|UNITED STATESSECURITIES
AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
|-------------------------------------------------------------------------------

||X| | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- | ---------------------------------------------------------------------------------------

|FOR THE QUARTERLY
PERIOD ENDED SEPTEMBER 30, 2002



OR
|-------------------------------------------------------

||_| | TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE TRANSITION PERIOD FROM _______ TO _______
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|Commission File Number
0-28488



ZONES, INC
(Exact name of registrant as specified in its charter)
|---------------------------------------------------------------------------------------------------

|                               | 
|------------------------------ | 
|Washington                     | 
|(State
      of Incorporation) | 
|                               | 

|707
      South Grady Way                      |  |            | 
|---------------------------------------------- |  | ---------- | 
|Renton,
      Washington                       |  | 98055-3233 | 
|(Address
      of Principal Executive Offices) |  | (Zip Code) | 

|(425) 430-3000
(Registrants TelephoneNumber, 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 |_|


The number of shares of the
registrants Common Stock outstanding as of November 7, 2002 was 13,609,956.

1
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ZONES, INC.



INDEX
|--------------------

|                                                                         | 
|------------------------------------------------------------------------ | 
|PART
      I. FINANCIAL INFORMATION                                      | 
|                                                                         | 
|Item 1. Consolidated
      Financial Statements: (unaudited)             | 
|                                                                         | 
|Consolidated Balance Sheets                                              | 
|September 30, 2002 and December 31,
      2001                           | 
|                                                                         | 
|Consolidated Statements of Operations                                    | 
|Three and nine months ended September
      30, 2002 and 2001            | 
|                                                                         | 
|Statement of Shareholders Equity                                        | 
|Nine months ended September 30, 2002                                     | 
|                                                                         | 
|Consolidated Statements of Cash Flows                                    | 
|Nine months ended September 30, 2002
      and 2001                      | 
|                                                                         | 
|Notes to Consolidated Financial Statements                               | 
|                                                                         | 
|                                                                         | 
|Item 2. Managements
      Discussion and Analysis of                    | 
|Financial Condition and Results of Operations                            | 
|                                                                         | 
|Item 3. Quantitative
      and Qualitative Disclosures About Market Risk | 
|                                                                         | 
|Item 4. Controls
      and Procedures                                    | 
|                                                                         | 
|PART
      II. OTHER INFORMATION                                         | 
|                                                                         | 
|Item 1. Legal
      Proceedings                                          | 
|                                                                         | 
|Item 6. Exhibits
      and Reports on Form 8-K                           | 
|                                                                         | 
|Signatures                                                               | 
|                                                                         | 
|Certifications                                                           | 
|                                                                         | 

|2
|-

|Part
        I.



      Item 1Financial
        Statements

      
      
      ZONES,
        INC.
        CONSOLIDATED BALANCE SHEETS
        (in thousands)
        (unaudited)
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                        | September 30,
      2002 |           | December 31,
      2001 |         
|------------------------------------------------------- | ------------------------ | --------- | ----------------------- | --------
|ASSETS                                                  |                          |           |                         |         
|Current assets:                                         |                         
|Cash
      and cash equivalents                         |                          | $   9,210 |                         | $ 12,141
|Restricted
      cash                                   |                          | 930       |                         | 930     
|Receivables,
      net                                  |                          | 33,776    |                         | 32,120  
|Inventories,
      net                                  |                          | 12,083    |                         | 16,896  
|Prepaid
      expenses                                  |                          | 1,096     |                         | 979     
|Deferred
      tax asset                                |                          | 1,743     |                         | 1,743   
|                                                        |                          |           |                         |         
|Total
      current assets                              |                          | 58,838    |                         | 64,809  
|Property
      and equipment, net                       |                          | 5,985     |                         | 7,543   
|Deferred
      tax asset                                |                          | 4,834     |                         | 5,207   
|Other assets                                            |                          | 300       |                         | 342     
|                                                        |                          |           |                         |         
|Total
      assets                                      |                          | $ 69,957  |                         | $ 77,901
|                                                        |                          |           |                         |         
|LIABILITIES
      AND SHAREHOLDERS EQUITY              |                         
|Current liabilities:                                    |                         
|Accounts
      payable                                  |                          | $ 31,417  |                         | $ 37,994
|Accrued
      liabilities                               |                          | 5,511     |                         | 6,126   
|Current
      portion of capital lease obligations      |                          | 514       |                         | 1,412   
|                                                        |                          |           |                         |         
|Total
      current liabilities                         |                          | 37,442    |                         | 45,532  
|Capital lease
      obligations, net of current portion |                          | 31        |                         | 226     
|Other liabilities                                       |                          | 308       |                         | 585     
|                                                        |                          |           |                         |         
|Total
      liabilities                                 |                          | 37,781    |                         | 46,343  
|                                                        |                          |           |                         |         
|Commitments
      and contingencies                     |                         
|Shareholders
      equity:                             |                         
|Common
      stock                                      |                          | 39,541    |                         | 39,500  
|Accumulated
      deficit                               |                          | (7,365    | )                       | (7,942  
|                                                        |                          |           |                         |         
|Total
      shareholders equity                        |                          | 32,176    |                         | 31,558  
|                                                        |                          |           |                         |         
|Total
      liabilities and shareholders equity        |                          | $ 69,957  |                         | $ 77,901
|                                                        |                          |           |                         |         

|See notes to
consolidated financial statements


3
|--------------------------------------------------

|ZONES, INC. AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except earnings per share)(unaudited)
|---------------------------------------------------------------------------------------------------------------------

|                                                | Three months
      ended
      September 30, |              | Nine months
      ended 
      September 30, |            
|----------------------------------------------- | -------------------------------------------- | ------------ | -------------------------------------------- | -----------
|
|Net
      sales                                 |                                              | $ 102,365    |                                              | $ 120,723  
|Cost
      of sales                             |                                              | 91,595       |                                              | 108,551    
|                                                |                                              |              |                                              |            
|Gross
      profit                              |                                              | 10,770       |                                              | 12,172     
|                                                |                                              |              |                                              |            
|Selling,
      general and administrative       |                                              | 10,556       |                                              | 12,629     
|                                                |                                              |              |                                              |            
|Income
      (loss) from operations             |                                              | 214          |                                              | (457       
|                                                |                                              |              |                                              |            
|                                                |                                              |              |                                              |            
|Interest
      (income) expense, net            |                                              | 22           |                                              | 33         
|Other
      (income) expense, net               |                                              | (19          | )                                            | (47        
|Minority
      interest                         |                                              |              |                                              |            
|                                                |                                              |              |                                              |            
|Other (income) expense                          |                                              | 3            |                                              | (14        
|                                                |                                              |              |                                              |            
|Income
      (loss) before income taxes         |                                              | 211          |                                              | (443       
|Provision
      (benefit) for income taxes      |                                              | 87           |                                              | (186       
|                                                |                                              |              |                                              |            
|Net
      income (loss)                         |                                              | $        124 |                                              | $      (257
|                                                |                                              |              |                                              |            
|                                                |                                              |              |                                              |            
|Basic
      earnings (loss) per share           |                                              | $       0.01 |                                              | $    (0.02 
|                                                |                                             
|Shares
      used in computing basic earnings   |                                             
|(loss)
      per share                          |                                              | 13,594       |                                              | 13,499     
|                                                |                                              |              |                                              |            
|Diluted
      earnings (loss) per share         |                                              | $       0.01 |                                              | $    (0.02 
|                                                |                                             
|Shares
      used in computing diluted earnings |                                             
|(loss)
      per share                          |                                              | 13,705       |                                              | 13,499     

|See notes to
consolidated financial statements


4
|--------------------------------------------------

|ZONES, INC.STATEMENT OF
SHAREHOLDERS EQUITY(in thousands, except share data)(unaudited)
|----------------------------------------------------------------------------------------

|                                  | Common
      Stock |            | Accumulated |         |  |        
|--------------------------------- | ------------------ | ---------- | ----------- | ------- |  | -------
|
|Balance,
      January 1, 2002    |                    | 13,536,406 |             | $39,500 |  | $(7,942
|Issuance
      of common stock    |                    | 57,980     |             | 41      |  |        
|Net income                        |                    |            |             |         |  | 577    
|                                  |                    |            |             |         |  |        
|Balance,
      September 30, 2002 |                    | 13,594,386 |             | $39,541 |  | $(7,365
|                                  |                    |            |             |         |  |        

|See notes to
consolidated financial statements


5
|--------------------------------------------------

|ZONES, INC.CONSOLIDATED
STATEMENTS OF CASH FLOWS(in thousands)(unaudited)
|-------------------------------------------------------------------------

|                                                           | Nine months
      ended
      September 30, |           
|---------------------------------------------------------- | ------------------------------------------- | ----------
|
|Cash
      flows from operating activities:                |                                             |           
|Net
      income (loss)                                    |                                             | $      577
|Adjustments
      to reconcile net income (loss) to net    |                                            
|cash
      provided by (used in) operating activities:     |                                            
|Depreciation
      and amortization                        |                                             | 2,815     
|Deferred
      income taxes                                |                                             | 373       
|Loss
      on disposal of asset                            |                                             | 14        
|Minority
      interest                                    |                                             |           
|Changes
      in assets and liabilities:                   |                                             |           
|Receivables,
      net                                     |                                             | (1,656    
|Inventories,
      net                                     |                                             | 4,813     
|Prepaid
      expenses and other assets                    |                                             | (75       
|Accounts
      payable                                     |                                             | (7,037    
|Accrued
      and other liabilities                        |                                             | (892      
|                                                           |                                             |           
|Net
      cash (used in) provided by operating activities  |                                             | (1,068    
|                                                           |                                            
|Cash flows
      from investing activities:                |                                            
|Purchases
      of property and equipment                  |                                             | (1,271    
|                                                           |                                             |           
|Net
      cash used in investing activities                |                                             | (1,271    
|                                                           |                                            
|Cash flows
      from financing activities:                |                                            
|Net
      change in book overdraft                         |                                             | 460       
|Net
      proceeds from sale of common stock               |                                             | 41        
|Net
      proceeds from capital lease                      |                                             |           
|Payments
      on capital leases                           |                                             | (1,093    
|                                                           |                                             |           
|Net
      cash (used in) provided by financing activities  |                                             | (592      
|                                                           |                                            
|Net (decrease)
      increase in cash and cash equivalents |                                             | (2,931    
|Cash and
      cash equivalents at beginning of period     |                                             | 12,141    
|                                                           |                                             |           
|                                                           |                                            
|Cash and
      cash equivalents at end of period           |                                             | $   9,210 
|                                                           |                                             |           

|See notes to
consolidated financial statements



6
|---------------------------------------------------

|ZONES, INC.NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS(unaudited)



1. Description of
Business


Zones, Inc. (the Company)
is a single-source, multi-vendor direct reseller of name-brand information technology
products to the growing small to medium sized business market (SMB),
enterprise and government and education accounts. The Company sells these products through
outbound and inbound account executives, specialty print and e-catalogs and the Internet.
The Company offers more than 150,000 products from leading manufacturers including Apple,
Hewlett-Packard, IBM, Microsoft and Toshiba.


The Company was incorporated in
November 1988 as a Washington corporation. The Companys headquarters are located in
Renton, Washington.



2. Summary of
Significant Accounting Policies


The accompanying unaudited
consolidated 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. In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial position and operating results for the interim
periods. 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, 2001 as filed with the
Securities and Exchange Commission on February 26, 2002.



Principles of
Consolidation


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



Property and Equipment


Property and equipment is recorded at
cost. Depreciation is computed based on the straight-line method over the estimated useful
lives of the related assets. Useful lives for computer hardware and software range from 3
to 5 years and other property and equipment from 3 to 10 years. Capital leases are
amortized based on the straight-line method over the estimated useful lives of the related
assets or lease life, whichever is shorter, generally 3 to 10 years. Expenditures for
maintenance and repairs are charged to expense as incurred, while additions, renewals and
improvements are capitalized. Gains or losses from sales or retirements are included in
other income and expense. The Company evaluates the carrying value of long-lived assets
based upon current and anticipated undiscounted cash flows, and recognizes impairment when
it is probable that such estimated future net cash flows will be less than the asset
carrying value.


In January 2002, the Company revised
its estimate of the useful lives of certain technology assets. These changes reduced
amortization for the three and nine months ended September 30, 2002 by approximately
$203,000 and $893,000, respectively, and increased net income by $119,000 and $542,000,
respectively. The change was made to better reflect the estimated periods during which the
assets will remain in service. The revision was primarily due to the Companys
planned investment in a new enterprise system that was cancelled due to the economic
environment. As a result, the Company reevaluated the useful life of its existing
enterprise system, in conjunction with the estimated life of its investment in web
development.



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. To eliminate the need to defer revenue according to SEC Staff
Accounting Bulletin No. 101 Revenue Recognition in Financial Statements, Zones
will insure all orders shipped during the last seven calendar days of its calendar
quarter. The underlying intent is to allow revenue to be recognized at the point of
shipment, as title and risk and rewards of ownership pass to the customer, but the burden
of loss shifts from the seller to the insurance company. Additionally, 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.
7
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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. The Company excludes all options to purchase common stock from the
calculation of diluted net loss per share if such securities are antidilutive.



Recent Accounting
Pronouncements


In August 2001, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards No. 144
Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS
144). SFAS 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the
disposal of a segment of a business. The provisions of SFAS 144 are effective for fiscal
years beginning after December 15, 2001. The adoption of SFAS 144 on January 1, 2002 did
not have a material impact on the Companys results of operations or financial
position.


In June 2002, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards 146
Accounting for the Costs Associated with Exit or Disposal Activities
(SFAS 146). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities. SFAS 146 nullifies Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). SFAS 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized and measured initially at fair value only when the
liability is incurred. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does not believe the
adoption of SFAS 146 will have a significant impact on the Companys results of
operations or financial position.

8
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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. The options may 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).
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                     | Three months
      ended
      September 30, |           | Nine months
      ended
      September 30, |            
|---------------------------------------------------- | -------------------------------------------- | --------- | ------------------------------------------- | -----------
|
|Basic
      earnings (loss) per share:               |                                              |           |                                             |            
|                                                     |                                             
|Income (loss)
      available to common shareholders |                                              | $     124 |                                             | $      (257
|                                                     |                                              |           |                                             |            
|Weighted
      average shares outstanding            |                                              | 13,594    |                                             | 13,499     
|                                                     |                                              |           |                                             |            
|Basic earnings
      (loss) per share                |                                              | $    0.01 |                                             | $     (0.02
|                                                     |                                              |           |                                             |            
|Diluted
      earnings (loss) per share:             |                                             
|                                                     |                                             
|Net income
      (loss)                              |                                              | $     124 |                                             | $      (257
|                                                     |                                             
|Weighted
      average shares outstanding            |                                              | 13,594    |                                             | 13,499     
|Diluted effect
      of stock options                |                                              | 111       |                                             |            
|                                                     |                                              |           |                                             |            
|Total common
      shares and dilutive securities    |                                              | 13,705    |                                             | 13,499     
|                                                     |                                              |           |                                             |            
|                                                     |                                             
|Diluted earnings
      (loss) per share              |                                              | $    0.01 |                                             | $     (0.02
|                                                     |                                              |           |                                             |            

|Options with exercise prices greater
than the average market price for the periods indicated were not included in the
computation of diluted earnings per share because the effect of the options on the
calculation would have been anti-dilutive. These options totaled 1,480,902 for the
three and nine months ended September 30, 2002 and 1,651,690 for the three and nine months
ended September 30, 2001.



4. Commitments and
Contingencies



Legal Proceedings


Except as noted below, various legal
claims and actions considered normal to the Companys business have been asserted and
are pending against the Company. The Company believes that such claims and actions will
not have a material adverse effect upon the Companys business, financial position,
cash flows or results of operations.


The Washington State Department of
Revenue (the Department) is currently examining the Companys state tax
returns for the years 1996, 1997, 1998 and 1999. The Company has received a final report
from the auditor, and the Department has assessed $2.1 million plus approximately $800,000
of accrued interest. The Company disagrees with substantially all of the deficiencies and
is contesting such deficiencies through the administrative appeals process. There can be
no assurance that the Company will be successful, in whole or in part, in challenging the
proposed deficiencies. Additionally, the Department may also make a similar assessment for
2000, 2001 and 2002. An unfavorable decision could have a material adverse effect on the
Company.


The Company has been named as a
defendant in Massachusetts Institute of Technology, et al. v. Abacus Software, Inc., et
al., which is pending in the U.S. District Court for the Eastern District of Texas,
Texarkana Division, Case No. 501-CV-344. Plaintiffs allege that scanners and digital
cameras manufactured by other entities and sold by the Company infringe on United States
Patent No. 4,500,919, a patent assigned to plaintiff Massachusetts Institute of Technology
and licensed to co-plaintiff Electronics for Imaging, Inc. The Company has retained
counsel to defend its interests in this action and believes that it has strong defenses to
plaintiffs claims, including defenses as to the validity of the patent and as to
patent marking issues. The Company is one of 214 original defendants sued in this patent
infringement action. The case is in its infancy and the parties have only recently
exchanged their initial disclosures. The Company does not believe that the claims will
have a material adverse effect on its business, financial position, cash flows or results
of operations; however, it is not yet possible to accurately assess the extent of its
exposure to such claims.

9
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Liquidity


The Companys net amount of
accounts payable outstanding at September 30, 2002 was $31.4 million, of which $14.6
million of non-interest bearing amounts were drawn from a $35.0 million credit facility,
which is collateralized by inventories and accounts receivable. The Companys credit
facility was renewed on September 16, 2002, and expires July 21, 2003.


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 for at least the next 12
months at its current revenue level. However, if the Companys future revenues
decline below the current level, or if working capital erodes and other capital
requirements are greater than currently anticipated, the Company could be required to 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


SFAS 131, Disclosures About
Segments of an Enterprise and Related Information, requires that public companies
report profits and losses and certain other information on their reportable operating
segments. These segments are based on the method of internal reporting used by the
decision-maker of the Company to allocate resources and assess performance.


In the third quarter of 2001, the
Company replaced its operating unit approach with a single segment approach. The
Companys one reportable segment is a single-source, multi-vendor direct reseller of
name-brand information technology products to small to medium sized businesses,
enterprise, and government and education markets.


Substantially all of the
Companys net sales for the three and nine months ended September 30, 2002 were made
to customers located in the United States. All of the Companys assets at September
30, 2002 and December 31, 2001 were located within the United States. Sales to one of the
Companys customers represented 10.6% and 15.6% of total sales for the three and nine
months ended September 30, 2002. Net sales to this customer were $10.8 million and $48.3
million for three and nine months ended September 30, 2002, compared to $33.2 million and
$127.6 million for three and nine months ended September 30, 2001. The contract with this
customer will be up for renewal in June 2003



      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, 2001, which was
filed on February 26, 2002 with the Securities Exchange Commission.


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



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.

10
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|No Assurance as to Levels of
Revenue or 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 general economic conditions and the level of corporate
investment in new IT related capital equipment. There has been a decreased demand for the
products the Company sell that has adversely affected its sales and results of operations.
There is no assurance that the Companys sales will not further decline, or that the
Company will be able to maintain being profitable in the face of further declining sales.
Either of which would further adversely affect the Companys business, financial
condition, cash flows or results of operations.


Variability of Operating
Results. The Company has experienced significant fluctuations in its operating results
from quarter to quarter as a result of many factors, including investment in activities to
increase the productivity of its sales team, general economic conditions, the condition of
the computer products industry, shifts in demand for computer products and industry
announcements of new products or upgrades. For this reason, period to period comparisons
of the Companys financial results may not accurately forecast future
performance.  If the Company is not profitable on a quarterly or annual basis, or if
future operating results fall below the expectations of securities analysts or investors,
its common stock price may decline.


Pressure on Margins. The
computer products industry has experienced intense price competition. The Company believes
that its competition may aggressively price their product offerings to gain market
share.  The Company may be required to reduce its profit margins to remain
competitive in the future.  The slowdown in U.S. corporate IT spending has created a
more intense competitive landscape that is disrupting the stability of pricing and
exerting downward pressure on profit margins across all product lines.  Additionally,
a number of manufacturers are providing their products direct to customers.  There
can be no assurance that the Company will be able to maintain its gross margins in the
future. If it is unable to maintain gross margins in the future, this could have an
adverse effect on business, financial condition, cash flows or results of operations.


Competition. The
computer products industry is highly competitive. The Company believes           that
product selection, availability and price are the three most important
          competitive factors. The Company competes with other national direct marketers,
          including CDW Computer Centers, Inc., Insight Enterprises, Inc., PC Connection,
          and PC Mall, Inc. The Company also competes with product manufacturers, such as
          Dell and Gateway, that sell direct to end-users and with large manufacturers,
          such as Hewlett Packard and IBM which are refining a customer direct model;
          specialty computer retailers; computer and general merchandise superstores; and
          consumer electronic and office supply stores. Many of these competitors rely
          heavily on the Internet as a marketing and sales channel. Some of the
          Companys larger competitors compete principally on the basis of price and
          may 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 and better-financed competitors
          as a consequence of such consolidation. Additional competition may also arise
if           other methods of distribution emerge in the future. The Company competes not
          only for customers, but also for co-op advertising support from computer
product           manufacturers. 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 Sales or Use Tax
Uncertainties. The Company currently collects sales taxes or similar taxes on sales to
customers in the States of Washington, Nevada, Tennessee, Illinois and Ohio. Various
states have sought to require direct marketers to collect sales taxes on sales shipped to
residents of those states. 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 mail order company whose contacts with the state are 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 interstate common
carrier. However, legislation that would expand the ability of states to impose sales tax
collection obligations on direct marketers has been introduced in Congress on many
occasions. Due to its presence in various forms of electronic media and other factors,
states could argue that the Companys current contact with various states exceeds the
level of contact involved in the Supreme Court case. The Company cannot predict with
certainty the level of contact that is sufficient to permit a state to impose a sales tax
collection obligation on the Company. If legislation is passed to overturn the Supreme
Court decision, the requirement to collect sales taxes or similar taxes on sales would
result in additional administrative expenses for us, could result in increased prices to
customers and could have a material adverse effect on the Companys business,
financial condition, cash flows or results of operations.

11
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|The Company drop-ships product into
various states in which it does not collect sales tax.  There can be no assurance
that drop-ship sales will not be taxed in the future and, if such transactions are taxed,
there can be no assurance that the Company will be able to maintain the same level of
sales in these states.


The Washington State Department of
Revenue (the Department) is currently examining the Companys state tax
returns for the years 1996, 1997, 1998 and 1999. The Company has received a final report
from the auditor, and the Department has assessed $2.1 million plus approximately $800,000
accrued interest. The Company disagrees with substantially all of the deficiencies and is
contesting such deficiencies through the administrative appeals process. There can be no
assurance that the Company will be successful, in whole or in part, in challenging the
proposed deficiencies. Additionally, the Department may also make a similar assessment for
2000, 2001 and 2002. An unfavorable decision could have a material adverse effect on the
Company.


Major Customer. Sales to one
of the Companys customers represented 10.6% and 15.6% of total sales for the three
and nine months ended September 30, 2002, compared to 27.5% and 29.9% for the three and
nine months ended September 30, 2001. Net sales to this customer were $10.8 million and
$48.3 million for three and nine months ended September 30, 2002, compared to $33.2
million and $127.6 million for three and nine months ended September 30, 2001. The
contract with this customer will be up for renewal in June 2003. There are no assurances
that the contract will be renewed under the terms and conditions that currently exist, or
that the contract will continue through the completion of its term. Additionally, the
Company is currently designated as a minority-owned business for purposes of qualifying as
a vendor for certain sales. There can be no assurances that this designation will
contribute to future growth or that the Company will continue to hold this designation or
to qualify for such sales.


Vendor Support. The Company
has various relationships with its vendors, whose programs contribute to profitability.
The Company relies on its vendor partners for co-op advertising, which is a pass-through
of expenses associated with catalogs, e-vehicles and direct mail pieces. In addition,
certain manufacturers and distributors provide the Company with incentives in the form of
rebates, discounts and trade allowances. If any of these relationships are terminated,
there can be no assurance that the Companys business, financial condition, cash
flows or results of operations will not be adversely affected.


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 direct marketers 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.


Rapid Technological Change and
Inventory Obsolescence. The computer industry is characterized by rapid technological
change and frequent introductions of new products and product enhancements. In order to
satisfy customer demand and obtain greater purchase discounts, the Company may be required
to carry increased inventory levels of certain products, which will subject 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
obsolete inventory. 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 such as only holding stock
on hand for a two-week sell through run-rate, there can be no assurance that the Company
will be able to avoid losses related to obsolete inventory.


Reliance on Outsourced
Distribution. Airborne Logistics Services, an affiliate of Airborne Express, provides
and operates a warehouse and distribution center for the Company in Wilmington, Ohio under
a renewable contract that expires in August 2003. Any limitation or interruption of the
service being provided by Airborne Logistics could have a material adverse effect on the
Companys business, financial condition, cash flows or results of operations. Certain
distributors also participate in the Companys logistics 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.

12
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|Major Shareholder. Firoz H.
Lalji, the Companys Chairman and Chief Executive Officer, beneficially owns 46.5% of
the outstanding shares of the Companys common stock, excluding shares that he may
acquire upon exercise of stock options that he holds. If Mr. Lalji exercises all options
and retains the shares of common stock issued to him upon such exercise, his collective
ownership would increase to 48.9% of the outstanding shares of the Companys common
stock. The voting power of these shares will likely enable 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 impeded 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.


Dependence on Key Personnel.
The Companys future success will depend to a significant extent upon the 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 and results of operations.


Potential Increases in Postage,
Shipping and Paper Costs. Postage and shipping costs, as well as the cost of paper for
the Companys catalogs, are significant expenses in the operation of the
Companys business. The Company generally mails its catalogs through the U.S. Postal
Service and ships its products to customers by overnight delivery. Any future increases in
postage, shipping rates or paper costs could have a material adverse effect on the
Companys business, financial condition, cash flows or results of operations.


Changing Methods of
Distribution. The market for computer products is evolving rapidly in terms of product
offerings and methods of distribution. New methods of distribution, such as on-line
shopping services and electronic distribution of software, have emerged. Additionally,
some manufacturers sell their hardware and software products directly to individual
end-users or corporate accounts. These methods of distribution have resulted in increased
patronage and other new methods of distribution may emerge in the future. The Company will
be required to remain competitive with existing and evolving distribution channels and
methods, and may be required to develop or adopt new methods for distribution in the
future. Failure by the Company to do so could have a material adverse effect on its
business, financial condition, cash flows or results of operations.


Potential Disruption of
Business. The Companys success is dependent in part on the quality, reliability
and proper utilization of its information, telecommunication, desktop publishing and other
systems, which are used for web-based distribution, marketing, catalog design and
production, purchasing, inventory management, order processing, product distribution,
accounts receivable, customer service and general accounting functions. Interruption in
any of the Companys operating systems, Internet systems, Internet connectivity or
telecommunication systems could have a material adverse effect on the Companys
business, financial condition, cash flows or results of operations.



General


The Companys revenues consist
primarily of sales of computer hardware, software, peripherals and accessories, as well as
revenue associated with freight billed to its customers. Net sales are product sales only,
and reflect the effects of product returns. Gross profit consists of net sales less
product and freight costs. Selling, general and administrative expenses include
advertising expense net of vendor co-op, warehousing, selling commissions, order
processing, telephone, credit card fees, and other costs such as administrative salaries,
depreciation, rent, and general overhead expenses. Other (income) expense represents
interest expense and net non-operating expenses.

13
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|Results of Operations


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

|                                                      | Three months
      ended
      September 30, |           | Nine months
      ended
      September 30, |          
|----------------------------------------------------- | -------------------------------------------- | --------- | ------------------------------------------- | ---------
|
|Net
      sales                                       |                                              | 100.0     | %                                           | 100.0    
|Cost
      of sales                                   |                                              | 89.5      |                                             | 89.9     
|                                                      |                                              |           |                                             |          
|Gross
      profit                                    |                                              | 10.5      |                                             | 10.1     
|Selling,
      general and administrative expenses    |                                              | 10.3      |                                             | 10.5     
|                                                      |                                              |           |                                             |          
|Income
      (loss) from operations                   |                                              | 0.2       |                                             | (0.4     
|Other
      (income) expense                          |                                              | 0.0       |                                             | 0.0      
|                                                      |                                              |           |                                             |          
|Income
      (loss) before income taxes               |                                              | 0.2       |                                             | (0.4     
|Provision
      (benefit) for income taxes            |                                              | 0.1       |                                             | (0.2     
|                                                      |                                              |           |                                             |          
|Net
      income (loss)                               |                                              | 0.1       | %                                           | (0.2     
|                                                      |                                              |           |                                             |          
|                                                      |                                             
|Selected
      domestic operating data:               |                                             
|Catalog
      circulation                             |                                              | 2,935,000 |                                             | 4,050,000
|E-media
      circulation                             |                                              | 4,068,000 |                                             | 2,390,000
|Number
      of orders                                |                                              | 124,000   |                                             | 139,000  
|Average
      order size                              |                                              | $822      |                                             | $864     
|Number
      of B2B account executives, end of period |                                              | 206       |                                             | 207      

|Comparison of Three Month
Periods Ended September 30, 2002 and 2001


Net Sales.Net sales for the
quarter ended September 30, 2002 decreased 15.2% to $102.4 million compared to $120.7
million in the third quarter of 2001. The decrease in total net sales resulted primarily
from a decline in sales to a major customer, which decreased 67.4% to $10.8 million for
the quarter ended September 30, 2002 compared to $33.2 million in the same period of 2001.
The Companys fundamental net sales, which exclude sales to this major customer,
increased 4.6% to $91.5 million in the third quarter of 2002 compared to $87.5 million in
the comparable quarter of 2001, and grew 5.2% sequentially from $87.0 million in the
second quarter of 2002. The growth in our fundamental sales was primarily due to an
increase in our inbound Mac-platform sales. The Company continues to look for
opportunities to increase its share of the inbound Mac-platform product market to the
consumer and SOHO customer. Inbound Mac sales increased 8.3% to $19.6 million for the
three months ended September 30, 2002 compared to $18.1 million in the comparable period
in 2001, and increased 14.6% sequentially from $17.1 million in the second quarter of
2002. Additionally, the Company increased its sales in the core SMB market by 2.9% to
$46.0 million in the third quarter of 2002 from $44.7 million in the third quarter of
2001. This increase in core SMB sales was primarily due to the Companys focus on
increasing the productivity of its outbound account executives.


The Companys average order size
decreased to $822 for the three months ended September 30, 2002 from $864 in the third
quarter of 2001. This decrease was primarily due to a decline in sales in the
Companys enterprise division, particularly sales to a major customer, as these sales
generally have larger per order shipments.


Gross Profit. Gross profit
dollar contribution decreased to $10.8 million for the third quarter of 2002, down 11.5%
from the second quarter of 2001, which corresponds to the decline in sales volume.
However, gross profit as a percentage of net sales increased to 10.5% in the quarter ended
September 30, 2002 compared to 10.1% in the third quarter of 2001. This increase in gross
profit margin percentage was primarily due to higher margin product mix and vendor
programs, as well as aggressively taking advantage of early pay discounts. Gross profit
margins as a percent of sales may vary on a quarterly basis due to vendor programs,
product mix, pricing strategies, customer mix, and economic conditions.

14
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|Selling, General and
Administrative (SG&A) Expenses.SG&A expenses decreased 15.9% to
$10.6 million for the quarter ended September 30, 2002 from $12.6 million in the third
quarter of 2001, but increased sequentially 3.9% from $10.2 million in the second quarter
of 2002. The sequential increase was primarily due to increased account executive
headcount. As a percent of sales, SG&A decreased to 10.3% for the quarter ended
September 30, 2002 from 10.5% in the third quarter of 2001. The Company maintained tight
controls on discretionary spending and critically evaluated all advertising expenditures
throughout the third quarter of 2002.


The Company produces and distributes
catalogs at various intervals throughout the year. The Companys net cost of
advertising decreased to $411,000 in the three month period ended September 30, 2002 from
$461,000 in the comparable 2001 period. This decrease in net cost was primarily due to a
decline in the Companys print catalog circulation and the discontinuation of the
Brand catalog.


Other Income/Expense.Other
expense was $3,000 for the quarter ended September 30, 2002 compared to other income of
$14,000 in the third quarter of 2001. The change was primarily due to an increase in
interest expense incurred in the third quarter of 2002 compared with the same period of
2001.


Provision for Income Taxes.
The provision for income taxes for the quarter ended September 30, 2002 was $87,000 as
compared to a benefit of $186,000 in the comparable period of the prior year. The
Companys effective tax rate expressed as a percentage of income before taxes was
41.2% for the quarter ended September 30, 2002 compared to 42.0% for the quarter ended
September 30, 2001.


Net Income.Net income for the
quarter ended September 30, 2002 was $124,000 compared to a net loss of $257,000 in the
third quarter of 2001. Basic and diluted earnings per share was $0.01 for the quarter
ended September 30, 2002 compared to a basic and diluted loss per share of $0.02 in the
third quarter of 2001.



      Comparison
        of Nine Month Periods Ended September 30, 2002 and 2001


Net Sales.Net sales for the
nine months ended September 30, 2002 decreased 27.4% to $310.0 million compared to $427.1
million in the comparable period of 2001. The decrease in sales resulted primarily from
the impact of the sluggish economy that has reduced IT spending by businesses, as well as
a decline in sales to a major customer, which decreased 62.1% to $48.3 million for the
nine months ended September 30, 2002 compared to $127.6 million in the same period of
2001. The Companys fundamental net sales, which exclude sales to this major
customer, decreased 12.6% to $261.7 million in the nine months ended September 30, 2002
compared to $299.5 million in the comparable period of 2001. Total outbound sales to the
small to medium sized businesses (SMB), enterprise and government and
education accounts decreased 29.5% to $257.6 million in the nine months ended September
30, 2002 from $365.5 million in the same period of 2001. Net sales to the inbound Mac
customers decreased 14.8% to $52.4 million for the nine months ended September 30, 2002
compared to $61.5 million in the comparable period in 2001. The Company is continually
looking for opportunities to increase its share of the inbound Mac-platform product market
to the consumer and SOHO customer. Additionally, the Companys sales declined in its
core SMB market 18.6% to $136.1 million in the nine months ended September 30, 2002 from
$167.3 million in the comparable period of 2001.


The Companys average order size
decreased to $821 for the nine months ended September 30, 2002 from $924 in the comparable
period of 2001. This was primarily due to a decline in sales in the Companys
enterprise division, particularly sales to a major customer, as these sales generally have
larger per order shipments.


Gross Profit. Gross profit
dollar contribution decreased to $32.1 million for the nine months ended September 30,
2002, down 23.3% from the same period of the prior year. The decrease in gross profit
dollars was primarily due to the decline in sales volume. Gross profit as a percentage of
net sales increased to 10.4% in the nine months ended September 30, 2002 compared to 9.8%
in the comparable period of 2001. This increase in gross profit margin percentage was
primarily due to higher margin product mix and vendor programs, as well as aggressively
taking advantage of early pay discounts. Gross profit margins as a percent of sales may
vary on a quarterly basis due to vendor programs, product mix, pricing strategies,
customer mix, and economic conditions.

15
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|Selling, General and
Administrative Expenses.SG&A expenses decreased 25.5% to $31.2 million for the
nine months ended September 30, 2002 from $41.9 million in the comparable period a year
ago. The Company eliminated non-productive sales headcount, maintained tight controls on
discretionary spending and critically evaluated all advertising expenditures throughout
2002, while prudently investing in the hiring and development of its account executives in
anticipation of an IT spending rebound. As a percent of sales, SG&A increased to 10.1%
for the nine months ended September 30, 2002 from 9.8% in the comparable period of 2001.


The Company produces and distributes
catalogs at various intervals throughout the year. The Companys net cost of
advertising decreased to $1.1 million in the nine month period ended September 30, 2002
from $2.1 million in the comparable 2001 period. This decrease in net cost was primarily
due to a decline in specialty print catalog circulation, the discontinuation of the PC
Zone and Brand catalogs, and the on-line advertising expense associated with the PC
consumer customer segment.


Other Income/Expense.Other
income was $9,000 for the nine months ended September 30, 2002 compared to other expense
of $111,000 in the nine months ended September 30, 2001. The change was primarily due to a
decrease in interest expense incurred in 2002 compared with the same period of 2001.


Provision for Income Taxes.
The provision for income taxes for the nine months ended September 30, 2002 was $374,000
as compared to a benefit of $47,000 in the comparable period of the prior year. The
Companys effective tax rate expressed as a percentage of income before taxes was
39.3% for the nine months ended September 30, 2002 compared to 43.1% for the nine months
ended September 30, 2001.


Net Income.Net income for the
nine months ended September 30, 2002 was $577,000 compared to net loss of $62,000 in the
comparable period of 2001. Basic and diluted earnings per share were $0.04 for the nine
months ended September 30, 2002 and basic and diluted loss per share were $0.01 for the
nine months ended September 30, 2001.



Trends


During the third quarter, the Company
experienced modest improvement in demand from its fundamental sales channels, which
exclude the demand in sales to a major customer. However, to increase sales by any
meaningful measure in todays economic climate, the Company must increase its overall
market share. A key driver to increased market penetration is the number of account
executives (AEs) available to support new and existing customers. The Company
continues to invest in the future of its business through the recruitment of additional
AEs. The additional headcount may increase selling, general and administrative
(SG&A) expense, but the Company believes that SG&A as a percent of
sales will remain relatively flat as it endeavors to increase sales. Although short term
sequential net sales may experience a slight decline to a nominal increase in relation to
historical patterns, the Company believes it is in a position to leverage its existing
infrastructure to take advantage of any technology spending. In response to a continued
static environment, the Company is focusing on the key elements of its business:
diversification of sales, improvement in gross profit margin, and continued control of
discretionary expenses.


The Company markets its products
across several sectors to drive sales growth, while striving to become one of the leading
business to business direct marketers of IT infrastructure solutions. Its outbound sales
force, in conjunction with the small business group, actively pursues the small to medium
sized business customer. The small business group is the training ground for less tenured
account executives, and is the growth engine for the Company focused on lead generation.
The Company began investing in new account executives in the first half of 2002, and
aggressively pursued hiring during the third quarter of 2002, increasing outbound sales
headcount by 44 team members, and intends to continue hiring account executives in future
quarters. The Company is building a niche in the enterprise business arena, and believes
it is in a position to fulfill enterprise business level needs efficiently and profitably.
During the second quarter, the Company opened a Chicago satellite office to support its
Midwest enterprise endeavors. The Company has high expectations for its Chicago office,
and invested $0.01 per share during the third quarter. Sales to a major customer have
declined year over year, but the Company believes that sales generated by this customer
will stabilize around 10% of overall sales in the fourth quarter of 2002. Additionally,
there is growth potential in its Public Sector division and it is pursuing education,
state and local government initiatives. Lastly, the Companys legacy is in the Mac
market. Increasing Mac market share remains a key objective and the Company intends to
promote Mac-platform products to both its outbound businesses and inbound consumers.

16
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|The economic downturn in the IT
market has led to an intense focus on the key drivers of gross profit margin. This focus
has led to several initiatives intended to grow the Companys gross profit margin
percentage. The initiatives are driven by several factors including: product mix and
related vendor programs, attach rates, freight, purchasing power, account executive
education, pricing strategies as well as taking advantage of early pay discounts. As long
as the economic environment remains sluggish, the Company may experience pricing pressures
in pursuit of increasing its market share.


The Company constantly reviews all
internal processes in an effort to create efficiencies and reduce waste. It continues its
efforts to maintain tight controls over all discretionary expenses, including advertising
expenses, which has been a focal point for the past several quarters due to the existing
economic conditions. The Company anticipates total SG&A costs to increase slightly due
to its investment in the hiring and training of new account executives, as well as the
satellite sales office opened during May of 2002 in Chicago. The Company believes that the
costs associated with the investment in additional headcount will narrow in future
quarters as the account executives mature and become increasingly productive.



Industry


The market for computer products is
characterized by rapid changes and frequent introductions of new products and product
enhancements. These changes result in rapid price fluctuations and have led to continued
average selling price reductions and lower margin dollars per transaction. In order to
remain competitive, the Company may be required to reduce its prices. Such a reduction in
prices could have a material adverse effect on the Companys future results of
operations.



Inflation


The Company does not believe that
inflation has had a material impact on its results of operations. However, there can be no
assurance that inflation will not have such an effect in future periods.



Liquidity and Capital
Resources


As of September 30, 2002, the Company
had total assets of $70.0 million, of which $58.8 million were current assets. At
September 30, 2002 and December 31, 2001 the Company had cash and cash equivalents, and
restricted cash of $10.1 million and $13.1 million, respectively. During 2002, the Company
utilized its cash position to aggressively take advantage of favorable discount terms
offered by certain vendors. The Companys accounts receivable days outstanding
increased to 44 days at September 30, 2002 compared to 32 days at December 31, 2001. The
increase in accounts receivable days outstanding was primarily due to a change in payment
terms with a major customer. However, the Company believes that accounts receivable days
outstanding will stabilize at this level. The Companys working capital was $21.4
million and $19.3 million at September 30, 2002 and December 31, 2001, respectively.


Net cash used by operating activities
was $1.1 million for the nine months ended September 30, 2002 compared to cash provided by
operating activities of $4.5 million for the nine months ended September 30, 2001. The
cash outflow for the nine months ended September 30, 2002 was primarily due to increases
in accounts receivable and decreases in accounts payable and was partially offset by a
decline in inventories. At September 30, 2002, accounts receivable increased $1.7 million
and accounts payable decreased $6.6 million, net of the $460,000 increase in book
overdraft, while inventories decreased by $4.8 million from December 31, 2001.

17
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Cash outlays for capital expenditures
were $1.3 and $2.2 million in the nine months ended September 30, 2002 and 2001,
respectively. These expenditures were primarily for continued improvement, and other
enhancements, of the Companys information systems. The Company will continue to
upgrade its internal information systems as a means to increase operational efficiencies.


The net amount of accounts payable
outstanding at September 30, 2002 was $31.4 million, of which $14.6 million of
non-interest bearing amounts were drawn from a $35.0 million credit facility,
collateralized by inventories and accounts receivable. This credit facility was renewed on
September 16, 2002, and will expire on July 21, 2003. The facility contains various
restrictive covenants relating to profitability, tangible net worth, leverage,
dispositions and use of collateral, other asset dispositions, and a merger and
consolidation of the Company. At September 30, 2002, the Company was in compliance with
all covenants related to its credit facility. For the period ending September 30, 2002,
the Company had no outstanding borrowings on the working capital line of credit.
Additionally, at September 30, 2002, the Company had restricted cash as collateral for an
unused standby letter of credit of $930,000.


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 for at least the next 12
months at its current revenue level. However, if the Companys future revenues
decline below the current level, or if working capital erodes and other capital
requirements are greater than currently anticipated, the Company could be required to 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.



      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


(a) Under
the supervision and with the participation of management, including the           Chief
Executive Officer and Chief Financial Officer, the Company conducted an
          evaluation of its disclosure controls and procedures, as such term is defined
          under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as
          amended (the Exchange Act), within 90 days of the filing date of
          this report. Based on the evaluation, the Chief Executive Officer and Chief
          Financial Officer concluded that the Companys disclosure controls and
          procedures are effective.


(b)     There
have been no significant changes (including corrective actions with regard           to
significant deficiencies or material weaknesses) in the Companys           internal
controls or in other factors that could significantly affect these           controls
subsequent to the date of the evaluation referenced in paragraph (a)           above.



      Part
        II.



      Item 1. Legal
        Proceedings


Except as noted below, various claims
and actions of a type commonly encountered in the Companys industry have been
asserted and are pending against the Company. The Company believes that such claims and
actions will not have a material adverse effect upon the Companys financial position
or results of operations.

18
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The Washington State Department of
Revenue (the Department) is currently examining the Companys state tax
returns for the years 1996, 1997, 1998 and 1999. The Company has received a final report
from the auditor, and the Department has assessed $2.1 million plus approximately $800,000
of accrued interest. The Company disagrees with substantially all of the deficiencies and
is contesting such deficiencies through the administrative appeals process. There can be
no assurance that the Company will be successful, in whole or in part, in challenging the
proposed deficiencies. Additionally, the Department may also make a similar assessment for
2000, 2001 and 2002. An unfavorable decision could have a material adverse effect on the
Company.


The Company has been named as a
defendant in Massachusetts Institute of Technology, et al. v. Abacus Software, Inc., et
al., which is pending in the U.S. District Court for the Eastern District of Texas,
Texarkana Division, Case No. 501-CV-344. Plaintiffs allege that scanners and digital
cameras manufactured by other entities and sold by the Company infringe on United States
Patent No. 4,500,919, a patent assigned to plaintiff Massachusetts Institute of Technology
and licensed to co-plaintiff Electronics for Imaging, Inc. The Company has retained
counsel to defend its interests in this action and believes that it has strong defenses to
plaintiffs claims, including defenses as to the validity of the patent and as to
patent marking issues. The Company is one of 214 original defendants sued in this patent
infringement action. The case is in its infancy and the parties have only recently
exchanged their initial disclosures. The Company does not believe that the claims will
have a material adverse effect on its business, financial position, cash flows or results
of operations; however, it is not yet possible to accurately assess the extent of its
exposure to such claims.

19
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Item 6. Exhibits
        and Reports on Form 8-K
|------------------------------------------------

|(a) | Exhibits
|--- | --------

| | 10.1 | Microsoft
Corporation Amendment of Authorized Source Agreement
| | ---- | --------------------------------------------------------------

| | 99.1 | Certification
of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Reports
on Form 8-K
|--- | -------------------

| | No
reports on Form 8-K were filed during the quarter ended September 30, 2002.
| | ------------------------------------------------------------------------------

|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:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date: November 11, 2002 |  | ZONES, INC.
        By: /S/ FIROZ H. LALJI
               
               Firoz H. Lalji, Chairman and
        Chief Executive Officer
      /S/ RONALD P. MCFADDEN
               
              Ronald P. McFadden, Senior Vice President
        and
              Chief Financial Officer
|----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|20
|--

|Certifications


I, Firoz Lalji, Chairman and Chief
Executive Officer of Zones, Inc., certify that:
|---------------------------------------------------------------------------------------------------

|1. | I
have reviewed this quarterly report on Form 10-Q of Zones, Inc.;
|-- | ------------------------------------------------------------------

|2. | Based
on my knowledge, this quarterly report does not contain any untrue           statement of
a material fact or omit to state a material fact necessary to make           the
statements made, in light of the circumstances under which such statements           were
made, not misleading with respect to the period covered by this quarterly
          report;
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Based
on my knowledge, the financial statements, and other financial information
          included in this quarterly report, fairly present in all material respects the
          financial condition, results of operations and cash flows of the registrant as
          of, and for, the periods presented in this quarterly report;
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | The
registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | designed such
      disclosure controls and procedures to ensure that material information relating
      to the registrant, including its consolidated subsidiaries, is made known
      to us by others within those entities, particularly during the period in
      which this quarterly report is being prepared;
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | evaluated
the effectiveness of the registrants disclosure controls and
                    procedures as of a date within 90 days prior to the filing date of
this                     quarterly report (the Evaluation Date); and
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | presented
in this quarterly report our conclusions about the effectiveness of
                    the disclosure controls and procedures based on our evaluation as of
the                     Evaluation Date;
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. | The
registrants other certifying officers and I have disclosed, based on           our
most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent functions):
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | all
significant deficiencies in the design or operation of internal controls
                    which could adversely affect the registrants ability to record,
process,                     summarize and report financial data and have identified for
the                     registrants auditors any material weaknesses in internal
controls; and
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | any
fraud, whether or not material, that involves management or other employees
                    who have a significant role in the registrants internal
controls; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | The
registrants other certifying officers and I have indicated in this
          quarterly report whether or not there were significant changes in internal
          controls or in other factors that could significantly affect internal controls
          subsequent to the date of our most recent evaluation, including any corrective
          actions with regard to significant deficiencies and material weaknesses.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date: November 11, 2002 |  | By: /S/ FIROZ H. LALJI
               
               Firoz H. Lalji, Chairman and
        Chief Executive Officer
|----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------

|21
|--

|I, Ronald McFadden, Senior Vice
President and Chief Financial Officer of Zones, Inc., certify that:
|---------------------------------------------------------------------------------------------------

|1. | I
have reviewed this quarterly report on Form 10-Q of Zones, Inc.;
|-- | ------------------------------------------------------------------

|2. | Based
on my knowledge, this quarterly report does not contain any untrue           statement of
a material fact or omit to state a material fact necessary to make           the
statements made, in light of the circumstances under which such statements           were
made, not misleading with respect to the period covered by this quarterly
          report;
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Based
on my knowledge, the financial statements, and other financial information
          included in this quarterly report, fairly present in all material respects the
          financial condition, results of operations and cash flows of the registrant as
          of, and for, the periods presented in this quarterly report;
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | The
registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | designed
such disclosure controls and procedures to ensure that material
                    information relating to the registrant, including its consolidated
subsidiaries,                     is made known to us by others within those entities,
particularly during the                     period in which this quarterly report is
being prepared;
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | evaluated
the effectiveness of the registrants disclosure controls and
                    procedures as of a date within 90 days prior to the filing date of
this                     quarterly report (the Evaluation Date); and
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c) | presented
in this quarterly report our conclusions about the effectiveness of
                    the disclosure controls and procedures based on our evaluation as of
the                     Evaluation Date;
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. | The
registrants other certifying officers and I have disclosed, based on           our
most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent functions):
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a) | all
significant deficiencies in the design or operation of internal controls
                    which could adversely affect the registrants ability to record,
process,                     summarize and report financial data and have identified for
the                     registrants auditors any material weaknesses in internal
controls; and
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | any
fraud, whether or not material, that involves management or other employees
                    who have a significant role in the registrants internal
controls; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | The
registrants other certifying officers and I have indicated in this
          quarterly report whether or not there were significant changes in internal
          controls or in other factors that could significantly affect internal controls
          subsequent to the date of our most recent evaluation, including any corrective
          actions with regard to significant deficiencies and material weaknesses.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date: November 11, 2002 |  | /S/ RONALD P. MCFADDEN
        
        Ronald P. McFadden, Senior Vice President and 
        Chief Financial Officer
|----------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------

|22
|--