**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**FORM
      10-Q**





**x**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**FOR
      THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005**


**OR**





** ̈**
            **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 0-28488**







**ZONES,
      INC**


(Exact
      name of registrant as specified in its charter)





**Washington**
            
            **91-1431894**(State
                of Incorporation)
            
            (I.R.S.
                Employer Identification Number)





**1102
                15****th****Street SW, Suite 102****Auburn,
                Washington**
            
            **98001-6509**(Address
                of Principal Executive Offices)
            
            (Zip
                Code)





**(253)
                205-3000**(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  ̈





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Exchange Act).





Yes  ̈ No x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).





Yes  ̈ No x





The
      number of shares of the registrant's Common Stock outstanding as of November
      7,
      2005 was 13,381,389


















**ZONES,
      INC.**





**INDEX**





**PART
      I. FINANCIAL INFORMATION**




Item
                1.
            Consolidated
                Financial Statements:Consolidated
                Balance SheetsSeptember
                30, 2005 and December 31, 2004
            3Consolidated
                Statements of OperationsThree
                and nine months ended September 30, 2005 and 2004
            4Statements
                of Shareholders’ EquityNine
                months ended September 30, 2005
            5Consolidated
                Statements of Cash FlowsNine
                months ended September 30, 2005 and 2004
            6Notes
                to Consolidated Financial
                Statements
            7Item
                2.
            Management’s
                Discussion and Analysis ofFinancial
                Condition and Results of Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            22Item
                4.
            Controls
                and Procedures
            22







**PART
      II. OTHER INFORMATION**




Item
                1.
            Legal
                Proceedings
            22Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            22Item
                6.
            Exhibits
            24Signatures
            24




2
 Index





**Part
      I.**





**Item
                1.**
            **Financial
                Statements**





**ZONES,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(in
      thousands)**





**September
                30,**
            
            **December
                31,****2005**
            
            **2004****(unaudited)****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            3,076
            
            $
            6,457Receivables,
                net of allowance for doubtful accounts of $2,557 and
                $2,666
            
            
            66,054
            
            
            53,903Vendor
                receivables
            
            
            9,686
            
            
            10,035Inventories
            
            
            19,998
            
            
            17,405Prepaid
                expenses
            
            
            1,414
            
            
            958Deferred
                tax asset
            
            
            1,525
            
            
            1,525Total
                current assets
            
            
            101,753
            
            
            90,283Property
                and equipment, net
            
            
            3,557
            
            
            3,951Goodwill
            
            
            5,098
            
            
            5,098Deferred
                tax asset
            
            
            108
            
            
            2,640Other
                assets
            
            
            190
            
            
            172Total
                assets
            
            $
            110,706
            
            $
            102,144**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            48,741
            
            $
            34,250Inventory
                financing
            
            
            8,926
            
            
            14,306Accrued
                liabilities
            
            
            7,253
            
            
            7,331Line
                of credit
            
            
            3,400
            
            
            6,100Notes
                payable to former shareholders of CPCS
            
            
            1,472
            
            
            1,272Total
                current liabilities
            
            
            69,792
            
            
            63,259Notes
                payable, net of current portion
            
            
            26
            
            
            1,307Deferred
                rent
            
            
            1,115
            
            
            1,027Total
                liabilities
            
            
            70,933
            
            
            65,593Commitments
                and contingenciesShareholders'
                equity:Common
                stock
            
            
            37,933
            
            
            38,788Retained
                earnings (deficit)
            
            
            1,840
            
            
            (2,237
            )Total
                shareholders' equity
            
            
            39,773
            
            
            36,551Total
                liabilities and shareholders' equity
            
            $
            110,706
            
            $
            102,144




See
      notes
      to consolidated financial statements




3
 Index





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF
      OPERATIONS**


**(in
      thousands, except per share data)**


**(unaudited)**





**Three
                months ended**
              **September
                30,**
            
            **Nine
                months ended**
              **September
                30,******
            
            **2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                sales
            
            $
            152,758
            
            $
            129,829
            
            $
            406,719
            
            $
            367,943Cost
                of sales
            
            
            138,146
            
            
            115,693
            
            
            362,809
            
            
            325,634Gross
                profit
            
            
            14,612
            
            
            14,136
            
            
            43,910
            
            
            42,309Selling,
                general and administrative
            
            
            10,068
            
            
            10,162
            
            
            32,246
            
            
            31,413Advertising
                expenses, net
            
            
            1,607
            
            
            1,634
            
            
            4,747
            
            
            5,218Income
                from operations
            
            
            2,937
            
            
            2,340
            
            
            6,917
            
            
            5,678Interest
                expense
            
            
            206
            
            
            93
            
            
            367
            
            
            277Other
                income
            
            
            (15
            )
            
            (44
            )
            
            (65
            )
            
            (61
            )Other
                expense
            
            
            191
            
            
            49
            
            
            302
            
            
            216Income
                before taxes
            
            
            2,746
            
            
            2,291
            
            
            6,615
            
            
            5,462Provision
                for income taxes
            
            
            1,055
            
            
            889
            
            
            2,538
            
            
            2,118Net
                income
            
            $
            1,691
            
            $
            1,402
            
            $
            4,077
            
            $
            3,344Basic
                earnings per share
            
            $
            0.13
            
            $
            0.10
            
            $
            0.30
            
            $
            0.25Shares
                used in computing basic earnings per share
            
            
            13,398
            
            
            13,452
            
            
            13,407
            
            
            13,594Diluted
                earnings per share
            
            $
            0.12
            
            $
            0.10
            
            $
            0.28
            
            $
            0.23Shares
                used in computing diluted earnings per share
            
            
            14,327
            
            
            14,264
            
            
            14,340
            
            
            14,429




See
      notes
      to consolidated financial statements





4
 Index





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS'
      EQUITY**


**(in
      thousands, except share data)**


**(unaudited)**




Common
                Stock
            
            RetainedShares
            
            Amount
            
            Earnings
            
            TotalBalance,
                January 1, 2005
            
            
            13,507,727
            
            $
            38,788
            
            $
            (2,237
            )
            $
            36,551Purchase
                and retirement of common stock
            
            
            (280,450
            )
            
            (1,094
            )
            
            
            
            
            (1,094
            )Tax
                effect of stock options exercised
            
            
            
            
            
            5
            
            
            
            
            
            5Issuance
                of common stock on exercise of stock options
            
            
            139,921
            
            
            234
            
            
            
            
            
            234Net
                income
            
            
            
            
            
            
            
            
            4,077
            
            
            4,077Balance,
                September 30, 2005
            
            
            13,367,198
            
            $
            37,933
            
            $
            1,840
            
            $
            39,773




See
      notes
      to consolidated financial statements





5
 Index





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**


**(unaudited)**





**Nine
                months ended****September
                30,****2005**
            
            **2004**Cash
                flows from operating activities:Net
                income
            
            $
            4,077
            
            $
            3,344Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
            
            
            1,467
            
            
            1,870Deferred
                taxes
            
            
            2,538
            
            
            2,118(Increase)
                decrease in assets and liabilities:Receivables,
                net
            
            
            (11,803
            )
            
            (1,515
            )Inventories
            
            
            (2,593
            )
            
            (5,900
            )Prepaid
                expenses and other assets
            
            
            (474
            )
            
            (190
            )Accounts
                payable and inventory financing
            
            
            4,519
            
            
            10,911Accrued
                liabilities and deferred rent
            
            
            11
            
            
            (1,180
            )Net
                cash provided by (used in) operating activities
            
            
            (2,258
            )
            
            9,458Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (1,072
            )
            
            (1,721
            )Net
                cash used in investing activities
            
            
            (1,072
            )
            
            (1,721
            )Cash
                flows from financing activities:Net
                change in book overdraft
            
            
            4,591
            
            
            (1,400
            )Net
                change in line of credit
            
            
            (2,700
            )
            
            (5,250
            )Purchase
                and retirement of common stock
            
            
            (1,094
            )
            
            (1,348
            )Proceeds
                from exercise of stock options
            
            
            234
            
            
            26Payments
                of notes payable
            
            
            (1,082
            )
            
            (662
            )Net
                cash used in financing activities
            
            
            (51
            )
            
            (8,634
            )Net
                decrease in cash and cash equivalents
            
            
            (3,381
            )
            
            (897
            )Cash
                and cash equivalents at beginning of period
            
            
            6,457
            
            
            5,180Cash
                and cash equivalents at end of period
            
            $
            3,076
            
            $
            4,283Non-cash
                investing and financing activity:Note
                payable to replace earn-out provision of Corporate PC Source (“CPCS”)
                acquisition
            
            
            
            
            $
            1,200Note
                payable for fixed asset purchase
            
            
            
            
            $
            39Non-cash
                reduction to note payable for purchase price adjustment of
                CPCS
            
            
            
            
            $
            (295
            )




See
      notes
      to consolidated financial statements





6
 Index





**ZONES,
      INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(unaudited)**





**1.**
            **Description
                of Business**





Zones,
      Inc. (the “Company”) is a single-source direct marketing reseller of name-brand
      information technology (“IT”) products to the small to medium sized business
      market, enterprise and public sector accounts, while supporting their legacy
      Mac
      customers. Zones sells through outbound and inbound account executives,
      specialty print and e-catalogs, and the internet. Zones offers more than 150,000
      products from leading manufacturers including 3COM, Adobe, Apple, Cisco, Epson,
      Hewlett Packard, IBM, Kingston, Lenovo, Microsoft, Sony and
      Toshiba.





The
      Company was incorporated in November 1988 as a Washington corporation. The
      Company’s headquarters are located in Auburn, Washington. Buying information is
      available at http://www.zones.com ,
      or by
      calling 800-258-2088. The Company’s investor relations information can be
      accessed online at www.zones.com/IR.





**2.**
            **Summary
                of Significant Accounting
                Policies**





The
      accompanying unaudited consolidated interim financial statements and notes
      have
      been prepared in accordance with the rules and regulations of the Securities
      and
      Exchange Commission and consequently do not include all of the disclosures
      normally required by generally accepted accounting principles for annual
      financial statements.





*Basis
      of Presentation*


In
      the
      opinion of management, the accompanying unaudited consolidated financial
      statements reflect all adjustments (consisting of normal recurring accruals)
      which in the opinion of management are necessary for a fair statement of the
      financial position and operating results for the interim periods presented.
      The
      results of operations for such interim periods are not necessarily indicative
      of
      results for the full year. These financial statements should be read in
      conjunction with the audited financial statements and notes thereto contained
      in
      the Company’s Annual Report on Form 10-K for the year ended December 31, 2004,
      as filed with the Securities and Exchange Commission on March 4, 2005.





*Principles
      of Consolidation*


The
      accompanying consolidated interim financial statements include the accounts
      of
      the Company and its subsidiaries. Intercompany transactions have been eliminated
      in consolidation.





*Goodwill*


In
      accordance with SFAS No. 142,"Goodwill and Other Intangible Assets," goodwill
      will be tested for impairment at least annually, or when events indicate that
      impairment exists. The Company performs the assessment annually on March 31.
      The
      changes in the carrying amount of goodwill for the nine months ended September
      30, 2005, are as follows (in thousands):





Balance
                as of January 1, 2005
            
            $
            5,098Goodwill
                acquired
            
            
            -Impairment
                loss
            
            
            -Balance
                as of September 30, 2005
            
            $
            5,098





The
      Company completed the assessment required by SFAS No. 142 on March 31, 2005,
      and
      determined that its goodwill was not impaired.





*Use
      of Estimates*


The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those estimates.





7
 Index





*Revenue
      Recognition*


The
      Company recognizes revenue on product sales when persuasive evidence of an
      arrangement exists, delivery has occurred, prices are fixed or determinable,
      and
      collectability is probable. The Company considers the point of delivery of
      the
      product to be when the risks and rewards of ownership have transferred to the
      customer. The Company offers limited return rights on its product sales. At
      the
      point of sale, the Company also provides an allowance for sales returns, which
      is established based on historical experience. Amounts billed for shipping
      and
      handling are recorded as revenue. Pursuant to EITF 99-19 “Reporting Revenue
      Gross as a Principal versus Net as an Agent,” when the Company sets prices, has
      inventory risk, and credit risk, revenues are recorded gross. If any of those
      criteria are not present, revenue and cost of sales are recorded net. The
      Company has recorded certain customer initiated transactions on a bill and
      hold
      basis and only recognizes revenue when all criterion of Staff Accounting
      Bulletin 104, “Revenue Recognition” have been met.





*Comprehensive
      Income*


The
      Company has no differences between net income and comprehensive
      income.




8
 Index





*Stock
      Compensation*


The
      Company accounts for its stock option plans by measuring compensation cost
      using
      the intrinsic value based method presented by Accounting Principles Board Option
      No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.
      No compensation cost is reflected in consolidated net income, as all options
      granted under the plans had an exercise price equal to the market value of
      the
      underlying common stock on the date of grant. Had compensation cost for the
      Company’s stock option plans been determined based on the fair value at the
      grant date of the awards, consistent with the provisions of SFAS 123, the
      Company’s net income and income per share would have decreased to the pro forma
      amounts indicated below (in thousands, except per share data):




**Three
                months ended****September
                30,****2005**
            
            **2004**Net
                income - as reported
            
            $
            1,691
            
            $
            1,402Add:Total
                compensation cost included in net income, net of taxLess:Total
                compensation cost determined under fair value based method for all
                awards,
                net of tax
            
            
            (381
            )
            
            (219
            )Net
                income - pro forma
            
            $
            1,310
            
            $
            1,183Basic
                income per share - as reported
            
            $
            0.13
            
            $
            0.10Diluted
                income per share - as reported
            
            $
            0.12
            
            $
            0.10Basic
                income per share - pro forma
            
            $
            0.10
            
            $
            0.09Diluted
                income per share - pro forma
            
            $
            0.09
            
            $
            0.08**Nine
                months ended**
              **September
                30,****2005**
            
            
            **2004**Net
                income - as reported
            
            $
            4,077
            
            $
            3,344Add:Total
                compensation cost included in net income, net of taxLess:Total
                compensation cost determined under fair value based method for all
                awards,
                net of tax
            
            
            (889
            )
            
            (527
            )Net
                income - pro forma
            
            $
            3,188
            
            $
            2,817Basic
                income per share - as reported
            
            $
            0.30
            
            $
            0.25Diluted
                income per share - as reported
            
            $
            0.28
            
            $
            0.23Basic
                income per share - pro forma
            
            $
            0.24
            
            $
            0.21Diluted
                income per share - pro forma
            
            $
            0.22
            
            $
            0.20





The
      fair
      value of each option grant is estimated for the purposes of these pro formas
      on
      the date of grant using the Black-Scholes option-pricing model with the
      following weighted-average assumptions used for grants in 2005 and 2004,
      respectively: expected volatility of 186% and 201%; risk-free interest rate
      of
      3.93% and 3.41%; and expected lives of 5 years.





9
 Index





*Earnings
      Per Share*


Earnings
      per share (“EPS”) is based on the weighted average number of shares outstanding
      during the period. Basic EPS excludes all dilution. Diluted EPS reflects the
      potential dilution that would occur if securities or other contracts to issue
      common stock were exercised or converted into common stock.





*Recent
      Accounting Pronouncements*


In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), a revision of SFAS
      No. 123, “Accounting for Stock-Based Compensation.” SFAS 123R will require
      the Company to, among other things, measure all employee stock-based
      compensation awards using a fair value method and record such expense in the
      Company’s consolidated financial statements. The provisions of SFAS 123R are
      effective for the first annual reporting period that begins after June 15,
      2005; therefore, the Company will adopt the new requirements beginning January
      1, 2006. Adoption of the expensing requirements will reduce the Company’s
      reported earnings. Management is currently evaluating the specific impacts
      of
      adoption.





**3.**
            **Earnings
                Per Share**





The
      Company has 45,000,000 common shares authorized as of September 30, 2005. The
      Company has granted options to purchase common shares to team members and
      directors of the Company. Certain options have a dilutive effect on the
      calculation of earnings per share. The following is a reconciliation of the
      numerators and denominators of the basic and diluted earnings per share
      computations (in thousands, except per share data).





**Three
                months ended September 30,**
            
            **Nine
                months ended September 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004****Basic
                earnings per share:**Net
                income
            
            $
            1,691
            
            $
            1,402
            
            $
            4,077
            
            $
            3,344Weighted
                average shares outstanding
            
            
            13,398
            
            
            13,452
            
            
            13,407
            
            
            13,594Basic
                earnings per share
            
            $
            0.13
            
            $
            0.10
            
            $
            0.30
            
            $
            0.25**Diluted
                earnings per share:**Net
                income
            
            $
            1,691
            
            $
            1,402
            
            $
            4,077
            
            $
            3,344Weighted
                average shares outstanding
            
            
            13,398
            
            
            13,452
            
            
            13,407
            
            
            13,594Stock
                options
            
            
            929
            
            
            812
            
            
            933
            
            
            835Total
                common shares and dilutive securities
            
            
            14,327
            
            
            14,264
            
            
            14,340
            
            
            14,429Diluted
                earnings per share
            
            $
            0.12
            
            $
            0.10
            
            $
            0.28
            
            $
            0.23





For
      the
      three and nine months ended September 30, 2005, 547,299 and 547,499 shares,
      respectively, were attributable to outstanding stock options that were excluded
      from the calculation of diluted earnings per share because their effect was
      anti-dilutive. For the three and nine months ended September 30, 2004, 1,374,198
      and 1,574,198 shares, respectively, were attributable to outstanding stock
      options that were excluded from the calculation of diluted earnings per share
      because their effect was anti-dilutive.





**4.**
            **Commitments
                and Contingencies**





*Legal
      Proceedings*


From
      time
      to time, the Company is a party to various legal proceedings, claims, disputes
      and litigation arising in the ordinary course of business, some of which may
      involve material amounts. The Company currently believes that the ultimate
      outcome of any of these proceedings, individually or in the aggregate, will
      not
      have a material adverse effect on the Company’s business, financial condition,
      cash flows or results of operations. However, because of the nature and inherent
      uncertainties of litigation, should the outcome of these actions be unfavorable,
      the Company’s business, financial condition, cash flows or results of operations
      could be materially affected.





10
 Index





*Liquidity*


The
      Company believes that its existing available cash and cash equivalents,
      operating cash flow and existing credit facilities will be sufficient to satisfy
      its operating cash needs, as well as principle payments of $1.5 million owed
      to
      the former shareholders of CPCS and up to the remaining balance of $2.7 million
      authorized in the Company’s stock repurchase program which will terminate in
      July 2006 unless renewed, for at least the next 12 months at its current level
      of business. However, if the Company’s working capital or other capital
      requirements are greater than currently anticipated, the Company could be
      required to curtail its stock repurchase program and seek additional funds
      through sales of equity, debt or convertible securities or increased credit
      facilities. There can be no assurance that additional financing will be
      available or that, if available, the financing will be on terms favorable to
      the
      Company and its shareholders.





**5.**
            **Segment
                Information**





In
      fiscal
      years 2003 and 2004, the Company reported its subsidiary, CPCS, and its Zones
      reporting unit as separate segments. On April 1, 2005, the Company merged the
      CPCS subsidiary into the Zones reporting unit. Accordingly, no separate segment
      for this subsidiary currently exists. As of the second quarter of 2005, the
      Company is represented by one reportable segment: a single-source, multi-vendor
      direct marketing reseller of name-brand information technology products to
      small
      to medium sized businesses, enterprise and the public sector markets.





A
      summary
      of the Company’s sales by product mix follows (in thousands):





**Three
                months ended September 30,**
            
            **Nine
                months ended September 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Notebook
                & PDA’s
            
            $
            26,300
            
            $
            16,495
            
            $
            61,736
            
            $
            55,547Desktops
                & Servers
            
            
            25,403
            
            
            25,331
            
            
            82,074
            
            
            73,540Software
            
            
            26,099
            
            
            27,175
            
            
            67,819
            
            
            65,499Storage
            
            
            12,339
            
            
            9,976
            
            
            35,750
            
            
            31,519NetComm
            
            
            6,321
            
            
            6,214
            
            
            16,456
            
            
            16,898Printers
            
            
            24,075
            
            
            11,443
            
            
            47,829
            
            
            34,429Monitors
                & Video
            
            
            12,418
            
            
            14,375
            
            
            38,213
            
            
            38,084Memory
                & Processors
            
            
            6,511
            
            
            6,964
            
            
            20,801
            
            
            18,202Accessories
                & Other
            
            
            13,292
            
            
            11,856
            
            
            36,041
            
            
            34,225





Substantially
      all of the Company’s net sales for the three and nine months ended September 30,
      2005 and September 30, 2004 were made to customers located in the United States.
      All of the Company’s assets at September 30, 2005 and December 31, 2004 were
      located within the United States. The Company had one customer which represented
      over 10% of total sales for the three month period ended September 30, 2005.
      Net
      sales to this customer were $25.6 for the three months ended September 30,
      2005.





**6.**
            **Related
                Party Disclosure**





In
      June
      2004, Fana Auburn LLC, a company owned by an officer and majority shareholder
      of
      the Company, purchased the property and buildings in which the Company’s
      headquarters are located, subject to the Company’s existing 11-year lease. Under
      the terms of the lease agreement, the Company will pay lease payments
      aggregating from $1.0 million to $1.2 million per year, plus certain real estate
      taxes, insurance and common area maintenance charges. For the three and nine
      months ended September 30, 2005 the Company paid Fana Auburn LLC $433,000 and
      $1.3 million, respectively, related to the lease. The Company’s Audit Committee
      reviewed and approved this related party transaction, and also the potential
      corporate opportunity, recognizing that in the future the Company may have
      to
      renew and re-negotiate this lease and that such renewal and re-negotiation
      would
      also present a related party transaction subject to further Audit Committee
      review and consideration.




11
 Index





**7.**
            **Share
                Repurchase Program**





In
      July
      2004, the Board of Directors authorized a share repurchase program under which
      the Company could repurchase up to $3.0 million in shares of the Company’s
      common stock through July 2005 in open market or private transactions at then
      prevailing market prices. Under this repurchase program, the Company purchased
      and retired a total of 650,040 shares of its common stock at a total cost of
      $2.1 million (an average price of $3.27 per share).





In
      July
      2005, the Board of Directors authorized the continuation of the Company’s share
      repurchase program until July 2006. The Company is authorized to repurchase
      up
      to an additional $3.0 million in shares of the Company’s common stock through
      July 2006 in open market or private transactions at then prevailing market
      prices. Under this repurchase program, the Company has purchased and retired
      78,800 shares of its common stock at a total cost of $314,000 (an average price
      of $3.99 per share) during the three month period ended September 30, 2005.





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





The
      matters described below contain forward-looking statements which involve known
      and unknown risks, uncertainties, and other factors that may cause actual
      results, performance, achievements of the Company or industry trends, to differ
      materially from those expressed or implied by such forward-looking statements.
      Forward-looking statements may be identified by the use of forward-looking
      terminology such as “may,” “will,” “expect,” “estimate,” “anticipate,”
“continue,” or similar terms, variations of such terms or the negative of those
      terms, but the absence of such terms does not mean that a statement is not
      forward-looking. Potential risks
      and uncertainties that
      may
      cause actual
      results to
      differ materially from those expressed or implied include, among
      others, those set forth in this document and
      those contained in the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2004, which was filed on March 4, 2005 with the Securities Exchange
      Commission.





As
      used
      in this quarterly report on Form 10-Q, unless the context otherwise requires,
      the terms “the Company” and “Zones” refer to Zones, Inc., a Washington
      corporation.





**General**





The
      Company's net sales consist primarily of sales of computer hardware, software,
      peripherals and accessories, as well as revenue associated with freight billed
      to its customers, net of product returns. Gross profit consists of net sales
      less product and freight costs. Selling, general and administrative ("SG&A")
      expenses include warehousing and distribution costs, selling commissions, order
      processing, telephone and credit card fees and other costs such as
      administrative salaries, depreciation, rent and general overhead expenses.
      Advertising expense is marketing costs associated with vendor programs, net
      of
      vendor cooperative advertising expense reimbursements allowable under EITF
      02-16
“Accounting for Consideration Received from a Vendor by a Customer (Including
      a
      Reseller of the Vendor’s Products).” Other expense represents interest expense,
      net of non-operating income.





**Overview**





Zones,
      Inc. is a direct marketing reseller of technology hardware, software and
      services. The Company procures and fulfills IT solutions to the small to medium
      business (between 50 and 1000 computer users), enterprise customers (greater
      than 1000 computer users) and public sector marketplaces (education and state
      and local governments). Relationships with small to medium sized businesses
      (“SMB”), large enterprise customers and public sector institutions represented
      97.4% and 96.3% of total net sales during the three and nine months ending
      September 30, 2005, respectively. The remaining sales were from inbound
      customers, generally defined as consumers and small office/home office accounts
      purchasing primarily Mac platform products.





The
      Company reaches its customers through an integrated marketing and merchandising
      strategy designed to attract and retain customers. This strategy involves a
      relationship-based selling model utilizing outbound account executives;
      customized web stores for corporate customers through ZonesConnect, a state
      of
      the art internet portal at www.zones.com ;
      dedicated e-marketing; and direct marketing vehicles and catalogs for demand
      response opportunities and corporate branding.





12
 Index





The
      Company utilizes its purchasing and inventory management capabilities to support
      its primary business objective of providing name brand products at competitive
      prices. The Company offers over 150,000 hardware, software, peripheral and
      accessory products and services for users of PC and Mac platform computers
      from
      over 2,000 manufacturers.





The
      management team regularly reviews the Company’s performance using a variety of
      financial and non-financial metrics including, but not limited to, net sales,
      gross margin, co-op advertising reimbursements, advertising expenses, personnel
      costs, productivity per team member, average order size, accounts receivable
      aging, inventory turnover, liquidity and cash resources.   Management
      compares these various metrics against goals and budgets and takes appropriate
      action to enhance Company performance.





The
      Company is dedicated to creating a learning community of empowered individuals
      to serve its customers with integrity, commitment and passion. At September
      30,
      2005, the Company had 589 team members in its consolidated operations; 270
      of
      whom were inbound and outbound account executives. The majority of the Company’s
      team members work at its corporate headquarters in Auburn, Washington.





Additional
      information is available free of charge on the Company’s website at www.zones.com/IR .





**Critical
      Accounting Policies**





In
      Item 7
      (“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations”) of our Annual Report on Form 10-K for the year ended December 31,
      2004, which was filed with the Securities and Exchange Commission on March
      4,
      2005, the Company included a discussion of the most significant accounting
      policies and estimates used in the preparation of its financial statements.
      There has been no material change in the policies and estimates used by the
      Company in the preparation of its financial statements since the filing of
      the
      most recent annual report.




13
 Index





**Results
      of Operations**





The
      following table presents the Company’s unaudited consolidated results of
      operations, as a percentage of net sales, and selected operating data for the
      periods indicated.





**Three
                months ended September 30,**
            
            **Nine
                months ended September 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of sales
            
            
            90.4
            
            
            89.1
            
            
            89.2
            
            
            88.5Gross
                profit
            
            
            9.6
            
            
            10.9
            
            
            10.8
            
            
            11.5Selling,
                general and administrative expenses
            
            
            6.6
            
            
            7.8
            
            
            7.9
            
            
            8.5Advertising
                expenses, net
            
            
            1.1
            
            
            1.3
            
            
            1.2
            
            
            1.4Income
                from operations
            
            
            1.9
            
            
            1.8
            
            
            1.7
            
            
            1.6Other
                expense
            
            
            0.1
            
            
            0.0
            
            
            0.1
            
            
            0.1Income
                before income taxes
            
            
            1.8
            
            
            1.8
            
            
            1.6
            
            
            1.5Provision
                for income taxes
            
            
            0.7
            
            
            0.7
            
            
            0.6
            
            
            0.6Net
                income
            
            
            1.1
            %
            
            1.1
            %
            
            1.0
            %
            
            0.9
            %**Selected
                operating data:**Number
                of orders
            
            
            97,000
            
            
            104,000
            
            
            295,000
            
            
            317,000Average
                order size
            
            $
            1,586
            
            $
            1,254
            
            $
            1,407
            
            $
            1,180Sales
                force, end of period
            
            
            270
            
            
            281
            
            
            270
            
            
            281**Product
                Mix (% of Net Sales):**Notebook
                & PDA’s
            
            
            17.2
            %
            
            12.7
            %
            
            15.2
            %
            
            15.1
            %Desktops
                & Servers
            
            
            16.6
            
            
            19.5
            
            
            20.2
            
            
            20.0Software
            
            
            17.1
            
            
            20.9
            
            
            16.7
            
            
            17.8Storage
            
            
            8.1
            
            
            7.7
            
            
            8.8
            
            
            8.6NetComm
            
            
            4.1
            
            
            4.8
            
            
            4.0
            
            
            4.6Printers
            
            
            15.8
            
            
            8.8
            
            
            11.8
            
            
            9.4Monitors
                & Video
            
            
            8.1
            
            
            11.1
            
            
            9.4
            
            
            10.4Memory
                & Processors
            
            
            4.3
            
            
            5.4
            
            
            5.1
            
            
            4.9Accessories
                & Other
            
            
            8.7
            
            
            9.1
            
            
            8.8
            
            
            9.2





*Comparison
      of Three Month Periods Ended September 30, 2005 and 2004*





*Net
      Sales.* Consolidated
      net sales for the quarter ended September 30, 2005 increased 17.7% to $152.8
      million compared to $129.8 million in the third quarter of 2004. The increase
      is
      primarily due to growth in sales to the Company’s enterprise customers, which
      increased 41.0% to $87.7 million from $62.2 million in the prior year. Included
      in the enterprise increase for the three months ended September 30, 2005 was
      a
      major customer IT rollout which increased sales by $25.6 million. These sales
      were for a second half of 2005 rollout and the Company does not believe it
      is
      indicative of future sales to this customer. The Company expects that from
      time
      to time there will be additional opportunities to be selected by enterprise
      customers to fulfill IT rollouts. Consolidated outbound sales (relationship
      based selling) to commercial and public sector customers increased 23.7% to
      $148.8 million in the third quarter of 2005 from $120.3 million in the third
      quarter of 2004. The Company’s focus is on the outbound sales customer who
      responds to a relationship based selling model. Sales by the Company’s inbound
      (demand response selling) departments declined to $4.0 million during the third
      quarter of 2005 compared to $9.5 million for the three months ended September
      30, 2004, and declined as a percent of total sales to 2.6% from 7.3%.





*Gross
      Profit.* Consolidated gross profit increased to $14.6 million for the third quarter
      of
      2005, compared to $14.3 million in the third quarter of 2004. Gross profit
      as a
      percentage of net sales decreased to 9.6% in the quarter ended September 30,
      2005 compared to 10.9% in the third quarter of 2004. The decline is primarily
      due to the Company’s competitive cost concession for the enterprise net sales of
      $25.6 million to a major customer in support of a significant purchase of
      technology products. These sales were for a second half of 2005 rollout and
      the
      Company does not believe it is indicative of future sales to this customer.
      Gross profit margins will continue to vary due to changes in vendor programs,
      product mix, pricing strategies, customer mix and economic conditions. Lastly,
      the Company categorizes its warehousing and distribution network costs in
      selling, general and administrative expenses. Due to this classification, the
      Company’s gross profit may not be comparable to that of a company that includes
      its warehousing and distribution network costs as a cost of sales.





14
 Index





*Selling,
      General and Administrative (“SG&A”) Expenses.* SG&A
      expense dollars decreased slightly to $10.1 million for the quarter ended
      September 30, 2005 compared to $10.2 million in the third quarter of 2004.
      As a
      percent of sales, SG&A was 6.6% for the quarter ended September 30, 2005
      compared to 7.8% for the third quarter of 2004. The Company continues its
      efforts to maintain tight controls on its operational spending, while investing
      in its future through the hiring of account executives.


·
            Salaries,
                wages and benefits decreased $183,000 during the third quarter 2005
                compared to the third quarter of the prior year. The decline is primarily
                due to a decrease in the average salary per team member. This is
                offset by
                the Company’s total headcount increase of 3.2% to 589 team members at
                September 30, 2005 from 571 at September 30, 2004 primarily due to
                staffing the warehouse operations in the Bensenville facility.


·
            Depreciation
                expense declined $111,000 for the three months ended September 30,
                2005
                compared to the same period of the prior year. The decline is due
                to the
                Company’s decision to reduce capital
                expenditures.


·
            State
                tax expense increased by $271,000 for the third quarter 2005 compared
                to
                the same period of the prior year. The increase is primarily due
                to the
                Washington State Department of Revenue tax audit for the tax period
                January 2001 through March 2005.


·
            For
                the period ending September 30, 2005 and 2004, warehousing and
                distribution network costs totaled $559,000 and $484,000 respectively.
                The
                year over year increase is primarily due to the Company’s integration of
                its warehouse operations to its Bensenville, IL facility from a third
                party partner.


·
            Declines
                in other administrative expenses individually are not significant,
                but
                taken as a whole reflect the remaining change in SG&A expense dollars.





*Advertising
      Expenses, net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, as well as engaging in other activities, to increase the awareness of
      its
      brand and as demand response vehicles. The Company's net cost of advertising
      remained flat at $1.6 million in the three month period ended September 30,
      2005, compared to the third quarter of 2004. Net cost of advertising costs
      will
      vary based on available vendor programs.


·
            Gross
                advertising expense decreased to $1.7 million for the third quarter
                of
                2005 compared to $1.8 million in the third quarter of 2004.


·
            The
                Company’s gross advertising reimbursements decreased to $82,000 in third
                quarter of 2005 from $198,000 in the third quarter of 2004. The decline
                is
                primarily due to an increase in the percent of total reimbursements
                categorized as a reduction of cost of
                sales.





*Interest
      Expense.* Interest
      expense was $206,000 for the quarter ended September 30, 2005, compared to
      $93,000 in the third quarter of 2004. The Company’s use of its line of credit to
      fund the expansion of accounts receivable and inventory incurred interest
      expense of $179,000 and $60,000 for the three month periods ended September
      30,
      2005 and 2004, respectively. The remaining expense was due to interest owed
      on
      the outstanding note payable to the former shareholders of CPCS.





*Other
      income, net.* Other
      income was $15,000 for the three months ended September 30, 2005 compared to
      $44,000 at September 30, 2004.





*Provision
      for Income Taxes.* The
      provision for income taxes for the quarter ended September 30, 2005 was $1.1
      million compared to $889,000 in the comparable period of the prior year. The
      Company’s effective tax rate expressed as a percentage of income before taxes
      was 38.4% for the quarter ended September 30, 2005, compared to 38.8% in the
      quarter ended September 30, 2004.





15
 Index





*Net
      Income.* Net
      income for the quarter ended September 30, 2005 was $1.7 million compared to
      $1.4 million in the third quarter of 2004. Basic and diluted income per share
      was $0.13 and $0.12, respectively, for the three months ended September 30,
      2005
      compared to $0.10 and $0.10, respectively, for the quarter ended September
      30,
      2004.





*Comparison
      of Nine Month Periods Ended September 30, 2005 and 2004*





*Net
      Sales.* Consolidated
      net sales for the nine months ended September 30, 2005 increased 10.5% to $406.7
      million compared to $367.9 million in 2004. The increase is primarily due to
      growth in sales to the Company’s enterprise customers, which increased 25.4% to
      $220.8 million from $176.0 million in the prior year. The Company has increased
      its penetration into existing enterprise customer accounts and, the Company’s
      enterprise business was impacted by a major customer during the three months
      ended September 30, 2005 which generated net sales of $25.6 million. These
      sales
      were for a second half of 2005 rollout and the Company does not believe it
      is
      indicative of future sales to this customer. The Company expects that from
      time
      to time there will be additional opportunities to be selected by enterprise
      customers to fulfill IT rollouts. Consolidated outbound sales (relationship
      based selling) to commercial and public sector customers increased 16.7% to
      $391.9 million in the first three quarters of 2005 from $335.9 million in 2004.
      Sales by the Company’s inbound (demand response selling) departments declined to
      $14.8 million during the first nine months of 2005 compared to $32.1 million
      for
      the nine months ended September 30, 2004, and declined as a percent of total
      sales to 3.7% from 8.7%. The Company has continued to reduce its focus on the
      inbound sales customer who are generally consumer and small office/home office
      accounts.





*Gross
      Profit.* Consolidated gross profit increased to $43.9 million for the nine months ended
      September 30, 2005, compared to $42.3 million in 2004. Gross profit as a
      percentage of net sales decreased to 10.8% in the nine months ended September
      30, 2005 compared to 11.5% in 2004. The decline is primarily due to the
      Company’s competitive cost concession for the third quarter 2005 enterprise net
      sales of $25.6 million to a major customer in support of a significant purchase
      of technology products. These sales were for a second half of 2005 rollout
      and
      the Company does not believe it is indicative of future sales to this customer.
      Gross profit margins will continue to vary due to changes in vendor programs,
      product mix, pricing strategies, customer mix and economic conditions. Lastly,
      the Company categorizes its warehousing and distribution network costs in
      selling, general and administrative expenses. Due to this classification, the
      Company’s gross profit may not be comparable to a company that includes its
      warehousing and distribution network costs as a cost of sales.





*SG&A
      Expenses.* SG&A
      expense dollars increased to $32.2 million for the nine months ended September
      30, 2005, compared to $31.4 million in the nine months ended September 30,
      2004.
      As a percent of sales, SG&A was 7.9% for the nine months ended September 30,
      2005 compared to 8.5% for the comparable period of 2004. The Company continues
      its efforts to maintain tight controls on its operational spending, while
      investing in its future through the hiring of account executives.


·
            Salaries,
                wages and benefits increased $893,000 for the first nine months of
                2005
                compared to the same period of the prior year. The Company’s total
                headcount increased 3.2% to 589 team members at September 30, 2005
                from
                571 at September 30, 2004.


·
            State
                taxes and licensing in the first nine months of 2005 increased $384,000
                compared to the same period of the prior year. The increase is due
                to the
                Company’s tax audit with the Washington State Department of Revenue for
                the tax period January 2001 through March 2005, as well as increased
                net
                sales to customers in the state of Washington which, in turn, increased
                the amount of business and occupation tax
                expense.


·
            Professional
                fees increased $243,000 for the first nine months of 2005 compared
                to the
                same period of the prior year. The increase is primarily due to increased
                consulting fees associated with outsourcing the Company’s request for
                proposal and bid process for the public sector. The Company anticipates
                that consulting fees will remain at current levels as it continues
                to
                outsource this function.


·
            Depreciation
                expense decreased $373,000 for the nine months ended September 30,
                2005
                compared to the prior year period. The decline is due to the Company’s
                decision to reduce capital
                expenditures.


·
            For
                the nine month periods ending September 30, 2005 and 2004, warehousing
                and
                distribution network costs totaled $1.6 million and $1.3 million,
                respectively. The year over year increase is primarily due to the
                Company’s integration of its warehouse operations to its Bensenville, IL
                facility from a third party
                partner.


·
            Declines
                in other administrative expenses individually are not significant,
                but
                taken as a whole reflect the remaining change in SG&A expense dollars.





16
 Index





*Advertising
      Expenses, net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, as well as engaging in other activities, to increase the awareness of
      its
      brand and as demand response vehicles. The Company's net cost of advertising
      decreased to $4.7 million in the nine month period ended September 30, 2005
      from
      $5.2 million in the comparable 2004 period. Net cost of advertising will vary
      based on available vendor programs.


·
            Gross
                advertising expense decreased to $5.1 million for the first nine
                months of
                2005 compared to $5.6 million in 2004.


·
            The
                Company’s gross advertising reimbursements decline to $336,000 in the nine
                months ended 2005 from $399,000 in the comparable period of 2004.





*Interest
      Expense.* Interest
      expense was $367,000 for the nine months ended September 30, 2005 compared
      to
      $277,000 in the first nine months of 2004. The Company’s use of its working
      capital line to fund the expansion of accounts receivable and inventory incurred
      interest expense of $276,000 and $180,000 for the nine-month periods ended
      September 30, 2005 and 2004, respectively. The remaining expense was due to
      interest owed on the outstanding note payable to the former shareholders of
      CPCS.





*Other
      income, net.* Other
      income was $65,000 for the nine months ended September 30, 2005 compared to
      $61,000 at September 30, 2004. The increase was primarily due to increased
      finance charges collected from certain customers.





*Provision
      for Income Taxes.* The
      provision for income taxes for the nine months ended September 30, 2005 was
      $2.5
      million compared to $2.1 million in the comparable period of the prior year.
      The
      Company’s effective tax rate expressed as a percentage of income before taxes
      was 38.4% for the nine months ended September 30, 2005, compared to 38.8% in
      the
      comparable period of 2004.





*Net
      Income.* Net
      income for the nine months ended September 30, 2005 was $4.1 million compared
      to
      $3.3 million in the first nine months of 2004. Basic and diluted income per
      share was $0.30 and $0.28, respectively, for the nine months ended September
      30,
      2005 compared to $0.25 and $0.23, respectively, for the nine months ended
      September 30, 2004.





**Liquidity
      and Capital Resources**





As
      of
      September 30, 2005, the Company had total assets of $110.7 million, of which
      $101.8 million were current assets. At
      September 30, 2005 and December 31, 2004 the
      Company had cash and cash equivalents of $3.1 million and $6.5 million,
      respectively. The Company utilized its cash position to reduce the amounts
      due
      under its working capital line of credit. The Company’s working capital was
      $32.0 million and $27.0 million at September 30, 2005 and December 31, 2004,
      respectively.





Net
      cash
      used by operating activities was $2.3 million for the nine months ended
      September 30, 2005 compared to net cash provided by operating activities of
      $9.5
      million for the nine months ended September 30, 2004. The primary factors that
      affected current year cash flow from operations were account and vendor
      receivables, accounts payable and inventory financing, and inventories. Account
      and vendor receivables increased $11.8 million. This is offset by the balance
      in
      accounts payable and inventory financing increase of $4.5 million. The accounts
      payable and inventory financing balance change is due to purchasing and payment
      cycles. Inventories increased $2.6 million. The Company’s inventory turnover
      increased to 31 days at September 30, 2005 from 26 at December 31, 2004.
      Included in inventory at September 30, 2005, was $1.4 million of
      inventories not available for sale at September 30, 2005 that represent
      inventories segregated pursuant to binding customer contracts, which will be
      recorded as net sales when the criteria for sales recognition are met.





Net
      cash
      used in investing activities for the nine months ended September 30, 2005 was
      $1.1 million. Cash outlays for capital expenditures were $1.1 million and $1.7
      million for the nine months ended September 30, 2005 and 2004, respectively.
      The
      2005 capital expenditures were primarily for leasehold improvements for the
      Company’s corporate headquarters and continued improvement, and other
      enhancements, of the Company’s information systems. The Company intends to
      continue to upgrade its internal information systems as a means to increase
      operational efficiencies. The capital expenditures during the first nine months
      of 2004 were primarily for leasehold improvements for the Company’s new
      corporate headquarters, costs to transition the Company’s warehousing facility
      to its Bensenville, IL facility from a third party vendor and continued
      improvement, and other enhancements, of the Company’s information systems.





17
 Index





The
      Company’s financing activities for the nine months ended September 30, 2005
      included the payment of an amount due on the note payable issued in its
      acquisition of CPCS. The Company paid the former shareholders of CPCS $300,000
      on March 15, 2005 and $771,932 on April 28, 2005. A payment to the former
      shareholders of CPCS of $200,000 is due on October 1, 2005.





The
      Company committed to a stock repurchase program in July of 2004 under which
      the
      Company could repurchase up to $3.0 million in shares of the Company’s common
      stock through July 2005 in either open market or private transactions at then
      prevailing market prices. During the twelve months ended June 30, 2005, the
      Company purchased and retired a total of 650,040 shares of its common stock
      at a
      total cost of $2.1 million (an average price of $3.27 per share). In July 2005,
      the Board of Directors authorized the continuation of the Company’s share
      repurchase program, pursuant to which the Company may repurchase up to an
      additional $3.0 million in shares of the Company’s common stock through July
      2006 in open market or private transactions at then prevailing market prices.
      For the three months ended September 30, 2005, the Company purchased and retired
      78,800 shares of its common stock at a total cost of $314,000 (an average price
      of $3.99 per share).





At
      September 30, 2005, the Company had $40.0 million available under a secured
      line
      of credit with a major financial institution.  The credit facility is
      collateralized by accounts receivable and inventory and can be utilized as
      both
      a working capital line of credit and an inventory financing facility used to
      purchase inventory from several suppliers under certain terms and
      conditions.  This credit facility has an annual automatic renewal which
      occurs on November 26 of each fiscal year. Either party can terminate this
      agreement with 60 days written notice prior to the renewal date.  The
      working capital and inventory financing bear interest at a rate of Prime +
      0.50%. The Company’s line of credit is characterized by quick turnover, large
      amounts and short maturities. All amounts owed under the Company’s line of
      credit are due on demand. Inventory financing does not bear interest if paid
      within terms, usually 30 days from advance date.  The facility contains
      various restrictive covenants relating to tangible net worth, leverage,
      dispositions and use of collateral, other asset dispositions, and merger and
      consolidation of the Company. At September 30, 2005, the Company was compliant
      with all covenants of this facility. At September 30, 2005, there was $3.4
      million of working capital advances outstanding and $8.9 million related to
      inventory purchases.





The
      Company believes that its existing available cash and cash equivalents, 2005
      operating cash flow and existing credit facilities will be sufficient to satisfy
      its operating cash needs, as well as principle payments of $1.5 million owed
      to
      the former shareholders of CPCS and the remaining balance of $2.7 million
      authorized in the Company’s stock repurchase program which will terminate in
      July 2006 unless renewed, for at least the next 12 months at its current level
      of business. However, if the Company’s working capital or other capital
      requirements are greater than currently anticipated, the Company could be
      required to curtail its stock repurchase program and seek additional funds
      through sales of equity, debt or convertible securities or increased credit
      facilities. There can be no assurance that additional financing will be
      available or that, if available, the financing will be on terms favorable to
      the
      Company and its shareholders.





**Contractual
      Obligations**





There
      have been no material changes during the period covered by this report, outside
      of the ordinary course of the Company’s business, to contractual obligations
      specified in the table of contractual obligations included in the section
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” incorporated by reference in the Company’s Fiscal 2004 Annual Report
      on Form 10-K.





**Risk
      Factors**





There
      are
      a number of important factors that could cause the Company’s actual results to
      differ materially from historical results or those indicated by any
      forward-looking statements, including the risk factors identified below or
      other
      factors of which the Company may not yet be aware.





18
 Index





*No
      Assurance of Future Profitability.* The
      Company’s sales and operating results are difficult to forecast, and several
      factors affecting sales and operating results are outside of the Company’s
      control, such as purchasing cycles of commercial and public sector customers,
      cost of compliance with new legal and regulatory requirements, the level of
      corporate investment in new IT-related capital equipment, the decision by IT
      equipment manufacturers to increase their direct sales, industry announcements
      of new products or upgrades, industry consolidation and general economic
      conditions. The Company has taken a number of steps to reduce fixed costs,
      such
      as reducing redundant headcount and obtaining a more favorable facilities lease.
      The Company intends to continue exploring additional means of cost reduction,
      but there is no assurance that the Company will be able to continue to identify
      or achieve additional cost savings or to maintain profitability going forward.





*No
      Assurance as to Sales Levels.* There is
      no assurance that the Company will be able to sustain its current sales levels.
      Sales may decline for any number of reasons, such as a renewed decline in
      corporate investment in IT-related equipment, increased competition, more
      manufacturers going direct, changes in customers’ buying habits, the loss of
      significant customers, changes in the selection of products available for resale
      by the Company, or general economic conditions. A decline in sales levels could
      adversely affect the Company’s business, financial condition, cash flows or
      results of operations.





*Pressure
      on Margins.* There is
      intense price competition and pressure on profit margins in the computer
      products industry. An increasing number of manufacturers are also providing
      their products direct to customers. Various other factors also may create
      downward pressure on the Company’s gross margins, such as shifts in vendor
      programs and an increasing proportion of sales to large, public sector or other
      competitive bid accounts. If the Company is unable to maintain or improve gross
      margins in the future, this could have an adverse effect on the Company’s
      business, financial condition, or results of operations.





*Account
      Executive Hiring, Retention and Productivity.* The
      Company intends to continue to recruit account executives. The Company hopes
      to
      hire approximately 15 to 25 new account executives each month through November
      2005 subject to economic conditions. However, there are no assurances that
      the
      Company will be able to hire to these levels each month, recruit the quality
      individuals that it hopes to recruit and hire, or that the individuals hired
      will remain with the Company for an extended period of time, or that the Company
      will not lose existing account executives. The productivity of account
      executives has historically been closely correlated with tenure. Historically,
      the Company has experienced significant attrition in its sales force and in
      the
      past they have been the subject of aggressive hiring efforts by competitors.
      Even if the Company does retain its account executives, there are no assurances
      that they will become productive at historical levels. Additionally, the Company
      may open an additional call center in the Pacific Northwest subject to market
      conditions. There is no assurance that a new call center would attract qualified
      account executives, or that the Company will be able to remotely manage and
      retain the account executives.





*Vendor
      Support.* The
      Company has a variety of relationships with its vendors that have in the past
      contributed significantly to profit margins. For example, certain product
      manufacturers and distributors provide the Company with incentives in the form
      of rebates, volume incentive rebates, discounts and trade allowances. In
      addition, many of the Company’s vendors provide the Company with cooperative
      advertising funds, which reimburse the Company for expenses associated with
      specific forms of advertising. Industry-wide, manufacturers, distributors and
      vendors have been reducing these incentives and curtailing these programs.
      If
      these forms of vendor support decline further, or if the Company is otherwise
      unable to take advantage of continuing vendor support programs, or if the
      Company fails to manage the complexity of these programs, the Company’s
      business, financial condition, cash flows or results of operations could be
      adversely affected.





*Major
      Shareholder* .
      Firoz
      H. Lalji, the Company’s Chairman and Chief Executive Officer, beneficially owns
      51.5% of the outstanding shares of the Company’s common stock, excluding shares
      that he may acquire upon exercise of stock options that he holds. If Mr. Lalji
      exercises all options and retains the shares of common stock issued to him
      upon
      such exercise, his collective ownership would increase to 55.3% of the
      outstanding shares of the Company’s common stock. The voting power of these
      shares enables Mr. Lalji to significantly influence the Company’s affairs and
      the vote on corporate matters to be decided by the Company’s shareholders,
      including the outcome of elections of directors. This effective voting control
      may preclude other shareholders from being able to influence shareholder votes
      and could impede potential merger transactions or block changes to the Company’s
      articles of incorporation or bylaws, which could adversely affect the trading
      price of the Company’s common stock. The Company’s certification as a Minority
      Business Enterprise is dependent on Mr. Lalji’s maintenance of voting control
      and a decrease in his level of voting power could have an adverse effect on
      the
      Company’s ability to retain certain customers or compete for certain
      opportunities.





19
 Index





*Increased
      Expenses of Being a Public Company* .
      The
      costs of being a public company have increased significantly since the enactment
      of the Sarbanes-Oxley Act of 2002. Legal counsel fees specific to the increased
      disclosure requirements and the need to comply with new corporate governance
      requirements have increased under the Sarbanes-Oxley Act as well as SEC
      regulations and new NASDAQ rules. Additionally, independent registered public
      accounting firm audit fees have significantly increased, and are expected to
      increase even more as requirements associated with corporate governance and
      internal controls become effective. These increasing costs may affect the
      Company’s business, financial condition, cash flows or results of
      operations.





*Competition.* The
      computer products industry is highly competitive. The Company believes that
      the
      relationships with the customer, product selection and availability and price
      are the three most important competitive factors. The Company competes with
      other national direct marketers (“DMR”), including CDW Corporation, Insight
      Enterprises, Inc., PC Connection, Inc. and PC Mall, Inc. The Company also
      competes with product manufacturers, such as Apple, Dell, Hewlett Packard,
      IBM
      and Lenovo, which sell direct to end-users; specialty computer retailers;
      computer and general merchandise superstores; and consumer electronic and office
      supply stores. Many of the Company’s competitors compete principally on the
      basis of price and have lower costs than the Company. The Company believes
      that
      competition may intensify in the future due to market conditions and
      consolidation. In the future, the Company may face fewer, but larger or
      better-financed competitors. Additional competition may also arise if other
      methods of distribution emerge in the future. There can be no assurance that
      the
      Company will be able to compete effectively with existing competitors or new
      competitors that may enter the market, or that the Company’s business, financial
      condition, cash flows or results of operations will not be adversely affected
      by
      intensified competition.





*State
      Tax Uncertainties.* The
      Company collects and remits sales and use taxes in states in which it has
      voluntarily registered and/or has a physical presence. Various states have
      sought to require the collection of state and local sales taxes on products
      shipped to the taxing jurisdiction’s residents by DMRs. The United States
      Supreme Court held in 1992 that it is unconstitutional for a state to impose
      sales or use tax collection obligations on an out-of-state company whose
      contacts with the state were limited to the distribution of catalogs and other
      advertising materials through the mail and the subsequent delivery of purchased
      goods by United States mail or by common carrier. The Company cannot predict
      the
      level of contact, including electronic commerce and Internet activity that
      might
      give rise to future or past tax collection obligations based on that Supreme
      Court case. Many states aggressively pursue out of state businesses, and
      legislation that would expand the ability of states to impose sales tax
      collection obligations on out of state businesses has been introduced in
      Congress on many occasions. A change in the law could require the Company to
      collect sales taxes or similar taxes on sales into states in which it has no
      presence, and could potentially subject it to a liability for prior year sales,
      either of which could have a material adverse effect on the Company’s business,
      financial condition, and results of operations. Additionally, the Company is
      evaluating establishing sales tax nexus in the majority of the contiguous United
      States.





*Rapid
      Technological Change and Inventory Obsolescence* .
      The
      computer industry is characterized by rapid technological change and frequent
      introductions of new products and product enhancements. To satisfy customer
      demand and obtain greater purchase discounts, the Company may be required to
      carry significant inventory levels of certain products, which subjects it to
      increased risk of inventory obsolescence. The Company participates in
      first-to-market and end-of-life-cycle purchase opportunities, both of which
      carry the risk of inventory obsolescence. Special purchase products are
      sometimes acquired without return privileges, and there can be no assurance
      that
      the Company will be able to avoid losses related to such products. Within the
      industry, vendors are becoming increasingly restrictive in guaranteeing return
      privileges. While the Company seeks to reduce its inventory exposure through
      a
      variety of inventory control procedures and policies, there can be no assurance
      that the Company will be able to avoid losses related to obsolete
      inventory.





*Reliance
      on Vendor Relationships* .
      The
      Company acquires products directly from manufacturers as well as from
      distributors such as Ingram Micro, Tech Data and others. Certain hardware
      manufacturers limit the number of product units available to DMRs such as the
      Company. Substantially all of the Company’s contracts and arrangements with its
      vendors are terminable without notice or upon short notice. Termination,
      interruption or contraction of the Company’s relationships with its vendors
      could have a material adverse effect on the Company’s business, financial
      condition, cash flows or results of operations.





20
 Index





*Reliance
      on Distribution* .
      The
      Company operates a warehouse and distribution center in Bensenville, IL. Any
      limitation or interruption of the service being provided could have a material
      adverse effect on the Company’s business, financial condition, cash flow or
      results of operations. The Company has decided to move its Henderson, NV
      warehouse to Seattle, WA during the fourth quarter of 2005. There are no
      assurances that transitioning the warehouse location would better support the
      Company’s customers on the West Coast, and any limitation or interruption of
      service could have an adverse effect on the Company’s business, financial
      condition, cash flow or results of operations. Additionally, certain
      distributors also participate in the Company’s logistics operations through
      electronic data interchange. Failure to develop and maintain relationships
      with
      these and other vendors would limit the Company’s ability to obtain sufficient
      quantities of merchandise on acceptable commercial terms and could have a
      material adverse effect on the Company’s business, financial condition, cash
      flows or results of operations.





*Risk
      Associated with CPCS Merger.* Effective
      April 1, 2005, the Company merged the operations of CPCS with Zones other wholly
      owned subsidiary, Zones Corporate Solutions, Inc. The Company believes the
      integration will create efficiencies that may decrease future operating costs.
      However, there are no assurances that the integration will reduce future costs
      below historical levels. In addition, there are risks associated with the
      resulting change which increase product and other costs, cause disruption of
      service or cause the potential loss of customers or team members, any of which
      could have an adverse effect on the Company’s business, financial condition,
      cash flows or results of operations.





*Major
      Customer.* From
      time
      to time, the Company has customers which represent more than 10% of total sales.
      For the three months ended September 30, 2005, one of the Company’s customers,
      State Farm, represented 16.8% of total sales. For the nine months ended
      September 30, 2005, and in the prior year, no one customer represented more
      than
      10% of total sales. The loss of any major customer could have an adverse effect
      on the Company’s business, financial condition, cash flows or results of
      operations.





*Dependence
      on Key Personnel* .
      The
      Company’s future success will depend to a significant extent upon its ability to
      attract and retain skilled personnel. Although the Company’s success will depend
      on its ability to hire, train and retain competent personnel in all areas of
      its
      business, there are certain individuals that play a key role within the
      organization. Loss of any of these individuals could have an adverse effect
      on
      the Company’s business, financial condition, cash flows or results of
      operations.





*Liquidity
      of Stock and NASDAQ National Market Listing* .
      There
      is relatively limited trading of the Company’s stock in the public markets, and
      this may impose significant practical limitations on any shareholder’s ability
      to achieve liquidity at any particular quoted price. Efforts to sell significant
      amounts of the Company’s stock on the open market may precipitate significant
      declines in the prices quoted by market makers. The limitation on shareholder
      liquidity resulting from this relatively thin trading volume could be
      exacerbated if the Company’s stock were to be de-listed from The NASDAQ National
      Market. The Company has on two prior occasions received delisting notifications
      from The NASDAQ National Market relating to its $1.00 minimum bid price
      requirement. The NASDAQ National Market also imposes a requirement for continued
      listing that mandates the value of shares publicly held, excluding directors,
      officers and beneficial owners, exceeds certain minimums. Even though the
      Company has regained compliance with National Market listing requirements,
      a
      potential future delisting of the Company’s common stock could result in
      significantly reduced circulation of its common stock, reduced interest by
      investors in the common stock, adverse effects on the trading market, downward
      pressure on the price for and liquidity of the Company’s stock, and reduced
      ability to issue additional securities or to secure additional financing.





*Potential
      Disruption of Business From Information Systems Failure* .
      The
      Company’s operations are dependent on the reliability of its information,
      telecommunication, and other systems, which are used for sales, distribution,
      marketing, purchasing, inventory management, order processing, customer service
      and general accounting functions. Interruption of the Company’s information
      systems, Internet or telecommunication systems could have a material adverse
      effect on the Company’s business, financial condition cash flows or results of
      operations.





21
 Index




**Item3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**




The
      Company is subject to the risk of fluctuating interest rates in the normal
      course of business, primarily as a result of its short-term borrowing and
      investment activities, which generally bear interest at variable rates. Because
      the short-term borrowings and investments have maturities of three months or
      less, the Company believes that the risk of material loss is low.





**Item
                4.**
            **Controls
                and Procedures**





Under
      the
      supervision and with the participation of the Company’s management, including
      its Chief Executive Officer and Chief Financial Officer, the Company evaluated
      the effectiveness of its disclosure controls and procedures, as such term is
      defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of
      1934,
      as amended. Based on this evaluation, the Company’s Chief Executive Officer and
      Chief Financial Officer concluded that its disclosure controls and procedures
      were effective as of the end of the period covered by this quarterly report.





There
      has
      been no change in the Company’s internal control over financial reporting during
      our most recently completed fiscal quarter that materially affected, or is
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





The
      Company is in the process of implementing the requirements of Section 404 of
      the
      Sarbanes-Oxley Act of 2002, which requires management to assess the
      effectiveness of internal controls over financial reporting and include an
      assertion in its annual report as to the effectiveness of the controls.
      Subsequently, its independent registered public accounting firm, Grant Thornton
      LLP, will be required to attest to whether the assessment of the effectiveness
      of internal controls over financial reporting is fairly stated in all material
      respects and separately report on whether it believes the Company maintained,
      in
      all material respects, effective internal controls over financial reporting
      as
      of December 31, 2007. The Company is in the process of performing the system
      and
      process documentation, evaluation and testing required for management to make
      this assessment and for Grant Thornton LLP to provide its attestation report.
      The Company has not completed this process or its assessment, and this process
      will require significant amounts of management time and resources. In the course
      of evaluation and testing, management may identify deficiencies that will need
      to be addressed and remediated.





**Part
      II.**





**Item
                1.**
            **Legal
                Proceedings**





From
      time
      to time, the Company is a party to various legal proceedings, claims, disputes
      and litigation arising in the ordinary course of business. The Company currently
      believes that the ultimate outcome of any of these proceedings, individually
      or
      in the aggregate, will not have a material adverse effect on the Company’s
      business, financial condition, cash flows or results of operations. However,
      because of the nature and inherent uncertainties of litigation, should the
      outcome of these actions be unfavorable, the Company’s business, financial
      condition, cash flows or results of operations could be materially
      affected.





**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





In
      July
      2004, the Board of Directors authorized a share repurchase program under which
      the Company could repurchase up to $3.0 million in shares of the Company’s
      common stock through July 2005 in open market or private transactions at then
      prevailing market prices. Under this repurchase program, the Company purchased
      and retired a total of 650,040 shares of its common stock at a total cost of
      $2.1 million (an average price of $3.27 per share).





In
      July
      2005, the Board of Directors authorized the continuation of the Company’s share
      repurchase program until July 2006. The Company is authorized to repurchase
      up
      to an additional $3.0 million in shares of the Company’s common stock through
      July 2006 in open market or private transactions at then prevailing market
      prices. Under this repurchase program, the Company has purchased and retired
      78,800 shares of its common stock at a total cost of $314,000 (an average price
      of $3.99 per share) during the three month period ended September 30, 2005.





22
 Index





The
      following table sets forth information on the Company’s common stock repurchase
      program for the quarter ended September 30, 2005:





**Period**
            
            **Total
                number of shares purchased**
            
            **Average
                price paid per share**
            
            **Total
                number of shares purchased as part of a publicly announced plan or
                program**
            
            **Maximum
                amount that may yet be purchased under the plan or
                program**July1,
                2005 throughJuly
                31, 2005
            
            
            0
            
            $
            -
            
            
            0
            
            $
            3,000,000August
                1, 2005 through August 31, 2005
            
            
            78,800
            
            $
            3.99
            
            
            78,800
            
            $
            2,685,280September
                1, 2005 through September 30, 2005
            
            
            0
            
            $
            -
            
            
            0
            
            $
            2,685,280




23
 Index





**Item
                6.**
            **Exhibits**




Exhibit
                No.
            Description
            Filed
                Herewith
            Incorporated
                by ReferenceForm
            Exhibit
                No.
            File
                No.
            Filing
                Date10.1
            Industrial
                Lease Agreement dated September 21, 2005 between Zones Inc. and the
                Trustees Under the Will and of the Estate of James Campbell,
                Deceased
            X31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X32.1
            Certification
                of Chief Executive Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and the
                regulations promulgated thereunder
            X32.2
            Certification
                ofChief
                Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
                of
                2002 and the regulations promulgated thereunder
            X














Signatures








Pursuant
      to the requirements 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:






ZONES,
              INC.Date:
              November 9, 2005By:
            /S/
                FIROZ H. LALJIFiroz
                H. Lalji, Chairman and Chief Executive Officer/S/
                RONALD P. MCFADDENRonald
                P. McFadden, Chief Financial
                Officer




24