**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, 2005




**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.
                EmployerIdentification
                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 checkmark 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,
      2005) ,
      was
      approximately  $8.8
      million.




As
      of
      March 23, 2006, 95,811,278 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 2006
      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
            122.
            
            Properties
            123.
            
            Legal
                Proceedings
            124.
            
            Submission
                of Matters to a Vote of Security Holders
            12





**Part
      II**





5.
            
            Market
                forRegistrant’s
                CommonEquity,Related
                Stockholder Matters and Issuer Purchases of Equity
                Securities
            136.
            
            Selected
                Financial Data
            147.
            
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            177A.
            
            Quantitative
                and Qualitative Disclosures about Market Risk
            358.
            
            Financial
                Statements and Supplementary Data
            359.
            
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            359A.
            
            Controls
                and Procedures
            359B.
            
            Other
                Information
            36





**Part
      III**





10.
            
            Directors
                and Executive Officers of the Registrant
            3611.
            
            Executive
                Compensation
            3612.
            
            Security
                Ownership of Certain Beneficial Owners and Managementand
                Related Stockholder Matters
            3613.
            
            Certain
                Relationships and Related Transactions
            3614.
            
            Principal
                Accountant Fees and Services
            36**Part
                IV**15.
            
            Exhibits
                and Financial Statement Schedules
            37




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. Further details of the transaction in
      which
      we acquired Solunet Storage are
      included below in Note 5 to our consolidated financial statements included
      in
“Item 15. Exhibits and Financial Statement Schedules” (“Item 15”) and under the
      section of this report titled “ Item
      13.
      Certain Relationships and Related Transactions, ” and can
      also be found in a Form 8-K dated April 4, 2003 filed by the Company on April
      21, 2003 and amended September 25, 2003 and March 31, 2004.





As
      further discussed in Notes 1 and 5 to our consolidated financial
      statements included
      in Item 15 ,
      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.





2





Our
      principal executive offices are located at 9800 Pyramid Court, Suite 130,
      Englewood, CO 80112. Our telephone number is (303) 660-3933.




**Products
      and Services**




Beginning
      in 2005, we are reporting our operations as two business segments: (1) 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
                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 12 to the consolidated financial statements
      included in Item 15, 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
      (“SAN”) and network attached storage (“NAS”) 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.





SAN
      and
      NAS 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 those 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.





SAN
      and
      NAS have become accepted solutions for data storage, and are increasingly
      replacing traditional server-based (or “direct-attached”) storage architectures
      in which the storage device is incorporated into a single server or otherwise
      dedicated to a single computing device. SAN and NAS have been 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 by multiple servers both locally and over
      long distances, thereby increasing resource utilization and allowing the data
      to
      be shared, managed and accessed by diverse end-users operating on diverse
      servers, even those running different computer operating systems or software
      applications. 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. In addition, centralizing and networking
      an
      organization’s data storage can provide superior system performance, which is
      particularly important for applications that depend on the transfer of high
      volumes of data such as those often found in complex research and development,
      financial analysis, imaging, records management and a variety of business
      services.





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
      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
      53% from 2004 to 2005. In 2005, our revenue from professional services
      represented 9.5% of total revenue as compared to 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 2005, 2004 and 2003. Total EarthWhere license and services revenue
      for each of those years is $1,932,000, $749,000, and $87,000, respectively.
      As
      in 2004, during 2005 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
      increase our revenue in the Federal government sector and operate an office
      of
      approximately 35 people in Vienna, Virginia. The majority of these personnel
      are
      billable engineers and consultants, and for 2005 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 2005 accounted for approximately 39% of total storage solutions
      revenue, of which approximately 44% consisted of sales directly to the Federal
      government and the remaining 56% 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,
      San Jose, Denver, Houston, Dallas, Akron 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.




**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
            ●
                Network Appliance
            ●
                ADIC
            ●
                Avnet
            ●
                Arrow Electronics




●
                Sun Microsystems (including Sun-branded Hitachi Data Systems
                products)





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.





5





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 Washington, DC. 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,
      although we have begun to engage third parties to sell our software in a
“channel distribution” model. Currently, our direct sales efforts are focused
      within the United States, but as part of our channel distribution model we
      have
      also entered into a distribution agreement with a third-party for pursuit of
      EarthWhere sale opportunities in certain regions outside of 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 more than 17% and 24% of
      our
      total company revenue in 2005 and 2004, respectively. Additionally, separate
      branches and agencies within the U.S. Department of Defense (which undertake
      buying decisions independently of one another) taken together accounted for
      approximately 12% and 17% of our total company revenue in 2005 and 2004,
      respectively. While we currently do not have any expectation that the U.S.
      Department of Defense as a whole will cease or significantly reduce its levels
      of business with us, if it were to do so, that cessation or 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 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. Additionally, for 2005 and 2004, our third quarter sales have been
      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 $1.9 million and $1.8 million
      at December 31, 2005 and December 31, 2004, 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 ADIC, EMC, 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 2005, 2004 and 2003 were approximately
      $1,130,000, $589,000 and $332,000, respectively. All amounts incurred relate
      to
      EarthWhere  software
      development efforts. During 2005, we continued to enhance the functionality
      of
      EarthWhere with the release of version 4.0. 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, 2005, we employed 124 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.





***We
      may not be successful in generating revenue and gross profit at levels
      sufficient to cover our operating costs and cash investment requirements.***





We
      incurred a net loss of $15.8 million in 2005. We have incurred operating losses
      in each of the last three years (2003-2005) and have not had a profitable
      quarter since our inception as a public reporting company. However, from 2003
      to
      2004, we reduced our operating losses from $5.2 million in 2003 to $3.5 million
      in 2004, and, although our 2005 operating loss was $11.3 million, it included
      a
      non-cash charge of $9.2 million for a goodwill impairment related to our Storage
      Solutions segment. These operating loss reductions have occurred even as we
      have
      continued to increase our investment in the development, sales and distribution
      build-out of our EarthWhere segment over this same period. In our Storage
      Solutions segment, we continue to focus on growing our professional services
      revenue as an important means for increasing gross profits. Although 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.





***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.





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 receive much more frequently than in the past, 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.





8





***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.***





As
      discussed previously in “Item 1. Business,” approximately 39% of our 2005 sales
      were to Federal government customers or to support Federal government projects.
      Moreover, various agencies and branches of the U.S. Department of Defense,
      taken
      together, accounted for approximately 12% of total sales in 2005. 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 Bank, National
      Association (“Wells Fargo”), however, funds available 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 was to accelerate the
      loan, we would need to obtain cash from other sources to repay the loan. At
      December 31, 2005, we had $7.3 million of outstanding debt and $1.7 million
      of
      availability on our revolving credit facility with Wells Fargo. Additionally,
      we
      had $6,000 of cash and a working capital deficit (current liabilities greater
      than current assets) of $19.6 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.





These
      matters are discussed further in “ Item
      7. Management’s
      Discussion and Analysis of Financial Condition and Results of Operations — Liquidity
      and
      Capital Resources.”





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





From
      inception through December 31, 2005, we have invested approximately $7 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 additional working capital for our
      Company, on March 2, 2006, we completed a private placement transaction exempt
      from registration under the Securities Act of 1933, as amended pursuant to
      Section 4 (2) and Regulation D promulgated thereunder. The securities issued
      by
      the Company in this private placement transaction consisted of convertible
      preferred stock with common stock purchase warrants sold to a limited number
      of
      outside, accredited investors and the Company’s management, which generated
      approximately $2.5 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 the Company’s
      outstanding debt to the Company’s convertible preferred stock. Additionally, Sun
      Solunet and the Company agreed to execute a new borrowing agreement whereby
      the
      remaining Sun Solunet debt of $5.0 million would be converted to a three-year
      term note, which will be due in March 2009.





9





We
      believe that our current sources of capital, which includes our Wells Fargo
      credit facility, the term loan with Sun Solunet, current credit lines with
      our
      suppliers and the recent cash equity infusion, provides us adequate liquidity
      to
      operate for the next twelve months, assuming we operate at our current gross
      profit levels. However, there can be no assurance that we will operate at
      sufficient gross profit levels, in which case it would be necessary to further
      cut costs or raise additional debt or equity capital, or a combination of the
      two. No assurance can be given that additional financing will be available
      or
      that, if available, it will be on terms favorable to us.





These
      matters are discussed further in “ Item
      7. Management’s
      Discussion and Analysis of Financial Condition and Results of Operations -
      Liquidity and Capital Resources.”





***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 2006 we issued convertible preferred stock
      and common stock purchase warrants as part of a private placement transaction
      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 .





***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 2005, 2004 and 2003 of
      approximately $1.9 million, $750,000 and $87,000, respectively. From inception
      through December 31, 2005, we have invested approximately $7 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.





***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 Sun Microsystems, EMC/Legato,
      Hitachi Data Systems, and Network Appliance. 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.




10


***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
      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
      December 31, 2005, Sun Solunet owned approximately 58.4%
      of
      our outstanding shares of
      common
      stock, and with its ownership in the Company’s issuance of convertible Series A
      Preferred Stock in March 2006, owns approximately 65% of our outstanding common
      stock on an “as converted” basis. These
      shares give Sun Solunet the power to elect a majority of our board of
      directors and, through that board control, set direction for the Company. The
      ability of other shareholders to influence the direction of the Company (for
      example, through the election of directors) is therefore limited.





***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.***





Sun
      Solunet owns approximately 65% of the Company’s common stock (assuming the
      conversion of the outstanding convertible Series A Preferred Stock held by
      Sun
      Solunet). If Sun Solunet were to begin selling shares in the market rather
      than
      hold all of those shares over a longer term, the added availability 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 it shares at a price lower
      than the currently-prevailing market price, thereby depressing that price.





***No
      dividends.***





SANZ
      has
      never paid cash dividends on its common stock. We do not contemplate paying
      dividends 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.
      See “ Item
      5. Market
      for Common Equity and Related Stockholder Matters — Dividend
      Policy.”





***Our*** ***articles*** ***of*** ***incorporation*** ***permit us to issue preferred stock with rights superior to the common stock.***





We
      are
      authorized under our articles
      of incorporation to issue up
      to 10,000,000 shares of preferred stock. Our
      board of directors has the
      power to establish the dividend rates, liquidation preferences, voting rights,
      redemption and conversion terms and privileges with respect to any series of
      preferred stock. 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. Preferred shares could also be issued as a device
      to
      prevent a change in control of SANZ.





***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.




11


**Item
        1B. Unresolved Staff Comments**
 
 Not
        applicable.
 
 **Item
        2. Properties**
 
 We do
        not
        own any real property. We occupy approximately 9,595
        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 $14,000
        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 (1)
            
            
            Headquarters,
                executive and administrative offices, as well as data center and
                research
                and development
            
            
            9,595
            
            
            100
            %Richardson,
                TX
            
            
            Call
                center, data center, engineering management and regional sales
                office
            
            
            9,546
            
            
            90
            %Vienna,
                VA (2)
            
            
            Engineering
                management and regional sales office
            
            
            4,720
            
            
            100
            %Stafford,
                TX
            
            
            Regional
                sales office
            
            
            3,422
            
            
            90
            %Campbell,
                CA
            
            
            Regional
                sales office
            
            
            1,680
            
            
            75
            %Seattle,
                WA
            
            
            Regional
                sales office
            
            
            1,967
            
            
            100
            %







(1)
      We
      have entered into a three-year lease agreement beginning February 2006 for
      an
      additional 5,354 square feet in our Englewood, CO office to house the EarthWhere
      group.




(2)
      We
      have entered into a three-year lease agreement beginning in February 2006 for
      an
      additional 1,830 square feet adjacent to the current office in Vienna, VA.





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 2005.





12





**PART
      II**





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





Our
      common stock is quoted on the 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 2005 and 2004. 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
                Stock$
                High
            
            $
                Low**2005**First
                Quarter
            
            $
            0.45
            
            $
            0.28Second
                Quarter
            
            
            0.33
            
            
            0.18Third
                Quarter
            
            
            0.29
            
            
            0.20Fourth
                Quarter
            
            
            0.24
            
            
            0.18**2004**First
                Quarter
            
            
            0.66
            
            
            0.48Second
                Quarter
            
            
            0.54
            
            
            0.38Third
                Quarter
            
            
            0.44
            
            
            0.24Fourth
                Quarter
            
            
            0.43
            
            
            0.24





On
      March
      23, 2006, the last reported sale price for our common stock was $0.23.





**Holders**





As
      of
      March 23, 2006, there were 95,811,278 shares of SANZ 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 .





13


**Equity
      Compensation Plan Information**





The
      following table sets forth information regarding compensation plans (including
      individual compensation arrangements) in effect at December 31, 2005, under
      which equity securities are authorized for issuance, aggregated as follows:
      (i)
      all compensation plans previously approved by shareholders; and (ii) all
      compensation plans not previously approved by shareholders.





**Plan
                Category**
            
            **Number
                of securities to**
              **be
                issued upon exercise of outstanding options,**
              **warrants
                and rights**
            
            **Weighted-average**
              **exercise**
              **price
                of outstanding**
              **options,
                warrants and****rights**
            
            **Number
                of securities**
              **remaining
                available for**
              **future
                issuance under**
              **equity
                compensation plans**
              **(excluding
                securities**
              **reflected
                in column (a))**(a)
            
            (b)
            
            (c)Equity
                compensation plans approved by security holders
            
            
            573,031
                (1
            )
            $
            2.05
            
            
            -0-Equity
                compensation plans not approved by security holders
            
            
            9,957,638
            
            $
            0.45
            
            
            9,952,001Total
            
            
            10,530,669
                (1
            )
            $
            0.54
            
            
            9,952,001





(1)
      Excludes 600,000 options with an exercise price of $0.70 per share that failed
      to vest at accelerated dates when specified performance targets were not met
      at
      those dates, but that will vest if the holder is still employed by us on March
      26, 2013.





**Description
      of Non-Shareholder Approved Plans**





On
      September 20, 2001, our board of directors adopted
      the 2001 Stock Option Plan. At December 31, 2005 , the
      total number of shares of common stock reserved for options issuable under
      this
      plan was 5,000,000. Options granted under the plan vest generally over three
      to
      ten years. The exercise price of options granted under this plan is
      required to be  not
      less
      than 80% of the fair market value per share on the date of option grant. With
      the exception of “roll-over” options that were included in the plan upon our
      acquisition of ITIS Services (i.e., options previously issued by ITIS Services
      that we assumed in that acquisition), all options granted to date under the
      plan
      have had an exercise price equal to, or in excess of, fair market value at
      the
      date of grant.





On
      December 18, 2003, our board of directors adopted
      the 2003 Stock Option Plan. At December 31, 2005 , the
      total number of shares of common stock reserved for options issuable under
      this
      plan was 15,000,000. Options granted under the plan generally vest over
      four
      years. The exercise price of options granted under this plan is
      equal
      to the
      fair market value per share on the date of option grant. All options granted
      to
      date under the plan have had an exercise price equal to fair market value at
      the
      date of grant.





**Issuer
      Purchases of Equity Securities**





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





**Item
      6. Selected Financial Data**





The
      fiscal year 2005, 2004, and 2003 statements of operations data, and the 2005
      and
      2004 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 2002 and 2001 and the balance
      sheet data for 2003 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.





14





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 the consolidated financial statements and associated notes
      found in Item 15 .





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






StorNet,
                    Inc.**Consolidated
                    Statement of**
                  **Operations
                    Data**
                
                Jan.
                    1, 2002 to
                  Sept.
                    25, 2002
                
                Year
                    ended
                  December
                    31, 2001Revenue
                
                $
                42,446
                
                $
                97,441Loss
                    from operations
                
                
                (9,556
                )
                
                (19,815
                )Net
                    loss
                
                
                (10,362
                )
                
                (22,012
                )Basic
                    and diluted loss per share
                
                $
                (0.52
                )
                $
                (1.24
                )**Balance
                    Sheet Data:**Working
                    capital (deficit)
                
                
                (32,876
                )
                
                (24,873
                )Total
                    assets
                
                
                10,997
                
                
                25,626Total
                    long-term debt
                
                
                --
                
                
                63Total
                    stockholders’ deficit
                
                
                (32,087
                )
                
                (21,726
                )


(1)
            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 LLC (“Sun Solunet”),
                pursuant to a debt guaranty provided by Sun Capital Partners II,
                LP (“Sun
                Capital II”), an affiliate of Sun Solunet, on our revolving credit lines
                with Harris N.A. (formerly known as Harris Trust and Savings Bank)
                (“Harris”). See further discussion in “Item 7. Management’s Discussion and
                Analysis of Financial Condition and Results of
                Operations.”





(2)
            The
                2005 loss from operations and net loss included a charge in the amount
                of
                $9.2 million for goodwill impairment related to our Storage Solutions
                segment. See further discussion in “Item 7. Management’s Discussion and
                Analysis of Financial Condition and Results of
                Operations.”




15





**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**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
            
            
            3,352
            
            (1)Net
                loss
            
            
            (1,513
            )
            
            (1,560
            )
            
            (506
            )
            
            (12,224
            )
            (2)Net
                loss per share, basic and diluted
            
            
            (0.01
            )
            
            (0.01
            )
            
            (0.00
            )
            
            (0.11
            )**2004**Net
                sales
            
            $
            16,839
            
            $
            15,248
            
            $
            17,965
            
            $
            16,106Gross
                Profit
            
            
            3,933
            
            
            2,979
            
            
            3,825
            
            
            3,213
            
            (3)Net
                loss
            
            
            (484
            )
            
            (1,572
            )
            
            (308
            )
            
            (4,386
            )
            (4)Net
                loss per share, basic and diluted
            
            
            (0.01
            )
            
            (0.02
            )
            
            (0.00
            )
            
            (0.04
            )


(1)
              For
                  the first, second and third quarters of 2005, gross profit as reported
                  above was lower by $21,000, $21,000 and $36,000, respectively,
                  than
                  previously reported in our Quarterly Reports on Form 10-Q and 10-Q/A
                  as a
                  result of the reclassification of amortization of capitalized software
                  costs from operating expense to cost of revenue.(2)
              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
                  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
                  further
                  discussion in “Item 7. Management’s Discussion and Analysis of Financial
                  Condition and Results of
                  Operations.”


(3)
                For
                    the four quarters of 2004, gross profit as reported above is
                    lower by
                    $189,000, $140,000, $239,000 and $82,000, respectively, than
                    previously
                    reported in our Quarterly Reports on Form 10-Q. The differences
                    are the
                    result of the reclassification of reimbursements from certain
                    suppliers of
                    marketing development expense from cost of revenue to selling,
                    general and
                    administrative expense, and the reclassification of amortization
                    of
                    capitalized software costs from operating expense to cost of
                    revenue. For
                    the 2004 year, the total amount of marketing development reimbursements
                    and amortization of capitalized software development costs were
                    approximately $550,000 and $100,000, respectively.(4)
                The
                    fourth quarter of 2004 includes a charge of $2.5 million related
                    to a
                    stock purchase warrant issued to Sun Solunet in consideration
                    for a
                    guaranty provided by Sun Capital II on our revolving credit lines
                    with
                    Harris. See further discussion in “Item 7. Management’s Discussion and
                    Analysis of Financial Condition and Results of
                    Operations.”The
                    fourth quarter of 2004 also includes approximately $850,000 of
                    expenses
                    related to closed offices and employee severance. Of this amount,
                    approximately $500,000 was an accrual for remaining lease and
                    severance
                    agreements to be paid in 2005 and
                    2006.


16





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





**General**





SANZ’
      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 further
      discussed in Notes 1 and 5 to our consolidated financial statements included
      under Item 15 of this report ,
      the
      transaction was accounted for as a reverse acquisition, 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.





**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:





·
            ***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
                services***on
                storage hardware and software;·
            ***Storage-related
                professional services***;·
            ***A
                proprietary data management software product known as
                “EarthWhereTM”***(“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.
      While  the
      market for data storage solutions is large (sources such as VARBusiness
      magazine estimated the 2004 global storage services market at
      $23.5
      billion in an August, 2004 publication), 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.


17


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, a 45% increase.
      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.).





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





18





●
            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;●
            Borderpatrolenforcement teams who use imagery to plan for more effective “route”
                control and intercept;●
            Oil
                and gas and minerals exploration analysts;●
            Emergencymanagementteams 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 completely support 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 penetrated a number of Federal agencies that hold significant potential
      for broad application of the EarthWhere software product. 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. Our
      business development efforts through 2005 have been primarily founded on a
      direct sales model, though we have taken steps to develop a channel sales model.
      We expect to increase revenue in 2006 as we continue to invest in building
      out
      our sales and distribution model and move some of our existing clients from
      department to “enterprise” use of the product.





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.





19





Currently
      we believe that we have nominal direct competition for the EarthWhere product.
      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 2005, we
      capitalized $911,000 of software development costs related to EarthWhere, and
      expensed $219,000 in research and development costs related
      thereto.





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 management organizational structure as of January 1, 2005.
      A
      detailed description of the products and services, as well as financial data,
      for each segment can be found in Note 12 to the consolidated financial
      statements included in Item 15. Based on the way in which management reviews
      and
      evaluates segment performance, the segment operating results shown below for
      2005, 2004 and 2003 do not include non-allocated corporate expenses, interest
      expense, charges for debt guaranty warrants 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)
            
            **2005**
            
            **2004**
            
            **2003**Net
                revenueProduct
                sales and vendor supplied services
            
            $
            43,333
            
            $
            53,970
            
            $
            47,522Consulting
                and engineering services
            
            
            4,773
            
            
            3,272
            
            
            2,120Maintenance
                services and contract fees
            
            
            8,895
            
            
            7,763
            
            
            5,748Total
                net revenue
            
            $
            57,001
            
            $
            65,005
            
            $
            55,390Gross
                Profit
            
            
            13,440
            
            
            13,388
            
            
            12,940Loss
                from operations (1)
            
            
            (8,851
            )
            
            (1,578
            )
            
            (1,436
            )





(1)
      For
      2005, this included a non-cash charge in the amount of $9.2 million for goodwill
      impairment.





Storage
      Solutions revenue decreased by 12% from 2004 to 2005, but yielded higher gross
      profit year over year. Storage Solutions generated positive income from
      operations for the first time in 2005, excluding the non-cash charge of $9.2
      million for goodwill impairment, based on higher gross margins and lower
      operating costs than in previous years. Higher professional services revenue
      year on year was a primary factor in increasing gross margins from 2004 to
      2005.
      Our commercial sector faced more difficult general market conditions in their
      small-to-midsize business market segment than anticipated and had lower rates
      of
      professional services, primarily from the continued shift from tape to disk
      product concentration. Our Federal Storage Solutions business executed
      successfully its professional service growth strategy, with an increase in
      billable consultants and engineers of more than 20 over 2004.




20





EarthWhere





(in
                thousands)
            
            **2005**
            
            **2004**
            
            **2003**Net
                revenueEarthWhere
                licenses and services
            
            $
            1,932
            
            $
            749
            
            $
            87Other
                hardware and software
            
            
            182
            
            
            404
            
            
            20Total
                net revenue
            
            $
            2,114
            
            $
            1,153
            
            $
            107Gross
                Profit
            
            
            1,398
            
            
            562
            
            
            35Loss
                from operations
            
            $
            (1,732
            )
            $
            (1,453
            )
            $
            (1,207
            )





EarthWhere
      revenue increased by 84% from 2004 to 2005, and sales of our software licenses
      increased nearly three-fold, from $316,000 in 2004 to $926,000 in 2005. In
      October 2005, we sold our largest single software license of $365,000. In
      addition, our EarthWhere consulting and engineering service revenue more than
      doubled in 2005 as compared to 2004. At the same time, we have significantly
      increased our investment in expanding the EarthWhere business, with the number
      of dedicated EarthWhere employees increasing from 5 to 15 to 26 at December
      31,
      2003, 2004 and 2005, respectively. Operating expenses, including an allocation
      for general and administrative expenses, increased from $1,307,000 in 2003
      to
      $2,114,000 in 2004, and to $3,265,000 in 2005.




**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 and those relating to the
      impairment testing of goodwill and intangible assets.





***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 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.





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.





21





EarthWhere
      License Fees





The
      Company recognizes revenue on EarthWhere license fees in accordance with the
      American Institute of Certified Public Accountants’ 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 other applicable authoritative accounting literature.





For
      software 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.
      The Company’s software license agreements generally do not include multiple
      products and services. 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.





Service
      sales





Service
      revenue, including material installation services, is recognized as the related
      services are completed.





Maintenance
      Services





The
      Company provides “first call” technical support for certain hardware and
      software products that we sell. For maintenance services on these products,
      we
      defer the associated revenue at the inception of the contract, and recognize
      revenue on a straight-line basis over its contractual terms. Likewise, we defer
      the costs of such maintenance contracts and amortize them on a straight-line
      basis over their contractual terms.





Maintenance
      services on EarthWhere licenses are billed separately from the license fees
      and
      include post-contract customer support (“PCS”) along with unspecified upgrades
      and enhancements. Revenue from these maintenance agreements is recognized on
      a
      straight-line basis over their contractual terms.





Maintenance
      contract fees





For
      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.





Multiple
      deliverable arrangements





In
      accordance with EITF 00-21, for sales transactions that include the resale
      and
      installation of data storage systems and the sale of first call maintenance
      contracts denominated as a single, lump-sum price, we allocate the aggregate
      transaction revenue among the multiple elements based on their relative fair
      values. This process involves the application of management’s judgment and
      estimates regarding those relative fair values.





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.


22




***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, allowances for credit losses on accounts receivable,
      allowances for impairment in the value of inventory, recognition of revenue,
      and
      the useful lives of intangible assets.





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. As you might expect,
      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
      and Intangible Assets





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 we will assess goodwill for impairment more frequently. The
      performance of the 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, we perform
      the
      second step (“Step II test”) 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, 2005, we reviewed goodwill associated with both of our reporting
      units for impairment, and, as part of our assessment, we engaged an independent
      valuation firm (“independent firm”). The independent firm performed its
      valuation using primarily discounted cash flow and comparable public company
      analyses. 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, 2005, we have recorded an impairment charge for goodwill related
      to our Storage Solutions reporting unit in the amount of $9.2 million.





For
      our
      EarthWhere reporting unit in 2005, we concluded that the recorded goodwill
      was
      not impaired. Additionally, for both 2004 and 2003, we concluded that our
      goodwill, as analyzed on a total Company basis, was not impaired.





23





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
      tradenames and customer lists. The usefulness of customer lists declines
      gradually due to customer turnover. In the case of tradenames, 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
      undiscounted cash flows or fair values, whichever is more readily determinable,
      to the carrying value of the related asset.





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.





Inventory





We
      also
      utilize a specific reserve methodology for our inventory, in which we
      periodically review our tangible 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.





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.) Also among these estimates, judgments
      and assumptions are judgments regarding revenue recognition when a particular
      services engagement has achieved completion and recognition of revenue is
      therefore appropriate.





24





***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.





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.





***Recent
      Accounting Pronouncements***





In
      December 2004, the Financial Accounting Standards Board (“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 will
      be
      recognized over the period during which an employee is required to provide
      service in exchange for the award, usually the vesting period. The Company
      is
      required to adopt SFAS 123R at the beginning of 2006.





Under
      SFAS 123R, we must determine the appropriate fair value model to be used for
      valuing share-based payments, the amortization method for compensation cost
      and
      the transition method to be used at date of adoption. The transition methods
      include the modified prospective and modified retrospective adoption options.
      The modified prospective method requires that compensation expense be recorded
      for all unvested stock options and restricted stock over the remaining award
      service period beginning on January 1, 2006, while the modified retrospective
      method requires that all prior periods presented be adjusted to reflect
      compensation expense under the fair value method of accounting for awards
      granted, modified or settled after December 31, 1994. We expect that the
      adoption of SFAS 123R will have a material impact on our consolidated results
      of
      operations and earnings per share. We plan to use the modified prospective
      transition method and will use the Black-Scholes valuation model. We expect
      the
      adoption of SFAS 123R to result in compensation expense amounts that are similar
      to those currently disclosed under SFAS 123.





In
      June
      2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections”
(“SFAS 154”). SFAS 154 supersedes APB Opinion No. 20, “Accounting
      Changes,” and SFAS 3, “Reporting Accounting Changes in Interim Financial
      Statements,” and changes the requirements for the accounting for and reporting
      of a change in accounting principle. SFAS 154 applies to all voluntary changes
      in accounting principle and to changes required by an accounting pronouncement
      in the unusual instance that the pronouncement does not include specific
      transition provisions. SFAS 154 must be adopted for accounting changes and
      corrections of errors made in fiscal years beginning after December 15,
      2005. Early adoption is permitted for accounting changes and corrections of
      errors made in fiscal years beginning after the date SFAS 154 is issued.





The
      Company does not expect the adoption of SFAS No. 154 to have a material
      impact on its financial statements.




**Results
      of Operations**





SANZ
      and
      Solunet Storage Holding merged effective April 1, 2003. As discussed in Notes
      1
      and 5 to our consolidated financial statements included
      in Item 15 ,
      this
      transaction has been accounted for as an acquisition of SANZ by Solunet Storage
      Holding. 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. The results of operations of the acquired business and
      the
      assets of that acquired business are reflected in our consolidated financial
      statements only for the periods after the date of acquisition, April 1, 2003.




When
      we
      refer to the operations or net assets of only one of the constituent businesses,
      independent of the other, we use the term “legacy,” as in “legacy SANZ” or
“legacy Solunet.”


25


**Selected
      Consolidated Statements of Operations Data**





The
      following tables present Consolidated Statements of Operations data for the
      years ended December 31, 2005 and December 31, 2004 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, 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 suppliedservices
            
            $
            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 suppliedservices
            
            
            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.


26


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 (“Federal sector”) 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.





***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 selling, marketing, engineering, and general and
      administrative (“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. We recorded no impairment charge for 2004.





***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. See further discussion regarding the debt
      guaranty warrants issued in the discussion of “—Liquidity and Capital Resources”
below.


27


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


***Compared
      to Results of Operations for the Year Ended December 31, 2003***





(In
                thousands, except for percentages)
            
            **For
                the year ended December 31,**
            
            **$
                Change**
            
            **%
                Change****2004**
            
            %
                of rev
            
            **2003**
            
            %
                of rev
            
            **2003-2004**
            
            **2003-2004****Revenue**Product
                sales and vendor suppliedservices
            
            $
            54,690
            
            
            82.7
            %
            $
            47,597
            
            
            85.8
            %
            $
            7,093
            
            
            14.9
            %Consulting
                and engineering services
            
            
            3,680
            
            
            5.5
            
            
            2,133
            
            
            3.8
            
            
            1,547
            
            
            72.5Maintenance
                services and contract fees
            
            
            7,788
            
            
            11.8
            
            
            5,767
            
            
            10.4
            
            
            2,021
            
            
            35.0Total
                Revenue
            
            
            **66,158**
            
            
            100.0
            
            
            **55,497**
            
            
            100.0
            
            
            **10,661**
            
            
            19.2**Gross
                Profit (% of respective revenue)**Product
                sales and vendor suppliedservices
            
            
            9,939
            
            
            18.2
            
            
            9,938
            
            
            20.9
            
            
            1
            
            
            0.0Consulting
                and engineering services
            
            
            1,549
            
            
            42.1
            
            
            1,066
            
            
            50.0
            
            
            483
            
            
            45.3Maintenance
                services and contract fees
            
            
            2,462
            
            
            31.6
            
            
            1,971
            
            
            34.2
            
            
            491
            
            
            24.9Total
                Gross Profit
            
            
            **13,950**
            
            
            21.1
            
            
            **12,975**
            
            
            23.4
            
            
            **975**
            
            
            7.5**Operating
                expenses**Selling,
                general and administrative
            
            
            14,893
            
            
            22.5
            
            
            15,059
            
            
            27.1
            
            
            (166
            )
            
            (1.1
            )Severance
                and closed office expense
            
            
            1,226
            
            
            1.9
            
            
            --
            
            
            0.0
            
            
            1,226
            
            
            100.0Acquisition-related
                costs
            
            
            34
            
            
            0.0
            
            
            1,987
            
            
            3.6
            
            
            (1,953
            )
            
            (98.3
            )Depreciation
                and amortization ofintangibles
            
            
            1,306
            
            
            2.0
            
            
            1,154
            
            
            2.1
            
            
            152
            
            
            13.2Total
                operating expenses
            
            
            **17,459**
            
            
            26.4
            
            
            **18,200**
            
            
            32.8
            
            
            **(741**
            **)**
            
            (4.1
            )**Loss
                from operations**
            
            
            **(3,509**
            **)**
            
            (5.3
            )
            
            **(5,225**
            **)**
            
            (9.4
            )
            
            **1,716**
            
            
            (32.8
            )Other
                income (expense)Interest
                expense
            
            
            (1,221
            )
            
            (1.8
            )
            
            (817
            )
            
            (1.5
            )
            
            (404
            )
            
            49.4Charge
                for warrants issued to
              relatedparty
                for debt guaranty
            
            
            (2,469
            )
            
            (3.7
            )
            
            --
            
            
            0.0
            
            
            (2,469
            )
            
            100.0Other
                income (expense)
            
            
            121
            
            
            0.1
            
            
            (11
            )
            
            (0.0
            )
            
            132
            
            
            (1200.0
            )Loss
                before income taxes
            
            
            (7,078
            )
            
            (10.7
            )
            
            (6,053
            )
            
            (10.9
            )
            
            (1,025
            )
            
            16.9Income
                tax (expense) benefit
            
            
            328
            
            
            0.5
            
            
            115
            
            
            0.2
            
            
            213
            
            
            185.2**Net
                loss**
            
            
            **(6,750**
            **)**
            
            (10.2
            )%
            **$**
            **(5,938**
            **)**
            
            (10.7
            )%
            **$**
            **(812**
            **)**
            
            13.7
            %




It
      is
      important to note that the 2003 consolidated financial statements do not include
      the operations of SANZ prior to April 1, 2003 (referred to as “legacy SANZ”). As
      such, we believe that a comparison of the results of operations of both Solunet
      Storage and legacy SANZ combined on a pro forma basis for the year ended
      December 31, 2003, giving effect to pro forma adjustments as if the companies
      had been combined as of January 1, 2003, and as reported in our Quarterly Report
      on Form 10-QSB for the quarterly period ended September 30, 2003 (“pro forma”),
      is important to the understanding of our results for the year ended December
      31,
      2004. Accordingly, in our discussion and analysis below, we have included a
      discussion of 2004 reported results compared to both 2003 reported results
      and
      2003 pro forma combined results.


28


***Revenue**.* Our
      total revenue for the year ended December 31, 2004 was $66.2 million. This
      represented an increase of $10.7 million, or 19%, over the $55.5 million
      recorded for the year ended December 31, 2003. The increase was primarily a
      result of the combination of sales of legacy SANZ and Solunet Storage for 2004,
      which accounted for $7.5 million of the increase.





Had
      the
      combination of SANZ and Solunet Storage been completed at January 1, 2003,
      the
      combined revenues of both organizations for 2003, on a pro forma basis, would
      have been $63.0 million. The additional $3.2 million increase in revenue from
      2003 pro forma to 2004 was based on a combination of factors. Product sales
      and
      vendor supplied services increased only slightly on a pro forma basis, from
      $54.4 million to $54.7 million. This increase was primarily the result of sales
      increases in the Federal sector, partially offset by soft general market
      conditions as a result of reductions in information technology spending in
      the
      U.S. Consulting and engineering services increased by 36%, from $2.7 million
      in
      2003 pro forma to $3.7 million in 2004, as a result
      of the Company’s continued commitment to grow this part of its business, which
      generally has produced higher gross margins. Maintenance services and contract
      fees increased by nearly 32%, from $5.9 million in 2003 pro forma to $7.8
      million in 2004. This
      revenue increase was primarily the result of legacy SANZ’ shift from reselling
      supplier provided maintenance (i.e., maintenance contract fees) to providing
      “first call” maintenance services.





***Gross
      Profit and Gross Margin*** .
      Gross
      profit for the year ended December 31, 2004 was $14.0 million, compared to
      a
      gross profit of $13.0 million recorded during the prior year. Of the $1.0
      million increase, approximately $2.5 million was attributable to the increase
      in
      total revenue, offset by a decline of approximately $1.5 million attributable
      to
      lower gross margin from product mix described below .





On
      a
      percentage basis, gross margin declined from 23.4% in 2003 to 21.1% in 2004.
      On
      a pro forma basis, gross margin declined from 22.2% in 2003 to 21.1% in 2004.
      The decrease in overall gross margin is primarily related to gross margins
      of
      sales of hardware, software and vendor supplied services, which declined from
      19.3% in 2003 pro forma to 18.2% in 2004. This decrease is due to project and
      product mix shift and to market pricing pressures. Specifically, in 2004, tape
      system sales and disk sales were approximately $12.6 million and $15.3 million,
      respectively. This compared to tape system and disk sales of $18.3 million
      and
      $12.6 million, respectively, for the 2003 pro forma year. Tape systems typically
      carry higher margins as compared to disk margins. In addition, gross margins
      related to sales of hardware, software and services were further depressed
      in
      2004 due to changes in supplier mix.





***Operating
      Expenses**.* Our
      operating expenses for 2004 were $17.5 million. Of this amount, $14.9 million
      consists of SG&A expenses and $1.3 million consists of depreciation and
      amortization. The remaining $1.3 million of expense represents amounts paid
      in 2004 and charges for future payments required in 2005 and 2006 related to
      regional office closures and severance costs associated with the reduction
      in
      force during 2004 of various management personnel. Excluding the severance
      and
      closed office expense, operating expenses were $16.2 million.





The
      total
      operating expense of $17.5 million in 2004 represented a decrease of $0.7
      million from the $18.2 million of total operating expenses recorded in 2003.
      The
      2003 amount includes $15.0 million of SG&A expenses, $2.0 million of
      expense relating directly to the acquisition of Solunet Storage, and $1.2
      million of depreciation and amortization. Excluding the acquisition-related
      expense, 2003 operating expenses were $16.2 million.




On
      a pro
      forma basis, excluding all acquisition related expenses for both SANZ and
      Solunet Storage, operating expense in 2003 was $18.4 million. The 2004 operating
      expenses of $17.5 million represented a decrease of $0.9 million, or
      5%, as compared to 2003 pro forma operating expenses. This decrease was a result
      of personnel reductions made after the combination of the two companies,
      particularly in areas such as finance, sales support, back-office
      administration, engineering and management, where we had duplicate and/or
      redundant positions. Total headcount at December 31, 2004 was 101, as compared
      to total headcount at December 31, 2003 of 112. In addition, in 2004 we closed
      three regional offices, and concentrated our resources in regions where we
      believed we had greater critical mass and thus greater sales
      potential.





***Interest
      Expense**.* During
      2004, interest expense was $1.2 million, an increase of $400,000 from 2003
      interest expense of $817,000. This increase was primarily due to higher
      borrowing levels, averaging approximately $16 million in 2004 as compared
      to an average debt outstanding of approximately $10 million the prior year.
      Interest expense in 2004 and 2003 included approximately $150,000 paid to an
      affiliate of Sun Solunet for loan guaranties issued on our behalf by Sun Capital
      II.


29


***Charge
      for Warrant issued to Related Party for Debt Guaranty**.* In
      November 2004 and in partial consideration for our Harris debt guaranty provided
      by Sun Capital II, we were obligated to issue to Sun Solunet a stock purchase
      warrant for a total of 7,715,545 shares of our common stock with an exercise
      price of $0.001 per share. Based on the number of shares issued pursuant to
      the
      warrant, we recorded a charge of approximately $2.5 million, calculated as
      the
      number of shares issued multiplied by the closing market price of SANZ’ common
      stock as of November 16, 2004. This warrant was issued on March 23, 2005. See
      further discussion regarding the debt guaranty warrant issued in the discussion
      of “—Liquidity and Capital Resources” below.





***Other
      Income and (Expense)**.* Other
      income and (expense) for 2004 was $121,000 as compared to ($11,000) for 2003.
      The net increase in other income in 2004 was principally due to a settlement
      on
      litigation in the form of shares in a private company and resultant gains from
      sales of a portion of those shares during the third quarter of 2004, the
      combination of which totaled $229,000. Offsetting this income were losses of
      $113,000 on disposals of property, equipment and leasehold improvements related
      to the consolidation of two Colorado corporate offices into a single corporate
      headquarters in May 2004.





***Income
      Taxes**.* For the
      year ended 2004, we received and recorded 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. We recorded the income tax refund as an income tax benefit
      in
      the Statement of Operations. In 2003, we received and recorded income tax
      refunds of $115,000 related to various states.





**Liquidity
      and Capital Resources**





**Liquidity**





Our
      consolidated financial statements as presented in Item 15 have been prepared
      in
      conformity with US GAAP, which contemplate our continuation as a going concern.
      However, we have incurred substantial losses from operations since inception
      and
      have incurred a net loss of $15,803,000 for the year ended December 31, 2005.
      In
      addition, as of December 31, 2005, we have negative working capital (current
      liabilities in excess of current assets) of $19,626,000. Accordingly, as of
      December 31, 2005, 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.





As
      of
      December 31, 2005, we had approximately $1.7 million of undrawn availability
      on
      our borrowing facility with Wells Fargo Bank, National Association (“Wells
      Fargo”). Our ability to borrow under the Wells Fargo facility is dependent at
      any time on our having adequate eligible accounts receivable to support
      borrowings and complying with financial covenants related thereto.




As
      of
      December 31, 2005, we also held a credit facility with our majority shareholder,
      Sun Solunet (the “Sun Loan”), which was fully drawn at $13.0 million. In
      February 2006, the Sun Loan was amended to increase the borrowing availability
      from $13.0 million to $14.0 million, plus accrued interest. We borrowed the
      additional $1.0 million in February 2006 to fund operations.





On
      March
      2, 2006, we entered into a private placement transaction exempt from
      registration under the Securities Act of 1933, as amended pursuant to Section
      4
      (2) and Regulation D promulgated thereunder (the “Private Placement”) with
      third-party investors, Company executive management and Sun Solunet. We raised
      approximately $2.5 million in cash, and Sun Solunet converted $8.0 million
      of
      the Sun Loan 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 a three-year term loan (“Sun Term Loan”), bearing interest at
      prime plus 1.0%. We expect to use the net cash proceeds of approximately $2.5
      million from the Private Placement for general working capital needs. We believe
      that the net cash proceeds from the Private Placement and our Wells Fargo credit
      facility will provide us adequate working capital for the next twelve months.
      See further discussion of the Private Placement in Note 3 to
      the
      consolidated financial statements included in Item 15.


30


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 be: 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 also continue to invest in our EarthWhere business, in
      particular in the product development and sales and distribution 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. By continuing to generate positive operating cash
      flow from our storage solutions business, or achieving break-even to positive
      operating cash flow from our EarthWhere business, and assuming continuation
      of
      current bank debt facilities, the Sun Loan, and current business trends and
      supplier relations, we believe that our existing credit facilities are adequate
      in providing sufficient liquidity to fund our operations. However, we may need
      either to undertake further cost-cutting measures (which could entail curtailing
      certain operations), or to raise additional debt or equity capital, or both.
      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. If equity capital is raised, the issuance of those shares would
      also be dilutive to the ownership interests of all other
      stockholders.




**Cash
      and Cash Flows**




At
      December 31, 2005, we had $6,000 in cash and cash equivalents. In addition
      to
      cash, at that date we had undrawn availability of $1.7 million on our Wells
      Fargo credit facility.




For
      the
      year ended December 31, 2005, our operating activities used $5.2 million of
      cash, including: (1) the net loss incurred during the year of $15.8 million,
      of
      which $13.4 million related to non-cash charges for goodwill impairment,
      depreciation and amortization and warrants issued to a related party in the
      amounts of $9.2 million, $1.3 million and $2.9 million, respectively; (2) a
      decrease in our accounts payable of $3.8 million, due primarily to lower trade
      purchases related to lower invoicing in the fourth quarter of 2005 as compared
      to the fourth quarter of 2004; and (3) a decrease in deferred revenue of $1.1
      million, due to lower maintenance services billings in the fourth quarter of
      2005 as compared to the fourth quarter of 2004. Partially offsetting these
      decreases, cash from operations in 2005 was increased by a reduction in our
      accounts receivable of $1.3 million, due to lower invoicing in December
      2005 as compared to December 2004. The decrease in invoicing from the fourth
      quarter of 2004 to the fourth quarter of 2005 was in part due to the timing
      of
      shipments and the completion of projects, as new order bookings for Q4 2005
      and
      Q4 2004 remained consistent at approximately $13.3 million in both periods.
      Cash from operations was also increased by a decrease in deferred maintenance
      contracts of $0.9 million, directly related to the decrease in deferred revenue
      mentioned above.





Cash
      used
      in investing activities was $1.2 million in 2005, consisting of $318,000 for
      the
      purchase of property and equipment, and $911,000 for the capitalization of
      costs
      for software developed for resale, discussed further below under the section
      “Capital Expenditures.”




Cash
      provided by financing activities totaled $5.9 million in 2005, consisting of
      net
      borrowings on our Wells Fargo line of credit of $0.5 million, net borrowings
      on
      our Harris lines of credit of $4.4 million, and net borrowings on our Sun Loan
      of $1.0 million.




31
 Loan Facilities


Wells
      Fargo Line of Credit





We
      have a
      revolving credit line with Wells Fargo to borrow up to $12 million, subject
      to
      availability based on a borrowing base calculation. Funds available under the
      credit facility are limited to 85% of the amount of eligible accounts receivable
      and fluctuations in the timing of customer orders can limit our ability to
      draw
      on the line when needed. Eligible accounts consist of substantially all accounts
      receivable, subject to customary exceptions (including those aged over 90 days,
      otherwise-current receivables from customers with material amounts outstanding
      over 90 days, and more than a pre-set percentage of total receivables from
      a
      single customer). Borrowings against receivables owed directly by Federal
      government end-users are further limited to 80% of the amount of eligible
      accounts receivable up to $500,000 in the aggregate unless we obtain 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 limit.





This
      credit line expires in May 2007 and is secured by substantially all assets
      of
      SANZ Inc. and Solunet Storage, Inc. (“SANZ Inc. et al”), wholly-owned
      subsidiaries of the Company. As of December 31, 2005, this credit line bore
      interest at prime plus 4.0% (11.25%), and based on our eligible collateral
      at
      that date, we had $9.0 million available for borrowing ,
      of
      which $7.3 million was drawn and $1.7 million remained available.





Wells
      Fargo may declare the loan in default if SANZ Inc. et al does not meet certain
      financial performance measures. At December 31, 2005, we were in compliance
      with
      all of these covenants. During the June and the September 2005 quarters, the
      Company was not in compliance with a minimum availability covenant required
      for
      cash transfers from SANZ Inc. to Solunet Storage. This violation occurred on
      one
      such transfer each in June and in September 2005. Subsequent to the June and
      September 2005 quarters, the Company received a waiver from Wells Fargo for
      each
      of these periods.





As
      part
      of an amendment to the credit facility in March 2005, Wells Fargo waived the
      Company’s non-compliance on certain financial covenants as of December 31, 2004.
      In addition, Wells Fargo reset the following financial covenant requirements
      effective January 1, 2005: (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. and its
      wholly-owned subsidiary, Solunet Storage, (the Company’s borrowers) 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. and its subsidiary, Solunet Storage, 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.





The
      current credit agreement also includes as a co-borrower Solunet Storage, which
      in March 2005 became a wholly-owned subsidiary of SANZ Inc. Each borrower
      maintains a separate borrowing base; however, total borrowings under the
      facility are limited to $12,000,000. 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, subject to an
      annual limit, and to a minimum availability on the date of any such transfer.
      As
      noted above, during 2005, the Company was not in compliance with the minimum
      availability covenant required on two such cash transfers, and the Company
      subsequently received a waiver from Wells Fargo for each of these defaults.




Also
      as
      part of the amended agreement and effective January 1, 2005, Wells Fargo
      increased the interest rate on our borrowings to prime plus 5.0%. This rate
      is
      subject to potential decreases, as permitted by Wells Fargo, based on SANZ
      Inc.
      et al achieving certain net income (loss) levels. For 2005, the Company’s
      interest rate ranged from 4.0% to 5.0% plus prime based on its quarterly minimum
      net loss results. At December 31, 2005, our borrowing rate prime plus 4.0%,
      or
      11.25%. For the fourth quarter of 2005, we did not achieve the minimum net
      loss
      threshold; therefore, effective January 1, 2006, the interest rate on the Wells
      Fargo facility increased to prime plus 5.0%.


32


Harris
      and Sun Solunet Credit Facilities





As
      of
      December 31, 2004, the Company maintained two Harris credit facilities, one
      held
      by SAN Holdings and the other by our Solunet Storage subsidiary, which allowed
      for borrowings up to an aggregate of $8.0 million. On
      February 16, 2005, we entered into a revised credit agreement with Harris,
      which
      increased our availability by $2.0 million, for a total of $10.0 million,
      and consolidated the two credit lines into one facility maintained by SAN
      Holdings and guaranteed by Sun Capital II. On June 3 and October 4, 2005, we
      executed additional amendments to the Harris credit agreement, which increased
      the facility to $11.5 million and $13.0 million, respectively. The interest
      rate
      on this credit facility was prime plus 1.0%.





This
      credit facility was unsecured, not limited by availability under a borrowing
      base, and did not require the maintenance of specified financial covenants. Sun
      Capital II guaranteed this credit facility and 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 and all
      obligations expired on November 23, 2005, the date on which Harris
      assigned this credit facility 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”).





As
      consideration for Sun Capital II’s guaranty and pursuant to a credit support
      agreement (the “Credit Support Agreement”), the Company was obligated to issue
      stock purchase warrants (“Debt Guaranty warrants”) to Sun Solunet, to the extent
      that the Company’s guaranteed debt on the Harris credit facility exceeded $3.0
      million. Debt Guaranty warrants were issuable at six-month intervals beginning
      on November 16, 2004, and calculated as follows:





Debt
                Guaranty Warrants =
            (Guaranteed
                Debt - $3,000,000)x   fixed number of shares at particular date$2,000,000





The
      number of shares used in the calculation of debt guaranty warrants for a
      particular date are listed in the table below, pursuant to the Credit Support
      Agreement:





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




Until
      the
      Company reduced the guaranteed debt to $3.0 million or less, it was required
      to
      issue additional warrants to Sun Solunet at six-month intervals (each May and
      November), according to formulas applicable to each such date, shown in the
      table above.





The
      Debt
      Guaranty warrant issuable for November 16, 2004 was issued on March 23, 2005.
      During 2005, the Company issued Debt Guaranty warrants on May 16 and November
      16, 2005.




Additionally,
      and as consideration for increases on the Harris credit facility on February
      16
      and June 3, 2005, the Company was obligated to issue and issued additional
      Debt
      Guaranty warrants to Sun Solunet on March 23 and June 27, 2005, respectively.
      These Debt Guaranty warrants as well as the Debt Guaranty warrants issued under
      the Credit Support Agreement 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. The following table
      summarizes the Debt Guaranty warrants issued to Sun Solunet for 2004 and 2005
      related to the Sun Capital II guaranty.





Date
                of warrant
            
            #
                of warrants issued
            
            Charge
                for warrant
            
            Exercise
                PriceNovember
                16, 2004
            
            
            7,715,545
            
            $
            2,469,000
            
            $
            0.001March
                23, 2005
            
            
            3,086,218
            
            
            1,049,000
            
            
            0.001May
                16, 2005
            
            
            2,244,522
            
            
            405,000
            
            
            0.001June
                27, 2005
            
            
            480,969
            
            
            115,000
            
            
            0.001November
                16, 2005
            
            
            6,539,490
            
            
            1,308,000
            
            
            0.001


33


Under
      the
      Sun Loan effected on 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). At December 31, 2005, the Company had borrowed $13.1
      million on the Sun Loan, which bore interest at a rate of prime plus 1.0% (8.25%
      at December 31). 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.





On
      March
      2, 2006, we entered into the Private Placement with third-party investors,
      Company executive management and Sun Solunet. We raised approximately $2.5
      million in cash, net of placement agent and legal fees, and Sun Solunet
      converted $8.0 million of the Sun Loan 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 a three-year term loan
      (without a demand note stipulation), bearing interest at prime plus 1.0%. As
      a
      result, we terminated the Credit Support Agreement with Sun Capital II, and
      we
      are no longer obligated to issue Debt Guaranty warrants to Sun Solunet as
      described above. See further discussion of the Private Placement in Note 3 to
      the
      Consolidated Financial Statements included in Item 15.





**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, the Company’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 the Company to maintain total cash and customer
      receivables (less indebtedness of the Company 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 the Company in connection with
      the
      Company’s principal borrowing facility with Wells Fargo and to evidence the
      subordination, Avnet and Wells Fargo entered into an intercreditor
      agreement.




**Capital
      Expenditures**





During
      the years ended December 31, 2005 and 2004, we purchased approximately $318,000
      and $372,000, respectively, of property and equipment for cash. For 2006, we
      anticipate spending in the range of $300,000 to $400,000 on property and
      equipment. During 2005 and 2004 we also invested approximately $911,000 and
      $53,000, respectively, in capitalized software development costs. We expect
      to
      capitalize additional software development costs in 2006 of approximately
      $900,000. We expect to fund these capital expenditures from cash, which in
      turn
      will be from cash from operations and existing cash on hand.




**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, 2005 were as follows:





Cash
                payment obligations(due by period)(In
                thousands)
            
            Less
                than 1 Year
            
            1
                -
                3 Years
            
            3
                -
                5 Years
            
            TotalLine
                of credit obligations (1)
            
            $
            20,401
            
            $
            --
            
            $
            --
            
            $
            20,401Operating
                lease obligations(operating
                locations)
            
            
            666
            
            
            1,512
            
            
            --
            
            
            2,178Capital
                lease obligations
            
            
            27
            
            
            44
            
            
            --
            
            
            71Closed
                office obligations (2)
            
            
            67
            
            
            --
            
            
            --
            
            
            67$
            21,161
            
            $
            1,556
            
            $
            --
            
            $
            22,717


(1)
              The
                  line of credit obligations were comprised of $7.3 million due to
                  Wells
                  Fargo and $13.1 million due to Sun Solunet. Effective October 2004,
                  the
                  Wells Fargo credit facility was renewed and extended through May
                  2007. The
                  Sun Loan was a demand note, but was due to expire in December 2006.
                  In
                  March 2006, $8.0 million of the Sun Loan was converted to equity
                  in
                  connection with the Private Placement, resulting in a remaining
                  $5.0
                  million balance, which was converted to a three-year term loan
                  bearing
                  interest at prime plus 1.0%.(2)
              In
                  2004, we closed three of our regional offices located in Waltham,
                  Massachusetts,Norwalk, Connecticutand Chadds Ford, Pennsylvania, for which we remain subject to leases
                  expiring in 2005 and 2006. In 2001, we closed a regional office
                  in
                  Orlando, Florida, for which we remain subject to a lease through
                  January
                  2006. We have accrued the remaining obligation on these leases,
                  net of any
                  sublease income, for the life of the leases, as well as estimated
                  relocation costs.


34


**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.




**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, 2005, we had $20.4 million in variable, prime rate based
      bank debt. At December 31, 2005, our Sun Loan of $13.0 million bore
      interest at the rate of prime plus 1.0% (or 8.25%) and our Wells Fargo line
      of
      credit of $7.3 million bore interest at the rate of prime plus 4.0% (or 11.25%).
      At December 31, 2005, a hypothetical 100 basis point increase in the prime
      rate
      would result in additional interest expense of $203,000 on an annualized basis,
      assuming estimated borrowing amounts of $13.0 million for the Sun Loan and
      $7.3
      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**





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. In designing and evaluating the disclosure controls and procedures,
      management recognizes that any controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives, and management is required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible controls and
      procedures.


35


As
      required by SEC Rule 13a-15(b), the Company 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. We
      have not made any changes in our disclosure controls and procedures or in other
      factors during the quarter ended December 31, 2005 that have materially
      affected or are reasonably likely to materially affect those disclosure controls
      and procedures subsequent to the date of the evaluation described
      above.





**Item
      9B. Other Information**





None.





**PART
      III**





Information
      required by this Part III (Items 10, 11, 12, 13, and 14) is hereby
      incorporated by reference to portions of the registrant’s Definitive Proxy
      Statement for the 2006 Annual Shareholder Meeting (“2006 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 and Executive Officers of the Registrant**





The
      information required by this Item 10 is incorporated by reference to the
      information in the Company’s 2006 Proxy Statement.





**Item
      11. Executive Compensation**





The
      information required by this Item 11 is incorporated by reference to the
      information in the Company’s 2006 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 the Company’s 2006 Proxy Statement.




**Item
      13. Certain Relationships and Related Transactions**





The
      information required by this Item 13 is incorporated by reference to the
      information in the Company’s 2006 Proxy Statement.





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





The
      information required by this Item 14 is incorporated by reference to the
      information in the Company’s 2006 Proxy Statement.


36


**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, 2005 and December 31, 2004
            F-2Consolidated
                Statements of Operations for the Years ended December 31, 2005,December
                31, 2004 and December 31, 2003
            F-3Consolidated
                Statements of Stockholders’ Equity for the Years ended December 31, 2005,December
                31, 2004 and December 31, 2003
            F-4Consolidated
                Statements of Cash Flows for the Years ended December 31, 2005,December
                31, 2004 and December 31, 2003
            F-5Notes
                to Consolidated Financial Statements
            F-7





**(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 the consolidated
      financial statements or notes thereto described in Item 15(a)(1) above.




37





**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, 2005 and 2004, and the related consolidated
        statements of operations, stockholders’ equity and cash flows for each of the
        three years in the period ended December 31, 2005. 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, 2005 and 2004, and the results of their
        operations and their cash flows for each of the three years in the period
        ended
        December 31, 2005, in conformity with accounting principles generally accepted
        in the United States of America.


*/s/GRANT
      THORNTON, LLP*




Denver,
      Colorado


March
      31,
      2006





F-1





**SAN
      Holdings, Inc.**


**Consolidated
      Balance Sheets**


(In
      thousands, except share data)





December
                31,ASSETS
            
            2005
            
            2004Current
                assetsCash
                and cash equivalents
            
            $
            6
            
            $
            486Accounts
                receivable, net of allowance for doubtful accounts of $168and
                $140, respectively
            
            
            11,832
            
            
            13,097Inventories,
                net of valuation allowance of $29 and $137,respectively
            
            
            176
            
            
            467Deferred
                maintenance contracts
            
            
            2,060
            
            
            2,914Prepaid
                expenses and other current assets
            
            
            676
            
            
            512Total
                current assets
            
            
            14,750
            
            
            17,476Property
                and equipment, net
            
            
            673
            
            
            1,005Capitalized
                software, net
            
            
            872
            
            
            194Goodwill
            
            
            22,808
            
            
            32,008Intangible
                assets, net
            
            
            1,736
            
            
            2,205Other
                assets
            
            
            378
            
            
            384Total
                long-term assets
            
            
            26,467
            
            
            35,796TOTAL
                ASSETS
            
            $
            41,217
            
            $
            53,272LIABILITIES
                AND STOCKHOLDERS’ EQUITYLines
                of creditWells
                Fargo Bank, National Association
            
            
            7,292
            
            $
            6,759Sun
                Solunet, LLC
            
            
            13,109
            
            
            --Harris
                N.A.
            
            
            --
            
            
            7,700Accounts
                payable
            
            
            8,610
            
            
            12,453Accrued
                expenses
            
            
            2,560
            
            
            2,651Deferred
                revenue
            
            
            2,805
            
            
            3,942Total
                current liabilities
            
            
            34,376
            
            
            33,505Commitments
                and contingencies (Note 8)Stockholders’
                equityPreferred stock; no par value; 10,000,000 shares authorized;-0-
                shares issued and outstanding
            
            
            --
            
            
            --Common stock; no par value, 200,000,000 shares authorized,95,811,278
                shares issued and outstanding
            
            
            32,577
            
            
            32,577Warrants
            
            
            8,568
            
            
            5,691Accumulated deficit
            
            
            (34,304
            )
            
            (18,501
            )Total
                stockholders’ equity
            
            
            6,841
            
            
            19,767TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            41,217
            
            $
            53,272





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 31,2005
            
            2004
            
            2003RevenueProduct
                sales and vendor supplied services
            
            $
            44,446
            
            $
            54,690
            
            $
            47,597Consulting
                and engineering services
            
            
            5,612
            
            
            3,680
            
            
            2,133Maintenance
                services and maintenance contract fees
            
            
            9,057
            
            
            7,788
            
            
            5,767Total
                revenue
            
            
            59,115
            
            
            66,158
            
            
            55,497Cost
                of revenueProduct
                sales and vendor supplied services
            
            
            34,525
            
            
            44,751
            
            
            37,659Consulting
                and engineering services
            
            
            3,495
            
            
            2,131
            
            
            1,067Maintenance
                services and maintenance contract fees
            
            
            6,257
            
            
            5,326
            
            
            3,796Total
                cost of revenue
            
            
            44,277
            
            
            52,208
            
            
            42,522Gross
                profit
            
            
            14,838
            
            
            13,950
            
            
            12,975Operating
                expensesSelling,
                general and administrative
            
            
            15,822
            
            
            14,893
            
            
            15,059Charge
                for goodwill impairment
            
            
            9,200
            
            
            --
            
            
            --Severance
                and closed office expense
            
            
            --
            
            
            1,226
            
            
            --Acquisition-related
                costs
            
            
            --
            
            
            34
            
            
            1,987Depreciation
                and amortization of intangibles
            
            
            1,099
            
            
            1,306
            
            
            1,154Total
                operating expenses
            
            
            26,121
            
            
            17,459
            
            
            18,200Loss
                from operations
            
            
            (11,283
            )
            
            (3,509
            )
            
            (5,225
            )Other
                income (expense)Interest
                expense
            
            
            (1,610
            )
            
            (1,221
            )
            
            (817
            )Charge
                for warrant issued to related party for debt guaranty
            
            
            (2,877
            )
            
            (2,469
            )
            
            --Other
                income (expense)
            
            
            1
            
            
            121
            
            
            (11
            )Loss
                before income taxes
            
            
            (15,769
            )
            
            (7,078
            )
            
            (6,053
            )Income
                tax (expense) benefit
            
            
            (34
            )
            
            328
            
            
            115Net
                loss
            
            $
            (15,803
            )
            $
            (6,750
            )
            $
            (5,938
            )Basic
                and diluted net loss per share
            
            $
            (0.15
            )
            $
            (0.08
            )
            $
            (0.12
            )Weighted
                average shares outstanding - basic and diluted
            
            
            108,446,023
            
            
            86,254,827
            
            
            48,899,805




The
            accompanying notes are an integral part of the consolidated financial
            statements.
 F-3





**SAN
      Holdings, Inc.**


**Consolidated
      Statements of Stockholders’ Equity**


(In
      thousands, except share data)





Series
                B Preferred Stock
            
            Common
                Stock
            
            Warrants
            
            AccumulatedDeficit
            
            Total
                Stockholders’ EquityShares
            
            Amount
            
            Shares
            
            AmountBalances,
                January 1, 2003
            
            
            --
            
            $
            --
            
            
            20,000,000
            
            $
            1,000
            
            $
            --
            
            $
            (5,813
            )
            $
            (4,813
            )Reverse
                acquisition (Note 5)
            
            
            748.07306
            
            
            12,718
            
            
            38,269,102
            
            
            18,859
            
            
            3,222
            
            
            
            
            
            34,799Cash-less
                exercise of warrants
            
            
            
            
            
            
            
            
            138,523
            
            
            
            
            
            
            
            
            
            
            
            --Net
                loss for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,938
            )
            
            (5,938
            )Balances,
                December 31, 2003
            
            
            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
            )
            $
            6,841





The
            accompanying notes are an integral part of the consolidated financial
            statements.
 F-4





**SAN
      HOLDINGS, INC.**


**Consolidated
      Statements of Cash Flows**


(In
      thousands)




Years
                Ended December 31,2005
            
            2004
            
            2003Cash
                flows from operating activities:Net
                loss
            
            $
            (15,803
            )
            $
            (6,750
            )
            $
            (5,938
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Charge
                for goodwill impairment
            
            
            9,200
            
            
            --
            
            
            --Depreciation
                and amortization
            
            
            1,233
            
            
            1,406
            
            
            1,218Write-off
                of capitalized software development costs
            
            
            99
            
            
            --
            
            
            --Charge
                for warrant issued to related party for debt guaranty
            
            
            2,877
            
            
            2,469
            
            
            --Loss
                on disposal of property and equipment
            
            
            1
            
            
            113
            
            
            --Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            1,265
            
            
            2,115
            
            
            (1,246
            )Inventories
            
            
            310
            
            
            608
            
            
            243Deferred
                maintenance contracts
            
            
            854
            
            
            (285
            )
            
            (1,802
            )Prepaid
                expenses and other current assets
            
            
            (164
            )
            
            624
            
            
            (807
            )Other
                assets
            
            
            6
            
            
            (265
            )
            
            (17
            )Accounts
                payable
            
            
            (3,843
            )
            
            (692
            )
            
            2,794Accrued
                expenses
            
            
            (91
            )
            
            (150
            )
            
            463Deferred
                revenue
            
            
            (1,137
            )
            
            (80
            )
            
            1,238Net
                cash used in operating activities
            
            
            (5,193
            )
            
            (887
            )
            
            (3,854
            )Cash
                flows from investing activities:Purchase
                of property and equipment, net
            
            
            (318
            )
            
            (372
            )
            
            (121
            )Acquisition
                costs, net of cash acquired
            
            
            --
            
            
            --
            
            
            (188
            )Capitalized
                software costs
            
            
            (911
            )
            
            (53
            )
            
            (207
            )Net
                cash used in investing activities
            
            
            (1,229
            )
            
            (425
            )
            
            (516
            )Cash
                flows from financing activities:Net borrowings (payments) on line of credit - Wells Fargo BankNational
              Association
            
            
            533
            
            
            (1,494
            )
            
            6,633Net borrowings on line of credit - Sun Solunet, LLC
            
            
            967
            
            
            --
            
            
            --Net borrowings (payments) on line of credit - Harris N.A.
            
            
            4,442
            
            
            (500
            )
            
            8,200Net payments on other borrowings
            
            
            --
            
            
            --
            
            
            (6,832
            )Decrease in restricted cash
            
            
            --
            
            
            --
            
            
            148Net
                cash provided by (used in) financing activities
            
            
            5,942
            
            
            (1,994
            )
            
            8,149Net
                increase (decrease) in cash and cash equivalents
            
            
            (480
            )
            
            (3,306
            )
            
            3,779Cash
                and cash equivalents at beginning of year
            
            
            486
            
            
            3,792
            
            
            13Cash
                and cash equivalents at end of year
            
            $
            6
            
            $
            486
            
            $
            3,792Supplemental
                disclosure of other cash flow information:Interest
                paid
            
            $
            1,578
            
            $
            1,193
            
            $
            879Taxes
                paid
            
            
            34
            
            
            --
            
            
            --




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 31,2005
            
            2004
            
            2003Supplemental
                disclosure of non-cash investing and financing activities:Transfer
                of inventory to property and equipment
            
            $
            20
            
            $
            352
            
            $
            --Assignment
                of Harris N.A. line of credit to Sun Solunet, LLC
            
            
            12,142Conversion
                of note payable and accrued interest to common stock
            
            $
            --
            
            $
            --
            
            $
            4,100Significant
                acquisition:Fair
                value of assets acquired
            
            $
            --
            
            $
            --
            
            $
            42,096Purchase
                price transaction costs paid
            
            
            
            
            
            
            
            
            (505
            )Purchase
                price transaction costs accrued
            
            
            
            
            
            
            
            
            (430
            )Common
                stock exchanged
            
            
            
            
            
            
            
            
            (14,759
            )Preferred
                stock issued
            
            
            
            
            
            
            
            
            (12,718
            )Warrants
                issued
            
            
            
            
            
            
            
            
            (3,222
            )Liabilities
                assumed
            
            $
            --
            
            $
            --
            
            $
            (10,462
            )




The
            accompanying notes are an integral part of the consolidated financial
            statements.
 F-6




**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
      subsidiaries, SANZ, Inc. (formerly known as Storage Area Networks, Inc.) and
      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. However, we have incurred
      substantial losses from operations since inception and have incurred a net
      loss
      of $15,803,000, which included a $9.2 million charge for goodwill impairment,
      for the year ended December 31, 2005. In addition, as of December 31, 2005,
      we
      have negative working capital (current liabilities in excess of current assets)
      of $19,626,000. Accordingly, the recoverability of a major portion of the
      recorded asset amounts as of December 31, 2005, 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.





At
      December 31, 2005, the Company had $1.7 million of undrawn availability on
      its
      borrowing facility with Wells Fargo Bank, National Association (“Wells Fargo”).
      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 the lender, the facility could cease to be available
      to us. During the June and the September 2005 quarters, the Company was not
      in
      compliance with a minimum availability covenant required for cash transfers
      from
      SANZ Inc. to Solunet Storage. This violation occurred on one such transfer
      each
      in June and in September 2005. Subsequent to the June and September 2005
      quarters, the Company received a waiver from Wells Fargo for each of these
      periods. As of December 31, 2005, the Company was in compliance with all of
      the
      financial covenants under the Wells Fargo credit agreement. See further
      discussion of the Wells Fargo credit facility in Note 6.





At
      December 31, 2005, the Company also held a $13.0 million credit facility (which
      was fully drawn) with its majority shareholder, Sun Solunet (“Sun Loan”). See
      further discussion of the Sun Loan borrowing terms and subsequent restructuring
      in 2006 in Notes 6 and 3, respectively.





See
      further discussion of the Company’s financial condition in Note 3.





F-7





**NOTE
      3 - PRIVATE PLACEMENT**





On
      March
      2, 2006 (the “Closing Date”), the Company entered into a private placement
      equity transaction (the “Private Placement”), dated and effective as of February
      28, 2006 with third-party investors, Company executive management (collectively,
      the “Purchasers”) and Sun Solunet, its majority shareholder. In consideration
      for approximately $2.5 million of cash and the conversion of $8.0 million of
      $14.0 million in debt owed by the Company to Sun Solunet under the Sun Loan,
      as
      assignee of Harris N.A (formerly known as Harris Trust and Savings Bank)
      (“Harris”), the Company issued a total of 236.8 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;(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 (together with the warrants described in clause (b) above,
                  the
                  “Warrants”).


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 the Closing Date, 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 carries
      a 3% dividend, payable in kind at the date of conversion to the Company’s common
      stock. Total net cash proceeds from the Private Placement from the
      Purchasers was approximately $2.5 million.


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.


Also
      as
      of the Closing Date, 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 of the
      Closing Date. As a result thereof, on the Closing Date, the Company and Sun
      Capital Partners II, LP (“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 includes 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), which will be due in
                  March 2009,
                  bearing interest at prime plus 1.0%.(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.





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





F-8





•
            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
                (“Common Stock”) 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.





The
      Company expects to use the cash proceeds from the Private Placement for general
      working capital needs. As of the Closing Date, the Company had total cash on
      hand of $2.1 million plus undrawn availability on its Wells Fargo credit
      facility of $1.6 million.





**NOTE
      4 - 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. T he
      following table summarizes information related to our allowance for doubtful
      accounts (in thousands): 
 2005
              
              2004
              
              2003Balance
                  at beginning of year
              
              $
              (140
              )
              $
              (336
              )
              $
              (746
              )Bad debt (expense) credit
              
              
              52
              
              
              82
              
              
              178Write-offs (recoveries)
              
              
              (80
              )
              
              114
              
              
              232Balance
                  at end of year
              
              $
              (168
              )
              $
              (140
              )
              $
              (336
              )





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): 
 2005
              
              2004
              
              2003Balance
                  at beginning of year
              
              $
              (137
              )
              $
              (707
              )
              $
              (675
              )Inventory writedowns
              
              
              (89
              )
              
              (68
              )
              
              (267
              )Inventory write-offs
              
              
              197
              
              
              638
              
              
              235Balance
                  at end of year
              
              $
              (29
              )
              $
              (137
              )
              $
              (707
              )





**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 4 - 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:





(In
                thousands)
            
            December
                312005
            
            2004Computer
                equipment and software
            
            $
            1,708
            
            $
            1,649Office
                equipment and furniture
            
            
            95
            
            
            221Leasehold
                improvements
            
            
            24
            
            
            23Less:
                accumulated depreciation
            
            
            (1,154
            )
            
            (888
            )$
            673
            
            $
            1,005





Depreciation
      expense for the years ended December 31, 2005, 2004 and 2003 was $630,000,
      $620,000, and $330,000, 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.





For
      the
      years ended December 31, 2005, 2004 and 2003, the Company capitalized software
      development costs of $911,000, $53,000, and $207,000, respectively.
      Additionally, the Company expensed research and development costs (“R&D”)
      related thereto of $219,000, $536,000, and $125,000, for the aforementioned
      years, respectively. In 2005, the Company wrote off the remaining net book
      value
      of the software development costs that it had capitalized in 2003, since such
      costs were deemed to have insufficient contemporaneous documentation to support
      capitalization. This charge was $99,000 and expensed as R&D, which is
      included in selling, general and administrative expense.





F-10





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 $134,000,
      $100,000, and $64,000 for the years ended December 31, 2005, 2004 and 2003,
      respectively, and is included in “Cost of revenue—product sales” in the
      consolidated statements of operations.





(In
                thousands)
            
            December
                312005
            
            2004Capitalized
                software costs
            
            $
            964
            
            $
            358Less:
                accumulated amortization
            
            
            (92
            )
            
            (164
            )$
            872
            
            $
            194





**Goodwill
      and Other Intangible Assets**





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, we perform the second step (“Step II test”) 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, 2005, we reviewed goodwill associated with both of our reporting
      units for impairment, and, as part of our assessment, we engaged an independent
      valuation firm (“independent firm”). The independent firm performed its
      valuation using primarily discounted cash flow and comparable public company
      analyses. 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, 2005, we have recorded an impairment charge for goodwill related
      to our Storage Solutions reporting unit in the amount of $9.2 million.





For
      our
      EarthWhere reporting unit in 2005, we concluded that the recorded goodwill
      was
      not impaired. Additionally, for both 2004 and 2003, we concluded that our
      goodwill, as analyzed on a total Company basis, was not impaired.





F-11





The
      change in the Company’s goodwill assets, as allocated between the two reporting
      units on January 1, 2005, was as follows:





(in
                thousands)
            
            Solutions
            
            EarthWhere
            
            TotalDecember
                31, 2004
            
            $
            30,719
            
            $
            1,289
            
            $
            32,008Impairment
                charge
            
            
            (9,200
            )
            
            --
            
            
            --December
                31, 2005
            
            $
            21,519
            
            $
            1,289
            
            $
            22,808





Other
      intangible assets include tradenames, 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 follows:








(In
                thousands)
            
            December
                31, 2005
            
            December
                31, 2004Asset
              (Estimated
                Life)
            
            Intangible
                Assets, Gross
            
            Accumulated
                Amortization
            
            Intangible
                Assets, Net
            
            Intangible
                Assets, Gross
            
            Accumulated
                Amortization
            
            Intangible
                Assets, NetTradenames(2.5
                to 10 years)
            
            $
            2,799
            
            $
            (1,132
            )
            $
            1,667
            
            $
            2,799
            
            $
            (852
            )
            $
            1,947Customer
                lists(3
                to 5 years)
            
            
            893
            
            
            (841
            )
            
            52
            
            
            893
            
            
            (718
            )
            
            175Software
                technologies(3
                years)
            
            
            200
            
            
            (183
            )
            
            17
            
            
            200
            
            
            (117
            )
            
            83$
            3,892
            
            $
            (2,156
            )
            $
            1,736
            
            $
            3,892
            
            $
            (1,687
            )
            $
            2,205





Amortization
      expense for intangible assets subject to amortization for the years ended
      December 31, 2005, 2004 and 2003 was $470,000, $615,000, and $745,000,
      respectively. Estimated aggregate amortization expense for intangible assets
      subject to amortization for each of the five succeeding fiscal years is as
      follows:





(In
                thousands)2006
            
            $
            2902007
            
            
            2442008
            
            
            2302009
            
            
            2302010
            
            
            230Thereafter
            
            
            512$
            1,736





**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 undiscounted cash
      flows
      or fair values, whichever is more readily determinable, to the carrying value
      of
      the related asset.





F-12





**Fair
      Value of Financial Instruments**





The
      Company’s financial instruments consist principally of cash and cash
      equivalents, accounts receivable, accounts payable and borrowings under its
      lines of credit. The Company believes that all of the financial instruments’
recoverable values approximate fair value because of their short-term
      nature.





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





Product
      Sales (Hardware/Software)





Revenue
      from the resale of data storage systems is recognized upon either (i) the
      shipment of goods for 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.





EarthWhere
      License Fees





The
      Company recognizes revenue on EarthWhere license fees in accordance with the
      American Institute of Certified Public Accountants’ 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 other applicable authoritative accounting literature.





For
      software 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.
      The Company’s software license agreements generally do not include multiple
      products and services. 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.




F-13





Service
      sales





Service
      revenue, including material installation services, is recognized as the related
      services are completed.





Maintenance
      Services





The
      Company provides “first call” technical support for certain hardware and
      software products that we sell. For maintenance services on these products,
      we
      defer the associated revenue at the inception of the contract, and recognize
      revenue on a straight-line basis over its contractual terms. Likewise, we defer
      the costs of such maintenance contracts and amortize them on a straight-line
      basis over their contractual terms.





Maintenance
      services on EarthWhere licenses are billed separately from the license fees
      and
      include post-contract customer support (“PCS”) along with unspecified upgrades
      and enhancements. Revenue from these maintenance agreements is recognized on
      a
      straight-line basis over their contractual terms.





Maintenance
      contract fees





For
      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.





Multiple
      deliverable arrangements





In
      accordance with EITF 00-21, for sales transactions that include the resale
      and
      installation of data storage systems and the sale of first call maintenance
      contracts denominated as a single, lump-sum price, we allocate the aggregate
      transaction revenue among the multiple elements based on their relative fair
      values. This process involves the application of management’s judgment and
      estimates regarding those relative fair values.





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.





Shipping
      and Handling Costs





Shipping
      and handling costs are included in cost of revenue.





F-14





**Advertising
      Costs**





Advertising
      costs are expensed as incurred. Advertising expense was $266,000, $607,000
      and
      $389,000 for the years ended December 31, 2005, 2004 and 2003, 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
      loss per share is calculated based on the weighted average number of common
      shares outstanding. Diluted 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 had been issued. For 2005, 2004 and 2003, basic and diluted loss
      per share are equal, as the inclusion of potentially dilutive common shares
      is
      anti-dilutive based on the respective net losses incurred for those years.
      Options and warrants to purchase 27,168,754, 33,473,008 and 41,083,076 shares
      of
      common stock were excluded from diluted share calculations for 2005, 2004 and
      2003, respectively, as these options and warrants were anti-dilutive.





Effective
      March 2, 2006 and as part of the Private Placement as discussed in Note 3,
      the
      Company issued 236.8 shares of its Series A Preferred Stock. Each share is
      convertible into 333,333 shares of the Company’s common stock at an exercise
      price of $0.15 per share, resulting in approximately 78.9 million common shares
      or approximately 42% of the total shares used in the calculation of basic and
      diluted loss per share as of December 31, 2005. Also as part of the Private
      Placement, the Company issued approximately 79.0 million stock purchase
      warrants, which are exercisable into shares of the Company’s common stock at
      exercise prices of $0.30 and $0.50 per share (approximately 39.5 million
      warrants exercisable at each price).





**Stock-Based
      Compensation**





As
      permitted under Statement of Financial Accounting Standards No. 123, “Accounting
      for Stock-Based Compensation” (“FAS 123”), the Company accounts for stock-based
      compensation using the intrinsic value method in accordance with Accounting
      Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“ABP
      25”) and related interpretations. Accordingly, no compensation expense has been
      recognized for options granted to employees with an exercise price equal to
      the
      market value at the date of grant. The Company accounts for equity instruments
      issued to non-employees in accordance with the provisions of FAS 123 and related
      interpretations.





F-15




The
        following table illustrates the effect on net loss and net loss per share
        for
        the years ended December 31, 2005, 2004 and 2003 if the Company had applied
        the
        fair-value based method of FAS 123 to stock-based
        compensation:





(In
              thousands, except for per share data)
            
            Year
                ended December 31,2005
            
            2004
            
            2003Net
                loss, as reported
            
            $
            (15,803
            )
            $
            (6,750
            )
            $
            (5,938
            )Deduct,
                Total stock-based compensation expense determined under fair-value
                based
                method, net of related tax effects
            
            
            (246
            )
            
            (889
            )
            
            (2,290
            )Pro
                forma net loss
            
            $
            (16,049
            )
            $
            (7,639
            )
            $
            (8,228
            )Basic
                and diluted net loss per share:As
                reported
            
            $
            (0.15
            )
            $
            (0.08
            )
            $
            (0.12
            )Pro
                forma
            
            $
            (0.15
            )
            $
            (0.09
            )
            $
            (0.17
            )





See
      Note
      9 for the assumptions and methodology used to determine the fair value of
      stock-based compensation.





**Recent
      Accounting Pronouncements**





In
      December 2004, the Financial Accounting Standards Board (“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 will
      be
      recognized over the period during which an employee is required to provide
      service in exchange for the award, usually the vesting period. The Company
      is
      required to adopt SFAS 123R at the beginning of 2006.





Under
      SFAS 123R, we must determine the appropriate fair value model to be used for
      valuing share-based payments, the amortization method for compensation cost
      and
      the transition method to be used at date of adoption. The transition methods
      include the modified prospective and modified retrospective adoption options.
      The modified prospective method requires that compensation expense be recorded
      for all unvested stock options and restricted stock over the remaining award
      service period beginning on January 1, 2006, while the modified retrospective
      method requires that all prior periods presented be adjusted to reflect
      compensation expense under the fair value method of accounting for awards
      granted, modified or settled after December 31, 1994. We expect that the
      adoption of SFAS 123R will have a material impact on our consolidated results
      of
      operations and earnings per share. We plan to use the modified prospective
      transition method and will use the Black-Scholes valuation model. We expect
      the
      adoption of SFAS 123R to result in compensation expense amounts that are similar
      to those currently disclosed under SFAS 123.





See
      “Stock-Based Compensation Plans” above for information related to the pro forma
      effects on our net income and earnings per share if we had applied the fair
      value recognition provisions of SFAS 123, “Accounting for Stock-Based
      Compensation,” to stock-based employee compensation.





In
      June
      2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections”
(“SFAS 154”). SFAS 154 supersedes APB Opinion No. 20, “Accounting
      Changes,” and SFAS 3, “Reporting Accounting Changes in Interim Financial
      Statements,” and changes the requirements for the accounting for and reporting
      of a change in accounting principle. SFAS 154 applies to all voluntary changes
      in accounting principle and to changes required by an accounting pronouncement
      in the unusual instance that the pronouncement does not include specific
      transition provisions. SFAS 154 must be adopted for accounting changes and
      corrections of errors made in fiscal years beginning after December 15,
      2005. Early adoption is permitted for accounting changes and corrections of
      errors made in fiscal years beginning after the date SFAS 154 is issued. The
      Company does not expect the adoption of SFAS No. 154 to have a material
      impact on its financial results.





F-16





**Reclassifications**





Certain
      reclassifications have been made to prior years’ balances to conform with
      current year presentations.




**NOTE
      5 - SANZ AND SOLUNET STORAGE BUSINESS COMBINATION**





Effective
      April 1, 2003, SANZ completed a business combination with Solunet Storage.
      The
      transaction was accounted for as a reverse acquisition, with Solunet Storage
      being treated as the acquirer for accounting purposes. As a result, for all
      periods prior to April 1, 2003, the financial statements of Solunet Storage
      have
      been adopted as SANZ’ historical financial statements.





The
      business combination was effected in an all-stock transaction in which SANZ
      issued 20,000,000 shares of common stock and 748.07306 shares of Series B
      convertible preferred stock (“preferred stock”) for all of the outstanding
      common stock of Solunet Storage. On April 12, 2004, the preferred stock
      automatically converted into 37,403,653 shares of common stock upon the
      amendment of our Articles of Incorporation, which increased the number of
      authorized shares of common stock to 200,000,000 shares. As part of the business
      combination, we issued to Sun Solunet, the principal stockholder of Solunet
      Storage, a warrant 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.





In
      accordance with SFAS 141, “Business Combinations,” the Company accounted for
      this transaction under the purchase method of accounting, in which the purchase
      price was allocated across all classes of tangible and intangible assets in
      accordance with their fair values, and any excess of the purchase price over
      the
      fair values of the identified assets was recorded as goodwill. Because of the
      reverse nature of the acquisition, the purchase price was computed as the sum
      (a) of the value of the SANZ shares outstanding before the transaction (valued
      at the market price over a range of trading days before and after the
      announcement of the definitive agreement), (b) the fair value of the SANZ
      warrants and options outstanding prior to the closing, and (c) capitalizable
      transaction costs incurred directly related to the business combination. The
      Company determined the fair value of the warrants and options to be $3,222,000
      using a Black-Scholes option-pricing model with the following assumptions:
      dividend yield of 0%, volatility of 50%, risk-free interest rate of 3.0% and
      expected life equal to the remaining life for each tranche.





The
      purchase price is summarized as follows:





(In
                thousands)Common
                stock
            
            $
            27,477Warrants
                and options
            
            
            3,222Transaction
                costs
            
            
            935Purchase
                price
            
            $
            31,634





The
      purchase price, including all adjustments was allocated as follows:





(In
                thousands)Tangible
                assetsCash
            
            $
            317Other
                current assets
            
            
            5,858Property,
                equipment and other long-term assets
            
            
            883Identifiable
                intangible assets
            
            
            3,03010,088Less:
                liabilities assumed
            
            
            (10,462
            )Net
                liabilities assumed
            
            
            (374
            )Goodwill
                recorded
            
            
            32,008Purchase
                price
            
            $
            31,634




F-17





The
      Company does not expect that any of this goodwill will be deductible for federal
      income tax purposes. As of December 31, 2005, the Company concluded that a
      portion of its recorded goodwill was impaired. See further discussion in Note
      4.





**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, subject to availability under its borrowing base, and is secured by
      substantially all assets of SANZ Inc. and Solunet Storage, Inc. (“SANZ Inc. et
      al”), wholly-owned 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.
      As of December 31, 2005, based on our eligible collateral at that date, we
      had
      $9.0 million available for borrowing on the Wells Fargo credit facility, of
      which $7.3 million was drawn and $1.7 million remained available. This
      credit line expires in May 2007.





Wells
      Fargo may declare the loan in default if SANZ Inc. et al does not meet certain
      financial performance measures. At December 31, 2005, the Company was in
      compliance with all of these covenants. During the June and the September 2005
      quarters, the Company was not in compliance with a minimum availability covenant
      required for cash transfers from SANZ Inc. to Solunet Storage. This violation
      occurred on one such transfer each in June and in September 2005. Subsequent
      to
      the June and September 2005 quarters, the Company received a waiver from Wells
      Fargo for each of these periods.





As
      part
      of an amendment to the credit facility in March 2005, Wells Fargo waived the
      Company’s non-compliance on certain financial covenants as of December 31, 2004.
      In addition, Wells Fargo reset the following financial covenant requirements
      effective January 1, 2005: (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. and its
      wholly-owned subsidiary, Solunet Storage, (the Company’s borrowers) 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. and its subsidiary, Solunet Storage, 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.





Additionally,
      under the amended credit agreement, the Company added a co-borrower, Solunet
      Storage, which in March 2005 became a wholly-owned subsidiary of SANZ Inc.
      Each
      borrower maintains a separate borrowing base; however, total borrowings under
      the facility are limited to $12,000,000. 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, subject to
      an annual limit, and to a minimum availability on the date of any such transfer.
      As noted above, during 2005, the Company was not in compliance with the minimum
      availability covenant required on two such cash transfers, and the Company
      subsequently received a waiver from Wells Fargo for each of these defaults.





Also
      as
      part of the amended agreement and effective January 1, 2005, Wells Fargo
      increased the interest rate on our borrowings to prime plus 5.0%. This rate
      is
      subject to potential decreases, as permitted by Wells Fargo, based on SANZ
      Inc.
      et al achieving certain net income (loss) levels. For 2005, the Company’s
      interest rate ranged from 4.0% to 5.0% plus prime based on its quarterly minimum
      net loss results. At December 31, 2005, our borrowing rate was prime plus 4.0%,
      or 11.25%. For the fourth quarter of 2005, we did not achieve the minimum net
      loss threshold; therefore, effective January 1, 2006, the interest rate on
      the
      Wells Fargo facility increased to prime plus 5.0%.





F-18





The
      Company’s revolving credit facility with Wells Fargo 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.”




**Harris
      and Sun Solunet Credit Facilities**





As
      of
      December 31, 2004, the Company maintained two credit facilities with Harris,
      one
      held by SAN Holdings and the other by our Solunet Storage subsidiary, which
      allowed for borrowings up to an aggregate of $8.0 million. On February 16,
      2005,
      the Company entered into a revised credit agreement with Harris, which increased
      our availability by $2.0 million, for a total of $10.0 million, and consolidated
      the two credit lines into one facility maintained by SAN Holdings and guaranteed
      by Sun Capital II. On June 3 and October 4, 2005, the Company executed
      additional amendments to the Harris credit agreement, which increased the
      facility to $11.5 million and $13.0 million, respectively. The interest rate
      on
      this credit facility was prime plus 1.0%.





This
      credit facility was unsecured, not limited by availability under a borrowing
      base, and did not require the maintenance of specified financial covenants. Sun
      Capital II guaranteed this credit facility and 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 and all
      obligations expired on November 23, 2005, the date on which Harris
      assigned this credit facility 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”).





As
      consideration for Sun Capital II’s guaranty and pursuant to the Credit Support
      Agreement, the Company was obligated to issue stock purchase warrants (“Debt
      Guaranty warrants”) to Sun Solunet, to the extent that the Company’s guaranteed
      debt on the Harris credit facility exceeded $3.0 million. Debt Guaranty warrants
      were issuable at six-month intervals beginning on November 16, 2004. The Debt
      Guaranty warrant issuable for this date was issued on March 23, 2005. During
      2005, the Company issued Debt Guaranty warrants on May 16 and November 16,
      2005.





Additionally,
      and as consideration for increases on the Harris credit facility on February
      16
      and June 3, 2005, the Company was obligated to issue and issued additional
      Debt
      Guaranty warrants to Sun Solunet on March 23 and June 27, 2005, respectively.
      These Debt Guaranty warrants as well as the Debt Guaranty warrants issued under
      the Credit Support Agreement 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. The following table
      summarizes the Debt Guaranty warrants issued to Sun Solunet for 2004 and 2005
      related to the Sun Capital II guaranty.





Date
                of warrant
            
            #
                of warrants issued
            
            Charge
                for warrant
            
            Exercise
                PriceNovember
                16, 2004
            
            
            7,715,545
            
            $
            2,469,000
            
            $
            0.001March
                23, 2005
            
            
            3,086,218
            
            
            1,049,000
            
            
            0.001May
                16, 2005
            
            
            2,244,522
            
            
            405,000
            
            
            0.001June
                27, 2005
            
            
            480,969
            
            
            115,000
            
            
            0.001November
                16, 2005
            
            
            6,539,490
            
            
            1,308,000
            
            
            0.001





See
      Note
      11 for further discussion of the calculation of the Debt Guaranty
      warrants.





F-19





Under
      the
      Sun Loan effected on 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). At December 31, 2005, the Company had borrowed $13.1
      million on the Sun Loan, which bore interest at a rate of prime plus 1.0% (8.25%
      at December 31, 2005). 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 Company’s Private Placement, Sun Solunet converted
      $8.0 million of its loan to the Company’s Series A Preferred Stock, and the
      Company paid down $1.0 million of the Sun Loan. The Company and Sun Solunet
      entered into a three-year $5.0 million (the balance due after the conversion
      and
      cash pay-down) term loan (“Sun Term Loan”). As part of the new agreement, the
      Company is no longer obligated to issue Debt Guaranty warrants to Sun Solunet.
      See further discussion of the Sun Term Loan in Note 3.





**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, the Company’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 the Company to maintain total cash and customer
      receivables (less indebtedness of the Company 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 the Company in connection with
      the
      Company’s principal borrowing facility with Wells Fargo and to evidence the
      subordination, Avnet and Wells Fargo entered into an intercreditor
      agreement.





The
      following summarizes our debt outstanding:





(In
                thousands)
            
            December
                31, 2005
            
            December
                31, 2004Line
                of credit with Wells Fargo
            
            $
            7,292
            
            $
            6,759Line
                of credit with Sun Solunet
            
            
            13,109
            
            
            --Line
                of credit with Harris
            
            
            --
            
            
            7,700$
            20,401
            
            $
            14,459





**NOTE
      7 - INCOME TAXES**





For
      2005,
      total tax expense of $34,000 represented state income taxes paid during
      2005.





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 carries 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.





During
      2003, the Company received a state income tax refund of $115,000. The Company
      recorded this refund as a benefit from income taxes.


F-20


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:




(In
                thousands)
            
            Year
                ended December 31,2005
            
            2004
            
            2003Income
                tax benefit at federal statutory rate
            
            $
            (5,429
            )
            $
            (2,407
            )
            $
            (2,119
            )State
                income tax benefit, net of federal benefit
            
            
            (48
            )
            
            (75
            )
            
            (117
            )State
                income taxes paid
            
            
            34
            
            
            --
            
            
            --Federal
                income tax refund
            
            
            --
            
            
            (328
            )
            
            (115
            )Goodwill
                impairment charge
            
            
            3,128
            
            
            --
            
            
            --Warrant
                charge for debt guaranty
            
            
            978
            
            
            839
            
            
            --Nondeductible
                items
            
            
            22
            
            
            19
            
            
            28Valuation
                allowance
            
            
            1,349
            
            
            1,624
            
            
            2,208$
            34
            
            $
            (328
            )
            $
            (115
            )





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:








(In
                thousands)
            
            December
                31,2005
            
            2004Deferred
                tax assets:Current:Reserves
                and accrued expenses
            
            $
            247
            
            $
            389Non-currentNet
                operating loss carryforwards
            
            
            14,374
            
            
            12,961Intangible
                assets
            
            
            556
            
            
            421Property
                and equipment
            
            
            11
            
            
            68Total
                deferred tax assets
            
            
            15,188
            
            
            13,839Deferred
                tax liabilities
            
            
            --
            
            
            --Valuation
                allowance
            
            
            (15,188
            )
            
            (13,839
            )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, 2005, the Company had net operating loss carryforwards available
      to
      offset future federal taxable income of approximately $41,000,000. Such
      carryforwards expire between 2010 and 2025. 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 has been limited by the ownership change resulting
      from the SANZ and Solunet Storage business combination. Future ownership changes
      could further limit the utilization of the Company’s net operating loss
      carryforwards.




F-21





**NOTE
      8 - COMMITMENTS AND CONTINGENCIES**





**Leases**





The
      Company leases office space and equipment under various non-cancelable operating
      leases. At December 31, 2005, the aggregate future minimum lease commitments
      were as follows (in thousands):




2006
            
            $
            7322007
            
            
            9662008
            
            
            5122009
            
            
            342010
            
            
            --$
            2,244





Rent
      expense totaled $488,000, $977,000 and $714,000 in the years ended December
      31,
      2005, 2004 and 2003, respectively.





**Closed
      Offices**





In
      accordance with SFAS no. 146, “Accounting for Costs Associated in Exit or
      Disposal Activities,” in the fourth quarter of 2004 the Company recorded a
      liability in the amount of $279,000 for expenses related to the closure of
      three
      regional offices. The accrued expenses included rent payments for the remaining
      lease terms, net of any sublease agreements. At December 31, 2005, the remaining
      liability on the closed offices was $68,000.





**Severance
      agreements**





In
      the
      fourth quarter of 2004, the Company entered into separation agreements with
      several key management personnel. In conjunction with these agreements, we
      recorded a liability in the amount of $216,000 for severance and other
      termination benefits to be paid out in 2005.





The
      following table summarizes the accrued severance and closed office activity
      during 2005:





Accrued
              Liability
            
            Balance
                at
            
            2005
            
            2005
            
            Balance
                at
            
            Scheduled
                Payments(in
                thousands)
            
            12/31/04
            
            Payments
            
            Accruals
            
            12/31/05
            
            2006Severance
            
            $
            216
            
            $
            216
            
            $
            --
            
            $
            --
            
            $
            --Closed
                Offices
            
            
            279
            
            
            211
            
            
            --
            
            
            68
            
            
            68TOTAL
            
            $
            495
            
            $
            427
            
            $
            --
            
            $
            68
            
            $
            68




**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.




F-22





**NOTE
      9 - STOCKHOLDERS’ EQUITY**





**Private
      Placement**





Effective
      March 2, 2006 and as part of the Private Placement as discussed in Note 3,
      the
      Company issued 236.8 shares of its Series A Preferred Stock. Each share is
      convertible into 333,333 shares of the Company’s common stock at an exercise
      price of $0.15 per share, resulting in approximately 78.9 million common shares
      or approximately 42% of the total shares used in the calculation of basic and
      diluted loss per share as of December 31, 2005. Also as part of the Private
      Placement, the Company issued approximately 79.0 million stock purchase
      warrants, which are exercisable into shares of the Company’s common stock at
      exercise prices of $0.30 and $0.50 per share (approximately 39.5 million
      warrants exercisable at each price).





**Stock
      options**





The
      Company has in effect three Stock Option Plans, a 2000 Stock Option Plan, a
      2001
      Stock Option Plan and a 2003 Stock Option Plan. The
      2001
      Stock Option Plan was adopted on September 20, 2001. At December 31, 2005,
      the
      total number of shares of common stock reserved for options issuable under
      this
      plan was 5,000,000. Options granted under the plan vest generally over three
      to
      ten years. The exercise price of options granted under this plan is required
      to
      be not less than 80% of the fair market value per share on the date of option
      grant. With the exception of “roll-over” options that were included in the plan
      upon our acquisition of ITIS Services (i.e., options previously issued by ITIS
      Services that we assumed in that acquisition), all options granted to date
      under
      the plan 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. The total number of shares
      of common stock subject to options that may be granted under the 2003 Plan
      may
      not exceed 15,000,000 shares. Options granted to date under the 2003 Plan have
      had
      an exercise price equal to fair market value at the date of grant, and vest
      generally over four years. All options and warrants discussed herein pertain
      to
      SAN Holdings, Inc. and not to Solunet Storage, as the accounting
      acquirer.





The
      Company has adopted only the disclosure provisions of Statement of Financial
      Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-based
      Compensation,” for employee stock options and continues to apply Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” for
      recording stock options granted.




For
      SFAS
      123 disclosure purposes, the fair value of these options was estimated at the
      date of grant using the Black-Scholes option pricing model with the following
      weighted average assumptions:




Years
                ended December 31,2005
            
            2004
            
            2003Expected
                dividend yield
            
            
            0%
            
            
            0%
            
            
            0%Expected
                volatility
            
            
            64%
            
            
            68%
            
            
            80%Expected
                term
            
            
            5
                years
            
            
            5
                years
            
            
            5
                yearsRisk-free
                interest rate
            
            
            4.00%
            
            
            3.95%
            
            
            2.0%





The
      weighted average fair value of options granted were $0.29, $0.36 and $0.28
      per
      share for the years ended December 31, 2005, 2004 and 2003,
      respectively.




F-23





The
      following table summarizes option activity for the three stock option plans
      during the three years ended December 31, 2005, 2004 and 2003, respectively
      (in
      thousands, except per share data):





Number
                of Shares
              Underlying
            
            Weighted
                AverageOptions
            
            Exercise
                PriceOutstanding
                at December 31, 2002
            
            
            6,542
            
            
            1.08Granted
            
            
            8,310
            
            
            0.42Forfeited
            
            
            (794
            )
            
            1.28Exercised
            
            
            (150
            )
            
            0.33Outstanding
                at December 31, 2003
            
            
            13,908
            
            $
            .69Granted
            
            
            3,010
            
            
            0.40Forfeited
            
            
            (2,924
            )
            
            0.80Outstanding
                at December 31, 2004
            
            
            13,994
            
            
            0.61Granted
            
            
            1,535
            
            
            0.29Forfeited
            
            
            (4,398
            )
            
            0.73Outstanding
                at December 31, 2005
            
            
            11,131
            
            
            0.51Exercisable
                at December 31, 2003
            
            
            4,662
            
            $
            0.99Exercisable
                at December 31, 2004
            
            
            6,928
            
            $
            0.79Exercisable
                at December 31, 2005
            
            
            6,117
            
            $
            0.60





Further
      information regarding options outstanding and options exercisable at December
      31, 2005 is summarized below (in thousands, except per share data):





Options
                Outstanding
            
            Options
                ExercisableRange
                of exercise prices
            
            Number
                of Shares
            
            Weighted
                Average Remaining Life (Years)
            
            Weighted
                Average Exercise Price
            
            Number
                of Shares
            
            Weighted
                Average Exercise Price$0.20
                to $0.49
            
            
            8,670
            
            
            8.1
            
            $
            0.37
            
            
            4,258
            
            $
            0.38$0.57
                to $1.00
            
            
            1,888
            
            
            4.2
            
            
            0.69
            
            
            1,286
            
            
            0.69$1.50
                to $2.25
            
            
            573
            
            
            2.1
            
            
            2.05
            
            
            573
            
            
            2.0511,131
            
            
            7.1
            
            $
            0.51
            
            
            6,117
            
            $
            0.60





**Stock
      warrants**





As
      discussed in Note 6, during 2004 and 2005, the Company issued 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.





F-24





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.





The
      following table summarizes warrant activity for the three years ended December
      31, 2005, 2004 and 2003, respectively (in thousands, except per share
      data):





Number
                of Shares Underlying Warrants
            
            Weighted
                Average Exercise PriceOutstanding
                at December 31, 2002
            
            
            7,349
            
            $
            0.94Granted
            
            
            21,526
            
            
            0.90
            *Exercised
            
            
            (195
            )
            
            0.63Forfeited
            
            
            (1,506
            )
            
            1.25Outstanding
                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
            *Exercisable
                at December 31, 2003
            
            
            8,644
            
            $
            0.91
            *Exercisable
                at December 31, 2004
            
            
            13,827
            
            $
            0.29
            *Exercisable
                at December 31, 2005
            
            
            26,025
            
            $
            0.14
            *





**NOTE
      10 - 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. For the years ended December 31, 2005, 2004 and
      2003,
      employer matching contributions were $-0-, $-0- and $46,000, respectively.




F-25





**NOTE
      11 - 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 2005, 2004 and 2003, 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, 2005 and 2004, the Company had $-0- due to Sun Capital Management
      for management fees and related expenses. For the years ended December 31,
      2005,
      2004 and 2003, the Company paid $318,000, $323,000 and $443,000, respectively,
      to Sun Capital Management for management fees and related expenses.





**Debt
      Guaranty Warrants**





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 credit facility exceeded $3.0 million. 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. During 2005, the Company issued Debt Guaranty warrants on May 16 and
      November 16, 2005. Warrants issued for November 16, 2004 and May 16 and November
      16 2005 were calculated in accordance with formula below and as stipulated
      in
      the Credit Support Agreement. Additionally, and 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 are 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 Company’s increased Harris credit facility, the Company issued
      a Debt Guaranty warrant to Sun Solunet to purchase 3,086,218 shares of common
      stock. These Debt Guaranty warrants are 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.





F-26





On
      June
      27, 2005 and in consideration of an additional $1.5 million guaranty by Sun
      Capital II on the Company’s increased Harris credit facility, 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. This warrant was immediately
      exercisable upon issuance.





**Sun
      Loan**





As
      of
      December 31, 2005 and 2004, the Company had $13.1 million, including accrued
      interest, and $-0-, respectively, outstanding on the Sun Loan, which Sun Solunet
      had purchased from Harris on November 23, 2005. See further discussion of the
      Sun Loan in Note 6.





**Private
      Placement**





As
      discussed in Note 3, 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 includes 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) at a borrowing rate of prime
                plus
                1.0%.(b)
            The
                parties agreed that Sun Solunet and the 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.





**NOTE
      12 - 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:





F-27





●
            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.




Selected
      financial information for each reportable segment was as follows for the years
      ended December 31, 2005, 2004, and 2003 (in thousands):





**Storage
                Solutions**
            
            **EarthWhere**
            
            **Total****2005**Total
                net revenue
            
            $
            57,001
            
            $
            2,114
            
            $
            59,115Depreciation
                and amortization
            
            
            839
            
            
            260
            
            
            1,099Loss
                from operations (1)
            
            
            (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
            )**2003**Total
                net revenue
            
            
            55,390
            
            
            107
            
            
            55,497Depreciation
                and amortization
            
            
            1,057
            
            
            97
            
            
            1,154Loss
                from operations
            
            
            (1,436
            )
            
            (1,207
            )
            
            (2,643
            )





(1)
      The
      Storage Solutions segment loss from operations for 2005 included a charge of
      $9.2 million for goodwill impairment.





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):





**Expenditures
                for segment assets**
            
            Years
                ended December 31,2005
            
            2004
            
            2003Storage
                Solutions
            
            $
            214
            
            $
            242
            
            $
            --EarthWhere
            
            
            1,015
            
            
            183
            
            
            516Corporate
            
            
            --
            
            
            --
            
            
            --**Total
                expenditures for assets**
            
            $
            1,229
            
            
            425
            
            
            516




F-28





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 31,2005
            
            2004
            
            2003**Net
                segment revenue**
            
            $
            59,115
            
            $
            66,158
            
            $
            55,497Loss
                from operations:Total
                segment loss from operations
            
            
            (10,583
            )
            
            (3,031
            )
            
            (2,643
            )Unallocated
                corporate costs
            
            
            (700
            )
            
            (478
            )
            
            (2,582
            )**Loss
                from operations**
            
            
            (11,283
            )
            
            (3,509
            )
            
            (5,225
            )Interest
                expense
            
            
            (1,610
            )
            
            (1,221
            )
            
            (817
            )Charge
                for warrants issued to related party for
              debt
                guaranty
            
            
            (2,877
            )
            
            (2,469
            )
            
            --Other
                income (expense)
            
            
            1
            
            
            121
            
            
            (11
            )**Loss
                before income taxes**
            
            $
            (15,769
            )
            $
            (7,078
            )
            $
            (6,053
            )





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, 2005 and 2004 (in
      thousands) are as follows:





December
                31,**Assets**
            
            
            2005
            
            
            2004Storage
                Solutions
            
            $
            37,267
            
            $
            51,466EarthWhere
            
            
            3,213
            
            
            666Corporate
            
            
            737
            
            
            1,140**Total
                assets**
            
            
            41,217
            
            
            53,272





December
                31,**Liabilities**
            
            
            2005
            
            
            2004Storage
                Solutions
            
            $
            26,541
            
            $
            29,308EarthWhere
            
            
            7,339
            
            
            3,927Corporate
            
            
            496
            
            
            270**Total
                liabilities**
            
            
            34,376
            
            
            33,505





**Customer
      Concentration**





The
      following table shows significant customers as a percentage of accounts
      receivable at December 31, 2005 and 2004 and as a percentage of revenue for
      the
      years ended December 31, 2005, 2004, and 2003, respectively. Customer A
      represents the aggregate of all Federal government agencies to which the Company
      sells directly. The associated credit risk from Customer B’s concentration was
      limited, as all orders from this customer in excess of $1.0 million were
      processed under an escrow agreement, which guaranteed payment to SANZ upon
      the
      customer’s receipt of payment from the end user. Both the Storage Solutions and
      EarthWhere segments report revenue from Customer A; all of Customer B’s revenue
      is reported under the Storage Solutions segment.





Accounts
                receivable
            
            RevenueFor
                the year endedDecember
                31,
            
            December
                31,2005
            
            2004
            
            2005
            
            2004
            
            2003Customer
                A
            
            
            30.3
            %
            
            31.1
            %
            
            17.1
            %
            
            24.1
            %
            
            14.0
            %Customer
                B
            
            
            --
            
            
            --
            
            
            12.2
            
            
            --
            
            
            --





**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-29





**(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, 2003.10.01
            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.





38




**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
            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, 2003.10.11
            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, 2003.10.12
            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, 2003.10.13
            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, 2003.10.14
            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,
                2003.10.15
            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,
                2003.10.16
            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, 2003.10.17
            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, 2003.10.18
            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, 2003.10.19
            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, 2003.10.20
            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,
                2005.10.21
            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, 2004.10.22
            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, 2003.10.23
            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, 2004.10.24
            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, 2002.10.25
            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, 2002.10.26
            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.





39




**Exhibit**
              **Number**
            **Description**


10.27
            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, 2002.10.28
            Separation
                Agreement and Release, dated November 1, 2004, between SAN Holdings,
                Inc.
                and Michael J. Phelan. Incorporated by reference to Exhibit 10.1
                to the
                Registrant’s Current Report on Form 8-K dated November 1, 2004 filedonNovember
                4, 2004.10.29
            Amendment
                to Grant Agreement, dated November 1, 2004, between SAN Holdings,
                Inc. and
                Michael J. Phelan. Incorporated by reference to Exhibit 10.2 to the
                Registrant’s Current Report on Form 8-K dated November 1, 2004 filedonNovember
                4, 2004.10.30
            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, 2005.10.31
            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, 2005.10.32
            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, 2005.10.33
            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, 2005.10.34
            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, 2006.10.35
            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,
                2005.10.36
            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, 2006.14.01
            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.




40





**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 7, 2006
            By:
/s/
                John
                JenkinsJohn
                JenkinsChief
                Executive OfficerDate:
                April 7, 2006
            By: /s/
              Robert C.
              OgdenRobert
                C. OgdenChief
                Financial Officer,Principal
                Financial and Accounting
                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 7,
                2006
              /s/John JenkinsJohn Jenkins, ChairmanDate:   April 7,
                2006
              /s/Rodger R. KrouseRodger R. Krouse, DirectorDate:   April 7,
                2006
              /s/Marc
                J. LederMarc J. Leder, DirectorDate:   April 7,
                2006
              /s/ Clarence
                E. TerryClarence E. Terry, DirectorDate:   April 7,
                2006
              /s/M. Steven LiffM. Steven Liff, DirectorDate:   April 7,
                2006
              /s/Stephen G. MarbleStephen G. Marble,
                DirectorDate:   April 7,
                2006
              /s/T. Scott KingT. Scott King, DirectorDate:   April 7,
                2006
              /s/ Gary
                F. HollowayGary F. Holloway, DirectorDate:   April 7,
                2006
              /s/ C.
                Daryl HollisC. Daryl Hollis, DirectorDate:   April 7,
                2006
              /s/George
                R. ReaGeorge R. Rea,
                Director


41