UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 FORM
10-Q
 
 x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  FOR
THE QUARTERLY PERIOD ENDED MARCH 31, 2008
 OR
 
  ̈
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE TRANSITION PERIOD FROM __________ TO
    __________
 
 Commission
File Number     0-28488
 
 
 ZONES,
INC
 (Exact
name of registrant as specified in its charter)
 
 Washington
              91-1431894(State
      of Incorporation)
              (I.R.S.
      Employer Identification Number)1102
      15th
      Street SW, Suite 102Auburn,
      Washington
              98001-6509(Address
      of Principal Executive Offices)
              (Zip
      Code)
 
 (253)
205-3000
 (Registrant's
Telephone Number,
Including Area Code)
 
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes  x    No
 ̈ .
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (Check one):
 Large
accelerated filer  ̈
Accelerated filer   ̈ Non-accelerated filer
 ̈   Smaller
reporting company x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes  ̈   No
x
 
 The
number of shares of the registrant's Common Stock outstanding as of May 8, 2008
was 13,220,853.
  
  
  ZONES, INC.
 FORM
10-Q QUARTERLY REPORT
 TABLE
OF CONTENTS
 
 PART
I.  FINANCIAL INFORMATION
  Item
      1.
              Consolidated Financial Statements
    (unaudited):Consolidated Balance Sheets March 31, 2008 and December 31,
      2007
              3Consolidated Statements of Operations Three months ended
      March 31, 2008 and 2007
              4Consolidated Statements of Shareholders’ Equity Three
      months ended March 31, 2008
              5Consolidated Statements of Cash Flows Three months ended
      March 31, 2008 and 2007
              6Notes to Consolidated Financial
    Statements
              7Item
      2.
              Management’s Discussion and Analysis of  Financial
      Condition and Results of Operations
              10Item
      3.
              Quantitative and Qualitative Disclosures About Market
      Risk
              16Item
      4.
              Controls and Procedures
              16
  
 PART
II.  OTHER INFORMATION
  Item
      1.
              Legal Proceedings
              16Item
      1A.
              Risk Factors
              16Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              20Item
      6.
              Exhibits
              21Signatures
              21
  2
 Table of Contents
  Part I.
 
 Item
      1.
              Financial Statements
 
 ZONES,
INC.
 CONSOLIDATED
BALANCE SHEETS
 (in
thousands)
 (unaudited)
 
 March
      31,
              
              
              December
      31,2008
              
              
              2007ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              13,892
              
              
              $
              12,004Receivables,
      net of allowances of $1,263 and $1,213
              
              
              63,162
              
              
              
              73,581Vendor
      receivables, net of allowances of $984 and $780
              
              
              13,098
              
              
              
              15,139Inventories
              
              
              23,815
              
              
              
              21,278Prepaid
      expenses
              
              
              1,067
              
              
              
              861Deferred
      income taxes
              
              
              1,377
              
              
              
              1,377Total
      current assets
              
              
              116,411
              
              
              
              124,240Property
      and equipment, net
              
              
              3,119
              
              
              
              3,383Goodwill
              
              
              5,098
              
              
              
              5,098Deferred
      income taxes
              
              
              411
              
              
              
              411Other
      assets
              
              
              190
              
              
              
              190Total
      assets
              
              $
              125,229
              
              
              $
              133,322LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
              
              $
              34,691
              
              
              $
              37,040Inventory
      financing
              
              
              11,466
              
              
              
              20,252Accrued
      liabilities
              
              
              11,528
              
              
              
              11,479Income
      taxes payable
              
              
              1,216
              
              
              
              510Total
      current liabilities
              
              
              58,901
              
              
              
              69,281Deferred
      rent obligation
              
              
              1,670
              
              
              
              1,733Total
      liabilities
              
              
              60,571
              
              
              
              71,014Commitments
      and contingenciesShareholders'
      equity:Common
      stock
              
              
              35,447
              
              
              
              35,676Retained
      earnings
              
              
              29,211
              
              
              
              26,632Total
      shareholders' equity
              
              
              64,658
              
              
              
              62,308Total
      liabilities and shareholders' equity
              
              $
              125,229
              
              
              $
              133,322
 
 
 See notes
to consolidated financial statements
  3
 Table of Contents
  ZONES, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except per share data)
 (unaudited)
 
 
 Three
      Months ended
                  March
      31,2008
                
                
                2007Net
      sales
                
                $
                166,757
                
                
                $
                148,182Cost
      of sales
                
                
                147,193
                
                
                
                129,982Gross
      profit
                
                
                19,564
                
                
                
                18,200Selling,
      general and administrative expenses
                
                
                13,818
                
                
                
                12,596Advertising
      expenses
                
                
                1,742
                
                
                
                1,883Income
      from operations
                
                
                4,004
                
                
                
                3,721Other
      income, net
                
                
                104
                
                
                
                24Income
      before income taxes
                
                
                4,108
                
                
                
                3,745Provision
      for income taxes
                
                
                1,529
                
                
                
                1,433Net
      income
                
                $
                2,579
                
                
                $
                2,312Basic
      income per share
                
                $
                0.20
                
                
                $
                0.18Shares
      used in computing basic income per share
                
                
                13,156
                
                
                
                13,138Diluted
      income per share
                
                $
                0.18
                
                
                $
                0.16Shares
      used in computing diluted income per share
                
                
                14,604
                
                
                
                14,718
 
 
 See notes
to consolidated financial statements
  4
 Table of Contents
  ZONES, INC.
 CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY
 (in
thousands, except share data)
 (unaudited)
 
 
 Common
      Stock
              
              
              RetainedShares
              
              
              Amount
              
              
              Earnings
              
              
              TotalBalance,
      January 1, 2008
              
              
              13,133,114
              
              
              $
              35,676
              
              
              $
              26,632
              
              
              $
              62,308Purchase
      and retirement of common stock
              
              
              (47,600
              )
              
              
              (455
              )
              
              
              
              
              
              
              (455
              )Exercise
      of stock options
              
              
              50,620
              
              
              
              86
              
              
              
              
              
              
              
              86Excess
      tax benefit from stock options exercised
              
              
              
              
              
              
              115
              
              
              
              
              
              
              
              115Stock-based
      compensation
              
              
              
              
              
              
              25
              
              
              
              
              
              
              
              25Net
      income
              
              
              
              
              
              
              
              
              
              
              2,579
              
              
              
              2,579Balance,
      March 31, 2008
              
              
              13,136,134
              
              
              $
              35,447
              
              
              $
              29,211
              
              
              $
              64,658
 
 
 See notes
to consolidated financial statements
  5
 Table of Contents
  ZONES, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
thousands)
 (unaudited)
 
 Three
      months ended
                March
      31,2008
              
              
              2007Cash
      flows from operating activities:Net
      income
              
              $
              2,579
              
              
              $
              2,312Adjustments
      to reconcile net income to net cash provided by (used in) operating
      activities:Depreciation
              
              
              422
              
              
              
              448Non-cash
      stock-based compensation
              
              
              25
              
              
              
              52Excess
      tax benefit from exercise of stock options
              
              
              (115
              )
              
              
              (61
              )(Increase)
      decrease in assets and liabilities:Receivables,
      net
              
              
              12,459
              
              
              
              (16,998
              )Inventories
              
              
              (2,537
              )
              
              
              (5,366
              )Prepaid
      expenses
              
              
              (206
              )
              
              
              (302
              )Accounts
      payable
              
              
              1,773
              
              
              
              (1,813
              )Accrued
      liabilities and deferred rent
              
              
              (14
              )
              
              
              (1,374
              )Income
      taxes payable
              
              
              822
              
              
              
              1,413Net
      cash provided by (used in) operating activities
              
              
              15,208
              
              
              
              (21,689
              )Cash
      flows from investing activities:Purchases
      of property and equipment
              
              
              (158
              )
              
              
              (1,002
              )Net
      cash used in investing activities
              
              
              (158
              )
              
              
              (1,002
              )Cash
      flows from financing activities:Net
      change in book overdraft
              
              
              (4,122
              )
              
              
              (3,913
              )Net
      change in line of credit
              
              
              -
              
              
              
              12,300Net
      change in inventory financing
              
              
              (8,786
              )
              
              
              8,755Excess
      tax benefit from exercise of stock options
              
              
              115
              
              
              
              61Purchase
      and retirement of common stock
              
              
              (455
              )
              
              
              (552
              )Proceeds
      from exercise of stock options
              
              
              86
              
              
              
              70Net
      cash provided by (used in) financing activities
              
              
              (13,162
              )
              
              
              16,721Net
      increase (decrease) in cash and cash equivalents
              
              
              1,888
              
              
              
              (5,970
              )Cash
      and cash equivalents at beginning of period
              
              
              12,004
              
              
              
              9,191Cash
      and cash equivalents at end of period
              
              $
              13,892
              
              
              $
              3,221
 
 
 See notes
to consolidated financial statements
  6
 Table of Contents
  ZONES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited)
 
 1.  Description
of Business
 
 Zones,
Inc. (the “Company,” “We”) is a single-source direct marketing reseller of
name-brand information technology products to the small-to-medium-sized business
market (“SMB”), large enterprise accounts and public sector
accounts.  We sell these products through outbound and inbound account
executives, a national field sales force, catalogs and the
Internet.  We offer more than 150,000 products from leading
manufacturers, including Adobe, Apple, Avaya, Cisco, Epson, HP, IBM, Kingston,
Lenovo, Microsoft, NEC, Nortel Networks, Sony, Symantec and
Toshiba.
 
 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.
 
 Basis
of Presentation
 In the
opinion of management, the accompanying unaudited consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
which in the opinion of management are necessary for a fair statement of the
financial position and operating results for the interim periods
presented.  The results of operations for such interim periods are not
necessarily indicative of results for the full year.  These financial
statements should be read in conjunction with the audited financial statements
and notes thereto contained in our Annual Report on Form 10-K for the year ended
December 31, 2007 as filed with the Securities and Exchange Commission on March
3, 2008.
 
 Summary
of significant accounting policies
 The
significant accounting policies used in the preparation of our financial
statements are disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2007.
 
 Goodwill
 In
accordance with SFAS No. 142,"Goodwill and Other Intangible Assets," goodwill is
tested for impairment annually on the purchase date or sooner when events
indicate that a potential impairment exists.  We perform the
assessment annually on March 31, and all goodwill relates to the purchase of
Corporate PC Source, Inc.  There were no changes to the carrying
amount of goodwill for the periods ended March 31, 2008 and December 31,
2007.
 
 Revenue
Recognition
 We adhere
to the revised guidelines and principles of sales recognition in Staff
Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition,” issued by the
staff of the SEC as a revision to Staff Accounting Bulletin No. 101, “Revenue
Recognition.”  We recognize revenue on product sales when persuasive
evidence of an arrangement exists, delivery has occurred, prices are fixed or
determinable, and ability to collect is probable.  We consider the
point of delivery of the product to be when the risks and rewards of ownership
have transferred to the customer.  Our shipping terms dictate that the
passage of title occurs upon receipt of products by the customer except for the
last seven calendar days of each fiscal quarter, when all shipments are insured
in the name of the customer. For these seven days, passage of risk of loss and
title occur at the shipping point.
 
 The
majority of our sales relate to physical products. For all product sales,
shipped directly from our warehouse or from our suppliers to customers, we are
the primary obligor, have full latitude in establishing price with the customer,
select the supplier to provide the product, take title to the product sold upon
shipment, bear credit risk, and bear inventory risk for returned
products.  These sales are recognized on a gross basis with the
selling price to the customer recorded as sales and the acquisition cost of the
product recorded as cost of sales.  Additionally, amounts billed for
shipping and handling are recorded as sales.
  7
 Table of Contents
  For all
third-party services, we are the primary obligor to our customer, we have full
latitude in establishing price with the customer, we select the third-party
service provider, we are obligated to compensate the service provider for work
performed regardless of whether the customer accepts the work and we bear credit
risk; therefore, these revenues are recognized on a gross basis with the selling
price to the customer recorded as sales and the acquisition cost of the service
recorded as cost of sales.
 
 Software
maintenance contracts, software agency fees, and extended warranties that we
sell (for which we are not the primary obligor), are recognized on a net basis
in accordance with Emerging Issues Task Force Issue No. 99-19 (“EITF
99-19”), “Reporting Revenue Gross as a Principal versus Net as an
Agent.”  We do not take title to the products or assume any
maintenance or return obligations in these transactions; title is passed
directly from the supplier to our customer. Accordingly, such revenues are
recognized in sales either at the time of sale or over the contract period,
based on the nature of the contract, at the net amount retained by us, with no
cost of goods sold.
 
 Sales are
reported net of sales, use or other transaction taxes that are collected from
the customers and remitted to taxing authorities.  Sales are reported
net of returns and allowances.  We offer limited return rights on our
product sales.  We make what we believe to be reasonable estimates of
product returns based on significant historical experience. We had allowances
for sales returns of $70,000 and $76,000 at March 31, 2008 and December 31,
2007, respectively.
 
 Comprehensive
Income
 We have
no differences between net income and comprehensive income.
 
 Stock
Based Compensation
 We
maintain equity incentive plans under which we may grant non-qualified stock
options, incentive stock options, restricted stock, restricted stock units
(“RSU”) or stock appreciation rights to team members and non-employee directors.
We issue new shares of common stock upon exercise of stock options, grant of
restricted stock and the vesting of RSUs.
 
 Each
stock option granted has an exercise price of 100% of the market value of the
common stock on the date of the grant. The options generally have a contractual
life of 10 years and vest and become exercisable in 20% increments over
five years.  As of March 31, 2008, there was $64,000 of total
unrecognized pre-tax compensation expense related to non-vested stock options
granted under our equity incentive plans. This cost is expected to be recognized
over a weighted-average period of 1.13 years.  There were no
stock options granted in the three months ended March 31, 2008 or
2007.  Although we do not currently plan to grant additional stock
options in 2008, we granted 75,000 shares of performance based restricted stock
to certain team members during the second quarter of 2008.
 
 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.  We exclude all options to purchase common stock from the
calculation of diluted net income per share if such securities are
antidilutive.
 
 Recent
Accounting Pronouncements
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”), which defines fair value, establishes a framework
for measuring fair value in generally accepted accounting principles and expands
disclosures about fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. SFAS 157 is effective for our fiscal
year 2008. In February 2008, the FASB issued Staff Position No. 157-2,
which provides a one-year delayed application of SFAS 157 for nonfinancial
assets and liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
Early adoption is permitted. The adoption of SFAS 157 did not have a significant
effect on our financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities” (“SFAS 159”). Under SFAS 159,
entities may elect to measure specified financial instruments and warranty and
insurance contracts at fair value on a contract-by-contract basis, with changes
in fair value recognized in earnings each reporting period. The election, called
the fair value option, will enable entities to achieve an offset accounting
effect for changes in fair value of certain related assets and liabilities
without having to apply complex hedge accounting provisions. SFAS 159 is
effective as of the beginning of a company’s first fiscal year that begins after
November 15, 2007. Early adoption is permitted. The adoption of SFAS 159
did not have a significant effect on our financial statements.
  8
 Table of Contents
  In
December 2007, the FASB issued SFAS No. 141 (revised 2007),
“Business Combinations” (“SFAS 141R”), which replaces SFAS No. 141.
SFAS 141R establishes principles and requirements for how an acquirer recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, any resulting goodwill, and any noncontrolling interest in
the acquiree. SFAS 141R also provides for disclosures to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination. SFAS 141R is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and must be
applied prospectively to business combinations completed on or after that date.
We will evaluate how the new requirements could impact the accounting for any
acquisitions completed beginning in fiscal 2009 and beyond, and the potential
impact on our consolidated financial statements.
 
 3.  Earnings
Per Share
 
 We have
45,000,000 common shares authorized.  We have also granted options to
purchase common shares to team members and non-employee
directors.  The following is a reconciliation of the numerators and
denominators of the basic and diluted earnings per share computations (in
thousands, except per share data).
 
 Three
      months ended March 31,2008
              
              
              2007Basic
      earnings per share:Net
      income
              
              $
              2,579
              
              
              $
              2,312Weighted-average
      shares used in computing basic earnings per share
              
              
              13,156
              
              
              
              13,138Basic
      earnings per share
              
              $
              0.20
              
              
              $
              0.18Diluted
      earnings per share:Net
      income
              
              $
              2,579
              
              
              $
              2,312Weighted
      average shares outstanding
              
              
              13,156
              
              
              
              13,138Stock
      options
              
              
              1,448
              
              
              
              1,580Total
      common shares and dilutive securities
              
              
              14,604
              
              
              
              14,718Diluted
      earnings per share
              
              $
              0.18
              
              
              $
              0.16
 
 For the
three months ended March 31, 2008 and 2007, 77,768 shares attributable to
outstanding stock options were excluded from the calculation of diluted earnings
per share because the effect was anti-dilutive.
 
 4. Commitments
and Contingencies
 
 Legal
Proceedings
 From time
to time, we are a party to various legal proceedings, claims, disputes or
litigation arising in the ordinary course of business.  We currently
believe that the ultimate outcome of any of these proceedings, individually or
in the aggregate, will not have a material adverse effect on our business,
financial condition, cash flows or results of operations.
 
 Related
Party
 In June
2004, Fana Auburn LLC, a company owned by one of our officers, who is a majority
shareholder and a member of our board of directors, purchased the property and
buildings in which our headquarters are located, subject to the existing 11-year
lease.  Under the terms of the lease agreement, we are obligated to
pay lease payments aggregating from $1.0 million to $1.3 million per year, plus
apportioned real estate taxes, insurance and common area maintenance charges.
Our Audit Committee reviewed and approved this related party transaction, and
also the potential corporate opportunity, recognizing that in the future we may
have to renew and renegotiate our lease and that such renewal and renegotiation
would also present a related party transaction, which would be subject to
further Audit Committee review and consideration.  In May 2006, after
further review and approval by our Audit Committee, we signed an amendment to
the lease agreement increasing the rentable square feet by approximately 18,923
square feet.  The additional square feet increased our annual lease
payment by $259,000. Effective January 1, 2007, we have approximately 125,196
rentable square feet located at 1102 15th Street
SW, Auburn, WA.   In April 2007, we received a tenant improvement
reimbursement from Fana Auburn LLC in the amount of $378,000 related to
construction on the additional leased space, which will be amortized over the
remaining life of the lease.  For the three months ended March 31,
2008 and 2007 we paid Fana Auburn LLC $534,000 related to the lease, which is
recorded in selling, general and administrative expenses.
  9
 Table of Contents
  5.  Segment
Information
 
 Our
business comprises one reportable segment: a single-source, multi-vendor direct
marketing reseller of name brand information technology products to
small-to-medium-sized businesses, large enterprise accounts and the public
sector markets.
 
 A summary
of our sales by product mix follows (in thousands):
 
 Three
      months ended March 31,2008
              
              
              2007Notebook
      & PDA’s
              
              $
              46,178
              
              
              $
              19,913Desktops
      & Servers
              
              
              25,896
              
              
              
              32,673Software
              
              
              25,905
              
              
              
              24,329Storage
      devices
              
              
              12,129
              
              
              
              11,712NetComm
      products
              
              
              7,976
              
              
              
              8,477Printers
              
              
              11,319
              
              
              
              13,027Monitors
      & Video
              
              
              12,878
              
              
              
              14,491Memory
      & Processors
              
              
              4,869
              
              
              
              7,915Accessories
      & Other
              
              
              19,607
              
              
              
              15,645Total
              
              $
              166,757
              
              
              $
              148,182
 
 Substantially
all of our net sales for the three months ended March 31, 2008 and 2007 were
made to customers located in the United States.  Substantially all of
our assets at March 31, 2008 and December 31, 2007 were located within the
United States.  The amount of service revenue included in net sales
for the three months ended March 31, 2008 was $2.0 million, or 1.2% of net
sales, compared with $1.2 million, or 0.8% of net sales, for the three months
ended March 31, 2007.  We had one customer which represented over 10%
of total sales for the three month periods ended March 31, 2008 and
2007.  Net sales to this customer were $25.6 million and $15.7 million
for the three months ended March 31, 2008 and 2007,
respectively.  Receivables from this customer represented
approximately 8.9% and 16.0% of total trade receivables as of March 31, 2008 and
2007, respectively.
 
 6.  Share
Repurchase Program
  Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our
Board of Directors.  Share repurchases may be made from time to time
in both open market and private transactions, as conditions warrant, at then
prevailing market prices As of March 31, 2008, $2.5 million remained available
for repurchase of shares of our common stock under the program.  The
current repurchase program is expected to remain in effect through
February 2009, unless earlier terminated by the Board or
completed.
  10
 Table of Contents
  Item
2.   Management’s Discussion and
Analysis of Financial Condition and Results of Operations
 
 This
section contains forward-looking statements based on management’s current
expectations, estimates and projections about the industry, management’s
beliefs, and certain assumptions made by management. These statements are made
pursuant to the safe harbor provision of the Private Securities Litigation
Reform Act of 1995.All
statements, trends, analyses and other information contained in this report
relative to trends in net sales, gross margin and anticipated expense levels, as
well as other statements, including words such as “anticipate,” “believe,”
“plan,” “expect,” “estimate,” “intend” and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those anticipated
or expressed in such statements.  Potential risks and uncertainties
that may cause actual results to differ materially from those expressed or
implied include, among others, those set forth in Item 1A of this document and
those contained in our Annual Report on Form 10-K for the year ended December
31, 2007 as filed with the Securities and Exchange Commission on March 3,
2008.  Except as required by law, we undertake no obligation to update
any forward-looking statement, whether as a result of new information, future
events or otherwise.
 
 The
following discussion and analysis should be read in conjunction with our
Consolidated Financial Statements and Notes included in this quarterly report on
Form 10-Q.  As used in this quarterly report on Form 10-Q, unless the
context otherwise requires, the terms “the Company,” “we” and “Zones” refer to
Zones, Inc., a Washington corporation.
 
 General
 
 Our net
sales consist primarily of sales of computer hardware, software, peripherals and
accessories, as well as revenue associated with freight billed to our customers,
net of product returns. Gross profit consists of net sales less product and
freight costs. Selling, general and administrative (“SG&A”) expenses include
warehousing and distribution costs, selling salaries including commissions,
order processing, telephone and credit card fees, and other costs such as
administrative salaries, stock compensation expense, depreciation, rent and
general overhead expenses. Advertising expense is marketing costs associated
with vendor programs, net of vendor cooperative advertising expense
reimbursements allowable under EITF 02-16 “Accounting for Consideration Received
from a Vendor by a Customer (Including a Reseller of the Vendor’s
Products).”   Other expense represents interest expense, net of
non-operating income.
 
 Overview
 
 We are a
direct marketing reseller of technology hardware, software and services. We
procure and fulfill IT solutions for the SMB market (between 50 and 1000
computer users), large and enterprise customers (greater than 1000 computer
users) and the public sector (education and state and local governments).
Relationships with SMB, large and enterprise customers, and public sector
institutions represented 99.3% and 98.9% of total net sales during the three
months ended March 31, 2008 and 2007, respectively. The remaining sales were
from inbound customers, primarily consumers and small office/home office
accounts purchasing mostly Mac platform products.
 
 We reach
our customers through an integrated marketing and merchandising strategy
designed to attract and retain customers. This strategy involves a
relationship-based selling model executed through outbound account executives, a
national field sales force, customized Web stores for corporate customers
through ZonesConnect, a state-of-the-art Internet portal at www.zones.com,
dedicated e-marketing and direct marketing vehicles, and catalogs for
demand-response opportunities and corporate branding.
 
 We
utilize our purchasing and inventory management capabilities to support our
primary business objective of providing name-brand products at competitive
prices. We offer our customers more than 150,000 hardware, software, peripheral
and accessory products and services from more than 2,000
manufacturers.
 
 The
management team regularly reviews our performance using a variety of financial
and non-financial metrics, including, but not limited to, net sales, gross
margin, cooperative advertising reimbursements, advertising expenses, personnel
costs, productivity per team member, accounts receivables aging, inventory
aging, liquidity and cash resources.   Management compares the various
metrics against goals and budgets and takes appropriate action to enhance
performance.
  11
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  We are
dedicated to creating a learning community of empowered individuals to serve our
customers with integrity, commitment and passion. At March 31, 2008 we had 692
team members in our consolidated operations, 334 of whom were inbound and
outbound account executives. The majority of our team members work at our
corporate headquarters in Auburn, Washington.
 
 We make
additional company information available free of charge on our website,
www.zones.com/IR.
 
 Critical
Accounting Policies
 
 In
Item 7 (“Management’s Discussion and Analysis of Financial Condition and
Results of Operations”) of our Annual Report on Form 10-K for the year ended
December 31, 2007, which was filed with the Securities and Exchange
Commission on March 3, 2008, we included a discussion of the most significant
accounting policies and estimates used in the preparation of our financial
statements. There has been no material change in the policies and estimates used
in the preparation of our financial statements since the filing of our most
recent annual report.
 
 Results
of Operations
 
 The
following table presents our unaudited consolidated results of operations, as a
percentage of net sales, and selected operating data for the periods
indicated.
 
 Three
      months ended March 31,2008
              
              
              2007Net
      sales
              
              
              100.0
              %
              
              
              100.0
              %Cost
      of sales
              
              
              88.3
              
              
              
              87.7Gross
      profit
              
              
              11.7
              
              
              
              12.3Selling,
      general and administrative expenses
              
              
              8.3
              
              
              
              8.5Advertising
      expense
              
              
              1.0
              
              
              
              1.3Income
      from operations
              
              
              2.4
              
              
              
              2.5Other
      income, net
              
              
              (0.1
              )
              
              
              (0.1
              )Income
      before income taxes
              
              
              2.5
              
              
              
              2.6Provision
      for income taxes
              
              
              0.9
              
              
              
              1.0Net
      income
              
              
              1.6
              %
              
              
              1.6
              %Product
      Mix (% of Net Sales):Notebook
      & PDA’s
              
              
              27.7
              %
              
              
              13.4
              %Desktops
      & Servers
              
              
              15.5
              
              
              
              22.0Software
              
              
              15.5
              
              
              
              16.4Storage
      devices
              
              
              7.3
              
              
              
              7.9NetComm
      products
              
              
              4.8
              
              
              
              5.7Printers
              
              
              6.8
              
              
              
              8.8Monitors
      & Video
              
              
              7.7
              
              
              
              9.8Memory
      & Processors
              
              
              2.9
              
              
              
              5.3Accessories
      & Other
              
              
              11.8
              
              
              
              10.7
 
 Comparison
of Three Month Periods Ended March 31, 2008 and 2007
 
 Net
Sales.Consolidated net sales for the quarter ended March 31,
2008 increased 12.5% to $166.8 million compared to $148.2 million in the first
quarter of 2007.  Consolidated outbound sales to commercial and public
sector accounts increased 13.0% to $165.6 million in the first quarter of 2008
from $146.6 million in the corresponding period of the prior
year.  Sales to our SMB customers increased 12.3% to $71.9 million for
the quarter ended March 31, 2008 from $64.0 million in the first quarter of
2007.  Growth in the SMB sales was primarily due to increased
headcount and increased productivity of each sales account
executive.  Sales to our enterprise customers increased 14.0% to $88.1
million in the first quarter of 2008 compared to $77.3 million in the first
quarter of 2007.  Sales to our large enterprise customers are often
defined by large non-recurring product roll-outs and specific contractual
obligations which have expiration dates.  During the first quarter of
2008, we had one customer which represented 15.4% of consolidated net
sales.  Since these sales relate to our fulfillment of the customers
first quarter 2008 roll-out plan, which is essentially complete, we do not
expect the magnitude of sales to this customer to continue for the remainder of
the year.  Net sales to public sector customers increased to $5.6
million in the first quarter of 2008 from $5.3 million in the first quarter of
2007.  Inbound sales to consumer and small office home office
customers declined 28.2% to $1.1 million, which represented 0.7% of net
sales.
  12
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  Gross Profit. Consolidated
gross profit increased to $19.6 million for the first quarter of 2008, compared
to $18.2 million in the first quarter of 2007.  Gross profit as a
percentage of net sales decreased to 11.7% in the quarter ended March 31, 2008
compared to 12.3% in the corresponding period of the prior year. The increase in
gross profit dollars is due to the increased sales volume in our SMB customer
base that generally generates higher point of sale margins.  The
decline in gross profit percent was primarily due to a large sale to a single
customer during the first quarter of 2008, the associated product mix, and
shifts in certain vendor programs.  Gross profit margins will continue
to vary, and may decline from current levels, due to changes in vendor programs,
product mix, pricing strategies, customer mix, bid-based sales, the sale of
third-party services and other fee or commission based sales, and economic
conditions.  Lastly, we categorize our warehousing and distribution
network costs in selling, general and administrative expenses.  Due to
this classification, gross profit may not be comparable to a company that
includes its warehousing and distribution network costs as a cost of
sales.
 
 Selling, General and Administrative
Expenses.SG&A expenses increased to $13.8 million for the
quarter ended March 31, 2008, compared to $12.6 million in the prior year
period.  As a percent of sales, SG&A decreased to 8.3% for the
quarter ended March 31, 2008 from 8.5% in the first quarter of
2007.  The decrease in operating expense percentage reflects our
ability to leverage our existing infrastructure as we increase our sales
volumes.  The overall increase in SG&A expense was due to the
following principle factors:
 ·
              Salaries,
      wages and benefits increased $914,000 during the first quarter of 2008
      compared to the prior year.  The increase was primarily due to a
      combination of increased headcount and expenses associated with variable
      compensation programs.
 ·
              Professional
      fees increased $293,000 for the quarter ended March 31, 2008 compared to
      the quarter ended March 31, 2007.  Professional fees include
      one-time expenses associated with the settlement of a
    dispute.
 ·
              Depreciation
      expense decreased $64,000 in the first quarter of 2008 compared to the
      first quarter of 2007.  The decline was primarily due to more of
      our assets becoming fully
depreciated.
 
 For the
periods ending March 31, 2008 and 2007, warehousing and distribution network
costs totaled $599,000 and $558,000, respectively.
 
 Advertising Expenses,
net.  We produce and distribute direct mail collateral,
targeted campaign materials and catalogs at various intervals throughout the
year to increase awareness of our brand and to stimulate demand
response.  Our net cost of advertising decreased slightly to $1.7
million in the three month period ended March 31, 2008 from $1.9 million in the
comparable 2007 period.
 ·
              Gross
      advertising expense decreased slightly to $2.2 million for the first
      quarter of 2008 compared to $2.3 million in the first quarter of 2007,
      primarily due to expenses associated with vendor-specific marketing
      activities.
 ·
              Gross
      advertising vendor reimbursements decreased to $443,000 in the first
      quarter of 2008 from $452,000 in the first quarter of 2007.  We
      have classified substantially all vendor consideration as a reduction of
      cost of goods sold rather than as a reduction of advertising
      expense.
 
 Other income,
net.  Other income, net was $104,000 for the three months ended
March 31, 2008 compared to $24,000 for the quarter ended March 31,
2007.  The amounts recorded were primarily interest income earned on
short-term investments and finance charges collected from certain customers,
which vary from period to period.  Offsetting interest income was
interest expense related to our use of the working capital line of $2,000 and
$33,000 for the three months ended March 31, 2008 and 2007,
respectively.
  13
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  Provision for Income
Taxes.  The provision for income taxes for the quarter ended
March 31, 2008 was $1.5 million compared to $1.4 million in the comparable
period of the prior year.  Our effective tax rate expressed as a
percentage of income before taxes was 37.2% for the quarter ended March 31, 2008
compared to 38.3% for the quarter ended March 31, 2007.  The effective
tax rate is dependent upon our estimations regarding the level of annual pre-tax
income, state taxes, the magnitude of any nondeductible expenses in relation to
that pre-tax amount and various other factors.
 
 Net Income.Net
income for the quarter ended March 31, 2008 was $2.6 million compared to $2.3
million in the first quarter of 2007.  Basic and diluted income per
share was $0.20 and $0.18, respectively, for the three months ended March 31,
2008, compared to $0.18 and $0.16, respectively, for the three months ended
March 31, 2007.
 
 Liquidity
and Capital Resources
 
 Working
Capital.
 
 Our total
assets were $125.2 million at March 31, 2008, of which $116.4 million were
current assets.  At March 31, 2008 and December 31, 2007, we had cash
and cash equivalents of $13.9 million and $12.0 million, respectively, and had
working capital of $57.5 million and $55.0 million, respectively. The increase
in working capital was primarily a result of a decline in our accounts payable
and inventory flooring balance, and collection of trade accounts receivable
which increased our on-hand cash and cash equivalents.
 
 Stock
Repurchase Program.
  Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our
Board of Directors.  Share repurchases may be made from time to time
in both open market and private transactions, as conditions warrant, at then
prevailing market prices.  As of March 31, 2008, $2.5 million remained
available for share repurchases under the program. The current repurchase
program is expected to remain in effect through February 2009, unless
earlier terminated by the Board or completed.
  
 The
following table represents the common stock repurchased and retired during the
first quarter of 2008.
 
 Period
              
              Total
      number of shares purchased
              
              
              Average
      price paid per share
              
              
              Total
      number of shares purchased as part of a publicly announced plan or
      program
              
              
              Maximum
      amount that may yet be purchased under the plan or
      programJanuary
      1, 2008 through January 31, 2008
              
              
              0
              
              
              $
              -
              
              
              
              
              
              $
              3,000,000February
      1, 2008 through February 28, 2008
              
              
              47,600
              
              
              $
              9.56
              
              
              
              47,600
              
              
              $
              2,544,723March
      1, 2008 through March 31, 2008
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              2,544,723
 
 
 Approximately
94% of our sales are processed on open account terms offered to our customers,
and we typically experience significant sales during the last month of the
period on open account, which could cause fluctuation in our accounts receivable
balance.  To finance these sales, we leverage our secured line of
credit to offset timing differences in cash inflows and cash outflows, to invest
in capital equipment purchases, to purchase inventory for general stock as well
as for identified customers, and to take full advantage of available early pay
discounts.
 
 We have a
$50.0 million secured line of credit facility with a major financial
institution, which is collateralized by accounts receivable and inventory, and
it can be utilized as both a working capital line of credit and an inventory
financing facility to purchase products from several suppliers under certain
terms and conditions.  This credit facility has an annual automatic renewal
which occurs on November 26 of each fiscal year. Either party can terminate this
agreement with 60 days written notice prior to the renewal date.  The
working capital and inventory advances bear interest at a rate of Prime plus
0.50%.  Our line of credit is defined by quick turnover, large amounts
and short maturities. All amounts owed under the line of credit are due on
demand.  Amounts owed under the inventory financing facility do not
bear interest if paid within terms, usually 30 days from invoice date.  The
facility contains various restrictive covenants relating to tangible net worth,
leverage, dispositions and use of collateral, other asset dispositions, and
merger and consolidation.  At March 31, 2008, there were no
outstanding working capital advances, and inventory financing arrangements of
$11.5 million were owed to this financial institution.  At March 31,
2008, we were in compliance with all covenants of this
facility.
  14
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  We
believe that our existing available cash and cash equivalents, operating cash
flow, and existing credit facilities will be sufficient to satisfy our operating
cash needs, and to fund the remaining balance of $2.5 million authorized in our
stock repurchase program, for at least the next 12 months at our current level
of business.  However, if our working capital or other capital
requirements are greater than currently anticipated, we could be required to
reduce or curtail our stock repurchase program and seek additional funds through
sales of equity, debt or convertible securities, or through 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
us and our shareholders.
 
 Cash
Flows.
 Net cash
provided by operating activities was $15.2 million in the three months ended
March 31, 2008.  The primary factors that affected net cash flow from
operations were net income, account and vendor receivables, and
inventory.  Our operations contributed $2.6 million of net
income.  Account and vendor receivables declined by $12.5 million due
to the timing of sales throughout the quarter and the related collection
effort.  Inventories increased by $2.5 million due to on-hand customer
inventory.
 
 Net cash
used in investing activities was $158,000 for the three months ended March 31,
2008.  Cash outlays for capital expenditures were $158,000 and $1.0
million for the three months ended March 31, 2008 and 2007,
respectively.  Capital expenditures were primarily for leasehold
improvements for our corporate headquarters and continued improvement, and other
enhancements, of our information systems.  We intend to continue to
upgrade our internal information systems as a means to increase operational
efficiencies.
 
 Net cash
used in financing activities was $13.2 million for the three months ended March
31, 2008.  The most significant components of our financing activities
are the net change in book overdraft, net change of inventory financing and
the purchase of common stock under our share repurchase program.  The
net change in book overdraft for the three month period ended March 31, 2008 was
a decrease of $4.1 million.  Net change in our inventory financing for
the three month period ended March 31, 2008 was a decrease of $8.8
million.  For the three month period ended March 31, 2008, we
repurchased $455,000 of our common stock under our share repurchase
program.
 
 Item
3.  Quantitative and Qualitative
Disclosures About Market Risk
 
 We are
subject to the risk of fluctuating interest rates in the normal course of
business, primarily as a result of our 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, we believe that the risk of material loss is low.
 
 Item
4. Controls and
Procedures
 
 Under the
supervision and with the participation of our management team, including our
Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of our disclosure controls and procedures, as such term is defined
in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as
amended.  Based on this evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures
were effective as of the end of the period covered by this quarterly
report.
 
 There has
been no change in our internal control over financial reporting during our most
recently completed fiscal quarter that materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
  15
 Table of Contents
  Part II.
 
 Item
1.  Legal
Proceedings
 
 From time
to time, we are party to various legal proceedings, claims, disputes or
litigation arising in the ordinary course of business.  We currently
believe that the ultimate outcome of any of these proceedings, individually or
in the aggregate, will not have a material adverse effect on our business,
financial condition, cash flows or results of operations.
 
 Item
1A.  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 and other factors of
which we may or may not yet be aware.
 
 Our
operating results are difficult to predict and may adversely affect our stock
price.
 Our
operating results are difficult to forecast, and there are a number of factors
outside of our control, including:
 ·
              purchasing
      cycles of commercial and public sector
  customers;
 ·
              the
      level of corporate investment in new IT-related capital
      equipment;
 ·
              more
      manufacturers going direct;
 ·
              industry
      announcements of new products or
upgrades;
 ·
              industry
      consolidation and increased
competition;
 ·
              cost
      of compliance with new legal and regulatory
  requirements;
 ·
              general
      economic conditions; and
 ·
              variability
      of vendor programs.
 Based on
those and other risks, there can be no assurance that we will be able to
maintain the profitability we have experienced going forward.
 
 We experience variability in our net
sales and net income on a quarterly basis.
 There is
no assurance that we will sustain our current sales or income
levels.  Sales and income may decline for any number of reasons,
including:
 ·
              a
      decline in corporate profits leading to a change in corporate investment
      in IT-related equipment;
 ·
              increased
      competition;
 ·
              more
      manufacturers going direct;
 ·
              changes
      in customers’ buying habits;
 ·
              the
      loss of significant customers;
 ·
              changes
      in the selection of products available for resale;
  or
 ·
              general
      economic conditions.
 A decline
in sales levels could adversely affect our business, financial condition, cash
flows or results of operations.
 
 Our
narrow gross margins magnify the impact of variations in our operating
costs.
 There is
intense price competition and pressure on profit margins in the computer
products industry.  A number of manufacturers also provide their
products directly to customers.  Various other factors also may create
downward pressure on our gross margins, such as the quarter-to-quarter
variability in vendor programs and an increasing proportion of sales to
enterprise, public sector or other competitive bid accounts on which margins
could be lower.  If we are unable to maintain or improve gross margins
in the future, this could have an adverse effect on our business, financial
condition, or results of operations.
  Our
increased investments in hiring, retaining and productivity of our sales force
may not improve our profitability or result in expanded market
share.
 We ended
the first quarter of 2008 with 334 account executives.  We expect to
continue to hire account executives, but at a lower rate of growth due to
corporate initiatives to lower turnover thus reducing hiring requirements in
2008. However, there are no assurances that we will be able to hire to our
expected levels, or recruit the quality individuals that we hope to hire, or
that the individuals hired will remain employed for an extended period of time,
or that we will not lose existing account executives.  The
productivity of account executives has historically been closely correlated with
tenure.  Even if we do retain our account executives, there are no
assurances that they will become productive at historical
levels.  Additionally, there are no assurances that the locations of
our call centers will continue to attract qualified account executives, or that
we will be able to remotely manage and retain the new account
executives.
  16
 Table of Contents
  Certain of our key vendors provide us
with incentives and other assistance, and any future decline in these incentives
and other assistance could materially harm our profit margins and operating
results.
 We have a
variety of relationships with our vendors that in the past have contributed
significantly to profit margins.  For example, certain product
manufacturers and distributors provide us with incentives in the form of
rebates, volume incentive rebates, cash discounts and trade
allowances.  Our vendors continue to redefine current programs and
there are no assurances that we will attain the level of vendor support in the
future that we have obtained in the past.  In addition, many of our
vendors provide us with cooperative advertising funds, which reimburse us for
expenses associated with specific forms of
advertising.  Industry-wide, the trend has been for manufacturers,
distributors and vendors to reduce these incentives and programs.  We
believe that the 2008 incentives may decline as a percentage of sales compared
with historical amounts due to changes in available programs and
targets.  If these forms of vendor support significantly decline, or
if we are otherwise unable to take advantage of continuing vendor support
programs, or if we fail to manage the complexity of these programs, our
business, financial condition, cash flows or results of operations could be
adversely affected.
  We
are controlled by a principal stockholder.
 Firoz H.
Lalji, our Chairman and Chief Executive Officer, beneficially owns 51% of the
outstanding shares of Zones common stock, excluding shares that he may acquire
upon exercise of stock options that he holds.  The voting power of these
shares enables Mr. Lalji to significantly influence our affairs and the vote on
corporate matters to be decided by our 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 our articles of incorporation
or bylaws, which could adversely affect the trading price of our common
stock.
  We
may lose potential revenue and competitive advantage if we lose our
certification as a Minority Business Enterprise.
 We are
certified as a Minority Business Enterprise (“MBE”) based on Mr. Lalji’s
maintenance of voting control of our outstanding common stock.  A decrease
in Mr. Lalji’s level of voting power through the issuance of additional equity
capital or through a business combination transaction could cause us to lose our
MBE certification.  Our MBE certification allows us to compete for certain
sales opportunities for which we otherwise may not be able to compete and gives
us an advantage in other sales opportunities.  Although we are unable to
quantify the portion of our revenue that we receive or retain primarily as a
result of our MBE certification, we believe a loss of our MBE certification
would cause us to lose potential revenue and competitive advantage in certain
sales opportunities and would have an adverse affect on our ability to retain
certain customers and compete for certain sales opportunities, as well as on our
financial performance.
  17
 Table of Contents
  We
may not be able to compete successfully against existing or future competitors,
which include some of our largest vendors.
 The
computer products industry is highly competitive. We compete with other national
direct marketers, including CDW Corporation, Insight Enterprises, Inc. and PC
Connection, Inc. We also compete with product manufacturers, such as Apple,
Dell, Hewlett-Packard, IBM and Lenovo, which sell directly to end-users, in
addition to competing with specialty computer retailers, computer and general
merchandise superstores, and consumer electronic and office supply
stores.  Many of our competitors compete principally on the basis of
price and have lower costs.  We believe that competition may intensify
in the future due to market conditions and consolidation.  In the
future, we may face fewer, but larger or better-financed
competitors.  Additional competition may also arise if other methods
of distribution emerge in the future. There can be no assurance that we will be
able to compete effectively with existing competitors or new competitors that
may enter the market, or that our business, financial condition, cash flows or
results of operations will not be adversely affected by intensified
competition.
  We
are exposed to inventory obsolescence due to the rapid technological changes
occurring in the personal computer industry.
 The
computer industry is characterized by rapid technological change and frequent
introductions of new products and product enhancements.  To satisfy
customer demand and obtain greater purchase discounts, we may be required to
carry significant inventory levels of certain products, which would subject us
to increased risk of inventory obsolescence. We participate in first-to-market
and end-of-lifecycle 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 we will be able to avoid
losses related to such products.  Within the industry, vendors are
becoming increasingly restrictive in guaranteeing return
privileges.  While we seek to reduce our inventory exposure through a
variety of inventory control procedures and policies, there can be no assurance
that we will be able to avoid losses related to obsolete inventory.
 
 We
may not be able to maintain existing or build new vendor relationships, which
may affect our ability to offer a broad selection of products at competitive
prices and negatively impact our results of operations.
 We
acquire products directly from manufacturers, such as Apple, Hewlett-Packard,
IBM and Lenovo, as well as from distributors such as Ingram Micro, Synnex, Tech
Data and others.  Certain hardware manufacturers limit the number of
product units available to DMRs.  Substantially all of our contracts
and arrangements with vendors are terminable without notice or upon short
notice. If we do not maintain our existing relationships or build new
relationships with vendors on acceptable terms, including favorable product
pricing and vendor consideration, we may not be able to offer a broad selection
of products or continue to offer products at competitive prices. Termination,
interruption or contraction of our relationships with our vendors could have a
material adverse effect on our business, financial condition, cash flows or
results of operations.
 
 If
we fail to achieve and maintain adequate internal controls, we may not be able
to produce reliable financial reports in a timely manner or prevent financial
fraud.
 We will
continue to document and test our internal control procedures on an ongoing
basis in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002, which requires annual management assessments of the
effectiveness of internal controls over financial reporting and a report by an
independent registered public accounting firm addressing such assessments if
applicable. During the course of our testing we may from time to time identify
deficiencies which we may not be able to remediate. In addition, if we fail to
achieve or maintain the adequacy of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act of 2002. Effective internal controls, particularly those
related to revenue recognition, are necessary for us to produce reliable
financial reports and are important in helping prevent financial fraud. If we
cannot provide reliable financial reports on a timely basis or prevent financial
fraud, our business and operating results could be harmed, investors could lose
confidence in our reported financial information, and the trading price of our
stock could drop significantly.
  We
face many uncertainties relating to the collection of state sales and use
tax.
 We
collect and remit sales and use taxes in states in which we have voluntarily
registered and/or have a physical presence. Various states have sought to
require the collection of state and local sales taxes on products shipped to the
taxing jurisdiction’s residents by DMRs.  The United States Supreme
Court held in 1992 that it is unconstitutional for a state to impose sales or
use tax collection obligations on an out-of-state company whose contacts with
the state were limited to the distribution of catalogs and other advertising
materials through the mail and the subsequent delivery of purchased goods by
United States mail or by common carrier. We cannot predict the level of contact,
including electronic commerce and Internet activity, which might give rise to
future or past tax collection obligations based on that Supreme Court
case.  Many states aggressively pursue out-of-state businesses, and
legislation that would expand the ability of states to impose sales tax
collection obligations on out-of-state businesses has been introduced in
Congress on many occasions. A change in the law could require us to collect
sales taxes or similar taxes on sales in states in which we have no presence and
could potentially subject us to a liability for prior year sales, either of
which could have a material adverse effect on our business, financial condition,
and results of operations.
 
 We
rely on our distribution centers and certain distributors to meet the product
needs of our customers.
 We
operate warehouse and distribution centers in Bensenville, Illinois and in
Seattle, Washington.  There are no assurances that our warehouse
locations will best support our customer base.  Additionally, certain
distributors participate in our logistics operations through electronic data
interchange.  Failure to develop and maintain relationships with these
and other vendors would limit our ability to obtain sufficient quantities of
merchandise on acceptable commercial terms and could have a material adverse
effect on our business, financial condition, cash flows or results of
operations.
  18
 Table of Contents
  We
are heavily dependent on commercial delivery services.
 We
generally ship our products to customers by DHL, Eagle, FedEx, United Parcel
Service and other commercial delivery services and invoice customers for
delivery charges. If we are unable to pass on to our customers future increases
in the cost of commercial delivery services, our profitability could be
adversely affected. Additionally, strikes or other service interruptions by such
shippers could adversely affect our ability to deliver products on a timely
basis.
 
 We
may not be able to attract and retain key personnel.
 Our
future success will depend to a significant extent upon our ability to attract,
train and retain skilled personnel.  Although our success will depend
on personnel in all areas of our business, there are certain individuals that
play key roles within the organization.  Loss of any of these
individuals could have an adverse effect on our business, financial condition,
cash flows or results of operations.
 
 We
may be impacted by the loss of a major customer.
 From time
to time we have customers that represent more than 10% of total sales. For the
three months ended March 31, 2008 and 2007, State Farm Group individually
represented more than 10% of total net sales.  Net sales to this
customer were $25.6 and $15.7 million for the three months ended March 31, 2008
and 2007, respectively.  Trade receivables for this customer
represented approximately 8.9% and 16.0% of total trade receivables for the
three months ended March 31, 2008 and 2007, respectively.  The loss of
business with any major customer could have a material adverse effect on our
business, financial condition, cash flows or results of operations.
  Our
systems are vulnerable to natural disasters or other catastrophic
events.
 Our
operations are dependent on the reliability of information, telecommunication
and other systems, which are used for sales, distribution, marketing,
purchasing, inventory management, order processing, customer service and general
accounting functions.  Interruption of our information systems,
Internet or telecommunication systems could have a material adverse effect on
our business, financial condition, cash flows or results of
operations.
 
 Privacy
concerns with respect to list development and maintenance may materially
adversely affect our business.
 If third
parties or our team members are able to penetrate our network security or
otherwise misappropriate our customers’ personal information or credit card
information, we could be subject to liability.  We also mail catalogs
and send electronic messages to names in our proprietary customer database and
to potential customers whose names we obtain from rented or exchanged mailing
lists. World-wide public concern regarding personal privacy has subjected the
rental and use of customer mailing lists and other customer information to
increased scrutiny. Any domestic or foreign legislation enacted limiting or
prohibiting these practices could negatively affect our business.
  Our
stock price may be volatile.
 There is
relatively limited trading of our stock in the public markets, and this may
impose significant practical limitations on any shareholder’s ability to achieve
liquidity at any particular quoted price.  Efforts to sell significant
amounts of our stock on the open market may precipitate significant declines in
the prices quoted by market makers.  The limitation on shareholder
liquidity resulting from this relatively thin trading volume could be
exacerbated if our stock were to be delisted from the NASDAQ Global
Market.  The NASDAQ Global Market imposes a requirement for continued
listing that the value of shares publicly held, excluding those held by
directors, officers and beneficial owners, exceed certain minimums.  A
potential future delisting of our common stock could result in significantly
reduced volume of our common stock traded, more limited press coverage, reduced
interest by investors in the common stock, adverse effects on the trading
market, downward pressure on the price for and liquidity of our stock, and
reduced ability to issue additional securities or to secure additional
financing.
  19
 Table of Contents
  Item
2.  Unregistered Sales of Equity
Securities and Use of Proceeds
 
  Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our
Board of Directors.  Share repurchases may be made from time to time
in both open market and private transactions, as conditions warrant, at then
prevailing market prices.  As of March 31, 2008, $2.5 million remained
available for share repurchases under the program. The current repurchase
program is expected to remain in effect through February 2009, unless
earlier terminated by the Board or completed.
  
 The
following table represents the common stock repurchased and retired during the
first quarter of 2008.
 
 Period
              
              Total
      number of shares purchased
              
              
              Average
      price paid per share
              
              
              Total
      number of shares purchased as part of a publicly announced plan or
      program
              
              
              Maximum
      amount that may yet be purchased under the plan or
      programJanuary
      1, 2008 through January 31, 2008
              
              
              0
              
              
              $
              -
              
              
              
              
              
              $
              3,000,000February
      1, 2008 through February 28, 2008
              
              
              47,600
              
              
              $
              9.56
              
              
              
              47,600
              
              
              $
              2,544,723March
      1, 2008 through March 31, 2008
              
              
              0
              
              
              $
              -
              
              
              
              0
              
              
              $
              2,544,723
  20
 Table of Contents
  Item
6.  Exhibits
 
 Exhibit
      No.
              Description
              Filed
      Herewith
              Incorporated
      by ReferenceForm
              Exhibit
      No.
              File
      No.
              Filing
      Date10.1
              Form
      of Restricted Stock Purchase Agreement
              X31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002 and the regulations promulgated thereunder
              X31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002 and the regulations promulgated thereunder
              X32.1
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 and the regulations promulgated thereunder
              X32.2
              Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 and the regulations promulgated thereunder
              X
 
 Signatures
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized:
 
 
 ZONES,
INC.
 
 
 Date:  May
9, 2008
 
 By:
              /S/     FIROZ
      H. LALJIFiroz
      H. Lalji, Chairman and Chief Executive Officer/S/     RONALD
      P. MCFADDENRonald
      P. McFadden, Chief Financial
Officer
   21