**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, 2004




**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
Mount 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 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 an accelerated filer (as defined in Rule
12b-2 of the 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,
2004) , was
approximately  $13.7
million.




As of
March 25, 2005, 95,811,278 shares of the registrant’s common stock were
outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE: None





**SAN
HOLDINGS, INC.**


**FORM
10-K**




**TABLE
OF CONTENTS**


****





**Item No.**
    
    PageForward-Looking
      Statements
    3





**Part
I**





1.
    
    Business
    32.
    
    Properties
    143.
    
    Legal
      Proceedings
    144.
    
    Submission
      of Matters to a Vote of Security Holders
    15







**Part
II**





5.
    
    
    Market
      forCommonEquityand
      Related Stockholder Matters
    156.
    
    
    Selected
      Financial Data
    177.
    
    
    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
    187A.
    
    
    Quantitative
      and Qualitative Disclosures about Market Risk
    338.
    
    
    Financial
      Statements and Supplementary Data
    339.
    
    
    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
    339A.
    
    
    Controls
      and Procedures
    339B.
    
    
    Other
      Information
    34







**Part
III**





10.
    
    
    Directors
      and Executive Officers of the Registrant
    3411.
    
    
    Executive
      Compensation
    3712.
    
    
    Security
      Ownership of Certain Beneficial Owners and Management
      and
      Related Stockholder Matters
    3913.
    
    
    Certain
      Relationships and Related Transactions
    4114.
    
    
    Principal
      Accountant Fees and Services
    42







**Part
IV**





15.
    
    
    Exhibits
      and Financial Statement Schedules
    43


****


****


2


**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 regard ing 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 7.  Management’s
Discussion and Analysis of Financial Condition and Results of
Operations —Investment
Considerations” 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
sophisticated 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. In addition, we have developed and sell a proprietary
data-management software application designed specifically for the Geospatial
Information Systems (GIS) market. Because we typically design integrated
solutions for our clients rather than merely selling them hardware, we are known
in the industry as a “storage solution provider.”





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 early 2003, we
acquired Solunet Storage Holding Corp. (“Solunet Storage”) and, indirectly, its
operating subsidiary Solunet Storage, Inc. (d.b.a. “StorNet Solutions”). Solunet
Storage was another storage solution provider, and like SANZ was based in the
greater Denver area. Solunet Storage itself had acquired substantially all of
the assets of StorNet, Inc. in September 2002 in a private foreclosure
transaction. At the time of the acquisition by SANZ, Solunet Storage 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 4 to our consolidated financial statements 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 Note 1 to our consolidated financial statements included
in this report ,
because the
transaction with Solunet Storage was accounted for as a reverse acquisition, the
consolidated financial statements of Solunet Storage have been adopted as the
historical financial statements of SANZ for all periods prior to April 1, 2003.
The consolidated financial statements consist of the operations of both Solunet
Storage and SANZ for the period from April 1, 2003 through December 31, 2003 and
for all of 2004.





3




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





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




**Products
and Services**




In the
course of our business, we provide the following products and services, all of
which are reported as a single segment in our financial statements included in
this report:





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





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





·
    ***Storage-related
      consulting services***;





·
    ***A
      proprietary data management software product known as
      “EarthWhere***TM,”which
      facilitates imagery data access and provisioning for geospatial digital
      imageryusers(principally satellite and aerial imagery and map data),together with associated support and consulting services.





*Data
Storage Networks, and Backup and Recovery Systems.* We
design, deliver and manage sophisticated 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 generally robust and broad-based, although not
immune to 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 a
proliferation of data-intensive applications, from areas as sophisticated as
document imaging, pharmaceutical development, electronic banking, satellite
imagery manipulation and scientific research, to those as commonplace as email.
In addition to our clients’ fundamental need to store vast 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 addresses 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 lowering costs through
increased utilization and more efficient management.





SAN and
NAS have become the prevailing, state-of-the-art architectures for data storage,
and are rapidly 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
      high cost of direct-attached storage environments due to inefficient
      storage utilization and high maintenance costs in those
      environments;


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


·
    Greater
      complexity of upgrading server and storage capacities in direct-attachedenvironments;and


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





4


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 often greater than the hardware and software costs, this
increased manageability also provides significant cost savings over traditional
direct-attached storage. In addition, centralizing and networking an
organization’s data storage provides 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 exist a variety of technologies for building such
backup and disaster recovery systems, including both tape and disk systems .
A significant part of
our role is to advise clients on which technologies best suit their
requirements.





*Maintenance
Services.* Because
of the complexity of data storage hardware and software, clients generally
purchase maintenance and support contracts on those products. Prior to the
acquisition of Solunet Storage in 2003, the only maintenance and support
contracts we sold were serviced entirely by the product manufacturers. Through
that acquisition, we obtained Solunet Storage’s “technical services center,” a
call center in which our own engineers now 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 service contracts under which we take
first call than on service contracts under which we do not take first call. The
ongoing communication with the client associated with taking first call also
helps us to maintain a closer relationship with the client as its “trusted
advisor,” and helps us to identify new sale opportunities within the client.





Revenues
from maintenance services are reflected in two separate categories in the
financial statements included in this report: “maintenance services” are
services under contracts that obligate us to take first call, and “maintenance
contract fees” are net revenues from the resale of manufacturer’s contracts
where the manufacturer provides all of the service.





*Storage-Related
Consulting Services.* In many
cases, we provide systems design recommendations and similar expertise to our
clients as part of the sales process, yielding higher product margins than those
typically obtained from a simple resale of off-the-shelf products, but not
resulting in a separately identifiable charge to the client. 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 increased the
volume of our consulting services in 2003
and 2004, which
generally yield higher margins than sales of hardware or third-party software.
Nonetheless, in both 2003 and 2004, revenues from consulting and integration
services combined aggregated less than 5% of our total revenues, and
are not
separately reported in the financial statements included in this report.





*EarthWhereTM
Software.* EarthWhere TM 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 TM 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 TM
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.





5


We began
developing EarthWhere TM in 2000,
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 TM .” In
2004, we took the further step of filing for U.S. patent protection on certain
aspects of the EarthWhere TM software .
The government’s review and subsequent patent prosecution process generally takes a
number of years before any resulting patent will issue.





EarthWhere TM customers typically also have data storage needs, and we expect that sales of
EarthWhere TM software
may also lead in some cases to opportunities for storage solutions sales. We
have found that sales of EarthWhere TM software
also provide opportunities for additional revenue from implementation services
and other GIS-related consulting services as described below.
While sales of EarthWhere TM software
have grown over the course of 2003 and 2004, with recorded license and software
maintenance revenues of approximately $280,000 in 2004, up from $107,000 in
2003, these sales still represent less than 1% of our overall revenues and are
therefore not separately reported in the financial statements included in this
report. In 2004, in addition to software license sales, we also recorded sales
of $404,000 of hardware and $390,000 of services related to EarthwhereTM
projects. In late 2004 we devoted even greater resources to accelerating the
growth in EarthWhere TM sales,
and we expect these sales to grow in 2005.





*Geospatial
Imagery-Related Consulting Services.* Because
of the complexity of geospatial imagery data files and the systems used to
manipulate them, end users often require specialized expertise to assist them.
As a further outgrowth of our combined expertise in data storage and in the
needs of the GIS vertical market, we also sell technical consulting services as
an adjunct to our EarthWhere TM software
offering.




**Markets
for Our Products and Services**




*Storage
Solutions, Services and Maintenance Clients.* We have
always sought to serve both government and commercial markets, but until the
acquisition of ITIS at the end of 2001 our sales were highly concentrated in the
federal government sector. By acquiring ITIS, with its east -coast
commercial client base, we achieved a more balanced mix of federal government
and commercial business. We further augmented our client base in the commercial
sector with our acquisition of Solunet Storage in 2003, which had a smaller
concentration of federal government sales. As a consequence, our market sector
mix today is approximately 2:1 commercial to government. Our government sector
sales now also include sales to
state and local governments, although the federal government continues to
represent the substantial majority of our total government sales. Substantially
all of our storage solutions sales are within the United States.





While we
do not restrict our commercial business to specified industries, we have
developed a relatively greater number of clients in certain segments, including:





●
    computer
      services and software development
    ●
    financial
      services●
    telecommunications
      / wireless
    ●
    oil
      and gas●
    higher
      education
    ●
    utilities


Most of
our federal
government clients are
agencies involved in national defense, homeland security and government
logistics .
To a lesser
extent , we have
government clients in diverse areas such as financial regulation and legislative
operations. Included in our federal government business are sales directly to
government end-users, as well as sales to prime contractors who provide various
services to government end-users. Our sales in the government sector during 2004
represented approximately 33% of our total
sales, of which approximately 22% consisted of sales directly to the federal
government and the remaining 11% consisted of sales to third parties acting as
prime contractors or sales to state or local governments.





6


*EarthWhereTM
Software Customers.* EarthWhereTM 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 TM is
within the federal government, including a variety of defense agencies,
intelligence agencies and civilian agencies. Our first major
EarthWhere TM installation (in 2003) was for the U.S. Geological Survey, a civilian agency
charged with providing mapping and similar information to other agencies within
the federal government. Since that time we have completed installations (either
completed sales or ongoing product trials) within all three types of agencies.
We also believe that there exists a smaller but nonetheless significant
commercial market for EarthWhere TM , in part
within companies that themselves produce geospatial imagery data or sell such
data to end users, and in part 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, and is not under common ownership with
any of the manufacturers of the products used in our networked storage
solutions. We build and manage our “best of breed” solutions by integrating
product offerings from our technology product suppliers. While our choice of
products 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 ability to maintain good relationships with
those suppliers and/or their distributors, some of our current key suppliers
are:





●
StorageTek


●
EMC


● Network
Appliance


●
ADIC


●
Veritas


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





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





We
believe we have strong relationships with our technology partners. In many
cases, our technology partners engage us for the expertise we bring to a
technology team, in particular in heterogeneous 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.* In our
storage solutions business, 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 cases 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 are engaged to 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 rely heavily on cooperative selling with our technology
partners, nearly all of whom have sales personnel who are tasked to support
channel partners such as SANZ. In many of the sales opportunities, we call upon
our technology partners for direct support in the sales process, in the
implementation process, or to provide lease financing for large projects. At
times our technology partners also provide opportunity leads for us to execute
directly, or include us as part of a large system solution delivery project that
they are managing.





In a full
storage solution implementation, our engineering staff designs a “best of breed”
system to meet the client’s business and technology needs, selects and acquires
the hardware and software components from our technology suppliers, and finally
coordinates 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.





7


*EarthWhere* *TM* *Sales Model.* For
sales of our EarthWhere TM 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. At
this time 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 TM sale
opportunities in certain regions outside of the United States. To date, all of
our EarthWhere TM sales
have been within the United States.




**Significant
Customers**




No single
customer accounted for more than 10% of our total revenue in either 2004 or
2003. However, various separate branches and agencies within the U.S. Department
of Defense (which undertake buying decisions independently of one another) taken
together accounted for approximately 17% of our total revenue in 2004 and 15% of
our total revenue in 2003. 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.







**Competition**





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





We face
more direct competition from manufacturers specializing in storage technology
products. Some of these manufacturers are ADIC, EMC, Hitachi Data Systems, LSI
Logic, Network Appliance, Qualstar, StorageTek, and Veritas.  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 the
section titled
“— Investment Considerations, ” 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 user client level. At times, we
face competition from other resellers offering the same or similar equipment
from the same technology partners. In general, these competitors are regional.





We
compete with companies that characterize themselves as storage solution
providers, in whole or in part, such as GTSI, MTI, Cranel and
Datalink.  Some of
these, such as GTSI, are large component and subsystem resellers who have moved
into the market for complete solution delivery relatively recently. Others, such
as Datalink, have applied the solution sale model for a longer time.





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 significant 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,
we hold and maintain a Facility Clearance and certain personnel hold Secret and
Top Secret Clearances, which enable us to provide services on projects that are
restricted to holders of these clearances.





8


*EarthWhere* *TM* *.* While
there are other software products in the marketplace that provide a limited
portion of the overall functionality provided by EarthWhere TM , **** we are
unaware of any other software application that is commercially available at this
time that seeks to provide all or most of EarthWhere TM ’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 TM in the
future.




**Research
and Development**




Our
research and development expenditures in 2004, 2003 and 2002 have been
approximately $589,000, $332,000 and $-0-, respectively. The full amount
incurred in 2003 and 2004 relates to EarthWhere TM development efforts. We continually seek to enhance the functionality of
EarthWhere TM through
further development efforts. While it is also possible that we may seek to
develop additional storage-related software tools for vertical markets outside
of the GIS sector as we identify new opportunities, we do not have any
development efforts unrelated to EarthWhere TM ongoing
at this time.




**Employees**




As of
December 31, 2004, we employed 101 full-time people. None of our employees are
subject to collective bargaining agreements. We believe that our relations with
our employees are good.








**Investment
Considerations**





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, but
that may 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 revenues and gross profits at a level
sufficient to support the investment we have made in infrastructure and
technical resources. Even after recent cost reductions and revenue increases
derived from the combination of SANZ and Solunet Storage and otherwise, our
gross profits still may not be sufficient to cover this overhead and to enable
us to become profitable without further reductions in that
overhead.*** **





We
incurred a net loss of $6.3 million in 2004. As of December 31, 2004 we had an
accumulated deficit of $18 million. We have not had a profitable quarter
since our inception as a publicly-reporting company. Our April 2003 acquisition
of Solunet Storage has led to a substantial increase in our revenues, a
narrowing of our net loss, and the achievement of positive earnings before
interest, taxes, depreciation and amortization, and other non-operating income
or expense (“EBITDA") in two of the last four quarters. However, EBITDA does not
reflect all cash costs and positive EBITDA does not equate to a net profit. We
hope to achieve full profitability in the near future; however, there can be no
assurance whether or when we will achieve that goal.





We have
expanded our engineering staff and sales force and improved our infrastructure,
both through internal growth and through acquisitions, to support both expanded
selling and project execution elements necessary for our growth objectives. The
acquisition of Solunet Storage more than doubled our total workforce, even after
staff reductions associated with the combination, to 112 employees at December
31, 2003 and 101 employees at December 31, 2004. We have also made investments
in various software packages, testing lab equipment and other fixed assets to
support operations over recent periods. Either an increase in gross profits, or
further reductions in our overhead, or a combination of the two, will be
necessary to enable us to become profitable, and there can be no assurance that
we will be successful in doing so.





9


***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.*** **





At
December 31, 2004, we had $0.4 million of cash. For the year ended December 31,
2004, we had a net loss of $6.3 million. At December 31, 2004 we also had a
working capital deficit (current liabilities greater than current assets) of
$16.0 million.





We have a
revolving credit line with Wells Fargo to borrow up to $12 million, subject to
availability under its borrowing base.  It should
be noted, however, that the funds available under the credit line are limited by
the amount of eligible accounts receivable we hold at any given time, and
fluctuations in the timing of customer orders can adversely affect our ability
to draw on the line when required. Covenants also permit the lender to declare
the loan in default if our operating subsidiary does not achieve certain net
income targets during each calendar quarter, or if the book net worth plus
subordinated debt of our operating subsidiary falls below levels that we have
agreed to maintain. We were not in compliance with certain of those covenants at
December 31, 2004 ;
however, Wells Fargo did not issue a formal, written notice of default. Under an
amendment to the credit agreement executed in March 2005, Wells Fargo granted
us a waiver of non-compliance on these covenants. In the past, we
have periodically been in default under the covenants, and have required waivers
from the lender. If we were to not be in compliance with financial covenants and
were unable to obtain such a waiver, and the lender was to accelerate the loan,
the company would need to obtain credit from other sources to repay the loan.
These matters are discussed further in “ Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources.”





Further,
we purchase most of our products from our suppliers on open trade credit terms.
Many of these suppliers set limits on the open trade credit they will afford us
at any given time. If our significant suppliers were to cease to sell to us on
open trade credit terms, or were to substantially lower the credit limits they
have set on our accounts, we would need to accelerate our payments to those
vendors, creating additional demands on our cash resources, or we would need to
find other sources for those goods.





***We
may seek to raise additional capital through bank borrowings or public or
private offerings of equity or debt securities or from other sources. No
assurance can be given that additional financing will be available or that, if
available, it will be on terms favorable to us. Future issuances of securities
could adversely affect the interests of our prior
shareholders.*** **





The
acquisition of Solunet Storage as well as actions taken by SANZ in 2004 were
intended to reduce expenses to levels at or below anticipated gross profit
levels and, in so doing, to reduce net cash requirements. The principal
reductions resulting from all of those actions were to personnel expense (our
largest expense item). While total selling, general and administrative expense
was reduced by more than $1.7 million per quarter from the second quarter of
2003 (in which the combination of SANZ and Solunet Storage was closed) to the
fourth quarter of 2004, fluctuations in sales and gross profit over the same
period have prevented these actions from fully closing the gap between gross
profits and expenses. Management believes, however, that continued focus on cost
reductions coupled with modest increases in gross profits will be sufficient to
enable SANZ to operate with its existing capital base for at least the next
twelve months. These actions and their effects are discussed in “ Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.”





While
these actions are currently projected to enable us to reach profitability
without raising additional capital, there can be no assurance that they will
succeed in doing so. For this reason, and because of the continued uncertainty
in the level of technology spending, there is a possibility that we will need
either to take further action to reduce expenses (which could entail curtailing
certain operations), or to seek additional debt or equity capital, or both. If
we do seek additional debt or equity capital, there is no assurance that it will
be available on favorable terms or in an amount sufficient to avoid the need
for further reductions
in expenses .





10


The
issuance of securities has been a significant source of cash in the past. We
also have issued material amounts of securities at various times to acquire
other companies and assets. Due to our limited cash resources, any future
acquisitions likely could be effected only by our issuance of securities, and
management may in the future deem raising capital through the sale of additional
securities to be preferable to bank financing. Additional funds raised through
the issuance of equity securities or securities convertible into 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 .





***We
have a single controlling shareholder that owns*** ***approximately*** ***58.4%
of our outstanding shares*** ***of
common stock*** ***and
that has the power to elect a majority of*** ***our
board of directors*** ***and control the strategic direction of*** ***SANZ*** ***.***





In our
acquisition of Solunet Storage, we issued shares of common stock and voting
preferred stock representing approximately 58.4% of
the aggregate voting stock of SANZ to Sun Solunet. 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.





***Public
sale of previously restricted shares by Sun Solunet could cause the market price
of our shares to drop significantly, even if our business is doing
well.*** **





Approximately
58.4 % of our
outstanding shares are held by Sun Solunet. These shares first became eligible
for sale under Rule 144 in April 2004, subject to volume limitations restricting
sales to just under one million shares per three-month period. (Due to the size
of Sun Solunet’s holdings, those volume limitations are expected to remain in
force indefinitely, and will not lapse when the shares have been held for two
years.) Further, at the time we acquired Solunet Storage, we entered into an
agreement granting Sun Solunet the right to require us to register its shares
for public resale. 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 even if our
business is doing well. Furthermore, in light of the large number of shares that
it holds and its acquisition cost of those shares (derivative of the price at
which Solunet Storage acquired StorNet’s assets out of foreclosure), Sun Solunet
could be willing to sell it shares at a price lower than the
currently-prevailing market price, thereby depressing that price.





***Future
“debt guaranty” warrants issued to Sun Solunet could result in dilution of the
other shareholders of the Company.***





In
partial consideration for the guaranty provided by Sun Capital Partners II, LP
(“Sun Capital II”), an affiliate of Sun Capital and Sun Solunet, on our two
revolving Harris Trust credit facilities, if the guaranteed Harris Trust debt
was not reduced to $3.0 million or less starting in November 2004 (18
months after the effective date of the guaranty), the Company was obligated to
issue stock purchase warrants at an exercise price of $0.001 to Sun Solunet
based on the excess guaranteed debt over $3.0 million.





Pursuant
to this agreement, in November 2004, the Company was obligated to issue, and on
March 23, 2005, the Company issued to Sun Solunet a stock purchase warrant to
purchase 7,715,545 shares of common stock at an exercise price of $0.001 per
share. In March 2005, pursuant to the February 2005 revision of the credit
agreement with Harris Trust, which increased the Company’s availability by $2.0
million, the Company approved the issuance of an additional stock purchase
warrant to Sun Solunet for the purchase of 3,086,218 shares of common stock at
an exercise price of $0.001 per share. This warrant was issued on March 23,
2005.





Until the
Company reduces the guaranteed debt to $3.0 million or less, it will be required
to issue additional warrants to Sun Solunet at six-month intervals in the future
(each May and November), according to formulas applicable to each such date. The
issuance of additional stock purchase warrants would result in dilution of the
other shareholders of the Company.


******


11


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





Most of
our revenue and a majority of our gross profit come from selling integrated
solutions, consisting of combinations of hardware and software products produced
by others. While our relationships change from time to time, some of our most
significant technology partners at this time are Sun Microsystems, StorageTek,
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.





***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.*** **





Our
EarthWhere TM software
product became “generally available” in 2003 and we achieved several sales
during the course of 2003 and 2004. The resources that we expended over four
years of development were several times the amount of the 2003 and 2004 sales;
the direct cost of EarthWhere development activities in 2004 alone was
approximately $600,000. This amount includes both capitalized amounts and
amounts expensed for research and development.





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.





***Due
to the significant change in our size, the “project based” nature of our
business, the uncertain acceptance of our new products and the uncertain
turn-around in technology spending in general, we may have difficulty predicting
revenue for future periods and appropriately budgeting for expenses, resulting
in expense levels unjustified by actual revenues.*** **





A variety
of factors coincide to reduce our ability to accurately forecast our quarterly
and annual revenue. These include the significant growth and changes in our
operations as a consequence of the Solunet Storage acquisition, the newness of
our EarthWhereTM product to the market, uncertainties in the pace of technology
spending in the market as a whole as the United States economy recovers from
recession, and other factors beyond our control. If our revenue does not
increase as anticipated or if it decreases, significant losses could result due
to expense levels that were established in anticipation of revenue
growth.





***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 orders
received by the company: we now regularly receive orders of more than $1 million
in a single transaction. The timing of large orders from customers and the
product integration cycle of those orders can cause significant fluctuations
from period to period. Other factors include the tendency of customers to change
their order requirements frequently with little or no advance notice to us;
deferrals of customer orders in anticipation of new products, services, or
product enhancements from us or our competitors; and the rate at which new
markets emerge for products we are currently developing. In addition to the
forecasting difficulties posed by these fluctuations, our reported results from
any one period may not be a reliable indicator to investors of the financial
results to be expected in future periods.





12


***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 this Item, approximately 33% of our current sales are to U.S. government
customers or to support U.S. government projects. Moreover, various agencies and
branches of the U.S. Department of Defense, taken together, accounted for
approximately 17% of total sales in 2004. While it is not legally necessary to
be an approved vendor in order to sell to the government, we have established
“GSA Schedules” with the U.S. General Services Administration (GSA) 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
government end-users. If the GSA were to refuse to renew those GSA Schedules, we
could lose much of our government revenue base and our business and results of
operations would be materially and adversely affected. SANZ’ GSA Schedule was
most recently renewed in February 2003, and is valid through February
2008.





***Acquisitions
of other companies could disrupt our business and harm our financial condition,
and we could fail to recognize synergies expected from any such
acquisition.*** **





SANZ has
grown over the past few years in significant part through acquiring other
companies, and it is possible that we will seek opportunities to acquire other
businesses or technologies. Acquisitions entail a number of risks,
including but not
limited to problems
integrating the acquired operations’ technologies or products with our existing
business and products; diversion of management’s time and attention from our
core business; and difficulties in retaining business relationships with
suppliers and customers of the acquired company.  Achieving the anticipated benefits of any acquisition will depend in part upon
whether we are able to effectively integrate the businesses. While we believe we
have been successful in integrating the businesses of SANZ and Solunet Storage,
the change inherent in any integration inevitably results in some amount of
dislocation. If we undertake any additional acquisitions, there can be no
assurance that any anticipated synergies will be achieved even if we are able to
integrate the acquired business’ operations and economic conditions remain
stable.





***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.





***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 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. We used that power to complete the acquisition of
Solunet Storage in 2003 (although the preferred stock issued in that transaction
did not have rights superior to the common stock into which it was convertible).
Such an issuance 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.





13


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





Our
future success depends on our ability
to attract qualified, storage technology 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 revenues to offset our
operating costs.







**Item
2. Properties**





We do not
own any real property. We occupy approximately 9,595
square 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
EarthWhereTM development functions. We are currently leasing this facility under
a sub-lease agreement, which expires on September 14, 2005. The monthly rent
under this sub-lease is $10,395 plus the costs of utilities, property taxes,
insurance, repair and maintenance expenses and common area
utilities.  We are in
the process of negotiating a renewal for this lease at its expiration.





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





**Location**
    **Function**
    **Square
      Footage**
    **Utilization**Englewood,
      CO
    Headquarters,
      executive and administrative offices, as well as data center and research
      and development
    9,595
    90%Richardson,
      TX
    Call
      center, data center, engineering management and regional sales
      office
    9,546
    90%Vienna,
      VA (1)
    Engineering
      management and regional sales office
    2,559
    100%Stafford,
      TX
    Regional
      sales office
    2,202
    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 in April 2005 for
      an additional 2,142 square feet adjacent to the current office in Vienna,
      VA.





In 2004,
we closed three of our regional offices located in Waltham, Massachusetts;
Norwalk, Connecticut; and 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.





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**





Prior to
December 1999, we owned a minority interest (less than 5%) in an unrelated
company, Alliance Medical Corporation. In December 1999, we placed those shares
(the “Alliance Shares”) into an escrow account, to be distributed either to
SANZ’ shareholders of record at December 31, 1999 or back to SANZ, based on the
outcome of certain future events. We contended that the requirements for a
distribution of the Alliance Shares to those record-date
shareholders failed to
occur, and that SANZ was therefore entitled to recover the Alliance Shares, but
certain of the record-date shareholders disputed our contention. In late 2002
the escrow agent deposited the Alliance Shares with the District Court of
Arapahoe County, Colorado. Between 2002 and December 31, 2004, we either settled
with or obtained default judgments against a substantial majority of the
record-date shareholders, and in doing so obtained clear title to slightly more
than half of the Alliance Shares. Under those settlement agreements we waived
our claim to approximately 37% of the Alliance Shares. Approximately 10% of the
original Alliance Shares remain the subject of the litigation.





14




**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 2004.




**PART
II**





**Item
5. Market for Common Equity and Related Stockholder
Matters**





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 2004 and 2003. 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**2004**First
      Quarter
    0.66
    0.48Second
      Quarter
    0.54
    0.38Third
      Quarter
    0.44
    0.24Fourth
      Quarter
    0.43
    0.24**2003**First
      Quarter
    0.78
    0.42Second
      Quarter
    0.90
    0.41Third
      Quarter
    0.60
    0.38Fourth
      Quarter
    0.63
    0.40





On March
24, 2005, the last reported sale price for our common stock was $0.34.





**Holders**





As of
March 10, 2005, there were 95,811,278 shares of SANZ common stock outstanding,
held of record by approximately 370 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.





**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 .





15


**Equity
Compensation Plan Information**





The
following table sets forth information regarding compensation plans (including
individual compensation arrangements) in effect at December 31, 2004, 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
    1,083,357
      (1)
    $ 2.32
    -0-Equity
      compensation plans not approved by security holders
    12,311,302
    $ 0.44
    7,598,337Total
    13,394,659
      (1)
    $ 0.59
    7,598,337





(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, 2004, 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, 2004, 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.





16





**Item
6. Selected Financial Data**





The
fiscal year 2004, 2003 and 2002 statements of operations data, and the 2004 and
2003 balance sheet data, have been derived from our consolidated financial statements and notes appearing in Item 15 of this report . The
statement of operations data for 2001 has been derived from our historical
financial statements for that year. The balance sheet data for Solunet Storage
Holding Corp. as of December 31, 2002 and for StorNet, Inc. as of September 25,
2002 and December 31, 2001 have been derived from our historical financial
statements for those periods. The statement of operations and balance sheet data
for 2000 are not available, as StorNet, Inc. was not a reporting
company.





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 of this report.




**Consolidated
      Statement of Operations Data**
    San Holdings, Inc.
    Solunet
      Storage
      Holding
      Corp. (1)
    StorNet,
      Inc. (2)Years Ended
      December 31,
    Sept.
      26, 2002
      to
      Dec.
      31, 2002
    Jan.
      1, 2002
      to
      Sept.
      25, 2002
    Year
      ended
      December
      31,
      20012004
    2003
      (1)Total
      Revenue
    $    66,158
    $    55,497
    $    11,554
    $     42,446
    $    97,441Loss
      from operations (3)
    (3,044)
    (5,225)
    (5,627)
    (9,556)
    (19,815)Net
      loss (4)
    (6,285)
    (5,938)
    (5,813)
    (10,362)
    (22,012)Basic
      and diluted loss per share
    $  
         (0.07)
    $ 
          (0.12)
    $  
         (0.29)
    $  
         (0.52)
    $  
         (1.24)**Balance
      Sheet Data:**Working
      capital (deficit)
    (16,029)
    (12,225)
    (2,038)
    (32,876)
    (24,873)Total
      assets
    53,737
    60,469
    12,320
    10,997
    25,626Total
      long-term debt
    —
    —
    4,000
    —
    63Total
      stockholders’
      equity
      (deficit)
    20,232
    24,048
    (4,813)
    (32,087)
    (21,726)


(1)
Solunet Storage Holding Corp. is the accounting predecessor to SAN Holdings,
Inc. Effective April 1, 2003, SANZ completed a business combination with Solunet
Storage, which was accounted for as a reverse acquisition, with Solunet Storage
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 financial statements
presented here as the financial statements of SANZ consist of the accounts of
Solunet Storage for all periods presented, together with the assets, liabilities
and results of operations of SAN Holdings, Inc. and its subsidiaries from April
1, 2003.







Solunet
Storage 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’s operations for 2002 consist
solely of operations conducted during a period of slightly more than three
months, from September 26, 2002 to December 31, 2002.





(2) On
September 26, 2002, Solunet Storage acquired the assets of an ongoing business
(StorNet); therefore , StorNet
is considered to be an accounting predecessor of Solunet Storage, and thus of
SANZ. The results of operations of StorNet are presented as prior period
financial statements. However, 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 those of SANZ for
2003 or 2004.





(3) In
2003, our loss from operations included $2.0 million of non-recurring costs
related to the acquisition of Solunet Storage, and $1.2 million of depreciation
and amortization expense. In 2004, our loss from operations included $1.2
million of severance and closed office expense, related to continuing cost
reduction efforts. The 2004 loss from operations also included $1.4 million of
depreciation and amortization.





(4) The
2004 net loss included a $2.5 million charge related to the obligation to issue
a stock purchase warrant to our majority shareholder, Sun Solunet, pursuant to a
debt guaranty provided by Sun Capital II, an affiliate of Sun Solunet. See
further discussion in “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations.”





17




**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**2004**
    
    March
      31
    
    June
      30
    
    Sept.
      30
    
    Dec.
      31Net
      sales
    
    $
    16,839
    
    $
    15,248
    
    $
    17,965
    
    $
    16,106Gross
      Profit
    
    
    4,122
    
    
    3,119
    
    
    4,064
    
    
    3,295Net
      loss
    
    
    (484
    )
    
    (1,463
    )
    
    (198
    )
    
    (4,140
    )(1)Net
      loss per share, basic and diluted
    
    
    (0.01
    )
    
    (0.02
    )
    
    --
    
    
    (0.04**2003
      (2)**Net
      sales
    
    
    7,146
    
    
    17,382
    
    
    15,969
    
    
    15,000Gross
      Profit
    
    
    1,554
    
    
    4,299
    
    
    3,952
    
    
    3,686Net
      loss
    
    
    (1,440
    )
    
    (3,529
    )
    
    (373
    )
    
    (596Net
      loss per share, basic and diluted
    
    
    (0.07
    )
    
    (0.06
    )
    
    (0.01
    )
    
    (0.01





(1)
    The
      fourth quarter of 2004 includes a charge of $2.5 million related to a
      stock purchase warrant issued to our majority shareholder, Sun Solunet.
      This warrant was issued to Sun Solunet in partial consideration for a
      guaranty provided by Sun Capital II on our two revolving credit lines with
      Harris Trust. 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 office and employee severance. Of
      this amount, nearly $500,000 was an accrual for remaining lease and
      severance agreements to be paid in 2005 and
2006.





(2)
    The
      business combination between SAN Holdings and Solunet Storage was
      completed on April 1, 2003, and 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 financial information presented in
      the above table include the results of operations of Solunet Storage only
      for the first quarter of 2003, and of SAN Holdings, Inc. and its
      subsidiaries (SANZ and Solunet Storage combined) from April 1,
    2003.









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





**Executive
Summary**





SANZ’
Storage Solutions Business :





SANZ provides
sophisticated 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.





Because
we typically design integrated solutions for our clients rather than merely
selling them hardware, 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 all of those sometimes competing offerings to provide an optimized
price-performance combination for the client’s specific needs. This expertise is
our primary differentiating factor.





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 Dallas,
TX, Houston, TX, Englewood, CO and Washington, DC. These facilities are used to
test proposed solutions and to demonstrate those solutions to prospective
clients.





18


In many
cases, we provide solution design recommendations to our clients as part of the
sales process, often yielding higher margins on products than those typically
obtained from a simple resale of off-the-shelf products, but not resulting in a
separately identifiable charge to the client. 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 focused on and have
grown the
technical professional services content of our business, from $2.7 million in
2003 to $3.3 million in 2004, a 22% increase. Sales of professional services
generally provide higher gross margins than the re-sale 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.





Because
of the complexity of data storage hardware and software, clients generally
purchase maintenance and support contracts on those products. We provide these
services from our Dallas, TX based “technical services center,” a call center in
which our own engineers field support calls from clients with respect to many,
but not all, 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.” We generally
receive higher gross margins on service contracts under which we take first
call. The ongoing communication with the client associated with taking first
call also helps us to maintain a closer relationship with the client as its
“trusted advisor,” and helps us to identify new sales opportunities within the
client. SANZ’ full complement of services, from initial consulting through
post-installation technical support, creates a “full service” model for our
clients.





We market
our Storage Solution 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 that can stretch to near 12 months; requires that
we maintain presence on certain Federal procurement vehicles
(i.e., GSA Schedules) that generally limit available margin on third party
product re-sale; and typically provides greater opportunity for higher levels of
professional services sales. The commercial market
for SANZ is much more geographically diverse; normally involves smaller average
project size with shorter sales cycles of generally 90 days; faces certain
market access limitations from our technology partners as most reserve many of
the Fortune 1000 accounts for direct 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. The sales cycles of Federal and commercial procurement are different and generally complementary; the commercial markets
tend to provide more early adopters of new storage technologies; and, as we
serve both markets from a similar portfolio of technology partners, it allows us
to extract better financial leverage from our investment in training and vendor
management efforts.





While we
believe 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), robust 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 not immune to fluctuations in capital
spending in general and in information technology (IT) spending in
particular.





19


Capital
investment in IT has been generally depressed since the expansion in
2000. In
addition, in the storage sector, a rapid pace of technological change has put
additional pressure on new project revenues and product re-sale margins. Disk
prices have continued to fall through the introduction of new technologies and
improved manufacturing techniques. This has created margin pressures in the
market for disk products and applied derivative pressure on tape and tape
related product sales. The price per unit volume of general data storage
capacity has continued to trend downward. IDC Corp.’s “Worldwide Disk Storage
System Tracker” reported December quarter 2004 results as 1% revenue growth and
57.7% capacity growth year on year. The number of software offerings for
traditional functions such as backup and recovery has increased in number and
improved in functionality, again increasing downward pricing
pressure.





To
counter these downward
pricing pressures,
we have focused on increasing unit volume capacity sales and growing our higher
margin product and service offerings such as professional services.
We believe
that we have
been generally successful on both counts, but have had to make major changes in
our overall cost structure in the process, and re-direct our available resources
to a tighter market focus. In 2004 these changes in structure resulted in $1.2
million of severance and office closure costs.





Our
strategy for the Storage Solutions business is to 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 driving to increase the individual productivity of our
sales staff and the billable utilization of our existing engineering staff. In
parallel, we are moving to increase the mix of our higher margin services
business, and continue to reduce the costs of our back office and support
operations through ever improved application of systems and technology.





SANZ’
EarthWhereTM 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 TM 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 TM predominantly to government agencies that use geospatial digital imagery in
their business or mission. These many uses may include:





●
    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;





●
    Municipal
      planning, taxing and control organizations who use imagery to address
      zoning compliance and other real estate development
  issues.





20


While
there are no specific market estimates for software products and services that
provide the EarthWhereTM 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, put 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 imagery to meet the needs of
geospatial imagery 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.





The process of
delivering imagery to meet the needs of geospatial imagery users is slow,
time intensive (therefore costly), and often fails to meet timing or general
mission needs of the business
user . The
larger effect is that the cost and lack of timeliness of the process itself
currently limits the growth rate of the market. In order to serve more business
users, today’s process model requires an investment in more imagery
analysts which, in many
cases, is an
unacceptable condition.





SANZ
management believes that the introduction of EarthWhereTM 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 Geological Survey and other users, the
application of EarthWhereTM improved productivity of some operations by as much
as 20 to 1. 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.





Our first
real year of product introduction was
2004. We made
solid penetration in a number of Federal agencies that hold significant
potential for broad application of the EarthWhereTM software product. The sales
cycle for an “enterprise class” software product typically exceeds 12 months,
from initial introduction to full deployment. We expect that the EarthWhereTM
sales cycle will follow this pattern. A relatively small license sale that
supports a typical “department” use is in the range of $100,000. Our business
development efforts through 2004 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 2005 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.





At this
stage we have no direct competition for the EarthWhereTM 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 are
investing at significant levels in continued product development, which we
expect will be necessary to continue to maintain a
competitive position. We
capitalize software development costs according to accounting
principles generally accepted in the United States (“US GAAP”). In 2004, we
capitalized $509,000 of software costs related to the development and production
of EarthWhereTM.





While we
expect increases in sales of EarthWhereTM 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
put a significant strain on the Company’s cash resources.





**General**





SANZ’
current line of business operations commenced in 2000. Effective April 1, 2003,
we completed the acquisition of Solunet Storage and, indirectly, its operating
subsidiary Solunet Storage, Inc. (d/b/a “StorNet Solutions”). As further
discussed in Note 1 and Note 4 to our consolidated financial
statements included
in this report , the
transaction was accounted for as a reverse acquisition, and as a result, the
financial statements of Solunet Storage have been adopted as the historical
financial statements of SANZ for all periods prior to April 1, 2003. For the
period from April 1, 2003 through December 31, 2004, the consolidated financial
statements consist of both the operations of Solunet Storage and
SANZ.





21


In this
report or in our other reports filed with the SEC, we at times make reference to
“EBITDA,” which is a non-US GAAP measure. Unless otherwise defined in a specific
report, “EBITDA” consists of net income computed in accordance with US GAAP
excluding the effects of depreciation and amortization, interest and other
non-operating income or expense, and taxes. Management believes that EBITDA may
be useful to investors in assessing SANZ’ near-term performance because it
excludes the impact of depreciation, amortization and similar costs (or
recoveries) related to prior investments, and because depreciation and
amortization are not controllable in the current period. Although it is a widely
recognized measure, EBITDA is not meant to be considered a substitute or
replacement for net income as computed in accordance with US GAAP. In addition,
our calculation of EBITDA may be different from the calculation used by other
companies and, therefore, comparability may be limited.





**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 primarily from two sources: (i) the resale and
installation of data storage systems, which consist of computer hardware,
software, and data storage related services, and (ii) 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.





Service
sales





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





Maintenance
Services





Revenue
from maintenance agreements is recognized in one of two ways, based on whether
or not the Company performs “first call” maintenance support. The Company
operates a first call technical support center for certain of the hardware and
software products that we sell. For first call maintenance services, we record
the gross sale price of the applicable support or maintenance contract as
deferred revenue, and recognize revenue on a straight-line basis over the
contractual terms of the agreements. Likewise, the cost to acquire such
maintenance agreements from the hardware and software vendors is also deferred
and amortized on a straight-line basis over the contractual terms of the
maintenance agreements. Revenue from these arrangements is set forth
under the
heading “Maintenance services” in the Consolidated Statement of
Operations included
in Item 15 to this report .





22


Maintenance
contract fees, net





For
products for which we do not perform first call maintenance, but resell the
vendor’s maintenance contract for a fee, we recognize revenue from the resale of
those maintenance agreements, net of the cost to acquire the maintenance
agreements, at the beginning of the maintenance period. Revenue from these
arrangements is set forth
under the
heading “Maintenance contract fees, net” in the Consolidated Statement of
Operations included
in Item 15 to this report .





Multiple
deliverable arrangements





In
accordance with EITF 00-21, for sales transactions that include the resale and
installation of data storage systems and the resale of 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 standalone 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
items typically include installation, training, and other professional services.





Deferred
revenue, whether associated with maintenance contracts or undelivered elements,
is included within deferred revenue on our balance
sheet included
in this report .





***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 revenues 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.





23


Goodwill
and Intangible Assets


The
Company reviews the carrying value of goodwill annually, or more often in
certain circumstances. The performance of the test involves a two-step process.
The first step 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 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 effect the calculation. It is at least reasonably possible that
the estimates we use to evaluate the realizability of goodwill will be
materially different from actual amounts or results. Goodwill was subjected to
fair value impairment tests in 2004 and 2003 and no impairments were
recognized.





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 its third quarter of 2005.





We are
currently evaluating the impact of SFAS 123R on our financial position and
results of operations as well as alternative transition methods under
SFAS 123R. In addition, we have not determined whether the adoption of
SFAS 123R will result in amounts that are similar to the current pro forma
disclosures under SFAS 123.





In 2004,
the FASB also issued the following Statements of Financial Accounting
Standards:





● ** Statement
No. 151, “ *Inventory
Costs—an amendment of ARB No. 43, Chapter 4,”* issued in
November 2004;


●
Statement No. 152, “ *Accounting
for Real Estate Time-Sharing Transactions—an amendment of FASB Statements No. 66
and* 67, *”* ** issued in
December 2004; and **


●
Statement No. 153, “ *Exchanges
of Nonmonetary Assets—an amendment of APB Opinion No.* 29, *”* issued
in December 2004.





Management
believes that adoption of these new standards will not have a material impact on
the Company’s financial results.





**Results
of Operations**





SANZ and
Solunet Storage combined effective April 1, 2003. As discussed in Notes 1 and 4
to our consolidated financial statements included
in this report , this
transaction has been accounted for as an acquisition of SANZ by Solunet Storage.
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
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.





25


Solunet
Storage, in turn, had acquired the net assets of StorNet, Inc. effective
September 26, 2002, pursuant to a private foreclosure transaction. The 2002
results of operations and cash flows refer to the combined operations of StorNet
Inc. during the period January 1, 2002 through September 25, 2002 and the
operations of Solunet Storage from September 26, 2002 through December 31, 2002.
In the discussion below, we refer to this combination as “StorNet/Solunet.” The
statements of operations of StorNet, Inc. for the nine month period ended
September 25, 2002 (the date of StorNet, Inc.’s liquidation) are included in
this report , but are
not considered to be comparable to our 2004 or 2003 results of operations
because, among other factors, the StorNet financial statements for 2002 have
been prepared on a liquidation basis of accounting. For this reason, the reader
is cautioned in making comparisons between the 2003 and 2002 results of
operations.





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 StorNet/Solunet.”





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


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





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.





***Sales.*** Our
sales during the year ended December 31, 2004 were $66.2 million. This
represents an increase of $10.7 million, or 19%, over the $55.5 million
recorded during the year ended December 31, 2003. The increase is primarily a
result of the combination of sales of legacy SANZ and Solunet Storage for 2004,
which accounts 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. Specifically,
hardware and software sales increased by $1.3 million, or 2.2%, from 2003 pro
forma to 2004. We believe that the modest increase in hardware and software
sales was due to gains in market share in the Federal government sector,
partially offset by soft general market conditions in the commercial sector,
caused by reductions in capital spending in the U.S. markets as a whole. Revenue
from maintenance services increased from $4.9 million in 2003 to $6.9 million in
2004, a $2.0 million or 40% increase. This revenue increase is primarily
the result of legacy SANZ’ shift from reselling supplier provided maintenance
(i.e., maintenance contract fees) to providing “first call” maintenance
services. Maintenance services revenue, as defined, generally provides the
Company more predictable recurring future revenue streams based on maintenance
service renewals, and generally, higher gross margins as compared to maintenance
contract fees. Revenue from maintenance contract fees, which are shown on a “net
basis” in the Statement of Operations included
in this report ,
increased marginally from $817,000 to $878,000 from 2003 to 2004, an 8%
increase. On a gross revenue basis, this represents an approximate $0.6 million
increase, which is consistent with the percentage increase in our hardware and
software sales.





***Gross
Margin*** . Gross
profit for the year ended December 31, 2004 was $14.6 million, compared to a
gross profit of $13.5 million recorded during the prior year. Of the $1.1
million increase, approximately $2.6 million is 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 .





26


On a
percentage basis, gross margin declined from 24.3% in 2003 to 22.1% in 2004. On
a pro forma basis, gross margin declined from 23.0% in 2003 to 22.1% in 2004.
The decrease in overall gross margin is primarily related to gross margins of
sales of hardware, software and services, which declined from 21.7% in 2003 pro
forma to 20.8% 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 compares 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 $17.6 million. Of this amount, $15.0 million
consists of selling, general and administrative expenses (“SG&A”) and $1.4
million consists of depreciation and amortization. The remaining
$1.2 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 $16.4 million.





The total
operating expense of $17.6 million in 2004 represents a decrease of $1.1 million
from the $18.7 million of total operating expenses recorded in 2003. The 2003
amount includes $15.5 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 $16.7 million.





On a pro
forma basis, excluding all acquisition related expenses for both SANZ and
Solunet Storage, operating expense in 2003 was $18.9 million. The 2004 operating
expenses of $17.6 million represent a decrease of $1.3 million, or 7%,
as compared to 2003 pro forma operating expenses. This decrease is 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, concentrating our resources in regions where we believe
we have 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 reflects 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.





***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, an affiliate of our majority shareholder, we were obligated
to issue to our majority shareholder, 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 is 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.





27


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


***Compared
to Results of Operations of Solunet Storage and StorNet for the Year Ended
December 31, 2002***





***Sales.*** Our
sales during the year ended December 31, 2003 were $55.5 million. This
represents an increase of $1.5 million, or 3%, over the $54.0 million
recorded during the year ended December 31, 2002. We estimate that this net
increase consists of an increase of approximately $22 million attributable to
the addition of sales by the legacy SANZ business over the nine-month period
commencing April 1, 2003, offset by an almost equal ($20 million) decline
in sales by the legacy StorNet/Solunet business from the significantly higher
volumes that were recorded in the early portion of 2002. Of that decline, we
estimate that approximately $8 million or 40% resulted from the effects of
StorNet/Solunet’s deteriorating financial condition over the course of 2002,
with the resulting losses in personnel and customer confidence that occurred
until it was stabilized by Sun Solunet’s acquisition of the business in
September 2002. We estimate that the other $12 million or 60% of the decline
reflects the effects of the decline in capital spending on IT products
in the U.S. economy as a whole, which began in 2001 and continued through 2003
and which affected both the legacy SANZ business and the legacy StorNet/Solunet
business.





***Gross
Margin*** . Gross
profit for the year ended December 31, 2003 was $13.5 million, compared to a
gross profit of $13.3 million recorded during the prior year. On a percentage
basis, gross margin declined from 24.7% to 24.3% from 2002 to 2003. The $180,000
increase in gross profit (in dollars) consists of an increase of approximately
$370,000 attributable to the increase in total revenue, offset by a decline of
approximately $190,000 attributable to the slight decline in percentage margin.
The decline in percentage margin in turn results principally from the addition
of the legacy SANZ business, which historically operated at percentage gross
margins several points lower than the legacy StorNet/Solunet business. The
higher margins of the legacy StorNet/Solunet business, and the higher margins
recorded in 2002, reflect the fact that the legacy StorNet/Solunet business
includes a smaller percentage of federal government business than the federal
sales historically recorded by SANZ.





***Operating
Expenses.*** Our
operating expenses for 2003 were $18.7 million. Of this amount, $15.5 million
consists of SG &A , $2.0
million consists of expense relating directly to the acquisition of Solunet
Storage, and $1.2 million consists of depreciation and amortization. Excluding
only the acquisition-related expense, operating expenses were $16.7 million;
excluding both acquisition-related expense and depreciation and amortization,
operating expenses were $15.5 million.





The total
operating expense of $18.7 million in 2003 represents a decrease of $9.8 million
from the $28.5 million of total operating expense recorded in 2002. The 2002
amount includes a total of $11.9 million in charges for non-cancelable
leases, for a loss on liquidation value of assets (both of which were recorded
by StorNet in connection with its liquidation in September 2002), and for
post-transaction business continuation expense (recorded by Solunet Storage in
connection with commencing operation of the business acquired from StorNet)
(these three items are referred to as the “special charges”). Excluding the
special charges, 2002 operating expenses were $16.6 million; excluding both the
special charges and depreciation and amortization, 2002 operating expenses were
$15.4 million.





***Interest
Expense.*** During
2003, interest expense (net) decreased by $500,000, from $1.3 million to
$800,000. This decrease reflects a decline of approximately $650,000 due to
decreased average borrowing levels and lower interest rates in 2003 as compared
to 2002, offset by approximately $150,000 paid to an affiliate of Sun Solunet
for loan guaranties issued on our behalf by Sun Capital II.







**Liquidity
and Capital Resources**





**Liquidity**





Our
consolidated financial statements as presented in “Item 15. Exhibits and
Financial Statement Schedules - Financial Statements” 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 $6,285,000 for the year ended December 31, 2004. In
addition, as of December 31, 2004, we have negative working capital (current
liabilities in excess of current assets) of $16,029,000. Accordingly, the
recoverability of a major portion of the recorded asset amounts as of December
31, 2004 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.





28


As of
December 31, 2004, we had approximately $2.9 million of undrawn availability in
the aggregate on our Wells Fargo and Harris Trust lines of credit. While
availability on our lines of credit with Harris Trust is not subject to asset
levels, borrowing under our line of credit with Wells Fargo is dependent at any
time on our having adequate eligible accounts receivable to support borrowings.
Although we generated positive earnings before interest, taxes, depreciation and
amortization, and other non-operating income or expense, or EBITDA, during the
first and third quarters of 2004, we recorded negative EBITDA for 2004. We must
achieve either greater gross profits, or a continued reduction of operating
expenses, or a combination of both, if we are to achieve true and sustained
profitability.





While the
cost reduction actions taken since the SANZ and Solunet merger and continued
efforts to minimize expense, coupled with stabilization or modest increase in
gross profit levels, are currently projected to enable the Company to reach
positive cash flow in 2005, there can be no assurance that we will succeed in
doing so. By generating positive operating cash flow in 2005, and assuming
continuation of current business trends and supplier relations, we believe that
our existing credit facilities are adequate in providing sufficient liquidity to
fund our operations for 2005. However, given the additional uncertainty
regarding the turnaround in the information technology market sector, there is a
possibility that we will 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, 2004, we had $486,000 in cash and cash equivalents. In addition to
cash, at that date we had undrawn availability of $2.9 million on our Wells
Fargo and Harris Trust credit facilities, resulting in a total of $3.4 million
of cash plus undrawn availability. Management believes this total represents a
better measure of our liquidity than does our cash alone.




For the
year ended December 31, 2004, our operating activities used $431,000 of cash,
compared to $3.9 million of cash used in operating activities during 2003.
Significant uses of cash from operations for 2004 were: (1) the net loss
incurred during the year of $6.3 million, of which nearly $4.0 million was
non-cash expense, (2) a decrease in our accounts payable of $0.7 million, due to
lower trade purchases related to lower invoicing in December 2004 as compared to
December 2003, partially offset by increased lines of credit with significant
vendors during the year. In addition, cash from operations in 2004 was increased
by a reduction in our accounts receivable of $2.1 million, due to improved
collection efforts in 2004 and lower invoicing in December 2004 as compared to
December 2003. Cash from operations was also increased by a decrease in
inventory of $0.6 million, primarily due to the timing of shipments of
in-transit inventory.





Cash used
in investing activities was $0.9 million in 2004, as compared to $0.5 million in
2003. For 2004, we expended $0.4 million for the purchase of property and
equipment, and $0.5 million for the capitalization of costs for software
developed for resale, discussed further below under the section “Capital
Expenditures.”





Cash used
in financing activities totaled $2.0 million in 2004, consisting of net payments
on our Wells Fargo line of credit of $0.5 million and net payments on our Harris
Trust lines of credit of $1.5 million.





29


**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. Under this facility, we
routinely draw and repay funds on a daily or near-daily basis to address timing
differences between our collections from clients and our payments to vendors.
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 adversely affect 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
sub-limit.





This
credit line expires in May 2007 and is secured by substantially all assets of
SANZ Inc., a wholly-owned subsidiary of the Company. As of December 31, 2004,
this credit line bore interest at prime plus 2% (7.25%), and based on our
eligible collateral at that date, we had $9.4 million available for
borrowing , of
which $6.8 million was drawn and $2.6 million remained available.





Wells
Fargo may declare the loan in default if SANZ Inc. does not meet certain
financial performance measures. At December 31, 2004, we were not in compliance
with certain of those covenants; however, Wells Fargo did not issue a formal,
written notice of default. Under an amendment to the credit agreement executed
in March 2005, Wells Fargo granted us a waiver of non-compliance on these
covenants , and
reset financial covenant requirements effective January 1, 2005 for: (1) minimum
net income 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. from SAN Holdings 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 SAN Holdings or an outside source if SANZ Inc. generates a net
loss in a given quarter and has 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.





As part
of the amendment and effective January 1, 2005, Wells Fargo increased our
borrowing rate to prime plus 5.0%, an increase of three points. This rate is
subject to potential decreases, as allowed by Wells Fargo, based on SANZ Inc.
achieving certain net income levels during 2005.





Additionally,
the amended credit agreement includes as an additional borrower, Solunet
Storage, Inc., which in March 2005 became a wholly-owned subsidiary of SANZ Inc.
As part of the co-borrowing arrangement with SANZ Inc. and Solunet Storage,
Inc., each of the borrowers has a separate borrowing base; however, total
borrowings under the facility shall not exceed $12,000,000. Additionally, each
entity is required to guaranty each other’s debt under the borrowing facility.
Cash transfers from SANZ Inc. to Solunet Storage, Inc. are limited to the
funding of Solunet Storage, Inc.’s operating expenses, subject to an annual
limit, and to a minimum availability on the date of any such
transfer.





We
believe that our ability to meet our covenant levels in the future has been
strengthened by the cost reductions that we realized during 2004, and assuming
continuation of current IT market trends, we expect that we will be able to meet
the covenant levels in place for 2005. However, our continued availability on
this line is dependent on our ability to maintain covenant
compliance.





Harris
Trust and Savings Bank





At
December 31, 2004, the Company also maintained two revolving credit facilities
with Harris Trust, which allowed for borrowings up to an aggregate of $8.0
million. One of the facilities, with a maximum amount of $6.8 million at
December 31, 2004, was maintained by SAN Holdings and was unsecured, not limited
by availability under a borrowing base, and did not require the maintenance of
specified financial covenants. The other facility, with a maximum amount of $1.2
million at December 31, 2004, was maintained by our Solunet Storage subsidiary,
and was secured by substantially all of the assets of Solunet Storage, but was
not limited by availability under a borrowing base and did not require the
maintenance of specified financial covenants. Sun Capital II, an affiliate of
Sun Solunet, our majority shareholder, guaranteed these facilities, both of
which were demand notes. At December 31, 2004, we had borrowed $7.7 million on
these facilities, which bore interest at a rate of prime plus 0.75% (6.00% at
December 31).





30


In
partial consideration for the guaranty provided by Sun Capital on the revolving
Harris Trust credit facilities, if the guaranteed Harris Trust debt was not
reduced to $3.0 million or less starting in November 2004 (18 months after
the effective date of the guaranty), the Company was required to issue stock
purchase warrants at an exercise price of $0.001 to Sun Solunet based on the
excess guaranteed debt over $3 million, 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 a Credit Support
Agreement dated March 31, 2003:





Date
    
    Number
      of SharesNovember
      2004
    
    
    3,086,218May
      2005
    
    
    641,292November
      2005
    
    
    1,307,898May
      2006
    
    
    1,342,776November
      2006
    
    
    1,379,067May
      2007
    
    
    1,416,849November
      2007
    
    
    1,456,206May
      2008
    
    
    1,497,226Each
      six months thereafter*
    
    
    291,346





*
    A
      number of shares equal to 0.5% of the shares outstanding upon the closing
      of the Solunet Storage business combination.





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





On
November 16, 2004, the Company became
obligated under the Credit Support Agreement to issue , and on
March 23, 2005, the Company issued to Sun
Solunet a stock purchase warrant to purchase 7,715,545 shares of the Company’s
common stock, no par value per share, at an exercise price of $0.001 per share.
The number of shares was calculated according to the formula above, and was
based on $8.0 million of guaranteed Harris Trust debt. The common
stock issuable
by the Company upon the exercise of the Guaranty Warrant represented
approximately 8% of the Company’s outstanding common
stock as of
November 16, 2004. As of that date, giving effect to the issuance
and exercise
of the Guaranty Warrant (but not to the exercise of any other outstanding
warrants or options), Sun Solunet directly held approximately 61.5% of the pro
forma outstanding common stock of the Company.  The
Company did not
receive any cash
proceeds from the issuance of the Guaranty Warrant.





On
February 16, 2005, we
entered into a revised credit agreement with Harris Trust, which increased our
availability by $2.0 million, for a total of $10.0 million, and consolidated the
credit lines into one facility maintained by SAN Holdings. This facility is
unsecured, is not limited by availability under a borrowing base, does not
require the maintenance of specified financial covenants, and as of February 16,
2005, bore interest at a rate of prime plus 0.75% (6.25%). While the Harris
Trust facility is a demand note, under the revised agreement it has been
extended to February 2006, unless called earlier by the lender. Sun
Capital II has guaranteed the Harris Trust credit facility and has agreed that,
upon the written request of SANZ, it will provide SANZ with sufficient funds to
repay the debt outstanding under the credit facility in the event that Harris
Trust requires repayment of such debt or, at Sun Capital II’s election, pay the
outstanding debt directly to Harris Trust; provided that in no event will Sun
Capital II’s obligation exceed the amount of Sun Capital II’s guaranty. This
guaranty and all obligations expire on December 31, 2005.





31


Pursuant
to the revised credit facility, on March 10, 2005, the Company approved the
issuance of an additional stock purchase warrant to Sun Solunet for the purchase
of 3,086,218 shares of common stock at an exercise price of $0.001 per share as
consideration for the additional $2.0 million debt guaranty provided by Sun
Capital II. This warrant was issued on March 23, 2005. The number of shares
underlying the warrant was calculated based on the formula above as if the debt
was outstanding as of November 16, 2004 . The
issuance of these warrants will result in dilution of the other shareholders of
the Company.





The
Company is continually evaluating potential transactions to refinance a portion
of the guaranteed debt with either other debt or equity, in conjunction with its
existing availability on its Wells Fargo credit facility, as permitted under the
financial covenants. However, there can be no assurance in being successful in
obtaining additional debt or equity financing.





**Capital
Expenditures**





During
the years ended December 31, 2004 and 2003, we purchased approximately $372,000
and $121,000, respectively, of property and equipment for cash. For 2005, we
anticipate spending in the range of $200,000 - $300,000 on property and
equipment. During 2004 and 2003 we also invested approximately $509,000 and
$207,000, respectively, in capitalized software development costs. We expect to
capitalize additional software development costs in 2005 of approximately $1.0
million. We expect to fund these capital expenditures from cash, which in turn
will be from our line of credit borrowings.





**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, 2004 are 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)
    
    $
    14,459
    
    $
    —
    
    $
    —
    
    $
    14,459Operating
      lease obligations
      (operating
      locations)
    
    
    419
    
    
    459
    
    
    4
    
    
    882Closed
      office obligations (2)
    
    
    241
    
    
    84
    
    
    —
    
    
    325Severance
      (3)
    
    
    285
    
    
    —
    
    
    —
    
    
    285$
    15,404
    
    $
    543
    
    $
    4
    
    $
    15,951





(1)
    The
      line of credit obligations are comprised of $6.8 million due to Wells
      Fargo and $7.7 million due to Harris Trust. Effective October 2004, the
      Wells Fargo credit facility was renewed and extended through May
      2007. The Harris Trust credit facilities are demand obligations, but
      expire in February 2006 if not called by the lender prior to that date. We
      have no reason to believe that Harris Trust will not extend its facility
      at the expiration date. Further, we have no reason to believe that Harris
      Trust will call its facilities prior to that
date.





(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.





(3)
    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. A
      liability in the amount of $69,000 remains on our balance sheet at
      December 31, 2004, for a severance agreement concluded in 2003, the
      remainder of which will be paid out in 2005.





32


**Seasonality**





Historically,
we have not experienced significant seasonality in our business, although our
revenue is subject to fluctuation due to government and commercial purchasing
cycles as
described in “Item 1. Business - Investment Considerations.”





**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, 2004, we had $14.5 million in variable, Prime rate based
bank debt. At December 31, 2004, our Harris Trust debt of $7.7 million bore
interest at the rate of Prime + 0.75%, or 6.00%, and our Wells Fargo line of
credit of $6.8 million bore interest at the rate of Prime + 2.0%, or 7.25%. At
December 31, 2004, a hypothetical 50 basis point increase in the Prime rate
would result in additional interest expense of $85,000 on an annualized basis,
assuming estimated borrowing amounts of $10.0 million for Harris Trust and $7.0
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**





There
were no changes or disagreements required to be reported under this Item.







**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 Securities
and Exchange Commission’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.





33


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 significant changes in our disclosure controls and procedures
or in other factors that could significantly affect those disclosure controls
and procedures subsequent to the date of the evaluation described above.







**Item
9B. Other** **Information**





None.





**PART
III**





**Item
10. Directors and Executive Officers of the Registrant**





The
Company’s bylaws provide
that each director is to hold office until the next Annual Meeting of
Shareholders and until his successor is elected and qualified or until such
director’s earlier
death, resignation or removal. The Company’s directors and executive officers
are as follows:





***John
Jenkins*** *, Age
54, Chairman and CEO* since
November 2000, President since November 2004. From January 1995 through June
2000, Mr. Jenkins was CEO, president and a director of TAVA Technologies, Inc.,
where he led the build-out of a national systems integration business. In 1999,
all outstanding TAVA shares were sold in a cash transaction approved by TAVA
shareholders. From 1990 until he joined TAVA in 1995, he had served as president
of Morgan Technical Ceramics, Inc., a wholly-owned subsidiary of Morgan Crucible
plc, a diversified industrial products company based in England and
publicly-traded on the London stock exchange. Mr. Jenkins holds a B.S. from the
University of Washington and a J.D. from the University of Denver.





***Marc
J. Leder,*** *Age
43, Director* since
April 2003, pursuant to our acquisition agreement with Solunet Storage. Mr.
Leder has served as a managing director of Sun Capital Partners, Inc., a private
investment firm, since May 1995. Prior to founding Sun Capital Partners, Inc.
(with Mr. Krouse) in 1995, Mr. Leder served in various capacities with Lehman
Brothers, an investment bank based in New York City, most recently as Senior
Vice President. Mr. Leder also currently serves as a director of Catalina
Lighting, Inc., Northland Cranberries, Inc., and LOUD Technologies, Inc., all of
which are publicly held companies, and as a director of a number of private
companies.





***Rodger
R. Krouse,*** *Age
43, Director* since
April 2003, pursuant to our acquisition agreement with Solunet Storage. Mr.
Krouse has served as a managing director of Sun Capital Partners, Inc., a
private investment firm, since May 1995. Prior to founding Sun Capital Partners,
Inc. (with Mr. Leder) in 1995, Mr. Krouse served in various capacities with
Lehman Brothers, an investment bank based in New York City, most recently as
Senior Vice President. Mr. Krouse also currently serves as a director of
Catalina Lighting, Inc., Northland Cranberries, Inc., and LOUD Technologies,
Inc., all of which are publicly held companies, and as a director of a number of
private companies.





***Clarence
E. Terry,*** *Age
58, Director* since
April 2003, pursuant to our acquisition agreement with Solunet Storage. Mr.
Terry also serves as Chairman of the Compensation Committee. Mr. Terry has
served as a managing director of Sun Capital Partners, Inc., a private
investment firm, since September 1999. From October 1973 to September 1999, he
was principally employed as vice president of Rain Bird Sprinkler Manufacturing
Corporation, a leading irrigation manufacturer. Currently, he also serves as a
director of Catalina Lighting, Inc., Northland Cranberries, Inc., and LOUD
Technologies, Inc., all of which are publicly held companies, and as a director
of a number of private companies.





***M.
Steven Liff,***  *Age
33* , *Director* since
April 2004. Mr. Liff has served as a principal of Sun Capital Partners, Inc.
since March 2000. From 1994 until joining Sun Capital Partners, Inc., he was
employed by Bank of America Commercial Finance, most recently as senior
marketing executive, focusing on marketing, underwriting and closing new
leveraged and turnaround transactions.





34


***Benjamin
S. Emmons,***  *Age
36* , *Director* from
April 2004 to March 2005. Mr. Emmons has served as a vice president of Sun
Capital Partners, Inc., a private investment firm, since 2002. Before joining
Sun Capital Partners, Inc., Mr. Emmons spent four and one-half years with CIT
Business Credit, most recently as marketing manager for the southeast region.
Mr. Emmons resigned from the board of directors in March 2005.





***Stephen
G. Marble,***  *Age
41, Director* since
October 2004. Mr. Marble has served as a vice president of Sun Capital Partners,
Inc. since February 2004. Prior to joining Sun Capital, he served as Chief
Financial Officer of Catalina Lighting, Inc., a Sun Capital portfolio
company.  Prior to being appointed CFO, he served as Catalina’s Corporate
Controller.  Mr. Marble’s experience spans a broad variety of industries
including banking, mortgage banking, specialty finance, equipment leasing and
medical services.  Mr. Marble is a CPA and began his career with Deloitte
and Touche most recently as an audit manager.





***Gary
F. Holloway,***  *Age
53* , *Director
and member of the Compensation Committee* since
April 2004. Mr. Holloway is vice chairman of Five Mile Capital Partners, a
privately held investment firm. Prior to joining Five Mile Capital Partners and
Five Mile Ventures in 2000, Mr. Holloway served as the chairman of the board of
Greenwich Capital Markets, Inc., where he previously held the position of
president and CEO. He also served as co-CEO of Greenwich NatWest. Mr. Holloway
currently serves on the Boards of Directors of Aviation Facilities Corporation,
Bank of New Canaan, The Wireless Generation, Inc., and the boards of several
educational and charitable organizations. Mr. Holloway holds a BA degree from
Washington and Lee University and an MBA from the Colgate Darden School at the
University of Virginia.





***C.
Daryl Hollis,***  *Age
61,*  *Director
and*  *Chairman
of the Audit Committee* since
April 2004. Mr. Hollis, a certified public accountant, has been a business
consultant since 1998. He has served in the past as Executive Vice President and
Chief Financial Officer of The Panda Project, Inc., a developer, manufacturer
and marketer of proprietary semiconductor packaging and interconnect devices,
and as Senior Vice President and Chief Financial Officer of Pointe Financial
Corporation, a bank holding company. Mr. Hollis was also a partner with Ernst
& Young LLP from 1977 through 1990. Additionally, he currently serves as a
director and chairs the audit committee of four other publicly held companies:
Medical Staffing Network Holdings, Inc.; Northland Cranberries, Inc.; Catalina
Lighting, Inc. and LOUD Technologies, Inc.





***George
R. Rea,***  *Age
66,*  *Director
and member of the Audit Committee* since
April 2004. Mr. Rea is currently a business consultant. Mr. Rea has held various
senior management positions in several high technology companies, retiring as
executive vice president of Conner Peripherals (NYSE) in 1994. Since retiring,
Mr. Rea has served as a business consultant and as a director of private and
public companies in high technology and other industries. Currently he is a
director of the following public companies: Catalina Lighting, Inc.; Northland
Cranberries, Inc., and LOUD Technologies, Inc.





***Robert
C. Ogden*** *, Age
44, Vice President Finance, Treasurer, Secretary and Chief Financial Officer* since May
2004. From 2000 to 2004, Mr. Ogden was a financial consultant serving companies
in a variety of industries, including software, computer hardware, on-line
education and financial services. In 2003, he served as the Acting Controller
for Exabyte Corporation, a computer tape drive manufacturer. From 1997 to 2000,
he served as Vice President, Corporate Controller and Chief Accounting Officer
for TAVA Technologies, a systems integration and software firm, which was
successfully sold in 1999. Prior to TAVA Technologies, Mr. Ogden held various
senior management finance positions with several start-up companies. He began
his career as a public accountant with Price Waterhouse, most recently as audit
manager. Mr. Ogden holds a B.S. in Commerce from the University of Virginia, and
is a certified public accountant.





35


***Board
Committees***




Our
board of directors has
established a compensation committee, an audit committee and an independent
committee .





*Compensation
Committee.* The compensation
committee currently consists of one independent director, Mr. Holloway , as well
as Mr. Jenkins and Mr. Terry, who serves as chairman.





*Audit
Committee; Audit Committee Financial Expert.* The
audit committee currently consists of two directors,  Messrs.
Hollis and Rea . The
chairman of the audit committee is Mr. Hollis. Our board of
directors has
determined that Mr. Hollis is an “audit committee financial expert” and that he
is independent.





*Independent
Committee.* The
independent committee currently
consists of four directors, Messrs. Jenkins, Holloway, Hollis and Rea, all of
our directors that are not affiliated with Sun Solunet LLC, our majority
stockholder, for purposes of approving certain transactions as may be submitted
by our board of directors from time to time.




***Section
16(a) Beneficial Reporting Compliance***





Section
16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, and the persons who own more than 10% of our common stock, to file
with the SEC initial
reports of ownership and reports of changes in ownership of our common stock.
Officers, directors and greater than 10% stockholders are required by regulation
of the SEC to furnish us with copies of all Section 16(a) forms they
file.





Based solely on a
review of copies of
Forms 3, 4 and 5, and the amendments thereto, received by us for the year ended
December 31, 2004, or written representations from certain reporting persons
that no Forms 5 were required to be filed by those persons, we believe
that we
believe that during the year ended December 31, 2004, all
filing requirements were complied with by our executive officers, directors and
beneficial owners of more than ten percent of our stock, except with respect
to the
following: (1) Robert C. Ogden, an officer, was late in filing certain reports
under Section 16 of the Securities Exchange Act. Mr. Ogden did not timely file a
Form 3 - Initial Statement of Beneficial Ownership of Securities and did not
timely file a Form 4 - Statement of Changes in Beneficial Ownership - to report
the grant of options to him in October 2004.  (2) John
Jenkins, an officer and director, filed an amended Form 4 on March 2, 2005 for a
correction of the amount of securities beneficially owned related to a purchase
of SANZ common shares on August 19, 2004.





***Code
of Ethics***





Our board
of directors adopted a code of business conduct and ethics applicable to our
directors, officers, including our principal executive officer, principal
financial officer and principal accounting officer as well as our employees in
accordance with applicable rules and regulations of the SEC. The code of ethics
was previously filed with the SEC as Exhibit 14.1 to our Quarterly Report on
Form 10-QSB for the fiscal quarter ended March 31, 2004, filed on May 11, 2004.
We will provide to any person, without charge, upon request, a copy of such code
of ethics. Requests should be made by calling (303)
660-3933 or by submitting a request in writing to the company at 9800 Mount
Pyramid Court, Suite 130, Englewood, CO 80112, Attention: Robert C.
Ogden.





36


**Item
11. Executive Compensation**




The
following table sets forth the salary and other compensation paid to our Chief
Executive Officer and each of our other three most highly compensated executive
officers (“named executive officers”) for the
fiscal years ended December 31, 2004, 2003 and 2002.





***Summary
Compensation Table***





**Annual
      Compensation**
    **Long
      Term Compensation****Name
      and Principal Position**
    **Year**
    **Salary
      ($)**
    **Bonus
      ($)**
    **Securities
      Underlying Options/SARs(#)**
    **All
      Other Compensation ($)**John
      Jenkins
    2004
    $227,488
    
    $8,694
    -0-
    
    $-0-President
      and CEO (1)
    2003
    $227,867
    
    $6,600
    1,100,000
    (2)
    $5,500
    (4)2002
    $227,400
    
    $23,950
    500,000
    (3)
    $4,583
    (4)Robert
      C. Ogden
    2004
    $96,667
    (5)
    $2,134
    350,000
    (6)
    $-0-Vice
      President - Finance & CFO (5)Michael
      Phelan
    2004
    $200,000
    (8)
    $30,016
    -0-
    
    $-0-President
      and COO (8)
    2003
    $150,012
    (7)
    $-0-
    1,100,000
    (8)
    $-0-Chris
      Wilkes
    2004
    $172,519
    
    $10,000
    -0-
    
    $-0-Executive
      Vice President (9)
    2003
    $123,750
    (7)
    $-0-
    450,000
    (2)
    $5,394
    (4)





(1)
    Mr.
      Jenkins has been employed as our Chief Executive Officer during the past
      three fiscal years, and during that period also served as President
      through April 4, 2003, and again effective November 1, 2004.(2)
    These
      options are exercisable at $0.40 per share. One fourth of the total
      options granted become exercisable each year over the next four years,
      commencing on April 1, 2004.(3)
    These
      options are exercisable at $0.29 per share.(4)
    Consists
      solely of company matching contributions to 401(k) defined contribution
      plan, available to all employees of the company following 90 days of full
      time employment. Amounts earned in the stated year were paid in the
      following year.(5)
    Represents
      compensation paid since May 3, 2004, when Mr. Ogden became employed by
      SANZ as Vice President - Finance and Chief Financial Officer.(6)
    250,000
      of these options are exercisable at $0.42 per share; 100,000 of these
      options are exercisable at $0.38 per share.(7)
    Represents
      compensation paid since April 4, 2003, when these executive officers
      became employed by SANZ pursuant to our acquisition agreement with Solunet
      Storage.(8)
    Effective
      November 1, 2004, Mr. Phelan resigned as an employee anddirectorof
      the Company. Under his separation agreement, he received severance pay of
      $33,333 from November 1, 2004 through December 31, 2004, which is included
      in the base salary amount. Additionally 550,000 options became fully
      vested on November 1, 2004.(9)
    Effective
      August 26, 2004, Mr. Wilkes ceased being an executive officer of SANZ. He
      continued to be employed as President of our wholly-owned subsidiary,
      Solunet Storage, Inc.







37


***Option
and Stock Appreciation Right Grants Table***




The
following table sets forth information regarding the grant of options and stock
appreciation rights during the year ended December 31, 2004 to each of our named executive
officers .





**Name**
    **Number
      of Securities**
      **Underlying
      Options/ SARs**
      **granted
      (#)**
    **Percent
      of total options/**
      **SARs
      granted to employees**
      **in
      fiscal year (%)**
    **Exercise
      or**
      **base
      price**
      **($/Sh)**
    **Expiration**
      **date**John
      Jenkins
    -0-
    
    —%
    
    $  
            —
    —Robert
      C. Ogden
    250,000
    
    8.3%
    
    $    
       0.42
    06/23/2014100,000
    
    3.3%
    
    $   
        0.38
    10/11/2014Michael
      J. Phelan
    -0-
    
    —%
    
    $     
         —
    —Chris
      Wilkes
    -0-
    
    —%
    
    $    
          —
    —







***Aggregated
Option/SAR Exercises in Last Fiscal Year***


***and
FY-End Option/SAR Values*** **





The
following table shows the number of shares underlying unexercised options held
at December 31, 2004 by each of our
named executive officers , and the
aggregate dollar value of in-the-money, unexercised options held at the end of
the fiscal year. SANZ has not granted any stock appreciation rights.





**Name**
    **Number
      of Securities Underlying**
      **Unexercised
      Options/SARs**
      **at
      FY-End (#)**
      **Exercisable/Unexercisable)
      (1)**
    **Value
      of unexercised**
      **in-the-money
      options**
      **at
      FY-end ($)**
      **Exercisable/Unexercisable
      (2)**John
      Jenkins
    1,075,000
      / 825,000
    $
      5,000 / $ -0-Robert
      C. Ogden
    -0-
      / 350,000
    $
      -0- /$ -0-Michael
      J. Phelan
    550,000
      / -0-
    $
      -0- /$ -0-Chris
      Wilkes
    112,500
      / 337,500
    $
      -0- /$ -0-





(1)
    Includes
      both “in-the-money” and “out-of-the-money” options. “In-the-money” options
      are options with exercise prices below the market price of SANZ’ common
      stock (as noted) on December 31, 2004.(2)
    Fair
      market value of SANZ’ common stock on December 31, 2004, the last trading
      day of fiscal 2004 ($0.30, based on the closing sales price reported on
      theover-the-counter
      bulletin board)
      less the exercise price of the option.





***Compensation
of Directors***





As of
December 31, 2004, we had no standing arrangement to compensate directors for
their services. During the fiscal year ended December 31, 2004, we granted
50,000 options, exercisable at $0.42 per share (the market value on the date of
grant) to each of the following independent directors: Gary F. Holloway and
George R. Rea, and 75,000 options, exercisable at $0.42 per share (the market
value on the date of grant), to C. Daryl Hollis, who is also an independent
director. No other compensation was paid to these individuals during 2004.
Effective January 1, 2005, all of our independent directors are compensated in
either cash or stock options (at each director’s discretion) in the amount of
$25,000 per year, payable quarterly. In addition, the audit
committee chairman is paid
an additional $12,500 per year, payable quarterly.








38








***Employment
Contracts and Termination of Employment and*** ***Change
in Control Arrangements***





We have a
three year employment agreement with John Jenkins, our CEO, which requires us to
continue paying his salary for a period of 12 months following termination of
employment in the following cases:





●
    
    if
      he terminates his employment within 90 days following specified change of
      control events,●
    
    if
      he terminates his employment due to our material change of his employment
      conditions, or●
    
    if
      we terminate his employment agreement other than for cause.





On
November 1, 2004, Michael Phelan resigned his position as a director of SANZ.
Mr. Phelan’s resignation was not due to a disagreement with the Company known to
any executive officer of the Company, and Mr. Phelan did not serve on any
committees of our
board of directors . Mr.
Phelan also ceased to serve as our President and Chief Operating Officer, as an officer of each of the Company’s
subsidiaries, and as an employee of the Company. Two agreements entered into
with Mr. Phelan on November 1, 2004 in connection with the termination of his
employment, provide for certain severance payments, non-competition obligations,
and amendments to the terms of a stock option.





The
options granted under the 2003 Stock Option Plan, including those granted to the
executive officers named above, will vest in the event the company is sold for
cash or for marketable securities meeting certain minimum liquidity standards.
The options granted under that plan to John Jenkins, our CEO, will also vest if
we terminate his employment without cause or demote him, in either case in
connection with a change of control that does not meet the foregoing standards.





***Additional
Information with Respect to Compensation Committee Interlocks and Insider
Participation***





During
2004, no executive officer served as a member of the board of directors
or compensation committee of any entity that has one or more executive officers
serving as a member of our board of directors or compensation
committee.







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





Information
regarding our securities authorized for issuance under equity compensation plans is
set forth above under “Item 5. Market for Common Equity and Related Stockholder
Matters—Equity Compensation Plan Information.”





The table
below reflects the number of shares of our common
stock beneficially owned as of March 25, 2005 by:





●
    
    each
      person or group we believe to be the beneficial owner of more than five
      percent of our voting securities;●
    
    each
      director;●
    
    eachnamedexecutive
      officer;and●
    
    all
      directors and executive officers, as a group.







Shares of our common
stock subject to options and warrants currently exercisable or convertible, or
exercisable or convertible within 60 days of March 25, 2005, are deemed
outstanding for purposes of computing the percentage beneficially owned by the
person or entity holding those securities, but are not deemed outstanding for
purposes of computing the percentage beneficially owned by any other person or
entity. Percentage of beneficial ownership is based on 95,811,278 shares of our common
stock outstanding as of the close of business on March 25, 2005 :





39








Name
      and address #
    **Amount
      and Nature of Beneficial********Ownership**
    **Percentage
      of Common Stock**John
      Jenkins
    1,680,000
    (1)
    1.73%Marc
      J. Leder
    68,205,416
    (2)
    63.97%Rodger
      R. Krouse
    68,205,416
    (2)
    63.97%Clarence
      E. Terry
    -0-
    
    -0-M.
      Steven Liff
    -0-
    
    -0-Benjamin
      S. Emmons (10)
    -0-
    
    -0-Stephen
      G. Marble
    -0-
    
    -0-Gary
      F. Holloway
    2,809,709
    (3)
    2.93%George
      R. Rea
    32,500
    (4)
    *C.
      Daryl Hollis
    18,750
    (5)
    *Robert
      C. Ogden
    82,500
    (6)
    *Michael
      J. Phelan
    1,985,091
    (7)
    2.06%Chris
      Wilkes
    225,000
    (8)
    *All
      directors and executive officers, as a group (13 persons)
    82,133,047
    
    69.08%Sun
      Solunet LLC
    68,205,416
    (9)
    63.97%c/o
      Sun Capital Partners II, LPc/o
      Sun Capital Advisors II, LPc/o
      Sun Capital Partners, LLC5200
      Town Center Circle, Suite 470Boca
      Raton, FL 33486*
    Less
      than 1%#
    The
      address for each listed director and executive officer unless otherwise
      indicated is SANZ, Inc., 9800 Mt. Pyramid Court,Suite
      130, Englewood, Colorado 80112.





(1)
    
    Includes
      500,000 shares underlying an option currently exercisable at $0.29 per
      share, 300,000 shares underlying an option currently exercisable at $2.25
      per share, 275,000 shares underlying an option currently exercisable at
      $0.40 and 275,000 shares underlying an option that will become exercisable
      at $0.40 per share. Also includes 40,000 shares underlying a warrant
      currently exercisable at $0.625 per share, and 40,000 shares underlying a
      warrant currently exercisable at $1.25 per share.(2)
    
    Includes
      10,801,763 shares underlying a warrant currently exercisable at
      $0.001
      per share.Also, consists of shares held by Sun Solunet over which he may be deemed
      to have control. Marc J. Leder and Rodger R. Krouse may each be deemed to
      control Sun Solunet, Sun Capital Partners II, LP, Sun Capital Advisors II,
      LP, and Sun Capital Partners LLC, as Leder and Krouse each own 50% of the
      membership interests in Sun Capital Partners LLC, which in turn is the
      general partner of Sun Capital Advisors II, LP, which in turn is the
      general partner of Sun Capital Partners II, LP, and Sun Capital Partners
      II, LP owns 99% of the membership interests of Sun Solunet. Therefore,
      Messrs. Leder and Krouse may each be deemed to have voting and dispositive
      power over the shares held by Sun Solunet.(3)
    
    Includes
      12,500 options currently exercisable at $0.42 per share and 2,797,209
      shares held by Hollger LLC, a privately held investment firm, over which
      Mr. Holloway may be deemed to have control.(4)
    
    Includes
      12,500 shares underlying an option currently exercisable at $0.42 per
      share.(5)
    
    Consists
      solely of 18,750 shares underlying an option currently exercisable at
      $0.42 per share.(6)
    
    Includes
      62,500 shares underlying an option that will become exercisable at $0.42
      per share.(7)
    
    Includes
      550,000 shares underlying an option currently exercisable at $0.40 per
      share. The outstanding shares beneficially owned by Mr. Phelan are held of
      record by Mr. Phelan jointly with his wife. All of Mr. Phelan's shares are
      subject to a Shareholder Agreement that, among other things, (a) grants
      Sun Solunet sole power to vote those shares, (b) grants Sun Solunet a
      right of first refusal on those shares, (c) obligates Mr. Phelan to sell
      his shares to a party that intends to purchase shares from Sun Solunet, if
      so demanded by Sun Solunet, and (d) grants Mr. Phelan the right to require
      a purchaser of shares from Sun Solunet also to purchase a pro rata number
      of Mr. Phelan's shares on the same terms.(8)
    
    Includes
      112,500 shares underlying an option currently exercisable at $0.40 per
      share and 112,500 shares underlying an option that will become exercisable
      at $0.40 per share.(9)
    
    Consists
      of 55,968,852 shares of common stock owned directly by Sun Solunet and
      1,435,091 shares of common stock owned by Mr. Phelan over which Sun
      Solunet has voting control. Marc J. Leder and Rodger R. Krouse may each be
      deemed to control Sun Solunet, Sun Capital Partners II, LP, Sun Capital
      Advisors II, LP, and Sun Capital Partners LLC, as Leder and Krouse each
      own 50% of the membership interests in Sun Capital Partners LLC, which in
      turn is the general partner of Sun Capital Advisors II, LP, which in turn
      is the general partner of Sun Capital Partners II, LP, and Sun Capital
      Partners II, LP owns 99% of the membership interests of Sun Solunet.
      Therefore, Messrs. Leder and Krouse may each be deemed to have voting and
      dispositive power over the shares held by Sun Solunet.(10)
    
    Mr.
      Emmons resigned from the Company’s board of directors in March
      2005.





40







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





Debt
Guaranty





Pursuant
to our acquisition agreement with Solunet Storage in 2003, Sun Solunet became
our majority shareholder, and currently holds approximately 58.4% of
our outstanding shares of common stock. Sun Capital Partners II and Sun Capital
Partners Management LLC (“Sun Capital Management”) are both affiliates of Sun
Solunet.  Pursuant
to that acquisition agreement, we entered into a Credit Support Agreement with
Sun Capital II under which Sun Capital II has agreed to guarantee a minimum of
$3 million of the debt of the combined company. As of December 31, 2004, this
guaranty was currently in place in support of a loan facility maintained by
Solunet Storage. The guaranty has been used to obtain greater liquidity (in the
form of a higher advance rate) under that loan facility than would have been
available in the absence of a guaranty. We have not paid Sun Capital II or its
affiliates any separate consideration for this guaranty. See
“Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Loan
Facilities—Harris Trust and Savings Bank.”





In
addition, under the Credit Support Agreement we may request at any time that Sun
Capital II guaranty up to an additional $2 million of our debt. However, Sun
Capital II has the discretion whether or not to issue such a guaranty if so
requested. As of December 31, 2004 Sun Capital II had issued a guaranty of up to
$8.0 million, or $5.0 million more than the minimum committed
amount.





In
exchange for the guaranty above the minimum committed amount and as stipulated
under the Credit Support Agreement, the Company is required to issue to Sun
Solunet a warrant to purchase shares at six-month intervals, beginning November
16, 2004. The amount of the shares underlying the warrant is based on a formula,
contained in the Credit Support Agreement for each six-month measurement date,
which is disclosed in Note 10 of the Company’s consolidated financial statements
for 2004 included
in this report.





On
November 16, 2004, we
became obligated under the Credit Support Agreement to issue , and on
March 23, 2005, we issued to Sun
Solunet a stock purchase warrant to
purchase 7,715,545 shares of the Company’s common stock, at an
exercise price of $0.001 per share as
described above
under “Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations—Loan Facilities—Harris Trust and Savings
Bank.”





On March
10, 2005, we approved
the issuance of an
additional stock purchase warrant to Sun
Solunet for the purchase of 3,086,218 shares of the Company’s common stock at an exercise price of $0.001
per share as
consideration for an additional $2.0 million debt guaranty provided by Sun
Capital II on our Harris Trust credit facility. This warrant was issued on March
23, 2005. See further discussion under “Item 7. Management’s Discussion and
Analysis of Financial Condition and Results
of Operations—Loan Facilities—Harris Trust and Savings Bank.”





41




Management
and Consulting Services





Pursuant
to the “Management Services Agreement” with Sun Capital Management, we pay a
quarterly fee of $75,000 per calendar quarter (plus reimbursement of
out-of-pocket expenses) to Sun Capital Management in exchange for financial and
management consulting services. The fee is fixed at this rate through the
quarter ending March 31, 2005, at which time it will be reset, based primarily
on the fees Sun Capital Management is then charging the other Sun Capital
portfolio companies. This agreement will remain in effect until the first date
when all of the following have occurred: (a) the designees of Sun Capital
Management and its affiliates no longer constitute a majority of our board of directors ; (b) Sun
Capital Management and its affiliates no longer own or control at least 30% of
our outstanding shares; and (c) Sun Capital Management and its affiliates
(including Sun Capital II) no longer guarantee any portion of our debt. If the
foregoing three events have not yet occurred, the Management Services Agreement
will terminate on April 4, 2013.




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





The
following table shows the fees that the Company incurred for audit and other
services provided by Grant Thornton LLP (“Grant Thornton”):





(In
      thousands)
    
    **2004**
    
    **2003**Audit
      Fees
    
    $
    160
    
    $
    470Audit-Related
      Fees
    
    
    —
    
    
    —Tax
      Fees
    
    
    44
    
    
    37All
      Other Fees
    
    
    —
    
    
    —Total
    
    $
    204
    
    $
    507





*Audit
Fees* . This
category includes the audit of the Company’s annual financial statements, review
of financial statements included in our
quarterly reports on Form
10-Q , and
services that are normally provided by the independent auditors in connection
with statutory and regulatory filings or engagements for those fiscal years.
This category also includes advice on audit and accounting matters that arose
during, or as a result of, the audit or the review of interim financial
statements, and the preparation of annual “management letter” on internal
control matters. For 2004, the amount stated includes the audit and quarterly
reviews of SAN Holdings, Inc. for the year ended December 31, 2004. For 2003,
the amount stated includes (a) $365,000 for the audits of StorNet, Inc. for the
year ended December 31, 2001 and the nine month period ended September 25, 2002,
and the audit of Solunet Storage Holding Corp. for the period from September 26
through December 31, 2002, and (b) $105,000 for the audit and quarterly reviews
of SAN Holdings, Inc. for the year ended December 31, 2003.





*Tax
Fees.* This
category consists of professional services rendered by the Company’s auditors
for tax compliance and tax advice. The services for the fees disclosed under
this category include tax return preparation and technical tax
advice.





*Pre-Approval
of Audit and Permitted Non-Audit Services.* The audit
committee charter
requires the Company to have the audit
committee approve
in advance any and all audit services and all permitted non-audit services
(unless de minimus) provided by the independent accountants, as well as the fees
and other compensation to be paid to the independent accountants. The
independent accountants submit requests to the audit
committee for
pre-approval of any such allowable services. In 2004, all of the audit and
permitted non-audit services rendered by the Company’s  independent
accountants were approved by the audit
committee .





42





**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, 2004 and December 31, 2003
    
    F-2Consolidated
      Statements of Operations for the Years ended December 31, 2004
      and
      December 31, 2003
    
    F-3Consolidated
      Statement of Operations for Solunet Storage Holding Corp. (accounting
      predecessor to SAN Holdings, Inc.) for the period from September 26, 2002
      (inception) through December 31, 2002
    
    F-4Statement
      of Discontinued Operations - Liquidation Basis for StorNet, Inc.
      (accounting predecessor to Solunet Storage Holding Corp. and SAN Holdings,
      Inc.) for the period from January 1, 2002 though September 25,
      2002
    
    F-5Consolidated
      Statements of Stockholders’ Equity for SAN Holdings, Inc. for the Years
      ended December 31, 2004 and December 31, 2003 and for Solunet Storage
      Holding Corp. (accounting predecessor to SAN Holdings, Inc.) for the
      period from September 26, 2002 (inception) through December 31,
      2002
    
    F-6Statement
      of Stockholders' Deficit - Liquidation Basis for StorNet, Inc. (accounting
      predecessor to Solunet Storage Holding Corp. and SAN Holdings, Inc.) for
      the period from January 1, 2002 through September 25, 2002
    
    F-7Consolidated
      Statements of Cash Flows for the Years ended December 31, 2004 and
      December 31, 2003
    
    F-8Consolidated
      Statement of Cash Flows for Solunet Storage Holding Corp. (accounting
      predecessor to SAN Holdings, Inc.) for the period from September 26, 2002
      (inception) through December 31, 2002
    
    F-10Statement
      of Cash Flows - Liquidation Basis for StorNet, Inc. (accounting
      predecessor to Solunet Storage Holding Corp. and SAN Holdings, Inc.) for
      the period from January 1, 2002 through September 25, 2002
    
    F-11Notes
      to Consolidated Financial Statements
    
    F-12





**(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.





43







**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, 2004 and 2003, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years then
ended. Also, we have audited the accompanying consolidated statement of
operations, stockholders’ equity and cash flows of Solunet Storage Holding Corp.
(accounting predecessor of SAN Holdings, Inc.) for the period from September 26,
2002 (inception) through December 31, 2002. In addition, we have audited the
accompanying statements of discontinued operations, stockholders’ deficit and
cash flows on a liquidation basis of StorNet, Inc. (accounting predecessor to
Solunet Storage Holding Corp.) for the period from January 1, 2002 through
September 25, 2002. 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.





SAN
Holdings, Inc. completed a business combination with Solunet Storage Holding
Corp. (Solunet Storage) effective April 1, 2003. The business combination
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 SAN Holdings, Inc.’s historical financial statements. Solunet Storage
commenced operations on September 26, 2002 when it acquired certain assets
of StorNet, Inc. (StorNet) that had been foreclosed upon by StorNet’s lenders
under Article 9 of the Uniform Commercial Code. The results of Solunet Storage’s
operations for 2002 consist solely of operations conducted during the period
from September 26, 2002 to December 31, 2002. Because the assets that
Solunet Storage acquired were those of an ongoing business (i.e., StorNet),
StorNet is considered to be an accounting predecessor of Solunet Storage and
thus of SAN Holdings, Inc. The results of operations of StorNet are also
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
presented.





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, 2004 and 2003, and the results of their
operations and their cash flows for the year then ended, the results of Solunet
Storage Holding Corp. and subsidiary’s operations and their cash flows for the
period from September 26, 2002 (inception) through December 31, 2002,
and the results of StorNet, Inc.’s discontinued operations and their cash flows
for the period from January 1, 2002 through September 25 , 2002,
in conformity with accounting principles generally accepted in the United States
of America. For StorNet, Inc. these principles have been applied on a
liquidation basis.








*/s/GRANT
THORNTON, LLP*








Denver,
Colorado


March 30,
2005




F-1





**SAN
Holdings, Inc.**


**Consolidated
Balance Sheets**


(In
thousands, except share data)





December
      31,ASSETS
    
    2004
    
    2003Current
      assetsCash
      and cash equivalents
    
    $
    486
    
    $
    3,792Accounts
      receivable, net of allowance for doubtful accounts of $140
      and
      $336, respectively
    
    
    13,097
    
    
    15,212Inventories,
      net of valuation allowance of $137 and $707,
      respectively
    
    
    467
    
    
    1,427Deferred
      maintenance contracts
    
    
    2,914
    
    
    2,629Prepaid
      expenses and other current assets
    
    
    512
    
    
    1,136Total
      current assets
    
    
    17,476
    
    
    24,196Property
      and equipment, net
    
    
    1,005
    
    
    1,014Capitalized
      software, net
    
    
    659
    
    
    241Goodwill
    
    
    32,008
    
    
    32,008Intangible
      assets, net
    
    
    2,205
    
    
    2,820Other
      assets
    
    
    384
    
    
    190Total
      long-term assets
    
    
    36,261
    
    
    36,273TOTAL
      ASSETS
    
    $
    53,737
    
    $
    60,469LIABILITIES
      AND STOCKHOLDERS’ EQUITYLines
      of creditWells
      Fargo Business Credit, Inc.
    
    $
    6,759
    
    $
    8,253Harris
      Trust and Savings Bank
    
    
    7,700
    
    
    8,200Accounts
      payable
    
    
    12,453
    
    
    13,145Accrued
      expenses
    
    
    2,651
    
    
    2,801Deferred
      revenue
    
    
    3,942
    
    
    4,022Total
      current liabilities
    
    
    33,505
    
    
    36,421Commitments
      and contingencies (Note 7)Stockholders’
      equityPreferred
      stock: Series A; no par value; 8,000 shares authorized;
      -0-
      shares issued and outstanding, respectively
    
    
    —
    
    
    —Preferred
      stock; Series B; no par value; 2,000 shares authorized;
      -0-
      and 748.07306 shares issued and outstanding, respectively
    
    
    —
    
    
    12,718Common
      stock; no par value, 200,000,000 and 75,000,000 shares
      authorized,
      respectively; 95,811,278 and 58,407,625 shares issued
      and
      outstanding, respectively
    
    
    32,577
    
    
    19,859Warrants
    
    
    5,691
    
    
    3,222Accumulated
      deficit
    
    
    (18,036
    )
    
    (11,751
    )Total
      stockholders’ equity
    
    
    20,232
    
    
    24,048TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
    
    $
    53,737
    
    $
    60,469







The
accompanying notes are an integral part of the financial
statements.
 F-2







**SAN
Holdings, Inc.**


**Consolidated
Statements of Operations**


(In
thousands, except share and per share data)




Years
      Ended December 31,2004
    
    2003RevenueSales
      of hardware, software and services
    
    $
    58,370
    
    $
    49,730Maintenance
      services
    
    
    6,910
    
    
    4,950Maintenance
      contract fees, net
    
    
    878
    
    
    817Total
      revenue
    
    
    66,158
    
    
    55,497Cost
      of revenue
    
    
    51,558
    
    
    42,006Gross
      profit
    
    
    14,600
    
    
    13,491Operating
      expensesSelling,
      general and administrative
    
    
    14,987
    
    
    15,511Severance
      and closed office expense
    
    
    1,226
    
    
    —Acquisition-related
      costs
    
    
    34
    
    
    1,987Depreciation
      and amortization
    
    
    1,397
    
    
    1,218Total
      operating expenses
    
    
    17,644
    
    
    18,716Loss
      from operations
    
    
    (3,044
    )
    
    (5,225
    )Other
      income (expense)Interest
      expense
    
    
    (1,221
    )
    
    (817
    )Charge
      for warrant issued to related party for debt guaranty
    
    
    (2,469
    )
    
    —Other
      income (expense)
    
    
    121
    
    
    (11
    )Loss
      before income taxes
    
    
    (6,613
    )
    
    (6,053
    )Income
      tax benefit
    
    
    328
    
    
    115Net
      loss
    
    $
    (6,285
    )
    $
    (5,938
    )Basic
      and diluted net loss per share
    
    $
    (0.07
    )
    $
    (0.12
    )Weighted
      average shares outstanding - basic and diluted
    
    
    86,254,827
    
    
    48,899,805


****





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







**Solunet
Storage Holding Corp.(accounting predecessor to SAN Holdings,
Inc.)**


**Consolidated
Statement of Operations**


**For
the Period from September 26, 2002 (inception) through December 31,
2002**


(In
thousands, except share and per share data)




RevenueSales
      of hardware, software and services
    
    $
    10,856Maintenance
      services
    
    
    359Maintenance
      contract fees, net
    
    
    339Total
      revenue
    
    
    11,554Cost
      of revenue
    
    
    8,922Gross
      profit
    
    
    2,632Operating
      expensesSelling,
      general and administrative
    
    
    3,748Post-transaction
      business continuation expenses
    
    
    4,144Depreciation
      and amortization
    
    
    367Total
      operating expenses
    
    
    8,259Loss
      from operations
    
    
    (5,627
    )Other
      income (expense)Interest
      expense
    
    
    (208
    )Other
      income
    
    
    22Net
      loss
    
    $
    (5,813
    )Basic
      and diluted net loss per share
    
    $
    (0.29
    )Weighted
      average shares outstanding - basic and diluted
    
    
    20,000,000


****





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







**StorNet,
Inc.(accounting predecessor to Solunet Storage Holding Corp. and SAN
Holdings, Inc.)**


**Statement
of Discontinued Operations - Liquidation Basis**


**For
the Period from January 1, 2002 through September 25, 2002**


(In
thousands, except share and per share data)




RevenueSales
      of hardware, software and services
    
    $
    35,933Maintenance
      services
    
    
    6,038Maintenance
      contract fees, net
    
    
    475Total
      revenue
    
    
    42,446Cost
      of revenue
    
    
    31,765Gross
      profit
    
    
    10,681Operating
      expensesSelling,
      general and administrative
    
    
    11,687Impairment
      of assets
    
    
    5,824Provision
      for non-cancelable leases
    
    
    1,969Depreciation
      and amortization
    
    
    757Total
      operating expenses
    
    
    20,237Loss
      from operations
    
    
    (9,556
    )Other
      income (expense)Interest
      expense
    
    
    (1,115
    )Other
      income
    
    
    21Loss
      before income taxes
    
    
    (10,650
    )Income
      tax benefit
    
    
    288Net
      loss
    
    $
    (10,362
    )Basic
      and diluted net loss per share
    
    $
    (0.52
    )Weighted
      average shares outstanding - Basic and diluted
    
    
    20,000,000












The
accompanying notes are an integral part of the financial
statements.
 F-5





**SAN
Holdings, Inc.**


**Solunet
Storage Holding Corp. (accounting predecessor to SAN Holdings,
Inc.)**


**Consolidated
Statements of Stockholders’ Equity**


**For
the Period from September 26, 2002 (inception of Solunet Storage Holding Corp.)
through December 31, 2004**


(In
thousands, except share data)





Series
      B Preferred Stock
    
    Common
      Stock
    
    Warrants
    
    AccumulatedDeficit
    
    Total
      Stockholders’ EquityShares
    
    Amount
    
    Shares
    
    AmountBalances,
      September 26, 2002
    
    $
    —
    
    $
    —
    
    
    20,000,000
    
    $
    1,000
    
    $
    —
    
    $
    —
    
    $
    1,000Net
      loss for the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,813
    )
    
    (5,813
    )Balances,
      December 31, 2002
    
    
    
    
    
    —
    
    
    20,000,000
    
    
    1,000
    
    
    
    
    
    (5,813
    )
    
    (4,813
    )Reverse
      acquisition (Note 4)
    
    
    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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,285
    )
    
    (6,285
    )Balances,
      December 31, 2004
    
    
    —
    
    $
    —
    
    
    95,811,278
    
    $
    32,577
    
    $
    5,691
    
    $
    (18,036
    )
    $
    20,232










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


****


**StorNet,
Inc.**


**(accounting
predecessor to Solunet Storage Holding Corp. and SAN Holdings,
Inc.)**


**Statement
of Stockholders’ Deficit - Liquidation Basis**


**For
the Period from January 1, 2002 through September 25, 2002**


(In
thousands except for share data)





Common
      Stock
    
    AccumulatedDeficit
    
    TotalShares
    
    AmountBalance,
      January 1, 2002
    
    
    20,000,000
    
    $
    8,596
    
    $
    (30,322
    )
    $
    (21,726
    )Net
      loss for the nine month period ended September 25, 2002
    
    
    
    
    
    
    
    
    (10,362
    )
    
    (10,362
    )Balance,
      September 25, 2002
    
    
    20,000,000
    
    $
    8,596
    
    $
    (40,684
    )
    $
    (32,088
    )








The
accompanying notes are an integral part of the financial
statements.
 F-7







****SAN
HOLDINGS, INC.**Consolidated Statements of Cash
Flows**


(In
thousands)








Years
      Ended December 31,2004
    
    2003Cash
      flows from operating activities:Net
      loss
    
    $
    (6,285
    )
    $
    (5,938
    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
    
    
    1,397
    
    
    1,218Charge
      for warrant issued to related party for debt guaranty
    
    
    2,469
    
    
    —Loss
      on disposal of property and equipment
    
    
    113
    
    
    —Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    2,115
    
    
    (1,246
    )Inventories
    
    
    608
    
    
    243Deferred
      maintenance contracts
    
    
    (285
    )
    
    (1,802
    )Prepaid
      expenses and other current assets
    
    
    624
    
    
    (807
    )Other
      assets
    
    
    (265
    )
    
    (17
    )Accounts
      payable
    
    
    (692
    )
    
    2,794Accrued
      expenses
    
    
    (150
    )
    
    463Deferred
      revenue
    
    
    (80
    )
    
    1,238Net
      cash provided by (used in) operating activities
    
    
    (431
    )
    
    (3,854
    )Cash
      flows from investing activities:Purchase
      of property and equipment, net
    
    
    (372
    )
    
    (121
    )Acquisition
      costs, net of cash acquired
    
    
    —
    
    
    (188
    )Capitalized
      software costs
    
    
    (509
    )
    
    (207
    )Net
      cash provided by (used in) investing activities
    
    
    (881
    )
    
    (516
    )Cash
      flows from financing activities:Net
      borrowings (payments) on line of credit - Harris Trust & Savings
    
    
    (500
    )
    
    8,200Net
      borrowings (payments) on line of credit - Wells Fargo Business
      Credit
    
    
    (1,494
    )
    
    6,633Net
      borrowings (payments) on other borrowings
    
    
    —
    
    
    (6,832
    )Decrease
      in restricted cash
    
    
    —
    
    
    148Net
      cash provided by (used in) financing activities
    
    
    (1,994
    )
    
    8,149Net
      increase in cash and cash equivalents
    
    
    (3,306
    )
    
    3,779Cash
      and cash equivalents at beginning of year
    
    
    3,792
    
    
    13Cash
      and cash equivalents at end of year
    
    $
    486
    
    $
    3,792Supplemental
      disclosure of other cash flow information:Interest
      paid
    
    $
    1,193
    
    $
    879








The
accompanying notes are an integral part of the financial
statements.
 F-8







****SAN
HOLDINGS, INC.**Consolidated Statements of Cash
Flows**


(In
thousands)




Years
      Ended December 31,2004
    
    2003Supplemental
      disclosure of non-cash investing and financing activities:Transfer
      of inventory to property and equipment
    
    $
    352
    
    $
    —Conversion
      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 financial
statements.
 F-9







****Solunet
Storage Holding Corp. (accounting predecessor to SAN Holdings,
Inc.)**Consolidated Statement of Cash
Flows**


**For
the Period from September 26, 2002 (inception) through December 31,
2002**


(In
thousands)





Cash
      flows from operating activities:Net
      loss
    
    $
    (5,813
    )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Non-cash
      post-transaction business continuation expenses
    
    
    1,629Depreciation
      and amortization
    
    
    367Amortization
      of debt issuance cost
    
    
    19Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    1,193Inventories
    
    
    (1,104
    )Deferred
      maintenance contracts
    
    
    (827
    )Prepaid
      expenses
    
    
    (145
    )Other
      assets
    
    
    (94
    )Accounts
      payable
    
    
    1,790Unpresented
      checks
    
    
    506Accrued
      expenses
    
    
    (52
    )Deferred
      revenue
    
    
    2,725Net
      cash provided by operating activities
    
    
    194Cash
      flows from investing activities:Acquisition
      of business, net of cash acquired
    
    
    (10,169
    )Purchase
      of property and equipment
    
    
    (21
    )Net
      cash used in investing activities
    
    
    (10,190
    )Cash
      flows from financing activities:Net
      proceeds from current borrowings
    
    
    5,202Proceeds
      from notes payable
    
    
    4,000Proceeds
      from issuance of common stock
    
    
    1,000Payment
      for restricted cash
    
    
    (148
    )Loan
      origination fees paid
    
    
    (45
    )Net
      cash provided by financing activities
    
    
    10,009Net
      increase in cash and cash equivalents
    
    $
    13Cash
      and cash equivalents at beginning of period
    
    
    —Cash
      and cash equivalents at end of period
    
    $
    13Supplemental
      disclosure of other cash flow information:Interest
      paid
    
    $
    125Supplemental
      disclosure of non-cash investing and financing activities:Acquisition
      of businessTangible
      assets acquired
    
    $
    10,778Intangible
      assets acquired
    
    
    862Liabilities
      assumed
    
    
    (1,333
    )10,307Less:
      cash acquired
    
    
    (138
    )Net
      cash paid for acquisition
    
    $
    10,169


****





The
accompanying notes are an integral part of the financial
statements.
 F-10







**StorNet,
Inc.(accounting predecessor to Solunet Storage Holding Corp. and SAN
Holdings, Inc.)**


**Statement
of Cash Flows - Liquidation Basis**


**For
the Period from January 1, 2002 through September 25, 2002**


(in
thousands)





Cash
      flows from operating activities:Net
      loss
    
    $
    (10,362
    )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
    
    
    757Impairment
      of assets
    
    
    5,824Provision
      for non-cancelable leases
    
    
    1,969Other
    
    
    52Changes
      in operating assets and liabilities:Accounts
      receivable
    
    
    7,837Inventories
    
    
    235Deferred
      maintenance contracts
    
    
    413Prepaid
      expenses
    
    
    40Other
      assets
    
    
    48Accounts
      payable
    
    
    (370
    )Unpresented
      checks
    
    
    (3,667
    )Accrued
      expenses
    
    
    (245
    )Deferred
      revenue
    
    
    (849
    )Net
      cash provided by operating activities
    
    
    1,682Cash
      flows from investing activities:Purchase
      of property and equipment
    
    
    (67
    )Net
      cash used in investing activities
    
    
    (67
    )Cash
      flows from financing activities:Net
      proceeds from current borrowings
    
    
    (1,488
    )Proceeds
      from notes payable
    
    
    (163
    )Net
      cash used in financing activities
    
    
    (1,651
    )Net
      decrease in cash and cash equivalents
    
    
    (36
    )Cash
      and cash equivalents at beginning of period
    
    
    115Cash
      and cash equivalents at end of period
    
    $
    79Supplemental
      disclosure of other cash flow information:Interest
      paid
    
    $
    893Supplemental
      disclosure of non-cash investing and financing activities:Write-down
      of assets due to pending liquidation
    
    $
    5,824









The
accompanying notes are an integral part of the financial
statements.
 F-11




**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 Holding Corp. (“Solunet Storage”), and its wholly-owned
subsidiary, Solunet Storage, Inc. (formerly known as StorNet, Inc.). The Company
operates as a single business segment, which sells and installs computer data
storage systems and provides related services throughout the United States.
Effective April 1, 2003, SANZ completed a business combination with Solunet
Storage, 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 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 financial statements
presented in this report as the
financial statements of SANZ consist of the accounts of Solunet Storage for all
periods presented, together with the assets, liabilities and results of
operations of SAN Holdings, Inc. and its subsidiary from April 1,
2003.





Solunet
Storage commenced operations on September 26, 2002, when it acquired certain
assets of StorNet, Inc. (“StorNet”) from its secured lender in a foreclosure
sale. The results of Solunet Storage’s operations for 2002 consist solely of
operations conducted during a period of slightly more than three months, from
September 26, 2002 to December 31, 2002.





Because
the assets that Solunet Storage acquired were those of an ongoing business
(i.e., StorNet), StorNet is considered to be an accounting predecessor of
Solunet Storage, and thus of SANZ. The results of operations of StorNet are also
presented as prior period financial statements. However, 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 those of SANZ for the current period. We have therefore
included in this report StorNet’s statements of operations, stockholders’ deficit and cash flows for the
nine month period ended September 25, 2002 on separate pages from the
corresponding statements of SANZ for the current period.





**NOTE
2 - FINANCIAL CONDITION**





The
accompanying consolidated financial statements have been prepared in conformity
with United States generally accepted accounting principles (“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 $6,285,000 for the year ended December 31, 2004. In addition, as of December
31, 2004, we have negative working capital (current liabilities in excess of
current assets) of $16,029,000. Accordingly, the recoverability of a major
portion of the recorded asset amounts as of December 31, 2004 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.





We
completed the business combination with Solunet Storage on April 1, 2003,
described in Notes 1 and 4, to achieve the economies that we believe are
available by spreading our fixed cost base across a greater volume of sales. As
anticipated, the cost reductions (personnel reductions and office closures)
afforded by the combination have been phased in over 2003 and 2004. We continue
to examine our operations for opportunities to extract additional costs at the
same time as we seek to increase our sales and gross profits in order to achieve
sustained profitability.





F-12


As a
result of the business combination with Solunet Storage, the Company has
substantially increased its accounts receivable, which is the borrowing base for
its principal borrowing facility with Wells Fargo Business Credit, Inc. (“Wells
Fargo”). At December 31, 2004, the Company had $2.6 million of undrawn
availability on this line. The increased borrowing limit, the expanding supplier
lines of credit and the Harris Trust debt facilities described below are
anticipated to provide continued liquidity for the foreseeable future, or next
12 months. However, 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.





At
December 31, 2004, the Company was not in compliance with certain financial
covenants; however, Wells Fargo did not issue a formal, written notice of
default. Under an amendment to the credit facility, Wells Fargo issued to the
Company a waiver of non-compliance for these covenants and, effective January 1,
2005, increased our borrowing rate to Prime + 5.0%, an increase of three points,
and set new covenants for 2005. See further discussion of the amended credit
agreement in Note 5.





In 2004,
the Company also maintained two revolving credit facilities with Harris Trust
and Savings Bank (“Harris Trust”),which in the aggregate were $8.0 million at
December 31, 2004. In February 2005, we entered into a revised credit agreement
with Harris Trust, which increased our availability by $2.0 million, for a total
of $10.0 million, and consolidated the credit lines into one facility maintained
by SAN Holdings. At December 31, the Company had borrowed $7.7 million and had
$0.3 million of undrawn availability on this facility. While the Harris Trust
facility is a demand note, under the revised agreement it has been extended to
February 2006, unless called earlier by the lender. Sun
Capital Partners II, LP (“Sun Capital II”), an affiliate of our majority
shareholder, Sun Solunet, has guaranteed the Harris Trust credit facility and
has agreed that, upon the written request of SANZ, it will provide SANZ with
sufficient funds to repay the debt outstanding under the credit facility in the
event that Harris Trust requires repayment of such debt or, at Sun Capital II’s
election, pay the outstanding debt directly to Harris Trust; provided that in no
event will Sun Capital II’s obligation exceed the amount of Sun Capital II’s
guaranty. This guaranty and all obligations expire on December 31,
2005. See
further discussion of the Harris Trust facility in Note 5.





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





**Principles
of Consolidation**





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





**Cash
and Cash Equivalents**





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





**Accounts
Receivable and Concentration of Credit Risk**





The
Company is subject to credit risk from accounts receivable with its customers.
The majority of the Company’s accounts receivable are due from 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, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts. Credit losses have consistently been within management’s
expectations.





F-13


No single
customer accounted for more than 10% of total revenue in 2004, 2003, or 2002.
Additionally, the Company had no customers that individually represented more
than 10% of accounts receivable at December 31, 2004 or December 31,
2003.





**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.





**Deferred
Maintenance Contracts**





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





**Property
and equipment**





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





Property
and equipment consist of the following:





(In
      thousands)
    
    December
      312004
    
    2003Computer
      equipment and software
    
    $
    1,649
    
    $
    960Office
      equipment and furniture
    
    
    221
    
    
    391Leasehold
      improvements
    
    
    23
    
    
    33Less:
      accumulated depreciation
    
    
    (888
    )
    
    (370
    )$
    1,005
    
    $
    1,014





Depreciation
expense for the years ended December 31, 2004, 2003 and 2002 was $620,000,
$330,000 and $572,000, respectively.





**Software
development costs**





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





F-14


For the
years ended December 31, 2004, 2003 and 2002, the Company capitalized software
development costs of $509,000, $207,000 and $-0-, respectively. Additionally,
the Company expensed research and development costs related thereto of $80,000,
$125,000, and $-0-, for the aforementioned years, respectively.





Capitalized
software costs are amortized on a product-by-product basis over their expected
useful life, which is generally three years. The annual amortization related to
software to be sold is the greater of the amount computed using (a) the
ratio that current gross revenue for a product compares to the total of current
and anticipated future gross revenue for that product or (b) the
straight-line method over the remaining estimated economic life of the product.
Amortization expense related to capitalized software costs totaled $91,000,
$64,000 and $-0- for the years ended December 31, 2004, 2003 and 2002,
respectively.








(In
      thousands)
    
    December
      312004
    
    2003Capitalized
      software costs
    
    $
    814
    
    $
    305Less:
      accumulated amortization
    
    
    (155
    )
    
    (64
    )$
    659
    
    $
    241








**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 Standards No. 142, “Goodwill and Other Intangible
Assets,” (“SFAS 142”), which it adopted January 1, 2002. SFAS 142 requires that
goodwill no longer be amortized but instead that it be tested for impairment at
least annually. For purposes of testing for goodwill impairment, the Company has
determined that it has one reporting unit.





The
Company reviews the carrying value of goodwill annually, or more often in
certain circumstances. The performance of the test involves a two-step process.
The first step 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 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 effect the calculation. It is at least reasonably possible that
the estimates we use to evaluate the realizability of goodwill will be
materially different from actual amounts or results. Goodwill was subjected to
fair value impairment tests in 2004 and 2003 and no impairments were
recognized.





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:





F-15





(In thousands)
    
    December
      31, 2004
    
    December
      31, 2003Asset
      (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
    
    $
    (852
    )
    $
    1,947
    
    $
    2,799
    
    $
    (422
    )
    $
    2,377Customer lists
      (3 to 5 years)
    
    
    893
    
    
    (718
    )
    
    175
    
    
    893
    
    
    (600
    )
    
    293Software
      technologies
      (3 years)
    
    
    200
    
    
    (117
    )
    
    83
    
    
    200
    
    
    (50
    )
    
    150$
    3,892
    
    $
    (1,687
    )
    $
    2,205
    
    $
    3,892
    
    $
    (1,072
    )
    $
    2,820


Amortization
expense for intangible assets subject to amortization for the years ended
December 31, 2004, 2003 and 2002 was $615,000, $745,000 and $397,000,
respectively. Estimated aggregate amortization expense for intangible assets
subject to amortization for each of the five succeeding fiscal years is as
follows:





(In
      thousands)2005
    
    $
    4652006
    
    
    2902007
    
    
    2442008
    
    
    2302009
    
    
    230Thereafter
    
    
    746$
    2,205





**Long-lived
assets**





The
Company evaluates the carrying value of long-lived assets, including
identifiable intangible assets, 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. For the
nine months ended September 25, 2002, the Company recorded an impairment charge
of $5,824,000 to reflect the liquidation value of its assets. For 2004 and 2003,
no events occurred that required the Company to consider an impairment
charge.





**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.





F-16


The
Company’s revenue is derived primarily from two sources: (i) the resale and
installation of data storage systems, which consist of computer hardware,
software, and data storage related services, and (ii) 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.





Service
sales





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





Maintenance
Services





Revenue
from maintenance agreements is recognized in one of two ways, based on whether
or not the Company performs “first call” maintenance support. The Company
operates a first call technical support center for certain of the hardware and
software products that we sell. For first call maintenance services, we record
the gross sale price of the applicable support or maintenance contract as
deferred revenue, and recognize revenue on a straight-line basis over the
contractual terms of the agreements. Likewise, the cost to acquire such
maintenance agreements from the hardware and software vendors is also deferred
and amortized on a straight-line basis over the contractual terms of the
maintenance agreements. Revenue from these arrangements is included in the
heading “Maintenance services” in the Consolidated Statement of
Operations.





Maintenance
contract fees, net





For
products for which we do not perform first call maintenance, but resell the
vendor’s maintenance contract for a fee, we recognize revenue from the resale of
those maintenance agreements, net of the cost to acquire the maintenance
agreements, at the beginning of the maintenance period. Revenue from these
arrangements is included in the heading “Maintenance contract fees, net” in the
Consolidated Statement of Operations.





Multiple
deliverable arrangements





In
accordance with EITF 00-21, for sales transactions that include the resale and
installation of data storage systems and the resale of 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 standalone 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
items typically include installation, training, and other professional services.





The
amount 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. If the undelivered element represents services, a
residual method of allocating revenue is used. Under the residual method,
revenue is deferred 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, revenue is allocated to the separate elements based on their relative
fair values.





F-17


Deferred
revenue, whether associated with maintenance contracts or undelivered elements,
is included within Deferred revenue on the balance sheet.





Shipping
and Handling Costs





Shipping
and handling costs are included in cost of revenue.







**Advertising
Costs**





Advertising
costs are expensed as incurred. Advertising expense was $607,000, $389,000 and
$279,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Reimbursements of advertising expense from product vendors are treated as
reductions to cost of sales.





**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 revenues 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 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 33,473,008 and 41,083,076 shares of common
stock were excluded from diluted share calculations for 2004 and 2003,
respectively, as these options and warrants were anti-dilutive. On March 10,
2005, the Company approved the issuance of a warrant to purchase 3,086,218 of
the Company’s common stock to its majority shareholder. See further discussion
in Notes 5, 8, and 10.





As of
December 31, 2002, Solunet Storage (accounting predecessor to SANZ) had no
options outstanding. However, as of December 31, 2002, SANZ had 13,891,758
options and warrants outstanding which carried over as potentially dilutive
securities with the SANZ and Solunet Storage merger. These options and warrants
would have been excluded from dilutive share calculations, as they were
anti-dilutive.





**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-18





The
following table illustrates the effect on net loss and net loss per share for
the years ended December 31, 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 31,2004
    
    2003Net
      loss, as reported
    
    $
    (6,285
    )
    $
    (5,938
    )Deduct,
      Total stock-based compensation expense determined under fair-value based
      method, net of related tax effects
    
    
    (889
    )
    
    (2,290
    )Pro
      forma net loss
    
    $
    (7,174
    )
    $
    (8,228
    )Basic and diluted net loss per share:As reported
    
    $
    (0.07
    )
    $
    (0.12
    )Pro forma
    
    $
    (0.08
    )
    $
    (0.17
    )








As of
December 31, 2002, Solunet Storage had no options or warrants outstanding. As of
September 25, 2002, the balance sheet date of StorNet (accounting predecessor to
Solunet Storage), the Company determined that the outstanding options and
warrants had no measurable value based on the liquidation event of the
predecessor company. In addition, none of the outstanding options or warrants
carried over to Solunet Storage. Accordingly, for the period ended September 25,
2002, the Company had no stock-based compensation expense.





For 2004
and 2003, see Note 8 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 its third quarter of 2005.





We are
currently evaluating the impact of SFAS 123R on our financial position and
results of operations as well as alternative transition methods under
SFAS 123R. In addition, we have not determined whether the adoption of
SFAS 123R will result in amounts that are similar to the current pro forma
disclosures 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 2004,
the Financial Accounting Standards Board also issued the following Statements of
Financial Accounting Standards:





●
Statement No. 151, “Inventory Costs-an amendment of ARB No. 43, Chapter 4,”
issued in November


2004;


●
Statement No. 152, “Accounting for Real Estate Time-Sharing Transactions-an
amendment of FASB


Statements
No. 66 and 67, ” issued
in December 2004; and


●
Statement No. 153, “Exchanges of Nonmonetary Assets-an amendment of APB Opinion
No. 29, ” ** issued


in
December  2004.





F-19


Management
believes that adoption of these new standards will not have a material effect on
the Company’s financial results.





**Reclassifications**





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








**NOTE
4 - 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.





Among the
principal reasons for the acquisition were management’s belief that it would
afford opportunities to spread the company’s fixed costs over a broader revenue
base, thereby providing increased operating leverage, and its belief that SANZ’
business would be strengthened by extending the company’s geographic presence to
regions of the United States where the company did not previously have
operations. This broader geographic scope was expected to reduce the company’s
reliance on any one region, and to better enable the company to service its
existing customers, many of whom have operations in multiple geographic regions.





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, 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








F-20


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





The
Company does not expect that any of this goodwill will be deductible for federal
income tax purposes.







The
following unaudited pro forma information is presented as if the business
combination had occurred as of the beginning of the years presented. The pro
forma information is presented for illustrative purposes only and is not
necessarily indicative of the operating results that would have occurred if the
business combination had been consummated as of the beginning of the years
presented, nor is it necessarily indicative of the future operating
results:





(In thousands, except per share data)
    
    Years
      ended December 31,2003
    
    
    
    2002Pro forma results of operations:
    
    (Unaudited)
    
    
    
    (Unaudited)Revenue
    
    $
    63,029
    
    
    
    
    $
    87,003Net loss
    
    $
    (6,032
    )(1)
    $
    (19,056
    )(2)Net
      loss per share
    
    $
    (0.10
    )
    
    
    
    $
    (0.33
    )


(1)
    Includes
      reduction in acquisition-related expenses in the amount of $1,127,000 for
      fees paid to investment bankers and severance payments that were
      contractually triggered by the business
combination.


(2)
    Includes
      a net reduction of $150,000 in operating expenses for additional expense
      of $70,000 for amortization of intangibles and a reduction in depreciation
      of $220,000.








**NOTE
5 - DEBT**





**Wells
Fargo Line of Credit**





The
Company has a revolving credit line with Wells Fargo to borrow up to $12
million, subject to availability under its borrowing base, and is secured by
substantially all assets of SANZ Inc., a wholly-owned subsidiary of the Company.
This credit line expires in May 2007, and at December 31, 2004, bore interest at
prime plus 2% (7.25% at December 31). 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, 2004, based on
our eligible collateral at that date, we had $9.4 million available for
borrowing on the Wells Fargo credit facility, of which $6.8 million was drawn
and $2.6 million remained available.





F-21


Wells
Fargo may declare the loan in default if SANZ Inc. does not meet certain
financial performance measures. At December 31, 2004, we were not in compliance
with certain of those covenants; however, Wells Fargo did not issue a formal,
written notice of default. Under an amendment to the credit agreement executed
in March 2005, Wells Fargo waived non-compliance on these covenants, and reset
financial covenant requirements effective January 1, 2005 for: (1) minimum net
income 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. from SAN Holdings 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 SAN Holdings or an outside source if SANZ Inc. generates a net
loss in a given quarter and has 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.





As part
of the amended agreement and effective January 1, 2005, Wells Fargo increased
our borrowing rate to prime plus 5.0%, an increase of three points. This rate is
subject to potential decreases, as allowed by Wells Fargo, based on SANZ Inc.
achieving certain net income levels during 2005.





Additionally,
the amended credit agreement includes as an additional borrower, Solunet
Storage, Inc., which in March 2005 became a wholly-owned subsidiary of SANZ Inc.
As part of the co-borrowing arrangement with SANZ Inc. and Solunet Storage,
Inc., each of the borrowers has a separate borrowing base; however, total
borrowings under the facility shall not exceed $12,000,000. Additionally, each
entity is required to guaranty each other’s debt under the borrowing facility.
Cash transfers from SANZ Inc. to Solunet Storage, Inc. are limited to the
funding of Solunet Storage, Inc.’s operating expenses, subject to an annual
limit, and to a minimum availability on the date of any such
transfer.





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
Trust and Savings Bank**





At
December 31, 2004, the Company also maintained two revolving credit facilities
with Harris Trust, which allowed for borrowings up to an aggregate of $8.0
million. One of the facilities, with a maximum amount of $6.8 million at
December 31, 2004, was maintained by SAN Holdings and was unsecured, not limited
by availability under a borrowing base, and did not require the maintenance of
specified financial covenants. The other facility, with a maximum amount of $1.2
million at December 31, 2004, was maintained by our Solunet Storage subsidiary,
and was secured by substantially all of the assets of Solunet Storage, but was
not limited by availability under a borrowing base and did not require the
maintenance of specified financial covenants. At December 31, 2004, we had
borrowed $7.7 million on these facilities, which bore interest at a rate of
prime plus 0.75% (6.00% at December 31).





On
February 16, 2005, we entered into a revised credit agreement with Harris Trust,
which increased our availability by $2.0 million, for a total of $10.0 million,
and consolidated the credit lines into one facility maintained by SAN Holdings
and guaranteed by an affiliate of our majority stockholder. This facility is
unsecured, is not limited by availability under a borrowing base, does not
require the maintenance of specified financial covenants, and as of February 16,
2005, bore interest at a rate of prime plus 0.75% (6.25% at February 16). While
the Harris Trust facility is a demand note, under the revised agreement it has
been extended to February 2006, unless called earlier by the lender. Sun
Capital II has guaranteed the Harris Trust credit facility and has agreed that,
upon the written request of SANZ, it will provide SANZ with sufficient funds to
repay the debt outstanding under the credit facility in the event that Harris
Trust requires repayment of such debt or, at Sun Capital II’s election, pay the
outstanding debt directly to Harris Trust; provided that in no event will Sun
Capital II’s obligation exceed the amount of Sun Capital II’s guaranty. This
guaranty and all obligations expire on December 31, 2005.





F-22


In
exchange for the guaranty by Sun Capital on the increased Harris Trust line of
credit, on March 10, 2005, the Company approved the issuance of a warrant
to purchase 3,086,218 shares of our common stock with an exercise price of
$0.001 per share to our majority shareholder, Sun Solunet . The issuance of this
warrant will result in dilution of the other shareholders of the Company. See
further discussion in Note 10. Based on the number of shares issued pursuant to
the warrant, the Company expects to record in the first quarter of 2005 a charge
calculated as the number of shares issued under the warrant multiplied by the
closing market price of SANZ’ common stock for this date. Based on the closing
price of our common stock on March 10, 2005, we expect this charge to be
approximately $1.4 million.





**Other
Financing Arrangements**





In
January 2003, the Company entered into a revolving credit facility with The CIT
Group, supported by a limited guaranty by an affiliate of Sun Solunet, which
replaced a Harris Trust credit facility. After the business combination of SANZ
and Solunet Storage, the Company refinanced the CIT Group facility with a new
facility with Harris Trust (the second of the two Harris Trust facilities
described in the prior section). The Company had originally capitalized the
costs incurred in establishing the CIT Group facility, and in June 2003, wrote
off the full remaining amount of those capitalized costs of
$232,000.





In the
original capitalization of Solunet Storage in September 2002, Sun Solunet
invested $1,000,000, as equity and $4,000,000 in the form of a promissory note,
bearing interest at a rate of 5%. In March 2003, Sun Solunet sold a portion of
both the common stock and the promissory note to an officer of Solunet Storage.
Immediately prior to the SANZ and Solunet Storage business combination, Sun
Solunet and the officer of Solunet Storage converted the foregoing $4,000,000
promissory note plus accrued interest of $100,000 into common shares of stock in
Solunet Storage. These shares were exchanged for SANZ shares in the SANZ and
Solunet Storage business combination.





The
following summarizes our debt outstanding:





(In
      thousands)
    
    December
      31, 2004
    
    December
      31, 2003Line
      of credit with Wells Fargo
    
    $
    6,759
    
    $
    8,253Lines
      of credit with Harris Trust
    
    
    7,700
    
    
    8,200$
    14,459
    
    $
    16,453




**NOTE
6 - INCOME TAXES**





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-23


For the
years ended December 31, 2004 and 2003 and the period from September 26 through
December 31, 2002 (the period from Solunet Storage’s Inception through December
31, 2002), total income tax 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
    
    Year
      ended
    
    Period
      from September 26 throughDecember
      31, 2004
    
    December
      31, 2003
    
    December
      31, 2002Income tax benefit at federal statutory rate
    
    $
    (2,248
    )
    $
    (2,119
    )
    $
    (1,975
    )State income tax benefit, net of federal benefit
    
    
    (68
    )
    
    (117
    )
    
    —Federal income tax refund
    
    
    (328
    )
    
    (115
    )
    
    —Warrant charge for debt guaranty
    
    
    839
    
    
    —
    
    
    —Nondeductible items
    
    
    19
    
    
    28
    
    
    6Valuation allowance
    
    
    1,458
    
    
    2,208
    
    
    1,969$
    (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
      31,2004
    
    2003Deferred tax assets:Current:Accounts receivable reserves
    
    $
    49
    
    $
    118Inventory
      reserves
    
    
    48
    
    
    247Accrued expenses
    
    
    316
    
    
    150Other
    
    
    (24
    )
    
    621Non-currentNet operating loss carryforwards
    
    
    12,961
    
    
    11,400Intangible assets
    
    
    421
    
    
    272Property and equipment
    
    
    (95
    )
    
    —Total deferred tax assets
    
    
    13,676
    
    
    12,808Deferred tax liabilities
    
    
    —
    
    
    (84
    )Valuation allowance
    
    
    (13,676
    )
    
    (12,724
    )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, 2004, the Company has net operating loss carryforwards available to
offset future federal taxable income of approximately $37,000,000. Such
carryforwards expire between 2010 and 2024. 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-24





**NOTE
7 - COMMITMENTS AND CONTINGENCIES**





**Leases**





The
Company leases office space and equipment under various non-cancelable operating
leases. At December 31, 2004, the aggregate future minimum lease commitments
were as follows (in thousands):





2005
    
    $
    5882006
    
    
    3432007
    
    
    1702008
    
    
    242009
    
    
    4$
    1,129





Rent
expense totaled $977,000, $714,000 and $964,000 in the years ended December 31,
2004, 2003 and 2002, respectively. Rent expense for the year ended December 31,
2004 included a charge of $279,000 for three closed offices (see
below).





**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 include rent payments for the remaining
lease terms, net of any sublease agreements.





**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 2004:





Accrued Liability
      (in thousands)
    Balance
      at 12/31/03
    2004
      Payments
    2004
      Accruals
    Balance
      at 12/31/04
    Scheduled
      Payments2005
    2006Severance
    $   286
    $   217
    $   216
    $   285
    $   285
    $  
      —Closed Offices
    105
    59
    279
    325
    241
    84TOTAL
    $   391
    $   276
    $   495
    $   610
    $   526
    $   
      84


**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-25





**NOTE
8 - STOCKHOLDERS’ EQUITY**





**Preferred
stock conversion**





At the
Annual Meeting of Shareholders held on April 12, 2004, SANZ’ shareholders voted
to amend the Company’s Articles of Incorporation to increase the authorized
common stock from 75,000,000 shares to 200,000,000 shares. An amendment to the
Company’s Articles of Incorporation implementing that increase was filed and
became effective on April 13, 2004. The terms of the previously outstanding
Series B Preferred Stock provided that all of those shares would convert into
common stock — automatically and at a fixed conversion ratio — at such time as
SANZ had sufficient authorized common shares to permit that conversion.
Accordingly, the increase in the Company’s authorized shares of common stock on
April 13, 2004 caused all of the Company’s previously outstanding Series B
Preferred Stock to convert into a total of 37,403,653 shares of common
stock.





**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 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 under the 2003 Plan 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 31,2004
    2003
    2002Expected dividend yield
    0%
    0%
    0%Expected volatility
    142%
    80%
    105%Expected term
    5
      years
    5
      years
    5
      yearsRisk-free interest rate
    3.95%
    2.0%
    2.6%





The
weighted average fair value of options granted were $0.36, $0.28 and $0.29 per
share for the years ended December 31, 2004, 2003 and 2002,
respectively.





The
following table summarizes option activity for the three stock option plans
during the three years ended December 31, 2004, 2003 and 2002, respectively (in
thousands, except per share data):





Number
      of Shares
    
    Weighted
      AverageUnderlying
      Options
    
    Exercise
      PriceOutstanding at January 1, 2002
    
    
    7,117
    
    $
    1.34Granted
    
    
    1,218
    
    
    0.43Forfeited
    
    
    (1,793
    )
    
    1.66Outstanding
      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
    
    
    0.61Exercisable at December 31, 2002
    
    
    4,192
    
    $
    1.09Exercisable at December 31, 2003
    
    
    4,662
    
    $
    0.99Exercisable at December 31, 2004
    
    
    6,928
    
    $
    0.79





F-26


Further
information regarding options outstanding and options exercisable at December
31, 2004 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$0.29 to $0.49
    9,532
    8.7
    $    0.39
    
    3,152
    $    0.37$0.57
      to $1.00
    3,529
    3.4
    0.68
    
    2,843
    0.68$1.50
      to $2.25
    873
    2.5
    2.01
    
    873
    2.01$10.00
      to $10.32
    60
    0.2
    10.14
    
    60
    10.1413,994
    6.9
    $    0.61
    
    6,928
    $    0.79








**Stock
warrants**





On
November 16, 2004, the Company became obligated, under a letter agreement dated
March 31, 2003 (“Credit Support Agreement”), to issue, and on March 23, 2005,
the Company issued to Sun Solunet a stock purchase warrant (the “Guaranty
Warrant”) to purchase 7,715,545 shares of the Company’s common stock, no par
value per share at an exercise price of $0.001 per share. The Company was
obligated to issue the Guaranty Warrant to Sun Solunet in partial consideration
for a guaranty provided by Sun Capital II, an affiliate of Sun Solunet, (the
“Guarantor”) on the two revolving credit lines of the Company with Harris Trust
pursuant to the Credit Support Agreement.







The
number of shares exercisable under the Guaranty was determined pursuant to a
formula set forth in the Credit Support Agreement and was based on the amount
that the outstanding guaranty provided on behalf of the Company by the Guarantor
on the credit lines with Harris Trust exceeded $3.0 million as of the Issue Date
(18 months after the effective date of the guarantee). Until the Company reduces
the guaranteed debt to $3.0 million or less, it will be required to issue
additional warrants to Sun Solunet at six-month intervals in the future (each
May and November), according to formulas applicable to each such date, which are
disclosed in Note 10. Pursuant to the obligation to issue the Guaranty Warrant,
the Company recorded in November 2004 a charge of $2,469,000, calculated as the
number of shares to be issued under the warrant multiplied by the closing market
price of SANZ’ common stock ($0.32 per share) for this date.





On
February 16, 2005, the Company, pursuant to a revised revolving credit facility
agreement with Harris Trust, increased its borrowing availability from $8.0
million to $10.0 million. Sun Capital II has guaranteed this facility, and, on
March 10, 2005, as consideration for the guaranty, the Company approved the
issuance of a warrant to purchase 3,086,218 shares of the Company’s common stock
at an exercise price of $0.001 per share to this affiliate. This warrant was
issued on March 23, 2005.





F-27


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, 2004, 2003 and 2002, respectively (in thousands, except per share
data):





Number
      of Shares Underlying Warrants
    
    Weighted
      Average Exercise PriceOutstanding at January 1, 2002
    
    
    6,993
    
    
    1.13Granted
    
    
    506
    
    
    0.69Forfeited
    
    
    (150
    )
    
    8.95Outstanding 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*Exercisable at December 31, 2002
    
    
    7,349
    
    $
    0.94Exercisable
      at December 31, 2003
    
    
    8,644
    
    $
    0.91*Exercisable at December 31, 2004
    
    
    13,827
    
    $
    0.29*




**NOTE
9 - DEFINED CONTRIBUTION PLAN**





The
Company maintains a defined contribution plan under Section 401(k) of the
Internal Revenue Code, covering all employees who have three months of service
with the Company. The Plan allows participants to make voluntary pre-tax
contributions of up to 100% of their pre-tax earnings, not to exceed the IRS
annual limit. In addition, Company management, at its discretion, may partially
match participant contributions. For the years ended December 31, 2004, 2003 and
2002, employer matching contributions were $-0-, $46,000 and $62,000,
respectively.





F-28







**NOTE
10 - RELATED PARTY TRANSACTIONS**





As
discussed in Note 1, Sun Solunet is the majority shareholder of SANZ. The
Company pays quarterly $75,000 for management and consulting services to Sun
Capital Partners Management LLC (“Sun Capital Management”), an affiliate of Sun
Solunet. In addition, Sun Capital II, who is also an affiliate of Sun Solunet,
guarantees the Harris Trust debt, as described in Notes 5 and 8. While SANZ
receives material benefits from this guaranty, the Company pays no specified
cash consideration for the guaranty. The Company has 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 receives under
the Sun Capital guaranty. The balance of the management and consulting services
fee has been recorded as general and administrative expense.





If the
guaranteed Harris Trust debt is not reduced to $3 million or less, the Company
is obligated to issue stock purchase warrants at an exercise price of $0.001 to
Sun Solunet based on the excess guaranteed debt over $3 million, 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 to be used in the calculation of debt guaranty warrants for a
particular date are listed in the table below. As discussed in Note 8, the
Company was obligated to issue to Sun Solunet a stock purchase warrant for the
purchase of 7,715,545 shares of common stock on November 16, 2004 based on $8.0
million of Harris Bank debt guaranteed by Sun Capital II.





Date
    
    Number
      of SharesMay 2005
    
    
    641,292November 2005
    
    
    1,307,898May 2006
    
    
    1,342,776November 2006
    
    
    1,379,067May 2007
    
    
    1,416,849November 2007
    
    
    1,456,206May 2008
    
    
    1,497,226Each
      six months thereafter*
    
    
    291,346





* A
number of shares equal to 0.5% of the shares outstanding upon the closing of the
Solunet Storage business combination.





On March
10, 2005, the Company approved the issuance to Sun Solunet of an additional
stock purchase warrant for the purchase of 3,086,218 shares of common stock as
consideration for an additional $2.0 million debt guaranty provided by Sun
Capital II on the Company’s Harris Trust credit facility. The number of shares
underlying the warrant was calculated as if the $2.0 million debt guaranty was
in place as of November 16, 2004. The Company is continually evaluating
potential transactions to refinance a portion of the guaranteed debt with either
other debt or equity, and, in conjunction with its existing availability on it
Wells Fargo credit facility and cash from operations. However, there can be no
assurance that we will be successful in obtaining additional debt or equity
financing.





As of
December 31, 2004 and 2003, the Company had $-0- and $91,000, respectively, due
to Sun Capital Management for management fees and bank debt interest. For the
years ended December 31, 2004, 2003 and 2002, the Company paid $323,000,
$443,000 and $-0-, respectively, to Sun Capital Management for management fees,
a portion of which has been recorded as interest expense due to guaranties on
the Harris Trust debt as discussed above.





F-29






**NOTE
11 -INVESTMENT IN ALLIANCE MEDICAL CORPORATION**


The
Company has been in litigation since late 2002 seeking to recover approximately
575,000 shares of common stock of a private company, Alliance Medical
Corporation (“Alliance”), that were placed in an escrow account at the end of
1999. The escrow agent deposited those shares with the court at the outset of
the litigation. The opposing claimants to these shares were SANZ’ stockholders
as of a December 31, 1999 record date to whom a “contingent dividend” was made,
subject to conditions subsequent that the Company contends were not fulfilled.
Certain of the opposing claimants contend principally that the deadline
determining the satisfaction of the condition was extended to 2005. Prior to
2004, the Company recorded no value on these shares due to the disputed
title.





In
November 2001, Alliance effected a 1 for 3.3297 reverse stock split.
Accordingly, all share amounts discussed below are listed in duplicate as
follows - pre-reverse split # and post-reverse split #. Through a series of
default judgments and settlement agreements entered into between the
commencement of the litigation and September 30, 2004, the Company obtained
clear title to approximately 300,000/90,098 shares of the Alliance stock. Under
these settlement agreements, the Company has also waived any claim to
approximately 215,000/64,570 additional shares in Alliance. Approximately
60,000/18,020 shares remain the subject of the litigation.





In
September 2004, the Company sold an aggregate of 85,000/25,528 shares it had
obtained to an employee and existing shareholder of SANZ and two other
purchasers, who had no prior relationship to SANZ, for total cash proceeds of
$212,500. Also in September 2004, in accordance with a Settlement Agreement
discussed in our 2003 Annual Report on Form 10-KSB that resolved a separate
litigation related to Alliance that had been brought against SANZ and
approximately ten other defendants, the Company used $210,000 of these proceeds
(in lieu of a transfer of Alliance shares) to satisfy its obligations under that
Settlement Agreement. In the September quarter, the Company recorded the net of
these transactions (the initial recording of the shares to which clear title had
been obtained, the sale of a portion of those shares for cash, and the cash
payment to the other litigant) as Other Income. The Company has not recorded any
value with respect to the approximately 60,000/18,020 shares that remain the
subject of the litigation.





As of
December 31, 2004, SANZ held approximately 215,000/64,570 shares of Alliance
stock, which are carried at $229,000 in Other Assets. The Company has recorded
this investment at its best estimate of fair value, based on various factors
including the following: (1) Alliance is a private company with no readily
determinable market value; (2) because Alliance is private, SANZ has a limited
market to liquidate any or all of its Alliance shares; (3) the price obtained in
recent arms-length sales of Alliance stock by SANZ; (4) a review of Alliance’s
most recent audited financial statements; and, (5) discussions with financial
management of Alliance as to external valuations completed on Alliance.




F-30


**(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
    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. #10.08
    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, 2003.10.09
    Shareholders
      Agreement dated April 4, 2003. Incorporated by reference from
      Exhibit 2.8 to the Registrant’s Current Report on Form 8-K dated
      April 4, 2003, filed on April 21, 2003.10.10
    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, 2003.10.11
    Stock
      Option Agreement dated March 31, 2003. Incorporated by reference to
      Exhibit 2.2 to the Registrant’s Current Report on Form 8-K/A
      No. 1 dated April 1, 2003, filed on April 3, 2003.
  44
 **Exhibit**
      **Number**
    **Description**
 10.12
    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, 2003.10.13
    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,
      2003.10.14
    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,
      2003.10.15
    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, 2003.10.16
    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, 2003.10.17
    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, 2003.10.18
    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, 2003.10.19
    Fourth
      Amendment, dated November 26, 2003, to SAN Holdings Inc. - Harris
      Trust and Savings Bank Loan Authorization Agreement. #10.20
    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, 2004.10.21
    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, 2003.10.22
    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, 2004.10.23
    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, 2002.10.24
    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, 2002.10.25
    2003
      Stock Option Plan. Incorporated by reference to Exhibit 10.22 to the
      Registrant’s Annual Report on Form 10-KSB for the year ended
      December 31, 2003, filed on April 22, 2003.10.26
    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, 2002.10.27
    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, 2004.10.28
    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, 2004.10.29
    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.
   45
 **Exhibit**
      **Number**
    **Description**
 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. #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).#99.01
    Reconciliation
      of EBITDA to Net Loss.#___________
      #
      Filed herewith







46




**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:
      March 29, 2005
    By:/s/
      John Jenkins
      John
      Jenkins
      Chief
      Executive Officer







Date:
      March 29, 2005
    By:/s/
      Robert C. Ogden
      Robert
      C. Ogden
      Chief
      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: March 29,
2005  /s/ John
Jenkins


John Jenkins, Chairman





Date: March
29,
2005   / s/Rodger
R. Krouse


Rodger R. Krouse, Director





Date: March 29, 2005  /s/ Marc
J. Leder


Marc J. Leder, Director





Date: March 29,
2005  /s/ Clarence
E. Terry


Clarence E. Terry, Director





Date: March 29,
2005  /s/ M.
Steven Liff


M. Steven Liff, Director





Date: March 29,
2005


Stephen G. Marble, Director





Date: March 29,
2005  /s/ Gary
F. Holloway


Gary F. Holloway, Director





Date: March 29,
2005  /s/ C.
Daryl Hollis


C. Daryl Hollis, Director





Date: March 29,
2005  /s/ George
R. Rea


George R. Rea, Director










47