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

|[X] |  | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
QUARTERLY PERIOD ENDED JUNE 30, 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) | 91-1431894
(I.R.S. Employer
Identification Number)
|----------------------------------- | --------------------------------------------------

|707 South Grady WayRenton, Washington(Address of Principal Executive Offices) | 98055-3233(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 August 9, 2002 was 13,594,386.


1
ZONES, INC.


INDEX


PART I.
FINANCIAL INFORMATION
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Item 1. |  | Consolidated Financial Statements: |  | 
|------- |  | ---------------------------------- |  | 

| |  | Consolidated Balance SheetsJune 30, 2002 and December 31, 2001 (unaudited) |  | 3
| |  | -------------------------------------------------------------------------- |  | -

| |  | Consolidated Statements of OperationsThree and six months ended June 30, 2002 and 2001 (unaudited) |  | 4
| |  | -------------------------------------------------------------------------------------------------- |  | -

| |  | Statements of Shareholders EquitySix months ended June 30, 2002 (unaudited) |  | 5
| |  | ---------------------------------------------------------------------------- |  | -

| |  | Consolidated Statements of Cash FlowsSix months ended June 30, 2002 and 2001 (unaudited) |  | 6
| |  | ---------------------------------------------------------------------------------------- |  | -

| |  | Notes to Consolidated Financial Statements (unaudited) |  | 7
| |  | ------------------------------------------------------ |  | -

|Item 2. |  | Managements Discussion and Analysis ofFinancial Condition and Results of Operations |  | 10
|------- |  | ------------------------------------------------------------------------------------ |  | --

|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk |  | 17
|------- |  | ---------------------------------------------------------- |  | --

|PART II. OTHER INFORMATION
|--------------------------

|Item 1. |  | Legal Proceedings |  | 18
|------- |  | ----------------- |  | --

|Item 4. |  | Submission of Matters to a vote of Security Holders |  | 20
|------- |  | --------------------------------------------------- |  | --

|Item 6. |  | Exhibits and Reports on Form 8-K |  | 20
|------- |  | -------------------------------- |  | --

| |  | Signatures |  | 20
| |  | ---------- |  | --

|2
Part I.


Item 1. Financial Statements




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

|                                                  | June 30,2002 |  | December 31,2001 |       
|------------------------------------------------- | ------------ |  | ---------------- | ------
|ASSETS                                            |              |  |                  |       
|Current assets:                                   |              | 
|Cash and cash equivalents                         |              |  | $                | 1,524 
|Restricted cash                                   |              |  |                  | 930   
|Receivables, net                                  |              |  |                  | 40,156
|Inventories, net                                  |              |  |                  | 13,775
|Prepaid expenses                                  |              |  |                  | 683   
|Deferred tax asset                                |              |  |                  | 1,743 
|                                                  |              |  |                  |       
|Total current assets                              |              |  |                  | 58,811
|Property and equipment, net                       |              |  |                  | 6,623 
|Deferred tax asset                                |              |  |                  | 4,921 
|Other assets                                      |              |  |                  | 296   
|                                                  |              |  |                  |       
|Total assets                                      |              |  | $                | 70,651
|                                                  |              |  |                  |       
|                                                 
|LIABILITIES AND SHAREHOLDERS EQUITY              |              | 
|Current liabilities:                              |              | 
|Accounts payable                                  |              |  | $                | 31,105
|Accrued liabilities                               |              |  |                  | 5,332 
|Line of credit                                    |              |  |                  | 900   
|Current portion of capital lease obligations      |              |  |                  | 785   
|                                                  |              |  |                  |       
|Total current liabilities                         |              |  |                  | 38,122
|Capital lease obligations, net of current portion |              |  |                  | 85    
|Other liabilities                                 |              |  |                  | 401   
|                                                  |              |  |                  |       
|Total liabilities                                 |              |  |                  | 38,608
|                                                  |              |  |                  |       
|                                                 
|Commitments and contingencies                     |              | 
|                                                 
|Shareholders equity:                             |              | 
|Common stock                                      |              |  |                  | 39,531
|Accumulated deficit                               |              |  |                  | (7,488
|                                                  |              |  |                  |       
|Total shareholders equity                        |              |  |                  | 32,043
|                                                  |              |  |                  |       
|Total liabilities and shareholders equity        |              |  | $                | 70,651
|                                                  |              |  |                  |       

|See notes to consolidated financial statements


3



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

|                                                    | Three months endedJune 30, |  | Six months endedJune 30, |        
|--------------------------------------------------- | -------------------------- |  | ------------------------ | -------
|
|Net sales                                           |                            |  | $                        | 107,771
|Cost of sales                                       |                            |  |                          | 96,948 
|                                                    |                            |  |                          |        
|Gross profit                                        |                            |  |                          | 10,823 
|                                                   
|Selling, general and administrative                 |                            |  |                          | 10,214 
|                                                    |                            |  |                          |        
|Income from operations                              |                            |  |                          | 609    
|                                                    |                            |  |                          |        
|                                                   
|Interest expense                                    |                            |  |                          | 24     
|Other (income) expense, net                         |                            |  |                          | (22    
|Minority interest                                   |                            |  |                          |        
|                                                    |                            |  |                          |        
|Other (income) expense                              |                            |  |                          | 2      
|                                                    |                            |  |                          |        
|Income before taxes                                 |                            |  |                          | 607    
|Provision for income taxes                          |                            |  |                          | 234    
|                                                    |                            |  |                          |        
|Net income                                          |                            |  | $                        | 373    
|                                                    |                            |  |                          |        
|                                                   
|Basic earnings per share                            |                            |  | $                        | 0.03   
|                                                   
|Shares used in computing basic earnings per share   |                            |  |                          | 13,581 
|                                                   
|Diluted earnings per share                          |                            |  | $                        | 0.03   
|                                                   
|Shares used in computing diluted earnings per share |                            |  |                          | 13,700 

|See notes to consolidated financial statements


4



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

|                         | Common Stock |  | Accumulated |           
|------------------------ | ------------ |  | ----------- | ----------
|
|Balance, January 1, 2002 |              |  |             | 13,536,406
|Issuance of common stock |              |  |             | 44,763    
|Net income               |              |  |             |           
|                         |              |  |             |           
|Balance, June 30, 2002   |              |  |             | 13,581,169
|                         |              |  |             |           

|See notes to consolidated financial statements


5



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

|                                                     | Six months endedJune 30, | 
|---------------------------------------------------- | ------------------------ | 
|
|Cash flows from operating activities:                |                          | 
|Net income                                           |                          | 
|Adjustments to reconcile net income to net           |                          | 
|cash provided by (used in) operating activities:     |                          | 
|Depreciation and amortization                        |                          | 
|Deferred income taxes                                |                          | 
|Minority interest                                    |                          | 
|Changes in assets and liabilities:                   |                          | 
|Receivables, net                                     |                          | 
|Inventories, net                                     |                          | 
|Prepaid expenses and other assets                    |                          | 
|Accounts payable                                     |                          | 
|Accrued and other liabilities                        |                          | 
|                                                     |                          | 
|Net cash (used in) provided by operating activities  |                          | 
|                                                    
|Cash flows from investing activities:                |                          | 
|Purchases of property and equipment                  |                          | 
|                                                     |                          | 
|Net cash used in investing activities                |                          | 
|                                                    
|Cash flows from financing activities:                |                          | 
|Net borrowing under line of credit arrangement       |                          | 
|Net change in book overdraft                         |                          | 
|Net proceeds from sale of common stock               |                          | 
|Net proceeds from capital lease                      |                          | 
|Payments on capital leases                           |                          | 
|                                                     |                          | 
|Net cash provided by (used in) financing activities  |                          | 
|                                                    
|Net increase (decrease) in cash and cash equivalents |                          | 
|Cash and cash equivalents at beginning of period     |                          | 
|                                                     |                          | 
|                                                    
|Cash and cash equivalents at end of period           |                          | 
|                                                     |                          | 

|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, Compaq,
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 an 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 six months ended June 30,
2002 by approximately $321,000 and $691,000, respectively, and were made to
better reflect the estimated periods during which the assets will remain in
service. The impact was primarily due to the Companys planned investment
in a new enterprise system that was cancelled due to the economic environment.
Therefore, 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. 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 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 and 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. 93-4, 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, financial position and cash flows.


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 June 30, |  | Six months ended June 30, |       
|------------------------------------------- | --------------------------- |  | ------------------------- | ------
|
|Basic earnings per share:                   |                             |  |                           |       
|                                           
|Income available to common shareholders     |                             |  | $                         | 373   
|                                            |                             |  |                           |       
|Weighted average shares outstanding         |                             |  |                           | 13,581
|                                            |                             |  |                           |       
|Basic earnings per share                    |                             |  | $                         | 0.03  
|                                            |                             |  |                           |       
|                                           
|Diluted earnings per share:                 |                             | 
|                                           
|Net income                                  |                             |  | $                         | 373   
|                                           
|Weighted average shares outstanding         |                             |  |                           | 13,581
|Stock options                               |                             |  |                           | 119   
|                                            |                             |  |                           |       
|Total common shares and dilutive securities |                             |  |                           | 13,700
|                                            |                             |  |                           |       
|                                           
|Diluted earnings per share                  |                             |  | $                         | 0.03  
|                                            |                             |  |                           |       

|8
4. Commitments and Contingencies


Legal Proceedings


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
financial position 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, 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 has contested such deficiencies
through the administrative appeals process and is pursuing further litigation.
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 and 2001. An unfavorable decision could
have a material 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 Zones infringe on United States Patent No. 4,500,919, a patent assigned to
plaintiff Massachusetts Institute of Technology and licensed to coplaintiff
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 defendants sued in this
patent infringement action. The case is in its infancy and discovery has not yet
begun. The Company does not believe that the claims will have a material adverse
effect on its financial position, however, it is not yet possible to accurately
assess the extent of its exposure to such claims.


Liquidity


The Companys net
amount of accounts payable outstanding at June 30, 2002 was $31.1 million, of
which $7.7 million was drawn from a $35.0 million credit facility,
collateralized by inventories and accounts receivable. This credit facility
expired July 21, 2002, but has been extended until August 31, 2002 during which
time the Company intends to renegotiate the terms of an annual renewal. The
Company does not anticipate any complications renegotiating the terms and timing
of this renewal.


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.


9
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 the government and education
markets.


Substantially all of the
Companys net sales for the three and six months ended June 30, 2002 were
made to customers located in the United States. All of the Companys assets
at June 30, 2002 and December 31, 2001 were located within the United States.
Sales to one of the Companys customers represented 19.3% and 18.0% of
total sales for the three and six months ended June 30, 2002. Net sales to this
customer were $20.8 million and $37.5 million for three and six months ended
June 30, 2002, compared to $47.9 million and $94.4 million for three and six
months ended June 30, 2001. The Company believes that sales to this customer
over future quarters may further decline.




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 our 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.


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 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.


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, and the Department has assessed $2.1
million plus approximately $800,000 accrued interest. The Company disagrees with
substantially all of the deficiencies and has contested such deficiencies
through the administrative appeals process and is pursuing further litigation.
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 and 2001. An unfavorable decision could
have a material effect on the Company.


10
No Assurance of Revenue
or Profitability. The Companys sales and operating results are
difficult to forecast, and several factors are outside of the Companys
control. There is no assurance that the Company will, at any point, attain
increased sales or profitability, which could adversely affect the
Companys business, financial condition, cash flows or results of
operations.


Future Growth. If
the Company does not successfully manage growth in the future, it could
significantly limit its ability to meet customer demand and business could be
harmed. The current business strategy is to pursue additional growth and expand
its customer base through increased profitability and productivity in the
Companys account executives and targeted marketing tools for acquisition
of new customers, retention of its current customers and reactivation of our
previous customers. The Companys future success will depend, in part, on
our ability to manage this growth.


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, it could have
an adverse effect on business, financial condition, cash flows and 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.


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 large manufacturers, such as
Compaq and IBM which are developing 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 and results of
operations will not be adversely affected by intensified competition.


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.


11
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.


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.


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.


Major Customer.
Sales to one of the Companys customers represented 19.3% and 18.0% of
total sales for the three and six months ended June 30, 2002. Net sales to this
customer were $20.8 million and $37.5 million for three and six months ended
June 30, 2002, compared to $47.9 million and $94.4 million for three and six
months ended June 30, 2001. The Companys relationship with this customer
has changed, and sales to this customer may continue to decline throughout 2002.
Additionally, the Company is currently designated as a minority-owned business.
This designation has contributed to the Companys total net sales. There
can be no assurances that this designation will contribute to future growth or
that the Company will continue to hold this designation.


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 and 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 that would limit
the Companys ability to obtain sufficient quantities of merchandise on
acceptable commercial terms could have a material adverse effect on the
Companys business, financial condition, cash flows and results of
operations.


12
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.


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 (SG&A) 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.


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.
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|                                                | Three months endedJune 30, |  | Six months endedJune 30, |          
|----------------------------------------------- | -------------------------- |  | ------------------------ | ---------
|
|Net sales                                       |                            |  |                          | 100.0    
|Cost of sales                                   |                            |  |                          | 90.0     
|                                                |                            |  |                          |          
|Gross profit                                    |                            |  |                          | 10.0     
|Selling, general and administrative expenses    |                            |  |                          | 9.5      
|                                                |                            |  |                          |          
|Income from operations                          |                            |  |                          | 0.5      
|Other (income) expense                          |                            |  |                          | 0.0      
|                                                |                            |  |                          |          
|Income before income taxes                      |                            |  |                          | 0.5      
|Provision for income taxes                      |                            |  |                          | 0.2      
|                                                |                            |  |                          |          
|Net income                                      |                            |  |                          | 0.3      
|                                                |                            |  |                          |          
|                                               
|Selected domestic operating data:               |                            | 
|Catalog circulation                             |                            |  |                          | 3,145,000
|E-media circulation                             |                            |  |                          | 3,340,000
|Number of orders                                |                            |  |                          | 124,000  
|Average order size                              |                            |  |                          | $870     
|Number of B2B account executives, end of period |                            | 
|                                                |                            |  |                          | 172      

|13
Comparison of Three
Month Periods Ended June 30, 2002 and 2001


Net Sales.Net sales
for the quarter ended June 30, 2002 decreased 25.8% to $107.8 million compared
to $145.2 million in the second quarter of 2001, but increased sequentially 7.9%
from $99.8 million in the first quarter of 2002. 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 56.6% to $20.8 million for the quarter ended June 30, 2002 compared to
$47.9 million in the same period of 2001. Total outbound sales to the small to
medium sized businesses (SMB), enterprise and government and
education accounts decreased 27.6% to $90.7 million in the second quarter of
2002 from $125.3 million in the second quarter of 2001, but grew 7.7%
sequentially from $84.2 million in the first quarter of 2002. The Company has
experienced two consecutive quarters of sequential sales increase in its core
SMB market, growing 6.0% to $46.4 million in the second quarter of 2002 from
$43.8 million in the first quarter of 2002. Although sales in certain sectors
have exhibited modest sequential quarter improvement, it is increasingly
apparent that the aggressive acceleration in IT spending that was predicted for
the second half of 2002 is being deferred. The Companys goals are to focus
on increasing the productivity of its commercial accounts sales force and expand
its portfolio of enterprise accounts. Additionally, the Company is continually
looking for opportunities to increase its share of the Mac-platform product
market, emphasizing a vertical marketing approach to increase sales to business
customers. Sales by the Companys Mac division decreased 14.0% to $17.1
million for the three months ended June 30, 2002 compared to $19.9 million in
the comparable period in 2001, but increased 9.3% sequentially from $15.6
million in the first quarter of 2002.


The Companys average
order size decreased to $870 for the three months ended June 30, 2002 from
$1,026 in the second quarter of 2001. This is primarily due to a decline in
sales in the Companys enterprise division as enterprise sales generally
have larger per order shipments. Average order size did, however, increase
sequentially from $775 in the first quarter of 2002.


Gross Profit. Gross
profit dollar contribution decreased to $10.8 million for the second quarter of
2002, down 24.2% 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 10.0% in the quarter ended June 30, 2002 compared to 9.8% in the
second quarter of 2001. This increase in gross profit margin percentage has been
primarily due to product mix and related 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.


Selling, General and
Administrative (SG&A) Expenses.SG&A expenses decreased
27.5% to $10.2 million for the quarter ended June 30, 2002 from $14.1 million in
the second quarter of 2001 and decreased sequentially 2.1% from $10.4 million in
the first quarter of 2002. As a percent of sales, SG&A decreased to 9.5% for
the quarter ended June 30, 2002 from 9.7% in the second quarter of 2001. The
Company eliminated non-productive sales headcount, maintained tight controls on
discretionary spending and critically evaluated all advertising expenditures
throughout the second quarter of 2002.


The Company produces and
distributes catalogs at various intervals throughout the year. The
Companys net cost of advertising decreased to $455,000 in the three month
period ended June 30, 2002 from $848,000 in the comparable 2001 period. This
decrease in net cost is primarily due to the discontinuation of the PC Zone and
Brand catalog and the on-line advertising expense associated with the PC
consumer customer segment.


Other Income/Expense.Other expense was $2,000 for the quarter ended June 30, 2002 compared to
other expense of $15,000 in the second quarter of 2001. The change was primarily
due to a decrease in interest expense incurred in the second quarter of 2002
compared with the same period of 2001.


Provision for Income
Taxes. The provision for income taxes for the quarter ended June 30, 2002
was $234,000 as compared to a provision of $73,000 in the comparable period of
the prior year. The Companys effective tax rate expressed as a percentage
of income before taxes was 38.6% for the quarter ended June 30, 2002 compared to
44.2% for the quarter ended June 30, 2001.


14
Net Income.Net
income for the quarter ended June 30, 2002 was $373,000 compared to net income
of $92,000 in the second quarter of 2001. Basic and diluted earnings per share
was $0.03 for the quarter ended June 30, 2002 and basic and diluted earnings per
share was $0.01 in the second quarter of 2001.


Comparison of Six
Month Periods Ended June 30, 2002 and 2001


Net Sales.Net sales
for the six months ended June 30, 2002 decreased 32.2% to $207.6 million
compared to $306.3 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 60.3% to $37.5 million for the six months ended June
30, 2002 compared to $94.4 million in the same period of 2001. Total outbound
sales to the SMB, enterprise and government and education accounts decreased
33.5% to $174.9 million in the first half of 2002 from $262.9 million in the
first half of 2001. Additionally, it is increasingly apparent that the
aggressive acceleration in IT spending that was predicted for the second half of
2002 is being deferred. The Companys goals are to focus on increasing the
productivity of its commercial accounts sales force and expand its portfolio of
enterprise accounts. Additionally, the Company is continually looking for
opportunities to increase its share of the Mac-platform product market,
emphasizing a vertical marketing approach to increase sales to business
customers. Sales by the Companys Mac division decreased 24.5% to $32.8
million for the six months ended June 30, 2002 compared to $43.4 million in the
comparable period in 2001.


The Companys average
order size decreased to $821 for the six months ended June 30, 2002 from $949 in
the comparable quarter of 2001. This is primarily due to a decline in sales in
the Companys enterprise division as enterprise sales generally have larger
per order shipments.


Gross Profit. Gross
profit dollar contribution decreased to $21.4 million for the six months ended
June 30, 2002, down 28.1% 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 10.3% in the six months ended
June 30, 2002 compared to 9.7% in the comparable period of 2001. This increase
in gross profit margin percentage has been primarily due to product mix and
related 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.


Selling, General and
Administrative Expenses.SG&A expenses decreased 29.5% to $20.6 million
for the six months ended June 30, 2002 from $29.3 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 the first half of 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 9.9% for the six months ended June 30, 2002 from 9.6% 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 $657,000 in the six month
period ended June 30, 2002 from $1.6 million in the comparable 2001 period. This
decrease in net cost is primarily due to the discontinuation of the Brand
Catalog and the on-line advertising expense associated with the PC consumer
customer segment.


Other Income/Expense.Other income was $13,000 for the six months ended June 30, 2002 compared to
other expense of $125,000 in the six months ended June 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 six months ended June 30, 2002
was $287,000 as compared to a provision of $138,000 in the comparable period of
the prior year. The Companys effective tax rate expressed as a percentage
of income before taxes was 38.7% for the six months ended June 30, 2002 compared
to 41.4% for the six months ended June 30, 2001.


15
Net Income.Net
income for the six months ended June 30, 2002 was $454,000 compared to net
income of $196,000 in the comparable period of 2001. Basic and diluted earnings
per share were $0.03 for the six months ended June 30, 2002 and basic and
diluted earnings per share was $0.01 for the six months ended June 30, 2001.


Trends


The Company has been
affected by the pervasive slowdown in U.S. corporate information technology
(IT) spending over the past several quarters. The Company is still
operating in an intensely competitive environment, and customer-purchasing
trends continue to be difficult to forecast. While there are some encouraging
signs in certain sectors, it is becoming increasingly apparent that the highly
anticipated second half acceleration in IT spending is being deferred. In
response to this continued static environment, the Company is focusing on the
key elements of its business to reach its three year goal: diversification of
sales, initiatives to improve gross profit margin, and continued control of
discretionary expenses.


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 as technology spending rebounds and has set
ambitious internal goals to grow its net sales to $1.0 billion by 2005. In order
to meet its sales goal, the Company plans to continue to hire account
executives, while selectively replacing administrative team members it loses
through attrition. The additional headcount may increase selling, general and
administrative (SG&A) expense, but the Company believes the
overall SG&A as a percent of sales will remain relatively flat as the
increase will be proportional to the increase in sales.


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, which is the training ground for less tenured account executives,
actively pursues the small to medium sized business customer. The Company slowly
began investing in new account executives in the first quarter of 2002, and
aggressively pursued hiring during the second quarter of 2002. The Company
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 invested in a Chicago satellite office to
support its Midwest enterprise endeavors. The Company believes there is growth
potential in its Public Sector division and is pursuing education and state and
local government initiatives. Lastly, the Companys legacy is in the Mac
market. As previously noted, increasing Mac market share is a key objective and
the Company intends to continue to promote Mac-platform products to both
businesses and consumers. Specifically, the Company is emphasizing its vertical
marketing approach to increase Mac sales to business customers.


The economic downturn in
the IT market, as well as the Companys disappointing sequential gross
profit percentage decline primarily as a response to external pricing pressures,
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, 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, which has been a focal point for the past several
quarters due to the existing economic conditions, as well as advertising
expenditures. 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.


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.


16
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 June 30, 2002, the
Company had total assets of $70.7 million, of which $58.8 million were current
assets. At June 30, 2002 and December 31, 2001 the Company had cash and cash
equivalents, and restricted cash of $2.5 million and $13.1 million,
respectively. 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 39 days at June
30, 2002 compared to 32 days at December 31, 2001. The Company anticipated the
increase in accounts receivable days outstanding due to a change in payment
terms with a major customer. The Companys working capital was $20.7
million and $19.3 million at June 30, 2002 and December 31, 2001, respectively.


Net cash used by operating
activities was $13.7 million for the six months ended June 30, 2002 compared to
cash provided by operating activities of $13.9 million for the six months ended
June 30, 2001. Cash outflows for the three months ended June 30, 2002 were
primarily due to increases in accounts receivable and decreases in accounts
payable partially offset by a decline in inventories. At June 30, 2002, accounts
receivable increased $8.0 million and accounts payable decreased $6.9 million,
net of $3.9 million of cash overdraft, while inventories decreased by $3.1
million from December 31, 2001.


Cash outlays for capital
expenditures were $1.0 and $1.9 million in the six months ended June 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 June 30, 2002 was $31.1 million, of which $7.7 million
was drawn from a $35.0 million credit facility, collateralized by inventories
and accounts receivable. This credit facility expired July 21, 2002, but has
been extended until August 31, 2002 during which time the Company intends to
renegotiate the terms of an annual renewal. The Company does not anticipate any
complications renegotiating the terms and timing of this renewal. The facility
contains various restrictive covenants relating to profitability, tangible net
worth, leverage, dispositions and use of collateral, other asset dispositions,
and merger and consolidation of the Company. At June 30, 2002, the Company was
in compliance with all covenants related to its credit facility. For the period
ending June 30, 2002, the Company had borrowed $900,000 on the working capital
line of credit. Additionally, at June 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.


17
Part II.




Item 1.  Legal Proceedings


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.


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, 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 has contested such deficiencies
through the administrative appeals process and is pursuing further litigation.
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 and 2001. An unfavorable decision could
have a material 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 Zones infringe on United States Patent No. 4,500,919, a patent assigned to
plaintiff Massachusetts Institute of Technology and licensed to coplaintiff
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 defendants sued in this
patent infringement action. The case is in its infancy and discovery has not yet
begun. The Company does not believe that the claims will have a material adverse
effect on its financial position, however, it is not yet possible to accurately
assess the extent of its exposure to such claims.


18
Item 4.  Submission of Matters to a vote of Security Holders
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------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|(a) |  | The
Company held its annual meeting of shareholders on April 25, 2002.
|--- |  | ----------------------------------------------------------------------

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

|1.  Election of Directors
|-------------------------

|Nominee            |  | Votes For  | Against | Withheld | 
|------------------ |  | ---------- | ------- | -------- | 
|John H. Bauer      |  | 12,773,514 |         | 38,799   | 
|John T. Carleton   |  | 12,774,314 |         | 37,999   | 
|Firoz H. Lalji     |  | 12,773,748 |         | 38,565   | 
|Kathleen S. Pushor |  | 12,774,294 |         | 38,019   | 
|Richard E. Carter  |  | 12,774,514 |         | 37,799   | 

|2.  Ratification of Appointment of Auditors
|-------------------------------------------

| |  | Votes For  | Votes Against | Abstentions | 
| |  | ---------- | ------------- | ----------- | 
| |  | 12,782,857 | 21,061        | 8,395       | 

|19



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

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

| |  | 99.1 |  | Certification
of Chief Executive Officer
| |  | ---- |  | ----------------------------------------

| |  | 99.2 |  | Certification
of Chief Financial Officer
| |  | ---- |  | ----------------------------------------

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

| | On
May 1, 2002, the Company filed a report on form 8-K containing the Companys press
release to the effect that its Chairman and Chief Executive Officer, Firoz Lalji, had
filed a Schedule 13D disclosing the purchase of an additional 900,000 shares of the
Companys common stock in a private transaction. Additionally, the Company reported
that Nasdaq had notified it that it is not in compliance with Nasdaqs minimum bid
price per share requirement.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
May 22, 2002, the Company filed a report on form 8-K containing the Companys press
release to the effect that Nasdaq had notified it that the Company had regained
compliance with Nasdaqs minimum bid price per share requirement for continued
listing on the Nasdaq National Market.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
June 7, 2002, the Company filed a report on form 8-K containing the Companys press
release to the effect that its Chairman and Chief Financial Officer, Firoz Lalji, had
filed a Schedule 13D disclosing the purchase of an additional 1,651,000 shares of the
Companys common stock in a private transaction and his acquisition of beneficial
ownership of 92,800 shares of the Companys common stock in various open market
transactions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
other Reports on Form 8-K were filed during the quarter ended June 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:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date: August 14, 2002 |  | ZONES, INC.
By: /S/ FIROZ H. LALJI

Firoz H. Lalji, Chairman and Chief Executive Officer

/S/ RONALD P. MCFADDEN

Ronald P. McFadden, Chief Financial Officer
|--------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|20
|--