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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

For the transition period from ____________________ to ____________________.

Commission File Number 0-16423

SAN Holdings, Inc.
(Exact name of registrant as specified in its charter)

9800 Mt. Pyramid Ct., Suite 130, Englewood, CO 80112-2694
(Address of principal executive offices)

(303) 660-3933
(Registrant’s telephone number, incluiding 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 [   ]

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

As of November 10, 2004, 95,811,278 common shares, no par value per share, were outstanding.

SAN Holdings, Inc.

TABLE OF CONTENTS

2

Part I. Financial Information

Item 1. Financial Statements

SAN Holdings, Inc.
Consolidated Balance Sheets
(In thousands, except for share data)

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

3

SAN Holdings, Inc.
Consolidated Statements of Operations
(Unaudited)
(In thousands, except share and per share data)

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

4

SAN Holdings, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

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

5

SAN Holdings, Inc.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
(In thousands)

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

6

SAN Holdings, Inc.
Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or 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-KSB for the year ended December 31, 2003.

Effective April 1, 2003, SAN Holdings, Inc. (“SANZ”) completed a business combination with Solunet Storage Holding Corp. (“Solunet Storage”) and, indirectly, its operating subsidiary Solunet Storage, Inc. (d/b/a “StorNet Solutions”). Solunet Storage was majority-owned by Sun Solunet LLC (“Sun Solunet”), an affiliate of Sun Capital Partners, Inc. (“Sun Capital”), a private investment 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 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 statements presented in this Quarterly 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. Accordingly, the information presented in the Statement of Operations and the Statement of Cash Flows for the nine months ended September 30, 2003 consist of the results of operations and cash flows of Solunet Storage only for the period from January 1 to March 31, 2003, and of the combined entity (Solunet and SANZ) from April 1, 2003 to September 30, 2003.

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 $5,938,000 for the year ended December 31, 2003, and a net loss of $2,145,000 for the nine months ended September 30, 2004. In addition, as of September 30, 2004, we have negative working capital (current liabilities in excess of current assets) of $14,293,000. Accordingly, as of September 30, 2004, 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.

We completed the business combination with Solunet Storage on April 1, 2003, described in Note 1, to achieve the economies that we believe are available by spreading our fixed cost base across a greater volume of sales. As anticipated, we have achieved cost reductions afforded by the combination, chiefly, the reduction of selling, general and administrative (“SG&A”) expenses. For the three months ended September 30, 2004, these expenses were lower by $43,000 as compared to the three months ended September 30, 2003. However, it should be noted that the SG&A expenses for the September 2004 quarter included approximately $250,000 of severance and related expense for personnel terminated in this quarter. More importantly, and as evidence to previous disclosures regarding operating expense reductions, the September 2004 quarter SG&A expenses of $3,821,000 (which includes the aforementioned $250,000 of severance and related expense) reflect a decrease of $320,000 from the June 2004 quarter SG&A expenses of $4,141,000, and a decrease of $1,369,000 from the June 2003 quarter (the first quarter following the SANZ-Solunet Storage combination), excluding acquisition related costs incurred in the June 2003 quarter. We continue to be “cost-conscious,” and intend to make further cost reductions as appropriate to business conditions.

7

SAN Holdings, Inc.
Notes to Consolidated Financial Statements (Unaudited)

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 September 30, 2004, the Company had $3.7 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. As of September 30, 2004, the Company was in compliance with all of the financial covenants under the Wells Fargo credit agreement. In October 2004, the Company and Wells Fargo agreed to extend the credit facility through May 2007, a two-year extension to the previous agreement. Key revisions under the renewal agreement are: (1) an interest rate reduction from Prime + 5.0% to Prime + 2.0%, (2) an increased advance rate on certain accounts receivable, and (3) amendments to financial covenants regarding Minimum Net Income, Minimum Cash on Hand Plus Availability, and Capital Expenditures, for periods ending September 30, 2004 and thereafter. The Company was in compliance with the revised financial covenants as of September 30, 2004.

Also in 2003, the Company further enhanced its liquidity through two additional revolving credit lines with Harris Trust and Savings Bank (“Harris Trust”). An affiliate of the Company’s majority stockholder has guaranteed both of these credit lines, $6.8 million and $4.2 million, respectively. The $6.8 million facility is maintained by SAN Holdings, Inc. and is unsecured, is not limited by availability under a borrowing base and does not stipulate financial covenants. The second facility is secured by substantially all of the assets of Solunet Storage, is not limited by availability under a borrowing base and does not stipulate financial covenants. While the Harris facilities are demand notes, they both expire in May 2005, unless called earlier by the lender. At September 30, 2004, the Company had borrowed $9.7 million and had $1.3 million of undrawn availability on these two facilities.

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 earnings and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:

8

SAN Holdings, Inc.
Notes to Consolidated Financial Statements (Unaudited)

NOTE 4 – EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is based on the weighted average number of common shares outstanding. 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 35,120,080 and 33,407,637 shares of common stock as of September 30, 2004 and 2003, respectively, have been excluded from the diluted share calculations for the three-month periods ending September 30, 2004 and 2003, respectively, and the nine-month periods ending September 30, 2004 and 2003, respectively, as they were antidilutive as a result of the net losses incurred for all periods presented. Accordingly, basic shares equal diluted shares for all periods presented.

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 our authorized shares of common stock on April 13, 2004 caused all of the Company’s previously outstanding Series B Preferred Stock to convert into common stock at a ratio of 50,000:1, or into a total of 37,403,653 shares of common stock. Following this conversion, and as of April 13, 2004, there are now 95,811,278 shares of common stock outstanding and zero shares of Series B Preferred Stock outstanding.

As discussed in further detail in Note 7 below, the Company expects to issue a stock purchase warrant for approximately 7.7 million shares of SANZ’ common stock to its majority shareholder, Sun Solunet, on November 16, 2004. This warrant is immediately exercisable on a one for one basis into shares of common stock at an exercise price of $0.001, and will result in dilution to our common shareholders of approximately 8.0%.

NOTE 5 – DEBT

In March 2004, the Company amended one of its two revolving credit facilities with Harris Trust, increasing the borrowing availability from $4.8 million to $6.8 million. Borrowing availability on the other Harris credit facility remains at $4.2 million, resulting in aggregate availability under the two facilities of $11.0 million at September 30, 2004. During the nine months ended September 30, 2004, the Company borrowed an additional $1.5 million on the Harris facilities. As a result, the total outstanding debt with Harris Trust at September 30, 2004 was $9.7 million.

In October 2004, the Company and Wells Fargo agreed to extend the Wells Fargo credit facility through May 2007, a two-year extension to the previous agreement. Key revisions under the renewal agreement are: (1) an interest rate reduction from Prime + 5.0% to Prime + 2.0%, (2) an increased advance rate on certain accounts receivable, and (3) amendments to financial covenants regarding Minimum Net Income, Minimum Cash on Hand Plus Availability, and Capital Expenditures, for periods ending September 30, 2004 and thereafter. The Company was in compliance with the revised financial covenants as of September 30, 2004.

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.

NOTE 7 – COMMITMENTS AND CONTINGENCIES

Harris Debt Guaranty Warrants

As discussed in Note 2 above, the Harris Trust debt facility term extends until May 2005. If we do not reduce the amount of the guaranteed debt to $3.0 million by November 16, 2004, in consideration of the guarantees issued to date, we will be obligated to issue additional warrants with an exercise price of $0.001 per share to our majority shareholder, Sun Solunet (an affiliate of which is the guarantor of the Harris Trust debt). The issuance of these warrants will result in dilution of the other shareholders of the Company. The number of warrants to be issued is dependent on the amount by which the remaining guaranteed debt exceeds $3.0 million, according to the following formula:

9

SAN Holdings, Inc.
Notes to Consolidated Financial Statements (Unaudited)

We do not anticipate being able to reduce the guaranteed debt to $3.0 million by November 16, 2004. At this time, we anticipate that the guaranteed debt will be approximately $8.0 million on that date. Based on an $8.0 million balance of guaranteed debt outstanding as of November 16, 2004, we will issue to Sun Solunet a stock purchase warrant for a total of 7,715,545 shares of our common stock on that date. Based on the number of shares issued pursuant to the warrant, the Company expects to record on November 16, 2004 a non-cash 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 a thirty-day average of our common stock price through November 5, we expect this charge in the fourth quarter to be approximately $2.5 million.

The actual guaranteed debt level on November 16, 2004 will depend on a number of variables, including but not limited to:

Until the Company reduces the guaranteed debt to $3.0 million or less, it is 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, as disclosed in our 2003 Annual Report on Form 10-KSB. The warrants required to be issued at those subsequent dates are substantially fewer in number, at any given debt level, than the warrants issuable at November 16, 2004.

Key Employee Termination and Office Closures

Subsequent to September 30, 2004, SANZ finalized a separation agreement regarding its President and Chief Operating Officer, and will record a severance and related charge in the fourth quarter of 2004 of approximate