**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 JUNE 30, 2005**


**OR**





o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934 FOR THE TRANSITION PERIOD FROM __________ TO
                __________**





**Commission
      File Number 0-28488**







**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 o





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





Yes o No x





The
      number of shares of the registrant's Common Stock outstanding as of August
      8,
      2005 was 13,443,998.










1




**ZONES,
      INC.**





**INDEX**





**PART
      I. FINANCIAL INFORMATION**




Item 1.
            Consolidated
              Financial Statements
              (unaudited):Consolidated
                Balance Sheets June 30, 2005 and December 31,
                2004
            3Consolidated
                Statements of Operations Three and six
                months ended June 30, 2005 and 2004
            4Statements
                of Shareholders’ Equity Six months ended June
                30, 2005
            5Consolidated
                Statements of Cash Flows Six months ended
                June 30, 2005 and 2004
            6Notes
                to Consolidated Financial
                Statements
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            21Item
                4.
            Controls
                and Procedures
            21






**PART
      II. OTHER INFORMATION**




Item
                1.
            Legal
                Proceedings
            22Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            22Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            23Item
                6.
            Exhibits
            24Signatures
            24




2
 *Index*





**Part
      I.**





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





**ZONES,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(in
      thousands)**


**(unaudited)**




**June
                30, 2005**
            
            **December
                31, 2004****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            3,094
            
            $
            6,457Receivables,
                net of allowance for doubtful accounts of $2,376 and
                $2,666
            
            
            53,580
            
            
            53,903Vendor
                receivables
            
            
            9,951
            
            
            10,035Inventories,
                net
            
            
            15,492
            
            
            17,405Prepaid
                expenses
            
            
            1,175
            
            
            958Deferred
                tax asset
            
            
            1,525
            
            
            1,525Total
                current assets
            
            
            84,817
            
            
            90,283Property
                and equipment, net
            
            
            3,744
            
            
            3,951Goodwill
            
            
            5,098
            
            
            5,098Deferred
                tax asset
            
            
            1,163
            
            
            2,640Other
                assets
            
            
            187
            
            
            172Total
                assets
            
            $
            95,009
            
            $
            102,144**LIABILITIES
              AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            35,183
            
            $
            34,250Inventory
                financing
            
            
            7,514
            
            
            14,306Accrued
                liabilities
            
            
            7,463
            
            
            7,331Line
                of credit
            
            
            3,900
            
            
            6,100Notes
                payable to former shareholders of CPCS
            
            
            1,468
            
            
            1,272Total
                current liabilities
            
            
            55,528
            
            
            63,259Notes
                payable for purchase of fixed asset
            
            
            32
            
            
            35Notes
                payable to former shareholders of CPCS, net of current
                portion
            
            
            -
            
            
            1,272Deferred
                rent
            
            
            1,113
            
            
            1,027Total
                liabilities
            
            
            56,673
            
            
            65,593Commitments
                and contingenciesShareholders'
                equity:Common
                stock
            
            
            38,186
            
            
            38,788Retained
                earnings (accumulated deficit)
            
            
            150
            
            
            (2,237
            )Total
                shareholders' equity
            
            
            38,336
            
            
            36,551Total
                liabilities and shareholders' equity
            
            $
            95,009
            
            $
            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**
              **June
                30,**
            
            **Six
                months ended**
              **June
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                sales
            
            $
            127,630
            
            $
            124,023
            
            $
            253,961
            
            $
            238,114Cost
                of sales
            
            
            113,094
            
            
            109,765
            
            
            224,663
            
            
            209,941Gross
                profit
            
            
            14,536
            
            
            14,258
            
            
            29,298
            
            
            28,173Selling,
                general and administrative
            
            
            10,979
            
            
            10,602
            
            
            22,178
            
            
            21,251Advertising
                expenses, net
            
            
            1,400
            
            
            1,695
            
            
            3,139
            
            
            3,584Income
                from operations
            
            
            2,157
            
            
            1,961
            
            
            3,981
            
            
            3,338Interest
                expense
            
            
            63
            
            
            97
            
            
            160
            
            
            184Other
                income
            
            
            (13
            )
            
            (7
            )
            
            (50
            )
            
            (17
            )Other
                expense
            
            
            50
            
            
            90
            
            
            110
            
            
            167Income
                before taxes
            
            
            2,107
            
            
            1,871
            
            
            3,871
            
            
            3,171Provision
                for income taxes
            
            
            811
            
            
            720
            
            
            1,484
            
            
            1,229Net
                income
            
            $
            1,296
            
            $
            1,151
            
            $
            2,387
            
            $
            1,942Basic
                earnings per share
            
            $
            0.10
            
            $
            0.08
            
            $
            0.18
            
            $
            0.14Shares
                used in computing basic earnings per share
            
            
            13,380
            
            
            13,669
            
            
            13,412
            
            
            13,666Diluted
                earnings per share
            
            $
            0.09
            
            $
            0.08
            
            $
            0.17
            
            $
            0.13Shares
                used in computing diluted earnings per share
            
            
            14,148
            
            
            14,534
            
            
            14,347
            
            
            14,511




</TABLE> 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,
                December 31, 2004
            
            
            13,507,727
            
            $
            38,788
            
            $
            (2,237
            )
            $
            36,551Purchase
                and retirement of common stock
            
            
            (201,650
            )
            
            (779
            )
            
            
            
            
            (779
            )Tax
                effect of stock options exercised
            
            
            
            
            
            5
            
            
            
            
            
            5Issuance
                of common stock on exercise of stock options
            
            
            117,081
            
            
            172
            
            
            
            
            
            172Net
                income
            
            
            
            
            
            
            
            
            2,387
            
            
            2,387Balance,
                June 30, 2005
            
            
            13,423,158
            
            $
            38,186
            
            $
            150
            
            $
            38,336





See
      notes
      to consolidated financial statements





5
 *Index*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**


**(unaudited)**





**Six
                months ended**
              **June
                30,****2005**
            
            **2004**Cash
                flows from operating activities:Net
                income
            
            $
            2,387
            
            $
            1,942Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
            
            
            1,023
            
            
            1,269Deferred
                tax asset
            
            
            1,477
            
            
            1,229Tax
                effect of stock option exercise
            
            
            5Loss
                on disposal of asset
            
            
            
            
            
            (2
            )(Increase)
                decrease in assets and liabilities:Receivables,
                net
            
            
            407
            
            
            2,731Inventories,
                net
            
            
            1,913
            
            
            (2,670
            )Prepaid
                expenses and other assets
            
            
            (232
            )
            
            (93
            )Accounts
                payable and inventory financing
            
            
            (6,723
            )
            
            2,144Accrued
                liabilities and deferred rent
            
            
            218
            
            
            (328
            )Net
                cash provided by operating activities
            
            
            475
            
            
            6,222Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (816
            )
            
            (1,301
            )Net
                cash used in investing activities
            
            
            (816
            )
            
            (1,301
            )Cash
                flows from financing activities:Net
                change in book overdraft
            
            
            864
            
            
            (968
            )Net
                change in line of credit
            
            
            (2,200
            )
            
            (4,855
            )Purchase
                and retirement of common stock
            
            
            (779
            )Proceeds
                from exercise of stock options
            
            
            172
            
            
            19Payments
                of notes payable
            
            
            (1,079
            )
            
            (662
            )Net
                cash used in financing activities
            
            
            (3,022
            )
            
            (6,466
            )Net
                decrease in cash and cash equivalents
            
            
            (3,363
            )
            
            (1,545
            )Cash
                and cash equivalents at beginning of period
            
            
            6,457
            
            
            5,180Cash
                and cash equivalents at end of period
            
            $
            3,094
            
            $
            3,635Non-cash
                investing and financing activity:Note
                payable for fixed asset purchase
            
            
            
            
            $
            (42
            )Non-cash
                reduction to note payable for purchase price adjustment of Corporate
                PC
                Source (“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 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 31st.
      The changes in the carrying amount of goodwill for the six months ended June
      30,
      2005 are as follows (in thousands):





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





The
      Company completed the impairment review 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.
      For the period ending June 30, 2005, the Company analyzed the historical
      collection rate for vendor receivables. Based on current information, the
      Company decreased its estimate for the allowance for vendor receivables by
      $278,000 at June 30, 2005 compared to March 31, 2005.





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 shppping
      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. The Company only recognizes revenue when all criterion of Staff
      Accounting Bulletin 101, “Revenue Recognition” have been met.





*Comprehensive
      Income*


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





8
 *Index*





*Stock
      Compensation*


The
      Company accounted 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
      (loss), 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**
              **June
                30,****2005**
            
            **2004**Net
                income - as reported
            
            $
            1,296
            
            $
            1,151Add: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
            
            
            (271
            )
            
            (179
            )Net
                income - pro forma
            
            $
            1,025
            
            $
            972Basic
                income per share - as reported
            
            $
            0.10
            
            $
            0.08Diluted
                income per share - as reported
            
            $
            0.09
            
            $
            0.08Basic
                income per share - pro forma
            
            $
            0.08
            
            $
            0.07Diluted
                income per share - pro forma
            
            $
            0.07
            
            $
            0.07





**Six
                months ended**
              **June
                30,****2005**
            
            **2004**Net
                income - as reported
            
            $
            2,387
            
            $
            1,942Add: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
            
            
            (508
            )
            
            (308
            )Net
                income - pro forma
            
            $
            1,879
            
            $
            1,634Basic
                income per share - as reported
            
            $
            0.18
            
            $
            0.14Diluted
                income per share - as reported
            
            $
            0.17
            
            $
            0.13Basic
                income per share - pro forma
            
            $
            0.14
            
            $
            0.12Diluted
                income per share - pro forma
            
            $
            0.13
            
            $
            0.11





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 189% and 200%; risk-free interest rate
      of
      3.88% and 3.36%; 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
      June 2005, the FASB’s Emerging Issues Task Force reached a consensus on
      Issue No. 05-6, “Determining the Amortization Period for Leasehold
      Improvements” (“EITF 05-6”). The guidance requires that leasehold improvements
      acquired in a business combination or purchased subsequent to the inception
      of a
      lease be amortized over the lesser of the useful life of the assets or a term
      that includes renewals that are reasonably assured at the date of the business
      combination or purchase. The guidance is effective for periods beginning after
      June 29, 2005. The adoption of EITF 05-6 is not expected to have a material
      effect on the Company’s consolidated financial position or results of
      operations.





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 no later than
      the
      beginning of its first quarter of fiscal 2006. Adoption of the expensing
      requirements will reduce the Company’s reported earnings. Management is
      currently evaluating the specific impacts of adoption.





In
      May
      2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
      Corrections” (“SFAS 154”) which replaces Accounting Principles Board
      Opinions No. 20 “Accounting Changes” and SFAS No. 3, “Reporting
      Accounting Changes in Interim Financial Statements — An Amendment of APB
      Opinion No. 28.” SFAS 154 provides guidance on the accounting for and
      reporting of accounting changes and error corrections. It establishes
      retrospective application, or the latest practicable date, as the required
      method for reporting a change in accounting principle and the reporting of
      a
      correction of an error. SFAS 154 is effective for accounting changes and
      corrections of errors made in fiscal years beginning after December 15,
      2005 and are required to be adopted by the Company in the first quarter of
      fiscal 2006. The Company is currently evaluating the effect that the adoption
      of
      SFAS 154 will have on its consolidated results of operations and financial
      condition but does not expect it to have a material impact.





In
      March
      2005, the FASB issued Staff Position (FSP) No. FIN 46(R)-5, Implicit Variable
      Interests under FASB Interpretation No. 46 (revised December 2003),
      Consolidation of Variable Interest Entities. This FSP clarifies that when
      applying the variable interest consolidation model, a reporting enterprise
      should consider whether it holds an implicit variable interest in a variable
      interest entity (VIE) or potential VIE when specific conditions exist. FSP
      No.
      FIN 46(R)-5 is effective as of April 1, 2005.  Management evaluated the
      impact of FSP No. FIN 46(R)-5 and determined that it had no impact on the
      Company’s financial statements.





10
 *Index*





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





The
      Company has 45,000,000 common shares authorized. The Company has granted options
      to purchase common shares to employees 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 June 30,**
            
            **Six
                months ended June 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004****Basic
                earnings per share:**Net
                income
            
            $
            1,296
            
            $
            1,151
            
            $
            2,387
            
            $
            1,942Weighted
                average shares outstanding
            
            
            13,380
            
            
            13,669
            
            
            13,412
            
            
            13,666Basic
                earnings per share
            
            $
            0.10
            
            $
            0.08
            
            $
            0.18
            
            $
            0.14**Diluted
                earnings per share:**Net
                income
            
            $
            1,296
            
            $
            1,151
            
            $
            2,387
            
            $
            1,942Weighted
                average shares outstanding
            
            
            13,380
            
            
            13,669
            
            
            13,412
            
            
            13,666Stock
                options
            
            
            768
            
            
            865
            
            
            935
            
            
            845Total
                common shares and dilutive securities
            
            
            14,148
            
            
            14,534
            
            
            14,347
            
            
            14,511Diluted
                earnings per share
            
            $
            0.09
            
            $
            0.08
            
            $
            0.17
            
            $
            0.13





For
      the
      three and six months ended June 30, 2005, 492,070 and 477,259 shares,
      respectively, which were outstanding stock options that were excluded from
      the
      calculation of diluted earnings per share because the effect was anti-dilutive.
      For the period ended June 30, 2004, the Company had 220,552 of contingent
      convertible notes outstanding which were not included in the calculation of
      earnings per share.





**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.





*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 any amounts owed to the former shareholders
      of CPCS and up to the remaining balance of $3.0 million authorized in the
      Company’s stock repurchase program, 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.





11
 *Index*





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





**Three
                months ended**
              **June
                30,**
            
            **Six
                months ended**
              **June
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Notebook
                & PDA’s
            
            $
            19,116
            
            $
            18,256
            
            $
            35,481
            
            $
            39,036Desktops
                & Servers
            
            
            25,326
            
            
            25,908
            
            
            56,593
            
            
            48,206Software
            
            
            20,703
            
            
            21,000
            
            
            41,730
            
            
            38,346Storage
            
            
            11,950
            
            
            11,205
            
            
            23,395
            
            
            21,536NetComm
            
            
            5,353
            
            
            5,875
            
            
            10,137
            
            
            10,684Printers
            
            
            12,460
            
            
            11,745
            
            
            23,843
            
            
            22,982Monitors
                & Video
            
            
            13,152
            
            
            11,996
            
            
            25,767
            
            
            23,714Memory
                & Processors
            
            
            7,645
            
            
            5,807
            
            
            14,271
            
            
            11,242Accessories
                & Other
            
            
            11,925
            
            
            12,231
            
            
            22,744
            
            
            22,368





Substantially
      all of the Company’s net sales for the three and six months ended June 30, 2005
      and June 30, 2004 were made to customers located in the United States. All
      of
      the Company’s assets at June 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 and six month period ended June 30, 2005. Net sales
      to
      this customer were $17.6 million and $34.6 million for the three and six months
      ended June 30, 2005, respectively.





**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 agreement, the Company will pay lease payments aggregating
      from
      $1.0 million to $1.2 million per year, plus real estate taxes, insurance and
      common area maintenance charges. For the three and six months ended June 30,
      2005 the Company paid Fana Auburn LLC $424,000 and $852,000 related to the
      lease. The Company’s Audit Committee reviewed and approved the related party
      transaction, and also the potential corporate opportunity, recognizing that
      in
      the future the Company may have to renew and re-negotiate its lease and that
      such renewal and re-negotiation would also present a related party transaction
      subject to further Audit Committee review and consideration.





**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 36,150 shares of its common stock at a total cost of $130,000 (an
      average price of $3.59 per share) during the three month period ended June
      30,
      2005. Over the past twelve months, the Company has purchased and retired a
      total
      of 650,040 shares of its common stock at a total cost of $2.1 million (average
      price of $3.27).





In
      July
      2005, the Board of Directors authorized the continuation of the Company’s share
      repurchase program. 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.


**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.


12
 *Index*






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), large enterprise customer
      (greater than 1000 computer users) and public sector marketplaces (education
      and
      state and local government). Relationships with small to medium sized businesses
      (“SMB”), large enterprise customers and public sector institutions represented
      96.2% and 95.7% of total net sales during the three and six months ending June
      30, 2005, respectively. The remaining sales were from inbound customers,
      generally defined as consumers and small office/home office accounts.





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 utilized by 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.





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
      corporate 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 employee, average order size, accounts
      receivables aging, inventory turnover, liquidity and cash resources.  
Company management compares the 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 June 30,
      2005,
      the Company had 590 team members in its consolidated operations; 275 of which
      are inbound and outbound account executives. The majority of the Company’s team
      members work at its corporate headquarters in Auburn, Washington. The Company
      makes additional company information available free of charge on its website, www.zones.com/IR ,.





13
 *Index*





**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
      Annual Report.





**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 June 30,**
            
            **Six
                months ended June 30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of sales
            
            
            88.6
            
            
            88.5
            
            
            88.5
            
            
            88.2Gross
                profit
            
            
            11.4
            
            
            11.5
            
            
            11.5
            
            
            11.8Selling,
                general and administrative expenses
            
            
            8.6
            
            
            8.5
            
            
            8.7
            
            
            8.9Advertising
                expenses, net
            
            
            1.1
            
            
            1.4
            
            
            1.2
            
            
            1.5Income
                (loss) from operations
            
            
            1.7
            
            
            1.6
            
            
            1.6
            
            
            1.4Other
                (income) expense
            
            
            0.1
            
            
            0.1
            
            
            0.1
            
            
            0.1Income
                (loss) before income taxes
            
            
            1.6
            
            
            1.5
            
            
            1.5
            
            
            1.3Provision
                (benefit) for income taxes
            
            
            0.6
            
            
            0.6
            
            
            0.6
            
            
            0.5Net
                income (loss)
            
            
            1.0
            %
            
            0.9
            %
            
            0.9
            %
            
            0.8
            %**Selected
                operating data:**Number
                of orders
            
            
            99,000
            
            
            101,000
            
            
            198,000
            
            
            213,000Average
                order size
            
            $
            1,340
            
            $
            1,222
            
            $
            1,320
            
            $
            1,143Sales
                force, end of period
            
            
            275
            
            
            274
            
            
            275
            
            
            274**Product
                Mix (% of Net Sales):**Notebook
                & PDA’s
            
            
            15.0
            %
            
            14.7
            %
            
            14.0
            %
            
            16.4
            %Desktops
                & Servers
            
            
            19.8
            
            
            20.9
            
            
            22.3
            
            
            20.2Software
            
            
            16.2
            
            
            16.9
            
            
            16.4
            
            
            16.1Storage
            
            
            9.4
            
            
            9.0
            
            
            9.2
            
            
            9.0NetComm
            
            
            4.2
            
            
            4.7
            
            
            4.0
            
            
            4.5Printers
            
            
            9.8
            
            
            9.5
            
            
            9.4
            
            
            9.7Monitors
                & Video
            
            
            10.3
            
            
            9.7
            
            
            10.1
            
            
            10.0Memory
                & Processors
            
            
            6.0
            
            
            4.7
            
            
            5.6
            
            
            4.7Accessories
                & Other
            
            
            9.3
            
            
            9.9
            
            
            9.0
            
            
            9.4





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





*Net
      Sales.* Consolidated
      net sales for the quarter ended June 30, 2005 increased 2.9% to $127.6 million
      compared to $124.0 million in the second quarter of 2004. The increase is
      primarily due to growth in sales to the Company’s large enterprise customers,
      which increased 11.5% to $67.5 million from $60.5 million in the prior year.
      The
      Company has increased its penetration into existing large enterprise customer
      accounts. Consolidated outbound sales (relationship based selling) to commercial
      and public sector customers increased 8.0% to $122.7 million in the second
      quarter of 2005 from $113.7 million in the second 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 $4.9 million during the second quarter of 2005 compared
      to $10.4 million for the three months ended June 30, 2004, and declined as
      a
      percent of total sales to 3.8% from 8.3%.





14
 *Index*





*Gross
      Profit.* Consolidated gross profit increased to $14.5 million for the second quarter
      of
      2005, compared to $14.3 million in the second quarter of 2004. Gross profit
      as a
      percentage of net sales decreased slightly to 11.4% in the quarter ended June
      30, 2005 compared to 11.5% in the second quarter of 2004. The decline is
      primarily due to product mix. Sales of desktops and servers and software as
      a
      percent of sales represents 19.8% and 16.2%, respectively, of second quarter
      2005 sales. The gross margin associated with these product lines is generally
      lower than for other product lines. 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.





*Selling,
      General and Administrative (“SG&A”) Expenses.* SG&A
      expense dollars increased to $11.0 million for the quarter ended June 30, 2005
      compared to $10.6 million in the second quarter of 2004. As a percent of sales,
      SG&A was 8.6% for the quarter ended June 30, 2005 compared to 8.5% for the
      second 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 increased $564,000 during the second quarter 2005
                compared to the second quarter of the prior year. The Company’s total
                headcount increased 6.1% to 590 team members at June 30, 2005 from
                556 at
                June 30, 2004 primarily due to staffing the warehouse operations
                in the
                Bensenville facility.


·
            Depreciation
                expense declined $132,000 for the three months ended June 30, 2005
                compared to the prior year. The decline is due to the Company’s decision
                to reduce capital expenditures.


·
            Credit
                card processing fees in the second quarter of 2005 declined $58,000
                compared to the prior year. The decline is due to the Company’s focus on
                outbound selling to businesses, which tend to purchase on open account
                rather than by credit card.


·
            Professional
                fees increased $146,000 for the second quarter of 2005 compared to
                the
                second quarter of the prior year. The increase is primarily due to
                increased Board of Directors fees and consulting fees associated
                with the
                Company’s documentation of internal
                controls.


·
            For
                the period ending June 30, 2005 and 2004, warehousing and distribution
                network costs totaled $628,000 and $393,000 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
      decreased to $1.4 million in the three month period ended June 30, 2005 from
      $1.7 million in the comparable 2004 period. Net cost of advertising costs will
      vary based on available vendor programs.


·
            Gross
                advertising expense decreased to $1.5 million for the second quarter
                of
                2005 compared to $1.8 million in the second quarter of 2004.


·
            The
                Company’s gross advertising reimbursements increased to $116,000 in 2005
                from $105,000 in 2004.





*Interest
      Expense.* Interest
      expense was $63,000 for the quarter ended June 30, 2005 compared to $97,000
      in
      the second quarter of 2004. The Company’s use of its line of credit incurred
      interest expense of $37,000 and $71,000 for the periods ended June 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 $13,000 for the three months ended June 30, 2005 compared to $7,000
      at June 30, 2004. The increase was primarily due to increased finance charges
      collected from certain customers.





15
 *Index*





*Provision
      for Income Taxes.* The
      provision for income taxes for the quarter ended June 30, 2005 was $811,000
      compared to $720,000 in the comparable period of the prior year. The Company’s
      effective tax rate expressed as a percentage of income before taxes was 38.5%
      for the quarter ended June 30, 2005, flat compared to the quarter ended June
      30,
      2004.





*Net
      Income.* Net
      income for the quarter ended June 30, 2005 was $1.3 million compared to $1.2
      million in the second quarter of 2004. Basic and diluted income per share was
      $0.10 and $0.09, respectively, for the three months ended June 30, 2005 compared
      to $0.08 and $0.08, respectively, for the quarter ended June 30, 2004.





*Comparison
      of Six Month Periods Ended June 30, 2005 and 2004*





*Net
      Sales.* Consolidated
      net sales for the six months ended June 30, 2005 increased 6.7% to $254.0
      million compared to $238.1 million in 2004. The increase is primarily due to
      growth in sales to the Company’s enterprise customers, which increased 16.9% to
      $133.1 million from $113.8 million in the prior year. The Company has increased
      its penetration into existing enterprise customer accounts. Consolidated
      outbound sales (relationship based selling) to commercial and public sector
      customers increased 12.8% to $243.1 million in the first half of 2005 from
      $215.6 million in the first half of 2004. Sales by the Company’s inbound (demand
      response selling) departments declined to $10.9 million during the first half
      of
      2005 compared to $22.5 million for the six months ended June 30, 2004, and
      declined as a percent of total sales to 4.3% from 9.5%. 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 $29.3 million for the six months ended
      June 30, 2005, compared to $28.2 million in the first half of 2004. Gross profit
      as a percentage of net sales decreased to 11.5% in the six months ended June
      30,
      2005 compared to 11.8% in 2004. The decline is primarily due to product mix.
      Sales of desktops and servers and software as a percent of sales represent
      22.3%
      and 16.4%, respectively, of first half of 2005 sales. The gross margin
      associated with these product lines is generally lower than other product lines.
      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.





*Selling,
      General and Administrative (“SG&A”) Expenses.* SG&A
      expense dollars increased to $22.2 million for the six months ended June 30,
      2005 compared to $21.3 million in 2004. As a percent of sales, SG&A was 8.7%
      for the six months ended June 30, 2005 compared to 8.9% for the first half
      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 $1.5 million for the first half of 2005
                compared to the same period of the prior year. The Company’s total
                headcount increased 6.1% to 590 team members at June 30, 2005 from
                556 at
                June 30, 2004 primarily due to staffing the warehouse operations
                in the
                Bensenville facility.


·
            Credit
                card processing fees in the first half of 2005 declined $157,000
                compared
                to the same period of the prior year. The decline is due to the Company’s
                focus on outbound selling to businesses, which tend to purchase on
                open
                account rather than credit card.


·
            Professional
                fees increased $190,000 for the first half of 2005 compared to the
                first
                half of the prior year. The increase is primarily due to increased
                Board
                of Directors fees and consulting fees associated with the Company’s
                documentation of internal controls.


·
            For
                the six month periods ending June 30, 2005 and 2004, warehousing
                and
                distribution network costs totaled $1.0 million and $801,000 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.





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 $3.1 million in the six month period ended June 30, 2005 from
      $3.6
      million in the comparable 2004 period. Net cost of advertising will vary based
      on available vendor programs.


·
            Gross
                advertising expense decreased to $3.4 million for the first half
                of 2005
                compared to $3.8 million in 2004.


·
            The
                Company’s gross advertising reimbursements increased to $253,000 in 2005
                from $200,000 in 2004.





*Interest
      Expense.* Interest
      expense was $160,000 for the six months ended June 30, 2005 compared to $184,000
      in the first half of 2004. The Company’s use of its working capital line
      incurred interest expense of $97,000 and $119,000 for the six month periods
      ended June 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 $50,000 for the six months ended June 30, 2005 compared to $17,000
      at
      June 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 six months ended June 30, 2005 was $1.5
      million compared to $1.2 million in the comparable period of the prior year.
      The
      Company’s effective tax rate expressed as a percentage of income before taxes
      was 38.3% for the six months ended June 30, 2005, compared to 38.8% in 2004.





*Net
      Income.* Net
      income for the six months ended June 30, 2005 was $2.4 million compared to
      $1.9
      million in the first half of 2004. Basic and diluted income per share was $0.18
      and $0.17, respectively, for the six months ended June 30, 2005 compared to
      $0.14 and $0.13, respectively, for the six months ended June 30, 2004.





**Liquidity
      and Capital Resources**





As
      of
      June 30, 2005, the Company had total assets of $95.0 million, of which $84.8
      million were current assets. At
      June
      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
      $29.3 million and $27.0 million at June 30, 2005 and December 31, 2004,
      respectively.





Net
      cash provided by operating activities was $475,000 for the six months ended
      June
      30, 2005 compared to $6.2 million for the six months ended June 30, 2004. The
      primary factors that affected cash flow from operations were accounts payable
      and inventory financing, and inventories. The balance in accounts payable and
      inventory financing decreased $6.7 million. The accounts payable and inventory
      financing balance change is due to purchasing and payment cycles, and the
      Company’s decision to take advantage of additional early pay discounts.
      Inventories decreased $1.9 million, primarily due to quicker inventory turnover.
      The Company’s inventory turnover increased to 28 days at June 30, 2005 from 26
      at December 31, 2004. Included in inventory at June 30, 2005 was
      $3.5 million of inventories not available for sale at June 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 six months ended June 30, 2005 was
      $816,000. Cash outlays for capital expenditures were $816,000 and $1.3 million
      for the six months ended June 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 half 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.





The
      Company’s financing activities 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.





17
 *Index*





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 three months ended June 30, 2005, the
      Company purchased and retired 36,150 shares of its common stock at a total
      cost
      of $130,000 (an average price of $3.59 per share). For the six months ended
      June
      30, 2005, the Company purchased and retired a total of 201,650 shares of its
      common stock at a total cost of $779,000 (average price of $3.86). Over the
      past
      twelve months, the Company has purchased and retired a total of 650,040 shares
      of its common stock at a total cost of $2.1 million (average price of $3.27).
      In
      July 2005, the Board of Directors authorized the continuation of the Company’s
      share repurchase program. 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.





At
      June
      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 June 30, 2005,
      the
      Company was compliant with all covenants of this facility. At June 30, 2005,
      there was $3.9 million of working capital advances outstanding and $7.5 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 any amounts owed to the former shareholders
      of CPCS and the remaining balance of $3.0 million authorized in the Company’s
      stock repurchase program, 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.





*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, 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.





18
 *Index*





*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, 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 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 expects
      to hire approximately 15 to 25 new account executives each month subject to
      economic conditions. However, there are no assurances that the Company will
      be
      able to 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
      51.3% 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 55.1% 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.





*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.





19
 *Index*





*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, 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 and IBM, 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.





*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.





*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.





20
 *Index*





*Major
      Customer.* One
      of
      the Company’s customers, IBM Global Services, represented 13.8% and 13.6% of
      total sales for the three and six months ended June 30, 2005. In the prior
      year,
      sales to this customer represented 10.2% of total sales for the three months
      ended June 30, 2004, but represented less than 10% of total sales for the six
      months ended June 30, 2004. The loss of this customer could have a material
      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, 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.





*Reliance
      on Distribution* .
      The
      Company operates a warehouse and distribution center in Bensenville, Illinois.
      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 may move its Henderson, NV warehouse
      to the Pacific Northwest. 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 adverst
      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.





**Item
                3.**
            **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.





21
 *Index*





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, PricewaterhouseCoopers 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, 2006. 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 PricewaterhouseCoopers 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
      of 2004, the Company’s Board of Directors authorized a share repurchase
      program under which the Company may repurchase up to $3.0 million in shares
      of
      the Company’s common stock until July 2005 in open market or private
      transactions at then prevailing market prices.





In
      July
      2005, the Board of Directors authorized the continuation of the Company’s share
      repurchase program. 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.





The
      following table sets forth information on the Company’s common stock repurchase
      program for the quarter ended June 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**April
                1, 2005 through April 30, 2005
            
            0
            
            $-
            
            0
            
            $
                1,002,449May
                1, 2005 through May 31, 2005
            
            36,150
            
            $3.59
            
            36,150
            
            $   
                872,758June
                1, 2005 through June 30, 2005
            
            0
            
            $-
            
            0
            
            $   
                872,758




22
 *Index*





**Item
                4.**
            **Submission
                of Matters to a vote of Security
                Holders**





(a)
            The
                Company held its annual meeting of shareholders on May 5,
                2005.





(b)
            Two
                matters were voted upon and approved by the shareholders. The presentation
                below describes the matters voted upon and the results of the shareholders
                vote.




1. 
      Election of Directors





**Nominee**
            
            **Votes
                For**
            
            **Withheld**John
                H. Bauer
            
            11,914,587
            
            32,454John
                T. Carleton
            
            11,909,582
            
            37,459Firoz
                H. Lalji
            
            11,905,219
            
            41,822Kathryn
                Hatch
            
            11,912,784
            
            34,257William
                C. Keiper
            
            11,908,219
            
            41,822





2. 
      Ratification of Appointment of PricewaterhouseCoopers LLP as the Company’s
      independent registered public accounting firm





**Votes
                For**
            
            **Votes
                Against**
            
            **Abstentions**
            
            **Broker
                Non Votes**11,927,030
            
            8,256
            
            11,755
            
            1,411,493




23
 *Index*





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


(a)
            Exhibits





Exhibit
                No.
            Description
            Filed
                Herewith
            Incorporated
                by ReferenceForm
            Exhibit
                No.
            File
                No.
            Filing
                Date10.1
            Summary
                of board meeting fees and basic compensation for members of the Board
                of
                Directors
            X10.2
            Form
                of Stock Option Agreement (used for grants to outside directors under
                the
                2003 Equity Incentive Plan)
            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:
                August 10, 2005By:
            /S/ 
                FIROZ H. LALJIFiroz
                H. Lalji, Chairman and Chief Executive Officer/S/
                 RONALD P. MCFADDENRonald
                P. McFadden, Chief Financial Officer





24