**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**FORM
      10-Q**





**x**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**FOR
      THE QUARTERLY PERIOD ENDED JUNE 30, 2006**


**OR**





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





**Commission
      File Number 0-28488**







**ZONES,
      INC**


(Exact
      name of registrant as specified in its charter)





**Washington**
            **91-1431894**(State
                of Incorporation)
            (I.R.S.
                Employer Identification
                Number)





**1102
                15****th****Street SW, Suite 102****Auburn,
                Washington**
            **98001-6509**(Address
                of Principal Executive Offices)
            (Zip
                Code)




**(253)
      205-3000**


(Registrant's
      Telephone


Number,
      Including Area Code)







Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x  No o .





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):   Large accelerated filer o Accelerated filer  o Non-accelerated filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).  Yes o No x





The
      number of shares of the registrant's Common Stock outstanding as of May 10,
      2006
      was 13,240,958.







1




**ZONES,
      INC.**





**INDEX**





**PART
      I. FINANCIAL INFORMATION**




Item
                1.
            Consolidated
                Financial Statements
                (unaudited):Consolidated
                Balance Sheets June 30, 2006 and
                December 31, 2005
            3Consolidated
                Statements of Operations Three
                and six months ended June 30, 2006 and 2005
            4Statements
                of Shareholders’ Equity Six months ended
                June 30, 2006
            5Consolidated
                Statements of Cash Flows Six months ended
                June 30, 2006 and 2005
            6Notes
                to Consolidated Financial
                Statements
            7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            19Item
                4.
            Controls
                and Procedures
            19**PART
                II. OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            20Item
                1A.
            Risk
                Factors
            20Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            23Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            24Item
                6.
            Exhibits
            25Signatures
            25




2
 *Index*





**Part
      I.**





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





**ZONES,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(in
      thousands)**


**(unaudited)**




**June
                  30,**
              **2006**
            
            **December
                  31,**
              **2005****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            3,335
            
            $
            3,195Receivables,
                net of allowance for doubtful accounts of $1,915 and
                $1,562
            
            
            61,772
            
            
            68,318Vendor
                receivables
            
            
            12,901
            
            
            14,750Inventories
            
            
            18,723
            
            
            19,736Prepaid
                expenses
            
            
            1,174
            
            
            922Deferred
                tax asset
            
            
            1,346
            
            
            1,346Total
                current assets
            
            
            99,251
            
            
            108,267Property
                and equipment, net
            
            
            3,924
            
            
            3,810Goodwill
            
            
            5,098
            
            
            5,098Other
                assets
            
            
            187
            
            
            179Total
                assets
            
            $
            108,460
            
            $
            117,354**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            38,981
            
            $
            45,359Inventory
                financing
            
            
            11,766
            
            
            8,469Accrued
                liabilities
            
            
            10,856
            
            
            8,621Line
                of credit
            
            
            
            
            
            10,700Income
                taxes payable
            
            
            410
            
            
            448Notes
                payable to former shareholders of CPCS
            
            
            
            
            
            1,272Total
                current liabilities
            
            
            62,013
            
            
            74,869Notes
                payable for purchase of fixed asset
            
            
            14
            
            
            21Deferred
                income tax
            
            
            35
            
            
            35Deferred
                rent
            
            
            1,323
            
            
            1,112Total
                liabilities
            
            
            63,385
            
            
            76,037Commitments
                and contingenciesShareholders'
                equity:Common
                stock
            
            
            36,639
            
            
            37,503Retained
                earnings
            
            
            8,436
            
            
            3,814Total
                shareholders' equity
            
            
            45,075
            
            
            41,317Total
                liabilities and shareholders' equity
            
            $
            108,460
            
            $
            117,354





See
      notes
      to consolidated financial statements





3
 *Index*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF
      OPERATIONS**


**(in
      thousands, except per share data)**


**(unaudited)**




**Three
                    months ended**
                  **June
                    30,**
                
                **Six
                    months ended**
                  **June
                    30,****2006**
                
                **2005**
                
                **2006**
                
                **2005**Net
                    sales
                
                $
                145,210
                
                $
                127,630
                
                $
                279,208
                
                $
                253,961Cost
                    of sales
                
                
                125,822
                
                
                113,094
                
                
                243,233
                
                
                224,663Gross
                    profit
                
                
                19,388
                
                
                14,536
                
                
                35,975
                
                
                29,298Selling,
                    general and administrative
                
                
                12,765
                
                
                10,979
                
                
                24,627
                
                
                22,178Advertising
                    expenses, net
                
                
                1,768
                
                
                1,400
                
                
                3,570
                
                
                3,139Income
                    from operations
                
                
                4,855
                
                
                2,157
                
                
                7,778
                
                
                3,981Interest
                    expense
                
                
                145
                
                
                63
                
                
                344
                
                
                160Other
                    income
                
                
                (23
                )
                
                (13
                )
                
                (44
                )
                
                (50
                )Other
                    expense, net
                
                
                122
                
                
                50
                
                
                300
                
                
                110Income
                    before taxes
                
                
                4,733
                
                
                2,107
                
                
                7,478
                
                
                3,871Provision
                    for income taxes
                
                
                1,816
                
                
                811
                
                
                2,856
                
                
                1,484Net
                    income
                
                $
                2,917
                
                $
                1,296
                
                $
                4,622
                
                $
                2,387Basic
                    income per share
                
                $
                0.22
                
                $
                0.10
                
                $
                0.35
                
                $
                0.18Shares
                    used in computing basic income per share
                
                
                13,165
                
                
                13,380
                
                
                13,172
                
                
                13,412Diluted
                    income per share
                
                $
                0.20
                
                $
                0.09
                
                $
                0.32
                
                $
                0.17Shares
                    used in computing diluted income per share
                
                
                14,633
                
                
                14,148
                
                
                14,667
                
                
                14,347


See
      notes
      to consolidated financial statements





4
 *Index*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS'
      EQUITY**


**(in
      thousands, except share data)**


**(unaudited)**








Common
                Stock
            
            RetainedShares
            
            Amount
            
            Earnings
            
            TotalBalance,
                January 1, 2006
            
            
            13,265,049
            
            $
            37,503
            
            $
            3,814
            
            $
            41,317Purchase
                and retirement of common stock
            
            
            (371,600
            )
            
            (2,295
            )
            
            
            
            
            (2,295
            )Exercise
                of stock options
            
            
            298,687
            
            
            861
            
            
            
            
            
            861Excess
                tax benefit from stock options exercised
            
            
            
            
            
            368
            
            
            
            
            
            368Stock
                option plan expense
            
            
            
            
            
            202
            
            
            
            
            
            202Net
                income
            
            
            
            
            
            
            
            
            4,622
            
            
            4,622Balance,
                June 30, 2006
            
            
            13,192,136
            
            $
            36,639
            
            $
            8,436
            
            $
            45,075





See
      notes
      to consolidated financial statements





5
 *Index*





**ZONES,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**


**(unaudited)**





**Six
                months ended**
              **June
                30,****2006**
            
            **2005**Cash
                flows from operating activities:Net
                income
            
            $
            4,622
            
            $
            2,387Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
            
            
            965
            
            
            1,023Non-cash
                stock based compensation
            
            
            202Excess
                tax benefit from exercise of stock options
            
            
            (368
            )
            
            5Deferred
                tax asset
            
            
            
            
            
            1,477(Increase)
                decrease in assets and liabilities:Receivables,
                net
            
            
            8,396
            
            
            407Inventories,
                net
            
            
            1,013
            
            
            1,913Prepaid
                expenses and other assets
            
            
            (260
            )
            
            (232
            )Accounts
                payable
            
            
            (1,488
            )
            
            69Inventory
                financing
            
            
            3,296
            
            
            (6,792
            )Accrued
                liabilities and deferred rent
            
            
            2,446
            
            
            218Income
                taxes payable
            
            
            331Net
                cash provided by operating activities
            
            
            19,154
            
            
            475Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (1,080
            )
            
            (816
            )Net
                cash used in investing activities
            
            
            (1,080
            )
            
            (816
            )Cash
                flows from financing activities:Net
                change in book overdraft
            
            
            (4,890
            )
            
            864Net
                change in line of credit
            
            
            (10,700
            )
            
            (2,200
            )Excess
                tax benefit from exercise of stock options
            
            
            368Purchase
                and retirement of common stock
            
            
            (2,295
            )
            
            (779
            )Proceeds
                from exercise of stock options
            
            
            861
            
            
            172Payments
                of notes payable
            
            
            (1,279
            )
            
            (1,079
            )Net
                cash used in financing activities
            
            
            (17,935
            )
            
            (3,022
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            140
            
            
            (3,363
            )Cash
                and cash equivalents at beginning of period
            
            
            3,195
            
            
            6,457Cash
                and cash equivalents at end of period
            
            $
            3,335
            
            $
            3,094





See
      notes
      to consolidated financial statements





6
 *Index*





**ZONES,
      INC.**


**NOTES
      TOCONSOLIDATED 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. The Company sells through outbound and
      inbound account executives, specialty print and e-catalogs, and the Internet.
      The Company offers more than 150,000 products from leading manufacturers
      including 3COM, Adobe, Apple, Cisco, Epson, Hewlett Packard, IBM, Kingston,
      Lenovo, Microsoft, Sony and Toshiba.





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





**2.**
            **Summary
                of Significant Accounting
                Policies**





The
      accompanying unaudited consolidated interim financial statements and notes
      have
      been prepared in accordance with the rules and regulations of the Securities
      and
      Exchange Commission and consequently do not include all of the disclosures
      normally required by generally accepted accounting principles for annual
      financial statements.





*Basis
      of Presentation*


In
      the
      opinion of management, the accompanying unaudited consolidated financial
      statements reflect all adjustments (consisting of normal recurring accruals)
      which in the opinion of management are necessary for a fair statement of the
      financial position and operating results for the interim periods presented.
      The
      results of operations for such interim periods are not necessarily indicative
      of
      results for the full year. These financial statements should be read in
      conjunction with the audited financial statements and notes thereto contained
      in
      the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 as
      filed with the Securities and Exchange Commission on February 24, 2006.





*Principles
      of Consolidation*


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





*Goodwill*


In
      accordance with SFAS No. 142,"Goodwill and Other Intangible Assets," goodwill
      will be tested for impairment at least annually, or when events indicate that
      impairment exists. The Company performs the assessment annually on March 31.
      The
      changes in the carrying amount of goodwill for the six months ended June 30,
      2006 are as follows (in thousands):





Balance
                as of January 1, 2006
            
            $
            5,098Goodwill
                acquired
            
            
            -Impairment
                loss
            
            
            -Balance
                as of June 30, 2006
            
            $
            5,098





The
      Company completed the impairment review required by SFAS No. 142 on March 31,
      2006 and determined that its goodwill was not impaired.





*Revenue
      Recognition*


The
      Company recognizes revenue on product sales when persuasive evidence of an
      arrangement exists, delivery has occurred, prices are fixed or determinable,
      and
      collectability is probable. The Company considers the point of delivery of
      the
      product to be when the risks and rewards of ownership have transferred to the
      customer. The Company offers limited return rights on its product sales. At
      the
      point of sale, the Company also provides an allowance for sales returns, which
      is established based on historical experience.





7
 *Index*





*Comprehensive
      Income*


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





*Stock
      Compensation*


The
      Company’s stock option plans grant options to acquire shares of common stock to
      certain team members and non-employee directors. Each option granted has an
      exercise price of 100% of the market value of the common stock on the date
      of
      the grant. The majority of the options have a contractual life of 10 years
      and vest and become exercisable at 20% increments over five years.





Effective
      January 1, 2006, the Company adopted Statement of Financial Accounting
      Standards No. 123R, *Share-Based
      Payment* (“SFAS 123R”).
      SFAS 123R supersedes the Company’s previous accounting under Accounting
      Principles Board Opinion No. 25, *Accounting
      for Stock issued to Employees* (“APB 25”),
      for periods beginning in fiscal 2006. Previously, under APB 25, the Company
      accounted for stock options under the intrinsic value method. Accordingly,
      the
      Company did not recognize expense related to employee stock options because
      the
      exercise price of such options equaled the fair value of the underlying stock
      on
      the grant date. The Company previously disclosed the fair value of its stock
      options under the provisions of Statement of Financial Accounting Standards
      No. 123, *Accounting
      for Stock Based Compensation* (“SFAS 123”). The fair value of option grants prior to January 1, 2006 was
      estimated on the date of grant using the Black-Scholes option-pricing
      model.





The
      Company adopted SFAS 123R using the modified prospective transition method,
      which requires the application of the accounting standard as of January 1,
      2006, the first day of the Company’s fiscal year 2006. The Company’s condensed
      consolidated financial statements for prior periods have not been restated
      to
      reflect, and do not include, the impact of SFAS 123R.





Total
      stock-based compensation expense recognized in the consolidated statement of
      earnings for the three and six months ended June 30, 2006 was $92,000 and
      $202,000, respectively, before income taxes, and did not have a material impact
      on net income or earnings per share.   The Company used the criteria
      in SFAS No. 123R to calculate and establish the beginning balance of the
      additional paid-in capital pool (“APIC pool”) related to the tax effects of
      employee stock-based compensation and to determine the subsequent effect on
      the
      APIC pool and consolidated statements of cash flows of the tax effects of
      employee stock-based compensation awards that were outstanding upon adoption
      of
      SFAS No. 123R. The tax benefit for stock options exercised during the three
      and six months ended June 30, 2006 was $207,000 and $368,000, respectively.





Prior
      to
      the adoption of SFAS 123R, the Company presented all tax benefits resulting
      from
      the exercise of stock options as operating cash inflows in the consolidated
      statements of cash flows, in accordance with the provisions of the Emerging
      Issues Task Force (“EITF”) Issue No 00-15, “Classification in the Statement of
      Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of
      a
      Nonqualified Employee Stock Option.” SFAS 123R requires the benefits of tax
      deductions in excess of the compensation cost recognized for those options
      to be
      classified as financing cash inflows rather than operating cash inflows, on
      a
      prospective basis. This amount is shown as “Excess tax benefit from exercise of
      stock options” on the consolidated statement of cash flows.





8
 *Index*





The
      following table shows the prior year effect on net earnings and earnings per
      share had compensation cost been recognized based upon the estimated fair value
      on the grant date of stock options, in accordance with SFAS 123, as amended
      by
      SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and
      Disclosure” ( *in
      thousands, except earnings per share* ):





**Three
                months ended**
              **June
                30,**
              **2005**Net
                income - as reported
            
            $
            1,296Add:Total
                compensation cost included in net income, net of taxLess:Total
                compensation cost determined under fair value based method for all
                awards,
                net of tax
            
            
            (271
            )Net
                income - pro forma
            
            $
            1,025Basic
                income per share - as reported
            
            $
            0.10Diluted
                income per share - as reported
            
            $
            0.09Basic
                income per share - pro forma
            
            $
            0.08Diluted
                income per share - pro forma
            
            $
            0.07




**Six
                months ended**
              **June
                30,**
              **2005**Net
                income - as reported
            
            $
            2,387Add:Total
                compensation cost included in net income, net of taxLess:Total
                compensation cost determined under fair value based method for all
                awards,
                net of tax
            
            
            (508
            )Net
                income - pro forma
            
            $
            1,879Basic
                income per share - as reported
            
            $
            0.18Diluted
                income per share - as reported
            
            $
            0.17Basic
                income per share - pro forma
            
            $
            0.14Diluted
                income per share - pro forma
            
            $
            0.13





For
      grants made in the three and six months ended June 30, 2005, 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: expected
      volatility of 189%; risk-free interest rate of 3.88%; and expected lives of
      5
      years.





Disclosures
      for the periods ended June 30, 2006 are not presented because the amounts are
      recognized in the consolidated financial statements.





There
      were no options granted in the three or six months ended June 30, 2006. The
      current expense for all outstanding options granted prior to January 1,
      2006 has been recognized in the consolidated statement of earnings for the
      three
      and six months ended June 30, 2006. Forfeitures will be estimated and revised,
      if necessary, in subsequent periods if actual forfeitures differ from those
      estimates. As of June 30, 2006, there is $402,000 of total unrecognized pre-tax
      compensation expense related to nonvested stock options granted under the
      Company’s stock option plans. This cost is expected to be recognized over a
      weighted-average period of 1.5 years.





9
 *Index*





*Earnings
      Per Share*


Earnings
      per share (“EPS”) is based on the weighted average number of shares outstanding
      during the period. Basic EPS excludes all dilution. Diluted EPS reflects the
      potential dilution that would occur if securities or other contracts to issue
      common stock were exercised or converted into common stock. 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
      June
      2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in
      Income Taxes - an interpretation of FASB Statement No. 109" (FIN 48). This
      interpretation clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise's financial statements in accordance with SFAS
      No.
      109, "Accounting for Income Taxes." This Interpretation prescribes a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position taken or expected to be taken in a tax return.
      This Interpretation also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition. FIN 48 is effective for fiscal years beginning after December 15,
      2006. The Company is currently evaluating the impact of FIN 48 on its
      consolidated results of operations and financial condition.





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





The
      Company has 45,000,000 common shares authorized. The Company has granted options
      to purchase common shares to employees and directors of the Company. Certain
      options have a dilutive effect on the calculation of earnings per share. The
      following is a reconciliation of the numerators and denominators of the basic
      and diluted earnings per share computations (in thousands, except per share
      data).





**Three
                months ended June 30,**
            
            **Six
                months ended June 30,****2006**
            
            **2005**
            
            **2006**
            
            **2005****Basic
                earnings per share:**Net
                income
            
            $
            2,917
            
            $
            1,296
            
            $
            4,622
            
            $
            2,387Weighted
                average shares outstanding
            
            
            13,165
            
            
            13,380
            
            
            13,172
            
            
            13,412Basic
                income per share
            
            $
            0.22
            
            $
            0.10
            
            $
            0.35
            
            $
            0.18**Diluted
                earnings per share:**Net
                income
            
            $
            2,917
            
            $
            1,296
            
            $
            4,622
            
            $
            2,387Weighted
                average shares outstanding
            
            
            13,165
            
            
            13,380
            
            
            13,172
            
            
            13,412Stock
                options
            
            
            1,468
            
            
            768
            
            
            1,495
            
            
            935Total
                common shares and dilutive securities
            
            
            14,633
            
            
            14,148
            
            
            14,667
            
            
            14,347Diluted
                income per share
            
            $
            0.20
            
            $
            0.09
            
            $
            0.32
            
            $
            0.17





Options
      may have a dilutive effect on the calculation of earnings per share. For the
      three and six months ended June 30, 2006, 90,573 shares underlying outstanding
      stock options were excluded from the calculation of diluted earnings per share
      because the effect was anti-dilutive. For the three and six months ended June
      30, 2005, 492,070 and 477,259 shares, respectively, underlying 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, the Company is a party to various legal proceedings, claims, disputes
      or litigation arising in the ordinary course of business, some of which may
      involve material amounts. The Company currently believes that the ultimate
      outcome of any of these proceedings, individually or in the aggregate, will
      not
      have a material adverse effect on the Company’s business, financial condition,
      cash flows or results of operations.





10
 *Index*





**5.**
            **Segment
                Information**





In
      fiscal
      years 2003 and 2004, the Company reported its subsidiary, CPCS, and its Zones
      reporting unit as separate segments. On April 1, 2005, the Company merged CPCS
      into the Zones reporting unit. Accordingly, no separate segment for CPCS
      currently exists. The Company now comprises one reportable segment: a
      single-source, multi-vendor direct marketing reseller of name brand information
      technology products to small to medium-sized businesses, enterprise and the
      public sector markets.





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





**Three
                months ended**
              **June
                30,**
            
            **Six
                months ended**
              **June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Notebook
                & PDA’s
            
            $
            18,426
            
            $
            19,116
            
            $
            35,430
            
            $
            35,481Desktops
                & Servers
            
            
            31,813
            
            
            25,326
            
            
            58,212
            
            
            56,593Software
            
            
            23,973
            
            
            20,703
            
            
            44,990
            
            
            41,730Storage
            
            
            13,638
            
            
            11,950
            
            
            27,422
            
            
            23,395NetComm
            
            
            6,543
            
            
            5,353
            
            
            12,783
            
            
            10,137Printers
            
            
            10,095
            
            
            12,460
            
            
            21,128
            
            
            23,843Monitors
                & Video
            
            
            12,455
            
            
            13,152
            
            
            28,013
            
            
            25,767Memory
                & Processors
            
            
            9,631
            
            
            7,645
            
            
            19,137
            
            
            14,271Accessories
                & Other
            
            
            18,636
            
            
            11,925
            
            
            32,093
            
            
            22,744





Substantially
      all of the Company’s net sales for the three and six months ended June 30, 2006
      and June 30, 2005 were made to customers located in the United States.
      Substantially all of the Company’s assets at June 30, 2006 and December 31, 2005
      were located within the United States. The Company had one customer which
      represented over 10% of total sales for the six month period ended June 30,
      2006. Net sales to this customer were $30.9 million for the six months ended
      June 30, 2006. The Company had one customer which represented over 10% of total
      sales for the three and six month periods ended June 30, 2005. Net sales to
      this
      customer were $17.6 million and $34.6 million for the three and six months
      ended
      June 30, 2005, respectively.





**6.**
            **Related
                Party Disclosure**





In
      June
      2004, Fana Auburn LLC, a company owned by an officer and majority shareholder
      of
      the Company, purchased the property and buildings in which the Company’s
      headquarters are located, subject to the Company’s existing 11-year lease. Under
      the terms of the lease agreement, the Company will pay lease payments
      aggregating from $1.0 million to $1.2 million per year, plus apportioned real
      estate taxes, insurance and common area maintenance charges. For the three
      months ended June 30, 2006 and 2005 the Company paid Fana Auburn LLC $431,000
      and $424,000, respectively, related to the lease. For the six months ended
      June
      30, 2006 and 2005 the Company paid Fana Auburn LLC $762,000 and $852,000,
      respectively, related to the lease. The Company’s Audit Committee reviewed and
      approved this related party transaction, and also the potential corporate
      opportunity, recognizing that in the future the Company may have to renew and
      re-negotiate its lease and that such renewal and re-negotiation would also
      present a related party transaction subject to further Audit Committee review
      and consideration. In May 2006, the Company signed an amendment to the lease
      agreement. Pursuant to the terms of the amendment, Fana Auburn LLC has agreed
      to
      increase the rentable square feet by approximately 18,923 square feet. The
      additional square feet will increase the annual lease payment by $259,000.
      Effective January 1, 2007, the Company will have approximately 125,196 rentable
      square feet located at 1102 15 th Street
      SW, Auburn, WA.





11
 *Index*





**7.**
            **Share
                Repurchase Program**





The
      Board
      of Directors authorized a stock repurchase program in July of 2004 under which
      the Company could repurchase up to $3.0 million in shares of the Company’s
      common stock through July 2005 in either open market or private transactions
      at
      then prevailing market prices. During the twelve months ended June 30, 2005,
      the
      Company purchased and retired a total of 650,040 shares of its common stock
      at a
      total cost of $2.1 million (an average price of $3.27 per share).





In
      July
      2005, the Board of Directors authorized a continuation of the Company’s share
      repurchase program, pursuant to which the Company could repurchase up to an
      additional $3.0 million in shares of the Company’s common stock through July
      2006 in open market or private transactions at then prevailing market prices.
      For the six months ended December 31, 2005, the Company purchased and retired
      222,800 shares of its common stock at a total cost of $1.0 million (an average
      price of $4.64 per share).





In
      February 2006, the Board of Directors authorized an increase to the Company’s
      share repurchase program, pursuant to which the Company could repurchase up
      to
      an additional $1.0 million in shares of the Company’s common stock through
      February 2007 in open market or private transactions at then prevailing market
      prices. For the three months ended March 31, 2006, the Company purchased and
      retired 313,600 shares of its common stock at a total cost of $1.9 million
      (an
      average price of $6.10 per share).





In
      April
      2006, the Board of Directors authorized an additional $2.0 million increase
      to
      the Company’s share repurchase program through February 2007. For the three
      months ended June 30, 2006, the Company purchased and retired 58,000 shares
      of
      its common stock at a total cost of $381,000 (an average price of $6.57 per
      share).





The
      Company now has a $2.7 million remaining balance in its current repurchase
      program. The Company currently anticipates the use of the remaining balance
      by
      the termination of the program in February of 2007 if market conditions and
      prices warrant the investment.





**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 “plan,” “intend,” “should,” “could,” “may,” “will,”
“expect,” “estimate,” “anticipate,” “continue,” or similar terms, variations of
      such terms or the negative of those terms, but the absence of such terms does
      not mean that a statement is not forward-looking. Potential risks
      and uncertainties that
      may
      cause actual
      results to
      differ materially from those expressed or implied include, among
      others, those set forth in this document and
      those contained in the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2005, which was filed on February 24, 2006 with the Securities
      Exchange Commission.





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





**General**





The
      Company's net sales consist primarily of sales of computer hardware, software,
      peripherals and accessories, as well as revenue associated with freight billed
      to its customers, net of product returns. Gross profit consists of net sales
      less product and freight costs. Selling, general and administrative ("SG&A")
      expenses include warehousing, selling commissions, order processing, telephone
      and credit card fees and other costs such as administrative salaries,
      depreciation, rent and general overhead expenses. Advertising expense is
      marketing costs associated with vendor programs, net of vendor cooperative
      advertising expense reimbursements allowable under EITF 02-16 “Accounting for
      Consideration Received from a Vendor by a Customer (Including a Reseller of
      the
      Vendor’s Products).” Other expense represents interest expense net of
      non-operating income.





12
 *Index*





**Overview**





Zones
      Inc. is a direct marketing reseller of technology hardware, software and
      services. The Company procures and fulfills information technology solutions
      to
      commercial customers, specifically small to medium business (between 50 and
      1,000 computer users) (“SMB”), and enterprise (greater than 1,000 computer
      users) customers, and the public sector market place (education and state and
      local government). Relationships with SMB, enterprise customers and public
      sector institutions represented 97.9% of total net sales during the three months
      ended June 30, 2006. The remaining sales were from inbound customers, primarily
      consumers and small office home office accounts.





The
      Company reaches its customers through an integrated marketing and merchandising
      strategy designed to attract and retain customers. This strategy involves a
      relationship-based selling model utilizing outbound account executives,
      customized web stores for corporate customers through ZonesConnect, a state
      of
      the art Internet portal at www.zones.com ,
      dedicated e-marketing and direct marketing vehicles and catalogs for demand
      response opportunities and corporate branding.





The
      Company utilizes its purchasing and inventory management capabilities to support
      its primary business objective of providing name brand products at competitive
      prices. The Company offers over 150,000 hardware, software, peripheral and
      accessory products and services for users of PC and Mac platform computers
      from
      over 2,000 manufacturers.





The
      corporate management team regularly reviews the Company’s performance using a
      variety of financial and non-financial metrics including, but not limited to,
      net sales, gross margin, vendor programs and co-op advertising reimbursements,
      advertising expenses, personnel costs, productivity per team member, average
      order size, accounts receivables aging, inventory aging, liquidity and cash
      resources.   Company management compares the various metrics against
      goals and budgets, and takes appropriate action to enhance Company
      performance.





The
      Company is dedicated to creating a learning community of empowered individuals
      to serve its customers with integrity, commitment and passion. At June 30,
      2006,
      the Company had 622 team members in its consolidated operations, 300 of whom
      are
      inbound and outbound account executives. The Company makes additional company
      information available free of charge on its 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, 2005, which was filed with the Securities and Exchange
      Commission on February 24, 2006, the Company included a discussion of the most
      significant accounting policies and estimates used in the preparation of its
      financial statements. There has been no material change in the policies and
      estimates used by the Company in the preparation of its financial statements
      since the filing of our most recent annual report.





13
 *Index*





**Results
      of Operations**





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





**Three
                months ended**
              **June
                30,**
            
            **Six
                months ended**
              **June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Net
                sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of sales
            
            
            86.6
            
            
            88.6
            
            
            87.1
            
            
            88.5Gross
                profit
            
            
            13.4
            
            
            11.4
            
            
            12.9
            
            
            11.5Selling,
                general and administrative expenses
            
            
            8.8
            
            
            8.6
            
            
            8.8
            
            
            8.7Advertising
                expenses, net
            
            
            1.2
            
            
            1.1
            
            
            1.3
            
            
            1.2Income
                (loss) from operations
            
            
            3.4
            
            
            1.7
            
            
            2.8
            
            
            1.6Other
                (income) expense
            
            
            0.1
            
            
            0.1
            
            
            0.1
            
            
            0.1Income
                (loss) before income taxes
            
            
            3.3
            
            
            1.6
            
            
            2.7
            
            
            1.5Provision
                (benefit) for income taxes
            
            
            1.3
            
            
            0.6
            
            
            1.0
            
            
            0.6Net
                income (loss)
            
            
            2.0
            %
            
            1.0
            %
            
            1.7
            %
            
            0.9
            %**Selected
                operating data:**Number
                of orders
            
            
            100,000
            
            
            99,000
            
            
            203,000
            
            
            198,000Average
                order size
            
            $
            1,480
            
            $
            1,340
            
            $
            1,406
            
            $
            1,320Sales
                force, end of period
            
            
            300
            
            
            275
            
            
            300
            
            
            275**Product
                Mix (% of Net Sales):**Notebook
                & PDA’s
            
            
            12.7
            %
            
            15.0
            %
            
            12.7
            %
            
            14.0
            %Desktops
                & Servers
            
            
            21.9
            
            
            19.8
            
            
            20.9
            
            
            22.3Software
            
            
            16.5
            
            
            16.2
            
            
            16.1
            
            
            16.4Storage
            
            
            9.4
            
            
            9.4
            
            
            9.8
            
            
            9.2NetComm
            
            
            4.5
            
            
            4.2
            
            
            4.6
            
            
            4.0Printers
            
            
            7.0
            
            
            9.8
            
            
            7.6
            
            
            9.4Monitors
                & Video
            
            
            8.6
            
            
            10.3
            
            
            10.0
            
            
            10.1Memory
                & Processors
            
            
            6.6
            
            
            6.0
            
            
            6.9
            
            
            5.6Accessories
                & Other
            
            
            12.8
            
            
            9.3
            
            
            11.4
            
            
            9.0





*Comparison
      of Three Month Periods Ended June 30, 2006 and 2005*





*Net
      Sales.* Consolidated
      net sales for the quarter ended June 30, 2006 increased 13.8% to $145.2 million
      compared to $127.6 million in the second quarter of 2005. The increase is
      primarily due to growth in sales to the Company’s outbound customers.
      Consolidated outbound sales to commercial and public sector accounts increased
      15.9% to $142.2 million in the second quarter of 2006 from $122.7 million in
      the
      corresponding period of the prior year, and they now represent 97.9% of the
      Company’s total net sales. Sales to the Company’s SMB customers increased 16.9%
      to $52.6 million for the three months ended June 30, 2006, compared to $45.0
      million in the three months ended June 30, 2005. Sales to the Company’s
      enterprise customers increased 16.2% to $78.4 million for the three months
      ended
      June 30, 2006 compared to $67.5 million in the three months ended June 30,
      2006.
      Net sales to public sector customers increased 11.1% to $10.7 million in the
      second quarter of 2006 from $9.6 million in the second quarter of 2005. Inbound
      sales to our legacy Mac-platform consumer and small office/home office (“SOHO”)
      customers declined 38.4% to $3.0 million, or 2.1% of net sales. This decline
      was
      anticipated as the Company’s focus is on outbound sales customers who respond to
      the relationship-based selling model.





*Gross
      Profit.* Consolidated gross profit increased 33.4% to $19.4 million for the second
      quarter of 2006, compared to $14.5 million in the second quarter of 2005. Gross
      profit as a percentage of net sales increased to 13.4% in the quarter ended
      June
      30, 2006 compared to 11.4% in the second quarter of 2005. The increase is
      primarily due to vendor programs and the net contribution from sales of
      Microsoft Enterprise Agreements. Gross profit margins will continue to vary
      due
      to changes in vendor programs, product mix, pricing strategies, customer mix
      and
      economic conditions. Lastly, the Company categorizes its warehousing and
      distribution network costs in selling, general and administrative expenses.
      Due
      to this classification, the Company’s gross profit may not be comparable to that
      of a company that includes its warehousing and distribution network costs as
      a
      cost of sales.





14
 *Index*





*Selling,
      General and Administrative (“SG&A”) Expenses.* SG&A
      expense dollars increased to $12.8 million for the quarter ended June 30, 2006
      compared to $11.0 million in the second quarter of 2005. As a percent of sales,
      SG&A was 8.8% for the quarter ended June 30, 2006 compared to 8.6% for the
      second quarter of 2005. The Company continues its efforts to maintain tight
      controls on its operational spending, while investing in its future through
      the
      hiring of account executives.


·
            Salaries,
                wages and benefits increased $1.5 million during the second quarter
                2006
                compared to the second quarter of the prior year. The Company’s total
                headcount increased 5.4% to 622 team members at June 30, 2006 from
                590 at
                June 30, 2005 primarily due to recruiting efforts to increase the
                sales
                force. Total sales headcount increased 9.0% to 300 account executives
                compared to 275 at June 30, 2005. Additionally, the Company had increased
                management incentive compensations expense in the three months ended
                June
                30, 2006 compared to the prior year.


·
            Professional
                fees increased $256,000 for the second quarter of 2006 compared to
                the
                second quarter of the prior year. The increase is due to consulting
                fees
                associated with the Company’s documentation of internal controls and
                business process outsourcing arrangements, increased legal fees and
                recruiting fees associated with hiring account executives.


·
            For
                the period ending June 30, 2006 and 2005, warehousing and distribution
                network costs totaled $587,000 and $597,000 respectively.


·
            Facilities
                expense increased by $98,000 during the second quarter of 2006 compared
                to
                the second quarter of 2005. The increase in facilities expense is
                primarily due to the new Portland
                location.


·
            Declines
                in other administrative expenses individually are not significant,
                but
                taken as a whole reflect the remaining change in SG&A expense dollars.





*Advertising
      Expenses, net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, as well as engaging in other activities, to increase the awareness of
      its
      brand and as demand response vehicles. The Company's net cost of advertising
      increased to $1.7 million in the three month period ended June 30, 2006 from
      $1.4 million in the comparable 2005 period. Net cost of advertising costs will
      vary based on available vendor programs.


·
            Gross
                advertising expense increased to $2.2 million for the second quarter
                of
                2006 compared to $1.4 million in the second quarter of 2005.


·
            The
                Company’s gross advertising reimbursements increased to $385,000 in 2006
                from $116,000 in 2005.





*Interest
      Expense.* Interest
      expense was $145,000 for the quarter ended June 30, 2006 compared to $63,000
      in
      the second quarter of 2005. The Company’s use of its line of credit incurred
      interest expense of $140,000 and $37,000 for the three month periods ended
      June
      30, 2006 and 2005, respectively. The remaining expense was due to interest
      owed
      on the outstanding note payable to the former shareholders of CPCS.





*Other
      income, net.* Other
      income was $23,000 for the three months ended June 30, 2006 compared to $13,000
      at June 30, 2005. The increase was primarily due to increased finance charges
      collected from certain customers.





*Provision
      for Income Taxes.* The
      provision for income taxes for the quarter ended June 30, 2006 was $1.8 million
      compared to $811,000 in the comparable period of the prior year. The Company’s
      effective tax rate expressed as a percentage of income before taxes was 38.4%
      for the quarter ended June 30, 2006 compared to 38.5% for the quarter ended
      June
      30, 2005.





*Net
      Income.* Net
      income for the quarter ended June 30, 2006 was $2.9 million compared to $1.3
      million in the second quarter of 2005. Basic and diluted income per share was
      $0.22 and $0.20, respectively, for the three months ended June 30, 2006 compared
      to $0.10 and $0.09, respectively, for the quarter ended June 30, 2005.





15
 *Index*





*Comparison
      of Six Month Periods Ended June 30, 2006 and 2005*





*Net
      Sales.* Consolidated
      net sales for the six months ended June 30, 2006 increased 9.9% to $279.2
      million compared to $254.0 million in 2005. The increase is primarily due to
      growth in sales to the Company’s outbound customers. Consolidated outbound sales
      to commercial and public sector accounts increased 12.2% to $272.8 million
      in
      the first six months of 2006 from $243.1 million in the corresponding period
      of
      the prior year, and they now represent 97.7% of the Company’s total net sales.
      Sales to the Company’s SMB customers increased 10.6% to $102.5 million for the
      six months ended June 30, 2006, compared to $92.7 million in the six months
      ended June 30, 2005. Sales to the Company’s enterprise customers increased 14.3%
      to $152.1 million for the six months ended June 30, 2006 compared to $133.1
      million in the six months ended June 30, 2006. Net sales to public sector
      customers increased to $17.1 million in the six months ended June 30, 2006
      from
      $15.9 million in the six months ended June 30, 2005. Inbound sales to our legacy
      Mac-platform consumer and small office/home office customers declined 40.8%
      to
      $6.4 million, or 2.3% of net sales. This decline was anticipated as the
      Company’s focus is on outbound sales customers who respond to the
      relationship-based selling model.





*Gross
      Profit.* Consolidated gross profit increased to $36.0 million for the six months ended
      June 30, 2006, compared to $29.3 million in the first half of 2005. Gross profit
      as a percentage of net sales increased to 12.9% in the six months ended June
      30,
      2006 compared to 11.5% in 2005. The increase is primarily due to product mix
      and
      vendor programs, as well increased net contribution from Microsoft Enterprise
      Agreements. Gross profit margins will continue to vary due to changes in vendor
      programs, product mix, pricing strategies, customer mix and economic conditions.
      Lastly, the Company categorizes its warehousing and distribution network costs
      in selling, general and administrative expenses. Due to this classification,
      the
      Company’s gross profit may not be comparable to a company that includes its
      warehousing and distribution network costs as a cost of sales.





*Selling,
      General and Administrative (“SG&A”) Expenses.* SG&A
      expense dollars increased to $24.6 million for the six months ended June 30,
      2006 compared to $22.2 million in 2005. As a percent of sales, SG&A was 8.8%
      for the six months ended June 30, 2006 compared to 8.7% for the first half
      of
      2005. The Company continues its efforts to maintain tight controls on its
      operational spending, while investing in its future through the hiring of
      account executives.


·
            Salaries,
                wages and benefits increased $1.8 million during the first half of
                2006
                compared to the first half of the prior year. The Company’s total
                headcount increased 5.4% to 622 team members at June 30, 2006 from
                590 at
                June 30, 2005 primarily due to recruiting efforts to increase the
                sales
                force. Total sales headcount increased 9.0% to 300 account executives
                compared to 275 at June 30, 2005. Additionally, the Company had increased
                management incentive compensations expense in the six months ended
                June
                30, 2006 compared to the prior year.


·
            Professional
                fees increased $407,000 for the first half of 2006 compared to the
                first
                half of the prior year. The increase is due to increased consulting
                fees
                associated with the Company’s documentation of internal controls and
                business process outsourcing arrangements, legal fees and recruiting
                fees
                associated with hiring account executives.
                .


·
            For
                the six month periods ending June 30, 2006 and 2005, warehousing
                and
                distribution network costs totaled $1.2 million and $1.0 million,
                respectively. The year over year increase is primarily due to the
                Company’s increased labor costs in its Bensenville, IL
                facility.


·
            Declines
                in other administrative expenses individually are not significant,
                but
                taken as a whole reflect the remaining change in SG&A expense dollars.





*Advertising
      Expenses, net* .
      The
      Company produces and distributes catalogs at various intervals throughout the
      year, as well as engaging in other activities, to increase the awareness of
      its
      brand and as demand response vehicles. The Company's net cost of advertising
      increased to $3.6 million in the six month period ended June 30, 2006 from
      $3.1
      million in the comparable 2005 period. Net cost of advertising will vary based
      on available vendor programs.


·
            Gross
                advertising expense increased to $4.3 million for the first half
                of 2006
                compared to $3.4 million in 2005.


·
            The
                Company’s gross advertising reimbursements increased to $758,000 in 2006
                from $253,000 in 2005.





16
 *Index*





*Interest
      Expense.* Interest
      expense was $344,000 for the six months ended June 30, 2006 compared to $160,000
      in the first half of 2005. The Company’s use of its working capital line
      incurred interest expense of $310,000 and $97,000 for the six month periods
      ended June 30, 2006 and 2005, respectively. The remaining expense was due to
      interest owed on the outstanding note payable to the former shareholders of
      CPCS.





*Other
      income, net.* Other
      income was $44,000 for the six months ended June 30, 2006 compared to $50,000
      at
      June 30, 2005. The decrease was primarily due to a decline in the average cash
      available to invest in interest bearing securities.





*Provision
      for Income Taxes.* The
      provision for income taxes for the six months ended June 30, 2006 was $2.9
      million compared to $1.5 million in the comparable period of the prior year.
      The
      Company’s effective tax rate expressed as a percentage of income before taxes
      was 38.2% for the six months ended June 30, 2006, compared to 38.3% in 2005.





*Net
      Income.* Net
      income for the six months ended June 30, 2006 was $4.6 million compared to
      $2.4
      million in the first half of 2005. Basic and diluted income per share was $0.35
      and $0.32, respectively, for the six months ended June 30, 2006 compared to
      $0.18 and $0.17, respectively, for the six months ended June 30, 2005.





**Liquidity
      and Capital Resources**





*Working
      Capital*


The
      Company’s total assets were $108.5 million at June 30, 2006, of which $99.0
      million were current assets. At June 30, 2006 and December 31, 2005, the Company
      had cash and cash equivalents of $3.3 million and $3.2 million respectively,
      and
      had net working capital of $37.2 million and $33.4 million, respectively.





The
      Board
      of Directors authorized a stock repurchase program in July of 2004 under which
      the Company could repurchase up to $3.0 million in shares of the Company’s
      common stock through July 2005 in either open market or private transactions
      at
      then prevailing market prices. During the twelve months ended June 30, 2005,
      the
      Company purchased and retired a total of 650,040 shares of its common stock
      at a
      total cost of $2.1 million (an average price of $3.27 per share).





In
      July
      2005, the Board of Directors authorized a continuation of the Company’s share
      repurchase program, pursuant to which the Company could repurchase up to an
      additional $3.0 million in shares of the Company’s common stock through July
      2006 in open market or private transactions at then prevailing market prices.
      For the six months ended December 31, 2005, the Company purchased and retired
      222,800 shares of its common stock at a total cost of $1.0 million (an average
      price of $4.64 per share).





In
      February 2006, the Board of Directors authorized an increase to the Company’s
      share repurchase program, pursuant to which the Company could repurchase up
      to
      an additional $1.0 million in shares of the Company’s common stock through
      February 2007 in open market or private transactions at then prevailing market
      prices. For the three months ended March 31, 2006, the Company purchased and
      retired 313,600 shares of its common stock at a total cost of $1.9 million
      (an
      average price of $6.10 per share).





In
      April
      2006, the Board of Directors authorized an additional $2.0 million increase
      to
      the Company’s share repurchase program through February 2007. For the three
      months ended June 30, 2006, the Company purchased and retired 58,000 shares
      of
      its common stock at a total cost of $381,000 (an average price of $6.57 per
      share).





The
      Company now has a $2.7 million remaining balance in its current repurchase
      program. The Company currently anticipates the use of the remaining balance
      by
      the termination of the program in February of 2007 if market conditions and
      prices warrant the investment.





17
 *Index*





The
      following table represents the Company’s common stock repurchased and retired
      during the second quarter of 2006.





**Period**
            
            **Total
                number**
              **of
                shares**
              **purchased**
            
            **Average**
              **price
                paid**
              **per
                share**
            
            **Total
                number of shares**
              **purchased
                as part of a**
              **publicly
                announced**
              **plan
                or program**
            
            **Maximum
                amount**
              **that
                may yet be**
              **purchased
                under the**
              **plan
                or program**April
                1, 2006 through April 30, 2006
            
            
            0
            
            $
            -
            
            
            
            
            $
            3,052,989May
                1, 2006 through May 31, 2006
            
            
            58,000
            
            $
            6.57
            
            
            58,000
            
            $
            2,671,929June
                1, 2006 through June 30, 2006
            
            
            0
            
            $
            -
            
            
            0
            
            $
            2,671,929




Due
      to
      the fundamental shift in its cash flow cycle, the Company leverages its secured
      line of credit to manage timing differences in cash inflows and cash outflows
      to
      invest in the growth of its business. The secured line of credit is utilized
      to
      invest in capital purchases, to invest in inventory, and to take advantage
      of
      available early pay discounts offered by certain vendors.




At
      June
      30, 2006, the Company had $40.0 million available under a secured line of credit
      with a major financial institution.  The credit facility is collateralized
      by accounts receivable and inventory, and it 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
      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 + 0.50%. The Company’s line of credit is defined by quick
      turnover, large amounts and short maturities. All amounts owed under the
      Company’s line of credit are due on demand. Inventory advances under the
      inventory financing facility do not bear interest if paid within terms, usually
      30 days from advance date.  The facility contains various restrictive
      covenants relating to tangible net worth, leverage, dispositions and use of
      collateral, other asset dispositions, and merger and consolidation of the
      Company. At June 30, 2006, the Company was compliant with all covenants of
      this
      facility. At June 30, 2006, there were no working capital advances outstanding
      and amounts owed for flooring arrangements of $11.8 million were owed to this
      financial institution related to inventory purchases.




The
      Company believes that its existing available cash and cash equivalents,
      operating cash flow, and existing credit facilities will be sufficient to
      satisfy its operating cash needs, and up to the remaining balance of $2.7
      million authorized in the Company’s stock repurchase program, which will
      terminate in February 2007 unless renewed, 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 reduce or curtail its stock repurchase program and seek
      additional funds through sales of equity, debt or convertible securities, or
      increased credit facilities. There can be no assurance that additional financing
      will be available or that, if available, the financing will be on terms
      favorable to the Company and its shareholders.





*Cash
      Flows*


Net
      cash
      provided by operating activities was $19.2 million in the six months ended
      June
      30, 2006. The primary factors that affected cash flow from operating activities
      in the six months ended June 30, 2006, were receipts of account and vendor
      receivables, the net decrease of accounts payable and inventory financing,
      and
      the increase in accrued liabilities. Account and vendor receivables decreased
      $8.4 million due to a decline in net sales compared to December 31, 2005. The
      net change in accounts payable and inventory financing was a decrease of $1.8
      million. The net accounts payable and inventory financing balance change is
      due
      to purchasing and payment cycles. The Company’s accrued liabilities increased by
      $2.4 million due payroll costs associated with the Company’s incentive
      compensation programs, as well as an increase in taxes payable.





18
 *Index*





Net
      cash
      used in investing activities was $1.1 million in the six months ended June
      30,
      2006. Cash outlays for capital expenditures were $1.1 million and $816,000
      for
      the six months ended June 30, 2006 and 2005, respectively. The 2006 capital
      expenditures were primarily related to the start-up costs associated with the
      Portland call center which opened in February 2006. The 2005 capital
      expenditures were primarily for leasehold improvements for the Company’s
      corporate headquarters and continued improvement, and other enhancements, of
      the
      Company’s information systems. The Company intends to continue to upgrade its
      internal information systems as a means to increase operational efficiencies.





The
      most
      significant components of the Company’s financing activities are:  the
      purchase of the Company’s common stock under its share repurchase
      program, net change in the Company’s secured line of credit, and net change
      in book overdraft. For the six months ended June 30, 2006, the Company
      repurchased $2.3 million of its common stock under its share repurchase program.
      Net changes in the Company’s line of credit and book overdraft were a decrease
      of $10.7 million and $4.9 million, respectively. The Company’s financing
      activities for the six months ended June 30, 2006, also included the payment
      of
      an amount due on the note payable issued in its acquisition of CPCS. The Company
      paid the final payment during the second quarter of 2006. For the six months
      ended June 30, 2006 and 2005, the Company paid former shareholders of CPCS
      $1.3
      million and $1.1 million, respectively.





**Contractual
      Obligations**





There
      have been no material changes during the period covered by this report, outside
      of the ordinary course of the Company’s business, to the contractual obligations
      specified in the table of contractual obligations included in the section
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” incorporated by reference in the Company’s Fiscal 2005 Annual Report
      on Form 10-K.





**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**





The
      Company is subject to the risk of fluctuating interest rates in the normal
      course of business, primarily as a result of its short-term borrowing and
      investment activities, which generally bear interest at variable rates. Because
      the short-term borrowings and investments have maturities of three months or
      less, the Company believes that the risk of material loss is low.





**Item
                4.**
            **Controls
                and Procedures**





Under
      the
      supervision and with the participation of the Company’s management, including
      its Chief Executive Officer and Chief Financial Officer, the Company evaluated
      the effectiveness of its disclosure controls and procedures, as such term is
      defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of
      1934,
      as amended. Based on this evaluation, the Company’s Chief Executive Officer and
      Chief Financial Officer concluded that its disclosure controls and procedures
      were effective as of the end of the period covered by this quarterly report.





There
      has
      been no change in the Company’s internal control over financial reporting during
      our most recently completed fiscal quarter that materially affected, or is
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





The
      Company is in the process of implementing the requirements of Section 404 of
      the
      Sarbanes-Oxley Act of 2002, which requires management to assess the
      effectiveness of internal controls over financial reporting and include an
      assertion in its annual report as to the effectiveness of the controls.
      Subsequently, its independent registered public accounting firm, Grant Thornton
      LLP, will be required to attest to whether the assessment of the effectiveness
      of internal controls over financial reporting is fairly stated in all material
      respects and separately report on whether it believes the Company maintained,
      in
      all material respects, effective internal controls over financial reporting
      as
      of December 31, 2007. The Company is in the process of performing the system
      and
      process documentation, evaluation and testing required for management to make
      this assessment and for Grant Thornton LLP to provide its attestation report.
      The Company has not completed this process or its assessment, and this process
      will require significant amounts of management time and resources. In the course
      of evaluation and testing, management may identify deficiencies that will need
      to be addressed and remediated.





19
 *Index*





**Part
      II.**





**Item
                1.**
            **Legal
                Proceedings**





From
      time
      to time, the Company is party to various legal proceedings, claims, disputes
      or
      litigation arising in the ordinary course of business. The Company currently
      believes that the ultimate outcome of any of these proceedings, individually
      or
      in the aggregate, will not have a material adverse effect on the Company’s
      business, financial condition, cash flows or results of operations.





**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.





*No
      Assurance of Future Profitability.* Our
      operating results are difficult to forecast, and there are a number of factors
      outside of our control affecting sales and operating results,
      including:


·
            purchasing
                cycles of commercial and public sector customers;


·
            the
                level of corporate investment in new IT-related capital
                equipment;


·
            decisions
                by IT equipment manufacturers to increase their direct sales
                initiatives;


·
            industry
                announcements of new products or
                upgrades;


·
            industry
                consolidation;


·
            cost
                of compliance with new legal and regulatory requirements;
                and


·
            general
                economic conditions.


There
      can
      be no assurance that we will be able to continue to identify or achieve
      additional cost savings or to maintain profitability going forward.





*No
      Assurance as to Sales Levels.* There is
      no assurance that we will sustain our current sales levels. Sales 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.





*Pressure
      on Margins.* There is
      intense price competition and pressure on profit margins in the computer
      products industry. An increasing number of manufacturers are also providing
      their products direct to customers. Various other factors also may create
      downward pressure on our gross margins, such as shifts 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.





*Account
      Executive Hiring, Retention and Productivity.* We
      intend to continue to recruit account executives. We ended the second quarter
      of
      2006 with 300 account executives compared to 275 in 2005. We hope to be able
      to
      hire and retain approximately 100 new account executives by the end of 2006
      for
      our Portland, Oregon call center, and continue to hire for our Auburn
      headquarters. However, there are no assurances that we will be able to hire
      to
      these 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 our
      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 our new Portland, Oregon call center will attract qualified account
      executives, or that we will be able to remotely manage and retain the new
      account executives.





20
 *Index*





*Vendor
      Support.* 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 current vendor programs
      continue to be refined 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 curtail these programs. If these forms of vendor
      support decline further, 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.





*Major
      Shareholder* .
      Firoz
      H. Lalji, our Chairman and Chief Executive Officer, beneficially owns 52.1%
      of
      the outstanding shares of our 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 are also certified as a Minority Business Enterprise based on Mr. Lalji’s
      maintenance of voting control. The certification allows us to compete for
      certain sales opportunities. A decrease in Mr. Lalji’s level of voting power
      could have an adverse effect on our ability to retain certain customers or
      compete for certain opportunities.





*Competition.* The
      computer products industry is highly competitive. We compete with other national
      direct marketers, including CDW Corporation, Insight Enterprises, Inc., PC
      Connection, Inc. and PC Mall, Inc. We compete with product manufacturers, such
      as Apple, Dell, Hewlett-Packard, IBM and Lenovo that sell direct to end-users;
      we also compete 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.





*Rapid
      Technological Change and Inventory Obsolescence* .
      The
      computer industry is characterized by rapid technological change and frequent
      introductions of new products and product enhancements. To satisfy customer
      demand and obtain greater purchase discounts, we may be required to carry
      significant inventory levels of certain products, which subject us to increased
      risk of inventory obsolescence. We participate 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 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.





*Reliance
      on Vendor Relationships* .
      We
      acquire products directly from manufacturers, such as 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 direct marketing resellers. Substantially, all of our contracts
      and
      arrangements with its vendors are terminable without notice or upon short
      notice. 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.





*Increased
      Expenses of Being a Public Company* .
      The
      costs of being a public company have increased significantly since the enactment
      of the Sarbanes-Oxley Act of 2002. Legal counsel fees specific to increased
      disclosure and corporate governance requirements have increased under the
      Sarbanes-Oxley Act as well as SEC regulations and new NASDAQ rules.
      Additionally, independent registered public accounting firm audit fees have
      significantly increased and are expected to increase even more as requirements
      associated with corporate governance and internal controls become effective.
      These increasing costs may affect our business, financial condition, cash flows
      or results of operations.





21
 *Index*





*State
      Tax Uncertainties.* We
      collect and remit sales and use taxes in states in which we have voluntarily
      registered and/or has a physical presence. Various states have sought to require
      the collection of state and local sales taxes on products shipped to the taxing
      jurisdiction’s residents by DMRs. The United States Supreme Court held in 1992
      that it is unconstitutional for a state to impose sales or use tax collection
      obligations on an out-of-state company whose contacts with the state were
      limited to the distribution of catalogs and other advertising materials through
      the mail and the subsequent delivery of purchased goods by United States mail
      or
      by common carrier. We cannot predict the level of contact, including electronic
      commerce and Internet activity that might give rise to future or past tax
      collection obligations based on that Supreme Court case. Many states
      aggressively pursue out of state businesses, and legislation that would expand
      the ability of states to impose sales tax collection obligations on out of
      state
      businesses has been introduced in Congress on many occasions. A change in the
      law could require us to collect sales taxes or similar taxes on sales in states
      in which hawse 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.





*Reliance
      on Distribution* .
      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 also
      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.





*Dependence
      on Key Personnel* .
      Our
      future success will depend to a significant extent upon its 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
      a key role 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.





*Major
      Customer* .
      From
      time to time we have customers that represent a credit concentration with more
      than 10% of total net sales. One of the Company’s customers, IBM Global Services
      who purchases on behalf of many varied end-users, represented a credit
      concentration whose sales were 11% for the six months ended June 30, 2006,
      and
      were 13.8% and 13.6% of total sales for the three and six months ended June
      30,
      2005. The concentration of credit risk associated with this major customer
      could
      have a material adverse effect on the Company’s business, financial condition,
      cash flows or results of operations.





*Potential
      Disruption of Business From Information Systems Failure.* 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.





*Liquidity
      of Stock and NASDAQ National Market Listing* .
      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 National Market. The NASDAQ National Market also
      imposes a requirement for continued listing that mandates 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 circulation of our common stock,
      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.





22
 *Index*





**Item
                2.**
            **Unregistered
                Sales of Equity Securities and Use of
                Proceeds**





The
      Board
      of Directors committed to a stock repurchase program in July of 2004 under
      which
      the Company could repurchase up to $3.0 million in shares of the Company’s
      common stock through July 2005 in either open market or private transactions
      at
      then prevailing market prices. During the twelve months ended June 30, 2005,
      the
      Company purchased and retired a total of 650,040 shares of its common stock
      at a
      total cost of $2.1 million (an average price of $3.27 per share).





In
      July
      2005, the Board of Directors authorized a continuation of the Company’s share
      repurchase program, pursuant to which the Company could repurchase up to an
      additional $3.0 million in shares of the Company’s common stock through July
      2006 in open market or private transactions at then prevailing market prices.
      For the six months ended December 31, 2005, the Company purchased and retired
      222,800 shares of its common stock at a total cost of $1.0 million (an average
      price of $4.64 per share).





In
      February 2006, the Board of Directors authorized an increase to the Company’s
      share repurchase program, pursuant to which the Company could repurchase up
      to
      an additional $1.0 million in shares of the Company’s common stock through
      February 2007 in open market or private transactions at then prevailing market
      prices. For the three months ended March 31, 2006, the Company purchased and
      retired 313,600 shares of its common stock at a total cost of $1.9 million
      (an
      average price of $6.10 per share).





In
      April
      2006, The Board of Directors authorized an additional $2.0 million increase
      to
      the Company’s share repurchase program through February 2007. For the three
      months ended June 30, 2006, the Company purchased and retired 58,000 shares
      of
      its common stock at a total cost of $381,000 (an average price of $6.57 per
      share).





The
      Company now has a $2.7 million remaining balance in its current repurchase
      program. The Company currently anticipates the use of the remaining balance
      by
      the termination of the program in February of 2007 if market conditions and
      prices warrant the investment.





The
      following table represents the Company’s common stock repurchased and retired
      during the second quarter of 2006.





**Period**
            
            **Total
                number**
              **of
                shares**
              **purchased**
            
            **Average**
              **price
                paid**
              **per
                share**
            
            **Total
                number of shares**
              **purchased
                as part of a**
              **publicly
                announced**
              **plan
                or program**
            
            **Maximum
                amount**
              **that
                may yet be**
              **purchased
                under the**
              **plan
                or program**April
                1, 2006 through April 30, 2006
            
            
            0
            
            $
            -
            
            
            
            
            $
            3,052,989May
                1, 2006 through May 31, 2006
            
            
            58,000
            
            $
            6.57
            
            
            58,000
            
            $
            2,671,929June
                1, 2006 through June 30, 2006
            
            
            0
            
            $
            -
            
            
            0
            
            $
            2,671,929





23
 *Index*





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





(a)
            The
                Company held its annual meeting of shareholders on April 27,
                2006





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





1.
            Election
                of Directors




**Nominee**
            
            **Votes
                For**
            
            **Withheld**John
                H. Bauer
            
            11,581,187
            
            35,689Kenneth
                Kirkpatrick
            
            11,594,378
            
            22,498Firoz
                H. Lalji
            
            11,528,745
            
            88,131Kathryn
                Hatch
            
            11,594,148
            
            22,728William
                C. Keiper
            
            11,537,155
            
            79,721





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





**Votes
                For**
            
            **Votes
                Against**
            
            **Abstentions**
            
            **Broker
                Non Votes**11,603,159
            
            4,554
            
            9,163
            
            0





24
 *Index*





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





Exhibit
                No.
            Description
            Filed
                Herewith
            Incorporated
                by ReferenceForm
            Exhibit
                No.
            File
                No.
            Filing
                Date31.1
            Certification
                of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X31.2
            Certification
                of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 and the regulations promulgated thereunder
            X32.1
            Certification
                of Chief Executive Officerpursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and the
                regulations promulgated thereunder
            X32.2
            Certification
                ofChief
                Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
                of
                2002 and the regulations promulgated thereunder
            X







Signatures




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized:




ZONES,
              INC.Date:
                August 11, 2006By:
            /S/   
                FIROZ H. LALJIFiroz
                H. Lalji, Chairman and Chief Executive Officer/S/   
                RONALD P. MCFADDENRonald
                P. McFadden, Chief Financial
                Officer






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