San 10Q/A 2005 Q2 Quarterly report (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(Amendment No. 1)

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________.

Commission File Number 0-16423

SAN Holdings, Inc.

(Exact name of registrant as specified in its charter)

Colorado		84-0907969
(State of incorporation)		(I.R.S. Employer ID Number)

9800 Pyramid Ct., Suite 130, Englewood, CO 80112-2694

(Address of principal executive offices)

(303) 660-3933

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

As of August 8, 2005, 95,811,278 shares of the registrant’s common stock, no par value per share, were outstanding.

SAN HOLDINGS, INC.

EXPLANATORY NOTE

This Amendment No. 1 on Form 10−Q/A (the “Form 10−Q/A”) to the Quarterly Report on Form 10−Q for SAN Holdings, Inc. for the period ended June 30, 2005, initially filed with the Securities and Exchange Commission (the “SEC”) on August 15, 2005 (the “Original Filing”), is being filed to report restated comparative 2004 financial information and the effects of the 2004 restatement on the June 30, 2005 balance sheet.

As previously disclosed in filings made with the SEC, San Holdings, Inc. (“SANZ,” the “Company” or “we”) is restating its consolidated financial statements for the year 2004. During the September 2005 quarter, we initiated a project to prepare stand-alone financial statements for audit of our EarthWhere™ (“EarthWhere”) business. Beginning in 2003, the Company capitalized certain software development costs related to its EarthWhere geospatial imaging software in accordance with Statement of Financial Accounting Standard No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” (“SFAS 86”). As all of the Company’s capitalized software costs pertain to the EarthWhere business, such costs are considered to be material to the total assets of that business unit, but were not considered material to the total assets of the Company as a whole as of December 31, 2003 or December 31, 2004. As we undertook this project, we determined that the assumptions and evidential matter that the Company had used in capitalization of software development costs during 2003 and 2004 did not provide sufficient “contemporaneous documentation” to support capitalization.

As a result, on November 14, 2005, the Board of Directors of the Company in consultation with management concluded that the Company’s financial statements as of and for the year ended December 31, 2004 and the interim financial statements as of and for the quarter and six months ended June 30, 2004, as of and for the quarter and nine months ended September 30, 2004, for the quarter ended December 31, 2004 and as of March 31, 2005 and June 30, 2005 should not be relied upon. The restatement reflects the expensing of certain software development costs in 2004 related to the Company’s proprietary software that were capitalized on the Company’s previously reported financial statements for the 2004 periods referred to above. For a more detailed description of the effects of the restatement, see Note 1, “Basis of Presentation—Restatement” to the accompanying unaudited consolidated financial statements in Part I, Item 1 of this report.

Concurrently with the filing of this Form 10−Q/A, the Company is also filing Amendment No. 1 on Form 10-K/A to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 to reflect restatements of the Company’s consolidated balance sheet as of December 31, 2004 and the Company’s consolidated statements of operations, cash flows and stockholders’ equity for the year ended December 31, 2004 and the notes related thereto, and restated 2005 interim financial statements on Form 10-Q/A for the quarter ended March 31, 2005 to report restated comparative 2004 financial information and the effects of this restatement on the March 31, 2005 balance sheets. The Company is not restating its 2003 financial statements due to the immateriality of the impact to both 2003 and 2005.

For the convenience of the reader, this Form 10−Q/A sets forth the Original Filing in its entirety. However, this Form 10−Q/A only amends and restates Items 1, 2 and 4 of Part I of the Original Filing, in each case, solely as a result of, and to reflect, the restatement, and no other information in the Original Filing is amended hereby. The foregoing items have not been updated to reflect other events occurring after the Original Filing or to modify or update those disclosures affected by subsequent events. In addition, pursuant to the rules of the SEC, Item 6 of Part II of the Original Filing has been amended to contain currently dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes−Oxley Act of 2002, and are attached as Exhibits 31.01, 31.02, 32.01 and 32.02 to this report.

Except for the foregoing amended information, this Form 10−Q/A continues to speak as of the date of the Original Filing, and the Company has not updated the disclosures contained herein to reflect events that occurred at a later date. Other events occurring after the filing of the Original Filing or other disclosures necessary to reflect subsequent events have been or will be addressed in the Company’s Quarterly Report on Form 10−Q for the quarterly period ended September 30, 2005, filed on November 21, 2005, and any reports filed with the SEC subsequent to the date of this filing.

The Company has not amended and does not intend to amend its previously filed Quarterly Reports on Form 10−Q for the periods affected by the restatement prior to December 31, 2004. For this reason, the consolidated financial statements and related financial information for the affected periods contained in such reports should no longer be relied upon.

SAN Holdings, Inc.

TABLE OF CONTENTS

Part I: FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets (unaudited) as restated	4
	Consolidated Statements of Operations (unaudited) as restated	5
	Consolidated Statements of Cash Flows (unaudited) as restated	6
	Notes to Consolidated Financial Statements (unaudited) as restated	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	23

Part II: OTHER INFORMATION

Item 6.	Exhibits	24

Signatures		25

Part I. Financial Information

Item 1. Financial Statements

SAN Holdings, Inc.

Consolidated Balance Sheets

(Unaudited)

(In thousands, except for share data)

		June 30,			December 31,
		2005			2004
ASSETS		As restated			As restated

Current assets:
Cash and cash equivalents	$	73		$	486
Accounts receivable, net of allowance for doubtful accounts of $119 and $140, respectively		10,626			13,097
Inventories, net of valuation allowance of $85 and $137, respectively		354			467
Deferred maintenance contracts		2,671			2,914
Prepaid expenses and other current assets		1,047			512
Total current assets		14,771			17,476

Property and equipment, net		819			1,005
Capitalized software, net		598			194
Goodwill		32,008			32,008
Intangible assets, net		1,946			2,205
Other assets		403			384
Total long-term assets		35,774			35,796

TOTAL ASSETS	$	50,545		$	53,272

LIABILITIES AND STOCKHOLDERS’ EQUITY

Lines of credit:
Wells Fargo Business Credit, Inc.	$	3,588		$	6,759
Harris N.A.		11,500			7,700
Accounts payable		11,069			12,453
Accrued expenses		2,092			2,651
Deferred revenue		4,033			3,942
Total current liabilities		32,282			33,505

Commitments and contingencies (Note 6)

Stockholders’ equity
Preferred stock; Series A; no par value; 8,000 shares authorized; -0- shares issued and outstanding		--			--
Preferred stock; Series B; no par value; 2,000 shares authorized; -0- shares issued and outstanding		--			--
Common stock; no par value, 200,000,000 shares authorized; 95,811,278 shares issued and outstanding		32,577			32,577
Warrants		7,260			5,691
Accumulated deficit		(21,574	)		(18,501	)
Total stockholders’ equity		18,263			19,767

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	50,545		$	53,272

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

SAN Holdings, Inc.

Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
		2005			2004			2005			2004
					As restated						As restated
Revenue
Product sales and vendor supplied services	$	9,549		$	12,370		$	21,784		$	26,327
Consulting and engineering services		1,187			997			2,444			2,002
Maintenance services and maintenance contract fees		2,537			1,881			4,561			3,758
Total revenue		13,273			15,248			28,789			32,087

Cost of revenue
Product sales and vendor supplied services		7,513			10,423			17,106			21,407
Consulting and engineering services		726			568			1,472			1,134
Maintenance services and maintenance contract fees		1,827			1,259			3,226			2,584
Total cost of revenue		10,066			12,250			21,804			25,125

Gross profit		3,207			2,998			6,985			6,962

Operating expenses
Selling, general and administrative		3,518			4,172			7,053			8,012
Depreciation and amortization of intangibles		325			357			680			668
Total operating expenses		3,843			4,529			7,733			8,680

Loss from operations		(636	)		(1,531	)		(748	)		(1,718	)

Other income (expense)
Interest expense		(405	)		(285	)		(752	)		(574	)
Charge for warrants issued to related party for debt guaranty		(520	)		--			(1,569	)		--
Other income (expense)		1			(111	)		(4	)		(108	)

Loss before income taxes		(1,560	)		(1,927	)		(3,073	)		(2,400	)

Income tax benefit		--			355			--			344

Net loss	$	(1,560	)	$	(1,572	)	$	(3,073	)	$	(2,056	)

Basic and diluted net loss per share	$	(0.01	)	$	(0.02	)	$	(0.03	)	$	(0.03	)

Weighted average shares outstanding - basic and diluted		107,895,625			90,878,928			105,876,751			74,643,277

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

SAN Holdings, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Six months ended June 30,
		2005			2004
					As restated
Cash flows from operating activities:
Net loss	$	(3,073	)	$	(2,056	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		680			668
Charge for warrants issued to related party for debt guaranty		1,569			--
Loss on disposals of property and equipment		--			113
Changes in operating assets and liabilities:
Accounts receivable		2,471			2,686
Inventories		132			293
Deferred maintenance contracts		243			85
Prepaid expenses and other current assets		(535	)		120
Other assets		(19	)		(23	)
Accounts payable		(1,384	)		(2,859	)
Accrued expenses		(559	)		(818	)
Deferred revenue		91			(345	)
Net cash used in operating activities		(384	)		(2,136	)

Cash flows from investing activities:
Purchase of property and equipment, net		(161	)		(201	)
Capitalized software costs		(497	)		--
Net cash used in investing activities		(658	)		(201	)

Cash flows from financing activities:
Net borrowings (payments) on line of credit - Harris N.A.		3,800			2,700
Net borrowings (payments) on line of credit - Wells Fargo Business Credit		(3,171	)		(3,211	)
Net cash provided by (used in) financing activities		629			(511	)

Net decrease in cash and cash equivalents		(413	)		(2,848	)

Cash and cash equivalents at beginning of period		486			3,792

Cash and cash equivalents at end of period	$	73		$	944

Supplemental disclosure of other cash flow information:
Interest paid	$	684		$	582

Supplemental disclosure of non-cash investing and financing activities:

Transfer of inventory to property and equipment	$	19		$	296

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

SAN Holdings, Inc.

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 - BASIS OF PRESENTATION

The accompanying consolidated financial statements of SAN Holdings, Inc. (“SANZ,” the “Company” or “we”) and its wholly-owned subsidiary, SANZ Inc., and its wholly-owned subsidiary, Solunet Storage, Inc. (“Solunet Storage”), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). All significant intercompany transactions and balances have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements, and reflect all adjustments, consisting only of normal, recurring adjustments, necessary for a fair presentation in accordance with US GAAP. The results of operations for interim periods presented are not necessarily indicative of the operating results for the full year. These consolidated financial statements should be read in connection with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2004 (the “2004 Annual Report on Form 10-K”).

Reclassifications

Certain reclassifications have been made to the prior periods’ balances to conform to current period presentations.

Restatement

We have restated our consolidated financial statements as of and for the year ended December 31, 2004. The purpose of this Form 10−Q/A is to report restated comparative 2004 financial information and the effects of the 2004 restatement on the June 30, 2005 balance sheet. Notes 1, 2, and 3 to the unaudited financial statements as well as Item 2—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” have been amended in this Form 10-Q/A to reflect the effects of the restatement.

As previously disclosed on our Current Report on Form 8-K filed on November 17, 2005, during the September 2005 quarter, we initiated a project to prepare stand-alone financial statements for audit of our EarthWhere™ (“EarthWhere”) business. We believe that this is an important step in further supporting the growth opportunities of that business. Beginning in 2003, the Company capitalized certain software development costs related to its EarthWhere geospatial imaging software in accordance with Statement of Financial Accounting Standard No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” (“SFAS 86”). As all of the Company’s capitalized software costs pertain to the EarthWhere business, such costs are considered to be material to the total assets of that business unit, but were not considered material to the total assets of the Company as a whole as of December 31, 2003 or December 31, 2004. As we undertook this project, we determined that the assumptions and evidential matter that the Company had used in capitalization of software development costs during 2003 and 2004 did not provide sufficient “contemporaneous documentation” to support capitalization.

The restatement reflects the expensing of certain software development costs in 2004 related to the Company’s proprietary software that were capitalized on the Company’s original filings for the 2004 periods referred to above. The Company is not restating its 2003 financial statements due to the immateriality of the impact to both 2003 and 2005.

The primary impact of the restatement on the consolidated balance sheets at December 31, 2004 and at June 30, 2005 was to decrease the capitalized software asset and increase the accumulated deficit by $465,000. For the quarter and the six months ended June 30, 2005 there was no effect on loss from operations, net loss or net loss per share. There was also no effect to cash balances or cash flows for the six months ended June 30, 2005. The impact of the restatement on the consolidated statement of operations for the quarter and the six months ended June 30, 2004 was an increase in the loss from operations and the net loss of $109,000, with no change to net loss per share. Net cash used in operating activities increased by $152,000 and net cash used in investing activities decreased by the same amount for the six months ended June 30, 2004, with no effect to cash balances. The impact of the restatement on the consolidated financial statements as of December 31, 2004, as of and for the quarter and six months ended June 30, 2004 and as of June 30, 2005 is shown in the following (unaudited) tables:

Balance Sheet Data
(in thousands)		As reported		Adjustment			As restated

December 31, 2004
Capitalized software, net	$	659	$	(465	)	$	194
Total long-term assets		36,261		(465	)		35,796
Total stockholders' equity	$	20,232	$	(465	)	$	19,767

June 30, 2005
Capitalized software, net	$	1,063	$	(465	)	$	598
Total long-term assets		36,239		(465	)		35,774
Total stockholders' equity	$	18,728	$	(465	)	$	18,263

Statement of Operations Data
(in thousands, except per share data)		As reported			Adjustment			As restated

For the quarter ended June 30, 2004
Selling, general and administrative expenses	$	4,020		$	152		$	4,172
Depreciation and amortization		400			(43	)		357
Loss from operations		(1,422	)		(109	)		(1,531	)
Net loss		(1,463	)		(109	)		(1,572	)
Basic and diluted net loss per share	$	(0.02	)	$	--		$	(0.02	)

For the six months ended June 30, 2004
Selling, general and administrative expenses	$	7,860		$	152		$	8,012
Depreciation and amortization		711			(43	)		668
Loss from operations		(1,609	)		(109	)		(1,718	)
Net loss		(1,947	)		(109	)		(2,056	)
Basic and diluted net loss per share	$	(0.03	)	$	--		$	(0.03	)

Statement of Cash Flows Data
(in thousands)		As reported			Adjustment			As restated

June 30, 2004
Net cash used in operating activities	$	(1,984	)	$	(152	)	$	(2,136	)
Net cash used in investing activities		(353	)		152			(201	)
Cash and cash equivalents at end of period	$	944			--		$	944

NOTE 2 - FINANCIAL CONDITION

The accompanying consolidated financial statements have been prepared in conformity with US GAAP (except with regard to omission of certain disclosures within interim financial statements, as permitted by the SEC), which contemplate our continuation as a going concern. However, we have incurred substantial losses from operations since inception, including a net loss of $6,750,000 for the year ended December 31, 2004, and a net loss of $3,073,000 for the six months ended June 30, 2005. In addition, as of June 30, 2005, we have negative working capital (current liabilities in excess of current assets) of $17,511,000. Accordingly, as of June 30, 2005, the recoverability of a major portion of the recorded asset amounts, including “Goodwill,” is dependent on our continuing operations, which in turn is dependent on our ability to maintain our current financing arrangements and our ability to become profitable in our future operations. Our consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary if we were unable to continue as a going concern.

As of June 30, 2005, the Company had $3.2 million of undrawn availability on its principal borrowing facility with Wells Fargo Business Credit, Inc. (“Wells Fargo”). This debt facility, combined with the Harris N.A. (formerly known as Harris Trust and Savings Bank) (“Harris”) subordinated credit facility and open credit lines with suppliers, 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. During the June 2005 quarter, the Company was not in compliance with a minimum availability covenant required for cash transfers from Sanz Inc. to Solunet Storage. This violation occurred on one such transfer in June 2005. The Company subsequently received a waiver from Wells Fargo. As of June 30, 2005, the Company was in compliance with all of the other financial covenants under the Wells Fargo credit agreement. See further discussion of the Wells Fargo credit facility in Note 5.

As of June 30, 2005, the Company had an $11.5 million debt facility with Harris which is unsecured but guaranteed by Sun Capital Partners II, LP (“Sun Capital II”), an affiliate of the Company’s majority shareholder, Sun Solunet LLC (“Sun Solunet”). In June 2005, this facility was increased from $10.0 million to $11.5 million. While this facility is in the form of a demand note, it expires in February 2006, unless called earlier by the lender. As part of its guaranty, Sun Capital II 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 requires repayment of such debt or, at Sun Capital II’s election, pay the outstanding debt directly to Harris; 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 credit facility in Note 5.

NOTE 3 - STOCK-BASED COMPENSATION

As permitted under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 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” (“APB 25”) and related interpretations. Accordingly, no compensation expense has been recognized in connection with the grant of stock options to employees and directors during the periods presented, as all options granted had an exercise price equal to the market value of the underlying stock at the date of grant. The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS 123:

	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except for per share data)		2005			2004			2005			2004
					As restated						As restated

Net loss, as reported	$	(1,560	)	$	(1,572	)	$	(3,073	)	$	(2,056	)

Deduct, total stock-based compensation expense determined under fair-value based method, net of related tax effects		(60	)		(3	)		(185	)		(234	)

Pro forma net loss	$	(1,620	)	$	(1,575	)	$	(3,258	)	$	(2,290	)

Basic and diluted net loss per share:
As reported	$	(0.01	)	$	(0.02	)	$	(0.03	)	$	(0.03	)
Pro forma	$	(0.02	)	$	(0.02	)	$	(0.03	)	$	(0.03	)

NOTE 4 - EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is based on the weighted average number of common shares outstanding. In addition to common shares outstanding, and in accordance with Statement of Financial Standards No. 128, “Earnings per Share” (“SFAS 128”), any shares issuable for little or no cash consideration are considered outstanding shares and included in the calculation of weighted average number of common shares. Accordingly, for the three and six months ended June 30, 2005, the weighted average number of common shares outstanding included 13,527,254 shares issuable under outstanding debt guaranty warrants that were immediately exercisable at $0.001 per share, and held by our majority shareholder, Sun Solunet. See Note 5 below for additional information regarding the debt guaranty warrants issued.

Diluted earnings (loss) per share is computed using the weighted average number of common shares outstanding plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares. Warrants and options outstanding to purchase an aggregate of 45,707,201 and 41,700,165 shares of common stock as of June 30, 2005 and 2004, respectively, have been excluded from the diluted share calculations for the three-month and six-month periods ending June 30, 2005 and 2004, respectively, as they were antidilutive as a result of the net losses incurred for those periods. Accordingly, basic shares equal diluted shares for all periods presented.

NOTE 5 - DEBT

Wells Fargo Line of Credit

In March 2005, the Company amended its $12.0 million credit facility with Wells Fargo. As part of the amendment, Wells Fargo waived the Company’s non-compliance on certain financial covenants as of December 31, 2004. In addition, Wells Fargo reset the following financial covenant requirements effective January 1, 2005: (1) minimum net income on a year to date basis, calculated quarterly; (2) minimum net worth plus “subordinated debt” (measured in the aggregate, with amounts loaned to SANZ Inc. and its wholly-owned subsidiary, Solunet Storage, (the Company’s borrowers) from SANZ being defined as subordinated debt), calculated on a monthly basis; (3) minimum availability, calculated monthly; (4) capital expenditure limit, calculated on an annual basis; and (5) a minimum cash infusion from SANZ or an outside source if SANZ Inc. and its subsidiary, Solunet Storage, generate a net loss in a given quarter and have generated a net loss on a year to date basis at that time, in an amount equal to the lesser of the quarterly net loss or the year to date net loss.

Additionally, the amended credit agreement with Wells Fargo includes as an additional borrower, Solunet Storage, which in March 2005 became a wholly-owned subsidiary of SANZ Inc., itself a wholly-owned subsidiary of SANZ. As part of the co-borrowing arrangement with SANZ Inc. and Solunet Storage, each of the borrowers has a separate borrowing base; however, total borrowings under the facility may 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 are limited to the funding of Solunet Storage’s operating expenses, subject to an annual limit, and to a minimum availability on the date of any such transfer. During the June 2005 quarter, the Company was not in compliance with the minimum availability covenant required for such cash transfers. This violation occurred on one cash transfer in June 2005. The Company subsequently received a waiver from Wells Fargo. As of June 30, the Company was in compliance with all of the other financial covenants under the Wells Fargo credit agreement.

Also as part of the amended agreement and effective January 1, 2005, Wells Fargo increased the interest rate on our borrowings to prime plus 5.0%, an increase of three points. This rate is subject to potential decreases, as permitted by Wells Fargo, based on SANZ Inc. and its subsidiary, Solunet Storage, achieving certain net income levels during 2005. For the March 2005 quarter, SANZ Inc. and Solunet Storage achieved a minimum net loss threshold and the borrowing rate on the facility was reduced to prime plus 4.0%, effective May 1, 2005. Our borrowing rate on this facility at June 30, 2005 was prime plus 4.0%, or 10.0%. SANZ Inc. and Solunet Storage did not achieve a minimum net loss threshold for the six months ended June 30, 2005, and as such, effective July 1, 2005, the interest rate on the Company’s borrowings increased to prime plus 5.0% from prime plus 4.0%.

Harris Credit Facility

On February 16, 2005, we entered into a revised credit agreement with Harris, which increased our availability by $2.0 million, for a total of $10.0 million, and consolidated two credit lines (one maintained by Solunet Storage and one maintained by SANZ) into one facility with SANZ as the sole borrower and guaranteed by Sun Capital II, an affiliate of our majority shareholder, Sun Solunet. On June 3, 2005, we entered into a revised credit agreement with Harris, which increased the facility from $10.0 million to $11.5 million. 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 June 30, 2005, bore interest at a rate of prime plus 1.0%, or 7.0%. While the Harris facility is a demand note, under the revised agreement it has been extended to February 16, 2006, unless called earlier by the lender. Sun Capital II has guaranteed this 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 requires repayment of such debt or, at Sun Capital II’s election, pay the outstanding debt directly to Harris; 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.

NOTE 6 - COMMITMENTS AND CONTINGENCIES

Debt Guaranty Warrants

As discussed in Notes 2 and 5 above, the Harris credit facility term extends until February 2006. Pursuant to a letter agreement dated March 31, 2003 (“Credit Support Agreement”) provided by Sun Capital II, an affiliate of the Company’s majority shareholder, until the Company reduces the guaranteed debt to $3.0 million or less, it is required to issue stock purchase warrants at an exercise price of $0.001 to Sun Solunet beginning on November 16, 2004 and continuing at six-month intervals in the future (each May and November). The number of warrants to be issued is dependent on the amount by which the remaining guaranteed debt exceeds $3.0 million, according to formulas applicable to each such date, as disclosed in our 2004 Annual Report on Form 10-K. The issuance of these warrants will result in dilution of the other shareholders of the Company.

As consideration for the Sun Capital II guaranty on the $2.0 million increase in the Harris credit facility in February 2005, the Company issued on March 23, 2005 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 number of shares underlying the warrant was calculated using the formula applicable to the November 16, 2004 measurement (as if the $2.0 million debt guaranty was in place as of November 16, 2004). This warrant was immediately exercisable and resulted in approximately 3% dilution of the other shareholders of the Company. Based on the number of underlying shares issued pursuant to the warrant, the Company recorded in the March 2005 quarter a charge of $1.1 million, calculated as the number of shares issued under the warrant multiplied by the closing market price of SANZ’ common stock on the issuance date.

Pursuant to the Credit Support Agreement, on May 16, 2005, the Company became obligated to issue and issued to Sun Solunet a stock purchase warrant to purchase 2,244,522 shares of the Company’s common stock at an exercise price of $0.001 per share. This warrant was immediately exercisable upon issuance. The number of shares underlying this warrant represented approximately 2% of the Company’s outstanding common stock as of the issuance date and was calculated in accordance with the formula set forth in the Credit Support Agreement. Pursuant to the warrant issuance, the Company recorded in May 2005 a charge of $405,000, calculated as the number of shares issued under the warrant multiplied by the closing market price of SANZ’ common stock on May 16, 2005.

On June 27, 2005 and in consideration of an additional $1.5 million guaranty by Sun Capital II on the Company’s increased Harris facility, the Company issued a warrant to purchase 480,969 shares of our common stock with an exercise price of $0.001 per share to our majority shareholder, Sun Solunet. The Company and Sun Solunet agreed that the number of shares exercisable under this warrant would be calculated pursuant to the same formula set forth in the Credit Support Agreement, based on the amount that the outstanding guaranty provided on behalf of the Company by Sun Capital II on the Harris Facility exceeded $3.0 million as of May 16, 2005 (as if the additional $1.5 million guaranty was in place as of May 16, 2005). This warrant was immediately exercisable upon issuance and the number of shares underlying this warrant represented approximately 0.5% of the Company’s outstanding common stock as of the issuance date. Pursuant to the warrant issuance, the Company recorded in June 2005 a charge of $115,000, calculated as the number of shares issued under the warrant multiplied by the closing market price of SANZ’ common stock on June 3, 2005, the effective date of the revised Harris credit facility and Sun Capital II guaranty.

NOTE 7 - 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. Under SFAS 123R, the Company was required to adopt SFAS 123R at the beginning of its third quarter of 2005. In April 2005, the SEC postponed the required adoption of SFAS 123R until the beginning of fiscal years starting after June 15, 2005, which for SANZ will be effective beginning January 1, 2006.

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

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Restatement

As previously disclosed on our Current Report on Form 8-K filed on November 17, 2005, during the September 2005 quarter, we initiated a project to prepare stand-alone financial statements for audit of our EarthWhere business. We believe that this is an important step in further supporting the growth opportunities of that business. Beginning in 2003, the Company capitalized certain software development costs related to its EarthWhere geospatial imaging software in accordance with SFAS 86. As all of the Company’s capitalized software costs pertain to the EarthWhere business, such costs are considered to be material to the total assets of that business unit, but were not considered material to the total assets of the Company as a whole as of December 31, 2003 or December 31, 2004. As we undertook this project, we determined that the assumptions and evidential matter that the Company had used in capitalization of software development costs during 2003 and 2004 did not provide sufficient “contemporaneous documentation” to support capitalization.

The primary impact of the restatement on the consolidated balance sheets at December 31, 2004 and at June 30, 2005 was to decrease the capitalized software asset and increase the accumulated deficit by $465,000. For the quarter and the six months ended June, 2005 there was no effect on loss from operations, net loss or net loss per share. There was also no effect to cash balances or cash flows for the six months ended June 30, 2005. The impact of the restatement on the consolidated statement of operations for the quarter and the six months ended June, 2004 was an increase in the loss from operations and the net loss of $109,000, with no change to net loss per share. Net cash used in operating activities increased by $152,000 and net cash used in investing activities decreased by the same amount for the six months ended June 30, 2004, with no effect to cash balances. The impact of the restatement on the consolidated financial statements as of December 31, 2004 and as of and for the quarter and the six months ended June 30, 2004 is shown in the tables in Note 1 to the consolidated financial statements in Part I, Item 1 of this report.

FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. In many but not all cases you can identify forward-looking statements by words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will” and “would” or the negative of these terms or other similar expressions. These forward-looking statements include statements regarding our expectations, beliefs, or intentions about the future, and are based on information available to us at this time. We assume no obligation to update any of these statements and specifically decline any obligation to update or correct any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Actual events and results could differ materially from our expectations as a result of many factors, including those identified in 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 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. Additional factors are discussed in the Company’s 2004 Annual Report on Form 10-K and its other reports filed with the SEC, to which reference should be made.

Overview

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. 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.”

In the course of our business, we provide the following products and services:

·	*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;

·	*Storage-related engineering and consulting services*;

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

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

We refer to these first three products and services as our “storage solutions” business and the fourth item as our “geospatial” or “EarthWhere” business.

Second Quarter 2005 Financial Overview

In evaluating our current financial operating performance, we believe, based on feedback from investors, analysts and other users of the Company’s financial information, that earnings before interest, taxes, depreciation and amortization (“EBITDA”) is an appropriate and important financial measure. Since EBITDA is a non-GAAP measure, reconciliations of EBITDA losses to our reported net losses for the June 2005 and 2004 quarters and the six months ended June 30, 2005 and 2004 are provided below.

Reconciliation of Net loss to EBITDA loss	Three Months Ended June 30							Six Months Ended June 30
(In thousands)		2005			2004			2005			2004
					As restated						As restated
Net loss	$	(1,560	)	$	(1,572	)	$	(3,073	)	$	(2,056	)

Interest expense and related charges
Interest expense		405			285			752			574
Charge for warrants issued to related party for debt guaranty		520			--			1,569			--
Depreciation and amortization		325			357			680			668
Income tax benefit		--			(355	)		--			(344	)

EBITDA loss	$	(310	)	$	(1,285	)	$	(72	)	$	(1,158	)

For the quarter ended June 30, 2005, our loss from operations was $636,000 as compared to $1,531,000 for the quarter ended June 30, 2004. This represents a 58% decrease quarter over quarter and is primarily a result of the cost reductions taken in our storage solutions business during the second half of 2004, despite a revenue decrease of approximately $2.5 million for this business unit quarter over quarter. This revenue decrease was primarily attributable to a $4.5 million order that was expected in May 2005, but was delayed due to additional testing requirements by the customer. We received this order in July 2005.

Revenue from software sales and services from our EarthWhere software business unit increased from $149,000 in the June 2004 quarter and $283,000 in the March 2005 quarter to $721,000 in the June 2005 quarter, increases of 383% and 154%, respectively. Gross profit less direct operating expense and allocated corporate general and administrative expense for EarthWhere for these same periods were $(374,000), $(244,000) and $120,000, respectively. This improvement in the June 2005 quarter was achieved even as we continued to increase spending on business development, sales, marketing and technical development in support of our growth objectives for this part of our business.

For the June 2005 quarter, revenue from our storage solutions consulting and engineering services (“professional services”) increased 8% over the June 2004 quarter. The majority of this increase was in the Federal government sector, where we continue to see most of our new significant professional services opportunities. Additionally, our storage solutions maintenance services revenue (our “first call” maintenance service agreements) grew substantially at 41% quarter over quarter. Growing both professional and maintenance services we believe are critical elements in our drive to improve overall gross margin performance in our storage solutions business. During the quarter, we added another original equipment manufacturer (“OEM”) supplier, Sun Microsystems, to our list of OEMs for whose products we are authorized to provide first call maintenance services.

For the June 2005 quarter, we recognized record revenue of $721,000 from our EarthWhere products and services business. Software license sales and related services revenue totaled $624,000 for the quarter, compared to $115,000 in the June 2004 quarter, a five-fold increase. We continued to expand our business development activity and make significant progress in several accounts at large Federal agencies, most of which we expect will provide revenue in 2005. Additionally, during the June 2005 quarter, we completed a software and service sale to a state agency. We believe that state agencies represent an additional market opportunity. Our product and service offering continues to be well received and we expect to invest further resources to take advantage of the market opportunities.

Results of Operations

Selected Consolidated Statements of Operations Data

The following tables present Consolidated Statements of Operations data for the three months and six months ended June 30, 2005 and June 30, 2004 based on the percentage of revenue for each line item, as well as the dollar and percentage change of each of the items.

Results of Operations for the Three Months Ended June 30, 2005

Compared to the Three Months Ended June 30, 2004

(In thousands, except for percentages)	For the three months ended June 30,											$ Change		% Change
		2005		% of rev			2004		% of rev			2004 - 2005		2004 - 2005
Revenue							As restated
Product sales and vendor supplied services	$	9,549		71.9	%	$	12,370		81.1	%	$	(2,821	)	(22.8	)%
Consulting and engineering services		1,187		8.9			997		6.5			190		19.1
Maintenance services and contract fees		2,537		19.1			1,881		12.3			656		34.9
Total Revenue		13,273		100.0			15,248		100.0			(1,975	)	(13.0	)

Gross Profit (% of respective revenue)
Product sales and vendor supplied services		2,036		21.3			1,947		15.7			89		4.6
Consulting and engineering services		461		38.8			429		43.0			32		7.5
Maintenance services and contract fees		710		28.0			622		33.1			88		14.1
Total Gross Profit		3,207		24.2			2,998		19.7			209		7.0

Operating expenses
Selling, general and administrative		3,518		26.5			4,172		27.4			(654	)	(15.7	)
Depreciation and amortization		325		2.4			357		2.3			(32	)	(9.0	)
Total operating expenses		3,843		28.9			4,529		29.7			(686	)	(15.1	)

Loss from operations		(636	)	(4.8	)		(1,531	)	(10.0	)		895		(58.5	)

Other income (expense)
Interest expense		(405	)	(3.1	)		(285	)	(1.9	)		(120	)	42.1
Charge for warrants issued to related party for debt guaranty		(520	)	(3.9	)		--		0.0			(520	)	100.0
Other income (expense)		1		(0.0	)		244		1.6			(243	)	(99.6	)

Net loss	$	(1,560	)	(11.8	)%	$	(1,572	)	(10.3	)%	$	12		(0.8	)%

Revenue. Our sales of products (hardware and software) and vendor supplied services decreased from the second quarter of 2004 to the second quarter of 2005. This decrease is primarily due to the timing of a $4.5 million Federal order, which was expected in the second quarter but was not received until July, 2005, due to additional customer testing requirements.

Revenue from professional services increased by nearly 20% from the second quarter of 2004 to the second quarter of 2005, and as a percentage of total revenue, increased approximately 35%. The increase from the June 2004 quarter is primarily a result of growth in our consulting and engineering services in our Federal government storage solutions and EarthWhere businesses.

Revenue from maintenance services and maintenance contract fees (“first call” maintenance services and the resale of vendor maintenance contracts) increased by 35% from the second quarter of 2004 to the second quarter of 2005, and as a percentage of total revenue, increased approximately 55%. These increases reflect our continued growth in both the first call maintenance services and maintenance service renewals sectors.

Gross Profit and Margin. Despite lower revenue compared to the prior year, gross profit for the quarter ended June 30, 2005 was up compared to the same period of the prior year. Of the $209,000 increase in gross profit, $388,000 (unfavorable) was due to decreased revenue, offset by $597,000 (favorable) attributable to a higher gross margin percentage (“gross margin”) in the second quarter of 2005 as compared to the second quarter of 2004. As we are a project business, gross margins fluctuate from project to project, and, as a result, depending on mix, may fluctuate from quarter to quarter.

Gross margin increased from 19.7% in the June 2004 quarter to 24.2% in the June 2005 quarter. Gross margins on product sales and vendor supplied services were higher in the June 2005 quarter, primarily from a favorable product mix. Increased sales of EarthWhere™ software licenses ($391,000 in 2005 and $-0- in 2004) contributed to the improved gross margin in the June 2005 quarter. Gross margin on consulting and engineering services was lower in 2005, primarily due to the utilization of outside contractors on a significant Federal government storage solutions project. The maintenance revenue gross margins decreased in the second quarter of 2005 compared to the second quarter of 2004 in part due to a lower percentage of sales of vendor maintenance contracts, which are reported on a net revenue basis.

Operating Expenses. Operating expenses comprise selling, marketing, engineering, and general and administrative (“SG&A”) expenses, as well as depreciation and amortization expense. For the three months ended June 30, 2005, SG&A expenses decreased more than 15% as compared to the same period of the prior year. This decrease is the result of cost reduction efforts in SG&A expense that we made in our storage solutions business, which came primarily from employee reductions and three office closures. These reductions were implemented in the second half of 2004. This decrease was achieved even as we significantly increased our investment in expanding our geospatial software business. Our average headcount for the June 2005 quarter was 112, of which 19 were employed in our geospatial business, as compared to average headcount for the June 2004 quarter, which was 118, of which 8 were dedicated to our geospatial business.

Depreciation and amortization expense for the second quarter of 2005 decreased as compared to 2004, due in part to the completion of amortization of certain intangible assets acquired as part of the Solunet Storage acquisition in 2003.

Interest Expense. Interest expense for the second quarter of 2005 increased approximately 42% compared to the second quarter of 2004. The increase is due to higher average borrowings in 2005 as well as to higher interest rates, which increased on average by nearly 2 points in the second quarter of 2005 compared to the second quarter of 2004. Average debt outstanding for the second quarter of 2005 was $17.1 million as compared to $15.6 million for the second quarter of 2004.

Charge for Warrants issued to Related Party for Debt Guaranty. In May and June 2005 and in consideration for our Harris debt guaranty provided by Sun Capital II, an affiliate of our majority shareholder, Sun Solunet, we were obligated to issue and issued to Sun Solunet two stock purchase warrants for a total of 2,244,522 and 480,969 shares of our common stock, respectively, with an exercise price of $0.001 per share. These warrants were immediately exercisable upon issuance. Based on the number of shares issued pursuant to the warrants, we recorded non-cash charges aggregating approximately $520,000, calculated as the number of shares issued multiplied by the closing market price of SANZ’ common stock as of May 16, 2005 and June 3, 2005, the dates of issuance of the respective warrants. See further discussion regarding the debt guaranty warrant issued in the discussion of “—Liquidity and Capital Resources” below.

Results of Operations for the Six Months Ended June 30, 2005

Compared to the Six Months Ended June 30, 2004

(In thousands, except for percentages)	For the six months ended June 30,										$ Change			% Change
		2005		% of rev			2004		% of rev			2004 - 2005			2004 - 2005
Revenue							As restated
Product sales and vendor supplied services	$	21,784		75.7	%	$	26,327		82.0	%	$	(4,543	)		( 17.3	)%
Consulting and engineering services		2,444		8.5			2,002		6.2			442			22.1
Maintenance services and contract fees		4,561		15.8			3,758		11.7			803			21.4
Total Revenue		28,789		100.0			32,087		100.0			(3,298	)		(10.3	)

Gross Profit (% of respective revenue)
Product sales and vendor supplied services		4,678		21.5			4,920		18.7			(242	)		(4.9	)
Consulting and engineering services		972		39.8			868		43.4			104			12.0
Maintenance services and contract fees		1,335		29.3			1,174		31.2			161			13.7
Total Gross Profit		6,985		24.3			6,962		21.7			23			0.3

Operating expenses
Selling, general and administrative		7,053		24.5			8,012		25.0			(959	)		(12.0	)
Depreciation and amortization		680		2.4			668		2.1			12			1.8
Total operating expenses		7,733		26.9			8,680		27.1			(947	)		(10.9	)

Loss from operations		(748	)	(2.6	)		(1,718	)	(5.4	)		970			(56.5	)

Other income (expense)
Interest expense		(752	)	(2.6	)		(574	)	(1.8	)		(178	)		31.0
Charge for warrants issued to related party for debt guaranty		(1,569	)	(5.4	)		--		0.0			(1,569	)		100.0
Other income (expense)		(4	)	(0.0	)		236		0.7			(240	)		(101.7	)

Net loss	$	(3,073	)	(10.7	)%	$	(2,056	)	(6.4	)%	$	(1,017	)		49.5	%

Revenue. Our sales of products (hardware and software) and vendor supplied services decreased from the first half of 2004 to the first half of 2005. This decrease is primarily due to the timing of a $4.5 million order, which was expected in the second quarter but was not received until July, 2005, due to additional customer testing requirements.

Revenue from professional services increased by 22% from the first half of 2004 to the first half of 2005, and as a percentage of total revenue, increased approximately 35%. This increase from the first half of 2004 was primarily a result of growth in our consulting and engineering services in our Federal government storage solutions and EarthWhere businesses.

Revenue from maintenance services and maintenance contract fees (“first call” maintenance services and the resale of vendor maintenance contracts) increased by 21% from the first half of 2004 to the first half of 2005, and as a percentage of total revenue, increased approximately 35%. These increases reflect our continued growth in both the first call maintenance services and maintenance service renewals sectors.

Gross Profit and Margin. Despite lower revenue compared to the prior year, gross profit for the six months ended June 30, 2005 was up compared to the same period of the prior year. Of the $23,000 increase in gross profit, $716,000 (unfavorable) was due to decreased revenue, offset by $739,000 (favorable) attributable to a higher gross margin in the first half of 2005 as compared to the first half of 2004. As we are a project business, gross margins fluctuate from project to project, and, as a result, depending on mix, may fluctuate from quarter to quarter.

Gross margin increased from 21.7% in the six months ended June 2004 to 24.3% in the six months ended June 2005. Gross margins on product sales and vendor supplied services were higher in 2005, primarily from a favorable product mix. Increased sales of EarthWhere™ software licenses ($506,000 in 2005 and $13,000 in 2004) contributed to the improved gross margin in 2005. Gross margin on consulting and engineering services was lower in 2005, primarily due to the utilization of outside contractors on a significant Federal government storage solutions project. The maintenance revenue gross margins decreased in the first half of 2005 compared to the first half of 2004 in part due to a lower percentage of sales of vendor maintenance contracts, which are reported on a net revenue basis.

Operating Expenses. Operating expenses comprise selling, marketing, engineering, and general and administrative (“SG&A”) expenses, as well as depreciation and amortization expense. For the six months ended June 30, 2005, SG&A expenses decreased nearly 12% as compared to the same period of the prior year. This decrease is the result of cost reduction efforts in SG&A expense that we made in our storage solutions business, which came primarily from employee reductions and three office closures. The reductions were implemented in the second half of 2004. This decrease was achieved even as we significantly increased our investment in expanding our geospatial software business.

Depreciation and amortization expense for the first half of 2005 decreased as compared to 2004, due in part to the completion of amortization of certain intangible assets acquired as part of the Solunet Storage acquisition in 2003.

Interest Expense. Interest expense for the first half of 2005 increased approximately 31% compared to the first half of 2004. The increase is due to higher average borrowings in 2005 as well as to higher interest rates, which increased on average by nearly 2 points in the first half of 2005 compared to the first half of 2004. Average debt outstanding for the first six months of 2005 was $16.8 million as compared to $16.4 million for the first six months of 2004.

Charge for Warrants issued to Related Party for Debt Guaranty. In March, May and June 2005 and in consideration for our Harris debt guaranty provided by Sun Capital II, an affiliate of our majority shareholder, Sun Solunet, we were obligated to issue and issued to Sun Solunet three stock purchase warrants for a total of 3,086,218, 2,244,522 and 480,969 shares of our common stock, respectively, with an exercise price of $0.001 per share. These warrants were immediately exercisable upon issuance. Based on the number of shares issued pursuant to the warrants, we recorded non-cash charges which aggregated approximately $1,569,000, calculated as the number of shares issued multiplied by the closing market price of SANZ’ common stock as of March 23, May 16, and June 3, 2005, the dates of issuance of the respective warrants. See further discussion regarding the debt guaranty warrants issued in the discussion of “—Liquidity and Capital Resources” below.

Liquidity and Capital Resources

Liquidity

Our unaudited consolidated financial statements as presented in Part I—Item 1 of this Report have been prepared in conformity with US GAAP (except with regard to omission of certain disclosures within interim financial statements, as permitted by the SEC), which contemplate our continuation as a going concern. However, we have incurred substantial losses from operations since inception, including a net loss of $6.8 million for the year ended December 31, 2004, and a net loss of $3.1 million for the six months ended June 30, 2005. In addition, as of June 30, 2005, we have negative working capital (current liabilities in excess of current assets) of $17.5 million. Accordingly, as of June 30, 2005, the recoverability of a major portion of the recorded asset amounts, including “Goodwill,” is dependent on our continuing operations, which in turn is dependent on our ability to maintain our current financing arrangements and our ability to become profitable in our future operations. Our consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary if we were unable to continue as a going concern.

As of June 30, 2005, we had $73,000 in cash and $3.2 million of undrawn availability on our credit facilities with Wells Fargo and Harris, resulting in total cash and availability of $3.3 million. While availability on our Harris credit facility 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 and complying with financial covenants related thereto.

While the continued efforts to minimize expense, coupled with stabilization or modest increase in revenue and related 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.

Wells Fargo Line of Credit

In March 2005, we amended our $12.0 million credit facility with Wells Fargo. As part of the amendment, Wells Fargo waived our non-compliance on certain financial covenants as of December 31, 2004. In addition, Wells Fargo reset the following financial covenant requirements effective January 1, 2005: (1) minimum net income on a year to date basis, calculated quarterly (see covenants below); (2) minimum net worth plus “subordinated debt” (measured in the aggregate, with amounts loaned to SANZ Inc. and its wholly-owned subsidiary, Solunet Storage, (the Company’s borrowers) from SANZ being defined as subordinated debt), calculated on a monthly basis (see covenants below); (3) minimum average availability of $500,000, calculated monthly; (4) capital expenditure limit of $1,500,000, calculated on an annual basis; and (5) a minimum cash infusion from SANZ or an outside source if SANZ Inc. and its subsidiary, Solunet Storage, generate a net loss in a given quarter and 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.

Period	Minimum Net Income (Operating subsidiaries only)
Three months ending March 31, 2005	$ (300,000)
Six months ending June 30, 2005	(250,000)
Nine months ending September 30, 2005	0
Twelve months ending December 31, 2005	300,000

Period	Minimum Book Net Worth plus Subordinated Debt (Operating subsidiaries only)

March 31, 2005	$ 26,231,447
April 30, 2005	25,845,023
May 31, 2005	25,370,393
June 30, 2005	26,281,447
July 31, 2005	26,041,364
August 31, 2005	25,645,398
September 30, 2005	26,531,447
October 31, 2005	26,277,279
November 30, 2005	25,910,771
December 31, 2005 and each month thereafter	26,831,447

Also, as part of the amended agreement and effective January 1, 2005, Wells Fargo increased the interest rate on our borrowings to prime plus 5.0%, an increase of three points. This rate is subject to potential decreases, as permitted by Wells Fargo, based on SANZ Inc. and its subsidiary, Solunet Storage, achieving certain net income levels during 2005. For the March 2005 quarter, SANZ Inc. and Solunet Storage achieved a minimum net loss threshold and the borrowing rate was reduced to prime plus 4.0%, effective May 1, 2005. Our borrowing rate on this facility at June 30, 2005 was prime plus 4.0% or 10.0%. SANZ Inc. and Solunet Storage did not achieve a minimum net loss threshold for the six months ended June 30, 2005, and as such, effective July 1, 2005, the interest rate on the Company’s borrowings reverted to prime plus 5.0% from prime plus 4.0%.

Harris Credit Facility

On February 16, 2005, we entered into a revised credit agreement with Harris, which increased our availability by $2.0 million, for a total of $10.0 million, and consolidated two credit lines (one maintained by Solunet Storage and one maintained by SANZ) into one facility with SANZ as the sole borrower and guaranteed by Sun Capital II, an affiliate of our majority shareholder, Sun Solunet. On June 3, 2005, we entered into a revised credit agreement with Harris, which increased the facility from $10.0 million to $11.5 million. 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 June 30, 2005, bore interest at a rate of prime plus 1.0% or 7.0%. While the Harris 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 this 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 requires repayment of such debt or, at Sun Capital II’s election, pay the outstanding debt directly to Harris; 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.

Debt Guaranty Warrants

As discussed above, the Harris credit facility term extends until February 2006. Pursuant to the Credit Support Agreement provided by Sun Capital II, until the Company reduces the guaranteed debt to $3.0 million or less, it is required to issue stock purchase warrants at an exercise price of $0.001 to Sun Solunet beginning on November 16, 2004 and continuing at six-month intervals in the future (each May and November). The number of warrants to be issued is dependent on the amount by which the remaining guaranteed debt exceeds $3.0 million, according to formulas applicable to each such date, as disclosed in our 2004 Annual Report on Form 10-K. The issuance of these warrants will result in dilution of the other shareholders of the Company.

As consideration for the Sun Capital II guaranty on the $2.0 million increase in the Harris facility in February 2005, the Company issued on March 23, 2005 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 number of shares underlying the warrant was calculated using the formula applicable to the November 16, 2004 measurement (as if the $2.0 million debt guaranty was in place as of November 16, 2004). This warrant was immediately exercisable and resulted in approximately 3% dilution of the other shareholders of the Company. Based on the number of underlying shares issued pursuant to the warrant, the Company recorded in the March 2005 quarter a charge of $1.1 million, calculated as the number of shares issued under the warrant multiplied by the closing market price of SANZ’ common stock on the issuance date.

Cash and Cash Flows

Our cash and cash equivalents decreased from $486,000 at December 31, 2004 to $73,000 at June 30, 2005. For the six months ended June 30, 2005, we used $0.4 million of cash in operating activities, compared to $2.1 million used in the same period of 2004. Significant uses of cash from operations for the six months ended June 30, 2005 were: (1) the net loss incurred for the period of $3.1 million, less a $1.6 million non-cash charge related to a warrant issued to Sun Solunet, discussed above; (2) a decrease in our accounts payable of $1.3 million primarily as a result of the lower customer billings, offset by approximately $0.3 million of prepaid external professional services on a large Federal storage solutions order and the timing of payments to suppliers at the end of the June 2005 quarter; (3) an increase in prepaid expenses, primarily related to external professional services noted above; and (4) a decrease in accrued expenses related to payments in 2005 for severance and office lease commitments accrued as of December 31, 2004. Our significant source of cash from operations was a decrease in our accounts receivable of $2.5 million, due primarily to lower customer billings for the month of June 2005 compared to the month of December 2004.

Cash used in investing activities for the first six months of 2005 was comprised of purchases of equipment of $161,000 and capitalized software costs of $497,000. Cash provided by financing activities for the first three months of 2005 consisted of net payments of $3.2 million on our Wells Fargo line of credit as a result of a lower accounts receivable borrowing base at June 30, 2005 as compared to December 31, 2004, and additional borrowings of $3.8 million on our Harris credit facility as a result of the lower borrowing availability on our Wells Fargo facility.

Capital Resources

We anticipate our capital expenditures for property and equipment for the remainder of 2005 to be in the range of $50,000 to $75,000 per quarter ($200,000 to $300,000 annually), consistent with the first six months’ expenditures of $161,000. In addition, we will continue to capitalize the development of our EarthWhere™ software products, which we anticipate will be approximately $250,000 per quarter for the remainder of 2005, consistent with the $497,000 capitalized during the first six months of the year. We expect to fund these capital expenditures from cash, either from operations or line of credit borrowings.

Contractual Obligations

There were no material changes in our contractual obligations, excluding bank debt obligations, during the second quarter of 2005.

Critical Accounting Policies

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. We have not adopted any material changes to our critical accounting policies from those discussed under this heading in our 2004 Annual Report on Form 10-K/A.

Recent Accounting Pronouncements

In December 2004, the FASB issued 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. Under SFAS 123R, the Company was required to adopt SFAS 123R at the beginning of its third quarter of 2005. In April 2005, the SEC postponed the required adoption of SFAS 123R until the beginning of fiscal years starting after June 15, 2005, which for SANZ will be effective beginning January 1, 2006.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risk from changes in interest rates on our outstanding bank debt. At June 30, 2005, we had $15.1 million in variable, prime rate based bank debt. At June 30, 2005, our Harris debt of $11.5 million bore interest at the rate of prime plus 1.0% (or 7.0%) and our Wells Fargo line of credit of $3.6 million bore interest at the rate of prime plus 4.0% (or 10.0%). At June 30, 2005, a hypothetical 100 basis point increase in the prime rate would result in additional interest expense of $151,000 on an annualized basis, assuming estimated borrowing amounts of $11.5 million for Harris and $3.6 million for Wells Fargo. Currently, we do not utilize interest rate swaps or other types of financial derivative instruments.

Item 4. Controls and Procedures

We have adopted and maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act, is recorded, processed, summarized and reported within the time periods required under the SEC’s rules and forms and that the information is gathered and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

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. This evaluation included consideration of the restatements described in Note 1 to the Company’s unaudited consolidated financial statements included in Part I, Item 1 of this report further described below. 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.

As previously disclosed on our Current Report on Form 8-K filed on November 17, 2005, during the September 2005 quarter, we initiated a project to prepare stand-alone financial statements for audit of our EarthWhere business. As we undertook this project, we determined that the assumptions and evidential matter that the Company had used in capitalization of software development costs during 2003 and 2004 did not provide sufficient “contemporaneous documentation” to support capitalization.

As disclosed in Note 1 to the Company’s unaudited consolidated financial statements included in Part I, Item 1 of this report, the Company is restating its financial statements for December 31, 2004 and the interim financial statements as of and for the quarter and six months ended June 30, 2004, as of and for the quarter and nine months ended September 30, 2004, for the quarter ended December 31, 2004 and as of March 31, 2005 and June 30, 2005. Management believes that the control deficiency of insufficient contemporaneous documentation to support capitalization of software development costs that led to this restatement is a “significant deficiency,” as defined under standards established by the Public Companies Accounting Oversight Board. Management has reported this significant deficiency to the audit committee in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. Management believes that it has corrected this significant deficiency by reviewing and revising our methodologies and assumptions for capitalizing software development costs and providing contemporaneous documentation for such costs.

Other than the corrective actions described above, we have not made any changes in our disclosure controls and procedures or in other factors that could have materially affected or are reasonably likely to materially affect those disclosure controls and procedures subsequent to the date of the evaluation described above.

Part II. Other Information

Item 6. Exhibits

(a)		Exhibits. The following exhibits are filed with this Form 10-Q:

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).
31.01		CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

SIGNATURES

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


	SAN Holdings, Inc. (Registrant)

Date: December 16, 2005	By:	/s/ John Jenkins
		John Jenkins, Chief Executive Officer



Date: December 16, 2005	By:	/s/ Robert C. Ogden
		Robert C. Ogden, Chief Financial Officer
		(Principal Financial and Accounting Officer

San (SNZH) Inactive 10-Q/A2005 Q2 Quarterly report (amended)