
      March 2005, Solunet Storage Holding was merged into Solunet Storage, with
      Solunet Storage being the surviving entity.





**NOTE
      2 - FINANCIAL CONDITION**





The
      accompanying consolidated financial statements have been prepared in conformity
      with United States generally accepted accounting principles (“US GAAP”) and
      contemplate our continuation as a going concern, and do not include any
      adjustments relating to the recoverability and classification of recorded asset
      amounts or amounts and classification of liabilities that might be necessary
      if
      we were unable to continue as a going concern.. However, we have incurred
      substantial losses from operations since inception and have incurred a net
      loss
      of $33.0 million for the year ended December 31, 2006, which included non-cash
      charges of $22.3 million for goodwill and intangible asset impairments. In
      addition, as of December 31, 2006, we have negative working capital (current
      liabilities in excess of current assets) of $7.1 million, an accumulated deficit
      of $72.1 million and a stockholders’ deficit of $9.9 million. Accordingly, the
      recoverability of a major portion of the recorded asset amounts as of December
      31, 2006, including goodwill, is dependent on our continuing operations, which
      in turn is dependent on our ability to maintain our current financing
      arrangements and our ability to become profitable in our future operations.
      These factors raise substantial doubt about the Company’s ability to continue as
      a going concern.





We
      continue to attempt to improve our liquidity through improving our operating
      results and exploring debt and equity capital opportunities. Key
      operating performance improvement levers continue to include sustaining or
      moderately increasing existing revenue levels, achieving higher revenue gross
      margins from increased services revenue and EarthWhere software license sales,
      and maintaining operating expenses as a percentage of gross profit at the same
      or lower percentage. Assuming continuation of our current credit facilities
      with Wells
      Fargo Bank, National Association (“Wells Fargo”) and Harris
      N.A. (“Harris”) ,
      current
      business trends and supplier relations, we believe that our liquidity sources
      are adequate to fund our operations for at least the next twelve months,
      assuming that we operate at current gross profit levels and that Sun
      Capital Partners II, LP (“Sun Capital II”), an affiliate of our majority
      shareholder, Sun Solunet, continues to provide us with liquidity as
      they have done historically. However, there can be no assurance that we will
      operate at sufficient gross profit levels or that Sun Capital II will continue
      to provide us with liquidity, in which case it would be necessary to further
      cut
      costs, raise additional debt or equity capital, or sell assets.





As
      of
      December 31, 2006, the Company had $5.0 million of undrawn availability on
      its
      borrowing facility with Wells Fargo and as of March 31, 2007, the Company had
      $2.1 million drawn and $2.2 million of undrawn availability on this
      facility. Our ability to borrow under the Wells Fargo facility is subject to
      maintaining our accounts receivable balance at current levels, as well as
      complying with the financial covenants we have made to the lender. If we are
      unable to comply with our financial covenants to Wells Fargo, the facility
      could
      cease to be available to us. On April 2, 2007, the Company and Wells Fargo
      executed an amendment to the current facility, which extended its duration
      through May 2010. On April 13, 2007, we obtained a waiver of default from Wells
      Fargo waiving the event of default that would have resulted under the facility
      as a result of the “going concern” qualification on our independent registered
      public accounting firm’s report on our financial statements for the fiscal year
      ended December 31, 2006.


F-8





At
      December 31, 2006, the Company also held a $5.0 million three-year term loan
      (“Sun Term Loan”) with its majority shareholder, Sun Solunet, that is payable in
      full in March
      2009.





At
      December 31, 2006, the Company had $1.5 million of borrowings outstanding on
      a
      $1.5 million revolving credit facility (the “Harris 2006 Facility”) with Harris.
      Borrowings under the Harris 2006 Facility bear interest at prime and are payable
      upon demand by Harris. The purpose of obtaining this facility was to provide
      additional working capital to the Company and its subsidiaries. On March 13
      and
      March 23, 2007 the Company increased its borrowing availability with Harris
      through amendments to the Harris 2006 Facility in the amounts of $1.5 million
      and $1.5 million, respectively.





See
      further discussion of these borrowing arrangements in Note 6.





**NOTE
      3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





**Principles
      of Consolidation**





The
      consolidated financial statements include the accounts of the Company and its
      wholly-owned subsidiaries. All significant intercompany transactions and
      balances have been eliminated in consolidation.





**Cash
      and Cash Equivalents**





Cash
      equivalents are short-term highly liquid investments that are both readily
      convertible to cash and have original maturities of three months or less at
      the
      date of purchase.





**Accounts
      Receivable and Concentration of Credit Risk**





The
      Company is subject to credit risk from accounts receivable with its customers.
      The Company’s accounts receivable are due from both governmental and commercial
      entities. Credit is extended based on evaluation of the customers’ financial
      condition and, generally, collateral is not required. Accounts receivable are
      generally due within 30 to 60 days and are stated at amounts due from customers
      net of an allowance for doubtful accounts. Accounts outstanding longer than
      the
      contractual payment terms are considered past due.





The
      Company determines its allowance for doubtful accounts by considering a number
      of factors, including the length of time trade accounts receivable are past
      due,
      the Company’s previous loss history, the customer’s current ability to pay its
      obligation to the Company and economic and industry conditions. The Company
      writes off accounts receivable when they become uncollectible. Credit losses
      have consistently been within management’s expectations. The following table
      summarizes information related to our allowance for doubtful accounts (in
      thousands):





2006
            
            2005
            
            2004Balance
                at beginning of year
            
            $
            (168
            )
            $
            (140
            )
            $
            (336
            )Bad
                debt (expense) credit
            
            
            (23
            )
            
            52
            
            
            82Write-offs
                (recoveries)
            
            
            48
            
            
            (80
            )
            
            114Balance
                at end of year
            
            $
            (143
            )
            $
            (168
            )
            $
            (140
            )




F-9





**Inventories**





Inventories
      are comprised of hardware and software supplied by original equipment
      manufacturers and are stated at the lower of cost or market. Cost is determined
      by the first-in, first-out method. The following table summarizes information
      related to our inventory reserves (in thousands):





2006
            
            2005
            
            2004Balance
                at beginning of year
            
            $
            (29
            )
            $
            (137
            )
            $
            (707
            )Inventory
                write-downs
            
            
            -
            
            
            (89
            )
            
            (68
            )Inventory
                write-offs
            
            
            23
            
            
            197
            
            
            638Balance
                at end of year
            
            $
            (6
            )
            $
            (29
            )
            $
            (137
            )




**Deferred
      Maintenance Contracts**





Consistent
      with the Company’s revenue recognition policy for resale of certain maintenance
      agreements acquired from hardware and software vendors where the Company
      performs a portion of the maintenance services, the Company defers the costs
      of
      maintenance contracts at the inception of the maintenance period. All such
      costs
      are amortized on a straight-line basis over the contractual terms of the
      maintenance agreements. See further discussion in Note 3 - Revenue
      Recognition.





**Property
      and Equipment**





Property
      and equipment are recorded at cost. Depreciation is computed using the
      straight-line method over the estimated useful lives of the respective
      depreciable assets, which range from three to seven years. Leasehold
      improvements are amortized on a straight-line basis over the lesser of the
      useful life of the asset or the life of the lease. Maintenance and repairs
      are
      expensed as incurred and improvements are capitalized.





Property
      and equipment consist of the following:




December
                31(In
                  thousands)
            
            2006
            
            2005Computer
                equipment and software
            
            $
            1,520
            
            $
            1,708Office
                equipment and furniture
            
            
            141
            
            
            95Leasehold
                improvements
            
            
            75
            
            
            24Less:
                accumulated depreciation
            
            
            (1,264
            )
            
            (1,154
            )$
            472
            
            $
            673





Depreciation
      expense for the years ended December 31, 2006, 2005 and 2004 was $480,000,
      $630,000, and $620,000, respectively.





**Software
      Development Costs**





The
      Company expenses the costs of developing computer software to be sold, leased
      or
      otherwise marketed until technological feasibility is established and
      capitalizes all costs incurred from that time until the software is available
      for general customer release or ready for its intended use, at which time
      amortization of the capitalized costs begins. Technological feasibility for
      the
      Company's computer software products is based upon the earlier of the
      achievement of: (a) a detailed program design free of high-risk development
      issues; or (b) completion of a working model. Costs of major enhancements
      to existing products are capitalized while routine maintenance of existing
      products is charged to expense as incurred. The ongoing assessment of the
      recoverability of capitalized computer software development costs requires
      considerable judgment by management with respect to certain external factors,
      including, but not limited to, technological feasibility, anticipated future
      gross revenue, estimated economic life and changes in software and hardware
      technology. The Company also contracts with third parties to develop or test
      software that will be sold to customers and generally capitalizes these
      third-party costs.


F-10





For
      the
      years ended December 31, 2006, 2005, and 2004, the Company capitalized software
      development costs of $898,000, $911,000 and $53,000, respectively. Additionally,
      the Company expensed research and development costs (“R&D”) related thereto
      of $62,000, $219,000 and $536,000 for the aforementioned years, respectively.





Capitalized
      software costs are amortized on a product-by-product basis over their expected
      useful life, which is generally three years. The annual amortization related
      to
      software to be sold is the greater of the amount computed using (a) the
      ratio that current gross revenue for a product compares to the total of current
      and anticipated future gross revenue for that product or (b) the
      straight-line method over the remaining estimated economic life of the product.
      Amortization expense related to capitalized software costs totaled $376,000,
      $134,000 and $100,000, for the years ended December 31, 2006, 2005 and 2004,
      respectively, and is included in “Cost of revenue—product sales” in the
      consolidated statements of operations.




December
                31(In
                  thousands)
            
            2006
            
            2005Capitalized
                software costs
            
            $
            1,862
            
            $
            964Less:
                accumulated amortization
            
            
            (468
            )
            
            (92
            )$
            1,394
            
            $
            872




**Goodwill**





Goodwill
      represents the excess of the purchase price over the fair value of identifiable
      tangible and intangible net assets relating to business acquisitions. The
      Company accounts for goodwill and intangible assets in accordance with Statement
      of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”
(“SFAS 142”). SFAS 142 requires that goodwill be tested for impairment at least
      annually.





The
      Company reviews the carrying value of goodwill annually and uses the last date
      of its fiscal year (December 31) as the measurement date. Under certain
      circumstances, SFAS 142 requires an assessment of goodwill impairment more
      frequently. The performance of the impairment test involves a two-step process.
      The first step (“Step I test”) of the impairment test involves comparing the
      fair value of the Company’s reporting unit with the reporting unit’s carrying
      amount, including goodwill. If the carrying amount of the reporting unit exceeds
      its fair value, the second step (“Step II test”) is performed to determine the
      amount of the impairment loss. The impairment loss is determined by comparing
      the implied fair value of our goodwill with the carrying amount of that
      goodwill. We believe that our estimates of fair value are reasonable. Changes
      in
      estimates of such fair value, however, could affect the calculation.





In
      2005,
      the Company began segment reporting, and, at that time, determined that, as
      defined under SFAS 142, it had two reporting units - Storage Solutions and
      EarthWhere. Accordingly, we allocated our recorded goodwill to both of these
      reporting units based on the percentage of gross profit generated by each
      reporting unit for the year ended December 31, 2004, the most recent year prior
      to our commencement of segment reporting. We believed that this was the most
      appropriate financial measure for allocation purposes based on the different
      stages of the reporting units’ businesses. This resulted in approximately 4% or
      $1.3 million of the total goodwill asset allocated to our EarthWhere reporting
      unit.





As
      of
      December 31, 2006 and 2005, the Company reviewed goodwill associated with both
      of its reporting units for impairment, and, as part of its assessment, engaged
      an independent valuation firm (“independent firm”). The independent firm
      performed its valuation using primarily discounted cash flow and comparable
      public company analyses. For both 2006 and 2005, the result of the Step I test
      for our Storage Solutions reporting unit was that the carrying amount of this
      reporting unit exceeded its fair value. Because of the impairment determined
      under the Step I test, we were required to complete the Step II test, which
      involved a valuation of this reporting unit’s assets and liabilities, including
      intangibles. Based on the Step II analysis, as of December 31, 2006 and 2005,
      we
      recorded impairment charges for goodwill related to our Storage Solutions
      reporting unit in the amount of $21.5 million and $9.2 million, respectively.
      For 2006, based on the independent firm’s valuation as well as management’s
      assessment of the current operating performance of the Storage Solutions
      reporting unit, the Company concluded that the entire Storage Solutions
      reporting unit’s goodwill asset was fully impaired, and wrote off the remaining
      balance in 2006.


F-11





As
      of
      December 31, 2006 and 2005, we concluded that the recorded goodwill for our
      EarthWhere reporting unit was not impaired.





The
      Company does not expect that any of its recorded goodwill will be deductible
      for
      federal income tax purposes. The change in the Company’s goodwill assets for
      2005 and 2006 was as follows:




(In
              thousands)
            
            Solutions
            
            EarthWhere
            
            TotalJanuary
                1, 2005
            
            $
            30,719
            
            $
            1,289
            
            $
            32,008Impairment
                charge
            
            
            (9,200
            )
            
            -
            
            
            (9,200
            )December
                31, 2005
            
            
            21,519
            
            
            1,289
            
            
            22,808Impairment
                charge
            
            
            (21,519
            )
            
            -
            
            
            (21,519
            )December
                31, 2006
            
            $
            -
            
            $
            1,289
            
            $
            1,289




**Intangible
      Assets**





Intangible
      assets include trade names, customer lists and software technologies, which
      were
      initially valued by independent appraisers and recorded as part of business
      acquisitions. The Company has identified all intangible assets with definite
      lives and subject to amortization as in the tables below.





As
      a
      result of the impairment of goodwill, the Company first reviewed intangible
      assets in accordance with SFAS No. 144. This evaluation resulted in the
      determination that the undiscounted cash flows associated with the trade names
      would not be sufficient to recover the carrying amounts at December 31, 2006.
      As
      a result, the Company recorded a charge in the amount of $800,000 for the
      impairment of the SANZ commercial trade name. This asset is carried on the
      Company’s Storage Solutions reporting unit.





Gross
                  intangible assets
                (In
                  thousands)
            
            Trade
                names
            
            Customer
                Lists
            
            Software
                Technologies
            
            Patents
                and Trademarks
            
            TotalDecember
                31, 2004
            
            $
            2,799
            
            $
            893
            
            $
            200
            
            $
            -
            
            $
            3,892Additions
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -December
                31, 2005
            
            
            2,799
            
            
            893
            
            
            200
            
            
            -
            
            
            3,892Additions
            
            
            -
            
            
            -
            
            
            -
            
            
            34
            
            
            34Write-off
                of fullyamortized
                assets
            
            
            (499
            )
            
            (802
            )
            
            (200
            )
            
            -
            
            
            (1,501
            )Impairment
                charge
            
            
            (800
            )
            
            -
            
            
            -
            
            
            -
            
            
            (800
            )December
                31, 2006
            
            $
            1,500
            
            $
            91
            
            $
            -
            
            $
            34
            
            $
            1,625




F-12





(In
              thousands)
            
            December
                31, 2006Asset
                (Estimated Life)
            
            Intangible
                Assets, Gross
            
            Accumulated
                Amortization
            
            Intangible
                Assets, NetTrade
                names (2.5 to 10 years)
            
            $
            1,500
            
            $
            (863
            )
            $
            637Customer
                lists (3 to 5 years)
            
            
            91
            
            
            (77
            )
            
            14Patents
                and trademarks (3 years)
            
            
            34
            
            
            (19
            )
            
            15$
            1,625
            
            $
            (959
            )
            $
            666







(In
              thousands)
            
            December
                31, 2005Asset
                (Estimated Life)
            
            Intangible
                Assets, Gross
            
            Accumulated
                Amortization
            
            Intangible
                Assets, NetTrade
                names (2.5 to 10 years)
            
            $
            2,799
            
            $
            (1,132
            )
            $
            1,667Customer
                lists (3 to 5 years)
            
            
            893
            
            
            (841
            )
            
            52Software
                technologies (3 years)
            
            
            200
            
            
            (183
            )
            
            17$
            3,892
            
            $
            (2,156
            )
            $
            1,736





Amortization
      expense for intangible assets subject to amortization for the years ended
      December 31, 2006, 2005, and 2004 was $303,000, $470,000 and $615,000,
      respectively. Estimated aggregate amortization expense for intangible assets
      subject to amortization for each of the five succeeding fiscal years is as
      follows:





(In
                thousands)2007
            
            $
            1312008
            
            
            1022009
            
            
            1022010
            
            
            1022011
            
            
            102Thereafter
            
            
            127$
            666





**Long-Lived
      Assets**





The
      Company evaluates the carrying value of long-lived assets, including
      identifiable intangible assets with a finite useful life, whenever events or
      changes in circumstances indicate the carrying amount may not be fully
      recoverable. If that analysis indicates that an impairment has occurred, the
      Company measures the impairment based on a comparison of discounted cash flows
      or fair values, whichever is more readily determinable, to the carrying value
      of
      the related asset.





**Fair
      Value of Financial Instruments and Derivative Financial
      Instruments**





The
      Company’s financial instruments consist principally of accounts receivable,
      accounts payable and debt borrowings. The Company believes that all of its
      current financial instruments’ carrying values approximate fair value because of
      their short-term nature. Additionally, the carrying value of the Sun Term Loan
      is deemed to approximate fair value because of its variable interest rate.





During
      2006, the accounting for and valuation of preferred stock, warrants, derivative
      financial instruments and other potential derivatives, which relate to the
      issuance of the Company’s Series A Preferred Stock and Warrants (as defined in
      Note 4 below) issued in the Private Placement (as defined in Note 4 below),
      became an additional significant accounting policy for the Company. As further
      described in Note 4, the Company evaluates its equity instruments as potential
      derivative financial instruments in accordance with Statement of Financial
      Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative
      Instruments and Hedging Activities,” Emerging Issues Task Force (“EITF”)
      No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and
      Potentially Settled in, a Company’s Own Stock,” EITF 05-4, “The Effect of a
      Liquidated Damages Clause on a Freestanding Financial Instrument Subject to
      Issue No. 00-19,” EITF Topic D-98, “Classification and Measurement of Redeemable
      Securities,” EITF 98-5, “Accounting for Convertible Securities with Beneficial
      Conversion Features or Contingently Adjustable Conversion Ratios,” EITF 00-27,
“Application of Issue No. 98-5 to Certain Convertible Instruments,” and the SEC
      Staff comments in its “Current Accounting and Disclosure Issues,” dated December
      1, 2005.


F-13





**Revenue
      Recognition**





The
      Company recognizes revenue from the design, installation and support of data
      storage solutions, which may include hardware, software and services. The
      Company’s revenue recognition policies are based on the guidance in Staff
      Accounting Bulletin No. 104, “Revenue Recognition,” (“SAB 104”) in conjunction
      with Emerging Issues Task Force (“EITF”) Issue Number 00-21, “Revenue
      Arrangements with Multiple Deliverables” (“EITF 00-21”), the American Institute
      of Certified Public Accountants’(“AICPA”) Statement of Position (“SOP”) 97-2,
“Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP
      97-2, Software Revenue Recognition, with Respect to Certain Transactions,” EITF
      03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software
      Deliverables in an Arrangement Containing More-Than-Incidental Software,” and
      EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.”





The
      Company recognizes revenue when:





·
            persuasive
                evidence of an arrangement exists,


·
            delivery
                has occurred or services have been rendered,


·
            the
                sales price is fixed or determinable, and


·
            collectibility
                of the resulting accounts receivable is reasonably assured.





The
      Company’s revenue is derived from two segments—Storage Solutions and
      EarthWhere—and from four sources:





(1)
            the
                resale of computer hardware, software and related vendor supplied
                services;


(2)
            the
                sale of the Company’s proprietary software product,
                EarthWhere;


(3)
            professional
                services, including installation, assessment, and on-site consulting;
                and


(4)
            the
                sale of maintenance and technical support agreements on data storage
                devices and software.





Storage
      Solutions Product Sales (Hardware/Software)





Revenue
      from the resale of data storage systems is recognized upon either (i) the
      shipment of goods for freight-on-board (“FOB”) origin shipments or (ii) the
      delivery of goods to the customer for FOB destination shipments, provided that
      no significant uncertainties regarding customer acceptance exist, and depending
      on the terms of the contract and applicable commercial law.





Our
      Storage Solutions arrangements may include multiple elements, including the
      resale of third-party computer hardware, software, maintenance support, and
      professional services (e.g., assessment, training and installation).
      Arrangements generally fall into one of the following scenarios:





(a)
            The
                software and maintenance elements are more than incidental to the
                product
                as a whole, and essential to the functionality of the hardware. In
                this
                type of an arrangement, and in accordance with EITF 03-5, the hardware
                is
                considered software-related, and we account for the entire arrangement
                -
                hardware, software and related maintenance support - in accordance
                with
                SOP 97-2. Since these arrangements involve the resale of third-party
                elements, we have published price lists from our vendors for these
                products and services, and accordingly, we establish vendor specific
                objective evidence (“VSOE”) of fair value for these elements from these
                price lists.


F-14





(b)
            The
                software and maintenance are incidental to the product as a whole.





(c)
            The
                resale of hardware contains no software. Multiple elements in these
                arrangements may include the sale of professional services (i.e.
                installation) and maintenance contracts on the hardware
                elements.





In
      accordance with EITF 03-5, when the hardware is a non-software element and
      any
      software or software-related elements are not more than incidental to the
      product as a whole as described in clauses (b) and (c) above, the arrangements
      do not fall under the scope of SOP 97-2, and are accounted for in accordance
      with SAB 104 and EITF 00-21.





For
      arrangements that include the resale and installation of third-party data
      storage systems (i.e., stand-alone hardware or hardware with incidental software
      and maintenance, as described in clauses (b) and (c) above) denominated as
      a
      single, lump-sum price, we allocate the aggregate transaction revenue among
      the
      multiple elements based on their relative fair values in accordance with EITF
      00-21. We determine relative fair value for each revenue element based on
      published price lists from our vendors for these products and/or services.





When
      some
      elements are delivered prior to others in a multiple element arrangement,
      revenue for the delivered elements is separately recognized, provided all of
      the
      following criteria are met:





·
            the
                delivered item has value to the customer on a stand-alone
                basis,


·
            there
                is objective and reliable evidence of the fair value of the undelivered
                item(s), and


·
            delivery
                or performance of the undelivered item(s) is considered probable
                and
                substantially in
                the control of the vendor.





Undelivered
      revenue elements typically include installation, training, and other
      professional services.





The
      amount of revenue allocated to delivered items is limited to the amount that
      is
      not contingent upon the delivery of additional items or meeting other specified
      performance conditions. For undelivered services revenue, we use a residual
      method of allocating revenue, and defer revenue for the estimated fair value
      of
      the undelivered services. The Company estimates the fair value of the
      undelivered services based on separate service offerings with customers. For
      undelivered elements other than services, we allocate revenue to the separate
      elements based on their relative fair values.





EarthWhere
      License Fees





The
      Company recognizes revenue on EarthWhere license fees in accordance with SOP
      97-2, as amended by SOP 98-9.





For
      EarthWhere license agreements that do not require significant modifications or
      customization of the software, the Company recognizes software license revenue
      when persuasive evidence of an agreement exists, delivery of the product has
      occurred, the license fee is fixed or determinable and collection is probable.
      Consulting and maintenance services are billed separately from the license.
      Acceptance provisions included in a software license agreement generally grant
      customers a right of refund or replacement only if the licensed software does
      not perform in accordance with its published specifications. Based on the
      Company’s history, the likelihood of non-acceptance in these situations is
      remote, and the Company recognizes revenue when all other criteria of revenue
      recognition are met. If the likelihood of non-acceptance is determined to be
      other than remote, revenue is recognized upon the earlier of receipt of written
      acceptance or when the acceptance period has lapsed.





The
      company’s software license agreements may include multiple products and
      services, including maintenance, and we determine the fair value of and
      recognize revenue from the various elements of the arrangements in accordance
      with SOP 97-2 and 98-9. We establish VSOE of fair value for our EarthWhere
      software licenses through our price list which is published with the General
      Services Administration (“GSA Price List”) for sale to Federal government
      customers. Typically, we sell our EarthWhere licenses along with a maintenance
      agreement; however, if we sell a license separately, without maintenance, it
      is
      sold at the same price according to the GSA Price List. In cases where we can
      establish VSOE only for the undelivered elements in an arrangement (i.e.
      maintenance), we apply the residual method to recognize revenue for the
      delivered elements in accordance with SOP 98-9.


F-15





Professional
      Services





Revenue
      from professional services, excluding maintenance services, and which include
      installation, assessment, training and resident services, is recognized as
      the
      related services are completed.





Maintenance
      Services





The
      Company provides “first call” technical support for certain third-party hardware
      and software products that we sell. Additionally, on our EarthWhere product,
      we
      provided maintenance services and post-contract customer support along with
      unspecified upgrades and enhancements. Revenue from maintenance contracts is
      recognized on a straight-line basis over the contractual term of the contracts.
      Likewise, we defer the costs of third-party maintenance contracts and amortize
      them on a straight-line basis over their contractual terms.




Maintenance
      Contract fees





For
      third-party products for which we do not perform first call maintenance, we
      often resell the vendor’s maintenance contract for a fee. On these arrangements,
      we recognize revenue at the inception of the contract, net of the cost of the
      contract in accordance with EITF 99-19.





Shipping
      and Handling Costs





Shipping
      and handling costs are included in cost of revenue.




**Advertising
      Costs**





Advertising
      costs are expensed as incurred. Advertising expense was $293,000, $266,000
      and
      $607,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
      Reimbursements of advertising expense from product vendors are treated as
      reductions to advertising expense.





**Use
      of Estimates**




The
      Company has prepared these consolidated financial statements in conformity
      with
      US GAAP, which require the use of management’s estimates and assumptions that
      affect the reported amounts of assets and liabilities, the disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenue and expenses during the reporting period. The
      Company periodically evaluates estimates and assumptions related to revenue
      recognition, allowances for credit losses on accounts receivable, allowances
      for
      impairment in the value of inventory, the useful lives of intangible assets
      and
      software development costs and related impairment tests, and litigation and
      other loss contingencies. Some of these estimates, judgments and assumptions
      relate to expected outcomes or uncertainties of specified events. Others relate
      to the anticipated dollar amounts arising out of events that are reasonably
      certain to occur. Accordingly, actual results could differ from those estimates.




**Loss
      Per Share**





Basic
      earnings (loss) per share is based on the weighted average number of common
      shares outstanding. In addition to common shares outstanding and common stock
      dividends declared on July 31, 2006, and in accordance with Statement of
      Financial Accounting Standard No. 128, “Earnings per Share” (“SFAS 128”), any
      shares issuable for little or no cash consideration are considered outstanding
      shares and included in the calculation of weighted average number of common
      shares. Accordingly, for 2006, 2005 and 2004, the weighted average number of
      common shares outstanding included 20.1 million, 12.6 million and 1.0 million
      shares, respectively, issuable under outstanding debt guaranty warrants that
      were immediately exercisable at $0.001 per share, and held by our majority
      shareholder, Sun Solunet.


F-16





Diluted
      earnings (loss) per share is computed using the weighted average number of
      common shares outstanding plus the number of common shares that would be issued
      assuming exercise or conversion of all potentially dilutive common shares.
      Convertible Series A Preferred Stock, warrants and options outstanding to
      purchase an aggregate of 203.5 million, 27.2 million and 33.5 million shares
      of
      common stock have been excluded from the diluted share calculations for 2006,
      2005 and 2004, respectively, as they were antidilutive as a result of the net
      losses incurred for those periods. Accordingly, basic shares equal diluted
      shares for all periods presented.





**Share-Based
      Compensation**





In
      December 2004, the FASB issued Statement of Financial Accounting Standard No.
      123 (revised) (“SFAS 123R”), “Share-Based Payment,” which provides guidance on
      share-based payment transactions and requires fair value accounting for all
      share-based compensation. SFAS 123R requires the Company to measure the cost
      of
      employee services received in exchange for an award of equity instruments based
      on the grant date fair value of the award (with limited exceptions). That cost
      is recognized over the period during which an employee is required to provide
      service in exchange for the award, usually the vesting period.





On
      January 1, 2006, the Company adopted the provisions of SFAS 123R using the
      modified prospective method, which requires that compensation expense be
      recorded for all unvested stock options and restricted stock over the remaining
      award service period. See further discussion and disclosures in Note
      5.




**Recent
      Accounting Pronouncements**





In
      February 2006, the FASB issued Statement of Financial Accounting Standard No.
      155 (“SFAS 155”), “Accounting for Certain Hybrid Financial Instruments—An
      Amendment of FASB Statements No. 133 and 140,” to simplify and make more
      consistent the accounting for certain financial instruments. Specifically,
      SFAS
      155 amends SFAS 133 to permit fair value remeasurement for any hybrid financial
      instrument with an embedded derivative that otherwise would require bifurcation,
      provided that the whole instrument is accounted for on a fair value basis.
      Prior
      to fair value measurement, however, interests in securitized financial assets
      must be evaluated to identify interests containing embedded derivatives
      requiring bifurcation. The amendments to SFAS 133 also clarify that
      interest-only and principal-only strips are not subject to the requirements
      of
      SFAS 133, and that concentrations of credit risk in the form of subordination
      are not embedded derivatives. Finally, SFAS 155 amends Statement of Financial
      Accounting Standards No. 140, “Accounting for the Impairment or Disposal of
      Long-lived Assets,” to allow a qualifying special-purpose entity (SPE) to hold a
      derivative financial instrument that pertains to a beneficial interest other
      than another derivative financial instrument. SFAS 155 applies to all financial
      instruments acquired or issued after the beginning of an entity’s first fiscal
      year that begins after September 15, 2006, with earlier application allowed.
      The
      adoption of this accounting pronouncement did not have a material impact on
      our
      consolidated financial statements.





In
      June
      2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
      Income Taxes—an interpretation of FASB Statement No. 109, ‘Accounting for Income
      Taxes’” (“FIN 48”), which clarifies the accounting for uncertainty in income
      taxes recognized in a company’s financial statements. FIN 48 prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. The Interpretation gives guidance regarding the recognition of
      a tax
      position based on a “more likely than not” recognition threshold; that is,
      evaluating whether the position is more likely than not of being sustained
      upon
      examination by the appropriate taxing authorities, based on the technical merits
      of the position. FIN 48 also provides guidance on de-recognition,
      classification, interest and penalties, accounting in interim periods and
      disclosure. The provisions of FIN 48 are effective for fiscal years beginning
      after December 15, 2006 with the cumulative effect of the change in accounting
      principle recorded as an adjustment to opening retained earnings. The Company
      believes that the adoption of this pronouncement will not have a material impact
      on its consolidated financial statements.





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive
      guidance on the SEC’s views regarding the process of quantifying materiality of
      financial statement misstatements. SAB 108 is effective for fiscal years ending
      after November 15, 2006, with early application for the first interim period
      ending after November 15, 2006. The adoption of this accounting pronouncement
      did not have a material impact on our consolidated financial
      statements.


F-17





In
      September 2006, the FASB issued Statement of Financial Accounting Standard
      No.
      157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value,
      establishes a framework for measuring fair value in generally accepted
      accounting principles, and expands disclosures about fair value measurements.
      The Company will be required to adopt SFAS 157 effective for the fiscal year
      beginning January 1, 2008. Management is currently evaluating the potential
      impact of adopting SFAS 157 on the Company’s financial statements.





In
      June
      2006, the FASB ratified EITF Issue No. 06-3 “How Taxes Collected from
      Customers and Remitted to Governmental Authorities Should Be Presented in the
      Income Statement (That Is, Gross Versus Net Presentation)” (“EITF 06-3”). The
      scope of EITF 06-3 includes any tax assessed by a governmental authority that
      is
      directly imposed on a revenue-producing activity between a seller and a customer
      and may include, but is not limited to, sales, use, value added, and some excise
      taxes. EITF 06-3 also concluded that the presentation of taxes within its scope
      on either a gross (included in revenues and costs) or net (excluded from
      revenues) basis is an accounting policy decision subject to appropriate
      disclosure. The Company currently presents all taxes on a net basis and has
      elected not to change its presentation method. EITF 06-3 is effective for
      interim and annual reporting periods beginning after December 15, 2006,
      with earlier application permitted.





The
      Company has considered all other recently issued accounting pronouncements
      and
      does not believe that the adoption of such pronouncements will have a material
      impact on its consolidated financial statements.





**NOTE
      4 - PRIVATE PLACEMENT**





On
      March
      2, 2006, April 18, 2006 and May 4, 2006 (the “Closing Dates”), the Company
      completed three closings of a private placement transaction exempt from
      registration under the Securities Act of 1933, as amended (the “1933 Act”)
      pursuant to Section 4(2) of the 1933 Act and Regulation D promulgated thereunder
      (the “Private Placement”), dated and effective as of February 28, 2006, April
      18, 2006 and May 4, 2006, respectively, with third-party investors, Company
      executive management (collectively, the “Purchasers”) and Sun Solunet, its
      majority shareholder. In consideration for net proceeds of approximately $12.3
      million, comprised of $4.3 million of cash, net of placement agent and
      legal fees of approximately $784,000, and the conversion of $8.0 million of
      $14.0 million in debt owed by the Company under its credit facility with Sun
      Solunet (the “Sun Loan”), as assignee of Harris, the Company issued a total of
      277.6 units (“Units”), each Unit consisting of:





(a)
            one
                share of the Company’s newly designated convertible series A preferred
                stock, no par value per share (“Series A Preferred Stock”) initially
                convertible into 333,333 shares of the Company’s common stock at an
                exercise price of $0.15 per share, no par value per share;





(b)
            a
                warrant to purchase 166,667 shares of common stock exercisable for
                five
                years from the Closing Date at an initial exercise price of $0.30
                per
                share (the “A Warrants”);





(c)
            a
                warrant to purchase 166,667 shares of common stock exercisable for
                five
                years from the Closing Date at an initial exercise price of $0.50
                per
                share (the “B Warrants”) (together with the warrants described in clause
                (b) above, the “Warrants”).





The
      Company used the cash proceeds from the Private Placement for general working
      capital needs and funding its operating loss for 2006.





In
      connection with the Units issued by the Company on the Closing Dates in the
      Private Placement, and as part of the consideration paid by the Company to
      the
      placement agent, the Company issued to the placement agent a warrant to purchase
      approximately 1,685,000 shares of its common stock at an exercise price of
      $0.15
      per share, on substantially the same terms as the Warrants.


F-18





Also
      on
      March 2, 2006, the Company paid down approximately $1.0 million of the
      outstanding debt owed under the Sun Loan, resulting in total outstanding debt
      owed by the Company under the Sun Loan of $5.0 million plus accrued interest
      of
      $296,000 from November 23, 2005, the inception of the Sun Loan. As a result
      thereof, on March 2, 2006, the Company and Sun Capital II, an affiliate of
      Sun Solunet, entered into a termination letter (the “Credit Support Termination
      Agreement”) to the letter agreement, dated as of March 31, 2003, as amended on
      November 23, 2005, by and between Sun Capital II and the Company, acknowledged
      and agreed to by Sun Solunet (the “Credit Support Agreement”). The Credit
      Support Termination Agreement included the following provisions, among
      others:





(a)
            The
                Company and Sun Solunet agreed to decrease the Company’s borrowing
                availability under the Sun Loan from $14.0 million to $5.0 million
                and to
                modify the Sun Loan from a revolving line of credit to a three-year
                term
                loan without a demand note stipulation (the “Sun Term Loan”), which will
                be due in March 2009.





(b)
            The
                parties agreed that Sun Solunet and Sun Capital II have no additional
                lending obligation to the Company.





(c)
            The
                parties terminated the Credit Support Agreement and the obligations
                of all
                parties, including the requirement of the Company to issue additional
                debt
                guaranty warrants to Sun Solunet.





On
      April
      19, 2006, the Company and Sun Solunet executed an amendment to the Sun Loan
      agreement, which formalized the agreement with respect to the Sun Loan that
      had
      been previously made in the Credit Support Termination Agreement on March 2,
      2006.





Pursuant
      to the Private Placement, Sun Solunet agreed in a letter to third-party
      investors to the following:





·
            To
                cause each of the directors of the Company who is employed by or
                who is an
                officer of Sun Solunet (the “Sun Directors”) to, as soon as reasonably
                practicable after the Company files its Annual Report on Form 10-K
                for the
                fiscal year ended December 31, 2005, take steps reasonably necessary
                to
                call a shareholder meeting to vote on the measures described below;





·
            To
                vote all of its shares of the Company’s common stock, no par value,
                entitled to vote at the shareholder meeting in favor of a reverse
                stock
                split of the Company’s common stock on whatever basis is determined by the
                board of directors of the Company and an increase in the Company’s
                authorized capital in an amount determined by the board of directors,
                to
                increase the authorized capital of the Company in an amount sufficient
                to
                provide for the issuance of all of the shares of the Company’s common
                stock that is issuable upon exercise of the Warrants and conversion
                of the
                Series A Preferred Stock;




·
            To
                cause the Sun Directors to take steps reasonably necessary to cause
                certain governance changes to the Company, including but not limited
                to
                (i) reducing the size of the board of directors of the Company to
                a number
                equal to or less than 9 directors; (ii) increasing the size of the
                Audit
                Committee to include at least three members that must all be independent
                (but permitting an additional member that is not independent); (iii)
                to
                require that future decisions relating to the compensation of the
                executive officers of the Company be recommended to the board of
                directors
                for determination by either a majority of the independent directors
                of the
                Company, or a compensation committee comprised solely of independent
                directors.




Sun
      Solunet’s obligations under the letter terminate on the earliest to occur of (a)
      a written agreement of at least 66% of Purchasers other than Sun Solunet, (b)
      the five year anniversary of the letter, (c) the date on which the Purchasers
      other than Sun Solunet collectively own less than 25% of the securities they
      purchased on the Closing Date and (d) the date on which the Sun Directors no
      longer constitute a majority of the directors of the Company.





At
      our
      annual meeting of shareholders held on July 28, 2006 (the “Annual Meeting”) our
      shareholders voted and approved the following proposals:





·
            An
                increase in the authorized capital of the Company from 200,000,000
                to
                400,000,000 shares. An amendment to our Articles of Incorporation
                implementing this increase was filed and became effective on July
                31,
                2006.


F-19




·
            A
                reverse stock split of the outstanding common stock within the range
                of 1
                for 10 shares and 1 for 25 shares, to be determined by the board
                of
                directors. As of the date of this filing, the board of directors
                has not
                authorized a reverse stock split.




**Preferred
      Stock**





Also
      in
      connection with the Private Placement, the Company designated 400 shares of
      previously undesignated authorized preferred stock as a new series of Series
      A
      Preferred Stock. On March 2, 2006, the Company filed Articles of Amendment
      that
      included the Designation of Series A Preferred Stock (the “Certificate”) with
      the Secretary of State of the State of Colorado. Upon filing, the Certificate
      became a part of the Company’s Articles of Incorporation, as amended. The
      Certificate sets forth the voting powers, designation, conversion rights,
      preferences, limitations, restrictions and relative rights of the Series A
      Preferred Stock and the holders thereof.





The
      Series A Preferred Stock has limited voting rights, including those required
      by
      Colorado law and in circumstances in which the Company proposes to: (a) alter
      or
      change the designations, powers, preferences or rights, or the qualifications,
      limitations or restrictions of the Series A Preferred Stock; (b) authorize,
      create or issue any class or series of capital stock (or securities convertible
      into or exchangeable for such capital stock) ranking senior to or pari passu
      with the Series A Preferred Stock; (c) pay dividends on capital stock ranking
      junior to the Series A Preferred Stock to the extent that all accrued but unpaid
      dividends have not been paid or are not contemporaneously paid to the holders
      of
      the Series A Preferred Stock; (d) take other actions, including but not limited
      to amending the Company’s charter documents that would adversely affect the
      holders of the Series A Preferred Stock; or (e) reclassify shares of the
      Company’s capital stock that is junior to the Series A Preferred Stock that
      would adversely affect the holders of Series A Preferred Stock or that would
      rank senior to or pari passu with the Series A Preferred Stock.





The
      Series A Preferred Stock is perpetual and carries a 3% cumulative dividend,
      payable in shares of the Company’s common stock based on the market price of the
      Company’s common stock calculated as set forth in the Certificate. Dividends are
      required to be declared and authorized by the Company’s board of directors on
      each July 31 and January 31 anniversary, beginning on July 31, 2006. As of
      July
      31, 2006, the Company declared a common stock dividend payable in 704,799 shares
      of the Company’s common stock. For the year ended December 31, 2006, the Company
      recorded common stock dividends in the amount of approximately $340,000, which
      included the 704,799 shares declared on July 31, 2006 and an additional amount
      for the period from August 1 to December 31, 2006. As of January 31, 2007,
      the
      Company had accumulated and declared, but not issued, an additional 1.2 million
      shares related to this dividend.





The
      Series A Preferred Stock does not have a mandatory redemption feature, and
      because there is no redemption feature that is not solely within the Company’s
      control, in accordance with EITF Topic D-98, we determined that the Series
      A
      Preferred Stock was more akin to equity than debt. However, based on the
      beneficial conversion feature, as described below, and in accordance with EITF
      00-27, we determined that the Series A Preferred Stock should be classified
      as
      temporary equity because, at the time of its issuance, the Company did not
      have
      sufficient authorized shares of its common stock, and therefore the Series
      A
      Preferred Stock did not meet all of the requirements for equity classification
      under EITF 00-19. Based on the increase of our authorized shares at our Annual
      Meeting on July 28, 2006, we concluded that the criteria for equity
      classification of the Series A Preferred Stock as stipulated in EITF 00-19
      (sufficient authorized shares in order to net-share or physically settle all
      issued and outstanding convertible preferred stock, warrants and other
      commitments) was met as of that date. Accordingly, effective July 28, 2006,
      the
      Series A Preferred Stock was reclassified from temporary to permanent
      equity.




**Beneficial
      Conversion Feature**





Each
      share of the Series A Preferred Stock is initially convertible into 333,333
      shares of the Company’s common stock, and the conversion ratio with respect to
      the securities issued in the Private Placement is based on a common stock price
      of $0.15 per share, which was less than the closing common stock price on each
      of the Closing Dates. We considered this conversion feature to be a potential
      “embedded” derivative and the preferred stock to be a “host contract” as defined
      in SFAS 133, but concluded that the economic characteristics and risks of the
      conversion feature are clearly and closely related to the economic
      characteristics and risks of the Series A Preferred Stock, and that the
      conversion feature should not be separated from the Series A Preferred Stock
      (host contract) and should not be accounted for as a derivative instrument
      pursuant to SFAS 133. We accounted for the conversion feature in accordance
      with
      EITF 98-5, “Accounting for Convertible Securities With Beneficial Conversion
      Features or Contingently Adjustable Conversion Features” and EITF 00-27,
“Application of Issue No. 98-5 to Certain Convertible Instruments.”


F-20


For
      the
      March 2, 2006 closing of the Private Placement (the “March Closing”), we
      calculated the conversion feature in the amount of approximately $10.0 million,
      but under EITF 00-27, this amount was limited to the net proceeds of the March
      Closing allocated to the Series A Preferred Stock of $4.5 million as calculated
      below. Accordingly, we recorded the conversion feature as a deemed dividend
      to
      preferred stockholders in the amount of $4.5 million.





Similarly,
      for the April and May closings of the Private Placement (the “April and May
      Closings”), we calculated the conversion feature in the amount of approximately
      $3.1 million, but under EITF 00-27, this amount was limited to the net cash
      proceeds of the April and May Closings allocated to the Series A Preferred
      Stock
      of $-0- as calculated below. Because we did not allocate any of the net cash
      proceeds to the Series A Preferred Stock, we did not record a deemed dividend
      to
      preferred stockholders in the second quarter of 2006.





**Warrants**





The
      Warrants issued in the Private Placement (which include Warrants issued to
      Sun
      Solunet, LLC, outside investors, management and the placement agent) require
      physical settlement or net-share settlement. We evaluated the Warrants as a
      potential derivative under the criteria in paragraph 11(a) of SFAS 133, which
      require that a contract (Warrants) issued by a reporting entity be accounted
      for
      as a derivative unless it is both (1) indexed to its own stock and (2)
      classified in stockholders’ equity in its statement of financial position. We
      concluded that the Warrants were indexed to the Company’s own stock, but should
      not be classified in stockholders’ equity because they do not comply with all of
      the requirements as stipulated in EITF 00-19. Accordingly, we determined that
      the Warrants should be classified as a liability and accounted for as a
      derivative financial instrument at estimated fair value in accordance with
      SFAS
      133, and this derivative liability was revalued at fair value at each reporting
      period until it was reclassified to equity on July 28, 2006.





As
      of the
      March Closing, we recorded the Warrants issued in the March Closing at an
      initial fair value of approximately $6.0 million. The balance of the net
      proceeds of $4.5 million ($10.5 million total net proceeds raised in the March
      Closing less the $6.0 million fair value of the Warrants issued in the March
      Closing) was allocated to the Series A Preferred Stock.





As
      of the
      April and May Closings, we recorded the Warrants at an initial fair value of
      approximately $2.6 million. Because the estimated fair value of the Warrants
      exceeded the net cash proceeds of $1.7 million raised in the April and May
      Closings, we recorded a charge in the statement of operations of $924,000 for
      the difference between the estimated fair value of the Warrants and the net
      cash
      proceeds raised. As a result, no value was allocated to the Series A Preferred
      Stock.





Based
      on
      the increase of our authorized shares at our Annual Meeting on July 28, 2006,
      we
      concluded that one of the criteria for equity classification of the Warrants
      as
      stipulated in EITF 00-19 (sufficient authorized shares in order to net-share
      or
      physically settle all issued and outstanding Warrants and other commitments)
      was
      met as of that date. In addition, we further considered another requirement
      for
      equity classification of the Warrants under EITF 00-19 regarding liquidated
      damages related to the registration rights agreement associated with the
      Warrants. We considered EITF 05-4, from which we adopted “View C” of the three
      alternative views with regard to the registration rights agreement, which
      stipulates that, “the registration rights agreement and the warrant agreement
      are separate agreements and the liquidated damages penalty under the
      registration rights agreement [does] not affect the Issue 00-19 analysis,” (EITF
      Agenda Committee Meeting (Potential New Issues), dated February 1, 2005). The
      Financial Accounting Standards Board (“FASB”) further confirmed this position in
      its proposed FASB Staff Position (“FSP”) EITF 00-19-b in October 2006, which
      stipulates that registration rights agreements “should be separately recognized
      and measured in accordance with FASB Statement No. 5, Accounting for
      Contingencies.” Since
      we
      accounted for the registration rights agreement separately from the Warrants,
      we
      determined that the Warrants met all of the requirements for equity
      classification under EITF 00-19 as of July 28, 2006.




F-21




Accordingly,
      effective July 28, 2006, we concluded that the Warrants should be reclassified
      from a derivative financial instrument liability to “Warrants and options” under
      stockholders’ equity. We revalued the Warrants as of this date and classified
      the Warrants to stockholders’ equity.





The
      estimated fair value of the Warrants issued in the Private Placement at
      inception (the Closing Dates) through July 28, 2006 is as follows (in
      thousands):





Warrants
                issued to Sun Solunet and management - related parties
            
            Warrants
                issued to outside investors
            
            TotalIssuance
                of Warrants in
              March,
                April and May
              Closings
            
            $
            4,465
            
            $
            4,191
            
            $
            8,656Change
                in estimated fair
              value
                of Warrants
            
            
            1,191
            
            
            (817
            )
            
            374July
                28, 2006
            
            $
            5,656
            
            $
            3,374
            
            $
            9,030





The
      net
      change in estimated fair value for 2006 is included as a charge in the statement
      of operations and totaled $374,000.





We
      estimated the fair value of the Warrants issued in the Private Placement using
      the Black-Scholes option pricing model with the following
      assumptions:





Closing
                Dates
            
            March
                31, 2006
            
            June
                30, 2006
            
            July
                28, 2006Expected
                dividend yield
            
            
            0%
            
            
            0%
            
            
            0%
            
            
            0%Expected
                volatility
            
            
            62
                - 64.8%
            
            
            62%
            
            
            64.8%
            
            
            63.7%Contractual
                term
            
            
            5
                years
            
            
            4.91
                years
            
            
            4.66
                - 4.83 years
            
            
            4.5
                - 4.75 yearsRisk-free
                interest rate
            
            
            4.66
                - 5.00%
            
            
            4.78%
            
            
            5.18%
            
            
            4.98%




We
      estimated volatility primarily based on historical volatility rates for the
      years 2001 through September 2006. The Warrants have a transferability provision
      and based on guidance provided in the SEC’s Staff Accounting Bulletin No. 107
      (“SAB 107”), for options issued with such a provision, we used the full,
      five-year contractual term as the expected term of the Warrants. For the
      risk-free interest rate, we used the five year U.S. Treasury zero coupon rate
      as
      of the measurement dates.





**Registration
      Rights Agreement**





As
      part
      of the Private Placement, the Company executed a registration rights agreement
      (the “Registration Rights Agreement”) Under the terms of the Registration Rights
      Agreement, the Series A Preferred Stock and the Warrants carry registration
      rights that required the Company to remunerate liquidated damages (2% per month
      in the form of cash) to the investors in the event of failing to register the
      shares of common stock that the Company is required to issue upon conversion
      of
      the Series A Preferred Stock, upon exercise of the Warrants and as common stock
      dividends, payable on the Series A Preferred Stock, within 150 days of the
      Closing Dates (with respect to the shares of Series A Preferred Stock and
      Warrants issued on such date) and, with certain exceptions, to maintain said
      registration of the shares of the Company’s common stock underlying the Series A
      Preferred Stock and Warrants for so long as those securities remain outstanding
      The first of these dates was August 1, 2006. The liquidated damages were payable
      on each monthly anniversary until the registration statement was declared
      effective by the SEC. In addition, interest accrued on the liquidated damages
      at
      a rate of 12% per annum, if the payments were not made within seven days after
      the date payable.




F-22




On
      November 22, 2006, the Company entered into agreements (the “Settlement
      Agreement”) with substantially all of the Purchasers in the Private Placement,
      which set forth the amount of liquidated damages and interest related thereto
      due to said Purchasers. Under the terms of the Settlement Agreement, the Company
      was obligated to pay liquidated damages and interest accrued through November
      15, 2006 (the “Liquidated Damages”), and had no further obligation to any of
      such Purchasers for liquidated damages beyond this date. Additionally, and
      as
      part of the Settlement Agreement, the Company and the Purchasers agreed to
      reprice the B Warrants from an exercise price of $0.50 per share to $0.20 per
      share. The exercise price of the A Warrants remained at $0.30 per share. This
      modification resulted in a non-cash charge in the amount of $2,314,000 in the
      third fiscal quarter of 2006 to reflect the agreement to reprice the B Warrants
      as of November 15, 2006. The Warrants were valued as of November 15, 2006 using
      the Black Scholes option pricing model with the following assumptions: estimated
      volatility of 63.7%; risk free interest rate of 4.6%; the remaining contractual
      life of 4.3 years and no dividends. These settlements of Liquidated Damages
      and
      the modification of the Warrants were in satisfaction of all amounts due under
      the Registration Rights Agreement and therefore, under SFAS No. 5, the
      Company accrued $3.4 million ($1.1 million of Liquidated Damages and $2.3
      million related to the agreement to reprice the B Warrants) during the third
      fiscal quarter of 2006.





On
      December 8, 2006, the Company issued an unsecured promissory note (the
“Promissory Note”) to each of the Purchasers that were a party to the Settlement
      Agreement for payment of the Liquidated Damages. Terms of each Promissory Note
      were: (1) payment in cash, or, at the option of the Purchaser, in shares of
      the
      Company’s common stock (the terms of any issuance of common stock to be mutually
      agreed upon by the Company and the Purchaser); (2) payment due 15 months from
      the date of issuance of the Promissory Note; and (3) interest payable at the
      due
      date at 12% per annum.





**NOTE
      5 - STOCK OPTIONS AND STOCK PURCHASE WARRANTS**





**Stock
      Option Plans**





The
      Company has in effect three Stock Option Plans, the “2000 Stock Option Plan,”
the “2001 Stock Option Plan” and the “2003 Stock Option Plan.”





On
      March
      1, 2000, shareholders of the Company approved the 2000 Stock Option Plan. The
      total number of shares of common stock reserved for options issuable under
      this
      plan may not exceed 1,500,000 shares. On September 20, 2001, the Company adopted
      the 2001 Stock Option Plan. At December 31, 2006, the total number of shares
      of
      common stock reserved for options issuable under this plan was 5,000,000.
      Options granted under these plans vest generally over three to ten years. The
      exercise price of options granted under both plans is required to be not less
      than 80% of the fair market value per share on the date of option grant.
      Substantially all options granted to date under both plans have had an exercise
      price equal to, or in excess of, fair market value at the date of
      grant.





The
      2003
      Stock Option Plan was adopted on December 18, 2003. At December 31, 2006, the
      total number of shares of common stock subject to options that may be granted
      under the 2003 Plan may not exceed 25,000,000 shares, and all options must
      be
      granted at an exercise price equal to fair market value at the date of grant,
      vest generally over four years and have a contractual life of ten years.





We
      recognize compensation costs for these awards on a straight-line basis over
      the
      service period.





The
      Company’s policy is to issue new shares upon the exercise of stock
      options.





On
      May 3,
      2006, the compensation committee of the board of directors approved the grant
      of
      4,740,000 stock options to certain of the Company’s officers and employees with
      an exercise price of $0.35 per share and an expiration date of 10 years from
      the
      date of grant under the 2003 Stock Option Plan, vesting 25% per year over four
      years.




F-23




For
      the
      year ended December 31, 2006, the Company recorded $375,000 of share-based
      compensation expense. No tax benefits were recognized for this expense due
      to
      our recurring losses, and there were no options exercised during 2006. The
      expense recorded during the year related to the compensation expense for stock
      options granted during 2006 and for unvested stock options granted in prior
      years as calculated under the provisions of Statement of Financial Accounting
      Standard No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation.” In
      accordance with SFAS 123R, we accounted for options granted in prior years
      using
      the fair value pricing model used at the grant date to calculate the pro-forma
      compensation expense required for disclosure under SFAS 123, adjusted to include
      a provision for estimated forfeitures. During 2006, we estimated forfeitures
      at
      20% annually, based on historical trends related to employee turnover and the
      market price of the Company’s common stock. At December 31, 2006, we adjusted
      the share-based compensation expense for actual forfeitures that occurred as
      of
      that date. As our policy for 2007, we will continue to record expense based
      on
      estimated forfeitures, but will adjust for actual forfeitures at the end of
      the
      vesting period for each tranche of options. The Company considers revisions
      to
      its assumptions in estimating forfeitures on an ongoing basis.





For
      the
      options granted in 2006, we estimated the expected term of the options using
      the
“simplified method” as discussed in SAB 107, that is, the arithmetic mean of the
      weighted vesting period and contractual life, or 6.25 years. We used the
      Black-Scholes option pricing model, as we believe this model best reflects
      the
      Company’s historical option exercise patterns, with
      the
      following weighted average assumptions:





Years
                ended December 31,2006
            
            2005
            
            2004Expected
                dividend yield
            
            
            0%
            
            
            0%
            
            
            0%Expected
                volatility
            
            
            64.8%
            
            
            64%
            
            
            68%Expected
                term
            
            
            6.25
                years
            
            
            5
                years
            
            
            5
                yearsRisk-free
                interest rate
            
            
            5.01%
            
            
            4.00%
            
            
            3.95%





The
      weighted average grant date fair value of options granted was $0.23, $0.16
      and
      $0.24 per share for the years ended December 31, 2006, 2005 and 2004,
      respectively.





F-24


The
      following table summarizes option activity for our three stock option plans
      during the three years ended December 31, 2006, 2005 and 2004, respectively
      (in
      thousands, except per share data):





#
                of Shares Underlying Options
            
            Weighted
                Average Exercise Price
            
            Weighted
                Average Remaining Contractual Term
            
            Aggregate
                Intrinsic ValueOutstanding
                at January 1, 2004
            
            $
            13,908
            
            $
            0.69Granted
            
            
            3,010
            
            
            0.40Exercised
            
            
            -
            
            
            -Forfeited
                or expired
            
            
            (2,924
            )
            
            0.80Outstanding
                at December 31, 2004
            
            
            13,994
            
            
            0.61
            
            
            6.9
                years
            
            $
            7Granted
            
            
            1,535
            
            
            0.29Exercised
            
            
            -
            
            
            -Forfeited
                or expired
            
            
            (4,398
            )
            
            0.73Outstanding
                at December 31, 2005
            
            
            11,131
            
            
            0.51
            
            
            7.1
                years
            
            $
            -Granted
            
            
            4,740
            
            
            0.35Exercised
            
            
            -
            
            
            -Forfeited
                or expired
            
            
            (3,309
            )
            
            0.46Outstanding
                at December 31, 2006
            
            
            12,562
            
            $
            0.46
            
            
            7.7
                years
            
            $
            -Vested
                and exercisable at December 31, 2004
            
            
            6,928
            
            
            0.79
            
            
            4.9
                years
            
            $
            7Vested
                and exercisable at December 31, 2005
            
            
            6,117
            
            
            0.60
            
            
            5.9
                years
            
            $
            -Vested
                and exercisable at December 31, 2006
            
            
            5,502
            
            $
            0.57
            
            
            6.5
                years
            
            $
            -





The
      total
      fair value of options vested during the years ended December 31, 2006, 2005
      and
      2004 was approximately $365,000, $431,000 and $609,000, respectively. The total
      compensation cost related to nonvested options not yet recognized at December
      31, 2006 was $1.3 million and the weighted-average period over which this
      expense is expected to be recognized is approximately
      3.3 years.





F-25


Prior
      to
      the adoption of SFAS 123R, as permitted under SFAS 123, the Company accounted
      for stock-based compensation using the intrinsic value method in accordance
      with
      Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
      Employees” (“APB 25”) and related interpretations. Accordingly, no compensation
      expense was recognized in connection with the grant of stock options to
      employees and directors prior to the adoption of SFAS 123R on January 1, 2006,
      as all options granted had an exercise price equal to the market value of the
      underlying stock at the date of grant. Under the modified prospective method,
      the Company did not restate its operating results related to share-based
      compensation expense for the years ended December 31, 2005 or 2004, but
      continues to disclose the pro forma effect for those periods as if the Company
      had applied the fair value recognition provisions of SFAS 123.




Year
                Ended December 31,(In
              thousands, except for per share
              data)
            
            2005
            
            2004Net
                loss, as reported
            
            $
            (15,803
            )
            $
            (6,750
            )Deduct,
                total stock-based compensation expense determined
              under
                fair-value based method, net of related tax effects
            
            
            (246
            )
            
            (889
            )Pro
                forma net loss
            
            $
            (16,049
            )
            $
            (7,639
            )Basic
                and diluted net loss per share:As
                reported
            
            $
            (0.15
            )
            $
            (0.08
            )Pro
                forma
            
            $
            (0.15
            )
            $
            (0.09
            )




**Stock
      Purchase Warrants**





As
      part
      of the Private Placement, the Company issued to the Purchasers approximately
      92.5 million stock purchase warrants exercisable into shares of the Company’s
      common stock at exercise prices of $0.30 (“A Warrants”) and $0.50 (“B
      Warrants”). The B warrants were repriced from $0.50 to $0.20 per share effective
      November 23, 2006. Approximately 46.25 million warrants each are exercisable
      at
      $0.20 and $0.30, respectively. Additionally, as part of the Private Placement,
      the Company issued approximately 1.7 million placement agent warrants,
      exercisable at $0.15 per share.





During
      2004 and 2005, the Company issued stock purchase warrants (“Debt Guaranty”
warrants) to Sun Solunet, its majority shareholder, in consideration for the
      guaranty provided by Sun Capital II on its Harris credit facility. The Debt
      Guaranty warrants were immediately exercisable upon issuance at an exercise
      price of $0.001 per share. See further discussion in Note 10.





On
      April
      1, 2003, as part of the SANZ and Solunet Storage business combination, the
      Company issued to Sun Solunet a warrant (“Schedule A warrants”) to purchase a
      maximum of 19,976,737 shares of common stock at various prices ranging from
      $0.29 to $10.82, and over various terms. The number of Schedule A warrants
      was
      based on a percentage of SANZ’ outstanding warrants and options at the date of
      the business combination. The exercise of the Schedule A warrants is contingent
      upon the prior exercise of 2,958,951 warrants and/or options issued to previous
      holders, and, therefore, it is not determinable which Schedule A warrants will
      become exercisable, if any. Correspondingly, it is not known which Schedule
      A
      warrants will expire because it is not determinable which corresponding warrants
      and/or options of those previously outstanding will comprise the first 2,958,951
      exercised. Based on these contingent exercise provisions, the stated
      weighted-average exercise prices in the table below denoted by the * are pro
      forma amounts with regards to the Schedule A warrants, and have been calculated
      without consideration that certain of these warrants will not become
      exercisable.





F-26


The
      following table summarizes warrant activity for the three years ended December
      31, 2006, 2005 and 2004, respectively (in thousands, except per share
      data):





Number
                of Shares Underlying Warrants
            
            Weighted
                Average Exercise PriceOutstanding
                at December 31, 2003
            
            
            27,174
            
            $
            0.91
            *Granted
            
            
            7,716
            
            
            -Forfeited
            
            
            (7,696
            )
            
            1.31Outstanding
                at December 31, 2004
            
            
            27,194
            
            $
            0.47
            *Granted
            
            
            12,351
            
            
            -Forfeited
            
            
            (3,440
            )
            
            2.00Outstanding
                at December 31, 2005
            
            
            36,105
            
            $
            0.28
            *Granted
            
            
            94,219
            
            
            0.25Forfeited
            
            
            (11,860
            )
            
            0.70Outstanding
                at December 31, 2006
            
            
            118,464
            
            
            0.21Exercisable
                at December 31, 2004
            
            
            13,827
            
            $
            0.29
            *Exercisable
                at December 31, 2005
            
            
            26,025
            
            $
            0.14
            *Exercisable
                at December 31, 2006
            
            
            116,369
            
            $
            0.21
            *




**NOTE
      6 - DEBT**





**Wells
      Fargo Line of Credit**





The
      Company has a revolving credit line with Wells Fargo to borrow up to $12.0
      million, which is secured by substantially all assets of SANZ Inc. and Solunet
      Storage, Inc. (“SANZ Inc. et al” or the “Borrowers”), wholly-owned subsidiaries
      or indirect subsidiaries of the Company. The funds available under the credit
      facility are limited to 85% of the amount of eligible accounts receivable,
      which
      consist of substantially all accounts receivable, subject to exclusions for
      invoices aged over 90 days, otherwise-current receivables from customers with
      material amounts outstanding over 90 days and subject to a percentage limit
      of
      accounts receivable from a single customer. Borrowings against receivables
      owed
      directly by Federal government end-users are further limited to 80% of the
      eligible accounts receivable up to $500,000 in the aggregate unless we have
      obtained an “assignment of claim” executed by the government agency. Receivables
      from commercial entities acting as prime contractors for Federal government
      end-users are not subject to this sub-limit. Borrowings against receivables
      on
      maintenance services and maintenance contract fees are limited to 35% of the
      eligible accounts receivable up to $1,000,000 in the aggregate.





As
      of
      December 31, 2006, based on our eligible collateral at that date, we had $11.2
      million available for borrowing on the Wells Fargo credit facility, of which
      $6.2 million was drawn and $5.0 million remained available. Wells Fargo may
      declare the loan in default if the Company does not meet certain financial
      performance measures. At December 31, 2006, the Company was in compliance with
      all covenants as set for 2006. As of December 31, 2006, this credit facility
      bore interest at the rate of prime plus 5.0% or 13.25%.




F-27





On
      April
      2, 2007, the Company and Wells Fargo executed an amendment to this credit
      facility agreement. This amendment extended the credit facility through May
      2010
      and set financial covenants for 2007, which are effective beginning March 31,
      2007. Borrowings under this facility bear interest at prime plus 3.0%. Financial
      covenants for 2007 are as follows: (1) minimum net income (loss) on a year
      to
      date basis, calculated quarterly; (2) minimum net worth plus “subordinated debt”
(measured in the aggregate, with amounts loaned to SANZ Inc. et al from SANZ
      being defined as subordinated debt), calculated on a monthly basis; (3) minimum
      availability, calculated monthly; (4) capital expenditure limit, calculated
      on
      an annual basis; and (5) a minimum cash infusion from SANZ or an outside source
      if SANZ Inc. et al generate a net loss in a given quarter and have generated
      a
      net loss on a year to date basis at that time, in an amount equal to the lesser
      of the quarterly net loss or the year to date net loss. On
      April
      13, 2007, we obtained a waiver of default from Wells Fargo waiving the event
      of
      default that would have resulted under the facility as a result of the “going
      concern” qualification on our independent registered public accounting firm’s
      report on our financial statements for the fiscal year ended December 31,
      2006.





Each
      Borrower maintains a separate borrowing base; however, total borrowings under
      the facility are limited to $12 million. Additionally, each Borrower is required
      to guaranty the other’s debt. Cash transfers from SANZ Inc. to Solunet Storage
      are limited to the funding of Solunet Storage’s operating expenses and to a
      minimum availability on the date of any such transfer.





This
      revolving credit facility requires a lock-box arrangement, which provides for
      all receipts to be swept daily to reduce borrowings outstanding under the
      revolving credit facility. This arrangement, combined with the existence of
      a
      subjective acceleration clause in the revolving credit facility, requires the
      classification of outstanding borrowings under the revolving credit facility
      as
      a current liability in accordance with EITF Issue 95-22, “Balance Sheet
      Classification of Borrowings Outstanding under Revolving Credit Agreements
      that
      Include Both a Subjective Acceleration Clause and a Lock-Box
      Arrangement.”




**Sun
      Loan and Sun Term Loan**





On
      November 23, 2005, Harris
      assigned its credit facility (the “Harris 2004-2005 Facility”) with the Company
      to Sun Solunet, the Company’s majority shareholder. At this date, Sun Solunet
      purchased the outstanding principal balance of $11,999,965 plus accrued interest
      in the amount of $138,038, and the Company became obligated to Sun Solunet
      (said
      principal and accrued interest referred to as the “Sun Loan”). At December 31,
      2005, the Company had $13.1 million outstanding and due to Sun Solunet on the
      Sun Loan.





On
      February 6, 2006, the Sun Loan was amended in order to increase the borrowing
      availability from $13.0 million to $14.0 million. In addition to increasing
      the
      Company’s borrowing availability, this amendment changed the maturity date to
      December 31, 2006 and permitted accrual of interest to the principal amount
      of
      the loan until maturity.





Effective
      March 2, 2006, as part of the March 2006 closing of the Private Placement,
      Sun
      Solunet converted $8.0 million of the Sun Loan to the Company into Units as
      described in Note 4, and the Company paid down $1.0 million of the Sun Loan.
      On
      April 19, 2006, the Company and Sun Solunet executed an amendment to the Sun
      Loan agreement, which reduced the loan balance from $13.0 million to $5.0
      million and modified the loan from a revolving line of credit to a term loan
      (the “Sun Term Loan”) maturing on March 2, 2009. The parties agreed that Sun
      Solunet had no additional lending obligation to the Company under the credit
      facility. Also as part of the new agreement, the Company was no longer obligated
      to issue debt guaranty warrants to Sun Solunet. See discussion of debt guaranty
      warrants in Note 10. This amendment formalized the agreement with respect to
      the
      Sun Loan that had been previously made in the Credit
      Support Termination Agreement on March 2, 2006. The Sun Term Loan bears interest
      at prime plus 1.0% (9.25% at December 31, 2006) and all interest accrues and
      is
      payable on the maturity date. As of December 31, 2006, the Company had $5.0
      million in principal and $680,000 of accrued interest due on the Sun Term
      Loan.





F-28


**Harris
      2006 Facility**





On
      October 27, 2006, the Company entered into the Harris 2006 Facility, which
      allowed for borrowings up to $1.5 million. Borrowings under the Harris 2006
      Facility bear interest at prime (8.25% as of December 31, 2006) and are payable
      upon demand by Harris. The purpose of obtaining this facility was to provide
      additional working capital to the Company and its subsidiaries. This credit
      facility is unsecured, is not limited by availability under a borrowing base,
      and does not require the maintenance of specified financial covenants. As a
      condition precedent to obtaining the Harris 2006 Facility, Sun Capital II,
      an
      affiliate of Sun Solunet, entered into an ongoing guaranty of the debt incurred
      by the Company under this facility. Additionally, Sun Capital II agreed that,
      upon the written request of SANZ, it would provide SANZ with sufficient funds
      to
      repay the debt outstanding under the credit facility in the event that Harris
      required repayment of such debt or, at Sun Capital II’s election, pay the
      outstanding debt directly to Harris; provided that in no event would Sun Capital
      II’s obligation exceed the amount of Sun Capital II’s guaranty. This guaranty
      expires on December 31, 2007. As of December 31, 2006, the Company had principal
      borrowings outstanding under the Harris 2006 Facility of $1.5
      million.





On
      March
      13 and March 23, 2007 the Company increased its borrowing availability with
      Harris through amendments to the Harris 2006 Facility in the amounts of $1.5
      million and $1.5 million, respectively. The $3 million of available borrowings
      under these amendments was for additional working capital, and was secured
      by
      cash collateral posted by Sun Capital II. Total borrowings allowed under the
      Harris 2006 Facility, as amended, were $4.5 million, all of which were
      outstanding as of March 30, 2007.





**Investor
      Promissory Notes**





On
      December 8, 2006, the Company issued an unsecured promissory note (the
“Promissory Note”) to each of the Purchasers (collectively, the “Investor
      promissory notes”) in the Private Placement that were a party to the Settlement
      Agreement for payment of the Liquidated Damages. Terms of each Promissory Note
      were: (1) payment in cash, or, at the option of the Purchaser, in shares of
      the
      Company’s common stock (the terms of any issuance of common stock to be mutually
      agreed upon by the Company and the Purchaser); (2) payment due 15 months from
      the date of issuance of the Promissory Note; and (3) interest payable at the
      due
      date at 12% per annum. At December 31, 2006, the Company had $1,134,000
      outstanding and due under the Investor Promissory Notes. ****





**Other
      Financing**





In
      October 2005, SANZ Inc. executed a security agreement with Avnet, its largest
      supplier, granting a security interest in all of its assets. Pursuant to the
      security agreement, SANZ Inc.’s indebtedness with Avnet is secured, except for
      $1,000,000. The security agreement specifies events of default, including but
      not limited to any failure by SANZ Inc. to maintain total cash and customer
      receivables (less indebtedness of SANZ Inc. to Wells Fargo) in an amount that
      is
      at least equal to the amount of outstanding trade accounts payable to Avnet,
      less $2,000,000. The security interest granted to Avnet is subordinate to the
      security interest granted to Wells Fargo by SANZ Inc. in connection with the
      its
      principal borrowing facility with Wells Fargo and to evidence the subordination,
      Avnet and Wells Fargo entered into an intercreditor agreement. As of December
      31, 2006 the Company was in compliance with all of the provisions of the
      security agreement with Avnet.





The
      Company purchases over half of its products from Avnet. If Avnet were to cease
      to sell to us on trade credit terms, the Company would need to accelerate
      payments to Avnet, creating additional demands on its cash resources, or the
      Company would need to find other sources for those goods. Management believes
      that other suppliers could provide these goods; however, a change in suppliers
      could cause delays in shipments and a possible loss of sales, which would affect
      operating results adversely.





F-29


The
      following summarizes our debt outstanding:




(In
                thousands)
            
            December
                31, 2006
            
            December
                31, 2005Line
                of credit with Wells Fargo
            
            $
            6,203
            
            $
            7,292Line
                of credit with Harris
            
            
            1,500
            
            
            –Sun
                Term Loan (including accrued interest of $680,000)
            
            
            5,680
            
            
            –Sun
                Loan
            
            
            –
            
            
            13,109Investor
                promissory notes
            
            
            1,134
            
            
            –$
            14,517
            
            $
            20,401





For
      the
      years 2006 and 2005, the Company’s weighted average interest rate on short term
      borrowings was approximately 12.5% and 9.5%, respectively.






**NOTE
      7 - INCOME TAXES**





Total
      tax
      expense for 2006 and 2005 was $45,000 and $34,000, respectively, and represented
      state income taxes paid during those years, respectively.





In
      June
      2004, the Company received a Federal income tax refund in the amount of
      $352,000. The refund was the result of the carryback of the net operating loss
      for 2002 for StorNet Inc., whose assets, including rights to tax refunds, we
      acquired in 2002 from the secured lender of StorNet Inc. in a foreclosure sale.
      This net operating loss carryback was allowed under a recent law change, which
      increased the carryback period from two to five years for net operating losses
      generated in 2001 and 2002. The Company filed the amended income tax return
      in
      February 2004; however, because the Company carried a deferred tax valuation
      allowance equal to 100% of total deferred tax assets, the Company did not record
      the benefit until the cash refund was received.





Total
      income tax (expense) benefit differs from the amount computed by applying the
      U.S. federal income tax rate of 34% to loss before income taxes as
      follows:





Year
                ended December 31,(In
              thousands)
            
            2006
            
            2005
            
            2004Income
                tax benefit at federal statutory rate
            
            $
            (11,190
            )
            $
            (5,429
            )
            $
            (2,407
            )State
                income tax benefit, net of federal benefit
            
            
            –
            
            
            (48
            )
            
            (75
            )State
                income taxes paid
            
            
            45
            
            
            34
            
            
            –Federal
                income tax refund
            
            
            –
            
            
            –
            
            
            (328
            )Goodwill
                and trade name impairment charges
            
            
            7,588
            
            
            3,128
            
            
            –Warrant
                charge for debt guaranty
            
            
            
            
            
            978
            
            
            839Non–cash
                charges related to issuance of equity securities to related parties
                and
                outside investors
            
            
            1,228
            
            
            –
            
            
            –Nondeductible
                items
            
            
            18
            
            
            22
            
            
            19Valuation
                allowance
            
            
            2,356
            
            
            1,349
            
            
            1,624$
            45
            
            $
            34
            
            $
            (328
            )





F-30


Deferred
      tax assets and liabilities are recorded for the estimated future tax effects
      of
      temporary differences between the tax basis of assets and liabilities and their
      basis for financial reporting purposes, and for operating loss carryforwards.
      Temporary differences that give rise to deferred tax assets and liabilities
      are
      as follows:







December
                31,(In
              thousands)
            
            2006
            
            2005Deferred
                tax assets:Current:Reserves
                and accrued expenses
            
            $
            193
            
            $
            247Non-currentNet
                operating loss carryforwards
            
            
            16,017
            
            
            14,374Notes
                payable to outside investors and
              related
                parties
            
            
            390
            
            
            –Intangible
                assets
            
            
            923
            
            
            556Other
            
            
            –
            
            
            11Total
                deferred tax assets
            
            
            17,523
            
            
            15,188Deferred
                tax liabilities
            
            
            –
            
            
            –Property
                and equipment
            
            
            (119
            )
            
            (140
            )Valuation
                allowance
            
            
            (17,404
            )
            
            (15,048
            )Net
                deferred tax asset
            
            $
            –
            
            $
            –





The
      Company carries a deferred tax valuation allowance equal to 100% of total
      deferred assets. In recording this allowance, management has considered a number
      of factors, but chiefly, the Company’s recent history of sustained operating
      losses. Management has concluded that a valuation allowance is required for
      100%
      of the total deferred tax assets as it is more likely than not that the deferred
      tax assets will not be realized.





At
      December 31, 2006, the Company had net operating loss carryforwards available
      to
      offset future federal taxable income of approximately $45 million. Such
      carryforwards expire between 2009 and 2026. Under the Tax reform Act of 1986,
      the amount of and the benefit from net operating losses that can be carried
      forward may be limited in certain circumstances. Events that may cause changes
      in the Company’s tax carryovers include, but are not limited to, a cumulative
      ownership change of more than 50% over a three-year period. A portion of the
      Company’s operating loss carryforwards that can be utilized in any one taxable
      year for federal tax purposes is limited by the ownership change resulting
      from
      the SANZ and Solunet Storage business combination in 2003. Future ownership
      changes could further limit the utilization of the Company’s net operating loss
      carryforwards.




**NOTE
      8 - COMMITMENTS AND CONTINGENCIES**





**Leases**





The
      Company leases office space and equipment under various non-cancelable operating
      leases. At December 31, 2006, the aggregate future minimum lease commitments
      were as follows (in thousands):





2007
            
            $
            7182008
            
            
            5472009
            
            
            1062010
            
            
            –2011
            
            
            –$
            1,371





Rent
      expense totaled $726,000, $488,000 and $977,000 in the years ended December
      31,
      2006, 2005 and 2004, respectively.




F-31




**Severance**




As
      previously disclosed in our periodic reports, Mr. Jenkins resigned as our Chief
      Executive Officer, President and Chairman on March 12, 2007. In connection
      therewith, Mr. Jenkins and SANZ entered into a separation and general release
      agreement (the “Separation Agreement”) dated March 12, 2007 and effective on May
      11, 2007 (the “Separation Date”). Pursuant to the Separation Agreement, Mr.
      Jenkins remains our employee (with the same base salary and benefits) until
      the
      Separation Date. Thereafter, subject to the satisfaction of certain conditions,
      Mr. Jenkins is entitled to 12 months of severance payments and benefits equal
      to
      his base salary and benefits that were in effect prior to his resignation.
      Our
      board of directors, including our compensation committee, also extended the
      vesting period of options to purchase 1,100,000 shares (275,000 options of
      which
      were unvested) of the Company’s common stock at an exercise price of $0.40 per
      share issued under our 2003 Stock Option Plan until the Separation Date. Our
      board, including our compensation committee, also extended the exercise period
      on these options as well as options to purchase 500,000 shares of the Company’s
      common stock at an exercise price of $0.29 per share granted under the Company’s
      2001 Stock Option Plan held by Mr. Jenkins that have vested as of the Separation
      Date to May 11, 2008.





**Litigation**





The
      Company is periodically engaged in the defense of certain claims and lawsuits
      arising out of the ordinary course and conduct of its business, the outcome
      of
      which is not determinable at this time. In the opinion of management, any
      liability that might be incurred by the Company upon the resolution of these
      claims and lawsuits will not, in the aggregate, have a material adverse effect
      on the Company’s consolidated results of operations, cash flows or financial
      condition.




**NOTE
      9 - DEFINED CONTRIBUTION PLAN**





The
      Company maintains a defined contribution plan under Section 401(k) of the
      Internal Revenue Code, covering all employees who have three months of service
      with the Company. The Plan allows participants to make voluntary pre-tax
      contributions of up to 100% of their pre-tax earnings, not to exceed the IRS
      annual limit. In addition, the Company, at its discretion, may partially match
      participant contributions. No employer matching contributions were made for
      the
      years ended December 31, 2006, 2005 and 2004.





**NOTE
      10 - RELATED PARTY TRANSACTIONS**





**Management
      Fees**





The
      Company pays $75,000 quarterly for management and consulting services to Sun
      Capital Partners Management LLC (“Sun Capital Management”), an affiliate of our
      majority shareholder, Sun Solunet. Sun Capital II, who is also an affiliate
      of
      Sun Solunet, provided a guaranty on the Company’s Harris credit facility under
      the Credit Support Agreement through November 23, 2005, the date on which Harris
      assigned the note to Sun Solunet. See further discussion below. While SANZ
      received material benefits from this guaranty, the Company paid no specified
      cash consideration for the guaranty. For 2006, 2005 and 2004, the Company
      allocated a portion of the management and consulting services fee paid to Sun
      Capital Management to interest expense, based on the financing-related benefits
      that it received under the Sun Capital II guaranty. The balance of the
      management and consulting services fee was recorded as general and
      administrative expense.





As
      of
      December 31, 2006 and 2005, the Company had $-0- due to Sun Capital Management
      for management fees and related expenses. For the years ended December 31,
      2006,
      2005 and 2004, the Company paid $354,000, $318,000 and $323,000, respectively,
      to Sun Capital Management for management fees and related expenses.





F-32


**Debt
      Guaranty Warrants**





During
      2004 and 2005 and in accordance with the Credit Support Agreement, the Company
      was obligated to issue Debt Guaranty warrants to Sun Capital to the extent
      that
      the Company’s guaranteed debt on the Harris 2004-2005 Facility exceeded $3.0
      million under the terms and stated formulas as stipulated below. Debt Guaranty
      warrants were issuable at six-month intervals beginning on November 16, 2004.
      The Debt Guaranty warrant issued for this date was issued on March 23, 2005.
      Warrants issued for November 16, 2004 and May 16 and November 16, 2005 were
      calculated in accordance with formula below. Under the Sun Loan agreement,
      effected November 23, 2005, the Credit Support Agreement remained effective
      and
      the Company was obligated to issue Debt Guaranty warrants under its terms and
      stated formulas (on May 16 and November 16 intervals for debt in excess of
      $3.0
      million) as stipulated below. The Debt Guaranty warrants were exercisable
      immediately upon issuance at an exercise price of $0.001 per share. Based on
      the
      number of shares issued pursuant to the Debt Guaranty warrants, the Company
      recorded charges calculated as the number of shares issued under the warrant
      multiplied by the closing market price of SANZ’ common stock on the date of
      issuance.





Debt
      Guaranty Warrants = ( Guaranteed
      Debt - $3,000,000) x fixed
      number of shares at particular date


$2,000,000





The
      fixed
      number of shares used in the calculation of Debt Guaranty warrants for a
      particular date are listed in the table below.





Date
            
            Number
                of SharesNovember
                16, 2004
            
            
            3,086,218May
                16, 2005
            
            
            641,292November
                16, 2005
            
            
            1,307,898




On
      March
      23, 2005, and as consideration of an additional $2.0 million guaranty by Sun
      Capital II on the Harris 2004-2005 Facility (which was increased by $2.0 million
      on February 16, 2005), the Company issued a Debt Guaranty warrant to Sun Solunet
      to purchase 3,086,218 shares of common stock. These Debt Guaranty warrants
      were
      exercisable immediately upon issuance at an exercise price of $0.001 per share.
      The Company and Sun Solunet agreed that the number of shares exercisable under
      this warrant would be calculated pursuant to the same formula above, and as
      if
      the additional $2.0 million debt guaranty was in place as of November 16, 2004.





On
      June
      27, 2005 and in consideration of an additional $1.5 million guaranty by Sun
      Capital II on the Harris 2004-2005 Facility (which was increased by $1.5 million
      on June 3, 2005), the Company issued a Debt Guaranty warrant to Sun Solunet
      to
      purchase 480,969 shares of our common stock. These Debt Guaranty warrants were
      immediately exercisable upon issuance with an exercise price of $0.001 per
      share. The
      Company and Sun Solunet agreed that the number of shares exercisable under
      this
      warrant would be calculated pursuant to the same formula above, and as if the
      additional $1.5 million guaranty was in place as of May 16, 2005.





**Sun
      Loan and Sun Term Loan**





As
      of
      December 31, 2006, the Company had $5.7 million, including $680,000 of accrued
      interest, outstanding on the Sun Term Loan. As of December 31, 2005, the Company
      had $13.1 million, including accrued interest, outstanding on the Sun Loan,
      which Sun Solunet had purchased from Harris on November 23, 2005.




**Private
      Placement**





As
      discussed in Note 4, on March 2, 2006 the Company completed the Private
      Placement, which included Sun Solunet converting $8.0 million of the Sun Loan
      to
      176.5 Units. The Sun Solunet debt conversion was at the same price, net of
      placement agent fees that third-party investors and Company executive management
      had purchased for cash shares of the Series A Preferred Stock, and was approved
      by the Company’s Independent Committee of the Board of Directors. Additionally,
      on the Closing Date, the Company
      paid down $1.0 million of the remaining outstanding balance, resulting in total
      outstanding debt owed by the Company under the Sun Loan of $5.0 million plus
      accrued interest of $296,000 from November 23, 2005, the inception of the Sun
      Loan. As a result thereof, on the Closing Date, the Company and Sun Capital
      II
      entered into the Credit Support Termination Agreement to the Credit Support
      Agreement. The Credit Support Termination Agreement included the following
      provisions, among others:





(a)
            The
                Company and Sun Solunet agreed to decrease the Company’s borrowing
                availability under the Sun Loan from $14 million to $5.0 million
                and to
                modify the Sun Loan from a revolving line of credit to a three-year
                term
                loan without a demand note stipulation (the “Sun Term Loan”) at a
                borrowing rate of prime plus 1.0%.


F-33


(b)
            The
                parties agreed that Sun Solunet and Sun Capital II have no additional
                lending obligation to the Company.





(c)
            The
                parties terminated the Credit Support Agreement and the obligations
                of all
                parties, including the requirement of the Company to issue additional
                Debt
                Guaranty warrants to Sun Solunet.





**Investor
      Promissory Notes**





Also,
      as
      further discussed in Note 4, on November 22, 2006, the Company entered into
      the
      Settlement Agreement with all of the Purchasers in the Private Placement,
      including Sun Solunet, for the payment of liquidated damages and interest
      accrued through November 15, 2006 pursuant to the Company’s failure to register
      the underlying shares of common stock issuable upon conversion or exercise
      of
      the securities issued in the Private Placement. Also under the Settlement
      Agreement, the Company and the Purchasers, including Sun Solunet, agreed to
      reprice the B Warrants from an exercise price of $0.50 per share to $0.20 per
      share. On December 8, 2006, the Company issued a Promissory Note to each of
      the
      Purchasers that were a party to the Settlement Agreement, including Sun Solunet,
      for payment of the Liquidated Damages. The Investor promissory notes are due
      in
      March of 2008 and bear interest at 12%. As of December 31, 2006, the amount
      due
      to Sun Solunet under the promissory note, including accrued interest was
      $744,000.





**NOTE
      11 - SEGMENT INFORMATION**





**Description
      of Segments**





Beginning
      in 2005, with the increased significance of its EarthWhere business, SANZ is
      reporting its operations as two business segments: (1) a data storage systems
      integrator (“Storage Solutions”) and (2) a spatial data management software and
      services provider (“EarthWhere”).





A
      description of the types of products and services provided by each reportable
      segment follows:




·
        The
        Storage Solutions segment is a system integrator that provides data storage
        solutions to meet a client’s specific needs, including both data storage
        networks and data backup/recovery systems; along with associated maintenance
        services and storage-related consulting services;




·
        The
        EarthWhere segment consists of the resale of our proprietary data management
        software product, “EarthWhereTM,” which facilitates imagery data access and
        provisioning for geospatial digital imagery users (principally satellite
        and
        aerial imagery and map data), together with associated support and consulting
        services.





**Segment
      Data**





The
      results of the reportable segments are derived directly from SANZ’ internal
      management reporting system. The accounting policies used to derive reportable
      segment results are substantially the same as those used by the consolidated
      Company. Management measures the performance of each segment based on several
      metrics, including income (loss) from operations. These results are used, in
      part, to evaluate the performance of, and to assign resources to, each of the
      segments. A significant portion of total consolidated expenditures are directly
      attributable to the two business segments. However, certain operating expenses,
      which are separately managed at the corporate level, are not allocated to
      segments. These unallocated costs include certain audit, consulting, and legal
      costs incurred on a corporate level, Sun Capital management fees and acquisition
      related costs. There was no intersegment revenue for all years
      presented.




F-34




Selected
      financial information for each reportable segment was as follows for the years
      ended December 31, 2006, 2005, and 2004 (in thousands):





**Storage
                Solutions**
            
            **EarthWhere**
            
            **Total****2006**Total
                net revenue
            
            $
            55,639
            
            $
            3,106
            
            $
            58,745Depreciation
                and amortization
            
            
            650
            
            
            133
            
            
            783Loss
                from operations (1) (2)
            
            
            (22,903
            )
            
            (2,929
            )
            
            (25,832
            )**2005**Total
                net revenue
            
            
            57,001
            
            
            2,114
            
            
            59,115Depreciation
                and amortization
            
            
            839
            
            
            260
            
            
            1,099Loss
                from operations (1) (2)
            
            
            (8,851
            )
            
            (1,732
            )
            
            (10,583
            )**2004**Total
                net revenue
            
            
            65,005
            
            
            1,153
            
            
            66,158Depreciation
                and amortization
            
            
            1,110
            
            
            196
            
            
            1,306Loss
                from operations
            
            $
            (1,578
            )
            $
            (1,453
            )
            $
            (3,031
            )





(1)
              The
                  Storage Solutions segment loss from operations for 2006 and 2005
                  included
                  charges for goodwill impairment of $21.5 and $9.2 million, respectively.
                  The Storage Solutions segment loss from operations also included
                  a charge
                  for the impairment of the SANZ commercial trade name in the amount
                  of
                  $800,000.





(2)
            The
                EarthWhere segment loss from operations for 2006, 2005 and 2004 included
                amortization of capitalized software development costs, recorded
                as cost
                of goods sold, in the amount of $376,000, $134,000 and $100,000,
                respectively.





Capital
      expenditures, which consist of purchases of property and equipment for the
      Solutions segment and purchases of property and equipment and capitalized
      software costs for the EarthWhere segment, were as follows (in
      thousands):





Years
                ended December 31,**Expenditures
              for segment assets**
            
            2006
            
            2005
            
            2004Storage
                Solutions
            
            $
            271
            
            $
            214
            
            $
            242EarthWhere
            
            
            960
            
            
            1,015
            
            
            183Corporate
            
            
            -
            
            
            -
            
            
            -**Total
                expenditures for assets**
            
            $
            1,231
            
            $
            1,229
            
            $
            425





F-35




The
      reconciliation of segment loss from operations to SANZ’ consolidated loss from
      operations and loss before income taxes was as follows (in
      thousands):




Years
                  ended December 31,2006
              
              2005
              
              2004**Net
                  segment revenue**
              
              $
              58,745
              
              $
              59,115
              
              $
              66,158Loss
                  from operations:Total
                  segment loss from operations
              
              
              (25,832
              )
              
              (10,583
              )
              
              (3,031
              )Unallocated
                  corporate costs
              
              
              (767
              )
              
              (700
              )
              
              (478
              )**Loss
                  from operations**
              
              
              (26,599
              )
              
              (11,283
              )
              
              (3,509
              )Interest
                  expense
              
              
              (1,474
              )
              
              (1,610
              )
              
              (1,221
              )Charge
                  for warrants issued to related party for debt guaranty
              
              
              -
              
              
              (2,877
              )
              
              (2,469
              )Charge
                  for change in estimated fair value of derivative financial instruments
                  -
                  Warrants
              
              
              (374
              )
              
              -
              
              
              -Charge
                  for fair value of Warrants in excess of net cash proceeds
              
              
              (924
              )
              
              -
              
              
              -Charge
                  due to the agreement to reprice Warrants
              
              
              (2,314
              )
              
              -
              
              
              -Liquidated
                  damages
              
              
              (1,117
              )
              
              -
              
              
              -Other
                  income (expense)
              
              
              (110
              )
              
              1
              
              
              121**Loss
                  before income taxes**
              
              $
              (32,912
              )
              $
              (15,769
              )
              $
              (7,078
              )





Assets
      are allocated to the individual segments based on the primary segment benefiting
      from the assets. Corporate assets are composed primarily of cash and cash
      equivalents, investments, and prepaid expenses. Total assets and liabilities
      by
      segment and the reconciliation of segment assets and liabilities to SANZ’
consolidated assets and liabilities as of December 31, 2006 and 2005 (in
      thousands) are as follows:





December
                31,2006
            
            2005**Assets**Storage
                Solutions
            
            $
            17,679
            
            $
            37,267EarthWhere
            
            
            3,896
            
            
            3,213Corporate
            
            
            580
            
            
            737**Total
                assets**
            
            $
            22,155
            
            $
            41,217





December
                31,2006
            
            
            2005**Liabilities**Storage
                Solutions
            
            $
            18,812
            
            $
            26,541EarthWhere
            
            
            11,867
            
            
            7,339Corporate
            
            
            1,334
            
            
            496**Total
                liabilities**
            
            $
            32,013
            
            $
            34,376





F-36


**Customer
      Concentration**





The
      following table shows significant customers as a percentage of accounts
      receivable at December 31, 2006 and 2005 and as a percentage of revenue for
      the
      years ended December 31, 2006, 2005, and 2004, respectively. Customer A
      represents the aggregate of all Federal government agencies to which the Company
      sells directly. Customer B and C are both third party government contractors.
      Both the Storage Solutions and EarthWhere segments report revenue from Customer
      A; all of Customer B and C’s revenue is reported under the Storage Solutions
      segment.





Accounts
                receivable
            
            RevenueFor
                the year endedDecember
                31,
            
            December
                31,2006
            
            2005
            
            2006
            
            2005
            
            2004Customer
                A
            
            
            12.5
            %
            
            30.3
            %
            
            9.6
            %
            
            17.1
            %
            
            24.1
            %Customer
                B
            
            
            9.0
            
            
            –
            
            
            8.5
            
            
            12.2
            
            
            –Customer
                C
            
            
            14.2
            %
            
            0.9
            %
            
            5.0
            %
            
            2.4
            %
            
            –
            %








**Geographic
      Information**




All
      of
      the Company’s assets are located in and all of the Company’s operating results
      are derived from operations in the United States.





F-37




**(3)
      Exhibits**





The
      exhibits filed as a part of this report are
      listed below and this list is intended to comprise the exhibit
      index:





**Exhibit**
              **Number**
            
            **Description**2.01
            
            Agreement
                and Plan of Merger dated March 31, 2003 relating to the acquisition
                of Solunet Storage. Incorporated by reference to Exhibit 2.1 to the
                Registrant’s Current Report on Form 8-K/A No. 1 dated
                April 1, 2003, filed on April 3, 2003.3.01
            
            Second
                Amended and Restated Articles of Incorporation, as filed with the
                Colorado
                Secretary of State on April 13, 2004. Incorporated by reference to
                Exhibit
                3.1 to the Registrant’s Quarterly Report on Form 10-QSB for the fiscal
                quarter ended March 31, 2004, filed on May 11, 2004.3.02
            
            Articles
                of Amendment to the Second Amended and Restated Articles of Incorporation,
                as filed with the Colorado Secretary of State on March 2, 2006.
                Incorporated by reference to Exhibit 3.1 to the Registrant’s Current
                Report on Form 8-K dated March 2, 2006, filed on March 8,
                2006.3.03
            
            Second
                Amended and Restated Bylaws, effective April 4, 2003. Incorporated by
                reference to Exhibit 2.9 to the Registrant’s Current Report on
                Form 8-K/A No. 1 dated April 1, 2003, filed on April 3,
                2003.4.01
            
            Designation
                of Series A and Series B Preferred Stock - April 3, 2003. Incorporated
                by
                reference to Exhibit 2.10 to the Registrant’s Current Report on Form 8-K
                dated April 1, 2003, filed on April 3, 2003.4.02
            
            Designation
                of Series A Preferred Stock. Incorporated by reference to Exhibit
                4.01 to
                the Registrant’s Current Report on Form 8-K dated March 2, 2006, filed on
                March 8, 2006.10.01
            
            Credit
                and Security Agreement, dated May 31, 2001, by and between Storage
                Area Networks, Inc., and Wells Fargo Business Credit, Inc. Incorporated
                by
                reference to Exhibit 10.1 to the Registrant’s Quarterly Report on
                Form 10-QSB for the quarter ended June 30, 2001, filed on
                August 13, 2001.10.02
            
            First
                Amendment, dated January 17, 2002, to Credit and Security Agreement
                by and
                between Storage Area Networks, Inc. and Wells Fargo Business Credit,
                Inc.
                Incorporated by reference to Exhibit 10.1 to the Registrant’s
                Quarterly Report on Form 10-QSB for the quarter ended March 31,
                2002, filed on May 14, 2002.10.03
            
            Subordination
                Agreement, dated January 17, 2002 by and between SAN Holdings, Inc.
                and
                Wells Fargo Business Credit, Inc. Incorporated by reference to
                Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended March 31, 2002, filed on May 14, 2002.10.04
            
            Second
                Amendment, dated July 1, 2002, to Credit and Security Agreement, by
                and between Storage Area Networks, Inc., and Wells Fargo Business
                Credit,
                Inc. Incorporated by reference to Exhibit 10.16 to the Registrant’s
                Registration Statement on Form SB-2/A No. 2, File No. 333-87196,
                filed on November 4, 2002.10.05
            
            Fifth
                Amendment, dated September 22, 2003, to Credit and Security Agreement
                by and between the Registrant (f/k/a Storage Area Networks, Inc.)
                and
                Wells Fargo Business Credit, Inc.. Incorporated by reference to
                Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-QSB
                for the quarter ended September 30, 2003, filed on November 13,
                2003.10.06
            
            Eighth
                Amendment, dated October 29, 2004, to Credit and Security Agreement
                by and
                between the Registrant (f/k/a Storage Area Networks, Inc.) and Wells
                Fargo
                Business Credit, Inc. Incorporated by reference to Exhibit 10.1 to
                the
                Registrant’s Current Report on Form 8-K dated October 29, 2004 filedonNovember
                4, 2004.10.07
            
            Ninth
                Amendment, dated March 29, 2005, to Credit and Security Agreement
                by and
                between the Registrant (f/k/a Storage Area Networks, Inc.) and Wells
                Fargo
                Business Credit, Inc.Incorporated
                by reference to Exhibit 10.07 to the Registrant’s Annual Report on
                Form 10-K for the year ended December 31, 2004, filed on March 31,
                2005.10.08
            
            Tenth
              Amendment, dated November 11, 2005, to Credit and Security Agreement,
              by and between Registrant (f/k/a Storage Area Networks, Inc.) and Wells
              Fargo Business Credit, Inc. Incorporated by reference to Exhibit 10.1
              to the Registrant’s Current Report on Form 8-K dated
              November 11, 2005, filed on November 17,
              2005.




47




**Exhibit**
              **Number**
            
            **Description**10.09
            
            Patent
                and Trademark Security Agreement, dated September 22, 2003, by and
                between the Registrant and Wells Fargo Business Credit, Inc. Incorporated
                by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on
                Form 10-QSB for the quarter ended September 30, 2003, filed on
                November 13, 2003.10.10
            
            Eleventh
                Amendment to Credit and Security Agreement and Waiver of Defaults,
                dated
                as of April 17, 2006, by and among SANZ Inc., Solunet Storage, Inc.
                and
                Wells Fargo Bank, National Association, acting through its Wells
                Fargo
                Business Credit operating division. Incorporated by reference to
                Exhibit
                10.01 to the Registrant's Quarterly Report on Form 10-Q for the fiscal
                quarter ended March 31, 2006, filed on May 15, 2006.10.11
            
            Twelfth
                Amendment to Credit and Security Agreement, dated as of March 29,
                2007, by
                and among SANZ Inc., Solunet Storage, Inc. and Wells Fargo Bank,
                National
                Association, acting through its Wells Fargo Business Credit operating
                division. #10.12
            
            Shareholders
                Agreement dated April 4, 2003. Incorporated by reference from
                Exhibit 2.8 to the Registrant’s Current Report on Form 8-K/A
                dated April 4, 2003, filed on April 21, 2003.10.13
            
            Credit
                Support Document dated March 31, 2003. Incorporated by reference
                to
                Exhibit 2.3 to the Registrant’s Current Report on Form 8-K/A dated April
                1, 2003, filed on April 3, 2003.10.14
            
            Stock
                Option Agreement dated March 31, 2003. Incorporated by reference to
                Exhibit 2.2 to the Registrant’s Current Report on Form 8-K dated
                April 4, 2003, filed on April 21, 2003.10.15
            
            SANZ
                Common Stock Purchase Warrant dated April 4, 2003. Incorporated by
                reference to Exhibit 2.4 to the Registrant’s Current Report on
                Form 8-K/A No. 1 dated April 1, 2003, filed on
                April 3, 2003.10.16
            
            Management
                Services Agreement dated April 4, 2003. Incorporated by reference to
                Exhibit 2.5 to the Registrant’s Current Report on Form 8-K/A
                No. 1 dated April 1, 2003, filed on April 3,
                2003.10.17
            
            Registration
                Rights Agreement dated April 4, 2003. Incorporated by reference to
                Exhibit 2.6 to the Registrant’s Current Report on Form 8-K/A
                No. 1 dated April 1, 2003, filed on April 3,
                2003.10.18
            
            SAN
                Holdings, Inc - Harris Trust and Savings Bank Loan dated May 16,
                2003. Incorporated by reference to Exhibit 10.6 to the Registrant’s
                Quarterly Report on Form 10-QSB/A No. 1 for the quarter ended
                June 30, 2003, filed on October 2, 2003.10.19
            
            First
                Amendment, dated June 13, 2003, to San Holdings, Inc. - Harris Trust
                and Savings Bank Loan Authorization Agreement. Incorporated by reference
                to Exhibit 10.7 to the Registrant’s Quarterly Report on
                Form 10-QSB/A No. 1 for the quarter ended June 30, 2003,
                filed on October 2, 2003.10.20
            
            Second
                Amendment, dated June 20, 2003, to SAN Holdings Inc. - Harris Trust
                and Savings Bank Loan Authorization Agreement. Incorporated by reference
                to Exhibit 10.8 to the Registrant’s Quarterly Report on
                Form 10-QSB/A No. 1 for the quarter ended June 30, 2003,
                filed on October 2, 2003.10.21
            
            Third
                Amendment, dated August 14, 2003, to SAN Holdings Inc. - Harris Trust
                and Savings Bank Loan Authorization Agreement. Incorporated by reference
                to Exhibit 10.9 to the Registrant’s Quarterly Report on
                Form 10-QSB/A No. 1 for the quarter ended June 30, 2003,
                filed on October 2, 2003.10.22
            
            Fourth
                Amendment, dated November 26, 2003, to SAN Holdings, Inc. - Harris
                Trust and Savings Bank Loan Authorization Agreement. Incorporated
                by
                reference to Exhibit 10.19 to the Registrant’s Annual Report on
                Form 10-K for the year ended December 31, 2004, filed on March 31,
                2005.10.23
            
            Fifth
                Amendment, dated February 27, 2004, to SAN Holdings Inc. - Harris
                Trust and Savings Bank Loan Authorization Agreement. Incorporated
                by
                reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form
                10-QSB for the fiscal quarter ended March 31, 2004, filed on May
                11, 2004.10.24
            
            Solunet
                Storage Inc. - Harris Trust and Savings Bank Loan Authorization Agreement
                dated August 14, 2003, and Incorporated by reference to
                Exhibit 10.1 - to the Registrant’s Quarterly Report on
                Form 10-QSB/A No. 1 for the quarter ended June 30, 2003,
                filed on October 2, 2003.10.25
            
            First
                Amendment, dated November 22, 2004, to Solunet Storage Inc. - Harris
                Trust
                and Savings Bank Loan Authorization Agreement. Incorporated by reference
                to Exhibit 10.01 to the Registrant’s Current Report on Form 8-K dated
                November 16, 2004, filed on November 22,
                2004.




48




**Exhibit**
              **Number**
            
            **Description**10.26
            
            2000
                Stock Option Plan. Incorporated by reference to Exhibit 99.1 to the
                Registrant’s Registration Statement on Form S-8 (File
                No. 333-81910), filed on January 31, 2002.10.27
            
            2001
                Stock Option Plan. Incorporated by reference to Exhibit 99.2 to the
                Registrant’s Registration Statement on Form S-8 (File No. 333-81910),
                filed on January 31, 2002.10.28
            
            2003
                Stock Option Plan. Incorporated by reference to Exhibit 10.22 to
                the
                Registrant’s Annual Report on Form 10-KSB for the year ended
                December 31, 2003, filed on April 22, 2003.10.29
            
            Executive
                Employment Agreement dated February 1, 2001 - John Jenkins.
                Incorporated by reference to Exhibit 10.7 to the Registrant’s Annual
                Report on Form 10-KSB for the year ended December 31, 2001,
                filed on April 1, 2002.10.30
            
            Executive
                Employment Letter Agreement dated March 2, 2007 between SAN Holdings,
                Inc.
                and Todd A. Oseth dated March 2, 2007. #10.31
            
            Separation
                and General Release Agreement, executed March 2, 2007 and effective
                as of
                May 11, 2007 between SAN Holdings, Inc. and John Jenkins.
                #10.32
            
            Sixth
                Amendment, dated February 16, 2005, to SAN Holdings Inc. - Harris
                Trust
                and Savings Bank Loan Authorization Agreement. Incorporated by reference
                to Exhibit10.01
                to the Registrant’s Current Report on Form 8-K dated March 10, 2005, filed
                on March 11, 2005.10.33
            
            Seventh
                Amendment, dated June 3, 2005, to SAN Holdings Inc. - Harris Trust
                and
                Savings Bank Loan Authorization Agreement. Incorporated by reference
                to
                Exhibit 10.01 to the Registrant’s Current Report on Form 8-K dated June 3,
                2005, filed on June 7, 2005.10.34
            
            Eighth
                Amendment, dated October 4, 2005, to SAN Holdings Inc. - Harris Trust
                and
                Savings Bank Loan Authorization Agreement. Incorporated by reference
                to
                Exhibit 10.01 to the Registrant’s Current Report on Form 8-K dated October
                4, 2005, filed on October 12, 2005.10.35
            
            Ninth
                Amendment, dated February 6, 2006, to SAN Holdings Inc. - Harris
                Trust and
                Savings Bank Loan Authorization Agreement. Incorporated by reference
                to
                Exhibit 10.01 to the Registrant’s Current Report on Form 8-K dated
                February 6, 2006, filed on February 9, 2006.10.36
            
            Tenth
                Amendment to the Loan Authorization Agreement, executed April 19,
                2006 and
                effective March 2, 2006, between Sun Solunet, LLC and the Company.
                Incorporated by reference to Exhibit 10.04 to the Registrant’s Current
                Report on Form 8-K dated April 18, 2006, filed on April 21,
                2006.10.37
            
            Security
                Agreement, dated October 12, 2005, by and between Registrant and
                Avnet,
                Inc. Incorporated by reference to Exhibit 10.1 to the Registrant’s Current
                Report on Form 8-K dated October 12, 2005, filed on October 18,
                2005.10.38
            
            Letter
                Agreement, dated November 23, 2005, by and between Registrant and
                Sun
                Capital Partners II, LP. Incorporated by reference to Exhibit 10.1
                to the
                Registrant’s Current Report on Form 8-K, dated November 23, 2005, filed on
                November 29, 2005.10.39
            
            Securities
                Purchase Agreement, dated February 28, 2006. Incorporated by
                reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
                dated March 2, 2006, filed on March 8, 2006.10.40
            
            Credit
                Support Termination Agreement, dated as of March 2, 2006, to the
                letter
                agreement dated as of March 31, 2003, as amended on November 23,
                2005, by
                and between Sun Capital Partners II, LP and the Company, acknowledged
                and
                agreed to by Sun Solunet, LLC. Incorporated by reference to Exhibit
                9.1 to
                the Registrant's Current Report on Form 8-K dated March 2, 2006,
                filed on
                March 8, 2006.10.41
            
            Letter
                from Sun Solunet, LLC dated March 2, 2006. Incorporated by reference
                to
                Exhibit 9.1 to the Registrant's Current Report on Form 8-K dated
                March 2,
                2006, filed on March 8, 2006.10.42
            
            Registration
                Rights Agreement, dated February 28, 2006, by and among the Company
                and
                the purchasers that executed a signature page thereto. Incorporated
                by
                reference to Exhibit 10.02 to the Registrant’s Current Report on Form 8-K
                dated March 2, 2006, filed on March 8, 2006.10.43
            
            Form
                of the Company Common Stock Purchase Warrants issued on March 2,
                2006.
                Incorporated by reference to Exhibit 10.03 to the Registrant’s Current
                Report on Form 8-K dated March 2, 2006, filed on March 8,
                2006.10.44
            
            Securities
              Purchase Agreement, dated as of April 18, 2006, by and among the Company
              and the purchasers that executed a signature page thereto. Incorporated
              by
              reference to Exhibit 10.01 to the Registrant’s Current Report on Form 8-K
              dated March 2, 2006, filed on March 8,
              2006.




49




**Exhibit**
              **Number**
            
            **Description**10.45
            
            Form
                of the Company Common Stock Purchase Warrants issued on April 18,
                2006.
                Incorporated by reference to Exhibit 10.03 to the Registrant's Current
                Report on Form 8-K dated April 18, 2006, filed on April 21,
                2006.10.46
            
            Securities
                Purchase Agreement, dated as of May 4, 2006, by and between the Company
                and Millennium Partners, L.P. Incorporated by reference to Exhibit
                10.01
                to the Registrant's Current Report on Form 8-K dated May 4, 2006,
                filed on
                May 9, 2006.10.47
            
            Form
                of the Company Common Stock Purchase Warrants issued on May 4, 2006.
                Incorporated by reference to Exhibit 10.03 to the Registrant's Current
                Report on Form 8-K dated May 4, 2006, filed on May 9,
                2006.10.48
            
            Harris
                Loan Authorization Agreement, dated as of October 27, 2006, between
                SAN
                Holdings, Inc. and Harris N.A. Incorporated by reference to Exhibit
                10.01
                of the Registrant’s Current Report on Form 8-K filed on November 2,
                2006.10.49
            
            First
                Amendment to Harris Loan Authorization Agreement, dated as March
                12, 2007,
                between SAN Holdings, Inc. and Harris N.A. Incorporated by reference
                to
                Exhibit 10.01 of the Registrant’s Current Report on Form 8-K filed on
                March 14, 2006.10.50
            
            Second
                Amendment to Harris Loan Authorization Agreement, dated as of March
                23,
                2007, between SAN Holdings, Inc. and Harris N.A. Incorporated by
                reference
                to Exhibit 10.01 of the Registrant’s Current Report on Form 8-K filed on
                March 27, 2006.10.51
            
            Agreement,
                dated as of November 22, 2006, among SAN Holdings, Inc. and the investors
                that are a signatory thereto (2006 private placement investors).
                Incorporated by reference to Exhibit 10.01 of the Registrant’s Quarterly
                Report on Form 10-Q for the fiscal quarter ended September 30, 2006
                filed
                on November 27, 2006.14.01
            
            Code
                of Ethics for Officers of SAN Holdings, Inc. and Subsidiaries, adopted
                on
                May 7, 2004. Incorporated by reference to Exhibit 14.1 to the Registrant’s
                Quarterly Report on Form 10-QSB for the fiscal quarter ended March
                31,
                2004, filed on May 11, 2004.22.01
            
            List
                of Subsidiaries. Incorporated by reference to Exhibit 22.01 to the
                Registrant’s Annual Report on Form 10-K for the year ended December
                31, 2004, filed on March 31, 2005.23.01
            
            Consent
                of Grant Thornton LLP. #31.01
            
            CEO
                Certification pursuant to Rule 13a-14(a)/15(d)-14(a).
                #31.02
            
            CFO
                Certification pursuant to Rule 13a-14(a)/15(d)-14(a).
                #32.01
            
            CEO
                Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002 (18 U.S.C. 1350). #32.02
            
            CFO
                Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002 (18 U.S.C. 1350). #







#
        Filed
        herewith.




50




**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
      the
      registrant has caused this report to be signed on its behalf by the undersigned,
      thereunto duly authorized.


SAN
                Holdings, Inc.
              (Registrant)Date:
                April 16, 2007
            By:
            /s/ Todd
              A.
              OsethTodd
                Oseth
              Chief
                  Executive Officer
                (Principal
                    Executive Officer)




In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.




Date: April 16,
              2007
            
            /s/ Todd
              A.
              OsethTodd
                A. Oseth, Chairman of the Board,
              Chief
                Executive Officer (Principal Executive
                Officer)


Date: April 16,
                2007
              
              /s/ Robert
                C.
                OgdenRobert
                  C. Ogden, Chief Financial Officer
                  (Principal
                    Financial Officer and Principal
                  Accounting
                    Officer), Secretary and
                  Treasurer
 Date: April 16,
                    2007
                  
                  /s/ Clarence
                    E. TerryClarence
                        E. Terry, Director
  Date: April 16,
                        2007
                      
                      /s/ Michael
                        T. GillenMichael
                            T. Gillen, Director
  Date: April 16,
                            2007
                          
                          /s/ Case
                            H.
                            KuehnCase
                                H. Kuehn, Director


Date: April 16,
                  2007
                
                /s/ M.
                  Steven
                  LiffM.
                    Steven Liff, Director
  Date: April 16,
                      2007
                    
                    /s/ Kevin
                      J. CalhounKevin
                        J. Calhoun, Director
 Date: April 16,
                          2007
                        
                        /s/ Kent
                          J. LundKent
                              J. Lund, Director
 Date: April 16,
                              2007
                            
                            /s/ C.
                              Daryl
                              HollisC.
                                  Daryl Hollis, Director
  Date: April 16,
                                  2007
                                
                                /s/ George
                                  R.
                                  ReaGeorge
                                      R. Rea, Director
  51