|UNITED STATESSECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q
|----------------------------------------------------------------------------------

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

|FOR THE QUARTERLY
PERIOD ENDED MARCH 31, 2003


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                      
| | (Address
      of Principal Executive Offices)

|(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 |_|


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


Yes |_|     No |X|


The number of shares of the
registrants Common Stock outstanding as of May 8, 2003 was 13,641,492.
1
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|ZONES, INC.


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

|                                                                           | 
|-------------------------------------------------------------------------- | 
|PART
      I.  FINANCIAL INFORMATION                                       | 
|                                                                           | 
|Item 1.   Consolidated
      Financial Statements (unaudited):             | 
|                                                                           | 
|Consolidated
      Balance Sheets                                          | 
|March
      31, 2003 and December 31, 2002                                 | 
|                                                                           | 
|Consolidated
      Statements of Operations                                | 
|Three
      months ended March 31, 2003 and 2002                           | 
|                                                                           | 
|Statements
      of Shareholders Equity                                   | 
|Three
      months ended March 31, 2003                                    | 
|                                                                           | 
|Consolidated
      Statements of Cash Flows                                | 
|Three
      months ended March 31, 2003 and 2002                           | 
|                                                                           | 
|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 1. Financial
Statements



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

|                                                   | March
      31,
      2003 |  | December
      31,
      2002 |       
|-------------------------------------------------- | -------------------------- |  | ----------------------------- | ------
|ASSETS                                             |                            |  |                               |       
|Current assets:                                    |                            | 
|Cash
      and cash equivalents                    |                            |  | $                             | 5,593 
|Receivables,
      net                             |                            |  |                               | 57,363
|Inventories,
      net                             |                            |  |                               | 12,474
|Prepaid
      expenses                             |                            |  |                               | 1,276 
|Deferred
      tax asset                           |                            |  |                               | 2,297 
|                                                   |                            |  |                               |       
|Total
      current assets                         |                            |  |                               | 79,003
|Property
      and equipment, net                  |                            |  |                               | 5,306 
|Goodwill                                           |                            |  |                               | 4,098 
|Deferred
      tax asset                           |                            |  |                               | 5,367 
|Other assets                                       |                            |  |                               | 220   
|                                                   |                            |  |                               |       
|Total
      assets                                 |                            |  | $                             | 93,994
|                                                   |                            |  |                               |       
|LIABILITIES
      AND SHAREHOLDERS EQUITY         |                            | 
|Current liabilities:                               |                            | 
|Accounts
      payable                             |                            |  | $                             | 41,480
|Accrued
      liabilities                          |                            |  |                               | 12,128
|Payable
      to CPCS shareholders                 |                            |  |                               | 4,881 
|Line
      of credit                               |                            |  |                               | 2,181 
|Current
      portion of capital lease obligations |                            |  |                               | 146   
|Current
      portion of deferred rent obligations |                            |  |                               | 123   
|Notes
      payable                                |                            |  |                               | 833   
|Income
      taxes payable                         |                            |  |                               | 92    
|                                                   |                            |  |                               |       
|Total
      current liabilities                    |                            |  |                               | 61,864
|Notes payable,
      net of current portion        |                            |  |                               | 1,668 
|                                                   |                            |  |                               |       
|Total
      liabilities                            |                            |  |                               | 63,532
|                                                   |                            |  |                               |       
|                                                   |                            | 
|Commitments
      and contingencies                |                            | 
|                                                   |                            | 
|Shareholders
      equity:                        |                            | 
|Common
      stock                                 |                            |  |                               | 39,565
|Accumulated
      deficit                          |                            |  |                               | (9,103
|                                                   |                            |  |                               |       
|Total
      shareholders equity                   |                            |  |                               | 30,462
|                                                   |                            |  |                               |       
|Total
      liabilities and shareholders equity   |                            |  | $                             | 93,994
|                                                   |                            |  |                               |       

|See notes to
consolidated financial statements
3
|------------------------------------------------

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

|                                                                 | Three
      months ended
      March 31, | 
|---------------------------------------------------------------- | ---------------------------------------- | 
|
|                                                                 |                                          | 
|Net
      sales                                                  |                                          | 
|Cost of sales                                                    |                                          | 
|                                                                 |                                          | 
|Gross profit                                                     |                                          | 
|                                                                 |                                          | 
|Selling,
      general and administrative expenses               |                                          | 
|Advertising
      expenses, net                                  |                                          | 
|                                                                 |                                          | 
|Income (loss)
      from operations                              |                                          | 
|                                                                 |                                          | 
|                                                                 |                                          | 
|Interest
      expense                                           |                                          | 
|Other (income),
      net                                        |                                          | 
|                                                                 |                                          | 
|Other
      (income) expense                                     |                                          | 
|                                                                 |                                          | 
|Income (loss)
      before taxes                                 |                                          | 
|Provision
      (benefit) for income taxes                       |                                          | 
|                                                                 |                                          | 
|Net income
      (loss)                                          |                                          | 
|                                                                 |                                          | 
|                                                                 |                                          | 
|Basic earnings
      (loss) per share                            |                                          | 
|Shares used
      in computing basic earnings (loss) per share   |                                          | 
|                                                                 |                                          | 
|Diluted earnings
      (loss) per share                          |                                          | 
|Shares used
      in computing diluted earnings (loss) per share |                                          | 

|See notes to
consolidated financial statements
4
|------------------------------------------------

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

|                               | Common Stock |  | AccumulatedDeficit |            |  |  
|------------------------------ | ------------ |  | ------------------ | ---------- |  | -
|
|Balance,
      January 1, 2003 |              |  |                    | 13,609,956 |  | $
|Issuance
      of common stock |              |  |                    | 14,712     |  |  
|Net income                     |              |  |                    |            |  |  
|                               |              |  |                    |            |  |  
|Balance,
      March 31, 2003  |              |  |                    | 13,624,668 |  | $
|                               |              |  |                    |            |  |  

|See notes to
consolidated financial statements
5
|------------------------------------------------

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

|                                                          | Three months
      ended
      March 31, | 
|--------------------------------------------------------- | ---------------------------------------- | 
|
|Cash
      flows from operating activities:               |                                          | 
|Net
      income (loss)                                   |                                          | 
|Adjustments
      to reconcile net income to net          |                                          | 
|cash
      used in operating activities:                  |                                          | 
|Depreciation                                              |                                          | 
|Deferred
      tax asset                                  |                                          | 
|Changes
      in assets and liabilities:                  |                                          | 
|Receivables,
      net                                    |                                          | 
|Inventories,
      net                                    |                                          | 
|Prepaid
      expenses and other assets                   |                                          | 
|Accounts
      payable                                    |                                          | 
|Accrued
      and other liabilities                       |                                          | 
|                                                          |                                          | 
|Net
      cash used in operating activities               |                                          | 
|                                                          |                                          | 
|Cash flows
      from investing activities:               |                                          | 
|Fees
      for acquisition of CPCS                        |                                          | 
|Cash
      obtained in acquisition of CPCS                |                                          | 
|Purchases
      of property and equipment                 |                                          | 
|                                                          |                                          | 
|Net
      cash provided by (used in) investing activities |                                          | 
|                                                          |                                          | 
|Cash flows
      from financing activities:               |                                          | 
|Net
      change in book overdraft                        |                                          | 
|Net
      proceeds from sale of common stock              |                                          | 
|Payments
      on capital leases                          |                                          | 
|                                                          |                                          | 
|Net
      cash provided by financing activities           |                                          | 
|                                                          |                                          | 
|Net decrease
      in cash and cash equivalents           |                                          | 
|Cash and
      cash equivalents at beginning of period    |                                          | 
|                                                          |                                          | 
|                                                          |                                          | 
|Cash and
      cash equivalents at end of period          |                                          | 
|                                                          |                                          | 
|                                                          |                                          | 
|Non-cash
      investing and financing activity:          |                                          | 
|Note
      payable for acquisition of CPCS                |                                          | 
|Payable
      to CPCS shareholder's                       |                                          | 

|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 direct marketing reseller of name-brand information technology products
to the small to medium sized business market, enterprise and public sector accounts, while
supporting their legacy Mac customers through an inbound call center promoted by
circulation of the Mac Zone catalog and a dedicated website. Zones sells through outbound
and inbound account executives, specialty print and e-catalogs, and the Internet. Zones
offers more than 150,000 products from leading manufacturers including 3COM, Adobe, Apple,
Cisco, Epson, HP, IBM, Kingston, Sony and Toshiba.


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


2. Summary of
Significant Accounting Policies


The accompanying unaudited
consolidated 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, 2002 as filed with the
Securities and Exchange Commission on February 26, 2003.


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
betterments 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.


Goodwill


In accordance with SFAS No.
142,Goodwill and Other Intangible Assets, goodwill will be tested for
impairment at least annually, or when events indicate that impairment exists.


Stock Compensation


The Company accounted for its stock
option plans by measuring compensation cost using the intrinsic value based method
presented by Accounting Principles Board Option No. 25, Accounting for Stock Issued
to Employees, and related interpretations. No compensation cost is reflected in
consolidated net loss, as all options granted under the plans had an exercise price equal
to the market value of the underlying common stock on the date of grant. Had compensation
cost for the Companys stock option plans been determined based on the fair value at
the grant date of the awards, consistent with the provisions of SFAS 123, the
Companys net income (loss) and income (loss) per share would have increased to the
pro forma amounts indicated below (in thousands, except per share data):
7
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

| |                                                                                |  | Three months
      ended
      March 31, |      
| | ------------------------------------------------------------------------------ |  | ---------------------------------------- | -----
|
| | Net
      income (loss) - as reported                                          |  | $                                        | (646 
| | Add:                                                                           | 
| | Total compensation
      cost included in net income (loss), net of tax        | 
| | Less:                                                                          | 
| | Total compensation cost
      determined under fair value based method for all |  |                                          |      
| | awards, net
      of tax                                                       |  |                                          | (104 
| |                                                                                |  |                                          |      
| |                                                                                | 
| | Net loss
      - pro forma                                                     |  | $                                        | (750 
| |                                                                                | 
| | Basic and
      diluted loss per share - as reported                           |  | $                                        | (0.05
| | Basic and
      diluted loss per share - pro forma                             |  | $                                        | (0.06

|The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in 2003 and 2002, respectively:
expected volatility of 214% and 195%; risk-free interest rate of 2.91% and 4.46%; and
expected lives of 4 years


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.


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 July 2001, the Financial
Accounting Standards Board issued SFAS 143, Accounting for Asset Retirement
Obligations (SFAS 143). SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. It applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction,
development, and (or) the normal operation of a long-lived asset, except for certain
obligations of lessees. The provisions of SFAS 143 will be effective for Zones
fiscal year 2003. The adoption of SFAS 143 did not have a significant impact on the
Companys results of operations, financial position or cash flows.


In June 2002, the FASB issued SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
This statement addresses financial accounting and reporting for costs associated with exit
or disposal activities and nullifies EITF Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit and Activity (including
Certain Costs Incurred in a Restructuring). This statement requires that a liability
for a cost associated with an exit or disposal activity be recognized at fair value when
the liability is incurred. The provisions of SFAS 146 will be effective for exit and
disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not
have a significant impact on the Companys results of operations, financial position
or cash flows.
8
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|In November 2002, the FASB issued
Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Guarantees of Indebtedness of Others  an Interpretation of
FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34
(Interpretation No. 45). This interpretation expands on the existing accounting guidance
and disclosure requirements for most guarantees. It requires that at the time a company
issues a guarantee, the company must disclose that information in its interim and annual
financial statements. The provisions for initial recognition and measurement of the
liability will be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 did not have a significant impact on the
Companys results of operations, financial position or cash flows.


In January 2003, the FASB issued FASB
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to
be consolidated by the primary beneficiary of the entity if the equity investors in the
entity do not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The Company is required to apply FIN 46
to all new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the Company is
required to apply FIN 46 on July 1, 2003. The Company does not believe FIN 46 will have a
significant impact on its results of operations, financial position or cash flows.


In November 2002, the EITF reached
consensus on Issue No. 02-16, Accounting for Consideration Received from a
Vendor by a Customer (Including a Reseller of the Vendors Products). Cash
consideration should generally be considered an adjustment of the prices of the
vendors products and, therefore, characterized as a reduction of cost of sales when
recognized in the resellers income statement unless certain conditions apply. The
Company adopted the provisions of this issue for all agreements modified or entered into
on or after January 1, 2003. The adoption of this issue resulted in the reclassification
of certain amounts historically classified as a reduction of advertising expense to a
reduction of cost of sales on a prospective basis. The adoption of this issue had no
impact on the Companys net income (loss) from operations, shareholders equity
or cash flows. The following table gives pro-forma information as if this issue had been
implemented for all periods presented. The non-GAAP information for three months ended
March 31, 2003 is presented for comparison purposes only (in thousands):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                           | Three
      months ended March 31, 2003
|-------------------------- | ---------------------------------------
|
|Cost
      of sales        |                                        
|Gross
      Profit         |                                        
|Advertising
      expenses |                                        
|                           |                                        
|
|
|Cost
      of sales        |                                        
|Gross
      Profit         |                                        
|Advertising
      expenses |                                        

|9
|-

|3.   Earnings Per Share


The Company has 45,000,000 common
shares authorized at March 31, 2003 and 2002. 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 March 31, |  
|----------------------------------------------------- | ---------------------------------- | -
|
|Basic
      earnings (loss) per share:                |                                    |  
|Net
      income (loss)                               |                                    | $
|                                                      |                                    |  
|Weighted-average
      shares used in computing basic |                                   
|earnings
      (loss) per share                       |                                    |  
|                                                      |                                    |  
|Basic
      earnings (loss) per share                 |                                    | $
|                                                      |                                    |  
|                                                      |                                   
|Diluted
      earnings (loss) per share:              |                                   
|Net
      income (loss)                               |                                    | $
|                                                      |                                    |  
|                                                      |                                   
|Weighted
      average shares outstanding             |                                    |  
|Stock
      options                                   |                                    |  
|                                                      |                                    |  
|Total
      commons shares and dilutive securities    |                                    |  
|                                                      |                                    |  
|Diluted
      earnings (loss) per share               |                                    | $
|                                                      |                                    |  

|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. Except as otherwise indicated, 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.


On November 21, 2002, the Washington
State Department of Revenue (the Department) issued a final determination
regarding the Companys state tax returns for the years 1996, 1997, 1998 and 1999.
The Department upheld the auditors assessment of business and occupation tax on
certain expense reimbursements the Company received from vendors during the audit period.
The Company petitioned the Department for a reconsideration of its determination, which
stayed the payment of the assessment until the petition for reconsideration is resolved.
However, as a result of the determination the Company recorded a charge of $2.1 million
during the fourth quarter of 2002. The Company intends to pursue all of its appeal rights,
but there can be no assurance that the Company will be successful, in whole or in part, in
challenging the determination. Additionally, the Department may also make a similar
assessment for all future periods after 1999. The Company has fully reserved against the
possibility of a similar assessment for these periods.


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.
10
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Liquidity


The Company believes that its
existing available cash and cash equivalents and existing credit facilities will be
sufficient to satisfy its operating cash needs for at least the next 12 months at its
current level of business. However, if the Companys working capital or other capital
requirements are greater than currently anticipated, the Company could be required to 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.


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 the government and education markets.


Substantially all of the
Companys net sales for the three months ended March 31, 2003 were made to customers
located in the United States. All of the Companys assets at March 31, 2003 and
December 31, 2002 were located within the United States. Sales to one of the
Companys customers represented 13.0% and 16.7% of total sales for the three months
ended March 31, 2003 and 2002. Net sales to this customer were $12.8 million for quarter
ended March 31, 2003 compared to $16.7 million for the quarter ended March 31, 2002.


6.   Acquisition of
Corporate PC Source, Inc.


On March 31, 2003, the Company
acquired Corporate PC Source, Inc. (CPCS), an Illinois corporation, pursuant
to a Stock Purchase Agreement (SPA) by and among the Company, CPCS and the
shareholders of CPCS. The acquisition of CPCS extends the Companys reach into the
mid-west and eastern United States Fortune 2000 customers.


Upon consummation of the transactions
contemplated by the SPA, CPCS became a wholly owned subsidiary of the Company. Under the
terms of the SPA, at closing the Company paid to the shareholders of CPCS $4,881,000 in
cash and issued notes in the aggregate principle amount of $2,500,000; $2,250,000
non-convertible notes, $250,000 convertible notes. Each non-convertible note has a three
year term, with interest paid quarterly, and one third of the principal amount due and
payable at the end of each of the earn-out periods, which occurs annually on the
transaction date. These notes shall bear interest at the rate the Company pays to its
primary lender less 1⁄4%. In addition, these notes are subject to reduction for
failure to reach a threshold of earnings before income tax, depreciation and amortization,
or EBITDA, which could adjust the purchase price in the future. Each convertible note has
a three year term and one-third of the amount payable at the end of each of the earn-out
periods may at any time before the payment thereof, at the option of the prior
shareholders, be converted into the Companys common shares at $2.50 per share. The
Companys general corporate funds were the source of the funds used for the cash
portion of the purchase price.


Additionally, the SPA contains a
provision for an earn-out over three years contingent upon CPCS exceeding minimum levels
of EBITDA. The former shareholders of CPCS will receive a percentage of earnings each year
on an escalating scale based on the applicable EBITDA threshold. The additional earn-out
payments will be accounted for as future purchase price adjustments of the SPA.


CPCSs results of operations
will be included in the Companys consolidated financial statements only for the
periods after the date of closing, March 31, 2003.
11
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The following table summarizes the
fair values of the assets acquired and liabilities assumed at the date of the acquisition.
The current purchase price allocation is preliminary, and is subject to further adjustment
and review.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                            |  | Three
      months ended
      March 31, 2003 |       
| | ---------------------------------------------------------- |  | --------------------------------------------- | ------
| | Current
      Assets                                       |  | $                                             | 12,709
| | Property,
      plant and equipment                        |  |                                               | 349   
| | Other assets                                               |  |                                               | 32    
| | Goodwill                                                   |  |                                               | 4,098 
| |                                                            |  |                                               |       
| | Total
      assets acquired                                |  |                                               | 17,188
| | Current liabilities                                        |  |                                               | 9,771 
| |                                                            |  |                                               |       
| | Net assets
      acquired                                  |  |                                               | 7,417 
| | Less cash
      acquired                                   |  |                                               | 1,458 
| |                                                            |  |                                               |       
| | Purchase
      price for acquisition, net of cash acquired |  | $                                             | 5,959 
| |                                                            |  |                                               |       

|The following unaudited pro forma
information presents the results of the Companys operations as if the acquisition of
CPCS had taken place as of the beginning of the periods presented (amounts in thousands,
except per share data):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                           |  | Three months
      ended March 31, 2003 |       
| | ------------------------- |  | --------------------------------------- | ------
|
| | Net
      sales           |  | $                                       | 98,632
| | Net income
      (loss)   |  |                                         | (646  
| | Earnings
      per share: | 
| | Basic                     |  | $                                       | (0.05 
| | Diluted                   |  | $                                       | (0.05 
|
|
|
| | Net sales                 |  | $                                       | 99,848
| | Net income
      (loss)   |  |                                         | 81    
| | Earnings
      per share: | 
| | Basic                     |  | $                                       | 0.01  
| | Diluted                   |  | $                                       | 0.01  

|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 those contained in the
Companys Annual Report on Form 10-K for the year ended December 31, 2002, which was
filed on February 26, 2003 with the Securities and Exchange Commission. Particular
attention should be paid to the cautionary statements involving a possible delisting of
the Companys securities from the Nasdaq National Market, state tax uncertainties,
the industrys rapid technological change and exposure to inventory obsolescence,
availability and allocation of goods, reliance on vendor support and relationships,
competitive risks, pricing risks and economic risks.
12
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 we may not yet be aware.


Possible Delisting of Securities
from Nasdaq National Market.  The Companys common stock is currently quoted
on the Nasdaq National Market (the National Market).  However, in order
to continue to be included in the National Market, a company must maintain, among other
things, a minimum closing bid price of $1.00 per share.  Since January 17, 2003, our
common stock has consecutively failed to maintain a minimum closing bid price of $1.00 per
share.  The Company has until September 2, 2003, to regain compliance with these
standards. Under National Market rules, the Company may demonstrate compliance by
maintaining a $1.00 minimum closing bid price per share for a minimum of ten consecutive
trading days by that date. If the Company is unable to demonstrate compliance by that
date, it may appeal a determination by Nasdaq that the common stock be delisted from the
National Market, or it may decide to file an application to be transferred to the Nasdaq
SmallCap Market.


In order to maintain compliance with
the National Market listing requirements, the Company may be required to take various
measures including, but not limited to, raising additional capital and affecting a reverse
split of its common stock. If the Company is unable to demonstrate compliance by September
2, 2003 and does not appeal a determination by Nasdaq, its common stock will be delisted
from the National Market.  The delisting of its common stock would have an adverse
impact on the market price and liquidity of the Companys securities and may
adversely affect the ability to obtain additional financing.  As a result of such
delisting, a shareholder may find it more difficult to dispose of, or to obtain accurate
quotations as to the market value of, the Companys common stock.


State Sales or Use Tax
Uncertainties.In accordance with current industry practice, the Company does not
collect sales taxes or other taxes with respect to shipments of goods into states other
than Washington, Nevada, Tennessee, Illinois, California, Missouri and Ohio. Various
states have sought to require the collection of state and local sales taxes on the sales
of products shipped to the taxing jurisdictions residents by direct marketing
resellers. The United States Supreme Court held in 1992 that it is unconstitutional for a
state to impose sales or use tax collection obligations on an out-of-state company whose
contacts with the state were limited to the distribution of catalogs and other advertising
materials through the mail and the subsequent delivery of purchased goods by United States
mail or by common carrier. The Company cannot predict the level of contact, including
electronic commerce and Internet activity, that might give rise to future or past tax
collection obligations based on the Supreme Court case. In addition, states aggressively
pursue out of state businesses, and legislation that would expand the ability of states to
impose sales tax collection obligations on out of state businesses has been introduced in
Congress on many occasions. A change in the law could require the Company to collect sales
taxes or similar taxes on and potentially subject it to a liability for prior year sales,
either of which could have a material adverse effect on the Companys business,
financial condition, cash flows or results of operations. The Company has petitioned the
Washington State Department of Revenue for reconsideration of its determination regarding
the Companys tax returns for the years 1996, 1997, 1998 and 1999. The Company
recorded a charge for this determination of $2.1 million in the fourth quarter, and may
have to pay this amount, plus interest, if the petition is denied. Additionally, the
Department may also make a similar assessment for all future periods after 1999. The
Company has fully reserved against the possibility of a similar assessment for these
periods.


No Assurance as to Profitability
or Levels of Revenue. The Company has not been profitable in any of the last three
fiscal years. In addition, 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 the level of corporate investment in new IT related
capital equipment and general economic conditions. 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 assurance that this designation will contribute to future growth or
that the Company will continue to hold this designation or to qualify for such sales.
Overall, there has been a decreased demand for the products the Company sells that has
adversely affected its sales and results of operations. There is no assurance that the
Company will achieve profitability, or that the Companys sales will not further
decline or that the Company will achieve profitability in the face of further declining
sales. A failure to achieve profitability or a decline in revenue levels would adversely
affect the Companys business, financial condition, cash flows or results of
operations.
13
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------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|Variability of Operating
Results. Historically, the Company has experienced significant fluctuations in its
operating results from quarter to quarter as a result of many factors, and may experience
significant fluctuations in its operating results in the future for many reasons,
including the purchasing cycles of major enterprise customers, investment in activities to
increase the productivity of its sales team, the condition of the computer products
industry, shifts in demand for computer products, industry announcements of new products
or upgrades, industry consolidation and acquisition disruptions and general economic
conditions. 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.


On March 31, 2003, the Company
acquired all of the outstanding shares of capital stock of Corporate PC Source, Inc.
(CPCS), an Illinois based reseller. The Company paid the shareholders of
CPCS $4,881,000 in cash and issued $2,500,000 of notes payable. The purchase price of CPCS
was based on the historical financial results of CPCSs operations. There is no
assurance that CPCS will continue to perform as it has in the past or that the purchase
price that was paid for CPCS will reflect a fair value in the future. In addition, there
are risks associated with the acquisition and the resulting change of control of CPCS,
including potential for dispute over earn out payment obligations, and the loss of
customers or key employees of CPCS. Any of which could have an adverse effect on the
Companys business, financial condition, cash flows or results of operations.


Pressure on Margins. The
computer products industry has experienced intense price competition. Historically, the
Companys competition has aggressively priced their product offerings to gain market
share, and the Company believes its competition will continue to do so.  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 both
on average selling price and 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 the Companys 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, 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 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           cooperative
advertising expense reimbursements 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.


Major Customer. Sales to one
of the Companys customers represented 13.0% and 16.7% of total sales for the three
months ended March 31, 2003 and 2002. Net sales to this customer were $12.8 million for
quarter ended March 31, 2003 compared to $16.7 million for the quarter ended March 31,
2002. The contract with this customer expires in June 2003. While the Company may continue
to receive some level of business from this customer, it anticipates that net sales to
this customer will decline significantly after the expiration of the contract. The Company
is not optimistic about an extension of the current contract with this customer. There are
no assurances that the Company will be able to replace these sales with increased sales to
other enterprise or SMB customers.
14
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Account Executive Hiring and
Productivity. The Company intends to aggressively recruit account executives during
2003. The Company hopes to hire approximately 20 new account executives each month. There
are no assurances that the Company will be able to recruit the quality individuals that it
hopes to recruit and hire, or that the individuals hired will remain with the Company for
an extended period of time. The productivity of account executives has historically been
based on tenure. If the Company does not retain the account executive, there can be no
assurances of increasing average tenure or increased productivity. Additionally, the
Companys account executives are occasionally the subject of aggressive hiring by
competitors.


Vendor Support. The Company
has various relationships with its vendors, whose programs contribute to profitability.
The Company relies on its vendors for cooperative advertising, which is a reimbursement 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. Many of these back-end programs are complex and difficult
to administer, and can be terminated with little or no notice. If any of these
relationships or programs were terminated or substantially curtailed, or if the Company
failed to manage the complexity of these programs, 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 significant 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
such products. Within the industry, vendors are becoming increasingly restrictive in
guaranteeing return privileges. While the Company seeks to reduce its inventory exposure
through a variety of inventory control procedures and policies 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.


Major Shareholder. Firoz H.
Lalji, the Companys Chairman and Chief Executive Officer, beneficially owns 48.2% 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 50.0% of the outstanding shares of the Companys common
stock. The voting power of these shares enables Mr. Lalji to significantly influence the
Companys affairs and the vote on corporate matters to be decided by the
Companys shareholders, including the outcome of elections of directors. This
effective voting control may preclude other shareholders from being able to influence
shareholder votes and could impede potential merger transactions or block changes to the
Companys articles of incorporation or bylaws, which could adversely affect the
trading price of the Companys common stock.
15
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 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. Additionally, the
Companys headquarters lease expires on July 31, 2003. If the Company is unable to
renew the lease on favorable terms and is required to move its headquarters, there is a
risk that there could be an interruption of the Companys information systems, which
could have a material adverse effect on the Companys business, financial condition,
cash flows or 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 net sales consist
primarily of sales of computer hardware, software, peripherals and accessories, as well as
revenue associated with freight billed to its customers, 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 applicable 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.


In Item 7 (Managements
Discussion and Analysis of Financial Condition and Results of Operations) of the
Companys Annual Report on Form 10-K for the year ended December 31, 2002, which was
filed with the Securities and Exchange Commission on February 26, 2003, included a
discussion of the most significant accounting policies and estimates used in the
preparation of the Companys financial statements. During the first quarter of 2003,
the Company adopted EITF 02-16 Issue No. 02-16, Accounting for Consideration
Received from a Vendor by a Customer (Including a Reseller of the Vendors
Products). Due to the adoption of EITF 02-16, the Company recorded $568,000 of
vendor consideration as a reduction to cost of sales in the first quarter of 2003 that
offset advertising expense in prior periods. There has been no other material change in
the policies and estimates used by the Company in the preparation of its financial
statements since the filing of the Annual Report.
16
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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
      March 31, |          
| | -------------------------------------------------- |  | ---------------------------------------- | ---------
|
| | Net
      sales                                    |  |                                          | 100.0    
| | Cost of sales                                      |  |                                          | 89.5     
| |                                                    |  |                                          |          
| | Gross profit                                       |  |                                          | 10.5     
| | Selling,
      general and administrative expenses |  |                                          | 10.3     
| | Advertising
      expenses, net                    |  |                                          | 1.3      
| |                                                    |  |                                          |          
| | Income (loss)
      from operations                |  |                                          | (1.1     
| | Other (income)
      expense                       |  |                                          | 0.0      
| |                                                    |  |                                          |          
| | Income (loss)
      before income taxes            |  |                                          | (1.1     
| | Provision
      for (benefit from) income taxes    |  |                                          | (0.4     
| |                                                    |  |                                          |          
| | Net income
      (loss)                            |  |                                          | (0.7     
| |                                                    |  |                                          |          
| |                                                    | 
| | Selected
      domestic operating data:            | 
| | Catalog circulation                                |  |                                          | 2,980,000
| | E-media circulation                                |  |                                          | 3,965,000
| | Number of
      orders                             |  |                                          | 124,000  
| | Average order
      size                           |  |                                          | $803     
| | Number of
      account executives, end of period  |  |                                          | 194      

|Comparison of Three Month
Periods Ended March 31, 2003 and 2002


Net Sales.Net sales for the
quarter ended March 31, 2003 decreased 1.2% to $98.6 million compared to $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, and as a result of the
anticipated decline in sales to a major customer. Sales to this major customer decreased
23.4% to $12.8 million for the quarter ended March 31, 2003 compared to $16.7 million in
the same period of 2002. The contract with this customer expires in June 2003. While the
Company may continue to receive some level of business from this customer, it anticipates
that net sales to this customer will decline significantly after the expiration of the
contract. Total outbound sales to the SMB, enterprise and public sector accounts increased
2.6% to $86.4 million in the first quarter of 2003 from $84.2 million in the first quarter
of 2002. However, the Company had a sales decrease in its core SMB market, which decreased
8.4% to $40.1 million in the first quarter of 2003 from $43.8 million in the first quarter
of 2002. The primary reason for this decline is the economic slowdown for purchases of IT
equipment. As a value-added service to its business customers, the Company began
collecting sales tax in the States of California and Missouri during the first quarter of
2003. Sales by the Companys Mac division was impacted by this decision with sales
decreasing 21.8% to $12.2 million for the three months ended March 31, 2003 compared to
$15.6 million in the comparable period in 2002.


Gross Profit. Gross profit
dollar contribution decreased to $10.3 million for the first quarter of 2003, down 2.0%
from the first quarter of 2002, which corresponds to the decline in sales volume. Gross
profit as a percentage of net sales decreased slightly to 10.5% in the quarter ended March
31, 2003 compared to 10.6% in the first quarter of 2002, and increased sequentially from
10.3% in the fourth quarter of 2002. Gross profit margins were impacted by the
Companys adoption of Emerging Issues Task Force (EITF) Issue No. 02-16,
Accounting for Consideration Received from a Vendor by a Customer (Including a
Reseller of the Vendors Products). Due to the adoption of EITF 02-16, the
Company recorded $568,000 of vendor consideration as a reduction to cost of sales in the
first quarter of 2003. Excluding the impact of EITF 02-16, the gross profit margin would
have declined to 9.9% for the first quarter of 2003. This percentage is a non-GAAP measure
that is being presented for comparison purposes only as the adoption of EITF 02-16 did not
impact prior year gross profit margins. Gross profit margins as a percent of sales will
continue to vary on a quarterly basis due to vendor programs, product mix, pricing
strategies, customer mix, and economic conditions.
17
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Selling, General and
Administrative (SG&A) Expenses. SG&A expense dollars remained flat
at $10.2 million for the quarter ended March 31, 2003 compared to the first quarter of
2002, but sequentially, SG&A expense dollars decreased 17.1% from $12.3 million in the
fourth quarter of 2002. The sequential decline is due to the $2.1 million expense booked
in the fourth quarter of 2002 for the state tax adjustment. The Company continues to
maintain tight controls on its discretionary spending. As a percent of sales, SG&A
increased to 10.3% for the quarter ended March 31, 2003 from 10.2% in the first quarter of
2002 due to the decline in sales volume.


Advertising expenses, net. The
Company produces and distributes catalogs at various intervals throughout the year, as
well as engaging in other activities to increase the awareness of its brand and as demand
response vehicles. The Companys net cost of advertising increased to $1.2 million in
the three month period ended March 31, 2003 from $202,000 in the comparable 2002 period.
This increase is primarily due to the Companys adoption of EITF 02-16,
Accounting for Consideration Received from a Vendor by a Customer (Including a
Reseller of the Vendors Products). Due to the adoption of EITF 02-16, the
Company recorded $568,000 of vendor consideration as a reduction to cost of sales in the
first quarter of 2003 that offset advertising expense in prior periods. Additionally,
advertising expense was impacted by a decline in the amount of cooperative advertising
revenue received from the Companys vendors.


Other Income/Expense.Other
income was $7,000 for the quarter ended March 31, 2003 compared to other income of $14,000
in the first quarter of 2002. The change was primarily due to an decrease in interest
income incurred in the first quarter of 2003 compared with the same period of 2002.


Provision/Benefit for Income
Taxes. The benefit for income taxes for the quarter ended March 31, 2003 was $398,000
as compared to a provision of $52,000 in the comparable period of the prior year. The
Companys effective tax rate expressed as a percentage of income before taxes was
38.1% for the quarter ended March 31, 2003 compared to 39.1% for the quarter ended March
31, 2002.


Net Income/Loss.Net loss for
the quarter ended March 31, 2003 was $646,000 compared to net income of $81,000 in the
first quarter of 2002. Basic and diluted loss per share was $0.05 for the quarter ended
March 31, 2003 and basic and diluted earnings per share was $0.01 in the first quarter of
2002.
18
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Trends


The Companys first quarter 2003
operating results reflect the continuation of a muted environment for IT purchases as well
as the additional economic pressures exerted by a wartime economy. The Company remains
cautious about 2003 due to anticipated lackluster economic performance for the remainder
of the year. However, the Company believes the acquisition of Corporate PC Source, Inc.
(CPCS) should contribute positively to future quarters results and may
serve as a buffer to moderate the effects, if any, of future economic weakness. 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 up-tick in technology spending. In
anticipation of 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. The Company began an aggressive investment in new
account executives in the second half of 2002, and continued hiring during the first
quarter of 2003, hiring and training 59 team members. Subject to current market
conditions, the Company will continue to invest in the business by hiring and training
additional account executives as circumstances allow 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. Sales in
its enterprise divisions, excluding sales to a major customer, increased 83.5% to $26.3
million compared to the first quarter 2002, and increased 23.5% sequentially from the
fourth quarter of 2002.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Company acquired CPCS on March 31, 2003. CPCS resells IT products and services to
businesses in the Fortune 2000. CPCSs results of operations will be included in the
Companys consolidated financial statements only for the periods after the date of
closing.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
Company believes it has growth potential in its Public Sector division and it is pursuing
education, state and local government initiatives.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

|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. Gross
profit margins will continue to vary based on each of these factors. As long as the
economic environment remains sluggish, the Company may experience pricing pressures in
pursuit of increasing its market share.


During the first quarter of 2003, the
Company adopted EITF 02-16, Accounting for Consideration Received from a Vendor by a
Customer (Including a Reseller of the Vendors Products). Due to the adoption
of EITF 02-16, the Company recorded $568,000 of vendor consideration as a reduction to
cost of sales in the first quarter of 2003 that offset advertising expense in prior
periods. The adoption of this issue had no impact on net income (loss) from operations,
shareholders equity or cash flows of the Company. EITF 02-16 only impacts contracts signed
or revised on or after January 1, 2003. As new contracts are signed, or existing contracts
are modified, there may be a shift towards increased gross profit margins and a concurrent
growth in the net cost of advertising.


The Company constantly reviews all
internal processes in an effort to create efficiencies and 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. 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.
19
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 March 31, 2003, the Company had
total assets of $94.0 million, of which $79.0 million were current assets. At March 31,
2003 and December 31, 2002 the Company had cash and cash equivalents of $5.6 million and
$9.0 million, respectively, and working capital of $17.1 million and $20.6 million,
respectively. The decline is primarily due to the March 31, 2003 acquisition of Corporate
PC Source, Inc. The Company continued to utilize its cash position to take advantage of
favorable discount terms offered by certain vendors.


Net inventory increased to $12.5
million at March 31, 2003. However, excluding the effect of the acquisition, net inventory
decreased to $10.6 million at March 31, 2003 from $11.3 million as of December 31, 2002.
This non-GAAP measure is given for comparison purposes only and is the basis for the
calculation of inventory turns. Inventory turns increased slightly to 33 times annually,
compared with 32 times annually at December 31, 2002. Concurrently, open account trade
receivable increased to $48.9 million at March 31, 2003. Excluding the effect of the
acquisition, open account trade receivable increased to $40.1 million at March 31, 2003
from $37.9 million as of December 31, 2002. This non-GAAP measure is given for comparison
purposes only and is the basis for the calculation of accounts receivable days
outstanding. Accounts receivable days outstanding increased to 46 as of March 31, 2003
compared to 43 days outstanding as of December 31, 2002.


Net cash used by operating activities
was $5.4 million for the three months ended March 31, 2003 compared to cash used by
operating activities of $2.3 million for the three months ended March 31, 2002. Cash
outflows for the three months ended March 31, 2003 were primarily due to increases in
accounts receivable and a decrease in accounts payable. In the three months ended March
31, 2003, accounts receivable increased $2.7 million while accounts payable decreased by
$4.1 million from December 31, 2002.


Cash outlays for capital expenditures
were $172,000 and $651,000 in the three months ended March 31, 2003 and 2002,
respectively. These expenditures were primarily for continued improvement, and other
enhancements, of the Companys information systems. Additionally, on March 31, 2003,
the Company received $1.5 million cash in its acquisition of CPCS.


At March 31, 2003, the Company has a
consolidated aggregate $60.0 million available under secured lines of credits with 2 major
financial institutions, through three separate agreements.  The Company has a $30.0
million facility, collateralized by accounts receivable and inventory, that can be
utilized as both a working capital line of credit and a flooring facility used to purchase
inventory from several suppliers under certain terms and conditions.  This credit
facility expires on November 25, 2004.  The working capital and inventory advances
bear interest at a rate of Prime + 0.50%. Inventory advances do not bear interest if paid
within terms, usually 30 days from advance date.  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 March 31, 2003, no working capital advances were outstanding and
accounts payable of $8.7 million was owed to this financial institution related to
inventory purchases at March 31, 2003.


The second facility is a $5.0 million
inventory flooring facility collateralized by the inventory purchases financed on the
facility.  The facility expires on July 21, 2003 and is subject to annual renewals.
The inventory advances bear interest at a rate of Prime if not paid within terms, usually
30 days from advance date.  Amounts due under this line are included in accounts
payable and were $4.5 million at March 31, 2003.
20
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Lastly, at March 31, 2003, CPCS also
has a facility with one of the major financial institutions. The $25.0 million facility,
collateralized by accounts receivable and inventory, can be utilized as both a working
capital line of credit and a flooring facility. This credit facility expires on May 30,
2003 and will not be renewed as the Company is working on a consolidated facility. The
working capital and inventory advances bear interest at a rate of Prime + 0.25%. Inventory
advances do not bear interest if paid within terms, usually 30 days from advance date. At
March 31, 2003, a $2.2 million working capital advance was outstanding and accounts
payable included $6.0 million owed to this financial institution related to inventory
purchases.


Subsequent to March 31, 2003, the
Company has renegotiated its primary facility. The facility was increased from $30.0
million to $40.0 million. Additionally, the Company is in the process of renegotiating its
inventory flooring facility to meet the needs of the consolidated company. The Company
expects to have this facility in place by May 30, 2003.


The Company believes that its
existing available cash and cash equivalents and existing credit facilities will be
sufficient to satisfy its operating cash needs for at least the next 12 months at its
current level of business. However, if the Companys working capital or other capital
requirements are greater than currently anticipated, the Company could be required to 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.


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


Various claims and actions of a type
commonly encountered in the Companys industry have been asserted and are pending
against the Company. Except as otherwise indicated, 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.


On November 21, 2002, the Washington
State Department of Revenue (the Department) issued a final determination
regarding the Companys state tax returns for the years 1996, 1997, 1998 and 1999.
The Department upheld the auditors assessment of business and occupation tax on
certain expense reimbursements the Company received from vendors during the audit period.
The Company petitioned the Department for a reconsideration of its determination, which
stayed the payment of the assessment until the petition for reconsideration is resolved.
21
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|However, as a result of the
determination by the Department, the Company recorded a charge of $2.1 million during the
fourth quarter of 2002. The Company intends to pursue all of its appeal rights, but there
can be no assurance that the Company will be successful, in whole or in part, in
challenging the determination. Additionally, the Department may also make a similar
assessment for all future periods after 1999. The Company has fully reserved against the
possibility of a similar assessment for these periods.


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.


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

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

| | 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
|--- | -------------------

| | On
March 19, 2003, the Company filed a report on Form 8-K containing information regarding
the Companys receipt of a letter from Nasdaq that notified the Company that it was
not in compliance with Nasdaqs minimum bid price per share requirement of $1.00 for
continued listing on the Nasdaq National Market.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
other reports on Form 8-K were filed during the quarter ended March 31, 2003.
| | --------------------------------------------------------------------------------

|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:
        May 13, 2003 |  | 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

|22
|--

|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: May 13, 2003
|------------------

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

|A signed original of this written
statement required by Section 906 has been provided to Zones, Inc. and will be retained by
the Company and furnished to the Securities and Exchange Commission or its staff upon
request.
23
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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: May 13, 2003
|------------------

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

|A signed original of this written
statement required by Section 906 has been provided to Zones, Inc. and will be retained by
the Company and furnished to the Securities and Exchange Commission or its staff upon
request.
24
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------