|UNITED STATESSECURITIES
AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
|--------------------------------------------------------------------------------

||X| | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
|--- | -----------------------------------------------------------------------------------

|FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2002


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

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

|Commission File Number
0-28488


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

|Washington                                     | 91-1431894                  
|---------------------------------------------- | ----------------------------
|(State
      of Incorporation)                 | (I.R.S.
      Employer      
|                                               | Identification
      Number)
|                                               |                             
|707
      South Grady Way                      |                             
|Renton,
      Washington                       | 98055-3233                  
|(Address
      of Principal Executive Offices) | (Zip Code)                  

|(425) 430-3000 (Registrants
Telephone Number, Including Area Code)


Securities registered
pursuant to Section 12(b) of the Act: None


Securities registered
pursuant to Section 12(g) of the Act: Common Stock


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


Indicate by check mark if disclosure
of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of the registrants knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. |X|


Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes |_| No |X|


The aggregate market value of the
Common Stock held by non-affiliates as of June 30, 2002 was approximately $9,884,517
(1), based upon the last sales price per share of $1.40 as reported by the
Nasdaq National Market.


The number of shares of the
registrants Common Stock outstanding as of February 19, 2003, was 13,624,668.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(1) | Excludes value of Common Stock held of record as of June 30, 2002 by executive
          officers, directors and other 10% shareholders of the registrant. Includes
          Common Stock held of record as of that date by certain depository organizations.
          Exclusion of shares held by any person should not be construed to indicate that
          such person possesses the power, direct or indirect, to direct or cause the
          direction of the management or policies of the registrant, or that such person
          is controlled by or is under common control with the registrant.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|ZONES, INC.FORM 10-K
ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 2002 TABLE OF CONTENTS
|-----------------------------------------------------------------------------------------

|PART
I                                                                                              |  |  |  |    | 
|--------------------------------------------------------------------------------------------------- |  |  |  | -- | 
|
|
|                                                                                                    |  | 
|Item 1. Business                                                                                    |  |  |  | 3  | 
|                                                                                                    |  |  |  |    | 
|Item 2. Properties                                                                                  |  |  |  | 13 | 
|                                                                                                    |  |  |  |    | 
|Item 3. Legal
      Proceedings                                                                     |  |  |  | 13 | 
|                                                                                                    |  |  |  |    | 
|Item 4. Submission
      of Matters to a Vote of Security Holders                                   |  |  |  | 13 | 
|                                                                                                    |  |  |  |    | 
|Item 4a.
      Executive Officers of the Registrant                                                 |  |  |  | 13 | 
|                                                                                                    |  | 
|PART
II                                                                                             |  | 
|                                                                                                    |  |  |  |    | 
|Item 5. Market
      for Registrants Common Equity and Related Shareholder Matters                 |  |  |  | 14 | 
|                                                                                                    |  |  |  |    | 
|Item 6. Selected
      Financial Data                                                               |  |  |  | 14 | 
|                                                                                                    |  |  |  |    | 
|Item 7. Managements
      Discussion and Analysis of Financial Condition and Results of Operations |  |  |  | 16 | 
|                                                                                                    |  |  |  |    | 
|Item 7a.
      Quantitative and Qualitative Disclosures About Market Risk                           |  |  |  | 20 | 
|                                                                                                    |  |  |  |    | 
|Item 8. Financial
      Statements and Supplementary Data                                           |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Item 9. Changes
      in and Disagreements with Accountants on Accounting and Financial Disclosure  |  |  |  | 21 | 
|                                                                                                    |  | 
|PART
III                                                                                            |  | 
|                                                                                                    |  |  |  |    | 
|Item 10.
      Directors and Executive Officers of the Registrant                                   |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Item 11.
      Executive Compensation                                                               |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Item 12.
      Security Ownership of Certain Beneficial Owners and Management                       |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Item 13.
      Certain Relationships and Related Transactions                                       |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Item 14.
      Controls and Procedures                                                              |  |  |  | 21 | 
|                                                                                                    |  | 
|PART
IV                                                                                             |  | 
|                                                                                                    |  |  |  |    | 
|Item 15.
      Exhibits, Financial Statement Schedules and Reports on Form 8-K                      |  |  |  | 21 | 
|                                                                                                    |  |  |  |    | 
|Signatures                                                                                          |  |  |  | 24 | 
|                                                                                                    |  |  |  |    | 
|Certifications                                                                                      |  |  |  | 25 | 

|2
|-

|Part I


Item 1. Business


This section contains forward-looking
statements based on managements current expectations, estimates and projections
about the industry in which we operate, managements beliefs and certain assumptions
made by management. These statements are made pursuant to the safe harbor provision of the
Private Securities Litigation Reform Act of 1995. All statements, trends, analyses and
other information contained in this report relative to trends in net sales, gross margin
and anticipated expense levels, as well as other statements, including words such as
anticipate, believe, plan, expect,
estimate and intend and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those anticipated or
expressed in such statements. Potential risks and uncertainties include, among others,
those set forth in this document. Particular attention should be paid to the cautionary
statements involving the industrys rapid technological change and the Companys
exposure to inventory obsolescence, availability and allocations of goods, reliance on
vendor support and relationships, tax uncertainties, competitive risks, pricing risks and
economic risks. Except as required by law, the Company undertakes no obligation to update
any forward-looking statement, whether as a result of new information, future events or
otherwise.


General


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


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


Industry Background


The Company believes that many
businesses have become more receptive to direct marketing resellers (DMR) and
now make their information technology (IT) purchasing decisions primarily on
product selection, availability, convenience and price. DMRs aspire to offer a broad
product and service selection and purchasing convenience. Zones is part of the DMR channel
which serves a very fragmented market whose projected annual sales are in the
multi-billions of dollars. DMRs strive to have a low cost structure driven by few
fixed costs. Low costs can result from rapid inventory turns, a centralized sales force
and highly automated internal processes; specifically including the use of the Internet
and electronic data interchange (EDI) links with major vendors to streamline
operations. The DMR business model is a fulfillment model, which integrates the
procurement and resale of traditional product lines with value added logistics services to
create a single solution based provider.


The industry is waiting for IT
spending to rebound, which is expected to resume as corporate profits begin to accelerate.
Growth in 2003 will depend on gains in market share as well as procuring a greater portion
of existing customers IT products. Zones primary target for growth in this
environment is the small to medium sized business (SMB) market. Historically,
the SMB market has a very high adoption rate for IT products, and has not been as price
sensitive as enterprise level customers. Additionally, the Company believes the SMB
customer has adopted the relationship based outbound selling model due to its ability to
offer a single-source for IT procurement.


In general, the economic slump has
been an impetus for businesses to decrease the number of vendor relationships and find an
integrated solution provider that can be a single-source partner. The Company believes
that this new partner needs to offer a lower cost of procurement coupled with an enriching
customer relationship. The four main reasons for a specific vendor preference among SMB
customers include, among others:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Relationships
 familiarity/predictability with the provider or             method of provision;
|- | ------------------------------------------------------------------------------------------------

| | Single
point of contact with procurement-process simplicity;
|- | ------------------------------------------------------------

| | Low
cost  usually focusing solely on product cost as opposed to the             total cost
of procurement; and
|- | ---------------------------------------------------------------------------------------------------------------

| | Quality
and low-variability of service.
|- | ---------------------------------------

|3
|-

|This creates an opportunity for Zones
to gain market share from the fragmented value added resellers (VAR) and other
DMRs, especially those that cannot provide end-to-end IT procurement and related
services to the SMB market. The Company believes that DMRs that can effectively
address and communicate their value-add as it relates to these issues, and can expand the
way customers think about the procurement processes, will prevail in the changing market.


Risk Factors


There are a number of important
factors that could cause the Companys actual results to differ materially from
historical results or those indicated by any forward-looking statements, including the
risk factors identified below and other factors of which the Company may or may not yet be
aware.


No Assurance as
to Profitability or Levels of Revenue. The
Company has not been profitable in any of the last three fiscal years. In addition, the
Companys sales and operating results are difficult to forecast, and several factors
affecting sales and operating results are outside of the Companys control, such as
the level of corporate investment in new IT related capital equipment and general economic
conditions. Additionally, the Company is currently designated as a minority-owned business
for purposes of qualifying as a vendor for certain sales. There can be no assurance that
this designation will contribute to future growth or that the Company will continue to
hold this designation or to qualify for such sales. Overall, there has been a decreased
demand for the products the Company sells that has adversely affected its sales and
results of operations. There is no assurance that the Company will achieve profitability,
or that the Companys sales will not further decline or that the Company will achieve
profitability in the face of further declining sales. A failure to achieve profitability
or a decline in revenue levels would adversely affect the Companys business,
financial condition, cash flows or results of operations.


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


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


     Competition. The computer products industry is highly competitive. The Company
          believes that product selection, availability and price are the three most
          important competitive factors. The Company competes with other national direct
          marketers, including CDW Computer Centers, Inc., Insight Enterprises, Inc., PC
          Connection, and PC Mall, Inc. The Company also competes with product
          manufacturers, such as Dell and Gateway, that sell direct to end-users and with
          large manufacturers, such as Hewlett Packard and IBM, specialty computer
          retailers; computer and general merchandise superstores; and consumer electronic
          and office supply stores. Many of these competitors rely heavily on the Internet
          as a marketing and sales channel. Some of the Companys competitors compete
          principally on the basis of price and may have lower costs than the Company. The
          Company believes that competition may intensify in the future due to market
          conditions and consolidation. In the future, the Company may face fewer, but
          larger and better-financed competitors as a consequence of such consolidation.
          Additional competition may also arise if other methods of distribution emerge in
          the future. The Company competes not only for customers, but also for
          cooperative advertising expense reimbursements from computer product
          manufacturers. There can be no assurance that the Company will be able to
          compete effectively with existing competitors or new competitors that may enter
          the market, or that the Companys business, financial condition, cash flows
          or results of operations will not be adversely affected by intensified
          competition.

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

|Possible Delisting
of Securities from Nasdaq National Market.
The Companys common stock is currently quoted on the Nasdaq National Market. 
However, in order to continue to be included in the National Market, a company must
maintain, among other things, a minimum closing bid price of $1.00 per share.  The
Companys common stock has periodically failed to maintain a minimum closing bid
price of $1.00 per share. If the Company is unable to maintain the standards set by the
National Market, the delisting of its common stock would have an adverse impact on the
market price and liquidity of the Companys securities and may adversely affect the
ability to obtain additional financing.  As a result of such delisting, a shareholder
may find it more difficult to dispose of, or to obtain accurate quotations as to the
market value of, the Companys common stock.


State Sales or
Use Tax Uncertainties. In accordance with current industry practice,
the Company does not collect sales taxes or other taxes with respect to shipments of goods
into states other than Washington, Nevada, Tennessee, Illinois, California, Missouri and
Ohio. Various states have sought to require the collection of state and local sales taxes
on the sales of products shipped to the taxing jurisdictions residents by direct
marketing resellers. The United States Supreme Court held in 1992 that it is
unconstitutional for a state to impose sales or use tax collection obligations on an
out-of-state company whose contacts with the state were limited to the distribution of
catalogs and other advertising materials through the mail and the subsequent delivery of
purchased goods by United States mail or by common carrier. The Company cannot predict the
level of contact, including electronic commerce and Internet activity, that might give
rise to future or past tax collection obligations based on the Supreme Court case. In
addition, states aggressively pursue out of state businesses, and legislation that would
expand the ability of states to impose sales tax collection obligations on out of state
businesses has been introduced in Congress on many occasions. A change in the law could
require the Company to collect sales taxes or similar taxes on and potentially subject it
to a liability for prior year sales, either of which could have a material adverse effect
on the Companys business, financial condition, cash flows or results of operations.


Major Customer. Sales
to one of the Companys customers, Microsoft Corporation, represented 14.7% and 28.7%
of total sales for the twelve months ended December 31, 2002 and 2001, respectively. Net
sales to Microsoft were $60.7 million and $155.2 million for fiscal years 2002 and 2001,
respectively. The contract with this customer will be up for renewal in June 2003. There
are no assurances that the contract will continue through the completion of its term, that
the contract will be renewed, or if renewed, that the terms and conditions that currently
exist will continue, or that if the Company experiences further declines in sales to
Microsoft that it will be able to replace those sales with increased sales to other
enterprise or SMB customers.


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


Vendor Support. The
Company has various relationships with its vendors, whose programs contribute to
profitability. The Company relies on its vendors for cooperative advertising, which is a
reimbursement of expenses associated with catalogs, e-vehicles and direct mail pieces. In
addition, certain manufacturers and distributors provide the Company with incentives in
the form of rebates, discounts and trade allowances. Many of these back-end programs are
complex and difficult to administer. If any of these relationships or programs were
terminated or substantially curtailed, or if the Company failed to manage the complexity
of these programs, there can be no assurance that the Companys business, financial
condition, cash flows or results of operations will not be adversely affected.




Reliance on Vendor Relationships.The Company acquires products directly from manufacturers as well as from distributors
such as Ingram Micro, Tech Data and others. Certain hardware manufacturers limit the
number of product units available to direct marketers such as the Company. Substantially
all of the Companys contracts and arrangements with its vendors are terminable
without notice or upon short notice. Termination, interruption or contraction of the
Companys relationships with its vendors could have a material adverse effect on the
Companys business, financial condition, cash flows or results of operations.



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

|Rapid Technological
Change and Inventory Obsolescence. The computer industry is
characterized by rapid technological change and frequent introductions of new products and
product enhancements. In order to satisfy customer demand and obtain greater purchase
discounts, the Company may be required to carry significant inventory levels of certain
products, which will subject it to increased risk of inventory obsolescence. The Company
participates in first-to-market and end-of-life-cycle purchase opportunities, both of
which carry the risk of inventory obsolescence. Special purchase products are sometimes
acquired without return privileges and there can be no assurance that the Company will be
able to avoid losses related to such products. Within the industry, vendors are becoming
increasingly restrictive in guaranteeing return privileges. While the Company seeks to
reduce its inventory exposure through a variety of inventory control procedures and
policies such as only holding stock on hand for a two-week sell through run-rate, there
can be no assurance that the Company will be able to avoid losses related to obsolete
inventory.


Reliance on Outsourced
Distribution. Airborne Logistics Services, an affiliate of Airborne Express, provides
and operates a warehouse and distribution center for the Company in Wilmington, Ohio
under a renewable contract that expires in August 2003. Any limitation or interruption of
the service being provided by Airborne Logistics could have a material adverse effect on
the Companys business, financial condition, cash flows or results of operations.
Certain distributors also participate in the Companys logistics through electronic
data interchange. Failure to develop and maintain relationships with these and other
vendors would limit the Companys ability to obtain sufficient quantities of
merchandise on acceptable commercial terms and could have a material adverse effect on
the Companys business, financial condition, cash flows or results of operations.


Major Shareholder.
Firoz H. Lalji, the Companys Chairman and Chief Executive Officer, beneficially owns
48.2% of the outstanding shares of the Companys common stock, excluding shares that
he may acquire upon exercise of stock options that he holds. If Mr. Lalji exercises all
options and retains the shares of common stock issued to him upon such exercise, his
collective ownership would increase to 50.0% of the outstanding shares of the
Companys common stock. The voting power of these shares enables Mr. Lalji to
significantly influence the Companys affairs and the vote on corporate matters to be
decided by the Companys shareholders, including the outcome of elections of
directors. This effective voting control may preclude other shareholders from being able
to influence shareholder votes and could impede potential merger transactions or block
changes to the Companys articles of incorporation or bylaws, which could adversely
affect the trading price of the Companys common stock.


Dependence on
Key Personnel. The Companys future success will depend to a
significant extent upon the ability to attract and retain skilled personnel. Although the
Companys success will depend on its ability to hire, train and retain competent
personnel in all areas of its business, there are certain individuals that play a key role
within the organization. Loss of any of these individuals could have an adverse effect on
the Companys business, financial condition, cash flows and results of operations.


Potential Disruption
of Business. The Companys success is dependent in part on the quality,
reliability and proper utilization of its information, telecommunication, desktop
publishing and other systems, which are used for web-based distribution, marketing,
catalog design and production, purchasing, inventory management, order processing, product
distribution, accounts receivable, customer service and general accounting functions.
Interruption in any of the Companys operating systems, Internet systems, Internet
connectivity or telecommunication systems could have a material adverse effect on the
Companys business, financial condition, cash flows or results of operations.
Additionally, the Companys headquarters lease expires on July 31, 2003. If the
Company is unable to renew the lease on favorable terms and is required to move its
headquarters, there is a risk that there could be an interruption of the Companys
information systems, which could have a material adverse effect on the Companys
business, financial condition, cash flows or results of operations.


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

6
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----------------------------------------------------------------------------------------------------------------------------------------------

|The Business


The Companys business is the
procurement and fulfillment of IT solutions to the SMB, enterprise and public sector
market place. Relationships with SMB, large enterprise, and public sector institutions
represented 82.8% of sales revenue in 2002. The remaining revenue was primarily Mac
platform consumers and small office home office customers.


The Companys core business is
focused on the SMB market. This is a large, addressable market of companies primarily
served by a highly fragmented VAR community. The Company believes that the SMB customer is
generally less sensitive to price, has a high adoption rate for IT solutions and is
looking for a single source provider to handle their procurement from end to end.


The enterprise market is defined by
customers within the Fortune 2000. These customers demand a much higher level of customer
service and generally have longer purchasing cycles. Supported by a full enterprise team
at the Renton headquarters, as well as account executives in California, Illinois and
Missouri, Zones is able to integrate the business needs and processes of its customer
through ZonesConnect, the Companys robust automated web-based procurement system.


The public sector market is made up
of three primary customer segments: state and local government, federal government and
education. These sectors require special education pricing and participation in a bid
process.


The Business Strategy


The Company acquires and develops
on-going relationships primarily with SMB, enterprise accounts and public sector
institutions through dedicated teams of outbound account executives (AE).
Although outbound telemarketing is the Companys primary customer contact, it also
reaches customers through an integrated marketing and merchandising strategy designed to
attract customers using dedicated e-marketing and direct marketing vehicles, catalogs for
demand response opportunities and corporate branding, and providing customized web stores
for its corporate customers through ZonesConnect. Throughout the year, the Company will
refine the target customer in each market and create specific marketing collateral to
reach that audience.


Zones support divisions have
aligned their processes, pricing, stocking strategies, marketing programs, quotas,
communication methodology and training to the priorities set for each sales division. The
marketing and merchandising departments generate correlated programs focused on meeting
the needs of its customers. These programs will align with the priorities set for each
sales division and provide the sales divisions information to ensure that each program is
maximized.


Zones believes that the U.S.
economic environment in 2003 is likely to be substantially similar to the environment in
2002, and its ability to grow in 2003 will hinge on increases in market share and the
depth of IT spend generated from existing customers. The Company offers a sales solution
that will lower the total cost of procurement.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Zones
provides a single-source of more than 150,000 products from over 2,000 vendors;
| | - | -------------------------------------------------------------------------------------

| |  | Zones
offers automated procurement through ZonesConnect;
| | - | --------------------------------------------------------

| |  | Zones
runs a low-cost operational model utilizing technological             solutions and
process driven fulfillment; and,
| | - | --------------------------------------------------------------------------------------------------------------------------

| |  | Zones establishes a proactive partnership with each customer through a dedicated AE
supported by a team of experts for full sales cycle support.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

|The specific areas of concentration
to realize share growth are:


     Hiring. To drive market share growth, the Company has planned aggressive hiring goals in
          2003. Each new AE will participate in a two month, intensive training program,
          before transitioning into the Small Business Group (SBG). SBG
          focuses on account acquisition to achieve its sales goal and reinforces Company
          best practices learned in the training program to effectively become part of the
          Zones Business Solutions (ZBS) team. As a part of the ZBS team, each
          AE will focus on increasing the productivity of each customer by developing the
          relationship to garner more of the total IT spend out of each account.

7
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Focus on
expansion of Customer Base. Relationships with SMB, large
enterprise, and public sector institutions represent future growth opportunities for the
Company. The Company intends to continue its efforts to increase sales to these accounts
by focusing on its relationship based model, in which its AEs develop long-term
relationships with customers through frequent telephone contact, knowledgeable technical
advice, individual attention, quality service, and convenient one-stop shopping. The
Company also intends to focus its efforts on these customers through targeted marketing
and the hiring of more AEs.


Training and AE
development. The Company continually seeks to attract, retain and motivate high
quality personnel. Management focuses on training and coaching AEs to access
supportive collateral on the available programs and promotions developed by marketing and
merchandising for effective account acquisition, execute on strategies in place to further
penetrate existing accounts. The Companys AEs are paid a commission based
salary. Commissions are tied to sales volume and gross profit dollar metrics. The
Companys average tenure of its current AEs remained relatively flat at 30
months at the end of fiscal year 2002 compared to a year ago.


Product Breadth
and Depth. The Company depends upon relationships with key vendors for
opportunistic product purchases to enhance its margin. Through a strategic mix of products
and vendors, the Company offers its customer a broad selection at competitive pricing. The
Company generally stocks 20% of its product offerings, which represent 80% of its total
revenue, in its Ohio warehousing facility. The remaining items are offered to the customer
through the Companys virtual warehousing partnerships with key distributors and
vendors, via electronic data interchange (EDI). The Company uses its warehouse
and EDI partners to fulfill its customers needs with broad product availability. EDI
provides the Companys customers access to its partners inventory of products
and reduces the Companys handling costs. Information on price and product
availability is uploaded into the Companys enterprise resource planning
(ERP) system. The Company places individual orders directly with its EDI
partner who assembles these orders and ships directly to the Companys customers.


     Zones Connect. The Companys ZonesConnect web sites provide a personalized, self-service
          tool available 24 hours a day, 7 days a week to Zones customers.
          ZonesConnect adds value by providing access to information that simplifies
          customers business purchasing process. Through the Companys robust
          e-commerce engine, customers are able to integrate their business processes and
          automate their procurement with customized ZonesConnect sites. ZonesConnect is a
          free online procurement management system providing the customer with a unique
          extranet for online ordering, featuring indispensable procurement management and
          reporting capabilities including order tracking and history, serial number
          tracking, purchase authorization levels, preconfigured bundled solutions,
          standards lists and time-release reporting.


Mac Zone. The Mac Zone
division focuses on small office home office and consumers. The Mac business is based on a
direct response model utilizing catalog circulation, marketing/merchandising programs, the
Mac Zone web store and an inbound call center to drive sales. The 2003 focus will be on
first to market promotions and creating programs that provide a valuable incentive to each
customer.


Sales and Marketing


The Company reaches customers through
an integrated marketing and merchandising strategy designed to attract customers using
dedicated e-marketing and direct marketing vehicles, catalogs for demand response
opportunities and corporate branding, and providing customized web stores for its
corporate customers through its ZonesConnect service. Throughout the year, marketing will
refine the target customer in each market and create specific marketing collateral to
reach that audience.


Outbound Telemarketing.
As of December 31, 2002, the Company had a staff of 171 AEs who actively pursued
sales to SMB, enterprise and public sector institutions by establishing one-to-one
relationships through outbound telemarketing. The primary targets for AEs in the SMB
divisions are the small business customers, while enterprise AEs focus on companies
with in the Fortune 2000. These commissioned AEs develop long-term relationships
with their accounts through frequent telephone contact, knowledgeable technical advice,
individual attention, quality service, and convenient one-stop shopping.


Inbound Sales. The
Company believes it has well trained and knowledgeable inbound telemarketing
representatives. The Company offers toll-free numbers for inbound sales that are staffed
seven days a week. Sophisticated systems allow the Companys representatives to
quickly access a customers record and billing information and review details of past
purchases. For most products sold, the systems also contain an extensive on-line database
of information on product specifications, benefits and features; compatibility of related
products; and system requirements for software programs. In addition, the systems
automatically prompt telemarketing representatives to offer customers the latest upgrades
and complementary software and peripherals. The Companys inbound telephone sales
personnel are also available to assist online customers.


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

|Extranet Commerce. The
Company offers no-fee web stores for its customers through ZonesConnect. These web pages
provide its customers with various benefits, including secure on-line purchasing,
comprehensive product and manufacturer information, order status information, multiple
shopping baskets, varying ship-to options per order, enhanced search and browse
capabilities and historical purchase information. In addition, we often provide more
customized extranet sites for larger customers with specific online procurement needs.


Internet Commerce. The
Companys electronic commerce sites on the Internet, Zones.com and MacZone.com,
provide a lower-cost sales channel to both supplement and enhance our person-to person
selling model, and to provide its customers detailed product information and the
convenience of on-line purchasing. To drive traffic to its Internet sites, the Company
leverages its catalog circulation by featuring the Internet address throughout the
catalogs. The web sites are featured on all the Companys promotional communications
and advertising. The Company also utilizes marketing through e-catalogs, as well as
on-line price promotions and affiliations. The Company sent 14.7 million e-catalogs in
2002.


     Catalogs. The Company markets products through targeted mailings of its monthly catalogs.
          The Mac Zone catalog continues to be strong demand response vehicle and the
          primary driver of the Mac inbound and online business. As the SMB business model
          evolves and continues to focus on outbound sales and e-commerce, reliance on the
          IT catalogs shift from a direct response vehicle to an opportunity for corporate
          branding. The Company utilizes its catalog distribution as both a customer
          acquisition and retention strategy by using the catalog as both a direct
          marketing tool and a branding vehicle to drive significant traffic to its
          electronic commerce sites, Zones.com and MacZone.com, as well as to the inbound
          sales force.


The Company uses cooperative
advertising funds, which are proof of performance expense reimbursements, to substantially
offset the costs associated with its catalog circulation and other marketing activities.
The amount of funding available from the Companys vendors has generally declined
both in dollars and as a percentage of sales. The Companys net cost of advertising
totaled $1.4 million in 2002. Domestic net advertising costs were $2.5 million in 2001 and
$3.1 million in 2000. Net advertising costs may continue to fluctuate or rise in the
future, as the Company continues to adapt and adjust its catalog circulation, Internet and
other marketing activities to optimize sales and profitability in light of changing market
conditions.


Products and
Merchandising


Through the Companys catalogs,
electronic commerce sites and sales force, the Company offers customers access to over
150,000 hardware, software, peripheral and accessory products and services for users of PC
and Mac computers from over 2,000 manufacturers.


Computers and
Servers. The Company offers a large selection of desktop, laptop and notebook
personal computer systems and servers from leading manufacturers such as Apple, Dell,
Hewlett-Packard, Fujitsu, IBM, Sony, and Toshiba.


Peripherals,
Accessories and Networking. The Company carries a full line of
peripherals products such as printers, monitors, keyboards, handhelds (PDAs),
memory, storage devices, modems, projectors, scanners, and digital cameras, as well as
various accessories and printing supplies such as toner cartridges, storage media and
cables. Brands offered by the Company include APC, Apple, Canon, Epson, Hewlett-Packard,
In Focus, Iomega, Kingston, Kodak, Fuji, Logitech, NEC, Okidata, Palm, Phillips, Quantum,
Sony, UMAX, ViewSonic and Western Digital.


     Networking. The Company provides networking products such as switches, hubs, routers,
          firewalls and wireless devices. Brands offered by the Company include Asante,
          Cisco, 3Com, Linksys, Netgear, Nortel Networks, Intel, Hewlett-Packard, D-Link
          and Buffalo.


     Software. The Company sells a wide variety of packaged software and licensing programs in
          the business, personal productivity, connectivity, utility, language,
          educational, entertainment and other categories. The Company offers products
          from larger, well-known manufacturers as well as numerous specialty products
          from new and emerging software development companies. Brands offered by the
          Company include Adobe, Computer Associates, Corel, Intuit, Macromedia,
          Microsoft, Novell, Symantec and Quark, among others.

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

|The following table shows the
Companys gross sales attributable to various product categories during 2002, 2001,
and 2000.
|---------------------------------------------------------------------------------------------------------------------------

|                                              |  | Year
      ended December 31,
|--------------------------------------------- |  | -----------------------------
|                                             
|                                             
|                                             
|Computers
      and servers                   |  | 35.0                         
|Peripherals,
      accessories and networking |  | 48.4                         
|                                              |  |                              
|Total
      hardware                          |  | 83.4                         
|Software                                      |  | 16.6                         
|                                              |  |                              
|Total                                         |  | 100.0                        
|                                              |  |                              

|The Companys category
merchandising group determines the manufacturers whose products are featured in its
Internet and catalog offerings and negotiates the terms and conditions of product
coverage. It is the merchants responsibility to review product availability and
determine stocking strategy. Additionally, each merchant reviews their managed
SKUs to ensure that the Company is offering differentiating programs and is pricing
competitively in the market. Each managed SKU also has component and add-on information to
assist the AE in the selling process. Zones merchants have aligned their processes,
pricing, stocking strategies, marketing programs, quotas, communication methodology and
training to the priorities set for each sales division. The merchandising group negotiates
with certain manufacturers and distributors to provide the Company with incentives in the
form of rebates, discounts and trade allowances. Vendors also help offset the cost of
returned inventory with discretionary return privileges. If any of these relationships are
terminated, there can be no assurance that the Companys business, financial
condition, cash flows or results of operations will not be adversely affected.


Purchasing


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s purchasing team
works to develop and maintain relationships with a broad base of reliable, high-quality
suppliers. Through strategic negotiation, the team works to obtain the lowest overall
acquisition cost, in an effort to enable the Company to provide competitive pricing for
its clients while enhancing its margins.


The Company acquires products
directly from manufacturers such as Apple, Hewlet-Packard and IBM, as well as through
distributors such as Ingram Micro, Tech Data, Synnex, and others. In 2002, The Company
purchased approximately 51.6% of its merchandise from distributors which is flat compared
to 2001, and the balance directly from manufacturers. The Company believes that its
sourcing strategy enables it to take advantage of significant special offers, discounts
and supplier reimbursements, while also minimizing inventory costs. The Company believes
it has excellent relationships with its suppliers and attempts to take advantage of all
appropriate discounts.


The Company utilizes a blend of
stocking, just-in-time procurement, and indirect fulfillment in executing its inventory
management strategy. The Company generally stocks products that represent the top 80% of
total revenue, including high-velocity and strategic products, as well as opportunistic
purchases. The remaining products are provided to its customers primarily through virtual
warehousing partnerships with key distributors and manufacturers. Through these
relationships, the Company is able to offer a broad selection of products, and provide
prompt, cost-efficient fulfillment with minimal inventory exposure. This virtual
fulfillment model is facilitated through industry-standard EDI linkages with suppliers.
All associated transactions are managed through and integrated within the Companys
ERP system, which lowers administrative overhead.


At December 31, 2002, the Company
maintained an investment in inventory of $11.3 million, which turned an average of 24
times in 2002. This compares to an investment in inventory of $16.9 million at December
31, 2001, which turned an average of 20 times during 2001.


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

|Order Fulfillment and
Distribution


The Company distributes products
virtually through its EDI arrangement with its vendors, as well as through its Airborne
Logistics Services (ALS) warehouse in Wilmington, Ohio and its Henderson,
Nevada warehouse.


ALS provides and operates a
full-service warehouse and distribution center for the Company at the Airborne Commerce
Park in Wilmington, Ohio under a contract that expires in August 2003. At this time the
Company intends to negotiate the renewal of this contract. Employees of Airborne Logistics
utilize the Companys systems, policies and procedures to receive, log and warehouse
inventory shipments from product suppliers, fill and ship customer orders, and return
inventory to product suppliers when requested by the Company. The Company also uses this
warehouse facility to house special buys, constrained product and other high velocity
product.


The Company pays a flat rate for each
order filled by ALS. Orders received by the Company are electronically transmitted on a
dedicated data line to its computer equipment at the Airborne Logistics distribution
center, where a packing slip is printed out for order fulfillment and inventory
availability is automatically updated on all of the Companys information systems.
All inventory items are bar coded and located in designated areas that are easily
identified on the packing slip. All items are checked with bar code scanners prior to
final packing, which helps to ensure that orders are filled correctly. Orders accepted for
items in stock by 12:00 a.m. Eastern Time can generally be delivered overnight via
Airborne Express. Upon request, orders may also be shipped for Saturday delivery or by
ground service or other overnight delivery services.


The Company operates a return
logistics/fulfillment warehouse in Henderson, Nevada. The returns warehouse accepts
returns on certain products, processes the return and determines viability of the product.
The warehouse is then responsible for the returned merchandise that will be returned to
vendor, returned to general inventory, repaired or liquidated.


The Company continues to experience a
significant decline in domestic customer return rates. Its returns decreased to 2.7% of
gross sales in 2002 compared to 3.5% in 2001. Decreases in product returned to Henderson
in 2002 were primarily attributable to facilitating certain product returns be sent
directly to the vendor. Product returns are closely monitored to identify trends in
product offerings, enhance customer satisfaction and reduce overall returns.


Technical Support and
Customer Service


The Company maintains a staff of
dedicated technical support personnel who provide pre- and post-sale technical support
both for Zones account managers and its customers. In addition to a broad base of A+
certifications, the team also maintains a number of distinguished manufacturer
certifications, including Cisco CCIE, CCNA, Microsoft MCSE, Citrix CCA, Compaq Master ASE
and SAN Architect, and HP STAR.


Pre-sales support is utilized
primarily by the Companys account managers to assist them in optimizing product
recommendations, assessing compatibility and other technical requirements, providing
technical consulting and design services, and offering configuration and custom imaging
support services. Post-sales support is provided primarily to assist customers with their
technical questions concerning the installation and operation of the products they
purchase.


The Company also employs a staff of
dedicated customer service representatives who respond to and facilitate inquiries
regarding order status and related matters, shipment tracking, billing issues, and return
requests. These services are provided via toll-free telephone support. The Company
believes the employment of this comprehensive suite of technical support and customer
service offerings improves the quality of its recommended technology solutions, reduces
product returns, increases customer satisfaction, and encourages repeat business.


Systems


The Company continues to commit
significant resources to the development of sophisticated management information,
telecommunication, catalog production and other systems, which are employed in virtually
all aspects of its business, including marketing, purchasing, inventory management, order
processing, product distribution, accounts receivable, customer service and general
accounting functions. During 2002, the Company made significant technology changes to
improve its sales processes with the objective of efficiency and automation. A
company-wide software refresh was done to include WinXP, Office XP and IE 6.0 on desktops.
Similarly, the server software was upgraded to Win 2000 and SQL 2000.

11
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|The e-commerce web site was improved
during 2002 using the latest technology to increase response time and provide greater
scalability. This upgrade further allowed the Company to add business process
functionalities for its enterprise customers who shop online. The Company developed a
content management system for product information management. This system acts as a
centralized repository for all product information, including product image and data
specification. EDI remains the primary tool for exchanging transactions with enterprise
customers, distributors and vendors; however, the Company has adopted a new form of
transaction with external customers using XML, cXML and xCBL. The need for this form of
transacting with external customers is growing for the SMB customers as well as enterprise
customers. The Company is continually looking at technological advances to increase the
productivity of its employees.


Database Marketing


The Company maintains a proprietary
database containing over 5.0 million customer and inquirer records. The Company attracts
new customers and prospective customers and retains current customers through their
catalogs, on-line media, e-marketing, advertising in trade publications, targeted direct
mail programs and managing leads for its outbound telemarketing sales force through the
Companys customer relationship management system. The catalogs circulation is
comprised of customer records as well as names on mailing lists obtained from list
brokers, product manufacturers, trade magazine publishers, association memberships and
other sources. The Company regularly analyzes and updates its database and other available
information in order to enhance customer response and order rates. The Company tracks the
buying patterns of its customers in an attempt to anticipate customers needs and
generate additional product orders. The Company believes that by selectively targeting its
print media and e-vehicles to specific groups of customers with known product affinities
and purchasing characteristics, it will be able to increase order rates from customers.
This also enhances the effectiveness of the Companys print catalogs and e-vehicles,
and their desirability as a marketing channel for product manufacturers. The Company
leverages its database marketing capabilities by providing key product manufacturers with
marketing research such as price sensitivity tests, list response analyses, and database
marketing consulting services. The Company believes these efforts assist it in promoting
and preserving positive relationships with these manufacturers.


Employees


At December 31, 2002, the Company had
517 employees in its operations. The Company considers its employee relations to be good.
The Company has never had a work stoppage and believes no employees are represented by a
labor organization. The Company emphasizes the recruiting and training of high quality
personnel and, to the extent possible, promotes people to positions of increased
responsibility from within the Company.


Sales Team Education


The Company provides a balanced
8-week accelerated training program consisting of classroom and practical, on-the-job
learning within an outbound sales environment. Zones Team Development takes an integrated
approach in developing the new hires skills for acquiring and developing customers
using a relationship building sales methodology. AEs learn to utilize various
internal and external systems and receive hardware and software product education. In
addition, the Company involves key vendor partners to educate its AEs by offering
monthly vendor fairs, lunch and learns and on-the-job cart product knowledge training.


Mission & Values.


The Company is dedicated to creating
a learning community of empowered individuals to serve its customers with integrity,
commitment and passion. It strives to achieve this by stimulating a positive and
collaborative workplace environment, delivering high speed and quality service to its
customers, and adapting to external changes with flexibility, innovation and leading edge
technology.


Trademarks



The Company conducts its business in
the United States primarily under the service marks Zones® and The Mac Zone®
registered with the United States Patent and Trademark Office. These registrations can be
renewed as long as the service marks are used in connection with the Companys
business activities. The Company believes that these, and its other marks have significant
value and are an important factor in the marketing of its products. If challenged, there
are no assurances that the Company will be able to protect its intellectual property.

12
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Regulatory and Legal
Matters


In addition to federal, state and
local laws applicable to all corporations and employers in general, the direct marketing
business as conducted by the Company is subject to the Federal Trade Commissions
Merchandise Mail Order Rule and related regulations. The Company is also subject to laws
and regulations relating to truth-in-advertising and other fair trade practices. The
Company has implemented programs and systems to promote ongoing compliance with these laws
and regulations.


Item 2. Properties


The Company currently leases
approximately 132,000 square feet of space for its corporate headquarters, including its
telemarketing operations, in Renton, Washington, approximately 18,000 square feet of space
for its return warehouse facility in Henderson, Nevada and approximately 1,200, 200 and
500 square feet of space for field sales offices in Schaumberg, Illinois; Kansas City,
Missouri; and, Oakland, California, respectively. The Companys lease on its
corporate headquarters expires on July 31, 2003. There can be no assurance that the
Company will be able to renew the lease with similar terms or that the Company will not
have to relocate its corporate headquarters.


Item 3. Legal Proceedings


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


On November 21, 2002, the Washington
State Department of Revenue (the Department) issued a final determination
regarding the Companys state tax returns for the years 1996, 1997, 1998 and 1999.
The Department upheld the auditors assessment of business and occupation tax on
certain expense reimbursements the Company received from vendors during the audit period.
The Company intends to petition the Department for a reconsideration of its determination,
which will stay payment of the assessment until the petition for reconsideration is
denied. However, as a result of the determination by the Department, the Company recorded
a charge of $2.1 million during the fourth quarter of 2002. The Company intends to pursue
all of its appeal rights, but there can be no assurance that the Company will be
successful, in whole or in part, in challenging the determination. Additionally, the
Department may also make a similar assessment for 2000, 2001 and 2002. The Company has
reserved against the possibility of a similar assessment for these years.


Item 4. Submission of
Matters to a Vote of Security Holders


None.


Item 4a. Executive
Officers of the Registrant


Firoz H. Lalji,
age 56, has served as the Companys President and Chief Executive Officer since May
of 1998, and as Chairman of the Board since March of 1999. Mr. Lalji was co-founder and
has served as a director of the Company since March 1990. Mr. Lalji is also President and
Chief Executive Officer of Fana Capital Corporation, an investment holding company. From
1981 to 1997, he was President and Chief Executive Officer of Kits Cameras, Inc., which
operated over 140 camera specialty stores in eight western states.


Scott F.
Koerner, age 45, has served as Executive Vice President and Chief Operating Officer
since December 2000. Prior to that, Mr. Koerner was Senior Vice President and General
Manager for Zones Business Solutions since April 2000. From 1999 to 2000, Mr. Koerner
served as Vice President of Marketing and Merchandising for ZBS. From 1998 to 1999, Mr.
Koerner served as the Senior Vice President of Sales and Marketing for Sayers Computer
Source, a Midwest VAR servicing corporation. From 1996 to 1998, Mr. Koerner served as
Senior Vice President and General Manager of Elek-Tek/Creative Computers. From 1994 to
1996, he served in various positions while at Montgomery Ward & Company including Vice
President, Electric Avenue and Regional Managing Director.


13
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Ronald P.
McFadden, age 46, has served as Senior Vice President and Chief Financial Officer
since May 2000. Prior to this position Mr. McFadden was the Companys Vice President
of Finance and Administration since May 1999. He joined the Company in June 1998,
initially serving as Vice President of International Operations. From 1991 to 1998, Mr.
McFadden was Chief Financial Officer for Kits Cameras, Inc., which operated over 140
camera specialty stores. Between 1984 and 1991 he served as Vice President of Finance for
Interpace Industries.


Anwar Jiwani, age 48,
has served as Senior Vice President and Chief Information Officer since April 1999. Prior
to this Mr. Jiwani served for 23 years with The Royal Bank of Canada.


Part II


Item 5. Market for
Registrants Common Equity and Related Shareholder Matters


The Companys Common Stock is
quoted on the Nasdaq National Market under the symbol ZONS. The following table sets forth
the range of high and low sales prices for the Common Stock as reported by the Nasdaq
National Market.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     | Year
      ended December 31, | 
|-------------------- | ----------------------------- | 
|
|
|
|
|
|First
      quarter  | $1.24                         | 
|Second
      quarter | 1.92                          | 
|Third
      quarter  | 1.52                          | 
|Fourth
      quarter | 1.28                          | 

|As of the March 12, 2003 record date,
the Company had approximately 6,200 beneficial holders of record of its Common Stock. The
Company has never paid, and has no present plans to pay, a cash dividend on its Common
Stock. The Company intends to retain its earnings to finance the expansion of its
business.


Item 6. Selected
Financial Data


The following table sets forth the
selected historical consolidated income and balance sheet data of Zones, Inc. and its
subsidiaries. The balance sheet data at December 31, 2002 and 2001 and the statement of
operations data for the years ended December 31, 2002, 2001 and 2000 have been derived
from the audited consolidated financial statements and notes thereto included in this
Annual Report on Form 10-K. The balance sheet data for the years ended December 31, 2000,
1999 and 1998 and the statement of operations data for the years ended December 31, 1999
and 1998 have been derived from audited consolidated financial statements and notes
thereto not included in this Annual Report on Form 10-K. This information should be read
in conjunction with the consolidated financial statements and notes thereto included in
Item 8 and Item 7 Managements Discussion and Analysis of Financial Condition
and Results of Operations.
14
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                          | Year
      ended December 31, |           
|--------------------------------------------------------- | ----------------------------- | ----------
|
|
|
|Statement of Operations
      Data:                       |                               |           
|Net sales                                                 | $                             | 414,643   
|Cost of sales (5)                                         |                               | 371,725   
|                                                          |                               |           
|Gross profit                                              |                               | 42,918    
|Selling, general and
      administrative expenses (4, 5) |                               | 41,648    
|                                                          |                               |           
|Income (loss) from
      operations before state tax      |                               |           
|adjustment                                                |                               | 1,270     
|State tax adjustment (1)                                  |                               | 2,145     
|                                                          |                               |           
|Loss from operations                                      |                               | (875      
|Other (income) expense,
      net (3, 4, 5)               |                               | (58       
|                                                          |                               |           
|Loss before income
      taxes                            |                               | (817      
|Benefit from income
      taxes                           |                               | (302      
|                                                          |                               |           
|Loss before cumulative
      effect of change in          |                               |           
|accounting principle                                      |                               | (515      
|Cumulative effect
      of change in method of            |                               |           
|revenue recognition
      (2)                             |                               |           
|                                                          |                               |           
|Net loss                                                  | $                             | (515      
|                                                          |                               |           
|                                                          |                               |           
|Basic and diluted
      loss per share                    | $                             | (0.04     
|                                                          |                               |           
|Weighted average shares
      used in computation of      |                               |           
|basic and diluted
      loss per share                    |                               | 13,587    
|                                                          |                               |           
|Pro forma amounts
      assuming the new revenue          |                               |           
|recognition principle
      is applied retroactively (2)  |                               |           
|Net
      loss                                            |                               |           
|Basic
      and diluted loss per share                    |                               |           
|                                                          |                               |           
|Balance Sheet Data:                                       |                               |           
|Working capital                                           | $                             | 20,587    
|Total assets                                              |                               | 79,952    
|Short-term debt                                           |                               | 226       
|Long-term debt, net
      of current portion              |                               |           
|Total shareholders
      equity                          | $                             | 31,097    
|                                                          |                               |           
|Selected Operating
      Data: (6)                        |                               |           
|Catalogs distributed                                      |                               | 12,543,000
|e-media distributed                                       |                               | 14,716,000
|Number of shipments (7)                                   |                               | 506,877   
|Average order size (7)                                    | $                             | 821       
|Number of outbound
      account executives               |                               | 171       

|(1) | During
the fourth quarter of 2002, the Company received the final determination from the
Washington State Department of Revenue regarding the tax years 1996 through 1999. The
Company recorded a charge for this determination of $2.1 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | During
  the   fourth   quarter   of  2000,   the   Company   implemented   Staff    Accounting
  Bulletin   (SAB)   101, RevenueRecognitioninFinancialStatements.    Effective   January  1,   2000,   the   Company   recorded
 the   cumulative    effect   of   the  accounting   change.   The   pro   forma  amounts
  shown   on   the   income   statement   have  been adjusted for the effect of
retroactive application of  the   revenue   recognition   method,  which   would   have
  been   made  had   the   new    method   been  in   effect,   net   of   related
 income   taxes.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | During
the first quarter of 2000, the Company recognized a one time gain on the sale of its
Indian subsidiary of $1.3 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------

|(4) | During
1999, the Company recognized gains and losses on the divestiture of an investment with
majority control in Austria, France, Germany, Mexico, Switzerland and the United Kingdom,
resulting in a net loss of $541,000.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | During
1998, the Company recorded charges related to the write-off of inventory, the closure of
international subsidiaries, staffing reductions and the disposal of unproductive computer
hardware and software. Excluding the effect of these charges, the Company would have
reported a net loss of $2,600,000 or $0.20 per share.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Selected
operating data excludes the affect of international operations consolidated during 1998.
|--- | -------------------------------------------------------------------------------------------------

|(7) | Number
of shipments is the number of domestic outbound orders to customers from the third-party
distribution center utilized by the Company. Average order size is calculated by dividing
domestic gross sales by the number of domestic orders.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|15
|--

|Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operations


The following discussion and analysis
of the Companys financial condition and results of operations contains certain
forward-looking statements. For this purpose, any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, the words believes, anticipates,
plans, expects and similar expressions are intended to identify
forward-looking statements. There are a number of important factors that could cause the
Companys actual results to differ materially from those indicated by any such
forward-looking statements. These factors include, without limitation, those items set
forth in Item 1 above under the caption Risk Factors.


The following discussion and analysis
should be read in conjunction with the Companys Selected Consolidated Financial and
Operating Data and the Consolidated Financial Statements and Notes included in this Annual
Report on Form 10-K.


General


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


Critical Accounting
Policies


The Companys discussion and
analysis of its financial condition and results of operations are based upon its
consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The Company believes the following
critical accounting policies affect its more significant judgments and estimates used in
the preparation of its consolidated financial statements, and should be read in
conjunction with its summary of significant accounting policies (see Note 2 of the
Companys Notes to Consolidated Financial Statements). The Companys critical
accounting policies are as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Revenue
recognition
| | - | -------------------

| |  | Valuation
of current assets and estimating market inventory obsolescence
| | - | ------------------------------------------------------------------------

| |  | Accounting
for income taxes
| | - | ---------------------------

|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. Additionally, the Company offers limited return rights on its
product sales. At the point of sale, the Company also provides for an allowance for sales
returns, which is established based on historical experience.


Valuation of
current assets and estimating market inventory
obsolescence.


The Company uses significant judgment
and estimates in the preparation of its financial statements that affect the carrying
values of its assets and liabilities. On an on-going basis, the Company evaluates its
estimates.


The Company maintains an allowance
for doubtful accounts based on estimates of future collectibility of its accounts
receivable. The Company regularly analyzes its accounts receivable in evaluating the
adequacy of the allowance for doubtful accounts. The adequacy of the allowance is
determined during the current period based on historical collection experience, customer
credit worthiness based on published information and other known factors.



The Company maintains a valuation
allowance for potentially uncollectable amounts due from its vendors which arise from
product returns, standard vendor price protection programs and vendor rebate programs.
Amounts received from vendors may vary from amounts recorded based on the difference
between the current market price of a product returned and its acquisition price or the
denial of price protection or vendor rebates due to noncompliance with specific attributes
of the vendor programs. The Company regularly reviews its vendor receivables and provides
a valuation allowance based on historical collections and the comparison of amounts
recorded versus subsequently received.


16
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|The Company records inventory at
lower of FIFO cost or market. It estimates the amount of unmarketable inventory based on
the difference between the cost of the inventory and the market value, which is based on
assumptions of market demand, current market conditions, most recent actual sales prices
and age and condition of products.


Accounting for income
taxes.


The Company is required to estimate
income taxes in the jurisdiction in which it operates. This process involves estimating
actual tax exposure while assessing temporary differences resulting in differing treatment
for tax and accounting purposes. These differences result in deferred tax assets and
liabilities. The Company assesses the likelihood that its deferred tax assets will be
recovered through future taxable income and or other tax planning strategies. The Company
exercised judgment as of December 31, 2002 and 2001, and did not provide a valuation
allowance against its deferred tax asset believing that it is more likely than not that
future taxable income and tax planning will be sufficient to recover the deferred tax
asset. However, the guidelines provided by SFAS 109 are stringent and if the Company is
unable to provide positive evidence that the deferred tax asset is recoverable, it will be
required to provide a valuation allowance against the deferred tax asset. If a valuation
allowance is deemed to be required, an expense will be recorded within the tax provision
in the Consolidated Statement of Operations.


Results of Operations


The following table sets forth, for
the periods indicated, selected items from the Companys Consolidated Statements of
Operations expressed as a percentage of net sales.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                | Year
      ended December 31, |   
|------------------------------- | ----------------------------- | --
|
|
|
|Net sales                       | 100.0                         | % 
|Cost of sales                   | 89.6                          |   
|                                |                               |   
|Gross profit                    | 10.4                          |   
|SG&A expenses                   | 10.0                          |   
|                                |                               |   
|State tax adjustment            | 0.6                           |   
|Loss from operations            | (0.2                          | ) 
|                                |                               |   
|Other expense                   | 0.0                           |   
|Loss before income
      taxes  | (0.2                          | ) 
|                                |                               |   
|Benefit from income
      taxes | (0.1                          | ) 
|Net loss                        | (0.1                          | )%
|                                |                               |   

|Comparison of Years Ended
December 31, 2002 and 2001


Net Sales. Net
sales decreased 23.4%, to $414.6 million in 2002 from $541.1 million in 2001. The decrease
was primarily due to the economic recession experienced over the past several quarters,
competitive pressures on selling prices and a decline in sales to a major customer.
Business customers slowed the purchases of technology products across all targeted markets
throughout 2001 and 2002, reducing the number of shipped orders to 507,000 in 2002 from
611,000 during 2001. The Companys average order size decreased to $821 in 2002
compared to $896 in 2001. Product sales to a major customer decreased 60.9% to $60.7
million in 2002 compared to 2001 product sales of $155.2 million. Reclassifications of
freight revenue into net sales amounted to $6.4 million in 2002 compared to $9.2 million
in 2001. The Company expects U.S. economic conditions in 2003 to be substantially similar
to those experienced in 2002. As a value-added service to its business customers, the
Company will begin collecting sales tax in the States of California and Missouri during
2003. This change may impact the Companys Mac sales division as its customers are
primarily consumer and small office home office in nature and the added burden of tax may
affect sales of products to these customers.


Gross Profit. Gross
profit decreased 20% to $42.9 million in 2002 from $53.6 million in 2001, but increased to
10.4% of net sales in 2002 from 9.9% of net sales in 2001. Gross profit dollars declined
as a function of the decline in total sales. The increase in gross profit percentage is
primarily due to the Company aggressively taking advantage of favorable discount terms
offered by certain vendors, which decreased cost of sales, shifts in product mix to higher
margin product lines such as software and participating in vendor programs.

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

|Selling, General
and Administrative Expenses. SG&A expenses decreased 22.9% to
$41.6 million in 2002 from $54.0 million in 2001, but remained flat as a percentage of net
sales at 10.0% due to the Companys decline in sales volume. The variable costs
associated with credit card fees and warehousing costs declined by $1.2 million in 2002
compared to prior year in conjunction with the decline in sales volume. The Company made
improvements in business processes resulting in the elimination of redundant headcount and
reduced technology infrastructure costs. Total wages and benefits declined by $4.8 million
during 2002 compared to prior year. This decrease includes wage reductions due to
headcount eliminations and declines in variable commission costs that declined due to the
drop in sales volume. In addition, it reassessed the estimated useful lives of selected
technology assets and extended their depreciation period resulting in a reduction of
depreciation expense of approximately $990,000 in 2002. Additionally, the Company reduced
its net cost of advertising in fiscal year 2002 by $1.1 million compared to fiscal year
2001.


State Tax
Adjustment. The Washington State Department of Revenue issued its final
determination regarding the Companys 1996 through 1999 tax years. Due to the
determination, the Company recorded a $2.1 million charge to expense during the fourth
quarter of 2002. The Company intends to file a petition for reconsideration of this
determination and will not have to pay this tax until that petition is denied.


Other Income/Expense.
Other income was $58,000 in 2002 compared to $26,000 in 2001. This represents
interest income from short-term investments offset by interest expense.


Income Tax
Benefit. The income tax benefit for 2002 was $302,000. The income tax benefit for
2001 was $149,000. The tax rates were 36.9% and 44.6% for the years ended December 31,
2002 and 2001, respectively. The change in the effective rate is due to the impact of
certain permanent tax differences and changes in prior year estimated taxes.


Net Loss. For the year
ended December 31, 2002, the Company recorded a net loss of $515,000, or $0.04 per basic
and diluted share. This loss includes a one-time, after-tax charge of $1.3 million
relating to Washington State tax audit adjustment. This compares to fiscal year
2001s net loss of $185,000, or $0.01 per share.


Comparison of Years Ended
December 31, 2001 and 2000


Net Sales. Net
sales decreased 14.7%, to $541.1 million in 2001 from $634.1 million in 2000. The decrease
was primarily due to the economic recession experienced over the past several quarters,
exacerbated by the tragic events of September 11, 2001, and competitive pressures on
selling price. Business customers have slowed the purchases of technology products across
all targeted markets, reducing the number of shipped orders to 611,000 during 2001 from
867,000 during 2000. Reclassifications of freight revenue into net sales amounted to $9.2
million in 2001 compared to $12.4 million in 2000.


Gross Profit. Gross
profit decreased 10.7% to $53.6 million in 2001 from $60.0 million in 2000, but increased
to 9.9% of net sales in 2001 from 9.5% of net sales in 2000. Gross profit dollars declined
as a function of the decline in total sales. The increase in gross profit percentage is
primarily due to the Companys focus on higher margin product lines, a change in the
Companys customer mix and participating in vendor programs.


Selling, General
and Administrative Expenses. SG&A expenses decreased 12.3% to
$54.0 million in 2001 from $61.6 million in 2000, but increased as a percentage of net
sales between periods to 10.0% from 9.8%. The percentage increase is due to the
Companys decline in sales volume. The decrease in SG&A expense dollars is
primarily due to tightened controls placed on discretionary spending and the elimination
of redundant processes and headcount. Credit card fees decreased by $2.1 million in 2001
compared to the prior year in conjunction with the Companys transition away from the
PC consumer, as business accounts generally tend to be open account customers. The
variable warehousing costs declined by $1.9 million in 2002 compared to prior year due to
the decline in sales volume. Additionally, the Company reduced its net cost of advertising
in fiscal year 2001 by $588,000 compared to fiscal year 2000.


Other Income/Expense.
Other income was $26,000 in 2001 compared to $1.1 million in 2000. In the first
quarter of 2000, the Company realized a one-time gain on the sale of its Indian subsidiary
of $1.3 million.


Income Tax
Benefit. The income tax benefit for 2001 was $149,000. The income tax benefit for
2000 was $188,000. The tax rates were 44.6% and 34.6% for the years ended December 31,
2001 and 2000, respectively. The change in the effective rate is due to the impact of
certain permanent tax differences and changes in prior year estimated taxes.





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

|Net Loss. For the year
ended December 31, 2001, the Company reduced its net loss by 55.3% compared to prior year.
It recorded a net loss of $185,000, or $0.01 per share, in fiscal year 2001. This compares
to fiscal year 2000s net loss of $414,000, or $0.03 per share, which included the
cumulative effect of the change in accounting principle that increased the net loss by
$59,000, or $0.01 per share.


Industry


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


Inflation


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


Liquidity and Capital
Resources


The Company had total assets of $80.0
million at December 31, 2002, of which $69.4 million were current assets. At December 31,
2002 and 2001, the Company had cash, cash equivalents, and restricted cash of $9.0 million
and $13.1 million respectively, and working capital of $20.6 million and $18.9 million,
respectively. Net cash used by operating activities was $3.0 million in 2002 and net cash
provided by operating activities was $19.5 million in 2001. The cash outflow in 2002 was
primarily due to a significant increase in accounts receivable, a reduction in accounts
payable; offset by a decline in inventory. Accounts receivable increased by $11.1 million,
while inventory and accounts payable declined by $5.6 million and $3.6 million,
respectively. Accounts receivable days outstanding at December 31, 2002 increased to 41
days compared to 33 for the year ended December 31, 2001. The Company anticipated the days
outstanding to increase in fiscal year 2002 due to a change in payment terms with a major
customer.


Cash outlays for capital expenditures
were $1.6 million in 2002 and $1.9 million for 2001. These expenditures were primarily for
information systems and software, leasehold improvements, telecommunications system
enhancements and furniture and equipment. During 2001, the Company financed $573,000 for
additional system hardware and a telephone system upgrade.


In November 2002, the Company
replaced its outstanding $35.0 million credit facility. At December 31, 2002, the Company
has an aggregate $35.0 million available under secured lines of credits with 2 major
financial institutions.  The Company has a $30.0 million facility, collateralized by
accounts receivable and inventory, that can be utilized as both a working capital line of
credit and a flooring facility used to purchase inventory from several suppliers under
certain terms and conditions.  This credit facility expires on November 25,
2004.  The working capital and inventory advances bear interest at a rate of Prime +
0.50%. Inventory advances do not bear interest if paid within terms, usually 30 days from
advance date.  No working capital advances were outstanding and accounts payable of
$9.1 million was owed to this financial institution related to inventory purchases at
December 31, 2002.


The second facility is a $5.0 million
inventory flooring facility collateralized by the inventory purchases financed on the
facility.  The facility expires on July 21, 2003 and is subject to annual renewals.
The inventory advances bear interest at a rate of Prime if not paid within terms, usually
30 days from advance date.  Amounts due under this line are included in accounts
payable and were $3.0 million at December 31, 2002.


The Company believes that its
existing available cash and cash equivalents, 2003 operating cash flow and existing credit
facilities will be sufficient to satisfy its operating cash needs for at least the next 12
months at its current level of business. However, if the Companys working capital or
other capital requirements are greater than currently anticipated, the Company could be
required to seek additional funds through sales of equity, debt or convertible securities
or increased credit facilities. There can be no assurance that additional financing will
be available or that, if available, the financing will be on terms favorable to the
Company.
19
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Other Matters


New Accounting
Pronouncements


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


In April 2002, the Financial
Accounting Standards Board issued SFAS 145 Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS
145). The provisions of SFAS 145 will be effective for the Companys fiscal
year 2003. The Company does not believe that SFAS 145 will have a significant impact on
its results of operations, financial position or cash flows.


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


In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based Compensation  Transition Disclosure
 and amendment of FASB Statement No. 123. This statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting for stock
based employee compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock based employee compensation
and the effect of the method used on reported results. The Companys adoption of this
statement for the year ended December 31, 2002 did not have an impact on its results of
operations, financial position or cash flows.


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


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


Item 7a. 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. The Company invests cash balances in excess of operating requirements in short-term
securities, generally with maturities of 90 days or less. In addition, the Companys
unsecured credit agreement provides for borrowings which bear interest at variable rates
based on the prime rate. The Company had no interest bearing borrowings outstanding
pursuant to the credit agreement as of December 31, 2002. The Company believes that the
effect, if any, of reasonably possible near-term changes in interest rates on the
Companys financial position, results of operations and cash flows should not be
material.


20
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Item 8. Financial
Statements and Supplementary Data


The information required by this item
is included in this report beginning at page 27.


Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure


None.


Part III


Item 10. Directors and Executive
Officers of the Registrant


The information required by this item
is contained in, and incorporated by reference from, the Proxy Statement for the
Companys 2003 Annual Meeting of Shareholder under the caption Proposal No. 1:
Election of Directors, and Section 16(a) Beneficial Ownership Reporting
Compliance. See also the information concerning executive officers of the Company
included in Item 4a of Part I in this Report.


Item 11. Executive
Compensation


The information required by this item
is contained in, and incorporated by reference from, the Proxy Statement for the
Companys 2003 Annual Meeting of Shareholders under the caption Executive
Compensation.


Item 12. Security
Ownership of Certain Beneficial Owners and Management


The information required by this item
is contained in, and incorporated by reference from, the Proxy Statement for the
Companys 2003 Annual Meeting of Shareholders under the caption Stock Ownership
of Management and Certain Other Holders.


Item 13. Certain
Relationships and Related Transactions


The information required by this item
is contained in, and incorporated by reference from, the Proxy Statement for the
Companys 2003 Annual Meeting of Shareholders under the caption Certain
Relationships and Related Transactions.


Item 14. Controls and
Procedures


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


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


Part IV


Item 15. Exhibits,
Financial Statement Schedules and Reports on form 8-K


     (a)       
          1. Financial Statements:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
financial statements of Zones, Inc. and its subsidiary, and the Report of Independent
Accountants are included herein beginning on page 27.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

|21
|--

|2.   Financial Statement Schedules:


See
Schedule II, Valuation and Qualifying Accounts


     3.   Exhibits:
|--------------------------------------------------------------------------------------------------------------

|ExhibitNo. |  |                                                                    |  | FiledHerewith | Incorporated
      by Reference |       |  |      
|---------- |  | ------------------------------------------------------------------ |  | ------------- | ------------------------------- | ----- |  | -----
|
|
|
|3.1        |  | Restated Articles
      of Incorporation of Multiple Zones         |  |               |                                 | S-1   |  | 3.1  
|           |  | International, Inc.                                                |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|3.2        |  | Articles of Amendment
      of Multiple Zones, Inc.                |  |               |                                 | 8-K   |  | 3.1  
|           |  |                                                                    |  |               |                                 |       |  |      
|3.3        |  | Amended and Restated
      Bylaws of Multiple Zones                |  |               |                                 | 10-K  |  | 3.2  
|           |  | International, Inc.                                                |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|4.1        |  | Form of Common Stock
      Certificate of Zones, Inc.              |  | X             |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.1       |  | Multiple Zones International,
      Inc. Amended and Restated      |  | X             |                                 |       |  |      
|           |  | 1993 Stock Incentive
      Plan*                                   |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.2       |  | Multiple Zones International,
      Inc. 1999 Director Stock       |  | X             |                                 |       |  |      
|           |  | Option Plan*                                                       |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.3       |  | Form of Stock Option
      Agreement (used for grants to           |  |               |                                 | S-1   |  | 10.4 
|           |  | executive officers
      after March 31, 1996)*                    |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.4       |  | Form of Stock Option
      Agreement (used for grants to outside   |  |               |                                 | S-1   |  | 10.16
|           |  | directors)*                                                        |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.5       |  | Multiple Zones International,
      Inc. 401(k) Plan*              |  |               |                                 | S-1   |  | 10.5 
|           |  |                                                                    |  |               |                                 |       |  |      
|10.6       |  | Multiple Zones International,
      Inc. Employee Stock Purchase   |  |               |                                 | S-1   |  | 10.6 
|           |  | Plan*                                                              |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.7       |  | Multiple Zones International,
      Inc. Management Incentive      |  |               |                                 | S-1/A |  | 10.7 
|           |  | Plan*                                                              |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.8       |  | Form of Indemnification
      Agreement between Multiple           |  |               |                                 | S-1   |  | 10.15
|           |  | Zones International,
      Inc. and certain executive officers and |  |               |                                 |       |  |      
|           |  | outside directors*                                                 |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.9       |  | Employment Agreement
      dated as of February 1, 2001            |  |               |                                 | 10-Q  |  | 10.1 
|           |  | between Multiple Zones,
      Inc. and Scott Koerner*              |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.10      |  | Office Lease dated
      April 1, 1996 between Multiple Zones      |  |               |                                 | S-1   |  | 10.24
|           |  | International, Inc.
      and Renton Talbot Delaware, Inc.         |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.11      |  | Industrial Real Estate
      Lease dated April 10, 1997 between    |  |               |                                 | 10-K  |  | 10.18
|           |  | Multiple Zones International,
      Inc. and Pacific Industrial    |  |               |                                 |       |  |      
|           |  | Park, LLC                                                          |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.12      |  | Ingram Micro Resale
      Agreement dated April 1, 1996            |  |               |                                 | S-1   |  | 10.25
|           |  | between Multiple Zones
      International, Inc. and Ingram        |  |               |                                 |       |  |      
|           |  | Micro                                                              |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.13      |  | Authorized Apple Catalog
      Reseller Agreement between          |  |               |                                 | S-1   |  | 10.26
|           |  | Multiple Zones International,
      Inc. and Apple Computer, Inc.  |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.14      |  | Storage and Distribution
      Agreement dated September 28,       |  |               |                                 | S-1   |  | 10.27
|           |  | 1992 between Multiple
      Zones International, Inc. and          |  |               |                                 |       |  |      
|           |  | Advanced Logistics
      Services Corp.                            |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.15      |  | Amendment to Storage
      and Distribution Agreement dated        |  |               |                                 | 10-K  |  | 10.18
|           |  | September 1, 2000
      between Multiple Zones International,      |  |               |                                 |       |  |      
|           |  | Inc. and Airborne
      Logistics Services Corp.                   |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.16      |  | Business Loan Agreement
      dated December 10, 1999              |  |               |                                 | 10-K  |  | 10.21
|           |  | between Multiple Zones
      International, Inc. and U.S. Bank     |  |               |                                 |       |  |      
|           |  | National Association                                               |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.17      |  | Microsoft Corporation
      Authorized Source Agreement dated      |  |               |                                 | 10-Q  |  | 99.1 
|           |  | July 1, 2000 between
      Multiple Zones International, Inc. and  |  |               |                                 |       |  |      
|           |  | Microsoft Corporation                                              |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.18      |  | Inventory and Working
      Capital Financing Agreement dated      |  |               |                                 | 10-K  |  | 10.23
|           |  | July 21, 2000 between
      Multiple Zones International, Inc.     |  |               |                                 |       |  |      
|           |  | and IBM Credit Corporation                                         |  |               |                                 |       |  |      
|           |  |                                                                    |  |               |                                 |       |  |      
|10.19      |  | Amendment to the Microsoft
      Corporation Authorized            |  |               |                                 | 10-Q  |  | 10.1 
|           |  | Source Agreement dated
      January 1, 2002 between Zones,        |  |              
|           |  | Inc. and Microsoft
      Corporation                               |  |              
|          
|           |  |                                                                    |  |               |                                 |       |  |      
|10.20      |  | Loan and Security
 Agreement dated                                 |  | X            
|           |  | November 25, 2002
      between Zones, Inc and TransAmerica        |  |              
|           |  | Commercial Finance                                                 |  |              
|          
|           |  |                                                                    |  |               |                                 |       |  |      
|23.1       |  | Consent of PricewaterhouseCoopers
      LLP                        |  | X            
|          
|           |  |                                                                    |  |               |                                 |       |  |      
|99.1       |  | Certification of Chief
      Executive Officer and Chief Financial |  | X            
|           |  | Officer pursuant to
      Section 906 of the Sarbanes-Oxley Act    |  |              
|           |  | of 2002                                                            |  |              
|           |  |                                                                    |  |              
|*          |  | Management contract
      or compensatory plan or arrangement      |  |              

|22
|--

| | (b) | 3. Reports
      on Form 8-K
| | --- | ----------------------------

| | On
December 9, 2002, the Company filed a report on form 8-K containing the Companys
press release to the effect that it was intending to aggressively hire account executives
in 2003.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 29, 2002, the Company filed a report on form 8-K containing the Companys
press release regarding its new $30.0 million credit facility with Transamerica
Commercial. The Company also announced it had received the determination of the
administrative law judge in its appeal with the Washington State Department of Revenue
which has been examining the Companys state tax returns for the years 1996, 1997,
1998 and 1999.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
other Reports on Form 8-K were filed during the quarter ended December 31, 2002.
| | -----------------------------------------------------------------------------------

|23
|--

|SIGNATURES


Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Date:
      February 25, 2003 |  | ZONES, INC.
      By:  /s/ FIROZ H. LALJI
            
            Firoz H. Lalji, Chairman and Chief Executive
      
            Officer 
      By:  /s/ RONALD P. MCFADDEN
            
            Ronald P. McFadden, Chief Financial
      Officer
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Each person whose individual
signature appears below hereby authorizes and appoints Firoz H. Lalji and Ronald P.
McFadden, and each of them, with full power of substitution and resubstitution and full
power to act without the other, as his or her true and lawful attorney-in-fact and agent
to act in his or her name, place and stead and to execute in the name and on behalf of
each person, individually and in each capacity stated below, and to file, any and all
amendments to this Report, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing, ratifying and confirming all that said
attorneys-in-fact and agents or any of them or their or his or her substitute or
substitutes may lawfully do or cause to be done by virtue thereof.


Pursuant to the requirements of the
Securities Exchange act of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the date indicated.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                             |  |         
|---------------------------- |  | --------
|
|                             |  |         
|                             |  |         
|/s/
      JOHN H. BAUER      |  | Director
|                             |  |         
|John
      H. Bauer         
|                             |  |         
|/s/
      JOHN T. CARLETON   |  | Director
|                             |  |         
|John
      T. Carleton      
|                             |  |         
|/s/
      RICHARD E. CARTER  |  | Director
|                             |  |         
|Richard
      E. Carter     
|                             |  |         
|/s/
      FIROZ H. LALJI     |  | Director
|                             |  |         
|Firoz
      H. Lalji        
|                             |  |         
|/s/
      KATHLEEN S. PUSHOR |  | Director
|                             |  |         
|Kathleen
      S. Pushor    

|24
|--

|Certifications


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

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

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

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

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

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

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

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

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

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

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

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

|Date: February 25, 2003 |  | By:  /s/ FIROZ H. LALJI
      
      Firoz H. Lalji, Chairman and Chief Executive  
      Officer
|----------------------- |  | -------------------------------------------------------------------------------------------------------------------

|25
|--

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

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

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

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

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

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

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

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

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

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

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

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

|Date: February 25, 2003 |  | By:  /s/ RONALD P. MCFADDEN
            
            Ronald P. McFadden, Chief Financial
      Officer
|----------------------- |  | ------------------------------------------------------------------------------------------------------------------------

|26
|--

|ZONES, INC. INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS
|------------------------------------------------------

|                                                           | 
|---------------------------------------------------------- | 
|Consolidated
      Financial Statements:                   | 
|                                                           | 
|Consolidated
      Balance Sheets                          | 
|December
      31, 2002 and 2001                           | 
|                                                           | 
|Consolidated
      Statements of Operations                | 
|Twelve months
      ended December 31, 2002, 2001 and 2000 | 
|                                                           | 
|Consolidated
      Statement of Shareholders Equity       | 
|Twelve months
      ended December 31, 2002, 2001 and 2000 | 
|                                                           | 
|Consolidated
      Statements of Cash Flows                | 
|Twelve months
      ended December 31, 2002, 2001 and 2000 | 
|                                                           | 
|Notes to
      Consolidated Financial Statements           | 
|                                                           | 
|Report of
      Independent Accountants                    | 
|                                                           | 
|Schedule
      II  Valuation and Qualifying Accounts      | 

|27
|--

|ZONES, INC.
                                                    CONSOLIDATED BALANCE SHEETS
                                                 (in thousands, except share data)
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                              | December
      31, |       
|------------------------------------------------------------- | ------------------ | ------
|
|
|                                                              |                    |       
|ASSETS                                                        |                    |       
|Current assets:                                               |                    |       
|Cash and
      cash equivalents                               | $                  | 9,048 
|Restricted
      cash                                         |                    |       
|Receivables,
      net                                        |                    | 45,368
|Inventories,
      net                                        |                    | 11,273
|Prepaid
      expenses                                        |                    | 1,239 
|Deferred
      income taxes                                   |                    | 2,514 
|                                                              |                    |       
|Total
      current assets                                    |                    | 69,442
|Property
      and equipment, net                             |                    | 5,565 
|Deferred
      income taxes                                   |                    | 4,771 
|Other
      assets                                            |                    | 174   
|                                                              |                    |       
|Total
      assets                                            | $                  | 79,952
|                                                              |                    |       
|                                                              |                    |       
|LIABILITIES AND
      SHAREHOLDERS EQUITY                    |                    |       
|Current liabilities:                                          |                    |       
|Accounts
      payable                                        | $                  | 38,453
|Accrued
      liabilities                                     |                    | 9,930 
|Current
      portion of capital lease obligations            |                    | 226   
|Current
      portion of deferred rent obligation             |                    | 216   
|Income
      taxes payable                                    |                    | 30    
|                                                              |                    |       
|Total
      current liabilities                               |                    | 48,855
|Capital lease obligations,
      net of current portion       |                    |       
|Deferred rent obligation                                      |                    |       
|                                                              |                    |       
|Total
      liabilities                                       |                    | 48,855
|                                                              |                    |       
|                                                              |                    |       
|Commitments and contingencies
      (Note 9)                  |                    |       
|                                                              |                    |       
|Shareholders equity:                                         |                    |       
|Common
      stock, no par value, 45,000,000 authorized;      |                    |       
|13,609,956
      and 13,536,406 shares issued and outstanding |                    |       
|at
      December 31, 2002 and 2001, respectively             |                    | 39,554
|Accumulated
      deficit                                     |                    | (8,457
|                                                              |                    |       
|Total
      shareholders equity                              |                    | 31,097
|                                                              |                    |       
|Total
      liabilities and shareholders equity              | $                  | 79,952
|                                                              |                    |       

|The accompanying notes
are an integral part of the consolidated financial statements.
28
|----------------------------------------------------------------------------------------

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

|                                                                           | Year
      ended December 31, |        
|-------------------------------------------------------------------------- | ----------------------------- | -------
|
|
|                                                                           |                               |        
|Net sales                                                                  | $                             | 414,643
|Cost of sales                                                              |                               | 371,725
|                                                                           |                               |        
|Gross profit                                                               |                               | 42,918 
|                                                                           |                               |        
|Selling, general and
      administrative expenses                         |                               | 41,648 
|                                                                           |                               |        
|Income (loss) from
      operations before state tax adjustment            |                               | 1,270  
|State tax adjustment                                                       |                               | 2,145  
|                                                                           |                               |        
|Loss from operations                                                       |                               | (875   
|                                                                           |                               |        
|                                                                           |                               |        
|Interest expense                                                           |                               | 94     
|Other (income) expense                                                     |                               | (152   
|Minority interest                                                          |                               |        
|                                                                           |                               |        
|                                                                           |                               | (58    
|                                                                           |                               |        
|Loss before income
      taxes                                             |                               | (817   
|Benefit for income
      taxes                                             |                               | (302   
|                                                                           |                               |        
|Loss before cumulative
      effect of change in accounting principle      |                               | (515   
|Cumulative effect
      of change in method of revenue recognition         |                               |        
|                                                                           |                               |        
|                                                                           |                               |        
|Net loss                                                                   | $                             | (515   
|                                                                           |                               |        
|                                                                           |                               |        
|Basic and diluted
      loss per share before cumulative effect            | $                             | (0.04  
|Basic and diluted
      loss per share of cumulative effect                |                               |       
|                                                                           |                               |        
|Basic and diluted
      loss per share after cumulative effect             | $                             | (0.04  
|                                                                           |                               |        
|                                                                           |                               |        
|Weighted average shares
      used in computing basic and diluted loss per |                               |        
|share                                                                      |                               | 13,587 
|                                                                           |                               |        
|                                                                           |                               |        
|Pro forma amount assuming
      the new revenue recognition principle is   |                               |        
|applied retroactively-                                                     |                               |        
|Net
      loss                                                             |                               |        
|Basic
      and diluted loss per share                                     |                               |        

|The accompanying notes
are an integral part of the consolidated financial statements.


29
|------------------------------------------------------------------------------------------

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

|                                            |            |  | Accumulated
      Deficit |        |  | Accumulated
      Other
      Comprehensive
      Income (Loss) |        |   |  |   |    
|------------------------------------------- | ---------- |  | ------------------------- | ------ |  | --------------------------------------------------------------- | ------ | - |  | - | ---
|
|
|
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Balance, January 1,
      2000              | 13,346,287 |  | $                         | 39,184 |  | $                                                               | (7,368 | ) |  | $ | 24 
|Issuance of common
      stock              | 23,053     |  |                           | 92     |  |                                                                 |        |   |  |   |    
|Exercise of stock
      options             | 34,318     |  |                           | 84     |  |                                                                 |        |   |  |   |    
|Net loss                                    |            |  |                           |        |  |                                                                 | (414   | ) |  |   |    
|Tax effect of stock
      options exercised |            |  |                           |        |  |                                                                 | 25     |   |  |   |    
|Translation adjustment                      |            |  |                           |        |  |                                                                 |        |   |  |   | (24
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Balance, December
      31, 2000            | 13,403,658 |  |                           | 39,360 |  |                                                                 | (7,757 | ) |  |   |   
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Issuance of common
      stock              | 131,248    |  |                           | 136    |  |                                                                 |        |   |  |   |    
|Exercise of stock
      options             | 1,500      |  |                           | 4      |  |                                                                 |        |   |  |   |    
|Net loss                                    |            |  |                           |        |  |                                                                 | (185   | ) |  |   |    
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Balance, December
      31, 2001            | 13,536,406 |  |                           | 39,500 |  |                                                                 | (7,942 | ) |  |   |   
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Issuance of common
      stock              | 73,550     |  |                           | 54     |  |                                                                 |        |   |  |   |    
|Net loss                                    |            |  |                           |        |  |                                                                 | (515   | ) |  |   |    
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    
|Balance, December
      31, 2002            | 13,609,956 |  | $                         | 39,554 |  | $                                                               | (8,457 | ) |  | $ |   
|                                            |            |  |                           |        |  |                                                                 |        |   |  |   |    

|The accompanying notes
are an integral part of the consolidated financial statements.

30
|-----------------------------------------------------------------------------------------

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

|                                                           | Year
      ended December 31,
|---------------------------------------------------------- | -----------------------------
|                                                          
|                                                          
|Cash flows
      from operating activities:                |                              
|Net
      loss                                             | $                            
|Adjustments
      to reconcile net loss to net             |                              
|cash provided
      by (used in) operating activities:     |                              
|Depreciation
      and amortization                        |                              
|Deferred
      income taxes                                |                              
|Loss
      on disposal of assets                           |                              
|Gain
      on disposal of subsidiaries                     |                              
|Minority
      interest                                    |                              
|Tax
      effect of stock options exercised                |                              
|Changes
      in assets and liabilities:                   |                              
|Accounts
      receivable                                  |                              
|Inventories                                                |                              
|Prepaid
      expenses and other assets                    |                              
|Accounts
      payable                                     |                              
|Accrued
      liabilities                                  |                              
|                                                           |                              
|Net
      cash provided by (used in)operating activities   |                              
|                                                           |                              
|                                                           |                              
|Cash flows
      from investing activities:                |                              
|Purchases
      of property and equipment                  |                              
|Proceeds
      on disposal of subsidiaries                 |                              
|                                                           |                              
|Net
      cash used in investing activities                |                              
|                                                           |                              
|                                                           |                              
|Cash flows
      from financing activities:                |                              
|Net
      change in book overdrafts                        |                              
|Payments
      on capital lease obligations                |                              
|Restricted
      cash                                      |                              
|Proceeds
      from sale of common stock                   |                              
|                                                           |                              
|Net cash
      provided by (used in) financing activities  |                              
|                                                           |                              
|                                                           |                              
|Net increase
      (decrease) in cash and cash equivalents |                              
|Cash and
      cash equivalents at beginning of period     |                              
|                                                           |                              
|                                                           |                              
|Cash and
      cash equivalents at end of period           | $                            
|                                                           |                              
|                                                           |                              
|Supplemental
      cash flow information:                  |                              
|Cash
      paid for interest                               | $                            
|Cash
      paid (received) for income taxes                | $                            
|                                                           |                              
|Noncash
      investing and financing activity:            |                              
|Capital
      leases to finance purchases of               |                              
|Note
      received on sale of subsidiary                  |                              

|The accompanying notes
are an integral part of the consolidated financial statements.


31
|------------------------------------------------------------------------------------------

|ZONES, INC.NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


1. Description of
Business
|----------------------------------------------------------------------------------

| | Zones,
Inc. (the Company) is a single-source, multi-vendor direct marketing reseller
of name-brand information technology products to the small to medium sized business
market, enterprise and public sector accounts. Zones sells these products through outbound
and inbound account executives, specialty print, e-catalogs and its internet site
(www.zones.com). Zones offers more than 150,000 products from leading manufacturers
including Apple, Hewlett-Packard, IBM, Microsoft and Toshiba.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|2. Summary of
Significant Accounting Policies


Principles of Consolidation
|---------------------------------------------------------------------------

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

Cash and Cash Equivalents

| | Cash
and cash equivalents represent highly liquid investments with original maturities of three
months or less at the date of purchase.
| | ---------------------------------------------------------------------------------------------------------------------------------------

Restricted Cash

| | The
Company purchased a certificate of deposit in the amount of $930,000 in December 2000.
This certificate of deposit was required as security in obtaining a new lease and was
restricted for one full year. In December 2001, the restriction was extended for one more
year. As of December 31, 2002, this certificate of deposit has been redeemed and is no
longer restricted.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Concentration of Credit Risk

| | Cash
balances subject to credit risk consist of cash balances held in one financial institution
in the United States. The Company has not experienced any losses associated with cash
balances and believes that there is minimal risk associated with the cash balances. Except
for amounts due from a significant customer (see Note 13), concentration of credit risk
with respect to trade receivables is limited due to the Companys diverse customer
base. The Company closely monitors extensions of credit, but does not require collateral.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Inventories

| | Inventories
consist primarily of computer hardware and software. Inventories are valued at the lower
of first-in, first-out (FIFO) cost or market. Market valuation was determined to be less
than FIFO at December 31, 2002 and 2001, and allowances were provided for obsolescence of
approximately $1,084,000 and $1,531,000, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company currently buys a significant portion of its products from three suppliers.
Purchases from Ingram Micro, Apple Computer and Tech Data represented 26.0%, 13.8% and
12.1%, respectively, of the Companys total product purchases in 2002. Purchases from
Ingram Micro, Tech Data and Apple Computer represented 30.8%, 14.6% and 10.5%,
respectively, of the Companys total product purchases in 2001. Purchases from Ingram
Micro and Apple Computer represented 39.1% and 10.8%, respectively, of the Companys
total product purchases in 2000. No other vendor supplied more than 10.0% of the
Companys total product purchases in 2002, 2001 or 2000. Although there are a limited
number of manufacturers, the Company believes that other suppliers could provide similar
products if its relationship with any of these suppliers was interrupted.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Property and Equipment

| | Property
and equipment is recorded at cost. Depreciation is computed based on the straight-line
method over the estimated useful lives of the related assets. Useful lives for computer
hardware and software range from 2 to 5 years and other property and equipment from 3 to
10 years. Capital leases are amortized based on the straight-line method over the
estimated useful lives of the related assets or lease life, whichever is shorter,
generally 3 to 10 years. Expenditures for maintenance and repairs are charged to expense
as incurred, while additions, renewals and betterments are capitalized. Gains or losses
from sales or retirements are included in other income and expense. The Company evaluates
the carrying value of long-lived assets based upon current and anticipated undiscounted
cash flows, and recognizes impairment when it is probable that such estimated future cash
flows will be less than the asset carrying value.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32
|--

| | In
January 2002, the Company revised its estimate of the useful lives of certain technology
assets. These changes were made to better reflect the estimated periods during which the
assets will remain in service. The impact was primarily due to the Companys planned
investment in a new enterprise system that was delayed due to the economic environment.
Therefore, the Company reevaluated the useful life of its existing enterprise system, in
conjunction with the estimated life of its investment in web development. The change had
the effect of reducing depreciation expense for the year ending December 31, 2002 by
approximately $990,000.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Income Taxes
|------------

| | Deferred
income taxes are provided based on the estimated future tax effects of temporary
differences between financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates that are expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Stock Compensation
|------------------

| | The
Company accounted for its stock option plans described in Note 10 by measuring
compensation cost using the intrinsic value based method presented by Accounting
Principles Board Option No. 25, Accounting for Stock Issued to Employees, and
related interpretations. No compensation cost is reflected in consolidated net loss, as
all options granted under the plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. Had compensation cost for the Companys
stock option plans been determined based on the fair value at the grant date of the
awards, consistent with the provisions of SFAS 123, the Companys net loss and loss
per share would have increased to the pro forma amounts indicated below (in thousands,
except per share data):
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                               |   | Year
      ended December 31, |        |  
|-------------------------------------------------------------- | - | ----------------------------- | ------ | -
|
|
|Net loss - as reported                                         |   | $                             | (515   | )
|Add:                                                           |   |                               |        |  
|Total
      compensation cost included in net loss, net of tax |   |                               |        |  
|                                                               |   |                               |        |  
|Less:                                                          |   |                               |        |  
|Total compensation cost determined under fair                  |   |                               |        |  
|value based
      method for all awards, net of tax            |   | (571                          | )      |  
|                                                               |   |                               |        |  
|                                                               |   |                               |        |  
|Net loss - pro forma                                           |   | $                             | (1,086 | )
|                                                               |   |                               |        |  
|Basic and
      diluted loss per share - as reported           | $ | (0.04                         | )      |  
|Basic and
      diluted loss per share - pro forma             | $ | (0.07                         | )      |  

| | The
fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for grants in
2002, 2001 and 2000, respectively: expected volatility of 195%, 119% and 106%; risk-free
interest rate of 3.82%, 4.55% and 6.15%; and expected lives of 4 years
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Use of Estimates
|----------------

| | The
preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 provides for an
allowance for sales returns, which is established based on historical experience.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|33
|--

| | The
Company adopted Staff Accounting Bulletin No. 101 Revenue Recognition
(SAB 101) in the fourth quarter of fiscal year 2000 and retroactively applied
it to January 1, 2000, which resulted in a cumulative effect adjustment for a change in
accounting principle of a $59,000 charge to income. The adjustment resulted from the
change in timing of revenue recognition resulting from the implementation of SAB 101, from
the point of shipment to the point of delivery to the customer. The pro forma amounts
shown on the consolidated statements of operations have been adjusted for the effect of
retroactive application of the revenue recognition method, which would have been made had
the new method been in effect, net of related income taxes.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company adopted EITF Issue 00-10 Accounting for Shipping and Handling Fees and
Costs in the fourth quarter of fiscal year 2000. For all future fiscal years, the
Company will classify amounts billed for shipping and handling as revenue. Freight revenue
amounted to $7,894,000, $9,211,000 and $12,361,000 for the years ending December 31, 2002,
2001 and 2000, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Catalog Costs and Revenues
|--------------------------

| | The
Company produces and distributes catalogs at various intervals throughout the year. Costs
to produce and distribute individual catalogs; including paper, printing, postage,
production and design costs, are capitalized and amortized to selling expense during the
period in which the catalogs are generating substantial sales (generally one month).
Capitalized advertising costs of $514,000 and $416,000 were included with prepaid expenses
at December 31, 2002 and 2001, respectively. The Company receives cooperative advertising
expense reimbursements from most vendors for whom the Company places advertisements in its
catalogs. These funds reduce the net advertising expense in the same period in which the
corresponding catalog cost is recognized. Advertising expense, net of cooperative
advertising reimbursements, is included in selling, general and administrative expenses
and totaled $1,355,000, $2,525,000 and $3,113,000 for the years ended December 31, 2002,
2001 and 2000, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Segment Reporting
|-----------------

| | The
Companys reportable segment is a single-source, multi-vendor direct marketing
reseller of name-brand information technology products to small to medium sized
businesses, enterprise, and government and education markets.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Recent Accounting Pronouncements
|--------------------------------

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

| | In
April 2002, the Financial Accounting Standards Board issued SFAS 145 Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145). The provisions of SFAS 145 will be effective for
the Companys fiscal year 2003. The Company does not believe that SFAS 145 will have
a significant impact on its results of operations, financial position or cash flows.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|34
|--

| | In
December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation
 Transition Disclosure  and amendment of FASB Statement No. 123. This
statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock based employee compensation. In addition, this statement
amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for stock
based employee compensation and the effect of the method used on reported results. The
Companys adoption of this statement for the year ended December 31, 2002 did not
have an impact on its results of operations, financial position or cash flows.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

|Reclassifications
|-----------------

| | Certain
reclassifications of prior years balances have been made to conform to the fiscal
year 2002 presentation. Such reclassifications had no effect on shareholders equity
or net income as previously reported.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. Fair Value of
Financial Instruments
|--------------------------------------

| | The
estimated fair value of the Companys financial instruments approximates their
carrying value due to their short-term nature. The estimated fair value of the line of
credit approximates the carrying value as this instrument requires interest payments at a
market rate of interest plus a margin.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. Receivables


Receivables
consist of the following (in thousands):
|---------------------------------------------------------------------

|                                           | December
      31, |       
|------------------------------------------ | ------------------ | ------
|
|
|Trade                                      | $                  | 39,483
|Vendor receivables/Co-op
      advertising |                    | 6,797 
|Other                                      |                    | 921   
|                                           |                    |       
|                                           |                    | 47,201
|Less allowances                            |                    | (1,833
|                                           |                    |       
|                                           | $                  | 45,368
|                                           |                    |       

|35
|--

|5. Property and
Equipment
|-------------------------

| | Property
and equipment consists of the following (in thousands):
| | ----------------------------------------------------------------

|                                                          | December
      31,
|--------------------------------------------------------- | ------------------
|                                                         
|                                                         
|Equipment                                                 | $                 
|Computer
      hardware and software under capital leases |                   
|Computer
      software/Web development                   |                   
|Furniture
      and fixtures and leasehold improvements   |                   
|                                                          |                   
|                                                          |                   
|Less accumulated
      depreciation and amortization      |                   
|                                                          |                   
|Property
      and equipment, net                         | $                 
|                                                          |                   

| | Included
in accumulated depreciation and amortization is accumulated amortization associated with
capital leases at December 31, 2002 and 2001 of $5,713,000 and $5,722,000, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. Line of Credit
|-----------------

| | In
November 2002, the Company replaced its outstanding $35,000,000 credit facility. At
December 31, 2002, the Company has an aggregate $35,000,000 available under secured lines
of credit with two major financial institutions.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has a $30,000,000 credit facility, collateralized by accounts receivable and
inventory, that can be utilized as both a working capital line of credit and a flooring
facility used to purchase inventory from several suppliers under certain terms and
conditions.  This credit facility expires on November 25, 2004.  The working
capital and inventory advances bear interest at a rate of Prime + 0.50%, 4.75% at December
31, 2002.  Inventory advances do not bear interest if paid within terms, usually 30
days from advance date.  No working capital advances were outstanding and accounts
payable included $9,122,000 owed to this financial institution related to inventory
purchases at December 31, 2002.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company uses this credit facility under its cash management system to cover checks
presented for payment in excess of cash balances. As of December 31, 2002 and 2001, the
Company had book overdrafts of $2,345,000 and $404,000, respectively, which are included
with accounts payable.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
second facility is a $5,000,000 inventory flooring facility collateralized by the
inventory purchases financed on the facility.  The facility expires on July 21, 2003
and is subject to annual renewals. The inventory advances bear interest at a rate of
Prime, 4.25% at December 31, 2002, if not paid within terms, usually 30 days from advance
date.  Amounts due under this line are included in accounts payable and were
$3,002,000 at December 31, 2002.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
line of credit agreement contains certain covenants and restrictions requiring, among
other things, a minimum tangible net worth and certain other financial ratios and
restrictions. The Company was in compliance with the restrictive covenants contained in
the agreements at December 31, 2002.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|7. Accrued Liabilities
and Other
|--------------------------------

| | Accrued
liabilities consist of the following (in thousands):
| | ------------------------------------------------------------

| | December
      31, 
| | -------------------
|
| |                    
| | Accrued payroll    
| | Accrued taxes      
| | Accrued advertising
| | Other accruals     
| |                    
| | Total              
| |                    

|36
|--

|8. Income Taxes


The
income tax (benefit) expense consists of the following (in thousands):
|--------------------------------------------------------------------------------------------

|         | Year ended
      December 31, | 
|-------- | ----------------------------- | 
|
|         |                               | 
|Current  |                               | 
|Deferred |                               | 
|         |                               | 
|Total    |                               | 
|         |                               | 

|The
components of deferred taxes were as follows (in thousands):
|----------------------------------------------------------------

|                                      | December
      31,
|------------------------------------- | ------------------
|
|
|Assets:                               |                   
|Allowance
      for doubtful accounts |                   
|Inventory
      allowances            |                   
|Deferred
      rent obligation        |                   
|Accrued
      liabilities and other   |                   
|Net
      operating losses            |                   
|                                      |                   
|                                      |                   
|                                      |                   
|Liabilities:                          |                   
|Property
      and equipment          |                   
|                                      |                   
|                                      |                   
|                                      |                   
|Net deferred
      tax asset          |                   
|                                      |                   

| | The
      net deferred tax asset is recognized in the accompanying balance sheet as
      follows (in thousands):
| | -----------------------------------------------------------------------------------------------------------------

|                                     |  | 
|------------------------------------ |  | 
|Current deferred
      tax asset     |  | 
|                                     |  | 
|Non-current
      deferred tax asset |  | 
|                                     |  | 
|                                     |  | 
|Net deferred
      tax asset         |  | 
|                                     |  | 
|                                     |  | 

| | Although
realization is not assured, management believes it is more likely than not that the
deferred tax asset will be realized through future taxable income. The Companys net
operating losses begin expiring in 2019.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
reconciliation of the effective income tax rate on loss before taxes with the federal
statutory rate follows:
| | ---------------------------------------------------------------------------------------------------------------

|                                            | Year ended
      December 31, | 
|------------------------------------------- | ----------------------------- | 
|
|
|Statutory
      rate                        |                               | 
|State
      income tax                      |                               | 
|Permanent
      differences                 |                               | 
|Changes
      in prior year estimated taxes |                               | 
|                                            |                               | 
|Effective
      tax rate                    |                               | 
|                                            |                               | 

|9.Commitments and
Contingencies


Operating Leases
|--------------------------------------------------

| | The
Company leases its office, returns warehouse space and other equipment under noncancelable
operating leases that expire through 2005. Under the terms of certain leases, the Company
is responsible for its share of taxes, insurance and common area charges. At December 31,
2002, future minimum payments under operating leases were as follows (in thousands):
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|      | 
|----- | 
|2003  | 
|2004  | 
|2005  | 
|      | 
|Total | 
|      | 

|37
|--

| | Rental
expense, which is recorded on a straight line basis, totaled $2,564,000, $2,823,000 and
$2,405,000 for the years ended December 31, 2002, 2001 and 2000, respectively. The
Companys lease on its corporate headquarters expires on July 31, 2003. There can be
no assurance that the Company will be able to renew the lease with similar terms or that
the Company will not have to relocate its corporate headquarters.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Obligations Under Capital Leases
|--------------------------------

| | The
Company leases equipment and software under various long-term capital leases that expire
through 2003. Future lease payments as of December 31, 2002 were as follows (in
thousands):
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                            | 
|------------------------------------------- | 
|Total future
      minimum lease payments   | 
|                                            | 
|Less amount representing interest           | 
|                                            | 
|Present value of net minimum lease payments | 
|Less current portion                        | 
|                                            | 
|Non-current portion                         | 
|                                            | 

|Distribution Center
|-------------------

| | The
Company has contracted with a logistics company to provide and operate its primary
distribution center under a renewable contract that expires August 31, 2003. Under this
contract, the Company pays a flat rate for each purchase order received and customer order
filled. During the years ended December 31, 2002, 2001 and 2000, warehousing expense
totaled $2,089,000, $2,650,000 and $4,529,000, respectively, and was included in selling,
general and administrative expense on the Statement of Operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Legal Proceedings
|-----------------

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

| | On
November 21, 2002, the Washington State Department of Revenue (the Department)
issued a final determination regarding the Companys state tax returns for the years
1996, 1997, 1998 and 1999. The Department upheld the auditors assessment of business
and occupation tax on certain expense reimbursements the Company received from vendors
during the audit period. The Company intends to petition the Department for a
reconsideration of its determination, which will stay payment of the assessment until the
petition for reconsideration is denied. However, as a result of the determination the
Company recorded a charge of $2.1 million during the fourth quarter of 2002. The Company
intends to pursue all of its appeal rights, but there can be no assurance that the Company
will be successful, in whole or in part, in challenging the determination. Additionally,
the Department may also make a similar assessment for 2000, 2001 and 2002. The Company has
reserved against the possibility of a similar assessment for these years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Liquidity
|---------

| | The
Company believes that its existing available cash and cash equivalents, 2003 operating
cash flow and existing credit facilities will be sufficient to satisfy its operating cash
needs for at least the next 12 months at its current level of business. However, if the
Companys working capital or other capital requirements are greater than currently
anticipated, the Company could be required to seek additional funds through sales of
equity, debt or convertible securities or increased credit facilities. There can be no
assurance that additional financing will be available or that, if available, the financing
will be on terms favorable to the Company.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10. Shareholders
Equity


Stock Options
|----------------------------------------

| | In
1993, the Company adopted a Stock Incentive Plan (the Plan) whereby the
Company may issue incentive or nonqualified stock options, restricted shares, stock units
or stock appreciation rights to key employees. As of December 31, 2002, only stock options
have been granted under the Plan. Stock options are granted solely at the discretion of
the Board of Directors and are generally issued at a price equal to the estimated fair
market value of the stock at the date of grant. The term of each option granted is for
such period as determined by the Board of Directors, but not more than ten years from date
of grant. Options may generally be exercised based on a vesting schedule determined by the
Board of Directors, and the Plan provides for acceleration of outstanding options under
certain conditions, including certain changes in control of the Company. Grants are
nontransferable, and shares acquired upon exercise of options may be subject to repurchase
at the option of the Company under certain conditions. The maximum number of shares to be
granted under the Plan was 2,650,000 at December 31, 2002.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|38
|--

| | In
addition to options granted under the Plan, the Company has granted options under a
separate plan to the Board of Directors. Options outstanding to these individuals at
December 31, 2002 were 105,000 shares at option prices of $0.81  $12.00 per share.
The maximum number of shares to be granted under this plan was 150,000 at December 31,
2002.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2003, the Board of Directors adopted the Zones, Inc. 2003 Equity Incentive Plan
(the New Plan), under which the Company may issue, among other things,
incentive or nonqualified stock options, restricted shares, stock units or stock
appreciation. No stock options will be granted under the New Plan until shareholders
approve of it. Under the New Plan, stock options are granted solely at the discretion of
the Board of Directors, and the term of each option granted will be for such period as
determined by the Board of Directors, but not more than ten years from date of grant.
Options will generally be exercisable based on a vesting schedule determined by the Board
of Directors, and the plan provides for acceleration of outstanding options under certain
conditions, including certain changes in control of the Company. Grants are
nontransferable, and shares acquired upon exercise of options may be subject to repurchase
at the option of the Company under certain conditions. The maximum number of shares that
may be granted under the New Plan is 1,000,000.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Information
regarding the stock option plans is as follows:
| | -----------------------------------------------------------

|                                     | Options   | Weighted-Average
      Exercise Price | Options
      Exercisable | 
|------------------------------------ | --------- | ------------------------------------- | ------------------------- | 
|                                     |           |                                       |                           | 
|Outstanding,
      January 1, 2000   | 1,215,993 |                                       | 6.93                      | 
|Granted                              | 871,951   |                                       | 5.00                      | 
|Exercised                            | (34,318   | )                                     | 3.33                      | 
|Cancelled                            | (529,933  | )                                     | 6.17                      | 
|                                     |           |                                       |                           | 
|Outstanding,
      December 31, 2000 | 1,523,693 |                                       | 6.14                      | 
|Granted                              | 892,532   |                                       | 1.87                      | 
|Exercised                            | (1,500    | )                                     | 3.13                      | 
|Cancelled                            | (393,990  | )                                     | 6.22                      | 
|                                     |           |                                       |                           | 
|Outstanding,
      December 31, 2001 | 2,020,735 |                                       | 4.24                      | 
|Granted                              | 492,200   |                                       | 0.88                      | 
|Cancelled                            | (189,524  | )                                     | 3.52                      | 
|                                     |           |                                       |                           | 
|Outstanding,
      December 31, 2002 | 2,323,411 |                                       | 3.58                      | 
|                                     |           |                                       |                           | 

| | For
the years ended December 31, 2002, 2001 and 2000, the weighted-average fair value of
options granted was as follows:
| | ------------------------------------------------------------------------------------------------------------------------

|                                         | Year ended
      December 31,
|---------------------------------------- | -----------------------------
|
|
|Exercise
      price equals market price |                              

|39
|--

| | The
following tables summarize information about fixed-price stock options outstanding at
December 31, 2002:
| | ------------------------------------------------------------------------------------------------------------

|Options Outstanding  
|---------------------
|
|
|                     
|$0.81
      - $  0.92
|$1.05
      - $  3.19
|$3.25
      - $  6.31
|$6.63 -
      $18.25 
|                     
|$0.81 -
      $18.25 
|                     

|Options
      Exercisable
|-------------------------
|
|
|
|
|$                        
|$                        
|$                        
|$                        
|                         
|$                        
|                         

|Employee Stock
Purchase Plan
|----------------------------

| | In
December 1995, the Company adopted an Employee Stock Purchase Plan (the Purchase
Plan) which was effective upon the completion of the public offering. Under the
terms of the Purchase Plan, employees other than officers and employees of the
Companys subsidiaries may purchase a total of up to 700,000 shares of common stock.
The purchase price per share is 85% of the lower of the market value per share of common
stock determined as of the beginning or end of the quarterly purchase period specified in
the Purchase Plan. As of December 31, 2002, the Company had 306,750 available shares.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11. Earnings Per Share
|----------------------

| | The
Company has 45,000,000 common shares authorized, and 13,609,956 issued and outstanding at
December 31, 2002. The Company has also granted options to purchase common shares to the
employees and directors of the Company. The following is a reconciliation of the numerator
and denominator of the basic and diluted earnings per share computations (in thousands,
except per share data).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                      | Year
      ended December 31, |       
|----------------------------------------------------- | ----------------------------- | ------
|                                                     
|                                                     
|Basic and
      diluted earnings per share:           |                              
|Net loss                                              | $                             | (515  
|                                                     
|Weighted-average
      shares used in computing basic |                              
|and diluted
      loss per share                      |                               | 13,587
|                                                     
|Basic and
      diluted loss per share                | $                             | (0.04 
|                                                     
|Pro forma
      amounts assuming the new revenue      |                              
|recognition
      principle is applied retroactively- |                              
|Net
      loss                                        |                               |       
|Basic
      and diluted loss per share                |                               |       

| | The
options may have a dilutive effect on the calculation of earnings per share. All options
to purchase common stock were excluded from the computation of diluted earnings per share
for the years ended December 31, 2002, 2001, and 2000 because the effect of the options on
the calculation would have been antidilutive.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|40
|--

|12. Deferred Income
401(k) Plan
|-------------------------------

| | The
Company offers a deferred income 401(k) plan to substantially all full time employees with
a minimum of six months of service. Participants may make tax-deferred contributions of up
to 15% of annual compensation subject to certain limitations specified by the Internal
Revenue Code. During fiscal year 2000, the Company provided a 25% match for all employee
contributions, up to 6% of the employees annual compensation. During fiscal year
2001, the Company provided a 35% match for all employee contributions, up to 6% of the
employees annual compensation. During fiscal year 2002, the Company provided a 50%
match for all employee contributions, up to 6% of the employees annual compensation.
During fiscal 2002, 2001, and 2000, the Company expensed $276,000, $191,000 and $109,000,
respectively, relating to employer contributions under the plan.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 13. Segment Information

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

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

| | Substantially
all of the Companys net sales for the twelve months ended December 31, 2002 were
made to customers located in the United States. All of the Companys assets at
December 31, 2002 and 2001 were located within the United States. Sales to one of the
Companys customers represented over 10% of total sales for the years ended December
31, 2002, 2001 and 2000, respectively. Net sales to this customer were $60,746,000,
$155,170,000 and $128,263,000 for the years ended December 31, 2002, 2001 and 2000,
respectively. The contract with this customer expires in June 2003.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Divestiture of International Subsidiaries
|-----------------------------------------

| | During
the first quarter of 2000, the Company entered into a definitive agreement to sell its
remaining minority interest in its India subsidiary. The Company recognized a gain on the
transaction of $1,330,000 in fiscal year 2000. The Company has no further commitments to
any subsidiaries.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|41
|--

|14. Selected Quarterly
Financial Date (Unaudited)
|-------------------------------------------------

| | The
following information is for the years ended December 31, 2002 and 2001:
| | ----------------------------------------------------------------------------

|                                                     |  |  |   | First   |   |   | Second  |  |   | Third   |   |   | Fourth  |  
|---------------------------------------------------- |  |  | - | ------- | - | - | ------- |  | - | ------- | - | - | ------- | -
|
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Net sales                                            |  |  | $ | 99,848  |   | $ | 107,771 |  | $ | 102,365 |   | $ | 104,659 |  
|                                                     |  |  |   |        
|Cost of sales                                        |  |  |   | 89,297  |   |   | 96,948  |  |   | 91,595  |   |   | 93,885  |  
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Gross profit                                         |  |  |   | 10,551  |   |   | 10,823  |  |   | 10,770  |   |   | 10,774  |  
|                                                     |  |  |   |        
|SG& A expenses                                       |  |  |   | 10,432  |   |   | 10,214  |  |   | 10,556  |   |   | 10,446  |  
|                                                     |  |  |   |         |   |   |         | 
|                                                     |  |  |   |         |   |   |         |  |   |         |   |   |         |  
|Income from
      operations before state tax        |  |  |   |         |   |   |         |  |   |         |   |   |         |  
|adjustment                                           |  |  |   | 119     |   |   | 609     |  |   | 214     |   |   | 328     |  
|                                                     |  |  |   |        
|State tax
      adjustment                           |  |  |   |         |   |   |         |  |   |         |   |   | 2,145   |  
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Income (loss)
      from operations                  |  |  |   | 119     |   |   | 609     |  |   | 214     |   |   | (1,817  | )
|                                                     |  |  |   |        
|Other (income)
      expense                         |  |  |   | (14     | ) |   | 2       |  |   | 3       |   |   | (49     | )
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Income (loss)
      before income taxes              |  |  |   | 133     |   |   | 607     |  |   | 211     |   |   | (1,768  | )
|                                                     |  |  |   |        
|Provision
      (benefit from) for income taxes      |  |  |   | 52      |   |   | 234     |  |   | 87      |   |   | (675    | )
|                                                     |  |  |   |         |   |   |         | 
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|Net income
      (loss)                              |  |  | $ | 81      |   | $ | 373     |  | $ | 124     |   | $ | (1,093  | )
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Basic and
      diluted earnings (loss) per share(1) |  |  | $ | 0.01    |   | $ | 0.03    |  | $ | 0.01    |   | $ | (0.08   | )
|                                                     |  |  |   |         |   |   |         | 
|
|
|
|                                                     |  |  |   |        
|
|Net sales                                            |  |  | $ | 161,169 |   | $ | 145,163 |  | $ | 120,723 |   | $ | 114,020 |  
|                                                     |  |  |   |        
|Cost of sales                                        |  |  |   | 145,691 |   |   | 130,894 |  |   | 108,551 |   |   | 102,314 |  
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Gross profit                                         |  |  |   | 15,478  |   |   | 14,269  |  |   | 12,172  |   |   | 11,706  |  
|                                                     |  |  |   |        
|SG&A expenses                                        |  |  |   | 15,199  |   |   | 14,089  |  |   | 12,629  |   |   | 12,068  |  
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Income (loss)
      from operations                  |  |  |   | 279     |   |   | 180     |  |   | (457    | ) |   | (362    | )
|                                                     |  |  |   |        
|Other (income)
      expense                         |  |  |   | 110     |   |   | 15      |  |   | (14     | ) |   | (137    | )
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Income (loss)
      before income taxes              |  |  |   | 169     |   |   | 165     |  |   | (443    | ) |   | (225    | )
|                                                     |  |  |   |        
|Provision
      (benefit from) for income taxes      |  |  |   | 65      |   |   | 73      |  |   | (186    | ) |   | (101    | )
|                                                     |  |  |   |         |   |   |         | 
|                                                     |  |  |   |        
|                                                     |  |  |   |        
|Net income
      (loss)                              |  |  | $ | 104     |   | $ | 92      |  | $ | (257    | ) | $ | (124    | )
|                                                     |  |  |   |        
|                                                     |  |  |   |         |   |   |         | 
|Basic and
      diluted earnings (loss) per share(1) |  |  | $ | 0.01    |   | $ | 0.01    |  | $ | (0.02   | ) | $ | (0.01   | )
|                                                     |  |  |   |         |   |   |         | 

|(1) | Net
income (loss) per share is computed independently for each of the       quarters
presented therefore, the sum of the quarterly net income (loss)       per share may not
equal the total computed for the year due to shares       issued each quarter.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|42
|--

|REPORT OF INDEPENDENT
ACCOUNTANTS



To the
Shareholders of Zones, Inc. Renton, Washington



In our opinion, the consolidated
financial statements listed in the index appearing under Item 15(a)(1) present fairly, in
all material respects, the financial position of Zones, Inc. and its subsidiaries at
December 31, 2002 and December 31, 2001, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of America.
In addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2) presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedule are the
responsibility of the Companys management; our responsibility is to express an opinion
on these financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.



PricewaterhouseCoopers LLP Seattle,
Washington February 20, 2003
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|43
|--

|ZONES, INC.
                                          SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
|-----------------------------------------------------------------------------------------------------

|Description                                |  |  | Balance at
      beginning of
      period |       | Charges to
      costs and
      expenses |   | Charges to
      other
      accounts |  | Deductions |  | Balance at
      end of period
|------------------------------------------ |  |  | ------------------------------------------ | ----- | ----------------------------------------- | - | ------------------------------------- |  | ---------- |  | ------------------------------
|                                           |  |  |                                            |       |                                           |   |                                       |  |            |  |                               
|Year Ended
      December 31, 2002         |  |  |                                            |       |                                           |   |                                       |  |            |  |                               
|Allowance
      for doubtful accounts      |  |  | $                                          | 1,845 |                                           | $ | 479                                   |  | $          |  |                               
|Allowance
      for inventory obsolescence |  |  | $                                          | 1,531 |                                           | $ | 333                                   |  | $          |  |                               
|Year Ended
      December 31, 2001         |  | 
|Allowance
      for doubtful accounts      |  |  | $                                          | 2,156 |                                           | $ | 459                                   |  | $          |  |                               
|Allowance
      for inventory obsolescence |  |  | $                                          | 1,691 |                                           | $ | 288                                   |  | $          |  |                               
|Year Ended
      December 31, 2000         |  | 
|Allowance
      for doubtful accounts      |  |  | $                                          | 2,644 |                                           | $ | 554                                   |  | $          |  |                               
|Allowance
      for inventory obsolescence |  |  | $                                          | 1,001 |                                           | $ | 1,228                                 |  | $          |  |                               

|(a) | Uncollectible items written off, less recoveries of items previously written
          off.
|--- | -------------------------------------------------------------------------------------------

|44
|--